Mortgage-Backed Securities

The Company classifies its Non-Agency RMBS as senior, senior IO, subordinated, or subordinated IO. The Company also invests in residential and commercial Agency MBS. Senior interests in Non-Agency RMBS are considered to be entitled to the first principal repayments in their pro-rata ownership interests at the acquisition date.



			September 30, 2016
			(dollars in thousands)
	Principal or Notional Value		Total Premium		Total Discount			Amortized Cost		Fair Value		Gross Unrealized Gains		Gross Unrealized Losses			Net Unrealized Gain/(Loss)
Non-Agency RMBS
Senior	$	3,308,463	$	237	$	(1,457,711	)	$	1,850,990	$	2,585,386	$	734,998	$	(602	)	$	734,396
Senior, interest-only	5,733,457		303,539		—			303,539		291,526		28,598		(40,611		)	$	(12,013	)
Subordinated	668,946		16,416		(218,239		)	467,125		546,825		79,895		(195		)	$	79,700
Subordinated, interest-only	269,868		14,183		—			14,183		13,498		41		(726		)	$	(685	)
Agency MBS
Residential	2,672,093		138,970		—			2,811,063		2,861,468		51,842		(1,437		)	$	50,405
Commercial	1,273,235		36,001		(2,717		)	1,306,518		1,343,994		39,496		(2,020		)	$	37,476
Interest-only	3,474,731		163,542		—			163,542		157,088		2,274		(8,728		)	$	(6,454	)
Total	$	17,400,793	$	672,888	$	(1,678,667	)	$	6,916,960	$	7,799,785	$	937,144	$	(54,319	)	$	882,825



			December 31, 2015
			(dollars in thousands)
	Principal or Notional Value		Total Premium		Total Discount			Amortized Cost		Fair Value		Gross Unrealized Gains		Gross Unrealized Losses			Net Unrealized Gain/(Loss)
Non-Agency RMBS
Senior	$	3,651,869	$	309	$	(1,553,317	)	$	2,098,860	$	2,826,121	$	736,040	$	(8,779	)	$	727,261
Senior, interest-only	5,426,029		268,515		—			268,515		234,171		18,113		(52,457		)	(34,344		)
Subordinated	762,466		23,635		(258,128		)	527,975		604,295		83,896		(7,577		)	76,319
Subordinated, interest-only	284,931		15,226		—			15,226		11,254		62		(4,035		)	(3,973		)
Agency MBS
Residential	5,045,418		255,837		—			5,301,255		5,267,848		18,593		(52,001		)	(33,408		)
Commercial	952,091		24,815		(3,170		)	973,736		973,787		8,052		(8,001		)	51
Interest-only	6,722,472		280,073		—			280,073		273,189		2,756		(9,640		)	(6,884		)
Total	$	22,845,276	$	868,410	$	(1,814,615	)	$	9,465,640	$	10,190,665	$	867,512	$	(142,490	)	$	725,022

The table below presents changes in accretable yield, or the excess of the security’s cash flows expected to be collected over the Company’s investment, solely as it pertains to the Company’s Non-Agency RMBS portfolio accounted for according to the provisions of ASC 310-30.



	For the Quarter Ended						For the Nine Months Ended
	September 30, 2016			September 30, 2015			September 30, 2016			September 30, 2015
	(dollars in thousands)						(dollars in thousands)
Balance at beginning of period	$	1,714,592		$	1,698,323		$	1,742,744		$	1,534,497
Purchases	18,316			133,227			60,915			241,852
Yield income earned	(69,850		)	(72,557		)	(141,256		)	(213,267		)
Reclassification (to) from non-accretable difference	(29,490		)	19,205			(2,031		)	238,012
Sales and deconsolidation	(12,907		)	(418		)	(39,711		)	(23,314		)
Balance at end of period	$	1,620,661		$	1,777,780		$	1,620,661		$	1,777,780

The table below presents the outstanding principal balance and related amortized cost at September 30, 2016 and December 31, 2015 as it pertains to the Company’s Non-Agency RMBS portfolio accounted for according to the provisions of ASC 310-30.



	For the Quarter Ended		For the Year Ended
	September 30, 2016		December 31, 2015
	(dollars in thousands)
Outstanding principal balance:
Beginning of period	$	3,343,812	$	3,325,335
End of period	$	3,228,137	$	3,550,698
Amortized cost:
Beginning of period	$	1,806,344	$	1,741,780
End of period	$	1,743,116	$	1,958,726

The following tables present the gross unrealized losses and estimated fair value of the Company’s RMBS by length of time that such securities have been in a continuous unrealized loss position at September 30, 2016 and December 31, 2015. All securities in an unrealized loss position have been evaluated by the Company for OTTI as discussed in Note 2(d).



						September 30, 2016
						(dollars in thousands)
	Unrealized Loss Position for Less than 12 Months						Unrealized Loss Position for 12 Months or More						Total
	Estimated Fair Value		Unrealized Losses			Number of Securities	Estimated Fair Value		Unrealized Losses			Number of Securities	Estimated Fair Value		Unrealized Losses			Number of Securities
Non-Agency RMBS
Senior	$	2,340	$	(111	)	1	$	60,325	$	(491	)	2	$	62,665	$	(602	)	3
Senior, interest-only	36,729		(3,867		)	33	90,295		(36,744		)	85	127,024		(40,611		)	118
Subordinated	—		—			—	1,726		(195		)	1	1,726		(195		)	1
Subordinated, interest-only	—		—			—	12,433		(726		)	3	12,433		(726		)	3
Agency MBS
Residential	235,048		(1,146		)	10	57,562		(291		)	1	292,610		(1,437		)	11
Commercial	140,402		(1,320		)	32	55,068		(700		)	43	195,470		(2,020		)	75
Interest-only	68,822		(1,587		)	19	36,645		(7,141		)	11	105,467		(8,728		)	30
Total	$	483,341	$	(8,031	)	95	$	314,054	$	(46,288	)	146	$	797,395	$	(54,319	)	241



						December 31, 2015
						(dollars in thousands)
	Unrealized Loss Position for Less than 12 Months						Unrealized Loss Position for 12 Months or More						Total
	Estimated Fair Value		Unrealized Losses			Number of Securities	Estimated Fair Value		Unrealized Losses			Number of Securities	Estimated Fair Value		Unrealized Losses			Number of Securities
Non-Agency RMBS
Senior	$	294,520	$	(8,779	)	20	$	—	$	—		—	$	294,520	$	(8,779	)	20
Senior, interest-only	81,919		(18,715		)	83	64,058		(33,742		)	47	145,977		(52,457		)	130
Subordinated	138,257		(7,577		)	22	—		—			—	138,257		(7,577		)	22
Subordinated, interest-only	6,455		(1,039		)	1	3,635		(2,996		)	2	10,090		(4,035		)	3
Agency MBS
Residential	4,468,717		(44,687		)	116	290,926		(7,314		)	4	4,759,643		(52,001		)	120
Commercial	393,058		(7,969		)	140	4,986		(32		)	4	398,044		(8,001		)	144
Interest-only	94,969		(3,457		)	24	39,707		(6,183		)	7	134,676		(9,640		)	31
Total	$	5,477,895	$	(92,223	)	406	$	403,312	$	(50,267	)	64	$	5,881,207	$	(142,490	)	470

At September 30, 2016, the Company did not intend to sell any of its RMBS that were in an unrealized loss position, and it was not more likely than not that the Company would be required to sell these RMBS before recovery of their amortized cost basis, which may be at their maturity. With respect to RMBS held by consolidated VIEs, the ability of any entity to cause the sale by the VIE prior to the maturity of these RMBS is either expressly prohibited, not probable, or is limited to specified events of default, none of which have occurred as of September 30, 2016.

Gross unrealized losses on the Company’s Agency residential and commercial MBS were $3 million and $60 million as of September 30, 2016 and December 31, 2015, respectively. Given the inherent credit quality of Agency MBS, the Company does not consider any of the current impairments on its Agency MBS to be credit related. In evaluating whether it is more likely than not that it will be required to sell any impaired security before its anticipated recovery, which may be at their maturity, the Company considers the significance of each investment, the amount of impairment, the projected future performance of such impaired securities, as well as the Company’s current and anticipated leverage capacity and liquidity position. Based on these analyses, the Company determined that at September 30, 2016 and December 31, 2015, unrealized losses on its Agency MBS were temporary.

Gross unrealized losses on the Company’s Non-Agency RMBS (excluding Non-Agency IO MBS strips which are reported at fair value with changes in fair value recorded in earnings) were $1 million and $16 million at September 30, 2016 and December 31, 2015, respectively. Based upon the most recent evaluation, the Company does not consider these unrealized losses to be indicative of OTTI and does not believe that these unrealized losses are credit related, but rather are due to other factors. The Company has reviewed its Non-Agency RMBS that are in an unrealized loss position to identify those securities with losses that are other-than-temporary based on an assessment of changes in cash flows expected to be collected for such RMBS, which considers recent bond performance and expected future performance of the underlying collateral.

A summary of the OTTI included in earnings for the quarters and nine months ended September 30, 2016 and 2015 is presented below.



	For the Quarter Ended						For the Nine Months Ended
	September 30, 2016			September 30, 2015			September 30, 2016			September 30, 2015
	(dollars in thousands)
Total other-than-temporary impairment losses	$	(993	)	$	(3,129	)	$	(8,555	)	$	(6,389	)
Portion of loss recognized in other comprehensive income (loss)	(10,581		)	(14,703		)	(34,652		)	(46,359		)
Net other-than-temporary credit impairment losses	$	(11,574	)	$	(17,832	)	$	(43,207	)	$	(52,748	)

The following table presents a roll forward of the credit loss component of OTTI on the Company’s Non-Agency RMBS for which a portion of loss was previously recognized in OCI. The table delineates between those securities that are recognizing OTTI for the first time as opposed to those that have previously recognized OTTI.



	For the Quarter Ended						For the Nine Months Ended
	September 30, 2016			September 30, 2015			September 30, 2016			September 30, 2015
	(dollars in thousands)
Cumulative credit loss beginning balance	$	546,187		$	528,548		$	529,112		$	507,548
Additions:
Other-than-temporary impairments not previously recognized	6,184			7,863			17,137			34,133
Reductions for securities sold or deconsolidated during the period	(2,630		)	(3,963		)	(6,890		)	(5,697		)
Increases related to other-than-temporary impairments on securities with previously recognized other-than-temporary impairments	5,390			9,969			26,069			18,615
Reductions for increases in cash flows expected to be collected over the remaining life of the securities	(1,494		)	—			(11,791		)	(12,182		)
Cumulative credit impairment loss ending balance	$	553,637		$	542,417		$	553,637		$	542,417

Cash flows generated to determine net other-than-temporary credit impairment losses recognized in earnings are estimated using significant unobservable inputs. The significant inputs used to measure the component of OTTI recognized in earnings for the Company’s Non-Agency RMBS are summarized as follows:



	For the Nine Months Ended
	September 30, 2016	September 30, 2015
Loss Severity
Weighted Average	59%	56%
Range	25% - 85%	17% - 92%
60+ days delinquent
Weighted Average	21%	20%
Range	0% - 40%	2% - 41%
Credit Enhancement ⁽¹⁾
Weighted Average	29%	8%
Range	0% - 100%	0% - 27%
3 Month CPR
Weighted Average	5%	8%
Range	0% - 19%	3% - 27%
12 Month CPR
Weighted Average	4%	8%
Range	0% - 21%	3% - 20%

(1) Calculated as the combined credit enhancement to the Re-REMIC and underlying from each of their respective capital structures.

The following tables present a summary of unrealized gains and losses at September 30, 2016 and December 31, 2015. IO MBS included in the tables below represent the right to receive a specified portion of the contractual interest cash flows of the underlying principal balance of specific securities. At September 30, 2016, IO MBS had a net unrealized loss of $19 million and had an amortized cost of $481 million. At December 31, 2015, IO MBS had a net unrealized loss of $45 million and had an amortized cost of $564 million. The fair value of IOs at September 30, 2016 and December 31, 2015 was $462 million, and $519 million, respectively. All changes in fair value of IOs are reflected in Net Income in the Consolidated Statements of Operations and Comprehensive Income.



			September 30, 2016
			(dollars in thousands)
	Gross Unrealized Gain Included in Accumulated Other Comprehensive Income		Gross Unrealized Gain Included in Accumulated Deficit		Total Gross Unrealized Gain		Gross Unrealized Loss Included in Accumulated Other Comprehensive Income			Gross Unrealized Loss Included in Accumulated Deficit			Total Gross Unrealized Loss
Non-Agency RMBS
Senior	$	734,998	$	—	$	734,998	$	(602	)	$	—		$	(602	)
Senior, interest-only	—		28,598		28,598		—			(40,611		)	(40,611		)
Subordinated	75,446		4,449		79,895		—			(195		)	(195		)
Subordinated, interest-only	—		41		41		—			(726		)	(726		)
Agency MBS
Residential	51,842		—		51,842		(1,437		)	—			(1,437		)
Commercial	39,496		—		39,496		(2,020		)	—			(2,020		)
Interest-only	—		2,274		2,274		—			(8,728		)	(8,728		)
Total	$	901,782	$	35,362	$	937,144	$	(4,059	)	$	(50,260	)	$	(54,319	)



			December 31, 2015
			(dollars in thousands)
	Gross Unrealized Gain Included in Accumulated Other Comprehensive Income		Gross Unrealized Gain Included in Accumulated Deficit		Total Gross Unrealized Gain		Gross Unrealized Loss Included in Accumulated Other Comprehensive Income			Gross Unrealized Loss Included in Accumulated Deficit			Total Gross Unrealized Loss
Non-Agency RMBS
Senior	$	736,040	$	—	$	736,040	$	(8,779	)	$	—		$	(8,779	)
Senior, interest-only	—		18,113		18,113		—			(52,457		)	(52,457		)
Subordinated	81,588		2,309		83,896		(1,971		)	(5,606		)	(7,577		)
Subordinated, interest-only	—		62		62		—			(4,035		)	(4,035		)
Agency MBS
Residential	18,593		—		18,593		(52,001		)	—			(52,001		)
Commercial	8,052		—		8,052		(8,001		)	—			(8,001		)
Interest-only	—		2,756		2,756		—			(9,640		)	(9,640		)
Total	$	844,273	$	23,240	$	867,512	$	(70,752	)	$	(71,738	)	$	(142,490	)

Changes in prepayments, actual cash flows, and cash flows expected to be collected, among other items, are affected by the collateral characteristics of each asset class. The Company chooses assets for the portfolio after carefully evaluating each investment’s risk profile.

The following tables provide a summary of the Company’s RMBS portfolio at September 30, 2016 and December 31, 2015.



	September 30, 2016
	Principal or Notional Value at Period-End (dollars in thousands)		Weighted Average Amortized Cost Basis		Weighted Average Fair Value		Weighted Average Coupon		Weighted Average Yield at Period-End ⁽¹⁾
Non-Agency RMBS
Senior	$	3,308,463	$	55.95	$	78.14	4.0	%	15.2	%
Senior, interest-only	5,733,457		5.29		5.08		2.0	%	11.1	%
Subordinated	668,946		69.83		81.74		3.4	%	10.2	%
Subordinated, interest-only	269,868		5.26		5.00		1.1	%	11.4	%
Agency MBS
Residential pass-through	2,672,093		105.20		107.09		3.9	%	2.7	%
Commercial pass-through	1,273,235		102.61		105.56		3.6	%	2.9	%
Interest-only	3,474,731		4.71		4.52		0.9	%	3.7	%

(1) Bond Equivalent Yield at period end.



	December 31, 2015
	Principal or Notional Value at Period-End (dollars in thousands)		Weighted Average Amortized Cost Basis		Weighted Average Fair Value		Weighted Average Coupon		Weighted Average Yield at Period-End ⁽¹⁾
Non-Agency RMBS
Senior	$	3,651,869	$	57.47	$	77.39	3.8	%	13.7	%
Senior, interest-only	5,426,029		4.95		4.32		1.7	%	12.9	%
Subordinated	762,466		69.25		79.26		3.2	%	8.8	%
Subordinated, interest-only	284,931		5.34		3.95		1.2	%	10.9	%
Agency MBS
Residential pass-through	5,045,418		105.07		104.41		3.7	%	2.8	%
Commercial pass-through	952,091		102.27		102.28		3.4	%	2.9	%
Interest-only	6,722,472		4.17		4.06		0.8	%	3.4	%

(1) Bond Equivalent Yield at period end.

The following table presents the weighted average credit rating, based on the lowest rating available, of the Company’s Non-Agency RMBS portfolio at September 30, 2016 and December 31, 2015.



	September 30, 2016		December 31, 2015
AAA	0.4	%	0.5	%
AA	0.3	%	0.4	%
A	0.7	%	0.8	%
BBB	0.3	%	0.4	%
BB	3.1	%	5.2	%
B	4.0	%	3.0	%
Below B or not rated	91.2	%	89.7	%
Total	100.0	%	100.0	%

Actual maturities of MBS are generally shorter than the stated contractual maturities. Actual maturities of the Company’s MBS are affected by the contractual lives of the underlying mortgages, periodic payments of principal and prepayments of principal. The following tables provide a summary of the fair value and amortized cost of the Company’s MBS at September 30, 2016 and December 31, 2015 according to their estimated weighted-average life classifications. The weighted-average lives of the MBS in the tables below are based on lifetime expected prepayment rates using an industry prepayment model for the Agency MBS portfolio and the Company’s prepayment assumptions for the Non-Agency RMBS. The prepayment model considers current yield, forward yield, steepness of the interest rate curve, current mortgage rates, mortgage rates of the outstanding loan, loan age, margin, and volatility.



	September 30, 2016
	(dollars in thousands)
	Weighted Average Life
	Less than one year		Greater than one year and less than five years		Greater than five years and less than ten years		Greater than ten years		Total
Fair value
Non-Agency RMBS
Senior	$	22,267	$	477,875	$	1,393,164	$	692,080	$	2,585,386
Senior interest-only	606		42,519		136,316		112,085		291,526
Subordinated	1,473		76,840		215,695		252,817		546,825
Subordinated interest-only	—		—		13,498		—		13,498
Agency MBS
Residential	—		2,451,083		410,385		—		2,861,468
Commercial	11,384		16,473		50,624		1,265,513		1,343,994
Interest-only	—		85,447		66,082		5,559		157,088
Total fair value	$	35,730	$	3,150,237	$	2,285,764	$	2,328,054	$	7,799,785
Amortized cost
Non-Agency RMBS
Senior	$	18,823	$	374,436	$	987,116	$	470,615	$	1,850,990
Senior interest-only	2,197		54,411		138,744		108,187		303,539
Subordinated	1,455		58,783		172,437		234,450		467,125
Subordinated interest-only	—		—		14,183		—		14,183
Agency MBS
Residential	—		2,420,774		390,289		—		2,811,063
Commercial	11,198		16,567		50,270		1,228,483		1,306,518
Interest-only	—		86,304		71,898		5,340		163,542
Total amortized cost	$	33,673	$	3,011,275	$	1,824,937	$	2,047,075	$	6,916,960



	December 31, 2015
	(dollars in thousands)
	Weighted Average Life
	Less than one year		Greater than one year and less than five years		Greater than five years and less than ten years		Greater than ten years		Total
Fair value
Non-Agency RMBS
Senior	$	—	$	374,462	$	1,629,564	$	822,095	$	2,826,121
Senior interest-only	1,458		41,862		123,538		67,313		234,171
Subordinated	2,229		108,728		212,003		281,335		604,295
Subordinated interest-only	—		—		11,254		—		11,254
Agency MBS
Residential	—		150,357		5,117,491		—		5,267,848
Commercial	—		—		29,176		944,611		973,787
Interest-only	—		106,069		161,413		5,707		273,189
Total fair value	$	3,687	$	781,478	$	7,284,439	$	2,121,061	$	10,190,665
Amortized cost
Non-Agency RMBS
Senior	$	—	$	281,255	$	1,235,528	$	582,077	$	2,098,860
Senior interest-only	2,440		59,823		135,359		70,893		268,515
Subordinated	2,208		86,728		168,403		270,636		527,975
Subordinated interest-only	—		—		15,226		—		15,226
Agency MBS
Residential	—		149,111		5,152,144		—		5,301,255
Commercial	—		—		29,156		944,580		973,736
Interest-only	—		106,708		167,646		5,719		280,073
Total amortized cost	$	4,648	$	683,625	$	6,903,462	$	1,873,905	$	9,465,640

The Non-Agency RMBS portfolio is subject to credit risk. The Company seeks to mitigate credit risk through its asset selection process. The Non-Agency RMBS portfolio is primarily collateralized by what the Company classifies as Alt-A first lien mortgages. An Alt-A mortgage is a type of U.S. mortgage that, for various reasons, is considered riskier than A-paper, or prime, and less risky than subprime, the riskiest category. Alt-A interest rates, which are determined by credit risk, therefore tend to be between those of prime and subprime home loans. Typically, Alt-A mortgages are characterized by borrowers with less than full documentation, lower credit scores and higher loan-to-value ratios. The Company defines Alt-A mortgage securities as Non-Agency RMBS where (i) the underlying collateral has weighted average FICO scores between 680 and 720 or (ii) the FICO scores are greater than 720 and RMBS have 30% or less of the underlying collateral composed of full documentation loans. At September 30, 2016 and December 31, 2015, 69% and 64% of the Non-Agency RMBS collateral was classified as Alt-A, respectively. At September 30, 2016 and December 31, 2015, 15% and 17% of the Non-Agency RMBS collateral was classified as prime, respectively. The remaining Non-Agency RMBS collateral is classified as subprime.

The Non-Agency RMBS in the Portfolio have the following collateral characteristics at September 30, 2016 and December 31, 2015.



	September 30, 2016				December 31, 2015
Weighted average maturity (years)		21.3				22.0
Weighted average amortized loan to value⁽¹⁾		66.8		%		67.9		%
Weighted average FICO⁽²⁾		675				671
Weighted average loan balance (in thousands)		$	327			$	330
Weighted average percentage owner occupied		83.1		%		82.7		%
Weighted average percentage single family residence		65.7		%		65.9		%
Weighted average current credit enhancement		2.3		%		2.4		%
Weighted average geographic concentration of top four states	CA	32.6		%	CA	30.4		%
	FL	8.0		%	FL	8.0		%
	NY	7.9		%	NY	8.0		%
	NJ	2.6		%	NJ	2.5		%

(1) Value represents appraised value of the collateral at the time of loan origination.

(2) FICO as determined at the time of loan origination.

The table below presents the origination year of the underlying loans related to the Company’s portfolio of Non-Agency RMBS at September 30, 2016 and December 31, 2015.



Origination Year	September 30, 2016		December 31, 2015
1999	0.1	%	0.1	%
2000	0.5	%	0.6	%
2001	1.5	%	1.6	%
2002	0.5	%	0.5	%
2003	1.1	%	2.2	%
2004	4.2	%	3.7	%
2005	20.2	%	21.7	%
2006	38.1	%	32.9	%
2007	31.1	%	34.2	%
2008	1.8	%	1.9	%
2009	0.4	%	—	%
2013	0.4	%	0.5	%
2014	0.1	%	0.1	%
Total	100.0	%	100.0	%

Gross realized gains and losses are recorded in “Net realized gains (losses) on sales of investments” on the Company’s Consolidated Statements of Operations and Comprehensive Income. The proceeds and gross realized gains and gross realized losses from sales of investments for the quarters and nine months ended September 30, 2016 and 2015 are as follows:



	For the Quarter Ended						For the Nine Months Ended
	September 30, 2016			September 30, 2015			September 30, 2016			September 30, 2015
	(dollars in thousands)
Proceeds from sales	$	58,036		$	196,192		$	2,697,239		$	3,433,527
Gross realized gains	3,622			4,612			16,798			46,007
Gross realized losses	(543		)	(1,073		)	(9,763		)	(3,218		)
Net realized gain (loss)	$	3,079		$	3,539		$	7,035		$	42,789

Included in the gross realized gains for the quarter and nine months ended September 30, 2016 in the table above are exchanges of securities with a fair value of $30 million and $47 million, where the Company exchanged its investment in a re-remic security for the underlying collateral supporting the group related to the exchanged asset. These exchanges were treated as non-cash sales and purchases and resulted in a realized gain of $2 million and $1 million reflected in earnings for the quarter and nine months ended September 30, 2016. For the quarter and nine months ended September 30, 2015, the fair value of these exchanges of securities was $11 million and $26 million, respectively and resulted in a realized gain of $3 million and $7 million, respectively.