Fair Value

3 Months Ended

Mar. 31, 2021

Fair Value

Fair Value

19. Fair Value

GAAP establishes a hierarchy of valuation techniques based on the observability of inputs utilized in measuring financial assets and liabilities at fair value. GAAP establishes market-based or observable inputs as the preferred source of values, followed by valuation models using management assumptions in the absence of market inputs. The three levels of the hierarchy are described below:

Level I—Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.

Level II—Inputs (other than quoted prices included in Level I) are either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date and for the duration of the instrument’s anticipated life.

Level III—Inputs reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model.

Valuation Process

We have valuation control processes in place to validate the fair value of the Company’s financial assets and liabilities measured at fair value including those derived from pricing models. These control processes are designed to assure that the values used for financial reporting are based on observable inputs wherever possible. In the event that observable inputs are not available, the control processes are designed to assure that the valuation approach utilized is appropriate and consistently applied and the assumptions are reasonable.

Pricing Verification—We use recently executed transactions, other observable market data such as exchange data, broker/dealer quotes, third party pricing vendors and aggregation services for validating the fair values generated using valuation models. Pricing data provided by approved external sources is evaluated using a number of approaches; for example, by corroborating the external sources’ prices to executed trades, analyzing the methodology and assumptions used by the external source to generate a price and/or by evaluating how active the third party pricing source (or originating sources used by the third party pricing source) is in the market.

Unobservable Inputs—Where inputs are not observable, we review the appropriateness of the proposed valuation methodology to ensure it is consistent with how a market participant would arrive at the unobservable input. The valuation methodologies utilized in the absence of observable inputs may include extrapolation techniques and the use of comparable observable inputs.

Any changes to the valuation methodology will be reviewed by our management to ensure the changes are appropriate. The methods used may produce a fair value calculation that is not indicative of net realizable value or reflective of future fair values. Furthermore, while we anticipate that our valuation methods are appropriate and consistent with other market participants, the use of different methodologies, or assumptions, to determine the fair value could result in a different estimate of fair value at the reporting date.

Fair Value on a Recurring Basis

We determine the fair value of our financial assets and liabilities measured at fair value on a recurring basis as follows:

Loans held-for-sale, commercial

We measure the fair value of our commercial mortgage loans held-for-sale using a discounted cash flow analysis unless observable market data (i.e., securitized pricing) is available. A discounted cash flow analysis requires management to make estimates regarding future interest rates and credit spreads. The most significant of these inputs relates to credit spreads and is unobservable. Thus, we have determined that the fair values of mortgage loans valued using a discounted cash flow analysis should be classified in Level III of the fair value hierarchy, while mortgage loans valued using securitized pricing should be classified in Level II of the fair value hierarchy. Mortgage loans classified in Level III are transferred to Level II if securitized pricing becomes available.

Loans held-for-sale and loans held-for-investment, residential

We measure the fair value of our residential loans held-for-sale and held-for-investment based on the net present value of expected future cash flows using a combination of observable and unobservable inputs. Observable market participant assumptions include pricing related to trades of residential loans with similar characteristics. Unobservable inputs include the expectation of future cash flows, which involves judgments about the underlying collateral, the creditworthiness of the borrower, estimated prepayment speeds, estimated future credit losses, forward interest rates, investor yield requirements and certain other factors. At each measurement date, we consider both the observable and unobservable valuation inputs in the determination of fair value. However, given the significance of the unobservable inputs, these loans have been classified within Level III.

RMBS

RMBS are valued utilizing observable and unobservable market inputs. The observable market inputs include recent transactions, broker quotes and vendor prices (“market data”). However, given the implied price dispersion amongst the market data, the fair value determination for RMBS has also utilized significant unobservable inputs in discounted cash flow models including prepayments, default and severity estimates based on the recent performance of the collateral, the underlying collateral characteristics, industry trends, as well as expectations of macroeconomic events (e.g., housing price curves, interest rate curves, etc.). At each measurement date, we consider both the observable and unobservable valuation inputs in the determination of fair value. However, given the significance of the unobservable inputs these securities have been classified within Level III.

CMBS

CMBS are valued utilizing both observable and unobservable market inputs. These factors include projected future cash flows, ratings, subordination levels, vintage, remaining lives, credit issues, recent trades of similar securities and the spreads used in the prior valuation. We obtain current market spread information where available and use this information in evaluating and validating the market price of all CMBS. Depending upon the significance of the fair value inputs used in determining these fair values, these securities are classified in either Level II or Level III of the fair value hierarchy. CMBS may shift between Level II and Level III of the fair value hierarchy if the significant fair value inputs used to price the CMBS become or cease to be observable.

Equity security

The equity security is publicly registered and traded in the U.S. and its market price is listed on the London Stock Exchange. The security has been classified within Level I.

Domestic servicing rights

The fair value of this intangible is determined using discounted cash flow modeling techniques which require management to make estimates regarding future net servicing cash flows, including forecasted loan defeasance, control migration, delinquency and anticipated maturity defaults which are calculated assuming a debt yield at which default occurs. Since the most significant of these inputs are unobservable, we have determined that the fair values of this intangible in its entirety should be classified in Level III of the fair value hierarchy.

Derivatives

The valuation of derivative contracts are determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market based inputs, including interest rate curves, spot and market forward points and implied volatilities. The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash payments and the discounted expected variable cash receipts. The variable cash receipts are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves.

We incorporate credit valuation adjustments to appropriately reflect both our own non-performance risk and the respective counterparty’s non-performance risk in the fair value measurements. In adjusting the fair value of our derivative contracts for the effect of non-performance risk, we have considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees.

The valuation of over the counter derivatives are determined using discounted cash flows based on Overnight Index Swap (“OIS”) rates. Fully collateralized trades are discounted using OIS with no additional economic adjustments to arrive at fair value. Uncollateralized or partially collateralized trades are also discounted at OIS, but include appropriate economic adjustments for funding costs (i.e., a LIBOR OIS basis adjustment to approximate uncollateralized cost of funds) and credit risk. For credit index instruments, fair value is determined based on changes in the relevant indices from the date of initiation of the instrument to the reporting date, as these changes determine the amount of any future cash settlement between us and the counterparty. These indices are considered Level II inputs as they are directly observable.

Although we have determined that the majority of the inputs used to value our derivatives fall within Level II of the fair value hierarchy, the credit valuation adjustments associated with our derivatives utilize Level III inputs, such as estimates of current credit spreads to evaluate the likelihood of default by us and our counterparties. However, as of March 31, 2021 and December 31, 2020, we have assessed the significance of the impact of the credit valuation adjustments on the overall valuation of our derivative positions and have determined that the credit valuation adjustments are not significant to the overall valuation of our derivatives. As a result, we have determined that our derivative valuations in their entirety are classified in Level II of the fair value hierarchy.

Liabilities of consolidated VIEs

Our consolidated VIE liabilities generally represent bonds that are not owned by us. The majority of these are either traded in the marketplace or can be analogized to similar securities that are traded in the marketplace. For these liabilities, pricing is considered to be Level II, where the valuation is based upon quoted prices for similar instruments traded in active markets. We generally utilize third party pricing service providers for valuing these liabilities. In order to determine whether to utilize the valuations provided by third parties, we conduct an ongoing evaluation of their valuation methodologies and processes, as well as a review of the individual valuations themselves. In evaluating third party pricing for reasonableness, we consider a variety of factors, including market transaction information for the particular bond, market transaction information for bonds within the same trust, market transaction information for similar bonds, the bond’s ratings and the bond’s subordination levels.

For the minority portion of our consolidated VIE liabilities which consist of unrated or non-investment grade bonds that are not owned by us, pricing may be either Level II or Level III. If independent third party pricing similar to that noted above is available, we consider the valuation to be Level II. If such third party pricing is not available, the valuation is generated from model-based techniques that use significant unobservable assumptions, and we consider the valuation to be Level III. For VIE liabilities classified as Level III, valuation is determined based on discounted expected future cash flows which take into consideration expected duration and yields based on market transaction information, ratings, subordination levels, vintage and current market spread. VIE liabilities may shift between Level II and Level III of the fair value hierarchy if the significant fair value inputs used to price the VIE liabilities become or cease to be observable.

Assets of consolidated VIEs

The securitization VIEs in which we invest are “static”; that is, no reinvestment is permitted, and there is no active management of the underlying assets. In determining the fair value of the assets of the VIE, we maximize the use of observable inputs over unobservable inputs. The individual assets of a VIE are inherently incapable of precise measurement given their illiquid nature and the limitations on available information related to these assets. Because our methodology for valuing these assets does not value the individual assets of a VIE, but rather uses the value of the VIE liabilities as an indicator of the fair value of VIE assets as a whole, we have determined that our valuations of VIE assets in their entirety should be classified in Level III of the fair value hierarchy.

Fair Value Only Disclosed

We determine the fair value of our financial instruments and assets where fair value is disclosed as follows:

Loans held-for-investment and loans held-for-sale

We estimate the fair values of our loans not carried at fair value on a recurring basis by discounting their expected cash flows at a rate we estimate would be demanded by the market participants that are most likely to buy our loans. The expected cash flows used are generally the same as those used to calculate our level yield income in the financial statements. Since these inputs are unobservable, we have determined that the fair value of these loans in their entirety would be classified in Level III of the fair value hierarchy.

HTM debt securities

We estimate the fair value of our mandatorily redeemable preferred equity interests in commercial real estate companies and infrastructure bonds using the same methodology described for our loans held-for-investment. We estimate the fair value of our HTM CMBS using the same methodology described for our CMBS carried at fair value on a recurring basis.

Secured financing agreements and CLO

The fair value of the secured financing agreements and CLO are determined by discounting the contractual cash flows at the interest rate we estimate such arrangements would bear if executed in the current market. We have determined that our valuation of these instruments should be classified in Level III of the fair value hierarchy.

Unsecured senior notes

The fair value of our unsecured senior notes is determined based on the last available bid price for the respective notes in the current market. As these prices represent observable market data, we have determined that the fair value of these instruments would be classified in Level II of the fair value hierarchy.

Fair Value Disclosures

The following tables present our financial assets and liabilities carried at fair value on a recurring basis in the condensed consolidated balance sheets by their level in the fair value hierarchy as of March 31, 2021 and December 31, 2020 (amounts in thousands):

	March 31, 2021
	Total		Level I		Level II		Level III
Financial Assets:
Loans under fair value option	$	763,773	$	—	$	—	$	763,773
RMBS		160,301		—		—		160,301
CMBS		19,256		—		—		19,256
Equity security		10,655		10,655		—		—
Domestic servicing rights		12,406		—		—		12,406
Derivative assets		38,029		—		38,029		—
VIE assets		62,367,110		—		—		62,367,110
Total	$	63,371,530	$	10,655	$	38,029	$	63,322,846
Financial Liabilities:
Derivative liabilities	$	34,805	$	—	$	34,805	$	—
VIE liabilities		60,896,709		—		58,669,281		2,227,428
Total	$	60,931,514	$	—	$	58,704,086	$	2,227,428

	December 31, 2020
	Total		Level I		Level II		Level III
Financial Assets:
Loans under fair value option	$	1,022,979	$	—	$	—	$	1,022,979
RMBS		167,349		—		—		167,349
CMBS		19,457		—		—		19,457
Equity security		11,247		11,247		—		—
Domestic servicing rights		13,202		—		—		13,202
Derivative assets		40,555		—		40,555		—
VIE assets		64,238,328		—		—		64,238,328
Total	$	65,513,117	$	11,247	$	40,555	$	65,461,315
Financial Liabilities:
Derivative liabilities	$	41,324	$	—	$	41,324	$	—
VIE liabilities		62,776,371		—		60,756,495		2,019,876
Total	$	62,817,695	$	—	$	60,797,819	$	2,019,876

The changes in financial assets and liabilities classified as Level III are as follows for the three months ended March 31, 2021 and 2020 (amounts in thousands):

							Domestic
	Loans at						Servicing				VIE
Three Months Ended March 31, 2021	Fair Value		RMBS		CMBS		Rights		VIE Assets		Liabilities		Total
January 1, 2021 balance	$	1,022,979	$	167,349	$	19,457	$	13,202	$	64,238,328	$	(2,019,876)	$	63,441,439
Total realized and unrealized gains (losses):
Included in earnings:
Change in fair value / gain on sale		(9,478)		—		372		(796)		(2,264,591)		65,681		(2,208,812)
Net accretion		—		2,606		—		—		—		—		2,606
Included in OCI		—		(2,403)		—		—		—		—		(2,403)
Purchases / Originations		375,270		—		—		—		—		—		375,270
Sales		(571,927)		—		—		—		—		—		(571,927)
Issuances		—		—		—		—		—		(11,604)		(11,604)
Cash repayments / receipts		(53,071)		(7,251)		(573)		—		—		(1,137)		(62,032)
Transfers into Level III		—		—		—		—		—		(409,267)		(409,267)
Transfers out of Level III		—		—		—		—		—		148,775		148,775
Consolidation of VIEs		—		—		—		—		393,373		—		393,373
March 31, 2021 balance	$	763,773	$	160,301	$	19,256	$	12,406	$	62,367,110	$	(2,227,428)	$	61,095,418
Amount of unrealized gains (losses) attributable to assets still held at March 31, 2021:
Included in earnings	$	(7,708)	$	2,606	$	372	$	(796)	$	(2,264,591)	$	65,681	$	(2,204,436)
Included in OCI	$	—	$	(2,403)	$	—	$	—	$	—	$	—	$	(2,403)

							Domestic
	Loans at						Servicing				VIE
Three Months Ended March 31, 2020	Fair Value		RMBS		CMBS		Rights		VIE Assets		Liabilities		Total
January 1, 2020 balance	$	1,436,194	$	189,576	$	25,008	$	16,917	$	62,187,175	$	(2,537,392)	$	61,317,478
Total realized and unrealized gains (losses):
Included in earnings:
Change in fair value / gain on sale		(16,134)		—		5,738		(393)		(3,506,792)		146,282		(3,371,299)
Net accretion		—		2,661		—		—		—		—		2,661
Included in OCI		—		(15,048)		—		—		—		—		(15,048)
Purchases / Originations		746,880		—		—		—		—		—		746,880
Sales		(751,746)		—		(7,940)		—		—		—		(759,686)
Issuances		—		—		—		—		—		(24,376)		(24,376)
Cash repayments / receipts		(67,397)		(6,549)		(371)		—		—		(8,916)		(83,233)
Transfers into Level III		—		—		—		—		—		(101,265)		(101,265)
Transfers out of Level III		—		—		—		—		—		1,090,325		1,090,325
Consolidation of VIEs		—		—		—		—		2,477,422		(71,095)		2,406,327
March 31, 2020 balance	$	1,347,797	$	170,640	$	22,435	$	16,524	$	61,157,805	$	(1,506,437)	$	61,208,764
Amount of unrealized (losses) gains attributable to assets still held at March 31, 2020:
Included in earnings	$	(39,070)	$	2,661	$	(647)	$	(393)	$	(3,506,792)	$	146,282	$	(3,397,959)
Included in OCI	$	—	$	(15,048)	$	—	$	—	$	—	$	—	$	(15,048)

Amounts were transferred from Level II to Level III due to a decrease in the observable relevant market activity and amounts were transferred from Level III to Level II due to an increase in the observable relevant market activity.

The following table presents the fair values of our financial instruments not carried at fair value on the condensed consolidated balance sheets (amounts in thousands):

	March 31, 2021				December 31, 2020
	Carrying		Fair		Carrying		Fair
	Value		Value		Value		Value
Financial assets not carried at fair value:
Loans held-for-investment and loans held-for-sale	$	12,402,351	$	12,460,388	$	11,116,929	$	11,107,316
HTM debt securities		488,075		466,687		538,605		515,253
Financial liabilities not carried at fair value:
Secured financing agreements and CLO	$	11,827,110	$	11,900,381	$	11,076,744	$	11,108,364
Unsecured senior notes		1,735,658		1,803,224		1,732,520		1,786,667

The following is quantitative information about significant unobservable inputs in our Level III measurements for those assets and liabilities measured at fair value on a recurring basis (dollars in thousands):

	Carrying Value at		Valuation	Unobservable	Range (Weighted Average) as of (1)
	March 31, 2021		Technique	Input	March 31, 2021	December 31, 2020
Loans under fair value option	$	763,773	Discounted cash flow, market pricing	Coupon (d)	3.4% - 9.5% (5.5%)	3.3% - 9.7% (5.9%)
				Remaining contractual term (d)	7.0 - 39.0 years (24.7 years)	7.3 - 39.3 years (26.3 years)
				FICO score (a)	519 - 823 (732)	519 - 823 (727)
				LTV (b)	15% - 94% (66%)	5% - 94% (68%)
				Purchase price (d)	85.6% - 104.8% (101.7%)	84.4% - 104.8% (99.8%)
RMBS		160,301	Discounted cash flow	Constant prepayment rate (a)	3.5% - 17.3% (7.4%)	3.6% - 19.4% (7.6%)
				Constant default rate (b)	0.7% - 5.0% (2.2%)	0.7% - 5.4% (2.4%)
				Loss severity (b)	0% - 84% (17%) (f)	0% - 85% (20%) (f)
				Delinquency rate (c)	9% - 32% (18%)	10% - 32% (19%)
				Servicer advances (a)	23% - 84% (53%)	23% - 82% (54%)
				Annual coupon deterioration (b)	0.0% - 1.2% (0.1%)	0.0% - 0.9% (0.1%)
				Putback amount per projected total collateral loss (e)	0% -17% (0.8%)	0% -17% (0.8%)
CMBS		19,256	Discounted cash flow	Yield (b)	0% - 298.5% (5.9%)	0% - 536.6% (7.1%)
				Duration (c)	0 - 7.6 years (6.0 years)	0 - 7.6 years (5.3 years)
Domestic servicing rights		12,406	Discounted cash flow	Debt yield (a)	7.25% (7.25%)	7.50% (7.50%)
				Discount rate (b)	15% (15%)	15% (15%)
VIE assets		62,367,110	Discounted cash flow	Yield (b)	0% - 752.4% (16.9%)	0% - 312.2% (14.3%)
				Duration (c)	0 - 20.6 years (3.8 years)	0 - 16.3 years (3.8 years)
VIE liabilities		(2,227,428)	Discounted cash flow	Yield (b)	0% - 752.4% (17.3%)	0% - 312.2% (14.4%)
				Duration (c)	0 - 11.0 years (3.7 years)	0 - 10.8 years (3.8 years)

(1) Unobservable inputs were weighted by the relative carrying value of the instruments as of March 31, 2021 and December 31, 2020.

Information about Uncertainty of Fair Value Measurements

(a) Significant increase (decrease) in the unobservable input in isolation would result in a significantly higher (lower) fair value measurement.

(b) Significant increase (decrease) in the unobservable input in isolation would result in a significantly lower (higher) fair value measurement.

(c) Significant increase (decrease) in the unobservable input in isolation would result in either a significantly lower or higher (higher or lower) fair value measurement depending on the structural features of the security in question.

(d) This unobservable input is not subject to variability as of the respective reporting dates.

(e) Any delay in the putback recovery date leads to a decrease in fair value for the majority of securities in our RMBS portfolio.

(f) 14% and 23% of the portfolio falls within a range of 45% - 80% as of March 31, 2021 and December 31, 2020, respectively.