Fair Value of Financial Instruments

6 Months Ended

Jun. 30, 2013

Fair Value of Financial Instruments

Fair Value of Financial Instruments

Note 4 — Fair Value of Financial Instruments

Fair Value Accounting Elections

The Company has elected the fair value option for all of its RMBS, and as a result, all changes in the fair value of such securities are reflected in the results of operations.

Financial Instruments carried at Fair Value

The following tables present the Company’s financial instruments, carried at fair value as of June 30, 2013 and December 31, 2012, based upon the valuation hierarchy (dollars in thousands):

	June 30, 2013
	Fair Value
	Level I		Level II		Level III		Total
Assets
Agency RMBS	$	—	$	3,913,602	$	—	$	3,913,602
Agency Interest-Only Strips accounted for as derivatives, included in RMBS	—		99,574		—		99,574
Non-Agency RMBS			173,574		—		173,574
Subtotal			4,186,750		—		4,186,750
Derivative assets	—		118,332		—		118,332
Non-Agency linked transactions			1,647		—		1,647
Total	$	—	$	4,306,729	$	—	$	4,306,729
Liabilities
Derivative liabilities	$	—	$	1,484	$	—	$	1,484
Total	$	—	$	1,484	$	—	$	1,484

	December 31, 2012
	Fair value
	Level I		Level II		Level III		Total
Assets
Agency RMBS	$	—	$	5,118,121	$	—	$	5,118,121
Agency Interest-Only Strips accounted for as derivatives, included in RMBS	—		75,387		—		75,387
Non-Agency RMBS			19,073				19,073
Subtotal			5,212,581				5,212,581
Derivative assets	—		24,344		—		24,344
Total	$	—	$	5,236,925	$	—	$	5,236,925
Liabilities
Derivative liabilities	$	—	$	4,771	$	—	$	4,771
Total	$	—	$	4,771	$	—	$	4,771

The Company primarily utilizes an independent third party pricing service as the primary source for valuing the Company’s assets.  All valuations received from independent pricing services are non-binding.

The Company generally receives one independent pricing service price for each investment in its portfolio.  The Manager has established a process to review and validate the pricing received from the independent pricing service and has a process for challenging prices received from the independent pricing service when necessary.  The Company utilizes its Manager’s policies in this regard.  The Company’s and the Manager’s review of the independent third party pricing data may consist of a review of the daily change in the prices provided by the independent pricing vendor which exceed established tolerances or comparisons to executed transaction prices.  The Manager’s pricing group, which functions independently from its portfolio management personnel, corroborates the price differences or changes in price by comparing the vendor price to alternate sources including other independent pricing services or broker quotations.  If the price change or difference cannot be corroborated, the Manager’s pricing group consults with the portfolio management team for market color in reviewing such pricing data as warranted.  To the extent that the Manager has information, typically in the form of broker quotations that would indicate that a price received from the independent pricing service is outside of a tolerance range, the Manager generally challenges the independent pricing service price.

To ensure proper fair value hierarchy, the Company and the Manager review the methodology used by the third party pricing service to understand whether observable or unobservable inputs are being utilized in the vendor’s evaluation methodology.  Generally, this review is conducted annually, however ad-hoc reviews of the evaluation methodology and the assumptive data does occur.  The review of the assumptive data received from the vendor includes comparing key inputs such as weighted average life, spread, prepayment assumptions to data obtained from other third-party data providers or internal valuation models.  In addition, as part of the Company’s regular review of pricing, the Manager’s pricing group may have informal discussions with the independent pricing vendor regarding their evaluation methodology or the inputs into their method.

Other Fair Value Disclosures

Cash and cash equivalents as well as Due from counterparties and Due to counterparties on the Company’s Balance Sheets are reflected at cost which approximates fair value.

The fair value of the repurchase agreements is a Level II fair value measurement, based on an expected present value technique. This method discounts future estimated cash flows using rates the Company determined best estimate current market interest rates that would be offered for loans with similar characteristics and credit quality. The use of different market assumptions or estimation methodologies can have a material effect on the fair value amounts. At June 30, 2013, the Company’s borrowings under repurchase agreements had a fair value of approximately $4.0 billion and a carrying value of approximately $4.0 billion.