Fair Value of Financial Instruments

The following tables present the Company's financial instruments carried at fair value as of December 31, 2017 and December 31, 2016, based upon the valuation hierarchy (dollars in thousands):



	December 31, 2017
	Fair Value
Assets	Level I		Level II		Level III		Total
Agency RMBS:
20-Year mortgage	$	—	$	53,783	$	—	$	53,783
30-Year mortgage	—		241,642		—		241,642
40-Year mortgage	—		376,752		—		376,752
Agency RMBS Interest-Only Strips	—		15,437		—		15,437
Agency RMBS Interest-Only Strips accounted for as derivatives, included in MBS	—		10,419		—		10,419
Agency CMBS	—		2,137,583		17,217		2,154,800
Agency CMBS Interest-Only Strips	—		10		—		10
Agency CMBS Interest-Only Strips accounted for as derivatives, included in MBS	—		5,757		—		5,757
Subtotal Agency MBS	—		2,841,383		17,217		2,858,600

Non-Agency RMBS	—		90,819		13		90,832
Non-Agency RMBS Interest-Only Strips	—		—		8,722		8,722
Non-Agency CMBS	—		278,604		—		278,604
Subtotal Non-Agency MBS	—		369,423		8,735		378,158

Other securities	—		112,826		9,239		122,065
Total mortgage-backed securities and other securities	—		3,323,632		35,191		3,358,823

Residential Whole-Loans	—		—		237,423		237,423
Residential Bridge Loans	—		—		64,526		64,526
Securitized commercial loan	—		—		24,876		24,876
Derivative assets	728		—		—		728
Total Assets	$	728	$	3,323,632	$	362,016	$	3,686,376

Liabilities
Derivative liabilities	$	50	$	4,296	$	—	$	4,346
Securitized debt	—		—		10,945		10,945
Total Liabilities	$	50	$	4,296	$	10,945	$	15,291



	December 31, 2016
	Fair Value
Assets	Level I		Level II		Level III		Total
Agency RMBS:
20-Year mortgage	$	—	$	498,470	$	—	$	498,470
30-Year mortgage	—		935,207		—		935,207
Agency RMBS Interest-Only Strips	—		19,790		—		19,790
Agency RMBS Interest-Only Strips accounted for as derivatives, included in MBS	—		16,503		—		16,503
Agency CMBS	—		290,605		73,059		363,664
Agency CMBS Interest-Only Strips	—		231		—		231
Agency CMBS Interest-Only Strips accounted for as derivatives, included in MBS	—		7,729		—		7,729
Subtotal Agency MBS	—		1,768,535		73,059		1,841,594

Non-Agency RMBS	—		240,422		619		241,041
Non-Agency RMBS Interest-Only Strips	—		—		64,116		64,116
Non-Agency RMBS Interest-Only Strips accounted for as derivatives, included in MBS	—		—		3,085		3,085
Non-Agency CMBS	—		351,163		7,756		358,919
Subtotal Non-Agency MBS	—		591,585		75,576		667,161

Other securities	—		36,406		31,356		67,762
Total mortgage-backed securities and other securities	—		2,396,526		179,991		2,576,517

Residential Whole-Loans	—		—		192,136		192,136
Securitized commercial loan	—		—		24,225		24,225
Derivative assets	71		20,500		—		20,571
Total Assets	$	71	$	2,417,026	$	396,352	$	2,813,449

Liabilities
Derivative liabilities	$	2,487	$	177,998	$	1,673	$	182,158
Securitized debt	—		—		10,659		10,659
Total Liabilities	$	2,487	$	177,998	$	12,332	$	192,817

When available, the Company uses quoted market prices to determine the fair value of an asset or liability. If quoted market prices are not available, the Company will use independent pricing services and if the independent pricing service cannot price a particular asset or liability, the Company will obtain third party broker quotes. The Manager's pricing group, which functions independently from its portfolio management personnel, reviews the third party broker quotes by comparing the broker quotes for reasonableness to alternate sources when available. If independent pricing service, or third party broker quotes are not available, the Company determines the fair value of the securities using valuation techniques that use, when possible, current market-based or independently-sourced market parameters, such as interest rates and when applicable, estimates of prepayments and credit losses.

Mortgage-backed securities and other securities

In determining the proper fair value hierarchy or level the Company considers the amount of available observable market data for each security. Agency RMBS, given the amount of available observable market data, are classified in Level II. For Non-Agency RMBS, CMBS and other securities, to determine whether a security should be a Level II, the securities are grouped by security type and the Manager reviews the internal trade history, for the quarter, for each security type. If there is sufficient trade data above a predetermined threshold of a security type, the Manager determines it has sufficient observable market data and the security will be categorized as a Level II.

Values for the Company's securities are based upon prices obtained from independent third party pricing services. The valuation methodology of the third party pricing services incorporates a commonly used market pricing method. Depending on the type of asset and the underlying collateral, the primary inputs to the model include yields for TBAs, Agency RMBS, the U.S. Treasury market and floating rate indices such as LIBOR, the Constant Maturity Treasury rate and the prime rate as a benchmark yield. In addition, the model may incorporate the current weighted average maturity and additional pool level information such as prepayment speeds, default frequencies and default severities, if applicable. When the third party pricing service cannot adequately price a particular security, the Company utilizes a broker's quote which is reviewed for reasonableness by the Manager's pricing group.

Residential Whole-Loans and Residential Bridge Loans

Values for the Company's Residential Whole-Loans and Bridge Loans are based upon prices obtained from an independent third party pricing service that specializes in loans, utilizing a trade based valuation model. Their valuation methodology incorporates commonly used market pricing methods, including loan to value ("LTV"), debt to income, maturity, interest rates, collateral location, and unpaid principal balance, prepayment penalties, FICO scores, lien position and times late. Due to the inherent uncertainty of such valuation, the fair values established for residential loans held by the Company may differ from the fair values that would have been established if a readily available market existed for these loans. Accordingly, the Company's loans are classified as Level III.

Securitized commercial loan and securitized debt

Values for the Company's securitized commercial loan and securitized debt are based on which fair value is more observable of the fair value of the securitized commercial loan or the securitized debt. Since there is an extremely limited market for the securitized commercial loan, the Company determined the fair value of the securitized debt was more observable. The fair value of the securitized debt was based upon a third party broker quote, which is validated by the Manager's pricing group. Due to the inherent uncertainty of such valuation the Company classifies its securitized commercial loan and securitized debt as Level III.

Derivatives

Values for the Company's derivatives are based upon prices from third party pricing services, whose pricing is subject to review by the Manager's pricing committee. In valuing its over-the-counter interest rate derivatives, such as swaps and swaptions, and its currency derivatives, such as swaps and forwards and credit derivatives such as total return swaps, the Company considers the creditworthiness of both the Company and its counterparties, along with collateral provisions contained in each derivative agreement, from the perspective of both the Company and its counterparties. No credit valuation adjustment was made in determining the fair value of interest rate and/or currency derivatives for the years ended December 31, 2017 and December 31, 2016.

The Company performs quarterly reviews of the independent third party pricing data. These reviews 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, utilizing the Manager's pricing group. The Manager's pricing group, which functions independently from its portfolio management personnel, reviews 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.

The following tables present additional information about the Company's financial instruments which are measured at fair value on a recurring basis for which the Company has utilized Level III inputs to determine fair value:



	Year ended December 31, 2017
$ in thousands	Agency MBS			Non-Agency MBS			Other Securities			Residential Whole-Loans			Residential Bridge Loans			Securitized Commercial Loan			Securitized Debt			Derivative Liability
Beginning balance	$	73,059		$	75,576		$	31,356		$	192,136		$	—		$	24,225		$	10,659		$	1,673
Transfers into Level III from Level II	—			—			9,470			—			—			—			—			—
Transfers from Level III into Level II	(73,714		)	(7,433		)	(33,080		)	—			—			—			—			—
Purchases	17,217			8,937			—			86,921			63,969			—			—			—
Sales and settlements	—			(60,132		)	—			—			—			—			—			552
Principal repayments	—			(378		)	(425		)	(41,312		)	—			(154		)	(68		)	—
Total net gains/losses included in net income
Realized gains/(losses), net	—			2,623			—			—			—			—			—			(552		)
Other than temporary impairment	—			—			(1,823		)	—			—			—			—			—
Unrealized gains/(losses), net on assets⁽¹⁾	635			(9,415		)	1,522			724			571			805			—			—
Unrealized (gains)/losses, net on liabilities⁽²⁾	—			—			—			—			—			—			354			(1,673		)
Premium and discount amortization, net	20			(1,043		)	2,219			(1,046		)	(14		)	—			—			—
Ending balance	$	17,217		$	8,735		$	9,239		$	237,423		$	64,526		$	24,876		$	10,945		$	—

(1)

For Agency MBS, Non-Agency MBS, other securities, Residential Whole-Loans, Residential Bridge Loans and Securitized commercial loan classified as Level III at December 31, 2017, the Company recorded gross unrealized gains of approximately $0, $0, $43 thousand, $1.8 million, $655 thousand and $805 thousand and gross unrealized losses of approximately $0, $16 thousand, $0, $400 thousand, $84 thousand and $0, respectively. These gains and losses are included in "Unrealized gain (loss), net" in the Consolidated Statements of Operations.


(2)	For securitized debt and derivative liability classified as Level III at December 31, 2017, the Company recorded gross unrealized gains of $0 and $0 and gross unrealized losses of $354 thousand and $0, respectively. These gains and losses are included in "Unrealized gain (loss), net" in the Consolidated Statements of Operations.



	Year ended December 31, 2016
$ in thousands	Agency MBS			Non-Agency MBS			Other Securities			Residential Whole-Loans			Securitized commercial loan			Securitized debt			Derivative liability
Beginning balance	$	24,690		$	369,650		$	71,996		$	218,538		$	25,000		$	11,000		$	—
Transfers into Level III from Level II	—			—			—			—			—			—			—
Transfers from Level III into Level II	(16,730		)	(198,078		)	(6,079		)	—			—			—			—
Purchases	72,642			94			—			28,226			—			—			—
Sales and settlements	(6,776		)	(49,560		)	(32,226		)	—			—			—			(38		)
Principal repayments	(141		)	(15,508		)	(2,049		)	(52,573		)	—			—			—
Total net gains / (losses) included in net income
Realized gains/(losses), net	(56		)	(9,345		)	45			—			—			—			38
Other than temporary impairment	—			(3,436		)	(3,301		)	—			—			—			—
Unrealized gains/(losses), net on assets⁽¹⁾	(570		)	(4,889		)	(86		)	(42		)	(775		)	—			—
Unrealized (gains)/losses, net on liabilities⁽²⁾	—			—			—			—			—			(341		)	1,673
Premium and discount amortization, net	—			(13,352		)	3,056			(2,013		)	—			—			—
Ending balance	$	73,059		$	75,576		$	31,356		$	192,136		$	24,225		$	10,659		$	1,673

(1)

For Agency MBS, Non-Agency MBS, other securities, Residential Whole-Loans and Securitized commercial loan classified as Level III at December 31, 2016, the Company recorded gross unrealized gains of approximately $417 thousand, $492 thousand, $420 thousand, $1.2 million and $0 and gross unrealized losses of approximately $0, $6.8 million, $823 thousand, $663 thousand and $775 thousand, respectively. These gains and losses are included in "Unrealized gain (loss), net" in the Consolidated Statements of Operations.


(2)	For securitized debt and derivative liability classified as Level III at December 31, 2016, the Company recorded gross unrealized gains of 341 thousand and $0 and gross unrealized losses of $0 and $1.7 million, respectively. These gains and losses are included in "Unrealized gain (loss), net" in the Consolidated Statements of Operations.

Transfers between hierarchy levels during operations for the years ended December 31, 2017 and December 31, 2016 were based on the availability of sufficient observable inputs to meet Level II versus Level III criteria. The leveling of these assets was based on information received from a third party pricing service which, along with the back-testing of historical sales transactions performed by the Manager provided the sufficient observable data for the movement from Level III to Level II. The Company did not have transfers between Level I and Level II for the years ended December 31, 2017 and December 31, 2016.

Other Fair Value Disclosures

Certain Residential Bridge Loans, repurchase agreement borrowings and convertible senior unsecured notes are not carried at fair value in the consolidated financial statements. The following table presents the carrying value and estimated fair value of the Company’s financial instruments that are not carried at fair value, as of December 31, 2017, in the consolidated financial statements (dollars in thousands):



	Carrying Value		Estimated Fair Value
Assets
Residential Bridge Loans	$	42,147	$	42,881
Total	$	42,147	$	42,881

Liabilities
Borrowings under repurchase agreements	$	3,251,686	$	3,257,956
Convertible senior unsecured notes	108,743		114,819
Total	$	3,360,429	$	3,372,775

"Due from counterparties" and "Due to counterparties" in the Company’s Consolidated Balance Sheets are reflected at cost which approximates fair value.

Residential Bridge Loans

The fair values of the Residential Bridge Loans are based upon prices obtained from an independent third party pricing service that specializes in whole loans, utilizing a trade based valuation model. Their valuation methodology incorporates commonly used market pricing methods, including loan to value (“LTV”), debt to income, maturity, interest rates, collateral location, and unpaid principal balance, prepayment penalties, FICO scores, lien position and times late. Due to the inherent uncertainty of such valuation, the fair values established for residential bridge loans held by the Company may differ from the fair values that would have been established if a readily available market existed for these loans. Accordingly, the Company's loans are classified as Level III.

Borrowings under repurchase agreements

The fair values of the borrowings under repurchase agreements are based on a net present value technique. This method discounts future estimated cash flows using rates the Company determined best estimates 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 could have a material effect on the fair value amounts. This fair value measurement is based on observable inputs, and as such, are classified as Level II.

Convertible senior unsecured notes

The fair value of the convertible senior unsecured notes are based on quoted market prices. Accordingly, the Company's convertible senior unsecured notes are classified as Level I.