4. Fair Value

Fair Value Measurement

Financial assets and liabilities recorded at fair value on a recurring basis are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

The following table sets forth the Company's financial instruments that were accounted for at fair value on a recurring basis at December 31, 2014, by level within the fair value hierarchy:

	Assets and Liabilities at Fair Value
	Level 1		Level 2		Level 3		Total
Assets
Mortgage loans held for investment	$	—	$	—	$	415,959,838	$	415,959,838
Mortgage loans held for sale		—		97,690,960		—		97,690,960
Non-Agency RMBS		—		—		148,585,733		148,585,733
Other Investment Securities		—		—		2,040,532		2,040,532
MSRs		—		—		33,378,978		33,378,978
Derivative assets		—		—		2,485,100		2,485,100
Total	$	—	$	97,690,960	$	602,450,181	$	700,141,141
Liabilities
Derivative liabilities	$	—	$	2,585,184	$	—	$	2,585,184
Total	$	—	$	2,585,184	$	—	$	2,585,184

The following table sets forth the Company's financial instruments that were accounted for at fair value on a recurring basis at December 31, 2013, by level within the fair value hierarchy:

	Assets and Liabilities at Fair Value
	Level 1		Level 2		Level 3		Total
Assets
Mortgage loans held for investment	$	—	$	—	$	331,785,542	$	331,785,542
Non-Agency RMBS		—		—		226,155,221		226,155,221
Derivative assets		—		284,454		—		284,454
Total	$	—	$	284,454	$	557,940,763	$	558,225,217
Liabilities
Derivative liabilities		—		1,471,607	$	—	$	1,471,607
Total	$	—	$	1,471,607	$	—	$	1,471,607

The following table presents 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 3 inputs to determine fair value:

	Year Ended December 31, 2014									Year Ended December 31, 2013
	Mortgage Loans held for investment			RMBS			Other Investment Securities			Mortgage Loans held for investment			RMBS
Beginning balance	$	331,785,542		$	226,155,221		$	—		$	—		$	100,911,651
Total net transfers into/out of Level 3		—			—			—			—			—
Acquisitions		85,579,169			47,034,327			12,926,953			334,162,044			234,397,506
Proceeds from sales		—			(102,635,229	)		(11,067,378	)		—			(68,190,593	)
Net accretion of discounts		7,497,341			5,528,538			180,438			3,059,231			3,727,702
Proceeds from principal repayments		(31,759,326	)		(28,197,740	)		—			(13,871,059	)		(39,338,730	)
Conversion of mortgage loans to REO		(1,796,028	)		—			—			—			—
Total losses (realized/unrealized) included in earnings		(8,250,003	)		(6,694,487	)		(226,224	)		(6,344,877	)		(9,138,009	)
Total gains (realized/unrealized) included in earnings		32,903,143			7,395,103			226,743			14,780,203			3,785,694
Ending balance	$	415,959,838		$	148,585,733		$	2,040,532		$	331,785,542		$	226,155,221

	Year Ended December 31, 2014
	LPCs		IRLCs
Beginning balance	$	—	$	—
Acquisition of GMFS		—		2,702,954
Change in unrealized gain or loss		4,037		(221,891	)
Ending balance	$	4,037	$	2,481,063

	Year Ended December 31, 2014								Year Ended December 31, 2013
	Mortgage Loans held for investment		RMBS			Other Investment Securities			Mortgage Loans held for investment		RMBS
The amount of total gains or (losses) for the period included in earnings attributable to the change in unrealized gains or losses relating to assets or liabilities still held at the reporting date	$	22,957,500	$	(1,039,499	)	$	(226,224	)	$	7,136,482	$	(2,822,969	)

The following table presents additional information about the Company's MSRs which are also financial instruments that are measured at fair value on a recurring basis for which the Company has utilized Level 3 inputs to determine fair value:

	Year Ended December 31, 2014

Balance at beginning of year	$	—
Acquisition of MSRs in connection with purchase of GMFS		32,300,337
Additions due to loans sold, servicing retained		2,763,014
Fair value adjustment:⁽¹⁾
Changes in assumptions⁽²⁾		(1,420,925	)
Other changes⁽³⁾		(263,448	)
Balance at December 31, 2014	$	33,378,978

The amount of total gains or (losses) for the period included in earnings attributable to the change in unrealized gains or losses relating to assets or liabilities still held at the reporting date	$	(1,420,925	)

(1)	Included in change in fair value of MSRs on the consolidated statements of operations.
(2)	Primarily reflects changes in prepayment assumptions due to changes in interest rates and discount rates.
(3)

Represents decrease in value due to passage of time, including the impact from both regularly scheduled loan principal payments and loans that were paid down or paid off during the period.

There were no financial assets or liabilities that were accounted for at fair value on a nonrecurring basis at December 31, 2014 and December 31, 2013. During the year ended December 31, 2014, real estate owned was transferred out of Level 3. There were no other transfers into or out of Level 1, Level 2 or Level 3 during the years ended December 31, 2014 or December 31, 2013.

The following tables present quantitative information about the Company's mortgage loans held for investment, real estate securities and Other Investment Securities which are measured at fair value on a recurring basis for which the Company has utilized Level 3 inputs to determine fair value:

	Fair Value at December 31, 2014		Valuation Technique(s)	Unobservable Input	Min/Max					Weighted Average
Mortgage loans held for investment	$	415,959,838	Discounted cash flow model	Constant voluntary prepayment		1.4	%	27.1	%		3.9	%
				Constant default rate		0.0	%	4.0	%		2.9	%
				Loss severity		0.0	%	40.5	%		23.8	%
				Delinquency		0.1	%	13.6	%		10.6	%

	Fair Value at December 31, 2014		Valuation Technique(s)	Unobservable Input	Min/ Max					Weighted Average
Non-Agency RMBS⁽¹⁾
Alternative – A	$	61,296,540	Broker quotes/ comparable trades	Constant voluntary prepayment		1.6	%	24.8	%		13.6	%
				Constant default rate		0.1	%	8.4	%		3.1	%
				Loss severity		0.0	%	81.1	%		20.5	%
				Delinquency		1.3	%	25.9	%		10.1	%
Pay option adjustable rate	$	45,541,325	Broker quotes/ comparable trades	Constant voluntary prepayment		1.7	%	20.1	%		8.9	%
				Constant default rate		1.6	%	19.4	%		4.3	%
				Loss severity		0.0	%	66.2	%		38.0	%
				Delinquency		6.8	%	29.1	%		15.2	%
Prime	$	39,065,076	Broker quotes/ comparable trades	Constant voluntary prepayment		2.6	%	17.3	%		9.2	%
				Constant default rate		0.2	%	9.2	%		4.1	%
				Loss severity		0.0	%	78.3	%		28.2	%
				Delinquency		5.0	%	24.8	%		13.0	%
Subprime	$	2,682,792	Broker quotes/ comparable trades	Constant voluntary prepayment		2.4	%	7.4	%		4.7	%
				Constant default rate		6.0	%	8.0	%		7.7	%
				Loss severity		65.0	%	85.0	%		72.0	%
				Delinquency		25.5	%	27.7	%		26.8	%
Total Non-Agency RMBS	$	148,585,733

(1)

The Company uses third-party dealer quotes to estimate fair value of some of its financial assets. The Company verifies selected prices by using a variety of methods, including comparing prices to internally estimated prices and corroborating the prices by reference to other independent market data, such as relevant benchmark indices and prices of similar instruments. Where the Company has disclosed unobservable inputs for broker quotes or comparable trades, those inputs are based on the Company's validations performed at the security level.

Fair Value at
December 31, 2014

Valuation
Technique(s)

Unobservable Input

Weighted
Average

Other Investment Securities⁽¹⁾

2,040,532

Broker quotes/
comparable trades

Constant voluntary prepayment

7.5

(1)

The following table presents quantitative information about the Company's MSRs which are measured at fair value on a recurring basis for which the Company has utilized Level 3 inputs to determine fair value:

	Fair Value at Year Ended, 2014		Valuation Technique(s)	Unobservable Input	Min/Max						Weighted Average
MSRs	$	33,378,978	Discounted cash flow model	Constant prepayment rate		7.6	%		58.2	%		10.6	%
				Cost of servicing	$	76		$	533		$	91
				Discount rate		9.0	%		10.0	%		9.4	%

The following is a quantitative summary of key inputs used in the valuation of the Company's MSRs at December 31, 2014 and the effect on the estimated fair value from adverse changes in those assumptions (weighted averages are based upon unpaid principal balance):

	December 31, 2014 Range (Weighted average) Fair value

Discount rate		9.0% - 10.0	%
		(9.4	%)
Effect on fair value of adverse change of:
5%	$	(683,406	)
10%	$	(1,366,812	)
20%	$	(2,655,493	)

Prepayment speed⁽¹⁾		7.6% - 58.2	%
		(10.6	%)
Effect on fair value of adverse change of:
5%	$	(639,594	)
10%	$	(1,279,187	)
20%	$	(2,468,154	)

Per-loan annual cost of servicing		$76 - $533
	$	(91	)
Effect on fair value of adverse change of:
5%	$	(389,384	)
10%	$	(778,768	)
20%	$	(1,557,561	)

(1)	Prepayment speed is measured using CPR.

Derivative Financial Instruments

The Company estimates the fair value of IRLCs based on quoted Agency MBS prices, its estimate of the fair value of the MSRs it expects to receive in the sale of the loans and the probability that the mortgage loan will be purchased as a percentage of the commitments it has made (the “pull-through rate”). The Company categorizes IRLCs as a “Level 3” financial statement item.

The significant unobservable inputs used in the fair value measurement of the Company's IRLCs are the pull-through rate and the MSR component of the Company's estimate of the value of the mortgage loans it has committed to purchase. Significant changes in the pull-through rate and the MSR component of the IRLCs, in isolation, may result in a significant change in fair value. The financial effects of changes in these assumptions are generally inversely correlated as increasing interest rates have a positive effect on the fair value of the MSR component of IRLC value, but increase the pull-through rate for loans that have decreased in fair value.

The following is a quantitative summary of key unobservable inputs used in the valuation of IRLCs:

Key inputs		December 31, 2014
Pull-through rate
Range		55.7% – 100.0%
Weighted average		85.0%
MSR value expressed as:
Servicing fee multiple
Range		0.4 – 6.0
Weighted average		4.4
Percentage of unpaid principal balance
Range		0.2% – 1.9%
Weighted average		1.1%

The fair value measurements of these assets are sensitive to changes in assumptions regarding prepayment, probability of default, loss severity in the event of default, forecasts of home prices, and significant activity or developments in the real estate market. Significant changes in any of those inputs in isolation may result in significantly higher or lower fair value measurements. A change in the assumption used for forecasts of home price changes is accompanied by directionally opposite changes in the assumptions used for probability of default and loss severity. Significant increases (decreases) in any of these inputs in isolation would result in significantly lower (higher) fair value measurements.

Fair Value Option

Changes in fair value for assets and liabilities for which the fair value option was elected are recognized in earnings as they occur. The fair value option may be elected on an instrument-by-instrument basis at initial recognition of an asset or liability or upon an event that gives rise to a new basis of accounting for that instrument.

The following table presents the difference between the fair value and the aggregate unpaid principal amount and/or notional balance of assets for which the fair value option was elected at December 31, 2014 and December 31, 2013:

	December 31, 2014							December 31, 2013
			Unpaid Principal and/or Notional							Unpaid Principal and/or Notional
	Fair Value		Balance⁽¹⁾		Difference			Fair Value		Balance⁽¹⁾		Difference
Financial instruments, at fair value Assets
Mortgage loans held for investment	$	415,959,838	$	464,877,028	$	(48,917,190	)	$	331,785,542	$	398,828,497	$	(67,042,955	)
Mortgage loans held for sale		97,690,960		92,917,659		4,773,301			—		—		—
Non-Agency RMBS		148,585,733		226,501,915		(77,916,182	)		226,155,221		324,241,597		(98,086,376	)
Other Investment Securities		2,040,532		2,250,000		(209,468	)		—		—		—
MSRs		33,378,978		3,078,974,342		(3,045,595,364	)		—		—		—
Total financial instruments, at fair value	$	697,656,041	$	3,865,520,944	$	(3,167,864,903	)	$	557,940,763	$	723,070,094	$	(165,129,331	)

(1)	Non-Agency RMBS includes an IO with a notional balance of $48.6 million and $64.3 million at December 31, 2014 and December 31, 2013, respectively.

Fair Value of Other Financial Instruments

In addition to the above disclosures regarding assets or liabilities which are recorded at fair value, U.S. GAAP requires disclosure about the fair value of all other financial instruments. Estimated fair value of financial instruments was determined by the Company using available market information and appropriate valuation methodologies. Considerable judgment is necessary to interpret market data and develop estimated fair values. The use of different market assumptions and/or estimation methodologies may have a material effect on estimated fair values.

The following table summarizes the estimated fair value for all other financial instruments at December 31, 2014 and December 31, 2013:

	December 31, 2014				December 31, 2013
	Fair Value		Carrying Value		Fair Value		Carrying Value
Other financial instruments
Assets
Cash	$	33,791,013	$	33,791,013	$	57,060,806	$	57,060,806
Restricted cash		7,143,078		7,143,078		2,128,236		2,128,236
Liabilities
Warehouse lines of credit	$	89,417,564	$	89,417,564	$	—		—
Loan Repurchase Facilities		300,092,293		300,092,293		236,727,512		236,058,976
Securities repurchase agreements		103,014,105		103,014,105		138,790,158		138,591,678
Exchangeable Senior Notes		59,933,400		55,474,741		54,737,573		54,539,057

Cash includes cash on hand for which fair value equals carrying value (a Level 1 measurement). Restricted cash represents the Company's cash held by counterparties as collateral against the Company's derivatives, Loan Repurchase Facilities and securities repurchase agreements. Due to the short-term nature of the restrictions, fair value approximates carrying value (a Level 1 measurement). The fair value of the Company's warehouse lines of credit and repurchase agreements related to its GMFS origination platform, Loan Repurchase Facilities and securities repurchase agreements is based on an expected present value technique using observable market interest rates. As such, the Company considers the estimated fair value to be a Level 2 measurement. This method discounts future estimated cash flows using rates the Company determined best reflect current market interest rates that would be offered for loans with similar characteristics and credit quality. The fair value of the Exchangeable Senior Notes is based on observable market prices (a Level 2 measurement).