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FAIR VALUE OF FINANCIAL INSTRUMENTS

6 Months Ended

Jun. 30, 2019

9. FAIR VALUE OF FINANCIAL INSTRUMENTS

Fair value is based upon internal models, using market quotations, broker quotations, counterparty quotations or pricing services quotations, which provide valuation estimates based upon reasonable market order indications and are subject to significant variability based on market conditions, such as interest rates, credit spreads and market liquidity. The fair value of the mortgage loan receivables held for sale is based upon a securitization model utilizing market data from recent securitization spreads and pricing.

Fair Value Summary Table

The carrying values and estimated fair values of the Company’s financial instruments, which are both reported at fair value on a recurring basis (as indicated) or amortized cost/par, at June 30, 2019 and December 31, 2018 are as follows ($ in thousands):

June 30, 2019



											Weighted Average
	Outstanding Face Amount			Amortized Cost Basis/Purchase Price			Fair Value			Fair Value Method	Yield %		Remaining Maturity/Duration (years)
Assets:
CMBS(1)	$	1,642,160		$	1,643,149		$	1,653,703		Internal model, third-party inputs	3.31	%	2.26
CMBS interest-only(1)	2,166,640		(2)	42,689			44,052			Internal model, third-party inputs	3.63	%	2.67
GNMA interest-only(3)	118,858		(2)	2,483			2,291			Internal model, third-party inputs	9.13	%	2.72
Agency securities(1)	652			664			663			Internal model, third-party inputs	1.78	%	2.11
GNMA permanent securities(1)	32,055			32,291			33,084			Internal model, third-party inputs	3.74	%	4.72
Corporate bonds(1)	41,205			40,581			41,418			Internal model, third-party inputs	4.82	%	1.64
Equity securities(3)	N/A			13,720			13,204			Observable market prices	N/A		N/A
Mortgage loan receivables held for investment, net, at amortized cost:
Mortgage loan receivables held for investment, net, at amortized cost	3,136,334			3,119,857			3,133,579			Discounted Cash Flow(4)	8.01	%	1.19
Provision for loan losses	N/A			(18,500		)	(18,500		)	(5)	N/A		N/A
Mortgage loan receivables held for sale	112,099			111,977			116,531			Internal model, third-party inputs(6)	5.05	%	9.41
FHLB stock(7)	61,619			61,619			61,619			(7)	5.50	%	N/A
Nonhedge derivatives(1)(8)	344,171			N/A			536			Counterparty quotations	N/A		0.25

Liabilities:
Repurchase agreements - short-term	957,902			957,902			957,902			Discounted Cash Flow(9)	3.07	%	0.29
Repurchase agreements - long-term	309,469			309,469			309,469			Discounted Cash Flow(10)	3.36	%	1.52
Mortgage loan financing	729,685			734,652			750,161			Discounted Cash Flow(10)	5.09	%	1.82
CLO debt	263,216			263,216			263,216			Discounted Cash Flow(9)	5.10	%	4.89
Borrowings from the FHLB	1,191,449			1,191,449			1,199,510			Discounted Cash Flow	2.58	%	2.34
Senior unsecured notes	1,166,201			1,156,400			1,185,576			Broker quotations, pricing services	5.39	%	3.78


(1)	Measured at fair value on a recurring basis with the net unrealized gains or losses recorded as a component of other comprehensive income (loss) in equity.


(2)	Represents notional outstanding balance of underlying collateral.


(3)	Measured at fair value on a recurring basis with the net unrealized gains or losses recorded in current period earnings.


(4)	Fair value for floating rate mortgage loan receivables, held for investment is estimated to approximate the outstanding face amount given the short interest rate reset risk (30 days) and no significant change in credit risk. Fair value for fixed rate mortgage loan receivables, held for investment is measured using a discounted cash flow model.


(5)	Fair value is estimated to equal par value.


(6)	Fair value for mortgage loan receivables, held for sale is measured using a hypothetical securitization model utilizing market data from recent securitization spreads and pricing.


(7)	Fair value of the FHLB stock approximates outstanding face amount as the Company’s captive insurance subsidiary is restricted from trading the stock and can only put the stock back to the FHLB, at the FHLB’s discretion, at par.


(8)	The outstanding face amount of the nonhedge derivatives represents the notional amount of the underlying contracts.

(9)

Fair value for repurchase agreement liabilities and CLO debt is estimated to approximate carrying amount primarily due to the short interest rate reset risk (30 days) of the financings and the high credit quality of the assets collateralizing these positions. If the collateral is determined to be impaired, the related financing would be revalued accordingly. There are no impairments on any positions.


(10)	For repurchase agreements - long term and mortgage loan financing, the carrying value approximates the fair value discounting the expected cash flows at current market rates. If the collateral is determined to be impaired, the related financing would be revalued accordingly. There are no impairments on any positions.

December 31, 2018



											Weighted Average
	Outstanding Face Amount			Amortized Cost Basis			Fair Value			Fair Value Method	Yield %		Remaining Maturity/Duration (years)
Assets:
CMBS(1)	$	1,258,819		$	1,257,801		$	1,252,640		Internal model, third-party inputs	3.14	%	2.33
CMBS interest-only(1)	2,373,936		(2)	55,534			55,691			Internal model, third-party inputs	2.80	%	2.69
GNMA interest-only(3)	135,932		(2)	2,862			2,648			Internal model, third-party inputs	6.30	%	4.11
Agency securities(1)	668			682			662			Internal model, third-party inputs	1.83	%	2.36
GNMA permanent securities(1)	32,633			32,889			33,064			Internal model, third-party inputs	3.76	%	5.03
Corporate bonds(1)	55,305			54,257			53,871			Internal model, third-party inputs	5.04	%	2.51
Equity securities(3)	N/A			13,154			11,550			Observable market prices	N/A		N/A
Mortgage loan receivables held for investment, net, at amortized cost:
Mortgage loan receivables held for investment, net, at amortized cost	3,340,381			3,318,390			3,324,588			Discounted Cash Flow(4)	7.84	%	1.32
Provision for loan losses	N/A			(17,900		)	(17,900		)	(5)	N/A		N/A
Mortgage loan receivables held for sale	181,905			182,439			187,870			Internal model, third-party inputs(6)	5.46	%	9.75
FHLB stock(7)	57,915			57,915			57,915			(7)	4.50	%	N/A
Nonhedge derivatives(1)(8)	—			N/A			—			Counterparty quotations	N/A		0.00

Liabilities:
Repurchase agreements - short-term	436,957			436,957			436,957			Discounted Cash Flow(9)	3.42	%	0.23
Repurchase agreements - long-term	226,728			226,728			226,728			Discounted Cash Flow(10)	3.47	%	1.73
Mortgage loan financing	738,825			743,902			735,662			Discounted Cash Flow(10)	5.09	%	2.61
CLO debt	601,543			601,543			601,543			Discounted Cash Flow(9)	4.41	%	9.40
Participation Financing - Mortgage Loan Receivable	2,453			2,453			2,453			Discounted Cash Flow(11)	17.00	%	0.43
Borrowings from the FHLB	1,286,000			1,286,000			1,286,664			Discounted Cash Flow	2.55	%	2.46
Senior unsecured notes	1,166,201			1,154,991			1,111,288			Broker quotations, pricing services	5.39	%	4.28
Nonhedge derivatives(1)(8)	578,971			N/A			975			Counterparty quotations	N/A		0.25


(1)	Measured at fair value on a recurring basis with the net unrealized gains or losses recorded as a component of other comprehensive income (loss) in equity.


(2)	Represents notional outstanding balance of underlying collateral.


(3)	Measured at fair value on a recurring basis with the net unrealized gains or losses recorded in current period earnings.


(4)	Fair value for floating rate mortgage loan receivables, held for investment is estimated to approximate the outstanding face amount given the short interest rate reset risk (30 days) and no significant change in credit risk. Fair value for fixed rate mortgage loan receivables, held for investment is measured using a discounted cash flow.


(5)	Fair value is estimated to equal par value.


(6)	Fair value for mortgage loan receivables, held for sale is measured using a hypothetical securitization model utilizing market data from recent securitization spreads and pricing.


(7)	Fair value of the FHLB stock approximates outstanding face amount as the Company’s captive insurance subsidiary is restricted from trading the stock and can only put the stock back to the FHLB, at the FHLB’s discretion, at par.


(8)	The outstanding face amount of the nonhedge derivatives represents the notional amount of the underlying contracts.

(9)


(10)	For repurchase agreements - long term and mortgage loan financing, the carrying value approximates the fair value discounting the expected cash flows at current market rates. If the collateral is determined to be impaired, the related financing would be revalued accordingly. There are no impairments on any positions.


(11)	Fair value for Participation Financing - Mortgage Loan Receivable approximates amortized cost as this is a loan participation to a third party.

The following table summarizes the Company’s financial assets and liabilities, which are both reported at fair value on a recurring basis (as indicated) or amortized cost/par, at June 30, 2019 and December 31, 2018 ($ in thousands):

June 30, 2019



Financial Instruments Reported at Fair Value on Consolidated Statements of Financial Condition	Outstanding Face Amount			Fair Value
	Outstanding Face Amount			Level 1		Level 2		Level 3			Total

Assets:
CMBS(1)	$	1,629,992		$	—	$	—	$	1,642,058		$	1,642,058
CMBS interest-only(1)	2,155,495		(2)	—		—		43,179			43,179
GNMA interest-only(3)	118,858		(2)	—		—		2,291			2,291
Agency securities(1)	652			—		—		663			663
GNMA permanent securities(1)	32,055			—		—		33,084			33,084
Corporate bonds(1)	41,205			—		—		41,418			41,418
Equity securities	N/A			13,204		—		—			13,204
Nonhedge derivatives(4)	344,171			—		536		—			536
				$	13,204	$	536	$	1,762,693		$	1,776,433

Financial Instruments Not Reported at Fair Value on Consolidated Statements of Financial Condition	Outstanding Face Amount			Fair Value
	Outstanding Face Amount			Level 1		Level 2		Level 3			Total

Assets:
Mortgage loan receivable held for investment, net, at amortized cost:
Mortgage loans held by consolidated subsidiaries	$	3,136,334		$	—	$	—	$	3,133,579		$	3,133,579
Provision for loan losses	N/A			—		—		(18,500		)	(18,500		)
Mortgage loan receivable held for sale	112,099			—		—		116,531			116,531
CMBS(5)	12,168			—		—		11,645			11,645
CMBS interest-only(5)	11,145		(2)	—		—		873			873
FHLB stock	61,619			—		—		61,619			61,619
				$	—	$	—	$	3,305,747		$	3,305,747
Liabilities:
Repurchase agreements - short-term	957,902			$	—	$	—	$	957,902		$	957,902
Repurchase agreements - long-term	309,469			—		—		309,469			309,469
Mortgage loan financing	729,685			—		—		750,161			750,161
CLO debt	263,216			—		—		263,216			263,216
Borrowings from the FHLB	1,191,449			—		—		1,199,510			1,199,510
Senior unsecured notes	1,166,201			—		—		1,185,576			1,185,576
				$	—	$	—	$	4,665,834		$	4,665,834


(1)	Measured at fair value on a recurring basis with the net unrealized gains or losses recorded as a component of other comprehensive income (loss) in equity.


(2)	Represents notional outstanding balance of underlying collateral.


(3)	Measured at fair value on a recurring basis with the net unrealized gains or losses recorded in current period earnings.


(4)	Measured at fair value on a recurring basis with the net unrealized gains or losses recorded in current period earnings. The outstanding face amount of the nonhedge derivatives represents the notional amount of the underlying contracts.


(5)	Restricted securities which are designated as risk retention securities under the Dodd-Frank Act and are therefore subject to transfer restrictions over the term of the securitization trust, which are classified as held-to-maturity and reported at amortized cost.

December 31, 2018



Financial Instruments Reported at Fair Value on Consolidated Statements of Financial Condition	Outstanding Face Amount			Fair Value
	Outstanding Face Amount			Level 1		Level 2		Level 3			Total

Assets:
CMBS(1)	$	1,246,609		$	—	$	—	$	1,241,334		$	1,241,334
CMBS interest-only(1)	2,362,747		(2)	—		—		54,789			54,789
GNMA interest-only(3)	135,932		(2)	—		—		2,648			2,648
Agency securities(1)	668			—		—		662			662
GNMA permanent securities(1)	32,633			—		—		33,064			33,064
Corporate bonds(1)	55,305			—		—		53,871			53,871
Equity securities	N/A			11,550		—		—			11,550
				$	11,550	$	—	$	1,386,368		$	1,397,918
Liabilities:
Nonhedge derivatives(4)	$	605,871		$	—	$	975	$	—		$	975


Financial Instruments Not Reported at Fair Value on Consolidated Statements of Financial Condition	Outstanding Face Amount			Fair Value
	Outstanding Face Amount			Level 1		Level 2		Level 3			Total

Assets:
Mortgage loan receivable held for investment, net, at amortized cost:
Mortgage loans held by consolidated subsidiaries	$	3,340,381		$	—	$	—	$	3,324,588		$	3,324,588
Provision for loan losses	N/A			—		—		(17,900		)	(17,900		)
Mortgage loan receivables held for sale	181,905			—		—		187,870			187,870
CMBS(5)	12,210			—		—		11,306			11,306
CMBS interest-only(5)	11,189		(2)	—		—		902			902
FHLB stock	57,915			—		—		57,915			57,915
				$	—	$	—	$	3,564,681		$	3,564,681
Liabilities:
Repurchase agreements - short-term	436,957			$	—	$	—	$	436,957		$	436,957
Repurchase agreements - long-term	226,728			—		—		226,728			226,728
Mortgage loan financing	738,825			—		—		735,662			735,662
CLO debt	601,543			—		—		601,543			601,543
Participation Financing - Mortgage Loan Receivable	2,453			—		—		2,453			2,453
Borrowings from the FHLB	1,286,000			—		—		1,286,664			1,286,664
Senior unsecured notes	1,166,201			—		—		1,111,288			1,111,288
				$	—	$	—	$	4,401,295		$	4,401,295


(1)	Measured at fair value on a recurring basis with the net unrealized gains or losses recorded as a component of other comprehensive income (loss) in equity.


(2)	Represents notional outstanding balance of underlying collateral.


(3)	Measured at fair value on a recurring basis with the net unrealized gains or losses recorded in current period earnings.


(4)	Measured at fair value on a recurring basis with the net unrealized gains or losses recorded in current period earnings. The outstanding face amount of the nonhedge derivatives represents the notional amount of the underlying contracts.


(5)	Restricted securities which are designated as risk retention securities under the Dodd-Frank Act and are therefore subject to transfer restrictions over the term of the securitization trust, which are classified as held-to-maturity and reported at amortized cost.

The following table summarizes changes in Level 3 financial instruments reported at fair value on the consolidated statements of financial condition for the six months ended June 30, 2019 and 2018 ($ in thousands):



	Six Months Ended June 30,
Level 3	2019			2018

Balance at January 1,	$	1,385,957		$	1,106,517
Transfer from level 2	—			—
Purchases	847,318			243,921
Sales	(379,961		)	(161,518		)
Paydowns/maturities	(110,400		)	(56,707		)
Amortization of premium/discount	(6,267		)	(12,724		)
Unrealized gain/(loss)	18,804			(10,789		)
Realized gain/(loss) on sale(1)	7,242			(2,342		)
Balance at June 30,	$	1,762,693		$	1,106,358


(1)	Includes realized losses on securities recorded as other than temporary impairments.

The following is quantitative information about significant unobservable inputs in our Level 3 measurements for those assets and liabilities measured at fair value on a recurring basis ($ in thousands):

June 30, 2019



Financial Instrument	Carrying Value			Valuation Technique	Unobservable Input	Minimum		Weighted Average		Maximum

CMBS(1)	$	1,653,703		Discounted cash flow	Yield (4)	—	%	3.23	%	20.87	%
					Duration (years)(5)	0.00		1.71		7.37
CMBS interest-only(1)	44,052		(2)	Discounted cash flow	Yield (4)	1.95	%	4.16	%	9.88	%
					Duration (years)(5)	0.20		2.63		3.85
					Prepayment speed (CPY)(5)	100.00		100.00		100.00
GNMA interest-only(3)	2,291		(2)	Discounted cash flow	Yield (4)	(6	)%	14.03	%	59.34	%
					Duration (years)(5)	0.62		2.81		10.02
					Prepayment speed (CPJ)(5)	5.00		6.74		15.00
Agency securities(1)	663			Discounted cash flow	Yield (4)	—	%	1.53	%	2.01	%
					Duration (years)(5)	0.00		2.58		3.39
GNMA permanent securities(1)	33,084			Discounted cash flow	Yield (4)	2.08	%	3.52	%	6.67	%
					Duration (years)(5)	2.62		3.60		6.67
Corporate bonds(1)	41,418			Discounted cash flow	Yield (4)	3.48	%	3.51	%	3.52	%
					Duration (years)(5)	1.27		1.37		2.07
Total	$	1,775,211


(1)	CMBS, CMBS interest-only securities, Agency securities, GNMA construction securities, GNMA permanent securities and corporate bonds are classified as available-for-sale and reported at fair value with changes in fair value recorded in the current period in other comprehensive income.


(2)	The amounts presented represent the principal amount of the mortgage loans outstanding in the pool in which the interest-only securities participate.


(3)	Agency interest-only securities are recorded at fair value with changes in fair value recorded in current period earnings.

Sensitivity of the Fair Value to Changes in the Unobservable Inputs


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


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

December 31, 2018



Financial Instrument	Carrying Value			Valuation Technique	Unobservable Input	Minimum		Weighted Average		Maximum

CMBS(1)	$	1,252,640		Discounted cash flow	Yield (3)	—	%	3.54	%	21.67	%
					Duration (years)(4)	0.00		2.50		7.78
CMBS interest-only(1)	55,691		(2)	Discounted cash flow	Yield (3)	0.87	%	4.71	%	8.11	%
					Duration (years)(4)	0.14		2.96		6.86
					Prepayment speed (CPY)(4)	100.00		100.00		100.00
GNMA interest-only(3)	2,648		(2)	Discounted cash flow	Yield (4)	1.21	%	5.54	%	10.21	%
					Duration (years)(5)	0.04		3.13		4.77
					Prepayment speed (CPJ)(5)	5.00		6.58		15.00
Agency securities(1)	662			Discounted cash flow	Yield (4)	—	%	2.1	%	2.84	%
					Duration (years)(5)	0.00		2.83		3.82
GNMA permanent securities(1)	33,064			Discounted cash flow	Yield (4)	—	%	3.51	%	4	%
					Duration (years)(5)	0.00		5.62		5.88
Corporate bonds(1)	53,871			Discounted cash flow	Yield (4)	5.3	%	5.35	%	5.46	%
					Duration (years)(5)	1.94		2.19		2.70
Total	$	1,398,576


(1)	CMBS, CMBS interest-only securities, Agency securities, GNMA construction securities, GNMA permanent securities and corporate bonds are classified as available-for-sale and reported at fair value with changes in fair value recorded in the current period in other comprehensive income.


(2)	The amounts presented represent the principal amount of the mortgage loans outstanding in the pool in which the interest-only securities participate.


(3)	Agency interest-only securities are recorded at fair value with changes in fair value recorded in current period earnings.

Sensitivity of the Fair Value to Changes in the Unobservable Inputs


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


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

Nonrecurring Fair Values

The Company measures fair value of certain assets on a nonrecurring basis when events or changes in circumstances indicate that the carrying value of the assets may not be recoverable. Adjustments to fair value generally result from the application of lower of amortized cost or fair value accounting for assets held for sale or write-down of assets value due to impairment.

There were no assets carried at fair value on a nonrecurring basis at June 30, 2019 and December 31, 2018.

The following table summarizes the fair value write-downs to assets carried at fair value on a nonrecurring basis ($ in thousands):



	Three Months Ended June 30,				Six Months Ended June 30,
	2019		2018		2019		2018
Impairment of real estate
Real estate, net(1)(2)	$	—	$	—	$	1,350	$	—

(1)

The write down to fair value was recorded based on contracted sales price and classified as Level 2 of the fair valuation hierarchy. On May 1, 2019, the Company completed the sale of the property recognizing $3.9 million of operating lease income, $3.5 million realized loss on sale of real estate, net and $0.4 million of depreciation and amortization expense, resulting in a $20 thousand loss on sale of real estate, net.

(2)

Impairment is discussed in further detail in Note 6, Real Estate and Related Lease Intangibles, Net.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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