FAIR VALUE OF FINANCIAL INSTRUMENTS

ASC Topic 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC Topic 820 clarifies that fair value should be based on the assumptions market participants would use when pricing an asset or liability and also requires an entity to consider all aspects of nonperformance risk, including the entity's own credit standing, when measuring fair value of a liability. ASC Topic 820 established a valuation hierarchy of three levels as follows:


•	Level 1 – Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities as of the measurement date.


•	Level 2 – Inputs include quoted prices in active markets for similar assets or liabilities; quoted prices in inactive markets for identical or similar assets or liabilities; or inputs either directly observable or indirectly observable through correlation with market data at the measurement date and for the duration of the instrument’s anticipated life.


•	Level 3 – Unobservable inputs are supported by little or no market activity. The unobservable inputs represent management’s best estimate of how market participants would price 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.

The Company reviews the classification of its financial instruments within the fair value hierarchy on a quarterly basis, and management may conclude that its financial instruments should be reclassified to a different level in the future if a change in type of inputs occurs.

The following table presents the fair value of the Company’s assets and liabilities presented on its consolidated balance sheets, segregated by the hierarchy level of the fair value estimate, that are measured at fair value on a recurring basis as of the dates indicated:



	December 31, 2016
	Fair Value		Level 1 - Unadjusted Quoted Prices in Active Markets		Level 2 - Observable Inputs		Level 3 - Unobservable Inputs
Assets:
Mortgage-backed securities	$	3,212,084	$	—	$	3,201,157	$	10,927
Derivative assets	28,534		—		28,534		—
Total assets carried at fair value	$	3,240,618	$	—	$	3,229,691	$	10,927
Liabilities:
Derivative liabilities	$	6,922	$	—	$	6,922	$	—
Total liabilities carried at fair value	$	6,922	$	—	$	6,922	$	—



	December 31, 2015
	Fair Value		Level 1 - Unadjusted Quoted Prices in Active Markets		Level 2 - Observable Inputs		Level 3 - Unobservable Inputs
Assets:
Mortgage-backed securities	$	3,493,701	$	—	$	3,477,266	$	16,435
Derivative assets	7,835		—		7,835		—
Total assets carried at fair value	$	3,501,536	$	—	$	3,485,101	$	16,435
Liabilities:
Derivative liabilities	$	41,205	$	29,097	$	12,108	$	—
Total liabilities carried at fair value	$	41,205	$	29,097	$	12,108	$	—

The Company did not have assets or liabilities measured at fair value on a non-recurring basis as of December 31, 2016 or December 31, 2015.

As of December 31, 2016, the Company's derivative assets and liabilities consisted only of interest rate swaps as the Company terminated all positions in Eurodollar futures during the fourth quarter of 2016. Eurodollar futures as of December 31, 2015 were valued based on closing exchange prices and were thus classified as Level 1 measurements. Interest rate swaps are valued using the income approach with the primary input being the forward interest rate swap curve, which is considered an observable input, and thus their fair values are considered Level 2 measurements as of December 31, 2016 and December 31, 2015.

The fair value measurements for a majority of the Company's MBS are considered Level 2. These Level 2 securities are substantially similar to securities that either are actively traded or have been recently traded in their respective markets. The Company receives a price evaluation for each of its MBS from a primary pricing service selected by the Company. To determine each security's valuation, the primary pricing service uses either a market approach, which uses observable prices and other relevant information that is generated by market transactions of identical or similar securities, or an income approach, which uses valuation techniques to convert future amounts to a single, discounted present value amount. The Company also reviews the assumptions and inputs utilized in the valuation techniques of its primary pricing service. Examples of these observable inputs and assumptions include market interest rates, credit spreads, and projected prepayment speeds, among other things. The Company compares the price received from its primary pricing service to other prices received from additional third party pricing services and multiple broker quotes for reasonableness.

The Company owns certain non-Agency MBS for which there are not sufficiently recent trades of substantially similar securities, and their fair value measurements are thus considered Level 3. The Company determines the fair value of its Level 3 securities by discounting the estimated future cash flows derived from cash flow models using significant inputs which are determined by the Company when market observable inputs are not available. Information utilized in those pricing models include the security’s credit rating, coupon rate, estimated prepayment speeds, expected weighted average life, collateral composition, estimated future interest rates, expected credit losses, and credit enhancement as well as certain other relevant information. Significant changes in any of these inputs in isolation may result in a significantly different fair value measurement. Level 3 assets are generally most sensitive to the default rate and severity assumptions.

The table below presents quantitative information about the significant unobservable inputs used in the fair value measurement for the Company's Level 3 non-Agency CMBS and RMBS as of December 31, 2016:



	Unobservable Inputs
	Prepayment Speed	Default Rate		Severity		Discount Rate
Non-Agency CMBS ⁽¹⁾	0 CPY	—		—		9.8	%
Non-Agency RMBS	10 CPR	1.0	%	20.0	%	6.3	%


(1)	As of December 31, 2016, there are too few loans collateralizing our non-Agency CMBS to reasonably apply average prepayment speed, average default rate, or average severity. The loans were individually evaluated for prepayment and default in projecting the cash flows. Based on that review, the loans are expected to pay as scheduled.

The activity of the instruments measured at fair value on a recurring basis using Level 3 inputs is presented in the following table for the period indicated:



	Level 3 Fair Value
	Non-Agency CMBS			Non-Agency RMBS			Total assets
Balance as of December 31, 2015	$	14,903		$	1,532		$	16,435
Unrealized loss included in OCI ⁽¹⁾	(1,055		)	(2		)	(1,057		)
Principal payments	(5,747		)	(272		)	(6,019		)
Accretion	1,568			—			1,568
Balance as of December 31, 2016	$	9,669		$	1,258		$	10,927


(1)	Amount included in "change in net unrealized gain on available-for-sale investments" on consolidated statements of comprehensive income (loss).

The following table presents a summary of the carrying value and estimated fair values of the Company’s financial instruments as of the dates indicated:



	December 31, 2016				December 31, 2015
	Carrying Value		Fair Value		Carrying Value		Fair Value
Assets:
Mortgage-backed securities	$	3,212,084	$	3,212,084	$	3,493,701	$	3,493,701
Mortgage loans held for investment, net⁽¹⁾	19,036		15,971		24,145		20,849
Investment in FHLB stock	9		9		11,475		11,475
Derivative assets	28,534		28,534		7,835		7,835
Liabilities:
Repurchase agreements ⁽²⁾	$	2,898,952	$	2,898,952	$	2,589,420	$	2,589,420
FHLB advances ⁽²⁾	—		—		520,000		520,000
Non-recourse collateralized financing ⁽¹⁾	6,440		6,357		8,442		8,102
Derivative liabilities	6,922		6,922		41,205		41,205


(1)	The Company determines the fair value of its mortgage loans held for investment, net and its non-recourse collateralized financing using internally developed cash flow models with inputs similar to those used to estimate the fair value of the Company's Level 3 non-Agency MBS.


(2)	The carrying value of repurchase agreements and FHLB advances generally approximates fair value due to their short term maturities.