v2.4.0.6
Valuation
 3 Months Ended
Mar. 31, 2012
Valuation [Abstract]  
Valuation

3. Valuation

The following is a description of the valuation methodologies used for the Company's financial instruments.

Level 1 valuation methodologies include the observation of quoted prices (unadjusted) for identical assets or liabilities in active markets, often received from widely recognized data providers.

Level 2 valuation methodologies include the observation of (i) quoted prices for similar assets or liabilities in active markets, (ii) inputs other than quoted prices that are observable for the asset or liability (for example, interest rates and yield curves) in active markets and (iii) quoted prices for identical or similar assets or liabilities in markets that are not active.

Level 3 valuation methodologies include (i) the use of proprietary models that require the use of a significant amount of judgment and the application of various assumptions including, but not limited to, prepayment and default rate assumptions and (ii) the solicitation of valuations from third parties (typically, broker-dealers). Third-party valuation providers often utilize proprietary models that are highly subjective and also require the use of a significant amount of judgment and the application of various assumptions including, but not limited to, prepayment and default rate assumptions. The Manager utilizes such information to assign a good faith valuation (the estimated price that would be received to sell an asset or paid to transfer a liability in an orderly transaction at the valuation date) to such financial instruments. The Manager has been able to obtain third-party valuations on the vast majority of the Company's financial instruments and expects to continue to solicit third-party valuations on substantially all of the Company's financial instruments in the future to the extent practical.

 

The Manager uses its judgment based on its own models, the assessments of its portfolio managers and third-party valuations it obtains, to determine and assign fair values to the Company's Level 3 financial instruments. Because of the inherent uncertainty of valuation, estimated values may differ significantly from the values that would have been used had a ready market for the financial instruments existed and the differences could be material to the consolidated financial statements.

The table below reflects the value of the Company's Level 1, Level 2 and Level 3 financial instruments at March 31, 2012:

 

(In thousands)                         

Description

    Level 1     Level 2     Level 3     Total  

Assets:

         

Cash and cash equivalents

    $ 51,546      $ —        $ —        $ 51,546   
  

 

 

    

 

 

    

 

 

    

 

 

  

Investments at fair value-

         

Agency residential mortgage-backed securities

    $ —        $ 794,667      $ 6,016      $ 800,683   

Private label residential mortgage-backed securities

      —          —          408,230        408,230   

Private label commercial mortgage-backed securities

      —          —          12,171        12,171   

Commercial mortgage loans

      —          —          4,500        4,500   
  

 

 

    

 

 

    

 

 

    

 

 

  

Total investments at fair value

      —          794,667        430,917        1,225,584   
  

 

 

    

 

 

    

 

 

    

 

 

  

Financial derivatives-assets at fair value-

         

Credit default swaps on asset-backed securities

      —          —          48,746        48,746   

Credit default swaps on asset-backed indices

      —          45,223        —          45,223   

Interest rate swaps

      —          87        —          87   
  

 

 

    

 

 

    

 

 

    

 

 

  

Total financial derivatives-assets at fair value

      —          45,310        48,746        94,056   
  

 

 

    

 

 

    

 

 

    

 

 

  

Repurchase agreements

      —          13,650        —          13,650   
  

 

 

    

 

 

    

 

 

    

 

 

  

Total investments, financial derivatives-assets at fair value and repurchase agreements

    $ —        $ 853,627      $ 479,663      $ 1,333,290   
  

 

 

    

 

 

    

 

 

    

 

 

  

Liabilities:

         

Investments sold short at fair value-

         

U.S. Treasury and Agency residential mortgage-backed securities

    $ —        $ (579,852 )    $ —        $ (579,852 ) 
  

 

 

    

 

 

    

 

 

    

 

 

  

Financial derivatives-liabilities at fair value-

         

Credit default swaps on corporate indices

      —          (364 )      —          (364 ) 

Credit default swaps on asset backed indices

      —          (20,536 )      —          (20,536 ) 

Total return swaps

      —          (249 )      —          (249 ) 

Interest rate swaps

      —          (6,097 )      —          (6,097 ) 

Unrealized depreciation on futures contracts

      (52 )      —          —          (52 ) 
  

 

 

    

 

 

    

 

 

    

 

 

  

Total financial derivatives-liabilities at fair value

      (52 )      (27,246 )      —          (27,298 ) 
  

 

 

    

 

 

    

 

 

    

 

 

  

Securitized debt

      —          —          (1,485 )      (1,485 ) 
  

 

 

    

 

 

    

 

 

    

 

 

  

Total investments sold short, financial derivatives-liabilities at fair value and securitized debt

    $ (52 )    $ (607,098 )    $ (1,485 )    $ (608,635 ) 
  

 

 

    

 

 

    

 

 

    

 

 

  

Investments under the Agency residential mortgage-backed securities Level 3 category are investments in Agency interest only RMBS securities. There were no transfers of financial instruments between Level 1, Level 2 or Level 3 during the three month period ended March 31, 2012.

 

The following table identifies the significant unobservable inputs that affect the valuation of the Company's Level 3 assets and liabilities as of March 31, 2012:

 

    Fair Value as of
March 31, 2012		     

Valuation Technique

  

Unobservable Input

   Range     Weighted
Average		  

Description

          Min     Max    
    (In thousands)                             

Private label residential mortgage-backed securities (1)

  $ 406,745       Discounted Cash Flows   Yield     4.7 %      22.7 %      9.5 % 
       Projected Collateral Prepayments     0.6 %      38.8 %      16.4 % 
       Projected Collateral Losses     4.2 %      88.4 %      36.7 % 
       Projected Collateral Recoveries     0.0 %      42.6 %      20.7 % 
       Projected Collateral Scheduled Amortization     3.0 %      89.4 %      26.2 % 
            

 

 

  
               100.0 % 
            

 

 

  

Credit default swaps on asset-backed securities

     48,746       Net Discounted Cash Flows        
       Projected Collateral Prepayments     5.3 %      36.2 %      13.1 % 
       Projected Collateral Losses     25.2 %      62.1 %      49.1 % 
       Projected Collateral Recoveries     11.7 %      34.0 %      20.3 % 
       Projected Collateral Scheduled Amortization     7.7 %      37.0 %      17.5 % 
            

 

 

  
               100.0 % 
            

 

 

  

Private label commercial mortgage-backed securities and Commercial mortgage loans

     16,671       Discounted Cash Flows   Yield     7.9 %      10.9 %      9.7 % 
       Projected Collateral Losses     0.0 %      30.5 %      4.6 % 
       Projected Collateral Recoveries     0.0 %      46.4 %      14.9 % 
       Projected Collateral Scheduled Amortization     47.8 %      100.0 %      80.5 % 
            

 

 

  
               100.0 % 
            

 

 

  

Agency interest only residential mortgage-backed securities

     6,016       Option Adjusted Spread ("OAS")   LIBOR OAS(2)     741        2,754        1,107   
       Projected Collateral Prepayments     74.3 %      93.0 %      81.8 % 
       Projected Collateral Scheduled Amortization     7.0 %      25.7 %      18.2 % 
            

 

 

  
               100.0 % 
            

 

 

  

(1)

Includes securitized debt with a fair value of $1.5 million as of March 31, 2012.

(2) 

Shown in basis points.

Collateral prepayments, losses, recoveries and scheduled amortization are projected over the remaining life of the collateral and expressed as a percentage of the collateral's current principal balance.

The Company uses a LIBOR Option Adjusted Spread ("OAS") valuation methodology to value its Agency interest only RMBS assets. In the LIBOR OAS methodology, cash flows are projected using Ellington's models over multiple interest rate scenarios, and these projected cash flows are then discounted using the LIBOR rates implied by each interest rate scenario. The LIBOR OAS of an asset is then computed as the unique constant yield spread that, when added to all LIBOR rates in each interest rate scenario generated by the model, will equate (a) the expected present value of the projected asset cash flows over all model scenarios to (b) the actual current market price of the asset. LIBOR OAS is therefore model-dependent. Generally speaking, LIBOR OAS measures the additional yield spread over LIBOR that an asset provides at its current market price after taking into account any interest rate options embedded in the asset.

Material changes in any of the inputs above in isolation could result in a significant change to reported fair value measurements. Additionally, fair value measurements are impacted by the interrelationships of these inputs. For example, a higher expectation of collateral prepayments will generally result in a lower expectation of collateral losses. Conversely, higher losses will generally result in lower prepayments. Because the Company's credit default swaps on asset-backed security holdings represent credit default swap contracts whereby the Company has purchased credit protection, such default swaps on asset-backed securities generally have the directionally opposite sensitivity to prepayments, losses and recoveries as compared to the Company's long securities holdings. Prepayments do not represent a significant input for the Company's commercial mortgage-backed securities and commercial mortgage loans. Losses and recoveries do not represent a significant input for the Company's Agency RMBS interest only securities, given the guarantee of the issuing government agency or government-sponsored enterprise.

The Company's reverse repurchase agreements are carried at cost, which approximates fair value. These liabilities are classified as Level 2 liabilities based on the adequacy of the collateral and their short term nature.

 

The table below reflects the value of the Company's Level 1, Level 2 and Level 3 financial instruments at December 31, 2011:

 

(In thousands)                           

Description

    Level 1      Level 2     Level 3      Total  

Assets:

           

Cash and cash equivalents

    $ 62,737       $ —        $ —         $ 62,737   
  

 

 

     

 

 

    

 

 

     

 

 

  

Investments at fair value-

           

U.S. Treasury and Agency residential mortgage-backed securities

    $ —         $ 769,120      $ 5,337       $ 774,457   

Private label residential mortgage-backed securities

      —           —          417,533         417,533   

Private label commercial mortgage-backed securities

      —           —          16,093         16,093   

Commercial mortgage loans

      —           —          4,400         4,400   
  

 

 

     

 

 

    

 

 

     

 

 

  

Total investments at value

      —           769,120        443,363         1,212,483   
  

 

 

     

 

 

    

 

 

     

 

 

  

Financial derivatives-assets at fair value-

           

Credit default swaps on corporate indices

      —           963        —           963   

Credit default swaps on asset-backed securities

      —           —          61,498         61,498   

Credit default swaps on asset-backed indices

      —           40,303        —           40,303   

Interest rate swaps

      —           95        —           95   

Unrealized appreciation on futures contracts

      12         —          —           12   
  

 

 

     

 

 

    

 

 

     

 

 

  

Total financial derivatives-assets at fair value

      12         41,361        61,498         102,871   
  

 

 

     

 

 

    

 

 

     

 

 

  

Repurchase agreements

      —           15,750        —           15,750   
  

 

 

     

 

 

    

 

 

     

 

 

  

Total investments, financial derivatives-assets at fair value and repurchase agreements

    $ 12       $ 826,231      $ 504,861       $ 1,331,104   
  

 

 

     

 

 

    

 

 

     

 

 

  

Liabilities:

           

Investments sold short at fair value-

           

U.S. Treasury and Agency residential mortgage-backed securities

    $ —         $ (462,394 )    $ —         $ (462,394 ) 
  

 

 

     

 

 

    

 

 

     

 

 

  

Financial derivatives-liabilities at fair value-

           

Credit default swaps on asset-backed indices

      —           (9,548 )      —           (9,548 ) 

Total return swaps

      —           (274 )      —           (274 ) 

Interest rate swaps

      —           (17,218 )      —           (17,218 ) 
  

 

 

     

 

 

    

 

 

     

 

 

  

Total financial derivatives-liabilities at fair value

      —           (27,040 )      —           (27,040 ) 
  

 

 

     

 

 

    

 

 

     

 

 

  

Total investments sold short and financial derivatives-liabilities at fair value

    $ —         $ (489,434 )    $ —         $ (489,434 ) 
  

 

 

     

 

 

    

 

 

     

 

 

  

Investments under the U.S. Treasury and Agency residential mortgage-backed securities Level 3 category are investments in Agency interest only RMBS securities. There were no transfers of financial instruments between Level 1, Level 2 or Level 3 during the year ended December 31, 2011.

 

The tables below include a roll-forward of the Company's financial instruments for the three month periods ended March 31, 2012 and 2011, respectively (including the change in fair value), for financial instruments classified by the Company within Level 3 of the valuation hierarchy.

Level 3—Fair Value Measurement Using Significant Unobservable Inputs:

Three Month Period Ended March 31, 2012

 

(In thousands)    Beginning
Balance as of
December 31,
2011		      Accreted
Discounts /
Amortized
Premiums		     Realized
Gain/
(Loss)		     Change in Net
Unrealized
Gain/(Loss)		      Purchases      Sales     Transfers In
and/or Out
of Level 3		      Ending Balance
as of March
31, 2012		  

Assets:

                     

Investments at fair value-

                     

Agency residential mortgage-backed securities

    $ 5,337       $ (624 )    $ —        $ 431       $ 872       $ —        $ —         $ 6,016   

Private label residential mortgage-backed securities

      417,533         4,374        6,201        17,660         98,678         (136,216 )      —           408,230   

Private label commercial mortgage-backed securities

      16,093         117        344        1,688         1,308         (7,379 )      —           12,171   

Commercial mortgage loans

      4,400         28        —          72         —           —          —           4,500   
  

 

 

     

 

 

    

 

 

    

 

 

     

 

 

     

 

 

    

 

 

     

 

 

  

Total investments at fair value

      443,363         3,895        6,545        19,851         100,858         (143,595 )      —           430,917   
  

 

 

     

 

 

    

 

 

    

 

 

     

 

 

     

 

 

    

 

 

     

 

 

  

Financial derivatives- assets at fair value

                     

Credit default swaps on asset-backed securities

      61,498         —          (4,744 )      6,799         123         (14,930 )      —           48,746   
  

 

 

     

 

 

    

 

 

    

 

 

     

 

 

     

 

 

    

 

 

     

 

 

  

Total financial derivatives- assets at fair value

      61,498         —          (4,744 )      6,799         123         (14,930 )      —           48,746   
  

 

 

     

 

 

    

 

 

    

 

 

     

 

 

     

 

 

    

 

 

     

 

 

  

Total investments and financial derivatives-assets at fair value

    $ 504,861       $ 3,895      $ 1,801      $ 26,650       $ 100,981       $ (158,525 )    $ —         $ 479,663   
  

 

 

     

 

 

    

 

 

    

 

 

     

 

 

     

 

 

    

 

 

     

 

 

  

Liabilities:

                     

Securitized debt

    $ —         $ (13 )    $ —        $ 10       $ —         $ (1,482 )    $ —         $ (1,485 ) 
  

 

 

     

 

 

    

 

 

    

 

 

     

 

 

     

 

 

    

 

 

     

 

 

  

Total securitized debt

    $ —         $ (13 )    $ —        $ 10       $ —         $ (1,482 )    $ —         $ (1,485 ) 
  

 

 

     

 

 

    

 

 

    

 

 

     

 

 

     

 

 

    

 

 

     

 

 

  

All amounts of net realized and change in net unrealized gain (loss) in the table above are reflected in the accompanying Consolidated Statement of Operations. The table above incorporates changes in net unrealized gain (loss) for both Level 3 financial instruments held by the Company at March 31, 2012, as well as Level 3 financial instruments disposed of by the Company during the three month period ended March 31, 2012. For Level 3 financial instruments held by the Company at March 31, 2012, change in net unrealized gain (loss) of $12.7 million, $(4.5) million and $0.01 million, for the three month period ended March 31, 2012 relate to investments, financial derivative-assets and securitized debt, respectively.

 

Level 3—Fair Value Measurement Using Significant Unobservable Inputs:

Three Month Period Ended March 31, 2011

 

(In thousands)    Beginning
Balance as of
December 31,
2010		      Accreted
Discounts /
Amortized
Premiums		     Realized
Gain/(Loss)		      Change in Net
Unrealized
Gain/(Loss)		     Purchases      Sales     Transfers In
and/or Out of
Level 3		      Ending Balance
as of March
31, 2011		  

Assets:

                     

Investments at fair value-

                     

Agency residential mortgage-backed securities

    $ —         $ (93 )    $ —         $ 8      $ 4,383       $ —        $ —         $ 4,298   

Private label residential mortgage-backed securities

      338,839         3,649        11,177         (6,637 )      96,427         (88,773 )      —           354,682   

Private label commercial mortgage-backed securities

      1,850         83        772         (248 )      15,345         (4,719 )      —           13,083   

Commercial mortgage loans

      —           15        —           (15 )      4,675         —          —           4,675   
  

 

 

     

 

 

    

 

 

     

 

 

    

 

 

     

 

 

    

 

 

     

 

 

  

Total investments at value

      340,689         3,654        11,949         (6,892 )      120,830         (93,492 )      —           376,738   
  

 

 

     

 

 

    

 

 

     

 

 

    

 

 

     

 

 

    

 

 

     

 

 

  

Financial derivatives- assets at fair value

                     

Credit default swaps on asset-backed securities

      102,850         —          2,681         (3,251 )      376         (12,274 )      —           90,382   
  

 

 

     

 

 

    

 

 

     

 

 

    

 

 

     

 

 

    

 

 

     

 

 

  

Total financial derivatives- assets at fair value

      102,850         —          2,681         (3,251 )      376         (12,274 )      —           90,382   
  

 

 

     

 

 

    

 

 

     

 

 

    

 

 

     

 

 

    

 

 

     

 

 

  

Total investments and financial derivatives-assets at fair value

    $ 443,539       $ 3,654      $ 14,630       $ (10,143 )    $ 121,206       $ (105,766 )    $ —         $ 467,120   
  

 

 

     

 

 

    

 

 

     

 

 

    

 

 

     

 

 

    

 

 

     

 

 

  

All amounts of net realized and change in net unrealized gain (loss) in the table above are reflected in the accompanying Consolidated Statement of Operations. The table above incorporates changes in net unrealized gain (loss) for both Level 3 financial instruments held by the Company at March 31, 2011, as well as Level 3 financial instruments disposed of by the Company during the three month period ended March 31, 2011. For Level 3 financial instruments held by the Company at March 31, 2011, change in net unrealized gain (loss) of $(1.5) million and $(3.4) million for the three month period ended March 31, 2011 relate to investments and financial derivative-assets, respectively.