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Fair Value of Financial Instruments | 9 Months Ended
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Sep. 30, 2019
Fair Value Disclosures [Abstract] |
Fair Value of Financial Instruments | Fair Value of Financial Instruments The Company has established and documented processes for determining fair values. Fair value is based upon quoted market prices, where available. If listed prices or quotes are not available, then fair value is based upon internally developed models that primarily use inputs that are market-based or independently-sourced market parameters, including interest rate yield curves. A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The three levels of valuation hierarchy are defined as follows: Level 1 - inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets. Level 2 - inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. Level 3 - inputs to the valuation methodology are unobservable and significant to the fair value measurement. The following describes the valuation methodologies used for the Company’s financial instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy.
a. | Investment Securities, Available for Sale – The Company determines the fair value of the investment securities in our portfolio, except the CMBS held in securitization trusts, using a third-party pricing service or quoted prices provided by dealers who make markets in similar financial instruments. Dealer valuations typically incorporate common market pricing methods, including a spread measurement to the Treasury curve or interest rate swap curve as well as underlying characteristics of the particular security including coupon, periodic and life caps, collateral type, rate reset period and seasoning or age of the security. If quoted prices for a security are not reasonably available from a dealer, the security will be classified as a Level 3 security and, as a result, management will determine fair value by modeling the security based on its specific characteristics and available market information. Management reviews all prices used in determining fair value to ensure they represent current market conditions. This review includes surveying similar market transactions, comparisons to interest pricing models as well as offerings of like securities by dealers. The Company's investment securities, except the CMBS held in securitization trusts, are valued based upon readily observable market parameters and are classified as Level 2 fair values.
The Company’s CMBS held in securitization trusts at December 31, 2018 were comprised of first loss POs and certain IOs for which there were not substantially similar securities that traded frequently. The Company classified these securities as Level 3 fair values. Fair value of the Company’s CMBS investments held in securitization trusts was based on an internal valuation model that considered expected cash flows from the underlying loans and yields required by market participants. The significant unobservable inputs used in the measurement of these investments were projected losses of certain identified loans within the pool of loans and a discount rate. The discount rate used in determining fair value incorporated default rate, loss severity and current market interest rates. The discount rate ranged from 4.5% to 9.5% as of December 31, 2018. Significant increases or decreases in these inputs would have resulted in a significantly lower or higher fair value measurement.
b. | Multi-Family Loans Held in Securitization Trusts – Multi-family loans held in securitization trusts are carried at fair value and classified as Level 3 fair values. In accordance with the practical expedient in ASC 810, the Company determines the fair value of multi-family loans held in securitization trusts based on the fair value of its Multi-Family CDOs and its retained interests from these securitizations (eliminated in consolidation in accordance with GAAP), as the fair value of these instruments is more observable.
c. | Derivative Instruments – The Company’s derivative instruments are classified as Level 2 fair values and are measured using valuations reported by the clearing house, CME Clearing, through which these instruments were cleared. The derivatives are presented net of variation margin payments pledged or received.
d. | Multi-Family CDOs – Multi-Family CDOs are recorded at fair value and classified as Level 3 fair values. The fair value of Multi-Family CDOs is determined using a third party pricing service or are based on quoted prices provided by dealers who make markets in similar financial instruments. The dealers will consider contractual cash payments and yields expected by market participants. Dealers also incorporate common market pricing methods, including a spread measurement to the Treasury curve or interest rate swap curve as well as underlying characteristics of the particular security including coupon, periodic and life caps, collateral type, rate reset period and seasoning or age of the security.
e. | Investments in Unconsolidated Entities – Fair value for investments in unconsolidated entities is determined based on a valuation model using assumptions for the timing and amount of expected future cash flow for income and realization events for the underlying assets in the unconsolidated entities and a discount rate. This fair value measurement is generally based on unobservable inputs and, as such, is classified as Level 3 in the fair value hierarchy.
f. | Residential Mortgage Loans – Certain of the Company’s acquired distressed and other residential mortgage loans are recorded at fair value and classified as Level 3 in the fair value hierarchy. The fair value for distressed and other residential mortgage loans is determined using valuations obtained from a third party that specializes in providing valuations of residential mortgage loans. The valuation approach depends on whether the residential mortgage loan is considered performing, re-performing or non-performing at the date the valuation is performed.
For performing and re-performing loans, estimates of fair value are derived using a discounted cash flow model, where estimates of cash flows are determined from scheduled payments for each loan, adjusted using forecast prepayment rates, default rates and rates for loss upon default. For non-performing loans, asset liquidation cash flows are derived based on the estimated time to liquidate the loan, expected liquidation costs and home price appreciation. The discount rate used in determining fair value for distressed and other residential mortgage loans ranges from 3.9% to 12.8%. Any changes to the valuation methodology are reviewed by management to ensure the changes are appropriate. As markets and products develop and the pricing for certain products becomes more transparent, the Company continues to refine its valuation methodologies. The methods described above may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, while the Company believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies, or assumptions, to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. The Company uses inputs that are current as of each reporting date, which may include periods of market dislocation, during which time price transparency may be reduced. This condition could cause the Company’s financial instruments to be reclassified from Level 2 to Level 3 in future periods. The following table presents the Company’s financial instruments measured at fair value on a recurring basis as of September 30, 2019 and December 31, 2018, respectively, on the Company’s condensed consolidated balance sheets (dollar amounts in thousands):
| Measured at Fair Value on a Recurring Basis at
| September 30, 2019 |  | December 31, 2018
| Level 1 |  | Level 2 |  | Level 3 |  | Total |  | Level 1 |  | Level 2 |  | Level 3 |  | Total
Assets carried at fair value |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Investment securities available for sale: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Agency RMBS | $ | — |  |  | $ | 955,838 |  |  | $ | — |  |  | $ | 955,838 |  |  | $ | — |  |  | $ | 1,037,730 |  |  | $ | — |  |  | $ | 1,037,730 |
Non-Agency RMBS | — |  |  | 621,528 |  |  | — |  |  | 621,528 |  |  | — |  |  | 214,037 |  |  | — |  |  | 214,037 |
CMBS | — |  |  | 278,398 |  |  | — |  |  | 278,398 |  |  | — |  |  | 207,785 |  |  | 52,700 |  |  | 260,485 |
ABS | — |  |  | 48,254 |  |  | — |  |  | 48,254 |  |  | — |  |  | — |  |  | — |  |  | — |
Multi-family loans held in securitization trusts | — |  |  | — |  |  | 15,863,264 |  |  | 15,863,264 |  |  | — |  |  | — |  |  | 11,679,847 |  |  | 11,679,847 |
Distressed and other residential mortgage loans, at fair value | — |  |  | — |  |  | 1,116,128 |  |  | 1,116,128 |  |  | — |  |  | — |  |  | 737,523 |  |  | 737,523 |
Derivative assets: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Interest rate swaps (1) | — |  |  | 20,673 |  |  | — |  |  | 20,673 |  |  | — |  |  | 10,263 |  |  | — |  |  | 10,263 |
Investments in unconsolidated entities | — |  |  | — |  |  | 76,249 |  |  | 76,249 |  |  | — |  |  | — |  |  | 32,994 |  |  | 32,994 |
Total | $ | — |  |  | $ | 1,924,691 |  |  | $ | 17,055,641 |  |  | $ | 18,980,332 |  |  | $ | — |  |  | $ | 1,469,815 |  |  | $ | 12,503,064 |  |  | $ | 13,972,879 |
Liabilities carried at fair value |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Multi-family collateralized debt obligations | $ | — |  |  | $ | — |  |  | $ | 14,978,199 |  |  | $ | 14,978,199 |  |  | $ | — |  |  | $ | — |  |  | $ | 11,022,248 |  |  | $ | 11,022,248 |
Total | $ | — |  |  | $ | — |  |  | $ | 14,978,199 |  |  | $ | 14,978,199 |  |  | $ | — |  |  | $ | — |  |  | $ | 11,022,248 |  |  | $ | 11,022,248 |
(1) | All of the Company's interest rate swaps outstanding are cleared through a central clearing house. The Company exchanges variation margin for swaps based upon daily changes in fair value. Includes derivative liabilities of $40.4 million netted against a variation margin of $61.1 million at September 30, 2019. Includes derivative assets of $1.8 million and variation margin of $8.5 million at December 31, 2018.
The following tables detail changes in valuation for the Level 3 assets for the nine months ended September 30, 2019 and 2018, respectively (amounts in thousands): Level 3 Assets:
| Nine Months Ended September 30, 2019
| Multi-family loans held in securitization trusts |  | Distressed and other residential mortgage loans |  | Investments in unconsolidated entities |  | CMBS held in securitization trusts |  | Total
Balance at beginning of period | $ | 11,679,847 |  |  | $ | 737,523 |  |  | $ | 32,994 |  |  | $ | 52,700 |  |  | $ | 12,503,064 |
Total gains/(losses) (realized/unrealized) |  |  |  |  |  |  |  |  |
Included in earnings | 760,132 |  |  | 44,913 |  |  | 7,169 |  |  | 17,734 |  |  | 829,948 |
Included in other comprehensive income (loss) | — |  |  | — |  |  | — |  |  | (13,665 | ) |  | (13,665 | )
Transfers in | — |  |  | — |  |  | — |  |  | — |  |  | — |
Transfers out | — |  |  | (437 | ) |  | — |  |  | — |  |  | (437 | )
Contributions | — |  |  | — |  |  | 50,000 |  |  | — |  |  | 50,000 |
Paydowns/Distributions | (368,811 | ) |  | (106,113 | ) |  | (13,914 | ) |  | — |  |  | (488,838 | )
Charge-off | (3,510 | ) |  | — |  |  | — |  |  | — |  |  | (3,510 | )
Sales | — |  |  | (19,814 | ) |  | — |  |  | (56,769 | ) |  | (76,583 | )
Purchases (1) | 3,795,606 |  |  | 460,056 |  |  | — |  |  | — |  |  | 4,255,662 |
Balance at the end of period | $ | 15,863,264 |  |  | $ | 1,116,128 |  |  | $ | 76,249 |  |  | $ | — |  |  | $ | 17,055,641 |
(1) | During the nine months ended September 30, 2019, the Company purchased first loss PO securities, and certain IOs and senior or mezzanine CMBS securities issued from securitizations that it determined to consolidate and included in the Consolidated K-Series. As a result, the Company consolidated assets of these securitizations in the amount of $3.8 billion during the nine months ended September 30, 2019 (see Notes 2 and 6).
| Nine Months Ended September 30, 2018
| Multi-family loans held in securitization trusts |  | Distressed and other residential mortgage loans |  | Investments in unconsolidated entities |  | CMBS held in securitization trusts |  | Total
Balance at beginning of period | $ | 9,657,421 |  |  | $ | 87,153 |  |  | $ | 42,823 |  |  | $ | 47,922 |  |  | $ | 9,835,319 |
Total (losses)/gains (realized/unrealized) |  |  |  |  |  |  |  |  |
Included in earnings | (289,797 | ) |  | (1,361 | ) |  | 7,930 |  |  | 2,928 |  |  | (280,300 | )
Included in other comprehensive income (loss) | — |  |  | — |  |  | — |  |  | 901 |  |  | 901 |
Transfers in | — |  |  | — |  |  | — |  |  | — |  |  | — |
Transfers out | — |  |  | — |  |  | — |  |  | — |  |  | — |
Contributions | — |  |  | — |  |  | — |  |  | — |  |  | — |
Paydowns/Distributions | (101,953 | ) |  | (15,456 | ) |  | (15,692 | ) |  | — |  |  | (133,101 | )
Sales | — |  |  | (7,105 | ) |  | — |  |  | — |  |  | (7,105 | )
Purchases (1) | 805,163 |  |  | 118,679 |  |  | — |  |  | — |  |  | 923,842 |
Balance at the end of period | $ | 10,070,834 |  |  | $ | 181,910 |  |  | $ | 35,061 |  |  | $ | 51,751 |  |  | $ | 10,339,556 |
(1) | During the nine months ended September 30, 2018, the Company purchased first loss PO securities and certain IOs and mezzanine CMBS securities issued from securitizations that it determined to consolidate and included in the Consolidated K-Series. As a result, the Company consolidated assets of these securitizations in the amount of $0.8 billion during the nine months ended September 30, 2018 (see Notes 2 and 6).
The following table details changes in valuation for the Level 3 liabilities (Multi-family CDOs) for the nine months ended September 30, 2019 and 2018, respectively (amounts in thousands): Level 3 Liabilities:
| Nine Months Ended September 30,
| 2019 |  | 2018
Balance at beginning of period | $ | 11,022,248 |  |  | $ | 9,189,459 |
Total losses (gains) (realized/unrealized) |  |  |
Included in earnings | 694,043 |  |  | (350,674 | )
Purchases (1) | 3,633,525 |  |  | 767,477 |
Paydowns | (368,107 | ) |  | (101,949 | )
Charge-off | (3,510 | ) |  | — |
Balance at the end of period | $ | 14,978,199 |  |  | $ | 9,504,313 |
(1) | During the nine months ended September 30, 2019 and 2018, the Company purchased PO securities and certain IOs and senior or mezzanine CMBS securities issued from securitizations that it determined to consolidate and included in the Consolidated K-Series. As a result, the Company consolidated liabilities of these securitizations in the amount of $3.6 billion and $0.8 billion during the nine months ended September 30, 2019 and 2018, respectively (see Notes 2 and 6).
The following table details the changes in unrealized gains (losses) included in earnings for the three and nine months ended September 30, 2019 and 2018 for our Level 3 assets and liabilities held as of September 30, 2019 and 2018, respectively (dollar amounts in thousands):
| Three Months Ended September 30, |  | Nine Months Ended September 30,
| 2019 |  | 2018 |  | 2019 |  | 2018
Assets |  |  |  |  |  |  |
Multi-family loans held in securitization trusts (1) | $ | 197,837 |  |  | $ | (33,153 | ) |  | $ | 802,625 |  |  | $ | (252,899 | )
Investments in unconsolidated entities (2) | 449 |  |  | 4,092 |  |  | 1,295 |  |  | 5,359 |
Distressed and other residential mortgage loans, at fair value (1) | 17,413 |  |  | (629 | ) |  | 37,079 |  |  | (754 | )
Liabilities |  |  |  |  |  |  |
Multi-family debt held in securitization trusts (1) | (190,207 | ) |  | 45,456 |  |  | (780,378 | ) |  | 284,766 |
(1) | Presented in unrealized gains (losses), net on the Company's condensed consolidated statements of operations.
(2) | Presented in other income on the Company's condensed consolidated statements of operations.
The following table presents assets measured at fair value on a non-recurring basis as of September 30, 2019 and December 31, 2018, respectively, on the Company's condensed consolidated balance sheets (dollar amounts in thousands):
| Assets Measured at Fair Value on a Non-Recurring Basis at
| September 30, 2019 |  | December 31, 2018
| Level 1 |  | Level 2 |  | Level 3 |  | Total |  | Level 1 |  | Level 2 |  | Level 3 |  | Total
Residential mortgage loans held in securitization trusts – impaired loans, net | — |  |  | — |  |  | $ | 5,350 |  |  | $ | 5,350 |  |  | — |  |  | — |  |  | $ | 5,921 |  |  | $ | 5,921 |
The following table presents gains (losses) incurred for assets measured at fair value on a non-recurring basis for the three and nine months ended September 30, 2019 and 2018, respectively, on the Company’s condensed consolidated statements of operations (dollar amounts in thousands):
| Three Months Ended September 30, |  | Nine Months Ended September 30,
| 2019 |  | 2018 |  | 2019 |  | 2018
Residential mortgage loans held in securitization trusts – impaired loans, net | $ | 13 |  |  | $ | (17 | ) |  | $ | (24 | ) |  | $ | 93 |
Residential Mortgage Loans Held in Securitization Trusts – Impaired Loans, net – Impaired residential mortgage loans held in securitization trusts are recorded at amortized cost less specific loan loss reserves. Impaired loan value is based on management’s estimate of the net realizable value taking into consideration local market conditions of the property, updated appraisal values of the property and estimated expenses required to remediate the impaired loan. The following table presents the carrying value and estimated fair value of the Company’s financial instruments at September 30, 2019 and December 31, 2018, respectively (dollar amounts in thousands):
|  |  | September 30, 2019 |  | December 31, 2018
| Fair Value Hierarchy Level |  | Carrying Value |  | Estimated Fair Value |  | Carrying Value |  | Estimated Fair Value
Financial Assets: |  |  |  |  |  |  |  |  |
Cash and cash equivalents | Level 1 |  | $ | 65,906 |  |  | $ | 65,906 |  |  | $ | 103,724 |  |  | $ | 103,724 |
Investment securities, available for sale | Level 2 or 3 |  | 1,904,018 |  |  | 1,904,018 |  |  | 1,512,252 |  |  | 1,512,252 |
Distressed and other residential mortgage loans, at fair value | Level 3 |  | 1,116,128 |  |  | 1,116,128 |  |  | 737,523 |  |  | 737,523 |
Distressed and other residential mortgage loans, net | Level 3 |  | 210,466 |  |  | 213,398 |  |  | 285,261 |  |  | 289,376 |
Investments in unconsolidated entities | Level 3 |  | 168,933 |  |  | 170,150 |  |  | 73,466 |  |  | 73,833 |
Preferred equity and mezzanine loan investments | Level 3 |  | 178,997 |  |  | 181,626 |  |  | 165,555 |  |  | 167,739 |
Multi-family loans held in securitization trusts | Level 3 |  | 15,863,264 |  |  | 15,863,264 |  |  | 11,679,847 |  |  | 11,679,847 |
Derivative assets | Level 2 |  | 20,673 |  |  | 20,673 |  |  | 10,263 |  |  | 10,263 |
Mortgage loans held for sale, net (1) | Level 3 |  | 2,437 |  |  | 2,525 |  |  | 3,414 |  |  | 3,584 |
Mortgage loans held for investment (1) | Level 3 |  | — |  |  | — |  |  | 1,580 |  |  | 1,580 |
Financial Liabilities: |  |  |  |  |  |  |  |  |
Repurchase agreements | Level 2 |  | 2,559,880 |  |  | 2,559,880 |  |  | 2,131,505 |  |  | 2,131,505 |
Residential collateralized debt obligations | Level 3 |  | 42,119 |  |  | 40,534 |  |  | 53,040 |  |  | 50,031 |
Multi-family collateralized debt obligations | Level 3 |  | 14,978,199 |  |  | 14,978,199 |  |  | 11,022,248 |  |  | 11,022,248 |
Securitized debt | Level 3 |  | — |  |  | — |  |  | 42,335 |  |  | 45,030 |
Subordinated debentures | Level 3 |  | 45,000 |  |  | 41,273 |  |  | 45,000 |  |  | 44,897 |
Convertible notes | Level 2 |  | 132,395 |  |  | 140,557 |  |  | 130,762 |  |  | 135,689 |
(1) | Included in receivables and other assets in the accompanying condensed consolidated balance sheets.
In addition to the methodology to determine the fair value of the Company’s financial assets and liabilities reported at fair value on a recurring basis and non-recurring basis, as previously described, the following methods and assumptions were used by the Company in arriving at the fair value of the Company’s other financial instruments in the table immediately above:
a. | Cash and cash equivalents – Estimated fair value approximates the carrying value of such assets.
b. | Distressed and other residential mortgage loans, net and Mortgage loans held for sale, net – The fair value is determined using valuations obtained from a third party that specializes in providing valuations of residential mortgage loans. For performing and re-performing loans, estimates of fair value are derived using a discounted cash flow model, where estimates of cash flows are determined from scheduled payments for each loan, adjusted using forecast prepayment rates, default rates and rates for loss upon default. For non-performing loans, asset liquidation cash flows are derived based on the estimated time to liquidate the loan, expected liquidation costs and home price appreciation.
c. | Preferred equity and mezzanine loan investments – Estimated fair value is determined by both market comparable pricing and discounted cash flows. The discounted cash flows are based on the underlying contractual cash flows and estimated changes in market yields. The fair value also reflects consideration of changes in credit risk since the origination or time of initial investment.
d. | Repurchase agreements – The fair value of these repurchase agreements approximates cost as they are short term in nature.
e. | Residential collateralized debt obligations – The fair value of these CDOs is based on discounted cash flows as well as market pricing on comparable obligations.
f. | Securitized debt – The fair value of securitized debt is based on discounted cash flows using management’s estimate for market yields.
g. | Subordinated debentures – The fair value of these subordinated debentures is based on discounted cash flows using management’s estimate for market yields.
h. Convertible notes – The fair value is based on quoted prices provided by dealers who make markets in similar financial instruments.

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- 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. + References Reference 1: http://www.xbrl.org/2003/role/disclosureRef -Publisher FASB -Name Accounting Standards Codification -Topic 820 -SubTopic 10 -Section 50 -Paragraph 2 -URI http://asc.fasb.org/extlink&oid=117815213&loc=d3e19207-110258 + Details
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