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Fair Value of Financial Instruments

12 Months Ended

Dec. 31, 2019

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.

Investment Securities, Available for Sale – The Company determines the fair value of the investment securities in our portfolio, except the CMBS held in re-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. The Company’s investment securities, except the CMBS held in re-securitization trusts, are valued based upon readily observable market parameters and are classified as Level 2 fair values.

The Company’s CMBS held in re-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 re-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 result in a significantly lower or higher fair value measurement.

Multi-Family Loans and Residential Mortgage Loans Held in Securitization Trusts, at fair value – Multi-family and residential mortgage 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 and residential mortgage loans held in securitization trusts based on the fair value of its Multi-Family CDOs and SLST 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.

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 3.8% to 16.1%.


d.	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.

Investments in Unconsolidated Entities – Fair value for investments in unconsolidated entities is determined either by a valuation model using assumptions for the timing and amount of expected future cash flow for income and realization events for the underlying assets and a discount rate or the valuation process for residential mortgage loans as described in c. above. These fair value measurements are generally based on unobservable inputs and, as such, are classified as Level 3 in the fair value hierarchy.

Multi-Family and Residential Collateral Debt Obligations, at fair value – Multi-Family CDOs and SLST CDOs are classified as Level 3 fair values. The fair value of Multi-Family CDOs and SLST 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.

Management reviews all prices used in determining fair value to ensure they represent current market conditions. This review includes surveying similar market transactions and comparisons to interest pricing models as well as offerings of like securities by dealers. 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 December 31, 2019 and 2018, respectively, on the Company’s consolidated balance sheets (dollar amounts in thousands):



	Measured at Fair Value on a Recurring Basis at
	December 31, 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, at fair value:
Agency RMBS	$	—	$	922,877	$	—	$	922,877	$	—	$	1,037,730	$	—	$	1,037,730
Agency CMBS	—		50,958		—		50,958		—		—		—		—
Non-Agency RMBS	—		715,314		—		715,314		—		214,037		—		214,037
CMBS	—		267,777		—		267,777		—		207,785		52,700		260,485
ABS	—		49,214		—		49,214		—		—		—		—
Multi-family loans held in securitization trusts, at fair value	—		—		17,816,746		17,816,746		—		—		11,679,847		11,679,847
Residential mortgage loans held in securitization trust, at fair value	—		—		1,328,886		1,328,886		—		—		—		—
Distressed and other residential mortgage loans, at fair value	—		—		1,429,754		1,429,754		—		—		737,523		737,523
Derivative Assets:
Interest rate swaps ⁽¹⁾	—		15,878		—		15,878		—		10,263		—		10,263
Investments in unconsolidated entities	—		—		83,882		83,882		—		—		32,994		32,994
	$	—	$	2,022,018	$	20,659,268	$	22,681,286	$	—	$	1,469,815	$	12,503,064	$	13,972,879
Liabilities carried at fair value
Multi-family collateralized debt obligations, at fair value	$	—	$	—	$	16,724,451	$	16,724,451	$	—	$	—	$	11,022,248	$	11,022,248
Residential collateralized debt obligations, at fair value	—		—		1,052,829		1,052,829		—		—		—		—
Total	$	—	$	—	$	17,777,280	$	17,777,280	$	—	$	—	$	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 $29.0 million netted against a variation margin of $44.8 million at December 31, 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 years ended December 31, 2019, 2018, and 2017, respectively (dollar amounts in thousands):

Level 3 Assets:



	Year Ended December 31, 2019
	Multi-family loans held in securitization trusts			Distressed and other residential mortgage loans			Investments in unconsolidated entities			CMBS held in re-securitization trusts			Residential mortgage loans held in securitization trust			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	533,094			55,459			15,100			17,734			(445		)	620,942
Included in other comprehensive income (loss)	—			—			—			(13,665		)	—			(13,665		)
Transfers out ⁽¹⁾	—			(913		)	—			—			—			(913		)
Contributions	—			—			50,000			—			—			50,000
Paydowns/Distributions	(992,912		)	(171,909		)	(14,212		)	—			(3,729		)	(1,182,762		)
Charge-off	(3,257		)	—			—			—			—			(3,257		)
Sales	—			(19,814		)	—			(56,769		)	—			(76,583		)
Purchases ⁽²⁾	6,599,974			829,408			—			—			1,333,060			8,762,442
Balance at the end of period	$	17,816,746		$	1,429,754		$	83,882		$	—		$	1,328,886		$	20,659,268


⁽¹⁾	Transfers out of Level 3 assets include the transfer of residential mortgage loans to real estate owned during the year ended December 31, 2019.

⁽²⁾

During the year ended December 31, 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 include in the Consolidated K-Series. Also during the year ended December 31, 2019, the Company purchased first loss subordinated securities, IOs and senior RMBS securities issued from a securitization that it determined to consolidate as Consolidated SLST. As a result, the Company consolidated assets of the respective securitizations (see Notes 2 and 6).



	Year Ended December 31, 2018
	Multi-family loans held in securitization trusts			Distressed and other residential mortgage loans			Investments in unconsolidated entities			CMBS held in re-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	(134,298		)	3,913			9,075			3,980		(117,330		)
Included in other comprehensive income (loss)	—			—			—			798		798
Transfers out ⁽¹⁾	—			(56		)	—			—		(56		)
Paydowns/Distributions	(137,820		)	(24,064		)	(18,904		)	—		(180,788		)
Sales	—			(18,173		)	—			—		(18,173		)
Purchases ⁽²⁾	2,294,544			688,750			—			—		2,983,294
Balance at the end of period	$	11,679,847		$	737,523		$	32,994		$	52,700	$	12,503,064


⁽¹⁾	Transfers out of Level 3 assets include the transfer of residential loans to real estate owned during the year ended December 31, 2018.


⁽²⁾	During the year ended December 31, 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 (see Notes 2 and 6).



	Year Ended December 31, 2017
	Multi-family loans held in securitization trusts			Distressed and other residential mortgage loans			Investments in unconsolidated entities			CMBS held in re-securitization trusts		Total
Balance at beginning of period	$	6,939,844		$	17,769		$	60,332		$	43,897	$	7,061,842
Total (losses)/gains (realized/unrealized)
Included in earnings	(31,784		)	135			10,385			3,423		(17,841		)
Included in other comprehensive income (loss)	—			—			—			602		602
Contributions	—			—			2,500			—		2,500
Paydowns/Distributions	(137,164		)	(8,479		)	(30,394		)	—		(176,037		)
Sales	—			(7,224		)	—			—		(7,224		)
Purchases ⁽¹⁾	2,886,525			84,952			—			—		2,971,477
Balance at the end of period	$	9,657,421		$	87,153		$	42,823		$	47,922	$	9,835,319


⁽¹⁾	During the year ended December 31, 2017, 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 (see Notes 2 and 6).

The following tables detail changes in valuation for the Level 3 liabilities for the years ended December 31, 2019, 2018 and 2017, respectively (dollar amounts in thousands):

Level 3 Liabilities:



	Year Ended December 31, 2019
	Multi-Family CDOs			SLST CDOs			Total
Balance at beginning of period	$	11,022,248		$	—		$	11,022,248
Total losses (realized/unrealized)
Included in earnings	443,796			27			443,823
Purchases ⁽¹⁾	6,253,739			1,055,720			7,309,459
Paydowns	(992,075		)	(2,918		)	(994,993		)
Charge-off	(3,257		)	—			(3,257		)
Balance at the end of period	$	16,724,451		$	1,052,829		$	17,777,280

⁽¹⁾

During the year ended December 31, 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 include in the Consolidated K-Series. Also during the year ended December 31, 2019, the Company purchased first loss subordinated securities, IOs and senior RMBS securities issued from a securitization that it determined to consolidate as Consolidated SLST. As a result, the Company consolidated liabilities of the respective securitizations (see Notes 2 and 6).



	Year Ended December 31, 2018
	Multi-Family CDOs
Balance at beginning of period	$	9,189,459
Total losses (realized/unrealized)
Included in earnings	(211,738		)
Purchases ⁽¹⁾	2,182,330
Paydowns	(137,803		)
Balance at the end of period	$	11,022,248


⁽¹⁾	During the year ended December 31, 2018, the Company purchased first loss PO securities and certain IOs and mezzanine CMBS securities issued from securitizations that it determined to consolidate and include in the Consolidated K-Series. As a result, the Company consolidated liabilities of these securitizations (see Notes 2 and 6).



	Year Ended December 31, 2017
	Multi-Family CDOs
Balance at beginning of period	$	6,624,896
Total losses (realized/unrealized)
Included in earnings	(82,650		)
Purchases ⁽¹⁾	2,784,377
Paydowns	(137,164		)
Balance at the end of period	$	9,189,459


⁽¹⁾	During the year ended December 31, 2017, the Company purchased first loss PO securities and certain IOs and mezzanine CMBS securities issued from securitizations that it determined to consolidate and include in the Consolidated K-Series. As a result, the Company consolidated liabilities of these securitizations (see Notes 2 and 6).

The following table details the changes in unrealized gains (losses) included in earnings for the years ended December 31, 2019, 2018 and 2017, respectively, for our Level 3 assets and liabilities held as of December 31, 2019, 2018 and 2017, respectively (dollar amounts in thousands):



	Years Ended December 31,
	2019			2018			2017
Assets
Multi-family loans held in securitization trusts, at fair value ⁽¹⁾	$	586,993		$	(85,115	)	$	10,021
Residential mortgage loans held in securitization trust, at fair value ⁽¹⁾	300			—			—
Distressed and other residential mortgage loans, at fair value ⁽¹⁾	44,470			4,333			—
Investments in unconsolidated entities ⁽²⁾	5,374			6,091			3,686

Liabilities
Multi-family collateralized debt obligations, at fair value ⁽¹⁾	$	(563,031	)	$	122,696		$	8,851
Residential collateralized debt obligations, at fair value ⁽¹⁾	(383		)	—			—


⁽¹⁾	Presented in unrealized gains (losses), net on the Company’s consolidated statements of operations.


⁽²⁾	Presented in other income on the Company’s consolidated statements of operations.

The following table presents assets measured at fair value on a non-recurring basis as of December 31, 2019 and 2018, respectively, on the Company’s consolidated balance sheets (dollar amounts in thousands):



	Assets Measured at Fair Value on a Non-Recurring Basis at
	December 31, 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	$	—	$	—	$	5,256	$	5,256	$	—	$	—	$	5,921	$	5,921

The following table presents gains (losses) incurred for assets measured at fair value on a non-recurring basis for the years ended December 31, 2019, 2018 and 2017, respectively, on the Company’s consolidated statements of operations (dollar amounts in thousands):



	Years Ended December 31,
	2019			2018			2017
Residential mortgage loans held in securitization trusts – impaired loans, net	$	(24	)	$	(165	)	$	(472	)
Real estate owned held in residential securitization trusts	—			—			(6		)

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.

Real Estate Owned Held in Residential Securitization Trusts – Real estate owned held in the residential securitization trusts were recorded at net realizable value. Any subsequent adjustment resulted in the reduction in carrying value with the corresponding amount charged to earnings. Net realizable value was based on an estimate of disposal taking into consideration local market conditions of the property, updated appraisal values of the property and estimated expenses required to sell the property.

The following table presents the carrying value and estimated fair value of the Company’s financial instruments at December 31, 2019 and 2018, respectively (dollar amounts in thousands):



		December 31, 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	$	118,763	$	118,763	$	103,724	$	103,724
Investment securities, available for sale	Level 2 or 3	2,006,140		2,006,140		1,512,252		1,512,252
Distressed and other residential mortgage loans, at fair value	Level 3	1,429,754		1,429,754		737,523		737,523
Distressed and other residential mortgage loans, net	Level 3	202,756		208,471		285,261		289,376
Investments in unconsolidated entities	Level 3	189,965		191,359		73,466		73,833
Preferred equity and mezzanine loan investments	Level 3	180,045		182,465		165,555		167,739
Multi-family loans held in securitization trusts, at fair value	Level 3	17,816,746		17,816,746		11,679,847		11,679,847
Residential mortgage loans held in securitization trust, at fair value	Level 3	1,328,886		1,328,886		—		—
Derivative assets	Level 2	15,878		15,878		10,263		10,263
Mortgage loans held for sale, net ⁽¹⁾	Level 3	2,406		2,482		3,414		3,584
Mortgage loans held for investment ⁽¹⁾	Level 3	—		—		1,580		1,580
Financial Liabilities:
Repurchase agreements	Level 2	3,105,416		3,105,416		2,131,505		2,131,505
Residential collateralized debt obligations	Level 3	40,429		38,888		53,040		50,031
Multi-family collateralized debt obligations, at fair value	Level 3	16,724,451		16,724,451		11,022,248		11,022,248
Residential collateralized debt obligations, at fair value	Level 3	1,052,829		1,052,829		—		—
Securitized debt	Level 3	—		—		42,335		45,030
Subordinated debentures	Level 3	45,000		41,592		45,000		44,897
Convertible notes	Level 2	132,955		140,865		130,762		135,689


⁽¹⁾	Included in receivables and other assets in the accompanying 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.

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 was based on discounted cash flows using management’s estimate for market yields at December 31, 2018. There was no securitized debt outstanding at December 31, 2019.


g.	Subordinated debentures – The fair value of these subordinated debentures is based on discounted cash flows using management’s estimate for market yields.

Convertible notes – The fair value is based on quoted prices provided by dealers who make markets in similar financial instruments.

- 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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