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Fair Value of Financial Instruments

9 Months Ended

Sep. 30, 2020

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 available for sale in our portfolio by considering several observable market data points, including prices obtained from third-party pricing services or dealers who make markets in similar financial instruments, as well as dialogue with market participants. Third-party pricing services typically incorporate commonly used market pricing methods, trading activity observed in the marketplace and other data inputs. The methodology considers the characteristics of the particular security and its underlying collateral, which are observable inputs. These inputs include, but are not limited to, historical performance, coupon, periodic and life caps, collateral type, rate reset period, seasoning, prepayment speeds and credit enhancement levels. The Company’s investment securities available for sale are valued based upon readily observable market parameters and are classified as Level 2 fair values.

b.Multi-Family Loans Held in Securitization Trusts and Residential Loans Held in Consolidated SLST – Multi-family loans held in securitization trusts and residential loans held in Consolidated SLST 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 and residential loans held in Consolidated SLST 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.

c.Residential Loans and Residential Loans Held in Securitization Trusts – The Company’s acquired residential loans are recorded at fair value and classified as Level 3 in the fair value hierarchy. The fair value for residential loans is determined using valuations obtained from a third party that specializes in providing valuations of residential loans. The valuation approach depends on whether the residential 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. Estimated cash flows for both performing and non-performing loans are discounted at yields considered appropriate to arrive at a reasonable exit price for the asset. Indications of loan value such as actual trades, bids, offers and generic market color may be used in determining the appropriate discount yield.

d.Derivative Instruments – The Company’s derivative instruments as of December 31, 2019 were classified as Level 2 fair values and were measured using valuations reported by the clearing house, CME Clearing, through which these instruments were cleared. The derivatives were presented net of variation margin payments pledged or received.

e.Investments in Unconsolidated Entities – Fair value for investments in unconsolidated entities is determined by (i) the valuation process for residential loans as described in c. above, (ii) the valuation process for preferred equity and mezzanine loan investments as described in f. below or (iii) provided by the general partner of the equity investment entity. These fair value measurements are generally based on unobservable inputs and, as such, are classified as Level 3 in the fair value hierarchy.

f.Preferred Equity and Mezzanine Loan Investments – Fair value for preferred equity and mezzanine loan investments 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. This fair value measurement is generally based on unobservable inputs and, as such, is classified as Level 3 in the fair value hierarchy.

g.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 by considering several market data points, including prices obtained from third-party pricing services or dealers who make markets in similar financial instruments. The third-party pricing service or dealers incorporate common market pricing methods, including a spread measurement to the Treasury curve or interest rate swap curve as well as underlying characteristics of a particular security. They will also consider contractual cash payments and yields expected by market participants.

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 September 30, 2020 and December 31, 2019, respectively, on the Company’s condensed consolidated balance sheets (dollar amounts in thousands):


	Measured at Fair Value on a Recurring Basis at
	September 30, 2020								December 31, 2019
	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
Agency CMBS	—		—		—		—		—		50,958		—		50,958
Non-Agency RMBS	—		375,765		—		375,765		—		715,314		—		715,314
CMBS	—		182,925		—		182,925		—		267,777		—		267,777
ABS	—		45,007		—		45,007		—		49,214		—		49,214
Residential loans, at fair value:
Residential loans	—		—		1,177,298		1,177,298		—		—		1,429,754		1,429,754
Consolidated SLST	—		—		1,290,005		1,290,005		—		—		1,328,886		1,328,886
Residential loans held in securitization trusts	—		—		355,486		355,486		—		—		—		—
Investments in unconsolidated entities	—		—		218,706		218,706		—		—		83,882		83,882
Preferred equity and mezzanine loan investments	—		—		183,154		183,154		—		—		—		—
Multi-family loans held in securitization trusts, at fair value	—		—		—		—		—		—		17,816,746		17,816,746
Derivative assets:
Interest rate swaps (1)	—		—		—		—		—		15,878		—		15,878
Total	$	—	$	603,697	$	3,224,649	$	3,828,346	$	—	$	2,022,018	$	20,659,268	$	22,681,286
Liabilities carried at fair value
Multi-family collateralized debt obligations, at fair value	$	—	$	—	$	—	$	—	$	—	$	—	$	16,724,451	$	16,724,451





Residential collateralized debt obligations, at fair value	—		—		1,077,980		1,077,980		—		—		1,052,829		1,052,829
Total	$	—	$	—	$	1,077,980	$	1,077,980	$	—	$	—	$	17,777,280	$	17,777,280

(1)All of the Company's interest rate swaps were cleared through a central clearing house. The Company exchanged variation margin for swaps based upon daily changes in fair value. Included derivative liabilities of $29.0 million netted against a variation margin of $44.8 million at December 31, 2019.

The following tables detail changes in valuation for the Level 3 assets for the nine months ended September 30, 2020 and 2019, respectively (dollar amounts in thousands):

Level 3 Assets:


	Nine Months Ended September 30, 2020
	Residential loans		Consolidated SLST		Residential loans held in securitization trusts		Investments in unconsolidated entities		Preferred equity and mezzanine loan investments		Multi-family loans held in securitization trusts		Total
Balance at beginning of period	$	1,429,754	$	1,328,886	$	—	$	83,882	$	—	$	17,816,746	$	20,659,268
Total (losses)/gains (realized/unrealized)
Included in earnings	(26,069)		24,096		8,836		14,573		9,760		41,795		72,991

Transfers in (1)	164,279		—		46,572		107,477		182,465		—		500,793
Transfers out (2) (3)	(5,061)		—		(1,497)		—		—		(237,297)		(243,855)
Transfer to securitization trust (4)	(317,089)		—		317,089		—		—		—		—
Contributions	—		—		—		35,951		13,712		—		49,663
Paydowns/Distributions	(224,073)		(62,977)		(15,514)		(23,177)		(22,783)		(239,796)		(588,320)
Recovery of charge-off	—		—		—		—		—		35		35
Sales (3)	(93,755)		—		—		—		—		(17,381,483)		(17,475,238)
Purchases	249,312		—		—		—		—		—		249,312
Balance at the end of period	$	1,177,298	$	1,290,005	$	355,486	$	218,706	$	183,154	$	—	$	3,224,649

(1)As of January 1, 2020, the Company has elected to account for all residential loans, residential loans held in securitization trusts, investments in unconsolidated entities and preferred equity and mezzanine loan investments using the fair value option (see Note 2).

(2)Transfers out of Level 3 assets include the transfer of residential loans to real estate owned.

(3)During the nine months ended September 30, 2020, the Company sold first loss PO securities included in the Consolidated K-Series and, as a result, de-consolidated multi-family loans held in securitization trusts and transferred its remaining securities owned in the Consolidated K-Series to investment securities available for sale (see Notes 2 and 6).

(4)In July 2020, the Company completed a securitization of certain performing, re-performing and non-performing residential loans (see Note 9).


	Nine Months Ended September 30, 2019
	Residential loans		Investments in unconsolidated entities		Multi-family loans held in securitization trusts		CMBS held in securitization trusts		Total
Balance at beginning of period	$	737,523	$	32,994	$	11,679,847	$	52,700	$	12,503,064
Total gains/(losses) (realized/unrealized)
Included in earnings	44,913		7,169		760,132		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	(106,113)		(13,914)		(368,811)		—		(488,838)
Charge-off	—		—		(3,510)		—		(3,510)
Sales	(19,814)		—		—		(56,769)		(76,583)
Purchases (1)	460,056		—		3,795,606		—		4,255,662
Balance at the end of period	$	1,116,128	$	76,249	$	15,863,264	$	—	$	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).

The following tables detail changes in valuation for the Level 3 liabilities for the nine months ended September 30, 2020 and 2019, respectively (dollar amounts in thousands):

Level 3 Liabilities:


	Nine Months Ended September 30, 2020
	Multi-Family CDOs		SLST CDOs		Total
Balance at beginning of period	$	16,724,451	$	1,052,829	$	17,777,280
Total losses/(gains) (realized/unrealized)
Included in earnings	35,018		66,203		101,221


Paydowns	(147,376)		(63,278)		(210,654)
Sales (1)	(16,612,093)		22,226		(16,589,867)
Transfers out	—		—		—
Balance at the end of period	$	—	$	1,077,980	$	1,077,980

(1)During the nine months ended September 30, 2020, the Company sold first loss PO securities included in the Consolidated K-Series and, as a result, de-consolidated the Multi-Family CDOs (see Notes 2 and 6). Also includes the Company's net sales of senior securities issued by Consolidated SLST during the nine months ended September 30, 2020 (see Note 4).


	Nine Months Ended September 30, 2019
	Multi-Family CDOs
Balance at beginning of period	$	11,022,248
Total losses (realized/unrealized)
Included in earnings	694,043

Purchases (1)	3,633,525
Paydowns	(368,107)

Charge-off	(3,510)
Balance at the end of period	$	14,978,199

(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 liabilities of these securitizations in the amount of $3.6 billion during the nine months ended September 30, 2019 (see Notes 2 and 6).

The following table discloses quantitative information regarding the significant unobservable inputs used in the valuation of our Level 3 assets and liabilities measured at fair value (dollar amounts in thousands, except input values):


September 30, 2020	Fair Value	Valuation Technique	Unobservable Input	Weighted Average	Range
Assets
Residential loans, at fair value:
Residential loans and residential loans held in securitization trusts (1)	$1,397,090	Discounted cash flow	Lifetime CPR	9.6%	—	-	67.6%
			Lifetime CDR	2.6%	—	-	100.0%
			Loss severity	16.3%	—	-	100.0%
			Yield	5.3%	2.3%	-	35.0%

	$135,694	Liquidation model	Annual home price appreciation	0.1%	—	-	5.7%
			Liquidation timeline (months)	29	1	-	57
			Property value	$572,723	$12,430	-	$3,550,000
			Yield	7.1%	7.0%	-	35.0%

Residential loans held in Consolidated SLST (2)	$1,290,005		Liability price	N/A

Total	$2,822,789

Investments in unconsolidated entities (1)	$145,250	Discounted cash flow	Discount rate	12.5%	12.0%	-	13.5%
			Months to assumed redemption	42	18	-	56
			Loss severity	—

Preferred equity and mezzanine loan investments (1)	$183,154	Discounted cash flow	Discount rate	12.4%	11.5%	-	16.0%
			Months to assumed redemption	45	1	-	186
			Loss severity	—
Liabilities
Residential collateralized debt obligations, at fair value
SLST CDOs (2) (3)	$1,077,980	Discounted cash flow	Yield	2.3%	1.2%	-	11.5%
			Collateral prepayment rate	5.5%	2.8%	-	6.1%
			Collateral default rate	2.0%	—	-	6.8%
			Loss severity	21.1%	—	-	23.7%

(1)Weighted average amounts are calculated based on the weighted average fair value of the assets.

(2)In accordance with the practical expedient in ASC 810, the Company determines the fair value of the residential loans held in Consolidated SLST based on the fair value of SLST CDOs, including securities we own, as the fair value of these instruments is more observable. At September 30, 2020, the fair value of securities we owned in Consolidated SLST was $210.9 million.

(3)Weighted average yield calculated based on the weighted average fair value of the liabilities. Weighted average collateral prepayment rate, weighted average collateral default rate, and weighted average loss severity are calculated based on the weighted average unpaid balance of the liabilities.

The following table details the changes in unrealized gains (losses) included in earnings for the three and nine months ended September 30, 2020 and 2019 for our Level 3 assets and liabilities held as of September 30, 2020 and 2019, respectively (dollar amounts in thousands):


	Three Months Ended September 30,				Nine Months Ended September 30,
	2020		2019		2020		2019
Assets
Residential loans, at fair value
Residential loans (1)	$	35,420	$	17,413	$	(883)	$	37,079
Consolidated SLST (1)	41,063		—		28,014		—
Residential loans held in securitization trusts (1)	817		—		(823)		—
Investments in unconsolidated entities (2)	7		449		(4,052)		1,295
Preferred equity and mezzanine loan investments (1)	(955)		—		(6,518)		—
Multi-family loans held in securitization trusts, at fair value (1)	—		197,837		—		802,625
Liabilities
Multi-family collateralized debt obligations, at fair value (1)	—		(190,207)		—		(780,378)
Residential collateralized debt obligations, at fair value (1)	(13,918)		—		(62,907)		—

(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 December 31, 2019, on the Company's condensed consolidated balance sheets (dollar amounts in thousands):


	December 31, 2019
	Level 1	Level 2	Level 3		Total
Residential loans held in securitization trusts – impaired loans, net	—	—	$	5,256	$	5,256

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, respectively, on the Company’s condensed consolidated statements of operations (dollar amounts in thousands):


	Three Months Ended September 30, 2019		Nine Months Ended September 30, 2019
Residential loans held in securitization trusts – impaired loans, net	$	13	$	(24)

Residential Loans Held in Securitization Trusts – Impaired Loans, net – Impaired residential loans held in securitization trusts, net were recorded at amortized cost less specific loan loss reserves. Impaired loan value was 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, 2020 and December 31, 2019, respectively (dollar amounts in thousands):


		September 30, 2020				December 31, 2019
	Fair Value Hierarchy Level	Carrying Value		Estimated Fair Value		Carrying Value		Estimated Fair Value
Financial Assets:
Cash and cash equivalents	Level 1	$	649,822	$	649,822	$	118,763	$	118,763
Investment securities available for sale, at fair value	Level 2	603,697		603,697		2,006,140		2,006,140
Residential loans, at fair value
Residential loans	Level 3	1,177,298		1,177,298		1,429,754		1,429,754
Consolidated SLST	Level 3	1,290,005		1,290,005		1,328,886		1,328,886
Residential loans held in securitization trusts	Level 3	355,486		355,486		—		—
Residential loans, net	Level 3	—		—		202,756		208,471
Investments in unconsolidated entities	Level 3	218,706		218,706		189,965		191,359
Preferred equity and mezzanine loan investments	Level 3	183,154		183,154		180,045		182,465
Multi-family loans held in securitization trusts, at fair value	Level 3	—		—		17,816,746		17,816,746
Derivative assets	Level 2	—		—		15,878		15,878
Loans held for sale, net (1)	Level 3	—		—		2,406		2,482


Financial Liabilities:
Repurchase agreements	Level 2	672,519		672,519		3,105,416		3,105,416
Securitized debt	Level 2	88,791		90,096		—		—
Residential collateralized debt obligations	Level 3	268,820		269,749		40,429		38,888
Multi-family collateralized debt obligations, at fair value	Level 3	—		—		16,724,451		16,724,451
Residential collateralized debt obligations, at fair value	Level 3	1,077,980		1,077,980		1,052,829		1,052,829


Subordinated debentures	Level 3	45,000		32,548		45,000		41,592
Convertible notes	Level 2	134,720		135,457		132,955		140,865

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.Repurchase agreements – The fair value of these repurchase agreements approximates cost as they are short term in nature.

c.Securitized debt - The fair value is based on discounted cash flows as well as market pricing on comparable obligations.

d.Residential collateralized debt obligations – The fair value of these CDOs is based on discounted cash flows as well as market pricing on comparable obligations.

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

f.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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