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Valuation
 9 Months Ended
Sep. 30, 2013
Fair Value Disclosures [Abstract]  
Valuation
Valuation
The Company applies ASC 820-10, Fair Value Measurement and Disclosures ("ASC 820-10"), to its holdings of financial instruments. ASC 820-10 establishes a three-level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. Financial instruments include securities and derivatives. 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 inputs or methodology used for valuing securities are not necessarily an indication of the risk associated with investing in these securities. The following is a description of the valuation methodologies used for 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.
The Company's Agency RMBS, exclusive of Agency interest only securities, or "Agency IOs," are classified as Level 2 assets. Fair value for Agency RMBS, excluding Agency IOs is determined using inputs considered to be observable including multiple indicative quotes from broker-dealers and recent trading activity for similar securities.
Level 3—valuation methodologies include (i) the solicitation of valuations from third parties (typically, broker-dealers), (ii) 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 assumptions and default rate assumptions, and (iii) the assessment of observable or reported recent trading activity. The Company utilizes such information to assign a good faith fair value (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 each such financial instrument. The Company's non-Agency RMBS and Agency IOs are classified as Level 3 assets.
The Company seeks to obtain at least one third-party indicative valuation for each instrument, and often obtains multiple indicative valuations when available. 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 assumptions and default rate assumptions. The Company has been able to obtain third-party valuations on the vast majority of its assets, and the Company expects to continue to solicit third-party valuations on substantially all assets in the future to the extent practical. Beginning January 1, 2013, the Company generally values each financial instrument at the average of third-party valuations received and not rejected as described below. Third-party valuations are not binding on the Company and while the Company generally does not adjust valuations it receives, it may challenge or reject a valuation when, based on validation criteria, the Company determines that such valuation is unreasonable or erroneous. Furthermore, the Company may determine, based on validation criteria, that for a given instrument the average of the third-party valuations received does not result in what the Company believes to be fair value, and in such circumstances the Company may override this average with its own good faith valuation. The validation criteria include the use of the Company's own models, recent trading activity in the same or similar instruments, and valuations received from third parties. Prior to 2013, the valuation process relied more heavily on the use of models and the observation of reported recent trading activity, which was substantiated by third-party valuations. The Company's valuation process, including the application of validation criteria, is overseen by a valuation committee. Because of the inherent uncertainty of valuation, these 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 following tables present the Company's financial instruments measured at fair value on:
September 30, 2013:
(In thousands)
 
 
 
 
 
 
 
 
Description
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
 
Real estate securities, at fair value:
 
 
 
 
 
 
 
 
Agency RMBS:
 
 
 
 
 
 
 
 
15-year fixed rate mortgages
 
$
—

 
$
199,450

 
$
—

 
$
199,450

30-year fixed rate mortgages
 
—

 
1,194,445

 
—

 
1,194,445

Adjustable rate mortgages
 
—

 
31,707

 
—

 
31,707

Interest only securities
 
—

 
—

 
12,722

 
12,722

Non-Agency RMBS
 
—

 
—

 
34,467

 
34,467

Real estate securities, at fair value
 
—

 
1,425,602

 
47,189

 
1,472,791

Financial derivatives-assets at fair value:
 
 
 
 
 
 
 
 
Fixed payer interest rate swaps
 
—

 
23,077

 
—

 
23,077

TBAs
 
—

 
104

 
—

 
104

Total financial derivatives-assets at fair value
 
—

 
23,181

 
—

 
23,181

Total real estate securities and financial derivatives-assets, at fair value
 
$
—

 
$
1,448,783

 
$
47,189

 
$
1,495,972

Liabilities:
 
 
 
 
 
 
 
 
Financial derivatives-liabilities at fair value:
 
 
 
 
 
 
 
 
Fixed payer interest rate swaps
 
$
—

 
$
(1,409
)
 
$
—

 
$
(1,409
)
Fixed payer swaptions
 
—

 
(86
)
 
—

 
(86
)
TBAs
 
—

 
(5,572
)
 
—

 
(5,572
)
Total financial derivatives-liabilities at fair value
 
$
—

 
$
(7,067
)
 
$
—

 
$
(7,067
)
There were no transfers of financial instruments between Levels 1, 2, or 3 of the fair value hierarchy during the nine month period ended September 30, 2013.
December 31, 2012:
(In thousands)
 
 
 
 
 
 
 
 
Description
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
 
Real estate securities, at fair value:
 
 
 
 
 
 
 
 
Non-Agency RMBS
 
$
—

 
$
—

 
$
13,596

 
$
13,596

Total real estate securities, at fair value
 
$
—

 
$
—

 
$
13,596

 
$
13,596

There were no transfers of financial instruments between Levels 1, 2, or 3 of the fair value hierarchy during the period September 25, 2012 (commencement of operations) through December 31, 2012.
The following tables present additional information about the Company's investments which are measured at fair value for which the Company has utilized Level 3 inputs to determine fair value:
Three month period ended September 30, 2013:
(In thousands)
Agency
RMBS
 
Non-Agency RMBS
Beginning balance at 6/30/2013
$
9,905

 
$
38,810

Transfers(1):
 
 
 
Transfers into level 3
—

 
—

Transfers out of level 3
—

 
—

Purchases
3,094

 
6,402

Proceeds from sales
—

 
(9,247
)
Principal repayments
—

 
(2,927
)
(Amortization)/accretion, net
(626
)
 
307

Net realized gains
—

 
581

Change in net unrealized gains (losses)
349

 
541

Ending balance at 9/30/2013
$
12,722

 
$
34,467

Change in net unrealized gains (losses) for level 3 assets still held as of September 30, 2013
$
349

 
$
718

(1)
Transfers are assumed to occur at the beginning of the period.
Nine month period ended September 30, 2013:
(In thousands)
Agency
RMBS
 
Non-Agency RMBS
Beginning balance at 12/31/2012
$
—

 
$
13,596

Transfers(1):
 
 
 
Transfers into level 3
—

 
—

Transfers out of level 3
—

 
—

Purchases
12,116

 
37,180

Proceeds from sales
—

 
(14,556
)
Principal repayments
—

 
(4,390
)
(Amortization)/accretion, net
(761
)
 
631

Net realized gains
—

 
1,469

Change in net unrealized gains (losses)
1,367

 
537

Ending balance at 9/30/2013
$
12,722

 
$
34,467

Change in net unrealized gains (losses) for level 3 assets still held as of September 30, 2013
$
1,367

 
$
630

(1)
Transfers are assumed to occur at the beginning of the period.

September 25, 2012 (commencement of operations) to September 30, 2012:
(In thousands)
Non-Agency RMBS
Beginning balance at 09/25/2012
$
—

Transfers(1):
 
Transfers into level 3
—

Transfers out of level 3
—

Purchases
5,134

Proceeds from sales
—

Principal repayments
—

(Amortization)/accretion, net
—

Net realized gains
—

Change in net unrealized gains (losses)
—

Ending balance at 9/30/2012
$
5,134

Change in net unrealized gains (losses) for level 3 assets still held as of September 30, 2013
$
—

(1)
Transfers are assumed to occur at the beginning of the period.
The following tables identify the significant unobservable inputs that affect the valuation of the Company's Level 3 assets and liabilities as of September 30, 2013 and December 31, 2012:
September 30, 2013:
 
 
Range
 
 
Description
 
Fair Value
 
Valuation Technique
 
Significant
Unobservable Input
 
Min
 
Max
 
Weighted Average(1)
 
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
Private Label Residential Mortgage-Backed Securities
 
$
30,962

 
Market quotes
 
Non Binding Indicative Price
 
$
30.25

 
$
102.97

 
$
78.94

Private Label Residential Mortgage-Backed Securities
 
$
3,505

 
Discounted Cash Flows
 
Yield
 
12.0
%
 
19.1
%
 
15.9
%
 
 
 
 
 
 
Projected Collateral Prepayments
 
30.0
%
 
43.3
%
 
37.3
%
 
 
 
 
 
 
Projected Collateral Losses
 
4.0
%
 
6.0
%
 
4.9
%
 
 
 
 
 
 
Projected Collateral Recoveries
 
6.5
%
 
12.6
%
 
9.2
%
 
 
 
 
 
 
Projected Collateral Scheduled Amortization
 
46.3
%
 
51.4
%
 
48.6
%
 
 
 
 
 
 
 
 
 
 
 
 
100.0
%
Agency RMBS–Interest Only Securities
 
$
2,351

 
Option Adjusted Spread ("OAS")
 
LIBOR OAS (2)
 
540

 
645

 
583

 
 
 
 
 
 
Projected Collateral Prepayments
 
59.1
%
 
67.7
%
 
62.6
%
 
 
 
 
 
 
Projected Collateral Scheduled Amortization
 
32.3
%
 
40.9
%
 
37.4
%
 
 
 
 
 
 
 
 
 
 
 
 
100.0
%
Agency RMBS–Interest Only Securities
 
$
10,371

 
Market quotes
 
Non Binding Indicative Price
 
$
4.89

 
$
21.42

 
$
13.80

(1)
Averages are weighted based on the fair value of the related instrument.
(2)
Shown in basis points.
December 31, 2012:
 
 
Range
 
 
Description
 
Fair Value
 
Valuation Technique
 
Significant
Unobservable Input
 
Min
 
Max
 
Weighted Average(1)
 
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
Private Label Residential Mortgage-Backed Securities
 
$
13,596

 
Discounted Cash Flows
 
Yield
 
6.2
%
 
20.4
%
 
8.5
%
 
 
 
 
 
 
Projected Collateral Prepayments
 
12.6
%
 
52.2
%
 
29.4
%
 
 
 
 
 
 
Projected Collateral Losses
 
11.3
%
 
41.4
%
 
26.9
%
 
 
 
 
 
 
Projected Collateral Recoveries
 
6.8
%
 
33.2
%
 
23.8
%
 
 
 
 
 
 
Projected Collateral Scheduled Amortization
 
3.0
%
 
52.7
%
 
19.9
%
 
 
 
 
 
 
 
 
 
 
 
 
100.0
%
(1)
Averages are weighted based on the fair value of the related instrument.
Third-party non-binding indicative prices are validated by comparing such prices to internally generated prices based on the Company's models and to recent trading activity in the same or similar instruments. For those instruments valued using discounted cash flows, 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. For those assets valued using the LIBOR Option Adjusted Spread ("OAS") valuation methodology, cash flows are projected using the Company'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. 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.