View:
Download DOC
Download PDF
Download XLS
Download XBRL
Document


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2016
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to         
Commission file number 001-35896
Ellington Residential Mortgage REIT
(Exact Name of Registrant as Specified in Its Charter)
Maryland
 
46-0687599
(State or Other Jurisdiction of Incorporation)
 
(IRS Employer Identification No.)
53 Forest Avenue
Old Greenwich, CT 06870
(Address of principal executive offices, zip code)
(203) 698-1200
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x No ¨ 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer
¨
 
Accelerated Filer
x
Non-Accelerated Filer (do not check if a smaller reporting company)
¨
 
Smaller Reporting Company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  ¨  No  x
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
Class
 
Outstanding at October 28, 2016
Common Shares of Beneficial Interest, $0.01 par value per share
 
9,127,039


ELLINGTON RESIDENTIAL MORTGAGE REIT
INDEX
PART I. Financial Information
 
Item 1. Consolidated Financial Statements (unaudited)
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Item 4. Controls and Procedures
PART II. Other Information
 
Item 1. Legal Proceedings
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 6. Exhibits





PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (unaudited)
ELLINGTON RESIDENTIAL MORTGAGE REIT
CONSOLIDATED BALANCE SHEET
(UNAUDITED)
 
September 30, 2016
 
December 31, 2015
(In thousands except for share amounts)
 
 
 
ASSETS
 
 
 
Cash and cash equivalents
$
43,026

 
$
40,166

Mortgage-backed securities, at fair value
1,233,134

 
1,242,266

Due from brokers
33,462

 
33,297

Financial derivatives–assets, at fair value
1,641

 
2,183

Reverse repurchase agreements
77,932

 
78,632

Receivable for securities sold
37,057

 
155,526

Interest receivable
4,274

 
4,325

Other assets
357

 
289

Total Assets
$
1,430,883

 
$
1,556,684

LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
LIABILITIES

 
 
Repurchase agreements
$
1,158,962

 
$
1,222,719

Payable for securities purchased
34,808

 
98,949

Due to brokers
538

 
439

Financial derivatives–liabilities, at fair value
9,885

 
4,725

U.S. Treasury securities sold short, at fair value
77,263

 
78,447

Dividend payable
3,651

 
4,111

Accrued expenses
622

 
533

Management fee payable
539

 
545

Interest payable
1,341

 
1,361

Total Liabilities
1,287,609

 
1,411,829

SHAREHOLDERS' EQUITY
 
 
 
Preferred shares, par value $0.01 per share, 100,000,000 shares authorized;
(0 shares issued and outstanding, respectively)
—

 
—

Common shares, par value $0.01 per share, 500,000,000 shares authorized;
(9,127,039 and 9,135,103 shares issued and outstanding, respectively)
92

 
92

Additional paid-in-capital
180,952

 
181,027

Accumulated deficit
(37,770
)
 
(36,264
)
Total Shareholders' Equity
143,274

 
144,855

Total Liabilities and Shareholders' Equity
$
1,430,883

 
$
1,556,684



3

ELLINGTON RESIDENTIAL MORTGAGE REIT
CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
 
 
Three Month
Period Ended
September 30, 2016
 
Three Month
Period Ended
September 30, 2015
 
Nine Month
Period Ended
September 30, 2016
 
Nine Month
Period Ended
September 30, 2015
(In thousands except for per share amounts)
 
 
 
 
 
 
 
 
INTEREST INCOME (EXPENSE)
 
 
 
 
 
 
 
 
Interest income
 
$
7,096

 
$
11,315

 
$
24,285

 
$
31,436

Interest expense
 
(2,279
)
 
(1,642
)
 
(6,589
)
 
(4,420
)
Total net interest income
 
4,817

 
9,673

 
17,696

 
27,016

EXPENSES
 
 
 
 
 
 
 
 
Management fees
 
539

 
557

 
1,596

 
1,759

Professional fees
 
171

 
144

 
549

 
422

Compensation expense(1)
 
142

 
168

 
463

 
533

Other operating expenses(1)
 
402

 
406

 
1,269

 
1,241

Total expenses
 
1,254

 
1,275

 
3,877

 
3,955

OTHER INCOME (LOSS)
 
 
 
 
 
 
 
 
Net realized gains (losses) on securities
 
3,892

 
596

 
9,003

 
8,760

Net realized gains (losses) on financial derivatives
 
(3,920
)
 
(3,252
)
 
(21,523
)
 
(15,838
)
Change in net unrealized gains (losses) on securities
 
(124
)
 
4,862

 
14,388

 
(7,674
)
Change in net unrealized gains (losses) on financial derivatives
 
3,215

 
(15,421
)
 
(5,792
)
 
(9,258
)
Total other income (loss)
 
3,063

 
(13,215
)
 
(3,924
)
 
(24,010
)
NET INCOME (LOSS)
 
$
6,626

 
$
(4,817
)
 
$
9,895

 
$
(949
)
NET INCOME (LOSS) PER COMMON SHARE:
 
 
 
 
 
 
 
 
Basic and Diluted
 
$
0.73

 
$
(0.53
)
 
$
1.09

 
$
(0.10
)
CASH DIVIDENDS PER COMMON SHARE:
 
 
 
 
 
 
 
 
Dividends declared
 
$
0.40

 
$
0.45

 
$
1.25

 
$
1.55

(1)
Conformed to current period presentation.


See Notes to Consolidated Financial Statements
4

ELLINGTON RESIDENTIAL MORTGAGE REIT
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(UNAUDITED)
 
Common Shares
 
Common
Shares,
par value
 
Preferred Shares
 
Preferred Shares,
par value
 
Additional Paid-in-Capital
 
Accumulated (Deficit) Earnings
 
Total
(In thousands except for share amounts)
 
 
 
 
 
 
 
 
 
 
 
 
 
BALANCE, December 31, 2014
9,149,274

 
$
91

 
—

 
$
—

 
$
181,282

 
$
(18,008
)
 
$
163,365

Share based compensation
 
 
 
 
 
 
 
 
88

 
 
 
88

Issuance of restricted shares
9,228

 
—

 
—

 
—

 
—

 
 
 
—

Repurchase of common shares
(23,481
)
 
—

 
—

 
—

 
(304
)
 
 
 
(304
)
Dividends declared
 
 
 
 
 
 
 
 
 
 
(14,175
)
 
(14,175
)
Net loss
 
 
 
 
 
 
 
 
 
 
(949
)
 
(949
)
BALANCE, September 30, 2015
9,135,021

 
91

 
—

 
—

 
181,066

 
(33,132
)
 
148,025

 
 
 
 
 
 
 
 
 
 
 
 
 
 
BALANCE, December 31, 2015
9,135,103

 
92

 
—

 
—

 
181,027

 
(36,264
)
 
144,855

Share based compensation
 
 
 
 
 
 
 
 
121

 
 
 
121

Issuance of restricted shares
9,856

 
—

 
—

 
—

 
—

 
 
 
—

Repurchase of common shares
(17,920
)
 
—

 
—

 
—

 
(196
)
 
 
 
(196
)
Dividends declared
 
 
 
 
 
 
 
 
 
 
(11,401
)
 
(11,401
)
Net income
 
 
 
 
 
 
 
 
 
 
9,895

 
9,895

BALANCE, September 30, 2016
9,127,039

 
$
92

 
—

 
$
—

 
$
180,952

 
$
(37,770
)
 
$
143,274


See Notes to Consolidated Financial Statements
5

ELLINGTON RESIDENTIAL MORTGAGE REIT
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
 
 
Nine Month
Period Ended
September 30, 2016
 
Nine Month
Period Ended
September 30, 2015
(In thousands)
 
 
 
 
Cash flows provided by (used in) operating activities:
 
 
 
 
Net income (loss)
 
$
9,895

 
$
(949
)
Reconciliation of net income (loss) to net cash provided by (used in) operating activities:
 
 
 
 
Net realized (gains) losses on securities
 
(9,003
)
 
(8,760
)
Change in net unrealized (gains) losses on securities
 
(14,388
)
 
7,674

Net realized (gains) losses on financial derivatives
 
21,523

 
15,838

Change in net unrealized (gains) losses on financial derivatives
 
5,792

 
9,258

Amortization of premiums and accretion of discounts (net)
 
12,555

 
6,468

Share based compensation
 
121

 
88

(Increase) decrease in assets:
 
 
 
 
Due from brokers
 
(165
)
 
(22,537
)
Interest receivable
 
51

 
9

Other assets
 
(68
)
 
(90
)
Increase (decrease) in liabilities:
 
 
 
 
Due to brokers
 
99

 
2,071

Accrued expenses
 
89

 
(119
)
Interest payable
 
(20
)
 
729

Management fees payable
 
(6
)
 
6

Net cash provided by (used in) operating activities
 
26,475

 
9,686

Cash flows provided by (used in) investing activities:
 
 
 
 
Purchases of securities
 
(1,778,907
)
 
(1,479,612
)
Proceeds from sale of securities
 
1,751,631

 
1,496,506

Principal repayments of mortgage-backed securities
 
104,551

 
103,189

Proceeds from investments sold short
 
454,489

 
675,693

Repurchase of investments sold short
 
(458,652
)
 
(619,180
)
Proceeds from disposition of financial derivatives
 
6,575

 
10,700

Purchase of financial derivatives
 
(28,188
)
 
(26,538
)
Payments made on reverse repurchase agreements
 
(13,672,316
)
 
(10,639,503
)
Proceeds from reverse repurchase agreements
 
13,673,016

 
10,576,879

Net cash provided by (used in) investing activities
 
52,199

 
98,134

Cash flows provided by (used in) financing activities:
 
 
 
 
Repurchase of common shares
 
(196
)
 
(304
)
Dividends paid
 
(11,861
)
 
(15,096
)
Borrowings under repurchase agreements
 
1,583,173

 
2,010,434

Repayments of repurchase agreements
 
(1,646,930
)
 
(2,107,609
)
Cash provided by (used in) financing activities
 
(75,814
)
 
(112,575
)
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
 
2,860

 
(4,755
)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
 
40,166

 
45,237

CASH AND CASH EQUIVALENTS, END OF PERIOD
 
$
43,026

 
$
40,482

Supplemental disclosure of cash flow information:
 
 
 
 
Interest paid
 
$
6,610

 
$
3,691

Dividends payable
 
$
3,651

 
$
4,111


See Notes to Consolidated Financial Statements
6


ELLINGTON RESIDENTIAL MORTGAGE REIT
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2016
(UNAUDITED)
1. Organization and Investment Objective
Ellington Residential Mortgage REIT, or "EARN," was formed as a Maryland real estate investment trust, or "REIT," on August 2, 2012, and commenced operations on September 25, 2012. EARN conducts its business through its wholly owned subsidiaries, EARN OP GP LLC, or the "General Partner," and Ellington Residential Mortgage LP, or the "Operating Partnership," which were formed as a Delaware limited liability company and a Delaware limited partnership, respectively, on July 31, 2012 and commenced operations on September 25, 2012. The Operating Partnership conducts its business of acquiring, investing in, and managing residential mortgage-related and real estate-related assets through its wholly owned subsidiaries. EARN, the General Partner, the Operating Partnership, and their consolidated subsidiaries are hereafter defined as the "Company."
Ellington Residential Mortgage Management LLC, or the "Manager," serves as the Manager of the Company pursuant to the terms of the Fourth Amended and Restated Management Agreement (the "Management Agreement"). The Manager is an affiliate of Ellington Management Group, L.L.C., or "EMG," an investment management firm that is an SEC-registered investment adviser with a 21-year history of investing in a broad spectrum of mortgage-backed securities and related derivatives, with an emphasis on the residential mortgage-backed securities, or "RMBS," market. In accordance with the terms of the Management Agreement and the Services Agreement (as described in Note 9), the Manager is responsible for administering the Company's business activities and day-to-day operations, and performs certain services, subject to oversight by the Board of Trustees. See Note 9 for further information on the Management Agreement.
The Company acquires and manages RMBS, for which the principal and interest payments are guaranteed by a U.S. government agency or a U.S. government-sponsored entity, or "Agency RMBS," and RMBS that do not carry such guarantees, or "non-Agency RMBS," such as RMBS backed by prime jumbo, Alternative A-paper, manufactured housing, and subprime residential mortgage loans. Agency RMBS include both Agency pools and Agency collateralized mortgage obligations, or "CMOs," and non-Agency RMBS primarily consist of non-Agency CMOs, both investment grade and non-investment grade. The Company may also acquire and manage mortgage servicing rights, residential mortgage loans, and other mortgage- and real estate-related assets. The Company may also invest in other instruments including, but not limited to, forward-settling To-Be-Announced Agency pass-through certificates, or "TBAs," interest rate swaps and swaptions, U.S. Treasury securities, Eurodollar and U.S. Treasury futures, other financial derivatives, and cash equivalents. The Company's targeted investments may range from unrated first loss securities to AAA senior securities.
The Company has elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended, or "the Code," and intends to conduct its operations to be qualified and taxed as a REIT. As a REIT, the Company is required to distribute annually at least 90% of its taxable income. As long as the Company continues to qualify as a REIT, it will not be subject to U.S. federal corporate taxes on its taxable income to the extent that it distributes all of its annual taxable income to its shareholders. It is the intention of the Company to distribute at least 100% of its taxable income, after application of available tax attributes, within the time limits prescribed by the Code, which may extend into the subsequent taxable year.
2. Significant Accounting Policies
(A) Basis of Presentation: The Company's unaudited interim consolidated financial statements have been prepared in conformity with generally accepted accounting principles in the United States of America, or "U.S. GAAP." Entities in which the Company has a controlling financial interest, through ownership of the majority of the entities' voting equity interests, or through other contractual rights that give the Company control, are consolidated by the Company. All inter-company balances and transactions have been eliminated. The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates and those differences could be material. In management's opinion, all material adjustments, considered necessary for a fair presentation of the Company's interim consolidated financial statements have been included and are only of a normal recurring nature. Interim results are not necessarily indicative of the results that may be expected for the entire fiscal year. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 2015.
(B) 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

7


measurements. The valuation hierarchy is based upon the observability of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follows:
•
Level 1—inputs to the valuation methodology are observable and reflect quoted prices (unadjusted) for identical assets or liabilities in active markets. Currently, the types of financial instruments the Company generally includes in this category are, exchange-traded derivatives;
•
Level 2—inputs to the valuation methodology other than quoted prices included in Level 1 are observable for the asset or liability, either directly or indirectly. Currently, the types of financial instruments that the Company generally includes in this category are Agency RMBS, non-Agency RMBS determined to have sufficiently observable market data, U.S. Treasury securities, actively traded derivatives such as TBAs, interest rate swaps, and swaptions; and
•
Level 3—inputs to the valuation methodology are unobservable and significant to the fair value measurement. Currently, this category includes RMBS where there is less price transparency.
For certain financial instruments, the various inputs that management uses to measure fair value for such financial instrument may fall into different levels of the fair value hierarchy. In such cases, the determination of which category within the fair value hierarchy is appropriate for such financial instrument is based on the lowest level of input that is significant to the fair value measurement. ASC 820 prioritizes the various inputs that management uses to measure fair value with the highest priority to inputs that are observable and reflect quoted prices (unadjusted) for identical assets or liabilities in active markets (Level 1) and the lowest priority to inputs that are unobservable and significant to the fair value measurement (Level 3). The assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the financial instrument. The Company may use valuation techniques consistent with the market and income approaches to measure the fair value of its assets and liabilities. The market approach uses third-party valuations and information obtained from market transactions involving identical or similar assets or liabilities. The income approach uses projections of the future economic benefits of an instrument to determine its fair value, such as in the discounted cash flow methodology. The inputs or methodology used for valuing financial instruments are not necessarily an indication of the risk associated with investing in these financial instruments. Transfers between levels of the fair value hierarchy are assumed to occur at the end of the reporting period.
Summary Valuation Techniques
For financial instruments that are traded in an "active market," the best measure of fair value is the quoted market price. However, many of the Company's financial instruments are not traded in an active market. Therefore, management generally uses third-party valuations when available. If third-party valuations are not available, management uses other valuation techniques, such as the discounted cash flow methodology. The following are summary descriptions, for the various categories of financial instruments, of the valuation methodologies management uses in determining fair value of the Company's financial instruments in such categories. Management utilizes such methodologies to assign a good faith fair value (the estimated price that, in an orderly transaction at the valuation date, would be received to sell an asset, or paid to transfer a liability, as the case may be) to each such financial instrument.
Valuations for fixed rate RMBS pass-throughs issued by a U.S government agency or government-sponsored enterprise, or "GSE," are typically based on observable pay-up data (pay-ups are price premiums for specified categories of fixed rate pools relative to their TBA counterparts) or models that use observable market data, such as interest rates and historical prepayment speeds, and are validated against third-party valuations. With respect to the Company's other RMBS investments and TBAs, management seeks to obtain at least one third-party valuation, and often obtains multiple valuations when available. Management has been able to obtain third-party valuations on the vast majority of these instruments and expects to continue to solicit third-party valuations in the future. Management 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, and while management generally does not adjust the valuations it receives, management may challenge or reject a valuation when, based on its validation criteria, management determines that such valuation is unreasonable or erroneous. Furthermore, based on its validation criteria, management may determine that the average of the third-party valuations received for a given instrument does not result in what management believes to be the fair value of such instrument, and in such circumstances management may override this average with its own good faith valuation. The validation criteria may take into account output from management's own models, recent trading activity in the same or similar instruments, and valuations received from third parties. The use of proprietary models requires the use of a significant amount of judgment and the application of various assumptions including, but not limited to, assumptions concerning future prepayment rates and default rates.
Given their relatively high level of price transparency, Agency RMBS pass-throughs and TBAs are typically designated as Level 2 assets, although Agency interest only and inverse interest only RMBS are currently designated as Level 3 assets since they generally have less price transparency. Non-Agency RMBS are generally classified as either Level 2 or Level 3 based on

8


analysis of available market data such as recent trades and executable bids. Furthermore, the methodology used by the third-party valuation providers is reviewed at least annually by management, so as to ascertain whether such providers are utilizing observable market data to determine the valuations that they provide.
Interest rate swaps and swaptions are typically valued based on internal models that use observable market data, including applicable interest rates in effect as of the measurement date; the model-generated valuations are then typically compared to counterparty valuations for reasonableness. These financial derivatives are generally designated as Level 2 instruments.
In valuing its derivatives, the Company also considers the creditworthiness of both the Company and its counterparties, along with collateral provisions contained in each derivative agreement.
The Company's repurchase and reverse repurchase agreements are carried at cost, which approximates fair value. Repurchase agreements and reverse repurchase agreements are classified as Level 2 assets and liabilities based on the adequacy of the collateral and their short term nature.
The Company's valuation process, including the application of validation criteria, is overseen by the Manager's Valuation Committee. The Valuation Committee includes senior level executives from various departments within the Manager, and each quarter the Valuation Committee reviews and approves the valuations of the Company's investments. The valuation process also includes a monthly review by the Company's third party administrator. The goal of this review is to replicate various aspects of the Company's valuation process based on the Company's documented procedures.
Because of the inherent uncertainty of valuation, the estimated fair value of the Company's financial instruments 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.
(C) Accounting for Securities: Purchases and sales of investments are recorded on trade date and realized and unrealized gains and losses are calculated based on identified cost.
The Company has chosen to make a fair value election pursuant to ASC 825-10, Financial Instruments, for its securities portfolio. Electing the fair value option allows the Company to record changes in fair value in the Consolidated Statement of Operations, which, in management's view, more appropriately reflects the results of operations for a particular reporting period as all securities activities will be recorded in a similar manner. As such, securities are recorded at fair value on the Consolidated Balance Sheet and the period change in fair value is recorded in current period earnings on the Consolidated Statement of Operations as a component of Change in net unrealized gains (losses) on securities.
(D) Interest Income: Coupon interest income on investment securities is accrued based on the outstanding principal balance or notional amount and the current coupon rate on each security. The Company amortizes purchase premiums and accretes purchase discounts on its fixed income securities. For RMBS that are deemed to be of high credit quality at the time of purchase, premiums and discounts are generally amortized/accreted into interest income over the life of such securities using the effective interest method. For securities whose cash flows vary depending on prepayments, an effective yield retroactive to the time of purchase is periodically recomputed based on actual prepayments and changes in projected prepayment activity, and a catch-up adjustment is made to amortization to reflect the cumulative impact of the change in effective yield. For RMBS that are deemed not to be of high credit quality at the time of purchase, interest income is recognized based on the effective interest method. For purposes of determining the effective interest rate, management estimates the future expected cash flows of its investment holdings based on assumptions including, but not limited to, assumptions for future prepayment rates, default rates, and loss severities (each of which may in turn incorporate various macro-economic assumptions, such as future housing prices). These assumptions are re-evaluated not less than quarterly. Principal write-offs are generally treated as realized losses. Changes in projected cash flows, as applied to the current amortized cost of the security, may result in a prospective change in the yield/interest income recognized on such securities.
The Company's accretion of discounts and amortization of premiums on securities for U.S. federal and other tax purposes is likely to differ from the accounting treatment under U.S. GAAP of these items as described above.
(E) Cash and Cash Equivalents: Cash and cash equivalents include cash and short term investments with original maturities of three months or less at the date of acquisition. Cash and cash equivalents typically include amounts held in an interest bearing overnight account and amounts held in money market funds, and these balances generally exceed insured limits. The Company holds its cash at institutions that it believes to be highly creditworthy.
(F) Due from brokers/Due to brokers: Due from brokers and Due to brokers accounts on the Consolidated Balance Sheet include collateral transferred to or received from counterparties, including clearinghouses, along with receivables and payables for open and/or closed derivative positions.

9


(G) Financial Derivatives: The Company enters into various types of financial derivatives subject to its investment guidelines, which include restrictions associated with maintaining its qualification as a REIT. The Company's financial derivatives are predominantly subject to bilateral collateral arrangements or clearing in accordance with the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. The Company may be required to deliver or may receive cash or securities as collateral upon entering into derivative transactions. In addition, changes in the relative value of financial derivative transactions may require the Company or the counterparty to post or receive additional collateral. In the case of cleared financial derivatives, the clearinghouse becomes the Company's counterparty and a futures commission merchant acts as intermediary between the Company and the clearinghouse with respect to all facets of the related transaction, including the posting and receipt of required collateral. Collateral received by the Company is reflected on the Consolidated Balance Sheet as "Due to Brokers." Conversely, collateral posted by the Company is reflected as "Due from Brokers" on the Consolidated Balance Sheet. The types of financial derivatives that have been utilized by the Company to date are interest rate swaps, TBAs, swaptions, and futures.
Swaps: The Company enters into interest rate swaps. Interest rate swaps are contractual agreements whereby one party pays a floating interest rate on a notional principal amount and receives a fixed rate payment on the same notional principal, or vice versa, for a fixed period of time. The Company enters into interest rate swap contracts primarily to mitigate interest rate risk. The Company is subject to interest rate risk exposure in the normal course of pursuing its investment objectives.
Swaps change in value with movements in interest rates or total return of the reference securities. During the term of swap contracts, changes in value are recognized as unrealized gains or losses on the Consolidated Statement of Operations. When a contract is terminated, the Company realizes a gain or loss equal to the difference between the proceeds from (or cost of) the closing transaction and the Company's basis in the contract, if any. Periodic payments or receipts required by swap agreements are recorded as unrealized gains or losses when accrued and realized gains or losses when received or paid. Upfront payments paid and/or received by the Company to open swap contracts are recorded as an asset and/or liability on the Consolidated Balance Sheet and are recorded as a realized gain or loss on the termination date.
TBA Securities: The Company transacts in the forward settling TBA market. A TBA position is a forward contract for the purchase ("long position") or sale ("short position") of Agency RMBS at a predetermined price, face amount, issuer, coupon, and maturity on an agreed-upon future delivery date. For each TBA contract and delivery month, a uniform settlement date for all market participants is determined by the Securities Industry and Financial Markets Association. The specific Agency RMBS to be delivered into the contract at the settlement date are not known at the time of the transaction. The Company typically does not take delivery of TBAs, but rather enters into offsetting transactions and settles the associated receivable and payable balances with its counterparties. The Company primarily uses TBAs to mitigate interest rate risk, but from time to time it also holds net long positions in certain TBA securities as a means of acquiring exposure to Agency RMBS.
TBAs are accounted for by the Company as financial derivatives. The difference between the contract price and the fair value of the TBA position as of the reporting date is included in Change in net unrealized gains (losses) on financial derivatives in the Consolidated Statement of Operations. Upon settlement of the TBA contract, the realized gain (loss) on the TBA contract is equal to the net cash amount received (paid).
Options: The Company enters into swaption contracts. It may purchase or write put, call, straddle, or other similar options contracts. The Company enters into options contracts primarily to help mitigate interest rate risk. When the Company purchases an options contract, the option asset is initially recorded at an amount equal to the premium paid, if any, and is subsequently marked-to-market. Premiums paid for purchasing options contracts that expire unexercised are recognized on the expiration date as realized losses. If an options contract is exercised, the premium paid is subtracted from the proceeds of the sale or added to the cost of the purchase to determine whether the Company has realized a gain or loss on the related investment transaction. When the Company writes an options contract, the option liability is initially recorded at an amount equal to the premium received, if any, and is subsequently marked-to-market. Premiums received for writing options contracts that expire unexercised are recognized on the expiration date as realized gains. If an options contract is exercised, the premium received is subtracted from the cost of the purchase or added to the proceeds of the sale to determine whether the Company has realized a gain or loss on the related investment transaction. When the Company enters into a closing transaction, the Company will realize a gain or loss depending upon whether the amount from the closing transaction is greater or less than the premiums paid or received. In general, the Company's options contracts contain forward-settling premiums. In this case, no money is exchanged upfront; instead, the agreed-upon premium is paid by the buyer upon expiration of the options contract, regardless of whether or not the options contract is exercised.
Futures Contracts: The Company enters into Eurodollar futures contracts. A futures contract is an exchange-traded agreement to buy or sell an asset for a set price on a future date. Initial margin deposits are made upon entering into futures contracts and can be either in the form of cash or securities. During the period the futures contract is open, changes in the value of the contract are recognized as unrealized gains or losses by marking-to-market to reflect the current market value of the

10


contract. Variation margin payments are made or received periodically, depending upon whether unrealized losses or gains are incurred. When the contract is closed, the Company records a realized gain or loss equal to the difference between the proceeds of the closing transaction and the Company's basis in the contract.
Financial derivative assets are included in Financial derivatives–assets, at fair value on the Consolidated Balance Sheet while financial derivative liabilities are included in Financial derivatives–liabilities, at fair value on the Consolidated Balance Sheet.
(H) Repurchase Agreements: The Company enters into repurchase agreements with third-party broker-dealers, whereby it sells securities under agreements to repurchase at an agreed upon price and date. The Company accounts for repurchase agreements as collateralized borrowings, with the initial sale price representing the amount borrowed, and with the future repurchase price consisting of the amount borrowed plus interest, at the implied interest rate of the repurchase agreement, on the amount borrowed over the term of the repurchase agreement. The interest rate on a repurchase agreement is based on competitive market rates (or competitive market spreads, in the case of agreements with floating interest rates) at the time such agreement is entered into. When the Company enters into a repurchase agreement, the lender establishes and maintains an account containing cash and/or securities having a value not less than the repurchase price, including accrued interest, of the repurchase agreement. Repurchase agreements are carried at their contractual amounts, which approximate fair value due to their short-term nature.
(I) Reverse Repurchase Agreements: The Company enters into reverse repurchase agreement transactions with third-party broker-dealers, whereby it purchases securities under agreements to resell at an agreed upon price and date. The interest rate on a reverse repurchase agreement is based on competitive market rates (or competitive market spreads, in the case of agreements with floating interest rates) at the time such agreement is entered into. Reverse repurchase agreements are carried at their contractual amounts, which approximate fair value due to their short-term nature. Repurchase and reverse repurchase agreements that are conducted with the same counterparty can be reported on a net basis if they meet the requirements of ASC 210-20, Balance Sheet Offsetting.
There are currently no repurchase and reverse repurchase agreements reported on a net basis in the Company's consolidated financial statements.
(J) Securities Sold Short: The Company may purchase or engage in short sales of U.S. Treasury securities to mitigate the potential impact of changes in interest rates on the performance of its portfolio. When the Company sells securities short, it typically satisfies its security delivery settlement obligation by obtaining the security sold short from the same or a different counterparty. The Company generally is required to deliver cash or securities as collateral to the counterparty for the Company's obligation to return the borrowed security.
The Company has chosen to make a fair value election pursuant to ASC 825-10, Financial Instruments, for its securities sold short. Electing the fair value option allows the Company to record changes in fair value in the Consolidated Statement of Operations, which, in management's view, more appropriately reflects the results of operations for a particular reporting period as all securities activities will be recorded in a similar manner. As such, securities sold short are recorded at fair value on the Consolidated Balance Sheet and the period change in fair value is recorded in current period earnings on the Consolidated Statement of Operations as a component of Change in net unrealized gains (losses) on securities. A realized gain or loss will be recognized upon the termination of a short sale if the market price is less or greater than the proceeds originally received. Such realized gain or loss is recorded on the Company's Consolidated Statement of Operations in Net realized gains (losses) on securities.
(K) Offering Costs/Deferred Offering Costs: Offering costs are charged against shareholders' equity within Additional paid-in-capital, and typically include legal, accounting, printing, and other fees associated with the cost of raising equity capital.
(L) Share Based Compensation: The Company applies the provisions of ASC 718, Compensation—Stock Compensation ("ASC 718"), with regard to its equity incentive plans. ASC 718 covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. ASC 718 requires that compensation cost relating to share-based payment transactions be recognized in financial statements. The cost is measured based on the fair value, at the grant date, of the equity or liability instruments issued and is amortized over the vesting period. Restricted shares issued to the Company's independent directors and partially dedicated personnel are participating securities and receive dividends prior to vesting. Fair value for such awards is based on the closing stock price on the New York Stock Exchange at the grant date. The vesting period for restricted share awards is typically one to two years.
(M) Dividends: Dividends payable are recorded on the declaration date.

11


(N) Expenses: Expenses are recognized as incurred on the Consolidated Statement of Operations.
(O) Earnings Per Share: In accordance with the provisions of ASC 260, Earnings per Share, the Company calculates basic income (loss) per share by dividing net income (loss) for the period by the weighted average of the Company's common shares outstanding for that period. Diluted income (loss) per share takes into account the effect of dilutive instruments, such as share options and warrants, and uses the average share price for the period in determining the number of incremental shares that are to be added to the weighted average number of shares outstanding.
(P) Share Repurchases: Common shares that are repurchased by the Company subsequent to issuance decrease the total number of shares issued and outstanding and are immediately retired upon settlement. The cost of such share repurchases is charged against Additional paid-in-capital on the Company's Consolidated Balance Sheet.
(Q) Income Taxes: The Company has elected to be taxed as a REIT under Sections 856 to 860 of the Code. As a REIT, the Company is generally not subject to corporate-level federal and state income tax on net income it distributes to its shareholders. To qualify as a REIT, the Company must meet a number of organizational and operational requirements, including the distribution of at least 90% of its annual taxable income to shareholders. Even if the Company qualifies as a REIT, it may be subject to certain federal, state, local and foreign taxes on its income and property and to federal income and excise taxes on its undistributed taxable income. If the Company fails to qualify as a REIT, and does not qualify for certain statutory relief provisions, it will be subject to U.S. federal, state, and local income taxes and may be precluded from qualifying as a REIT for the four taxable years following the year in which the Company fails to qualify as a REIT.
The Company follows the authoritative guidance on accounting for and disclosure of uncertainty on tax positions, which requires management to determine whether a tax position of the Company is more likely than not to be sustained upon examination by the applicable taxing authority, including resolution of any related appeals or litigation processes, based on the technical merits of the position. For uncertain tax positions, the tax benefit to be recognized is measured as the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. The Company did not have any unrecognized tax benefits resulting from tax positions related to the current period or to 2015, 2014, or 2013 (its open tax years). In the normal course of business, the Company may be subject to examination by federal, state, local, and foreign jurisdictions, where applicable, for the current period, 2015, 2014, and 2013 (its open tax years). The Company may take positions with respect to certain tax issues which depend on legal interpretation of facts or applicable tax regulations. Should the relevant tax regulators successfully challenge any of such positions, the Company might be found to have a tax liability that has not been recorded in the accompanying consolidated financial statements. Also, management's conclusions regarding the authoritative guidance may be subject to review and adjustment at a later date based on changing tax laws, regulations, and interpretations thereof. There were no amounts accrued for penalties or interest as of or during the periods presented in these consolidated financial statements.
(R) Recent Accounting Pronouncements: Under the Jumpstart Our Business Startups Act, or the "JOBS Act," the Company meets the definition of an "emerging growth company." The Company has elected to follow the extended transition period for complying with new or revised U.S. accounting standards pursuant to Section 107(b) of the JOBS Act. As a result, the Company will comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for non-public entities.
In June 2014, the FASB issued ASU No. 2014-11, Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures ("ASU 2014-11"). This amends ASC 860, Transfers and Servicing ("ASC 860"), to require disclosure of repurchase-to-maturity transactions to be accounted for as secured borrowings rather than sales of an asset, and transfers of financial assets with a contemporaneous repurchase agreement will no longer be evaluated to determine whether they should be accounted for on a combined basis as forward contracts. The new guidance also prescribes additional disclosures particularly on the nature of collateral pledged under repurchase agreements accounted for as secured borrowings. ASU 2014-11 is effective for annual periods beginning after December 15, 2014 and interim periods beginning after December 31, 2015. The adoption of ASC 860, as amended by ASU 2014-11 did not have a material impact on the Company's consolidated financial statements.
In August 2014, the FASB issued ASU 2014-15, Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern ("ASU 2014-15"). ASU 2014-15 requires management to perform interim and annual assessments of an entity's ability to continue as a going concern and to provide disclosure if events or conditions arise that would place substantial doubt on the entity's ability to continue as a going concern. ASU 2014-15 is effective for the annual period ending after December 15, 2016, and subsequent interim and annual periods with early adoption permitted. The adoption of ASU 2014-15 is not expected to have a material impact on the Company's consolidated financial statements.
In February 2015, the FASB issued ASU 2015-02, Amendments to the Consolidation Analysis ("ASU 2015-02"). This amends ASC 810, Consolidation (ASC "810"), to improve targeted areas of consolidation guidance by simplifying the

12


requirements of consolidation and placing more emphasis on risk of loss when determining a controlling financial interest. ASU 2015-02 is effective for annual periods beginning after December 15, 2016 and interim periods beginning after December 15, 2017 with early adoption permitted. The adoption of ASU 2015-02 is not expected to have a material impact on the Company's consolidated financial statements.
3. Mortgage-Backed Securities
The following tables present details of the Company's mortgage-backed securities portfolio at September 30, 2016 and December 31, 2015, respectively. The Company's Agency RMBS include mortgage pass-through certificates and CMOs representing interests in or obligations backed by pools of residential mortgage loans issued or guaranteed by a U.S. government agency or GSE. The non-Agency RMBS portfolio is not issued or guaranteed by the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, or any agency of the U.S. Government and is therefore subject to greater credit risk.
By RMBS Type –
September 30, 2016:
($ in thousands)
 
 
 
 
 
 
Gross Unrealized
 
 
 
Weighted Average
 
Current Principal
 
Unamortized Premium (Discount)
 
Amortized
Cost
 
Gains
 
Losses
 
Fair Value
 
Coupon
 
Yield
 
Life
(Years)(1)
Agency RMBS:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
15-year fixed rate mortgages
$
134,770

 
$
6,796

 
$
141,566

 
$
1,820

 
$
(86
)
 
$
143,300

 
3.41%
 
2.12%
 
4.43
20-year fixed rate mortgages
10,710

 
820

 
11,530

 
130

 
—

 
11,660

 
4.00%
 
2.51%
 
5.89
30-year fixed rate mortgages
881,351

 
59,169

 
940,520

 
17,371

 
(471
)
 
957,420

 
4.00%
 
2.73%
 
6.73
Adjustable rate mortgages
30,645

 
1,534

 
32,179

 
223

 
(61
)
 
32,341

 
4.00%
 
2.47%
 
4.59
Reverse mortgages
57,088

 
5,853

 
62,941

 
788

 
(52
)
 
63,677

 
4.51%
 
2.60%
 
6.24
Interest only securities
 n/a
 
 n/a
 
8,730

 
18

 
(1,908
)
 
6,840

 
3.88%
 
1.50%
 
1.84
Total Agency RMBS
1,114,564

 
74,172

 
1,197,466

 
20,350

 
(2,578
)
 
1,215,238

 
3.95%
 
2.63%
 
6.03
Non-Agency RMBS
23,591

 
(6,848
)
 
16,743

 
1,596

 
(443
)
 
17,896

 
2.80%
 
7.29%
 
5.18
Total RMBS
$
1,138,155

 
$
67,324

 
$
1,214,209

 
$
21,946

 
$
(3,021
)
 
$
1,233,134

 
3.93%
 
2.70%
 
6.01
(1)
Average lives of RMBS are generally shorter than stated contractual maturities. Average lives are affected by the contractual maturities of the underlying mortgages, scheduled periodic payments of principal, and unscheduled prepayments of principal.
For the nine month period ended September 30, 2016, the weighted average holdings of RMBS investments based on amortized cost was $1.217 billion.

13


December 31, 2015:
($ in thousands)
 
 
 
 
 
 
Gross Unrealized
 
 
 
Weighted Average
 
Current Principal
 
Unamortized Premium (Discount)
 
Amortized
Cost
 
Gains
 
Losses
 
Fair Value
 
Coupon
 
Yield
 
Life
(Years)(1)
Agency RMBS:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
15-year fixed rate mortgages
$
162,546

 
$
7,839

 
$
170,385

 
$
531

 
$
(655
)
 
$
170,261

 
3.38%
 
2.31%
 
4.99
20-year fixed rate mortgages
18,477

 
1,277

 
19,754

 
153

 
(77
)
 
19,830

 
4.00%
 
2.75%
 
6.50
30-year fixed rate mortgages
842,524

 
53,832

 
896,356

 
8,117

 
(3,679
)
 
900,794

 
4.12%
 
3.11%
 
8.29
Adjustable rate mortgages
36,433

 
2,196

 
38,629

 
81

 
(180
)
 
38,530

 
4.05%
 
2.68%
 
5.44
Reverse mortgages
68,690

 
6,515

 
75,205

 
34

 
(1,547
)
 
73,692

 
4.63%
 
2.54%
 
5.64
Interest only securities
 n/a
 
 n/a
 
8,491

 
248

 
(981
)
 
7,758

 
3.82%
 
3.30%
 
2.36
Total Agency RMBS
1,128,670

 
71,659

 
1,208,820

 
9,164

 
(7,119
)
 
1,210,865

 
4.03%
 
2.94%
 
7.16
Non-Agency RMBS
48,408

 
(18,013
)
 
30,395

 
2,264

 
(1,258
)
 
31,401

 
2.48%
 
20.97%
 
4.81
Total RMBS
$
1,177,078

 
$
53,646

 
$
1,239,215

 
$
11,428

 
$
(8,377
)
 
$
1,242,266

 
3.97%
 
3.39%
 
7.07
(1)
Average lives of RMBS are generally shorter than stated contractual maturities. Average lives are affected by the contractual maturities of the underlying mortgages, scheduled periodic payments of principal, and unscheduled prepayments of principal.
For the year ended December 31, 2015, the weighted average holdings of RMBS investments based on amortized cost was $1.323 billion.
By Estimated Weighted Average Life
As of September 30, 2016:
($ in thousands)
 
Agency RMBS
 
Agency Interest Only Securities
 
Non-Agency RMBS
Estimated Weighted Average Life(1)
 
Fair
Value
 
Amortized Cost
 
Weighted Average Coupon
 
Fair Value
 
Amortized Cost
 
Weighted Average Coupon
 
Fair Value
 
Amortized Cost
 
Weighted Average Coupon
Less than three years
 
$
100,104

 
$
97,761

 
4.19
%
 
$
5,340

 
$
6,990

 
3.73
%
 
$
929

 
$
962

 
6.00
%
Greater than three years and less than seven years
 
538,644

 
527,194

 
4.05
%
 
1,500

 
1,740

 
5.06
%
 
16,967

 
15,781

 
2.64
%
Greater than seven years and less than eleven years
 
568,402

 
562,541

 
3.83
%
 
—

 
—

 
—
%
 
—

 
—

 
—
%
Greater than eleven years
 
1,248

 
1,240

 
4.00
%
 
—

 
—

 
—
%
 
—

 
—

 
—
%
Total
 
$
1,208,398

 
$
1,188,736

 
3.96
%
 
$
6,840

 
$
8,730

 
3.88
%
 
$
17,896

 
$
16,743

 
2.80
%
(1)
Average lives of RMBS are generally shorter than stated contractual maturities.
As of December 31, 2015:
($ in thousands)
 
Agency RMBS
 
Agency Interest Only Securities
 
Non-Agency RMBS
Estimated Weighted Average Life(1)
 
Fair
Value
 
Amortized Cost
 
Weighted Average Coupon
 
Fair Value
 
Amortized Cost
 
Weighted Average Coupon
 
Fair Value
 
Amortized Cost
 
Weighted Average Coupon
Less than three years
 
$
30,054

 
$
30,227

 
4.76
%
 
$
4,974

 
$
5,701

 
3.55
%
 
$
2,558

 
$
1,543

 
3.21
%
Greater than three years and less than seven years
 
273,477

 
273,107

 
3.78
%
 
2,784

 
2,790

 
4.97
%
 
24,736

 
25,478

 
2.66
%
Greater than seven years and less than eleven years
 
893,730

 
891,112

 
4.10
%
 
—

 
—

 
—
%
 
4,107

 
3,374

 
0.55
%
Greater than eleven years
 
5,846

 
5,883

 
3.81
%
 
—

 
—

 
—
%
 
—

 
—

 
—
%
Total
 
$
1,203,107

 
$
1,200,329

 
4.04
%
 
$
7,758

 
$
8,491

 
3.82
%
 
$
31,401

 
$
30,395

 
2.48
%
(1)
Average lives of RMBS are generally shorter than stated contractual maturities.

14


The following table reflects the components of interest income on the Company's RMBS for the three and nine month periods ended September 30, 2016:
 
 
Three Month Period Ended
September 30, 2016
 
Nine Month Period Ended
September 30, 2016
($ in thousands)
 
Coupon Interest
 
Net Amortization
 
Interest
Income
 
Coupon Interest
 
Net Amortization
 
Interest
Income
Agency RMBS
 
$
11,917

 
$
(5,413
)
 
$
6,504

 
$
35,845

 
$
(13,504
)
 
$
22,341

Non-Agency RMBS
 
162

 
336

 
498

 
721

 
953

 
1,674

Total
 
$
12,079

 
$
(5,077
)
 
$
7,002

 
$
36,566

 
$
(12,551
)
 
$
24,015

The following table reflects the components of interest income on the Company's RMBS for the three and nine month periods ended September 30, 2015:
 
 
Three Month Period Ended
September 30, 2015
 
Nine Month Period Ended
September 30, 2015
($ in thousands)
 
Coupon Interest
 
Net Amortization
 
Interest
Income
 
Coupon Interest
 
Net Amortization
 
Interest
Income
Agency RMBS
 
$
12,392

 
$
(1,744
)
 
$
10,648

 
$
37,071

 
$
(7,795
)
 
$
29,276

Non-Agency RMBS
 
294

 
373

 
667

 
873

 
1,256

 
2,129

Total
 
$
12,686

 
$
(1,371
)
 
$
11,315

 
$
37,944

 
$
(6,539
)
 
$
31,405


15


4. Valuation
The following tables present the Company's financial instruments measured at fair value on:
September 30, 2016:
(In thousands)
 
 
 
 
 
 
 
 
Description
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
 
Mortgage-backed securities, at fair value:
 
 
 
 
 
 
 
 
Agency RMBS:
 
 
 
 
 
 
 
 
15-year fixed rate mortgages
 
$
—

 
$
143,300

 
$
—

 
$
143,300

20-year fixed rate mortgages
 
—

 
11,660

 
—

 
11,660

30-year fixed rate mortgages
 
—

 
957,420

 
—

 
957,420

Adjustable rate mortgages
 
—

 
32,341

 
—

 
32,341

Reverse mortgages
 
—

 
63,677

 
—

 
63,677

Interest only securities
 
—

 
—

 
6,840

 
6,840

Non-Agency RMBS
 
—

 
13,828

 
4,068

 
17,896

Mortgage-backed securities, at fair value
 
—

 
1,222,226

 
10,908

 
1,233,134

Financial derivatives–assets, at fair value:
 
 
 
 
 
 
 
 
TBAs
 
—

 
174

 
—

 
174

Interest rate swaps
 
—

 
1,467

 
—

 
1,467

Total financial derivatives–assets, at fair value
 
—

 
1,641

 
—

 
1,641

Total mortgage-backed securities and financial derivatives–assets, at fair value
 
$
—

 
$
1,223,867

 
$
10,908

 
$
1,234,775

Liabilities:
 
 
 
 
 
 
 
 
U.S. Treasury securities sold short, at fair value
 
$
—

 
$
(77,263
)
 
$
—

 
$
(77,263
)
Financial derivatives–liabilities, at fair value:
 
 
 
 
 
 
 
 
TBAs
 
—

 
(606
)
 
—

 
(606
)
Interest rate swaps
 
—

 
(9,275
)
 
—

 
(9,275
)
Futures
 
(4
)
 
—

 
—

 
(4
)
Total financial derivatives–liabilities, at fair value
 
(4
)
 
(9,881
)
 
—

 
(9,885
)
Total U.S. Treasury securities sold short and financial derivatives–liabilities, at fair value
 
$
(4
)
 
$
(87,144
)
 
$
—

 
$
(87,148
)
There were no transfers of financial instruments between Levels 1 and 2 of the fair value hierarchy during the nine month period ended September 30, 2016.

16


December 31, 2015:
(In thousands)
 
 
 
 
 
 
 
 
Description
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
 
Mortgage-backed securities, at fair value:
 
 
 
 
 
 
 
 
Agency RMBS:
 
 
 
 
 
 
 
 
15-year fixed rate mortgages
 
$
—

 
$
170,261

 
$
—

 
$
170,261

20-year fixed rate mortgages
 
—

 
19,830

 
—

 
19,830

30-year fixed rate mortgages
 
—

 
900,794

 
—

 
900,794

Adjustable rate mortgages
 
—

 
38,530

 
—

 
38,530

Reverse mortgages
 
—

 
73,692

 
—

 
73,692

Interest only securities
 
—

 
—

 
7,758

 
7,758

Non-Agency RMBS
 
—

 
27,381

 
4,020

 
31,401

Mortgage-backed securities, at fair value
 
—

 
1,230,488

 
11,778

 
1,242,266

Financial derivatives–assets, at fair value:
 
 
 
 
 
 
 
 
TBAs
 
—

 
417

 
—

 
417

Interest rate swaps
 
—

 
1,748

 
—

 
1,748

Futures
 
18

 
—

 
—

 
18

Total financial derivatives–assets, at fair value
 
18

 
2,165

 
—

 
2,183

Total mortgage-backed securities and financial derivatives–assets, at fair value
 
$
18

 
$
1,232,653

 
$
11,778

 
$
1,244,449

Liabilities:
 
 
 
 
 
 
 
 
U.S. Treasury securities sold short, at fair value
 
$
—

 
$
(78,447
)
 
$
—

 
$
(78,447
)
Financial derivatives–liabilities, at fair value:
 
 
 
 
 
 
 
 
TBAs
 
—

 
(364
)
 
—

 
(364
)
Interest rate swaps
 
—

 
(4,361
)
 
—

 
(4,361
)
Total financial derivatives–liabilities, at fair value
 
—

 
(4,725
)
 
—

 
(4,725
)
Total U.S. Treasury securities sold short and financial derivatives–liabilities, at fair value
 
$
—

 
$
(83,172
)
 
$
—

 
$
(83,172
)
There were no transfers of financial instruments between Levels 1 or 2 of the fair value hierarchy during the year ended December 31, 2015.
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, 2016:
(In thousands)
Non-Agency RMBS
 
Agency RMBS
Beginning balance as of June 30, 2016
$
5,208

 
$
7,631

Purchases
—

 
—

Proceeds from sales
(1,270
)
 
—

Principal repayments
(629
)
 
—

(Amortization)/accretion, net
258

 
(921
)
Net realized gains (losses)
1,079

 
(156
)
Change in net unrealized gains (losses)
(578
)
 
286

Transfers:
 
 
 
Transfers into level 3
—

 
—

Transfers out of level 3
—

 
—

Ending balance as of September 30, 2016
$
4,068

 
$
6,840


17


All amounts of net realized and changes in net unrealized gains (losses) in the table above are reflected in the accompanying Consolidated Statement of Operations. The table above incorporates changes in net unrealized gains (losses) for both Level 3 financial instruments held by the Company at September 30, 2016, as well as Level 3 financial instruments disposed of by the Company during the three month period ended September 30, 2016. For Level 3 financial instruments held by the Company as of September 30, 2016, change in net unrealized gains (losses) of $0.5 million and $0.2 million, for the three month period ended September 30, 2016 relate to non-Agency RMBS and Agency RMBS, respectively.
Three month period ended September 30, 2015:
(In thousands)
Non-Agency RMBS
 
Agency RMBS
Beginning balance as of June 30, 2015
$
5,556

 
$
7,070

Purchases
—

 
1,696

Proceeds from sales
—

 
—

Principal repayments
(512
)
 
—

(Amortization)/accretion, net
208

 
(737
)
Net realized gains (losses)
—

 
—

Change in net unrealized gains (losses)
44

 
(755
)
Transfers:
 
 
 
Transfers into level 3
824

 
—

Transfers out of level 3
—

 
—

Ending balance as of September 30, 2015
$
6,120

 
$
7,274

All amounts of net realized and changes in net unrealized gains (losses) in the table above are reflected in the accompanying Consolidated Statement of Operations. The table above incorporates changes in net unrealized gains (losses) for both Level 3 financial instruments held by the Company at September 30, 2015, as well as Level 3 financial instruments disposed of by the Company during the three month period ended September 30, 2015. For Level 3 financial instruments held by the Company at September 30, 2015, change in net unrealized gains (losses) of $26 thousand and $(0.8) million, for the three month period ended September 30, 2015 relate to non-Agency RMBS and Agency RMBS, respectively.
During the three month period ended September 30, 2015, the Company transferred $0.8 million of non-Agency RMBS from Level 2 to Level 3. Following June 30, 2015, these securities exhibited indications of a reduced level of price transparency. Examples of such indications include wider spreads and/or higher delinquencies relative to similar securities and a reduction in observable transactions or executable quotes involving these and similar securities. Changes in these indications could impact price transparency, and thereby cause a change in the level designation in future periods.
Nine month period ended September 30, 2016:
(In thousands)
Non-Agency RMBS
 
Agency RMBS
Beginning balance as of December 31, 2015
$
4,020

 
$
7,758

Purchases
—

 
2,965

Proceeds from sales
(1,270
)
 
—

Principal repayments
(1,040
)
 
—

(Amortization)/accretion, net
361

 
(2,495
)
Net realized gains (losses)
1,080

 
(230
)
Change in net unrealized gains (losses)
(722
)
 
(1,158
)
Transfers:
 
 
 
Transfers into level 3
3,366

 
—

Transfers out of level 3
(1,727
)
 
—

Ending balance as of September 30, 2016
$
4,068

 
$
6,840

All amounts of net realized and changes in net unrealized gains (losses) in the table above are reflected in the accompanying Consolidated Statement of Operations. The table above incorporates changes in net unrealized gains (losses) for both Level 3 financial instruments held by the Company at September 30, 2016, as well as Level 3 financial instruments disposed of by the Company during the nine month period ended September 30, 2016. For Level 3 financial instruments held

18


by the Company as of September 30, 2016, change in net unrealized gains (losses) of $0.8 million and $(1.3) million, for the nine month period ended September 30, 2016 relate to non-Agency RMBS and Agency RMBS, respectively.
During the nine month period ended September 30, 2016, the Company transferred $1.7 million of non-Agency RMBS from Level 3 to Level 2. These assets were transferred from Level 3 to Level 2 based on an increased volume of observed trading of these and similar assets. This increase in observed trading activity has led to greater price transparency for these assets, thereby making a Level 2 designation appropriate in the Company's view. However, changes in the volume of observable inputs for these assets, such as a decrease in observed trading, could impact price transparency, and thereby cause a change in the level designation for these assets in future periods.
During the nine month period ended September 30, 2016, the Company transferred $3.4 million of non-Agency RMBS from Level 2 to Level 3. Since December 31, 2015, these securities have exhibited indications of a reduced level of price transparency. Examples of such indications include wider spreads and/or higher delinquencies relative to similar securities and a reduction in observable transactions or executable quotes involving these and similar securities. Changes in these indications could impact price transparency, and thereby cause a change in the level designation in future periods.
Nine month period ended September 30, 2015:
(In thousands)
Non-Agency RMBS
 
Agency RMBS
Beginning balance as of December 31, 2014
$
10,082

 
$
11,244

Purchases
—

 
3,397

Proceeds from sales
(2,861
)
 
(4,538
)
Principal repayments
(1,381
)
 
—

(Amortization)/accretion, net
806

 
(2,012
)
Net realized gains (losses)
791

 
602

Change in net unrealized gains (losses)
(649
)
 
(1,419
)
Transfers:
 
 
 
Transfers into level 3
4,025

 
—

Transfers out of level 3
(4,693
)
 
—

Ending balance as of September 30, 2015
$
6,120

 
$
7,274

All amounts of net realized and changes in net unrealized gains (losses) in the table above are reflected in the accompanying Consolidated Statement of Operations. The table above incorporates changes in net unrealized gains (losses) for both Level 3 financial instruments held by the Company as of September 30, 2015, as well as Level 3 financial instruments disposed of by the Company during the nine month period ended September 30, 2015. For Level 3 financial instruments held by the Company as of September 30, 2015, change in net unrealized gains (losses) of $0.1 million and $(0.6) million, for the nine month period ended September 30, 2015 relate to non-Agency RMBS and Agency RMBS, respectively.
During the nine month period ended September 30, 2015, the Company transferred $4.7 million of non-Agency RMBS from Level 3 to Level 2. These assets were transferred from Level 3 to Level 2 based on an increased volume of observed trading of these and similar assets. This increase in observed trading activity has led to greater price transparency for these assets, thereby making a Level 2 designation appropriate in the Company's view. However, changes in the volume of observable inputs for these assets, such as a decrease in observed trading, could impact price transparency, and thereby cause a change in the level designation for these assets in future periods.
During the nine month period ended September 30, 2015, the Company transferred $4.0 million of non-Agency RMBS from Level 2 to Level 3. Following December 31, 2014, these securities exhibited indications of a reduced level of price transparency. Examples of such indications include wider spreads and/or higher delinquencies relative to similar securities and a reduction in observable transactions or executable quotes involving these and similar securities. Changes in these indications could impact price transparency, and thereby cause a change in the level designation in future periods.

19


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, 2016 and December 31, 2015:
September 30, 2016:
 
 
Range
 
 
Description
 
Fair Value
 
Valuation Technique
 
Significant
Unobservable Input
 
Min
 
Max
 
Weighted Average(1)
 
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
Non-Agency RMBS
 
$
702

 
Discounted Cash Flows
 
Yield
 
24.9
%
 
24.9
%
 
24.9
%
 
 
 
 
 
 
Projected Collateral Prepayments
 
36.5
%
 
36.5
%
 
36.5
%
 
 
 
 
 
 
Projected Collateral Losses
 
1.7
%
 
1.7
%
 
1.7
%
 
 
 
 
 
 
Projected Collateral Recoveries
 
3.3
%
 
3.3
%
 
3.3
%
 
 
 
 
 
 
Projected Collateral Scheduled Amortization
 
58.5
%
 
58.5
%
 
58.5
%
 
 
 
 
 
 
 
 
 
 
 
 
100.0
%
Non-Agency RMBS
 
3,366

 
Market quotes
 
Non-Binding Third-Party Valuation
 
$
62.72

 
$
70.65

 
$
65.95

Agency RMBS–Interest Only Securities
 
4,122

 
Market quotes
 
Non-Binding Third-Party Valuation
 
$
4.02

 
$
20.93

 
$
10.65

Agency RMBS–Interest Only Securities
 
2,718

 
Option Adjusted Spread ("OAS")
 
LIBOR OAS (2)
 
392

 
1,147

 
677

 
 
 
 
 
 
Projected Collateral Prepayments
 
65.4
%
 
93.5
%
 
81.5
%
 
 
 
 
 
 
Projected Collateral Scheduled Amortization
 
6.5
%
 
34.6
%
 
18.5
%
 
 
 
 
 
 
 
 
 
 
 
 
100.0
%
(1)
Averages are weighted based on the fair value of the related instrument.
(2)
Shown in basis points.
December 31, 2015:
 
 
Range
 
 
Description
 
Fair Value
 
Valuation Technique
 
Significant
Unobservable Input
 
Min
 
Max
 
Weighted Average(1)
 
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
Non-Agency RMBS
 
$
4,020

 
Discounted Cash Flows
 
Yield
 
8.8
%
 
25.7
%
 
13.4
%
 
 
 
 
 
 
Projected Collateral Prepayments
 
32.5
%
 
68.7
%
 
60.5
%
 
 
 
 
 
 
Projected Collateral Losses
 
1.3
%
 
9.0
%
 
5.3
%
 
 
 
 
 
 
Projected Collateral Recoveries
 
3.4
%
 
9.2
%
 
6.4
%
 
 
 
 
 
 
Projected Collateral Scheduled Amortization
 
13.1
%
 
60.1
%
 
27.8
%
 
 
 
 
 
 
 
 
 
 
 
 
100.0
%
Agency RMBS–Interest Only Securities
 
5,645

 
Market quotes
 
Non-Binding Third-Party Valuation
 
$
4.39

 
$
21.63

 
$
11.88

Agency RMBS–Interest Only Securities
 
2,113

 
Option Adjusted Spread ("OAS")
 
LIBOR OAS(2)
 
221

 
984

 
576

 
 
 
 
 
 
Projected Collateral Prepayments
 
52.7
%
 
88.0
%
 
74.1
%
 
 
 
 
 
 
Projected Collateral Scheduled Amortization
 
12.0
%
 
47.3
%
 
25.9
%
 
 
 
 
 
 
 
 
 
 
 
 
100.0
%
(1)
Averages are weighted based on the fair value of the related instrument.
(2)
Shown in basis points.

20


Third-party non-binding valuations are validated by comparing such valuations 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, or "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.
The following table summarizes the estimated fair value of all other financial instruments not included in the disclosures above as of September 30, 2016 and December 31, 2015:
 
 
September 30, 2016
 
December 31, 2015
(In thousands)
 
Fair Value
 
Carrying Value
 
Fair Value
 
Carrying Value
Other financial instruments
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
43,026

 
$
43,026

 
$
40,166

 
$
40,166

Due from brokers
 
33,462

 
33,462

 
33,297

 
33,297

Reverse repurchase agreements
 
77,932

 
77,932

 
78,632

 
78,632

Liabilities:
 
 
 
 
 
 
 
 
Repurchase agreements
 
1,158,962

 
1,158,962

 
1,222,719

 
1,222,719

Due to brokers
 
538

 
538

 
439

 
439

Cash and cash equivalents includes cash held in an interest bearing overnight account for which fair value equals the carrying value and cash held in money market accounts which are liquid in nature and for which fair value equals the carrying value; such assets are considered Level 1 assets. Due from brokers and Due to brokers include collateral transferred to or received from counterparties, along with receivables and payables for open and/or closed derivative positions. These receivables and payables are short term in nature and any collateral transferred consists primarily of cash; fair value of these items approximates carrying value and such items are considered Level 1 assets and liabilities. The Company's repurchase and reverse repurchase agreements are carried at cost, which approximates fair value due to their short term nature. Repurchase agreements and reverse repurchase agreements are classified as Level 2 assets and liabilities based on the adequacy of the collateral and their short term nature.
5. Financial Derivatives
The Company is exposed to certain risks arising from both its business operations and economic conditions. Specifically, the Company's primary source of financing is repurchase agreements and the Company enters into financial derivative and other instruments to manage exposure to variable cash flows on portions of its borrowings under those repurchase agreements. Since the interest rates on repurchase agreements typically change with market interest rates such as LIBOR, the Company is exposed to constantly changing interest rates, which accordingly affects cash flows associated with the Company's borrowings. To mitigate the effect of changes in these interest rates and their related cash flows, the Company may enter into a variety of derivative contracts, including interest rate swaps, swaptions, and TBAs. Additionally, from time to time, the Company may use short positions in U.S. Treasury securities to mitigate its interest rate risk.

21


The following table details the fair value of the Company's holdings of financial derivatives as of September 30, 2016 and December 31, 2015:
 
 
September 30, 2016
 
December 31, 2015
 
 
(In thousands)
Financial derivatives–assets, at fair value:
 
 
 
 
TBA securities purchase contracts
 
$
142

 
$
115

TBA securities sale contracts
 
32

 
302

Fixed payer interest rate swaps
 
112

 
891

Fixed receiver interest rate swaps
 
1,355

 
857

Futures
 
—

 
18

Total financial derivatives–assets, at fair value
 
1,641

 
2,183

Financial derivatives–liabilities, at fair value:
 
 
 
 
TBA securities purchase contracts
 
(3
)
 
(49
)
TBA securities sale contracts
 
(603
)
 
(315
)
Fixed payer interest rate swaps
 
(9,275
)
 
(4,361
)
Futures
 
(4
)
 
—

Total financial derivatives–liabilities, at fair value
 
(9,885
)
 
(4,725
)
Total
 
$
(8,244
)
 
$
(2,542
)
Interest Rate Swaps
The following tables provide information about the Company's fixed payer interest rate swaps as of September 30, 2016 and December 31, 2015:
September 30, 2016:
 
 
 
 
 
 
Weighted Average
Maturity
 
Notional Amount
 
Fair Value
 
Pay Rate
 
Receive Rate
 
Remaining Years to Maturity
 
 
(In thousands)
 
 
 
 
 
 
2016
 
$
26,500

 
$
(43
)
 
0.70
%
 
0.69
%
 
0.13
2017
 
74,750

 
(283
)
 
1.21

 
0.78

 
0.84
2018
 
65,990

 
1

 
0.97

 
0.72

 
1.68
2019
 
4,200

 
11

 
0.96

 
0.79

 
2.85
2020
 
79,500

 
(1,478
)
 
1.48

 
0.72

 
3.57
2022
 
13,044

 
(451
)
 
1.75

 
0.75

 
5.93
2023
 
42,200

 
(1,946
)
 
1.90

 
0.76

 
6.60<