EARN 2014.09.30 10Q


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, 2014
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
¨
Non-Accelerated Filer (do not check if a smaller reporting company)
x
 
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 November 7, 2014
Common Shares of Beneficial Interest, $0.01 par value per share
 
9,149,274




ELLINGTON RESIDENTIAL MORTGAGE REIT
FORM 10-Q
PART I. Financial Information
 
 




PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (unaudited)
ELLINGTON RESIDENTIAL MORTGAGE REIT
CONSOLIDATED BALANCE SHEET
(UNAUDITED)

 
September 30, 2014
 
December 31, 2013
(In thousands except share amounts)
 
 
 
ASSETS
 
 
 
Cash and cash equivalents
$
51,063

 
$
50,112

Mortgage-backed securities, at fair value
1,368,092

 
1,326,036

Due from brokers
20,071

 
18,347

Financial derivatives–assets, at fair value
8,439

 
34,963

Reverse repurchase agreements
2,484

 

Receivable for securities sold
25,945

 
76,692

Interest receivable
5,601

 
4,766

Other assets
497

 
174

Total Assets
$
1,482,192

 
$
1,511,090

LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
LIABILITIES

 
 
Repurchase agreements
$
1,233,333

 
$
1,310,347

Payable for securities purchased
63,143

 
2,776

Due to brokers
3,889

 
22,788

Financial derivatives–liabilities, at fair value
2,850

 
1,069

U.S. Treasury securities sold short, at fair value
2,483

 

Dividend payable
5,032

 
4,570

Accrued expenses
754

 
996

Management fee payable
574

 
600

Interest payable
591

 
764

Total Liabilities
1,312,649

 
1,343,910

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;
(9,149,274 and 9,139,842 shares issued and outstanding, respectively)
91

 
91

Additional paid-in-capital
181,252

 
181,147

Accumulated deficit
(11,800
)
 
(14,058
)
Total Shareholders' Equity
169,543

 
167,180

Total Liabilities and Shareholders' Equity
$
1,482,192

 
$
1,511,090



See Notes to Consolidated Financial Statements
3


ELLINGTON RESIDENTIAL MORTGAGE REIT
CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)

 
 
Three Month
Period Ended
September 30, 2014
 
Three Month
Period Ended
September 30, 2013
 
Nine Month
Period Ended
September 30, 2014
 
Nine Month
Period Ended
September 30, 2013
(In thousands except per share amounts)
 
 
INTEREST INCOME (EXPENSE)
 
 
 
 
 
 
 
 
Interest income
 
$
11,484

 
$
11,223

 
$
35,018

 
$
15,815

Interest expense
 
(1,121
)
 
(1,248
)
 
(3,346
)
 
(1,773
)
Total net interest income
 
10,363

 
9,975

 
31,672

 
14,042

EXPENSES
 
 
 
 
 
 
 
 
Management fees
 
574

 
644

 
1,733

 
1,466

Professional fees
 
123

 
200

 
399

 
468

Other operating expenses
 
597

 
513

 
1,873

 
980

Total expenses
 
1,294

 
1,357

 
4,005

 
2,914

OTHER INCOME (LOSS)
 
 
 
 
 
 
 
 
Net realized gains (losses) on mortgage-backed securities
 
2,030

 
(24,173
)
 
(613
)
 
(26,290
)
Net realized gains (losses) on financial derivatives
 
(4,391
)
 
4,273

 
(18,955
)
 
12,650

Change in net unrealized gains (losses) on mortgage-backed
 securities
 
(5,455
)
 
30,239

 
37,550

 
(15,391
)
Change in net unrealized gains (losses) on financial derivatives
 
2,280

 
(12,172
)
 
(28,305
)
 
16,114

Total other income (loss)
 
(5,536
)
 
(1,833
)
 
(10,323
)
 
(12,917
)
NET INCOME (LOSS)
 
$
3,533

 
$
6,785

 
$
17,344

 
$
(1,789
)
NET INCOME (LOSS) PER COMMON SHARE:
 
 
 
 
 
 
 
 
Basic and Diluted
 
$
0.39

 
$
0.74

 
$
1.90

 
$
(0.31
)
CASH DIVIDENDS PER COMMON SHARE:
 
 
 
 
 
 
 
 
Dividends declared
 
$
0.55

 
0.50

 
$
1.65

 
$
0.64



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
 
Total
(In thousands except share amounts)
 
BALANCE, December 31, 2012
1,633,378

 
$
16

 

 
$

 
$
32,674

 
$
(1,726
)
 
$
30,964

Issuance of common shares
7,500,000

 
75

 

 

 
149,925

 
 
 
150,000

Issuance of restricted shares
6,464

 

 

 

 

 
 
 

Share based compensation
 
 
 
 
 
 
 
 
3

 
 
 
3

Offering costs
 
 
 
 
 
 
 
 
(1,498
)
 
 
 
(1,498
)
Dividends declared
 
 
 
 
 
 
 
 
 
 
(5,848
)
 
(5,848
)
Net loss
 
 
 
 
 
 
 
 
 
 
(1,789
)
 
(1,789
)
BALANCE, September 30, 2013
9,139,842

 
$
91

 

 
$

 
$
181,104

 
$
(9,363
)
 
$
171,832

 
 
 
 
 
 
 
 
 
 
 
 
 
 
BALANCE, December 31, 2013
9,139,842

 
$
91

 

 
$

 
$
181,147

 
$
(14,058
)
 
$
167,180

Issuance of restricted shares
9,432

 

 

 

 

 
 
 

Share based compensation
 
 
 
 
 
 
 
 
105

 
 
 
105

Dividends declared
 
 
 
 
 
 
 
 
 
 
(15,086
)
 
(15,086
)
Net income
 
 
 
 
 
 
 
 
 
 
17,344

 
17,344

BALANCE, September 30, 2014
9,149,274

 
$
91

 

 
$

 
$
181,252

 
$
(11,800
)
 
$
169,543


See Notes to Consolidated Financial Statements
5


ELLINGTON RESIDENTIAL MORTGAGE REIT
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)

 
 
Nine Month
Period Ended
September 30, 2014
 
Nine Month
Period Ended
September 30, 2013
(In thousands)
 
 
Cash flows provided by (used in) operating activities:
 
 
 
 
Net income (loss)
 
$
17,344

 
$
(1,789
)
Reconciliation of net income to net cash provided by (used in) operating activities:
 
 
 
 
Net realized (gains) losses on mortgage-backed securities
 
613

 
26,290

Change in net unrealized (gains) losses on mortgage-backed securities
 
(37,550
)
 
15,391

Net realized (gains) losses on financial derivatives
 
18,955

 
(12,650
)
Change in net unrealized (gains) losses on financial derivatives
 
28,305

 
(16,114
)
Amortization of premiums and accretion of discounts (net)
 
5,254

 
2,498

Share based compensation
 
105

 
3

(Increase) decrease in assets:
 
 
 
 
Due from brokers
 
(1,724
)
 
(13,724
)
Interest receivable
 
(835
)
 
(4,331
)
Other assets
 
(258
)
 
(261
)
Increase (decrease) in liabilities:
 
 
 
 
Due to brokers
 
(18,899
)
 
22,160

Accrued expenses
 
(69
)
 
14

Interest payable
 
(173
)
 
597

Management fees payable
 
(26
)
 
528

Net cash provided by operating activities
 
11,042

 
18,612

Cash flows provided by (used in) investing activities:
 
 
 
 
Purchases of mortgage-backed securities
 
(1,478,619
)
 
(2,365,561
)
Proceeds from sale of mortgage-backed securities
 
1,506,513

 
891,017

Principal repayments of mortgage-backed securities
 
72,761

 
29,276

Proceeds from investments sold short
 
141,527

 
2,043

Repurchase of investments sold short
 
(138,957
)
 
(2,036
)
Proceeds from disposition of financial derivatives
 
7,592

 
24,849

Purchase of financial derivatives
 
(26,547
)
 
(12,199
)
Payments made on reverse repurchase agreements
 
(712,899
)
 
(4,098
)
Proceeds from reverse repurchase agreements
 
710,415

 
4,098

Net cash provided by (used in) investing activities
 
81,786

 
(1,432,611
)
Cash flows provided by (used in) financing activities:
 
 
 
 
Proceeds from issuance of common shares
 

 
150,000

Offering costs paid
 
(239
)
 
(1,498
)
Dividends paid
 
(14,624
)
 
(1,279
)
Borrowings under repurchase agreements
 
4,484,173

 
4,424,530

Repayments of repurchase agreements
 
(4,561,187
)
 
(3,131,584
)
Cash provided by (used in) financing activities
 
(91,877
)
 
1,440,169

NET INCREASE IN CASH AND CASH EQUIVALENTS
 
951

 
26,170

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
 
50,112

 
18,161

CASH AND CASH EQUIVALENTS, END OF PERIOD
 
$
51,063

 
$
44,331

Supplemental disclosure of cash flow information:
 
 
 
 
Interest paid
 
$
3,520

 
$
1,176


See Notes to Consolidated Financial Statements
6



ELLINGTON RESIDENTIAL MORTGAGE REIT
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2014
(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 Second Amended and Restated Management Agreement effective as of March 13, 2014, or the "Management Agreement." The Manager is an affiliate of Ellington Management Group, L.L.C., or "EMG," an investment management firm that is registered as an investment adviser with a 19-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 discussed in Note 10, 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.
The Company was formed through an initial strategic venture among affiliates of EMG and the Blackstone Tactical Opportunity Funds, or the "Blackstone Funds." These initial investors made an aggregate investment of approximately $31.5 million on September 25, 2012. On May 1, 2013, the Company priced an initial public offering of its common shares, pursuant to which it sold 6,450,000 shares to the public at a price of $20.00 per share. Concurrent with the initial public offering, the Company completed a private placement of 1,050,000 common shares to its initial investors at a purchase price of $20.00 per share which generated gross proceeds of $21.0 million. Proceeds to the Company, net of offering costs, were approximately $148.5 million.
The Company acquires and manages Agency and non-Agency RMBS, including Agency pools and Agency collateralized mortgage obligations, or "CMOs," and 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 made the election to be taxed as a REIT under the Internal Revenue Code of 1986, as amended, or "the Code" commencing with the Company's short taxable year ended December 31, 2013. 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 or state 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 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 right 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. 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, 2013.

7



(B) Valuation: The Company applies Accounting Standards Codification, or "ASC," 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. 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,
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, and
Level 3—inputs to the valuation methodology are unobservable and significant to the fair value measurement.
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.
(C) Accounting for Mortgage-Backed Securities: Investments in mortgage-backed securities are recorded on trade date. The Company has chosen to make a fair value election pursuant to ASC 825-10, Financial Instruments, for its mortgage-backed 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, the mortgage-backed 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 mortgage-backed securities.
Realized gains or losses on sales of mortgage-backed securities are included in Net realized gains (losses) on mortgage-backed securities on the Consolidated Statement of Operations, and are recorded at the time of disposition. The cost of positions sold is calculated based on identified cost.
(D) Interest Income: The Company accretes market discounts and amortizes market premiums on debt securities using the effective yield method. Accretion of market discount and amortization of market premiums requires the application of several assumptions including, but not limited to, prepayment assumptions and default rate assumptions, which are re-evaluated not less than quarterly and require the use of a significant amount of judgment. Principal write-offs are generally treated as realized losses. The Company's accretion of discounts and amortization of premiums for U.S. federal and other tax purposes is likely to differ from the financial 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 equivalents are recorded at cost plus accrued interest, which approximates fair value. Cash accounts are maintained with financial institutions and these balances generally exceed insured limits.
(F) Due from brokers/Due to brokers: Due from brokers and Due to brokers accounts on the Consolidated Balance Sheet include collateral paid or received from counterparties, including clearinghouses, along with receivables and payables for open and or closed derivative positions.
(G) Financial Derivatives: The Company may enter into various types of financial derivatives subject to its investment guidelines, which include restrictions associated with maintaining 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, or "FCM," 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 has entered into interest rate swaps, which are contractual agreements whereby one party pays a floating rate of interest on a notional principal amount and receives a fixed rate on the same notional principal, or vice versa, for a fixed period of time.

8



While the Company does not intend to operate its non-Agency RMBS investment strategy on a credit hedged basis, the Company may opportunistically enter into various credit hedging transactions, such as involving credit default swaps, total return swaps, or other derivative contracts. The Company may use credit default swaps to hedge non-Agency RMBS credit risk by buying protection on a basket or index of non-Agency RMBS assets or on a single non-Agency RMBS. For credit hedging purposes the Company may also enter into credit default swaps which reference other mortgage-backed securities, or "MBS," or the corporate credit of certain corporations, or indices on the foregoing. In addition, the Company may enter into various other financial derivative contracts, including total return swaps. Generally, a total return swap would reference either the corporate credit or equity of certain corporations. However, the Company's ability to use credit hedges is subject to the Company's qualifying and maintaining its qualification as a REIT and maintaining its exclusion from regulation as an investment company under the Investment Company Act.
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 has transacted in the forward settling To Be Announced RMBS ("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 hedge 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. The Company estimates the fair value of TBA positions based on similar methods used to value mortgage-backed securities. 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 has entered into swaption contracts. It may purchase or write put, call, straddle, or other similar options contracts. The Company enters into options primarily to help mitigate interest rate risk. When the Company purchases an option, 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 that expire unexercised are recognized on the expiration date as realized losses. If an option 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 option, 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 that expire unexercised are recognized on the expiration date as realized gains. If an option 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 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 option, regardless of whether or not the option is exercised.
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 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.

9



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 and Reverse 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 also 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 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 or 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. When the Company enters into a repurchase agreement, the lender establishes and maintains an account containing cash and securities having a value not less than the repurchase price, including accrued interest, of the repurchase agreement. Repurchase and reverse repurchase agreements that are conducted with the same counterparty can be reported on a net basis if they meet the requirements under the authoritative guidance. Repurchase agreements and reverse repurchase agreements are carried at their contractual amounts, which approximate fair value.
(I) U.S. Treasury Securities: The Company may purchase or sell short U.S. Treasury securities to help mitigate the potential impact of changes in interest rates on the performance of its portfolio. The Company may borrow securities under reverse repurchase agreements to enable it to deliver U.S. Treasury securities that it has sold short.
(J) Offering Costs/Deferred Offering Costs: Offering costs are charged against shareholders' equity and typically include legal, accounting, printing, and other fees associated with the cost of raising equity capital.
(K) Share Based Compensation: The Company applies the provisions of ASC 718, Compensation—Shares 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 of the equity or liability instruments issued.
(L) Dividends: Dividends payable are recorded on the declaration date.
(M) 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.
(N) Share Repurchases: Common shares that are repurchased by the Company subsequent to issuance decrease the total number of shares issued and outstanding.
(O) Income Taxes: Prior to May 1, 2013, the Company, as a business trust with more than one owner, was considered a partnership for U.S. federal income tax purposes. In general, partnerships are not subject to entity-level tax on their income, but the income of a partnership is taxable to its owners on a flow-through basis. Interest, dividend, and other income realized by the Company from non-U.S. sources and capital gains realized on the sale of securities of non-U.S. issuers may be subject to entity level tax such as withholding and other taxes levied by the jurisdiction in which the income is sourced. For the periods September 25, 2012 (commencement of operations) through December 31, 2012 and January 1, 2013 through April 30, 2013, the Company filed its tax return as a partnership. Effective May 1, 2013, the Company made the election to be taxed as a corporation. In addition, the Company elected to be taxed as a REIT under Sections 856 to 860 of the Code commencing with the short taxable period May 1, 2013 through December 31, 2013. To qualify as a REIT, the Company must meet certain requirements, including the distribution of at least 90% of its annual taxable income to shareholders.
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 of the litigation process, 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 fifty percent likely of being realized upon ultimate settlement. The Company did not have any unrecognized tax benefits at December 31, 2013. 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, 2013, and 2012 (its open tax years). The Company may take positions with respect to certain tax issues which depend on legal interpretation of facts or applicable

10



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.
(P) 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 repo 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 interim and annual periods beginning after December 15, 2014. The adoption of ASC 860, as amended by ASU 2014-11 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, 2014 and December 31, 2013, 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 government-sponsored enterprises, or "GSEs." 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, 2014:
($ in thousands)
 
 
 
 
 
 
Gross Unrealized
 
 
 
Weighted Average
 
Current Principal
 
Unamortized Premium (Discount)
 
Amortized
Cost
 
Gains
 
Losses
 
Fair Value
 
Coupon
 
Yield
 
Weighted Average Life(Years)(1)
Agency RMBS:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
15-year fixed rate mortgages
$
136,558

 
$
6,498

 
$
143,056

 
$
524

 
$
(223
)
 
$
143,357

 
3.40%
 
2.51%
 
5.55
20-year fixed rate mortgages
9,974

 
596

 
10,570

 
93

 
(1
)
 
10,662

 
4.00%
 
3.44%
 
7.11
30-year fixed rate mortgages
1,036,799

 
55,491

 
1,092,290

 
11,061

 
(4,590
)
 
1,098,761

 
4.04%
 
3.29%
 
8.98
Adjustable rate mortgages
43,288

 
2,945

 
46,233

 
121

 
(233
)
 
46,121

 
4.63%
 
3.16%
 
6.03
Reverse mortgages
19,523

 
1,580

 
21,103

 
118

 
(4
)
 
21,217

 
4.73%
 
2.77%
 
4.86
Interest only securities
 n/a
 
 n/a
 
12,108

 
2,457

 
(323
)
 
14,242

 
4.19%
 
10.58%
 
3.55
Total Agency RMBS
1,246,142

 
67,110

 
1,325,360

 
14,374

 
(5,374
)
 
1,334,360

 
4.02%
 
3.26%
 
7.99
Non-Agency RMBS
52,785

 
(21,568
)
 
31,217

 
3,166

 
(651
)
 
33,732

 
2.30%
 
9.71%
 
5.22
Total RMBS
$
1,298,927

 
$
45,542

 
$
1,356,577

 
$
17,540

 
$
(6,025
)
 
$
1,368,092

 
3.96%
 
3.41%
 
7.91
(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 three month and nine month periods ended September 30, 2014, the weighted average holdings of RMBS investments based on amortized cost were $1.352 billion and $1.359 billion, respectively.

11



December 31, 2013:
($ in thousands)
 
 
 
 
 
 
Gross Unrealized
 
 
 
Weighted Average
 
Current Principal
 
Unamortized Premium (Discount)
 
Amortized
Cost
 
Gains
 
Losses
 
Fair Value
 
Coupon
 
Yield
 
Weighted Average Life(Years)(1)
Agency RMBS:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
15-year fixed rate mortgages
$
179,906

 
$
7,153

 
$
187,059

 
$
65

 
$
(3,252
)
 
$
183,872

 
3.09%
 
2.52%
 
5.76
30-year fixed rate mortgages
1,029,629

 
41,565

 
1,071,194

 
490

 
(28,111
)
 
1,043,573

 
3.79%
 
3.30%
 
9.80
Adjustable rate mortgages
43,525

 
2,647

 
46,172

 
46

 
(103
)
 
46,115

 
4.72%
 
3.24%
 
3.79
Reverse mortgages
7,581

 
673

 
8,254

 
16

 
(2
)
 
8,268

 
4.85%
 
2.90%
 
3.41
Interest only securities
n/a
 
n/a
 
10,718

 
2,841

 
(32
)
 
13,527

 
3.97%
 
11.79%
 
5.02
Total Agency RMBS
1,260,641

 
52,038

 
1,323,397

 
3,458

 
(31,500
)
 
1,295,355

 
3.75%
 
3.26%
 
8.67
Non-Agency RMBS
50,006

 
(21,327
)
 
28,679

 
2,196

 
(194
)
 
30,681

 
2.84%
 
9.12%
 
5.54
Total RMBS
$
1,310,647

 
$
30,711

 
$
1,352,076

 
$
5,654

 
$
(31,694
)
 
$
1,326,036

 
3.72%
 
3.38%
 
8.56
(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, 2013, the weighted average holdings of RMBS investments based on amortized cost was $879.9 million.
By Estimated Weighted Average Life
As of September 30, 2014:
($ in thousands)
 
Agency RMBS
 
Agency Interest Only Securities
 
Non-Agency RMBS
Estimated Weighted Average Life
 
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
 
$
8,216

 
$
8,160

 
4.85
%
 
$
4,665

 
$
4,930

 
3.34
%
 
$
3,113

 
$
1,945

 
3.02
%
Greater than three years and less than seven years
 
253,354

 
252,667

 
3.95
%
 
9,577

 
7,178

 
5.11
%
 
18,274

 
18,061

 
2.66
%
Greater than seven years and less than eleven years
 
1,058,548

 
1,052,425

 
4.01
%
 

 

 
%
 
12,345

 
11,211

 
1.24
%
Total
 
$
1,320,118

 
$
1,313,252

 
4.00
%
 
$
14,242

 
$
12,108

 
4.19
%
 
$
33,732

 
$
31,217

 
2.30
%
As of December 31, 2013:
($ in thousands)
 
Agency RMBS
 
Agency Interest Only Securities
 
Non-Agency RMBS
Estimated Weighted Average Life
 
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
 
$
5,554

 
$
5,518

 
5.68
%
 
$
955

 
$
762

 
6.48
%
 
$
1,715

 
$
1,216

 
2.38
%
Greater than three years and less than seven years
 
243,120

 
246,342

 
3.48
%
 
7,643

 
6,198

 
3.31
%
 
16,488

 
15,950

 
3.42
%
Greater than seven years and less than eleven years
 
1,031,552

 
1,059,223

 
3.79
%
 
4,929

 
3,758

 
4.91
%
 
11,656

 
10,708

 
1.43
%
Greater than eleven years
 
1,602

 
1,596

 
4.50
%
 

 

 
%
 
822

 
805

 
7.69
%
Total
 
$
1,281,828

 
$
1,312,679

 
3.73
%
 
$
13,527

 
$
10,718

 
3.97
%
 
$
30,681

 
$
28,679

 
2.84
%

12



The following table illustrates components of interest income on the Company's RMBS for the three and nine month periods ended September 30, 2014:
 
 
Three Month Period Ended
September 30, 2014
 
Nine Month Period Ended
September 30, 2014
($ in thousands)
 
Coupon Interest
 
Net Amortization
 
Interest
Income
 
Coupon Interest
 
Net Amortization
 
Interest
Income
Agency RMBS
 
$
13,254

 
$
(2,575
)
 
$
10,679

 
$
39,323

 
$
(6,618
)
 
$
32,705

Non-Agency RMBS
 
303

 
502

 
805

 
947

 
1,359

 
2,306

Total
 
$
13,557

 
$
(2,073
)
 
$
11,484

 
$
40,270

 
$
(5,259
)
 
$
35,011

The following table illustrates components of interest income on the Company's RMBS for the three and nine month periods ended September 30, 2013:
 
 
Three Month Period Ended
September 30, 2013
 
Nine Month Period Ended
September 30, 2013
($ in thousands)
 
Coupon Interest
 
Net Amortization
 
Interest
Income
 
Coupon Interest
 
Net Amortization
 
Interest
Income
Agency RMBS
 
$
12,570

 
$
(2,089
)
 
$
10,481

 
$
17,484

 
$
(3,129
)
 
$
14,355

Non-Agency RMBS
 
428

 
307

 
735

 
824

 
631

 
1,455

Total
 
$
12,998

 
$
(1,782
)
 
$
11,216

 
$
18,308

 
$
(2,498
)
 
$
15,810

4. Valuation
The Company applies 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, pricing services and 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 of its assets in the future to the extent practical. 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

13



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. 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, 2014:
(In thousands)
 
 
 
 
 
 
 
 
Description
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
 
Mortgage-backed securities, at fair value:
 
 
 
 
 
 
 
 
Agency RMBS:
 
 
 
 
 
 
 
 
15-year fixed rate mortgages
 
$

 
$
143,357

 
$

 
$
143,357

20-year fixed rate mortgages
 

 
10,662

 

 
10,662

30-year fixed rate mortgages
 

 
1,098,761

 

 
1,098,761

Adjustable rate mortgages
 

 
46,121

 

 
46,121

Reverse mortgages
 

 
21,217

 

 
21,217

Interest only securities
 

 

 
14,242

 
14,242

Non-Agency RMBS
 

 

 
33,732

 
33,732

Mortgage-backed securities, at fair value
 

 
1,320,118

 
47,974

 
1,368,092

Financial derivatives–assets, at fair value:
 
 
 
 
 
 
 
 
TBAs
 

 
397

 

 
397

Fixed payer interest rate swaps
 

 
8,042

 

 
8,042

Total financial derivatives–assets, at fair value
 

 
8,439

 

 
8,439

Reverse repurchase agreements
 

 
2,484

 

 
2,484

Total mortgage-backed securities, financial derivatives–assets, and reverse repurchase agreements, at fair value
 
$

 
$
1,331,041

 
$
47,974

 
$
1,379,015

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

 
$
(2,483
)
 
$

 
$
(2,483
)
Financial derivatives–liabilities, at fair value:
 
 
 
 
 
 
 
 
TBAs
 

 
(492
)
 

 
(492
)
Fixed payer interest rate swaps
 

 
(2,333
)
 

 
(2,333
)
Fixed payer swaptions
 

 
(25
)
 

 
(25
)
Total financial derivatives–liabilities, at fair value
 
$

 
$
(2,850
)
 
$

 
$
(2,850
)
Total U.S. Treasury securities and financial derivatives–liabilities, at fair value
 
$

 
$
(5,333
)
 
$

 
$
(5,333
)
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, 2014.

14



December 31, 2013:
(In thousands)
 
 
 
 
 
 
 
 
Description
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
 
Mortgage-backed securities, at fair value:
 
 
 
 
 
 
 
 
Agency RMBS:
 
 
 
 
 
 
 
 
15-year fixed rate mortgages
 
$

 
$
183,872

 
$

 
$
183,872

30-year fixed rate mortgages
 

 
1,043,573

 

 
1,043,573

Adjustable rate mortgages
 

 
46,115

 

 
46,115

Reverse mortgages
 

 
8,268

 

 
8,268

Interest only securities
 

 

 
13,527

 
13,527

Non-Agency RMBS
 

 

 
30,681

 
30,681

Mortgage-backed securities, at fair value
 

 
1,281,828

 
44,208

 
1,326,036

Financial derivatives–assets, at fair value:
 
 
 
 
 
 
 
 
TBAs
 

 
2,263

 

 
2,263

Fixed payer interest rate swaps
 

 
32,700

 

 
32,700

Total financial derivatives–assets, at fair value
 

 
34,963

 

 
34,963

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

 
$
1,316,791

 
$
44,208

 
$
1,360,999

Liabilities:
 
 
 
 
 
 
 
 
Financial derivatives–liabilities, at fair value:
 
 
 
 
 
 
 
 
TBAs
 
$

 
$
(28
)
 
$

 
$
(28
)
Fixed payer interest rate swaps
 

 
(956
)
 

 
(956
)
Fixed payer swaptions
 

 
(85
)
 

 
(85
)
Total financial derivatives–liabilities, at fair value
 
$

 
$
(1,069
)
 
$

 
$
(1,069
)
There were no transfers of financial instruments between Levels 1, 2, or 3 of the fair value hierarchy during the year ended December 31, 2013.
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, 2014:
(In thousands)
Non-Agency
RMBS
 
Agency RMBS
Beginning balance as of June 30, 2014
$
35,668

 
$
14,276

Transfers:
 
 
 
Transfers into level 3

 

Transfers out of level 3

 

Purchases
2,543

 
545

Proceeds from sales
(3,688
)
 

Principal repayments
(1,373
)
 

(Amortization)/accretion, net
502

 
(906
)
Net realized gains
1,145

 

Change in net unrealized gains (losses)
(1,065
)
 
327

Ending balance as of September 30, 2014
$
33,732

 
$
14,242

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, 2014, as well as Level 3 financial instruments disposed of by the Company during the three month period ended September 30, 2014. For Level 3 financial instruments held

15



by the Company at September 30, 2014, change in net unrealized gains (losses) of $0.3 million and $(0.1) million, for the three month period ended September 30, 2014 relate to Agency RMBS and non-Agency RMBS, respectively.
Three month period ended September 30, 2013:
(In thousands)
Non-Agency
RMBS
 
Agency RMBS
Beginning balance as of June 30, 2013
$
38,810

 
$
9,905

Transfers:
 
 
 
Transfers into level 3

 

Transfers out of level 3

 

Purchases
6,402

 
3,094

Proceeds from sales
(9,247
)
 

Principal repayments
(2,927
)
 

(Amortization)/accretion, net
307

 
(626
)
Net realized gains
581

 

Change in net unrealized gains (losses)
541

 
349

Ending balance as of September 30, 2013
$
34,467

 
$
12,722

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, 2013, as well as Level 3 financial instruments disposed of by the Company during the three month period ended September 30, 2013. For Level 3 financial instruments held by the Company at September 30, 2013, change in net unrealized gains (losses) of $0.3 million and $0.7 million, for the three month period ended September 30, 2013 relate to Agency RMBS and non-Agency RMBS.
Nine month period ended September 30, 2014:
(In thousands)
Non-Agency
RMBS
 
Agency RMBS
Beginning balance as of December 31, 2013
$
30,681

 
$
13,527

Transfers:
 
 
 
Transfers into level 3

 

Transfers out of level 3

 

Purchases
14,711

 
4,640

Proceeds from sales
(11,104
)
 
(1,282
)
Principal repayments
(3,945
)
 

(Amortization)/accretion, net
1,359

 
(2,326
)
Net realized gains
1,518

 
358

Change in net unrealized gains (losses)
512

 
(675
)
Ending balance as of September 30, 2014
$
33,732

 
$
14,242

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, 2014, as well as Level 3 financial instruments disposed of by the Company during the nine month period ended September 30, 2014. For Level 3 financial instruments held by the Company at September 30, 2014, change in net unrealized gains (losses) of $(0.5) million and $0.8 million, for the nine month period ended September 30, 2014 relate to Agency RMBS and non-Agency RMBS, respectively.

16



Nine month period ended September 30, 2013:
(In thousands)
Non-Agency
RMBS
 
Agency RMBS
Beginning balance as of December 31, 2012
$
13,596

 
$

Transfers:
 
 
 
Transfers into level 3

 

Transfers out of level 3

 

Purchases
37,180

 
12,116

Proceeds from sales
(14,556
)
 

Principal repayments
(4,390
)
 

(Amortization)/accretion, net
631

 
(761
)
Net realized gains
1,469

 

Change in net unrealized gains (losses)
537

 
1,367

Ending balance as of September 30, 2013
$
34,467

 
$
12,722

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, 2013, as well as Level 3 financial instruments disposed of by the Company during the nine month period ended September 30, 2013. For Level 3 financial instruments held by the Company at September 30, 2013, change in net unrealized gains (losses) of $1.4 million and $0.6 million, for the nine month period ended September 30, 2013 relate to Agency RMBS and non-Agency RMBS, respectively.
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, 2014 and December 31, 2013:
September 30, 2014:
 
 
Range
 
 
Description
 
Fair Value
 
Valuation Technique
 
Significant
Unobservable Input
 
Min
 
Max
 
Weighted Average(1)
 
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
Non-Agency RMBS
 
$
28,493

 
Market quotes
 
Non-Binding Indicative Price
 
$
46.05

 
$
106.25

 
$
76.25

Non-Agency RMBS
 
5,239

 
Discounted Cash Flows
 
Yield
 
7.3
%
 
15.6
%
 
9.2
%
 
 
 
 
 
 
Projected Collateral Prepayments
 
30.8
%
 
41.7
%
 
37.1
%
 
 
 
 
 
 
Projected Collateral Losses
 
3.9
%
 
7.2
%
 
5.5
%
 
 
 
 
 
 
Projected Collateral Recoveries
 
5.2
%
 
10.9
%
 
8.4
%
 
 
 
 
 
 
Projected Collateral Scheduled Amortization
 
46.2
%
 
53.8
%
 
49.0
%
 
 
 
 
 
 
 
 
 
 
 
 
100.0
%
Agency RMBS–Interest Only Securities
 
12,402

 
Market quotes
 
Non-Binding Indicative Price
 
$
4.82

 
$
21.42

 
$
14.23

Agency RMBS–Interest Only Securities
 
1,840

 
Option Adjusted Spread ("OAS")
 
LIBOR OAS (2)
 
80

 
417

 
224

 
 
 
 
 
 
Projected Collateral Prepayments
 
70.2
%
 
70.9
%
 
70.5
%
 
 
 
 
 
 
Projected Collateral Scheduled Amortization
 
29.1
%
 
29.8
%
 
29.5
%
 
 
 
 
 
 
 
 
 
 
 
 
100.0
%
(1)
Averages are weighted based on the fair value of the related instrument.
(2)
Shown in basis points.

17



December 31, 2013:
 
 
Range
 
 
Description
 
Fair Value
 
Valuation Technique
 
Significant
Unobservable Input
 
Min
 
Max
 
Weighted Average(1)
 
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
Non-Agency RMBS
 
$
27,422

 
Market quotes
 
Non-Binding Indicative Price
 
$
20.00

 
$
100.25

 
$
75.39

Non-Agency RMBS
 
3,259

 
Discounted Cash Flows
 
Yield
 
6.0
%
 
17.0
%
 
11.9
%
 
 
 
 
 
 
Projected Collateral Prepayments
 
12.2
%
 
58.1
%
 
33.9
%
 
 
 
 
 
 
Projected Collateral Losses
 
6.4
%
 
26.5
%
 
11.8
%
 
 
 
 
 
 
Projected Collateral Recoveries
 
4.6
%
 
12.8
%
 
8.8
%
 
 
 
 
 
 
Projected Collateral Scheduled Amortization
 
29.9
%
 
54.9
%
 
45.5
%
 
 
 
 
 
 
 
 
 
 
 
 
100.0
%
Agency RMBS–Interest Only Securities
 
12,368

 
Market quotes
 
Non-Binding Indicative Price
 
$
4.99

 
$
22.47

 
$
14.92

Agency RMBS–Interest Only Securities
 
1,159

 
Option Adjusted Spread ("OAS")
 
LIBOR OAS(2)
 
436

 
436

 
436

 
 
 
 
 
 
Projected Collateral Prepayments
 
57.8
%
 
57.8
%
 
57.8
%
 
 
 
 
 
 
Projected Collateral Scheduled Amortization
 
42.2
%
 
42.2
%
 
42.2
%
 
 
 
 
 
 
 
 
 
 
 
 
100.0
%
(1)
Averages are weighted based on the fair value of the related instrument.
(2)
Shown in basis points.
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, 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.
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 debt 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 these rates on its 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, interest rate swaptions, and TBAs. Additionally, from time to time, the Company may use short positions in U.S. Treasury securities to hedge its interest rate risk.

18



The following table details fair value of the Company's holdings of financial derivatives as of September 30, 2014 and December 31, 2013:
 
 
September 30, 2014
 
December 31, 2013
 
 
(In thousands)
Financial derivatives–assets, at fair value:
 
 
 
 
TBA securities purchase contracts
 
$
28

 
$
1

TBA securities sale contracts
 
369

 
2,262

Fixed payer interest rate swaps
 
8,042

 
32,700

Total financial derivatives–assets, at fair value:
 
$
8,439

 
$
34,963

Financial derivatives–liabilities, at fair value:
 
 
 
 
TBA securities purchase contracts
 
$
(81
)
 
$

TBA securities sale contracts
 
(411
)
 
(28
)
Fixed payer interest rate swaps
 
(2,333
)
 
(956
)
Swaptions
 
(25
)
 
(85
)
Total financial derivatives–liabilities, at fair value:
 
$
(2,850
)
 
$
(1,069
)
Total
 
$
5,589

 
$
33,894

Interest Rate Swaps
The following tables provide information about the Company's interest rate swaps as of September 30, 2014 and December 31, 2013:
September 30, 2014:
 
 
 
 
 
 
Weighted Average
Remaining Maturity
 
Notional Amount
 
Fair Value
 
Pay Rate
 
Receive Rate
 
Remaining Years to Maturity
 
 
(In thousands)
 
 
 
 
 
 
2016
 
$
48,000

 
$
(37
)
 
0.80
%
 
0.23
%
 
2.02
2017
 
74,750

 
(96
)
 
1.21

 
0.24

 
2.84
2018
 
33,500

 
695

 
0.88

 
0.24

 
3.63
2020
 
43,200

 
1,313

 
1.42

 
0.23

 
5.62
2021
 
27,000

 
(150
)
 
2.29

 
0.23

 
6.77
2023
 
210,600

 
5,034

 
2.13

 
0.23

 
8.65
2024
 
27,700

 
(340
)
 
2.74

 
0.21

 
9.83
2043
 
54,500

 
(119
)
 
3.15

 
0.23

 
28.68
2044
 
9,820

 
(591
)
 
3.48

 
0.23

 
29.66
Total
 
$
529,070

 
$
5,709

 
1.91
%
 
0.23
%
 
9.08

19



December 31, 2013:
 
 
 
 
 
 
Weighted Average
Remaining Maturity
 
Notional Amount
 
Fair Value
 
Pay Rate
 
Receive Rate
 
Remaining Years to Maturity
 
 
(In thousands)
 
 
 
 
 
 
2016
 
$
48,000

 
$
(171
)
 
0.80
%
 
0.24
%
 
2.77
2017
 
124,000

 
(517
)
 
1.19

 
0.24

 
3.61
2018
 
156,500

 
2,784

 
1.19

 
0.24

 
4.63
2020
 
137,100

 
6,444

 
1.49

 
0.24

 
6.06
2023
 
218,000

 
14,599

 
2.16

 
0.24

 
9.41
2043
 
64,750

 
8,605

 
3.18

 
0.24

 
29.44
Total
 
$
748,350

 
$
31,744

 
1.67
%
 
0.24
%
 
8.14
The Company uses period end notional values as a percentage of average monthly notional values as an indicator of the volume of activity with respect to financial derivatives. For the nine month period ended September 30, 2014, period end aggregate notional value of interest rate swaps reflected above represents approximately 88% of average monthly notional values during the period. For the year ended December 31, 2013, period end aggregate notional value of interest rate swaps reflected above represents approximately 123% of average monthly notional values during the period.
Interest Rate Swaptions
The following tables provide information about the Company's swaptions as of September 30, 2014 and December 31, 2013.
September 30, 2014:
Option
 
Underlying Swap
Type
 
Fair Value
 
Months to Expiration
 
Notional
Amount
 
Term (Years)
 
 
Fixed Rate
($ in thousands)
 
 
 
 
 
 
 
 
 
 
Straddle
 
$
(25
)
 
9.5
 
$
9,700

 
10
 
3.00%
December 31, 2013:
Option
 
Underlying Swap
Type
 
Fair Value
 
Months to Expiration
 
Notional
Amount