XNYS:AI Arlington Asset Investment Corp. Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549


FORM 10-Q

 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2012
OR

o
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: 001-34374


ARLINGTON ASSET INVESTMENT CORP.
(Exact name of Registrant as specified in its charter)

 
Virginia
 
54-1873198
(State or Other Jurisdiction of Incorporation or Organization)
 
(I.R.S. Employer Identification No.)
 
 
 
1001 Nineteenth Street North
Arlington, VA
 
22209
(Address of Principal Executive Offices)
 
(Zip Code)

(703) 373-0200
(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 o

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 (Sec.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 o

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 o
Accelerated filer x
Non-accelerated filer o
Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): Yes o No x

Number of shares outstanding of each of the registrant’s classes of common stock, as of July 31, 2012:

Title
 
Outstanding
Class A Common Stock
 
9,115,203 shares
Class B Common Stock
 
566,112 shares
 


 
 

 
 
ARLINGTON ASSET INVESTMENT CORP.
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2012

 
 
 
Page
PART I—FINANCIAL INFORMATION
 
 
 
 
 
Item 1.
 
1
 
 
 
 
 
 
1
 
 
 
 
 
 
2
 
 
 
 
 
 
3
 
 
 
 
 
 
4
 
 
 
 
 
 
5
 
 
 
 
Item 2.
 
17
 
 
 
 
Item 3.
 
29
 
 
 
 
Item 4.
 
32
 
 
 
 
PART II—OTHER INFORMATION
 
 
 
 
 
Item 1.
 
34
 
 
 
 
Item 1A.
 
34
 
 
 
 
Item 2.
 
34
 
 
 
 
Item 4.
 
34
 
 
 
 
Item 6.
 
35
 
 
 
 
 
 
36

 
 


PART I
FINANCIAL INFORMATION


ARLINGTON ASSET INVESTMENT CORP.
(Dollars in thousands)
(Unaudited)

 
 
June 30, 2012
 
 
December 31, 2011
 
ASSETS
 
 
 
 
 
 
Cash and cash equivalents
 
$
21,137
 
 
$
20,018
 
Receivables
 
 
 
 
 
 
 
 
Interest
 
 
3,360
 
 
 
2,366
 
Sold securities receivable
 
 
70,727
 
 
 
41,321
 
Other
 
 
106
 
 
 
11
 
Mortgage-backed securities, at fair value
 
 
 
 
 
 
 
 
Available-for-sale
 
 
173,042
 
 
 
179,566
 
Trading
 
 
1,017,822
 
 
 
636,872
 
Other investments
 
 
2,931
 
 
 
2,946
 
Derivative assets, at fair value
 
 
1,899
 
 
 
504
 
Deposits
 
 
88,074
 
 
 
71,079
 
Prepaid expenses and other assets
 
 
367
 
 
 
377
 
Total assets
 
$
1,379,465
 
 
$
955,060
 
 
 
 
 
 
 
 
 
 
LIABILITIES AND EQUITY
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
Repurchase agreements
 
$
963,051
 
 
$
647,977
 
Interest payable
 
 
410
 
 
 
504
 
Accrued compensation and benefits
 
 
2,564
 
 
 
6,177
 
Dividend payable
 
 
8,566
 
 
 
6,785
 
Derivative liabilities, at fair value
 
 
81,028
 
 
 
63,024
 
Purchased securities payable
 
 
 
 
 
15,820
 
Securities sold but not yet purchased, at fair value
 
 
70,965
 
 
 
 
Accounts payable, accrued expenses and other liabilities
 
 
16,789
 
 
 
16,401
 
Long-term debt
 
 
15,000
 
 
 
15,000
 
Total liabilities
 
 
1,158,373
 
 
 
771,688
 
 
 
 
 
 
 
 
 
 
Commitments and contingencies
 
 
 
 
 
 
Equity:
 
 
 
 
 
 
 
 
Preferred stock, $0.01 par value, 25,000,000 shares authorized, none issued and outstanding
 
 
 
 
 
 
Class A common stock, $0.01 par value, 450,000,000 shares authorized, 9,115,203 and 7,099,336 shares issued and outstanding, respectively
 
 
91
 
 
 
71
 
Class B common stock, $0.01 par value, 100,000,000 shares authorized, 566,112 shares issued and outstanding
 
 
6
 
 
 
6
 
Additional paid-in capital
 
 
1,554,952
 
 
 
1,508,713
 
Accumulated other comprehensive income, net of taxes
 
 
33,807
 
 
 
38,367
 
Accumulated deficit
 
 
(1,367,764
)
 
 
(1,363,785
)
Total equity
 
 
221,092
 
 
 
183,372
 
Total liabilities and equity
 
$
1,379,465
 
 
$
955,060
 

See notes to consolidated financial statements.

 
1

 
ARLINGTON ASSET INVESTMENT CORP.
(Dollars in thousands, except per share data)
 
(Unaudited)
 
   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
   
2012
   
2011
   
2012
   
2011
 
Interest income
  $ 16,031     $ 13,262     $ 29,394     $ 25,757  
                                 
Interest expense
                               
Interest on short-term debt
    994       477       1,686       794  
Interest on long-term debt
    123       115       248       230  
Total interest expense
    1,117       592       1,934       1,024  
Net interest income
    14,914       12,670       27,460       24,733  
Other (loss) income, net
                               
Investment (loss) gain, net
    (8,677 )     (8,484 )     (5,869 )     2,740  
Other loss
    (4 )     (4 )     (8 )     (7 )
Total other (loss) income, net
    (8,681 )     (8,488 )     (5,877 )     2,733  
Operating income before other expenses
    6,233       4,182       21,583       27,466  
Other expenses
                               
Compensation and benefits
    2,101       2,570       4,061       5,006  
Professional services
    891       561       2,475       684  
Business development
    55       47       72       79  
Occupancy and equipment
    150       92       245       188  
Communications
    53       50       105       96  
Other operating expenses
    460       425       898       720  
Total other expenses
    3,710       3,745       7,856       6,773  
Income before income taxes
    2,523       437       13,727       20,693  
Income tax provision
    379       346       821       817  
Net income
  $ 2,144     $ 91     $ 12,906     $ 19,876  
                                 
Basic earnings per share
  $ 0.22     $ 0.01     $ 1.47     $ 2.58  
Diluted earnings per share
  $ 0.22     $ 0.01     $ 1.47     $ 2.57  
Dividends declared per share
  $ 0.875     $ 0.875     $ 1.75     $ 1.625  
Weighted-average shares outstanding
                               
(in thousands)
                               
Basic
    9,726       7,723       8,795       7,692  
Diluted
    9,733       7,736       8,803       7,728  
                                 
Other comprehensive income (loss), net of taxes
                               
Unrealized gains (losses) for the period on available-for-sale securities (net of taxes of $-0-)
  $ 343     $ (1,597 )   $ (4,560 )   $ (136 )
Reclassification adjustment for gains included in net income on available-for-sale securities (net of taxes of $-0-)
          (2,089 )           (13,794 )
Comprehensive income (loss)
  $ 2,487     $ (3,595 )   $ 8,346     $ 5,946  
 
See notes to consolidated financial statements.

 
2

 
ARLINGTON ASSET INVESTMENT CORP.
(Dollars in thousands)
(Unaudited)

 
 
Class A
Common
Stock (#)
 
 
Class A
Amount
($)
 
 
Class B
Common
Stock (#)
 
 
Class B
Amount
($)
 
 
Additional
Paid-In
Capital
 
 
Accumulated
Other
Comprehensive
Income
 
 
Accumulated
Deficit
 
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balances, December 31, 2010
 
 
7,106,330
 
 
$
71
 
 
 
566,112
 
 
$
6
 
 
$
1,505,971
 
 
$
63,495
 
 
$
(1,352,799
)
 
$
216,744
 
Net income
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
15,173
 
 
 
15,173
 
Issuance of Class A common stock
 
 
29,147
 
 
 
 
 
 
 
 
 
 
 
 
545
 
 
 
 
 
 
 
 
 
545
 
Repurchase of Class A common stock
 
 
(8,910
)
 
 
 
 
 
 
 
 
 
 
 
(229
)
 
 
 
 
 
 
 
 
(229
)
Forfeitures of Class A common stock
 
 
(27,231
)
 
 
 
 
 
 
 
 
 
 
 
(770
)
 
 
 
 
 
 
 
 
(770
)
Amortization of Class A common shares issued as stock-based awards
 
 
 
 
 
 
 
 
 
 
 
 
 
 
601
 
 
 
 
 
 
 
 
 
601
 
Reclassification of restricted stock units issued as stock based awards
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2,595
 
 
 
 
 
 
 
 
 
2,595
 
Other comprehensive income
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net change in unrealized gain on available-for-sale investment securities, (net of taxes of $-0-)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(25,128
)
 
 
 
 
 
(25,128
)
Dividends declared
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(26,159
)
 
 
(26,159
)
Balances, December 31, 2011
 
 
7,099,336
 
 
 
71
 
 
 
566,112
 
 
 
6
 
 
 
1,508,713
 
 
 
38,367
 
 
 
(1,363,785
)
 
 
183,372
 
Net income
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
12,906
 
 
 
12,906
 
Issuance of Class A common stock
 
 
2,018,250
 
 
 
20
 
 
 
 
 
 
 
 
 
45,995
 
 
 
 
 
 
 
 
 
46,015
 
Forfeitures of Class A common stock
 
 
(2,383
)
 
 
 
 
 
 
 
 
 
 
 
(55
)
 
 
 
 
 
 
 
 
(55
)
Amortization of Class A common shares issued as stock-based awards
 
 
 
 
 
 
 
 
 
 
 
 
 
 
299
 
 
 
 
 
 
 
 
 
299
 
Other comprehensive income
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net change in unrealized gain on available-for-sale investment securities, (net of taxes of $-0-)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(4,560
)
 
 
 
 
 
(4,560
)
Dividends declared
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(16,885
)
 
 
(16,885
)
Balances, June 30, 2012
 
 
9,115,203
 
 
$
91
 
 
 
566,112
 
 
$
6
 
 
$
1,554,952
 
 
$
33,807
 
 
$
(1,367,764
)
 
$
221,092
 

See notes to consolidated financial statements.

 
3


ARLINGTON ASSET INVESTMENT CORP.

(Dollars in thousands)
(Unaudited)

 
 
Six Months Ended June 30,
 
 
 
2012
 
 
2011
 
Cash flows from operating activities:
 
 
 
 
 
 
Net income
 
$
12,906
 
 
$
19,876
 
Adjustments to reconcile net income to net cash provided by operating activities
 
 
 
 
 
 
 
 
Net investment loss (gain)
 
 
5,869
 
 
 
(2,740
)
Net (discount)/premium (accretion)/amortization on mortgage-backed securities
 
 
(5,458
)
 
 
(5,991
)
Depreciation and amortization
 
 
24
 
 
 
24
 
Other
 
 
538
 
 
 
465
 
Changes in operating assets
 
 
 
 
 
 
 
 
Interest receivable
 
 
(994
)
 
 
(1,409
)
Other receivables
 
 
(95
)
 
 
19
 
Prepaid expenses and other assets
 
 
692
 
 
 
664
 
Changes in operating liabilities
 
 
 
 
 
 
 
 
Accounts payable and accrued expenses
 
 
1
 
 
 
592
 
Accrued compensation and benefits
 
 
(3,613
)
 
 
(1,467
)
Net cash provided by operating activities
 
 
9,870
 
 
 
10,033
 
 
 
 
 
 
 
 
 
 
Cash flows from investing activities:
 
 
 
 
 
 
 
 
Purchases of available-for-sale mortgage-backed securities
 
 
(470
)
 
 
(17,190
)
Purchases of trading mortgage-backed securities
 
 
(508,374
)
 
 
(663,542
)
Proceeds from sales of available-for-sale mortgage-backed securities
 
 
 
 
 
73,294
 
Proceeds from sales of trading mortgage-backed securities
 
 
112,067
 
 
 
176,278
 
Receipt of principal payments on available-for-sale mortgage-backed securities
 
 
7,807
 
 
 
8,097
 
Receipt of principal payments on trading mortgage-backed securities
 
 
31,143
 
 
 
13,255
 
Payments for purchased securities payable
 
 
(15,820
)
 
 
(2,555
)
Proceeds from sold securities receivable
 
 
41,321
 
 
 
 
Payments for derivatives and deposits, net
 
 
(18,085
)
 
 
(31,623
)
Other
 
 
(4,325
)
 
 
5,253
 
Net cash used in investing activities
 
 
(354,736
)
 
 
(438,733
)
 
 
 
 
 
 
 
 
 
Cash flows from financing activities:
 
 
 
 
 
 
 
 
Proceeds from repurchase agreements, net
 
 
315,074
 
 
 
449,023
 
Proceeds from stock issuance
 
 
46,015
 
 
 
 
Dividends paid
 
 
(15,104
)
 
 
(10,459
)
Repayments of short-term debt
 
 
 
 
 
(970
)
Repurchase of common stock
 
 
 
 
 
(229
)
Net cash provided by financing activities
 
 
345,985
 
 
 
437,365
 
 
 
 
 
 
 
 
 
 
Net increase in cash and cash equivalents
 
 
1,119
 
 
 
8,665
 
Cash and cash equivalents, beginning of period
 
 
20,018
 
 
 
12,412
 
Cash and cash equivalents, end of period
 
$
21,137
 
 
$
21,077
 
 
 
 
 
 
 
 
 
 
Supplemental cash flow information
 
 
 
 
 
 
 
 
Cash payments for interest
 
$
2,028
 
 
$
966
 
Cash payments for taxes
 
$
274
 
 
$
195
 

See notes to consolidated financial statements.

 
4


ARLINGTON ASSET INVESTMENT CORP.

(Dollars in thousands, except per share data)
(Unaudited)

1.
Basis of Presentation:

The consolidated financial statements of Arlington Asset Investment Corp. (Arlington Asset) and its subsidiaries (unless the context otherwise provides, collectively, the Company) have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial information and with the instructions to Form 10-Q. Therefore, they do not include all information required by GAAP for complete financial statements. The interim financial statements reflect all adjustments (consisting only of normal recurring adjustments) which are, in the opinion of management, necessary for a fair statement of the results for the periods presented. All significant intercompany accounts and transactions have been eliminated in consolidation. The results of operations for the three and six months ended June 30, 2012 are not necessarily indicative of the operating results for the entire year or any other subsequent interim period. The Company’s unaudited condensed consolidated financial statements and notes thereto should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.

The preparation of the Company’s financial statements in conformity with GAAP requires the Company to make estimates and assumptions affecting the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Although the Company based the estimates and assumptions on historical experience, when available, market information, and on various other factors that the Company believes to be reasonable under the circumstances, management exercises significant judgment in the final determination of the estimates. Actual results may differ from these estimates.

Certain amounts in the consolidated financial statements and notes for prior periods have been reclassified to conform to the current period presentation. These reclassifications had no effect on the results of operations of the Company.

2.
Financial Instruments:
 
  Fair Value of Financial Instruments

The accounting principles related to fair value measurements define fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, not adjusted for transaction costs. Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 820, Fair Value Measurements and Disclosures (ASC 820), establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels giving the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3) as described below:

Level 1 Inputs—
Unadjusted quoted prices in active markets for identical assets or liabilities that are accessible by the Company;

Level 2 Inputs—
Quoted prices in markets that are not active or financial instruments for which all significant inputs are observable, either directly or indirectly; and

Level 3 Inputs—
Unobservable inputs for the asset or liability, including significant assumptions of the Company and other market participants.

The Company determines fair values for the following assets and liabilities:

Mortgage-backed securities (MBS), at fair value

Agency-backed MBS - The Company’s agency-backed MBS, the principal and interest payments on which are guaranteed by the Federal National Mortgage Association (Fannie Mae) or the Federal Home Loan Mortgage Corporation (Freddie Mac), are generally classified within Level 2 of the fair value hierarchy as they are valued after considering quoted market prices provided by a broker or dealer, or alternative pricing sources with reasonable levels of price transparency. The Company reviews broker or pricing service quotes to determine whether the quotes are relevant, for example, whether an active market exists to provide price transparency or whether the quote is an indicative price or a binding offer. The independent brokers and dealers providing market prices are those who make markets in these financial instruments.
 
 
5

 
Private-label MBS - The Company classifies private-label MBS within Level 3 of the fair value hierarchy because they trade infrequently and, therefore, have little or no price transparency. The Company utilizes present value techniques based on estimated cash flows of the instrument taking into consideration various assumptions derived by management and other assumptions used by other market participants. These assumptions are corroborated by evidence such as historical data, risk characteristics, transactions in similar instruments, and completed or pending transactions, when available. The significant inputs in the Company’s valuation process include default rate, loss severity, prepayment rate and discount rate. In general, significant increases (decreases) in default rate, loss severity or discount rate, in isolation, would result in a significantly lower (higher) fair value measurement.  However, significant increases (decreases) in prepayment rate may result in a significantly higher (lower) fair value measurement. It is difficult to generalize the interrelationships between these significant inputs as the actual results could differ considerably on an individual security basis.  For example, an increase in the default rate may not increase the loss severity rate if actual losses are lower than the average.  Also, changes in discount rates may be greatly influenced by market expectation at any given point based upon many variables not directly related to the MBS market.  Therefore, each significant input is closely analyzed to ascertain the reasonableness for the Company’s valuation purposes.

Establishing fair value is inherently subjective given the volatile and sometimes illiquid markets for these private-label MBS and requires management to make a number of assumptions, including assumptions about the future of interest rates, prepayment rates, discount rates, credit loss rates, and the timing of cash flows and credit losses. The assumptions the Company applies are specific to each security. Although the Company relies on the internal calculations to compute the fair value of these private-label MBS, the Company requests and considers indications of value (mark) from third-party dealers to assist in the valuation process.

Securities sold but not yet purchased, at fair value—The Company’s securities sold but not yet purchased, at fair value, represent obligations of the Company to deliver a specified MBS at a contracted price, which create a liability to purchase that MBS at prevailing prices in order to deliver the MBS in satisfaction of this obligation. The Company’s liability for the purchase of the MBS to be delivered is measured at the fair value of the MBS as of the date of the financial statements. However, these transactions expose the Company to price risk until settled, as the Company’s ultimate cost to satisfy the delivery of securities sold but not yet purchased, at fair value, may exceed the amount reflected in the consolidated balance sheet. The Company classifies MBS sold but not yet purchased, at fair value, within Level 2 of the fair value hierarchy, as they are valued after considering quoted market prices provided by a broker or dealer, or alternative pricing sources, with reasonable levels of price transparency. The Company reviews broker or pricing service quotes to determine whether the quotes are relevant, for example, whether an active market exists to provide price transparency or whether the quote is an indicative price or a binding offer. The independent brokers and dealers providing market prices are those who make markets in these financial instruments.

Other investments—The Company’s other investments consist of investments in equity securities, investment funds, interest-only MBS, and other MBS-related securities. Interest-only MBS and residual interest in a securitization of which the Company is not considered the primary beneficiary are classified within Level 3 of the fair value hierarchy.

Derivative instruments—In the normal course of the Company’s operations, the Company is a party to various financial instruments that are accounted for as derivatives in accordance with ASC 815, Derivatives and Hedging (ASC 815). The derivative instruments that trade in active markets or exchanges are classified within Level 1 of the fair value hierarchy because they are valued using quoted market prices. Other derivative instruments are generally classified within Level 2 of the fair value hierarchy because they are valued using broker or dealer quotations, which are model-based calculations based on market-based inputs, including, but not limited to, contractual terms, market prices, yield curves, credit curves, measures of volatility, prepayment rates and correlations of such inputs.
 
Other—Cash and cash equivalents, interest receivable, sold securities receivable, deposits, other receivable, repurchase agreements, purchase securities payable, interest payable, accounts payable, accrued expenses and other liabilities are reflected in the consolidated balance sheets at their amortized cost, which approximates fair value because of the short term nature of these instruments.
 
 
6

 
The estimated fair values of the Company’s financial instruments are as follows:

 
 
June 30, 2012
 
 
December 31, 2011
 
 
 
Carrying
Amount
 
 
Estimated
Fair Value
 
 
Carrying
Amount
 
 
Estimated
Fair Value
 
Financial assets
 
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
21,137
 
 
$
21,137
 
 
$
20,018
 
 
$
20,018
 
Interest receivable
 
 
3,360
 
 
 
3,360
 
 
 
2,366
 
 
 
2,366
 
Sold securities receivable
 
 
70,727
 
 
 
70,727
 
 
 
41,321
 
 
 
41,321
 
Other receivables
 
 
106
 
 
 
106
 
 
 
11
 
 
 
11
 
MBS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agency-backed MBS
 
 
1,017,916
 
 
 
1,017,916
 
 
 
637,011
 
 
 
637,011
 
Private-label MBS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Senior securities
 
 
8,498
 
 
 
8,498
 
 
 
9,311
 
 
 
9,311
 
Re-REMIC securities
 
 
164,450
 
 
 
164,450
 
 
 
170,116
 
 
 
170,116
 
Derivative assets
 
 
1,899
 
 
 
1,899
 
 
 
504
 
 
 
504
 
Other investments
 
 
2,931
 
 
 
2,931
 
 
 
2,946
 
 
 
2,946
 
Deposits
 
 
88,074
 
 
 
88,074
 
 
 
71,079
 
 
 
71,079
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Repurchase agreements
 
 
963,051
 
 
 
963,051
 
 
 
647,977
 
 
 
647,977
 
Purchased securities payable
 
 
 
 
 
 
 
 
15,820
 
 
 
15,820
 
Securities sold but not yet purchased
 
 
70,965
 
 
 
70,965
 
 
 
 
 
 
 
Interest payable
 
 
410
 
 
 
410
 
 
 
504
 
 
 
504
 
Long-term debt
 
 
15,000
 
 
 
15,000
 
 
 
15,000
 
 
 
15,000
 
Derivative liabilities
 
 
81,028
 
 
 
81,028
 
 
 
63,024
 
 
 
63,024
 
Accounts payable, accrued expenses and other liabilities
 
 
16,789
 
 
 
16,789
 
 
 
16,401
 
 
 
16,401
 

  Fair Value Hierarchy

The following tables set forth financial instruments accounted for under ASC 820 by level within the fair value hierarchy as of June 30, 2012 and December 31, 2011. As required by ASC 820, assets and liabilities that are measured at fair value are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

Financial Instruments Measured at Fair Value on a Recurring Basis

 
 
June 30, 2012
 
 
 
Total
 
 
Level 1
 
 
Level 2
 
 
Level 3
 
MBS, at fair value
 
 
 
 
 
 
 
 
 
 
 
 
Trading
 
 
 
 
 
 
 
 
 
 
 
 
Agency-backed MBS
 
$
1,017,822
 
 
$
 
 
$
1,017,822
 
 
$
 
Available-for-sale
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agency-backed MBS
 
 
94
 
 
 
 
 
 
94
 
 
 
 
Private-label MBS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Senior securities
 
 
8,498
 
 
 
 
 
 
 
 
 
8,498
 
Re-REMIC securities
 
 
164,450
 
 
 
 
 
 
 
 
 
164,450
 
Total available-for-sale
 
 
173,042
 
 
 
 
 
 
94
 
 
 
172,948
 
Total MBS
 
 
1,190,864
 
 
 
 
 
 
1,017,916
 
 
 
172,948
 
Derivative assets, at fair value
 
 
1,899
 
 
 
 
 
 
1,899
 
 
 
 
Derivative liabilities, at fair value
 
 
(81,028
)
 
 
(80,512
)
 
 
(516
)
 
 
 
Securities sold but not yet purchased, at fair value
 
 
(70,965
)
 
 
 
 
 
(70,965
)
 
 
 
Interest-only MBS, at fair value
 
 
935
 
 
 
 
 
 
 
 
 
935
 
Total
 
$
1,041,705
 
 
$
(80,512
)
 
$
948,334
 
 
$
173,883
 

 
7

 
 
 
December 31, 2011
 
 
 
Total
 
 
Level 1
 
 
Level 2
 
 
Level 3
 
MBS, at fair value
 
 
 
 
 
 
 
 
 
 
 
 
Trading
 
 
 
 
 
 
 
 
 
 
 
 
Agency-backed MBS
 
$
636,872
 
 
$
 
 
$
636,872
 
 
$
 
Available-for-sale
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agency-backed MBS
 
 
139
 
 
 
 
 
 
139
 
 
 
 
Private-label MBS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Senior securities
 
 
9,311
 
 
 
 
 
 
 
 
 
9,311
 
Re-REMIC securities
 
 
170,116
 
 
 
 
 
 
 
 
 
170,116
 
Total available-for-sale
 
 
179,566
 
 
 
 
 
 
139
 
 
 
179,427
 
Total MBS
 
 
816,438
 
 
 
 
 
 
637,011
 
 
 
179,427
 
Derivative assets, at fair value
 
 
504
 
 
 
 
 
 
504
 
 
 
 
Derivative liabilities, at fair value
 
 
(63,024
)
 
 
(63,024
)
 
 
 
 
 
 
Interest-only MBS, at fair value
 
 
1,060
 
 
 
 
 
 
 
 
 
1,060
 
Total
 
$
754,978
 
 
$
(63,024
)
 
$
637,515
 
 
$
180,487
 

The total financial assets measured and reported at fair value on a recurring basis and classified within Level 3 were $173,883, or 12.61%, and $180,487, or 18.90%, of the Company’s total assets as of June 30, 2012 and December 31, 2011, respectively.

There were no significant transfers of securities in or out of Levels 1, 2 or 3 during the three or six months ended June 30, 2012 or the year ended December 31, 2011.

Level 3 Financial Assets and Liabilities

Financial Instruments Measured at Fair Value on a Recurring Basis

As of June 30, 2012, the fair value of the Company’s Level 3, available-for-sale, private-label MBS was $173,883. These securities are primarily senior and re-REMIC tranches in securitization trusts issued between 2005 and 2010. The senior securities represent interests in securitizations that have the first right to cash flows and absorb losses last. The re-REMIC securities represent interests in re-securitizations of senior MBS and pro-rata mezzanine securities. For re-REMIC securities, the cash flows from, and any credit losses absorbed by, the underlying MBS are allocated among the re-REMIC securities issued in the re-securitization transactions based on the re-REMIC structure. For example, prime and non-prime residential senior securities have been resecuritized to create a two-tranche structure with a re-REMIC senior security and a re-REMIC subordinated security. In these re-REMIC securities, all principal payments from the underlying securities are directed to the re-REMIC senior security until the face value is fully paid off. Thereafter, all principal payments are directed to the re-REMIC subordinated security. For pro-rata mezzanine securities, principal payments from the underlying MBS are typically allocated concurrently and proportionally to the mezzanine securities along with senior securities. The re-REMIC subordinated and mezzanine securities absorb credit losses, if any, first; however, these credit losses occur only when credit losses exceed the credit protection provided to the underlying securities. Senior, re-REMIC and mezzanine securities receive interest while any face value is outstanding.
 
As of June 30, 2012, the Company’s senior securities and re-REMIC securities were collateralized by residential Prime and Alt-A mortgage loans and had a weighted-average original loan-to-value of 71%, weighted-average original FICO score of 729, weighted-average three-month prepayment rate of 15% and weighted-average three-month loss severities of 49%. These underlying collateral loans had a weighted-average coupon rate of 5.20%. These securities are currently rated below investment grade. The significant unobservable inputs for the valuation model include the following weighted-averages:

 
 
June 30, 2012
 
 
December 31, 2011
 
 
 
Senior
Securities
 
 
Re-REMIC
Securities
 
 
Senior
Securities
 
 
Re-REMIC
Securities
 
Discount rate
 
 
6.80
%
 
 
8.50
%
 
 
7.00
%
 
 
8.75
%
Default rate
 
 
9.30
%
 
 
5.19
%
 
 
10.30
%
 
 
5.55
%
Loss severity rate
 
 
57.50
%
 
 
43.51
%
 
 
60.00
%
 
 
43.06
%
Prepayment rate
 
 
16.30
%
 
 
14.89
%
 
 
17.30
%
 
 
15.20
%

 
8

 
The ranges of the significant unobservable inputs for the valuation model were as follows as of the dates indicated:

 
 
June 30, 2012
 
 
December 31, 2011
 
 
 
Senior
Securities
 
 
Re-REMIC
Securities
 
 
Senior
Securities
 
 
Re-REMIC
Securities
 
Discount rate
 
 
6.80
%
 
 
7.15 – 13.73
%
 
 
7.00
%
 
 
7.45 – 13.73
%
Default rate
 
 
9.30
%
 
 
1.75 – 11.50
%
 
 
10.30
%
 
 
2.10 – 13.00
%
Loss severity rate
 
 
57.50
%
 
 
28.21 – 57.50
%
 
 
60.00
%
 
 
28.18 – 57.50
%
Prepayment rate
 
 
16.30
%
 
 
7.75 – 21.05
%
 
 
17.30
%
 
 
9.60 – 21.00
%
 
The tables below set forth a summary of changes in the fair value and gains and losses of the Company’s Level 3 financial assets and liabilities that are measured at fair value on a recurring basis for the three and six months ended June 30, 2012 and 2011.

 
 
Three Months Ended June 30, 2012
 
 
 
Senior
Securities
 
 
Re-REMIC
Securities
 
 
Total
 
Beginning balance, April 1, 2012
 
$
8,647
 
 
$
166,892
 
 
$
175,539
 
Total net gains (losses)
 
 
 
 
 
 
 
 
 
 
 
 
Included in earnings
 
 
 
 
 
(4,531
)
 
 
(4,531
)
Included in other comprehensive income
 
 
(74
)
 
 
503
 
 
 
429
 
Purchases
 
 
 
 
 
470
 
 
 
470
 
Sales
 
 
 
 
 
 
 
 
 
Payments, net
 
 
(428
)
 
 
(4,930
)
 
 
(5,358
)
Accretion of discount
 
 
353
 
 
 
6,046
 
 
 
6,399
 
Ending balance, June 30, 2012
 
$
8,498
 
 
$
164,450
 
 
$
172,948
 
 
 
 
 
 
 
 
 
 
 
 
 
 
The amount of net gains (losses) for the period included in earnings attributable to the change in unrealized gains (losses) relating to Level 3 assets still held at the reporting date
 
$
 
 
$
(4,531
)
 
$
(4,531
)

 
 
Three Months Ended June 30, 2011
 
 
 
Senior
Securities
 
 
Re-REMIC
Securities
 
 
Total
 
Beginning balance, April 1, 2011
 
$
15,865
 
 
$
185,457
 
 
$
201,322
 
Total net gains (losses)
 
 
 
 
 
 
 
 
 
 
 
 
Included in earnings
 
 
53
 
 
 
1,419
 
 
 
1,472
 
Included in other comprehensive income
 
 
(856
)
 
 
(2,837
)
 
 
(3,693
)
Purchases
 
 
 
 
 
6,212
 
 
 
6,212
 
Sales
 
 
(4,294
)
 
 
(6,971
)
 
 
(11,265
)
Payments, net
 
 
(586
)
 
 
(5,746
)
 
 
(6,332
)
Accretion of discount
 
 
391
 
 
 
6,246
 
 
 
6,637
 
Ending balance, June 30, 2011
 
$
10,573
 
 
$
183,780
 
 
$
194,353
 
 
 
 
 
 
 
 
 
 
 
 
 
 
The amount of net gains (losses) for the period included in earnings attributable to the change in unrealized gains (losses) relating to Level 3 assets still held at the reporting date
 
$
 
 
$
 
 
$
 
 
 
 
Six Months Ended June 30, 2012
 
 
 
Senior
Securities
 
 
Re-REMIC
Securities
 
 
Total
 
Beginning balance, January 1, 2012
 
$
9,311
 
 
$
170,116
 
 
$
179,427
 
Total net gains (losses)
 
 
 
 
 
 
 
 
 
 
 
 
Included in earnings
 
 
 
 
 
(4,531
)
 
 
(4,531
)
Included in other comprehensive income
 
 
(681
)
 
 
(3,773
)
 
 
(4,454
)
Purchases
 
 
 
 
 
470
 
 
 
470
 
Sales
 
 
 
 
 
 
 
 
 
Payments, net
 
 
(839
)
 
 
(9,816
)
 
 
(10,655
)
Accretion of discount
 
 
707
 
 
 
11,984
 
 
 
12,691
 
Ending balance, June 30, 2012
 
$
8,498
 
 
$
164,450
 
 
$
172,948
 
 
 
 
 
 
 
 
 
 
 
 
 
 
The amount of net gains (losses) for the period included in earnings attributable to the change in unrealized gains (losses) relating to Level 3 assets still held at the reporting date
 
$
 
 
$
(4,531
)
 
$
(4,531
)
 
 
9

 
 
 
Six Months Ended June 30, 2011
 
 
 
Senior
Securities
 
 
Re-REMIC
Securities
 
 
Total
 
Beginning balance, January 1, 2011
 
$
51,038
 
 
$
201,697
 
 
$
252,735
 
Total net gains (losses)
 
 
 
 
 
 
 
 
 
 
 
 
Included in earnings
 
 
3,525
 
 
 
8,628
 
 
 
12,153
 
Included in other comprehensive income
 
 
(6,082
)
 
 
(7,058
)
 
 
(13,140
)
Purchases
 
 
330
 
 
 
16,860
 
 
 
17,190
 
Sales
 
 
(37,229
)
 
 
(36,066
)
 
 
(73,295
)
Payments, net
 
 
(2,620
)
 
 
(13,334
)
 
 
(15,954
)
Accretion of discount
 
 
1,611
 
 
 
13,053
 
 
 
14,664
 
Ending balance, June 30, 2011
 
$
10,573
 
 
$
183,780
 
 
$
194,353
 
 
 
 
 
 
 
 
 
 
 
 
 
 
The amount of net gains (losses) for the period included in earnings attributable to the change in unrealized gains (losses) relating to Level 3 assets still held at the reporting date
 
$
 
 
$
 
 
$
 
 
Gains and losses included in earnings for the three and six months ended June 30, 2012 and 2011 are reported in the following statement of comprehensive income line descriptions:
 
   
Other (Loss) Income, Investment (Loss) Gain, net
 
   
Three Months Ended June 30,
   
Six Months Ended June 30,