TWO Quarterly report pursuant to Section 13 or 15(d)

Quarterly report pursuant to Section 13 or 15(d)

Available-for-Sale Securities, at Fair Value

Available-for-Sale Securities, at Fair Value

9 Months Ended

Sep. 30, 2020

Debt Securities, Available-for-sale [Abstract]

Available-for-Sale Securities, at Fair Value

The Company holds both Agency and non-Agency AFS investment securities which are carried at fair value on the condensed consolidated balance sheets. In the first quarter of 2020, the Company experienced unprecedented market conditions as a result of the global COVID-19 pandemic, including unusually significant spread widening in both Agency RMBS and non-Agency securities. In response, the Company focused its efforts on raising excess liquidity and de-risking its portfolio. On March 25, 2020, the Company sold substantially all of its non-Agency securities in order to eliminate the risks posed by continued margin calls and ongoing funding concerns associated with the significant spread widening on these assets. During the first quarter, the Company also sold approximately one-third of its Agency RMBS in order to reduce risk and raise cash to establish a strong defensive liquidity position to weather potential ongoing economic and market instability. Since then, the Company has added modestly to its Agency RMBS portfolio, deploying risk as the market entered a period of stabilization and asset price recovery.

The following table presents the Company’s AFS investment securities by collateral type as of September 30, 2020 and December 31, 2019:


(in thousands)	September 30, 2020		December 31, 2019
Agency
Federal National Mortgage Association	$	13,607,826	$	21,252,575
Federal Home Loan Mortgage Corporation	2,603,002		6,070,500
Government National Mortgage Association	345,500		454,980
Non-Agency	17,993		3,628,273
Total available-for-sale securities	$	16,574,321	$	31,406,328

At September 30, 2020 and December 31, 2019, the Company pledged AFS securities with a carrying value of $16.6 billion and $29.8 billion, respectively, as collateral for repurchase agreements and advances from the Federal Home Loan Bank of Des Moines, or the FHLB. See Note 11 - Repurchase Agreements and Note 12 - Federal Home Loan Bank of Des Moines Advances.

At September 30, 2020 and December 31, 2019, the Company did not have any securities purchased from and financed with the same counterparty that did not meet the conditions of ASC 860, Transfers and Servicing, to be considered linked transactions and, therefore, classified as derivatives.

The Company is not required to consolidate variable interest entities, or VIEs, for which it has concluded it does not have both the power to direct the activities of the VIEs that most significantly impact the entities’ performance, and the obligation to absorb losses or the right to receive benefits of the entities that could be significant. The Company’s investments in these unconsolidated VIEs include all non-Agency securities, which are classified within available-for-sale securities, at fair value on the condensed consolidated balance sheets. As of September 30, 2020 and December 31, 2019, the carrying value, which also represents the maximum exposure to loss, of all non-Agency securities in unconsolidated VIEs was $18.0 million and $3.6 billion, respectively.

The following tables present the amortized cost and carrying value of AFS securities by collateral type as of September 30, 2020 and December 31, 2019:


	September 30, 2020
(in thousands)	Principal/ Current Face		Un-amortized Premium		Accretable Purchase Discount		Amortized Cost		Allowance for Credit Losses		Unrealized Gain		Unrealized Loss		Carrying Value
Agency:
Principal and interest	$	15,040,007	$	688,566	$	(14)	$	15,728,559	$	—	$	722,176	$	(349)	$	16,450,386
Interest-only	2,189,734		126,068		—		126,068		(19,241)		12,298		(13,183)		105,942
Total Agency	17,229,741		814,634		(14)		15,854,627		(19,241)		734,474		(13,532)		16,556,328
Non-Agency:
Principal and interest	2,429		7		(38)		2,398		—		141		—		2,539
Interest-only	2,714,583		22,406		—		22,406		(6,254)		62		(760)		15,454
Total Non-Agency	2,717,012		22,413		(38)		24,804		(6,254)		203		(760)		17,993
Total	$	19,946,753	$	837,047	$	(52)	$	15,879,431	$	(25,495)	$	734,677	$	(14,292)	$	16,574,321


	December 31, 2019
(in thousands)	Principal/ Current Face		Un-amortized Premium		Accretable Purchase Discount		Credit Reserve Purchase Discount		Amortized Cost		Unrealized Gain		Unrealized Loss		Carrying Value
Agency:
Principal and interest	$	26,239,544	$	986,343	$	(19)	$	—	$	27,225,868	$	424,818	$	(8,815)	$	27,641,871
Interest-only	2,601,693		169,811		—		—		169,811		13,724		(47,351)		136,184
Total Agency	28,841,237		1,156,154		(19)		—		27,395,679		438,542		(56,166)		27,778,055
Non-Agency:
Principal and interest	5,498,654		8,980		(560,140)		(1,711,951)		3,235,543		341,583		(23,263)		3,553,863
Interest-only	4,356,603		79,935		—		—		79,935		3,039		(8,564)		74,410
Total Non-Agency	9,855,257		88,915		(560,140)		(1,711,951)		3,315,478		344,622		(31,827)		3,628,273
Total	$	38,696,494	$	1,245,069	$	(560,159)	$	(1,711,951)	$	30,711,157	$	783,164	$	(87,993)	$	31,406,328

The following tables present the carrying value of the Company’s AFS securities by rate type as of September 30, 2020 and December 31, 2019:


	September 30, 2020
(in thousands)	Agency		Non-Agency		Total
Adjustable Rate	$	11,798	$	16,235	$	28,033
Fixed Rate	16,544,530		1,758		16,546,288
Total	$	16,556,328	$	17,993	$	16,574,321


	December 31, 2019
(in thousands)	Agency		Non-Agency		Total
Adjustable Rate	$	14,584	$	3,344,287	$	3,358,871
Fixed Rate	27,763,471		283,986		28,047,457
Total	$	27,778,055	$	3,628,273	$	31,406,328

The following table presents the Company’s AFS securities according to their estimated weighted average life classifications as of September 30, 2020:


	September 30, 2020
(in thousands)	Agency		Non-Agency		Total
< 1 year	$	2,316	$	3,150	$	5,466
≥ 1 and < 3 years	215,402		14,843		230,245
≥ 3 and < 5 years	14,444,913		—		14,444,913
≥ 5 and < 10 years	1,892,932		—		1,892,932
≥ 10 years	765		—		765
Total	$	16,556,328	$	17,993	$	16,574,321

Measurement of Allowances for Credit Losses on AFS Securities (Subsequent to the Adoption of Topic 326)

Following the adoption of Topic 326 on January 1, 2020, the Company uses a discounted cash flow method to estimate and recognize an allowance for credit losses on both Agency and non-Agency AFS securities that are not accounted for under the fair value option. The estimated allowance for credit losses is equal to the difference between the prepayment adjusted contractual cash flows with no credit losses and the prepayment adjusted expected cash flows with credit losses, discounted at the effective interest rate on the AFS security that was in effect upon adoption of the standard. The contractual cash flows and expected cash flows are based on management’s best estimate and take into consideration current prepayment assumptions, lifetime expected losses based on past loss experience, current market conditions, and reasonable and supportable forecasts of future conditions. The allowance for credit losses on Agency AFS securities relates to prepayment assumption changes on interest-only Agency RMBS. The allowance for credit losses causes an increase in the AFS security amortized cost and recognizes an allowance for credit losses in the same amount, with the provision for credit losses recognized in earnings (within (loss) gain on investment securities) and the balance of the unrealized loss recognized in either other comprehensive income (loss), net of tax, or (loss) gain on investment securities, depending on the accounting treatment.

The following table presents the changes for the three and nine months ended September 30, 2020 in the allowance for credit losses on Agency and non-Agency AFS securities:


	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2020						2020
(in thousands)	Agency		Non-Agency		Total		Agency		Non-Agency		Total
Allowance for credit losses at beginning of period	$	(30,634)	$	(11,949)	$	(42,583)	$	—	$	(244,876)	$	(244,876)
Additions:
On securities for which credit losses were not previously recorded	(86)		—		(86)		(32,882)		(11,404)		(44,286)
Arising from purchases of securities accounted for as purchased credit deteriorated	—		—		—		—		—		—
Reductions:
For securities sold	—		—		—		—		246,792		246,792
Due to the intent to sell or more likely than not will be required to sell the security before recovery of its amortized cost	—		—		—		—		—		—
Increase (decrease) on securities with previously recorded credit losses	(558)		(6,456)		(7,014)		1,604		(11,249)		(9,645)
Writeoffs	12,037		12,151		24,188		12,037		17,018		29,055
Recoveries of amounts previously written off	—		—		—		—		(2,535)		(2,535)
Allowance for credit losses at end of period	$	(19,241)	$	(6,254)	$	(25,495)	$	(19,241)	$	(6,254)	$	(25,495)

The following table presents the components comprising the carrying value of AFS securities for which an allowance for credit losses has not been recorded by length of time that the securities had an unrealized loss position as of September 30, 2020 (subsequent to the adoption of Topic 326). At September 30, 2020, the Company held 833 AFS securities; of the securities for which an allowance for credit losses has not been recorded, 8 were in an unrealized loss position for less than twelve consecutive months and 11 were in an unrealized loss position for more than twelve consecutive months.


	September 30, 2020
	Unrealized Loss Position for
	Less than 12 Months				12 Months or More				Total
(in thousands)	Estimated Fair Value		Gross Unrealized Losses		Estimated Fair Value		Gross Unrealized Losses		Estimated Fair Value		Gross Unrealized Losses
Agency	$	17,991	$	(4,598)	$	12,962	$	(437)	$	30,953	$	(5,035)
Non-Agency	—		—		—		—		—		—
Total	$	17,991	$	(4,598)	$	12,962	$	(437)	$	30,953	$	(5,035)

Evaluating AFS Securities for Other-Than-Temporary Impairments (Prior to the Adoption of Topic 326)

In evaluating AFS securities for OTTI prior to the adoption of Topic 326, the Company determined whether there had been a significant adverse quarterly change in the cash flow expectations for a security. The Company compared the amortized cost of each security in an unrealized loss position against the present value of expected future cash flows of the security. The Company also considered whether there had been a significant adverse change in the regulatory and/or economic environment as part of this analysis. If the amortized cost of the security was greater than the present value of expected future cash flows using the original yield as the discount rate, an other-than-temporary credit impairment had occurred. If the Company did not intend to sell and would not be more likely than not required to sell the security, the credit loss was recognized in earnings and the balance of the unrealized loss was recognized in either other comprehensive income (loss), net of tax, or (loss) gain on investment securities, depending on the accounting treatment. If the Company intended to sell the security or would be more likely than not required to sell the security, the full unrealized loss was recognized in earnings.

During the three and nine months ended September 30, 2019, the Company recorded $6.0 million and $11.0 million in other-than-temporary credit impairments on a total of sixteen non-Agency securities where the future expected cash flows for each security were less than its amortized cost. At September 30, 2019, the Company did not intend to sell the securities and determined that it was not more likely than not that the Company would be required to sell the securities; therefore, only the projected credit loss was recognized in earnings. As of September 30, 2020, the Company no longer held any of the securities for which OTTI had been recognized prior to January 1, 2020.

The following table presents the changes in cumulative credit losses related to OTTI for the three and nine months ended September 30, 2020 and 2019:


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(in thousands)	2020		2019		2020		2019
Cumulative other-than-temporary credit losses at beginning of period	$	—	$	(9,376)	$	(17,021)	$	(6,865)
Additions:
Other-than-temporary impairments not previously recognized	—		(5,950)		—		(10,353)
Increases related to other-than-temporary impairments on securities with previously recognized other-than-temporary impairments	—		—		—		(651)
Reductions:
Decreases related to other-than-temporary impairments on securities paid down	—		—		—		1,703
Decreases related to other-than-temporary impairments on securities sold	—		1,613		17,021		2,453
Cumulative other-than-temporary credit losses at end of period	$	—	$	(13,713)	$	—	$	(13,713)

Cumulative credit losses related to OTTI are reduced for securities sold as well as for securities that mature, are paid down, or are prepaid such that the outstanding principal balance is reduced to zero. Additionally, increases in cash flows expected to be collected over the remaining life of the security cause a reduction in the cumulative credit loss.

Prior to the adoption of Topic 326 on January 1, 2020, when the Company purchased a credit-sensitive AFS security at a significant discount to its face value, the Company did not amortize into income a significant portion of this discount that the Company was entitled to earn because the Company did not expect to collect the entire discount due to the inherent credit risk of the security. The Company may have also recorded an OTTI for a portion of its investment in the security in an unrealized loss position to the extent the Company believed that the amortized cost would exceed the present value of expected future cash flows. The amount of principal that the Company did not amortize into income was designated as a credit reserve on the security, with unamortized net discounts or premiums amortized into income over time to the extent realizable.

The following table presents the changes for the nine months ended September 30, 2019 in the net unamortized discount/premium and designated credit reserve on non-Agency AFS securities:


	Nine Months Ended
	September 30, 2019
(in thousands)	Designated Credit Reserve		Net Unamortized Discount/Premium		Total
Beginning balance at January 1	$	(1,322,762)	$	(603,591)	$	(1,926,353)
Acquisitions	(471,746)		10,524		(461,222)
Accretion of net discount	—		27,782		27,782
Realized credit losses	18,668		—		18,668
Reclassification adjustment for other-than-temporary impairments	(6,847)		—		(6,847)
Transfers from (to)	34,157		(34,157)		—
Sales, calls, other	24,892		226,923		251,815
Ending balance at September 30	$	(1,723,638)	$	(372,519)	$	(2,096,157)

The following table presents the components comprising the carrying value of AFS securities not deemed to be other-than-temporarily impaired by length of time that the securities had an unrealized loss position as of December 31, 2019 (prior to the adoption of Topic 326). At December 31, 2019, the Company held 1,237 AFS securities, of which 122 were in an unrealized loss position for less than twelve consecutive months and 151 were in an unrealized loss position for more than twelve consecutive months.


	December 31, 2019
	Unrealized Loss Position for
	Less than 12 Months				12 Months or More				Total
(in thousands)	Estimated Fair Value		Gross Unrealized Losses		Estimated Fair Value		Gross Unrealized Losses		Estimated Fair Value		Gross Unrealized Losses
Agency	$	3,322,894	$	(6,645)	$	524,739	$	(49,521)	$	3,847,633	$	(56,166)
Non-Agency	647,849		(18,416)		210,988		(13,411)		858,837		(31,827)
Total	$	3,970,743	$	(25,061)	$	735,727	$	(62,932)	$	4,706,470	$	(87,993)

Gross Realized Gains and Losses

Gains and losses from the sale of AFS securities are recorded as realized gains (losses) within (loss) gain on investment securities in the Company’s condensed consolidated statements of comprehensive income (loss). The following table presents details around sales of AFS securities during the three and nine months ended September 30, 2020 and 2019:


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(in thousands)	2020		2019		2020		2019
Proceeds from sales of available-for-sale securities	$	—	$	6,111,897	$	16,969,870	$	14,065,573
Amortized cost of available-for-sale securities sold	—		(5,861,630)		(17,947,686)		(13,809,174)
Total realized gains (losses) on sales, net	$	—	$	250,267	$	(977,816)	$	256,399

Gross realized gains	$	—	$	254,655	$	280,885	$	380,808
Gross realized losses	—		(4,388)		(1,258,701)		(124,409)
Total realized gains (losses) on sales, net	$	—	$	250,267	$	(977,816)	$	256,399