NEW YORK MORTGAGE TRUST INC - 10-K filing on 2014-03-10

Note 13 - Fair Value of Financial Instruments

12 Months Ended

Dec. 31, 2013

13. Fair Value of Financial Instruments

The Company has established and documented processes for determining fair values. Fair value is based upon quoted market prices, where available. If listed prices or quotes are not available, then fair value is based upon internally developed models that primarily use inputs that are market-based or independently-sourced market parameters, including interest rate yield curves.

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 three levels of valuation hierarchy are defined as follows:

Level 1 - inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2 - inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

Level 3 - inputs to the valuation methodology are unobservable and significant to the fair value measurement.

The following describes the valuation methodologies used for the Company’s financial instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy.

Investment Securities Available for Sale (RMBS and CLOs) – Fair value for the RMBS in our portfolio are valued using a third-party pricing service or are based on quoted prices provided by dealers who make markets in similar financial instruments. The dealers will incorporate common market pricing methods, including a spread measurement to the Treasury curve or interest rate swap curve as well as underlying characteristics of the particular security including coupon, periodic and life caps, collateral type, rate reset period and seasoning or age of the security. If quoted prices for a security are not reasonably available from a dealer, the security will be re-classified as a Level 3 security and, as a result, management will determine the fair value based on characteristics of the security that the Company receives from the issuer and based on available market information. Management reviews all prices used in determining valuation to ensure they represent current market conditions. This review includes surveying similar market transactions, comparisons to interest pricing models as well as offerings of like securities by dealers. The Company's investment securities that are comprised of RMBS and CLOs are valued based upon readily observable market parameters and are classified as Level 2 fair values.

Investment Securities Available for Sale Held in Securitization Trusts (CMBS) – As the Company’s CMBS investments are comprised of securities for which there are not substantially similar securities that trade frequently, the Company classifies these securities as Level 3 fair values. Fair value of the Company’s CMBS investments is based on an internal valuation model that considers expected cash flows from the underlying loans and yields required by market participants. The significant unobservable inputs used in the measurement of these investments are projected losses of certain identified loans within the pool of loans and a discount rate. The discount rate used in determining fair value incorporates default rate, loss severity and current market interest rates. The discount rate ranges from 4.2% to 16.1%. Significant increases or decreases in these inputs would result in a significantly lower or higher fair value measurement.

Multi-Family Loans Held in Securitization Trusts – Multi-family loans held in securitization trusts are recorded at fair value and classified as Level 3 fair values. Fair value is based on an internal valuation model that considers expected cash flows from the underlying loans and yields required by market participants. The significant unobservable inputs used in the measurement of these investments are discount rates. The discount rate used in determining fair value incorporates default rate, loss severity and current market interest rates. The discount rate ranges from 3.4% to 6.5%. Significant increases or decreases in these inputs would result in a significantly lower or higher fair value measurement.

Derivative Instruments – The fair value of interest rate swaps, swaptions, options and TBAs are based on dealer quotes. The fair value of futures are based on exchange-traded prices. The Company’s derivatives are classified as Level 1 or Level 2 fair values.

Multi-Family CDOs – The fair value of Multi-Family CDOs is determined using a third party pricing service or are based on quoted prices provided by dealers who make markets in similar financial instruments. The dealers will consider contractual cash payments and yields expected by market participants. Dealers also incorporate common market pricing methods, including a spread measurement to the Treasury curve or interest rate swap curve as well as underlying characteristics of the particular security including coupon, periodic and life caps, collateral type, rate reset period and seasoning or age of the security.

The following table presents the Company’s financial instruments measured at fair value on a recurring basis as of December 31, 2013 and 2012, respectively, on the Company’s consolidated balance sheets (dollar amounts in thousands):

	Measured at Fair Value on a Recurring Basis at
	December 31, 2013								December 31, 2012
	Level 1		Level 2		Level 3		Total		Level 1		Level 2		Level 3		Total
Assets carried at fair value
Investment securities available for sale:
Agency RMBS	$	—	$	876,874	$	—	$	876,874	$	—	$	1,001,239	$	—	$	1,001,239
Non-Agency RMBS		—		2,361		—		2,361		—		2,687		—		2,687
CLOs		—		33,208		—		33,208		—		30,785		—		30,785
Investment securities available for sale held in securitization trusts:
CMBS		—		—		92,578		92,578		—		—		71,159		71,159
Multi-family loans held in securitization trusts		—		—		8,111,022		8,111,022		—		—		5,442,906		5,442,906
Derivative Assets:										—		—		—		—
TBA Securities		—		190,742		—		190,742		—		244,789		—		244,789
Options on U.S. Treasury futures		7		—		—		7		—		59		—		59
U.S. Treasury futures		3,257		—		—		3,257		676		—		—		676
Interest rate swap futures		238		—		—		238		8		—		—		8
Interest rate swaps		—		2,041		—		2,041		—		—		—		—
Swaptions		—		1,305		—		1,305		—		597		—		597
Total	$	3,502	$	1,106,531	$	8,203,600	$	9,313,633	$	684	$	1,280,156	$	5,514,065	$	6,794,905
Liabilities carried at fair value
Multi-family collateralized debt obligations	$	—	$	—	$	7,871,020	$	7,871,020	$	—	$	—	$	5,319,573	$	5,319,573
Derivative liabilities:
Interest rate swaps		—		—		—		—		—		1,744		—		1,744
Eurodollar futures		1,432		—		—		1,432		3,798		—		—		3,798
Total	$	1,432	$	—	$	7,871,020	$	7,872,452	$	3,798	$	1,744	$	5,319,573	$	5,325,115

The following table details changes in valuation for the Level 3 assets for the years ended December 31, 2013, 2012 and 2011, respectively (amounts in thousands):

Level 3 Assets:

	Years Ended December 31,
	2013			2012			2011
Balance at beginning of period	$	5,514,065		$	41,185		$	—
Total gains (realized/unrealized)
Included in earnings ⁽¹⁾		(470,467	)		167,094			—
Included in other comprehensive income		15,532			3,768			(1,036	)
Purchases		3,218,301			4,212,009			42,221
Paydowns		(73,831	)		(28,034	)		—
Transfers ⁽²⁾		—			1,118,043			—
Balance at the end of period	$	8,203,600		$	5,514,065		$	41,185

⁽¹⁾	Amounts included in interest income from multi-family loans held in securitization trusts and unrealized gain on multi-family loans and debt held in securitization trusts, net.

⁽²⁾	Based on a number of factors, we determined that we were the primary beneficiary of one K-Series securitization as of January 4, 2012 and have consolidated its assets, liabilities, income and expenses in our consolidated financial statements.

The following table details changes in valuation for the Level 3 liabilities for the years ended December 31, 2013, 2012 and 2011, respectively (amounts in thousands):

Level 3 Liabilities:

	Years Ended December 31,
	2013			2012			2011
Balance at beginning of period	$	5,319,573		$	—		$	—
Total gains (realized/unrealized)
Included in earnings ⁽¹⁾		(521,416	)		152,440			—
Included in other comprehensive income		—			—			—
Purchases		3,146,676			4,077,276			—
Paydowns		(73,813	)		(28,034	)		—
Transfers ⁽²⁾		—			1,117,891			—
Balance at the end of period	$	7,871,020		$	5,319,573		$	—

⁽¹⁾	Amounts included in interest income from multi-family loans held in securitization trusts and unrealized gain on multi-family loans and debt held in securitization trusts, net.

⁽²⁾	Based on a number of factors, we determined that we were the primary beneficiary of one K-Series securitization as of January 4, 2012 and have consolidated its assets, liabilities, income and expenses in our consolidated financial statements.

The following table details the changes in unrealized gains (losses) included in earnings for our Level 3 assets and liabilities for the years ended December 31, 2013, 2012 and 2011, respectively (dollar amounts in thousands):

	Years Ended December 31,
	2013			2012			2011
Change in unrealized gains (losses) – assets	$	(423,949	)	$	194,363		$	—
Change in unrealized gains (losses) – liabilities		455,444			(187,701	)		—
Net change in unrealized gains included in earnings for assets and liabilities	$	31,495		$	6,662		$	—

Any changes to the valuation methodology are reviewed by management to ensure the changes are appropriate. As markets and products develop and the pricing for certain products becomes more transparent, the Company continues to refine its valuation methodologies. The methods described above may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, while the Company believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies, or assumptions, to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. The Company uses inputs that are current as of each reporting date, which may include periods of market dislocation, during which time price transparency may be reduced. This condition could cause the Company’s financial instruments to be reclassified from Level 2 to Level 3 in future periods.

The following table presents assets measured at fair value on a non-recurring basis as of December 31, 2013 and 2012, respectively, on the consolidated balance sheets (dollar amounts in thousands):

	Assets Measured at Fair Value on a Non-Recurring Basis at
	December 31, 2013						December 31, 2012
	Level 1	Level 2	Level 3		Total		Level 1		Level 2		Level 3		Total
Residential Mortgage loans held in securitization trusts – impaired loans (net)	$	$	$	6,591	$	6,591	$	—	$	—	$	5,059	$	5,059
Real estate owned held in residential securitization trusts				1,108		1,108		—		—		732		732

The following table presents losses incurred for assets measured at fair value on a non-recurring basis for the years ended December 31, 2013, 2012 and 2011, respectively, on the Company’s consolidated statements of operations (dollar amounts in thousands):

	Years Ended December 31,
	2013		2012		2011

Residential mortgage loans held in securitization trusts – impaired loans (net)	$	701	$	707	$	1,380
Real estate owned held in residential securitization trusts		433		45		87

Residential Mortgage Loans Held in Securitization Trusts – Impaired Loans (net) – Impaired residential mortgage loans held in securitization trusts are recorded at amortized cost less specific loan loss reserves. Impaired loan value is based on management’s estimate of the net realizable value taking into consideration local market conditions of the property, updated appraisal values of the property and estimated expenses required to remediate the impaired loan.

Real Estate Owned Held in Residential Securitization Trusts – Real estate owned held in the residential securitization trusts are recorded at net realizable value. Any subsequent adjustment will result in the reduction in carrying value with the corresponding amount charged to earnings. Net realizable value based on an estimate of disposal taking into consideration local market conditions of the property, updated appraisal values of the property and estimated expenses required to sell the property.

The following table presents the carrying value and estimated fair value of the Company’s financial instruments at December 31, 2013 and 2012, respectively, (dollar amounts in thousands):

		December 31, 2013				December 31, 2012
	Fair Value Hierarchy Level	Carrying Value		Estimated Fair Value		Carrying Value		Estimated Fair Value
Financial Assets:
Cash and cash equivalents	Level 1	$	31,798	$	31,798	$	31,777	$	31,777
Investment securities available for sale	Level 2		912,443		912,443		1,034,711		1,034,711
Investment securities available for sale, at fair value held in securitization trusts	Level 3		92,578		92,578		71,159		71,159
Residential mortgage loans held in securitization trusts (net)	Level 3		163,237		152,104		187,229		165,919
Distressed residential mortgage loans (net) ⁽¹⁾	Level 3		264,434		254,543		60,459		60,459
Multi-family loans held in securitization trusts	Level 3		8,111,022		8,111,022		5,442,906		5,442,906
Derivative assets	Level 1 or 2		197,590		197,590		246,129		246,129
Mortgage loans held for sale (net) ⁽²⁾	Level 3		2,496		2,595		2,837		2,837
First mortgage loans ⁽²⁾	Level 3		8,249		8,318		1,755		1,775
Mezzanine loan and equity investments ⁽²⁾	Level 3		21,568		21,812		3,522		3,522

Financial Liabilities:
Financing arrangements, portfolio investments	Level 2	$	791,125	$	791,125	$	889,134	$	889,134
Residential collateralized debt obligations	Level 3		158,410		151,910		180,979		160,506
Multi-family collateralized debt obligations	Level 3		7,871,020		7,871,020		5,319,573		5,319,573
Securitized debt	Level 3		304,964		311,535		117,591		118,402
Derivative liabilities	Level 1 or 2		1,432		1,432		5,542		5,542
Payable for securities purchased	Level 1		191,592		191,592		245,931		245,931
Subordinated debentures	Level 3		45,000		39,310		45,000		34,108

⁽¹⁾

Includes distressed residential mortgage loans held in securitization trusts with a carrying value amounting to approximately $254.7 million and $60.5 million at December 31, 2013 and December 31, 2012, respectively. Distressed residential mortgage loans with a carrying value amounting to approximately $9.7 million are included in receivables and other assets in the accompanying consolidated balance sheets at December 31, 2013.

⁽²⁾

Included in receivables and other assets in the accompanying consolidated balance sheets.

In addition to the methodology to determine the fair value of the Company’s financial assets and liabilities reported at fair value on a recurring basis and non-recurring basis, as previously described, the following methods and assumptions were used by the Company in arriving at the fair value of the Company’s other financial instruments in the table immediately above:

Cash and cash equivalents – Estimated fair value approximates the carrying value of such assets.

Residential mortgage loans held in securitization trusts (net) – Residential mortgage loans held in the securitization trusts are recorded at amortized cost. Fair value is based on an internal valuation model that considers the aggregated characteristics of groups of loans such as, but not limited to, collateral type, index, interest rate, margin, length of fixed-rate period, life cap, periodic cap, underwriting standards, age and credit estimated using the estimated market prices for similar types of loans.

Distressed residential mortgage loans (net) – Fair value is estimated using pricing models taking into consideration current interest rates, loan amount, payment status and property type, and forecasts of future interest rates, home prices and property values, prepayment speeds, default, loss severities, and actual purchases and sales of similar loans.

Mortgage loans held for sale (net) – The fair value of mortgage loans held for sale (net) are estimated by the Company based on the price that would be received if the loans were sold as whole loans taking into consideration the aggregated characteristics of the loans such as, but not limited to, collateral type, index, interest rate, margin, length of fixed interest rate period, life time cap, periodic cap, underwriting standards, age and credit.

First mortgage loan and mezzanine loan and equity investments – Estimated fair value is determined by both market comparable pricing and discounted cash flows. The discounted cash flows are based on the underlying contractual cash flows and estimated changes in market yields. The fair value also reflects consideration of changes in credit risk since the origination or time of initial investment.

Financing arrangements – The fair value of these financing arrangements approximates cost as they are short term in nature.

Residential collateralized debt obligations – The fair value of these CDOs is based on discounted cash flows as well as market pricing on comparable obligations.

Securitized debt – The fair value of securitized debt is based on discounted cash flows using management’s estimate for market yields.

Payable for securities purchased – Estimated fair value approximates the carrying value of such liabilities.

Subordinated debentures – The fair value of these subordinated debentures is based on discounted cash flows using management’s estimate for market yields.