10.	Derivatives and Other Hedging Instruments

In connection with the Company’s risk management strategy, the Company hedges a portion of its interest rate risk by entering into derivative contracts. The Company may enter into agreements for interest rate swaps, interest rate swaptions, interest rate cap or floor contracts and futures or forward contracts. The Company’s risk management strategy attempts to manage the overall risk of the portfolio, reduce fluctuations in book value and generate additional income distributable to shareholders. For additional information regarding the Company’s derivative instruments and its overall risk management strategy, please refer to the discussion of derivative instruments in Note 2.

The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts). The variable cash payments (or receipts) are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. The fair values of interest rate swaptions are based on the fair value of the underlying interest rate swaps that the Company has the option to enter, and are based on inputs from the counterparty and pricing models. The fair value of Futures Contracts is based on quoted prices from the exchange on which they trade. The fair value of MBS forward purchase commitments was determined using the same methodology as MBS as described in Note 5. The fair value of forward purchase commitments for whole loans was determined using the same methodologies as mortgage loans as described in Note 6. The Company applies fallout assumptions to the third-party pricing of forward purchase commitments regarding loans that the counterparties may not successfully issue. The table below presents the fair value of the Company’s derivative instruments as well as their classification on the consolidated balance sheets as of December 31, 2015 and 2014, respectively.

Derivative Instruments	Balance Sheet Location	December 31, 2015		December 31, 2014

Interest rate swaps and swaptions	Derivative assets	$	2,031	$	11,050
Futures contracts	Derivative assets		693		-
Forward purchase commitments - MBS	Derivative assets		165		16,101
Forward purchase commitments - mortgage loans	Derivative assets		25		-
		$	2,914	$	27,151


Interest rate swaps	Derivative liabilities	$	6,802	$	42,052
Futures contracts	Derivative liabilities		286,058		202,501
Forward purchase commitments - MBS	Derivative liabilities		32,373		36
Forward purchase commitments - mortgage loans	Derivative liabilities		-		2
		$	325,233	$	244,591

Interest Rate Swaps and Swaptions

The Company finances its activities primarily through repurchase agreements, which are generally settled on a short-term basis, usually from one to three months. At each settlement date, the Company refinances each repurchase agreement at the market interest rate at that time. Since the Company is exposed to interest rates on its borrowings that change on a short-term basis, it enters into hedging agreements to mitigate the effect of these changes. Interest rate swaps involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. The effect of these hedges is to synthetically lockup interest rates on a portion of the Company’s repurchase agreements for the terms of the interest rate swaps. Although the Company’s objective is to hedge the risk associated with changing repurchase agreement rates, the Company’s interest rate swaps are benchmark interest rate swaps which perform with reference to LIBOR. Therefore, the Company remains at risk to the variability of the spread between repurchase agreement rates and LIBOR interest rates.

Until September 30, 2013, the Company elected cash flow hedge accounting for its interest rate swaps. Under cash flow hedge accounting, effective hedge gains or losses are initially recorded in AOCI and subsequently reclassified into net income in the period that the hedged forecasted transaction affects earnings. Ineffective hedge gains and losses are recorded on a current basis in earnings. The hedge ineffectiveness is attributable primarily to differences in the reset dates on the Company’s interest rate swaps versus the refinancing dates of its repurchase agreements. See “Financial Statement Presentation” below for quantification of gains and losses on interest rate swaps for the three years ended December 31, 2015.

On September 30, 2013, the Company de-designated its interest rate swaps as cash flow hedges, thus terminating cash flow hedge accounting. As long as the forecasted rollovers of the related repurchase agreements are still expected to occur, amounts in AOCI related to the cash flow hedges through September 30, 2013 will remain in AOCI and will continue to be reclassified to interest expense as interest is accrued and paid on the related repurchase agreements. During the next 12 months, the Company estimates that an additional $1,864 will be reclassified out of AOCI as an increase to interest expense.

The Company continues to hedge its exposure to variability in future funding costs via interest rate swaps and other derivative instruments. As a result of discontinuing hedge accounting, beginning October 1, 2013, changes in the fair value of the Company’s interest rate swaps are recorded in “Loss on derivative instruments, net” in the consolidated statements of income, consistent with the Company’s historical accounting for Futures Contracts, as described below. Monthly net cash settlements under the interest rate swaps are also recorded in “Loss on derivative instruments, net” beginning October 1, 2013.

The volume of activity for the Company’s interest rate swap instruments is shown in the table below.

	Notional Value
	Years Ended December 31
	2015			2014
Beginning of period	$	8,300,000		$	10,500,000
Additions		-			-
Expirations and terminations		(3,700,000	)		(2,200,000	)
End of period	$	4,600,000		$	8,300,000

During 2015, the Company terminated swaps with $1,400,000 of notional value for a payment of $5,210. The terminated swaps had original maturities extending through December 31, 2015.

Information regarding the Company’s interest rate swaps as of December 31, 2015 follows.

			Wtd. Avg.
			Remaining		Wtd. Avg.
	Notional		Term		Fixed Interest
Maturity	Amount		in Months		Rate in Contract

12 months or less	$	2,400,000		6		0.92%
Over 12 months to 24 months		1,800,000		17		0.89%
Over 24 months to 36 months		400,000		26		0.96%

Total	$	4,600,000		12		0.91%

A swaption is a derivative instrument that gives the holder the option to enter into a pay-fixed interest rate swap in the future, if it so desires. As of December 31, 2015, the Company had six interest rate swaptions outstanding, all of which were entered into during 2015:

	Options						Underlying Swaps
Swaptions	Original Cost		Fair Value		Wtd. Avg. Months to Expiration		Notional		Wtd. Avg. Fixed Pay Rate		Receive Rate	Wtd. Avg. Term (Years)
Fixed payer	$	10,813	$	727		6	$	3,065,000		3.23%	3 month LIBOR		6

As of December 31, 2014, the Company had four interest rate swaptions outstanding:

	Options						Underlying Swaps
Swaptions	Original Cost		Fair Value		Wtd. Avg. Months to Expiration		Notional		Wtd. Avg. Fixed Pay Rate		Receive Rate	Wtd. Avg. Term (Years)
Fixed payer	$	20,080	$	4,561		6	$	992,300		2.74%	3 month LIBOR		7

During 2015, the Company terminated the swaptions held as of December 31, 2014 and received proceeds of $2,049

Eurodollar Futures Contracts

The Company uses Futures Contracts to 1) synthetically replicate an interest rate swap, or 2) offset the changes in value of its forward purchases of certain MBS and mortgage loans. The following tables present the composition of the Company’s Futures Contracts as of December 31, 2015 and 2014, respectively.

	Fair Value
	December 31, 2015			December 31, 2014
Futures Contracts designed to replicate swaps	$	(285,711	)	$	(202,202	)
Futures Contracts designed to hedge value changes in forward purchases		346			(299	)
Total fair value of Futures Contracts	$	(285,365	)	$	(202,501	)

The volume of activity for the Company’s Futures Contracts is shown in the table below.

	Number of Contracts
	Years Ended December 31
	2015			2014
Beginning of period		130,074			95,327
New positions opened		55,494			136,610
Early settlements		(41,813	)		(93,053	)
Settlements at maturity		(34,931	)		(8,810	)
End of period		108,824			130,074

Each Futures Contract embodies $1 million of notional value and corresponds to a Eurodollar contract for a specific three month timeframe. The effective dates of the Eurodollar contracts underlying the Company’s Futures Contracts range from 2015 through 2021.

The Company has not designated its Futures Contracts as hedges for accounting purposes. As a result, realized and unrealized changes in fair value thereon are recognized in net income in the period in which the changes occur. See “Financial Statement Presentation” below for quantification of gains and losses on Futures Contracts for the years ended December 31, 2015 and 2014.

To-Be-Announced Securities Purchases and Mortgage Loan Commitments

The Company purchases certain of its investment securities in the forward market. The Company purchases ARM TBA contracts and fixed-rate TBA contracts from dealers. ARM TBA contracts are not a frequently-traded security and are generally used to acquire MBS for the portfolio. Fixed-rate TBA contracts are a highly liquid security, and may be physically settled, net settled or traded as an investment. The Company also has commitments with various mortgage origination companies to purchase their production as it becomes securitized. Forward purchases do not qualify for trade date accounting and are considered derivatives for financial statement purposes, as described in Note 2. The net fair value of the forward commitment is reported on the balance sheet as an asset or liability. Whether the unrealized gain (or loss) recognized in net income or other comprehensive income depends on whether or not the commitment has been designated as an accounting hedge, as discussed in Note 2. Forward purchase commitments on ARMs are designated as all-in-one cash flow hedges and the related unrealized gain or loss is recorded in other comprehensive income. Unrealized gains and losses on forward purchase commitments on mortgage loans and fixed-rate TBA dollar roll securities are recorded in net income.

The following table summarizes the Company’s forward purchase commitments as of December 31, 2015.

	Face / UPB		Cost		Fair Market Value		Net Asset (Liability)
ARMs - originators	$	145,246	$	147,749	$	147,914	$	165
Fixed-rate TBA dollar roll securities		2,655,000		2,736,748		2,704,375		(32,373	)
Whole mortgage loans		26,523		26,700		26,725		25
Total purchase commitments	$	2,826,769	$	2,911,197	$	2,879,014	$	(32,183	)

The following table summarizes the Company’s forward purchase commitments as of December 31, 2014.

	Face / UPB		Cost		Fair Market Value		Net Asset (Liability)
ARMs - originators	$	376,936	$	384,673	$	388,829	$	4,156
ARMs - dealers		20,095		20,553		20,517		(36	)
Fixed-rate TBA dollar roll securities		3,400,000		3,509,871		3,521,816		11,945
Whole mortgage loans		11,656		11,937		11,935		(2	)
Total purchase commitments	$	3,808,687	$	3,927,034	$	3,943,097	$	16,063

Financial Statement Presentation

The Company does not use either offsetting or netting to present any of its derivative assets or liabilities. The following table shows the gross amounts associated with the Company’s derivative financial instruments and the impact if netting were used as of December 31, 2015.

	Assets/(Liabilities)			Cash Collateral Posted (Held)			Net Asset/(Liability)
Interest rate swaps	$	1,304		$	-		$	1,304
Interest rate swaptions		727			(1,106	)		(379	)
Futures Contracts		693			-			693
Forward purchase commitments		190			-			190

Interest rate swaps	$	(6,802	)	$	14,626		$	7,824
Futures Contracts		(286,058	)		335,084			49,026
Forward purchase commitments		(32,373	)		25,687			(6,686	)

The following table shows the gross amounts associated with the Company’s derivative financial instruments and the impact if netting were used as of December 31, 2014.

	Assets/(Liabilities)			Cash Collateral Posted (Held)			Net Asset/(Liability)
Interest rate swaps	$	6,489		$	-		$	6,489
Interest rate swaptions		4,561			(1,558	)		3,003
Futures Contracts		-			-			-
Forward purchase commitments		16,101			-			16,101

Interest rate swaps	$	(42,052	)	$	66,653		$	24,601
Forward purchase commitments		(38	)		5,585			5,547
Futures Contracts		(202,501	)		251,553			49,052

The following table shows the components of “Loss on derivative instruments, net” for the three years ended December 31, 2015, 2014 and 2013. Impacts from the Company’s interest rate swaps subsequent to the September 30, 2013 hedge de-designation are included herein.

	Years Ended December 31
	2015			2014			2013
Interest rate swaps – net realized and unrealized gains	$	24,851		$	73,729		$	25,036
Interest rate swaptions – net realized and unrealized losses		(12,597	)		(15,520	)		-
Interest rate swaps – monthly net settlements		(55,064	)		(113,919	)		(30,985	)
Futures Contracts – fair value adjustments		(82,864	)		(176,916	)		(25,585	)
Futures Contracts – losses from maturities		(48,120	)		-			-
Futures Contracts – other realized losses		(45,836	)		(29,423	)		(33,298	)
Mortgage loan purchase commitments - fair value adjustments		11			(2	)		-
TBA dollar roll income		83,397			92,008			5,605
TBA dollar rolls - net realized and unrealized gains (losses)		(52,194	)		28,610			(10,488	)
Net gain (loss) on derivative instruments	$	(188,416	)	$	(141,433	)	$	(69,715	)

See Note 2 for a discussion of TBA dollar roll transactions and TBA dollar roll income.

As discussed above, effective September 30, 2013, the Company discontinued cash flow hedge accounting for its interest rate swaps. The table below presents the effect of the interest rate swaps that were previously designated as cash flow hedges on the Company’s net income and other comprehensive income for the years ended December 31, 2015, 2014 and 2013.

	Years Ended December 31
	2015			2014			2013
Amount of gain recognized in OCI (effective portion)	$	-		$	-		$	15,030
Amount of loss reclassified from OCI into net income as interest expense (effective portion)		(30,715	)		(81,132	)		(116,847	)
Amount of loss recognized in net income as interest expense (ineffective portion)		-			-			(205	)

The following table presents the impact of the Company’s interest rate swap agreements on the Company’s AOCI for the years ended December 31, 2015, 2014 and 2013.

	Years Ended December 31
	2015			2014			2013
Beginning balance	$	(30,042	)	$	(111,174	)	$	(243,051	)
Unrealized gain on interest rate swaps		-			-			15,030
Reclassification of net losses included in income statement		30,715			81,132			116,847
Ending balance	$	673		$	(30,042	)	$	(111,174	)

Credit-risk-related Contingent Features

The Company has agreements with its interest rate swap and swaption counterparties that contain a provision where if the Company defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then the Company could also be declared in default on its derivative obligations.

The Company has agreements with certain of its derivative counterparties that contain a provision where if the Company’s GAAP shareholders’ equity declines by a specified percentage over a specified time period, or if the Company fails to maintain a minimum shareholders’ equity threshold, then the Company could be declared in default on its derivative obligations. The Company also has agreements with several of those counterparties that contain provisions regarding maximum leverage ratios. At December 31, 2015, the Company was in compliance with these requirements.

As of December 31, 2015, the fair value of derivatives in a net liability position related to these agreements was $6,802. The Company has collateral posting requirements with each of its counterparties and all interest rate swap agreements were fully collateralized as of December 31, 2015.