Derivatives and Hedging Activity

12 Months Ended

Dec. 31, 2011

Derivatives and Hedging Activity

Derivatives and Hedging Activity

8. Derivatives and Hedging Activity

Risk Management Objective of Using Derivatives

        We are exposed to certain risks arising from both our business operations and economic conditions. We principally manage our exposures to a wide variety of business and operational risks through management of our core business activities. We manage economic risks, including interest rate, foreign exchange, liquidity, and credit risk primarily by managing the amount, sources, and duration of our debt funding and the use of derivative financial instruments. Specifically, we enter into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates, credit spreads, and foreign exchange rates. Our derivative financial instruments are used to manage differences in the amount, timing, and duration of the known or expected cash receipts and known or expected cash payments principally related to our investments, anticipated level of loan sales, and borrowings.

Cash Flow Hedges of Forecasted Interest Payments

        Our objectives in using interest rate derivatives are to add stability to interest expense and to manage our exposure to interest rate movements. To accomplish this objective, we primarily use interest rate swaps as part of our interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for us making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.

        In connection with our repurchase agreements, we have entered into six interest rate swaps that have been designated as cash flow hedges of the interest rate risk associated with forecasted variable interest payments. As of December 31, 2011, the aggregate notional amount of our interest rate swaps designated as cash flow hedges of forecasted variable interest payments totaled $297.3 million. Under these agreements, we will pay fixed monthly coupons at fixed rates ranging from 0.722% to 2.228% of the notional amount to the counterparty and receive floating rate LIBOR. Our interest rate swaps designated as cash flow hedges of interest rate risk have maturities ranging from November 2012 to December 2017.

        The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in accumulated other comprehensive income (loss) and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings. During the years ended December 31, 2011 and 2010, and the period ended December 31, 2009, we recorded $45 thousand, $46 thousand and $0, respectively as hedge ineffectiveness in earnings, which is included in interest expense on the consolidated statements of operations.

        Amounts reported in accumulated other comprehensive income (loss) related to derivatives will be reclassified to interest expense as interest payments are made on the associated variable-rate debt. Over the next twelve months, we estimate that an additional $1.5 million will be reclassified as an increase to interest expense. We are hedging our exposure to the variability in future cash flows for forecasted transactions over a maximum period of 59 months.

Non-designated Hedges

        Derivatives not designated as hedges are derivatives that do not meet the criteria for hedge accounting under GAAP or for which we have not elected to designate as hedges. We do not use these derivatives for speculative purposes but are instead used to manage our exposure to foreign exchange rates, interest rate changes, and certain credit spreads. Changes in the fair value of derivatives not designated in hedging relationships are recorded directly in net (losses) gains on interest rate hedges in the consolidated statements of operations.

        During 2010, we entered into a series of forward contracts whereby we agreed to sell an amount of GBP for an agreed upon amounts of USD at various dates through October of 2013. These forward contracts were executed to economically fix the USD amounts of GBP-denominated cash flows expected to be received by us related to our GBP-denominated loan investment. During 2011, we entered into a series of forward contracts whereby we agreed to sell an amount of EUR for an agreed upon amount of USD at various dates through June of 2014. These forward contracts were executed to economically fix the USD amount of EUR-denominated cash flows expected to be received by us related to our mezzanine loan in Germany. As of December 31, 2011, we had 12 foreign exchange forward derivatives to sell GBP with a total notional amount of GBP 99.1 million and 13 foreign exchange forward derivatives to sell EUR with a total notional of EUR 64.7 million that were not designated as hedges in qualifying hedging relationships.

        During 2010 and 2011, we entered into several interest rate swaps that were not designated as hedges. Under these agreements, we pay fixed coupons at fixed rates ranging from 0.716% to 3.10% of the notional amount to the counterparty and receive floating rate LIBOR. These interest rate swaps are used to limit the price exposure of certain assets due to changes in benchmark USD-LIBOR swap rates from which the pricing of these assets is derived. As of December 31, 2011, the aggregate notional amount of these interest rate swaps totaled $265.0 million. Changes in the fair value of these interest rate swaps are recorded in net (losses) gains on interest rate hedges in the consolidated statements of operations.

        In connection with our acquisition of a loan portfolio from an international bank during the fourth quarter of 2011, we acquired an interest in nine interest rate swaps whereby we receive fixed coupons ranging from 2.86% to 6.28% of the notional amount and pay floating rate LIBOR. We acquired these positions at a cost of $7.5 million. The premium paid reflects the fact that these swaps had above market rates which we receive. These swaps effectively convert certain floating rate loans we acquired to fixed rates. As of December 31, 2011, the aggregate notional amount of these swaps totaled $108.3 million. Changes in the fair value of these interest rate swaps are recorded directly in earnings.

        During the year ended December 31, 2011, we entered into a series of derivatives that are intended to hedge against increases in market credit spreads of CMBS. Such movements would have a negative impact on the proceeds we expect to receive from selling the loans. Under the terms of the contract, a market credit spread index was defined at the contract's inception by reference to a portfolio of specific independent CMBS. To the extent the referenced credit spread index increased, our counterparty paid us. To the extent the referenced credit spread index decreased, we paid our counterparty. We settled approximately every 30 days based upon the movement in the referenced index during such period. As of December 31, 2011, all contracts had matured and we realized net gains of $2.4 million.

        The table below presents the fair value of the Company's derivative financial instruments as well as their classification on the balance sheet as of December 31, 2011 and December 31, 2010 (amounts in thousands).

Tabular Disclosure of Fair Values of Derivative Instruments

	Derivatives in an Asset Position						Derivatives in a Liability Position
	As of December 31, 2011			As of December 31, 2010			As of December 31, 2011			As of December 31, 2010
	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
Derivatives designated as hedging instruments
Interest rate swaps	N/A	$	—	Derivative Assets	$	89	Derivative Liabilities	$	1,420	Derivative Liabilities	$	1,714
Total derivatives designated as hedging instruments		$	—		$	89		$	1,420		$	1,714
Derivatives not designated as hedging instruments
Interest rate swaps	Derivative Assets	$	7,555	Derivative Assets	$	248	Derivative Liabilities	$	11,342	Derivative Liabilities	$	303
Foreign exchange contracts	Derivative Assets		5,261	N/A		—	Derivative Liabilities		6,890	Derivative Liabilities		7,383
Total derivatives not designated as hedging instruments		$	12,816		$	248		$	18,232		$	7,686

        The tables below present the effect of the Company's derivative financial instruments on the statements of operations and of comprehensive income (loss) for the years ended December 31, 2011 and December 31, 2010.

        Cash flow hedges' impact for the year ended December 31, 2011 (amounts in thousands):

Derivative type for cash flow hedge	Amount of loss recognized in OCI on derivative (effective portion)		Location of loss reclassified from accumulated OCI into income (effective portion)	Amount of loss reclassified from accumulated OCI into income (effective portion)		Location of loss recognized in income on derivative (ineffective portion)	Amount of loss recognized in income on derivative (ineffective portion)
Interest Rate Swaps	$	1,951	Interest Expense	$	2,113	Interest Expense	$	45

        Cash flow hedges' impact for the year ended December 31, 2010:

Derivative type for cash flow hedge	Amount of loss recognized in OCI on derivative (effective portion)		Location of loss reclassified from accumulated OCI into income (effective portion)	Amount of loss reclassified from accumulated OCI into income (effective portion)		Location of gain recognized in income on derivative (ineffective portion)	Amount of gain recognized in income on derivative (ineffective portion)
Interest Rate Swaps	$	3,367	Interest Expense	$	1,742	Interest Expense	$	46

        Non-designated derivatives' impact for the years ended December 31, 2011 and December 31, 2010 (amounts in thousands):

		Amount of Gain/(Loss) Recognized in Income on Derivative
	Location of Gain/(Loss) Recognized in Income on Derivative
Derivatives Not Designated as Hedging Instruments		2011			2010
Interest Rate Swaps—Realized losses	Gains (losses) on interest rate hedges	$	(15,843	)	$	(1,630	)
Interest Rate Swaps—Unrealized losses	Gains (losses) on interest rate hedges	$	(11,287	)	$	(55	)
Foreign Exchange—Realized losses	Gains (losses) on currency hedges	$	(1,264	)	$	(117	)
Foreign Exchange—Unrealized gains(losses)	Gains (losses) on currency hedges	$	5,755		$	(7,383	)
Credit Spread Derivative—Realized gains	Gains (losses) on credit spread hedges	$	2,358		$	—

Credit-risk-related Contingent Features

        We have entered into agreements with certain of our derivative counterparties that contain provisions where if we were to default on any of our indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, we may also be declared in default on our derivative obligations. We also have certain agreements that contain provisions where if our ratio of principal amount of indebtedness to total assets at any time exceeds 75%, then we could be declared in default of our derivative obligations.

        As of December 31, 2011 the fair value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk related to these agreements, was $17.2 million. As of December 31, 2011, we had posted collateral of $5.2 million related to these agreements. If we had breached any of these provisions at December 31, 2011, we could have been required to settle our obligations under the agreements at their termination liability value of $17.2 million.