Derivatives and Hedging Activity

9 Months Ended

Sep. 30, 2013

Derivatives and Hedging Activity

Derivatives and Hedging Activity

13. Derivatives and Hedging Activity

Risk Management Objective of Using Derivatives

We are exposed to certain risk arising from both our business operations and economic conditions. Refer to our consolidated financial statements and notes thereto included in our Form 10-K for further discussion of our risk management objectives and policies.

Cash Flow Hedges of Forecasted Interest Payments

In connection with our repurchase agreements, we have entered into eight outstanding interest rate swaps that have been designated as cash flow hedges of the interest rate risk associated with forecasted interest payments. As of September 30, 2013, the aggregate notional of our interest rate swaps designated as cash flow hedges of interest rate risk totaled $183.4 million.  Under these agreements, we will pay fixed monthly coupons at a fixed rates ranging from 0.557% 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 May 2014 to May 2021.

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 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 three and nine months ended September 30, 2013 and 2012 we did not recognize any hedge ineffectiveness in earnings.

Amounts reported in accumulated other comprehensive income 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 $1.4 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 93 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.  Changes in the fair value of derivatives not designated in hedging relationships are recorded directly in gain (loss) on derivative financial instruments in the consolidated statements of operations.

During the three months ended September 30, 2013, we entered into 14 forward contracts whereby we agree to sell an amount of GBP or EUR for agreed upon amount of USD at various dates from October 2013 through March 2016. These forward contracts were executed to economically fix the USD amounts of foreign denominated cash flows expected to be received by us related to foreign denominated loan investments.

As of September 30, 2013, we had 45 foreign exchange forward derivatives to sell GBP with a total notional amount of GBP 198.3 million, one foreign exchange forward derivative to buy GBP with a total notional amount of GBP 64.1 million and 20 foreign exchange forward derivatives to sell EUR with a total notional of EUR 132.4 million that were not designated as hedges in qualifying hedging relationships.

The LNR conduit platform uses interest rate and credit index instruments to manage exposures related to commercial mortgage loans held-for-sale. As of September 30, 2013, there were 34 interest rate swaps where the Company is paying fixed rates, with maturities ranging from 3 to 10 years and a total notional amount of $239.1 million.  As of September 30, 2013, there were four credit index instruments with a total notional amount of $50.0 million.

The table below presents the fair value of our derivative financial instruments as well as their classification on the balance sheet as of September 30, 2013 and December 31, 2012 (amounts in thousands):

Tabular Disclosure of Fair Values of Derivative Instruments

	DerivativesinanAssetPosition						DerivativesinaLiabilityPosition
	AsofSeptember 30, 2013			AsofDecember 31,2012			Asof September 30, 2013			AsofDecember31,2012
	BalanceSheetLocation	FairValue		BalanceSheetLocation	FairValue		Balance Sheet Location	FairValue		BalanceSheetLocation	FairValue
Derivatives designated as hedging instruments:
Interest rate swaps	Derivative Assets	$	96	Derivative Assets	$	—	Derivative Liabilities	$	1,084	Derivative Liabilities	$	2,571
Total derivatives designated as hedging instruments		96			—			1,084			2,571
Derivatives not designatedas hedging instruments:
Interest rate swaps	Derivative Assets	3,243		Derivative Assets	4,892		Derivative Liabilities	6,186		Derivative Liabilities	1,772
Foreign exchange contracts	Derivative Assets	3,243		N/A	4,335		Derivative Liabilities	24,982		Derivative Liabilities	23,427
Credit index instruments	Derivative Assets	2,931		N/A	—		Derivative Liabilities	—		N/A	—
Total derivatives not designated as hedging instruments		9,417			9,227			31,168			25,199
Total derivatives		$	9,513		$	9,227		$	32,252		$	27,770

Cash flow hedges impact for the three months ended September 30, 2013:

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	$	594	Interest Expense	$	397	Interest Expense	$	—

Cash flow hedges impact for the three months ended September 30, 2012:

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	$	1,072	Interest Expense	$	661	Interest Expense	$	—

Cash flow hedges impact for the nine months ended September 30, 2013:

Derivative type for cash flow hedge	Amount of Gain 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	$	332	Interest Expense	$	1,251	Interest Expense	$	—

Cash flow hedges impact for the nine months ended September 30, 2012:

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	$	3,534	Interest Expense	$	1,911	Interest Expense	$	—

Non-Designated derivatives impact for the three months ended September 30, 2013 and 2012:

Derivatives Not Designated	Location of Gain/(Loss) Recognized in Income on	Amount of Gain/(Loss) Recognized in Income on Derivative
as Hedging Instruments	Derivative	2013			2012
Interest Rate Swaps	Gain (loss) on derivative financial instruments	$	(4,261	)	$	(51	)
Foreign Exchange Contracts	Gain (loss) on derivative financial instruments	(17,459		)	(7,510		)
Credit Index Instruments	Gain (loss) on derivative financial instruments	(731		)	—
		$	(22,451	)	$	(7,561	)

Non-Designated derivatives impact for the nine months ended September 30, 2013 and 2012:

Derivatives Not Designated	Location of Gain/(Loss) Recognized in Income on	Amount of Gain/(Loss) Recognized in Income on Derivative
as Hedging Instruments	Derivative	2013			2012
Interest Rate Swaps	Gain (loss) on derivative financial instruments	$	2,752		$	608
Foreign Exchange Contracts	Gain (loss) on derivative financial instruments	(2,692		)	(10,392		)
Credit Index Instruments	Gain (loss) on derivative financial instruments	(125		)	—
		$	(65	)	$	(9,784	)

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 September 30, 2013, the fair value of derivatives in a liability position was $32.3 million. As of September 30, 2013, we had posted collateral of $14.6 million related to our derivative financial instruments.