Derivative Instruments

3 Months Ended

Mar. 31, 2020

Derivative Instruments and Hedging Activities Disclosure [Abstract]

On March 3, 2020, the Federal Open Market Committee reduced the target federal funds rate by 50 basis points to 1.00% to 1.25%. This rate was further reduced to a target range of 0.0% to 0.25% on March 16, 2020. These reductions in interest rates and other effects of the COVID-19 outbreak caused volatility in interest rates. As a result, we received significant margin calls on our interest rate swap positions. In this very low interest rate environment the Company's interest rate swaps were no longer effective. In March 2020, the Company terminated fixed-pay interest rate swaps with a notional value of approximately $3.1 billion and variable-pay interest rate with a notional value of approximately $1.9 billion to reduce hedging costs and associated margin volatility.

The Company’s derivatives may include interest rate swaps, swaptions, options, futures contracts, TBAs, Agency and Non-Agency Interest-Only Strips that are classified as derivatives, credit default swaps and total return swaps.

The following table summarizes the Company’s derivative instruments at March 31, 2020 and December 31, 2019 (dollars in thousands):


			March 31, 2020						December 31, 2019
Derivative Instrument	Accounting Designation	Consolidated Balance Sheets Location	Notional Amount		Fair Value		Notional Amount		Fair Value
Interest rate swaps, asset	Non-Hedge	Derivative assets, at fair value	$	—	$	—	$	2,701,000	$	3,017
Swaptions, asset	Non-Hedge	Derivative assets, at fair value	50,000		195		—		—




Credit default swaps, asset	Non-Hedge	Derivative assets, at fair value	47,260		15,557		60,100		948
TBA securities, asset	Non-Hedge	Derivative assets, at fair value	778,200		17,923		1,000,000		1,146
Total derivative instruments, assets					33,675				5,111

Interest rate swaps, liability	Non-Hedge	Derivative liability, at fair value	—		—		1,255,000		(501)
Swaptions, liability	Non-Hedge	Derivative liability, at fair value	255,000		(14)		—		—



Credit default swaps, liability	Non-Hedge	Derivative liability, at fair value	97,260		(22,106)		90,900		(3,795)
TBA securities, liability	Non-Hedge	Derivative liability, at fair value	778,200		(21,847)		1,000,000		(2,074)
Total derivative instruments, liabilities					(43,967)				(6,370)
Total derivative instruments, net					$	(10,292)			$	(1,259)

The following tables summarize the effects of the Company’s derivative positions, including Interest-Only Strips characterized as derivatives and TBAs, which are reported in "Gain (loss) on derivative instruments, net" in the Consolidated Statements of Operations for the three months ended March 31, 2020 and March 31, 2019 (dollars in thousands):


	Realized Gain (Loss), net
Description	Other Settlements / Expirations		Variation Margin Settlement		Return (Recovery) of Basis		Mark-to-Market		Contractual interest income (expense), net⁽¹⁾		Total
Three months ended March 31, 2020
Interest rate swaps	$	(262)	$	(179,759)	$	262	$	(2,515)	$	(1,395)	$	(183,669)
Interest rate swaptions	—		—		—		181		—		181
Interest-Only Strips— accounted for as derivatives	—		—		(545)		(839)		636		(748)





Credit default swaps	(1,315)		—		—		(2,638)		—		(3,953)
TBAs	1,494		—		—		(2,996)		—		(1,502)
Total	$	(83)	$	(179,759)	$	(283)	$	(8,807)	$	(759)	$	(189,691)


Three months ended March 31, 2019
Interest rate swaps	$	(3)	$	(37,838)	$	1,528	$	7,090	$	2,755	$	(26,468)

Interest-Only Strips— accounted for as derivatives	—		—		(595)		(59)		784		130

Futures contracts	(4,503)		—		—		4,657		—		154


Credit default swap	(589)		—		—		(375)		—		(964)

Total	$	(5,095)	$	(37,838)	$	933	$	11,313	$	3,539	$	(27,148)

At March 31, 2020 and December 31, 2019, the Company had cash pledged as collateral for derivatives of approximately $27.1 million and $55.4 million, respectively, which is reported in "Due from counterparties" in the Consolidated Balance Sheets. The Company received cash of approximately $16.3 million and $0 as collateral against derivatives at March 31, 2020 and December 31, 2019, respectively, which is reported in "Due to counterparties" in the Consolidated Balance Sheets.

Interest rate swaps and interest rate swaptions

The Company enters into interest rate swaps and interest rate swaptions to mitigate its exposure to higher short-term interest rates in connection with its repurchase agreements. Interest rate swaps generally involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the interest rate swap without exchange of the underlying notional amount. Notwithstanding the foregoing, in order to manage its hedge position with regard to its liabilities, the Company on occasion will enter into interest rate swaps which involve the receipt of fixed-rate amounts from a counterparty in exchange for the Company making variable-rate payments over the life of the interest rate swap without exchange of the underlying notional amount. The Company also enters into forward starting swaps and interest rate swaptions to help mitigate the effects of changes in interest rates on a portion of its borrowings under repurchase agreements. Interest rate swaptions provide the Company the option to enter into an interest rate swap agreement for a predetermined notional amount, stated term and pay and receive interest rates in the future. The Company generally enters into MAC (Market Agreed Coupon) interest rate swaps in which it may receive or make a payment at the time of entering such interest rate swap to compensate for the out of the market nature of such interest rate swap. Similar to all other interest rate swaps, these interest rate swaps are also subject to margin requirements as previously described.

The Company has not elected to account for its interest rate swaps as “hedges” under GAAP, accordingly the change in fair value of the interest rate swaps not designated in hedging relationships are recorded together with periodic net interest settlement amounts in "Gain (loss) on derivatives instruments, net" in the Consolidated Statements of Operations.

Interest Rate Swaps

The Company did not have any interest rate swaps in its holdings at March 31, 2020. The following tables provide additional information on our fixed pay interest rate swaps and the variable pay interest rate swap as of December 31, 2019 (dollars in thousands):


	December 31, 2019
Fixed Pay Interest Rate Swap Remaining Term	Notional Amount		Average Fixed Pay Rate	Average Floating Receive Rate	Average Maturity (Years)
1 year or less	$	200,000	1.8 %	1.9 %	0.4

Greater than 3 years and less than 5 years	622,400		2.6 %	1.9 %	4.1
Greater than 5 years	1,728,600		2.1 %	2.0 %	8.9
Total	$	2,551,000	2.2 %	2.0 %	7.1


	December 31, 2019
Variable Pay Interest Rate Swap Remaining Term	Notional Amount		Average Variable Pay Rate	Average Fixed Receive Rate	Average Maturity (Years)
Greater than 1 year and less than 3 years	$	810,000	2.0 %	2.0 %	1.6
Greater than 3 years and less than 5 years	550,000		1.9 %	1.6 %	5.0
Greater than 5 years	45,000		1.9 %	2.3 %	19.5
Total	$	1,405,000	2.0 %	1.9 %	3.5

Interest Rate Swaptions

The following table summarizes the swaptions held by the Company as of March 31, 2020 (dollars in thousands):


	March 31, 2020
	Options					Underlying-Swap
Fixed Pay Rate for Underlying Swap	Fair Value		Weighted Average Months Until Option Expiration	Notional Amount		Weighted Average Swap Term (Years)
1.76 - 2.00%	$	195	4	$	50,000	30.0
Total	$	195	4	$	50,000	30.0


	March 31, 2020
	Options					Underlying-Swap
Variable Pay Rate for Underlying Swap	Fair Value		Weighted Average Months Until Option Expiration	Notional Amount		Weighted Average Swap Term (Years)
1.26 - 1.50%	$	(14)	4	$	255,000	5.0
Total	$	(14)	4	$	255,000	5.0

As of December 31, 2019, the Company did not have any swaptions in its derivative holdings.

Futures Contracts

From time to time, the Company may enter into Eurodollar, Volatility Index, and U.S. Treasury futures. As of March 31, 2020 and December 31, 2019, the Company had no open futures contracts.

To-Be-Announced Securities

The Company purchased or sold TBAs during the three months ended March 31, 2020 and the year ended December 31, 2019.The following is a summary of the Company's TBA positions as of March 31, 2020 and December 31, 2019, reported in "Derivative assets, at fair value" and "Derivative liability, at fair value" in the Consolidated Balance Sheets (dollars in thousands):


	March 31, 2020						December 31, 2019
	Notional Amount		Fair Value		Notional Amount		Fair Value
Purchase contracts, asset	$	778,200	$	17,923	$	1,000,000	$	1,146



Sale contracts, liability	(778,200)		(21,847)		(1,000,000)		(2,074)

TBA securities, net	$	—	$	(3,924)	$	—	$	(928)

The following table presents additional information about the Company's contracts to purchase and sell TBAs for the three months ended March 31, 2020 (dollars in thousands):


	Notional Amount				Settlement, Termination,		Notional Amount
	December 31, 2019		Additions		Expiration or Exercise		March 31, 2020
Purchase of TBAs	$	1,000,000	$	4,478,800	$	(4,700,600)	$	778,200
Sale of TBAs	$	1,000,000	$	4,478,800	$	(4,700,600)	$	778,200

Interest-Only Strips

The Company also invests in Interest-Only Strips. In determining the classification of its holdings of Interest-Only Strips, the Company evaluates the securities to determine if the nature of the cash flows has been altered from that of the underlying mortgage collateral. Generally, Interest-Only Strips for which the security represents a strip off of a mortgage pass through security will be considered a hybrid instrument classified as an MBS investment in the Consolidated Balance Sheets utilizing the fair value option. Alternatively, those Interest-Only Strips, for which the underlying mortgage collateral has been included into a structured security that alters the cash flows from the underlying mortgage collateral, are accounted for as derivatives at fair value with changes recognized in "Gain (loss) on derivative instruments, net" in the Consolidated Statements of Operations, along with any interest received. The carrying value of these Interest-Only Strips is included in "Agency mortgage-backed securities, at fair value" in the Consolidated Balance Sheets.

Credit Default Swaps

The Company entered into credit default swaps and, in the future, may continue to enter into these types of credit derivatives. Under these instruments, the buyer makes a monthly premium payment over the term of the contract in exchange for the seller making a payment for losses of the reference securities, upon the occurrence of a specified credit event.