Derivative Financial Instruments

3 Months Ended

Mar. 31, 2015

Derivative Financial Instruments [Abstract]

Derivative Financial Instruments

NOTE 4. DERIVATIVE FINANCIAL INSTRUMENTS

In connection with its interest rate risk management strategy, the Company economically hedges a portion of the cost of its repurchase agreement funding by entering into derivatives and other hedging contracts. To date, we have entered into Eurodollar and T-Note futures contracts and interest rate swaptions, but may enter into other contracts in the future.  The Company has not elected hedging treatment under GAAP, and as such all gains or losses (realized and unrealized) on these instruments are reflected in earnings for all periods presented.

In addition, the Company utilizes TBA securities as a means of investing in and financing Agency RMBS or as a means of reducing its exposure to Agency RMBS, and not as a hedge.The Company accounts for TBA securities as derivative instruments if either the TBA securities do not settle in the shortest period of time possible or if the Company cannot assert that it is probable at inception and throughout the term of the TBA securities that it will take physical delivery of the Agency RMBS upon settlement of the trade.

Derivative Assets (Liability), at Fair Value

The table below summarizes fair value information about our derivative assets and liability as of March 31, 2015 and December 31, 2014.

(in thousands)
Derivative Instruments and Related Accounts	Balance Sheet Location	March 31, 2015		December 31, 2014
Assets
Eurodollar futures - Margin posted to counterparty	Restricted cash	$	6,078	$	5,174
Payer swaptions	Derivative assets, at fair value		126		1,217
TBA securities	Derivative assets, at fair value		92		-
		$	6,296	$	6,391
Liability
Payer swaptions - Margin posted by counterparty	Other liabilities	$	(207)	$	(1,364)

The tables below present information related to the Company’s Eurodollar futures positions at March 31, 2015 and December 31, 2014.

($ in thousands)
	March 31, 2015					December 31, 2014
			Average					Average
	Weighted		Contract			Weighted		Contract
	Average		Notional		Open	Average		Notional		Open
Expiration Year	LIBOR Rate		Amount		Equity(1)	LIBOR Rate		Amount		Equity(1)
2015	0.51%	$	800,000	$	(1,791)	0.63%	$	650,000	$	(1,039)
2016	1.13%		900,000		(3,435)	1.54%		800,000		139
2017	1.74%		825,000		(4,976)	2.23%		800,000		(1,041)
2018	2.09%		800,000		(5,061)	2.54%		800,000		(2,361)
Total / Weighted Average	1.37%	$	835,714	$	(15,263)	1.73%	$	760,000	$	(4,302)

Open equity represents the cumulative gains (losses) recorded on open futures positions from inception.

The table below presents information related to the Company’s interest rate swaption positions at March 31, 2015.

($ in thousands)
	Option					Underlying Swap
					Weighted					Weighted
					Average			Fixed	Receive	Average
				Fair	Months to		Notional	Pay	Rate	Term
Expiration		Cost		Value	Expiration		Amount	Rate	(LIBOR)	(Years)
March 31, 2015
≤ 1 year	$	5,350	$	126	3	$	375,000	2.79%	3 Month	7.3
December 31, 2014
≤ 1 year	$	5,350	$	1,217	6	$	375,000	2.79%	3 Month	7.3

The following table summarizes our contracts to purchase and sell TBA securities as of March 31, 2015.

($ in thousands)
								Net
		Notional		Cost		Market		Carrying
		Amount(1)		Basis(2)		Value(3)		Value(4)
Open purchase trade	$	75,000	$	81,722	$	81,730	$	8
Open sale trade		(75,000)		(81,930)		(81,950)		(20)
Unsettled offsetting purchases and sales trades		-		-		104		104
	$	-	$	(208)	$	(116)	$	92

• Notional amount represents the par value (or principal balance) of the underlying Agency RMBS.
• Cost basis represents the forward price to be paid (received) for the underlying Agency RMBS.
• Market value represents the current market value of the TBA securities (or of the underlying Agency RMBS) as of period-end.
• Net carrying value represents the difference between the market value and the cost basis of the TBA securities as of period-end and is reported in derivative assets, at fair value in our consolidated balance sheets.

Gain (Loss) From Derivative Instruments, Net

The table below presents the effect of the Company’s derivative financial instruments on the statements of operations for thethree months ended March 31, 2015 and 2014.

(in thousands)
		Three Months Ended March 31,
		2015		2014
Eurodollar futures contracts (short positions)	$	(11,317)	$	(1,537)
Payer swaptions		(1,091)		(156)
Net TBA securities		57		-
	$	(12,351)	$	(1,693)

Credit Risk-Related Contingent Features

The use of derivatives creates exposure to credit risk relating to potential losses that could be recognized in the event that the counterparties to these instruments fail to perform their obligations under the contracts. We minimize this risk by limiting our counterparties for instruments which are not centrally cleared on a registered exchange to major financial institutions with acceptable credit ratings and monitoring positions with individual counterparties. In addition, we may be required to pledge assets as collateral for our derivatives, whose amounts vary over time based on the market value, notional amount and remaining term of the derivative contract. In the event of a default by a counterparty, we may not receive payments provided for under the terms of our derivative agreements, and may have difficulty obtaining our assets pledged as collateral for our derivatives. The cash and cash equivalents pledged as collateral for our derivative instruments are included in restricted cash on our balance sheets.