Derivative Financial Instruments

9 Months Ended

Sep. 30, 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 securitiesthat it will take physical deliveryof the Agency RMBS for a long position, or make delivery of the Agency RMBS for a short position, 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 September 30, 2015 and December 31, 2014.

(in thousands)
Derivative Instruments and Related Accounts	Balance Sheet Location	September 30, 2015		December 31, 2014
Assets
Futures contracts - Margin posted to counterparty	Restricted cash	$	9,188	$	5,174
Payer swaptions	Derivative assets, at fair value		-		1,217
		$	9,188	$	6,391
Liability
Payer swaptions - Margin posted by counterparty	Other liabilities	$	-	$	(1,364)

The tables below present information related to the Company’s Eurodollar and T-Note futures positions at September 30, 2015 and December 31, 2014.

($ in thousands)
			September 30, 2015
			Average	Weighted	Weighted
			Contract	Average	Average
			Notional	Entry	Effective		Open
Expiration Year			Amount	Rate	Rate		Equity(1)
Eurodollar Futures Contracts (Short Positions)
2015		$	1,400,000	0.79%	0.42%	$	(1,303)
2016			900,000	1.51%	0.72%		(7,035)
2017			900,000	2.31%	1.26%		(9,486)
2018			900,000	2.77%	1.70%		(9,625)
2019			900,000	2.56%	1.94%		(1,372)
Total / Weighted Average		$	935,714	2.07%	1.19%	$	(28,821)
Treasury Note Futures Contracts (Short Position)(2)
December 2015 10 year T-Note futures
	(Dec 2015 - Dec 2025 Hedge Period)	$	185,000	1.94%	1.71%	$	(2,818)

($ in thousands)
		December 31, 2014
		Average	Weighted	Weighted
		Contract	Average	Average
		Notional	Entry	Effective		Open
Expiration Year		Amount	Rate	Rate		Equity(1)
Eurodollar Futures Contracts (Short Positions)
2015	$	650,000	0.79%	0.63%	$	(1,039)
2016		800,000	1.52%	1.54%		139
2017		800,000	2.36%	2.23%		(1,041)
2018		800,000	2.94%	2.54%		(2,361)
Total / Weighted Average	$	760,000	1.88%	1.73%	$	(4,302)

• Open equity represents the cumulative gains (losses) recorded on open futures positions from inception.
• T-Note futures contracts were valued at a price of $128.73 at September 30, 2015. The nominal value of the short position was $238.2 million.

The table below presents information related to the Company’s interest rate swaption positions at December 31, 2014.

($ 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)
December 31, 2014
≤ 1 year	$	5,350	$	1,217	6	$	375,000	2.79%	3 Month	7.3

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 thenine and three months ended September 30, 2015 and 2014.

(in thousands)
		Nine Months Ended September 30,				Three Months Ended September 30,
		2015		2014		2015		2014
Eurodollar futures contracts (short positions)	$	(26,406)	$	(3,316)	$	(15,446)	$	2,820
T-Note futures contracts (short position)		(8,061)		72		(7,050)		72
Payer swaptions		(1,217)		(1,120)		(65)		165
Net TBA securities		24		-		55		-
	$	(35,660)	$	(4,364)	$	(22,506)	$	3,057

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.