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Derivative Financial Instruments
 6 Months Ended
Jun. 30, 2016
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, the Company has entered into Eurodollar and T-Note futures contracts, interest rate swaps, 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 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 liabilities as of June 30, 2016 and December 31, 2015.

(in thousands)
Derivative Instruments and Related AccountsBalance Sheet LocationJune 30, 2016December 31, 2015
Assets
Receiver swaptionsDerivative assets, at fair value-669
Total derivative assets, at fair value$-$669
Liabilities
Interest rate swapsDerivative liabilities, at fair value$5,560$-
TBA securitiesDerivative liabilities, at fair value313-
Total derivative liabilities, at fair value$5,873$-
Margin Balances Posted to Counterparties
Futures contractsRestricted cash$3,458$8,483
Interest rate swap contractsRestricted cash11,692-
Total margin balances on derivative contracts$15,150$8,483

Eurodollar and T-Note futures are cash settled futures contracts on an interest rate, with gains and losses credited or charged to the Company’s cash accounts on a daily basis. A minimum balance, or “margin”, is required to be maintained in the account on a daily basis. The tables below present information related to the Company’s Eurodollar and T-Note futures positions at June 30, 2016 and December 31, 2015.

($ in thousands)
June 30, 2016
AverageWeightedWeighted
ContractAverageAverage
NotionalEntryEffectiveOpen
Expiration YearAmountRateRateEquity(1)
Eurodollar Futures Contracts (Short Positions)
2016$200,0001.68%0.66%$(1,019)
2017200,0002.14%0.75%(2,776)
2018200,0002.53%0.94%(3,181)
2019200,0002.55%1.07%(743)
Total / Weighted Average$200,0002.24%0.83%$(7,719)
Treasury Note Futures Contracts (Short Position)(2)
September 2016 10 year T-Note futures
(Sep 2016 - Sep 2026 Hedge Period)$185,0001.65%1.25%$(6,099)

($ in thousands)
December 31, 2015
AverageWeightedWeighted
ContractAverageAverage
NotionalEntryEffectiveOpen
Expiration YearAmountRateRateEquity(1)
Eurodollar Futures Contracts (Short Positions)
2016$900,0001.51%0.98%$(4,718)
2017900,0002.31%1.59%(6,550)
2018900,0002.77%1.99%(7,060)
2019900,0002.56%2.17%(865)
Total / Weighted Average$900,0002.23%1.57%$(19,193)
Treasury Note Futures Contracts (Short Position)(2)
December 2015 10 year T-Note futures
(Dec 2015 - Dec 2025 Hedge Period)$185,0001.99%1.95%$1,091

  • Open equity represents the cumulative gains (losses) recorded on open futures positions from inception.
  • T-Note futures contracts were valued at a price of $132.98 at June 30, 2016 and $125.91 at December 31, 2015. The nominal values of the short positions was $246.0 million and $232.9 million at June 30, 2016 and December 31, 2015, respectively.

($ in thousands)
AverageNet
FixedAverageEstimatedAverage
NotionalPayReceiveFairMaturity
ExpirationAmountRateRateValue(Years)
> 3 to ≤ 5 years$600,0001.05%0.63%$(5,560)3.6

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

($ in thousands)
OptionUnderlying Swap
WeightedWeighted
AverageFixedReceiveAverage
FairMonths toNotionalPayRateTerm
ExpirationCostValueExpirationAmountRate(LIBOR)(Years)
Receiver Swaptions
≤ 1 year$1,100$6694.2$100,0001.77%3 Month5.0

The following table summarizes our contracts to purchase and sell TBA securities as of June 30, 2016.

($ in thousands)
NotionalNet
AmountCostMarketCarrying
Long (Short)(1)Basis(2)Value(3)Value(4)
30-Year TBA securities:
4.0%$(100,000)$(106,922)$(107,235)$(313)
$(100,000)$(106,922)$(107,235)$(313)

  • 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 (liabilities), 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 consolidated statements of operations for the six and three months ended June 30, 2016 and 2015.

(in thousands)
Six Months Ended June 30,Three Months Ended June 30,
2016201520162015
Eurodollar futures contracts (short positions)$(18,701)$(10,960)$(1,196)$358
T-Note futures contracts (short position)(13,976)(1,011)(5,001)(1,011)
Interest rate swaps(4,629)-(4,608)-
Receiver swaptions36---
Payer swaptions-(1,152)-(61)
Net TBA securities(1,911)(31)(786)(88)
$(39,181)$(13,154)$(11,591)$(802)

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 consolidated balance sheets.