Derivative Financial Instruments

12 Months Ended

Dec. 31, 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 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 December 31, 2016 and 2015.

(in thousands)
Derivative Instruments and Related Accounts	Balance Sheet Location	2016		2015
Assets
Interest rate swaps	Derivative assets, at fair value	$	10,302	$	-
Receiver swaptions	Derivative assets, at fair value		-		669
TBA securities	Derivative assets, at fair value		63		-
Total derivative assets, at fair value		$	10,365	$	669
Liability
Interest rate swaps	Derivative liabilities, at fair value	$	802	$	-
TBA securities	Derivative liabilities, at fair value		1,180		-
Total derivative liabilities, at fair value		$	1,982	$	-
Margin Balances Posted to Counterparties
Futures contracts	Restricted cash	$	9,419	$	8,483
TBA securities	Restricted cash		446		-
Total margin balances on derivative contracts		$	9,865	$	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 December 31, 2016 and 2015.

($ in thousands)
			December 31, 2016
			Average	Weighted	Weighted
			Contract	Average	Average
			Notional	Entry	Effective		Open
Expiration Year			Amount	Rate	Rate		Equity(1)
Eurodollar Futures Contracts (Short Positions)
2017		$	600,000	1.48%	1.28%	$	(1,206)
2018			600,000	1.81%	1.82%		76
2019			675,000	2.00%	2.21%		1,429
2020			700,000	2.65%	2.45%		(1,394)
Total / Weighted Average		$	643,750	2.01%	1.97%	$	(1,095)
Treasury Note Futures Contracts (Short Position)(2)
March 2017 10 year T-Note futures
	(Mar 2017 - Mar 2027 Hedge Period)	$	465,000	2.27%	2.24%	$	(3,134)

($ in thousands)
			December 31, 2015
			Average	Weighted	Weighted
			Contract	Average	Average
			Notional	Entry	Effective		Open
Expiration Year			Amount	Rate	Rate		Equity(1)
Eurodollar Futures Contracts (Short Positions)
2016		$	900,000	1.51%	0.98%	$	(4,718)
2017			900,000	2.31%	1.59%		(6,550)
2018			900,000	2.77%	1.99%		(7,060)
2019			900,000	2.56%	2.17%		(865)
Total / Weighted Average		$	900,000	2.23%	1.57%	$	(19,193)
Treasury Note Futures Contracts (Short Position)(2)
December 2015 10 year T-Note futures
	(Dec 2015 - Dec 2025 Hedge Period)	$	185,000	1.99%	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 $124.28 at December 31, 2016 and $125.91 at December 31, 2015. The nominal value of the short positions was $577.9 million was $232.9 million at December 31, 2016 and December 31, 2015, respectively.

Under our interest rate swap agreements, we typically pay a fixed rate and receive a floating rate based on LIBOR ("payer swaps"). The floating rate we receive under our swap agreements has the effect of offsetting the repricing characteristics of our repurchase agreements and cash flows on such liabilities. We are typically required to post collateral on our interest rate swap agreements. The table below presents information related to the Company’s interest rate swap positions at December 31, 2016.

($ in thousands)
			Average			Net
			Fixed	Average		Estimated	Average
		Notional	Pay	Receive		Fair	Maturity
Expiration		Amount	Rate	Rate		Value	(Years)
> 3 to ≤ 5 years	$	700,000	1.20%	0.91%	$	9,500	3.4

($ 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, 2015 - Receiver Swaptions
≤ 1 year	$	1,100	$	669	4.2	$	100,000	1.77%	3 Month	5.0

The following table summarizes our contracts to purchase and sell TBA securities as of December 31, 2016.

($ in thousands)
			Notional						Net
			Amount		Cost		Market		Carrying
			Long (Short)(1)		Basis(2)		Value(3)		Value(4)
30-Year TBA securities:
	3.0%	$	(100,000)	$	(99,406)	$	(99,344)	$	62
	4.0%		(100,000)		(103,898)		(105,078)		(1,180)
		$	(200,000)	$	(203,304)	$	(204,422)	$	(1,118)

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 years ended December 31, 2016, 2015 and 2014.

(in thousands)
		2016		2015		2014
Eurodollar futures contracts (short positions)	$	(12,808)	$	(17,741)	$	(9,558)
T-Note futures contract (short position)		(3,600)		(3,887)		72
Interest rate swaps		9,503		-		-
Receiver swaptions		36		(431)		-
Payer swaptions		-		(1,217)		(4,439)
Net TBA securities		(2,518)		386		-
	$	(9,387)	$	(22,890)	$	(13,925)

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.