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Derivative Financial Instruments
 6 Months Ended
Jun. 30, 2017
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 also a hedge for tax purposes. 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 (Liabilities), at Fair Value

The table below summarizes fair value information about our derivative assets and liabilities as of June 30, 2017 and December 31, 2016.

(in thousands)
Derivative Instruments and Related AccountsBalance Sheet LocationJune 30, 2017December 31, 2016
Assets
Interest rate swapsDerivative assets, at fair value$8,523$10,302
TBA securitiesDerivative assets, at fair value2,09063
Total derivative assets, at fair value$10,613$10,365
Liabilities
Interest rate swapsDerivative liabilities, at fair value$2,712$802
TBA securitiesDerivative liabilities, at fair value-1,180
Total derivative liabilities, at fair value$2,712$1,982
Margin Balances Posted to Counterparties
Futures contractsRestricted cash$10,021$9,419
TBA securitiesRestricted cash257446
Interest rate swap contractsRestricted cash3,047-
Total margin balances on derivative contracts$13,325$9,865

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, 2017 and December 31, 2016.

($ in thousands)
June 30, 2017
AverageWeightedWeighted
ContractAverageAverage
NotionalEntryEffectiveOpen
Expiration YearAmountRateRateEquity(1)
Eurodollar Futures Contracts (Short Positions)
2017$1,000,0001.56%1.42%$(723)
20181,000,0001.84%1.68%(1,666)
20191,000,0002.09%1.95%(1,463)
2020925,0002.62%2.16%(4,268)
Total / Weighted Average$978,5712.08%1.85%$(8,120)
Treasury Note Futures Contracts (Short Position)(2)
September 2017 10-year T-Note futures
(Sep 2017 - Sep 2027 Hedge Period)$465,0002.06%2.12%$1,582

($ in thousands)
December 31, 2016
AverageWeightedWeighted
ContractAverageAverage
NotionalEntryEffectiveOpen
Expiration YearAmountRateRateEquity(1)
Eurodollar Futures Contracts (Short Positions)
2017$600,0001.48%1.28%$(1,206)
2018600,0001.81%1.82%76
2019675,0002.00%2.21%1,429
2020700,0002.65%2.45%(1,394)
Total / Weighted Average$643,7502.01%1.97%$(1,095)
Treasury Note Futures Contracts (Short Position)(2)
March 2017 10 year T-Note futures
(Mar 2017 - Mar 2027 Hedge Period)$465,0002.27%2.24%$(3,134)

  • Open equity represents the cumulative gains (losses) recorded on open futures positions from inception.
  • T-Note futures contracts were valued at a price of $125.53 at June 30, 2017 and $124.28 at December 31, 2016. The notional contract values of the short positions were $583.7 million and $577.9 million at June 30, 2017 and December 31, 2016, respectively.

Under our interest rate swap agreements, we typically pay a fixed rate and receive a floating rate based on the London Interbank Offered Rate (“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 June 30, 2017 and December 31, 2016.

($ in thousands)
AverageNet
FixedAverageEstimatedAverage
NotionalPayReceiveFairMaturity
AmountRateRateValue(Years)
June 30, 2017
Expiration > 1 to ≤ 3 years$ 650,000 1.09%1.18%$8,4852.6
Expiration > 3 to ≤ 5 years 300,000 2.08%1.24%(2,674)4.7
$ 950,000 1.40%1.20%$5,8113.2
December 31, 2016
Expiration > 3 to ≤ 5 years$ 700,000 1.20%0.91%$9,5003.4

The following table summarizes our contracts to purchase and sell TBA securities as of June 30, 2017 and December 31, 2016.

($ in thousands)
NotionalNet
AmountCostMarketCarrying
Long (Short)(1)Basis(2)Value(3)Value(4)
June 30, 2017
30-Year TBA securities:
3.0%$(250,000)$(251,063)$(249,628)$1,435
4.5%(150,000)(161,531)(160,876)655
$(400,000)$(412,594)$(410,504)$2,090
December 31, 2016
30-Year TBA securities:
3.0%$(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)

  • 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, 2017 and 2016.

(in thousands)
Six Months Ended June 30,Three Months Ended June 30,
2017201620172016
Eurodollar futures contracts (short positions)$(7,562)$(18,701)$(6,990)$(1,196)
T-Note futures contracts (short position)(9,740)(13,976)(5,890)(5,001)
Interest rate swaps(4,175)(4,629)(4,178)(4,608)
Receiver swaptions-36--
Net TBA securities(2,384)(1,911)(2,384)(786)
$(23,861)$(39,181)$(19,442)$(11,591)

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.