DERIVATIVE FINANCIAL INSTRUMENTS

9 Months Ended

Sep. 30, 2017

Derivative Financial Instruments [Abstract]

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 September 30, 2017 and December 31, 2016.

(in thousands)
Derivative Instruments and Related Accounts	Balance Sheet Location	September 30, 2017		December 31, 2016
Assets
Interest rate swaps	Derivative assets, at fair value	$	10,693	$	10,302
Payer swaptions	Derivative assets, at fair value		3,194		-
TBA securities	Derivative assets, at fair value		2,984		63
Total derivative assets, at fair value		$	16,871	$	10,365

Liabilities
Interest rate swaps	Derivative liabilities, at fair value	$	2,591	$	802
TBA securities	Derivative liabilities, at fair value		-		1,180
Total derivative liabilities, at fair value		$	2,591	$	1,982

Margin Balances Posted to (from) Counterparties
Futures contracts	Restricted cash	$	6,193	$	9,419
TBA securities	Restricted cash		-		446
TBA securities	Other liabilities		(1,867)		-
Interest rate swaption contracts	Other liabilities		(2,776)		-
Interest rate swap contracts	Restricted cash		1,437		-
Total margin balances on derivative contracts		$	2,987	$	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 September 30, 2017 and December 31, 2016.

($ in thousands)
			September 30, 2017
			Average	Weighted	Weighted
			Contract	Average	Average
			Notional	Entry	Effective		Open
Expiration Year			Amount	Rate	Rate		Equity⁽¹⁾
Eurodollar Futures Contracts (Short Positions)
2017		$	1,000,000	1.62%	1.48%	$	(340)
2018			1,000,000	1.84%	1.73%		(1,091)
2019			1,000,000	2.09%	1.98%		(1,138)
2020			925,000	2.62%	2.13%		(4,505)
Total / Weighted Average		$	976,923	2.13%	1.91%	$	(7,074)

Treasury Note Futures Contracts (Short Position)⁽²⁾
September 2017 10-year T-Note futures
	(Sep 2017 - Sep 2027 Hedge Period)	$	115,000	1.98%	2.16%	$	(81)

($ 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)
			Average			Net
			Fixed	Average		Estimated	Average
		Notional	Pay	Receive		Fair	Maturity
		Amount	Rate	Rate		Value	(Years)
September 30, 2017
Expiration > 1 to ≤ 3 years	$	650,000	1.09%	1.31%	$	10,318	2.3
Expiration > 3 to ≤ 5 years		360,000	2.05%	1.32%		(2,216)	4.5
	$	1,010,000	1.43%	1.31%	$	8,102	3.1
December 31, 2016
Expiration > 3 to ≤ 5 years	$	700,000	1.20%	0.91%	$	9,500	3.4

The table below presents information related to the Company’s interest rate swaption positions at September 30, 2017.

($ in thousands)

Option

Underlying Swap

Weighted

Average

Fixed

Receive

Average

Fair

Months to

Notional

Pay

Rate

Term

Expiration

Cost

Value

Expiration

Amount

Rate

(LIBOR)

(Years)

Payer Swaptions

≤ 1 year

2,367

3,194

11.0

200,000

2.16%

3 Month

6.9

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

($ in thousands)
			Notional						Net
			Amount		Cost		Market		Carrying
			Long (Short)⁽¹⁾		Basis⁽²⁾		Value⁽³⁾		Value⁽⁴⁾
September 30, 2017
30-Year TBA securities:
	3.0%	$	(300,000)	$	(303,773)	$	(300,789)	$	2,984
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)
Total		$	(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 nine and three months ended September 30, 2017 and 2016.

(in thousands)
		Nine Months Ended September 30,				Three Months Ended September 30,
		2017		2016		2017		2016
Eurodollar futures contracts (short positions)	$	(6,955)	$	(17,507)	$	607	$	1,194
T-Note futures contracts (short position)		(16,190)		(12,288)		(6,450)		1,688
Interest rate swaps		(3,170)		(450)		1,005		4,179
Receiver swaptions		-		36		-		-
Payer swaptions		827		-		827		-
Net TBA securities		(3,843)		(2,385)		(1,459)		(474)
Total	$	(29,331)	$	(32,594)	$	(5,470)	$	6,587

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.

^{[1],[2],[3],[4],[5],[6]}

[1]	Market value represents the current market value of the TBA securities (or of the underlying Agency RMBS ) as of period-end
[2]	Market value represents the current market value of the TBA securities (or of the underlying Agency RMBS ) as of period-end
[3]	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 valu e in our consolidated balance sheets
[4]	Notional amount represents the par value (or principal balance) of the underlying Agency RMBS
[5]	Open equity represents the cumulative gains (losses) recorded on open futures positions from inception
[6]	T -Note f utures c ontracts were valued at a price of $ 125.31 at September 30, 2017 and $12 4.28 at December 31, 201 6 . The no tional contract values of the short positions were $ 144.1 million and $ 577.9 million at September 30, 2017 and December 31, 2016, respectively