DERIVATIVE FINANCIAL INSTRUMENTS

6 Months Ended

Jun. 30, 2018

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. 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, 2018 and December 31, 2017.

(in thousands)
Derivative Instruments and Related Accounts	Balance Sheet Location	June 30, 2018		December 31, 2017
Assets
Interest rate swaps	Derivative assets, at fair value	$	26,334	$	13,745
Payer swaptions	Derivative assets, at fair value		7,233		3,405
Receiver swaptions	Derivative assets, at fair value		640		-
TBA securities	Derivative assets, at fair value		-		10
Total derivative assets, at fair value		$	34,207	$	17,160

Liabilities
Interest rate swaps	Derivative liabilities, at fair value	$	-	$	215
TBA securities	Derivative liabilities, at fair value		2,240		1,823
Total derivative liabilities, at fair value		$	2,240	$	2,038

Margin Balances Posted to (from) Counterparties
Futures contracts	Restricted cash	$	5,922	$	5,545
TBA securities	Restricted cash		2,050		1,508
TBA securities	Other liabilities		-		(59)
Interest rate swaption contracts	Other liabilities		(7,959)		(3,505)
Total margin balances on derivative contracts		$	13	$	3,489

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, 2018 and December 31, 2017.

($ in thousands)
			June 30, 2018
			Average	Weighted	Weighted
			Contract	Average	Average
			Notional	Entry	Effective		Open
Expiration Year			Amount	Rate	Rate		Equity⁽¹⁾
Eurodollar Futures Contracts (Short Positions)
2018		$	1,375,000	1.97%	2.56%	$	4,035
2019			1,500,000	2.16%	2.88%		10,779
2020			1,500,000	2.64%	2.98%		5,011
Total / Weighted Average		$	1,475,000	2.32%	2.86%	$	19,825

Treasury Note Futures Contracts (Short Position)⁽²⁾
September 2018 5-year T-Note futures
	(Sep 2018 - Sep 2023 Hedge Period)	$	165,000	2.90%	3.04%	$	(7)

($ in thousands)
			December 31, 2017
			Average	Weighted	Weighted
			Contract	Average	Average
			Notional	Entry	Effective		Open
Expiration Year			Amount	Rate	Rate		Equity⁽¹⁾
Eurodollar Futures Contracts (Short Positions)
2018		$	1,212,500	1.86%	1.98%	$	1,418
2019			1,350,000	2.11%	2.27%		2,152
2020			987,500	2.59%	2.36%		(2,360)
Total / Weighted Average		$	1,183,333	2.16%	2.20%	$	1,210

Treasury Note Futures Contracts (Short Position)⁽²⁾
March 2018 10 year T-Note futures
	(Mar 2018 - Mar 2028 Hedge Period)	$	140,000	2.23%	2.33%	$	755

($ in thousands)
			Average			Net
			Fixed	Average		Estimated	Average
		Notional	Pay	Receive		Fair	Maturity
		Amount	Rate	Rate		Value	(Years)
June 30, 2018
Expiration > 1 to ≤ 3 years	$	650,000	1.09%	2.36%	$	16,223	1.6
Expiration > 3 to ≤ 5 years		360,000	2.05%	2.33%		10,111	3.8
	$	1,010,000	1.43%	2.35%	$	26,334	2.4
December 31, 2017
Expiration > 1 to ≤ 3 years	$	650,000	1.09%	1.41%	$	11,828	2.1
Expiration > 3 to ≤ 5 years		360,000	2.05%	1.53%		1,702	4.3
	$	1,010,000	1.43%	1.45%	$	13,530	2.8

The table below presents information related to the Company’s interest rate swaption positions at June 30, 2018 and December 31, 2017.

($ in thousands)
		Option					Underlying Swap
						Weighted				Average	Weighted
						Average			Average	Adjustable	Average
					Fair	Months to		Notional	Fixed	Rate	Term
Expiration			Cost		Value	Expiration		Amount	Rate	(LIBOR)	(Years)
June 30, 2018
≤ 1 year
	Payer Swaptions	$	9,770	$	7,232	6.4	$	950,000	3.20%	3 Month	9.3
	Receiver Swaptions		760		640	7.4		100,000	2.80%	3 Month	5.0
December 31, 2017
≤ 1 year
	Payer Swaptions	$	2,367	$	3,405	8.0	$	200,000	2.16%	3 Month	6.0

The following table summarizes our contracts to purchase and sell TBA securities as of June 30, 2018 and December 31, 2017.

($ in thousands)
			Notional						Net
			Amount		Cost		Market		Carrying
			Long (Short)⁽¹⁾		Basis⁽²⁾		Value⁽³⁾		Value⁽⁴⁾
June 30, 2018
30-Year TBA securities:
	3.0%	$	(200,000)	$	(192,404)	$	(193,624)	$	(1,220)
	3.5%		(200,000)		(197,980)		(199,000)		(1,020)
Total		$	(400,000)	$	(390,384)	$	(392,624)	$	(2,240)
December 31, 2017
30-Year TBA securities:
	3.0%	$	(300,000)	$	(299,371)	$	(300,153)	$	(782)
	4.0%		(357,000)		(373,403)		(373,477)		(74)
	4.5%		356,556		380,371		379,414		(957)
Total		$	(300,444)	$	(292,403)	$	(294,216)	$	(1,813)

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, 2018 and 2017.

(in thousands)
		Six Months Ended June 30,				Three Months Ended June 30,
		2018		2017		2018		2017
Eurodollar futures contracts (short positions)	$	20,661	$	(7,562)	$	6,121	$	(6,990)
T-Note futures contracts (short position)		7,750		(9,740)		928		(5,890)
Interest rate swaps		14,037		(4,175)		3,530		(4,178)
Receiver swaptions		(779)		-		(430)		-
Payer swaptions		5,213		-		3,146		-
Net TBA securities		9,971		(2,384)		1,564		(2,384)
Total	$	56,853	$	(23,861)	$	14,859	$	(19,442)

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 $ 113.62 at June 30, 2018 and $12 4.05 at December 31, 2017 . The no tional contract values of the short positions were $ 187.5 million and $ 173.7 million at June 30, 2018 and December 31, 2017 , respectively