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Note 5 - Derivative and Other Hedging Instruments

9 Months Ended

Sep. 30, 2023

Notes to Financial Statements

Derivative Instruments and Hedging Activities Disclosure [Text Block]

NOTE 5. DERIVATIVE AND OTHER HEDGING INSTRUMENTS

The table below summarizes fair value information about the Company’s derivative and other hedging instruments assets and liabilities as of September 30, 2023 and December 31, 2022.

(in thousands)
Derivative and Other Hedging Instruments	*Balance Sheet Location*		*September 30, 2023*				*December 31, 2022*
Assets
Interest rate swaps	Derivative assets, at fair value		$	5,286			$	4,983
Payer swaptions (long positions)	Derivative assets, at fair value			1,418				33,398
Interest rate caps	Derivative assets, at fair value			704				1,119
Interest rate floors (long positions)	Derivative assets, at fair value			3,981				-
TBA securities	Derivative assets, at fair value			9,216				672
Total derivative assets, at fair value			$	20,605			$	40,172

Liabilities
Payer swaptions (short positions)	Derivative liabilities, at fair value		$	-			$	5,982
Interest rate floors (short positions)	Derivative liabilities, at fair value			2,500				-
TBA securities	Derivative liabilities, at fair value			231				1,179
Total derivative liabilities, at fair value			$	2,731			$	7,161

Margin Balances Posted to (from) Counterparties
Futures contracts	Restricted cash		$	3,067			$	16,493
TBA securities	Restricted cash			1,670				1,734
TBA securities	Other liabilities			(11,052	)			(532	)
Interest rate swaptions	Restricted cash			1,530				-
Interest rate swaptions	Other liabilities			(1,520	)			(12,489	)
Total margin balances on derivative contracts			$	(6,305	)		$	5,206

Fed Funds 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 T-Note futures positions at September 30, 2023 and December 31, 2022.

($ in thousands)
		*September 30, 2023*
		*Average*				*Weighted*				*Weighted*
		*Contract*				*Average*				*Average*
		*Notional*				*Entry*				*Effective*				*Open*
Expiration Year		*Amount*				*Rate*				*Rate*				Equity⁽¹⁾
Treasury Note Futures Contracts (Short Positions)(2)
December 2023 5-year T-Note futures (Dec 2023 - Feb 2028 Hedge Period)		$	471,500				4.33	%			4.78	%		$	5,414
December 2023 10-year T-Note futures (Dec 2023 - Aug 2030 Hedge Period)		$	395,000				4.24	%			4.97	%		$	9,069

($ in thousands)
		*December 31, 2022*
		*Average*				*Weighted*				*Weighted*
		*Contract*				*Average*				*Average*
		*Notional*				*Entry*				*Effective*				*Open*
Expiration Year		*Amount*				*Rate*				*Rate*				Equity⁽¹⁾
Treasury Note Futures Contracts (Short Position)(2)
March 2023 5-year T-Note futures (Mar 2023 - Mar 2028 Hedge Period)		$	750,500				4.20	%			4.22	%		$	(100	)
March 2023 10-year Ultra futures (Mar 2023 - Mar 2033 Hedge Period)		$	174,500				3.66	%			3.79	%		$	965

(1)	Open equity represents the cumulative gains (losses) recorded on open futures positions from inception.

(2)

5-Year T-Note futures contracts were valued at a price of $105.4 at September 30, 2023 and $107.9 at December 31, 2022. The contract values of the short positions were $496.7 million and $810.0 million at September 30, 2023 and December 31, 2022, respectively. 10-Year T-Note futures contracts were valued at a price of $108.1 at September 30, 2023. The contract values of the short positions were $426.8 million at September 30, 2023.

Under its interest rate swap agreements, the Company typically pays a fixed rate and receives a floating rate ("payer swaps") based on an index, such as SOFR. The floating rate the Company receives under its swap agreements has the effect of offsetting the repricing characteristics of its repurchase agreements and cash flows on such liabilities. The Company is typically required to post margin on its interest rate swap agreements. The table below presents information related to the Company’s interest rate swap positions at September 30, 2023 and December 31, 2022.

($ in thousands)
						*Average*
						*Fixed*				*Average*				*Average*
		*Notional*				*Pay*				*Receive*				*Maturity*
		*Amount*				*Rate*				*Rate*				*(Years)*
September 30, 2023
Expiration > 1 to ≤ 5 years		$	500,000				0.84	%			5.31	%			3.0
Expiration > 5 years			2,126,500				2.84	%			5.31	%			7.4
		$	2,626,500				2.46	%			5.31	%			6.6
December 31, 2022
Expiration > 1 to ≤ 5 years		$	500,000				0.84	%			4.75	%			3.7
Expiration > 5 years			900,000				1.70	%			4.23	%			6.6
		$	1,400,000				1.39	%			4.41	%			5.6

As of September 30, 2023, the table above includes swaps with aggregate notional amounts of $175.0 million that begin accruing interest October 23, 2023 with a weighted fixed pay rate of 3.53% and a receive rate indexed to overnight SOFR, and $274.0 million that begin accruing interest February 24, 2024 with a weighted fixed pay rate of 3.43% and a receive rate indexed to overnight SOFR . In accordance with procedures prescribed by the Chicago Mercantile Exchange ("CME"), all of the Company’s remaining LIBOR interest rate swaps cleared through the CME have been converted into SOFR interest rate swaps, effective September 10, 2023.

Our interest rate swaps are centrally cleared through two registered commodities exchanges, the CME and the London Clearing House (“LCH”). The clearing exchanges require that we post an "initial margin" amount determined by the exchanges. The initial margin amount is intended to be set at a level sufficient to protect the exchange from the interest rate swap's maximum estimated single-day price movement and is subject to adjustment based on changes in market volatility and other factors. We also exchange daily settlements of "variation margin" based upon changes in fair value, as measured by the exchanges.

The table below presents information related to the Company’s interest rate cap positions at September 30, 2023 and December 31, 2022.

($ in thousands)
										*Strike*
		*Notional*								*Swap*			*Curve*		*Fair*
		*Amount*				*Cost*				*Rate*			*Spread*		*Value*
September 30, 2023
February 8, 2024		$	200,000			$	1,450				0.09	%	2Y10Y		$	704

December 31, 2022
February 8, 2024		$	200,000			$	1,450				0.09	%	2Y10Y		$	1,119

The table below presents information related to the Company’s interest rate floor positions at September 30, 2023.

($ in thousands)
										*Strike*
		*Notional*								*Swap*					*Fair*
		*Amount*				*Cost*				*Rate*			*Terms*		*Value*
September 30, 2023
Long Position		$	1,000,000			$	2,500				0.13	%	2Y_2s30s		$	3,981
Short Position		$	(1,000,000	)		$	(1,358	)			(0.37	)%	2Y_2s30s		$	(2,500	)

The table below presents information related to the Company’s interest rate swaption positions at September 30, 2023 and December 31, 2022.

($ in thousands)
		*Option*												*Underlying Swap*
										*Weighted*													*Weighted*
										*Average*								*Average*			*Average*		*Average*
						*Fair*				*Months to*				*Notional*				*Fixed*			*Adjustable*		*Term*
Expiration		*Cost*				*Value*				*Expiration*				*Amount*				*Rate*			*Rate*		*(Years)*
September 30, 2023
Payer Swaptions (long positions)
≤ 1 year		$	1,619			$	1,418				8.0			$	800,000				5.40	%	SOFR			1.0
		$	1,619			$	1,418				8.0			$	800,000				5.40	%				1.0
December 31, 2022
Payer Swaptions (long positions)
≤ 1 year		$	36,685			$	21,253				9.6			$	1,250,000				4.09	%	SOFR			10.0
> 10 years			11,021				12,145				239.5				120,000				2.05	%	SOFR			10.0
		$	47,706			$	33,398				29.8			$	1,370,000				3.91	%				10.0
Payer Swaptions (short positions)
≤ 1 year		$	(17,800	)		$	(5,982	)			3.6			$	(917,000	)			4.09	%	SOFR			10.0

The following table summarizes the Company’s contracts to purchase and sell TBA securities as of September 30, 2023 and December 31, 2022.

($ in thousands)
		*Notional*												*Net*
		*Amount*				*Cost*				*Market*				*Carrying*
		Long (Short)⁽¹⁾				Basis⁽²⁾				Value⁽³⁾				Value⁽⁴⁾
September 30, 2023
15-Year TBA securities:
5.0%		$	100,000			$	97,617			$	97,386			$	(231	)
*30-Year TBA securities:*
3.0%			(350,000	)			(297,154	)			(290,116	)			7,038
6.0%			(100,000	)			(99,872	)			(98,766	)			1,106
6.5%			(152,500	)			(154,382	)			(153,310	)			1,072
Total		$	(502,500	)		$	(453,791	)		$	(444,806	)		$	8,985
December 31, 2022
*30-Year TBA securities:*
2.0%		$	(175,000	)		$	(142,268	)		$	(143,145	)		$	(877	)
3.0%			(500,000	)			(440,644	)			(440,274	)			370
Total		$	(675,000	)		$	(582,912	)		$	(583,419	)		$	(507	)

(1)	Notional amount represents the par value (or principal balance) of the underlying Agency RMBS.

(2)	Cost basis represents the forward price to be paid (received) for the underlying Agency RMBS.

(3)	Market value represents the current market value of the TBA securities (or of the underlying Agency RMBS) as of period-end.

(4)	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 the balance sheets.

Gain (Loss) From Derivative and Other Hedging Instruments, Net

The table below presents the effect of the Company’s derivative and other hedging instruments on the statements of comprehensive income for the nine and three months ended September 30, 2023 and 2022.

(in thousands)
		*Nine Months Ended September 30,*								*Three Months Ended September 30,*
		*2023*				*2022*				*2023*				*2022*
T-Note futures contracts (short position)		$	66,642			$	207,165			$	42,640			$	84,543
Interest rate swaps			101,257				170,987				78,317				65,247
Payer swaptions (short positions)			4,113				(80,183	)			(718	)			(35,239	)
Payer swaptions (long positions)			(7,389	)			150,445				1,613				59,131
Interest rate caps			(415	)			988				493				(499	)
Interest rate floors (short positions)			(1,143	)			-				73				-
Interest rate floors (long positions)			2,666								137
TBA securities (short positions)			31,120				14,194				21,511				10,642
TBA securities (long positions)			(2,598	)			1,200				(2,024	)			106
Total		$	194,253			$	464,796			$	142,042			$	183,931

Credit Risk-Related Contingent Features

The use of derivatives and other hedging instruments 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. The Company attempts to minimize this risk by limiting its 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, the Company may be required to pledge assets as collateral for its 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, the Company may not receive payments provided for under the terms of its derivative agreements, and may have difficulty obtaining its assets pledged as collateral for its derivatives. The cash and cash equivalents pledged as collateral for the Company derivative instruments are included in restricted cash on its balance sheets.

It is the Company's policy not to offset assets and liabilities associated with open derivative contracts. However, CME and LCH rules characterize variation margin transfers as settlement payments, as opposed to adjustments to collateral. As a result, derivative assets and liabilities associated with centrally cleared derivatives for which the CME or LCH serves as the central clearing party are presented as if these derivatives had been settled as of the reporting date.