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Note 5 - Derivative and Other Hedging Instruments

6 Months Ended

Jun. 30, 2024

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 June 30, 2024 and December 31, 2023.

(in thousands)
Derivative and Other Hedging Instruments	*Balance Sheet Location*		*June 30, 2024*				*December 31, 2023*
Assets
Interest rate swaps	Derivative assets, at fair value		$	29,214			$	6,348
Payer swaption (long position)	Derivative assets, at fair value			-				72
Dual digital option	Derivative assets, at fair value			105				-
Total derivative assets, at fair value			$	29,319			$	6,420

Liabilities
TBA securities	Derivative liabilities, at fair value		$	844			$	12,694
Total derivative liabilities, at fair value			$	844			$	12,694

Margin Balances Posted to (from) Counterparties
Futures contracts	Restricted cash		$	2,098			$	4,096
TBA securities	Restricted cash			2,282				23,720
Interest rate swaption contracts	Restricted cash			403				580
Total margin balances on derivative contracts			$	4,783			$	28,396

Fed Funds, T-Note and SOFR 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 and SOFR futures positions at June 30, 2024 and December 31, 2023.

($ in thousands)
		*June 30, 2024*
		*Average*				*Weighted*				*Weighted*
		*Contract*				*Average*				*Average*
		*Notional*				*Entry*				*Effective*				*Open*
Expiration Year		*Amount*				*Rate*				*Rate*				Equity⁽¹⁾
Treasury Note Futures Contracts (Short Positions)⁽²⁾
September 2024 5-year T-Note futures (Sep 2024 - Sep 2029 Hedge Period)		$	421,500				4.42	%			4.52	%		$	(2,025	)
SOFR Futures Contracts (Short Positions)
December 2024 3-Month SOFR futures (Sep 2024 - Dec 2024 Hedge Period)		$	25,000				4.27	%			5.15	%		$	220
March 2025 3-Month SOFR futures (Dec 2024 - Mar 2025 Hedge Period)			25,000				3.90	%			4.86	%			239
June 2025 3-Month SOFR futures (Mar 2025 - Jun 2025 Hedge Period)			25,000				3.58	%			4.57	%			245
September 2025 3-Month SOFR futures (Jun 2025 - Sep 2025 Hedge Period)			25,000				3.37	%			4.32	%			237
December 2025 3-Month SOFR futures (Sep 2025 - Dec 2025 Hedge Period)			25,000				3.25	%			4.12	%			218
March 2026 3-Month SOFR futures (Dec 2025 - Mar 2026 Hedge Period)			25,000				3.21	%			3.97	%			191

($ in thousands)
		*December 31, 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⁾
March 2024 5-year T-Note futures (Mar 2024 - Mar 2029 Hedge Period)		$	421,500				4.36	%			4.04	%		$	(9,936	)
March 2024 10-year T-Note futures (Mar 2024 - Mar 2034 Hedge Period)			320,000				4.38	%			4.39	%			(11,393	)
SOFR Futures Contracts (Short Positions)
June 2024 3-Month SOFR futures (Mar 2024 - Jun 2024 Hedge Period)		$	25,000				5.08	%			4.99	%		$	(24	)
September 2024 3-Month SOFR futures (Jun 2024 - Sep 2024 Hedge Period)			25,000				4.67	%			4.52	%			(39	)
December 2024 3-Month SOFR futures (Sep 2024 - Dec 2024 Hedge Period)			25,000				4.27	%			4.10	%			(44	)
March 2025 3-Month SOFR futures (Dec 2024 - Mar 2025 Hedge Period)			25,000				3.90	%			3.73	%			(43	)
June 2025 3-Month SOFR futures (Mar 2025 - Jun 2025 Hedge Period)			25,000				3.58	%			3.42	%			(41	)
September 2025 3-Month SOFR futures (Jun 2025 - Sep 2025 Hedge Period)			25,000				3.37	%			3.21	%			(39	)
December 2025 3-Month SOFR futures (Sep 2025 - Dec 2025 Hedge Period)			25,000				3.25	%			3.10	%			(37	)
March 2026 3-Month SOFR futures (Dec 2025 - Mar 2026 Hedge Period)			25,000				3.21	%			3.07	%			(35	)

(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 $106.58 at June 30, 2024 and $108.77 at December 31, 2023. The contract values of the short positions were $449.2 million and $458.5 million at June 30, 2024 and December 31, 2023, respectively. 10-Year T-Note futures contracts were valued at a price of $112.89 at December 31, 2023. The contract value of the short position was $361.2 million at December 31, 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 June 30, 2024 and December 31, 2023.

($ in thousands)
						*Average*
						*Fixed*				*Average*				*Average*
		*Notional*				*Pay*				*Receive*				*Maturity*
		*Amount*				*Rate*				*Rate*				*(Years)*
June 30, 2024
Expiration > 1 to ≤ 5 years		$	1,200,000				1.34	%			5.45	%			3.6
Expiration > 5 years			1,936,800				3.56	%			5.37	%			7.5
		$	3,136,800				2.71	%			5.40	%			6.0
December 31, 2023
Expiration > 1 to ≤ 5 years		$	500,000				0.84	%			5.64	%			2.7
Expiration > 5 years			1,826,500				2.62	%			5.40	%			6.8
		$	2,326,500				2.24	%			5.45	%			5.9

Our interest rate swaps are centrally cleared through two registered commodities exchanges, the Chicago Mercantile Exchange ("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 dual digital option and payer swaption positions at June 30, 2024 and December 31, 2023.

($ in thousands)

Option

Underlying Swap

Weighted

Weighted

Average

Average

Adjustable

Average

Fair

Months to

Notional

Fixed

Rate

Term

Cost

Value

Expiration

Amount

Rate

Index

(Years)

June 30, 2024

Dual Digital Option⁽¹⁾

$

500

$

105

2.7

$

9,412

n/a

n/a

n/a

December 31, 2023

Payer Swaption (long position)

$

1,619

$

72

5.0

$

800,000

5.40

%

SOFR

1.0

(1)	If, on September, 20, 2024, the S&P 500 Index (SPX) is lower than 4,725.166, and the SOFR 10 Year Swap Rate is above 3.883%, the Company will receive the notional amount. If either condition is not met, the Company will receive $0.

We purchase interest rate swaptions to help mitigate the potential impact of larger, more rapid changes in interest rates on the performance of our investment portfolio. Interest rate swaptions provide us the option to enter into an interest rate swap agreement for a predetermined notional amount, stated term and pay and receive interest rates in the future. Our interest rate swaption agreements are not subject to central clearing. The difference between the premium paid and the fair value of the swaption is reported in gain (loss) on derivative and other hedging instruments in our statements of comprehensive income (loss). If a swaption expires unexercised, the realized loss on the swaption would be equal to the premium paid. If we sell or exercise a swaption, the realized gain or loss on the swaption would be equal to the difference between the cash or the fair value of the underlying interest rate swap and the premium paid.

A dual digital option is a type of binary, or digital option, that involves both upper and lower conditions. A dual digital option will only activate if both conditions are met at expiration. If both conditions are met, we will receive the notional amount. If either condition is not met, we will lose our premium.

The following table summarizes the Company’s contracts to purchase and sell TBA securities as of June 30, 2024 and December 31, 2023.

($ in thousands)
		Notional
		Amount												Net
		Long				Cost				Market				Carrying
		(Short)(1)				Basis(2)				Value(3)				Value(4)
June 30, 2024
*30-Year TBA securities:*
3.0%		$	(400,000	)		$	(340,281	)		$	(341,125	)		$	(844	)
Total		$	(400,000	)		$	(340,281	)		$	(341,125	)		$	(844	)
December 31, 2023
*30-Year TBA securities:*
3.0%		$	(70,700	)		$	(59,278	)		$	(62,647	)		$	(3,369	)
5.0%			(250,000	)			(242,725	)			(247,657	)			(4,932	)
5.5%			(325,000	)			(322,410	)			(326,803	)			(4,393	)
Total		$	(645,700	)		$	(624,413	)		$	(637,107	)		$	(12,694	)

(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 (loss) for the six and three months ended June 30, 2024 and 2023.

(in thousands)
		*Six Months Ended June 30,*								*Three Months Ended June 30,*
		*2024*				*2023*				*2024*				*2023*
Interest rate futures contracts (short position)		$	30,768			$	24,002			$	11,678			$	28,040
Interest rate swaps			70,616				22,940				11,518				49,084
Payer swaptions (short positions)			-				4,831				-				(1,754	)
Payer swaptions (long positions)			(72	)			(9,002	)			(14	)			3,107
Interest rate caps			-				(908	)			-				(263	)
Dual digital option			(395	)			-				(156	)			-
Interest rate floors (short positions)			-				(1,216	)			-				(1,216	)
Interest rate floors (long positions)			-				2,529				-				1,344
TBA securities (short positions)			12,945				9,609				3,042				15,599
TBA securities (long positions)			105				(574	)			-				(574	)
Total		$	113,967			$	52,211			$	26,068			$	93,367

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.