DERIVATIVES

As of September 30, 2012 and December 31, 2011, the Company’s derivative financial instruments are comprised entirely of interest rate swaps, and are designated as either hedging instruments or trading instruments. The tables below summarize information about the Company’s derivative financial instruments on the balance sheet as of the dates indicated:



		September 30, 2012							December 31, 2011
Accounting Designation:	Balance Sheet Location:	Fair Value			Cumulative Notional Amount		Weighted-average Fixed Rate Swapped		Fair Value			Cumulative Notional Amount		Weighted-average Fixed Rate Swapped
Hedging instruments		$	(43,802	)	$	1,485,000	1.50	%	$	(25,512	)	$	1,065,000	1.55	%
Trading instruments		(2,694		)	27,000		2.88	%	(2,485		)	27,000		2.88	%
	Derivative liabilities	$	(46,496	)					$	(27,997	)

Included in the balance as of September 30, 2012 are seven forward-starting interest rate swaps with a combined notional balance of $275,000 and a weighted average pay-fixed rate of 1.62% which are not effective until 2013.

The following table summarizes the contractual maturities remaining for the Company’s outstanding interest rate swap agreements as of September 30, 2012:



Remaining Maturity	Notional Amount: Trading		Notional Amount: Hedging		Notional Amount: Total		Number of Swaps	Weighted-Average Fixed Rate Swapped
0-12 months	$	—	$	75,000	$	75,000	2	1.30	%
13-36 months	—		565,000		565,000		10	1.44	%
37-60 months	27,000		445,000		472,000		16	1.60	%
Over 60 months	—		400,000		400,000		14	1.60	%
	$	27,000	$	1,485,000	$	1,512,000	42	1.53	%

With respect to hedging instruments, the Company’s objective for using interest rate swaps is to minimize its exposure to the risk of increased interest expense resulting from its existing and forecasted short-term, fixed-rate borrowings. The Company continuously borrows funds via sequential fixed-rate, short-term repurchase agreement borrowings. As each fixed-rate repurchase agreement matures, it is replaced with new fixed-rate agreements based on the market interest rate in effect at the time of such replacement. This sequential rollover borrowing program creates a variable interest expense pattern. The changes in the cash flows of the interest rate swaps are expected to be highly effective at offsetting changes in the interest portion of the cash flows expected to be paid at maturity of each borrowing.

The table below presents the effect of the derivatives designated as hedging instruments on the Company’s consolidated statement of comprehensive income for the periods indicated:



Type of Derivative Designated as Cash Flow Hedge	Amount of Gain (Loss) Recognized in OCI (Effective Portion)	Location of Amount Reclassified from OCI into Net Income (Effective Portion)	Amount Reclassified from OCI into Net Income (Effective Portion)	Location of Loss Recognized in Net Income (Ineffective Portion)	Amount of Gain (Loss) Recognized in Net Income (Ineffective Portion)
For the three months ended September 30, 2012:
Interest rate swaps	$(11,073)	Interest expense	$3,827	Other income, net	$(107)
For the three months ended September 30, 2011:
Interest rate swaps	$(18,251)	Interest expense	$3,383	Other income, net	$(31)
For the nine months ended September 30, 2012:
Interest rate swaps	$(28,853)	Interest expense	$10,602	Other income, net	$(38)
For the nine months ended September 30, 2011:
Interest rate swaps	$(31,974)	Interest expense	$8,325	Other income, net	$(55)

As of September 30, 2012, the Company estimates that $17,094 will be reclassified from AOCI into earnings as an increase to interest expense within the next 12 months.

The Company’s objective for designating certain interest rate swaps as trading instruments is to offset the changes in market value for a portion of its Agency CMBS investments that are also designated as trading. The table below presents the effect of the derivatives designated as trading instruments on the Company’s consolidated statements of income for the periods indicated.



Type of Derivative Designated as Trading	Location On Income Statement	Amount of Loss Recognized in Net Income
Type of Derivative Designated as Trading	Location On Income Statement	Three Months Ended						Nine Months Ended
		September 30, 2012			September 30, 2011			September 30, 2012			September 30, 2011
Interest rate swaps	Fair value adjustments, net	$	(333	)	$	(1,446	)	$	(907	)	$	(2,649	)

These interest rate swap agreements contain various covenants related to the Company’s credit risk. Specifically, if the Company defaults on any of its indebtedness, including those circumstances whereby repayment of the indebtedness has not been accelerated by the lender, or is declared in default of any of its covenants with any counterparty, then the Company could also be declared in default of its derivative obligations. Additionally, the agreements outstanding with its derivative counterparties allow those counterparties to require settlement of its outstanding derivative transactions if the Company fails to earn GAAP net income greater than one dollar as measured on a rolling two quarter basis. These interest rate agreements also contain provisions whereby, if the Company fails to maintain a minimum net amount of shareholders’ equity, then the Company may be declared in default on its derivative obligations. As of September 30, 2012, the Company had derivatives in a net liability position with its derivative counterparties for which it had pledged Agency MBS with a fair value of $50,966 and cash of $38 as collateral. If the Company had breached any of these agreements as of September 30, 2012, it could have been required to settle those derivatives at their estimated termination value of $47,115, which includes accrued interest but excludes any adjustment for nonperformance risk. As of September 30, 2012, the Company was in compliance with all covenants.