DERIVATIVES

As part of its risk management activities, the Company’ utilizes derivative financial instruments to manage its exposure to cash flow volatility and market value risk related to interest rate risk on the Company's investments and their associated financing. The Company's derivative instruments are comprised entirely of interest rate swaps which 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:



		March 31, 2013							December 31, 2012
Accounting Designation:	Balance Sheet Location:	Fair Value			Aggregate Notional Amount		Weighted-average Fixed Rate Swapped		Fair Value			Aggregate Notional Amount		Weighted-average Fixed Rate Swapped
Hedging instruments		$	(35,314	)	$	1,410,000	1.51	%	$	(39,813	)	$	1,435,000	1.50	%
Trading instruments		(2,373		)	27,000		2.88	%	(2,724		)	27,000		2.88	%
	Derivative liabilities	$	(37,687	)					$	(42,537	)

Included in the balance as of March 31, 2013 is one forward-starting interest rate swap with a notional balance of $25,000 and a weighted average pay-fixed rate of 1.70% which will not be effective until the second quarter of 2013.

The following table summarizes the contractual maturities remaining for the Company’s outstanding interest rate swap agreements as of March 31, 2013:



Remaining Maturity	Notional Amount: Trading		Notional Amount: Hedging		Notional Amount: Total		Number of Swaps	Weighted-Average Fixed Rate Swapped
0-12 months	$	—	$	300,000	$	300,000	5	1.29	%
13-36 months	—		490,000		490,000		11	1.76	%
37-60 months	27,000		220,000		247,000		10	1.29	%
Over 60 months	—		400,000		400,000		14	1.60	%
	$	27,000	$	1,410,000	$	1,437,000	40	1.54	%

With respect to hedging instruments, the Company’s objective for using interest rate swaps is to minimize its exposure to the risk of cash flow volatility from increased interest expense on its repurchase agreement borrowings. As repurchase agreements are short-term in nature, as they mature, the interest rate on the new repurchase agreement resets to a market interest rate. 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 Amount Recognized in Net Income (Ineffective Portion)	Amount of Loss Recognized in Net Income (Ineffective Portion)
For the three months ended March 31, 2013:
Interest rate swaps	$437	Interest expense	$4,103	Other income, net	$(41)
For the three months ended March 31, 2012:
Interest rate swaps	$(3,087)	Interest expense	$3,266	Other income, net	$(62)

As of March 31, 2013, the Company estimates that $17,955 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 amount of loss recognized in net income for the changes in fair value of the derivatives designated as trading instruments for the periods indicated:



Type of Derivative Designated as Trading	Location On Income Statement	Three Months Ended
Type of Derivative Designated as Trading	Location On Income Statement	March 31, 2013			March 31, 2012
Interest rate swaps	Fair value adjustments, net	$	(17	)	$	(74	)

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 yet 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 March 31, 2013, 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 $40,568 and cash of $38 as collateral. If the Company had breached any of these agreements as of March 31, 2013, it could have been required to settle those derivatives at their estimated termination value of $38,560, which includes accrued interest but excludes any adjustment for nonperformance risk. As of March 31, 2013, the Company was in compliance with all covenants.