DERIVATIVES

The Company is a party to certain types of financial instruments that are accounted for as derivative instruments. Please refer to Note 1 for information related to the Company’s accounting policy for its derivative instruments.

Types and Uses of Derivatives Instruments

Interest Rate Derivatives. Changing interest rates impact the fair value of the Company’s investments as well as the interest rates on the Company’s repurchase agreement borrowings used to finance its investments. The Company primarily uses interest rate swaps and Eurodollar futures as economic hedges to mitigate declines in book value and to protect some portion of the Company's earnings from rising interest rates.

TBA Transactions. The Company also holds long positions in TBA securities by executing a series of transactions which effectively delay the settlement of a forward purchase of a non-specified Agency RMBS by entering into an offsetting TBA short position, net settling the paired-off positions in cash, and simultaneously entering into an identical TBA long position with a later settlement date. These long positions in TBA securities (“dollar roll positions”) are viewed by management as economically equivalent to investing in and financing non-specified fixed-rate Agency RMBS. TBA securities purchased for a forward settlement month are generally priced at a discount relative to TBA securities sold for settlement in the current month. This discount, often referred to as “drop income” represents the economic equivalent of net interest income (interest income less implied financing cost) on the underlying Agency security from trade date to settlement date.

Periodically, the Company may also hold short positions in TBA securities for the purpose of economically hedging a portion of the impact of changing interest rates on the fair value of the Company’s fixed-rate Agency RMBS. The Company did not hold any short positions in TBA securities as of September 30, 2018.

Other Derivatives. The Company periodically utilizes options on Treasury futures in order to manage the duration of the Company’s investment portfolio while minimizing the impact on the Company’s exposure to the spread risk inherent in owning MBS. The options on Treasury futures outstanding as of September 30, 2018 will expire during the fourth quarter of 2018.

The table below summarizes information about the fair value by type of derivative instrument on the Company’s consolidated balance sheets as of the dates indicated:



Type of Derivative Instrument	Balance Sheet Location	Purpose	September 30, 2018			December 31, 2017
Interest rate swaps	Derivative assets	Economic hedging	$	694		$	791
Eurodollar futures	Derivative assets	Economic hedging	—			666
TBA securities	Derivative assets	Trading	871			1,483
Call Options on U.S. Treasury futures	Derivative assets	Trading	328			—
Put Options on U.S. Treasury futures	Derivative assets	Trading	719			—
			$	2,612		$	2,940

TBA securities	Derivative liabilities	Trading	$	(2,039	)	$	—
TBA securities	Derivative liabilities	Economic hedging	—			(269		)
			$	(2,039	)	$	(269	)

The following tables present information about the Company’s interest rate swaps as of the dates indicated:



	September 30, 2018
			Weighted-Average:
Years to Maturity:	Net Notional Amount ⁽¹⁾		Pay Rate ⁽²⁾		Life Remaining (in Years)	Fair Value ⁽³⁾
< 3 years	$	1,520,000	2.01	%	1.4	$	694
>3 and < 6 years	1,290,000		2.10	%	4.1	—
>6 and < 10 years	1,150,000		2.61	%	7.9	—
>10 years	220,000		2.81	%	22.2	—
Total	$	4,180,000	2.24	%	5.1	$	694

	December 31, 2017
			Weighted-Average:
Years to Maturity:	Net Notional Amount ⁽¹⁾		Pay Rate ⁽²⁾		Life Remaining (in Years)	Fair Value ⁽³⁾
< 3 years	$	3,320,000	1.35	%	0.7	$	791
>3 and < 6 years	1,210,000		2.00	%	4.6	—
>6 and < 10 years	1,025,000		2.49	%	8.0	—
>10 years	120,000		2.75	%	17.3	—
Total	$	5,675,000	1.71	%	3.1	$	791


(1)	The net notional amounts included in the tables above represent pay-fixed interest rate swaps, net of any receive-fixed interest rate swaps, and include $1,525,000 and $2,655,000 of pay-fixed forward starting interest rate swaps as of September 30, 2018 and December 31, 2017, respectively.


(2)	Excluding forward starting pay-fixed interest rate swaps, the weighted average pay rate was 1.66% and 1.36% as of September 30, 2018 and December 31, 2017, respectively.


(3)	The majority of the Company’s interest rate swap agreements are centrally cleared through the CME. Please refer to Note 1 for information regarding the exchange of variation margin being legally considered as settlement of the derivative as opposed to a pledge of collateral.

The following table summarizes information about the Company's TBA securities as of the dates indicated:



	September 30, 2018
TBA Securities:	Notional Amount ⁽¹⁾		Implied Cost Basis ⁽²⁾			Implied Market Value ⁽³⁾			Net Carrying Value ⁽⁴⁾
Dollar roll positions	$	761,000	$	780,865		$	779,697		$	(1,168	)
Economic hedges	$	—	$	—		$	—		$	—
	December 31, 2017
	Notional Amount ⁽¹⁾		Implied Cost Basis ⁽²⁾			Implied Market Value ⁽³⁾			Net Carrying Value ⁽⁴⁾
Dollar roll positions	$	795,000	$	829,425		$	830,908		$	1,483
Economic hedges	$	150,000	$	(153,797	)	$	(154,066	)	$	(269	)


(1)	Notional amount represents the par value (or principal balance) of the underlying Agency MBS as if settled as of the end of the period.


(2)	Implied cost basis represents the forward price to be paid for the underlying Agency MBS as if settled as of end of the period.


(3)	Implied market value represents the estimated fair value of the underlying Agency MBS as if settled as of the end of the period.


(4)	Net carrying value is the amount included on the consolidated balance sheets within “derivative assets (liabilities)” and represents the difference between the implied market value and the implied cost basis of the TBA security as of the end of the period.

The tables below summarize changes in the Company’s derivative instruments for the periods indicated:



Type of Derivative Instrument	Notional Amount as of December 31, 2017		Additions		Settlements, Terminations, or Pair-Offs			Notional Amount as of September 30, 2018
Receive-fixed interest rate swaps	$	100,000	$	—	$	(100,000	)	$	—
Pay-fixed interest rate swaps	5,775,000		955,000		(2,550,000		)	4,180,000
Eurodollar futures ⁽¹⁾	1,950,000		—		(1,950,000		)	—
TBA dollar roll positions	795,000		7,857,000		(7,891,000		)	761,000
TBA economic hedges	150,000		—		(150,000		)	—
Call Options on U.S. Treasury futures	—		100,000		—			100,000
Put Options on U.S. Treasury futures	—		400,000		(300,000		)	100,000


(1)	The Eurodollar futures notional amounts represent the total notional of the 3-month contracts all of which expire in 2018. The maximum notional outstanding for any future 3-month period did not exceed $650,000 during the period indicated.

The table below provides detail of the Company’s “gain (loss) on derivative instruments, net” by type of derivative for the periods indicated:



	Three Months Ended						Nine Months Ended
	September 30,						September 30,
Type of Derivative Instrument	2018			2017			2018			2017
Receive-fixed interest rate swaps	$	(153	)	$	(99	)	$	(1,658	)	$	746
Pay-fixed interest rate swaps	25,172			(611		)	95,491			(18,799		)
Eurodollar futures	(189		)	—			1,886			—
TBA dollar roll positions	(5,204		)	6,703			(18,256		)	8,419
TBA economic hedges	—			—			293			—
Call Options on U.S. Treasury futures	148			—			148			—
Put Options on U.S. Treasury futures	(275		)	—			616			—
Gain (loss) on derivative instruments, net	$	19,499		$	5,993		$	78,520		$	(9,634	)

There is a net unrealized gain of $240 remaining in AOCI on the Company’s consolidated balance sheet as of September 30, 2018 which represents the activity related to interest rate swap agreements while they were previously designated as cash flow hedges, and this amount will be recognized in the Company’s net income as an adjustment to “interest expense” over the remaining contractual life of the agreements. The Company estimates a credit of $177 will be reclassified to net income as a reduction of “interest expense” within the next 12 months.

A portion of the Company’s interest rate swaps were entered into under bilateral agreements which contain cross-default provisions with other agreements between the parties. In addition, these bilateral agreements contain financial and operational covenants similar to those contained in the repurchase agreements as described in Note 3. The Company was in compliance with all covenants with respect to bilateral agreements under which interest rate swaps were entered into as of September 30, 2018.

The Company's derivatives are subject to underlying agreements with master netting or similar arrangements, which provide for the right of offset in the event of default or in the event of bankruptcy of either party to the transactions. The Company reports its derivative assets and liabilities subject to these arrangements on a gross basis. The following tables present information regarding those derivative assets and liabilities subject to such arrangements as if the Company had presented them on a net basis as of September 30, 2018 and December 31, 2017:



	Offsetting of Assets
	Gross Amount of Recognized Assets		Gross Amount Offset in the Balance Sheet		Net Amount of Assets Presented in the Balance Sheet		Gross Amount Not Offset in the Balance Sheet ⁽¹⁾						Net Amount
	Gross Amount of Recognized Assets		Gross Amount Offset in the Balance Sheet		Net Amount of Assets Presented in the Balance Sheet		Financial Instruments Received as Collateral			Cash Received as Collateral			Net Amount
September 30, 2018
Interest rate swaps	$	694	$	—	$	694	$	—		$	—		$	694
Eurodollar Futures	—		—		—		—			—			—
TBA securities	871		—		871		(346		)	(123		)	402
Options on U.S. Treasury futures	1,047		—		1,047		(1,047		)	—			—
Derivative assets	$	2,612	$	—	$	2,612	$	(1,393	)	$	(123	)	$	1,096
December 31, 2017
Interest rate swaps	$	791	$	—	$	791	$	—		$	—		$	791
Eurodollar Futures	666		—		666		—			(666		)	—
TBA securities	1,483		—		1,483		(180		)	—			1,303
Options on U.S. Treasury futures	—		—		—		—			—			—
Derivative assets	$	2,940	$	—	$	2,940	$	(180	)	$	(666	)	$	2,094



	Offsetting of Liabilities
	Gross Amount of Recognized Liabilities		Gross Amount Offset in the Balance Sheet		Net Amount of Liabilities Presented in the Balance Sheet		Gross Amount Not Offset in the Balance Sheet ⁽¹⁾						Net Amount
	Gross Amount of Recognized Liabilities		Gross Amount Offset in the Balance Sheet		Net Amount of Liabilities Presented in the Balance Sheet		Financial Instruments Posted as Collateral			Cash Posted as Collateral			Net Amount
September 30, 2018
Interest rate swaps	$	—	$	—	$	—	$	—		$	—		$	—
TBA securities	2,039		—		2,039		(346		)	(873		)	820
Derivative liabilities	$	2,039	$	—	$	2,039	$	(346	)	$	(873	)	$	820

December 31, 2017
Interest rate swaps	$	—	$	—	$	—	$	—		$	—		$	—
TBA securities	269		—		269		(180		)	—			89
Derivative liabilities	$	269	$	—	$	269	$	(180	)	$	—		$	89


(1)	Amounts disclosed for collateral received by or posted to the same counterparty include cash and the fair value of MBS up to and not exceeding the net amount of the asset or liability presented in the balance sheet. The fair value of the total collateral received by or posted to the same counterparty may exceed the amounts presented.

Please see Note 3 for information related to the Company’s repurchase agreements which are also subject to underlying agreements with master netting or similar arrangements.