DERIVATIVE INSTRUMENTS

9 Months Ended

Sep. 30, 2012

DERIVATIVE INSTRUMENTS

7.            DERIVATIVE INSTRUMENTS

In connection with the Company’s interest rate risk management strategy, the Company economically hedges a portion of its interest rate risk by entering into derivative financial instrument contracts.  As of September 30, 2012, such instruments are comprised of interest rate swaps, which in effect modify the cash flows on repurchase agreements, or convert floating rate liabilities to fixed rates.  The purpose of the swaps is to mitigate the risk of rising interest rates that affect the Company’s cost of funds.  The use of interest rate swaps creates exposure to credit risk relating to potential losses that could be recognized if the counterparties to these instruments fail to perform their obligations under the contracts.  In the event of a default by the counterparty, the Company could have difficulty obtaining its Investment Securities pledged as collateral for swaps.  The Company does not anticipate any defaults by its counterparties.  The Company’s interest rate swaps have not been designated as hedging instruments for accounting purposes.

The location and fair value of interest rate swaps reported in the Consolidated Statements of Financial Condition as of September 30, 2012 and December 31, 2011 are as follows:

	Location on Consolidated Statements of Financial Condition	Notional Amount		Net Estimated Fair Value
		(dollars in thousands)
September 30, 2012	Assets:  Interest rate swaps, at fair value		-		-
September 30, 2012	Liabilities:   Interest rate swaps, at fair value	$	46,746,710	$	(2,926,461	)
December 31, 2011	Assets:   Interest rate swaps, at fair value		-		-
December 31, 2011	Liabilities:   Interest rate swaps, at fair value	$	40,109,880	$	(2,552,687	)

The effect of  interest rate swaps on the Consolidated Statements of Comprehensive Income is as follows:

	Location on Consolidated Statements of Comprehensive Income
	Realized Gains (Losses) on Interest Rate Swaps*			Gain (loss) on Termination of Interest Rate Swaps			Unrealized Gains (Losses) on Interest Rate Swaps
	(dollars in thousands)
For the Quarter Ended September 30, 2012	$	(224,272	)		-		$	(104,197	)
For the Quarter Ended September 30, 2011	$	(231,849	)		-		$	(1,505,333	)
For the Nine Months Ended September 30, 2012	$	(665,614	)	$	(2,385	)	$	(373,773	)
For the Nine Months Ended September 30, 2011	$	(654,757	)		-		$	(1,802,968	)

* Net interest payments on interest rate swaps is presented in the Company’s Consolidated Statements of Comprehensive Income as realized gains (losses) on interest rate swaps.

The Company’s interest rate swap weighted average pay rate at September 30, 2012 was 2.23% and the weighted average receive rate was 0.27%.  The weighted average pay rate at December 31, 2011 was 2.55% and the weighted average receive rate was 0.33%.  Without netting the market value of the swaps by dealer at September 30, 2012, the gross unrealized losses on interest rate swaps was $2.9 billion, with a notional amount of $46.2 billion and the gross unrealized gains on interest rate swaps was $10.5 million with a notional amount of $500.0 million. Without netting the market value of the swaps by dealer at December 31, 2011, the gross unrealized loss on interest rate swaps was $2.6 billion, with a notional amount of $40.1 billion.

Certain of the Company’s derivative contracts are subject to International Swaps and Derivatives Association Master Agreements (“ISDA”) which contain provisions that grant counterparties certain rights with respect to the applicable ISDA upon the occurrence of (i) negative performance that results in a decline in net assets in excess of specified thresholds or dollar amounts over set periods of time, (ii) the Company’s failure to maintain its REIT status, (iii) the Company’s failure to comply with limits on the amount of leverage, and (iv) the Company’s stock being delisted from the New York Stock Exchange (NYSE). Upon the occurrence of items (i) through (iv), the counterparty to the applicable ISDA has a right to terminate the ISDA in accordance with its provisions. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that are in a net liability position at September 30, 2012 is approximately $3.0 billion, including accrued interest, which represents the maximum amount the Company would be required to pay upon termination, which is fully collateralized.

In connection with RCap’s proprietary trading activities, it has entered into exchange traded U.S. interest rate, equity index, and FX futures and options contracts as well as German interest rate futures contracts for speculative or hedging purposes. RCap invests in futures and options contracts for economic hedging purposes to reduce exposure to changes in yields of its U.S Treasury securities and for speculative purposes to achieve capital appreciation.  The use of options contracts creates exposure to credit risk relating to potential losses that could be recognized if the counterparties to these instruments fail to perform their obligations under the contracts.  RCap executes these trades through an independent futures and options broker.