DERIVATIVE INSTRUMENTS

3 Months Ended

Mar. 31, 2013

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 March 31, 2013, 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’s interest rate swaps have not been designated as hedging instruments for accounting purposes.

The Company elected to net, by counterparty, the fair value of interest rate swap contracts.  These contracts contain legally enforceable provisions that allow for netting or setting off swap receivables and payables with each counterparty and, therefore, the fair value of those swap contracts are netted by counterparty. The following table summarizes notional amounts and unrealized gains (losses) of interest rate swap contracts on a gross basis, amounts offset in accordance with netting arrangements and net amounts as presented in the Consolidated Statements of Financial Condition as of March 31, 2013 and December 31, 2012.

	March 31, 2013
	Interest Rate Swaps - Asset						Interest Rate Swaps - Liability
	Notional			Unrealized Gains			Notional		Unrealized Losses
	(dollars in thousands)
Gross Amounts	$	1,910,000		$	46,612		$	46,312,800	$	2,305,785
Amounts Offset		(1,910,000	)		(46,612	)		1,910,000		(46,612	)
Netted Amounts		-			-		$	48,222,800	$	2,259,173
	December 31, 2012
	Interest Rate Swaps - Asset						Interest Rate Swaps - Liability
	Notional			Unrealized Gains			Notional		Unrealized Losses
	(dollars in thousands)
Gross Amounts	$	1,100,000		$	26,020		$	45,811,800	$	2,610,927
Amounts Offset		(1,100,000	)		(26,020	)		1,100,000		(26,020	)
Netted Amounts		-			-		$	46,911,800	$	2,584,907

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

	Location on Consolidated Statements of Operations and Comprehensive Income (Loss)
	Realized Gains (Losses) on Interest Rate Swaps(1)			Realized Gains (Losses) on Termination of Interest Rate Swaps			Unrealized Gains (Losses) on Interest Rate Swaps
	(dollars in thousands)
For the Quarter Ended March 31, 2013	$	(225,476	)	$	(16,378	)	$	325,734
For the Quarter Ended March 31, 2012	$	(219,340	)	$	(2,385	)	$	341,639

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

The Company’s interest rate swap weighted average pay rate at March 31, 2013 was 2.08% and the weighted average receive rate was 0.23%.  The weighted average pay rate at December 31, 2012 was 2.21% and the weighted average receive rate was 0.24%.

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 March 31, 2013 is approximately $2.3 billion, including accrued interest, which represents the maximum amount the Company would be required to pay upon termination. This amount is fully collateralized.

In connection with RCap’s proprietary trading activities, it enters primarily into U.S. Treasury, Eurodollar, federal funds, German government and U.S. equity index futures and options contracts. 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 futures and 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 uses an appropriately licensed futures commission merchant and options broker dealer to execute its orders to buy and sell futures and options contracts. RCap’s derivative contracts are presented in the Consolidated Statements of Financial Condition as Other derivatives.