DERIVATIVE INSTRUMENTS

3 Months Ended

Mar. 31, 2015

DERIVATIVE INSTRUMENTS

8. DERIVATIVE INSTRUMENTS

In connection with the Company’s investment/market rate risk management strategy, the Company economically hedges a portion of its interest rate risk by entering into derivative financial instrument contracts, which include interest rate swaps, swaptions and futures contracts. The Company may also enter into TBA derivatives, MBS options and eurodollar futures contracts to economically hedge its exposure to market risks. The purpose of using derivatives is to manage overall portfolio risk with the potential to generate additional income for distribution to stockholders. These derivatives are subject to changes in market values resulting from changes in interest rates, volatility, Agency mortgage-backed security spreads to U.S. Treasuries and market liquidity. The use of derivatives also 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 stated contract. Additionally, the Company may have to pledge cash or assets as collateral for the derivative transactions, the amount of which may vary based on the market value, notional amount and remaining term of the derivative contract. In the event of a default by the counterparty, the Company could have difficulty obtaining its Investment Securities pledged as collateral as well as receiving payments in accordance with the terms of the derivative contracts.

The table below summarizes fair value information about our derivative assets and liabilities as of March 31, 2015 and December 31, 2014:

Derivatives Instruments	Balance Sheet Location	March 31, 2015		December 31, 2014
Assets:		(dollars in thousands)
Interest rate swaps	Interest rate swaps, at fair value	$	25,908	$	75,225
Interest rate swaptions	Other derivative contracts, at fair value		574		5,382
TBA derivatives	Other derivative contracts, at fair value		112,929		-
Futures contracts	Other derivative contracts, at fair value		-		117
		$	139,411	$	80,724
Liabilities:
Interest rate swaps	Interest rate swaps, at fair value	$	2,025,170	$	1,608,286
TBA derivatives	Other derivative contracts, at fair value		-		4,258
Futures contracts	Other derivative contracts, at fair value		61,778		3,769
		$	2,086,948	$	1,616,313

The following table summarizes certain characteristics of the Company’s interest rate swaps at March 31, 2015 and December 31, 2014:

March 31, 2015
Maturity	Current Notional (1)		Weighted Average Pay Rate (2) (3)			Weighted Average Receive Rate (2)			Weighted Average Years to Maturity (2)
(dollars in thousands)
0 - 3 years	$	2,852,488		1.78	%		0.18	%		2.45
3 - 6 years		10,463,000		1.85	%		0.41	%		4.99
6 - 10 years		11,110,100		2.60	%		0.37	%		8.64
Greater than 10 years		3,634,400		3.70	%		0.22	%		20.12
Total / Weighted Average	$	28,059,988		2.37	%		0.35	%		8.09
December 31, 2014
Maturity	Current Notional (1)		Weighted Average Pay Rate (2) (3)			Weighted Average Receive Rate (2)			Weighted Average Years to Maturity (2)
(dollars in thousands)
0 - 3 years	$	2,502,505		1.63	%		0.17	%		2.64
3 - 6 years		11,138,000		2.06	%		0.22	%		5.18
6 - 10 years		13,069,200		2.67	%		0.23	%		8.57
Greater than 10 years		4,751,800		3.58	%		0.20	%		19.53
Total / Weighted Average	$	31,461,505		2.49	%		0.22	%		8.38

(1) Notional amount includes $3.0 billion and $500.0 million in forward starting pay fixed swaps as of March 31, 2015 and December 31, 2014, respectively.

(2) Excludes forward starting swaps.

(3) Weighted average fixed rate on forward starting pay fixed swaps was 1.88% and 3.25% as of March 31, 2015 and December 31, 2014, respectively.

The following table summarizes certain characteristics of the Company’s interest rate swaptions at March 31, 2015 and December 31, 2014:

March 31, 2015	Current Underlying Notional		Weighted Average Underlying Pay Rate	Weighted Average Underlying Receive Rate	Weighted Average Underlying Years to Maturity	Weighted Average Months to Expiration
	(dollars in thousands)
Long	$	1,000,000	2.61%	3M LIBOR	8.19	2.15
December 31, 2014	Current Underlying Notional		Weighted Average Underlying Pay Rate	Weighted Average Underlying Receive Rate	Weighted Average Underlying Years to Maturity	Weighted Average Months to Expiration
	(dollars in thousands)
Long	$	1,750,000	2.88%	3M LIBOR	9.17	3.59

The following table summarizes certain characteristics of the Company’s TBA derivatives as of March 31, 2015 and December 31, 2014:

March 31, 2015
Purchase and sale contracts for derivative TBAs	Notional			Implied Cost Basis			Implied Market Value			Net Carrying Value
(dollars in thousands)
Purchase contracts	$	13,750,000		$	14,279,766		$	14,392,695		$	112,929
Sale contracts		-			-			-			-
Net TBA derivatives	$	13,750,000		$	14,279,766		$	14,392,695		$	112,929
December 31, 2014
Purchase and sale contracts for derivative TBAs	Notional			Implied Cost Basis			Implied Market Value			Net Carrying Value
(dollars in thousands)
Purchase contracts	$	-		$	-		$	-		$	-
Sale contracts		(375,000	)		(375,430	)		(379,688	)		(4,258	)
Net TBA derivatives	$	(375,000	)	$	(375,430	)	$	(379,688	)	$	(4,258	)

The Company presents derivative contracts on a gross basis on the Consolidated Statements of Financial Condition. Derivative contracts may contain legally enforceable provisions that allow for netting or setting off receivables and payables with each counterparty.

The following tables present information about derivative assets and liabilities that are subject to such provisions and can potentially be offset on our Consolidated Statements of Financial Condition as of March 31, 2015 and December 31, 2014, respectively.

March 31, 2015			Amounts Eligible for Offset
	Gross Amounts		Financial Instruments			Cash Collateral			Net Amounts
Assets:	(dollars in thousands)
Interest rate swaps, at fair value	$	25,908	$	(24,782	)	$	-		$	1,126
Interest rate swaptions, at fair value		574		-			-			574
TBA derivatives, at fair value		112,929		-			-			112,929
Liabilities:
Interest rate swaps, at fair value	$	2,025,170	$	(24,782	)	$	(1,111,199	)	$	889,189
Futures contracts, at fair value		61,778		-			(61,778	)		-
December 31, 2014			Amounts Eligible for Offset
	Gross Amounts		Financial Instruments			Cash Collateral			Net Amounts
Assets:	(dollars in thousands)
Interest rate swaps, at fair value	$	75,225	$	(66,180	)	$	-		$	9,045
Interest rate swaptions, at fair value		5,382		-			-			5,382
Futures contracts, at fair value		117		(117	)		-			-
Liabilities:
Interest rate swaps, at fair value	$	1,608,286	$	(66,180	)	$	(869,302	)	$	672,804
TBA derivatives, at fair value		4,258		-			-			4,258
Futures contracts, at fair value		3,769		(117	)		-			3,652

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

	Location on Consolidated Statements of 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)
Quarter Ended:
March 31, 2015	$	(158,239	)	$	(226,462	)	$	(466,202	)
March 31, 2014	$	(260,435	)	$	(6,842	)	$	(348,942	)

(1) Interest expense related to the Company’s interest rate swaps is recorded in Realized gains (losses) on interest rate swaps on the Consolidated Statements of Comprehensive Income (Loss).

The effect of other derivative contracts on the Company’s Consolidated Statements of Comprehensive Income (Loss) is as follows:

Quarter Ended March 31, 2015
Derivative Instruments	Realized Gain (Loss)			Unrealized Gain (Loss)			Amount of Gain/(Loss) Recognized in Net Gains (Losses) on Trading Assets
(dollars in thousands)
Net TBA derivatives (1)	$	(55,644	)	$	117,188		$	61,544
Net interest rate swaptions	$	(21,891	)	$	17,083		$	(4,808	)
Futures	$	(5,506	)	$	(58,126	)	$	(63,632	)
							$	(6,896	)
Quarter Ended March 31, 2014
Derivative Instruments	Realized Gain (Loss)			Unrealized Gain (Loss)			Amount of Gain/(Loss) Recognized in Net Gains (Losses) on Trading Assets
(dollars in thousands)
Net TBA derivatives (1)	$	(37,837	)	$	(11,410	)	$	(49,247	)
Net interest rate swaptions	$	(40,943	)	$	(52,917	)	$	(93,860	)
Futures	$	(5,669	)	$	(3,048	)	$	(8,717	)
							$	(151,824	)

(1) Includes options on TBA securities.