13. 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 U.S. Treasury or Eurodollar futures contracts and certain forward purchase commitments 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 and terms of the derivative contract. In the event of a default by the counterparty, the Company could have difficulty obtaining its Residential 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 at September 30, 2017 and December 31, 2016:

Derivatives Instruments	Balance Sheet Location	September 30, 2017		December 31, 2016
Assets:		(dollars in thousands)
Interest rate swaps	Interest rate swaps, at fair value	$	12,250	$	68,194
Interest rate swaptions	Other derivatives, at fair value	37,037		—
TBA derivatives	Other derivatives, at fair value	22,641		2,774
Futures contracts	Other derivatives, at fair value	206,431		168,209
Purchase commitments	Other derivatives, at fair value	123		283
Credit derivatives	Other derivatives, at fair value	17		—
		$	278,499	$	239,460
Liabilities:
Interest rate swaps	Interest rate swaps, at fair value	$	606,960	$	1,443,765
TBA derivatives	Other derivatives, at fair value	40,876		60,972
Futures contracts	Other derivatives, at fair value	31,642		24,912
Purchase commitments	Other derivatives, at fair value	221		553
Credit derivatives	Other derivatives, at fair value	2,790		—
		$	682,489	$	1,530,202

The following table summarizes certain characteristics of the Company’s interest rate swaps at September 30, 2017 and December 31, 2016:

September 30, 2017
Maturity	Current Notional ⁽¹⁾		Weighted Average Pay Rate		Weighted Average Receive Rate		Weighted Average Years to Maturity
(dollars in thousands)
0 to 3 years	$	8,617,000	1.72	%	1.36	%	2.45
>3 to 6 years	10,609,050		2.17	%	1.31	%	4.59
>6 to 10 years	9,805,000		2.41	%	1.40	%	7.74
Greater than 10 years	3,826,400		3.65	%	1.28	%	18.72
Total / Weighted Average	$	32,857,450	2.27	%	1.35	%	6.44

December 31, 2016
Maturity	Current Notional ⁽¹⁾		Weighted Average Pay Rate		Weighted Average Receive Rate		Weighted Average Years to Maturity
(dollars in thousands)
0 to 3 years	$	3,444,365	1.37	%	1.00	%	2.71
>3 to 6 years	10,590,000		1.92	%	0.99	%	3.94
>6 to 10 years	8,206,900		2.35	%	1.10	%	7.82
Greater than 10 years	3,634,400		3.70	%	0.83	%	18.36
Total / Weighted Average	$	25,875,665	2.22	%	1.02	%	6.87

(1) There were no forward starting swaps at September 30, 2017 and December 31, 2016.

The following table presents swaptions outstanding at September 30, 2017. There were no swaptions at December 31, 2016.

September 30, 2017	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	$	4,000,000	2.57	%	3M LIBOR	9.96	6.88

The following table summarizes certain characteristics of the Company’s TBA derivatives at September 30, 2017 and December 31, 2016:

September 30, 2017
Purchase and sale contracts for derivative TBAs	Notional		Implied Cost Basis		Implied Market Value		Net Carrying Value
(dollars in thousands)
Purchase contracts	$	19,960,000	$	20,844,380	$	20,826,145	$	(18,235	)

December 31, 2016
Purchase and sale contracts for derivative TBAs	Notional		Implied Cost Basis		Implied Market Value		Net Carrying Value
(dollars in thousands)
Purchase contracts	$	11,223,000	$	11,495,514	$	11,437,316	$	(58,198	)

The following table summarizes certain characteristics of the Company’s futures derivatives at September 30, 2017 and December 31, 2016 :

	September 30, 2017
	Notional - Long Positions		Notional - Short Positions			Weighted Average Years to Maturity
	(dollars in thousands)
2-year swap equivalent Eurodollar contracts	$	—	$	(17,080,875	)	2.00
U.S. Treasury futures - 5 year	—		(4,217,400		)	4.41
U.S. Treasury futures - 10 year and greater	—		(4,646,000		)	7.03
Total	$	—	$	(25,944,275	)	3.29

	December 31, 2016
	Notional - Long Positions		Notional - Short Positions			Weighted Average Years to Maturity
	(dollars in thousands)
2-year swap equivalent Eurodollar contracts	$	—	$	(14,968,250	)	2.00
U.S. Treasury futures - 5 year	—		(1,697,200		)	4.42
U.S. Treasury futures - 10 year and greater	—		(2,250,000		)	8.39
Total	$	—	$	(18,915,450	)	2.98

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 at September 30, 2017 and December 31, 2016, respectively.

September 30, 2017			Amounts Eligible for Offset
	Gross Amounts		Financial Instruments			Cash Collateral			Net Amounts
Assets:	(dollars in thousands)
Interest rate swaps, at fair value ⁽¹⁾	$	12,250	$	(10,998	)	$	—		$	1,252
Interest rate swaptions, at fair value	37,037		—			—			37,037
TBA derivatives, at fair value	22,641		(20,688		)	—			1,953
Futures contracts, at fair value	206,431		(31,642		)	—			174,789
Purchase commitments	123		—			—			123
Credit derivatives	17		(17		)	—			—
Liabilities:
Interest rate swaps, at fair value ⁽¹⁾	$	606,960	$	(10,998	)	$	—		$	595,962
TBA derivatives, at fair value	40,876		(20,688		)	—			20,188
Futures contracts, at fair value	31,642		(31,642		)	—			—
Purchase commitments	221		—			—			221
Credit derivatives	2,790		(17		)	(300		)	2,473

December 31, 2016			Amounts Eligible for Offset
	Gross Amounts		Financial Instruments			Cash Collateral			Net Amounts
Assets:	(dollars in thousands)
Interest rate swaps, at fair value	$	68,194	$	(68,194	)	$	—		$	—
TBA derivatives, at fair value	2,774		(2,172		)	—			602
Futures contracts, at fair value	168,209		(24,912		)	—			143,297
Purchase commitments	283		—			—			283
Liabilities:
Interest rate swaps, at fair value	$	1,443,765	$	(68,194	)	$	(768,877	)	$	606,694
TBA derivatives, at fair value	60,972		(2,172		)	—			58,800
Futures contracts, at fair value	24,912		(24,912		)	—			—
Purchase commitments	553		—			—			553

(1)

As a result of a change to a clearing organization’s rulebook effective January 3, 2017, beginning with the first quarter 2017 and in subsequent periods the Company is presenting the fair value of centrally cleared interest rate swaps net of variation margin pledged under such transactions. The variation margin was previously reported under cash and cash equivalents and is currently reported as a reduction to interest rate swaps, at fair value.

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)
Three Months Ended:
September 30, 2017	$	(88,211	)	$	—		$	56,854
September 30, 2016	$	(124,572	)	$	1,337		$	256,462
Nine Months Ended:
September 30, 2017	$	(288,837	)	$	(58	)	$	28,471
September 30, 2016	$	(402,809	)	$	(58,727	)	$	(1,148,478	)

(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:

Three Months Ended September 30, 2017
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⁾	$	110,067		$	29,728		$	139,795
Net interest rate swaptions	—			(9,137		)	(9,137		)
Futures	(70,054		)	92,784			22,730
Purchase commitments	—			(108		)	(108		)
Credit derivatives	495			433			928
Total							$	154,208

Three Months Ended September 30, 2016
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⁾	$	174,086		$	(78,677	)	$	95,409
Net interest rate swaptions	4,180			93			4,273
Futures	(47,035		)	110,218			63,183
Purchase commitments	—			116			116
Total							$	162,981

Nine Months Ended September 30, 2017
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⁾	$	215,529		$	39,964		$	255,493
Net interest rate swaptions	—			(19,574		)	(19,574		)
Futures	(128,478		)	31,492			(96,986		)
Purchase commitments	—			165			165
Credit derivatives	632			356			988
Total							$	140,086

Nine Months Ended September 30, 2016
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⁾	$	492,450		$	66,376		$	558,826
Net interest rate swaptions	4,180			93			4,273
Futures	(169,716		)	(23,465		)	(193,181		)
Purchase commitments	—			116			116
Total							$	370,034

(1) Includes options on TBA contracts.

Certain of the Company’s derivative contracts are subject to International Swaps and Derivatives Association Master Agreements or other similar agreements which may contain provisions that grant counterparties certain rights with respect to the applicable agreement upon the occurrence of certain events such as (i) a decline in stockholders’ equity 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 any one of items (i) through (iv), or another default under the agreement, the counterparty to the applicable agreement has a right to terminate the agreement in accordance with its provisions. The aggregate fair value of all derivative instruments with the aforementioned features that are in a net liability position at September 30, 2017 was approximately $416.3 million, which represents the maximum amount the Company would be required to pay upon termination. This amount is fully collateralized.