| DERIVATIVE INSTRUMENTS |
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.
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