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 case of MAC interest rate swaps, the Company may make or receive a payment at the time of entering into such interest rate swap to compensate for the out of market nature of such interest rate swap. Similar to other interest rate swaps, the Company may have to pledge cash or assets as collateral for the MAC interest rate swap transactions. 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 June 30, 2018 and December 31, 2017:



Derivatives Instruments	Balance Sheet Location	June 30, 2018		December 31, 2017
Assets:		(dollars in thousands)
Interest rate swaps	Interest rate swaps, at fair value	$	82,458	$	30,272
Interest rate swaptions	Other derivatives, at fair value	82,034		36,150
TBA derivatives	Other derivatives, at fair value	36,394		29,067
Futures contracts	Other derivatives, at fair value	4,857		218,361
Purchase commitments	Other derivatives, at fair value	258		35
Credit derivatives ⁽¹⁾	Other derivatives, at fair value	6,137		—
		$	212,138	$	313,885
Liabilities:
Interest rate swaps	Interest rate swaps, at fair value	$	376,106	$	569,129
TBA derivatives	Other derivatives, at fair value	63		21,776
Futures contracts	Other derivatives, at fair value	111,610		12,285
Purchase commitments	Other derivatives, at fair value	25		157
Credit derivatives ⁽¹⁾	Other derivatives, at fair value	6,233		4,507
		$	494,037	$	607,854


⁽¹⁾	The notional amount of the credit derivatives in which the Company purchased protection was $60.0 million at June 30, 2018. The maximum potential amount of future payments is the notional amount of $357.6 million and $125.0 million at June 30, 2018 and December 31, 2017, respectively. The credit derivative tranches referencing the basket of bonds had a range of ratings between AAA and BBB-.

The following table summarizes certain characteristics of the Company’s interest rate swaps at June 30, 2018 and December 31, 2017:



June 30, 2018
Maturity	Current Notional ⁽¹⁾		Weighted Average Pay Rate		Weighted Average Receive Rate		Weighted Average Years to Maturity
(dollars in thousands)
0 - 3 years	$	32,086,800	1.76	%	2.34	%	1.62
3 - 6 years	15,449,650		2.27	%	2.31	%	4.67
6 - 10 years	12,476,900		2.45	%	2.24	%	8.59
Greater than 10 years	4,076,400		3.58	%	2.21	%	17.48
Total / Weighted Average	$	64,089,750	2.08	%	2.31	%	4.43

December 31, 2017
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	$	6,532,000	1.56	%	1.62	%	2.08
3 - 6 years	14,791,800		2.12	%	1.57	%	4.51
6 - 10 years	10,179,000		2.35	%	1.58	%	8.04
Greater than 10 years	3,826,400		3.65	%	1.51	%	18.47
Total / Weighted Average	$	35,329,200	2.22	%	1.58	%	6.72


⁽¹⁾	There were no forward starting swaps at June 30, 2018. Notional amount includes $8.1 billion of forward starting pay fixed swaps at December 31, 2017.


⁽²⁾	Excludes forward starting swaps.


⁽³⁾	Weighted average fixed rate on forward starting pay fixed swaps was 1.86% at December 31, 2017.

The following table presents swaptions outstanding at June 30, 2018 and December 31, 2017.



June 30, 2018	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	$	3,250,000	2.75	%	3M LIBOR	10.28	3.16

December 31, 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	$	6,000,000	2.62	%	3M LIBOR	9.97	4.49

The following table summarizes certain characteristics of the Company’s TBA derivatives at June 30, 2018 and December 31, 2017:



June 30, 2018
Purchase and sale contracts for derivative TBAs	Notional			Implied Cost Basis			Implied Market Value			Net Carrying Value
(dollars in thousands)
Purchase contracts	$	8,000,000		$	8,144,363		$	8,180,694		$	36,331

December 31, 2017
Purchase and sale contracts for derivative TBAs	Notional			Implied Cost Basis			Implied Market Value			Net Carrying Value
(dollars in thousands)
Purchase contracts	$	15,828,000		$	16,381,826		$	16,390,251		$	8,425
Sale contracts	(250,000		)	(254,804		)	(255,938		)	(1,134		)
Net TBA derivatives	$	15,578,000		$	16,127,022		$	16,134,313		$	7,291

The following table summarizes certain characteristics of the Company’s futures derivatives at June 30, 2018 and December 31, 2017:



	June 30, 2018
	Notional - Long Positions		Notional - Short Positions			Weighted Average Years to Maturity
	(dollars in thousands)
U.S. Treasury futures - 2 year	$	—	$	(480,000	)	2.00
U.S. Treasury futures - 5 year	$	—	$	(4,987,400	)	4.42
U.S. Treasury futures - 10 year and greater	—		(10,274,500		)	7.13
Total	$	—	$	(15,741,900	)	6.12

	December 31, 2017
	Notional - Long Positions		Notional - Short Positions			Weighted Average Years to Maturity
	(dollars in thousands)
2-year swap equivalent Eurodollar contracts	$	—	$	(17,161,000	)	2.00
U.S. Treasury futures - 5 year	—		(4,217,400		)	4.41
U.S. Treasury futures - 10 year and greater	—		(4,914,500		)	7.01
Total	$	—	$	(26,292,900	)	3.32

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 June 30, 2018 and December 31, 2017, respectively.



	June 30, 2018
			Amounts Eligible for Offset
	Gross Amounts		Financial Instruments			Cash Collateral			Net Amounts
Assets:	(dollars in thousands)
Interest rate swaps, at fair value	$	82,458	$	(44,260	)	$	—		$	38,198
Interest rate swaptions, at fair value	82,034		—			—			82,034
TBA derivatives, at fair value	36,394		(63		)	—			36,331
Futures contracts, at fair value	4,857		(4,857		)	—			—
Purchase commitments	258		—			—			258
Credit derivatives	6,137		(5,736		)	—			401
Liabilities:
Interest rate swaps, at fair value	$	376,106	$	(44,260	)	$	—		$	331,846
TBA derivatives, at fair value	63		(63		)	—			—
Futures contracts, at fair value	111,610		(4,857		)	(106,753		)	—
Purchase commitments	25		—			—			25
Credit derivatives	6,233		(5,736		)	(497		)	—

	December 31, 2017
			Amounts Eligible for Offset
	Gross Amounts		Financial Instruments			Cash Collateral			Net Amounts
Assets:	(dollars in thousands)
Interest rate swaps, at fair value	$	30,272	$	(27,379	)	$	—		$	2,893
Interest rate swaptions, at fair value	36,150		—			—			36,150
TBA derivatives, at fair value	29,067		(12,551		)	—			16,516
Futures contracts, at fair value	218,361		(12,285		)	—			206,076
Purchase commitments	35		—			—			35
Liabilities:
Interest rate swaps, at fair value	$	569,129	$	(27,379	)	$	—		$	541,750
TBA derivatives, at fair value	21,776		(12,551		)	—			9,225
Futures contracts, at fair value	12,285		(12,285		)	—			—
Purchase commitments	157		—			—			157
Credit derivatives	4,507		—			(3,520		)	987

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)
	Net Interest Component of Interest Rate Swaps			Realized Gains (Losses) on Termination or Maturity of Interest Rate Swaps			Unrealized Gains (Losses) on Interest Rate Swaps
	(dollars in thousands)
Three Months Ended:
June 30, 2018	$	31,475		$	—		$	343,475
June 30, 2017	$	(96,470	)	$	(58	)	$	(177,567	)
Six Months Ended:
June 30, 2018	$	(16,685	)	$	834		$	1,320,760
June 30, 2017	$	(200,626	)	$	(58	)	$	(28,383	)

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



Three Months Ended June 30, 2018
Derivative Instruments	Realized Gains (Losses)			Unrealized Gains (Losses)			Amount of Gains (Losses) Recognized in Net Gains (Losses) on Other Derivatives
(dollars in thousands)
Net TBA derivatives	$	(30,228	)	$	11,123		$	(19,105	)
Net interest rate swaptions	(35,667		)	3,999			(31,668		)
Futures	62,618			15,684			78,302
Purchase commitments	—			59			59
Credit derivatives	2,889			3,712			6,601
Total							$	34,189

Three Months Ended June 30, 2017
Derivative Instruments	Realized Gains (Losses)			Unrealized Gains (Losses)			Amount of Gains (Losses) Recognized in Net Gains (Losses) on Other Derivatives
(dollars in thousands)
Net TBA derivatives	$	165,777		$	(72,844	)	$	92,933
Net interest rate swaptions	—			(10,438		)	(10,438		)
Futures	(59,397		)	(37,588		)	(96,985		)
Purchase commitments	—			8			8
Credit derivatives	136			(77		)	59
Total							$	(14,423	)

Six Months Ended June 30, 2018
Derivative Instruments	Realized Gains (Losses)			Unrealized Gains (Losses)			Amount of Gains (Losses) Recognized in Net Gains (Losses) on Other Derivatives
(dollars in thousands)
Net TBA derivatives	$	(308,127	)	$	29,039		$	(279,088	)
Net interest rate swaptions	(57,100		)	71,220			14,120
Futures	557,630			(312,828		)	244,802
Purchase commitments	—			425			425
Credit derivatives	4,402			2,383			6,785
Total							$	(12,956	)

Six Months Ended June 30, 2017
Derivative Instruments	Realized Gains (Losses)			Unrealized Gains (Losses)			Amount of Gain (Losses) Recognized in Net Gains (Losses) on Other Derivatives
(dollars in thousands)
Net TBA derivatives	$	105,463		$	10,237		$	115,700
Net interest rate swaptions	—			(10,438		)	(10,438		)
Futures	(58,424		)	(61,292		)	(119,716		)
Purchase commitments	—			272			272
Credit derivatives	136			(77		)	59
Total							$	(14,123	)

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.

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 June 30, 2018 was approximately $330.8 million, which represents the maximum amount the Company would be required to pay upon termination. This amount is fully collateralized.