Derivative Instruments

The Company’s derivative instruments are currently comprised of Swaps, which are designated as cash flow hedges against the interest rate risk associated with its borrowings. Prior to 2015, the Company had also entered into Linked Transactions, which were not designated as hedging instruments. (See Note 2(p), and below) The following table presents the fair value of the Company’s derivative instruments and their balance sheet location at March 31, 2016 and December 31, 2015:



			March 31, 2016					December 31, 2015
Derivative Instrument	Designation	Balance Sheet Location	Notional Amount		Fair Value			Notional Amount		Fair Value
(In Thousands)
Non-cleared legacy Swaps (1)	Hedging	Assets	$	300,000	$	152		$	450,000	$	1,127
Non-cleared legacy Swaps (1)	Hedging	Liabilities	$	150,000	$	(117	)	$	50,000	$	(59	)
Cleared Swaps (2)	Hedging	Liabilities	$	2,550,000	$	(118,776	)	$	2,550,000	$	(70,467	)

(1) Non-cleared legacy Swaps include Swaps executed and settled bilaterally with counterparties without the use of an organized exchange or central clearing house.

(2) Cleared Swaps include Swaps executed bilaterally with a counterparty in the over-the-counter market but then novated to a central clearing house, whereby the central clearing house becomes the counterparty to both of the original counterparties.

Swaps

Consistent with market practice, the Company has agreements with its Swap counterparties that provide for the posting of collateral based on the fair values of its derivative contracts. Through this margining process, either the Company or its derivative counterparty may be required to pledge cash or securities as collateral. In addition, Swaps novated to and cleared by a central clearing house are subject to initial margin requirements. Certain derivative contracts provide for cross collateralization with repurchase agreements with the same counterparty.

A number of the Company’s Swap contracts include financial covenants, which, if breached, could cause an event of default or early termination event to occur under such agreements. Such financial covenants include minimum net worth requirements and maximum debt-to-equity ratios. If the Company were to cause an event of default or trigger an early termination event pursuant to one of its Swap contracts, the counterparty to such agreement may have the option to terminate all of its outstanding Swap contracts with the Company and, if applicable, any close-out amount due to the counterparty upon termination of the Swap contracts would be immediately payable by the Company. The Company was in compliance with all of its financial covenants through March 31, 2016. At March 31, 2016, the aggregate fair value of assets needed to immediately settle Swap contracts that were in a liability position to the Company, if so required, was approximately $120.2 million, including accrued interest payable of approximately $1.3 million.

The following table presents the assets pledged as collateral against the Company’s Swap contracts at March 31, 2016 and December 31, 2015:



(In Thousands)	March 31, 2016		December 31, 2015
Agency MBS, at fair value	$	36,927	$	38,569
Restricted cash	118,264		70,573
Total assets pledged against Swaps	$	155,191	$	109,142

The use of derivative hedging instruments exposes the Company to counterparty credit risk. In the event of a default by a derivative counterparty, the Company may not receive payments to which it is entitled under its derivative agreements, and may have difficulty recovering its assets pledged as collateral against such agreements. If, during the term of a derivative contract, a counterparty should file for bankruptcy, the Company may experience difficulty recovering its assets pledged as collateral which could result in the Company having an unsecured claim against such counterparty’s assets for the difference between the fair value of the derivative and the fair value of the collateral pledged to such counterparty.

The Company’s derivative hedging instruments, or a portion thereof, could become ineffective in the future if the associated repurchase agreements that such derivatives hedge fail to exist or fail to have terms that match those of the derivatives that hedge such borrowings. At March 31, 2016, all of the Company’s derivatives were deemed effective for hedging purposes and no derivatives were terminated during the three months ended March 31, 2016 and 2015.

The Company’s Swaps designated as hedging transactions have the effect of modifying the repricing characteristics of the Company’s repurchase agreements and cash flows for such liabilities. To date, no cost has been incurred at the inception of a Swap (except for certain transaction fees related to entering into Swaps cleared though a central clearing house), pursuant to which the Company agrees to pay a fixed rate of interest and receive a variable interest rate, generally based on one-month or three-month London Interbank Offered Rate (“LIBOR”), on the notional amount of the Swap. The Company did not recognize any change in the value of its existing Swaps designated as hedges through earnings as a result of hedge ineffectiveness during the three months ended March 31, 2016 and 2015.

At March 31, 2016, the Company had Swaps designated in hedging relationships with an aggregate notional amount of $3.000 billion, which had net unrealized losses of $118.7 million, and extended 43 months on average with a maximum term of approximately 89 months.

The following table presents certain information with respect to the Company’s Swap activity during the three months ended March 31, 2016:



(Dollars in Thousands)	Three Months Ended March 31, 2016
New Swaps:
Aggregate notional amount	$	—
Weighted average fixed-pay rate	—		%
Initial maturity date	N/A
Number of new Swaps	—
Swaps amortized/expired:
Aggregate notional amount	$	50,000
Weighted average fixed-pay rate	2.13		%

The following table presents information about the Company’s Swaps at March 31, 2016 and December 31, 2015:



	March 31, 2016						December 31, 2015
	Notional Amount		Weighted Average Fixed-Pay Interest Rate		Weighted Average Variable Interest Rate (2)		Notional Amount		Weighted Average Fixed-Pay Interest Rate		Weighted Average Variable Interest Rate (2)

Maturity (1)
(Dollars in Thousands)
Within 30 days	$	—	—	%	—	%	$	50,000	2.13	%	0.42	%
Over 6 months to 12 months	150,000		0.54		0.44		100,000		0.48		0.32
Over 12 months to 24 months	300,000		0.57		0.44		350,000		0.58		0.27
Over 24 months to 36 months	650,000		1.53		0.44		550,000		1.49		0.32
Over 36 months to 48 months	100,000		1.71		0.43		200,000		1.71		0.42
Over 48 months to 60 months	1,600,000		2.22		0.44		1,500,000		2.22		0.36
Over 60 months to 72 months	100,000		2.21		0.44		200,000		2.20		0.30
Over 84 months (3)	100,000		2.75		0.43		100,000		2.75		0.40
Total Swaps	$	3,000,000	1.82	%	0.44	%	$	3,050,000	1.82	%	0.34	%

(1) Each maturity category reflects contractual amortization and/or maturity of notional amounts.

(2) Reflects the benchmark variable rate due from the counterparty at the date presented, which rate adjusts monthly or quarterly based on one-month or three-month LIBOR, respectively.

(3) Reflects one Swap with a maturity date of July 2023.

The following table presents the net impact of the Company’s derivative hedging instruments on its interest expense and the weighted average interest rate paid and received for such Swaps for the three months ended March 31, 2016 and 2015:



	Three Months Ended March 31,
(Dollars in Thousands)	2016			2015
Interest expense attributable to Swaps	$	10,650		$	15,382
Weighted average Swap rate paid	1.82		%	1.84		%
Weighted average Swap rate received	0.42		%	0.17		%

Impact of Derivative Hedging Instruments on AOCI

The following table presents the impact of the Company’s derivative hedging instruments on its AOCI for the three months ended March 31, 2016 and 2015:



	Three Months Ended March 31,
(In Thousands)	2016			2015
AOCI from derivative hedging instruments:
Balance at beginning of period	$	(69,399	)	$	(59,062	)
Unrealized loss on Swaps, net	(49,342		)	(32,367		)
Balance at end of period	$	(118,741	)	$	(91,429	)

Counterparty Credit Risk from Use of Swaps

By using Swaps, the Company is exposed to counterparty credit risk if counterparties to the derivative contracts do not perform as expected. If a counterparty fails to perform, the Company’s counterparty credit risk is equal to the amount reported as a derivative asset on its consolidated balance sheets to the extent that amount exceeds collateral obtained from the counterparty or, if in a net liability position, the extent to which collateral posted exceeds the liability to the counterparty. The amounts reported as a derivative asset/(liability) are derivative contracts in a gain/(loss) position, and to the extent subject to master netting arrangements, net of derivatives in a loss/(gain) position with the same counterparty and collateral received/(pledged). The Company attempts to minimize counterparty credit risk through credit approvals, limits, monitoring procedures, executing master netting arrangements and obtaining collateral, where appropriate. Counterparty credit risk related to the Company’s Swaps is considered in determining the fair value of such derivatives and in its assessment of hedge effectiveness.

Linked Transactions

Prior to January 1, 2015, the Company’s Linked Transactions had been evaluated on a combined basis, reported as forward (derivative) instruments and presented as assets on the Company’s consolidated balance sheets at fair value. The fair value of Linked Transactions reflected the value of the underlying Non-Agency MBS, linked repurchase agreement borrowings and accrued interest receivable/payable on such instruments. The Company’s Linked Transactions were not designated as hedging instruments and, as a result, the change in the fair value and net interest income from Linked Transactions had been reported in Other Income, net on the Company’s consolidated statements of operations.

New accounting guidance that was effective for the Company on January 1, 2015 prospectively eliminated the use of Linked Transaction accounting. An entity is required to present changes in accounting for transactions outstanding on the effective date as a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption. Accordingly, on adoption of the new standard on January 1, 2015, the Company reclassified $1.913 billion of Non-Agency MBS and $4.6 million of CRT securities that were previously reported as a component of Linked Transactions to Non-Agency MBS and CRT securities, respectively on the consolidated balance sheet. In addition, liabilities of $1.520 billion that were previously presented as a component of Linked Transactions were reclassified to Repurchase agreements on the consolidated balance sheet. Furthermore, an amount of $4.5 million representing net unrealized gains on securities previously reported as a component of Linked Transactions as of December 31, 2014 was reclassified from Accumulated deficit to AOCI. These reclassification adjustments had no net impact on the Company’s overall Total Stockholders’ Equity.