Derivatives

12 Months Ended

Dec. 31, 2011

Derivatives

Derivatives

4.Derivatives

The Company’s derivatives are comprised of Swaps and Swaptions, which are designated as cash flow hedges against the interest rate risk associated with its borrowings, and Linked Transactions, which are not designated as hedging instruments.  The following table presents the fair value of the Company’s derivative instruments and their balance sheet location at December 31, 2011 and December 31, 2010:

		Balance Sheet	December 31,			December 31,
Derivative Instrument	Designation	Location	2011			2010
(In Thousands)
Swaps, at fair value ($125.0 million notional)	Hedging	Assets	$	26		$	—
Swaptions, at fair value	Hedging	Assets	$	—		$	—
Linked Transactions, at fair value	Non-Hedging	Assets	$	55,801		$	179,915
Swaps, at fair value ($3.253 billion notional)	Hedging	Liabilities	$	(114,220	)	$	(139,142	)

Linked Transactions

The Company’s Linked Transactions are 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 reflect 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 are not designated as hedging instruments and, as a result, the change in the fair value and net interest income from Linked Transactions is reported in other income on the Company’s consolidated statements of operations.

The following tables present certain information about the Non-Agency MBS and repurchase agreements underlying the Company’s Linked Transactions at December 31, 2011 and December 31, 2010:

Linked Transactions at December 31, 2011

Linked Repurchase Agreements

			Weighted
			Average
			Interest
Maturity or Repricing	Balance		Rate
(Dollars in Thousands)
Within 30 days	$	141,719	1.89	%
>30 days to 90 days	29,178		1.81
Total	$	170,897	1.88	%

Linked MBS

							Weighted
							Average
			Amortized		Par/Current		Coupon
Non-Agency MBS	Fair Value		Cost		Face		Rate
(Dollars in Thousands)
Rated AAA	$	29,057	$	29,917	$	30,675	3.31	%
Rated AA	17,427		16,858		17,297		5.00
Rated BBB	41,825		42,419		49,781		2.81
Rated CCC	20,782		20,988		26,680		4.42
Rated CC	43,644		47,060		61,470		6.00
Rated C	32,870		36,934		45,857		5.20
Rated D	40,364		43,419		57,776		5.54
Total	$	225,969	$	237,595	$	289,536	4.74	%

Linked Transactions at December 31, 2010

Linked Repurchase Agreements

			Weighted
Maturity or Repricing	Balance		Average Interest Rate
(Dollars in Thousands)
Within 30 days	$	289,522	1.62	%
>30 days to 90 days	277,765		1.62
Total	$	567,287	1.62	%

Linked MBS

							Weighted
							Average
Non-Agency MBS	Fair Value		Amortized Cost		Par/Current Face		Coupon Rate
(Dollars in Thousands)
Rated AAA	$	46,710	$	46,367	$	47,151	4.13	%
Rated AA	57,634		54,176		61,389		3.51
Rated A	36,440		34,620		41,984		2.53
Rated BBB	69,397		66,848		78,741		3.38
Rated BB	14,536		14,456		17,513		2.51
Rated B	129,962		121,198		139,763		4.28
Rated CCC	216,398		211,302		255,667		4.98
Rated CC	89,833		86,509		110,518		5.45
Rated C	78,181		78,038		100,204		5.77
Unrated	5,278		5,220		10,350		6.00
Total	$	744,369	$	718,734	$	863,280	4.56	%

At December 31, 2011, Linked Transactions also included $1.1 million of associated accrued interest receivable and $412,000 of accrued interest payable.  At December 31, 2010, Linked Transactions also included $3.4 million of associated accrued interest receivable and $565,000 of accrued interest payable.

The following table presents certain information about the components of the unrealized net gains and net interest income from Linked Transactions included in the Company’s consolidated statements of operations for the years ended December 31, 2011, 2010 and 2009:

Components of Unrealized Net Gains and Net Interest	For the Year Ended December 31,
Income from Linked Transactions	2011			2010			2009
(In Thousands)
Interest income attributable to MBS underlying Linked Transactions	$	25,592		$	35,313		$	6,249
Interest expense attributable to linked repurchase agreement borrowings underlying Linked Transactions	(4,794		)	(6,432		)	(1,254		)
Change in fair value of Linked Transactions included in earnings	(17,783		)	24,881			3,834
Unrealized net gains and net interest income from Linked Transactions	$	3,015		$	53,762		$	8,829

Derivative Hedging Instruments

Consistent with market practice, the Company has agreements with its Swap and Swaption 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.  Collateral requirements vary by counterparty and change over time based on the market value, notional amount and remaining term of the derivative contract.  Certain derivative contracts provide for cross collateralization with repurchase agreements with the same counterparty.

A number of the Company’s derivative contracts include financial covenants, which, if breached, could cause an event of default or early termination event to occur under such agreements.  If the Company were to cause an event of default or trigger an early termination event pursuant to one of its derivative contracts, the counterparty to such agreement may have the option to terminate all of its outstanding derivative contracts with the Company and, if applicable, any close-out amount due to the counterparty upon termination of the derivative contracts would be immediately payable by the Company.  The Company was in compliance with all of its financial covenants through December 31, 2011.  At December 31, 2011, the aggregate fair value of assets needed to immediately settle derivative contracts that were in a liability position to the Company, if so required, was approximately $114.2 million.

The following table presents the assets pledged as collateral against the Company’s derivative contracts at December 31, 2011 and December 31, 2010:

	December 31,
(In Thousands)	2011		2010
Agency MBS, at fair value	$	117,687	$	153,534
Restricted cash	15,502		35,083
Total assets pledged against derivative contracts	$	133,189	$	188,617

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.  At December 31, 2011, all of the Company’s derivative counterparties were rated A or better by a Rating Agency.

The Company’s derivative hedging instruments, or a portion thereof, could become ineffective in the future if the associated repurchase agreements or securitized debt that such derivatives hedge fail to exist or fail to have terms that match those of the derivatives that hedge such borrowings.  At December 31, 2011, all of the Company’s derivatives were deemed effective for hedging purposes and no derivatives were terminated during the years ended December 31, 2011 and December 31, 2010.

Swaps

The Company’s Swaps 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, 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 has not recognized any change in the value of its derivative hedging instruments in earnings as a result of the hedge or a portion thereof being ineffective during any of the three years ended December 31, 2011.

At December 31, 2011, the Company had Swaps with an aggregate notional amount of $3.378 billion, which had gross unrealized losses of $114.2 million, gross unrealized gains of $26,000 and extended 22 months on average with a maximum term of approximately 50 months.  During the year ended December 31, 2011, the Company entered into Swaps with an aggregate notional amount of $1.215 billion and had Swaps expire with an aggregate notional amount of $642.6 million.  The following table presents information about the Company’s Swaps at December 31, 2011 and December 31, 2010:

	December 31, 2011						December 31, 2010
			Weighted						Weighted
			Average		Weighted				Average		Weighted
	Notional		Fixed-Pay		Average Variable		Notional		Fixed-Pay		Average Variable
Maturity (1)	Amount		Interest Rate		Interest Rate (2)		Amount		Interest Rate		Interest Rate (2)
(Dollars in Thousands)
Within 30 days	$	34,056	4.05	%	0.37	%	$	55,267	3.90	%	0.28	%
Over 30 days to 3 months	120,001		4.43		0.38		160,589		4.35		0.27
Over 3 months to 6 months	275,351		2.54		0.33		169,258		4.02		0.28
Over 6 months to 12 months	528,894		4.42		0.39		257,482		4.09		0.28
Over 12 months to 24 months	974,352		2.78		0.30		833,302		4.40		0.27
Over 24 months to 36 months	685,042		2.28		0.31		849,351		3.10		0.26
Over 36 months to 48 months	710,170		1.96		0.29		360,042		3.32		0.27
Over 48 months to 60 months	50,000		2.13		0.29		120,170		2.87		0.27
Total Swaps	$	3,377,866	2.80	%	0.32	%	$	2,805,461	3.74	%	0.27	%

(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. 

The following table presents the net impact of the Company’s Swaps on its interest expense and the weighted average interest rate paid and received for such Swaps for the years ended December 31, 2011, 2010 and 2009:

	For the Year Ended December 31,
(Dollars in Thousands)	2011			2010			2009
Interest expense attributable to Swaps	$	95,677		$	111,791		$	120,834
Weighted average Swap rate paid	3.13		%	3.97		%	4.22		%
Weighted average Swap rate received	0.25		%	0.30		%	0.67		%

Swaptions

In June 2011, the Company purchased a Swaption, for which it paid a premium of $915,000, that provided the Company with the right to enter into a fixed-pay Swap at termination of the option period in early January 2012.  The terms of the Swap that the Company may enter into are as follows:  $100.0 million notional; four-year term; fixed strike rate 1.90%; variable index equal to one month LIBOR.  Swaptions are used as a hedge against the risk of changes in the interest component above a specified level on a portion of forecasted one-month fixed rate borrowings.  At December 31, 2011, the Company’s Swaption had a fair value of zero.  During the year ended December 31, 2011, the Company recognized $915,000 of expense in other income, reflecting changes in the time-value component of the Swaption.  At the termination of the option period in January 2012, the Company allowed the option to expire.

Impact of Hedging Instruments on Accumulated Other Comprehensive (Loss)/Income

The following table presents the impact of the Company’s Swaps on its accumulated other comprehensive (loss)/income for the years ended December 31, 2011, 2010 and 2009:

	For the Year Ended December 31,
(In Thousands)	2011			2010			2009
Accumulated other comprehensive loss from derivative hedging instruments:
Balance at beginning of period	$	(139,142	)	$	(152,463	)	$	(237,291	)
Unrealized gain on Swaps, net	24,948			13,321			84,828
Balance at end of period	$	(114,194	)	$	(139,142	)	$	(152,463	)

Counterparty Credit Risk

By using derivative hedging instruments, 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 balance sheet 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 derivative hedging instruments is considered in determining fair value of such derivatives and its assessment of hedge effectiveness.