Derivatives

3 Months Ended

Mar. 31, 2012

Derivatives

Derivatives

4.      Derivatives

The Company’s derivatives are comprised of Swaps, 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 March 31, 2012 and December 31, 2011:

Derivative Instrument		Balance Sheet	March 31,			December 31,
(In Thousands)	Designation	Location	2012			2011
Swaps, at fair value ($0 notional at March 31, 2012)	Hedging	Assets	$	—		$	26
Linked Transactions, at fair value	Non-Hedging	Assets	$	20,124		$	55,801
Swaps, at fair value ($3.224 billion notional at March 31, 2012)	Hedging	Liabilities	$	(102,103	)	$	(114,220	)

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 March 31, 2012 and December 31, 2011:

Linked Transactions at March 31, 2012

Linked Repurchase Agreements					Linked MBS
			Weighted									Weighted
			Average									Average
Maturity or Repricing			Interest		Non-Agency MBS			Amortized		Par/Current		Coupon
(Dollars in Thousands)	Balance		Rate		(Dollars in Thousands)	Fair Value		Cost		Face		Rate
Within 30 days	$	82,576	1.67	%	Rated AAA	$	28,582	$	28,928	$	29,628	3.33	%
>30 days to 90 days	2,200		1.75		Rated AA	16,480		15,813		16,236		5.00
Total	$	84,776	1.67	%	Rated BBB	43,343		41,663		48,664		2.83
					Rated C	3,378		3,196		4,475		5.99
					Rated D	12,884		13,362		18,019		5.75
					Total	$	104,667	$	102,962	$	117,022	3.83	%

Linked Transactions at December 31, 2011

Linked Repurchase Agreements					Linked MBS
			Weighted									Weighted
			Average									Average
Maturity or Repricing			Interest		Non-Agency MBS			Amortized		Par/Current		Coupon
(Dollars in Thousands)	Balance		Rate		(Dollars in Thousands)	Fair Value		Cost		Face		Rate
Within 30 days	$	141,719	1.89	%	Rated AAA	$	29,057	$	29,917	$	30,675	3.31	%
>30 days to 90 days	29,178		1.81		Rated AA	17,427		16,858		17,297		5.00
Total	$	170,897	1.88	%	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
					Unrated	40,364		43,419		57,776		5.54
					Total	$	225,969	$	237,595	$	289,536	4.74	%

At March 31, 2012, Linked Transactions also included $371,000 of associated accrued interest receivable and $138,000 of accrued interest payable.  At December 31, 2011, Linked Transactions also included $1.1 million of associated accrued interest receivable and $412,000 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 quarterly periods ended March 31, 2012 and 2011:

Components of Unrealized Net Gains and Net Interest Income
from Linked Transactions	Three Months Ended March 31,
(In Thousands)	2012			2011
Interest income attributable to MBS underlying Linked Transactions	$	2,288		$	9,437
Interest expense attributable to linked repurchase agreement borrowings underlying Linked Transactions	(504		)	(1,766		)
Change in fair value of Linked Transactions included in earnings	5,915			7,179
Unrealized net gains and net interest income from Linked Transactions	$	7,699		$	14,850

Derivative Hedging Instruments

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.  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 March 31, 2012.  At March 31, 2012, 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 $106.1 million, including accrued interest payable of approximately $4.0 million.

The following table presents the assets pledged as collateral against the Company’s derivative contracts at March 31, 2012 and December 31, 2011:

(In Thousands)	March 31, 2012		December 31, 2011
Agency MBS, at fair value	$	108,769	$	117,687
Restricted cash	13,005		15,502
Total assets pledged against derivative contracts	$	121,774	$	133,189

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 March 31, 2012, 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 March 31, 2012, all of the Company’s derivatives were deemed effective for hedging purposes and no derivatives were terminated during the three months ended March 31, 2012 and March 31, 2011.

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 the three months ended March 31, 2012 and March 31, 2011.

At March 31, 2012, the Company had Swaps with an aggregate notional amount of $3.224 billion, which had gross unrealized losses of $102.1 million, and extended 20 months on average with a maximum term of approximately 46 months.  During the three months ended March 31, 2012, the Company did not enter into any new Swaps, and had Swaps with an aggregate notional amount of $154.1 million amortize and/or expire.  The following table presents information about the Company’s Swaps at March 31, 2012 and December 31, 2011:

	March 31, 2012						December 31, 2011
			Weighted						Weighted
			Average		Weighted				Average		Weighted
Maturity (1)	Notional		Fixed-Pay		Average Variable		Notional		Fixed-Pay		Average Variable
(Dollars in Thousands)	Amount		Interest Rate		Interest Rate (2)		Amount		Interest Rate		Interest Rate (2)
Within 30 days	$	34,108	4.16	%	0.41	%	$	34,056	4.05	%	0.37	%
Over 30 days to 3 months	241,243		2.31		0.29		120,001		4.43		0.38
Over 3 months to 6 months	187,743		4.41		0.32		275,351		2.54		0.33
Over 6 months to 12 months	397,165		4.36		0.40		528,894		4.42		0.39
Over 12 months to 24 months	960,189		2.76		0.26		974,352		2.78		0.30
Over 24 months to 36 months	1,053,361		2.06		0.26		685,042		2.28		0.31
Over 36 months to 48 months	350,000		2.07		0.24		710,170		1.96		0.29
Over 48 months to 60 months	—		—		—		50,000		2.13		0.29
Total Swaps	$	3,223,809	2.73	%	0.28	%	$	3,377,866	2.80	%	0.32	%

(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 three months ended March 31, 2012 and 2011:

	Three Months Ended
	March 31,
(Dollars in Thousands)	2012			2011
Interest expense attributable to Swaps	$	20,823		$	24,034
Weighted average Swap rate paid	2.78		%	3.67		%
Weighted average Swap rate received	0.31		%	0.27		%

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 January 2012.  The terms of the Swap that the Company could have entered into were 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 the termination of the option period in January 2012, the Company allowed the Swaption to expire.

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

The following table presents the impact of the Company’s Swaps on its accumulated other comprehensive income/(loss) for the three months ended March 31, 2012 and 2011:

	Three Months Ended
	March 31,
(In Thousands)	2012			2011
Accumulated other comprehensive loss from derivative hedging instruments:
Balance at beginning of period	$	(114,194	)	$	(139,142	)
Unrealized gain on Swaps, net	12,091			25,671
Balance at end of period	$	(102,103	)	$	(113,471	)

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.