DERIVATIVE FINANCIAL INSTRUMENTS

9 Months Ended

Sep. 30, 2019

Derivative Instruments and Hedging Activities Disclosure [Abstract]

NOTE 5. DERIVATIVE FINANCIAL INSTRUMENTS

In connection with its interest rate risk management strategy, the Company economically hedges a portion of the cost of its repurchase agreement funding and junior subordinated notes by entering into derivatives and other hedging contracts. To date the Company has entered into Eurodollar and T-Note futures contracts, but may enter into other contracts in the future. The Company has not elected hedging treatment under GAAP, and as such all gains or losses (realized and unrealized) on these instruments are reflected in earnings for all periods presented.

In addition, the Company utilizes TBA securities as a means of investing in and financing MBS or as a means of reducing its exposure to MBS. The Company accounts for TBA securities as derivative instruments.

Derivative Liabilities, at Fair Value

The table below summarizes fair value information about our derivative liabilities as of September 30, 2019 and December 31, 2018.

(in thousands)
Derivative Instruments and Related Accounts	Balance Sheet Location	September 30, 2019		December 31, 2018
Liabilities
TBA Securities	Other liabilities	$	53	$	938
Total derivative liabilities, at fair value		$	53	$	938

Margin Balances Posted To (From) Counterparties
Futures contracts	Restricted cash	$	690	$	520
TBA securities	Restricted cash		-		543
TBA securities	Other liabilities		(91)		-
Total margin balances on derivative contracts		$	599	$	1,063

Eurodollar and T-Note futures are cash settled futures contracts on an interest rate, with gains and losses credited or charged to the Company’s cash accounts on a daily basis. A minimum balance, or “margin”, is required to be maintained in the account on a daily basis. The tables below present information related to the Company’s Eurodollar and T-note futures positions at September 30, 2019 and December 31, 2018.

($ in thousands)
As of September 30, 2019
			Repurchase Agreement Funding Hedges
			Average	Weighted	Weighted
			Contract	Average	Average
			Notional	Entry	Effective		Open
Expiration Year			Amount	Rate	Rate		Equity⁽¹⁾
Eurodollar Futures Contracts (Short Positions)
2019		$	120,000	2.83%	1.96%	$	(261)
2020			120,000	2.90%	1.54%		(1,632)
2021			80,000	2.80%	1.38%		(1,135)
Total / Weighted Average		$	102,222	2.86%	1.54%	$	(3,028)

Treasury Note Futures Contracts (Short Position)⁽²⁾
December 2019 5-year T-Note futures
	(Dec 2019 - Dec 2024 Hedge Period)	$	20,000	1.79%	1.96%	$	161

($ in thousands)
As of September 30, 2019
	Junior Subordinated Debt Funding Hedges
		Average	Weighted	Weighted
		Contract	Average	Average
		Notional	Entry	Effective		Open
Expiration Year		Amount	Rate	Rate		Equity⁽¹⁾
2019	$	26,000	1.77%	1.96%	$	13
2020		19,500	1.92%	1.57%		(69)
Total / Weighted Average	$	20,800	1.88%	1.67%	$	(56)

($ in thousands)
As of December 31, 2018
		Repurchase Agreement Funding Hedges
		Average	Weighted	Weighted
		Contract	Average	Average
		Notional	Entry	Effective		Open
Expiration Year		Amount	Rate	Rate		Equity⁽¹⁾
2019	$	125,000	2.56%	2.67%	$	139
2020		150,000	2.84%	2.49%		(523)
2021		100,000	2.80%	2.46%		(346)
Total / Weighted Average	$	125,000	2.74%	2.54%	$	(730)

($ in thousands)
As of December 31, 2018
	Junior Subordinated Debt Funding Hedges
		Average	Weighted	Weighted
		Contract	Average	Average
		Notional	Entry	Effective		Open
Expiration Year		Amount	Rate	Rate		Equity⁽¹⁾
2019	$	26,000	1.63%	2.68%	$	271
2020		26,000	1.95%	2.49%		142
2021		26,000	2.22%	2.46%		61
Total / Weighted Average	$	26,000	1.93%	2.54%	$	474

The following table summarizes our contracts to purchase and sell TBA securities as of September 30, 2019 and December 31, 2018.

($ in thousands)
			Notional						Net
			Amount		Cost		Market		Carrying
			Long (Short)⁽¹⁾		Basis⁽²⁾		Value⁽³⁾		Value⁽⁴⁾
September 30, 2019
30-Year TBA Securities:
	3.5%	$	(50,000)	$	(51,268)	$	(51,321)	$	(53)
December 31, 2018
30-Year TBA Securities:
	3.0%	$	(50,000)	$	(47,844)	$	(48,782)	$	(938)

(1)Notional amount represents the par value (or principal balance) of the underlying Agency MBS.

(2)Cost basis represents the forward price to be paid (received) for the underlying Agency MBS.

(3)Market value represents the current market value of the TBA securities (or of the underlying Agency MBS) as of period-end.

(4)Net carrying value represents the difference between the market value and the cost basis of the TBA securities as of period-end and is reported in derivative assets (liabilities), at fair value in our consolidated balance sheets.

(Losses) Gains On Derivative Instruments

The table below presents the effect of the Company’s derivative financial instruments on the consolidated statements of operations for the nine and three months ended September 30, 2019 and 2018

(in thousands)
		Nine Months Ended September 30,				Three Months Ended September 30,
			2019		2018		2019		2018
Eurodollar futures contracts (short positions)
	Repurchase agreement funding hedges	$	(2,995)	$	2,101	$	(164)	$	477
	Junior subordinated debt funding hedges		(409)		679		-		122
T-Note futures contracts (short positions)
	Repurchase agreement funding hedges		(696)		759		(115)		-
Net TBA securities			(2,005)		19		(204)		349
(Losses) gains on derivative instruments		$	(6,105)	$	3,558	$	(483)	$	948

Credit Risk-Related Contingent Features

The use of derivatives creates exposure to credit risk relating to potential losses that could be recognized in the event that the counterparties to these instruments fail to perform their obligations under the contracts. The Company attempts to minimize this risk in several ways. For instruments which are not centrally cleared on a registered exchange, the Company limits its counterparties to major financial institutions with acceptable credit ratings, and by monitoring positions with individual counterparties. In addition, the Company may be required to pledge assets as collateral for its derivatives, whose amounts vary over time based on the market value, notional amount and remaining term of the derivative contract. In the event of a default by a counterparty, the Company may not receive payments provided for under the terms of its derivative agreements, and may have difficulty recovering its assets pledged as collateral for its derivatives. The cash and cash equivalents pledged as collateral for the Company’s derivative instruments are included in restricted cash on the consolidated balance sheets.

^[1]

[1]	Open equity represents the cumulative gains (losses) recorded on open futures positions from inception.