Derivative Instruments

9 Months Ended

Sep. 30, 2022

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Derivative InstrumentsIn connection with the Company’s interest rate risk strategy, the Company may economically hedge a portion of its interest rate risk by entering into derivative financial instrument contracts in the form of interest rate swaps, swaptions, and Treasury futures. Swaps are used to lock in a fixed rate related to a portion of its current and anticipated payments on its secured financing agreements. The Company typically agrees to pay a fixed rate of interest, or pay rate, in exchange for the right to receive a floating rate of interest, or receive rate, over a specified period of time. Interest rate swaptions provide the option to enter into an interest rate swap agreement for a predetermined notional amount, stated term and pay and receive interest rates in the future. The Company’s swaptions are not centrally cleared. Treasury futures are derivatives which track the prices of generic benchmark Treasury securities with identical maturity and are traded on an active exchange. It is generally the

Company’s policy to close out any Treasury futures positions prior to delivering the underlying security. Treasury futures lock in a fixed rate related to a portion of its current and anticipated payments on its secured financing agreements.

The Company’s derivatives are recorded as either assets or liabilities in the Consolidated Statements of Financial Condition and measured at fair value. These derivative financial instrument contracts are not designated as hedges for GAAP; therefore, all changes in fair value are recognized in earnings. The Company elects to net the fair value of its derivative contracts by counterparty when appropriate. These contracts contain legally enforceable provisions that allow for netting or setting off of all individual derivative receivables and payables with each counterparty and therefore, the fair values of those derivative contracts are reported net by counterparty.

The use of derivatives 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 contracts. In the event of a default by the counterparty, the Company could have difficulty obtaining its RMBS or cash pledged as collateral for these derivative instruments. The Company periodically monitors the credit profiles of its counterparties to determine if it is exposed to counterparty credit risk. See Note 15 for further discussion of counterparty credit risk.

During the second quarter of 2022, the Company purchased a swaption contract for a one-year forward starting swap of $1.0 billion in notional amount with a 3.26% strike rate. The underlying swap terms will allow the Company to pay a fix rate of 3.26% and receive floating overnight SOFR rate. The Company paid a $6 million premium for the purchase of this swaption contract. The Company also maintains collateral in the form of cash on margin from counterparty to its swaption contact. In accordance with the Company's netting policy, the Company presents the fair value of its swaption contract net of cash margin received. See Note 15 for additional details on derivative netting.

This swaption contract is subject to certain early termination provisions. These provisions include that the Company maintains $1.0 billion or higher total stockholders' equity, and a leverage ratio below twelve. Currently, the Company is in compliance with these early termination provisions and does not expect to fail to comply with any of these early termination provisions within the next twelve months.

The Company entered into two, pay fix - receive float, SOFR based interest rate swaps during the quarter ended September 30, 2022 with a $885 million notional amount. The weighted average pay rate on the Company's interest rate swaps at September 30, 2022 was 3.94% and the weighted average receive rate was 2.98%. The swaps had remaining maturity range of two years to five years and weighted average maturity of three years.

The table below summarizes the location and fair value of the derivatives reported in the Consolidated Statements of Financial Condition after counterparty netting and posting of cash collateral as of September 30, 2022. The Company did not have any derivative instruments as of December 31, 2021.


			September 30, 2022
			Derivative Assets			Derivative Liabilities
Derivative Instruments	Notional Amount Outstanding		Location on Consolidated Statements of Financial Condition	Net Estimated Fair Value/Carrying Value		Location on Consolidated Statements of Financial Condition	Net Estimated Fair Value/Carrying Value
			(dollars in thousands)
Interest Rate Swaps	885,000		Derivatives, at fair value	$	4,187	Derivatives, at fair value	$	—
Swaptions	1,000,000		Derivatives, at fair value	$	202	Derivatives, at fair value	$	—

Total	$	1,885,000		$	4,389		$	—

The effect of the Company’s derivatives on the Consolidated Statements of Operations for the quarter and the nine months ended September 30, 2022 and September 30, 2021, respectively is presented below.


		Net gains (losses) on derivatives for the quarters ended				Net gains (losses) on derivatives for the nine months ended
Derivative Instruments	Location on Consolidated Statements of Operations and Comprehensive Income	September 30, 2022		September 30, 2021		September 30, 2022		September 30, 2021
		(dollars in thousands)				(dollars in thousands)
Interest Rate Swaps	Net unrealized gains (losses) on derivatives	3,718		$	—	3,718		$	—
Interest Rate Swaps	Periodic interest cost of interest rate swaps, net	(122)		—		(122)		—




Swaptions	Net unrealized gains (losses) on derivatives	6,589		—		4,971		—



Total		$	10,185	$	—	$	8,567	$	—

When the Company enters into derivative contracts, they are typically 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, or NYSE. 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. If the Company breaches any of these provisions, it will be required to settle its obligations under

the agreements at their termination values, which approximates fair value.