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Financial Derivatives
 9 Months Ended
Sep. 30, 2019
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
Financial Derivatives
Financial Derivatives
The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company manages certain risks associated with its investments and borrowings, including interest rate, credit, liquidity, and foreign exchange rate risk primarily by managing the amount, sources, and duration of its investments and borrowings, and through the use of derivative financial instruments. The Company's derivative financial instruments are used to manage differences in the amount, timing, and duration of its known or expected cash receipts and its known or expected cash payments principally related to its investments and borrowings.
The following table details the fair value of the Company's holdings of financial derivatives as of September 30, 2019:
 
 
September 30, 2019
 
 
(In thousands)
Financial derivatives–assets, at fair value:
 
 
TBA securities purchase contracts
 
$
43

TBA securities sale contracts
 
99

Fixed payer interest rate swaps
 
1,760

Fixed receiver interest rate swaps
 
1,680

Credit default swaps on asset-backed securities
 
1,078

Credit default swaps on asset-backed indices
 
2,146

Credit default swaps on corporate bonds
 
41

Credit default swaps on corporate bond indices
 
5,060

Total return swaps
 
235

Futures
 
484

Forwards
 
114

Total financial derivatives–assets, at fair value
 
12,740

Financial derivatives–liabilities, at fair value:
 
 
TBA securities sale contracts
 
(904
)
Fixed payer interest rate swaps
 
(12,099
)
Fixed receiver interest rate swaps
 
(16
)
Credit default swaps on asset-backed indices
 
(194
)
Credit default swaps on corporate bonds
 
(186
)
Credit default swaps on corporate bond indices
 
(11,185
)
Total return swaps
 
(921
)
Futures
 
(67
)
Total financial derivatives–liabilities, at fair value
 
(25,572
)
Total
 
$
(12,832
)

Interest Rate Swaps
The following table provides information about the Company's fixed payer interest rate swaps as of September 30, 2019:
 
 
 
 
 
 
Weighted Average
Maturity
 
Notional Amount(1)
 
Fair Value(1)
 
Pay Rate(2)(3)
 
Receive Rate(2)
 
Remaining Years to Maturity(4)
 
 
(In thousands)
 
 
 
 
 
 
2020
 
$
68,607

 
$
92

 
1.74
%
 
2.16
%
 
0.50
2021
 
169,567

 
(610
)
 
1.86

 
2.19

 
1.76
2023
 
101,012

 
(1,773
)
 
2.06

 
2.18

 
3.54
2024
 
52,426

 
(126
)
 
1.72

 
2.24

 
4.68
2026
 
73,782

 
1,059

 
1.67

 
2.15

 
6.75
2028
 
32,942

 
(2,356
)
 
2.40

 
2.17

 
8.59
2029
 
76,773

 
(4,630
)
 
2.25

 
2.24

 
9.58
2030
 
685

 
(60
)
 
2.38

 
2.14

 
11.15
2036
 
1,100

 
33

 
n/a

 
n/a

 
16.39
2049
 
7,020

 
(1,968
)
 
2.89

 
2.32

 
29.28
Total
 
$
583,914

 
$
(10,339
)
 
1.98
%
 
2.19
%
 
4.60
(1)
Includes forward-starting interest rate swaps with a notional amount of $85.2 million and fair value of $1.3 million.
(2)
Excludes forward-starting interest rate swaps.
(3)
Including forward-starting interest rate swaps the total weighted average pay rate was1.87%.
(4)
Includes forward-starting interest rate swaps, all of which start within six months of period end.
The following table provides information about the Company's fixed receiver interest rate swaps as of September 30, 2019:
 
 
 
 
 
 
Weighted Average
Maturity
 
Notional Amount
 
Fair Value
 
Pay Rate
 
Receive Rate
 
Remaining Years to Maturity
 
 
(In thousands)
 
 
 
 
 
 
2021
 
$
12,500

 
$
23

 
2.15
%
 
1.75
%
 
1.97
2022
 
53,974

 
309

 
2.13

 
1.85

 
2.42
2023
 
48,657

 
803

 
2.16

 
2.00

 
3.51
2024
 
11,342

 
456

 
2.32

 
2.33

 
4.48
2029
 
5,800

 
73

 
2.20

 
1.72

 
9.87
Total
 
$
132,273

 
$
1,664

 
2.16
%
 
1.93
%
 
3.28
Credit Default Swaps
The following table provides information about the Company's credit default swaps as of September 30, 2019:
Type(1)
 
Notional
 
Fair Value
 
Weighted Average Remaining Term (Years)
 
 
(In thousands)
 
 
Asset:
 
 
 
 
 
 
Long:
 
 
 
 
 
 
Credit default swaps on asset-backed indices
 
$
729

 
$
9

 
23.78
Credit default swaps on corporate bonds
 
430

 
2

 
0.72
Credit default swaps on corporate bond indices
 
130,743

 
4,920

 
2.68
Short:
 
 
 
 
 
 
Credit default swaps on asset-backed securities
 
(2,750
)
 
1,078

 
15.90
Credit default swaps on asset-backed indices
 
(25,960
)
 
2,137

 
37.05
Credit default swaps on corporate bonds
 
(2,118
)
 
39

 
0.52
Credit default swaps on corporate bond indices
 
(1,940
)
 
140

 
4.22
Liability:
 
 
 
 
 
 
Long:
 
 
 
 
 
 
Credit default swaps on asset-backed indices
 
361

 
(155
)
 
29.62
Credit default swaps on corporate bonds
 
2,114

 
(58
)
 
0.57
Short:
 
 
 
 
 
 
Credit default swaps on asset-backed indices
 
(4,500
)
 
(39
)
 
40.57
Credit default swaps on corporate bonds
 
(7,500
)
 
(128
)
 
0.58
Credit default swaps on corporate bond indices
 
(218,547
)
 
(11,185
)
 
2.40
 
 
$
(128,938
)
 
$
(3,240
)
 
10.44
(1)
Long notional represents contracts where the Company has written protection and short notional represents contracts where the Company has purchased protection.
Futures
The following table provides information about the Company's short positions in futures as of September 30, 2019:
Description
 
Notional Amount
 
Fair Value
 
Remaining Months to Expiration
 
 
(In thousands)
 
 
U.S. Treasury futures
 
$
(20,900
)
 
$
285

 
2.75
Eurodollar futures
 
(21,000
)
 
(67
)
 
5.60
Currency futures
 
(12,128
)
 
199

 
2.57
Total
 
$
(54,028
)
 
$
417

 
3.82

TBAs
The Company transacts in the forward settling TBA market. Pursuant to these TBA transactions, the Company agrees to purchase or sell, for future delivery, Agency RMBS with certain principal and interest terms and certain types of underlying collateral, but the particular Agency RMBS to be delivered is not identified until shortly before the TBA settlement date. TBAs are generally liquid, have quoted market prices, and represent the most actively traded class of MBS. The Company uses TBAs to mitigate interest rate risk, usually by taking short positions. The Company also invests in TBAs as a means of acquiring additional exposure to Agency RMBS, or for speculative purposes, including holding long positions.
The Company does not generally take delivery of TBAs; rather, it settles the associated receivable and payable with its trading counterparties on a net basis. Transactions with the same counterparty for the same TBA that result in a reduction of the position are treated as extinguished.
As of September 30, 2019, the Company had outstanding TBA purchase and sale contracts as follows:
TBA Securities
 
Notional Amount(1)
 
Cost
Basis(2)
 
Market Value(3)
 
Net Carrying Value(4)
(In thousands)
 
 
 
 
 
 
 
 
Purchase contracts:
 
 
 
 
 
 
 
 
Assets
 
$
28,789

 
$
29,709

 
$
29,752

 
$
43

 
 
28,789

 
29,709

 
29,752

 
43

Sale contracts:
 
 
 
 
 
 
 
 
Assets
 
(136,628
)
 
(141,297
)
 
(141,198
)
 
99

Liabilities
 
(729,158
)
 
(762,438
)
 
(763,342
)
 
(904
)
 
 
(865,786
)
 
(903,735
)
 
(904,540
)
 
(805
)
Total TBA securities, net
 
$
(836,997
)
 
$
(874,026
)
 
$
(874,788
)
 
$
(762
)
(1)
Notional amount represents the principal balance of the underlying Agency RMBS.
(2)
Cost basis represents the forward price to be paid (received) for the underlying Agency RMBS.
(3)
Market value represents the current market value of the underlying Agency RMBS (on a forward delivery basis) as of period end.
(4)
Net carrying value represents the difference between the market value of the TBA contract as of period end and the cost basis, and is reported in Financial derivatives-assets, at fair value and Financial derivatives-liabilities, at fair value on the Condensed Consolidated Balance Sheet.
Gains and losses on the Company's derivative contracts for the three-month period ended September 30, 2019 are summarized in the table below:
Derivative Type
 
Primary 
Risk
Exposure
 
Net Realized Gains (Losses) on Periodic Settlements of Interest Rate Swaps
 
Net Realized Gains (Losses) on Financial Derivatives Other Than Periodic Settlements of Interest Rate Swaps(1)
 
Net Realized Gains (Losses) on Financial Derivatives(1)
 
Change in Net Unrealized Gains (Losses) on Accrued Periodic Settlements of Interest Rate Swaps
 
Change in Net Unrealized Gains (Losses) on Financial Derivatives Other Than on Accrued Periodic Settlements of Interest Rate Swaps(2)
 
Change in Net Unrealized Gains (Losses) on Financial Derivatives(2)
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
 
Interest Rate
 
$
82

 
$
34

 
$
116

 
$
171

 
$
(2,598
)
 
$
(2,427
)
Credit default swaps on asset-backed securities
 
Credit
 
 
 
16

 
16

 
 
 
(12
)
 
(12
)
Credit default swaps on asset-backed indices
 
Credit
 
 
 
(261
)
 
(261
)
 
 
 
(81
)
 
(81
)
Credit default swaps on corporate bond indices
 
Credit
 
 
 
(1,113
)
 
(1,113
)
 
 
 
909

 
909

Credit default swaps on corporate bonds
 
Credit
 
 
 
(259
)
 
(259
)
 
 
 
268

 
268

Total return swaps
 
Equity Market/Credit
 
 
 
251

 
251

 
 
 
(716
)
 
(716
)
TBAs
 
Interest Rate
 
 
 
(5,067
)
 
(5,067
)
 
 
 
1,542

 
1,542

Futures
 
Interest Rate/Currency
 
 
 
(3,551
)
 
(3,551
)
 
 
 
1,627

 
1,627

Forwards
 
Currency
 
 
 
525

 
525

 
 
 
379

 
379

Total
 
 
 
$
82

 
$
(9,425
)
 
$
(9,343
)
 
$
171

 
$
1,318

 
$
1,489

(1)
Includes gain/(loss) on foreign currency transactions on financial derivatives in the amount of $17 thousand for the three-month period ended September 30, 2019, which is included on the Condensed Consolidated Statement of Operations in Other, net.
(2)
Includes foreign currency remeasurement on financial derivatives in the amount of $16 thousand for the three-month period ended September 30, 2019, which is included on the Condensed Consolidated Statement of Operations in Other, net.
Gains and losses on the Company's derivative contracts for the nine-month period ended September 30, 2019 are summarized in the table below:
Derivative Type
 
Primary 
Risk
Exposure
 
Net Realized Gains (Losses) on Periodic Settlements of Interest Rate Swaps
 
Net Realized Gains (Losses) on Financial Derivatives Other Than Periodic Settlements of Interest Rate Swaps(1)
 
Net Realized Gains (Losses) on Financial Derivatives(1)
 
Change in Net Unrealized Gains (Losses) on Accrued Periodic Settlements of Interest Rate Swaps
 
Change in Net Unrealized Gains (Losses) on Financial Derivatives Other Than on Accrued Periodic Settlements of Interest Rate Swaps(2)
 
Change in Net Unrealized Gains (Losses) on Financial Derivatives(2)
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
 
Interest Rate
 
$
852

 
$
(1,117
)
 
$
(265
)
 
$
(60
)
 
$
(11,915
)
 
$
(11,975
)
Credit default swaps on asset-backed securities
 
Credit
 
 
 
419

 
419

 
 
 
(394
)
 
(394
)
Credit default swaps on asset-backed indices
 
Credit
 
 
 
(1,245
)
 
(1,245
)
 
 
 
(832
)
 
(832
)
Credit default swaps on corporate bond indices
 
Credit
 
 
 
(4,387
)
 
(4,387
)
 
 
 
(1,026
)
 
(1,026
)
Credit default swaps on corporate bonds
 
Credit
 
 
 
(764
)
 
(764
)
 
 
 
1,110

 
1,110

Total return swaps
 
Equity Market/Credit
 
 
 
(1,046
)
 
(1,046
)
 
 
 
(681
)
 
(681
)
TBAs
 
Interest Rate
 
 
 
(17,183
)
 
(17,183
)
 
 
 
3,680

 
3,680

Futures
 
Interest Rate/Currency
 
 
 
(8,365
)
 
(8,365
)
 
 
 
761

 
761

Forwards
 
Currency
 
 
 
1,068

 
1,068

 
 
 
228

 
228

Options
 
Interest Rate
 
 
 
(35
)
 
(35
)
 
 
 
1

 
1

Total
 
 
 
$
852

 
$
(32,655
)
 
$
(31,803
)
 
$
(60
)
 
$
(9,068
)
 
$
(9,128
)
(1)
Includes gain/(loss) on foreign currency transactions on financial derivatives in the amount of $47 thousand for the nine-month period ended September 30, 2019, which is included on the Condensed Consolidated Statement of Operations in Other, net.
(2)
Includes foreign currency remeasurement on financial derivatives in the amount of $8 thousand for the nine-month period ended September 30, 2019, which is included on the Condensed Consolidated Statement of Operations in Other, net.
The table below details the average notional values of the Company's financial derivatives, using absolute value of month end notional values, for the nine-month period ended September 30, 2019:
Derivative Type
 
Nine-Month
Period Ended
September 30, 2019
(In thousands)
 
 
Interest rate swaps
 
$
730,908

TBAs
 
1,087,157

Credit default swaps
 
410,213

Total return swaps
 
39,779

Futures
 
199,246

Options
 
25,772

Forwards
 
33,360

Warrants
 
2,281


From time to time the Company enters into credit derivative contracts for which the Company sells credit protection ("written credit derivatives"). As of September 30, 2019, all of the Company's open written credit derivatives were credit default swaps on either mortgage/asset-backed indices (ABX and CMBX indices) or corporate bond indices (CDX), collectively referred to as credit indices, or on individual corporate bonds, for which the Company receives periodic payments at fixed rates from credit protection buyers, and is obligated to make payments to the credit protection buyer upon the occurrence of a "credit event" with respect to underlying reference assets.
Written credit derivatives held by the Company at September 30, 2019 are summarized below:
Credit Derivatives
 
September 30, 2019
(In thousands)
 
 
Fair Value of Written Credit Derivatives, Net
 
$
4,718

Fair Value of Purchased Credit Derivatives Offsetting Written Credit Derivatives with Third Parties (1)
 
(2,581
)
Notional Value of Written Credit Derivatives (2)
 
134,377

Notional Value of Purchased Credit Derivatives Offsetting Written Credit Derivatives with Third Parties (1)
 
(84,029
)
(1)
Offsetting transactions with third parties include purchased credit derivatives which have the same reference obligation.
(2)
The notional value is the maximum amount that a seller of credit protection would be obligated to pay, and a buyer of credit protection would receive, upon occurrence of a "credit event." Movements in the value of credit default swap transactions may require the Company or the counterparty to post or receive collateral. Amounts due or owed under credit derivative contracts with an International Swaps and Derivatives Association, or "ISDA," counterparty may be offset against amounts due or owed on other credit derivative contracts with the same ISDA counterparty. As a result, the notional value of written credit derivatives involving a particular underlying reference asset or index has been reduced (but not below zero) by the notional value of any contracts where the Company has purchased credit protection on the same reference asset or index with the same ISDA counterparty.
A credit default swap on a credit index or a corporate bond typically terminates at the stated maturity date in the case of corporate indices or bonds, or, in the case of ABX and CMBX indices, the date that all of the reference assets underlying the index are paid off in full, retired, or otherwise cease to exist. Implied credit spreads may be used to determine the market value of such contracts and are reflective of the cost of buying/selling credit protection. Higher spreads would indicate a greater likelihood that a seller will be obligated to perform (i.e., make protection payments) under the contract. In situations where the credit quality of the underlying reference assets has deteriorated, the percentage of notional values that would be paid up front to enter into a new such contract ("points up front") is frequently used as an indication of credit risk. Credit protection sellers entering the market in such situations would expect to be paid points up front corresponding to the approximate fair value of the contract. For the Company's written credit derivatives that were outstanding at September 30, 2019, implied credit spreads on such contracts ranged between 14.0 and 449.1 basis points. Excluded from these spread ranges are contracts outstanding for which the individual spread is greater than 2,000 basis points. The Company believes that these contracts would be quoted based on estimated points up front. The total fair value of contracts with individual implied credit spreads in excess of 2,000 basis points was $(0.2) million as of September 30, 2019. Estimated points up front on these contracts as of September 30, 2019 ranged between 55.9 and 82.3 points. Total net up-front payments (paid) or received relating to written credit derivatives outstanding at September 30, 2019 were $(3.2) million.
Financial Derivatives
Gains and losses on the Company's derivative contracts for the three- and nine-month periods ended September 30, 2018 are summarized in the table below:
 
 
 
 
Three-Month Period Ended September 30, 2018
 
Nine-Month Period Ended September 30, 2018
Derivative Type
 
Primary Risk
Exposure
 
Net Realized
Gain/(Loss)(1)
 
Change in Net Unrealized Gain/(Loss)(2)
 
Net Realized
Gain/(Loss)(1)
 
Change in Net Unrealized Gain/(Loss)(2)
(In thousands)
 
 
 
 
 
 
 
 
 
 
Credit default swaps on asset-backed securities
 
Credit
 
$
(986
)
 
$
1,307

 
$
(739
)
 
$
759

Credit default swaps on asset-backed indices
 
Credit
 
(153
)
 
(291
)
 
(2,199
)
 
1,161

Credit default swaps on corporate bond indices
 
Credit
 
(1,085
)
 
(247
)
 
(3,322
)
 
2,181

Credit default swaps on corporate bonds
 
Credit
 
1,234

 
(1,031
)
 
4,230

 
(1,823
)
Total return swaps
 
Equity Market/Credit
 
32

 
(1,425
)
 
455

 
(1,739
)
Interest rate swaps
 
Interest Rate
 
1,000

 
1,171

 
(500
)
 
8,301

Futures
 
Interest Rate/Currency
 
729

 
1,021

 
1,652

 
2,002

Forwards
 
Currency
 
10

 
228

 
(59
)
 
712

Options
 
Interest Rate/
Equity Market
 
—

 
—

 
(62
)
 
76

Total
 
 
 
$
781

 
$
733

 
$
(544
)
 
$
11,630


(1)
Includes gain/(loss) on foreign currency transactions on derivatives in the amount of $5 thousand and $(0.2) million, for the three- and nine-month periods ended September 30, 2018, respectively, which is included on the Consolidated Statement of Operations in Realized gain (loss) on foreign currency transactions.
(2)
Includes foreign currency translation on derivatives in the amount of $32 thousand and $0.3 million, for the three- and nine-month periods ended September 30, 2018, respectively, which is included on the Consolidated Statement of Operations in Change in net unrealized gain (loss) on foreign currency translation.
The table below details the average notional values of the Company's financial derivatives, using absolute value of month end notional values, for the year ended December 31, 2018:
Derivative Type
 
Year Ended
December 31, 2018
 
 
(In thousands)
Interest rate swaps
 
$
1,059,756

Credit default swaps
 
566,805

Total return swaps
 
53,603

Futures
 
201,295

Options
 
99,891

Forwards
 
45,522


From time to time the Company enters into credit derivative contracts for which the Company sells credit protection ("written credit derivatives"). As of December 31, 2018 all of the Company's open written credit derivatives were credit default swaps on either mortgage/asset-backed indices (ABX and CMBX indices) or corporate bond indices (CDX), collectively referred to as credit indices, or on individual corporate bonds, for which the Company receives periodic payments at fixed rates from credit protection buyers, and is obligated to make payments to the credit protection buyer upon the occurrence of a "credit event" with respect to underlying reference assets.
Written credit derivatives held by the Company at December 31, 2018 are summarized below:
Credit Derivatives
 
December 31, 2018
(In thousands)
 
 
Fair Value of Written Credit Derivatives, Net
 
$
(4,339
)
Fair Value of Purchased Credit Derivatives Offsetting Written Credit Derivatives with Third Parties (1)
 
(284
)
Notional Value of Written Credit Derivatives (2)
 
98,586

Notional Value of Purchased Credit Derivatives Offsetting Written Credit Derivatives with Third Parties (1)
 
(41,134
)
(1)
Offsetting transactions with third parties include purchased credit derivatives which have the same reference obligation.
(2)
The notional value is the maximum amount that a seller of credit protection would be obligated to pay, and a buyer of credit protection would receive, upon occurrence of a "credit event." Movements in the value of credit default swap transactions may require the Company or the counterparty to post or receive collateral. Amounts due or owed under credit derivative contracts with an International Swaps and Derivatives Association, or "ISDA," counterparty may be offset against amounts due or owed on other credit derivative contracts with the same ISDA counterparty. As a result, the notional value of written credit derivatives involving a particular underlying reference asset or index has been reduced (but not below zero) by the notional value of any contracts where the Company has purchased credit protection on the same reference asset or index with the same ISDA counterparty.
A credit default swap on a credit index or a corporate bond typically terminates at the stated maturity date in the case of corporate indices or bonds, or, in the case of ABX and CMBX indices, the date that all of the reference assets underlying the index are paid off in full, retired, or otherwise cease to exist. Implied credit spreads may be used to determine the market value of such contracts and are reflective of the cost of buying/selling credit protection. Higher spreads would indicate a greater likelihood that a seller will be obligated to perform (i.e., make protection payments) under the contract. In situations where the credit quality of the underlying reference assets has deteriorated, the percentage of notional values that would be paid up front to enter into a new such contract ("points up front") is frequently used as an indication of credit risk. Credit protection sellers entering the market in such situations would expect to be paid points up front corresponding to the approximate fair value of the contract. For the Company's written credit derivatives that were outstanding at December 31, 2018, implied credit spreads on such contracts ranged between 42.6 and 815.1 basis points. Excluded from this spread range are contracts outstanding for which the individual spread is greater than 2,000 basis points. The Company believes that these contracts would be quoted based on estimated points up front. The total fair value of contracts with individual implied credit spreads in excess of 2,000 basis points was $(1.0) million as of December 31, 2018. Estimated points up front on these contracts as of December 31, 2018 ranged between 36.9 and 75.2 points. Total net up-front payments (paid) or received relating to written credit derivatives outstanding at December 31, 2018 were $(2.0) million.