Derivatives and Hedging Activities

The following table presents information with respect to the Company's derivative instruments:



$ in thousands	Notional Amount as of January 1, 2016	Additions	Settlement, Termination, Expiration or Exercise		Notional Amount as of June 30, 2016
Interest Rate Swaptions	300,000	—	(300,000	)	—
Interest Rate Swaps	11,450,000	—	(4,800,000	)	6,650,000
Currency Forward Contracts	76,324	162,843	(154,867	)	84,300
Credit Derivatives	645,000	—	(73,399	)	571,601
Total	12,471,324	162,843	(5,328,266	)	7,305,901

Credit Derivatives

The Company's GSE CRTs purchased prior to August 24, 2015 are accounted for as hybrid financial instruments consisting of a debt host contract and an embedded derivative and are reported at fair value. At June 30, 2016 and December 31, 2015, terms of the GSE CRT embedded derivatives are:



$ in thousand	June 30, 2016		December 31, 2015
Fair value amount	(6,493	)	(25,722	)
Notional amount	571,601		645,000
Maximum potential amount of future undiscounted payments	571,601		645,000

Interest Rate Swaps

The Company's repurchase agreements are usually settled on a short-term basis ranging from one to twelve months. At each settlement date, the Company typically refinances each repurchase agreement at the market interest rate at that time. In addition, the Company's secured loans have floating interest rates. As such, the Company is exposed to changing interest rates. The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposures to interest rate movements. To accomplish this objective, the Company primarily uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.

Effective December 31, 2013, the Company voluntarily discontinued cash flow hedge accounting for its interest rate swaps to gain greater flexibility in managing interest rate exposures. Amounts recorded in AOCI prior to the Company discontinuing cash flow hedge accounting for its interest rate swaps are reclassified to interest expense on repurchase agreements on the condensed consolidated statements of operations as interest is accrued and paid on the related repurchase agreements over the remaining life of the interest rate swap agreements. The Company reclassified $3.2 million (June 30, 2015: $16.3 million) and $16.2 million (June 30, 2015: $35.5 million) as an increase to interest expense for the three and six months ended June 30, 2016, respectively. During the next 12 months, the Company estimates that $23.7 million will be reclassified as a decrease to interest expense, repurchase agreements. As of June 30, 2016, $164.2 million (December 31, 2015: $148.3 million) of unrealized gain/(loss) on discontinued cash flow hedges, net is still included in accumulated other comprehensive income.

As of June 30, 2016, the Company had the following interest rate swaps outstanding:



$ in thousands Counterparty	Notional	Maturity Date	Fixed Interest Rate in Contract
Deutsche Bank AG	150,000	2/5/2018	2.90	%
ING Capital Markets LLC	350,000	2/24/2018	0.95	%
UBS AG	500,000	5/24/2018	1.10	%
ING Capital Markets LLC	400,000	6/5/2018	0.87	%
CME Central Clearing	300,000	2/5/2021	2.50	%
CME Central Clearing	300,000	2/5/2021	2.69	%
Wells Fargo Bank, N.A.	200,000	3/15/2021	3.14	%
CME Central Clearing	500,000	5/24/2021	2.25	%
Citibank, N.A.	200,000	5/25/2021	2.83	%
CME Central Clearing	500,000	6/24/2021	2.44	%
HSBC Bank USA, National Association	550,000	2/24/2022	2.45	%
CME Central Clearing	1,000,000	6/9/2022	2.21	%
The Royal Bank of Scotland Plc	500,000	8/15/2023	1.98	%
CME Central Clearing	600,000	8/24/2023	2.88	%
HSBC Bank USA, National Association	500,000	12/15/2023	2.20	%
CME Central Clearing	100,000	4/2/2025	2.04	%
Total	6,650,000		2.16	%

At June 30, 2016, the Company’s counterparties held $267.0 million in cash margin deposits and approximately $200.2 million in Agency RMBS as collateral against its interest rate swaps. Cash margin posted by the Company is classified as due from counterparties, and cash margin posted by counterparties that are restricted in use, if any, is classified as restricted cash. As of June 30, 2016 and December 31, 2015, the Company did not have any restricted cash. The Agency RMBS collateral posted by the Company is included in total mortgage-backed and credit risk transfer securities on the Company’s condensed consolidated balance sheets. Cash collateral that is not restricted for use by the Company is included in cash and cash equivalents and the liability to return the collateral is included in collateral held payable on the condensed consolidated balance sheets. Non-cash collateral posted by counterparties to the Company would be recognized if any counterparty defaults or if the Company sold the pledged collateral. As of June 30, 2016 and December 31, 2015, the Company did not recognize any non-cash collateral held as collateral.

Interest Rate Swaptions

The Company has purchased interest rate swaptions to help mitigate the potential impact of increases or decreases in interest rates on the performance of a portion of the Company’s investment portfolio (referred to as “convexity risk”). The interest rate swaptions provide the Company the option to enter into interest rate swap agreements for a predetermined notional amount, stated term and pay and receive interest rates in the future. The premium paid for interest rate swaptions is reported as a derivative asset in the Company’s condensed consolidated balance sheets. The premium is valued at an amount equal to the fair value of the swaption that would have the effect of closing the position adjusted for nonperformance risk, if any. The difference between the premium and the fair value of the swaption is reported in gain (loss) on derivative instruments, net in the Company’s condensed consolidated statements of operations. If an interest rate swaption expires unexercised, the loss on the interest rate swaption would be equal to the premium paid. If the Company sells or exercises an interest rate swaption, the realized gain or loss on the interest rate swaption would be equal to the difference between the cash or the fair value of the underlying interest rate swap received and the premium paid. As of June 30, 2016, we have no outstanding interest rate swaptions.

The Company did not record any realized or unrealized gains or losses on interest rate swaptions in the three months ended June 30, 2016 (June 30, 2015: $3.1 million of realized loss and $2.3 million of unrealized gain). The Company recorded $1.5 million of unrealized gain representing the change in fair value of the Company's interest rate swaptions and $1.5 million of realized loss on interest rate swaptions that expired unexercised during the six months ended June 30, 2016 (June 30, 2015: $6.0 million of unrealized gain and $7.7 million of realized loss).

TBAs, Futures and Currency Forward Contracts

The Company purchases or sells certain TBAs and U.S. Treasury futures contracts to help mitigate the potential impact of changes in interest rates on the performance of the Company's portfolio. Realized and unrealized gains and losses associated with the purchase or sales of the TBAs and U.S. Treasury futures contracts are recognized in gain (loss) on derivative instruments, net in the Company's condensed consolidated statements of operations.

The Company uses currency forward contracts to help mitigate the potential impact of changes in foreign currency exchange rates on the Company's investments denominated in foreign currencies. Realized and unrealized gains and losses associated with the purchases or sales of currency forward contracts are recognized in gain (loss) on derivative instruments, net in the Company's condensed consolidated statements of operations.

Tabular Disclosure of the Effect of Derivative Instruments on the Balance Sheet

The table below presents the fair value of the Company’s derivative financial instruments, as well as their classification on the condensed consolidated balance sheets as of June 30, 2016 and December 31, 2015.

$ in thousands

Derivative Assets

Derivative Liabilities

As of June 30, 2016

As of December 31, 2015

As of June 30, 2016

As of December 31, 2015

Balance

Sheet

Fair Value

Balance

Sheet

Fair Value

Interest Rate Swap Asset

—

6,795

Interest Rate Swap Liability

447,632

238,045

Currency Forward Contracts

5,502

1,864

Currency Forward Contracts

106

103

Embedded derivatives associated with GSE CRTs are recorded within mortgage-backed and credit risk transfer securities, at fair value, on the consolidated balance sheets. The fair value of the embedded derivatives associated with the GSE CRTs is a net liability of $6.5 million as of June 30, 2016 (December 31, 2015: $25.7 million).

Tabular Disclosure of the Effect of Derivative Instruments on the Income Statement

The tables below present the effect of the Company’s derivative financial instruments on the condensed consolidated statements of operations for the three and six months ended June 30, 2016 and 2015.



$ in thousands
Derivative not designated as hedging instrument	Location of unrealized gain (loss) recognized in income on derivative	Three months ended June 30, 2016	Three months ended June 30, 2015
CDS Contract	Realized and unrealized credit derivative income (loss), net	—	806
GSE CRT Embedded Derivatives	Realized and unrealized credit derivative income (loss), net	11,116	(4,915	)
Total		11,116	(4,109	)



$ in thousands
Derivative not designated as hedging instrument	Location of unrealized gain (loss) recognized in income on derivative	Six months ended June 30, 2016	Six months ended June 30, 2015
CDS Contract	Realized and unrealized credit derivative income (loss), net	—	744
GSE CRT Embedded Derivatives	Realized and unrealized credit derivative income (loss), net	13,212	11,123
Total		13,212	11,867

The following table summarizes the effect of interest rate swaps, swaption contracts, TBAs, futures contracts and currency forward contracts reported in gain (loss) on derivative instruments, net on the condensed consolidated statements of operations for the three and six months ended June 30, 2016 and 2015:



$ in thousands	Three months ended June 30, 2016
Derivative not designated as hedging instrument	Realized gain (loss) on settlement, termination, expiration or exercise, net		Contractual interest expense		Unrealized gain (loss), net		Gain (loss) on derivative instruments, net
Interest Rate Swaps	(20,105	)	(24,985	)	(49,711	)	(94,801	)
Currency Forward Contracts	(479	)	—		4,917		4,438
Total	(20,584	)	(24,985	)	(44,794	)	(90,363	)



$ in thousands	Six months ended June 30, 2016
Derivative not designated as hedging instrument	Realized gain (loss) on settlement, termination, expiration or exercise, net		Contractual interest expense		Unrealized gain (loss), net		Gain (loss) on derivative instruments, net
Interest Rate Swaps	(64,000	)	(54,076	)	(216,382	)	(334,458	)
Interest Rate Swaptions	(1,485	)	—		1,485		—
Currency Forward Contracts	1,916		—		3,636		5,552
Total	(63,569	)	(54,076	)	(211,261	)	(328,906	)



$ in thousands	Three months ended June 30, 2015
Derivative not designated as hedging instrument	Realized gain (loss) on settlement, termination, expiration or exercise, net		Contractual interest expense		Unrealized gain (loss), net		Gain (loss) on derivative instruments, net
Interest Rate Swaps	(12,826	)	(46,011	)	116,623		57,786
Interest Rate Swaptions	(3,050	)	—		2,326		(724	)
Currency Forward Contracts	664		—		(1,723	)	(1,059	)
Total	(15,212	)	(46,011	)	117,226		56,003



$ in thousands	Six months ended June 30, 2015
Derivative not designated as hedging instrument	Realized gain (loss) on settlement, termination, expiration or exercise, net		Contractual interest expense		Unrealized gain (loss), net		Gain (loss) on derivative instruments, net
Interest Rate Swaps	(31,881	)	(91,619	)	60,666		(62,834	)
Interest Rate Swaptions	(7,738	)	—		6,005		(1,733	)
TBAs	(2,292	)	—		558		(1,734	)
Futures Contracts	(943	)	—		(90	)	(1,033	)
Currency Forward Contracts	1,539		—		(947	)	592
Total	(41,315	)	(91,619	)	66,192		(66,742	)

Credit-risk-related Contingent Features

The Company has agreements with each of its bilateral derivative counterparties. Some of those agreements contain a provision whereby if the Company defaults on any of its indebtedness, including default whereby repayment of the indebtedness has not been accelerated by the lender, the Company could be declared in default on its derivative obligations.

At June 30, 2016, the fair value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for non-performance risk related to these agreements, was $182.4 million. The Company has minimum collateral posting thresholds with certain of its derivative counterparties and has posted collateral of $200.2 million of Agency RMBS and $267.0 million of cash as of June 30, 2016. If the Company had breached any of these provisions at June 30, 2016, it could have been required to settle its obligations under the agreements at their termination value.

In addition, as of June 30, 2016, the Company has an agreement with a central clearing counterparty. The fair value of such derivatives in a net liability position, which includes accrued interest but excludes any adjustment for non-performance risk related to this agreement, was $270.4 million.

The Company was in compliance with all of the financial provisions of these counterparty agreements as of June 30, 2016.