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USE OF DERIVATIVES, OFFSETTING DISCLOSURES AND CHANGES IN OTHER COMPREHENSIVE INCOME BY COMPONENT
 9 Months Ended
Sep. 30, 2019
Derivative Instruments And Hedging Activities Disclosure [Abstract]  
USE OF DERIVATIVES, OFFSETTING DISCLOSURES AND CHANGES IN OTHER COMPREHENSIVE INCOME BY COMPONENT

NOTE 6 — USE OF DERIVATIVES, OFFSETTING DISCLOSURES AND CHANGES IN OTHER COMPREHENSIVE INCOME BY COMPONENT

Capstead’s portfolio of derivative instruments hedge the variability of the underlying benchmark interest rate of current and forecasted 30- to 90-day secured borrowings.  The Company attempts to mitigate exposure to higher interest rates primarily by entering into one- and three-month LIBOR-indexed, pay-fixed, receive-variable, interest rate swap agreements for terms of two and three years. From an economic perspective, this hedge relationship establishes a relatively stable fixed rate on related borrowings because the variable-rate payments received on the swap agreements offset a significant portion of the interest accruing on the borrowings, leaving the fixed-rate swap payments as the Company’s effective borrowing rate, subject to certain adjustments. Additionally, changes in fair value of these Derivatives tend to partially offset opposing changes in fair value of the Company’s residential mortgage investments that can occur in response to changes in market interest rates.

Historically, the Company designated its interest rate swaps related to secured borrowings as hedges for accounting purposes, whereby changes in the swaps’ fair values were recorded in Accumulated other comprehensive income (loss).  The Company discontinued hedge accounting on March 1, 2019 for these swaps and, for GAAP purposes, related changes in the fair value are recorded in the Company’s consolidated statements of operations beginning on that date. Also, for GAAP purposes, related net unrealized gains recorded in Accumulated other comprehensive income (loss) through February 28, 2019 are being recognized as a component of interest expense in the Company’s consolidated statements of operations over the remaining lives of these swaps.

During the quarter and nine months ended September 30, 2019, Capstead entered into swap agreements with notional amounts of $1.70 billion and $6.40 billion, respectively, requiring fixed-rate interest payments averaging 1.60% and 2.17%. During the quarter and nine months ended September 30, 2019, $550 million and $3.15 billion, respectively, notional amount of swaps requiring fixed-rate interest payments averaging 1.40% and 1.42% matured. The Company also terminated $1.5 billion and $2.60 billion notional amount of swaps requiring fixed-rate interest payments averaging 2.64% and 2.72% during the quarter and nine months ended September 30, 2019.  At September 30, 2019 the Company’s swap positions related to secured borrowings had the following characteristics (dollars in thousands):

 

Period of

Contract Expiration

 

Notional

Amount

 

 

Average Fixed-Rate

Payment Requirement

 

Fourth quarter 2019

 

$

700,000

 

 

 

1.72

%

First quarter 2020

 

 

600,000

 

 

 

2.07

 

Second quarter 2020

 

 

200,000

 

 

 

2.56

 

Third quarter 2020

 

 

200,000

 

 

 

1.64

 

Fourth quarter 2020

 

 

200,000

 

 

 

2.04

 

Second quarter 2021

 

 

800,000

 

 

 

1.95

 

Third quarter 2021

 

 

1,700,000

 

 

 

1.60

 

First quarter 2022

 

 

1,500,000

 

 

 

2.50

 

Second quarter 2022

 

 

1,300,000

 

 

 

2.30

 

 

 

$

7,200,000

 

 

 

 

 

 

During the quarter and nine months ended September 30, 2019, the Company entered into a series of $500 million notional amount three-month  Eurodollar futures contracts with a weighted average rate of 1.62% with maturities through June 2020.

The Company has three-month LIBOR-indexed, pay-fixed, receive-variable, interest rate swap agreements with notional amounts totaling $100 million and average fixed rates of 4.09% with 20-year payment terms coinciding with the floating-rate terms of the Company’s Unsecured borrowings.  These Derivatives, which are designated as cash flow hedges for accounting purposes, hedge the variability of the underlying contractual rate associated with the floating-rate terms of these long-term borrowings which began on various dates between October 2015 and September 2016.

 

Interest rate swap agreements are measured at fair value on a recurring basis primarily using Level 2 Inputs in accordance with ASU 2010-06, Fair Value Measurements and Disclosures (Topic 820).  Fair value estimates for these Derivatives are calculated using the net discounted future fixed cash payments and the discounted future variable cash receipts which are based on expected future interest rates derived from observable market interest rate curves.  The Company also incorporates both its own nonperformance risk and its counterparties’ nonperformance risk in determining fair value.  In considering the effect of nonperformance risk, the Company considered the impact of netting and credit enhancements, such as collateral postings and guarantees, and has concluded that counterparty risk is not significant to the overall valuation.  

 

The fair value of exchange-traded swap agreements hedging Secured borrowings is calculated including accrued interest and net of variation margin amounts received or paid through the exchange, resulting in separately presenting on the balance sheet a significantly reduced fair value amount representing the unsettled fair value of these Derivatives.  Non-exchange traded swap agreements held as cash flow hedges of Unsecured borrowings are reported at fair value calculated excluding accrued interest.  At September 30, 2019, Cash collateral receivable from derivative counterparties includes initial margin for all swap agreements and variation margin for non-exchange traded swap agreements.  Accrued interest for non-exchange traded swap agreements is included in Accounts payable and accrued expenses.  

Eurodollar futures are measured at fair value using Level 1 inputs based on quoted exchange prices on these contracts.

 

The following tables include fair value and other related disclosures regarding all Derivatives held as of and for the indicated periods (in thousands):

 

 

 

Balance Sheet

 

September 30

 

 

December 31

 

 

 

Location

 

2019

 

 

2018

 

Balance sheet-related

 

 

 

 

 

 

 

 

 

 

Swap agreements in a gain position (an asset) related to

   secured borrowings

 

(a)

 

$

492

 

 

$

–

 

Eurodollar futures contracts in a gain position

 

(a)

 

 

775

 

 

–

 

Swap agreements in a loss position (a liability) related to

 

 

 

 

 

 

 

 

 

 

unsecured borrowings

 

(a)

 

 

(35,515

)

 

 

(17,834

)

Related net interest payable

 

(b)

 

 

(916

)

 

 

(372

)

 

 

 

 

$

(35,164

)

 

$

(18,206

)

 

(a)

The fair value of Derivatives with unrealized gains are aggregated and recorded as an asset on the face of the Balance Sheets separately from the fair value of Derivatives with unrealized losses that are recorded as a liability.  The amount of unrealized losses, net of unrealized gains, included in Accumulated other comprehensive income (loss) and scheduled to be recognized in the Statements of Operations over the next twelve months primarily in the form of a fixed-rate swap payments in excess of current market rates on swaps related to unsecured borrowings and amortization of net unrealized losses on de-designated interest rate swaps totaled $(409,000) at September 30, 2019.

(b)

Included in “Accounts payable and accrued expenses” on the face of the Balance Sheets.

 

Location of

Gain or (Loss)

Recognized in

 

Quarter Ended September 30

 

 

Nine Months Ended September 30

 

 

Net Income

 

 

2019

 

 

 

2018

 

 

 

2019

 

 

 

2018

 

Income statement-related

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Components of Secured borrowings-related effects

   on interest expense:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amount of gain reclassified from

   Accumulated other comprehensive

   income (loss)

 

 

$

–

 

 

$

11,585

 

 

$

7,891

 

 

$

27,277

 

Amortization of unrealized gain, net

   of unrealized losses on de-designated

   Derivatives

 

 

 

3,120

 

 

–

 

 

$

12,854

 

 

–

 

 

(a)

 

 

3,120

 

 

 

11,585

 

 

 

20,745

 

 

 

27,277

 

Component of Unsecured borrowings-related

   effects on interest expense:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amount of loss reclassified from Accumulated

   other comprehensive income (loss)

(b)

 

 

(418

)

 

 

(423

)

 

 

(1,121

)

 

 

(1,501

)

Decrease in interest expense as a result of the

   use of Derivatives

 

 

$

2,702

 

 

$

11,162

 

 

$

19,624

 

 

$

25,776

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Realized and unrealized (loss) gain on

   non-designated Derivatives (net) related to:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate swap agreements

 

 

$

(10,262

)

 

$

–

 

 

$

(106,761

)

 

$

–

 

Eurodollar futures

 

 

 

1,041

 

 

–

 

 

 

1,041

 

 

–

 

 

(c)

 

$

(9,221

)

 

$

–

 

 

$

(105,720

)

 

$

–

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income-related

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amount of (loss) gain recognized in Other

   comprehensive income

 

 

$

(7,648

)

 

$

7,580

 

 

$

(22,945

)

 

$

46,385

 

 

(a)

Included in “Interest expense:  Secured borrowings” on the face of the Statements of Operations.

(b)

Included in “Interest expense:  Unsecured borrowings” on the face of the Statements of Operations.

(c)

Included in “Loss on derivative instruments (net)” on the face of the Statement of Operations.

 

Capstead’s swap agreements and borrowings under repurchase arrangements are subject to master netting arrangements in the event of default on, or termination of, any one contract.  See NOTE 5 for more information on the Company’s use of secured borrowings.  The following tables provide disclosures concerning offsetting of financial liabilities and Derivatives as of the indicated dates (in thousands):

 

 

 

Offsetting of Derivative Assets

 

 

 

 

 

 

 

Gross

 

 

Net Amounts

 

 

Gross Amounts Not Offset

 

 

 

 

 

 

 

Gross

 

 

Amounts

 

 

of Assets

 

 

in the Balance Sheet (b)

 

 

 

 

 

 

 

Amounts of

 

 

Offset in

 

 

Presented in

 

 

 

 

 

 

Cash

 

 

 

 

 

 

 

Recognized

 

 

the Balance

 

 

the Balance

 

 

Financial

 

 

Collateral

 

 

Net

 

 

 

Assets (a)

 

 

Sheet (a)

 

 

Sheet

 

 

Instruments

 

 

Received

 

 

Amount

 

September 30, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Counterparty 4

 

$

5,726

 

 

$

(4,459

)

 

$

1,267

 

 

$

–

 

 

$

–

 

 

$

1,267

 

December 31, 2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Counterparty 4

 

$

26,787

 

 

$

(26,787

)

 

$

–

 

 

$

–

 

 

$

–

 

 

$

–

 

 

(a)

Included in gross amounts of recognized assets at September 30, 2019 are the fair value of exchange-traded swap agreements, calculated including accrued interest, and the fair value of Eurodollar futures contracts.  Included in gross amounts offset in the balance sheet are variation margin amounts associated with exchange-traded swaps at September 30, 2019.

(b)

Amounts presented are limited to recognized liabilities and cash collateral received associated with the indicated counterparty sufficient to reduce the related Net Amount to zero in accordance with ASU No. 2011-11, as amended by ASU No. 2013-01.

 

 

 

Offsetting of Financial Liabilities and Derivative Liabilities

 

 

 

 

 

 

 

Gross

 

 

Net Amounts

 

 

Gross Amounts Not Offset

 

 

 

 

 

 

 

Gross

 

 

Amounts

 

 

of Liabilities

 

 

in the Balance Sheet (c)

 

 

 

 

 

 

 

Amounts of

 

 

Offset in

 

 

Presented in

 

 

 

 

 

 

Cash

 

 

 

 

 

 

 

Recognized

 

 

the Balance

 

 

the Balance

 

 

Financial

 

 

Collateral

 

 

Net

 

 

 

Liabilities (a)

 

 

Sheet (a)

 

 

Sheet (b)

 

 

Instruments

 

 

Pledged

 

 

Amount

 

September 30, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivatives by

   counterparty:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Counterparty 1

 

$

36,431

 

 

$

–

 

 

$

36,431

 

 

$

–

 

 

$

(36,431

)

 

$

–

 

Counterparty 4

 

 

77,317

 

 

 

(77,317

)

 

–

 

 

–

 

 

–

 

 

–

 

 

 

 

113,748

 

 

 

(77,317

)

 

 

36,431

 

 

–

 

 

 

(36,431

)

 

–

 

Borrowings under

   repurchase

   arrangements (d)

 

 

10,299,497

 

 

–

 

 

 

10,299,497

 

 

 

(10,299,497

)

 

–

 

 

–

 

 

 

$

10,413,245

 

 

$

(77,317

)

 

$

10,335,928

 

 

$

(10,299,497

)

 

$

(36,431

)

 

$

–

 

December 31, 2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivatives by

   counterparty:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Counterparty 1

 

$

18,205

 

 

$

–

 

 

$

18,205

 

 

$

–

 

 

$

(18,205

)

 

$

–

 

Counterparty 4

 

 

9,718

 

 

 

(9,718

)

 

 

–

 

 

 

–

 

 

–

 

 

–

 

 

 

 

27,923

 

 

 

(9,718

)

 

 

18,205

 

 

 

–

 

 

 

(18,205

)

 

–

 

Borrowings under

   repurchase

   arrangements (d)

 

 

10,987,329

 

 

–

 

 

 

10,987,329

 

 

 

(10,987,329

)

 

–

 

 

–

 

 

 

$

11,015,252

 

 

$

(9,718

)

 

$

11,005,534

 

 

$

(10,987,329

)

 

$

(18,205

)

 

$

–

 

 

(a)

Included in gross amounts of recognized liabilities at September 30, 2019 is the fair value of non-exchange traded swap agreements (Counterparty 1) and exchange-traded swap agreements (Counterparty 4), calculated including accrued interest.  Included in gross amounts offset in the balance sheet are variation margin amounts associated with exchange-traded swap agreements at September 30, 2019.

(b)

Amounts presented are limited to recognized liabilities and cash collateral received associated with the indicated counterparty sufficient to reduce the related Net Amount to zero in accordance with ASU No. 2011-11, as amended by ASU No. 2013-01.

(c)

Amounts presented are limited to recognized assets and collateral pledged associated with the indicated counterparty sufficient to reduce the related Net Amount to zero in accordance with ASU No. 2011-11, as amended by ASU No. 2013-01.

(d)

Amounts include accrued interest payable of $7.5 million and $9.0 million on borrowings under repurchase arrangements as of September 30, 2019 and December 31, 2018, respectively.

Changes in Accumulated other comprehensive income (loss) by component for the quarter and nine months ended September 30, 2019 were as follows (in thousands):

 

 

Unrealized

Gains and Losses

on Cash Flow

Hedges

 

 

Unrealized Gains

and Losses on

Available-for-Sale

Securities

 

 

Total

 

Balance at June 30, 2019

 

$

(26,019

)

 

$

64,780

 

 

$

38,761

 

Activity for the quarter ended September 30, 2019:

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive loss before

   reclassifications

 

 

(7,648

)

 

 

(2,692

)

 

 

(10,340

)

Amounts reclassified from accumulated

   other comprehensive income

 

 

(2,702

)

 

–

 

 

 

(2,702

)

Other comprehensive loss

 

 

(10,350

)

 

 

(2,692

)

 

 

(13,042

)

Balance at September 30, 2019

 

$

(36,369

)

 

$

62,088

 

 

$

25,719

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2018

 

$

6,200

 

 

$

(27,246

)

 

$

(21,046

)

Activity for the nine months ended September 30, 2019:

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive loss before

   reclassifications

 

 

(22,945

)

 

 

89,334

 

 

 

66,389

 

Amounts reclassified from accumulated other

   comprehensive income

 

 

(19,624

)

 

–

 

 

 

(19,624

)

Other comprehensive loss

 

 

(42,569

)

 

 

89,334

 

 

 

46,765

 

Balance at September 30, 2019

 

$

(36,369

)

 

$

62,088

 

 

$

25,719