Derivatives (Notes)

6 Months Ended

Jun. 30, 2020

Derivative Instruments and Hedging Activities Disclosure [Abstract]

DERIVATIVES

Types and Uses of Derivatives Instruments

Interest Rate Derivatives. Prior to the end of the first quarter of 2020, the Company primarily used interest rate swaps as economic hedges to mitigate declines in book value and to protect some portion of the Company's earnings from rising interest rates; however, the Company substantially reduced its notional balance of interest rate swaps late in the first quarter of 2020 due to the significant reduction of its MBS portfolio. In addition, counterparties began expanding initial margin requirements for interest rate swaps. The Company added short positions in U.S. Treasury futures and increased its holdings of put options on U.S. Treasury futures as these derivative instruments are viewed by management as more liquid and having more favorable margin requirements versus interest rate swaps.

TBA Transactions. The Company purchases TBA securities as a means of investing in non-specified fixed-rate Agency RMBS and may also periodically sell TBA securities as a means of economically hedging its book value exposure to Agency RMBS as well as earnings exposure from rising financing costs. The Company holds long and short positions in TBA securities by executing a series of transactions, commonly referred to as “dollar roll” transactions, which effectively delay the settlement of a forward purchase (or sale) of a non-specified Agency RMBS by entering into an offsetting TBA position, net settling the paired-off positions in cash, and simultaneously entering into an identical TBA long (or short) position with a later settlement date. TBA securities purchased (or sold) for a forward settlement date are generally priced at a discount relative to TBA securities settling in the current month. This discount, often referred to as “drop income” represents the economic equivalent of net interest income (interest income less implied financing cost) on the underlying Agency security from trade date to settlement date. The Company accounts for all TBAs (whether net long or net short positions, or collectively “TBA dollar roll positions”) as derivative instruments because it cannot assert that it is probable at inception and throughout the term of an individual TBA transaction that its settlement will result in physical delivery of the underlying Agency RMBS, or that the individual TBA transaction will not settle in the shortest period possible.

Loss on Derivative Instruments, Net

The table below provides detail of the Company’s “loss on derivative instruments, net” by type of derivative for the periods indicated:


	Three Months						Six Months Ended
	June 30,						June 30,
Type of Derivative Instrument	2020		2019		2020		2019
Interest rate swaps	$	(1,672)	$	(124,213)	$	(183,852)	$	(195,978)
Interest rate swaptions	—		—		(573)		—
Futures	(10,928)		(102)		(19,377)		(211)
Options on U.S. Treasury futures	(6,680)		—		(17,406)		—
TBA securities - long positions	8,688		6,780		27,119		16,956
TBA securities - short positions	2,029		—		(10,041)		—
Loss on derivative instruments, net	$	(8,563)	$	(117,535)	$	(204,130)	$	(179,233)

The table below summarizes information about the fair value by type of derivative instrument on the Company’s consolidated balance sheets as of the dates indicated:


Type of Derivative Instrument	Balance Sheet Location	Purpose	June 30, 2020		December 31, 2019
Options on U.S. Treasury futures	Derivative assets	Economic hedging	$	3,168	$	2,883
Interest rate swaptions	Derivative assets	Economic hedging	—		573
TBA securities - long positions	Derivative assets	Investing	4,758		834
Total derivatives assets			$	7,926	$	4,290

U.S. Treasury futures	Derivative liabilities	Economic hedging	$	(4,208)	$	—
TBA securities - short positions	Derivative liabilities	Economic hedging	—		(974)
Total derivatives liabilities			$	(4,208)	$	(974)

Interest Rate Swaps

The Company has interest rate swap agreements outstanding with various counterparties that are centrally cleared through the CME. As explained in Note 1, the exchange of variation margin for CME cleared interest rate swaps is legally considered to be the settlement of the derivative itself as opposed to a pledge of collateral. Because the Company accounts for this daily exchange of variation margin for its CME cleared interest rate swaps as an increase or decrease to the carrying value of the related derivative asset or liability, the fair value of the interest rate swaps nets to $0 on the Company’s

consolidated balance sheet. The Company had net settlement amounts of $(2,866) and $(9,265) in variation margin for its interest rate swaps as of June 30, 2020 and December 31, 2019, respectively.

The following tables present information about the Company’s interest rate swaps as of the dates indicated:


	June 30, 2020									December 31, 2019
			Weighted-Average							Weighted-Average
Years to Maturity:	Notional Amount		Pay Rate		Life Remaining (in Years)	Notional Amount		Pay Rate		Life Remaining (in Years)
< 3 years	$	50,000	1.35	%	0.3	$	2,860,000	1.58	%	1.5
>3 and < 6 years	—		—	%	—	700,000		1.43	%	4.7
>6 and < 10 years	425,000		0.69	%	9.9	545,000		1.78	%	9.4
>10 years	—		—	%	—	120,000		2.84	%	27.7
Total	$	475,000	0.76	%	9.0	$	4,225,000	1.62	%	3.8

U.S. Treasury Futures and Options

The following table presents information about the Company’s U.S. Treasury futures and options outstanding as of the dates indicated:


	Cost Basis		Fair Value		Notional Amount
As of June 30, 2020:
Options on U.S. Treasury futures ⁽¹⁾	$	20,622	$	3,168	$	1,425,000
U.S. Treasury futures - short positions	n/a		(4,208)		1,225,000

As of December 31, 2019:
Options on U.S. Treasury futures ⁽²⁾	$	4,359	$	2,883	$	1,350,000
Pay-fixed interest rate swaptions ⁽²⁾	6,180		573		750,000

(1) All futures and options outstanding as of June 30, 2020 will expire in September of 2020.

(2) All options outstanding as of December 31, 2019 expired during the first quarter of 2020.

TBA Securities

The following table summarizes information about the Company's TBA securities as of the dates indicated:


	June 30, 2020						December 31, 2019
	Long Positions		Short Positions		Long Positions		Short Positions
Implied market value ⁽¹⁾	$	1,290,078	$	—	$	442,161	$	(520,117)
Implied cost basis ⁽²⁾	1,285,320		—		441,327		(519,143)
Net carrying value ⁽³⁾	$	4,758	$	—	$	834	$	(974)

(1) Implied market value represents the estimated fair value of the underlying Agency MBS as of the date indicated.

(2) Implied cost basis represents the forward price to be paid for the underlying Agency MBS as of the date indicated.

(3) Net carrying value is the amount included on the consolidated balance sheets within “derivative assets (liabilities)” and represents the difference between the implied market value and the implied cost basis of the TBA security as of the date indicated.

Volume of Activity

The tables below summarize changes in the Company’s derivative instruments for the period indicated:


Type of Derivative Instrument	Notional Amount as of December 31, 2019		Additions		Settlements, Terminations, or Pair-Offs		Notional Amount as of June 30, 2020
Interest rate swaps	$	4,225,000	$	2,915,000	$	(6,665,000)	$	475,000
Interest rate swaptions	750,000		—		(750,000)		—
U.S. Treasury futures - short positions	—		2,212,600		(3,437,600)		(1,225,000)
Options on U.S. Treasury futures	1,350,000		3,425,000		(3,350,000)		1,425,000
TBA - long positions	435,000		5,311,000		(4,496,000)		1,250,000
TBA - short positions	500,000		3,017,000		(3,517,000)		—

Offsetting

The Company's derivatives are subject to underlying agreements with master netting or similar arrangements, which provide for the right of offset in the event of default or in the event of bankruptcy of either party to the transactions. The Company reports its derivative assets and liabilities subject to these arrangements on a gross basis. The following tables present information regarding those derivative assets and liabilities subject to such arrangements as if the Company had presented them on a net basis as of June 30, 2020 and December 31, 2019:


	Offsetting of Assets
	Gross Amount of Recognized Assets		Gross Amount Offset in the Balance Sheet		Net Amount of Assets Presented in the Balance Sheet		Gross Amount Not Offset in the Balance Sheet ⁽¹⁾						Net Amount
														Financial Instruments Received as Collateral	Cash Received as Collateral
June 30, 2020

Options on U.S. Treasury futures	$	3,168	—		$	3,168	$	—	$	—	$	3,168
TBA - long positions	4,758		—		4,758		—		—		4,758
Derivative assets	$	7,926	$	—	$	7,926	$	—	$	—	$	7,926
December 31, 2019
Interest rate swaptions	$	573	$	—	$	573	$	—	$	—	$	573
Options on U.S. Treasury futures	2,883		—		2,883		—		—		2,883
TBA - long positions	834		—		834		(380)		—		454
Derivative assets	$	4,290	$	—	$	4,290	$	(380)	$	—	$	3,910


	Offsetting of Liabilities
	Gross Amount of Recognized Liabilities		Gross Amount Offset in the Balance Sheet		Net Amount of Liabilities Presented in the Balance Sheet		Gross Amount Not Offset in the Balance Sheet ⁽¹⁾						Net Amount
														Financial Instruments Posted as Collateral	Cash Posted as Collateral
June 30, 2020
U.S. Treasury futures	$	(4,208)	—		$	(4,208)	$	—	$	4,208	$	—
TBA - short positions	—		—		—		—		—		—
Derivative liabilities	$	(4,208)	$	—	$	(4,208)	$	—	$	4,208	$	—

December 31, 2019
TBA - short positions	$	(974)	—		$	(974)	$	380	—		$	(594)
Derivative liabilities	$	(974)	$	—	$	(974)	$	380	$	—	$	(594)

(1) Amounts disclosed for collateral received by or posted to the same counterparty include cash and the fair value of MBS up to and not exceeding the net amount of the derivative asset or liability presented in the balance sheet. The fair value of the total collateral received by or posted to the same counterparty may exceed the amounts presented. Please refer to the consolidated balance sheets for the total cash posted as collateral, which is recorded as "restricted cash," and the total fair value of financial instruments pledged as collateral for derivatives and repurchase agreements, which is shown parenthetically.

Please see Note 3 for information related to the Company’s repurchase agreements, which are also subject to underlying agreements with master netting or similar arrangements.