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DERIVATIVE INSTRUMENTS | 9 Months Ended
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Sep. 30, 2022
Derivative Instruments and Hedging Activities Disclosure [Abstract] |
DERIVATIVE INSTRUMENTS |
11. DERIVATIVE INSTRUMENTS
Derivative instruments include, but are not limited to, interest rate swaps, options to enter into interest rate swaps (“swaptions”), TBA derivatives, options on TBA securities (“MBS options”), U.S. Treasury and Eurodollar futures contracts and certain forward purchase commitments. The Company may also enter into other types of mortgage derivatives such as interest-only securities, credit derivatives referencing the commercial mortgage-backed securities index and synthetic total return swaps. In connection with the Company’s investment/market rate risk management strategy, the Company economically hedges a portion of its interest rate risk by entering into derivative financial instrument contracts, which include interest rate swaps, swaptions and futures contracts. The Company may also enter into TBA derivatives, MBS options and U.S. Treasury or Eurodollar futures contracts, certain forward purchase commitments and credit derivatives to economically hedge its exposure to market risks. The purpose of using derivatives is to manage overall portfolio risk with the potential to generate additional income for distribution to stockholders. These derivatives are subject to changes in market values resulting from changes in interest rates, volatility, Agency mortgage-backed security spreads to U.S. Treasuries and market liquidity. The use of derivatives also 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 stated contract. Additionally, the Company may have to pledge cash or assets as collateral for the derivative transactions, the amount of which may vary based on the market value and terms of the derivative contract. In the case of market agreed coupon (“MAC”) interest rate swaps, the Company may make or receive a payment at the time of entering into such interest rate swaps, which represents fair value of these swaps, to compensate for the out of market nature of such interest rate swaps. Subsequent changes in fair value from inception of these interest rate swaps are reflected within Net gains (losses) on derivatives in the Consolidated Statements of Comprehensive Income (Loss). Similar to other interest rate swaps, the Company may have to pledge cash or assets as collateral for the MAC interest rate swap transactions. In the event of a default by the counterparty, the Company could have difficulty obtaining its pledged collateral as well as receiving payments in accordance with the terms of the derivative contracts. Derivatives are recognized as either assets or liabilities at fair value in the Consolidated Statements of Financial Condition with changes in fair value recognized in the Consolidated Statements of Comprehensive Income (Loss). The changes in the estimated fair value are presented within Net gains (losses) on derivatives. None of the Company’s derivative transactions have been designated as hedging instruments for accounting purposes. The Company also maintains collateral in the form of cash on margin with counterparties to its interest rate swaps and other derivatives. In accordance with a clearing organization’s rulebook, the Company presents the fair value of centrally cleared interest rate swaps net of variation margin pledged under such transactions. At September 30, 2022 and December 31, 2021, ($3.2) billion and ($0.4) billion, respectively, of variation margin was reported as an adjustment to interest rate swaps, at fair value. Interest Rate Swap Agreements – Interest rate swap agreements are the primary instruments used to mitigate interest rate risk. In particular, the Company uses interest rate swap agreements to manage its exposure to changing interest rates on its repurchase agreements by economically hedging cash flows associated with these borrowings. The Company may have outstanding interest rate swap agreements where the floating leg is linked to the London Interbank Offered Rate (“LIBOR”), the overnight index swap rate or another index. Interest rate swap agreements may or may not be cleared through a derivatives clearing organization (“DCO”). Uncleared interest rate swaps are fair valued using internal pricing models and compared to the counterparty market values. Centrally cleared interest rate swaps, including MAC interest rate swaps, are generally fair valued using the DCO’s market values. If an interest rate swap is terminated, the realized gain (loss) on the interest rate swap would be equal to the difference between the cash received or paid and fair value. Swaptions – Swaptions are purchased or sold to mitigate the potential impact of increases or decreases in interest rates. 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. The premium paid or received for swaptions is reported as an asset or liability in the Consolidated Statements of Financial Condition. If a swaption expires unexercised, the realized gain (loss) on the swaption would be equal to the premium received or paid. If the Company sells or exercises a swaption, the realized gain (loss) on the swaption would be equal to the difference between the cash received or the fair value of the underlying interest rate swap received and the premium paid. The fair value of swaptions are estimated using internal pricing models and compared to the counterparty market values. TBA Dollar Rolls – TBA dollar roll transactions are accounted for as a series of derivative transactions. The fair value of TBA derivatives is based on methods similar to those used to value Agency mortgage-backed securities. MBS Options – MBS options are generally options on TBA contracts, which help manage mortgage market risks and volatility while providing the potential to enhance returns. MBS options are over-the-counter traded instruments and those written on current-coupon mortgage-backed securities are typically the most liquid. MBS options are measured at fair value using internal pricing models and compared to the counterparty market value at the valuation date. Futures Contracts – Futures contracts are derivatives that track the prices of specific assets or benchmark rates. Short sales of futures contracts help to mitigate the potential impact of changes in interest rates on the portfolio performance. The Company maintains margin accounts which are settled daily with Futures Commission Merchants (“FCMs”). The margin requirement varies based on the market value of the open positions and the equity retained in the account. Futures contracts are fair valued based on exchange pricing. Forward Purchase Commitments – The Company may enter into forward purchase commitments with counterparties whereby the Company commits to purchasing residential mortgage loans at a particular price, provided the residential mortgage loans close with the counterparties. The counterparties are required to deliver the committed loans on a “best efforts” basis. Credit Derivatives – The Company may enter into credit derivatives referencing a commercial mortgage-backed securities index, such as the CMBX index, and synthetic total return swaps. The table below summarizes fair value information about our derivative assets and liabilities at September 30, 2022 and December 31, 2021:
Derivatives Instruments |  |  | September 30, 2022 |  | December 31, 2021
Assets |  |  | (dollars in thousands)
Interest rate swaps |  |  | $ | 36,861 |  |  | $ | — |
Interest rate swaptions |  |  | 344,301 |  |  | 105,710 |
TBA derivatives |  |  | 28,033 |  |  | 52,693 |
Futures contracts |  |  | 1,539,298 |  |  | 9,028 |
Purchase commitments |  |  | 1,037 |  |  | 1,779 |
Credit derivatives (1) |  |  | — |  |  | 1,160 |
Total derivative assets |  |  | $ | 1,949,530 |  |  | $ | 170,370 |
Liabilities |  |  |  |  |
Interest rate swaps |  |  | $ | 108,071 |  |  | $ | 747,036 |
TBA derivatives |  |  | 635,652 |  |  | 3,916 |
Futures contracts |  |  | 2,946 |  |  | 129,134 |
Purchase commitments |  |  | 2,485 |  |  | 870 |
Credit derivatives (1) |  |  | 15,381 |  |  | 581 |
Total derivative liabilities |  |  | $ | 764,535 |  |  | $ | 881,537 |
(1) The maximum potential amount of future payments is the notional amount of credit derivatives in which the Company sold protection of $420.0 million and $400.0 million at September 30, 2022 and December 31, 2021, respectively, plus any coupon shortfalls on the underlying tranche. As of September 30, 2022 and December 31, 2021 the credit derivative tranches referencing the basket of bonds had a range of ratings between AAA and AA.
The following table summarizes certain characteristics of the Company’s interest rate swaps at September 30, 2022 and December 31, 2021:
September 30, 2022
Maturity | Current Notional (1)(2) |  | Weighted Average Pay Rate |  | Weighted Average Receive Rate |  | Weighted Average Years to Maturity (3)
(dollars in thousands)
0 - 3 years | $ | 21,501,900 |  |  | 1.08 | % |  | 2.95 | % |  | 0.66
3 - 6 years | 1,120,400 |  |  | 2.20 | % |  | 2.95 | % |  | 4.32
6 - 10 years | 15,936,200 |  |  | 2.06 | % |  | 2.99 | % |  | 9.29
Greater than 10 years | 2,309,000 |  |  | 3.49 | % |  | 2.89 | % |  | 23.18
Total / Weighted average | $ | 40,867,500 |  |  | 1.53 | % |  | 2.96 | % |  | 5.40
December 31, 2021
Maturity | Current Notional (1)(2) |  | Weighted Average Pay Rate |  | Weighted Average Receive Rate |  | Weighted Average Years to Maturity (3)
(dollars in thousands)
0 - 3 years | $ | 32,709,300 |  |  | 0.25 | % |  | 0.06 | % |  | 1.10
3 - 6 years | 2,780,000 |  |  | 0.21 | % |  | 0.07 | % |  | 3.46
6 - 10 years | 9,118,000 |  |  | 1.43 | % |  | 0.13 | % |  | 9.05
Greater than 10 years | 1,300,000 |  |  | 4.04 | % |  | 0.11 | % |  | 18.70
Total / Weighted average | $ | 45,907,300 |  |  | 0.59 | % |  | 0.08 | % |  | 3.32
(1) As of September 30, 2022, 22%, 30% and 48% of the Company’s interest rate swaps were linked to LIBOR, the Federal funds rate and the Secured Overnight Financing Rate, respectively. As of December 31, 2021, 18%, 53% and 29% of the Company’s interest rate swaps were linked to LIBOR, the Federal funds rate and the Secured Overnight Financing Rate, respectively. (2) There were no forward starting swaps at September 30, 2022 and December 31, 2021. (3) At September 30, 2022 and December 31, 2021, the weighted average years to maturity of payer interest rate swaps is offset by the weighted average years to maturity of receiver interest rate swaps. As such, the net weighted average years to maturity for each maturity bucket may fall outside of the range listed.
The following table summarizes certain characteristics of the Company’s swaptions at September 30, 2022 and December 31, 2021:
September 30, 2022
|  | Current Underlying Notional |  | Weighted Average Underlying Fixed Rate |  | Weighted Average Underlying Floating Rate |  | Weighted Average Underlying Years to Maturity |  | Weighted Average Months to Expiration
(dollars in thousands)
Long pay |  | $3,000,000 |  | 2.03% |  | 3M LIBOR |  | 8.71 |  | 14.56
Long receive |  | $750,000 |  | 1.57% |  | 3M LIBOR |  | 11.32 |  | 15.89
December 31, 2021
|  | Current Underlying Notional |  | Weighted Average Underlying Fixed Rate |  | Weighted Average Underlying Floating Rate |  | Weighted Average Underlying Years to Maturity |  | Weighted Average Months to Expiration
(dollars in thousands)
Long pay |  | $4,050,000 |  | 2.00% |  | 3M LIBOR |  | 9.65 |  | 19.50
Long receive |  | $2,000,000 |  | 1.47% |  | 3M LIBOR |  | 10.95 |  | 11.38
The following table summarizes certain characteristics of the Company’s TBA derivatives at September 30, 2022 and December 31, 2021:
September 30, 2022
Purchase and sale contracts for derivative TBAs | Notional |  | Implied Cost Basis |  | Implied Market Value |  | Net Carrying Value
(dollars in thousands)
Purchase contracts | $ | 18,064,000 |  |  | $ | 17,686,372 |  |  | $ | 17,060,584 |  |  | $ | (625,788) |
Sale contracts | (1,980,000) |  |  | (1,895,947) |  |  | (1,877,778) |  |  | 18,169 |
Net TBA derivatives | $ | 16,084,000 |  |  | $ | 15,790,425 |  |  | $ | 15,182,806 |  |  | $ | (607,619) |
December 31, 2021
Purchase and sale contracts for derivative TBAs | Notional |  | Implied Cost Basis |  | Implied Market Value |  | Net Carrying Value
(dollars in thousands)
Purchase contracts | $ | 20,133,000 |  |  | $ | 20,289,856 |  |  | $ | 20,338,633 |  |  | $ | 48,777 |
The following table summarizes certain characteristics of the Company’s futures derivatives at September 30, 2022 and December 31, 2021:
September 30, 2022
| Notional - Long Positions |  | Notional - Short Positions |  | Weighted Average Years to Maturity
| (dollars in thousands) |  |  |  |
U.S. Treasury futures - 2 year | $ | — |  |  | $ | (17,391,000) |  |  | 1.97
U.S. Treasury futures - 5 year | — |  |  | (6,503,400) |  |  | 4.38
U.S. Treasury futures - 10 year and greater | — |  |  | (18,376,900) |  |  | 7.40
Total | $ | — |  |  | $ | (42,271,300) |  |  | 4.70
December 31, 2021
| Notional - Long Positions |  | Notional - Short Positions |  | Weighted Average Years to Maturity
| (dollars in thousands) |  |  |  |
U.S. Treasury futures - 2 year | $ | — |  |  | $ | (7,509,200) |  |  | 1.96
U.S. Treasury futures - 5 year | — |  |  | (5,644,900) |  |  | 4.38
U.S. Treasury futures - 10 year and greater | — |  |  | (9,381,000) |  |  | 6.84
Total | $ | — |  |  | $ | (22,535,100) |  |  | 4.60
The Company presents derivative contracts on a gross basis in the Consolidated Statements of Financial Condition. Derivative contracts may contain legally enforceable provisions that allow for netting or setting off receivables and payables with each counterparty. The following tables present information about derivative assets and liabilities that are subject to such provisions and can be offset in our Consolidated Statements of Financial Condition at September 30, 2022 and December 31, 2021, respectively.
September 30, 2022
|  |  | Amounts Eligible for Offset |  |
| Gross Amounts |  | Financial Instruments |  | Cash Collateral |  | Net Amounts
Assets | (dollars in thousands)
Interest rate swaps, at fair value | $ | 36,861 |  |  | $ | (26,666) |  |  | $ | — |  |  | $ | 10,195 |
Interest rate swaptions, at fair value | 344,301 |  |  | — |  |  | — |  |  | 344,301 |
TBA derivatives, at fair value | 28,033 |  |  | (9,864) |  |  | — |  |  | 18,169 |
Futures contracts, at fair value | 1,539,298 |  |  | (2,946) |  |  | — |  |  | 1,536,352 |
Purchase commitments | 1,037 |  |  | — |  |  | — |  |  | 1,037 |
Liabilities |
Interest rate swaps, at fair value | $ | 108,071 |  |  | $ | (26,666) |  |  | $ | — |  |  | $ | 81,405 |
TBA derivatives, at fair value | 635,652 |  |  | (9,864) |  |  | — |  |  | 625,788 |
Futures contracts, at fair value | 2,946 |  |  | (2,946) |  |  | — |  |  | — |
Purchase commitments | 2,485 |  |  | — |  |  | — |  |  | 2,485 |
Credit derivatives | 15,381 |  |  | — |  |  | (10,373) |  |  | 5,008 |
December 31, 2021
|  |  | Amounts Eligible for Offset |  |
| Gross Amounts |  | Financial Instruments |  | Cash Collateral |  | Net Amounts
Assets | (dollars in thousands)
Interest rate swaptions, at fair value | $ | 105,710 |  |  | $ | — |  |  | $ | — |  |  | $ | 105,710 |
TBA derivatives, at fair value | 52,693 |  |  | (3,876) |  |  | — |  |  | 48,817 |
Futures contracts, at fair value | 9,028 |  |  | (9,028) |  |  | — |  |  | — |
Purchase commitments | 1,779 |  |  | — |  |  | — |  |  | 1,779 |
Credit derivatives | 1,160 |  |  | (516) |  |  | — |  |  | 644 |
Liabilities |
Interest rate swaps, at fair value | $ | 747,036 |  |  | $ | — |  |  | $ | (77,607) |  |  | $ | 669,429 |
TBA derivatives, at fair value | 3,916 |  |  | (3,876) |  |  | (40) |  |  | — |
Futures contracts, at fair value | 129,134 |  |  | (9,028) |  |  | (120,106) |  |  | — |
Purchase commitments | 870 |  |  | — |  |  | — |  |  | 870 |
Credit derivatives | 581 |  |  | (516) |  |  | (65) |  |  | — |
The effect of interest rate swaps in the Consolidated Statements of Comprehensive Income (Loss) is as follows:
Location on Consolidated Statements of Comprehensive Income (Loss)
| Net Interest Component of Interest Rate Swaps (1) |  | Realized Gains (Losses) on Termination of Interest Rate Swaps (1) |  | Unrealized Gains (Losses) on Interest Rate Swaps (1)
For the three months ended | (dollars in thousands)
September 30, 2022 | $ | 141,110 |  |  | $ | (83,393) |  |  | $ | 1,251,350 |
September 30, 2021 | $ | (54,411) |  |  | $ | (1,196,417) |  |  | $ | 1,380,946 |
For the nine months ended |
September 30, 2022 | $ | 79,561 |  |  | $ | (83,409) |  |  | $ | 3,472,326 |
September 30, 2021 | $ | (217,245) |  |  | $ | (1,196,417) |  |  | $ | 2,012,141 |
(1) Included in Net gains (losses) on derivatives in the Consolidated Statements of Comprehensive Income (Loss).
The effect of other derivative contracts in the Company’s Consolidated Statements of Comprehensive Income (Loss) is as follows:
Three Months Ended September 30, 2022
Derivative Instruments | Realized Gain (Loss) |  | Unrealized Gain (Loss) |  | Amount of Gain/(Loss) Recognized in Net Gains (Losses) on Derivatives
(dollars in thousands)
Net TBA derivatives | $ | (430,528) |  |  | $ | (577,156) |  |  | $ | (1,007,684) |
Net interest rate swaptions | (18,949) |  |  | 30,610 |  |  | 11,661 |
Futures | 611,661 |  |  | 1,197,942 |  |  | 1,809,603 |
Purchase commitments | — |  |  | (4,530) |  |  | (4,530) |
Credit derivatives | 1,105 |  |  | (1,982) |  |  | (877) |
Total |  |  |  |  | $ | 808,173 |
Three Months Ended September 30, 2021
Derivative Instruments | Realized Gain (Loss) |  | Unrealized Gain (Loss) |  | Amount of Gain/(Loss) Recognized in Net Gains (Losses) on Derivatives
(dollars in thousands)
Net TBA derivatives | $ | 155,569 |  |  | $ | (182,845) |  |  | $ | (27,276) |
Net interest rate swaptions | (24,265) |  |  | (44,602) |  |  | (68,867) |
Futures | (229,534) |  |  | 279,293 |  |  | 49,759 |
Purchase commitments | — |  |  | 920 |  |  | 920 |
Credit derivatives | 2,616 |  |  | (2,320) |  |  | 296 |
Total |  |  |  |  | $ | (45,168) |
Nine Months Ended September 30, 2022
Derivative Instruments | Realized Gain (Loss) |  | Unrealized Gain (Loss) |  | Amount of Gain/(Loss) Recognized in Net Gains (Losses) on Other Derivatives
(dollars in thousands)
Net TBA derivatives | $ | (2,250,909) |  |  | $ | (656,394) |  |  | $ | (2,907,303) |
Net interest rate swaptions | (33,399) |  |  | 272,668 |  |  | 239,269 |
Futures | 2,332,338 |  |  | 1,656,458 |  |  | 3,988,796 |
Purchase commitments | — |  |  | (2,358) |  |  | (2,358) |
Credit derivatives | 2,539 |  |  | (14,510) |  |  | (11,971) |
Total |  |  |  |  | $ | 1,306,433 |
Nine Months Ended September 30, 2021
Derivative Instruments | Realized Gain (Loss) |  | Unrealized Gain (Loss) |  | Amount of Gain/(Loss) Recognized in Net Gains (Losses) on Other Derivatives
(dollars in thousands)
Net TBA derivatives | $ | (122,275) |  |  | $ | (249,847) |  |  | $ | (372,122) |
Net interest rate swaptions | (69,262) |  |  | 28,528 |  |  | (40,734) |
Futures | 250,013 |  |  | 218,527 |  |  | 468,540 |
Purchase commitments | — |  |  | 1,389 |  |  | 1,389 |
Credit derivatives | 7,024 |  |  | 8,634 |  |  | 15,658 |
Total |  |  |  |  | $ | 72,731 |
Certain of the Company’s derivative contracts are 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. 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. The aggregate fair value of all derivative instruments with the aforementioned features were in a net asset position at September 30, 2022.

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- Definition The entire disclosure for derivative instruments and hedging activities including, but not limited to, risk management strategies, non-hedging derivative instruments, assets, liabilities, revenue and expenses, and methodologies and assumptions used in determining the amounts. + References Reference 1: http://fasb.org/us-gaap/role/ref/legacyRef -Publisher FASB -Name Accounting Standards Codification -Topic 815 -URI https://asc.fasb.org/topic&trid=2229140 Reference 2: http://www.xbrl.org/2003/role/disclosureRef -Publisher FASB -Name Accounting Standards Codification -Topic 815 -SubTopic 40 -Section 50 -Paragraph 5 -Subparagraph (f) -URI https://asc.fasb.org/extlink&oid=126731327&loc=d3e90205-114008 + Details
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