v3.19.1
Financial Derivatives
 3 Months Ended
Mar. 31, 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 March 31, 2019:
 
 
March 31, 2019
(In thousands)
 
 
Financial derivatives–assets, at fair value:
 
 
TBA securities purchase contracts
 
$
445

TBA securities sale contracts
 
86

Fixed payer interest rate swaps
 
2,291

Fixed receiver interest rate swaps
 
3,096

Basis swaps
 
4

Credit default swaps on asset-backed securities
 
1,233

Credit default swaps on asset-backed indices
 
3,276

Credit default swaps on corporate bonds
 
715

Credit default swaps on corporate bond indices
 
3,519

Total return swaps
 
123

Futures
 
138

Forwards
 
430

Total financial derivatives–assets, at fair value
 
$
15,356

Financial derivatives–liabilities, at fair value:
 
 
TBA securities purchase contracts
 
$
(33
)
TBA securities sale contracts
 
(3,042
)
Fixed payer interest rate swaps
 
(6,243
)
Fixed receiver interest rate swaps
 
(1,328
)
Credit default swaps on asset-backed indices
 
(822
)
Credit default swaps on corporate bonds
 
(945
)
Credit default swaps on corporate bond indices
 
(11,907
)
Recovery swaps
 
(8
)
Futures
 
(2,454
)
Forwards
 
(122
)
Total financial derivatives–liabilities, at fair value
 
$
(26,904
)
Total
 
$
(11,548
)

Interest Rate Swaps
The following table provides information about the Company's fixed payer interest rate swaps as of March 31, 2019:
 
 
 
 
 
 
Weighted Average
Maturity
 
Notional Amount
 
Fair Value
 
Pay Rate
 
Receive Rate
 
Remaining Years to Maturity
 
 
(In thousands)
 
 
 
 
 
 
2020
 
$
68,607

 
$
549

 
1.74
%
 
2.61
%
 
1.00
2021
 
121,499

 
(603
)
 
2.71

 
2.63

 
1.82
2023
 
101,012

 
858

 
2.06

 
2.66

 
4.04
2024
 
77,700

 
(1,021
)
 
2.58

 
2.76

 
4.81
2025
 
30,023

 
296

 
2.09

 
2.64

 
6.67
2026
 
10,200

 
191

 
2.02

 
2.67

 
7.44
2028
 
69,602

 
(1,975
)
 
2.71

 
2.68

 
9.25
2029
 
70,000

 
(1,825
)
 
2.70

 
2.77

 
9.80
2030
 
685

 
2

 
2.38

 
2.68

 
11.65
2045
 
7,896

 
19

 
2.54

 
2.63

 
26.69
2049
 
6,700

 
(443
)
 
2.89

 
2.80

 
29.78
Total
 
$
563,924

 
$
(3,952
)
 
2.41
%
 
2.68
%
 
5.49
The following table provides information about the Company's fixed receiver interest rate swaps as of March 31, 2019:
 
 
 
 
 
 
Weighted Average
Maturity
 
Notional Amount
 
Fair Value
 
Pay Rate
 
Receive Rate
 
Remaining Years to Maturity
 
 
(In thousands)
 
 
 
 
 
 
2021
 
$
5,928

 
$
(21
)
 
2.61
%
 
2.00
%
 
2.21
2022
 
53,974

 
(761
)
 
2.63

 
1.85

 
2.92
2023
 
48,657

 
(509
)
 
2.62

 
2.00

 
4.01
2024
 
68,500

 
816

 
2.38

 
2.56

 
4.80
2029
 
79,550

 
1,800

 
2.30

 
2.66

 
9.82
2049
 
6,700

 
443

 
2.80

 
2.89

 
29.78
Total
 
$
263,309

 
$
1,768

 
2.47
%
 
2.34
%
 
6.36
The following table provides information about the Company's basis swaps as of March 31, 2019:
 
 
 
 
 
 
Weighted Average
Maturity
 
Notional Amount
 
Fair Value
 
Pay Rate
 
Receive Rate
 
Remaining Years to Maturity
 
 
(In thousands)
 
 
 
 
 
 
2019
 
$
(12,900
)
 
$
4

 
2.61
%
 
2.64
%
 
0.21
Total
 
$
(12,900
)
 
$
4

 
2.61
%
 
2.64
%
 
0.21
Credit Default Swaps
The following table provides information about the Company's credit default swaps as of March 31, 2019:
March 31, 2019:
Type(1)
 
Notional
 
Fair Value
 
Remaining Term (Years)
 
 
(In thousands)
 
 
Asset:
 
 
 
 
 
 
Long:
 
 
 
 
 
 
Credit default swaps on asset-backed indices
 
$
837

 
$
9

 
23.57
Credit default swaps on corporate bonds
 
3,070

 
296

 
2.97
Credit default swaps on corporate bond indices
 
76,904

 
3,519

 
4.09
Short:
 
 
 
 
 
 
Credit default swaps on asset-backed securities
 
(2,909
)
 
1,233

 
16.41
Credit default swaps on asset-backed indices
 
(32,326
)
 
3,267

 
37.60
Credit default swaps on corporate bonds
 
(3,033
)
 
419

 
1.98
Liability:
 
 
 
 
 
 
Long:
 
 
 
 
 
 
Credit default swaps on asset-backed indices
 
5,439

 
(819
)
 
40.73
Credit default swaps on corporate bonds
 
2,980

 
(407
)
 
1.97
Short:
 
 
 
 
 
 
Credit default swaps on asset-backed indices
 
(2,500
)
 
(3
)
 
38.58
Credit default swaps on corporate bonds
 
(16,955
)
 
(538
)
 
1.14
Credit default swaps on corporate bond indices
 
(223,080
)
 
(11,907
)
 
2.47
Recovery swaps
 
(2,600
)
 
(8
)
 
0.22
 
 
$
(194,173
)
 
$
(4,939
)
 
7.04
(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 March 31, 2019:
March 31, 2019:
Description
 
Notional Amount
 
Fair Value
 
Remaining Months to Expiration
 
 
(In thousands)
 
 
U.S. Treasury futures
 
$
(151,600
)
 
$
(2,380
)
 
2.79
Eurodollar futures
 
(63,000
)
 
(74
)
 
5.97
Currency futures
 
(15,840
)
 
138

 
2.60
Total
 
$
(230,440
)
 
$
(2,316
)
 
3.64

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. From time to time, the Company also invests in TBAs as a means of acquiring additional exposure to Agency RMBS, or for speculative purposes, including holding long positions. Overall, the Company typically holds a net short position.
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 March 31, 2019, the Company had outstanding contracts to purchase ("long positions") and sell ("short positions") TBA securities as follows:
 
 
March 31, 2019
TBA Securities
 
Notional Amount(1)
 
Cost
Basis(2)
 
Market Value(3)
 
Net Carrying Value(4)
(In thousands)
 
 
 
 
 
 
 
 
Purchase contracts:
 
 
 
 
 
 
 
 
Assets
 
$
167,641

 
$
173,619

 
$
174,064

 
$
445

Liabilities
 
25,500

 
25,875

 
25,842

 
(33
)
 
 
193,141

 
199,494

 
199,906

 
412

Sale contracts:
 
 
 
 
 
 
 
 
Assets
 
(155,175
)
 
(158,767
)
 
(158,681
)
 
86

Liabilities
 
(572,003
)
 
(589,105
)
 
(592,147
)
 
(3,042
)
 
 
(727,178
)
 
(747,872
)
 
(750,828
)
 
(2,956
)
Total TBA securities, net
 
$
(534,037
)
 
$
(548,378
)
 
$
(550,922
)
 
$
(2,544
)
(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 March 31, 2019 are summarized in the tables 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
 
$
719

 
$
1,458

 
$
2,177

 
$
(275
)
 
$
(5,774
)
 
$
(6,049
)
Credit default swaps on asset-backed securities
 
Credit
 
 
 
275

 
275

 
 
 
(239
)
 
(239
)
Credit default swaps on asset-backed indices
 
Credit
 
 
 
(746
)
 
(746
)
 
 
 
(548
)
 
(548
)
Credit default swaps on corporate bond indices
 
Credit
 
 
 
(2,513
)
 
(2,513
)
 
 
 
(2,407
)
 
(2,407
)
Credit default swaps on corporate bonds
 
Credit
 
 
 
(425
)
 
(425
)
 
 
 
766

 
766

Total return swaps
 
Equity Market/Credit
 
 
 
(1,298
)
 
(1,298
)
 
 
 
129

 
129

TBAs
 
Interest Rate
 
 
 
(6,435
)
 
(6,435
)
 
 
 
1,898

 
1,898

Futures
 
Interest Rate/Currency
 
 
 
(2,433
)
 
(2,433
)
 
 
 
359

 
359

Forwards
 
Currency
 
 
 
(114
)
 
(114
)
 
 
 
423

 
423

Options
 
Interest Rate
 
 
 
(33
)
 
(33
)
 
 
 
—

 
—

Total
 
 
 
$
719

 
$
(12,264
)
 
$
(11,545
)
 
$
(275
)
 
$
(5,393
)
 
$
(5,668
)
(1)
Includes gain/(loss) on foreign currency transactions on financial derivatives in the amount of $25 thousand for the three-month period ended March 31, 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 $21 thousand for the three-month period ended March 31, 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 three-month period ended March 31, 2019:
Derivative Type
 
Three-Month
Period Ended
March 31, 2019
(In thousands)
 
 
Interest rate swaps
 
$
912,934

TBAs
 
984,292

Credit default swaps
 
403,254

Total return swaps
 
38,400

Futures
 
280,947

Options
 
51,545

Forwards
 
29,078

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 March 31, 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 March 31, 2019 are summarized below:
Credit Derivatives
 
March 31, 2019
(In thousands)
 
 
Fair Value of Written Credit Derivatives, Net
 
$
2,598

Fair Value of Purchased Credit Derivatives Offsetting Written Credit Derivatives with Third Parties (1)
 
(167
)
Notional Value of Written Credit Derivatives (2)
 
89,230

Notional Value of Purchased Credit Derivatives Offsetting Written Credit Derivatives with Third Parties (1)
 
13,153

(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 March 31, 2019, implied credit spreads on such contracts ranged between 21.8 and 1,956.0 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 March 31, 2019. Estimated points up front on these contracts as of March 31, 2019 ranged between 56.3 and 74.7 points. Total net up-front payments (paid) or received relating to written credit derivatives outstanding at March 31, 2019 were $(2.0) million.
Financial Derivatives
Gains and losses on the Company's derivative contracts for the three-month period March 31, 2018 are summarized in the table below:
 
 
 
 
Three-Month Period Ended March 31, 2018
Derivative Type
 
Primary Risk
Exposure
 
Net Realized
Gain/(Loss)(1)
 
Change in Net Unrealized Gain/(Loss)(2)
(In thousands)
 
 
 
 
 
 
Credit default swaps on asset-backed securities
 
Credit
 
$
86

 
$
(71
)
Credit default swaps on asset-backed indices
 
Credit
 
(1,842
)
 
1,452

Credit default swaps on corporate bond indices
 
Credit
 
(1,562
)
 
1,563

Credit default swaps on corporate bonds
 
Credit
 
4,469

 
(3,855
)
Total return swaps
 
Equity Market/Credit
 
166

 
17

Interest rate swaps
 
Interest Rate
 
(824
)
 
5,039

Futures
 
Interest Rate/Currency
 
(761
)
 
(561
)
Forwards
 
Currency
 
(1,174
)
 
384

Options
 
Interest Rate/
Equity Market
 
(61
)
 
76

Total
 
 
 
$
(1,503
)
 
$
4,044


(1)
Includes gain/(loss) on foreign currency transactions on derivatives in the amount of $(0.2) million 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 $47 thousand 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.