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Derivative Financial Instruments
 9 Months Ended
Sep. 30, 2014
Derivative Financial Instruments

Note 10. Derivative Financial Instruments

The following table presents the fair value and notional amount of derivative financial instruments held by us at September 30, 2014 and December 31, 2013.

 

                     September 30, 2014                                       December 31, 2013                   
     Fair      Notional      Fair      Notional  

(In Thousands)

    Value      Amount      Value      Amount  

Assets - Risk Management Derivatives

            

Interest rate swaps

     $ 148          $ 60,500          $ 5,972          $ 268,000     

TBAs

      1,496           671,000           1,138           241,000     

Swaptions

      2,744           420,000           596           340,000     

Credit default index swaps

      2,372           75,000           -               -         

Assets - Other Derivatives

            

Loan purchase commitments

      933           273,781           -               360     

Loan forward sale commitments

      63           128,232           81           10,000     
  

 

 

     

 

 

     

 

 

     

 

 

  

Total Assets

     $ 7,756          $ 1,628,513          $ 7,787          $ 859,360     
  

 

 

     

 

 

     

 

 

     

 

 

  

Liabilities - Cash Flow Hedges

            

Interest rate swaps

     $ (33,973)         $ 139,500          $ (16,519)         $ 139,500     

Liabilities - Risk Management Derivatives

            

Interest rate swaps

      (476)          154,500           (80)          50,500     

TBAs

      (3,298)          1,274,500           (661)          235,000     

Futures

      (411)          108,000           (528)          162,000     

Liabilities - Other Derivatives

            

Loan purchase commitments

      (82)          50,439           (379)          42,562     

Loan forward sale commitments

      (23)          200,000           -               -         
  

 

 

     

 

 

     

 

 

     

 

 

  

Total Liabilities

     $ (38,263)         $ 1,926,939          $ (18,167)         $ 629,562     
  

 

 

     

 

 

     

 

 

     

 

 

  

Total Derivative Financial Instruments, Net

     $ (30,507)         $ 3,555,452          $ (10,380)         $ 1,488,922     
  

 

 

     

 

 

     

 

 

     

 

 

  

Risk Management Derivatives

To manage, to varying degrees, risks associated with certain assets and liabilities on our consolidated balance sheet, we may enter into derivative contracts. In order to manage certain risks associated with residential loans, residential securities, and commercial loans we own or plan to acquire, at September 30, 2014, we were party to swaps and swaptions with an aggregate notional amount of $635 million, TBA contracts sold with an aggregate notional amount of $1.9 billion, credit default index swaps with an aggregated notional amount of $75 million, and financial futures contracts with an aggregate notional amount of $108 million. Net market valuation adjustments on risk management derivatives were negative $4 million and negative $29 million for the three and nine months ended September 30, 2014, respectively, and positive less than $1 million and $51 million for the three and nine months ended September 30, 2013, respectively.

Loan Purchase and Forward Sale Commitments

LPCs and FSCs that qualify as derivatives are recorded at their estimated fair values. Net valuation adjustments on LPCs and FSCs were positive $2 million and $6 million for the three and nine months ended September 30, 2014, respectively, and are reported through our consolidated statements of income in mortgage banking activities, net.

 

Derivatives Designated as Cash Flow Hedges

To manage the variability in interest expense related to our long-term debt and certain adjustable-rate securitization entity liabilities that are included in our consolidated balance sheets for financial reporting purposes, we designated certain interest rate swaps as cash flow hedges with an aggregate notional balance of $140 million.

For the three months ended September 30, 2014 and 2013, designated cash flow hedges decreased in value by $3 million and increased in value by $4 million, respectively, which was recorded in accumulated other comprehensive income, a component of equity. For the nine months ended September 30, 2014 and 2013, these cash flow hedges decreased in value by $17 million and increased in value by $25 million, respectively. For interest rate agreements currently or previously designated as cash flow hedges, our total unrealized loss reported in accumulated other comprehensive income was $33 million and $16 million at September 30, 2014 and December 31, 2013, respectively. For both of the three months ended September 30, 2014 and 2013, we reclassified less than $100 thousand of unrealized losses on derivatives to interest expense. For the nine months ended September 30, 2014 and 2013, we reclassified $131 thousand and $219 thousand, respectively, of unrealized losses on derivatives to interest expense. Accumulated other comprehensive loss of less than $1 million will be amortized into interest expense, a component of our consolidated income statements, over the remaining life of the hedge liabilities.

The following table illustrates the impact on interest expense of our interest rate agreements accounted for as cash flow hedges for the three and nine months ended September 30, 2014 and 2013.

Impact on Interest Expense of Our Interest Rate Agreements Accounted for as Cash Flow Hedges

 

      Three Months Ended September 30,         Nine Months Ended September 30,    

(In Thousands)

    2014      2013      2014      2013  

Net interest expense on cash flow interest rate
agreements

     $ (1,487)         $ (1,474)         $ (4,465)         $ (4,406)    

Realized income (expense) due to ineffective
portion of hedges

      -               -               -               -         

Realized net losses reclassified from other
comprehensive income

      (32)          (62)          (131)          (219)    
  

 

 

     

 

 

     

 

 

     

 

 

  

Total Interest Expense

     $ (1,519)         $ (1,536)         $ (4,596)         $ (4,625)    
  

 

 

     

 

 

     

 

 

     

 

 

  

Derivative Counterparty Credit Risk

We incur credit risk to the extent that counterparties to our derivative financial instruments do not perform their obligations under specified contractual agreements. If a derivative counterparty does not perform, we may not receive the proceeds to which we may be entitled under these agreements. Each of our derivative counterparties that is not a clearinghouse must maintain compliance with International Swaps and Derivatives Association (“ISDA”) agreements or other similar agreements (or receive a waiver of non-compliance after a specific assessment) in order to conduct derivative transactions with us. Additionally, we review non-clearinghouse derivative counterparty credit standings, and in the case of a deterioration of creditworthiness, appropriate remedial action is taken. To further mitigate counterparty risk, we exit derivatives contracts with counterparties that (i) do not maintain compliance with (or obtain a waiver from) the terms of their ISDA or other agreements with us; or (ii) do not meet internally established guidelines regarding creditworthiness. Our ISDA and similar agreements currently require full bilateral collateralization of unrealized loss exposures with our derivative counterparties. Through a margin posting process, our positions are revalued with counterparties each business day and cash margin is generally transferred to either us or our derivative counterparties as collateral based upon the directional changes in fair value of the positions. We also attempt to transact with several different counterparties in order to reduce our specific counterparty exposure. With respect to certain of our derivatives, clearing and settlement is through one or more clearinghouses, which may be substituted as a counterparty. Clearing and settlement of derivative transactions through a clearinghouse is also intended to reduce specific counterparty exposure. We consider counterparty risk as part of our fair value assessments of all derivative financial instruments.

 

At September 30, 2014, we were in compliance with ISDA and similar agreements governing our open derivative positions. We assessed the risk associated with these counterparties as remote and did not record a specific valuation adjustment.