TWO Annual report pursuant to Section 13 and 15(d)

Annual report pursuant to Section 13 and 15(d)

Derivative Instruments and Hedging Activities

Derivative Instruments and Hedging Activities

12 Months Ended

Dec. 31, 2018

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Derivative Instruments and Hedging Activities

The Company enters into a variety of derivative and non-derivative instruments in connection with its risk management activities. The primary objective for executing these derivative and non-derivative instruments is to mitigate the Company’s economic exposure to future events that are outside its control, principally market risk and cash flow volatility associated with interest rate risk (including associated prepayment risk). Specifically, the Company enters into derivative and non-derivative instruments to economically hedge interest rate risk or “duration mismatch (or gap)” by adjusting the duration of its floating-rate borrowings into fixed-rate borrowings to more closely match the duration of its assets. This particularly applies to floating-rate borrowing agreements with maturities or interest rate resets of less than six months. Typically, the interest receivable terms (i.e., LIBOR) of certain derivatives match the terms of the underlying debt, resulting in an effective conversion of the rate of the related borrowing agreement from floating to fixed. The objective is to manage the cash flows associated with current and anticipated interest payments on borrowings, as well as the ability to roll or refinance borrowings at the desired amount by adjusting the duration.

To help manage the adverse impact of interest rate changes on the value of the Company’s portfolio as well as its cash flows, the Company may, at times, enter into various forward contracts, including short securities, Agency to-be-announced securities, or TBAs, options, futures, swaps, caps and total return swaps. In executing on the Company’s current risk management strategy, the Company has entered into interest rate swap, cap and swaption agreements, TBAs, put and call options for TBAs and total return swaps (based on the Markit IOS Index). The Company has also entered into a number of non-derivative instruments to manage interest rate risk, principally MSR and Agency interest-only securities (see discussion below).

The following summarizes the Company’s significant asset and liability classes, the risk exposure for these classes, and the Company’s risk management activities used to mitigate these risks. The discussion includes both derivative and non-derivative instruments used as part of these risk management activities. Any of the Company’s derivative and non-derivative instruments may be entered into in conjunction with one another in order to mitigate risks. As a result, the following discussions of each type of instrument should be read as a collective representation of the Company’s risk mitigation efforts and should not be considered independent of one another. While the Company uses derivative and non-derivative instruments to achieve the Company’s risk management activities, it is possible that these instruments will not effectively mitigate all or a substantial portion of the Company’s market rate risk. In addition, the Company might elect, at times, not to enter into certain hedging arrangements in order to maintain compliance with REIT requirements.

Balance Sheet Presentation

In accordance with ASC 815, Derivatives and Hedging, or ASC 815, the Company records derivative financial instruments on its consolidated balance sheets as assets or liabilities at fair value. Changes in fair value are accounted for depending on the use of the derivative instruments and whether they are designated or qualifying as hedge instruments. Due to the volatility of the credit markets and difficulty in effectively matching pricing or cash flows, the Company has not designated any current derivatives as hedging instruments.

The following tables present the gross fair value and notional amounts of the Company’s derivative financial instruments treated as trading derivatives as of December 31, 2018 and December 31, 2017.



	December 31, 2018
	Derivative Assets				Derivative Liabilities
(in thousands)	Fair Value		Notional		Fair Value			Notional
Inverse interest-only securities	$	70,813	$	476,299	$	—		$	—
Interest rate swap agreements	187,231		26,798,605		—			2,725,000
Interest rate cap contracts	40,335		2,500,000		—			—
Swaptions, net	—		—		(13,456		)	63,000
TBAs	21,602		6,484,000		—			—
Put and call options for TBAs, net	—		—		(25,296		)	1,767,000
Markit IOS total return swaps	—		—		(383		)	48,265
Short U.S. Treasuries	—		—		(781,455		)	800,000
Total	$	319,981	$	36,258,904	$	(820,590	)	$	5,403,265



	December 31, 2017
	Derivative Assets				Derivative Liabilities
(in thousands)	Fair Value		Notional		Fair Value			Notional
Inverse interest-only securities	$	91,827	$	588,246	$	—		$	—
Interest rate swap agreements	206,773		21,516,125		(29,867		)	6,966,000
Swaptions, net	10,405		2,666,000		—			—
TBAs	913		733,000		(1,930		)	1,306,000
Markit IOS total return swaps	—		—		(106		)	63,507
Total	$	309,918	$	25,503,371	$	(31,903	)	$	8,335,507

Comprehensive (Loss) Income Statement Presentation

The Company has not applied hedge accounting to its current derivative portfolio held to mitigate interest rate risk and credit risk. As a result, the Company is subject to volatility in its earnings due to movement in the unrealized gains and losses associated with its derivative instruments.

The following table summarizes the location and amount of gains and losses on derivative instruments reported in the consolidated statements of comprehensive (loss) income:



Derivative Instruments	Location of Gain (Loss) Recognized in Income on Derivatives	Amount of Gain (Loss) Recognized in Income on Derivatives
		Year Ended
(in thousands)		December 31,
		2018			2017			2016
Interest rate risk management
TBAs	(Loss) gain on other derivative instruments	$	(12,521	)	$	(46,778	)	$	51,816
Short U.S. Treasuries	(Loss) gain on other derivative instruments	(26,988		)	—			—
Put and call options for TBAs	(Loss) gain on other derivative instruments	(18,457		)	(22,623		)	64,920
Interest rate swaps - Payers	Gain (loss) on interest rate swap, cap and swaption agreements	48,995			67,124			(3,110		)
Interest rate swaps - Receivers	Gain (loss) on interest rate swap, cap and swaption agreements	(74,407		)	(17,677		)	37,272
Swaptions	Gain (loss) on interest rate swap, cap and swaption agreements	45,954			(59,200		)	11,209
Interest rate caps	Gain (loss) on interest rate swap, cap and swaption agreements	(4,499		)	—			—
Markit IOS total return swaps	(Loss) gain on other derivative instruments	125			(870		)	(36,898		)
Credit risk management
Credit default swaps - Receive protection	(Loss) gain on other derivative instruments	—			—			962
Non-risk management
Inverse interest-only securities	(Loss) gain on other derivative instruments	2,984			112			18,579
Forward purchase commmitments	(Loss) gain on other derivative instruments	—			—			2,418
Total		$	(38,814	)	$	(79,912	)	$	147,168

For the years ended December 31, 2018, 2017 and 2016, the Company recognized $49.2 million of income and $8.8 million, and $21.1 million of expenses, respectively, for the accrual and/or settlement of the net interest expense associated with its interest rate swaps and caps. The income/expenses result from receiving either LIBOR interest or a fixed interest rate and paying either a fixed interest rate or LIBOR interest on an average $29.4 billion, $19.4 billion and $15.5 billion notional, respectively.

The following tables present information with respect to the volume of activity in the Company’s derivative instruments during the years ended December 31, 2018 and 2017:



	Year Ended December 31, 2018
(in thousands)	Beginning of Period Notional Amount			Additions			Settlement, Termination, Expiration or Exercise			End of Period Notional Amount			Average Notional Amount			Realized Gain (Loss), net ⁽¹⁾
Inverse interest-only securities	$	588,246		$	—		$	(111,947	)	$	476,299		$	530,509		$	—
Interest rate swap agreements	28,482,125			49,269,781			(48,228,301		)	29,523,605			28,317,793			(71,578		)
Interest rate cap contracts	—			2,500,000			—			2,500,000			1,054,795			—
Swaptions, net	2,666,000			(35,000		)	(2,568,000		)	63,000			(1,495,421		)	67,985
TBAs, net	(573,000		)	64,988,000			(57,931,000		)	6,484,000			4,502,888			(35,140		)
Short U.S. Treasuries	—			(800,000		)	—			(800,000		)	(337,534		)	—
Put and call options for TBAs, net	—			(451,000		)	(1,316,000		)	(1,767,000		)	(804,997		)	6,839
Markit IOS total return swaps	63,507			—			(15,242		)	48,265			55,143			(765		)
Total	$	31,226,878		$	115,471,781		$	(110,170,490	)	$	36,528,169		$	31,823,176		$	(32,659	)



	Year Ended December 31, 2017
(in thousands)	Beginning of Period Notional Amount			Additions			Settlement, Termination, Expiration or Exercise			End of Period Notional Amount			Average Notional Amount			Realized Gain (Loss), net ⁽¹⁾
Inverse interest-only securities	$	740,844		$	—		$	(152,598	)	$	588,246		$	662,273		$	(40	)
Interest rate swap agreements	20,371,063			36,642,245			(28,531,183		)	28,482,125			19,447,067			54,476
Swaptions, net	225,000			4,306,000			(1,865,000		)	2,666,000			1,014,578			8,694
TBAs, net	(1,489,000		)	(7,249,400		)	8,165,400			(573,000		)	(1,256,424		)	(51,810		)
Put and call options for TBAs, net	(1,136,000		)	4,460,000			(3,324,000		)	—			11,978			20,010
Markit IOS total return swaps	90,593			—			(27,086		)	63,507			74,183			(181		)
Total	$	18,802,500		$	38,158,845		$	(25,734,467	)	$	31,226,878		$	19,953,655		$	31,149

____________________


(1)	Excludes net interest paid or received in full settlement of the net interest spread liability.

Cash flow activity related to derivative instruments is reflected within the operating activities and investing activities sections of the consolidated statements of cash flows. Realized gains and losses and derivative fair value adjustments are reflected within the realized and unrealized losses (gains) on interest rate swaps, caps and swaptions and unrealized loss (gain) on other derivative instruments line items within the operating activities section of the consolidated statements of cash flows. The remaining cash flow activity related to derivative instruments is reflected within the (purchases) short sales of other derivative instruments, proceeds from sales (payments for termination) of other derivative instruments, net and increase (decrease) in due to counterparties, net line items within the investing activities section of the consolidated statements of cash flows.

Interest Rate Sensitive Assets/Liabilities

The Company’s Agency RMBS portfolio is generally subject to change in value when mortgage rates decline or increase, depending on the type of investment. Rising mortgage rates generally result in a slowing of refinancing activity, which slows prepayments and results in a decline in the value of the Company’s fixed-rate Agency pools. To mitigate the impact of this risk on the Company’s fixed-rate Agency pool portfolio, the Company maintains a portfolio of fixed-rate interest-only securities and MSR, which increase in value when interest rates increase. As of December 31, 2018 and December 31, 2017, the Company had $147.6 million and $117.8 million, respectively, of interest-only securities, and $2.0 billion and $1.1 billion, respectively, of MSR in place to economically hedge its Agency RMBS. Interest-only securities are included in AFS securities, at fair value, in the consolidated balance sheets.

The Company monitors its borrowings under repurchase agreements, FHLB advances and revolving credit facilities, which are generally floating-rate debt, in relation to the rate profile of its portfolio. In connection with its risk management activities, the Company enters into a variety of derivative and non-derivative instruments to economically hedge interest rate risk or “duration mismatch (or gap)” by adjusting the duration of its floating-rate borrowings into fixed-rate borrowings to more closely match the duration of its assets. This particularly applies to borrowing agreements with maturities or interest rate resets of less than six months. Typically, the interest receivable terms (i.e., LIBOR) of certain derivatives match the terms of the underlying debt, resulting in an effective conversion of the rate of the related borrowing agreement from floating to fixed. The objective is to manage the cash flows associated with current and anticipated interest payments on borrowings, as well as the ability to roll or refinance borrowings at the desired amount by adjusting the duration. To help manage the adverse impact of interest rate changes on the value of the Company’s portfolio as well as its cash flows, the Company may, at times, enter into various forward contracts, including short securities, TBAs, options, futures, swaps, caps, credit default swaps and total return swaps. In executing on the Company’s current interest rate risk management strategy, the Company has entered into TBAs, put and call options for TBAs, interest rate swap, cap and swaption agreements and Markit IOS total return swaps.

TBAs. At times, the Company may use TBAs as a means of deploying capital until targeted investments are available or to take advantage of temporary displacements, funding advantages or valuation differentials in the marketplace. Additionally, the Company may use TBAs independently, or in conjunction with other derivative and non-derivative instruments, in order to mitigate risks. TBAs are forward contracts for the purchase (long notional positions) or sale (short notional positions) of Agency RMBS. The issuer, coupon and stated maturity of the Agency RMBS are predetermined as well as the trade price, face amount and future settle date (published each month by the Securities Industry and Financial Markets Association). However, the specific Agency RMBS to be delivered upon settlement is not known at the time of the TBA transaction. As a result, and because physical delivery of the Agency RMBS upon settlement cannot be assured, the Company accounts for TBAs as derivative instruments.

The Company may hold both long and short notional TBA positions, which are disclosed on a gross basis according to the unrealized gain or loss position of each TBA contract regardless of long or short notional position. The following tables present the notional amount, cost basis, market value and carrying value (which approximates fair value) of the Company’s TBA positions as of December 31, 2018 and December 31, 2017:



	December 31, 2018
							Net Carrying Value ⁽⁴⁾
(in thousands)	Notional Amount ⁽¹⁾		Cost Basis ⁽²⁾		Market Value ⁽³⁾		Derivative Assets		Derivative Liabilities
Purchase contracts	$	6,484,000	$	6,734,858	$	6,756,460	$	21,602	$	—
Sale contracts	—		—		—		—		—
TBAs, net	$	6,484,000	$	6,734,858	$	6,756,460	$	21,602	$	—



	December 31, 2017
										Net Carrying Value ⁽⁴⁾
(in thousands)	Notional Amount ⁽¹⁾			Cost Basis ⁽²⁾			Market Value ⁽³⁾			Derivative Assets		Derivative Liabilities
Purchase contracts	$	733,000		$	769,446		$	770,359		$	913	$	—
Sale contracts	(1,306,000		)	(1,316,368		)	(1,318,297		)	—		(1,930		)
TBAs, net	$	(573,000	)	$	(546,922	)	$	(547,938	)	$	913	$	(1,930	)

___________________


(1)	Notional amount represents the face amount 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 TBA (or of the underlying Agency RMBS) as of period-end.


(4)	Net carrying value represents the difference between the market value of the TBA as of period-end and its cost basis, and is reported in derivative assets / (liabilities), at fair value, in the consolidated balance sheets.

Short U.S. Treasuries. The Company may use short U.S. Treasury securities independently, or in conjunction with other derivative and non-derivative instruments, in order to mitigate risks. As of December 31, 2018, the Company had short sold U.S. Treasuries with a notional amount of $800.0 million with a fair market value of $781.5 million included in derivative liabilities, at fair value, on the consolidated balance sheet as of December 31, 2018. The Company did not hold any short U.S. Treasuries as of December 31, 2017.

Put and Call Options for TBAs. The Company may use put and call options for TBAs independently, or in conjunction with other derivative and non-derivative instruments, in order to mitigate risks. As of December 31, 2018, the Company had purchased put and call options for TBAs with a notional amount of $5.4 billion and short sold put and call options for TBAs with a notional amount of $7.2 billion. The put and call options had a fair market value of $25.3 million included in derivative liabilities, at fair value, on the consolidated balance sheet as of December 31, 2018. The Company did not hold any put and call options for TBAs as of December 31, 2017.

Interest Rate Swap Agreements. The Company may use interest rate swaps independently, or in conjunction with other derivative and non-derivative instruments, in order to mitigate risks. As of December 31, 2018 and December 31, 2017, the Company held the following interest rate swaps that were utilized as economic hedges of interest rate exposure (or duration) whereby the Company receives interest at a three-month LIBOR rate:



(notional in thousands)
December 31, 2018
Swaps Maturities	Notional Amount ⁽¹⁾		Weighted Average Fixed Pay Rate ⁽²⁾		Weighted Average Receive Rate ⁽²⁾		Weighted Average Maturity (Years) ⁽²⁾
2019	$	4,336,897	1.769	%	2.565	%	0.79
2020	3,640,000		1.806	%	2.689	%	1.83
2021	4,117,000		1.550	%	2.687	%	2.69
2022	2,470,000		2.002	%	2.728	%	3.75
2023 and Thereafter	6,842,270		2.495	%	2.636	%	7.60
Total	$	21,406,167	1.978	%	2.651	%	3.75



(notional in thousands)
December 31, 2017
Swaps Maturities	Notional Amount ⁽¹⁾		Weighted Average Fixed Pay Rate ⁽²⁾		Weighted Average Receive Rate ⁽²⁾		Weighted Average Maturity (Years) ⁽²⁾
2018	$	4,320,000	1.155	%	1.508	%	0.50
2019	5,448,135		1.767	%	1.386	%	1.79
2020	5,490,000		1.945	%	1.509	%	2.87
2021	2,417,000		1.788	%	1.628	%	3.92
2022 and Thereafter	5,245,000		1.764	%	1.516	%	6.44
Total	$	22,920,135	1.694	%	1.493	%	3.01

____________________


(1)	Notional amount includes $572.0 million and $570.0 million in forward starting interest rate swaps as of December 31, 2018 and December 31, 2017, respectively.


(2)	Weighted averages exclude forward starting interest rate swaps. As of December 31, 2018 and December 31, 2017, the weighted average fixed pay rate on forward starting interest rate swaps was 2.8% and 2.1%, respectively.

Additionally, as of December 31, 2018 and December 31, 2017, the Company held the following interest rate swaps in order to mitigate mortgage interest rate exposure (or duration) risk whereby the Company pays interest at a three-month LIBOR rate:



(notional in thousands)
December 31, 2018
Swaps Maturities	Notional Amounts		Weighted Average Pay Rate		Weighted Average Fixed Receive Rate		Weighted Average Maturity (Years)
2020	$	250,000	2.469	%	2.258	%	1.06
2021	$	2,477,438	2.538	%	2.736	%	2.24
2022	800,000		2.653	%	2.975	%	3.39
2023 and Thereafter	4,590,000		2.653	%	2.757	%	7.37
Total	$	8,117,438	2.612	%	2.757	%	5.22



(notional in thousands)
December 31, 2017
Swaps Maturities	Notional Amounts		Weighted Average Pay Rate		Weighted Average Fixed Receive Rate		Weighted Average Maturity (Years)
2020	$	200,000	1.391	%	1.642	%	2.60
2021	500,000		1.357	%	1.327	%	3.05
2022 and Thereafter	4,861,990		1.475	%	2.325	%	8.34
Total	$	5,561,990	1.462	%	2.211	%	7.66

Interest Rate Swaptions. The Company may use interest rate swaptions (agreements to enter into interest rate swaps in the future for which the Company would either pay or receive a fixed rate) independently, or in conjunction with other derivative and non-derivative instruments, in order to mitigate risks. As of December 31, 2018 and December 31, 2017, the Company had the following outstanding interest rate swaptions that were utilized as macro-economic hedges:



	December 31, 2018
(notional and dollars in thousands)	Option								Underlying Swap
Swaption	Expiration	Cost Basis			Fair Value			Average Months to Expiration	Notional Amount			Average Pay Rate		Average Receive Rate		Average Term (Years)
Purchase contracts:
Payer	< 6 Months	$	4,855		$	2,430		5.13	$	900,000		3.16	%	3M Libor		10.0
Payer	≥ 6 Months	8,400			5,992			8.60	800,000			3.14	%	3M Libor		10.0
Total Payer		$	13,255		$	8,422		7.92	$	1,700,000		3.15	%	3M Libor		10.0
Sale contracts:
Receiver	< 6 Months	$	(4,855	)	$	(9,001	)	4.74	$	(845,000	)	3M Libor		2.66	%	10.0
Receiver	≥ 6 Months	$	(8,400	)	$	(12,877	)	8.60	$	(792,000	)	3M Libor		2.64	%	10.0
Total Receiver		$	(13,255	)	$	(21,878	)	7.52	$	(1,637,000	)	3M Libor		2.65	%	10.0



	December 31, 2017
(notional and dollars in thousands)	Option								Underlying Swap
Swaption	Expiration	Cost			Fair Value			Average Months to Expiration	Notional Amount			Average Fixed Pay Rate		Average Receive Rate		Average Term (Years)
Purchase contracts:
Payer	< 6 Months	$	21,380		$	17,736		4.03	$	7,200,000		2.27	%	3M Libor		3.8
Receiver	< 6 Months	$	4,660		$	2,982		3.72	$	2,300,000		3M Libor		2.10	%	10.0
Sale contracts:
Payer	< 6 Months	$	(7,950	)	$	(5,619	)	4.66	$	(1,693,000	)	2.70	%	3M Libor		10.0
Receiver	< 6 Months	$	(16,260	)	$	(4,694	)	5.17	$	(5,141,000	)	3M Libor		1.89	%	5.6

Interest Rate Cap Contracts. The Company may use interest rate caps independently, or in conjunction with other derivative and non-derivative instruments, in order to mitigate risks. As of December 31, 2018, the Company held the following interest rate caps that were utilized as economic hedges of interest rate exposure (or duration) whereby the Company receives interest at a three-month LIBOR rate, net of a fixed cap rate:



(notional in thousands)
December 31, 2018
Caps Maturities	Notional Amount		Weighted Average Cap Rate		Weighted Average Receive Rate		Weighted Average Maturity (Years)
2019	$	800,000	1.344	%	2.422	%	0.53
2020	$	1,700,000	1.250	%	2.766	%	1.29
Total	$	2,500,000	1.280	%	2.656	%	1.04

The Company did not hold any interest rate caps as of December 31, 2017.

Markit IOS Total Return Swaps. The Company may use total return swaps (agreements whereby the Company receives or makes payments based on the total return of an underlying instrument or index, such as the Markit IOS Index, in exchange for fixed or floating rate interest payments) independently, or in conjunction with other derivative and non-derivative instruments, in order to mitigate risks. The Company enters into total return swaps to help mitigate the potential impact of larger increases or decreases in interest rates on the performance of our portfolio (referred to as “convexity risk”). Total return swaps based on the Markit IOS Index are intended to synthetically replicate the performance of interest-only securities. The Company had the following total return swap agreements in place at December 31, 2018 and December 31, 2017:



(notional and dollars in thousands)
December 31, 2018
Maturity Date	Current Notional Amount			Fair Value			Cost Basis			Unrealized Gain (Loss)
January 12, 2043	$	(21,395	)	$	(153	)	$	(30	)	$	(123	)
January 12, 2044	(26,870		)	(230		)	(29		)	(201		)
Total	$	(48,265	)	$	(383	)	$	(59	)	$	(324	)



(notional and dollars in thousands)
December 31, 2017
Maturity Date	Current Notional Amount			Fair Value			Cost Basis		Unrealized Gain (Loss)
January 12, 2043	$	(24,362	)	$	(24	)	$	201	$	(225	)
January 12, 2044	(39,145		)	(82		)	366		(448		)
Total	$	(63,507	)	$	(106	)	$	567	$	(673	)

Credit Risk

The Company’s exposure to credit losses on its Agency RMBS portfolio is limited due to implicit or explicit backing from the GSEs. The payment of principal and interest on the Freddie Mac and Fannie Mae mortgage-backed securities are guaranteed by those respective agencies, and the payment of principal and interest on the Ginnie Mae mortgage-backed securities are backed by the full faith and credit of the U.S. government.

For non-Agency investment securities and residential mortgage loans, the Company may enter into credit default swaps to hedge credit risk. In future periods, the Company could enhance its credit risk protection, enter into further paired derivative positions, including both long and short credit default swaps, and/or seek opportunistic trades in the event of a market disruption (see discussion under “Non-Risk Management Activities” below). The Company also has processes and controls in place to monitor, analyze, manage and mitigate its credit risk with respect to non-Agency securities and residential mortgage loans.

Derivative financial instruments contain an element of credit risk if counterparties are unable to meet the terms of the agreements. Credit risk associated with derivative financial instruments is measured as the net replacement cost should the counterparties that owe the Company under such contracts completely fail to perform under the terms of these contracts, assuming there are no recoveries of underlying collateral, as measured by the market value of the derivative financial instruments. As of December 31, 2018, the fair value of derivative financial instruments as an asset and liability position was $320.0 million and $820.6 million, respectively.

The Company attempts to mitigate its credit risk exposure on derivative financial instruments by limiting its counterparties to banks and financial institutions that meet established credit guidelines. The Company also seeks to spread its credit risk exposure across multiple counterparties in order to reduce its exposure to any single counterparty. Additionally, the Company reduces credit risk on the majority of its derivative instruments by entering into agreements that permit the closeout and netting of transactions with the same counterparty or clearing agency, in the case of centrally cleared interest rate swaps, upon the occurrence of certain events. To further mitigate the risk of counterparty default, the Company maintains collateral agreements with certain of its counterparties and clearing agencies, which require both parties to maintain cash deposits in the event the fair values of the derivative financial instruments exceed established thresholds. The Company’s centrally cleared interest rate swaps require that the Company posts an “initial margin” amount determined by the clearing exchange, which is generally intended to be set at a level sufficient to protect the exchange from the interest rate swap’s maximum estimated single-day price movement. The Company also exchanges “variation margin” based upon daily changes in fair value, as measured by the exchange. As a result of amendments to rules governing certain central clearing activities, the exchange of variation margin is considered a settlement of the interest rate swap, as opposed to pledged collateral. Accordingly, beginning in the first quarter of 2018 and in subsequent periods, the Company accounts for the receipt or payment of variation margin as a direct reduction to the carrying value of the interest rate swap asset or liability. As of December 31, 2017, variation margin pledged or received was netted on a counterparty basis and classified within restricted cash, due from counterparties, or due to counterparties on the Company’s consolidated balance sheets.