Derivative Instruments and Hedging Activities (Notes)

v2.4.0.8

Derivative Instruments and Hedging Activities (Notes)	6 Months Ended
	Jun. 30, 2014
Derivative Instruments and Hedging Activities Disclosure [Abstract]
Derivative Instruments and Hedging Activities	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 Company’s 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. The Company’s derivative financial instruments are utilized principally to manage market risk and cash flow volatility associated with interest rate risk (including associated prepayment risk) related to certain assets and liabilities. As part of its risk management activities, the Company may, at times, enter into various forward contracts, including short securities, Agency to-be-announced securities, or TBAs, options, futures, swaps, caps, credit default swaps and total return swaps. In executing on the Company’s current risk management strategy, the Company has entered into interest rate swap and swaption agreements, TBAs, put and call options for TBAs, constant maturity swaps, credit default swaps 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 U.S. Treasuries and Agency interest-only securities. 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 certain of these risks. The discussion includes both derivative and non-derivative instruments used as part of these risk management activities. While the Company uses non-derivative and 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, as amended and interpreted, or ASC 815, the Company records derivative financial instruments on its condensed consolidated balance sheet 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 qualify for hedge accounting treatment. Due to the volatility of the credit markets and difficulty in effectively matching pricing or cash flows, the Company has elected to treat all current derivative contracts as trading instruments. The following tables present the gross fair value and notional amounts of the Company’s derivative financial instruments treated as trading instruments as of June 30, 2014 and December 31, 2013. (in thousands)   June 30, 2014     Derivative Assets   Derivative Liabilities Trading instruments   Fair Value   Notional   Fair Value   Notional Inverse interest-only securities   $ 207,260   $ 1,323,650   $ —   $ — Interest rate swap agreements   4,978   23,628,148   —   — Credit default swaps   —   —   (2,081 )   125,000 Swaptions, net   106,828   11,450,000   —   — TBAs   9,063   1,450,000   (13,566 )   1,822,000 Put and call options for TBAs, net   28   —   —   — Constant maturity swaps   —   —   (772 )   6,000,000 Markit IOS total return swaps   —   —   (678 )   576,478 Forward purchase commitments   3,444   647,941   —   — Total   $ 331,601   $ 38,499,739   $ (17,097 )   $ 8,523,478 (in thousands)   December 31, 2013     Derivative Assets   Derivative Liabilities Trading instruments   Fair Value   Notional   Fair Value   Notional Inverse interest-only securities   $ 221,364   $ 1,525,845   $ —   $ — Interest rate swap agreements   25,325   19,619,000   —   — Credit default swaps   —   —   (18,049 )   427,073 Swaptions, net   269,745   5,130,000   —   — TBAs   33,425   4,097,000   (125 )   400,000 Constant maturity swaps   —   —   (3,773 )   10,000,000 Markit IOS total return swaps   —   —   (134 )   49,629 Forward purchase commitments   —   12,063   —   — Total   $ 549,859   $ 30,383,908   $ (22,081 )   $ 10,876,702 Comprehensive Income Statement Presentation The Company has not applied hedge accounting to its current derivative portfolio held to mitigate the interest rate risk and credit risk associated with its debt portfolio. As a result, the Company is subject to volatility in its earnings due to movement in the unrealized gains and losses associated with its interest rate swaps and its other derivative instruments. The following table summarizes the location and amount of gains and losses on derivative instruments reported in the condensed consolidated statements of comprehensive income on the Company’s derivative trading instruments: (in thousands)                     Trading Instruments   Location of Gain/(Loss) Recognized in Income on Derivatives   Amount of Gain/(Loss) Recognized in Income on Derivatives         Three Months Ended June 30,   Six Months Ended June 30,         2014   2013   2014   2013 Interest rate risk management                     TBAs (1)   (Loss) gain on other derivative instruments   $ (29,877 )   $ 79,330   $ (47,780 )   $ 66,678 Put and call options for TBAs (1)   (Loss) gain on other derivative instruments   (4,614 )   52,426   (6,319 )   52,426 Constant maturity swaps (1)   (Loss) gain on other derivative instruments   (6,103 )   (14,057 )   5,428   (14,057 ) Short U.S. Treasuries (1)   (Loss) gain on other derivative instruments   (8 )   (990 )   (8 )   (990 ) Interest rate swap agreements - Receivers (1)   (Loss) gain on interest rate swap and swaption agreements   65,963   —   106,942   — Interest rate swap agreements - Payers (1)   (Loss) gain on interest rate swap and swaption agreements   (46,341 )   409   (59,761 )   320 Swaptions (1)   (Loss) gain on interest rate swap and swaption agreements   (57,250 )   73,794   (169,808 )   91,765 Markit IOS total return swaps (1)   (Loss) gain on other derivative instruments   353   —   (1,372 )   — Interest rate swap agreements - Payers (2)   (Loss) gain on interest rate swap and swaption agreements   (78,391 )   185,623   (98,920 )   186,713 Credit risk management                     Credit default swaps - Receive protection (3)   (Loss) gain on other derivative instruments   (5 )   (4,220 )   1,976   (9,862 ) Non-risk management                     TBAs   (Loss) gain on other derivative instruments   —   (10,057 )   (4,701 )   (9,654 ) Inverse interest-only securities   (Loss) gain on other derivative instruments   16,052   (40,149 )   34,375   (38,920 ) Forward purchase commitments   Gain (loss) on mortgage loans held-for-sale   4,163   (20,302 )   3,746   (20,015 ) Total       $ (136,058 )   $ 301,807   $ (236,202 )   $ 304,404 ____________________ (1) Includes derivative instruments held to mitigate interest rate risk associated with the Company’s investment portfolio. (2) Includes derivative instruments held to mitigate interest rate risk associated with the Company’s repurchase agreements and FHLB advances. (3) Includes derivative instruments held to mitigate credit risk associated with the Company’s non-Agency RMBS and mortgage loans held-for-sale. For the three and six months ended June 30, 2014, the Company recognized $18.9 million and $32.7 million, respectively, of expenses for the accrual and/or settlement of the net interest expense associated with its interest rate swaps. The expenses result from paying either a fixed interest rate or LIBOR interest on an average $23.5 billion and $21.3 billion notional, respectively, to economically hedge a portion of the Company’s interest rate risk on its short-term repurchase agreements, funding costs, and macro-financing risk and receiving either LIBOR interest or a fixed interest rate. For the three and six months ended June 30, 2013, the Company recognized $19.4 million and $33.4 million, respectively, of expenses for the accrual and/or settlement of the net interest expense associated with its interest rate swaps on an average $17.7 billion and $16.3 billion notional. The following tables present information with respect to the volume of activity in the Company’s derivative instruments during the three and six months ended June 30, 2014 and 2013: (in thousands)                       Three Months Ended June 30, Beginning of Period Notional Amount   Additions   Settlement, Termination, Expiration or Exercise   End of Period Notional Amount   Average Notional Amount   Realized Gain (Loss), net (1) 2014                       Inverse interest-only securities $ 1,412,374   $ —   $ (88,724 )   $ 1,323,650   $ 1,372,535   $ — Interest rate swap agreements 21,663,148   8,465,000   (6,500,000 )   23,628,148   23,467,489   (2,983 ) Credit default swaps 125,000   —   —   125,000   125,000   — Swaptions, net 9,500,000   3,250,000   (1,300,000 )   11,450,000   10,412,088   (2,178 ) TBAs, net (1,022,000 )   (2,032,000 )   2,682,000   (372,000 )   660,308   (26,530 ) Put and call options for TBAs, net 1,500,000   —   (1,500,000 )   —   901,099   (5,332 ) Constant maturity swaps 10,000,000   4,000,000   (8,000,000 )   6,000,000   5,571,429   (1,460 ) Markit IOS total return swaps 243,987   339,869   (7,378 )   576,478   393,910   — Short U.S. Treasuries —   (125,000 )   125,000   —   1,374   2 Forward purchase commitments 153,637   872,756   (378,452 )   647,941   367,940   332 Total $ 43,576,146   $ 14,770,625   $ (14,967,554 )   $ 43,379,217   $ 43,273,172   $ (38,149 ) 2013                       Inverse interest-only securities $ 1,960,087   $ 15,576   $ (176,691 )   $ 1,798,972   $ 1,895,789   $ — Interest rate swap agreements 16,685,000   1,800,000   —   18,485,000   17,655,220   — Credit default swaps 437,496   1,300,000   (107,092 )   1,630,404   764,914   (12,352 ) Swaptions, net 5,800,000   750,000   (300,000 )   6,250,000   5,748,352   (3,983 ) TBAs, net 2,150,000   (1,494,000 )   (3,377,000 )   (2,721,000 )   724,725   32,767 Put and call options for TBAs, net —   (502,000 )   292,000   (210,000 )   130,901   29,197 Constant maturity swaps —   19,000,000   —   19,000,000   5,532,967   — Short U.S. Treasuries —   (400,000 )   400,000   —   26,703   (876 ) Forward purchase commitments 8,745   510,185   (489,701 )   29,229   297,207   (18,988 ) Total $ 27,041,328   $ 20,979,761   $ (3,758,484 )   $ 44,262,605   $ 32,776,778   $ 25,765 (in thousands)                       Six Months Ended June 30, Beginning of Period Notional Amount   Additions   Settlement, Termination, Expiration or Exercise   End of Period Notional Amount   Average Notional Amount   Realized Gain (Loss), net (1) 2014                     Inverse interest-only securities $ 1,525,845   $ —   $ (202,195 )   $ 1,323,650   $ 1,421,330   $ 193 Interest rate swap agreements 19,619,000   11,409,148   (7,400,000 )   23,628,148   21,324,091   (3,005 ) Credit default swaps 427,073   —   (302,073 )   125,000   152,059   (13,705 ) Swaptions, net 5,130,000   7,150,000   (830,000 )   11,450,000   9,699,558   (3,396 ) TBAs, net 603,000   (2,924,000 )   1,949,000   (372,000 )   593,746   (14,677 ) Put and call options for TBAs, net —   1,500,000   (1,500,000 )   —   580,110   (5,332 ) Constant maturity swaps 10,000,000   12,000,000   (16,000,000 )   6,000,000   7,773,481   2,427 Markit IOS total return swaps 49,629   536,881   (10,032 )   576,478   274,573   — Short U.S. Treasuries —   (125,000 )   125,000   —   691   2 Forward purchase commitments 12,063   1,058,706   (422,828 )   647,941   204,336   302 Total $ 37,366,610   $ 30,605,735   $ (24,593,128 )   $ 43,379,217   $ 42,023,975   $ (37,191 ) 2013                       Inverse interest-only securities $ 1,909,351   $ 230,261   $ (340,640 )   $ 1,798,972   $ 1,908,919   $ — Interest rate swap agreements 14,070,000   12,575,000   (8,160,000 )   18,485,000   16,267,624   (58,692 ) Credit default swaps 438,440   1,300,000   (108,036 )   1,630,404   602,283   (12,352 ) Swaptions, net 4,950,000   1,600,000   (300,000 )   6,250,000   5,646,133   (3,983 ) TBAs, net 953,000   4,100,000   (7,774,000 )   (2,721,000 )   805,403   20,114 Put and call options for TBAs, net —   (502,000 )   292,000   (210,000 )   65,812   29,197 Constant maturity swaps —   19,000,000   —   19,000,000   2,781,768   — Short U.S. Treasuries —   (400,000 )   400,000   —   13,425   (876 ) Forward purchase commitments 56,865   510,185   (537,821 )   29,229   174,920   (18,576 ) Total $ 22,377,656   $ 38,413,446   $ (16,528,497 )   $ 44,262,605   $ 28,266,287   $ (45,168 ) ____________________ (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 condensed consolidated statements of cash flows. Derivative fair value adjustments are reflected within the unrealized loss (gain) on interest rate swaps and swaptions, unrealized loss on other derivative instruments, and (gain) loss on mortgage loans held-for-sale line items within the operating activities section of the condensed consolidated statements of cash flows. Realized losses on interest rate swap and swaption agreements are reflected within the loss on termination of interest rate swaps and swaptions line item within the operating activities section of the condensed consolidated statements of cash flows. The remaining cash flow activity related to derivative instruments is reflected within the purchases of other derivative instruments, proceeds from sales of other derivative instruments, and decrease in due to counterparties, net line items within the investing activities section of the condensed consolidated statements of cash flows. Interest Rate Sensitive Assets/Liabilities The Company’s RMBS investment securities and MSR are 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 and an increase in the value of the Company’s MSR. To mitigate the impact of this risk, the Company maintains a portfolio of financial instruments, primarily fixed-rate interest-only securities, which increase in value when interest rates increase. In addition, the Company has initiated TBA positions, put and call options for TBAs, constant maturity swaps and interest rate swap agreements to further mitigate its exposure to higher interest rates, decreased prepayment speeds and widening mortgage spreads. The objective is to reduce the risk of losses to the portfolio caused by interest rate changes and changes in prepayment speeds. As of June 30, 2014 and December 31, 2013, the Company had outstanding fair value of $66.8 million and $75.6 million, respectively, of interest-only securities in place to economically hedge its investment securities. These interest-only securities are included in AFS securities, at fair value, in the condensed consolidated balance sheets. The Company is exposed to interest rate risk on mortgage loans from the time it commits to purchase a mortgage loan until it acquires the loan from the originator and subsequently sells the loan to a third party. Changes in interest rates impact the market price for the mortgage loans. For example, as market interest rates decline, the value of mortgage loans held-for-sale increases, and vice versa. To mitigate the impact of this risk, the Company may enter into derivative contracts to hedge the interest rate risk related to its commitments to purchase mortgage loans and mortgage loans held-for-sale, such as interest rate swaps, swaptions, TBA positions, put and call options for TBAs and constant maturity swaps. TBAs - At times, the Company may use TBAs for risk management purposes or as a means of deploying capital until targeted investments are available and to take advantage of temporary displacements in the marketplace. 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. As of June 30, 2014, $1.5 billion of the Company’s long notional TBA positions and $1.8 billion of the Company’s short notional TBA positions were held in order to economically hedge portfolio risk. As of December 31, 2013, $0.4 billion of the Company’s long notional TBA positions and $1.9 billion of the Company’s short notional TBA positions were held in order to economically hedge portfolio risk, while the remaining $2.2 billion long notional TBA positions were held for non-risk management purposes (see “Non-Risk Management Activities” below). The Company discloses these positions 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 June 30, 2014 and December 31, 2013:   As of June 30, 2014               Net Carrying Value (4) (in thousands) Notional Amount (1)   Cost Basis (2)   Market Value (3)   Derivative Assets   Derivative Liabilities Purchase contracts $ 1,450,000   $ 1,423,492   $ 1,432,555   $ 9,063   $ — Sale contracts (1,822,000 )   (1,862,809 )   (1,876,375 )   —   (13,566 ) TBAs, net $ (372,000 )   $ (439,317 )   $ (443,820 )   $ 9,063   $ (13,566 )   As of December 31, 2013               Net Carrying Value (4) (in thousands) Notional Amount (1)   Cost Basis (2)   Market Value (3)   Derivative Assets   Derivative Liabilities Purchase contracts $ 2,550,000   $ 2,749,648   $ 2,767,295   $ 17,771   $ (125 ) Sale contracts (1,947,000 )   (1,959,256 )   (1,943,602 )   15,654   — TBAs, net $ 603,000   $ 790,392   $ 823,693   $ 33,425   $ (125 ) ___________________ (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 condensed consolidated balance sheets. Put and Call Options for TBAs - As of June 30, 2014, the Company had purchased put and call options for TBAs with a total notional amount of $1.0 billion and sold put and call options for TBAs with a total notional amount of $1.0 billion. The Company paid upfront premiums of approximately $5.5 million for the options purchased and received upfront premiums of approximately $4.5 million for the options sold. Each of the options will expire in August 2014. The put and call options had a net fair market value of $28,226, included in derivative assets, at fair value, in the condensed consolidated balance sheet as of June 30, 2014. The Company did not hold any put or call options for TBAs as of December 31, 2013. Constant Maturity Swaps - The Company has also entered into constant maturity swaps between the 10-year interest rate swap curve and the yield to maturity on a 30-year Fannie Mae TBA to economically hedge mortgage spread widening. The Company had the following constant maturity swap agreements in place at June 30, 2014 and December 31, 2013: (notional and dollars in thousands)                 June 30, 2014 Determination Date   Average Strike Swap Rate   Notional Amount   Fair Value   Upfront Premium Paid   Unrealized Gain/(Loss) September 2014   0.633 %   $ 6,000,000   $ (772 )   $ —   $ (772 ) Total   0.633 %   $ 6,000,000   $ (772 )   $ —   $ (772 ) (notional and dollars in thousands)                 December 31, 2013 Determination Date   Average Strike Swap Rate   Notional Amount   Fair Value   Upfront Premium Paid   Unrealized Gain/(Loss) February 2014   0.768 %   $ 3,000,000   $ 625   $ —   $ 625 March 2014   0.850 %   5,000,000   (3,171 )   —   (3,171 ) June 2014   0.828 %   2,000,000   (1,227 )   —   (1,227 ) Total   0.821 %   $ 10,000,000   $ (3,773 )   $ —   $ (3,773 ) Interest Rate Swap Agreements - As of June 30, 2014 and December 31, 2013, the Company held the following interest rate swaps in order to mitigate mortgage interest rate exposure (or duration) risk associated with the Company’s investment portfolio whereby the Company receives interest at a three-month LIBOR rate: (notional in thousands)             June 30, 2014 Swaps Maturities   Notional Amounts   Average Fixed Pay Rate   Average Receive Rate   Average Maturity (Years) 2015   $ —   — %   — %   — 2016   1,000,000   0.955 %   0.228 %   2.17 2017   —   — %   — %   — 2018   2,040,000   1.563 %   0.230 %   4.44 2019 and Thereafter   900,000   2.378 %   0.234 %   6.74 Total   $ 3,940,000   1.595 %   0.230 %   4.39 (notional in thousands)             December 31, 2013 Swaps Maturities   Notional Amounts   Average Fixed Pay Rate   Average Receive Rate   Average Maturity (Years) 2014   $ —   — %   — %   — 2015   —   — %   — %   — 2016   1,000,000   0.955 %   0.239 %   2.67 2017   —   — %   — %   — 2018 and Thereafter   2,040,000   1.563 %   0.241 %   4.94 Total   $ 3,040,000   1.363 %   0.240 %   4.20 Additionally, as of June 30, 2014 and December 31, 2013, the Company held the following interest rate swaps in order to mitigate mortgage interest rate exposure (or duration) risk associated with the Company’s investment portfolio whereby the Company pays interest at a three-month LIBOR rate: (notional in thousands)             June 30, 2014 Swaps Maturities   Notional Amounts   Average Pay Rate   Average Fixed Receive Rate   Average Maturity (Years) 2015   $ —   — %   — %   — 2016   —   — %   — %   — 2017   —   — %   — %   — 2018   575,000   0.227 %   1.440 %   4.39 2019 and Thereafter   2,523,148   0.231 %   2.487 %   7.70 Total   $ 3,098,148   0.230 %   2.292 %   7.08 (notional in thousands)             December 31, 2013 Swaps Maturities   Notional Amounts   Average Pay Rate   Average Fixed Receive Rate   Average Maturity (Years) 2014   $ —   — %   — %   — 2015   —   — %   — %   — 2016   —   — %   — %   — 2017   —   — %   — %   — 2018 and Thereafter   2,154,000   0.240 %   2.337 %   7.84 Total   $ 2,154,000   0.240 %   2.337 %   7.84 The Company monitors its borrowings under repurchase agreements and FHLB advances, which are generally floating rate debt, in relation to the rate profile of its investment securities. When it is cost effective to do so, the Company may enter into interest rate swap arrangements to align the interest rate composition of its borrowings under repurchase agreements and FHLB advances with that of its investment securities and debt portfolios. 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 the interest rate swaps match the terms of the underlying debt, resulting in an effective conversion of the rate of the related repurchase agreement or FHLB advance from floating to fixed. As of June 30, 2014 and December 31, 2013, the Company had the following outstanding interest rate swaps that were utilized as economic hedges of interest rate exposure (or duration) associated with the Company’s short-term repurchase agreements and FHLB advances: (notional in thousands)             June 30, 2014 Swaps Maturities   Notional Amount   Average Fixed Pay Rate   Average Receive Rate   Average Maturity (Years) 2015   $ —   — %   — %   — 2016   10,250,000   0.563 %   0.228 %   1.92 2017   4,035,000   0.950 %   0.230 %   3.04 2018   1,125,000   1.314 %   0.230 %   3.99 2019 and Thereafter   1,180,000   2.536 %   0.228 %   8.79 Total   $ 16,590,000   0.848 %   0.228 %   2.82 (notional in thousands)             December 31, 2013 Swaps Maturities   Notional Amount   Average Fixed Pay Rate   Average Receive Rate   Average Maturity (Years) 2014   $ 3,900,000   0.300 %   0.245 %   0.76 2015   1,000,000   0.383 %   0.244 %   1.04 2016   2,950,000   0.626 %   0.246 %   2.42 2017   5,300,000   0.920 %   0.217 %   3.49 2018 and Thereafter   1,275,000   1.406 %   0.242 %   5.04 Total   $ 14,425,000   0.698 %   0.235 %   2.50 Interest Rate Swaptions - As of June 30, 2014 and December 31, 2013, the Company had the following outstanding 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) that were utilized as macro-economic hedges: June 30, 2014 (notional and dollars in thousands)   Option   Underlying Swap Swaption   Expiration   Cost   Fair Value   Average Months to Expiration   Notional Amount   Average Pay Rate   Average Receive Rate   Average Term (Years) Purchase contracts:                                 Payer   ≥ 6 Months   $ 223,504   $ 146,198   34.34   $ 6,000,000   4.27 %   3M Libor   9.0 Total Payer       $ 223,504   $ 146,198   34.34   $ 6,000,000   4.27 %   3M Libor   9.0                                   Receiver   < 6 Months   $ 10,106   $ 3,171   3.61   $ 4,250,000   3M Libor   1.59 %   5.3 Receiver   ≥ 6 Months   900   341   6.30   2,000,000   3M Libor   1.08 %   5.0 Total Receiver       $ 11,006   $ 3,512   4.48   $ 6,250,000   3M Libor   1.43 %   5.2                                   Sale contracts:                                 Payer   ≥ 6 Months   $ (81,248 )   $ (42,882 )   36.02   $ (800,000 )   3.44 %   3M Libor   10.0 Total Payer       $ (81,248 )   $ (42,882 )   36.02   $ (800,000 )   3.44 %   3M Libor   10.0 December 31, 2013 (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   $ 10,431   $ 10,458   2.78   $ 675,000   3.33 %   3M Libor   10.0 Payer   ≥ 6 Months   223,504   353,108   39.14   6,000,000   4.27 %   3M Libor   9.0 Total Payer       $ 233,935   $ 363,566   38.16   $ 6,675,000   4.18 %   3M Libor   9.1                                   Receiver   < 6 Months   $ 3,991   $ 681   1.93   $ 275,000   3M Libor   2.89 %   10.0 Total Receiver       $ 3,991   $ 681   1.93   $ 275,000   3M Libor   2.89 %   10.0                                   Sale contracts:                                 Payer   < 6 Months   $ (3,455 )   $ (7,679 )   1.93   $ (510,000 )   1.60 %   3M Libor   5.0 Payer   ≥ 6 Months   (81,248 )   (86,361 )   42.02   (800,000 )   3.44 %   3M Libor   10.0 Total Payer       $ (84,703 )   $ (94,040 )   33.68   $ (1,310,000 )   2.72 %   3M Libor   8.1                                   Receiver   < 6 Months   $ (3,455 )   $ (462 )   1.93   $ (510,000 )   3M Libor   1.60 %   5.0 Total Receiver       $ (3,455 )   $ (462 )   1.93   $ (510,000 )   3M Libor   1.60 %   5.0 Markit IOS Total Return Swaps - The Company also enters into 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) to help mitigate the potential impact of larger increases or decreases in interest rates on the performance of our investment 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 June 30, 2014 and December 31, 2013: (notional and dollars in thousands)           June 30, 2014 Maturity Date   Current Notional Amount   Fair Value   Upfront (Payable)/Receivable   Unrealized Gain/(Loss) 1/12/2043   $ (432,105 )   $ (464 )   $ (1,457 )   $ (1,921 ) 1/12/2044   (144,373 )   (214 )   (126 )   (340 ) Total   $ (576,478 )   $ (678 )   $ (1,583 )   $ (2,261 ) (notional and dollars in thousands)           December 31, 2013 Maturity Date   Current Notional Amount   Fair Value   Upfront Payable   Unrealized Gain/(Loss) 1/12/2043   $ (49,629 )   $ (134 )   $ (453 )   $ (587 ) Total   $ (49,629 )   $ (134 )   $ (453 )   $ (587 ) Credit Risk The Company’s exposure to credit losses on its U.S. Treasuries and Agency portfolio of investment securities is limited because these securities are issued by the U.S. Department of the Treasury or 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. Credit Default Swaps - For non-Agency investment securities and 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 of “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 RMBS and mortgage loans. As of June 30, 2014, the Company held credit default swaps whereby the Company receives credit protection for a fixed premium. The maximum payouts for these credit default swaps are limited to the current notional amounts of each swap contract. Maximum payouts for credit default swaps do not represent the expected future cash requirements, as the Company’s credit default swaps are typically liquidated or expire and are not exercised by the holder of the credit default swaps. The following tables present credit default swaps whereby the Company is receiving protection held as of June 30, 2014 and December 31, 2013: (notional and dollars in thousands)                 June 30, 2014 Protection Maturity Date   Average Implied Credit Spread   Current Notional Amount   Fair Value   Upfront (Payable)/Receivable   Unrealized Gain/(Loss) Receive 6/20/2016   105.50   $ (100,000 )   $ (1,689 )   $ (260 )   $ (1,949 )   12/20/2016   496.00   (25,000 )   (392 )   (4,062 )   (4,454 )   Total   183.60   $ (125,000 )   $ (2,081 )   $ (4,322 )   $ (6,403 ) (notional and dollars in thousands)                 December 31, 2013 Protection Maturity Date   Average Implied Credit Spread   Current Notional Amount   Fair Value   Upfront Payable   Unrealized Gain/(Loss) Receive 6/20/2016   105.50   $ (100,000 )   $ (2,149 )   $ (260 )   $ (2,409 )   12/20/2016   496.00   (25,000 )   (401 )   (4,062 )   (4,463 )   12/20/2018   393.31   (270,000 )   (23,568 )   12,838   (10,730 )   5/25/2046   356.00   (32,073 )   8,069   (15,026 )   (6,957 )   Total   329.13   $ (427,073 )   $ (18,049 )   $ (6,510 )   $ (24,559 ) 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 June 30, 2014, the fair value of derivative financial instruments as an asset and liability position was $331.6 million and $17.1 million, respectively. The Company mitigates the credit risk exposure on derivative financial instruments by limiting the counterparties to those major banks and financial institutions that meet established credit guidelines. The Company also seeks to transact with several different counterparties in order to reduce the 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 upon occurrence of certain events. To further mitigate the risk of counterparty default, the Company maintains collateral agreements with certain of its counterparties, which require both parties to maintain cash deposits in the event the fair values of the derivative financial instruments exceed established thresholds. As of June 30, 2014, the Company has received cash deposits from counterparties of $93.8 million and placed cash deposits of $225.0 million in accounts maintained by counterparties, of which the amounts are netted on a counterparty basis and classified within restricted cash, due from counterparties, or due to counterparties on the condensed consolidated balance sheet. Non-Risk Management Activities The Company has entered into certain financial instruments that are considered derivative contracts under ASC 815 that are not for purposes of hedging. These contracts are currently limited to forward purchase commitments, TBAs and inverse interest-only RMBS. Commitments to Purchase Mortgage Loans Held-for-Sale - Prior to a mortgage loan purchase, the Company may enter into forward purchase commitments with counterparties whereby the Company commits to purchasing the loans at a particular interest rate, provided the borrower elects to close the loan. These commitments to purchase mortgage loans have been defined as derivatives and are, therefore, recorded on the balance sheet as assets or liabilities and measured at fair value. Subsequent changes in fair value are recorded on the balance sheet as adjustments to the carrying value of these assets or liabilities with a corresponding adjustment recognized in current period earnings. As of June 30, 2014 and December 31, 2013, the Company had outstanding commitments to purchase $647.9 million and $12.1 million of mortgage loans, subject to fallout if the loans do not close, with a fair value liability of $3.4 million at June 30, 2014. As of December 31, 2013, no fair value was assigned to the derivative as there was not a meaningful change in market value from commitment date to December 31, 2013. TBAs - As of December 31, 2013, the Company held $2.2 billion notional TBAs as a means of deploying capital until targeted investments are available, and to take advantage of temporary displacements in the marketplace. None of the Company’s TBAs were held for this purpose as of June 30, 2014. Inverse Interest-Only Securities - As of June 30, 2014 and December 31, 2013, inverse interest-only securities with a carrying value of $207.3 million and $221.4 million, including accrued interest receivable of $2.5 million and $2.9 million, respectively, are accounted for as derivative financial instruments in the condensed consolidated financial statements. The following table presents the amortized cost and carrying value (which approximates fair value) of inverse interest-only securities as of June 30, 2014 and December 31, 2013: (in thousands) June 30, 2014   December 31, 2013 Face Value $ 1,323,650   $ 1,525,845 Unamortized premium —   — Unamortized discount       Designated credit reserve —   — Net, unamortized (1,123,574 )   (1,292,785 ) Amortized Cost 200,076   233,060 Gross unrealized gains 11,542   5,891 Gross unrealized losses (6,845 )   (20,442 ) Carrying Value $ 204,773   $ 218,509