Derivative Financial Instruments

9 Months Ended

Sep. 30, 2015

Derivative Financial Instruments [Abstract]

Derivative Financial Instruments

8. DERIVATIVE FINANCIAL INSTRUMENTS

FASB ASC 815, Derivatives and Hedging (“FASB ASC 815”), provides for optional hedge accounting. When a derivative is deemed to be a hedge and certain documentation and effectiveness testing requirements are met, reporting entities are allowed to record all or a portion of the change in the fair value of a designated hedge as an adjustment to other comprehensive income (“OCI”) rather than as a gain or loss in the statements of operations. To date, the Company has not designated any derivatives as hedges under the provisions included in FASB ASC 815.

Derivative financial instruments are recorded at fair value. If the derivative was entered into as part of the Company’s broker-dealer operations, it will be included as a component of investments-trading or trading securities sold, not yet purchased. If it is entered into to hedge for another financial instrument included in other investments, at fair value then the derivative will be included as a component of other investments, at fair value.

The Company may, from time to time, enter into derivatives to manage its risk exposures (i) arising from fluctuations in foreign currency rates with respect to the Company’s investments in foreign currency denominated investments; (ii) arising from the Company’s investments in interest sensitive investments; and (iii) arising from the Company’s facilitation of mortgage-backed trading. Derivatives entered into by the Company, from time to time, may include (i) foreign currency forward contracts; (ii) purchase and sale agreements of TBAs and other forward agency MBS contracts; and (iii) other extended settlement trades.

TBAs are forward contracts to purchase or sell mortgage-backed securities whose collateral remain “to be announced” until just prior to the trade settlement. In addition to TBAs, the Company sometimes enters into forward purchases or sales of agency mortgage-backed securities where the underlying collateral has been identified.  These transactions are referred to as other forward agency MBS contracts.   TBAs and other forward agency MBS contracts are accounted for as derivatives by the Company under FASB ASC 815.  The settlement of these transactions is not expected to have a material effect on the Company’s consolidated financial statements.

In addition to TBAs and other forward agency MBS contracts as part of the Company’s broker-dealer operations, the Company may from time to time enter into other securities or loan trades that do not settle within the normal securities settlement period. In those cases, the purchase or sale of the security or loan is not recorded until the settlement date.   However, from the trade date until the settlement date, the Company’s interest in the security is accounted for as a derivative as either a forward purchase commitment or forward sale commitment.

Derivatives involve varying degrees of off-balance sheet risk, whereby changes in the level or volatility of interest rates or market values of the underlying financial instruments may result in changes in the value of a particular financial instrument in excess of its carrying amount. Depending on the Company’s investment strategy, realized and unrealized gains and losses are recognized in principal transactions and other income or in net trading in the Company’s consolidated statements of operations on a trade date basis.

The Company may, from time to time, enter into the following derivative instruments.

Foreign Currency Forward Contracts

The Company invests in foreign currency denominated investments that expose it to fluctuations in foreign currency rates, and, therefore, the Company may, from time to time, hedge such exposure by using foreign currency forward contracts.  The Company carries the foreign currency forward contracts at fair value and includes them as a component of other investments, at fair value in the Company’s consolidated balance sheets.  As of September 30, 2015 and December 31, 2014, the Company had outstanding foreign currency forward contracts with a notional amount of 2.75 million Euros and 3 million Euros, respectively.  

TBAs and Other Forward Agency MBS Contracts

The Company enters into TBAs and other forward agency MBS transactions for three main reasons.

(i) The Company trades U.S. government agency obligations.  In connection with these activities, the Company may be required to maintain inventory in order to facilitate customer transactions.  In order to mitigate exposure to market risk, the Company may enter into the purchase and sale of TBAs and other forward agency MBS contracts.

(ii) The Company also enters into TBAs and other forward agency MBS contracts in order to assist clients (generally small to mid-size mortgage loan originators) in hedging the interest rate risk associated with the mortgages owned by these clients.

(iii) Finally, the Company may enter into TBAs and other forward agency MBS contracts on a speculative basis.

The Company carries the TBAs and other forward agency MBS contracts at fair value and includes them as a component of investments—trading or trading securities sold, not yet purchased in the Company’s consolidated balance sheets. At September 30, 2015, the Company had open TBA and other forward agency MBS sale agreements in the notional amount of $816,157 and open TBA and other forward agency MBS purchase agreements in the notional amount of $816,157. At December 31, 2014, the Company had open TBA and other forward agency MBS sale agreements in the notional amount of $318,463 and open TBA and other forward agency MBS purchase agreements in the notional amount of $318,463.

Other Extended Settlement Trades

When the Company buys or sells a financial instrument that will not settle in the regular time frame, the Company will account for that purchase and sale on the settlement date rather than the trade date.  In those cases, the Company accounts for the transaction between trade date and settlement date as a derivative as either a forward purchase commitment or a forward sale commitment.  The Company will record an unrealized gain or unrealized loss on the derivative for the difference between the fair value of the underlying financial instrument as of the reporting date and the agreed upon transaction price. At September 30, 2015, the Company had open forward purchase commitments of $11,889 and open forward sale commitments of $0.  At December 31, 2014, the Company had open forward purchase commitments of $3,517 and open forward sale commitments of $0.

The following table presents the Company’s derivative financial instruments and the amount and location of the fair value (unrealized gain / (loss)) recognized in the consolidated balance sheets as of September 30, 2015 and December 31, 2014.  

DERIVATIVE FINANCIAL INSTRUMENTS-BALANCE SHEET INFORMATION
(Dollars in Thousands)
Derivative Financial Instruments Not Designated as Hedging Instruments Under FASB ASC 815	Balance Sheet Classification		September 30, 2015		December 31, 2014
TBAs and other forward agency MBS	Investments-trading	$	6,462	$	1,928
Other extended settlement trades	Investments-trading		-		2
			6,462		1,930
Foreign currency forward contracts	Other investments, at fair value		22		83
TBAs and other forward agency MBS	Trading securities sold, not yet purchased		(5,995)		(1,666)
Other extended settlement trades	Trading securities sold, not yet purchased		-		(4)
			(5,995)		(1,670)
		$	489	$	343

The following table presents the Company’s derivative financial instruments and the amount and location of the net gain (loss) recognized in the consolidated statement of operations.

DERIVATIVE FINANCIAL INSTRUMENTS-STATEMENT OF OPERATIONS INFORMATION
(Dollars in Thousands)
Derivative Financial Instruments Not Designated as Hedging Instruments Under FASB ASC 815	Income Statement Classification		Nine Months Ended September 30, 2015		Nine Months Ended September 30, 2014
Foreign currency forward contracts	Revenues-principal transactions and other income	$	286	$	(347)
Other extended settlement trades	Revenue-net trading		2		-
TBAs and other forward agency MBS	Revenues-net trading		4,158		1,712
		$	4,446	$	1,365

DERIVATIVE FINANCIAL INSTRUMENTS-STATEMENT OF OPERATIONS INFORMATION
(Dollars in Thousands)
Derivative Financial Instruments Not Designated as Hedging Instruments Under FASB ASC 815	Income Statement Classification		Three Months Ended September 30, 2015		Three Months Ended September 30, 2014
Foreign currency forward contracts	Revenues-principal transactions and other income	$	(2)	$	-
Other extended settlement trades	Revenue-net trading		(26)		-
TBAs and other forward agency MBS	Revenues-net trading		1,115		485
		$	1,087	$	485