Note 9 - Derivative Financial Instruments

6 Months Ended

Jun. 30, 2022

Notes to Financial Statements

Derivative Instruments and Hedging Activities Disclosure [Text Block]

9. 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 can record all or a portion of the change in the fair value of a designated hedge as an adjustment to 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.

All of the derivatives that the Company enters into contain master netting arrangements.  If certain requirements are met, the offsetting provisions included in FASB ASC 210, Balance Sheet (“ASC 210”), allow (but do not require) the reporting entity to net the asset and liability on the consolidated balance sheets. It is the Company’s policy to present the derivative assets and liabilities on a net basis if the conditions of ASC 210 are met.  However, in general the Company does not enter in offsetting derivatives with the same counterparties.  Therefore, in all periods presented, no derivatives are presented on a net basis. 

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

TBAs are forward contracts to purchase or sell MBS with collateral that remains “to be announced” until just prior to the trade settlement date. In addition to TBAs, the Company sometimes enters into forward purchases or sales of agency MBS 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 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.  The Company will classify the related derivative either within investments-trading or other investments, at fair value depending on where it intends to classify the investment once the trade settles.

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.

Equity Derivatives

A significant portion of the Company’s equity holdings are carried at fair value.  The Company hedges a portion of this exposure by entering into equity derivatives such as puts and short call options from time to time. These derivative positions are carried at fair value as a component of other investments, at fair value and other investments sold, not yet purchased in the Company’s consolidated balance sheets.  As of   June 30, 2022 and December 31, 2021, the Company had no put or short call options.  From time to time, the Company may also enter into forward purchase commitments for equity securities.  

The Company also hedges a portion of the exposure from these equity investments by entering into short trades.  These short trades are not treated as derivatives and are carried as a component of other investments sold, not yet purchased.  See Note 7.

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 June 30, 2022, the Company had open TBA and other forward MBS purchase agreements in the notional amount of $ 1,158,000 and open TBA and other forward MBS sale agreements in the notional amount of $ 1,180,350. At December 31, 2021, the Company had open TBA and other forward agency MBS purchase agreements in the notional amount of $1,243,250 and open TBA and other forward agency MBS sale agreements in the notional amount of $1,283,850.

Other Extended Settlement Trades

When the Company buys or sells a financial instrument that will not settle in the regular timeframe, the Company will account for that purchase or 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 either a forward purchase commitment or a forward sale commitment, both considered derivatives.  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. As of   June 30, 2022, and   December 31, 2021, the Company had no open forward purchase or sales commitments.

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 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 June 30, 2022 and December 31, 2021, the Company had no outstanding foreign currency forward contracts. 

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 June 30, 2022 and December 31, 2021.  

DERIVATIVE FINANCIAL INSTRUMENTS-BALANCE SHEET INFORMATION

(Dollars in Thousands)

Derivative Financial Instruments Not Designated as Hedging Instruments Under FASB ASC 815	Balance Sheet Classification	June 30, 2022			December 31, 2021
TBAs and other forward agency MBS	Investments-trading	$	4,189		$	1,275
TBAs and other forward agency MBS	Trading securities sold, not yet purchased		(2,884	)		(424	)
		$	1,305		$	851

The following tables present the Company’s derivative financial instruments and the amount and location of the net gain (loss) recognized in the consolidated statements 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	Three Months Ended June 30, 2022		Three Months Ended June 30, 2021
Other extended settlement trades	Revenue-net trading	$	-	$	20
TBAs and other forward agency MBS	Revenue-net trading		2,960		1,967
Equity derivatives	Principal transactions and other income		-		58
		$	2,960	$	2,045

Derivative Financial Instruments Not Designated as Hedging Instruments Under FASB ASC 815	Income Statement Classification	Six Months Ended June 30, 2022		Six Months Ended June 30, 2021
Other extended settlement trades	Revenue-net trading	$	-	$	20
TBAs and other forward agency MBS	Revenue-net trading		5,598		4,576
Equity derivatives	Principal transactions and other income		-		192
		$	5,598	$	4,788