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FAIR VALUES OF FINANCIAL INSTRUMENTS

12 Months Ended

Dec. 31, 2019

NOTE 8 — FAIR VALUES OF FINANCIAL INSTRUMENTS

The fair value of Capstead’s financial assets and liabilities are influenced by changes in, and market expectations for changes in, interest rates and market liquidity conditions, as well as other factors beyond the control of management. With the exception of the fair value of Eurodollar futures and lending counterparty investments, all fair values were determined using Level 2 Inputs in accordance with ASU 2010-06, Fair Value Measurements and Disclosures (Topic 820). Eurodollar futures are Derivatives for which Level 1 inputs are used to determine fair value. Lending counterparty investments were nonmarketable securities classified as assets for which Level 3 Inputs were used to determine fair value.

Residential mortgage investments, nearly all of which are mortgage securities classified as available-for-sale, are measured at fair value on a recurring basis. In determining fair value estimates the Company considers recent trading activity for similar investments and pricing levels indicated by lenders in connection with designating collateral for secured borrowings, provided such pricing levels are considered indicative of actual market clearing transactions. The Company currently bases fair value for Unsecured borrowings on discounted cash flows using Company estimates for market yields. Excluded from these disclosures are financial instruments for which cost basis is deemed to approximate fair value due primarily to the short duration of these instruments, which are valued using primarily Level 1 measurements, including Cash and cash equivalents, Cash collateral receivable from derivative counterparties, receivables, payables and Secured borrowings with initial terms of 120 days or less. See NOTE 6 for information relative to the valuation of interest rate swap agreements.

The following table presents the fair value for the Company’s financial instruments as of the indicated dates (in thousands):

		December 31, 2019				December 31, 2018
	Fair Value Hierarchy	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial assets:
Residential mortgage loans	Level 2	$	637	$	650	$	1,425	$	1,400
Lending counterparty investments	Level 3		–		–		5,002		5,002
Secured borrowings-related interest rate swap agreements	Level 2		733		733		–		–
Eurodollar futures	Level 1		738		738		–		–
Financial liabilities:
Unsecured borrowings	Level 2		98,392		68,100		98,292		76,600
Unsecured borrowings-related interest rate swap agreements	Level 2		29,156		29,156		17,834		17,834

Fair value-related disclosures for debt securities were as follows as of the indicated dates (in thousands):

	Amortized		Gross Unrealized
	Cost Basis		Gains		Losses		Fair Value
December 31, 2019
Agency Securities classified as available-for-sale:
Fannie Mae/Freddie Mac	$	8,890,949	$	64,593	$	23,753	$	8,931,789
Ginnie Mae		2,284,331		11,560		7,133		2,288,758
Residential mortgage securities classified as held-to-maturity		998		2		–		1,000
December 31, 2018
Agency Securities classified as available-for-sale:
Fannie Mae/Freddie Mac	$	8,949,793	$	56,041	$	74,276	$	8,931,558
Ginnie Mae		3,040,275		8,681		17,692		3,031,264
Residential mortgage securities classified as held-to-maturity		1,134		3		–		1,137

	December 31, 2019				December 31, 2018
	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
Securities in an unrealized loss position:
One year or greater	$	2,590,214	$	22,844	$	4,736,171	$	83,407
Less than one year		1,890,032		8,042		1,475,120		8,561
	$	4,480,246	$	30,886	$	6,211,291	$	91,968

Declines in fair value caused by increases in interest rates are typically relatively modest for investments in ARM Agency Securities compared to investments in longer-duration fixed-rate assets. These declines are generally recoverable in a relatively short period of time as coupon interest rates on the underlying mortgage loans reset to rates more reflective of the then-current interest rate environment.

From a credit risk perspective, federal government support for Fannie Mae and Freddie Mac helps ensure that fluctuations in value due to credit risk associated with these securities will be limited. Given that (a) any existing unrealized losses on mortgage securities held by the Company are not attributable to credit risk and declines in fair value of ARM securities due to changes in interest rates are generally recoverable in a relatively short period of time, (b) the Company typically holds its investments to maturity, and (c) it is more likely than not that the Company will not be required to sell any of its investments, none of these investments were considered other-than-temporarily impaired at December 31, 2019.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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