Cohen & Co Inc. - Quarter Report: 2019 March (Form 10-Q)

/ 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q





☒QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2019

or

☐TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission File Number: 001-32026

 

COHEN & COMPANY INC.

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code: (215) 701-9555

Not applicable

(Former name, former address and former fiscal year, if changed since last report)



Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    ☒    Yes    ☐  No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted  pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    ☒  Yes    ☐  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the Registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).    ☐  Yes    ☒  No

Securities registered pursuant to Section 12(b) of the Act:

As of April 30, 2019, there were 1,217,624 shares of common stock ($0.01 par value per share) of Cohen & Company Inc. outstanding. 

---

 

Cohen & Company Inc. 

FORM 10-Q

INDEX TO QUARTERLY REPORT ON FORM 10-Q

March 31, 2019

 

---

 

Forward-Looking Statements



This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended or the Exchange Act. Forward-looking statements discuss matters that are not historical facts. Because they discuss future events or conditions, forward-looking statements may include words such as “anticipate,” “believe,” “estimate,” “intend,” “could,” “should,” “would,” “may,” “seek,” “plan,” “might,” “will,” “expect,” “predict,” “project,” “forecast,” “potential,” “continue,” negatives thereof or similar expressions. Forward-looking statements speak only as of the date they are made, are based on various underlying assumptions and current expectations about the future and are not guarantees. Such statements involve known and unknown risks, uncertainties, and other factors that may cause our actual results, level of activity, performance, or achievement to be materially different from the results of operations or plans expressed or implied by such forward-looking statements.



These forward-looking statements are found at various places throughout this Quarterly Report on Form 10-Q and include information concerning possible or assumed future results of our operations, including statements about the following subjects:





These forward-looking statements represent our intentions, plans, expectations, assumptions, and beliefs about future events and are subject to risks, uncertainties, and other factors. Many of those factors are outside of our control and could cause actual results to differ materially from the results expressed or implied by those forward-looking statements. In light of these risks, uncertainties, and assumptions, the events described in the forward-looking statements might not occur or might occur to a different extent or at a different time than we have described. You should consider the areas of risk and uncertainty described above and discussed under “Item 1A — Risk Factors” included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018. Actual results may differ materially as a result of various factors, some of which are outside our control, including the following:

---

 



You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q. All subsequent written and oral forward-looking statements concerning other matters addressed in this Quarterly Report on Form 10-Q and attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this Quarterly Report on Form 10-Q. Except to the extent required by law, we undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events, a change in events, conditions, circumstances, or assumptions underlying such statements, or otherwise.

---

 

Certain Terms Used in this Quarterly Report on Form 10-Q

In this Quarterly Report on Form 10-Q, unless otherwise noted or as the context otherwise requires, the “Company,” “we,” “us,” and “our” refer to Cohen & Company Inc. (formerly Institutional Financial Markets, Inc.), a Maryland corporation, and its subsidiaries on a consolidated basis; and “Cohen & Company, LLC” (formerly IFMI, LLC) or the “Operating LLC” refer to the main operating subsidiary of the Company. 

“JVB Holdings” refers to JVB Financial Holdings, L.P.; “JVB” refers to J.V.B. Financial Group, LLC, a broker dealer subsidiary; “CCFL” refers to Cohen & Company Financial Limited (formerly known as EuroDekania Management LTD), a subsidiary regulated by the Financial Conduct Authority (formerly known as the Financial Services Authority) in the United Kingdom (the “FCA”); and “EuroDekania” refers to EuroDekania (Cayman) Ltd., a Cayman Islands exempted company, that is externally managed by CCFL.

“Securities Act”  refers to the Securities Act of 1933, as amended; and “Exchange Act” refers to the Securities Exchange Act of 1934, as amended.

---

 



PART I. FINANCIAL INFORMATION

ITEM 1.FINANCIAL STATEMENTS.

COHEN & COMPANY INC.

CONSOLIDATED BALANCE SHEETS

(Dollars in Thousands)









See accompanying notes to unaudited consolidated financial statements.







---

 

COHEN & COMPANY INC.

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

(Dollars in Thousands, except share or per share information)

(Unaudited)





See accompanying notes to unaudited consolidated financial statements.

 

---

 

COHEN & COMPANY INC.

Consolidated Statement of Changes in Equity

(Dollars in Thousands)

(Unaudited)

 



See accompanying notes to unaudited consolidated financial statements.

   





 

---

 

COHEN & COMPANY INC.

Consolidated Statements of Cash Flows

(Dollars in Thousands)

(Unaudited)





See accompanying notes to unaudited consolidated financial statements.

 

---

 

COHEN & COMPANY INC.

Notes to Consolidated Financial Statements

(Dollars in Thousands, except share and per share information)

(Unaudited)



1. ORGANIZATION AND NATURE OF OPERATIONS

Organizational History

Cohen Brothers, LLC (“Cohen Brothers”) was formed on October 7, 2004 by Cohen Bros. Financial, LLC (“CBF”). Cohen Brothers was established to acquire the net assets of CBF’s subsidiaries (the “Formation Transaction”): Cohen Bros. & Company, Inc.; Cohen Frères SAS; Dekania Investors, LLC; Emporia Capital Management, LLC; and the majority interest in Cohen Bros. & Toroian Investment Management, Inc. The Formation Transaction was accomplished through a series of transactions occurring between March 4, 2005 and May 31, 2005.

From its formation until December 16, 2009, Cohen Brothers operated as a privately-owned limited liability company. On December 16, 2009, Cohen Brothers completed its merger (the “Merger”) with a subsidiary of Alesco Financial Inc. (“AFN”), a publicly traded real estate investment trust.  

As a result of the Merger, AFN contributed substantially all of its assets into Cohen Brothers in exchange for newly issued membership units directly from Cohen Brothers. In addition, AFN received additional Cohen Brothers membership interests directly from its members in exchange for AFN common stock. In accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”), the Merger was accounted for as a reverse acquisition, and Cohen Brothers was deemed to be the accounting acquirer. As a result, all of AFN’s assets and liabilities were required to be revalued at fair value as of the acquisition date. The remaining membership interests of Cohen Brothers that were not held by AFN were included as a component of non-controlling interest in the consolidated balance sheets.

Subsequent to the Merger, AFN was renamed Cohen & Company Inc. In January 2011, it was renamed again as Institutional Financial Markets, Inc. (“IFMI”) and on September 1, 2017, it was renamed again as Cohen & Company Inc. Effective January 1, 2010, the Company ceased to qualify as a REIT.

The Company

The Company is a financial services company specializing in fixed income markets. As of March 31, 2019, the Company had $2.78 billion in assets under management (“AUM”) of which 83.1%, or $2.31 billion, was in collateralized debt obligations (“CDOs”).  The remaining portion of AUM is from a diversified mix of Investment Vehicles.   

In these financial statements, the “Company” refers to Cohen & Company Inc. and its subsidiaries on a consolidated basis. Cohen & Company, LLC or the “Operating LLC” refers to the main operating subsidiary of the Company.  “Cohen Brothers” refers to the pre-Merger Cohen Brothers, LLC and its subsidiaries. “AFN” refers to the pre-merger Alesco Financial Inc. and its subsidiaries. When the term “Cohen & Company Inc.” is used, it is referring to the parent company itself. “JVB Holdings” refers to J.V.B. Financial Holdings, LLC; “JVB” refers to J.V.B. Financial Group LLC, a broker dealer subsidiary; “CCFL” refers to Cohen & Company Financial Limited (formerly known as EuroDekania Management LTD), a subsidiary regulated by the Financial Conduct Authority (formerly known as Financial Services Authority) in the United Kingdom; and “EuroDekania” refers to EuroDekania (Cayman) Ltd., a Cayman Islands exempted company that is externally managed by CCFL.

The Company’s business is organized into the following three business segments.

Capital Markets: The Company’s Capital Markets business segment consists primarily of fixed income sales, trading, matched book repurchase agreement (“repo”) financing, new issue placements in corporate and securitized products, and advisory services. The Company’s fixed income sales and trading group provides trade execution to corporate investors, institutional investors, mortgage originators, and other smaller broker-dealers. The Company specializes in a variety of products, including but not limited to: corporate bonds, asset backed securities (“ABS”), mortgage backed securities (“MBS”), residential mortgage backed securities (“RMBS”), CDOs, collateralized loan obligations (“CLOs”), collateralized bond obligations (“CBOs”), collateralized mortgage obligations (“CMOs”), municipal securities, to-be-announced securities (“TBAs”) and other forward agency MBS contracts, Small Business Administration (“SBA”) loans, U.S. government bonds, U.S. government agency securities, brokered deposits and certificates of deposit (“CDs”) for small banks, and hybrid capital of financial institutions including trust preferred securities (“TruPS”), whole loans, and other structured financial instruments. The Company also offers execution and brokerage services for equity products. The Company carries out its capital markets activities primarily through its subsidiaries: JVB in the United States and CCFL in Europe.

Asset Management: The Company’s Asset Management business segment manages assets within CDOs, managed accounts, joint ventures, and investment funds (collectively referred to as “Investment Vehicles”). A CDO is a form of secured borrowing. The borrowing is secured by different types of fixed income assets such as corporate or mortgage loans or bonds. The borrowing is in the

---

 

form of a securitization, which means that the lenders are actually investing in notes backed by the assets. In the event of default, the lenders will have recourse only to the assets securing the loan. The Company’s Asset Management business segment includes its fee-based asset management operations, which include ongoing base and incentive management fees.

Principal Investing: The Company’s Principal Investing business segment is comprised of investments that the Company has made for the purpose of earning an investment return rather than investments made to support the Company’s trading, matched book repo, or other Capital Markets business segment activities.  These investments are a component of the Company’s other investments, at fair value and investment in equity method affiliates in our consolidated balance sheets.

The Company generates its revenue by business segment primarily through the following activities.

Capital Markets

Asset Management

Principal Investing

2. BASIS OF PRESENTATION

The financial statements of the Company included herein were prepared in conformity with U.S. GAAP for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. The information furnished includes all adjustments and accruals of a normal recurring nature, which, in the opinion of management, are necessary for a fair presentation of results for the interim month periods. All intercompany accounts and transactions have been eliminated in consolidation. The results for the three months ended March 31, 2019 and 2018 are not necessarily indicative of the results for the entire year or any subsequent interim period. These financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018.  

Capitalized terms used herein without definition have the meanings ascribed to them in the Annual Report on Form 10-K for the year ended December 31, 2018.  



3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

A. Adoption of New Accounting Standards



In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers  (Topic 606).  Subsequent to that date, the FASB has issued additional ASUs clarifying certain aspects of ASU 2014-09 but they did not change the core principal of ASU 2014-09.  The new guidance requires entities to recognize revenue in a way that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.  The Company adopted the new guidance on January 1, 2018 using the retrospective transition method. This ASU excludes from its scope revenue recognition related to items the Company records as a component of net trading and principal transactions within its consolidated statements of operations and, therefore, this ASU had no impact on these items.  In terms of asset management and other revenue, the main impact of Topic 606 related to the timing of the recognition of incentive management fees in certain cases.  Prior to the adoption of Topic 606, the Company would recognize incentive fees when they were fixed and determinable.  Under Topic 606, the Company is required to recognize incentive fees when they are probable and there is not a significant chance of reversal in the future.  For the asset management contracts in place at the time of adoption, this change in policy did not result in any actual change in revenue that had already been recognized and, therefore, there was no transition adjustment necessary.



---

 

In February 2016, the FASB issued ASU 2016-01, Financial Instruments-Overall (Subtopic 825-10).  The amendments in ASU 2016-01, among other things, require equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income; require public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; require separate presentation of financial assets and liabilities by measurement category and form of financial asset; and eliminate the requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost. The Company’s adoption of the provisions of ASU 2016-01 effective January 1, 2018 did not have an effect on the Company’s consolidated financial statements



In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). Under the new guidance (subsequently updated with ASU 2018-01, ASU 2018-10, ASU 2018-11,  ASU 2018-20 and ASU  2019-01), lessees will be required to recognize the following for all leases with the exception of short-term leases:  (i) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis, and (ii) a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term.  Lessor accounting is largely unchanged.  The Company adopted the provisions of the new guidance effective January 1, 2019.  The Company recorded the following:  (a) a right of use asset of $8,416, (b) a lease commitment liability of $8,860, (c) a reduction in retained earnings from cumulative effect of adoption of $20, (d) an increase in other receivables of $18, and (e) a reduction in other liabilities of $406.  See note 12.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments.  The amendments in this ASU provide cash flow statement classification guidance on eight specific cash flow presentation issues with the objective of reducing existing diversity in practice.  The Company’s adoption of the provisions of ASU 2016-15 effective January 1, 2018 did not have an effect on the Company’s consolidated financial statements

In October 2016, the FASB issued ASU 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other than Inventory.  The amendments in this ASU require an entity to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs.  The amendments eliminate the exception of an intra-entity transfer of an asset other than inventory.  The Company’s adoption of the provisions of ASU 2016-16 effective January 1, 2018 did not have an effect on the Company’s consolidated financial statements

In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805):    Clarifying the Definition of a Business.  The amendments in this ASU clarify the definition of a business and affect all companies and other reporting organizations that must determine whether they have acquired or sold a business. The Company’s adoption of the provisions of ASU 2017-01 effective January 1, 2018 did not have an effect on the Company’s consolidated financial statements



In February 2017, the FASB issued ASU 2017-05, Other Income – Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20):  Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets.  The amendments in this ASU clarify that a financial asset within the scope of this topic may include nonfinancial assets transferred within a legal entity to counterparty.  The amendments clarify that an entity should identify each distinct nonfinancial asset or in substance nonfinancial asset promised to counterparty and derecognize each asset when counterparty obtains control of it. The Company’s adoption of the provisions of ASU 2017-05 effective January 1, 2018 did not have an effect on the Company’s consolidated financial statements.



In June 2018, the FASB issued ASU 2018-07, Compensation – Stock Compensation (Topic 718):  Improvements to Nonemployee Share-Based Payment Accounting.  The amendments in this ASU expand the scope of Topic 718, which previously only included share-based payments to employees, to include share-based payments issued to nonemployees for goods or services.  Consequently, the accounting for share-based payments to nonemployees and employees will be substantially aligned. The Company’s adoption of the provisions of ASU 2018-07 effective January 1, 2019 did not have an effect on the Company’s consolidated financial statements.



In March 2017, the FASB issued ASU 2017-08, Receivables – Nonrefundable Fees and Other Costs, Premium Amortization on Purchased Callable Debt Securities (Sub-Topic 310-20).  The amendments in this ASU shorten the amortization period for certain callable debt securities held at a premium.  Specifically, the amendments require the premium to be amortized to the earliest call date.  The amendments do not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity.  The Company’s adoption of the provisions of ASU 2017-08 effective January 1, 2019 did not have an effect on the Company’s consolidated financial statements.



In May 2017, the FASB issued ASU 2017-09, Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting. The amendments in this ASU provide guidance on determining those changes to the terms and conditions of share-based payment awards that require an entity to apply modification accounting.  The Company’s adoption of the provisions of ASU 2017-09 effective January 1, 2018 did not have an effect on the Company’s consolidated financial statements.



---

 

In August 2017, the FASB issued ASU 2017-12, Derivative and Hedging – Targeted Improvements to Accounting for Hedging Activities (Topic 815).  The amendments in this ASU refine and expand hedge accounting for both financial and commodity risks and contain provisions to create more transparency and clarify how economic results are presented. The Company’s adoption of the provisions of ASU 2017-12 effective January 1, 2019 did not have an effect on the Company’s consolidated financial statements.



In February 2018, the FASB issued ASU 2018-02, Income Statement –  Reporting Comprehensive Income (Topic 220):  Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.  The amendments in this ASU provide the option to reclassify stranded tax effects within accumulated other comprehensive income (“AOCI”) to retained earnings in each period in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Act (or portion thereof) is recorded. The Company’s adoption of the provisions of ASU 2018-02 effective January 1, 2019 did not have an effect on the Company’s consolidated financial statements.

B. Recent Accounting Developments



In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The amendments in this ASU require the measurement of all expected credit losses for financial assets held at the reporting date to be based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The amendments in this ASU are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years.  Early adoption is permitted beginning after December 15, 2018, including interim periods within those fiscal years.  The Company is currently evaluating the new guidance to determine the impact it may have on its consolidated financial statements.



In January 2017, the FASB issued ASU 2017-04, Intangibles  – Goodwill and Other (Topic 350):  Simplifying the Test for Goodwill Impairment. The amendments in this ASU eliminate Step 2 from the goodwill impairment test. The annual or interim goodwill impairment test is performed by comparing the fair value of a reporting unit with its carrying amount.  An impairment charge should be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit.  This ASU is effective for fiscal years beginning after December 15, 2019.  Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017 and should be applied on a prospective basis. The Company is currently evaluating the new guidance to determine the impact it may have on its consolidated financial statements.



In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework –Changes to the Disclosure Requirements for Fair Value Measurement.  The ASU modifies the disclosure requirements in Topic 820, by removing certain disclosure requirements related to the fair value hierarchy, modifying existing disclosure requirements related to measurement uncertainty, and adding new disclosure requirements such as disclosing the changes in unrealized gains and losses for the period included in other comprehensive income for recurring level 3 fair value measurements held at the end of the reporting period and disclosing the range and weighted average of significant unobservable inputs used to develop level 3 fair value measurements. This ASU is effective for public companies for annual reporting periods and interim periods within those annual periods beginning after December 15, 2019. Early adoption is permitted.  The Company is currently evaluating the new guidance to determine the impact it may have on its consolidated financial statements.



In November 2018, the FASB issued ASU 2018-18, Collaborative Arrangements (Topic 808): Clarifying the Interaction Between Topic 808 and Topic 606.  The ASU also provides more comparability in the presentation of revenue for certain transactions between collaborative arrangement participants. It accomplishes this by allowing organizations to only present units of account in collaborative arrangements that are within the scope of the revenue recognition standard together with revenue accounted for under the revenue recognition standard.  The parts of the collaborative arrangement that are not in the scope of the revenue recognition standard should be presented separately from revenue accounted for under the revenue recognition.  This ASU is effective for public companies for annual reporting periods and interim periods within those annual periods beginning after December 15, 2019. The Company is currently evaluating the new guidance to determine the impact it may have on its consolidated financial statements.

C. Fair Value of Financial Instruments

The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments. These determinations were based on available market information and appropriate valuation methodologies. Considerable judgment is required to interpret market data to develop the estimates and, therefore, these estimates may not necessarily be indicative of the amount the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. Refer to note 8 for a discussion of the valuation hierarchy with respect to investments-trading; other investments, at fair value; and derivatives held by the Company. 



---

 

Cash equivalents: Cash equivalents are carried at historical cost, which is assumed to approximate fair value. The estimated fair value measurement of cash equivalents is classified within level 1 of the valuation hierarchy.  

Investments-trading: These amounts are carried at fair value. The fair value is based on either quoted market prices of an active exchange, independent broker market quotations, market price quotations from third party pricing services, or valuation models when quotations are not available.

Other investments, at fair value: These amounts are carried at fair value. The fair value is based on quoted market prices of an active exchange, independent broker market quotations, or valuation models when quotations are not available. In the case of investments in alternative investment funds, fair value is generally based on the reported net asset value of the underlying fund.

Receivables under resale agreements: Receivables under resale agreements are carried at their contracted resale price, have short-term maturities, and are repriced frequently or bear market interest rates and, accordingly, these contracts are at amounts that approximate fair value. The estimated fair value measurements of receivables under resale agreements are based on observations of actual market activity and are generally classified within level 2 of the valuation hierarchy.  

Trading securities sold, not yet purchased: These amounts are carried at fair value. The fair value is based on quoted market prices of an active exchange, independent market quotations, market price quotations from third party pricing services, or valuation models when quotations are not available.

Securities sold under agreements to repurchase: The liabilities for securities sold under agreements to repurchase are carried at their contracted repurchase price, have short-term maturities, and are repriced frequently with amounts normally due in one month or less and, accordingly, these contracts are carried at amounts that approximate fair value. The estimated fair value measurements of securities sold under agreements to repurchase are based on observations of actual market activity and are generally classified within level 2 of the valuation hierarchy.

Redeemable financial instruments:  The liabilities for redeemable financial instruments are carried at their redemption value, which approximates fair value. The estimated fair value measurement of the redeemable financial instruments is classified within level 3 of the valuation hierarchy. 

Debt: These amounts are carried at outstanding principal less unamortized discount and deferred financing costs. However, a substantial portion of the debt was assumed in the Merger and recorded at fair value as of that date.  As of March 31, 2019, and December 31, 2018, the fair value of the Company’s debt was estimated to be $51,181 and $50,159, respectively. The estimated fair value measurements of the debt are generally based on discounted cash flow models prepared by the Company’s management primarily using discount rates for similar instruments issued to companies with similar credit risks to the Company and are generally classified within level 3 of the value hierarchy.

Derivatives: These amounts are carried at fair value. Derivatives may be included as a component of investments-trading; trading securities sold, not yet purchased; and other investments, at fair value. See notes 8 and 9. The fair value is generally based on quoted market prices on an exchange that is deemed to be active for derivative instruments such as foreign currency forward contracts and Eurodollar futures.  For derivative instruments, such as TBAs and other extended settlement trades, the fair value is generally based on market price quotations from third party pricing services.





4. NEW BUSINESS



U.S. Insurance JV



On May 16, 2018, the Company committed to invest up to $3,000 in a newly formed joint venture (the “U.S. Insurance JV”) with an outside investor who committed to invest approximately $63,000 of equity in the U.S. Insurance JV.  The U.S. Insurance JV was formed for the purposes of investing in debt issued by small and medium sized U.S. and Bermuda insurance and reinsurance companies and is managed by the Company. The Company is required to invest 4.5% of the total equity of the U.S. Insurance JV with an absolute limit of $3,000.  The U.S. Insurance JV may use leverage to grow its assets.

The insurance company debt that will be funded by the U.S. Insurance JV may be originated by the Company and there may be origination fees earned in connection with such transactions. The Company will also earn management fees as manager of the U.S. Insurance JV.  The Company is entitled to a quarterly base management fee, an annual incentive fee (if certain return hurdles are met), and an additional incentive fee upon the liquidation of the portfolio (if certain return hurdles are met).

The Company has elected the fair value option in accordance with the provisions of FASB ASC 820, Fair Value Measurements (“FASB ASC 820”) to account for its investment in the U.S. Insurance JV.  The investment is included in other investments, at fair value, on the consolidated balance sheets, and gains and losses (both realized and unrealized) are recognized in the consolidated statement of operations as a component of principal transactions and other income.  Because the U.S. Insurance JV has the attributes of investment companies as described in FASB ASC 946-15-2, the Company will estimate the fair value of its investment using the net asset value (“NAV”) per share (or its equivalent) as of the reporting date in accordance with the “practical expedient” provisions

---

 

related to investments in certain entities that calculate net asset value per share (or its equivalent) included in FASB ASC 820 for all entities. See note 7.

SPAC Fund



On August 6, 2018, the Company invested in and became the general partner of a newly formed partnership (the “SPAC Fund”) for the purposes of investing in the equity interests of special purpose acquisition companies (“SPACs”).  The Company is the manager of the SPAC Fund.  The Company has invested $600 in the SPAC Fund.  The Company is entitled to a quarterly base management fee based on a percentage of the NAV of the SPAC Fund and an annual incentive allocation based on the actual returns earned by the SPAC Fund.  

The Company has elected the fair value option in accordance with the provisions of FASB ASC 820 to account for its investment in the SPAC Fund.  The investment is included in other investments, at fair value on the consolidated balance sheets, and gains and losses (both realized and unrealized) are recognized in the statement of operations as a component of principal transactions and other revenue.  Because the SPAC Fund has the attributes of investment companies as described in FASB ASC 946-15-2, the Company will estimate the fair value of its investment using the NAV per share (or its equivalent) as of the reporting date in accordance with the “practical expedient” provisions related to investments in certain entities that calculate net asset value per share (or its equivalent) included in FASB ASC 820 for all entities. See note 7. 

ViaNova Capital Group LLC

In 2018, the Company formed a wholly-owned subsidiary, ViaNova Capital Group LLC (“ViaNova”), for the purpose of building a residential transition loan (“RTL”) business.  RTLs are small balance commercial loans that are secured by first lien mortgages used by professional investors and real estate developers to finance the purchase and rehabilitation of residential properties.  The business of ViaNova includes buying, aggregating, and distributing these loans to produce superior risk-adjusted returns through the pursuit of opportunities overlooked by commercial banks. The Company consolidates ViaNova. 

On November 20, 2018, ViaNova entered into a Warehousing Credit and Security Agreement with LegacyTexas Bank (the “LegacyTexas Credit Facility” with an effective date of November 16, 2018. The LegacyTexas Credit Facility supports the buying, aggregating and distributing of residential loans performed by the business of ViaNova.   As of March 31, 2019, ViaNova has not yet acquired any assets or drawn down under the LegacyTexas Credit Facility.  See Note 16.

Insurance Acquisition Corporation (the “Insurance SPAC”)



The Company is the sponsor of the Insurance SPAC, a blank check company that will seek to effect a merger, capital stock exchange, asset acquisition, stock purchase, reorganization or similar business combination with one or more businesses (each a “Business Combination”).



On March 22, 2019, the Insurance SPAC completed the sale of 15,065,000 units (the “SPAC Units”) in its initial public offering (the “IPO”). Each Unit consists of one share of the SPAC’s Class A common stock, par value $0.0001 per share (“SPAC Common Stock”), and one-half of one warrant (each, a “SPAC Warrant”), where each whole SPAC Warrant entitles the holder to purchase one share of Common Stock for $11.50 per share. The SPAC Units were sold in the IPO at an offering price of $10.00 per SPAC Unit, for gross proceeds of $150,650 (before underwriting discounts and commissions and offering expenses).  Pursuant to the underwriting agreement in the IPO, the Insurance SPAC granted the underwriters in the IPO (the “Underwriters”) a 45-day option to purchase up to 1,965,000 additional SPAC Units solely to cover over-allotments, if any (the “Over-Allotment Option”); and on March 21, 2019, the Underwriters exercised the Over-Allotment Option in full.  Immediately following the completion of the IPO, there were an aggregate of 20,653,333 shares of SPAC Common Stock issued and outstanding.

 

If the Insurance SPAC fails to consummate a Business Combination within the first 18 months following the IPO, its corporate existence will cease except for the purposes of winding up its affairs and liquidating its assets.

 

The Operating LLC is the manager and a member of each of two entities: Insurance Acquisition Sponsor, LLC and Dioptra Advisors, LLC (together, the “Sponsor Entities”).  The Sponsor Entities purchased 375,000 of the Insurance SPAC’s placement units in a private placement that occurred simultaneously with the IPO for an aggregate purchase price of $3,750, or $10.00 per placement unit.  Each placement unit consists of one share of SPAC Common Stock and one-half of one warrant (the “Placement Warrant”).  The placement units are identical to the SPAC Units sold in the IPO except (i) the shares of SPAC Common Stock issued as part of the placement units and the Placement Warrants will not be redeemable by the Insurance SPAC, (ii) the Placement Warrants may be exercised by the holders on a cashless basis, (iii) the shares of SPAC Common Stock issued as part of the placement units, together with the Placement Warrants, are entitled to certain registration rights, and (iv) for so long as they are held by the IPO underwriter, the placement units will not be exercisable more than five years following the effective date of the registration statement filed by the Insurance SPAC in connection with the IPO. Subject to certain limited exceptions, the placement units (including the underlying Placement Warrants and SPAC Common Stock and the shares of SPAC Common Stock issuable upon exercise of the Placement Warrants) will not be transferable, assignable, or salable until 30 days after the completion of our Business Combination.

---

 



The Sponsor Entities raised $2,550 from third party investors and the remaining investment in the private placement was made by the Company.  The Company consolidates the Sponsor Entities and treats its investment in the Insurance SPAC as an equity method investment.  The $2,550 raised from third party investors is treated as non-controlling interest.    See notes 11 and 17. 

 

The proceeds from the placement units were added to the net proceeds from the IPO to be held in a trust account. If the Insurance SPAC does not complete a Business Combination within the first 18 months following the IPO, the proceeds from the sale of the Placement Units will be used to fund the redemption of the SPAC Common Stock sold as part of the Units in the IPO (subject to the requirements of applicable law) and the Placement Warrants will expire worthless.

 

The Sponsor Entities collectively hold 5,103,333 founder shares of the Insurance SPAC.  Subject to certain limited exceptions, placement units held by the Sponsor Entities will not be transferable or salable until 30 days following a Business Combination, and founder shares held by the Sponsor Entities will not be transferable or salable except (a) with respect to 20% of such shares, until consummation of a Business Combination, and (b) with respect to additional 20% tranches of such shares, when the closing price of the Common Stock exceeds $12.00, $13.50, $15.00 and $17.00, respectively, for 20 out of any 30 consecutive trading days following the consummation of a Business Combination, in each case subject to certain limited exceptions.



5. NET TRADING



Net trading consisted of the following in the periods presented.







Trading inventory includes investments classified as investments-trading as well as trading securities sold, not yet purchased.  See note 7.  See note 10 for discussion of receivables under resale agreements and securities sold under agreements to repurchase.  See note 6 for discussion of margin payable.

 



6. RECEIVABLES FROM AND PAYABLES TO BROKERS, DEALERS, AND CLEARING AGENCIES

Amounts receivable from brokers, dealers, and clearing agencies consisted of the following.



 



Amounts payable to brokers, dealers, and clearing agencies consisted of the following.







Deposits with clearing agencies represent contractual amounts the Company is required to deposit with its clearing agents.



Securities transactions that settle in the regular way are recorded on the trade date, as if they had settled. The related amounts receivable and payable for unsettled securities transactions are recorded net in receivables from or payables to brokers, dealers, and clearing agencies on the Company’s consolidated balance sheets.



Receivables from clearing agencies are primarily comprised of (i) cash received by the Company upon execution of short trades that is restricted from withdrawal by the clearing agent and (ii) cash deposited with the FICC to support the Company’s General Collateral Funding (“GCF”) matched book repo business.



Margin payable represents amounts borrowed from Pershing, LLC to finance the Company’s trading portfolio.  Effectively, all of the Company’s investments-trading and deposits with clearing agencies serve as collateral for the margin payable.  See note 5 for interest expense incurred on margin payable.

   

---

 

7. FINANCIAL INSTRUMENTS

Investments—Trading

Investments-trading consisted of the following.







Trading Securities Sold, Not Yet Purchased

Trading securities sold, not yet purchased consisted of the following.





The Company seeks to manage its exposure to changes in interest rates for the interest rate sensitive securities it holds by entering into offsetting short positions for similar fixed rate securities. See note 5 for realized and unrealized gains recognized on investments-trading.



---

 

Other Investments, at fair value

Other investments, at fair value consisted of the following.





 

 

8. FAIR VALUE DISCLOSURES

Fair Value Option

The Company has elected to account for certain of its other financial assets at fair value under the fair value option provisions of FASB ASC 825. The primary reason for electing the fair value option was to reduce the burden of monitoring the differences between the cost and the fair value of the Company’s investments, previously classified as available for sale securities, including the assessment as to whether the declines are temporary in nature and to further remove an element of management judgment.

Such financial assets accounted for at fair value include:

The changes in fair value (realized and unrealized gains and losses) of these instruments for which the Company has elected the fair value option are recorded in principal transactions and other income in the consolidated statements of operations. All of the investments for which the Company has elected the fair value option are included as a component of other investments, at fair value in the consolidated balance sheets. The Company recognized net gains (losses) related to changes in fair value of investments of $249 and $151 during the three months ended March 31, 2019 and 2018, respectively. 

Fair Value Measurements

In accordance with FASB ASC 820, the Company has categorized its financial instruments, based on the priority of the inputs to the valuation technique, into a three level fair value hierarchy. The hierarchy gives the highest priority to unadjusted quoted prices in

---

 

active markets for identical assets or liabilities (level 1 measurement) and the lowest priority to unobservable inputs (level 3 measurement). The three levels of the hierarchy under FASB ASC 820 are described below.

Level 1            Financial assets and liabilities that have values based on unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

Level 2            Financial assets and liabilities that have values based on one or more of the following:

Level 3            Financial assets and liabilities that have values based on prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable. These inputs reflect management’s own assumptions about the assumptions a market participant would use in pricing the asset or liability.

In certain cases, the inputs used to measure fair value may fall into different levels of the valuation hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability.

Both observable and unobservable inputs may be used to determine the fair value of positions that the Company has classified within the level 3 of the valuation hierarchy. As a result, the unrealized gains and losses for assets and liabilities within the level 3 of the valuation hierarchy presented in the tables below may include changes in fair value that were attributable to both observable (e.g., changes in market interest rates) and unobservable (e.g., changes in unobservable long-dated volatilities) inputs.

A review of the valuation hierarchy classifications is conducted on a quarterly basis. Changes in the type of inputs may result in a reclassification for certain financial assets or liabilities.  There were no transfers between level 1 and level 2 of the valuation hierarchy during the three months ended March 31, 2019 and 2018.  Reclassifications between levels of the valuation hierarchy are reported as transfers in or transfers out as of the beginning of the quarter in which reclassifications occur.

---

 



The following tables present information about the Company’s assets and liabilities measured at fair value on a recurring basis as of March 31, 2019 and December 31, 2018, and indicate the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value.





(1)As a practical expedient, the Company uses NAV or its equivalent to measure the fair value of its investments in EuroDekania, the U.S. Insurance JV, and the SPAC Fund.  EuroDekania invests in hybrid capital securities of European companies.  The U.S. Insurance JV invests in debt issued by small and medium sized U.S. and Bermuda insurance and reinsurance companies.  The SPAC Fund invests in equity securities of SPACs.  According to ASC 820, these investments are not categorized within the fair value hierarchy. 

 

---

 





(1)As a practical expedient, the Company uses NAV or its equivalent to measure the fair value of its investments in EuroDekania, the U.S. Insurance JV, and the SPAC Fund.  EuroDekania invests in hybrid capital securities of European companies.  The U.S. Insurance JV invests in debt issued by small and medium sized U.S. and Bermuda insurance and reinsurance companies.  The SPAC Fund invests in equity securities of SPACs.  According to ASC 820, these investments are not categorized within the fair value hierarchy.

---

 

 

The following provides a brief description of the types of financial instruments the Company holds, the methodology for estimating fair value, and the level within the hierarchy of the estimate. The discussion that follows applies regardless of whether the instrument is included in investments-trading; other investments, at fair value; or trading securities sold, not yet purchased.

U.S. Government Agency MBS and CMOs: These are securities that are generally traded over-the-counter. The Company generally values these securities using third party quotations such as unadjusted broker-dealer quoted prices or market price quotations from third party pricing services. These valuations are based on a market approach. The Company classifies the fair value of these securities within level 2 of the valuation hierarchy.

U.S. Government Agency Debt Securities: Callable and non-callable U.S. government agency debt securities are measured primarily based on quoted market prices obtained from third party pricing services. Non-callable U.S. government agency debt securities are generally classified within level 1 and callable U.S. government agency debt securities are classified within level 2 of the valuation hierarchy.

RMBS: The Company generally values these securities using third party quotations such as unadjusted broker-dealer quoted prices or market price quotations from third party pricing services. These valuations are based on a market approach. The Company generally classifies the fair value of these securities based on third party quotations within level 2 of the valuation hierarchy.

U.S. Treasury Securities: U.S. Treasury securities include U.S. Treasury bonds and notes and the fair values of the U.S. Treasury securities are based on quoted prices or market activity in active markets. Valuation adjustments are not applied. The Company classifies the fair value of these securities within level 1 of the valuation hierarchy.

CLOs, CDOs, and ABS: CLOs, CDOs, and ABS are interests in securitizations. ABS may include, but are not limited to, securities backed by auto loans, credit card receivables, or student loans. When the Company is able to obtain independent market quotations from at least two broker-dealers and when a price within the range of at least two broker-dealers is used or market price quotations from third party pricing services is used, these interests in securitizations will generally be classified within level 2 of the valuation hierarchy. These valuations are based on a market approach. The independent market quotations from broker-dealers are generally nonbinding. The Company seeks quotations from broker-dealers that historically have actively traded, monitored, issued, and been knowledgeable about the interests in securitizations. The Company generally believes to the extent that it (i)  receives two quotations in a similar range from broker-dealers knowledgeable about these interests in securitizations and (ii)  considers the broker-dealers gather and utilize observable market information such as new issue activity in the primary market, trading activity in the secondary market, credit spreads versus historical levels, bid-ask spreads, and price consensus among market participants and sources, then classification within level 2 of the valuation hierarchy is appropriate. In the absence of two broker-dealer market quotations, a single broker-dealer market quotation may be used without corroboration of the quote in which case the Company generally classifies the fair value within level 3 of the valuation hierarchy.

 

If quotations are unavailable, prices observed by the Company for recently executed market transactions or valuation models prepared by the Company’s management may be used, which are based on an income approach. These models prepared by the Company’s management include estimates, and the valuations derived from them could differ materially from amounts realizable in an open market exchange. Each CLO and CDO position is evaluated independently taking into consideration available comparable market levels, underlying collateral performance and pricing, deal structures, and liquidity.  Fair values based on internal valuation models prepared by the Company’s management are generally classified within level 3 of the valuation hierarchy. 

Establishing fair value is inherently subjective (given the volatile and sometimes illiquid markets for certain interests in securitizations) and requires management to make a number of assumptions, including assumptions about the future of interest rates, discount rates, and the timing of cash flows. The assumptions the Company applies are specific to each security. Although the Company may rely on internal calculations to compute the fair value of certain interest in securitizations, the Company requests and considers indications of fair value from third party pricing services to assist in the valuation process.

SBA Loans: SBA loans include loans and SBA interest only strips.  In the case of loans, the Company generally values these securities using third party quotations such as unadjusted broker-dealer quoted prices, internal valuation models using observable inputs, or market price quotations from third party pricing services. The Company generally classifies these investments within level 2 of the valuation hierarchy. These valuations are based on a market approach. SBA interest only strips do not trade in an active market with readily available prices. Accordingly, the Company generally uses valuation models to determine fair value and classifies the fair value of the SBA interest only strips within level 2 or level 3 of the valuation hierarchy depending on whether the model inputs are observable or not. 

Corporate Bonds and Redeemable Preferred Stock: The Company uses recently executed transactions or third party quotations from independent pricing services to arrive at the fair value of its investments in corporate bonds and redeemable preferred stock.

---

 

These valuations are based on a market approach. The Company generally classifies the fair value of these bonds within level 2 of the valuation hierarchy. In instances where the fair values of securities are based on quoted prices in active markets (for example with redeemable preferred stock), the Company classifies the fair value of these securities within level 1 of the valuation hierarchy.

Foreign Government Bonds: The fair value of foreign government bonds is estimated using valuations provided by third party pricing services and are valued within level 2 of the valuation hierarchy.

Municipal Bonds: Municipal bonds, which include obligations of U.S. states, municipalities, and political subdivisions, primarily include bonds or notes issued by U.S. municipalities. The Company generally values these securities using third party quotations such as market price quotations from third party pricing services. The Company generally classifies the fair value of these bonds within level 2 of the valuation hierarchy. The valuations are based on a market approach. In instances where the Company is unable to obtain reliable market price quotations from third party pricing services, the Company will use its own internal valuation models. In these cases, the Company will classify such securities within level 3 of the valuation hierarchy until it is able to obtain third party pricing.

Certificates of Deposit: The fair value of certificates of deposit is estimated using valuations provided by third party pricing services. Certificates of deposit are categorized in level 2 of the valuation hierarchy.

Residential Loans: Management utilizes home price indices or market indications to value the residential loans. These are considered  level 2 in the valuation hierarchy.

Equity Securities: The fair value of equity securities that represent unrestricted investments in publicly traded companies (common or preferred shares, options, warrants, and other equity investments) are determined using the closing price of the security as of the reporting date. These are securities that are traded on a recognized liquid exchange and classified within level 1 of the valuation hierarchy. 

The Company may own an option or warrant where the underlying security is publicly traded but the option or warrant is not.  In those cases, the Company may determine fair value using a Black-Scholes model and will generally classify this to be level 2 within the valuation hierarchy. 

The Company may own an equity investment in a publicly traded company that is restricted as to resale. In those cases, the Company may determine fair value by preparing a model. The valuation will be classified within level 2 if the inputs to the model are observable.  Otherwise, it will be considered a level 3 valuation. 

The Company may own an equity interest in a private company.  In those cases, the Company may determine fair value by preparing a model.  The model may be either a market based or income-based model,  whichever is considered the most appropriate in each case.  The valuation will be classified within level 2 if the inputs to the model are observable.  Otherwise, it will be considered a level 3 valuation.

Derivatives

Foreign Currency Forward Contracts

Foreign currency forward contracts are exchange-traded derivatives, which transact on an exchange that is deemed to be active.  The fair value of the foreign currency forward contracts is based on current quoted market prices.  Valuation adjustments are not applied.  These are considered level 1 in the valuation hierarchy. See note 9.

TBAs and Other Forward Agency MBS Contracts

The Company generally values these securities using third party quotations such as unadjusted broker-dealer quoted prices or market price quotations from third party pricing services. TBAs and other forward agency MBS contracts are generally classified within level 2 of the valuation hierarchy. If there is limited transaction activity or less transparency to observe market based inputs to valuation models, TBAs and other forward agency MBS contracts are classified in level 3 of the valuation hierarchy.  U.S. government agency MBS and CMOs include TBAs and other forward agency MBS contracts.  Unrealized gains on TBAs and other forward agency MBS contracts are included in investments-trading on the Company’s consolidated balance sheets and unrealized losses on TBAs and other forward agency MBS contracts are included in trading securities sold, not yet purchased on the Company’s consolidated balance sheets. See note 9.  

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 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 a derivative (as either a purchase commitment or 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.  The Company will determine the fair value of the financial instrument using the methodologies described above.

 

Level 3 Financial Assets and Liabilities

Financial Instruments Measured at Fair Value on a Recurring Basis

The following table presents additional information about assets measured at fair value on a recurring basis and for which the Company has utilized level 3 inputs to determine fair value.











The circumstances that would result in transferring certain financial instruments from level 2 to level 3 of the valuation hierarchy would typically include what the Company believes to be a decrease in the availability, utility, and reliability of observable market information such as new issue activity in the primary market, trading activity in the secondary market, credit spreads versus historical levels, bid-ask spreads, and price consensus among market participants and sources. There were no transfers between level 2 and 3 during the periods presented.



 The following tables provide the quantitative information about level 3 fair value measurements as of March 31, 2019 and December 31, 2018.











---

 



Sensitivity of Fair Value to Changes in Significant Unobservable Inputs

For recurring fair value measurements categorized within level 3 of the valuation hierarchy, the sensitivity of the fair value measurement to changes in significant unobservable inputs and interrelationships between those unobservable inputs (if any) are described below.

Investments in Certain Entities that Calculate NAV Per Share (or its Equivalent)

The following table presents additional information about investments in certain entities that calculate NAV per share (regardless of whether the “practical expedient” provisions of FASB ASC 820 have been applied), which are measured at fair value on a recurring basis at March 31, 2019 and December 31, 2018.

---

 









N/ANot applicable.





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 are permitted to record all or a portion of the change in the fair value of a designated hedge as an adjustment to AOCI 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 (“FASB 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 assets and liabilities on a net basis if the conditions of FASB ASC 210 are met.  However, in general the Company does not enter into offsetting derivatives with the same counterparties.  Therefore, in all of the 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 to hedge 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 securities 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 MBS whose collateral remain “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 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 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 March 31, 2019 and December 31, 2018, the Company had outstanding foreign currency forward contracts with a notional amount of 1.250 million Euros and 1.250 million Euros, respectively.

EuroDollar Futures

The Company invests in floating rate investments that expose it to fluctuations in interest rates and, therefore, the Company may, from time to time, hedge such exposure using EuroDollar futures.  The Company carries such EuroDollar future 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.  As of March 31, 2019 and December 31, 2018, the Company had no outstanding EuroDollar future contracts.

TBAs and Other Forward Agency MBS Contracts

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

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 March 31, 2019, the Company had open TBA and other forward MBS purchase agreements in the notional amount of $1,642,700 and open TBA and other forward MBS sale agreements in the notional amount of $1,693,890. At December 31, 2018, the Company had open TBA and other forward agency MBS purchase agreements in the notional amount of $1,025,850 and open TBA and other forward agency MBS sale agreements in the notional amount of $1,069,688.

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 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. At March 31, 2019 and December 31, 2018, the Company had open forward purchase commitments in the notional amount of $13,707 and $15,295, respectively.



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 March 31, 2019 and December 31, 2018.  



 

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













 

10. COLLATERALIZED SECURITIES TRANSACTIONS

Matched Book Repo Business

The Company enters into repurchase and reverse repurchase agreements as part of its matched book repo business.  In general, the Company will lend money to a counterparty after obtaining collateral securities from that counterparty pursuant to a reverse repurchase agreement.  The Company will borrow money from another counterparty using those same collateral securities pursuant to a repurchase agreement.  The Company seeks to earn net interest income on these transactions. Currently, the Company categorizes its matched book repo business into two major groups: gestational repo and GCF repo.

Gestational Repo

For several years, the Company has operated a matched book gestational repo program.  Gestational repo involves entering into repurchase and reverse repurchase agreements where the underlying collateral security represents a pool of newly issued mortgage loans.  The borrowers (the reverse repurchase agreement counterparties) are generally mortgage originators.  The lenders (the repurchase agreement counterparties) are a diverse group of the counterparties comprised of banks, insurance companies, and other financial institutions.  The Company’s gestational repo transactions were cleared through Industrial and Commercial Bank of China (“ICBC”) through April 1, 2018.  Subsequent to that date, the Company has self-cleared its gestational repo transactions.

---

 

GCF Repo

On October 18, 2017, the Company was notified that it had been approved as a full netting member of the FICC’s Government Securities Division.  As a member of the FICC, the Company has access to the FICC’s GCF repo service that provides netting and settlement services for repurchase transactions where the underlying security is general collateral (primarily U.S. Treasuries and U.S. Agency securities).  The Company began entering into matched book GCF repo transactions in November 2017.  The borrowers (the reverse repurchase agreement counterparties) are a diverse group of financial institutions including hedge funds, registered investment funds, REITs, and other similar counterparties.  The lender (the repurchase agreement counterparty) is primarily the FICC itself.  The Company uses Bank of New York (“BONY”) as its settlement agent for its GCF repo matched book transactions.  The Company is considered self-clearing for this business.  In connection with the Company’s full netting membership of the FICC, the Company agreed to establish and maintain a committed line of credit in a minimum amount of $25,000 on or prior to April 30, 2018.  The Company entered into the $25,000 MB LOC on April 25, 2018. The line of credit arrangement was subsequently amended.  See note 16.

Other Repo Transactions

In addition to the Company’s matched book repo business, the Company may also enter into reverse repurchase agreements to acquire securities to cover short positions or as an investment.  Additionally, the Company may enter into repurchase agreements to finance the Company’s securities positions held in inventory.  These repurchase and reverse repurchase agreements are generally cleared on a bilateral or triparty basis; no clearing broker is involved.  These transactions are not matched.

Repo Information 

At March 31, 2019 and December 31, 2018, the Company held reverse repurchase agreements of $4,510,389 and $5,171,053, respectively, and the fair value of collateral received under reverse repurchase agreements was $4,744,785, and $5,444,823,  respectively.  As of March 31, 2019, the reverse repurchase agreement balance was comprised of receivables collateralized by securities with 35 counterparties.  As of December 31, 2018, the reverse repurchase agreements balance was comprised of receivables collateralized by securities with 36 counterparties. 

At March 31, 2019 and December 31, 2018, the Company held repurchase agreements of $4,560,713 and $5,210,587, respectively, and the fair value of securities and cash pledged as collateral under repurchase agreements was $4,610,690 and $5,233,017, respectively. These amounts include collateral for reverse repurchase agreements that were re-pledged as collateral for repurchase agreements.

Intraday Lending Facility

In conjunction with the Company’s GCF repo business, on October 19, 2018, the Company and BONY renewed an intraday lending facility.  This lending facility allows for BONY to advance funds to JVB in order to facilitate the settlement of GCF repo transactions.  The total committed amount at March 31, 2019 was  $100,000.  Effective April 11, 2019, this commitment amount was be reduced to $75,000.  The reduction was initiated by the Company as a cost savings measure and because an intraday line of $100,000 was not deemed necessary.  The termination date of the intraday lending facility is October 19, 2019. It is expected that this facility will be renewed for successive 364-day periods provided that the Company continues its GCF repo business.    



The BONY lending facility is structured so that advances are generally repaid before the end of each business day.  However, if an advance is not repaid by the end of any business day, the advance is converted to an overnight loan.  Intraday loans accrue interest at an annual rate of 0.12%.  Interest is charged based on the number of minutes in a day the advance is outstanding.  Overnight loans are charged interest at the base rate plus 3% on a daily basis.  The base rate is the higher of the federal funds rate  plus 0.50% or the prime rate in effect at that time.  For the three months ended March 31, 2019 and 2018, the Company received no advances under the intraday lending facility.



Concentration



In the matched book repo business, the demand for borrowed funds is generated by the reverse repurchase agreement counterparty and the supply of funds is provided by the repurchase agreement counterparty. 



On the demand side, the Company does not consider its GCF repo business to be concentrated.  The Company’s reverse repo counterparties are a diverse group of financial institutions.  On the supply side, the Company obtains nearly all of its funds from the FICC.  If the FICC were to reduce its repo lending activities or make significant adverse changes to the cost of such lending, the Company may not be able to replace the FICC funding, or if the Company does so, it may be at a higher cost of funding.  Therefore, the Company considers its GCF repo business to be concentrated from the funding side of the business. 

---

 



The gestational repo business has been and continues to be concentrated as to reverse repurchase counterparties.  The Company conducts this business with a limited number of reverse repo counterparties.  As of March 31, 2019 and December 31, 2018, the Company’s gestational reverse repurchase agreements shown in the tables below represented balances from six counterparties.  The Company also has a limited number of repurchase agreement counterparties in the gestational repo business, however, it is primarily a function of the limited number of reverse repurchase agreement counterparties with whom the Company conducts this business rather than a reflection of a limited supply of funds.  Therefore, the Company considers the gestational repo business to be concentrated on the demand side. 



The total net revenue earned by the Company on its matched book repo business (both gestational repo and GCF repo) was $1,294 and $1,110 for the three months ended March 31, 2019 and 2018, respectively. 



The following tables summarize the remaining contractual maturity of the gross obligations under repurchase agreements accounted for as secured borrowings segregated by the underlying collateral pledged as of each date shown. The table reconciles the gross amounts to the net amounts presented in the statement of financial condition.  All gross amounts as well as counterparty cash collateral (see note 13) are subject to master netting arrangements; however, there is no offsetting other than the balances with the FICC, as shown below.  











---

 

 

11. INVESTMENT IN EQUITY METHOD AFFILIATE



Equity method accounting requires that the Company record its investment in equity method affiliates on the consolidated balance sheets and recognize its share of the equity method affiliates’ net income as earnings each reporting period. 



The Company has certain equity method affiliates for which it has elected the fair value option.  Those investees are excluded from the table below.  Those investees are included as a component of other investments, at fair value in the consolidated balance sheets.  All asset management fees and gains and losses (unrealized and realized) from securities classified as other investments, at fair value in the consolidated balance sheets are recorded as a component of asset management and principal transactions and other income in the consolidated statement of operations. See note 23.



The following table summarizes the activity and earnings in the Company’s investment that is accounted for under the equity method.  See note 4.





---

 







12. LEASES



The Company leases office space and certain computer and related equipment under noncancelable operating leases.  The company determines if an arrangement is a lease at the inception date of the contract.   The Company measures operating lease liabilities using an estimated incremental borrowing rate as there is no rate implicit in the Company’s operating lease arrangements.  An incremental borrowing rate was calculated for each operating lease based on the term of the lease, the U.S. Treasury term interest rate, and an estimated spread to borrow on a secured basis.



The Company adopted the provisions of ASC 842 effective January 1, 2019.  At adoption, the Company elected to not restate prior periods and rather record a cumulative effect of accounting change effective January 1, 2019.  The Company recorded the following: (a) a right of use asset of $8,416, (b) a lease commitment liability of $8,860, (c) a reduction in retained earnings from cumulative effect of adoption of $20, (d) an increase in other receivables of $18, and (e) a reduction in other liabilities of $406.



Rent expense is recognized on a straight-line basis over the lease term and is in included business development, occupancy, and equipment expense.



As of March 31, 2019, all of the leases to which the Company was a  party were operating leases.  The weighted average remaining term of the leases was 8.65 years.  The weighted average discount rate for the leases was 5.27%.  Summarized information regarding these leases is shown in the following table.





During the three months ended March 31, 2019, total cash payments of $286 were recorded as a reduction in the operating lease obligation.  No cash payments were made to acquire right of use assets.  Rent expense, net of sublease income of $65, was $390 for the three months ended March 31, 2019.