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Derivative Financial Instruments
 9 Months Ended
Sep. 30, 2013
Derivative Financial Instruments [Abstract]  
Derivative Financial Instruments

8. DERIVATIVE FINANCIAL INSTRUMENTS

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

Derivative financial instruments are recorded at fair value. If the derivative was entered into as part of the Company’s broker-dealer operations, it will be included as a component of investments-trading or trading securities sold, not yet purchased. If it is entered into as an economic hedge for another financial instrument included in other investments, at fair value then the derivative will be included as a component of other investments, at fair value. The Company may, from time to time, enter into derivatives to manage its risk exposures (i) arising from fluctuations in foreign currency rates with respect to the Company’s investments in foreign currency denominated investments; (ii) arising from the Company’s investments in interest rate sensitive investments; and (iii) arising from the Company’s facilitation of mortgage-backed trading. Derivatives entered into by the Company, from time to time, may include (i) foreign currency forward contracts; (ii) Eurodollar futures; and (iii) purchase and sale agreements of TBAs. TBAs are forward mortgage-backed securities whose collateral remain “to be announced” until just prior to the trade settlement. TBAs are accounted for as derivatives under FASB ASC 815 when either of the following conditions exists: (i) when settlement of the TBA trade is not expected to occur at the next regular settlement date (which is typically the next month) or (ii) a mechanism exists to settle the contract on a net basis. Otherwise, TBAs are recorded as a standard security trade. The settlement of these transactions is not expected to have a material effect on the Company’s consolidated financial statements.

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

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

Foreign Currency Forward Contracts

The Company invests in foreign currency denominated investments that expose it to fluctuations in foreign currency rates, and, therefore, the Company may, from time to time, hedge such exposure by using foreign currency forward contracts.  The Company carries the foreign currency forward contracts at fair value and includes them as a component of other investments, at fair value in the Company’s consolidated balance sheets.  As of September 30, 2013, the Company had outstanding foreign currency forward contracts with a notional amount of 1.25 billion Japanese Yen. As of December 31, 2012, the Company had no outstanding foreign currency forward contracts.

TBAs

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 enters in to the purchase and sale of TBAs. The Company carries the TBAs at fair value and includes them as a component of investments—trading or trading securities sold, not yet purchased in the Company’s consolidated balance sheets. At September 30, 2013, the Company had open TBA sale agreements in the notional amount of $60,736 and open TBA purchase agreements in the notional amount of $55,692. At December 31, 2012, the Company had open TBA sale agreements in the notional amount of $40,125 and open TBA purchase agreements in the notional amount of $32,794. 

 

The following table presents the Company’s derivative financial instruments and the amount and location of the fair value (unrealized gain / (loss)) recognized in the consolidated balance sheets as of September 30, 2013 and December 31, 2012, respectively.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

DERIVATIVE FINANCIAL INSTRUMENTS-BALANCE SHEET INFORMATION

(Dollars in Thousands)

 

 

 

 

 

 

 

 

 

Derivative Financial Instruments Not Designated as Hedging Instruments Under FASB ASC 815

 

Balance Sheet Classification

 

 

September 30, 2013

 

 

December 31, 2012

 

 

 

 

 

 

 

 

 

TBAs

 

Investments-trading

 

$
429 

 

$
35 

Foreign currency forward contracts

 

Other investments, at fair value

 

 
(271)

 

 

 -

TBAs

 

Trading securities sold, not yet purchased

 

 
(663)

 

 
(13)

 

 

 

 

$
(505)

 

$
22 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

DERIVATIVE FINANCIAL INSTRUMENTS-STATEMENT OF OPERATIONS INFORMATION

(Dollars in Thousands)

 

 

 

 

 

 

 

 

 

Derivative Financial Instruments Not Designated as Hedging Instruments Under FASB ASC 815

 

Income Statement Classification

 

 

Nine Months Ended September 30, 2013

 

 

Nine Months Ended September 30, 2012

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

Revenues-principal transactions and other income

 

$
(481)

 

$
(323)

TBAs

 

Revenues-net trading

 

 
2,608 

 

 
680 

 

 

 

 

$
2,127 

 

$
357 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

DERIVATIVE FINANCIAL INSTRUMENTS-STATEMENT OF OPERATIONS INFORMATION

(Dollars in Thousands)

 

 

 

 

 

 

 

 

 

Derivative Financial Instruments Not Designated as Hedging Instruments Under FASB ASC 815

 

Income Statement Classification

 

 

Three Months Ended September 30, 2013

 

 

Three Months Ended September 30, 2012

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

Revenues-principal transactions and other income

 

$
(119)

 

$
(288)

TBAs

 

Revenues-net trading

 

 
591 

 

 
426 

 

 

 

 

$
472 

 

$
138 

 

 

 

 

 

 

 

 

 

 

In addition to the above activities related to TBAs, the Company also enters into TBAs 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 the clients. In general, the Company will enter into a TBA purchase agreement with the client. Then, the Company will immediately enter into a TBA sale agreement with identical terms and settlement date with a separate counterparty. The Company seeks to profit through a small mark-up in the price of the transaction. The TBAs will match underlying terms and settlement dates. Because the Company has purchased and sold the same security, it is no longer exposed to market movements of the underlying TBA. The gain or loss on the transaction is recorded as a component of net trading in the consolidated statement of operations and is included in due to or due from broker in the consolidated balance sheet until it settles. As of September 30, 2013, the Company had unsettled TBA purchase contracts and offsetting TBA sale agreements in the notional amount of $292,350. The net profit on these transactions is recorded as a component of net trading revenue and is included as a component of TBA revenue in the table above. Any revenue on trades that have not yet settled is included as a component of due to or due from brokers, dealers, and clearing agencies.