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Note 9 - Fair Value Disclosures
 12 Months Ended
Dec. 31, 2021
Notes to Financial Statements  
Fair Value Disclosures [Text Block]

9. 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 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:

 

 

•

securities that would otherwise qualify for available for sale treatment;

 

•

investments in equity method affiliates that have the attributes in ASC 946-10-15-2 (commonly referred to as investment companies); and

 

•

investments in residential loans.

 

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) of  $35,421, $43,413, and $1,080 related to changes in fair value of investments that are included as a component of other investments, at fair value during the years ended December 31, 2021, 2020, and 2019, respectively. The Company recognized net gains (losses) of $830, $1,063, and $0 related to changes in fair value of investments that are included as a component of other investments, sold not purchased during the years ended December 31, 2021, 2020, and 2019, respectively.

   

Fair Value Measurements

 

In accordance with ASC 820, the Company has categorized its financial instruments, based on the priority of the inputs to the valuation technique, into a three-level valuation hierarchy. The valuation 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 valuation hierarchy under ASC 820 are described below.

 

Level 1

Financial assets and liabilities whose values are 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 whose values are based on one or more of the following:

 

 

1.

Quoted prices for similar assets or liabilities in active markets;

 

2.

Quoted prices for identical or similar assets or liabilities in non-active markets;

 

 

3.

Pricing models whose inputs are derived, other than quoted prices, are observable for substantially the full term of the asset or liability; or

 

4.

Pricing models whose inputs are derived principally from or corroborated by observable market data through correlation or other means for substantially the full term of the asset or liability.

 

Level 3

Financial assets and liabilities whose values are 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 valuation 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 category. As a result, the unrealized gains and losses for assets and liabilities within the level 3 category 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.

 

 

The following tables present information about the Company’s assets and liabilities measured at fair value as of  December 31, 2021 and 2020 and indicates the valuation hierarchy of the valuation techniques utilized by the Company to determine such fair value.

 

 

FAIR VALUE MEASUREMENTS ON A RECURRING BASIS

As of December 31, 2021

(Dollars in Thousands)

 

          

Significant

  

Significant

 
      

Quoted Prices in

  

Other Observable

  

Unobservable

 
      

Active Markets

  

Inputs

  

Inputs

 

Assets

 

Fair Value

  

(Level 1)

  

(Level 2)

  

(Level 3)

 

Investments-trading:

                

U.S. government agency MBS and CMOs

 $134,093  $-  $134,093  $- 

U.S. government agency debt securities

  22,373   -   22,373   - 

RMBS

  9   -   9   - 

ABS

  1   -   1   - 

Corporate bonds and redeemable preferred stock

  45,519   -   45,519   - 

Foreign government bonds

  467   -   467   - 

Municipal bonds

  18,841   -   18,841   - 

Certificates of deposit

  169   -   169   - 

Derivatives

  1,275   -   1,275   - 

Equity securities

  1,118   -   1,118   - 

Total investments - trading

 $223,865  $-  $223,865  $- 
                 

Other investments, at fair value:

                

Equity securities

 $24,733   24,733  $-  $- 

Restricted equity securities

  19,449   -   19,449   - 

Corporate bonds and redeemable preferred stock

  476   -   476   - 

Residential loans

  115   -   115   - 
   44,773  $24,733  $20,040  $- 

Investments measured at NAV (1)

  11,260             

Total other investments, at fair value

 $56,033             
                 

Liabilities

                

Trading securities sold, not yet purchased:

                

U.S. government agency debt securities

 $1  $1  $-  $- 

U.S. Treasury securities

  29,513   29,513   -   - 

Corporate bonds and redeemable preferred stock

  32,574   -   32,574   - 

Derivatives

  424   -   424   - 

Total trading securities sold, not yet purchased

 $62,512  $29,514  $32,998  $- 



                

Other investments, sold not yet purchased:

                

Equity securities

 $2,488  $2,488  $-  $- 

Total other investments, sold not yet purchased

 $2,488  $2,488  $-  $- 

 

(1)

As a practical expedient, the Company uses NAV (or its equivalent) to measure the fair value of its investments in the U.S. Insurance JV, the SPAC Fund and the CREO JV. The U.S. Insurance JV invests in USD denominated debt issued by small insurance and reinsurance companies.  The SPAC Fund invests in equity securities of SPACs.  The CREO JV invests in primarily multi-family commercial real estate mortgage-backed loans and below-investment grade rated tranches in CRE CLOs collateralized by mostly transitional commercial real estate mortgage-backed loans. See note 4. According to ASC 820, these investments are not categorized within the valuation hierarchy.  



 

 

FAIR VALUE MEASUREMENTS ON A RECURRING BASIS

As of December 31, 2020

(Dollars in Thousands)

 

          

Significant

  

Significant

 
      

Quoted Prices in

  

Other Observable

  

Unobservable

 
      

Active Markets

  

Inputs

  

Inputs

 

Assets

 

Fair Value

  

(Level 1)

  

(Level 2)

  

(Level 3)

 

Investments-trading:

                

U.S. government agency MBS and CMOs

 $162,031  $-  $162,031  $- 

U.S. government agency debt securities

  6,904   -   6,904   - 

RMBS

  14   -   14   - 

U.S. Treasury securities

  607   607   -   - 

ABS

  1   -   1   - 

SBA loans

  2,742   -   2,742   - 

Corporate bonds and redeemable preferred stock

  36,388   -   36,388   - 

Foreign government bonds

  659   -   659   - 

Municipal bonds

  19,400   -   19,400   - 

Certificates of deposit

  70   -   70   - 

Derivatives

  13,717   -   13,717   - 

Equity securities

  428   -   428   - 

Total investments - trading

 $242,961  $607  $242,354  $- 
                 

Other investments, at fair value:

                

Equity securities

 $17,421  $17,421  $-  $- 

Restricted equity securities

  34,172   -   34,172   - 

Corporate bonds and redeemable preferred stock

  476   -   476   - 

Subordinated Notes

  1,519   -   1,519   - 

RTLs

  2,300   -   2,300   - 

Residential loans

  104   -   104   - 
   55,992  $17,421  $38,571  $- 

Investments measured at NAV (1)

  2,548             

Total other investments, at fair value

 $58,540             
                 

Liabilities

                

Trading securities sold, not yet purchased:

                

U.S. Treasury securities

 $3,348  $3,348  $-  $- 

Corporate bonds and redeemable preferred stock

  29,206   -   29,206   - 

Municipal bonds

  20   -   20   - 

Derivatives

  11,822   -   11,822   - 

Equity securities

  43   43   -   - 

Total trading securities sold, not yet purchased

 $44,439  $3,391  $41,048  $- 



                

Other investments, sold not yet purchased:

                

Derivatives

 $233  $233  $-  $- 

Equity securities

  7,182   7,182   -   - 

Total other investments, sold not yet purchased

 $7,415  $7,415  $-  $- 
                 

 

 

(1)

As a practical expedient, the Company uses NAV per share (or its equivalent) to measure the fair value of its investments in the U.S. Insurance JV and the SPAC Fund.  The U.S. Insurance JV invests in USD denominated debt issued by small insurance and reinsurance companies.  The SPAC Fund invests in equity securities of SPACs.  According to ASC 820, these investments are not categorized within the valuation 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 valuation hierarchy of the estimate. The discussion that follows applies regardless of whether the instrument is included in investments-trading; other investments, at fair value; other investments sold, not yet purchased; 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 where 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 classifies the fair value 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 as level 3 within 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. The Company classifies the fair value of certificates of deposit within level 2 of the valuation hierarchy.

 

Residential Loans: Management utilizes home price indices or market indications to value the residential loans. The Company classifies the fair value of these loans within level 2 in the valuation hierarchy.

 

Residential transition loans: The Company uses valuation models prepared by management which are based on an income approach. These models include estimates, and the valuations derived from them could differ materially from amounts realizable in an open market exchange. Fair values based on internal valuation models prepared by the Company’s management are generally classified within level 3 of 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 the Company classifies their fair value within level 1 of the valuation hierarchy.  The fair value of equity securities that represent investments in privately held companies are generally determined either (i) based on a valuation model or (ii) based on recently observed transactions in the same instrument or similar instrument that we hold.  These valuations are generally classified within either level 2 or level 3 of the valuation hierarchy.  

 

Restricted Equity Securities:  Restricted equity securities are investments in publicly traded companies.  However, they are restricted from re-sale until either (a) the share price trades above a certain threshold for a certain period of time; or (b) a certain period of time elapses or both. The Company determines the fair value by utilizing a model that starts with the publicly traded share price but then applies a discount based on a Monte Carlo simulation.  The inputs to this model are observable so the Company classifies these securities within level 2 of the valuation hierarchy.  The Company is not allowed to sell these shares during the restriction period and there is no certainty as to when these hurdles will be met or if they will be met at all.

 

Subordinated Notes: The Company uses recently executed transactions or third-party quotations from independent pricing services to arrive at the fair value of its investments in subordinated notes. 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.

 

Derivatives:

 

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 within 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 10.

 

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.

 

Equity Derivatives

 

The Company enters into equity derivatives such as puts and short call options. These are securities that are traded on a recognized liquid exchange and the Company classifies their fair value within level 1 of the valuation hierarchy. See note 10.

 

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 classified within level 1 of the valuation hierarchy. See note 9.

 

Level 3 Financial Assets and Liabilities

 

Financial Instruments Measured at Fair Value on a Recurring Basis

 

The following table present 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.

 

 

 

LEVEL 3 ROLLFORWARD

(Dollars in thousands)

 

  

Year Ended December 31,

 
  

2021

  

2020

 

Beginning of Period

 $-  $2,522 

Net trading

  -   (57)

Gains & losses (1)

  -   (604)

Accretion of income (1)

  -   124 

Purchases

  -   638 

Sales and returns of capital

  -   (5,601)

Reclassification of RTLs

  -   5,278 

Transfer out of Level 3 (2)

  -   (2,300)

End of Period

 $-  $- 
         

Change in unrealized gains / (losses) (3)

 $-  $- 

 

 

(1)

Gains and losses on and accretion of income on other investments, at fair value are recorded as a component of principal transactions and other income in the consolidated statements of operations.

(2)RTL was reclassified from level 3 to level 2 due to availability of observable inputs. 

(3)

Represents the change in unrealized gains and losses for the period included in earnings for assets held at the end of the reporting period.

 

 

Investments in Certain Entities that Calculate Net Asset Value 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 ASC 820 have been applied), which are measured at fair value on a recurring basis as of December 31, 2021 and 2020.

  

FAIR VALUE MEASUREMENTS OF INVESTMENTS IN CERTAIN ENTITIES

THAT CALCULATE NET ASSET VALUE PER SHARE (OR ITS EQUIVALENT)

(Dollars in thousands)

 

  

December 31, 2021

  

Unfunded Commitments

  

Redemption Frequency

  

Redemption Notice Period

 

Other investments, at fair value

                

CREO (a)

 $5,830  $9,170   

N/A

   

N/A

 

U.S. Insurance JV (b)

  3,450   N/A   

N/A

   

N/A

 

SPAC Fund (c)

  1,980   N/A   

Quarterly after 1 year lock up

   

30 days

 
  $11,260             

 

  

December 31, 2020

  

Unfunded Commitments

  

Redemption Frequency

  

Redemption Notice Period

 

Other investments, at fair value

                

U.S. Insurance JV (a)

 $1,564  $1,567   N/A   N/A 

SPAC Fund (b)

  984   NA   Quarterly after 1 year lock up   30 days 
  $2,548             

 

N/A – Not applicable.

 

(a)The CREO JV invests in primarily multi-family commercial real estate mortgage-backed loans and below-investment grade rated tranches in CRE CLOs collateralized by mostly transitional commercial real estate mortgage-backed loans. See note 4.

(b)

The U.S. Insurance JV invests in USD denominated debt issued by small and medium sized insurance and reinsurance companies.

(c)

The SPAC Fund invests in equity interests of SPACs.