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Note 9 - Derivative Financial Instruments

6 Months Ended

Jun. 30, 2024

Notes to Financial Statements

Derivative Instruments and Hedging Activities Disclosure [Text Block]

9. DERIVATIVE FINANCIAL INSTRUMENTS

FASB ASC 815, Derivatives and Hedging (“ASC 815”), provides for optional hedge accounting. When a derivative is deemed to be a hedge and certain documentation and effectiveness testing requirements are met, reporting entities can record all or a portion of the change in the fair value of a designated hedge as an adjustment to 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 ASC 815.

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

Derivative financial instruments are recorded at fair value. If the derivative was entered into as part of the Company’s broker-dealer operations, it will be included as a component of investments-trading or trading securities sold, not yet purchased. If it was entered into as a hedge for another financial instrument included in other investments, at fair value, then the derivative will be included as a component of other investments, at fair value.

The Company may, from time to time, enter into derivatives to manage its risk exposures arising from (i) fluctuations in foreign currency rates with respect to the Company’s investments in foreign currency denominated investments; (ii) the Company’s investments in interest sensitive investments; (iii) the Company's investment in equities; and (iv) the Company’s facilitation of mortgage-backed trading. Derivatives entered into by the Company, from time to time, may include (a) foreign currency forward contracts; (b) purchase and sale agreements of TBAs and other forward agency MBS contracts; (c) other extended settlement trades; and (d) SFAs.

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

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

Equity Derivatives

A significant portion of the Company’s equity holdings are carried at fair value. From time to time, the Company hedges a portion of this exposure by entering into equity derivatives such as puts and short call options. These derivative positions are held at fair value as a component of other investments, at fair value and other investments sold, not yet purchased in the Company’s consolidated balance sheets. As of June 30, 2024 and December 31, 2023, the Company had no options. From time to time, the Company may also enter into forward purchase commitments for equity securities.

In addition, the Company may engage in advisory transactions that result in a receivable that can be paid in cash or a variable number of equity instruments. In such instances, the Company would record the receivable as a component of other assets in its consolidated balance sheets and record the equity component as an embedded derivative. All equity derivatives are carried at fair value as a component of other investments, at fair value or other investments sold, not yet purchased in the Company’s consolidated balance sheets. As of June 30, 2024 and December 31, 2023, the Company had equity derivatives included in other investments, at fair value of $876 and $1,447, respectively.

The Company may hedge a portion of the exposure from these equity investments by entering into short trades. These short trades are not treated as derivatives and are carried as a component of other investments sold, not yet purchased in the Company’s consolidated balance sheets. See note 7.

TBAs and Other Forward Agency MBS Contracts

TBAs are forward contracts to purchase or sell MBS with collateral that remains “to be announced” until just prior to the trade settlement date. In addition to TBAs, the Company sometimes enters into forward purchases or sales of agency MBS where the underlying collateral has been identified. These transactions are referred to as other forward agency MBS contracts. TBAs and other forward agency MBS contracts are accounted for as derivatives by the Company under ASC 815. The settlement of these transactions is not expected to have a material effect on the Company’s consolidated financial statements.

In addition to TBAs and other forward agency MBS contracts as part of the Company’s broker-dealer operations, the Company may from time to time enter into other securities or loan trades that do not settle within the normal securities settlement period. In those cases, the purchase or sale of the security or loan is not recorded until the settlement date. However, from the trade date until the settlement date, the Company’s interest in the security is accounted for as a derivative as either a forward purchase commitment or forward sale commitment. The Company will classify the related derivative either within investments-trading or other investments, at fair value, depending on where it intends to classify the investment once the trade settles.

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

	(i)	The Company trades U.S. government agency obligations. In connection with these activities, the Company may be required to maintain inventory in order to facilitate customer transactions. In order to mitigate exposure to market risk, the Company may enter into the purchase and sale of TBAs and other forward agency MBS contracts.
	(ii)	The Company also enters into TBAs and other forward agency MBS contracts in order to assist clients (generally small to mid-size mortgage loan originators) in hedging the interest rate risk associated with the mortgages owned by these clients.

(iii)

Finally, the Company may enter into TBAs and other forward agency MBS contracts on a speculative basis.

The Company carries TBAs and other forward agency MBS contracts at fair value and includes them as a component of investments-trading or trading securities sold, not yet purchased in the Company’s consolidated balance sheets. At June 30, 2024, the Company had open TBAs and other forward MBS purchase agreements in the notional amount of $1,111,500 and open TBAs and other forward MBS sale agreements in the notional amount of $1,134,610. At December 31, 2023, the Company had open TBAs and other forward agency MBS purchase agreements in the notional amount of $592,000 and open TBAs and other forward agency MBS sale agreements in the notional amount of $618,425.

Other Extended Settlement Trades

When the Company buys or sells a financial instrument that will not settle in the regular timeframe, the Company will account for that purchase or sale on the settlement date rather than the trade date. In those cases, the Company accounts for the transaction between trade date and settlement date as either a forward purchase commitment or a forward sale commitment, which are both considered derivatives. The Company will record an unrealized gain or unrealized loss on the derivative for the difference between the fair value of the underlying financial instrument as of the reporting date and the agreed upon transaction price. As of June 30, 2024 and December 31, 2023, the Company had no open forward purchase or sales commitments.

Foreign Currency Forward Contracts

The Company invests in foreign currency denominated investments that expose it to fluctuations in foreign currency rates, and, therefore, the Company may, from time to time, hedge such exposure by using foreign currency forward contracts. The Company carries foreign currency forward contracts at fair value and includes them as a component of other investments, at fair value in the Company’s consolidated balance sheets. As of June 30, 2024 and December 31, 2023, the Company had no outstanding foreign currency forward contracts.

The following table presents the Company’s derivative financial instruments and the amount and location of the fair value (unrealized gain / (loss)) recognized in the consolidated balance sheets as of June 30, 2024 and December 31, 2023.

DERIVATIVE FINANCIAL INSTRUMENTS-BALANCE SHEET INFORMATION

(Dollars in Thousands)

Derivative Financial Instruments Not Designated as Hedging Instruments Under FASB ASC 815		Balance Sheet Classification		June 30, 2024				December 31, 2023
TBAs and other forward agency MBS		Investments-trading		$	1,438			$	7,470
TBAs and other forward agency MBS		Trading securities sold, not yet purchased			(438	)			(6,719	)
Equity derivatives		Other investments, at fair value			876				1,447
Share forward liabilities		Other investments sold, not yet purchased, at fair value			(7,010	)			(24,645	)
				$	(5,134	)		$	(22,447	)

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

DERIVATIVE FINANCIAL INSTRUMENTS-STATEMENT OF OPERATIONS INFORMATION

(Dollars in Thousands)

				Three Months Ended June 30,
Derivative Financial Instruments Not Designated as Hedging Instruments Under FASB ASC 815		Income Statement Classification		2024				2023
TBAs and other forward agency MBS		Revenue-net trading		$	1,249			$	1,531
Equity derivatives		Principal transactions and other income (loss)			(79	)			788
Share forward liabilities		Principal transactions and other income (loss)			8,782				23,039
				$	9,952			$	25,358

				Six Months Ended June 30,
Derivative Financial Instruments Not Designated as Hedging Instruments Under FASB ASC 815		Income Statement Classification		2024				2023
TBAs and other forward agency MBS		Revenue-net trading		$	2,603			$	1,922
Equity derivatives		Principal transactions and other income (loss)			(643	)			788
Share forward liabilities		Principal transactions and other income (loss)			16,332				23,039
				$	18,292			$	25,749

The share forward liabilities offset certain long positions included as a component of other investments, at fair value. The offsetting long positions had income / (loss) of ($17,088) and ($13,634) for the six months ended June 30, 2024 and 2023, respectively.

SFAs

The Company has engaged in several transactions known as SFAs. In a typical SFA transaction, the Company acquires an interest in a publicly traded company (referred to as the "SFA Counterparty") through open-market purchases, direct acquisitions from the SFA Counterparty, or a combination thereof. These interests can take the form of unrestricted common shares, restricted common shares, equity derivatives, or fair value receivables.

Upon acquiring these interests, the Company enters into an SFA derivative arrangement with the SFA Counterparty. In cases where the Company acquires its interests in the SFA Counterparty through open- market purchases, the SFA generally requires an up-front payment to the Company from the SFA Counterparty. The amount of this payment equals the cost paid by the Company for those interests, less a shortfall amount in certain cases. To fund the shortfall portion of the initial investment, the Company will utilize available cash on hand or available financing.

The SFA stipulates that the Company must make a payment to the SFA Counterparty on a certain maturity date. Depending on the terms of the SFA, this payment may be made in cash, by returning the acquired interests in kind, or through a combination of both. In some cases, the SFA requires the payment to be made exclusively in cash.

Importantly, the SFA does not obligate the Company to hold the interests that it acquired in the SFA Counterparty. Following the execution of the SFA, the Company is free to sell the interests in the SFA Counterparty (assuming the interests themselves are not restricted from transfer). Additionally, SFAs generally include a feature whereby if the Company holds the interests in the SFA Counterparty that it acquired until maturity or another agreed-upon date, the Company becomes eligible to receive an additional payment from the SFA Counterparty, either in cash or in additional interests in the SFA Counterparty. Such a payment is known as the "Maturity Consideration."

Furthermore, SFAs usually include a provision allowing the Company to terminate the SFA, either in whole or in part, before its maturity by making an agreed-upon payment based on an amount defined in the SFA (the “Reset Price”). The Reset Price may either remain fixed throughout the term of the SFA or fluctuate based on certain calculations within the SFA.

SFAs also impose various obligations on the SFA Counterparty that may include registering a predetermined number of the interests in the SFA Counterparty (subject to the SFA) with the SEC, maintaining a listing of the SFA Counterparty securities on a national exchange, and/or that the closing price of the SFA Counterparty's shares on the public exchange does not fall below a predetermined price for a specific period of time. If any of these SFA Counterparty obligations are breached or not satisfied, the Company may have the right to terminate the SFA early and accelerate the payment of the Maturity Consideration upon termination. The SFAs provide the right of set off in the case of Maturity Consideration thereby allowing the Company to keep the interests it holds in the SFA Counterparty and offset the Maturity Consideration it is owed following termination of the applicable SFA.

The Company accounts for SFA transactions as follows:

●

The interests in public companies that it owns are carried at fair value. Refer to note 8 for further details on determining the fair value of unrestricted common shares, restricted common shares, equity derivatives, or fair value receivables.

●

The derivative obligation arising from the SFA is also carried at fair value. Fair value represents the amount the Company would need to pay to settle the SFA obligation at any reporting period date. If the SFA allows the Company multiple methods of settling the obligation, the Company will choose the most advantageous one to value the derivative obligation. In performing this calculation, only settlement methods contractually available to the Company at the reporting date will be considered (i.e., ones available at some future date will not be considered). For instance, if the Company may early terminate the SFA by either returning common shares or making a cash payment based on the Reset Price, the liability will be valued at the lower of: (i) the fair value of the common shares and (ii) the cash amount based on the Reset Price.

●

The Company does not recognize any Maturity Consideration as revenue until it is earned under the contract, either by meeting the hold period requirement or due to a breach of obligation by the SFA Counterparty that enables the Company to terminate the SFA early.

●

In cases where the Company earns Maturity Consideration and the amount it is owed exceeds the fair value of the interest it owns that is available to offset, the Company will consider the probability of payment of the remaining Maturity Consideration based on the credit quality of the SFA Counterparty and general market conditions. If the Company determines the collection of the remaining Maturity Consideration owed is not probable, the Company will not record the unpaid portion.

The following table shows the carrying value of the assets and liabilities of SFA transactions as of the reporting period dates.

SHARE FORWARD ARRANGEMENTS

(Dollars in Thousands)

		June 30, 2024				December 31, 2023
Equity securities		$	2,284			$	26,079
Equity derivatives			804				1,447
Fair value receivables			2,538				6,278
Share forward liabilities			(7,010	)			(24,645	)
Net fair value of share forward arrangements		$	(1,384	)		$	9,159