Table of Contents



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 June 30, 2020

 

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)


 

Maryland

16-1685692

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)



 

Cira Centre

2929 Arch Street,  Suite 1703

Philadelphia,  Pennsylvania

19104

(Address of principal executive offices)

(Zip Code)

 

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.



 

 

 

Large accelerated filer

Accelerated filer

Non-accelerated filer

☐  

Smaller reporting company



 

Emerging growth company

 

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:

 

Title of each class

 

Trading Symbol(s)

 

Name of each exchange on which registered

Common Stock, par value $0.01 per share

 

COHN

 

The NYSE American Stock Exchange

 

As of July 31, 2020, there were 1,246,710, shares of common stock ($0.01 par value per share) of Cohen & Company Inc. (“Common Stock”) outstanding.

 

 

 

 

 

Cohen & Company Inc. 

FORM 10-Q

INDEX TO QUARTERLY REPORT ON FORM 10-Q

June 30, 2020

  



 

 

 

 

Page 

PART I. FINANCIAL INFORMATION

 



 

 

Item 1.

Financial Statements (Unaudited)

5



 

 

 

Consolidated Balance Sheets—June 30, 2020 and December 31, 2019

5



 

 

 

Consolidated Statements of Operations and Comprehensive Income (Loss)—Three and Six Months Ended June 30, 2020 and 2019

6



 

 

 

Consolidated Statements of Changes in Equity—Three and Six Months Ended June 30, 2020 and 2019

7



 

 

 

Consolidated Statements of Cash Flows—Six Months Ended June 30, 2020 and 2019

8



 

 

 

Notes to Consolidated Financial Statements (Unaudited)

9



 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

55



 

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

76



 

 

Item 4.

Controls and Procedures

77



 

Part II. OTHER INFORMATION

 



 

 

Item 1.

Legal Proceedings

78



 

 

Item 1A.

Risk Factors

78



 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

79



 

 

Item 6.

Exhibits

80



 

Signatures

81

 

 

2

 

 

 

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:

 

 

● 

integration of operations;

 

● 

business strategies;

 

● 

growth opportunities;

 

● 

competitive position;

 

● 

market outlook;

 

● 

expected financial position;

 

● 

expected results of operations;

 

● 

future cash flows;

 

● 

financing plans;

 

● 

plans and objectives of management;

 

● 

tax treatment of the business combinations;

    Insurance Acquisition Corporation (Nasdaq: INSU) and the potential merger of its subsidiary, IAC Merger Sub, Inc., and Shift Technologies, Inc., a Delaware corporation ("Shift");
 

● 

fair value of assets; and

 

● 

any other statements regarding future growth, future cash needs, future operations, business plans, future financial results, and any other statements that are not historical facts.

 

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, 2019. Actual results may differ materially as a result of various factors, some of which are outside our control, including the following:

 

 

● 

a decline in general economic conditions or the global financial markets;

 

● 

losses or reductions in business volume due to impact of the COVID-19 pandemic;

 

● 

losses caused by financial or other problems experienced by third parties;

 

● 

losses due to unidentified or unanticipated risks;

 

● 

losses (whether realized or unrealized) on our principal investments;

 

● 

a lack of liquidity, i.e., ready access to funds for use in our businesses, including the availability of securities financing from our clearing agency and the Fixed Income Clearing Corporation the (“FICC”); or the availability of financing at prohibitive  rates;

 

● 

the ability to attract and retain personnel;

 

● 

the ability to meet regulatory capital requirements administered by federal agencies;

 

● 

an inability to generate incremental income from acquired, newly established or expanded businesses;

 

● 

unanticipated market closures due to inclement weather or other disasters;

 

● 

the volume of trading in securities including collateralized securities transactions;

 

● 

the liquidity in capital markets;

 

● 

the creditworthiness of our correspondents, trading counterparties, and banking and margin customers;

 

● 

changing interest rates and their impacts on U.S. residential mortgage volumes;

 

● 

competitive conditions in each of our business segments;

 

● 

the availability of borrowings under credit lines, credit agreements, warehouse agreements, and our credit facilities;

 

● 

our continued membership in the FICC;

 

● 

the potential misconduct or errors by our employees or by entities with whom we conduct business; and

 

● 

the potential for litigation and other regulatory liability.

 

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.

 

 

3

 

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., a wholly owned subsidiary of the Operating LLC; “JVB” refers to J.V.B. Financial Group, LLC, a wholly owned broker-dealer subsidiary of JVB Holdings; “CCFL” refers to Cohen & Company Financial Limited (formerly known as EuroDekania Management LTD), a wholly owned subsidiary of the Operating LLC regulated by the Financial Conduct Authority (formerly known as the Financial Services Authority) in the United Kingdom (the “FCA”); “CCFEL” refers to Cohen & Company Financial (Europe) Limited, a wholly owned subsidiary of the Operating LLC regulated by the Central Bank of Ireland ( the “CBI”) and “EuroDekania” refers to EuroDekania (Cayman) Ltd., a Cayman Islands exempted company that was 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.

 

4

 

 

 

PART I. FINANCIAL INFORMATION 

 

ITEM 1.FINANCIAL STATEMENTS.

 

COHEN & COMPANY INC.

 

CONSOLIDATED BALANCE SHEETS 

(Dollars in Thousands) 

 

   

June 30, 2020

         
   

(unaudited)

   

December 31, 2019

 

Assets

               

Cash and cash equivalents

  $ 235,018     $ 8,304  

Receivables from brokers, dealers, and clearing agencies

    69,996       96,132  

Due from related parties

    773       466  

Other receivables

    4,723       46,625  

Investments-trading

    237,541       307,852  

Other investments, at fair value

    9,693       14,864  

Receivables under resale agreements

    5,504,667       7,500,002  

Investments in equity method affiliates

    4,556       3,799  

Goodwill

    109       7,992  

Right-of-use asset - operating leases

    6,583       7,155  

Other assets

    3,023       8,433  

Total assets

  $ 6,076,682     $ 8,001,624  
                 

Liabilities

               

Payables to brokers, dealers, and clearing agencies

  $ 121,458     $ 241,261  

Accounts payable and other liabilities

    227,022       20,295  

Accrued compensation

    7,402       4,046  

Trading securities sold, not yet purchased

    66,156       77,947  

Securities sold under agreements to repurchase

    5,524,758       7,534,443  

Deferred income taxes

    1,329       1,339  

Lease liability - operating leases

    7,091       7,693  

Redeemable financial instruments

    16,878       16,983  

Debt

    64,209       48,861  

Total liabilities

    6,036,303       7,952,868  
                 

Commitments and contingencies (See note 21)

               
                 

Stockholders' Equity:

               

Voting Non-Convertible Preferred Stock, $0.001 par value per share, 60,000,000 shares authorized, 27,413,098 shares issued and outstanding, respectively

    27       27  

Common Stock, $0.01 par value per share, 100,000,000 shares authorized, 1,246,710 and 1,193,624 shares issued and outstanding, respectively, including 86,566 and 73,715 unvested or restricted share awards, respectively

    12       12  

Additional paid-in capital

    68,669       68,714  

Accumulated other comprehensive loss

    (925 )     (915 )

Accumulated deficit

    (36,782 )     (34,519 )

Total stockholders' equity

    31,001       33,319  

Non-controlling interest

    9,378       15,437  

Total equity

    40,379       48,756  

Total liabilities and equity

  $ 6,076,682     $ 8,001,624  

( 

 

See accompanying notes to unaudited consolidated financial statements.

 

5

 

 

 

COHEN & COMPANY INC. 

 

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

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

(Unaudited)

 

   

Three Months Ended June 30,

   

Six Months Ended June 30,

 
   

2020

   

2019

   

2020

   

2019

 

Revenues

                               

Net trading

  $ 20,006     $ 8,670     $ 38,567     $ 17,394  

Asset management

    1,692       1,745       3,307       3,747  

Principal transactions and other income

    2,421       754       15       1,168  

Total revenues

    24,119       11,169       41,889       22,309  
                                 

Operating expenses

                               

Compensation and benefits

    11,324       6,432       25,458       12,796  

Business development, occupancy, equipment

    640       895       1,396       1,706  

Subscriptions, clearing, and execution

    2,548       2,056       5,128       4,329  

Professional fee and other operating

    1,597       1,190       3,379       2,869  

Depreciation and amortization

    84       78       164       159  

Impairment of goodwill

    -       -       7,883       -  

Total operating expenses

    16,193       10,651       43,408       21,859  
                                 

Operating income (loss)

    7,926       518       (1,519 )     450  
                                 

Non-operating income (expense)

                               

Interest expense, net

    (3,081 )     (1,939 )     (5,686 )     (3,793 )

Income (loss) from equity method affiliates

    (1,233 )     (248 )     (1,340 )     (256 )

Income (loss) before income tax expense (benefit)

    3,612       (1,669 )     (8,545 )     (3,599 )

Income tax expense (benefit)

    343       (641 )     (29 )     (747 )

Net income (loss)

    3,269       (1,028 )     (8,516 )     (2,852 )

Less: Net income (loss) attributable to the non-controlling interest

    2,368       (618 )     (6,315 )     (1,240 )

Net income (loss) attributable to Cohen & Company Inc.

  $ 901     $ (410 )   $ (2,201 )   $ (1,612 )

Income (loss) per share data (see note 20)

                               

Income (loss) per common share-basic:

                               
Basic income (loss) per common share   $ 0.78     $ (0.36 )   $ (1.91 )   $ (1.42 )

Weighted average shares outstanding-basic

    1,160,144       1,143,909       1,153,512       1,138,538  

Income (loss) per common share-diluted:

                               
Diluted income (loss) per common share   $ 0.69     $ (0.36 )   $ (1.92 )   $ (1.42 )

Weighted average shares outstanding-diluted

    5,020,453       1,676,318       3,951,843       1,670,947  
                                 

Dividends declared per common share

  $ -     $ 0.20     $ -     $ 0.40  
                                 

Comprehensive income (loss)

                               

Net income (loss)

  $ 3,269     $ (1,028 )   $ (8,516 )   $ (2,852 )

Other comprehensive income (loss) item:

                               

Foreign currency translation adjustments, net of tax of $0

    37       16       (63 )     25  

Other comprehensive income (loss), net of tax of $0

    37       16       (63 )     25  

Comprehensive income (loss)

    3,306       (1,012 )     (8,579 )     (2,827 )

Less: comprehensive income (loss) attributable to the non-controlling interest

    2,394       (614 )     (6,360 )     (1,233 )

Comprehensive income (loss) attributable to Cohen & Company Inc.

  $ 912     $ (398 )   $ (2,219 )   $ (1,594 )

 

 

See accompanying notes to unaudited consolidated financial statements.

 

6

 

 

 

COHEN & COMPANY INC. 

 

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

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

(Unaudited)

 

   

Cohen & Company Inc.

                 
   

Six Months Ended June 30, 2020

                 
                           

Retained

   

Accumulated

                         
                   

Additional

   

Earnings

   

Other

   

Total

                 
   

Preferred Stock

   

Common Stock

    Paid-In Capital     (Accumulated Deficit)     Comprehensive Income (Loss)     Stockholders' Equity     Non-controlling Interest    

Total Equity

 

December 31, 2019

  $ 27     $ 12     $ 68,714     $ (34,519 )   $ (915 )   $ 33,319     $ 15,437     $ 48,756  

Net loss

    -       -       -       (3,102 )     -       (3,102 )     (8,683 )     (11,785 )

Other comprehensive income / (loss)

    -       -       -       -       (29 )     (29 )     (71 )     (100 )

Acquisition / (surrender) of additional units of consolidated subsidiary, net

    -       -       (123 )     -       8       (115 )     115       -  

Equity-based compensation and vesting of shares

    -       -       46       -       -       46       112       158  

Shares withheld for employee taxes

    -       -       (15 )     -       -       (15 )     (39 )     (54 )

Dividends/Distributions

    -       -       -       (62 )     -       (62 )     -       (62 )

March 31, 2020

  $ 27     $ 12     $ 68,622     $ (37,683 )   $ (936 )   $ 30,042     $ 6,871     $ 36,913  

Net income

    -       -       -       901       -       901       2,368       3,269  

Other comprehensive income / (loss)

    -       -       -       -       11       11       26       37  

Equity-based compensation and vesting of shares

    -       -       47       -       -       47       113       160  

June 30, 2020

  $ 27     $ 12     $ 68,669     $ (36,782 )   $ (925 )   $ 31,001     $ 9,378     $ 40,379  

 

 

 

   

Cohen & Company Inc.

                 
   

Six Months Ended June 30, 2019

                 
                           

Retained

   

Accumulated

                         
                   

Additional

   

Earnings

   

Other

   

Total

                 
   

Preferred Stock

   

Common Stock

    Paid-In Capital     (Accumulated Deficit)    

Comprehensive Income (Loss)

    Stockholders' Equity     Non-controlling Interest    

Total Equity

 

December 31, 2018

  $ 5     $ 12     $ 68,591     $ (31,926 )   $ (908 )   $ 35,774     $ 6,664     $ 42,438  

Net loss

    -       -       -       (1,202 )     -       (1,202 )     (622 )     (1,824 )

Other comprehensive income

    -       -       -       -       6       6       3       9  

Cumulative effect adjustment - adoption of ASU 2016-02

    -       -       -       (20 )     -       (20 )     -       (20 )

Acquisition / (surrender) of additional units of consolidated subsidiary, net

    -       -       133       -       (14 )     119       (119 )     -  

Equity-based compensation and vesting of shares

    -       -       117       -       -       117       55       172  

Shares withheld for employee taxes

    -       -       (87 )     -       -       (87 )     (41 )     (128 )

Purchase and retirement of Common Stock

    -       -       (65 )     -       -       (65 )     -       (65 )

Investment in non-controlling interest

    -       -       -       -       -       -       2,550       2,550  

Dividends/Distributions

    -       -       -       (290 )     -       (290 )     (106 )     (396 )

March 31, 2019

  $ 5     $ 12     $ 68,689     $ (33,438 )   $ (916 )   $ 34,352     $ 8,384     $ 42,736  

Net loss

    -       -       -       (410 )     -       (410 )     (618 )     (1,028 )

Other comprehensive income

    -       -       -       -       12       12       4       16  

Equity-based compensation and vesting of shares

    -       -       130       -       -       130       62       192  

Dividends/Distributions

    -       -       -       (229 )     -       (229 )     (108 )     (337 )

June 30, 2019

  $ 5     $ 12     $ 68,819     $ (34,077 )   $ (904 )   $ 33,855     $ 7,724     $ 41,579  

 

 

  

See accompanying notes to unaudited consolidated financial statements.

 

7

 

 

 

 

COHEN & COMPANY INC. 

 

Consolidated Statements of Cash Flows

(Dollars in Thousands)

(Unaudited)

 

   

Six Months Ended June 30,

 
   

2020

   

2019

 

Operating activities

               

Net income (loss)

  $ (8,516 )   $ (2,852 )

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:

               

Equity-based compensation

    318       363  

Accretion of income on other investments, at fair value

    (124 )     (198 )

Realized loss (gain) on other investments, at fair value

    697       (567 )

Change in unrealized (gain) loss on other investments, at fair value

    (242 )     (172 )

(Income) / loss from equity method affiliates

    1,340       256  

Depreciation and amortization

    164       159  

Impairment of goodwill

    7,883       -  

Amortization of discount on debt

    345       256  

Deferred tax provision (benefit)

    (10 )     (747 )

Change in operating assets and liabilities, net:

               

Change in receivables from / payables to brokers, dealers, and clearing agencies

    (93,667 )     (69,218 )

Change in receivables from / payables to related parties, net

    (307 )     298  

(Increase) decrease in other receivables

    41,902       4,819  

(Increase) decrease in investments-trading

    70,311       63,285  

(Increase) decrease in receivables under resale agreement

    1,995,335       1,577,409  

(Increase) decrease in other assets

    5,934       (783 )

Increase (decrease) in accounts payable and other liabilities

    205,982       1,061  

Increase (decrease) in accrued compensation

    3,356       (2,499 )

Increase (decrease) in trading securities sold, not yet purchased

    (11,791 )     (12,486 )

(Increase) decrease in securities sold under agreement to repurchase

    (2,009,685 )     (1,566,997 )

Net cash provided by (used in) operating activities

    209,225       (8,613 )

Investing activities

               

Purchase of other investments, at fair value

    (119 )     (705 )

Sales and returns of principal-other investments, at fair value

    4,959       8,008  

Investment in equity method affiliate

    (2,097 )     (3,775 )

Purchase of furniture, equipment, and leasehold improvements

    (116 )     (28 )

Net cash provided by (used in) investing activities

    2,627       3,500  

Financing activities

               

Proceeds from draws on revolving credit facility

    17,500       1,210  
Proceeds from PPP loan     2,166       -  

Proceeds from non-convertible debt

    4,500       -  

Repayment of debt

    (9,163 )     -  

Proceeds from redeemable financial instruments

    -       1,268  

Cash used to net share settle equity awards

    (54 )     (128 )

Purchase and retirement of Common Stock

    -       (65 )

Proceeds from non-controlling interest investment

    -       2,550  

Non-controlling interest distributions

    -       (213 )

Cohen & Company Inc. dividends

    (62 )     (519 )

Net cash provided by (used in) financing activities

    14,887       4,103  

Effect of exchange rate on cash

    (25 )     (19 )

Net increase (decrease) in cash and cash equivalents

    226,714       (1,029 )

Cash and cash equivalents, beginning of period

    8,304       14,106  

Cash and cash equivalents, end of period

  $ 235,018     $ 13,077  

 

 

 

See accompanying notes to unaudited consolidated financial statements.

 

8

 

 

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 “AFN Merger”) with a subsidiary of Alesco Financial Inc. (“AFN”), a publicly traded real estate investment trust.

 

As a result of the AFN Merger, AFN contributed substantially all of its assets into Cohen Brothers in exchange for newly issued units of membership interests 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 AFN 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 units of 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 AFN 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 June 30, 2020, the Company had $2.63 billion in assets under management (“AUM”) of which 78.2%, or $2.06 billion, was in collateralized debt obligations (“CDOs”). The remaining portion of AUM is from a diversified mix of Investment Vehicles (as defined herein).

 

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; “CCFEL” refers to Cohen & Company Financial (Europe) Limited, a subsidiary regulated by the Central Bank of Ireland in Ireland; 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, residential transition loans, (“RTLs”), and other structured financial instruments. The Company also offers execution and brokerage services for equity products. The Company operates its capital markets activities primarily through its subsidiaries: JVB in the United States, and CCFL and CCFEL 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 included in the Company’s other investments, at fair value and investments in equity method affiliates in the Company’s consolidated balance sheets.

 

9

 

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

 

Capital Markets

 

 

● 

Trading activities of the Company, which include execution and brokerage services, riskless trading activities as well as gains and losses (unrealized and realized) and income and expense earned on securities and derivatives classified as trading;

 

● 

Net interest income on the Company’s matched book repo financing activities; and

 

● 

New issue and advisory revenue comprised primarily of (i) new issue revenue associated with originating, arranging, or placing newly created financial instruments and (ii) revenue from advisory services.

 

Asset Management

 

 

● 

Asset management fees for the Company’s on-going asset management services provided to certain Investment Vehicles, which may include fees both senior and subordinate to the securities in the Investment Vehicle, and incentive management fees earned based on the performance of the various Investment Vehicles.

 

Principal Investing

 

 

● 

Gains and losses (unrealized and realized) and income and expense earned on securities classified as other investments, at fair value.

 

 

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 six months ended June 30, 2020 and 2019 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, 2019.  

 

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, 2019.  

 

Effective June 1, 2019, the Company changed its accounting policy regarding the netting of reverse repurchase agreement and repurchase agreement transactions and updated prior periods’ balances to be consistent with this new accounting policy.  See note 10. 

 

 

3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

A. Adoption of New Accounting Standards

 

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 13.  

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.  Under this guidance (subsequently updated with ASU 2018-19, ASU 2019-05, ASU 2019-11 and ASU 2020-02), the measurement of all expected credit losses for financial assets held at the reporting date is 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 Company’s adoption of the provisions of ASU 2016-13, effective January 1, 2020 did not have a material effect on the Company’s 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.  The Company adopted the provisions of ASU 2017-04, effective January 1, 2020.  The Company recorded an impairment of goodwill for the six months ended June 30, 2020.  See note 12.  This impairment charge was not the result of the adoption of ASU 2017-04. 

 

 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 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.

 

10

 

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.

 

 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 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 valuation 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. The Company’s adoption of the provisions of ASU 2018-13, effective January 1, 2020 did not have an effect on the Company’s consolidated financial statements.

 

In October 2018, the FASB issued ASU 2018-17, Consolidation (Topic 810):  Target Improvements to Related Party Guidance for Variable Interest Entities.  The ASU made targeted changes to the related party consolidation guidance. The new guidance changes how entities evaluate decision-making fees under the variable interest entity guidance. To determine whether decision-making fees represent a variable interest, an entity will need to consider indirect interests held through related parties under common control on a proportionate basis under the new guidance, rather than in their entirety, as has been the case under current guidance. The guidance is effective in annual periods beginning after December 15, 2019 and interim periods within those fiscal years. The Company’s adoption of the provisions of ASU 2018-17, effective January 1, 2020 did not have an effect on the Company’s 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 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.  The Company’s adoption of the provisions of ASU 2018-18, effective January 1, 2020 did not have an effect on the Company’s consolidated financial statements.

 

In November 2019, the FASB issued ASU 2019-08, Compensation – Stock Compensation (Topic (718) and Revenue from Contracts with Customers (Topic 606): Codification Improvements– Share-Based Consideration Payable to a Customer.  This ASU requires companies to measure and classify (on the balance sheet) share-based payments to customers by applying the guidance in Topic 718, Compensation—Stock Compensation.  As a result, the amount recorded as a reduction in revenue would be measured based on the grant-date fair value of the share-based payment. The Company’s adoption of the provisions of ASU 2019-08, effective January 1, 2020 did not have an effect on the Company’s consolidated financial statements.

 

In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. This ASU provides temporary optional guidance to ease the burden in accounting for reference rate reform by providing optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued.  The ASU is intended to help stakeholders during the global market wide reference rate transition period and will be in effect for a limited time through December 31, 2022. The Company’s adoption of the provisions of ASU 2020-04, effective March 12, 2020 did not have an effect on the Company’s consolidated financial statements.

 

B. Recent Accounting Developments 

 

In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740):  Simplifying the Accounting for Income Taxes. This ASU is intended to simplify accounting for income taxes. It removes specific exceptions to the general principles in Topic 740 and amends existing guidance to improve consistent application.  This ASU is effective for fiscal years beginning after December 15, 2020 and interim period with 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 2020, the FASB issued ASU 2020-01,  Investments—Equity Securities (Topic 321), Investments—Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815)—Clarifying the Interactions between Topic 321, Topic 323, and Topic 815.  This ASU clarifies certain accounting certain topics impacted by Topic 321 Investments-Equity Securities. These topics include measuring equity securities using the measurement alternative, how the measurement alternative should be applied to equity method accounting, and certain forward contracts and purchased options which would be accounted for under the equity method of accounting upon settlement or exercise. This ASU is effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. 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.

 

11

 

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 or bear market interest rates 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 AFN Merger and recorded at fair value as of that date. As of June 30, 2020, and December 31, 2019, the fair value of the Company’s debt was estimated to be $67,571 and $58,635, 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. 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.

 

 

12

 

 

4. OTHER RECENT BUSINESS TRANSACTIONS OR EVENTS 

 

Insurance Acquisition Corporation ("Insurance SPAC")

 

The Company is the sponsor of Insurance Acquisition Corporation (Nasdaq: INSU) (“Insurance SPAC”), a blank check company that is seeking 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, Insurance SPAC completed the sale of 15,065,000 units (the “SPAC Units”) in its initial public offering (the “IPO”), including the underwriters’ over-allotment option. Each SPAC Unit consists of one share of Insurance SPAC’s Class A common stock, par value $0.0001 per share (“IAC 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 IAC 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 $150.7 million (before underwriting discounts and commissions and offering expenses). Pursuant to the underwriting agreement in the IPO, 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”).  On March 22, 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 IAC Common Stock issued and outstanding.

 

If 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 unless an extension is approved by its shareholders.

 

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”). Insurance Acquisition Sponsor, LLC purchased 375,000 of 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 IAC 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 IAC Common Stock issued as part of the placement units and the Placement Warrants will not be redeemable by Insurance SPAC, (ii) the Placement Warrants may be exercised by the holders on a cashless basis, (iii) the shares of IAC 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 Insurance SPAC in connection with the IPO. Subject to certain limited exceptions, the placement units (including the underlying Placement Warrants and IAC Common Stock and the shares of IAC Common Stock issuable upon exercise of the Placement Warrants) will not be transferable, assignable, or salable until 30 days after the completion of the Business Combination.

 

Of the $3,750 invested by Insurance Acquisition Sponsor, LLC in consideration for the above described placement units of Insurance SPAC, the Sponsor Entities raised $2,550 from investors other than the Company and the remaining investment in the private placement was made by the Company.  The $2,550 raised from investors other than the Company is treated as non-controlling interest.  Certain of the non-controlling interests are key employees, related parties, or affiliates of the Company.  The Company consolidates the Sponsor Entities and treats its investment in Insurance SPAC as an equity method investment. 

 

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

 

Upon the IPO closing the Sponsor Entities initially collectively held 5,103,333 founder shares of 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.

 

On June 29, 2020, Insurance SPAC entered into an Agreement and Plan of Merger (the “Merger Agreement”) with IAC Merger Sub, Inc., a Delaware corporation and direct wholly owned subsidiary of Insurance SPAC (“Merger Sub”), and Shift Technologies, Inc., a Delaware corporation (“Shift”).  The Merger Agreement provides for, among other things, the acquisition of Shift by Insurance SPAC pursuant to the proposed merger of Merger Sub with and into Shift with Shift continuing as the surviving entity and a direct wholly owned subsidiary of Insurance SPAC (the “Merger”).

 

Consummation of the transactions contemplated by the Merger Agreement is subject to customary conditions of the respective parties, including, among others, that (i) the Merger be approved by the Insurance SPAC's stockholders and the Shift Stockholders; (ii) there has been no material adverse effect that is continuing with respect to Shift or the Insurance SPAC since the date of the Merger Agreement; (iii) the filings of  the Insurance SPAC and Shift pursuant to the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, if any, shall have been made and the applicable waiting period and any extension thereof will have expired or been terminated; and (iv) Insurance SPAC will have at least $5,000 of net tangible assets immediately following the closing (after giving effect to the redemption of public shares by IAC’s public stockholders, the PIPE investment (see below) and the other transactions contemplated to occur upon the closing). The Merger Agreement also provides that, upon consummation of the Merger, Insurance SPAC will enter into a letter agreement with subsidiaries of the Company (“Sponsor”) providing for certain board observer rights in favor of Sponsor.

 

Concurrently with the execution and delivery of the Merger Agreement, certain institutional accredited investors (the “PIPE Investors”), including a subsidiary of the Company, entered into subscription agreements (the “PIPE Subscription Agreements”) pursuant to which the PIPE Investors have committed to subscribe for and purchase up to 18,500,000 shares of Insurance SPAC Class A Common Stock (the “IAC Common Stock”) at a purchase price per share of $10.00. The purchase of IAC Common Stock by the PIPE Investors will be consummated concurrently with the closing of the Merger, subject to certain additional closing conditions that are customary for transactions of this nature. The PIPE Subscription Agreement with the Company’s subsidiary, dated June 29, 2020 (the “Subsidiary Subscription Agreement”), provides for the purchase of 200,000 shares of Insurance SPAC Common Stock by the Company’s subsidiary, which number of shares may be increased by up to 1,300,000 shares of Insurance SPAC Common Stock at the election of the Company’s subsidiary, subject to certain limitations. The Subsidiary Subscription Agreement also contains provisions regarding registration rights that, among other matters, requires Insurance SPAC to file with the Securities and Exchange Commission, within 15 days following the closing, a registration statement relating to the resale of the IAC Common Stock purchased by the Company’s subsidiary pursuant to the Subsidiary Subscription Agreement.

 

13

 

Upon closing of the Merger, the Company currently expects the Sponsor Entities to collectively retain 375,000 placement units and between 4,000,000 and 4,500,000 founder shares (collectively, the “Sponsor Shares”) of Insurance SPAC.  As noted, the Company currently consolidates the Sponsor Entities and treats its investment in Insurance SPAC as an equity method investment.  Also, upon closing of the Merger, the Company will reclassify its equity method investment in Insurance SPAC to other investments, at fair value and adopt fair value accounting for the investment in Insurance SPAC, resulting in an amount of principal transaction revenue derived from the (i) the final amount of Sponsor Shares retained by the Sponsor Entities; (ii) the trading share price of IAC Common Stock; (iii) fair value discounts related to the share sale restrictions on the Sponsor Shares outlined above; and (iv) the valuation of the warrants included with the placement units.  Upon recognition of the principal transaction revenue described above, the Company will record a non-controlling interest expense or compensation expense related to the amount of Sponsor Shares distributable to the non-controlling interests.  If the non controlling interest holder is an employee of the Company, the expense will be recorded as compensation.  Otherwise, the expense will be non-controlling interest expenses.  The Company currently expects 253,000 placement units and between 2,200,000 and 2,500,000 founders shares to be distributable to the non-controlling interests. Shortly after the merger is completed, these non-controlling interest Sponsor Shares will be distributed to the non-controlling interest holders. 

 

All of the Sponsor Shares and the shares purchased pursuant to the Subsidiary Subscription Agreement will be subject to restrictions on resale under applicable securities laws until the resale of such shares is either registered under the Securities Act of 1933 or otherwise exempt from registration.  Further, subject to certain limited exceptions, the initial placement shares and founders shares will not be transferable or salable except in accordance with the conditions set forth above.

 

There can be no assurance that the merger with Shift will be completed.  If it is not, and no other Business Combination is completed by the Insurance SPAC, the Sponsor Entities will likely write off their equity method investment and the Company will likely write off advances it has made to the Insurance SPAC.  See notes 11, 24, and 25. Further, even if the merger with Shift is completed, there can be no assurance that the amount of Sponsor Shares expected to be retained, as mentioned above, will not change significantly. 

 

The transaction is expected to close in 2020 and in connection with the closing of the transaction, Insurance SPAC intends to change its name to Shift Technologies, Inc.

 

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. 

 

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 was amended on May 4,  2019 and again on September 25, 2019 and October 28, 2019.  The LegacyTexas Credit Facility supported the buying, aggregating, and distributing of RTLs performed by the business of ViaNova.

 

On March 19, 2020, ViaNova received a notice of default from LegacyTexas Bank regarding the LegacyTexas Credit Facility, stating that ViaNova’s unrestricted cash balance was less than the amount required.  Also, on March 19, 2020, ViaNova received notice from LegacyTexas Bank that the Bank had suspended funding all “Alternative” loans for all of their clients, including the RTL loans that are the subject of the LegacyTexas Credit Facility with LegacyTexas Bank.  Since March 19, 2020 ViaNova has repaid all outstanding indebtedness under the LegacyTexas Credit Facility.   ViaNova stopped acquiring new RTLs and does not intend to acquire any new RTLs in the future.  As of June 30, 2020, the Company had two RTLs and several interest strips representing a par value of $2,363 and a fair value of $2,322, including the fair value of interest strips held.  These RTLs and interest strips are included as a component of investments-trading (see note 7).  The Company intends to opportunistically sell these RTLs if possible or allow them to mature.  The latest maturity date of the RTLs is January 1, 2021.   

 

COVID 19 / Impairment of Goodwill 

 

In March 2020, the World Health Organization declared the outbreak of a novel coronavirus (COVID-19) as a pandemic, which continues to spread throughout the United States. The spread of COVID-19 has caused significant volatility in domestic and international markets. There is on-going uncertainty around the breadth and duration of business disruptions related to COVID-19, as well as its impact on the U.S. and international economies.  While the Company cannot fully assess the impact COVID-19 will have on all of its operations at this time, there are certain impacts that the Company has identified:

 

 

● 

The unprecedented volatility of the financial markets experienced since March 2020, has caused the Company to operate JVB at a lower level of leverage than prior to the pandemic.  Specifically, JVB has reduced the size of its GCF repo operations and the volume of its TBA trading.  The Company determined that at its pre-pandemic levels in these businesses, it was exposed to a higher level of counterparty credit risk than it should have and was experiencing too much volatility in its available liquidity to conservatively meet capital requirements and margin calls in these businesses.  The Company expects JVB to operate at lower volumes in both these businesses for an indefinite period of time, which could unfavorably impact the operating profitability of JVB.  

 

● 

The financial market volatility, as well as the reduction in volumes in the GCF repo and TBA businesses, that resulted from COVID-19 required the Company to reassess the goodwill it had recorded related to JVB under the guidance of ASC 350.  The Company determined that the fair value of JVB was less than the carrying value (including the goodwill).  As a result, the Company recorded an impairment loss of $7,883 in the six months ended June 30, 2020.  See note 12.  

 

● 

The Company expects that its asset management segment may also be adversely impacted by the pandemic.  While it is difficult to determine the extent of the impact at this time, the Company expects that raising capital for new funds may become more challenging.  Nevertheless, in July 2020, the Company was able to successfully close the PriDe III Fund with total investor commitments in excess of €375,000.  In addition, lower returns earned by funds may adversely impact the Company’s asset management fees and investors’ need for liquidity may result in reductions in AUM.  

 

● 

JVB’s mortgage group’s operations are centered on serving the financial needs of mortgage originators and institutions that invest in mortgage backed securities.  Prolonged high unemployment will most likely impact mortgage originations and demand for and supply of mortgage backed securities, which may have a significant unfavorable impact on the revenue earned by JVB’s mortgage group.  

 

The Company will likely be impacted by the pandemic in other ways which the Company cannot yet determine.  The Company will continue to monitor market conditions and respond accordingly. 

 

14

 

The Company applied for and received a $2,166 loan under the Paycheck Protection Program (PPP) of the Coronavirus Aid, Relief, and Economic Security (CARES) Act.  The Company carefully considered the eligibility requirements for PPP loans as well as supplemental guidance regarding the PPP beyond the applicable statute issued from time to time by government agencies and certain government officials. The Company was eligible for a PPP loan because it has fewer than 500 employees. Further, although the Company is public and listed on the NYSE American stock exchange, the Company’s market capitalization is small, and the Company believes that it does not have access to the public capital markets at this time. In part due to the PPP loan, the Company does not anticipate any significant workforce reduction or reductions in compensation levels in the near future. However, the Company will continue to carefully monitor revenue levels to assess whether compensatory or other cost-cutting measures might be necessary. See note 17.

 

The 2020 Senior Notes 

 

On January 31, 2020, the Operating LLC entered into a note purchase agreement with JKD Capital Partners I LTD, a New York corporation (“JKD Investor”), and RN Capital Solutions LLC, a Delaware limited liability company (“RNCS”).  The JKD Investor is owned by Jack DiMaio, the vice chairman of the Company’s board of directors and his spouse.

 

Pursuant to the note purchase agreement, JKD Investor and RNCS each purchased a senior promissory note in the principal amount of $2,250 (for an aggregate investment of $4,500).  The senior promissory notes bear interest at a fixed rate of 12% per annum and mature on January 31, 2022.  On February 3, 2020, pursuant to the note purchase agreement, the Operating LLC used the proceeds received from the issuance of the senior promissory notes to repay in full all amounts outstanding under the senior promissory note, dated September 25, 2019, issued by the Company to Pensco Trust Company, Custodian fbo Edward E. Cohen IRA in the principal amount of $4,386 (the “Cohen IRA Note”).  The Cohen IRA Note is included as a portion of the 2019 Senior Notes outstanding as of December 31, 2019.  The Cohen IRA Note was fully paid and extinguished on February 3, 2020.  Subsequent to this repayment, $2,400 of the 2019 Senior Notes remain outstanding.  See note 17. 

 

15

 

5. NET TRADING 

 

Net trading consisted of the following in the periods presented.



NET TRADING

(Dollars in Thousands)

 
   

Three Months Ended

   

Six Months Ended

 
   

June 30,

   

June 30,

   

June 30,

   

June 30,

 
   

2020

   

2019

   

2020

   

2019

 

Net realized gains (losses) - trading inventory

  $ 8,226     $ 3,540     $ 18,669     $ 9,926  

Net unrealized gains (losses) - trading inventory

    2,005       1,967       1,565       2,371  

Net gains and losses

    10,231       5,507       20,234       12,297  
                                 

Interest income- trading inventory

    2,071       2,060       4,548       3,674  

Interest income - residential transition loans

    -       33       -       47  

Interest income-receivables under resale agreements

    16,643       46,335       58,128       83,819  

Interest income

    18,714       48,428       62,676       87,540  
                                 

Interest expense-securities sold under agreements to repurchase

    (8,775 )     (44,120 )     (43,541 )     (80,502 )

Interest expense-LegacyTexas Credit Facility

    -       (26 )     (39 )     (29 )

Interest expense-margin payable

    (164 )     (1,119 )     (763 )     (1,912 )

Interest expense

    (8,939 )     (45,265 )     (44,343 )     (82,443 )
                                 

Net trading

  $ 20,006     $ 8,670     $ 38,567     $ 17,394  

 

Trading inventory includes investments classified as investments-trading as well as trading securities sold, not yet purchased.  See note 7. 

 

During 2019, RTLs were accounted for at lower of cost or market and included as a component of other assets and the interest income related to those loans was shown separately in the table above.  Effective January 1, 2020, in connection with the adoption of ASC 326, the Company began accounting for RTLs at fair value and including them as a component of investments-trading. Therefore, also effective January 1, 2020, income earned on RTLs is included in interest income-trading inventory in the table above.   

 

Also, 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.  See note 17 for discussion of LegacyTexas Credit Facility. 

  

16

 

 

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

 

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

 

RECEIVABLES FROM BROKERS, DEALERS, AND CLEARING AGENCIES

(Dollars in Thousands)

 

   

June 30, 2020

   

December 31, 2019

 

Deposits with clearing agencies

  $ 250     $ 250  

Unsettled regular way trades, net

    8,653       12,170  

Receivables from clearing agencies

    61,093       83,712  

Receivables from brokers, dealers, and clearing agencies

  $ 69,996     $ 96,132  

 

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



PAYABLES TO BROKERS, DEALERS, AND CLEARING AGENCIES

(Dollars in Thousands)

 

   

June 30, 2020

   

December 31, 2019

 

Margin payable

  $ 121,458     $ 208,441  

Due to clearing agent

    -       32,820  

Payables to brokers, dealers, and clearing agencies

  $ 121,458     $ 241,261  

 

  

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.  Substantially 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.

 

Due to clearing agent represents amounts due to Bank of New York under the Company’s intra-day and overnight lending facility supporting the GCF matched repo business. See note 10.

  

17

 

 

7. FINANCIAL INSTRUMENTS

 

Investments—Trading

 

Investments-trading consisted of the following.

 

INVESTMENTS - TRADING

(Dollars in Thousands)

 

   

June 30, 2020

   

December 31, 2019

 

U.S. government agency MBS and CMOs

  $ 154,592     $ 196,146  

U.S. government agency debt securities

    6,938       14,680  

RMBS

    16       15  

U.S. Treasury securities

    6,425       11,105  

ABS

    1       100  

SBA loans

    15,574       27,634  

Corporate bonds and redeemable preferred stock

    36,044       38,503  

Foreign government bonds

    732       844  

Municipal bonds

    3,488       13,737  

Certificates of deposit

    36       841  

Derivatives

    11,305       3,686  

Equity securities

    68       561  

Residential transition loans

    2,322       -  

Investments-trading

  $ 237,541     $ 307,852  

 

Trading Securities Sold, Not Yet Purchased

 

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

 

TRADING SECURITIES SOLD, NOT YET PURCHASED

(Dollars in Thousands)

 

   

June 30, 2020

   

December 31, 2019

 

U.S. Treasury securities

  $ 6,657     $ 16,827  

Corporate bonds and redeemable preferred stock

    49,261       58,083  

Municipal bonds

    20       20  

Derivatives

    10,218       3,017  

Trading securities sold, not yet purchased

  $ 66,156     $ 77,947  

 

The Company manages 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.

 

OTHER INVESTMENTS, AT FAIR VALUE

(Dollars in Thousands)

 

   

June 30, 2020

 
   

Amortized

   

Carrying

   

Unrealized

 
   

Cost

   

Value

   

Gain / (Loss)

 

Equity securities

  $ 6,905     $ 7,528     $ 623  

U.S. Insurance JV

    1,225       1,370       145  

SPAC Fund

    646       696       50  

Residential loans

    126       99       (27 )

Other investments, at fair value

  $ 8,902     $ 9,693     $ 791  

 

  

   

December 31, 2019

 
   

Amortized

   

Carrying

   

Unrealized

 
   

Cost

   

Value

   

Gain / (Loss)

 

Equity securities

  $ 8,598     $ 9,352     $ 754  

CLOs

    2,894       2,522       (372 )

U.S. Insurance JV

    2,048       2,223       175  

SPAC Fund

    646       668       22  

Residential loans

    129       99       (30 )

Other investments, at fair value

  $ 14,315     $ 14,864     $ 549  

 

18

 

 

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:

 

 

● 

securities that would otherwise qualify for available for sale treatment;

 

● 

investments in equity method affiliates that have the attributes in FASB 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) related to changes in fair value of investments that are included as a component of other investments, at fair value during the three months ended June 30, 2020 and 2019 of $2,240 and $490 respectively. The Company recognized net gains (losses) related to changes in fair value of investments that are included as a component of other investments, at fair value during the six months ended June 30, 2020 and 2019 of $(455) and $739 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 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 FASB 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.

 

19

 

The following tables present information about the Company’s assets and liabilities measured at fair value as of June 30, 2020 and December 31, 2019 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

June 30, 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

  $ 154,592     $ -     $ 154,592     $ -  

U.S. government agency debt securities

    6,938       -       6,938       -  

RMBS

    16       -       16       -  

U.S. Treasury securities

    6,425       6,425       -       -  

ABS

    1       -       1       -  

SBA loans

    15,574       -       15,574       -  

Corporate bonds and redeemable preferred stock

    36,044       -       36,044       -  

Foreign government bonds

    732       -       732       -  

Municipal bonds

    3,488       -       3,488       -  

Certificates of deposit

    36       -       36       -  

Derivatives

    11,305       -       11,305       -  

Equity securities

    68       -       68       -  

Residential transition loans

    2,322       -       -       2,322  

Total investments - trading

  $ 237,541     $ 6,425     $ 228,794     $ 2,322  
                                 

Other investments, at fair value:

                               

Equity securities

  $ 7,528     $ -     $ 7,528     $ -  

Residential loans

    99       -       99       -  
      7,627     $ -     $ 7,627     $ -  

Investments measured at NAV (1)

    2,066                          

Total other investments, at fair value

    9,693                          
                                 

Liabilities

                               

Trading securities sold, not yet purchased:

                               

U.S. Treasury securities

  $ 6,657     $ 6,657     $ -     $ -  

Corporate bonds and redeemable preferred stock

    49,261       -       49,261       -  

Municipal bonds

    20       -       20       -  

Derivatives

    10,218       -       10,218       -  

Total trading securities sold, not yet purchased

  $ 66,156     $ 6,657     $ 59,499     $ -  

 

(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.

 

 

20

 

 

FAIR VALUE MEASUREMENTS ON A RECURRING BASIS

December 31, 2019

(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

  $ 196,146     $ -     $ 196,146     $ -  

U.S. government agency debt securities

    14,680       -       14,680       -  

RMBS

    15       -       15       -  

U.S. Treasury securities

    11,105       11,105       -       -  

ABS

    100       -       100       -  

SBA loans

    27,634       -       27,634       -  

Corporate bonds and redeemable preferred stock

    38,503       -       38,503       -  

Foreign government bonds

    844       -       844       -  

Municipal bonds

    13,737       -       13,737       -  

Certificates of deposit

    841       -       841       -  

Derivatives

    3,686       -       3,686       -  

Equity securities

    561       -       561       -  

Total investments - trading

  $ 307,852     $ 11,105     $ 296,747     $ -  
                                 

Other investments, at fair value:

                               

Equity Securities

  $ 9,352     $ 2,009     $ 7,343     $ -  

CLOs

    2,522       -       -       2,522  

Residential loans

    99       -       99       -  
      11,973     $ 2,009     $ 7,442     $ 2,522  

Investments measured at NAV (1)

    2,891                          

Total other investments, at fair value

  $ 14,864                          

Liabilities

                               

Trading securities sold, not yet purchased:

                               

U.S. Treasury securities

  $ 16,827     $ 16,827     $ -     $ -  

Corporate bonds and redeemable preferred stock

    58,083       -       58,083       -  

Municipal bonds

    20       -       20       -  

Derivatives

    3,017       -       3,017       -  

Total trading securities sold, not yet purchased

  $ 77,947     $ 16,827     $ 61,120     $ -  

 

 (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 and medium size 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; 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.

 

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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.