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FAIR VALUES OF FINANCIAL INSTRUMENTS

12 Months Ended

Dec. 31, 2018

NOTE 8 — FAIR VALUES OF FINANCIAL INSTRUMENTS

The carrying amount of the Company’s Cash and cash equivalents, Cash collateral receivable from, or payable to, interest rate swap counterparties, receivables, payables and secured borrowings with initial terms of 120 days or less approximate fair value due to the short-term nature of these assets and liabilities. With the exception of the fair value of lending counterparty investments, all fair values were determined using Level 2 Inputs in accordance with ASU 2010-06, Fair Value Measurements and Disclosures (Topic 820). Lending counterparty investments are nonmarketable securities classified as assets for which Level 3 Inputs are used to determine fair value. These assets are considered strategic investments that are carried at cost and periodically valued and evaluated for impairment. No impairment charges have been recorded relative to these investments and the Company’s cost basis is deemed to approximate fair value.

Residential mortgage investments, nearly all of which are mortgage securities classified as available-for-sale, are measured at fair value on a recurring basis. In determining fair value estimates the Company considers recent trading activity for similar investments and pricing levels indicated by lenders in connection with designating collateral for secured borrowings, provided such pricing levels are considered indicative of actual market clearing transactions. In determining fair value estimates for Secured borrowings with initial terms of greater than 120 days, the Company considers pricing levels indicated by lenders for entering into new transactions using similar pledged collateral with terms equal to the remaining terms of these borrowings. The Company bases fair value for Unsecured borrowings on discounted cash flows using Company estimates for market yields.

The following table presents the fair value for the Company’s financial instruments as of the indicated dates (in thousands):

		December 31, 2018				December 31, 2017
	Fair Value Hierarchy	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial assets:
Residential mortgage loans	Level 2	$	1,425	$	1,400	$	1,864	$	1,900
Lending counterparty investments	Level 2		5,002		5,002		5,002		5,002
Financial liabilities:
Secured borrowings with initial terms of greater than 120 days	Level 2		–		–		33,073		33,100
Unsecured borrowings	Level 2		98,292		76,600		98,191		74,100
Unsecured borrowings-related interest rate swap agreements	Level 2		17,834		17,834		23,772		23,772

Fair value-related disclosures for debt securities were as follows as of the indicated dates (in thousands):

	Amortized		Gross Unrealized
	Cost Basis		Gains		Losses		Fair Value
December 31, 2018
Agency Securities classified as available-for-sale:
Fannie Mae/Freddie Mac	$	8,949,793	$	56,041	$	74,276	$	8,931,558
Ginnie Mae		3,040,275		8,681		17,692		3,031,264
Residential mortgage securities classified as held-to-maturity		1,134		3		–		1,137
December 31, 2017
Agency Securities classified as available-for-sale:
Fannie Mae/Freddie Mac	$	10,529,646	$	85,740	$	37,022	$	10,578,364
Ginnie Mae		2,875,637		8,958		12,432		2,872,163
Residential mortgage securities classified as held-to-maturity		1,706		17		–		1,723

	December 31, 2018				December 31, 2017
	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
Securities in an unrealized loss position:
One year or greater	$	4,736,171	$	83,407	$	2,552,668	$	26,701
Less than one year		1,475,120		8,561		4,665,883		22,752
	$	6,211,291	$	91,968	$	7,218,551	$	49,453

Capstead typically holds its investments in relatively short-duration ARM Agency Securities until payoff absent a major shift in strategy or a severe contraction in the Company’s ability to obtain financing to support its portfolio. Declines in fair value caused by increases in interest rates are generally recoverable in a relatively short period of time as coupon interest rates on the underlying mortgage loans reset to rates more reflective of the then-current interest rate environment. From a credit risk perspective, federal government support for Fannie Mae and Freddie Mac helps ensure that fluctuations in value due to credit risk associated with these securities are limited. Given the Company’s buy and hold strategy and that existing unrealized losses on mortgage securities held by the Company are not attributable to credit risk, together with the resiliency of the financing market for Agency Securities, it is more likely than not that the Company will not be required to sell any of its investments. Therefore, none of these investments were considered other-than-temporarily impaired at December 31, 2018.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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