PIPER JAFFRAY COMPANIES - FORM 10-Q - May 4, 2018

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
 
þ

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2018
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 No. 001-31720
PIPER JAFFRAY COMPANIES
(Exact Name of Registrant as specified in its Charter)
DELAWARE
 
30-0168701
(State or Other Jurisdiction of Incorporation or Organization)
 
(IRS Employer Identification No.)
800 Nicollet Mall, Suite 1000
Minneapolis, Minnesota
 
55402
(Address of Principal Executive Offices)
 
(Zip Code)
 
(612) 303-6000
 
(Registrant's Telephone Number, Including Area Code)

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  þ No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files). Yes  þ 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
þ
 
Accelerated filer
¨
Non-accelerated filer
¨
(Do not check if a smaller reporting company)
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 in Rule 12b-2 of the Exchange Act).
Yes  ¨ No  þ

As of April 30, 2018, the registrant had 15,198,317 shares of Common Stock outstanding.

 



Piper Jaffray Companies
Index to Quarterly Report on Form 10-Q

PART I. FINANCIAL INFORMATION
 
 
 
 
ITEM 1.
 
 
 
 
 
 
 
 
 
 
 
ITEM 2.
 
ITEM 3.
 
ITEM 4.
 
 
 
 
 
PART II. OTHER INFORMATION
 
 
 
 
ITEM 1.
 
ITEM 1A.
 
ITEM 2.
 
ITEM 6.
 
 
 




PART I.    FINANCIAL INFORMATION

ITEM 1.    FINANCIAL STATEMENTS.
Piper Jaffray Companies
Consolidated Statements of Financial Condition
 
March 31,
 
December 31,
 
2018
 
2017
(Amounts in thousands, except share data)
(Unaudited)
 
 
Assets
 
 
 
Cash and cash equivalents
$
27,642

 
$
33,793

Receivables from brokers, dealers and clearing organizations
46,302

 
145,394

 
 
 
 
Financial instruments and other inventory positions owned
529,943

 
663,330

Financial instruments and other inventory positions owned and pledged as collateral
503,860

 
720,047

Total financial instruments and other inventory positions owned
1,033,803

 
1,383,377

 
 
 
 
Fixed assets (net of accumulated depreciation and amortization of $58,059 and $55,944, respectively)
24,787

 
25,179

Goodwill
81,855

 
81,855

Intangible assets (net of accumulated amortization of $88,032 and $85,417, respectively)
20,219

 
22,834

Investments
169,739

 
176,212

Net deferred income tax assets
95,595

 
101,205

Other assets
77,424

 
54,834

Total assets
$
1,577,366

 
$
2,024,683

 
 
 
 
Liabilities and Shareholders' Equity
 
 
 
Short-term financing
$
186,254

 
$
289,937

Senior notes
125,000

 
125,000

Payables to brokers, dealers and clearing organizations
33,582

 
19,392

Financial instruments and other inventory positions sold, but not yet purchased
320,469

 
399,227

Accrued compensation
127,351

 
400,092

Other liabilities and accrued expenses
49,703

 
49,800

Total liabilities
842,359

 
1,283,448

 
 
 
 
Shareholders' equity:
 
 
 
Common stock, $0.01 par value:
 
 
 
Shares authorized: 100,000,000 at March 31, 2018 and December 31, 2017;
 
 
 
Shares issued: 19,513,856 at March 31, 2018 and 19,512,914 at December 31, 2017;
 
 
 
Shares outstanding: 13,298,825 at March 31, 2018 and 12,911,149 at December 31, 2017
195

 
195

Additional paid-in capital
802,566

 
791,970

Retained earnings (1)
152,701

 
176,270

Less common stock held in treasury, at cost: 6,215,031 at March 31, 2018 and 6,601,765 shares at December 31, 2017
(266,720
)
 
(273,824
)
Accumulated other comprehensive loss
(750
)
 
(1,279
)
Total common shareholders' equity
687,992

 
693,332

 
 
 
 
Noncontrolling interests
47,015

 
47,903

Total shareholders' equity
735,007

 
741,235

 
 
 
 
Total liabilities and shareholders' equity
$
1,577,366

 
$
2,024,683

                     
(1)
Includes the cumulative effect adjustment upon adoption of ASU 2014-09, as amended. See Note 2 for further discussion.
See Notes to the Consolidated Financial Statements

3
Piper Jaffray Companies
Consolidated Statements of Operations
(Unaudited)

 
Three Months Ended
 
March 31,
(Amounts in thousands, except per share data)
2018
 
2017
Revenues:
 
 
 
Investment banking
$
120,841

 
$
132,250

Institutional brokerage
27,645

 
39,136

Asset management
12,589

 
16,007

Interest
10,413

 
7,719

Investment income
2,912

 
10,375

 
 
 
 
Total revenues
174,400

 
205,487

 
 
 
 
Interest expense
5,338

 
4,958

 
 
 
 
Net revenues
169,062

 
200,529

 
 
 
 
Non-interest expenses:
 
 
 
Compensation and benefits
115,170

 
134,378

Outside services
8,939

 
10,328

Occupancy and equipment
8,578

 
8,462

Communications
8,626

 
7,616

Marketing and business development
7,299

 
7,547

Deal-related expenses
5,051

 
—

Trade execution and clearance
2,163

 
1,811

Intangible asset amortization
2,615

 
3,822

Back office conversion costs
—

 
866

Other operating expenses
2,583

 
2,890

 
 
 
 
Total non-interest expenses
161,024

 
177,720

 
 
 
 
Income before income tax benefit
8,038

 
22,809

 
 
 
 
Income tax benefit
(2,581
)
 
(395
)
 
 
 
 
Net income
10,619

 
23,204

 
 
 
 
Net income applicable to noncontrolling interests
16

 
2,929

 
 
 
 
Net income applicable to Piper Jaffray Companies
$
10,603

 
$
20,275

 
 
 
 
Net income applicable to Piper Jaffray Companies' common shareholders
$
6,435

 
$
16,828

 
 
 
 
Earnings per common share
 
 
 
Basic
$
0.47

 
$
1.33

Diluted
$
0.47

 
$
1.31

 
 
 
 
Dividends declared per common share
$
2.00

 
$
0.31

 
 
 
 
Weighted average number of common shares outstanding
 
 
 
Basic
13,096

 
12,594

Diluted
13,382

 
12,922


See Notes to the Consolidated Financial Statements

4
Piper Jaffray Companies
Consolidated Statements of Comprehensive Income
(Unaudited)

 
Three Months Ended
 
March 31,
(Amounts in thousands)
2018
 
2017
Net income
$
10,619

 
$
23,204

 
 
 
 
Other comprehensive income, net of tax:
 
 
 
Foreign currency translation adjustment
529

 
223

 
 
 
 
Comprehensive income
11,148

 
23,427

 
 
 
 
Comprehensive income applicable to noncontrolling interests
16

 
2,929

 
 
 
 
Comprehensive income applicable to Piper Jaffray Companies
$
11,132

 
$
20,498


See Notes to the Consolidated Financial Statements


5
Piper Jaffray Companies
Consolidated Statements of Cash Flows
(Unaudited)

 
Three Months Ended
 
March 31,
(Dollars in thousands)
2018
 
2017
 
 
 
 
Operating Activities:
 
 
 
Net income
$
10,619

 
$
23,204

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization of fixed assets
2,003

 
1,703

Deferred income taxes
5,610

 
13,916

Stock-based compensation
8,970

 
4,676

Amortization of intangible assets
2,615

 
3,822

Amortization of forgivable loans
1,298

 
1,820

Decrease/(increase) in operating assets:
 
 
 
Receivables:
 
 
 
Customers
—

 
8,428

Brokers, dealers and clearing organizations
99,092

 
18,444

Securities purchased under agreements to resell
—

 
(71,423
)
Net financial instruments and other inventory positions owned
270,816

 
145,860

Investments
6,473

 
8,382

Other assets
(23,256
)
 
(14,170
)
Increase/(decrease) in operating liabilities:
 
 
 
Payables:
 
 
 
Customers
—

 
12,242

Brokers, dealers and clearing organizations
14,190

 
163,221

Securities sold under agreements to repurchase
—

 
(480
)
Accrued compensation
(247,363
)
 
(153,843
)
Other liabilities and accrued expenses
(4,619
)
 
(1,993
)
 
 
 
 
Net cash provided by operating activities
146,448

 
163,809

 
 
 
 
Investing Activities:
 
 
 
Purchases of fixed assets, net
(1,560
)
 
(1,756
)
 
 
 
 
Net cash used in investing activities
(1,560
)
 
(1,756
)
 
 
 
 
Continued on next page

6
Piper Jaffray Companies
Consolidated Statements of Cash Flows – Continued
(Unaudited)

 
Three Months Ended
 
March 31,
(Dollars in thousands)
2018
 
2017
 
 
 
 
Financing Activities:
 
 
 
Decrease in short-term financing
$
(103,683
)
 
$
(121,686
)
Payment of cash dividend
(30,375
)
 
(4,746
)
Decrease in noncontrolling interests
(904
)
 
(16,154
)
Repurchase of common stock
(16,797
)
 
(19,788
)
Proceeds from stock option exercises
—

 
1,703

 
 
 
 
Net cash used in financing activities
(151,759
)
 
(160,671
)
 
 
 
 
Currency adjustment:
 
 
 
Effect of exchange rate changes on cash
720

 
145

 
 
 
 
Net increase/(decrease) in cash, cash equivalents and restricted cash (1)
(6,151
)
 
1,527

 
 
 
 
Cash, cash equivalents and restricted cash at beginning of period (1)
33,793

 
70,374

 
 
 
 
Cash, cash equivalents and restricted cash at end of period (1)
$
27,642

 
$
71,901

 
 
 
 
Supplemental disclosure of cash flow information –
 
 
 
Cash paid during the period for:
 
 
 
Interest
$
5,615

 
$
4,464

Income taxes
$
12,474

 
$
7,710

                     
(1)
Upon adoption of ASU 2016-18, restricted cash includes cash and cash equivalents previously segregated for regulatory purposes. See Note 2 for further discussion.
See Notes to the Consolidated Financial Statements


7
Piper Jaffray Companies
Notes to the Consolidated Financial Statements
(Unaudited)


Index


8
Piper Jaffray Companies
Notes to the Consolidated Financial Statements
(Unaudited)

Note 1 Organization and Basis of Presentation

Organization

Piper Jaffray Companies is the parent company of Piper Jaffray & Co. ("Piper Jaffray"), a securities broker dealer and investment banking firm; Piper Jaffray Ltd., a firm providing securities brokerage and mergers and acquisitions services in Europe; Piper Jaffray Finance LLC, which facilitates corporate debt underwriting in conjunction with affiliated credit vehicles; Advisory Research, Inc. ("ARI"), which provides asset management services to separately managed accounts, closed-end and open-end funds and partnerships; Piper Jaffray Investment Group Inc. and PJC Capital Management LLC, which consist of entities providing alternative asset management services; Piper Jaffray Financial Products Inc. and Piper Jaffray Financial Products II Inc., entities that facilitate derivative transactions; and other immaterial subsidiaries.

Effective August 7, 2017, Piper Jaffray transitioned from a self clearing securities broker dealer to a fully disclosed clearing model. Pershing LLC ("Pershing") is Piper Jaffray's clearing broker dealer responsible for the clearance and settlement of firm and customer cash and security transactions.

Piper Jaffray Companies and its subsidiaries (collectively, the "Company") operate in two reporting segments: Capital Markets and Asset Management. A summary of the activities of each of the Company's business segments is as follows:

Capital Markets

The Capital Markets segment provides investment banking services and institutional sales, trading and research services. Investment banking services include financial advisory services, management of and participation in underwritings and public finance activities. Revenues are generated through the receipt of advisory and financing fees. Institutional sales, trading and research services focus on the trading of equity and fixed income products with institutions, government and non-profit entities. Revenues are generated through commissions and sales credits earned on equity and fixed income institutional sales activities, net interest revenues on trading securities held in inventory, and profits and losses from trading these securities. Also, the Company generates revenue through strategic trading and investing activities, which focus on investments in municipal bonds, U.S. government agency securities, and merchant banking activities involving equity or debt investments in late stage private companies. The Company has created alternative asset management funds in merchant banking, energy and senior living in order to invest firm capital and to manage capital from outside investors. The Company receives management and performance fees for managing these funds.

Asset Management

The Asset Management segment provides traditional asset management services with product offerings in master limited partnerships and equity securities to institutions and individuals. Revenues are generated in the form of management and performance fees. Revenues are also generated through investments in the partnerships and funds that the Company manages.

Basis of Presentation

The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles ("U.S. GAAP") for interim financial information and the rules and regulations of the Securities and Exchange Commission ("SEC"). Pursuant to this guidance, certain information and disclosures have been omitted that are included within complete annual financial statements. Except as disclosed herein, there have been no material changes in the information reported in the financial statements and related disclosures in the Company's Annual Report on Form 10-K for the year ended December 31, 2017.

The consolidated financial statements include the accounts of Piper Jaffray Companies, its wholly owned subsidiaries, and all other entities in which the Company has a controlling financial interest. Noncontrolling interests represent equity interests in consolidated entities that are not attributable, either directly or indirectly, to Piper Jaffray Companies. Noncontrolling interests include the minority equity holders' proportionate share of the equity in the Company's alternative asset management funds. All material intercompany balances have been eliminated.

Management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Although these estimates and assumptions are based on the best information available, actual results could differ from those estimates.

9
Piper Jaffray Companies
Notes to the Consolidated Financial Statements
(Unaudited)

Note 2 Accounting Policies and Pronouncements

Summary of Significant Accounting Policies

Refer to the Company's Annual Report on Form 10-K for the year ended December 31, 2017 for a full description of the Company's significant accounting policies. Changes to the Company's significant accounting policies are described below.

Revenue Recognition

Investment Banking – Investment banking revenues, which include advisory and underwriting fees, are recorded when the performance obligation for the transaction is satisfied under the terms of each engagement. Expenses associated with such transactions are deferred until the related revenue is recognized or the engagement is otherwise concluded. Investment banking revenues are presented gross of related client reimbursed deal expenses. Expenses for completed deals are reported separately in deal-related expenses on the consolidated statements of operations. Expenses related to investment banking deals not completed are recognized as non-interest expenses on the consolidated statements of operations.

The Company's advisory fees generally consist of a nonrefundable up-front fee and a success fee. The nonrefundable fee is recorded as deferred revenue upon receipt and recognized at a point in time when the performance obligation is satisfied, or when the transaction is deemed by management to be terminated. Management's judgment is required in determining when a transaction is considered to be terminated.

The substantial majority of the Company's advisory and underwriting fees (i.e., the success related advisory fee) are considered variable consideration and recognized when it is probable that the variable consideration will not be reversed in a future period. The variable consideration is considered to be constrained until satisfaction of the performance obligation. The Company's performance obligation is generally satisfied at a point in time upon the closing of a strategic transaction, completion of a financing or underwriting arrangement, or some other defined outcome. At this time, the Company has transferred control of the promised service and the customer obtains control. As these arrangements represent a single performance obligation, allocation of the transaction price is not necessary. The Company has elected to apply the following optional exemptions regarding disclosure of its remaining performance obligations: (i) the Company's performance obligation is part of a contract that has an original expected duration of one year or less and/or (ii) the variable consideration is allocated entirely to a wholly unsatisfied promise to transfer a distinct service that forms part of a single performance obligation.

Institutional Brokerage – Institutional brokerage revenues include (i) commissions received from customers for the execution of brokerage transactions in listed and over-the-counter (OTC) equity, fixed income and convertible debt securities, which are recognized at a point in time on the trade date because the customer has obtained the rights to the underlying security provided by the trade execution service, (ii) trading gains and losses, recorded on changes in the fair value of long and short security positions in the reporting period and (iii) fees received by the Company for equity research, which are generally recognized in the period received. The Company permits institutional customers to allocate a portion of their gross commissions to pay for research products and other services provided by third parties. The amounts allocated for those purposes are commonly referred to as soft dollar arrangements. As the Company is not acting as a principal in satisfying the performance obligation for these arrangements, expenses relating to soft dollars are netted against commission revenues and included in other liabilities and accrued expenses on the consolidated statements of financial condition.

Asset Management – Asset management fees include revenues the Company receives in connection with management and investment advisory services performed for separately managed accounts and various funds and partnerships. The performance obligation related to the transfer of these services is satisfied over time and the related fees are recognized under the output method, which reflects the fees that the Company has a right to invoice based on the services provided during the period. Fees are defined in client contracts as a percentage of portfolio assets under management. Amounts related to remaining performance obligations are not disclosed as the Company applies the output method.


10
Piper Jaffray Companies
Notes to the Consolidated Financial Statements
(Unaudited)

Asset management revenues may also include performance fees. Performance fees, if earned, are recognized when it is probable that such revenue will not be reversed in a future period. For the Company's alternative asset management funds, management will consider such factors as the remaining assets and residual life of the fund to conclude whether it is probable that a significant reversal of revenue will not occur in the future. For the Company's traditional asset management funds, performance fees are earned when the investment return on assets under management exceeds certain benchmark targets or other performance targets over a specified measurement period (monthly, quarterly or annually). These performance fees are typically annual performance hurdles and recognized in the fourth quarter of the applicable year, or upon client liquidation.

Adoption of New Accounting Standards

Revenue Recognition

In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-09, "Revenue from Contracts with Customers (Topic 606)" ("ASU 2014-09"), which supersedes previous revenue recognition guidance, including most industry-specific guidance. ASU 2014-09, as amended, requires a company to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods and services, and also requires enhanced disclosures.

The Company adopted this guidance effective as of January 1, 2018 under the modified retrospective method, in which the cumulative effect of applying the standard was recognized at the date of initial application. The cumulative effect adjustment that the Company recognized upon adoption as of January 1, 2018 was a decrease to retained earnings of $3.6 million, net of tax. The Company applied the guidance only to those contracts that were not completed at the date of initial application.

The previous broker dealer industry treatment of netting deal expenses with investment banking revenues was superseded under the new guidance. As a result of adopting ASU 2014-09, the Company now presents investment banking revenues gross of related client reimbursed deal expenses and deal-related expenses as non-interest expenses on the consolidated statements of operations, rather than the previous presentation of netting deal expenses incurred for completed investment banking deals within revenues. For the three months ended March 31, 2018, the Company reported higher investment banking revenues and higher non-compensation expenses of $5.1 million, respectively. This change did not impact earnings. In addition, the Company now defers the recognition of performance fees on its merchant banking, energy and senior living alternative asset management funds until such fees are no longer subject to reversal, which will cause a delay in the recognition of these fees as revenue. For the three months ended March 31, 2018, the amount of asset management revenue from performance fees that the Company would have recognized if not for this change was not material. With the exception of the above, the Company’s previous methods of recognizing investment banking revenues were not significantly impacted by the new guidance.

Recognition and Measurement of Financial Assets and Financial Liabilities

In January 2016, the FASB issued ASU No. 2016-01, "Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities" ("ASU 2016-01"). The amendments in ASU 2016-01 address certain aspects of the recognition, measurement, presentation and disclosure of financial instruments. ASU 2016-01 became effective for the Company as of January 1, 2018. There was no material impact to the Company's results of operations, financial position or disclosures upon adoption as the Company's financial instruments are already recorded at fair value.
 
Statement of Cash Flows

In August 2016, the FASB issued ASU No. 2016-15, "Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments" ("ASU 2016-15"). ASU 2016-15 clarifies how entities should classify certain cash receipts and cash payments on the statement of cash flows. The amendments in ASU 2016-15 became effective for the Company as of January 1, 2018, with retrospective application. There was no material impact to the Company's presentation of its consolidated statements of cash flows upon adoption of ASU 2016-15.


11
Piper Jaffray Companies
Notes to the Consolidated Financial Statements
(Unaudited)

In November 2016, the FASB issued ASU No. 2016-18, "Statement of Cash Flows (Topic 230): Restricted Cash" ("ASU 2016-18"). Under ASU 2016-18, restricted cash will be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period amounts shown on the consolidated statements of cash flows. ASU 2016-18 became effective for the Company as of January 1, 2018, with retrospective application. As a registered broker dealer, Piper Jaffray is subject to Rule 15c3-3 of the Securities Exchange Act of 1934, which requires broker dealers carrying customer accounts to maintain cash or qualified securities in a segregated reserve account for the exclusive benefit of its customers. These accounts were previously classified as cash and cash equivalents segregated for regulatory purposes on the consolidated statements of financial condition. Subsequent to transitioning to a fully disclosed clearing model in 2017, Piper Jaffray no longer carries customer accounts and is no longer subject to Rule 15c3-3. The following table provides a reconciliation of cash, cash equivalents and restricted cash for all periods presented on the consolidated statements of cash flows:
 
December 31,
 
March 31,
 
December 31,
(Dollars in thousands)
2017
 
2017
 
2016
Cash and cash equivalents
$
33,793

 
$
18,879

 
$
41,359

Cash and cash equivalents segregated for regulatory purposes
—

 
53,022

 
29,015

Cash, cash equivalents and restricted cash
$
33,793

 
$
71,901

 
$
70,374


Future Adoption of New Applicable Accounting Standards

Leases

In February 2016, the FASB issued ASU No. 2016-02, "Leases (Topic 842)" ("ASU 2016-02"). ASU 2016-02 requires lessees to recognize a right-of-use asset and lease liability on the consolidated statements of financial position and disclose key information about leasing arrangements. The recognition, measurement and presentation of expenses and cash flows arising from a lease by a lessee have not significantly changed from current U.S. GAAP. ASU 2016-02 is effective for annual and interim periods beginning after December 15, 2018. As of March 31, 2018, the Company had approximately 65 operating leases for office space with aggregate minimum lease commitments of $78.7 million. Upon adoption, this lease commitment will be reflected on the statement of financial condition as a right-of-use asset and a lease commitment liability. The Company is evaluating other service contracts which may include embedded leases, however, the Company does not expect these to be material. Upon adoption of ASU 2016-02, the Company does not expect material changes to the recognition of rent expense in its consolidated statements of operations. The impact of the new guidance on Piper Jaffray's net capital is expected to be minimal.

Financial Instruments – Credit Losses

In June 2016, the FASB issued ASU No. 2016-13, "Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments" ("ASU 2016-13"). The new guidance requires an entity to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts as opposed to delaying recognition until the loss was probable of occurring. ASU 2016-13 is effective for annual and interim periods beginning after December 15, 2019. Early adoption is permitted for annual and interim periods beginning after December 15, 2018. The Company does not expect the adoption of ASU 2016-13 to have a material impact on its consolidated financial statements.


12
Piper Jaffray Companies
Notes to the Consolidated Financial Statements
(Unaudited)

Note 3 Financial Instruments and Other Inventory Positions Owned and Financial Instruments and Other Inventory Positions Sold, but Not Yet Purchased

 
March 31,
 
December 31,
(Dollars in thousands)
2018
 
2017
Financial instruments and other inventory positions owned:
 
 
 
Corporate securities:
 
 
 
Equity securities
$
16,009

 
$
51,896

Convertible securities
90,841

 
74,456

Fixed income securities
35,582

 
30,145

Municipal securities:
 
 
 
Taxable securities
50,346

 
67,699

Tax-exempt securities
449,016

 
744,241

Short-term securities
113,775

 
62,251

Mortgage-backed securities
284

 
481

U.S. government agency securities
258,684

 
317,318

U.S. government securities
299

 
9,317

Derivative contracts
18,967

 
25,573

Total financial instruments and other inventory positions owned
$
1,033,803

 
$
1,383,377

 
 
 
 
Financial instruments and other inventory positions sold, but not yet purchased:
 
 
 
Corporate securities:
 
 
 
Equity securities
$
77,542

 
$
101,517

Fixed income securities
29,998

 
30,292

U.S. government agency securities
23,674

 
49,077

U.S. government securities
185,010

 
213,312

Derivative contracts
4,245

 
5,029

Total financial instruments and other inventory positions sold, but not yet purchased
$
320,469

 
$
399,227


At March 31, 2018 and December 31, 2017, financial instruments and other inventory positions owned in the amount of $503.9 million and $720.0 million, respectively, had been pledged as collateral for short-term financings.

Financial instruments and other inventory positions sold, but not yet purchased represent obligations of the Company to deliver the specified security at the contracted price, thereby creating a liability to purchase the security in the market at prevailing prices. The Company is obligated to acquire the securities sold short at prevailing market prices, which may exceed the amount reflected on the consolidated statements of financial condition. The Company economically hedges changes in the market value of its financial instruments and other inventory positions owned using inventory positions sold, but not yet purchased, interest rate derivatives, credit default swap index contracts, U.S. treasury bond futures and exchange traded options.

Derivative Contract Financial Instruments

The Company uses interest rate swaps, interest rate locks, credit default swap index contracts, U.S. treasury bond futures and equity option contracts as a means to manage risk in certain inventory positions. The Company also enters into interest rate swaps to facilitate customer transactions. The following describes the Company's derivatives by the type of transaction or security the instruments are economically hedging.

Customer matched-book derivatives: The Company enters into interest rate derivative contracts in a principal capacity as a dealer to satisfy the financial needs of its customers. The Company simultaneously enters into an interest rate derivative contract with a third party for the same notional amount to hedge the interest rate and credit risk of the initial client interest rate derivative contract. In certain limited instances, the Company has only hedged interest rate risk with a third party, and retains uncollateralized credit risk as described below. The instruments use interest rates based upon either the London Interbank Offer Rate ("LIBOR") index or the Securities Industry and Financial Markets Association ("SIFMA") index.

13
Piper Jaffray Companies
Notes to the Consolidated Financial Statements
(Unaudited)

Trading securities derivatives: The Company enters into interest rate derivative contracts and uses U.S. treasury bond futures to hedge interest rate and market value risks associated with its fixed income securities. These instruments use interest rates based upon either the Municipal Market Data ("MMD") index, LIBOR or the SIFMA index. The Company also enters into credit default swap index contracts to hedge credit risk associated with its taxable fixed income securities and option contracts to hedge market value risk associated with its convertible securities.

Derivatives are reported on a net basis by counterparty (i.e., the net payable or receivable for derivative assets and liabilities for a given counterparty) when a legal right of offset exists and on a net basis by cross product when applicable provisions are stated in master netting agreements. Cash collateral received or paid is netted on a counterparty basis, provided a legal right of offset exists. The total absolute notional contract amount, representing the absolute value of the sum of gross long and short derivative contracts, provides an indication of the volume of the Company's derivative activity and does not represent gains and losses. The following table presents the gross fair market value and the total absolute notional contract amount of the Company's outstanding derivative instruments, prior to counterparty netting, by asset or liability position:
 
 
March 31, 2018
 
December 31, 2017
(Dollars in thousands)
 
Derivative
 
Derivative
 
Notional
 
Derivative
 
Derivative
 
Notional
Derivative Category
 
Assets (1)
 
Liabilities (2)
 
Amount
 
Assets (1)
 
Liabilities (2)
 
Amount
Interest rate
 
 
 
 
 
 
 
 
 
 
 
 
Customer matched-book
 
$
194,735

 
$
182,472

 
$
2,682,335

 
$
239,224

 
$
225,890

 
$
2,819,006

Trading securities
 
2,393

 
1,389

 
455,775

 
126

 
4,459

 
399,450

Equity options
 
 
 
 
 
 
 
 
 
 
 
 
Trading securities
 
—

 
—

 
—

 
6

 
—

 
9,635

 
 
$
197,128

 
$
183,861

 
$
3,138,110

 
$
239,356

 
$
230,349

 
$
3,228,091

(1)
Derivative assets are included within financial instruments and other inventory positions owned on the consolidated statements of financial condition.
(2)
Derivative liabilities are included within financial instruments and other inventory positions sold, but not yet purchased on the consolidated statements of financial condition.

The Company's derivative contracts do not qualify for hedge accounting, therefore, unrealized gains and losses are recorded on the consolidated statements of operations. The gains and losses on the related economically hedged inventory positions are not disclosed below as they are not in qualifying hedging relationships. The following table presents the Company's unrealized gains/(losses) on derivative instruments:
 
 
 
 
Three Months Ended
(Dollars in thousands)
 
 
 
March 31,
Derivative Category               
 
Operations Category
 
2018
 
2017
Interest rate derivative contract
 
Investment banking
 
$
(795
)
 
$
(292
)
Interest rate derivative contract
 
Institutional brokerage
 
5,062

 
(14,738
)
Credit default swap index contract
 
Institutional brokerage
 
—

 
255

 
 
 
 
$
4,267

 
$
(14,775
)

Credit risk associated with the Company's derivatives is the risk that a derivative counterparty will not perform in accordance with the terms of the applicable derivative contract. Credit exposure associated with the Company's derivatives is driven by uncollateralized market movements in the fair value of the contracts with counterparties and is monitored regularly by the Company's financial risk committee. The Company considers counterparty credit risk in determining derivative contract fair value. The majority of the Company's derivative contracts are substantially collateralized by its counterparties, who are major financial institutions. The Company has a limited number of counterparties who are not required to post collateral. Based on market movements, the uncollateralized amounts representing the fair value of the derivative contract can become material, exposing the Company to the credit risk of these counterparties. As of March 31, 2018, the Company had $17.0 million of uncollateralized credit exposure with these counterparties (notional contract amount of $179.9 million), including $12.9 million of uncollateralized credit exposure with one counterparty.


14
Piper Jaffray Companies
Notes to the Consolidated Financial Statements
(Unaudited)

Note 4 Fair Value of Financial Instruments

Based on the nature of the Company's business and its role as a "dealer" in the securities industry or as a manager of alternative asset management funds, the fair values of its financial instruments are determined internally. The Company's processes are designed to ensure that the fair values used for financial reporting are based on observable inputs wherever possible. In the event that observable inputs are not available, unobservable inputs are developed based on an evaluation of all relevant empirical market data, including prices evidenced by market transactions, interest rates, credit spreads, volatilities and correlations and other security-specific information. Valuation adjustments related to illiquidity or counterparty credit risk are also considered. In estimating fair value, the Company may utilize information provided by third party pricing vendors to corroborate internally-developed fair value estimates.

The Company employs specific control processes to determine the reasonableness of the fair value of its financial instruments. The Company's processes are designed to ensure that the internally-estimated fair values are accurately recorded and that the data inputs and the valuation techniques used are appropriate, consistently applied, and that the assumptions are reasonable and consistent with the objective of determining fair value. Individuals outside of the trading departments perform independent pricing verification reviews as of each reporting date. The Company has established parameters which set forth when the fair value of securities are independently verified. The selection parameters are generally based upon the type of security, the level of estimation risk of a security, the materiality of the security to the Company's financial statements, changes in fair value from period to period, and other specific facts and circumstances of the Company's securities portfolio. In evaluating the initial internally-estimated fair values made by the Company's traders, the nature and complexity of securities involved (e.g., term, coupon, collateral, and other key drivers of value), level of market activity for securities, and availability of market data are considered. The independent price verification procedures include, but are not limited to, analysis of trade data (both internal and external where available), corroboration to the valuation of positions with similar characteristics, risks and components, or comparison to an alternative pricing source, such as a discounted cash flow model. The Company's valuation committee, comprised of members of senior management and risk management, provides oversight and overall responsibility for the internal control processes and procedures related to fair value measurements.

The following is a description of the valuation techniques used to measure fair value.

Cash Equivalents

Cash equivalents include highly liquid investments with original maturities of 90 days or less. Actively traded money market funds are measured at their net asset value and classified as Level I.

Financial Instruments and Other Inventory Positions Owned

The Company records financial instruments and other inventory positions owned and financial instruments and other inventory positions sold, but not yet purchased at fair value on the consolidated statements of financial condition with unrealized gains and losses reflected on the consolidated statements of operations.

Equity securities – Exchange traded equity securities are valued based on quoted prices from the exchange for identical assets or liabilities as of the period-end date. To the extent these securities are actively traded and valuation adjustments are not applied, they are categorized as Level I. Non-exchange traded equity securities (principally hybrid preferred securities) are measured primarily using broker quotations, prices observed for recently executed market transactions and internally-developed fair value estimates based on observable inputs and are categorized within Level II of the fair value hierarchy.

Convertible securities – Convertible securities are valued based on observable trades, when available. Accordingly, these convertible securities are categorized as Level II.

Corporate fixed income securities – Fixed income securities include corporate bonds which are valued based on recently executed market transactions of comparable size, internally-developed fair value estimates based on observable inputs, or broker quotations. Accordingly, these corporate bonds are categorized as Level II.

Taxable municipal securities – Taxable municipal securities are valued using recently executed observable trades or market price quotations and therefore are generally categorized as Level II.

15
Piper Jaffray Companies
Notes to the Consolidated Financial Statements
(Unaudited)

Tax-exempt municipal securities – Tax-exempt municipal securities are valued using recently executed observable trades or market price quotations and therefore are generally categorized as Level II. Certain illiquid tax-exempt municipal securities are valued using market data for comparable securities (maturity and sector) and management judgment to infer an appropriate current yield or other model-based valuation techniques deemed appropriate by management based on the specific nature of the individual security and are therefore categorized as Level III.

Short-term municipal securities – Short-term municipal securities include auction rate securities, variable rate demand notes, and other short-term municipal securities. Variable rate demand notes and other short-term municipal securities are valued using recently executed observable trades or market price quotations and therefore are generally categorized as Level II. Auction rate securities with limited liquidity are categorized as Level III and are valued using discounted cash flow models with unobservable inputs such as the Company's expected recovery rate on the securities.

Mortgage-backed securities – Mortgage-backed securities are valued using observable trades, when available. Certain mortgage-backed securities are valued using models where inputs to the model are directly observable in the market, or can be derived principally from or corroborated by observable market data. To the extent we hold, these mortgage-backed securities are categorized as Level II. Certain mortgage-backed securities collateralized by residential mortgages are valued using cash flow models that utilize unobservable inputs including credit default rates, prepayment rates, loss severity and valuation yields. As judgment is used to determine the range of these inputs, these mortgage-backed securities are categorized as Level III.

U.S. government agency securities – U.S. government agency securities include agency debt bonds and mortgage bonds. Agency debt bonds are valued by using either direct price quotes or price quotes for comparable bond securities and are categorized as Level II. Mortgage bonds include bonds secured by mortgages, mortgage pass-through securities, agency collateralized mortgage-obligation ("CMO") securities and agency interest-only securities. Mortgage pass-through securities, CMO securities and interest-only securities are valued using recently executed observable trades or other observable inputs, such as prepayment speeds and therefore are generally categorized as Level II. Mortgage bonds are valued using observable market inputs, such as market yields ranging from 293-348 basis points ("bps") on spreads over U.S. treasury securities, or models based upon prepayment expectations ranging from 0%-13% conditional prepayment rate ("CPR"). These securities are categorized as Level II.

U.S. government securities – U.S. government securities include highly liquid U.S. treasury securities which are generally valued using quoted market prices and therefore categorized as Level I. The Company does not transact in securities of countries other than the U.S. government.

Derivatives – Derivative contracts include interest rate swaps, interest rate locks, credit default swap index contracts, U.S. treasury bond futures and equity option contracts. These instruments derive their value from underlying assets, reference rates, indices or a combination of these factors. The Company's equity option derivative contracts are valued based on quoted prices from the exchange for identical assets or liabilities as of the period-end date. To the extent these contracts are actively traded and valuation adjustments are not applied, they are categorized as Level I. The Company's credit default swap index contracts are valued using market price quotations and are classified as Level II. The majority of the Company's interest rate derivative contracts, including both interest rate swaps and interest rate locks, are valued using market standard pricing models based on the net present value of estimated future cash flows. The valuation models used do not involve material subjectivity as the methodologies do not entail significant judgment and the pricing inputs are market observable, including contractual terms, yield curves and measures of volatility. These instruments are classified as Level II within the fair value hierarchy. Certain interest rate locks transact in less active markets and were valued using valuation models that included the previously mentioned observable inputs and certain unobservable inputs that required significant judgment, such as the premium over the MMD curve. These instruments are classified as Level III.


16
Piper Jaffray Companies
Notes to the Consolidated Financial Statements
(Unaudited)

Investments

The Company's investments valued at fair value include equity investments in private companies and partnerships, investments in registered mutual funds, warrants of public and private companies and private company debt. Investments in registered mutual funds are valued based on quoted prices on active markets and classified as Level I. Company-owned warrants, which have a cashless exercise option, are valued based upon the Black-Scholes option-pricing model and certain unobservable inputs. The Company applies a liquidity discount to the value of its warrants in public and private companies. For warrants in private companies, valuation adjustments, based upon management's judgment, are made to account for differences between the measured security and the stock volatility factors of comparable companies. Company-owned warrants are reported as Level III assets. Investments in private companies are valued based on an assessment of each underlying security, considering rounds of financing, third party transactions and market-based information, including comparable company transactions, trading multiples (e.g., multiples of revenue and earnings before interest, taxes, depreciation and amortization ("EBITDA")) and changes in market outlook, among other factors. These securities are generally categorized as Level III.

Fair Value Option – The fair value option permits the irrevocable fair value option election on an instrument-by-instrument basis at initial recognition of an asset or liability or upon an event that gives rise to a new basis of accounting for that instrument. The fair value option was elected for certain merchant banking and other investments at inception to reflect economic events in earnings on a timely basis. Merchant banking and other equity investments of $15.0 million and $14.1 million, included within investments on the consolidated statements of financial condition, are accounted for at fair value and are classified as Level III assets at March 31, 2018 and December 31, 2017, respectively. The realized and unrealized net gains from fair value changes included in earnings as a result of electing to apply the fair value option to certain financial assets were $0.8 million and $0.5 million for the three months ended March 31, 2018 and 2017, respectively.

The following table summarizes quantitative information about the significant unobservable inputs used in the fair value measurement of the Company's Level III financial instruments as of March 31, 2018:
 
Valuation
 
 
 
 
 
Weighted
 
Technique
 
Unobservable Input
 
Range      
 
Average
Assets:
 
 
 
 
 
 
 
Financial instruments and other inventory positions owned:
 
 
 
 
 
 
 
Derivative contracts:
 
 
 
 
 
 
 
Interest rate locks
Discounted cash flow
 
Premium over the MMD curve (1)
 
2 - 38 bps
 
23.8 bps
Investments at fair value:
 
 
 
 
 
 
 
Equity securities in private companies
Market approach
 
Revenue multiple (2)
 
2 - 5 times
 
4.2 times
 
 
 
EBITDA multiple (2)
 
11 - 15 times
 
12.4 times
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
Financial instruments and other inventory positions sold, but not yet purchased:
 
 
 
 
 
 
 
Derivative contracts:
 
 
 
 
 
 
 
Interest rate locks
Discounted cash flow
 
Premium over the MMD curve (1)
 
2 - 36 bps
 
13.6 bps
Sensitivity of the fair value to changes in unobservable inputs:
(1)
Significant increase/(decrease) in the unobservable input in isolation would result in a significantly lower/(higher) fair value measurement.
(2)
Significant increase/(decrease) in the unobservable input in isolation would result in a significantly higher/(lower) fair value measurement.


17
Piper Jaffray Companies
Notes to the Consolidated Financial Statements
(Unaudited)

The following table summarizes the valuation of the Company's financial instruments by pricing observability levels defined in FASB Accounting Standards Codification Topic 820, "Fair Value Measurement" ("ASC 820") as of March 31, 2018:
 
 
 
 
 
 
 
Counterparty
 
 
 
 
 
 
 
 
 
and Cash
 
 
 
 
 
 
 
 
 
Collateral
 
 
(Dollars in thousands)
Level I
 
Level II
 
Level III
 
Netting (1)
 
Total
Assets:
 
 
 
 
 
 
 
 
 
Financial instruments and other inventory positions owned:
 
 
 
 
 
 
 
 
 
Corporate securities:
 
 
 
 
 
 
 
 
 
Equity securities
$
1,360

 
$
14,649

 
$
—

 
$
—

 
$
16,009

Convertible securities
—

 
90,841

 
—

 
—

 
90,841

Fixed income securities
—

 
35,582

 
—

 
—

 
35,582

Municipal securities:
 
 
 
 
 
 
 
 
 
Taxable securities
—

 
50,346

 
—

 
—

 
50,346

Tax-exempt securities
—

 
449,016

 
—

 
—

 
449,016

Short-term securities
—

 
113,056

 
719

 
—

 
113,775

Mortgage-backed securities
—

 
—

 
284

 
—

 
284

U.S. government agency securities
—

 
258,684

 
—

 
—

 
258,684

U.S. government securities
299

 
—

 
—

 
—

 
299

Derivative contracts
—

 
194,984

 
2,144

 
(178,161
)
 
18,967

Total financial instruments and other inventory positions owned
1,659

 
1,207,158

 
3,147

 
(178,161
)
 
1,033,803

 
 
 
 
 
 
 
 
 
 
Cash equivalents
1,896

 
—

 
—

 
—

 
1,896

 
 
 
 
 
 
 
 
 
 
Investments at fair value
39,953

 
—

 
121,637

(2)
—

 
161,590

Total assets
$
43,508

 
$
1,207,158

 
$
124,784

 
$
(178,161
)
 
$
1,197,289

 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
Financial instruments and other inventory positions sold, but not yet purchased:
 
 
 
 
 
 
 
 
 
Corporate securities:
 
 
 
 
 
 
 
 
 
Equity securities
$
74,239

 
$
3,303

 
$
—

 
$
—

 
$
77,542

Fixed income securities
—

 
29,998

 
—

 
—

 
29,998

U.S. government agency securities
—

 
23,674

 
—

 
—

 
23,674

U.S. government securities
185,010

 
—

 
—

 
—

 
185,010

Derivative contracts
—

 
182,472

 
1,389

 
(179,616
)
 
4,245

Total financial instruments and other inventory positions sold, but not yet purchased
$
259,249

 
$
239,447

 
$
1,389

 
$
(179,616
)
 
$
320,469

(1)
Represents cash collateral and the impact of netting on a counterparty basis. The Company had no securities posted as collateral to its counterparties.
(2)
Noncontrolling interests of $47.0 million are attributable to third party ownership in consolidated merchant banking and senior living funds.


18
Piper Jaffray Companies
Notes to the Consolidated Financial Statements
(Unaudited)

The following table summarizes the valuation of the Company's financial instruments by pricing observability levels defined in ASC 820 as of December 31, 2017:
 
 
 
 
 
 
 
Counterparty
 
 
 
 
 
 
 
 
 
and Cash
 
 
 
 
 
 
 
 
 
Collateral
 
 
(Dollars in thousands)
Level I
 
Level II
 
Level III
 
Netting (1)
 
Total
Assets:
 
 
 
 
 
 
 
 
 
Financial instruments and other inventory positions owned:
 
 
 
 
 
 
 
 
 
Corporate securities:
 
 
 
 
 
 
 
 
 
Equity securities
$
1,863

 
$
50,033

 
$
—

 
$
—

 
$
51,896

Convertible securities
—

 
74,456

 
—

 
—

 
74,456

Fixed income securities
—

 
30,145

 
—

 
—

 
30,145

Municipal securities:
 
 
 
 
 
 
 
 
 
Taxable securities
—

 
67,699

 
—

 
—

 
67,699

Tax-exempt securities
—

 
743,541

 
700

 
—

 
744,241

Short-term securities
—

 
61,537

 
714

 
—

 
62,251

Mortgage-backed securities
—

 
—

 
481

 
—

 
481

U.S. government agency securities
—

 
317,318

 
—

 
—

 
317,318

U.S. government securities
9,317

 
—

 
—

 
—

 
9,317

Derivative contracts
6

 
239,224

 
126

 
(213,783
)
 
25,573

Total financial instruments and other inventory positions owned
11,186

 
1,583,953

 
2,021

 
(213,783
)
 
1,383,377

 
 
 
 
 
 
 
 
 
 
Cash equivalents
3,782

 
—

 
—

 
—

 
3,782

 
 
 
 
 
 
 
 
 
 
Investments at fair value
39,504

 
—

 
126,060

(2)
—

 
165,564

Total assets
$
54,472

 
$
1,583,953

 
$
128,081

 
$
(213,783
)
 
$
1,552,723

 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
Financial instruments and other inventory positions sold, but not yet purchased:
 
 
 
 
 
 
 
 
 
Corporate securities:
 
 
 
 
 
 
 
 
 
Equity securities
$
91,934

 
$
9,583

 
$
—

 
$
—

 
$
101,517

Fixed income securities
—

 
30,292

 
—

 
—

 
30,292

U.S. government agency securities
—

 
49,077

 
—

 
—

 
49,077

U.S. government securities
213,312

 
—

 
—

 
—

 
213,312

Derivative contracts
—

 
225,916

 
4,433

 
(225,320
)
 
5,029

Total financial instruments and other inventory positions sold, but not yet purchased
$
305,246

 
$
314,868

 
$
4,433

 
$
(225,320
)
 
$
399,227

(1)
Represents cash collateral and the impact of netting on a counterparty basis. The Company had no securities posted as collateral to its counterparties.
(2)
Noncontrolling interests of $44.4 million are attributable to third party ownership in consolidated merchant banking and senior living funds.

The Company's Level III assets were $124.8 million and $128.1 million, or 10.4 percent and 8.2 percent of financial instruments measured at fair value at March 31, 2018 and December 31, 2017, respectively. The value of transfers between levels are recognized at the beginning of the reporting period. There were no significant transfers between Level I, Level II or Level III for the three months ended March 31, 2018.
 

19
Piper Jaffray Companies
Notes to the Consolidated Financial Statements
(Unaudited)

The following tables summarize the changes in fair value associated with Level III financial instruments held at the beginning or end of the periods presented:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unrealized gains/
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(losses) for assets/
 
Balance at
 
 
 
 
 
 
 
 
 
Realized
 
Unrealized
 
Balance at
 
liabilities held at
 
December 31,
 
 
 
 
 
Transfers
 
Transfers
 
gains/
 
gains/
 
March 31,
 
March 31,
(Dollars in thousands)
2017
 
Purchases
 
Sales
 
in
 
out
 
(losses) (1)
 
(losses) (1)
 
2018
 
2018 (1)
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial instruments and other inventory positions owned:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Municipal securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Tax-exempt securities
$
700

 
$
—

 
$
—

 
$
—

 
$
(700
)
 
$
—

 
$
—

 
$
—

 
$
—

Short-term securities
714

 
—

 
—

 
—

 
—

 
—

 
5

 
719

 
5

Mortgage-backed securities
481

 
—

 
(5
)
 
—

 
—

 
—

 
(192
)
 
284

 
3

Derivative contracts
126

 
—

 
(1,760
)
 
—

 
—

 
1,760

 
2,018

 
2,144

 
2,144

Total financial instruments and other inventory positions owned
2,021

 
—

 
(1,765
)
 
—

 
(700
)
 
1,760

 
1,831

 
3,147

 
2,152

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Investments at fair value
126,060

 
601

 
(4,154
)
 
—

 
—

 
3,402

 
(4,272
)
 
121,637

 
(869
)
Total assets
$
128,081

 
$
601

 
$
(5,919
)
 
$
—

 
$
(700
)
 
$
5,162

 
$
(2,441
)
 
$
124,784

 
$
1,283

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial instruments and other inventory positions sold, but not yet purchased:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivative contracts
$
4,433

 
$
(1,305
)
 
$
3,226

 
$
—

 
$
—

 
$
(1,921
)
 
$
(3,044
)
 
$
1,389

 
$
1,389

Total financial instruments and other inventory positions sold, but not yet purchased
$
4,433

 
$
(1,305
)
 
$
3,226

 
$
—

 
$
—

 
$
(1,921
)
 
$
(3,044
)
 
$
1,389

 
$
1,389

(1)
Realized and unrealized gains/(losses) related to financial instruments, with the exception of customer matched-book derivatives, are reported in institutional brokerage on the consolidated statements of operations. Realized and unrealized gains/(losses) related to customer matched-book derivatives are reported in investment banking. Realized and unrealized gains/(losses) related to investments are reported in investment banking revenues or investment income on the consolidated statements of operations.

20
Piper Jaffray Companies
Notes to the Consolidated Financial Statements
(Unaudited)

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unrealized gains/
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(losses) for assets/
 
Balance at
 
 
 
 
 
 
 
 
 
Realized
 
Unrealized
 
Balance at
 
liabilities held at
 
December 31,
 
 
 
 
 
Transfers
 
Transfers
 
gains/
 
gains/
 
March 31,
 
March 31,
(Dollars in thousands)
2016
 
Purchases
 
Sales
 
in
 
out
 
(losses) (1)
 
(losses) (1)
 
2017
 
2017 (1)
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial instruments and other inventory positions owned:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Municipal securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Taxable securities
$
2,686

 
$
—

 
$
(2,703
)
 
$
—

 
$
—

 
$
716

 
$
(699
)
 
$
—

 
$
—

Tax-exempt securities
1,077

 
—

 
—

 
—

 
—

 
—

 
40

 
1,117

 
40

Short-term securities
744

 
—

 
—

 
—

 
—

 
—

 
—

 
744

 
—

Mortgage-backed securities
5,364

 
996

 
(790
)
 
—

 
—

 
314

 
(393
)
 
5,491

 
(71
)
Derivative contracts
13,952

 
240

 
(10,885
)
 
—

 
—

 
10,645

 
(12,319
)
 
1,633

 
(347
)
Total financial instruments and other inventory positions owned
23,823

 
1,236

 
(14,378
)
 
—

 
—

 
11,675

 
(13,371
)
 
8,985

 
(378
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Investments at fair value
123,319

 
6,587

 
(24,469
)
 
—

 
—

 
8,656

 
(3,400
)
 
110,693

 
6,493

Total assets
$
147,142

 
$
7,823

 
$
(38,847
)
 
$
—

 
$
—

 
$
20,331

 
$
(16,771
)
 
$
119,678

 
$
6,115

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial instruments and other inventory positions sold, but not yet purchased:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivative contracts
$
1,487

 
$
(719
)
 
$
—

 
$
—

 
$
—

 
$
719

 
$
2,419

 
$
3,906

 
$
3,061

Total financial instruments and other inventory positions sold, but not yet purchased
$
1,487

 
$
(719
)
 
$
—

 
$
—

 
$
—

 
$
719

 
$
2,419

 
$
3,906

 
$
3,061

(1)
Realized and unrealized gains/(losses) related to financial instruments, with the exception of customer matched-book derivatives, are reported in institutional brokerage on the consolidated statements of operations. Realized and unrealized gains/(losses) related to customer matched-book derivatives are reported in investment banking. Realized and unrealized gains/(losses) related to investments are reported in investment banking revenues or investment income on the consolidated statements of operations.

The carrying values of the Company's cash, receivables and payables either from or to brokers, dealers and clearing organizations and short-term financings approximate fair value due to their liquid or short-term nature.

Note 5 Variable Interest Entities ("VIEs")

The Company has investments in and/or acts as the managing partner of various partnerships, limited liability companies, and registered mutual funds. These entities were established for the purpose of investing in securities of public or private companies, or municipal debt obligations, or providing financing to senior living facilities, and were initially financed through the capital commitments or seed investments of the members.

VIEs are entities in which equity investors lack the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities. The determination as to whether an entity is a VIE is based on the structure and nature of each entity. The Company also considers other characteristics such as the power through voting rights or similar rights to direct the activities of an entity that most significantly impact the entity's economic performance and how the entity is financed.

The Company is required to consolidate all VIEs for which it is considered to be the primary beneficiary. The determination as to whether the Company is considered to be the primary beneficiary is based on whether the Company has both the power to direct the activities of the VIE that most significantly impact the entity's economic performance and the obligation to absorb losses or the right to receive benefits of the VIE that could potentially be significant to the VIE.


21
Piper Jaffray Companies
Notes to the Consolidated Financial Statements
(Unaudited)

Consolidated VIEs

The Company's consolidated VIEs at March 31, 2018 included certain alternative asset management funds in which the Company has an investment and, as the managing partner, is deemed to have both the power to direct the most significant activities of the funds and the right to receive benefits (or the obligation to absorb losses) that could potentially be significant to these funds.

The following table presents information about the carrying value of the assets and liabilities of the VIEs which are consolidated by the Company and included on the consolidated statements of financial condition at March 31, 2018. The assets can only be used to settle the liabilities of the respective VIE, and the creditors of the VIEs do not have recourse to the general credit of the Company. One of these VIEs has $25.0 million of bank line financing available with an interest rate based on prime plus an applicable margin. The assets and liabilities are presented prior to consolidation, and thus a portion of these assets and liabilities are eliminated in consolidation.

 
 
Alternative Asset
(Dollars in thousands)
 
Management Funds
Assets:
 
 
Receivables from brokers, dealers and clearing organizations
 
$
3,223

Financial instruments and other inventory positions owned and pledged as collateral
 
216,884

Investments
 
106,515

Other assets
 
6,780

Total assets
 
$
333,402

 
 
 
Liabilities:
 
 
Short-term financing
 
$
136,284

Payables to brokers, dealers and clearing organizations
 
6,169

Financial instruments and other inventory positions sold, but not yet purchased
 
51,531

Other liabilities and accrued expenses
 
8,846

Total liabilities
 
$
202,830


The Company has investments in a grantor trust which was established as part of a nonqualified deferred compensation plan. The Company is the primary beneficiary of the grantor trust. Accordingly, the assets and liabilities of the grantor trust are consolidated by the Company on the consolidated statements of financial condition. See Note 12 for additional information on the nonqualified deferred compensation plan.

Nonconsolidated VIEs

The Company determined it is not the primary beneficiary of certain VIEs and accordingly does not consolidate them. These VIEs had net assets approximating $0.5 billion and $0.6 billion at March 31, 2018 and December 31, 2017, respectively. The Company's exposure to loss from these VIEs is $6.4 million, which is the carrying value of its capital contributions recorded in investments on the consolidated statements of financial condition at March 31, 2018. The Company had no liabilities related to these VIEs at March 31, 2018 and December 31, 2017, respectively. Furthermore, the Company has not provided financial or other support to these VIEs that it was not previously contractually required to provide as of March 31, 2018.

Note 6 Receivables from and Payables to Brokers, Dealers and Clearing Organizations

 
March 31,
 
December 31,
(Dollars in thousands)
2018
 
2017
Receivable arising from unsettled securities transactions
$
3,223

 
$
9,218

Receivable from clearing organizations
7,991

 
109,270

Deposits with clearing organizations
14,745

 
11,019

Receivable from brokers and dealers
16,011

 
12,041

Other
4,332

 
3,846

Total receivables from brokers, dealers and clearing organizations
$
46,302

 
$
145,394


22
Piper Jaffray Companies
Notes to the Consolidated Financial Statements
(Unaudited)


 
March 31,
 
December 31,
(Dollars in thousands)
2018
 
2017
Payable arising from unsettled securities transactions
$
6,169

 
$
808

Payable to clearing organizations
25,655

 
—

Payable to brokers and dealers
1,758

 
18,584

Total payables to brokers, dealers and clearing organizations
$
33,582

 
$
19,392


As discussed in Note 1, Piper Jaffray transitioned from a self clearing securities broker dealer to a fully disclosed clearing model in 2017. Under the Company's fully disclosed clearing agreement, the majority of its securities inventories and all of its customer activities are held by or cleared through Pershing. The Company has also established an arrangement to obtain financing from Pershing related to the majority of its trading activities. Financing under this arrangement is secured primarily by securities, and collateral limitations could reduce the amount of funding available under this arrangement. The funding is at the discretion of Pershing and could be denied. The Company's clearing arrangement activities are recorded net from trading activity. The Company's fully disclosed clearing agreement includes a covenant requiring Piper Jaffray to maintain excess net capital of $120 million.

Note 7 Investments

The Company's investments include investments in private companies and partnerships, registered mutual funds, warrants of public and private companies and private company debt.
 
March 31,
 
December 31,
(Dollars in thousands)
2018
 
2017
Investments at fair value
$
161,590

 
$
165,564

Investments at cost
1,661

 
2,416

Investments accounted for under the equity method
6,488

 
8,232

Total investments
169,739

 
176,212

 
 
 
 
Less investments attributable to noncontrolling interests (1)
(47,015
)
 
(44,397
)
 
$
122,724

 
$
131,815

(1)
Noncontrolling interests are attributable to third party ownership in consolidated merchant banking and senior living funds.

At March 31, 2018, investments carried on a cost basis had an estimated fair market value of $3.0 million. Because valuation estimates were based upon management's judgment, investments carried at cost would be categorized as Level III assets in the fair value hierarchy, if they were carried at fair value.

Investments accounted for under the equity method include general and limited partnership interests. The carrying value of these investments is based on the investment vehicle's net asset value. The net assets of investment partnerships consist of investments in both marketable and non-marketable securities. The underlying investments held by such partnerships are valued based on the estimated fair value determined by management in the Company's capacity as general partner or investor and, in the case of investments in unaffiliated investment partnerships, are based on financial statements prepared by the unaffiliated general partners.


23
Piper Jaffray Companies
Notes to the Consolidated Financial Statements
(Unaudited)

Note 8 Other Assets

 
March 31,
 
December 31,
(Dollars in thousands)
2018
 
2017
Fee receivables
$
23,602

 
$
20,884

Income tax receivables
19,193

 
—

Accrued interest receivables
9,838

 
6,981

Forgivable loans, net
7,756

 
7,452

Prepaid expenses
6,439