Note 7.—Fair Value of Financial Instruments

The use of fair value to measure the Company’s financial instruments is fundamental to its consolidated financial statements and is a critical accounting estimate because a substantial portion of its assets and liabilities are recorded at estimated fair value.

FASB ASC 825 requires disclosure of the estimated fair value of certain financial instruments and the methods and significant assumptions used to estimate such fair values. The following table presents the estimated fair value of financial instruments included in the consolidated financial statements as of the dates indicated:


	September 30, 2018								December 31, 2017
	Carrying		Estimated Fair Value						Carrying		Estimated Fair Value
	Amount		Level 1		Level 2		Level 3		Amount		Level 1		Level 2		Level 3
Assets
Cash and cash equivalents	$	29,217	$	29,217	$	—	$	—	$	33,223	$	33,223	$	—	$	—
Restricted cash		4,440		4,440		—		—		5,876		5,876		—		—
Mortgage loans held-for-sale		344,681		—		344,681		—		568,781		—		568,781		—
Finance receivables		731		—		731		—		41,777		—		41,777		—
Mortgage servicing rights		181,005		—		—		181,005		154,405		—		—		154,405
Derivative assets, lending, net		4,352		—		534		3,818		4,777		—		420		4,357
Securitized mortgage collateral		3,302,192		—		—		3,302,192		3,662,008		—		—		3,662,008

Liabilities
Warehouse borrowings	$	315,152	$	—	$	315,152	$	—	$	575,363	$	—	$	575,363	$	—
MSR financings		62,000		—		—		62,000		35,133		—		—		35,133
Convertible notes		24,982		—		—		24,982		24,974		—		—		24,974
Contingent consideration		—		—		—		—		554		—		—		554
Long-term debt		46,738		—		—		46,738		44,982		—		—		44,982
Securitized mortgage borrowings		3,296,242		—		—		3,296,242		3,653,265		—		—		3,653,265

The fair value amounts above have been estimated by management using available market information and appropriate valuation methodologies. Considerable judgment is required to interpret market data to develop the estimates of fair value in both inactive and orderly markets. Accordingly, the estimates presented are not necessarily indicative of the amounts that could be realized 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.

For securitized mortgage collateral and securitized mortgage borrowings, the underlying Alt-A (non-conforming) residential and commercial loans and mortgage-backed securities market have experienced significant declines in market activity, along with a lack of orderly transactions. The Company’s methodology to estimate fair value of these assets and liabilities include the use of internal pricing techniques such as the net present value of future expected cash flows (with observable market participant assumptions, where available) discounted at a rate of return based on the Company’s estimates of market participant requirements. The significant assumptions utilized in these internal pricing techniques, which are based on the characteristics of the underlying collateral, include estimated credit losses, estimated prepayment speeds and appropriate discount rates.

Refer to Recurring Fair Value Measurements below for a description of the valuation methods used to determine the fair value of investment securities available-for-sale, securitized mortgage collateral and borrowings, derivative assets and liabilities, long-term debt, mortgage servicing rights and mortgage loans held-for-sale.

The carrying amount of cash, cash equivalents and restricted cash approximates fair value.

Finance receivables carrying amounts approximate fair value due to the short-term nature of the assets and do not present unanticipated interest rate or credit concerns.

Warehouse borrowings carrying amounts approximate fair value due to the short-term nature of the liabilities and do not present unanticipated interest rate or credit concerns.

Convertible notes are recorded at amortized cost.

MSR financings carrying amount approximates fair value as the underlying facility bears interest at a rate that is periodically adjusted based on a market index.

Fair Value Hierarchy

The application of fair value measurements may be on a recurring or nonrecurring basis depending on the accounting principles applicable to the specific asset or liability or whether management has elected to carry the item at its estimated fair value.

FASB ASC 820-10-35 specifies a hierarchy of valuation techniques based on whether the inputs to those techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. These two types of inputs create the following fair value hierarchy:

Level 1—Quoted prices (unadjusted) in active markets for identical instruments or liabilities that an entity has the ability to assess at measurement date.

Level 2—Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; inputs other than quoted prices that are observable for an asset or liability, including interest rates and yield curves observable at commonly quoted intervals, prepayment speeds, loss severities, credit risks and default rates; and market-corroborated inputs.

Level 3—Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers is unobservable.

This hierarchy requires the Company to use observable market data, when available, and to minimize the use of unobservable inputs when estimating fair value.

As a result of the lack of observable market data resulting from inactive markets, the Company has classified its investment securities available-for-sale, mortgage servicing rights, securitized mortgage collateral and borrowings, derivative assets and liabilities (trust and IRLCs), and long-term debt as Level 3 fair value measurements. Level 3 assets and liabilities measured at fair value on a recurring basis were approximately 91% and 99% and 87% and 99%, respectively, of total assets and total liabilities measured at estimated fair value at September 30, 2018 and December 31, 2017.

Recurring Fair Value Measurements

The Company assesses the financial instruments on a quarterly basis to determine the appropriate classification within the fair value hierarchy, as defined by ASC Topic 810. Transfers between fair value classifications occur when there are changes in pricing observability levels. Transfers of financial instruments among the levels occur at the beginning of the reporting period. There were no material transfers between Level 1 and Level 2 classified instruments during the nine months ended September 30, 2018.

The following tables present the Company’s assets and liabilities that are measured at estimated fair value on a recurring basis, including financial instruments for which the Company has elected the fair value option at September 30, 2018 and December 31, 2017, based on the fair value hierarchy:


	Recurring Fair Value Measurements
	September 30, 2018						December 31, 2017
	Level 1		Level 2		Level 3		Level 1		Level 2		Level 3
Assets
Mortgage loans held-for-sale	$	—	$	344,681	$	—	$	—	$	568,781	$	—
Derivative assets, lending, net (1)		—		534		3,818		—		420		4,357
Mortgage servicing rights		—		—		181,005		—		—		154,405
Securitized mortgage collateral		—		—		3,302,192		—		—		3,662,008
Total assets at fair value	$	—	$	345,215	$	3,487,015	$	—	$	569,201	$	3,820,770
Liabilities
Securitized mortgage borrowings	$	—	$	—	$	3,296,242	$	—	$	—	$	3,653,265
Long-term debt		—		—		46,738		—		—		44,982
Contingent consideration		—		—		—		—		—		554
Total liabilities at fair value	$	—	$	—	$	3,342,980	$	—	$	—	$	3,698,801

(1)

At September 30, 2018, derivative assets, lending, net included $3.8 million in IRLCs and $534 thousand in hedging instruments, respectively, and is included in other assets in the accompanying consolidated balance sheets. At December 31, 2017, derivative assets, lending, net included $4.4 million in IRLCs and $420 thousand in hedging instruments, respectively, and is included in other assets in the accompanying consolidated balance sheets.

The following tables present reconciliations for all assets and liabilities measured at estimated fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended September 30, 2018 and 2017:


	Level 3 Recurring Fair Value Measurements
	For the Three Months Ended September 30, 2018

							Interest
	Securitized		Securitized		Mortgage		rate lock		Long-
	mortgage		mortgage		servicing		commitments,		term
	collateral		borrowings		rights		net		debt
Fair value, June 30, 2018	$	3,401,037	$	(3,393,721)	$	180,733	$	4,538	$	(45,787)
Total gains (losses) included in earnings:
Interest income (1)		7,097		—		—		—		—
Interest expense (1)		—		(13,487)		—		—		(191)
Change in fair value		59,727		(60,393)		(5,445)		(720)		(785)
Change in fair value of instrument specific credit risk		—		—		—		—		25	(2)
Total gains (losses) included in earnings		66,824		(73,880)		(5,445)		(720)		(951)
Transfers in and/or out of Level 3		—		—		—		—		—
Purchases, issuances and settlements:
Purchases		—		—		—		—		—
Issuances		—		—		5,717		—		—
Settlements		(165,669)		171,359		—		—		—
Fair value, September 30, 2018	$	3,302,192	$	(3,296,242)	$	181,005	$	3,818	$	(46,738)
Unrealized (losses) gains still held (3)	$	(403,516)	$	2,592,866	$	181,005	$	3,818	$	15,262

(1)

Amounts primarily represent accretion to recognize interest income and interest expense using effective yields based on estimated fair values for trust assets and trust liabilities. Net interest income, including cash received and paid, was $1.9 million for three months ended September 30, 2018. The difference between accretion of interest income and expense and the amounts of interest income and expense recognized in the consolidated statements of operations and comprehensive (loss) earnings is primarily from contractual interest on the securitized mortgage collateral and borrowings.

(2)

Amount represents the change in instrument specific credit risk in other comprehensive earnings in the consolidated statements of operations and comprehensive (loss) earnings as required by the adoption of ASU 2016-01 on January 1, 2018.

(3)

Represents the amount of unrealized gains (losses) relating to assets and liabilities classified as Level 3 that are still held and reflected in the fair values at September 30, 2018.


	Level 3 Recurring Fair Value Measurements
	For the Three Months Ended September 30, 2017

							Interest
	Securitized		Securitized		Mortgage		rate lock		Long-
	mortgage		mortgage		servicing		commitments,		term		Contingent
	collateral		borrowings		rights		net		debt		consideration
Fair value, June 30, 2017	$	3,776,184	$	(3,767,519)	$	152,273	$	9,546	$	(44,536)	$	(14,926)
Total gains (losses) included in earnings:
Interest income (1)		9,979		—		—		—		—		—
Interest expense (1)		—		(30,810)		—		—		(129)		—
Change in fair value		118,384		(122,863)		(11,177)		2,469		104		4,402
Total gains (losses) included in earnings		128,363		(153,673)		(11,177)		2,469		(25)		4,402
Transfers in and/or out of Level 3		—		—		—		—		—		—
Purchases, issuances and settlements:
Purchases		—		—		—		—		—		—
Issuances		—		—		17,854		—		—		—
Settlements		(146,407)		169,361		—		—		—		4,708
Fair value, September 30, 2017	$	3,758,140	$	(3,751,831)	$	158,950	$	12,015	$	(44,561)	$	(5,816)
Unrealized (losses) gains still held (2)	$	(580,845)	$	2,734,962	$	158,950	$	12,015	$	(17,439)	$	(5,816)

(1)

Amounts primarily represent accretion to recognize interest income and interest expense using effective yields based on estimated fair values for trust assets and trust liabilities. Net interest income, including cash received and paid, was $2.0 million for the three months ended September 30, 2017. The difference between accretion of interest income and expense and the amounts of interest income and expense recognized in the consolidated statements of operations and comprehensive (loss) earnings is primarily from contractual interest on the securitized mortgage collateral and borrowings.

(2)

Represents the amount of unrealized gains (losses) relating to assets and liabilities classified as Level 3 that are still held and reflected in the fair values at September 30, 2017.


	Level 3 Recurring Fair Value Measurements
	For the Nine Months Ended September 30, 2018

							Interest
	Securitized		Securitized		Mortgage		rate lock		Long-
	mortgage		mortgage		servicing		commitments,		term			Contingent
	collateral		borrowings		rights		net		debt			consideration
Fair value, December 31, 2017	$	3,662,008	$	(3,653,265)	$	154,405	$	4,357	$	(44,982)		$	(554)
Total gains (losses) included in earnings:
Interest income (1)		24,071		—		—		—		—			—
Interest expense (1)		—		(50,684)		—		—		(513)			—
Change in fair value		39,658		(42,848)		4,127		(539)		697			—
Change in fair value of instrument specific credit risk		—		—		—		—		(1,940)	(2)		—
Total gains (losses) included in earnings		63,729		(93,532)		4,127		(539)		(1,756)			—
Transfers in and/or out of Level 3		—		—		—		—		—			—
Purchases, issuances and settlements:
Purchases		—		—		—		—		—			—
Issuances		—		—		22,473		—		—			—
Settlements		(423,545)		450,555		—		—		—			554
Fair value, September 30, 2018	$	3,302,192	$	(3,296,242)	$	181,005	$	3,818	$	(46,738)		$	—

(1)

Amounts primarily represent accretion to recognize interest income and interest expense using effective yields based on estimated fair values for trust assets and trust liabilities. Net interest income, including cash received and paid, was $5.9 million for nine months ended September 30, 2018. The difference between accretion of interest income and expense and the amounts of interest income and expense recognized in the consolidated statements of operations and comprehensive (loss) earnings is primarily from contractual interest on the securitized mortgage collateral and borrowings.

(2)


	Level 3 Recurring Fair Value Measurements
	For the Nine Months Ended September 30, 2017

							Interest
	Securitized		Securitized		Mortgage		rate lock		Long-
	mortgage		mortgage		servicing		commitments,		term		Contingent
	collateral		borrowings		rights		net		debt		consideration
Fair value, December 31, 2016	$	4,021,891	$	(4,017,603)	$	131,537	$	11,169	$	(47,207)	$	(31,072)
Total gains (losses) included in earnings:
Interest income (1)		39,564		—		—		—		—		—
Interest expense (1)		—		(108,010)		—		—		(631)		—
Change in fair value		219,604		(221,510)		(20,038)		846		(2,657)		9,104
Total gains (losses) included in earnings		259,168		(329,520)		(20,038)		846		(3,288)		9,104
Transfers in and/or out of Level 3		—		—		—		—		—		—
Purchases, issuances and settlements:
Purchases		—		—		5,618		—		—		—
Issuances		—		—		42,728		—		—		—
Settlements		(522,919)		595,292		(895)		—		5,934		16,152
Fair value, September 30, 2017	$	3,758,140	$	(3,751,831)	$	158,950	$	12,015	$	(44,561)	$	(5,816)

(1)

Amounts primarily represent accretion to recognize interest income and interest expense using effective yields based on estimated fair values for trust assets and trust liabilities. Net interest income, including cash received and paid, was $6.1 million for the nine months ended September 30, 2017. The difference between accretion of interest income and expense and the amounts of interest income and expense recognized in the consolidated statements of operations and comprehensive (loss) earnings is primarily from contractual interest on the securitized mortgage collateral and borrowings.

The following table presents quantitative information about the valuation techniques and unobservable inputs applied to Level 3 fair value measurements for financial instruments measured at fair value on a recurring and nonrecurring basis at September 30, 2018:


	Estimated		Valuation	Unobservable	Range of		Weighted
Financial Instrument	Fair Value		Technique	Input	Inputs		Average
Assets and liabilities backed by real estate
Securitized mortgage collateral, and	$	3,302,192	DCF	Prepayment rates	2.3 - 21.0	%	6.9	%
Securitized mortgage borrowings		(3,296,242)		Default rates	0.01 - 4.0	%	1.5	%
				Loss severities	6.6 - 86.7	%	41.4	%
				Discount rates	3.0 - 25.0	%	4.2	%
Other assets and liabilities
Mortgage servicing rights	$	181,005	DCF	Discount rate	9.0 - 15.2	%	10.2	%
				Prepayment rates	6.7 - 88.8	%	9.3	%
Derivative assets - IRLCs, net		3,818	Market pricing	Pull-through rate	8.6 - 99.9	%	74.6	%
Long-term debt		(46,738)	DCF	Discount rate	10.0	%	10.0	%

DCF = Discounted Cash Flow

For assets and liabilities backed by real estate, a significant increase in discount rates, default rates or loss severities would result in a significantly lower estimated fair value. The effect of changes in prepayment speeds would have differing effects depending on the seniority or other characteristics of the instrument. For other assets and liabilities, a significant increase in discount rates would result in a significantly lower estimated fair value. A significant increase in one-month LIBOR would result in a significantly higher estimated fair value for derivative liabilities, net, securitized trusts. The Company believes that the imprecision of an estimate could be significant.

The following tables present the changes in recurring fair value measurements included in net earnings for the three months ended September 30, 2018 and 2017:


	Recurring Fair Value Measurements
	Changes in Fair Value Included in Net Earnings
	For the Three Months Ended September 30, 2018
					Change in Fair Value of
	Interest		Interest		Net Trust		Long-term		Other Revenue		Gain on Sale
	Income (1)		Expense (1)		Assets		Debt		and Expense		of Loans, net		Total
Securitized mortgage collateral	$	7,097	$	—	$	59,727	$	—	$	—	$	—	$	66,824
Securitized mortgage borrowings		—		(13,487)		(60,393)		—		—		—		(73,880)
Long-term debt		—		(191)		—		(785)		—		—		(976)
Mortgage servicing rights (2)		—		—		—		—		(5,445)		—		(5,445)
Mortgage loans held-for-sale		—		—		—		—		—		(6,901)		(6,901)
Derivative assets — IRLCs		—		—		—		—		—		(720)		(720)
Derivative liabilities — Hedging Instruments		—		—		—		—		(331)		1,044		713
Total	$	7,097	$	(13,678)	$	(666)	$	(785)	$	(5,776)	$	(6,577)	$	(20,385)

(1)

Amounts primarily represent accretion to recognize interest income and interest expense using effective yields based on estimated fair values for trust assets and trust liabilities.

(2)

Included in loss on MSRs, net in the consolidated statements of operations and comprehensive (loss) earnings.


	Recurring Fair Value Measurements
	Changes in Fair Value Included in Net Earnings
	For the Three Months Ended September 30, 2017
					Change in Fair Value of
	Interest		Interest		Net Trust		Long-term		Other		Gain on Sale
	Income (1)		Expense (1)		Assets		Debt		Revenue		of Loans, net		Total
Securitized mortgage collateral	$	9,979	$	—	$	118,384	$	—	$	—	$	—	$	128,363
Securitized mortgage borrowings		—		(30,810)		(122,863)		—		—		—		(153,673)
Long-term debt		—		(129)		—		104		—		—		(25)
Mortgage servicing rights (2)		—		—		—		—		(11,177)		—		(11,177)
Contingent consideration		—		—		—		—		4,402		—		4,402
Mortgage loans held-for-sale		—		—		—		—		—		(1,336)		(1,336)
Derivative assets — IRLCs		—		—		—		—		—		2,469		2,469
Derivative liabilities — Hedging Instruments		—		—		—		—		(214)		(758)		(972)
Total	$	9,979	$	(30,939)	$	(4,479)	$	104	$	(6,989)	$	375	$	(31,949)

(1)

Amounts primarily represent accretion to recognize interest income and interest expense using effective yields based on estimated fair values for trust assets and trust liabilities.

(2)

Included in loss on MSRs, net in the consolidated statements of operations and comprehensive (loss) earnings.

The following tables present the changes in recurring fair value measurements included in net earnings for the nine months ended September 30, 2018 and 2017:


	Recurring Fair Value Measurements
	Changes in Fair Value Included in Net Earnings
	For the Nine Months Ended September 30, 2018
					Change in Fair Value of
	Interest		Interest		Net Trust			Long-term		Other Revenue		Gain on Sale
	Income (1)		Expense (1)		Assets			Debt		and Expense		of Loans, net		Total
Securitized mortgage collateral	$	24,071	$	—	$	39,658		$	—	$	—	$	—	$	63,729
Securitized mortgage borrowings		—		(50,684)		(42,848)			—		—		—		(93,532)
Long-term debt		—		(513)		—			697		—		—		184
Mortgage servicing rights (2)		—		—		—			—		4,127		—		4,127
Mortgage loans held-for-sale		—		—		—			—		—		(12,182)		(12,182)
Derivative assets — IRLCs		—		—		—			—		—		(539)		(539)
Derivative liabilities — Hedging Instruments		—		—		—			—		(85)		198		113
Total	$	24,071	$	(51,197)	$	(3,190)	(3)	$	697	$	4,042	$	(12,523)	$	(38,100)

(1)

Amounts primarily represent accretion to recognize interest income and interest expense using effective yields based on estimated fair values for trust assets and trust liabilities.

(2)

Included in loss on MSRs, net in the consolidated statements of operations and comprehensive (loss) earnings.

(3)

For the nine months ended September 30, 2018, change in the fair value of net trust assets, excluding REO was $3.2 million.


	Recurring Fair Value Measurements
	Changes in Fair Value Included in Net Earnings
	For the Nine Months Ended September 30, 2017
					Change in Fair Value of
	Interest		Interest		Net Trust			Long-term		Other Revenue		Gain on Sale
	Income (1)		Expense (1)		Assets			Debt		and Expense		of Loans, net		Total
Securitized mortgage collateral	$	39,564	$	—	$	219,604		$	—	$	—	$	—	$	259,168
Securitized mortgage borrowings		—		(108,010)		(221,510)			—		—		—		(329,520)
Long-term debt		—		(631)		—			(2,657)		—		—		(3,288)
Mortgage servicing rights (2)		—		—		—			—		(20,038)		—		(20,038)
Contingent consideration		—		—		—			—		9,104		—		9,104
Mortgage loans held-for-sale		—		—		—			—		—		8,262		8,262
Derivative assets — IRLCs		—		—		—			—		—		846		846
Derivative liabilities — Hedging Instruments		—		—		—			—		(296)		1,616		1,320
Total	$	39,564	$	(108,641)	$	(1,906)	(3)	$	(2,657)	$	(11,230)	$	10,724	$	(74,146)

(1)

Amounts primarily represent accretion to recognize interest income and interest expense using effective yields based on estimated fair values for trust assets and trust liabilities.

(2)

Included in loss on MSRs, net in the consolidated statements of operations and comprehensive (loss) earnings.

(3)

For the nine months ended September 30, 2017, change in the fair value of net trust assets, excluding REO was $1.9 million.

The following is a description of the measurement techniques for items recorded at estimated fair value on a recurring basis.

Mortgage servicing rights—The Company elected to carry its MSRs arising from its mortgage loan origination operation at estimated fair value. The fair value of MSRs is based upon market prices for similar instruments and a discounted cash flow model. The valuation model incorporates assumptions that market participants would use in estimating the fair value of servicing. These assumptions include estimates of prepayment speeds, discount rate, cost to service, escrow account earnings, contractual servicing fee income, prepayment and late fees, among other considerations. Mortgage servicing rights are considered a Level 3 measurement at September 30, 2018.

Mortgage loans held-for-sale—The Company elected to carry its mortgage loans held-for-sale originated or acquired at estimated fair value. Fair value is based on quoted market prices, where available, prices for other traded mortgage loans with similar characteristics, and purchase commitments and bid information received from market participants. Given the meaningful level of secondary market activity for mortgage loans, active pricing is available for similar assets and accordingly, the Company classifies its mortgage loans held-for-sale as a Level 2 measurement at September 30, 2018.

Securitized mortgage collateral—The Company elected to carry its securitized mortgage collateral at fair value. These assets consist primarily of non-conforming mortgage loans securitized between 2002 and 2007. Fair value measurements are based on the Company’s internal models used to compute the net present value of future expected cash flows with observable market participant assumptions, where available. The Company’s assumptions include its expectations of inputs that other market participants would use in pricing these assets. These assumptions include judgments about the underlying collateral, prepayment speeds, estimated future credit losses, forward interest rates, investor yield requirements and certain other factors. As of September 30, 2018, securitized mortgage collateral had UPB of $3.7 billion, compared to an estimated fair value on the Company’s balance sheet of $3.3 billion. The aggregate UPB exceeds the fair value by $0.4 billion at September 30, 2018. As of September 30, 2018, the UPB of loans 90 days or more past due was $0.4 billion compared to an estimated fair value of $0.2 billion. The aggregate UPB of loans 90 days or more past due exceed the fair value by $0.2 billion at September 30, 2018. Securitized mortgage collateral is considered a Level 3 measurement at September 30, 2018.

Securitized mortgage borrowings—The Company elected to carry its securitized mortgage borrowings at fair value. These borrowings consist of individual tranches of bonds issued by securitization trusts and are primarily backed by non-conforming mortgage loans. Fair value measurements include the Company’s judgments about the underlying collateral and assumptions such as prepayment speeds, estimated future credit losses, forward interest rates, investor yield requirements and certain other factors. As of September 30, 2018, securitized mortgage borrowings had an outstanding principal balance of $3.7 billion, net of $2.2 billion in bond losses, compared to an estimated fair value of $3.3 billion. The aggregate outstanding principal balance exceeds the fair value by $0.4 billion at September 30, 2018. Securitized mortgage borrowings are considered a Level 3 measurement at September 30, 2018.

Contingent consideration—Contingent consideration was applicable to the acquisition of CCM and was estimated and recorded at fair value at the acquisition date as part of purchase price consideration. Additionally, each reporting period, the Company estimated the change in fair value of the contingent consideration and any change in fair value is recognized in the Company’s consolidated statements of operations and comprehensive (loss) earnings if it is determined to not be a measurement period adjustment. The estimate of the fair value of contingent consideration required significant judgment and assumptions to be made about future operating results, discount rates and probabilities of various projected operating result scenarios. In the fourth quarter of 2017, the earn-out period ended and the remaining $554 thousand in contingent consideration payments were paid during the three months ended March 31, 2018. Contingent consideration was considered a Level 3 measurement at September 30, 2017, and as of September 30, 2018, we have no further obligations related to contingent consideration.

Long-term debt—The Company elected to carry its remaining long-term debt (consisting of junior subordinated notes) at fair value. These securities are measured based upon an analysis prepared by management, which considered the Company’s own credit risk, including settlements with trust preferred debt holders and discounted cash flow analysis. As of September 30, 2018, long-term debt had UPB of $62.0 million compared to an estimated fair value of $46.7 million. The aggregate UPB exceeds the fair value by $15.3 million at September 30, 2018. The long-term debt is considered a Level 3 measurement at September 30, 2018.

Derivative assets and liabilities, lending—The Company’s derivative assets and liabilities are carried at fair value as required by GAAP and are accounted for as free standing derivatives. The derivatives include IRLCs with prospective residential mortgage borrowers whereby the interest rate on the loan is determined prior to funding and the borrowers have locked in that interest rate. These commitments are determined to be derivative instruments in accordance with GAAP. The derivatives also include hedging instruments (typically TBA MBS) used to hedge the fair value changes associated with changes in interest rates relating to its mortgage lending originations as well as mortgage servicing rights. The Company hedges the period from the interest rate lock (assuming a fall-out factor) to the date of the loan sale. The estimated fair value of IRLCs are based on underlying loan types with similar characteristics using the TBA MBS market, which is actively quoted and easily validated through external sources. The data inputs used in this valuation include, but are not limited to, loan type, underlying loan amount, note rate, loan program and expected sale date of the loan, adjusted for current market conditions. These valuations are adjusted at the loan level to consider the servicing release premium and loan pricing adjustments specific to each loan. For all IRLCs, the base value is then adjusted for the anticipated Pull-through Rate. The anticipated Pull-through Rate is an unobservable input based on historical experience, which results in classification of IRLCs as a Level 3 measurement at September 30, 2018.

The fair value of the Hedging Instruments is based on the actively quoted TBA MBS market using observable inputs related to characteristics of the underlying MBS stratified by product, coupon and settlement date. Therefore, the Hedging Instruments are classified as a Level 2 measurement at September 30, 2018.

The following table includes information for the derivative assets and liabilities, lending for the periods presented:


					Total Gains (Losses)				Total Gains (Losses)
	Notional Amount				For the Three Months Ended				For the Nine Months Ended
	September 30,		December 31,		September 30,				September 30,
	2018		2017		2018		2017		2018		2017
Derivative – IRLC's (1)	$	236,115	$	398,225	$	(720)	$	2,469	$	(539)	$	846
Derivative – TBA MBS (2)		155,205		687,500		759		(2,570)		10,034		(3,941)

(1)

Amounts included in gain on sale of loans, net within the accompanying consolidated statements of operations and comprehensive (loss) earnings.

(2)

Amounts included in gain on sale of loans, net and gain (loss) on mortgage servicing rights, net within the accompanying consolidated statements of operations and comprehensive (loss) earnings.

Nonrecurring Fair Value Measurements

The Company is required to measure certain assets and liabilities at estimated fair value from time to time. These fair value measurements typically result from the application of specific accounting pronouncements under GAAP. The fair value measurements are considered nonrecurring fair value measurements under FASB ASC 820-10.

The following tables present financial and non-financial assets and liabilities measured using nonrecurring fair value measurements at September 30, 2018 and 2017, respectively:


	Nonrecurring Fair Value Measurements						Total Losses (1)		Total Losses (1)
	September 30, 2018						For the Three Months Ended		For the Nine Months Ended
	Level 1		Level 2		Level 3		September 30, 2018		September 30, 2018
REO (2)	$	—	$	1,982	$	—	$	(649)	$	(46)
Deferred charge (3)		—		—		—		—		—
Intangible assets		—		—		380		(4,897)		(18,347)
Goodwill		—		—		—		(29,925)		(104,587)

(1)

Total losses reflect losses from all nonrecurring measurements during the period.

(2)

Balance represents REO at September 30, 2018, which have been impaired subsequent to foreclosure. For the three and nine months ended September 30, 2018, the Company recorded $649 thousand and $46 thousand, respectively, in losses related to changes in net realizable value (NRV) of properties. Losses represent impairment of the NRV attributable to an increase in state specific loss severities on properties held during the period, which resulted in a decrease to NRV.

(3)

With the adoption of ASU 2016-16 on January 1, 2018, $7.8 million in deferred charge was eliminated with a cumulative effect adjustment to opening retained earnings.


	Nonrecurring Fair Value Measurements						Total Gains (Losses) (1)		Total Gains (Losses) (1)
	September 30, 2017						For the Three Months Ended		For the Nine Months Ended
	Level 1		Level 2		Level 3		September 30, 2017		September 30, 2017
REO (2)	$	—	$	2,870	$	—	$	2,734	$	8,484
Deferred charge (3)		—		—		8,094		(71)		(591)

(1)

Total gains (losses) reflect losses from all nonrecurring measurements during the period.

(2)

Balance represents REO at September 30, 2017 which has been impaired subsequent to foreclosure. For the three and nine months ended September 30, 2017, the Company recorded $2.7 million and $8.5 million, respectively, in gains which represent recovery of the NRV attributable to an improvement in state specific loss severities on properties held during the period which resulted in an increase to NRV.

(3)

For the three and nine months ended September 30, 2017, the Company recorded $71 thousand and $591 thousand in income tax expense resulting from impairment write-downs of deferred charge based on changes in estimated cash flows and lives of the related mortgages retained in the securitized mortgage collateral.

Real estate owned—REO consists of residential real estate acquired in satisfaction of loans. Upon foreclosure, REO is adjusted to the estimated fair value of the residential real estate less estimated selling and holding costs, offset by expected contractual mortgage insurance proceeds to be received, if any. Subsequently, REO is recorded at the lower of carrying value or estimated fair value less costs to sell. REO balance representing REOs which have been impaired subsequent to foreclosure are subject to nonrecurring fair value measurement and included in the nonrecurring fair value measurements tables. Fair values of REO are generally based on observable market inputs, and are considered Level 2 measurements at September 30, 2018.

Deferred charge— Deferred charge represented the deferral of income tax expense on inter-company profits that resulted from the sale of mortgages from taxable subsidiaries to IMH in prior years. The Company evaluated the deferred charge for impairment quarterly using internal estimates of estimated cash flows and lives of the related mortgages retained in the securitized mortgage collateral. If the deferred charge was determined to be impaired, it was recognized as a component of income tax expense. On January 1, 2018, the Company adopted ASU 2016-16, which resulted in a $7.8 million cumulative effect adjustment to opening retained earnings eliminating the remaining deferred charge on the balance sheet. Deferred charge was considered a Level 3 measurement at September 30, 2018.

Intangible assets— The methodology used to determine the fair value as well as measure potential impairment of trademarks includes assumptions with inherent uncertainty, including projected sales volumes and related projected revenues, long-term growth rates, royalty rates that a market participant might assume and judgments regarding the factors to develop an applied discount rate. The carrying value of intangible assets is at risk of impairment if future projected usage, revenues or long-term growth rates are lower than those currently projected, or if factors used in the development of a discount rate result in the application of a higher discount rate. As the results of the Company’s testing indicated that the carrying values of certain of these assets would not be recoverable, we recorded intangible asset impairment of approximately $4.9 million during the quarter ended September 30, 2018. The intangible assets are considered Level 3 nonrecurring fair value measurements at September 30, 2018.

Goodwill— For goodwill, the determination of fair value of a reporting unit involves, among other things, application of various approaches, which include developing forecasts of future cash flows with a number of assumptions including but not limited to, origination and margin projections, growth and terminal value projections, and judgements regarding the factors to develop discount rates and cost of capital. The Company reviews its goodwill for impairment at least annually as of December 31 or more frequently if facts and circumstances indicate that it is more likely than not that the fair value of a reporting unit that has goodwill is less than its carrying value. The Company compared the fair value of its net assets using three methodologies (two income approaches and one market approach), to the carrying value and determined that its goodwill was impaired. As a result, we recorded an impairment charge of $29.9 million related to goodwill during the quarter ended September 30, 2018. Goodwill is considered a Level 3 nonrecurring fair value measurement at September 30, 2018.