Note 8—Fair Value

We use fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Assets and liabilities recorded at fair value on a recurring basis are presented in the first table below in this Note. From time to time, we may be required to measure at fair value other assets on a nonrecurring basis such as certain loans held for investment or investments in partnerships. These nonrecurring fair value adjustments typically involve application of lower-of-cost-or-market accounting or write-downs of individual assets.

Fair Value Hierarchy

The Company measures the fair value of its assets and liabilities based upon their contractual terms and using relevant market information. A description of the methods used by the Company to measure fair value is provided below. Fair value measurements are subjective in nature, involve uncertainties and often require the Company to make significant judgments. Changes in assumptions could significantly affect the Company’s measurement of fair value.

GAAP establishes a three-level hierarchy that prioritizes inputs into the valuation techniques used to measure fair value. Fair value measurements associated with assets and liabilities are categorized into one of the following levels of the hierarchy based upon how observable the valuation inputs are that are used in the fair value measurements.

Level 1: Valuation is based upon quoted prices in active markets for identical instruments.

Level 2: Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which significant inputs or significant value drivers are observable in active markets.

Level 3: Valuation is generated from techniques that use significant assumptions that are not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability.

Recurring Changes in Fair Value

The following tables present the carrying amounts of assets and liabilities that are measured at fair value on a recurring basis by instrument type and based upon the level of the fair value hierarchy within which fair value measurements of our assets and liabilities are categorized:


	At
	March 31,		Fair Value Measurements
(in thousands)	2020		Level 1		Level 2		Level 3
Assets:
Investments in debt securities	$	29,645	$	─	$	─	$	29,645
Loans held for investment		1,271		─		─		1,271
Derivative instruments		924		─		924		─

Liabilities:
Derivative instruments	$	2,312	$	─	$	2,312	$	─


	At
	December 31,		Fair Value Measurements
(in thousands)	2019		Level 1		Level 2		Level 3
Assets:
Investments in debt securities	$	31,365	$	─	$	─	$	31,365
Loans held for investment		500		─		─		500
Derivative instruments		597		─		597		─

Liabilities:
Derivative instruments	$	117	$	─	$	117	$	─

Changes in Fair Value

Changes in the fair value of assets and liabilities that are measured at fair value on a recurring basis and that are categorized as Level 3 within the fair value hierarchy are attributed in the following table to identified activities that occurred during the three months ended March 31, 2020:


	Investments
	in Debt		Loans Held for
(in thousands)	Securities		Investment
Balance, January 1, 2020	$	31,365	$	500
Net losses included in earnings (1)		─		(9)
Net change in AOCI (2)		(1,763)		─
Impact from loan originations / advances		─		780
Impact from settlements (3)		43		─
Balance, March 31, 2020	$	29,645	$	1,271

⁽¹⁾

This amount represents $9 thousand of unrealized losses recognized during this reporting period in connection with the Company’s loan investment held at March 31, 2020. This amount is classified as “net losses on loans and extinguishment of liabilities” in the Company’s Consolidated Statement of Operations.

⁽²⁾

This amount represents $1.8 million of net unrealized losses recognized during this reporting period in connection with the Company’s bond investments.

⁽³⁾

This impact considers the effect of principal payments received and amortization of cost basis adjustments.


	Investments
	in Debt		Derivative
(in thousands)	Securities		Assets
Balance, January 1, 2019	$	97,190	$	1,130
Net losses included in earnings		─		(152)
Net change in AOCI (1)		(3,165)		─
Impact from sales or redemptions		(12,590)		─
Impact from settlements (2)		(333)		(202)
Balance, March 31, 2019	$	81,102	$	776

⁽¹⁾

This amount represents the reclassification into the Consolidated Statements of Operations of $3.6 million of net fair value gains related to bonds that were sold or redeemed during this reporting period. This decline was partially offset by $0.4 million of net unrealized holding gains recognized during the period in connection with the Company’s bond investments.

⁽²⁾

This impact considers the effect of principal payments received and amortization of cost basis adjustments. Included in this amount is $0.3 million of cumulative transition adjustment to retained earnings that was recognized in connection with the Company’s adoption of ASU No. 2017-08, “Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-10): Premium Amortization on Purchased Callable Debt Securities” on January 1, 2019.

The following table provides information about the amount of realized and unrealized (losses) gains that were reported in the Company’s Consolidated Statements of Operations for the three months ended March 31, 2019, related to activity presented in the preceding table:



	Net gains on		Net losses on
(in thousands)	bonds (1)		derivatives (2)
Change in unrealized losses related to assets and liabilities held at March 31, 2019	$	─	$	(72)
Change in unrealized losses related to assets and liabilities held at January 1, 2019, but settled during 2019		─		(80)
Additional realized gains recognized		3,571		148
Total net gains (losses) reported in earnings	$	3,571	$	(4)

⁽¹⁾

Amounts are classified as “Net gains on bonds” in the Company’s Consolidated Statements of Operations.

⁽²⁾

Amounts are classified as “Net losses on derivatives” in the Company’s Consolidated Statements of Operations.

Fair Value Measurements of Instruments That Are Classified as Level 3

Significant unobservable inputs presented in the tables that follow are those we consider significant to the fair value of the Level 3 asset or liability. We consider unobservable inputs to be significant if, by their exclusion, the fair value of the Level 3 asset or liability would be impacted by a predetermined percentage change, or based on qualitative factors, such as nature of the instrument, type of valuation technique used and the significance of the unobservable inputs relative to other inputs used within the valuation. Following is a description of the significant unobservable inputs that are referenced in the tables below:

Market yield – is a market rate of return used to calculate the present value of future expected cash flows to arrive at the fair value of an instrument. The market yield typically consists of a benchmark rate component and a risk premium component. The benchmark rate component, for example, MMD or SIFMA, is generally observable within the market and is necessary to appropriately reflect the time value of money. The risk premium component reflects the amount of compensation market participants require due to the uncertainty inherent in the instrument’s cash flows resulting from risks such as credit and liquidity. A significant decrease in this input in isolation would result in a significantly higher fair value measurement.

Capitalization rate – is calculated as the ratio between the NOI produced by a commercial real estate property and the price for the asset. A significant decrease in this input in isolation would result in a significantly higher fair value measurement.

NOI annual growth rate – is the amount of future growth in NOI that the Company projects each property to generate on an annual basis over the 10‑year projection period. These annual growth estimates take into account the Company’s expectation about the future increases, or decreases, in rental rates, vacancy rates, bad debt expense, concessions and operating expenses for each property. Generally, an increase in NOI will result in an increase to the fair value of the property.

Valuation technique weighting factors – represent factors that, in the aggregate, sum to 100% and that are individually applied to two or more indications of fair value considering the reasonableness of the range indicated by those results.

Contract or bid prices – represents a third-party sale agreement or purchase offer executed in connection with the pending sale of an affordable housing property that secures one of the Company’s bond investments. In instances where multiple purchase offers have been received an average of the offers received is utilized. Estimated proceeds from the sale, or average offers, of such property that are determined to be allocable to a bond investment are used to measure the investment’s fair value at a given reporting date.

The tables that follow provide quantitative information about the valuation techniques and the range and weighted-average of significant unobservable inputs used in the valuation of substantially all of our Level 3 assets and liabilities measured at fair value on a recurring basis for which we use an internal model to measure fair value. The significant unobservable inputs for Level 3 assets and liabilities that are valued using dealer pricing are not included in the tables, as the specific inputs applied are not provided by the dealer.

Fair Value Measurement at March 31, 2020

Significant

Valuation

Unobservable

Weighted

(dollars in thousands)

Fair Value

Techniques

Inputs (1)

Range (1)

Average

Recurring Fair Value Measurements:

Investments in debt securities:

Infrastructure Bond

23,531

Discounted cash flow

Market yield

7.8

N/A

Multifamily tax-exempt bonds

Subordinated cash flow

6,114

Discounted cash flow

Market yield

7.2

N/A

Capitalization rate

6.2

N/A

Loans held for investment

1,271

Discounted cash flow

Market yield

8.4

N/A

⁽¹⁾

Unobservable inputs reflect information that is not based upon independent sources that are readily available. These inputs are based upon assumptions and internally generated data made by the Company, which may include significant judgment that has been developed based upon available information from third-party sources or dealers about what a market participant would use in valuing the asset.

Fair Value Measurement at December 31, 2019

Significant

Valuation

Unobservable

Weighted

(dollars in thousands)

Fair Value

Techniques

Inputs (1)

Range (1)

Average (2)

Recurring Fair Value Measurements:

Investments in debt securities:

Infrastructure Bond

25,339

Discounted cash flow

Market yield

7.0

N/A

Multifamily tax-exempt bonds

Subordinated cash flow

6,026

Discounted cash flow

Market yield

7.3

N/A

Capitalization rate

6.2

N/A

Valuation technique weighting factors:

• NOI annual growth rate (50% weighting factor)

0.7

N/A

• Bid price (50% weighting factor)

16,611

N/A

Loans held for investment

500

Discounted cash flow

Market yield

8.0

⁽¹⁾

⁽²⁾

Weighted-averages are calculated using outstanding UPB for cash instruments, such as loans and securities, and notional amounts for derivative instruments.

Nonrecurring Changes in Fair Value

There were no nonrecurring fair value adjustments recorded for the three months ended March 31, 2020 and March 31, 2019.

Additional Disclosures Related To The Fair Value of Financial Instruments That Are Not Carried On The Consolidated Balance Sheets at Fair Value

The tables that follow provide information about the carrying amounts and fair values of those financial instruments of the Company for which fair value is not measured on a recurring basis and organizes the information based upon the level of the fair value hierarchy within which fair value measurements are categorized. Assets and liabilities that do not represent financial instruments (e.g., premises and equipment) are excluded from these disclosures.

March 31, 2020

Carrying

Fair Value

(in thousands)

Amount

Level 1

Level 2

Level 3

Assets:

Cash and cash equivalents

23,164

─

Restricted cash

7,009

─

Liabilities:

Notes payable and other debt - non-bond related

8,730

─

7,304

Revolving credit facility obligations

120,000

─

120,000

Subordinated debt issued by MFH

94,923

─

30,773

December 31, 2019

Carrying

Fair Value

(in thousands)

Amount

Level 1

Level 2

Level 3

Assets:

Cash and cash equivalents

8,555

─

Restricted cash

4,250

─

Loans held for investment

53,600

─

54,276

Liabilities:

Notes payable and other debt - non-bond related

11,828

─

10,888

Revolving credit facility obligations

94,500

─

94,500

Subordinated debt issued by MFH

95,488

─

46,934

Valuation Techniques

Cash and cash equivalents and restricted cash – The carrying value of these assets approximated fair value due to the short-term nature and negligible credit risk inherent in them.

Loans held for investment – Fair value is measured using a discounted cash flow methodology pursuant to which contractual payments are discounted based upon market yields for similar credit risks.

Notes payable and other debt – Fair value is measured by discounting contractual cash flows using a market rate of interest or by estimating the fair value of the collateral supporting a debt arrangement, taking into account credit risk.

Subordinated debt – Fair value is measured by discounting projected contractual payments of principal and interest using the instrument’s estimated market yield, which was 15.6% and 11.7% at March 31, 2020 and December 31, 2019, respectively. As outlined in the table above, at March 31, 2020, the aggregate fair value was measured at $30.8 million. At March 31, 2020, the measured fair value of this debt would have been $39.0 million and $25.2 million had its market yield been 12.1% and 19.1%, respectively. The measured fair value of this debt is inherently judgmental and based on management’s assumption of market yields. There can be no assurance that the Company could repurchase the remaining subordinated debt at the measured fair values reflected in the table above or that the debt would trade at that price.

Revolving credit facility debt obligations – Fair value of these debt obligations is measured by discounting projected contractual payments of interest and principal using an estimated market yield.