22. Fair Value of Financial Instruments

Current accounting guidance on fair value measurements establishes a framework for measuring fair value and provides for expanded disclosures about fair value measurements. The guidance:

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Defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date; and

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Establishes a three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability on the measurement date.

Inputs refer broadly to the assumptions that market participants would use in pricing the asset or liability, including assumptions about risk. To increase consistency and comparability in fair value measurements and related disclosures, the fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The three levels of the hierarchy are defined as follows:

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Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities.

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Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

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Level 3 inputs are unobservable inputs for asset or liabilities.

The categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

Following is a description of the valuation methodologies used for assets and liabilities measured at fair value.

Investments in MRBs and Bond Purchase Commitments. The fair values of the Partnership’s investments in MRBs and mortgage bond purchase commitments have each been based on a discounted cash flow or yield to maturity analysis. There is no active trading market for the MRBs and price quotes for the MRBs are not available. If available, the Partnership may also consider price quotes on similar MRBs or other information from external sources, such as pricing services. The estimates of the fair values of these MRBs, whether estimated by the Partnership or based on external sources, are based largely on unobservable inputs the Partnership believes would be used by market participants. Additionally, the calculation methodology used by the external sources and the Partnership encompasses the use of judgment in its application. To validate changes in the fair value of the Partnership’s investments in MRBs between reporting periods, the Partnership looks at the key inputs such as changes in the ‘A’ rated municipal bond rates on similar MRBs as well as changes in the operating performance of the underlying property serving as collateral for each MRB. The Partnership validates that the changes in the estimated fair value of the MRBs move with the changes in these monitored factors. Given these facts, the fair value measurement of the Partnership’s investment in MRBs is categorized as a Level 3 input. At March 31, 2017, the range of effective yields on the individual MRBs was 4.8% to 12.0% per annum. At December 31, 2016, the range of effective yields on the individual MRBs was 4.9% to 12.4% per annum.

The fair value of the bond purchase commitments is determined in the same manner as the MRBs.

Investments in Public Housing Capital Fund Trust Certificates. The fair value of the Partnership’s investment in PHC Certificates at March 31, 2017 is based upon prices obtained from a third-party pricing service, which are indicative of market prices. There is no active trading market for the trusts’ certificates owned by the Partnership. The valuation methodology of the Partnership’s third party pricing service incorporates commonly used market pricing methods. It considers the underlying characteristics of each PHC Trust as well as other quantitative and qualitative characteristics including, but not limited to, market interest rates, security ratings from rating agencies, the impact of potential political and regulatory change, and other inputs. The Partnership analyzes pricing data received from the third-party pricing service by comparing it to the Partnership’s internal valuation methodology. The Partnership’s internal valuation methodology begins with the current market yield rate for a “AAA” rated tax-free municipal bond for a term consistent with the weighted-average life of each of the Public Housing Capital Fund trusts, adjusted largely for unobservable inputs the Partnership believes would be used by market participants. The valuation methodologies used by the third-party pricing service and the Partnership encompass the use of judgment in their application. Due to the judgments involved, the fair value measurement of the Partnership’s investment in PHC Certificates is categorized as a Level 3 input.

The fair value of the Partnership’s investment in PHC Certificates at December 31, 2016 was based on a yield to maturity analysis performed by the Partnership. The Partnership’s valuation methodology begins with the current market yield rate for a “AAA” rated tax-free municipal bond for a term consistent with the weighted-average life of each of the Public Housing Capital Fund trusts, adjusted largely for unobservable inputs the Partnership believes would be used by market participants. The Partnership validates that the changes in the estimated fair value of PHC Certificates move with the changes in the market yield rates of investment grade rated mortgage revenue municipal bonds with terms of similar length. Given these facts, the fair value measurement of the Partnership’s investment in PHC Certificates is categorized as a Level 3 input. At December 31, 2016, the range of effective yields on the PHC Certificates was 4.3% to 6.0% per annum.

Taxable Bonds. The fair values of the Partnership’s investments in taxable bonds have each been based on a discounted cash flow or yield to maturity analysis. There is no active trading market for the taxable bonds and price quotes are not available. The estimates of the fair values of these taxable bonds, whether estimated by the Partnership or based on external sources, are based largely on unobservable inputs the Partnership believes would be used by market participants. Additionally, the calculation methodology used by the external sources and the Partnership encompasses the use of judgment in its application. To validate changes in the fair value of the Partnership’s investments in taxable bonds between reporting periods, management looks at the key inputs such as changes in the current market yields on similar bonds as well as changes in the operating performance of the underlying property serving as collateral for each bond. The Partnership validates that the changes in the estimated fair value of the taxable bonds move with the changes in these monitored factors. Given these facts the fair value measurement of the Partnership’s investment in taxable bonds is categorized as a Level 3 input.

Interest Rate Derivatives. The effect of the Partnership’s interest rate derivatives is to set a cap, or upper limit, on the base rate of interest paid on the Partnership’s variable rate debt equal to the notional amount of the derivative agreement. The effect of the Partnership’s interest rate swaps is to change a variable rate debt obligation to a fixed rate for that portion of the debt equal to the notional amount of the derivative agreement. The fair value of the interest rate derivatives is based on a model whose inputs are not observable and therefore is categorized as a Level 3 input. The inputs in the valuation model include three-month LIBOR rates, unobservable adjustments to account for the SIFMA index, as well as any recent interest rate cap trades with similar terms.

Assets and liabilities measured at fair value on a recurring basis at March 31, 2017 are summarized as follows:

	Fair Value Measurements at March 31, 2017
Description	Assets and Liabilities at Fair Value			Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets and Liabilities
Mortgage revenue bonds, held in trust	$	731,091,380		$	-	$	-	$	731,091,380
Mortgage revenue bonds		27,814,516			-		-		27,814,516
Bond purchase commitments (reported within other assets)		2,620,393			-		-		2,620,393
PHC Certificates		55,851,799			-		-		55,851,799
Taxable bonds (reported within other assets)		4,179,205			-		-		4,179,205
Derivative contracts (reported within other assets)		151,730			-		-		151,730
Derivative swap liability		(1,228,758	)		-		-		(1,228,758	)
Total Assets and Liabilities at Fair Value, net	$	820,480,265		$	-	$	-	$	820,480,265

The following tables summarizes the activity related to Level 3 assets and liabilities for the three months ended March 31, 2017:

	For the Three Months Ended March 31, 2017
	Fair Value Measurements Using Significant
	Unobservable Inputs (Level 3)
	Mortgage Revenue Bonds ⁽¹⁾			Bond Purchase Commitments		PHC Certificates			Taxable Bonds			Interest Rate Derivatives ⁽²⁾			Total
Beginning Balance January 1, 2017	$	680,211,051		$	2,399,449	$	57,158,068		$	4,084,599		$	(955,679	)	$	742,897,488
Total gains (losses) (realized/unrealized)
Included in earnings (interest income and interest expense)		53,355			-		(17,588	)		-			(121,349	)		(85,582	)
Included in other comprehensive (loss) income		20,170,553			220,944		(1,288,681	)		98,494			-			19,201,310
Purchases		59,585,000			-		-			-			-			59,585,000
Settlements		(1,114,063	)		-		-			(3,888	)		-			(1,117,951	)
Ending Balance March 31, 2017	$	758,905,896		$	2,620,393	$	55,851,799		$	4,179,205		$	(1,077,028	)	$	820,480,265
Total amount of losses for the period included in earnings attributable to the change in unrealized gains or losses relating to assets or liabilities held on March 31, 2017	$	-		$	-	$	-		$	-		$	(121,349	)	$	(121,349	)

⁽¹⁾ Mortgage revenue bonds includes both bonds held in trust as well as those held by the Partnership.
⁽²⁾ Interest rate derivatives include derivative contracts reported in other assets as well as derivative swap liabilities.

Assets and liabilities measured at fair value on a recurring basis at December 31, 2016 are summarized as follows:

	Fair Value Measurements at December 31, 2016
Description	Assets and Liabilities at Fair Value			Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets and Liabilities
Mortgage revenue bonds held in trust	$	590,194,179		$	-	$	-	$	590,194,179
Mortgage revenue bonds		90,016,872			-		-		90,016,872
Bond purchase commitments (reported within other assets)		2,399,449			-		-		2,399,449
PHC Certificates		57,158,068			-		-		57,158,068
Taxable bonds (reported within other assets)		4,084,599			-		-		4,084,599
Derivative contracts (reported within other assets)		383,604			-		-		383,604
Interest swap liability		(1,339,283	)		-		-		(1,339,283	)
Total Assets and Liabilities at Fair Value	$	742,897,488		$	-	$	-	$	742,897,488

The following tables summarizes the activity related to Level 3 assets and liabilities for the three months ended March 31, 2016:

	For the Three Months Ended March 31, 2016
	Fair Value Measurements Using Significant
	Unobservable Inputs (Level 3)
	Mortgage Revenue Bonds ⁽¹⁾			Bond Purchase Commitments		PHC Certificates			Taxable Bonds			Interest Rate Derivatives ⁽²⁾			Total
Beginning Balance January 1, 2016	$	583,683,137		$	5,634,360	$	60,707,290		$	4,824,060		$	(972,898	)	$	653,875,949
Total gains (losses) (realized/unrealized)
Included in earnings		-			-		-			-			(1,110,407	)		(1,110,407	)
Included in other comprehensive (loss) income		11,351,627			1,587,813		869,344			116,456			-			13,925,240
Purchases		11,500,000			-		-			-			-			11,500,000
Sale of securities		(9,747,125	)		-		-			-			(399	)		(9,747,524	)
Settlements		(411,270	)		-		(1,071,294	)		(2,412	)		-			(1,484,976	)
Ending Balance March 31, 2016	$	596,376,369		$	7,222,173	$	60,505,340		$	4,938,104		$	(2,083,704	)	$	666,958,282
Total amount of losses for the period included in earnings attributable to the change in unrealized gains or losses relating to assets or liabilities still held as of March 31, 2016	$	-		$	-	$	-		$	-		$	(1,110,407	)	$	(1,110,407	)

⁽¹⁾ Mortgage revenue bonds includes both bonds held in trust as well as those held by the Partnership.
⁽²⁾ Interest rate derivatives include derivative contracts reported in other assets as well as derivative swap liabilities.

Total gains and losses included in earnings for the periods shown above are included in the Partnership’s condensed consolidated statements of operations as interest expense.

The Partnership estimates the fair value of each financial liability using a discounted cash flow model based on the debt amortization schedules at the effective rate of interest for each period represented. This estimate of fair value is based on Level 3 inputs. The table below represents the fair value of the financial liabilities held on the condensed consolidated balance sheets at March 31, 2017 and December 31, 2016.

	March 31, 2017				December 31, 2016
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial Liabilities:
Debt financing and LOCs	$	598,123,706	$	597,301,799	$	555,199,700	$	553,083,924
Mortgages payable and other secured financing	$	51,175,060	$	51,210,197	$	51,379,512	$	51,595,281