21. 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

•

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:

•

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

•

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.

•

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.

The Partnership early adopted ASU 2018-13, “Fair Value Measurement (Topic 820),” that modified required disclosures related to fair value measurements effective September 30, 2018. The modified disclosures are incorporated in the disclosures within this note.

The following are descriptions of the valuation methodologies used for the Partnership’s assets and liabilities measured at fair value.

Investments in MRBs and Bond Purchase Commitments

The fair value of the Partnership’s investments in MRBs and bond purchase commitments at September 30, 2018 and December 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 MRBs and price quotes for the MRBs are not available. The valuation methodology of the Partnership’s third-party pricing service incorporates commonly used market pricing methods. It considers the underlying characteristics of each MRB as well as other quantitative and qualitative characteristics including, but not limited to, market interest rates, legal structure of the borrower, collateral, seniority to other obligations, operating results of the underlying property, geographic location, and property quality. These characteristics are used to estimate an estimated effective yield for each MRB. The MRB fair value is estimated using a discounted cash flow and yield to maturity or call analysis by applying the effective yield to contractual cash flows. Significant increases (decreases) in the effective yield would have resulted in a significantly lower (higher) fair value estimate. Changes in fair value due to an increase or decrease in the effective yield do not impact the Partnership’s cash flows.

The Partnership evaluates pricing data received from the third-party pricing service by evaluating consistency with information from either the third-party pricing service or public sources. The fair value estimates of the MRBs are based largely on unobservable inputs believed to be used by market participants and requires the use of judgment on the part of the third-party pricing service and the Partnership. Due to the judgments involved, the fair value measurements of the Partnership’s investments in MRBs and bond purchase commitments are categorized as a Level 3 input. At September 30, 2018, the range of effective yields on the individual MRBs was 3.5% to 9.3% per annum, with a weighted average effective yield of 4.9% when weighted by the principal outstanding of MRBs as of the reporting date. At December 31, 2017, the range of effective yields on the individual MRBs and bond purchase commitments was 2.9% to 8.8% per annum.

Investments in Public Housing Capital Fund Trust Certificates

The fair value of the Partnership’s investment in PHC Certificates at September 30, 2018 and December 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 PHC 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 Certificate 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 reviews the inputs used by the primary third-party pricing service by reviewing source information and reviews the methodology for reasonableness. The Partnership also engages a second third-party pricing service to confirm the values developed by the primary third-party pricing service. The valuation methodologies used by the third-party pricing services 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.

Taxable MRBs

The fair value of the Partnership’s taxable MRBs at September 30, 2018 and December 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 taxable MRBs and price quotes are not available. The valuation methodology of the Partnership’s third-party pricing service incorporates commonly used market pricing methods. It considers the underlying characteristics of each taxable MRB as well as other quantitative and qualitative characteristics including, but not limited to, market interest rates, legal structure of the borrower, collateral, subordination to other obligations, operating results of the underlying property, geographic location, and property quality. These characteristics are used to estimate an estimated effective yield for each MRB. The taxable MRB fair value is estimated using a discounted cash flow and yield to maturity or call analysis by applying the effective yield to contractual cash flows. Significant increases (decreases) in the effective yield would have resulted in a significantly lower (higher) fair value estimate. Changes in fair value due to an increase or decrease in the effective yield do not impact the Partnership’s cash flows.

The Partnership evaluates pricing data received from the third-party pricing service by evaluating consistency with information from either the third-party pricing service or public sources. The fair value estimates of the taxable MRBs are based largely on unobservable inputs believed to be used by market participants and requires the use of judgment on the part of the third-party pricing service and management. Due to the judgments involved, the fair value measurement of the Partnership’s investments in taxable MRBs is categorized as a Level 3 input. At September 30, 2018, the range of effective yields on the individual taxable MRBs was 8.3% to 9.5% per annum, with a weighted average effective yield of 9.1% when weighted by the principal outstanding of taxable MRBs as of the reporting date. At December 31, 2017, the range of effective yields on the individual taxable MRBs was 7.9% to 9.2% per annum.

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 financings 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 September 30, 2018 are summarized as follows:

	Fair Value Measurements at September 30, 2018
Description	Assets (Liabilities) at Fair Value			Quoted Prices in Active Markets for Identical Assets (Liabilities) (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets and Liabilities
Mortgage revenue bonds, held in trust	$	678,700,712		$	-	$	-	$	678,700,712
Mortgage revenue bonds		63,765,212			-		-		63,765,212
Bond purchase commitments (reported within other assets)		1,046,445			-		-		1,046,445
PHC Certificates		48,741,478			-		-		48,741,478
Taxable mortgage revenue bonds (reported within other assets)		2,339,902			-		-		2,339,902
Derivative instruments (reported within other assets)		1,063,975			-		-		1,063,975
Derivative swap liability		(26,798	)		-		-		(26,798	)
Total Assets and Liabilities at Fair Value, net	$	795,630,926		$	-	$	-	$	795,630,926

The following tables summarize the activity related to Level 3 assets and liabilities for the three and nine months ended September 30, 2018:

	For the Three Months Ended September 30, 2018
	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 July 1, 2018	$	767,629,337		$	994,685	$	49,070,710		$	2,357,952		$	897,958	$	820,950,642
Total gains (losses) (realized/unrealized)
Included in earnings (interest income and interest expense)		36,126			-		(19,274	)		-			91,679		108,531
Included in earnings (impairment of securities)		-			-		(309,958	)		-			-		(309,958	)
Included in other comprehensive (loss) income		(6,729,317	)		51,760		-			(15,192	)		-		(6,692,749	)
Purchases		-			-		-			-			-		-
Settlements		(18,470,222	)		-		-			(2,858	)		47,540		(18,425,540	)
Ending Balance September 30, 2018	$	742,465,924		$	1,046,445	$	48,741,478		$	2,339,902		$	1,037,177	$	795,630,926
Total amount of gains (losses) for the period included in earnings attributable to the change in unrealized gains (losses) relating to assets or liabilities held on September 30, 2018	$	-		$	-	$	(309,958	)	$	-		$	91,679	$	(218,279	)

⁽¹⁾	Mortgage revenue bonds includes both bonds held in trust as well as those held by the Partnership.

⁽²⁾	Interest rate derivatives include derivative instruments reported in other assets as well as derivative swap liabilities.

	For the Nine Months Ended September 30, 2018
	Fair Value Measurements Using Significant
	Unobservable Inputs (Level 3)
	Mortgage Revenue Bonds ⁽¹⁾			Bond Purchase Commitments			PHC Certificates			Taxable Mortgage Revenue Bonds			Interest Rate Derivatives ⁽²⁾			Total
Beginning Balance January 1, 2018	$	788,621,707		$	3,002,540		$	49,641,588		$	2,422,459		$	(229,631	)	$	843,458,663
Total gains (losses) (realized/unrealized)
Included in earnings (interest income and interest expense)		108,661			-			(57,822	)		-			1,088,060			1,138,899
Included in earnings (impairment of securities)		-			-			(1,141,020	)		-			-			(1,141,020	)
Included in other comprehensive (loss) income		(24,048,645	)		(1,956,095	)		525,446			(49,173	)		-			(25,528,467	)
Purchases		19,540,000			-			-			-			-			19,540,000
Settlements		(41,755,799	)		-			(226,714	)		(33,384	)		178,748			(41,837,149	)
Ending Balance September 30, 2018	$	742,465,924		$	1,046,445		$	48,741,478		$	2,339,902		$	1,037,177		$	795,630,926
Total amount of gains (losses) for the period included in earnings attributable to the change in unrealized gains (losses) relating to assets or liabilities held on September 30, 2018	$	-		$	-		$	(1,141,020	)	$	-		$	1,088,060		$	(52,960	)

⁽¹⁾	Mortgage revenue bonds includes both bonds held in trust as well as those held by the Partnership. The beginning balance also in includes the cumulative effect of accounting change related to the adoption of ASU 2017-08 effective January 1, 2018.

⁽²⁾	Interest rate derivatives include derivative instruments reported in other assets as well as derivative swap liabilities.

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

	Fair Value Measurements at December 31, 2017
Description	Assets (Liabilities) at Fair Value			Quoted Prices in Active Markets for Identical Assets (Liabilities) (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets and Liabilities
Mortgage revenue bonds, held in trust	$	710,867,447		$	-	$	-	$	710,867,447
Mortgage revenue bonds		77,971,208			-		-		77,971,208
Bond purchase commitments (reported within other assets)		3,002,540			-		-		3,002,540
PHC Certificates		49,641,588			-		-		49,641,588
Taxable mortgage revenue bonds (reported within other assets)		2,422,459			-		-		2,422,459
Derivative instruments (reported within other assets)		597,221			-		-		597,221
Derivative swap liability		(826,852	)		-		-		(826,852	)
Total Assets and Liabilities at Fair Value, net	$	843,675,611		$	-	$	-	$	843,675,611

The following tables summarize the activity related to Level 3 assets and liabilities for the three and nine months ended September 30, 2017:

	For the Three Months Ended September 30, 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 July 1, 2017	$	768,129,658		$	3,165,172	$	55,791,371		$	3,931,471		$	(761,648	)	$	830,256,024
Total gains (losses) (realized/unrealized)
Included in earnings (interest income and interest expense)		53,117		-			(14,129	)	-				(66,917	)		(27,929	)
Included in other comprehensive (loss) income		1,501,150			189,875		309,808			2,356		-				2,003,189
Purchases		12,471,000		-		-			-				59,217			12,530,217
Settlements		(2,841,047	)	-			(1,173,302	)		(4,066	)	-				(4,018,415	)
Ending Balance September 30, 2017	$	779,313,878		$	3,355,047	$	54,913,748		$	3,929,761		$	(769,348	)	$	840,743,086
Total amount of losses for the period included in earnings attributable to the change in unrealized gains (losses) relating to assets or liabilities held on September 30, 2017	$	-		$	-	$	-		$	-		$	(66,917	)	$	(66,917	)

⁽¹⁾	Mortgage revenue bonds includes both bonds held in trust as well as those held by the Partnership.

⁽²⁾	Interest rate derivatives include derivative instruments reported in other assets as well as derivative swap liabilities.

	For the Nine Months Ended September 30, 2017
	Fair Value Measurements Using Significant
	Unobservable Inputs (Level 3)
	Mortgage Revenue Bonds ⁽¹⁾			Bond Purchase Commitments		PHC Certificates			Taxable Mortgage Revenue 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)		159,707		-			(45,846	)	-				(369,686	)		(255,825	)
Included in other comprehensive (loss) income		31,731,448			955,598		(588,172	)		(122,908	)	-				31,975,966
Purchases		72,056,000		-		-			-				556,017			72,612,017
Settlements		(4,844,328	)	-			(1,610,302	)		(31,930	)	-				(6,486,560	)
Ending Balance September 30, 2017	$	779,313,878		$	3,355,047	$	54,913,748		$	3,929,761		$	(769,348	)	$	840,743,086
Total amount of losses for the period included in earnings attributable to the change in unrealized gains (losses) relating to assets or liabilities held on September 30, 2017	$	-		$	-	$	-		$	-		$	(369,686	)	$	(369,686	)

⁽¹⁾	Mortgage revenue bonds includes both bonds held in trust as well as those held by the Partnership.

⁽²⁾	Interest rate derivatives include derivative instruments reported in other assets as well as derivative swap liabilities

Total gains and loss included in earnings for the interest rate derivatives are reported as interest expense in the condensed consolidated statements of operations.

In September 2018, the Partnership determined that the land held for development in Gardner, KS was impaired. The Partnership recorded an impairment charge of $150,000 in the third quarter of 2018, which represents the difference between the Partnership’s carrying value and the estimated fair value of the land.

At September 30, 2018 and December 31, 2017, the Partnership utilized a third-party pricing service to determine the fair value of the Partnership’s financial liabilities, which are indicative of market prices. The valuation methodology of the Partnership’s third-party pricing service incorporates commonly used market pricing methods. It considers the underlying characteristics of each financial liability as well as other quantitative and qualitative characteristics including, but not limited to, market interest rates, legal structure, seniority to other obligations, operating results of the underlying assets, and asset quality. The financial liabilities values are then estimated using a discounted cash flow and yield to maturity or call analysis.

The Partnership evaluates pricing data received from the third-party pricing service, including consideration of current market interest rates, quantitative and qualitative characteristics of the underlying collateral, and other information from either the third-party pricing service or public sources. The fair value estimates of these financial liabilities are based largely on unobservable inputs believed to be used by market participants and requires the use of judgment on the part of the third-party pricing service and the Partnership. Due to the judgments involved, the fair value measurements of the Partnership’s financial liabilities are categorized as a Level 3 input. The TEBS and variable-rate TOB debt financings are credit enhanced by Freddie Mac and Deutsche Bank, respectively. The table below summarizes the fair value of the financial liabilities at September 30, 2018 and December 31, 2017:

	September 30, 2018				December 31, 2017
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial Liabilities:
Debt financing and LOCs	$	573,183,744	$	578,207,938	$	608,328,347	$	618,412,150
Mortgages payable and other secured financing		27,681,596		27,804,110		35,540,174		35,767,924