Note 13 — Fair Value

Fair value estimates are dependent upon subjective assumptions and involve significant uncertainties resulting in variability in estimates with changes in assumptions. The following table summarizes the principal amounts, carrying values and the estimated fair values of our financial instruments (in thousands):

	March 31, 2018						December 31, 2017
	Principal / Notional Amount		Carrying Value		Estimated Fair Value		Principal / Notional Amount		Carrying Value		Estimated Fair Value
Financial assets:
Loans and investments, net	$	2,776,422	$	2,702,097	$	2,774,333	$	2,652,538	$	2,579,127	$	2,652,520
Loans held-for-sale, net	281,761		286,325		292,153		292,249		297,443		302,883
Capitalized mortgage servicing rights, net	n/a		255,732		299,392		n/a		252,608		286,073
Securities held-to-maturity, net	52,673		36,764		37,273		40,566		27,837		28,439
Derivative financial instuments	292,411		2,763		2,763		77,984		684		684

Financial liabilities:
Credit and repurchase facilities	$	629,724	$	626,063	$	628,510	$	530,938	$	528,573	$	529,992
Collateralized loan obligations	1,436,274		1,419,838		1,438,567		1,436,274		1,418,422		1,436,871
Debt fund	70,000		68,176		70,139		70,000		68,084		70,000
Senior unsecured notes	197,860		196,090		198,995		97,860		95,280		99,582
Convertible senior unsecured notes, net	243,750		232,577		254,727		243,750		231,287		254,335
Junior subordinated notes	154,336		139,760		94,638		154,336		139,590		94,215
Related party financing	—		—		—		50,000		50,000		49,682
Derivative financial instruments	57,850		300		300		291,421		1,306		1,306

Assets and liabilities disclosed at fair value are categorized based upon the level of judgment associated with the inputs used to measure their fair value. Hierarchical levels directly related to the amount of subjectivity associated with the inputs to fair valuation of these assets and liabilities are as follows:

Level 1—Inputs are unadjusted and quoted prices exist in active markets for identical assets or liabilities, such as government, agency and equity securities.

Level 2—Inputs (other than quoted prices included in Level 1) are observable for the asset or liability through correlation with market data. Level 2 inputs may include quoted market prices for a similar asset or liability, interest rates and credit risk. Examples include non-government securities, certain mortgage and asset-backed securities, certain corporate debt and certain derivative instruments.

Level 3—Inputs reflect our best estimate of what market participants would use in pricing the asset or liability and are based on significant unobservable inputs that require a considerable amount of judgment and assumptions. Examples include certain mortgage and asset-backed securities, certain corporate debt and certain derivative instruments.

Determining which category an asset or liability falls within the hierarchy requires significant judgment and we evaluate our hierarchy disclosures each quarter.

The following is a description of the valuation techniques used to measure fair value and the general classification of these instruments pursuant to the fair value hierarchy.

Loans and investments, net. Fair values of loans and investments that are not impaired are estimated using Level 3 inputs based on direct capitalization rate and discounted cash flow methodologies using discount rates, which, in our opinion, best reflect current market interest rates that would be offered for loans with similar characteristics and credit quality. Fair values of impaired loans and investments are estimated using Level 3 inputs that require significant judgments, which include assumptions regarding discount rates, capitalization rates, creditworthiness of major tenants, occupancy rates, availability of financing, exit plan and other factors.

Loans held-for-sale, net. Consists of originated loans that are generally transferred or sold within 60 days of loan funding, and are valued using pricing models that incorporate observable inputs from current market assumptions or a hypothetical securitization model utilizing observable market data from recent securitization spreads and observable pricing of loans with similar characteristics (Level 2). Fair value includes the fair value allocated to the associated future MSRs and is calculated pursuant to the valuation techniques described below for capitalized mortgage servicing rights, net (Level 3).

Capitalized mortgage servicing rights, net. Fair values are estimated using Level 3 inputs based on discounted future net cash flow methodology. The fair value of MSRs carried at amortized cost are estimated using a process that involves the use of independent third-party valuation experts, supported by commercially available discounted cash flow models and analysis of current market data. The key inputs used in estimating fair value include the contractually specified servicing fees, prepayment speed of the underlying loans, discount rate, annual per loan cost to service loans, delinquency rates, late charges and other economic factors.

Securities held-to-maturity, net. Fair values are approximated using Level 3 inputs based on current market quotes received from financial sources that trade such securities and are based on prevailing market data and, in some cases, are derived from third party proprietary models based on well recognized financial principles and reasonable estimates about relevant future market conditions.

Derivative financial instruments. The fair values of rate lock and forward sale commitments are estimated using valuation techniques, which include internally-developed models developed based on changes in the U.S. Treasury rate and other observable market data (Level 2). The fair value of rate lock commitments includes the fair value of the expected net cash flows associated with the servicing of the loans, see capitalized mortgage servicing rights, net above for details on the applicable valuation technique (Level 3). We also consider the impact of counterparty non-performance risk when measuring the fair value of these derivatives. Given the credit quality of our counterparties, the short duration of interest rate lock commitments and forward sale contracts, and our historical experience, the risk of nonperformance by our counterparties is not significant.

Credit facilities and repurchase agreements. Fair values for credit facilities and repurchase agreements of the Structured Business are estimated at Level 3 using discounted cash flow methodology, using discount rates, which, in our opinion, best reflect current market interest rates for financing with similar characteristics and credit quality. The majority of our credit facilities and repurchase agreement for the Agency Business bear interest at rates that are similar to those available in the market currently and the fair values are estimated using Level 2 inputs. For these facilities, the fair values approximate their carrying values.

Collateralized loan obligations, Debt Fund, junior subordinated notes and related party financing. Fair values are estimated at Level 3 based on broker quotations, representing the discounted expected future cash flows at a yield that reflects current market interest rates and credit spreads.

Senior unsecured notes. Fair values are estimated at Level 1 when current market quotes received from active markets are available. If quotes from active markets are unavailable, then the fair values are estimated at Level 2 utilizing current market quotes received from inactive markets.

Convertible senior unsecured notes, net. Fair values are estimated at Level 2 based on current market quotes received from inactive markets.

We measure certain financial assets and financial liabilities at fair value on a recurring basis. The fair values of these financial assets and liabilities were determined using the following input levels as of March 31, 2018 (in thousands):

					Fair Value Measurements Using Fair Value Hierarchy
	Carrying Value		Fair Value		Level 1		Level 2		Level 3

Financial assets:
Derivative financial instruments	$	2,763	$	2,763	$	—	$	2,046	$	717

Financial liabilities:
Derivative financial instruments	$	300	$	300	$	—	$	300	$	—

We measure certain financial and non-financial assets at fair value on a nonrecurring basis. The fair values of these financial and non-financial assets were determined using the following input levels as of March 31, 2018 (in thousands):

					Fair Value Measurements Using Fair Value Hierarchy
	Net Carrying Value		Fair Value		Level 1		Level 2		Level 3

Financial assets:
Impaired loans, net (1 )	$	100,798	$	100,798	$	—	$	—	$	100,798

(1)

We had an allowance for loan losses of $63.1 million relating to five loans with an aggregate carrying value, before loan loss reserves, of $163.9 million at March 31, 2018.

Loan impairment assessments. Loans held for investment are intended to be held to maturity and, accordingly, are carried at cost, net of unamortized loan origination costs and fees, loan purchase discounts, and net of the allowance for loan losses, when such loan or investment is deemed to be impaired. We consider a loan impaired when, based upon current information, it is probable that we will be unable to collect all amounts due for both principal and interest according to the contractual terms of the loan agreement. We evaluate our loans to determine if the value of the underlying collateral securing the impaired loan is less than the net carrying value of the loan, which may result in an allowance and corresponding charge to the provision for loan losses. These valuations require significant judgments, which include assumptions regarding capitalization and discount rates, revenue growth rates, creditworthiness of major tenants, occupancy rates, availability of financing, exit plan and other factors. The table above and below includes all impaired loans, regardless of the period in which the impairment was recognized.

Quantitative information about Level 3 fair value measurements at March 31, 2018 were as follows ($ in thousands):

			Valuation
	Fair Value		Techniques	Significant Unobservable Inputs

Financial assets:
Impaired loans:
				Discount rate	15.00	%
Land	$	70,965	Discounted cash flows	Capitalization rate	7.25	%
				Revenue growth rate	3.00	%

				Discount rate	9.00	%
Hotel	29,050		Discounted cash flows	Capitalization rate	7.00	%
				Revenue growth rate	6.50	%

				Discount rate	11.00	%
Office	783		Discounted cash flows	Capitalization rate	9.00	%
				Revenue growth rate	2.50	%

Derivative financial instruments:

Rate lock commitments	717		Discounted cash flows	W/A discount rate	10.19	%

The derivative financial instruments using Level 3 inputs are outstanding for short periods of time (generally less than 60 days). A roll-forward of Level 3 derivative instruments were as follows (in thousands):

	Fair Value Measurements Using Significant Unobservable Inputs
	Three Months Ended March 31,
	2018			2017
Derivative assets and liabilities, net
Balance at beginning of period	$	276		$	2,816
Settlements	(19,193		)	(19,649		)
Realized gains recorded in earnings	18,917			16,833
Unrealized gains recorded in earnings	717			381

Balance at end of period	$	717		$	381

The following table presents the components of fair value and other relevant information associated with our rate lock commitments, forward sales commitments and the estimated fair value of cash flows from servicing on loans held-for-sale (in thousands):

March 31, 2018	Notional/ Principal Amount		Fair Value of Servicing Rights		Interest Rate Movement Effect			Total Fair Value Adjustment
Rate lock commitments	$	34,250	$	717	$	(278	)	$	439
Forward sale commitments	316,011		—		278			278
Loans held-for-sale, net (1)	281,761		5,200		—			5,200

Total			$	5,917	$	—		$	5,917

(1)

Loans held-for-sale, net are recorded at the lower of cost or market on an aggregate basis and includes fair value adjustments related to estimated cash flows from MSRs.

We measure certain assets and liabilities for which fair value is only disclosed. The fair value of these assets and liabilities was determined using the following input levels as of March 31, 2018 (in thousands):

					Fair Value Measurements Using Fair Value Hierarchy
	Carrying Value		Fair Value		Level 1		Level 2		Level 3

Financial assets:
Loans and investments, net	$	2,702,097	$	2,774,333	$	—	$	—	$	2,774,333
Loans held-for-sale, net	286,325		292,153		—		286,953		5,200
Capitalized mortgage servicing rights, net	255,732		299,392		—		—		299,392
Securities held-to-maturity, net	36,764		37,273		—		—		37,273

Financial liabilities:
Credit and repurchase facilities	$	626,063	$	628,510	$	—	$	281,338	$	347,172
Collateralized loan obligations	1,419,838		1,438,567		—		—		1,438,567
Debt fund	68,176		70,139		—		—		70,139
Senior unsecured notes	196,090		198,995		98,995		100,000		—
Convertible senior unsecured notes, net	232,577		254,727		—		254,727		—
Junior subordinated notes	139,760		94,638		—		—		94,638