Fair Value Measurements

6 Months Ended

Jun. 30, 2020

Fair Value Measurements

Fair Value Measurements

4. Fair Value Measurements

Fair Value Measurements and Disclosures

The Company determines fair values in compliance with The Fair Value Measurements and Disclosures Topic of the ASC (the “Fair Value Topic”). The Fair Value Topic defines fair value, establishes a framework for measuring fair value in GAAP and expands disclosures about fair value measurements. The Fair Value Topic defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. The Fair Value Topic assumes that transactions upon which fair value measurements are based occur in the principal market for the asset or liability being measured. Further, fair value measurements made under the Fair Value Topic exclude transaction costs and are not the result of forced transactions.

The Fair Value Topic includes a fair value hierarchy that classifies fair value measurements based upon the inputs used in valuing the assets or liabilities that are the subject of fair value measurements. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs, as indicated below.

● Level 1 Inputs: Unadjusted quoted prices in active markets for identical assets or liabilities that the Company can access at the measurement date.

● Level 2 Inputs: Observable inputs other than Level 1 prices. Level 2 inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, yield curves, prepayment speeds, default rates, credit risks and loss severities), and inputs that are derived from or corroborated by market data, among others.

● Level 3 Inputs: Unobservable inputs that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities. Level 3 inputs include pricing models and discounted cash flow techniques, among others.

Fair Value Option

The Company has elected to measure PrimeLending’s retained mortgage servicing rights (“MSR”) asset and substantially all of mortgage loans held for sale at fair value, under the provisions of the Fair Value Option. The Company elected to apply the provisions of the Fair Value Option to these items so that it would have the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. At June 30, 2020 and December 31, 2019, the aggregate fair value of PrimeLending’s mortgage loans held for sale accounted for under the Fair Value Option was $2.45 billion and $1.94 billion, respectively, and the unpaid principal balance of those loans was $2.33 billion and $1.88 billion, respectively. The interest component of fair value is reported as interest income on loans in the accompanying consolidated statements of operations.

The Company holds a number of financial instruments that are measured at fair value on a recurring basis, either by the application of the Fair Value Option or other authoritative pronouncements. The fair values of those instruments are determined primarily using Level 2 inputs. Those inputs include quotes from mortgage loan investors and derivatives dealers and data from independent pricing services. The fair value of loans held for sale is determined using an exit price method.

The following tables present information regarding financial assets and liabilities measured at fair value on a recurring basis (in thousands).

	Level 1		Level 2		Level 3		Total
June 30, 2020	Inputs		Inputs		Inputs		Fair Value
Trading securities	$	50,771	$	597,266	$	—	$	648,037
Available for sale securities		—		1,091,348		—		1,091,348
Equity securities		122		—		—		122
Loans held for sale		—		2,357,115		91,936		2,449,051
Derivative assets		—		148,573		—		148,573
MSR asset		—		—		81,264		81,264
Securities sold, not yet purchased		24,027		31,313		—		55,340
Derivative liabilities		—		58,436		—		58,436

	Level 1		Level 2		Level 3			Total
December 31, 2019	Inputs		Inputs		Inputs			Fair Value
Trading securities	$	—	$	689,576	$	—	$	689,576
Available for sale securities		—		911,493		—		911,493
Equity securities		166		—		—		166
Loans held for sale		—		1,868,518		67,195		1,935,713
Derivative assets		—		33,129		—		33,129
MSR asset		—		—		55,504		55,504
Securities sold, not yet purchased		29,080		14,737		—		43,817
Derivative liabilities		—		17,140		—		17,140

The following tables include a rollforward for those financial instruments measured at fair value using Level 3 inputs (in thousands).

									Total Gains or Losses
									(Realized or Unrealized)
	Balance at										Included in Other
	Beginning of		Purchases/		Sales/		Transfers to		Included in		Comprehensive		Balance at
	Period		Additions		Reductions		(from) Level 3		Net Income		Income (Loss)		End of Period
Three months ended June 30, 2020
Loans held for sale	$	79,588	$	34,339	$	(26,768)	$	2,746	$	2,031	$	—	$	91,936
MSR asset		30,299		59,440		—		—		(8,475)		—		81,264
Total	$	109,887	$	93,779	$	(26,768)	$	2,746	$	(6,444)	$	—	$	173,200
Six months ended June 30, 2020
Loans held for sale	$	67,195	$	48,623	$	(30,943)	$	8,967	$	(1,906)	$	—	$	91,936
MSR asset		55,504		63,915		(18,650)		—		(19,505)		—		81,264
Total	$	122,699	$	112,538	$	(49,593)	$	8,967	$	(21,411)	$	—	$	173,200
Three months ended June 30, 2019
Loans held for sale	$	57,844	$	14,053	$	(11,108)	$	(612)	$	(3,378)	$	—	$	56,799
MSR asset		62,049		2,547		—		—		(10,901)		—		53,695
Total	$	119,893	$	16,600	$	(11,108)	$	(612)	$	(14,279)	$	—	$	110,494
Six months ended June 30, 2019
Loans held for sale	$	50,464	$	29,480	$	(18,084)		425	$	(5,486)	$	—	$	56,799
MSR asset		66,102		4,408		—		—		(16,815)		—		53,695
Total	$	116,566	$	33,888	$	(18,084)	$	425	$	(22,301)	$	—	$	110,494

All net realized and unrealized gains (losses) in the tables above are reflected in the accompanying consolidated financial statements. The unrealized gains (losses) relate to financial instruments still held at June 30, 2020.

For Level 3 financial instruments measured at fair value on a recurring basis at June 30, 2020 and December 31, 2019, the significant unobservable inputs used in the fair value measurements were as follows.

			Range (Weighted-Average)
			June 30,							December 31,
Financial instrument	Valuation Technique	Unobservable Inputs	2020							2019
Loans held for sale	Discounted cash flows / Market comparable	Projected price	91	-	95	%	(	94	%)	92	-	96	%	(	95	%)
MSR asset	Discounted cash flows	Constant prepayment rate			13.45		%					13.16		%
		Discount rate			14.62		%					11.14		%

The fair value of certain loans held for sale that cannot be sold through normal sale channels or are non-performing is measured using Level 3 inputs. The fair value of such loans is generally based upon estimates of expected cash flows using unobservable inputs, including listing prices of comparable assets, uncorroborated expert opinions, and/or management’s knowledge of underlying collateral.

The MSR asset, which is included in other assets within the Company’s consolidated balance sheets, is reported at fair value using Level 3 inputs. The MSR asset is valued by projecting net servicing cash flows, which are then discounted to estimate the fair value. The fair value of the MSR asset is impacted by a variety of factors. Prepayment rates and discount rates, the most significant unobservable inputs, are discussed further in Note 7 to the consolidated financial statements. The increase in the weighted average discount rate used to value the MSR asset at June 30, 2020, compared to December 31, 2019, addresses the potential effect of the reduction in third-party servicing outlets during the second quarter of 2020 resulting from the impact of the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”).

The CARES Act permits borrowers of federally-backed mortgage loans to forbear payments, which could negatively impact servicers’ liquidity and their ability to purchase servicing.

The Company had no transfers between Levels 1 and 2 during the periods presented. Any transfers are based on changes in the observability and/or significance of the valuation inputs and are assumed to occur at the beginning of the quarterly reporting period in which they occur.

The following table presents those changes in fair value of instruments recognized in the consolidated statements of operations that are accounted for under the Fair Value Option (in thousands).

	Three Months Ended June 30, 2020						Three Months Ended June 30, 2019
			Other		Total				Other		Total
	Net		Noninterest		Changes in		Net		Noninterest		Changes in
	Gains (Losses)		Income		Fair Value		Gains (Losses)		Income		Fair Value
Loans held for sale	$	24,499	$	—	$	24,499	$	17,179	$	—	$	17,179
MSR asset		(8,475)		—		(8,475)		(10,901)		—		(10,901)

	Six Months Ended June 30, 2020						Six Months Ended June 30, 2019
			Other		Total				Other		Total
	Net		Noninterest		Changes in		Net		Noninterest		Changes in
	Gains (Losses)		Income		Fair Value		Gains (Losses)		Income		Fair Value
Loans held for sale	$	58,478	$	—	$	58,478	$	3,855	$	—	$	3,855
MSR asset		(19,505)		—		(19,505)		(16,815)		—		(16,815)

The Fair Value of Financial Instruments Subsection of the ASC requires disclosure of the fair value of financial assets and liabilities, including the financial assets and liabilities previously discussed. There have been no changes to the methods for determining estimated fair value for financial assets and liabilities as described in detail in Note 3 to the consolidated financial statements included in the Company’s 2019 Form 10-K.

The following tables present the carrying values and estimated fair values of financial instruments not measured at fair value on either a recurring or non-recurring basis (in thousands).

			Estimated Fair Value
	Carrying		Level 1		Level 2		Level 3
June 30, 2020	Amount		Inputs		Inputs		Inputs		Total
Financial assets:
Cash and cash equivalents	$	1,655,877	$	1,655,877	$	—	$	—	$	1,655,877
Assets segregated for regulatory purposes		194,626		194,626		—		—		194,626
Securities purchased under agreements to resell		161,457		—		161,457		—		161,457
Held to maturity securities		343,198		—		359,542		—		359,542
Loans held for sale		143,256		—		143,256		—		143,256
Loans held for investment, net		7,693,521		—		422,891		7,508,015		7,930,906
Broker-dealer and clearing organization receivables		1,222,627		—		1,222,627		—		1,222,627
Other assets		72,574		—		70,461		2,113		72,574
Financial liabilities:
Deposits		11,649,598		—		11,668,575		—		11,668,575
Broker-dealer and clearing organization payables		1,158,628		—		1,158,628		—		1,158,628
Short-term borrowings		720,164		—		720,164		—		720,164
Debt		517,170		—		517,170		—		517,170
Other liabilities		9,603		—		9,603		—		9,603

			Estimated Fair Value
	Carrying		Level 1		Level 2		Level 3
December 31, 2019	Amount		Inputs		Inputs		Inputs		Total
Financial assets:
Cash and cash equivalents	$	434,020	$	434,020	$	—	$	—	$	434,020
Assets segregated for regulatory purposes		157,436		157,436		—		—		157,436
Securities purchased under agreements to resell		59,031		—		59,031		—		59,031
Held to maturity securities		386,326		—		388,930		—		388,930
Loans held for sale		170,648		—		170,648		—		170,648
Loans held for investment, net		7,320,264		—		576,527		6,990,706		7,567,233
Broker-dealer and clearing organization receivables		1,780,280		—		1,780,280		—		1,780,280
Other assets		71,040		—		69,580		1,460		71,040
Financial liabilities:
Deposits		9,032,214		—		9,032,496		—		9,032,496
Broker-dealer and clearing organization payables		1,605,518		—		1,605,518		—		1,605,518
Short-term borrowings		1,424,010		—		1,424,010		—		1,424,010
Debt		323,281		—		323,281		—		323,281
Other liabilities		8,340		—		8,340		—		8,340

The Company held equity investments other than securities of $61.1 million and $36.6 million at June 30, 2020 and December 31, 2019, respectively, which are included within other assets in the consolidated balance sheets. Of the $61.1 million of such equity investments held at June 30, 2020, $20.6 million do not have readily determinable fair values and each is measured at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. The following table presents the adjustments to the carrying value of these investments during the periods presented (in thousands).

	Three Months Ended June 30,				Six Months Ended June 30,
	2020		2019		2020		2019
Balance, beginning of period	$	19,088	$	20,477	$	19,771	$	20,376
Additional investments		—		—		—		—
Upward adjustments		1,525		101		1,631		202
Impairments and downward adjustments		—		(672)		(789)		(672)
Dispositions		—		—		—		—
Balance, end of period	$	20,613	$	19,906	$	20,613	$	19,906