19. Fair Value

GAAP establishes a hierarchy of valuation techniques based on the observability of inputs utilized in measuring financial assets and liabilities at fair value. GAAP establishes market-based or observable inputs as the preferred source of values, followed by valuation models using management assumptions in the absence of market inputs. The three levels of the hierarchy are described below:

Level I—Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.

Level II—Inputs (other than quoted prices included in Level I) are either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date and for the duration of the instrument’s anticipated life.

Level III—Inputs reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model.

Valuation Process

We have valuation control processes in place to validate the fair value of the Company’s financial assets and liabilities measured at fair value including those derived from pricing models. These control processes are designed to assure that the values used for financial reporting are based on observable inputs wherever possible. Refer to Note 20 to the consolidated financial statements included in our Form 10-K for further discussion of our valuation process.

We determine the fair value of our assets and liabilities measured at fair value on a recurring and nonrecurring basis in accordance with the methodology described in our Form 10-K.

Fair Value Disclosures

The following tables present our financial assets and liabilities carried at fair value on a recurring basis in the condensed consolidated balance sheets by their level in the fair value hierarchy as of September 30, 2017 and December 31, 2016 (amounts in thousands):


	September 30, 2017
	Total		Level I		Level II		Level III
Financial Assets:
Loans held-for-sale, fair value option	$	608,624	$	—	$	—	$	608,624
RMBS		253,252		—		—		253,252
CMBS		23,841		—		—		23,841
Equity security		13,529		13,529		—		—
Domestic servicing rights		33,781		—		—		33,781
Derivative assets		38,293		—		38,293		—
VIE assets		51,197,981		—		—		51,197,981
Total	$	52,169,301	$	13,529	$	38,293	$	52,117,479
Financial Liabilities:
Derivative liabilities	$	22,890	$	—	$	22,890	$	—
VIE liabilities		50,150,781		—		47,890,998		2,259,783
Total	$	50,173,671	$	—	$	47,913,888	$	2,259,783


	December 31, 2016
	Total		Level I		Level II		Level III
Financial Assets:
Loans held-for-sale, fair value option	$	63,279	$	—	$	—	$	63,279
RMBS		253,915		—		—		253,915
CMBS		31,546		—		—		31,546
Equity security		12,177		12,177		—		—
Domestic servicing rights		55,082		—		—		55,082
Derivative assets		89,361		—		89,361		—
VIE assets		67,123,261		—		—		67,123,261
Total	$	67,628,621	$	12,177	$	89,361	$	67,527,083
Financial Liabilities:
Derivative liabilities	$	3,904	$	—	$	3,904	$	—
VIE liabilities		66,130,592		—		63,545,223		2,585,369
Total	$	66,134,496	$	—	$	63,549,127	$	2,585,369

The changes in financial assets and liabilities classified as Level III are as follows for the three and nine months ended September 30, 2017 and 2016 (amounts in thousands):


							Domestic
	Loans						Servicing				VIE
Three Months Ended September 30, 2017	Held‑for‑sale		RMBS		CMBS		Rights		VIE Assets		Liabilities		Total
July 1, 2017 balance	$	610,116	$	256,397	$	13,848	$	38,648	$	53,902,715	$	(2,164,593)	$	52,657,131
Total realized and unrealized gains (losses):
Included in earnings:
Change in fair value / gain on sale		19,485		—		(673)		(4,867)		(3,533,620)		151,273		(3,368,402)
Net accretion		—		3,187		—		—		—		—		3,187
Included in OCI		—		3,975		—		—		—		—		3,975
Purchases / Originations		524,409		—		11,798		—		—		—		536,207
Sales		(517,350)		—		—		—		—		—		(517,350)
Issuances		—		—		—		—		—		(1,469)		(1,469)
Cash repayments / receipts		(28,036)		(10,307)		(1,666)		—		—		(4,910)		(44,919)
Transfers into Level III		—		—		—		—		—		(233,367)		(233,367)
Transfers out of Level III		—		—		—		—		—		67,272		67,272
Consolidation of VIEs		—		—		—		—		964,564		(75,585)		888,979
Deconsolidation of VIEs		—		—		534		—		(135,678)		1,596		(133,548)
September 30, 2017 balance	$	608,624	$	253,252	$	23,841	$	33,781	$	51,197,981	$	(2,259,783)	$	49,857,696
Amount of total (losses) gains included in earnings attributable to assets still held at September 30, 2017	$	(2,597)	$	3,187	$	(230)	$	(4,867)	$	(3,533,620)	$	151,273	$	(3,386,854)


							Domestic
	Loans						Servicing				VIE
Three Months Ended September 30, 2016	Held‑for‑sale		RMBS		CMBS		Rights		VIE Assets		Liabilities		Total
July 1, 2016 balance	$	237,106	$	251,260	$	114,340	$	83,301	$	80,076,117	$	(3,540,652)	$	77,221,472
Total realized and unrealized gains (losses):
Included in earnings:
Change in fair value / gain on sale		49,996		—		(2,993)		(14,283)		(8,143,518)		653,103		(7,457,695)
Net accretion		—		4,197		—		—		—		—		4,197
Included in OCI		—		6,105		—		—		—		—		6,105
Purchases / Originations		709,045		8,868		—		—		—		—		717,913
Sales		(648,179)		—		(17,456)		—		—		—		(665,635)
Cash repayments / receipts		(478)		(9,917)		(12,289)		—		—		7,819		(14,865)
Transfers into Level III		—		—		—		—		—		(1)		(1)
Transfers out of Level III		—		—		—		—		—		40,959		40,959
Consolidation of VIEs		—		—		(24,403)		—		2,268,424		(109,913)		2,134,108
Deconsolidation of VIEs		—		—		1,586		—		(277,324)		37,188		(238,550)
September 30, 2016 balance	$	347,490	$	260,513	$	58,785	$	69,018	$	73,923,699	$	(2,911,497)	$	71,748,008
Amount of total gains (losses) included in earnings attributable to assets still held at September 30, 2016	$	9,746	$	4,197	$	(1,852)	$	(14,283)	$	(8,143,518)	$	653,103	$	(7,492,607)


							Domestic
	Loans						Servicing				VIE
Nine Months Ended September 30, 2017	Held‑for‑sale		RMBS		CMBS		Rights		VIE Assets		Liabilities		Total
January 1, 2017 balance	$	63,279	$	253,915	$	31,546	$	55,082	$	67,123,261	$	(2,585,369)	$	64,941,714
Total realized and unrealized gains (losses):
Included in earnings:
Change in fair value / gain on sale		45,484		—		(4,359)		(21,301)		(15,773,529)		749,757		(15,003,948)
OTTI		—		(109)		—		—		—		—		(109)
Net accretion		—		10,375		—		—		—		—		10,375
Included in OCI		—		10,728		—		—		—		—		10,728
Purchases / Originations		1,527,364		7,433		11,798		—		—		—		1,546,595
Sales		(987,828)		—		(11,134)		—		—		—		(998,962)
Issuances		—		—		—		—		—		(11,657)		(11,657)
Cash repayments / receipts		(39,675)		(29,090)		(8,754)		—		—		(40,946)		(118,465)
Transfers into Level III		—		—		—		—		—		(616,794)		(616,794)
Transfers out of Level III		—		—		—		—		—		231,012		231,012
Consolidation of VIEs		—		—		—		—		2,092,516		(75,585)		2,016,931
Deconsolidation of VIEs		—		—		4,744		—		(2,244,267)		89,799		(2,149,724)
September 30, 2017 balance	$	608,624	$	253,252	$	23,841	$	33,781	$	51,197,981	$	(2,259,783)	$	49,857,696
Amount of total (losses) gains included in earnings attributable to assets still held at September 30, 2017	$	(2,621)	$	10,159	$	56	$	(21,301)	$	(15,773,529)	$	749,757	$	(15,037,479)


							Domestic
	Loans						Servicing				VIE
Nine Months Ended September 30, 2016	Held‑for‑sale		RMBS		CMBS		Rights		VIE Assets		Liabilities		Total
January 1, 2016 balance	$	203,865	$	176,224	$	212,981	$	119,698	$	76,675,689	$	(2,552,448)	$	74,836,009
Impact of ASU 2015-02 adoption (1)		—		—		—		(17,467)		17,467		—		—
Total realized and unrealized gains (losses):
Included in earnings:
Change in fair value / gain on sale		70,122		—		(677)		(33,213)		(16,483,798)		946,703		(15,500,863)
Net accretion		—		11,354		—		—		—		—		11,354
Included in OCI		—		8,656		—		—		—		—		8,656
Purchases / Originations		1,197,801		97,204		57,576		—		—		—		1,352,581
Sales		(1,123,512)		—		(18,725)		—		—		—		(1,142,237)
Issuances		—		—		—		—		—		(596)		(596)
Cash repayments / receipts		(786)		(32,925)		(31,734)		—		—		28,591		(36,854)
Transfers into Level III		—		—		—		—		—		(972,588)		(972,588)
Transfers out of Level III		—		—		—		—		—		187,683		187,683
Consolidation of VIEs		—		—		(162,745)		—		19,118,645		(593,818)		18,362,082
Deconsolidation of VIEs		—		—		2,109		—		(5,404,304)		44,976		(5,357,219)
September 30, 2016 balance	$	347,490	$	260,513	$	58,785	$	69,018	$	73,923,699	$	(2,911,497)	$	71,748,008
Amount of total gains (losses) included in earnings attributable to assets still held at September 30, 2016	$	9,746	$	11,354	$	263	$	(33,213)	$	(16,483,798)	$	946,703	$	(15,548,945)

(1)

Our implementation of ASU 2015-02 resulted in the consolidation of certain CMBS trusts effective January 1, 2016, which required the elimination of $17.5 million of domestic servicing rights associated with these newly consolidated trusts.

Amounts were transferred from Level II to Level III due to a decrease in the observable relevant market activity and amounts were transferred from Level III to Level II due to an increase in the observable relevant market activity.

The following table presents the fair values, all of which are classified in Level III of the fair value hierarchy, of our financial instruments not carried at fair value on the condensed consolidated balance sheets (amounts in thousands):


	September 30, 2017				December 31, 2016
	Carrying		Fair		Carrying		Fair
	Value		Value		Value		Value
Financial assets not carried at fair value:
Loans held-for-investment and loans transferred as secured borrowings	$	6,456,710	$	6,539,259	$	5,882,995	$	5,934,219
HTM securities		411,196		408,442		509,980		504,165
Financial liabilities not carried at fair value:
Secured financing agreements and secured borrowings on transferred loans	$	5,588,895	$	5,559,888	$	4,189,126	$	4,198,136
Unsecured senior notes		2,044,523		2,097,835		2,011,544		2,088,374

The following is quantitative information about significant unobservable inputs in our Level III measurements for those assets and liabilities measured at fair value on a recurring basis (dollars in thousands):


	Carrying Value at		Valuation	Unobservable	Range as of (1)
	September 30, 2017		Technique	Input	September 30, 2017	December 31, 2016
Loans held-for-sale, fair value option	$	608,624	Discounted cash flow	Yield (b)	4.3% - 5.9%	5.0% - 5.7%
				Duration (c)	3.3 - 12.8 years	10.0 years
RMBS		253,252	Discounted cash flow	Constant prepayment rate (a)	2.4% - 19.4%	2.8% - 17.0%
				Constant default rate (b)	0.8% - 5.8%	1.1% - 8.1%
				Loss severity (b)	16% - 79% (e)	12% - 79% (e)
				Delinquency rate (c)	4% - 34%	2% - 29%
				Servicer advances (a)	20% - 84%	23% - 94%
				Annual coupon deterioration (b)	0% - 0.8%	0% - 0.6%
				Putback amount per projected total collateral loss (d)	0% - 15%	0% - 15%
CMBS		23,841	Discounted cash flow	Yield (b)	0% - 167.1%	0% - 172.0%
				Duration (c)	0 - 9.9 years	0 - 18.7 years
Domestic servicing rights		33,781	Discounted cash flow	Debt yield (a)	7.75%	7.75%
				Discount rate (b)	15%	15%
				Control migration (b)	0% - 80%	0% - 80%
VIE assets		51,197,981	Discounted cash flow	Yield (b)	0% - 813.9%	0% - 960.4%
				Duration (c)	0 - 11.6 years	0 - 12.0 years
VIE liabilities		2,259,783	Discounted cash flow	Yield (b)	0% - 813.9%	0% - 960.4%
				Duration (c)	0 - 11.6 years	0 - 12.0 years

(1)

The ranges of significant unobservable inputs are represented in percentages and years.

Sensitivity of the Fair Value to Changes in the Unobservable Inputs

(a)

Significant increase (decrease) in the unobservable input in isolation would result in a significantly higher (lower) fair value measurement.

(b)

Significant increase (decrease) in the unobservable input in isolation would result in a significantly lower (higher) fair value measurement.

(c)

Significant increase (decrease) in the unobservable input in isolation would result in either a significantly lower or higher (higher or lower) fair value measurement depending on the structural features of the security in question.

(d)

Any delay in the putback recovery date leads to a decrease in fair value for the majority of securities in our RMBS portfolio.

(e)

81% and 57% of the portfolio falls within a range of 45%-80% as of September 30, 2017 and December 31, 2016, respectively.