NOTE 10—FAIR VALUE MEASUREMENTS

The Company uses valuation techniques that are consistent with the market approach, the income approach, and/or the cost approach to measure assets and liabilities that are measured at fair value. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity's own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. In that regard, accounting standards establish a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

Level 1—Financial assets and liabilities whose values are based on unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access.

Level 2—Financial assets and liabilities whose values are based on inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might 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, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.

Level 3—Financial assets and liabilities whose values are based on inputs that are both unobservable and significant to the overall valuation.

The Company's MSRs are measured at fair value on a nonrecurring basis. That is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). The Company's MSRs do not trade in an active, open market with readily observable prices. While sales of multifamily MSRs do occur, precise terms and conditions vary with each transaction and are not readily available. Accordingly, the estimated fair value of the Company’s MSRs was developed using discounted cash flow models that calculate the present value of estimated future net servicing income. The model considers contractually specified servicing fees, prepayment assumptions, delinquency rates, late charges, other ancillary revenue, costs to service, and other economic factors. The Company periodically reassesses and adjusts, when necessary, the underlying inputs and assumptions used in the model to reflect observable market conditions and assumptions that a market participant would consider in valuing an MSR asset. MSRs are carried at the lower of amortized cost or fair value.

A description of the valuation methodologies used for assets and liabilities measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below. These valuation methodologies were applied to all of the Company's assets and liabilities carried at fair value:

Derivative Instruments—The derivative positions consist of interest rate lock commitments and forward sale agreements. These instruments are valued using a discounted cash flow model developed based on changes in the U.S. Treasury rate and other observable market data. The value was determined after considering the potential impact of collateralization, adjusted to reflect nonperformance risk of both the counterparty and the Company, and are classified within Level 3 of the valuation hierarchy.

Loans Held for Sale—The loans held for sale are reported at fair value. The Company determines the fair value of the loans held for sale using discounted cash flow models that incorporate quoted observable prices from market participants. Therefore, the Company classifies these loans held for sale as Level 2.

Pledged Securities—The pledged securities are valued using quoted market prices from recent trades. Therefore, the Company classifies pledged securities as Level 1.

The following table summarizes financial assets and financial liabilities measured at fair value on a recurring basis as of December 31, 2015 and 2014, segregated by the level of the valuation inputs within the fair value hierarchy used to measure fair value:


	Quoted Prices in		Significant		Significant
	Active Markets		Other		Other
	For Identical		Observable		Unobservable
	Assets		Inputs		Inputs		Balance as of
(in thousands)	(Level 1)		(Level 2)		(Level 3)		Period End
December 31, 2015
Assets
Loans held for sale	$	—	$	2,499,111	$	—	$	2,499,111
Pledged securities		72,190		—		—		72,190
Derivative assets		—		—		11,678		11,678
Total	$	72,190	$	2,499,111	$	11,678	$	2,582,979

Liabilities
Derivative liabilities	$	—	$	—	$	1,333	$	1,333
Total	$	—	$	—	$	1,333	$	1,333

December 31, 2014
Assets
Loans held for sale	$	—	$	1,072,116	$	—	$	1,072,116
Pledged securities		67,719		—		—		67,719
Derivative assets		—		—		14,535		14,535
Total	$	67,719	$	1,072,116	$	14,535	$	1,154,370

Liabilities
Derivative liabilities	$	—	$	—	$	4,877	$	4,877
Total	$	—	$	—	$	4,877	$	4,877

There were no transfers between any of the levels within the fair value hierarchy during the year ended December 31, 2015.

Derivative instruments (Level 3) are outstanding for short periods of time (generally less than 60 days). A roll forward of derivative instruments is presented below:


	Fair Value Measurements
	Using Significant
	Unobservable Inputs:
	Derivative Instruments
(in thousands)	December 31, 2015
Derivative assets and liabilities, net
Beginning balance December 31, 2014	$	9,658
Settlements		(289,779)
Realized gains recorded in earnings (1)		280,121
Unrealized gains recorded in earnings (1)		10,345
Ending balance December 31, 2015	$	10,345


	Fair Value Measurements
	Using Significant
	Unobservable Inputs:
	Derivative Instruments
(in thousands)	December 31, 2014
Derivative assets and liabilities, net
Beginning balance December 31, 2013	$	19,341
Settlements		(231,666)
Realized gains (losses) recorded in earnings (1)		212,325
Unrealized gains (losses) recorded in earnings (1)		9,658
Ending balance December 31, 2014	$	9,658

(1)

Realized and unrealized gains from derivatives are recognized in Gains from mortgage banking activities in the Consolidated Statements of Income.

The following table presents information about significant unobservable inputs used in the measurement of the fair value of the Company’s Level 3 assets and liabilities as of December 31, 2015:


	Quantitative Information about Level 3 Measurements
(in thousands)	Fair Value		Valuation Technique	Unobservable Input (1)	Input Value (1)
Derivative assets	$	11,678	Discounted cash flow	Counterparty credit risk	—
Derivative liabilities	$	1,333	Discounted cash flow	Counterparty credit risk	—

(1)

Significant increases in this input may lead to significantly lower fair value measurements.

The carrying amounts and the fair values of the Company's financial instruments as of December 31, 2015 and 2014 are presented below:


	December 31, 2015				December 31, 2014
	Carrying		Fair		Carrying		Fair
(in thousands)	Amount		Value		Amount		Value
Financial assets:
Cash and cash equivalents	$	136,988	$	136,988	$	113,354	$	113,354
Restricted cash		5,306		5,306		13,854		13,854
Pledged securities		72,190		72,190		67,719		67,719
Loans held for sale		2,499,111		2,499,111		1,072,116		1,072,116
Loans held for investment, net		231,493		233,370		223,059		225,318
Derivative assets		11,678		11,678		14,535		14,535
Total financial assets	$	2,956,766	$	2,958,643	$	1,504,637	$	1,506,896

Financial liabilities:
Derivative liabilities	$	1,333	$	1,333	$	4,877	$	4,877
Warehouse notes payable		2,649,470		2,652,011		1,214,279		1,216,245
Note payable		164,462		168,431		169,095		173,250
Total financial liabilities	$	2,815,265	$	2,821,775	$	1,388,251	$	1,394,372

The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:

Cash and Cash Equivalents and Restricted Cash—The carrying amounts, at face value or cost plus accrued interest, approximate fair value because of the short maturity of these instruments (Level 1).

Pledged Securities—Consist of highly liquid investments in commercial paper of AAA rated entities, investments in money market accounts invested in government securities, and investments in government guaranteed securities. Investments typically have maturities of 90 days or less and are valued using quoted market prices from recent trades.

Loans Held For Sale—Consist of originated loans that are generally transferred or sold within 60 days from the date that a mortgage loan is funded and are valued using discounted cash flow models that incorporate observable prices from market participants.

Loans Held For Investment—Consist of originated interim loans which the Company expects to hold for investment for the term of the loan, which is three years or less, and are valued using discounted cash flow models that incorporate primarily observable inputs from market participants and also credit-related adjustments, if applicable (Level 3). As of December 31, 2015 and 2014, no credit-related adjustments were required.

Derivative Instruments—Consist of interest rate lock commitments and forward sale agreements. These instruments are valued using discounted cash flow models developed based on changes in the U.S. Treasury rate and other observable market data. The value is determined after considering the potential impact of collateralization, adjusted to reflect nonperformance risk of both the counterparty and the Company.

Warehouse Notes Payable—Consist of borrowings outstanding under warehouse line agreements. The borrowing rates on the warehouse lines are based upon 30-day LIBOR plus a margin. The unpaid principal balance of warehouse notes payable approximates fair value because of the short maturity of these instruments and the monthly resetting of the index rate to prevailing market rates (Level 2).

Note Payable—Consists of borrowings outstanding under a term note agreement. The borrowing rate on the note payable is based upon 30-day LIBOR plus an applicable margin. The Company estimates the fair value by discounting the future cash flows at market rates (Level 2).

Fair Value of Derivative Instruments and Loans Held for Sale—In the normal course of business, the Company enters into contractual commitments to originate and sell multifamily mortgage loans at fixed prices with fixed expiration dates. The commitments become effective when the borrowers "lock-in" a specified interest rate within time frames established by the Company. All mortgagors are evaluated for creditworthiness prior to the extension of the commitment. Market risk arises if interest rates move adversely between the time of the "lock-in" of rates by the borrower and the sale date of the loan to an investor.

To mitigate the effect of the interest rate risk inherent in providing rate lock commitments to borrowers, the Company's policy is to enter into a sale commitment with the investor simultaneous with the rate lock commitment with the borrower. The sale contract with the investor locks in an interest rate and price for the sale of the loan. The terms of the contract with the investor and the rate lock with the borrower are matched in substantially all respects, with the objective of eliminating interest rate risk to the extent practical. Sale commitments with the investors have an expiration date that is longer than our related commitments to the borrower to allow, among other things, for the closing of the loan and processing of paperwork to deliver the loan into the sale commitment.

Both the rate lock commitments to borrowers and the forward sale contracts to buyers are undesignated derivatives and, accordingly, are marked to fair value through Gains on mortgage banking activities in the Consolidated Statements of Income. The fair value of the Company's rate lock commitments to borrowers and loans held for sale and the related input levels includes, as applicable:

the assumed gain/loss of the expected resultant loan sale to the investor (Level 2);

the expected net cash flows associated with servicing the loan (Level 2);

the effects of interest rate movements between the date of the rate lock and the balance sheet date (Level 2); and

the nonperformance risk of both the counterparty and the Company (Level 3).

The fair value of the Company's forward sales contracts to investors considers effects of interest rate movements between the trade date and the balance sheet date (Level 2). The market price changes are multiplied by the notional amount of the forward sales contracts to measure the fair value.

The assumed gain/loss considers the amount that the Company has discounted the price to the borrower from par for competitive reasons, if at all, and the expected net cash flows from servicing to be received upon securitization of the loan (Level 2). The fair value of the expected net cash flows associated with servicing the loan is calculated pursuant to the valuation techniques described previously for mortgage servicing rights (Level 2).

To calculate the effects of interest rate movements, the Company uses applicable published U.S. Treasury prices, and multiplies the price movement between the rate lock date and the balance sheet date by the notional loan commitment amount (Level 2).

The fair value of the Company's forward sales contracts to investors considers the market price movement of the same type of security between the trade date and the balance sheet date (Level 2). The market price changes are multiplied by the notional amount of the forward sales contracts to measure the fair value.

The fair value of the Company’s interest rate lock commitments and forward sales contracts is adjusted to reflect the risk that the agreement will not be fulfilled. The Company’s exposure to nonperformance in rate lock and forward sale contracts is represented by the contractual amount of those instruments. Given the credit quality of our counterparties, the short duration of interest rate lock commitments and forward sale contracts, and the Company’s historical experience with the agreements, the risk of nonperformance by the Company’s counterparties is not significant (Level 3).

The following table presents the components of fair value and other relevant information associated with the Company’s derivative instruments and loans held for sale as of December 31, 2015 and 2014.


			Fair Value Adjustment Components						Balance Sheet Location
													Fair Value
	Notional or		Assumed		Interest Rate		Total						Adjustment
	Principal		Gain		Movement		Fair Value		Derivative		Derivative		To Loans
(in thousands)	Amount		on Sale		Effect		Adjustment		Assets		Liabilities		Held for Sale
December 31, 2015
Rate lock commitments	$	267,710	$	9,467	$	(1,494)	$	7,973	$	7,973	$	—	$	—
Forward sale contracts		2,747,590		—		2,371		2,371		3,705		(1,333)		—
Loans held for sale		2,479,880		20,108		(877)		19,231		—		—		19,231
Total			$	29,575	$	—	$	29,575	$	11,678	$	(1,333)	$	19,231

December 31, 2014
Rate lock commitments	$	472,558	$	11,279	$	273	$	11,552	$	11,552	$	—	$	—
Forward sale contracts		1,529,241		—		(1,894)		(1,894)		2,983		(4,877)		—
Loans held for sale		1,056,683		13,812		1,621		15,433		—		—		15,433
Total			$	25,091	$	—	$	25,091	$	14,535	$	(4,877)	$	15,433