NOTE 9—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 on a recurring basis, 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 on a recurring basis:

Derivative Instruments—The derivative instruments used by the Company 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—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 March 31, 2017, and December 31, 2016, 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
March 31, 2017
Assets
Loans held for sale	$	—	$	1,230,311	$	—	$	1,230,311
Pledged securities		86,900		—		—		86,900
Derivative assets		—		—		15,446		15,446
Total	$	86,900	$	1,230,311	$	15,446	$	1,332,657

Liabilities
Derivative liabilities	$	—	$	—	$	9,449	$	9,449
Total	$	—	$	—	$	9,449	$	9,449

December 31, 2016
Assets
Loans held for sale	$	—	$	1,858,358	$	—	$	1,858,358
Pledged securities		84,850		—		—		84,850
Derivative assets		—		—		61,824		61,824
Total	$	84,850	$	1,858,358	$	61,824	$	2,005,032

Liabilities
Derivative liabilities	$	—	$	—	$	4,396	$	4,396
Total	$	—	$	—	$	4,396	$	4,396

There were no transfers between any of the levels within the fair value hierarchy during the three months ended March 31, 2017.

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 for the three months ended March 31, 2017 and 2016:


	Fair Value Measurements
	Using Significant Unobservable Inputs:
	Derivative Instruments
	For the three months ended
	March 31,
(in thousands)	2017		2016
Derivative assets and liabilities, net
Beginning balance	$	57,428	$	10,345
Settlements		(147,863)		(49,159)
Realized gains recorded in earnings (1)		90,435		38,814
Unrealized gains recorded in earnings (1)		5,997		9,578
Ending balance	$	5,997	$	9,578

(1)

Realized and unrealized gains from derivatives are recognized in Gains from mortgage banking activities in the Condensed 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 March 31, 2017:


	Quantitative Information about Level 3 Measurements
(in thousands)	Fair Value		Valuation Technique	Unobservable Input (1)	Input Value (1)
Derivative assets	$	15,446	Discounted cash flow	Counterparty credit risk	—
Derivative liabilities	$	9,449	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 March 31, 2017 and December 31, 2016 are presented below:


	March 31, 2017				December 31, 2016
	Carrying		Fair		Carrying		Fair
(in thousands)	Amount		Value		Amount		Value
Financial assets:
Cash and cash equivalents	$	50,745	$	50,745	$	118,756	$	118,756
Restricted cash		9,313		9,313		9,861		9,861
Pledged securities		86,900		86,900		84,850		84,850
Loans held for sale		1,230,311		1,230,311		1,858,358		1,858,358
Loans held for investment, net		311,242		313,355		220,377		222,313
Derivative assets		15,446		15,446		61,824		61,824
Total financial assets	$	1,703,957	$	1,706,070	$	2,354,026	$	2,355,962

Financial liabilities:
Derivative liabilities	$	9,449	$	9,449	$	4,396	$	4,396
Warehouse notes payable		1,406,462		1,407,696		1,990,183		1,992,111
Note payable		164,088		167,051		164,163		167,327
Total financial liabilities	$	1,579,999	$	1,584,196	$	2,158,742	$	2,163,834

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 approximate fair value because of the short maturity of these instruments (Level 1).

Pledged Securities—Consist of highly liquid 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 the mortgage loan is funded and are valued using discounted cash flow models that incorporate observable inputs 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 March 31, 2017 and December 31, 2016, 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 Condensed 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, net of any guaranty obligations retained (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 sale 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 applicable to MSRs (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 or loan origination 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 interest rate lock commitments and forward sale contracts is represented by the contractual amount of those instruments. Given the credit quality of our counterparties and the short duration of interest rate lock commitments and forward sale contracts, the risk of nonperformance by the Company’s counterparties has historically not been 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 March 31, 2017 and December 31, 2016.


			Fair Value Adjustment Components						Balance Sheet Location
													Fair Value
	Notional or		Assumed				Total						Adjustment
	Principal		Gain		Interest Rate		Fair Value		Derivative		Derivative		To Loans
(in thousands)	Amount		on Sale		Movement		Adjustment		Assets		Liabilities		Held for Sale
March 31, 2017
Rate lock commitments	$	481,351	$	12,923	$	1,289	$	14,212	$	14,212	$	—	$	—
Forward sale contracts		1,680,620		—		(8,215)		(8,215)		1,234		(9,449)		—
Loans held for sale		1,199,269		24,116		6,926		31,042		—		—		31,042
Total			$	37,039	$	—	$	37,039	$	15,446	$	(9,449)	$	31,042

December 31, 2016
Rate lock commitments	$	395,462	$	15,844	$	(2,275)	$	13,569	$	14,482	$	(913)	$	—
Forward sale contracts		2,248,385		—		43,859		43,859		47,342		(3,483)		—
Loans held for sale		1,852,923		47,019		(41,584)		5,435		—		—		5,435
Total			$	62,863	$	—	$	62,863	$	61,824	$	(4,396)	$	5,435