Note 7 – Fair value measurements

The Company adopted the provisions of ASC 820 Fair Value Measurement, which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. ASC 820 established a fair value hierarchy that prioritizes and ranks the level of market price observability used in measuring investments at fair value. Market price observability is impacted by a number of factors, including the type of investment, the characteristics specific to the investment, and the state of the marketplace (including the existence and transparency of transactions between market participants). Investments with readily available, actively quoted prices, or for which fair value can be measured from actively quoted prices in an orderly market, will generally have a higher degree of market price observability and a lesser degree of judgment used in measuring fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). Investments measured and reported at fair value are classified and disclosed into one of the following categories based on the inputs as follows:

Level 1 — Quoted prices (unadjusted) in active markets for identical assets and liabilities that the Company has the ability to access.

Level 2 — Pricing inputs are other than quoted prices in active markets, including, but not limited to, quoted prices for similar assets and liabilities in markets that are active, 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 assets or liabilities (such as interest rates, yield curves, volatilities, prepayment speeds, loss severities, credit risks and default rates) or other market corroborated inputs.

Level 3 — Significant unobservable inputs are based on the best information available in the circumstances, to the extent observable inputs are not available, including the Company’s own assumptions used in determining the fair value of investments. Fair values for these investments are determined using valuation methodologies that consider a range of factors, including but not limited to the price at which the investment was acquired, the nature of the investment, local market conditions, trading values on public exchanges for comparable securities, current and projected operating performance, and financing transactions subsequent to the acquisition of the investment. The inputs into the determination of fair value require significant management judgment.

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an investment’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the investment.

The following table presents the Company’s financial instruments carried at fair value on a recurring basis as of September 30, 2019:


(In Thousands)	Level 1		Level 2		Level 3		Total
Assets:
Loans, held for sale, at fair value	$	—	$	206,185	$	—	$	206,185
Loans, net, at fair value		—		—		20,434		20,434
Mortgage backed securities, at fair value		—		65,888		30,293		96,181
Derivative instruments, at fair value		—		—		4,181		4,181
Residential mortgage servicing rights, at fair value		—		—		84,638		84,638
Total assets	$	—	$	272,073	$	139,546	$	411,619

Liabilities:
Derivative instruments, at fair value	$	—	$	11,906	$	—	$	11,906
Total liabilities	$	—	$	11,906	$	—	$	11,906

The following table presents the Company’s financial instruments carried at fair value on a recurring basis as of December 31, 2018:


(In Thousands)	Level 1		Level 2		Level 3		Total
Assets:
Cash held in money market funds	$	586	$	—	$	—	$	586
Loans, held for sale, at fair value		—		115,258		—		115,258
Loans, net, at fair value		—		—		22,664		22,664
Mortgage backed securities, at fair value		—		79,789		12,148		91,937
Derivative instruments, at fair value		—		294		1,776		2,070
Residential mortgage servicing rights, at fair value		—		—		93,065		93,065
Total assets	$	586	$	195,341	$	129,653	$	325,580

Liabilities:
Derivative instruments, at fair value	$	—	$	3,625	$	—	$	3,625
Contingent consideration		—		—		1,207		1,207
Total liabilities	$	—	$	3,625	$	1,207	$	4,832

The following tables present a summary of changes in our Level 3 assets and liabilities:


	Three Months Ended September 30, 2019
(In Thousands)	MBS		Derivatives		Loans, held at fair value		Residential MSRs, at fair value		Contingent consideration
Beginning Balance	$	36,655	$	3,670	$	20,409	$	85,658	$	—
Purchases or Originations		—		—		—		9,028		—
Sales / Principal payments		(673)		—		(45)		(2,466)		—
Realized gains, net		169				38		—		—
Unrealized gains (losses), net		87		511		32		(7,582)		—
Accreted discount, net		49		—		—		—		—
Transfer to (from) Level 3		(5,994)		—		—		—		—
Ending Balance	$	30,293	$	4,181	$	20,434	$	84,638	$	—

Unrealized gains (losses), net on assets or liabilities held at the end of the period	$	2,946	$	4,181	$	363	$	(10,287)	$	—


	Three Months Ended September 30, 2018
(In Thousands)	MBS		Derivatives		Loans, held at fair value		Residential MSRs, at fair value		Contingent consideration
Beginning Balance	$	126	$	2,832	$	34,354	$	85,554	$	1,686
Purchases or Originations		—		—		—		—		—
Additions due to loans sold, servicing retained		—		—		—		5,502		—
Sales / Principal payments		—		—		(12,454)		(1,665)		—
Realized gains, net		—		—		101		—		—
Unrealized gains (losses), net		(11)		(1,412)		679		2,317		—
Amortization and adjustment for earn-out payments		—		—		—		—		87
Ending Balance	$	115	$	1,420	$	22,680	$	91,708	$	1,773

Unrealized gains (losses), net on assets or liabilities held at the end of the period	$	—	$	1,420	$	325	$	(970)	$	—


	Nine Months Ended September 30, 2019
(In Thousands)	MBS		Derivatives		Loans, held at fair value		Residential MSRs, at fair value		Contingent consideration
Beginning Balance	$	12,148	$	1,776	$	22,664	$	93,065	$	—
Purchases or Originations		9,593		—		-		18,482		—
Sales / Principal payments		(1,342)		—		(2,239)		(5,861)		—
Realized gains, net		276		—		(128)				—
Unrealized gains (losses), net		376		2,405		137		(21,048)		—
Accreted discount, net		95		—		—		—		—
Transfer to (from) Level 3		9,147		—		—		—		—
Ending Balance	$	30,293	$	4,181	$	20,434	$	84,638	$	—

Unrealized gains (losses), net on assets or liabilities held at the end of the period	$	2,946	$	4,181	$	363	$	(10,287)	$	—


	Nine Months Ended September 30, 2018
(In Thousands)	MBS		Derivatives		Loans, held at fair value		Residential MSRs, at fair value		Contingent consideration
Beginning Balance	$	126	$	2,832	$	34,354	$	85,554	$	1,686
Purchases or Originations		—		—		—		—		—
Additions due to loans sold, servicing retained		—		—		—		5,502		—
Sales / Principal payments		(11)		—		(12,454)		(1,665)		—
Realized gains, net		—		—		101		—		—
Unrealized gains (losses), net		—		(1,412)		679		2,317		—
Amortization and adjustment for earn-out payments		—		—		—		—		87
Ending Balance	$	115	$	1,420	$	22,680	$	91,708	$	1,773

Unrealized gains (losses), net on assets or liabilities held at the end of the period	$	—	$	1,420	$	325	$	(970)	$	—

The Company’s policy is to recognize transfers in and transfers out as of the end of the period of the event or the date of the change in circumstances that caused the transfer. Transfers between Level 2 and Level 3 generally relate to whether there were changes in the significant relevant observable and unobservable inputs that are available for the fair value measurements of such financial instruments. Transfers into or out of Level 3 of the fair value hierarchy are recorded at the end of the reporting period.

Valuation process for fair value measurements

The Company establishes valuation processes and procedures designed so that fair value measurements are appropriate and reliable, that they are based on observable inputs where possible, and that valuation approaches are consistently applied and the assumptions and inputs are reasonable. The Company has also established processes to provide that the valuation methodologies, techniques and approaches for investments that are categorized within Level 3 of the fair value hierarchy are fair, consistent and verifiable. The Company’s processes provide a framework that ensures the oversight of the Company’s fair value methodologies, techniques, validation procedures, and results.

The Company designates a valuation committee (the “Committee”) to oversee the entire valuation process of the Company’s Level 3 investments. The Committee is comprised of various personnel who are responsible for developing the Company’s written valuation policies, processes and procedures, conducting periodic reviews of the valuation policies, and performing validation procedures on the overall fairness and consistent application of the valuation policies and processes and that the assumptions and inputs used in valuation are reasonable.

The validation procedures overseen by the Committee are also intended to provide that the values received from external third-party pricing sources are consistent with the Company’s Valuation Policy and are carried at fair value. To the extent that there is no exchange pricing, vendor marks or broker quotes readily available, the Company may use an internal valuation model or other valuation methodology that may be based on unobservable market inputs to fair value the investment.

The values provided by a third-party pricing service are calculated based on key inputs provided by the Company including collateral values, unpaid principal balances, cash flow velocity, contractual status and anticipated disposition timelines. In addition, the Company performs an internal valuation used to assess and review the reasonableness and validity of the fair values provided by a third party. The Company also performs analytical procedures, which include automated checks consisting of prior-period variance analysis, comparisons of actual prices to internally calculate expected prices based on observable market changes, analysis of changes in pricing ranges, and relative value and yield comparisons using the Company’s proprietary valuation models.

Upon completion of the review process described above, the Company may provide additional quantitative and qualitative data to the third-party pricing service to consider in valuing certain financial assets and liabilities, as applicable. Such data may include deal specific information not included in the data tape provided to the third party, outliers when compared to the unpaid principal balance and collateral value and knowledge of any impending liquidation of an investment. If deemed necessary by the third party and management, the investments are re-valued by the third party to account for the updated information.

The following table summarizes the valuation techniques and significant unobservable inputs used for the Company’s financial instruments that are categorized within Level 3 of the fair value hierarchy as of September 30, 2019 using third party information without adjustment:

Predominant

Weighted

Valuation

Average Price

(In Thousands, except price)

Fair Value

Technique

Type

Price Range

(a)

Loans, held at fair value

20,434

Single External Source

Third Party Mark

99.97 – 112.70

101.81

Mortgage backed securities, at fair value(b)

30,190

Broker Quotes

Third Party Mark

65.38 – 97.00

85.00

Mortgage backed securities, at fair value

103

Transaction Price

99.00 – 99.00

99.00

Residential mortgage servicing rights, at fair value

84,638

Single external source

Discounted cash flow

N/A

(a)

Prices are weighted based on the unpaid principal balance of the loans and securities included in the range for each class

(b)

Price ranges and weighted averages exclude interest-only strips with a fair value of $0.4 million as of September 30, 2019

The following table summarizes the valuation techniques and significant unobservable inputs used for the Company’s financial instruments that are categorized within Level 3 of the fair value hierarchy as of December 31, 2018 using third-party information without adjustment:

Predominant

Weighted

Valuation

Average Price

(In Thousands, except price)

Fair Value

Technique

Type

Price Range

(a)

Loans, held at fair value

22,664

Single External Source

Third Party Mark

99.41 – 105.21

101.52

Mortgage backed securities, at fair value (b)

12,033

Broker Quotes

Third Party Mark

44.65 – 97.50

70.92

Mortgage backed securities, at fair value

115

Transaction Price

99.00 – 99.00

99.00

Residential mortgage servicing rights, at fair value

93,065

Single external source

Discounted cash flow

N/A

Contingent consideration

1,207

Single external source

Discounted cash flow

N/A

(a)

Prices are weighted based on the unpaid principal balance of the loans and securities included in the range for each class

The fair value measurements of these assets are sensitive to changes in assumptions regarding prepayment, probability of default, loss severity in the event of default, forecasts of home prices, and significant activity or developments in the real estate market. Significant changes in any of those inputs in isolation may result in significantly higher or lower fair value measurements. Generally, an increase in the probability of default and loss severity in the event of default would result in a lower fair value measurement. A decrease in these assumptions would have the opposite effect. Conversely, an assumption that the home prices will increase would result in a higher fair value measurement. A decrease in the assumption for home prices would have the opposite effect.

Financial instruments not carried at fair value

The following table presents the carrying value and estimated fair value of our financial instruments that are not carried at fair value on the unaudited interim consolidated balance sheets and are classified as Level 3:


	September 30, 2019				December 31, 2018
(In Thousands)	Carrying Value		Fair Value		Carrying Value		Fair Value
Assets:
Loans, net	$	3,288,458	$	3,406,938	$	2,391,702	$	2,434,185
Servicing rights		29,842		34,661		26,997		28,441
Total assets	$	3,318,300	$	3,441,599	$	2,418,699	$	2,462,626
Liabilities:
Secured borrowings	$	1,315,534	$	1,315,534	$	834,547	$	834,547
Securitized debt obligations of consolidated VIEs, net		1,465,539		1,506,300		905,367		918,536
Senior secured note, net		179,189		191,796		178,870		176,981
Guaranteed loan financing		25,571		27,571		229,678		236,804
Convertible notes, net		110,773		121,359		109,979		101,581
Corporate debt, net		104,441		109,567		48,457		48,457
Total liabilities	$	3,201,047	$	3,272,127	$	2,306,898	$	2,316,906

Other assets totaling $15.2 million at September 30, 2019 and $14.5 million at December 31, 2018 are not carried at fair value and include due from servicers and accrued interest, which are reflected in Note 19. Receivable from third parties totaling $0.7 million at September 30, 2019 and $8.9 million at December 31, 2018 are not carried at fair value. For these instruments, carrying value approximates fair value and are classified as Level 3.

Accounts payable and other accrued liabilities totaling $13.8 million at September 30, 2019 and $16.8 million at December 31, 2018 are not carried at fair value and include Payable to related parties and Accrued interest payable which are included in Note 19. For these instruments, carrying value approximates fair value and are classified as Level 3.