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Fair Value

6 Months Ended

Jun. 30, 2021

Note 9 – Fair Value

Fair Value Measurements

ASC 820 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 at the measurement date. ASC 820 clarifies that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The fair value hierarchy gives the highest priority to quoted prices available in active markets (i.e., observable inputs) and the lowest priority to data lacking transparency (i.e., unobservable inputs). Additionally, ASC 820 requires an entity to consider all aspects of nonperformance risk, including the entity’s own credit standing, when measuring the fair value of a liability.

ASC 820 establishes a three-level hierarchy to be used when measuring and disclosing fair value. An instrument’s categorization within the fair value hierarchy is based on the lowest level of significant input to its valuation. Following is a description of the three levels:

•	Level 1 inputs are quoted prices in active markets for identical assets or liabilities as of the measurement date under current market conditions. Additionally, the entity must have the ability to access the active market and the quoted prices cannot be adjusted by the entity.

•

Level 2 inputs include quoted prices in active markets for similar assets or liabilities; quoted prices in inactive markets for identical or similar assets or liabilities; or inputs that are observable or can be corroborated by observable market data by correlation or other means for substantially the full-term of the assets or liabilities.

•

Level 3 unobservable inputs are supported by little or no market activity. The unobservable inputs represent the assumptions that management believes market participants would use to price the assets and liabilities, including risk. Generally, Level 3 assets and liabilities are valued using pricing models, discounted cash flow methodologies, or similar techniques that require significant judgment or estimation.

Recurring Fair Value Measurements

The following is a description of the methods used to estimate the fair values of the Company’s assets and liabilities measured at fair value on a recurring basis, as well as the basis for classifying these assets and liabilities as Level 2 or 3 within the fair value hierarchy. The Company’s valuations consider assumptions that it believes a market participant would consider in valuing the assets and liabilities, the most significant of which are disclosed below. The Company reassesses and periodically adjusts the underlying inputs and assumptions used in the valuations for recent historical experience, as well as for current and expected relevant market conditions.

RMBS

The Company holds a portfolio of RMBS that are classified as available for sale and are carried at fair value in the consolidated balance sheets. The Company determines the fair value of its RMBS based upon prices obtained from third-party pricing providers. The third-party pricing providers use pricing models that generally incorporate such factors as coupons, primary and secondary mortgage rates, rate reset period, issuer, prepayment speeds, credit enhancements and expected life of the security. As a result, the Company classified 100% of its RMBS as Level 2 fair value assets at June 30, 2021 and December 31, 2020.

MSRs

The Company, through its subsidiary Aurora, holds a portfolio of MSRs that are reported at fair value in the consolidated balance sheets. The Company uses a discounted cash flow model to estimate the fair value of these assets. Although MSR transactions are observable in the marketplace, the valuation includes unobservable market data inputs (prepayment speeds, delinquency levels, costs to service and discount rates). As a result, the Company classified 100% of its MSRs as Level 3 fair value assets at June 30, 2021 and December 31, 2020.

Derivative Instruments

The Company enters into a variety of derivative instruments as part of its economic hedging strategies. The Company executes interest rate swaps, swaptions, TBAs and U.S. Treasury futures. The Company utilizes third-party pricing providers to value its derivative instruments. As a result, the Company classified 100% of its derivative instruments as Level 2 fair value assets and liabilities at June 30, 2021 and December 31, 2020.

Both the Company and the derivative counterparties under their netting arrangements are required to post cash collateral based upon the net underlying market value of the Company’s open positions with the counterparties. Posting of cash collateral typically occurs daily, subject to certain dollar thresholds. Due to the existence of netting arrangements, as well as frequent cash collateral posting at low posting thresholds, credit exposure to the Company and/or counterparties is considered materially mitigated. The Company’s interest rate swaps and U.S. Treasury futures are required to be cleared on an exchange, which further mitigates, but does not eliminate, credit risk. Based on the Company’s assessment, there is no requirement for any additional adjustment to derivative valuations specifically for credit.

The following tables present the Company’s assets and liabilities measured at fair value on a recurring basis as of the dates indicated (dollars in thousands).

Recurring Fair Value Measurements

As of June 30, 2021

	Level 1		Level 2		Level 3		Carrying Value
Assets
RMBS
Fannie Mae	$	-	$	617,044	$	-	$	617,044
Freddie Mac		-		381,755		-		381,755
RMBS total		-		998,799		-		998,799
Derivative assets
Interest rate swaps		-		15,164		-		15,164
Interest rate swaptions		-		1,516		-		1,516
TBAs		-		883		-		883
U.S. treasury futures options		-		83		-		83
Derivative assets total		-		17,646		-		17,646
Servicing related assets		-		-		211,995		211,995
Total Assets	$	-	$	1,016,445	$	211,995	$	1,228,440
Liabilities
Derivative liabilities
Interest rate swaps		-		896		-		896
U.S. treasury futures		-		24		-		24
Derivative liabilities total		-		920		-		920
Total Liabilities	$	-	$	920	$	-	$	920

As of December 31, 2020

	Level 1		Level 2		Level 3		Carrying Value
Assets
RMBS
Fannie Mae	$	-	$	715,156	$	-	$	715,156
Freddie Mac		-		506,954		-		506,954
Private Label MBS		-		6,141		-		6,141
RMBS total		-		1,228,251		-		1,228,251
Derivative assets
Interest rate swaps		-		10,791		-		10,791
Interest rate swaptions		-		798		-		798
TBAs		-		4,129		-		4,129
Treasury futures		-		252		-		252
Derivative assets total		-		15,970		-		15,970
Servicing related assets		-		-		174,414		174,414
Total Assets	$	-	$	1,244,221	$	174,414	$	1,418,635
Liabilities
Derivative liabilities
Interest rate swaps		-		5,878		-		5,878
Derivative liabilities total		-		5,878		-		5,878
Total Liabilities	$	-	$	5,878	$	-	$	5,878

The Company may be required to measure certain assets or liabilities at fair value from time to time. These periodic fair value measures typically result from application of certain impairment measures under GAAP. These items would constitute nonrecurring fair value measures under ASC 820. As of June 30, 2021 and December 31, 2020, the Company did not have any assets or liabilities measured at fair value on a nonrecurring basis in the periods presented.

Level 3 Assets and Liabilities

The valuation of Level 3 assets and liabilities requires significant judgment by management. The Company estimates the fair value of its Servicing Related Assets based on internal pricing models rather than quotations, and compares the results of these internal models against the results from models generated by third-party pricing providers. The third-party pricing providers and management rely on inputs such as market price quotations from market makers (either market or indicative levels), original transaction price, recent transactions in the same or similar instruments, and changes in financial ratios or cash flows to determine fair value. Level 3 instruments may also be discounted to reflect illiquidity and/or non-transferability, with the amount of such discount estimated by third-party pricing providers and management in the absence of market information. Assumptions used by third-party pricing providers and management due to lack of observable inputs may significantly impact the resulting fair value and, therefore, the Company’s consolidated financial statements. The Company’s management reviews all valuations that are based on pricing information received from third-party pricing providers. As part of this review, prices are compared against other pricing or input data points in the marketplace, along with internal valuation expertise, to ensure the pricing is reasonable.

Changes in market conditions, as well as changes in the assumptions or methodology used to determine fair value, could result in a significant change to estimated fair values. The determination of estimated cash flows used in pricing models is inherently subjective and imprecise. It should be noted that minor changes in assumptions or estimation methodologies can have a material effect on these derived or estimated fair values, and that the fair values reflected below are indicative of the interest rate and credit spread environments as of June 30, 2021 and December 31, 2020 and do not take into consideration the effects of subsequent changes in market or other factors.

The tables below present the reconciliation for the Company’s Level 3 assets (Servicing Related Assets) measured at fair value on a recurring basis as of the dates indicated (dollars in thousands):

Level 3 Fair Value Measurements

As of June 30, 2021

	Level 3
	MSRs
Balance at December 31, 2020	$	174,414
Purchases, sales and principal paydowns:
Purchases		36,059
Other changes ^(A)		(441	)
Purchases, sales and principal paydowns:	$	35,618
Changes in Fair Value due to:
Changes in valuation inputs or assumptions used in valuation model		47,201
Other changes in fair value ^(B)		(45,238	)
Unrealized gain (loss) included in Net Income	$	1,963
Balance at June 30, 2021	$	211,995

As of December 31, 2020

	Level 3
	MSRs
Balance at December 31, 2019	$	291,111
Purchases, sales and principal paydowns:
Purchases		54,439
Sales		(27,754	)
Other changes ^(A)		(1,482	)
Purchases, sales and principal paydowns:	$	25,203
Changes in Fair Value due to:
Changes in valuation inputs or assumptions used in valuation model		(8,318	)
Other changes in fair value ^(B)		(133,582	)
Unrealized gain (loss) included in Net Income	$	(141,900	)
Balance at December 31, 2020	$	174,414

(A)	Represents purchase price adjustments, principally contractual prepayment protection, and changes due to the Company’s repurchase of the underlying collateral.

(B)	Represents changes due to realization of expected cash flows and estimated MSR runoff.

The tables below present information about the significant unobservable inputs used in the fair value measurement of the Company’s Servicing Related Assets classified as Level 3 fair value assets as of the dates indicated (dollars in thousands):

Fair Value Measurements

As of June 30, 2021

	Fair Value		Valuation Technique	Unobservable Input ^(A)	Range		Weighted Average
MSRs	$	211,995	Discounted cash flow	Constant prepayment speed	6.9% - 25.0	%		12.7	%
				Uncollected payments	0.3% - 2.5	%		0.7	%
				Discount rate				7.0	%
				Annual cost to service, per loan			$	76
Total	$	211,995

As of December 31, 2020

	Fair Value		Valuation Technique	Unobservable Input ^(A)	Range		Weighted Average
MSRs	$	174,414	Discounted cash flow	Constant prepayment speed	5.0% -38.0	%		15.4	%
				Uncollected payments	0.3% - 2.6	%		0.6	%
				Discount rate				6.1	%
				Annual cost to service, per loan			$	76
Total	$	174,414

(A)

Significant increases (decreases) in any of the inputs in isolation may result in significantly lower (higher) fair value measurements. A change in the assumption used for discount rates may be accompanied by a directionally similar change in the assumption used for the probability of uncollected payments and a directionally opposite change in the assumption used for prepayment rates.

(B)

Weighted averages for unobservable inputs are calculated based on the unpaid principal balance of the portfolios.

Fair Value of Financial Assets and Liabilities

In accordance with ASC 820, the Company is required to disclose the fair value of financial instruments, both assets and liabilities recognized and not recognized in the consolidated balance sheets, for which fair value can be estimated. The following describes the Company’s methods for estimating the fair value for financial instruments.

•	RMBS available for sale securities, Servicing Related Assets, derivative assets and derivative liabilities are recurring fair value measurements; carrying value equals fair value. See discussion of valuation methods and assumptions within the “Fair Value Measurements” section of this footnote.

•	Cash and cash equivalents and restricted cash have a carrying value which approximates fair value because of the short maturities of these instruments.

•	The carrying value of repurchase agreements and corporate debt that mature in less than one year generally approximates fair value due to the short maturities. The Company does not hold any repurchase agreements that are considered long-term.

Corporate debt that matures in more than one year consists solely of financing secured by Aurora’s Servicing Related Assets. All of the Company’s debt is revolving and bears interest at adjustable rates. The Company considers that the amount of the corporate debt generally approximates fair value. The fixed rate portion of the financing for all of the Company’s Servicing Related Assets was paid in full on June 30, 2020.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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