Fair Value Measurements

There are three measurement input levels for determining fair value: Level 1, Level 2, and Level 3. Fair values determined by Level 1 inputs utilize quoted prices in active markets for identical assets or liabilities that the Company has the ability to access. Fair values determined by Level 2 inputs utilize inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability.

Assets Measured on a Recurring Basis

The Company measures both mortgage loans held for sale and interest rate lock commitments (“IRLCs”) at fair value. Fair value measurement results in a better presentation of the changes in fair values of the loans and the derivative instruments used to economically hedge them.

In the normal course of business, our financial services segment enters into contractual commitments to extend credit to buyers of single-family homes with fixed expiration dates. The commitments become effective when the borrowers “lock-in” a specified interest rate within established time frames. 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 enters into optional or mandatory delivery forward sale contracts to sell whole loans and mortgage-backed securities to broker/dealers. The forward sale contracts lock in an interest rate and price for the sale of loans similar to the specific rate lock commitments. The Company does not engage in speculative or trading derivative activities. Both the rate lock commitments to borrowers and the forward sale contracts to broker/dealers or investors are undesignated derivatives, and accordingly, are marked to fair value through earnings. Changes in fair value measurements are included in earnings in the accompanying statements of operations.

The fair value of mortgage loans held for sale is estimated based primarily on published prices for mortgage-backed securities with similar characteristics. To calculate the effects of interest rate movements, the Company utilizes applicable published mortgage-backed security prices, and multiplies the price movement between the rate lock date and the balance sheet date by the notional loan commitment amount. The Company sells the majority of its loans on a servicing released basis, and receives a servicing release premium upon sale. Thus, the value of the servicing rights included in the fair value measurement is based upon contractual terms with investors and depends on the loan type. The Company applies a fallout rate to IRLCs when measuring the fair value of rate lock commitments. Fallout is defined as locked loan commitments for which the Company does not close a mortgage loan and is based on management’s judgment and company experience.

The fair value of the Company’s forward sales contracts to broker/dealers solely considers the market price movement of the same type of security between the trade date and the balance sheet date. The market price changes are multiplied by the notional amount of the forward sales contracts to measure the fair value.

Interest Rate Lock Commitments. IRLCs are extended to certain home-buying customers who have applied for a mortgage loan and meet certain defined credit and underwriting criteria. Typically, the IRLCs will have a duration of less than six months; however, in certain markets, the duration could extend to twelve months.

Some IRLCs are committed to a specific third party investor through the use of best-efforts whole loan delivery commitments matching the exact terms of the IRLC loan. Uncommitted IRLCs are considered derivative instruments and are fair value adjusted, with the resulting gain or loss recorded in current earnings.

Forward Sales of Mortgage-Backed Securities. Forward sales of mortgage-backed securities (“FMBSs”) are used to protect uncommitted IRLC loans against the risk of changes in interest rates between the lock date and the funding date. FMBSs related to uncommitted IRLCs are classified and accounted for as non-designated derivative instruments and are recorded at fair value, with gains and losses recorded in current earnings.

Mortgage Loans Held for Sale. Mortgage loans held for sale consist primarily of single-family residential loans collateralized by the underlying property. During the intervening period between when a loan is closed and when it is sold to an investor, the interest rate risk is covered through the use of a best-efforts contract or by FMBSs. The FMBSs are classified and accounted for as non-designated derivative instruments, with gains and losses recorded in current earnings.

The table below shows the notional amounts of our financial instruments at December 31, 2013 and 2012:



	December 31,
Description of financial instrument (in thousands)	2013		2012
Best efforts contracts and related committed IRLCs	$	2,494	$	1,184
Uncommitted IRLCs	49,710		25,854
FMBSs related to uncommitted IRLCs	48,000		26,000
Best efforts contracts and related mortgage loans held for sale	63,386		25,441
FMBSs related to mortgage loans held for sale	20,000		44,000
Mortgage loans held for sale covered by FMBSs	19,884		44,524

The table below shows the level and measurement of assets and liabilities measured on a recurring basis at December 31, 2013 and 2012:



Description of Financial Instrument (in thousands)	Fair Value Measurements December 31, 2013			Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
Mortgage loans held for sale	$	81,810		$	—	$	81,810		$	—
Forward sales of mortgage-backed securities	745			—		745			—
Interest rate lock commitments	(319		)	—		(319		)	—
Best-efforts contracts	479			—		479			—
Total	$	82,715		$	—	$	82,715		$	—



Description of Financial Instrument (in thousands)	Fair Value Measurements December 31, 2012			Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
Mortgage loans held for sale	$	71,121		$	—	$	71,121		$	—
Forward sales of mortgage-backed securities	253			—		253			—
Interest rate lock commitments	1			—		1			—
Best-efforts contracts	(3		)	—		(3		)	—
Total	$	71,372		$	—	$	71,372		$	—

The following table sets forth the amount of (loss) gain recognized, within our revenue in the Condensed Consolidated Statements of Operations, on assets and liabilities measured on a recurring basis for the years ended December 31, 2013, 2012 and 2011:



	Year Ended December 31,
Description (in thousands)	2013			2012			2011
Mortgage loans held for sale	$	(2,094	)	$	(1,494	)	$	3,065
Forward sales of mortgage-backed securities	492			723			(591		)
Interest rate lock commitments	(320		)	(357		)	366
Best-efforts contracts	482			128			(436		)
Total (loss) gain recognized	$	(1,440	)	$	(1,000	)	$	2,404

The following tables set forth the fair value of the Company's derivative instruments and their location within the Condensed Consolidated Balance Sheets for the periods indicated (except for mortgage loans held for sale which is disclosed as a separate line item):

Asset Derivatives

Liability Derivatives

December 31, 2013

Description of Derivatives

Balance Sheet

Location

Fair Value

(in thousands)

Balance Sheet Location

Fair Value

(in thousands)

Forward sales of mortgage-backed securities

Other assets

745

Other liabilities

—

Interest rate lock commitments

Other assets

—

Other liabilities

319

Best-efforts contracts

Other assets

479

Other liabilities

—

Total fair value measurements

1,224

319

Asset Derivatives

Liability Derivatives

December 31, 2012

Description of Derivatives

Balance Sheet

Location

Fair Value

(in thousands)

Balance Sheet Location

Fair Value

(in thousands)

Forward sales of mortgage-backed securities

Other assets

253

Other liabilities

—

Interest rate lock commitments

Other assets

Other liabilities

—

Best-efforts contracts

Other assets

—

Other liabilities

Total fair value measurements

254

Assets Measured on a Non-Recurring Basis

The Company assesses inventory for recoverability on a quarterly basis if events or changes in local or national economic conditions indicate that the carrying amount of an asset may not be recoverable. Our determination of fair value is based on projections and estimates, which are Level 3 measurement inputs. For further explanation on the Company's policy regarding our assessment of recoverability for assets measured on a non-recurring basis, please see Note 1 to our Consolidated Financial Statements. The tables below show the level and measurement of assets measured on a non-recurring basis for the years ended December 31, 2013 and 2012:



		Year Ended December 31,
Description (in thousands)	Hierarchy	2013		2012 (2)		2011 (2)

Adjusted basis of inventory (1)	Level 3	$	5,494	$	6,658	$	44,629
Total losses		5,805		3,502		21,993

Initial basis of inventory (3)		$	11,299	$	10,160	$	66,622


(1)	The fair values in the table above represent only assets whose carrying values were adjusted in the respective period.


(2)	The carrying values for these assets may have subsequently increased or decreased from the fair value reported due to activities that have occurred since the measurement date.

(3)

This amount is inclusive of our investments in unconsolidated joint ventures. There were no losses on our investments in unconsolidated joint ventures in 2013. The fair value of these investments in unconsolidated joint ventures was $1.1 million and $1.0 million for 2012 and 2011, respectively. The total loss for these unconsolidated joint ventures was $0.4 million and $1.0 million for 2012 and 2011, respectively.

Financial Instruments

Counterparty Credit Risk. To reduce the risk associated with accounting losses that would be recognized if counterparties failed to perform as contracted, the Company limits the entities with whom management can enter into commitments. This risk of accounting loss is the difference between the market rate at the time of non-performance by the counterparty and the rate to which the Company committed.

The following table presents the carrying amounts and fair values of the Company's financial instruments at December 31, 2013 and 2012. Fair value is defined 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 (an exit price).



	December 31, 2013				December 31, 2012
(In thousands)	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Assets:
Cash, cash equivalents and restricted cash	$	142,627	$	142,627	$	154,178	$	154,178
Mortgage loans held for sale	81,810		81,810		71,121		71,121
Split dollar life insurance policies	171		171		710		678
Notes receivable	3,151		2,784		8,787		7,460
Commitments to extend real estate loans	—		—		1		1
Best-efforts contracts for committed IRLCs and mortgage loans held for sale	479		479		—		—
Forward sales of mortgage-backed securities	745		745		253		253
Liabilities:
Notes payable - banks	80,029		80,029		67,957		67,957
Notes payable - other	7,790		7,452		11,105		11,148
Convertible senior subordinated notes due 2017	57,500		74,391		57,500		74,175
Convertible senior subordinated notes due 2018	86,250		95,845		—		—
Senior notes due 2018	228,070		248,975		227,670		250,700
Commitments to extend real estate loans	319		319		—		—
Best-efforts contracts for committed IRLCs and mortgage loans held for sale	—		—		3		3
Off-Balance Sheet Financial Instruments:
Letters of credit	—		413		—		493

The following methods and assumptions were used by the Company in estimating its fair value disclosures of financial instruments at December 31, 2013 and 2012:

Cash, Cash Equivalents and Restricted Cash. The carrying amounts of these items approximate fair value because they are short-term by nature.

Mortgage Loans Held for Sale, Forward Sales of Mortgage-Backed Securities, Commitments to Extend Real Estate Loans, Best-Efforts Contracts for Committed IRLCs and Mortgage Loans Held for Sale, 2017 Convertible Senior Subordinated Notes, 2018 Convertible Senior Subordinated Notes and 2018 Senior Notes. The fair value of these financial instruments was determined based upon market quotes at December 31, 2013 and 2012. The market quotes used were quoted prices for similar assets or liabilities along with inputs taken from observable market data by correlation. The inputs were adjusted to account for the condition of the asset or liability.

Split Dollar Life Insurance Policies and Notes Receivable. The estimated fair value was determined by calculating the present value of the amounts based on the estimated timing of receipts using discount rates that incorporate management's estimate of risk associated with the corresponding note receivable. During the year ended December 31, 2013, the balance of our split dollar life insurance policies decreased by $0.5 million due to the surrender of a policy (and termination of the related split-dollar agreement) by an officer.

Note Payable - Banks. The interest rate available to the Company during the year ended December 31, 2013 fluctuated with the Alternate Base Rate or the Eurodollar Rate (for the Company's $200 million unsecured revolving credit facility (the “Credit Facility”)) or LIBOR (for M/I Financial's $100 million secured mortgage warehousing agreement as amended and restated on March 29, 2013 (the “MIF Mortgage Warehousing Agreement”) and for M/I Financial's $15 million mortgage repurchase agreement dated November 13, 2012, as amended (the “MIF Mortgage Repurchase Facility”))), and thus their carrying value is a reasonable estimate of fair value. During the second quarter of 2013, M/I Financial exercised the accordion feature under the MIF Mortgage Warehousing Agreement to increase the maximum borrowing availability amount thereunder by $20.0 million to $100.0 million.

Notes Payable - Other. The estimated fair value was determined by calculating the present value of the future cash flows using the Company's current incremental borrowing rate.

Letters of Credit. Letters of credit of $25.8 million and $25.7 million represent potential commitments at December 31, 2013 and 2012, respectively. The letters of credit generally expire within one or two years. The estimated fair value of letters of credit was determined using fees currently charged for similar agreements.