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

To meet financing needs of our home-buying customers, M/I Financial is party to interest rate lock commitments (“IRLCs”), which are extended to customers who have applied for a mortgage loan and meet certain defined credit and underwriting criteria. These IRLCs are considered derivative financial instruments. M/I Financial manages interest rate risk related to its IRLCs and mortgage loans held for sale through the use of forward sales of mortgage-backed securities (“FMBSs”), the use of best-efforts whole loan delivery commitments, and the occasional purchase of options on FMBSs in accordance with Company policy. These FMBSs, options on FMBSs, and IRLCs covered by FMBSs are considered non-designated derivatives. These amounts are either recorded in Other Assets or Other Liabilities on the Consolidated Balance Sheets (depending on the respective balance for that year ended December 31).

The Company measures both mortgage loans held for sale and 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 Consolidated Statements of Income.

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 loans on a servicing released or servicing retained basis, and receives servicing compensation. 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 term of less than six months; however, in certain markets, the term 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 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, 2016 and 2015:



	December 31,
Description of Financial Instrument (in thousands)	2016		2015
Best efforts contracts and related committed IRLCs	$	6,607	$	2,625
Uncommitted IRLCs	66,875		46,339
FMBSs related to uncommitted IRLCs	66,000		46,000
Best efforts contracts and related mortgage loans held for sale	125,348		100,152
FMBSs related to mortgage loans held for sale	33,000		27,000
Mortgage loans held for sale covered by FMBSs	32,870		26,690

The table below shows the level and measurement of assets and liabilities measured on a recurring basis at December 31, 2016 and 2015:



Description of Financial Instrument (in thousands)	Fair Value Measurements December 31, 2016			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	$	154,020		$	—	$	154,020		$	—
Forward sales of mortgage-backed securities	230			—		230			—
Interest rate lock commitments	250			—		250			—
Best-efforts contracts	(90		)	—		(90		)	—
Total	$	154,410		$	—	$	154,410		$	—



Description of Financial Instrument (in thousands)	Fair Value Measurements December 31, 2015			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	$	127,001		$	—	$	127,001		$	—
Forward sales of mortgage-backed securities	(93		)	—		(93		)	—
Interest rate lock commitments	321			—		321			—
Best-efforts contracts	(206		)	—		(206		)	—
Total	$	127,023		$	—	$	127,023		$	—

The following table sets forth the amount of (loss) gain recognized, within our revenue in the Consolidated Statements of Income, on assets and liabilities measured on a recurring basis for the years ended December 31, 2016, 2015 and 2014:



	Year Ended December 31,
Description (in thousands)	2016			2015			2014
Mortgage loans held for sale	$	(3,591	)	$	(590	)	$	3,191
Forward sales of mortgage-backed securities	323			89			(927		)
Interest rate lock commitments	(71		)	32			607
Best-efforts contracts	116			(258		)	(426		)
Total (loss) gain recognized	$	(3,223	)	$	(727	)	$	2,445

The following tables set forth the fair value of the Company’s derivative instruments and their location within the 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, 2016

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

230

Other liabilities

—

Interest rate lock commitments

Other assets

250

Other liabilities

—

Best-efforts contracts

Other assets

—

Other liabilities

Total fair value measurements

480

Asset Derivatives

Liability Derivatives

December 31, 2015

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

—

Other liabilities

Interest rate lock commitments

Other assets

321

Other liabilities

—

Best-efforts contracts

Other assets

—

Other liabilities

206

Total fair value measurements

321

299

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 of 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, 2016 and 2015:



		Year Ended December 31,
Description (in thousands)	Hierarchy	2016		2015 ⁽²⁾		2014 ⁽²⁾

Adjusted basis of inventory ⁽¹⁾	Level 3	$	12,921	$	11,885	$	3,730
Total losses		3,992		3,638		3,457

Initial basis of inventory ⁽³⁾		$	16,913	$	15,523	$	7,187


(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 joint venture arrangements. There were no losses on our investments in joint venture arrangements for 2016 and 2015. The total loss for these joint venture arrangements was $1.0 million for 2014.

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, 2016 and 2015. The objective of the fair value measurement is defined to estimate the price at which an orderly transaction to sell the asset or transfer the liability would take place between market participants at the measurement date under current market conditions.



	December 31, 2016				December 31, 2015
(In thousands)	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Assets:
Cash, cash equivalents and restricted cash	$	34,441	$	34,441	$	13,101	$	13,101
Mortgage loans held for sale	154,020		154,020		127,001		127,001
Split dollar life insurance policies	214		214		199		199
Notes receivable	763		687		3,153		3,076
Commitments to extend real estate loans	250		250		321		321
Forward sales of mortgage-backed securities	230		230		—		—
Liabilities:
Notes payable - homebuilding operations	40,300		40,300		43,800		43,800
Notes payable - financial services operations	152,895		152,895		123,648		123,648
Notes payable - other	6,415		5,999		8,441		8,039
Convertible senior subordinated notes due 2017^(a)	57,500		65,957		57,500		61,884
Convertible senior subordinated notes due 2018 ^(a)	86,250		88,105		86,250		84,741
Senior notes due 2021^(a)	300,000		314,250		300,000		295,500
Best-efforts contracts for committed IRLCs and mortgage loans held for sale	90		90		206		206
Forward sales of mortgage-backed securities	—		—		93		93
Off-Balance Sheet Financial Instruments:
Letters of credit	—		702		—		735


(a)	Our senior notes and convertible senior subordinated notes are stated at the principal amount outstanding which does not include the impact of premiums, discounts, and debt issuance costs that are amortized to interest cost over the respective terms of the notes.

The following methods and assumptions were used by the Company in estimating its fair value disclosures of financial instruments at December 31, 2016 and 2015:

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, Convertible Senior Subordinated Notes due 2017, Convertible Senior Subordinated Notes due 2018 and Senior Notes due 2021. The fair value of these financial instruments was determined based upon market quotes at December 31, 2016 and 2015. 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 Policy 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.

Notes Payable - Homebuilding Operations. The interest rate available to the Company during the year ended December 31, 2016 fluctuated with the Alternate Base Rate or the Eurodollar Rate for the Company’s $400 million unsecured revolving credit facility dated July 18, 2013, as amended (the “Credit Facility”), and thus the carrying value is a reasonable estimate of fair value. Refer to Note 11 for additional information regarding the Credit Facility.

Notes Payable - Financial Services Operations. M/I Financial is a party to two credit agreements: (1) a $125 million secured mortgage warehousing agreement, dated June 24, 2016 (the “MIF Mortgage Warehousing Agreement”), and (2) a $15 million mortgage repurchase agreement, dated November 3, 2015, as amended on October 31, 2016 (the “MIF Mortgage Repurchase Facility”). For each of these credit facilities, the interest rate is based on a variable rate index, and thus their carrying value is a reasonable estimate of fair value. The interest rate available to the Company during 2016 fluctuated with LIBOR. Refer to Note 11 for additional information regarding the MIF Mortgage Warehousing Agreement and the MIF Mortgage Repurchase Facility.

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 $37.7 million and $42.5 million represent potential commitments at December 31, 2016 and 2015, 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.