Fair Value Measurements

9 Months Ended

Sep. 30, 2020

Fair Value Measurements [Abstract]

Fair Value Disclosures [Text Block]

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 trading or 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 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 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 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. Mortgage servicing rights (Level 3 financial instruments as they are measured using significant unobservable inputs such as mortgage prepayment rates, discount rates and delinquency rates) are periodically evaluated for impairment. The amount of impairment is the amount by which the mortgage servicing rights, net of accumulated amortization, exceed their fair value, which is calculated using third-party valuations. Impairment, if any, is recognized through a valuation allowance and a reduction of revenue. The carrying value and fair value of mortgage servicing rights was $11.9 million and $11.4 million, respectively, at September 30, 2020. Therefore, the Company increased its $0.4 million valuation allowance and impairment related to our mortgage servicing rights taken during the first half of 2020 by $0.1 million during the quarter ended September 30, 2020 (which was recorded as a decrease in revenue during the quarter) to bring the carrying value down to the fair value, for a net valuation allowance and impairment of $0.5 million for the nine months ended September 30, 2020. This $0.5 million decrease in the value of our mortgage servicing rights was caused by the disruption in the mortgage industry as a result of the COVID-19 pandemic. At December 31, 2019, the carrying value and fair value of our mortgage servicing rights were both $9.6 million.

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 homebuying 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 nine months.

Some IRLCs are committed to a specific third-party investor through the use of 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 and FMBSs related to mortgage loans held for sale 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 consists primarily of single-family residential loans collateralized by the underlying property.  Generally, all of the mortgage loans and related servicing rights are sold to third-party investors shortly after origination.  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 whole loan contract or by FMBSs.

The table below shows the notional amounts of our financial instruments at September 30, 2020 and December 31, 2019:

Description of Financial Instrument (in thousands)	September 30, 2020		December 31, 2019
Whole loan contracts and related committed IRLCs	$	2,924	$	1,445
Uncommitted IRLCs	213,146		87,340
FMBSs related to uncommitted IRLCs	186,000		88,000
Whole loan contracts and related mortgage loans held for sale	13,750		6,125
FMBSs related to mortgage loans held for sale	116,000		144,000
Mortgage loans held for sale covered by FMBSs	120,257		144,411

The following table sets forth the amount of (loss) gain recognized, within our revenue in the Unaudited Condensed Consolidated Statements of Income, on assets and liabilities measured on a recurring basis for the three and nine months ended September 30, 2020 and 2019:

	Three Months Ended September 30,				Nine Months Ended September 30,
Description (in thousands)	2020		2019		2020		2019
Mortgage loans held for sale	$	(1,338)	$	(1,964)	$	(911)	$	(2,981)
Forward sales of mortgage-backed securities	1,670		2,299		507		3,631
Interest rate lock commitments	(853)		(686)		704		(258)
Whole loan contracts	(20)		121		(68)		174
Total (loss) gain recognized	$	(541)	$	(230)	$	232	$	566

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

	Asset Derivatives			Liability Derivatives
	September 30, 2020			September 30, 2020
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	$	171	Other liabilities	$	—
Interest rate lock commitments	Other assets	1,380		Other liabilities	—
Whole loan contracts	Other assets	—		Other liabilities	106
Total fair value measurements		$	1,551		$	106

	Asset Derivatives			Liability Derivatives
	December 31, 2019			December 31, 2019
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	$	336
Interest rate lock commitments	Other assets	654		Other liabilities	—
Whole loan contracts	Other assets	—		Other liabilities	16
Total fair value measurements		$	654		$	352

Assets Measured on a Non-Recurring Basis

Inventory. The Company assesses inventory for recoverability on a quarterly basis based on the difference in the carrying value of the inventory and its fair value at the time of the evaluation. Determining the fair value of a community’s inventory involves a number of variables, estimates and projections, which are Level 3 measurement inputs. See Note 1, “Summary of Significant Accounting Policies - Inventory” in the Company’s 2019 Form 10-K for additional information regarding the Company’s methodology for determining fair value.

The Company uses significant assumptions to evaluate the recoverability of its inventory, such as estimated average selling price, construction and development costs, absorption rate (reflecting any product mix change strategies implemented or to be implemented), selling strategies, alternative land uses (including disposition of all or a portion of the land owned), or discount rates. Changes in these assumptions could materially impact future cash flow and fair value estimates and may lead the Company to incur additional impairment charges in the future. Our analysis is conducted only if indicators of a decline in value of our inventory exist, which include, among other things, declines in gross margin on sales contracts in backlog or homes that have been delivered, slower than anticipated absorption pace, declines in average sales price or high incentive offers by management to improve absorptions, declines in margins regarding future land sales, or declines in the value of the land itself as a result of third party appraisals. If communities are not recoverable based on the estimated future undiscounted cash flows, the impairment to be recognized is measured as the amount by which the carrying amount of the assets exceeds the estimated fair value of the assets. During the three and nine months ended September 30, 2020 and 2019, the Company did not record any impairment charges on its inventory.

Investment in Unconsolidated Joint Ventures.  We evaluate our investments in unconsolidated joint ventures for impairment on a quarterly basis based on the difference in the investment’s carrying value and its fair value at the time of the evaluation. If the Company has determined that the decline in value is other than temporary, the Company would write down the value of the investment to its estimated fair value. Determining the fair value of investments in unconsolidated joint ventures involves a number of variables, estimates and assumptions, which are Level 3 measurement inputs. See Note 1, “Summary of Significant Accounting Policies - Investment in Unconsolidated Joint Ventures,” in the Company’s 2019 Form 10-K for additional information regarding the Company’s methodology for determining fair value. Because of the high degree of judgment involved in developing these assumptions, it is possible that changes in these assumptions could materially impact future cash flow and fair value estimates of the investments which may lead the Company to incur additional impairment charges in the future. During the three and nine months ended September 30, 2020 and 2019, the Company did not record any impairment charges on its investments in unconsolidated joint ventures.

Financial Instruments

Counterparty Credit Risk. To reduce the risk associated with 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 September 30, 2020 and December 31, 2019. The objective of the fair value measurement is 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.

		September 30, 2020				December 31, 2019
(In thousands)	Fair Value Hierarchy	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Assets:
Cash, cash equivalents and restricted cash	Level 1	$	202,512	$	202,512	$	6,083	$	6,083
Mortgage loans held for sale	Level 2	140,046		140,046		155,244		155,244
Interest rate lock commitments	Level 2	1,380		1,380		654		654
Forward sales of mortgage-backed securities	Level 2	171		171		—		—
Liabilities:
Notes payable - homebuilding operations	Level 2	—		—		66,000		66,000
Notes payable - financial services operations	Level 2	136,119		136,119		136,904		136,904
Notes payable - other	Level 2	5,325		5,016		5,828		5,286
Senior notes due 2021 (a)	Level 2	—		—		300,000		299,250
Senior notes due 2025 (a)	Level 2	250,000		258,125		250,000		261,563
Senior notes due 2028 (a)	Level 2	400,000		412,000		—		—
Whole loan contracts for committed IRLCs and mortgage loans held for sale	Level 2	106		106		16		16
Forward sales of mortgage-backed securities	Level 2	—		—		336		336

(a)Our senior 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 September 30, 2020 and December 31, 2019:

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, Whole loan Contracts for Committed IRLCs and Mortgage Loans Held for Sale, Senior Notes due 2021, Senior Notes due 2025 and  Senior Notes due 2028. The fair value of these financial instruments was determined based upon market quotes at September 30, 2020 and December 31, 2019. 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.

Notes Payable - Homebuilding Operations. The interest rate available to the Company during the quarter ended September 30, 2020 under the Company’s $500 million unsecured revolving credit facility, dated July 18, 2013, as amended most recently on June 30, 2020 (the “Credit Facility”), fluctuated daily with the one-month LIBOR rate plus a margin of 250 basis points, and thus the carrying value is a reasonable estimate of fair value. See Note 8 to our financial statements for additional information regarding the Credit Facility.

Notes Payable - Financial Services Operations. M/I Financial, LLC (“M/I Financial”) is a party to two credit agreements: (1) a $125 million secured mortgage warehousing agreement (which increases to $160 million from September 25, 2020 to October 15, 2020 and to $185 million from November 15, 2020 to February 4, 2021, which are periods of increased volume of mortgage originations), dated June 24, 2016, as amended (the “MIF Mortgage Warehousing Agreement”); and (2) a $65 million mortgage repurchase agreement, dated October 30, 2017, as amended (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 M/I Financial during the third quarter of 2020 fluctuated with LIBOR. See Note 8 to our financial statements 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.