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Fair Value of Financial Instruments
12 Months Ended
Dec. 31, 2018
Fair Value of Financial Instruments  
Fair Value of Financial Instruments

Note 12.—Fair Value of Financial Instruments

The use of fair value to measure the Company’s financial instruments is fundamental to its consolidated financial statements and is a critical accounting estimate because a substantial portion of its assets and liabilities are recorded at estimated fair value.

FASB ASC 825 requires disclosure of the estimated fair value of certain financial instruments and the methods and significant assumptions used to estimate such fair values. On January 1, 2018, the Company adopted ASU 2016-01 and ASU 2018-03 which requires the use of the exit price notion when measuring the fair values of financial instruments for disclosure purposes.  Starting in the first quarter of 2018, we updated our methodology used to estimate fair value to conform to the new requirements.  The following table presents the estimated fair value of financial instruments included in the consolidated financial statements as of the dates indicated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2018

 

December 31, 2017

 

 

 

Carrying

 

Estimated Fair Value

 

Carrying

 

Estimated Fair Value

 

 

 

Amount

 

Level 1

 

Level 2

 

Level 3

 

Amount

 

Level 1

 

Level 2

 

Level 3

 

Assets

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents

 

$

23,200

 

$

23,200

 

$

 —

 

$

 —

 

$

33,223

 

$

33,223

 

$

 —

 

$

 —

 

Restricted cash

 

 

6,989

 

 

6,989

 

 

 —

 

 

 —

 

 

5,876

 

 

5,876

 

 

 —

 

 

 —

 

Mortgage loans held-for-sale

 

 

353,601

 

 

 —

 

 

353,601

 

 

 —

 

 

568,781

 

 

 —

 

 

568,781

 

 

 —

 

Finance receivables

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

41,777

 

 

 —

 

 

41,777

 

 

 —

 

Mortgage servicing rights

 

 

64,728

 

 

 —

 

 

 —

 

 

64,728

 

 

154,405

 

 

 —

 

 

 —

 

 

154,405

 

Derivative assets, lending, net

 

 

3,351

 

 

 —

 

 

 —

 

 

3,351

 

 

4,777

 

 

 —

 

 

420

 

 

4,357

 

Securitized mortgage collateral

 

 

3,157,071

 

 

 —

 

 

 —

 

 

3,157,071

 

 

3,662,008

 

 

 —

 

 

 —

 

 

3,662,008

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Warehouse borrowings

 

$

284,137

 

$

 —

 

$

284,137

 

$

 —

 

$

575,363

 

$

 —

 

$

575,363

 

$

 —

 

MSR financings

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

35,133

 

 

 —

 

 

 —

 

 

35,133

 

Convertible notes

 

 

24,985

 

 

 —

 

 

 —

 

 

24,985

 

 

24,974

 

 

 —

 

 

 —

 

 

24,974

 

Contingent consideration

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

554

 

 

 —

 

 

 —

 

 

554

 

Long-term debt

 

 

44,856

 

 

 —

 

 

 —

 

 

44,856

 

 

44,982

 

 

 —

 

 

 —

 

 

44,982

 

Securitized mortgage borrowings

 

 

3,148,215

 

 

 —

 

 

 —

 

 

3,148,215

 

 

3,653,265

 

 

 —

 

 

 —

 

 

3,653,265

 

Derivative liabilities, lending, net

 

 

683

 

 

 —

 

 

683

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

The fair value amounts above have been estimated by management using available market information and appropriate valuation methodologies. Considerable judgment is required to interpret market data to develop the estimates of fair value in both inactive and orderly markets. Accordingly, the estimates presented are not necessarily indicative of the amounts that could be realized in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

For securitized mortgage collateral and securitized mortgage borrowings, the underlying Alt‑A (non-conforming) residential and commercial loans and mortgage‑backed securities market have experienced significant declines in market activity, along with a lack of orderly transactions. The Company’s methodology to estimate fair value of these assets and liabilities include the use of internal pricing techniques such as the net present value of future expected cash flows (with observable market participant assumptions, where available) discounted at a rate of return based on the Company’s estimates of market participant requirements. The significant assumptions utilized in these internal pricing techniques, which are based on the characteristics of the underlying collateral, include estimated credit losses, estimated prepayment speeds and appropriate discount rates.

Refer to Recurring Fair Value Measurements below for a description of the valuation methods used to determine the fair value of securitized mortgage collateral and borrowings, derivative assets and liabilities, long‑term debt, mortgage servicing rights, loans held‑for‑sale.

The carrying amounts of cash and cash equivalents and restricted cash approximates fair value.

Finance receivables carrying amounts approximate fair value due to the short-term nature of the assets and do not present unanticipated interest rate or credit concerns.

Warehouse borrowings carrying amounts approximate fair value due to the short‑term nature of the liabilities and do not present unanticipated interest rate or credit concerns.

Convertible notes are recorded at amortized cost, which approximates fair value.

MSR financings carrying amount approximates fair value as the underlying facility bears interest at a rate that is periodically adjusted based on a market index.

Fair Value Hierarchy

The application of fair value measurements may be on a recurring or nonrecurring basis depending on the accounting principles applicable to the specific asset or liability or whether management has elected to carry the item at its estimated fair value.

FASB ASC 820‑10‑35 specifies a hierarchy of valuation techniques based on whether the inputs to those techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. These two types of inputs create the following fair value hierarchy:

·

Level 1—Quoted prices (unadjusted) in active markets for identical instruments or liabilities that an entity has the ability to assess at measurement date.

·

Level 2—Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; inputs other than quoted prices that are observable for an asset or liability, including interest rates and yield curves observable at commonly quoted intervals, prepayment speeds, loss severities, credit risks and default rates; and market‑corroborated inputs.

·

Level 3—Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.

This hierarchy requires the Company to use observable market data, when available, and to minimize the use of unobservable inputs when estimating fair value.

As a result of the lack of observable market data resulting from inactive markets, the Company has classified its mortgage servicing rights, securitized mortgage collateral and borrowings, derivative assets (IRLCs), convertible notes, contingent consideration and long‑term debt as Level 3 fair value measurements. Level 3 assets and liabilities measured at fair value on a recurring basis were approximately 90% and 99% and 87% and 99%, respectively, of total assets and total liabilities measured at estimated fair value at December 31, 2018 and 2017.

Recurring Fair Value Measurements

The Company assesses its financial instruments on a quarterly basis to determine the appropriate classification within the fair value hierarchy, as defined by FASB ASC Topic 810. Transfers between fair value classifications occur when there are changes in pricing observability levels. Transfers of financial instruments among the levels occur at the beginning of the reporting period. There were no material transfers between Level 1, Level 2 or Level 3 classified instruments during the year ended December 31, 2018.

The following tables present the Company’s assets and liabilities that are measured at estimated fair value on a recurring basis, including financial instruments for which the Company has elected the fair value option at December 31, 2018 and 2017, based on the fair value hierarchy:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Recurring Fair Value Measurements

 

 

 

December 31, 2018

 

December 31, 2017

 

 

    

Level 1

    

Level 2

    

Level 3

    

Level 1

    

Level 2

    

Level 3

 

Assets

   

 

    

   

 

    

   

 

    

   

 

    

   

 

    

   

 

    

 

Mortgage loans held-for-sale

 

$

 —

 

$

353,601

 

$

 —

 

$

 —

 

$

568,781

 

$

 —

 

Derivative assets, lending, net (1)

 

 

 —

 

 

 —

 

 

3,351

 

 

 —

 

 

420

 

 

4,357

 

Mortgage servicing rights

 

 

 —

 

 

 —

 

 

64,728

 

 

 —

 

 

 —

 

 

154,405

 

Securitized mortgage collateral

 

 

 —

 

 

 —

 

 

3,157,071

 

 

 —

 

 

 —

 

 

3,662,008

 

Total assets at fair value

 

$

 —

 

$

353,601

 

$

3,225,150

 

$

 —

 

$

569,201

 

$

3,820,770

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Securitized mortgage borrowings

 

$

 —

 

$

 —

 

$

3,148,215

 

$

 —

 

$

 —

 

$

3,653,265

 

Long-term debt

 

 

 —

 

 

 —

 

 

44,856

 

 

 —

 

 

 —

 

 

44,982

 

Contingent consideration

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

554

 

Derivative liabilities, lending, net (2)

 

 

 —

 

 

683

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

Total liabilities at fair value

 

$

 —

 

$

683

 

$

3,193,071

 

$

 —

 

$

 —

 

$

3,698,801

 


(1)

At December 31, 2018, derivative assets, lending, net included $3.4 million in IRLCs and is included in other assets in the accompanying consolidated balance sheets. At December 31, 2017, derivative assets, lending, net included $4.4 million in IRLCs and $420 thousand in Hedging instruments and is included in other assets in the accompanying consolidated balance sheets.

(2)

At December 31, 2018, derivative liabilities, lending, net are included in other liabilities in the accompanying consolidated balance sheets.

 

The following tables present reconciliation for all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years ended December 31, 2018 and  2017:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Level 3 Recurring Fair Value Measurements

 

 

 

For the Year Ended December 31, 2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest

 

 

 

 

 

 

 

 

 

Securitized

 

Securitized

 

Mortgage

 

rate lock

 

Long-

 

 

 

 

 

 

mortgage

 

mortgage

 

servicing

 

commitments,

 

term

 

Contingent

 

 

    

collateral

    

borrowings

    

rights

    

net

    

debt

    

consideration

 

Fair value, December 31, 2017

  

$

3,662,008

 

$

(3,653,265)

 

$

154,405

 

$

4,357

 

$

(44,982)

 

$

(554)

 

Total gains (losses) included in earnings:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income (1)

 

 

28,165

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

Interest expense (1)

 

 

 —

 

 

(60,889)

 

 

 —

 

 

 —

 

 

(711)

 

 

 —

 

Change in fair value

 

 

43,272

 

 

(44,871)

 

 

3,757

 

 

(1,006)

 

 

3,978

 

 

 —

 

Change in fair value of instrument specific credit risk

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(3,141)

(2)

 

 —

 

Total gains (losses) included in earnings

 

 

71,437

 

 

(105,760)

 

 

3,757

 

 

(1,006)

 

 

126

 

 

 —

 

Transfers in and/or out of Level 3

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

Purchases, issuances and settlements:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Purchases

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

Issuances

 

 

 —

 

 

 —

 

 

24,879

 

 

 —

 

 

 —

 

 

 —

 

Settlements

 

 

(576,374)

 

 

610,810

 

 

(118,313)

 

 

 —

 

 

 —

 

 

554

 

Fair value, December 31, 2018

 

$

3,157,071

 

$

(3,148,215)

 

$

64,728

 

$

3,351

 

$

(44,856)

 

$

 —

 

Unrealized gains (losses) still held (3)

 

$

(383,134)

 

$

2,580,638

 

$

64,728

 

$

3,351

 

$

17,144

 

$

 —

 


(1)

Amounts primarily represent accretion to recognize interest income and interest expense using effective yields based on estimated fair values for trust assets and trust liabilities. Net interest income, including cash received and paid, was $7.7 million for the year ended December 31, 2018. The difference between accretion of interest income and expense and the amounts of interest income and expense recognized in the consolidated statements of operations and comprehensive loss is primarily from contractual interest on the securitized mortgage collateral and borrowings.

(2)

Amount represents the change in instrument specific credit risk in other comprehensive earnings in the consolidated statements of operations and comprehensive loss as required by the adoption of ASU 2016-01 on January 1, 2018.

(3)

Represents the amount of unrealized gains (losses) relating to assets and liabilities classified as Level 3 that are still held and reflected in the fair values at December 31, 2018.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Level 3 Recurring Fair Value Measurements

 

 

 

For the Year Ended December 31, 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest

 

 

 

 

 

 

 

 

Securitized

 

Securitized

 

Mortgage

 

rate lock

 

Long-

 

 

 

 

 

 

mortgage

 

mortgage

 

servicing

 

commitments,

 

term

 

Contingent

 

 

    

collateral

    

borrowings

    

rights

    

net

    

debt

    

consideration

 

Fair value, December 31, 2016

 

$

4,021,891

 

$

(4,017,603)

 

$

131,537

 

$

11,169

 

$

(47,207)

 

$

(31,072)

 

Total gains (losses) included in earnings:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income (1)

 

 

46,077

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

Interest expense (1)

 

 

 —

 

 

(131,507)

 

 

 —

 

 

 —

 

 

(760)

 

 

 —

 

Change in fair value

 

 

245,364

 

 

(246,576)

 

 

(37,904)

 

 

(6,812)

 

 

(2,949)

 

 

11,268

 

Total gains (losses) included in earnings

 

 

291,441

 

 

(378,083)

 

 

(37,904)

 

 

(6,812)

 

 

(3,709)

 

 

11,268

 

Transfers in and/or out of Level 3

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

Purchases, issuances and settlements:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Purchases

 

 

 —

 

 

 —

 

 

5,618

 

 

 —

 

 

 —

 

 

 —

 

Issuances

 

 

 —

 

 

 —

 

 

56,049

 

 

 —

 

 

 —

 

 

 —

 

Settlements

 

 

(651,324)

 

 

742,421

 

 

(895)

 

 

 —

 

 

5,934

 

 

19,250

 

Fair value, December 31, 2017

 

$

3,662,008

 

$

(3,653,265)

 

$

154,405

 

$

4,357

 

$

(44,982)

 

$

(554)

 

Unrealized gains (losses) still held (2)

 

$

(526,134)

 

$

2,686,398

 

$

154,405

 

$

4,357

 

$

17,018

 

$

(554)

 


(1)

Amounts primarily represent accretion to recognize interest income and interest expense using effective yields based on estimated fair values for trust assets and trust liabilities. Net interest income, including cash received and paid, was $8.1 million for the year ended December 31, 2017. The difference between accretion of interest income and expense and the amounts of interest income and expense recognized in the consolidated statements of operations and comprehensive loss is primarily from contractual interest on the securitized mortgage collateral and borrowings.

(2)

Represents the amount of unrealized gains (losses) relating to assets and liabilities classified as Level 3 that were still held and reflected in the fair values at December 31, 2017.

 

The following table presents quantitative information about the valuation techniques and unobservable inputs applied to Level 3 fair value measurements for financial instruments measured at fair value on a recurring and non‑recurring basis at December 31, 2018.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Estimated

 

Valuation

 

Unobservable

 

Range of

 

Weighted

 

Financial Instrument

    

Fair Value

    

Technique

    

Input

    

Inputs

    

Average

 

Assets and liabilities backed by real estate

    

 

 

    

 

    

 

    

 

 

 

 

Securitized mortgage collateral, and

 

$

3,157,071

 

DCF

 

Prepayment rates

 

3.6 - 19.9

%  

8.0

%

Securitized mortgage borrowings

 

 

(3,148,215)

 

 

 

Default rates

 

0.02 - 6.5

%  

1.0

%

 

 

 

 

 

 

 

Loss severities

 

3.1 - 81.9

%  

46.4

%

 

 

 

 

 

 

 

Discount rates

 

3.7 - 25.0

%  

4.9

%

Other assets and liabilities

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage servicing rights

 

$

64,728

 

DCF

 

Discount rate

 

9.0 - 14.0

%  

9.2

%

 

 

 

 

 

 

 

Prepayment rates

 

6.7 - 86.6

%  

10.6

%

Derivative assets - IRLCs, net

 

 

3,351

 

Market pricing

 

Pull-through rate

 

7.6 - 99.7

%  

75.4

%

Long-term debt

 

 

(44,856)

 

DCF

 

Discount rate

 

 10.0

%  

10.0

%


DCF = Discounted Cash Flow

 

For assets and liabilities backed by real estate, a significant increase in discount rates, default rates or loss severities would result in a significantly lower estimated fair value. The effect of changes in prepayment speeds would have differing effects depending on the seniority or other characteristics of the instrument. For other assets and liabilities, a significant increase in discount rates would result in a significantly lower estimated fair value. A significant increase or decrease in pull‑through rate assumptions would result in a significant increase or decrease in the fair value of IRLCs. The Company believes that the imprecision of an estimate could be significant.

The following tables present the changes in recurring fair value measurements included in net earnings for the years ended December 31, 2018 and 2017:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Recurring Fair Value Measurements

 

 

 

Changes in Fair Value Included in Net Loss

 

 

 

For the Year Ended December 31, 2018

 

 

 

 

 

 

 

 

 

Change in Fair Value of

 

 

 

 

 

 

Interest

 

Interest

 

Net Trust

 

Long-term

 

Other Revenue

 

Gain on Sale

 

 

 

 

 

 

Income (1)

 

Expense (1)

 

Assets

 

Debt

 

and Expense

 

of Loans, net

 

     Total     

 

Securitized mortgage collateral

 

$

28,165

 

$

 —

 

$

43,272

 

$

 —

 

$

 —

 

$

 —

 

$

71,437

 

Securitized mortgage borrowings

 

 

 —

 

 

(60,889)

 

 

(44,871)

 

 

 —

 

 

 —

 

 

 —

 

 

(105,760)

 

Long-term debt

 

 

 —

 

 

(711)

 

 

 —

 

 

3,978

 

 

 —

 

 

 —

 

 

3,267

 

Mortgage servicing rights (2)

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

3,757

 

 

 —

 

 

3,757

 

Mortgage loans held-for-sale

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(14,762)

 

 

(14,762)

 

Derivative assets — IRLCs

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(1,006)

 

 

(1,006)

 

Derivative liabilities — Hedging Instruments

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(85)

 

 

(1,019)

 

 

(1,104)

 

Total

 

$

28,165

 

$

(61,600)

 

$

(1,599)

(3)

$

3,978

 

$

3,672

 

$

(16,787)

 

$

(44,171)

 


(1)

Amounts primarily represent accretion to recognize interest income and interest expense using effective yields based on estimated fair values for trust assets and trust liabilities.

(2)

Included in loss on mortgage servicing rights, net in the consolidated statements of operations and comprehensive loss.

(3)

For the year ended December 31, 2018, change in the fair value of trust assets, excluding REO was $1.6 million.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Recurring Fair Value Measurements

 

 

 

Changes in Fair Value Included in Net Loss

 

 

 

For the Year Ended December 31, 2017

 

 

 

 

 

 

 

 

 

Change in Fair Value of

 

 

 

 

 

 

Interest

 

Interest

 

Net Trust

 

Long-term

 

Other Revenue

 

Gain on Sale

 

 

 

 

 

 

Income (1)

 

Expense (1)

 

Assets

 

Debt

 

and Expense

 

of Loans, net

 

Total

 

Securitized mortgage collateral

 

$

46,077

 

$

 —

 

$

245,364

 

$

 —

 

$

 —

 

$

 —

 

$

291,441

 

Securitized mortgage borrowings

 

 

 —

 

 

(131,507)

 

 

(246,576)

 

 

 —

 

 

 —

 

 

 —

 

 

(378,083)

 

Long-term debt

 

 

 —

 

 

(760)

 

 

 —

 

 

(2,949)

 

 

 —

 

 

 —

 

 

(3,709)

 

Mortgage servicing rights (2)

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(37,904)

 

 

 —

 

 

(37,904)

 

Contingent consideration (3)

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

11,268

 

 

 —

 

 

11,268

 

Mortgage loans held-for-sale

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

8,367

 

 

8,367

 

Derivative assets — IRLCs

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(6,812)

 

 

(6,812)

 

Derivative liabilities — Hedging Instruments

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

357

 

 

400

 

 

757

 

Total

 

$

46,077

 

$

(132,267)

 

$

(1,212)

(4)

$

(2,949)

 

$

(26,279)

 

$

1,955

 

$

(114,675)

 


(1)

Amounts primarily represent accretion to recognize interest income and interest expense using effective yields based on estimated fair values for trust assets and trust liabilities.

(2)

Included in loss on mortgage servicing rights, net in the consolidated statements of operations and comprehensive loss.

(3)

Included $2.1 million of accretion of the contingent consideration liability.

(4)

For the year ended December 31, 2017, change in the fair value of trust assets, excluding REO was $1.2 million.

 

The following is a description of the measurement techniques for items recorded at estimated fair value on a recurring basis.

Mortgage servicing rights—The Company elected to carry its mortgage servicing rights arising from its mortgage loan origination operation at fair value. The fair value of mortgage servicing rights is based upon a discounted cash flow model. The valuation model incorporates assumptions that market participants would use in estimating the fair value of servicing. These assumptions include estimates of prepayment speeds, discount rate, cost to service, escrow account earnings, contractual servicing fee income, prepayment and late fees, among other considerations. Mortgage servicing rights are considered a Level 3 measurement at December 31, 2018 and 2017.

Mortgage loans held‑for‑sale—The Company elected to carry its mortgage loans held‑for‑sale originated or acquired from its mortgage lending operation at fair value. Fair value is based on quoted market prices, where available, prices for other traded mortgage loans with similar characteristics, and purchase commitments and bid information received from market participants. Given the meaningful level of secondary market activity for mortgage loans, active pricing is available for similar assets and accordingly, the Company classifies its mortgage loans held‑for‑sale as a Level 2 measurement at December 31, 2018 and 2017.

Securitized mortgage collateral—The Company elected to carry its securitized mortgage collateral at fair value. These assets consist primarily of non‑conforming mortgage loans securitized between 2002 and 2007. Fair value measurements are based on the Company’s internal models used to compute the net present value of future expected cash flows, with observable market participant assumptions, where available. The Company’s assumptions include its expectations of inputs that other market participants would use in pricing these assets. These assumptions include judgments about the underlying collateral, prepayment speeds, estimated future credit losses, forward interest rates, investor yield requirements and certain other factors. As of December 31, 2018, securitized mortgage collateral had an unpaid principal balance of $3.5 billion, compared to an estimated fair value on the Company’s balance sheet of $3.2 billion. The aggregate unpaid principal balance exceeds the fair value by $0.3 billion at December 31, 2018. As of December 31, 2018, the unpaid principal balance of loans 90 days or more past due was $0.4 billion compared to an estimated fair value of $0.2 billion. The aggregate unpaid principal balances of loans 90 days or more past due exceed the fair value by $0.2 billion at December 31, 2018. Securitized mortgage collateral is considered a Level 3 measurement at December 31, 2018 and 2017.

Securitized mortgage borrowings—The Company elected to carry all of its securitized mortgage borrowings at fair value. These borrowings consist of individual tranches of bonds issued by securitization trusts and are primarily backed by non‑conforming mortgage loans. Fair value measurements include the Company’s judgments about the underlying collateral and assumptions such as prepayment speeds, estimated future credit losses, forward interest rates, investor yield requirements and certain other factors. As of December 31, 2018, securitized mortgage borrowings had an outstanding principal balance of $3.5 billion, net of $2.2 billion in bond losses, compared to an estimated fair value of $3.1 billion. The aggregate outstanding principal balance exceeds the fair value by $0.4 billion at December 31, 2018. Securitized mortgage borrowings are considered a Level 3 measurement at December 31, 2018 and 2017.

Contingent consideration—Contingent consideration was applicable to the acquisition of CCM and was estimated and recorded at fair value at the acquisition date as part of purchase price consideration. Additionally, each reporting period, the Company estimated the change in fair value of the contingent consideration and any change in fair value is recognized in the Company's consolidated statements of operations and comprehensive loss if it is determined to not be a measurement period adjustment. The estimate of the fair value of contingent consideration required significant judgment and assumptions to be made about future operating results, discount rates and probabilities of various projected operating result scenarios. In the fourth quarter of 2017, the earn-out period ended and the remaining $554 thousand in contingent consideration payments were paid during the three months ended March 31, 2018. Contingent consideration was considered a Level 3 measurement at December 31, 2017.  The Company has no further obligations related to contingent consideration as of December 31, 2018.

 

Long‑term debt—The Company elected to carry its  remaining long‑term debt (consisting of junior subordinated notes) at fair value. These securities are measured based upon an analysis prepared by management, which considered the Company’s own credit risk, including settlements with trust preferred debt holders and discounted cash flow analysis. As of December 31, 2018, long‑term debt had an unpaid principal balance of $62.0 million compared to an estimated fair value of $44.9 million. The aggregate unpaid principal balance exceeds the fair value by $17.1 million at December 31, 2018. The long‑term debt is considered a Level 3 measurement at December 31, 2018 and 2017.

Derivative assets and liabilities, Lending—The Company’s derivative assets and liabilities are carried at fair value as required by GAAP and are accounted for as free standing derivatives. The derivatives include IRLCs with prospective residential mortgage borrowers whereby the interest rate on the loan is determined prior to funding and the borrowers have locked in that interest rate. These commitments are determined to be derivative instruments in accordance with GAAP. The derivatives also include hedging instruments (typically TBA MBS) used to hedge the fair value changes associated with changes in interest rates relating to its mortgage lending originations as well as mortgage servicing rights. The Company hedges the period from the interest rate lock (assuming a fall‑out factor) to the date of the loan sale. The estimated fair value of IRLCs are based on underlying loan types with similar characteristics using the TBA MBS market, which is actively quoted and easily validated through external sources. The data inputs used in this valuation include, but are not limited to, loan type, underlying loan amount, note rate, loan program, and expected sale date of the loan, adjusted for current market conditions. These valuations are adjusted at the loan level to consider the servicing release premium and loan pricing adjustments specific to each loan. For all IRLCs, the base value is then adjusted for the anticipated Pull‑through Rate. The anticipated Pull‑through Rate is an unobservable input based on historical experience, which results in classification of IRLCs as a Level 3 measurement at December 31, 2018 and 2017.

The fair value of the Hedging Instruments is based on the actively quoted TBA MBS market using observable inputs related to characteristics of the underlying MBS stratified by product, coupon and settlement date. Therefore, the Hedging Instruments are classified as a Level 2 measurement at December 31, 2018 and 2017.

Nonrecurring Fair Value Measurements

The Company is required to measure certain assets and liabilities at estimated fair value from time to time. These fair value measurements typically result from the application of specific accounting pronouncements under GAAP. The fair value measurements are considered nonrecurring fair value measurements under FASB ASC 820‑10.

The following table presents financial and non‑financial assets and liabilities measured using nonrecurring fair value measurements at December 31, 2018 and 2017, respectively:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nonrecurring Fair Value Measurements 

 

 

 

December 31, 2018

 

December 31, 2017

 

 

 

Level 1

 

Level 2

 

Level 3

 

Level 1

 

Level 2

 

Level 3

 

REO (1)

    

$

 —

    

$

1,674

    

$

 —

 

$

 —

    

$

440

    

$

 —

 

Deferred charge (2)

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

7,827

 

Intangible assets

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

21,582

 

Goodwill

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

104,587

 


(1)

Balance represents REO at December 31, 2018 and December 31, 2017 which has been impaired subsequent to foreclosure.

(2)

With the adoption of ASU 2016-16 on January 1, 2018, $7.8 million in deferred charge was eliminated with a cumulative effect adjustment to opening retained deficit.

 

 

The following table presents total gains and (losses) on financial and non‑financial assets and liabilities measured using nonrecurring fair value measurements for the years ended December 31, 2018 and 2017, respectively:

 

 

 

 

 

 

 

 

 

 

Total Gains (Losses) (1)

 

 

For the Year Ended December 31, 

 

 

2018

 

2017

 

REO (2)

    

$

(950)

    

$

7,425

 

Deferred charge (3)

 

 

 —

 

 

(858)

 

Intangible assets

 

 

(18,347)

 

 

 —

 

Goodwill

 

 

(104,587)

 

 

 —

 


(1)

Total losses reflect losses from all nonrecurring measurements during the period.

(2)

For the years ended December 31, 2018 and 2017, the Company recorded $950 thousand and $7.4 million, respectively, in (losses) gains related to changes in the net realizable value (NRV) of properties.  Gains represent recovery of the NRV attributable to an improvement in state specific loss severities on properties held during the period which resulted in an increase to NRV. Losses represent impairment of the NRV attributable to an increase in state specific loss severities on properties held during the period which resulted in a decrease to NRV.

(3)

With the adoption of ASU 2016-16 on January 1, 2018, $7.8 million in deferred charge was eliminated with a cumulative effect adjustment to opening retained earnings. For the year ended December 31, 2017, the Company recorded $858 thousand in income tax expense resulting from impairment write-downs based on changes in estimated cash flows and lives of the related mortgages retained in the securitized mortgage collateral.

 

Real estate owned—REO consists of residential real estate acquired in satisfaction of loans. Upon foreclosure, REO is adjusted to the estimated fair value of the residential real estate less estimated selling and holding costs, offset by expected contractual mortgage insurance proceeds to be received, if any. Subsequently, REO is recorded at the lower of carrying value or estimated fair value less costs to sell. REO balance representing REOs which have been impaired subsequent to foreclosure are subject to nonrecurring fair value measurement and included in the nonrecurring fair value measurements tables. Fair values of REO are generally based on observable market inputs, and considered Level 2 measurements at December 31, 2018 and 2017.

Deferred charge—Deferred charge represents the deferral of income tax expense on inter‑company profits that resulted from the sale of mortgages from taxable subsidiaries to IMH in prior years. The Company evaluates the deferred charge for impairment quarterly using internal estimates of estimated cash flows and lives of the related mortgages retained in the securitized mortgage collateral. If the deferred charge is determined to be impaired, it is recognized as a component of income tax expense. On January 1, 2018, the Company adopted ASU 2016-16, which resulted in a $7.8 million cumulative effect adjustment to opening retained earnings eliminating the remaining deferred charge on the balance sheet.  Deferred charge was considered a Level 3 measurement at December 31, 2017, and as of December 31, 2018, the Company had no deferred charge remaining.

Intangible assets— The methodology used to determine the fair value as well as measure potential impairment of trademarks includes assumptions with inherent uncertainty, including projected sales volumes and related projected revenues, long-term growth rates, royalty rates that a market participant might assume and judgments regarding the factors to develop an applied discount rate. The carrying value of intangible assets is at risk of impairment if future projected usage, revenues or long-term growth rates are lower than those currently projected, or if factors used in the development of a discount rate result in the application of a higher discount rate.  The Company’s testing indicated that the carrying value of certain intangible assets would not be recoverable, and as a result the Company recorded intangible asset impairment of approximately $18.3 million during the year ended December 31, 2018. Intangible assets were considered Level 3 nonrecurring fair value measurements for the year ended December 31, 2018, and as of December 31, 2018, the Company had no intangible assets remaining.

Goodwill— For goodwill, the determination of fair value of a reporting unit involves, among other things, application of various approaches, which include developing forecasts of future cash flows with a number of assumptions including but not limited to, origination and margin projections, growth and terminal value projections, and judgements regarding the factors to develop discount rates and cost of capital. The Company reviewed its goodwill for impairment at least annually as of December 31 or more frequently if facts and circumstances indicate that it is more likely than not that the fair value of a reporting unit that has goodwill is less than its carrying value. The Company compared the fair value of its net assets using three methodologies (two income approaches and one market approach), to the carrying value and determined that its goodwill was impaired.  As a result, we recorded an impairment charge of $104.6 million related to goodwill during the year ended December 31, 2018.  Goodwill was considered a Level 3 nonrecurring fair value measurement for the year ended December 31, 2018, and as of December 31, 2018, the Company had no goodwill remaining.