Fair Value of Financial Instruments

The Company maximizes the use of observable inputs and minimizes the use of unobservable inputs to the extent possible to measure a financial instrument’s fair value. Observable inputs reflect the assumptions market participants would use in pricing an asset or liability, and are affected by the type of product, whether the product is traded on an active exchange or in the secondary market, as well as current market conditions. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement in its entirety. Fair value is estimated by applying the hierarchy discussed in Note (2) Summary of Significant Accounting Policies which prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement. Accordingly, the degree of judgment exercised by the Company in determining fair value is greatest for instruments categorized within Level 3 of the fair value hierarchy.

The Company’s fair value measurement is based primarily on a market approach, which utilizes prices and other relevant information generated by market transactions involving identical or comparable financial instruments. Sources of inputs to the market approach include third-party pricing services, independent broker quotations and pricing matrices. Management analyzes the third party valuation methodologies and its related inputs to perform assessments to determine the appropriate level within the fair value hierarchy and to assess reliability of values. Further, management has a process in place to review all changes in fair value that occurred during each measurement period. Any discrepancies or unusual observations are followed through to resolution through the source of the pricing as well as utilizing comparisons, if applicable, to alternate pricing sources. In addition, the Company utilizes an income approach to measure the fair value of NPLs, as discussed below.

The Company utilizes observable and unobservable inputs within its valuation methodologies. Observable inputs may include: benchmark yields, reported trades, broker-dealer quotes, issuer spreads, benchmark securities, bids, offers and reference data. In addition, specific issuer information and other market data is used. Broker quotes are obtained from sources recognized to be market participants. Unobservable inputs may include: expected cash flow streams, default rates, supply and demand considerations and market volatility.

Available for Sale Securities

Available for sale securities are generally classified within either Level 1 or Level 2 of the fair value hierarchy and are based on prices provided by an independent pricing service and a third party investment manager who provide a single price or quote per security.

The following details the methods and assumptions used to estimate the fair value of each class of available for sale securities and the applicable level each security falls within the fair value hierarchy:

U.S Treasury Securities, Obligations of U.S. Government Authorities and Agencies, Obligations of State and Political Subdivisions, Corporate Securities, Asset-Backed Securities, and Obligations of Foreign Governments: Fair values were obtained from an independent pricing service and a third party investment manager. The prices provided by the independent pricing service are based on quoted market prices, when available, non-binding broker quotes, or matrix pricing and fall under Level 2 or Level 3 of the fair value hierarchy.

Certificates of Deposit: The estimated fair value of certificates of deposit approximate carrying value and fall under Level 1 of the fair value hierarchy.

Equity securities, at fair value

The fair values of publicly traded common and preferred stocks were obtained from market value quotations provided by an independent pricing service and fall under Level 1 of the fair value hierarchy. The fair values of non-publicly traded common and preferred stocks were based on prices obtained from an independent pricing service using unobservable inputs and fall under Level 3 of the fair value hierarchy.

The Company’s investment in Invesque is subject to certain contractual and functional sale restrictions. The functional restriction period is sequential to the contractual restriction period. As of December 31, 2018, the weighted average estimated contractual sale restriction period was 3 months, with 70% of the shares restricted from sale for a period from 1 to 7 months. In addition, as of December 31, 2018 the weighted average estimated functional restriction period was 0.8 months, with 70% of the shares restricted for a period from 0.75 to 2.25 months. The fair value of the Invesque shares is based on the market price adjusted for the impact of these restrictions, and as a result of the discount on the Invesque investment, the fair value measurement falls under Level 2 of the fair value hierarchy.

Loans, at fair value

Corporate Loans: These loans are comprised of a diversified portfolio of middle market and broadly syndicated leveraged loans and are generally classified within either Level 2 or Level 3 in the fair value hierarchy. To determine fair value, the Company uses quoted prices which include those provided from pricing vendors, where available. We perform internal price verification procedures to ensure that the prices and quotes provided from the independent pricing vendors are reasonable. Such verification procedures include comparison of pricing sources and analysis of variances among pricing sources. The Company has evaluated each loan’s respective liquidity and has additionally performed valuation benchmarking. The key characteristics which were evaluated as part of this determination were liquidity ratings, price changes to index benchmarks, depth of quotes, credit ratings and industry trends.

Mortgage Loans Held for Sale: Mortgage loans held for sale are generally classified as Level 2 in the fair value hierarchy and fair value is based upon forward sales contracts with third party investors, including estimated loan costs, and reserves.

Nonperforming Loans and REO: The Company determines the purchase price for NPLs at the time of acquisition and for each subsequent valuation by using a discounted cash flow valuation model and considering alternate loan resolution probabilities, including modification, liquidation, or conversion to REO. The significant unobservable inputs used in the fair value measurement of our NPLs are discount rates, loan resolution timeline, and the value of underlying properties. The fair values of NPLs which are making payments (generally based on a modification or a workout plan) are primarily based upon secondary market transaction prices, which are expressed as a percentage of unpaid principal balance (UPB). Observable inputs to the model include loan amounts, payment history, and property types. Our NPLs are on nonaccrual status at the time of purchase as it is probable that principal or interest is not fully collectible. NPLs are included in loans, at fair value and fall under Level 3 of the fair value hierarchy.

NPLs that have become REOs were measured at fair value on a non-recurring basis at the time of transfer during the year ended December 31, 2018 and the year ended December 31, 2017. The carrying value of REOs at December 31, 2018 and December 31, 2017 was $10,019 and $16,056, respectively. Upon conversion to REO, the fair value is estimated using broker price opinion (BPO). BPOs are subject to judgments of a particular broker formed by visiting a property, assessing general home values in an area, reviewing comparable listings, and reviewing comparable completed sales. These judgments may vary among brokers and may fluctuate over time based on housing market activities and the influx of additional comparable listings and sales. REO is included in other investments. Subsequent to conversion, REOs are carried at lower of cost or market.

Derivative Assets and Liabilities

Derivatives are comprised of interest rate lock commitments (IRLC) and to be announced mortgage backed securities (TBA). The fair value of these instruments is based upon valuation pricing models, which represent the amount the Company would expect to receive or pay at the balance sheet date to exit the position. Our mortgage origination subsidiaries issue IRLCs to its customers, which are carried at estimated fair value on the Company’s consolidated balance sheet. The estimated fair values of these commitments are generally calculated by reference to the value of the underlying loan associated with the IRLC net of costs to produce and an expected fall out assumption. The fair values of these commitments generally result in a Level 3 classification. Our mortgage origination subsidiaries manage their exposure by entering into forward delivery commitments with loan investors. For loans not locked with investors under a forward delivery commitment, the Company enters into hedge instruments, primarily TBAs, to protect against movements in interest rates. The fair values of TBA mortgage backed securities and forward delivery contracts generally result in a Level 2 classification.

The following tables present the Company’s fair value hierarchies for financial assets and liabilities, measured on a recurring basis:



	As of December 31, 2018
	Quoted prices in active markets Level 1		Other significant observable inputs Level 2		Significant unobservable inputs Level 3		Fair value
Assets:
Available for sale securities, at fair value:
U.S. Treasury securities and obligations of U.S. government authorities and agencies	$	—	$	71,748	$	—	$	71,748
Obligations of state and political subdivisions	—		67,446		—		67,446
Obligations of foreign governments	—		6,751		—		6,751
Certificates of deposit	1,241		—		—		1,241
Asset backed securities	—		39,144		1,508		40,652
Corporate securities	—		95,725		—		95,725
Total available for sale securities, at fair value	1,241		280,814		1,508		283,563

Loans, at fair value:
Corporate loans	—		22,697		108,213		130,910
Mortgage loans held for sale	—		56,917		—		56,917
Non-performing loans	—		—		27,556		27,556
Total loans, at fair value	—		79,614		135,769		215,383

Equity securities, at fair value	9,323		113,138		518		122,979

Other investments:
Derivative assets:
Forward delivery contracts	—		5				5
Interest rate lock commitments	—		—		3,460		3,460
TBA mortgage backed securities	—		39		—		39
Total derivative assets	—		44		3,460		3,504
CLOs	—		—		5,027		5,027
Total other investments, at fair value	—		44		8,487		8,531

Total	$	10,564	$	473,610	$	146,282	$	630,456

Liabilities:
Derivative liabilities:
Forward delivery contracts	$	—	$	52	$	—	$	52
TBA mortgage backed securities	—		824		—		824
Total derivative liabilities (included in other liabilities and accrued expenses)	—		876		—		876



	As of December 31, 2018
	Quoted prices in active markets Level 1		Other significant observable inputs Level 2		Significant unobservable inputs Level 3		Fair value
Total	$	—	$	876	$	—	$	876



	As of December 31, 2017
	Quoted prices in active markets Level 1		Other significant observable inputs Level 2		Significant unobservable inputs Level 3		Fair value
Assets:
Available for sale securities, at fair value:
Equity securities	$	541	$	—	$	47	$	588
U.S. Treasury securities and obligations of U.S. government authorities and agencies	—		47,945		—		47,945
Obligations of state and political subdivisions	—		46,981		—		46,981
Obligations of foreign governments	—		570		—		570
Certificates of deposit	896		—		—		896
Asset backed securities	—		23,493		—		23,493
Corporate bonds	—		61,975		—		61,975
Total available for sale securities, at fair value	1,437		180,964		47		182,448

Loans, at fair value:
Corporate loans	—		40,925		116,736		157,661
Mortgage loans held for sale	—		62,846		—		62,846
Non-performing loans	—		—		37,666		37,666
Total loans, at fair value	—		103,771		154,402		258,173

Equity securities, at fair value	25,536		—		—		25,536

Other investments:
Derivative assets:
Forward delivery contracts	—		30		—		30
Interest rate lock commitments	—		—		4,808		4,808
TBA mortgage backed securities	—		175		—		175
Total derivative assets	—		205		4,808		5,013
CLOs	—		—		3,409		3,409
Total other investments, at fair value	—		205		8,217		8,422

Total	$	26,973	$	284,940	$	162,666	$	474,579

Liabilities:
Derivative liabilities:
TBA mortgage backed securities	$	—	$	117	$	—	$	117
Total derivative liabilities (included in other liabilities and accrued expenses)	—		117		—		117
Total	$	—	$	117	$	—	$	117

The following table represents additional information about assets that are measured at fair value on a recurring basis for which the Company has utilized Level 3 inputs to determine fair value for the following periods:



	Year Ended December 31,
	2018 ⁽¹⁾			2017 ⁽¹⁾
	Non-CLO assets			Non-CLO assets			CLO assets
Balance at January 1,	$	162,666		$	211,192		$	585,870
Net realized gains (losses)	521			8,835			(1,668		)
Net unrealized gains (losses)	(4,123		)	923			89
Origination of IRLC	49,067			73,554			—
Purchases	65,661			64,718			76,123
Sales ⁽¹⁾	(71,282		)	(102,725		)	(193,205		)
Issuances	373			683			675
Transfer into Level 3 ⁽¹⁾	12,748			—			17,601
Transfer adjustments (out of) Level 3 ⁽¹⁾	(11,567		)	(9,089		)	(23,427		)
Deconsolidation of CLOs due to sale	—			2,817			(462,058		)
Conversion to real estate owned	(7,367		)	(15,033		)	—
Conversion to mortgage held for sale	(50,415		)	(72,519		)	—
Transfer to assets held for sale	—			(690		)	—
Balance at December 31,	$	146,282		$	162,666		$	—

Changes in unrealized gains (losses) included in earnings related to assets still held at period end	$	(2,971	)	$	3,809		$	—

(1) All transfers are deemed to occur at end of period. Transfers between Level 2 and 3 were a result of subjecting third-party pricing on both CLO and Non-CLO assets to various liquidity, depth, bid-ask spread and benchmarking criteria as well as assessing the availability of observable inputs affecting their fair valuation.

The following table represents additional information about liabilities that are measured at fair value on a recurring basis for which the Company has utilized Level 3 inputs to determine fair value for the following periods:



	Year Ended December 31,
	2018		2017
	Non-CLO liabilities		Non-CLO liabilities			CLO liabilities
Balance at January 1,	$	—	$	3,084		$	912,034
Net unrealized (gains) losses	—		—			(1,377		)
Settlements	—		(4,838		)	(155,194		)
Dispositions	—		—			(49,011		)
FV adjustment	—		1,754			—
Deconsolidation of CLOs due to sale	—		—			(706,452		)
Balance at December 31,	$	—	$	—		$	—

Changes in unrealized (gains) losses included in earnings related to liabilities still held at period end	$	—	$	—		$	—

The following is quantitative information about Level 3 assets with significant unobservable inputs used in fair valuation.



	Fair Value as of						Actual or Range (Weighted average)
Assets	December 31, 2018		December 31, 2017		Valuation technique	Unobservable input(s)	December 31, 2018	December 31, 2017
Interest rate lock commitments	$	3,460	$	4,808	Internal model	Pull through rate	50% - 95%	50% - 95%
NPLs	27,556		37,666		Discounted cash flow	See table below ⁽¹⁾	See table below	See table below
Total	$	31,016	$	42,474

(1)

Significant changes in any of these inputs in isolation could result in a significant change to the fair value measurement. A decline in the discount rate in isolation would increase the fair value. A decrease in the housing pricing index in isolation would decrease the fair value. Individual loan characteristics, such as location and value of underlying collateral, affect the loan resolution timeline. An increase in the loan resolution timeline in isolation would decrease the fair value. A decrease in the value of underlying properties in isolation would decrease the fair value.

The following table sets forth quantitative information about the significant unobservable inputs used to measure the fair value of our NPLs. For NPLs that are not making payments, discount rate, loan resolution time-line, value of underlying properties, holdings costs and liquidation costs are the primary inputs used to measure fair value. For NPLs that are making payments, note rate and secondary market transaction prices/UPB are the primary inputs used to measure fair value.



	As of December 31, 2018			As of December 31, 2017
Unobservable inputs	High	Low	Average⁽¹⁾	High	Low	Average⁽¹⁾
Discount rate	30.0%	16.0%	23.6%	30.0%	16.0%	23.5%
Loan resolution time-line (Years)	2.1	0.6	1.2	2.3	0.5	1.3
Value of underlying properties	$1,780	$55	$383	$1,775	$40	$306
Holding costs	14.7%	5.0%	6.9%	22.0%	5.3%	7.6%
Liquidation costs	14.2%	8.4%	9.2%	16.8%	8.4%	9.4%
Note rate	6.0%	3.0%	4.9%	6.0%	3.0%	4.8%
Secondary market transaction prices/UPB	88.3%	74.5%	83.3%	88.5%	75.5%	83.4%


(1)	Weighted based on value of underlying properties.

The following table presents the carrying amounts and estimated fair values of financial assets and liabilities that are not recorded at fair value and their respective levels within the fair value hierarchy:



	As of December 31, 2018					As of December 31, 2017
	Level within fair value hierarchy	Fair value		Carrying value		Level within fair value hierarchy	Fair value		Carrying value
Assets:
Debentures	2	$	5,134	$	5,134	2	$	4,163	$	4,163
Notes and accounts receivable, net	2	13,057		13,057		2	12,225		12,225
Total assets		$	18,191	$	18,191		$	16,388	$	16,388

Liabilities:
Debt, net	3	$	363,769	$	363,769	3	$	356,537	$	355,913
Total liabilities		$	363,769	$	363,769		$	356,537	$	355,913

Debentures: Since interest rates on debentures are at current market rates for similar credit risks, the carrying amount approximates fair value. These values are net of allowance for doubtful accounts.

Notes and Accounts Receivable: To the extent that carrying amounts differ from fair value, fair value is determined based on contractual cash flows discounted at market rates for similar credits. Categorized as Level 2 of the fair value hierarchy.

Debt: The carrying value, which approximates fair value of LIBOR based debt, represents the total debt balance at face value excluding the unamortized discount. The fair value of the Junior subordinated notes is determined based on dealer quotes. Categorized as Level 3 of the fair value hierarchy.

Additionally, the following financial assets and liabilities on the consolidated balance sheets are not carried at fair value, but whose carrying amounts approximate their fair value:

Cash and Cash Equivalents: The carrying amounts of cash and cash equivalents are carried at cost which approximates fair value. Categorized as Level 1 of the fair value hierarchy.

Accounts and Premiums Receivable, net, retrospective commissions receivable and other receivables: The carrying amounts approximate fair value since no interest rate is charged on these short duration assets. Categorized as Level 2 of the fair value hierarchy. See Note (6) Notes and Accounts Receivable, net.

Due from Brokers, Dealers, and Trustees and Due to Brokers, Dealers and Trustees: The carrying amounts are included in other assets and other liabilities and accrued expenses and approximate their fair value due to their short‑term nature. Categorized as Level 2 of the fair value hierarchy.