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 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 generally sells 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 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 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 September 30, 2014 and December 31, 2013:



Description of Financial Instrument (in thousands)	September 30, 2014		December 31, 2013
Best efforts contracts and related committed IRLCs	$	4,616	$	2,494
Uncommitted IRLCs	56,470		49,710
FMBSs related to uncommitted IRLCs	57,000		48,000
Best efforts contracts and related mortgage loans held for sale	41,058		63,386
FMBSs related to mortgage loans held for sale	34,000		20,000
Mortgage loans held for sale covered by FMBSs	33,736		19,884

The table below shows the level and measurement of assets and liabilities measured on a recurring basis at September 30, 2014 and December 31, 2013:



Description of Financial Instrument (in thousands)	Fair Value Measurements September 30, 2014			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	$	76,983		$	—	$	76,983		$	—
Forward sales of mortgage-backed securities	(41		)	—		(41		)	—
Interest rate lock commitments	434			—		434			—
Best-efforts contracts	51			—		51			—
Total	$	77,427		$	—	$	77,427		$	—



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		$	—

The following table sets forth the amount of gain (loss) recognized, within our revenue in the Unaudited Condensed Consolidated Statements of Operations, on assets and liabilities measured on a recurring basis for the three and nine months ended September 30, 2014 and 2013:



	Three Months Ended September 30,						Nine Months Ended September 30,
Description (in thousands)	2014			2013			2014			2013
Mortgage loans held for sale	$	(959	)	$	3,365		$	2,556		$	1,782
Forward sales of mortgage-backed securities	398			(5,262		)	(786		)	(2,224		)
Interest rate lock commitments	(144		)	1,677			753			941
Best-efforts contracts	164			(193		)	(428		)	(176		)
Total (loss) gain recognized	$	(541	)	$	(413	)	$	2,095		$	323

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 is disclosed as a separate line item):

Asset Derivatives

Liability Derivatives

September 30, 2014

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

434

Other liabilities

—

Best-efforts contracts

Other assets

Other liabilities

—

Total fair value measurements

485

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

Assets Measured on a Non-Recurring Basis

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 2013 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. As of September 30, 2014, the Company's projections generally assume a gradual improvement in market conditions over time. The Company assumed no increase in weighted average sales price or assumed weighted average costs to build and deliver homes in 2014, an increase ranging from 2% to 4% in 2015 and 2016, and a 2% increase in in 2017 and beyond. 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. The Company estimates the fair value of each impaired community by determining the present value of the estimated future cash flows and discounting those cash flow projections using an appropriate risk-adjusted interest rate. As of September 30, 2014, we utilized discount rates ranging from 13% to 16% in our valuations.

Due to the fact that the Company's cash flow models and estimates of fair values are based upon management estimates and assumptions, unexpected changes in market conditions and/or changes in management's intentions with respect to the inventory may lead the Company to incur additional impairment charges in the future. Changes in our key assumptions, including estimated average selling price, construction and development costs, absorption pace (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, could materially impact future cash flow and fair value estimates.

The table below shows the level and measurement of the Company's assets measured on a non-recurring basis as of and for the three and nine months ended September 30, 2014 and 2013:



		Three Months Ended September 30,				Nine Months Ended September 30,
Description (in thousands)	Hierarchy	2014		2013 (2)		2014		2013 (2)

Adjusted basis of inventory (1)	Level 3	$	76	$	1,975	$	1,605	$	3,876
Total losses		622		2,136		1,426		4,237

Initial basis of inventory		$	698	$	4,111	$	3,031	$	8,113


(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.

Variable Interest Entities. In order to minimize our investment and risk of land exposure in a single location, we have periodically partnered with other land developers or homebuilders to share in the land investment and development of a property through joint ownership and development agreements, joint ventures, and other similar arrangements. During the nine month period ended September 30, 2014, we increased our total investment in such joint venture arrangements from December 31, 2013 by $5.5 million primarily due to a joint investment with another builder in a land development in our Southern region.

For joint venture arrangements where a special purpose entity is established to own the property, we generally enter into limited liability company or similar arrangements (“LLCs”) with the other partners. The Company's ownership interest in these LLCs as of September 30, 2014 ranged from 25% to 61%. These entities typically engage in land development activities for the purpose of distributing or selling developed lots to the Company and its partners in the LLC. With respect to our investments in these LLCs, we are required, under ASC 810-10, Consolidation (“ASC 810-10”), to evaluate whether or not such entities should be consolidated into our financial statements. We initially perform these evaluations when each new entity is created and upon any events that require reconsideration of the entity. In order to determine if we should consolidate an LLC, we determine (1) if the LLC is a variable interest entity (“VIE”) and (2) if we are the primary beneficiary of the entity.

As of September 30, 2014, we have determined that one of the LLCs in which we have an interest meets the requirements of a VIE due to a lack of equity at risk in the entity. However, we have determined that we do not have substantive control over the VIE as we do not have the ability to control the activities that most significantly impact its economic performance. As a result, we are not considered the primary beneficiary of the VIE and are not required to consolidate the VIE or any of the LLCs in which we have an interest into our financial statements. We instead recorded the VIE and the LLCs in Investment in Unconsolidated Joint Ventures on our Unaudited Condensed Consolidated Balance Sheets.

We enter into option or purchase agreements to acquire land or lots, for which we generally pay non-refundable deposits. We also analyze these agreements under ASC 810-10 to determine whether we are the primary beneficiary of the VIE, if applicable, using an analysis similar to that described above. If we are deemed to be the primary beneficiary of the VIE, we will consolidate the VIE in our consolidated financial statements. In cases where we are the primary beneficiary, even though we do not have title to such land, we are required to consolidate these purchase/option agreements and reflect such assets and liabilities as Consolidated Inventory not Owned in our Unaudited Condensed Consolidated Balance Sheets.

Investment In Unconsolidated Joint Ventures. We use the equity method of accounting for investments in unconsolidated joint ventures over which we exercise significant influence but do not have a controlling interest. Under the equity method, our share of the unconsolidated joint ventures' earnings or loss, if any, is included in our statement of operations. We evaluate our investments in unconsolidated joint ventures for impairment at least quarterly as described in Note 1, “Summary of Significant Accounting Policies - Inventory” in the Company's 2013 Form 10-K. Determining the fair value of investments in unconsolidated joint ventures involves a number of variables, many of which are interrelated and require management to make certain assumptions. As of September 30, 2014, the Company used a discount rate of 16% in determining the fair value of its investments in unconsolidated joint ventures. In addition to the assumptions management must make to determine if the investment's fair value is less than the carrying value, management must also use judgment in determining whether the impairment is other than temporary. Because of the high degree of judgment involved in developing these assumptions, it is possible that the Company may determine the investment is not impaired in the current period; however, due to the passage of time, changes in market conditions, and/or changes in management's intentions with respect to the investment, a change in assumptions could result and impairment could occur. During the three and nine months ended September 30, 2014 and 2013, the Company did not record any impairment charges on its investments in unconsolidated joint ventures.

We believe that the Company's maximum exposure related to its investment in these unconsolidated joint ventures as of September 30, 2014 is the amount invested of $40.8 million, which is reported as Investment in Unconsolidated Joint Ventures on our Unaudited Condensed Consolidated Balance Sheets, in addition to a $2.5 million note due to the Company from one of the unconsolidated joint ventures (reported in Other Assets), although we expect to invest further amounts in these unconsolidated joint ventures as development of the properties progresses. Included in the Company's investment in unconsolidated joint ventures at both September 30, 2014 and December 31, 2013 were $0.8 million of capitalized interest and other costs.

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, 2014 and December 31, 2013. 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).



	September 30, 2014				December 31, 2013
(In thousands)	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Assets:
Cash, cash equivalents and restricted cash	$	26,066	$	26,066	$	142,627	$	142,627
Mortgage loans held for sale	76,983		76,983		81,810		81,810
Split dollar life insurance policies	189		189		171		171
Notes receivable	4,406		3,778		3,151		2,784
Commitments to extend real estate loans	434		434		—		—
Best-efforts contracts for committed IRLCs and mortgage loans held for sale	51		51		479		479
Forward sales of mortgage-backed securities	—		—		745		745
Liabilities:
Notes payable - banks	88,178		88,178		80,029		80,029
Notes payable - other	8,530		8,012		7,790		7,452
Convertible senior subordinated notes due 2017	57,500		63,322		57,500		74,391
Convertible senior subordinated notes due 2018	86,250		86,142		86,250		95,845
Senior notes due 2018	228,369		240,350		228,070		248,975
Commitments to extend real estate loans	—		—		319		319
Forward sales of mortgage-backed securities	41		41		—		—
Off-Balance Sheet Financial Instruments:
Letters of credit	—		595		—		413

The following methods and assumptions were used by the Company in estimating its fair value disclosures of financial instruments at September 30, 2014 and December 31, 2013:

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 September 30, 2014 and December 31, 2013. 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.

Notes Payable - Banks. The Company is a party to three primary credit agreements: (1) a $200 million unsecured revolving credit facility dated July 18, 2013, with M/I Homes, Inc. as borrower and guaranteed by the Company's wholly owned homebuilding subsidiaries (the “Credit Facility”); (2) a $110 million secured mortgage warehousing agreement, with M/I Financial as borrower, amended on March 28, 2014 (the “MIF Mortgage Warehousing Agreement”); and (3) a $15 million mortgage repurchase agreement, with M/I Financial as borrower, amended on November 6, 2013 (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 the third quarter of 2014 fluctuated with the Alternate Base Rate or the Eurodollar Rate (for the Credit Facility) or LIBOR (for the MIF Mortgage Warehousing Agreement and the MIF Mortgage Repurchase Facility). Refer to Note 12 for additional information regarding the Credit 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 $28.2 million and $25.8 million represent potential commitments at September 30, 2014 and December 31, 2013, 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.