MORTGAGE LOANS

To manage the interest rate risk inherent in its mortgage operations, the Company hedges its risk using various derivative instruments, which include forward sales of mortgage-backed securities (MBS), Eurodollar Futures Contracts (EDFC) and put options on both MBS and EDFC. Use of the term “hedging instruments” in the following discussion refers to these securities collectively, or in any combination. The Company does not enter into or hold derivatives for trading or speculative purposes.

Mortgage Loans Held for Sale

Mortgage loans held for sale consist primarily of single-family residential loans collateralized by the underlying property. At March 31, 2013, mortgage loans held for sale had an aggregate fair value of $394.3 million and an aggregate outstanding principal balance of $382.9 million. At September 30, 2012, mortgage loans held for sale had an aggregate fair value of $345.3 million and an aggregate outstanding principal balance of $332.9 million. During the three and six months ended March 31, 2013, the Company had net gains on sales of loans and servicing rights of $26.7 million and $54.2 million, respectively, compared to $14.9 million and $25.1 million in the same periods of 2012. Net gains on sales of loans and servicing rights are included in financial services revenues on the consolidated statements of operations. Approximately 56% of the mortgage loans sold by DHI Mortgage during the six months ended March 31, 2013 were sold to one major financial institution.

Newly originated loans that have been closed but not committed to third-party purchasers are hedged to mitigate the risk of changes in their fair value. Hedged loans are committed to third-party purchasers typically within three days after origination. The notional amounts of the hedging instruments used to hedge mortgage loans held for sale vary in relationship to the underlying loan amounts, depending on the movements in the value of each hedging instrument relative to the value of the underlying mortgage loans. The fair value change related to the hedging instruments generally offsets the fair value change in the mortgage loans held for sale, which for the three and six months ended March 31, 2013 and 2012 was not significant, and is recognized in financial services revenues on the consolidated statements of operations. As of March 31, 2013, the Company had a notional amount of $223.5 million in mortgage loans held for sale not committed to third-party purchasers and the notional amounts of the hedging instruments related to those loans totaled $224.0 million.

Other Mortgage Loans and Loss Reserves

Mortgage loans are sold with limited recourse provisions which include industry-standard representations and warranties, primarily involving the absence of misrepresentations by the borrower or other parties, insurability if applicable and, depending on the agreement, may include requiring a minimum number of payments to be made by the borrower. The Company generally does not retain any other continuing interest related to mortgage loans sold in the secondary market. Other mortgage loans generally consist of loans repurchased due to these limited recourse obligations. Typically, these loans are impaired and some become real estate owned through the foreclosure process. At March 31, 2013 and September 30, 2012, the Company’s total other mortgage loans and real estate owned, before loss reserves were as follows:



	March 31, 2013		September 30, 2012
	(In millions)
Other mortgage loans	$	35.4	$	38.1
Real estate owned	1.0		1.3
	$	36.4	$	39.4

The Company has recorded reserves for estimated losses on other mortgage loans, real estate owned and future loan repurchase obligations due to the limited recourse provisions, all of which are recorded as reductions of financial services revenue. The loss reserve for loan recourse obligations is estimated based on an analysis of loan repurchase requests received, actual repurchases and losses through the disposition of such loans or requests, discussions with mortgage purchasers and analysis of mortgages originated. The reserve balances at March 31, 2013 and September 30, 2012 were as follows:



	March 31, 2013		September 30, 2012
	(In millions)
Loss reserves related to:
Other mortgage loans	$	4.2	$	5.0
Real estate owned	0.3		0.4
Loan repurchase and settlement obligations – known and expected	26.1		25.5
	$	30.6	$	30.9

Other mortgage loans and real estate owned and the related loss reserves are included in financial services other assets, while loan repurchase obligations are included in financial services accounts payable and other liabilities in the accompanying consolidated balance sheets.

Loan Commitments and Related Derivatives

The Company is party to interest rate lock commitments (IRLCs) which are extended to borrowers who have applied for loan funding and meet defined credit and underwriting criteria. At March 31, 2013, the notional amount of IRLCs, which are accounted for as derivative instruments recorded at fair value, totaled $332.2 million.

The Company manages interest rate risk related to its IRLCs through the use of best-efforts whole loan delivery commitments and hedging instruments. These instruments are considered derivatives in an economic hedge and are accounted for at fair value with gains and losses recognized in financial services revenues on the consolidated statements of operations. As of March 31, 2013, the Company had a notional amount of approximately $15.7 million of best-efforts whole loan delivery commitments and a notional amount of $283.0 million of hedging instruments related to IRLCs not yet committed to purchasers.