MORTGAGE LOANS

Mortgage Loans Held for Sale

Mortgage loans held for sale consist primarily of single-family residential loans collateralized by the underlying property. At June 30, 2016, mortgage loans held for sale had an aggregate fair value of $634.5 million and an aggregate outstanding principal balance of $609.3 million. At September 30, 2015, mortgage loans held for sale had an aggregate fair value of $631.0 million and an aggregate outstanding principal balance of $608.9 million. During the nine months ended June 30, 2016 and 2015, mortgage loans originated totaled $4.0 billion and $3.6 billion, respectively, and mortgage loans sold totaled $4.0 billion and $3.5 billion, respectively. The Company had gains on sales of loans and servicing rights of $59.8 million and $143.6 million during the three and nine months ended June 30, 2016, respectively, compared to $52.2 million and $125.7 million in the prior year periods. Net gains on sales of loans and servicing rights are included in financial services revenues in the consolidated statements of operations. Approximately 92% of the mortgage loans sold by DHI Mortgage during the nine months ended June 30, 2016 were sold to four major financial entities, one of which purchased 27% of the total loans sold.

To manage the interest rate risk inherent in its mortgage operations, the Company hedges its risk using derivative instruments, generally forward sales of mortgage-backed securities (MBS), which are referred to as “hedging instruments” in the following discussion. The Company does not enter into or hold derivatives for trading or speculative purposes.

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. The net fair value change, which for the three and nine months ended June 30, 2016 and 2015 was not significant, is recognized in financial services revenues in the consolidated statements of operations. At June 30, 2016 and September 30, 2015, the Company’s mortgage loans held for sale that were not committed to third-party purchasers totaled $403.8 million and $385.3 million, respectively, and the notional amounts of the hedging instruments related to those loans totaled $403.6 million and $383.8 million, respectively.

Other Mortgage Loans and Loss Reserves

Mortgage loans are sold with limited recourse provisions derived from industry-standard representations and warranties in the relevant agreements. These representations and warranties primarily involve the absence of misrepresentations by the borrower or other parties, the appropriate underwriting of the loan and in some cases, a required 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. The majority of other mortgage loans consists 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 June 30, 2016 and September 30, 2015, the Company’s total other mortgage loans and real estate owned, before loss reserves, were as follows:



	June 30, 2016		September 30, 2015
	(In millions)
Other mortgage loans	$	40.7	$	49.0
Real estate owned	0.5		0.6
	$	41.2	$	49.6

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 repurchase and settlement 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 June 30, 2016 and September 30, 2015 were as follows:



	June 30, 2016		September 30, 2015
	(In millions)
Loss reserves related to:
Other mortgage loans	$	3.9	$	1.5
Real estate owned	—		0.1
Loan repurchase and settlement obligations – known and expected	2.2		9.8
	$	6.1	$	11.4

The decrease in the reserve balance is primarily due to the payment of a full settlement with a significant third-party purchaser for loans previously sold to them. Other mortgage loans and real estate owned net of 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 June 30, 2016 and September 30, 2015, the notional amount of IRLCs, which are accounted for as derivative instruments recorded at fair value, totaled $645.8 million and $370.9 million, respectively.

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 in the consolidated statements of operations. At June 30, 2016 and September 30, 2015, the notional amount of best-efforts whole loan delivery commitments totaled $46.8 million and $37.7 million, respectively, and the notional amount of hedging instruments related to IRLCs not yet committed to purchasers totaled $532.4 million and $297.2 million, respectively.