Mortgage Loans

9 Months Ended

Jun. 30, 2011

NOTE H – 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. 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. Approximately 87% of the mortgage loans sold by DHI Mortgage during the nine months ended June 30, 2011 were sold to two major financial institutions pursuant to their loan purchase agreements. At June 30, 2011, mortgage loans held for sale had an aggregate fair value of $286.2 million and an aggregate outstanding principal balance of $281.7 million. During the three months ended June 30, 2011 and 2010, the Company had net gains on sales of loans of $11.1 million and $13.9 million, respectively. During the nine months ended June 30, 2011 and 2010, the Company had net gains on sales of loans of $30.9 million and $32.9 million, respectively, which includes the effect of recording recourse expense, as discussed below in “Other Mortgage Loans and Loss Reserves,” of $7.7 million and $11.7 million, respectively.

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 nine months ended June 30, 2011 and 2010 was not significant, and is recognized in current earnings. As of June 30, 2011, the Company had $79.4 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 $79.7 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 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 often become real estate owned through the foreclosure process. At June 30, 2011 and September 30, 2010, the Company’s total other mortgage loans and real estate owned, before loss reserves were as follows:


	June 30,		September 30,
	2011		2010
	(In millions)
Other mortgage loans	$	42.6	$	43.0
Real estate owned		1.3		4.9

	$	43.9	$	47.9

Based on historical performance and current housing and credit market conditions, 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 reserve balances at June 30, 2011 and September 30, 2010 were as follows:


	June 30,		September 30,
	2011		2010
	(In millions)
Loss reserves related to:
Other mortgage loans	$	5.8	$	9.0
Real estate owned		0.7		1.8
Loan repurchase obligations – known and expected		24.1		28.2

	$	30.6	$	39.0

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.

A subsidiary of the Company reinsured a portion of the private mortgage insurance written on loans originated by DHI Mortgage in prior years. At June 30, 2011 and September 30, 2010, reserves for expected future losses under the reinsurance program totaled $0.8 million and $9.7 million, respectively, and are included in financial services accounts payable and other liabilities in the accompanying consolidated balance sheets. It is possible that future losses may exceed the amount of reserves and, if so, additional charges will be required.

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. The expected net future cash flows related to the associated servicing of a loan are included in the measurement of all written loan commitments that are accounted for at fair value through earnings at the time of commitment. At June 30, 2011, IRLCs, which are accounted for as derivative instruments recorded at fair value, totaled $228.7 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 current earnings. As of June 30, 2011, the Company had approximately $22.4 million of best-efforts whole loan delivery commitments and $185.0 million of hedging instruments related to IRLCs not yet committed to purchasers.