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Financial Instruments and Fair Value Disclosures
9 Months Ended
Aug. 31, 2017
Fair Value Disclosures [Abstract]  
Financial Instruments and Fair Value Disclosures
Financial Instruments and Fair Value Disclosures
The following table presents the carrying amounts and estimated fair values of financial instruments held by the Company at August 31, 2017 and November 30, 2016, using available market information and what the Company believes to be appropriate valuation methodologies. Considerable judgment is required in interpreting market data to develop the estimates of fair value. The use of different market assumptions and/or estimation methodologies might have a material effect on the estimated fair value amounts. The table excludes cash and cash equivalents, restricted cash, receivables, net and accounts payable, all of which had fair values approximating their carrying amounts due to the short maturities and liquidity of these instruments.
 
 
 
August 31, 2017
 
November 30, 2016
 
Fair Value
 
Carrying
 
Fair
 
Carrying
 
Fair
(In thousands)
Hierarchy
 
Amount
 
Value
 
Amount
 
Value
ASSETS
 
 
 
 
 
 
 
 
 
Rialto:
 
 
 
 
 
 
 
 
 
Loans receivable, net
Level 3
 
$
52,779

 
52,784

 
111,608

 
113,747

Investments held-to-maturity
Level 3
 
$
142,462

 
143,737

 
71,260

 
69,992

Lennar Financial Services:
 
 
 
 
 
 
 
 
 
Loans held-for-investment, net
Level 3
 
$
37,665

 
35,378

 
30,004

 
31,233

Investments held-to-maturity
Level 2
 
$
53,631

 
53,658

 
41,991

 
42,058

LIABILITIES
 
 
 
 
 
 
 
 
 
Lennar Homebuilding senior notes and other debts payable
Level 2
 
$
5,523,765

 
5,730,227

 
4,575,977

 
4,669,643

Rialto notes and other debts payable
Level 2
 
$
617,152

 
632,128

 
622,335

 
646,366

Lennar Financial Services notes and other debts payable
Level 2
 
$
719,727

 
719,727

 
1,077,228

 
1,077,228


The following methods and assumptions are used by the Company in estimating fair values:
Rialto—The fair values for loans receivable, net are based on the fair value of the collateral less estimated cost to sell or discounted cash flows, if estimable. The fair value for investments held-to-maturity is based on discounted cash flows. For notes and other debts payable, the fair value is calculated based on discounted cash flows using quoted interest rates and for the warehouse repurchase financing agreements fair values approximate their carrying value due to their short-term maturities.  
Lennar Financial Services—The fair values above are based on quoted market prices, if available. The fair values for instruments that do not have quoted market prices are estimated by the Company on the basis of discounted cash flows or other financial information. For notes and other debts payable, the fair values approximate their carrying value due to variable interest pricing terms and the short-term nature of the borrowings.
Lennar Homebuilding—For senior notes and other debts payable, the fair value of fixed-rate borrowings is primarily based on quoted market prices and the fair value of variable-rate borrowings is based on expected future cash flows calculated using current market forward rates.
Fair Value Measurements:
GAAP provides a framework for measuring fair value, expands disclosures about fair value measurements and establishes a fair value hierarchy which prioritizes the inputs used in measuring fair value summarized as follows:
Level 1: Fair value determined based on quoted prices in active markets for identical assets.
Level 2: Fair value determined using significant other observable inputs.
Level 3: Fair value determined using significant unobservable inputs.
The Company’s financial instruments measured at fair value on a recurring basis are summarized below:
(In thousands)
Fair Value
Hierarchy
 
Fair Value at
August 31,
2017
 
Fair Value at
November 30,
2016
Rialto Financial Assets:
 
 
 
 
 
RMF loans held-for-sale (1)
Level 3
 
$
285,747

 
126,947

Credit default swaps (2)
Level 2
 
$
1,510

 
2,863

Rialto Financial Liabilities:
 
 
 
 
 
Interest rate swaps and swap futures (3)
Level 2
 
$
2,318

 
6

Credit default swaps (3)
Level 2
 
$
3,982

 
377

Lennar Financial Services Assets (Liabilities):
 
 
 
 
 
Loans held-for-sale (4)
Level 2
 
$
661,649

 
939,405

Investments available-for-sale
Level 1
 
$
57,784

 
53,570

Mortgage loan commitments
Level 2
 
$
17,543

 
7,437

Forward contracts
Level 2
 
$
(5,529
)
 
26,467

Mortgage servicing rights
Level 3
 
$
27,721

 
23,930


(1)
The aggregate fair value of RMF loans held-for-sale of $285.7 million at August 31, 2017 exceeds their aggregate principal balance of $283.2 million by $2.5 million. The aggregate fair value of loans held-for-sale of $126.9 million at November 30, 2016 was below their aggregate principal balance of $127.8 million by $0.9 million.
(2)
Rialto's credit default swaps are included within Rialto's other assets.
(3)
Rialto's interest rate swaps and swap futures and credit default swaps are included within Rialto's other liabilities.
(4)
The aggregate fair value of Lennar Financial Services loans held-for-sale of $661.6 million at August 31, 2017 exceeds their aggregate principal balance of $635.0 million by $26.6 million. The aggregate fair value of Lennar Financial Services loans held-for-sale of $939.4 million at November 30, 2016 exceeded their aggregate principal balance of $931.0 million by $8.4 million.
The estimated fair values of the Company’s financial instruments have been determined by using available market information and what the Company believes to be appropriate valuation methodologies. Considerable judgment is required in interpreting market data to develop the estimates of fair value. The use of different market assumptions and/or estimation methodologies might have a material effect on the estimated fair value amounts. The following methods and assumptions are used by the Company in estimating fair values:
Rialto loans held-for-sale- The fair value of loans held-for-sale is calculated from model-based techniques that use discounted cash flow assumptions and the Company’s own estimates of CMBS spreads, market interest rate movements and the underlying loan credit quality. Loan values are calculated by allocating the change in value of an assumed CMBS capital structure to each loan. The value of an assumed CMBS capital structure is calculated, generally, by discounting the cash flows associated with each CMBS class at market interest rates and at the Company’s own estimate of CMBS spreads. The Company estimates CMBS spreads by observing the pricing of recent CMBS offerings, secondary CMBS markets, changes in the CMBX index, and general capital and commercial real estate market conditions. Considerations in estimating CMBS spreads include comparing the Company’s current loan portfolio with comparable CMBS offerings containing loans with similar duration, credit quality and collateral composition. These methods use unobservable inputs in estimating a discount rate that is used to assign a value to each loan. While the cash payments on the loans are contractual, the discount rate used and assumptions regarding the relative size of each class in the CMBS capital structure can significantly impact the valuation. Therefore, the estimates used could differ materially from the fair value determined when the loans are sold to a securitization trust.
Rialto credit default swaps- The fair value of credit default swaps (derivatives) is based on quoted market prices for similar investments traded in active markets.
Rialto interest rate swaps and swap futures- The fair value of interest rate swaps (derivatives) is based on observable values for underlying interest rates and market determined risk premiums. The fair value of interest rate swap futures (derivatives) is based on quoted market prices for similar investments traded in active markets.
Lennar Financial Services loans held-for-sale- Fair value is based on independent quoted market prices, where available, or the prices for other mortgage whole loans with similar characteristics. Management believes carrying loans held-for-sale at fair value improves financial reporting by mitigating volatility in reported earnings caused by measuring the fair value of the loans and the derivative instruments used to economically hedge them without having to apply complex hedge accounting provisions. In addition, the Company recognizes the fair value of its rights to service a mortgage loan as revenue upon entering into an interest rate lock loan commitment with a borrower. The fair value of these servicing rights is included in Lennar Financial Services’ loans held-for-sale as of August 31, 2017 and November 30, 2016. Fair value of servicing rights is determined based on actual sales of servicing rights on loans with similar characteristics.
Lennar Financial Services investments available-for-sale- The fair value of these investments is based on the quoted market prices for similar financial instruments.
Lennar Financial Services mortgage loan commitments- Fair value of commitments to originate loans is based upon the difference between the current value of similar loans and the price at which the Lennar Financial Services segment has committed to originate the loans. The fair value of commitments to sell loan contracts is the estimated amount that the Lennar Financial Services segment would receive or pay to terminate the commitments at the reporting date based on market prices for similar financial instruments. In addition, the Company recognizes the fair value of its rights to service a mortgage loan as revenue upon entering into an interest rate lock loan commitment with a borrower. The fair value of servicing rights is determined based on actual sales of servicing rights on loans with similar characteristics. The fair value of the mortgage loan commitments and related servicing rights is included in Lennar Financial Services’ other assets.
Lennar Financial Services forward contracts- Fair value is based on quoted market prices for similar financial instruments. The fair value of forward contracts is included in the Lennar Financial Services segment's other liabilities as of August 31, 2017. The fair value of forward contracts is included in the Lennar Financial Services segment's other assets as of November 30, 2016.
The Lennar Financial Services segment uses mandatory mortgage-backed securities ("MBS") forward commitments, option contracts and investor commitments to hedge its mortgage-related interest rate exposure. These instruments involve, to varying degrees, elements of credit and interest rate risk. Credit risk associated with MBS forward commitments, option contracts and loan sales transactions is managed by limiting the Company’s counterparties to investment banks, federally regulated bank affiliates and other investors meeting the Company’s credit standards. The segment’s risk, in the event of default by the purchaser, is the difference between the contract price and fair value of the MBS forward commitments and option contracts. At August 31, 2017, the segment had open commitments amounting to $1.1 billion to sell MBS with varying settlement dates through November 2017.
Lennar Financial Services mortgage servicing rights- Lennar Financial Services records mortgage servicing rights when it sells loans on a servicing-retained basis or through the acquisition or assumption of the right to service a financial asset. The fair value of the mortgage servicing rights is calculated using third-party valuations. The key assumptions, which are generally unobservable inputs, used in the valuation of the mortgage servicing rights include mortgage prepayment rates, discount rates and delinquency rates. As of August 31, 2017, the key assumptions used in determining the fair value include a 15.1% mortgage prepayment rate, a 12.3% discount rate and a 6.2% delinquency rate. The fair value of mortgage servicing rights is included in the Lennar Financial Services segment's other assets.
The changes in fair values for Level 1 and Level 2 financial instruments measured on a recurring basis are shown below by financial instrument and financial statement line item:
 
Three Months Ended
 
Nine Months Ended
 
August 31,
 
August 31,
(In thousands)
2017
 
2016
 
2017
 
2016
Changes in fair value included in Lennar Financial Services revenues:
 
 
 
 
 
 
 
Loans held-for-sale
$
(5,804
)
 
(2,808
)
 
18,233

 
826

Mortgage loan commitments
$
(829
)
 
1,781

 
10,106

 
7,603

Forward contracts
$
1,267

 
(362
)
 
(31,996
)
 
(2,542
)
Investments available-for-sale
$

 
31

 
(4
)
 
37

Changes in fair value included in Rialto revenues:
 
 
 
 
 
 
 
Financial Assets:
 
 
 
 
 
 
 
Credit default swaps
$
(536
)
 
(1,570
)
 
(1,852
)
 
(1,547
)
Financial Liabilities:
 
 
 
 
 
 
 
Interest rate swaps and swap futures
$
(1,412
)
 
(133
)
 
(2,312
)
 
740

Credit default swaps
$
15

 
183

 
124

 
173

Changes in fair value included in other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Lennar Financial Services investments available-for-sale
$
165

 
639

 
1,556

 
1,121


Interest on Lennar Financial Services loans held-for-sale and Rialto loans held-for-sale measured at fair value is calculated based on the interest rate of the loan and recorded as revenues in the Lennar Financial Services’ statement of operations and Rialto's statement of operations, respectively.
The following table represents the reconciliation of the beginning and ending balance for the Level 3 recurring fair value measurements:
 
Three Months Ended August 31,
 
2017
 
2016
 
Lennar Financial Services
 
Rialto
 
Lennar Financial Services
 
Rialto
(In thousands)
Mortgage servicing rights
 
RMF loans held-for-sale
 
Mortgage servicing rights
 
RMF loans held-for-sale
Beginning balance
$
27,370

 
82,803

 
18,241

 
199,415

Purchases/loan originations
2,447

 
439,266

 
2,275

 
520,510

Sales/loan originations sold, including those not settled

 
(235,922
)
 

 
(491,428
)
Disposals/settlements
(1,092
)
 

 
(1,311
)
 

Changes in fair value (1)
(1,004
)
 
707

 
(836
)
 
522

Interest and principal paydowns

 
(1,107
)
 

 
(88
)
Ending balance
$
27,721

 
285,747

 
18,369

 
228,931

 
Nine Months Ended August 31,
 
2017
 
2016
 
Lennar Financial Services
 
Rialto
 
Lennar Financial Services
 
Rialto
(In thousands)
Mortgage servicing rights
 
RMF loans held-for-sale
 
Mortgage servicing rights
 
RMF loans held-for-sale
Beginning balance
$
23,930

 
126,947

 
16,770

 
316,275

Purchases/loan originations
8,159

 
1,262,926

 
6,269

 
1,174,483

Sales/loan originations sold, including those not settled

 
(1,106,316
)
 

 
(1,259,320
)
Disposals/settlements
(2,887
)
 

 
(2,881
)
 

Changes in fair value (1)
(1,481
)
 
3,205

 
(1,789
)
 
(687
)
Interest and principal paydowns

 
(1,015
)
 

 
(1,820
)
Ending balance
$
27,721

 
285,747

 
18,369

 
228,931


(1)
Changes in fair value for Rialto loans held-for-sale and Lennar Financial Services mortgage servicing rights are included in Rialto's and Lennar Financial Services' revenues, respectively.
The Company’s assets measured at fair value on a nonrecurring basis are those assets for which the Company has recorded valuation adjustments and write-offs. The fair values included in the table below represent only those assets whose carrying values were adjusted to fair value during the respective periods disclosed. The assets measured at fair value on a nonrecurring basis are summarized below:
 
 
 
Three Months Ended August 31,
 
 
 
2017
 
2016
(In thousands)
Fair Value
Hierarchy
 
Carrying Value
 
Fair Value
 
Total Gains (Losses), Net (1)
 
Carrying Value
 
Fair Value
 
Total Losses, Net (1)
Financial assets
 
 
 
 
 
 
 
 
 
 
 
 
 
Rialto:
 
 
 
 
 
 
 
 
 
 
 
 
 
Impaired loans receivable
Level 3
 
$

 

 

 
52,460

 
48,130

 
(4,330
)
FDIC Portfolios loans held-for-sale
Level 3
 
$
20,863

 
19,237

 
(1,626
)
 

 

 

Non-financial assets
 
 
 
 
 
 
 
 
 
 
 
 
 
Lennar Homebuilding:
 
 
 
 
 
 
 
 
 
 
 
 
 
Land and land under development (2)
Level 3
 
$

 

 

 
23,736

 
18,000

 
(5,736
)
Rialto:
 
 
 
 
 
 
 
 
 
 
 
 
 
REO, net (3):
 
 
 
 
 
 
 
 
 
 
 
 
 
Upon acquisition/transfer
Level 3
 
$
1,200

 
1,376

 
176

 
9,220

 
8,799

 
(421
)
Upon management periodic valuations
Level 3
 
$
35,507

 
22,765

 
(12,742
)
 
28,910

 
22,715

 
(6,195
)

 
 
 
Nine Months Ended August 31,
 
 
 
2017
 
2016
(In thousands)
Fair Value
Hierarchy
 
Carrying Value
 
Fair Value
 
Total Losses, Net (1)
 
Carrying Value
 
Fair Value
 
Total Gains (Losses), Net (1)
Financial assets
 
 
 
 
 
 
 
 
 
 
 
 
 
Rialto:
 
 
 
 
 
 
 
 
 
 
 
 
 
Impaired loans receivable
Level 3
 
$
31,554

 
18,885

 
(12,669
)
 
72,375

 
61,324

 
(11,051
)
FDIC Portfolios loans held-for-sale
Level 3
 
$
26,081

 
19,237

 
(6,844
)
 

 

 

Non-financial assets
 
 
 
 
 
 
 
 
 
 
 
 
 
Lennar Homebuilding:
 
 
 
 
 
 
 
 
 
 
 
 
 
Finished homes and construction in progress (2)
Level 3
 
$
6,659

 
2,745

 
(3,914
)
 

 

 

Land and land under development (2)
Level 3
 
$
6,771

 
3,094

 
(3,677
)
 
29,418

 
22,925

 
(6,493
)
Rialto:
 
 
 
 
 
 
 
 
 
 
 
 
 
REO, net (3):
 
 
 
 
 
 
 
 
 
 
 
 
 
Upon acquisition/transfer
Level 3
 
$
31,503

 
30,066

 
(1,437
)
 
42,657

 
44,292

 
1,635

Upon management periodic valuations
Level 3
 
$
118,497

 
79,601

 
(38,896
)
 
68,148

 
54,347

 
(13,801
)
(1)
Represents losses due to valuation adjustments, write-offs, gains (losses) from transfers or acquisitions of real estate through foreclosure and REO impairments recorded during the three and nine months ended August 31, 2017 and 2016.
(2)
Valuation adjustments were included in Lennar Homebuilding costs and expenses in the Company's condensed consolidated statement of operations for the nine months ended August 31, 2017 and the three and nine months ended August 31, 2016.
(3)
The fair value of REO, net is based upon appraised value at the time of foreclosure or management's best estimate. In addition, management periodically performs valuations of its REO. The gains (losses), net upon the transfer or acquisition of REO and impairments were included in Rialto other expense, net, in the Company’s condensed consolidated statement of operations for the three and nine months ended August 31, 2017 and 2016.
Finished homes and construction in progress are included within inventories. Inventories are stated at cost unless the inventory within a community is determined to be impaired, in which case the impaired inventory is written down to fair value. The Company disclosed its accounting policy related to inventories and its review for indicators of impairment in the Summary of Significant Accounting Policies in its Form 10-K for the year ended November 30, 2016.
The Company estimates the fair value of inventory evaluated for impairment based on market conditions and assumptions made by management at the time the inventory is evaluated, which may differ materially from actual results if market conditions or assumptions change. For example, changes in market conditions and other specific developments or changes in assumptions may cause the Company to re-evaluate its strategy regarding previously impaired inventory, as well as inventory not currently impaired but for which indicators of impairment may arise if market deterioration occurs, and certain other assets that could result in further valuation adjustments and/or additional write-offs of option deposits and pre-acquisition costs due to abandonment of those options contracts.
On a quarterly basis, the Company reviews its active communities for indicators of potential impairments. As of August 31, 2017 and 2016, there were 753 and 691 active communities, excluding unconsolidated entities, respectively. As of August 31, 2017, the Company identified six communities with 499 homesites and a corresponding carrying value of $31.9 million as having potential indicators of impairment. For the three months ended August 31, 2017, the Company recorded no impairments. For the nine months ended August 31, 2017, the Company recorded a valuation adjustment of $7.5 million on 469 homesites in six communities with a carrying value of $12.0 million.
As of August 31, 2016, the Company identified 16 communities with 444 homesites and a corresponding carrying value of $134.7 million as having potential indicators of impairment. For the nine months ended August 31, 2016, the Company recorded no impairments.
The table below summarizes the most significant unobservable inputs used in the Company's discounted cash flow model to determine the fair value of its communities for which the Company recorded valuation adjustments during the nine months ended August 31, 2017:
 
Nine Months Ended
 
August 31, 2017
Unobservable inputs
Range
Average selling price
$
125,000

-
$567,000
Absorption rate per quarter (homes)
4

-
10
Discount rate
20%