Note 13: Fair Value Measurement

We use a fair-value approach to value certain liabilities. Fair value is 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. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. We use a fair value hierarchy, which distinguishes between assumptions based on market data (observable inputs) and an entity’s own assumptions (unobservable inputs). The hierarchy consists of three levels:

•	Level 1 — Inputs to the valuation methodology are quoted prices for identical assets or liabilities traded in active markets;
•	Level 2 — Inputs to the valuation methodology include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability and market corroborated inputs; and
•	Level 3 — Valuations based on models where significant inputs are not observable. The unobservable inputs reflect the Company’s own assumptions about the inputs that market participants would use.

Determining which category an asset or liability falls within the fair value accounting guidance hierarchy requires significant judgment. We evaluate our hierarchy disclosures each quarter. Assets and liabilities measured at fair value on a recurring basis are summarized as follows:

The financial instrument that is measured at fair value on a recurring basis is summarized as follows as of December 31, 2017:

(in thousands)

Assets

Level 1

Level 2

Level 3

December 31, 2017

Derivative embedded conversion feature

—

The financial instrument that is measured at fair value on a recurring basis is summarized as follows as of December 31, 2016:

	(in thousands)
Assets	Level 1		Level 2		Level 3		December 31, 2016
Derivative embedded conversion feature	$	—	$	—	$	80,651	$	80,651

The following table shows the change in Level 3 financial instrument measured at fair value on a recurring basis for the period ended December 31, 2017:

	Derivative asset (liability) embedded conversion feature (in thousands)
Balance, January 1, 2015	$	—
Issuance during 2015		(66,227	)
Loss on change in fair value		(54,621	)
Balance, December 31, 2015		(120,848	)
Gain on change in fair value		201,499
Balance, December 31, 2016		80,651
Gain on change in fair value		28,242
Reclassification of derivative asset		(108,893	)
Balance, December 31, 2017	$	—

On January 5, 2015, WMIH raised $600.0 million of capital (less transaction costs) through the issuance of 600,000 shares of Original Series B Preferred Stock. The shares carry a liquidation preference of $1,000 per share, equal to their initial purchase price. In addition, they have a mandatory redemption right three years from the issuance date at a price equal to the initial investment amount, and initially accrued dividends at 3% per annum. The Original Series B Preferred Stock was amended on December 8, 2017 and this amendment became effective on January 5, 2018. As a result of this amendment which is detailed in Note 15: Subsequent Events, dividends earned subsequent to the Amendment Date are payable in common stock accrued at the rate of 5% per annum.

The purpose of the capital raise was principally to pursue strategic acquisitions of operating companies that fit the Company’s desired business model. Management intends to pursue such an acquisition or acquisitions with the proceeds of the capital raise, and should it occur during the term of the Series B Preferred Stock, there is a mandatory conversion of these shares into common stock of WMIH. Mandatory conversion (prior to the Amendment Date) occurred at a price that was the lesser of:

$2.25 per share of WMIH’s common stock; and

ii)

the arithmetic average of daily volume weighted-average prices of WMIH’s common stock during the 20 trading day period ending on the trading day immediately preceding the public announcement by WMIH of its entry into a definitive agreement for such acquisition, subject to a floor of $1.75 per share of WMIH’s common stock.

Subsequent to the Amendment Date, if there is a mandatory conversion of these shares into common stock of WMIH, the shares convert at a rate of $1.35 per share of WMIH’s common stock.

We used a binomial lattice option pricing model to value the embedded conversion feature that is subject to fair value liability accounting. The key inputs which we utilized in the determination of the fair value as of the reporting date include our stock price as well as assumptions regarding a number of complex and subjective variables. These variables included, but were not limited to, expected stock price volatility over the term of the convertible preferred securities, which we estimated at 60% as of December 31, 2017, and 40% as of December 31, 2016, and risk-free interest rate, which was estimated at 1.6% as of December 31, 2017, and 0.6% as of December 31, 2016. In addition, the model requires the input of an expected probability of occurrence, which we estimated at 95% as of December 31, 2017 and 90% as of December 31, 2016, and the timing of a Qualified Acquisition which initiates the mandatory conversion, which we estimated at 9 months from December 31, 2017 and 6 months from December 31, 2016. The fair value of the embedded conversion feature liability was revalued each reportable balance sheet date utilizing our model computations with the decrease or increase in fair value being reported in the consolidated statements of operations as gain or (loss) on change in fair value of derivative embedded conversion feature, respectively. The primary factors affecting the fair value of the embedded conversion feature liability were the probability of occurrence and timing of a Qualified Acquisition, our stock price and our stock price volatility. In addition, the use of a model requires the input of subjective assumptions, and changes to these assumptions could provide differing results. As a result of the amendment of the terms of the Series B Preferred Stock’s conversion price the derivative embedded conversion feature was adjusted to its fair value at December 31, 2017. The variance from the fair value at December 31, 2016, $28.2 million was recorded as other income and the fair market value as of December 31, 2017, $108.9 million was transferred to equity. The embedded conversion feature, subsequent to the Amendment Date, will not be considered a derivative, primarily due to the elimination of the variance in the conversion price and the determination that the conversion feature is indexed to WMIH’s common stock, and therefore, will not be revalued in future periods.