Note 14 — Fair Value

Fair value estimates are dependent upon subjective assumptions and involve significant uncertainties resulting in variability in estimates with changes in assumptions. The following table summarizes the principal amounts, carrying values and the estimated fair values of our financial instruments:

	September 30, 2017						December 31, 2016
	Principal / Notional Amount		Carrying Value		Estimated Fair Value		Principal / Notional Amount		Carrying Value		Estimated Fair Value
Financial assets:
Loans and investments, net	$	2,094,376,123	$	1,997,555,985	$	2,056,020,469	$	1,790,159,966	$	1,695,732,351	$	1,749,130,232
Loans held-for-sale, net	333,983,865		333,267,976		338,766,761		675,493,536		673,367,304		683,833,449
Capitalized mortgage servicing rights, net	n/a		247,875,659		293,807,076		n/a		227,742,986		245,455,881
Available-for-sale securities	58,789		4,707,085		4,707,085		58,789		5,403,463		5,403,463
Securities held-to-maturity, net	28,035,293		18,851,089		18,882,997		—		—		—
Derivative financial instuments	100,898,203		488,747		488,747		550,117,700		5,614,990		5,614,990

Financial liabilities:
Credit and repurchase facilities	$	564,231,866	$	562,326,537	$	563,366,477	$	908,680,198	$	906,636,790	$	907,882,886
Collateralized loan obligations	1,079,874,000		1,066,230,488		1,080,228,695		737,000,000		728,441,109		728,642,500
Senior unsecured notes	97,860,025		95,088,379		99,817,226		97,860,025		94,521,566		99,034,345
Convertible senior unsecured notes, net	100,000,000		95,381,121		105,438,000		86,250,000		80,660,038		86,586,375
Junior subordinated notes	154,336,000		139,418,416		93,833,687		175,858,000		157,858,555		105,649,537
Related party financing	50,000,000		50,000,000		53,270,857		50,000,000		50,000,000		55,119,744
Derivative financial instruments	287,993,000		1,881,450		1,881,450		522,650,829		2,451,422		2,451,422

Assets and liabilities disclosed at fair value are categorized based upon the level of judgment associated with the inputs used to measure their fair value. Hierarchical levels directly related to the amount of subjectivity associated with the inputs to fair valuation of these assets and liabilities are as follows:

Level 1 — Inputs are unadjusted and quoted prices exist in active markets for identical assets or liabilities, such as government, agency and equity securities.

Level 2 — Inputs (other than quoted prices included in Level 1) are observable for the asset or liability through correlation with market data. Level 2 inputs may include quoted market prices for a similar asset or liability, interest rates and credit risk. Examples include non-government securities, certain mortgage and asset-backed securities, certain corporate debt and certain derivative instruments.

Level 3 — Inputs reflect our best estimate of what market participants would use in pricing the asset or liability and are based on significant unobservable inputs that require a considerable amount of judgment and assumptions. Examples include certain mortgage and asset-backed securities, certain corporate debt and certain derivative instruments.

Determining which category an asset or liability falls within the hierarchy requires significant judgment and we evaluate our hierarchy disclosures each quarter.

The following is a description of the valuation techniques used to measure fair value and the general classification of these instruments pursuant to the fair value hierarchy.

Loans and investments, net. Fair values of loans and investments that are not impaired are estimated using Level 3 inputs based on direct capitalization rate and discounted cash flow methodologies using discount rates, which, in our opinion, best reflect current market interest rates that would be offered for loans with similar characteristics and credit quality. Fair values of impaired loans and investments are estimated using Level 3 inputs that require significant judgments, which include assumptions regarding discount rates, capitalization rates, creditworthiness of major tenants, occupancy rates, availability of financing, exit plan and other factors.

Loans held-for-sale, net. Consists of originated loans that are generally transferred or sold within 60 days of loan funding, and are valued using pricing models that incorporate observable inputs from current market assumptions or a hypothetical securitization model utilizing observable market data from recent securitization spreads and observable pricing of loans with similar characteristics (Level 2). Fair value includes the fair value allocated to the associated future MSRs and is calculated pursuant to the valuation techniques described below for capitalized mortgage servicing rights, net (Level 3).

Capitalized mortgage servicing rights, net. Fair values are estimated using Level 3 inputs based on discounted future net cash flow methodology. The fair value of MSRs carried at amortized cost are estimated using a process that involves the use of independent third-party valuation experts, supported by commercially available discounted cash flow models and analysis of current market data. The key inputs used in estimating fair value include the contractually specified servicing fees, prepayment speed of the underlying loans, discount rate, annual per loan cost to service loans, delinquency rates, late charges and other economic factors.

Available-for-sale securities. Fair values are estimated based on current market quotes received from active markets or financial sources that trade such securities. The fair values of available-for-sale equity securities traded in active markets are estimated using Level 1 inputs. The fair values of available-for-sale debt securities are estimated using the recent purchase price and subsequent sales price of the securities, which are deemed Level 2 inputs. The fair value of our Agency IOs were estimated using Level 3 inputs and are derived from third party proprietary models using discounted cash flows based on the underlying contractual cash flows and require significant judgements, including assumptions on discount rates and constant prepayment rates.

Securities held-to-maturity, net. Fair values are approximated using Level 3 inputs based on current market quotes received from financial sources that trade such securities and are based on prevailing market data and, in some cases, are derived from third party proprietary models based on well recognized financial principles and reasonable estimates about relevant future market conditions.

Derivative financial instruments. The fair values of rate lock and forward sale commitments are estimated using valuation techniques, which include internally-developed models developed based on changes in the U.S. Treasury rate and other observable market data (Level 2). The fair value of rate lock commitments includes the fair value of the expected net cash flows associated with the servicing of the loans, see capitalized mortgage servicing rights, net above for details on the applicable valuation technique (Level 3). We also consider the impact of counterparty non-performance risk when measuring the fair value of these derivatives. Given the credit quality of our counterparties, the short duration of interest rate lock commitments and forward sale contracts, and our historical experience, the risk of nonperformance by our counterparties is not significant.

Credit facilities and repurchase agreements. Fair values for the Structured Business are estimated at Level 3 using discounted cash flow methodology, using discount rates, which, in our opinion, best reflect current market interest rates for financing with similar characteristics and credit quality. The majority of our credit facilities for the Agency Business bear interest at rates that are similar to those available in the market currently and the fair values are estimated using Level 2 inputs. For these facilities, the fair values approximate their carrying values.

Collateralized loan obligations, junior subordinated notes and related party financing. Fair values are estimated at Level 3 based on broker quotations, representing the discounted expected future cash flows at a yield that reflects current market interest rates and credit spreads.

Senior unsecured notes. Fair values are estimated at Level 1 based on current market quotes received from active markets.

Convertible senior unsecured notes, net. Fair values are estimated at Level 2 based on current market quotes received from inactive markets.

We measure certain financial assets and financial liabilities at fair value on a recurring basis. The fair value of these financial assets and liabilities was determined using the following input levels as of September 30, 2017:

	Carrying				Fair Value Measurements Using Fair Value Hierarchy
	Value		Fair Value		Level 1		Level 2		Level 3

Financial assets:
Available-for-sale securities	$	4,707,085	$	4,707,085	$	264,553	$	—	$	4,442,532
Derivative financial instruments	488,747		488,747		—		68,989		419,758

Financial liabilities:
Derivative financial instruments	$	1,881,450	$	1,881,450	$	—	$	1,881,450	$	—

See Note 8 — Securities for a roll-forward of our available-for-sale securities fair valued using Level 3 inputs.

We measure certain financial and non-financial assets at fair value on a nonrecurring basis. The fair values of these financial and non-financial assets were determined using the following input levels as of September 30, 2017:

	Net Carrying				Fair Value Measurements Using Fair Value Hierarchy
	Value		Fair Value		Level 1		Level 2		Level 3

Financial assets:
Impaired loans, net (1)	$	101,284,128	$	101,284,128	$	—	$	—	$	101,284,128

Non-financial assets:
Long-lived assets (2)	$	11,540,664	$	11,540,664	$	—	$	—	$	11,540,664

(1)

We had an allowance for loan losses of $83.3 million relating to six loans with an aggregate carrying value, before loan loss reserves, of $184.5 million at September 30, 2017.

(2)

During the second quarter of 2016, we determined that a real estate owned hotel property exhibited indicators of impairment and an impairment analysis was performed, which resulted in an impairment loss of $11.2 million. During the first half of 2017, we received additional market analyses which resulted in a further impairment loss of $2.7 million.

Loan impairment assessments. Loans held for investment are intended to be held to maturity and, accordingly, are carried at cost, net of unamortized loan origination costs and fees, loan purchase discounts, and net of the allowance for loan losses, when such loan or investment is deemed to be impaired. We consider a loan impaired when, based upon current information, it is probable that we will be unable to collect all amounts due for both principal and interest according to the contractual terms of the loan agreement. We evaluate our loans to determine if the value of the underlying collateral securing the impaired loan is less than the net carrying value of the loan, which may result in an allowance and corresponding charge to the provision for loan losses. These valuations require significant judgments, which include assumptions regarding capitalization and discount rates, revenue growth rates, creditworthiness of major tenants, occupancy rates, availability of financing, exit plan and other factors. The table above and below includes all impaired loans, regardless of the period in which the impairment was recognized.

Long-lived assets: We review our real estate owned assets when events or circumstances change, indicating that the carrying amount of an asset may not be recoverable. In the evaluation of a real estate owned asset for impairment, many factors are considered, including estimated current and expected operating cash flows from the asset during the projected holding period, costs necessary to extend the life or improve the asset, expected capitalization rates, projected stabilized net operating income, selling costs, and the ability to hold and dispose of the asset in the ordinary course of business. We first compare the undiscounted cash flows to be generated by the asset to the carrying value of such asset. If the undiscounted cash flows are less than the carrying value, we recognize impairment based on discounted cash flows.

Quantitative information about Level 3 fair value measurements at September 30, 2017 were as follows:

			Valuation
	Fair Value		Techniques	Significant Unobservable Inputs

Financial assets:
Impaired loans (1):


				Discount rate	11.00%
Office	$	792,500	Discounted cash flows	Capitalization rate	8.10%
				Revenue growth rate	2.50%

				Discount rate	15.00%
Land	71,441,628		Discounted cash flows	Capitalization rate	7.25%
				Revenue growth rate	3.00%

				Discount rate	9.00%
Hotel	29,050,000		Discounted cash flows	Capitalization rate	7.00%
				Revenue growth rate	3.30%

Derivative financial instruments:


Rate lock commitments	419,758		Discounted cash flows	W/A discount rate	10.22%

Non-financial assets:
Long-lived assets:
				Discount rate	11.75%
Hotel	11,540,664		Discounted cash flows	Capitalization rate	9.75%
				Revenue growth rate	3.50%
				Hold period	3 years

(1)

Includes all impaired loans regardless of the period in which a loan loss provision was recorded.

The derivative financial instruments using Level 3 inputs are outstanding for short periods of time (generally less than 60 days). A roll-forward of Level 3 derivative instruments were as follows:

	Fair Value Measurements Using Significant Unobservable Inputs
	Three Months Ended September 30,						Nine Months Ended September 30,
	2017			2016			2017			2016
Derivative assets and liabilities, net
Balance at beginning of period	$	1,419,530		$	—		$	2,816,132		$	—
Additions from the Acquisition	—			4,528,640			—			4,528,640
Settlements	(18,897,011		)	(15,286,185		)	(57,578,012		)	(15,286,185		)
Realized gains recorded in earnings	17,477,481			10,757,545			54,761,880			10,757,545
Unrealized gains recorded in earnings	419,758			681,882			419,758			681,882

Balance at end of period	$	419,758		$	681,882		$	419,758		$	681,882

The following table presents the components of fair value and other relevant information associated with our rate lock commitments, forward sales commitments and the estimated fair value of cash flows from servicing on loans held-for-sale.

	Notional/ Principal Amount		Fair Value of Servicing Rights		Interest Rate Movement Effect			Total Fair Value Adjustment
September 30, 2017
Rate lock commitments	$	30,179,000	$	419,758	$	(64,378	)	$	355,380
Forward sale commitments	358,712,203		—		64,378			64,378
Loans held-for-sale, net (1)	328,533,203		5,450,662		—			5,450,662

Total			$	5,870,420	$	—		$	5,870,420

(1)

Loans held-for-sale, net are recorded at the lower of cost or market on an aggregate basis and includes fair value adjustments related to estimated cash flows from mortgage servicing rights.

We measure certain assets and liabilities for which fair value is only disclosed. The fair value of these assets and liabilities was determined using the following input levels as of September 30, 2017:

					Fair Value Measurements Using Fair Value Hierarchy
	Carrying Value		Fair Value		Level 1		Level 2		Level 3

Financial assets:
Loans and investments, net	$	1,997,555,985	$	2,056,020,469	$	—	$	—	$	2,056,020,469
Loans held-for-sale, net	333,267,976		338,766,761		—		333,316,099		5,450,662
Capitalized mortgage servicing rights, net	247,875,659		293,807,076		—		—		293,807,076
Securities held-to-maturity, net	18,851,089		18,882,997		—		—		18,882,997

Financial liabilities:
Credit and repurchase facilities	$	562,326,537	$	563,366,477	$	—	$	327,987,187	$	235,379,290
Collateralized loan obligations	1,066,230,488		1,080,228,695		—		—		1,080,228,695
Senior unsecured notes	95,088,379		99,817,226		99,817,226		—		—
Convertible senior unsecured notes, net	95,381,121		105,438,000		—		105,438,000		—
Junior subordinated notes	139,418,416		93,833,687		—		—		93,833,687
Related party financing	50,000,000		53,270,857		—		—		53,270,857