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NOTE 5 FAIR VALUE OF FINANCIAL INSTRUMENTS

9 Months Ended

Sep. 30, 2013

Fair Value Disclosures [Abstract]

FAIR VALUE OF FINANCIAL INSTRUMENTS

NOTE 5

FAIR VALUE OF FINANCIAL INSTRUMENTS

We estimate fair value based on a hierarchy that maximizes the use of observable inputs and minimizes the use of unobservable inputs. Observable inputs are inputs that reflect the assumptions that market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the reporting entity. Unobservable inputs are inputs that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. The fair value hierarchy prioritizes the inputs to valuation techniques into three broad levels whereby the highest priority is given to Level 1 inputs and the lowest to Level 3 inputs.

Level 1: Quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity can access at the measurement date.

Level 2: Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly.

Level 3: Unobservable inputs for the asset or liability.

We classify assets in their entirety based on the lowest level of input that is significant to the fair value measurement.

The carrying amounts and the estimated fair values of our financial instruments and our nonfinancial assets measured at fair value are as follows:

				September 30, 2013								December 31, 2012
		Level		Carrying Value				Fair Value				Carrying Value				Fair Value
Financial assets:
Loans held for sale, at fair value (1)		2		$	335,102			$	335,102			$	426,480			$	426,480
Loans held for sale, at lower of cost or fair value (2)		3			86,753				86,753				82,866				82,866
Loans – restricted for securitization investors, at fair value (1)		3			290,853				290,853				—				—
Advances and match funded advances (3)		3			1,480,012				1,480,012				3,233,707				3,233,707
Receivables, net (3)		3			223,404				223,404				137,713				137,713

Financial liabilities:
Match funded liabilities (3)		3		$	363,012			$	363,012			$	2,532,745			$	2,533,278
Other borrowings:
Senior secured term loan (3)		3			1,287,821				1,278,273				305,997				310,822
Secured borrowings – owed to securitization investors, at fair value (1)		3			284,276				284,276				—				—
Other (3)		3			1,020,494				1,020,494				790,682				790,682
Total Other borrowings					2,592,591				2,583,043				1,096,679				1,101,504

Derivative financial instruments (1):
Interest rate lock commitments (IRLCs)		2		$	13,491			$	13,491			$	5,781			$	5,781
Interest rate swaps		3			—				—				(10,836	)			(10,836	)
Forward MBS trades		1			(12,185	)			(12,185	)			(1,719	)			(1,719	)
U.S. Treasury futures		1			—				—				(1,258	)			(1,258	)
Interest rate caps		3			—				—				168				168

MSRs, at fair value (1)		3		$	96,938			$	96,938			$	85,213			$	85,213

(1)

Measured at fair value on a recurring basis.

(2)

Measured at fair value on a non-recurring basis.

(3)

Disclosed, but not carried, at fair value.

The following tables present a reconciliation of the changes in fair value of Level 3 assets that we measure at fair value on a recurring basis:

		Loans – restricted for securitization investors				Secured borrowings – owed to securitization investors				Derivative Financial Instruments				MSRs at Fair Value				Total

Three Months Ended September 30, 2013:
Beginning balance		$	76,649			$	(73,641	)		$	176			$	97,163			$	100,347

Purchases, issuances, sales and settlements:
Purchases			—				—				—				—				—
Issuances			211,052				(206,714	)			—				—				4,338
Sales			—				—				—				—				—
Settlements			(1,293	)			1,021				(176	)			—				(448	)
			209,759				(205,693	)			(176	)			—				3,890

Total realized and unrealized gains and (losses) (1):
Included in Other, net			4,445				(4,942	)			—				(225	)			(722	)
Included in Other comprehensive income (loss)			—				—				—				—				—
			4,445				(4,942	)			—				(225	)			(722	)

Transfers in and / or out of Level 3			—				—				—				—				—
Ending balance		$	290,853			$	(284,276	)		$	—			$	96,938			$	103,515

Three Months Ended September 30, 2012:
Beginning balance		$	—			$	—			$	(14,905	)		$	—			$	(14,905	)

Purchases, issuances, sales and settlements:
Settlements			—				—				102				—				102
			—				—				102				—				102

Total realized and unrealized gains and (losses) (1):
Included in Other, net			—				—				1,397				—				1,397
Included in Other comprehensive income (loss)			—				—				(2,688	)			—				(2,688	)
			—				—				(1,291	)			—				(1,291	)

Transfers in and / or out of Level 3			—				—				—				—				—
Ending balance		$	—			$	—			$	(16,094	)		$	—			$	(16,094	)

		Loans – restricted for securitization investors				Secured borrowings – owed to securitization investors				Derivative Financial Instruments				MSRs at Fair Value				Total

Nine Months Ended September 30, 2013:
Beginning balance		$	—			$	—			$	(10,668	)		$	85,213			$	74,545

Purchases, issuances, sales and settlements:
Purchases			10,251				(10,179	)			—				—				72
Issuances			274,081				(272,652	)			—				—				1,429
Sales			—				—				24,156				—				24,156
Settlements			(2,164	)			1,888				(1,242	)			—				(1,518	)
			282,168				(280,943	)			22,914				—				24,139

Total realized and unrealized gains and (losses) (1):
Included in Other, net			8,685				(3,333	)			117				11,725				17,194
Included in Other comprehensive income (loss)			—				—				(12,363	)			—				(12,363	)
			8,685				(3,333	)			(12,246	)			11,725				4,831

Transfers in and / or out of Level 3			—				—				—				—				—
Ending balance		$	290,853			$	(284,276	)		$	—			$	96,938			$	103,515

Nine Months Ended September 30, 2012:
Beginning balance		$	—			$	—			$	(16,676	)		$	—			$	(16,676	)

Purchases, issuances, sales and settlements:
Settlements			—				—				2,524				—				2,524
			—				—				2,524				—				2,524

Total realized and unrealized gains and (losses) (1):
Included in Other, net			—				—				6,645				—				6,645
Included in Other comprehensive income (loss)			—				—				(8,587	)			—				(8,587	)
			—				—				(1,942	)			—				(1,942	)

Transfers in and / or out of Level 3			—				—				—				—				—
Ending balance		$	—			$	—			$	(16,094	)		$	—			$	(16,094	)

(1)

For derivative financial instruments held at September 30, 2012, total net losses were $1.3 million and $7.7 million for the three and nine months ended September 30, 2012, respectively.

The methodologies that we use and key assumptions that we make to estimate the fair value of financial instruments and other assets and liabilities measured at fair value on a recurring or non-recurring basis are described below:

Loans Held for Sale

We originate and purchase residential forward and reverse mortgage loans that we intend to sell to the GSEs. We also own residential mortgage loans that are not eligible to be sold to the GSEs due to delinquency or other factors. Residential forward and reverse mortgage loans that we intend to sell to the GSEs are carried at fair value as a result of a fair value election. Such loans are subject to changes in fair value due to fluctuations in interest rates from the closing date through the date of the sale of the loan into the secondary market. These loans are classified within Level 2 of the valuation hierarchy as the primary component of the price is obtained from observable values of mortgage forwards for loans of similar terms and characteristics. We have the ability to access this market, and it is the market into which conforming mortgage loans are typically sold.

We report all other loans held for sale at the lower of cost or fair value. Current market illiquidity has reduced the availability of observable pricing data for certain of these loans. When we enter into an agreement to sell a loan or pool of loans to an investor at a set price, we value the loan or loans at the commitment price. We base the fair value of uncommitted loans on the expected future cash flows discounted at a rate commensurate with the risk of the estimated cash flows. Assumptions used in the valuation of performing loans include historical default rates, re-performance rates on defaulted loans, loss severity on defaulted loans, average resolution timeline, average coupon rate and a discount rate. Significant assumptions used in the valuation of nonperforming loans include the current market value of the underlying collateral based on third party sources such as appraisals or broker price opinions, resolution timeline, estimated foreclosure and disposition costs that are based on historical experience and a discount rate. The assumptions we used in the valuation of these performing and non-performing loans at September 30, 2013 have not changed significantly from those we used in the December 31, 2012 valuations.

We repurchase certain loans from Ginnie Mae guaranteed securitizations in connection with loan modifications and loan resolution activity as part of our servicing obligations. These are classified as loans held for sale at the lower of cost or fair value, in the case of modified loans, as we expect to redeliver (sell) the loans to new Ginnie Mae guaranteed securitizations. The fair value of these loans is estimated using published forward Ginnie Mae prices. Loans repurchased in connection with loan resolution activities are modified or otherwise remediated through loss mitigation activities or are reclassified to receivables. Because these loans are insured or guaranteed by the FHA or VA, the fair value of these loans represents the net recovery value taking into consideration the insured or guaranteed claim.

Loans – Restricted for Securitization Investors

These loans are not traded in an active, open market with readily observable prices. We base the fair value of transferred reverse mortgage loans that do not qualify as sales for accounting purposes on the expected future cash flows discounted over the expected life of the loans at a rate commensurate with the risk of the estimated cash flows. Significant assumptions included expected prepayment and delinquency rates and cumulative loss curves. The discount rate assumption for these assets is primarily based on an assessment of current market yields on newly originated reverse mortgage loans, expected duration of the asset, and current market interest rates.

The more significant assumptions used in the September 30, 2013 valuation of our Loans – Restricted for Securitization Investors include:

●

Life in years ranging from 2.97 to 23.52 (weighted average of 6.79);

●

Conditional repayment rate ranging from 4.80% to 38.40% (weighted average of 8.44%); and

●

Discount rate of 1.84%.

Significant increases or decreases in any of these assumptions in isolation would result in a significantly higher or lower fair value.

Mortgage Servicing Rights

Amortized Cost MSRs

We estimate the fair value of MSRs carried at amortized cost using a combination of internal models and data provided by third-party valuation experts. The most significant assumptions used in the valuation of MSRs are the speed at which mortgages prepay and delinquency experience. Other assumptions typically used in the valuation of MSRs are:

	●	Cost of servicing

	●	Discount rate

	●	Interest rate used for computing the cost of financing servicing advances

	●	Interest rate used for computing float earnings

	●	Compensating interest expense

	●	Collection rate of other ancillary fees

The significant components of the estimated future cash inflows for MSRs include servicing fees, late fees, float earnings and other ancillary fees. Significant cash outflows include the cost of servicing, the cost of financing servicing advances and compensating interest payments.

We perform an impairment analysis based on the difference between the carrying amount and fair value after grouping our loans into the applicable strata. As a result of the Homeward and ResCap Acquisitions, management has re-evaluated the portfolio and determined the appropriate strata are Agency and Non-Agency. The Agency stratum includes all GSE MSRs. The Non-Agency stratum includes all private label primary and master MSRs.

We estimate fair value using internal models and with the assistance of third-party valuation experts. Our internal models calculate the present value of expected future cash flows utilizing assumptions that we believe are used by market participants. We derived prepayment speeds and delinquency assumptions from historical experience adjusted for prevailing market conditions. We utilize a discount rate provided by third-party valuation experts, and we consider external market-based assumptions in determining the interest rate for the cost of financing advances, the interest rate for float earnings and the cost of servicing.

Third-party valuation experts generally utilize: (a) transactions involving instruments with similar collateral and risk profiles, adjusted as necessary based on specific characteristics of the asset or liability being valued; and/or (b) industry-standard modeling, such as a discounted cash flow model, in arriving at their estimate of fair value. The prices provided by the valuation experts reflect their observations and assumptions related to market activity, including risk premiums and liquidity adjustments. The models and related assumptions used by the valuation experts are owned and managed by them and, in many cases, the significant inputs used in the valuation techniques are not reasonably available to us. However, we have an understanding of the processes and assumptions used to develop the prices based on our ongoing due diligence, which includes regular discussions with the valuation experts. We believe that the procedures executed by the valuation experts, combined with our internal verification and analytical procedures, provide assurance that the prices used in our consolidated financial statements comply with the accounting guidance for fair value measurements and disclosures and reflect the assumptions that a market participant would use.

The more significant assumptions used in the September 30, 2013 valuation of our MSRs carried at amortized cost include:

●

Prepayment speeds ranging from 7.39% to 19.23% (weighted average of 14.87%) depending on loan type;

●

Delinquency rates ranging from 6.55% to 29.42% (weighted average of 17.04%) depending on loan type;

●

Interest rate of 1-month LIBOR plus 3.75% for computing the cost of financing advances;

●

Interest rate of 1-month LIBOR for computing float earnings; and

●

Discount rates ranging from 11.33% to 17.13% (weighted average of 12.80%).

We perform an impairment analysis based on the difference between the carrying amount and fair value after grouping our loans into the applicable strata based on one or more of the predominant risk characteristics of the underlying loans. As a result of the Homeward and ResCap Acquisitions, management has re-evaluated the portfolio and determined the appropriate strata are Agency and Non-Agency. The Agency stratum includes all GSE MSRs. The Non-Agency stratum includes all private label primary and master MSRs.

Fair Value MSRs

MSRs carried at fair value are classified within Level 3 of the valuation hierarchy due to the use of third party valuation expert pricing without adjustment. The fair value of these MSRs is within the range of prices provided by the valuation experts, however, a change in the valuation inputs utilized by the valuation expert or a change in the best point price in the range might result in a significantly higher or lower fair value measurement.

The key assumptions (generally unobservable inputs) used in the valuation of these MSRs include:

●

Mortgage prepayment speeds;

●

Delinquency rates, and

●

Discount rates.

The primary assumptions used in the September 30, 2013 valuation include an 8.95% weighted average constant prepayment rate and a discount rate equal to 1-Month LIBOR plus 10.50%.

Advances

We value advances that we make on loans that we service for others at their net realizable value which generally approximates fair value because advances have no stated maturity, generally are realized within a relatively short period of time and do not bear interest.

Receivables

The carrying value of receivables generally approximates fair value because of the relatively short period of time between their origination and realization.

Secured Borrowings – Owed to Securitization Investors

We recognize the proceeds from the transfer of reverse mortgages as a secured borrowing that we account for at fair value. These borrowings are not actively traded and therefore quoted market prices are not available. We determine fair value by discounting the future principal and interest repayments over the estimated life of the borrowing at a market rate commensurate with the risk of the estimated cash flows. Significant assumptions include prepayments, discount rate and borrower mortality rates for reverse mortgages. The discount rate assumption for these liabilities is based on an assessment of current market yields for newly issued HMBS, expected duration and current market interest rates.

The more significant assumptions used in the September 30, 2013 valuation of our Secured Borrowings – Owed to Securitization Investors include:

●

Life in years ranging from 2.94 to 22.85 (weighted average of 6.15),

●

Conditional repayment rate ranging from 4.80% to 37.97% (weighted average of 8.44%) and

●

Discount rate of 1.17%.

Significant increases or decreases in any of these assumptions in isolation would result in a significantly higher or lower fair value.

Match Funded Liabilities and Other Borrowings

The carrying value of match funded liabilities and secured borrowings that bear interest at a rate that is adjusted regularly based on a market index approximates fair value. For other match funded or secured borrowings that bear interest at a fixed rate, we determine fair value by discounting the future principal and interest repayments at a market rate commensurate with the risk of the estimated cash flows. We estimate principal repayments of match funded liabilities during the amortization period based on our historical advance collection rates and taking into consideration any plans to refinance the notes. At September 30, 2013, the interest on all borrowings under match funded facilities was based on a variable rate adjusted regularly using a market index and therefore the carrying value approximates fair value. For the SSTL, we used a discount rate of 5.50% and the repayment schedule specified in the loan agreement to determine fair value.

Derivative Financial Instruments

We may execute interest rate swaps to hedge against the effects of changes in interest rates on our borrowings under advance funding facilities. These derivatives are not exchange-traded and, therefore, quoted market prices or other observable inputs are not available. Fair value is based on information provided by third-party pricing sources. Third-party valuations are derived from proprietary models based on inputs that include yield curves and contractual terms such as fixed interest rates and payment dates. Although we have not adjusted the information obtained from the third-party pricing sources, we review this information to ensure that it provides a reasonable basis for estimating fair value. Our review is designed to identify information that appears stale, information that has changed significantly from the prior period and other indicators that the information may not be accurate. For interest rate contracts, significant increases or decreases in the unobservable portion of the yield curves in isolation will result in substantial changes in the fair value measurement. We terminated our outstanding interest rates swaps on May 31, 2013.

In addition, we may use interest rate caps to minimize future interest rate exposures on variable rate debt issued on servicing advance facilities from increases in one-month LIBOR interest rates. The fair value for interest rate caps is based on counterparty market prices and adjusted for counterparty credit risk.

We enter into forward trades to provide an economic hedge against changes in the value of residential forward and reverse mortgage loans held for sale that we carry at fair value. Forward trades are primarily used to fix the forward sales price that will be realized upon the sale of mortgage loans into the secondary market. Forward contracts are actively traded in the market and we obtained unadjusted market quotes for these derivatives, thus they are classified within Level 1 of the valuation hierarchy.

IRLCs represent an agreement to purchase loans from a third-party originator, or an agreement to extend credit to a mortgage applicant (locked pipeline), or an agreement to sell a loan to investors, whereby the interest rate is set prior to funding. IRLCs are classified within Level 2 of the valuation hierarchy as the primary component of the price is obtained from observable values of mortgage forwards for loans of similar terms and characteristics. Fair value amounts of IRLCs are adjusted for expected “fallout” (locked pipeline loans not expected to close), using models that consider cumulative historical fallout rates and other factors.

We previously entered into derivative contracts that included interest rate swaps, U.S. Treasury futures and forward contracts to hedge against the effects of changes in the value of the MSRs that we carry at fair value. Effective April 1, 2013, we modified our strategy for managing the risks of the underlying loan portfolios and no longer use derivative contracts to hedge against the effects of changes in the value of MSRs which we carry at fair value. The fair value of interest rate swaps were based upon projected short-term interest rates and volatility based on published market based sources, a Level 3 valuation. Because futures and forward contracts are actively traded in the market, they are classified within Level 1 of the valuation hierarchy.

See Note 19 – Derivative Financial Instruments and Hedging Activities for additional information regarding derivative financial instruments.

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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