Note 5 — Fair Value

Fair value is estimated 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 at December 31:



		2013				2012
	Level	Carrying Value		Fair Value		Carrying Value			Fair Value
Financial assets:
Loans held for sale:
Loans held for sale, at fair value (a)	2	$	503,753	$	503,753	$	426,480		$	426,480
Loans held for sale, at lower of cost or fair value (b)	3	62,907		62,907		82,866			82,866
Total Loans held for sale		$	566,660	$	566,660	$	509,346		$	509,346
Loans held for investment - Reverse mortgages, at fair value (a)	3	$	618,018	$	618,018	$	—		$	—
Advances and match funded advances (c)	3	3,443,215		3,443,215		3,233,707			3,233,707
Receivables, net (c)	3	152,516		152,516		132,853			132,853

Financial liabilities:
Match funded liabilities (c)	3	$	2,364,814	$	2,364,814	$	2,532,745		$	2,533,278
Financing liabilities:
HMBS-related borrowings, at fair value (a)	3	$	615,576	$	615,576	$	—		$	—
Other (c)	3	651,397		651,397		306,308			306,308
Total Financing liabilities		$	1,266,973	$	1,266,973	$	306,308		$	306,308
Other secured borrowings:
Senior secured term loan (c)	3	$	1,284,901	$	1,270,108	$	305,997		$	310,822
Other (c)	3	492,768		492,768		484,374			484,374
Total Other secured borrowings		$	1,777,669	$	1,762,876	$	790,371		$	795,196

Derivative financial instruments (a):
IRLCs	2	$	8,433	$	8,433	$	5,781		$	5,781
Interest rate swaps	3	—		—		(10,836		)	(10,836		)
Forward MBS trades	1	6,905		6,905		(1,719		)	(1,719		)
U.S. Treasury futures	1	—		—		(1,258		)	(1,258		)
Interest rate caps	3	442		442		168			168

MSRs:
MSRs, at fair value (a)	3	$	116,029	$	116,029	$	85,213		$	85,213
MSRs, at amortized cost (c)	3	1,953,352		2,441,719		678,937			743,830
Total MSRs		$	2,069,381	$	2,557,748	$	764,150		$	829,043


(a)	Measured at fair value on a recurring basis.


(b)	Measured at fair value on a non-recurring basis.


(c)	Disclosed, but not carried, at fair value.

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



	Loans Held for Investment - Reverse Mortgages			HMBS-Related Borrowings			Derivative Financial Instruments, net			MSRs		Total
January 1, 2013	$	—		$	—		$	(10,668	)	$	85,213	$	74,545
Purchases, issuances, sales and settlements:
Purchases	10,251			(10,179		)	498			—		570
Issuances	609,555			(604,991		)	—			—		4,564
Sales	—			—			24,156			—		24,156
Settlements	(5,886		)	5,440			(1,241		)	—		(1,687		)
	613,920			(609,730		)	23,413			—		27,603
Total realized and unrealized gains and (losses): (1)
Included in earnings	4,098			(5,846		)	60			30,816		29,128
Included in Other comprehensive income (loss)	—			—			(12,363		)	—		(12,363		)
	4,098			(5,846		)	(12,303		)	30,816		16,765
Transfers in and / or out of Level 3	—			—			—			—		—
December 31, 2013	$	618,018		$	(615,576	)	$	442		$	116,029	$	118,913



	Derivative Financial Instruments, net			MSRs		Total
January 1, 2012	$	(16,676	)	$	—	$	(16,676	)
Purchases, issuances, sales and settlements:
Purchases	4,946			85,183		90,129
Issuances	—			—		—
Sales	(405		)	—		(405		)
Settlements	2,451			—		2,451
	6,992			85,183		92,175
Total realized and unrealized gains and (losses) (1):
Included in earnings	7,331			30		7,361
Included in Other comprehensive income (loss)	(8,315		)	—		(8,315		)
	(984		)	30		(954		)
Transfers in and / or out of Level 3	—			—		—
December 31, 2012	$	(10,668	)	$	85,213	$	74,545



	Derivative Financial Instruments, net
January 1, 2011	$	(15,351	)
Purchases, issuances, sales and settlements:
Purchases	3,688
Settlements	85
	3,773
Total realized and unrealized gains and (losses):
Included in earnings	(5,881		)
Included in Other comprehensive income (loss)	783
	(5,098		)
Transfers in and / or out of Level 3	—
December 31, 2011	$	(16,676	)


(1)	Total losses attributable to derivative financial instruments still held at December 31, 2012 and 2011 were $1.2 million and $5.1 million, respectively.

The methodologies that we use and key assumptions that we make to estimate the fair value of 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 because 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 conventional and government insured mortgage loans are typically sold.

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

For all other loans held for sale which we report at the lower of cost or fair value, market illiquidity has reduced the availability of observable pricing data. 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.

Loans Held for Investment – Reverse Mortgages

We have elected to measure these loans at fair value. For transferred reverse mortgage loans that do not qualify as sales for accounting purposes, we base the fair value 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 include 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 December 31, 2013 valuation include:


•	Life in years ranging from 2.76 to 23.25 (weighted average of 7.10);


•	Conditional repayment rate ranging from 4.83% to 38.40% (weighted average of 9.65%); and


•	Discount rate of 1.72%.

Significant increases or decreases in any of these assumptions in isolation could 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 our internal valuation are the speed at which mortgages prepay and delinquency experience. Other assumptions typically used in the internal valuation are:



•	Cost of servicing	•	Interest rate used for computing float earnings
•	Discount rate	•	Compensating interest expense
•	Interest rate used for computing the cost of financing servicing advances	•	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 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 derive 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 December 31, 2013 valuation of our MSRs carried at amortized cost include:


•	Prepayment speeds ranging from 6.41% to 17.50% (weighted average of 13.90%) depending on loan type;


•	Delinquency rates ranging from 6.18% to 30.82% (weighted average of 17.32%) depending on loan type;


•	Interest rate of 1-month LIBOR plus a range of 0.00% to 3.75% for computing the cost of financing servicing advances;


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


•	Discount rates ranging from 9.98%% to 16.73% (weighted average of 11.64%)

We perform an impairment analysis based on the difference between the carrying amount and fair value after grouping the underlying loans into the applicable strata. In response to the significant change in the composition of our MSR portfolio as a result of recent acquisitions, our stratum are defined as conventional (i.e. conforming to the underwriting standards of Fannie Mae or Freddie Mac), government insured (loans insured by FHA or VA) and non-Agency (i.e. all private label primary and master serviced loans).

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 December 31, 2013 valuation include a 7.75% weighted average constant prepayment rate and a discount rate equal to 1-Month LIBOR plus 9.00%.

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.

Borrowings

Match Funded Liabilities

For match funded liabilities that bear interest at a rate that is adjusted regularly based on a market index, the carrying value approximates fair value. For match funded liabilities 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 December 31, 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.

HMBS-Related Borrowings

We have elected to measure these borrowings at fair value. 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 December 31, 2013 valuation include:


•	Life in years ranging from 2.74 to 22.55 (weighted average of 6.42);


•	Conditional repayment rate ranging from 4.83% to 37.97% (weighted average of 9.65%); 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.

Financing Liability - MSRs Pledged

The carrying value of the Financing Liability - MSRs Pledged approximates fair value. We initially establish the value of the Financing Liability - MSRs Pledged based on the price at which the Rights to MSRs are sold to HLSS. Thereafter, the carrying value of the Financing Liability - MSRs pledged is adjusted from time to time to reflect changes in the net present value of the estimated future cash flows of the underlying MSRs. Since these cash flows are ceded to HLSS as part of the HLSS transactions, the future cash flows of the underlying MSRs also represent the future payments to HLSS of principal and interest on the Financing Liability - MSRs Pledged. As a result, the net present value of the future cash flows related to the underlying MSRs also represent the net present value of the principal and interest payments to be made on the Financing Liability - MSRs Pledged. The net present value of these future cash flows represents the fair value of the Financing Liability - MSRs Pledged.

Other Secured Borrowings

The carrying value of secured borrowings that bear interest at a rate that is adjusted regularly based on a market index approximates fair value. For other 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. For the SSTL, we used a discount rate of 5.57% and the repayment schedule specified in the loan agreement to determine fair value at December 31, 2013.

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 mortgage-backed securities (MBS) trades to provide an economic hedge against changes in fair value of residential forward and reverse mortgage loans held for sale that we carry at fair value. Forward MBS 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.

Interest rate lock commitments (IRLCs) represent an agreement to purchase loans from a third-party originator, 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 which 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.