Note 4 – 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 on a recurring or non-recurring basis are as follows at the dates indicated:



		September 30, 2014						December 31, 2013
	Level	Carrying Value			Fair Value			Carrying Value		Fair Value
Financial assets:
Loans held for sale:
Loans held for sale, at fair value (a)	2	$	335,950		$	335,950		$	503,753	$	503,753
Loans held for sale, at lower of cost or fair value (b)	3	71,937			71,937			62,907		62,907
Total Loans held for sale		$	407,887		$	407,887		$	566,660	$	566,660
Loans held for investment - Reverse mortgages, at fair value (a)	3	$	1,315,324		$	1,315,324		$	618,018	$	618,018
Advances and match funded advances (c)	3	3,346,865			3,346,865			3,443,215		3,443,215
Receivables, net (c)	3	245,817			245,817			152,516		152,516

Financial liabilities:
Match funded liabilities (c)	3	$	2,035,639		$	2,035,639		$	2,364,814	$	2,364,814
Financing liabilities:
HMBS-related borrowings, at fair value (a)	3	$	1,236,094		$	1,236,094		$	615,576	$	615,576
Financing liability - MSRs pledged (a)	3	618,855			618,855			633,804		633,804
Other (c)	3	202,541			206,261			17,593		17,593
Total Financing liabilities		$	2,057,490		$	2,061,210		$	1,266,973	$	1,266,973
Other secured borrowings:
Senior secured term loan (c)	3	$	1,276,142		$	1,259,601		$	1,284,901	$	1,270,108
Other (c)	3	390,285			390,285			492,768		492,768
Total Other secured borrowings		$	1,666,427		$	1,649,886		$	1,777,669	$	1,762,876

Senior unsecured notes	2	$	350,000		$	338,625		$	—	$	—

Derivative financial instruments (a):
IRLCs	2	$	6,117		$	6,117		$	8,433	$	8,433
Forward MBS trades	1	(1,089		)	(1,089		)	6,905		6,905
Interest rate caps	3	91			91			442		442

MSRs:
MSRs, at fair value (a)	3	$	101,948		$	101,948		$	116,029	$	116,029
MSRs, at amortized cost (c)	3	1,856,818			2,364,393			1,953,352		2,441,719
Total MSRs		$	1,958,766		$	2,466,341		$	2,069,381	$	2,557,748


(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 for the three and nine months ended September 30. The information presented for 2013 has been revised to include Financing liability - MSRs pledged in conformity with the 2014 presentation of Level 3 assets and liabilities.



	Loans Held for Investment - Reverse Mortgages			Financing Liability - MSRs Pledged			HMBS-Related Borrowings			Derivative Financial Instruments, net			MSRs			Total
Three months ended September 30, 2014
Fair value at July 1, 2014	$	1,107,626		$	(629,579	)	$	(1,033,712	)	$	97		$	104,220		$	(451,348	)
Purchases, issuances, sales and settlements:
Purchases	—			—			—			—			—			—
Issuances	208,566			—			(190,452		)	—			—			18,114
Sales	—			—			—			—			—			—
Settlements (1)	(27,592		)	10,724			12,690			—			(934		)	(5,112		)
	180,974			10,724			(177,762		)	—			(934		)	13,002
Total realized and unrealized gains and (losses):
Included in earnings	26,724			—			(24,620		)	(6		)	(1,338		)	760
Included in Other comprehensive income (loss)	—			—			—			—			—			—
	26,724			—			(24,620		)	(6		)	(1,338		)	760
Transfers in and / or out of Level 3	—			—			—			—			—			—
Fair value at September 30, 2014	$	1,315,324		$	(618,855	)	$	(1,236,094	)	$	91		$	101,948		$	(437,586	)



	Loans Held for Investment - Reverse Mortgages			Financing Liability - MSRs Pledged			HMBS-Related Borrowings			Derivative Financial Instruments, net			MSRs			Total
Three months ended September 30, 2013
Fair value at July 1, 2013	$	76,649		$	(437,734	)	$	(73,641	)	$	176		$	97,163		$	(337,387	)
Purchases, issuances, sales and settlements:
Purchases	—			—			—			—			—			—
Issuances	211,052			(239,851		)	(206,714		)	—			—			(235,513		)
Sales	—			—			—						—			—
Settlements	(1,293		)	17,764			1,021			(176		)	—			17,316
	209,759			(222,087		)	(205,693		)	(176		)	—			(218,197		)
Total realized and unrealized gains and (losses):
Included in earnings	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	—			—			—			—			—			—
Fair value at September 30, 2013	$	290,853		$	(659,821	)	$	(284,276	)	$	—		$	96,938		$	(556,306	)



	Loans Held for Investment - Reverse Mortgages			Financing Liability - MSRs Pledged			HMBS-Related Borrowings			Derivative Financial Instruments, net			MSRs			Total
Nine months ended September 30, 2014
Fair value at January 1, 2014	$	618,018		$	(633,804	)	$	(615,576	)	$	442		$	116,029		$	(514,891	)
Purchases, issuances, sales and settlements:
Purchases	—			—			—			23			—			23
Issuances	565,670			—			(572,031		)	—			—			(6,361		)
Transfer from loans held for sale, at fair value	110,874			—			—			—			—			110,874
Sales	—			—			—			—			—			—
Settlements (1)	(56,193		)	14,949			25,725			—			(934		)	(16,453		)
	620,351			14,949			(546,306		)	23			(934		)	88,083
Total realized and unrealized gains and (losses): (2)
Included in earnings	76,955			—			(74,212		)	(374		)	(13,147		)	(10,778		)
Included in Other comprehensive income (loss)	—			—			—			—			—			—
	76,955			—			(74,212		)	(374		)	(13,147		)	(10,778		)
Transfers in and / or out of Level 3	—			—			—			—			—			—
Fair value at September 30, 2014	$	1,315,324		$	(618,855	)	$	(1,236,094	)	$	91		$	101,948		$	(437,586	)



	Loans Held for Investment - Reverse Mortgages			Financing Liability - MSRs Pledged			HMBS-Related Borrowings			Derivative Financial Instruments, net			MSRs		Total
Nine months ended September 30, 2013
Fair value at January 1, 2013	$	—		$	(303,705	)	$	—		$	(10,668	)	$	85,213	$	(229,160	)
Purchases, issuances, sales and settlements:
Purchases	10,251			—			(10,179		)	—			—		72
Issuances	274,081			(388,473		)	(272,652		)	—			—		(387,044		)
Sales	—			—			—			24,156			—		24,156
Settlements	(2,164		)	32,357			1,888			(1,242		)	—		30,839
	282,168			(356,116		)	(280,943		)	22,914			—		(331,977		)
Total realized and unrealized gains and (losses):
Included in earnings	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	—			—			—			—			—		—
Fair value at September 30, 2013	$	290,853		$	(659,821	)	$	(284,276	)	$	—		$	96,938	$	(556,306	)


(1)	In the event of a transfer of servicing to another party related to Rights to MSRs sold to HLSS, we are required to reimburse HLSS at predetermined contractual rates for the loss of servicing revenues. Settlements for Financing liability - MSRs pledged for the three and nine months ended September 30, 2014 includes $2.0 million of such reimbursements.


(2)	Total losses attributable to derivative financial instruments still held at September 30, 2014 were $0.4 million for the nine months ended September 30, 2014.

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 and those disclosed, but not carried, at fair value 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 September 30, 2014 valuation include:


•	Life in years ranging from 6.64 to 10.75 (weighted average of 6.99);


•	Conditional repayment rate ranging from 4.82% to 53.75% (weighted average of 19.28%); and


•	Discount rate of 3.20%.

Significant increases or decreases in any of these assumptions in isolation could result in a significantly lower or higher fair value, respectively. The effects of changes in the assumptions used to value the loans held for investment are largely offset by the effects of changes in the assumptions used to value the HMBS-Related Borrowings that are associated with these loans.

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.

Our 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 unaudited 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, 2014 valuation of our MSRs carried at amortized cost include:


•	Prepayment speeds ranging from 9.87% to 16.82% (weighted average of 14.16%) depending on loan type;


•	Delinquency rates ranging from 6.77% to 24.32% (weighted average of 18.96%) depending on loan type;


•	Interest rate of 1-month LIBOR plus a range of 0.00% to 3.50% for computing the cost of financing servicing advances;


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


•	Discount rates ranging from 9.23% to 16.74% (weighted average of 12.01%).

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 strata are defined as conventional, government insured 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 September 30, 2014 valuation include an 8.55% weighted average constant prepayment rate and a discount rate equal to 1-Month LIBOR plus 9.01%.

Advances

We value advances at their net realizable value, which generally approximates fair value, because advances have no stated maturity, are generally 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 September 30, 2014, 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 September 30, 2014 valuation include:


•	Life in years ranging from 4.97 to 10.75 (weighted average of 5.65);


•	Conditional repayment rate ranging from 4.82% to 53.75% (weighted average of 19.28%); and


•	Discount rate of 2.44%.

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

Financing Liabilities

MSRs Pledged

We periodically sell rights to receive servicing fees, excluding ancillary income, with respect to certain MSRs (Rights to MSRs) and the related servicing advances to HLSS in transactions we refer to as the HLSS Transactions. Because we have retained legal title to the MSRs, the sales of Rights to MSRs are accounted for as financings. 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 to fair value at each reporting date.

Secured Notes

We issued Ocwen Asset Servicing Income Series (OASIS), Series 2014-1 Notes secured by Ocwen-owned MSRs relating to Freddie Mac mortgages. We accounted for this transaction as a financing. We determine the fair value based on bid prices provided by third parties involved in the issuance and placement of the notes.

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 5.71% and the repayment schedule specified in the loan agreement to determine fair value at September 30, 2014.

Senior Unsecured Notes

We base the fair value on quoted prices in markets with limited trading activity.

Derivative Financial Instruments

Interest rate lock commitments (IRLCs) represent an agreement to purchase loans from a third-party originator or an agreement to extend credit to a mortgage applicant (locked pipeline), 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 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 obtain unadjusted market quotes for these derivatives, thus they are classified within Level 1 of the valuation hierarchy.

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.

See Note 15 – Derivative Financial Instruments and Hedging Activities for additional information regarding derivative financial instruments.