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Section 1: 10-Q (10-Q)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

 

 

 

    (Mark One)

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2016

OR

 

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to

Commission File Number: 001-35000

 

Walker & Dunlop, Inc.

 

(Exact name of registrant as specified in its charter)

 

Maryland

 

80-0629925

(State or other jurisdiction of

 

(I.R.S. Employer Identification No.)

incorporation or organization)

 

 

7501 Wisconsin Avenue, Suite 1200E

Bethesda, Maryland 20814

(301) 215-5500

 

(Address of principal executive offices and registrant’s telephone number, including

area code)

 

Not Applicable

 

(Former name, former address, and former fiscal year if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

 

 

 

 

 

 

Large accelerated filer ☒

 

Accelerated filer ☐

 

Non-accelerated filer ☐

 

Smaller reporting company ☐

 

 

(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

As of October 26, 2016, there were 30,804,028 total shares of common stock outstanding.

 

 

 


 

Table of Contents

 

Walker & Dunlop, Inc.
Form 10-Q
INDEX

 

 

 

 

 

 

 

 

 

 

 

 

Page

 

 

 

 

PART I 

 

FINANCIAL INFORMATION

 

 

 

 

Item 1. 

 

Financial Statements

 

 

 

 

Item 2. 

 

Management's Discussion and Analysis of Financial Condition and Results of Operations

21 

 

 

 

 

Item 3. 

 

Quantitative and Qualitative Disclosures About Market Risk

43 

 

 

 

 

Item 4. 

 

Controls and Procedures

44 

 

 

 

 

PART II 

 

OTHER INFORMATION

44 

 

 

 

 

Item 1. 

 

Legal Proceedings

44 

 

 

 

 

Item 1A. 

 

Risk Factors

45 

 

 

 

 

Item 2. 

 

Unregistered Sales of Equity Securities and Use of Proceeds

45 

 

 

 

 

Item 3. 

 

Defaults Upon Senior Securities

45 

 

 

 

 

Item 4. 

 

Mine Safety Disclosures

45 

 

 

 

 

Item 5. 

 

Other Information

45 

 

 

 

 

Item 6. 

 

Exhibits

45 

 

 

 

 

 

 

Signatures

47 

 

 

 

 

 

 

Exhibit Index

48 

 

 

 

 

 


 

Table of Contents

PART I

FINANCIAL INFORMATION

Item 1. Financial Statements

 

Walker & Dunlop, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

September 30, 2016 and December 31, 2015

(In thousands, except per share data)

 

 

 

 

 

 

 

 

 

 

 

September 30, 

    

December 31, 

 

 

 

2016

 

2015

 

 

 

(unaudited)

 

 

 

 

Assets

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

83,887

 

$

136,988

 

Restricted cash

 

 

14,370

 

 

5,306

 

Pledged securities, at fair value

 

 

81,933

 

 

72,190

 

Loans held for sale, at fair value

 

 

1,299,028

 

 

2,499,111

 

Loans held for investment, net

 

 

261,915

 

 

231,493

 

Servicing fees and other receivables, net

 

 

28,316

 

 

23,844

 

Derivative assets

 

 

33,796

 

 

11,678

 

Mortgage servicing rights

 

 

496,678

 

 

412,348

 

Goodwill and other intangible assets

 

 

91,340

 

 

91,488

 

Other assets

 

 

39,854

 

 

30,545

 

Total assets

 

$

2,431,117

 

$

3,514,991

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

Accounts payable and other liabilities

 

$

202,533

 

$

169,109

 

Performance deposits from borrowers

 

 

13,885

 

 

5,112

 

Derivative liabilities

 

 

2,918

 

 

1,333

 

Guaranty obligation, net of accumulated amortization

 

 

30,938

 

 

27,570

 

Allowance for risk-sharing obligations

 

 

3,400

 

 

5,586

 

Warehouse notes payable

 

 

1,440,425

 

 

2,649,470

 

Note payable

 

 

164,238

 

 

164,462

 

Total liabilities

 

$

1,858,337

 

$

3,022,642

 

 

 

 

 

 

 

 

 

Equity

 

 

 

 

 

 

 

Preferred shares, Authorized 50,000, none issued.

 

$

 —

 

$

 —

 

Common stock, $0.01 par value. Authorized 200,000; issued and outstanding 29,375 shares at September 30, 2016 and 29,466 shares at December 31, 2015

 

 

294

 

 

295

 

Additional paid-in capital

 

 

223,603

 

 

215,575

 

Retained earnings

 

 

344,241

 

 

272,030

 

Total stockholders’ equity

 

$

568,138

 

$

487,900

 

Noncontrolling interests

 

 

4,642

 

 

4,449

 

Total equity

 

$

572,780

 

$

492,349

 

Commitments and contingencies (Note 9)

 

 

 —

 

 

 —

 

Total liabilities and equity

 

$

2,431,117

 

$

3,514,991

 

 

See accompanying notes to condensed consolidated financial statements.

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Walker & Dunlop, Inc. and Subsidiaries

Condensed Consolidated Statements of Income

(In thousands, except per share data)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the three months ended

 

For the nine months ended

 

 

 

September 30, 

 

September 30, 

 

 

    

2016

    

2015

    

2016

    

2015

 

Revenues

 

 

 

 

 

 

 

 

 

 

 

 

 

Gains from mortgage banking activities

 

$

100,630

 

$

70,810

 

$

249,406

 

$

213,480

 

Servicing fees

 

 

37,134

 

 

29,328

 

 

101,554

 

 

84,227

 

Net warehouse interest income

 

 

5,614

 

 

6,860

 

 

15,925

 

 

17,824

 

Escrow earnings and other interest income

 

 

2,630

 

 

1,166

 

 

6,225

 

 

3,123

 

Other

 

 

8,778

 

 

12,622

 

 

23,775

 

 

28,179

 

Total revenues

 

$

154,786

 

$

120,786

 

$

396,885

 

$

346,833

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

Personnel

 

$

64,377

 

$

49,328

 

$

154,365

 

$

135,366

 

Amortization and depreciation

 

 

29,244

 

 

25,644

 

 

80,824

 

 

73,788

 

Provision for credit losses

 

 

283

 

 

94

 

 

166

 

 

576

 

Interest expense on corporate debt

 

 

2,485

 

 

2,484

 

 

7,419

 

 

7,433

 

Other operating expenses

 

 

9,685

 

 

9,790

 

 

29,511

 

 

28,176

 

Total expenses

 

$

106,074

 

$

87,340

 

$

272,285

 

$

245,339

 

Income from operations

 

$

48,712

 

$

33,446

 

$

124,600

 

$

101,494

 

Income tax expense

 

 

18,851

 

 

12,735

 

 

47,295

 

 

39,179

 

Net income before noncontrolling interests

 

$

29,861

 

$

20,711

 

$

77,305

 

$

62,315

 

Less: net income from noncontrolling interests

 

 

233

 

 

460

 

 

198

 

 

598

 

Walker & Dunlop net income

 

$

29,628

 

$

20,251

 

$

77,107

 

$

61,717

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share

 

$

1.01

 

$

0.69

 

$

2.62

 

$

2.06

 

Diluted earnings per share

 

$

0.96

 

$

0.66

 

$

2.51

 

$

1.99

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic weighted average shares outstanding

 

 

29,374

 

 

29,165

 

 

29,417

 

 

29,904

 

Diluted weighted average shares outstanding

 

 

30,793

 

 

30,460

 

 

30,743

 

 

31,045

 

 

See accompanying notes to condensed consolidated financial statements.

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Walker & Dunlop, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30, 

 

 

   

2016

    

2015

 

Cash flows from operating activities

 

 

 

 

 

 

 

Net income before noncontrolling interests

 

$

77,305

 

$

62,315

 

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

 

 

 

 

 

 

 

Gains attributable to the fair value of future servicing rights, net of guaranty obligation

 

 

(127,724)

 

 

(97,491)

 

Change in the fair value of premiums and origination fees

 

 

(17,728)

 

 

2,650

 

Amortization and depreciation

 

 

80,824

 

 

73,788

 

Provision for credit losses

 

 

166

 

 

576

 

Other operating activities, net

 

 

1,253,069

 

 

(32,619)

 

Net cash provided by (used in) operating activities

 

$

1,265,912

 

$

9,219

 

 

 

 

 

 

 

 

 

Cash flows from investing activities

 

 

 

 

 

 

 

Capital expenditures

 

$

(1,821)

 

$

(1,281)

 

Net cash paid to increase ownership interest in a previously held equity method investment

 

 

(1,058)

 

 

 —

 

Acquisitions, net of cash received

 

 

 —

 

 

(12,767)

 

Purchase of mortgage servicing rights

 

 

(42,705)

 

 

 —

 

Originations of loans held for investment

 

 

(218,958)

 

 

(144,950)

 

Principal collected on loans held for investment

 

 

187,820

 

 

22,920

 

Net cash provided by (used in) investing activities

 

$

(76,722)

 

$

(136,078)

 

 

 

 

 

 

 

 

 

Cash flows from financing activities

 

 

 

 

 

 

 

Borrowings (repayments) of warehouse notes payable, net

 

$

(1,239,677)

 

$

28,976

 

Borrowings of interim warehouse notes payable

 

 

148,478

 

 

110,829

 

Repayments of interim warehouse notes payable

 

 

(138,898)

 

 

(17,190)

 

Repayments of note payable

 

 

(829)

 

 

(4,543)

 

Proceeds from issuance of common stock

 

 

3,439

 

 

5,677

 

Repurchase of common stock

 

 

(12,374)

 

 

(50,062)

 

Debt issuance costs

 

 

(2,425)

 

 

(850)

 

Distributions to noncontrolling interests

 

 

(5)

 

 

 —

 

Tax benefit from vesting of equity awards

 

 

 —

 

 

831

 

Net cash provided by (used in) financing activities

 

$

(1,242,291)

 

$

73,668

 

 

 

 

 

 

 

 

 

Net increase (decrease) in cash and cash equivalents

 

$

(53,101)

 

$

(53,191)

 

Cash and cash equivalents at beginning of period

 

 

136,988

 

 

113,354

 

Cash and cash equivalents at end of period

 

$

83,887

 

$

60,163

 

 

 

 

 

 

 

 

 

Supplemental Disclosure of Cash Flow Information:

 

 

 

 

 

 

 

Cash paid to third parties for interest

 

$

28,592

 

$

24,813

 

Cash paid for income taxes

 

 

23,061

 

 

27,038

 

 

See accompanying notes to condensed consolidated financial statements.

 

 

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NOTE 1—ORGANIZATION AND BASIS OF PRESENTATION

These financial statements represent the condensed consolidated financial position and results of operations of Walker & Dunlop, Inc. and its subsidiaries. Unless the context otherwise requires, references to “we,” “us,” “our,” “Walker & Dunlop” and the “Company” mean the Walker & Dunlop consolidated companies. The statements have been prepared in conformity with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. Because the accompanying condensed consolidated financial statements do not include all of the information and footnotes required by GAAP, they should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015 (“2015 Form 10-K”). In the opinion of management, all adjustments (consisting only of normal recurring accruals except as otherwise noted herein) considered necessary for a fair presentation of the results for the Company in the interim periods presented have been included. Results of operations for the three and nine months ended September 30, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016 or thereafter.

Walker & Dunlop, Inc. is a holding company and conducts substantially all of its operations through Walker & Dunlop, LLC, the operating company. Walker & Dunlop is one of the leading commercial real estate finance companies in the United States. The Company originates, sells, and services a range of multifamily and other commercial real estate financing products and provides multifamily investment sales brokerage services. The Company originates and sells loans pursuant to the programs of the Federal National Mortgage Association (“Fannie Mae”), the Federal Home Loan Mortgage Corporation (“Freddie Mac,” and together with Fannie Mae, the “GSEs”), the Government National Mortgage Association (“Ginnie Mae”), and the Federal Housing Administration, a division of the U.S. Department of Housing and Urban Development (together with Ginnie Mae, “HUD”). The Company also offers a proprietary loan program offering interim loans (the “Interim Program”) and, until it was terminated in the fourth quarter of 2016, a program offering loans for a commercial mortgage backed securities (“CMBS”) execution (the “CMBS Program”).

Prior to 2016, the Company executed the CMBS Program through a partnership in which the Company owned a noncontrolling interest. The Company accounted for its investment in the partnership under the equity method of accounting. Effective January 1, 2016, the Company’s partner exited the CMBS Program, and the Company increased its ownership percentage to 100%. As the CMBS Program is now wholly owned, the Company began to consolidate the activities, financial results, and balances of the CMBS Program beginning in the first quarter of 2016, primarily impacting loans held for sale, warehouse notes payable, and gains from mortgage banking activities. The Company terminated the CMBS Program in the fourth quarter of 2016 and is in the process of winding down its operations.

NOTE 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Consolidation—The condensed consolidated financial statements include the accounts of Walker & Dunlop, Inc., its wholly owned subsidiaries, and its majority owned subsidiaries. All intercompany transactions have been eliminated in consolidation. When the Company has significant influence over operating and financial decisions for an entity but does not own a majority of the voting interests, the Company accounts for the investment using the equity method of accounting.

Subsequent Events—The Company has evaluated the effects of all events that have occurred subsequent to September 30, 2016. There have been no material events that would require recognition in the condensed consolidated financial statements. The Company has made certain disclosures in the notes to the condensed consolidated financial statements of events that have occurred subsequent to September 30, 2016. No other material subsequent events have occurred that would require disclosure.

Use of Estimates—The preparation of condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, including guaranty obligations, allowance for risk-sharing obligations, allowance for loan losses, capitalized mortgage servicing rights, derivative instruments, and the disclosure of contingent assets and liabilities. Actual results may vary from these estimates.

Comprehensive Income—For the three and nine months ended September 30, 2016 and 2015, comprehensive income equaled net income; therefore, a separate statement of comprehensive income is not included in the accompanying condensed consolidated financial statements.

Loans Held for Investment, netLoans held for investment are multifamily loans originated by the Company through the Interim Program for properties that currently do not qualify for permanent GSE or HUD financing. These loans have terms of up to three years. The

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loans are carried at their unpaid principal balances, adjusted for net unamortized loan fees and costs, and net of any allowance for loan losses. Interest income is accrued based on the actual coupon rate, adjusted for the amortization of net deferred fees and costs, and is recognized as revenue when earned and deemed collectible. All loans held for investment are multifamily loans with similar risk characteristics. As of September 30, 2016, Loans held for investment, net consisted of $264.5 million of unpaid principal balance less $2.1 million of net unamortized deferred fees and costs and $0.5 million of allowance for loan losses. As of December 31, 2015, Loans held for investment, net consisted of $233.4 million of unpaid principal balance less $1.1 million of net unamortized deferred fees and costs and $0.8 million of allowance for loan losses.

 

The allowance for loan losses is the Company’s estimate of credit losses inherent in the interim loan portfolio at the balance sheet date. The Company has established a process to determine the appropriateness of the allowance for loan losses that assesses the losses inherent in the portfolio. That process includes assessing the credit quality of each of the loans held for investment by monitoring the financial condition of the borrower and the financial trends of the underlying property. The allowance levels are influenced by the outstanding portfolio balance, delinquency status, historic loss experience, and other conditions influencing loss expectations, such as economic conditions. The allowance for loan losses is estimated collectively for loans with similar characteristics and for which there is no evidence of impairment. The allowances for loan losses recorded as of September 30, 2016 and December 31, 2015 were based on the Company’s collective assessment of the portfolio.

 

Loans held for investment are placed on non-accrual status when full and timely collection of interest or principal is not probable. Loans held for investment are considered past due when contractually required principal or interest payments have not been made on the due dates and are charged off when the loan is considered uncollectible. The Company evaluates all loans held for investment for impairment. A loan is considered impaired when the Company believes that the facts and circumstances of the loan suggest that the Company will not be able to collect all contractually due principal and interest. Delinquency status and property financial condition are key components of the Company’s consideration of impairment status.

 

None of the loans held for investment was delinquent, impaired, or on non-accrual status as of September 30, 2016 or December 31, 2015. Additionally, we have not experienced any delinquencies related to these loans or charged off any loan held for investment since the inception of the Interim Program in 2012.

 

Provision for Credit Losses—The Company records the income statement impact of the changes in the allowance for loan losses and the allowance for risk-sharing obligations within Provision for credit losses in the Condensed Consolidated Statements of Income. Note 5 contains additional discussion related to the allowance for risk-sharing obligations. Provision for credit losses consisted of the following activity for the three and nine months ended September 30, 2016 and 2015:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the three months ended 

 

For the nine months ended 

 

 

 

September 30, 

 

September 30, 

 

(in thousands)

    

2016

    

2015

    

2016

    

2015

 

Provision (benefit) for loan losses

 

$

(49)

 

$

94

 

$

(287)

 

$

368

 

Provision for risk-sharing obligations

 

 

332

 

 

 —

 

 

453

 

 

208

 

Provision for credit losses

 

$

283

 

$

94

 

$

166

 

$

576

 

 

Net Warehouse Interest Income—The Company presents warehouse interest income net of warehouse interest expense. Warehouse interest income is the interest earned from loans held for sale and loans held for investment. Substantially all loans that are held for sale are financed with matched borrowings under our warehouse facilities incurred to fund a specific loan held for sale. A portion of all loans that are held for investment is financed with matched borrowings under our warehouse facilities. The portion of loans held for investment not funded with matched borrowings is financed with the Company’s own cash. Warehouse interest expense is incurred on borrowings used to fund loans solely while they are held for sale or for investment. Warehouse interest income and expense are earned or incurred on loans held for sale after a loan is closed and before a loan is sold. Warehouse interest income and expense are earned or incurred on loans held for investment after a loan is closed and before a loan is repaid. Included in Net warehouse interest income for the three and nine months ended September 30, 2016 and 2015 are the following components: 

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For the three months ended 

 

For the nine months ended 

 

 

 

September 30, 

 

September 30, 

 

(in thousands)

    

2016

    

2015

    

2016

    

2015

 

Warehouse interest income - loans held for sale

 

$

11,507

 

$

9,433

 

$

32,328

 

$

27,905

 

Warehouse interest expense - loans held for sale

 

 

(8,032)

 

 

(5,122)

 

 

(21,548)

 

 

(16,840)

 

Net warehouse interest income - loans held for sale

 

$

3,475

 

$

4,311

 

$

10,780

 

$

11,065

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Warehouse interest income - loans held for investment

 

$

3,518

 

$

4,318

 

$

8,971

 

$

11,145

 

Warehouse interest expense - loans held for investment

 

 

(1,379)

 

 

(1,769)

 

 

(3,826)

 

 

(4,386)

 

Net warehouse interest income - loans held for investment

 

$

2,139

 

$

2,549

 

$

5,145

 

$

6,759

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total net warehouse interest income

 

$

5,614

 

$

6,860

 

$

15,925

 

$

17,824

 

Recently Announced Accounting Pronouncements—The following table presents the accounting pronouncements that the Financial Accounting Standards Board (“FASB”) has issued and that have the potential to impact the Company but have not yet been adopted by the Company.

 

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Standard

Issue Date

Description

Effective Date

Expected Financial Statement Impact

Accounting Standards Update ("ASU") 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments

Q2 2016

ASU 2016-13 ("the Standard") represents a significant change to the incurred loss model currently used to account for credit losses. The Standard requires an entity to estimate the credit losses expected over the life of the credit exposure upon initial recognition of that exposure. The expected credit losses consider historical information, current information, and reasonable and supportable forecasts, including estimates of prepayments. Exposures with similar risk characteristics are required to be grouped together when estimating expected credit losses. The initial estimate and subsequent changes to the estimated credit losses are required to be reported in current earnings in the income statement and through an allowance in the balance sheet. ASU 2016-13 is applicable to financial assets subject to credit losses and measured at amortized cost and certain off-balance-sheet credit exposures. The Standard will modify the way the Company estimates its allowance for risk-sharing obligations and its allowance for loan losses.

January 1, 2020

The Company is still in the process of determining the significance of the impact the Standard will have on its financial statements and the timing of when it will adopt the Standard.

ASU 2016-02, Leases (Topic 842)

Q1 2016

ASU 2016-02 represents a significant reform to the accounting for leases. Lessees initially recognize a lease liability for the obligation to make lease payments and a right-of-use (“ROU”) asset for the right to use the underlying asset for the lease term. The lease liability is measured at the present value of the lease payments over the lease term. The ROU asset is measured at the lease liability amount, adjusted for lease prepayments, lease incentives received and the lessee’s initial direct costs. Lessees generally recognize lease expense for these leases on a straight-line basis, which is similar to what they do today. Entities are required to use a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements.

January 1, 2019

The Company is still in the process of determining the significance of the impact ASU 2016-02 will have on its financial statements.

ASU 2016-01, Financial Instruments – Overall – Recognition and Measurement of Financial Assets and Financial Liabilities

Q1 2016

The guidance requires that unconsolidated equity investments not accounted for under the equity method be recorded at fair value, with changes in fair value recorded through net income. The accounting principles that permitted available-for-sale classification with unrealized holding gains and losses recorded in other comprehensive income for equity securities will no longer be applicable. The guidance is not applicable to debt securities and loans and requires minor changes to the disclosure and presentation of financial instruments.

January 1, 2018

The Company does not believe that ASU 2016-01 will have a material impact on its reported financial results.

ASU 2014-09, Revenue from Contracts with Customers (Topic 606)

Q2 2014

ASU 2014-09 represents a comprehensive reform of many of the revenue recognition requirements in GAAP. The guidance in the ASU supersedes the revenue recognition requirements in Topic 605, Revenue Recognition, and supersedes or amends much of the industry-specific revenue recognition guidance found throughout the Accounting Standards Codification. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. The ASU creates a five-step process for achieving the core principle: 1) identifying the contract with the customer, 2) identifying the performance obligations in the contract, 3) determining the transaction price, 4) allocating the transaction price to the performance obligations, and 5) recognizing revenue when an entity has completed the performance obligations. The ASU also requires additional disclosures that allow users of the financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows resulting from contracts with customers. The guidance permits the use of the retrospective or cumulative effect transition methods.

January 1, 2018

The Company completed its analysis of ASU 2014-09 and concluded that it will not have a material impact on the amount or timing of revenue the Company records under its current revenue recognition practices. Additionally, the Company believes that this ASU will not impact the presentation of the Company's financial statements or require significant additional footnote disclosures.

 

There are no other accounting pronouncements previously issued by the FASB but not yet effective or not yet adopted by the Company that have the potential to impact the Company’s condensed consolidated financial statements.

 

There have been no material changes to the accounting policies discussed in Note 2 of the Company’s 2015 Form 10-K other than the changes made pursuant to the adoption of Accounting Standards Update 2016-09, Compensation—Stock Compensation (Topic 718):

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Improvements to Employee Share-Based Payment Accounting, as disclosed in the Company’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2016.

NOTE 3—GAINS FROM MORTGAGE BANKING ACTIVITIES

Gains from mortgage banking activities consisted of the following activity for the three and nine months ended September 30, 2016 and 2015:

 

 

 

 

 

 

 

 

 

 

 

 

 

For the three months ended 

 

For the nine months ended 

 

September 30, 

 

September 30, 

(in thousands)

2016

    

2015

 

2016

    

2015

Contractual loan origination related fees, net

$

52,401

 

$

36,994

 

$

121,682

 

$

115,989

Fair value of expected net cash flows from servicing recognized at commitment

 

50,964

 

 

35,845

 

 

135,971

 

 

104,095

Fair value of expected guaranty obligation recognized at commitment

 

(2,735)

 

 

(2,029)

 

 

(8,247)

 

 

(6,604)

Total gains from mortgage banking activities

$

100,630

 

$

70,810

 

$

249,406

 

$

213,480

The origination fees shown in the table are net of co-broker fees of $13.2 million and $2.3 million for the three months ended September 30, 2016 and 2015, respectively, and $29.8 million and $15.1 million for the nine months ended September 30, 2016 and 2015. Additionally, included in the contractual loan origination related fees, net balance are realized and unrealized losses related to the loans and derivative instruments from the CMBS Program of $1.2 million and $0 for the three months ended September 30, 2016 and 2015, respectively, and $0.6 million and $0 for the nine months ended September 30, 2016 and 2015, respectively.

NOTE 4—MORTGAGE SERVICING RIGHTS

Mortgage Servicing Rights (“MSRs”) represent the carrying value of the servicing rights retained by the Company for mortgage loans originated and sold. The initial capitalized amount is equal to the estimated fair value of the expected net cash flows associated with the servicing rights. MSRs are amortized using the interest method over the period that servicing income is expected to be received.

The fair values of the MSRs at September 30, 2016 and December 31, 2015 were $607.6 million and $510.6 million, respectively. The Company uses a discounted static cash flow valuation approach, and the key economic assumption is the discount rate. For example, see the following sensitivities:

The impact of a 100-basis point increase in the discount rate at September 30, 2016 is a decrease in the fair value of $19.4 million.

The impact of a 200-basis point increase in the discount rate at September 30, 2016 is a decrease in the fair value of $37.5 million.

These sensitivities are hypothetical and should be used with caution. These estimates do not include interplay among assumptions and are estimated as a portfolio rather than individual assets.

Activity related to capitalized MSRs for the three and nine months ended September 30, 2016 and 2015 is shown in the table below:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the three months ended

 

For the nine months ended

 

 

 

September 30, 

 

September 30, 

 

(in thousands)

    

2016

    

2015

    

2016

    

2015

 

Beginning balance

 

$

468,093

 

$

395,020

 

$

412,348

 

$

375,907

 

Additions, following the sale of loan

 

 

60,955

 

 

34,940

 

 

124,982

 

 

102,331

 

Purchases

 

 

 —

 

 

 —

 

 

42,705

 

 

 —

 

Amortization

 

 

(26,074)

 

 

(20,532)

 

 

(72,030)

 

 

(59,102)

 

Pre-payments and write-offs

 

 

(6,296)

 

 

(5,478)

 

 

(11,327)

 

 

(15,186)

 

Ending balance

 

$

496,678

 

$

403,950

 

$

496,678

 

$

403,950

 

 

As shown in the table above, during the first half of 2016, the Company purchased the rights to service a HUD loan portfolio from a third-party servicer. The closing-date purchase price was $44.8 million of cash consideration, with $43.4 million paid at closing and the

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remaining $1.4 million due upon the successful resolution of one defaulted loan, which occurred during the third quarter of 2016. The amount in the ‘Purchases’ line in the table above consists of the closing amount of $44.8 million, net of purchase-price adjustments reducing the closing amount by $2.1 million, for a revised purchase amount of $42.7 million. The servicing portfolio, after consideration of purchase-price adjustments, consisted of approximately $3.6 billion of unpaid principal balance and had a weighted average estimated remaining life of 10.9 years.

 

The following summarizes the components of the net carrying value of the Company’s acquired and originated MSRs as of September 30, 2016:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of September 30, 2016

 

 

  

Gross

  

Accumulated

  

Net

 

(in thousands)

 

  carrying value  

 

  amortization  

 

  carrying value  

 

Acquired MSRs

 

$

175,542

 

$

(99,124)

 

$

76,418

 

Originated MSRs

 

 

601,296

 

 

(181,036)

 

 

420,260

 

Total

 

$

776,838

 

$

(280,160)

 

$

496,678

 

 

The expected amortization of MSRs recorded as of September 30, 2016 is shown in the table below. Actual amortization may vary from these estimates.

 

 

 

 

 

 

 

 

 

 

 

 

  

Originated MSRs

  

Acquired MSRs

  

Total MSRs

 

(in thousands)

 

Amortization

 

Amortization

 

  Amortization  

 

Three Months Ending December 31, 

 

 

 

 

 

 

 

 

 

 

2016

 

$

21,821

 

$

4,012

 

$

25,833

 

Year Ending December 31, 

 

 

 

 

 

 

 

 

 

 

2017

 

 

80,561

 

 

15,092

 

 

95,653

 

2018

 

 

68,707

 

 

12,399

 

 

81,106

 

2019

 

 

60,161

 

 

10,952

 

 

71,113

 

2020

 

 

52,606

 

 

9,057

 

 

61,663

 

2021

 

 

43,947

 

 

7,071

 

 

51,018

 

Thereafter

 

 

92,457

 

 

17,835

 

 

110,292

 

Total

 

$

420,260

 

$

76,418

 

$

496,678

 

 

NOTE 5—GUARANTY OBLIGATION AND ALLOWANCE FOR RISK-SHARING OBLIGATIONS

When a loan is sold under the Fannie Mae DUS program, the Company typically agrees to guarantee a portion of the ultimate loss incurred on the loan should the borrower fail to perform. The compensation for this risk is a component of the servicing fee on the loan. The Company does not provide a guaranty for any other loan product it sells or brokers.

Activity related to the guaranty obligation for the three and nine months ended September 30, 2016 and 2015 is presented in the following table:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the three months ended

 

For the nine months ended

 

 

 

September 30, 

 

September 30, 

 

(in thousands)

    

2016

    

2015

    

2016

    

2015

 

Beginning balance

 

$

28,406

 

$

27,140

 

$

27,570

 

$

24,975

 

Additions, following the sale of loan

 

 

4,039

 

 

1,957

 

 

7,727

 

 

6,827

 

Amortization

 

 

(1,682)

 

 

(1,395)

 

 

(4,431)

 

 

(4,100)

 

Other

 

 

175

 

 

 —

 

 

72

 

 

 —

 

Ending balance

 

$

30,938

 

$

27,702

 

$

30,938

 

$

27,702

 

The Company evaluates the allowance for risk-sharing obligations by monitoring the performance of each loan for triggering events or conditions that may signal a potential default. In situations where payment under the guaranty is probable and estimable on a specific loan, the Company records an allowance for the estimated risk-sharing loss through a charge to the provision for risk-sharing obligations, which is a component of Provision for credit losses in the Condensed Consolidated Statements of Income, along with a write-off of the loan-

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specific MSR and guaranty obligation. The amount of the provision reflects our assessment of the likelihood of payment by the borrower, the estimated disposition value of the underlying collateral, and the level of risk sharing. Historically, the loss recognition occurs at or before the loan becomes 60 days delinquent. Activity related to the allowance for risk-sharing obligations for the three and nine months ended September 30, 2016 and 2015 is shown in the following table:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the three months ended

 

For the nine months ended

 

 

 

September 30, 

 

September 30, 

 

(in thousands)

    

2016

    

2015

    

2016

    

2015

 

Beginning balance

 

$

5,810

 

$

3,304

 

$

5,586

 

$

3,904

 

Provision for risk-sharing obligations

 

 

332

 

 

 —

 

 

453

 

 

208

 

Write-offs

 

 

(2,567)

 

 

 —

 

 

(2,567)

 

 

(808)

 

Other

 

 

(175)

 

 

 —

 

 

(72)

 

 

 —

 

Ending balance

 

$

3,400

 

$

3,304

 

$

3,400

 

$

3,304

 

When the Company places a loan for which it has a risk-sharing obligation on its watch list, the Company ceases to amortize the guaranty obligation and transfers the remaining unamortized balance of the guaranty obligation to the allowance for risk-sharing obligations. When a loan for which the Company has a risk-sharing obligation is removed from the watch list, the loan’s reserve is transferred from the allowance for risk-sharing obligations to the guaranty obligation, and the amortization of the remaining balance over the remaining estimated life is resumed. This net transfer of the unamortized balance of the guaranty obligation from a noncontingent classification to a contingent classification (and vice versa) is presented in the guaranty obligation and allowance for risk-sharing obligations tables above as ‘Other.’

During the third quarter of 2016, the Company and Fannie Mae settled the loss sharing amounts related to the last three remaining previously defaulted at risk loans. As a result of these loss settlements, the Allowance for Risk-sharing Obligations as of September 30, 2016 is based entirely on the Company’s collective assessment of the probability of loss related to the loans on the watch list as of September 30, 2016.

As of September 30, 2016, the maximum quantifiable contingent liability associated with the Company’s guarantees under the Fannie Mae DUS agreement was $4.6 billion. The maximum quantifiable contingent liability is not representative of the actual loss the Company would incur. The Company would be liable for this amount only if all of the loans it services for Fannie Mae, for which the Company retains some risk of loss, were to default and all of the collateral underlying these loans was determined to be without value at the time of settlement.

NOTE 6—SERVICING

The total unpaid principal balance of the Company’s servicing portfolio was $59.1 billion as of September 30, 2016 compared to $50.2 billion as of December 31, 2015. The September 30, 2016 balance includes the addition of $3.6 billion related to purchase activity as more fully discussed in Note 4.

NOTE 7—WAREHOUSE NOTES PAYABLE

At September 30, 2016, to provide financing to borrowers under the GSE and HUD programs and the Company’s CMBS and Interim Programs, the Company has arranged for warehouse lines of credit. In support of the GSE and HUD programs, the Company has warehouse lines of credit in the amount of $2.0 billion with certain national banks and a $1.0 billion uncommitted facility with Fannie Mae (collectively, the “Agency Warehouse Facilities”). In support of the CMBS Program, the Company has warehouse lines of credit in the amount of $0.2 billion with certain national banks (the “CMBS Warehouse Facilities”). The Company has pledged substantially all of its loans held for sale against the Agency Warehouse Facilities and the CMBS Warehouse Facilities. The Company has arranged for warehouse lines of credit in the amount of $0.4 billion with certain national banks to assist in funding loans held for investment under the Interim Program (“Interim Warehouse Facilities”). The Company has pledged substantially all of its loans held for investment against these Interim Warehouse Facilities. The maximum amount and outstanding borrowings under the warehouse notes payable at September 30, 2016 are shown in the table below:

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September 30, 2016

 

 

 

 

 

(dollars in thousands)

    

Maximum

    

Outstanding

    

Loan Type

    

    

 

Facility

 

Amount

 

Balance

 

Funded (1)

 

Interest rate

 

Agency warehouse facility #1

 

$

425,000

 

$

202,070

 

LHFS

 

30-day LIBOR plus 1.40%

 

Agency warehouse facility #2

 

 

650,000

 

 

452,182

 

LHFS

 

30-day LIBOR plus 1.40%

 

Agency warehouse facility #3

 

 

680,000

 

 

270,493

 

LHFS

 

30-day LIBOR plus 1.35%

 

Agency warehouse facility #4

 

 

250,000

 

 

115,628

 

LHFS

 

30-day LIBOR plus 1.40%

 

Agency warehouse facility #5

 

 

30,000

 

 

14,551

 

LHFS

 

30-day LIBOR plus 1.80%

 

Fannie Mae repurchase agreement, uncommitted line and open maturity

 

 

1,000,000

 

 

192,395

 

LHFS

 

30-day LIBOR plus 1.15%

 

Total agency warehouse facilities

 

$

3,035,000

 

$

1,247,319

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

CMBS warehouse facility #1

 

$

100,000

 

$

9,750

 

LHFS

 

30-day LIBOR plus 2.25%

 

CMBS warehouse facility #2

 

 

100,000

 

 

2,094

 

LHFS

 

30-day LIBOR plus 2.75%

 

Total CMBS warehouse facilities

 

$

200,000

 

$

11,844

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interim warehouse facility #1

 

$

85,000

 

$

36,916

 

LHFI

 

30-day LIBOR plus 1.90%

 

Interim warehouse facility #2

 

 

200,000

 

 

109,686

 

LHFI

 

30-day LIBOR plus 2.00%

 

Interim warehouse facility #3

 

 

75,000

 

 

36,005

 

LHFI

 

30-day LIBOR plus 2.00% to 2.50%

 

Total interim warehouse facilities

 

$

360,000

 

$

182,607

 

 

 

 

 

Debt issuance costs

 

 

 —

 

 

(1,345)

 

 

 

 

 

Total warehouse facilities

 

$

3,595,000

 

$

1,440,425

 

 

 

 

 


(1)

Type of loan the borrowing facility is used to fully or partially fund – loans held for sale (“LHFS”) or loans held for investment (“LHFI”).

 

 

During the fourth quarter of 2016, the Company executed the 12th amendment to the credit and security agreement related to Agency Warehouse Facility #1 that extended the maturity date to October 30, 2017. No other material modifications have been made to the agreement during 2016.

 

During the second quarter of 2016, the Company executed the eighth amendment to the amended and restated credit and security agreement related to Agency Warehouse Facility #2 that extended the maturity date to June 21, 2017. No other material modifications have been made to the agreement during 2016.

 

During the second quarter of 2016, the Company executed the fourth amendment to the credit and security agreement related to Agency Warehouse Facility #3. The amendment increased the committed amount to $280.0 million, reduced the interest rate to the 30-day London Interbank Offered Rate (“LIBOR”) plus 135 basis points, and extended the maturity date to April 30, 2017. Additionally, during the second and third quarters of 2016, the Company executed the fifth and sixth amendments to the credit and security agreement that provide temporary increases totaling $400.0 million to the maximum borrowing capacity that expire in January 2017. No other material modifications have been made to the agreement during 2016.

 

During the fourth quarter of 2016, the Company executed the second amendment to the warehouse loan and security agreement related to Agency Warehouse Facility #4 that provides a $100.0 million permanent increase to the maximum borrowing capacity and extends the maturity date of the facility to October 27, 2017. No other material modifications have been made to the agreement during 2016.

 

During the third quarter of 2016, the Company executed a warehousing credit and security agreement to establish Agency Warehouse Facility #5. The committed warehouse facility provides the Company with the ability to fund defaulted HUD and FHA loans. The warehouse agreement provides for a maximum borrowing amount of $30.0 million and is scheduled to mature in January 2018. The borrowings under the warehouse agreement bear interest at a rate of 30-day LIBOR plus 180 basis points.

 

During the third quarter of 2016, Fannie Mae increased the maximum borrowing capacity of the Fannie Mae uncommitted facility to $1.0 billion. No other material modifications have been made to the Fannie Mae facility during 2016.

 

During the second quarter of 2016, the Company executed a repurchase agreement to establish CMBS Warehouse Facility #2. The new warehouse facility has a maximum borrowing capacity of $100.0 million and matures in one year. The agreement provides the Company

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with the ability to fund first mortgage loans on various real estate property types for a short-term period, using available cash in combination with advances under the facility. All borrowings bear interest at 30-day LIBOR plus 275 basis points. The lender retains a first priority security interest in all mortgages funded by such advances on a cross-collateralized basis. Repayments under the credit agreement mirror the underlying mortgage loan, with each advance repaid upon sale of the underlying mortgage loan.

 

During the fourth quarter of 2016, the repurchase agreement related to CMBS Warehouse Facility #1 expired according to its terms, and the Company determined not to renew the facility.

 

During the second quarter of 2016, the Company executed the sixth amendment to the credit and security agreement related to Interim Warehouse Facility #1 that extended the maturity date to April 30, 2017. No other material modifications have been made to the agreement during 2016.

 

During the second quarter of 2016, the Company exercised its option to extend the maturity date of Interim Warehouse Facility #3 to May 19, 2017. Additionally, the Company executed the second amendment to the repurchase agreement related to Interim Warehouse Facility #3. The amendment provides the Company with an additional unilateral option to extend the maturity date one year. As a result of the amendment, the Company now has three remaining one-year options that, if exercised, extend the maturity date through May 19, 2020. No other material modifications have been made to the agreement during 2016.

 

 

The warehouse notes payable and the note payable are subject to various financial covenants, all of which the Company was in compliance with as of the current period end.

NOTE 8—FAIR VALUE MEASUREMENTS

The Company uses valuation techniques that are consistent with the market approach, the income approach, and/or the cost approach to measure assets and liabilities that are measured at fair value. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those 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. In that regard, accounting standards establish a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

·

Level 1—Financial assets and liabilities whose values are based on unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access.

·

Level 2—Financial assets and liabilities whose values are based on inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might 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 (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.

·

Level 3—Financial assets and liabilities whose values are based on inputs that are both unobservable and significant to the overall valuation.

The Company's MSRs are measured at fair value on a nonrecurring basis. That is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). The Company's MSRs do not trade in an active, open market with readily observable prices. While sales of multifamily MSRs do occur, precise terms and conditions vary with each transaction and are not readily available. Accordingly, the estimated fair value of the Company’s MSRs was developed using discounted cash flow models that calculate the present value of estimated future net servicing income. The model considers contractually specified servicing fees, prepayment assumptions, delinquency rates, late charges, other ancillary revenue, costs to service, and other economic factors. The Company periodically reassesses and adjusts, when necessary, the underlying inputs and assumptions used in the model to reflect observable market conditions and assumptions that a market participant would consider in valuing an MSR asset. MSRs are carried at the lower of amortized cost or fair value.

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A description of the valuation methodologies used for assets and liabilities measured at fair value on a recurring basis, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below. These valuation methodologies were applied to all of the Company's assets and liabilities carried at fair value on a recurring basis:

·

Derivative Instruments—The derivative instruments used by the Company consist of interest rate lock commitments (“IRLC”), forward sale agreements (“forwards”), interest rate swaps “(IRS”), and, on occasion, synthetic credit default swap index contracts (“CMBX”). The IRLCs and forwards are valued using a discounted cash flow model developed based on changes in the U.S. Treasury rate and other observable market data. The value was determined after considering the potential impact of collateralization, adjusted to reflect nonperformance risk of both the counterparty and the Company, and are classified within Level 3 of the valuation hierarchy. CMBX are traded on an active market with prices determined based on observable inputs such as credit curves, recovery rates, and current credit spreads obtained from market participants. IRS trade in the over-the-counter market where quoted prices are not available. Therefore, the Company uses internal valuation techniques with observable inputs from a liquid market, the most significant of which is the related yield curve, to estimate the fair value of interest rate swaps. There were no CMBX outstanding as of September 30, 2016 as the positions were closed just prior to the end of the first quarter of 2016. During the rest of the first quarter of 2016, the Company had CMBX with a $25.0 million notional amount outstanding. The Company classifies IRS and CMBX as Level 2.

·

Loans Held for Sale—The loans held for sale are reported at fair value as the Company has elected the fair value option for all loans held for sale. The Company determines the fair value of the loans held for sale intended to be sold to the GSEs and HUD using discounted cash flow models that incorporate quoted observable prices from market participants. The Company determines the fair value of the loans held for sale intended to be sold under a CMBS execution using a hypothetical securitization model utilizing market data from recent securitization spreads and pricing of loans with similar characteristics. As necessary, these fair values are adjusted for typical securitization activities, including portfolio composition, market conditions, and liquidity. The Company classifies all loans held for sale as Level 2.

·

Pledged Securities—The pledged securities are valued using quoted market prices from recent trades. Therefore, the Company classifies pledged securities as Level 1.

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The following table summarizes financial assets and financial liabilities measured at fair value on a recurring basis as of September 30, 2016, and December 31, 2015, segregated by the level of the valuation inputs within the fair value hierarchy used to measure fair value:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Quoted Prices in

    

Significant

    

Significant

    

    

 

 

 

 

Active Markets

 

Other

 

Other

 

 

 

 

 

 

For Identical

 

Observable

 

Unobservable

 

 

 

 

 

 

Assets

 

Inputs

 

Inputs

 

Balance as of

 

(in thousands)

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Period End

 

September 30, 2016