NOTE 8: FAIR VALUE OF FINANCIAL INSTRUMENTS

Fair Value of Financial Instruments

FASB ASC Topic 825, “Financial Instruments” requires disclosure of the fair value of financial instruments for which it is practicable to estimate that value. The fair value of investments in mortgages and loans, investments in securities, CDO notes payable, convertible senior notes, junior subordinated notes and derivative assets and liabilities is based on significant observable and unobservable inputs. The fair value of cash and cash equivalents, restricted cash, secured credit facilities, CMBS facilities and commercial mortgage facilities approximates cost due to the nature of these instruments.

The following table summarizes the carrying amount and the fair value of our financial instruments as of June 30, 2014:


Financial Instrument	Carrying Amount		Estimated Fair Value
Assets
Commercial mortgages, mezzanine loans, other loans and preferred equity interests, net	$	1,308,341	$	1,250,653
Investments in securities and security-related receivables		574,178		574,178
Cash and cash equivalents		75,079		75,079
Restricted cash		102,189		102,189
Derivative assets		754		754
Liabilities
Recourse indebtedness:
7.0% convertible senior notes		33,178		45,819
4.0% convertible senior notes		133,086		137,918
7.625% senior notes		60,000		59,472
Secured credit facilities		12,150		12,150
Junior subordinated notes, at fair value		12,740		12,740
Junior subordinated notes, at amortized cost		25,100		14,468
CMBS facilities		31,194		31,194
Commercial mortgage facility		45,697		45,697
Non-recourse indebtedness:
CDO notes payable, at amortized cost		1,101,867		935,577
CDO notes payable, at fair value		413,187		413,187
CMBS securitizations		235,232		235,004
Loans payable on real estate		313,739		317,005
Derivative liabilities		95,974		95,974
Warrants and investor SARs		41,786		41,786

The following table summarizes the carrying amount and the fair value of our financial instruments as of December 31, 2013:


Financial Instrument	Carrying Amount		Estimated Fair Value
Assets
Commercial mortgages, mezzanine loans, other loans and preferred equity interests	$	1,122,377	$	1,083,118
Investments in securities and security-related receivables		567,302		567,302
Cash and cash equivalents		88,847		88,847
Restricted cash		121,589		121,589
Derivative assets		1,305		1,305
Liabilities
Recourse indebtedness:
7.0% convertible senior notes		32,938		47,778
4.0% convertible senior notes		116,184		124,063
Secured credit facilities		11,129		11,129
Junior subordinated notes, at fair value		11,911		11,911
Junior subordinated notes, at amortized cost		25,100		14,007
CMBS facilities		30,618		30,618
Commercial mortgage facility		7,131		7,131
Non-recourse indebtedness:
CDO notes payable, at amortized cost		1,202,772		724,885
CDO notes payable, at fair value		377,235		377,235
CMBS securitization		100,139		100,214
Loans payable on real estate		171,244		176,979
Derivative liabilities		113,331		113,331
Warrants and investor SARs		31,304		31,304

Fair Value Measurements

The following tables summarize information about our assets and liabilities measured at fair value on a recurring basis as of June 30, 2014, and indicate the fair value hierarchy of the valuation techniques utilized to determine such fair value:


Assets:	Quoted Prices in Active Markets for Identical Assets (Level 1) (a)		Significant Other Observable Inputs (Level 2) (a)		Significant Unobservable Inputs (Level 3) (a)		Balance as of June 30, 2014
Trading securities
TruPS	$	0	$	0	$	488,558	$	488,558
Other securities		0		0		0		0
Available-for-sale securities		0		630		0		630
Security-related receivables
TruPS receivables		0		0		7,741		7,741
Unsecured REIT note receivables		0		32,932		0		32,932
CMBS receivables		0		43,256		0		43,256
Other securities		0		1,061		0		1,061
Derivative assets		0		754		0		754

Total assets	$	0	$	78,633	$	496,299	$	574,932


Liabilities:	Quoted Prices in Active Markets for Identical Assets (Level 1) (a)		Significant Other Observable Inputs (Level 2) (a)		Significant Unobservable Inputs (Level 3) (a)		Balance as of June 30, 2014
Junior subordinated notes, at fair value	$	0	$	0	$	12,740	$	12,740
CDO notes payable, at fair value		0		0		413,187		413,187
Derivative liabilities		0		34,611		61,363		95,974
Warrants and investor SARs		0		0		41,786		41,786

Total liabilities	$	0	$	34,611	$	529,076	$	563,687

(a)	During the six-month period ended June 30, 2014, there were no transfers between Level 1 and Level 2, as well as, there were no transfers into and out of Level 3.

The following tables summarize information about our assets and liabilities measured at fair value on a recurring basis as of December 31, 2013, and indicate the fair value hierarchy of the valuation techniques utilized to determine such fair value:


Assets:	Quoted Prices in Active Markets for Identical Assets (Level 1) (a)		Significant Other Observable Inputs (Level 2) (a)		Significant Unobservable Inputs (Level 3) (a)		Balance as of December 31, 2013
Trading securities
TruPS	$	0	$	0	$	480,845	$	480,845
Other securities		0		0		0		0
Available-for-sale securities		0		2		0		2
Security-related receivables
TruPS receivables		0		0		8,211		8,211
Unsecured REIT note receivables		0		33,046		0		33,046
CMBS receivables		0		44,118		0		44,118
Other securities		0		1,080		0		1,080
Derivative assets		0		1,305		0		1,305

Total assets	$	0	$	79,551	$	489,056	$	568,607


Liabilities:	Quoted Prices in Active Markets for Identical Assets (Level 1) (a)		Significant Other Observable Inputs (Level 2) (a)		Significant Unobservable Inputs (Level 3) (a)		Balance as of December 31, 2013
Junior subordinated notes, at fair value	$	0	$	0	$	11,911	$	11,911
CDO notes payable, at fair value		0		0		377,235		377,235
Derivative liabilities		0		45,926		67,405		113,331
Warrants and investor SARs		0		0		31,304		31,304

Total liabilities	$	0	$	45,926	$	487,855	$	533,781

(a)	During the year ended December 31, 2013, there were no transfers between Level 1 and Level 2, as well as, there were no transfers into and out of Level 3.

When estimating the fair value of our Level 3 financial instruments, management uses various observable and unobservable inputs. These inputs include yields, credit spreads, duration, effective dollar prices and overall market conditions on not only the exact financial instrument for which management is estimating the fair value but also financial instruments that are similar or issued by the same issuer when such inputs are unavailable. Generally, an increase in the yields, credit spreads or estimated duration will decrease the fair value of our financial instruments. Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value, as determined by management, may fluctuate from period to period and any ultimate liquidation or sale of the investment may result in proceeds that may be significantly different than fair value. The weighted average effective dollar price of our TruPS and TruPS receivables as of June 30, 2014 and December 31, 2013 was 76 and 75, respectively.

The following tables summarize additional information about assets and liabilities that are measured at fair value on a recurring basis for which we have utilized level 3 inputs to determine fair value for the six-month period ended June 30, 2014:


Assets	Trading Securities—TruPS and Subordinated Debentures		Security-Related Receivables—TruPS and Subordinated Debenture Receivables			Total Level 3 Assets
Balance, as of December 31, 2013	$	480,845	$	8,211		$	489,056
Change in fair value of financial instruments		7,713		(470	)		7,243
Purchases		0		0			0
Principal Repayments		0		0			0

Balance, as of June 30, 2014	$	488,558	$	7,741		$	496,299


Liabilities	Derivative Liabilities			Warrants and investor SARs			CDO Notes Payable, at Fair Value			Junior Subordinated Notes, at Fair Value		Total Level 3 Liabilities
Balance, as of December 31, 2013	$	67,405		$	31,304		$	377,235		$	11,911	$	487,855
Change in fair value of financial instruments		(6,042	)		(3,259	)		48,506			829		40,034
Purchases		0			13,741			0			0		13,741
Sales		0			0			0			0		0
Principal repayments		0			0			(12,554	)		0		(12,554	)

Balance, as of June 30, 2014	$	61,363		$	41,786		$	413,187		$	12,740	$	529,076

Our non-recurring fair value measurements relate primarily to our commercial real estate loans that are considered impaired and for which we maintain an allowance for loss. In determining the allowance for losses, we estimate the fair value of the respective commercial real estate loan and compare that fair value to our total investment in the loan. When estimating the fair value of the commercial real estate loan, management uses discounted cash flow analyses and capitalization rates on the underlying property’s net operating income. The discounted cash flow analyses and capitalization rates are based on market information and comparable sales of similar properties.

The following tables summarize the valuation technique and the level of the fair value hierarchy for financial instruments that are not fair valued in the accompanying consolidated balance sheets but for which fair value is required to be disclosed. The fair value of cash and cash equivalents, restricted cash, secured credit facilities, CMBS facilities and commercial mortgage facilities approximates cost due to the nature of these instruments and are not included in the tables below.


						Fair Value Measurement
	Carrying Amount as of June 30, 2014		Estimated Fair Value as of June 30, 2014		Valuation Technique	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Commercial mortgages, mezzanine loans and other loans, net	$	1,308,341	$	1,250,653	Discounted cash flows	$	0	$	0	$	1,250,653
7.0% convertible senior notes		33,178		45,819	Trading price		45,819		0		0
4.0% convertible senior notes		133,086		137,918	Trading price		137,918		0		0
7.625% senior notes		60,000		59,472	Trading price		59,472		0		0
Junior subordinated notes, at amortized cost		25,100		14,468	Discounted cash flows		0		0		14,468
CDO notes payable, at amortized cost		1,101,867		935,577	Discounted cash flows		0		0		935,577
CMBS securitizations		235,232		235,004	Discounted cash flows		0		0		235,004
Loans payable on real estate		313,739		317,005	Discounted cash flows		0		0		317,005


						Fair Value Measurement
	Carrying Amount as of December 31, 2013		Estimated Fair Value as of December 31, 2013		Valuation Technique	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Commercial mortgages, mezzanine loans and other loans	$	1,122,377	$	1,083,118	Discounted cash flows	$	0	$	0	$	1,083,118
7.0% convertible senior notes		32,938		47,778	Trading price		47,778		0		0
4.0% convertible senior notes		116,184		124,063	Trading price		124,063		0		0
Junior subordinated notes, at amortized cost		25,100		14,007	Discounted cash flows		0		0		14,007
CDO notes payable, at amortized cost		1,202,772		724,885	Discounted cash flows		0		0		724,885
CMBS securitization		100,139		100,214	Discounted cash flows		0		0		100,214
Loans payable on real estate		171,244		176,979	Discounted cash flows		0		0		176,979

Change in Fair Value of Financial Instruments

The following table summarizes realized and unrealized gains and losses on assets and liabilities for which we elected the fair value option of FASB ASC Topic 825, “Financial Instruments” and derivatives as reported in change in fair value of financial instruments in the accompanying consolidated statements of operations:


	For the Three-Month Periods Ended June 30						For the Six-Month Periods Ended June 30
Description	2014			2013			2014			2013
Change in fair value of trading securities and security-related receivables	$	2,132		$	3,053		$	8,574		$	18,166
Change in fair value of CDO notes payable, trust preferred obligations and other liabilities		(19,719	)		(80,393	)		(46,073	)		(190,267	)
Change in fair value of derivatives		(7,484	)		1,320			(11,711	)		(3,676	)

Change in fair value of financial instruments	$	(25,071	)	$	(76,020	)	$	(49,210	)	$	(175,777	)

The changes in the fair value for the trading securities and security-related receivables, CDO notes payable, and other liabilities for which the fair value option was elected for the three-month and six-month periods ended June 30, 2014 and 2013 was primarily attributable to changes in instrument specific credit risks. The changes in the fair value of the CDO notes payable for which the fair value option was elected was due to repayments at par because of OC failures when the CDO notes have a fair value of less than par. The changes in the fair value of derivatives for which the fair value option was elected for the three-month and six-month periods ended June 30, 2014 and 2013 was mainly due to changes in interest rates.