NOTE 7: 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, warrants and investor share appreciation rights, or SARs 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, commercial mortgage facilities and other indebtedness 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 March 31, 2016:

Financial Instrument	Carrying Amount		Estimated Fair Value
Assets
Commercial mortgages, mezzanine loans, and preferred equity interests	$	1,594,467	$	1,538,346
Cash and cash equivalents		94,569		94,569
Restricted cash		200,166		200,166
Derivative assets		6		6

Liabilities
Recourse indebtedness:
7.0% convertible senior notes		29,004		25,541
4.0% convertible senior notes		133,763		113,754
7.625% senior notes		58,014		47,712
7.125% senior notes		69,896		65,807
Senior secured notes		61,847		66,521
Junior subordinated notes, at fair value		9,785		9,785
Junior subordinated notes, at amortized cost		24,887		10,236
CMBS facilities		122,270		122,801
Non-recourse indebtedness:
Secured credit facilities		320,855		324,977
Term loans		89,277		90,216
CDO notes payable, at amortized cost		905,230		741,480
CMBS securitizations		660,139		657,753
Loans payable on real estate		757,668		787,681
Other indebtedness		24,595		24,321
Derivative liabilities		4,181		4,181
Warrants and investor SARs		29,100		29,100

The following table summarizes the carrying amount and the fair value of our financial instruments as of December 31, 2015:

Financial Instrument	Carrying Amount		Estimated Fair Value
Assets
Commercial mortgages, mezzanine loans, and preferred equity interests, net	$	1,606,486	$	1,537,086
Cash and cash equivalents		125,886		125,886
Restricted cash		213,012		213,012
Derivative assets		206		206
Liabilities
Recourse indebtedness:
7.0% convertible senior notes		28,868		27,795
4.0% convertible senior notes		133,039		104,184
7.625% senior notes		57,952		46,560
7.125% senior notes		69,749		62,471
Senior secured notes		63,045		66,725
Junior subordinated notes, at fair value		10,504		10,504
Junior subordinated notes, at amortized cost		24,884		11,221
CMBS facilities		96,723		97,067
Non-recourse indebtedness:
Secured credit facilities		267,155		271,500
Term loans		118,418		120,000
CDO notes payable, at amortized cost		937,569		801,289
CMBS securitizations		708,510		709,001
Loans payable on real estate		811,666		834,816
Derivative liabilities		4,727		4,727
Warrants and investor SARs		26,200		26,200

Fair Value Measurements

The following tables summarize information about our assets and liabilities measured at fair value on a recurring basis as of March 31, 2016, 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 March 31, 2016

Derivative assets

—

Total assets

—

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 March 31, 2016
Junior subordinated notes, at fair value	$	—	$	—	$	9,785	$	9,785
Derivative liabilities		—		4,181		—		4,181
Warrants and investor SARs		—		—		29,100		29,100
Total liabilities	$	—	$	4,181	$	38,885	$	43,066

(a)	During the three months ended March 31, 2016, there were no transfers between Level 1 and Level 2, and there were no transfers into and/or 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, 2015, 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, 2015

Derivative assets

—

206

—

206

Total assets

—

206

—

206

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, 2015
Junior subordinated notes, at fair value	$	—	$	—	$	10,504	$	10,504
Derivative liabilities		—		4,727		—		4,727
Warrants and investor SARs		—		—		26,200		26,200
Total liabilities	$	—	$	4,727	$	36,704	$	41,431

(a)	During the year ended December 31, 2015, there were no transfers between Level 1 and Level 2, and there were no transfers into and/or 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.

For the fair value of our junior subordinated notes, at fair value, and warrant and investor SARs classified as Level 3 liabilities, we estimate the fair value of these financial instruments using significant unobservable inputs. For the junior subordinated notes, at fair value, we use a discounted cash flow model as the valuation technique and the significant unobservable inputs as of December 31, 2015 include discount rates ranging from 12.9% to 13.3% and as of March 31, 2016 include discount rates ranging from 13.0% to 13.4%. For the warrants and investor SARs, we utilized a third party valuation firm who used a binomial model as the valuation technique and the significant unobservable inputs as of March 31, 2016 and December 31, 2015 include 61.0% and 61.0%, respectively, for the annual volatility of our common shares of beneficial interest over the term of the warrants and investor SARs, 11.5% and 12.0%, respectively, for the credit adjusted discount rate on our unsecured debt issued that may be issued in satisfaction of the warrants and investor SARs, and 10.0% and 10.6%, respectively, for the dividend rate and future dividend rate on our common shares of beneficial interest.

The following table summarizes 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 three months ended March 31, 2016:

Liabilities	Warrants and investor SARS		Junior Subordinated Notes, at Fair Value			Total Level 3 Liabilities
Balance, as of December 31, 2015	$	26,200	$	10,504		$	36,704
Change in fair value of financial instruments		2,900		(719	)		2,181
Purchases		—		—			—
Principal Repayments		—		—			—
Balance, as of March 31, 2016	$	29,100	$	9,785		$	38,885

Non-Recurring Fair Value Measurements

As of March 31, 2016, we measured a real estate asset at a fair value of $6,386 in our consolidated balance sheets as it was impaired. The fair value was based on an executed letter of intent to sell the real estate asset and was classified within Level 2 of the fair value hierarchy. The significant input was the purchase price derived by the potential buyer.

Our other 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. These methodologies are classified in Level 3 of the fair value hierarchy.

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, commercial mortgage facilities and other indebtedness approximates cost due to the nature of these instruments and are not included in the tables below.

						Fair Value Measurement
	Carrying Amount as of March 31, 2016		Estimated Fair Value as of March 31, 2016		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, other loans and preferred equity interests	$	1,594,467	$	1,538,346	Discounted cash flows	$	—	$	—	$	1,551,077
7.0% convertible senior notes		29,004		25,541	Trading price		25,506		—		—
4.0% convertible senior notes		133,763		113,754	Trading price		113,754		—
7.625% senior notes		58,014		47,712	Trading price		47,712		—		—
7.125% senior notes		69,896		65,807	Trading price		65,807		—
Senior secured notes		61,847		66,521	Discounted cash flows		—		—		66,521
Junior subordinated notes, at amortized cost		24,887		10,236	Discounted cash flows		—		—		10,236
CDO notes payable, at amortized cost		905,230		741,480	Discounted cash flows		—		—		741,480
CMBS securitizations		660,139		657,753	Discounted cash flows		—		—		657,753
Loans payable on real estate		757,668		787,681	Discounted cash flows		—		—		787,681

						Fair Value Measurement
	Carrying Amount as of December 31, 2015		Estimated Fair Value as of December 31, 2015		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, other loans and preferred equity interests	$	1,606,486	$	1,537,086	Discounted cash flows	$	—	$	—	$	1,537,086
7.0% convertible senior notes		28,868		27,795	Trading price		27,795		—		—
4.0% convertible senior notes		133,039		104,184	Trading price		104,184		—		—
7.625% senior notes		57,952		46,560	'Trading price		46,560		—		—
7.125% senior notes		69,749		62,471	Trading price		62,471		—		—
Senior secured notes		63,045		66,725	Discounted cash flows		—		—		66,725
Junior subordinated notes, at amortized cost		24,884		11,221	Discounted cash flows		—		—		11,221
CDO notes payable, at amortized cost		937,569		801,289	Discounted cash flows		—		—		801,289
CMBS securitization		708,510		709,001	Discounted cash flows		—		—		709,001
Loans payable on real estate		811,666		834,816	Discounted cash flows		—		—		834,816

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 Months Ended March 31,
Description	2016			2015
Change in fair value of trading securities and security-related receivables	$	—		$	(171	)
Change in fair value of junior subordinated notes		719			(81	)
Change in fair value of derivatives		(1,907	)		(2,047	)
Change in fair value of warrants and investors SARs		(2,900	)		6,789
Change in fair value of financial instruments	$	(4,088	)	$	4,490

The changes in the fair value for the trading securities and security-related receivables, and junior subordinated notes for which the fair value option was elected for the three months ended March 31, 2016 and 2015 was primarily attributable to changes in instrument specific credit risks. The changes in the fair value of derivatives for which the fair value option was elected for the three months ended March 31, 2016 and 2015 were mainly due to changes in interest rates. The changes in fair value of the warrants and investor SARs for the three months ended March 31, 2016 and 2015 were due to changes in the reference stock price and volatility.