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 June 30, 2016:

Financial Instrument	Carrying Amount		Estimated Fair Value
Assets
Total investment in mortgages and loans, net	$	1,477,106	$	1,437,291
Cash and cash equivalents		66,885		66,885
Restricted cash		159,429		159,429
Derivative assets		53		53

Liabilities
Recourse indebtedness:
7.0% convertible senior notes		843		935
4.0% convertible senior notes		119,474		116,452
7.625% senior notes		55,450		50,435
7.125% senior notes		68,899		69,486
Senior secured notes		60,645		66,851
Junior subordinated notes, at fair value		10,789		10,789
Junior subordinated notes, at amortized cost		24,890		11,318
CMBS facilities		138,618		138,977
Non-recourse indebtedness:
Secured credit facilities		243,604		247,335
Term loans		39,559		40,000
CDO notes payable, at amortized cost		765,299		633,692
CMBS securitizations		586,977		585,918
Loans payable on real estate		865,691		910,275
Other indebtedness		24,521		24,796
Derivative liabilities		3,972		3,972
Warrants and investor SARs		29,300		29,300

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
Total investment in mortgages and loans, 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 June 30, 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 June 30, 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 June 30, 2016
Junior subordinated notes, at fair value	$	—	$	—	$	10,789	$	10,789
Derivative liabilities		—		3,972		—		3,972
Warrants and investor SARs		—		—		29,300		29,300
Total liabilities	$	—	$	3,972	$	40,089	$	44,061

(a)	During the six months ended June 30, 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 June 30, 2016 include discount rates ranging from 11.3% to 11.7%. 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 June 30, 2016 and December 31, 2015 include 55.0% and 61.0%, respectively, for the annual volatility of our common shares of beneficial interest over the term of the warrants and investor SARs, 10.0% 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 10.1% 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 six months ended June 30, 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		3,100		285		3,385
Purchases		—		—		—
Principal Repayments		—		—		—
Balance, as of June 30, 2016	$	29,300	$	10,789	$	40,089

Liabilities	Warrants and investor SARS		Junior Subordinated Notes, at Fair Value		Total Level 3 Liabilities
Balance, as of March 31, 2016	$	29,100	$	9,785	$	38,885
Change in fair value of financial instruments		200		1,004		1,204
Purchases		—		—		—
Principal Repayments		—		—		—
Balance, as of June 30, 2016	$	29,300	$	10,789	$	40,089

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.

As of June 30, 2016, we measured a real estate asset at a fair value of $43,313 in our consolidated balance sheets as it was impaired. The fair value was based on an executed purchase and sale agreement and was classified within Level 2 of the fair value hierarchy. The significant input was the purchase price included in the purchase and sale agreement.

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.

Carrying Amount

as of June 30, 2016

Estimated Fair

Value as of June 30, 2016

Valuation

Technique

Level in Fair Value Hierarchy

Total investment in mortgages and loans, net

1,477,106

1,437,291

Discounted cash flows

Three

7.0% convertible senior notes

843

935

Trading price

One

4.0% convertible senior notes

119,474

116,452

Trading price

One

7.625% senior notes

55,450

50,435

Trading price

One

7.125% senior notes

68,899

69,486

Trading price

One

Senior secured notes

60,645

66,851

Discounted cash flows

Three

Junior subordinated notes, at amortized cost

24,890

11,318

Discounted cash flows

Three

CDO notes payable, at amortized cost

765,299

633,692

Discounted cash flows

Three

CMBS securitizations

586,977

585,918

Discounted cash flows

Three

Loans payable on real estate

865,691

910,275

Discounted cash flows

Three

Carrying Amount

as of December 31, 2015

Estimated Fair

Value as of December 31, 2015

Valuation

Technique

Level in Fair Value Hierarchy

Total investment in mortgages and loans, net

1,606,486

1,537,086

Discounted cash flows

Three

7.0% convertible senior notes

28,868

27,795

Trading price

One

4.0% convertible senior notes

133,039

104,184

Trading price

One

7.625% senior notes

57,952

46,560

Trading price

One

7.125% senior notes

69,749

62,471

Trading price

One

Senior secured notes

63,045

66,725

Discounted cash flows

Three

Junior subordinated notes, at amortized cost

24,884

11,221

Discounted cash flows

Three

CDO notes payable, at amortized cost

937,569

801,289

Discounted cash flows

Three

CMBS securitization

708,510

709,001

Discounted cash flows

Three

Loans payable on real estate

811,666

834,816

Discounted cash flows

Three

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 June 30,					For the Six Months Ended June 30,
Description	2016			2015		2016			2015
Change in fair value of trading securities and security-related receivables	$	—		$	—	$	—		$	(173	)
Change in fair value of junior subordinated notes		(1,004	)		316		(285	)		236
Change in fair value of derivatives		(388	)		1,627		(2,295	)		(420	)
Change in fair value of warrants and investors SARs		(200	)		6,413		(3,100	)		13,203
Change in fair value of financial instruments	$	(1,592	)	$	8,356	$	(5,680	)	$	12,846

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 and six months ended June 30, 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 and six months ended June 30, 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 and six months ended June 30, 2016 and 2015 were due to changes in the reference stock price and volatility.