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, loans, preferred equity interests, CDO notes payable, convertible senior notes, junior subordinated notes, warrants and investor share appreciations 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, CMBS facilities, and other indebtedness approximates their carrying amount or unpaid principal balance due to the nature of these instruments.

The following table summarizes the carrying amount and the fair value of our financial instruments as of December 31, 2016:

Financial Instrument	Carrying Amount		Estimated Fair Value
Assets
Total investment in mortgages and loans, net	$	1,280,285	$	1,256,342
Cash and cash equivalents		110,531		110,531
Restricted cash		190,179		190,179
Derivative assets		206		206
Liabilities
Recourse indebtedness:
7.0% convertible senior notes		831		890
4.0% convertible senior notes		120,271		116,861
7.625% senior notes		55,568		53,231
7.125% senior notes		69,188		69,118
Senior secured notes		58,233		62,620
Junior subordinated notes, at fair value		11,822		11,822
Junior subordinated notes, at amortized cost		25,100		13,099
CMBS facilities		24,908		26,421
Non-recourse indebtedness:
CDO notes payable, at amortized cost		534,501		477,032
CMBS securitizations		641,077		646,642
Loans payable on real estate		185,668		188,525
Other indebtedness		23,915		24,321
Derivative liabilities		-		-
Warrants and investor SARs		30,400		30,400

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		87,581		87,581
Restricted cash		207,599		207,599
Derivative assets		182		182
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:
CDO notes payable, at amortized cost		937,569		801,289
CMBS securitizations		708,510		709,001
Loans payable on real estate		268,632		281,840
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 December 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 of

December 31,

2016

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 of December 31, 2016
Junior subordinated notes, at fair value	$	—	$	—	$	11,822	$	11,822
Warrants and investor SARs		—		—		30,400		30,400
Total liabilities	$	—	$	—	$	42,222	$	42,222

(a)	During the year ended December 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 of

December 31,

2015

Derivative assets

182

Total assets

—

182

—

182

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 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 December 31, 2016 include discount rates ranging from 11.5% to 11.8%. 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 December 31, 2016 and 2015 include 51.0% 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 10.0% and 10.6%, respectively, for the dividend rate and future dividend rate on our common shares of beneficial interest.

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 year ended December 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		4,200		1,318		5,518
Purchases		—		—		—
Sales		—		—		—
Principal repayments		—		—		—
Balance, as of December 31, 2016	$	30,400	$	11,822	$	42,222

Liabilities	Warrants and investor SARs			Junior Subordinated Notes, at Fair Value			Total Level 3 Liabilities
Balance, as of December 31, 2014	$	35,384		$	13,102		$	48,486
Change in fair value of financial instruments		(9,184	)		(2,598	)		(11,782	)
Purchases		—			—			—
Principal repayments		—			—			—
Balance, as of December 31, 2015	$	26,200		$	10,504		$	36,704

Non-Recurring Fair Value Measurements

As of December 31, 2016, we measured three of our real estate assets at a fair value of $28,250 in our consolidated balance sheets as they were impaired. The fair values were based on an executed purchase and sale agreement 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 December 31, 2016, we measured three of our real estate assets at a fair value of $65,100 in our consolidated balance sheets as they were impaired. The fair values were 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 December 31, 2015, we measured two real estate assets at a fair value of $9,335 in our consolidated balance sheets as they were impaired. The fair values were based on purchase and sale agreements and were classified within Level 2 of the fair value hierarchy. The significant inputs to the valuations were the purchase prices 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 loan losses. In determining the allowance for loan losses, we estimate the fair value of the underlying collateral 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 underlying collateral of the commercial real estate loan, management uses discounted cash flow analyses and/or direct capitalization valuation analyses. The significant inputs to these valuations are capitalization rates and discount rates and are based on market information and comparable sales of similar properties. As of December 31, 2016, we measured the underlying collateral of six of our loans at a fair value of $107,865 in our consolidated balance sheets as they were impaired.

Fair Value of Financial Instruments

The following tables summarize the valuation technique and the level of the fair value hierarchy for financial instruments that are not recorded at fair value 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 and other indebtedness approximates cost due to the nature of these instruments and are not included in the tables below.

Carrying

Amount as of

December 31,

2016

Estimated Fair

Value as of

December 31,

2016

Valuation

Technique

Level in Fair Value Hierarchy

Total investment in mortgages and loans, net

1,280,285

1,256,342

Discounted cash flows

Three

7.0% convertible senior notes

831

890

Trading price

One

4.0% convertible senior notes

120,271

116,861

Trading price

One

7.625% senior notes

55,568

53,231

Trading price

One

7.125% senior notes

69,188

69,118

Trading price

One

Senior secured notes

58,233

62,620

Discounted cash flows

Three

Junior subordinated notes, at amortized cost

25,100

13,099

Discounted cash flows

Three

CDO notes payable, at amortized cost

534,501

477,032

Discounted cash flows

Three

CMBS securitizations

641,077

646,642

Discounted cash flows

Three

Loans payable on real estate

185,668

188,525

Discounted cash flows

Three

Other indebtedness

23,915

24,321

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

268,632

281,840

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 within FASB ASC Topic 825, “Financial Instruments” as reported in change in fair value of financial instruments in the accompanying consolidated statements of operations:

Description	For the Year Ended December 31, 2016			For the Year Ended December 31, 2015			For the Year Ended December 31, 2014
Change in fair value of trading securities and security-related receivables	$	—		$	(172	)	$	10,682
Change in fair value of junior subordinated notes		(1,524	)		2,598			(1,191	)
Change in fair value of CDO notes payable		—			—			(100,484	)
Change in fair value of derivatives		(222	)		28			(16,352	)
Change in fair value of warrants and investor SARs		(4,200	)		9,184			8,593
Change in fair value of financial instruments	$	(5,946	)	$	11,638		$	(98,752	)

The changes in the fair value for the trading securities and security-related receivables, CDO notes payable, and junior subordinated notes for which the fair value option was elected for the years ended December 31, 2016, 2015 and 2014 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 years ended December 31, 2016, 2015 and 2014 were mainly due to changes in interest rates. The changes in fair value of the warrants and investor SARs for the years ended December 31, 2016, 2015 and 2014 were due to changes in reference stock price and volatility.