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 loans, preferred equity interests, 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 warehouse 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 March 31, 2018:

Financial Instrument	Carrying Amount		Estimated Fair Value
Assets
Total investment in mortgage loans, held for investment, net	$	1,033,552	$	996,039
Investment in mortgage loans, held for sale		38,394		38,435
Cash and cash equivalents		84,483		84,483
Restricted cash		152,962		152,962
Derivative assets		73		73
Liabilities
Recourse indebtedness:
7.0% convertible senior notes		834		544
4.0% convertible senior notes		101,330		99,214
7.625% senior notes		54,926		41,680
7.125% senior notes		67,614		59,871
Senior secured notes		9,200		8,806
Junior subordinated notes, at fair value		7,052		7,052
Junior subordinated notes, at amortized cost		25,100		7,755
Non-recourse indebtedness:
CDO notes payable, at amortized cost		209,031		152,673
CMBS securitizations		694,643		700,918
Loans payable on real estate		61,619		63,404
Other indebtedness		40,948		40,830

The following table summarizes the carrying amount and the fair value of our financial instruments as of December 31, 2017:

Financial Instrument	Carrying Amount		Estimated Fair Value
Assets
Total investment in mortgage loans, held for investment, net	$	1,255,723	$	1,252,780
Cash and cash equivalents		53,380		53,380
Restricted cash		157,914		157,914
Derivative assets		11		11
Liabilities
Recourse indebtedness:
7.0% convertible senior notes		833		533
4.0% convertible senior notes		106,800		103,457
7.625% senior notes		54,867		43,009
7.125% senior notes		67,474		61,567
Senior secured notes		11,063		11,197
Junior subordinated notes, at fair value		8,121		8,121
Junior subordinated notes, at amortized cost		25,100		8,849
Secured warehouse facilities		21,743		22,313
Non-recourse indebtedness:
CDO notes payable, at amortized cost		254,724		196,212
CMBS securitizations		736,586		744,359
Loans payable on real estate		61,922		64,377
Other indebtedness		40,955		40,830
Derivative liabilities		—		—
Warrants and investor SARs		—		—

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, 2018, 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) (1)

Significant Other

Observable Inputs

(Level 2) (1)

Significant

Unobservable Inputs

(Level 3) (1)

Balance as of March 31, 2018

Derivative assets

—

Total assets

—

Liabilities:

Quoted Prices in

Active Markets for

Identical Assets

(Level 1) (1)

Significant Other

Observable Inputs

(Level 2) (1)

Significant

Unobservable Inputs

(Level 3) (1)

Balance as of March 31, 2018

Junior subordinated notes, at fair value

—

7,052

Total liabilities

—

7,052

(1)	During the three months ended March 31, 2018, 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, 2017, 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) (1)

Significant Other

Observable Inputs

(Level 2) (1)

Significant

Unobservable Inputs

(Level 3) (1)

Balance as of December 31, 2017

Derivative assets

—

Total assets

—

Liabilities:

Quoted Prices in

Active Markets for

Identical Assets

(Level 1) (1)

Significant Other

Observable Inputs

(Level 2) (1)

Significant

Unobservable Inputs

(Level 3) (1)

Balance as of December 31, 2017

Junior subordinated notes, at fair value

—

8,121

Total liabilities

—

8,121

(1)	During the year ended December 31, 2017, 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, 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 March 31, 2018 include discount rates ranging from 21.81% to 21.92% and as of December 31, 2017 include discount rates ranging from 18.01% to 18.21%. The gains attributable to changes in instrument-specific credit risk were determined by discounting the future cash flows of the notes at base market interest rates and subtracting this amount from the total fair value of the instrument.

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, 2018:

Liabilities	Junior Subordinated Notes, at Fair Value			Total Level 3 Liabilities
Balance, as of December 31, 2017	$	8,121		$	8,121
Change in fair value of financial instruments		(1,069	)		(1,069	)
Balance, as of March 31, 2018	$	7,052		$	7,052

Non-Recurring Fair Value Measurements

As of March 31, 2018, we measured one real estate asset at a fair value of $28,480 in our consolidated balance sheets as it was impaired. The fair value was based on an offer received to purchase the property and was classified within Level 2 of the fair value hierarchy. The significant input was the purchase price offered by the potential buyer.

As of March 31, 2018, we measured one real estate asset at a fair value of $0 in our consolidated balance sheets as we concluded that a market participant would not choose to acquire this asset due to the fact that the property’s ground lease payments exceed the operating income from the improvements and the ground lease is currently in default. This fair value measurement was classified within Level 3 of the fair value hierarchy.

Our other non-recurring fair value measurements relate primarily to our commercial real estate loans that are considered impaired. In evaluating our impaired loans, 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 March 31, 2018, we measured the underlying collateral of nine of our loans at a fair value of $109,123 in our consolidated balance sheet 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 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 warehouse 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 March 31, 2018

Estimated Fair

Value as of March 31, 2018

Valuation

Technique

Level in Fair Value Hierarchy

Total investment in mortgage loans, held for investment, net

1,033,552

996,039

Discounted cash flows

Three

Investment in mortgage loans, held for sale

38,394

38,435

Discounted cash flows

Three

7.0% convertible senior notes

834

544

Trading price

Two

4.0% convertible senior notes

101,330

99,214

Trading price

Two

7.625% senior notes

54,926

41,680

Trading price

Two

7.125% senior notes

67,614

59,871

Trading price

Two

Senior secured notes

9,200

8,806

Discounted cash flows

Three

Junior subordinated notes, at amortized cost

25,100

7,425

Discounted cash flows

Three

CDO notes payable, at amortized cost

209,031

152,673

Discounted cash flows

Three

CMBS securitizations

694,643

700,918

Discounted cash flows

Three

Loans payable on real estate

61,619

63,404

Discounted cash flows

Three

Other indebtedness

40,948

40,830

Discounted cash flows

Three

Carrying Amount

as of December 31, 2017

Estimated Fair

Value as of December 31, 2017

Valuation

Technique

Level in Fair Value Hierarchy

Total investment in mortgage loans, held for investment, net

1,255,723

1,252,780

Discounted cash flows

Three

7.0% convertible senior notes

833

533

Trading price

Two

4.0% convertible senior notes

106,800

103,457

Trading price

Two

7.625% senior notes

54,867

43,009

Trading price

Two

7.125% senior notes

67,474

61,567

Trading price

Two

Senior secured notes

11,063

11,197

Discounted cash flows

Three

Junior subordinated notes, at amortized cost

25,100

8,849

Discounted cash flows

Three

CDO notes payable, at amortized cost

254,724

196,212

Discounted cash flows

Three

CMBS securitizations

736,586

744,359

Discounted cash flows

Three

Loans payable on real estate

61,922

64,377

Discounted cash flows

Three

Other indebtedness

40,955

40,830

Discounted cash flows

Three

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	2018			2017
Change in fair value of junior subordinated notes		(269	)		(660	)
Change in fair value of derivatives		356			7
Change in fair value of warrants and investors SARs		—			(500	)
Change in fair value of financial instruments	$	87		$	(1,153	)

The changes in the fair value for the junior subordinated notes for which the fair value option was elected for the three months ended March 31, 2018 and 2017 was primarily attributable to changes in base market interest rates. The changes in the fair value of derivatives for the three months ended March 31, 2018 and 2017 was primarily attributable to changes in interest rates. The changes in fair value of the warrants and investor SARs for the three months ended March 31, 2017 was primarily attributable to changes in the reference stock price and volatility.