Notes Receivable and Allowance for Losses

The Company segregates its notes receivable for the purposes of evaluating allowances for credit losses between two categories: Mezzanine and Other Notes Receivable and Forgivable Notes Receivable. The Company utilizes the level of security it has in the various notes receivable as its primary credit quality indicator (i.e. senior, subordinated or unsecured) when determining the appropriate allowances for uncollectible loans within these categories.

Mezzanine, and Other Notes Receivables

The Company has provided financing to franchisees in support of the development of properties in key markets. These notes include non-interest bearing receivables as well as notes bearing market interest rates. Non-interest bearing notes are recorded at their unamortized discounts. At December 31, 2011 and 2010, all discounts were fully amortized. Interest income associated with these notes receivable is reflected in the accompanying consolidated statements of income under the caption interest income.

The Company expects the owners to repay the loans in accordance with the loan agreements, or earlier as the hotels mature and capital markets permit. The Company estimates the collectability and records an allowance for loss on its mezzanine and other notes receivable when recording the receivables in the Company’s financial statements. These estimates are updated quarterly based on available information.

The Company considers a loan to be impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. All amounts due according to the contractual terms means that both the contractual interest payments and the contractual principal payments of a loan will be collected as scheduled in the loan agreement. The Company measures loan impairment based on the present value of expected future cash flows discounted at the loan’s original effective interest rate or the estimated fair value of the collateral. For impaired loans, the Company establishes a specific impairment reserve for the difference between the recorded investment in the loan and the present value of the expected future cash flows or the estimated fair value of the collateral. The Company applies its loan impairment policy individually to all mezzanine and other notes receivable in the portfolio and does not aggregate loans for the purpose of applying such policy. For impaired loans, the Company recognizes interest income on a cash basis. If it is likely that a loan will not be collected based on financial or other business indicators it is the Company’s policy to charge off these loans to SG&A expenses in the accompanying consolidated statements of income in the quarter when it is deemed uncollectible. Recoveries of impaired loans are recorded as a reduction of SG&A expenses in the quarter received.

The Company assesses the collectability of its senior notes receivable by comparing the market value of the underlying assets to the carrying value of the outstanding notes. In addition, the Company evaluates the property’s operating performance, the borrower’s compliance with the terms of the loan and franchise agreements, and all related personal guarantees that have been provided by the borrower. For subordinated or unsecured receivables, the Company assesses the property’s operating performance, the subordinated equity available to the Company, the borrower’s compliance with the terms of loan and franchise agreements, and the related personal guarantees that have been provided by the borrower.

The Company considers loans to be past due and in default when payments are not made when due. Although the Company considers loans to be in default if payments are not received on the due date, the Company does not suspend the accrual of interest until those payments are more than 30 days past due. The Company applies payments received for loans on non-accrual status first to interest and then principal. The Company does not resume interest accrual until all delinquent payments are received.

The Company has determined that approximately $11.2 million and $10.8 million of its mezzanine and other notes receivable were impaired at December 31, 2011 and 2010, respectively. The Company has recorded an allowance for credit losses on these impaired loans at December 31, 2011 and 2010 totaling $8.2 million and $8.6 million resulting in a carrying value of impaired loans of $3.0 million and $2.2 million, respectively for which we had no related allowance for credit losses. The Company recognized approximately ten thousand dollars of interest income on impaired loans during the year ended December 31, 2011 on the cash basis. The Company did not recognize interest income on either the accrual or cash basis on its impaired loans during the year ended December 31, 2010. The Company has provided loan reserves on non-impaired loans totaling $0.2 million and $0.6 million at December 31, 2011 and 2010, respectively

Past due balances of mezzanine and other notes receivable by credit quality indicators are as follows:



	30-89 days Past Due		> 90 days Past Due		Total Past Due		Current		Total Receivables
As of December 31, 2011	($ in thousands)
Senior	$	—	$	—	$	—	$	7,900	$	7,900
Subordinated	—		9,773		9,773		4,219		13,992
	$	—	$	9,773	$	9,773	$	12,119	$	21,892
As of December 31, 2010
Senior	$	—	$	—	$	—	$	3,846	$	3,846
Subordinated	—		10,931		10,931		3,563		14,494
	$	—	$	10,931	$	10,931	$	7,409	$	18,340

Loans Acquired with Deteriorated Credit Quality

On December 2, 2011, the Company acquired an $11.5 million mortgage, held on a franchisee hotel asset, from a financial institution for $7.9 million. At the time of acquisition, the Company determined that it would be unable to collect all contractually required payments under the original mortgage terms. The contractually required payments receivable, including principal and interest, under the terms of the acquired mortgage totaled $12.0 million. The Company expects to collect $9.7 million of these contractually required payments. No prepayments were considered in the determination of contractual cash flows and cash flows expected to be collected. At December 31, 2011, the carrying amount of this loan was $7.9 million and there was no allowance for uncollectable amounts. The Company's accretable yield at both the acquisition date and December 31, 2011 was $1.8 million or 7.36%.

Forgivable Notes Receivable

In certain instances, the Company may provide financing to franchisees for property improvements and other purposes in the form of forgivable promissory notes which bear interest at market rates. Under these promissory notes, the franchisee promises to repay the principal sum together with interest upon maturity unless certain conditions are met throughout the term of the promissory note. The principal sum and related interest are forgiven ratably over the term of the promissory note if the franchisee remains in the system in good standing. If during the term of the promissory note, the franchisee exits our franchise system or is not operating their franchise in accordance with our quality or credit standards, the Company may declare a default under the promissory note and commence collection efforts with respect to the full amount of the then-current outstanding principal and interest.

In accordance with the terms of the promissory notes, the initial principal sum and related interest are ratably reduced over the term of the loan on each anniversary date until the outstanding amounts are reduced to zero as long as the franchisee remains within the franchise system and operates in accordance with our quality and brand standards. As a result, the amounts recorded as an asset on the Company's consolidated balance sheet are also ratably reduced since the amounts forgiven no longer represent probable future economic benefits to the Company. The Company records the reduction of its recorded assets through amortization expense on its consolidated statements of income.

The Company fully reserves all defaulted notes in addition to recording a reserve on the estimated uncollectible portion of the remaining notes. For those notes not in default, the Company calculates an allowance for losses and determines the ultimate collectability on these forgivable notes based on the historical default rates for those unsecured notes that are not forgiven but are required to be repaid. The Company records bad debt expense in SG&A expenses in the accompanying consolidated statements of income in the quarter when the note is deemed uncollectible.

As of December 31, 2011 and 2010, the unamortized balance of these notes totaled $7.9 million and $7.8 million, respectively. The Company recorded an allowance for credit losses on these forgivable unsecured notes receivable of $0.8 million at both December 31, 2011 and 2010, respectively. At December 31, 2011, the Company did not have any forgivable unsecured notes that were past due. Amortization expense included in the accompanying consolidated statements of income related to the notes was $2.3 million, $1.9 million and $2.0 million for the years ended December 31, 2011, 2010 and 2009 respectively.

A summary of the Company's notes receivable and related allowances are as follows:



	December 31, 2011						December 31, 2010
	($ in thousands)						($ in thousands)
Credit Quality Indicator	Forgivable Notes Receivable		Mezzanine & Other Notes Receivable		Total		Forgivable Notes Receivable		Mezzanine & Other Notes Receivable		Total
Senior	$	—	$	7,900	$	7,900	$	—	$	3,846	$	3,846
Subordinated	—		13,992		13,992		—		14,494		14,494
Unsecured	7,948		—		7,948		7,753		—		7,753
Total notes receivable	7,948		21,892		29,840		7,753		18,340		26,093
Allowance for losses on non-impaired loans	795		225		1,020		775		613		1,388
Allowance for losses on receivables specifically evaluated for impairment	—		8,208		8,208		—		8,638		8,638
Total loan reserves	795		8,433		9,228		775		9,251		10,026
Net carrying value	$	7,153	$	13,459	$	20,612	$	6,978	$	9,089	$	16,067
Current portion, net	$	102	$	3,002	$	3,104	$	114	$	3,852	$	3,966
Long-term portion, net	7,051		10,457		17,508		6,864		5,237		12,101
Total	$	7,153	$	13,459	$	20,612	$	6,978	$	9,089	$	16,067

The Company classifies notes receivable due within one year as other current assets and notes receivable with a maturity greater than one year as other assets in the Company’s consolidated balance sheets.

The following table summarizes the activity related to the Company’s Forgivable Notes Receivable and Mezzanine & Other Notes Receivable allowance for losses from December 31, 2010 through December 31, 2011:



	Forgivable Notes Receivable			Mezzanine & Other Notes Receivable
	(In thousands)
Balance, December 31, 2010	$	775		$	9,251
Provisions	269			713
Recoveries	(3		)	(1,157		)
Write-offs	(160		)	(374		)
Other⁽¹⁾	(86		)	—
Balance, December 31, 2011	$	795		$	8,433

⁽¹⁾ Consists of default rate assumption changes