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 strategic markets. 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 collectibility 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 the Company 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 collectibility 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. In addition, for properties under development, the Company evaluates the progress of development as compared to the project's development schedule and cost budget. 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 determined that approximately $1.9 million and $0.8 million of its mezzanine and other notes receivable were impaired at December 31, 2016 and 2015, respectively. The Company recorded an allowance for credit losses on these impaired loans of $1.6 million and $0.8 million for the years ended December 31, 2016 and 2015, respectively. For the years ended December 31, 2016 and 2015, the average mezzanine and other notes receivable on non-accrual status was approximately $1.4 million and $0.8 million, respectively. The Company recognized approximately $43 thousand and $33 thousand of interest income on impaired loans during the years ended December 31, 2016 and 2015, respectively, on the cash basis. The Company provided loan reserves on non-impaired loans totaling $0.8 million and $1.4 million at December 31, 2016 and 2015, 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 Mezzanine and Other Notes Receivables
As of December 31, 2016	(in thousands)
Senior	$	—	$	—	$	—	$	61,482	$	61,482
Subordinated	—		—		—		9,336		9,336
Unsecured	—		—		—		3,618		3,618
	$	—	$	—	$	—	$	74,436	$	74,436
As of December 31, 2015
Senior	$	—	$	—	$	—	$	40,388	$	40,388
Subordinated	—		—		—		6,197		6,197
Unsecured	—		—		—		3,526		3,526
	$	—	$	—	$	—	$	50,111	$	50,111

Variable Interest through Notes Issued

The Company has issued mezzanine and other notes receivables to certain entities that have created variable interests in these borrowers totaling $33.5 million at December 31, 2016. The Company has determined that it is not the primary beneficiary of these variable interest entities. Each of these loans have stated fixed and/or variable interest amounts. The Company has identified loans totaling approximately $2.0 million with stated interest rates that are less than market rate, representing a total discount of $0.2 million. These discounts are reflected as a reduction of the outstanding loan amounts and are amortized over the life of the related loan.

Forgivable Notes Receivable

In conjunction with brand and development programs, the Company may provide financing to franchisees for property improvements and other purposes in the form of forgivable unsecured promissory notes which bear interest at market rates. Under these promissory notes, the franchisee promises to repay the principal balance together with interest upon maturity unless certain conditions are met throughout the term of the promissory note. The principal balance 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 balance 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 and marketing and reservation system expense on its consolidated statements of income. Since these forgivable promissory notes receivable are predominately forgiven ratably over the term of the promissory note rather than repaid, the Company classifies the issuance and collection of these notes receivable as operating activities in its consolidated statement of cash flows.

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 and marketing and reservation system expenses in the accompanying consolidated statements of income in the quarter when the note is deemed uncollectible.

As of December 31, 2016 and 2015, the unamortized balance of these notes totaled $51.5 million and $44.3 million, respectively. The Company recorded an allowance for credit losses on these forgivable unsecured notes receivable of $5.0 million and $4.6 million at December 31, 2016 and 2015, respectively. At each of the years ended December 31, 2016 and 2015, the Company had $1.0 million and $1.2 million forgivable unsecured notes that were past due, respectively. Amortization expense included in the accompanying consolidated statements of income related to the notes was $9.0 million, $8.2 million and $5.0 million for the years ended December 31, 2016, 2015 and 2014, respectively.

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



	December 31, 2016						December 31, 2015
	(in thousands)
Credit Quality Indicator	Forgivable Notes Receivable		Mezzanine & Other Notes Receivable		Total		Forgivable Notes Receivable		Mezzanine & Other Notes Receivable		Total
Senior	$	—	$	61,482	$	61,482	$	—	$	40,388	$	40,388
Subordinated	—		9,336		9,336		—		6,197		6,197
Unsecured	51,475		3,618		55,093		44,333		3,526		47,859
Total notes receivable	51,475		74,436		125,911		44,333		50,111		94,444
Allowance for losses on non-impaired loans	5,013		1,647		6,660		4,615		1,364		5,979
Allowance for losses on receivables specifically evaluated for impairment	—		770		770		—		786		786
Total loan reserves	5,013		2,417		7,430		4,615		2,150		6,765
Net carrying value	$	46,462	$	72,019	$	118,481	$	39,718	$	47,961	$	87,679
Current portion, net	$	333	$	7,540	$	7,873	$	143	$	4,964	$	5,107
Long-term portion, net	46,129		64,479		110,608		39,575		42,997		82,572
Total	$	46,462	$	72,019	$	118,481	$	39,718	$	47,961	$	87,679

The Company classifies notes receivable due within one year as other current assets.

The following table summarizes the activity related to the Company’s Forgivable Notes Receivable and Mezzanine & Other Notes Receivable allowance for losses for the years ended December 31, 2016 and 2015:



	Year ended December 31, 2016						Year ended December 31, 2015
	Forgivable Notes Receivable			Mezzanine & Other Notes Receivable			Forgivable Notes Receivable			Mezzanine & Other Notes Receivable
	(in thousands)
Beginning balance	$	4,615		$	2,150		$	3,661		$	2,326
Provisions	1,458			861			1,742			—
Recoveries	(96		)	(164		)	(739		)	(176		)
Write-offs	(666		)	(430		)	(752		)	—
Other⁽¹⁾	(298		)	—			703			—
Ending balance	$	5,013		$	2,417		$	4,615		$	2,150

⁽¹⁾ Consists of default rate assumption changes and changes in foreign exchange rates