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Fair Value Measurements and the Fair Value Option

9 Months Ended

Sep. 30, 2020

FAIR VALUE MEASUREMENTS AND THE FAIR VALUE OPTION

The following table presents fair value measurements (including items that are required to be measured at fair value and items for which the fair value option has been elected) as of September 30, 2020:


(Dollars in millions)	Level 1		Level 2		Level 3		Total
Unconsolidated investments	$	—			$	1,114.6	$	1,114.6
Marketable securities	8.8		—		—		8.8
Net currency derivative contracts	—		(43.2)		—		(43.2)
Total	$	8.8	$	(43.2)	$	1,114.6	$	1,080.2


(Dollars in millions)	Level 1		Level 2		Level 3		Total
Unconsolidated investments	$	—	$	—	$	1,099.3	$	1,099.3
Net currency derivative contracts	—		(34.7)		—		(34.7)
Total	$	—	$	(34.7)	$	1,099.3	$	1,064.6

Marketable securities

Marketable securities include Kennedy Wilson's investment in publicly traded equity securities. The carrying value of marketable securities is a level 1 valuation as the fair value is based on unadjusted quoted market prices in active markets for the underlying securities and is included within other assets.

Unconsolidated Investments

Kennedy Wilson elected to use the fair value option for 28 unconsolidated investments to more accurately reflect the timing of the value created in the underlying investments and report those results in current operations. Kennedy Wilson's investment balance in the FV Option investments was $972.3 million and $959.7 million at September 30, 2020 and December 31, 2019, respectively, which is included in unconsolidated investments in the accompanying balance sheets.

Additionally, Kennedy Wilson records its investments in the Funds based upon the net assets that would be allocated to its interests in the Funds, assuming the Funds were to liquidate their investments at fair value as of the reporting date. Kennedy Wilson’s investment balance in the Funds was $142.3 million and $139.6 million at September 30, 2020 and December 31, 2019, respectively, which is included in unconsolidated investments in the accompanying consolidated balance sheets. As of September 30, 2020, Kennedy Wilson had unfunded capital commitments to the Funds in the amount of $78.7 million. See Note 4 for more information on the fluctuations for these investments.

In estimating fair value of real estate held by the Funds and the 28 FV Option investments, the Company considers significant unobservable inputs to be the capitalization and discount rates.

The following table presents changes in Level 3 investments in Funds and FV Options for the three and nine months ended September 30, 2020 and 2019:


	Three Months Ended September 30,				Nine Months Ended September 30,
(Dollars in millions)	2020		2019		2020		2019
Beginning balance	$	1,085.7	$	835.8	$	1,099.3	$	662.2
Unrealized and realized gains	31.5		34.6		71.3		89.0
Unrealized and realized losses	(5.2)		(7.8)		(14.9)		(11.1)
Contributions	17.2		34.5		67.0		204.5
Distributions	(29.2)		(12.3)		(109.5)		(60.6)
Other	14.6		(7.4)		1.4		(6.6)
Ending Balance	$	1,114.6	$	877.4	$	1,114.6	$	877.4

Unobservable Inputs for Real Estate

In determining estimated fair market values, the Company utilizes discounted cash flow models that estimate future cash flows (including terminal values) and discount those cash flows back to the current period. The accuracy of estimating fair value for investments cannot be determined with precision and cannot be substantiated by comparison to quoted prices in active markets and may not be realized in a current sale or immediate settlement of the asset or liability. Additionally, there are inherent uncertainties in any fair value measurement technique, and changes in the underlying assumptions used, including capitalization rates, discount rates, liquidity risks, and estimates of future cash flows could significantly affect the fair value measurement amounts. The table below describes the range of unobservable inputs for real estate assets as of September 30, 2020:


	Estimated Rates Used for
	Capitalization Rates	Discount Rates
Multifamily	3.75% —5.00%	6.25% — 8.15%
Office	4.00% — 7.50%	5.00% — 9.00%
Retail	6.50% — 8.75%	8.75% — 11.25%
Hotel	6.00% —6.00%	7.50% — 8.25%
Residential	N/A	12.00% — 12.00%

In valuing indebtedness, the Company considers significant inputs such as the term of the debt, value of collateral, market loan-to-value ratios, market interest rates and spreads, and credit quality of investment entities. The credit spreads used by Kennedy Wilson for these types of investments range from 1.40% to 4.90%.

There is no active secondary market for the Company's development projects and no readily available market value given the uncertainty of the amount and timing of future cash flows. Accordingly, its determination of fair value of its development projects requires judgment and extensive use of estimates. Therefore, the Company typically uses investment cost as the estimated fair value until future cash flows become more predictable. Additionally, the fair value of its development projects may differ significantly from the values that would have been used had a ready market existed for such investments and may differ materially from the values that the Company may ultimately realize. If the Company were required to liquidate an investment in a forced or liquidation sale, it could realize significantly less than the value at which the Company have recorded it. In addition, changes in the market environment and other events that may occur over the life of the investments may cause the gains or losses ultimately realized on these investments to be different than the unrealized gains or losses reflected in the currently assigned valuations.

The Company assessed the impact of the COVID-19 pandemic and its impact on the fair value of investments. Valuations of its assets that are reported at fair value and the markets in which they operate, to date, have not been significantly impacted by the COVID-19 pandemic as there has been little disruption to projected cash flows or market driven inputs on the underlying properties as a result of COVID-19. As a result of the rapid development, fluidity and uncertainty surrounding this

situation, the Company expects that information with respect to fair value measurement may change, potentially significantly, going forward and may not be indicative of the actual impact of the COVID-19 pandemic on its business, operations, cash flows and financial condition for the nine months ended September 30, 2020 and future periods.

Currency Derivative Contracts

Kennedy Wilson uses foreign currency derivative contracts such as forward contracts and options to manage its foreign currency risk exposure against the effects of a portion of its certain non-U.S. dollar denominated currency net investments. Foreign currency options are valued using a variant of the Black-Scholes model tailored for currency derivatives and the foreign currency forward contracts are valued based on the difference between the contract rate and the forward rate at maturity of the underlying currency applied to the notional value in the underlying currency discounted at a market rate for similar risks. Although the Company has determined that the majority of the inputs used to value its currency derivative contracts fall within Level 2 of the fair value hierarchy, the counterparty risk adjustments associated with the currency derivative contracts utilize Level 3 inputs. However, as of September 30, 2020, Kennedy Wilson assessed the significance of the impact of the counterparty valuation adjustments on the overall valuation of its derivative positions and determined that the counterparty valuation adjustments are not significant to the overall valuation of its derivative. As a result, the Company has determined that its derivative valuation in its entirety be classified in Level 2 of the fair value hierarchy.

Changes in fair value are recorded in other comprehensive income in the accompanying consolidated statements of comprehensive income as the portion of the currency forward and option contracts used to hedge currency exposure of its certain consolidated subsidiaries qualifies as a net investment hedge under ASC Topic 815, Derivatives and Hedging.

The fair value of the currency derivative contracts held as of September 30, 2020 and December 31, 2019 are reported in other assets for hedge assets and included in accrued expenses and other liabilities for hedge liabilities on the accompanying balance sheet.

The table below details the currency derivative contracts Kennedy Wilson held as of September 30, 2020 and the activity during the nine months ended September 30, 2020. For the nine months ended September 30, 2020, Kennedy Wilson had a gross foreign currency translation gain on its net assets of $33.8 million. See Note 10 for a complete discussion on other comprehensive income including currency derivative contracts and foreign currency translations.


(Dollars, Euros and British Pound Sterling in millions)				September 30, 2020				Nine Months Ended September 30, 2020
Currency Hedged	Underlying Currency	Notional		Hedge Asset		Hedge Liability		Change in Unrealized (Losses) Gains			Realized (Losses) Gains		Interest Expense		Cash Received
Outstanding
EUR	USD	€	232.5	$	5.3	$	(9.6)	$	(0.7)		$	(9.8)	$	2.5	$	—
EUR(1)	GBP	€	240.8	—		(53.7)		(13.6)			—		—		—
EUR(1)(2)	GBP			—		—		(41.7)			—		—		—
GBP	USD	£	455.0	18.7		(3.9)		16.3			—		3.3		—
Total Outstanding				24.0		(67.2)		(39.7)			(9.8)		5.8		—

Settled
EUR	USD			—		—		0.4			4.7		0.6		13.6
GBP	USD			—		—		22.2			—		0.9		22.7
Total Settled				—		—		22.6			4.7		1.5		36.3
Total				$	24.0	$	(67.2)	$	(17.1)	(3)	$	(5.1)	$	7.3	$	36.3

(1) Hedge is held by KWE on its wholly-owned subsidiaries.

(2) Relates to KWE's Euro Medium Term Note. See discussion in Note 9.

(3) Excludes deferred tax benefit of $7.8 million.

The gains recognized through other comprehensive income will remain in accumulated other comprehensive income until the underlying investments that they were hedging are substantially liquidated by Kennedy Wilson.

Interest Rate Swaps

The Company has interest rate swaps with a notional value of $163.4 million on some variable rate property-level mortgage loans. Interest expense relating to differences in variable rate and fixed interest rates was $0.7 million and is recorded through interest expense. Changes in fair value on contracts were a loss of $7.8 million and are recorded to other comprehensive income.

Fair Value of Financial Instruments

The carrying amounts of cash and cash equivalents, accounts receivable including related party receivables, accounts payable, accrued expenses and other liabilities, accrued salaries and benefits, and deferred and accrued income taxes approximate fair value due to their short-term maturities. The carrying value of loans (excluding related party loans as they are presumed not to be an arm’s length transaction) approximates fair value as the terms are similar to loans with similar characteristics available in the market.

Debt liabilities are accounted for at face value plus net unamortized debt premiums and any fair value adjustments as part of business combinations. The fair value as of September 30, 2020 and December 31, 2019 for the mortgage debt, Kennedy Wilson unsecured debt, and KWE unsecured bonds were estimated to be approximately $4.9 billion and $5.2 billion, respectively, based on a comparison of the yield that would be required in a current transaction, taking into consideration the risk of the underlying collateral and the Company's credit risk to the current yield of a similar security, compared to their carrying value of $5.1 billion and $5.0 billion at September 30, 2020 and December 31, 2019, respectively. The inputs used to value the Company's mortgage debt, Kennedy Wilson unsecured debt, and KWE unsecured bonds are based on observable inputs for similar assets and quoted prices in markets that are not active and are therefore determined to be Level 2 inputs.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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