Fair Value Measures

The Company determines fair value based on quoted prices when available or through the use of alternative approaches, such as discounting the expected cash flows using market interest rates commensurate with the credit quality and duration of the investment. U.S. GAAP guidance defines three levels of inputs that may be used to measure fair value:

Level 1 – Quoted prices in active markets for identical assets and liabilities that the reporting entity has the ability to access at the measurement date.

Level 2 – Inputs other than quoted prices included within Level 1 that are observable for the asset and liability or can be corroborated with observable market data for substantially the entire contractual term of the asset or liability.

Level 3 – Unobservable inputs reflect the entity’s own assumptions about the assumptions that market participants would use in the pricing of the asset or liability and are consequently not based on market activity, but rather through particular valuation techniques.

The determination of where an asset or liability falls in the hierarchy requires significant judgment and considers factors specific to the asset or liability. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company evaluates its hierarchy disclosures each quarter and depending on various factors, it is possible that an asset or liability may be classified differently from quarter to quarter. Changes in the type of inputs may result in a reclassification for certain assets. There were no transfers between Level 1, Level 2 or Level 3 of the fair value hierarchy during the year ended December 31, 2015. The Company expects that changes in classifications between levels will be infrequent.

Items Measured at Fair Value on a Recurring Basis

The following tables present information about the Company’s assets and liabilities measured at fair value on a recurring basis as of December 31, 2015 and 2014, aggregated by the level in the fair value hierarchy within which those instruments fall (in thousands):



	Level 1		Level 2			Level 3		Balance as of December 31, 2015
Assets:
CMBS	$	—	$	—		$	53,304	$	53,304
Interest rate swap assets	—		1,892			—		1,892
Total assets	$	—	$	1,892		$	53,304	$	55,196
Liabilities:
Interest rate swap liabilities	$	—	$	(6,922	)	$	—	$	(6,922	)

	Level 1		Level 2			Level 3		Balance as of December 31, 2014
Assets:
CMBS	$	—	$	—		$	58,646	$	58,646
Interest rate swap assets	—		5,509			—		5,509
Total assets	$	—	$	5,509		$	58,646	$	64,155
Liabilities:
Interest rate swap liabilities	$	—	$	(7,384	)	$	—	$	(7,384	)

CMBS – The Company’s CMBS are carried at fair value and are valued using Level 3 inputs. The Company used estimated non-binding quoted market prices from the trading desks of financial institutions that are dealers in such securities for similar CMBS tranches that actively participate in the CMBS market. Broker quotes are only indicative of fair value and may not necessarily represent what the Company would receive in an actual trade for the applicable instrument. Management determines that the prices are representative of fair value through its knowledge of and experience in the market. The significant unobservable input used in valuing the CMBS is the discount rate or market yield used to discount the estimated future cash flows expected to be received from the underlying investment, which include both future principal and interest payments. Significant increases or decreases in the discount rate or market yield would result in a decrease or increase in the fair value measurement. The following risks are included in the consideration and selection of discount rates or market yields: risk of default, rating of the investment and comparable company investments.

Derivatives – The valuation of derivative instruments is determined using a discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, as well as observable market-based inputs, including interest rate curves and implied volatilities. In addition, credit valuation adjustments are incorporated into the fair values to account for the Company’s potential nonperformance risk and the performance risk of the counterparties.

Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with those derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by the Company and its counterparties. However, as of December 31, 2015, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of the Company’s derivatives. As a result, the Company has determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.

The fair value of short-term financial instruments such as cash and cash equivalents, restricted cash, due to affiliates and accounts payable approximate their carrying value in the accompanying consolidated balance sheets due to their short-term nature and are classified as Level 1 under the fair value hierarchy.

The following are reconciliations of the changes in assets and (liabilities) with Level 3 inputs in the fair value hierarchy for the years ended December 31, 2015 and 2014 (in thousands):



	CMBS
Beginning balance, December 31, 2014	$	58,646
Total gains and losses:
Unrealized loss included in other comprehensive income, net	(977		)
Purchases, issuances, settlements and amortization:
Principal payments received	(4,504		)
Amortization included in net income	139
Ending Balance, December 31, 2015	$	53,304



	CMBS			Series D Preferred Stock Embedded Derivative			Contingent Consideration Arrangements			Total
Beginning balance, December 31, 2013	$	60,583		$	(16,736	)	$	—		$	43,847
Total gains and losses:
Unrealized gain included in other comprehensive income, net	8,731			—			—			8,731
Changes in fair value included in net loss	—			(13,594		)	3,292			(10,302		)
Purchases, issuances, settlements and amortization:
Fair value at purchase/issuance	151,197			—			(3,606		)	147,591
Sale of CMBS acquired in the Cole Merger	(158,637		)	—			—			(158,637		)
Return of principal received	(3,505		)	—			—			(3,505		)
Amortization included in net loss	277			—			—			277
Payment	—			—			314			314
Redemption of Series D	—			30,330			—			30,330
Ending Balance, December 31, 2014	$	58,646		$	—		$	—		$	58,646

The fair values of the Company’s financial instruments that are not reported at fair value in the consolidated balance sheets are reported below (dollar amounts in thousands):



	Level	Carrying Amount at December 31, 2015		Fair Value at December 31, 2015		Carrying Amount at December 31, 2014		Fair Value at December 31, 2014
Assets:
Loans held for investment	3	$	24,238	$	31,842	$	42,106	$	42,645

Liabilities⁽¹⁾:
Mortgage notes payable and other debt, net	2	$	3,133,005	$	3,240,153	$	3,805,761	$	3,931,029
Corporate bonds, net	2	2,547,255		2,580,786		2,546,499		2,709,845
Convertible debt, net	2	982,217		1,007,042		977,521		1,088,069
Credit facilities	2	1,460,000		1,536,264		3,184,000		3,145,884
Total liabilities		$	8,122,477	$	8,364,245	$	10,513,781	$	10,874,827

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(1)	Current and prior period liabilities’ carrying and fair values exclude net deferred financing costs, as discussed in Note 2 – Summary of Significant Accounting Policies.

Loans held for investment – The fair value of the Company’s fixed-rate loan portfolio is estimated with a discounted cash flow analysis, utilizing scheduled cash flows and discount rates estimated by management to approximate market interest rates.

Mortgage notes payable and other debt and credit facilities – The fair value is estimated by an independent third party using a discounted cash flow analysis, based on management’s estimates of observable market interest rates.

Convertible debt and corporate bonds – The fair value is estimated based on current pricing marks received from an independent third party.

Items Measured at Fair Value on a Non-Recurring Basis (Including Impairment Charges)

Certain financial and nonfinancial assets and liabilities are measured at fair value on a nonrecurring basis and are subject to fair value adjustments in certain circumstances, such as when there is evidence of impairment. The Company’s process for identifying and recording impairment related to real estate assets, goodwill and intangible assets is discussed in Note 2 – Summary of Significant Accounting Policies.

Real Estate Assets

As discussed in Note 6 – Real Estate Investments, during the year ended December 31, 2015, real estate assets related to 202 properties were deemed to be impaired and their carrying values were reduced to their estimated fair value of $248.3 million, resulting in impairment charges of $91.8 million. During the year ended December 31, 2014, real estate assets related to 16 properties were deemed to be impaired and their carrying values were reduced to their estimated fair values of $99.0 million, resulting in impairment charges of $100.5 million. The Company estimates fair values using Level 3 inputs and using a combined income and market approach, specifically using discounted cash flow analysis and recent comparable sales transactions. The evaluation of real estate assets for potential impairment requires the Company’s management to exercise significant judgment and to make certain key assumptions, including, but not limited to, the following: (1) capitalization rate; (2) discount rates; (3) number of years property will be held; (4) property operating expenses; and (5) re-leasing assumptions including number of months to re-lease, market rental income and required tenant improvements. There are inherent uncertainties in making these estimates such as market conditions and performance and sustainability of the Company’s tenants. For our impairment tests for the real estate assets during the year ended December 31, 2015, we used a range of discount rates from of 7.3% to 9.0% and capitalization rates from 7.5% to 18.0%.

The following table presents the impairment charges by asset class recorded during the years ended December 31, 2015 and 2014 (dollar amounts in thousands):



	Year Ended December 31,
	2015			2014
Properties impaired	202			16

Asset classes impaired:
Investment in real estate assets, net	$	88,465		$	100,547
Investment in direct financing leases, net	4,020			—
Below-market lease liabilities, net	(730		)	—
Total impairment loss	$	91,755		$	100,547

Goodwill and Intangible Assets

The Company recorded goodwill impairment charges to the Cole Capital reporting unit of $139.7 million and $223.1 million for the years ended December 31, 2015 and 2014, respectively. The Company also tested the goodwill allocated to the REI reporting unit for impairment during the years ended December 31, 2015 and 2014. The carrying values of the REI reporting unit were $17.4 billion and $19.3 billion at the 2015 and 2014 measurement dates, respectively, which exceeded the fair values by 13.0% and 5.5%, respectively. As such, no goodwill impairment was recorded during the years ended December 31, 2015 and 2014 to the REI reporting unit. In connection with the annual goodwill impairment test, the fair value of the intangible assets were also analyzed, as discussed in Note 5 – Goodwill and Other Intangibles. Based on this analysis, impairment charges of $73.7 million and $86.4 million were recorded for the years ended December 31, 2015 and 2014, respectively.

The Company estimated the fair value of the two reporting units, REI and Cole Capital, using both the income and market approach in evaluating goodwill for impairment. The assumptions utilized in the income approach include, but are not limited to, revenue growth rates, future cash flows and a discount rate. For our most recent impairment test for the intangible assets during the three moths ended December 31, 2015, we used a discount rate of 12.5%.The assumptions utilized in the market approach include, but are not limited to, future cash flows, the selection of comparable companies and measures of operating results and pricing multiples. AFFO and EBITDA multiples for market comparable companies were used to estimate the fair value of the REI and Cole Capital reporting units, respectively, by applying those multiples to the projected financial information prepared by management.

The uncertainties associated with the fair value assumptions for Cole Capital include, but are not limited to: (i) the Company’s ability to timely reinstate certain selling agreements that were suspended as a result of the Audit Committee Investigation and the resulting restatements, (ii) the timing and extent of capital raised and deployed on behalf of the Managed REITs, (iii) the actual timing of closing an offering or executing a liquidity event on behalf of a Managed REIT, and (iv) operations of future managed real estate programs. The uncertainties associated with the fair value assumptions for the goodwill allocated to the REI reporting unit are the same as the uncertainties for real estate assets.

If all other assumptions were held constant, increasing the discount rate by 1.0% for Cole Capital would increase the goodwill impairment charge by approximately $13.7 million or 9.8% and would increase the intangible assets impairment charge by approximately $1.3 million or 1.8%. If all other assumptions were held constant, increasing the discount rate by 1.0% would decrease the carrying value in excess of fair value of the REI reporting unit from 13.0% to 3.5%.