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Fair Value Measures

9 Months Ended

Sep. 30, 2020

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. The Company does not expect that changes in classifications between levels will be frequent.

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 September 30, 2020 and December 31, 2019, 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 September 30, 2020
Assets:


Investment in Cole REITs	$	—	$	—	$	6,943	$	6,943

Liabilities:
Derivative liabilities	$	—	$	(97,511)	$	—	$	(97,511)

	Level 1		Level 2		Level 3		Balance as of December 31, 2019
Assets:
Derivative assets	$	—	$	250	$	—	$	250
Investment in Cole REITs	—		—		7,552		7,552
Total assets	$	—	$	250	$	7,552	$	7,802
Liabilities:
Derivative liabilities	$	—	$	(28,081)	$	—	$	(28,081)

Derivative Assets and Liabilities – The Company’s derivative financial instruments relate to interest rate swaps. 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 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 September 30, 2020 and December 31, 2019, the Company assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and determined that the credit valuation adjustments are not significant to the overall valuation of the Company’s derivatives. As a result, the Company determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.

Investment in Cole REITs – The fair values of CCIT II, CCIT III and CCPT V were estimated using the net asset value per share, as most recently disclosed by each applicable REIT. Each of the Cole REIT’s share redemption programs includes restrictions that limit the number of shares redeemed by the respective Cole REIT.

The following are reconciliations of the changes in assets and liabilities with Level 3 inputs in the fair value hierarchy for the nine months ended September 30, 2020 and 2019 (in thousands):


	Investment in Cole REITs
Beginning balance, January 1, 2020	$	7,552
Unrealized loss included in other income, net	(609)
Ending Balance, September 30, 2020	$	6,943

Beginning balance, January 1, 2019	$	7,844

Unrealized loss included in other income, net	(292)








Ending Balance, September 30, 2019	$	7,552

Items Measured at Fair Value on a Non-Recurring Basis

Certain financial and nonfinancial assets and liabilities are measured at fair value on a non-recurring basis and are subject to fair value adjustments in certain circumstances, such as when there is evidence of impairment.

Real Estate Investments – The Company performs quarterly impairment review procedures for real estate investments and investments in unconsolidated entities, primarily through continuous monitoring of events and changes in circumstances that could indicate the carrying value of its real estate assets may not be recoverable.

As part of the Company’s quarterly impairment review procedures, net real estate assets representing 47 properties were deemed to be impaired resulting in impairment charges of $36.9 million during the nine months ended September 30, 2020. The impairment charges relate to certain office, retail and restaurant properties whose tenants filed for Chapter 11 bankruptcy during the nine months ended September 30, 2020, were identified by management for potential sale or were determined would not be re-leased by the tenant.

As a result of the COVID-19 pandemic, the Company considered whether there was any indication of impairment for properties that did not otherwise have potential impairment indicators and identified five properties to include on the Company’s impairment watch list as of September 30, 2020, however there were no additional impairment charges as a result of this assessment.

Based on the Company’s expected holding period for the properties and the economic conditions as of September 30, 2020, the Company believes that their carrying values are recoverable. However, the COVID-19 pandemic has negatively impacted the businesses of certain of our tenants so the Company continues to monitor for circumstances and events in future periods, which may result in impairment charges.

During the nine months ended September 30, 2019, net real estate assets related to 53 properties, were deemed to be impaired resulting in impairment charges of $24.2 million. The impairment charges related to certain office, retail and restaurant properties that, during the nine months ended September 30, 2019, management identified for potential sale or determined, based on discussions with the current tenants, would not be re-leased by the tenant and the Company believed the property would not be leased to another tenant at a rental rate that supports the current book value.

The Company estimates fair values using Level 3 inputs and uses 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 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 revenue 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 the Company’s impairment tests for the real estate assets during the nine months ended September 30, 2020, the Company used a range of discount rates from 7.9% to 8.6% with a weighted-average rate of 8.3% and capitalization rates from 7.4% to 8.1% with a weighted-average rate of 7.8%.

Goodwill – The Company evaluates goodwill for impairment annually or more frequently when an event occurs or circumstances change that indicate the carrying value may not be recoverable.

As a result of a decrease in the Company’s stock price during the nine months ended September 30, 2020, the Company assessed its goodwill for impairment as of September 30, 2020, which resulted in no impairments. The Company continues to monitor factors that may impact the fair value of goodwill including, but not limited to, market comparable company multiples, interest rates, and global economic conditions.

Fair Value of Financial Instruments

The fair value of short-term financial instruments such as cash and cash equivalents, restricted cash 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 fair values of the Company’s financial instruments are reported below (dollar amounts in thousands):


	Level	Carrying Amount at September 30, 2020		Fair Value at September 30, 2020		Carrying Amount at December 31, 2019		Fair Value at December 31, 2019



Liabilities (1):
Mortgage notes payable and other debt, net	2	$	1,336,629	$	1,385,727	$	1,535,918	$	1,590,915
Corporate bonds, net	2	3,435,457		3,689,038		2,839,581		3,022,087
Convertible debt, net	2	252,388		256,098		319,947		327,237
Credit facility	2	900,000		900,000		1,050,000		1,050,000
Total liabilities		$	5,924,474	$	6,230,863	$	5,745,446	$	5,990,239

_______________________________________________

(1)Current and prior period liabilities’ carrying and fair values exclude net deferred financing costs.

Debt – 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. Corporate bonds and convertible debt are valued using quoted market prices in active markets with limited trading volume when available.

- 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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