Note 10 — Fair Value

Fair Value of Financial Instruments

Fair value estimates are dependent upon subjective assumptions and involve significant uncertainties resulting in variability in estimates with changes in assumptions. The following table summarizes the carrying values and the estimated fair values of our financial instruments:

	June 30, 2015				December 31, 2014
			Estimated				Estimated
	Carrying Value		Fair Value		Carrying Value		Fair Value
Financial assets:
Loans and investments, net	$	1,468,566,061	$	1,506,763,960	$	1,459,475,650	$	1,478,778,674
Available-for-sale securities	823,050		823,050		2,499,709		2,499,709
Derivative financial instruments	14,807		14,807		1,995		1,995

Financial liabilities:
Credit and repurchase facilities	$	322,737,195	$	322,221,058	$	180,386,200	$	179,964,341
Collateralized loan obligations	500,250,000		500,535,000		458,250,000		459,673,750
Collateralized debt obligations	79,262,601		41,257,763		331,395,126		240,541,397
Senior unsecured notes	97,860,025		96,881,425		97,860,025		95,902,825
Junior subordinated notes	160,108,568		103,350,481		159,833,260		102,600,561
Notes payable	2,300,000		2,282,603		1,300,000		1,292,461
Mortgage note payable - real estate owned and held-for-sale	27,155,000		27,123,440		30,984,357		29,962,066
Derivative financial instruments	7,545,725		7,545,725		13,908,163		13,908,163

Fair Value Measurement

Fair value is defined as the price at which an asset could be exchanged in a current transaction between knowledgeable, willing parties. A liability’s fair value is defined as the amount that would be paid to transfer the liability to a new obligor, not the amount that would be paid to settle the liability with the creditor. Where available, fair value is based on observable market prices or parameters or derived from such prices or parameters. Where observable prices or inputs are not available, valuation models are applied. These valuation techniques involve some level of management estimation and judgment, the degree of which is dependent on the price transparency for the instruments or market and the instruments’ complexity.

Assets and liabilities disclosed at fair value are categorized based upon the level of judgment associated with the inputs used to measure their fair value. Hierarchical levels directly related to the amount of subjectivity associated with the inputs to fair valuation of these assets and liabilities are as follows:

Level 1 — Inputs are unadjusted and quoted prices exist in active markets for identical assets or liabilities at the measurement date. The types of assets and liabilities carried at Level 1 fair value generally are government and agency securities, equities listed in active markets, investments in publicly traded mutual funds with quoted market prices and listed derivatives.

Level 2 — Inputs (other than quoted prices included in Level 1) are either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date and for the duration of the instrument’s anticipated life. Level 2 inputs include quoted market prices in markets that are not active for an identical or similar asset or liability, and quoted market prices in active markets for a similar asset or liability. Fair valued assets and liabilities that are generally included in this category are non-government securities, municipal bonds, certain hybrid financial instruments, certain mortgage and asset-backed securities, certain corporate debt, certain commitments and guarantees, certain private equity investments and certain derivatives.

Level 3 — Inputs reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. These valuations are based on significant unobservable inputs that require a considerable amount of judgment and assumptions. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model. Generally, assets and liabilities carried at fair value and included in this category are certain mortgage and asset-backed securities, certain corporate debt, certain private equity investments, certain municipal bonds, certain commitments and guarantees and certain derivatives.

Determining which category an asset or liability falls within the hierarchy requires significant judgment and we evaluate our hierarchy disclosures each quarter.

The following is a description of the valuation techniques used to measure fair value and the general classification of these instruments pursuant to the fair value hierarchy.

Loans and investments, net: Fair values of loans and investments that are not impaired are estimated using Level 3 inputs based on discounted cash flow methodology, using discount rates, which, in the opinion of management, best reflect current market interest rates that would be offered for loans with similar characteristics and credit quality. Fair values of loans and investments that are impaired are estimated using Level 3 inputs by us that require significant judgments, which include assumptions regarding discount rates, capitalization rates, leasing, creditworthiness of major tenants, occupancy rates, availability of financing, exit plan, loan sponsorship, actions of other lenders and other factors deemed necessary by management.

Available-for-sale securities: Fair values are approximated based on current market quotes received from active markets or financial sources that trade such securities. The fair values of available-for-sale equity securities traded in active markets are approximated using Level 1 inputs, while the fair values of available-for-sale debt securities that are approximated using current, non-binding market quotes received from financial sources that trade such investments are valued using Level 3 inputs. The fair value of a CMBS security was estimated by us using Level 3 inputs that required significant judgments, which included assumptions regarding capitalization rates, leasing, creditworthiness of major tenants, occupancy rates, availability of financing, exit plan, loan sponsorship, actions of other lenders and other factors deemed necessary by management.

Derivative financial instruments: Fair values of interest rate and basis swap derivatives and LIBOR caps are approximated using Level 2 inputs based on current market data received from financial sources that trade such instruments and are based on prevailing market data and derived from third party proprietary models based on well recognized financial principles including counterparty risks, credit spreads and interest rate projections, as well as reasonable estimates about relevant future market conditions. These items are included in other assets and other liabilities on the consolidated balance sheets. We incorporate credit valuation adjustments in the fair values of our derivative financial instruments to reflect counterparty nonperformance risk.

Credit facilities, repurchase agreements, notes payable and mortgage notes payable: Fair values are estimated at Level 3 using discounted cash flow methodology, using discount rates, which, in the opinion of management, best reflect current market interest rates for financing with similar characteristics and credit quality.

Collateralized debt obligations and collateralized loan obligations: Fair values are estimated at Level 3 based on broker quotations, representing the discounted expected future cash flows at a yield that reflects current market interest rates and credit spreads.

Senior unsecured notes: Fair values are estimated at Level 1 based on current market quotes received from active markets.

Junior subordinated notes: Fair values are estimated at Level 3 based on broker quotations, representing the discounted expected future cash flows at a yield that reflects current market interest rates and credit spreads.

We measure certain financial assets and financial liabilities at fair value on a recurring basis. The fair value of these financial assets and liabilities was determined using the following inputs as of June 30, 2015:

					Fair Value Measurements
	Carrying		Fair		Using Fair Value Hierarchy
	Value		Value		Level 1		Level 2		Level 3
Financial assets:
Available-for-sale securities	$	823,050	$	823,050	$	823,050	$	—	$	—
Derivative financial instruments	14,807		14,807		—		14,807		—
Financial liabilities:
Derivative financial instruments	$	7,545,725	$	7,545,725	$	—	$	7,545,725	$	—

The following roll forward table reconciles the beginning and ending balances of financial assets measured at fair value on a recurring basis using Level 3 inputs:

	Available-for-sale
	Securities

Balance as of December 31, 2014	$	2,000,000
Adjustment to fair value:
Change in fair value	100,000
Payoff of CMBS investment	(2,100,000		)

Balance as of June 30, 2015	$	—

We measure certain financial and non-financial assets at fair value on a nonrecurring basis. The fair value of these financial assets was determined using the following inputs as of June 30, 2015:

	Net						Fair Value Measurements
	Carrying		Fair				Using Fair Value Hierarchy
	Value		Value		Level 1		Level 2		Level 3
Financial assets:
Impaired loans, net (1)	$	106,822,384	$	106,822,384	$	—	$	—	$	106,822,384

(1)

We had an allowance for loan losses of $117.6 million relating to 10 loans with an aggregate carrying value, before loan loss reserves, of approximately $224.4 million at June 30, 2015.

Loan impairment assessments: Loans held for investment are intended to be held to maturity and, accordingly, are carried at cost, net of unamortized loan origination costs and fees, loan purchase discounts, and net of the allowance for loan losses when such loan or investment is deemed to be impaired. We consider a loan impaired when, based upon current information and events, it is probable that we will be unable to collect all amounts due for both principal and interest according to the contractual terms of the loan agreement. We perform evaluations of our loans to determine if the value of the underlying collateral securing the impaired loan is less than the net carrying value of the loan, which may result in an allowance and corresponding charge to the provision for loan losses. These valuations require significant judgments, which include assumptions regarding capitalization and discount rates, revenue growth rates, leasing, creditworthiness of major tenants, occupancy rates, availability of financing, exit plan, loan sponsorship, actions of other lenders and other factors deemed necessary by management. The table above includes all impaired loans, regardless of the period in which an impairment was recognized.

Quantitative information about Level 3 fair value measurements on a recurring and non-recurring basis:

	June 30, 2015
			Valuation	Significant Unobservable	Range
	Fair Value		Technique(s)	Inputs	(Weighted Average)
Financial assets:

Impaired loans (1):

Multi-family	$	2,349,965	Direct capitalization analysis and discounted cash flows	Discount rate Capitalization rate Revenue growth rate	8.00% 6.50% to 9.75% (7.30)% 2.00%
Office	6,540,754		Discounted cash flows	Discount rate Capitalization rate Revenue growth rate	10.00% to 11.25% (10.50)% 8.25% to 9.25% (9.01)% 2.50% to 3.00% (2.63)%
Land	67,142,777		Discounted cash flows	Discount rate Capitalization rate Revenue growth rate	15.00% 7.25% 3.00%
Hotel	30,788,888		Discounted cash flows	Discount rate Capitalization rate Revenue growth rate	9.25% 7.25% 3.00%

(1)

Includes all impaired loans regardless of the period in which a loan loss provision was recorded.

We measure certain assets and liabilities for which fair value is only disclosed. The fair value of these assets and liabilities was determined using the following input levels as of June 30, 2015:

					Fair Value Measurements
	Carrying		Fair		Using Fair Value Hierarchy
	Value		Value		Level 1		Level 2		Level 3
Financial assets:
Loans and investments, net	$	1,468,566,061	$	1,506,763,960	$	—	$	—	$	1,506,763,960
Financial liabilities:
Credit facilities and repurchase agreements	$	322,737,195	$	322,221,058	$	—	$	—	$	322,221,058
Collateralized loan obligations	500,250,000		500,535,000		—		—		500,535,000
Collateralized debt obligation	79,262,601		41,257,763		—		—		41,257,763
Senior unsecured notes	97,860,025		96,881,425		96,881,425		—		—
Junior subordinated notes	160,108,568		103,350,481		—		—		103,350,481
Notes payable	2,300,000		2,282,603		—		—		2,282,603
Mortgage note payable — real estate owned	27,155,000		27,123,440		—		—		27,123,440