Fair Value Disclosure

GAAP establishes a hierarchy of valuation techniques based on the observability of the inputs utilized in measuring financial instruments at fair values. Market based or observable inputs are the preferred source of values, followed by valuation models using management assumptions in the absence of market inputs. The three levels of the hierarchy as noted in ASC 820, Fair Value Measurements and Disclosures, are described below:

Level I — Quoted prices in active markets for identical assets or liabilities.

Level II — Prices are determined using other significant observable inputs. Observable inputs are inputs that other market participants would use in pricing a security. These may include quoted prices for similar securities, interest rates, prepayment speeds, credit risk and others.

Level III — Prices are determined using significant unobservable inputs. In situations where quoted prices or observable inputs are unavailable (for example, when there is little or no market activity for an investment at the end of the period), unobservable inputs may be used.

While the Company anticipates that its valuation methods will be appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. The Company will use inputs that are current as of the measurement date, which may include periods of market dislocation, during which price transparency may be reduced.

The estimated fair value of the Company's CMBS portfolio is determined by reference to market prices provided by certain dealers who make a market in these financial instruments. The Company believes that these dealers who are usually market makers in these securities utilize various valuation techniques and inputs including, but not limited to, observable trades, discounted cash flow, market yield and duration to price these securities. 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 performs additional analysis on prices received based on broker quotes to validate the prices and adjustments are made as deemed necessary by management to capture current market information. As of December 31, 2016 the estimated fair values of the Company’s securities were based on observable inputs and were classified as Level II in the fair value hierarchy. In June 2017, the Manager determined that, based on illiquidity in the market for these securities, broker quotes lack observable inputs and thus a transfer into Level III in the fair value hierarchy was necessary. Based on this determination, as of June 30, 2017, we have applied Level III classification to these securities. In accordance with GAAP, the Company elects the fair value option for these securities at the date of purchase in order to allow the Company to measure these securities at fair value with the change in estimated fair value included as a component of earnings in order to reflect the performance of the investment in a timely manner.

The estimated fair values of the Company’s derivative instruments are determined using a discounted cash flow analysis on the expected cash flows of each derivative. The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts). The fair values of interest rate caps are determined using the market standard methodology of discounting the future expected cash receipts (or payments) that would occur if variable interest rates rise above the strike rate of the caps. The variable interest rates used in the calculation of projected cash flows are based on an expectation of future interest rates derived from observable market interest rate curves and volatilities. The fair values of foreign exchange forwards are determined by comparing the contracted forward exchange rate to the current market exchange rate. The current market exchange rates are determined by using market spot rates, forward rates and interest rate curves for the underlying countries. The Company’s derivative instruments are classified as Level II in the fair value hierarchy.

The following table summarizes the levels in the fair value hierarchy into which the Company’s financial instruments were categorized as of September 30, 2017 and December 31, 2016:



	Fair Value as of September 30, 2017										Fair Value as of December 31, 2016
	Level I		Level II			Level III		Total			Level I		Level II		Level III		Total
CMBS (Fair Value Option)	$	—	$	—		$	191,902	$	191,902		$	—	$	331,076	$	—	$	331,076
Derivative instruments, net	—		(11,746		)	—		(11,746		)	—		5,906		—		5,906
Total	$	—	$	(11,746	)	$	191,902	$	180,156		$	—	$	336,982	$	—	$	336,982

The following is a reconciliation of investments for which Level III inputs were used in determining fair value:



	CMBS
Fair value at December 31, 2016	$	—
Transfers into Level III ⁽¹⁾	254,484
Net realized loss on investments	(4,076		)
Net increase in unrealized gain on investments	13,488
Sales and repayments of investments	(71,073		)
Amortization of purchase discount, net	(921		)
Fair value at September 30, 2017	$	191,902

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(1) Transfers into Level III of the fair value hierarchy represent investments that experienced an insignificant level of market activity during the period and were thus valued in the absence of observable inputs. Transfers into Level III of the fair value hierarchy are recorded at the end of the reporting period. In June 2017, the Manager determined that, based on illiquidity in the market for these securities, broker quotes, which are the primary valuation technique used to mark these investments at fair value, lack observable inputs and thus a transfer into Level III was necessary. Based on this determination, as of June 30, 2017, we have applied Level III classification to these securities.

The following table summarizes information about significant unobservable inputs used in the fair value measurement of Level III investments as of September 30, 2017. There were no Level III investments as of December 31, 2016:



			Unobservable Input
Asset Category	Fair Value	Primary Valuation Technique	Input	Range
CMBS	191,902	Broker quotes	Price ⁽¹⁾	63 - 101

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(1) A significant increase (decrease) in the unobservable input in isolation would result in significantly higher (lower) fair value measurement.