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Fair Value Measurements
 9 Months Ended
Sep. 30, 2021
Fair Value Disclosures [Abstract]  
Fair Value Measurements Fair Value Measurements
Fair Value Hierarchy—For disclosure purposes, financial instruments, whether measured at fair value on a recurring or nonrecurring basis or not measured at fair value, are classified in a hierarchy consisting of three levels based on the observability of valuation inputs in the market place as discussed below:
•Level 1: Fair value measurements that are quoted prices (unadjusted) in active markets that we have the ability to access for identical assets or liabilities. Market price data generally is obtained from exchange or dealer markets.
•Level 2: Fair value measurements based on inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals.
•Level 3: Fair value measurements based on valuation techniques that use significant inputs that are unobservable. The circumstances for using these measurements include those in which there is little, if any, market activity for the asset or liability.
Fair values of interest rate caps and floors are determined using the market standard methodology of discounting the future expected cash receipts that would occur if variable interest rates fell below the strike rates of the floors or rise above the strike rates of the caps. Variable interest rates used in the calculation of projected receipts and payments on the caps, and floors are based on an expectation of future interest rates derived from observable market interest rate curves (LIBOR forward curves) and volatilities (Level 2 inputs). We also incorporate credit valuation adjustments (Level 3 inputs) to appropriately reflect both our own nonperformance risk and the respective counterparty’s nonperformance risk.
Fair values of credit default swaps are obtained from a third-party who publishes various information including the index composition and price data (Level 2 inputs). The fair value of credit default swaps does not contain credit-risk-related adjustments as the change in fair value is settled net through posting cash collateral or reclaiming cash collateral between us and our counterparty.
Fair values of interest rate floors are calculated using a third-party discounted cash flow model based on future cash flows that are expected to be received over the remaining life of the floor. These expected future cash flows are probability-weighted
projections based on the contract terms, accounting for both the magnitude and likelihood of potential payments, which are both computed using the appropriate LIBOR forward curve and market implied volatilities as of the valuation date (Level 2 inputs).
The Company initially recorded an embedded debt derivative of $43.7 million, which was attributed to compound embedded derivative liabilities associated with the Oaktree term loan.
The derivative liability is considered a Level 3 measurement due to the utilization of significant unobservable inputs in the valuation, which were based on ‘with and without’ valuation models. Based on the terms and provisions of the Oaktree Credit Agreement, with the assistance of a valuation specialist, the Company utilized a risk neutral model to estimate the fair value of the embedded derivative features requiring bifurcation as of the respective issuance dates and as of the September 30, 2021 reporting date. The risk neutral model is designed to utilize market data and the valuation specialist’s best estimates of the timing and likelihood of the settlement events that are related to the embedded derivative features in order to estimate the fair value of the respective notes with these embedded derivative features.
The fair value of the notes with the derivative features is compared to the fair value of a plain vanilla note (excluding the derivative features), which is calculated based on the present value of the future default adjusted expected cash flows. The difference between the two values represents the fair value of the bifurcated derivative features as of each respective valuation date.
The key inputs to the valuation models that were utilized to estimate the fair value of the embedded debt derivative are described as follows:
•the default probability-weighted exit fee and prepayment cash flows are based on the contractual terms of the Oaktree Credit Agreement and the expectation of an acceleration event, including default, of the Company;
•the remaining term was determined based on the remaining time period to maturity of the related note with embedded features subject to valuation (as of the respective valuation date);
•the Company’s equity volatility estimate was based on the historical equity volatility of the Company, based on the remaining term of the respective loans;
•the risk-free rate was the discount rate utilized in the valuation and was determined based on reference to market yields for U.S. treasury debt instruments with similar terms;
•the recovery rate assumed upon occurrence of a default event was estimated based upon recovery rate data published by credit rating agencies specific to the seniority of the notes; and
•the probabilities and timing of a default-related acceleration event were estimated using an annualized probability of default which was implied from the debt issuance proceeds as of the issuance date, and updated utilizing relevant market data including market observed option-adjusted spreads as of September 30, 2021.
The following table includes a summary of the derivative liabilities measured at fair value using significant unobservable (Level 3) inputs (in thousands):
Fair Value
Balance at January 1, 2021$— 
Additions43,680 
Re-measurement of fair value(1,279)
Balance at March 31, 2021$42,401 
Re-measurement of fair value2,676 
Balance at June 30, 2021$45,077 
Re-measurement of fair value(6,125)
Balance at September 30, 2021
$38,952 
Fair values of hotel properties are based on methodologies which include the development of the discounted cash flow method of the income approach with support based on the market approach (Level 3 inputs). See note 5.
When a majority of the inputs used to value our derivatives fall within Level 2 of the fair value hierarchy, the derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy. However, when valuation adjustments associated with our derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by us
and our counterparties, which we consider significant (10% or more) to the overall valuation of our derivatives, the derivative valuations in their entirety are classified in Level 3 of the fair value hierarchy. Transfers of inputs between levels are determined at the end of each reporting period. In determining the fair values of our derivatives at September 30, 2021, the LIBOR interest rate forward curve (Level 2 inputs) assumed an uptrend from 0.080% to 1.188% for the remaining term of our derivatives. Credit spreads (Level 3 inputs) used in determining the fair values of derivatives assumed an uptrend in nonperformance risk for us and all of our counterparties through the maturity dates.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The following table presents our assets and liabilities measured at fair value on a recurring basis aggregated by the level within which measurements fall in the fair value hierarchy (in thousands):
Quoted Market Prices (Level 1)Significant Other Observable Inputs (Level 2)Significant Unobservable Inputs (Level 3)Total
September 30, 2021:
Assets
Derivative assets:
Interest rate derivatives - floors$— $51 $— $51 
(1)
Interest rate derivatives - caps— 20 — 20 
(1)
Total$— $71 $— $71 
Liabilities
Embedded debt derivative— — (38,952)(38,952)
(2)
Net$— $71 $(38,952)$(38,881)
December 31, 2020:
Assets
Derivative assets:
Interest rate derivatives - floors$— $263 $— $263 
(1)
Total$— $263 $— $263 
____________________________________
(1)    Reported net as “derivative assets” in our consolidated balance sheets.
(2)    Reported in “indebtedness, net” in our consolidated balance sheet.
Effect of Fair Value Measured Assets and Liabilities on Condensed Consolidated Statements of Operations
The following table summarizes the effect of fair value measured assets and liabilities on our consolidated statements of operations (in thousands):
Gain (Loss) Recognized in Income
Three Months Ended September 30,
20212020
Assets
Derivative assets:
Interest rate derivatives - floors$(72)$(95)
Interest rate derivatives - caps(24)(59)
Credit default swaps— 323 
(4)
(96)169 
Non-derivative assets:
Equity— (724)
Total(96)(555)
Liabilities
Derivative liabilities:
Embedded debt derivative6,125 — 
Net$6,029 $(555)
Total combined
Interest rate derivatives - floors$(72)$6,185 
Interest rate derivatives - caps(24)(59)
Credit default swaps— 323 
Embedded debt derivative6,125 — 
Unrealized gain (loss) on derivatives6,029 
(1)
6,449 
(1)
Realized gain (loss) on interest rate floors
— (6,280)
(2)
Unrealized gain (loss) on marketable securities
— (758)
(3)
Realized gain (loss) on marketable securities
— 34 
(2)
Net$6,029 $(555)
____________________________________
(1)    Reported as “unrealized gain (loss) on derivatives” in our consolidated statements of operations.
(2)    Included in “other income (expense)” in our consolidated statements of operations.
(3)    Reported as “unrealized gain (loss) on marketable securities” in our consolidated statements of operations.
(4)    Excludes costs of $271 for the three months ended September 30, 2020 included in “other income (expense)” associated with credit default swaps.
Gain (Loss) Recognized in Income
Nine Months Ended September 30,
20212020
Assets
Derivative assets:
Interest rate derivatives - floors$(462)$668 
Interest rate derivatives - caps(554)(129)
Credit default swaps— 1,019 
(4)
(1,016)1,558 
Non-derivative assets:
Equity— 386 
Total(1,016)1,944 
Liabilities
Derivative liabilities:
Embedded debt derivative4,728 — 
Net$3,712 $1,944 
Total combined
Interest rate derivatives - floors$(462)$10,173 
Interest rate derivatives - caps(554)(129)
Credit default swaps— 1,019 
Embedded debt derivative4,728 — 
Unrealized gain (loss) on derivatives3,712 
(1)
11,063 
(1)
Realized gain (loss) on options on interest rate floors
— (9,505)
(2)
Unrealized gain (loss) on marketable securities
— (1,756)
(3)
Realized gain (loss) on marketable securities
— 2,142 
(2)
Net$3,712 $1,944 
____________________________________
(1)    Reported as “unrealized gain (loss) on derivatives” in our consolidated statements of operations.
(2)    Included in “other income (expense)” in our consolidated statements of operations.
(3)    Reported as “unrealized gain (loss) on marketable securities” in our consolidated statements of operations.
(4)    Excludes costs of $881 for the nine months ended September 30, 2020, included in “other income (expense)” associated with credit default swaps.