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Fair Value Measurements
 6 Months Ended
Jun. 30, 2024
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 marketplace 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 are 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.
The fair value of interest rate caps is determined using the market standard methodology of discounting the future expected cash receipts that would occur if variable interest rates rose above the strike rates of the caps. Variable interest rates used in the calculation of projected receipts and payments on the caps are based on an expectation of future interest rates derived from observable market interest rate curves (SOFR 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.
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 June 30, 2024, the SOFR interest rate forward curve (Level 2 inputs) assumed a downtrend from 5.340% to 3.877% 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.
The Company initially recorded an embedded debt derivative of $43.7 million, which was attributed to the compound embedded derivative liability associated with the Oaktree term loan.
The compound embedded 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 June 30, 2024 reporting date. The risk neutral model is designed to utilize market data and the Company’s best estimate 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 risk-free rate of 4.88% 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 of 61.2% 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 of 63.8% 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 June 30, 2024.
The following table includes a summary of the compound embedded derivative liabilities measured at fair value using significant unobservable (Level 3) inputs (in thousands):
Fair Value
Balance at December 31, 2022$23,687 
Re-measurement of fair value934 
Balance at March 31, 202324,621 
Re-measurement of fair value(1,961)
Balance at June 30, 202322,660 
Re-measurement of fair value436 
Balance at September 30, 2023
23,096 
Re-measurement of fair value600 
Balance at December 31, 2023
23,696 
Re-measurement of fair value(2,624)
Balance at March 31, 2024
21,072 
Re-measurement of fair value128 
Balance at June 30, 2024
$21,200 
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The following table presents our assets and liabilities measured at fair value on a recurring basis aggregated by the level within which measurements fall in the fair value hierarchy (in thousands):
Quoted Market Prices (Level 1)Significant Other Observable Inputs (Level 2)Significant Unobservable Inputs (Level 3)Total
June 30, 2024:
Assets
Derivative assets:
Interest rate derivatives - caps$— $16,332 $— $16,332 
(1)
Total$— $16,332 $— $16,332 
Liabilities
Embedded debt derivative$— $— $(21,200)$(21,200)
(2)
Net$— $16,332 $(21,200)$(4,868)
December 31, 2023:
Assets
Derivative assets:
Interest rate derivatives - caps$— $13,696 $— $13,696 
(1)
Total$— $13,696 $— $13,696 
Liabilities
Embedded debt derivative$— $— $(23,696)$(23,696)
(2)
Net$— $13,696 $(23,696)$(10,000)
____________________________________
(1)    Reported as “derivative assets” in our consolidated balance sheets.
(2)    Reported in “indebtedness, net” in our consolidated balance sheets.
Effect of Fair Value Measured Assets and Liabilities on 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 June 30,
20242023
Assets
Derivative assets:
Interest rate derivatives - caps$1,485 $10,621 
Total$1,485 $10,621 
Liabilities
Derivative liabilities:
Embedded debt derivative$(128)$1,962 
Net$1,357 $12,583 
Total combined
Interest rate derivatives - caps$(5,873)$(1,345)
Embedded debt derivative(128)1,962 
Unrealized gain (loss) on derivatives(6,001)
(1)
617 
(1)
Realized gain (loss) on interest rate caps7,358 
(1) (2)
11,966 
(1) (2)
Net$1,357 $12,583 
____________________________________
(1)    Reported as “realized and unrealized gain (loss) on derivatives” in our consolidated statements of operations.
(2)    Represents settled and unsettled payments from counterparties on interest rate caps.
Gain (Loss) Recognized in Income
Six Months Ended June 30,
20242023
Assets
Derivative assets:
Interest rate derivatives - caps$3,622 $6,141 
Total$3,622 $6,141 
Liabilities
Derivative liabilities:
Embedded debt derivative$2,496 $1,027 
Net$6,118 $7,168 
Total combined
Interest rate derivatives - caps$(12,450)$(15,352)
Embedded debt derivative2,496 1,027 
Unrealized gain (loss) on derivatives(9,954)
(1)
(14,325)
(1)
Realized gain (loss) on interest rate caps16,072 
(1) (2)
21,493 
(1) (2)
Net$6,118 $7,168 
____________________________________
(1)    Reported as “realized and unrealized gain (loss) on derivatives” in our consolidated statements of operations.
(2)    Represents settled and unsettled payments from counterparties on interest rate caps.