Note 15 - Fair Value Measurements

The Company measures the fair value of financial instruments based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering market participant assumptions in fair value measurements, a fair value hierarchy distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity and the reporting entity’s own assumptions about market participant assumptions. In accordance with the fair value hierarchy, Level 1 assets/liabilities are valued based on quoted prices for identical instruments in active markets, Level 2 assets/liabilities are valued based on quoted prices in active markets for similar instruments, on quoted prices in less active or inactive markets, or on other “observable” market inputs and Level 3 assets/liabilities are valued based significantly on “unobservable” market inputs.

The carrying amounts of cash and cash equivalents, restricted cash, escrow, deposits, receivables, certain other assets, dividends payable, and accrued expenses and other liabilities (excluding interest rate swaps), are not measured at fair value on a recurring basis, but are considered to be recorded at amounts that approximate fair value.

At September 30, 2015, the $336,157,000 estimated fair value of the Company’s mortgages payable is more than their carrying value by approximately $10,556,000 assuming a blended market interest rate of 4.2% based on the 9.1 year weighted average remaining term of the mortgages. At December 31, 2014, the $300,541,000 estimated fair value of the Company’s mortgages payable is more than their carrying value by approximately $8,492,000 assuming a blended market interest rate of 4.5% based on the 9.1 year weighted average remaining term of the mortgages.

At September 30, 2015 and December 31, 2014, the $35,750,000 and $13,250,000, respectively, carrying amount of the Company’s line of credit approximates its fair value.

The fair value of the Company’s mortgages payable and line of credit are estimated using unobservable inputs such as available market information and discounted cash flow analysis based on borrowing rates the Company believes it could obtain with similar terms and maturities. These fair value measurements fall within Level 3 of the fair value hierarchy.

Considerable judgment is necessary to interpret market data and develop estimated fair value. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

Fair Value on a Recurring Basis

The fair value of the Company’s available-for-sale securities and derivative financial instruments was determined using the following inputs (amounts in thousands):

		Carrying and		Fair Value Measurements on a Recurring Basis
	As of	Fair Value		Level 1		Level 2
Financial assets:
Available-for-sale securities:
Equity securities	September 30, 2015	$	31	$	31	$	—
	December 31, 2014	29		29		—
Derivative financial instruments:
Interest rate swaps	September 30, 2015	$	—	$	—	$	—
	December 31, 2014	27		—		27
Financial liabilities:
Derivative financial instruments:
Interest rate swaps	September 30, 2015	$	5,705	$	—	$	5,705
	December 31, 2014	3,139		—		3,139

The Company does not own any financial instruments that are classified as Level 3.

Available-for-sale securities

At September 30, 2015, the Company’s available-for-sale securities included a $31,000 investment in equity securities (included in other assets on the consolidated balance sheets). The aggregate cost of these securities was $5,300 and at September 30, 2015, the unrealized gain was $25,700. Such unrealized gains are included in accumulated other comprehensive loss on the consolidated balance sheets. Fair values are approximated based on current market quotes from financial sources that track such securities.

In May 2014, the Company sold to Gould Investors L.P., a related party, 37,081 shares of BRT Realty Trust, a related party, for $266,000 (based on the average of the closing prices for the 30 days preceding the sale). The cost of these shares was $132,000 and the Company realized a gain on sale of $134,000, of which $132,000 was reclassified from Accumulated other comprehensive loss on the consolidated balance sheets into earnings.

Derivative financial instruments

The Company’s objective in using interest rate swaps is to add stability to interest expense and to manage its exposure to interest rate movements. The Company does not use derivatives for trading or speculative purposes.

Fair values are approximated using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of the derivatives. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities.

Although the Company has 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 it use Level 3 inputs, such as estimates of current credit spreads, to evaluate the likelihood of default by the Company and its counterparty. As of September 30, 2015, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives. As a result, the Company determined that its derivative valuation is classified in Level 2 of the fair value hierarchy.

As of September 30, 2015, the Company had entered into 24 interest rate derivatives, all of which were interest rate swaps, related to 24 outstanding mortgage loans with an aggregate $117,401,000 notional amount and mature between 2016 and 2027 (weighted average remaining maturity of 7.6 years). Such interest rate swaps, all of which were designated as cash flow hedges, converted LIBOR based variable rate mortgages to fixed annual rate mortgages (with interest rates ranging from 3.55% to 5.75% and a weighted average interest rate of 4.66% at September 30, 2015). The fair value of the Company’s derivatives designated as hedging instruments in asset and liability positions reflected as other assets or other liabilities on the consolidated balance sheets were $0 and $5,705,000, respectively, at September 30, 2015, and $27,000 and $3,139,000, respectively, at December 31, 2014.

Three of the Company’s unconsolidated joint ventures, in which wholly-owned subsidiaries of the Company are 50% partners, had two interest rate derivatives outstanding at September 30, 2015 with an aggregate $11,050,000 notional amount. These interest rate swaps, which were designated as cash flow hedges, have interest rates of 3.49% and 5.81% and mature between April 2018 and March 2022.

The following table presents the effect of the Company’s derivative financial instruments on the consolidated statements of income for the periods presented (amounts in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2015			2014			2015			2014
One Liberty Properties and Consolidated Subsidiaries
Amount of loss recognized on derivatives in Other comprehensive loss	$	(3,609	)	$	(357	)	$	(4,500	)	$	(2,765	)
Amount of loss reclassification from Accumulated other comprehensive loss into Interest expense	(574		)	(476		)	(1,921		)	(1,300		)

Unconsolidated Joint Ventures (Company’s share)
Amount of (loss) gain recognized on derivatives in Other comprehensive loss	$	(122	)	$	11		(147		)	$	(37	)
Amount of loss reclassification from Accumulated other comprehensive loss into Equity in earnings of unconsolidated joint ventures	(29		)	(28		)	(80		)	(83		)

No gain or loss was recognized with respect to hedge ineffectiveness or to amounts excluded from effectiveness testing on the Company’s cash flow hedges for the three and nine months ended September 30, 2015 and 2014. During the nine months ended September 30, 2015, the Company terminated one of its interest rate swaps, in connection with the sale of its Cherry Hill, New Jersey property, and accelerated the reclassification of amounts in other comprehensive loss to earnings as a result of the hedged forecasted transactions being terminated. The accelerated amount was a loss of $472,000 and is included in Prepayment costs on debt on the Company’s consolidated statements of income. During the twelve months ending September 30, 2016, the Company estimates an additional $2,272,000 will be reclassified from other comprehensive income (loss) as an increase to interest expense.

The derivative agreements in effect at September 30, 2015 provide that if the wholly-owned subsidiary of the Company which is a party to the agreement defaults or is capable of being declared in default on any of its indebtedness, then a default can be declared on such subsidiary’s derivative obligation. In addition, the Company is a party to one of the derivative agreements and if there is a default by the subsidiary on the loan subject to the derivative agreement to which the Company is a party and if there are swap breakage losses on account of the derivative being terminated early, then the Company could be held liable for such swap breakage losses, if any.

As of September 30, 2015, the fair value of the derivatives in a liability position, including accrued interest and excluding any adjustments for nonperformance risk, was approximately $6,101,000. In the unlikely event that the Company breaches any of the contractual provisions of the derivative contracts, it would be required to settle its obligations thereunder at their termination liability value of $6,101,000. This termination liability value, net of $396,000 adjustments for nonperformance risk, or $5,705,000, is included in accrued expenses and other liabilities on the consolidated balance sheets at September 30, 2015.