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 and other assets and receivables (excluding available-for-sale securities), 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 June 30, 2016, the $371,766,000 estimated fair value of the Company’s mortgages payable is more than their $355,797,000 carrying value (before unamortized deferred financing costs) by approximately $15,969,000 assuming a blended market interest rate of 3.73% based on the 9.8 year weighted average remaining term of the mortgages. At December 31, 2015, the $346,614,000 estimated fair value of the Company’s mortgages payable is more than their $334,428,000 carrying value (before unamortized deferred financing costs) by approximately $12,186,000 assuming a blended market interest rate of 4.07% based on the 8.9 year weighted average remaining term of the mortgages.

At June 30, 2016 and December 31, 2015, the carrying amount of the Company’s line of credit (before unamortized deferred financing costs) of $25,350,000 and $18,250,000, respectively, 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):

				Fair Value Measurements
		Carrying and		on a Recurring Basis
	As of	Fair Value		Level 1		Level 2
Financial assets:
Available-for-sale securities:
Equity securities	June 30, 2016	$	—	$	—	$	—
	December 31, 2015	32		32		—
Financial liabilities:
Derivative financial instruments:
Interest rate swaps	June 30, 2016	$	10,502	$	—	$	10,502
	December 31, 2015	4,299		—		4,299

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

Available-for-sale securities

At December 31, 2015, the Company’s available-for-sale securities was a $32,000 investment in equity securities (included in other assets on the consolidated balance sheet). The aggregate cost of these securities was $5,300 and at December 31, 2015, the unrealized gain of $27,000 was included in accumulated other comprehensive loss on the consolidated balance sheet. Fair value was approximated based on current market quotes from financial sources that track such securities. During the three and six months ended June 30, 2016, the Company sold such equity securities for gross proceeds of $33,000 and recognized a gain of $27,000 (included in other income on the consolidated statement of income).

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 June 30, 2016, 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 June 30, 2016, the Company had entered into 30 interest rate derivatives, all of which were interest rate swaps, related to 30 outstanding mortgage loans with an aggregate $143,656,000 notional amount and mature between 2018 and 2028 (weighted average remaining maturity of 8.4 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 3.02% to 5.75% and a weighted average interest rate of 4.15% at June 30, 2016). 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 $10,502,000, respectively, at June 30, 2016, and $0 and $4,299,000, respectively, at December 31, 2015.

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 June 30, 2016 with an aggregate $10,870,000 notional amount. These interest rate swaps, which were designated as cash flow hedges, have interest rates of 3.49% and 5.81% and mature in 2022 and 2018, respectively.

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 June 30,						Six Months Ended June 30,
	2016			2015			2016			2015
One Liberty Properties, Inc. and Consolidated Subsidiaries
Amount of (loss) gain recognized on derivatives in Other comprehensive loss	$	(3,079	)	$	732		$	(7,582	)	$	(891	)
Amount of loss reclassification from Accumulated other comprehensive loss into Interest expense	(785		)	(458		)	(1,387		)	(1,347		)

Unconsolidated Joint Ventures (Company’s share)
Amount of (loss) gain recognized on derivatives in Other comprehensive loss	$	(55	)	$	46		$	(185	)	$	(25	)
Amount of loss reclassification from Accumulated other comprehensive loss into Equity in earnings of unconsolidated joint ventures	(24		)	(29		)	(49		)	(51		)

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 six months ended June 30, 2016 and 2015. During the twelve months ending June 30, 2017, the Company estimates an additional $2,458,000 will be reclassified from other Accumulated comprehensive loss as an increase to Interest expense and $92,000 will be reclassified from Accumulated other comprehensive loss as a decrease to Equity in earnings of unconsolidated joint ventures.

The derivative agreements in effect at June 30, 2016 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. During the six months ended June 30, 2016, the Company terminated three interest rate swaps in connection with the early payoff of the related mortgages, and during the six months ended June 30, 2015, the Company terminated one interest rate swap in connection with the sale of its Cherry Hill, New Jersey property. The Company accelerated the reclassification of amounts in other comprehensive loss to earnings as a result of these hedged forecasted transactions being terminated. During the three and six months ended June 30, 2016, the accelerated amounts were losses of $154,000 and $178,000, respectively, and during the six months ended June 30, 2015, the accelerated amount was a loss of $472,000, all of which are included in Prepayment costs on debt on the consolidated statements of income.

As of June 30, 2016, the fair value of the derivatives in the liability position, including accrued interest and excluding any adjustments for nonperformance risk, was approximately $11,277,000. In the 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 $11,277,000. This termination liability value, net of $775,000 adjustments for accrued interest and nonperformance risk, or $10,502,000, is included in Accrued expenses and other liabilities on the consolidated balance sheet at June 30, 2016.