9. Fair Value of Financial Instruments

The Company discloses fair value information about financial instruments, whether or not recognized in the statement of financial condition, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based upon the application of discount rates to estimated future cash flows based upon market yields or by using other valuation methodologies. Considerable judgment is necessary to interpret market data and develop estimated fair value. Accordingly, fair values are not necessarily indicative of the amounts the Company could realize on disposition of the financial instruments. The use of different market assumptions and/or estimation methodologies may have a material effect on estimated fair value amounts.

In connection with the Company’s disposal of Gramercy Finance, more fully described in Note 3 – “Dispositions and Assets Held-for-Sale”, the Company recorded recurring and non-recurring fair value measurements as of the date of disposal for certain financial instruments before derecognition.

The following table presents the carrying value in the Condensed Consolidated Balance Sheets, and approximate fair value of financial instruments at June 30, 2013 and December 31, 2012:

	June 30, 2013				December 31, 2012
	Carrying Value		Fair Value		Carrying Value		Fair Value
Financial assets:
Lending investments ^{(1), (2)}	$	-	$	-	$	784,135	$	816,283
CMBS ⁽²⁾	$	-	$	-	$	932,265	$	932,265
Derivative instruments ⁽²⁾	$	-	$	-	$	173	$	173
Retained CDO Bonds ⁽³⁾	$	7,645	$	7,645	$	-	$	-
Financial liabilities:
Collateralized debt obligations ^{(1), (2)}	$	-	$	-	$	2,188,579	$	1,474,236
Derivative instruments ⁽²⁾	$	-	$	-	$	173,623	$	173,623
Mortgage notes payable ⁽¹⁾	$	48,714	$	48,218	$	-	$	-

⁽¹⁾	Lending investments, mortgages notes payable, and CDOs are classified as Level III due to the significance of unobservable inputs which are based upon management assumptions.
⁽²⁾	In connection with the disposal of Gramercy Finance, lending investments, CMBS investments, derivative instruments, and collateralized debt obligations were classified as held-for-sale as of December 31, 2012.
⁽³⁾	Retained CDO Bonds represent the CDOs’ subordinate bonds, preferred shares, and ordinary shares, which were retained subsequent to the disposal of Gramercy Finance and were previously eliminated in consolidation.

The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate the value:

Cash and cash equivalents, accrued interest, and accounts payable: These balances in the Condensed Consolidated Financial Statements reasonably approximate their fair values due to the short maturities of these items.

Lending investments: These instruments are presented in the Condensed Consolidated Financial Statements at the lower of cost or market value and not at fair value. The fair values were estimated by using market floating rate and fixed rate yields (as appropriate) for loans with similar credit characteristics.

CMBS investments: These investments are presented in the Condensed Consolidated Financial Statements at fair value. The fair values were based upon valuations obtained from dealers of those securities, third-party pricing services, and internal models.

Collateralized debt obligations: These obligations are presented in the Condensed Consolidated Financial Statements on the basis of proceeds received at issuance and not at fair value. The fair value was estimated based upon the amount at which similarly placed financial instruments would be valued at December 31, 2012.

Derivative instruments: The Company’s derivative instruments, which are primarily comprised of interest rate swap agreements, are carried at fair value in the Condensed Consolidated Financial Statements based upon third-party valuations.

Retained CDO Bonds: Non-investment grade, subordinate CDO bonds, preferred shares and ordinary shares are presented on the Condensed Consolidated Financial Statements at fair value. The fair value is determined by an internally developed discounted cash flow model.

Mortgage notes payable: These obligations are presented in the Condensed Consolidated Financial Statements based on the actual balance outstanding and not at fair value. The fair value was estimated using discounted cash flows methodology, using discount rates that best reflect current market rates for financing with similar characteristics and credit quality.

Disclosure about fair value of financial instruments is based on pertinent information available to the Company at June 30, 2013 and December 31, 2012. Although the Company is not aware of any factors that would significantly affect the reasonable fair value amounts, such amounts have not been comprehensively revalued for the purpose of these Condensed Consolidated Financial Statements since June 30, 2013 and December 31, 2012, and current estimates of fair value may differ significantly from the amounts presented herein.

The following discussion of fair value was determined by the Company using available market information and appropriate valuation methodologies. Considerable judgment is necessary to interpret market data and develop estimated fair value. Accordingly, fair values are not necessarily indicative of the amounts the Company could realize on disposition of the financial instruments. Financial instruments with readily available actively quoted prices or for which fair value can be measured from actively quoted prices generally will have a higher degree of pricing observability and a lower degree of judgment utilized in measuring fair value. Conversely, financial instruments rarely traded or not quoted will generally have less, or no, pricing observability and a higher degree of judgment utilized in measuring fair value. The use of different market assumptions and/or estimation methodologies may have a material effect on estimated fair value amounts. Determining which category an asset or liability falls within the hierarchy requires significant judgment and the Company evaluates its hierarchy disclosures each quarter.

Fair Value on a Recurring Basis

Assets and liabilities measured at fair value on a recurring basis are categorized in the table below based upon the lowest level of significant input to the valuations.

At June 30, 2013	Total		Level I		Level II		Level III
Financial assets:
Derivative instruments:
Interest rate caps	$	-	$	-	$	-	$	-
Interest rate swaps		-		-		-		-
	$	-	$	-	$	-	$	-
CMBS available for sale:
Investment grade	$	-	$	-	$	-	$	-
Non-investment grade		-		-		-		-
	$	-	$	-	$	-	$	-
Retained CDO Bonds:
Non-investment grade, subordinate CDO bonds	$	7,645	$	-	$	-	$	7,645
	$	7,645	$	-	$	-	$	7,645
Financial liabilities:
Derivative instruments:
Interest rate caps	$	-	$	-	$	-	$	-
Interest rate swaps		-		-		-		-
	$	-	$	-	$	-	$	-

At December 31, 2012	Total		Level I		Level II		Level III
Financial assets:
Derivative instruments:
Interest rate caps	$	173	$	-	$	-	$	173
Interest rate swaps		-		-		-		-
	$	173	$	-	$	-	$	173
CMBS available for sale:
Investment grade	$	281,495	$	-	$	-	$	281,495
Non-investment grade		650,770		-		-		650,770
	$	932,265	$	-	$	-	$	932,265
Financial liabilities:
Derivative instruments:
Interest rate caps	$	173,623	$	-	$	-	$	173,623
Interest rate swaps		-		-		-		-
	$	173,623	$	-	$	-	$	173,623

Derivative instruments: Interest rate caps and swaps were valued with the assistance of a third-party derivative specialist, who uses a combination of observable market-based inputs, such as interest rate curves, and unobservable inputs which require significant judgment such as the credit valuation adjustments due to the risk of non-performance by both the Company and its counterparties. The fair value of derivatives classified as Level III are most sensitive to the credit valuation adjustment as all or a portion of the credit valuation adjustment may be reversed or otherwise adjusted in future periods in the event of changes in the credit risk of the Company or its counterparties.

Total losses or (gains) from derivatives for the period ended March 15, 2013 were $10,100 in accumulated other comprehensive income (loss), and then subsequently on the date of disposal, the Company reclassified the amounts out of accumulated other comprehensive income (loss) and derecognized the derivative instruments. During the three and six months ended June 30, 2013, the Company entered into no interest rate caps.

CMBS: CMBS are generally valued on a recurring basis by (i) obtaining assessments from third-party dealers who primarily use market-based inputs such as changes in interest rates and credit spreads, along with recent comparable trade data; and (ii) pricing services that use a combination of market-based inputs along with unobservable inputs that require significant judgment, such as assumptions on the underlying loans regarding net property operating income, capitalization rates, debt service coverage ratios and loan-to-value default thresholds, timing of workouts and recoveries, and loan loss severities. Third-party dealer marks, which were used to value the majority of the Company’s CMBS, are indications received from dealers in the respective security, from which the Company could transact at on the valuation date. The Company used all data points obtained, including comparable trades completed by the Company or available in the market place in determining its fair value of CMBS. Pricing service models are designed to replicate a market view of the underlying collateral, however, the models are most sensitive to the unobservable inputs such as timing of loan defaults and severity of loan losses and significant increases (decreases) in any of those inputs in isolation as well as any change in the expected timing of those inputs, would result in a significantly lower (higher) fair value measurement. Due to the inherent uncertainty in the determination of fair value, the Company had designated its CMBS as Level III.

Retained CDO Bonds: Retained CDO Bonds are valued on a recurring basis using an internally developed discounted cash flow model. Management estimates the timing and amount of cash flows expected to be collected and applies a discount rate equal to the yield that the Company would expect to pay for similar securities with similar risks at the valuation date. Future expected cash flows generated by management require significant assumptions and judgment regarding the expected resolution of the underlying collateral, which includes loans and other lending investments, real estate investments, and CMBS. The resolution of the underlying collateral requires further management assumptions regarding capitalization rates, lease-up periods, future occupancy rates, market rental rates, holding periods, capital improvements, net property operating income, timing of workouts and recoveries, loan loss severities and other factors. The models are most sensitive to the unobservable inputs such as the timing of a loan default or property sale and the severity of loan losses. Significant increases (decreases) in any of those inputs in isolation as well as any change in the expected timing of those inputs would result in a significantly lower (higher) fair value measurement. Due to the inherent uncertainty in the determination of fair value, the Company has designated its Retained CDO Bonds as Level III.

Quantitative information regarding the valuation techniques and the range of significant unobservable Level III inputs used to determine fair value measurements of the Retained CDO Bonds on a non-recurring basis as of June 30, 2013 are:

	At June 30, 2013
Financial Asset	Fair Value		Valuation Technique	Unobservable Inputs	Range
Retained CDO Bonds
Non-investment grade, subordinate CDO bonds	$	7,645	Discounted cash flows	Discount rate	25.00% to 40.00%

The following table reconciles the beginning and ending balances of financial assets measured at fair value on a recurring basis using Level III inputs:

	CMBS Available for sale - Investment Grade		CMBS Available for sale - Non-Investment Grade		Derivative Instruments		Retained CDO Bonds
Balance as of December 31, 2012	$	281,495	$	650,770	$	173	$	-
Change in CMBS investment
Change in CMBS investment status		(1,506)		1,506		-		-
Amortization of discounts or premiums		1,264		6,075		-		652
Proceeds from CMBS principal repayments		(10,526)		-		-		-
Gramercy Finance disposal		(274,133)		(670,387)		(219)		8,492
Adjustments to fair value:
Included in other comprehensive income		3,406		19,677		46		183
Other-than-temporary impairments		-		(7,641)		-		(1,682)
Balance as of June 30, 2013	$	-	$	-	$	-	$	7,645

The following roll forward table reconciles the beginning and ending balances of financial liabilities measured at fair value on a recurring basis using Level III inputs:

	Derivative Instruments - Interest Rate Swaps
Balance as of December 31, 2012	$	173,623
Gramercy Finance disposal		(163,716)
Adjustments to fair value:
Unrealized loss		(9,907)
Balance as of June 30, 2013	$	-

Fair Value on a Non-Recurring Basis

The Company used fair value measurements on a non-recurring basis in its assessment of fair value on loans and other lending investments that had been written down to fair value as a result of valuation allowances established for loan losses and loans and other lending investments classified as held-for-sale to adjust the carrying value to the lower of cost or fair value. As of March 15, 2013, or on the date of disposal of Gramercy Finance, the Company evaluated its loan investments for impairment before derecognizing the loan investments at the lower of cost or fair value. The Company recorded no impairments as of March 15, 2013. This differs from the Company’s determination of allowances for loan losses as the Company considered the value that a purchaser would be willing to acquire the asset at the date of disposal instead of at the ultimate resolution of the asset.

At June 30, 2013, the Company did not measure any assets at fair value on a non-recurring basis. The following table shows the fair value hierarchy for those assets measured at fair value on a non-recurring basis based upon the lowest level of significant input to the valuations for which a non-recurring change in fair value has been recorded during the year ended December 31, 2012.

At December 31, 2012	Total		Level I		Level II		Level III
Financial assets:
Lending investments - held-for-sale (allowance for loan loss):
Whole loans	$	60,335	$	-	$	-	$	60,335
Subordinate interests in whole loans		9,131		-		-		9,131
Mezzanine loans		-		-		-		-
Preferred equity		-		-		-		-
	$	69,466	$	-	$	-	$	69,466
Lending investments - held-for-sale (impairment for lower of cost or fair value):
Whole loans	$	174,477	$	-	$	-	$	174,477
Subordinate interests in whole loans		1,649		-		-		1,649
Mezzanine loans		20,422		-		-		20,422
Preferred equity		-		-		-		-
	$	196,548	$	-	$	-	$	196,548
Real estate investments:
Office	$	3,593	$	-	$	-	$	3,593
Land		24,195		-		-		24,195
Hotel		24,034		-		-		24,034
Branch		4,749		-		-		4,749
Industrial		-		-		-		-
	$	56,571	$	-	$	-	$	56,571

Real estate investments: The properties identified for impairment have been classified as assets held-for-sale. The impairment on properties classified as held-for-sale is calculated by comparing the results of the Company’s marketing efforts and unsolicited purchase offers to the carrying value of the respective property. The marketing valuations are based on internally developed discounted cash flow models which include assumptions that require significant management judgment regarding capitalization rates, lease-up periods, future occupancy rates, market rental rates, holding periods, capital improvements and other factors deemed necessary by management. The impairment is calculated by comparing the Company’s internally developed discounted cash flow methodology to the carrying value of the respective property.

Loans subject to impairments or reserves for loan loss: The loans identified for impairment or reserves for loan loss are collateral dependent loans. Impairment or reserves for loan loss are measured by comparing management’s estimated fair value of the underlying collateral to the carrying value of the respective loan. These valuations require significant judgments, which include assumptions regarding capitalization rates, leasing, creditworthiness of major tenants, occupancy rates, availability of financing, exit plan, loan sponsorship, actions of other lenders and other factors deemed necessary by management.

The valuations derived from pricing models may include adjustments to the financial instruments. These adjustments may be made when, in management’s judgment, either the size of the position in the financial instrument or other features of the financial instrument such as its complexity, or the market in which the financial instrument is traded (such as counterparty, credit, concentration or liquidity) require that an adjustment be made to the value derived from the pricing models. Additionally, an adjustment from the price derived from a model typically reflects management’s judgment that other participants in the market for the financial instrument being measured at fair value would also consider such an adjustment in pricing that same financial instrument.

Assets and liabilities presented at fair value and categorized as Level III are generally those that are marked to model using relevant empirical data to extrapolate an estimated fair value. The models’ inputs reflect assumptions that market participants would use in pricing the instrument in a current period transaction and outcomes from the models represent an exit price and expected future cash flows. The parameters and inputs are adjusted for assumptions about risk and current market conditions. Changes to inputs in valuation models are not changes to valuation methodologies; rather, the inputs are modified to reflect direct or indirect impacts on asset classes from changes in market conditions. Accordingly, results from valuation models in one period may not be indicative of future period measurements.