5. Fair Value Measurements and Interest Rate Derivatives

Fair Value of Financial Instruments

As of March 31, 2017 and December 31, 2016, the carrying amount of certain financial instruments, including cash and cash equivalents, restricted cash, accounts receivable, accounts payable and accrued expenses were representative of their fair values due to the short-term maturity of these instruments.

The Company follows the requirements of the Fair Value Measurement and Disclosure Topic of the FASB ASC, which establishes a framework for measuring fair value and disclosing fair value measurements by establishing a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below:


Level 1	Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2	Inputs reflect quoted prices for identical assets or liabilities in markets that are not active; quoted prices for similar assets or liabilities in active markets; inputs other than quoted prices that are observable for the asset or the liability; or inputs that are derived principally from or corroborated by observable market data by correlation or other means.

Level 3	Unobservable inputs reflecting the Company’s own assumptions incorporated in valuation techniques used to determine fair value. These assumptions are required to be consistent with market participant assumptions that are reasonably available.

As of March 31, 2017 and December 31, 2016, the only financial instruments that the Company measures at fair value are its interest rate derivatives, along with a life insurance policy and a related retirement benefit agreement. In accordance with the Fair Value Measurement and Disclosure Topic of the FASB ASC, the Company estimates the fair value of its interest rate derivatives using Level 2 measurements based on quotes obtained from the counterparties, which are based upon the consideration that would be required to terminate the agreements. Both the life insurance policy and the related retirement benefit agreement, which are for a former Company associate, are valued using Level 2 measurements.

The following table presents the Company’s assets measured at fair value on a recurring and non-recurring basis at March 31, 2017 and December 31, 2016 (in thousands):


			Fair Value Measurements at Reporting Date
	Total		Level 1		Level 2		Level 3

March 31, 2017 (unaudited):
Interest rate cap derivatives	$	4	$	—	$	4	$	—
Interest rate swap derivatives		2,421		—		2,421		—
Life insurance policy (1)		855		—		855		—
Total assets measured at fair value at March 31, 2017	$	3,280	$	—	$	3,280	$	—
December 31, 2016:
Interest rate cap derivative	$	—	$	—	$	—	$	—
Interest rate swap derivatives		1,749		—		1,749		—
Life insurance policy (1)		861		—		861		—
Total assets measured at fair value at December 31, 2016	$	2,610	$	—	$	2,610	$	—

(1)

Includes the split life insurance policy for a former Company associate. These amounts are included in other assets, net on the accompanying consolidated balance sheets, and will be used to reimburse the Company for payments made to the former associate from the related retirement benefit agreement, which is included in accrued payroll and employee benefits on the accompanying consolidated balance sheets.

The following table presents the Company’s liabilities measured at fair value on a recurring and non-recurring basis at March 31, 2017 and December 31, 2016 (in thousands):


			Fair Value Measurements at Reporting Date
	Total		Level 1		Level 2		Level 3

March 31, 2017 (unaudited):
Retirement benefit agreement (1)	$	855	$	—	$	855	$	—
Total liabilities measured at fair value at March 31, 2017	$	855	$	—	$	855	$	—

December 31, 2016:
Retirement benefit agreement (1)	$	861	$	—	$	861	$	—
Total liabilities measured at fair value at December 31, 2016	$	861	$	—	$	861	$	—

(1)

Includes the retirement benefit agreement for a former Company associate. The agreement calls for the balance of the retirement benefit to be paid out to the former associate in ten annual installments, beginning in 2011. As such, the Company has paid the former associate a total of $1.2 million through March 31, 2017, which was reimbursed to the Company using funds from the related split life insurance policy noted above. These amounts are included in accrued payroll and employee benefits on the accompanying consolidated balance sheets.

Interest Rate Derivatives

The Company’s interest rate derivatives, which are not designated as effective cash flow hedges, consisted of the following at March 31, 2017 (unaudited) and December 31, 2016 (in thousands):


									Estimated Fair Value Asset
		Strike / Capped			Effective	Maturity	Notional		March 31,		December 31,
Hedged Debt	Type	Rate		Index	Date	Date	Amount		2017		2016
Hilton San Diego Bayfront (1)	Cap	4.250	%	1-Month LIBOR	April 15, 2015	May 1, 2017	$	110,772	$	—	$	—
Hilton San Diego Bayfront (1)	Cap	4.250	%	1-Month LIBOR	May 1, 2017	May 1, 2019	$	N/A		4		—
$85.0 million term loan (2)	Swap	3.391	%	1-Month LIBOR	October 29, 2015	September 2, 2022	$	85,000		1,610		1,336
$100.0 million term loan (3)	Swap	3.653	%	1-Month LIBOR	January 29, 2016	January 31, 2023	$	100,000		811		413
									$	2,425	$	1,749

(1)

In March 2017, the Company purchased a new interest rate cap agreement for $19,000 related to the loan secured by the Hilton San Diego Bayfront. The new agreement, whose terms are substantially the same as the terms under the old cap agreement, will effectively replace the old agreement on May 1, 2017. The fair values of both Hilton San Diego Bayfront cap agreements are included in other assets, net on the accompanying consolidated balance sheets.

(2)

The fair value of the $85.0 million term loan swap agreement is included in other assets, net on the Company’s consolidated balance sheets. The 1-month LIBOR rate was swapped to a fixed rate of 1.591%.

(3)

The fair value of the $100.0 million term loan swap agreement is included in other assets, net on the Company’s consolidated balance sheets. The 1-month LIBOR rate was swapped to a fixed rate of 1.853%.

Noncash changes in the fair values of the Company’s interest rate derivatives resulted in (decreases) increases to interest expense for the three months ended March 31, 2017 and 2016 as follows (in thousands):


	Three Months Ended		Three Months Ended
	March 31, 2017		March 31, 2016
	(unaudited)		(unaudited)
(Gain) loss on derivatives, net	$	(657)	$	6,402

Fair Value of Debt

As of March 31, 2017 and December 31, 2016, 77.8% and 76.2%, respectively, of the Company’s outstanding debt had fixed interest rates, including the effects of interest rate swap agreements. The Company’s principal value of its consolidated debt totaled $1.0 billion and $0.9 billion as of March 31, 2017 and December 31, 2016, respectively. Using Level 3 measurements, the Company estimates that the fair market value of its debt totaled $1.0 billion and $0.9 billion as of March 31, 2017 and December 31, 2016, respectively.