FAIR VALUE

Valuation Allowance and Fair Value Measurement of Loans and Real Estate Owned

Our valuation analysis processes and procedures are disclosed in our previously filed Annual Report on Form 10-K for the fiscal year ended December 31, 2015. We perform a valuation analysis of our loans, REO held for sale and other REO not less frequently than on a quarterly basis. We consider all relevant, material circumstances to determine if, and the extent to which, a valuation allowance is required.

Impairment for our collateral dependent loans is measured at the balance sheet date based on the then fair value of the collateral in relation to contractual amounts due under the terms of the applicable loan if foreclosure is probable. Substantially all of our loans are deemed to be collateral dependent.

REO assets that are classified as held for sale and Other REO are measured at the lower of carrying amount or fair value, less estimated cost to sell. REO assets that are classified as operating properties or held for development are considered “held and used” and are evaluated for impairment when circumstances indicate that the carrying amount exceeds the sum of the undiscounted net cash flows expected to result from the development or operation and eventual disposition of the asset. If an asset is considered impaired, an impairment loss is recognized for the difference between the asset’s carrying amount and its fair value, less estimated cost to sell. If we elect to change the disposition strategy for our real estate held for development, and such assets were deemed to be held for sale, we may record additional impairment charges, and the amount of such charges could be significant.

We assess the extent, reliability and quality of market participant inputs such as sales pricing, cost data, absorption, discount rates, and other assumptions, as well as the significance of such assumptions in deriving valuation. We generally employ one of four valuation approaches (as applicable), or a combination of such approaches, in determining the fair value of the underlying collateral of each loan, REO held for sale and Other REO asset: (i) the development approach; (ii) the income capitalization approach; (iii) the sales comparison approach; or (iv) the receipt of recent offers on specific properties. The valuation approach taken depends on several factors including:


•	the type of property;


•	the current status of entitlement and level of development (horizontal or vertical improvements) of the respective project;


•	the likelihood of a bulk sale as opposed to individual unit sales;


•	whether the property is currently or near ready to produce income;


•	the current sales price of property in relation to cost of development;


•	the availability and reliability of market participant data; and


•	the date of an offer received in relation to the reporting period.

With respect to projects for which we have received a bona fide written third-party offer (or have executed a purchase and sale agreement) to buy our real estate or loan, or we or the borrower has received a bona fide written third-party offer (or has executed a purchase and sale agreement) to buy the related project, we generally utilize the offer or agreement amount even where the amount is outside our current valuation range. An offer or agreement is only considered for valuation purposes if we deem it to be valid, reasonable, negotiable, and we believe the counterparty has the financial wherewithal to execute the transaction. When deemed appropriate, the offers received may be discounted to allow for potential changes in our on-going negotiations.

Factors Affecting Valuation

The underlying collateral of our loans and our REO varies by stage of completion, which consists of either raw land (also referred to as pre-entitled land), entitled land, partially developed, or mostly developed/completed lots or projects. While we may engage outside independent third-party valuation firms on a periodic, as-needed basis to provide complete valuation reports for certain of our larger loans and REO assets, we rely primarily on our asset management consultants and internal staff to gather available market participant data from independent sources to establish assumptions used to derive fair value of the collateral supporting our loans and real estate owned for a majority of our loan and REO assets.

Our fair value measurement is based on the highest and best use of each property which is generally consistent with our current use for such property. In addition, our assumptions are consistent with those that we believe market participants for those assets would also use. During the quarter ended September 30, 2016, we performed both a macro analysis of market trends and economic estimates, as well as a detailed analysis on selected significant loan and REO assets.

The following is a summary of the procedures performed in connection with our fair value analysis as of and for the period ended September 30, 2016:


1.	We reviewed the status of each of our loans to ascertain the likelihood that we will collect all amounts due under the terms of the loans at maturity based on review of loan status and current real estate and credit market conditions.


2.	We reviewed the status of each of our REO assets to determine whether such assets continue to be properly classified as held for sale, held for development, operating properties or as other real estate owned as of the reporting date.

For the period ended September 30, 2016, given the lack of significant change in overall general market conditions since December 31, 2015 of our real estate asset portfolio, we performed an internal analysis to evaluate fair value of our portfolio. Our internal analysis of fair value included a review and update of current market participant activity, analysis of overall market conditions, the current status of any project related to that asset, our direct knowledge of local market activity affecting any such project, as well as other market indicators observed by our asset management group and third parties to determine whether there were any indications of a material increase or decrease in the value of the underlying collateral or REO asset since the last complete valuation for such asset. Our asset-specific analysis focused on the higher valued assets of our loan collateral and REO portfolio. We considered the results of our analysis and the potential valuation implication to the balance of the portfolio based on similar asset types and geographic location.

In addition, in those instances where we have received a bona fide written third-party offer to buy our loans or REO assets (or have executed a purchase and sale agreement), or the borrower has received a bona fide written third-party offer to buy the related project (or has executed a purchase and sale agreement), we generally utilized the purchase price in such offer or agreement regardless of whether that amount is within or outside our current valuation range. An offer or agreement is only considered if we deem it to be valid, reasonable and negotiable, and we believe the counterparty has the financial wherewithal to execute the transaction.

Based on our analysis, the valuation approach taken and assumptions utilized with respect to each asset at December 31, 2015 remained generally applicable at September 30, 2016, except for those assets subject to a recent bona fide written third-party offer or executed purchase and sales agreements. See our previously filed Annual Report on Form 10-K for the fiscal year ended December 31, 2015 for a summary of the key assumptions and valuation methodologies utilized to derive fair value.

Selection of Single Best Estimate of Value

We have historically obtained periodic valuation reports from third-party valuation specialists, consultants and/or from our internal asset management department for the underlying collateral of our loans and REO assets. The results of our valuation efforts generally provide a range of values for the collateral valued rather than a single point estimate because of variances in the potential value indicated from the available sources of market participant information. The selection of a value from within a range of values depends upon general overall market conditions as well as specific market conditions for each property valued and its stage of entitlement or development. In addition to third-party valuation reports, we utilize recently received bona fide purchase offers from independent third-party market participants or executed purchase and sale agreements that may be outside of the range of values indicated by the report from the third-party valuation specialist. In selecting the single best estimate of value, we consider the information in the valuation reports, credible purchase offers received and agreements executed, as well as multiple observable and unobservable inputs.

Valuation Conclusions

Based on the results of our evaluation and analysis, during the three and nine months ended September 30, 2016 and the three months ended September 30, 2015, we did not record any non-cash provision for credit losses on our loan portfolio. During the nine months ended September 30, 2015, we recorded a non-cash recovery of prior credit losses on our loan portfolio of $0.5 million. In addition, we recorded other net recoveries of credit losses of $0.1 million and $1,000 for the three months ended September 30, 2016 and 2015, respectively, relating to the collection of cash and other assets from guarantors on certain legacy loans, and $0.2 million and $10.7 million for the nine months ended September 30, 2016 and 2015, respectively. We did not record any impairment charges for real estate owned during the three or nine months ended September 30, 2016. During the three and nine months ended September 30, 2015 we recorded impairment charges of zero and $0.1 million, respectively.

As of September 30, 2016 and December 31, 2015, the valuation allowance totaled $12.7 million and $12.9 million, respectively, representing 97.2% and 53.6%, respectively, of the total outstanding loan principal and accrued interest balances. Based on the valuation and impairment allowance recorded as of September 30, 2016, we believe that, as of that date, the fair value of our loans, REO assets held for sale and Other REO is adequate in relation to the net carrying value of the related assets and that no additional valuation allowance or impairment is considered necessary. While the above results reflect management’s assessment of fair value as of September 30, 2016 based on currently available data, we will continue to evaluate our loan and REO portfolio to determine the adequacy and appropriateness of the valuation allowance and/or carrying value. Depending on market conditions, such updates may yield materially different values and potentially increase or decrease the valuation allowance for loans or impairment charges for REO assets.

Valuation Categories

There were no losses recorded during the three or nine months ended September 30, 2016 or 2015 in the categories for which net mortgage loans and REO held for sale were measured at fair value on a non-recurring basis based upon the lowest level of significant input to the valuation as of September 30, 2016 or 2015.

Additionally, there were no assets that were measured at fair value using Level 2 inputs for which any losses were recorded during the three or nine months ended September 30, 2016 or 2015. Generally, all of our mortgage loans, REO held for sale and other REO are valued using significant unobservable inputs (Level 3) obtained through updated analysis prepared by our asset management staff, except for such assets for which third party offers or executed purchase and sale agreements were used, which are considered Level 2 inputs. Changes in the use of Level 3 valuations are based solely on whether we utilized third party offers for valuation purposes.