FAIR VALUE

Valuation Allowance and Fair Value Measurement of Loans, Real Estate Held for Sale, Other REO

We perform a valuation analysis of our loans, REO held for sale, other REO and equity investments not less frequently than on a quarterly basis. Evaluating the collectability of a real estate loan is a matter of judgment. We evaluate our real estate loans for impairment on an individual loan basis, except for loans that are cross-collateralized within the same borrowing groups. For cross-collateralized loans within the same borrowing groups, we perform both an individual loan evaluation as well as a consolidated loan evaluation to assess our overall exposure from those loans. In addition to this analysis, we also complete an analysis of our loans as a whole to assess our exposure from loans made in various reporting periods and in terms of geographic diversity. The fact that a loan may be temporarily past due does not necessarily result in a presumption that the loan is impaired. Rather, we consider all relevant circumstances to determine if, and the extent to which, a valuation allowance is required. During the loan evaluation process, we consider the following matters, among others:


•	an estimate of the net realizable value of any underlying collateral in relation to the outstanding mortgage balance, including accrued interest and related costs;


•	the present value of cash flows we expect to receive;


•	the date and reliability of any valuations;


•	the financial condition of the borrower and any adverse factors that may affect its ability to pay its obligations in a timely manner;


•	prevailing economic conditions;


•	historical experience by market and in general; and


•	an evaluation of industry trends.

Impairment for 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. In the case of the loans that are not deemed to be collateral dependent, we measure impairment based on the present value of expected future cash flows.

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 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 operating properties or properties to be held and used, and such assets were deemed to be held for sale, we may record additional impairment charges, and the amounts 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 the 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 properties or loans for which we (or the borrower) have received a bona fide written third-party offer (or entered into a purchase and sale agreement) to buy the related property, we generally utilize the offer or agreement amount even where the amount is outside our current valuation range, as offers and purchase agreements are considered lower (Level 2) inputs. 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, REO held for sale and other REO assets vary by stage of completion, which consists of either raw land (also referred to as pre-entitled land), entitled land, partially developed land, or mostly developed/completed lots or projects. While we continue to utilize third party valuations for selected assets on a periodic basis as circumstances warrant, we rely primarily on our outside 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 based on assumptions that we believe market participants for those assets would also use. During the years ended December 31, 2018 and 2017, we performed both a macro analysis of market trends and economic estimates, as well as a detailed analysis on selected significant REO assets. In addition, our fair value analysis included a consideration of management’s pricing strategy in disposing of such assets.

The following is a summary of the procedures performed in connection with our fair value analysis as of and for the years ended December 31, 2018 and 2017:


1.	We reviewed the status of each of our loans and related collateral to ascertain the likelihood of collecting or recovering all amounts due under the terms of the loans at maturity based on 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, operating properties or other REO as of the reporting date.

For the years ended December 31, 2018 and 2017, we performed an internal analysis to evaluate fair value for the balance of the portfolio not covered by third-party valuation reports or existing offers or purchase and sale agreements. Our internal analysis of fair value included a review and update of current market participant activity, overall market conditions, the current status of the property, our direct knowledge of local market activity affecting the property, as well as other market indicators obtained through our asset management group and various 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 our previous analysis for such assets. Our asset-specific analysis focused on the higher valued assets of our total 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 connection with the consolidation of the New Mexico partnerships, during the year ended December 31, 2017, as described in Note 6, we estimated the fair value of assets and liabilities. The fair value of assets, which are primarily comprised of land and/or related rights to develop water, was based on recently prepared valuation reports and other available market data with respect to the land and water development rights, with consideration given to, and value adjusted for, management’s disposition strategy for such assets. The gross value was reduced by the estimated amount of selling costs, repair cost estimates to ready such assets for sale, and contingent liabilities due upon sale. The fair value of liabilities was based on the anticipated settlement amount of such liabilities.

For properties for which we or our borrower has received a bona fide written third-party offer or entered into a purchase and sale agreement to buy our loan or REO asset, we generally utilized the offer or agreement amount in those cases where that amount falls outside our current valuation conclusion. Such offers or agreements are only considered if we deem them to be valid, reasonable and negotiable, and we believe the counter-party has the financial wherewithal to execute the transaction.

Following is a table summarizing the methods used by management in estimating fair value as of December 31, 2018 and 2017:



	December 31, 2018
	% of Carrying Value
	Mortgage Loans, Net			Real Estate Held for Sale			Other REO
Basis for valuation	#	Percent		#	Percent		#	Percent
Third party valuations	1	16.7	%	1	12.5	%	0	—	%
Third party offers	0	—	%	3	37.5	%	1	12.5	%
Management analysis	5	83.3	%	4	50.0	%	7	87.5	%
Total portfolio	6	100.0	%	8	100.0	%	8	100.0	%



	December 31, 2017
	% of Carrying Value
	Mortgage Loans, Net			Real Estate Held for Sale			Other REO
Basis for valuation	#	Percent		#	Percent		#	Percent
Third party valuations	2	50.0	%	1	50.0	%	0	—	%
Third party offers	0	—	%	1	50.0	%	4	26.7	%
Management analysis	2	50.0	%	0	—	%	11	73.3	%
Total portfolio	4	100.0	%	2	100.0	%	15	100.0	%

As of December 31, 2018 and 2017, the highest and best use for the majority of our real estate collateral, REO held for sale and other REO was deemed to be held for investment and/or future development, rather than being subject to immediate development.

A summary of the valuation approaches taken and key assumptions that we utilized to derive fair value, is as follows:



	December 31, 2018
	% of Carrying Value
	Mortgage Loans, Net			Real Estate Held for Sale			Other REO
Valuation methodology	#	Percent		#	Percent		#	Percent
Comparable sales (as-is)	6	100.0	%	5	62.5	%	7	87.5	%
Development approach	—	—	%	—	—	%	—	—	%
Income capitalization approach	—	—	%	—	—	%	—	—	%
Third party offers	—	—	%	3	37.5	%	1	12.5	%
Total portfolio	6	100.0	%	8	100.0	%	8	100.0	%



	December 31, 2017
	% of Carrying Value
	Mortgage Loans, Net			Real Estate Held for Sale			Other REO
Valuation methodology	#	Percent		#	Percent		#	Percent
Comparable sales (as-is)	4	100.0	%	1	50.0	%	11	73.3	%
Development approach	—	—	%	—	—	%	—	—	%
Income capitalization approach	—	—	%	—	—	%	—	—	%
Third party offers	—	—	%	1	50.0	%	4	26.7	%
Total portfolio	4	100.0	%	2	100.0	%	15	100.0	%

For properties that included either unentitled or entitled raw land lacking any vertical or horizontal improvements the development approach was deemed to be unsupportable because market participant data was insufficient or other assumptions were not readily available. In such cases, the “highest and best use” standard required such property to be classified as “held for investment” purposes until market conditions provide observable development activity to support a valuation model for the development of the planned site. As a result, we utilized a sales comparison approach using available data to determine fair value.

Selection of Single Best Estimate of Value

The results of our valuation efforts generally provide a range of values for the collateral valued or REO assets rather than a single value. 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 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.

Fair Value Measurements of Derivative Instrument

As described in Note 7, during the year ended December 31, 2018, we purchased an interest rate cap in order to mitigate our risk on variable debt against rising interest rates. In order to estimate the fair value of this derivative instrument, we use valuation reports from the third party broker who issued the derivative instrument. The report contemplates fair value by using inputs, including market-observable data such as U.S dollar and foreign-denominated interest rate curves, foreign exchange rates, volatilities, and information derived from or corroborated by that market-observable data which are classified as Level 2 inputs in the fair value hierarchy. The fair value method does not contemplate credit valuation adjustments (“CVA”) which would be a Level 3 input as the CVA uses credit spreads which are generally unobservable to the market. The fair value used in these financial statements approximate fair value without the CVA. As of December 31, 2018, the fair value of the interest rate cap approximated $0.3 million and we recorded an unrealized loss on derivative instruments of $0.2 million during the year ended December 31, 2018.

Fair Value Measurements of Equity Securities

As described elsewhere in this Form 10-K, during the year ended December 31, 2018, we issued 2,352,941 shares of Series B-3 Preferred Stock and a detachable warrant to purchase 600,000 shares of common stock (the “Chase Warrant”). We also issued 22,000 shares of Series A Preferred Stock. In order to estimate the fair value of the securities issued in these transactions pursuant to applicable accounting guidance, we engaged a third party valuation firm to assist us in our fair value assessment as our securities are not traded on an open exchange. In estimating fair value, the valuation firm considered the negotiated terms of these transactions, utilized certain current and prospective financial and operational data provided by management, obtained financial and other data from various public, financial and industry sources, and evaluated applicable economic and industry conditions as of the valuation date and their effects on the Company. Based on this valuation assessment, management estimated the fair value of the equity securities issued or granted in connection with the transaction completed February 9, 2018 for the Series B-3 Preferred Stock and May 31, 2018 for the Series A Preferred Stock as follows:



Subject securities	Estimated Fair Value per Share
Series B-3 Preferred Stock	$	4.12
Series A Preferred Stock	$	1,000.00
Chase Warrant	$	1.52

We accounted for the issuance of the Series B-3 Preferred Stock and the Chase Warrant in accordance with applicable accounting guidance, under which we allocated the $8.0 million investment amount in proportion to the relative fair value of the Series B-3 Preferred Stock and the Chase Warrant. As described below, the fair value of the Chase Warrant was estimated at $0.9 million at date of issuance. However, the allocated relative fair value of the warrants of $0.7 million was recorded as additional paid-in capital with an offsetting discount to the Series B-3 Preferred Stock during the year ended December 31, 2018. The Chase Warrant has an exercise price of $2.25, a contractual term of 2 years and are not exercisable until February 9, 2021.

The fair value of the Chase Warrant was derived from the Black-Scholes valuation model, which is based on the exercise price of the award and other assumptions relating to expected dividend yield, expected stock price volatility, risk-free interest rate, and expected life of options granted. Expected volatility is based on the historical volatility of our peer companies’ stock for the length of time corresponding to the expected term of the warrants. The expected dividend yield is based on our historical and projected dividend payments. The risk-free interest rate is based on the U.S. treasury yield curve on the grant date for the expected term of the option or warrant. A summary of these applicable factors used in the valuation follows:



Expected stock price volatility	40	%
Risk-free interest rate	2	%
Expected life of warrants (in years)	3
Expected dividend yield	N/A
Common Stock value discount for lack of marketability	25	%

Valuation Conclusions

Based on the results of our evaluation and analysis, we did not record any non-cash provision for credit losses on our loan portfolio during the years ended December 31, 2018 and 2017. However, we recorded other net recoveries of investment and credit losses totaling $2.0 million and $6.5 million for the years ended December 31, 2018 and 2017, respectively, resulting from (i) the receipt of cash and/or other assets from guarantors on certain legacy loans, (ii) insurance recoveries, and (iii) additional provisions for credit losses.

The Company recorded losses on impairment of REO of $0.6 million and $0.7 million during the years ended December 31, 2018 and 2017, respectively, to reflect current market conditions and management’s decision to implement a more aggressive pricing strategy to sell the related REO.

As of December 31, 2018, the valuation allowance totaled $13.1 million, representing 37.1% of the total outstanding loan principal and accrued interest balances. As of December 31, 2017, the valuation allowance totaled $12.7 million, representing 39.2% of the total outstanding loan principal and accrued interest balances. With the existing valuation allowance recorded as of December 31, 2018, 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 December 31, 2018 based on currently available data, we will continue to evaluate our loans and REO assets to determine the appropriateness of the carrying value of such assets. 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

A summary of our assets measured at fair value on a nonrecurring basis as of December 31, 2018 for which losses were recorded during the year ended December 31, 2018 follows (in thousands):



Description	December 31, 2018		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Impairment Charges
REO held for sale	$	—	$	2,760	$	—	$	581
Derivatives	$	—	$	329	$	—	$	218

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 or internal assessment for valuation purposes.