Fair Value of Financial Instruments

9 Months Ended

Sep. 30, 2011

Fair Value of Financial Instruments

Fair Value of Financial Instruments

12. Fair Value of Financial Instruments

GAAP establishes a hierarchy of valuation techniques based on the observability of inputs utilized in measuring financial instruments at fair values. GAAP establishes market-based or observable inputs as the preferred source of values, followed by valuation models using management assumptions in the absence of market inputs. The three levels of the hierarchy are described below:

Level I - Quoted prices in active markets for identical assets or liabilities.

Level II - Prices are determined using other significant observable inputs. Observable inputs are inputs that other market participants would use in pricing a security. These may include quoted prices for similar securities, interest rates, prepayment speeds, credit risk and others.

Level III - Prices are determined using significant unobservable inputs. In situations where quoted prices or observable inputs are unavailable (for example, when there is little or no market activity for an investment) unobservable inputs may be used. Unobservable inputs reflect our own assumptions about the factors that market participants would use in pricing an asset or liability, and would be based on the best information available.

Any changes to the valuation methodology will be reviewed by our management to ensure the changes are appropriate. The methods used may produce a fair value calculation that is not indicative of net realizable value or reflective of future fair values. Furthermore, while we anticipate that our valuation methods are appropriate and consistent with other market participants, the use of different methodologies, or assumptions, to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. We use inputs that are current as of the measurement date, which may fall within periods of market dislocation, during which price transparency may be reduced.

The following table presents the Company’s financial instruments carried at fair value on a recurring basis in the consolidated balance sheet as of September 30, 2011 (amounts in thousands):

	Fair Value at Reporting Date Using Inputs:
	September 30, 2011
	Total			Level I		Level II			Level III
Loans held-for-sale at fair value	$	121,229							$	121,229
Available-for-sale debt securities:
Residential-mortgage-backed securities	164,393								164,393
Commercial-mortgage-backed securities	187,707								187,707
Total available-for-sale debt securities	352,100			—		—			352,100
Available-for-sale equity securities:
Real estate industry	9,985			$	9,985	—			—
Total available-for-sale equity securities:	9,985			9,985		—			—
Total investments:	483,314			9,985		—			473,329
Derivative Assets:
Foreign exchange contracts	3,588					3,588
Credit contracts	61					61
Derivatives Liabilities:
Interest rate contracts	(12,765		)			(12,765		)
Foreign exchange contracts	(8,297		)			(8,297		)
Total Derivatives:	(17,413		)	—		(17,413		)	—
Total:	$	465,901		$	9,985	$	(17,413	)	$	473,329

The changes in investments classified as Level III are as follows for the nine-months ended September 30, 2011 (amounts in thousands):

Fair Value Measurements Using Significant Unobservable Inputs

(Level III)

	Loans held-for-sale, at fair value			MBS available- for-sale at fair value			Total
Beginning balance, January 1, 2011	$	144,163		$	—		$	144,163
Purchases	—			94,544			94,544
Originations	270,066			—			270,066
Transfer in	(7,000		)	282,763			275,763
Sales	(294,149		)	—			(294,149		)
Settlements	(131		)	(17,474		)	(17,605		)
Net increase on assets	(31,214		)	359,833			328,619
Gain (loss) on loans held-for-sale, at fair value:
Unrealized gain on assets	(1,725		)	(11,952		)	(13,677		)
Realized gain on assets	10,337			—			10,337
Accretion of discount	—			5,111			5,111
OTTI	—			(892		)	(892		)
Other	(332		)	—			(332		)
Net gain on assets	8,280			(7,733		)	547
Ending balance, as of September 30, 2011	$	121,229		$	352,100		$	473,329

The following table presents the Company’s financial instruments carried at fair value on a recurring basis in the consolidated balance sheet as of December 31, 2010 (amounts in thousands):

	Fair Value at Reporting Date Using Inputs:
	December 31, 2010
	Total			Level I		Level II			Level III
Available-for-sale debt securities:
Residential-mortgage-backed securities	$	122,525				$	122,525
Commercial-mortgage-backed securities	275,155					275,155
Loans held-for-sale at fair value	144,163								$	144,163
Total available-for-sale debt securities:	541,843			—		397,680			144,163
Available-for-sale equity securities:
Real estate industry	8,177			$	8,177	—			—
Total available-for-sale equity securities:	8,177			8,177		—			—
Total available-for-sale securities:	550,020			8,177		397,680			144,163
Derivative Assets:
Interest rate contracts	337					337
Derivatives Liabilities:
Interest rate contracts	(2,017		)			(2,017		)
Foreign exchange contracts	(7,383		)			(7,383		)
Total Derivatives	(9,063		)	—		(9,063		)	—
Total:	$	540,957		$	8,177	$	388,617		$	144,163

The changes in investments classified as Level III are as follows for the year ended December 31, 2010 (amounts in thousands):

Beginning balance - January 1, 2010	$		—
Purchases of loans held-for-sale at fair value	144,163
Ending balance - December 31, 2010	$	144,163

During the nine months ended September 30, 2011, we originated various loans that we intend to sell in the short-term. At the time of the origination, we elected to account for these loans at fair value. The associated interest rate and credit spread derivatives were not designated as hedging instruments for accounting purposes. As a result, changes in the fair value of these derivatives are reported in current earnings. It is expected that changes in the fair value of the held-for-sale loans, which will also be recorded through earnings as a result of our fair value election, will materially offset the changes in the fair value of the interest rate and credit spread derivatives. The unpaid principal balance on the loans was $121.2 million at September 30, 2011.

GAAP requires disclosure of fair value information about financial instruments, whether or not recognized in the financial statements, for which it is practical to estimate the value. In cases where quoted market prices are not available, fair values are based upon the estimation of discount rates to estimated future cash flows using market yields or 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 amount we could realize on disposition of the financial instruments. The use of different market assumptions or estimation methodologies could have a material effect on the estimated fair value amounts.

The fair value of cash and cash equivalents, and cash collateral under treasury securities loan agreement accrued interest and accounts payable approximate to their carrying values due to their short-term nature. CMBS and RMBS securities are valued by averaging broker quotes from dealers in those securities as well as other available market data sources as deemed appropriate. Discounted cash flows, credit and tenant review as well as other quantitative and qualitative factors are evaluated to estimate the fair value of our loan portfolio.

The following table presents the fair value of our financial instruments, including loans held in securitization trust, not carried at fair value on the condensed consolidated balance sheet (amounts in thousands):

	Carrying Value as of September 30, 2011		Fair Value as of September 30, 2011		Carrying Value as of December 31, 2010		Fair Value as of December 31, 2010
Financial Instruments not carried at Fair Value:
Loans	$	1,866,358	$	1,895,688	$	1,281,080	$	1,319,979
Other Investments	$	33,530	$	33,530	$	6,000	$	6,000
Financial Liabilities:
Secured financing agreements and collateralized debt obligation in securitization trust	$	657,756	$	657,481	$	633,745	$	637,499