FAIR VALUE OF FINANCIAL INSTRUMENTS

3 Months Ended

Mar. 31, 2013

FAIR VALUE OF FINANCIAL INSTRUMENTS

FAIR VALUE OF FINANCIAL INSTRUMENTS

9. FAIR VALUE OF FINANCIAL INSTRUMENTS

The Company follows ASC 820-10, which expands the application of fair value accounting. ASC 820-10 defines fair value, establishes a framework for measuring fair value in accordance with GAAP and expands disclosure of fair value measurements. ASC 820-10 determines fair value to be the price that would be received for an investment in a current sale, which assumes an orderly transaction between market participants on the measurement date. The only financial instrument recorded at fair value on a recurring basis in the Company’s consolidated financial statements is a derivative instrument. The Company has not elected the fair value option for the remaining financial instruments, including loans held for investment, secured funding agreements and other debt instruments. Such financial instruments are carried at cost. ASC 820-10 specifies a hierarchy of valuation techniques based on the inputs used in measuring fair value. In accordance with ASC 820-10, these inputs are summarized in the three broad levels listed below:

The three levels of inputs that may be used to measure fair value are as follows:

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 at the end of the period), unobservable inputs may be used.

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 application of discount rates to estimated future cash flows using market yields, or other valuation methodologies. Any changes to the valuation methodology will be reviewed by the Company’s 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 the Company anticipates that the 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. The Company uses inputs that are current as of the measurement date, which may fall within periods of market dislocation, during which price transparency may be reduced.

Financial Instruments reported at fair value

The Company has certain assets and liabilities that are required to be recorded at fair value on a recurring basis in accordance with GAAP, including a derivative instrument. The Company did not have any other financial instruments at March 31, 2013 or December 31, 2012 that were required to be carried at fair value. The carrying values of cash and cash equivalents, restricted cash, interest receivable and accrued expenses approximate their fair values due to their short-term nature.

The following table summarizes the levels in the fair value hierarchy into which the Company’s financial instruments were categorized as of March 31, 2013 (in thousands):

	Fair Value as of March 31, 2013
	Level I		Level II		Level III		Total
Derivative instrument	$	-	$	-	$	2,223	$	2,223

The following table summarizes the levels in the fair value hierarchy into which the Company’s financial instruments were categorized as of December 31, 2012 (in thousands):

	Fair Value as of December 31, 2012
	Level I		Level II		Level III		Total
Derivative instrument	$	-	$	-	$	1,825	$	1,825

The valuation of derivative instruments are determined using widely accepted valuation techniques, including market yield analysis and discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs to the extent available, including interest rate curves, spot and market forward points.

The following table summarizes the significant unobservable inputs the Company used to value the derivative liability categorized within Level III as of March 31, 2013 (in thousands).

				Unobservable Input
	Fair		Primary			Weighted
Asset Category	Value		Valuation Technique	Input	Range	Average
Derivative liability	$	2,223	Option Pricing Model	Volatility	16.3% - 17.0%	16.3%

The following table summarizes the significant unobservable inputs the Company used to value the derivative liability categorized within Level III as of December 31, 2012 (in thousands).

			Unobservable Input
Asset Category	Fair Value	Primary Valuation Technique	Input	Range	Weighted Average
Derivative liability	$1,825	Option Pricing Model	Volatility	16.4% - 17.4%	16.4%

The tables above are not intended to be all-inclusive, but instead are intended to capture the significant unobservable inputs relevant to the Company’s determination of fair values.

Changes in market yields, discount rates or EBITDA multiples, each in isolation, may change the fair value of the derivative liability. Generally, an increase in market yields or discount rates or decrease in EBITDA multiples may result in a decrease in the fair value of the derivative liability.

Due to the inherent uncertainty of determining the fair value of derivative liabilities that do not have a readily available market value, the fair value of the Company’s derivative liability may fluctuate from period to period. Additionally, the fair value of the Company’s derivative liability may differ significantly from the values that would have been used had a ready market existed for such derivative liability.

The change in the derivative instrument classified as Level III is as follows for the three months ended March 31, 2013 (in thousands):

	Level III Derivative Instrument
Beginning balance, as of December 31, 2012	$	(1,825	)
Unrealized gain (loss) on derivative	(398		)
Ending balance, as of March 31, 2013	$	(2,223	)

The unrealized gain (loss) on derivatives is included in “other interest expense” on the consolidated statement of operations for the three months ended March 31, 2013.

The following table presents the carrying values and fair values of the Company’s financial assets and liabilities recorded at cost as of March 31, 2013 and December 31, 2012. Changes in market yields, credit quality and other variables may change the fair value of the Company’s assets and liabilities. All financial assets and liabilities recorded at cost are considered Level III financial instruments (in thousands).

	As of March 31, 2013		As of December 31, 2012
	Carrying Value	Fair Value	Carrying Value	Fair Value
Financial instruments not recorded at fair value:
Loans held for investment	$   409,943	$   409,943	$  353,500	$   353,500
Financial liabilities:
Secured financing agreements	200,050	200,050	144,256	144,256
Convertible notes	67,411	67,411	67,289	67,289