4. Fair Value of Investments

The “Fair Value Measurements and Disclosures” Topic of the FASB ASC defines fair value, establishes a framework for measuring fair value, and requires certain disclosures about fair value measurements under U.S. GAAP. Specifically, this guidance defines fair value based on exit price, or the price that would be received upon the sale of an asset or the transfer of a liability in an orderly transaction between market participants at the measurement date. Fair value under U.S. GAAP represents an exit price in the normal course of business, not a forced liquidation price. If the Company was forced to sell assets in a short period to meet liquidity needs, the prices it receives could be substantially less than their recorded fair values.

The Company follows the fair value measurement and disclosure guidance under U.S. GAAP, which establishes a hierarchical disclosure framework. This framework prioritizes and ranks the level of market price observability used in measuring investments at fair value. Market price observability is affected by a number of factors, including the type of investment, the characteristics specific to the investment and the state of the marketplace including the existence and transparency of transactions between market participants. Investments with readily available active quoted prices or for which fair value can be measured from actively quoted prices in an orderly market generally will have a higher degree of market price observability and a lesser degree of judgment used in measuring fair value. In all cases, an instrument’s level within the hierarchy is based upon the market pricing transparency of the instrument and does not necessarily correspond to the Company’s perceived risk or liquidity of the instrument.

The Company considers observable data to be market data which is readily available, regularly distributed or updated, reliable and verifiable, not proprietary, and provided by independent sources that are actively involved in the relevant market. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the determination of which category within the fair value hierarchy is appropriate for any given investment is based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires significant judgment and considers factors specific to the investment.

Assets and liabilities that are measured and reported at fair value are classified and disclosed in one of the following categories:

Level 1 — Fair value is determined based on quoted prices for identical assets or liabilities in an active market. Assets and liabilities included in Level 1 include listed securities. As required in the fair value measurement and disclosure guidance under U.S. GAAP, the Company does not adjust the quoted price for these investments. The hierarchy gives highest priority to Level 1.

Level 2 — Fair value is determined based on inputs other than quoted prices that are observable for the asset or liability either directly or indirectly as of the reporting date. Assets and liabilities which are generally included in this category include corporate bonds and loans, less liquid and restricted equity securities and certain over-the-counter derivatives, including foreign exchange forward contracts whose values are based on the following:

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Quoted prices for similar assets or liabilities in active markets.

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Quoted prices for identical or similar assets or liabilities in non-active markets.

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Pricing models whose inputs are observable for substantially the full term of the asset or liability.

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Pricing models whose inputs are derived principally from or corroborated by observable market data for substantially the full term of the asset or liability.

Level 3 — Fair value is determined based on inputs that are unobservable for the investment and includes situations where there is little, if any, market activity for the asset or liability. The inputs into the determination of fair value require significant management judgment or estimation and the Company may use models or other valuation methodologies to arrive at fair value. Investments that are included in this category generally include distressed debt, less liquid corporate debt securities, non-investment grade residual interests in securitizations, collateralized debt obligations and certain derivative contracts. The hierarchy gives the lowest priority to Level 3.

The Company has established a valuation process that applies for all levels of investments in the valuation hierarchy to ensure that the valuation techniques are consistent and verifiable. The valuation process includes discussions between the valuation team, portfolio management team and the valuation committee (the “Valuation Committee”). The Valuation Committee consists of senior members of ZAIS Group and is co-chaired by the Chief Risk Officer and Chief Financial Officer of ZAIS Group. The Valuation Committee meets to review and approve the results of the valuation process which are used in connection with the preparation of quarterly and annual financial statements. The Valuation Committee is responsible for oversight and review of the written valuation policies and procedures and ensuring that they are applied consistently.

The lack of an established, liquid secondary market for some of the Company’s holdings may have an adverse effect on the market value of those holdings and on the Company’s ability to dispose of them. Additionally, the public markets for the Company’s holdings may experience periods of volatility and periods of reduced liquidity and the Company’s holdings may be subject to certain other transfer restrictions that may further contribute to illiquidity. Such illiquidity may adversely affect the price and timing of liquidations of the Company’s holdings.

The following is a description of the valuation techniques used to measure fair value and the classification of these instruments pursuant to the fair value hierarchy:

Investments in affiliated funds and securities

The Company measures the fair value of its investments in affiliated funds and securities at the net asset value per share (or its equivalent) (“NAV”). If the investment can be redeemed at its NAV at the measurement date, the Company classifies the investment as Level 2. If the investment cannot be redeemed at its NAV as of the measurement date but the investment may be redeemable at a future date, the Company considers the length of time until the investment will become redeemable in determining whether to classify the investment as Level 2 or Level 3. Net gains or losses on investments in affiliated funds and securities are included in net gain (loss) on investments in the consolidated statements of comprehensive income (loss).

Investments

The Company determines the fair value of investments in short term high investment grade mutual funds using quoted market prices and, accordingly, the Company classifies these investments as Level 1. Net gains or losses on investments are included in net gain (loss) on investments in the consolidated statements of comprehensive income (loss).

Collateralized Loan Obligation – Warehouse

A Collateralized Loan Obligation Warehouse (the "CLO - Warehouse") was organized for the purpose of holding syndicate bank loans, also known as leveraged loans, during the warehouse period of an impending collateralized loan obligation vehicle. During the warehouse period, the CLO - Warehouse will secure investments and build a portfolio of primarily leveraged loans and other debt obligations. The warehouse period terminates when the collateralized loan obligation vehicle closes; at this time the underlying assets held by the CLO - Warehouse are securitized into a collateralized loan obligation vehicle and the underlying loans will be transferred in at their original cost.

The fair value of the CLO - Warehouse is determined by adding the excess spread (accrued interest plus interest received less financing cost) to the CLO - Warehouse equity contribution made by the Consolidated Fund, unless ZAIS Group determines that the securitization period will not be achieved, in which case, the fair value of the CLO - Warehouse will be established based on the fair value of the underlying bank loan positions which are valued in a manner consistent with ZAIS Group’s valuation policy and procedures. The net excess spread was 5.1% and 1.7% as of March 31, 2016 and December 31, 2015, respectively. Changes in the fair value of the CLO - Warehouse are reported in net gains (losses) of Consolidated Funds’ investments in the consolidated statements of comprehensive income (loss).

Investment in Affiliates

Under U.S. GAAP, the Company is permitted, as a practical expedient, to estimate the fair value of its investments in other investment companies using the NAV (or its equivalent) of the related investment company. Accordingly, the Company utilizes the practical expedient in valuing its investments in the unconsolidated ZAIS Managed Entities, which is an amount equal to the sum of the Company’s proportionate interest in the capital accounts of the affiliated funds at fair value. The fair value of the assets and liabilities of the ZAIS Managed Entities are determined by the Company in accordance with its valuation policies described above. The resulting net gains or losses on investments are included in net gain (loss) on investments in the consolidated statements of comprehensive income (loss).

At March 31, 2016 and December 31, 2015, the Company held investments in five unconsolidated ZAIS Managed Entities. The valuation of the investments in these entities represents the amount the Company would receive at March 31, 2016 and December 31, 2015, respectively, if it were to liquidate its investments in these entities. ZAIS Group has the ability to liquidate its investments according to the provisions of the respective entities’ operative agreements.

The following table summarizes the Company’s assets and liabilities measured at fair value on a recurring basis within the fair value hierarchy levels at March 31, 2016:

	March 31, 2016
	( Dollars in thousands )
	Level 1		Level 2		Level 3		Total
Assets, at fair value
Investments in affiliates	$	—	$	5,182	$	—	$	5,182
Investments, at fair value
CLO – Warehouse		—		—		42,026		42,026
Total investments, at fair value		—		—		42,026		42,026
Total assets, at fair value	$	—	$	5,182	$	42,026	$	47,208

The following table summarizes the Company’s assets and liabilities measured at fair value on a recurring basis within the fair value hierarchy levels at December 31, 2015:

	December 31, 2015
	( Dollars in thousands )
	Level 1		Level 2		Level 3		Total
Assets, at fair value
Investments in affiliates	$	—	$	5,242	$	—	$	5,242
Investments, at fair value
Short term high investment grade mutual funds		8,169		—		—		8,169
CLO – Warehouse		—		—		30,509		30,509
Total investments, at fair value		8,169		—		30,509		38,678
Total assets, at fair value	$	8,169	$	5,242	$	30,509	$	43,920

The following table summarizes the changes in the Company’s Level 3 assets and liabilities for the three months ended March 31, 2016:

	March 31, 2016
	( Dollars in thousands )
	Beginning Balance January 1, 2016		Purchases/ Issuances		Sales/ Redemptions/ Settlements		Total Realized and Change in Unrealized Gains (Losses)		Transfers to (from) Level 3		Ending Balance March 31, 2016		Change in Unrealized Gains/Losses Relating to Assets and Liabilities Still Held at March 31, 2016
CLO - Warehouse	$	30,509	$	10,000	$	—	$	1,517	$	—	$	42,026	$	1,517
Total assets, at fair value	$	30,509	$	10,000	$	—	$	1,517	$	—	$	42,026	$	1,517

The following table summarizes the changes in the Company’s Level 3 assets and liabilities for the year ended December 31, 2015:

	December 31, 2015
	( Dollars in thousands )
	Beginning Balance January 1, 2015		Purchases/ Issuances		Sales/ Redemptions/ Settlements		Total Realized and Change in Unrealized Gains (Losses)		Transfers to (from) Level 3		Ending Balance December 31, 2015		Change in Unrealized Gains/Losses Relating to Assets and Liabilities Still Held at December 31, 2015
CLO - Warehouse	$	—	$	30,000	$	—	$	509	$	—	$	30,509	$	509
Total assets, at fair value	$	—	$	30,000	$	—	$	509	$	—	$	30,509	$	509

The Company records transfers between Level 1, Level 2 and Level 3, if any, at the beginning of the period.

There were no transfers between Level 1, Level 2 and Level 3 during the three months ended March 31, 2016 and the year ended December 31, 2015.