Note 6. Fair Value Measurements

The Company adopted the provisions of ASC 820, Fair Value Measurement (“ASC 820”), which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. ASC 820 established a fair value hierarchy that prioritizes and ranks the level of market price observability used in measuring investments at fair value. Market price observability is impacted 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, actively quoted prices or for which fair value can be measured from actively quoted prices in an orderly market will generally have a higher degree of market price observability and a lesser degree of judgment used in measuring fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). Investments measured and reported at fair value are classified and disclosed into one of the following categories based on the inputs as follows:

Level 1 — Quoted prices (unadjusted) in active markets for identical assets and liabilities that the Company has the ability to access.

Level 2 — Pricing inputs are other than quoted prices in active markets, including, but not limited to, quoted prices for similar assets and liabilities in markets that are active, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the assets or liabilities (such as interest rates, yield curves, volatilities, prepayment speeds, loss severities, credit risks and default rates) or other market corroborated inputs.

Level 3 — Significant unobservable inputs are based on the best information available in the circumstances, to the extent observable inputs are not available, including the Company’s own assumptions used in determining the fair value of investments. Fair value for these investments are determined using valuation methodologies that consider a range of factors, including but not limited to the price at which the investment was acquired, the nature of the investment, local market conditions, trading values on public exchanges for comparable securities, current and projected operating performance, and financing transactions subsequent to the acquisition of the investment. The inputs into the determination of fair value require significant management judgment.

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an investment’s level within the fair value hierarchy 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 judgment, and considers factors specific to the investment.

As of March 31, 2020 and December 31, 2019, the Company has not elected the fair value option for its financial instruments, including loans held for investment, loans held for investment acquired through participation, obligations under participation agreements, mortgage loan payable, repurchase agreement payable and revolving credit facility payable. Such financial instruments are carried at cost, less impairment. Marketable securities are financial instruments that are reported at fair value.

Financial Instruments Carried at Fair Value on a Recurring Basis

In March 2020, the Company invested $3.4 million in short-term debt and equity securities. These securities are comprised of preferred stock and bonds. The Company classified these short-term marketable securities as available-for-sale securities, which are presented at fair value on the consolidated balance sheet with the change in fair value reported in other comprehensive income until the securities are realized.

The following tables present fair value measurements of marketable securities, by major class, as of March 31, 2020, according to the fair value hierarchy:



	March 31, 2020
	Fair Value Measurements
	Level 1		Level 2		Level 3		Total
Marketable Securities:
Preferred stock	$	1,028,189	$	—	$	—	$	1,028,189
Bonds	—		2,462,205		—		2,462,205
Total	$	1,028,189	$	2,462,205	$	—	$	3,490,394

The following table presents the activities of the marketable securities for the periods presented.



	Three Months Ended March 31,
	2020			2019
Beginning balance	$	—		$	—
Purchases	3,354,442			—
Proceeds from sale	(48,073		)	—
Net unrealized gains on marketable securities	192,919			—
Reclassification of realized gains ⁽²⁾	(8,894		)	—
Ending balance	$	3,490,394		$	—

_______________


(1)	Amount is presented as Net unrealized gains on marketable securities on the consolidated statements of comprehensive income.


(2)	Amount is presented as realized gains on marketable securities on the consolidated statements of operations.

Financial Instruments Not Carried at Fair Value

The following table presents the carrying value, which represents the principal amount outstanding, adjusted for the accretion of purchase discounts on loans and exit fees, and the amortization of purchase premiums on loans and origination fees, and estimated fair value of the Company’s financial instruments that are not carried at fair value on the consolidated balance sheets:



		March 31, 2020							December 31, 2019
	Level	Principal Amount		Carrying Value			Fair Value		Principal Amount		Carrying Value		Fair Value
Loans:
Loans held for investment, net	3	$	398,694,704	$	400,076,940		$	395,581,145	$	374,267,430	$	375,462,222	$	375,956,154
Loans held for investment acquired through participation, net	3	3,992,734		4,037,567			4,028,233		3,120,887		3,150,546		3,204,261
Allowance for loan losses		—		(1,144,994		)	—		—		—		—
Total loans		$	402,687,438	$	402,969,513		$	399,609,378	$	377,388,317	$	378,612,768	$	379,160,415
Liabilities:
Obligations under participation agreements	3	$	67,624,467	$	67,670,405		$	59,524,887	$	102,564,795	$	103,186,327	$	103,188,783
Mortgage loan payable	3	44,481,855		44,687,123			44,813,764		44,614,480		44,753,633		44,947,378
Repurchase agreement payable	3	92,546,529		91,352,312			92,546,529		81,134,436		79,608,437		81,134,436
Revolving credit facility payable	3	35,000,000		34,930,844			35,000,000		—		—		—
Total liabilities		$	239,652,851	$	238,640,684		$	231,885,180	$	228,313,711	$	227,548,397	$	229,270,597

The Company estimated that its other financial assets and liabilities, not included in the tables above, had fair values that approximated their carrying values at both March 31, 2020 and December 31, 2019 due to their short-term nature.

Valuation Process for Fair Value Measurement

The fair value of the Company’s investment in preferred stock is determined based on quoted prices in an active market and is classified as Level 1 of the fair value hierarchy. The fair value of the Company’s investment in bonds is determined based on a matrix which takes the following factors into consideration: structured product markets, interest rate movements, trends, spreads, new issue information and other pertinent data to produce price evaluations that are designed to represent closing market bids or means for the current day. Valuation of bonds falls within Level 2 of the fair value hierarchy.

Market quotations are not readily available for the Company’s real estate-related loan investments, all of which are included in Level 3 of the fair value hierarchy, and therefore these investments are valued utilizing a yield approach, i.e. a discounted cash flow methodology to arrive at an estimate of the fair value of each respective investment in the portfolio using an estimated market yield. In following this methodology, investments are evaluated individually, and management takes into account, in determining the risk-adjusted discount rate for each of the Company’s investments, relevant factors, including available current market data on applicable yields of comparable debt/preferred equity instruments; market credit spreads and yield curves; the investment’s yield; covenants of the investment, including prepayment provisions; the portfolio company’s ability to make payments, net operating income and debt-service coverage ratio; construction progress reports and construction budget analysis; the nature, quality and realizable value of any collateral (and loan-to-value ratio); the forces that influence the local markets in which the asset (the collateral) is purchased and sold, such as capitalization rates, occupancy rates, rental rates and replacement costs; and the anticipated duration of each real estate-related loan investment.

The Manager designates a valuation committee to oversee the entire valuation process of the Company’s Level 3 loans. The valuation committee is comprised of members of the Manager’s senior management, deal and portfolio management teams, who meet on a quarterly basis, or more frequently as needed, to review the Company investments being valued as well as the inputs used in the proprietary valuation model. Valuations determined by the valuation committee are supported by pertinent data and, in addition to a proprietary valuation model, are based on market data, industry accepted third-party valuation models and discount rates or other methods the valuation committee deems to be appropriate. Because there is no readily available market for these investments, the fair values of these investments are approved in good faith by the Manager pursuant to the Company’s valuation policy.

The fair values of the Company’s mortgage loan payable, repurchase agreement payable and revolving credit facility payable are determined by discounting the contractual cash flows at the interest rate the Company estimates such arrangements would bear if executed in the current market.

The following table summarizes the valuation techniques and significant unobservable inputs used by the Company to value the Level 3 loans as of March 31, 2020 and December 31, 2019. The tables are not intended to be all-inclusive, but instead identify the significant unobservable inputs relevant to the determination of fair values.



	Fair Value at March 31, 2020		Primary Valuation Technique	Unobservable Inputs	March 31, 2020
Asset Category	Fair Value at March 31, 2020		Primary Valuation Technique	Unobservable Inputs	Minimum		Maximum		Weighted Average
Assets:
Loans held for investment, net	$	395,581,145	Discounted cash flow	Discount rate	4.45	%	19.25	%	11.03	%
Loans held for investment acquired through participation, net	4,028,233		Discounted cash flow	Discount rate	13.15	%	13.15	%	13.15	%
Total Level 3 Assets	$	399,609,378
Liabilities:
Obligations under Participation Agreements	$	59,524,887	Discounted cash flow	Discount rate	9.86	%	19.25	%	13.23	%
Mortgage loan payable	44,813,764		Discounted cash flow	Discount rate	6.08	%	6.08	%	6.08	%
Repurchase agreement payable	92,546,529		Discounted cash flow	Discount rate	3.34	%	4.77	%	4.00	%
Revolving credit facility payable	35,000,000		Discounted cash flow	Discount rate	6.00	%	6.00	%	6.00	%
Total Level 3 Liabilities	$	231,885,180



	Fair Value at December 31, 2019		Primary Valuation Technique	Unobservable Inputs	December 31, 2019
Asset Category	Fair Value at December 31, 2019		Primary Valuation Technique	Unobservable Inputs	Minimum		Maximum		Weighted Average
Assets:
Loans held for investment, net	$	375,956,154	Discounted cash flow	Discount rate	4.71	%	14.95	%	9.77	%
Loans held for investment acquired through participation, net	3,204,261		Discounted cash flow	Discount rate	11.90	%	11.90	%	11.90	%
Total Level 3 Assets	$	379,160,415
Liabilities:
Obligations under Participation Agreements	$	103,188,783	Discounted cash flow	Discount rate	9.00	%	14.95	%	11.99	%
Mortgage loan	44,947,378		Discounted cash flow	Discount rate	6.08	%	6.08	%	6.08	%
Repurchase agreement payable	81,134,436		Discounted cash flow	Discount rate	4.11	%	4.75	%	4.33	%
Total Level 3 Liabilities	$	229,270,597