NOTE 8: FAIR VALUE MEASUREMENTS AND DERIVATIVE INSTRUMENTS

Our determination of fair value measurements is based on the assumptions that market participants would use in pricing the asset or liability. At December 31, 2017, the Company’s convertible debt (see Note 7) and certain derivative instruments were the only financial instruments measured in the consolidated financial statements at fair value on a recurring basis. Nonrecurring fair value measurements were utilized in the determination of the fair value of acquired hotel properties and related assumed debt in 2017, 2016, and 2015 (see Note 3), the acquisition accounting performed by the Atlanta JV in 2016 (see Note 5), in accounting for the equity transactions that occurred in March 2016 and 2017 (see Note 10), in the valuation of stock-based compensation grants (see Note 12), and in the valuation of impaired hotels during the years ended December 31, 2017, 2016, and 2015.

Derivative Instruments

Currently, the Company uses derivatives, such as interest rate swaps and caps, to manage its interest rate risk. The fair value of interest rate positions is determined using the standard market methodology of netting the discounted expected future cash receipts and payments. Variable interest rates used in the calculation of projected receipts and payments on the positions are based on an expectation of future interest rates derived from observable market interest rate curves and volatilities. Derivatives expose the Company to credit risk in the event of non-performance by the counterparties under the terms of the agreements. The Company believes it minimizes this credit risk by transacting with major creditworthy financial institutions. These interest rate positions at December 31, 2017 and 2016 are as follows:

Associated debt

Type

Terms

Effective Date

Maturity Date

Notional amount at December 31, 2017

Notional amount at December 31, 2016

Wells Fargo

Swap

Swaps 30-day LIBOR for fixed rate of 2.053%

11/2017

11/2022

26,465 (1)

Credit facility

Cap

Caps 30-day LIBOR at 2.50%

03/2017

03/2019

50,000

Huntington

Swap

Swaps 30-day LIBOR + 2.25% for fixed rate of

11/2015

11/2020

7,361 (1)

4.13 %; cancellable at Company's option anytime

after 11/01/2018 without penalty

Latitude

Cap

Caps 30-day LIBOR at 1.0%

03/2016

06/2017

11,124 (1)

(1)

Notional amounts amortize consistently with the principal amortization of the associated loans

Additionally, prior to the execution of the Exchange Agreement (see Note 10) on March 16, 2016 which extinguished the instrument, the Company was required to bifurcate and include on the balance sheet at fair value the embedded conversion option in the 6.25% Series C Cumulative Convertible Preferred Stock (“Series C Preferred Stock”) due to the presence of an antidilution provision that required an adjustment in the common stock conversion ratio should subsequent issuances of the Company’s common stock be issued below the instrument’s original conversion price.

Similarly, prior to the execution of the Exchange Agreement, the terms of the common stock warrants issued to the holders of the Series C Preferred Stock (see Note 10) also included an antidilution provision that required a reduction in the warrant’s exercise price should the conversion ratio of the Series C Preferred Stock be adjusted due to antidilution provisions. Accordingly, the warrants did not qualify for equity classification, and, as a result, the fair value of the derivative was shown as a derivative liability on the balance sheets. With the execution of the Exchange Agreement, this provision of these warrants was effectively eliminated and the conversion price was locked permanently. Following this modification of terms, the warrants qualified for equity classification and were reclassified to additional paid-in capital at their fair value of $611 on the date of the modification.

The fair value of these derivative liabilities recognized in connection with the Series C Preferred Stock were determined using the Monte Carlo simulation method. The Monte Carlo simulation method is a generally accepted statistical method used to generate a defined number of stock price paths in order to develop a reasonable estimate of the range of future expected stock prices of the Company and its peer group and minimize standard error and is considered a Level 3 fair value measurement.

Included in the Series E Preferred Stock issued on March 1, 2017 is a redemption right that allows the Company to redeem up to a total of 490,250 shares of Series E Preferred Stock for specific percentages of its liquidation preference (see Note 10). This option requires bifurcation and was determined to be an asset with a fair value on the date of issuance of $150 using a trinomial lattice-based model, considered a Level 3 fair value measurement.

All derivatives recognized by the Company are reported as either derivative assets or liabilities on the balance sheets and are adjusted to their fair value at each reporting date. All gains and losses on derivative instruments are included in net gain on derivatives and convertible debt and with the exception of realized gains and losses related to the interest rate instruments, which are included in interest expense on the statements of operations. Net gains of $190, $6,680, and $11,578 were recognized related to derivative instruments for the years ended December 31, 2017, 2016, and 2015, respectively.

Recurring Fair Value Measurements

The following tables provide the fair value of the Company’s financial assets and (liabilities) carried at fair value and measured on a recurring basis:


	Fair value at December 31, 2017		Level 1		Level 2		Level 3
Interest rate derivatives	$	77	$	-	$	77	$	-
Series E Preferred embedded redemption option		314		-		-		314
Convertible debt		(1,069)		-		-		(1,069)
Total	$	(678)	$	-	$	77	$	(755)


	Fair value at December 31, 2016		Level 1		Level 2		Level 3
Interest rate derivatives	$	(8)	$	-	$	(8)	$	-
Convertible debt		(1,315)		-		-		(1,315)
Total	$	(1,323)	$	-	$	(8)	$	(1,315)

There were no transfers between levels during the years ended December 31, 2017, 2016, or 2015.

The following tables present a reconciliation of the beginning and ending balances of items measured at fair value on a recurring basis that use significant unobservable inputs (Level 3) and the related gains and losses recorded in the statements of operations during the periods:


	Year ended December 31,
		2017					2016
	Series E Preferred embedded redemption option		Convertible debt		Total		Series C Preferred embedded derivative		RES warrant derivative		Convertible debt		Total
Fair value, beginning of period	$	-	$	(1,315)	$	(1,315)	$	(6,271)	$	(2,411)	$	-	$	(8,682)
Net gains (losses) recognized in earnings		164		246		410		4,848		1,800		(303)		6,345
Purchase and issuances		150		-		150		-		-		(1,012)		(1,012)
Sales and settlements		-		-		-		1,423		-		-		1,423
Gross transfers into Level 3		-		-		-		-		-		-		-
Gross transfers out of Level 3		-		-		-		-		611 (1)		-		611
Fair value, end of period	$	314	$	(1,069)	$	(755)	$	-	$	-	$	(1,315)	$	(1,315)

Total unrealized gains (losses) during the period included in earnings related to instruments held at end of period	$	164	$	246	$	410	$	-	$	-	$	(303)	$	(303)

(1)

RES warrants were permanently reclassified to additional paid-in capital as discussed above

Fair Value of Debt

The Company estimates the fair value of its fixed rate debt by discounting the future cash flows of each instrument at estimated market rates or credit spreads consistent with the maturity of debt obligations with similar credit policies. Credit spreads take into consideration general market conditions and maturity. The inputs utilized in estimating the fair value of debt are classified in Level 2 of the fair value hierarchy. Both the carrying value and the estimated fair value of the Company’s long-term debt, excluding convertible debt which is presented in the balance sheets at fair value, are presented in the table below net of deferred financing costs:



	Carrying value at December 31,				Estimated fair value at December 31,
	2017		2016		2017		2016
Held for use	$	115,605	$	47,918	$	115,239	$	48,034
Held for sale		4,976		14,802		4,976		15,186
Total	$	120,581	$	62,720	$	120,215	$	63,220

Impaired Hotel Properties

In the performance of impairment analysis for both held for sale and held for use properties, fair value is determined with the assistance of independent real estate brokers and through the use of operating results and revenue multiples based on the Company’s experience with hotel sales as well as available industry information. For held for sale properties, estimated selling costs are based on our experience with similar asset sales. These are considered Level 3 fair value measurements. The amount of impairment and recovery of previously recorded impairment recognized in the years ended December 31, 2017, 2016, and 2015 is shown in the tables below:


	Year ended December 31,
	2017			2016			2015
	Number of hotels	Impairment (loss) recovery		Number of hotels	Impairment (loss) recovery		Number of hotels	Impairment (loss) recovery
Continuing Operations:
Held for sale hotels:
Impairment loss	1	$	(1,448)	-	$	-	1	$	(1,537)
Sold hotels:
Impairment loss	2		(783)	5		(1,477)	5		(2,377)
Recovery of impairment	2		80	-		-	1		85
Net impairment loss reported in continuing operations	5	$	(2,151)	5	$	(1,477)	7	$	(3,829)

Discontinued Operations:
Sold hotels:
Impairment loss	-	$	-	-	$	-	1	$	(117)
Recovery of impairment	-		-	-		-	3		238
Net impairment loss reported in discontinued operations	-	$	-	-	$	-	4	$	121

Total net impairment:	5	$	(2,151)	5	$	(1,477)	11	$	(3,708)