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, 2019, 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 2018 and 2017 (see Note 3), in accounting for the equity transactions that occurred in March 2017 (see Note 10), in the valuation of stock-based compensation grants (see Note 12), and in the assessment of impaired and potentially impaired hotels during the years ended December 31, 2019, 2018, and 2017.

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, 2019 and 2018 are as follows:

Associated debt

Type

Terms

Effective Date

Maturity Date

Notional amount at December 31, 2019

Notional amount at December 31, 2018

Wells Fargo

Swap

Swaps 30-day LIBOR for fixed rate of 2.053%

11/2017

11/2022

25,612 (1)

26,048 (1)

Credit facility

Cap

Caps 30-day LIBOR at 2.50%

03/2017

03/2019

Not applicable

50,000

Credit facility

Cap

Caps 30-day LIBOR at 3.35%

4/1/2019

10/2020

30,000

Not applicable

(1)

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

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 (loss) of $(991), $248, and $190 were recognized related to derivative instruments for the years ended December 31, 2019, 2018, and 2017, 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, 2019		Level 1		Level 2		Level 3
Interest rate derivatives	$	(366)	$	-	$	(366)	$	-
Series E Preferred embedded redemption option		22		-		-		22
Convertible debt		(1,080)		-		-		(1,080)
Total	$	(1,424)	$	-	$	(366)	$	(1,058)


	Fair value at December 31, 2018		Level 1		Level 2		Level 3
Interest rate derivatives	$	350	$	-	$	350	$	-
Series E Preferred embedded redemption option		289		-		-		289
Convertible debt		(1,000)		-		-		(1,000)
Total	$	(361)	$	-	$	350	$	(711)

There were no transfers between levels during the years ended December 31, 2019, 2018, or 2017.

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,
		2019						2018
	Series E Preferred embedded redemption option		Convertible debt		Total		Series E Preferred embedded redemption option		Convertible debt		Total
Fair value, beginning of period	$	289	$	(1,000)	$	(711)	$	314	$	(1,069)	$	(755)
Net gains (losses) recognized in earnings		(267)		(80)		(347)		(25)		69		44
Purchase and issuances		-		-		-		-		-		-
Sales and settlements		-		-		-		-		-		-
Gross transfers into Level 3		-		-		-		-		-		-
Gross transfers out of Level 3		-		-		-		-		-		-
Fair value, end of period	$	22	$	(1,080)	$	(1,058)	$	289	$	(1,000)	$	(711)

Total unrealized gains (losses) during the period included in earnings related to instruments held at end of period	$	(267)	$	(80)	$	(347)	$	(25)	$	69	$	44

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 risks. 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,
	2019		2018		2019		2018
Held for use	$	134,001	$	135,810	$	134,288	$	134,773
Held for sale		-		1,120		-		1,120
Total	$	134,001	$	136,930	$	134,288	$	135,893

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, 2019, 2018, and 2017 is shown in the tables below:


	Year ended December 31,
	2019			2018			2017
	Number of hotels	Impairment (loss) recovery		Number of hotels	Impairment (loss) recovery		Number of hotels	Impairment (loss) recovery
Continuing Operations:
Sold hotels:
Impairment loss	-	$	-	-	$	-	3	$	(2,231)
Recovery of impairment	-		-	1		93	2		80
Total net impairment (loss) recovery:	-	$	-	1	$	93	5	$	(2,151)