5. Fair Value Measurements

U.S. GAAP establishes a hierarchy of valuation techniques based on the observability of inputs utilized in measuring financial assets and liabilities at fair value. U.S. GAAP establishes market-based or observable inputs as the preferred source of values, followed by valuation models using management assumptions in the absence of market inputs. The three levels of the hierarchy are described below:

Level I—Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.

Level II—Inputs (other than quoted prices included in Level I) are either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date and for the duration of the instrument’s anticipated life.

Level III—Inputs reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model.

Valuation Process

The Company has valuation control processes in place to validate the fair value of the Company’s financial assets and liabilities measured at fair value including those derived from pricing models. These control processes are designed to assure that the values used for financial reporting are based on observable inputs wherever possible. In the event that observable inputs are not available, the control processes are designed to assure that the valuation approach utilized is appropriate and consistently applied and the assumptions are reasonable.

Pricing Verification—The Company uses recently executed transactions, other observable market data such as exchange data, broker/dealer quotes, third party pricing vendors and aggregation services for validating the fair values generated using valuation models. Pricing data provided by approved external sources is evaluated using a number of approaches; for example, by corroborating the external sources’ prices to executed trades, analyzing the methodology and assumptions used by the external source to generate a price and/or by evaluating how active the third party pricing source (or originating sources used by the third party pricing source) is in the market.

Unobservable Inputs—Where inputs are not observable, the Company reviews the appropriateness of the proposed valuation methodology to ensure it is consistent with how a market participant would arrive at the unobservable input. The valuation methodologies utilized in the absence of observable inputs may include extrapolation techniques and the use of comparable observable inputs.

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 its valuation methods are appropriate and consistent with other market participants, the use of different methodologies, or assumptions, to determine the fair value could result in a different estimate of fair value at the reporting date.

Valuation of Financial Instruments Measured at Fair Value on a Recurring Basis

The Company measures the fair value of its loans receivable and secured financings using a discounted cash flow analysis unless observable market data is available. A discounted cash flow analysis requires management to make estimates regarding future interest rates and credit spreads. The most significant of these inputs relates to credit spreads and is unobservable. Thus, the Company has determined that the fair values of loans receivable and secured financings valued using a discounted cash flow analysis should be classified in Level III of the fair value hierarchy, while mortgage loans valued using securitized pricing should be classified in Level II of the fair value hierarchy. Mortgage loans classified in Level III are transferred to Level II if securitized pricing becomes available. The Company’s loans receivable are carried at fair value based on significant unobservable inputs. The Company determines fair value by utilizing or reviewing certain of the following inputs (i) discounted cash flow modeling, (ii) market yield data, (iii) collateral asset performance, (iv) macro real estate performance, (v) capital market conditions, (vi) loan-to-value ratio, debt service coverage and debt yield, and (vii) borrower financial condition and performance.

The Company measures the fair value of its foreign currency forward contracts by utilizing the foreign exchange forward curve, the yields on applicable government debt, and the counterparty credit risk. The most significant of these inputs relates to the foreign exchange forward curve and the yields on the applicable government debt, which are observable. Thus, the Company has determined that the fair values of the foreign currency forward contracts should be classified in Level II of the fair value hierarchy.

Foreign currency translation impacts reflected in the Level III rollforwards are included in Gain on foreign currency translation in the Consolidated Statements of Operations.

Valuation of Financial Instruments Not Measured at Fair Value

The fair values of certain short-term financial instruments such as cash and cash equivalents approximate their carrying value on the accompanying Consolidated Balance Sheets. Cash equivalents are primarily money market funds, which would have been classified as level 1 if they had been included in the Company’s fair value hierarchy.