COPT Defense Properties Quarterly report pursuant to Section 13 or 15(d)

Quarterly report pursuant to Section 13 or 15(d)

Fair Value Measurements

Fair Value Measurements

6 Months Ended

Jun. 30, 2016

Recurring Fair Value Measurements

COPT has a non-qualified elective deferred compensation plan for certain members of our management team that permits participants to defer up to 100% of their compensation on a pre-tax basis and receive a tax-deferred return on such deferrals. The assets held in the plan (comprised primarily of mutual funds and equity securities) and the corresponding liability to the participants are measured at fair value on a recurring basis on COPT’s consolidated balance sheet using quoted market prices, as are other marketable securities that we hold. The balance of the plan, which was fully funded, totaled $5.0 million as of June 30, 2016, and is included in the accompanying COPT consolidated balance sheets in the line entitled restricted cash and marketable securities. The offsetting liability associated with the plan is adjusted to fair value at the end of each accounting period based on the fair value of the plan assets and reported in other liabilities on COPT’s consolidated balance sheets. The assets of the plan and other marketable securities that we hold are classified in Level 1 of the fair value hierarchy. The liability associated with the plan is classified in Level 2 of the fair value hierarchy.

The fair values of our interest rate derivatives are determined using widely accepted valuation techniques, including a discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate market data and implied volatilities in such interest rates. While we determined that the majority of the inputs used to value our derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with our interest rate derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default. However, as of June 30, 2016, we assessed the significance of the impact of the credit valuation adjustments on the overall valuation of our derivatives and determined that these adjustments are not significant. As a result, we determined that our interest rate derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.

The carrying values of cash and cash equivalents, restricted cash, accounts receivable, other assets (excluding investing receivables) and accounts payable and accrued expenses are reasonable estimates of their fair values because of the short maturities of these instruments. As discussed in Note 6, we estimated the fair values of our investing receivables based on the discounted estimated future cash flows of the loans (categorized within Level 3 of the fair value hierarchy); the discount rates used approximate current market rates for loans with similar maturities and credit quality, and the estimated cash payments include scheduled principal and interest payments. For our disclosure of debt fair values in Note 8, we estimated the fair value of our unsecured senior notes based on quoted market rates for publicly-traded debt (categorized within Level 2 of the fair value hierarchy) and estimated the fair value of our other debt based on the discounted estimated future cash payments to be made on such debt (categorized within Level 3 of the fair value hierarchy); the discount rates used approximate current market rates for loans, or groups of loans, with similar maturities and credit quality, and the estimated future payments include scheduled principal and interest payments. Fair value estimates are made as of a specific point in time, are subjective in nature and involve uncertainties and matters of significant judgment. Settlement at such fair value amounts may not be possible and may not be a prudent management decision.

For additional fair value information, please refer to Note 6 for investing receivables, Note 8 for debt and Note 9 for interest rate derivatives.

COPT and Subsidiaries

The table below sets forth financial assets and liabilities of COPT and its subsidiaries that are accounted for at fair value on a recurring basis as of June 30, 2016 and the hierarchy level of inputs used in measuring their respective fair values under applicable accounting standards (in thousands):



Description	Quoted Prices in Active Markets for Identical Assets(Level 1)		Significant Other Observable Inputs(Level 2)		Significant Unobservable Inputs(Level 3)		Total
Assets:
Marketable securities in deferred compensation plan (1)
Mutual funds	$	4,954	$	—	$	—	$	4,954
Other	92		—		—		92
Total assets	$	5,046	$	—	$	—	$	5,046
Liabilities:
Deferred compensation plan liability (2)	$	—	$	5,046	$	—	$	5,046
Interest rate derivatives	—		20,245		—		20,245
Total liabilities	$	—	$	25,291	$	—	$	25,291

(1) Included in the line entitled “restricted cash and marketable securities” on COPT’s consolidated balance sheet.

(2) Included in the line entitled “other liabilities” on COPT’s consolidated balance sheet.

COPLP and Subsidiaries

The table below sets forth financial assets and liabilities of COPLP and its subsidiaries that are accounted for at fair value on a recurring basis as of June 30, 2016 and the hierarchy level of inputs used in measuring their respective fair values under applicable accounting standards (in thousands):



Description	Quoted Prices in Active Markets for Identical Assets(Level 1)		Significant Other Observable Inputs(Level 2)		Significant Unobservable Inputs(Level 3)		Total
Liabilities:
Interest rate derivatives	$	—	$	20,245	$	—	$	20,245

Nonrecurring Fair Value Measurements

During the second quarter of 2016, as part of our closing process, we conducted our quarterly review of our portfolio for indicators of impairment considering the refined investment strategy of our newly-appointed Chief Executive Officer and concluded that we would: (1) not hold our operating properties in Aberdeen, Maryland for the long-term; (2) sell specific properties in our Northern Virginia Defense/IT and Fort Meade/BW Corridor sub-segments; (3) not develop commercial properties on land in Frederick, Maryland; and (4) sell the remaining operating property in Greater Philadelphia that had not previously been classified as held for sale. Accordingly, we performed recoverability analyses for each of these properties and recorded the following impairment losses resulting from nonrecurring fair value measurements:

•

$34.4 million on operating properties in Aberdeen, Maryland (included in our Other segment). After shortening our estimated holding period for these properties, we determined that the carrying amount of the properties would not likely be recovered from the operation and eventual dispositions of the properties during the shortened holding period. Accordingly, we adjusted the properties to their estimated fair value;


•	$14.1 million on operating properties in our Northern Virginia Defense/IT and Fort Meade/BW Corridor sub-segments that we reclassified to held for sale during the period whose carrying amounts exceeded their estimated fair values less cost to sell;


•	$8.2 million on land in Frederick, Maryland. We determined that the carrying amount of the land would not likely be recovered from the sale of this property. Accordingly, we adjusted the land to its estimated fair value;


•	$6.2 million on a property in Greater Philadelphia (included in our Regional Office segment) that we reclassified to held for sale during the period whose carrying amounts exceeded its estimated fair value less cost to sell; and

•

$4.4 million on land in Aberdeen, Maryland. In performing our analysis related to the operating properties in Aberdeen, we determined that the weakening leasing and overall commercial real estate conditions in that market indicated that our land holdings in the market may be impaired. As a result, we determined that the carrying amount of the land was not recoverable and, accordingly, adjusted the land to its estimated fair value.

During the six months ended June 30, 2016, we also recognized the following impairment losses resulting from nonrecurring fair value measurements:

•

$3.4 million (primarily in the three months ended March 31, 2016) on land in Colorado Springs, Colorado, the carrying amount of which exceeded the estimated fair value less costs to sell. Most of these losses pertained to land we decided to sell during the three months ended March 31, 2016 that was reclassified as held for sale, and the remainder was attributable to further decreases in fair value of properties previously classified as held for sale based on recent bids from and negotiations with prospective buyers; and


•	$1.4 million (primarily in the three months ended March 31, 2016) primarily on operating properties in White Marsh, Maryland (included in our Regional Office segment) classified as held for sale whose carrying amounts exceeded their estimated fair values less costs to sell based on recent negotiations with prospective buyers.

The table below sets forth the fair value hierarchy of the valuation technique we used to determine nonrecurring fair value measurements of these assets as of June 30, 2016 (dollars in thousands):



	Fair Values as of June 30, 2016
	Quoted Prices in				Significant
	Active Markets for		Significant Other		Unobservable
	Identical Assets		Observable Inputs		Inputs
Description	(Level 1)		(Level 2)		(Level 3)		Total
Assets:
Operating properties, net (1)	$	—	$	—	$	13,700	$	13,700
Projects in development or held for future development (2)	—		—		9,117		9,117
Assets held for sale, net (3)	—		—		55,322		55,322


(1)	Valuations were determined using a discounted cash flow model. Refer to table below for quantitative information about significant unobservable inputs used in the model.

(2) Valuation was determined using the comparable sales approach.

(3) Represents fair value less estimated costs to sell using contract prices or bids that were deemed indicative of fair value.

The table below sets forth quantitative information about significant unobservable inputs used for the Level 3 fair value measurements reported above for operating properties as of June 30, 2016:



Unobservable Input		Range (Weighted Average)
Discount rate		11.0% to 12.0% (11.6%)
Capitalization rate		9.0% to 10.0% (9.5%)

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

+ References + Details