Earnings Call Transcript - OHI Q2 2022

Operator, Operator

Good morning, and welcome to the Omega Healthcare Investors Second Quarter 2022 Earnings Call. Please note this is being recorded. I would now like to turn the conference over to Michele Reber. Please go ahead.

Michele Reber, Senior Vice President

Thank you, and good morning. With me today are Omega's CEO, Taylor Pickett; COO, Dan Booth; CFO, Bob Stephenson; and Megan Krull, Senior Vice President of Operations. Comments made during this conference call that are not historical facts may be forward-looking statements such as statements regarding our financial projections, dividend policy, portfolio restructurings, rent payments, financial condition or prospects of our operators, contemplated acquisitions, dispositions or transitions and our business and portfolio outlook generally. These forward-looking statements involve risks and uncertainties, which may cause actual results to differ materially. Please see our press releases and our filings with the Securities and Exchange Commission, including, without limitation, our most recent report on Form 10-K which identifies specific factors that may cause actual results or events to differ materially from those described in forward-looking statements. During the call today, we will refer to some non-GAAP financial measures, such as NAREIT FFO, adjusted FFO, FAD and EBITDA. Reconciliations of these non-GAAP measures to the most comparable measure under generally accepted accounting principles as well as an explanation of the usefulness of the non-GAAP measures are available under the Financial Information section of our website at www.omegahealthcare.com, and, in the case of NAREIT FFO and adjusted FFO, in our recently issued press release. In addition, certain operator coverage and financial information that we discuss is based on data provided by our operators that has not been independently verified by Omega. I will now turn the call over to Taylor.

Taylor Pickett, CEO

Thanks, Michele. Good morning, and thank you for joining our second quarter 2022 earnings conference call. Today, I will discuss our second quarter financial results, skilled nursing facility industry trends and operator restructurings. Our first quarter adjusted FFO is $0.76 per share and funds available for distribution are $0.71 per share. We have maintained our quarterly dividend of $0.67 per share. The dividend payout ratio is 88% of adjusted FFO, and 94% of funds available for distribution. As we discussed last quarter, the ability to put restructuring portfolios back to work improved the FAD payout ratio by 7%. We expect over time to put additional portfolios back to work, further improving our FAD payout ratio and liquidity. Turning to skilled nursing facility industry trends. Occupancy continues to trend upward, while staffing availability is slowly improving. Wages for full-time staff are significantly higher than pre-COVID wages. We believe this is a permanent shift in the cost structure for our facilities. Fortunately, a number of states have announced significant increases in Medicaid rates, reflecting the need to fund these higher costs. Turning to operator restructurings. The strength of our portfolio assets generally allows us to work through operator restructurings with limited long-term cash flow downside. We've completed all of the restructuring work related to Gulf Coast. We are well down the restructuring pathway with the Agemo portfolio, which represents approximately 6% of contractual rent, none of which was recognized in the second quarter. The other portfolios with liquidity issues have generally committed to pay contractual rent obligations while we work through various asset sales or transitions to new operators. Finally, I again thank our operating partners, and in particular, the frontline caregivers and staff of care for the tens of thousands of residents within our facilities. I will now turn the call over to Bob.

Bob Stephenson, CFO

Thanks, Taylor, and good morning. Turning to our financials for the second quarter. Our NAREIT FFO for the second quarter was $161 million or $0.66 per share as compared to $181 million or $0.74 per share for the second quarter of 2021. Our adjusted FFO was $185 million or $0.76 per share for the quarter and excludes several items as outlined in our adjusted FFO reconciliation to net income found in our second quarter earnings release, as well as our second quarter financial supplemental. Revenue for the second quarter was approximately $245 million before adjusting for the nonrecurring items compared to $257 million for the second quarter of 2021. The year-over-year decrease is primarily the result of asset sales completed in 2021 and '22, operator restructurings, and revenue recorded in the second quarter of 2021 related to Agemo. The $245 million of revenue in the quarter included $11.7 million in revenue reductions primarily related to the write-off of straight-line receivables associated with 2 operators, transition to a cash basis for revenue recognition and includes $1.3 million of onetime revenue, both of which are excluded from adjusted FFO and FAD calculations. In our last earnings call, I provided revenue, adjusted FFO and FAD commentary on Agemo, Guardian and 2 additional operators. I want to provide an updated revenue status as of the end of July for these operators. Dan will provide contractual and operational updates on these tenants in his prepared talking points. First, regarding Agemo. As stated in the press release, Agemo continued to not pay its contractual rent or interest payments. No payments were made in July and Q3 2022 contractual rent and interest of $16 million will only be recognized to the extent that Agemo makes any payments. Turning to Guardian. In Q1, Guardian was placed on a cash basis, and we did not record any revenue as we did not receive any cash during the quarter. In the second quarter, Guardian resumed making contractual rent and interest payments in accordance with the agreed-upon terms. In the second quarter, we recorded $5.2 million in income related to Guardian, consisting of $3.8 million of contractual rent payments received and $1.4 million in interest payments received. Additionally, starting July 1, Guardian's rent and interest was reset to an aggregate $24 million per year. Guardian is current on rent and interest through July. As discussed last quarter, an operator representing 3.4% of Q1 annualized contractual rent and mortgage interest revenue did not pay any of its Q1 contractual rent and asked for a short-term forbearance. This operator remains on a straight-line basis for revenue recognition based on our conclusion that their contractual rent is fully collectible over the term of the lease. During the second quarter, the operator paid its full Q2 rent and interest obligations of $8.8 million. In the second quarter, the operator also borrowed the remaining $4 million on its $20 million credit facility with Omega. July contractual rent and interest of $2.9 million was paid in full. Also, as discussed last quarter, an additional operator representing 2.4% of Q1 contractual annualized rent and mortgage interest revenue did not pay its March contractual amounts due under its lease agreement. In April, the lease with this operator was amended to allow the operator to apply its $2 million security deposit to its March 2022 contractual rent payment and to allow for a short-term rent deferral for April with regular rental payments required to resume in May. In the first quarter, we recorded $5.9 million for both adjusted FFO and FAD purposes. This operator did pay contractual rent in May. However, this operator failed to make full contractual rent payments in June. We placed this operator on a cash basis of revenue recognition during the second quarter and wrote off $8.3 million of straight-line rent receivables through rental income. In the second quarter, we recorded the cash received of $2.5 million for both adjusted FFO and FAD purposes. Of the $2 million in contractual rent owed for the month of July, only $1.5 million was collected during July, and we will only recognize revenue, adjusted FFO, and FAD in the third quarter to the extent cash is received from the operator. Finally, in the press release, we discussed an operator representing 2.2% of our second quarter 2022 annualized contractual rent and mortgage interest that underpaid the contractual rent due under its lease agreement by $550,000. On June 30, we held a $5.4 million letter of credit as collateral from this operator. In July, we drew the full amount of the letter of credit and applied $550,000 of the proceeds to pay the underpaid portion of June's rent. This operator remains on a straight-line basis for recognizing revenue as we expect the operator will continue to pay contractual rent, with any unpaid portions in the short term being covered by the remaining collateral. In the second quarter, we recognized $5.5 million of contractual rent related to the operator. In July, the operator paid $1 million in rent, and we applied $800,000 in security deposits to fund the underpaid portion of July's rent. Moving to our balance sheet. It remains strong, thanks to the steps we've taken throughout 2021 and the first half of 2022 to further improve our liquidity, capital stack maturity ladder and overall cost of debt. In the second quarter, we repurchased 4.2 million shares of our common stock for $115 million while maintaining our first quarter leverage ratio. At June 30, we had $38 million of outstanding borrowings on our revolving credit facility, and we also had $165 million in cash. At June 30, 98% of our $5.4 billion in debt was fixed, and our net funded debt to adjusted annualized EBITDA was 5.3x, the same as our first quarter, and our fixed charge coverage ratio was 4.2x. It's important to note similar to NAREIT FFO, adjusted FFO and FAD, EBITDA in these liquidity calculations includes our ability to apply collateral and recognize revenue related to operator down payments previously discussed. However, if the collateral is exhausted, a decrease in EBITDA will impact our liquidity ratios. I will now turn the call over to Dan.

Dan Booth, COO

Thanks, Bob, and good morning, everyone. As of June 30, 2022, Omega had an operating asset portfolio of 921 facilities with approximately 92,000 operating beds. These facilities were spread across 63 third-party operators, and located within 42 states in the United Kingdom. Trailing 12-month operator EBITDARM and EBITDAR coverage for our core portfolio as of March 31, 2022, decreased to 1.44 and 1.10x, respectively, versus 1.48 and 1.14x, respectively, for the trailing 12-month period ended December 31, 2021. During the first quarter of 2022, our operators cumulatively recorded approximately $39 million in federal stimulus funds as compared to approximately $47 million recorded during the fourth quarter. Trailing 12-month operator EBITDARM and EBITDAR coverage would have decreased during the first quarter of 2022 to 1.24 and 0.92x, respectively, as compared to 1.26 and 0.93x, respectively, for the fourth quarter when excluding the benefit of entering federal stimulus funds. EBITDAR coverage for the stand-alone quarter ended March 31, 2022, for our core portfolio was 0.93x, including federal stimulus, and 0.76x, excluding the $39 million of federal stimulus funds. This compares to the stand-alone fourth quarter of 1.19x and 0.98x, with and without $47 million in federal stimulus funds, respectively. Occupancy for our overall core portfolio has slowly trended upward throughout 2021, reaching a high of 75.8% in December, up from a low in January of 2021 of 72.3%. In January of 2022, the portfolio saw a dip in occupancy to 74.6% due to the Omicron surge. But has since trended up, based upon preliminary results, increasing to 77.7% as of mid-July. Turning to our senior housing portfolio. Today, our overall senior housing investment comprises 181 assisted living, independent living and memory care assets in the United States and the United Kingdom. This portfolio on a pure-play basis had its trailing 12-month EBITDAR lease coverage decreased to 0.93x at the end of the first quarter as compared to the end of the fourth quarter of 2021, which covered at 0.94x. Based upon preliminary results, occupancy for this portfolio has recovered to 87.9% as of mid-July 2022 versus 83% in January of 2022. Turning to portfolio matters, Guardian. As previously reported, on April 8, 2022, Omega entered into a restructuring agreement with Guardian Healthcare. As part of that restructuring plan, Omega sold 12 facilities and released 8 facilities as anticipated. Beginning in April of 2022, Guardian resumed making contractual rent and interest payments. Agemo. We continue to be in ongoing discussions with Agemo on a restructure agreement which is expected to involve the sale of a material portion of Agemo's existing Omega portfolio. We will continue to provide updates as discussions progress. Other operators. As of today, Omega had 2 other operators that were unable to make their full contractual rent payments in the second quarter and subsequently in July of 2022. As it relates to operator number one, on April 29, 2022, Omega entered into a fourth amendment to an existing master lease, whereby we agreed to use an existing security deposit to pay March rent and agreed to defer April rent. While rent was paid in full for the month of May, June and July rents were only partially paid. Of the $2 million of monthly contractual rent due, Omega received $500,000 in June and $1.5 million in July. We are in ongoing discussions with this operator to rectify this situation, which may include future deferrals and/or asset sales or releases to other unrelated third parties. As it relates to operator number two, in the months of June and July, this operator also made only partial rent payments. The shortfall of $550,000 and $800,000 for the months of June and July, respectively, were covered by using a portion of an existing $5.4 million security deposit. The security deposit, which was in the form of a letter of credit, was drawn in full in July. We currently hold approximately $4 million of the remaining security deposit in cash. Similar to operator number one, we are in ongoing discussions with this operator, which will likely include future offsets to the remaining security deposit and potential asset sales and releases. Turning to new investments. On June 2, 2022, Omega completed a $20 million preferred equity investment in a joint venture which acquired an acute care hospital located in New York City. This preferred equity investment bears a cash yield of 12% and is structured to be redeemed within a 5-year term. Additionally, on October 28, 2022, Omega closed on a $36 million mezz loan investment and a $90 million working capital loan commitment, both to an existing operator. The mezz loan bears a cash yield of 12% and has a 3-year term, and the working capital loan bears a blended cash yield of 11% and has a 1-year term. Omega's new investments in capital expenditures for the quarter totaled $73 million. Year-to-date, as of June 30, 2022, Omega's new investments and capital expenditures totaled $214 million. The amounts exclude the $90 million working capital loan commitment. Turning to dispositions. During the second quarter of 2022, Omega divested 13 facilities for total proceeds of $54 million. I will now turn the call over to Megan.

Megan Krull, Senior Vice President of Operations

Thanks, Dan, and good morning, everyone. Community spread of COVID continues to be a leading indicator of the case load within the long-term care industry. Following that trend, there has therefore been a resurgence of cases of late. Thankfully, we continue to hear from operators that clinical outcomes are much improved from where they had been in the past. That said, any strain on an already tenuous staffing situation is concerning as it has the potential to delay an already slow occupancy recovery. Although occupancy continues to improve with 27% of core facilities now having recovered, and an additional 21% recovered to within 5% of pre-COVID levels, staffing shortages, which can be exacerbated by quarantine requirements, continue to have an impact. In June, ACA released the results of a survey of 759 nursing home providers, results of which showed that 61% are still limiting new admissions due to staffing limitations. At the same time, expenses continue to be elevated from pre-COVID levels, particularly as it relates to staffing and other staffing-related items. Agency expense on a per patient day basis for our core portfolio for the first quarter of 2022 continues to be elevated at 6x what it was in 2019. Last week, CMS issued its final 2023 payment rule, which while inclusive of a 5.1% rate increase beginning October 1, offset that increase by a cut of 2.3% related to bringing PDPM back to budget neutrality, resulting in a net increase of 2.7% or $904 million. While this is an improvement over the proposed rule, which incorporated the full 4.6% cut for the 2023 rate setting year, with the final rule spreading that over 2 years, it is still disappointing in light of the current environment. Conversely, as Taylor mentioned earlier, a limited number of our larger states appear, with strong lobbying efforts from the industry, to be reacting appropriately to the inflationary environment as well as the increased cost structure that operators are currently experiencing, while also balancing that with the desire for additional regulatory requirements. These states, such as Florida and Pennsylvania, to name a few, have required such things as increases in wages and minimum staffing levels, while also increasing reimbursement to more than defray these additional costs. Additionally, other states have provided for continued COVID-related FMAP rate increases post public health emergency, either on a permanent or phased-out basis. Given that the long-term care industry is still deeply entrenched in the recovery phase of this pandemic, we hope that the federal government takes note of some of these more balanced state actions and sees clear to provide funding for any mandates that it may impose. I will now open the call up for questions.

Operator, Operator

Our first question will come from Connor Siversky with Berenberg.

Connor Siversky, Analyst

I'm going to lump a couple together here pertaining to Guardian. So is the restructuring effort effectively complete? Are there any other moving pieces that you are taking into consideration here? And then for the master lease agreement revised to $24 million in annual rents to be paid to OHI, could you quantify at all what kind of haircut you would be taking on the remaining facilities compared to a more normalized or pre-pandemic environment?

Dan Booth, COO

So the Guardian restructure, as you suggested, is complete. We have sold and/or re-leased all the facilities that we intended to as part of that restructure, and we did reset the rent. The rent number is down, I would say, modestly from pre-COVID or pre-pandemic contractual rent rates, but it's not a meaningful or significant cut when you look at the new rent plus the rent equivalents from what we either sold or re-leased.

Connor Siversky, Analyst

Okay. I understand. Regarding Agemo, it seems there has been less transparency in its disclosures compared to Guardian, which limits how much you can discuss. Are you planning to adopt a similar approach to restructuring for Agemo as you did with Guardian? Given that Agemo functions in various markets, what criteria are you considering for deciding which assets to retain and which ones to sell or reposition?

Dan Booth, COO

Yes, there's a lot more details on Guardian because the restructuring has been completed. So, Agemo has not been completed. We're still working through it. It does involve asset sales, and we really can't lay out the details until that's really done. And then we'll give you, obviously, more details about what occurred and then what kind of hit we took, if any. But it is similar to the Guardian situation in terms of that we are selling and/or releasing a pretty fair number of facilities. We expect any cut to the pre-contractual rent to be modest at best.

Operator, Operator

Our next question will come from Jonathan Hughes with Raymond James.

Jonathan Hughes, Analyst

It's a question for Bob, and I asked a similar one last quarter. But just to simplify for us listening, could you give us the expected change from second quarter to third quarter driven by revenue from operators either resuming paying rent or no longer paying rent? I think last quarter, that number was kind of $11.5 million or so, and we did see FAD of about $10 million this past second quarter versus first quarter. But I just think that would be helpful for us listening if we could get a simplified sense of how a third quarter could shake out.

Taylor Pickett, CEO

I went into a lot of detail, and I apologize for not including my prepared remarks. The Agemo situation is straightforward, and it's currently in pay. We don’t anticipate any changes regarding negotiations at this time. For the Guardian cash basis, we are monitoring them; they made a payment in July. We currently expect an annual run rate of $24 million or $6 million for the quarter. The 3.4% operator also paid in July, so there is no change from the second quarter. As for the 2.4% operator, referred to as operator #1, they short paid in July and were only cash-based since the second quarter. So far, we have recorded $1.5 million there, having recorded $2.5 million in the second quarter. Regarding the 2.2% operator, they are on a straight-line basis and short paid in both June and July. However, we have letters of credit that support their payment. I expect they will pay, and if they fall short, we will utilize the letters of credit, which accounted for approximately $5.5 million in the second quarter. Lastly, we discussed some asset sales, which you can see on Page 19 of our supplemental material. We included information on how much revenue those sales contributed in the quarter and the pro forma amounts for the two new loans we secured and the projected additional revenue for the third quarter.

Jonathan Hughes, Analyst

Okay. All right. I'll have to go back and piece those together. But I mean, it sounds like it's your trend, maybe there's some puts and takes, but perhaps flat would be against the rough number if we put all those items together?

Taylor Pickett, CEO

Yes. Again, we have some on a cash basis, so it's going to be based on what they say. But, yes.

Jonathan Hughes, Analyst

That's helpful. And then my follow-up would be on just demand for skilled nursing assets in the private market. That's been incredibly strong, evidenced by the dispositions completed year-to-date. Has there been any change in that demand given the higher interest rate backdrop and the uncertain macroeconomic picture over the past kind of 3 months or so?

Dan Booth, COO

We haven't really been in the market, believe it or not, for the last quarter or 2 in terms of putting things for sale. So I'm not sure what the buyer universe is thinking about the interest rate increases. Obviously, they affect pricing and the way people think about the future. But most of these folks, most of these current buyers are looking out over the long term. Long-term deals really haven't gone up that much. So I think there's still a pretty strong buyer universe out there looking to buy assets, and that's what we're seeing right now. It really hasn't waned much just because of the rising interest rates.

Operator, Operator

Our next question will come from Dave Rodgers with Baird.

Dave Rodgers, Analyst

Wanted to ask about the broader restructuring and some of the leases that you were talking about as well as some of the asset sales. But maybe before I get to that, Bob, in terms of the letter of credit that you had taken down in the quarter. When you look at your entirety of your tenant base, how much of your rent is coming from letters of credit on the straight line side? Is that just that you're giving us the largest tenants that are having problems? Or is there an overall number that we can look at to kind of get a better sense of the total portfolio?

Bob Stephenson, CFO

What I outlined was the majority of it.

Dave Rodgers, Analyst

There's not much on the smaller tenants. Okay. That's helpful. And then I guess I did want to go back to the idea of kind of the timing on some of the restructuring of these leases. When do you think you get through all of this? Is there a major issue now that we're through, CMS you're starting to see some of the Medicaid plans come out? Does this accelerate the timing of Agemo and some other things? I mean, I guess, at what point do we get to the hinge point where some of the news starts to get a little bit better and the tenant issues start to dry up? Are we getting closer to that? Or do we think that that's going to continue throughout much of the year?

Dan Booth, COO

So Agemo, which is obviously the significant project, we are currently aiming for an early fourth quarter completion. That is the main focus. None of the news from the federal government or state reimbursements will impact this; it’s purely about restructuring and timing. Other projects involve a lengthy process, which can sometimes be quicker, but when it comes to sales or releases, there’s considerable lead time required. Many of our restructures are subject to this. When similar situations arise with other operators we’re discussing, it takes time to resolve. There’s a substantial amount of diligence required and significant regulatory involvement, all of which is time-consuming.

Dave Rodgers, Analyst

And the other part of that question I just wanted to get to was, you guys had mentioned in the past that you had anticipated maybe there was additional issues coming up. Are you still at a point today where you believe that you'll see additional issues arising with tenants? Or was this what you had anticipated and you would expect that they start to abate at this point?

Taylor Pickett, CEO

I think we still have to be cautious about the possibility of additional issues. But I will point out something that we talked about last quarter, which is that the issues that are coming up now are not as significant in terms of economic risk as we've seen in the last few months. So you think about the smaller operators that we're talking about now, the 2.2% revenue operator, we'll work through that. Those assets are strong. I don't see significant risk there, but it's obviously a headline that's tough for investors. I'll point out, Agemo is the one when you look at that, it's very big. It's fairly complicated. But if you put 6% of our revenue back to work, which is our goal and where we think we end up, it changes the metrics for everything. That payout ratios leverage a whole bunch of other issues. The things we're seeing today are just on the margin relative to something like Agemo.

Operator, Operator

Our next question will come from Michael Griffin with Citi.

Michael Griffin, Analyst

Maybe back to the Agemo restructuring and potential asset sales. Would the goal be similar sales relative to, say, the Gulf Coast portfolio earlier this year in terms of buyers and kind of expected disposition cap rates on those?

Taylor Pickett, CEO

Yes, it'd be similar. But that's a good comparison.

Michael Griffin, Analyst

Okay. And then maybe just on the phase, the CMS budget cuts you mentioned a little bit in your prepared remarks, but I'd just be curious maybe what you'd like to see greater from the federal government to be doing in order to support the industry.

Megan Krull, Senior Vice President of Operations

Yes. So obviously, it was great that they phased in that cut, but we would have liked to have seen that not picked in at all this time around given the environment. I think Medicare and CMS are talking about certain unfunded mandates that we like them, if they're going to do mandates in the future, to have some funding mechanism for those, like we're starting to see in the state. We're really concentrating a lot more on the states at both the largest payer source for our operators. If you think about where we are with our top 15 states, we've started to see some really good traction there. We have Florida with a 7.8% rate increase that kicked in or will kick in in October. We've got 4 of those states that have double-digit rate increases coming up later this year or early next year. Three of them have done continuation of the COVID FMAP funds post public health emergency, so given after that federal funding goes away. We're watching several other states as well, particularly Texas. But I think it's really the state side that we're looking at right now.

Operator, Operator

Our next question will come from Daniel Bernstein with Capital One.

Daniel Bernstein, Analyst

I wanted to revisit the topic of Agemo. Do you expect to start recording cash rents in the fourth quarter with the restructuring?

Dan Booth, COO

I think you were a little hard to hear, but I think I heard your question. Are we expecting cash rents from Agemo in the fourth quarter? The answer is no, not as part of the current restructuring discussions.

Daniel Bernstein, Analyst

Okay. And then the other question I had was, sorry, go ahead.

Dan Booth, COO

No, I was just going to say, we hope to complete it, and therefore, there will be potentially proceeds from asset sales or releases, but not cash rent coming in in the fourth quarter. I just want to make that clear.

Daniel Bernstein, Analyst

Okay. No, I appreciate that. And then the other question I had was on the hiring within the industry, the SNF industry in your portfolio. How long does it take for a new hire to actually contribute to staffing to maybe allow operators to increase occupancy and new admits?

Megan Krull, Senior Vice President of Operations

I mean, I think this is an industry where people come in on a regular basis. If you think about agency during COVID times, right, I mean, they get people acclimated pretty quickly and up and running pretty quickly on the first day they're in the door. So that helps with occupancy. I mean, again, that's where the agency aspect comes in. The bigger concern is making sure that someone gets more involved in the culture. From an agency perspective, we always have concerns over potential survey issues to people. But in terms of new hires, I think that's pretty quick.

Daniel Bernstein, Analyst

Okay. And then one last question from me, just kind of going back to the investment side of the business. Have you seen any indications that cap rates can move up or maybe leading indicators such as re-trades or deals that you looked at, got outbid, and now they're coming back to you? Just trying to kind of get a forward-looking sense of where pricing might go.

Taylor Pickett, CEO

Not a lot of good data there, Dan. Maybe just on the margin, you see it a little bit, but I would tell you that there's just not enough out there to say there's a trend yet.

Operator, Operator

Our next question will come from Nick Yulico with Scotiabank.

Nick Yulico, Analyst

First question was just going back to the 3.4% operator. I just want to make sure that I understand this correctly in terms of the operators paying rent again. I think you said it's also paid in July. But at the same time, you described in the release how they pretty much maxed out their line of credit facility. I just want to make sure that for that operator, we should be fully confident that they're going to continue to pay rent. Or was there a chance that some of the drawing on the credit facility was actually being used to help pay rent?

Dan Booth, COO

I believe we are still in discussions with that operator as we mentioned earlier. They are operating on a cash basis, so we won't be recording rental income at this time. However, our current expectation is that they will keep paying rent moving forward. We are also having conversations about possibly selling some of the underperforming assets.

Nick Yulico, Analyst

I just want to clarify something based on your release. From the start of the year, when they weren't paying rent, to June 30, when they were fully paying it, how much did they draw on the credit facility with your company?

Bob Stephenson, CFO

They drew $4 million since the beginning of the year, Nick. If you look, they paid $8.8 million in the second quarter, and they paid another just under $3 million in July.

Nick Yulico, Analyst

Got it. Okay. That's helpful, Bob. So the other question I had was in terms of the new investments you made, the mezz loan and the preferred equity investment. Are those both fully cash paying loans?

Bob Stephenson, CFO

Yes, they are.

Nick Yulico, Analyst

Okay. Following up on the mezzanine loan and the working capital loan, can you describe the health of the operator that you supported? Is this a troubled operator that needed capital, or is it an operator that hasn’t experienced any nonpayment of rent yet?

Bob Stephenson, CFO

So just the opposite. This is a very, very strong client. They've been with us for a very long time. We assisted them in our capital stack as part of an acquisition. So it had nothing to do with the restructuring.

Nick Yulico, Analyst

Okay. Great. And just one last question, I guess, is on the dividend. How we should think about that? It's pretty much paying out most of AFFO right now, if you look at your cash flow statement, you're paying out more in your dividends than you're getting in operating cash flow. So I mean what's the Board thinking in terms of the ability to keep the dividend as it is?

Taylor Pickett, CEO

Yes. As you know, cash flows will have certain timing aspects that will appear in the quarter, and Bob can elaborate on that. However, I think the key metric to focus on is FAD, which is cash per share compared to the dividend. We're currently distributing 94% of FAD. When we consider putting Agemo back to work, that number would drop into the 80s. We are very confident that Agemo will be back in action soon, and the other issues at hand are not significant enough to affect our outlook. That's a valid point, and as we mentioned before, if our perspective changes, we will reassess our dividend policy. But as long as we maintain the current outlook, you can expect us to sustain our dividend. Keep in mind that before all of this, our payout was already close to the minimum. As we address these matters, we expect to revert to the 80s, maintaining a similar position.

Operator, Operator

Our next question will come from Tayo Okusanya with Credit Suisse.

Tayo Okusanya, Analyst

Yes. I just wanted to kick back to something a little bit different. In the quarter, you guys kind of disclosed a legal reserve. I'm just kind of curious what that may have been in regards to.

Taylor Pickett, CEO

Yes, Tayo. There's a lawsuit that we inherited in a deal that we completed several years ago, and we think it's going to be settled, and that's what that reserve's for.

Tayo Okusanya, Analyst

Okay. That's helpful. And then, Taylor, I mean, some of the comments you've made, I mean, I guess I'm kind of reading cautious optimism from you and the rest of the team in regards to there could still be some near-term challenges, but the worst is over. I mean, is that what you really want us to take away from the call? Or should we still be concerned about potential things to get worse before they get better?

Taylor Pickett, CEO

I'm relatively optimistic about the long term. The short-term challenge, as Megan mentioned, is at the state level, where some states have responded positively with significant Medicaid rate increases to offset persistent labor costs. However, in Texas, with the current public health emergency, there's a $20 Medicaid add-on. Once the public health emergency concludes, whether that's in mid-October or extended into 2023, we need to observe how Texas will adjust its Medicaid rates. This is an area where I have hope, but there’s uncertainty. Overall, I'm optimistic in the long term and cautiously optimistic in the short term, with one of the key points being how state Medicaid rates will evolve over the next nine months.

Tayo Okusanya, Analyst

And Texas being the biggest wildcard for you guys?

Taylor Pickett, CEO

Well, just because it's one of our biggest states.

Operator, Operator

Our next question will come from Rich Anderson with SMBC.

Rich Anderson, Analyst

So regarding the 2.4% tenant, they made their payment in May but then changed their mind and didn't pay or only made a partial payment in June. What do you think caused this shift? Was it related to costs, labor issues, or something else that might not be immediately apparent? Also, how would you assess the quality of the portfolio in terms of your capacity to sell assets if you decide to pursue that option?

Dan Booth, COO

I think this operator, like most operators, I mean, to the extent that they have the cash on hand to pay rent, they pay rent. I think that they found themselves coming up short, so we ended up getting short paid. That's going to change from month to month. It depends. There are some months where they have 3 payrolls. They are some months where Medicaid remits are slow or they don't come in until the following month. There's a whole host of different things that can affect the cash flow. The assets in this portfolio are very, very high-quality assets.

Rich Anderson, Analyst

Okay. West Coast, I think?

Dan Booth, COO

Yes, no comment on that.

Rich Anderson, Analyst

All right. The broader question is, when you think about what you're going through today and how you're restructuring leases, how does this sort of manifest itself when you're thinking about escalators? Because in my view, investors and people like me care a lot more about coverage and coverage improving rather than any growth that you might get here or there out of a triple-net structure. So do you agree with that statement that it's more about coverage than it is about growth? You get your growth from external sources. And if that is the case, are you dialing down escalators when you're restructuring so that you don't run into or you lower the risk of running into similar problems in the future?

Taylor Pickett, CEO

Yes. Philosophically, we still think escalators that are a proxy for inflation is the right model. Now I've heard plenty of people argue that it's not the right model, but that's after going through an extended period of very low inflation. We know rates typically follow inflation. Rather than focusing on the handful of struggling operators, I'd point you to the majority of operators that continue to perform that are able to handle escalators. I think that economic proposition, that model, is something that we're not prepared to give away because we don't think that's the right way to look at it from an industry perspective. I get the alternative argument, but that's our view as we sit here today.

Rich Anderson, Analyst

Fair enough. And then last question. You mentioned Texas being your biggest state; it’s also a big state. How would you approach Texas right now? You're getting all these good reads on Medicaid from several states around the country, but you're kind of in a holding pattern with Texas until sometime next year. Would there be any situation where you'd be willing to make an investment of scale in Texas at this point? Or is it almost impossible for you to underwrite it at this juncture because you just don't know where it's going?

Taylor Pickett, CEO

We haven't had an opportunity to look at anything in Texas, as we obviously would with the right operating partner, somebody that's already in our portfolio where we understand the credit, and perhaps the credits are enhanced by the existing master lease. That being said, it's a fair point. You'd have to be able to look at Texas and say, if I assume minimal or no rate increases, what does that portfolio, that pro forma have to look like as part of the analysis? I think transacting in Texas is a bit of a wildcard until we see what the legislature does in 2023. As I think you know, they meet every other year. Fortunately, we're in a legislative year coming up in '23.

Operator, Operator

Our next question will come from Steven Valiquette with Barclays.

Steven Valiquette, Analyst

So I just want to touch on from your prepared remarks, you alluded to a large survey with some 60% plus of SNFs in that survey still having to turn away some patient volume due to staffing shortages. It’s probably incredibly difficult to quantify this. But I guess just based on feedback from your own operators, what do you think the magnitude of impact is just on your portfolio occupancy solely related to this dynamic of your SNF operators having to turn away patient volume due to staffing shortages? Are we talking tens of basis points or hundreds of basis points? Any thoughts on that would be helpful. Also, where do you think that volume goes? Is it just a fun of the home health? Curious where you think that volume goes if SNFs are not capturing it.

Megan Krull, Senior Vice President of Operations

I think to that last point, I don't know that it's necessarily home health. I do know that hospitals, sometimes those patients get trapped in the hospitals. They can't be moved on to SNFs because, in a certain particular area, there are events for them to go to. I don't know what the number is from an occupancy perspective, but it is having a significant impact on our occupancy. If you think about that ACA survey being a proxy for where we would be with 60% of buildings at any given time limiting capacity because of staffing issues. I think that is cause for concern in the industry in general. I will say anecdotally, I think our operators feel like that's getting a little bit better as they try to work through their staffing issues with wage increases and various different aspects, including some of our operators having some success with getting international nurses in, which is starting to help as well.

Operator, Operator

Our next question will come from Vikram Malhotra with Mizuho.

Vikram Malhotra, Analyst

Just on the point about investments, just maybe broadly, capital allocation. How are you thinking about buybacks at this level versus investments? And then within investments, is there an opportunity to maybe look at so-called value add given the trajectory you may contemplate long term? Or what type of assets are you focused on, on the investment side?

Taylor Pickett, CEO

In terms of stock buyback, I think if you look at where we bought stock over the last couple of quarters, that's a pretty good indication of how we think about stock buybacks versus our current price. In terms of capital allocation and value add, we're always looking at value add, thinking about it. But frankly, the best capital allocation we could do is with our existing operators. If I just contrast the U.S. versus the U.K., the U.K. pipelines are really active. We have a number of operators in the U.K. and that, I think, reflects almost a complete recovery from COVID in the U.K. in terms of occupancy and the operating model. Then contrasted to the U.S., where obviously we're not there yet. The level of activity is lower. But we are seeing some of our bigger operators become a little bit more acquisitive, which is why we participated as an example in the one deal that Dan mentioned this past quarter.

Vikram Malhotra, Analyst

Okay. Could you maybe just expand upon specifically your thoughts around taking on more senior housing assets in the RIDEA structure and your behavior?

Taylor Pickett, CEO

So we don't have any RIDEA. We really haven't found any opportunities where that seems attractive to us. Behavioral, we have a number of behavioral assets just in our other bucket. A couple of psychiatric hospitals, a bunch of substance use disorder assets. We continue to look at the asset class, and we like it. It's gotten a little bit expensive on a relative basis. But we know it, and we're interested, and we'll continue to look.

Vikram Malhotra, Analyst

Great. And then just last clarification. I think you mentioned we've obviously seen Florida and Pennsylvania. I think Virginia has a double-digit rate. Are there any other states, Mississippi and Kentucky, are there any I'm missing? Just to clarify on the Texas side, the way it works, is there a proposal and a comment period? Or is it just they meet in early next year, and we just get to know what that rate is?

Megan Krull, Senior Vice President of Operations

The other double-digit state that you're missing is Washington. You’ll remember that Washington State was hit the hardest at the beginning of COVID; they had that one building. They’re really far along. They have continued their COVID FMAP post-public health emergency as well. In terms of Texas, the rate setting will be until sometime next year, around April or May when they start their legislative session. What we have heard is that Governor Abbott believes the skilled nursing facilities do need rate increases, but what comes with that is still uncertain. The big push in the state is, at the very least, for the $20 Medicaid add-on to continue post-public health emergency, but it’s too soon to say where that goes. If the governor supports it, that's at least a good step in the right direction.

Operator, Operator

Our next question will come from Joshua Dennerlein with Bank of America.

Joshua Dennerlein, Analyst

On Agemo, I guess I'm just kind of curious on maybe what's taking so much time to come to an agreement. Just trying to figure out what the sticking points are, just maybe a better idea of when it might actually go through.

Dan Booth, COO

It's not necessarily the agreement. It's what goes into that agreement and what is part of it, which, as we've indicated, multiple quarters now involves some significant asset sales. You have to take that into account that it is a lengthy process.

Joshua Dennerlein, Analyst

Is it like lining up buyers or just trying to sort out with the Agemo what you're selling or how it's going to be sold?

Dan Booth, COO

No. It's more working out. First, you got to do, obviously, the marketing; you got to select the right buyers; negotiate your contracts; submit challenges; they got to do their due diligence; they got to get regulatory approval. I mean, the list goes on and on, and it is a lengthy process.

Joshua Dennerlein, Analyst

Were there any common themes regarding what caused the underpayments for the two tenants that underpaid in June and July?

Dan Booth, COO

I don't think there's any common themes. These operators do business in different states. I think it's just that their cash flow is thin at the moment.

Operator, Operator

It appears there are no further questions. This concludes our question-and-answer session. I would like to turn the conference back over to Taylor Pickett for any closing remarks.

Taylor Pickett, CEO

Thank you. Thanks, everybody, for joining us this morning. I appreciate it. As always, if you have any follow-ups, please reach out to Matthew or Bob. Thank you.

Operator, Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.