TFSA 10-K
Terra Income Fund 6, LLC (TFSA)
10-K
2024-03-15
For: 2023-12-31
View Original
Added on
April 09, 2026
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |||||
For the Fiscal Year Ended December 31 , 2023
| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |||||
For the Transition Period from to
Commission File Number: 000-55429
(Exact name of registrant as specified in its charter)
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |||||||
(Address of principal executive offices) (Zip Code)
(212 ) 753-5100
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol(s) | Name of exchange on which registered | ||||||||||||
Securities registered pursuant to Section 12(g) of the Act: None.
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer | ¨ | Accelerated filer | ¨ | ||||||||
þ | Smaller reporting company | ||||||||||
| Emerging growth company | |||||||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 USC. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. o
If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements. ☐
Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s executive officers during the relevant recovery period pursuant to §240.10D-1(b).☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ☑
All of the limited liability company interest in the registrant is held by an affiliate of the registrant. No market value has been computed based upon the fact that no active trading market had been established as of the date of this document.
Documents Incorporated by Reference
Omission of Certain Information
The registrant meets the conditions set forth in General Instruction I(1)(a) and (b) of Form 10-K and is therefore filing this Annual Report on Form 10-K with reduced disclosure format.
TABLE OF CONTENTS
| Page | ||||||||
| PART I | ||||||||
| PART II | ||||||||
| PART III | ||||||||
| PART IV | ||||||||
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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of the statements in this Annual Report on Form 10-K of Terra Income Fund 6, LLC (“Terra LLC”), a wholly owned subsidiary of Terra Property Trust, Inc. (“Terra REIT”) and the successor of Terra Income Fund 6, Inc. (“Terra BDC”), constitute forward-looking statements because they relate to future events or our future performance or financial condition. On October 1, 2022, pursuant to an Agreement and Plan of Merger, dated as of May 2, 2022, Terra BDC merged with and into Terra LLC, with Terra LLC continuing as the surviving entity of the merger (the “Merger”). In this report, as context requires, “we,” “us” and “our” refer to Terra BDC prior to the Merger and its successor, Terra LLC, after the Merger. The forward-looking statements contained in this Annual Report on Form 10-K may include, but are not limited to, statements as to:
•our expected financial performance and operating results;
•our ability to achieve the expected synergies, cost savings and other benefits from the Merger;
•risks associated with achieving expected synergies, cost savings and other benefits from the Merger;
•the availability of attractive risk-adjusted investment opportunities in our target asset class and other real estate-related investments that satisfy our objectives and strategies;
•the origination or acquisition of our targeted assets, including the timing of originations or acquisitions;
•volatility in our industry, interest rates and spreads, the debt or equity markets, the general economy or the real estate market specifically, whether the results of market events or otherwise;
•changes in our investment objectives and business strategy;
•the availability of strategic non-real estate investment opportunities;
•the availability of financing on acceptable terms or at all;
•the performance and financial condition of our borrowers;
•changes in interest rates and the market value of our assets;
•borrower defaults or decreased recovery rates from our borrowers;
•changes in prepayment rates on our loans;
•our use of financial leverage;
•actual and potential conflicts of interest with any of the following affiliated entities: Terra Capital Partners, LLC (“Terra Capital Partners”), our sponsor; Terra REIT Advisors, LLC, a subsidiary of Terra Capital Partners, and the external manager to our sole and managing member Terra REIT (“Terra REIT Advisors” or the “REIT Manager”); Terra Fund Advisors, LLC, an affiliate of Terra Capital Partners; Terra Secured Income Fund 5 International, Terra Income Fund International and Terra Secured Income Fund 7, LLC, (collectively, the “Terra Income Funds”); Terra Offshore Funds REIT, LLC; Mavik Capital Management, LP; Mavik Real Estate Special Opportunities Fund, LP; or any of their affiliates;
•our dependence on the REIT Manager or its affiliates and the availability of its senior management team and other personnel;
•actions and initiatives of the U.S., federal, state and local government and changes to the U.S. federal, state and local government policies and the execution and impact of these actions, initiatives and policies;
•the degree and nature of our competition.
In addition, words such as “anticipate,” “believe,” “expect” and “intend” indicate a forward-looking statement, although not all forward-looking statements include these words. The forward-looking statements contained in this Annual Report on Form 10-K involve risks and uncertainties. Our actual results could differ materially from those implied or expressed in the forward-looking statements for any reason, including the factors set forth in “Part I — Item 1A. Risk Factors” in this Annual Report. Other factors that could cause actual results to differ materially include:
•changes in the economy;
•risks associated with possible disruption in our operations or the economy generally due to terrorism or natural disasters; and
•future changes in laws or regulations and conditions in our operating areas.
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We have based the forward-looking statements included in this Annual Report on Form 10-K on information available to us on the date of this Annual Report on Form 10-K. Except as required by the federal securities laws, we undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise. Readers are advised to consult any additional disclosures that we may make through reports that we may file in the future with the Securities and Exchange Commission (the “SEC”), including annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K. The forward-looking statements and projections contained in this Annual Report on Form 10-K are excluded from the safe harbor protection provided by Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).
RISK FACTOR SUMMARY
We are subject to numerous risks and uncertainties that could cause our actual results and future events to differ materially from those set forth or contemplated in our forward-looking statements, including those summarized below. The following list of risks and uncertainties is only a summary of some of the most important factors and is not intended to be exhaustive. This risk factor summary should be read together with the more detailed discussion of risks and uncertainties set forth under Item 1A — Risk Factors.
Risks Related to Our Business and Structure
•Our loan portfolio is concentrated in a limited number of industries and borrowers, which may subject us to a risk of significant loss if there is a downturn in a particular industry in which we are concentrated or if one of our larger borrowers encounters financial difficulties.
•Inflation in the U.S. has accelerated in recent years and is currently expected to continue at an elevated level in the near-to/medium-term, which may have an adverse impact on the valuation of our investments.
•Terra REIT may change our operating policies, objectives or strategies without prior notice, and the effects of such a change may be adverse.
•Our ability to achieve our investment objectives depends on Terra REIT’s and Terra REIT Advisors’ ability to manage and support our investment process. If Terra REIT were to lose any members of its senior management team, our ability to achieve our investment objectives could be significantly harmed.
•The Current Expected Credit Loss (“CECL”) accounting standard requires us to make certain estimates and judgments, which may be difficult to determine and may have a material adverse effect on our financial condition and results of operations.
Risks Related to Terra REIT Advisors and its Affiliates
•Terra REIT Advisors and its affiliates, including some of Terra REIT’s directors, face conflicts of interest caused by compensation arrangements with us and our affiliates, which could result in actions that are not in our best interests.
•There may be conflicts of interest related to obligations Terra REIT Advisors has to our affiliates and to other clients.
Risks Related to Our Investments
•A covenant breach by any of our borrowers or investees may harm our operating results.
•A lack of liquidity in certain of our investments may adversely affect our business.
•Our real estate-related loans may be impacted by unfavorable real estate market conditions, which could decrease the value of our investments.
•Our real estate-related loans will be subject to interest rate fluctuations that could reduce our returns as compared to market interest rates.
•The mezzanine loans in which we may invest would involve greater risks of loss than senior loans secured by income-producing real properties.
•Investments in non-conforming or non-investment grade rated loans or securities involve greater risk of loss.
•We have no established investment criteria limiting the geographic concentration of our investments. If our investments are concentrated in an area that experiences adverse economic conditions, our investments may lose value and we may experience losses.
•Hedging against interest rate exposure may adversely affect our earnings, limit our gains or result in losses.
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•If we overestimate the value or income-producing ability or incorrectly price the risks of our investments, we may experience losses.
Risk Related to Debt Financing
•Changes in interest rates may affect our cost of capital
•Covenants in our debt agreements may restrict our operating activities and adversely affect our financial condition, operating results and cash flows.
General Risk Factors
•COVID-19, or the future outbreak of other highly infectious or contagious diseases, could materially and adversely impact or disrupt our investments, business, financial condition and results of operations.
•Future recessions, downturns, disruptions or instability could have a materially adverse effect on our business.
•As a public company, we are subject to regulations not applicable to private companies, such as provisions of the Sarbanes-Oxley Act. Efforts to comply with such regulations involves significant expenditures, and non-compliance with such regulations may adversely affect us.
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PART I
Item 1. Business.
Overview
Terra Income Fund 6, LLC (“Terra LLC”) was formed as a Delaware limited liability company on April 29, 2022 as a wholly owned subsidiary of Terra Property Trust, Inc. (“Terra REIT”). On October 1, 2022, pursuant to an Agreement and Plan of Merger, dated as of May 2, 2022 (as amended, the “Merger Agreement”), Terra Income Fund 6, Inc. (“Terra BDC”) merged with and into Terra LLC, with Terra LLC continuing as the surviving entity of the merger (the “Merger”). Subsequent to the Merger, Terra LLC became the successor of Terra BDC and assumed all of Terra BDC’s rights and obligations. The former members of Terra BDC’s board of directors (the “Terra BDC Board”) joined the board of directors of Terra REIT. Terra LLC does not have a board of directors and Terra REIT is the sole and managing member of Terra LLC. As context requires, “we,” “us” and “our” refer to Terra BDC prior to the Merger and its successor, Terra LLC, after the Merger.
Terra BDC was a Maryland corporation, formed on May 15, 2013 and commenced operations on June 24, 2015. Terra BDC elected to be regulated as a business development company (“BDC”) under the Investment Company Act of 1940, as amended (the “1940 Act”) until it withdrew its election on September 29, 2022. Terra BDC was an externally managed, non-diversified, closed-end management investment company that initially elected to be taxed for federal income tax purposes as a regulated investment company (“RIC”) until December 31, 2018, when it changed its tax election from taxation as a RIC to taxation as a real estate investment trust (“REIT”). Terra BDC elected to be taxed as a REIT under Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”), commencing with its short taxable year beginning October 1, 2018 and ending December 31, 2018. Concurrent with the change in its tax election, Terra BDC changed its fiscal year end from September 30 to December 31 to satisfy the REIT requirements under the Code. During the period beginning October 1, 2018 through our short taxable year ended October 1, 2022 (the “REIT Period”), as a REIT we were not subject to federal income taxes on income and gains distributed to the stockholders as long as certain requirements were satisfied, principally relating to the nature of income and the level of distributions, as well as other factors.
On February 10, 2021, Terra BDC issued $34.8 million in aggregate principal amount of 7.00% fixed-rate notes due 2026, and on February 26, 2021, the underwriters exercised the option to purchase an additional $3.6 million of the notes. Interest on the notes is paid quarterly in arrears every March 30, June 30, September 30 and December 30, at an annual rate of 7.00% per year, beginning June 30, 2021. The notes mature on March 31, 2026. The notes may be redeemed in whole or in part at any time or from time to time at our option on or after February 10, 2023.
Pursuant to the terms of the Merger Agreement, on October 1, 2022, except for any shares of common stock, par value $0.001 per share, of Terra BDC (“Terra BDC Common Stock”) held by Terra REIT or any wholly owned subsidiary of Terra REIT or Terra BDC, which shares were automatically retired and ceased to exist with no consideration paid therefor, each issued and outstanding share of Terra BDC Common Stock was automatically cancelled and retired and converted into the right to receive (i) 0.595 shares of the newly designated Class B Common Stock, par value $0.01 per share, of Terra REIT (“Class B Common Stock”) and (ii) cash, without interest, in lieu of any fractional shares of Class B Common Stock otherwise issuable in an amount, rounded to the nearest whole cent, determined by multiplying (x) the fraction of a share of Class B Common Stock to which such holder would otherwise be entitled by (y) $14.38.
Pursuant to the terms of the transactions described in the Merger Agreement, 4,847,910 shares of Class B Common Stock were issued to former Terra BDC stockholders in connection with the Merger. Following the consummation of the Merger, former Terra BDC stockholders own approximately 19.9% of the common equity of Terra REIT as the combined company.
In connection with the Merger, we assumed the obligations of Terra BDC under the indenture of the unsecured notes payable as well as the credit agreement to provide for a delayed draw term loan of up to $25.0 million. Additionally, the investment advisory and administrative service agreement between Terra BDC and Terra Income Advisors (the “Investment Advisory Agreement”) and the servicing plan between Terra BDC and Terra Capital Markets, LLC (“Terra Capital Markets”) (the “Servicing Plan”) were terminated on October 1, 2022 and fees pursuant to such agreements are no longer payable. Management fees are now payable by our parent and sole member, Terra REIT, to its external manager, Terra REIT Advisors, pursuant to the amended and restated management agreement, dated as of February 8, 2018 (the “Management Agreement”), by and between Terra REIT and Terra REIT Advisors. We have entered into a cost sharing and reimbursement agreement (the “Cost Sharing Agreement”) with Terra REIT pursuant to which we will be responsible for our allocable share of Terra REIT’s expenses, including fees paid by Terra REIT to its manager. Terra REIT’s investment objective is to provide attractive risk-adjusted returns to its stockholders, primarily through regular distributions. There can be no assurances that Terra REIT will be successful in meeting its investment objective.
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Terra BDC’s Investment Adviser
Terra BDC’s investment activities were externally managed by Terra Income Advisors, LLC (“Terra Income Advisors”, or the “Adviser”), a private investment firm affiliated with Terra BDC, pursuant to the Investment Advisory Agreement, under the oversight of the Terra BDC Board, a majority of whom were independent. Terra Income Advisors is registered as an investment adviser under the Investment Advisers Act of 1940, as amended (the “Advisers Act”). Under the Investment Advisory Agreement, Terra BDC paid Terra Income Advisors a base management fee as well as an incentive fee based on its investment performance.
Terra Income Advisors was responsible for sourcing potential investments, conducting due diligence on prospective investments, analyzing investment opportunities, structuring investments and monitoring Terra BDC’s portfolio on an ongoing basis according to asset allocation and other guidelines set by the Terra BDC Board. The level of Terra BDC’s investment activity depended on many factors, including the amount of debt and equity capital available to prospective borrowers, the level of refinancing activity for such companies, the availability of credit to finance transactions, the general economic environment and the competitive environment for the types of investments Terra BDC made.
The management of Terra BDC’s investment portfolio was the responsibility of Terra Income Advisors and its executive officers. The investment committee of Terra Income Advisors approved each new investment that Terra BDC made. The Terra BDC Board, including a majority of independent directors, oversaw and monitored Terra BDC’s investment performance and annually reviewed the compensation Terra BDC paid to Terra Income Advisors and its performance during the preceding 12 months to determine if the compensation paid to Terra Income Advisors was reasonable in relation to the nature and quality of the services performed, and that the provisions of the Investment Advisory Agreement were carried out.
As discussed above, in connection with the Merger, the Investment Advisory Agreement between Terra BDC and Terra Income Advisors was terminated on October 1, 2022 and fees pursuant to such agreement are no longer payable. Management fees are now payable by our parent and sole member, Terra REIT, to its external manager, Terra REIT Advisors, pursuant to the Management Agreement. We have entered into the Cost Sharing Agreement pursuant to which we are responsible for our allocable share of Terra REIT’s expenses, including fees paid by Terra REIT to Terra REIT Advisors.
Mavik Capital Management, LP and Terra Capital Partners
Mavik Capital Management, LP (“Mavik”), an entity controlled by Vikram S. Uppal, Terra REIT's Chief Executive Officer and Chief Investment Officer, is the sole and managing member of Terra Capital Partners. Terra Capital Partners is led by Mr. Uppal (Chief Executive Officer), Sarah Schwarzschild (Chief Operating Officer), Gregory M. Pinkus (Chief Financial Officer) and Daniel Cooperman (Chief Originations Officer). Mr. Uppal was a Partner of Axar Capital Management L.P. (“Axar Capital Management”) and its Head of Real Estate. Prior to Axar Capital Management, Mr. Uppal was a Managing Director on the Investment Team at Fortress Investment Group’s Credit and Real Estate Funds and Co-Head of North American Real Estate Investments at Mount Kellett Capital Management. Members of the Terra Capital Partners management team have broad based, long-term relationships with major financial institutions, property owners and commercial real estate service providers. The entire senior management team has held leadership roles at many top international real estate and investment banking firms, including Mount Kellett Capital Management, Fortress Investment Group and BGO Strategic Capital Partners.
Terra Capital Partners is a real estate credit focused investment manager based in New York City with a 20-year track record focused primarily on the origination and management of mezzanine loans, as well as first mortgage loans, bridge loans, and preferred equity investments in all major property types through multiple pooled investment vehicles. Since its formation in 2001 and its commencement of operations in 2002, Terra Capital Partners has been engaged in providing financing on commercial properties of all major property types throughout the United States. In the lead up to the global financial crisis in 2007, believing that the risks associated with commercial real estate markets had grown out of proportion to the potential returns from such markets, Terra Capital Partners sold 100% of its investment management interests prior to the global financial crisis. It was not until mid-2009, after its assessment that commercial mortgage markets would begin a period of stabilization and growth, that Terra Capital Partners began to sponsor new investment vehicles, which included the Terra Income Funds, to again provide debt capital to commercial real estate markets. The financings provided by all vehicles managed by Terra Capital Partners from January 2004 through December 31, 2023 have been secured by approximately 13.9 million square feet of office properties, 3.7 million square feet of retail properties, 7.1 million square feet of industrial properties, 5,058 hotel rooms and 30,080 apartment units. The value of the properties underlying this capital was approximately $11.9 billion based on appraised values as of the closing dates of each financing. In addition to its extensive experience originating and managing debt financings, Terra Capital Partners and its affiliates have owned and operated over six million square feet of office and industrial space between 2005 and 2007, and this operational experience further informs its robust origination and underwriting standards and would be beneficial should Terra REIT Advisors need to foreclose on a property
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underlying a financing. As of the date of this Annual Report on Form 10-K, Terra Capital Partners and its affiliates employed 28 persons.
Investment Objectives and Strategy
We are a wholly owned subsidiary of Terra REIT and our investment objective is to provide attractive risk-adjusted returns to Terra REIT’s stockholders, primarily through Terra REIT’s regular distributions. We originate, invest in and manage a diverse portfolio of real estate-related investments that generate a stable income stream. We directly originate, structure and underwrite most, if not all, of our loans, as we believe that doing so will provide us with the best opportunity to invest in loans that satisfy our standards, establish a direct relationship with the borrower and optimize the terms of our investments; however, we may acquire existing loans from the originating lender should our adviser determine such an investment is in our best interest. From time to time, we may acquire real estate encumbering the senior loans through foreclosure, may invest in real estate related joint ventures and may directly acquire real estate properties. We may also elect to make strategic non-real estate-related investments that align with our investment objectives and criteria. We may hold our investments until their scheduled maturity dates or may sell them if we are able to command favorable terms for their disposition. We may also seek to realize growth in the value of our investments by timing their sale to maximize value.
Terra REIT Advisors’ management team has extensive experience in originating, acquiring, structuring, managing and disposing of real estate-related loans similar to the types of loans in which we intend to invest. In order to meet our investment objectives, we generally seek to follow the following investment criteria:
•focus primarily on the origination of new loans;
•focus on loans backed by properties in the United States;
•invest primarily in floating rate rather than fixed rate loans, but we reserve the right to make debt investments that bear interest at a fixed rate;
•invest in loans expected to be repaid within one to five years;
•maximize current income;
•lend to creditworthy borrowers;
•construct a portfolio that is diversified by property type, geographic location, tenancy and borrower;
•source off-market transactions;
•hold investments until maturity unless, in Terra REIT Advisors’ judgment, market conditions warrant earlier disposition; and
•invest in strategic non-real estate-related investments that align with our investment objectives and criteria.
While the size of each of our investments generally range between $3 million and $50 million, our investments ultimately are at the discretion of Terra REIT Advisors, subject to oversight by Terra REIT’s board of directors (the “Terra REIT Board”). We focus on smaller, middle market loans which are financing properties in primary and secondary markets because we believe these loans are subject to less competition, offer higher risk adjusted returns than larger loans with similar risk metrics and facilitate portfolio diversification.
To enhance our returns, we employ leverage, including leverage resulting from issuance of the notes, as market conditions permit and at the discretion of Terra REIT Advisors. See Item 1A “Risk Factors — Risk Related to Debt Financing” for a discussion of the risks inherent in employing leverage.
Our Business Strategy
In executing our business strategy, we believe that we benefited from Terra REIT Advisors’ affiliation with Terra Capital Partners, given its strong track record and extensive experience and capabilities as real estate investment manager and sponsor of the Terra Income Funds. We believe the following core strengths enable us to realize our investment objectives and provided us with significant competitive advantages in the marketplace, and attractive risk-adjusted returns to Terra REIT’s stockholders.
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Significant Experience of Terra Capital Partners
Terra Capital Partners provides Terra REIT Advisors with all of its key investment personnel. Terra Capital Partners has developed a reputation within the commercial real estate finance industry as a leading sophisticated real estate investment and asset management company with a 20-year track record in originating, underwriting and managing commercial real estate and real estate-related loans, preferred equity investments and investments with similar characteristics to the assets that we acquire. We believe we benefit from the depth and the disciplined approach Terra Capital Partners brings to its underwriting and investment management processes to structure and manage investments prudently. In addition to its extensive experience originating and managing debt financings, Terra Capital Partners and its affiliates have owned and operated over six million square feet of office and industrial space between 2005 and 2007, and this operational experience has further informed its robust origination and underwriting standards.
Disciplined Investment Process
We follow a disciplined investment origination, underwriting and selection process. We follow an investment approach focused on long-term credit performance and capital protection. This investment approach involves a multi-phase evaluation, structuring and monitoring process for each potential investment opportunity. After investment, our management team focuses on a thorough review of our investments for potential credit quality deterioration and potential proactive steps to mitigate any losses to our invested capital. We believe this approach maximizes current income and minimizes capital loss.
Portfolio Construction
We construct a portfolio that is diversified by property type, geographic location and borrower. We construct our portfolio based on our evaluation of the impact of each potential investment on the risk/reward mix in our existing portfolio. By selecting those assets that we believe will maximize returns while minimizing investment-specific risk, we believe we can build and manage an investment portfolio that provides superior value to Terra REIT’s stockholders over time, both in absolute terms and relative to other commercial real estate loan and real estate-related investment vehicles.
Superior Analytical Approach
We believe that our management team possesses the superior analytical approach to evaluate each potential investment through the balanced use of qualitative and quantitative analysis, which helps us manage risk on an individual investment and portfolio basis. We rely on a variety of analytical approach and models to assess our investments and risk management. We also conduct an extensive evaluation of the numerous factors that affect our potential investments. These factors include:
•Top-down review of both the current macroeconomic environment generally and the real estate and commercial real estate loan market specifically;
•Detailed evaluation of the real estate industry and its sectors;
•Bottom-up review of each individual investment’s attributes and risk/reward profile relative to the macroeconomic environment;
•Quantitative cash flow analysis and impact of the potential investment on our portfolio; and
•Ongoing management and monitoring of all investments to assess changing conditions on our original investment assumptions.
Extensive Strategic Relationships
Our management team maintains extensive relationships within the real estate industry, including real estate developers, institutional real estate sponsors and investors, real estate funds, investment and commercial banks, private equity funds, asset originators and broker-dealers, as well as the capital and financing markets generally. We believe these relationships enhance our ability to source and finance our investments as well as mitigate their credit and interest rate risk. We leverage the many years of experience and well-established contacts of our management team, and use these relationships for the benefit of Terra REIT’s stockholders.
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Targeted Assets
Real Estate-Related Investments
We originate, structure, fund and manage commercial real estate loans, including mezzanine loans, first mortgage loans, subordinated mortgage loans and preferred equity investments related to high-quality commercial real estate in the United States. We may invest in our targeted assets directly or through joint ventures and acquire some equity participations in the underlying collateral of such loans. Certain of our real estate-related loans require the borrower to make payments of interest on the fully committed principal amount of the loan regardless of whether the full loan amount is outstanding. We may also acquire real estate properties encumbering the first mortgage loans through foreclosure or deed-in-lieu of foreclosure, may invest in joint ventures that own real estate properties and may directly acquire real estate properties.
We originate, structure and underwrite most, if not all, of our loans. We, in reliance on the REIT Manager, use what we consider to be conservative underwriting criteria, and our underwriting process involves comprehensive financial, structural, operational and legal due diligence to assess the risks of financings so that we can optimize pricing and structuring. By originating, not purchasing, loans, we are able to structure and underwrite financings that satisfy our standards, utilize our proprietary documentation and establish a direct relationship with our borrower. Described below are some of the types of loans we own and seek to originate with respect to high-quality properties in the United States. We continue to see attractive lending opportunities, and we expect market conditions to remain favorable for our strategy for the foreseeable future.
First Mortgage Loans. These loans generally finance the acquisition, refinancing, rehabilitation or construction of commercial real estate. First mortgage loans may be either short-term (one-to-five year) or long-term (up to 10-year), may be fixed or floating rate and are predominantly current-pay loans. We originate current-pay first mortgage loans backed by high-quality properties in the United States that fit our investment strategy. We selectively syndicate portions of these loans, including senior or junior participations that will effectively provide permanent financing or optimize returns which may include retained origination fees.
First mortgages provide for a higher recovery rate and lower defaults than other debt positions due to the lender’s senior position. However, such loans typically generate lower returns than subordinate debt such as mezzanine loans or B-notes.
Subordinated Mortgage Loans (B-notes). B-notes include structurally subordinated first mortgage loans and junior participations in first mortgage loans or participations in these types of assets. Like first mortgage loans, these loans generally finance the acquisition, refinancing, rehabilitation or construction of commercial real estate. B-notes may be either short-term (one-to-five year) or long-term (up to 10-year), may be fixed or floating rate and are predominantly current-pay loans. We may create B-notes by tranching our directly originated first mortgage loans generally through syndications of senior first mortgages or buy these loans directly from third-party originators. We believe that the opportunities to both directly originate and to buy these types of loans from third parties on favorable terms will continue to be attractive.
Investors in B-notes are compensated for the increased risk of such assets from a pricing perspective but still benefit from a lien on the related property. Investors typically receive principal and interest payments at the same time as senior debt unless a default occurs, in which case these payments are made only after any senior debt is made whole. Rights of holders of B-notes are usually governed by participation and other agreements that, subject to certain limitations, typically provide the holders of subordinated positions of the mortgage loan with the ability to cure certain defaults and control certain decisions of holders of senior debt secured by the same properties (or otherwise exercise the right to purchase the senior debt), which provides for additional downside protection and higher recoveries.
Mezzanine Loans. These are loans secured by ownership interests in an entity that owns commercial real estate and generally finance the acquisition, refinancing, rehabilitation or construction of commercial real estate. Mezzanine loans may be either short-term (one-to-five year) or long-term (up to 10-year) and may be fixed or floating rate. We may originate mezzanine loans backed by high-quality properties in the United States that fit our investment strategy. We may own such mezzanine loans directly or we may hold a participation in a mezzanine loan or a sub-participation in a mezzanine loan. These loans are predominantly current-pay loans (although there may be a portion of the interest that accrues) and may provide for participation in the value or cash flow appreciation of the underlying property as described below. Generally, we invest in mezzanine loans with last dollar loan-to-value ratios ranging from 60% to 85%.
Preferred Equity Investments. These are investments in preferred membership interests in an entity that owns commercial real estate and generally finance the acquisition, refinancing, rehabilitation or construction of commercial real estate. These investments are expected to have similar characteristics to and returns as mezzanine loans.
Equity Participations. In connection with our loan investments, we may pursue equity participation opportunities, or interests in the projects being financed, in instances when we believe that the risk-reward characteristics of the loan merit
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additional upside participation because of the possibility of appreciation in value of the underlying assets securing the loan. Equity participations can be paid in the form of additional interest, exit fees or warrants in the borrower. Equity participation can also take the form of a conversion feature, permitting the lender to convert a loan or preferred equity investment into equity in the borrower at a negotiated premium to the current net asset value (“NAV”) of the borrower. We expect to be able to obtain equity participations in certain instances where the loan collateral consists of an asset that is being repositioned, expanded or improved in some fashion which is anticipated to improve future cash flow. In such case, the borrower may wish to defer some portion of the debt service or obtain higher leverage than might be merited by the pricing and leverage level based on historical performance of the underlying asset. We generate additional revenues from these equity participations as a result of excess cash flows being distributed or as appreciated properties are sold or refinanced.
Equity Investment in Unconsolidated Investments and Joint Ventures. We may, to the extent consistent with our investment objectives and criteria, invest in our targeted assets directly or through joint ventures.
Other Real Estate-Related Securities. We may invest in other real estate-related securities, which may include marketable securities and securitizations, so long as such securities do not constitute more than 15% of our assets.
Non-Real Estate-Related Investments
From time to time, we may invest in strategic non-real estate-related investments that align with our investment objectives and criteria.
Human Capital Management
We do not currently have any employees and do not expect to have any employees. Services necessary for our business are provided by individuals who are employees of Terra Capital Partners, our sponsor, or by individuals who are contracted by Terra Capital Partners to work on behalf of us pursuant to the terms of the Management Agreement.
Regulation
Terra BDC elected to be regulated as a BDC under the 1940 Act until it withdrew its election on September 29, 2022. As with other companies regulated by the 1940 Act, a BDC must adhere to certain substantive regulatory requirements. The 1940 Act contains prohibitions and restrictions relating to transactions between BDCs and their affiliates (including any investment advisers or sub-advisers), principal underwriters and affiliates of those affiliates or underwriters and requires that a majority of the directors be persons other than “interested persons,” as that term is defined in the 1940 Act. The 1940 Act provides that a BDC may not change the nature of its business so as to cease to be, or to withdraw its election as, a BDC unless approved by a majority of its outstanding voting securities.
“A majority of the outstanding voting securities” of a company is defined under the 1940 Act as the lesser of: (i) 67% or more of the voting securities of such company present at a meeting if the holders of more than 50% of the company’s outstanding voting securities are present or represented by proxy; or (ii) more than 50% of the outstanding voting securities of such company. Terra BDC secured the majority approval of its outstanding voting securities to withdraw its election as a BDC on September 12, 2022.
Terra BDC’s Qualifying Assets
Under the 1940 Act, a BDC may not acquire any asset other than assets of the type listed in Section 55(a) of the 1940 Act, which are referred to as qualifying assets, unless, at the time the acquisition is made, qualifying assets represent at least 70% of the company’s total assets. The principal categories of qualifying assets that were relevant to Terra BDC’s business are the following:
1.Securities purchased in transactions not involving any public offering from the issuer of such securities, which issuer (subject to certain limited exceptions) is an eligible portfolio company, or from any person who is, or has been during the preceding 13 months, an affiliated person of an eligible portfolio company, or from any other person, subject to such rules as may be prescribed by the SEC. An eligible portfolio company is defined in the 1940 Act as any issuer which:
a.is organized under the laws of, and has its principal place of business in, the United States;
b.is not an investment company (other than a small business investment company wholly owned by the BDC) or a company that would be an investment company but for certain exclusions under the 1940 Act; and
c.satisfies any of the following:
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i.does not have any class of securities that is traded on a national securities exchange;
ii.has a class of securities listed on a national securities exchange, but has an aggregate market value of outstanding voting and non-voting common equity of less than $250 million;
iii.is controlled by a BDC or a group of companies including a BDC and the BDC has an affiliated person who is a director of the eligible portfolio company;
iv.is a small and solvent company having total assets of not more than $4 million and capital and surplus of not less than $2 million; or
v.meets such other criteria as may be established by the SEC.
2.Securities of any eligible portfolio company that Terra BDC control.
3.Securities purchased in a private transaction from a U.S. issuer that is not an investment company or from an affiliated person of the issuer, or in transactions incident thereto, if the issuer is in bankruptcy and subject to reorganization or if the issuer, immediately prior to the purchase of its securities, was unable to meet its obligations as they came due without material assistance other than conventional lending or financing arrangements.
4.Securities of an eligible portfolio company purchased from any person in a private transaction if there is no ready market for such securities and Terra BDC already owned 60% of the outstanding equity of the eligible portfolio company.
5.Securities received in exchange for or distributed on or with respect to securities described in (1) through (4) above, or pursuant to the exercise of warrants or rights relating to such securities.
6.Cash, cash equivalents, U.S. government securities or high-quality debt securities maturing in one year or less from the time of investment.
Control, as defined by the 1940 Act, is presumed to exist where a BDC beneficially owns more than 25% of the outstanding voting securities of the portfolio company.
In addition, a BDC must have been organized and have its principal place of business in the United States and must be operated for the purpose of making investments in the types of securities in eligible portfolio companies, or in other securities that are consistent with its purpose as a BDC.
Managerial Assistance to Portfolio Companies
In order to count portfolio securities as qualifying assets for the purpose of the 70% test, Terra BDC must have either controlled the issuer of the securities or must have offered to make available to the issuer of the securities (other than small and solvent companies described above) significant managerial assistance; except that, where Terra BDC purchased such securities in conjunction with one or more other persons acting together, one of the other persons in the group may have made available such managerial assistance. Making available significant managerial assistance means, among other things, any arrangement whereby the BDC, through its directors, officers or employees, offers to provide, and, if accepted, does so provide, significant guidance and counsel concerning the management, operations or business objectives and policies of a portfolio company.
Terra Income Advisors or its affiliates may have provided such managerial assistance on Terra BDC’s behalf to portfolio companies that requested this assistance, recognizing that Terra BDC’s involvement with each investment would vary based on factors including the size of the company, the nature of its investment, the company’s overall stage of development and Terra BDC’s relative position in the capital structure. Terra BDC may have received fees for these services.
Terra BDC’s Temporary Investments
Pending investment in other types of “qualifying assets,” as described above, Terra BDC’s investments may have consisted of cash, cash equivalents, U.S. government securities or high-quality debt securities maturing in one year or less from the time of investment, which Terra BDC referred to, collectively, as temporary investments, so that 70% of its assets were qualifying assets. Terra BDC typically invested in U.S. Treasury bills or in repurchase agreements, provided that such agreements were fully collateralized by cash or securities issued by the U.S. government or its agencies. A repurchase agreement involves the purchase by an investor, such as Terra BDC, of a specified security and the simultaneous agreement by the seller to repurchase it at an agreed-upon future date and at a price that is greater than the purchase price by an amount that reflects an agreed-upon
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interest rate. There was no percentage restriction on the proportion of Terra BDC’s assets that may have been invested in such repurchase agreements.
Terra BDC’s Indebtedness and Senior Securities
As a BDC, Terra BDC was permitted, under specified conditions, to issue multiple classes of indebtedness and one class of stock senior to its common stock if its asset coverage, as defined in the 1940 Act, is at least equal to 200% immediately after each such issuance. In addition, while any senior securities remained outstanding, Terra BDC must have generally made provisions to prohibit any distribution to its stockholders or the repurchase of such securities or stock unless it met the applicable asset coverage ratios at the time of the distribution or repurchase. Terra BDC may have also borrowed amounts up to 5% of the value of its total assets for temporary or emergency purposes without regard to asset coverage.
Terra BDC’s Common Stock
As a BDC, Terra BDC was subject to certain regulatory restrictions in making its investments. For example, Terra BDC may have been prohibited under the 1940 Act from knowingly participating in certain transactions with its affiliates without the prior approval of the Terra BDC Board who were not interested persons and, in some cases, prior approval by the SEC. The SEC granted Terra BDC exemptive relief permitting it, subject to satisfaction of certain conditions, to co-invest in certain privately negotiated investment transactions with certain affiliates of Terra Income Advisors, including the Terra Income Funds, Terra REIT, and any future BDC or closed-end management investment company that was registered under the 1940 Act and was advised by Terra Income Advisors or its affiliated investment advisers (the “Co-Investment Affiliates”). However, Terra BDC was prohibited from engaging in certain transactions with its affiliates even under the terms of this exemptive order. Terra BDC believed this relief not only enhanced its ability to further its investment objectives and strategy, but may have also increased favorable investment opportunities for it, in part by allowing it to participate in larger investments, together with its Co-Investment Affiliates, than would have been available to it if it had not obtained such relief.
Terra BDC’s Co-Investments
As a BDC, Terra BDC was subject to certain regulatory restrictions in making its investments. For example, Terra BDC may have been prohibited under the 1940 Act from knowingly participating in certain transactions with its affiliates without the prior approval of the Terra BDC Board who were not interested persons and, in some cases, prior approval by the SEC. The SEC granted Terra BDC exemptive relief permitting it, subject to satisfaction of certain conditions, to co-invest in certain privately negotiated investment transactions with certain affiliates of Terra Income Advisors, including the Terra Income Funds, Terra REIT, and any future BDC or closed-end management investment company that was registered under the 1940 Act and was advised by Terra Income Advisors or its affiliated investment advisers (the “Co-Investment Affiliates”). However, Terra BDC was prohibited from engaging in certain transactions with its affiliates even under the terms of this exemptive order. Terra BDC believed this relief not only enhanced its ability to further its investment objectives and strategy, but may have also increased favorable investment opportunities for it, in part by allowing it to participate in larger investments, together with its Co-Investment Affiliates, than would have been available to it if it had not obtained such relief.
Terra BDC’s Compliance Policies and Procedures
As a BDC, Terra BDC and Terra Income Advisors each adopted and implemented written policies and procedures reasonably designed to prevent violation of the federal securities laws and were required to review those compliance policies and procedures annually for their adequacy and the effectiveness of their implementation. Terra BDC’s Chief Compliance Officer and the Chief Compliance Officer of Terra Income Advisors were responsible for administering those policies and procedures.
Terra BDC’s Proxy Voting Policies and Procedures
Terra BDC delegated its proxy voting responsibility to Terra Income Advisors. The proxy voting policies and procedures of Terra Income Advisors are set forth below. The guidelines were reviewed periodically by Terra Income Advisors and Terra BDC’s disinterested directors. For purposes of these proxy voting policies and procedures described below, “we” “our” and “us” refer to Terra Income Advisors.
Proxy Policies
As an investment adviser registered under the Advisers Act, we have a fiduciary duty to act solely in the best interests of our clients. As part of this duty, we recognize that we must vote client securities in a timely manner free of conflicts of interest and in the best interests of our clients.
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These policies and procedures for voting proxies for our investment advisory clients are intended to comply with Section 206 of, and Rule 206(4)-6 under, the Advisers Act.
We vote proxies relating to our portfolio securities in the best interests of our clients’ stockholders. We review on a case-by-case basis each proposal submitted to a stockholder vote to determine its impact on the portfolio securities held by our clients. Although we generally vote against proposals that may have a negative impact on our clients’ portfolio securities, we may vote for such a proposal if there exist compelling long-term reasons to do so.
Our proxy voting decisions are made by the senior officers who are responsible for monitoring each of our client’s investments. To ensure that our vote is not the product of a conflict of interest, we require that: (i) anyone involved in the decision making process disclose to our Chief Compliance Officer any potential conflict that he or she is aware of and any contact that he or she has had with any interested party regarding a proxy vote; and (ii) employees involved in the decision making process or vote administration are prohibited from revealing how we intend to vote on a proposal in order to reduce any attempted influence from interested parties.
Proxy Voting Records
Investors may obtain information, without charge, regarding how Terra Income Advisors voted proxies with respect to our portfolio securities by making a written request for proxy voting information to: Chief Compliance Officer, Bernadette Murphy.
Available Information
We are required to file with or submit to the SEC annual, quarterly and current reports, proxy statements and other information meeting the informational requirements of the Exchange Act. Terra REIT, our parent and sole member, maintains a website at http://www.terrapropertytrust.com/filings-2-1-1-1-1, on which we make available, free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Information contained on that webpage is not incorporated by reference into this Annual Report on Form 10-K and investors should not consider information contained on that webpage to be part of this Annual Report on Form 10-K or any other report we file with the SEC. The SEC maintains an internet site that contains reports, proxy and information statements and other information filed electronically by us with the SEC, which are available on the SEC’s website at www.sec.gov.
Item 1A. Risk Factors.
Investing in our notes involves certain risks relating to our structure and investment objectives. Investors should carefully consider these risk factors, together with all of the other information included in this Annual Report on Form 10-K, including our consolidated financial statements and the related notes. The risks set forth below are not the only risks we face, and we may face other risks that we have not yet identified, which we do not currently deem material or which are not yet predictable. If any of the following risks occur, our business, financial condition and results of operations could be materially adversely affected. In such case, the trading price of the notes could decline, and investors may lose all or part of their investment.
Risks Related to Our Business and Structure
Our loan portfolio is concentrated in a limited number of industries and borrowers, which may subject us to a risk of significant loss if there is a downturn in a particular industry in which we are concentrated or if one of our larger borrowers encounters financial difficulties.
Our portfolio is concentrated in a limited number of industries and borrowers, and, as a result, a downturn in any particular industry or borrower in which we are heavily invested may significantly impact the aggregate returns we realize. If an industry in which we are heavily invested suffers from adverse business or economic conditions, a material portion of our investment could be affected adversely, which, in turn, could adversely affect our financial position and results of operations. As of December 31, 2023, our investments secured by office and infrastructure properties represented approximately 31.3% and 27.4%, respectively, of the carrying value of our total loan investments. In addition, as of December 31, 2023, we held only six loan investments and our largest loan investment represented approximately 31.3% of the carrying value of our total loan investments and our top three loan investments represented approximately 82.7% of the carrying value of our total loan investments. A covenant breach or other adverse event effecting a borrower would have a more weighted impact on our operating results and would require a write-down of a larger percentage of our assets. For further information on our loan
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portfolio, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Factors Impacting Operating Results” included in this Annual Report on Form 10-K.
Inflation in the U.S. has accelerated in recent years and is currently expected to continue at an elevated level in the near-to medium-term, which may have an adverse impact on the valuation of our investments.
Inflation in the U.S. has accelerated in recent years and is currently expected to continue at an elevated level in the near-to medium-term. While inflation in the U.S. appears to be easing gradually, there can be no assurance that further deterioration in financial market and economic conditions will not occur. Further, heightened competition for workers, supply chain issues, the relocation of foreign production and manufacturing businesses to the U.S., and rising energy and commodity prices have contributed to increasing wages and other economic inputs. Elevated inflation and input costs may have adverse effects on our commercial real estate-related loans, commercial real estate-related debt securities and select commercial real estate equity investments, which are subject to the risks typically associated with real estate. Inflation can negatively impact the profitability of real estate assets with long-term leases that do not provide for short-term rent increases or that provide for rent increases with a lower annual percentage increase than inflation. Continued inflation, particularly at elevated levels, may have an adverse impact on the valuation of our investments.
Terra REIT may change our operating policies, objectives or strategies without prior notice, and the effects of such a change may be adverse.
Terra REIT has the authority to modify or waive our current operating policies, objectives or investment criteria and strategies without prior notice. As a result, we may make strategic non-real estate-related investments that align with our investment objectives and criteria. We cannot predict the effect any changes to our current operating policies, investment criteria and strategies would have on our business, operating results and the value of the notes. However, the effects might be adverse, which could negatively impact our ability to pay principal and interest payments on the notes.
Our ability to achieve our investment objectives depends on Terra REIT’s and Terra REIT Advisors’ ability to manage and support our investment process. If Terra REIT were to lose any members of its senior management team, our ability to achieve our investment objectives could be significantly harmed.
Since we have no employees, we depend on the investment expertise, skill and network of business contacts of Terra REIT, which evaluates, negotiates, structures, executes, monitors and services our investments. Our future success depends to a significant extent on the continued service and coordination of Terra REIT and its senior management team. The departure of any members of Terra REIT’s senior management team could have a material adverse effect on our ability to achieve our investment objectives.
Our ability to achieve our investment objectives also depends on the ability of Terra REIT Advisors, the external manager to our sole and managing member, Terra REIT, to identify, analyze, invest in, finance and monitor companies that meet our investment criteria. Terra REIT Advisors’ capabilities in structuring the investment process, providing competent, attentive and efficient services to us and Terra REIT, and facilitating access to financing on acceptable terms depend on the employment of investment professionals in an adequate number and of adequate sophistication to match the corresponding flow of transactions. To achieve our investment objectives, Terra REIT Advisors may need to hire, train, supervise and manage new investment professionals to participate in our investment selection and monitoring process. Terra REIT Advisors may not be able to find investment professionals in a timely manner or at all. Failure to support our investment process could have a material adverse effect on our business, financial condition and results of operations.
In addition, the management agreement between Terra REIT and Terra REIT Advisors has termination provisions that allow the parties to terminate the agreement without penalty. The termination of this agreement may adversely impact the terms of any financing facility into which we may enter, which could have a material adverse effect on our business and financial condition.
We may make strategic non-real estate-related investments that align with our investment objectives and criteria.
Though our investments are primarily in real estate-related loans and other commercial real estate assets or interests, we may strategically invest in non-real estate-related investments that align with our focus on debt and debt-like instruments emphasizing the payment of current returns to investors and the preservation of invested capital. However, the underwriting process for non-real estate-related investments and the ongoing asset management and servicing of such investments is different from the investment process for real estate investments, and our Manager has not historically focused on non-real estate investing. We may not be able to achieve the returns on any non-real estate-related investments that we achieved on our real estate-related investments. Non-real estate-related investments are also not collateralized by real estate like our real estate investments and hence may be riskier because if the debt-like non-real estate-related investments default or do not perform, we
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may not have collateral to foreclose upon. Further, non-real estate-related investments will be subject to different regulatory risks which may distract the attention of our management, and be difficult and costly to comply with. As a result, to the extent we hold, acquire or transact in such non-real estate-related investments, we may be exposed to risks from a number of diverse issuers, industries and investment forms which may be difficult to determine and may have a material adverse effect on our financial condition and results of operations.
Because our business model depends to a significant extent upon relationships with real estate and real estate-related industry participants, investment banks and commercial banks, the inability of Terra REIT or Terra REIT Advisors to maintain or develop these relationships, or the failure of these relationships to generate investment opportunities, could adversely affect our business.
We expect that Terra REIT and Terra REIT Advisors will depend on their relationships with real estate and real estate-related industry participants, investment banks and commercial banks, and we will rely to a significant extent upon these relationships, to provide us with potential investment opportunities. If Terra REIT or Terra REIT Advisors fail to maintain their existing relationships or develop new relationships or sources of investment opportunities, we may not be able to grow our investment portfolio. In addition, individuals with whom Terra REIT and Terra REIT Advisors have relationships are not obligated to provide us with investment opportunities, and therefore there is no assurance that such relationships will generate investment opportunities for us.
We may face increasing competition for investment opportunities, which could delay deployment of our capital, reduce returns and result in losses.
We compete for investments with other alternative investment funds (including real estate and real estate-related investment funds, mezzanine funds and collateralized loan obligation funds), as well as traditional financial services companies such as commercial banks and other sources of funding. Moreover, alternative investment vehicles, such as hedge funds, have begun to invest in areas in which they have not traditionally invested, including assets of the type we intend to acquire. As a result of these new entrants, competition for investment opportunities in private real estate and real estate-related U.S. companies may intensify.
Many of our competitors are substantially larger and have considerably greater financial, technical and marketing resources than we do. These characteristics could allow our competitors to consider a wider variety of investments, establish more relationships and demand more favorable investment terms and more flexible structuring than we are able to do. We may lose investment opportunities if we do not match our competitors’ pricing, terms and structure. If we are forced to match our competitors’ terms and structure, we may not be able to achieve acceptable returns on our investments or may bear substantial risk of capital loss.
Changes in laws or regulations governing our operations or the operations of our business partners may adversely affect our business or cause us to alter our business strategy.
We and our borrowers and investees are subject to regulation at the local, state and federal level. New legislation may be enacted or new interpretations, rulings or regulations could be adopted, including those governing the types of investments we are permitted to make, any of which could harm us and holders of the notes, potentially with retroactive effect. Changes in laws or regulations governing the operations of those with whom we do business could also have a material adverse effect on our business, financial condition and results of operations.
In addition, any changes to the laws and regulations governing our operations relating to permitted investments may cause us to alter our investment strategy to avail ourselves of new or different opportunities. Such changes could result in material differences to our strategies and plans as set forth in this Annual Report on Form 10-K and may result in our investment focus shifting from the areas of expertise of Terra REIT Advisors to other types of investments in which Terra REIT Advisors may have less expertise or little or no experience. Thus, any such changes, if they occur, could have a material adverse effect on our results of operations and the value of each investor’s investment.
We may experience fluctuations in our quarterly results.
We could experience fluctuations in our quarterly operating results due to a number of factors, including our ability or inability to make investments in companies that meet our investment criteria, the interest rate payable on the debt securities we originate and acquire, the level of our expenses, variations in and the timing of the recognition of realized and unrealized gains or losses, the degree to which we encounter competition in our markets and general economic conditions. As a result of these factors, results for any previous period should not be relied upon as being indicative of performance in future periods.
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The CECL accounting standard requires us to make certain estimates and judgments, which may be difficult to determine and may have a material adverse effect on our financial condition and results of operations.
In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-13, Financial Instruments — Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”) which replaces the “incurred loss” model for recognizing credit losses with an “expected loss” model referred to as the CECL model. We adopted this ASU and related amendments on January 1, 2023. Under the CECL model, we are required to present certain financial assets carried at amortized cost, such as performing loans held for investment and held-to-maturity debt securities, at the net amount expected to be collected. The measurement of expected credit losses is based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This measurement will take place at the time the financial asset is first added to the balance sheet and periodically thereafter. This differs significantly from the “incurred loss” model required under current United States generally accepted accounting principles (“U.S. GAAP”), which delays recognition until it is probable a loss has been incurred. If we are required to materially increase our level of allowance for credit losses for any reason, such increase could adversely affect our business, financial condition and results of operations.
Our ability to maintain the security of customer, associate, third-party or company information could have an impact on our reputation and our results.
We have been, and likely will continue to be, subject to computer hacking, acts of vandalism or theft, malware, computer viruses or other malicious codes, phishing, employee error or malfeasance, catastrophes, unforeseen events or other cyber-attacks. To date, we have seen no material impact on our business or operations from these attacks or events. Any future significant compromise or breach of our data security, whether external or internal, or misuse of customer, associate, supplier or Company data, could result in significant costs, lost sales, fines, lawsuits, and damage to our reputation. However, the ever-evolving threats mean we and our third-party service providers and vendors must continually evaluate and adapt our respective systems and processes and overall security environment, as well as those of any companies we acquire. There is no guarantee that these measures will be adequate to safeguard against all data security breaches, system compromises or misuses of data. In addition, as the regulatory environment related to information security, data collection and use, and privacy becomes increasingly rigorous, with new and constantly changing requirements applicable to our business, compliance with those requirements could also result in additional costs.
We are subject to environmental, social and governance (“ESG”) risks that could adversely affect our reputation, business,
operations and earnings.
Certain organizations that provide corporate risk information to investors and shareholders have developed scores and ratings to evaluate companies based upon various ESG metrics. Currently, there are no universal standards for such scores or ratings, but ESG evaluations are increasingly being integrated into investment analysis. Views about ESG matters are diverse and rapidly changing, and companies are facing increasing scrutiny from regulators, investors, and other stakeholders related to their ESG practices and disclosure. If we fail to adapt to or comply with regulatory requirements or investor or stakeholder ESG standards, our reputation, ability to do business with certain partners, access to capital, operations and earnings could be adversely affected.
Risks Related to Terra REIT Advisors and its Affiliates
Terra REIT Advisors and its affiliates, including some of Terra REIT’s directors, face conflicts of interest caused by compensation arrangements with us and our affiliates, which could result in actions that are not in our best interests.
Pursuant to the Cost Sharing Agreement, Terra REIT Advisors and its affiliates receive substantial fees in return for their services to us, and these fees could influence the advice provided to us. Among other matters, the compensation arrangements could affect their judgment with respect to public offerings of equity by us, and consequently Terra REIT Advisors to earn increased asset management fees. In addition, the decision to utilize leverage will increase our assets and, as a result, will increase the amount of management fees payable to Terra REIT Advisors.
There may be conflicts of interest related to obligations Terra REIT Advisors has to our affiliates and to other clients.
Terra REIT Advisors, our parent’s external manager, and its affiliates serve as investment advisers or managers to other entities that share the same senior management and investment teams. As a result, the members of the senior management and investment teams of Terra REIT Advisors serve as officers, directors or principals of entities that operate in the same or a related line of business as we do, or of investment funds managed by the same personnel. In serving in these multiple and other capacities, they may have obligations to other clients or investors in those entities, the fulfillment of which may not be in our best interests or in the best interest of our security holders. Our investment objectives may overlap with the investment
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objectives of such investment funds, accounts or other investment vehicles. As a result, Terra REIT Advisors and its affiliates, their employees and certain of their affiliates will have conflicts of interest in allocating their time between us and other activities in which they are or may become involved. Terra REIT Advisors and its employees will devote only as much of its or their time to our business as Terra REIT Advisors and its employees, in their judgment, determine is reasonably required, which may be substantially less than their full time.
The time and resources that individuals employed by Terra REIT Advisors and its affiliates devote to us may be diverted, and we may face additional competition due to the fact that individuals employed by Terra REIT Advisors are not prohibited from raising money for or managing another entity that makes the same types of investments that we target.
Neither Terra REIT Advisors nor individuals employed by it are prohibited from raising money for and managing another investment entity that makes the same types of investments as those we target. As a result, the time and resources that these individuals may devote to us may be diverted. In addition, we may compete with any such investment entity for the same investors and investment opportunities.
Risks Related to Our Investments
A covenant breach by any of our borrowers may harm our operating results.
A borrower’s failure to satisfy financial or operating covenants imposed by us or other lenders could lead to defaults and, potentially, termination of its loans and foreclosure on its secured assets, which could trigger cross-defaults under other agreements and jeopardize a borrower’s ability to meet its obligations under the debt or equity securities that we hold. We may incur expenses to the extent necessary to seek recovery upon default or to negotiate new terms, which may include the waiver of certain financial covenants, with a defaulting borrower.
We may not realize gains from our preferred equity investments.
The preferred equity investments we make may not appreciate in value and, in fact, may decline in value. Accordingly, we may not be able to realize gains from our preferred equity investments, and any gains that we do realize on the disposition of any preferred equity investments may not be sufficient to offset any other losses we experience.
A lack of liquidity in certain of our investments may adversely affect our business.
We invest in certain real estate and real estate-related companies whose securities are not publicly traded or actively traded on the secondary market and are, instead, traded on a privately negotiated over-the-counter secondary market for institutional investors and whose securities are subject to legal and other restrictions on resale or are otherwise less liquid than publicly traded securities. The illiquidity of certain of our investments may make it difficult for us to sell these investments when desired. In addition, if we are required to liquidate all or a portion of our portfolio quickly, we may realize significantly less than the value at which we had previously recorded these investments. The reduced liquidity of our investments may make it difficult for us to dispose of them at a favorable price, and, as a result, we may suffer losses.
We may not have the funds or ability to make additional funding in our loan investments.
We may not have the funds or ability to make additional funding in our loan investments. After our initial funding in a loan, we may be called upon from time to time to provide additional funds to such company or have the opportunity to increase our investment. There is no assurance that we will make, or will have sufficient funds to make, follow-on investments. Any decisions not to make a follow-on investment or any inability on our part to make such an investment may have a negative impact on a loan investment in need of such an investment, may result in a missed opportunity for us to increase our participation in a successful operation or may reduce the expected return on the investment.
Our real estate-related loans may be impacted by unfavorable real estate market conditions, which could decrease the value of our investments.
The real estate-related loans we make or invest in will be at risk of defaults caused by many conditions beyond our control, including local and other economic conditions affecting real estate values and interest rate levels. We do not know whether the values of the property securing the real estate-related loans will remain at the levels existing on the dates of origination of such loans. If the values of the underlying properties drop, our risk will increase and the value of our investments may decrease.
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Our real estate-related loans will be subject to interest rate fluctuations that could reduce our returns as compared to market interest rates.
If we invest in fixed-rate, long-term real estate-related loans and interest rates rise, such loans could yield a return lower than then-current market rates. If interest rates decrease, we will be adversely affected to the extent that real estate-related loans are prepaid, because we may not be able to make new loans at the previously higher interest rate. If we invest in floating-rate loans, the income from such loans will increase and decrease directly with the fluctuation in the floating rate.
Delays in liquidating defaulted mortgage loans could reduce our investment returns.
If there are defaults under our mortgage loans, we may not be able to repossess and sell the underlying properties quickly. The resulting time delay could reduce the value of our investment in the defaulted mortgage loans. An action to foreclose on a property securing a mortgage loan is regulated by state statutes and rules and is subject to many of the delays and expenses of other lawsuits if the mortgagor raises defenses or counterclaims. In the event of default by a mortgagor, these restrictions, among other things, may impede our ability to foreclose on or sell the mortgaged property or to obtain proceeds sufficient to repay all amounts due to us on the mortgage loan.
Returns on our real estate-related loans may be limited by regulations.
Our loan investments may be subject to regulation by federal, state and local authorities and subject to various laws and judicial and administrative decisions. We may determine not to make or invest in real estate-related loans in any jurisdiction in which we believe we have not complied in all material respects with applicable requirements. If we decide not to make or invest in real estate-related loans in several jurisdictions, it could reduce the amount of income we would otherwise receive.
Foreclosures create additional ownership risks that could adversely impact our returns on mortgage investments.
If we acquire property by foreclosure following defaults under our mortgage loans, we will have the same economic and liability risks as the previous owner.
The mezzanine loans in which we may invest would involve greater risks of loss than senior loans secured by income-producing real properties.
We may invest in mezzanine loans that take the form of subordinated loans secured by second mortgages on the underlying real property or loans secured by a pledge of the ownership interests of the entity owning the real property. These types of investments involve a higher degree of risk than long-term senior mortgage lending secured by income-producing real property because the investment may become unsecured as a result of foreclosure by the senior lender. In the event of a bankruptcy of the entity providing the pledge of its ownership interests as security, we may not have full recourse to the assets of such entity, or the assets of the entity may not be sufficient to satisfy our mezzanine loan. If a borrower defaults on our mezzanine loan or debt senior to our loan, or in the event of a borrower bankruptcy, our mezzanine loan will be satisfied only after the senior debt. As a result, we may not recover some or all of our investment. In addition, mezzanine loans may have higher loan-to-value ratios than conventional mortgage loans, resulting in less equity in the real property and increasing the risk of loss of principal.
Our commercial real estate-related loans, commercial real estate-related debt securities and select commercial real estate equity investments will be subject to the risks typically associated with real estate.
Our commercial real estate-related loans, commercial real estate-related debt securities and select commercial real estate equity will generally be directly or indirectly secured by a lien on real property (or the equity interests in an entity that owns real property) that, upon the occurrence of a default on the loan, could result in our acquiring ownership of the property. We will not know whether the values of the properties ultimately securing our loans will remain at the levels existing on the dates of origination of those loans. If the values of the mortgaged properties drop, our risk will increase because of the lower value of the security associated with such loans. In this manner, real estate values could impact the values of our loan investments. Our investments in commercial real estate-related loans, commercial real estate-related debt securities and select commercial real estate equity investments (including potential investments in real property) may be similarly affected by real estate property values. Therefore, our investments will be subject to the risks typically associated with real estate.
The value of real estate may be adversely affected by a number of risks, including:
•natural disasters such as hurricanes, earthquakes and floods;
•acts of war or terrorism, including the consequences of terrorist attacks;
•adverse changes in national and local economic and real estate conditions;
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•an oversupply of (or a reduction in demand for) space in the areas where particular properties are located and the attractiveness of particular properties to prospective tenants;
•changes in governmental laws and regulations, fiscal policies and zoning ordinances and the related costs of compliance therewith and the potential for liability under applicable laws;
•costs of remediation and liabilities associated with environmental conditions affecting properties; and
•the potential for uninsured or underinsured property losses.
The value of each property is affected significantly by its ability to generate cash flow and net income, which in turn depends on the amount of rental or other income that can be generated net of expenses required to be incurred with respect to the property. Many expenditures associated with properties (such as operating expenses and capital expenditures) cannot be reduced when there is a reduction in income from the properties. These factors may have a material adverse effect on the ability of our borrowers to pay their loans, as well as on the value that we can realize from assets we originate, own or acquire.
Risks of cost overruns and non-completion of the construction or renovation of the properties underlying loans we make or acquire may materially adversely affect our investment.
The renovation, refurbishment or expansion by a borrower under a mortgaged or leveraged property involves risks of cost overruns and non-completion. Costs of construction or improvements to bring a property up to standards established for the market position intended for that property may exceed original estimates, possibly making a project uneconomical. Other risks may include environmental risks and construction, rehabilitation and subsequent leasing of the property not being completed on schedule. If such construction or renovation is not completed in a timely manner, or if it costs more than expected, the borrower may experience a prolonged impairment of net operating income and may not be able to make payments on our investment.
Our investments in commercial real estate-related loans are subject to changes in credit spreads.
Our investments in commercial real estate-related loans are subject to changes in credit spreads. When credit spreads widen, the economic value of such investments decrease. Even though a loan may be performing in accordance with its loan agreement and the underlying collateral has not changed, the economic value of the loan may be negatively impacted by the incremental interest foregone from the widened credit spread.
Investments in non-conforming or non-investment grade rated loans or securities involve greater risk of loss.
Some of our investments may not conform to conventional loan standards applied by traditional lenders and either will not be rated or will be rated as non-investment grade by the rating agencies. In addition, we may invest in securities that are rated below investment grade by rating agencies or that would be likely rated below investment grade if they were rated. Below investment grade securities, which are often referred to as “junk,” have predominantly speculative characteristics with respect to the issuer’s capacity to pay interest and repay principal. They may also be difficult to value and illiquid. The non-investment grade ratings for these assets typically result from the overall leverage of the loans, the lack of a strong operating history for the properties underlying the loans, the borrowers’ credit history, the properties’ underlying cash flow or other factors. As a result, these investments may have a higher risk of default and loss than investment grade-rated assets. Any loss we incur may be significant and may reduce cash available for principal and interest payments on the notes and adversely affect the value of our securities.
Investments that are not U.S. government insured involve risk of loss.
We may originate and acquire uninsured loans and assets as part of our investment strategy. Such loans and assets may include mortgage loans, mezzanine loans and bridge loans. While holding such interests, we are subject to risks of borrower defaults, bankruptcies, fraud, losses and special hazard losses that are not covered by standard hazard insurance. In the event of any default under loans, we bear the risk of loss of principal and nonpayment of interest and fees to the extent of any deficiency between the value of the collateral and the principal amount of the loan.
We have no established investment criteria limiting the geographic concentration of our investments in commercial real estate-related loans, commercial real estate-related debt securities and select commercial real estate equity investments. If our investments are concentrated in an area that experiences adverse economic conditions, our investments may lose value and we may experience losses.
Certain commercial real estate-related loans, commercial real estate-related debt securities and select commercial real estate equity investments in which we invest may be secured by a single property or properties in one geographic location. Further, we intend that our secured investments will be collateralized by properties located solely in the United States. These
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investments may carry the risks associated with significant geographical concentration. As a result, properties underlying our investments may be overly concentrated in certain geographic areas, and we may experience losses as a result. A worsening of economic conditions in the geographic area in which our investments may be concentrated could have an adverse effect on our business, including reducing the demand for new financings, limiting the ability of customers to pay financed amounts and impairing the value of our collateral.
We may invest in adjustable rate mortgage loans, which may entail greater risks of default to lenders than fixed rate mortgage loans.
Adjustable rate mortgage loans may contribute to higher delinquency rates. Borrowers with adjustable rate mortgage loans may be exposed to increased monthly payments if the related mortgage interest rate adjusts upward from the initial fixed rate or a low introductory rate, as applicable, in effect during the initial period of the mortgage loan to the rate computed in accordance with the applicable index and margin. This increase in borrowers’ monthly payments, together with any increase in prevailing market interest rates, after the initial fixed rate period, may result in significantly increased monthly payments for borrowers with adjustable rate mortgage loans, which may make it more difficult for the borrowers to repay the loan or could increase the risk of default of their obligations under the loan.
Prepayments can adversely affect the yields on our investments.
Prepayments on debt instruments, where permitted under the debt documents, are influenced by changes in current interest rates and a variety of economic, geographic and other factors beyond our control, and consequently, such prepayment rates cannot be predicted with certainty. If we are unable to invest the proceeds of such prepayments received or are forced to invest at yields lower than those on the debt instrument that was prepaid, the yield on our portfolio will decline. In addition, we may acquire assets at a discount or premium and if the asset does not repay when expected, our anticipated yield may be impacted. Under certain interest rate and prepayment scenarios we may fail to recoup fully our cost of acquisition of certain investments.
Hedging against interest rate exposure may adversely affect our earnings, limit our gains or result in losses, which could adversely affect cash available for distribution to Terra REIT and its stockholders and principal and interest payments on our outstanding notes.
We may enter into interest rate swap agreements or pursue other interest rate hedging strategies. Our hedging activity will vary in scope based on the level of interest rates, the type of portfolio investments held and other changing market conditions.
Any hedging activity we engage in may adversely affect our earnings, which could adversely affect cash available for distribution to Terra REIT and its stockholders and principal and interest payments on our outstanding notes. Therefore, while we may enter into such transactions to seek to reduce interest rate risks, unanticipated changes in interest rates may result in poorer overall investment performance than if we had not engaged in any such hedging transactions. In addition, the degree of correlation between price movements of the instruments used in a hedging strategy and price movements in the portfolio positions being hedged or liabilities being hedged may vary materially. Moreover, for a variety of reasons, we may not seek to establish a perfect correlation between such hedging instruments and the portfolio holdings being hedged. Any such imperfect correlation may prevent us from achieving the intended hedge and expose us to risk of loss.
Hedging instruments often are not traded on regulated exchanges or guaranteed by an exchange or its clearing house and involve risks and costs.
The cost of using hedging instruments increases as the period covered by the instrument increases and during periods of rising and volatile interest rates. We may increase our hedging activity and thus increase our hedging costs during periods when interest rates are volatile or rising and hedging costs have increased. In addition, hedging instruments involve risk since they often are not traded on regulated exchanges or guaranteed by an exchange or its clearing house. Furthermore, the enforceability of agreements underlying derivative transactions may depend on compliance with applicable statutory, commodity and other regulatory requirements and, depending on the identity of the counterparty, applicable international requirements.
Furthermore, derivative transactions are subject to increasing statutory and other regulatory requirements and, depending on the identity of the counterparty, applicable international requirements. Recently, new regulations have been promulgated by U.S. and foreign regulators attempting to strengthen oversight of derivative contracts. Any actions taken by regulators could constrain our strategy and could increase our costs, either of which could materially and adversely impact our operations.
The business failure of a hedging counterparty with whom we enter into a hedging transaction will most likely result in a default. Default by a party with whom we enter into a hedging transaction may result in the loss of unrealized profits and force us to cover our resale commitments, if any, at the then current market price. It may not always be possible to dispose of or close out a hedging position without the consent of the hedging counterparty, and we may not be able to enter into an offsetting
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contract in order to cover our risk. We cannot assure investors that a liquid secondary market will exist for hedging instruments purchased or sold, and we may be required to maintain a position until exercise or expiration, which could result in losses.
Our investments in debt securities and preferred equity securities will be subject to the specific risks relating to the particular issuer of the securities and may involve greater risk of loss than secured debt financings.
Our investments in debt securities and preferred and common equity securities involve special risks relating to the particular issuer of the securities, including the financial condition and business outlook of the issuer. Real estate company issuers are subject to the inherent risks associated with real estate and real estate-related investments discussed in this Annual Report on Form 10-K. Issuers that are debt finance companies are subject to the inherent risks associated with structured financing investments also discussed in this Annual Report on Form 10-K. Furthermore, debt securities and preferred and common equity securities may involve greater risk of loss than secured debt financings due to a variety of factors, including that such investments are generally unsecured and may also be subordinated to other obligations of the issuer. As a result, investments in debt securities and preferred and common equity securities are subject to risks of (i) limited liquidity in the secondary trading market, (ii) substantial market price volatility resulting from changes in prevailing interest rates, (iii) subordination to the prior claims of banks and other senior lenders to the issuer, (iv) the operation of mandatory sinking fund or call or redemption provisions during periods of declining interest rates that could cause the issuer to reinvest redemption proceeds in lower yielding assets, (v) the possibility that earnings of the issuer may be insufficient to meet its debt service and distribution obligations and (vi) the declining creditworthiness and potential for insolvency of the issuer during periods of rising interest rates and economic downturn. These risks may adversely affect the value of outstanding debt securities and preferred and common equity securities and the ability of the issuers thereof to make principal, interest and distribution payments to us.
Declines in the market values of our investments may adversely affect periodic reported results of operations and credit availability, which may reduce our earnings and, in turn, cash available for principal and interest payments on the notes.
A decline in the market value of our assets will reduce our earnings in the period recognized and may adversely affect us particularly in instances where we have borrowed money based on the market value of those assets. If the market value of those assets declines, the lender may require us to post additional collateral to support the loan. If we were unable to post the additional collateral, we may have to sell assets at a time when we might not otherwise choose to do so. A reduction in credit available may reduce our earnings and, in turn, cash available for principal and interest payments on the notes.
Further, credit facility providers may require us to maintain a certain amount of cash reserves or to set aside unlevered assets sufficient to maintain a specified liquidity position, which would allow us to satisfy our collateral obligations. As a result, we may not be able to leverage our assets as fully as we would choose, which could reduce our return on equity. In the event that we are unable to meet these contractual obligations, our financial condition could deteriorate rapidly.
Market values of our investments may decline for a number of reasons, such as changes in prevailing market rates, increases in defaults, increases in voluntary prepayments for those investments that we have that are subject to prepayment risk, widening of credit spreads and downgrades of ratings of the securities by ratings agencies.
With respect to mortgaged properties, options and other purchase rights may affect value or hinder recovery.
A borrower under certain mortgage loans may give its tenants or another person a right of first refusal or an option to purchase all or a portion of the related mortgaged property. These rights may impede the lender’s ability to sell the related mortgaged property at foreclosure or may adversely affect the value or marketability of the property.
If we overestimate the value or income-producing ability or incorrectly price the risks of our investments, we may experience losses.
Analysis of the value or income-producing ability of a commercial property is highly subjective and may be subject to error. We value our potential investments based on yields and risks, taking into account estimated future losses on the commercial real estate-related loans and the mortgaged property included in the securitization’s pools or select commercial real estate equity investments, and the estimated impact of these losses on expected future cash flows and returns. In the event that we underestimate the risks relative to the price we pay for a particular investment, we may experience losses with respect to such investment.
The leases on the properties underlying our investments may not be renewed on favorable terms.
The properties underlying our investments could be negatively impacted by deteriorating economic conditions and weaker rental markets. Upon expiration or earlier termination of leases on these properties, the space may not be relet or, if relet, the terms of the renewal or reletting (including the cost of required renovations or concessions to tenants) may be less favorable
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than current lease terms. In addition, poor economic conditions may reduce a tenant’s ability to make rent payments under their leases. Any of these situations may result in extended periods where there is a significant decline in revenues or no revenues generated by these properties. Additionally, if market rental rates are reduced, property-level cash flows would likely be negatively affected as existing leases renew at lower rates. If the leases for these properties cannot be renewed for all or substantially all of the space at these properties, or if the rental rates upon such renewal or reletting are significantly lower than expected, the value of our investments may be adversely affected.
A borrower’s form of entity may cause special risks or hinder our recovery.
Since most of the borrowers for our commercial real estate loan investments are legal entities rather than individuals, our risk of loss may be greater than those of mortgage loans made to individuals. Unlike individuals involved in bankruptcies, most of the entities generally do not have personal assets and creditworthiness at stake. The terms of the mortgage loans generally require that the borrowers covenant to be single-purpose entities, although in some instances the borrowers are not required to observe all covenants and conditions that typically are required in order for them to be viewed under standard rating agency criteria as “single-purpose entities.”
The bankruptcy of a borrower, or a general partner or managing member of a borrower, may impair the ability of the lender to enforce its rights and remedies under the related mortgage. Borrowers that are not single-purpose entities structured to limit the possibility of becoming insolvent or bankrupt may be more likely to become insolvent or the subject of a voluntary or involuntary bankruptcy proceeding because the borrowers may be (i) operating entities with a business distinct from the operation of the mortgaged property with the associated liabilities and risks of operating an ongoing business or (ii) individuals that have personal liabilities unrelated to the property.
We may be exposed to environmental liabilities with respect to properties to which we take title.
In the course of our business, we may take title to real estate, and, if we do take title, we could be subject to environmental liabilities with respect to these properties. In such a circumstance, we may be held liable to a governmental entity or to third parties for property damage, personal injury, and investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clean up hazardous or toxic substances, or chemical releases, at a property. The costs associated with investigation or remediation activities could be substantial. If we ever become subject to significant environmental liabilities, our business, financial condition, liquidity and results of operations could be materially and adversely affected.
Risk Related to Debt Financing
Changes in interest rates may affect our cost of capital
We use debt to finance investments, our net investment income will depend, in part, upon the difference between the rate at which we borrow funds and the rate at which we invest those funds. As a result, we can offer no assurance that a significant change in market interest rates will not have a material adverse effect on our net investment income. In periods of rising interest rates when we have debt outstanding, our cost of funds will increase, which could reduce our net investment income. We expect that any long-term fixed rate investments we acquire will be financed primarily with equity and long-term debt. We may use interest rate risk management techniques in an effort to limit our exposure to interest rate fluctuations. These techniques may include various interest rate hedging activities. These activities may limit our ability to participate in the benefits of lower interest rates with respect to the hedged portfolio. Adverse developments resulting from changes in interest rates or hedging transactions could have a material adverse effect on our business, financial condition and results of operations. Also, we have limited experience in entering into hedging transactions, and we will initially have to purchase or develop such expertise. A rise in the general level of interest rates can be expected to lead to higher interest rates applicable to our debt investments.
Covenants in our debt agreements may restrict our operating activities and adversely affect our financial condition, operating results and cash flows.
Our debt agreements contain various financial and operating covenants, including, among other things, certain coverage ratios and limitations on our ability to incur secured and unsecured debt. These restrictive covenants and operating restrictions could have a material adverse effect on our operating results, restrict our ability to finance or securitize new originations and acquisitions, force us to liquidate collateral and negatively affect our financial condition. The breach of any of these covenants, if not cured within any applicable cure period, could result in a default, including a cross-default, and acceleration of certain of our indebtedness. Accelerating repayment and terminating the agreements will require immediate repayment by us of the borrowed funds, which may require us to liquidate assets at a disadvantageous time, causing us to incur further losses and adversely affecting our results of operations and financial condition, which may impair our ability to make principal and interest
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payments on our debt obligations. Any failure to make payments when due or upon acceleration could result in the foreclosure upon our assets by our lenders.
Risk Related to our REIT Status during the REIT Period
If we did not qualify as a REIT during the REIT Period, we will be subject to tax as a regular corporation and could face a substantial tax liability on our income earned during the REIT Period.
We elected to operate so as to qualify as a REIT under the Code during the REIT Period. However, qualification as a REIT involves the application of highly technical and complex Code provisions for which only a limited number of judicial or administrative interpretations exist. Notwithstanding the availability of cure provisions in the Code, we could have failed various compliance requirements and could have jeopardized our REIT status. If we failed to qualify as a REIT during the REIT Period, then:
•we would be taxed as a regular domestic corporation during the REIT Period, ineligible to deduct dividends paid to our stockholders in computing taxable income and would be subject to federal income tax on our taxable income at regular corporate income tax rates during the REIT Period; and
•any resulting tax liability could be substantial and could have a material adverse effect on our value.
General Risk Factors
COVID-19, or the future outbreak of other highly infectious or contagious diseases, could materially and adversely impact or disrupt our investments, business, financial condition and results of operations.
As a result of a significant portion of our investments being in preferred equity, mezzanine loans, first mortgages, and credit facilities secured by office, multifamily, infrastructure and mixed-use properties located in the United States, any future local, regional, national or international outbreak of a contagious disease, including COVID-19 and its variants or any other similar diseases, may impact our investments and operating results to the extent that it reduces occupancy, increases the cost of operation or results in limited hours or necessitates the closure of such properties. In addition, quarantines, states of emergencies and other measures taken to curb the spread of any such future outbreak may negatively impact the ability of such properties to continue to obtain necessary goods and services or provide adequate staffing, which may also adversely affect our investments, business, financial condition and results of operations. The borrowers under the mezzanine loans, first mortgages, credit facilities or preferred equity in which we invest may fail to make timely and required payments under the terms of such instruments.
Future recessions, downturns, disruptions or instability could have a materially adverse effect on our business.
From time to time, the global capital markets may experience periods of disruption and instability, which could cause disruptions in liquidity in the debt capital markets, significant write-offs in the financial services sector, the re-pricing of credit risk in the broadly syndicated credit market and the failure of major financial institutions. Despite actions of U.S. and foreign governments, these events could contribute to worsening general economic conditions that materially and adversely impact the broader financial and credit markets and reduce the availability of debt and equity capital for the market as a whole and financial services firms in particular.
Deterioration of economic and market conditions in the future could negatively impact credit spreads as well as our ability to obtain financing, particularly from the debt markets.
Disruptions in the financial and banking sectors may adversely impact our access to capital and our cost of borrowing, which could adversely affect us, our business or our results of operations.
Disruptions and uncertainty in the financial and banking sectors, including due to recent regional bank failures and decreased consumer confidence in the banking system, may hinder our ability to access capital on reasonable terms or at all. The U.S. and global financial and banking sectors have experienced periods of increased turmoil and volatility in the recent past and may experience similar periods of disruption in the future due to factors beyond our control. Such periods of increased turmoil and volatility may adversely impact liquidity in the financial markets and make financings less attractive or, in some cases, unavailable. If our financing counterparties become capital constrained, tighten their lending standards or become insolvent, they may be unable or unwilling to fulfill their commitments to us. A material disruption to the banking system and financial markets could result in liquidity issues across the sector, which could adversely impact our access to capital and our cost of borrowing and adversely affect us, our business or our results of operations.
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Continued concerns over U.S. fiscal and political policy could, among other things, lead to future downgrade of the U.S. government's sovereign credit rating and contribute to a U.S. economic slowdown, which could have a material adverse effect on our business, financial condition and results of operations.
In recent years, financial markets were affected by significant uncertainty relating to the stability of U.S. fiscal and political policy. On August 1, 2023, Fitch Ratings Inc. downgraded the U.S. government’s sovereign credit rating to AA+, down one notch from its highest rating of AAA, citing the country’s growing debt obligations, deterioration in governance and political polarization. Concerns related to political turmoil, federal borrowing and the federal budget deficit have increased the possibility of future credit rating downgrades and economic slowdowns in the U.S. Any continuing uncertainty, together with the continuing U.S. debt and budget deficit concerns, could contribute to a U.S. economic slowdown. The impact of U.S. fiscal and political uncertainty is inherently unpredictable and could adversely affect U.S. and global financial markets and economic conditions. These developments could cause interest rates and borrowing costs to rise, which may negatively impact our ability to access the debt markets on favorable terms. Continued adverse economic conditions could have a material adverse effect on our business, financial condition and results of operations.
Cybersecurity risk and cyber incidents may adversely affect our business by causing a disruption to our operations, a compromise or corruption of the security, confidentiality, or integrity of our company, employee, customer or third-party confidential information and/or damage to our reputation or business relationships, any of which could negatively impact our financial results.
Risk of a cyber incident or disruption, particularly through cyber-attacks or cyber intrusions, including by computer hackers, nation-state affiliated actors and cyber terrorists, has generally increased as the number, intensity and sophistication of attempted attacks and intrusions from around the world have increased. The result of these incidents may include disrupted operations, misstated or unreliable financial data, misappropriation of assets, liability for stolen assets or information, increased cybersecurity protection and insurance cost, regulatory enforcement, litigation and damage to our relationships and reputation. These risks require continuous and likely increasing attention and other resources from us to, among other actions, identify and quantify these risks, upgrade and expand our technological capabilities, systems and processes to adequately address them. Such attention diverts time and other resources from other activities and there is no assurance that our efforts will be effective. Potential sources for disruption, damage or failure of our information technology systems include, without limitation, computer viruses, cyber incidents, human error, natural disasters and defects in design. In addition, we cannot be certain that our existing cyber insurance coverage will continue to be available on acceptable terms or that our insurers will not deny coverage as to all or part of any future claim or loss.
Additionally, we rely on third-party service providers for many aspects of our business. Notwithstanding our efforts to oversee and mitigate risks associated with our use of third-party service providers, we can provide no assurance that the networks and systems that our third-party vendors have established or use will be effective. As our reliance on technology has increased, so have the risks posed to both our information systems and those provided by third-party service providers. We have implemented processes, procedures and internal controls to help mitigate cybersecurity risks and cyber intrusions, but these measures, as well as our increased awareness of the nature and extent of a risk of a cyber incident, do not guarantee that our financial results, operations or confidential information will not be negatively impacted by such an incident.
Further, the SEC has recently adopted rules requiring public companies to disclose material cybersecurity incidents that they experience on a Current Report on Form 8-K within four business days of determining that a material cybersecurity incident has occurred and to disclose on an annual basis material information regarding their cybersecurity risk management, strategy and governance. These new reporting requirements will become effective for us on June 15, 2024. If we fail to comply with these new requirements, we could incur regulatory fines and our reputation, business, financial condition and results of operations could be harmed.
As a public company, we are subject to regulations not applicable to private companies, such as provisions of the Sarbanes-Oxley Act. Efforts to comply with such regulations involves significant expenditures, and non-compliance with such regulations may adversely affect us.
As a public company, we are subject to regulations not applicable to private companies, including provisions of the Sarbanes-Oxley Act and the related rules and regulations promulgated by the SEC. Our management is required to report on our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act and rules and regulations of the SEC thereunder. We are required to review on an annual basis our internal control over financial reporting, and on a quarterly and annual basis, to evaluate and disclose changes in our internal control over financial reporting. This process diverts management’s time and attention. We cannot be certain as to the impact of our evaluation, testing and remediation actions on our operations, and we may not be able to ensure that the process is effective or that our internal control over financial reporting
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is or will be effective in a timely manner. In the event that we are unable to maintain an effective system of internal controls and maintain or achieve compliance with the Sarbanes-Oxley Act and related rules, we may be adversely affected.
Item 1B. Unresolved Staff Comments.
None.
Item 1C. Cybersecurity.
Our management recognizes the importance of implementing and maintaining robust cybersecurity measures designed to address cybersecurity threats that pose risks to our business and operations. Therefore, we have established a comprehensive framework to identify, protect against, detect, respond to, and recover from cybersecurity incidents (“Incidents”). Our cybersecurity measures are designed to provide a structured approach to managing cybersecurity risks for an effective, efficient, an orderly response to any Incident.
As a critical component of our overall risk management process, we have adopted a framework that shares existing reporting channels and governance processes to identify, assess, manage and report cybersecurity threats on an ongoing basis. This risk management process is led by the REIT Manager’s Chief Compliance Officer and Cyber Security Committee (“CSC”).
Our management, including the REIT Manager’s Chief Compliance Officer and CSC, is authorized to take the appropriate steps deemed necessary to identify, assess, contain, mitigate, and resolve cybersecurity threats including by (a) maintaining (i) an Incident Response Plan in the event of an Incident and (ii) a Cybersecurity Policy which governs information technology security policies, (b) regularly monitoring all our systems and user accounts for any suspected Incidents, (c) performing annual audits on certain of our systems, and (d) providing general cybersecurity awareness and data protection training. In addition, depending on the circumstances of an Incident, we may engage third parties such as insurance carriers, outside legal counsel, forensic investigators, crisis communications or public relations firms, investor relations firms and response vendors and we may coordinate with regulators or law enforcement. We also assess third party risks when determining the selection and oversight of applicable third-party service providers.
Increased cybersecurity risk due to the diversification of our data across external service providers and cyber incidents may adversely affect our business by causing a disruption to our operations, compromise our confidential information and/or damage to our business relationships, all of which could negatively impact our financial results. As of the date of this Form 10-K, we are not aware of any risks from cybersecurity threats that have materially affected or are reasonably likely to materially affect us, including our financial position, results of operations and/or business strategy. While we have not, as of the date of this Form 10-K, experienced a cybersecurity threat or incident that resulted in a material adverse impact to our business or operations, there can be no guarantee that we will not experience such an incident in the future where we may be unable to implement effective preventative measures in a timely manner.
Further discussion of the potential impacts on our business from cyber intrusions is provided in “Risk Factors” in Part I, Item 1A of this Annual Report on Form 10-K.
Item 2. Properties.
Our administrative and principal executive offices are located at 205 West 28th Street, 12th Floor, New York, New York 10001. We believe that our office facilities are suitable and adequate for our business as it is presently conducted.
Item 3. Legal Proceedings.
Terra REIT previously owned a multi-tenant office building that is subject to a ground lease. The ground lease provides for a new base rent every five years based on the greater of the annual base rent for the prior lease year or 9% of the fair market value of the land. The next rent reset on the ground lease is scheduled for November 1, 2025. Terra REIT was litigating with the landlord with respect to the appropriate method for determining the fair value of the land for purposes of setting the ground rent. On October 19, 2023, Terra REIT conveyed its interest in the property to a subsidiary of Centennial Bank by deed-in-lieu of foreclosure. Accordingly, Terra REIT is no longer a party to the ground lease and has taken the necessary steps to terminate the associated litigation (styled Terra Ocean Ave., LLC v. Ocean Avenue Santa Monica Realty LLC, Superior Court of California, Los Angeles County, Case No. 20STCV34217).
Additionally, from time to time, we, Terra REIT and individuals employed by Terra REIT and Terra REIT Advisors may be a party to certain legal proceedings in the ordinary course of business, including proceedings relating to the enforcement of our rights under contracts with our borrowers and investees. While the outcome of these legal proceedings cannot be predicted
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with certainty, we do not expect that such proceedings will have a material effect upon our financial condition or results of operations.
Item 4. Mine Safety Disclosures.
Not applicable.
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
We are a wholly owned subsidiary of Terra REIT. Accordingly, there is no market for our equity.
Item 6. [Reserved].
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The information contained in this section should be read in conjunction with our audited consolidated financial statements and related notes thereto and other financial information included elsewhere in this Annual Report on Form 10-K.
Overview
Terra LLC was formed as a Delaware limited liability company on April 29, 2022 as a wholly owned subsidiary of Terra REIT. On October 1, 2022, pursuant to the Merger Agreement, Terra BDC merged with and into Terra LLC, with Terra LLC continuing as the surviving entity of the Merger. Subsequent to the Merger, Terra LLC became the successor of Terra BDC and assumed all of Terra BDC’s rights and obligations. The former members of the Terra BDC Board joined the Terra REIT Board. Terra LLC does not have a board of directors and Terra REIT is the sole and managing member of Terra LLC.
Prior to the Merger, Terra BDC was an investment company, as defined under U.S. GAAP, and applied accounting and reporting guidance in accordance with the FASB Accounting Standard Codification (“ASC”) Topic 946, Financial Services — Investment Companies (the “Predecessor Basis”). Terra LLC does not meet the requirements to be classified as an investment company, and as such, it is an operating company and reports its investments at historical cost (the “Successor Basis”).
Terra BDC was incorporated under the general corporation laws of the State of Maryland on May 15, 2013 and commenced operations on June 24, 2015. Terra BDC was an externally managed, non-diversified, closed-end management investment company that elected to be regulated as a BDC under the 1940 Act. Terra BDC elected to be taxed as a REIT under the Code commencing with its short taxable year beginning October 1, 2018 and ending December 31, 2018 and believed it operated so as to qualify to be taxed as a REIT under Subchapter M of the Code during the REIT Period.
Our investment activities were externally managed by Terra Income Advisors and supervised by the Terra BDC Board, a majority of whom were independent. Under the Investment Advisory Agreement, we paid Terra Income Advisors an annual base management fee based on our average quarterly gross assets, as well as incentive fees based on our performance. In connection with the Merger, the Investment Advisory Agreement was terminated and we no longer pay any fees to Terra Income Advisors. Management fees are now payable by our parent and sole member, Terra REIT, to its external manager, Terra REIT Advisors, pursuant to the Management Agreement. We have entered into the Cost Sharing Agreement pursuant to which we are responsible for our allocable share of Terra REIT’s expenses, including fees paid by Terra REIT to its manager. Terra REIT’s investment objective is to provide attractive risk-adjusted returns to its stockholders, primarily through regular distributions. There can be no assurances that Terra REIT will be successful in meeting its investment objective.
Pursuant to the terms of the Merger Agreement, on October 1, 2022, except for any shares of Terra BDC Common Stock held by Terra REIT or any wholly owned subsidiary of Terra REIT or Terra BDC, which shares were automatically retired and ceased to exist with no consideration paid therefor, each issued and outstanding share of Terra BDC Common Stock was automatically cancelled and retired and converted into the right to receive (i) 0.595 shares of the Class B Common Stock and (ii) cash, without interest, in lieu of any fractional shares of Class B Common Stock otherwise issuable in an amount, rounded to the nearest whole cent, determined by multiplying (x) the fraction of a share of Class B Common Stock to which such holder would otherwise be entitled by (y) $14.38.
Pursuant to the terms of the transactions described in the Merger Agreement, 4,847,910 shares of Class B Common Stock were issued to former Terra BDC stockholders in connection with the Merger. Following the consummation of the Merger, former Terra BDC stockholders own approximately 19.9% of the common equity of Terra REIT as the combined company.
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In connection with the Merger, Terra LLC assumed the obligations of Terra BDC under the indenture of the unsecured notes payable as well as the credit agreement to provide for a delayed draw term loan of up to $25.0 million. Additionally, the Servicing Plan was terminated on October 1, 2022 and fees pursuant to such agreement are no longer payable.
Portfolio Summary
Net Loan Portfolio
The following table provides a summary of our net loan portfolio as of:
| December 31, 2023 | December 31, 2022 | ||||||||||||||||||||||||||||||||||
| Fixed Rate | Floating Rate (1)(3) | Total | Fixed Rate | Floating Rate (2)(3) | Total | ||||||||||||||||||||||||||||||
| Number of loans | 4 | 2 | 6 | 6 | 3 | 9 | |||||||||||||||||||||||||||||
| Principal balance | $ | 44,377,373 | $ | 43,059,173 | $ | 87,436,546 | $ | 61,913,795 | $ | 61,826,028 | $ | 123,739,823 | |||||||||||||||||||||||
| Carrying value | $ | 44,528,468 | $ | 33,814,996 | $ | 78,343,464 | $ | 62,781,893 | $ | 58,631,133 | $ | 121,413,026 | |||||||||||||||||||||||
| Fair value | $ | 44,313,689 | $ | 34,214,046 | $ | 78,527,735 | $ | 62,035,611 | $ | 58,244,737 | $ | 120,280,348 | |||||||||||||||||||||||
| Weighted-average coupon rate | 13.7% | 16.6% | 15.1% | 14.1% | 14.4% | 14.2% | |||||||||||||||||||||||||||||
| Weighted-average remaining term (years) | 0.76 | 1.10 | 0.87 | 0.86 | 0.77 | 0.80 | |||||||||||||||||||||||||||||
(1)As of December 31, 2023, these loans pay a coupon rate of Secured Overnight Financing Rate (“SOFR”) or forward-looking term rate based on SOFR (“Term SOFR”), as applicable, plus a fixed spread. Coupon rates shown were determined using average SOFR and Term SOFR of 5.3% and 5.4%, respectively.
(2)As of December 31, 2022, these loans paid a coupon rate of London Interbank Offered Rate (“LIBOR”) or average SOFR, as applicable, plus a fixed spread. Coupon rates shown were determined using LIBOR of 4.4% and average SOFR of 4.1%.
(3)As of December 31, 2023 and 2022, two and three loans, respectively, were subject to a LIBOR, SOFR or Term SOFR floor, as applicable.
Equity Investments
In addition to our loan portfolio, we owned a $10.0 million mezzanine loan and also had participation rights in residual profit from the sale of the underlying real estate portfolio with the borrower. We accounted for the entire arrangement as equity investment in unconsolidated investment. In May 2023, we made a cash payment of $27.4 million and settled the $10.0 million mezzanine loan in exchange for an 80.0% equity interest in a joint venture that owns the real estate portfolio. In November 2023, in connection with the restructuring of a senior loan, we contributed $5.0 million to an additional joint venture that owns a real estate property. We account for our equity interest in the joint ventures as equity method investments because we do not have a controlling financial interest in the entities. As of December 31, 2023 and 2022, equity investment in unconsolidated investments had total carrying value of $40.4 million and $10.0 million, respectively.
Portfolio Investment Activity
For the year ended December 31, 2023 and 2022, we invested $48.3 million and $65.8 million in new and add-on investments, and had $52.0 million and $42.9 million of repayments, resulting in net repayments of $3.7 million and net investments of $22.8 million, respectively.
Senior Unsecured Notes
In February 2021, Terra BDC issued $38.4 million in aggregate principal amount of 7.00% fixed-rate notes due 2026, for net proceeds of $37.2 million after deducting underwriting commissions of $1.2 million. On October 1, 2022 in connection with the Merger, Terra BDC, Terra LLC and U.S. Bank National Association entered into a second supplemental indenture pursuant to which Terra LLC assumed the payment of the notes and the performance of every covenant of the indenture, to be previously performed or observed by Terra BDC. Interest on the notes is paid quarterly in arrears every March 30, June 30, September 30
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and December 30, at an annual rate of 7.00% per year, beginning June 30, 2021. The notes mature on March 31, 2026. The notes may be redeemed in whole or in part at any time or from time to time at our option on or after February 10, 2023.
Term Loan
In April 2021, we entered into a credit agreement (the “Credit Agreement”) with a lender to provide for a delayed draw term loan of $25.0 million (the “Term Loan”). On September 27, 2022, the Credit Agreement was amended to, among other things, remove the make whole premium on voluntary prepayment of the loans as well as to provide consent to the consummation of the Merger and the assumption by Terra LLC of all of the obligations of Terra BDC under the Credit Agreement. On June 30, 2023, we amended the Credit Agreement to extend the scheduled maturity date to March 31, 2024 and increase the rate on which the Term Loan bears interest from a fixed rate of 5.625% per annum to a floating rate based on SOFR plus 7.375% with a SOFR floor of 5.0%. In connection with the amendment, we made a $10.0 million repayment on the Term Loan. As of December 31, 2023, the Term Loan had an outstanding balance of $15.0 million.
Factors Impacting Operating Results
Our portfolio is concentrated in a limited number of industries and borrowers, and, as a result, a downturn in any particular industry or borrower in which we are heavily invested may significantly impact the aggregate returns we realize. If an industry in which we are heavily invested suffers from adverse business or economic conditions, a material portion of our investment could be affected adversely, which, in turn, could adversely affect our financial position and results of operations. For example, as of December 31, 2023, our investments secured by office and infrastructure properties represented approximately 31.3% and 27.4%, respectively, of the carrying value of our total loan investments. In addition, as of December 31, 2023, we held only six loan investments and our largest loan investment represented approximately 31.3% of the carrying value of our total loan investments and our largest three loan investments represented approximately 82.7% of the carrying value of our total loan investments.
Results of Operations
Operating results for the year ended December 31, 2023 and the three months ended December 31, 2022 (Successor Basis), and the nine months ended September 30, 2022 (Predecessor Basis) were as follows:
| Year Ended December 31, 2023 | Three Months Ended December 31, 2022 | ||||||||||
| Revenues | |||||||||||
| Interest income | $ | 10,226,670 | $ | 6,600,064 | |||||||
| Dividend and other income | 87,625 | 5,862 | |||||||||
| 10,314,295 | 6,605,926 | ||||||||||
| Operating expenses | |||||||||||
Asset management and asset servicing fees paid/payable to Terra REIT (1) | 1,682,414 | 395,129 | |||||||||
Operating expense reimbursement to Terra REIT (1) | 1,606,470 | 371,515 | |||||||||
| Provision for credit losses | 5,113,660 | 3,937,050 | |||||||||
| Professional fees | 711,754 | 324,599 | |||||||||
| Insurance expense | 125,334 | 78,501 | |||||||||
| General and administrative expenses | 30,855 | — | |||||||||
| 9,270,487 | 5,106,794 | ||||||||||
| Operating income | 1,043,808 | 1,499,132 | |||||||||
| Other income and expenses | |||||||||||
| Unrealized loss on investments, net | (18,601) | — | |||||||||
| Realized loss on investments, net | (12,512) | — | |||||||||
| (Loss) income from equity investment in unconsolidated investments | (1,004,325) | 13,691 | |||||||||
| Interest expense on unsecured notes payable | (3,856,889) | (944,466) | |||||||||
| Interest expense on term loan | (1,776,596) | (359,375) | |||||||||
| (6,668,923) | (1,290,150) | ||||||||||
| Net (loss) income | $ | (5,625,115) | $ | 208,982 | |||||||
(1)Fees were paid and payable, and expenses were reimbursed, to Terra REIT pursuant to the Cost Sharing Agreement with Terra REIT.
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| Nine Months Ended September 30, 2022 | ||||||||
| Investment income | ||||||||
| Interest income | $ | 11,648,944 | ||||||
| Dividend and other income | 62,821 | |||||||
| Total investment income | 11,711,765 | |||||||
| Operating expenses | ||||||||
| Base management fees | 1,964,830 | |||||||
| Reversal of incentive fees on capital gains | (102,160) | |||||||
| Operating expense reimbursement to Adviser | 946,934 | |||||||
| Reversal of servicing fees | (121,504) | |||||||
| Interest expense on unsecured notes payable | 2,299,538 | |||||||
| Professional fees | 1,139,775 | |||||||
| Interest expense from obligations under participation agreements | 433,622 | |||||||
| Interest expense on term loan | 1,101,797 | |||||||
| Directors’ fees | 84,378 | |||||||
| Insurance expense | 190,293 | |||||||
| Transaction costs | 1,459,762 | |||||||
| General and administrative expenses | 76,625 | |||||||
| Total operating expenses | 9,473,890 | |||||||
| Net investment income before income taxes | 2,237,875 | |||||||
| Income tax expense | 605,787 | |||||||
| Net investment income | 1,632,088 | |||||||
| Net change in unrealized depreciation on investments | (3,444,211) | |||||||
| Net change in unrealized depreciation on obligations under participation agreements | 42,128 | |||||||
| Net realized gain on investments | 55,783 | |||||||
| Net decrease in net assets resulting from operations | $ | (1,714,212) | ||||||
Net Loan Portfolio
In assessing the performance of our loans, we believe it is appropriate to evaluate the loans on an economic basis, that is, gross loans net of obligations under participation agreements. The following table presents a reconciliation of our loan portfolio on a weighted average basis from gross to net:
| Year Ended December 31, 2023 | Three Months Ended December 31, 2022 | Nine Months Ended September 30, 2022 | |||||||||||||||||||||||||||||||||
| Successor Basis | Predecessor Basis | ||||||||||||||||||||||||||||||||||
| Weighted Average Principal Amount | Weighted Average Coupon Rate | Weighted Average Principal Amount | Weighted Average Coupon Rate | Weighted Average Principal Amount | Weighted Average Coupon Rate | ||||||||||||||||||||||||||||||
| Gross loan investments | $ | 95,719,669 | 14.9% | $ | 119,449,179 | 13.4% | $ | 124,239,298 | 13.4% | ||||||||||||||||||||||||||
| Obligations under participation agreements | — | —% | — | —% | (5,567,579) | 11.1% | |||||||||||||||||||||||||||||
| Net loan investments | $ | 95,719,669 | 14.9% | $ | 119,449,179 | 13.4% | $ | 118,671,719 | 13.5% | ||||||||||||||||||||||||||
Interest Income
For the year ended December 31, 2023, the three months ended December 31, 2022 and the nine months ended September 30, 2022, interest income was $10.2 million, $6.6 million and $11.6 million, respectively. For the year ended December 31, 2023, interest income primarily consisted of contractual interest income of $10.7 million and interest income on cash and debt
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securities of $0.5 million, partially offset by amortization of net purchase discount recognized in connection with the Merger of $1.0 million. For the three months ended December 31, 2022, interest income was primarily consisting of contractual interest income of $3.4 million and amortization of net purchase premium recorded in connection with the Merger of $3.2 million. For the nine months ended September 30, 2022, interest income was primarily consisting of contractual interest income of $10.9 million and amortization of transaction fee income of $0.8 million.
Dividend and Other Income
For the year ended December 31, 2023, dividend and other income was $0.09 million, primarily related to dividend income earned on our marketable securities. For the three months ended December 31, 2022 and the nine months ended September 30, 2022, dividend and other income was $0.01 million and $0.06 million, respectively, primarily related to administrative fees earned in connection with servicing our loans.
Base Management, Asset Management and Asset Servicing Fees
Under the Investment Advisory Agreement, Terra BDC paid Terra Income Advisors a base management fee, which was calculated at an annual rate of 2.0% of our average gross assets. In connection with the Merger, the Investment Advisory Agreement was terminated and we entered into the Cost Sharing Agreement with Terra REIT.
For the year ended December 31, 2023 and the three months ended December 31, 2022, we paid management fees consisting of asset management and asset servicing fees of $1.7 million and $0.4 million, respectively, to Terra REIT pursuant to the Cost Sharing Agreement. For the nine months ended September 30, 2022, we paid base management fees of $2.0 million to Terra Income Advisors pursuant to the Investment Advisory Agreement.
Reversal of Incentive Fees on Capital Gains
Under the Investment Advisory Agreement, Terra BDC paid Terra Income Advisors an incentive fee on capital gains equal to 20.0% of our net realized and unrealized capital gains. No incentive fees on capital gains were actually payable by Terra BDC with respect to unrealized gains until those gains were realized. The Investment Advisory Agreement was terminated in connection with the Merger.
For the year ended December 31, 2023 and the three months ended December 31, 2022, there were no incentive fees on capital gains because the Investment Advisory Agreement was terminated on October 1, 2022. For the nine months ended September 30, 2022, we reversed previously recorded incentive fees on capital gains of $0.1 million as a result of a decline in the value of our investments.
Operating Expense Reimbursement
Under the Investment Advisory Agreement, Terra BDC reimbursed Terra Income Advisors for operating expenses incurred in connection with administrative services provided to us, including compensation to administrative personnel. In connection with the Merger, the Investment Advisory Agreement was terminated and we entered into the Cost Sharing Agreement with Terra REIT.
For the year ended December 31, 2023 and the three months ended December 31, 2022, we reimbursed Terra REIT $1.6 million and $0.4 million, respectively, for operating expense incurred on our behalf pursuant to the Cost Sharing Agreement. For the nine months ended September 30, 2022, we reimbursed Terra Income Advisors $0.9 million for operating expenses incurred on our behalf, pursuant to the Investment Advisory Agreement.
Servicing Fees
Terra BDC maintained the Servicing Plan whereby it paid selected dealers a servicing fee at an annual rate of 0.75% of the most recently published NAV per share of its common stock, in exchange for providing stockholder-related administrative support services. With respect to each share sold, excluding shares sold through the distribution reinvestment plan, the servicing fee was payable annually on the anniversary of the applicable month of purchase. In connection with the Merger, the Servicing Plan was terminated.
For the year ended December 31, 2023 and the three months ended December 31, 2022, there were no servicing fees. For the nine months ended September 30, 2022, we reversed previously accrued servicing fees of $0.1 million as a result of terminating the Servicing Plan in connection with the Merger.
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Provision for Credit Losses
On January 1, 2023, we adopted the provisions of ASU 2016-13, which requires entities to recognize credit losses on financial instruments based on an estimate of current expected credit losses. Prior to the adoption of ASU 2016-13 and the Merger on October 1, 2022, we followed investment company accounting and did not provide for allowance for credit losses.
For the year ended December 31, 2023 and the three months ended December 31, 2022, provision for credit losses was $5.1 million and $3.9 million, respectively, primarily as a result of a decline in the fair value of the collateral of a loan due to a decline in the macroeconomic outlook for commercial real estate. For the nine months ended September 30, 2022, there was no provision for credit losses as we followed investment company accounting during that period.
Interest Expense on Unsecured Notes Payable
In February 2021, Terra BDC issued $38.4 million in aggregate principal amount of 7.00% fixed-rate notes due 2026. On October 1, 2022 in connection with the Merger, Terra BDC, Terra LLC and U.S. Bank National Association entered into a second supplemental indenture pursuant to which Terra LLC assumed the payment of the notes and the performance of every covenant of the indenture, to be performed or observed by Terra BDC.
For the year ended December 31, 2023, the three months ended December 31, 2022 and the nine months ended September 30, 2022, interest expense on unsecured notes payable was $3.9 million, $0.9 million and $2.3 million, respectively. The increase in interest expense on unsecured notes payable for the year ended December 31, 2023 as compared to the year ended December 31, 2022 was primarily due to amortization of purchase discount recognized in connection with the Merger.
Professional Fees
For the year ended December 31, 2023, the three months ended December 31, 2022 and the nine months ended September 30, 2022, professional fees were $0.7 million, $0.3 million and $1.1 million, respectively. Professional fees for the nine months ended September 30, 2022 included a termination fee incurred in connection with terminating the contract with the transfer agent as a result of the Merger.
Interest Expense on Term Loan
In April 2021, Terra BDC entered into the Credit Agreement with a lender to provide for a delayed draw term loan of $25.0 million. The Term Loan carried interest at a rate equal to 5.625% and was scheduled to mature on April 9, 2025. We also paid, with respect to any unused portion of the Term Loan, a commitment fee of 0.75% per annum. On September 27, 2022, the Credit Agreement was amended to change the scheduled maturity date to July 1, 2023 and remove the make whole premium on voluntary prepayment of the loans as well as to provide consent to the consummation of the Merger and the assumption by Terra LLC of all of the obligations of Terra BDC under the Credit Agreement effective October 1, 2022. On June 30, 2023, we amended the Credit Agreement to extend the scheduled maturity date to March 31, 2024 and increase the rate on which the Term Loan bears interest from a fixed rate of 5.625% per annum to a floating rate based on SOFR plus 7.375% with a SOFR floor of 5.0%.
For the year ended December 31, 2023, the three months ended December 31, 2022 and the nine months ended September 30, 2022, interest expense on the Term Loan was $1.8 million, $0.4 million and $1.1 million, respectively. The increase in interest expense on the Term Loan for the year ended December 31, 2023 as compared to the year ended December 31, 2022 was primarily due to an increase in contractual interest rate, partially offset by a decrease in the weighted average outstanding balance.
Interest Expense From Obligations Under Participation Agreements
For the year ended December 31, 2023 and the three months ended December 31, 2022, there was no interest expense from obligations under participation agreements as the related obligation under participation agreements was extinguished in connection with the Merger. For the nine months ended September 30, 2022, interest expense from obligations under participation agreements was $0.4 million.
Directors’ Fees
For the year ended December 31, 2023 and the three months ended December 31, 2022, there were no directors' fees as we do not have a board of directors. Our sole and managing member, Terra REIT, has been responsible for paying directors' fees to its directors. Prior to the Merger and for the nine months ended September 30, 2022, directors' fees were $0.08 million.
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Transaction Costs
For the year ended December 31, 2023 and the three months ended December 31, 2022, there were no transaction costs incurred. For the nine months ended September 30, 2022, transaction costs were $1.5 million, primarily related to transaction costs incurred in connection with the Merger.
Loss From Equity Investment In Unconsolidated Investments
For the year ended December 31, 2023, we recognized a net loss from equity investment in unconsolidated investments of $1.0 million, as a result of depreciation and amortization and interest expense recognized by the joint ventures.
Income Tax Expense
During the third quarter of 2021, Terra BDC formed a taxable REIT subsidiary (“TRS”) to hold two credit facilities. Subsequent to the Merger on October 1, 2022, the TRS became a qualified REIT subsidiary of Terra REIT.
For the year ended December 31, 2023 and the three months ended December 31, 2022, there was no provision for income tax as a TRS has not been utilized subsequent to the Merger. For the nine months ended September 30, 2022, pre-tax income attributable to the TRS was $2.1 million. Based on the effective income tax rate of 28.2%, the provision for income tax for the TRS was $0.6 million.
Net Change in Unrealized Appreciation or Depreciation on Investments and Obligations under Participation Agreements
Net change in unrealized appreciation or depreciation on investments and obligations under participation agreements reflects the change in our portfolio investment values during the reporting period, including any reversal of previously recorded unrealized gains or losses, when gains or losses are realized. Valuation of our portfolio investments and obligations under participation agreements fluctuates over time, reflecting changes in the market yields for loans and debt investments, and any associated premium or discount and origination or exit fee are amortized down or accreted up to par value as each investment approaches maturity.
For the year ended December 31, 2023 and the three months ended December 31, 2022, we did not record any unrealized appreciation or depreciation on investments because investments were reported at carrying value subsequent to the Merger (Successor Basis).
For the nine months ended September 30, 2022, we recorded depreciation on investments of $3.4 million, respectively, primarily due to a decrease in the fair value of collateral on loans held for investment as well as an increase in the index rates.
Net (loss) income
For the year ended December 31, 2023 and the three months ended December 31, 2022, the resulting net (loss) income was $(5.6) million and $0.2 million, respectively.
Net Decrease in Net Assets Resulting from Operations
For the nine months ended September 30, 2022, we recorded a net decrease in net assets resulting from operations of $1.7 million. Based on the weighted average shares of common stock outstanding, our per share net decrease in net assets resulting from operations was $0.21.
Terra REIT’s Management Agreement with Terra REIT Advisors
Terra REIT is our parent and sole member. We have entered into a cost sharing arrangement with Terra REIT pursuant to which we will be responsible for our allocable share of Terra REIT’s expenses, including fees paid by Terra REIT to its manager, Terra REIT Advisors. Terra REIT currently pays the following fees to Terra REIT Advisors pursuant to the Management Agreement:
Origination and Extension Fee. An origination fee in the amount of 1.0% of the amount used to originate, acquire, fund or structure real estate-related investments, including any third-party expenses related to such loan. In the event that the term of any real estate-related loan is extended, Terra REIT Advisors also receives an origination fee equal to the lesser of (i) 1.0% of the principal amount of the loan being extended or (ii) the amount of fee paid by the borrower in connection with such extension.
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Asset Management Fee. A monthly asset management fee at an annual rate equal to 1.0% of the aggregate funds under management, which includes the loan origination amount or aggregate gross acquisition cost, as applicable, for each real estate-related loan and cash held by Terra REIT.
Asset Servicing Fee. A monthly asset servicing fee at an annual rate equal to 0.25% of the aggregate gross origination price or aggregate gross acquisition price for each real estate related loan then held by Terra REIT (inclusive of closing costs and expenses).
Disposition Fee. A disposition fee in the amount of 1.0% of the gross sale price received by Terra REIT from the disposition of each loan, but not upon the maturity, prepayment, workout, modification or extension of a loan unless there is a corresponding fee paid by the borrower, in which case the disposition fee will be the lesser of (i) 1.0% of the principal amount of the loan and ii) the amount of the fee paid by the borrower in connection with such transaction. If Terra REIT takes ownership of a property as a result of a workout or foreclosure of a loan, Terra REIT will pay a disposition fee upon the sale of such property equal to 1.0% of the sales price.
Transaction Breakup Fee. In the event that Terra REIT receive any “breakup fees,” “busted-deal fees,” termination fees, or similar fees or liquidated damages from a third-party in connection with the termination or non-consummation of any loan or disposition transaction, Terra REIT Advisors will be entitled to receive one-half of such amounts, in addition to the reimbursement of all out-of-pocket fees and expenses incurred by Terra REIT Advisors with respect to its evaluation and pursuit of such transactions.
In addition to the fees described above, Terra REIT reimburses Terra REIT Advisors for operating expenses incurred in connection with services provided to the operations of Terra REIT, including its allocable share of Terra REIT Advisors’ overhead, such as rent, employee costs, utilities, and technology costs.
Financial Condition, Liquidity and Capital Resources
We currently generate cash primarily from cash flows from interest, dividends and fees earned from our investments, principal repayments, and proceeds from sales of our investments. Our primary use of cash is for our targeted assets and payments of our expenses.
We may borrow funds to make investments to the extent we determine that leveraging our portfolio would be appropriate. In February 2021, Terra BDC issued $38.4 million in aggregate principal amount of 7.00% fixed-rate notes due 2026, for net proceeds of $37.2 million after deducting underwriting commissions of $1.2 million. On October 1, 2022 in connection with the Merger, Terra BDC, Terra LLC and U.S. Bank National Association entered into a second supplemental indenture pursuant to which Terra LLC assumed the payment of the notes and the performance of every covenant of the indenture, to be performed or observed by Terra BDC. In April 2021, Terra BDC entered into a Credit Agreement with a lender to provide for a delayed draw term loan of $25.0 million. The Term Loan bore interest at a rate equal to 5.625% and was scheduled to mature on April 9, 2025. On September 27, 2022, the Credit Agreement was amended to change the scheduled maturity date to July 1, 2023 and remove the make whole premium on voluntary prepayment of the loans as well as to provide consent to the consummation of the Merger and the assumption by Terra LLC of all of the obligations of Terra BDC under the Credit Agreement. On June 30, 2023, we amended the Credit Agreement to extend the scheduled maturity date to March 31, 2024 and increase the rate on which the Term Loan bears interest from a fixed rate of 5.625% per annum to a floating rate based on SOFR plus 7.375% with a SOFR floor of 5.0%. In connection with the amendment, we made a $10.0 million repayment on the Term Loan. As of December 31, 2023, the amount outstanding under the Term Loan was $15.0 million.
Certain of our loans provide for commitments to fund the borrower at a future date. As of December 31, 2023, we had one loan with funding commitments of $19.3 million, of which we funded $18.6 million. We do not expect to fund the remaining $0.7 million unfunded commitments to the borrower in the next twelve months as the borrower has not met the requirement for funding.
Cash Flows for the Year Ended December 31, 2023 (Successor Basis)
Operating Activities — For the year ended December 31, 2023, cash provided by operating activities was $2.6 million.
Investing Activities — For the year ended December 31, 2023, cash provided by investing activities was $4.1 million, primarily related to proceeds from repayment of loans of $42.0 million, proceeds from sale of held-to-maturity debt securities of $10.0 million and distributions received from unconsolidated investment of $0.5 million, partially offset by purchase of
29
equity interest in unconsolidated investment of $32.4 million, purchase of held-to-maturity debt securities of $10.0 million, payments for origination and purchase of loans of $5.4 million and payment for marketable securities of $0.5 million.
Financing Activities — For the year ended December 31, 2023, cash used in financing activities was $10.2 million, primarily due to the repayments of borrowings under term loan payable of $10.0 million and payment for financing cost of $0.2 million.
Cash Flows for the Three Months Ended December 31, 2022 (Successor Basis)
Operating Activities — For the three months ended December 31, 2022, cash used in operating activities was $0.1 million.
Investing Activities — For the three months ended December 31, 2022, cash used in investing activities was $17.7 million, related to purchases of investments.
Cash Flows for the Nine Months Ended September 30, 2022 (Predecessor Basis)
Operating Activities — For the nine months ended September 30, 2022, net cash used in operating activities was $6.9 million. The level of cash flows used in or provided by operating activities is affected by the timing of purchases, repayments and sales of portfolio investments, among other factors. Cash flows used in operating activities for the nine months ended September 30, 2022 were primarily related to purchases of investments of $48.1 million, partially offset by repayments and proceeds from sale of investments of $42.9 million and cash generated from operations of $1.8 million.
Financing Activities — For the nine months ended September 30, 2022, net cash provided by financing activities was $19.0 million, primarily related to proceeds from borrowings under the Term Loan of $19.9 million and proceeds from obligations under participation agreements of $1.2 million, partially offset by distributions paid to stockholders of $2.1 million.
Investment Advisory Agreement
Terra BDC entered into certain contracts under which it had material future commitments.
On April 20, 2015, Terra BDC entered into the Investment Advisory Agreement with Terra Income Advisors in accordance with the 1940 Act. Terra Income Advisors served as its investment adviser in accordance with the terms of the Investment Advisory Agreement. Payments under the Investment Advisory Agreement in each reporting period consist of (i) a base management fee equal to a percentage of the value of our average gross assets and (ii) an incentive fee based on our performance. Terra Income Advisors was reimbursed for allocated administrative expenses incurred on Terra BDC’s behalf. The Investment Advisory Agreement was terminated in connection with the Merger.
On September 30, 2017, Terra BDC adopted the Servicing Plan. Pursuant to the Servicing Plan, Terra Capital Markets was entitled to receive a servicing fee at an annual rate of 1.125% of the most recently published NAV per share of Terra BDC’s common stock, of which up to 0.75% was reallowed to selected dealers, in exchange for providing certain administrative support services. With respect to each share sold, excluding shares sold through our distribution reinvestment plan, the servicing fee was payable annually on the anniversary of the applicable month of purchase. On December 23, 2020, Terra Capital Markets assigned to Terra BDC certain of its administration support services and certain obligations under the dealer manager agreement, including making future payments of the previously reallowed servicing fee under the Servicing Plan directly to selected dealers, effectively reducing the servicing fee to 0.75%. In connection with the Merger, the Servicing Plan was terminated.
The following table presents a summary of such fees and reimbursements in accordance with the terms of the related agreements:
Year Ended December 31 2023 (1) | Three Months Ended December 31, 2022 (1) | Nine Months Ended September 30, 2022 | ||||||||||||||||||
| (Successor Basis) | (Predecessor Basis) | |||||||||||||||||||
| Amounts Included in the Statements of Operations | ||||||||||||||||||||
| Asset management and asset servicing fees | $ | 1,682,414 | $ | 395,129 | N/A | |||||||||||||||
| Base management fees | N/A | N/A | $ | 1,964,830 | ||||||||||||||||
Reversal of incentive fees on capital gains (2) | N/A | N/A | (102,160) | |||||||||||||||||
Operating expense reimbursement to Adviser (3) | 1,606,470 | 371,515 | 946,934 | |||||||||||||||||
| Servicing fee | N/A | N/A | (121,504) | |||||||||||||||||
| Origination, extension and disposition fees | 602,022 | N/A | N/A | |||||||||||||||||
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(1)These fees were incurred pursuant to the Cost Sharing Agreement between Terra LLC and Terra REIT.
(2)For the nine months ended September 30, 2022, the Company reversed previously accrued incentive fees on capital gains of $102,160, respectively. Incentive fees on capital gains were based on 20.0% of net realized and unrealized capital gains. No incentive fees on capital gains were actually payable by the Company with respect to unrealized gains unless and until those gains were realized.
(3)Amounts were primarily compensation for time spent supporting the Company’s day-to-day operations.
Critical Accounting Policies and Use of Estimates
Our consolidated financial statements are prepared in conformity with U.S. GAAP, which requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Critical accounting policies are those that require the application of management’s most difficult, subjective or complex judgments, often because of the need to make estimates about the effect of matters that are inherently uncertain and that may change in subsequent periods. In preparing the consolidated financial statements, management has made estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. In preparing the consolidated financial statements, management has utilized available information, including industry standards and the current economic environment, among other factors, in forming its estimates and judgments, giving due consideration to materiality. Actual results may differ from these estimates. In addition, other companies may utilize different estimates, which may impact the comparability of our results of operations to those of companies in similar businesses. As we execute our expected operating plans, we will describe additional critical accounting policies in the notes to our future consolidated financial statements in addition to those discussed below.
Allowance for Credit Losses
On January 1, 2023, we adopted the provisions of ASU 2016-13, which requires entities to recognize credit losses on financial instruments based on an estimate of current expected credit losses. The CECL model requires the consideration of possible credit losses over the life of an instrument as opposed to estimating credit losses upon the occurrence of an actual loss event under the previous “incurred loss” methodology.
We use a model based approach for estimating the allowance for credit losses on performing loans on a collective basis, including future funding commitments for which we do not have the unconditional right to cancel, as these loans share similar risk characteristics. We utilize information obtained from internal and external sources relating to past events, current economic conditions and reasonable and supportable forecasts about the future to determine the expected credit losses for our loan portfolio. We utilize a commercial mortgage based, third-party loan loss model and because we do not have a meaningful history of realized credit losses on our loan portfolio, we subscribe to a database service to provide historical proxy loan loss information. We employ logistic regression to forecast expected losses at the loan level based on a commercial real estate loan securitization database that contains activity dating back to 1998. We have chosen to incorporate a weighted average macroeconomic forecast that encompasses baseline, optimistic and pessimistic scenarios, into our allowance for credit losses on performing loans estimate during the reasonable and supportable forecast period which is currently eight quarters. We select certain economics variables from a group of independent variables such as Commercial Real Estate Price Index, unemployment and interest rate which are included in the model as part of macroeconomic forecast and updated regularly based on current economic trends. The specific loan level information input into the model includes loan-to-value and debt service coverage ratio metrics, as well as principal balances, property type, location, coupon rate, coupon rate type, original or remaining term, expected repayment dates and contractual future funding commitments. Based on the inputs, the loan loss model determines a loan loss rate through the generation of a probability of default (PD) and loss given default (LGD) for each loan. The allowance for credit losses on performing loans is then calculated by applying the loan loss rate to the total outstanding loan balance of each loan. These results require a significant amount of judgment applied in selecting inputs and analyzing the results produced by the models to determine the allowance for credit losses. Changes in such estimates can significantly affect the expected credit losses.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
We may be subject to financial market risks, including changes in interest rates. To the extent that we borrow money to make investments, our net investment income will be dependent upon the difference between the rate at which we borrow funds and the rate at which we invest these funds. In periods of rising interest rates, our cost of funds would increase, which may reduce our net investment income. As a result, there can be no assurance that a significant change in the market interest rates will not have a material adverse effect on our net investment income.
As of December 31, 2023, we had two variable rate investments with an aggregate principal balance of $43.1 million that are indexed to SOFR or Term SOFR and are subject to an applicable index floor. The following table summarizes estimated
31
changes in investment income on variable rate investments as of December 31, 2023 assuming hypothetical increases or decreases in the applicable index rates:
| 1.00% Decrease | 1.00% Increase | |||||||||||||
| Investment income from variable rate investments | $ | 419,425 | $ | (419,425) | ||||||||||
We may hedge against interest rate and currency exchange rate fluctuations by using standard hedging instruments, such as futures, options and forward contracts. While hedging activities may insulate us against adverse changes in interest rates, they may also limit our ability to participate in benefits of lower interest rates with respect to our portfolio of investments with fixed interest rates. For the years ended December 31, 2023 and 2022, we did not engage in interest rate hedging activities.
Item 8. Financial Statements and Supplementary Data.
Our financial statements are annexed to this Annual Report on Form 10-K beginning on page F-1.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
As required by Rule 13a-15(b) under the Exchange Act, we carried out an evaluation, under the supervision and with the participation of our management, including both the Chief Executive Officer and Chief Investment Officer and the Chief Financial Officer of our sole and managing member, Terra REIT, performing functions equivalent to those a principal executive officer and principal financial officer of our company would perform if we had any officers, of the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2023. Based on that evaluation, our management concluded that our disclosure controls and procedures were effective to provide reasonable assurance that we would meet our disclosure obligations.
Evaluation of Internal Controls Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets, (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of consolidated financial statements in accordance with U.S. generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of Terra REIT Advisors, and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the consolidated financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements in our financial statements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Under the supervision and with the participation of our management, including both the Chief Executive Officer and Chief Investment Officer and the Chief Financial Officer of our sole and managing member, Terra REIT, performing functions equivalent to those a principal executive officer and principal financial officer of our company would perform if we had any officers, we conducted an evaluation of the effectiveness of our internal control over financial reporting using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated
32
Framework (2013). Based on its evaluation, our management concluded that our internal control over financial reporting was effective as of the end of the fiscal year covered by this Annual Report on Form 10-K.
The rules of the SEC do not require, and this Annual Report on Form 10-K does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting.
Changes in Internal Control Over Financial Reporting
During the most recent fiscal quarter, there was no change in our internal controls over financial reporting, as defined under Rule 13a-15(f) under the Exchange Act, that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
Item 9B. Other Information
None
Item 9C. Disclosure Regarding Foreign Jurisdictions that Prevent Inspections
Not applicable.
PART III
Item 10. Directors, Executive Officers and Corporate Governance.
This section has been omitted pursuant to General Instruction I(2)(c) of Form 10-K.
Item 11. Executive Compensation.
This section has been omitted pursuant to General Instruction I(2)(c) of Form 10-K.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
This section has been omitted pursuant to General Instruction I(2)(c) of Form 10-K.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
This section has been omitted pursuant to General Instruction I(2)(c) of Form 10-K.
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Item 14. Principal Accountant Fees and Services.
On October 1, 2022, pursuant to the terms of the Merger Agreement, Terra BDC merged with and into us, with us continuing as the surviving entity of the Merger and as a wholly owned subsidiary of Terra REIT. We do not have a board of directors and Terra REIT is our sole and managing member. For the years ended December 31, 2023 and 2022, KPMG LLP (“KPMG”) served as our independent auditor and provided certain tax and other services. The Audit Committee of Terra REIT (the “Terra REIT Audit Committee”) currently anticipates that it will engage KPMG as our independent auditor to audit our consolidated financial statements for the year ended December 31, 2024, subject to agreeing on fee estimates for the audit work. The Terra REIT Audit Committee reserves the right, however, to select a new auditor at any time in the future in its discretion. Any such decision would be disclosed to Terra REIT’s stockholders in accordance with applicable securities laws, except that the applicable policies for the periods prior to the closing of the Merger on October 1, 2022 were the policies of Terra BDC which were substantially similar to the policies of Terra REIT and were administered by the audit committee of the Terra BDC Board during such periods.
Audit Fees
The following table displays fees for professional services by KPMG:
| Years Ended December 31, | |||||||||||
| 2023 | 2022 | ||||||||||
| Audit Fees | $ | 303,000 | $ | 378,600 | |||||||
| Audit-Related Fees | — | — | |||||||||
| Tax Fees | 3,476 | 44,227 | |||||||||
| All Other Fees | — | — | |||||||||
| Total | $ | 306,476 | $ | 422,827 | |||||||
Audit Fees. Audit fees include fees for services that normally would be provided by KPMG in connection with statutory and regulatory filings or engagements and that generally only an independent accountant can provide. In addition to fees for the audit of our annual financial statements and the review of our quarterly financial statements in accordance with the standards of the Public Company Accounting Oversight Board, this category contains fees for comfort letters, statutory audits, consents, and assistance with and review of documents filed with the SEC.
Audit-Related Fees. Audit-related services consist of fees billed for assurance and related services that are reasonably related to the performance of the audit or review of our financial statements and are not reported under “Audit Fees.” These services include attest services that are not required by statute or regulation and consultations concerning financial accounting and reporting standards.
Tax Services Fees. Tax services fees consist of fees billed for professional tax services. These services also include assistance regarding federal, state, and local tax compliance.
All Other Fees. Other fees would include fees for products and services other than the services reported above.
Pre-Approval Policies
Terra REIT has established a pre-approval policy that describes the permitted audit, audit-related, tax and other services to be provided by our independent auditor. Pursuant to this policy, the Terra REIT Audit Committee will pre-approve the audit and non-audit services performed by our independent auditor in order to assure that the provision of such services does not impair the auditor’s independence. Any requests for audit, audit-related, tax and other services that have not received general pre-approval must be submitted to the Terra REIT Audit Committee for specific pre-approval in accordance with the pre-approval policy, irrespective of the amount of fees associated with such services, and cannot commence until such approval has been granted. Normally, pre-approval is provided at the regularly scheduled meetings of the Terra REIT Audit Committee. However, the Terra REIT Audit Committee may delegate pre-approval authority to one or more of its members. The member or members to whom such authority is delegated must report any pre-approval decisions to the Terra REIT Audit Committee at its next scheduled meeting. The Terra REIT Audit Committee does not delegate its responsibilities to pre-approve services performed by our independent auditor to management. All services rendered by KPMG for the years ended December 31, 2023 and 2022 were pre-approved in accordance with the policies set forth above.
34
PART IV
Item 15. Exhibits and Financial Statement Schedules.
The following documents are filed as part of this Annual Report on Form 10-K:
(1) Financial Statements
The index to our financial statements is on page F-1 of this Annual Report on Form 10-K.
(2) Financial Statement Schedule
The index to our financial schedules is on page F-1 of this Annual Report on Form 10-K.
(3) Exhibits
The following exhibits are filed with this report. Documents other than those designated as being filed herewith are incorporated herein by reference.
| Exhibit No. | Description and Method of Filing | |||||||
| 2.1 | ||||||||
| 3.1 | ||||||||
| 3.2 | ||||||||
| 3.3 | ||||||||
| 3.4 | ||||||||
| 3.5 | ||||||||
| 4.1 | ||||||||
| 4.2 | ||||||||
| 4.3 | ||||||||
| 4.4 | ||||||||
| 10.1 | ||||||||
35
| Exhibit No. | Description and Method of Filing | |||||||
| 31.1* | ||||||||
| 31.2* | ||||||||
| 32.1** | ||||||||
| 101.INS | Inline XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document | |||||||
| 101.SCH | XBRL Taxonomy Extension Schema Document | |||||||
| 101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document | |||||||
| 101.LAB | XBRL Taxonomy Extension Label Linkbase Document | |||||||
| 101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document | |||||||
| 104 | Cover Page Interactive Data File Included as Exhibit 101 (embedded within the Inline XBRL document) | |||||||
* Filed herewith.
** Furnished herewith.
Item 16. Form 10-K Summary.
None.
36
Terra Income Fund 6, LLC
Index to Consolidated Financial Statements
| Page | ||||||||||||||||||||
| KPMG LLP | New York, NY | PCAOB ID: | ||||||||||||||||||
| Financial Statements: | ||||||||||||||||||||
F-39 | ||||||||||||||||||||
Schedules other than those listed are omitted as they are not applicable for the required or equivalent information has been included in the consolidated financial statements or notes thereto.
F-1
Report of Independent Registered Public Accounting Firm
To the Member
Terra Income Fund 6, LLC:
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated financial statements and the related notes and financial statement schedule IV (collectively, the consolidated financial statements) of Terra Income Fund 6, LLC and subsidiaries, successor to Terra Income Fund 6, Inc. and subsidiaries (collectively, the Company) as listed in the accompanying index. In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2023 and 2022 (Successor Basis), and the results of its operations and its cash flows for the year ended December 31, 2023 (Successor Basis), the three- month period ended December 31, 2022 (Successor Basis), and the nine-month period ended September 30, 2022 (Predecessor Basis), in conformity with U.S. generally accepted accounting principles.
Change in Accounting Principle
As discussed in Note 2 to the consolidated financial statements, the Company has changed its method of accounting for credit Losses as of January 1, 2023 due to the adoption of FASB Accounting Standard Update 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting.
Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
F-2
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of a critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Allowance for Credit Losses on Performing Loans
As discussed in Notes 2 and 3 to the consolidated financial statements, on January 1, 2023, the Company adopted the provisions of ASC 326, Financial Instruments—Credit Losses. The Company’s collective allowance for credit losses (ACL) on performing loans held for investment and performing loans held for investment acquired through participation interest (collectively, the ACL on performing loans) was $661,422 as of January 1, 2023. The Company’s ACL on performing loans totaled $469,011 as of December 31, 2023. The Company uses a model based approach for estimating the ACL on performing loans, including future funding commitments for which the Company does not have the unconditional right to cancel, as these loans share similar risk characteristics. The Company utilizes a commercial mortgage based, third-party loan loss model and because the Company does not have a meaningful history of realized credit losses on its loan portfolio, it subscribes to a database service to provide historical proxy loan loss information back to 1998. The Company has chosen to incorporate a weighted average macroeconomic forecast that encompasses baseline, optimistic and pessimistic scenarios, into its ACL on performing loans estimate during the reasonable and supportable forecast period which is currently eight quarters. Based on loan-level inputs and selection of macroeconomic forecasts and certain economics variables, the loan loss model determines a loan loss rate through the generation of probability of default and loss given default for each loan. The determination of the ACL on performing loans considers historical loss information and current economic conditions for each loan, reversion period, and reasonable and supportable forecasts about the future. The ACL on performing loans is then calculated by applying the loan loss rate to the total outstanding balance of each loan. The Company also performs a qualitative assessment and applies qualitative adjustments as necessary, usually due to limitations of the loan loss model.
We identified the assessment of the January 1, 2023 and the December 31, 2023 ACL on performing loans as a critical audit matter. A high degree of audit effort, including specialized skills and knowledge, and subjective and complex auditor judgment was involved in the assessment of the January 1, 2023 and the December 31, 2023 ACL on performing loans due to significant measurement uncertainty. Specifically, the assessment encompassed the evaluation of the ACL on performing loans methodology, including the loan loss model, used to estimate expected credit losses and the significant assumptions that include the (1) selection and weighting of macroeconomic forecast scenarios, (2) selection of certain economic variables, (3) reasonable and supportable forecast period, (4) reversion period, and (5) period of historical loss information.
The following are the primary procedures we performed to address this critical audit matter. We evaluated the Company’s process to develop the January 1, 2023 and the December 31, 2023 ACL on performing loans estimate by testing and evaluating the relevance and reliability of certain sources of data and assumptions that the Company used. We involved our credit risk professionals with specialized skills and knowledge to assist with:
•Evaluating the ACL on performing loans methodology for compliance with U.S. generally accepted accounting standards
•Assessing the conceptual soundness of the loan loss model by inspecting underlying documentation to determine whether the model is suitable for its intended use
F-3
•Evaluating the selection and weighting of the macroeconomic scenarios and the selection of certain economic variables used by comparing them to the Company's business environment and relevant industry practices
•Evaluating the length of the period from which historical loss information was used, the reasonable and supportable forecast period, and the reversion period by comparing to specific portfolio risk characteristics and trends
•Assessing the relevance of the proxy data by comparing to Company and specific portfolio risk characteristics.
We have served as the Company’s auditor since 2016.
/s/ KPMG LLP
We have served as the Company’s auditor since 2016.
March 15, 2024
F-4
Terra Income Fund 6, LLC
Consolidated Balance Sheets (Successor Basis)
| December 31, | |||||||||||
| 2023 | 2022 | ||||||||||
| Assets | |||||||||||
| Cash and cash equivalents | $ | $ | |||||||||
| Restricted cash | |||||||||||
Loans held for investment, net of allowance for credit losses of $ | |||||||||||
Loans held for investment acquired through participation, net of allowance for credit losses of $ | |||||||||||
| Equity investment in unconsolidated investment | |||||||||||
| Marketable securities | |||||||||||
| Interest receivable | |||||||||||
| Prepaid expenses and other assets | |||||||||||
| Total assets | $ | $ | |||||||||
| Liabilities and Equity | |||||||||||
| Liabilities: | |||||||||||
| Unsecured notes payable, net of purchase discount | |||||||||||
| Term loan payable, net of deferred financing cost | |||||||||||
| Interest reserve and other deposits held on investments | |||||||||||
| Other liabilities | |||||||||||
| Accrued expenses | |||||||||||
| Total liabilities | |||||||||||
| Equity: | |||||||||||
| Managing member | |||||||||||
| Total equity | |||||||||||
| Total liabilities and equity | $ | $ | |||||||||
See notes to consolidated financial statements.
F-5
Terra Income Fund 6, LLC
Consolidated Statement of Operations (Successor Basis)
| Year Ended December 31, 2023 | Three Months Ended December 31, 2022 | |||||||||||||
| Revenues | ||||||||||||||
| Interest income | $ | $ | ||||||||||||
| Dividend and other income | ||||||||||||||
| Operating expenses | ||||||||||||||
Asset management and asset servicing fees paid/payable to Terra REIT (1) | ||||||||||||||
Operating expense reimbursement to Terra REIT (1) | ||||||||||||||
| Provision for credit losses | ||||||||||||||
| Professional fees | ||||||||||||||
| Insurance expense | ||||||||||||||
| General and administrative | ||||||||||||||
| Operating income | ||||||||||||||
| Other income and expenses | ||||||||||||||
| Unrealized loss on investments, net | ( | |||||||||||||
| Realized loss on investments, net | ( | |||||||||||||
| (Loss) income from equity investment in unconsolidated investments | ( | |||||||||||||
| Interest expense on unsecured notes payable | ( | ( | ||||||||||||
| Interest expense on term loan | ( | ( | ||||||||||||
| ( | ( | |||||||||||||
| Net (loss) income | $ | ( | $ | |||||||||||
(1)Fees were paid and payable, and expenses were reimbursed, to Terra Property Trust, Inc. (“Terra REIT”) pursuant to a cost sharing agreement with Terra REIT (Note 5).
See notes to consolidated financial statements.
F-6
Terra Income Fund 6, LLC
Consolidated Statement of Operations (Predecessor Basis)
| Nine Months Ended September 30, 2022 | ||||||||
| Investment income | ||||||||
| Interest income | $ | |||||||
| Dividend and other income | ||||||||
| Total investment income | ||||||||
| Operating expenses | ||||||||
| Base management fees | ||||||||
Reversal of incentive fees on capital gains (1) | ( | |||||||
| ( | ||||||||
| Interest expense on unsecured notes payable | ||||||||
| Professional fees | ||||||||
| Interest expense on term loan | ||||||||
| Directors’ fees | ||||||||
| Insurance expense | ||||||||
| Transaction costs | ||||||||
| General and administrative expenses | ||||||||
| Total operating expenses | ||||||||
| Net investment income before income taxes | ||||||||
| Income tax expense | ||||||||
| Net investment income | ||||||||
| Net change in unrealized depreciation on investments | ( | |||||||
| Net change in unrealized depreciation on obligations under participation agreements | ||||||||
| Net realized gain on investments | ||||||||
| Net decrease in net assets resulting from operations | $ | ( | ||||||
| Per common share data: | ||||||||
| Net investment income per share | $ | |||||||
| Net decrease in net assets resulting from operations per share | $ | ( | ||||||
| Weighted average common shares outstanding | ||||||||
_______________
(1)For the nine months ended September 30, 2022, the Company reversed previously accrued incentive fees on capital gains of $102,160 . Incentive fees on capital gains were based on 20% of net realized and unrealized capital gains. No incentive fees on capital gains were actually payable by the Company with respect to unrealized gains unless and until those gains were realized.
See notes to consolidated financial statements.
F-7
Terra Income Fund 6, LLC
Consolidated Statement of Changes in Member’s Capital (Successor Basis)
| Managing Member | Total | |||||||||||||
| Balance, January 1, 2023 | $ | $ | ||||||||||||
| ( | ( | |||||||||||||
| Net loss | ( | ( | ||||||||||||
| Balance, December 31, 2023 | $ | $ | ||||||||||||
| Managing Member | Total | |||||||||||||
| Balance, October 1, 2022 | $ | $ | ||||||||||||
| Contribution | ||||||||||||||
| Net income | ||||||||||||||
| Balance, December 31, 2022 | $ | $ | ||||||||||||
See notes to consolidated financial statements.
F-8
Terra Income Fund 6, LLC
Consolidated Statement of Changes in Net Assets (Predecessor Basis)
| Nine Months Ended September 30, 2022 | ||||||||
| Operations | ||||||||
| Net investment income | $ | |||||||
| Net change in unrealized depreciation on investments | ( | |||||||
| Net change in unrealized depreciation on obligations under participation agreements | ||||||||
| Net realized gain on investments | ||||||||
| Net decrease in net assets resulting from operations | ( | |||||||
| Stockholder distributions | ||||||||
| Distributions from return of capital | ( | |||||||
| Distributions from net investment income | ( | |||||||
| Net decrease in net assets resulting from stockholder distributions | ( | |||||||
| Capital share transactions | ||||||||
| Reinvestment of stockholder distributions | ||||||||
| Net increase in net assets resulting from capital share transactions | ||||||||
| Net decrease in net assets | ( | |||||||
| Net assets, at beginning of period | ||||||||
| Net assets, at end of period | $ | |||||||
| Capital share activity | ||||||||
| Shares outstanding, at beginning of period | ||||||||
| Shares issued from reinvestment of stockholder distributions | ||||||||
| Shares outstanding, at end of period | ||||||||
See notes to consolidated financial statements.
F-9
Terra Income Fund 6, LLC
Consolidated Statement of Cash Flows (Successor Basis)
| Year Ended December 31, 2023 | Three Months Ended December 31, 2022 | |||||||||||||
| Cash flows from operating activities: | ||||||||||||||
| Net (loss) income | $ | ( | $ | |||||||||||
| Adjustments to reconcile net income from operations to net cash provided by (used in) operating activities: | ||||||||||||||
| Provision for credit losses | ||||||||||||||
| Amortization of premiums and discounts on investments | ( | |||||||||||||
| Amortization and accretion of investment-related fees, net | ( | ( | ||||||||||||
| Amortization of discount on debt | ||||||||||||||
| Amortization of deferred financing costs | ||||||||||||||
| Loss (income) from equity investment in unconsolidated investments | ( | |||||||||||||
| Realized loss on investments, net | ||||||||||||||
| Unrealized loss on investments, net | ||||||||||||||
| Changes in operating assets and liabilities: | ||||||||||||||
| Decrease (increase) in interest receivable | ( | |||||||||||||
| Increase in prepaid expenses and other assets | ( | ( | ||||||||||||
| Decrease in interest reserve and other deposits held on investments | ( | ( | ||||||||||||
| Decrease in accrued expenses | ( | ( | ||||||||||||
| Decrease in due to Adviser, net | ( | |||||||||||||
| Decrease in interest payable from obligations under participation agreements | ( | |||||||||||||
| Increase (decrease) in other liabilities | ( | |||||||||||||
| Net cash provided by (used in) operating activities | ( | |||||||||||||
| Cash flows from investing activities: | ||||||||||||||
| Repayment of loans | ||||||||||||||
| Purchase of equity interest in unconsolidated investment | ( | ( | ||||||||||||
| Purchase of held-to-maturity debt securities | ( | |||||||||||||
| Proceeds from redemption of held-to-maturity debt securities | ||||||||||||||
| Origination and purchase of loans | ( | ( | ||||||||||||
| Purchase of marketable securities | ( | |||||||||||||
| Distributions received from equity investment in unconsolidated investments | ||||||||||||||
| Net cash provided by (used in) investing activities | ( | |||||||||||||
| Cash flows from financing activities: | ||||||||||||||
| Repayments of borrowings under term loan payable | ( | |||||||||||||
| Payment of financing costs | ( | |||||||||||||
| Net cash used in financing activities | ( | |||||||||||||
| Net decrease in cash, cash equivalents and restricted cash | ( | ( | ||||||||||||
| Cash, cash equivalents and restricted cash, at beginning of period | ||||||||||||||
| $ | $ | |||||||||||||
| Supplemental disclosure of cash flow information: | ||||||||||||||
| Cash paid for interest | $ | $ | ||||||||||||
| Income taxes paid | $ | $ | ||||||||||||
| Supplemental non-cash information: | ||||||||||||||
| Loan contributed by Terra Property Trust, Inc. | $ | $ | ||||||||||||
Settlement of a mezzanine loan accounted for as an equity investment in | $ | $ | ||||||||||||
See notes to consolidated financial statements.
F-10
Terra Income Fund 6, LLC
Consolidated Statement of Cash Flows (Predecessor Basis)
| Nine Months Ended September 30, 2022 | ||||||||
| Cash flows from operating activities: | ||||||||
| Net decrease in net assets resulting from operations | $ | ( | ||||||
| Adjustments to reconcile net decrease in net assets resulting from operations to net cash used in operating activities: | ||||||||
| Net change in unrealized depreciation on investments | ||||||||
| Net change in unrealized depreciation on obligations under participation agreements | ( | |||||||
| Net realized gain on investments | ( | |||||||
| Amortization and accretion of investment-related fees, net | ( | |||||||
| Amortization of discount on debt issuance | ||||||||
| Amortization of deferred financing costs | ||||||||
| Purchases of investments | ( | |||||||
| Repayments and proceeds from sale of investments | ||||||||
| Changes in operating assets and liabilities: | ||||||||
| Decrease in interest receivable | ||||||||
| Decrease in prepaid expenses and other assets | ||||||||
| Increase in interest reserve and other deposits held on investments | ||||||||
| Decrease in due to related party | ( | |||||||
| Decrease in due to Adviser, net | ( | |||||||
| Increase in accrued expenses | ||||||||
| Increase in interest payable from obligations under participation agreements | ||||||||
| Decrease in other liabilities | ( | |||||||
| Net cash used in operating activities | ( | |||||||
| Cash flows from financing activities: | ||||||||
| Proceeds from borrowings under term loan payable | ||||||||
| Payments of stockholder distributions | ( | |||||||
| Proceeds from obligations under participation agreements | ||||||||
| Net cash provided by financing activities | ||||||||
| Net increase in cash, cash equivalents and restricted cash | ||||||||
| Cash, cash equivalents and restricted cash, at beginning of period | ||||||||
| $ | ||||||||
| Supplemental disclosure of cash flow information: | ||||||||
| Cash paid for interest | $ | |||||||
| Income taxes paid | $ | |||||||
| Supplemental non-cash information: | ||||||||
| Reinvestment of stockholder distributions | $ | |||||||
See notes to consolidated financial statements.
F-11
Terra Income Fund 6, LLC
Notes to Consolidated Financial Statements
Note 1. Principal Business and Organization
Terra Income Fund 6, LLC (“Terra LLC”) was formed as a Delaware limited liability company on April 29, 2022 as a wholly owned subsidiary of Terra Property Trust, Inc. (“Terra REIT”). On October 1, 2022, pursuant to an Agreement and Plan of Merger, dated as of May 2, 2022 (as amended, the “Merger Agreement”), Terra Income Fund 6, Inc. (“Terra BDC”) merged with and into Terra LLC, with Terra LLC continuing as the surviving entity of the merger (the “Merger”) (Note 5). Subsequent to the Merger, Terra LLC became the successor of Terra BDC and assumed all of Terra BDC’s rights and obligations. As context requires, the “Company” refers to Terra BDC prior to the Merger and its successor, Terra LLC, after the Merger.
Terra BDC was incorporated under the general corporation laws of the State of Maryland on May 15, 2013. Terra BDC elected to be regulated as a business development company (“BDC”) under the Investment Company Act of 1940, as amended (the “1940 Act”). On September 29, 2022, Terra BDC withdrew its election to be regulated as a BDC. Terra BDC was an externally managed, non-diversified, closed-end management investment company that elected to be taxed and qualified annually thereafter, as a real estate investment trust (“REIT”) for U.S. federal income tax purposes under Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”). Subsequent to the Merger, Terra LLC’s sole and managing member is responsible for paying tax, if any, on the Company’s taxable income.
Terra BDC’s investment activities were externally managed by Terra Income Advisors, LLC (“Terra Income Advisors” or the “Adviser”), a private investment firm affiliated with Terra BDC, pursuant to an investment advisory and administrative services agreement (the “Investment Advisory Agreement”), under the oversight of Terra BDC’s board of directors (the “Terra BDC Board”), a majority of whom were independent directors. In connection with the Merger, the Investment Advisory Agreement was terminated, and the former members of the Terra BDC Board were elected to the board of directors of Terra REIT (the “Terra REIT Board”). Terra LLC does not have a board of directors and Terra REIT is the sole and managing member of Terra LLC. Terra REIT’s investments activities are externally managed by Terra REIT Advisors, LLC (“REIT Manager”), an affiliate of the Company.
In February 2021, Terra BDC issued $38.4 million in aggregate principal amount of 7.00 % fixed-rate notes due 2026, for net proceeds of $37.2 million, after deducting underwriting commissions of $1.2 million, see “Unsecured Senior Notes” in Note 6 for more information.
The Company is a wholly owned subsidiary of Terra REIT, and its investment objective is to provide attractive risk-adjusted returns to Terra REIT’s stockholders, primarily through Terra REIT’s regular distributions. The Company originates, invests in and manages a diverse portfolio of real estate-related investments that generate a stable income stream. The Company directly originates, structures and underwrites most, if not all, of its loans, as it believes that doing so will provide it with the best opportunity to invest in loans that satisfy its standards, establish a direct relationship with the borrower and optimize the terms of its investments; however, the Company may acquire existing loans from the originating lender should its adviser determine such an investment is in its best interest. The Company may hold its investments until their scheduled maturity dates or may sell them if the Company is able to command favorable terms for their disposition. The Company may seek to realize growth in the value of its investments by timing their sale to maximize value.
Note 2. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying annual consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles (“U.S. GAAP”) and include the accounts of the Company and its consolidated subsidiaries. The accompanying annual consolidated financial statements of the Company and related financial information have been prepared pursuant to the requirements for reporting on Form 10-K and Articles 6 or 10 of Regulation S-X. Prior to the Merger, Terra BDC operated as and met the criteria of an investment company, as defined under U.S. GAAP, and applied accounting and reporting guidance in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standard Codification (“ASC”) Topic 946, Financial Services — Investment Companies (the “Predecessor Basis”). As a result of the Merger, Terra LLC has not met the requirements to be classified as an investment company since October 1, 2022. As such, Terra LLC is an operating company and reports its investments at historical cost (the “Successor Basis”). The consolidated financial statements reflect all adjustments and reclassifications that, in the opinion of management, are necessary for the fair presentation of the
F-12
Notes to Consolidated Financial Statements
Consolidation
As provided under Regulation S-X and ASC Topic 946, the Terra BDC generally did not consolidate its investment in a company other than an investment company or controlled operating company whose business consists of providing services to Terra BDC. Accordingly, Terra BDC consolidated the accounts of its wholly-owned subsidiaries that meet the aforementioned criteria in its consolidated financial statements as of September 30, 2022.
Terra LLC consolidates entities in which it has a controlling financial interest based on either the variable interest entity (“VIE”) or voting interest entity (“VOE”) model. Terra LLC is required to first apply the VIE model to determine whether it holds a variable interest in an entity, and if so, whether the entity is a VIE. If Terra LLC determines the entity is not a VIE, it then applies the VOE model. Under the VOE model, Terra LLC consolidates an entity when it holds a majority voting interest in an entity.
Cash and Cash Equivalents
The Company considers all highly liquid investments, with original maturities of ninety days or less when purchased, as cash equivalents. Cash and cash equivalents held at financial institutions, at times, may exceed the amount insured by the Federal Deposit Insurance Corporation.
Restricted Cash
Restricted cash represents cash held as additional collateral by the Company on behalf of the borrowers related to the investments for the purpose of such borrowers making interest and property-related operating payments. There is a corresponding liability of the same amount on the statements of assets and liabilities called “Interest reserve and other deposits held on investments.”
| December 31, 2023 | December 31, 2022 | September 30, 2022 | |||||||||||||||
| Cash and cash equivalents | $ | $ | $ | ||||||||||||||
| Restricted cash | |||||||||||||||||
| Total cash, cash equivalents and restricted cash shown in the consolidated statements of cash flows | $ | $ | $ | ||||||||||||||
Loans Held for Investment
The Company originates, acquires, and structures, or acquires through participations, real estate-related loans generally to be held to maturity (collectively the “loans”). Loans held for investment are carried at the principal amount outstanding, adjusted for the accretion of discounts on investments and exit fees, and the amortization of premiums on investments and origination fees. The Company’s preferred equity investments, which are economically similar to mezzanine loans and subordinate to any loans but senior to common equity, are accounted for as loans held for investment. Loans are carried at amortized cost less allowance for credit losses. Amortized cost is the amount at which a financing receivable or a loan is originated or acquired, adjusted for accretion, or amortization of premium, discount, and net deferred fees or costs, collection of cash and write-offs.
Prior to the Merger and under Predecessor Basis of accounting, the Company’s investments were reported at fair value, with the changes in fair value recorded as changes in unrealized gains or losses on investments in the consolidated statements of operations.
F-13
Notes to Consolidated Financial Statements
Allowance for Credit Losses
On January 1, 2023, the Company adopted the provisions of ASC 326, Financial Instruments – Credit Losses. ASC 326 mandates the use of a current expected credit loss (“CECL”) methodology for estimating future credit losses of certain financial instruments measured at amortized cost, instead of the “incurred loss” methodology previously required under U.S. GAAP. The CECL methodology requires the consideration of possible credit losses over the life of an instrument as opposed to estimating credit losses upon the occurrence of an actual loss event under the previous “incurred loss” methodology. As permitted by ASC 326, the Company elected not to measure an allowance for credit losses on accrued interest receivable (which is presented separately on the consolidated balance sheet), but rather write off in a timely manner by reversing interest income that would likely be uncollectible. The Company’s adoption of the ASC 326 resulted in a $0.7 million increase to total reserve, including reserve on future funding commitments, which was recognized as a cumulative-effect adjustment to member’s capital as of January 1, 2023. Subsequent to the adoption of the CECL methodology, any increase or decrease to the allowance for credit losses is recorded in earnings on the consolidated statement of operations.
Performing Loans
The Company uses a model based approach for estimating the allowance for credit losses on performing loans on a collective basis, including future funding commitments for which the Company does not have the unconditional right to cancel, as these loans share similar risk characteristics. The Company utilizes information obtained from internal and external sources relating to past events, current economic conditions and reasonable and supportable forecasts about the future to determine the expected credit losses for its loan portfolio. The Company utilizes a commercial mortgage based, third-party loan loss model and because the Company does not have a meaningful history of realized credit losses on its loan portfolio, it subscribes to a database service to provide historical proxy loan loss information. The Company employs logistic regression to forecast expected losses at the loan level based on a commercial real estate loan securitization database that contains activity dating back to 1998. The Company has chosen to incorporate a weighted average macroeconomic forecast that encompasses baseline, optimistic and pessimistic scenarios, into its allowance for credit losses on performing loans estimate during the reasonable and supportable forecast period which is currently eight quarters. The Company selects certain economics variables from a group of independent variables such as Commercial Real Estate Price Index, unemployment and interest rate which are included in the model as part of macroeconomic forecast and updated regularly based on current economic trends. For the year ended December 31, 2023, adjustments to the weights ascribed to the multiple macroeconomic forecast scenarios were made in response to changes in expectations of macroeconomic conditions such as inflation and interest rates. The specific loan level information input into the model includes loan-to-value and debt service coverage ratio metrics, as well as principal balances, property type, location, coupon rate, coupon rate type, original or remaining term, expected repayment dates and contractual future funding commitments. Based on the inputs, the loan loss model determines a loan loss rate through the generation of a probability of default (PD) and loss given default (LGD) for each loan. The allowance for credit losses on performing loans is then calculated by applying the loan loss rate to the total outstanding loan balance of each loan. These results require a significant amount of judgment applied in selecting inputs and analyzing the results produced by the models to determine the allowance for credit losses. Changes in such estimates can significantly affect the expected credit losses.
Beyond the Company’s reasonable and supportable forecast period, the Company reverts to historical loss information on a straight-line basis over the remaining contractual loan term, taken from a period that most accurately reflects the expectation of conditions expected to exist during the period of reversion. The Company may adjust historical loss information for differences in risk that may not reflect the characteristics of its current portfolio, including but not limited to, loan-to-value and debt service coverage ratios, among other relevant factors. The method of reversion selected represents the best estimate of the collectability of the investments and is reevaluated each reporting period.
The determination of the performing loans credit loss estimate considers historical loss information and current economic conditions for each loan, reversion period and reasonable and supportable forecasts about the future. The reasonable and supportable forecast period is determined based on the Company’s assessment of the most likely scenario of assumptions and plausible outcomes for the U.S. economy. The Company regularly evaluates the reasonable and supportable forecast period to determine if a change is needed.
The Company also performs a qualitative assessment and applies qualitative adjustments as necessary, usually due to limitations of the loan loss model. The Company’s qualitative analysis includes a review of data that may directly impact its estimates including internal and external information about the loan or property including current market conditions, asset specific conditions, property operations or borrower/sponsor details (i.e., refinance, sale, bankruptcy) which allows the Company to determine the amount of the expected loss more accurately and reasonably for these investments. The Company also evaluates the contractual life of its loans to determine if changes are needed for certain contractual extension options, renewals, modifications, and prepayments.
F-14
Notes to Consolidated Financial Statements
Unfunded Commitments
Some of the Company’s performing loans include commitments to fund incremental proceeds to the borrowers over the life of the loan and these unfunded commitments are also subject to the CECL methodology because the Company does not have an unconditional right to cancel such commitments. The allowance for credit losses related to unfunded commitments is recorded as a component of other liabilities on the Company’s consolidated balance sheets. This allowance for credit losses is estimated using the same method outlined above for the Company’s outstanding performing loan balances and increases or decreases are also recorded in earnings on the consolidated statements of operations.
Non-Performing Loans
During the loan review process, if the Company determines that it is not able to collect all amounts due for both principal and interest according to the contractual terms of a loan, the Company considers that loan non-performing. For all non- performing loans, such as those in default, collateral-dependent or modified loans, including historical troubled debt restructurings, the Company removes these loans from the industry loss rate approach described above and analyzes them separately. The credit loss reserve for these loans is calculated as any excess of the amortized cost of the loan over (i) the present value of expected future cash flows discounted at the appropriate discount rate or (ii) the fair value of collateral, if repayment is expected solely from the collateral.
As discussed below in Recent Accounting Pronouncements, the Company adopted the provisions of Accounting Standards Update (“ASU”) 2022-02 Financial Instruments—Credit Losses (Topic 326) Troubled Debt Restructurings and Vintage Disclosures (“ASU 2022-02”) concurrently with the adoption of CECL on January 1, 2023, prospectively.
Allowance for Loan Losses Prior to 2023
Prior to the adoption of the CECL methodology on January 1, 2023, the Company recorded an allowance for loan losses using the incurred loss methodology equal to (i) 1.5 % of the aggregate carrying amount of loans rated as a “4”, plus (ii) 5 % of the aggregate carrying amount of loans rated as a “5”, plus (iii) non-performing loan reserves, if any.
The Company assesses the risk factors of each loan and assigns each loan a risk rating between 1 and 5, which is an average of the numerical ratings in the following categories: (i) sponsor capability and financial condition; (ii) loan and collateral performance relative to underwriting; (iii) quality and stability of collateral cash flows and/or reserve balances; and (iv) loan to value. Based on a 5-point scale, the Company’s loans are rated “1” through “5”, from less risk to greater risk, as follows:
| Risk Rating | Description | |||||||
| 1 | Very low risk | |||||||
| 2 | Low risk | |||||||
| 3 | Moderate/average risk | |||||||
| 4 | Higher risk | |||||||
| 5 | Highest risk | |||||||
Equity Investment in Unconsolidated Investments
The Company accounts for its equity interests in unconsolidated investments under the equity method of accounting, i.e., at cost, increased or decreased by its share of earnings or losses, less distributions, plus contributions and other adjustments required by equity method accounting.
The Company evaluates its equity investment unconsolidated investments on a periodic basis to determine if there are any indicators that the value of its equity investments may be impaired and whether or not that impairment is other-than-temporary. To the extent an impairment has occurred and is determined to be other-than-temporary, the Company measures the charge as the excess of the carrying value of its investment over its estimated fair value, which is determined by calculating its share of the estimated fair market value of the underlying net assets based on the terms of the applicable partnership or joint venture agreements.
Held-to-Maturity Debt Securities
F-15
Notes to Consolidated Financial Statements
Marketable Securities
From time to time, the Company may invest in short term debt. These securities are classified as available-for-sale securities and are carried at fair value. Changes in the fair value of debt securities are reported in other comprehensive income until a gain or loss on the securities is realized.
Revenue Recognition
Revenue is recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.
Interest Income: Interest income is accrued based upon the outstanding principal amount and contractual terms of the loans and preferred equity investments that the Company expects to collect, and it is accrued and recorded on a daily basis. Discounts and premiums on investments purchased are accreted or amortized over the expected life of the respective loan using the effective yield method, and are included in interest income in the consolidated statements of operations. Loan origination fees and exit fees, net of portions attributable to obligations under participation agreements, if any, are capitalized and amortized or accreted to interest income over the life of the investment using the effective yield method. Outstanding interest receivable is assessed for recoverability. The Company generally reverses the accrued and unpaid interest against interest income and no longer accrues for the interest when, in the opinion of the Manager, recovery of income and principal becomes doubtful. Interest is then recorded on the basis of cash received until accrual is resumed when the loan becomes contractually current and performance is demonstrated. Interest payments received on non-accrual loans may be recognized as income or applied to principal depending upon management’s judgment regarding collectability.
The Company may hold loans in its portfolio that contain paid-in-kind (“PIK”) interest provisions. The PIK interest, which represents contractually deferred interest that is added to the principal balance that is due at maturity, is recorded on the accrual basis.
Other Revenues: Prepayment fee income is recognized as prepayments occur. All other income is recognized when earned.
Deferred Debt Issuance Costs
The Company records issue discounts and other financing costs related to its debt obligation as deferred debt issuance costs, which are presented as a direct deduction from the carrying value of the related debt liability. These expenses are deferred and amortized using the effective interest method over the stated maturity of the debt obligation.
Stockholder Dividends and Distributions
Dividends and distributions to stockholders, which were determined in accordance with federal income tax regulations, were recorded on the declaration date. The amount to be paid out as a dividend or distribution was approved by the Terra BDC Board. Net realized capital gains, if any, were generally distributed or deemed distributed at least annually. Terra BDC adopted an “opt in” distribution reinvestment plan (“DRIP”) pursuant to which its stockholders could have elected to have the full amount of stockholders’ cash distributions reinvested in additional shares of Terra BDC’s common stock, par value $0.001 per share (“Terra BDC Common Stock”). Participants in the DRIP were free to elect to participate or terminate participation in the plan within a reasonable time as specified in the plan. Pursuant to the DRIP, shares were issued at a price equal to Terra BDC’s most recently disclosed net asset value (“NAV”) per share of Terra BDC Common Stock immediately prior to the applicable distribution payment date. In connection with the Merger, the DRIP was terminated and Terra REIT will make monthly distributions to stockholders. On January 20, 2023, the Terra REIT Board adopted a distribution reinvestment plan (the “Plan”), pursuant to which Terra REIT’s stockholders may elect to reinvest cash distributions payable by Terra REIT in additional shares of its Class A Common Stock, par value $0.01 per share, and Class B Common Stock, par value $0.01 per share (“Class B Common Stock”), at the price per share determined pursuant to the Plan.
Incentive Fee on Capital Gains
Pursuant to the terms of the Investment Advisory Agreement, the incentive fee on capital gains was determined and payable in arrears as of the end of each fiscal year (or upon termination of the Investment Advisory Agreement). This fee equaled 20.0 % of Terra BDC’s incentive fee on capital gains, which equaled the realized capital gains on a cumulative basis from inception, calculated as of the end of the applicable period, computed net of all realized capital losses and unrealized capital depreciation on a cumulative basis, less the aggregate amount of any previously paid capital gains incentive fees. On a quarterly basis, Terra BDC accrued (but did not pay) for the capital gains incentive fee by calculating such fee as if it were due and payable as of the end of such period. While the Investment Advisory Agreement neither included nor contemplated the inclusion of unrealized gains in the calculation of the capital gains incentive fee, pursuant to an interpretation of an American
F-16
Notes to Consolidated Financial Statements
Institute of Certified Public Accountants Technical Practice Aid for investment companies, Terra BDC accrued for this incentive fee to include unrealized gains in the calculation of the capital gains incentive fee expense and related accrued capital gains incentive fee. This accrual reflected the incentive fees that would be payable to Terra Income Advisors if Terra BDC’s entire portfolio was liquidated at its fair value as of the balance sheet date even though Terra Income Advisors was not entitled to an incentive fee with respect to unrealized gains unless and until such gains are actually realized.
Servicing Fee
Income Taxes
Terra BDC elected to be taxed as a REIT under the Code commencing with its short taxable year beginning October 1, 2018 and ending December 31, 2018. In order to qualify as a REIT, Terra BDC was required, among other things, to distribute dividends equal to at least 90% of its REIT net taxable income to the stockholders annually and meet certain tests regarding the nature of its income and assets. As a REIT, Terra BDC was not subject to U.S. federal income taxes on income and gains distributed to the stockholders as long as certain requirements were satisfied, principally relating to the nature of income and the level of distributions, as well as other factors. For the nine months ended September 30, 2022, Terra BDC satisfied all the requirements for a REIT. Subsequent to the Merger, Terra REIT, the sole and managing member of Terra LLC, will be responsible for paying tax, if any, on the Company’s taxable income.
Terra BDC held certain portfolio company investments through consolidated taxable REIT subsidiaries (“TRSs”). Such subsidiaries may be subject to U.S. federal and state corporate-level income taxes. These consolidated subsidiaries recognized deferred tax assets and liabilities for the estimated future tax effects attributable to temporary differences between the tax basis of certain assets and liabilities and the reported amounts included in the accompanying consolidated statements of assets and liabilities using the applicable statutory tax rates in effect for the year in which any such temporary differences are expected to reverse. In connection with the Merger on October 1, 2022, Terra BDC’s TRS became a qualified REIT subsidiary of Terra REIT.
Terra BDC did not have any uncertain tax positions that met the recognition or measurement criteria under accounting for income taxes, nor did Terra BDC have any unrecognized tax benefits as of the periods presented herein. Terra BDC recognized interest and penalties, if any, related to unrecognized tax liabilities as income tax expense in its statements of operations. For the nine months ended September 30, 2022, Terra BDC did not incur any interest or penalties. Terra BDC’s 2020-2023 federal tax years remain subject to examination by the Internal Revenue Service and the state department of revenue.
Use of Estimates
The preparation of the consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and reported amounts of income, expenses and gains and losses during the reporting period. Actual results may ultimately differ from those estimates, and those differences could be material.
Recent Accounting Pronouncements
In June 2016, the FASB issued ASU 2016-13, Financial Instruments — Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). ASU 2016-13 introduces a new model for recognizing credit losses on financial instruments based on an estimate of current expected credit losses. In April 2019, the FASB issued additional amendments to clarify the scope of ASU 2016-13 and address issues related to accrued interest receivable balances, recoveries, variable interest rates and prepayments, among other things. In May 2019, the FASB issued ASU 2019-05 — Targeted Transition Relief, which provides an option to irrevocably elect the fair value option for certain financial assets previously
F-17
Notes to Consolidated Financial Statements
measured at amortized cost basis. In October 2019, the FASB decided that for smaller reporting companies, ASU 2016-13 and related amendments will be effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. The Company meets the definition of a smaller reporting company under the regulation of the Securities and Exchange Commission. The Company adopted this ASU and related amendments on January 1, 2023. The adoption of ASU 2016-13 resulted in an incremental reserve of approximately $0.7 million, which included reserve on future loan funding commitments. The Company recorded the cumulative effect of initially applying this guidance as an adjustment to member’s equity using the modified retrospective method of adoption.
London Interbank Offered Rate (“LIBOR”) is a benchmark interest rate referenced in a variety of agreements that are used by all types of entities. In July 2017, the U.K. Financial Conduct Authority, which regulates the LIBOR administrator, ICE Benchmark Administration Limited (“IBA”), announced that it would cease to compel banks to participate in setting LIBOR as a benchmark by the end of 2021, which was subsequently delayed to June 30, 2023. In March 2020, the FASB issued ASU. 2020-04, Reference Rate Reform (Topic 848) — Facilitation of the Effects of Reference Rate Reform on Financial Reporting (“ASU 2020-04”). The amendments in ASU 2020-04 provide optional expedients and exceptions for applying U.S. GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The amendments apply only to contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. In January 2021, the FASB issued ASU No. 2021-01, Reference Rate Reform (Topic 848), which expanded the scope of Topic 848 to include derivative instruments impacted by discounting transition (“ASU 2021-01”). As of December 31, 2023, all of the Company’s floating rate loans and related financings have transitioned to the applicable replacement benchmark rate, or reference a benchmark rate that is not expected to be replaced.
Note 3. Loans Held for Investment
The Company elected the practical expedient under ASC 326 to exclude accrued interest from amortized cost. As of December 31, 2023 and 2022, accrued interest receivable of $1.2 million and $1.4 million, respectively, is included in interest receivable on the consolidated balance sheets, and is excluded from the amortized cost of loans held for investment.
Portfolio Summary
The following table provides a summary of the Company’s loan portfolio:
| December 31, 2023 | December 31, 2022 | ||||||||||||||||||||||||||||||||||
| Fixed Rate | Floating Rate (1)(3) | Total | Fixed Rate | Floating Rate (2)(3) | Total | ||||||||||||||||||||||||||||||
| Number of loans | |||||||||||||||||||||||||||||||||||
| Principal balance | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
| Carrying value | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
| Fair value | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
| Weighted-average coupon rate | |||||||||||||||||||||||||||||||||||
| Weighted-average remaining term (years) | |||||||||||||||||||||||||||||||||||
(1)As of December 31, 2023, these loans pay a coupon rate of Secured Overnight Financing Rate (“SOFR”) or forward-looking term rate based on SOFR (“Term SOFR”), as applicable, plus a fixed spread. Coupon rates shown were determined using average SOFR and Term SOFR of 5.3 % and 5.4 %, respectively.
(2)As of December 31, 2022, these loans paid a coupon rate of LIBOR or average SOFR, as applicable, plus a fixed spread. Coupon rates shown were determined using LIBOR of 4.4 % and average SOFR of 4.1 %.
(3)As of December 31, 2023 and 2022, two and three loans, respectively, were subject to a LIBOR, SOFR or Term SOFR floor, as applicable.
F-18
Notes to Consolidated Financial Statements
Lending Activities
The following tables present the activities of the Company’s loan portfolio for the year ended December 31, 2023 and the three months ended December 31, 2022:
| Loans Held for Investment | Loans Held for Investment through Participation Interests | Total | |||||||||||||||
| Balance, January 1, 2023 | $ | $ | $ | ||||||||||||||
Cumulative effect of adoption of credit loss accounting standard | ( | ( | |||||||||||||||
| New loans made | |||||||||||||||||
| Principal repayments received | ( | ( | ( | ||||||||||||||
| Net amortization of premiums on loans | ( | ( | ( | ||||||||||||||
| Accrual, payment and accretion of investment-related fees and other, net | |||||||||||||||||
| Reversal of (provision for) credit losses | ( | ( | |||||||||||||||
Balance, December 31, 2023 | $ | $ | $ | ||||||||||||||
| Loans Held for Investment | Loans Held for Investment through Participation Interests | Total | |||||||||||||||
| Balance, October 1, 2022 | $ | $ | $ | ||||||||||||||
| Purchase discounts | |||||||||||||||||
| New loans made | |||||||||||||||||
| Principal repayments received | ( | ( | |||||||||||||||
| Net amortization of discounts on loans | ( | ||||||||||||||||
| Accrual, payment and accretion of investment-related fees and other, net | ( | ||||||||||||||||
| Provision for loan losses | ( | ( | |||||||||||||||
| Balance, December 31, 2022 | $ | $ | $ | ||||||||||||||
Portfolio Information
| December 31, 2023 | December 31, 2022 | |||||||||||||||||||||||||||||||||||||
| Loan Structure | Principal Balance | Carrying Value | % of Total | Principal Balance | Carrying Value | % of Total | ||||||||||||||||||||||||||||||||
| Preferred equity investments | $ | $ | % | $ | $ | % | ||||||||||||||||||||||||||||||||
| First mortgages | % | % | ||||||||||||||||||||||||||||||||||||
| Mezzanine loans | % | % | ||||||||||||||||||||||||||||||||||||
| Credit facility | % | % | ||||||||||||||||||||||||||||||||||||
| Allowance for credit losses | — | ( | ( | % | — | ( | ( | % | ||||||||||||||||||||||||||||||
| Total | $ | $ | % | $ | $ | % | ||||||||||||||||||||||||||||||||
F-19
Notes to Consolidated Financial Statements
| December 31, 2023 | December 31, 2022 | |||||||||||||||||||||||||||||||||||||
| Property Type | Principal Balance | Carrying Value | % of Total | Principal Balance | Carrying Value | % of Total | ||||||||||||||||||||||||||||||||
| Office | $ | $ | % | $ | $ | % | ||||||||||||||||||||||||||||||||
| Infrastructure | % | % | ||||||||||||||||||||||||||||||||||||
| Multifamily | % | % | ||||||||||||||||||||||||||||||||||||
| Mixed use | % | % | ||||||||||||||||||||||||||||||||||||
| Student housing | % | % | ||||||||||||||||||||||||||||||||||||
| Industrial | % | % | ||||||||||||||||||||||||||||||||||||
| Allowance for credit losses | — | ( | ( | % | — | ( | ( | % | ||||||||||||||||||||||||||||||
| Total | $ | $ | % | $ | $ | % | ||||||||||||||||||||||||||||||||
| December 31, 2023 | December 31, 2022 | |||||||||||||||||||||||||||||||||||||
| Geographic Location | Principal Balance | Carrying Value | % of Total | Principal Balance | Carrying Value | % of Total | ||||||||||||||||||||||||||||||||
| United States | ||||||||||||||||||||||||||||||||||||||
| New York | $ | $ | % | $ | $ | % | ||||||||||||||||||||||||||||||||
| California | % | % | ||||||||||||||||||||||||||||||||||||
| Utah | % | % | ||||||||||||||||||||||||||||||||||||
| Georgia | % | % | ||||||||||||||||||||||||||||||||||||
| North Carolina | % | % | ||||||||||||||||||||||||||||||||||||
| Allowance for credit losses | — | ( | ( | % | — | ( | ( | % | ||||||||||||||||||||||||||||||
| Total | $ | $ | % | $ | $ | % | ||||||||||||||||||||||||||||||||
Allowance for Credit Losses
As described in Note 2, on January 1, 2023, the Company adopted the provisions of ASU 2016-13, which requires entities to recognize credit losses on financial instruments based on an estimate of current expected credit losses. The adoption of ASU 2016-13 resulted in a $0.7 million increase to total reserve, including reserve on future funding commitments, which was recognized as a cumulative-effect adjustment to member’s capital as of January 1, 2023.
The following table presents the activity in allowance for credit losses for funded loans:
Year Ended December 31, 2023 | Three Months Ended December 31, 2022 | |||||||||||||
| Successor Basis | Predecessor Basis | |||||||||||||
| Allowance for credit losses, beginning of period | $ | $ | ||||||||||||
Provision for credit losses (1) | ||||||||||||||
| Charge-offs | ||||||||||||||
| Recoveries | ||||||||||||||
| Allowance for credit losses, end of period | $ | $ | ||||||||||||
(1) Prior to the adoption of the CECL model on January 1, 2023, the Company recorded an allowance for credit losses equal to (i) 1.5 % of the aggregate carrying amount of loans rated as a “4”, plus (ii) 5 % of the aggregate carrying amount of loans rated as a “5”, plus (iii) non-performing loan reserves, if any.
Certain of the Company’s performing loans contain provisions for future funding, which are subject to the borrower meeting certain performance-related metrics that are monitored by the Company. These unfunded commitments on loans that met funding requirements amounted to approximately none and $5.9 million as of December 31, 2023 and 2022, respectively.
F-20
Notes to Consolidated Financial Statements
The following table presents the activity in the liability for credit losses on unfunded commitments:
| Year Ended December 31, 2023 | |||||||||||
| Liability for credit losses on unfunded commitments, beginning of period | $ | ||||||||||
| Reversal of provision for credit losses | ( | ||||||||||
| Liability for credit losses on unfunded commitments, end of period | $ | ||||||||||
The liability for credit losses on unfunded commitments is included in other liabilities on the consolidated balance sheets.
Accrued Interest Receivable
The Company elected not to measure a CECL reserve on accrued interest receivable due to the Company’s policy of writing off uncollectible accrued interest receivable balances in a timely matter. If the Company determines it has uncollectible accrued interest receivable, it generally will reverse the accrued and unpaid interest against interest income and suspend the accrual for future interest income. For the year ended December 31, 2023 and 2022, the Company did not reverse any interest income accrual because all accrued interest income was deemed collectible. As of both December 31, 2023 and 2022, the Company had two 4.2 million, $0.9 million and $1.4 million for the year ended December 31, 2023, three months ended December 31, 2022 and nine months ended September 30, 2022, respectively, because recovery of such income was doubtful. As of December 31, 2023 and 2022, there was no outstanding interest receivable on these loans.
Non-Performing Loans
As discussed in Note 2, for loans that are considered non-performing, the Company removes them from the industry loss rate approach and analyzes them separately for recoverability or based on sponsor’s guarantee. As of both December 31, 2023 and 2022, the Company had two 27.1 million and $26.2 million, respectively. Accordingly, the Company utilized the estimated fair value of the loan collateral or based on sponsor’s guarantee to estimate the total allowance for credit losses of $9.2 million and $3.9 million as of December 31, 2023 and 2022, respectively. Please see “Significant Unobservable Inputs” in Note 4 for information on how the fair value of these loans were determined.
Loan Risk Rating
The Company assesses the risk factors of each loan and assigns each loan a risk rating between 1 and 5, which is an average of the numerical ratings in the following categories: (i) sponsor capability and financial condition; (ii) loan and collateral performance relative to underwriting; (iii) quality and stability of collateral cash flows and/or reserve balances; and (iv) loan to value. Based on a 5-point scale, the Company’s loans are rated “1” through “5”, from less risk to greater risk as follows:
| Risk Rating | Description | |||||||
| 1 | Very low risk | |||||||
| 2 | Low risk | |||||||
| 3 | Moderate/average risk | |||||||
| 4 | Higher risk | |||||||
| 5 | Highest risk | |||||||
F-21
Notes to Consolidated Financial Statements
| December 31, 2023 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Loan Risk Rating | Number of Loans | Amortized Cost | % of Total | Amortized Cost by Year Originated | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2023 | 2022 | 2021 | 2020 | 2019 | Prior | |||||||||||||||||||||||||||||||||||||||||||||||||||
| 1 | $ | % | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||||||||||||||||||
| 2 | % | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 3 | % | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 4 | % | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 5 | % | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Non-performing | % | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
| % | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Allowance for credit losses | ( | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total, net of allowance for credit losses | $ | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
The following table presents the principal balance and the amortized cost of the Company’s loans based on the loan risk rating as of December 31, 2022:
| December 31, 2022 | |||||||||||||||||||||||||||||
| Loan Risk Rating | Number of Loans | Principal Balance | Amortized Cost | % of Total | |||||||||||||||||||||||||
| 1 | $ | $ | % | ||||||||||||||||||||||||||
| 2 | % | ||||||||||||||||||||||||||||
| 3 | % | ||||||||||||||||||||||||||||
| 4 | % | ||||||||||||||||||||||||||||
| 5 | % | ||||||||||||||||||||||||||||
Non-performing (1) | % | ||||||||||||||||||||||||||||
| $ | % | ||||||||||||||||||||||||||||
| Allowance for credit losses | ( | ||||||||||||||||||||||||||||
| Total, net of allowance for credit losses | $ | ||||||||||||||||||||||||||||
Equity Investment in Unconsolidated Investment
On December 28, 2022, the Company originated a $10.0 million mezzanine loan to a borrower to finance the acquisition of a real estate portfolio. Additionally, the Company entered into a residual profit-sharing agreement with the borrower in which the borrower would pay the Company an additional amount of 35.0 % of remaining net cash flow from the sale of the real estate portfolio. The Company accounted for the entire arrangement as equity investment in unconsolidated investment. In May 2023, the Company made a cash payment of $27.4 million and settled the $10.0 million mezzanine loan in exchange for an 80.0 % equity interest in a joint venture that owns the real estate portfolio. In November 2023, the Company contributed $5.1 million to another joint venture that owns a real estate property. The Company accounts for its equity interest in the joint ventures as equity method investments because the Company does not have a controlling financial interest in the entities. As of December 31, 2023 and 2022, equity investment in unconsolidated investment had a carrying value of $40.4 million and $10.0 million, respectively. For the year ended December 31, 2023 and the three months ended December 31, 2022, the Company recorded net equity (loss) income from equity investment in unconsolidated investments of $(1.0 ) million and $0.01 million, respectively, and received distribution from equity investment in unconsolidated investments of $1.0 million and none respectively.
F-22
Notes to Consolidated Financial Statements
The following tables present estimated combined summarized financial information of the Company’s equity investment in the joint ventures. Amounts provided are the total amounts attributable to the joint ventures and do not represent the Company’s proportionate share:
| As of December 31, | ||||||||||||||
| 2023 | 2022 | |||||||||||||
| Net investments in real estate | $ | $ | ||||||||||||
| Other assets | ||||||||||||||
| Total assets | ||||||||||||||
| Mortgage loan payable | ||||||||||||||
| Other liabilities | ||||||||||||||
| Total liabilities | ||||||||||||||
| Members’ capital | $ | $ | ||||||||||||
| Years Ended December 31, | |||||||||||
| 2023 | 2022 | ||||||||||
| Revenues | $ | $ | |||||||||
| Operating expenses | ( | ||||||||||
| Depreciation and amortization expense | ( | ||||||||||
| Interest expense | ( | ||||||||||
| Net loss | $ | ( | $ | ||||||||
Held-to-Maturity Debt Securities
In the first quarter of 2023, the Company purchased $10.0 million of corporate bonds with a coupon rate of 6.125 % that matured on May 15, 2023. The Company classified these bonds as held-to-maturity debt securities, as it had the intent and ability to hold these securities until maturity. These securities were recorded at amortized cost and were fully redeemed at par on May 15, 2023.
Note 4. Fair Value Measurements
The Company follows the provisions of ASC 820, Fair Value Measurement (“ASC 820”), which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. ASC 820 established a fair value hierarchy that prioritizes and ranks the level of market price observability used in measuring investments at fair value. Market price observability is impacted by a number of factors, including the type of investment, the characteristics specific to the investment, and the state of the marketplace (including the existence and transparency of transactions between market participants). Investments with readily available, actively quoted prices or for which fair value can be measured from actively quoted prices in an orderly market will generally have a higher degree of market price observability and a lesser degree of judgment used in measuring fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). Investments measured and reported at fair value are classified and disclosed into one of the following categories based on the inputs as follows:
Level 1 — Quoted prices (unadjusted) in active markets for identical assets and liabilities that the Company has the ability to access.
Level 2 — Pricing inputs are other than quoted prices in active markets, including, but not limited to, quoted prices for similar assets and liabilities in markets that are active, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the assets or liabilities (such as interest rates, yield curves, volatilities, prepayment speeds, loss severities, credit risks and default rates) or other market corroborated inputs.
Level 3 — Significant unobservable inputs are based on the best information available in the circumstances, to the extent observable inputs are not available, including the Company’s own assumptions used in determining the fair value of investments. Fair value for these investments is determined using valuation methodologies that consider a range of factors, including but not limited to the price at which the investment was acquired, the nature of the investment, local market
F-23
Notes to Consolidated Financial Statements
conditions, trading values on public exchanges for comparable securities, current and projected operating performance, and financing transactions subsequent to the acquisition of the investment. The inputs into the determination of fair value require significant management judgment.
In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an investment’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and the Company considers factors specific to the investment.
As of December 31, 2023 and 2022, the Company had not elected the fair value option for its financial instruments, including loans held for investment, loans held for investment acquired through participation, term loan payable and unsecured notes payable. Such financial instruments are carried at cost, less impairment or less net deferred costs, where applicable. Held-to-maturity debt securities are financial instruments that are reported at amortized cost.
Financial Instruments Carried at Fair Value on a Recurring Basis
From time to time, the Company may invest in short-term debt and equity securities which are classified as available-for-sale securities, and are presented at fair value on the consolidated balance sheet. Changes in the fair value of equity securities are recognized in earnings. Changes in the fair value of debt securities are reported in other comprehensive income until the securities are realized. Additionally, the Company may invest in short-term money market funds. These funds are included in cash and cash equivalents on the consolidated balance sheet due to their short-term nature and can be easily converted to cash.
As of December 31, 2022, the Company did not own financial instruments that were carried at fair value. The following table presents fair value measurements of financial instruments that were carried at fair value, by major class, as of December 31, 2023, according to the fair value hierarchy:
| December 31, 2023 | ||||||||||||||||||||||||||
| Fair Value Measurements | ||||||||||||||||||||||||||
| Level 1 | Level 2 | Level 3 | Total | |||||||||||||||||||||||
| Marketable securities - debt securities | $ | $ | $ | $ | ||||||||||||||||||||||
| Total | $ | $ | $ | $ | ||||||||||||||||||||||
Years Ended December 31, | ||||||||||||||
| 2023 | 2022 | |||||||||||||
| Beginning balance | $ | $ | ||||||||||||
| Purchases | ||||||||||||||
| Unrealized loss on marketable securities | ( | |||||||||||||
| Ending balance | $ | $ | ||||||||||||
F-24
Notes to Consolidated Financial Statements
Financial Instruments Not Carried at Fair Value
The following table presents the carrying value and estimated fair value of the Company’s financial instruments that are not carried at fair value on the consolidated balance sheets as of:
| December 31, 2023 | December 31, 2022 | |||||||||||||||||||||||||||||||||||||||||||
| (Successor Basis) | ||||||||||||||||||||||||||||||||||||||||||||
| Level | Principal Balance | Carrying Value | Fair Value | Principal Balance | Carrying Value | Fair Value | ||||||||||||||||||||||||||||||||||||||
| Investments: | ||||||||||||||||||||||||||||||||||||||||||||
| Loans held for investment | 3 | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||||||||||
| Loans held for investment acquired through participation | 3 | |||||||||||||||||||||||||||||||||||||||||||
| Allowance for credit losses | — | ( | — | — | ( | — | ||||||||||||||||||||||||||||||||||||||
| Total loans | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||||||||
| Liabilities: | ||||||||||||||||||||||||||||||||||||||||||||
Unsecured notes payable (1)(2) | 1 | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||||||||||
Term loan payable (3)(4) | 3 | |||||||||||||||||||||||||||||||||||||||||||
| $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||||||||||||
(1)Carrying value is net of unamortized purchase discount of $3.2 million and $4.3 million as of December 31, 2023 and 2022, respectively.
(2)Valuation falls under Level 1 of the fair value hierarchy, which is based on the trading price of $23.64 and $23.05 as of the close of business day on December 31, 2023 and 2022, respectively.
(3)Carrying value is net of unamortized discount of $0.1 million as of December 31, 2023.
(4)Valuation falls under Level 3 of the fair value hierarchy, which is based on a discounted cash flow model with a discount rate of 12.477 % and 5.625 %, as of December 31, 2023 and 2022, respectively
Valuation Methodology
The fair value of the Company’s investment in corporate bonds, preferred stock and common stock within the marketable securities portfolio, if any, is determined based on quoted prices in an active market and is classified as Level 1 of the fair value hierarchy. Additionally, the fair value of the Company’s unsecured notes payable is determined based on quoted price in an active market and is also classified as Level 1.
Market quotations are not readily available for the Company’s real estate-related loan investments, all of which are included in Level 3 of the fair value hierarchy, as these investments are valued utilizing a yield approach, i.e., a discounted cash flow methodology to arrive at an estimate of the fair value of each respective investment in the portfolio using an estimated market yield. In following this methodology, investments are evaluated individually, and management takes into account, in determining the risk-adjusted discount rate for each of the Company’s investments, relevant factors, including available current market data on applicable yields of comparable debt/preferred equity instruments; market credit spreads and yield curves; the investment’s yield; covenants of the investment, including prepayment provisions; the ability of the Company’s borrowers and investees to make payments, net operating income and debt service coverage ratio; construction progress reports and construction budget analysis; the nature, quality and realizable value of any collateral (and loan-to-value ratio); the forces that influence the local markets in which the asset (the collateral) is purchased and sold, such as capitalization rates, occupancy rates, rental rates and replacement costs; and the anticipated duration of each real estate-related loan investment.
These valuation techniques are applied in a consistent and verifiable manner to all investments that are categorized within Level 3 of the fair value hierarchy and Terra REIT Advisors provides the Terra REIT Board, (a majority of which is made up of independent directors) with the investment valuations that are based on this discounted cash flow methodology. Valuations are prepared quarterly, or more frequently as needed, with each asset in the portfolio subject to a valuation prepared by a third-party valuation service at a minimum of once during every 12-month period. Terra REIT Advisors reviews the preliminary valuation with the Terra REIT Board and, together with an independent valuation firm, if applicable, responds and supplements the preliminary valuation to reflect any comments provided by the Terra REIT Board. Terra REIT Advisors discusses valuations and determines the fair value of each investment in the portfolio in good faith based on various metrics and other factors, including the input and recommendation provided by the Terra REIT Boards and any third-party valuation firm, if applicable.
F-25
Notes to Consolidated Financial Statements
Significant Unobservable Inputs
The following tables summarize the significant unobservable inputs used by the Company to value the Level 3 investments as of December 31, 2023 and 2022. The following tables are not intended to be all-inclusive, but instead identify the significant unobservable inputs relevant to the determination of fair values.
| December 31, 2023 | ||||||||||||||||||||||||||||||||||||||
| Primary Valuation Technique | Unobservable Input | Range | Weighted | |||||||||||||||||||||||||||||||||||
| Asset Category | Fair Value | Minimum | Maximum | Average | ||||||||||||||||||||||||||||||||||
| Assets: | ||||||||||||||||||||||||||||||||||||||
| Loans | $ | Discounted cash flow | Discount rate | % | % | % | ||||||||||||||||||||||||||||||||
Loans through participation interest (1) | Discounted cash flow | Discount rate | N/A | N/A | N/A | |||||||||||||||||||||||||||||||||
| Total Level 3 Assets | $ | |||||||||||||||||||||||||||||||||||||
(1)These were non-performing loans (Note 3). The fair market value estimates were determined primarily using discounted cash flow models and Level 3 inputs, which include estimates of property-specific cash flows over a specific holding period, a discount rate of 6.75 % and a terminal capitalization rate of 5.75 %. These inputs are based on the location, type and nature of the property, current sales and lease comparable, anticipated real estate and capital market conditions, and managements knowledge, experience and judgment. Additionally, the Company may use sales comparables to corroborate the estimated value of a loan’s collateral or may use sponsor’s guarantee to estimate the value of a non-performing loan.
| December 31, 2022 | ||||||||||||||||||||||||||||||||||||||
| Primary Valuation Technique | Unobservable Input | Range | Weighted | |||||||||||||||||||||||||||||||||||
| Asset Category | Fair Value | Minimum | Maximum | Average | ||||||||||||||||||||||||||||||||||
| Assets: | ||||||||||||||||||||||||||||||||||||||
| Loans | $ | Discounted cash flow | Discount rate | % | % | % | ||||||||||||||||||||||||||||||||
| Loans through participation interest | Discounted cash flow | Discount rate | % | % | % | |||||||||||||||||||||||||||||||||
| Total Level 3 Assets | $ | |||||||||||||||||||||||||||||||||||||
If the weighted average discount rate used to value the Company’s investments were to increase, the fair value of the Company’s investments would decrease. Conversely, if the weighted average discount rate used to value the Company’s investments were to decrease, the fair value of Company’s investments would increase.
Changes in the Company’s Level 3 investments for the nine months ended September 30, 2022 were as follows:
| Nine Months Ended September 30, 2022 (Predecessor Basis) | ||||||||||||||||||||||||||
Loans | Loans Through Participation | Total Loan Investments | Obligations under Participation Agreements | |||||||||||||||||||||||
| Balance as of January 1, 2022 | $ | $ | $ | $ | ||||||||||||||||||||||
| Purchases of investments | — | |||||||||||||||||||||||||
| Repayments of investments | ( | ( | ( | — | ||||||||||||||||||||||
| Net change in unrealized depreciation on investments | ( | ( | ( | — | ||||||||||||||||||||||
| Amortization and accretion of investment-related fees, net | ||||||||||||||||||||||||||
| Proceeds from obligations under participation agreements | — | — | — | |||||||||||||||||||||||
| Net change in unrealized depreciation on obligations under participation agreements | — | — | — | ( | ||||||||||||||||||||||
| Balance as of September 30, 2022 | $ | $ | $ | $ | ||||||||||||||||||||||
| Net change in unrealized appreciation or depreciation for the period relating to those Level 3 assets that were still held by the Company at the end of the period: | ||||||||||||||||||||||||||
| Net change in unrealized depreciation on loan investments and obligations under participation agreements | $ | ( | $ | ( | $ | ( | $ | ( | ||||||||||||||||||
F-26
Notes to Consolidated Financial Statements
Note 5. Related Party Transactions
Terra BDC entered into various agreements with Terra Income Advisors whereby Terra BDC paid and reimbursed Terra Income Advisors for certain fees and expenses. Additionally, Terra BDC paid Terra Capital Markets, LLC certain fees for providing certain administrative support services. In connection with the Merger, the Investment Advisory Agreement was terminated and the Company no longer pays or reimburses the following fees. Management fees are now payable by Terra REIT pursuant to its management agreement with its manager. Terra LLC and Terra REIT have entered into the Cost Sharing Agreement pursuant to which Terra LLC is responsible for its allocated share of Terra REIT’s expenses, including fees paid by Terra REIT to its manager.
Year Ended December 31 2023 (1) | Three Months Ended December 31, 2022 (1) | Nine Months Ended September 30, 2022 | ||||||||||||||||||
| (Successor Basis) | (Predecessor Basis) | |||||||||||||||||||
| Amounts Included in the Statements of Operations | ||||||||||||||||||||
| Asset management and asset servicing fees | $ | N/A | ||||||||||||||||||
| Base management fees | N/A | N/A | $ | |||||||||||||||||
Reversal of incentive fees on capital gains (2) | N/A | N/A | ( | |||||||||||||||||
Operating expense reimbursement to Adviser (3) | ||||||||||||||||||||
| Origination, extension and disposition fees | N/A | N/A | ||||||||||||||||||
(1)These fees were incurred pursuant to the Cost Sharing Agreement between Terra LLC and Terra REIT.
(2)For the nine months ended September 30, 2022, the Company reversed previously accrued incentive fees on capital gains of $102,160 , respectively. Incentive fees on capital gains were based on 20.0 % of net realized and unrealized capital gains. No incentive fees on capital gains were actually payable by the Company with respect to unrealized gains unless and until those gains were realized.
(3)Amounts were primarily compensation for time spent supporting the Company’s day-to-day operations.
Merger
On October 1, 2022, pursuant to the terms of the Merger Agreement, Terra BDC merged with and into Terra LLC, with Terra LLC continuing as the surviving entity of the Merger. Immediately following the Merger, Terra LLC remained a wholly owned subsidiary of Terra REIT. The Certificate of Merger and Articles of Merger with respect to the Merger were filed with the Secretary of State of the State of Delaware and State Department of Assessments and Taxation of Maryland, respectively, with an effective time and date of 12:02 a.m., Eastern Time, on October 1, 2022 (the “Effective Time”). Effective immediately following the Merger, Terra LLC changed its name to “Terra Income Fund 6, LLC.”
At the Effective Time, except for any shares of Terra BDC Common Stock held by Terra REIT or any wholly owned subsidiary of Terra REIT or Terra BDC, which shares were automatically retired and ceased to exist with no consideration paid therefor, each issued and outstanding share of Terra BDC Common Stock was automatically cancelled and retired and converted into the right to receive (i) 0.595 shares of the newly designated Class B Common Stock of Terra REIT and (ii) cash, without interest, in lieu of any fractional shares of Class B Common Stock otherwise issuable in an amount, rounded to the nearest whole cent, determined by multiplying (x) the fraction of a share of Class B Common Stock to which such holder would otherwise be entitled by (y) $14.38 .
Pursuant to the terms of the transactions described in the Merger Agreement, 4,847,910 shares of Class B Common Stock were issued to former Terra BDC stockholders in connection with the Merger. Following the consummation of the Merger, former Terra BDC stockholders own approximately 19.9 % of the common equity of Terra REIT as the combined company. In connection with the Merger, the Company incurred transaction costs totaling $1.5 million for the year ended December 31, 2022.
In connection with the Merger, Terra LLC assumed the obligations of Terra BDC under the indenture and supplemental indentures between Terra BDC and the Trustee as well as the Credit Agreement with Eagle Point (Note 6). Additionally, the
F-27
Notes to Consolidated Financial Statements
Investment Advisory Agreement and the servicing plan between Terra BDC and Terra Capital Partners, LLC (the "Servicing Plan") were terminated and fees pursuant to such agreements are no longer payable. Management fees are now payable by the Company’s parent, Terra REIT, to its manager pursuant to the management agreement with its manager.
Management and Incentive Fee Compensation to Adviser
Pursuant to the Investment Advisory Agreement, Terra Income Advisors was responsible for Terra BDC’s day-to-day operations. Pursuant to the Investment Advisory Agreement, Terra Income Advisors was paid for its services in two components — a base management fee and an incentive fee. The base management fee was calculated at an annual rate of 2.0 % of Terra BDC’s average gross assets. The base management fee was payable quarterly in arrears and calculated based on the average value of Terra BDC’s gross assets at the end of the two most recently completed calendar quarters.
The incentive fee consisted of two parts. The first part, which was referred to as the subordinated incentive fee on income, was calculated and payable quarterly in arrears based upon Terra BDC’s “pre-incentive fee net investment income” for the immediately preceding quarter. The subordinated incentive fee on income was subject to a quarterly hurdle rate, expressed as a rate of return on adjusted capital at the beginning of the most recently completed calendar quarter, of 2.0 % (8.0 % annualized), subject to a “catch-up” feature. For this purpose, “pre-incentive fee net investment income” meant interest income, dividend income and any other income (including any other fees, other than fees for providing managerial assistance, such as commitment, origination, structuring, diligence and consulting fees or other fees that Terra BDC received from portfolio companies) accrued during the calendar quarter, minus Terra BDC’s operating expenses for the quarter (including the base management fee, expenses reimbursed to Terra Income Advisors under the Investment Advisory Agreement and any interest expense and dividends paid on any issued and outstanding preferred stock, but excluding the incentive fee). Pre-incentive fee net investment income includes, in the case of investments with a deferred interest feature (such as original issue discount, debt instruments with PIK interest and zero-coupon securities), accrued income that the Company has not yet received in cash. Pre-incentive fee net investment income did not include any realized capital gains, realized capital losses or unrealized capital appreciation or depreciation. The calculation of the subordinated incentive fee on income for each quarter was as follows:
•No incentive fee was payable to Terra Income Advisors in any calendar quarter in which Terra BDC’s pre-incentive fee net investment income does not exceed the hurdle rate of 2.0 % (8.0 % annualized);
•100 % of Terra BDC’s pre-incentive fee net investment income, if any, that exceeded the hurdle rate but was less than or equal to 2.5 % in any calendar quarter (10.0 % annualized) was payable to Terra Income Advisors, all or any portion of which may be waived or deferred in Terra Income Advisors’ discretion. This portion of the pre-incentive fee net investment income (which exceeds the hurdle rate but is less than or equal to 2.5 %) was referred to as the “catch-up.” The catch-up provision was intended to provide Terra Income Advisors with an incentive fee of 20.0 % on all of Terra BDC’s pre-incentive fee net investment income when Terra BDC’s pre-incentive fee net investment income reaches 2.5 % in any calendar quarter; and
•20.0 % of the amount of Terra BDC’s pre-incentive fee net investment income, if any, that exceeded 2.5 % in any calendar quarter (10.0 % annualized) was payable to Terra Income Advisors once the hurdle rate was reached and the catch-up was achieved.
The second part of the incentive fee, which was referred to as the incentive fee on capital gains, was an incentive fee on capital gains earned on liquidated investments from the portfolio and was determined and payable in arrears as of the end of each calendar year (or upon termination of the Investment Advisory Agreement). This fee equaled 20.0 % of Terra BDC’s incentive fee on capital gains, which equaled the realized capital gains on a cumulative basis from inception, calculated as of the end of the applicable period, computed net of all realized capital losses and unrealized capital depreciation on a cumulative basis, less the aggregate amount of any previously paid capital gains incentive fees. On a quarterly basis, Terra BDC accrued (but did not pay) for the unrealized capital gains incentive fee by calculating such fee as if it were due and payable as of the end of such period.
In connection with the Merger, the Investment Advisory Agreement was terminated and the Company no longer pays base management and incentive fees to the Adviser. Management fees are now payable by Terra REIT pursuant to its management agreement with the REIT Manager. Terra REIT charges the Company for its allocable share of the management fees through the Cost Sharing Agreement.
Operating Expenses
Terra BDC reimbursed Terra Income Advisors for operating expenses incurred in connection with administrative services provided to Terra BDC, including compensation to administrative personnel. Terra BDC did not reimburse Terra Income
F-28
Notes to Consolidated Financial Statements
Advisors for personnel costs in connection with services for which Terra Income Advisors receives a separate fee. In addition, Terra BDC did not reimburse Terra Income Advisors for (i) rent or depreciation, capital equipment or other costs of Terra Income Advisors’ own administrative items, or (ii) salaries, fringe benefits, travel expenses and other administrative items incurred or allocated to any controlling person of Terra Income Advisors. In connection with the Merger, the Company no longer reimburses Terra Income Advisors for operating expenses incurred in connection with administrative services provided to the Company. Such expenses are now reimbursable by Terra REIT to the REIT Manager pursuant to its management agreement with the REIT manager. Terra REIT charges the Company for its allocable share of the operating expense reimbursement through the Cost Sharing Agreement.
Servicing Plan
Terra BDC Board adopted the Servicing Plan pursuant to which Terra BDC paid selected dealers a servicing fee to up 0.75 % of the most recently published NAV per share in exchange for providing certain administrative support services. With respect to each share sold, excluding shares sold through the DRIP, the servicing fee was payable annually on the anniversary of the applicable month of purchase. In connection with the Merger, the Servicing Plan was terminated.
Cost Sharing Agreement
On November 8, 2022, the Company entered into the Cost Sharing Agreement with Terra REIT effective October 1, 2022, pursuant to which the Company reimburses Terra REIT for its allocable portion of management and transaction fees and operating expenses incurred by Terra REIT, including fees paid by Terra REIT to the REIT Manager.
Terra REIT’s Management Agreement with Terra REIT Advisors
Terra REIT is the Company’s parent and sole member. The Company has entered into a cost sharing arrangement with Terra REIT pursuant to which the Company is responsible for its allocable share of Terra REIT’s expenses, including fees paid by Terra REIT to its manager, Terra REIT Advisors. Terra REIT currently pays the following fees to Terra REIT Advisors pursuant to the Management Agreement:
Origination and Extension Fee. An origination fee in the amount of 1.0 % of the amount used to originate, acquire, fund or structure real estate-related investments, including any third-party expenses related to such loan. In the event that the term of any real estate-related loan is extended, Terra REIT Advisors also receives an origination fee equal to the lesser of (i) 1.0 % of the principal amount of the loan being extended or (ii) the amount of fee paid by the borrower in connection with such extension.
Asset Management Fee. A monthly asset management fee at an annual rate equal to 1.0 % of the aggregate funds under management, which includes the loan origination amount or aggregate gross acquisition cost, as applicable, for each real estate-related loan and cash held by Terra REIT.
Asset Servicing Fee. A monthly asset servicing fee at an annual rate equal to 0.25 % of the aggregate gross origination price or aggregate gross acquisition price for each real estate related loan then held by Terra REIT (inclusive of closing costs and expenses).
Disposition Fee. A disposition fee in the amount of 1.0 % of the gross sale price received by Terra REIT from the disposition of each loan, but not upon the maturity, prepayment, workout, modification or extension of a loan unless there is a corresponding fee paid by the borrower, in which case the disposition fee will be the lesser of (i) 1.0 % of the principal amount of the loan and ii) the amount of the fee paid by the borrower in connection with such transaction. If Terra REIT takes ownership of a property as a result of a workout or foreclosure of a loan, Terra REIT will pay a disposition fee upon the sale of such property equal to 1.0 % of the sales price.
Transaction Breakup Fee. In the event that Terra REIT receive any “breakup fees,” “busted-deal fees,” termination fees, or similar fees or liquidated damages from a third-party in connection with the termination or non-consummation of any loan or disposition transaction, Terra REIT Advisors will be entitled to receive one-half of such amounts, in addition to the reimbursement of all out-of-pocket fees and expenses incurred by Terra REIT Advisors with respect to its evaluation and pursuit of such transactions.
In addition to the fees described above, Terra REIT reimburses Terra REIT Advisors for operating expenses incurred in connection with services provided to the operations of Terra REIT, including its allocable share of Terra REIT Advisors’ overhead, such as rent, employee costs, utilities, and technology costs.
F-29
Notes to Consolidated Financial Statements
Participation Agreements
The Company may enter into participation agreements with related and unrelated parties, primarily other affiliated funds of Terra REIT Advisors. The participation agreements provide the Company with the opportunity to invest along the same terms, conditions, price and rights in the specified investment. The purpose of the participation agreements is to allow the Company and an affiliate to originate a specified investment when, individually, the Company does not have the liquidity to do so or to achieve a certain level of portfolio diversification. The Company may transfer portions of its investments to other participants or it may be a participant to an investment held by another entity.
ASC Topic 860, Transfers and Servicing (“ASC 860”), establishes accounting and reporting standards for transfers of financial assets. ASC 860-10 provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. The Company has determined that the participation agreements it enters into are accounted for as secured borrowings under ASC Topic 860.
Participation interest purchased by the Company: The below tables list the investment interests purchased by the Company via participation agreements (each, a “PA”) as of December 31, 2023 and 2022. In accordance with the terms of each PA, each participant’s rights and obligations, including interest income and other income (e.g., exit fee and prepayment income) and related fees/expenses are based upon its respective pro-rata participation interest in such investments, as specified in the respective PA. The Company’s share of the investment is repayable only from the proceeds received from the related borrower/issuer of the investment, and therefore the Company is also subject to the credit risk (i.e., risk of default by the underlying borrower/issuer).
Pursuant to each PA, the affiliated fund receives and allocates the interest income and other related investment incomes in respect of the investment to the Company. The Company paid related expenses (i.e., the base management fee) directly to Terra Income Advisors prior to the Merger and to Terra REIT after the Merger.
| December 31, 2023 | December 31, 2022 | |||||||||||||||||||||||||||||||||||||
| (Successor Basis) | ||||||||||||||||||||||||||||||||||||||
| Participating Interests | Principal Balance | Carrying Value | Participating Interests | Principal Balance | Carrying Value | |||||||||||||||||||||||||||||||||
370 Lex Part Deux, LLC (1) | % | $ | $ | % | $ | $ | ||||||||||||||||||||||||||||||||
RS JZ Driggs, LLC (1) | % | % | ||||||||||||||||||||||||||||||||||||
William A. Shopoff & Cindy I. Shopoff (2) | % | % | ||||||||||||||||||||||||||||||||||||
Havemeyer TSM LLC (2)(3) | % | % | ||||||||||||||||||||||||||||||||||||
| Allowance for credit losses | — | ( | — | ( | ||||||||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||||
(1)The loan is held in the name of Terra REIT, the Company’s parent entity.
(2)This loan was repaid in the first quarter of 2023.
(3)The loan was held in the name of Mavik Real Estate Special Opportunities Fund REIT, LLC.
Co-investment
As a BDC, Terra BDC was subject to certain regulatory restrictions in making its investments. For example, Terra BDC may have been prohibited under the 1940 Act from knowingly participating in certain transactions with its affiliates without the prior approval of its Board who are not interested persons and, in some cases, prior approval by the SEC. The SEC granted Terra BDC exemptive relief permitting it, subject to satisfaction of certain conditions, to co-invest in certain privately negotiated investment transactions with certain affiliates of Terra Income Advisors, including Terra Secured Income Fund, LLC, Terra Secured Income Fund 2, LLC, Terra Secured Income Fund 3, LLC, Terra Secured Income Fund 4, LLC, Terra Secured Income Fund 5, LLC, Terra Secured Income Fund 5 International, Terra Income Fund International and Terra Secured Income Fund 7, LLC, Terra REIT and any future BDC or closed-end management investment company that is registered under the 1940 Act and is advised by Terra Income Advisors or its affiliated investment advisers (the “Co-Investment Affiliates”). However, Terra BDC was prohibited from engaging in certain transactions with its affiliates even under the terms of this exemptive order. Terra LLC is not subject to any such regulatory restrictions in making its investments.
F-30
Notes to Consolidated Financial Statements
Note 6. Debt
Senior Unsecured Notes
On February 10, 2021, Terra BDC issued $34.8 million in aggregate principal amount of 7.00 % fixed-rate notes due 2026, pursuant to an indenture between Terra BDC and U.S. Bank National Association, for net proceeds of $33.7 million after deducting underwriting commissions of $1.1 million. On February 26, 2021, the underwriters exercised the option to purchase an additional $3.6 million of the notes for net proceeds of $3.5 million, after deducting underwriting commissions of $0.1 million. Interest on the notes is paid quarterly in arrears every March 30, June 30, September 30 and December 30, at a rate of 7.00 % per year, beginning June 30, 2021. The notes mature on March 31, 2026. The notes may be redeemed in whole or in part at any time or from time to time at Terra BDC’s option on or after February 10, 2023. In connection with the issuance of the notes, Terra BDC incurred deferred financing costs totaling $1.0 million, to be amortized to interest expense over the term of the notes.
On October 1, 2022 in connection with the Merger, Terra BDC, Terra LLC and U.S. Bank National Association entered into a second supplemental indenture pursuant to which Terra LLC assumed the payment of the notes and the performance of every covenant of the indenture, to be performed or observed by Terra BDC.
The indenture between Terra LLC (as successor to Terra BDC) and the trustee contains certain debt limitations and asset coverage covenants. As of December 31, 2023 and 2022, the Company was in compliance with the asset coverage ratio requirements under the indenture.
For the year ended December 31, 2023, the three months ended December 31, 2022 and the nine months ended September 30, 2022, the components of interest expense were as follows:
| Year Ended December 31, 2023 | Three Months Ended December 31, 2022 | Nine Months Ended September 30, 2022 | |||||||||||||||
| (Successor Basis) | (Predecessor Basis) | ||||||||||||||||
| Stated interest expense | $ | $ | $ | ||||||||||||||
| Amortization of issue discount | |||||||||||||||||
| Amortization of financing costs | |||||||||||||||||
Amortization of purchase discount (1) | |||||||||||||||||
| Total interest expense | $ | $ | $ | ||||||||||||||
| Weighted average debt outstanding | $ | $ | $ | ||||||||||||||
| Cash paid for interest expense | $ | $ | $ | ||||||||||||||
| Stated interest rate | % | % | % | ||||||||||||||
Effective interest rate (2) | % | % | % | ||||||||||||||
(2)The effective interest rate of the debt component is equal to the stated interest rate plus the amortization of issue discount, if any.
Term Loan
On April 9, 2021, Terra BDC, as borrower, entered into a credit agreement (the “Credit Agreement”) with Eagle Point Credit Management LLC, as the administrative agent and collateral agent (“Eagle Point”), and certain funds and accounts managed by Eagle Point, as lenders (in such capacity, collectively, the “Lenders”). The Credit Agreement provides for (i) a delayed draw term loan to Terra BDC of $25.0 million (the “Term Loan”) and (ii) additional incremental loans in a minimum amount of $1.0 million and multiples of $0.5 million in excess thereof, which may be approved by a Lender in its sole discretion (“Incremental Loans,” and together with the Term Loan, the “Loans”).
The scheduled maturity date of the Loans was April 9, 2025. The Loans bore interest on the outstanding principal amount thereof at a rate equal to 5.625 % per annum; provided that if at any time Terra BDC was rated below investment grade, the interest rate would increase to 6.625 % until the rating is no longer below investment grade. In connection with the entry into the Credit Agreement, Terra BDC also agreed to pay Eagle Point an upfront fee in an amount equal to 2.50 % of the loan commitment amount on the initial borrowing date as described in the Credit Agreement. Terra BDC also paid, with respect to any unused portion of the Term Loan, a commitment fee of 0.75 % per annum.
F-31
Notes to Consolidated Financial Statements
In connection with entering into the Credit Agreement, Terra BDC incurred deferred financing costs totaling $0.3 million, to be amortized to interest expense over the term of the Term Loan. On August 31, 2021, Terra BDC made an initial draw on the Term Loan of $5.0 million and incurred an upfront fee of $0.6 million, which was deducted from proceeds from borrowings under the Term Loan. The discount is amortized to interest expense over the term of the Term Loan. During 2022, Terra BDC drew down an additional $20.0 million on the Term loan.
Terra BDC could prepay any Loan, in whole or in part, together with all accrued but unpaid interest thereon, upon at least 30 but not more than 60 days’ prior notice to the Agent. If Terra BDC elected to make such prepayments prior to October 9, 2023, Terra BDC would also be required to pay a make whole premium, being the present value at such date of (1) the principal amount being prepaid of such Loan, plus (2) all remaining required interest payments due on the principal amount being prepaid of such Loan through the maturity date (excluding accrued but unpaid interest to the date on which the make whole premium becomes owed), computed using a discount rate equal to the applicable U.S. Treasury rate (as set forth in the Credit Agreement) plus 50 basis points, over (B) the principal amount being prepaid of such Loan; provided that the make whole premium may in no event be less than zero.
In connection with its entry into the Credit Agreement, Terra BDC also entered into a security agreement (the “Security Agreement”), by and among Terra BDC, as grantor, and Eagle Point, as administrative agent, for the benefit of the Lenders, their affiliates and Eagle Point as the secured parties thereunder. Pursuant to the Security Agreement, Terra BDC pledged substantially all of its now owned and hereafter acquired property as security for the obligations of Terra BDC under the Credit Agreement, subject to certain limitations and restrictions set forth in the Security Agreements.
The Credit Agreement contains customary representations, warranties, reporting requirements, borrowing conditions and affirmative, negative and financial covenants, including REIT status requirements and minimum asset coverage ratio requirements. As of December 31, 2023 and 2022, the Company was in compliance with these covenants. The Credit Agreement also includes usual and customary events of default and remedies for credit agreements of this nature. Events of default under the Credit Agreement include, but are not limited to: (i) the failure by Terra BDC to make any payments when due under the Credit Agreement; (ii) the failure of Terra BDC to perform or observe any term, covenant or agreement under the Credit Agreement or any other loan document, subject to applicable cure periods; (iii) an event of default on other material indebtedness of Terra BDC; (iv) the bankruptcy or insolvency of Terra BDC; and (v) judgments and attachments, with customary limits and grace periods, against Terra BDC or its property. In addition, the Loans are subject to mandatory prepayment, at the option of each Lender, upon a change in control of Terra BDC (as defined by the Credit Agreement).
On September 27, 2022, Terra BDC, Terra LLC and Eagle Point and the Lenders entered into a Consent Letter and Amendment (the “Credit Facility Amendment”) effective October 1, 2022. Pursuant to the Credit Facility Amendment, (i) Eagle Point and the Lenders consented to the consummation of the Merger and the assumption by Terra LLC of all of the obligations of Terra BDC under the Credit Agreement, (ii) and the Credit Agreement was amended to, among other things, change the scheduled maturity date to July 1, 2023, and remove the make whole premium on voluntary prepayments of the loans.
On June 30, 2023, the Company, Eagle Point and the Lenders entered into an amendment to the Credit Agreement, pursuant to which the Credit Agreement was amended to, among other things, (i) extend the scheduled maturity date to March 31, 2024, and (ii) increase the rate on which the Term Loan bears interest from a fixed rate of 5.625 % per annum to a floating rate based on SOFR plus 7.375 % with a SOFR floor of 5.0 %. In connection with the amendment, the Company paid Eagle Point an amendment fee of $150,000 , to be amortized to interest expense over the remaining term of the Term Loan. Additionally, the Company made a repayment of $10.0 million on the Term Loan. As of December 31, 2023 and 2022, the principal amount outstanding under the Term Loan was $15.0 million and $25.0 million, respectively.
F-32
Notes to Consolidated Financial Statements
For the year ended December 31, 2023, three months ended December 31, 2022 and nine months ended September 30, 2022, the components of interest expense were as follows:
| Year Ended December 31, 2023 | Three Months Ended December 31, 2022 | Nine Months Ended September 30, 2022 | |||||||||||||||
| (Successor Basis) | (Predecessor Basis) | ||||||||||||||||
| Stated interest expense | $ | $ | $ | ||||||||||||||
| Amortization of issue discount | |||||||||||||||||
| Amortization of financing costs | |||||||||||||||||
| Unused fee | |||||||||||||||||
| Total interest expense | $ | $ | $ | ||||||||||||||
| Weighted average debt outstanding | $ | $ | $ | ||||||||||||||
| Cash paid for interest expense | $ | $ | $ | ||||||||||||||
| Stated interest rate | % | % | % | ||||||||||||||
Effective interest rate (1) | % | % | % | ||||||||||||||
_______________
(1)The effective interest rate of the debt component is equal to the stated interest rate plus the amortization of issue discount and fees paid to the lender, if any.
Scheduled Debt Principal Payments
| Years Ending December 31, | Total | |||||||
| 2024 | $ | |||||||
| 2025 | ||||||||
| 2026 | ||||||||
| 2027 | ||||||||
| 2028 | ||||||||
| Thereafter | ||||||||
| Unamortized discount, net | ( | |||||||
| Total | $ | |||||||
Note 7. Commitments and Contingencies
Funding Commitments
In the ordinary course of business, the Company may enter into future funding commitments, which are subject to the borrower meeting certain performance-related metrics that are monitored by the Company. As of December 31, 2023 and 2022, the Company had none and $5.9 million of unfunded commitments on loans that met funding requirements, respectively. The Company maintained sufficient cash on hand to fund such unfunded commitments, including matching these commitments with principal repayments on outstanding loans.
Other
The Company enters into contracts that contain a variety of indemnification provisions. The Company’s maximum exposure under these arrangements is unknown; however, the Company has not had prior claims or losses pursuant to these contracts. Management of Terra Income Advisors has reviewed the Company’s existing contracts and expects the risk of loss to the Company to be remote.
The Company is not currently subject to any material legal proceedings and, to the Company’s knowledge, no material legal proceedings are threatened against the Company. From time to time, the Company may be a party to certain legal proceedings in the ordinary course of business, including proceedings relating to the enforcement of the Company’s rights
F-33
Notes to Consolidated Financial Statements
under its contracts with its borrowers and investees. While the outcome of any legal proceedings cannot be predicted with certainty, the Company does not expect that any such proceedings will have a material adverse effect upon its financial condition or results of operations.
Note 8. Income Taxes
Terra BDC elected to be taxed as a REIT under the Code commencing with its short taxable year beginning October 1, 2018 through the Merger on October 1, 2022. In order to qualify as a REIT, Terra BDC was required, among other things, to distribute dividends equal to at least 90% of its REIT net taxable income to the stockholders annually and meet certain tests regarding the nature of its income and assets. Because federal income tax regulations differ from U.S. GAAP, distributions in accordance with tax regulations may differ from net investment for financial reporting purposes. Differences may be permanent or temporary in nature. Permanent differences are reclassified among capital accounts in the consolidated financial statements to reflect their tax character. Differences in classification may also result from the treatment of short-term gains as ordinary income for tax purposes.
Taxable income generally differs from net increase in net assets resulting from operations for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses and generally excludes unrealized appreciation (depreciation) on investments as investment gains and losses are not included in taxable income until they are realized.
The following table reconciles net increase in net assets resulting from operations to taxable income:
| Nine Months Ended September 30, 2022 | ||||||||
| (Predecessor Basis) | ||||||||
| Net decrease in net assets resulting from operations | $ | ( | ||||||
| Net change in unrealized depreciation on investments | ||||||||
| Net change in unrealized depreciation on obligations under participation agreements | ( | |||||||
| Income tax expense | ||||||||
| Reversal of incentive fees on capital gains | ( | |||||||
Other temporary differences (1) | ( | |||||||
| Total taxable income | $ | |||||||
Taxable REIT Subsidiary
Terra BDC held certain portfolio company investments through consolidated taxable REIT subsidiaries, of which it was the parent. Such subsidiaries may be subject to U.S. federal and state corporate-level income taxes. These consolidated subsidiaries recognize deferred tax assets and liabilities for the estimated future tax effects attributable to temporary differences between the tax basis of certain assets and liabilities and the reported amounts included in the accompanying consolidated statements of assets and liabilities using the applicable statutory tax rates in effect for the year in which any such temporary differences are expected to reverse. Terra BDC had one TRS prior to the Merger. In connection with the Merger on October 1, 2022, the TRS became a qualified REIT subsidiary of Terra REIT.
F-34
Notes to Consolidated Financial Statements
Income Tax Provision
The components of the Company's provision for income taxes were as follows:
| Nine Months Ended September 30, 2022 | |||||
| (Predecessor Basis) | |||||
| Federal | |||||
| Current | $ | ||||
| Deferred | ( | ||||
| State and Local | |||||
| Current | |||||
| Deferred | ( | ||||
| Total Provision for income taxes | $ | ||||
A reconciliation of effective income tax for the period presented is as follows:
| Nine Months Ended September 30, 2022 | |||||
| (Predecessor Basis) | |||||
| Pre-tax income attributable to taxable subsidiaries | $ | ||||
Federal provision at statutory tax rate (21%) | $ | ||||
| State and local taxes, net of deferred benefit | |||||
| Total provision for income taxes | $ | ||||
| Effective income tax rate | % | ||||
Income Taxes Paid
For the nine months ended September 30, 2022, the Company paid $0.6 million of income taxes. There were no income taxes payable as of December 31, 2023.
Source of Distribution
The following table reflects, for tax purposes, the estimated sources of the cash distributions that Terra BDC has paid on Terra BDC Common Stock:
| Nine Months Ended September 30, 2022 | |||||||||||
| (Predecessor Basis) | |||||||||||
| Source of Distribution | Distribution Amount (1) | % | |||||||||
| Return of capital | $ | % | |||||||||
Net investment income (2) | % | ||||||||||
| Distributions on a tax basis: | $ | % | |||||||||
(1)The Distribution Amount and Percentage reflected are estimated figures. The actual source of distributions was calculated in connection with the filing of Terra BDC’s tax return.
(2)The TRS’s taxable income was not available for distribution to Terra BDC’s stockholders until the income was distributed to the parent company. For the nine months ended September 30, 2022, all of the TRS’s taxable income was distributed to the parent company.
As of September 30, 2022, Terra BDC did not have differences between amortized cost basis and tax basis of investments.
F-35
Notes to Consolidated Financial Statements
Note 9. Directors’ Fees
Terra BDC’s directors who did not serve in an executive officer capacity for Terra BDC or Terra Income Advisors were entitled to receive annual cash retainer fees, fees for attending board and committee meetings and annual fees for serving as a committee chairperson. These directors received an annual fee of $20,000 , plus $2,500 for each board meeting attended in person, $1,000 for each board meeting attended via teleconference and $1,000 for each committee meeting attended. In addition, the chairman of the audit committee received an annual fee of $7,500 and the chairman of each of the nominating and corporate governance and the valuation committees, and any other committee, received an annual fee of $2,500 for their additional services. In connection with the Merger on October 1, 2022, Terra BDC’s directors were elected to the Terra REIT Board to fill the vacancies created by the Merger and Terra REIT will pay the fees to directors directly. For the nine months ended September 30, 2022, Terra BDC recorded $84,378 of directors’ fees expense.
Terra BDC also reimbursed each of the above directors for all reasonable and authorized business expenses in accordance with Terra BDC policies as in effect from time to time, including reimbursement of reasonable out-of-pocket expenses incurred in connection with attending each board meeting and each committee meeting not held concurrently with a board meeting.
Note 10. Capital
As of December 31, 2023 and 2022, all of the limited liability company interest in Terra LLC was held by Terra REIT.
Share Repurchase Program
Terra BDC implemented a share repurchase program whereby every quarter Terra BDC offered to repurchase up to 2.5 % of the weighed-average number of shares outstanding in the prior calendar year at a price per share equal to the most recently disclosed NAV per share of Terra BDC Common Stock immediately prior to the date of repurchase. The purpose of the share repurchase program was to provide stockholders with liquidity, because there was otherwise no public market for Terra BDC Common Stock. The Terra BDC Board was permitted to amend, suspend or terminate the share repurchase program upon 30 days’ notice. On March 30, 2022, the Terra BDC Board unanimously approved the suspension of the operation of the share repurchase program, effective as of April 30, 2022.
There were no shares of Terra BDC Common Stock repurchased for the nine months ended September 30, 2022.
Note 11. Net Increase in Net Assets
Income per share of Terra BDC Common Stock was computed by dividing income available to stockholders by the weighted average number of shares outstanding during the period. Other potentially dilutive shares, and the related impact to earnings, are considered when calculating earnings per share on a diluted basis.
The following information sets forth the computation of the weighted average net increase in net assets per share from operations:
| Nine Months Ended September 30, 2022 | ||||||||
| Basic | (Predecessor Basis) | |||||||
| Net decrease in net assets resulting from operations | $ | ( | ||||||
| Weighted average common shares outstanding | ||||||||
| Net decrease in net assets per share resulting from operations | $ | ( | ||||||
Note 12. Distributions
Distributions from net investment income and capital gain distributions are determined in accordance with U.S. federal income tax regulations, which differ from U.S. GAAP.
F-36
Notes to Consolidated Financial Statements
Subsequent to the Merger on October 1, 2022, Terra LLC has not made a distribution to Terra REIT. The following table reflects Terra BDC’s distributions for the nine months ended September 30, 2022:
| Record Date | Payment Date | Per Share Per Day | Distributions Paid in Cash | Distributions Paid through the DRIP | Total Distributions Paid/Accrued | |||||||||||||||||||||||||||
| January 26, 2022 | January 31, 2022 | $ | $ | $ | $ | |||||||||||||||||||||||||||
| February 23, 2022 | February 28, 2022 | |||||||||||||||||||||||||||||||
| March 28, 2022 | March 31, 2022 | |||||||||||||||||||||||||||||||
| April 27, 2022 | April 30, 2022 | |||||||||||||||||||||||||||||||
| May 26, 2022 | May 29, 2022 | |||||||||||||||||||||||||||||||
| June 25, 2022 | June 30, 2022 | |||||||||||||||||||||||||||||||
| July 26, 2022 | July 30, 2022 | |||||||||||||||||||||||||||||||
| August 26, 2022 | August 31, 2022 | |||||||||||||||||||||||||||||||
| September 27, 2022 | September 30, 2022 | |||||||||||||||||||||||||||||||
| $ | $ | $ | ||||||||||||||||||||||||||||||
Note 13. Financial Highlights
The following is a schedule of financial highlights for Terra BDC:
| Nine Months Ended September 30, 2022 | ||||||||
| (Predecessor Basis) | ||||||||
| Per share data: | ||||||||
| Net asset value at beginning of period | $ | |||||||
Results of operations (1): | ||||||||
| Net investment income | ||||||||
| Net change in unrealized depreciation on investments | ( | |||||||
| Net change in unrealized depreciation on obligations under participation agreements | ||||||||
| Net realized gain on investments | ||||||||
| Net decrease in net assets resulting from operations | ( | |||||||
Stockholder distributions (2): | ||||||||
| Distributions from return of capital | ( | |||||||
| Distributions from net investment income | ( | |||||||
| Net decrease in net assets resulting from stockholder distributions | ( | |||||||
| Net asset value, end of period | $ | |||||||
| Shares outstanding at end of period | ||||||||
Total return (3) | ( | % | ||||||
| Ratio/Supplemental data: | ||||||||
| Net assets, end of period | $ | |||||||
Ratio of net investment income to average net assets (4) | % | |||||||
Ratio of operating expenses to average net assets (4) (5) (6) | % | |||||||
| Portfolio turnover | % | |||||||
_______________
(1)The per share data was derived by using the weighted average shares outstanding during the applicable period.
(2)The per share data for distributions reflects the actual amount of distributions declared per share of Terra BDC Common Stock during the applicable period.
(3)Total return is calculated assuming a purchase of shares of Terra BDC Common Stock at the current net asset value on the first day and a sale at the current net asset value on the last day of the periods reported. Distributions, if any, are assumed
F-37
Notes to Consolidated Financial Statements
for purposes of this calculation to be reinvested at prices obtained under the DRIP. The total return does not consider the effect of any selling commissions or charges that may have been incurred in connection with the sale of shares of Terra BDC Common Stock.
(4)These ratios are calculated using annualized net investment income and operating expenses.
(5)Excluding the reversal of accrued incentive fees on capital gains and transaction costs, the ratio of operating expenses to average net assets was 16.0 %,
Note 13. Subsequent Events
F-38
Terra Income Fund 6, LLC
Schedule IV – Mortgage Loans on Real Estate (Successor Basis)
As of December 31, 2023
Description (1) | Property Type/Location | Contractual Interest Rate (2) | Final Maturity Date (3) | Periodic Payment Terms | Prior Liens | Face Amount | Carrying Amount | Principal Amount of Mortgages Subject to Delinquent Principal or Interest | ||||||||||||||||||||||||||||||||||||||||||
| Mezzanine loans: | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Loan A | Student housing/California | % | 5/6/2027 | Interest Only | $ | $ | $ | |||||||||||||||||||||||||||||||||||||||||||
| Preferred equity investments: | ||||||||||||||||||||||||||||||||||||||||||||||||||
Loan B (4)(5)(6) | Multifamily/New York | % | 7/1/2021 | Interest Only | ||||||||||||||||||||||||||||||||||||||||||||||
Loan C (4)(6)(7) | Office/New York | % | 7/9/2022 | Interest Only | ||||||||||||||||||||||||||||||||||||||||||||||
| Loan D | Multifamily/Georgia | % | 6/27/2026 | Interest Only | ||||||||||||||||||||||||||||||||||||||||||||||
| Loan E | Mixed-use/California | % | 8/5/2025 | Interest Only | ||||||||||||||||||||||||||||||||||||||||||||||
| First mortgages: | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Loan F | Infrastructure/Utah | % | 8/31/2024 | Interest Only | ||||||||||||||||||||||||||||||||||||||||||||||
| Total loans | $ | $ | ||||||||||||||||||||||||||||||||||||||||||||||||
Allowance for credit losses (8) | ( | |||||||||||||||||||||||||||||||||||||||||||||||||
| Carrying value, net | $ | |||||||||||||||||||||||||||||||||||||||||||||||||
___________________________
(1)All of the Company's loans have a prepayment provision.
(2)For all floating rate loans, contractual interest rate was determined using the applicable benchmark rate as of December 31, 2023.
(3)Maximum maturity date assumes all extension options are exercised.
(4)Participation interest is with Terra REIT, the Company’s parent, managed by the REIT Manager.
(5)The Company acquired these investments through participation agreements. See “Participation Agreements” in Note 5 in the accompanying notes to the consolidated financial statements.
(6)This loan is currently in maturity default. The Company initiated a litigation to seek full repayment of the loan from the sponsor.
(7)This loan is currently in maturity default. The Company recorded an allowance of credit losses of $9.2 million on this loan as a result of a decline in the fair value of the underlying collateral.
(8)Excludes $8,801 of allowance for credit losses related to unfunded commitments.
F-39
Terra Income Fund 6, LLC
Notes to Schedule IV - Mortgage Loans on Real Estate (Successor Basis)
December 31, 2023
| Reconciliation of Mortgage Loans on Real Estate | |||||||||||
For the Year Ended December 31, 2023 | |||||||||||
| Balance, beginning of period | $ | ||||||||||
| Additions during the period: | |||||||||||
| New mortgage loans | |||||||||||
| Accrual, payment and accretion of investment-related fees and other, net | |||||||||||
| Deductions during the period: | |||||||||||
| Collections of principal | ( | ||||||||||
| Provision for credit losses | ( | ||||||||||
| Net amortization of discount on investments | ( | ||||||||||
| ( | |||||||||||
| Balance, end of period | $ | ||||||||||
F-40
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: March 15, 2024
| TERRA INCOME FUND 6, LLC | |||||||||||
| By: Terra Property Trust, Inc., its sole and managing member | |||||||||||
| By: | /s/ Vikram S. Uppal | ||||||||||
| Vikram S. Uppal | |||||||||||
| Chairman of the Board, Chief Executive Officer and Chief Investment Officer | |||||||||||
| (Principal Executive Officer) | |||||||||||
| By: | /s/ Gregory M. Pinkus | ||||||||||
| Gregory M. Pinkus | |||||||||||
| Chief Financial Officer, Treasurer and Secretary | |||||||||||
| Treasurer and Secretary | |||||||||||
| (Principal Financial and Accounting Officer) | |||||||||||
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