TPTS 10-Q
Terra Property Trust, Inc. (TPTS)
10-Q
2023-08-11
For: 2023-06-30
View Original
Added on
April 09, 2026
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |||||
For the Quarterly Period Ended June 30, 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: 001-40496
(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)
(212 ) 753-5100
(Registrant’s telephone number, including area code)
Securities registered pursuant to section 12(b) of the Securities Exchange Act of 1934:
| Title of each class | Trading Symbol(s) | Name of exchange on which registered | ||||||||||||
Securities registered pursuant to section 12(g) of the Securities Exchange Act of 1934:
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 during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes þ No ¨
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 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. ☑
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☑
As of August 11, 2023, the registrant had 24,335,575 shares of Class B Common Stock, $0.01 par value, outstanding. 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.
TABLE OF CONTENTS
| Page | ||||||||
| PART I | ||||||||
| Item 1. | ||||||||
| Item 2. | ||||||||
| Item 3. | ||||||||
| Item 4. | ||||||||
| PART II | ||||||||
| Item 1. | ||||||||
| Item 1A. | ||||||||
| Item 2. | ||||||||
| Item 3. | ||||||||
| Item 4. | ||||||||
| Item 5. | ||||||||
| Item 6. | ||||||||
1
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Terra Property Trust, Inc.
Consolidated Balance Sheets
| June 30, 2023 | December 31, 2022 | ||||||||||
| (unaudited) | |||||||||||
| Assets | |||||||||||
| Cash and cash equivalents | $ | $ | |||||||||
| Restricted cash | |||||||||||
| Cash held in escrow by lender | |||||||||||
Loans held for investment, net of allowance for credit losses of $ and $ | |||||||||||
Loans held for investment acquired through participation, net of allowance for credit losses of $ | |||||||||||
| Equity investment in unconsolidated investments | |||||||||||
| Land, building and building improvements, net | |||||||||||
| Lease intangible assets, net | |||||||||||
| Operating lease right-of-use asset | |||||||||||
| Deal deposit | |||||||||||
| Interest receivable | |||||||||||
| Other assets | |||||||||||
| Total assets | $ | $ | |||||||||
| Liabilities and Equity | |||||||||||
| Liabilities: | |||||||||||
| Term loan payable | $ | $ | |||||||||
| Unsecured notes payable, net of debt issuance cost | |||||||||||
| Repurchase agreements payable, net of deferred financing fees | |||||||||||
| Mortgage loans payable, net of deferred financing fees and other | |||||||||||
| Revolving line of credit payable, net of deferred financing fees | |||||||||||
| Interest reserve and other deposits held on investments | |||||||||||
| Operating lease liability | |||||||||||
| Interest payable | |||||||||||
| Accounts payable and accrued expenses | |||||||||||
| Unearned income | |||||||||||
| Other liabilities | |||||||||||
| Total liabilities | |||||||||||
| Equity: | |||||||||||
Preferred stock, $ | |||||||||||
June 30, 2023 and December 31, 2022, respectively | |||||||||||
Class A Common Stock, $ shares issued, at both June 30, 2023 and December 31, 2022 | |||||||||||
Class B Common Stock, $ December 31, 2022, respectively | |||||||||||
| Additional paid-in capital | |||||||||||
| Accumulated deficit | ( | ( | |||||||||
| Total equity | |||||||||||
| Total liabilities and equity | $ | $ | |||||||||
See notes to consolidated financial statements.
2
Terra Property Trust, Inc.
Consolidated Statements of Operations
(Unaudited)
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
| 2023 | 2022 | 2023 | 2022 | ||||||||||||||||||||
| Revenues | |||||||||||||||||||||||
| Interest income | $ | $ | $ | $ | |||||||||||||||||||
| Real estate operating revenue | |||||||||||||||||||||||
| Prepayment fee income | |||||||||||||||||||||||
| Other operating income | |||||||||||||||||||||||
| Operating expenses | |||||||||||||||||||||||
| Operating expenses reimbursed to Manager | |||||||||||||||||||||||
| Asset management fee | |||||||||||||||||||||||
| Asset servicing fee | |||||||||||||||||||||||
| Provision for credit losses | |||||||||||||||||||||||
| Real estate operating expenses | |||||||||||||||||||||||
| Depreciation and amortization | |||||||||||||||||||||||
| Impairment charge | |||||||||||||||||||||||
| Professional fees | |||||||||||||||||||||||
| Directors’ fees | |||||||||||||||||||||||
| Other | |||||||||||||||||||||||
| Operating (loss) income | ( | ||||||||||||||||||||||
| Other income and expenses | |||||||||||||||||||||||
| Interest expense from obligations under participation agreements | ( | ( | ( | ( | |||||||||||||||||||
| Interest expense on repurchase agreements payable | ( | ( | ( | ( | |||||||||||||||||||
| Interest expense on mortgage loans payable | ( | ( | ( | ( | |||||||||||||||||||
| Interest expense on revolving line of credit | ( | ( | ( | ( | |||||||||||||||||||
| Interest expense on term loan payable | ( | ( | ( | ||||||||||||||||||||
| Interest expense on unsecured notes payable | ( | ( | ( | ( | |||||||||||||||||||
| Interest expense on secured borrowing | ( | ( | |||||||||||||||||||||
| Unrealized gains (losses) on investments, net | ( | ( | |||||||||||||||||||||
| Loss on sale of real estate | ( | ( | |||||||||||||||||||||
| (Loss) income from equity investment in unconsolidated investments | ( | ( | |||||||||||||||||||||
| Realized (losses) gains on investments, net | ( | ( | |||||||||||||||||||||
| ( | ( | ( | ( | ||||||||||||||||||||
| Net (loss) income | $ | ( | $ | $ | ( | $ | |||||||||||||||||
| Series A preferred stock dividend declared | $ | ( | $ | ( | $ | ( | |||||||||||||||||
| Net (loss) income allocable to common stock | $ | ( | $ | $ | ( | $ | |||||||||||||||||
(Loss) income per share — basic and diluted | $ | ( | $ | $ | ( | $ | |||||||||||||||||
Weighted-average shares — basic and diluted | |||||||||||||||||||||||
| Distributions declared per common share | $ | $ | $ | $ | |||||||||||||||||||
See notes to consolidated financial statements.
3
Terra Property Trust, Inc.
Consolidated Statements of Changes in Equity
(Unaudited)
| Preferred Stock | Class A Common Stock | Class B Common Stock | Additional Paid-in Capital | Accumulated Deficit | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
$ | $ | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | Shares | Amount | Total equity | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Balance at January 1, 2023 | $ | $ | $ | $ | $ | $ | ( | $ | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
| — | — | — | — | — | — | — | — | ( | ( | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Shares issued from reinvestment of shareholder distributions | — | — | — | — | — | — | — | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Redemption of Series A Preferred Stock | — | ( | ( | — | — | — | — | — | — | ( | ||||||||||||||||||||||||||||||||||||||||||||||||||||
Distributions declared on common shares ($ | — | — | — | — | — | — | — | — | ( | ( | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Distributions declared on preferred shares | — | — | — | — | — | — | — | — | ( | ( | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Net income | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Balance at March 31, 2023 | ( | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Shares issued from reinvestment of shareholder distributions | — | — | — | — | — | — | — | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
Distributions declared on common shares ($ | — | — | — | — | — | — | — | — | ( | ( | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Net loss | — | — | — | — | — | — | — | — | ( | ( | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Balance at June 30, 2023 | $ | $ | $ | $ | $ | $ | ( | $ | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
See notes to consolidated financial statements.
4
Terra Property Trust, Inc.
Consolidated Statements of Changes in Equity (Continued)
(Unaudited)
| Preferred Stock | Common Stock | Additional Paid-in Capital | Accumulated Deficit | |||||||||||||||||||||||||||||||||||||||||||||||
$ | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | Total equity | ||||||||||||||||||||||||||||||||||||||||||||||
| Balance at January 1, 2022 | $ | $ | $ | $ | $ | ( | $ | |||||||||||||||||||||||||||||||||||||||||||
Distributions declared on common shares ($ | — | — | — | — | — | — | ( | ( | ||||||||||||||||||||||||||||||||||||||||||
| Distributions declared on preferred shares | — | — | — | — | — | — | ( | ( | ||||||||||||||||||||||||||||||||||||||||||
| Net loss | — | — | — | — | — | — | ( | ( | ||||||||||||||||||||||||||||||||||||||||||
| Balance at March 31, 2022 | ( | |||||||||||||||||||||||||||||||||||||||||||||||||
Distributions declared on common shares ($ | — | — | — | — | — | — | ( | ( | ||||||||||||||||||||||||||||||||||||||||||
| Distributions declared on preferred shares | — | — | — | — | — | — | ( | ( | ||||||||||||||||||||||||||||||||||||||||||
| Net income | — | — | — | — | — | — | ||||||||||||||||||||||||||||||||||||||||||||
| Balance at June 30, 2022 | $ | $ | $ | $ | $ | ( | $ | |||||||||||||||||||||||||||||||||||||||||||
See notes to consolidated financial statements.
5
Terra Property Trust, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
| Six Months Ended June 30, | |||||||||||
| 2023 | 2022 | ||||||||||
| Cash flows from operating activities: | |||||||||||
| Net (loss) income | $ | ( | $ | ||||||||
| Adjustments to reconcile net income (loss) to net cash provided by operating activities: | |||||||||||
| Depreciation and amortization | |||||||||||
| Provision for credit losses | |||||||||||
| Impairment charge | |||||||||||
| Amortization of net purchase premiums on loans | |||||||||||
| Straight-line rent adjustments | |||||||||||
| Amortization of deferred financing costs | |||||||||||
| Amortization of discount on unsecured notes payable | |||||||||||
| Amortization of above- and below-market rent intangibles | ( | ( | |||||||||
| Amortization and accretion of investment-related fees, net | ( | ( | |||||||||
| Amortization of above-market rent ground lease | ( | ( | |||||||||
| Realized loss (gain) on investments, net | ( | ||||||||||
| Unrealized (gains) losses on investments, net | ( | ||||||||||
| Loss on sale of real estate | |||||||||||
| Distributions received from equity investment in unconsolidated investments | |||||||||||
| Loss (income) from equity investment in unconsolidated investments | ( | ||||||||||
| Changes in operating assets and liabilities: | |||||||||||
| Deal deposits | |||||||||||
| Interest receivable | ( | ( | |||||||||
| Due from related party | ( | ||||||||||
| Other assets | ( | ( | |||||||||
| Due to Manager | ( | ||||||||||
| Unearned income | |||||||||||
| Interest payable | ( | ||||||||||
| Accounts payable and accrued expenses | ( | ||||||||||
| Other liabilities | ( | ( | |||||||||
| Net cash provided by operating activities | |||||||||||
| Cash flows from investing activities: | |||||||||||
| Origination and purchase of loans | ( | ( | |||||||||
| Proceeds from repayments of loans | |||||||||||
| Purchase of real estate properties | ( | ||||||||||
| Purchase of held-for-maturity securities | ( | ||||||||||
| Proceeds from redemption of held-for-maturity securities | |||||||||||
| Purchase of marketable securities | ( | ||||||||||
| Proceeds from sale of marketable securities | |||||||||||
| Return of capital on equity interests in unconsolidated investments | |||||||||||
| Cash acquired in purchase of real estate | |||||||||||
| Purchase of equity interests in unconsolidated investments | ( | ||||||||||
| Proceeds from sale of real estate | |||||||||||
| Distributions in excess equity income | |||||||||||
| Net cash used in investing activities | ( | ( | |||||||||
6
Terra Property Trust, Inc.
Consolidated Statements of Cash Flows (Continued)
(Unaudited)
| Six Months Ended June 30, | |||||||||||
| 2023 | 2022 | ||||||||||
| Cash flows from financing activities: | |||||||||||
| Proceeds from borrowings under repurchase agreements | |||||||||||
| Proceeds from borrowings under revolving line of credit | |||||||||||
| Proceeds from mortgage loan payable | |||||||||||
| Proceeds from obligations under participation agreements | |||||||||||
| Repayments of borrowings under repurchase agreements | ( | ||||||||||
| Repayments of obligations under participation agreements | ( | ||||||||||
| Repayments of borrowings under revolving line of credit | ( | ( | |||||||||
| Distributions paid | ( | ( | |||||||||
| Repayment of borrowings under the term loan | ( | ( | |||||||||
| Proceeds from secured borrowing | |||||||||||
| Repayment of mortgage principal | ( | ( | |||||||||
| Change in interest reserve and other deposits held on investments | ( | ||||||||||
| Payment of financing costs | ( | ( | |||||||||
| Redemption of Series A Preferred Stock | ( | ||||||||||
| Net cash provided by financing activities | |||||||||||
| Net increase (decrease) in cash, cash equivalents and restricted cash | ( | ||||||||||
| Cash, cash equivalents and restricted cash at beginning of period | |||||||||||
| $ | $ | ||||||||||
| Six Months Ended June 30, | |||||||||||
| 2023 | 2022 | ||||||||||
Supplemental Disclosure of Cash Flows Information: | |||||||||||
| Cash paid for interest | $ | $ | |||||||||
| Supplemental non-cash information: | |||||||||||
| Reinvestment of stockholder distributions | $ | $ | |||||||||
7
Supplemental non-cash investing information:
In May 2023, the Company acquired five industrial buildings for a $3.5 million cash payment and the settlement of a mezzanine loan that was accounted for as an equity investment and five senior loans that were held for investment. The following table presents a summary of the total capitalized costs and the values of the net assets acquired:
| Total Capitalized Costs: | ||||||||
| Cash and cash equivalents | $ | |||||||
| Loans held for investment | ||||||||
| Equity investment in unconsolidated investment | ||||||||
| Interest receivable | ||||||||
| Other assets | ||||||||
| $ | ||||||||
| Net Assets Acquired | ||||||||
| Cash and cash equivalents | $ | |||||||
| Other assets | ||||||||
| Land | ||||||||
| Buildings and Improvements | ||||||||
| Intangible asset and liability: | ||||||||
| In-please lease | ||||||||
| Below-market rent | ( | |||||||
| Accounts payable and accrued expenses | ( | |||||||
| $ | ||||||||
See notes to consolidated financial statements.
8
Terra Property Trust, Inc.
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2023
Note 1. Business
Terra Property Trust, Inc. (and, together with its consolidated subsidiaries, the “Company” or “Terra Property Trust”) was incorporated under the Maryland General Corporation Law on December 31, 2015. Terra Property Trust is a real estate credit focused company that originates, structures, funds and manages commercial real estate investments, including mezzanine loans, first mortgage loans, subordinated mortgage loans and preferred equity investments. The Company’s loans finance the acquisition, construction, development or redevelopment of quality commercial real estate in the United States. The Company focuses on the origination of middle market loans in the approximately $10 million to $50 million range, to finance properties in primary and secondary markets.
On January 1, 2016, Terra Secured Income Fund 5, LLC (“Terra Fund 5”), the Company’s then parent, contributed its consolidated portfolio of net assets to the Company pursuant to a contribution agreement in exchange for shares of the Company’s common stock. Upon receipt of the contribution of the consolidated portfolio of net assets from Terra Fund 5, the Company commenced its operations on January 1, 2016. On March 2, 2020, the Company engaged in a series of transactions pursuant to which the Company issued an aggregate of 4,574,470.35 shares of its common stock in exchange for the settlement of an aggregate of $49.8 million of participation interests in loans held by the Company, cash of $25.5 million and other working capital.
The Company has elected to be taxed, and to qualify annually thereafter, as a real estate investment trust (“REIT”) under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”), commencing with the taxable year ended December 31, 2016. As a REIT, the Company is not subject to federal income taxes on income and gains distributed to the stockholders as long as certain requirements are satisfied, principally relating to the nature of income and the level of distributions, as well as other factors. The Company also operates its business in a manner that permits it to maintain its exemption from registration as an “investment company” under the Investment Company Act of 1940, as amended (the “1940 Act”).
The Company’s investment activities are externally managed by Terra REIT Advisors, LLC (“Terra REIT Advisors” or the “Manager”), a subsidiary of the Company’s sponsor, Terra Capital Partners, LLC (“Terra Capital Partners”), pursuant to a management agreement (the “Management Agreement”), under the oversight of the Company’s board of directors (the “Board”) (Note 8). The Company does not currently have any employees and does not expect to have any employees. Services necessary for the Company’s business are provided by individuals who are employees of the Manager or by individuals who were contracted by the Company or by the Manager to work on behalf of the Company pursuant to the terms of the Management Agreement.
On October 1, 2022, pursuant to that certain Agreement and Plan of Merger, dated as of May 2, 2022 (the “Merger Agreement”), Terra Income Fund 6, Inc. (“Terra BDC”), merged with and into Terra Income Fund 6, LLC (“Terra LLC”), a wholly owned subsidiary of the Company, with Terra LLC continuing as the surviving entity of the merger (the “BDC Merger”) and as a wholly owned subsidiary of the Company (Note 3).
Note 2. Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include all of the Company’s accounts and those of its consolidated subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. Certain prior period amounts have been reclassified to conform to the current period presentation.
The Company consolidates entities in which it has a controlling financial interest based on either the variable interest entity (“VIE”) or voting interest model. The Company 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 the Company determines it does not hold a variable
9
Notes to Unaudited Consolidated Financial Statements
interest in a VIE, it then applies the voting interest model. Under the voting interest model, the Company consolidates an entity when it holds a majority voting interest in an entity.
The Company accounts for investments in which it has significant influence but not a controlling financial interest using the equity method of accounting (see Note 5).
VIE Model
An entity is considered to be a VIE if any of the following conditions exist: (a) the total equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support, (b) the holders of the equity investment at risk, as a group, lack either the direct or indirect ability through voting rights or similar rights to make decisions that have a significant effect on the success of the entity or the obligation to absorb the entity’s expected losses or right to receive the entity’s expected residual returns, or (c) the voting rights of some equity investors are disproportionate to their obligation to absorb losses of the entity, their rights to receive returns from an entity, or both and substantially all of the entity’s activities either involve or are conducted on behalf of an investor with disproportionately few voting rights.
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.
Current Expected Credit Losses Reserve
Accounting Standards Codification (“ASC”) 326, Financial Instruments – Credit Losses, became effective for the Company on January 1, 2023. ASC 326 mandates the use of a current expected credit loss (“CECL”) model for estimating future credit losses of certain financial instruments measured at amortized cost, instead of the “incurred loss” credit model previously required under United States generally accepted accounting principles (“U.S. GAAP”). The CECL model requires the consideration of possible credit losses over the life of an instrument as opposed to only estimating credit losses upon the occurrence of a discrete loss event under the previous “incurred loss” methodology. The CECL model applies to the Company’s loan portfolio and the held-to-maturity debt securities which are carried at amortized cost, including future funding commitments for which the Company does not have the unconditional right to cancel. Amortized cost is defined as the principal amount outstanding, adjusted for the accretion of purchase discounts and disposition fees, and amortization of purchase premiums and origination fees, and includes accrued interest receivable related to these loans and securities. 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 CECL model resulted in a $4.6 million increase to total reserve, including reserve on future funding commitments, which was recognized as a cumulative-effect adjustment to accumulated deficit as of January 1, 2023. Subsequent to the adoption of the CECL model, any increase or decrease to the CECL reserve is recorded in earnings on the consolidated statements of operations.
The Company utilizes information obtained from internal and external sources relating to past events, current conditions and reasonable and supportable forecasts about the future to determine the expected credit losses for its loan portfolio. The Company does not have a meaningful history of realized credit losses on its loan portfolio so it has subscribed to a third-party database service to provide the Company with industry losses for its loans. The Company utilizes a loan loss model that is widely used among banks and commercial mortgage REITs and is marketed by a leading commercial mortgage-based security data analytics provider. It 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 provides specific loan-level inputs which include 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
10
Notes to Unaudited Consolidated Financial Statements
commitments. The Company selects from a group of independent five-year macroeconomic forecasts included in the model that are updated regularly based on current economic trends. Because the Company’s loan portfolio is comprised of a small number of loans, the Company measures the CECL reserve based on an evaluation of each loan as its own segregated asset. Based on the inputs, the loan loss model determines a loan loss rate through the generation of probability of defaults (PD) and loss given defaults (LGD) for each loan. The CECL reserve 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.
The calculation of the estimate of expected credit loss considers historical experience and current conditions for each loan 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, current portfolio composition, level of historical loss forecast estimates, material changes in growth and credit strategy and other factors that may affect its loss experience. The Company regularly evaluates the reasonable and supportable forecast period to determine if a change is needed.
Beyond the Company’s reasonable and supportable forecast period, the Company generally reverts to historical loss information, pooled by asset type and investment structure, over the remaining loan period, 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 Company generally expects to use an average historical loss for reversion, utilizing an immediate or straight-line method for the remaining life of the loans.
The Company also performs a qualitative assessment beyond model estimates and applies qualitative adjustments as necessary. 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 contractual extension options, renewals, modifications, and prepayments.
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.
Some of the Company’s 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 model because the Company does not have an unconditional right to cancel such commitments. The CECL reserve related to unfunded commitments is recorded as a component of other liabilities on the Company’s consolidated balance sheets. This CECL reserve is estimated using the same method outlined above for the Company’s outstanding loan balances, and increases or decreases in the CECL reserve relating to unfunded commitments are also recorded in earnings on the consolidated statements of operations.
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.
11
Notes to Unaudited Consolidated Financial Statements
Marketable Securities
The Company from time to time invests in short term debt and equity securities. These securities are classified as available-for-sale and are carried at fair value. 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 a gain or loss on the securities is realized.
Held-to-Maturity Debt Securities
The Company classifies debt securities for which it has both the positive intent and ability to hold until maturity of the security as held-to-maturity debt securities. These securities are recorded at amortized cost with changes in amortized cost recognized in earnings until realized. Held-to-maturity debt securities are subject to the CECL reserve described above.
Real Estate Owned, Net
Real estate acquired is recorded at its estimated fair value at acquisition and is shown net of accumulated depreciation and impairment charges.
Acquisition of properties generally are accounted for as asset acquisitions. Under asset acquisition accounting, the costs to acquire real estate, including transaction costs, are accumulated and then allocated to individual assets and liabilities acquired based upon their relative fair value. The Company allocates the purchase price of its real estate acquisitions to land, building, tenant improvements, acquired in-place leases, intangibles for the value of any above or below market leases at fair value and to any other identified intangible assets or liabilities. The Company amortizes the value allocated to in-place leases over the remaining lease term, which is reported in depreciation and amortization expense on its consolidated statements of operations. The value allocated to above or below market leases are amortized over the remaining lease term as an adjustment to rental income.
Real estate assets are depreciated using the straight-line method over their estimated useful lives: buildings and improvements - not to exceed 40 years, and tenant improvements - shorter of the lease term or life of the asset. Ordinary repairs and maintenance which are not reimbursed by the tenants are expensed as incurred. Major replacements and betterments which improve or extend the life of the asset are capitalized and depreciated over their estimated useful life.
Leases
The Company determines if an arrangement is a lease at inception. Operating leases in which the Company is the lessee are included in operating lease right-of-use (“ROU”) assets and operating lease liabilities in the consolidated balance sheets.
ROU assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent its obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As the Company’s lease typically does not provide an implicit rate, the Company uses its incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. The Company uses the implicit rate when readily determinable. The operating lease ROU asset also includes any lease payments made in advance and excludes lease incentives if there were any. The Company’s lease term may include options to extend or terminate the lease when it is reasonably certain that it will exercise that option. Lease expense is recognized on a straight-line basis over the lease term.
12
Notes to Unaudited Consolidated Financial Statements
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, 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 holds 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.
Real Estate Operating Revenues: Real estate operating revenue is derived from leasing of space to various types of tenants. The leases are for fixed terms of varying length and generally provide for annual rent increases and expense reimbursements to be paid in monthly installments. Lease revenue, or rental income from leases, is recognized on a straight-line basis over the term of the respective leases. Additionally, the Company recorded above- and below-market lease intangibles, which are included in real estate owned, net, in connection with the acquisition of the real estate properties. These intangible assets and liabilities are amortized to lease revenue over the remaining contractual lease term.
Other Revenues: Prepayment fee income is recognized as prepayments occur. All other income is recognized when earned.
Cash, Cash Equivalents and Restricted Cash
The Company considers all highly liquid investments, with original maturities of ninety days or less when purchased, as cash equivalents. Cash and cash equivalents are exposed to concentrations of credit risk. The Company maintains all of its cash at financial institutions which, at times, may exceed the amount insured by the Federal Deposit Insurance Corporation.
Restricted cash represents cash held as additional collateral by the Company on behalf of the borrowers related to the investments in loans or preferred equity instruments for the purpose of such borrowers making interest and property-related operating payments. Restricted cash is not available for general corporate purposes. The related liability is recorded in “Interest reserve and other deposits held on investments” on the consolidated balance sheets.
| June 30, | ||||||||||||||
| 2023 | 2022 | |||||||||||||
| Cash and cash equivalents | $ | $ | ||||||||||||
| Restricted cash | ||||||||||||||
| Cash held in escrow by lender | ||||||||||||||
| Total cash, cash equivalents and restricted cash shown in the consolidated statements of cash flows | $ | $ | ||||||||||||
13
Notes to Unaudited Consolidated Financial Statements
Fair Value Measurements
U.S. GAAP establishes market-based or observable inputs as the preferred source of values, followed by valuation models using management assumptions in the absence of market inputs. The Company has not elected the fair value option for its financial instruments, including loans held for investment, loans held for investment acquired through participation, obligations under participation agreements, secured borrowing, unsecured notes, mortgage loan payable, term loan payable, repurchase agreement payment and revolving line of credit. Such financial instruments are carried at cost, less impairment, where applicable. Marketable securities are financial instruments that are reported at fair value.
Income Taxes
The Company has elected to be taxed as a REIT under the Internal Revenue Code commencing with the taxable year ended December 31, 2016. In order to qualify as a REIT, the Company is required, among other things, to distribute dividends equal to at least 90% of its REIT net taxable income to the stockholders and meet certain tests regarding the nature of its income and assets. As a REIT, the Company is not subject to federal income taxes on income and gains distributed to the stockholders as long as certain requirements are satisfied, principally relating to the nature of income and the level of distributions, as well as other factors. If the Company fails to continue to qualify as a REIT in any taxable year and does not qualify for certain statutory relief provisions, the Company will be subject to U.S. federal and state income taxes at regular corporate rates (including any applicable alternative minimum tax) beginning with the year in which it fails to qualify and may be precluded from being able to elect to be treated as a REIT for the Company’s four subsequent taxable years. Any gains from the sale of foreclosed properties within two years are subject to U.S. federal and state income taxes at regular corporate rates. As of June 30, 2023, the Company has satisfied all the requirements for a REIT.
14
Notes to Unaudited Consolidated Financial Statements
Earnings Per Share
The Company has a simple equity capital structure with only common stock outstanding as of June 30, 2023 and common stock and preferred stock outstanding as of December 31, 2022. As a result, earnings per share, as presented, represent both basic and dilutive per-share amounts for the periods presented in the consolidated financial statements. Income per basic share of common stock is calculated by dividing net income allocable to common stock by the weighted-average number of shares of common stock issued and outstanding during such period.
Use of Estimates
The preparation of 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 as of the date of the consolidated financial statements and the reported amounts of revenues and expenses 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 Financial Accounting Standards Board (“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 measured at amortized cost basis. In October 2019, the FASB decided that for smaller reporting companies, ASU 2016-13 and related amendments are 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 $4.6 million, which included a reserve on future loan funding commitments. The Company recorded the cumulative effect of initially applying this guidance as an adjustment to Accumulated deficit 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 has subsequently been 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”). In December 2022, the FASB issued ASU 2022-06, Reference Rate Reform (Topic 848) — Deferral of the Sunset Date of Topic 848 (“ASU 2022-06”). ASU 2022-06 deferred the sunset date of ASU 2020-04 to
15
Notes to Unaudited Consolidated Financial Statements
Note 3. BDC Merger
BDC Merger
On October 1, 2022 (the “Closing Date”), pursuant to the Merger Agreement, Terra BDC merged with and into Terra LLC, with Terra LLC surviving as a wholly owned subsidiary of the Company. The Certificate of Merger and Articles of Merger with respect to the BDC Merger were filed with the Secretary of State of the State of Delaware and State Department of Assessments and Taxation of Maryland (the “SDAT”), respectively, with an effective time and date of 12:02 a.m., Eastern Time, on the Closing Date (the “Effective Time”).
At the Effective Time, except for any shares of common stock, par value $0.001 per share, of Terra BDC (“Terra BDC Common Stock”) held by the Company or any wholly owned subsidiary of the Company 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 (“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, approximately 4,847,910 shares of Class B Common Stock were issued to former Terra BDC stockholders in connection with the BDC Merger, based on the number of outstanding shares of Terra BDC Common Stock as of the Closing Date. Following the consummation of the BDC Merger, former Terra BDC stockholders owned approximately 19.9 % of the common equity of the Company.
The Company and Terra BDC prepared their respective financial statements in accordance with generally accepted accounting principles in the United States. The BDC Merger is accounted for using the acquisition method of accounting, with the Company being treated as the accounting acquirer. In identifying the Company as the acquiring entity for accounting purposes, the Company and Terra BDC took into account a number of factors, including the relative size of the merging companies, which entity issues additional shares in conjunction with the BDC Merger, the relative voting interests of the respective stockholders after consummation of the BDC Merger, and the composition of the Board and senior management of the combined company after consummation of the BDC Merger.
The Company, as the acquirer, accounted for the BDC Merger as an asset acquisition and all direct acquisition-related costs are capitalized to the total cost of the assets acquired and liabilities assumed. Pursuant to Accounting Standard Codification Topic 805, Business Combination, total cost is allocated to the assets acquired and liabilities assumed on a relative fair value basis.
16
Notes to Unaudited Consolidated Financial Statements
The following table summarizes the total consideration and the fair values of assets acquired and liabilities assumed in the BDC Merger:
| Total Consideration | ||||||||
Fair value of Terra Property Trust shares of common stock issued | $ | |||||||
| Cash paid for fractional shares | ||||||||
| Transaction costs | ||||||||
| $ | ||||||||
| Assets Acquired and Liabilities Assumed at Fair Value | ||||||||
| Cash and cash equivalents | $ | |||||||
| Restricted cash | ||||||||
| Loans held for investment | ||||||||
| Loans held for investment acquired through participation | ||||||||
| Interest receivable | ||||||||
| Other assets | ||||||||
| Term loan payable | ( | |||||||
| Unsecured notes payable | ( | |||||||
| Obligations under participation agreements | ( | |||||||
| Interest reserve and other deposits held on investments | ( | |||||||
| Due to manager | ( | |||||||
| Interest payable | ( | |||||||
| Accounts payable and accrued expenses | ( | |||||||
| Other liabilities | ( | |||||||
| Net assets acquired | $ | |||||||
The fair value of the 4,847,910 shares of the Class B Common Stock was determined based on the Company’s net asset value per share of $14.66 as of October 1, 2022.
Net Gain on Extinguishment of Obligations Under Participation Agreements
As discussed in Note 8, in the normal course of business, the Company may enter into participation agreements with related parties, primarily other affiliated funds managed by the Manager, and to a lesser extent, unrelated parties. As a result of the BDC Merger, the obligations under participation agreements with Terra BDC totaling $37.0 million were effectively extinguished and the Company recognized a net gain of $3.4 million, representing the difference between the carrying value of the Company’s obligations under participation agreements and the fair value of Terra BDC’s investments acquired through participation agreements.
Appointment of Directors
As of the Effective Time and in accordance with the Merger Agreement, the size of the Board was increased by three members and each of Spencer Goldenberg, Adrienne Everett and Gaurav Misra (each a “Terra BDC Designee”, and collectively, the “Terra BDC Designees”) were elected to the Board to fill the vacancies created by such increase, with each Terra BDC Designee to serve until the Company’s next annual meeting of stockholders and until his or her successor is duly elected and qualifies. Each of the other members of the Board immediately prior to the Effective Time continued as members following the Effective Time.
Voting Support Agreement
On the Closing Date, the Company, Terra JV and Terra Offshore REIT entered into a Voting Support Agreement (the “2022 Voting Agreement”). Pursuant to the 2022 Voting Agreement, effective as of the Closing Date, Terra JV and Terra
17
Notes to Unaudited Consolidated Financial Statements
Offshore REIT have agreed to, at any meeting of the Company’s stockholders called for the purpose of electing directors (or by any consent in writing or by electronic transmission in lieu of any such meeting), cast all votes entitled to be cast by each of them in favor of the election of the Terra BDC Designees until the earlier of (i) the first anniversary of the Closing Date, (ii) the TPT Class B Common Stock Distributions (as defined in the 2022 Voting Agreement) or (iii) an amendment and restatement of the amended and restated management agreement between the Company and Terra REIT Advisors approved by the Company’s Board, including the Terra BDC Designees.
Indemnification Agreements
The Company has entered into customary indemnification agreements with each member of the Board (including each Terra BDC Designee). These agreements, among other things, require the Company to indemnify each director to the maximum extent permitted by Maryland law, including indemnification of expenses such as attorney’s fees, judgments, fines and settlement amounts incurred in any action or proceeding, including any action or proceeding by or in right of the Company, arising out of his or her service as a director.
Note 4. Loans Held for Investment
The Company elected the practical expedient under ASC 326 to exclude accrued interest from amortized cost. As of June 30, 2023 and December 31, 2022, accrued interest receivable of $3.9 million and $4.1 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 as of:
| June 30, 2023 | December 31, 2022 | ||||||||||||||||||||||||||||||||||
| Fixed Rate | Floating Rate (1)(2)(3) | Total | Fixed Rate | Floating Rate (1)(2)(3) | Total | ||||||||||||||||||||||||||||||
| Number of loans | |||||||||||||||||||||||||||||||||||
| Principal balance | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
| Carrying value | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
| Fair value | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
| Weighted-average coupon rate | % | % | % | % | % | % | |||||||||||||||||||||||||||||
| Weighted-average remaining term (years) | |||||||||||||||||||||||||||||||||||
_______________
(1)These loans pay a coupon rate of LIBOR, 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 LIBOR of 5.22 %, average SOFR of 5.07 % and Term SOFR of 5.14 % as of June 30, 2023 and LIBOR of 4.39 %, average SOFR of 4.06 % and Term SOFR of 4.36 % as of December 31, 2022.
(2)As of June 30, 2023 and December 31, 2022, amount included $336.8 million and $413.1 million of senior mortgages used as collateral for $228.3 million and $261.0 million of borrowings under credit facilities, respectively (Note 9).
(3)As of June 30, 2023 and December 31, 2022, sixteen and twenty-one loans, respectively, were subject to a LIBOR, SOFR or Term SOFR floor, as applicable.
18
Notes to Unaudited Consolidated Financial Statements
Lending Activities
The following tables present the activities of the Company’s loan portfolio:
| Loans Held for Investment | Loans Held for Investment through Participation Interests | Total | |||||||||||||||
| Balance, January 1, 2023 | $ | $ | $ | ||||||||||||||
Cumulative effect of credit loss accounting standard effective | ( | ( | ( | ||||||||||||||
| New loans made | |||||||||||||||||
| Principal repayments received | ( | ( | ( | ||||||||||||||
| Net amortization of premiums on loans | ( | ( | |||||||||||||||
| ( | ( | ||||||||||||||||
| Accrual, payment and accretion of investment-related fees and other, net | ( | ( | ( | ||||||||||||||
| Provision for credit losses | ( | ( | ( | ||||||||||||||
| Balance, June 30, 2023 | $ | $ | $ | ||||||||||||||
| Loans Held for Investment | Loans Held for Investment through Participation Interests | Total | |||||||||||||||
| Balance, January 1, 2022 | $ | $ | $ | ||||||||||||||
| New loans made | |||||||||||||||||
| Principal repayments received | ( | ( | |||||||||||||||
| Net amortization of premiums on loans | ( | ( | |||||||||||||||
| Accrual, payment and accretion of investment-related fees and other, net | |||||||||||||||||
| Provision for credit losses | ( | ( | |||||||||||||||
| Balance, June 30, 2022 | $ | $ | $ | ||||||||||||||
Portfolio Information
| June 30, 2023 | December 31, 2022 | |||||||||||||||||||||||||||||||||||||
| Loan Structure | Principal Balance | Carrying Value | % of Total | Principal Balance | Carrying Value | % of Total | ||||||||||||||||||||||||||||||||
| First mortgages | $ | $ | % | $ | $ | % | ||||||||||||||||||||||||||||||||
| Preferred equity investments | % | % | ||||||||||||||||||||||||||||||||||||
| Mezzanine loans | % | % | ||||||||||||||||||||||||||||||||||||
| Credit facility | % | % | ||||||||||||||||||||||||||||||||||||
| Allowance for credit losses | — | ( | ( | % | — | ( | ( | % | ||||||||||||||||||||||||||||||
| Total | $ | $ | % | $ | $ | % | ||||||||||||||||||||||||||||||||
19
Notes to Unaudited Consolidated Financial Statements
| June 30, 2023 | December 31, 2022 | |||||||||||||||||||||||||||||||||||||
| Property Type | Principal Balance | Carrying Value | % of Total | Principal Balance | Carrying Value | % of Total | ||||||||||||||||||||||||||||||||
| Office | $ | $ | % | $ | $ | % | ||||||||||||||||||||||||||||||||
| Multifamily | % | % | ||||||||||||||||||||||||||||||||||||
| Industrial | % | % | ||||||||||||||||||||||||||||||||||||
| Mixed-use | % | % | ||||||||||||||||||||||||||||||||||||
| Infill land | % | % | ||||||||||||||||||||||||||||||||||||
| Hotel - full/select service | % | % | ||||||||||||||||||||||||||||||||||||
| Student housing | % | % | ||||||||||||||||||||||||||||||||||||
| Infrastructure | % | % | ||||||||||||||||||||||||||||||||||||
| Allowance for credit losses | — | ( | ( | % | — | ( | ( | % | ||||||||||||||||||||||||||||||
| Total | $ | $ | % | $ | $ | % | ||||||||||||||||||||||||||||||||
| June 30, 2023 | December 31, 2022 | |||||||||||||||||||||||||||||||||||||
| Geographic Location | Principal Balance | Carrying Value | % of Total | Principal Balance | Carrying Value | % of Total | ||||||||||||||||||||||||||||||||
| United States | ||||||||||||||||||||||||||||||||||||||
| California | $ | $ | % | $ | $ | % | ||||||||||||||||||||||||||||||||
| New York | % | % | ||||||||||||||||||||||||||||||||||||
| New Jersey | % | % | ||||||||||||||||||||||||||||||||||||
| Georgia | % | % | ||||||||||||||||||||||||||||||||||||
| Washington | % | % | ||||||||||||||||||||||||||||||||||||
| Utah | % | % | ||||||||||||||||||||||||||||||||||||
| Arizona | % | % | ||||||||||||||||||||||||||||||||||||
| North Carolina | % | % | ||||||||||||||||||||||||||||||||||||
| Massachusetts | % | % | ||||||||||||||||||||||||||||||||||||
| Texas | % | % | ||||||||||||||||||||||||||||||||||||
| Allowance for credit losses | — | ( | ( | % | — | ( | ( | % | ||||||||||||||||||||||||||||||
| Total | $ | $ | % | $ | $ | % | ||||||||||||||||||||||||||||||||
Current Expected Credit Losses Reserve
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 $4.6 million increase to total reserve, including reserve on future funding commitments, which was recognized as a cumulative-effect adjustment to accumulated deficits as of January 1, 2023.
The following table presents the activity in allowance for credit loss for funded loans:
| Six Months Ended June 30, | ||||||||||||||
| 2023 | 2022 | |||||||||||||
| Allowance for credit losses, beginning of period | $ | $ | ||||||||||||
Cumulative effect of credit loss accounting standard effective | — | |||||||||||||
Provision for credit losses (1) | ||||||||||||||
| Charge-offs | ||||||||||||||
| Recoveries | ||||||||||||||
| Allowance for credit losses, end of period | $ | $ | ||||||||||||
20
Notes to Unaudited Consolidated Financial Statements
_______________
(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 loans contain provisions for future fundings, which are subject to the borrower meeting certain performance-related metrics that are monitored by the Company. These unfunded commitments amounted to approximately $53.2 million and $47.3 million as of June 30, 2023 and December 31, 2022, respectively. The following table presents the activity in the liability for credit losses on unfunded commitments:
| Six Months Ended June 30, 2023 | ||||||||
| Liability for credit losses on unfunded commitments, beginning of period | $ | |||||||
| 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 would reverse the accrued and unpaid interest against interest income and no longer accrues for interest. For the three and six months ended June 30, 2023 and 2022, the Company did not reverse any interest income accrual because all accrued interest income were deemed collectible. As of June 30, 2023 and 2022, the Company had three and two loans that were in default, and suspended interest income accrual of $3.7 million and $1.2 million for the three months ended June 30, 2023 and 2022, respectively, because recovery of such income was doubtful. For the six months ended June 30, 2023 and 2022, the Company suspended interest income accrual of $7.2 million and $2.3 million on three and two loans, respectively, because recovery of such income was doubtful. As of June 30, 2023 and December 31, 2022, there was no
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. As of June 30, 2023 and December 31, 2022, the Company had four 89.7 million and $89.9 million, respectively. The allowance for credit losses for these non-performing loans were $25.5
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 | |||||||
21
Notes to Unaudited Consolidated Financial Statements
| June 30, 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 | $ | |||||||||||||||||||||||||
_______________
Troubled Debt Restructuring
As of December 31, 2022, there was one investment that qualified as troubled debt restructuring.
In December 2022, the borrower of a $40.1 million senior loan experienced financial difficulty and offered to repay the loan for $38.7 million. The remaining $1.4 million was converted to subordinated equity that accrues dividends at 8.0 % and the Company is entitled to receive waterfall profit upon a sale. The Company does not anticipate a full recovery of the equity position and does not expect to receive any additional income. As a result, the remaining $1.4
22
Notes to Unaudited Consolidated Financial Statements
The following table summarizes the recorded investment of TDR as of the date of restructuring:
| Number of loans modified | ||||||||
| Pre-modified recorded carrying value | $ | |||||||
Post-modified recorded carrying value (1) | $ | |||||||
(1) As of June 30, 2023 and December 31, 2022, the principal balance of this loan was the same as the carrying value. The Company recorded an allowance for credit losses of $1.4 million to fully reserve for the unpaid principal balance. There was no income from this investment from the date of modification on December 28, 2022 through June 30, 2023.
Note 5. Equity Investment in Unconsolidated Investments
The Company owns interests in a limited partnership and three
Equity Investment in a Limited Partnership
On August 3, 2020, the Company entered into a subscription agreement with Mavik Real Estate Special Opportunities Fund, LP (“RESOF”) whereby the Company committed to fund up to $50.0 million to purchase a limited partnership interest in RESOF. RESOF’s primary investment objective is to generate attractive risk-adjusted returns by purchasing performing and non-performing mortgages, loans, mezzanines and other credit instruments supported by underlying commercial real estate assets. RESOF may also opportunistically originate high-yield mortgages or loans in real estate special situations including rescue financings, bridge loans, restructurings and bankruptcies (including debtor-in-possession loans). The general partner of RESOF is Mavik Real Estate Special Opportunities Fund GP, LLC, which is a subsidiary of the Company’s sponsor, Terra Capital Partners. As of June 30, 2023 and December 31, 2022, the unfunded commitment was $37.4 million and $22.4 million, respectively.
The Company evaluated its equity interest in RESOF and determined it does not have a controlling financial interest and is not the primary beneficiary. Accordingly, the equity interest in RESOF is accounted for as an equity method investment. As of June 30, 2023 and December 31, 2022, the Company owned 14.9 % and 27.9 % of the equity interest in RESOF, respectively. As of June 30, 2023 and December 31, 2022, the carrying value of the Company’s investment in RESOF was $18.1 million and $36.8 million, respectively. For the three and six months ended June 30, 2023, the Company recorded equity loss from RESOF of $1.2 million and $0.9 million, respectively, as a result of adjustments made to equity income due to the dilution in the Company’s ownership interest in RESOF as new investors were admitted in 2022 and 2023. For the three and six months ended June 30, 2023, the Company received distributions from RESOF of $0.9 million and $4.7 million, respectively. For the three and six months ended June 30, 2022, the Company recorded equity income from RESOF of $1.6 million and $2.9 million, respectively, and received no
In connection with the equity investment in RESOF, the Company paid origination fees to the Manager totaling $0.5 million, to be amortized to equity income on a straight-line basis over the life of RESOF.
23
Notes to Unaudited Consolidated Financial Statements
The following tables present summarized financial information of the Company’s equity investment in RESOF. Amounts provided are the total amounts attributable to the investment and do not represent the Company’s proportionate share:
| As of | ||||||||||||||
| June 30, 2023 | December 31, 2022 | |||||||||||||
Investments at fair value (cost of $ | $ | $ | ||||||||||||
| Other assets | ||||||||||||||
| Total assets | ||||||||||||||
| Revolving line of credit, net of financing costs | ||||||||||||||
Obligations under participation agreement (proceeds of $ $ | ||||||||||||||
| Other liabilities | ||||||||||||||
| Total liabilities | ||||||||||||||
| Partners’ capital | $ | $ | ||||||||||||
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
| 2023 | 2022 | 2023 | 2022 | ||||||||||||||||||||
| Total investment income | $ | $ | $ | $ | |||||||||||||||||||
| Total expenses | |||||||||||||||||||||||
| Net investment income | |||||||||||||||||||||||
| Unrealized (depreciation) appreciation on investments | ( | ( | |||||||||||||||||||||
| Provision for income tax | ( | ( | |||||||||||||||||||||
| Net increase in partners’ capital resulting from operations | $ | $ | $ | $ | |||||||||||||||||||
Equity Investment in Joint Ventures
As of June 30, 2023 and December 31, 2022, the Company beneficially owned equity interests in three 53 % effective interest in two joint ventures and 59 % effective interest in another joint venture for a total of $33.7 million and recognized a gain on sale of $0.8 million.
In December 2022, the Company originated a $10.0 million mezzanine loan to a borrower to finance the acquisition of a real estate portfolio. In connection with this mezzanine loan, the Company entered into a residual profit sharing agreement with the borrower where 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 this arrangement using the equity method of accounting. In May 2023, the Company purchased the underlying asset (Note 8) and the $10.0 million mezzanine loan was settled in connection with the purchase.
24
Notes to Unaudited Consolidated Financial Statements
The following table presents a summary of the Company’s equity investment in unconsolidated investments as of:
| June 30, 2023 | December 31, 2022 | |||||||||||||||||||||||||||||||
| Entity | Co-owner (1) | Beneficial Ownership Interest | Carrying Value | Beneficial Ownership Interest | Carrying Value | |||||||||||||||||||||||||||
LEL Arlington JV LLC (1) | Affiliate/Third party | $ | $ | |||||||||||||||||||||||||||||
LEL NW 49th JV LLC (1) | Affiliate/Third party | |||||||||||||||||||||||||||||||
TCG Corinthian FL Portfolio JV LLV (1)(2) | Affiliate/Third Party | |||||||||||||||||||||||||||||||
SF-Dallas Industrial, LLC (3) | N/A | N/A | N/A | |||||||||||||||||||||||||||||
| $ | $ | |||||||||||||||||||||||||||||||
_______________
(1)The Company sold a portion of the interest in this investment to an affiliate in September 2022.
(2)This investment was purchased from a third party in March 2022.
(3)This investment that meets the definition of an equity investment was entered into in December 2022. As discussed above, this investment was settled in May 2023.
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 | ||||||||||||||
| June 30, 2023 | December 31, 2022 | |||||||||||||
| Net investments in real estate | $ | $ | ||||||||||||
| Other assets | ||||||||||||||
| Total assets | ||||||||||||||
| Mortgage loan payable | ||||||||||||||
| Other liabilities | ||||||||||||||
| Total liabilities | ||||||||||||||
| Members’ capital | $ | $ | ||||||||||||
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
| 2023 | 2022 | 2023 | 2022 | ||||||||||||||||||||
| Revenues | $ | $ | $ | $ | |||||||||||||||||||
| Operating expenses | ( | ( | ( | ( | |||||||||||||||||||
| Depreciation and amortization expense | ( | ( | ( | ( | |||||||||||||||||||
| Interest expense | ( | ( | ( | ( | |||||||||||||||||||
| Unrealized (losses) gains | ( | ( | |||||||||||||||||||||
| Net (loss) income | $ | ( | $ | ( | $ | ( | $ | ( | |||||||||||||||
For the three and six months ended June 30, 2023, the Company recorded net equity loss from the joint ventures and the mezzanine loan of $0.6 million and $1.3 million, respectively, and did not receive any distributions from the joint ventures. For the three and six months ended June 30, 2022, the Company recorded equity income from the joint ventures of $0.2 million and $0.1 million, respectively, and received distributions from the joint venture of $0.4 million and $0.7 million, respectively. In connection with these investments, the Company paid origination fee to the Manager totaling $0.5 million, to be amortized to equity income over the life of the respective joint venture.
25
Notes to Unaudited Consolidated Financial Statements
Note 6. Real Estate Owned, Net
Real Estate Activities
2023 — During the three and six months ended June 30, 2023, the Company recorded an impairment charge of $11.8 million on the multi-tenant office building located in California in order to reduce the carrying value of the building to its estimated fair value.
Additionally, during the six months ended June 30, 2023, the Company entered into the following investments:
| Property Location | Number of Properties | Date of Acquisition | Property Type | Total Capitalized Costs | ||||||||||||||||||||||
| Texas, United States | 3/24/2023 | Industrial | $ | |||||||||||||||||||||||
| Texas, United States | 5/25/2023 | Industrial | ||||||||||||||||||||||||
| $ | ||||||||||||||||||||||||||
These acquisitions were deemed to be real estate asset acquisitions, and therefore total transaction costs were capitalized to the cost basis of the assets. The following table presents an allocation of the total capitalized costs:
| Total Capitalized Costs: | ||||||||
| Cash and cash equivalents | $ | |||||||
| Loans held for investment | ||||||||
| Equity investment in unconsolidated investment | ||||||||
| Interest receivable | ||||||||
| Other assets | ||||||||
| $ | ||||||||
| Net Assets Acquired | ||||||||
| Cash and cash equivalents | $ | |||||||
| Other assets | ||||||||
| Land | ||||||||
| Buildings and Improvements | ||||||||
| Intangible assets and liabilities: | ||||||||
In-place lease (weighted-average expected life of | ||||||||
Below-market rent (weighted-average expected life of | ( | |||||||
| Accounts payable and accrued expenses | ( | |||||||
| $ | ||||||||
2022 — In June 2022, the Company sold the 4.9 acres of land it owned in Pennsylvania for net proceeds of $8.6 million, and recognized a net loss on sale of $0.1 million excluding impairment charges of $1.6 million and $3.4 million recognized in March 2022 and December 2021, respectively.
26
Notes to Unaudited Consolidated Financial Statements
Real Estate Owned, Net
Real estate owned is comprised of eight industrial buildings located in Texas and a multi-tenant office building located in California, with lease intangible assets and liabilities. The following table presents the components of real estate owned, net as of:
| June 30, 2023 | December 31, 2022 | ||||||||||||||||||||||||||||||||||
| Cost | Accumulated Depreciation/Amortization | Net | Cost | Accumulated Depreciation/Amortization | Net | ||||||||||||||||||||||||||||||
| Real estate: | |||||||||||||||||||||||||||||||||||
| Land | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
| Building and building improvements | ( | ( | |||||||||||||||||||||||||||||||||
| Tenant improvements | ( | ( | |||||||||||||||||||||||||||||||||
| Furniture and fixtures | ( | ( | |||||||||||||||||||||||||||||||||
| Total real estate | ( | ( | |||||||||||||||||||||||||||||||||
| Lease intangible assets: | |||||||||||||||||||||||||||||||||||
| In-place lease | ( | ( | |||||||||||||||||||||||||||||||||
| Above-market rent | ( | ( | |||||||||||||||||||||||||||||||||
| Total intangible assets | ( | ( | |||||||||||||||||||||||||||||||||
| Lease intangible liabilities: | |||||||||||||||||||||||||||||||||||
| Below-market rent | ( | ( | ( | ( | |||||||||||||||||||||||||||||||
| Above-market ground lease | ( | ( | ( | ( | |||||||||||||||||||||||||||||||
| Total intangible liabilities | ( | ( | ( | ( | |||||||||||||||||||||||||||||||
| Total real estate | $ | $ | ( | $ | $ | $ | ( | $ | |||||||||||||||||||||||||||
Real Estate Operating Revenues and Expenses
The following table presents the components of real estate operating revenues and expenses that are included in the consolidated statements of operations:
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
| 2023 | 2022 | 2023 | 2022 | ||||||||||||||||||||
| Real estate operating revenues: | |||||||||||||||||||||||
| Lease revenue | $ | $ | $ | $ | |||||||||||||||||||
| Other operating income | |||||||||||||||||||||||
| Total | $ | $ | $ | $ | |||||||||||||||||||
| Real estate operating expenses: | |||||||||||||||||||||||
| Utilities | $ | $ | $ | $ | |||||||||||||||||||
| Real estate taxes | |||||||||||||||||||||||
| Repairs and maintenances | |||||||||||||||||||||||
| Management fees | |||||||||||||||||||||||
| Lease expense, including amortization of above-market ground lease | |||||||||||||||||||||||
| Other operating expenses | |||||||||||||||||||||||
| Total | $ | $ | $ | $ | |||||||||||||||||||
Leases
As of June 30, 2023, the Company owned eight industrial buildings that were leased to ten tenants and a multi-tenant office building that was leased to three tenants. As of December 31, 2022, the Company owned a multi-tenant office building that was leased to three tenants. In addition, the office building is subject to a ground lease whereby the Company is the lessee (or a
27
Notes to Unaudited Consolidated Financial Statements
tenant) to the ground lease. The ground lease had a remaining lease term of 63.3 years as of June 30, 2023, and provides for a new base rent every 5 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. The Company is currently 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 – Terra Ocean Ave., LLC v. Ocean Avenue Santa Monica Realty LLC, Superior Court of California, Los Angeles County, Case No. 20STCV34217. The Company believes this determination should be based on comparable sales, while the landlord insists that the rent under the ground lease itself is also relevant. The Company’s position has prevailed in all three of the prior arbitrations to reset the ground rent. Since future rent reset determinations under the ground lease cannot be known at this time, the Company did not include any potential future rent increases in calculating the present value of future rent payments. The Company intends vigorously to pursue the litigation. While the Company believes its arguments will likely prevail, the outcome of the legal proceeding cannot be predicted with certainty. If the landlord prevails, the future rent reset determinations could result in significantly higher ground rent, which would likely result in a significant diminution in the value of the Company’s interest in the ground lease and the office building.
Scheduled Future Minimum Rent Income
| Years Ending December 31, | Total | |||||||
| 2023 (July 1 through December 31) | $ | |||||||
| 2024 | ||||||||
| 2025 | ||||||||
| 2026 | ||||||||
| 2027 | ||||||||
| Thereafter | ||||||||
| Total | $ | |||||||
Scheduled Annual Net Amortization of Intangibles
| Years Ending December 31, | Net Decrease in Real Estate Operating Revenue (1) | Increase in Depreciation and Amortization (1) | Decrease in Rent Expense (1) | Total | ||||||||||||||||||||||
| 2023 (July 1 through December 31) | $ | ( | $ | $ | ( | $ | ||||||||||||||||||||
| 2024 | ( | ( | ||||||||||||||||||||||||
| 2025 | ( | ( | ||||||||||||||||||||||||
| 2026 | ( | ( | ||||||||||||||||||||||||
| 2027 | ( | ( | ||||||||||||||||||||||||
| Thereafter | ( | ( | ( | |||||||||||||||||||||||
| Total | $ | ( | $ | $ | ( | $ | ( | |||||||||||||||||||
_______________
(1)Amortization of below-market rent and above-market rent intangibles is recorded as an adjustment to lease revenues; amortization of in-place lease intangibles is included in depreciation and amortization; and amortization of above-market ground lease is recorded as a reduction to rent expense.
28
Notes to Unaudited Consolidated Financial Statements
Supplemental Ground Lease Disclosures
| June 30, 2023 | December 31, 2022 | ||||||||||
| Operating lease | |||||||||||
| Operating lease right-of-use asset | $ | $ | |||||||||
| Operating lease liability | $ | $ | |||||||||
| Weighted average remaining lease term — operating lease (years) | |||||||||||
| Weighted average discount rate — operating lease | % | % | |||||||||
| Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||||||||||||
| 2023 | 2022 | 2023 | 2022 | |||||||||||||||||||||||
| Operating lease cost | $ | $ | $ | $ | ||||||||||||||||||||||
Supplemental non-cash information related to the ground lease was as follows:
| Six Months Ended June 30, | |||||||||||
| 2023 | 2022 | ||||||||||
| Amounts included in the measurement of lease liability: | |||||||||||
| Operating cash flows from an operating lease | $ | $ | |||||||||
| Right-of-use asset obtained in exchange for lease obligations: | |||||||||||
| Operating lease | $ | $ | |||||||||
| Years Ending December 31, | Operating Lease | |||||||
| 2023 (July 1 through December 31) | $ | |||||||
| 2024 | ||||||||
| 2025 | ||||||||
| 2026 | ||||||||
| 2027 | ||||||||
| Thereafter | ||||||||
| Total lease payments | ||||||||
| Less: Imputed interest | ( | |||||||
| Total | $ | |||||||
Note 7. Fair Value Measurements
29
Notes to Unaudited Consolidated Financial Statements
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 are 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 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 considers factors specific to the investment.
As of June 30, 2023 and December 31, 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, held-to-maturity debt securities, obligations under participation agreements, term loan payable, repurchase agreement payable, mortgage loan payable and revolving line of credit. Such financial instruments are carried at cost, less impairment or less net deferred costs, where applicable. Marketable securities and derivatives are financial instruments that are reported at fair value.
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, which are presented at fair value and included in Other assets in 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.
As discussed in Note 9, in March 2023, the Company entered into a loan agreement with a lender to provide financing for the acquisition of real estate properties (Note 6). In connection with the financing, the Company purchased an interest rate cap for $258,500 to effectively cap the related index rate at 5.0 %. The interest rate cap met all the criteria of a derivative under ASC 815, but it did not meet the criteria under ASC 815-20-25 to qualify for hedging accounting. As such, the interest rate cap is reported at fair value and is included in other assets in the consolidated balance sheet, and the change in the fair value of the interest rate cap is reported in income.
The following tables present fair value measurements of marketable securities and derivatives, by major class according to the fair value hierarchy as of:
| June 30, 2023 | ||||||||||||||||||||||||||
| Fair Value Measurements | ||||||||||||||||||||||||||
| Level 1 | Level 2 | Level 3 | Total | |||||||||||||||||||||||
Money market fund (1) | $ | $ | $ | $ | ||||||||||||||||||||||
Marketable securities - debt securities (2) | ||||||||||||||||||||||||||
Derivative - interest rate cap (2) | ||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | ||||||||||||||||||||||
30
Notes to Unaudited Consolidated Financial Statements
(1) Amount is included in cash and cash equivalents on the consolidated balance sheets.
(2) Amount is included in other assets on the consolidated balance sheets.
| December 31, 2022 | ||||||||||||||||||||||||||
| Fair Value Measurements | ||||||||||||||||||||||||||
| Level 1 | Level 2 | Level 3 | Total | |||||||||||||||||||||||
| Marketable Securities: | ||||||||||||||||||||||||||
| Debt securities | $ | $ | $ | $ | ||||||||||||||||||||||
| Total | $ | $ | $ | $ | ||||||||||||||||||||||
The following table presents the activities of the marketable securities and derivatives:
| Six Months Ended June 30, | ||||||||||||||||||||
| 2023 | 2022 | |||||||||||||||||||
| Marketable Securities | Derivatives | Marketable Securities | ||||||||||||||||||
| Beginning balance | $ | $ | $ | |||||||||||||||||
| Purchases | ||||||||||||||||||||
| Proceeds from sale | ( | |||||||||||||||||||
| Amortization of interest rate cap | ( | |||||||||||||||||||
| Reclassification of net realized gains on marketable securities into earnings | ||||||||||||||||||||
| Unrealized (losses) gains on marketable securities and derivatives | ( | |||||||||||||||||||
| Ending balance | $ | $ | $ | |||||||||||||||||
Financial Instruments Not Carried at Fair Value
In the first quarter of 2023, the Company purchased $20.0 million of corporate bonds with a coupon rate of 6.125 % with a maturity date of 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.
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:
| June 30, 2023 | December 31, 2022 | ||||||||||||||||||||||||||||||||||||||||
| Level | Principal Amount | Carrying Value | Fair Value | Principal Amount | Carrying Value | Fair Value | |||||||||||||||||||||||||||||||||||
| Loans: | |||||||||||||||||||||||||||||||||||||||||
| Loans held for investment | 3 | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||||
| Loans held for investment acquired through participation | 3 | ||||||||||||||||||||||||||||||||||||||||
| Allowance for loan losses | — | ( | — | — | ( | — | |||||||||||||||||||||||||||||||||||
| Total loans | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||||||||
| Liabilities: | |||||||||||||||||||||||||||||||||||||||||
| Term loan payable | 3 | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||||
| Unsecured notes payable | 1 | ||||||||||||||||||||||||||||||||||||||||
| Repurchase agreement payable | 3 | ||||||||||||||||||||||||||||||||||||||||
| Obligations under participation agreements | 3 | ||||||||||||||||||||||||||||||||||||||||
| Mortgage loan payable | 3 | ||||||||||||||||||||||||||||||||||||||||
| Revolving line of credit payable | 3 | ||||||||||||||||||||||||||||||||||||||||
| Total liabilities | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||||||||
31
Notes to Unaudited Consolidated Financial Statements
The Company estimated that its other financial assets and liabilities, not included in the tables above, had fair values that approximated their carrying values at both June 30, 2023 and December 31, 2022 due to their short-term nature.
Items Measured at Fair Value on a Non-Recurring Basis (Including Impairment Charges)
The Company periodically assesses whether there are any indicators that the value of its real estate investments may be impaired or that their carrying value may not be recoverable (Note 2).
The following tables present information about assets for which the Company recorded an impairment charge and that were measured at fair value on a non-recurring basis:
| Three Months Ended June 30, | ||||||||||||||||||||||||||
| 2023 | 2022 | |||||||||||||||||||||||||
| Fair Value | Impairment Charges | Fair Value | Impairment Charges | |||||||||||||||||||||||
| Impairment Charges | ||||||||||||||||||||||||||
| Real estate and intangibles | $ | $ | $ | $ | ||||||||||||||||||||||
| $ | $ | |||||||||||||||||||||||||
| Six Months Ended June 30, | ||||||||||||||||||||||||||
| 2023 | 2022 | |||||||||||||||||||||||||
| Fair Value | Impairment Charges | Fair Value | Impairment Charges | |||||||||||||||||||||||
| Impairment Charges | ||||||||||||||||||||||||||
| Real estate and intangibles | $ | $ | $ | $ | ||||||||||||||||||||||
| $ | $ | |||||||||||||||||||||||||
Impairment charges, and their related triggering events and fair value measurements, recognized during the three and six months ended June 30, 2023 and 2022 were as follows:
Real Estate and Intangibles
The impairment charges described below are reflected within Impairment charges in the consolidated statements of operations.
During the three and six months ended June 30, 2023, the Company recorded an impairment charge of $11.8 million on the multi-tenant office building located in California in order to reduce the carrying value of the building to its estimated fair value. The fair value measurement was determined by estimating discounted cash flows using two significant unobservable inputs, which were the cash flow discount rate (8.50 %) and terminal capitalization rate (7.50 %).
For the six months June 30, 2022, the Company recorded an impairment charge of $1.6 million on the 4.9 acres of land located in Pennsylvania to reduce the carrying value of the land to its estimated fair value, which was based on the selling price in the purchase and sale agreement. The land was sold in June 2022. There was no impairment charge recorded for the three months ended June 30, 2022.
Valuation Process for Fair Value Measurement
The fair value of the Company’s investment in equity securities, held-to-maturity debt securities and its unsecured notes payable is determined based on quoted prices in an active market and is classified as Level 1 of the fair value hierarchy.
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, and therefore 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, which may include available current market data on applicable yields of comparable debt/preferred equity instruments; market credit
32
Notes to Unaudited Consolidated Financial Statements
spreads and yield curves; the investment’s yield; covenants of the investment, including prepayment provisions; the portfolio company’s ability 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.
The Manager designates a valuation committee to oversee the entire valuation process of the Company’s Level 3 loans. The valuation committee is comprised of members of the Manager’s senior management, deal and portfolio management teams, who meet on a quarterly basis, or more frequently as needed, to review the Company investments being valued as well as the inputs used in the proprietary valuation model. Valuations determined by the valuation committee are supported by pertinent data and, in addition to a proprietary valuation model, are based on market data, industry accepted third-party valuation models and discount rates or other methods the valuation committee deems to be appropriate. Because there is no readily available market for these investments, the fair values of these investments are approved in good faith by the Company’s board of directors (which is made up exclusively of independent directors).
The fair values of the Company’s mortgage loan payable, secured borrowing, term loan payable and revolving line of credit are determined by discounting the contractual cash flows at the interest rate the Company estimates such arrangements would bear if executed in the current market.
The following tables summarize the valuation techniques and significant unobservable inputs used by the Company to value the Level 3 loans as of June 30, 2023 and December 31, 2022. The tables are not intended to be all-inclusive, but instead identify the significant unobservable inputs relevant to the determination of fair values.
| Fair Value at June 30, 2023 | Primary Valuation Technique | Unobservable Inputs | June 30, 2023 | |||||||||||||||||||||||||||||
| Asset Category | Minimum | Maximum | Weighted Average | |||||||||||||||||||||||||||||
| Assets: | ||||||||||||||||||||||||||||||||
| Loans held for investment, net | $ | Discounted cash flow | Discount rate | % | % | % | ||||||||||||||||||||||||||
| Loans held for investment acquired through participation, net | Discounted cash flow | Discount rate | % | % | % | |||||||||||||||||||||||||||
| Total Level 3 Assets | $ | |||||||||||||||||||||||||||||||
| Liabilities: | ||||||||||||||||||||||||||||||||
| Repurchase agreement payable | Discounted cash flow | Discount rate | % | % | % | |||||||||||||||||||||||||||
| Obligations under participation agreements | Discounted cash flow | Discount rate | % | % | % | |||||||||||||||||||||||||||
| Mortgage loan payable | Discounted cash flow | Discount rate | % | % | % | |||||||||||||||||||||||||||
| Term loan payable | Discounted cash flow | Discount rate | % | % | % | |||||||||||||||||||||||||||
| Revolving line of credit | Discounted cash flow | Discount rate | % | % | % | |||||||||||||||||||||||||||
| Total Level 3 Liabilities | $ | |||||||||||||||||||||||||||||||
| Fair Value at December 31, 2022 | Primary Valuation Technique | Unobservable Inputs | December 31, 2022 | |||||||||||||||||||||||||||||
| Asset Category | Minimum | Maximum | Weighted Average | |||||||||||||||||||||||||||||
| Assets: | ||||||||||||||||||||||||||||||||
| Loans held for investment, net | $ | Discounted cash flow | Discount rate | % | % | % | ||||||||||||||||||||||||||
| Loans held for investment acquired through participation, net | Discounted cash flow | Discount rate | % | % | % | |||||||||||||||||||||||||||
| Total Level 3 Assets | $ | |||||||||||||||||||||||||||||||
| Liabilities: | ||||||||||||||||||||||||||||||||
| Repurchase agreement payable | Discounted cash flow | Discount rate | % | % | % | |||||||||||||||||||||||||||
| Obligations under participation agreements | Discounted cash flow | Discount rate | % | % | % | |||||||||||||||||||||||||||
| Mortgage loan payable | Discounted cash flow | Discount rate | % | % | % | |||||||||||||||||||||||||||
| Term loan payable | Discounted cash flow | Discount rate | % | % | % | |||||||||||||||||||||||||||
| Revolving line of credit | Discounted cash flow | Discount rate | % | % | % | |||||||||||||||||||||||||||
| Total Level 3 Liabilities | $ | |||||||||||||||||||||||||||||||
33
Notes to Unaudited Consolidated Financial Statements
Note 8. Related Party Transactions
Management Agreement
The Company entered into the Management Agreement with the Manager whereby the Manager is responsible for its day-to-day operations. The Management Agreement runs co-terminus with the amended and restated operating agreement for Terra Fund 5, which is scheduled to terminate on December 31, 2023 unless Terra Fund 5 is dissolved earlier. The following table presents a summary of fees paid and costs reimbursed to the Manager in connection with providing services to the Company that are included on the consolidated statements of operations:
| Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||||||||||||
| 2023 | 2022 | 2023 | 2022 | |||||||||||||||||||||||
Origination and extension fee expense (1)(2) | $ | $ | $ | $ | ||||||||||||||||||||||
| Asset management fee | ||||||||||||||||||||||||||
| Asset servicing fee | ||||||||||||||||||||||||||
| Operating expenses reimbursed to Manager | ||||||||||||||||||||||||||
Disposition fee (3) | ||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | ||||||||||||||||||||||
_______________
(1)Origination and extension fee expense is generally offset with origination and extension fee income. Any excess is deferred and amortized to interest income over the term of the loan.
(2)Amount for the six months ended June 30, 2023 excluded $0.5 million of origination fee paid to the Manager in connection with the acquisition of the three industrial buildings in 2023. Amount for the six months ended June 30, 2022 excluded $0.2 million of origination fee paid to the Manager in connection with the Company’s equity investment in an unconsolidated investment. This origination fee was capitalized to the carrying value of the unconsolidated investment as a transaction cost.
Origination and Extension Fee Expense
Pursuant to the Management Agreement, the Manager or its affiliates receives an origination fee in the amount of 1 % of the amount used to originate, fund, acquire or structure real estate-related investments, including any third-party expenses related to such loans. In the event that the term of any real estate-related loan held by the Company is extended, the Manager also receives an extension fee equal to the lesser of (i) 1 % of the principal amount of the loan being extended or (ii) the amount of fee paid to the Company by the borrower in connection with such extension.
Asset Management Fee
Under the terms of the Management Agreement, the Manager or its affiliates provides the Company with certain investment management services in return for a management fee. The Company pays a monthly asset management fee at an annual rate of 1 % of the aggregate funds under management, which includes the loan origination price or aggregate gross acquisition price, as defined in the Management Agreement, for each real estate related loan and cash held by the Company.
Asset Servicing Fee
The Manager or its affiliates receives from the Company a monthly servicing fee at an annual rate of 0.25 % of the aggregate gross origination price or acquisition price, as defined in the Management Agreement, for each real estate-related loan held by the Company.
Transaction Breakup Fee
In the event that the Company receives 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, the Manager 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 the Manager with respect to its evaluation and pursuit of such transactions. As of June 30, 2023 and December 31, 2022, the Company had not
34
Notes to Unaudited Consolidated Financial Statements
Operating Expenses
The Company reimburses the Manager for operating expenses incurred in connection with services provided to the operations of the Company, including the Company’s allocable share of the Manager’s overhead, such as rent, employee costs, utilities, and technology costs.
Disposition Fee
Pursuant to the Management Agreement, the Manager or its affiliates receives a disposition fee in the amount of 1 % of the gross sale price received by the Company from the disposition of any real estate-related loan, or any portion of, or interest in, any real estate-related loan. The disposition fee is paid concurrently with the closing of any such disposition of all or any portion of any real estate-related loan or any interest therein, which is the lesser of (i) 1 % of the principal amount of the loan or debt-related loan prior to such transaction or (ii) the amount of the fee paid by the borrower in connection with such transaction. If the Company takes ownership of a property as a result of a workout or foreclosure of a loan, the Company will pay a disposition fee upon the sale of such property equal to 1 % of the sales price.
Cost Sharing and Reimbursement Agreement
The Company and Terra LLC have entered into a cost sharing and reimbursement agreement effective October 1, 2022, pursuant to which Terra LLC is responsible for its allocable share of the Company’s expenses, including fees paid by the Company to the Manager based on relative assets under management. These fees are eliminated in consolidation and therefore have no impact on the Company’s consolidated financial statements.
Distributions Paid
For the three months ended June 30, 2023 and 2022, the Company made distributions to investors totaling $4.7 million and $3.8 million, respectively, of which $4.7 million and $2.8 million were returns of capital, respectively. For the six months ended June 30, 2023 and 2022, the Company made distributions to investors totaling $9.3 million and $7.7 million, respectively, of which $8.8 million and $5.7 million were returns of capital, respectively (Note 11).
Due to Manager
As of June 30, 2023 and December 31, 2022, approximately $3.4 million and $3.9 million, respectively, was due to the Manager, as reflected on the consolidated balance sheets, primarily related to the present value of the disposition fees on individual loans due to the Manager.
Mavik Real Estate Special Opportunities Fund, LP
On August 3, 2020, the Company entered into a subscription agreement with RESOF whereby the Company committed to fund up to $50.0 million to purchase limited partnership interests in RESOF. For more information on this investment, please see Note 5.
Participation Agreements
In the normal course of business, the Company may enter into participation agreements with related parties, primarily other affiliated funds managed by the Manager, and to a lesser extent, unrelated parties (the “Participants”). The purpose of the participation agreements is to allow the Company and an affiliate to originate a specified loan 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 a loan held by another entity.
ASC 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 860 (See “Participation interests” in Note 2 and “Obligations under Participation Agreements and Secured Borrowing” in (Note 9).
35
Notes to Unaudited Consolidated Financial Statements
Participation Interests Purchased by the Company
From time to time, the Company may purchase investments from affiliates pursuant to participation agreements. In accordance with the terms of each participation agreement, each Participant’s rights and obligations, as well as the proceeds received from the related borrower/issuer of the loan, are based upon their respective pro rata participation interest in the loan.
The table below lists the participation interests purchased by the Company pursuant to participation agreements as of:
| June 30, 2023 | ||||||||||||||||||||
| Participating Interests | Principal Balance | Carrying Value | ||||||||||||||||||
Mesa AZ Industrial Owner, LLC (1) | $ | $ | ||||||||||||||||||
UNJ Sole Member, LLC (1) | ||||||||||||||||||||
| Allowance for credit losses | — | ( | ||||||||||||||||||
| $ | $ | |||||||||||||||||||
| December 31, 2022 | ||||||||||||||||||||
| Participating Interests | Principal Balance | Carrying Value | ||||||||||||||||||
Havemeyer TSM LLC (1)(2) | $ | $ | ||||||||||||||||||
Mesa AZ Industrial Owner, LLC (1) | ||||||||||||||||||||
UNJ Sole Member, LLC (1) | ||||||||||||||||||||
| $ | $ | |||||||||||||||||||
________________
(1)The loan is held in the name of Mavik Real Estate Special Opportunities Fund REIT, LLC, a related-party REIT managed by the Manager.
(2)This loan was repaid in February 2023.
Transfers of Participation Interest by the Company
| Transfers Treated as Obligations Under Participation Agreements as of June 30, 2023 | |||||||||||||||||||||||||||||
| Principal Balance | Carrying Value | % Transferred | Principal Balance | Carrying Value | |||||||||||||||||||||||||
610 Walnut Investors LLC (1) | $ | $ | % | $ | $ | ||||||||||||||||||||||||
| $ | $ | $ | $ | ||||||||||||||||||||||||||
| Transfers Treated as Obligations Under Participation Agreements as of December 31, 2022 | |||||||||||||||||||||||||||||
| Principal Balance | Carrying Value | % Transferred | Principal Balance | Carrying Value | |||||||||||||||||||||||||
610 Walnut Investors LLC (1) | $ | $ | % | $ | $ | ||||||||||||||||||||||||
| $ | $ | $ | $ | ||||||||||||||||||||||||||
________________
(1)Participant was a third party.
These investments are held in the name of the Company, but each of the Participant’s rights and obligations, including interest income and other income (e.g., exit fee, prepayment income) and related fees/expenses (e.g., disposition fees, asset management and asset servicing fees), are based upon their respective pro rata participation interest in such participated investments, as specified in the respective participation agreement. The Participants’ share of the investments is repayable only
36
Notes to Unaudited Consolidated Financial Statements
Note 9. Debt
Unsecured Notes Payable
The 6.00 % Senior Notes Due 2026
On June 10, 2021, the Company issued $78.5 million in aggregate principal amount of its 6.00 % notes due 2026 (the “initial note”), for net proceeds of $76.0 million after deducting underwriting commissions of $2.5 million, but before offering expenses payable by the Company. On June 25, 2021, the underwriters partially exercised their option to purchase an additional $6.6 million of the notes for net proceeds of $6.4 million (the “additional notes” and, together with the initial notes, the “6.00 % Senior Notes Due 2026”), after deducting underwriting commissions of $0.2 million, but before offering expenses payable by us, which closed on June 29, 2021. Interest on the 6.00 % Senior Notes Due 2026 is paid quarterly in arrears every March 30, June 30, September 30 and December 30, at a fixed rate of 6.00 % per year, beginning September 30, 2021. The 6.00 % Senior Notes Due 2026 mature on June 30, 2026, unless redeemed earlier by the Company, and may be redeemed in whole or in part at any time or from time to time at the Company’s option on or after June 10, 2023.
In connection with the issuance of the 6.00 % Senior Notes Due 2026, the Company entered into (i) an Indenture, dated June 10, 2021 (the “Base Indenture”), by and between the Company and U.S. Bank National Association, as trustee (the “Trustee”), and (ii) the First Supplemental Indenture thereto, dated June 10, 2021 (the “Supplemental Indenture” and, collectively with the Base Indenture, the “Indenture”), by and between the Company and the Trustee. The Indenture contains certain covenants that, among other things, limit the ability of the Company, subject to exceptions, to make distributions in excess of 90% of the Company’s taxable income, incur indebtedness (as defined in the Indenture) or purchase shares of the Company’s capital stock unless the Company has an asset coverage ratio (as defined in the Indenture) of at least 150 % after giving effect to such transaction. The Indenture also provides for customary events of default which, if any of them occurs, would permit or require the principal of and accrued interest on the notes to become or to be declared due and payable. As of June 30, 2023 and December 31, 2022, the Company was in compliance with the covenants included in the Indenture.
The 7.00 % Senior Notes Due 2026
As previously reported by Terra BDC, on February 10, 2021, Terra BDC issued $34.8 million in aggregate principal amount of 7.00 % fixed-rate notes due 2026, for net proceeds of $33.7 million after deducting underwriting commissions of $1.1 million and 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 (collectively the “7.00 % Senior Notes Due 2026”).
Pursuant to the Merger Agreement, Terra LLC agreed to take all necessary action to assume the payment of the principal of and interest on all of the 7.00 % Senior Notes Due 2026 outstanding as of the Effective Time and the performance of every covenant of the Indenture, dated February 10, 2021 (the “TIF6 Indenture”), between Terra BDC and the Trustee, as supplemented by the First Supplemental Indenture, dated February 10, 2021, by and between Terra BDC and the Trustee (the “First Supplemental Indenture”), to be performed or observed by Terra BDC, including, without limitation, the execution and delivery to the Trustee of a supplement to the TIF6 Indenture in form satisfactory to the Trustee.
On the Closing Date, Terra BDC, Terra LLC and the Trustee entered into a Second Supplemental Indenture pursuant to which Terra LLC assumed the payment of the 7.00 % Senior Notes Due 2026 and the performance of every covenant of the TIF6 Indenture, as supplemented by the First Supplemental Indenture, to be performed or observed by Terra BDC.
The 7.00 % Senior Notes Due 2026 will mature on March 31, 2026, unless earlier repurchased or redeemed. The 7.00 % Senior Notes Due 2026 bear interest at a rate of 7.00 % per annum, payable on March 30, June 30, September 30 and December 30 of each year. The 7.00 % Senior Notes Due 2026 are Terra LLC’s direct unsecured obligations and rank pari passu with all outstanding and future unsecured unsubordinated indebtedness issued by Terra LLC; effectively subordinated in right of payment to any of Terra LLC’s existing and future secured indebtedness to the extent of the value of the assets securing such indebtedness; and structurally subordinated to all existing and future indebtedness and other obligations of any of Terra LLC’s subsidiaries and financing vehicles. Terra LLC may redeem the 7.00 % Senior Notes Due 2026 in whole or in part at any time
37
Notes to Unaudited Consolidated Financial Statements
on or after February 10, 2023, at a redemption price equal to 100 % of the outstanding principal amount thereof, plus accrued and unpaid interest.
The TIF6 Indenture contains certain covenants that, among other things, limit the ability of Terra LLC, subject to exceptions, to incur indebtedness in violation of the 1940 Act, and to make distributions, incur indebtedness or repurchase shares of Terra LLC’s capital stock unless it satisfies asset coverage requirements set forth in the First Supplemental Indenture after giving effect to such transaction. The TIF6 Indenture also provides for customary events of default which, if any of them occurs, would permit or require the principal of and accrued interest on the 7.00 % Senior Notes Due 2026 to become or to be declared due and payable.
Summarized Information
The table below presents detailed information regarding the unsecured notes payable as of:
| June 30, 2023 | December 31, 2022 | |||||||||||||||||||||||||||||||||||||
| Principal Balance | Carrying Value | Fair Value | Principal Balance | Carrying Value | Fair Value | |||||||||||||||||||||||||||||||||
| $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||||||
| $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||||||
_______________
(1)Carrying value is net of unamortized issue discount of $1.7 million and $1.9 million, and unamortized deferred financing costs of $0.6 million and $0.7 million as of June 30, 2023 and December 31, 2022, respectively.
(2)Carrying value is net of unamortized purchase discount of $3.8 million and $4.3 million as of June 30, 2023 and December 31, 2022, respectively.
Revolving Line of Credit
On March 12, 2021, Terra Mortgage Portfolio II, LLC, an indirect wholly-owned subsidiary of the Company, entered into a Business Loan and Security Agreement (the “Revolving Line of Credit”) with Western Alliance Bank (“WAB”) to provide for advances up to the lesser of $75.0 million or the amount determined by the borrowing base, which is based on the eligible assets pledged to the lender. Prior to March 31, 2023 borrowings under the Revolving Line of Credit bore interest at an annual rate of LIBOR + 3.25 % with a combined floor of 4.0 %. In connection with the transition of LIBOR, on March 31, 2023, the Revolving Line of Credit was amended and the interest rate was changed to Term SOFR + 3.35 % with a combined floor of 6.0 %. The Revolving Line of Credit was scheduled to mature on March 12, 2023. On January 4, 2022, the Company amended the Revolving Line of Credit to increase the maximum amount available to $125.0 million and extended the maturity date of the facility to March 12, 2024 with an annual 12-month extension available at the Company’s option, which are subject to certain conditions. On August 3, 2022, the Company further amended the Revolving Line of Credit to increase the borrowing sub-limit in New York City and to allow for loans acquired through participation agreements as eligible assets.
In connection with the Revolving Line of Credit, the Company entered into a limited guaranty (the “Guaranty”) in favor of WAB, pursuant to which the Company guarantees the payment of up to 25 % of the amount outstanding under the Revolving Line of Credit. Under the Revolving Line of Credit and the Guaranty, the Company is required to maintain (i) a minimum total net worth of $250.0 million; (ii) a $3.5 million quarterly operating profit, as defined within the agreement; and (iii) a ratio of total debt to total net worth of no more than 2.50 to 1.00. As of June 30, 2023 and December 31, 2022, the Company was in compliance with these covenants.
The Revolving Line of Credit contains terms, conditions, covenants, and representations and warranties that are customary and typical for a transaction of this nature. The Revolving Line of Credit contains various affirmative and negative covenants, including maintenance of a debt to total net worth ratio and limitations on the incurrence of liens and indebtedness, loans, distributions, change of management and ownership, changes in the nature of business and transactions with affiliates.
The Revolving Line of Credit also includes customary events of default, including a cross-default provision applicable to debt obligations of Terra Mortgage Portfolio II, LLC or the Company. The occurrence of an event of default may result in termination of the Revolving Line of Credit and acceleration of amounts due under the Revolving Line of Credit.
38
Notes to Unaudited Consolidated Financial Statements
In connection with the closing of the Revolving Line of Credit, the Company also incurred financing fees of $0.6 million, to be amortized to interest expense over the life of the Revolving Line of Credit.
As of June 30, 2023 and December 31, 2022, borrowings under the Revolving Line of Credit were $105.4 million and $90.1 million, respectively, collateralized by $165.6 million and $177.4 million of eligible assets, respectively. For the six months ended June 30, 2023 and 2022, the Company received proceeds from the Revolving Line of Credit of $57.0 million and $41.2 million, respectively, and made repayments of $41.7 million and $30.9 million, respectively.
Repurchase Agreements
UBS Master Repurchase Agreement
On November 8, 2021, Terra Mortgage Capital III, LLC (the “Seller”), a special-purpose indirect wholly-owned subsidiary of the Company, entered into an Uncommitted Master Repurchase Agreement (the “UBS Master Repurchase Agreement”) with UBS AG ( the “Buyer”). The UBS Master Repurchase Agreement provides for advances of up to $195 million in the aggregate, which the Company expects to use to finance certain secured performing commercial real estate loans, including senior mortgage loans, where the underlying mortgaged properties consist of value-added assets with loan-to-value ratio between 65 % and 80 % that are typically yielding between 2.5 % and 5.0 %.
Advances under the UBS Master Repurchase Agreement accrue interest at a per annum pricing rate equal to the sum of (i) the 30-day LIBOR or Term SOFR if LIBOR is not available and (ii) the applicable spread, which ranges from 1.60 % to 2.25 %, and have a maturity date of November 7, 2024. The actual terms of financing for each asset will be determined at the time of financing in accordance with the UBS Master Repurchase Agreement. Subject to satisfaction of certain conditions, the Seller may extend the maturity date of the UBS Master Repurchase Agreement annually thereafter on mutually agreeable terms. In connection with the UBS Master Repurchase Agreement, the Company incurred deferred financing costs of $0.6 million, which are being amortized to interest expense over the term of the facility.
The UBS Master Repurchase Agreement contains margin call provisions that provide the Buyer with certain rights in the event of a decline in the credit of the underlying assets purchased under the UBS Master Repurchase Agreement. Upon the occurrence of a margin deficit event, the Buyer may require the Seller to make a payment to reduce the purchase price to eliminate any margin deficit.
In connection with the UBS Master Repurchase Agreement, the Company entered into a Guarantee Agreement in favor of the Buyer (the “UBS Guarantee Agreement”), pursuant to which the Company will guarantee the payment of up to 25 % of the amount outstanding under the UBS Master Repurchase Agreement. The UBS Master Repurchase Agreement and the UBS Guarantee Agreement contain various representations, warranties, covenants, conditions precedent to funding, events of default and indemnities that are customary for agreements of these types. In addition, the UBS Guarantee Agreement contains financial covenants, which require the Company to maintain: (i) cash liquidity of at least the greater of $5 million or 5 % of the then-current outstanding amount under the UBS Master Repurchase Agreement; (ii) total liquidity of at least the greater of $15 million or 10 % of the then-current outstanding amount under the UBS Master Repurchase Agreement (iii) tangible net worth at an amount equal to or greater than $215.7 million plus 75 % of new capital contributions thereafter; (iv) an EBITDA to interest expense ratio of not less than 1.50 to 1.00; and (v) a total indebtedness to tangible net worth ratio of not more than 3.50 to 1.00. In March 2022, the Company amended the UBS Guarantee Agreement to reduce the EBITDA to interest expense ratio of not less than 1.25
The following tables present detailed information with respect to each borrowing under the UBS Master Repurchase Agreement as of:
| June 30, 2023 | |||||||||||||||||||||||||||||||||||
| Collateral | Borrowings Under Master Repurchase Agreement | ||||||||||||||||||||||||||||||||||
| Principal Amount | Carrying Value | Fair Value | Borrowing Date | Principal Amount | Interest Rate | ||||||||||||||||||||||||||||||
| NB Factory TIC 1, LLC | $ | $ | $ | 11/8/2021 | $ | Term SOFR+ | |||||||||||||||||||||||||||||
| Grandview’s Remington Place, LLC | 5/6/2022 | Term SOFR + | |||||||||||||||||||||||||||||||||
| $ | $ | $ | $ | ||||||||||||||||||||||||||||||||
39
Notes to Unaudited Consolidated Financial Statements
| December 31, 2022 | |||||||||||||||||||||||||||||||||||
| Collateral | Borrowings Under Master Repurchase Agreement | ||||||||||||||||||||||||||||||||||
| Principal Amount | Carrying Value | Fair Value | Borrowing Date | Principal Amount | Interest Rate | ||||||||||||||||||||||||||||||
| NB Factory TIC 1, LLC | $ | $ | $ | 11/8/2021 | $ | LIBOR+ | |||||||||||||||||||||||||||||
| Grandview’s Madison Place, LLC | 3/7/2022 | Term SOFR + | |||||||||||||||||||||||||||||||||
| Grandview’s Remington Place, LLC | 5/6/2022 | Term SOFR + | |||||||||||||||||||||||||||||||||
| $ | $ | $ | $ | ||||||||||||||||||||||||||||||||
For the six months ended June 30, 2023, the Company had no additional borrowings and made a repayment of $13.6 million under the UBS Master Repurchase Agreement. For the six months ended June 30, 2022, the Company borrowed $29.7 million and did not make any repayments under the UBS Master Repurchase Agreement.
Goldman Master Repurchase Agreement
The Company entered into a credit agreement with Goldman Sachs Banks to provide for a term loan of up to $103.0 million. On February 18, 2022, Terra Mortgage Capital I, LLC (the “GS Seller”), a special-purpose indirect wholly-owned subsidiary of the Company, entered into an Uncommitted Master Repurchase and Securities Contract Agreement (the “Repurchase Agreement”) with Goldman Sachs Bank USA ( the “GS Buyer”). The Repurchase Agreement provides for advances of up to $200.0 million in the aggregate, which the Company expects to use to finance the originations of certain secured performing commercial real estate loans and the acquisitions of certain secured non-performing commercial real estate loans. The Repurchase Agreement replaced the term loan, at which time all mortgage assets under the term loan were assigned as purchased assets under the Repurchase Agreement.
Advances under the Repurchase Agreement accrue interest at a per annum pricing rate equal to the sum of (i) Term SOFR (subject to underlying loan floors on a case-by-case basis) and (ii) the applicable spread, which ranges from 1.75 % to 3.00 %, and have a maturity date of February 18, 2024. The actual terms of financing for each asset will be determined at the time of financing in accordance with the Repurchase Agreement. Subject to satisfaction of certain conditions, the GS Seller may extend the maturity date of the Repurchase Agreement for another 12-month term. In connection with the Repurchase Agreement, the Company incurred financing costs of $0.6 million, which are being amortized to interest expense over the term of the facility. Additionally, because the Repurchase Agreement was accounted for as a loan modification of the term loan, the remaining unamortized deferred financing fees of $1.7 million under the term loan were carried over to the Repurchase Agreement to be amortized over the life of the Repurchase Agreement.
The Repurchase Agreement contains margin call provisions that provide the GS Buyer with certain rights in the event of a decline in debt yield, loan-to-value ratio, and value of the underlying loans purchased under the Repurchase Agreement. Upon the occurrence of a margin deficit event, the GS Buyer may require the GS Seller to make a payment to reduce the purchase price to eliminate any margin deficit.
In connection with the Repurchase Agreement, the Company entered into a Guarantee Agreement in favor of the GS Buyer (the “Guarantee Agreement”), pursuant to which the Company will guarantee the obligations of the GS Seller under the Repurchase Agreement. Subject to certain exceptions, the maximum liability under the Repurchase Agreement will not exceed 25 % of the then currently outstanding repurchase obligations for performing loans and 50 % of the then currently outstanding repurchase obligations for non-performing loans under the Repurchase Agreement.
The Repurchase Agreement and the Guarantee Agreement contain various representations, warranties, covenants, conditions precedent to funding, events of default and indemnities that are customary for agreements of these types. In addition, the Guarantee Agreement contains financial covenants, which require the Company to maintain: (i) cash liquidity of at least the greater of $5 million or 5 % of the then-current outstanding amount under the Repurchase Agreement; (ii) total liquidity in an amount equal to or greater than the lesser of $15 million or 10 % of the then-current outstanding amount under the Repurchase Agreement (iii) tangible net worth at an amount no less than 75 % of that at closing; (iv) an EBITDA to adjusted interest expense ratio of not less than 1.50 to 1.00; and (v) a total indebtedness to tangible net worth ratio of not more than 3.00 to 1.00. As of June 30, 2023 and December 31, 2022, the Company was in compliance with these covenants.
40
Notes to Unaudited Consolidated Financial Statements
The following tables present detailed information with respect to each borrowing under the Repurchase Agreement as of:
| June 30, 2023 | |||||||||||||||||||||||||||||||||||
| Collateral | Borrowings Under Repurchase Agreement | ||||||||||||||||||||||||||||||||||
| Principal Amount | Carrying Value | Fair Value | Borrowing Date | Principal Amount | Interest Rate | ||||||||||||||||||||||||||||||
| 1389 Peachtree St, LP; 1401 Peachtree St, LP; and 1409 Peachtree St, LP | $ | $ | $ | 2/18/2022 | $ | Term SOFR + | |||||||||||||||||||||||||||||
| AGRE DCP Palm Springs, LLC | 2/18/2022 | Term SOFR + | |||||||||||||||||||||||||||||||||
| Patrick Henry Recovery Acquisition, LLC | 2/18/2022 | Term SOFR + | |||||||||||||||||||||||||||||||||
| $ | $ | $ | $ | ||||||||||||||||||||||||||||||||
| December 31, 2022 | |||||||||||||||||||||||||||||||||||
| Collateral | Borrowings Under Repurchase Agreement | ||||||||||||||||||||||||||||||||||
| Principal Amount | Carrying Value | Fair Value | Borrowing Date | Principal Amount | Interest Rate | ||||||||||||||||||||||||||||||
| 330 Tryon DE LLC | $ | $ | $ | 2/18/2022 | $ | Term SOFR + | |||||||||||||||||||||||||||||
| 1389 Peachtree St, LP; 1401 Peachtree St, LP; and 1409 Peachtree St, LP | 2/18/2022 | Term SOFR + | |||||||||||||||||||||||||||||||||
| AGRE DCP Palm Springs, LLC | 2/18/2022 | Term SOFR + | |||||||||||||||||||||||||||||||||
| Patrick Henry Recovery Acquisition, LLC | 2/18/2022 | Term SOFR + | |||||||||||||||||||||||||||||||||
| University Park Berkeley, LLC | 2/18/2022 | Term SOFR + | |||||||||||||||||||||||||||||||||
| $ | $ | $ | $ | ||||||||||||||||||||||||||||||||
For the six months ended June 30, 2023 and 2022 the Company borrowed $1.3 million and $118.3 million, respectively, under the Repurchase Agreement and made repayments of $35.7 million and zero , respectively.
Term Loan
As previously reported by Terra BDC, 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 of $25.0 million 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 (the “Term Loan”).
The scheduled maturity date of the Term Loan was April 9, 2025. The Term Loan 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.
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
41
Notes to Unaudited Consolidated Financial Statements
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 then owned and thereafter 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.
On September 27, 2022, Terra BDC, Terra LLC, 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 BDC 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 loans bear 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 a loan origination fee of $150,000 , to be amortized to interest expense over the remaining term of the Term Loan. As of June 30, 2023 and December 31, 2022, the principal amount outstanding under the Term Loan was $15.0 million and $25.0 million, respectively.
The Credit Agreement contains customary representations, warranties, reporting requirements, borrowing conditions and affirmative, negative and financial covenants. As of June 30, 2023 and December 31, 2022 , Terra LLC was in compliance with these covenants.
Mortgage Loans Payable
Mortgage Loan Financing Activities
2023 — During the six months ended June 30, 2023, the Company entered into the following financing arrangements:
•A mortgage loan with total commitment of $37.0 million for the acquisition of three industrial buildings in March 2023. As of June 30, 2023, total amount funded was $32.4 million; and
• A mortgage loan of $40.3 million to finance the acquisition of five industrial buildings in May 2023.
The following table presents certain information about mortgage loans payable as of:
| June 30, 2023 | December 31, 2022 | |||||||||||||||||||||||||||||||||||||||||||||||||
| Lender | Current Interest Rate | Maturity Date | Principal Amount | Carrying Value | Carrying Value of Collateral | Principal Amount | Carrying Value | Carrying Value of Collateral | ||||||||||||||||||||||||||||||||||||||||||
Centennial Bank (1) | Term SOFR + (Term SOFR Floor of | May 31, 2023 | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||||||||||||
TPG RE Finance 24, LTD (2) | Term SOFR + | April 9, 2027 | ||||||||||||||||||||||||||||||||||||||||||||||||
GSF Lender, LLC (3) | June 6, 2028 | |||||||||||||||||||||||||||||||||||||||||||||||||
| $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||||||||||||||||||
___________________
42
Notes to Unaudited Consolidated Financial Statements
(1)This loan is collateralized by a multi-tenant office building that the Company acquired through foreclosure. This loan is currently in maturity default. The Company has sought to convey its interest in the office building and ground lease in lieu of foreclosure.
(2)This loan is collateralized by three industrial buildings that the Company acquired in March 2023.
(3)This loan is collateralized by five industrial buildings that the Company acquired in May 2023.
Scheduled Debt Principal Payments
| Years Ending December 31, | Total | |||||||
| 2023 (July 1 through December 31) | $ | |||||||
| 2024 | ||||||||
| 2025 | ||||||||
| 2026 | ||||||||
| 2027 | ||||||||
| Thereafter | ||||||||
| Unamortized deferred financing costs | ( | |||||||
| Total | $ | |||||||
At June 30, 2023 and December 31, 2022, the unamortized deferred debt issuance costs were $8.7 million and $8.6 million, respectively.
Obligations Under Participation Agreements
Note 10. Commitments and Contingencies
Unfunded Commitments on Loans Held for Investment
Certain of the Company’s loans contain provisions for future fundings, which are subject to the borrower meeting certain performance-related metrics that are monitored by the Company. These fundings amounted to approximately $53.2 million and $47.3 million as of June 30, 2023 and December 31, 2022, respectively. The Company expects to maintain sufficient cash on hand to fund such commitments through matching these commitments with principal repayments on outstanding loans or draw downs on credit facilities.
Unfunded Investment Commitment
As discussed in Note 5, on August 3, 2020, the Company entered into a subscription agreement with RESOF whereby the Company committed to fund up to $50.0 million to purchase limited partnership interests in RESOF. As of June 30, 2023 and December 31, 2022, the unfunded investment commitment was $37.4 million and $22.4 million, respectively.
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
43
Notes to Unaudited Consolidated Financial Statements
contracts. The Manager has reviewed the Company’s existing contracts and expects the risk of loss to the Company to be remote.
From time to time, the Company and the Manager 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 under contracts with its portfolio companies. Additionally, as described above under “Note 6. Real Estate Owned, Net—Real Estate Operating Revenue and Expenses,” as of June 30, 2023 and December 31, 2022, the Company owned a multi-tenant office building that is subject to a ground lease. The ground lease provides for a new base rent every 5 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. The Company is currently 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 – Terra Ocean Ave., LLC v. Ocean Avenue Santa Monica Realty LLC, Superior Court of California, Los Angeles County, Case No. 20STCV34217. The Company believes this determination should be based on comparable sales, while the landlord insists that the rent under the ground lease itself is also relevant. The Company’s position has prevailed in all three of the prior arbitrations to reset the ground rent. Since future rent reset determinations under the ground lease cannot be known at this time, the Company did not include any potential future rent increases in calculating the present value of future rent payments. The Company intends vigorously to pursue the litigation. While the Company believes its arguments will likely prevail, the outcome of the legal proceeding cannot be predicted with certainty. If the landlord prevails, the future rent reset determinations could result in significantly higher ground rent, which would likely result in a significant diminution in the value of the Company’s interest in the ground lease and the office building.
On July 7, 2023, Centennial Bank filed a complaint for breach of guaranty against the Company in the United States District Court, Southern District of New York (SDNY). The complaint relates to a loan made by Centennial Bank to Terra Ocean Ave., LLC (“Terra Ocean”), and alleges that Centennial Bank allegedly made a mistake in July 2021, in demanding a prepayment of $11.3 million instead of $28.5 million with respect to the loan, and that the Company, as guarantor in certain limited respects, must now pay the difference (i.e. $17.2 million) plus interest and attorneys’ fees and costs. Centennial Bank’s now alleges that its mistake in determining the prepayment amount was caused by the wrongful failure to disclose the then-current status of the Lease Litigation by Terra Ocean and/or the Company. On July 24, 2023, the Company, through counsel appeared in the action. Although the action is in its initial stages, the Company is seeking a dismissal of the complaint at the pleading stage and, if not successful, is prepared to vigorously defend itself through trial. The Company believes the claim by Centennial Bank is without merit.
Also on July 17, 2023, Centennial Bank filed a complaint against Terra Ocean for: (i) Breach of Contract; (ii) Judicial Foreclosure and Deficiency Judgment; and (iii) Specific Performance and Appointment of Receiver in the Superior Court of the State of California, County of Los Angeles. Centennial Bank seeks to foreclose on the deed of trust encumbering the tenant’s interest in the above-mentioned multi-tenant office building and ground lease. In the complaint, Centennial Bank alleges that its loan to Terra Ocean is in default and the outstanding principal amount of the loan is $27.6 million as of the filing of the complaint. Prior to Centennial Bank filing its complaints against the Company and Terra Ocean, Terra Ocean sought to convey its interest in the ground lease in lieu of foreclosure. Terra Ocean is in the process of preparing an appropriate response to Centennial Bank’s claims in this action.
Note 11. Equity
Earnings Per Share
The following table presents earnings per share:
| Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||||||||||||
| 2023 | 2022 | 2023 | 2022 | |||||||||||||||||||||||
| Net (loss) income | $ | ( | $ | $ | ( | $ | ||||||||||||||||||||
| Series A preferred stock dividend declared | ( | ( | ( | |||||||||||||||||||||||
| Net (loss) income allocable to common stock | $ | ( | $ | $ | ( | $ | ||||||||||||||||||||
| Weighted-average shares outstanding - basic and diluted | ||||||||||||||||||||||||||
| (Loss) income per share - basic and diluted | $ | ( | $ | $ | ( | $ | ||||||||||||||||||||
44
Notes to Unaudited Consolidated Financial Statements
Preferred Stock Classes
Preferred Stock
The Company’s charter gives it authority to issue 50,000,000 0.01 no 125
Series A Preferred Stock
On November 30, 2016, the Board classified and designated 125 shares of Preferred Stock as a separate class of Preferred Stock to be known as the 12.5 % Series A Redeemable Cumulative Preferred Stock, $1,000 liquidation value per share (“Series A Preferred Stock”). In December 2016, the Company sold 125 shares of the Series A Preferred Stock for $125,000 . The Series A Preferred Stock paid dividends at an annual rate of 12.5 % of the liquidation preference. These dividends were cumulative and payable semi-annually in arrears on June 30 and December 31 of each year.
The Series A Preferred Stock, with respect to dividend rights and rights upon liquidation, dissolution or winding up of the Company, ranked senior to common stock. The Company, at its option, may redeem the shares, with written notice, at a redemption price of $1,000 per share, plus any accrued unpaid distribution through the date of the redemption. The Series A Preferred Stock carried a redemption premium of $50 per share if redeemed prior to January 1, 2019. The Series A Preferred Stock generally had no voting rights. However, the Series A Preferred Stockholders’ voting was required if (i) authorization or issuance of any securities senior to the Series A Preferred Stock; (ii) an amendment to the Company’s charter that has a material adverse effect on the rights and preference of the Series A Preferred Stock; and (iii) any reclassification of the Series A Preferred Stock.
In March 2023, the Series A Preferred Stock was fully redeemed at par for a total of $125,000 plus accrued dividends.
Common Stock
On October 1, 2022, in connection with the BDC Merger, the Company amended its charter to increase the shares authorized from 500,000,000 to 950,000,000 , consisting of 450,000,000 shares of Class A Common Stock, $0.01 par value per share (“Class A Common Stock”), 450,000,000 shares of Class B Common Stock, and 50,000,000 shares of Preferred Stock. Concurrently, 4,847,910 shares of Class B Common Stock were issued to former Terra BDC stockholders and each share of the Company’s common stock issued and outstanding immediately prior to the effective time of the BDC Merger was automatically changed into one 70.0 %, 19.9 % and 10.1 % of the issued and outstanding shares of the Class B Common Stock, respectively.
The Class B Common Stock rank equally with and have identical preferences, rights, voting powers, restrictions, limitations as to dividends and other distributions, qualifications, and terms and conditions of redemption as each other share of the Company’s common stock, except as set forth below with respect to conversion.
On the date that is 180 calendar days (or, if such date is not a business day, the next business day) after the date (the “First Conversion Date”) of initial listing of shares of Class A Common Stock for trading on a national securities exchange or such earlier date as approved by the Board, one-third of the issued and outstanding shares of Class B Common Stock will automatically and without any action on the part of the holder thereof convert into an equal number of shares of Class A Common Stock. On the date that is 365 calendar days (or, if such date is not a business day, the next business day) after the date of initial listing of shares of Class A Common Stock for trading on a national securities exchange or such earlier date following the First Conversion Date as approved by the Board (the “Second Conversion Date”), one-half of the issued and outstanding shares of Class B Common Stock will automatically and without any action on the part of the holder thereof convert into an equal number of shares of Class A Common Stock. On the date that is 545 calendar days (or, if such date is not a business day, the next business day) after the date of initial listing of shares of Class A Common Stock for trading on a national securities exchange or such earlier date following the Second Conversion Date as approved by the Board, all of the issued and outstanding shares of Class B Common Stock will automatically and without any action on the part of the holder thereof convert into an equal number of shares of Class A Common Stock.
45
Notes to Unaudited Consolidated Financial Statements
Distributions
The Company generally intends to distribute substantially all of its taxable income, which does not necessarily equal net income as calculated in accordance with U.S. GAAP, to its stockholders each year to comply with the REIT provisions of the Internal Revenue Code. All distributions will be made at the discretion of the Board and will depend upon its taxable income, financial condition, maintenance of REIT status, applicable law, and other factors as the Board deems relevant.
For the three months ended June 30, 2023 and 2022, the Company made distributions to investors totaling $4.7 million and $3.8 million, respectively, of which $4.7 million and $2.8 million were returns of capital, respectively. For the six months ended June 30, 2023 and 2022, the Company made distributions to investors totaling $9.3 million and $7.7 million, respectively, of which $8.8 million and $5.7 million were returns of capital, respectively. Additionally, for the three and six months ended June 30, 2023 and 2022, the Company made distributions to preferred stockholders of none and $3,906 , respectively, and $3,907 and $7,812 , respectively.
Dividend Reinvestment Plan
On January 20, 2023, the Board adopted a distribution reinvestment plan (the “Plan”), pursuant to which the Company’s stockholders may elect to reinvest cash distributions payable by the Company in additional shares of Class A Common Stock and Class B Common Stock, at the price per share determined pursuant to the Plan. For the six months ended June 30, 2023, the Company issued 143 shares of Class B Common Stock for a total of $1,988 pursuant to the Plan.
Note 12. Subsequent Events
Management has evaluated subsequent events through the date the consolidated financial statements were available to be issued. Management has determined that there are no material events other than the ones below that would require adjustment to, or disclosure in, the Company’s consolidated financial statements.
Termination of WMC Merger Agreement
On June 28, 2023, the Company announced it entered into an Agreement and Plan of Merger, dated as of June 27, 2023 (the “WMC Merger Agreement”), with Western Asset Mortgage Capital Corporation, a Delaware corporation (“WMC”). On July 27, 2023, WMC notified the Company that its board of directors determined that a proposal from AG Mortgage Investment Trust, Inc. (“MITT”) to acquire WMC was a “Parent Superior Proposal” under the WMC Merger Agreement and that WMC’s board of directors intended to terminate the WMC Merger Agreement unless WMC received a revised proposal from the Company by a specified deadline such that WMC’s board of directors determined that MITT’s proposal was no longer a “Parent Superior Proposal.”
On August 8, 2023, WMC terminated the WMC Merger Agreement pursuant to its terms (the “Termination”), and the Company was paid a termination fee of $3.0 million.
Upon the Termination, the amended and restated management agreement the Company entered into with WMC and the Manager on June 27, 2023, terminated in accordance with its terms. The Company continues to be managed by the Manager pursuant to the terms of the existing Management Agreement between the Company and the Manager.
46
Item 2. 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 unaudited consolidated financial statements and related notes thereto and other financial information included elsewhere in this quarterly report on Form 10-Q. In this report, “we,” “us” and “our” refer to Terra Property Trust, Inc. (and, together with its consolidated subsidiaries, the “Company” or “Terra Property Trust”).
FORWARD-LOOKING STATEMENTS
We make forward-looking statements in this quarterly report on Form 10-Q within the meaning of 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”). For these statements, we claim the protections of the safe harbor for forward-looking statements contained in such Sections. The forward-looking statements contained in this quarterly report on Form 10-Q may include, but are not limited to, statements as to:
•our expected financial performance, operating results and our ability to make distributions to our stockholders in the future;
•our ability to achieve the expected synergies, cost savings and other benefits from the BDC Merger (as defined below);
•risks associated with achieving expected synergies, cost savings and other benefits from our increased scale;
•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 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 Fund Advisors, LLC, Terra REIT Advisors, LLC (“Terra REIT Advisors” or our “Manager”), Terra Income Advisors, LLC; Terra Capital Partners, LLC (“Terra Capital Partners”), our sponsor; Terra Secured Income Fund 5, LLC (“Terra Fund 5”); Terra JV, LLC (“Terra JV”); Terra Income Fund 6, Inc. (“Terra Fund 6” or “Terra BDC”); Terra Secured Income Fund 5 International; Terra Income Fund International; Terra Secured Income Fund 7, LLC (“Terra Fund 7”); Terra Offshore Funds REIT, LLC (“Terra Offshore REIT”); Mavik Real Estate Special Opportunities Fund, LP (“RESOF”); or any of their affiliates;
•our dependence on our Manager or its affiliates and the availability of its senior management team and other personnel;
•liquidity transactions that may be available to us in the future, including a liquidation of our assets, a sale of our company, a listing of our shares of common stock on a national securities exchange, or an adoption of a share
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repurchase plan or a strategic business combination, in each case, which may include the distribution of our common stock indirectly owned by certain of our affiliate funds (the “Terra Funds”) to the ultimate investors in the Terra Funds, and the timing of any such transactions;
•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;
•limitations imposed on our business and our ability to satisfy complex rules in order for us to maintain our exemption exclusion or from registration under the Investment Company Act of 1940, as amended (the “1940 Act”), and to maintain our qualification as a real estate investment trust (“REIT”) for U.S. federal income tax purposes; and
•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 quarterly report on Form 10-Q 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 our annual report on Form 10-K for the year ended December 31, 2022 and in “Part II — Item 1A. Risk Factors” in this quarterly report on Form 10-Q. 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.
We have based the forward-looking statements included in this quarterly report on Form 10-Q on information available to us on the date of this quarterly report on Form 10-Q. 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. Stockholders are advised to consult any additional disclosures that we may make directly to stockholders or 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.
Overview
We are a real estate credit focused company that originates, structures, funds and manages commercial real estate investments, including mezzanine loans, first mortgage loans, subordinated mortgage loans and preferred equity investments throughout the United States, which we collectively refer to as our targeted assets. 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. Our loans finance the acquisition, construction, development or redevelopment of quality commercial real estate in the United States. We focus on the origination of middle market loans in the approximately $10 million to $50 million range, to finance properties primarily in primary and secondary markets. We believe loans in this size range are subject to less competition, offer higher risk adjusted returns than larger loans with similar risk metrics and facilitate portfolio diversification. Our investment objective is to provide attractive risk-adjusted returns to our stockholders, primarily through regular distributions. There can be no assurances that we will be successful in meeting our investment objective.
As of June 30, 2023, we held a net loan portfolio (gross loans less obligations under participation agreements and secured borrowing) comprised of 23 loans in nine states with an aggregate net principal balance of $528.2 million, a weighted average coupon rate of 12.7% and a weighted average remaining term to maturity of 0.7 years.
Each of our loans was originated by Terra Capital Partners or its affiliates. Our portfolio is diversified based on location of the underlying properties, loan structure and property type. As of June 30, 2023, our portfolio included underlying properties located in 23 markets, across nine states and includes property types such as multifamily housing, student housing, commercial offices, medical offices, mixed-use and industrial properties. The profile of these properties ranges from stabilized and value-added properties to pre-development and construction. Our loans are structured across mezzanine debt, first mortgages, preferred equity investments and credit facilities.
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We were incorporated under the Maryland General Corporation Law on December 31, 2015. Through December 31, 2015, our business was conducted through a series of predecessor private partnerships. At the beginning of 2016, we completed the merger of these private partnerships into a single entity as part of our plan to reorganize our business as a REIT for federal income tax purposes. Following the REIT formation transaction, Terra Fund 5 contributed the consolidated portfolio of net assets of certain Terra Funds to our company in exchange for all of the shares of our common stock. On March 2, 2020, we engaged in a series of transactions pursuant to which we issued an aggregate of 4,574,470.35 shares of common stock in exchange for the settlement of an aggregate of $49.8 million of participation interests in loans held by us, cash of $25.5 million and other working capital. Following the consummation of the BDC Merger (as defined below) and as of June 30, 2023, former Terra BDC stockholders owned approximately 19.9% of our common equity, Terra JV held 70.0% of the issued and outstanding shares of our common stock with the remainder of 10.1% held by Terra Offshore REIT; and Terra Fund 5 and Terra Fund 7 owned an 87.6% and 12.4% interest, respectively, in Terra JV.
We have elected to be taxed as a REIT for U.S. federal income tax purposes commencing with our taxable year ended December 31, 2016. So long as we qualify as a REIT, we generally are not subject to U.S. federal income tax on our net taxable income to the extent that we annually distribute all of our net taxable income to our stockholders.
Recent Developments
BDC Merger
On October 1, 2022 (the “Closing Date”), pursuant to that certain Agreement and Plan of Merger, dated as of May 2, 2022 (the "Merger Agreement"), Terra BDC merged with and into Terra LLC, our wholly owned subsidiary, with Terra LLC continuing as the surviving entity of the merger (the "BDC Merger") and as our wholly owned subsidiary. The Certificate of Merger and Articles of Merger with respect to the BDC Merger were filed with the Secretary of State of the State of Delaware and State Department of Assessments and Taxation of Maryland (the “SDAT”), respectively, with an effective time and date of 12:02 a.m., Eastern Time, on the Closing Date (the “Effective Time”).
At the Effective Time, except for any shares of Terra BDC Common Stock held by us or any of our wholly owned subsidiaries 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 our newly designated Class B Common Stock, par value $0.01 per share (“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, approximately 4,847,910 shares of Class B Common Stock were issued to former Terra BDC stockholders in connection with the BDC Merger, based on the number of outstanding shares of Terra BDC Common Stock as of the Closing Date. Following the consummation of the BDC Merger, former Terra BDC stockholders owned approximately 19.9% of our common equity.
Portfolio Summary
Net Loan Portfolio
The following tables provide a summary of our net loan portfolio as of:
| June 30, 2023 | |||||||||||||||||||||||||||||
| Fixed Rate | Floating Rate (1)(2)(3) | Total Gross Loans | Obligations under Participation Agreements | Total Net Loans | |||||||||||||||||||||||||
| Number of loans | 5 | 18 | 23 | 1 | 23 | ||||||||||||||||||||||||
| Principal balance | $ | 52,940,319 | $ | 488,915,124 | $ | 541,855,443 | $ | 13,678,820 | $ | 528,176,623 | |||||||||||||||||||
| Carrying value | 53,069,799 | 460,748,708 | 513,818,507 | 13,789,070 | 500,029,437 | ||||||||||||||||||||||||
| Fair value | 52,504,064 | 464,990,667 | 517,494,731 | 13,789,071 | 503,705,660 | ||||||||||||||||||||||||
| Weighted average coupon rate | 13.22 | % | 12.77 | % | 12.82 | % | 17.14 | % | 12.71 | % | |||||||||||||||||||
| Weighted-average remaining term (years) | 1.47 | 0.59 | 0.69 | 1.19 | 0.68 | ||||||||||||||||||||||||
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| December 31, 2022 | |||||||||||||||||||||||||||||
| Fixed Rate | Floating Rate (1)(2)(3) | Total Gross Loans | Obligations under Participation Agreements | Total Net Loans | |||||||||||||||||||||||||
| Number of loans | 8 | 23 | 31 | 1 | 31 | ||||||||||||||||||||||||
| Principal balance | $ | 90,990,183 | $ | 554,805,276 | $ | 645,795,459 | $ | 12,584,958 | $ | 633,210,501 | |||||||||||||||||||
| Carrying value | 92,274,998 | 534,215,769 | 626,490,767 | 12,680,594 | 613,810,173 | ||||||||||||||||||||||||
| Fair value | 90,729,098 | 532,416,656 | 623,145,754 | 12,680,595 | 610,465,159 | ||||||||||||||||||||||||
| Weighted average coupon rate | 13.82 | % | 11.23 | % | 11.59 | % | 16.36 | % | 11.50 | % | |||||||||||||||||||
| Weighted-average remaining term (years) | 1.35 | 1.10 | 1.14 | 1.69 | 1.13 | ||||||||||||||||||||||||
_______________
(1)These loans pay a coupon rate of London Interbank Offered Rate (“LIBOR”), Secured Overnight Financing Rate (“SOFR”), or forward-looking term rate SOFR (“Term SOFR”) plus a fixed spread. Coupon rates shown were determined using LIBOR of 5.22%, average SOFR of 5.07% and Term SOFR of 5.14% as of June 30, 2023, and LIBOR of 4.39%, average SOFR of 4.06% and Term SOFR of 4.36% as of December 31, 2022.
(2)As of June 30, 2023 and December 31, 2022, amount included $336.8 million and $413.1 million of senior mortgages used as collateral for $228.3 million and $261.0 million of borrowings under credit facilities, respectively.
(3)As of June 30, 2023 and December 31, 2022, 16 and 21 loans, respectively, are subject to a LIBOR, SOFR, or Term SOFR floor, as applicable.
Real Estate Ownership
In addition to our net loan portfolio, as of June 30, 2023, we owned eight industrial buildings acquired in 2023 and a multi-tenant office building acquired pursuant to a foreclosure; and as of December 31, 2022, we owned a multi-tenant office building acquired pursuant to a foreclosure. The real estate and related lease intangible assets and liabilities had a net carrying value of $159.3 million and $40.6 million as of June 30, 2023 and December 31, 2022, respectively. As of June 30, 2023, the mortgage loans payable encumbering the industrial buildings and the multi-tenant office building had an outstanding principal amount of $100.2 million and as of December 31, 2022, the mortgage loans payable encumbering the multi-tenant office building had an outstanding principal amount of $29.3 million.
Equity Investments
Additionally, as of June 30, 2023 and December 31, 2022, we owned 14.9% and 50.0%, respectively, of equity interest in a limited partnership that invests primarily in performing and non-performing mortgages, loans, mezzanines and other credit instruments supported by underlying commercial real estate assets. We also beneficially owned equity interests in three joint ventures that invest in real estate properties. In 2022, in connection with a mezzanine loan we originated, we entered into a residual profit sharing arrangement with the borrower. We accounted for this arrangement as an equity investment. In May 2023, we purchased the underlying assets and the $10.0 million mezzanine loan was settled in connection with the purchase. As of June 30, 2023 and December 31, 2022, these equity investments had total carrying value of $32.6 million and $62.5 million, respectively.
Book Value Per Share
We calculate our book value per share by dividing our net equity by the number of outstanding shares of our common stock, unless otherwise determined by our Board. Our book value per share of Class B Stock Common Stock as of June 30, 2023 and December 31, 2022 was $11.88 and $13.23, respectively.
Portfolio Investment Activity
Net Loan Portfolio
For the three months ended June 30, 2023 and 2022, we invested $7.5 million and $0.3 million in new and add-on investments and had $6.4 million and $10.6 million of repayments, resulting in net investments of $1.1 million and net repayment of investments of $10.9 million, respectively. Amounts are net of obligations under participation agreements,
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secured borrowing, borrowings under the master repurchase agreement, the term loan, the repurchase agreements and the revolving line of credit.
For the six months ended June 30, 2023 and 2022, we invested $33.2 million and $25.7 million in new and add-on investments and had $46.3 million and $11.9 million of repayments, resulting in net repayments of $13.1 million and net investments of $13.7 million, respectively. Amounts are net of obligations under participation agreements, secured borrowing, borrowings under the master repurchase agreement, the term loan, the repurchase agreements and the revolving line of credit.
Real Estate Ownership
Additionally, in the first quarter of 2023, we purchased three industrial buildings in Texas for total capitalized costs of $48.8 million. In the second quarter of 2023, we purchased another five industrial buildings in Texas and the related mezzanine loan that was accounted for as an equity investment and five senior loans that were accounted as loans held for investment were settled in connection with the acquisition. The five industrial buildings have total capitalized costs of $83.3 million. In connection with these acquisitions, we obtained mortgage financing totaling $72.6 million.
Net Loan Portfolio Information
The tables below set forth the types of loans in our loan portfolio, as well as the property type and geographic location of the properties securing these loans, on a net loan basis, which represents our proportionate share of the loans, based on our economic ownership of these loans as of:
| June 30, 2023 | December 31, 2022 | |||||||||||||||||||||||||||||||||||||
| Loan Structure | Principal Balance | Carrying Value | % of Total | Principal Balance | Carrying Value | % of Total | ||||||||||||||||||||||||||||||||
| First mortgages | $ | 380,923,792 | $ | 385,177,670 | 77.0 | % | $ | 456,408,889 | $ | 461,299,182 | 75.1 | % | ||||||||||||||||||||||||||
| Preferred equity investments | 123,242,640 | 123,957,220 | 24.8 | % | 121,231,434 | 122,132,177 | 19.9 | % | ||||||||||||||||||||||||||||||
| Mezzanine loans | 24,010,191 | 24,023,343 | 4.8 | % | 26,767,345 | 26,770,521 | 4.4 | % | ||||||||||||||||||||||||||||||
| Credit facility | — | — | — | % | 28,802,833 | 29,080,183 | 4.7 | % | ||||||||||||||||||||||||||||||
| Allowance for loan losses | — | (33,128,796) | (6.6) | % | — | (25,471,890) | (4.1) | % | ||||||||||||||||||||||||||||||
| Total | $ | 528,176,623 | $ | 500,029,437 | 100.0 | % | $ | 633,210,501 | $ | 613,810,173 | 100.0 | % | ||||||||||||||||||||||||||
| June 30, 2023 | December 31, 2022 | |||||||||||||||||||||||||||||||||||||
| Property Type | Principal Balance | Carrying Value | % of Total | Principal Balance | Carrying Value | % of Total | ||||||||||||||||||||||||||||||||
| Office | $ | 151,158,617 | $ | 151,538,052 | 30.2 | % | $ | 171,611,750 | $ | 172,042,063 | 27.9 | % | ||||||||||||||||||||||||||
| Multifamily | 103,427,397 | 104,222,850 | 20.8 | % | 104,589,464 | 105,570,432 | 17.2 | % | ||||||||||||||||||||||||||||||
| Industrial | 64,340,667 | 64,865,942 | 13.0 | % | 147,796,164 | 148,891,742 | 24.3 | % | ||||||||||||||||||||||||||||||
| Mixed-use | 62,746,351 | 63,257,099 | 12.7 | % | 64,880,450 | 65,838,965 | 10.7 | % | ||||||||||||||||||||||||||||||
| Infill land | 51,031,209 | 52,122,303 | 10.4 | % | 48,860,291 | 49,565,437 | 8.1 | % | ||||||||||||||||||||||||||||||
| Hotel - full/select service | 43,222,382 | 43,826,614 | 8.8 | % | 43,222,382 | 43,758,804 | 7.1 | % | ||||||||||||||||||||||||||||||
| Student housing | 31,000,000 | 31,768,579 | 6.4 | % | 31,000,000 | 31,774,261 | 5.2 | % | ||||||||||||||||||||||||||||||
| Infrastructure | 21,250,000 | 21,556,794 | 4.3 | % | 21,250,000 | 21,840,359 | 3.6 | % | ||||||||||||||||||||||||||||||
| Allowance for loan losses | — | (33,128,796) | (6.6) | % | — | (25,471,890) | (4.1) | % | ||||||||||||||||||||||||||||||
| Total | $ | 528,176,623 | $ | 500,029,437 | 100.0 | % | $ | 633,210,501 | $ | 613,810,173 | 100.0 | % | ||||||||||||||||||||||||||
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| June 30, 2023 | December 31, 2022 | |||||||||||||||||||||||||||||||||||||
| Geographic Location | Principal Balance | Carrying Value | % of Total | Principal Balance | Carrying Value | % of Total | ||||||||||||||||||||||||||||||||
| United States | ||||||||||||||||||||||||||||||||||||||
| California | $ | 125,567,737 | $ | 126,944,398 | 25.3 | % | $ | 151,668,387 | $ | 153,158,967 | 24.9 | % | ||||||||||||||||||||||||||
| New York | 88,336,078 | 88,336,079 | 17.7 | % | 91,845,479 | 91,877,084 | 14.9 | % | ||||||||||||||||||||||||||||||
| New Jersey | 77,371,876 | 78,691,851 | 15.7 | % | 62,228,622 | 62,958,482 | 10.3 | % | ||||||||||||||||||||||||||||||
| Georgia | 75,205,257 | 75,840,968 | 15.2 | % | 72,401,718 | 73,101,964 | 11.9 | % | ||||||||||||||||||||||||||||||
| Washington | 52,969,210 | 53,070,927 | 10.6 | % | 56,671,267 | 57,027,639 | 9.3 | % | ||||||||||||||||||||||||||||||
| Utah | 49,250,000 | 50,399,536 | 10.1 | % | 49,250,000 | 50,698,251 | 8.3 | % | ||||||||||||||||||||||||||||||
| Arizona | 31,000,000 | 31,296,394 | 6.3 | % | 31,000,000 | 31,276,468 | 5.1 | % | ||||||||||||||||||||||||||||||
| North Carolina | 21,476,465 | 21,578,080 | 4.3 | % | 43,520,028 | 44,041,162 | 7.2 | % | ||||||||||||||||||||||||||||||
| Massachusetts | 7,000,000 | 7,000,000 | 1.4 | % | 7,000,000 | 7,000,000 | 1.1 | % | ||||||||||||||||||||||||||||||
| Texas | — | — | — | % | 67,625,000 | 68,142,046 | 11.1 | % | ||||||||||||||||||||||||||||||
| Allowance for loan losses | — | (33,128,796) | (6.6) | % | — | (25,471,890) | (4.1) | % | ||||||||||||||||||||||||||||||
| Total | $ | 528,176,623 | $ | 500,029,437 | 100.0 | % | $ | 633,210,501 | $ | 613,810,173 | 100.0 | % | ||||||||||||||||||||||||||
Factors Impacting Operating Results
Our results of operations are affected by a number of factors and primarily depend on, among other things, the level of the interest income from targeted assets, the market value of our assets and the supply of, and demand for, real estate-related loans, including mezzanine loans, first mortgage loans, subordinated mortgage loans, preferred equity investments and other loans related to high quality commercial real estate in the United States, and the financing and other costs associated with our business. Interest income and borrowing costs may vary as a result of changes in interest rates, which could impact the net interest we receive on our assets. Our operating results may also be impacted by conditions in the financial markets and unanticipated credit events experienced by borrowers under our loan assets.
Credit Risk
Credit risk represents the potential loss that we would incur if our borrowers failed to perform pursuant to the terms of their obligations to us. With respect to our loan portfolio, we seek to manage credit risk by limiting exposure to any one individual borrower and any one asset class.
Additionally, our Manager employs an asset management approach and monitors the portfolio of investments through, at a minimum, quarterly financial review of property performance including net operating income, loan-to-value, debt service coverage ratio and the debt yield. Our Manager also requires certain borrowers to establish an interest reserve, as a form of additional collateral, for the purpose of providing for future interest or property-related operating payments.
The performance and value of our loans depends upon the sponsors’ ability to operate or manage the development of the respective properties that serve as collateral so that each property’s value ultimately supports the repayment of the loan balance. Mezzanine loans and preferred equity investments are subordinate to senior mortgage loans and, therefore, involve a higher degree of risk. In the event of a default, mezzanine loans and preferred equity investments will be satisfied only after the senior lender’s investment is fully recovered. As a result, in the event of a default, we may not recover all of our investments.
In addition, we are exposed to the risks generally associated with the commercial real estate market, including variances in occupancy rates, capitalization rates, absorption rates, and other macroeconomic factors beyond our control. We seek to manage these risks through our Manager's underwriting and asset management processes.
We maintain all of our cash at financial institutions which, at times, may exceed the amount insured by the Federal Deposit Insurance Corporation.
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Concentration Risk
We hold real estate-related loans. Thus, our loan portfolio may be subject to a more rapid change in value than would be the case if it were required to maintain a wide diversification among industries, companies and types of loans. The result of such concentration in real estate assets is that a loss in such loans could materially reduce our capital.
Interest Rate Risk
Interest rate risk represents the effect from a change in interest rates, which could result in an adverse change in the fair value of our interest-bearing financial instruments. With respect to our business operations, increases in interest rates, in general, may over time cause: (i) the interest expense associated with variable rate borrowings to increase; (ii) the value of real estate-related loans to decline; (iii) coupons on variable rate loans to reset, although on a delayed basis, to higher interest rates; (iv) to the extent applicable under the terms of our investments, prepayments on real estate-related loans to slow; and (v) to the extent we enter into interest rate swap agreements as part of our hedging strategy, the value of these agreements to increase.
Conversely, decreases in interest rates, in general, may over time cause: (i) the interest expense associated with variable rate borrowings to decrease; (ii) the value of real estate-related loans to increase; (iii) coupons on variable rate real estate-related loans to reset, although on a delayed basis, to lower interest rates; (iv) to the extent applicable under the terms of our investments, prepayments on real estate-related loans to increase; and (v) to the extent we enter into interest rate swap agreements as part of our hedging strategy, the value of these agreements to decrease.
Prepayment Risk
Prepayments can either positively or adversely affect the yields on our loans. 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 do not collect a prepayment fee in connection with a prepayment or are unable to invest the proceeds of such prepayments received, the yield on the portfolio will decline. In addition, we may acquire assets at a discount or premium and if the asset does not repay when expected, the anticipated yield may be impacted. Under certain interest rate and prepayment scenarios we may fail to recoup fully our cost of acquisition of certain loans.
Extension Risk
Extension risk is the risk that our assets will be repaid at a slower rate than anticipated and generally increases when interest rates rise. In which case, to the extent we have financed the acquisition of an asset, we may have to finance our asset at potentially higher costs without the ability to reinvest principal into higher yielding securities because borrowers prepay their mortgages at a slower pace than originally expected, adversely impacting our net interest spread, and thus our net interest income.
Real Estate Risk
The market values of commercial and residential mortgage assets are subject to volatility and may be affected adversely by a number of factors, including, but not limited to, national, regional and local economic conditions (which may be adversely affected by industry slowdowns and other factors); local real estate conditions; changes or continued weakness in specific industry segments; construction quality, age and design; demographic factors; retroactive changes to building or similar codes; pandemics; natural disasters; and other acts of god. In addition, decreases in property values reduce the value of the collateral and the potential proceeds available to a borrower to repay the underlying loans, which could also cause us to suffer losses.
Use of Leverage
We deploy moderate amounts of leverage as part of our operating strategy, which may consist of borrowings under first mortgage financings, warehouse facilities, term loans, repurchase agreements and other credit facilities. While borrowing and leverage present opportunities for increasing total return, they may have the effect of potentially creating or increasing losses.
Market Risk
Our loans are highly illiquid, and there is no assurance that we will achieve our investment objectives, including targeted returns. Due to the illiquidity of the loans, valuation of our loans may be difficult, as there generally will be no established markets for these loans.
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Results of Operations
The following table presents the comparative results of our operations:
| Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||||||||||||||||||||||||
| 2023 | 2022 | Change | 2023 | 2022 | Change | |||||||||||||||||||||||||||||||||
| Revenues | ||||||||||||||||||||||||||||||||||||||
| Interest income | $ | 15,878,453 | $ | 10,274,051 | $ | 5,604,402 | $ | 31,494,260 | $ | 19,156,202 | $ | 12,338,058 | ||||||||||||||||||||||||||
| Real estate operating revenue | 2,803,934 | 2,991,321 | (187,387) | 4,136,903 | 5,970,775 | (1,833,872) | ||||||||||||||||||||||||||||||||
| Prepayment fee income | — | 1,174,760 | (1,174,760) | — | 1,174,760 | (1,174,760) | ||||||||||||||||||||||||||||||||
| Other operating income | 100,068 | 247,981 | (147,913) | 153,463 | 498,646 | (345,183) | ||||||||||||||||||||||||||||||||
| 18,782,455 | 14,688,113 | 4,094,342 | 35,784,626 | 26,800,383 | 8,984,243 | |||||||||||||||||||||||||||||||||
| Operating expenses | ||||||||||||||||||||||||||||||||||||||
| Operating expenses reimbursed to Manager | 2,120,029 | 2,140,635 | (20,606) | 4,297,033 | 4,069,198 | 227,835 | ||||||||||||||||||||||||||||||||
| Asset management fee | 2,105,049 | 1,640,628 | 464,421 | 4,102,476 | 3,128,723 | 973,753 | ||||||||||||||||||||||||||||||||
| Asset servicing fee | 496,374 | 395,718 | 100,656 | 966,899 | 745,047 | 221,852 | ||||||||||||||||||||||||||||||||
| Provision for credit losses | 4,652,644 | 25,633 | 4,627,011 | 3,802,593 | 75,929 | 3,726,664 | ||||||||||||||||||||||||||||||||
| Real estate operating expenses | 1,864,212 | 1,247,328 | 616,884 | 3,074,124 | 2,465,291 | 608,833 | ||||||||||||||||||||||||||||||||
| Depreciation and amortization | 1,756,664 | 1,718,373 | 38,291 | 2,438,477 | 3,436,745 | (998,268) | ||||||||||||||||||||||||||||||||
| Impairment charge | 11,765,540 | — | 11,765,540 | 11,765,540 | 1,604,989 | 10,160,551 | ||||||||||||||||||||||||||||||||
| Professional fees | 787,427 | 1,011,354 | (223,927) | 1,767,322 | 1,753,872 | 13,450 | ||||||||||||||||||||||||||||||||
| Directors’ fees | 83,750 | 36,247 | 47,503 | 180,214 | 72,499 | 107,715 | ||||||||||||||||||||||||||||||||
| Other | 188,631 | 374,203 | (185,572) | 403,875 | 457,624 | (53,749) | ||||||||||||||||||||||||||||||||
| 25,820,320 | 8,590,119 | 17,230,201 | 32,798,553 | 17,809,917 | 14,988,636 | |||||||||||||||||||||||||||||||||
| Operating income | (7,037,865) | 6,097,994 | (13,135,859) | 2,986,073 | 8,990,466 | (6,004,393) | ||||||||||||||||||||||||||||||||
| Other income and expenses | — | |||||||||||||||||||||||||||||||||||||
| Interest expense from obligations under participation agreements | (576,915) | (1,238,655) | 661,740 | (1,109,061) | (2,313,764) | 1,204,703 | ||||||||||||||||||||||||||||||||
| Interest expense on repurchase agreements payable | (2,946,797) | (1,665,283) | (1,281,514) | (6,003,303) | (2,421,109) | (3,582,194) | ||||||||||||||||||||||||||||||||
| Interest expense on mortgage loans payable | (1,640,972) | (520,829) | (1,120,143) | (2,387,100) | (1,039,446) | (1,347,654) | ||||||||||||||||||||||||||||||||
| Interest expense on revolving line of credit | (2,540,047) | (700,737) | (1,839,310) | (4,505,581) | (1,225,031) | (3,280,550) | ||||||||||||||||||||||||||||||||
| Interest expense on term loan payable | (355,468) | — | (355,468) | (707,031) | (164,969) | (542,062) | ||||||||||||||||||||||||||||||||
| Interest expense on unsecured notes payable | (2,405,267) | (1,432,877) | (972,390) | (4,799,573) | (2,863,060) | (1,936,513) | ||||||||||||||||||||||||||||||||
| Interest expense on secured borrowing | — | (556,855) | 556,855 | — | (1,109,640) | 1,109,640 | ||||||||||||||||||||||||||||||||
| Unrealized gains (losses) on investments, net | 51,224 | (34,950) | 86,174 | 57,808 | (133,994) | 191,802 | ||||||||||||||||||||||||||||||||
| Loss on sale of real estate | — | (51,984) | 51,984 | — | (51,984) | 51,984 | ||||||||||||||||||||||||||||||||
| (Loss) income from equity investment in unconsolidated investments | (1,759,934) | 1,364,332 | (3,124,266) | (2,196,794) | 2,783,667 | (4,980,461) | ||||||||||||||||||||||||||||||||
| Realized (losses) gains on investments, net | (25,024) | 32,278 | (57,302) | (25,024) | 83,411 | (108,435) | ||||||||||||||||||||||||||||||||
| (12,199,200) | (4,805,560) | (7,393,640) | (21,675,659) | (8,455,919) | (13,219,740) | |||||||||||||||||||||||||||||||||
| Net (loss) income | $ | (19,237,065) | $ | 1,292,434 | $ | (20,529,499) | $ | (18,689,586) | $ | 534,547 | $ | (19,224,133) | ||||||||||||||||||||||||||
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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, term loan payable, revolving credit facility and repurchase agreement payable.
The following table presents a reconciliation of our loan portfolio on a weighted average basis from gross to net:
| Three Months Ended June 30, 2023 | Three Months Ended June 30, 2022 | |||||||||||||||||||||||||
Weighted Average Principal Amount (1) | Weighted Average Coupon Rate (2) | Weighted Average Principal Amount (1) | Weighted Average Coupon Rate (2) | |||||||||||||||||||||||
| Total portfolio | ||||||||||||||||||||||||||
| Gross loans | $ | 606,761,243 | 12.4 | % | $ | 557,341,571 | 8.4 | % | ||||||||||||||||||
| Obligations under participation agreements and secured borrowing | (13,459,586) | 17.1 | % | (85,476,509) | 10.5 | % | ||||||||||||||||||||
| Repurchase agreement payable | (147,054,763) | 7.0 | % | (186,274,094) | 3.5 | % | ||||||||||||||||||||
| Revolving line of credit | (117,050,294) | 8.5 | % | (61,522,134) | 4.0 | % | ||||||||||||||||||||
Net loans (3) | $ | 329,196,600 | 16.0 | % | $ | 224,068,834 | 13.0 | % | ||||||||||||||||||
| Senior loans | ||||||||||||||||||||||||||
| Gross loans | $ | 481,108,382 | 11.8 | % | 417,597,220 | 7.2 | % | |||||||||||||||||||
| Obligations under participation agreements and secured borrowing | — | — | % | (37,883,729) | 8.1 | % | ||||||||||||||||||||
| Repurchase agreement payable | (147,054,763) | 7.0 | % | (186,274,094) | 3.5 | % | ||||||||||||||||||||
| Revolving line of credit | (117,050,294) | 8.5 | % | (61,522,134) | 4.0 | % | ||||||||||||||||||||
Net loans (3) | $ | 217,003,325 | 16.8 | % | $ | 131,917,263 | 13.5 | % | ||||||||||||||||||
Subordinated loans (4) | ||||||||||||||||||||||||||
| Gross loans | 125,652,861 | 14.3 | % | 139,744,351 | 12.3 | % | ||||||||||||||||||||
| Obligations under participation agreements | (13,459,586) | 17.1 | % | (47,592,780) | 12.5 | % | ||||||||||||||||||||
Net loans (3) | $ | 112,193,275 | 14.0 | % | $ | 92,151,571 | 12.2 | % | ||||||||||||||||||
| Six Months Ended June 30, 2023 | Six Months Ended June 30, 2022 | |||||||||||||||||||||||||
Weighted Average Principal Amount (1) | Weighted Average Coupon Rate (2) | Weighted Average Principal Amount (1) | Weighted Average Coupon Rate (2) | |||||||||||||||||||||||
| Total portfolio | ||||||||||||||||||||||||||
| Gross loans | $ | 620,485,639 | 12.3 | % | $ | 531,915,282 | 8.4 | % | ||||||||||||||||||
| Obligations under participation agreements and secured borrowing | (13,181,738) | 17.1 | % | (82,267,911) | 10.5 | % | ||||||||||||||||||||
| Repurchase agreement payable | (157,207,602) | 7.0 | % | (144,128,510) | 3.5 | % | ||||||||||||||||||||
| Term loan payable | — | — | % | (20,836,327) | 5.3 | % | ||||||||||||||||||||
| Revolving line of credit | (107,111,725) | 8.5 | % | (53,252,643) | 5.0 | % | ||||||||||||||||||||
Net loans (3) | $ | 342,984,574 | 15.7 | % | $ | 231,429,891 | 11.8 | % | ||||||||||||||||||
| Senior loans | ||||||||||||||||||||||||||
| Gross loans | $ | 489,904,811 | 11.7 | % | 394,099,125 | 7.1 | % | |||||||||||||||||||
| Obligations under participation agreements and secured borrowing | — | — | % | (37,026,717) | 8.1 | % | ||||||||||||||||||||
| Repurchase agreement payable | (157,207,602) | 7.0 | % | (144,128,510) | 3.5 | % | ||||||||||||||||||||
| Term loan payable | — | — | % | (20,836,327) | 5.3 | % | ||||||||||||||||||||
| Revolving line of credit | (107,111,725) | 8.5 | % | (53,252,643) | 5.0 | % | ||||||||||||||||||||
Net loans (3) | $ | 225,585,484 | 16.5 | % | $ | 138,854,928 | 11.7 | % | ||||||||||||||||||
Subordinated loans (4) | ||||||||||||||||||||||||||
| Gross loans | 130,580,828 | 14.3 | % | 137,816,157 | 12.3 | % | ||||||||||||||||||||
| Obligations under participation agreements | (13,181,738) | 17.1 | % | (45,241,194) | 12.4 | % | ||||||||||||||||||||
Net loans (3) | $ | 117,399,090 | 14.0 | % | $ | 92,574,963 | 12.3 | % | ||||||||||||||||||
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_______________
(1)Amount is calculated based on the number of days each loan is outstanding.
(2)Amount is calculated based on the underlying principal amount of each loan.
(3)The weighted average coupon rate represents net interest income over the period calculated using the weighted average coupon rate and weighted average principal amount shown on the table (interest income on the loans less interest expense) divided by the weighted average principal amount of the net loans during the period.
(4)Subordinated loans include mezzanine loans, preferred equity investments and credit facilities.
Interest Income
For the three and six months ended June 30, 2023 as compared to the same periods in 2022, interest income increased by $5.6 million and $12.3 million, respectively, primarily due to an increase in contractual interest income as a result of an increase in the weighted average principal balance of gross loans due to new loans we originated in 2022 and loans we acquired in connection with the BDC Merger, as well as an increase in the weighted average coupon rate due to increases in the underlying index rates.
Real Estate Operating Revenue
For the three and six months ended June 30, 2023 as compared to the same periods in 2022, real estate operating revenue decreased by $0.2 million and $1.8 million, respectively, as a result of a decrease in rental income and lease termination income recognized in 2022 (there was no such lease termination income recognized in 2022), all of which were attributable to a lease termination in 2022.
Prepayment Fee Income
For the three and six months ended June 30, 2023, there was no early repayment of loans and we did not recognize any prepayment fee income. For both the three and six months ended June 30, 2022, we recognized prepayment fee income of $1.2 million on the early repayment of two loans.
Other Operating Income
For the three and six months ended June 30, 2023 as compared to the same periods in 2022, other operating income decreased by $0.1 million and $0.3 million, respectively, primarily as a result of a decrease in application fees income on deals under application.
Operating Expenses Reimbursed to Manager
Under the terms of a management agreement (the “Management Agreement”) with our Manager, we reimburse our Manager for operating expenses incurred in connection with services provided to us, including our allowable share of our Manager’s overhead, such as rent, employee costs, utilities and technology costs.
For the three and six months ended June 30, 2023 as compared to the same periods in 2022, operating expenses reimbursed to our Manager decreased by $0.02 million and increased by $0.2 million. The increase in the six-month period was primarily as a result of an increase in the allocation ratio resulting from an increase in total assets under management primarily due to loans acquired in connection with the BDC Merger.
Asset Management Fee
Under the terms of the Management Agreement with our Manager, we paid our Manager a monthly asset management fee at an annual rate of 1% of the aggregate funds under management, which included the aggregate gross acquisition price, net of participation interest sold to affiliates, for each real estate-related investment and cash held by us.
For the three and six months ended June 30, 2023 as compared to the same periods in 2022, asset management fees increased by $0.5 million and $1.0 million, respectively, primarily due to an increase in total assets under management primarily resulting from loans acquired in connection with the BDC Merger.
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Asset Servicing Fee
Under the terms of the Management Agreement with our Manager, we paid our Manager a monthly servicing fee at an annual rate of 0.25% of the aggregate gross origination price or acquisition price for each real estate-related loan held by us.
For the three and six months ended June 30, 2023 as compared to the same periods in 2022, asset servicing fees increased by $0.1 million and $0.2 million, respectively, primarily due to an increase in total assets under management primarily resulting from loans acquired in connection with the BDC Merger.
Provision for Credit Losses
On January 1, 2023, we adopted the provisions of Accounting Standards Update (“ASU”) 2016-13, Financial Instruments — Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“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, we 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) past due loan reserves, if any.
For the three and six months ended June 30, 2023, we recorded a provision for credit losses of $4.7 million and $3.8 million, respectively, primarily due to a decline in the fair value of the collateral on a loan. For the three and six months ended June 30, 2022, we recorded provision for credit losses of $0.03 million and $0.1 million, respectively.
Depreciation and Amortization
For the three months ended June 30, 2023 as compared to the same period in 2022, depreciation and amortization increased by $0.04 million as compared to the same period in 2022. For the six months ended June 30, 2023 as compared to the same period in 2022, depreciation and amortization decreased by $1.0 million, primarily due to a decrease in unamortized intangible assets as a result of a lease termination notice received in November 2021, at which time we accelerated the amortization of lease intangibles through November 2022, with no corresponding accelerated amortization recognized in six months ended June 30, 2023.
Impairment Charge
For both the three and six months ended June 30, 2023, we recognized an impairment charge of $11.8 million on the multi-tenant office building located in California in order to reduce the carrying value of the building to its estimated fair value. For the six months ended June 30, 2022, we recognized an impairment charge of $1.6 million, on 4.9 acres of the development land located in Pennsylvania in order to reduce the carrying value of the land to its estimated fair value, which is the estimated selling price less the cost of sale. The development land was sold in the second quarter of 2022. There was no impairment charge recorded for the three months ended June 30, 2022.
Professional Fees
For the three months ended June 30, 2023, as compared to the same period in 2022, professional fees decreased by $0.2 million, primarily due to higher legal costs incurred in 2022 in connection with the ground lease litigation. For the six months ended June 30, 2023 as compared to the same period in 2022, professional fees remained substantially the same.
Directors’ Fees
For the three and six months ended June 30, 2023 as compared to the same periods in 2022, directors’ fees increased by $0.05 million and $0.1 million, respectively, as a result of an increase in the size of our Board due to the BDC Merger.
Other
For the three and six months ended June 30, 2023 as compared to the same periods in 2022, other expense decreased by $0.2 million and $0.1 million, respectively, as a result of a fee paid to a third-party in connection with the sale of a parcel of land in June 2022.
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Interest from Obligations under Participation Agreements
For the three and six months ended June 30, 2023 as compared to the same periods in 2022, interest expense from obligations under participation agreements decreased by $0.7 million and $1.2 million, respectively, as a result of a decrease in the weighted average principal amount outstanding on obligations under participation agreements, primarily due to the release of obligations under participation agreements with Terra BDC in connection with the BDC Merger.
Interest Expense on Repurchase Agreements Payable
On November 8, 2021, we entered into a master repurchase agreement that provides for advances of up to $195 million which we expect to use to finance certain secured performing commercial real estate loans, including senior mortgage loans. Additionally, on February 18, 2022, we entered into another master repurchase agreement that provides for advances of up to $200 million, which we expect to use to finance the originations of certain secured performing commercial real estate loans and the acquisitions of certain secured non-performing commercial real estate loans.
For the three and six months ended June 30, 2023, as compared to the same periods in 2022, interest expense on repurchase agreement payable increased by $1.3 million and $3.6 million, respectively, as a result of an increase in the weighted average principal amount outstanding on repurchase agreements payable as well as an increase in the weighted average coupon rate.
Interest Expense on Mortgage Loans Payable
For the three and six months ended June 30, 2023, as compared to the same periods in 2022, interest expense on mortgage loan payable increased by $1.1 million and $1.3 million, respectively, as a result of an increase in the weighted average principal amount outstanding on mortgage loan payable, primarily due to financing obtained in connection with an acquisitions of real estate in 2023, as well as in increase in the index rate on the existing mortgage loan payable.
Interest Expense on Revolving Line of Credit
On March 12, 2021, we entered into a Business Loan and Security Agreement (the “revolving line of credit”) to provide for advances up to the lesser of $75.0 million or the amount determined by the borrowing base, which is based on the eligible assets pledged to the lender. On January 4, 2022, we amended the revolving line of credit to increase the maximum amount available to $125.0 million.
For the three and six months ended June 30, 2023, as compared to the same periods in 2022, interest expense on revolving line of credit increased by $1.8 million and $3.3 million, respectively, due to an increase in weighted average principal amount outstanding on the revolving line of credit as well as an increase in the index rate on the revolving line of credit.
Interest Expense on Term Loan Payable
On September 3, 2020, we entered into an indenture and credit agreement that provided for a floating rate loan of $103.0 million, $3.6 million of additional future advances, and up to $11.6 million of additional future discretionary advances, in connection with certain outstanding funding commitments under the mortgage assets owned by us and financed under the indenture and credit agreement. The loan bore interest at LIBOR plus 4.25% with a LIBOR floor of 1.0%. On February 18, 2022, we refinanced this loan with a new repurchase agreement. Additionally, in connection with the BDC Merger, we assumed a term loan of $25.0 million. The term loan bears interest at an annual rate of 5.625% and matures on July 1, 2023. In June 2023, the term loan was amended to extend the maturity date to March 31, 2024 and to increase the rate 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 repayment of $10.0 million on the term loan. As of June 30, 2023, the term loan had an outstanding principal balance of $15.0 million.
For the three and six months ended June 30, 2023, as compared to the same periods in 2022, interest expense on term loan payable increased by $0.4 million and $0.5 million, respectively, as a result of interest expense recognized on the term loan that we acquired in connection with the BDC Merger on October 1, 2022, partially offset by the reversal of the previously accrued step-up interest of $0.4 million during the first quarter of 2022 in connection with the termination of the old term loan.
Interest Expense on Unsecured Notes Payable
In June 2021, we issued $85.1 million in aggregate principal amount of 6.00% notes due 2026. In connection with the BDC Merger, we assumed $38.4 million in aggregate principal amount of 7.00% notes due in 2026.
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For the three and six months ended June 30, 2023, as compared to the same periods in 2022, interest expense on unsecured notes payable increased by $1.0 million and $1.9 million, respectively, as a result of an increase in the weighted average principal amount outstanding due to the assumption of unsecured notes payable in connection with the BDC Merger.
Interest Expense on Secured Borrowing
In March 2020, we entered into a financing transaction where a third-party purchased an A-note position. However, the sale of the A-note position did not qualify for sale accounting treatment and therefore, the gross amount of the loan remained in the consolidated balance sheets. The portion that was sold was reflected as secured borrowing in the consolidated balance sheets, and the associated interest was reflected as interest expense on secured borrowing in the consolidated statements of operations. The secured borrowing was repaid in August 2022.
For the three and six months ended June 30, 2023, there was no interest expense on secured borrowing as the secured borrowing was repaid in August 2022. For the three and six months ended June 30, 2022, interest expense on secured borrowing was $0.6 million and $1.1 million, respectively.
Loss on Sale of Real Estate
In June 2022, we sold the 4.9 acres of adjacent land located in Pennsylvania for net proceeds of $8.6 million, and recognized a net loss on sale of $0.1 million for three and six months ended June 30, 2022, excluding impairment charges of $1.6 million recognized in March 2022 and $3.4 million recognized in December 2021.
(Loss) Income from Equity Investment in Unconsolidated Investments
In August 2020, we entered into a subscription agreement with RESOF, an affiliate managed by our Manager, whereby we committed to fund up to $50.0 million to purchase partnership interest in RESOF. RESOF’s primary investment objective is to generate attractive risk-adjusted returns by purchasing performing and non-performing mortgages, loans, mezzanines and other credit instruments supported by underlying commercial real estate assets. RESOF may also opportunistically originate high-yield mortgages or loans in real estate special situations including rescue financings, bridge loans, restructurings and bankruptcies (including debtor-in-possession loans). As of June 30, 2023 and 2022, we owned 14.9% and 27.9% of the equity interest in RESOF, respectively.
We also owned beneficial equity interests in three joint ventures that invest in real estate properties. In 2022, in connection with a mezzanine loan we originated, we entered into a residual profit sharing arrangement with the borrower. We accounted for this arrangement as an equity investment. In May 2023, the mezzanine loan that was accounted for as an equity investment and five senior loans that were held for investment were settled and exchanged for five industrial buildings.
For the three and six months ended June 30, 2023, we recognized a loss from equity investment in unconsolidated investments of $1.8 million and $2.2 million, respectively, which consisted of equity loss from RESOF of $1.2 million and $0.9 million, respectively, and net equity loss from the joint ventures and the mezzanine loan of $0.6 million and $1.3 million, respectively. The equity loss from RESOF was a result of adjustments to equity income due to the dilution of our ownership interest in RESOF as new investors were admitted in 2022 and 2023. The equity loss from the joint ventures was result of depreciation and amortization and interest expense recognized by the joint ventures. For the three and six months ended June 30, 2022, we recognized income from equity investment in unconsolidated investments of $1.4 million and $2.8 million, which consisted of equity income from RESOF of $1.6 million and $2.9 million and equity loss from the joint ventures of $0.2 million and $0.1 million, respectively.
Net (Loss) Income
For the three and six months ended June 30, 2023, net loss was $19.2 million and $18.7 million, respectively, compared to net income of $1.3 million and $0.5 million, respectively, for the same periods in 2022.
Financial Condition, Liquidity and Capital Resources
Liquidity is a measure of our ability to meet potential cash requirements, including ongoing commitments to repay borrowings, funding and maintaining our assets and operations, making distributions to our stockholders and other general business needs. We use significant cash to purchase our target assets, repay principal and interest on our borrowings, make distributions to our investors and fund our operations. Our primary sources of cash generally consist of payments of principal and interest we receive on our portfolio of investments, cash generated from our operating results and unused borrowing
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capacity under our financing sources. We deploy moderate amounts of leverage as part of our operating strategy and use a number of sources to finance our target assets, including our senior notes, term loan, repurchase agreement and revolving line of credit. We may use other sources to finance our target assets, including bank financing and arranged financing facilities with domestic or international financing providers. In addition, we may divide the loans we originate into senior and junior tranches and dispose of the more senior tranches as an additional means of providing financing to our business.
We may also issue additional equity, equity-related and debt securities to fund our investment strategies. We may issue these securities to unaffiliated third parties or to vehicles advised by affiliates of Terra Capital Partners or third parties. As part of our capital raising transactions, we may grant to one or more of these vehicles certain control rights over our activities including rights to approve major decisions we take as part of our business. In order to qualify as a REIT, we must distribute to our stockholders, each calendar year, dividends equal to at least 90% of our REIT taxable income (including certain items of non-cash income), determined without regard to the deduction for dividends paid and excluding net capital gain. These distribution requirements limit our ability to retain earnings and thereby replenish or increase capital for our business.
We expect to fund approximately $35.4 million of the unfunded commitments to borrowers during the next twelve months. We expect to maintain sufficient liquidity to fund such commitments through matching these commitments with principal repayments on outstanding loans or draw downs on our credit facilities. Additionally, we had $27.6 million of borrowings outstanding under a mortgage loan payable that bear interest at an annual rate of Term SOFR plus 3.85% with a Term SOFR floor of 2.23%, that is collateralized by an office building. The mortgage loan payable matured on May 31, 2023. We have sought to convey our interest in the office building and ground lease in lieu of foreclosure. In connection with the BDC Merger, we assumed a $25.0 million term loan. This term loan bore interest at an annual rate of 5.625% and was to mature on July 1, 2023. In June 2023, the term loan was amended to extend the maturity date to March 31, 2024 and to increase the rate to a floating rate based on SOFR plus 7.375% with a SOFR floor of 5.0%. As of June 30, 2023, the term loan had an outstanding principal balance of $15.0 million. We expect to either maintain sufficient liquidity to repay the facility or refinance the facility. Our line of credit with outstanding principal balance of $105.4 million matures on March 12, 2024 and our GS repurchase agreement with outstanding principal balance of $85.4 million matures on February 18, 2024 (see Summary of Financing below). We expect to extend the maturity of both facilities by another year.
Summary of Financing
The table below summarizes our debt financing as of June 30, 2023:
| Type of Financing | Maximum Amount Available | Outstanding Balance | Amount Remaining Available | Interest Rate | Maturity Date | |||||||||||||||||||||||||||
| Fixed Rate: | ||||||||||||||||||||||||||||||||
| Senior unsecured notes | N/A | $ | 85,125,000 | N/A | 6.00% | 6/30/2026 | ||||||||||||||||||||||||||
| Senior unsecured notes | N/A | 38,375,000 | N/A | 7.00% | 3/31/2026 | |||||||||||||||||||||||||||
| Mortgage loan payable | N/A | 40,250,000 | N/A | 6.254% | 6/6/2028 | |||||||||||||||||||||||||||
| $ | 163,750,000 | |||||||||||||||||||||||||||||||
| Variable Rate: | ||||||||||||||||||||||||||||||||
| Mortgage loan payable | N/A | $ | 27,603,118 | N/A | Term SOFR plus 3.85% with a Term SOFR floor of 2.23% | 5/31/2023 | ||||||||||||||||||||||||||
| Mortgage loan payable | N/A | 32,368,367 | N/A | Term SOFR +3.5% (Term SOFR Floor of 3.75%) | 4/9/2027 | |||||||||||||||||||||||||||
| Term loan | N/A | 15,000,000 | N/A | SOFR plus 7.375% with a SOFR floor of 5.0% | 3/31/2024 | |||||||||||||||||||||||||||
| Line of credit | $ | 125,000,000 | 105,448,019 | $ | 19,551,981 | Term SOFR plus 3.35% with a combined floor of 6.00% | 3/12/2024 | |||||||||||||||||||||||||
| UBS repurchase agreement | 195,000,000 | 37,450,000 | 157,550,000 | Term SOFR plus a spread ranging from 1.60% to 2.25% | 11/7/2024 | |||||||||||||||||||||||||||
| GS repurchase agreement | 200,000,000 | 85,382,682 | 114,617,318 | Term SOFR (subject to underlying loan floors on a case-by-case basis) plus a spread ranging from 1.75% to 3.00% | 2/18/2024 | |||||||||||||||||||||||||||
| $ | 520,000,000 | $ | 303,252,186 | $ | 291,719,299 | |||||||||||||||||||||||||||
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Cash Flows Provided by Operating Activities
For the six months ended June 30, 2023, as compared to the same period in 2022, cash flows provided by operating activities increased by $8.6 million, primarily due to an increase in net contractual interest income.
Cash Flows Used in Investing Activities
For the six months ended June 30, 2023, cash flows used in investing activities were $6.8 million, primarily related to origination and purchase of loans of $63.8 million, purchase of real estate properties of $52.3 million, and purchase of debt securities of $21.1 million, partially offset by proceeds from repayments of loans of $99.0 million, proceeds from sale of debt securities of $20.0 million and return of capital on unconsolidated investments of $10.7 million.
For the six months ended June 30, 2022, cash flows used in investing activities were $74.4 million, primarily related to origination and purchase of loans of $120.4 million and purchase of equity interests in unconsolidated investments of $20.9 million, partially offset by proceeds from repayments of loans of $56.6 million, proceeds from sale of real estate of $8.6 million
and proceeds from sale of marketable securities of $1.3 million.
Cash Flows Provided by Financing Activities
For the six months ended June 30, 2023, cash flows provided by financing activities were $16.4 million, primarily due to proceeds from mortgage loan payable of $72.6 million, and borrowings under the revolving line of credit of $57.0 million, partially offset by repayments of borrowings under repurchase agreements of $49.3 million, repayments of borrowings under revolving line of credit of $41.7 million, repayments of borrowings under the term loan of $10.0 million, and distributions paid of $9.3 million.
For the six months ended June 30, 2022, cash flows from financing activities were $60.7 million, primarily due to proceeds from borrowings under the repurchase agreements of $148.1 million and proceeds from obligations under participation agreements and secured borrowing of $20.2 million. These cash inflows were partially offset by repayments on borrowings under the term loan of $93.8 million, repayments of obligations under participation agreements of $15.0 million and distributions paid of $7.7 million. Additionally, for the six months ended June 30, 2022, we received proceeds from borrowings under the revolving line of credit of $41.2 million and made repayments on borrowings under the revolving line of credit of $30.9 million.
Distribution Reinvestment Plan
On January 20, 2023, our Board adopted a distribution reinvestment plan (the “Plan”), pursuant to which our stockholders may elect to reinvest cash distributions payable by us in additional shares of Class A Common Stock and Class B Common Stock, at the price per share determined pursuant to the Plan.
Critical Accounting Policies and Use of Estimates
Our consolidated financial statements are prepared in conformity with United States generally accepted accounting principles, 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 periods. 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.
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Current Expected Credit Losses Reserve
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 (“CECL”). The CECL model requires the consideration of possible credit losses over the life of an instrument as opposed to only estimating credit losses upon the occurrence of a discrete loss event under the previous “incurred loss” methodology.
We utilize information obtained from internal and external sources relating to past events, current conditions and reasonable and supportable forecasts about the future to determine the expected credit losses for its loan portfolio. We utilize a loan loss model that is widely used among banks and commercial mortgage REITs and is marketed by a leading commercial mortgage-based security data analytics provider. It 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. We provide specific loan-level inputs which include 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. We select from a group of independent five-year macroeconomic forecasts included in the model that are updated regularly based on current economic trends. Based on the inputs, the loan loss model determines a loan loss rate through the generation of probability of defaults (PD) and loss given defaults (LGD) for each loan. The CECL reserve 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.
Management Agreement with Terra REIT Advisors
We currently pay 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, our Manager 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 us.
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 us (inclusive of closing costs and expenses).
Disposition Fee. A disposition fee in the amount of 1.0% of the gross sale price received by our company 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 we take ownership of a property as a result of a workout or foreclosure of a loan, we 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 we 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, our Manager 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 our Manager with respect to its evaluation and pursuit of such transactions.
In addition to the fees described above, we reimburse our Manager for operating expenses incurred in connection with services provided to the operations of our company, including our allocable share of our Manager’s overhead, such as rent, employee costs, utilities, and technology costs.
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The following table presents a summary of fees paid and costs reimbursed to our Manager in connection with providing services to us:
| Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||||||||||||
| 2023 | 2022 | 2023 | 2022 | |||||||||||||||||||||||
Origination and extension fee expense (1)(2) | 343,159 | 381,947 | $ | 814,607 | $ | 1,068,312 | ||||||||||||||||||||
| Asset management fee | 2,105,049 | 1,640,628 | 4,102,476 | 3,128,723 | ||||||||||||||||||||||
| Asset servicing fee | $ | 496,374 | $ | 395,718 | 966,899 | 745,047 | ||||||||||||||||||||
| Operating expenses reimbursed to Manager | 2,120,029 | 2,140,635 | 4,297,033 | 4,069,198 | ||||||||||||||||||||||
Disposition fee (3) | 917,750 | 479,500 | 1,208,563 | 479,500 | ||||||||||||||||||||||
| Total | $ | 5,982,361 | $ | 5,038,428 | $ | 11,389,578 | $ | 9,490,780 | ||||||||||||||||||
_______________
(1)Origination and extension fee expense is generally offset with origination and extension fee income. Any excess is deferred and amortized to interest income over the term of the loan.
(2)Amount for the six months ended June 30, 2023 excluded $0.5 million of origination fee paid to the Manager in connection with the acquisition of the three industrial buildings in 2023. Amount for the six months ended June 30, 2022 excluded $0.2 million of origination fees paid to our Manager in connection with our equity investment in an unconsolidated investment. These origination fees were capitalized to the carrying value of the unconsolidated investment as a transaction cost.
(3)Disposition fee is generally offset with exit fee income and included in interest income on the consolidated statements of operations.
Cost Sharing and Reimbursement Agreement with Terra LLC
We have entered into a cost sharing and reimbursement agreement with Terra LLC, effective October 1, 2022 pursuant to which Terra LLC will be responsible for its allocable share of our expenses, including fees paid by us to our Manager based on relative assets under management. These fees are eliminated in consolidation and therefore have no impact on our consolidated financial statements.
Participation Agreements
We have further diversified our exposure to loans and borrowers by entering into participation agreements whereby we transferred a portion of certain of our loans on a pari passu basis to related parties, primarily other affiliated funds managed by our Manager or its affiliates, and to a lesser extent, unrelated parties. We have also sold a portion of a loan to a third party that did not qualify for sale accounting. In connection with the BDC Merger, the obligations under participation agreements with Terra BDC totaling $37.0 million were effectively extinguished.
As of June 30, 2023, the principal balance of our participation obligation was $13.7 million, which was a participation obligation to a third party.
The loans that are subject to participation agreements are held in our name, but each of the participant’s rights and obligations, including with respect to interest income and other income (e.g., exit fee, prepayment income) and related fees/expenses (e.g., disposition fees, asset management and asset servicing fees), are based upon their respective pro rata participation interest in such participated investments, as specified in the respective participation agreements. We do not have direct liability to a participant with respect to the underlying loan and the participants’ share of the investments is repayable only from the proceeds received from the related borrower/issuer of the investments and, therefore, the participants also are subject to credit risk (i.e., risk of default by the underlying borrower/issuer).
Pursuant to the participation agreement with these entities, we receive and allocate the interest income and other related investment income to the participants based on their respective pro rata participation interest. The affiliated fund participant pays related expenses also based on their respective pro rata participation interest (i.e., asset management and asset servicing fees, disposition fees) directly to our Manager, as per the terms of each respective affiliate’s management agreement.
Other than for U.S. federal income tax purposes, our loan participations do not qualify for sale treatment. As such, the investments remain on our combined consolidated balance sheets and the proceeds are recorded as obligations under participation agreements. Similarly, interest earned on the entire loan balance is recorded within “Interest income” and the
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interest related to the participation interest is recorded within “Interest expense from obligations under participation agreements” in the consolidated statements of operations.
For the three and six months ended June 30, 2023, the weighted average outstanding principal balance on obligations under participation agreements was approximately $13.5 million and $13.2 million, respectively, and for both periods, the weighted average interest rate was approximately 17.1% , compared to the weighted average outstanding principal balance on obligations under participation agreements and secured borrowing of approximately 85.5 million and $82.3 million, respectively, and the weighted average interest rate was approximately 10.5% and 10.5%, respectively. The secured borrowing was repaid in August 2022.
Item 3. 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 market interest rates will not have a material adverse effect on our net investment income.
As of June 30, 2023, we had two investments with an aggregate principal balance of $16.6 million, net of obligations under participation agreements, that provide for interest income at an annual rate of LIBOR plus a spread, one of which is subject to a LIBOR floor. A decrease of 100 basis points in LIBOR would decrease our annual interest income, net of interest expense on participation agreements, by approximately $0.2 million, and an increase of 100 basis points in LIBOR would increase our annual interest income, net of interest expense on participation agreements, by approximately $0.2 million. Additionally, we had 16 investments with an aggregate principal balance of $458.6 million that provide for interest income at an annual rate of SOFR or Term SOFR, plus a spread, 15 of which were subject to a SOFR or Term SOFR floor. A decrease of 100 basis points in SOFR or Term SOFR would decrease our annual interest income by $4.9 million, and an increase of 100 basis points in SOFR or Term SOFR would increase our annual interest income by $5.0 million.
Additionally, as of June 30, 2023, we had $27.6 million of borrowings outstanding under a mortgage loan payable that bear interest at an annual rate of Term SOFR plus a spread that is collateralized by an office building; $32.4 million of borrowings outstanding under another mortgage loan payable that bear interest an annual rate of Term SOFR plus a spread that is collateralized by three industrial buildings; a revolving line of credit with an outstanding balance of $105.4 million that bears interest at an annual rate of Term SOFR plus a spread that is collateralized by $165.6 million of first mortgages; a repurchase agreement with an outstanding balance of $37.5 million that bears interest at an annual rate of Term SOFR, as applicable, plus a spread that is collateralized by $51.1 million of first mortgages; another repurchase agreement with an outstanding balance of $85.4 million that bears interest at an annual rate of Term SOFR plus a spread that is collateralized by $120.1 million of first mortgages; and a $15.0 million of term loan that bears interest at an annual rate of SOFR plus a spread of 7.375% with a SOFR floor of 5.0%. A decrease of 100 basis points in Term SOFR would decrease our annual interest expense by approximately $2.9 million, and an increase of 100 basis points in Term SOFR would increase our annual interest expense by approximately $3.0 million.
In July 2017, the U.K. Financial Conduct Authority, which regulates the LIBOR administrator, IBA, announced that it would cease to compel banks to participate in setting LIBOR as a benchmark by the end of 2021, which has subsequently been delayed to June 30, 2023. The Alternative Reference Rates Committee, a steering committee comprised of large U.S. financial institutions convened by the U.S. Federal Reserve, has recommended SOFR as a more robust reference rate alternative to U.S. dollar LIBOR. SOFR is calculated based on overnight transactions under repurchase agreements, backed by Treasury securities. SOFR is observed and backward looking, which stands in contrast with LIBOR under the current methodology, which is an estimated forward-looking rate and relies, to some degree, on the expert judgment of submitting panel members. Given that SOFR is a secured rate backed by government securities, it will be a rate that does not take into account bank credit risk (as is the case with LIBOR). SOFR is therefore likely to be lower than LIBOR and is less likely to correlate with the funding costs of financial institutions. Whether or not SOFR attains market traction as a LIBOR replacement tool remains in question. As such, the future of LIBOR at this time is uncertain.
Potential changes, or uncertainty related to such potential changes, may adversely affect the market for LIBOR-based loans, including our portfolio of LIBOR-indexed, floating-rate loans, or the cost of our borrowings. In addition, changes or reforms to the determination or supervision of LIBOR may result in a sudden or prolonged increase or decrease in reported LIBOR, which could have an adverse impact on the market for LIBOR-based loans, including the value of the LIBOR-indexed, floating-rate loans in our portfolio, or the cost of our borrowings. In the event LIBOR is unavailable, our investment documents
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provide for a substitute index, on a basis generally consistent with market practice, intended to put us in substantially the same economic position as LIBOR.
We may hedge against interest rate fluctuations by using standard hedging instruments, such as futures, options and forward contracts, subject to the requirements of the 1940 Act. 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 three and six months ended June 30, 2023 and 2022, we did not engage in interest rate hedging activities.
Prepayment Risks
Prepayments can either positively or adversely affect the yields on our loans. 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 do not collect a prepayment fee in connection with a prepayment or are unable to invest the proceeds of such prepayments received, the yield on the portfolio will decline. In addition, we may acquire assets at a discount or premium and if the asset does not repay when expected, the anticipated yield may be impacted. Under certain interest rate and prepayment scenarios we may fail to recoup fully our cost of acquisition of certain loans.
Extension Risk
Extension risk is the risk that our assets will be repaid at a slower rate than anticipated and generally increases when interest rates rise. In which case, to the extent we have financed the acquisition of an asset, we may have to finance our asset at potentially higher costs without the ability to reinvest principal into higher yielding securities because borrowers prepay their mortgages at a slower pace than originally expected, adversely impacting our net interest spread, and thus our net interest income.
Real Estate Risk
The market values of commercial and residential mortgage assets are subject to volatility and may be affected adversely by a number of factors, including, but not limited to, national, regional and local economic conditions (which may be adversely affected by industry slowdowns and other factors); local real estate conditions; changes or continued weakness in specific industry segments; construction quality, age and design; demographic factors; retroactive changes to building or similar codes; pandemics; natural disasters; and other acts of god. In addition, decreases in property values reduce the value of the collateral and the potential proceeds available to a borrower to repay the underlying loans, which could also cause us to suffer losses.
Credit Risk
We are subject to varying degrees of credit risk in connection with holding a portfolio of our target assets. With respect to our loan portfolio, we seek to manage credit risk by limiting exposure to any one individual borrower and any one asset class.
Additionally, our Manager employs an asset management approach and monitors the portfolio of investments through, at a minimum, quarterly financial review of property performance including net operating income, loan-to-value, debt service coverage ratio and the debt yield. Our Manager also requires certain borrowers to establish a cash reserve, as a form of additional collateral, for the purpose of providing for future interest or property-related operating payments.
Item 4. 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 our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of June 30, 2023. Based on that evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective to provide reasonable assurance that we would meet our disclosure obligations. Notwithstanding the foregoing, a control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that it will detect or uncover failures within the Company to disclose material information otherwise required to be set forth in our periodic reports.
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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.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
From time to time, we 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 portfolio companies. Additionally, as of June 30, 2023, we owned a multi-tenant office building that is subject to a ground lease. The ground lease provides for a new base rent every 5 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. We are currently 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 – Terra Ocean Ave., LLC v. Ocean Avenue Santa Monica Realty LLC, Superior Court of California, Los Angeles County, Case No. 20STCV34217. We believe this determination should be based on comparable sales, while the landlord insists that the rent under the ground lease itself is also relevant. Our position has prevailed in all three of the prior arbitrations to reset the ground rent. We intend vigorously to pursue the litigation. While we believe our arguments will likely prevail, the outcome of the legal proceeding cannot be predicted with certainty. If the landlord prevails, the future rent reset determinations could result in significantly higher ground rent, which would likely result in a significant diminution in the value of our interest in the ground lease and the office building.
On July 7, 2023, Centennial Bank filed a complaint for breach of guaranty against us in the United States District Court, Southern District of New York (SDNY). The complaint relates to a loan made by Centennial Bank to Terra Ocean Ave., LLC (“Terra Ocean”), and alleges that Centennial Bank allegedly made a mistake in July 2021, in demanding a prepayment of $11.3 million instead of $28.5 million with respect to the loan, and that we, as guarantor in certain limited respects, must now pay the difference (i.e. $17.2 million) plus interest and attorneys’ fees and costs. Centennial Bank’s now alleges that its mistake in determining the prepayment amount was caused by the wrongful failure to disclose the then-current status of the Lease Litigation by Terra Ocean and/or us. On July 24, 2023, we, through counsel appeared in the action. Although the action is in its initial stages, we are seeking a dismissal of the complaint at the pleading stage and, if not successful, is prepared to vigorously defend itself through trial. We believe the claim by Centennial Bank is without merit.
Also on July 17, 2023, Centennial Bank filed a complaint against Terra Ocean for: (i) Breach of Contract; (ii) Judicial Foreclosure and Deficiency Judgment; and (iii) Specific Performance and Appointment of Receiver in the Superior Court of the State of California, County of Los Angeles. Centennial Bank seeks to foreclose on the deed of trust encumbering the tenant’s interest in the above-mentioned multi-tenant office building and ground lease. In the complaint, Centennial Bank alleges that its loan to Terra Ocean is in default and the outstanding principal amount of the loan is $27.6 million as of the filing of the complaint. Prior to Centennial Bank filing its complaints against the Company and Terra Ocean, Terra Ocean sought to convey its interest in the ground lease in lieu of foreclosure. Terra Ocean is in the process of preparing an appropriate response to Centennial Bank’s claims in this action.
Item 1A. Risk Factors.
There have been no material changes from the risk factors set forth in our Annual Report on Form 10-K for the year ended December 31, 2022.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
None.
Item 3. Defaults Upon Senior Securities.
Not applicable.
Item 4. Mine Safety Disclosures.
Not applicable.
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Item 5. Other Information.
None
Item 6. 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 | ||||||||
| 2.2 | ||||||||
| 2.3 | ||||||||
| 2.4 | ||||||||
| 3.1 | ||||||||
| 3.2 | ||||||||
| 3.3 | ||||||||
| 3.4 | ||||||||
| 4.1 | ||||||||
| 4.2 | ||||||||
| 4.3 | ||||||||
| 4.4 | ||||||||
| 4.5 | ||||||||
| 4.6 | ||||||||
| 4.7 | ||||||||
| 10.1* | ||||||||
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| Exhibit No. | Description and Method of Filing | |||||||
| 31.1* | ||||||||
| 31.2* | ||||||||
| 32** | ||||||||
| 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 | Inline XBRL Taxonomy Extension Schema Document | |||||||
| 101.CAL | Inline XBRL Taxonomy Extension Calculation Linkbase Document | |||||||
| 101.LAB | Inline XBRL Taxonomy Extension Label Linkbase Document | |||||||
| 101.PRE | Inline 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.
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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: August 11, 2023
| TERRA PROPERTY TRUST, INC. | ||||||||
| By: | /s/ Vikram S. Uppal | |||||||
| Vikram S. Uppal | ||||||||
| Chief Executive Officer | ||||||||
| (Principal Executive Officer) | ||||||||
| By: | /s/ Gregory M. Pinkus | |||||||
| Gregory M. Pinkus | ||||||||
| Chief Financial Officer and Chief Operating Officer, | ||||||||
| (Principal Financial and Accounting Officer) | ||||||||
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