Item 2. Management’s Discussion and Analysis
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of the financial condition and results of operations should be read in conjunction with the financial statements and the notes to those statements included elsewhere in this report. Certain statements in this discussion and elsewhere in this report constitute forward-looking statements, within the meaning of section 21E of the Exchange Act, that involve risks and uncertainties. The actual results may differ materially from those anticipated in these forward-looking statements.
Company Overview
We are a Connecticut-based real estate finance company that specializes in originating, underwriting, funding, servicing and managing a portfolio of short-term ( i.e., three years or less) loans secured by first mortgage liens on real property. From our inception in December 2010, through our initial public offering, in February 2017, we operated as a limited liability company. On February 9, 2017, we completed our initial public offering (the “IPO”), the primary purpose of which was to raise equity capital to fund mortgage loans, expand our mortgage loan portfolio and diversify our ownership so that we could qualify, for federal income tax purposes, as a real estate investment trust, or REIT. We believe that, since consummation of the IPO, we meet all the requirements to qualify as a REIT for federal income tax purposes and elected to be taxed as a REIT beginning with our 2017 tax year. As a REIT, we are entitled to claim deductions for distributions of taxable income to our shareholders thereby eliminating any corporate tax on such taxable income. Any taxable income not distributed to shareholders is subject to tax at the regular corporate tax rates and may also be subject to a 4% excise tax to the extent it exceeds 10% of our total taxable income. To maintain our qualification as a REIT, we are required to distribute each year at least 90% of our taxable income. As a REIT, we may also be subject to federal excise taxes and state taxes.
Review of the First Quarter and Outlook for Balance of Year
Compared to the first quarter of 2022, revenue increased 42.8%, net income attributable to common shareholders increased 22.3%, and earnings per share remained unchanged at $0.10 per share. The revenue increase was directly related to the growth in our lending activities, reflected in our interest income which had an increase of 29.0% and our income from partnership investments that had an increase of 101.7%. We also recorded an unrealized gain of approximately $716,000 on investment securities in the first quarter of 2023 compared to a loss of $1.1 million in the first quarter of 2022, reflecting a $1.8 million increase in the value of those securities. The increase in revenue was partly offset by a 61.1% increase in operating costs and expenses. The increase in operating expenses is mainly attributable to a 76.3% increase in interest and amortization of deferred financing costs and an 79.0% increase in compensation and related expenses. The increase in compensation expense is mainly attributable to the addition of a Chief Financial Officer in August 2022 as well as additional staff positions that are part of our long-term growth strategy. Mortgages receivable increased by 34.7% compared to the same prior year period, while cash and cash equivalents decreased 64.9%. The increase in mortgages receivable was primarily due to increase in lending.
Our primary business objective for 2023 remains to grow our loan portfolio while protecting and preserving capital in a manner that provides for attractive risk-adjusted returns to our shareholders over the long term principally through dividends. We intend to achieve this objective by accelerating profitable growth and driving operational excellence. To accelerate profitable growth, we will continue to focus on selectively originating, managing, and servicing a portfolio of first mortgage real estate loans designed to generate attractive risk-adjusted returns across a variety of market conditions and economic cycles. We are also targeting larger-value commercial loans with strong, experienced sponsors. To drive additional operational excellence, we continuously review, assess, and upgrade our existing operational processes, from workflows and employee roles/responsibilities to decision trees and data collection forms. Additionally, we continue to focus on developing relationships with larger scale wholesale brokers, furthering our efforts to attract larger borrowers with better credit quality. We believe that our ability to react quickly to the needs of borrowers, our flexibility in terms of structuring loans to meet the needs of borrowers, our knowledge of the primary real estate markets we lend in, our expertise in “hard money” lending and our focus on newly originated first mortgage loans, should enable us to achieve our primary objective. Nevertheless, we remain flexible to take advantage of other real estate opportunities that may arise from time to time, whether they relate to the mortgage market or to direct or indirect investments in real estate.
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Our overall business strategy is as follows:
● capitalize on opportunities created by the long-term structural changes in the real estate lending market and the continuing lack of liquidity in the commercial and investment real estate markets;
● take advantage of the prevailing economic environment and current economic, political and social trends that may impact real estate lending, as well as the outlook for real estate in general and particular asset classes;
● remain flexible to capitalize on changing sets of investment opportunities that may be present in the various points of an economic cycle;
● continue to improve operational efficiencies and reduce general and administrative expenses as a percentage of revenue;
● maintain our status as a publicly-held company, subject to the reporting requirements of the Exchange Act, which gives us immediate access to the public markets for much-needed capital; and
● continue to operate to qualify as a REIT and continue to qualify for an exemption from registration under the Investment Company Act of 1940, as amended, or the Investment Company Act.
We expect 2023 to be a challenging year due to the following factors:
Interest rate compression. For the three months ended March 2023 and 2022, the yield on our mortgage loan portfolio, inclusive of default interest, was 11.69% and 11.30%, respectively. (For this purpose, yield only takes into account the stated interest rate on the mortgage note adjusted to the default rate, if applicable.) We believe the interest rate compression will continue to be a factor in 2023, particularly as the Federal Reserve Board continues to increase interest rates, thereby increasing our cost of capital. The rates on our existing credit facilities, including the Churchill Facility, the Wells Fargo Loan and the NHB Mortgage (refinanced in February 2023) (as defined below), have all increased. In addition, the interest rate on the September 2027 Notes, our last note offering in 2022, was 8%, the highest its ever been. Overall, our weighted average cost of capital as of March 31, 2023 was 7.23% compared to 6.08% as of March 31, 2022.
Geopolitical concerns. Various geopolitical concerns have led to market volatility, spikes in commodity prices, supply chain interruptions, heightened cybersecurity concerns and general concerns that it might lead to unconventional warfare. These concerns include the ongoing war between Russia and Ukraine, heightened tensions between the United States and China, Iran’s pursuit of nuclear weapons and North Korea’s ongoing belligerence. The true ramifications of this conflict and their impact on the markets and our business are not fully known at this time. Our business is purely domestic, but we are impacted by market volatility and cybersecurity is a concern for all businesses.
Increased competition. In the past, our primary competitors were other non-bank real estate finance companies (like Sachem Capital Corp.) and banks and other financial institutions. More recently, we are encountering competition from private equity funds, hedge funds and other specialty finance entities funded by investment banks, asset managers, private equity funds and hedge funds. Clearly, the primary driver for these new market participants is the need to generate yield. They are well-funded and aggressive in terms of pricing. In addition, competition is becoming more of a factor as we implement our strategy to focus on larger loans and more sophisticated borrowers. Given recent developments regarding mid-size regional banks, we believe competition from traditional banks will abate in 2023 rather than increase. However, as traditional banks exit the lending market, non-traditional lenders, such as non-bank real estate companies, hedge funds, private equity funds and insurance companies, are likely to step into the void. Our principal competitive advantages include our experience, our reputation, our size and our ability to address the needs of borrowers in terms of timing and structuring loan transactions.
Borrower expectations. The new competitive landscape is shifting the negotiating leverage in favor of borrowers. As borrowers have more choices, they are demanding better terms. This is particularly true as we focus more on larger loans and borrowers with better credit histories.
Property value fluctuations. We remain aware of property value market cycles and utilize a dashboard of indicators to track property value trends. Our response to this development would be to adhere to our underwriting guidelines and aggressively enforce our rights when loans go into default. By judiciously relying on our dashboard of leading indicators and continuing to make decisions
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in a sound and proper manner, we see no reason to expect any negative outcome regarding our business operations and growth. Some of our indicators within our dashboard are interest rate changes impacting mortgage rates, days-on-market, pending sales, NAHB’s Housing Market Index and the Senior Loan Officer Opinion Survey.
Increased operating expenses. Our operating expenses for the three months ended March 31, 2023 are significantly higher than they were in 2022 due to our higher debt load. In addition, we expect that our aggregate dividend payments will be higher in 2023 than in 2022 due to an increase in the number of our common shares (“Common Shares”) outstanding as well as the full year effect of our Series A Preferred Stock (“Series A Preferred Stock”), which carries a 7.75% annual dividend rate. Finally, our compensation expense has increased as we hired new personnel and increased salaries of existing employees to administer a larger loan portfolio and more complex loan transactions.
Unfunded commitments. Most of our loans are funded in full at closing. However, where all or a portion of the loan proceeds are to be used to fund the costs of renovating or constructing improvements on the property, only a portion of the loan may be funded at closing. At March 31, 2023, our mortgage loan portfolio included 171 loans with future funding obligations, in the aggregate principal amount of $114.9 million, compared to 204 loans in the aggregate principal amount of $115.4 million at March 31, 2022. Advances under construction loans are funded against requests supported by all required documentation (including lien waivers) as and when needed to pay contractors and other costs of construction. In order to deal with these obligations, we are compelled to maintain higher cash balances, which could adversely impact our financial performance.
Despite these challenges we continue to believe in the viability of our business model. We believe that there continues to be a significant market opportunity for a well-capitalized “hard money” lender to originate attractively priced loans to small- and mid-scale real estate developers with good collateral, particularly in markets where, traditionally, real estate values are stable and substandard properties are improved, rehabilitated, and renovated as well as under-developed markets that are experiencing rapid growth due to population shifts. We also believe developers will prefer to borrow from us rather than other lending sources because of flexibility in structuring loans to suit their needs, our lending criteria, which places greater emphasis on the value of the collateral rather than the property cash flow or credit of the borrower, and our ability to close quickly. Our goal is, and has always been, to continue to grow our mortgage loan portfolio and increase our loan profitability, while at the same time maintain or improve our existing underwriting and loan criteria.
Financing Strategy Overview
To continue to grow our business, we must increase the size of our loan portfolio, which requires that we use our existing working capital to fund new loans and raise additional capital either by selling shares of our capital stock or by incurring additional indebtedness and we are mindful of the need to repay it at the appropriate time. Although we have no pre-set guidelines in terms of leverage ratio, the amount of leverage we will deploy will depend on our assessment of a variety of factors, which may include the liquidity of the real estate market in which most of our collateral is located, employment rates, general economic conditions, the cost of funds relative to the yield curve, the potential for losses and extension risk in our portfolio, the gap between the duration of our assets and liabilities, our opinion regarding the creditworthiness of our borrowers, the value of the collateral underlying our portfolio, and our outlook for interest rates and property values. At March 31, 2023, debt represented approximately 59.9% of our total capital compared to 55.5% at March 31, 2022. To prudently grow the business and satisfy the tax requirement to distribute 90% of our taxable income, we expect to maintain our current level of debt and look to reduce our cost of capital. We intend to continue to leverage our portfolio for the sole purpose of financing our portfolio and not for speculating on changes in interest rates.
As of March 31, 2023, we had seven series of unsecured unsubordinated notes outstanding, having an aggregate outstanding principal balance of $288.4 million (collectively, the “Notes”) all of which rank equally in right of payment with all of our existing and future senior unsecured and unsubordinated indebtedness and are effectively subordinated in right of payment to all existing and future secured indebtedness (including indebtedness that is initially unsecured to which we subsequently grant a security interest) and structurally subordinated to all existing and future indebtedness of our subsidiaries. Interest on each series of notes is payable quarterly in arrears on each March 30, June 30, September 30 and December 30 of each year they are outstanding and, except as noted below, each series can be prepaid beginning on the second anniversary of its date of issuance. The net proceeds, net of the deferred financing costs, was approximately $276.4 million.
● $40,250,000 aggregate original principal amount, issued August 23, 2022, bearing interest at the rate of 8.00% per annum and maturing on September 30, 2027 (the “September 2027 Notes”) and which trade on the NYSE American under the symbol SCCG;
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● $30,000,000 aggregate original principal amount, issued May 11, 2022, bearing interest at the rate of 7.125% per annum and maturing on June 30, 2027 (the “June 2027 Notes”) and which trade on the NYSE American under the symbol SCCF;
● $51,875,000 aggregate original principal amount, issued March 9, 2022, bearing interest at the rate of 6.00% per annum and maturing on March 30, 2027 (the “March 2027 Notes”) and which trade on the NYSE American under the symbol SCCE;
● $51,750,000 million original principal amount, issued December 20, 2021, bearing interest at the rate of 6.00% per annum and maturing on December 30, 2026 (the “2026 Notes”) and which trade on the NYSE American under the symbol SCCD;
● $56,363,750 million aggregate original principal amount, of which approximately $14.4 million was issued September 4, 2020, $14.0 million was issued October 23, 2020 and $28.0 million was issued December 22, 2020, bearing interest at the rate of 7.75% per annum and maturing on September 30, 2025 (the “2025 Notes”) and which trade on the NYSE American under the symbol SCCC;
● $34,500,000 million original principal amount, issued November 7, 2019, bearing interest at the rate of 6.875% per annum and maturing on December 30, 2024 (the “December 2024 Notes”) and which trade on the NYSE American under the symbol SACC; and
● $23,663,000 million original principal amount, issued June 25, 2019, bearing interest at the rate of 7.125% per annum and maturing on June 30, 2024 (the “June 2024 Notes”) and which trade on the NYSE American under the symbol SCCB.
Each series of Notes was issued pursuant to the Indenture, dated June 21, 2019, and a supplement thereto, which provides for the form and terms, including default provisions and cures, applicable to each series. All the Notes are subject to (i) “Defeasance,” which means that, by depositing with a trustee an amount of cash and/or government securities sufficient to pay all principal and interest, if any, on such notes when due and satisfying any additional conditions required under the Indenture, we will be deemed to have been discharged from our obligations under such notes and (ii) an “Asset Coverage Ratio” requirement pursuant to which we may not (x) pay any dividends or make distributions in excess of 90% of our taxable income, (y) incur any indebtedness or (z) purchase any shares of our capital stock unless we have an “Asset Coverage Ratio” of at least 150% after giving effect to the payment of such dividend, the making of such distribution or the incurrence of such indebtedness. “Asset Coverage Ratio” means the ratio (expressed as a percentage) of the value of our total assets relative to the aggregate amount of its indebtedness.
Under the terms of the Indenture, we may, at our option, at any time and from time to time, on or after two years from the date of issuance redeem the Notes. Accordingly, notes in the aggregate principal amount of approximately $114.5 million are currently redeemable. Notes in the aggregate principal amount of $51.75 million will become redeemable on December 20, 2023 and Notes in the aggregate principal amount of $122.13 million will become redeemable at various dates in 2024. In all cases, the redemption price equal to 100% of the outstanding principal amount thereof plus accrued and unpaid interest to, but excluding, the date fixed for redemption. On and after any redemption date, interest will cease to accrue on the redeemed notes.
Our secured indebtedness includes the Churchill Facility, the Wells Fargo Loan, the New NHB Mortgage and the Needham Credit Facility (each as described below).
On July 21, 2021, we consummated a $200 million facility (the “Churchill Facility”) with Churchill MRA Funding I LLC (“Churchill”). Under the terms of the Churchill Facility, we have the right, but not the obligation, to sell mortgage loans to Churchill, and Churchill has the right, but not the obligation, to purchase those loans. In addition, we have the right and, in some instances the obligation, to repurchase those loans from Churchill. The amount that Churchill will pay for each mortgage loan it purchases will vary based on the attributes of the loan and various other circumstances but generally will not exceed 70% of the unpaid principal balance purchased. The repurchase price is calculated by applying an interest factor, as defined, to the purchase price of the mortgage loan. We also granted Churchill a first priority security interest on the mortgage loans sold to Churchill to secure our repurchase obligation. The cost of capital under the Churchill Facility is equal to the sum of (a) the greater of (i) 0.25% and (ii) the 90-day SOFR plus (b) 3% - 4%, depending on the aggregate principal amount of the mortgage loans held by Churchill at that time. Our obligations under the Churchill Facility are secured by a lien on the mortgage loans sold to Churchill. The Churchill Facility is also subject to various terms
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and conditions, including representations and warranties, covenants and agreements typically found in these types of financing arrangements, including a covenant that (A) prohibits us from (i) paying any dividend or make any distribution in excess of 90% of our taxable income, (ii) incurring any indebtedness or (iii) purchasing any shares of our capital stock, unless, in any case, we have an asset coverage ratio of at least 150%; and (B) requires us to maintain unencumbered cash and cash equivalents in an amount equal to or greater than 2.50% of the amount of our repurchase obligations. Churchill has the right to terminate the Churchill Facility at any time upon 180 days prior notice to us. At such time, we have an additional 180 days after termination to repurchase all the mortgage loans held by Churchill. We believe the Churchill Facility gives us the ability to raise capital as needed at a relatively low rate. It also gives us the flexibility to seek other sources of funding. At March 31, 2023, the amount outstanding under the Churchill Facility was approximately $54.1 million, which amount was accruing interest of an effective rate of 9.09% per annum.
In 2020, we established a margin loan account with Wells Fargo that allows us to borrow against our investment securities portfolio (the “Wells Fargo Loan”). The Wells Fargo Loan is secured by our portfolio of short-term securities, had a balance of approximately $13.7 million at March 31, 2023. The outstanding balance on this loan bears interest at a rate equal to 1.75% below the prime rate. At March 31, 2023 the prime rate was 8.0% and the interest rate on the Wells Fargo Loan was, thus, 6.25%.
In 2021, we obtained a $1.4 million adjustable-rate mortgage loan from New Haven Bank (the “NHB Mortgage”) of which $750,000 was funded at closing and remained outstanding as of December 31, 2022. The purpose of the NHB Mortgage was to fund the cost of our acquisition and renovation of the property located at 568 East Main Street, Branford, Connecticut, as our new corporate headquarters. The balance of the NHB Mortgage was to be funded when those renovations were completed. Prior to its refinancing in February 2023, as described below, the NHB Mortgage accrued interest at an initial rate of 3.75% per annum for the first 72 months and was to be due and payable in full on December 1, 2037. During the first 12 months, from December 1, 2021 to November 30, 2022, only interest was due and payable. Beginning December 1, 2022 and through December 1, 2037, principal and interest was to be due and payable monthly, based on a 20-year amortization schedule.
On February 28, 2023, we refinanced the NHB Mortgage with a new $1.66 million adjustable-rate mortgage loan from New Haven Bank (the “New NHB Mortgage”). The new loan accrues interest at an initial rate of 5.75% per annum for the first 60 months. The interest rate will be adjusted on each of March 1, 2028 and March 1, 2033 to the then published 5-year Federal Home Loan Bank of Boston Classic Advance Rate, plus 1.75%. Beginning on April 1, 2023 and through March 1, 2038, principal and interest will be due and payable monthly, based on a 20-year amortization schedule. The unpaid principal amount of the loan and all accrued and unpaid interest are due and payable in full on March 1, 2038. The new loan is a non-recourse obligation, secured primarily by a first mortgage lien on the properties located 698 Main Street, Branford, Connecticut and 568 East Main Street, Branford, Connecticut.
On March 2, 2023, we entered into a Credit and Security Agreement (the “Credit Agreement”), with Needham Bank, a Massachusetts co-operative bank, as the administrative agent (the “Administrative Agent”) for the lenders party thereto (the “Lenders”) with respect to a $45 million revolving credit facility (the “Needham Credit Facility”). Under the Credit Agreement, we have the right to request an increase in the size of the Needham Credit Facility up to $75 million, subject to certain conditions, including the approval of the Lenders. Loans under the Needham Credit Facility accrue interest at the greater of (i) the annual rate of interest equal to the “prime rate,” as published in the “Money Rates” column of The Wall Street Journal minus one-quarter of one percent (0.25%), and (ii) four and one-half percent (4.50%). All amounts borrowed under the Needham Credit Facility are secured by a first priority lien on virtually all our assets. Assets excluded from the lien include real estate owned by us (other than real estate acquired pursuant to foreclosure) and mortgages sold under the Churchill Facility. The Needham Credit Facility expires March 2, 2026 subject to our right to extend the term for one year upon the consent of the Administrative Agent and the Lenders, which consent cannot be unreasonably withheld, and so long as we are not in default and satisfy certain other conditions. All outstanding revolving loans and accrued but unpaid interest are due and payable on the expiration date. We have the right to terminate the Needham Credit Facility at any time without premium or penalty by delivering written notice to the Administrative Agent at least ten (10) days prior to the proposed date of termination. The Needham Credit Facility is subject to other terms and conditions, including representations and warranties, covenants and agreements typically found in these types of financing arrangements, including a covenant that requires us to maintain: (A) a ratio of Adjusted EBITDA (as defined in the Credit Agreement) to Debt Service (as defined in the Credit Agreement) of less than 1.40 to 1.0, tested on a trailing-twelve-month basis at the end of each fiscal quarter, commencing with the quarter ending June 30, 2023; (B) a sum of cash, cash equivalents and availability under the facility equal to or greater than $10 million; and (C) an asset coverage ratio of at least 150%. As of March 31, 2023, we have not yet drawn on the Needham Credit Facility.
Finally, from time-to-time we raise capital by selling our Common Shares in various at-the market offerings. During the three months ended March 31, 2023, under our at-the-market offering facility (see Note 16 to the consolidated financial statements), we sold
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an aggregate of 2,479,798 Common Shares, realizing gross proceeds of approximately $9.4 million and we sold shares of Series A Preferred Stock having an aggregate liquidation preference of $154,675, realizing gross proceeds of $139,500 representing a discount of approximately 10% from the liquidation preference. As of the date of this Report, we have approximately $61.4 million of availability remaining for sale through one of these offerings.
REIT Qualification
We believe that we have qualified as a REIT since the consummation of the IPO and that it is in the best interests of our shareholders that we operate as a REIT. We made the election to be taxed as a REIT beginning with our 2017 tax year. As a REIT, we are required to distribute at least 90% of our taxable income to our shareholders on an annual basis. We cannot assure you that we will be able to maintain REIT status.
Our qualification as a REIT depends on our ability to meet on a continuing basis, through actual investment and operating results, various complex requirements under the Internal Revenue Code of 1986, as amended, relating to, among other things, the sources of our gross income, the composition and values of our assets, our compliance with the distribution requirements applicable to REITs and the diversity of ownership of our outstanding Common Shares. We cannot assure you that we will be able to maintain our qualification as a REIT.
So long as we qualify as a REIT, we, generally, will not be subject to U.S. federal income tax on our taxable income that we distribute currently to our shareholders. If we fail to qualify as a REIT in any taxable year and do not qualify for certain statutory relief provisions, we will be subject to U.S. federal income tax at regular corporate income tax rates and may be precluded from electing to be treated as a REIT for four taxable years following the year during which we lose our REIT qualification. Even if we qualify for taxation as a REIT, we may be subject to certain U.S. federal, state and local taxes on our income.
Critical Accounting Policies and Use of Estimates
The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Management will base the use of estimates on (a) various assumptions that consider prior reporting results, (b) projections regarding future operations and (c) general financial market and local and general economic conditions. Actual amounts could differ materially from those estimates.
Interest income from commercial loans is recognized, as earned, over the loan period, whereas origination and modification fee revenue on commercial loans are amortized over the term of the respective notes.
Results of Operations
Three months ended March 31, 2023 compared to three months ended March 31, 2022
Total revenue
Total revenue for the three months ended March 31, 2023 was approximately $14.7 million compared to approximately $10.3 million for the three months ended March 31, 2022, an increase of approximately $4.4 million, or 42.8%. The increase in revenue is primarily attributable to an increase in our lending operations. For the 2023 period, interest income was approximately $11.0 million compared to approximately $8.5 million for the 2022 period, an increase of approximately $2.5 million or 29.0%. Income from partnership investments was approximately $550,000 for the 2023 period compared to approximately $272,000 for the 2022 period, an increase of approximately $277,000 or 101.7%. Other income was approximately $708,000 for the 2023 period compared to approximately $609,000 for the 2022 period, an increase of approximately $99,000 or 16.3%. In addition, unrealized gains on investment securities for the 2023 period were approximately $716,000 compared to an unrealized loss of approximately $1.1 million on investment securities in the 2022 period. The increases were partially offset by a decrease in origination and modification fees of approximately $368,000, or 20% in the 2023 period, from approximately $1.8 million in the 2022 period to approximately $1.5 million in the 2023 period.
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Operating costs and expenses
Total operating costs and expenses for three months ended March 31, 2023 were approximately $9.6 million compared to approximately $5.9 million for the three months ended March 31, 2022, an increase of approximately $3.6 million or 61.1%. The increase in operating costs and expenses is primarily attributable to the increase in our unsecured bond debt while growing our lending operations. In the 2023 period, interest and amortization of deferred financing costs were approximately $6.9 million compared to approximately $3.9 million in the same 2022 period, an increase of approximately $3.0 million or 76.3%. The remaining fluctuations in operating expenses were primarily attributable to (i) compensation, fees and taxes which increased approximately $785,000, and (ii) general and administrative expenses which increased approximately $266,000, partially offset by an increase in gain on sale of real estate of approximately $214,000 and a decrease in impairment loss of approximately $156,000.
Comprehensive income
For the quarter ended March 31, 2023, we reported an unrealized gain on investment securities of approximately $92,000 reflecting the decrease in prior unrealized losses since December 31, 2022. For the quarter ended March 31, 2022, we reported an unrealized gain on investment securities of approximately $243,000 reflecting the decrease in prior unrealized losses since December 31, 2021.
Net income
Net income attributable to common shareholders for the three months ended March 31, 2023 was approximately $4.2 million, or $0.10 per share, compared to approximately $3.4 million, or $0.10 per share for the three months ended March 31, 2022.
Non-GAAP Metrics – Adjusted Earnings
We invest our excess cash in marketable securities. Under GAAP, those securities are required to be “marked to market” at the end of each reporting period. Accordingly, if the value of certain of those securities increases, the increase is reported as revenue, as has been the case in the first quarter of 2023 and the increase in the other securities is reported as a change in accumulated other comprehensive income. On the other hand, if the value decreases, the decrease in value of certain of the securities reduces our revenues. For income tax purposes, we do not report the gain or loss on those securities until they are sold. This creates a discrepancy between our GAAP net income and our taxable income. To maintain our status as a REIT, we are required to distribute, on an annual basis, at least 90% of our taxable income. Thus, to give our shareholders a better perspective of our taxable income, we use a metric called Adjusted Earnings.
Adjusted Earnings is calculated as net income attributable to common shareholders, prior to the effect unrealized gains (losses) on securities available-for-sale. Adjusted Earnings should be examined in conjunction with net income (loss) as shown in our statements of comprehensive income. Adjusted Earnings should not be considered as an alternative to net income (loss) (determined in accordance with GAAP), or to cash flows from operating activities (determined in accordance with GAAP), as a measure of our liquidity. Similarly, Adjusted Earnings is not indicative of funds available to fund our cash needs or available for distribution to shareholders. Rather, Adjusted Earnings is an additional measure we use to analyze our business performance because it excludes the effects of certain non-cash charges that we believe are not necessarily indicative of our operating performance. It should be noted that our manner of calculating Adjusted Earnings may differ from the calculations of similarly-titled measures by other companies. In addition, there may be other differences between GAAP and tax accounting that would impact Adjusted Earnings, which are not reflected in the table below.
For the Period Ended March 31,
2023
2022
Adjusted earnings:
Net income attributable to common shareholders
$
4,195,460
$
3,429,700
Add: Unrealized (gains) losses on investment securities
(716,389)
1,052,230
Adjusted earnings attributable to common shareholders
$
3,479,071
$
4,481,930
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For the three months ended March 31, 2023 and 2022, Adjusted Earnings per share was $0.08 and $0.13, respectively.
Liquidity and Capital Resources
Total assets at March 31, 2023 were approximately $597.0 million compared to approximately $565.7 million at December 31, 2022, an increase of approximately $31.3 million, or 5.5%. The increase was due primarily to the increase of our mortgage loan portfolio of approximately $15.8 million, an increase in investments in partnerships of approximately $4.5 million and an increase in investment securities of approximately $11.3 million, offset in part by a decrease in cash and cash equivalents of approximately $3.4 million.
Total liabilities at March 31, 2023 were approximately $368.0 million compared to approximately $348.0 million at December 31, 2022, an increase of approximately $20.0 million, or 5.8%. This increase is principally due to increases in the repurchase facility of approximately $11.5 million and the line of credit of approximately $10.1 million, offset primarily by a decrease in accrued dividends payable of approximately $5.3 million.
Total shareholders’ equity at March 31, 2023 was approximately $229.0 million compared to approximately $217.7 million at December 31, 2022, an increase of approximately $11.3 million, or 5.2%. This increase was due primarily to net proceeds of $9.2 million from the sale of Common Shares and our net income of approximately $5.1 million, offset by dividends paid on our Series A Preferred Stock of approximately $0.9 million and a cumulative credit loss adjustment resulting from the adoption of ASU 2016-13 on January 1, 2023 of approximately $2.5 million.
Net cash provided by operating activities for the three months ended March 31, 2023 was approximately $5.0 million compared to approximately $7.6 million for the comparable 2022 period. For the 2023 period net cash provided by operating activities consisted primarily of net income of approximately $5.1 million, amortization of deferred financing costs and bond discount of approximately $600,000 and increases in deferred revenue of approximately $321,000 and advances from borrowers of approximately $1.4 million, offset by gain on the sale of real estate of approximately $148,000, unrealized gain on investment securities of approximately $716,000, gain on the sale of investment securities of approximately $276,000 and increases in due from borrowers of approximately $783,000, other assets of approximately $500,000, and interest and fees receivable of approximately $366,000. For the 2022 period net cash provided by operating activities consisted primarily of net income of approximately $4.4 million, amortization of deferred financing costs and bond discount of approximately $469,000, an impairment loss of approximately $261,000, a loss on the sale of marketable securities of approximately $154,000, unrealized loss on investment securities of approximately $1.1 million, and increases in advances from borrowers of approximately $1.6 million, deferred revenue of $233,000 and accrued interest of $122,000, offset by increases in interest and fees receivable of approximately $396,000, other receivables of approximately $211,000 and due from borrowers of approximately $292,000.
Net cash used for investing activities for the three months ended March 31, 2023 was approximately $34.0 million compared to approximately $48.4 million for the comparable 2022 period. For the 2023 period, net cash used for investing activities consisted primarily of purchases of investment securities of approximately $14.0 million, net purchases of interests in investment partnerships of approximately $4.5 million, purchase of property and equipment of approximately $711,000 and principal disbursements for mortgages receivable of approximately $58.9 million, offset by principal collections on mortgages receivable of approximately $39.9 million, proceeds from sale of real estate owned of approximately $515,000 and by proceeds from the sale of investment securities of approximately $3.8 million. For the 2022 period, net cash used for investing activities consisted primarily of purchases of investment securities of approximately $27.5 million, purchases of interests in investment partnerships of approximately $11.4 million and principal disbursements for mortgages receivable of approximately $88.7 million, offset by principal collections on mortgages receivable of approximately $27.1 million, proceeds from the sale of investment securities of approximately $51.7 million and proceeds from the sale of real estate owned of $623,000.
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Net cash provided by financing activities for the three months ended March 31, 2023 was approximately $25.6 million compared to approximately $56.8 million for the comparable 2022 period. Net cash provided by financing activities for the 2023 period consists principally of net proceeds from the issuance of Common Shares of approximately $9.2 million, net proceeds from line of credit of approximately $10.1 million, net proceeds from repurchase facility of approximately $11.5 million and proceeds from mortgage of $910,000, offset primarily by dividends paid on common stock of approximately $5.3 million and preferred stock of approximately $925,000. Net cash provided by financing activities for the 2022 period consists principally of net proceeds from the issuance of fixed rate notes of $48.2 million, net proceeds from the issuance of Common Shares of approximately $15.5 million and net proceeds from repurchase facility of approximately $7.9 million, offset by repayment of line of credit of approximately $9.9 million, dividends paid on Common Shares of approximately $3.9 million and dividends paid on preferred stock of approximately $922,000.
We project anticipated cash requirements for our operating needs as well as cash flows generated from operating activities available to meet these needs. Our short-term cash requirements primarily include funding of loans and construction draws and payments for usual and customary operating and administrative expenses, such as interest payments on notes payable, employee compensation, sales, marketing expenses and dividends. Based on this analysis, we believe that our current cash balances, and our anticipated cash flows from operations will be sufficient to fund the operations for the next 12 months.
Our long-term cash needs will include principal payments on outstanding indebtedness and funding of new mortgage loans. Funding for long-term cash needs will come from unused net proceeds from financing activities, operating cash flows and proceeds from sales of real estate owned.
From and after the effective date of our REIT election, we intend to pay regular quarterly distributions to holders of our Common Shares in an amount not less than 90% of our REIT taxable income (determined before the deduction for dividends paid and excluding any net capital gains).
Subsequent Events
Management has evaluated subsequent events through May 12, 2023 the date on which the financial statements were available to be issued. Based on the evaluation, no adjustments were required in the accompanying financial statements.
Off-Balance Sheet Arrangements
We are not a party to any off-balance sheet transactions, arrangements or other relationships with unconsolidated entities or other persons that are likely to affect liquidity or the availability of our requirements for capital resources.
Contractual Obligations
As of March 31, 2023, our contractual obligations include unfunded amounts of any outstanding construction loans and unfunded commitments for loans as well as contractual obligations consisting of operating leases for equipment, software licenses and investment in partnerships.
Less than
1 – 3
3 – 5
More than
Total
1 year
years
years
5 years
Investment in partnerships
$
572,518
$
572,518
$
—
$
—
$
—
Unfunded loan commitments
114,851,913
114,851,913
—
—
—
Total contractual obligations
$
115,424,431
$
115,424,431
$
—
$
—
$
—
Critical Accounting Policies and Recent Accounting Pronouncements
See “Note 2 — Significant Accounting Policies” to the financial statements for explanation of recent accounting pronouncements impacting us included elsewhere in this report and in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022.
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Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As a smaller reporting company, we are not required to provide the information required by this Item.
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.