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 Nine Months of 2023 and Outlook for Balance of Year
Compared to the nine months of 2022, revenue increased 33.8%, net income attributable to common shareholders increased 19.6%, while earnings per share remained consistent with September 30, 2022. The revenue increase was directly related to the growth in our lending activities as well as to the increase in the interest rates that we are able to charge borrowers, which is reflected in our interest income which had an increase of 21.9%, and our income from partnership investments that had an increase of 110.1%. We also recorded an unrealized gain of approximately $0.4 million on investment securities for the nine months of 2023 compared to a loss of $3.6 million for the nine months of 2022, reflecting a $4.0 million increase in the value of those securities. The increase in revenue was partially offset by a 45.7% increase in operating costs and expenses. The increase in operating expenses is mainly attributable to a 43.8% increase in interest and amortization of deferred financing costs and an 37.5% increase in compensation and related expenses. The increase in compensation expense is mainly attributable to the hiring of our former Chief Financial Officer in August of 2022 (see Note 12 in the accompanying consolidated financial statements), and to the hiring of additional employees in connection with our acquisition of the assets of Urbane New Haven, LLC in October of 2022. Mortgages receivable increased by approximately $47.4 million compared to the same prior year period, while cash and cash equivalents decreased by 27.3%. The increase in mortgages receivable was primarily due to an increase in lending.
Our primary business objective for the balance of 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, better capitalized and 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 finance 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 finance, 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.
To date, 2023 has been a challenging year and we expect it to continue to be one due to the following factors:
Rising interest rates and interest rate compression. 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 it has ever been. Overall, our weighted average cost of debt capital, excluding amortization of deferred financing costs, as of September 30, 2023 was 7.3% compared to 6.7% as of September 30, 2022. For the nine months ended September 30, 2023, and 2022, the yield on our mortgage loan portfolio, inclusive of default interest, was 12.2% and 11.3%, respectively. (For this purpose, yield only takes into account the stated interest rate on the mortgage note adjusted to the default rate, if applicable.) Nevertheless, we believe the interest rate compression will continue to be a factor during the remainder of 2023.
Geopolitical concerns. Various geopolitical concerns, including the ongoing conflict between Ukraine and Russia and Israel and Hamas, have heightened tensions between the U.S. and China regarding Taiwan and global trade, Iran’s continued pursuit of nuclear weapons and its ongoing attempts to destabilize the Middle East and North Korea’s belligerence, 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. The true ramifications of these conflicts and their impact on the markets and our business operations, specifically our borrowers and real estate prices 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 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. The primary driver for these new market participants, we believe, is their need to find higher yielding investments. Given that residential transition loan gross yields are in the 12-15% range, many institutions are deploying capital into credit products where the returns are nearing equity investments. These entities, in general, are well-funded, have relatively easy access to capital and are 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 continue to abate in 2023 and into 2024 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. As stated above the increased yield environment has resulted in an inflow of private capital into the transitional lending sector. As a result, some of the negotiating leverage has shifted in favor of borrowers who have multiple term sheets. As borrowers have more choices they are demanding better terms, relative to the current interest rate enviorment. While we are
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able to pass along most of the increased cost of capital to the borrowers, increased competition has the potential to hinder spreads. This is particularly true as we focus more on larger loans and borrowers with better credit histories.
Property value fluctuations. Property value market cycles could have an adverse impact on our operations and finacial condition. We monitor a variety of indicators to track property value trends, including the Federal Funds Rate, U.S Treasury data, days-on-market, pending sales, NAHB’s Housing Market Index and the Senior Loan Officer Opinion Survey. Additionally, we almost always utilize a third party valuation including, but not limited to, appraisals, Broker Price Opinions (“BPOs”), and Automated Valuation Models (“AVMs”), to assist in both our underwriting and monitoring of our portfolio assets. By judiciously relying on our indicators and continuing to make sound underwriting decisions, we are poised to respond quickly if asset valuations begin to decline.
Increased operating expenses. Our operating expenses for the three and nine months ended September 30, 2023 are significantly higher than they were in 2022 due to our higher debt load, as well as higher borrowing rates. In addition, we expect that our aggregate dividend payments will be higher in 2023 than in 2022 due to an increase in the outstanding number of our common shares (“Common Shares”), and 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 September 30, 2023, our mortgage loan portfolio included 144 loans with future funding obligations, in the aggregate principal amount of $107.7 million, compared 185 loans with future funding obligations, in the aggregate principal amount of approximately $118.0 million at September 30, 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. 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 September 30, 2023, debt represented approximately 61.0% of our total capital compared to 59.8% at September 30, 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 September 30, 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
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as noted below, each series can be prepaid beginning on the second anniversary of its date of issuance. The aggregate net proceeds, net of the deferred financing costs, from the sale of the notes 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;
● $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
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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 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 September 30, 2023, the amount outstanding under the Churchill Facility was approximately $47.9 million, which amount was accruing interest at the rate of 9.47% 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 $26.3 million at September 30, 2023. The outstanding balance on this loan bears interest at a rate equal to 1.75% below the prime rate. At September 30, 2023 the prime rate was 8.50% and the interest rate on the Wells Fargo Loan was, thus, 6.75%. As of the date of this report, there has not been a change in the interest rates stated as of September 30, 2023.
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 by a first mortgage lien on the property located at 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. As of September 8, 2023, the Needham Credit Facility was increased to $65 million. 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
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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 September 30, 2023 and November 10, 2023, the interest rate on the Needham Credit Facility was 8.25% per annum.
Finally, from time-to-time we raise capital by selling our Common Shares in various at-the market offerings. During the nine months ended September 30, 2023, under our at-the-market offering facility (see Note 17 to the accompanying consolidated financial statements), we sold an aggregate of 4,140,503 Common Shares, realizing gross proceeds of approximately $15.6 million and we sold shares of Series A Preferred Stock having an aggregate liquidation preference of $2,321,975, realizing gross proceeds of approximately $1.9 million representing a discount of approximately 16.7% from the liquidation preference. At September 30, 2023, approximately $55.7 million of Common Shares and $23.1 million of Series A Preferred Stock were available for future sale under the ongoing at-the-market offering.
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 September 30, 2023 compared to three months ended September 30, 2022
Total revenue
Total revenue for the three months ended September 30, 2023 was approximately $17.5 million compared to approximately $13.5 million for the three months ended September 30, 2022, an increase of approximately $4.0 million, or 29.5%. The increase in revenue is primarily attributable to an increase in our lending operations as well as to the increase in the interest rates that we are able
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to charge borrowers in comparison to the three months ended September 30, 2022. For the 2023 period, interest income was approximately $14.3 million compared to approximately $11.5 million for the 2022 period, representing an increase of approximately $2.8 million or 23.6%. Origination and modification fees were approximately $1.2 million compared to approximately $1.7 million for the 2022 period, representing a decrease of approximately $0.5 million or 28.4%. For the three months ended September 30, 2023, revenue was partially offset by approximately $0.2 million of unrealized losses on investment securities million compared to approximately $1.1 million for the 2022 period, representing an increase of approximately $0.8 million or 77.7%.
Operating costs and expenses
Total operating costs and expenses for three months ended September 30, 2023 were approximately $11.3 million compared to approximately $8.5 million for the three months ended September 30, 2022, an increase of approximately $2.8 million, or 33.7%. The increase in operating costs and expenses is primarily attributable to the increase in our indebtedness, which was the fuel for our revenue growth, along with increases in the cost of funds. In the 2023 period, interest and amortization of deferred financing costs was approximately $7.7 million compared to approximately $6.0 million in the same 2022 period, an increase of approximately $1.7 million or 28.6%. The balance of the increase in operating expenses was primarily attributable to (i) compensation, fees and taxes which increased approximately $0.2 million, a 15.0% increase over the comparable 2022 amount, and (ii) general and administrative expenses, which increased approximately $0.6 million, a 84.6% increase over the comparable 2022 amount.
Comprehensive income
For the quarter ended September 30, 2023, we reported an unrealized loss on investment securities of approximately $83,600 reflecting the decrease in the market value of certain securities since June 30, 2023. For the quarter ended September 30, 2022, we reported an unrealized loss on investment securities of approximately $132,000 reflecting a decrease in the market value of certain securities since June 30, 2022.
Net income
Net income attributable to common shareholders for the three months ended September 30, 2023 was approximately $5.2 million, or $0.12 per share, compared to approximately $4.1 million, or $0.11 per share for the three months ended September 30, 2022.
Nine months ended September 30, 2023 compared to nine months ended September 30, 2023
Total revenue
Total revenue for the nine months ended September 30, 2023 was approximately $48.7 million compared to approximately $36.4 million for the nine months ended September 30, 2022, an increase of approximately $12.3 million, or 33.8%. The increase in revenue is primarily attributable to the growth in our lending operations as well as to the increase in the interest rates that we are able to charge borrowers in comparison to the nine months ended September 30, 2022. For the 2023 period, interest income was approximately $37.2 million compared to approximately $30.5 million for the 2022 period, representing an increase of approximately $6.7 million or 21.9%. Income from partnership investments increased to approximately $2.3 million for the 2023 period compared to approximately $1.1 million for the 2022 period, an increase of approximately $1.2 million. Fee and other income was approximately $3.5 million for the 2023 period compared to approximately $2.0 million for the 2022 period, an increase of approximately $1.5 million. For the nine months ended September 30, 2023, unrealized gain on investment securities was approximately $0.4 million, an increase of approximately $4.0 million compared to revenue being partially offset by an unrealized loss of approximately $3.6 million for the nine months ended September 30, 2022.
Operating costs and expenses
Total operating costs and expenses for nine months ended September 30, 2023 were approximately $31.7 million compared to approximately $21.8 million for the nine months ended September 30, 2022, an increase of approximately $9.9 million, or 45.7%. The increase in operating costs and expenses is primarily attributable to the increase in our overall indebtedness along with increases in our cost of funds. In the 2023 period, interest and amortization of deferred financing costs was approximately $21.7 million compared to approximately $15.1 million in the same 2022 period, an increase of $6.6 million, or 43.8%. The balance of the increase in operating expenses was attributable to (i) compensation, fees and taxes which increased approximately $1.4 million, or 37.5%, (ii)
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general and administrative expenses which increased approximately $1.5 million, or 77.4%, and (iii) partially offset by an impairment loss which decreased approximately $0.2 million, or 22.5%.
Comprehensive income
For the nine months ended September 30, 2023, we reported an unrealized gain on investment securities of approximately $0.1 million reflecting the increase in the market value of such securities since December 31, 2022. For the nine months ended September 30, 2022, we reported an unrealized loss on investment securities of approximately $81,500 reflecting the decrease in the market value of such securities since December 31, 2021.
Net Income
Net income attributable to common shareholders for the nine months ended September 30, 2023 was approximately $14.2 million, or $0.32 per share, compared to $11.9 million, or $0.32 per share for the nine months ended September 30, 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, 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 Three Month
For the Nine Month
Period Ended September 30,
Period Ended September 30,
2023
2022
2023
2022
Adjusted Earnings:
Net income attributable to common shareholders
$
5,223,440
$
4,131,873
$
14,192,177
$
11,867,385
Add: Unrealized (gains) losses on investment securities
239,989
1,076,836
(360,610)
3,607,498
Adjusted earnings attributable to common shareholders
$
5,463,429
$
5,208,709
$
13,831,567
$
15,474,883
For the three months ended September 30, 2023 and 2022 adjusted earnings per share was $0.12 and $0.13, respectively. For the nine months ended September 30, 2023 and 2022 adjusted earnings per share was $0.32 and $0.42, respectively.
Liquidity and Capital Resources
Total assets at September 30, 2023 were approximately $637.8 million compared to approximately $565.7 million at December 31, 2022, an increase of approximately $72.2 million, or 12.8%. The increase was due primarily to the increase of our mortgage loan portfolio of approximately $35.3 million, an increase in investments in partnerships of approximately $9.1 million, an increase in net investments in rental real estate of approximately $10.4 million, and an increase in investment securities of approximately $12.5 million, partially offset by a decrease in real estate owned of approximately $1.7 million.
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Total liabilities at September 30, 2023 were approximately $402.3 million compared to approximately $348.0 million at December 31, 2022, an increase of approximately $54.4 million, or 15.6%. This increase is principally due to increases in the repurchase facility of approximately $5.4 million and the line of credit of approximately $47.8 million, offset primarily by a decrease in accrued dividends payable of approximately $5.3 million.
Total shareholders’ equity at September 30, 2023 was approximately $235.5 million compared to approximately $217.7 million at December 31, 2022, an increase of approximately $17.8 million, or 8.2%. This increase was due primarily to net proceeds of approximately $15.4 million from the sale of Common Shares, net proceeds of approximately $1.9 million from the sale of Series A Preferred Stock, and our net income of approximately $17.0 million, offset by dividends paid on our Series A Preferred Stock and Common Shares of approximately $2.8 million and $11.6 million, respectively, 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 nine months ended September 30, 2023 was approximately $18.9 million compared to approximately $12.4 million for the comparable 2022 period. For the 2023 period net cash provided by operating activities consisted primarily of net income of approximately $17.0 million, amortization of deferred financing costs and bond discount of approximately $1.8 million, stock-based compensation of approximately $0.6 million, impairment loss of approximately $0.6 million, increases in advances from borrowers of approximately $2.6 million and deferred revenue of approximately $0.6 million, offset by unrealized gain on investment securities of approximately $0.4 million, increase in due from borrowers of approximately $2.2 million, increase in other assets in aggregate of approximately $1.2 million, and an increase in interest and fees receivable of approximately $1.6 million. For the 2022 period net cash provided by operating activities was approximately $12.4 million. For the 2022 period net cash provided by operating activities consisted primarily of net income of approximately $14.6 million, amortization of deferred financing costs and bond discount of $1.7 million and unrealized loss on investment securities of approximately $3.6 million, offset by increases in interest and fees receivable of $2.2 million, due from borrowers of $1.5 million and decreases in advances from borrowers of approximately $5.1 million.
Net cash used for investing activities for the nine months ended September 30, 2023 was approximately $67.6 million compared to approximately $151.2 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 $21.1 million, net purchases of interests in investment partnerships of approximately $9.1 million, investment in rental real estate of approximately $10.7 million and principal disbursements for mortgages receivable of approximately $159.7 million, offset by principal collections on mortgages receivable of approximately $123.5 million, proceeds from sale of real estate owned of approximately $0.1 million, proceeds from sale of property and equipment of approximately $0.5 million, and by proceeds from the sale of investment securities of approximately $9.1 million. For the 2022 period, net cash used for investing activities for the nine months ended September 30, 2022 was approximately $151.2 million. For the 2022 period, net cash used for investing activities consisted primarily of purchases of investment securities of approximately $39.7 million, net purchases of interests in investment partnerships of approximately $16.5 million and principal disbursements for mortgages receivable of approximately $252.4 million, offset by proceeds from the sale of investment securities of approximately $62.2 million, proceeds from the sale of real estate owned of approximately $1.6 million, and by principal collections on mortgages receivable of approximately $95.2 million.
Net cash provided by financing activities for the nine months ended September 30, 2023 was approximately $50.7 million compared to approximately $132.3 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 $15.3 million, net proceeds from the issuance of Series A Preferred Stock of approximately $1.9 million, net proceeds from line of credit of approximately $47.8 million, net proceeds from repurchase facility of approximately $5.4 million, and proceeds from mortgage of $0.4 million, offset primarily by dividends paid on Common Shares of approximately $16.9 million and Series A Preferred Stock of approximately $2.8 million. Net cash provided by financing activities for the 2022 period consists principally of net proceeds from the issuance of fixed rate notes of approximately $122.1 million, net proceeds from the issuance of Common Shares of approximately $36.7 million and net proceeds from repurchase facility of approximately $24.0 million, offset primarily by repayment of line of credit of approximately $29.6 million, dividends paid on Common Shares of approximately $13.5 million, dividends paid on Series A Preferred Stock of approximately $2.8 million, and financing costs incurred in connection with fixed rate notes of approximately $4.5 million.
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
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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 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 September 30, 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
$
1,024,241
$
1,024,241
$
—
$
—
$
—
Unfunded loan commitments
107,727,624
107,727,624
—
—
—
Total contractual obligations
$
108,751,865
$
108,751,865
$
—
$
—
$
—
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.