ACRES Commercial Realty(ACR) - 2018 Q4 - Annual Report

FORM 10-K Filing Information Exantas Capital Corp. filed its 2018 Annual Report on Form 10-K, confirming its status as an accelerated filer and compliance with reporting requirements - Exantas Capital Corp. is an accelerated filer, not a well-known seasoned issuer, smaller reporting company, or emerging growth company[1] - The company has filed all required reports under Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months[1] Registrant's Key Information (December 31, 2018) | Metric | Value | | :--- | :--- | | Aggregate Market Value of Voting Common Equity Held by Non-Affiliates (June 30, 2018) | ~$306,188,522 | | Outstanding Shares of Common Stock (March 5, 2019) | 31,852,998 shares | Forward-Looking Statements The report contains forward-looking statements based on current beliefs, subject to risks that could cause actual results to differ materially Nature of Forward-Looking Statements The report contains forward-looking statements based on current beliefs, subject to risks that could cause actual results to differ materially - Forward-looking statements relate to expectations, beliefs, projections, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts[3] - These statements are based on current beliefs, assumptions, and expectations, which can change due to many possible events or factors, not all of which are known or within the company's control[4] - Readers are cautioned not to place undue reliance on these statements, which speak only as of the report date, and the company undertakes no obligation to update them[5] Key Risks and Uncertainties Forward-looking statements are subject to risks from industry, interest rate, market, capital, regulatory, and business strategy changes - Changes in industry, interest rates, debt securities markets, real estate markets or the general economy[4] - Increased rates of default and/or decreased recovery rates on investments[4] - Availability, terms and deployment of capital, and changes in governmental regulations, tax rates, and business strategy[4] PART I ITEM 1. BUSINESS Exantas Capital Corp. is a Maryland REIT externally managed, focused on CRE debt investments, aiming for stockholder returns through a strategic plan - Exantas Capital Corp. is a Maryland REIT, incorporated in 2005, primarily focused on originating, holding, and managing commercial mortgage loans and commercial real estate-related debt investments[6] - The company is externally managed by Exantas Capital Manager Inc., a subsidiary of C-III Capital Partners LLC, leveraging C-III's expertise in CRE investment management[6] - A strategic plan approved in November 2016 focused the company's strategy on CRE debt investments, involving the disposal of legacy CRE debt and non-core assets, and establishing a dividend policy based on sustainable earnings[8][9] General Business Overview The company operates as a REIT specializing in CRE debt, aiming for stockholder returns through distributions and capital appreciation while managing risks - The company's objective is to provide stockholders with total returns over time, including quarterly distributions and capital appreciation, while managing investment risks[7] - Financing is largely through borrowing strategies that match maturities and repricing dates of financings with investments, and interest rate risk is mitigated via derivative investments[7] - Investment strategy targets CRE/Core Asset Class including first mortgage loans (whole loans, A-notes, B-notes), mezzanine debt, preferred equity, CMBS, and CRE equity investments[8] Strategic Plan and Asset Disposition The 2016 strategic plan to focus on CRE debt is largely complete, with most non-core assets disposed of and capital redeployed - The strategic plan, approved in November 2016, focused on CRE debt investments, disposing of legacy CRE debt and exiting underperforming non-core asset classes[8] - Non-core operating segments (residential mortgage loans/RMBS and middle market secured corporate loans/preferred equity) were reclassified as held for sale and discontinued operations[9] Strategic Plan Asset Disposition Status (as of December 31, 2018) | Metric | Value (in millions) | | :--- | :--- | | Identified Plan Assets (initial) | $480.1 | | Remaining Plan Assets | $29.8 | | Remaining Legacy CRE Loans | $28.5 | Business Strategy and Investment Focus The business strategy focuses on investing in CRE assets, actively managing the portfolio, and mitigating interest rate and liquidity risks with derivatives - Investment in CRE assets: Goal to allocate 90% to 100% of equity to CRE investments. At December 31, 2018, 95% of equity was in core assets and 5% in non-core assets[12] - Managing investment portfolio: $2.1 billion of assets managed at December 31, 2018, with a core process of credit analysis, active monitoring, and loss mitigation[13] - Managing interest rate and liquidity risk: Utilizes derivative contracts (interest rate swaps and caps) and matches maturities/repricing dates of financings with investments[14] Repurchase Facilities with Debt Outstanding (as of December 31, 2018) | Facility Type | Lender | Borrowings (1)(2) (in thousands) | Value of Collateral (in thousands) | Equity at Risk (3) (in thousands) | | :--- | :--- | :--- | :--- | :--- | | CRE - Term Repurchase Facilities | Wells Fargo Bank, N. A. | $154,478 | $226,530 | $71,398 | | CRE - Term Repurchase Facilities | Morgan Stanley Bank, N. A. | $37,113 | $62,457 | $25,485 | | CRE - Term Repurchase Facilities | Barclays Bank PLC | $240,416 | $308,389 | $67,826 | | CRE - Term Repurchase Facilities | JPMorgan Chase Bank, N.A. | $75,440 | $98,839 | $21,788 | | CMBS - Short-Term Repurchase Agreements | RBC Capital Markets, LLC | $246,476 | $313,644 | $67,182 | | CMBS - Short-Term Repurchase Agreements | JP Morgan Securities LLC | $42,040 | $73,066 | $31,226 | | CMBS - Short-Term Repurchase Agreements | Deutsche Bank Securities Inc. | $7,305 | $9,158 | $1,868 | | Total | | $803,268 | $1,092,083 | | Operating Policies Operating policies cover investment guidelines, leverage, hedging for interest rate risk, and credit management to maintain REIT and Investment Company Act compliance - Investment guidelines: Established and approved by the Manager's investment committee and the Board, primarily for income, without specific geographic or industry focus[17] - Financing policies: Uses leverage to increase stockholder returns, with discretion for the Manager's investment committee to adjust leverage above targeted ranges, subject to existing financing arrangements[18] - Hedging and interest rate management policies: Uses derivative instruments (swaps, collars, caps, floors, options) to hedge interest rate risk, aiming for minimal volatility under GAAP while meeting economic objectives and maintaining liquidity[21] - Credit and risk management policies: Manager focuses on credit and risk assessment from early stages, screening investments for REIT qualification and Investment Company Act exclusion, and managing portfolio risks on a portfolio-by-portfolio basis[22] Investment Portfolio Summary The investment portfolio totaled approximately $2.0 billion in 2018, predominantly core CRE whole loans and CMBS, with minimal non-core assets Amortized Costs and Net Carrying Amounts of Core and Non-Core Investments (as of December 31, 2018) | Asset Type | Amortized Cost (in thousands) | Net Carrying Amount (in thousands) | Percent of Portfolio | Weighted Average Coupon | | :--- | :--- | :--- | :--- | :--- | | Core Assets: | | | | | | CRE whole loans (1)(2) | $1,517,598 | $1,516,196 | 76.27% | 6.34% | | CRE mezzanine loan and preferred equity investment (2) | $24,255 | $24,255 | 1.22% | 11.21% | | CMBS, fixed rate (3) | $121,487 | $119,739 | 6.02% | 4.12% | | CMBS, floating rate (3) | $301,132 | $299,259 | 15.06% | 5.11% | | Total Core Assets | $1,964,472 | $1,959,449 | 98.57% | | | Non-Core Assets: | | | | | | Structured notes (4) | $1,000 | $— | —% | N/A (7) | | Direct financing leases (4) | $801 | $66 | —% | N/A (7) | | Legacy CRE loans (5)(6) | $33,181 | $28,516 | 1.43% | 1.67% | | Total Non-Core Assets | $34,982 | $28,582 | 1.43% | | | Total Core and Non-Core Assets | $1,999,454 | $1,988,031 | 100.00% | | Core Asset Classes Core assets are primarily diversified CRE debt investments, including whole loans and CMBS, with concentrations in multifamily properties across specific regions - CRE Debt Investments: Primarily originates first mortgage whole loans, with typical LTV ratios not exceeding 85% and terms up to three years (with extensions to five years). Also invests in senior (A-notes) and subordinate (B-notes) interests, mezzanine loans, and preferred equity investments[24][26][27][29][30] - Property Type Diversification (as of December 31, 2018): Multifamily (63.5%), Office (13.4%), Hotel (11.4%), Retail (6.7%), Other (5.0%)[31] - Geographic Area by NCREIF Region (as of December 31, 2018): Southwest (32.3%, with 30.4% in Texas, 81.5% multifamily), Mountain (20.9%, with 11.3% in Arizona, 75.2% multifamily, 21.2% hotel), Pacific (17.1%, with 52.2% retail)[32] - CMBS investments are secured by pools of commercial mortgage loans and may be senior or subordinate, investment grade or non-investment grade. Yields depend on timely payment of interest and principal on underlying loans[34][35] Non-Core Asset Classes The company has largely exited non-core asset classes, including residential mortgage loans and middle market loans, as part of its strategic disposition plan - Structured Note Investments and RMBS: Primary Capital Mortgage, LLC (PCM) was moved to discontinued operations in Q4 2016, and remaining assets were liquidated in 2018. At December 31, 2018, one structured note investment had no carrying value and no RMBS investments were held[36][39] - Middle Market Loans: Business moved to discontinued operations in Q4 2016 and remaining loans were liquidated in 2018[37] - CRE Equity Investments: May invest directly in CRE equity by restructuring loans or acquiring properties, managed by an affiliate of the Manager. At December 31, 2018, no direct ownership of CRE equity investments[38] Management Agreement The Management Agreement with Exantas Capital Manager Inc. covers daily operations, investment, and financing, with fees and termination clauses - The Management Agreement, amended December 14, 2017, outlines the Manager's responsibilities for day-to-day operations, investment selection, financing, and advisory services, under Board supervision[40] - Manager's Compensation Structure: - Monthly base management fee: 1/12th of equity multiplied by 1.50%, fixed at $937,500 per month from Oct 1, 2017, through Dec 31, 2018[40] - Incentive compensation: Calculated quarterly as 20% of Core Earnings exceeding a specified hurdle, with up to 75% payable in cash and at least 25% in common stock[41][44] - Reimbursement for out-of-pocket expenses and certain personnel costs (CFO, accounting, finance, tax, investor relations professionals)[42][43] - The Management Agreement renews annually and can be terminated by the Board or stockholders for unsatisfactory performance or unfair fees, requiring 180 days' notice and a termination fee equal to four times the sum of average annual base management and incentive fees[45] - Termination for cause (e.g., material breach, fraud, gross negligence, bankruptcy, detrimental change of control) does not incur a termination fee[46] Regulatory Aspects of Investment Strategy The company maintains Investment Company Act exclusion through specific asset composition, primarily relying on Section 3(c)(5)(C) for its real estate subsidiary - The company operates to be excluded from regulation under the Investment Company Act, ensuring both the parent company and its subsidiaries qualify for an exclusion[49] - RCC Real Estate, holding substantially all CRE loan assets, relies on Section 3(c)(5)(C) exclusion, requiring at least 55% of assets in 'Qualifying Interests' (mortgage loans, real properties) and 80% in 'Qualifying Interests' and other real estate-related assets[50] - Investments in CRE whole loans, A-notes, specific B-notes, and mezzanine loans are treated as 'Qualifying Interests' consistent with SEC staff guidance. Other subsidiaries rely on Section 3(c)(1) or 3(c)(7) exclusions[52][54] - The company monitors its interests in subsidiaries to satisfy the 40% test for Exantas Capital Corp. itself, ensuring the value of 'investment securities' does not exceed 40% of total assets[55] Employees and Corporate Governance The company operates without direct employees, relying on its Manager, and maintains strong corporate governance with independent directors - The company has no direct employees; all management and support personnel are provided by its Manager and affiliates (C-III and Resource America)[58] - Corporate governance emphasizes professional conduct and ethics, with a Board composed of a majority of independent directors and exclusively independent directors on audit, compensation, and nominating/governance committees[59] ITEM 1A. RISK FACTORS This section details material risks across economic, financing, operational, investment, management, structural, and tax aspects of the company's business - The company's ability to obtain capital and financing for growth may be limited by deteriorating economic conditions, potentially affecting profitability, distributions, and stock price[61][62] - The portfolio is financed significantly through leverage, exposing the company to risks such as insufficient cash for payments, increased financing costs, and maturity mismatches[67] - The company relies on its Manager, C-III, and Resource America for operations and may face conflicts of interest regarding investment opportunities and time allocation, which could adversely affect business plans and returns[139][148][150] - Maintaining REIT qualification and exclusion from Investment Company Act regulation is complex and may require foregoing otherwise attractive investments or adjusting investment strategy, potentially impacting performance[179][186] Impact of Current Economic Conditions Economic downturns can restrict capital access, hinder growth, and impede asset disposition, potentially leading to losses - Limited capital and financing: Deteriorating economic conditions could limit access to debt or equity capital, impacting growth, profitability, distributions, and common stock market price[61][62] - Unpredictable government actions: Effects of U.S. government and agency responses to economic conditions are uncertain[63][64] - Disposition of Plan assets: Economic conditions may impede the disposition of remaining Plan assets (legacy CRE and non-CRE investments), potentially leading to losses if assets cannot be sold at book value[65][66] Risks Related to Our Financing Leverage exposes the company to debt payment, cost, and maturity risks, while hedging may not fully mitigate interest rate risk - Leverage risks: Insufficient cash for principal/interest, increased financing costs, and maturity mismatches between investments and financing[67] - CDO financing risks: Failure to meet performance tests (e.g., over-collateralization) could eliminate net income and cash flow from CDOs, as equity interests are subordinate[79][80][81][82] - Hedging limitations: Hedging transactions may not completely insulate from interest rate risk, can be expensive, may limit gains, and depend on correct interest rate predictions, potentially resulting in poorer overall investment performance[90][91][92][95][96] - Counterparty and liquidity risks: Repurchase agreements and short-term financings carry credit risks, including counterparty default and potential forced asset liquidation at a loss[70][71][72][75] Risks Related to Our Operations Operational risks include unapproved strategy changes, reliance on non-GAAP measures, internal control failures, illiquid investments, and asset repurchase obligations - Investment strategy changes: The company may change its investment strategy without stockholder consent, potentially leading to riskier investments and increased exposure to market fluctuations[102] - Non-GAAP measures: Reliance on 'Core Earnings' and 'economic book value' for performance and position assessment, which may not always reflect actual economic results or be comparable to other companies' measures[104][105][106][107] - Internal control and fraud: Failure to maintain an effective system of internal control could lead to inaccurate financial reporting or fraud[108][111] - Illiquid investments: Many investments may be illiquid, making quick sales difficult and potentially resulting in realizing less than recorded value[109][110] Risks Related to Our Investments Investment risks include market value declines, interest rate increases (especially LIBOR), higher loss potential in subordinated debt, and valuation uncertainties - Market value declines: Reductions in market values of 'available-for-sale' assets directly reduce stockholders' equity and can lead to impairment charges, reducing earnings and distributions[115][116][117] - Interest rate increases: Significant increases in long-term rates reduce asset market value, while short-term rate increases raise interest expense, reducing net interest spread and profitability[118][119] - LIBOR transition risk: Changes in LIBOR determination or its replacement may adversely affect loan, investment, and borrowing values, potentially causing financial market disruptions and increased financing costs[120][121] - Subordinated debt risks: Mezzanine debt, preferred equity, and subordinated CMBS tranches involve greater loss risks than senior secured debt due to their subordinate payment rights and higher LTVs[123][124] Risks Related to Real Estate Investments Real estate investments face property performance, delinquency, and foreclosure risks, concentration vulnerabilities, and additional risks from subordinated debt and environmental liabilities - Property performance risks: Commercial mortgage loans, mezzanine loans, and CRE equity investments are subject to risks of delinquency and foreclosure, with repayment dependent on property operation, affected by tenant mix, location, competition, laws, and economic conditions[131][132][133] - Concentration risks: The investment portfolio may have material geographic, sector, property-type, and sponsor concentrations, increasing vulnerability to adverse developments in those specific areas[134] - B-note and preferred equity risks: B-notes are subordinate to senior notes, increasing default risk. Preferred equity investments are subordinate to first mortgage and mezzanine debt, and generally lack direct collateralization by the property, leading to higher loss risk[135][136][138] - Environmental liabilities: Taking title to real estate through foreclosure could expose the company to substantial environmental investigation and clean-up costs[137] Risks Related to Our Manager Risks include high dependence on the Manager, potential conflicts of interest from fee structures and shared personnel, and limited Manager liability - Dependence on Manager: The company has no direct employees and relies entirely on its Manager, C-III, and Resource America for operations. The departure of key personnel or termination of the Management Agreement could harm investment performance[139][140] - Incentive fee structure: The Manager's incentive compensation, based on Core Earnings, may incentivize strategies that maximize earnings at the expense of capital preservation, potentially increasing investment risk[141][142][143][144] - Conflicts of interest: Conflicts may arise from the Manager's ability to invest in similar asset classes, allocate investment opportunities to other clients, and from shared officers/employees allocating their time across multiple entities[148][149][150][151] - Limited Manager liability: The Management Agreement limits the Manager's liability and requires the company to indemnify the Manager against certain liabilities, except for acts of bad faith, willful misconduct, gross negligence, or reckless disregard[157][158] Risks Related to Our Organization and Structure Organizational risks include anti-takeover provisions, limited stockholder recourse, distribution uncertainty, and the critical need to maintain Investment Company Act exclusion and REIT qualification - Anti-takeover provisions: Charter and bylaws include ownership limits (9.8% of any class of stock), Board's ability to issue stock with discouraging terms, and advance notice procedures for business/director nominations, potentially lowering common stock market price[162][163][164] - Maryland takeover statutes: Maryland Control Share Acquisition Act and business combination statutes may prevent changes in control, even if favorable to stockholders[165][168] - Limited recourse against directors, officers, and Manager: Liability limits for directors/officers and indemnification agreements, along with costly termination of the Management Agreement without cause, limit stockholder recourse[172][174] - Distribution uncertainty: No minimum distribution payment level is established, and future distributions depend on earnings, financial condition, and REIT qualification. Uninvested offering proceeds or borrowed funds may be used for distributions, reducing funds for investment or increasing future interest costs[175][176] - Loss of Investment Company Act exclusion: Failure to maintain exclusion (e.g., 40% investment securities test, 3(c)(5)(C) asset composition for RCC Real Estate) would require significant operational changes, potentially reducing stock price and distributions[178][179][180][182] Tax Risks Tax risks involve complex REIT compliance, potential loss of REIT status, excess inclusion income, and impacts from legislative changes like the TCJA - REIT compliance limitations: Must satisfy various tests (e.g., 75% asset test, 5% single issuer limit) which may require foregoing otherwise attractive investments or liquidating non-qualifying assets, hindering investment performance[186][187][188] - Failure to qualify as a REIT: Would result in federal income tax at corporate rates, reducing cash available for distributions, and preventing re-election of REIT status for five years[195][196][197] - Excess inclusion income: Realizing excess inclusion income (e.g., from REMIC residual interests or taxable mortgage pools) would increase tax liability for the company and stockholders, particularly tax-exempt entities and foreign persons[192][193][194] - TRS ownership limits: Ownership and transactions with Taxable REIT Subsidiaries (TRSs) are limited (e.g., no more than 20% of assets in TRS stock/securities), and failure to comply could jeopardize REIT qualification or incur a 100% excise tax[203][204][205] - Impact of Tax Cuts and Jobs Act (TCJA): While generally favorable to REITs, extensive changes to non-REIT provisions may have unanticipated effects. REIT dividends are eligible for a 20% deduction, resulting in a maximum individual tax rate of 29.6%[210][212][214] ITEM 1B. UNRESOLVED STAFF COMMENTS No unresolved staff comments from the SEC ITEM 2. PROPERTIES The company does not own real property, operating from leased offices in New York and Philadelphia - The company does not own any real property[225] - Offices are maintained in New York, New York (principal office in leased space) and Philadelphia, Pennsylvania[225] ITEM 3. LEGAL PROCEEDINGS The company faces ongoing shareholder derivative suits, with some federal actions nearing settlement, and potential litigation from past mortgage businesses - Open Litigation Matters: - Six New York State shareholder derivative suits and four Federal Demand Futile Actions, alleging breach of fiduciary duty, corporate waste, and unjust enrichment[227][228] - Three Federal Demand Refused Actions, alleging similar claims after the Board refused demands to litigate[229] - Agreement in principle to settle Federal Actions: Includes corporate governance changes and a $550,000 payment in plaintiffs' attorneys' fees, funded by insurers, pending court approval[230] - PCM litigation: Subject to claims for repurchases or indemnifications on loans sold to third parties. Reserves for these totaled $1.7 million at December 31, 2018 (down from $5.7 million in 2017)[235] - Settled Litigation Matters: - PCM lawsuit: Settled on January 8, 2018, regarding breaches of representations and warranties on residential mortgage loans[236] - Levin Action (securities litigation): Settled for $9.5 million in August 2018, primarily funded by insurance coverage, releasing the company and individual defendants from claims[237] ITEM 4. MINE SAFETY DISCLOSURES This item is not applicable to the company PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES The company's common and Series C Preferred Stock are NYSE-listed, with ongoing distribution plans and an active $50.0 million share repurchase program - Common stock listed on NYSE under symbol 'XAN' (formerly 'RSO')[240] - Intends to declare quarterly distributions on common stock, subject to earnings, financial condition, and REIT qualification[241] Equity Securities Outstanding (as of March 5, 2019) | Security Type | Shares Outstanding | | :--- | :--- | | Common Stock | 31,852,998 | | 8.625% Fixed-to-Floating Series C Cumulative Redeemable Preferred Stock | 4,800,000 (as of Dec 31, 2018) | - Redeemed all 8.50% Series A Cumulative Redeemable Preferred Stock and 8.25% Series B Cumulative Redeemable Preferred Stock in Q1 2018[243][647] - Securities repurchase program: $50.0 million authorized in March 2016, with $44.9 million remaining available at December 31, 2018. No repurchases in 2018[245] ITEM 6. SELECTED FINANCIAL DATA Selected financial data shows fluctuating net interest income and net income, with total assets increasing to $2.13 billion and equity decreasing in 2018 Consolidated Statements of Operations Data (in thousands, except per share amounts) | Metric | 2018 | 2017 | 2016 | 2015 | 2014 | | :--- | :--- | :--- | :--- | :--- | :--- | | Net interest income | $55,163 | $41,661 | $58,871 | $65,388 | $69,788 | | Net income (loss) from continuing operations | $27,306 | $47,457 | $(11,334) | $11,079 | $59,585 | | Dividends declared per common share | $0.475 | $0.20 | $1.31 | $2.34 | $3.20 | | Net income (loss) per common share - basic (Continuing operations) | $0.22 | $0.64 | $(1.10) | $(0.62) | $1.30 | | Weighted average number of common shares outstanding - basic | 31,198,319 | 30,836,400 | 30,539,369 | 32,280,319 | 32,007,766 | Consolidated Balance Sheets Data (in thousands) | Metric | 2018 | 2017 | 2016 | 2015 | 2014 | | :--- | :--- | :--- | :--- | :--- | :--- | | Total assets | $2,130,913 | $1,912,075 | $2,053,543 | $2,765,562 | $2,728,679 | | Borrowings | $1,554,223 | $1,163,485 | $1,191,456 | $1,621,713 | $1,503,159 | | Total Exantas Capital Corp. stockholders' equity | $553,819 | $671,476 | $704,299 | $818,863 | $935,523 | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This section analyzes financial condition and results, detailing the strategic shift to CRE debt, asset disposition impact, and performance for 2016-2018 - The company is a Maryland REIT focused on originating, holding, and managing commercial mortgage loans and CRE-related debt investments, externally managed by Exantas Capital Manager Inc.[252] - A strategic plan initiated in November 2016 to focus on CRE debt investments is substantially complete, with $29.8 million of identified Plan assets remaining as of December 31, 2018[260][261] - The company's net income allocable to common shares was $7.0 million ($0.22 per share) in 2018, up from $5.7 million ($0.18 per share) in 2017, and a net loss of $53.0 million ($(1.73) per share) in 2016[265] Overview The REIT focuses on CRE debt, manages risk, uses leverage, completed a strategic asset divestment, and achieved record loan production in 2018 - Primary focus: Originating, holding, and managing commercial mortgage loans and CRE-related debt investments[252] - Investment strategy targets: Whole loans, A-notes, B-notes, mezzanine debt, preferred equity investments, CMBS, and other CRE investments[253][254][255][256][257][258] - Strategic Plan (2016): Substantially completed, focusing on CRE debt, disposing of legacy CRE loans and non-core businesses (residential mortgage origination, middle market lending)[260][261] - 2018 Highlights: - Originated 41 new CRE loans with $861.6 million total commitments (highest production year)[262] - Acquired CMBS with $252.3 million total face values[262] - Redeemed all Series A and Series B Preferred Stock ($165.3 million total redemption cost), eliminating $13.7 million in annual dividends[263] - 6.00% Convertible Senior Notes matured, eliminating $4.2 million in annual interest expense[263] - Equity allocation: 95% in core assets, 5% in non-core assets (vs. 84% core, 16% non-core in 2017)[264] Results of Operations Net income allocable to common shares improved to $7.0 million in 2018, driven by increased net interest income and reduced operating expenses Net Income (Loss) Allocable to Common Shares (in thousands, except per share data) | Year | Net Income (Loss) | Per Share - Basic | Per Share - Diluted | | :--- | :--- | :--- | :--- | | 2018 | $6,973 | $0.22 | $0.22 | | 2017 | $5,677 | $0.18 | $0.18 | | 2016 | $(52,956) | $(1.73) | $(1.73) | Net Interest Income Net interest income increased to $55.2 million in 2018 due to higher CRE loan and CMBS income, partially offset by increased interest expense Net Interest Income (in thousands) | Year | Net Interest Income | | :--- | :--- | | 2018 | $55,163 | | 2017 | $41,661 | | 2016 | $58,871 | - 2018 vs. 2017: - Total interest income increased by $23.5 million (24%) due to increased CRE whole loan balances ($15.0 million) and CMBS acquisitions ($10.1 million), and higher LIBOR[267][269][270] - Total interest expense increased by $10.0 million (17%) due to new securitizations (XAN 2018-RSO6), increased LIBOR, and higher utilization of CRE term repurchase facilities[272][273][275] - 2017 vs. 2016: - Total interest income decreased by $13.3 million (12%) primarily due to a $17.0 million decrease in ABS interest income, partially offset by a $3.1 million increase in CMBS interest income and higher LIBOR[278][279] - Total interest expense increased by $3.9 million (7%) mainly due to increased LIBOR and higher financing of new CMBS acquisitions[280][281] Average Net Yield and Average Cost of Funds (2016-2018) | Metric | 2018 | 2017 | 2016 | | :--- | :--- | :--- | :--- | | Total interest income/average net yield | 6.79% | 6.24% | 6.66% | | Total interest expense/average cost of funds | (4.87)% | (5.00)% | (4.20)% | | Total net interest income/average spread | 1.92% | 1.24% | 2.46% | Other Revenue Other revenue decreased by $1.9 million in 2018, mainly due to reduced fee income from CLO management contract liquidations Other Revenue (in thousands) | Year | Other Revenue | | :--- | :--- | | 2018 | $120 | | 2017 | $2,048 | | 2016 | $3,809 | - 2018 vs. 2017: Decrease of $1.9 million, mainly from a $1.4 million decrease in fee income due to liquidation of CLO management contracts[284] - 2017 vs. 2016: Decrease of $1.8 million, primarily from a $1.3 million decrease in fee income from CLO management contract liquidations and a $695,000 decrease in management fee rebates[285] Operating Expenses Total operating expenses decreased by $9.7 million to $24.0 million in 2018, driven by lower management fees and G&A expenses Total Operating Expenses (in thousands) | Year | Total Operating Expenses | | :--- | :--- | | 2018 | $24,049 | | 2017 | $33,789 | | 2016 | $77,014 | - 2018 vs. 2017: - Management fees decreased by $1.9 million, primarily due to a $2.2 million incentive management fee recognized in 2017 related to the LCC liquidation[286] - General and administrative expenses decreased by $5.2 million, mainly from lower professional services (litigation reserve, legal expenses), operating expenses, director fees, and rating agency fees[288] - Net (recovery of) provision for loan and lease losses decreased by $3.4 million to a recovery, driven by a $1.6 million reduction in general reserve due to repaid loans[290] - 2017 vs. 2016: - Impairment losses decreased by $26.3 million, primarily due to a $19.9 million other-than-temporary impairment on RREF CDO 2007-1 in 2016[294] - Provision for loan and lease losses, net decreased by $16.0 million, mainly due to a large provision in 2016 for legacy CRE loans classified as held for sale[296] Other Income (Expense) Total other income (expense) shifted from a $44.2 million income in 2017 to a $(4.3) million expense in 2018, primarily due to non-recurring gains Total Other Income (Expense) (in thousands) | Year | Total Other Income (Expense) | | :--- | :--- | | 2018 | $(4,271) | | 2017 | $44,150 | | 2016 | $13,992 | - 2018 vs. 2017: - Equity in earnings of unconsolidated entities decreased by $39.3 million, primarily due to a $41.1 million realized gain on the sale of LCC in 2017 that did not recur[299] - Fair value adjustments on financial assets held for sale increased losses by $5.3 million, mainly due to a $7.2 million write-down on a legacy CRE loan[303] - Other income (expense) increased by $2.6 million from expense to income, driven by $1.4 million dividend income from Apidos CDO I, Ltd. and Apidos CDO III, Ltd., and $478,000 from asset sales[305] - 2017 vs. 2016: - Equity in earnings of unconsolidated entities increased by $33.6 million, primarily due to the $41.1 million realized gain on the liquidation of LCC[306] - Loss on extinguishment/reissuance of debt of $10.4 million was recorded in 2017[310] Net Income (Loss) From Discontinued Operations, Net of Tax Net income from discontinued operations improved to $121,000 in 2018, reflecting substantial disposition of non-CRE assets Net Income (Loss) From Discontinued Operations, Net of Tax (in thousands) | Year | Net Income (Loss) | | :--- | :--- | | 2018 | $121 | | 2017 | $(14,116) | | 2016 | $(19,260) | - The improvement in 2018 is primarily attributable to the disposition of assets held for sale and the wind-down of operations from the residential mortgage and middle market lending segments[312] Financial Condition Total assets increased to $2.1 billion in 2018, driven by CRE loan and CMBS growth, with a predominantly core investment portfolio Total Assets (in thousands) | Year | Total Assets | | :--- | :--- | | 2018 | $2,130,913 | | 2017 | $1,912,075 | - Increase in total assets primarily attributable to $832.0 million in fundings of CRE loans (net of repayments and sales) and $252.3 million in acquisitions of CMBS (net of repayments and sales), offset by reductions in cash and assets held for sale[315] Investment Portfolio The investment portfolio grew to $1.999 billion in 2018, primarily comprising CRE whole loans and CMBS, with significant acquisition activity Investment Portfolio Summary (Amortized Cost, in thousands) | Asset Type | Dec 31, 2018 | Dec 31, 2017 | | :--- | :--- | :--- | | Loans held for investment | $1,553,368 | $1,290,150 | | Investment securities available-for-sale | $422,619 | $211,065 | | Other investments | $1,548 | $12,051 | | Other assets held for sale | $21,666 | $112,025 | | Total Investment Portfolio | $1,999,201 | $1,625,291 | - CRE Loans: At December 31, 2018, the portfolio included 79 whole loans ($1.53 billion amortized cost), 1 mezzanine loan ($4.7 million), and 1 preferred equity investment ($19.6 million)[319] - CMBS: Purchased 28 CMBS securities with aggregate face values of $252.3 million in 2018. Remaining discount to be accreted was $43.9 million at December 31, 2018[322] CMBS Investments by Moody's Rating Category (Fair Value, in thousands) | Moody's Rating Category | Fair Value at Dec 31, 2017 | Net Purchases (Sales) | Net Upgrades (Downgrades) | Paydowns | MTM Change on Ratings | Fair Value at Dec 31, 2018 | | :--- | :--- | :--- | :--- | :--- | :--- | :--- | | Aaa | $8,390 | $— | $— | $(2,285) | $(151) | $5,954 | | Baa1 through Baa3 | $8,432 | $7,974 | $1,020 | $(7,259) | $(83) | $10,084 | | Non-Rated | $181,711 | $223,155 | $191 | $(4,912) | $(2,106) | $398,039 | | Total | $211,579 | $231,129 | $— | $(20,862) | $(2,848) | $418,998 | Financing Receivables The allowance for loan losses decreased to $1.4 million in 2018, reflecting loan repayments and charge-offs, with no impaired loans Allowance for Loan Losses (in thousands) | Metric | 2018 | 2017 | | :--- | :--- | :--- | | Allowance for loan losses at beginning of year | $5,328 | $3,829 | | (Recovery of) provision for loan losses, net | $(1,595) | $1,499 | | Loans charged-off | $(2,332) | $— | | Allowance for loan losses at end of year | $1,401 | $5,328 | - Credit quality indicators: CRE loans are assessed on a 1-5 risk rating scale (1=highest, 5=lowest credit quality) based on collateral performance, LTV ratios, loan structure, and exit plan[331][333][334][335][336] - Allowance computation: 1.5% of aggregate face values for loans rated 3, plus 5.0% for loans rated 4, plus specific allowances for individually impaired loans (rated 5)[338] - Impaired Loans: No impaired loans at December 31, 2018. At December 31, 2017, one whole loan was impaired with a carrying value of $4.5 million[348][341] - Legacy CRE loans held for sale: At December 31, 2018, one legacy CRE loan and one mezzanine loan with total carrying values of $17.0 million were held for sale[342] Restricted Cash Restricted cash decreased by $10.2 million to $12.7 million in 2018, mainly due to paydowns and interest payments Restricted Cash (in thousands) | Metric | Dec 31, 2018 | Dec 31, 2017 | | :--- | :--- | :--- | | Cash held by consolidated CRE securitizations, CDOs and CLOs | $6,190 | $20,846 | | Restricted cash pledged with minimum reserve balance requirements | $21 | $25 | | Margin posted to central clearinghouse on interest rate swaps | $6,447 | $1,903 | | Cash held in escrow | $— | $100 | | Total | $12,658 | $22,874 | - The $10.2 million decrease in restricted cash was primarily attributable to paydowns and interest payments on RCC 2017-CRE5 notes payable and future fundings made by RCC 2017-CRE5[351] Accrued Interest Receivable Accrued interest receivable increased by $1.3 million to $8.2 million in 2018, driven by new loan production and higher LIBOR Accrued Interest Receivable (in thousands) | Metric | Dec 31, 2018 | Dec 31, 2017 | Net Change | | :--- | :--- | :--- | :--- | | Accrued interest receivable from loans | $6,984 | $6,096 | $888 | | Accrued interest receivable from securities | $1,156 | $756 | $400 | | Accrued interest receivable from escrow, sweep and reserve accounts | $58 | $7 | $51 | | Total | $8,198 | $6,859 | $1,339 | - The increase was primarily attributable to new loan production and an increase of one-month LIBOR at December 31, 2018, as well as CMBS purchases during the year[352] Other Assets Other assets decreased by $3.8 million to $4.0 million in 2018, primarily due to reduced management fees and tax receivables Other Assets (in thousands) | Metric | Dec 31, 2018 | Dec 31, 2017 | Net Change | | :--- | :--- | :--- | :--- | | Tax receivables and prepaid taxes | $3,219 | $4,286 | $(1,067) | | Management fees receivable | $— | $2,029 | $(2,029) | | Investment securities, trading | $— | $178 | $(178) | | Total | $4,015 | $7,793 | $(3,778) | - The decrease was primarily attributable to a $2.0 million decrease of management fees receivable (due to amortization and sale of rights) and a $1.1 million decrease of tax receivables (due to tax refunds)[353] Deferred Tax Assets Net deferred tax assets were zero in 2018 and 2017 due to a full valuation allowance of $15.3 million and $9.9 million, respectively - Net deferred tax asset was zero at December 31, 2018 and 2017[354] - A full valuation allowance of $15.3 million (2018) and $9.9 million (2017) was recorded against net deferred tax assets due to cumulative historical losses and uncertainties regarding future taxable income[354] - The company completed its analysis of the Tax Cuts and Jobs Act (TCJA) provisions in 2018, resulting in immaterial adjustments[356] Core and Non-Core Asset Classes The investment strategy targets core CRE-related assets, with non-core asset classes largely exited as part of the 2016 strategic plan - Core Asset Class: Commercial real estate-related assets, including first mortgage loans (whole loans, A-notes, B-notes), mezzanine debt, preferred equity investments, CMBS, and CRE equity investments[357] - Non-Core Asset Classes (historically invested, largely exited): Residential real estate-related assets (residential mortgage loans, RMBS) and commercial finance assets (middle market secured corporate loans, ABS, CDOs/CLOs, structured notes, syndicated corporate loans, preferred equity in commercial leasing)[358] Assets and Liabilities Held for Sale Assets held for sale decreased significantly to $17.6 million in 2018, reflecting substantial disposition of non-CRE assets Assets and Liabilities Held for Sale (in thousands) | Category | Dec 31, 2018 | Dec 31, 2017 | | :--- | :--- | :--- | | ASSETS | | | | Loans held for sale (1) | $17,000 | $93,063 | | Other assets (2) | $645 | $14,450 | | Total assets held for sale | $17,645 | $107,718 | | LIABILITIES | | | | Accounts payable and other liabilities | $1,820 | $10,283 | | Management fee payable | $— | $56 | | Accrued interest payable | $— | $3 | | Total liabilities held for sale | $1,820 | $10,342 | - As of December 31, 2018, the company disposed of substantially all non-CRE assets identified for sale[312][734] Liquidity and Capital Resources Liquidity is managed through cash flow, debt, and equity, with $82.8 million unrestricted cash and $96.0 million available financing in 2018 - Liquidity sources: Operating activities, debt financing, and equity capital. In 2018, key sources included $839.4 million from CRE term facilities and CMBS repurchase agreements, $241.0 million from CRE loan repayments, and $63.2 million from XAN 2018-RSO6 securitization[402][404] - Financing arrangements: Primarily uses repurchase agreements (borrowing against loans/securities) and securitizations (non-recourse long-term financing for CRE loans) to match maturities and manage risk[406][407] Repurchase Agreements (as of December 31, 2018) | Facility Type | Lender | Maximum Capacity (in thousands) | Principal Outstanding (2) (in thousands) | Availability (in thousands) | | :--- | :--- | :--- | :--- | :--- | | CRE - Term Repurchase Facilities | Wells Fargo Bank, N.A. | $400,000 | $155,808 | $244,192 | | CRE - Term Repurchase Facilities | Morgan Stanley Bank, N.A. | $67,936 | $37,206 | $30,730 | | CRE - Term Repurchase Facilities | Barclays Bank PLC | $250,000 | $241,482 | $8,518 | | CRE - Term Repurchase Facilities | JPMorgan Chase Bank, N.A. | $250,000 | $77,308 | $172,692 | | Trust Certificates - Term Repurchase Facility | RSO Repo SPE Trust 2017 | N/A | $47,333 | N/A | | CMBS - Short-Term Repurchase Agreements | RBC Capital Markets, LLC | N/A | $245,763 | N/A | | CMBS - Short-Term Repurchase Agreements | JP Morgan Securities LLC | N/A | $41,991 | N/A | | CMBS - Short-Term Repurchase Agreements | Deutsche Bank Securities Inc. | N/A | $7,294 | N/A | | Total | | $854,185 | | | - Liquidity at December 31, 2018: $82.8 million of unrestricted cash and cash equivalents, and approximately $96.0 million of liquidity from available financing of unlevered CRE loans and CMBS[412] - Leverage ratio: Increased to 2.8 times in 2018 from 1.7 times in 2017, due to increased borrowings and decreased stockholders' equity (preferred stock redemption, distributions in excess of earnings)[413] - Distributions: Intends to make regular quarterly distributions to common and preferred stockholders to satisfy REIT requirements (at least 90% of taxable income annually)[414] Contractual Obligations and Commitments (as of December 31, 2018, in thousands) | Type | Total | Less than 1 year | 1-3 years | 3-5 years | More than 5 years | | :--- | :--- | :--- | :--- | :--- | :--- | | Securitizations | $506,702 | $— | $— | $— | $506,702 | | Unsecured junior subordinated debentures | $51,548 | $— | $— | $— | $51,548 | | 4.50% Convertible Senior Notes | $143,750 | $— | $— | $143,750 | $— | | 8.00% Convertible Senior Notes | $21,182 | $— | $21,182 | $— | $— | | Repurchase and credit facilities | $855,988 | $333,099 | $522,889 | $— | $— | | Unfunded commitments on CRE loans (5) | $108,083 | $31,019 | $77,064 | $— | $— | | Management fees (6) | $8,358 | $8,358 | $— | $— | $— | | Total | $1,695,611 | $372,476 | $621,135 | $143,750 | $558,250 | Critical Accounting Policies and Estimates Critical accounting policies involve fair value measurement, derivative hedging, income taxes, loan loss allowances, and VIE consolidation, requiring significant judgment - Valuation of Investment Securities: Classified as available-for-sale or trading, reported at fair value using independent third-party valuation firms and internal models. Unrealized gains/losses for available-for-sale are in OCI, for trading in net income. Quarterly evaluation for other-than-temporary impairment[424][425][496][497] - Accounting for Derivative Financial Instruments and Hedging Activities: Uses derivatives (interest rate swaps, caps) to mitigate interest rate risk, designated as cash flow hedges. Changes in fair value of effective hedges are in OCI; ineffective portions in earnings[426][427][527] - Income Taxes: Operates as a REIT, generally not subject to federal corporate income tax if 90% of taxable income is distributed. TRSs are subject to corporate taxes. Deferred income taxes recognized for temporary differences, with a valuation allowance established if realization is unlikely[429][430][431][516][517][520] - Allowance for Loan Losses: Maintained for loans held for investment, evaluated at least quarterly. Impaired loans (risk rating 5) are individually assessed; general reserve for loans rated 3 and 4[432][433][503] - Variable Interest Entities (VIE): Consolidates VIEs where the company is the primary beneficiary (power to direct activities, obligation to absorb losses or right to receive benefits)[434][435][482] Recent Accounting Pronouncements The company adopted several immaterial accounting standards in 2018 and anticipates future changes, including a higher provision for credit losses - Accounting Standards Adopted in 2018: Guidance on share-based payment modification, asset vs. business acquisition evaluation, restricted cash presentation, cash flow classification, and financial instrument recognition/measurement. None had a material impact[435][436][437][438][439][440][534][535][536][537][538][539] - Accounting Standards to be Adopted in Future Periods: - Fair value measurement disclosure requirements (effective after Dec 15, 2019)[441] - Simplified accounting for nonemployee share-based payments (effective after Dec 15, 2018)[442] - Reclassification of stranded tax effects from TCJA (effective after Dec 15, 2018)[443] - Improved financial reporting of hedging relationships (effective after Dec 15, 2018)[444] - Changes to credit loss determination for most financial assets, replacing incurred loss with expected loss model (effective after Dec 15, 2019). Expected to result in a higher provision for loan losses[446][545] - Lessees to recognize lease liability and right-of-use asset for all leases (effective on or after Dec 15, 2018)[447] Inflation Company performance is primarily influenced by interest rates, not inflation, with financial statements and distributions based on GAAP and REIT qualification - The company's performance is influenced by interest rates more than inflation, and interest rates do not necessarily correlate with inflation rates[448] - Financial statements are prepared in accordance with GAAP, and distributions are based on REIT qualification, without considering inflation[448] ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The primary market risk is interest rate risk, managed through asset-liability matching and derivatives, with sensitivity analysis showing significant fair value impacts - The primary component of market risk is interest rate risk, which can affect net interest income and the fair value of interest-earning assets and liabilities[449][450] - The company manages interest rate risk by matching adjustable-rate assets with variable-rate borrowings and using derivatives (e.g., interest rate swaps) to hedge against adverse rate movements[454] Sensitivity Analysis: Estimated Impact on Fair Value of Interest Rate Changes (as of December 31, 2018, in thousands) | Metric | Interest Rates Fall 100 Basis Points | Unchanged | Interest Rates Rise 100 Basis Points | | :--- | :--- | :--- | :--- | | Interest rate-sensitive investment securities: | | | | | Fair value | $118,526 | $111,924 | $106,586 | | Change in fair value | $6,602 | $— | $(5,338) | | Change as a percent of fair value | 5.90% | —% | (4.77)% | | Interest rate-sensitive hedging instruments: | | | | | Fair value | $(5,904) | $(57) | $5,327 | | Change in fair value | $(5,847) | $— | $5,384 | | Change as a percent of fair value | 10,211% | —% | (9,403)% | ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA This section presents audited consolidated financial statements for 2016-2018, including auditor's report, core statements, and detailed notes on accounting policies and financial items - The financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018, in conformity with accounting principles generally accepted in the United States of America[456] Report of Independent Registered Public Accounting Firm Grant Thornton LLP issued unqualified opinions on the 2018 and 2017 consolidated financial statements and 2018 internal control effectiveness - Grant Thornton LLP issued an unqualified opinion on the consolidated financial statements for the years ended December 31, 2018 and 2017, stating they are presented fairly in all material respects in conformity with GAAP[456] - An unqualified opinion was also expressed on the effectiveness of the company's internal control over financial reporting as of December 31, 2018, based on COSO criteria[457] Consolidated Balance Sheets Total assets increased to $2.13 billion in 2018, liabilities rose, and stockholders' equity decreased to $553.8 million Consolidated Balance Sheets (in thousands, except share and per share data) | ASSETS | Dec 31, 2018 | Dec 31, 2017 | | :--- | :--- | :--- | | Cash and cash equivalents | $82,816 | $181,490 | | Restricted cash | $12,658 | $22,874 | | CRE loans, net | $1,551,967 | $1,284,822 | | Investment securities available-for-sale | $418,998 | $211,737 | | Assets held for sale | $17,645 | $107,718 | | Total assets | $2,130,913 | $1,912,075 | | LIABILITIES | | | | Borrowings | $1,554,223 | $1,163,485 | | Liabilities held for sale | $1,820 | $10,342 | | Total liabilities | $1,577,094 | $1,240,599 | | STOCKHOLDERS' EQUITY | | | | Total stockholders' equity | $553,819 | $671,476 | | TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY | $2,130,913 | $1,912,075 | Assets and Liabilities of Consolidated VIEs (in thousands) | Metric | Dec 31, 2018 | Dec 31, 2017 | | :--- | :--- | :--- | | Total assets of consolidated VIEs | $742,031 | $699,596 | | Total liabilities of consolidated VIEs | $501,829 | $417,343 | Consolidated Statements of Operations Net income allocable to common shares was $7.0 million in 2018, with increased net interest income and decreased operating expenses Consolidated Statements of Operations (in thousands, except per share data) | Metric | 2018 | 2017 | 2016 | | :--- | :--- | :--- | :--- | | Total interest income | $122,779 | $99,318 | $112,618 | | Interest expense | $67,616 | $57,657 | $53,747 | | Net interest income | $55,163 | $41,661 | $58,871 | | Total operating expenses | $24,049 | $33,789 | $77,014 | | Total other (expense) income | $(4,271) | $44,150 | $13,992 | | Net income (loss) from continuing operations | $27,306 | $47,457 | $(11,334) | | Net income (loss) from discontinued operations, net of tax | $121 | $(14,116) | $(19,260) | | NET INCOME (LOSS) ALLOCABLE TO COMMON SHARES | $6,973 | $5,677 | $(52,956) | | Net income (loss) per common share - basic | $0.22 | $0.18 | $(1.73) | | Net income (loss) per common share - diluted | $0.22 | $0.18 | $(1.73) | Consolidated Statements of Comprehensive Income (Loss) Comprehensive income allocable to common shares decreased to $2.6 million in 2018, primarily due to net unrealized losses on investment securities and derivatives Consolidated Statements of Comprehensive Income (Loss) (in thousands) | Metric | 2018 | 2017 | 2016 | | :--- | :--- | :--- | :--- | | Net income (loss) | $27,427 | $33,341 | $(30,594) | | Total other comprehensive (loss) income | $(4,354) | $(1,784) | $4,047 | | Comprehensive income (loss) allocable to common shares | $2,619 | $3,893 | $(48,909) | - Total other comprehensive (loss) income was $(4.354) million in 2018, compared to $(1.784) million in 2017, primarily due to unrealized losses on investment securities available-for-sale[467] [Consolidated Statement of Changes