ACRES Commercial Realty(ACR) - 2023 Q3 - Quarterly Report

PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS This section presents the unaudited consolidated financial statements of ACRES Commercial Realty Corp. and its subsidiaries for the period ended September 30, 2023, including balance sheets, statements of operations, comprehensive income (loss), changes in equity, and cash flows, along with detailed notes explaining the company's accounting policies, financial instruments, and other relevant disclosures Consolidated Balance Sheets The consolidated balance sheets show a decrease in total assets and liabilities from December 31, 2022, to September 30, 2023, while total equity slightly increased | Metric | Sep 30, 2023 (in thousands) | Dec 31, 2022 (in thousands) | Change (in thousands) | | :-------------------------------- | :-------------------------- | :-------------------------- | :-------------------- | | Total assets | $2,261,496 | $2,376,652 | $(115,156) | | Total liabilities | $1,813,269 | $1,935,338 | $(122,069) | | Total equity | $448,227 | $441,314 | $6,913 | | CRE loans, net | $1,892,571 | $2,038,787 | $(146,216) | | Allowance for credit losses | $(27,634) | $(18,803) | $(8,831) | - Assets of consolidated Variable Interest Entities (VIEs) decreased from $1,503,132 thousand at December 31, 2022, to $1,474,780 thousand at September 30, 2023, primarily due to a reduction in CRE loans pledged as collateral[13] Consolidated Statements of Operations The company reported increased net income for both the three and nine months ended September 30, 2023, compared to the same periods in 2022, driven by higher total interest income and a lower provision for credit losses in the three-month period, despite increased interest expense | Metric (in thousands) | 3 Months Ended Sep 30, 2023 | 3 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | | :-------------------- | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | Total interest income | $48,208 | $34,065 | $140,685 | $83,760 | | Interest expense | $33,555 | $22,939 | $97,372 | $53,591 | | Net interest income | $14,653 | $11,126 | $43,313 | $30,169 | | Total revenues | $24,006 | $20,933 | $68,686 | $51,929 | | Total operating expenses | $16,552 | $17,450 | $54,349 | $41,070 | | Net income | $7,567 | $5,486 | $15,418 | $13,092 | | Net income (loss) allocable to common shares | $2,870 | $713 | $1,271 | $(1,368) | | Basic EPS | $0.34 | $0.08 | $0.15 | $(0.15) | | Diluted EPS | $0.33 | $0.08 | $0.15 | $(0.15) | - Provision for credit losses, net, decreased by $637 thousand for the three months ended September 30, 2023, compared to the same period in 2022, but increased significantly by $8,437 thousand for the nine months ended September 30, 2023, compared to 2022[15] Consolidated Statements of Comprehensive Income (Loss) Comprehensive income allocable to common shares increased for both the three and nine months ended September 30, 2023, compared to the prior year, primarily due to higher net income and reclassification adjustments from interest rate swaps | Metric (in thousands) | 3 Months Ended Sep 30, 2023 | 3 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | | :-------------------- | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | Net income | $7,567 | $5,486 | $15,418 | $13,092 | | Reclassification adjustments from interest rate swaps | $402 | $415 | $1,192 | $1,332 | | Comprehensive income (loss) allocable to common shares | $3,272 | $1,128 | $2,463 | $(36) | Consolidated Statements of Changes in Equity Total equity increased from $441.3 million at December 31, 2022, to $448.2 million at September 30, 2023, driven by net income, contributions from non-controlling interests, and amortization of terminated derivatives, partially offset by common stock repurchases and preferred stock dividends | Metric (in thousands) | Dec 31, 2022 | Sep 30, 2023 | Change | | :-------------------- | :----------- | :----------- | :----- | | Total Equity | $441,314 | $448,227 | $6,913 | | Common Stock Shares Outstanding | 8,708,100 | 8,448,524 | (259,576) | | Additional Paid-In Capital | $1,174,202 | $1,173,975 | $(227) | | Accumulated Other Comprehensive Loss | $(6,394) | $(5,202) | $1,192 | | Distributions in Excess of Earnings | $(732,359) | $(731,088) | $1,271 | | Non-controlling interests | $5,846 | $10,524 | $4,678 | - The company repurchased and retired 298,457 common shares during the nine months ended September 30, 2023, reducing common stock and additional paid-in capital[20][23][24] Consolidated Statements of Cash Flows Net cash provided by operating activities significantly increased for the nine months ended September 30, 2023, compared to 2022, while investing activities shifted from a net outflow to a net inflow, and financing activities saw a substantial net outflow | Metric (in thousands) | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | | :-------------------- | :-------------------------- | :-------------------------- | | Net cash provided by operating activities | $36,224 | $19,002 | | Net cash provided by (used in) investing activities | $106,954 | $(300,507) | | Net cash (used in) provided by financing activities | $(147,673) | $74,524 | | Net decrease in cash and cash equivalents and restricted cash | $(4,495) | $(206,981) | | Cash and cash equivalents and restricted cash at end of period | $100,316 | $76,950 | - Origination and purchase of loans decreased significantly from $543,783 thousand in 2022 to $75,002 thousand in 2023, contributing to the shift in investing activities[34] - Payments on borrowings, particularly securitizations and senior secured financing facilities, were a major use of cash in financing activities for the nine months ended September 30, 2023[34] Notes to Consolidated Financial Statements This section provides detailed disclosures on the company's financial statements, covering organization, significant accounting policies, variable interest entities, loan portfolio, real estate investments, financing arrangements, equity, related party transactions, fair value measurements, market risks, and commitments NOTE 1 - ORGANIZATION ACRES Commercial Realty Corp. is a Maryland REIT focused on originating, holding, and managing commercial real estate (CRE) mortgage loans and equity investments, operating through consolidated subsidiaries, with ACRES Realty Funding, Inc. holding core assets including CRE loans and securitizations - The Company is a REIT primarily focused on CRE mortgage loans and equity investments in multifamily, student housing, hospitality, office, and industrial properties in top U.S. markets[36] - ACRES Realty Funding, Inc. (ACRES RF), a wholly-owned subsidiary, holds the Company's core assets, including CRE loans, real estate investments, and CRE securitizations[37] NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The company's financial statements are prepared under GAAP, consolidating majority-owned subsidiaries and VIEs, with key policies including the use of estimates, classification of cash and restricted cash, depreciation of real estate assets, income tax valuation allowances, and the transition of floating-rate instruments from LIBOR to SOFR - The Company adopted new FASB guidance in 2023, eliminating troubled-debt restructuring (TDR) recognition and measurement guidance, which did not materially impact its financial statements[52] - The Company transitioned its entire portfolio of floating-rate whole loans and borrowings from LIBOR to SOFR by September 30, 2023, following the FCA's announcement[49][50] - A full valuation allowance was recorded against net deferred tax assets at September 30, 2023, due to historical losses and uncertainty regarding future taxable income from taxable REIT subsidiaries[47] NOTE 3 - VARIABLE INTEREST ENTITIES The company consolidates five CRE securitizations and CDOs as Variable Interest Entities (VIEs) where it is the primary beneficiary, financing assets with long-term debt, and also consolidated the FSU Student Venture due to a 72.1% interest, while unconsolidated VIEs are not consolidated as the company is not the primary beneficiary - The Company is the primary beneficiary of five consolidated VIEs (CRE securitizations and CDOs) at September 30, 2023, and December 31, 2022, which are used to invest in real estate-related securities and commercial mortgage-backed securities[54] | Asset/Liability (in thousands) | Consolidated VIEs (Sep 30, 2023) | | :----------------------------- | :------------------------------- | | Total assets | $1,474,780 | | Total liabilities | $1,207,616 | - The Company holds a 100% interest in the common shares of Resource Capital Trust I and RCC Trust II, valued at $1.5 million, which are unconsolidated VIEs where the Company is not the primary beneficiary[60] NOTE 4 - SUPPLEMENTAL CASH FLOW INFORMATION Supplemental cash flow information highlights significant non-cash investing and financing activities, including proceeds from deed-in-lieu of foreclosure and accrued preferred stock dividends | Supplemental Cash Flow Item (in thousands) | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | | :----------------------------------------- | :-------------------------- | :-------------------------- | | Interest expense paid in cash | $94,433 | $46,999 | | Proceeds from deed-in-lieu of foreclosure | $20,900 | $14,299 | | Distributions on preferred stock accrued but not paid | $3,262 | $3,262 | NOTE 5 - LOANS The company's CRE loan portfolio decreased from $2.06 billion at December 31, 2022, to $1.92 billion at September 30, 2023, with a significant concentration in multifamily properties (76.3%) and the Southwest region (24.2%), and all whole loans now use one-month Term SOFR, with a weighted-average benchmark rate of 5.37% at September 30, 2023 | Loan Type (in thousands) | Sep 30, 2023 Carrying Value | Dec 31, 2022 Carrying Value | | :----------------------- | :-------------------------- | :-------------------------- | | Whole loans | $1,892,571 | $2,038,787 | | Mezzanine loan | — | — | | Total CRE loans, net | $1,892,571 | $2,038,787 | | Property Type (Sep 30, 2023) | Carrying Value (in thousands) | % of Loan Portfolio | | :--------------------------- | :---------------------------- | :------------------ | | Multifamily | $1,443,261 | 76.3 % | | Office | $247,062 | 13.1 % | | Hotel | $146,144 | 7.7 % | | Self-Storage | $48,079 | 2.5 % | | Retail | $8,025 | 0.4 % | - At September 30, 2023, the weighted-average one-month benchmark rate for whole loans was 5.37%, up from 4.21% at December 31, 2022, with all whole loans transitioned to one-month Term SOFR[74] NOTE 6 - FINANCING RECEIVABLES The allowance for credit losses increased to $27.6 million at September 30, 2023, driven by increased modeled portfolio credit risk due to macroeconomic uncertainty, with individually evaluated impaired loans including a fully reserved office mezzanine loan and retail/office loans with probable foreclosure, but no CECL allowance due to appraised values | Metric (in thousands) | 9 Months Ended Sep 30, 2023 | Year Ended Dec 31, 2022 | | :-------------------- | :-------------------------- | :---------------------- | | Allowance for credit losses at beginning of period | $18,803 | $8,805 | | Provision for credit losses | $9,779 | $12,295 | | Charge offs | $(948) | $(2,297) | | Allowance for credit losses at end of period | $27,634 | $18,803 | - The provision for credit losses of $9.8 million for the nine months ended September 30, 2023, was primarily due to increased modeled portfolio credit risk related to ongoing macroeconomic uncertainty in the commercial real estate market[83] | Risk Rating | Sep 30, 2023 (in thousands) | Dec 31, 2022 (in thousands) | | :---------- | :-------------------------- | :-------------------------- | | Rating 2 | $1,049,699 | $1,635,376 | | Rating 3 | $709,481 | $309,491 | | Rating 4 | $128,161 | $85,226 | | Rating 5 | $32,864 | $27,497 | NOTE 7 - INVESTMENTS IN REAL ESTATE AND OTHER ACQUIRED ASSETS AND ASSUMED LIABILITIES The company held investments in six real estate properties at September 30, 2023, with a total net carrying value of $168.7 million, including a hotel property sold in February 2023 for a $745,000 gain and an office property acquired via deed-in-lieu of foreclosure in June 2023, valued at $20.9 million, resulting in a $948,000 charge-off against the allowance for credit losses - At September 30, 2023, the Company held investments in six real estate properties, with four in 'investments in real estate' and two in 'properties held for sale'[105] - A hotel property was sold in February 2023 for $15.1 million, generating a gain of $745,000[105] - An office property was acquired via deed-in-lieu of foreclosure in June 2023, valued at $20.9 million, leading to a $948,000 charge-off against the allowance for credit losses[106] NOTE 8 - LEASES The company has operating leases for office space and equipment, expiring between January 2024 and September 2029, in addition to a 93-year ground lease for a hotel property, with lease costs and cash payments for operating leases increasing for the nine months ended September 30, 2023, compared to 2022 | Operating Lease Metric (in thousands) | Sep 30, 2023 | Dec 31, 2022 | | :------------------------------------ | :----------- | :----------- | | Right of use assets | $716 | $822 | | Lease liabilities | $(760) | $(828) | | Lease Cost (in thousands) | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | | :------------------------ | :-------------------------- | :-------------------------- | | Operating lease cost | $154 | $73 | | Cash paid for operating leases | $113 | $70 | - The weighted average remaining lease term for operating leases is 6.0 years, with a weighted average discount rate of 8.70% at September 30, 2023[114] NOTE 9 - INVESTMENTS IN UNCONSOLIDATED ENTITIES The company holds a 100% interest in the common shares of RCT I and RCT II, valued at $1.5 million, accounted for using the cost method, with dividend income from these investments increasing for both the three and nine months ended September 30, 2023, compared to 2022 - The Company's investments in unconsolidated entities consist of a 100% interest in the common shares of RCT I and RCT II, totaling $1.5 million[118] | Dividend Income (in thousands) | 3 Months Ended Sep 30, 2023 | 3 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | | :----------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | Dividends from RCT I and RCT II | $37 | $25 | $107 | $60 | NOTE 10 - BORROWINGS Total borrowings decreased from $1.87 billion at December 31, 2022, to $1.74 billion at September 30, 2023, with a weighted average borrowing rate increasing to 7.28%, and the company's securitizations (ACR 2021-FL1 and ACR 2021-FL2) transitioned from LIBOR to Term SOFR in June 2023, with the reinvestment period for ACR 2021-FL1 ending in May 2023 | Borrowing Type (in thousands) | Sep 30, 2023 Outstanding | Dec 31, 2022 Outstanding | Sep 30, 2023 Avg Rate | Dec 31, 2022 Avg Rate | | :---------------------------- | :----------------------- | :----------------------- | :-------------------- | :-------------------- | | ACR 2021-FL1 Senior Notes | $640,493 | $671,397 | 6.95% | 5.81% | | ACR 2021-FL2 Senior Notes | $563,369 | $562,159 | 7.25% | 6.13% | | Senior secured financing facility | $61,383 | $87,890 | 9.11% | 7.94% | | CRE - term warehouse financing facilities | $250,494 | $328,288 | 8.02% | 6.85% | | Mortgage payable | $18,544 | $18,244 | 9.13% | 8.08% | | Construction loans | $5,020 | — | 7.26% (weighted) | — | | 5.75% Senior Unsecured Notes | $147,978 | $147,507 | 5.75% | 5.75% | | Unsecured junior subordinated debentures | $51,548 | $51,548 | 9.53% | 8.52% | | Total Borrowings | $1,738,829 | $1,867,033 | 7.28% | 6.29% | - The reinvestment period for ACR 2021-FL1 ended in May 2023, and for ACR 2021-FL2, it ends in December 2023, impacting the ability to reinvest principal proceeds[128][131][132] - The company was in compliance with all financial covenants for its financing arrangements at September 30, 2023, and December 31, 2022[142] NOTE 11 - SHARE ISSUANCE AND REPURCHASE The company has 4.8 million Series C Preferred Stock and 4.6 million Series D Preferred Stock outstanding, repurchased $2.7 million of common stock (298,000 shares) during the nine months ended September 30, 2023, with $4.5 million remaining under the November 2021 repurchase plan, and warrants to purchase 391,995 common shares issued to Oaktree remain unexercised - At September 30, 2023, the Company had 4.8 million shares of Series C Preferred Stock and 4.6 million shares of Series D Preferred Stock outstanding[163] - During the nine months ended September 30, 2023, the Company repurchased $2.7 million of its common stock, representing 298,000 shares[167] - Warrants to purchase 391,995 shares of common stock issued to Oaktree Capital Management, L.P. at an exercise price of $0.03 per share remain unexercised at September 30, 2023[168] NOTE 12 - SHARE-BASED COMPENSATION The company recognized $2.1 million in stock-based compensation expense for the nine months ended September 30, 2023, with unrecognized compensation costs for unvested restricted stock totaling $2.4 million, expected to be recognized over 2.2 years, and incentive compensation to the Manager is 50% cash and 50% common stock, with 38,881 shares issued during the nine-month period | Metric (in thousands) | 3 Months Ended Sep 30, 2023 | 3 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | | :-------------------- | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | Stock-based compensation expense | $482 | $913 | $2,095 | $2,648 | - Total unrecognized compensation costs for unvested restricted stock were $2.4 million at September 30, 2023, with a weighted average recognition period of 2.2 years[173] - Incentive compensation to the Manager for the nine months ended September 30, 2023, was $857,000, with 50% payable in cash and 50% in common stock (38,881 shares issued)[174][175] NOTE 13 - EARNINGS PER SHARE Basic and diluted earnings per common share increased significantly for both the three and nine months ended September 30, 2023, compared to the prior year, reflecting improved net income allocable to common shares | Metric | 3 Months Ended Sep 30, 2023 | 3 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | | :----- | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | Net income (loss) allocable to common shares (in thousands) | $2,870 | $713 | $1,271 | $(1,368) | | Basic EPS | $0.34 | $0.08 | $0.15 | $(0.15) | | Diluted EPS | $0.33 | $0.08 | $0.15 | $(0.15) | NOTE 14 - DISTRIBUTIONS The company did not pay common share distributions for the three and nine months ended September 30, 2023, but intends to continue regular quarterly distributions to preferred stockholders, with preferred stock dividends remaining consistent year-over-year - The Company did not pay any common share distributions for the three and nine months ended September 30, 2023, or 2022[184] | Preferred Stock | Date Paid (2023) | Total Distribution Paid (in thousands) | Distribution Per Share | | :-------------- | :--------------- | :----------------------------------- | :--------------------- | | Series C | Oct 30 | $2,587 | $0.5390625 | | Series D | Oct 30 | $2,268 | $0.4921875 | - The Company intends to distribute substantially all of its taxable income to qualify as a REIT and avoid corporate federal income taxes[183] NOTE 15 - ACCUMULATED OTHER COMPREHENSIVE LOSS The net unrealized loss on derivatives, the sole component of accumulated other comprehensive loss, decreased from $(6,394) thousand at January 1, 2023, to $(5,202) thousand at September 30, 2023, due to reclassification adjustments | Metric (in thousands) | Amount | | :-------------------- | :----- | | Balance at January 1, 2023 | $(6,394) | | Amounts reclassified from accumulated other comprehensive loss | $1,192 | | Balance at September 30, 2023 | $(5,202) | NOTE 16 - RELATED PARTY TRANSACTIONS The company has significant related party transactions with its Manager, ACRES Capital, LLC, including base management fees, incentive management fees (50% cash, 50% stock), expense reimbursements, and a $11.1 million loan receivable from ACRES Capital Corp., with other transactions including loan originations, securitization structuring, and development management fees | Related Party Transaction (in thousands) | 3 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2023 | | :--------------------------------------- | :-------------------------- | :-------------------------- | | Base management fees earned | $1,600 | $4,900 | | Incentive management fees earned | $473 | $857 | | Expense reimbursements to Manager | $670 | $3,000 | | Interest income on ACRES Loan | $85 | $254 | - The ACRES Loan, a $12.0 million loan to ACRES Capital Corp., had a principal balance of $11.1 million at September 30, 2023, accruing interest at 3.00% per annum[192][193] - The Company purchased a $22.5 million participation in one CRE whole loan from ACRES Commercial Mortgage, LLC during the nine months ended September 30, 2023[196] NOTE 17 - FAIR VALUE OF FINANCIAL INSTRUMENTS The company had no financial instruments carried at fair value on a recurring basis, with fair values for CRE whole loans, related party loans, and various borrowings estimated using discounted cash flow models or approximating carrying values for variable-rate instruments - The Company had no financial instruments carried at fair value on a recurring basis at September 30, 2023, and December 31, 2022[201] - Fair values of CRE whole loans are measured by discounting expected future cash flows using current interest rates for similar loans, with floating-rate loans approximating fair value unless credit deterioration exists[203] | Financial Instrument (in thousands) | Carrying Value (Sep 30, 2023) | Fair Value (Sep 30, 2023) | | :---------------------------------- | :---------------------------- | :------------------------ | | CRE whole loans | $1,892,571 | $1,923,014 | | Loan receivable - related party | $11,050 | $8,391 | | Senior notes in CRE securitizations | $1,203,862 | $1,161,331 | | 5.75% Senior Unsecured Notes | $147,978 | $136,980 | NOTE 18 - MARKET RISK AND DERIVATIVE INSTRUMENTS The company manages interest rate risk by matching adjustable-rate assets with variable-rate borrowings and historically used interest rate swaps as cash flow hedges, with all interest rate swap positions terminated in April 2020, resulting in a realized loss of $11.8 million, and remaining unrealized losses of $5.4 million amortized into interest expense - The Company terminated all interest rate swap positions in April 2020, realizing a loss of $11.8 million[212] - At September 30, 2023, the Company had $5.4 million in unrealized losses from terminated hedges recorded in accumulated other comprehensive loss, which are amortized into interest expense[212] | Derivative Effect (in thousands) | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | | :------------------------------- | :-------------------------- | :-------------------------- | | Interest rate swap contracts, hedging (Interest expense) | $(1,192) | $(1,332) | NOTE 19 - OFFSETTING OF FINANCIAL ASSETS AND LIABILITIES The company presents all balances associated with warehouse financing facilities on a gross basis on its consolidated balance sheets, despite underlying agreements providing for a right of offset in certain default or bankruptcy events - All balances associated with warehouse financing facilities are presented on a gross basis on the Company's consolidated balance sheets[215] - Certain warehouse financing facilities are governed by agreements that provide for a right of offset in the event of default or bankruptcy[216] NOTE 20 - COMMITMENTS AND CONTINGENCIES The company is subject to potential litigation and claims for loan repurchases/indemnifications, with reserves totaling $1.1 million at September 30, 2023, and also has unfunded loan commitments of $118.8 million for CRE loans and provides guarantees related to a student housing construction loan - Reserves for potential litigation and indemnification claims related to Primary Capital Mortgage, LLC (PCM) totaled $1.1 million at September 30, 2023[219] - Outstanding demands for indemnification, repurchase, or make-whole payments totaled $3.3 million at September 30, 2023[220] - Unfunded commitments on CRE loans were $118.8 million at September 30, 2023, down from $158.2 million at December 31, 2022[223] NOTE 21 - SUBSEQUENT EVENTS The company evaluated subsequent events through the filing date and determined no material adjustments or disclosures were required beyond those already described in other notes - No material subsequent events requiring adjustments or disclosures were identified beyond those already detailed in Notes 6, 10, 12, and 16[226] ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This section provides management's perspective on the company's financial performance and condition, highlighting the impact of macroeconomic factors like inflation and rising interest rates, detailing the company's strategy, investment portfolio, financing arrangements, and liquidity, emphasizing the shift to SOFR and efforts to manage credit risk and enhance returns Special Note Regarding Forward-Looking Statements This section cautions readers that the report contains forward-looking statements subject to risks and uncertainties, and actual results may differ materially, with the company disclaiming any obligation to update these statements - The report contains forward-looking statements that involve risks, uncertainties, and contingencies, meaning actual results may differ materially from expectations[229] - The Company disclaims any intention or obligation to update or revise forward-looking statements, except as required by applicable securities law[229] Overview ACRES Commercial Realty Corp. is an externally managed REIT focused on CRE mortgage loans and equity investments, with a strategy to drive book value growth by utilizing NOL carryforwards and deploying capital into new loan originations, actively managing liquidity and its diversified CRE loan portfolio amidst market disruptions from inflation and rising interest rates, which have increased net interest income but also pose non-performance risks - The Company is an externally managed REIT focused on originating, holding, and managing CRE mortgage loans and equity investments, primarily in multifamily, student housing, hospitality, office, and industrial properties[230] - The short-term strategy is to drive book value growth by utilizing NOL carryforwards ($46.6 million) and net capital loss carryforwards ($121.9 million) to grow the investable base and deploy capital into new whole loan originations at attractive yields[230] - Rising interest rates (Federal Funds rate increased by 5.25% between March 2022 and July 2023) generally correlate to increased net income but may adversely affect borrowers' ability to pay debt service, a risk partially mitigated by interest rate caps and debt service reserves[232][237][238] Results of Operations The company's net income allocable to common shares significantly increased for both the three and nine months ended September 30, 2023, compared to the prior year, driven by higher net interest income due to rising benchmark rates, partially offset by increased operating expenses and a decrease in real estate income | Metric (in thousands) | 3 Months Ended Sep 30, 2023 | 3 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | | :-------------------- | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | Net income allocable to common shares | $2,870 | $713 | $1,271 | $(1,368) | | Basic EPS | $0.34 | $0.08 | $0.15 | $(0.15) | | Diluted EPS | $0.33 | $0.08 | $0.15 | $(0.15) | Net Interest Income Net interest income increased by $3.5 million for the three months and $13.1 million for the nine months ended September 30, 2023, primarily due to a significant increase in benchmark interest rates, which boosted interest income from CRE whole loans and increased interest expense on floating-rate liabilities | Metric (in thousands) | 3 Months Ended Sep 30, 2023 | 3 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | | :-------------------- | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | Net interest income | $14,653 | $11,126 | $43,313 | $30,169 | | Increase in interest income | $14,143 | N/A | $56,925 | N/A | | Increase in interest expense | $10,616 | N/A | $43,781 | N/A | - The increase in interest income from CRE whole loans was primarily attributable to a significant increase in the benchmark rate over the comparative periods[259] - Securitized borrowings saw net increases in interest expense of $9.8 million (3 months) and $34.4 million (9 months) due to rising benchmark rates, partially offset by the liquidation of XAN 2020-RSO8 and XAN 2020-RSO9 in 2022[260] Real Estate Income and Other Revenue Aggregate real estate income and other revenue decreased by $457,000 for the three months ended September 30, 2023, but increased by $3.6 million for the nine months, primarily due to the acquisition of a hotel property in April 2022 and increased travel, partially offset by property sales | Revenue Type (in thousands) | 3 Months Ended Sep 30, 2023 | 3 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | Real estate income | $9,316 | $9,785 | $25,266 | $21,700 | | Other revenue | $37 | $25 | $107 | $60 | | Total | $9,353 | $9,810 | $25,373 | $21,760 | - The decrease in real estate income for the three-month period was mainly due to the sale of a hotel property in February 2023 and an office building in September 2022[267] - The increase for the nine-month period was primarily driven by the acquisition of a hotel property in April 2022 and improved performance at an existing hotel due to lifted COVID-19 restrictions[268] Operating Expenses Aggregate operating expenses decreased by $898,000 for the three months ended September 30, 2023, but increased by $13.3 million for the nine months, primarily due to higher real estate expenses from property acquisitions and a significant increase in the provision for credit losses | Operating Expense (in thousands) | 3 Months Ended Sep 30, 2023 | 3 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | | :------------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | Total operating expenses | $16,552 | $17,450 | $54,349 | $41,070 | | Real estate expenses | $9,706 | $10,099 | $29,058 | $24,055 | | Provision for credit losses, net | $1,983 | $2,620 | $9,779 | $1,342 | - The $5.0 million increase in real estate expenses for the nine months was mainly due to the acquisition of a hotel and a student housing complex in April 2022, and an office property via deed-in-lieu of foreclosure in June 2023[273] - The provision for credit losses, net, increased by $8.4 million for the nine months ended September 30, 2023, driven by modeled increases in general portfolio credit risk and macroeconomic uncertainty[274] Other Income (Expense) Aggregate other income decreased by $1.9 million for the three months and $1.3 million for the nine months ended September 30, 2023, primarily due to lower gains on real estate sales and the absence of a loan recovery seen in the prior year | Other Income (Expense) (in thousands) | 3 Months Ended Sep 30, 2023 | 3 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | | :------------------------------------ | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | Gain on sale of real estate | — | $1,870 | $745 | $1,870 | | Other income | $113 | $130 | $465 | $1,103 | | Total | $113 | $2,000 | $1,210 | $2,513 | - The decrease in gain on sale of real estate was due to the sale of a hotel property in February 2023 ($745,000 gain) compared to an office property sale in September 2022 ($1.9 million gain)[277] - The decrease in other income for the nine-month period was primarily due to a loan recovery received in 2022 that did not recur in 2023[277] Financial Condition The company's total assets decreased to $2.3 billion at September 30, 2023, primarily due to a reduction in CRE loans, with the allowance for credit losses increasing, reflecting macroeconomic uncertainty, and liquidity managed through operating cash flows and various financing arrangements, including securitizations and warehouse facilities, with a leverage ratio of 3.9 times - Total assets decreased from $2.4 billion at December 31, 2022, to $2.3 billion at September 30, 2023[279] - The leverage ratio (borrowings to total equity) decreased from 4.2 times at December 31, 2022, to 3.9 times at September 30, 2023, due to a net decrease in borrowings and a net increase in total equity[371] Investment Portfolio The total investment portfolio decreased to $2.18 billion at September 30, 2023, primarily driven by a $119.7 million net decrease in the par balance of CRE whole loans, with multifamily properties continuing to dominate the portfolio (76.3%), and the company holding investments in six real estate properties, including two held for sale | Investment Type (in thousands) | Sep 30, 2023 Net Carrying Amount | Dec 31, 2022 Net Carrying Amount | | :----------------------------- | :------------------------------- | :------------------------------- | | CRE whole loans, floating-rate | $1,892,571 | $2,038,787 | | Investments in unconsolidated entities | $1,548 | $1,548 | | Investments in real estate | $109,588 | $88,132 | | Property held for sale | $59,138 | $50,744 | | Total investment portfolio | $2,179,211 | $2,062,845 | - The CRE loan portfolio decreased by $119.7 million in par balance during the nine months ended September 30, 2023, with $38.5 million in new commitments and $194.9 million in loan payoffs[281] - Multifamily properties represent 76.3% of the CRE loan portfolio at September 30, 2023, maintaining its majority allocation[240] Financing Receivables The allowance for credit losses increased to $27.6 million at September 30, 2023, primarily due to increased modeled portfolio credit risk, with individually evaluated impaired loans including a fully reserved office mezzanine loan and retail/office loans with probable foreclosure, but no CECL allowance due to appraised values | Metric (in thousands) | 9 Months Ended Sep 30, 2023 | Year Ended Dec 31, 2022 | | :-------------------- | :-------------------------- | :---------------------- | | Allowance for credit losses at beginning of period | $18,803 | $8,805 | | Provision for credit losses | $9,779 | $12,295 | | Charge offs | $(948) | $(2,297) | | Allowance for credit losses at end of period | $27,634 | $18,803 | - The provision for credit losses of $9.8 million for the nine months ended September 30, 2023, was primarily driven by increased modeled portfolio credit risk related to ongoing macroeconomic uncertainty[293] - At September 30, 2023, four CRE whole loans ($47.8 million) and one mezzanine loan ($4.7 million) were in payment default, and one CRE whole loan ($44.8 million) was on nonaccrual status[312] Restricted Cash Restricted cash decreased by $2.7 million to $35.9 million at September 30, 2023, primarily due to reinvesting proceeds in one of the company's securitizations | Restricted Cash (in thousands) | Sep 30, 2023 | Dec 31, 2022 | | :----------------------------- | :----------- | :----------- | | Total restricted cash | $35,900 | $38,600 | - The decrease in restricted cash was primarily attributable to reinvesting proceeds in one of the Company's securitizations prior to the end of the reinvestment period[313] Accrued Interest Receivable Accrued interest receivable increased by $464,000 to $12.4 million at September 30, 2023, primarily due to rising benchmark rates | Accrued Interest Receivable (in thousands) | Sep 30, 2023 | Dec 31, 2022 | | :----------------------------------------- | :----------- | :----------- | | From loans | $12,401 | $11,936 | | From promissory note, escrow, sweep and reserve accounts | $32 | $33 | | Total | $12,433 | $11,969 | - The increase in accrued interest receivable was primarily attributable to rising benchmark rates[316] Other Assets Other assets decreased by $224,000 to $4.14 million at September 30, 2023, mainly due to changes in receivables at real estate properties, partially offset by other asset purchases | Other Assets (in thousands) | Sep 30, 2023 | Dec 31, 2022 | | :-------------------------- | :----------- | :----------- | | Total other assets | $4,140 | $4,364 | - The decrease in other assets was primarily attributable to receivables held at real estate properties and miscellaneous receivables from real estate properties acquired in 2022 and 2023, offset by the purchase of other assets[317] Deferred Tax Assets The net deferred tax asset remained zero at September 30, 2023, due to a full valuation allowance of $20.8 million, reflecting management's belief that realization of these assets is unlikely - At September 30, 2023, the net deferred tax asset was zero, with a full valuation allowance of $20.8 million, as the Company believed it was more likely than not that the deferred tax assets would not be realized[318] Derivative Instruments The company terminated all interest rate swap positions in April 2020, realizing an $11.8 million loss, and at September 30, 2023, $5.4 million in unrealized losses from these terminated hedges remained, being amortized into interest expense, with the effect of derivative instruments on operations for the nine months ended September 30, 2023, being a $1.19 million decrease to interest expense - The Company terminated all interest rate swap positions in April 2020, resulting in a realized loss of $11.8 million[320] - At September 30, 2023, $5.4 million in unrealized losses from terminated hedges were recorded in accumulated other comprehensive loss, amortized into interest expense[320] | Derivative Effect (in thousands) | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | | :------------------------------- | :-------------------------- | :-------------------------- | | Interest rate swap contracts, hedging (Interest expense) | $(1,192) | $(1,332) | Financing Arrangements The company utilizes various financing arrangements, including a senior secured financing facility, term warehouse financing facilities (JPMorgan Chase and Morgan Stanley), mortgage payable, and construction loans, with all facilities in compliance with covenants at September 30, 2023, and the MassMutual Facility transitioned to a floating-rate term loan, while the JPMorgan Chase and Morgan Stanley facilities had their amendments extended through December 2024 | Financing Arrangement (in thousands) | Sep 30, 2023 Outstanding Borrowings | Sep 30, 2023 Weighted Average Interest Rate | | :----------------------------------- | :---------------------------------- | :------------------------------------ | | Senior Secured Financing Facility | $61,383 | 9.11% | | JPMorgan Chase Facility | $117,637 | 7.99% | | Morgan Stanley Facility | $132,857 | 8.05% | | Mortgage Payable | $18,544 | 9.13% | | Construction Loans | $5,020 | 7.26% (Florida Pace) / 11.34% (Oceanview) | - The MassMutual Facility was amended in December 2022 to a senior secured term loan facility with a floating interest rate (one-month Term SOFR plus spread)[331] - The JPMorgan Chase Facility and Morgan Stanley Facility had amendments extending certain financial covenants through the quarter ending December 2024[333][334] Securitizations The company retains equity in two active CRE loan securitizations, ACR 2021-FL1 and ACR 2021-FL2, which transitioned from LIBOR to Term SOFR in June 2023, with the reinvestment period for ACR 2021-FL1 ending in May 2023, while ACR 2021-FL2's period ends in December 2023 - ACR 2021-FL1 and ACR 2021-FL2, with $802.6 million and $700.0 million financing capacity respectively, transitioned their non-recourse, floating-rate notes from one-month Term LIBOR to one-month Term SOFR in June 2023[339][340] - The reinvestment period for ACR 2021-FL1 ended in May 2023, and for ACR 2021-FL2, it ends in December 2023, affecting the ability to reinvest principal proceeds into new CRE loans[339][340] Corporate Debt The company's 4.50% Convertible Senior Notes matured and were paid off in August 2022, with the 5.75% Senior Unsecured Notes due 2026 remaining outstanding and redemption options available to the company, and unsecured junior subordinated debentures to RCT I and RCT II, totaling $51.5 million, are not consolidated and had interest rates of 9.49% and 9.58% at September 30, 2023 - The remaining $48.2 million of 4.50% Convertible Senior Notes were paid off upon maturity in August 2022[341] - The Company issued $150.0 million of 5.75% Senior Unsecured Notes due 2026, redeemable at the Company's option with a make-whole premium prior to May 15, 2026, and at par thereafter[343] - Unsecured junior subordinated debentures to RCT I and RCT II total $51.5 million, with interest rates of 9.49% and 9.58% respectively at September 30, 2023[345] Equity Total equity increased to $448.2 million at September 30, 2023, from $441.3 million at December 31, 2022, primarily due to contributions from non-controlling interests, partially offset by preferred stock distributions and common stock repurchases | Metric (in thousands) | Sep 30, 2023 | Dec 31, 2022 | | :-------------------- | :----------- | :----------- | | Total equity | $448,227 | $441,314 | - The increase in equity was primarily attributable to contributions from non-controlling interests, partially offset by distributions on preferred stock and common stock repurchases[346] Balance Sheet - Book Value Reconciliation Common stock book value increased to $25.07 per share at September 30, 2023, from $24.54 at December 31, 2022, driven by net income allocable to common shares and changes in other comprehensive income, partially offset by common stock repurchases | Metric | 9 Months Ended Sep 30, 2023 (Total Amount in thousands) | 9 Months Ended Sep 30, 2023 (Per Share Amount) | | :-------------------------------- | :-------------------------------------- | :--------------------------------------------- | | Common stock book value at beginning of period | $208,976 | $24.54 | | Net income allocable to common shares | $1,271 | $0.15 | | Change in other comprehensive income on derivatives | $1,192 | $0.14 | | Repurchase of common stock | $(2,684) | $0.56 | | Common stock book value at end of period | $211,213 | $25.07 | - Common stock repurchases were accretive to per share book value due to being purchased at significant discounts[348] Management Agreement Equity Equity, as defined in the Management Agreement for calculating base management fees, was $438.9 million at September 30, 2023, calculated based on capital stock issuances, retained earnings, and repurchases | Metric (in thousands) | Amount (Sep 30, 2023) | | :-------------------- | :-------------------- | | Proceeds from capital stock issuances, net | $1,330,472 | | Retained earnings, net | $(649,069) | | Payments for repurchases of capital stock | $(242,444) | | Total | $438,959 | - The monthly base management fee is 1/12 of 1.50% of the Company's equity, as defined in the Management Agreement[349] Earnings Available for Distribution Earnings Available for Distribution (EAD), a non-GAAP measure, increased significantly for both the three and nine months ended September 30, 2023, compared to the prior year, indicating improved performance and ability to pay dividends, with EAD for reporting purposes including incentive compensation payable to the Manager | Metric (in thousands) | 3 Months Ended Sep 30, 2023 | 3 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | | :-------------------- | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | GAAP net income (loss) allocable to common shares | $2,870 | $713 | $1,271 | $(1,368) | | Earnings Available for Distribution allocable to common shares | $6,292 | $3,467 | $15,950 | $5,164 | | EAD per common share - diluted | $0.73 | $0.40 | $1.85 | $0.58 | - EAD is a non-GAAP financial measure used to evaluate performance and dividend-paying ability, excluding non-cash items and non-core asset income/loss[350][352] - EAD in accordance with the Management Agreement (excluding incentive compensation) was $6.8 million ($0.79 per share) and $16.8 million ($1.95 per share) for the three and nine months ended September 30, 2023, respectively[353] Incentive Compensation Hurdle The incentive compensation hurdle calculation was revised starting December 31, 2022, now based on 20% of the excess of EAD over 7% per annum of book value equity, with the hurdle for the three months ended September 30, 2023, being $16.4 million - Commencing December 31, 2022, incentive compensation is calculated as 20% of the excess of EAD over 7% per annum of book value equity[356] | Metric (in thousands) | Amount (Sep 30, 2023) | | :-------------------- | :-------------------- | | Book value equity at September 30, 2023 | $234,052 | | Incentive Compensation Hurdle | $16,384 | Liquidity and Capital Resources The company's liquidity at September 30, 2023, included $64.4 million in unrestricted cash, $34.6 million in securitization reinvestment cash, and $5.0 million in unlevered financeable CRE loans, with key liquidity sources for the nine months ended September 30, 2023, including proceeds from loan purchases by securitizations, loan repayments, and property sales, offset by debt paydowns and investments - At September 30, 2023, liquidity consisted of $64.4 million in unrestricted cash, $34.6 million in reinvestment cash at CRE securitizations, and $5.0 million in unlevered financeable CRE loans[370] - Principal sources of liquidity for the nine months ended September 30, 2023, included $95.0 million from CRE whole loan purchases by ACR 2021-FL1, $32.2 million from loan repayments, and $14.3 million from real estate sales[359] | Securitization | Sep 30, 2023 Cash Distributions (in thousands) | Sep 30, 2023 Overcollateralization Cushion (in thousands) | Sep 30, 2023 Annualized Interest Coverage Cushion (in thousands) | | :------------- | :------------------------------------------- | :------------------------------------------------------- | :------------------------------------------------------- | | ACR 2021-FL1 | $19,283 | $12,488 | $22,221 | | ACR 2021-FL2 | $14,791 | $5,652 | $14,690 | Net Operating Losses and Loss Carryforwards The company has $46.6 million in cumulative net operating losses (NOLs) and $121.9 million in net capital losses to carry forward, with TRSs holding an additional $60.2 million in NOLs and $1.0 million in net capital losses, intended to shield future taxable income and grow book value | Tax Asset Item | Tax Year | Recognized REIT (QRS) Tax Loss Carryforwards (in millions) | TRS Tax Loss Carryforwards (in millions) | | :------------- | :------- | :----------------------------------------- | :--------------------------------------- | | Net Operating Loss Carryforwards | Cumulative as of 2022 | $46.6 | $60.2 | | Net Capital Loss Carryforwards | Cumulative as of 2022 | $121.9 | $1.0 | - NOLs can generally be carried forward indefinitely to offset both ordinary taxable income and capital gains, with a deduction limit of 80% of taxable income[374] Distributions The company did not pay common share distributions for the nine months ended September 30, 2023, prioritizing liquidity and book value growth through NOL utilization, and intends to resume common share distributions prudently and continue regular quarterly distributions to preferred stockholders - No common share distributions were paid during the nine months ended September 30, 2023, as the Company focused on retaining liquidity and growing book value using NOL carryforwards[376] - The Company intends to continue making regular quarterly distributions to preferred stockholders[377] - To qualify as a REIT, the Company must distribute at least 90% of its taxable income annually[377] Contractual Obligations and Commitments Total contractual commitments were $2.74 billion at September 30, 2023, with the largest portions in CRE securitizations ($1.21 billion) and lease liabilities ($855.1 million), and unfunded commitments on CRE loans totaling $118.8 million | Contractual Commitment (in thousands) | Total (Sep 30, 2023) | Less than 1 year | 1 - 3 years | 3 - 5 years | More than 5 years | | :------------------------------------ | :------------------- | :--------------- | :---------- | :---------- | :---------------- | | CRE securitizations | $1,210,132 | — | — | — | $1,210,132 | | Senior secured financing facility | $64,495 | — | — | $64,495 | — | | CRE - term warehouse financing facilities | $253,114 | — | $253,114 | — | — | | Mortgage payable | $18,854 | — | $18,854 | — | —