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EX-32.1 - EX-32.1 - NexPoint Real Estate Finance, Inc.nref-ex321_8.htm
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EX-10.3 - EX-10.3 - NexPoint Real Estate Finance, Inc.nref-ex103_130.htm
EX-10.1 - EX-10.1 - NexPoint Real Estate Finance, Inc.nref-ex101_131.htm

.

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2020

OR

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                      to                     

Commission File Number 001-39210

 

NexPoint Real Estate Finance, Inc.

(Exact Name of Registrant as Specified in Its Charter)

 

 

Maryland

 

84-2178264

(State or other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

 

300 Crescent Court, Suite 700, Dallas, Texas

(Address of Principal Executive Offices)

 

75201

(Zip Code)

 

(972) 628-4100

(Telephone Number, Including Area Code)

Securities registered pursuant to Section 12(b) of the Securities Exchange Act of 1934:

 

Title of each class

 

Trading Symbol

 

Name of each exchange on which registered

Common Stock, par value $0.01 per share

8.50% Series A Cumulative Redeemable Preferred Stock, par value 0.01 per share

 

NREF

NREF-PRA

 

New York Stock Exchange

New York Stock Exchange

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes      No  

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes      No  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large Accelerated Filer

 

Accelerated Filer

Non-Accelerated Filer

 

Smaller reporting company

Emerging growth company

 

 

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes      No  

As of October 30, 2020, the registrant had 5,113,403 shares of its common stock, par value $0.01 per share, outstanding.

 

 

 


 

NEXPOINT REAL ESTATE FINANCE, INC.

Form 10-Q

Quarter Ended September 30, 2020

INDEX

 

 

 

Page

Cautionary Statement Regarding Forward-Looking Statements

 

ii

 

 

 

 

 

 

PART I—FINANCIAL INFORMATION

 

 

 

 

Item 1.

 

Financial Statements

 

 

 

 

Consolidated Balance Sheets as of September 30, 2020 (Unaudited) and December 31, 2019

 

1

 

 

Consolidated Unaudited Statements of Operations for the Three and Nine Months Ended September 30, 2020

 

2

 

 

Consolidated Unaudited Statements of Stockholders’ Equity for the Three and Nine Months Ended September 30, 2020

 

3

 

 

Consolidated Unaudited Statements of Cash Flows for the Nine Months Ended September 30, 2020

 

4

 

 

Notes to Consolidated Unaudited Financial Statements

 

6

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

28

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

40

Item 4.

 

Controls and Procedures

 

41

 

 

 

 

 

 

PART II—OTHER INFORMATION

 

 

 

 

Item 1.

 

Legal Proceedings

 

42

Item 1A.

 

Risk Factors

 

42

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

43

Item 3.

 

Defaults Upon Senior Securities

 

43

Item 4.

 

Mine Safety Disclosures

 

43

Item 5.

 

Other Information

 

43

Item 6.

 

Exhibits

 

44

Signatures

 

 

 

45

 

i


 

Cautionary Statement Regarding Forward-Looking Statements

This quarterly report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that are subject to risks and uncertainties. In particular, statements relating to our liquidity and capital resources, our performance and results of operations contain forward-looking statements. Furthermore, all of the statements regarding future financial performance (including market conditions and demographics) are forward-looking statements. We caution investors that any forward-looking statements presented in this quarterly report are based on management’s current beliefs and assumptions made by, and information currently available to, management. When used, the words “anticipate,” “believe,” “expect,” “intend,” “may,” “might,” “plan,” “estimate,” “project,” “should,” “will,” “would,” “result,” the negative version of these words and similar expressions that do not relate solely to historical matters are intended to identify forward-looking statements. You can also identify forward-looking statements by discussions of strategy, plans or intentions.

Forward-looking statements are subject to risks, uncertainties and assumptions and may be affected by known and unknown risks, trends, uncertainties and factors that are beyond our control. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated or projected. We caution you therefore against relying on any of these forward-looking statements.

Some of the risks and uncertainties that may cause our actual results, performance, liquidity or achievements to differ materially from those expressed or implied by forward-looking statements include, among others, the following:

 

Our loans and investments expose us to risks similar to and associated with debt-oriented real estate investments generally;

 

Commercial real estate-related investments that are secured, directly or indirectly, by real property are subject to delinquency, foreclosure and loss, which could result in losses to us;

 

Risks associated with the current COVID-19 pandemic and the future outbreak of other highly infectious or contagious diseases;

 

Fluctuations in interest rate and credit spreads, could reduce our ability to generate income on our loans and other investments, which could lead to a significant decrease in our results of operations, cash flows and the market value of our investments;

 

Our loans and investments are concentrated in terms of geography, asset types and sponsors and may continue to be so in the future;

 

We have a substantial amount of indebtedness which may limit our financial and operating activities and may adversely affect our ability to incur additional debt to fund future needs;

 

We have limited operating history as a standalone company and may not be able to operate our business successfully, find suitable investments, or generate sufficient revenue to make or sustain distributions to our stockholders;

 

We may not replicate the historical results achieved by other entities managed or sponsored by affiliates of NexPoint Advisors, L.P. (our “Sponsor”), members of the NexPoint Real Estate Advisors VII L.P. (our “Manager”) management team or their affiliates.

 

We are dependent upon our Manager and its affiliates to conduct our day-to-day operations; thus, adverse changes in their financial health or our relationship with them could cause our operations to suffer;

 

Our Manager and its affiliates face conflicts of interest, including significant conflicts created by our Manager’s compensation arrangements with us, including compensation which may be required to be paid to our Manager if our management agreement is terminated, which could result in decisions that are not in the best interests of our stockholders;

 

We pay substantial fees and expenses to our Manager and its affiliates, which payments increase the risk that you will not earn a profit on your investment;

 

If we fail to qualify as a REIT for U.S. federal income tax purposes, cash available for distributions to be paid to our stockholders could decrease materially, which would limit our ability to make distributions to our stockholders; and

 

Any other risks included under the heading “Risk Factors,” in our Registration Statement on Form S-11, as amended (Registration No. 333-239862), filed with the Securities and Exchange Commission (“SEC”) on July 14, 2020 under the Securities Act of 1933 (the “Securities Act”) and under Part II, Item 1A, “Risk Factors” of this Quarterly Report on Form 10-Q.

While forward-looking statements reflect our good faith beliefs, they are not guarantees of future performance. They are based on estimates and assumptions only as of the date of this quarterly report. We undertake no obligation to update or revise any forward-looking statement to reflect changes in underlying assumptions or factors, new information, data or methods, future events or other changes, except as required by law.

 

ii


 

NEXPOINT REAL ESTATE FINANCE, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share amounts)

 

 

 

September 30, 2020

 

 

December 31, 2019

 

 

 

(Unaudited)

 

 

 

 

 

ASSETS

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

17,964

 

 

$

 

Loans, held-for-investment, net

 

 

36,527

 

 

 

 

Preferred stock

 

 

41,517

 

 

 

 

Mortgage loans, held-for-investment, net

 

 

927,632

 

 

 

 

Accrued interest and dividends

 

 

6,838

 

 

 

 

Mortgage loans held in variable interest entities, at fair value

 

 

5,094,579

 

 

 

 

CMBS structured pass through certificates, at fair value (Note 7)

 

 

39,845

 

 

 

 

Other assets

 

 

749

 

 

 

 

TOTAL ASSETS

 

$

6,165,651

 

 

$

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS' EQUITY

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

Secured financing agreements, net

 

$

786,939

 

 

$

 

Master repurchase agreements

 

 

160,212

 

 

 

 

 

Accounts payable and other accrued liabilities

 

 

2,336

 

 

 

 

Accrued interest payable

 

 

1,201

 

 

 

 

Bonds payable held in variable interest entities, at fair value

 

 

4,825,943

 

 

 

 

Total Liabilities

 

 

5,776,631

 

 

 

 

 

 

 

 

 

 

 

 

 

Redeemable noncontrolling interests in the Operating Partnership

 

 

265,155

 

 

 

 

 

 

 

 

 

 

 

 

 

Stockholders' Equity:

 

 

 

 

 

 

 

 

Preferred stock, $0.01 par value: 100,000,000 shares authorized; 1,645,000 and 0 shares issued and outstanding, respectively

 

 

16

 

 

 

 

Common stock, $0.01 par value: 500,000,000 shares authorized; 5,350,000 and 10 shares issued and 5,236,489 and 10 shares outstanding, respectively

 

 

53

 

 

 

 

Additional paid-in capital

 

 

137,787

 

 

 

 

Accumulated deficit

 

 

(3,709

)

 

 

 

Preferred stock held in treasury at cost; 355,000 shares

 

 

(8,567

)

 

 

 

Common stock held in treasury at cost; 113,511 shares

 

 

(1,715

)

 

 

 

Total Stockholders' Equity

 

 

123,865

 

 

 

 

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY

 

$

6,165,651

 

 

$

 

 

See Notes to Consolidated Financial Statements

 

1


 

NEXPOINT REAL ESTATE FINANCE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(Unaudited)

 

 

 

For the Three Months Ended September 30,

 

 

For the Nine Months Ended September 30,

 

 

 

2020

 

 

2020

 

Net interest income

 

 

 

 

 

 

 

 

Interest income

 

$

10,492

 

 

$

26,899

 

Interest expense

 

 

6,102

 

 

 

14,649

 

Total net interest income

 

$

4,390

 

 

 

12,250

 

Other income (loss)

 

 

 

 

 

 

 

 

Change in net assets related to consolidated CMBS variable interest entities

 

 

8,920

 

 

 

(1,207

)

Change in unrealized gain on CMBS structured pass through certificates

 

 

(200

)

 

 

101

 

Loan loss provision

 

 

14

 

 

 

(279

)

Dividend income, net

 

 

1,305

 

 

 

3,557

 

Total other income (loss)

 

$

10,039

 

 

 

2,172

 

Operating expenses

 

 

 

 

 

 

 

 

General and administrative expenses

 

 

1,167

 

 

 

2,361

 

Loan servicing fees

 

 

1,241

 

 

 

3,088

 

Management fees

 

 

480

 

 

 

1,027

 

Total operating expenses

 

$

2,888

 

 

 

6,476

 

Net income

 

 

11,541

 

 

 

7,946

 

Preferred stock dividends

 

 

874

 

 

 

874

 

Net income attributable to redeemable noncontrolling interests

 

 

7,805

 

 

 

5,293

 

Net income attributable to common stockholders

 

$

2,862

 

 

$

1,779

 

 

 

 

 

 

 

 

 

 

Weighted-average common shares outstanding - basic

 

 

5,261

 

 

 

5,253

 

Weighted-average common shares outstanding - diluted

 

 

5,550

 

 

 

5,379

 

 

 

 

 

 

 

 

 

 

Earnings per share - basic

 

$

0.54

 

 

$

0.34

 

Earnings per share - diluted

 

$

0.52

 

 

$

0.33

 

 

 

 

 

 

 

 

 

 

Dividends declared per common share

 

$

0.4000

 

 

$

1.0198

 

 

 

See Notes to Consolidated Financial Statements

 

 

2


 

NEXPOINT REAL ESTATE FINANCE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(dollars in thousands)

(Unaudited)

 

 

Preferred Stock

 

 

Common Stock

 

 

Additional

 

 

Accumulated

Earnings (Loss)

 

 

Common Stock

 

 

Preferred Stock

 

 

 

 

 

Three Months ended September 30, 2020

 

Number of

Shares

 

 

Par Value

 

 

Number of

Shares

 

 

Par Value

 

 

Paid-in

Capital

 

 

Less

Dividends

 

 

Held in Treasury

at Cost

 

 

Held in Treasury

at Cost

 

 

Total

 

Balances, June 30, 2020

 

 

 

 

$

 

 

 

5,262,534

 

 

$

53

 

 

$

91,933

 

 

$

(4,351

)

 

$

(1,338

)

 

$

 

 

$

86,297

 

Issuance of common stock through public offering, net

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(459

)

 

 

 

 

 

 

 

 

 

 

 

(459

)

Issuance of preferred stock through public offering, net

 

 

2,000,000

 

 

 

20

 

 

 

 

 

 

 

 

 

46,061

 

 

 

 

 

 

 

 

 

 

 

 

46,081

 

Vesting of stock-based compensation

 

 

 

 

 

 

 

 

 

 

 

 

 

 

252

 

 

 

 

 

 

 

 

 

 

 

 

252

 

Repurchase of common stock

 

 

 

 

 

 

 

 

(26,045

)

 

 

 

 

 

 

 

 

 

 

 

(377

)

 

 

 

 

 

(377

)

Repurchase of preferred stock

 

 

(355,000

)

 

 

(4

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(8,567

)

 

 

(8,571

)

Net income attributable to preferred stockholders

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

874

 

 

 

 

 

 

 

 

 

874

 

Net income attributable to common stockholders

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2,862

 

 

 

 

 

 

 

 

 

2,862

 

Preferred stock dividends declared ($0.5313 per share)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(874

)

 

 

 

 

 

 

 

 

(874

)

Common stock dividends declared ($0.4000 per share)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(2,220

)

 

 

 

 

 

 

 

 

(2,220

)

Balances, September 30, 2020

 

 

1,645,000

 

 

$

16

 

 

 

5,236,489

 

 

$

53

 

 

$

137,787

 

 

$

(3,709

)

 

$

(1,715

)

 

$

(8,567

)

 

$

123,865

 

 

 

 

 

Preferred Stock

 

 

Common Stock

 

 

Additional

 

 

Accumulated

Earnings (Loss)

 

 

Common Stock

 

 

Preferred Stock

 

 

 

 

 

Nine Months ended September 30, 2020

 

Number of

Shares

 

 

Par Value

 

 

Number of

Shares

 

 

Par Value

 

 

Paid-in

Capital

 

 

Less

Dividends

 

 

Held in Treasury

at Cost

 

 

Held in Treasury

at Cost

 

 

Total

 

Balances, December 31, 2019

 

 

 

 

$

 

 

 

 

 

$

 

 

$

 

 

$

 

 

$

 

 

$

 

 

$

 

Issuance of common stock through public offering, net

 

 

 

 

 

 

 

 

5,350,000

 

 

 

54

 

 

 

91,434

 

 

 

 

 

 

 

 

 

 

 

 

91,488

 

Issuance of preferred stock through public offering, net

 

 

2,000,000

 

 

 

20

 

 

 

 

 

 

 

 

 

46,061

 

 

 

 

 

 

 

 

 

 

 

 

46,081

 

Vesting of stock-based compensation

 

 

 

 

 

 

 

 

 

 

 

 

 

 

292

 

 

 

 

 

 

 

 

 

 

 

 

292

 

Repurchase of common stock

 

 

 

 

 

 

 

 

(113,511

)

 

 

(1

)

 

 

 

 

 

 

 

 

(1,715

)

 

 

 

 

 

(1,716

)

Repurchase of preferred stock

 

 

(355,000

)

 

 

(4

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(8,567

)

 

 

(8,571

)

Net income attributable to preferred stockholders

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

874

 

 

 

 

 

 

 

 

 

874

 

Net income attributable to common stockholders

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1,779

 

 

 

 

 

 

 

 

 

1,779

 

Preferred stock dividends declared ($0.5313 per share)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(874

)

 

 

 

 

 

 

 

 

(874

)

Common stock dividends declared ($1.0198 per share)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(5,488

)

 

 

 

 

 

 

 

 

(5,488

)

Balances, September 30, 2020

 

 

1,645,000

 

 

$

16

 

 

 

5,236,489

 

 

$

53

 

 

$

137,787

 

 

$

(3,709

)

 

$

(1,715

)

 

$

(8,567

)

 

$

123,865

 

 

 

See Notes to Consolidated Financial Statements

 

 

 

 

 

 

 

3


 

NEXPOINT REAL ESTATE FINANCE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CASH FLOWS

(in thousands)

(Unaudited)

 

 

 

For the Nine Months Ended September 30,

 

 

 

2020

 

Cash flows from operating activities

 

 

 

 

Net income

 

$

7,946

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

Amortization of premiums

 

 

5,620

 

Accretion of discounts

 

 

(1,549

)

Loan loss provision, net

 

 

279

 

Change in unrealized loss on investments held at fair value

 

 

11,130

 

Vesting of stock-based compensation

 

 

292

 

Changes in operating assets and liabilities:

 

 

 

 

Accrued interest and dividends receivable

 

 

(4,477

)

Other assets

 

 

(749

)

Accrued interest payable

 

 

1,201

 

Accounts payable, accrued expenses and other liabilities

 

 

1,341

 

Net cash provided by operating activities

 

 

21,034

 

 

 

 

 

 

Cash flows from investing activities

 

 

 

 

Proceeds from payments received on mortgage loans held in variable interest entities

 

 

82,671

 

Proceeds from payments received on mortgage loans held for investment

 

 

5,237

 

Purchases of loans, held-for-investment, net

 

 

(7,500

)

Purchases of CMBS structured pass through certificates, at fair value

 

 

(40,200

)

Purchases of CMBS securitizations held in variable interest entities, at fair value

 

 

(150,320

)

Net cash used in investing activities

 

 

(110,112

)

 

 

 

 

 

Cash flows from financing activities

 

 

 

 

Principal repayments on borrowings under secured financing agreements

 

 

(1,825

)

Distributions to bondholders of variable interest entities

 

 

(76,495

)

Borrowings under master repurchase agreements

 

 

160,379

 

Principal repayments on borrowings under master repurchase agreements

 

 

(167

)

Borrowings under bridge facility

 

 

86,000

 

Bridge facility payments

 

 

(181,000

)

Proceeds from the issuance of common stock through public offering, net of offering costs

 

 

91,488

 

Proceeds from the issuance of preferred stock through public offering, net of offering costs

 

 

46,081

 

Repurchase of preferred stock

 

 

(8,571

)

Repurchase of common stock

 

 

(1,716

)

Dividends paid to common stockholders

 

 

(5,367

)

Distributions to redeemable noncontrolling interests in the Operating Partnership

 

 

(13,548

)

Contributions from noncontrolling interests

 

 

11,783

 

Net cash provided by financing activities

 

 

107,042

 

 

 

 

 

 

Net increase in cash, cash equivalents and restricted cash

 

 

17,964

 

Cash, cash equivalents and restricted cash, beginning of period

 

 

 

Cash, cash equivalents and restricted cash, end of period

 

$

17,964

 

 

See Notes to Consolidated Financial Statements

4


 

NEXPOINT REAL ESTATE FINANCE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

 

Supplemental Disclosure of Cash Flow Information

 

 

 

 

Interest paid

 

$

16,499

 

Supplemental Disclosure of Noncash Activities (Note 2)

 

 

 

 

Contributions from noncontrolling interests, including consolidation of the associated mortgage loans held in variable interest entities

 

 

2,797,735

 

Other assets acquired from contributions from noncontrolling interests

 

 

3,616

 

Assumed debt on contributions from noncontrolling interests, including consolidation of the associated bonds payable held in variable interest entities

 

 

(2,539,724

)

Consolidation of mortgage loans and bonds payable held in variable interest entities

 

 

3,179,620

 

Increase in dividends payable upon vesting of restricted stock units

 

 

121

 

Stock dividends received

 

 

1,254

 

Increase in dividends payable to preferred stockholders

 

 

874

 

 

See Notes to Consolidated Financial Statements

 

 

5


 

NEXPOINT REAL ESTATE FINANCE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

1. Organization and Description of Business

NexPoint Real Estate Finance, Inc. (the “Company”, “we”, “our”) is a commercial mortgage real estate investment trust (“REIT”) incorporated in Maryland on June 7, 2019. We intend to elect to be treated as a REIT under the Internal Revenue Code of 1986, as amended (the “Code”), commencing with our taxable year ending December 31, 2020. The Company is focused on originating, structuring and investing in first-lien mortgage loans, mezzanine loans, preferred equity and preferred stock, as well as multifamily commercial mortgage-backed securities (“CMBS securitizations”). Substantially all of the Company’s business is conducted through NexPoint Real Estate Finance Operating Partnership, L.P. (the “OP”), the Company’s operating partnership. As of September 30, 2020, the Company holds approximately 50.28% of the common units of limited partnership interests in the OP (“OP Units”), and the OP owns approximately 27.78% of two of its subsidiary partnerships and 100% of one of its subsidiary partnerships (Note 11). NexPoint Real Estate Finance Operating Partnership GP, LLC (the “OP GP”) is the sole general partner of the OP.

The Company commenced operations on February 11, 2020 upon the closing of its initial public offering of shares of its common stock (the “IPO”). Prior to the closing of the IPO, the Company engaged in a series of transactions through which it acquired an initial portfolio consisting of senior pooled mortgage loans backed by single family rental (“SFR”) properties (the “SFR Loans”), the junior most bonds of multifamily CMBS securitizations (the “CMBS B-Pieces”), mezzanine loan and preferred equity investments in real estate companies and properties in other structured real estate investments within the multifamily, SFR and self-storage asset classes (the “Initial Portfolio”). The Initial Portfolio was acquired from affiliates (the “Contribution Group”) of NexPoint Advisors, L.P (our “Sponsor”), pursuant to a contribution agreement with the Contribution Group through which the Contribution Group contributed their interest in the Initial Portfolio to special purpose entities (“SPEs”) owned by subsidiary partnerships of the Company, in exchange for limited partnership interests in subsidiary partnerships of the OP (the “Formation Transaction”).

The Company is externally managed by NexPoint Real Estate Advisors VII, L.P. (the “Manager”), through a management agreement dated February 6, 2020 and amended as of July 17, 2020, for a three-year term set to expire on February 6, 2023 (as amended, the “Management Agreement”), by and among the Company and the Manager. The Manager conducts substantially all of the Company’s operations and provides asset management services for its real estate investments. The Company expects it will only have accounting employees while the Management Agreement is in effect. All of the Company’s investment decisions are made by the Manager, subject to general oversight by the Manager’s investment committee and the Company’s board of directors (the “Board”). The Manager is wholly owned by our Sponsor.

The Company’s primary investment objective is to generate attractive, risk-adjusted returns for stockholders over the long term. We intend to achieve this objective primarily by originating, structuring and investing in first-lien mortgage loans, mezzanine loans, preferred equity and preferred stock, as well as multifamily CMBS securitizations. We concentrate on investments in real estate sectors where our senior management team has operating expertise, including in the multifamily, SFR, self-storage, hospitality and office sectors predominantly in the top 50 metropolitan statistical areas. In addition, we target lending or investing in properties that are stabilized or have a “light transitional” business plan, meaning a property that requires limited deferred funding to support leasing or ramp-up of operations and for which most capital expenditures are for value-add improvements. Through active portfolio management we seek to take advantage of market opportunities to achieve a superior portfolio risk-mix that delivers attractive total returns.

2. Summary of Significant Accounting Policies

Basis of Accounting

The accompanying unaudited consolidated financial statements are presented in accordance with accounting principles generally accepted in the United States (“GAAP”). GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent liabilities at the dates of the unaudited consolidated financial statements and the amounts of revenues and expenses during the reporting periods. Actual amounts realized or paid could differ from those estimates. All significant intercompany accounts and transactions have been eliminated in consolidation. There have been no significant changes to the Company’s significant accounting policies during the nine months ended September 30, 2020.

The accompanying unaudited consolidated financial statements have been prepared according to the rules and regulations of the SEC.  Certain information and note disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted according to such rules and regulations, although management believes that the disclosures are adequate to make the information presented not misleading.

In the opinion of management, all adjustments and eliminations necessary for the fair presentation of the Company’s financial position as of September 30, 2020 and results of operations for the three and nine months ended September 30, 2020 have been included.  Such adjustments are normal and recurring in nature.  The unaudited information included in this quarterly report on Form 10-Q should be read in conjunction with the Company’s audited financial statements included in the Company’s Registration Statement on Form S-11, as amended (Registration No. 333-235698), filed with the SEC on February 4, 2020.

6


 

Secured Financing and Master Repurchase Agreements

The Company’s borrowings under secured financing agreements and master repurchase agreements are treated as collateralized financing arrangements carried at their contractual amounts, net of unamortized debt issuance costs, if any.

Use of Estimates and Assumptions

The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting periods. It is at least reasonably possible that these estimates could change in the near term.  Estimates are inherently subjective in nature and actual results could differ from our estimates and the differences could be material.

Since being reported in December 2019, COVID-19 has spread globally, including to every state in the United States. On March 11, 2020, the World Health Organization declared COVID-19 a pandemic, and on March 13, 2020, the United States declared a national emergency with respect to COVID-19.

The COVID-19 pandemic has had, and another pandemic in the future could have, repercussions across regional and global economies and financial markets. The outbreak of COVID-19 in many countries has significantly adversely impacted global economic activity and has contributed to significant volatility and negative pressure in financial markets. The global impact of the outbreak has evolved rapidly and, as cases of COVID-19 were identified in additional countries, many countries, including the United States, reacted by instituting quarantines, mandating business and school closures and restricting travel.

As a result of the recent spike in COVID-19 cases in the United States, certain states and cities have reinstituted restrictive quarantines, restrictions on travel, “shelter in place” rules, restrictions on the types of business that may continue to operate, and/or restrictions on the types of construction projects that may continue. Management expects that additional states and cities will implement similar restrictions if the current trend continues and cannot predict when such restrictions will expire. As a result, the COVID-19 pandemic has negatively impacted, and will likely continue to negatively impact, almost every industry directly or indirectly and may adversely impact our performance or the value of underlying real estate collateral relating to the Company’s investments, increase the default risk applicable to borrowers and make it relatively more difficult for the Company to generate attractive risk-adjusted returns. The extent to which COVID-19 impacts the Company will depend on future developments, which are highly uncertain and cannot be predicted, including additional actions taken to contain COVID-19 or treat its impact, among others. The COVID-19 outbreak, and future pandemics, could materially and adversely impact or disrupt our financial condition, results of operations, cash flows and performance.  COVID-19 may also negatively and materially impact estimates and assumptions used by the Company including, but not limited to, fair value estimates and estimates of an allowance for loan losses.

We are closely monitoring the impact of the COVID-19 pandemic on all aspects of our business. As of September 30, 2020, there have been two forbearance requests approved in our CMBS B-Piece portfolio, representing 0.8% of our consolidated unpaid principal balance outstanding. Additionally, there were nine forbearance requests approved in our SFR loan book. However, as of September 30, 2020, these loans were no longer in forbearance. Despite these forbearance requests, the master servicers continued to make payments to us for the portion of our CMBS B-Piece and SFR Loans that requested forbearance, and were approved by Freddie Mac, during the entire forbearance period. These agreed upon forbearance requests include both principal and interest payments for three months, with an option to the borrower to extend an additional three months, and require the borrower to repay Freddie Mac within twelve months of the end of the forbearance period.

Principles of Consolidation

The Company accounts for subsidiary partnerships in which it holds an ownership interest in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 810, Consolidation. The Company first evaluates whether each entity is a variable interest entity (“VIE”). Under the VIE model, the Company consolidates an entity when it has power to direct the activities of the VIE and the obligation to absorb losses or the right to receive benefits that could potentially be significant to the VIE. Under the voting model, the Company consolidates an entity when it controls the entity through ownership of a majority voting interest. The unaudited consolidated financial statements include the accounts of the Company and its subsidiaries, including the OP and its subsidiaries.  The Company’s sole significant asset is its investment in the OP, and consequently, substantially all of the Company’s assets and liabilities represent those assets and liabilities of the OP.  In addition, all of the Company’s debt is an obligation of the OP’s subsidiary partnerships.

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Variable Interest Entities

The Company evaluates all of its interests in VIEs for consolidation. When the Company’s interests are determined to be variable interests, the Company assesses whether it is deemed to be the primary beneficiary of the VIE. The primary beneficiary of a VIE is required to consolidate the VIE. FASB ASC Topic 810, Consolidation, defines the primary beneficiary as the party that has both (i) the power to direct the activities of the VIE that most significantly impact its economic performance, and (ii) the obligation to absorb losses and the right to receive benefits from the VIE which could be potentially significant. The Company considers its variable interests, as well as any variable interests of its related parties in making this determination. Where both of these factors are present, the Company is deemed to be the primary beneficiary, and it consolidates the VIE. Where either one of these factors is not present, the Company is not the primary beneficiary, and it does not consolidate the VIE.

CMBS Trusts

The Company consolidates the trusts that issue beneficial ownership interests in mortgage loans secured by commercial real estate (commonly known as CMBS) when the Company holds a variable interest in, and management considers the Company to be the primary beneficiary of those trusts. Management believes the performance of the assets that underlie CMBS issuances most significantly impact the economic performance of the trust, and the primary beneficiary is generally the entity that conducts activities that most significantly impact the performance of the underlying assets. In particular, the most subordinate tranches of CMBS expose the holder to greater variability of economic performance when compared to more senior tranches since the subordinate tranches absorb a disproportionately higher amount of the credit risk related to the underlying assets. Generally, a trust designates the most junior subordinate tranche outstanding as the controlling class, which entitles the holder of the controlling class to unilaterally appoint, remove and replace the special servicer for the trust. For the CMBS that the Company consolidates, the Company owns 100% of the most subordinate tranche of the securities issued by the trusts, which include the controlling class, and has the ability to remove and replace the special servicer.

On the Consolidated Balance Sheets as of September 30, 2020, we consolidated the five Freddie Mac K-Series securitization entities (the “CMBS Entities”) that we determined were VIEs and for which we determined we were the primary beneficiary. The CMBS Entities are independent of the Company, and the assets and liabilities of the CMBS Entities are not owned by and are not legal obligations of ours. Our exposure to the CMBS Entities is through the subordinated tranches. For financial reporting purposes, the underlying mortgage loans held by the trusts are recorded as a separate line item on the balance sheet under “Mortgage loans held in variable interest entities, at fair value.” The liabilities of the trusts consist solely of obligations to the CMBS holders of the consolidated trusts, excluding the CMBS B-Piece investments held by the Company. The liabilities are presented as “Bonds payable held in variable interest entities, at fair value” on the Consolidated Balance Sheets. The CMBS B-Pieces held by the Company and the interest earned thereon are eliminated in consolidation. Management has elected the measurement alternative in ASC 810 to report the fair value of the assets and liabilities of the consolidated CMBS Entities in order to provide users of the financial statements with better information regarding the effects of credit risk and other market factors on the CMBS B-Pieces owned by the Company. Management has elected to show interest income and interest expense related to the CMBS Entities in aggregate with the change in fair value as “Change in net assets related to consolidated CMBS variable interest entities.” The residual difference between the fair value of the CMBS Entities’ assets and liabilities represents the Company’s investments in the CMBS B-Pieces.

Investment in subsidiaries

The Company conducts its operations through the OP, which acts as the general partner of the subsidiary partnerships that own the investments through limited liability companies that are SPEs. The Company is the majority limited partner of the OP, holds approximately 50.28% of the OP Units in the OP and has the ability to remove the general partner of the OP with or without cause, and as such, consolidates the OP. The Company consolidates the SPEs in which it has a controlling financial interest as well as any VIEs where it is the primary beneficiary. All of the investments the SPEs own are consolidated in the unaudited consolidated financial statements. Generally, the assets of each entity can only be used to settle obligations of that particular entity, and the creditors of each entity have no recourse to the assets of other entities or the Company notwithstanding equity pledges various lenders may have in certain entities.

Redeemable Noncontrolling Interests

Noncontrolling interests represent the ownership interests in consolidated subsidiaries held by entities other than the Company. Those noncontrolling interests that the holder is allowed to redeem before liquidation or termination of the entity that issued those interests are considered redeemable noncontrolling interests.

The subsidiary partnerships of the OP have redeemable noncontrolling interests classified on the Consolidated Balance Sheets as temporary equity in accordance with ASC 480. This is presented as “Redeemable noncontrolling interests in the Operating Partnership” on the Consolidated Balance Sheets and their share of “Net Income (Loss)” as “Net Income (Loss) attributable to redeemable noncontrolling interests” in the accompanying Consolidated Statements of Operations.

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The redeemable noncontrolling interests were initially measured at the fair value of the contributed assets in accordance with ASC 805-50. The redeemable noncontrolling interests will be adjusted to their redemption value if such value exceeds the carrying value of the redeemable noncontrolling interests. Capital contributions, distributions and profits and losses are allocated to the redeemable noncontrolling interests in accordance with the terms of the partnership agreements of the subsidiary partnerships.

Acquisition Accounting

The Company accounts for the acquisitions of the SFR Loans and CMBS B-Pieces, as asset acquisitions pursuant to ASC 805-50 rather than as business combinations. Substantially all of the fair value of the assets acquired are concentrated in a group of similar identifiable assets, i.e. the SFR Loans represent one acquisition of similar identifiable assets, and the acquisition of the CMBS B-Pieces represents an additional acquisition of similar identifiable assets. Additionally, there were no corresponding in-place workforce, servicing platforms or any other item that could be considered an input or process associated with these assets. As such, the SFR Loans and the CMBS B-Pieces do not constitute businesses as defined by ASC 805-10-55.  As the investments in the Initial Portfolio were contributed to the OP’s subsidiary partnerships in a non-cash transaction, cost is based on the fair value of the assets acquired.

Formation Transaction  

The Company commenced operations on February 11, 2020 upon the closing of its IPO. Prior to the closing of the IPO, the Company engaged in the Formation Transaction through which it acquired the Initial Portfolio consisting of SFR Loans, CMBS B-Pieces, mezzanine loan and preferred equity investments in real estate companies and properties in other structured real estate investments within the multifamily, SFR and self-storage asset classes.  The Initial Portfolio was acquired from the Contribution Group pursuant to a contribution agreement through which the Contribution Group contributed their interest in the Initial Portfolio to SPEs owned by subsidiary partnerships of the Company, in exchange for limited partnership interests (“Sub OP Units”) in subsidiary partnerships of the OP (“Sub OPs”).  The assets and liabilities constituting the Initial Portfolio were contributed at fair value using a cutoff date of January 31, 2020.  The mezzanine loan, preferred stock and preferred equity investments were valued using a discounted cash flow model using discount rates negotiated with the Contribution Group.  A third-party valuation firm was utilized to value the SFR Loans using the income approach in accordance with ASC Topic 820.  The income approach utilizes a discounted cash flow method to present value the expected future cash flows.  The future cash flows were projected based on the terms of the loans including interest rates, current balances and servicing fees.  The future cash flows depend substantially on various other assumptions such as prepayment rates, prepayment charges, default rates, expected loss given default (severity), and other inputs.  The Credit Facility (defined below) contributed along with the SFR Loans was also valued using the income approach as previously described.  The equity and financial liabilities of the consolidated CMBS B-Pieces were valued using broker quotes (see Note 2 for more information on our valuation methodologies).  The Bridge Facility (defined below) was originated shortly before the closing of the IPO and was contributed at its carrying value, which approximated fair value.  The fair values of the contributed cash and accrued interest and dividends approximated their carrying values because of the short-term nature of these instruments.  The fair values of the contributed assets described above were agreed upon by the Contribution Group and used to determine the number of Sub OP Units issued.  Any purchase premiums or discounts are amortized over the expected life of the investment.  

The following table shows the par values, fair values and purchase premiums (discounts) of the Initial Portfolio as of February 11, 2020, the closing date of the IPO:

 

 

 

Par value

 

 

Fair Value

 

 

Premium (Discount)

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

Cash

 

$

302

 

 

$

302

 

 

$

 

Loans, held-for-investment, net

 

 

22,127

 

 

 

22,282

 

 

 

155

 

Preferred stock

 

 

40,000

 

 

 

40,400

 

 

 

400

 

Mortgage loans, held-for-investment, net

 

 

863,564

 

 

 

934,918

 

 

 

71,354

 

Accrued interest and dividends

 

 

3,616

 

 

 

3,616

 

 

 

 

Mortgage loans held in variable interest entities, at fair value

 

 

1,790,228

 

 

 

1,790,135

 

 

 

(93

)

 

 

$

2,719,837

 

 

$

2,791,653

 

 

$

71,816

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

Credit facility

 

$

788,764

 

 

$

788,764

 

 

$

 

Bridge facility

 

 

95,000

 

 

 

95,000

 

 

 

 

Bonds payable held in variable interest entities, at fair value

 

 

1,655,960

 

 

 

1,655,960

 

 

 

 

 

 

$

2,539,724

 

 

$

2,539,724

 

 

$

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total contributions

 

$

180,113

 

 

$

251,929

 

 

$

71,816

 

 

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Cash and Cash Equivalents

The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. Cash and cash equivalents are stated at cost, which approximates fair value.

Mortgage and other loans held-for-investment

Loans that are held-for-investment are carried at their aggregate outstanding face amount, net of applicable (i) unamortized origination or acquisition premium and discounts, (ii) unamortized deferred fees and other direct loan origination costs, (iii) valuation allowance for loan losses and (iv) write-downs of impaired loans. The effective interest method is used to amortize origination or acquisition premiums and discounts and deferred fees or other direct loan origination costs. In circumstances where, in management’s opinion, the difference between the straight-line and effective interest methods is immaterial, the straight-line method is used.  As prepayments of principal are received, any premiums paid are amortized against interest income.  In general, an increase in prepayment rates accelerates the amortization of purchase premiums, thereby reducing the interest income earned on the assets.  Conversely, discounts on such assets are accreted into interest income.  In general, an increase in prepayment rates accelerates the accretion of purchase discounts, thereby increasing the interest income earned on the assets.

Income Recognition

Interest Income - Loans held-for-investment, available-for-sale securities, CMBS structured pass through certificates, mortgage loans from the consolidated CMBS Entities and debt securities held-to-maturity where the Company expects to collect the contractual interest and principal payments are considered to be performing loans. The Company recognizes income on performing loans in accordance with the terms of the loan on an accrual basis. Interest income also includes amortization of loan premiums or discounts and loan origination costs.

Dividend Income - Dividend income is recorded when declared.

Realized Gain (Loss) on Sale of Investments - The Company recognizes the excess, or deficiency, of net proceeds received, less the carrying value of such investments, as realized gains or losses, respectively. The Company reverses cumulative, unrealized gains or losses previously reported in its Consolidated Statements of Operations with respect to the investment sold at the time of the sale.

Expense Recognition

Interest expense, in accordance with the Company’s financing agreements, is recorded on the accrual basis. General and administrative expenses are expensed as incurred.

Allowance for Loan Losses

 

The Company, with the assistance of an independent valuations firm, performs a quarterly evaluation of loans classified as held for investment for impairment on a loan by loan basis in accordance with ASC 310-10-35, Receivables, Subsequent Measurement (“ASC 310-10-35”). If we deem that it is probable that we will be unable to collect all amounts owed according to the contractual terms of a loan, impairment of that loan is indicated. If we consider a loan to be impaired, we will establish an allowance for loan losses, through a valuation provision in earnings that reduces carrying value of the loan to the present value of expected future cash flows discounted at the loan’s contractual effective rate or the fair value of the collateral, if repayment is expected solely from the collateral. For non-impaired loans with no specific allowance the Company determines an allowance for loan losses in accordance with ASC 450-20, Loss Contingencies (“ASC 450-20”), which represents management’s best estimate of incurred losses inherent in the portfolio at the balance sheet date, excluding impaired loans and loans carried at fair value. Management considers quantitative factors likely to cause estimated credit losses including default rate and loss severity rates. The Company also evaluates qualitative factors such as macroeconomic conditions, evaluations of underlying collateral, trends in delinquencies and non-performing assets.  Increases to (or reversals of) the allowance for loan loss are included in “Loan loss provision, net” on the accompanying Consolidated Statements of Operations.

Significant judgment is required in determining impairment and in estimating the resulting loss allowance, and actual losses, if any, could materially differ from those estimates.

We perform a quarterly review of our portfolio. In conjunction with this review, we assess the risk factors of each loan, including, without limitation, loan-to-value ratio, debt yield, property type, geographic and local market dynamics, physical condition, collateral, cash-flow volatility, leasing and tenant profile, loan structure, exit plan and project sponsorship. Based on a 5-point scale, our loans are rated “1” through “5,” from least risk to greatest risk, respectively, which ratings are defined as follows:

1 – Outperform – Materially exceeds performance metrics (for example, technical milestones, occupancy, rents, net operating income) included in original or current credit underwriting and business plan;

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2 – Exceeds Expectations – Collateral performance exceeds substantially all performance metrics included in original or current credit underwriting and business plan;

3 – Satisfactory – Collateral performance meets, or is on track to meet, underwriting; business plan is met or can reasonably be achieved;

4 – Underperformance – Collateral performance falls short of underwriting, material differences exist from business plan, or both; technical milestones have been missed; defaults may exist, or may soon occur absent material improvement; and

5 – Risk of Impairment/Default – Collateral performance is significantly worse than underwriting; major variance from business plan; loan covenants or technical milestones have been breached; timely exit from loan via sale or refinancing is questionable.

We regularly evaluate the extent and impact of any credit deterioration associated with the performance and/or value of the underlying collateral, as well as the financial and operating capability of the borrower. Specifically, the collateral’s operating results and any cash reserves are analyzed and used to assess (i) whether cash from operations is sufficient to cover the debt service requirements currently and into the future, (ii) the ability of the borrower to refinance the loan and/or (iii) the collateral’s liquidation value. We also evaluate the financial condition of any loan guarantors, as well as any changes in the borrower’s competency in managing and operating the collateral. In addition, we consider the overall economic environment, real estate or industry sector and geographic sub-market in which the borrower operates. Such impairment analyses are completed and reviewed by asset management and finance personnel who utilize various data sources, including (i) periodic financial data such as property operating statements, occupancy, tenant profile, rental rates, operating expenses, the borrower’s exit plan, and capitalization and discount rates, (ii) site inspections and (iii) current credit spreads and discussions with market participants.

We consider loans to be past-due when a monthly payment is due and unpaid for 60 days or more. Loans will be placed on nonaccrual status and considered non-performing when full payment of principal and interest is in doubt, which generally occurs when they become 120 days or more past-due unless the loan is both well secured and in the process of collection. Accrual of interest on individual loans is discontinued when management believes that, after considering economic and business conditions and collection efforts, the borrower’s financial condition is such that collection of interest is doubtful. Our policy is to stop accruing interest when a loan’s delinquency exceeds 120 days. All interest accrued but not collected for loans that are placed on nonaccrual status or subsequently charged-off are reversed against interest income. Income is subsequently recognized on the cash basis until, in management’s judgment, the borrower’s ability to make periodic principal and interest payments returns and future payments are reasonably assured, in which case the loan is returned to accrual status.

For individual loans, a troubled debt restructuring is a formal restructuring of a loan where, for economic or legal reasons related to the borrower’s financial difficulties, a concession that would not otherwise be considered is granted to the borrower. The concession may be granted in various forms, including providing a below-market interest rate, a reduction in the loan balance or accrued interest, an extension of the maturity date, or a combination of these. An individual loan that has had a troubled debt restructuring is considered to be impaired and is subject to the relevant accounting for impaired loans.

A loan is written off when it is no longer realizable and/or it is legally discharged.

We will evaluate acquired loans and debt securities for which it is probable at acquisition that all contractually required payments will not be collected in accordance with ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality.

Other-Than-Temporary Impairment

The Company accounts for its investment in Preferred Stock as a debt security held to maturity.  Debt securities held to maturity are evaluated on a quarterly basis, and more frequently when triggering events or market conditions warrant such an evaluation, to determine whether declines in their value are other-than-temporary impairments (“OTTI”). To determine whether a loss in value is other-than-temporary, the Company utilizes criteria including: the reasons underlying the decline, the magnitude and duration of the decline (greater or less than twelve months) and whether or not we intend to sell or expect that it is more likely than not that we will be required to sell the investment prior to an anticipated recovery of the carrying value. The term “other-than-temporary” is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the investment.

In the event that the fair value of debt securities held to maturity is less than amortized cost, we consider whether the unrealized holding loss represents an OTTI. If we do not expect to recover the carrying value of the debt security held-to-maturity based on future expected cash flows, an OTTI exists, and we reduce the carrying value by the impairment amount, recognize the portion of the impairment related to credit factors in earnings and the portion of the impairment related to other factors in accumulated other comprehensive income. For the three and nine months ended September 30, 2020, the Company did not recognize an OTTI related to its investment in debt securities held to maturity.

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Fair Value

GAAP requires the categorization of the fair value of financial instruments into three broad levels that form a hierarchy based on the transparency of inputs to the valuation.

Level 1 – Inputs are adjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.

Level 2 – Inputs are other than quoted prices that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar instruments in active markets, and inputs other than quoted prices that are observable for the asset or liability (other than quoted prices), such as interest rates and yield curves that are observable at commonly quoted intervals.

Level 3 – Inputs are unobservable for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability.

The Company follows this hierarchy for our financial instruments. Classifications will be based on the lowest level of input that is significant to the fair value measurement. We review the valuation of Level 3 financial instruments as part of our quarterly process.

Valuation of Consolidated VIEs

We report the financial assets and liabilities of each CMBS trust that we consolidate at fair value using the measurement alternative included in Accounting Standards Update (“ASU”) No. 2014-13, Measuring the Financial Assets and the Financial Liabilities of a Consolidated Collateralized Financing Entity (“ASU 2014-13”). Pursuant to ASU 2014-13, we measure both the financial assets and financial liabilities of the CMBS trusts we consolidate using the fair value of the financial liabilities (which we consider more observable than the fair value of the financial assets) and the equity of the CMBS trusts beneficially owned by us. As a result, we presented the CMBS issued by the consolidated trusts, but not beneficially owned by us, as financial liabilities in our consolidated financial statements, measured at their estimated fair value; we measured the financial assets as the total estimated fair value of the CMBS issued by the consolidated trust, regardless of whether such CMBS represent interests beneficially owned by us. Under the measurement alternative prescribed by ASU 2014-13, our “Net income (loss)” reflects the economic interests in the consolidated CMBS beneficially owned by us, presented as “Change in net assets related to consolidated CMBS variable interest entities” in our Consolidated Statements of Operations, which includes applicable (1) changes in the fair value of CMBS beneficially owned by us, (2) interest income, interest expense and servicing fees earned from the CMBS trusts and (3) other residual returns or losses of the CMBS trusts, if any.

Valuation Methodologies

CMBS Trusts - The financial liabilities and equity of the consolidated CMBS trusts were valued using broker quotes. Broker quotes represent the price that an investment could be sold for in a market transaction and represent fair market value. Loans and bonds with quotes that are based on actual trades with a sufficient level of activity on or near the valuation date are classified as Level 2 assets. Loans and bonds that are priced using quotes derived from implied values, bid/ask prices for trades that were never consummated, or a limited amount of actual trades are classified as Level 3 assets because the inputs used by the brokers and pricing services to derive the values are not readily observable.

CMBS Structured Pass Through Certificates - We categorize our CMBS Structured Pass Through Certificates (“CMBS I/O Strips”) as Level 2 assets in the fair value hierarchy. CMBS I/O Strips are valued by an independent third-party investment research firm that provides daily fair market value price updates to our investments.

SFR Loans, Preferred Equity Investments, Preferred Stock and Mezzanine Loans - We categorize our SFR Loans, preferred equity, preferred stock and mezzanine loan investments as Level 3 assets in the fair value hierarchy. SFR Loans, preferred equity, preferred stock and mezzanine loan investments are valued using a discounted cash flow model using discount rates derived from observable market data applied to the internal rate of return implied by the expected contractual cash flows.  The valuation is done for disclosure purposes only as these investments are not carried at fair value on the consolidated balance sheet.

Repurchase Agreements - We generally consider our repurchase agreements Level 3 liabilities in the fair value hierarchy as such liabilities represent borrowings on collateral with terms specific to each borrower. Given the short to moderate term of the floating-rate facilities, we generally expect the fair value of repurchase agreements to approximate their outstanding principal balances.

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis - Certain assets not measured at fair value on an ongoing basis but that are subject to fair-value adjustments only in certain circumstances, such as when there is evidence of impairment, will be measured at fair value on a nonrecurring basis. For first mortgage loans, mezzanine loans, preferred equity and preferred stock investments, we apply the amortized cost method of accounting, but may be required, from time to time, to record a nonrecurring fair value adjustment in the form of a provision for loan loss or OTTI as discussed above.

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Overall, our determination of fair value is based upon the best information available for a given circumstance and may incorporate assumptions that are our best estimates after consideration of a variety of internal and external factors. When an independent valuation firm expresses an opinion on the fair value of a financial instrument in the form of a range, we select a value within the range provided by the independent valuation firm, generally the midpoint, to assess the reasonableness of our estimated fair value for that financial instrument.

Income Taxes

The Company believes that it will operate in a manner that will allow it to qualify for taxation as a REIT under the Code, commencing with its taxable year ending December 31, 2020. As a result of the Company’s expected REIT qualification, the Company does not expect to pay U.S. federal corporate level taxes. To qualify as a REIT, the Company must meet a number of organizational and operational requirements, including a requirement to distribute annually at least 90% of its “REIT taxable income,” as defined by the Code, to its stockholders. If the Company fails to meet these requirements, it could be subject to federal income tax on all of the Company’s taxable income at regular corporate rates for that year. The Company would not be able to deduct distributions paid to stockholders in any year in which it fails to qualify as a REIT. Additionally, the Company will also be disqualified from electing to be taxed as a REIT for the four taxable years following the year during which qualification was lost unless the Company is entitled to relief under specific statutory provisions. Taxable income from certain non-REIT activities is managed through a taxable REIT subsidiary (“TRS”), which is subject to U.S. federal and applicable state and local corporate income taxes. As of September 30, 2020, the Company believes it is in compliance with all applicable REIT requirements and had no significant taxes associated with its TRS.

We evaluate the accounting and disclosure of tax positions taken or expected to be taken in the course of preparing our tax returns to determine whether the tax positions are “more-likely-than-not” (greater than 50 percent probability) of being sustained by the applicable tax authority. Tax positions not deemed to meet the more-likely-than-not threshold would be recorded as a tax benefit or expense in the current year. Our management is required to analyze all open tax years, as defined by the statute of limitations, for all major jurisdictions, which include federal and certain states. We have no examinations in progress and none are expected at this time.

We recognize our tax positions and evaluate them using a two-step process. First, we determine whether a tax position is more likely than not to be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. Second, we will determine the amount of benefit to recognize and record the amount that is more likely than not to be realized upon ultimate settlement. We had no material unrecognized tax benefit or expense, accrued interest or penalties as of September 30, 2020.

Recent Accounting Pronouncements

Section 107 of the Jumpstart Our Business Startups Act (“JOBS Act”) provides that an emerging growth company can take advantage of the extended transition period provided in Section 13(a) of the Securities Exchange Act of 1934 (the “Exchange Act”) for complying with new or revised accounting standards applicable to public companies. In other words, an emerging growth company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We have elected to take advantage of this extended transition period. As a result of this election, our financial statements may not be comparable to companies that comply with public company effective dates for such new or revised standards. We may elect to comply with public company effective dates at any time, and such election would be irrevocable pursuant to Section 107(b) of the JOBS Act.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses on Financial Instruments (“ASU 2016-13”), which establishes credit losses on certain types of financial instruments. The new approach changes the impairment model for most financial assets and will require the use of an “expected credit loss” model for financial instruments measured at amortized cost and certain other instruments. This model applies to trade and other receivables, loans, debt securities, net investments in leases, and off-balance sheet credit exposures (such as loan commitments, standby letters of credit, and financial guarantees not accounted for as insurance) and requires entities to estimate the lifetime expected credit loss on such instruments and record an allowance that represents the portion of the amortized cost basis that the entity does not expect to collect.

This allowance is deducted from the financial asset’s amortized cost basis to present the net amount expected to be collected. The new expected credit loss model will also apply to purchased financial assets with credit deterioration, superseding current accounting guidance for such assets. The amended guidance also amends the impairment model for available-for-sale debt securities, requiring entities to determine whether all or a portion of the unrealized loss on such securities is a credit loss, and also eliminating the option for management to consider the length of time a security has been in an unrealized loss position as a factor in concluding whether or not a credit loss exists. The amended model states that an entity will recognize an allowance for credit losses on available-for-sale debt securities as a contra account to the amortized cost basis, instead of a direct reduction of the amortized cost basis of the investment, as under current guidance. As a result, entities will recognize improvements to estimated credit losses on available-for-sale debt securities immediately in earnings as opposed to in interest income over time. There are also additional disclosure requirements included in this guidance. The amended guidance is to be applied on a modified retrospective basis with the cumulative

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effect of initially applying the amendments recognized in retained earnings at the date of initial application. However, certain provisions of the guidance are only required to be applied on a prospective basis. That methodology replaces the probable, incurred loss model for those assets. The new standard is effective for the Company for annual and interim periods beginning after December 15, 2023. While the Company is currently evaluating the impact ASU 2016-13 will have on the Company’s consolidated financial statements, the ultimate impact will depend on the portfolio and facts and circumstances near the date of adoption.

In November 2018, the FASB issued ASU 2018-19, Codification Improvements to Topic 326, Financial Instruments – Credit Losses, which updated the effective dates of implementation to align the implementation date for annual and interim financial statements as well as clarify the scope of the guidance in ASU 2016-13. This standard’s effective date is the same as ASU 2016-13.

In April 2019, the FASB issued ASU 2019-04, Codification Improvements to Topic 326. Financial Instruments – Credit Losses, which is intended to clarify the guidance introduced by ASU 2016-13. This standard’s effective date is the same as ASU 2016-13.

In May 2019, the FASB issued ASU 2019-05, Targeted Transition Relief for Topic 326. Financial Instruments – Credit Losses, which provides for an option to irrevocably elect the fair-value option for certain financial assets previously measured at amortized cost basis. Other than the Company’s investment in CMBS, the Company does not currently expect to elect the fair-value option for assets expected to be held at amortized cost. This standard’s effective date is the same as ASU 2016-13.

Other Matters

During the second quarter of 2020, immaterial errors were identified on the Q1 2020 consolidated statement of cash flows relating to the consolidation of the Company’s CMBS trusts where the Company is the primary beneficiary.  The correction of these errors would result in an increase of approximately $28.2 million in investing cash inflows with a corresponding increase in financing cash outflows in the March 31, 2020 consolidated statement of cash flows.  Additionally, for the three-month period ended March 31, 2020, the supplemental disclosures of non-cash investing and financing activities omitted non-cash increases in mortgage loans held in VIEs and non-cash increases in bonds payable from consolidated VIEs of approximately $48.0 million related to the consolidation of VIEs resulting from contributions of CMBS B-pieces in connection with the Formation Transaction. These errors have been corrected in the year-to-date cash flow information for 2020.  As a result, the table in Note 2 presenting the contributed assets and liabilities has also been corrected to reflect increases of approximately $48.0 million to both the mortgage loans held in VIEs and bonds payable held in VIEs.  There was no impact to total contributions.  There was also no impact to the Consolidated Balance Sheets, the Consolidated Statement of Operations or the Consolidated Statements of Stockholders’ Equity.  These errors have been corrected in the year-to-date cash flow information for 2020.

3. Loans Held for Investment

The Company’s investments in SFR Loans, mezzanine loans, and preferred equity are accounted for as loans held for investment. The following table summarizes our loans held for investment as of September 30, 2020 (dollars in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted Average

 

Loan Type

 

Outstanding

Face Amount

 

 

Carrying Value (1)

 

 

Loan Count

 

 

Fixed Rate (2)

 

 

Coupon (3)

 

 

Life (years) (4)

 

September 30, 2020

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

SFR Loans, held-for-investment

 

$

861,580

 

 

$

927,632

 

 

 

27

 

 

 

100.00

%

 

 

4.91

%

 

 

7.60

 

Mezzanine loan, held-for-investment

 

 

7,500

 

 

 

7,500

 

 

 

1

 

 

 

100.00

%

 

 

6.50

%

 

 

2.75

 

Preferred equity, held-for-investment

 

 

28,877

 

 

 

29,027

 

 

 

4

 

 

 

100.00

%

 

 

8.04

%

 

 

6.47