Finance Receivables

6 Months Ended

Jun. 30, 2020

Assets representing rights to receive money on demand or at fixed or determinable dates are referred to as finance receivables. Our finance receivables portfolio consists of our notes receivable (which are included in Accounts receivable and other assets, net in the condensed consolidated financial statements) and our Net investments in direct financing leases (net of allowance for credit losses). Operating leases are not included in finance receivables.

Notes Receivable

As of June 30, 2020, our notes receivable consisted of a $28.0 million mezzanine tranche of 10-year commercial mortgage-backed securities on the Cipriani banquet halls in New York, New York with a maturity date of July 2024. The mezzanine tranche is subordinated to a $60.0 million senior loan on the properties. Interest-only payments at a rate of 10% per annum are due through its maturity date. As of both June 30, 2020 and December 31, 2019, the balance for this note receivable remained $28.0 million. On July 28, 2020, we were notified that the borrower has defaulted on the mortgage loan senior to our mezzanine tranche. We are currently evaluating our rights and options in connection with the senior loan default (Note 13).

Interest income from our notes receivables was $0.7 million and $0.8 million for the three months ended June 30, 2020 and 2019, respectively, and $1.4 million and $2.7 million for the six months ended June 30, 2020 and 2019, respectively, and is included in Other operating and interest income in our condensed consolidated statements of operations.

Net Investments in Direct Financing Leases

Net investments in our direct financing lease investments is summarized as follows (in thousands):



	June 30, 2020			December 31, 2019
Lease payments receivable	$	53,555		$	55,278
Unguaranteed residual value	39,401			39,401
	92,956			94,679
Less: unearned income	(50,796		)	(52,625		)
Less: allowance for credit losses ^(a)	(11,768		)	—
	$	30,392		$	42,054

___________

(a)

Upon our adoption of ASU 2016-13 on January 1, 2020, we applied changes in loss reserves through a cumulative-effect adjustment to retained earnings totaling $6.9 million (Note 2). In addition, during the six months ended June 30, 2020, due to changes in expected economic conditions, we recorded an allowance for credit losses of $4.9 million, which was included in Allowance for credit losses in our condensed consolidated statements of operations.

Interest income from direct financing leases was $0.6 million and $0.9 million for the three months ended June 30, 2020 and 2019, respectively, and $1.6 million and $1.9 million for the six months ended June 30, 2020 and 2019, respectively, and is included in Lease revenues — net-leased in our condensed consolidated statements of operations.

Credit Quality of Finance Receivables

We generally invest in facilities that we believe are critical to a tenant’s business and therefore have a lower risk of tenant default. Due to changes in expected economic conditions, we recorded an allowance for credit losses (as noted above). As of December 31, 2019, we had no significant finance receivable balances that were past due. Additionally, there were no material modifications of finance receivables during the six months ended June 30, 2020.

We evaluate the credit quality of our finance receivables utilizing an internal five-point credit rating scale, with one representing the highest credit quality and five representing the lowest. A credit quality of one through three indicates a range of investment grade to stable. A credit quality of four through five indicates inclusion on the watch list to risk of default. The credit quality evaluation of our finance receivables is updated quarterly.

A summary of our finance receivables by internal credit quality rating is as follows (dollars in thousands):



	Number of Tenants/Obligors at		Carrying Value at
Internal Credit Quality Indicator	June 30, 2020	December 31, 2019	June 30, 2020		December 31, 2019
1 – 3	3	4	$	16,956	$	45,457
4	2	1	41,436		24,597
5	—	—	—		—
	0		$	58,392	$	70,054