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Notes Receivable and Current Expected Credit Losses

9 Months Ended

Sep. 30, 2020

Notes Receivable and Current Expected Credit Losses

Notes Receivable

The Company had the following notes receivable outstanding as of September 30, 2020 and December 31, 2019 ($ in thousands):



	Outstanding loan amount										Interest compounding
Development Project	September 30, 2020			December 31, 2019		Maximum loan commitment		Interest rate			Interest compounding
The Residences at Annapolis Junction	$	42,767		$	40,049	$	48,105	10.0	%	^(a)	Monthly
Delray Plaza	15,493			12,995		17,000		15.0	%	^(a)(b)(c)	Annually
Nexton Square	—			15,097		17,000		10.0	%		Monthly
Interlock Commercial	82,351			59,224		103,000		15.0	%	^(c)	None
Solis Apartments at Interlock	28,109			25,588		41,100		13.0	%		Annually
Total mezzanine	168,720			152,953		$	226,205
Other notes receivable	14			1,147
Notes receivable guarantee premium	3,034			5,271
Allowance for credit losses	(3,052		)	—
Total notes receivable	$	168,716		$	159,371

________________________________________

(a) Loan was placed on nonaccrual status effective April 1, 2020.

(b) $2.0 million of this loan is subject to an interest rate of 6%.

Interest on the mezzanine loans is accrued and funded utilizing the interest reserves for each loan, which are components of the respective maximum loan commitments, and such accrued interest is added to the loan receivable balances. The Company recognized interest income for the three and nine months ended September 30, 2020 and 2019 as follows (in thousands):



	Three Months Ended September 30,						Nine Months Ended September 30,
Development Project	2020			2019			2020			2019
1405 Point	$	—		$	—		$	—		$	783
North Decatur Square	—			178			—			1,509
The Residences at Annapolis Junction	—		^(a)	2,340		^(b)	2,468		^(a)(c)	6,536		^(b)
Delray Plaza	—		^(a)	429			489		^(a)	1,153
Nexton Square	380			550			1,177			1,584
Interlock Commercial	3,189		^(c)	1,595			9,364		^(c)	3,425
Solis Apartments at Interlock	847			596			2,522			1,567
Total mezzanine	4,416			5,688			16,020			16,557
Other interest income	1			22			35			65
Total interest income	$	4,417		$	5,710		$	16,055		$	16,622

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(a) Loan was placed on nonaccrual status effective April 1, 2020.

(b) Includes amortization of the $5.0 million loan modification fee paid by the borrower in November 2018.

Delray Plaza

On March 3, 2020, the Delray Plaza loan was modified to increase the maximum amount of the loan to $17.0 million, with $2.0 million of additional funds borrowed at an interest rate of 6% in order to fund final development activities. The borrower pledged 125,832 Class A Units as additional collateral for this loan.

Interlock Commercial

In May 2020, the Company modified the Interlock Commercial loan to allow for an additional $8.0 million of loan funding; this additional loan funding may be available for cost overruns as well as the building of townhome units as an additional phase of this development project. The borrower also modified the senior construction loan on the project. As part of this modification, the Company agreed to increase its payment guaranty for this senior loan to $34.3 million.

Nexton Square

On September 22, 2020, as part of the Nexton Square acquisition, the developer of this property repaid the Company's mezzanine note receivable of $16.4 million.

Current Expected Credit Losses

The Company is exposed to credit losses primarily through its mezzanine lending activities. As of September 30, 2020, the Company had four mezzanine loans, all of which are secured by second liens on development projects in various stages of completion or lease-up. Each of these projects is subject to a loan that is senior to the Company’s mezzanine loan. Interest on these loans is paid in kind and is generally not expected to be paid until a sale of the project after completion of the development.

The Company's management performs a quarterly analysis of the loan portfolio to determine the risk of credit loss based on the progress of development activities including leasing activities, projected development costs, and current and projected mezzanine and senior construction loan balances. The Company estimates future losses on its notes receivable using risk ratings that correspond to probabilities of default and loss given default. The Company's risk ratings are as follows:


•	Pass: loans in this category are adequately collateralized by a development project with conditions materially consistent with the Company's underwriting assumptions.


•	Special Mention: loans in this category show signs that the economic performance of the project may suffer as a result of slower-than-expected leasing activity or an extended development or marketing timeline. Loans in this category warrant increased monitoring by management.

•

Substandard: loans in this category may not be fully collected by the Company unless remediation actions are taken. Remediation actions may include obtaining additional collateral or assisting the borrower with asset management activities to prepare the project for sale. The Company will also consider placing the loan on nonaccrual status if it does not believe that additional interest accruals will ultimately be collected.

On a quarterly basis, the Company compares the risk inherent in its loans to industry loan loss data experienced during past business cycles. The Company updated the risk ratings for each of its notes receivable during the three months ended September 30, 2020. The Company obtained industry loan loss data relative to these risk ratings as of June 30, 2020.

The following table presents amortized cost basis of the portfolio by year of origination and risk rating as of September 30, 2020 (in thousands):



	Year of Origination
Risk Ratings	2020		2019		2018		2017		2016		Total
Pass	$	—	$	—	$	111,611	$	—	$	—	$	111,611
Special Mention	—		—		—		—		—		—
Substandard	—		—		—		14,723		42,368		57,091
Total amortized cost basis	$	—	$	—	$	111,611	$	14,723	$	42,368	$	168,702

As of December 31, 2019, there was no allowance for loan losses. At September 30, 2020, the Company reported $168.7 million of notes receivable, net of allowances of $3.1 million. Changes in the allowance for the nine months ended September 30, 2020 were as follows (in thousands):



	Nine Months Ended September 30, 2020
Beginning balance (December 31, 2019)	$	—
Cumulative effect of accounting change	2,825
Unrealized credit loss provision	227
Ending balance	$	3,052

The Company places loans on nonaccrual status when the loan balance, together with the balance of any senior loan, approximately equals the estimated realizable value of the underlying development project. As of December 31, 2019, there were no loans on nonaccrual status. During the nine months ended September 30, 2020, the Company placed the loans for Delray Plaza and The Residences at Annapolis Junction on nonaccrual status with total amortized cost basis of $57.1 million. As a result, there was $4.2 million of interest income not recognized during the nine months ended September 30, 2020.