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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
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☑ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Quarterly Period Ended March 31, 2024
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☐ | 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: 000-55429
Terra Income Fund 6, LLC
(Exact name of registrant as specified in its charter) | | | | | | | | |
Delaware | | 92-0548263 |
(State or other jurisdiction of incorporation or organization) | | (I.R.S. Employer Identification No.) |
205 West 28th Street, 12th Floor
New York, New York 10001
(Address of principal executive offices) (Zip Code)
(212) 753-5100
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
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Title of each class | | Trading Symbol(s) | | Name of exchange on which registered |
7.00% Notes due 2026 | | TFSA | | New York Stock Exchange |
Securities registered pursuant to Section 12(g) of the Act: None.
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 þ No o
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 þ No o
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 | þ | Smaller reporting company | þ |
| | 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. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ☑
All of the limited liability company interest in the registrant is held by an affiliate of the registrant. No market value has been computed based upon the fact that no active trading market had been established as of the date of this document.
OMISSION OF CERTAIN INFORMATION
The registrant meets the conditions set forth in General Instruction H(1)(a) and (b) of Form 10-Q and is therefore filing this Quarterly Report on Form 10-Q with reduced disclosure format.
TABLE OF CONTENTS
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PART I | | |
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Item 1. | | |
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Item 2. | | |
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Item 3. | | |
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Item 4. | | |
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PART II | | |
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Item 1. | | |
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Item 1A. | | |
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Item 2. | | |
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Item 3. | | |
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Item 4. | | |
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Item 5. | | |
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Item 6. | | |
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
Terra Income Fund 6, LLC
Consolidated Balance Sheets
| | | | | | | | | | | |
| March 31, 2024 | | December 31, 2023 |
| (unaudited) | | |
Assets | | | |
Cash and cash equivalents | $ | 13,603,224 | | | $ | 3,193,078 | |
Restricted cash | — | | | 106,918 | |
Loans held for investment, net of allowance for credit losses of $712,527 and $469,011 | 39,135,193 | | | 60,458,534 | |
Loans held for investment acquired through participation, net of allowance for credit losses of $9,810,699 and $9,234,320 | 17,334,858 | | | 17,884,930 | |
Equity investment in unconsolidated investment | 39,138,942 | | | 40,431,710 | |
Promissory note receivable (Note 6) | 10,687,278 | | | — | |
Marketable securities | 358,979 | | | 507,266 | |
Interest receivable | 518,167 | | | 1,241,308 | |
Prepaid expenses and other assets | 528,708 | | | 515,407 | |
Total assets | $ | 121,305,349 | | | $ | 124,339,151 | |
Liabilities and Equity | | | |
Liabilities: | | | |
Unsecured notes payable, net of purchase discount | 35,527,087 | | | 35,213,543 | |
Term loan payable, net of deferred financing cost | — | | | 14,948,604 | |
Obligation under participation agreement (Note 7) | 15,107,458 | | | — | |
Interest payable from obligation under participation agreement | 228,615 | | | — | |
Interest reserve and other deposits held on investments | — | | | 106,918 | |
Other liabilities | 13,253 | | | 410,075 | |
Accrued expenses | 230,798 | | | 254,716 | |
Total liabilities | 51,107,211 | | | 50,933,856 | |
Commitments and contingencies (Note 8) | | | |
Equity: | | | |
Managing member | 70,346,425 | | | 73,405,295 | |
Accumulated other comprehensive loss | (148,287) | | | — | |
Total equity | 70,198,138 | | | 73,405,295 | |
Total liabilities and equity | $ | 121,305,349 | | | $ | 124,339,151 | |
See notes to unaudited consolidated financial statements.
Terra Income Fund 6, LLC
Consolidated Statements of Operations and Comprehensive (Loss) Income
(Unaudited)
| | | | | | | | | | | | | | |
| | Three Months Ended March 31, |
| | 2024 | | 2023 |
Revenues | | | | |
Interest income | | $ | 2,164,276 | | | $ | 2,931,904 | |
Dividend and other income | | 16,332 | | | 5,575 | |
| | 2,180,608 | | | 2,937,479 | |
Operating expenses | | | | |
Asset management and asset servicing fees paid/payable to Terra REIT (1) | | 390,058 | | | 434,550 | |
Operating expense reimbursement to Terra REIT (1) | | 382,294 | | | 305,880 | |
Provision for (reversal of provision for) credit losses | | 824,348 | | | (115,337) | |
Professional fees | | 169,702 | | | 282,510 | |
Insurance expense | | 21,072 | | | 62,119 | |
General and administrative | | 36,238 | | | 12,660 | |
| | 1,823,712 | | | 982,382 | |
Operating income | | 356,896 | | | 1,955,097 | |
Other income and expenses | | | | |
(Loss) income from equity investment in unconsolidated investments | | (1,187,179) | | | 315,013 | |
Interest expense on unsecured notes payable | | (985,106) | | | (952,149) | |
Interest expense on term loan | | (517,528) | | | (351,563) | |
Interest expense from obligation under participation agreement | | (725,953) | | | — | |
| | (3,415,766) | | | (988,699) | |
Net (loss) income | | $ | (3,058,870) | | | $ | 966,398 | |
Other comprehensive loss | | | | |
Available -for-sale debt securities | | (148,287) | | | — | |
| | (148,287) | | | — | |
Comprehensive (loss) income | | $ | (3,207,157) | | | $ | 966,398 | |
______________(1)Fees were paid and payable, and expenses were reimbursed, to Terra Property Trust, Inc. (“Terra REIT”) pursuant to a cost sharing agreement with Terra REIT (Note 6).
See notes to unaudited consolidated financial statements.
Terra Income Fund 6, LLC
Consolidated Statement of Changes in Member’s Capital
(Unaudited)
| | | | | | | | | | | | | | | | | | | | |
| | Managing Member | | Accumulated Other Comprehensive Loss | | Total |
Balance, January 1, 2024 | | $ | 73,405,295 | | | $ | — | | | $ | 73,405,295 | |
Net loss | | (3,058,870) | | | — | | | (3,058,870) | |
Other comprehensive loss: | | | | | | |
Available-for-sale debt securities | | — | | | (148,287) | | | (148,287) | |
Balance, March 31, 2024 | | $ | 70,346,425 | | | $ | (148,287) | | | $ | 70,198,138 | |
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| | Managing Member | | Total |
Balance, January 1, 2023 | | $ | 79,691,832 | | | $ | 79,691,832 | |
Cumulative effect of adoption of credit loss accounting standard effective | | (661,422) | | | (661,422) | |
Net income | | 966,398 | | | 966,398 | |
Balance, March 31, 2023 | | $ | 79,996,808 | | | $ | 79,996,808 | |
See notes to unaudited consolidated financial statements.
Terra Income Fund 6, LLC
Consolidated Statement of Cash Flows
(Unaudited)
| | | | | | | | | | | | | | | |
| | Three Months Ended March 31, | |
| | 2024 | | 2023 | |
Cash flows from operating activities: | | | | | |
Net (loss) income | | $ | (3,058,870) | | | $ | 966,398 | | |
Adjustments to reconcile net income from operations to net cash (used in) provided by operating activities: | | | | | |
Provision for (reversal of provision for) credit losses | | 824,348 | | | (115,337) | | |
Amortization of premiums and discounts on investments | | 64,944 | | | 362,109 | | |
Amortization and accretion of investment-related fees, net | | 71,360 | | | (179,573) | | |
Amortization of discount on debt | | 313,544 | | | 280,587 | | |
Amortization of deferred financing costs | | 51,396 | | | — | | |
Loss (income) from equity investment in unconsolidated investments | | 1,187,181 | | | (315,013) | | |
Distributions received from equity investment in unconsolidated investments | | — | | | 262771 | |
Changes in operating assets and liabilities: | | | | | |
Decrease (increase) in interest receivable | | 723,141 | | | (262,924) | | |
Increase in prepaid expenses and other assets | | (13,301) | | | (160,551) | | |
(Decrease) increase in interest reserve and other deposits held on investments | | (106,918) | | | 184,246 | | |
Decrease in accrued expenses | | (23,918) | | | (291,151) | | |
Increase in interest payable from obligation under participation agreement | | 228,615 | | | — | | |
Decrease in other liabilities | | (401,275) | | | (252,045) | | |
Net cash (used in) provided by operating activities | | (139,753) | | | 479,517 | | |
Cash flows from investing activities: | | | | | |
Repayment of loans | | 21,462,500 | | | 20,149,840 | | |
Purchase of equity interest in unconsolidated investment | | (532) | | | — | | |
Funding for promissory note receivable | | (10,687,278) | | | — | | |
Proceeds from redemption of held-to-maturity debt securities | | — | | | (10,012,512) | | |
Origination and purchase of loans | | (437,824) | | | (2,177,941) | | |
Distributions on equity interest in unconsolidated investment | | 106,115 | | | — | | |
Net cash provided by investing activities | | 10,442,981 | | | 7,959,387 | | |
Cash flows from financing activities: | | | | | |
Proceeds from obligation under participation agreement | | 15,000,000 | | | — | | |
Repayment of term loan | | (15,000,000) | | | — | | |
Net cash used in financing activities | | — | | | — | | |
Net increase in cash, cash equivalents and restricted cash | | 10,303,228 | | | 8,438,904 | | |
Cash, cash equivalents and restricted cash, at beginning of period | | 3,299,996 | | | 6,739,953 | | |
Cash, cash equivalents and restricted cash, at end of period (Note 2) | | $ | 13,603,224 | | | $ | 15,178,857 | | |
| | | | | |
Supplemental disclosure of cash flow information: | | | | | |
Cash paid for interest | | $ | 1,527,573 | | | $ | 1,303,712 | | |
Income taxes paid | | $ | — | | | $ | 241,700 | | |
| | | | | |
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See notes to unaudited consolidated financial statements.
Terra Income Fund 6, LLC
Notes to Consolidated Financial Statements (Unaudited)
Note 1. Principal Business and Organization
Terra Income Fund 6, LLC (“Terra LLC”, and together with its consolidated subsidiaries, the “Company”) was formed as a Delaware limited liability company on April 29, 2022 as a wholly owned subsidiary of Terra Property Trust, Inc. (“Terra REIT”). On October 1, 2022, pursuant to an Agreement and Plan of Merger, dated as of May 2, 2022 (as amended, the “Merger Agreement”), Terra Income Fund 6, Inc. (“Terra BDC”) merged with and into Terra LLC, with Terra LLC continuing as the surviving entity of the merger (the “Merger”). Subsequent to the Merger, Terra LLC became the successor of Terra BDC and assumed all of Terra BDC’s rights and obligations.
In February 2021, Terra BDC issued $38.4 million in aggregate principal amount of 7.00% fixed-rate notes due 2026, for net proceeds of $37.2 million, after deducting underwriting commissions of $1.2 million, see “Unsecured Senior Notes” in Note 7 for more information. In connection with the Merger, Terra LLC assumed the obligations of Terra BDC under the indenture governing the 7.00% fixed-rate notes due 2026. The Company is a wholly owned subsidiary of Terra REIT, and its investment objective is to provide attractive risk-adjusted returns to Terra REIT’s stockholders, primarily through Terra REIT’s regular distributions. Terra REIT’s investments activities are externally managed by Terra REIT Advisors, LLC (the “REIT Manager”), an affiliate of the Company. The Company originates, invests in and manages a diverse portfolio of real estate-related investments that generate a stable income stream. The Company directly originates, structures and underwrites most, if not all, of its loans, as it believes that doing so will provide it with the best opportunity to invest in loans that satisfy its standards, establish a direct relationship with the borrower and optimize the terms of its investments; however, the Company may acquire existing loans from the originating lender should the REIT Manager determine such an investment is in its best interest. The Company may hold its investments until their scheduled maturity dates or may sell them if the Company is able to command favorable terms for their disposition. The Company may also seek to realize growth in the value of its investments by timing their sale to maximize value.
The Company may also make strategic non-real estate-related investments that align with its investment objectives and criteria.
Note 2. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying interim consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles (“U.S. GAAP”) and include the accounts of the Company and its consolidated subsidiaries. The accompanying interim consolidated financial statements of the Company and related financial information have been prepared pursuant to the requirements for reporting on Form 10-Q and Articles 6 or 10 of Regulation S-X.
Consolidation
Terra LLC consolidates entities in which it has a controlling financial interest based on either the variable interest entity (“VIE”) or voting interest entity (“VOE”) model. Terra LLC is required to first apply the VIE model to determine whether it holds a variable interest in an entity, and if so, whether the entity is a VIE. If Terra LLC determines the entity is not a VIE, it then applies the VOE model. Under the VOE model, Terra LLC consolidates an entity when it holds a majority voting interest in an entity.
Terra LLC accounts for investments in which it has significant influence but not a controlling financial interest using the equity method of accounting. All significant intercompany balances and transactions have been eliminated in consolidation.
Cash and Cash Equivalents
The Company considers all highly liquid investments, with original maturities of ninety days or less when purchased, as cash equivalents. Cash and cash equivalents held at financial institutions, at times, may exceed the amount insured by the Federal Deposit Insurance Corporation.
Restricted Cash
Restricted cash represents cash held as additional collateral by the Company on behalf of the borrowers related to the investments for the purpose of such borrowers making interest and property-related operating payments. There is a
Notes to Consolidated Financial Statements (Unaudited)
corresponding liability of the same amount on the statements of assets and liabilities called “Interest reserve and other deposits held on investments.”
The following table provides a reconciliation of cash, cash equivalents and restricted cash in the Company’s consolidated balance sheets to the total amount shown in its statements of cash flows:
| | | | | | | | | | | | |
| March 31, |
| 2024 | | | 2023 |
Cash and cash equivalents | $ | 13,603,224 | | | | $ | 14,779,253 | |
Restricted cash | — | | | | 399,604 | |
Total cash, cash equivalents and restricted cash shown in the consolidated statements of cash flows | $ | 13,603,224 | | | | $ | 15,178,857 | |
Loans Held for Investment
The Company originates, acquires, and structures, or acquires through participations, real estate-related loans generally to be held to maturity (collectively the “loans”). Loans held for investment are carried at the principal amount outstanding, adjusted for the accretion of discounts on investments and exit fees, and the amortization of premiums on investments and origination fees. The Company’s preferred equity investments, which are economically similar to mezzanine loans and subordinate to any loans but senior to common equity, are accounted for as loans held for investment. Loans are carried at amortized cost less allowance for credit losses. Amortized cost is the amount at which a financing receivable or a loan is originated or acquired, adjusted for accretion, or amortization of premium, discount, and net deferred fees or costs, collection of cash and write-offs.
Allowance for Credit Losses
On January 1, 2023, the Company adopted the provisions of Accounting Standards Codification (“ASC”) 326, Financial Instruments – Credit Losses. ASC 326 mandates the use of a current expected credit loss (“CECL”) methodology for estimating future credit losses of certain financial instruments measured at amortized cost, instead of the “incurred loss” methodology previously required under U.S. GAAP. The CECL methodology requires the consideration of possible credit losses over the life of an instrument as opposed to estimating credit losses upon the occurrence of an actual loss event under the previous “incurred loss” methodology. As permitted by ASC 326, the Company elected not to measure an allowance for credit losses on accrued interest receivable (which is presented separately on the consolidated balance sheet), but rather write off in a timely manner by reversing interest income that would likely be uncollectible. The Company’s adoption of the ASC 326 resulted in a $0.7 million increase to total reserve, including reserve on future funding commitments, which was recognized as a cumulative-effect adjustment to member’s capital as of January 1, 2023. Subsequent to the adoption of the CECL methodology, any increase or decrease to the allowance for credit losses is recorded in earnings on the consolidated statement of operations.
Performing Loans
The Company uses a model-based approach for estimating the allowance for credit losses on performing loans on a collective basis, including future funding commitments for which the Company does not have the unconditional right to cancel, as these loans share similar risk characteristics. The Company utilizes information obtained from internal and external sources relating to past events, current economic conditions and reasonable and supportable forecasts about the future to determine the expected credit losses for its loan portfolio. The Company utilizes a commercial mortgage-based, third-party loan loss model and because the Company does not have a meaningful history of realized credit losses on its loan portfolio, it subscribes to a database service to provide historical proxy loan loss information. The Company employs logistic regression to forecast expected losses at the loan level based on a commercial real estate loan securitization database that contains activity dating back to 1998. The Company has chosen to incorporate a weighted average macroeconomic forecast that encompasses baseline, optimistic and pessimistic scenarios, into its allowance for credit losses on performing loans estimate during the reasonable and supportable forecast period which is currently eight quarters. The Company selects certain economics variables from a group of independent variables such as Commercial Real Estate Price Index, unemployment and interest rate which are included in the model as part of macroeconomic forecast and updated regularly based on current economic trends. On a quarterly basis, adjustments to the weights ascribed to the multiple macroeconomic forecast scenarios are made in response to changes in expectations of macroeconomic conditions such as inflation and interest rates. The specific loan level information input into the model includes loan-to-value and debt service coverage ratio metrics, as well as principal balances, property type, location, coupon rate, coupon rate type, original or remaining term, expected repayment dates and contractual future funding commitments. Based on the inputs, the loan loss model determines a loan loss rate through the generation of a probability of default (PD) and loss given default (LGD) for each loan. The allowance for credit losses on performing loans is then calculated
Notes to Consolidated Financial Statements (Unaudited)
by applying the loan loss rate to the total outstanding loan balance of each loan. A significant amount of judgment is applied in selecting inputs and analyzing results produced by the models to determine the allowance for credit losses on performing loans. Changes in such estimates can significantly affect the expected credit losses.
Beyond the Company’s reasonable and supportable forecast period, the Company reverts to historical loss information on a straight-line basis over the remaining contractual loan term, taken from a period that most accurately reflects the expectation of conditions expected to exist during the period of reversion. The Company may adjust historical loss information for differences in risk that may not reflect the characteristics of its current portfolio, including but not limited to, loan-to-value and debt service coverage ratios, among other relevant factors. The method of reversion selected represents the best estimate of the collectability of the investments and is reevaluated each reporting period.
The determination of the performing loans credit loss estimate considers historical loss information and current economic conditions for each loan, reversion period and reasonable and supportable forecasts about the future. The reasonable and supportable forecast period is determined based on the Company’s assessment of the most likely scenario of assumptions and plausible outcomes for the U.S. economy. The Company regularly evaluates the reasonable and supportable forecast period to determine if a change is needed.
The Company also performs a qualitative assessment and applies qualitative adjustments as necessary, usually due to limitations of the loan loss model. The Company’s qualitative analysis includes a review of data that may directly impact its estimates including internal and external information about the loan or property including current market conditions, asset specific conditions, property operations or borrower/sponsor details (i.e., refinance, sale, bankruptcy) which allows the Company to determine the amount of the expected loss more accurately and reasonably for these investments. The Company also evaluates the contractual life of its loans to determine if changes are needed for certain contractual extension options, renewals, modifications, and prepayments.
Unfunded Commitments
Some of the Company’s performing loans include commitments to fund incremental proceeds to the borrowers over the life of the loan and these unfunded commitments are also subject to the CECL methodology because the Company does not have an unconditional right to cancel such commitments. The allowance for credit losses related to unfunded commitments is recorded as a component of other liabilities on the Company’s consolidated balance sheets. This allowance for credit losses is estimated using the same method outlined above for the Company’s outstanding performing loan balances and increases or decreases are also recorded in earnings on the consolidated statements of operations.
Non-Performing Loans
During the loan review process, if the Company determines that it is not able to collect all amounts due for both principal and interest according to the contractual terms of a loan, the Company considers that loan non-performing. For all non-performing loans, such as those in default, collateral-dependent or modified loans, including historical troubled debt restructurings, the Company removes these loans from the industry loss rate approach described above and analyzes them separately. The credit loss reserve for these loans is calculated as any excess of the amortized cost of the loan over (i) the present value of expected future cash flows discounted at the appropriate discount rate or (ii) the fair value of collateral, if repayment is expected solely from the collateral.
Equity Investment in Unconsolidated Investments
The Company accounts for its equity interests in unconsolidated investments under the equity method of accounting, i.e., at cost, increased or decreased by its share of earnings or losses, less distributions, plus contributions and other adjustments required by equity method accounting.
The Company classifies distributions received from equity method investments using the cumulative earnings approach. Distributions received are considered returns on the investment and classified as cash inflows from operating activities. If, however, the investor’s cumulative distributions received, less distributions received in prior periods determined to be returns of investment, exceeds cumulative equity in earnings recognized, the excess is considered a return of investment and is classified as cash inflows from investing activities.
The Company evaluates its equity investment unconsolidated investments on a periodic basis to determine if there are any indicators that the value of its equity investments may be impaired and whether or not that impairment is other-than-temporary. To the extent an impairment has occurred and is determined to be other-than-temporary, the Company measures the charge as the excess of the carrying value of its investment over its estimated fair value, which is determined by calculating its share of
Notes to Consolidated Financial Statements (Unaudited)
the estimated fair market value of the underlying net assets based on the terms of the applicable partnership or joint venture agreements.
Marketable Securities
From time to time, the Company may invest in short-term debt. These securities are classified as available-for-sale securities and are carried at fair value. Changes in the fair value of debt securities are reported in other comprehensive income until a gain or loss on the securities is realized.
Revenue Recognition
Revenue is recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.
Interest Income: Interest income is accrued based upon the outstanding principal amount and contractual terms of the loans and preferred equity investments that the Company expects to collect, and it is accrued and recorded on a daily basis. Discounts and premiums on investments purchased are accreted or amortized over the expected life of the respective loan using the effective yield method, and are included in interest income in the consolidated statements of operations. Loan origination fees and exit fees, net of portions attributable to obligations under participation agreements, if any, are capitalized and amortized or accreted to interest income over the life of the investment using the effective yield method. Outstanding interest receivable is assessed for recoverability. The Company generally reverses the accrued and unpaid interest against interest income and no longer accrues for the interest when, in the opinion of the REIT Manager, recovery of interest and principal becomes not probable. Interest is then recorded on the basis of cash received until accrual is resumed when the loan becomes contractually current and performance is demonstrated. Interest payments received on non-accrual loans may be recognized as income or applied to principal depending upon management’s judgment regarding collectability.
The Company may hold loans in its portfolio that contain paid-in-kind (“PIK”) interest provisions. The PIK interest, which represents contractually deferred interest that is added to the principal balance that is due at maturity, is recorded on the accrual basis.
Other Revenues: Prepayment fee income is recognized as prepayments occur. All other income is recognized when earned.
Deferred Debt Issuance Costs
The Company records issue discounts and other financing costs related to its debt obligation as deferred debt issuance costs, which are presented as a direct deduction from the carrying value of the related debt liability. These expenses are deferred and amortized using the effective interest method over the stated maturity of the debt obligation.
Use of Estimates
The preparation of the consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and reported amounts of income, expenses and gains and losses during the reporting period. Actual results may ultimately differ from those estimates, and those differences could be material.
Note 3. Loans Held for Investment
The Company elected the practical expedient under ASC 326 to exclude accrued interest from amortized cost. As of March 31, 2024 and December 31, 2023, accrued interest receivable of $0.5 million and $1.2 million, respectively, is included in interest receivable on the consolidated balance sheets, and is excluded from the amortized cost of loans held for investment.
Notes to Consolidated Financial Statements (Unaudited)
Portfolio Summary
The following table provides a summary of the Company’s loan portfolio:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| March 31, 2024 | | December 31, 2023 |
| Fixed Rate | | Floating Rate (1)(2) | | Total | | Fixed Rate | | Floating Rate (1)(2) | | Total |
Number of loans | 3 | | 2 | | 5 | | 4 | | 2 | | 6 |
Principal balance | $ | 23,565,197 | | | $ | 43,059,173 | | | $ | 66,624,370 | | | $ | 44,377,373 | | | $ | 43,059,173 | | | $ | 87,436,546 | |
Carrying value | $ | 23,362,940 | | | $ | 33,107,111 | | | $ | 56,470,051 | | | $ | 44,528,468 | | | $ | 33,814,996 | | | $ | 78,343,464 | |
Fair value | $ | 23,552,173 | | | $ | 33,491,863 | | | $ | 57,044,036 | | | $ | 44,313,689 | | | $ | 34,214,046 | | | $ | 78,527,735 | |
Weighted-average coupon rate | 13.4% | | 16.6% | | 15.4% | | 13.7% | | 16.6% | | 15.1% |
Weighted-average remaining term (years) | 0.60 | | 0.85 | | 0.72 | | 0.76 | | 1.10 | | 0.87 |
_______________(1)As of March 31, 2024 and December 31, 2023, these loans pay a coupon rate of Secured Overnight Financing Rate (“SOFR”) or forward-looking term rate based on SOFR (“Term SOFR”), as applicable, plus a fixed spread. Coupon rates shown were determined using both average SOFR and Term SOFR of 5.3%, as of March 31, 2024, and of 5.3% and 5.4%, respectively, as of December 31, 2023.
(2)As of both March 31, 2024 and December 31, 2023, two loans were subject to a SOFR or Term SOFR floor, as applicable.
Lending Activities
The following tables present the activities of the Company’s loan portfolio:
| | | | | | | | | | | | | | | | | | |
| Loans Held for Investment | | Loans Held for Investment through Participation Interests | | Total | |
Balance, January 1, 2024 | $ | 60,458,534 | | | $ | 17,884,930 | | | $ | 78,343,464 | | |
New loans made | 411,517 | | | 26,307 | | | 437,824 | | |
Principal repayments received | (21,462,500) | | | — | | | (21,462,500) | | |
Net amortization of premiums on loans | (64,944) | | | — | | | (64,944) | | |
Accrual, payment and accretion of investment-related fees and other, net | 36,102 | | | — | | | 36,102 | | |
Provision for credit losses | (243,516) | | | (576,379) | | | (819,895) | | |
Balance, March 31, 2024 | $ | 39,135,193 | | | $ | 17,334,858 | | | $ | 56,470,051 | | |
| | | | | | | | | | | | | | | | | | |
| Loans Held for Investment | | Loans Held for Investment through Participation Interests | | Total | |
Balance, January 1, 2023 | $ | 79,082,650 | | | $ | 42,330,376 | | | $ | 121,413,026 | | |
Cumulative effect of adoption of credit loss accounting standard effective January 1, 2023 (Note 2) | (593,040) | | | — | | | (593,040) | | |
New loans made | 2,034,194 | | | 143,747 | | | 2,177,941 | | |
Principal repayments received | (28,260) | | | (20,121,580) | | | (20,149,840) | | |
Net amortization of discounts on loans | (280,698) | | | (81,411) | | | (362,109) | | |
Accrual, payment and accretion of investment-related fees and other, net | 94,526 | | | 85,047 | | | 179,573 | | |
Reversal of provision for credit losses | 82,847 | | | — | | | 82,847 | | |
Balance, March 31, 2023 | $ | 80,392,219 | | | $ | 22,356,179 | | | $ | 102,748,398 | | |
Notes to Consolidated Financial Statements (Unaudited)
Portfolio Information
The tables below detail the types of loans in the Company’s loan portfolio, as well as the property type and geographic location of the properties securing these loans:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | March 31, 2024 | | December 31, 2023 | |
Loan Structure | | Principal Balance | | Carrying Value | | % of Total | | Principal Balance | | Carrying Value | | % of Total | |
Preferred equity investments | | $ | 63,624,370 | | | $ | 64,053,239 | | | 113.4 | % | | $ | 63,186,546 | | | $ | 63,648,991 | | | 81.3 | % | |
Mezzanine loans | | 3,000,000 | | | 2,940,038 | | | 5.2 | % | | 3,000,000 | | | 2,935,304 | | | 3.7 | % | |
First mortgages | | — | | | — | | | — | % | | 21,250,000 | | | 21,462,500 | | | 27.4 | % | |
Allowance for credit losses | | — | | | (10,523,226) | | | (18.6) | % | | — | | | (9,703,331) | | | (12.4) | % | |
Total | | $ | 66,624,370 | | | $ | 56,470,051 | | | 100.0 | % | | $ | 87,436,546 | | | $ | 78,343,464 | | | 100.0 | % | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | March 31, 2024 | | December 31, 2023 |
Property Type | | Principal Balance | | Carrying Value | | % of Total | | Principal Balance | | Carrying Value | | % of Total | |
Office | | $ | 24,491,877 | | | $ | 24,491,877 | | | 43.3 | % | | $ | 24,491,877 | | | $ | 24,491,877 | | | 31.3 | % | |
Multifamily | | 20,565,197 | | | 20,775,013 | | | 36.8 | % | | 20,127,373 | | | 20,360,300 | | | 26.0 | % | |
Mixed use | | 18,567,296 | | | 18,786,349 | | | 33.3 | % | | 18,567,296 | | | 18,796,814 | | | 24.0 | % | |
Student housing | | 3,000,000 | | | 2,940,038 | | | 5.2 | % | | 3,000,000 | | | 2,935,304 | | | 3.7 | % | |
Infrastructure | | — | | | — | | | — | % | | 21,250,000 | | | 21,462,500 | | | 27.4 | % | |
Allowance for credit losses | | — | | | (10,523,226) | | | (18.6) | % | | — | | | (9,703,331) | | | (12.4) | % | |
Total | | $ | 66,624,370 | | | $ | 56,470,051 | | | 100.0 | % | | $ | 87,436,546 | | | $ | 78,343,464 | | | 100.0 | % | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | March 31, 2024 | | December 31, 2023 |
Geographic Location | | Principal Balance | | Carrying Value | | % of Total | | Principal Balance | | Carrying Value | | % of Total |
United States | | | | | | | | | | | | |
New York | | $ | 27,145,557 | | | $ | 27,145,557 | | | 48.0 | % | | $ | 27,119,250 | | | $ | 27,119,250 | | | 34.7 | % |
California | | 21,567,296 | | | 21,726,387 | | | 38.5 | % | | 21,567,296 | | | 21,732,118 | | | 27.7 | % |
Georgia | | 17,911,517 | | | 18,121,333 | | | 32.1 | % | | 17,500,000 | | | 17,732,927 | | | 22.6 | % |
Utah | | — | | | — | | | — | % | | 21,250,000 | | | 21,462,500 | | | 27.4 | % |
Allowance for credit losses | | — | | | (10,523,226) | | | (18.6) | % | | — | | | (9,703,331) | | | (12.4) | % |
Total | | $ | 66,624,370 | | | $ | 56,470,051 | | | 100.0 | % | | $ | 87,436,546 | | | $ | 78,343,464 | | | 100.0 | % |
Allowance for Credit Losses
As described in Note 2, on January 1, 2023, the Company adopted the provisions of ASU 2016-13, Financial Instruments — Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). ASU 2016-13, which requires entities to recognize credit losses on financial instruments based on an estimate of current expected credit losses. The adoption of ASU 2016-13 resulted in a $0.7 million increase to total reserve, including reserve on future funding commitments, which was recognized as a cumulative-effect adjustment to member’s capital as of January 1, 2023.
Notes to Consolidated Financial Statements (Unaudited)
The following table presents the activity in allowance for credit losses for funded loans:
| | | | | | | | | | | | | | |
| | Three Months Ended March 31, |
| | 2024 | | 2023 |
Allowance for credit losses, beginning of period | | $ | 9,703,331 | | | $ | 3,937,050 | |
Cumulative effect of adoption of ASU 2016-13 effective January 1, 2023 (Note 2) | | — | | | 593,040 | |
Provision for (reversal of provision for) credit losses | | 819,895 | | | (82,847) | |
Charge-offs | | — | | | — | |
Recoveries | | — | | | — | |
Allowance for credit losses, end of period | | $ | 10,523,226 | | | $ | 4,447,243 | |
Certain of the Company’s performing loans contain provisions for future funding commitments, which are subject to the borrower meeting certain performance-related metrics that are monitored by the Company. These unfunded commitments on loans amounted to approximately $0.7 million and none as of March 31, 2024 and December 31, 2023, respectively.
The following table presents the activity in the liability for credit losses on unfunded commitments:
| | | | | | | | | | | |
| Three Months Ended March 31, |
| 2024 | | 2023 |
Liability for credit losses on unfunded commitments, beginning of period | $ | 8,801 | | | $ | — | |
Cumulative effect of credit loss accounting standard effective January 1, 2023 (Note 2) | — | | | 68,382 | |
Provision for (reversal of provision for) credit losses | 4,453 | | | (32,490) | |
Liability for credit losses on unfunded commitments, end of period | $ | 13,254 | | | $ | 35,892 | |
The liability for credit losses on unfunded commitments is included in other liabilities on the consolidated balance sheets.
Accrued Interest Receivable
The Company elected not to measure a CECL reserve on accrued interest receivable due to the Company’s policy of writing off uncollectible accrued interest receivable balances in a timely manner. If the Company determines it has uncollectible accrued interest receivable, it generally will reverse the accrued and unpaid interest against interest income and suspend the accrual for future interest income. For the three months ended March 31, 2024 and 2023, the Company did not reverse any interest income accrual because all accrued interest income was deemed collectible. As of both March 31, 2024 and December 31, 2023, the Company had two loans that were in default, and suspended interest income accrual of $1.2 million and $0.9 million for the three months ended March 31, 2024 and 2023, respectively, because recovery of such income was not probable. As of March 31, 2024 and December 31, 2023, there was no outstanding interest receivable on these loans.
Non-Performing Loans
As discussed in Note 2, for loans that are considered non-performing, the Company removes them from the industry loss rate approach and analyzes them separately for recoverability or based on sponsor’s guarantee. As of both March 31, 2024 and December 31, 2023, the Company had two non-performing loans with total carrying value of $27.1 million. Accordingly, the Company utilized the estimated fair value of the loan collateral or sponsor’s guarantee to estimate the total allowance for credit losses of $9.8 million and $9.2 million as of March 31, 2024 and December 31, 2023, respectively. Please see “Significant Unobservable Inputs” in Note 5 for information on how the fair values of these loans were determined. Loan Risk Rating
The Company assesses the risk factors of each loan and assigns each loan a risk rating between 1 and 5, which is an average of the numerical ratings in the following categories: (i) sponsor capability and financial condition; (ii) loan and collateral performance relative to underwriting; (iii) quality and stability of collateral cash flows and/or reserve balances; and (iv) loan to value. Based on a 5-point scale, the Company’s loans are rated “1” through “5”, from less risk to greater risk as follows:
Notes to Consolidated Financial Statements (Unaudited)
| | | | | | | | |
Risk Rating | | Description |
1 | | Very low risk |
2 | | Low risk |
3 | | Moderate/average risk |
4 | | Higher risk |
5 | | Highest risk |
The following tables present the amortized cost of the Company's loan portfolio by year of origination and loan risk rating as of:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | March 31, 2024 |
Loan Risk Rating | | Number of Loans | | Amortized Cost | | % of Total | | Amortized Cost by Year Originated |
| | | | 2024 | | 2023 | | 2022 | | 2021 | | 2020 | | Prior |
1 | | — | | | $ | — | | | — | % | | $ | — | | | — | | | — | | | — | | | — | | | — | |
2 | | — | | | — | | | — | % | | — | | | — | | | — | | | — | | | — | | | |
3 | | 2 | | | 21,061,371 | | | 31.5 | % | | — | | | | | — | | | 18,121,333 | | | — | | | 2,940,038 | |
4 | | 1 | | | 18,786,349 | | | 28.0 | % | | — | | | — | | | 18,786,349 | | | — | | | — | | | — | |
5 | | — | | | — | | | — | % | | — | | | — | | | — | | | — | | | — | | | — | |
Non-performing | | 2 | | | 27,145,557 | | | 40.5 | % | | — | | | — | | | — | | | — | | | — | | | 27,145,557 | |
| | 5 | | | 66,993,277 | | | 100.0 | % | | $ | — | | | $ | — | | | $ | 18,786,349 | | | $ | 18,121,333 | | | $ | — | | | $ | 30,085,595 | |
Allowance for credit losses | | (10,523,226) | | | | | | | | | | | | | | | |
Total, net of allowance for credit losses | | $ | 56,470,051 | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | December 31, 2023 |
Loan Risk Rating | | Number of Loans | | Amortized Cost | | % of Total | | Amortized Cost by Year Originated |
| | | | 2023 | | 2022 | | 2021 | | 2020 | | 2019 | | Prior |
1 | | — | | | $ | — | | | — | % | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | |
2 | | — | | | — | | | — | % | | — | | | — | | | — | | | — | | | — | | | |
3 | | 3 | | | 42,130,731 | | | 47.9 | % | | — | | | | | 39,195,427 | | | — | | | — | | | 2,935,304 | |
4 | | 1 | | | 18,796,818 | | | 21.3 | % | | — | | | 18,796,818 | | | — | | | — | | | — | | | — | |
5 | | — | | | — | | | — | % | | — | | | — | | | — | | | — | | | — | | | — | |
Non-performing | | 2 | | | 27,119,246 | | | 30.8 | % | | — | | | — | | | — | | | — | | | | | 27,119,246 | |
| | 6 | | | 88,046,795 | | | 100.0 | % | | $ | — | | | $ | 18,796,818 | | | $ | 39,195,427 | | | $ | — | | | $ | — | | | $ | 30,054,550 | |
Allowance for credit losses | | (9,703,331) | | | | | | | | | | | | | | | |
Total, net of allowance for credit losses | | $ | 78,343,464 | | | | | | | | | | | | | | | |
Held-to-Maturity Debt Securities
In the first quarter of 2023, the Company purchased $10.0 million of corporate bonds with a coupon rate of 6.125% that matured on May 15, 2023. The Company classified these bonds as held-to-maturity debt securities, as it had the intent and ability to hold these securities until maturity. These securities were recorded at amortized cost and were fully redeemed at par on May 15, 2023.
Note 4. Equity Investment in Unconsolidated Investments
As of March 31, 2024 and December 31, 2023, the Company owns equity interests in two joint ventures that own real estate properties. The Company accounts for its interests in these investments using the equity method of accounting because the Company does not have a controlling financial interest in these entities.
Notes to Consolidated Financial Statements (Unaudited)
The following table presents a summary of the Company’s equity investment in unconsolidated investments as of:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | March 31, 2024 | | December 31, 2023 |
Entity | | Co-owner | | Beneficial Ownership Interest | | Carrying Value | | Beneficial Ownership Interest | | Carrying Value |
SF - Dallas Industrial, LLC (1) | | Affiliate | | 80.0% | | $ | 34,929,282 | | | 80.0% | | $ | 35,690,795 | |
610 Walnut Investors LLC (2) | | Third party | | 42.4% | | 4,209,660 | | | 42.4% | | 4,740,915 | |
| | | | | | $ | 39,138,942 | | | | | $ | 40,431,710 | |
_______________(1)On December 28, 2022, the Company originated a $10.0 million mezzanine loan to a borrower to finance the acquisition of a real estate portfolio. Additionally, the Company entered into a residual profit-sharing agreement with the borrower in which the borrower would pay the Company an additional amount of 35.0% of remaining net cash flow from the sale of the real estate portfolio. The Company accounted for the entire arrangement as equity investment in unconsolidated investment. In May 2023, the Company made a cash payment of $27.4 million and settled the $10.0 million mezzanine loan in exchange for an 80.0% equity interest in a joint venture that owns the real estate portfolio. Terra REIT owns the other 20.0% of the joint venture.
(2)In November 2023, the Company contributed $5.1 million to a joint venture that owns a real estate property.
The following table presents a summary of equity income of and distributions received from the Company’s equity investment in unconsolidated investments:
| | | | | | | | | | | | | | |
| | Three Months Ended March 31, |
| | 2024 | | 2023 |
(Loss) income from equity investment in unconsolidated investments | | $ | (1,187,179) | | | $ | 315,013 | |
Distributions received from unconsolidated investments | | $ | 106,115 | | | $ | 262,770 | |
The following tables present estimated combined summarized financial information of the Company’s equity investment in the joint ventures. Amounts provided are the total amounts attributable to the joint ventures and do not represent the Company’s proportionate share:
| | | | | | | | | | | | | | |
| | March 31, 2024 | | December 31, 2023 |
Net investments in real estate | | $ | 116,896,696 | | | $ | 118,332,211 | |
Other assets | | 7,385,392 | | | 8,658,923 | |
Total assets | | 124,282,088 | | | 126,991,134 | |
Mortgage loan payable | | 77,267,288 | | | 77,223,082 | |
Other liabilities | | 4,765,886 | | | 5,501,677 | |
Total liabilities | | 82,033,174 | | | 82,724,759 | |
Members’ capital | | $ | 42,248,914 | | | $ | 44,266,375 | |
| | | | | | | | | | | |
| Three Months Ended March 31, |
| 2024 | | 2023 |
Revenues | $ | 1,715,745 | | | $ | — | |
Operating expenses | (631,144) | | | — | |
Depreciation and amortization expense | (1,563,913) | | | — | |
Interest expense | (1,537,056) | | | — | |
Net loss | $ | (2,016,368) | | | $ | — | |
Note 5. Fair Value Measurements
The Company follows the provisions of ASC 820, Fair Value Measurement (“ASC 820”), which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. ASC 820 established a fair value hierarchy that prioritizes and ranks the level of market price observability used in measuring investments at fair
Notes to Consolidated Financial Statements (Unaudited)
value. Market price observability is impacted by a number of factors, including the type of investment, the characteristics specific to the investment, and the state of the marketplace (including the existence and transparency of transactions between market participants). Investments with readily available, actively quoted prices or for which fair value can be measured from actively quoted prices in an orderly market will generally have a higher degree of market price observability and a lesser degree of judgment used in measuring fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). Investments measured and reported at fair value are classified and disclosed into one of the following categories based on the inputs as follows:
Level 1 — Quoted prices (unadjusted) in active markets for identical assets and liabilities that the Company has the ability to access.
Level 2 — Pricing inputs are other than quoted prices in active markets, including, but not limited to, quoted prices for similar assets and liabilities in markets that are active, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the assets or liabilities (such as interest rates, yield curves, volatilities, prepayment speeds, loss severities, credit risks and default rates) or other market corroborated inputs.
Level 3 — Significant unobservable inputs are based on the best information available in the circumstances, to the extent observable inputs are not available, including the Company’s own assumptions used in determining the fair value of investments. Fair value for these investments is determined using valuation methodologies that consider a range of factors, including but not limited to the price at which the investment was acquired, the nature of the investment, local market conditions, trading values on public exchanges for comparable securities, current and projected operating performance, and financing transactions subsequent to the acquisition of the investment. The inputs into the determination of fair value require significant management judgment.
In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an investment’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and the Company considers factors specific to the investment.
As of March 31, 2024 and December 31, 2023, the Company had not elected the fair value option for its financial instruments, including loans held for investment, loans held for investment acquired through participation, term loan payable and unsecured notes payable. Such financial instruments are carried at cost, less impairment or less net deferred costs, where applicable. Held-to-maturity debt securities are financial instruments that are reported at amortized cost.
Financial Instruments Carried at Fair Value on a Recurring Basis
From time to time, the Company may invest in short-term debt and equity securities which are classified as available-for-sale securities, and are presented at fair value on the consolidated balance sheet. Changes in the fair value of equity securities are recognized in earnings. Changes in the fair value of debt securities are reported in other comprehensive income until the securities are realized. Additionally, the Company may invest in short-term money market funds. These funds are included in cash and cash equivalents on the consolidated balance sheet due to their short-term nature and can be easily converted to cash.
The following tables present fair value measurements of financial instruments that were carried at fair value, by major class, according to the fair value hierarchy:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | March 31, 2024 |
| | Fair Value Measurements |
| | Level 1 | | Level 2 | | Level 3 | | Total |
Marketable securities - debt securities | | $ | 358,979 | | | $ | — | | | $ | — | | | $ | 358,979 | |
Total | | $ | 358,979 | | | $ | — | | | $ | — | | | $ | 358,979 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | December 31, 2023 |
| | Fair Value Measurements |
| | Level 1 | | Level 2 | | Level 3 | | Total |
Marketable securities - debt securities | | $ | 507,266 | | | $ | — | | | $ | — | | | $ | 507,266 | |
Total | | $ | 507,266 | | | $ | — | | | $ | — | | | $ | 507,266 | |
Notes to Consolidated Financial Statements (Unaudited)
The following table presents the activities of the marketable securities:
| | | | | | | | | | | | | | |
| | Three Months Ended March 31, |
| | 2024 | | 2023 |
Beginning balance | | $ | 507,266 | | | $ | — | |
Fair market value adjustment | | (148,287) | | | — | |
Ending balance | | $ | 358,979 | | | $ | — | |
Financial Instruments Not Carried at Fair Value
The following table presents the carrying value and estimated fair value of the Company’s financial instruments that are not carried at fair value on the consolidated balance sheets as of:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | March 31, 2024 | | December 31, 2023 |
| | Level | | Principal Balance | | Carrying Value | | Fair Value | | Principal Balance | | Carrying Value | | Fair Value |
Investments: | | | | | | | | | | | | | | |
Loans held for investment | | 3 | | $ | 39,478,813 | | | $ | 39,847,720 | | | $ | 39,709,179 | | | $ | 60,317,296 | | | $ | 60,927,545 | | | $ | 60,642,806 | |
Loans held for investment acquired through participation | | 3 | | 27,145,557 | | | 27,145,557 | | | 17,334,857 | | | 27,119,250 | | | 27,119,250 | | | 17,884,929 | |
Allowance for credit losses | | | | — | | | (10,523,226) | | | — | | | — | | | (9,703,331) | | | — | |
Total loans | | | | $ | 66,624,370 | | | $ | 56,470,051 | | | $ | 57,044,036 | | | $ | 87,436,546 | | | $ | 78,343,464 | | | $ | 78,527,735 | |
Liabilities: | | | | | | | | | | | | | | |
Unsecured notes payable (1)(2) | | 1 | | $ | 38,375,000 | | | $ | 35,527,087 | | | $ | 37,607,500 | | | $ | 38,375,000 | | | $ | 35,213,543 | | | $ | 36,287,400 | |
Obligation under participation agreement | | 3 | | 15,000,000 | | | 15,107,458 | | | 15,196,628 | | | — | | | — | | | — | |
Term loan payable (3)(4) | | 3 | | — | | | — | | | — | | | 15,000,000 | | | 14,948,604 | | | 15,000,000 | |
Total liabilities | | | | $ | 53,375,000 | | | $ | 50,634,545 | | | $ | 52,804,128 | | | $ | 53,375,000 | | | $ | 50,162,147 | | | $ | 51,287,400 | |
_______________(1)Carrying value is net of unamortized purchase discount of $2.8 million and $3.2 million as of March 31, 2024 and December 31, 2023, respectively.
(2)Valuation falls under Level 1 of the fair value hierarchy, which is based on the trading price of $24.50 and $23.64 as of the close of the business day on March 28, 2024 and December 29, 2023, respectively.
(3)Carrying value is net of unamortized discount of $0.1 million as of December 31, 2023.
(4)Valuation falls under Level 3 of the fair value hierarchy, which is based on a discounted cash flow model with a discount rate of 12.48%, as of December 31, 2023.
Valuation Methodology
The fair value of the Company’s investment in corporate bonds, preferred stock and common stock within the marketable securities portfolio, if any, is determined based on quoted prices in an active market and is classified as Level 1 of the fair value hierarchy. Additionally, the fair value of the Company’s unsecured notes payable is determined based on quoted price in an active market and is also classified as Level 1.
Market quotations are not readily available for the Company’s real estate-related loan investments, all of which are included in Level 3 of the fair value hierarchy, as these investments are valued utilizing a yield approach, i.e., a discounted cash flow methodology to arrive at an estimate of the fair value of each respective investment in the portfolio using an estimated market yield. In following this methodology, investments are evaluated individually, and management takes into account, in determining the risk-adjusted discount rate for each of the Company’s investments, relevant factors, including available current market data on applicable yields of comparable debt/preferred equity instruments; market credit spreads and yield curves; the investment’s yield; covenants of the investment, including prepayment provisions; the ability of the Company’s borrowers and investees to make payments, net operating income and debt service coverage ratio; construction progress reports and construction budget analysis; the nature, quality and realizable value of any collateral (and loan-to-value ratio); the forces that influence the local markets in which the asset (the collateral) is purchased and sold, such as capitalization rates, occupancy rates, rental rates and replacement costs; and the anticipated duration of each real estate-related loan investment.
Notes to Consolidated Financial Statements (Unaudited)
These valuation techniques are applied in a consistent and verifiable manner to all investments that are categorized within Level 3 of the fair value hierarchy and the REIT Manager provides the board of directors of Terra REIT (the “Terra REIT Board”), (a majority of which is made up of independent directors) with the investment valuations that are based on this discounted cash flow methodology. Valuations are prepared quarterly, or more frequently as needed, with each asset in the portfolio subject to a valuation prepared by a third-party valuation service at a minimum of once during every 12-month period. REIT Manager reviews the preliminary valuation with the Terra REIT Board and, together with an independent valuation firm, if applicable, responds and supplements the preliminary valuation to reflect any comments provided by the Terra REIT Board. The REIT Manager discusses valuations and determines the fair value of each investment in the portfolio in good faith based on various metrics and other factors, including the input and recommendation provided by the Terra REIT Board and any third-party valuation firm, if applicable.
Significant Unobservable Inputs
The following tables summarize the significant unobservable inputs used by the Company to value the Level 3 investments as of March 31, 2024 and December 31, 2023. The following tables are not intended to be all-inclusive, but instead identify the significant unobservable inputs relevant to the determination of fair values.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
March 31, 2024 |
| | | | Primary Valuation Technique | | Unobservable Input | | Range | | Weighted |
Asset Category | | Fair Value | | | | Minimum | | Maximum | | Average |
Assets: | | | | | | | | | | | | |
Loans | | $ | 39,709,179 | | | Discounted cash flow | | Discount rate | | 12.78 | % | | 16.38 | % | | 15.92 | % |
Loans through participation interest (1) | | 17,334,857 | | | Discounted cash flow | | Discount rate | | N/A | | N/A | | N/A |
Total Level 3 Assets | | $ | 57,044,036 | | | | | | | | | | | |
Liabilities: | | | | | | | | | | | | |
Obligation under participation agreement | | $ | 15,196,628 | | | Discounted cash flow | | Discount rate | | 16.38 | % | | 16.38 | % | | 16.38 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
December 31, 2023 |
| | | | Primary Valuation Technique | | Unobservable Input | | Range | | Weighted |
Asset Category | | Fair Value | | | | Minimum | | Maximum | | Average |
Assets: | | | | | | | | | | | | |
Loans | | $ | 60,642,806 | | | Discounted cash flow | | Discount rate | | 13.02 | % | | 16.95 | % | | 15.88 | % |
Loans through participation interest (1) | | 17,884,929 | | | Discounted cash flow | | Discount rate | | N/A | | N/A | | N/A |
Total Level 3 Assets | | $ | 78,527,735 | | | | | | | | | | | |
_______________(1)These were non-performing loans, as described in Note 3. The fair market value estimates were determined primarily using discounted cash flow models and Level 3 inputs, which include estimates of property-specific cash flows over a specific holding period, a discount rate of 6.75% and a terminal capitalization rate of 5.75%. These inputs are based on the location, type and nature of the property, current sales and lease comparables, anticipated real estate and capital market conditions, and management’s knowledge, experience and judgment. Additionally, the Company may use sales comparables to corroborate the estimated value of a loan’s collateral or may use sponsor’s guarantee to estimate the value of a non-performing loan. If the weighted average discount rate used to value the Company’s investments were to increase, the fair value of the Company’s investments would decrease. Conversely, if the weighted average discount rate used to value the Company’s investments were to decrease, the fair value of Company’s investments would increase.
Note 6. Related Party Transactions
Promissory Note Receivable
On January 24, 2024, the Company entered into a revolving promissory note receivable with Terra REIT. The promissory note receivable bears interest at the Prime Rate, as such Prime Rate is published in the Wall Street Journal, computed on the basis of the actual number of days elapsed and a year of 365 days. The promissory note matures on March 31, 2027. For the three months ended March 31, 2024, the Company provided funding under the promissory note receivable of $10.7 million and the amount outstanding under the promissory note receivable was $10.7 million. For the three months ended March 31, 2024,
Notes to Consolidated Financial Statements (Unaudited)
interest income recognized on the promissory note receivable was $0.1 million, which was included in Interest income on the consolidated statements of operations and comprehensive loss.
Cost Sharing Agreement
On November 8, 2022, the Company entered into the Cost Sharing Agreement with Terra REIT effective October 1, 2022, pursuant to which the Company reimburses Terra REIT for its allocable portion of management and transaction fees and operating expenses incurred by Terra REIT, including fees paid by Terra REIT to the REIT Manager.
The following table presents a summary of such fees and reimbursements incurred pursuant to the Cost Sharing Agreement between Terra LLC and Terra REIT:
| | | | | | | | | | | | | | |
| | Three Months Ended March 31, |
| | 2024 | | 2023 |
Amounts Included in the Statements of Operations |
Asset management and asset servicing fees | | $ | 390,058 | | | $ | 434,550 | |
Operating expense reimbursement to Adviser (1) | | 382,294 | | | 305,880 | |
Origination, extension and disposition fees | | 218,992 | | | — | |
_______________(1)Amounts were primarily compensation for time spent supporting the Company’s day-to-day operations.
Terra REIT’s Management Agreement with the REIT Manager
Terra REIT is the Company’s parent and sole member. The Company has entered into a cost sharing arrangement with Terra REIT pursuant to which the Company is responsible for its allocable share of Terra REIT’s expenses, including fees paid by Terra REIT to its manager, the REIT Manager. Terra REIT currently pays the following fees to the REIT Manager pursuant to the Management Agreement:
Origination and Extension Fee. An origination fee in the amount of 1.0% of the amount used to originate, acquire, fund or structure real estate-related investments, including any third-party expenses related to such loan. In the event that the term of any real estate-related loan is extended, the REIT Manager also receives an origination fee equal to the lesser of (i) 1.0% of the principal amount of the loan being extended or (ii) the amount of fee paid by the borrower in connection with such extension.
Asset Management Fee. A monthly asset management fee at an annual rate equal to 1.0% of the aggregate funds under management, which includes the loan origination amount or aggregate gross acquisition cost, as applicable, for each real estate-related loan and cash held by Terra REIT.
Asset Servicing Fee. A monthly asset servicing fee at an annual rate equal to 0.25% of the aggregate gross origination price or aggregate gross acquisition price for each real estate related loan then held by Terra REIT (inclusive of closing costs and expenses).
Disposition Fee. A disposition fee in the amount of 1.0% of the gross sale price received by Terra REIT from the disposition of each loan, but not upon the maturity, prepayment, workout, modification or extension of a loan unless there is a corresponding fee paid by the borrower, in which case the disposition fee will be the lesser of (i) 1.0% of the principal amount of the loan and ii) the amount of the fee paid by the borrower in connection with such transaction. If Terra REIT takes ownership of a property as a result of a workout or foreclosure of a loan, Terra REIT will pay a disposition fee upon the sale of such property equal to 1.0% of the sales price.
Transaction Breakup Fee. In the event that Terra REIT receive any “breakup fees,” “busted-deal fees,” termination fees, or similar fees or liquidated damages from a third-party in connection with the termination or non-consummation of any loan or disposition transaction, the REIT Manager will be entitled to receive one-half of such amounts, in addition to the reimbursement of all out-of-pocket fees and expenses incurred by the REIT Manager with respect to its evaluation and pursuit of such transactions.
In addition to the fees described above, Terra REIT reimburses the REIT Manager for operating expenses incurred in connection with services provided to the operations of Terra REIT, including its allocable share of the REIT Manager’s overhead, such as rent, employee costs, utilities, and technology costs.
Notes to Consolidated Financial Statements (Unaudited)
Management Agreement Amendment
On March 11, 2024, Terra REIT and the REIT Manager entered into an amendment to the Management Agreement, effective as of January 1, 2024 (the “Amendment”), in order to extend the term of the Management Agreement and modify the terms upon which the Management Agreement may be terminated. Except as discussed below, the terms of the Management Agreement remain unchanged by the Amendment. Except where the context requires otherwise, all references herein to the “Management Agreement” are to the Management Agreement as modified by the Amendment.
The term of the Management Agreement will expire on December 31, 2027 (the “Initial Term”) and will automatically renew for an unlimited number of additional one-year terms upon each anniversary date of the last day of the Initial Term (each, a “Renewal Term”), unless terminated by Terra REIT or the REIT Manager during the Initial Term or a Renewal Term in accordance with the terms of the Management Agreement (as described below).
The Management Agreement may be terminated by Terra REIT during the Initial Term or any Renewal Term upon a finding by either (i) at least two-thirds of the independent directors on the Terra REIT Board or (ii) the holders of a majority of the outstanding shares of Terra REIT’s common stock (other than those shares held by members of Terra REIT’s senior management team or affiliates of the REIT Manager) that either (a) there has been unsatisfactory performance by the REIT Manager that is materially detrimental to Terra REIT, or (b) the compensation payable to the REIT Manager pursuant to the Management Agreement is unfair; provided, however, that Terra REIT will not have the right to terminate the Management Agreement on the basis of unfair compensation to the REIT Manager if the REIT Manager agrees to continue to provide its services under the Management Agreement in exchange for reduced fees that at least two-thirds of the independent directors on the Terra REIT Board determine to be fair pursuant to the procedures set forth in the Management Agreement. Terra REIT must deliver prior written notice of any such termination to the REIT Manager at least 180 days prior to the last calendar day of the Initial Term or the then-current Renewal Term, as applicable, and the Management Agreement will terminate effective as of the last calendar day of the Initial Term or the then-current Renewal Term, as applicable.
Upon any termination of the Management Agreement by Terra REIT as discussed above, Terra REIT will pay the REIT Manager, on the date on which such termination is effective, a termination fee in an amount equal to three times the average annual fees of all types and expense reimbursements received by or owed to the REIT Manager pursuant to the Management Agreement during the 24-month period immediately preceding such termination (the “Termination Fee”), calculated as of the end of the most recently completed monthly prior to the date of such termination.
Terra REIT may also terminate the Management Agreement, effective upon 30 calendar days’ prior written notice from the Terra REIT Board to the REIT Manager, without payment of any Termination Fees or other penalties, upon (i) the material breach of the Management Agreement by the REIT Manager or its affiliates that continues for 30 days after written notice thereof to the REIT Manager (or 45 days after delivery of written notice thereof if the REIT Manager takes diligent steps to cure such breach within 30 days of delivery of the written notice), (ii) any fraud or other criminal conduct, gross negligence or breach of fiduciary duty by the REIT Manager or its affiliates in connection with the Management Agreement, as determined by a final, non-appealable judgment of a court of competent jurisdiction, (iii) the REIT Manager’s bankruptcy, insolvency or dissolution, or (iv) an Internalization Event (as defined in the Management Agreement). No Termination Fee or other penalty is payable upon such a termination by us.
The REIT Manager may terminate the Management Agreement, effective upon 60 days’ prior written from the REIT Manager to Terra REIT, if Terra REIT breaches the Management Agreement and such breach continues for 30 days after written notice thereof. Terra REIT will pay the REIT Manager the Termination Fee upon such termination by the REIT Manager.
Participation Agreements
The Company may enter into participation agreements with related and unrelated parties, primarily other affiliated funds of the REIT Manager. The participation agreements provide the Company with the opportunity to invest along the same terms, conditions, price and rights in the specified investment. The purpose of the participation agreements is to allow the Company and an affiliate to originate a specified investment when, individually, the Company does not have the liquidity to do so or to achieve a certain level of portfolio diversification. The Company may transfer portions of its investments to other participants or it may be a participant to an investment held by another entity.
ASC Topic 860, Transfers and Servicing (“ASC 860”), establishes accounting and reporting standards for transfers of financial assets. ASC 860-10 provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. The Company has determined that the participation agreements it enters into are accounted for as secured borrowings under ASC Topic 860.
Notes to Consolidated Financial Statements (Unaudited)
Participation interest purchased by the Company: The below tables list the investment interests purchased by the Company via participation agreements (each, a “PA”) as of March 31, 2024 and December 31, 2023. In accordance with the terms of each PA, each participant’s rights and obligations, including interest income and other income (e.g., exit fee and prepayment income) and related fees/expenses are based upon its respective pro-rata participation interest in such investments, as specified in the respective PA. The Company’s share of the investment is repayable only from the proceeds received from the related borrower/issuer of the investment, and therefore the Company is also subject to the credit risk (i.e., risk of default by the underlying borrower/issuer).
Pursuant to each PA, the affiliated fund receives and allocates the interest income and other related investment incomes in respect of the investment to the Company. The Company paid related expenses (i.e., the base management fee) directly to Terra REIT.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | March 31, 2024 | | December 31, 2023 |
| | Participating Interests | | Principal Balance | | Carrying Value | | Participating Interests | | Principal Balance | | Carrying Value |
370 Lex Part Deux, LLC (1) | | 35.0 | % | | $ | 24,491,877 | | | $ | 24,491,877 | | | 35.0 | % | | $ | 24,491,877 | | | $ | 24,491,877 | |
RS JZ Driggs, LLC (1) | | 50.0 | % | | 2,653,680 | | | 2,653,680 | | | 50.0 | % | | 2,627,373 | | | 2,627,373 | |
Allowance for credit losses | | | | — | | | (9,810,699) | | | | | — | | | (9,234,320) | |
Total | | | | $ | 27,145,557 | | | $ | 17,334,858 | | | | | $ | 27,119,250 | | | $ | 17,884,930 | |
_______________(1)The loan is held in the name of Terra REIT, the Company’s parent entity.
Transfers of participation interests by the Company: The following table summarizes the investment that was subject to a
PA with investment partnership affiliated with the REIT Manager as of March 31, 2024. There was no such investment as of December 31, 2023.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | March 31, 2024 |
| | | | | | Transfers treated as obligations under participation agreements |
| | Principal | | Carrying Value | | % Transferred | | Principal | | Carrying Value |
Asano Bankers Hill, LLC (1) | | $ | 18,567,296 | | | $ | 18,786,349 | | | 80.8 | % | | $ | 15,000,000 | | | $ | 15,107,458 | |
________________
(1)Participant is a certain separately managed account, an investment partnership managed by the REIT Manager.
This investment is held in the name of the Company, but the Participant’s rights and obligations, including interest income and other income (e.g., exit fee, prepayment income) and related fees/expenses (e.g., disposition fees, asset management and asset servicing fees), are based upon its pro rata participation interest in such participated investment, as specified in the participation agreement. The Participant’s share of the investment is repayable only from the proceeds received from the related borrower/issuer of the investment and, therefore, the Participant also is subject to credit risk (i.e., risk of default by the underlying borrower/issuer). Pursuant to the participation agreement with this entity, the Company receives and allocates the interest income and other related investment income to the Participant based on its pro rata participation interest. The Participant pays any expenses, including any fees to the REIT Manager, only on its pro rata participation interest, subject to the terms of the governing fee arrangements.
Note 7. Debt
Senior Unsecured Notes
On February 10, 2021, Terra BDC issued $34.8 million in aggregate principal amount of 7.00% fixed-rate notes due 2026, and on February 26, 2021, the underwriters exercised the option to purchase an additional $3.6 million of the notes (collectively the “7.00% Senior Notes Due 2026”). The 7.00% Senior Notes Due 2026 may be redeemed in whole or in part at any time or from time to time at Terra BDC’s option on or after February 10, 2023, at a redemption price equal to 100% of the outstanding principal amount thereof, plus accrued and unpaid interest. In connection with the Merger, Terra LLC assumed all of Terra BDC’s rights and obligations under the indenture governing the 7.00% Senior Notes Due 2026.
Notes to Consolidated Financial Statements (Unaudited)
The indenture between Terra LLC (as successor to Terra BDC) and the trustee contains certain debt limitations and asset coverage covenants. As of March 31, 2024, the Company was in compliance with the asset coverage ratio requirements under the indenture.
The following table is a summary of the Company’s unsecured notes payable outstanding as of:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Coupon Rate | | Effective Rate (1) | | Maturity Date | | March 31, 2024 | | December 31, 2023 |
7.00% Senior Notes Due 2026 (2) | | 7.00 | % | | 10.27 | % | | 3/31/2026 | | 38,375,000 | | | 38,375,000 | |
Unamortized purchase discount (2) | | | | | | | | (2,847,913) | | | (3,161,457) | |
Unsecured notes payable, net | | | | | | | | $ | 35,527,087 | | | $ | 35,213,543 | |
_______________(1)Includes purchase discount that is amortized to interest expense over the remaining life of the notes.
(2)In connection with the Merger, Terra LLC assumed all the obligations under the 7.00% Senior Notes and recorded a purchase discount of $4.6 million, representing the difference between the carrying value and the fair value of the notes on the date of the merger.
Term Loan
In April 2021, Terra BDC entered into a credit agreement (the “Credit Agreement”) with a lender to provide for a delayed draw term loan of $25.0 million (the “Term Loan”). On September 27, 2022, the Credit Agreement was amended to, among other things, remove the make whole premium on voluntary prepayment of the loans as well as to provide consent to the consummation of the Merger and the assumption by Terra LLC of all of the rights and obligations of Terra BDC under the Credit Agreement. On June 30, 2023, Terra LLC amended the Credit Agreement to, among other things, (i) decrease the principal amount to $15.0 million, (ii) extend the scheduled maturity date to March 31, 2024, and (iii) increase the rate on which the loans thereunder bear interest from a fixed rate of 5.625% per annum to a floating rate based on SOFR plus 7.375% with a SOFR floor of 5.0%, and repaid $10.0 million of the principal amount of the Term Loan. The Credit Agreement was secured by a lien on substantially all of Terra BDC's, and, following the Merger, Terra LLC’s owned and thereafter acquired property. In March 2024, the Credit Agreement was repaid in full.
The following table is a summary of the Company’s obligations under the Credit Agreement as of December 31, 2023. There was no such loan outstanding as of March 31, 2024.
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Maturity | | Interest rate | | Pledged Asset Carrying Value | | Principal Amount |
Term loan payable | | 3/31/2024 | | 12.72 | % | | $ | 130,435,138 | | | $ | 15,000,000 | |
Unamortized deferred financing cost | | | | | | | | (51,396) | |
Unsecured notes payable, net | | | | | | | | $ | 14,948,604 | |
Scheduled Debt Principal Payments
Scheduled debt principal payments for each of the five calendar years following March 31, 2024 are as follows:
| | | | | | | | |
Years Ending December 31, | | Total |
2024 (April 1 through December 31) | | $ | — | |
2025 | | — | |
2026 | | 38,375,000 | |
2027 | | |
2028 | | — | |
Thereafter | | — | |
| | 38,375,000 | |
Unamortized purchase discount | | (2,847,913) | |
Total | | $ | 35,527,087 | |
Notes to Consolidated Financial Statements (Unaudited)
Obligation Under Participation Agreement
As discussed in Note 2, the Company follows the guidance in ASC 860 when accounting for loan participation. Such guidance requires the transferred interests meet certain criteria in order for the transaction to be recorded as a sale. Loan participation from the Company which does not qualify for sale treatment remains on the Company’s consolidated balance sheets and the proceeds are recorded as obligation under participation agreement. As of March 31, 2024, obligation under participation agreement had a carrying value of $15.1 million, and the carrying value of the loan that is associated this obligation under participation agreement was $18.8 million (see “Participation Agreements” in Note 6). The interest rate on the obligation under participation agreement was 20.3%. There was no such obligation under participation agreement as of December 31, 2023. Note 8. Commitments and Contingencies
Unfunded Commitments on Loans Held for Investment
In the ordinary course of business, the Company may enter into future funding commitments, which are subject to the borrower meeting certain performance-related metrics that are monitored by the Company. As of both March 31, 2024 and December 31, 2023, the Company had $0.7 million of unfunded commitments. The Company maintained sufficient cash on hand to fund such unfunded commitments, including matching these commitments with principal repayments on outstanding loans.
Other
The Company enters into contracts that contain a variety of indemnification provisions. The Company’s maximum exposure under these arrangements is unknown; however, the Company has not had prior claims or losses pursuant to these contracts. Management of Terra Income Advisors has reviewed the Company’s existing contracts and expects the risk of loss to the Company to be remote.
The Company is not currently subject to any material legal proceedings and, to the Company’s knowledge, no material legal proceedings are threatened against the Company. From time to time, the Company may be a party to certain legal proceedings in the ordinary course of business, including proceedings relating to the enforcement of the Company’s rights under its contracts with its borrowers and investees. While the outcome of any legal proceedings cannot be predicted with certainty, the Company does not expect that any such proceedings will have a material adverse effect upon its financial condition or results of operations.
See Note 6 for a discussion of the Company’s commitments to Terra REIT. Note 9. Subsequent Events
The management of the Company has evaluated events and transactions through the date the consolidated financial statements were issued and has determined that there are no material events that would require adjustment to or disclosure in the Company’s consolidated financial statements.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The information contained in this section should be read in conjunction with our unaudited consolidated financial statements and related notes thereto and other financial information included elsewhere in this Quarterly Report on Form 10-Q. In this report, “we,” “us” and “our” refer to Terra Income Fund 6, LLC.
FORWARD-LOOKING STATEMENTS
Some of the statements in this quarterly report on Form 10-Q constitute forward-looking statements because they relate to future events or our future performance or financial condition. The forward-looking statements contained in this quarterly report on Form 10-Q may include, but are not limited to, statements as to:
•our expected financial performance and operating results;
•our ability to achieve the expected synergies, cost savings and other benefits from the Merger (as defined in the section entitled “Overview” below);
•risks associated with achieving expected synergies, cost savings and other benefits from the Merger;
•the availability of attractive risk-adjusted investment opportunities in our target asset class and other real estate-related investments that satisfy our objectives and strategies;
•the origination or acquisition of our targeted assets, including the timing of originations or acquisitions;
•volatility in our industry, interest rates and spreads, the debt or equity markets, the general economy or the real estate market specifically, whether the results of market events or otherwise;
•changes in our investment objectives and business strategy;
•the availability of financing on acceptable terms or at all;
•the performance and financial condition of our borrowers;
•changes in interest rates and the market value of our assets;
•borrower defaults or decreased recovery rates from our borrowers;
•changes in prepayment rates on our loans;
•our use of financial leverage;
•actual and potential conflicts of interest with any of the following affiliated entities: Terra Income Fund 6, Inc. (“Terra BDC”); Terra Income Fund 6 LLC (“Terra LLC”), a wholly owned subsidiary of Terra Property Trust, Inc. (“Terra REIT”) and the successor of Terra BDC; Terra Capital Partners, LLC (“Terra Capital Partners”), our sponsor; Terra REIT Advisors, LLC, a subsidiary of Terra Capital Partners, and the external manager to our sole member Terra REIT (the “REIT Manager”); Terra Fund Advisors, LLC, an affiliate of Terra Capital Partners; Terra Secured Income Fund 5 International, Terra Income Fund International and Terra Secured Income Fund 7, LLC, (collectively, the “Terra Income Funds”); Terra Offshore Funds REIT, LLC; Mavik Real Estate Special Opportunities Fund, LP; or any of their affiliates;
•our dependence on the REIT Manager or its affiliates and the availability of its senior management team and other personnel;
•actions and initiatives of the U.S., federal, state and local government and changes to the U.S. federal, state and local government policies and the execution and impact of these actions, initiatives and policies; and
•the degree and nature of our competition.
In addition, words such as “anticipate,” “believe,” “expect” and “intend” indicate a forward-looking statement, although not all forward-looking statements include these words. The forward-looking statements contained in this quarterly report on Form 10-Q involve risks and uncertainties. Our actual results could differ materially from those implied or expressed in the forward-
looking statements for any reason, including the factors set forth as “Risk Factors” in our Annual Report on Form 10-K. Other factors that could cause actual results to differ materially include:
•changes in the economy;
•risks associated with possible disruption in our operations or the economy generally due to terrorism or natural disasters; and
•future changes in laws or regulations and conditions in our operating areas.
We have based the forward-looking statements included in this quarterly report on Form 10-Q on information available to us on the date of this quarterly report on Form 10-Q. Except as required by the federal securities laws, we undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise. Stockholders are advised to consult any additional disclosures that we may make directly to stockholders or through reports that we may file in the future with the Securities and Exchange Commission (the “SEC”), including annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K. The forward-looking statements and projections contained in this quarterly report on Form 10-Q are excluded from the safe harbor protection provided by Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).
Overview
Terra LLC was formed as a Delaware limited liability company on April 29, 2022 as a wholly owned subsidiary of Terra REIT. On October 1, 2022, pursuant to an Agreement and Plan of Merger, dated as of May 2, 2022 (as amended, the “Merger Agreement”), Terra BDC merged with and into Terra LLC, with Terra LLC continuing as the surviving entity of the merger (the “Merger”). Subsequent to the Merger, Terra LLC became the successor of Terra BDC and assumed all of Terra BDC’s rights and obligations, including the obligations under the indenture governing Terra BDC’s unsecured notes payable.
We are a wholly owned subsidiary of Terra REIT. Terra REIT’s investments activities are externally managed by the REIT Manager, our affiliate. We originate, invest in and manage a diverse portfolio of real estate-related investments that generate a stable income stream. We directly originate, structure and underwrite most, if not all, of our loans, as we believe that doing so will provide us with the best opportunity to invest in loans that satisfy its standards, establish a direct relationship with the borrower and optimize the terms of its investments; however, we may acquire existing loans from the originating lender should its adviser determine such an investment is in its best interest. We may also make strategic non-real estate related investments that align with our investment objectives and criteria. We may hold our investments until their scheduled maturity dates or may sell them if we are able to command favorable terms for their disposition. We may seek to realize growth in the value of its investments by timing their sale to maximize value.
On November 8, 2022, we entered into a cost sharing agreement with Terra REIT effective October 1, 2022, pursuant to which we reimburse Terra REIT for its allocable portion of management and transaction fees and operating expenses incurred by Terra REIT, including fees paid by Terra REIT to the REIT Manager (the “Cost Sharing Agreement”).
Recent Developments
Securities Purchase Program
As previously disclosed, Terra REIT may repurchase certain of its 6.00% senior notes due 2026 listed on the New York Stock Exchange (“NYSE”) under the trading symbol “TPTA” and we may repurchase certain of our 7.00% senior notes due 2026 listed on the NYSE under the trading symbol “TFSA”. The repurchases may be made directly by us or made indirectly through an affiliated purchaser entity managed by the REIT Manager and co-owned by Terra REIT and other vehicles managed by the REIT Manager or its affiliates. Such affiliate purchaser entity may also purchase third-party marketable securities. The timing and amount of any transactions will be determined by the REIT Manager based on its evaluation of market conditions, prices, legal requirements and other factors, and may be made from time to time on the open market, in privately negotiated transactions or otherwise, in each case subject to compliance with all SEC rules and other legal requirements.
Portfolio Summary
Net Loan Portfolio
The following table provides a summary of our net loan portfolio as of:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| March 31, 2024 |
| Fixed Rate | | Floating Rate (1)(2) | | Total Gross Loans | | Obligations under Participation Agreements | | Total Net Loans |
Number of loans | 3 | | 2 | | 5 | | 1 | | 5 |
Principal balance | $ | 23,565,197 | | | $ | 43,059,173 | | | $ | 66,624,370 | | | $ | 15,000,000 | | $ | 51,624,370 | |
Carrying value | 23,362,940 | | | 33,107,111 | | | 56,470,051 | | | 15,107,458 | | 41,362,593 | |
Fair value | 23,552,173 | | | 33,491,863 | | | 57,044,036 | | | 15,196,628 | | 41,847,408 | |
Weighted-average coupon rate | 13.4% | | 16.6% | | 15.4% | | 20.3% | | 14.0% |
Weighted-average remaining term (years) | 0.60 | | 0.85 | | 0.72 | | 0.85 | | | 0.64 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2023 |
| Fixed Rate | | Floating Rate (1)(2) | | Total | | Obligations under Participation Agreements | | Total Net Loans |
Number of loans | 4 | | 2 | | 6 | | — | | 6 |
Principal balance | $ | 44,377,373 | | | $ | 43,059,173 | | | $ | 87,436,546 | | | $ | — | | | $ | 87,436,546 | |
Carrying value | 44,528,468 | | | 33,814,996 | | | 78,343,464 | | | — | | | 78,343,464 | |
Fair value | 44,313,689 | | | 34,214,046 | | | 78,527,735 | | | — | | | 78,527,735 | |
Weighted-average coupon rate | 13.7% | | 16.6% | | 15.1% | | —% | | 15.1% |
Weighted-average remaining term (years) | 0.76 | | 1.10 | | 0.87 | | — | | 0.87 |
_______________(1)As of March 31, 2024 and December 31, 2023, these loans pay a coupon rate of Secured Overnight Financing Rate (“SOFR”) or forward-looking term rate based on SOFR (“Term SOFR”), as applicable, plus a fixed spread. Coupon rates shown were determined using both average SOFR and Term SOFR of 5.3%, respectively, as of March 31, 2024, and 5.3% and 5.4%, respectively, as of December 31, 2023.
(2)As of both March 31, 2024 and December 31, 2023, two loans were subject to SOFR or Term SOFR floor, as applicable.
Equity Investments
In addition to our loan portfolio, we owned equity interests in two joint ventures that own real estate properties. We account for our equity interest in the joint ventures as equity method investments because we do not have a controlling financial interest in the entities. As of March 31, 2024 and December 31, 2023, these equity investments had total carrying value of $39.1 million and $40.4 million, respectively.
Portfolio Investment Activity
For the three months ended March 31, 2024 and 2023, we invested $11.1 million and $12.2 million in new and add-on investments, and had $21.5 million and $20.1 million of repayments, resulting in net repayments of $10.3 million and $8.0 million, respectively.
Senior Unsecured Notes
On February 10, 2021, Terra BDC issued $34.8 million in aggregate principal amount of 7.00% fixed-rate notes due 2026, and on February 26, 2021, the underwriters exercised the option to purchase an additional $3.6 million of the notes (collectively the “7.00% Senior Notes Due 2026”). The 7.00% Senior Notes Due 2026 may be redeemed in whole or in part at any time or from time to time at Terra BDC’s option on or after February 10, 2023, at a redemption price equal to 100% of the outstanding principal amount thereof, plus accrued and unpaid interest. In connection with the Merger, Terra LLC assumed all of Terra BDC’s rights and obligations under the indenture governing the 7.00% Senior Notes Due 2026.
Term Loan
In April 2021, Terra BDC entered into a credit agreement (the “Credit Agreement”) with a lender to provide for a delayed draw term loan of $25.0 million (the “Term Loan”). On September 27, 2022, the Credit Agreement was amended to, among other things, remove the make whole premium on voluntary prepayment of the loans as well as to provide consent to the consummation of the Merger and the assumption by Terra LLC of all of the rights and obligations of Terra BDC under the Credit Agreement. On June 30, 2023, we amended the Credit Agreement to, among other things, (i) decrease the principal amount to $15.0 million, (ii) extend the scheduled maturity date to March 31, 2024, and (iii) increase the rate on which the loans thereunder bear interest from a fixed rate of 5.625% per annum to a floating rate based on SOFR plus 7.375% with a SOFR floor of 5.0%, and repaid $10.0 million of the principal amount of the Term Loan. The Credit Agreement was secured by a lien on substantially all of Terra BDC’s, and, following the Merger, Terra LLC’s owned and thereafter acquired property. In March 2024, the Term Loan was repaid in full.
Factors Impacting Operating Results
Our portfolio is concentrated in a limited number of industries and borrowers, and, as a result, a downturn in any particular industry or borrower in which we are heavily invested may significantly impact the aggregate returns we realize. If an industry in which we are heavily invested suffers from adverse business or economic conditions, a material portion of our investment could be affected adversely, which, in turn, could adversely affect our financial position and results of operations. For example, as of March 31, 2024, our investments secured by office and multifamily properties represented approximately 47.4% and 39.8%, respectively, of the principal balance of our total net loan investments. In addition, as of March 31, 2024, we held only five loan investments and our largest net loan investment represented approximately 47.4% of the principal balance of our total net loan investments and our largest three net loan investments represented approximately 89.0% of the principal balance of our total net loan investments.
Results of Operations
Operating results for the three months ended March 31, 2024 and 2023 were as follows:
| | | | | | | | | | | | | | | | | |
| Three Months Ended March 31, |
| 2024 | | 2023 | | Change |
Revenues | | | | | |
Interest income | $ | 2,164,276 | | | $ | 2,931,904 | | | $ | (767,628) | |
Dividend and other income | 16,332 | | | 5,575 | | | 10,757 | |
| 2,180,608 | | | 2,937,479 | | | (756,871) | |
Operating expenses | | | | | |
Asset management and asset servicing fees paid/payable to Terra REIT (1) | 390,058 | | | 434,550 | | | (44,492) | |
Operating expense reimbursement to Terra REIT (1) | 382,294 | | | 305,880 | | | 76,414 | |
Provision for (reversal of provision for) credit losses | 824,348 | | | (115,337) | | | 939,685 | |
Professional fees | 169,702 | | | 282,510 | | | (112,808) | |
Insurance expense | 21,072 | | | 62,119 | | | (41,047) | |
General and administrative expenses | 36,238 | | | 12,660 | | | 23,578 | |
| 1,823,712 | | | 982,382 | | | 841,330 | |
Operating income | 356,896 | | | 1,955,097 | | | (1,598,201) | |
Other income and expenses | | | | | |
(Loss) income from equity investment in unconsolidated investments | (1,187,179) | | | 315,013 | | | (1,502,192) | |
Interest expense on unsecured notes payable | (985,106) | | | (952,149) | | | (32,957) | |
Interest expense on term loan | (517,528) | | | (351,563) | | | (165,965) | |
Interest expense from obligation under participation agreement | (725,953) | | | — | | | (725,953) | |
| (3,415,766) | | | (988,699) | | | (2,427,067) | |
Net (loss) income | $ | (3,058,870) | | | $ | 966,398 | | | $ | (4,025,268) | |
_____________(1)Fees were paid and payable, and expenses were reimbursed, to Terra REIT pursuant to the Cost Sharing Agreement with Terra REIT.
Net Loan Portfolio
In assessing the performance of our loans, we believe it is appropriate to evaluate the loans on an economic basis, that is, gross loans net of obligations under participation agreements. The following table presents a reconciliation of our loan portfolio on a weighted average basis from gross to net:
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended March 31, |
| 2024 | | | | | | 2023 |
| Weighted Average Principal Amount | | Weighted Average Coupon Rate | | | | | | Weighted Average Principal Amount | | Weighted Average Coupon Rate |
Gross loan investments | $ | 78,086,346 | | | 15.3% | | | | | | $ | 111,946,265 | | | 13.9% |
Obligation under participation agreement | (12,032,967) | | | 16.3% | | | | | | — | | | —% |
Net loan investments | $ | 66,053,379 | | | 15.1% | | | | | | $ | 111,946,265 | | | 13.4% |
Interest Income
For the three months ended March 31, 2024 as compared to the three months ended March 31, 2023, interest income decreased by $0.8 million, primarily due to a decrease in the weighted average principal balance of gross loans, partially offset by an increase in the weighted average coupon rate due to increases in the underlying index rates and the interest income earned on the promissory note receivable.
Dividend and Other Income
For the three months ended March 31, 2024 as compared to the three months ended March 31, 2023, dividend and other income increased by $0.01 million. For the three months ended March 31, 2024, dividend and other income primarily related to
dividend income earned on our marketable securities. For the three months ended March 31, 2023, dividend and other income was primarily related to administrative fees earned in connection with servicing our loans.
Asset Management and Asset Servicing Fees
On November 8, 2022, we entered into the Cost Sharing Agreement with Terra REIT effective October 1, 2022, pursuant to which we reimburse Terra REIT for our allocable portion of management and transaction fees and operating expenses incurred by Terra REIT, including fees paid by Terra REIT to the REIT Manager.
For the three months ended March 31, 2024 as compared to the three months ended March 31, 2023, management fees consisting of asset management and asset servicing fees paid/payable to Terra REIT pursuant to the Cost Sharing Agreement decreased by $0.04 million, primarily due to a decrease in total funds under management.
Operating Expense Reimbursement
For the three months ended March 31, 2024 as compared to the three months ended March 31, 2023, operating expense incurred on our behalf pursuant to the Cost Sharing Agreement increased by $0.1 million, primarily due to an increase in the REIT Manager’s allocable costs.
Provision for Credit Losses
On January 1, 2023, we adopted the provisions of Accounting Standards Update (“ASU2016-13,”) 2016-13, Financial Instruments— Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”), which requires entities to recognize credit losses on financial instruments based on an estimate of current expected credit losses.
For the three months ended March 31, 2024, we recorded a provision for credit losses of $0.8 million, primarily as a result of a decline in the fair value of the collateral of a loan due to a decline in the macroeconomic outlook for commercial real estate. For the three months ended March 31, 2023, we reversed $0.1 million of provision for credit losses due to an improvement in macroeconomic forecasts during the period.
Professional Fees
For the three months ended March 31, 2024 as compared to the three months ended March 31, 2023, professional fees decreased by $0.1 million, primarily due to legal fees incurred in connection with the SEC inquiry in 2023.
(Loss) Income From Equity Investment In Unconsolidated Investments
For the three months ended March 31, 2024, we recognized a loss from equity investment in unconsolidated investment of $1.2 million, related to our portion of the net loss incurred by the two joint ventures primarily as a result of the high depreciation and interest expense. For the three months ended March 31, 2023, we recognized income from equity investment in unconsolidated investment of $0.3 million, primarily related to interest income earned on a $10.0 million mezzanine loan for which we accounted for using the equity method of accounting because we also had an agreement with the borrower to share the residual profit from the sale of the real estate portfolio. The mezzanine loan was settled in June 2023.
Interest Expense on Unsecured Notes Payable
As discussed in the section entitled “Senior Unsecured Notes” above, we assumed the $38.4 million 7.00% Senior Notes Due 2026 in connection with the Merger.
For the three months ended March 31, 2024 as compared to the three months ended March 31, 2023, interest expense on unsecured notes payable remained substantially the same.
Interest Expense on Term Loan
As discussed in the section entitled “Term Loan” above, we assumed the $25 million Term Loan in connection with the Merger. In June 30, 2023, we made a $10.0 million partial repayment on the Term Loan. In March 2024, the Term Loan was repaid in full.
For the three months ended March 31, 2024 as compared to the same period in 2023, interest expense on the Term Loan increased by $0.2 million, primarily due to an increase in contractual interest rate, partially offset by a decrease in the weighted average outstanding balance.
Interest Expense From Obligation Under Participation Agreement
For the three months ended March 31, 2024, interest expense from obligation under participation agreement was $0.7 million, related to a portion of a loan we transferred to an affiliate via a participation agreement for which it did not qualify for sale treatment. There was no such interest expense for the three months ended March 31, 2023.
Net (loss) income
For the three months ended March 31, 2024, the resulting net loss was $3.1 million, compared to the resulting net income of $1.0 million for the three months ended March 31, 2023.
Terra REIT’s Management Agreement with the REIT Manager
Terra REIT is our parent and sole member. We have entered into a cost sharing arrangement with Terra REIT pursuant to which we will be responsible for our allocable share of Terra REIT’s expenses, including fees paid by Terra REIT to its manager, the REIT Manager. Terra REIT currently pays the following fees to the REIT Manager pursuant to the Management Agreement:
Origination and Extension Fee. An origination fee in the amount of 1.0% of the amount used to originate, acquire, fund or structure real estate-related investments, including any third-party expenses related to such loan. In the event that the term of any real estate-related loan is extended, the REIT Manager also receives an origination fee equal to the lesser of (i) 1.0% of the principal amount of the loan being extended or (ii) the amount of fee paid by the borrower in connection with such extension.
Asset Management Fee. A monthly asset management fee at an annual rate equal to 1.0% of the aggregate funds under management, which includes the loan origination amount or aggregate gross acquisition cost, as applicable, for each real estate-related loan and cash held by Terra REIT.
Asset Servicing Fee. A monthly asset servicing fee at an annual rate equal to 0.25% of the aggregate gross origination price or aggregate gross acquisition price for each real estate related loan then held by Terra REIT (inclusive of closing costs and expenses).
Disposition Fee. A disposition fee in the amount of 1.0% of the gross sale price received by Terra REIT from the disposition of each loan, but not upon the maturity, prepayment, workout, modification or extension of a loan unless there is a corresponding fee paid by the borrower, in which case the disposition fee will be the lesser of (i) 1.0% of the principal amount of the loan and ii) the amount of the fee paid by the borrower in connection with such transaction. If Terra REIT takes ownership of a property as a result of a workout or foreclosure of a loan, Terra REIT will pay a disposition fee upon the sale of such property equal to 1.0% of the sales price.
Transaction Breakup Fee. In the event that Terra REIT receive any “breakup fees,” “busted-deal fees,” termination fees, or similar fees or liquidated damages from a third-party in connection with the termination or non-consummation of any loan or disposition transaction, the REIT Manager will be entitled to receive one-half of such amounts, in addition to the reimbursement of all out-of-pocket fees and expenses incurred by the REIT Manager with respect to its evaluation and pursuit of such transactions.
In addition to the fees described above, Terra REIT reimburses the REIT Manager for operating expenses incurred in connection with services provided to the operations of Terra REIT, including its allocable share of the REIT Manager’s overhead, such as rent, employee costs, utilities, and technology costs.
Management Agreement Amendment
On March 11, 2024, Terra REIT and the REIT Manager entered into an amendment to the Management Agreement, effective as of January 1, 2024 (the “Amendment”), in order to extend the term of the Management Agreement and modify the terms upon which the Management Agreement may be terminated. Except as discussed below, the terms of the Management Agreement remain unchanged by the Amendment. Except where the context requires otherwise, all references herein to the “Management Agreement” are to the Management Agreement as modified by the Amendment.
The term of the Management Agreement will expire on December 31, 2027 (the “Initial Term”) and will automatically renew for an unlimited number of additional one-year terms upon each anniversary date of the last day of the Initial Term (each, a “Renewal Term”), unless terminated by Terra REIT or the REIT Manager during the Initial Term or a Renewal Term in accordance with the terms of the Management Agreement (as described below).
The Management Agreement may be terminated by Terra REIT during the Initial Term or any Renewal Term upon a finding by either (i) at least two-thirds of the independent directors on the Terra REIT Board or (ii) the holders of a majority of the outstanding shares of Terra REIT’s common stock (other than those shares held by members of Terra REIT’s senior management team or affiliates of the REIT Manager) that either (a) there has been unsatisfactory performance by the REIT Manager that is materially detrimental to Terra REIT, or (b) the compensation payable to the REIT Manager pursuant to the Management Agreement is unfair; provided, however, that Terra REIT will not have the right to terminate the Management Agreement on the basis of unfair compensation to the REIT Manager if the REIT Manager agrees to continue to provide its services under the Management Agreement in exchange for reduced fees that at least two-thirds of the independent directors on the Terra REIT Board determine to be fair pursuant to the procedures set forth in the Management Agreement. Terra REIT must deliver prior written notice of any such termination to the REIT Manager at least 180 days prior to the last calendar day of the Initial Term or the then-current Renewal Term, as applicable, and the Management Agreement will terminate effective as of the last calendar day of the Initial Term or the then-current Renewal Term, as applicable.
Upon any termination of the Management Agreement by Terra REIT as discussed above, Terra REIT will pay the REIT Manager, on the date on which such termination is effective, a termination fee in an amount equal to three times the average annual fees of all types and expense reimbursements received by or owed to the REIT Manager pursuant to the Management Agreement during the 24-month period immediately preceding such termination (the “Termination Fee”), calculated as of the end of the most recently completed monthly prior to the date of such termination.
Terra REIT may also terminate the Management Agreement, effective upon 30 calendar days’ prior written notice from the Terra REIT Board to the REIT Manager, without payment of any Termination Fees or other penalties, upon (i) the material breach of the Management Agreement by the REIT Manager or its affiliates that continues for 30 days after written notice thereof to the REIT Manager (or 45 days after delivery of written notice thereof if the REIT Manager takes diligent steps to cure such breach within 30 days of delivery of the written notice), (ii) any fraud or other criminal conduct, gross negligence or breach of fiduciary duty by the REIT Manager or its affiliates in connection with the Management Agreement, as determined by a final, non-appealable judgment of a court of competent jurisdiction, (iii) the REIT Manager’s bankruptcy, insolvency or dissolution, or (iv) an Internalization Event (as defined in the Management Agreement). No Termination Fee or other penalty is payable upon such a termination by us.
The REIT Manager may terminate the Management Agreement, effective upon 60 days’ prior written from the REIT Manager to Terra REIT, if Terra REIT breaches the Management Agreement and such breach continues for 30 days after written notice thereof. Terra REIT will pay the REIT Manager the Termination Fee upon such termination by the REIT Manager.
Financial Condition, Liquidity and Capital Resources
We currently generate cash primarily from cash flows from interest, dividends and fees earned from our investments, principal repayments, and proceeds from sales of our investments. Our primary use of cash is for our targeted assets and payments of our expenses.
We may borrow funds to make investments to the extent we determine that leveraging our portfolio would be appropriate. In February 2021, Terra BDC issued $38.4 million in aggregate principal amount of 7.00% fixed-rate notes due 2026, for net proceeds of $37.2 million after deducting underwriting commissions of $1.2 million. On October 1, 2022 in connection with the Merger, Terra BDC, Terra LLC and U.S. Bank National Association entered into a second supplemental indenture pursuant to which Terra LLC assumed the payment of the notes and the performance of every covenant of the indenture, to be performed or observed by Terra BDC.
Certain of our loans provide for commitments to fund the borrower at a future date. As of March 31, 2024, we had one loan with funding commitments of $19.3 million, of which we funded $18.6 million. We do not expect to fund the remaining $0.7 million unfunded commitments to the borrower in the next twelve months as the borrower has not met the requirement for funding. Additionally, our $15.0 million obligation under participation agreement will mature in the next twelve months. We expect to use the proceeds from the repayment of the corresponding investment to repay the participation obligation.
Cash Flows (Used in) Provided by Operating Activities
For the three months ended March 31, 2024, cash used in operating activities was $0.1 million. For the three months ended March 31, 2023, cash provided by operating activities was $0.5 million. The decrease in operating cash was due to decrease in contractual interest income.
Cash Flows Provided by Investing Activities
For the three months ended March 31, 2024, cash provided by investing activities was $10.4 million, primarily related to proceeds from repayment of loans of $21.5 million, partially offset by funding for promissory note receivable of $10.7 million.
For the three months ended March 31, 2023, cash provided by investing activities was $8.0 million, primarily related to proceeds from repayment of loans of $20.1 million, partially offset by purchases of investments of $12.2 million.
Cash Flows From Financing Activities
For the three months ended March 31, 2024, the proceeds from obligation under participation agreement of $15.0 million was offset by repayment of the Term Loan of $15.0 million.
Critical Accounting Policies and Use of Estimates
Our consolidated financial statements are prepared in conformity with United States generally accepted accounting principles (“U.S. GAAP”), which requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Critical accounting policies are those that require the application of management’s most difficult, subjective or complex judgments, often because of the need to make estimates about the effect of matters that are inherently uncertain and that may change in subsequent periods. In preparing the consolidated financial statements, management has made estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. In preparing the consolidated financial statements, management has utilized available information, including industry standards and the current economic environment, among other factors, in forming its estimates and judgments, giving due consideration to materiality. Actual results may differ from these estimates. In addition, other companies may utilize different estimates, which may impact the comparability of our results of operations to those of companies in similar businesses. As we execute our expected operating plans, we will describe additional critical accounting policies in the notes to our future consolidated financial statements in addition to those discussed below.
Allowance for Credit Losses
On January 1, 2023, we adopted the provisions of ASU 2016-13, which requires entities to recognize credit losses on financial instruments based on an estimate of current expected credit losses (“CECL”). The CECL model requires the consideration of possible credit losses over the life of an instrument as opposed to estimating credit losses upon the occurrence of an actual loss event under the previous “incurred loss” methodology.
We use a model-based approach for estimating the allowance for credit losses on performing loans on a collective basis, including future funding commitments for which we do not have the unconditional right to cancel, as these loans share similar risk characteristics. We utilize information obtained from internal and external sources relating to past events, current economic conditions and reasonable and supportable forecasts about the future to determine the expected credit losses for our loan portfolio. We utilize a commercial mortgage-based, third-party loan loss model and because we do not have a meaningful history of realized credit losses on our loan portfolio, we subscribe to a database service to provide historical proxy loan loss information. We employ logistic regression to forecast expected losses at the loan level based on a commercial real estate loan securitization database that contains activity dating back to 1998. We have chosen to incorporate a weighted average macroeconomic forecast that encompasses baseline, optimistic and pessimistic scenarios, into our allowance for credit losses on performing loans estimate during the reasonable and supportable forecast period which is currently eight quarters. We select certain economics variables from a group of independent variables such as Commercial Real Estate Price Index, unemployment and interest rate which are included in the model as part of macroeconomic forecast and updated regularly based on current economic trends. The specific loan level information input into the model includes loan-to-value and debt service coverage ratio metrics, as well as principal balances, property type, location, coupon rate, coupon rate type, original or remaining term, expected repayment dates and contractual future funding commitments. Based on the inputs, the loan loss model determines a loan loss rate through the generation of a probability of default (PD) and loss given default (LGD) for each loan. The allowance for credit losses on performing loans is then calculated by applying the loan loss rate to the total outstanding loan balance of
each loan. A significant amount of judgment is applied in selecting inputs and analyzing results produced by the models to determine the allowance for credit losses. Changes in such estimates can significantly affect the expected credit losses.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
This section has been omitted pursuant to General Instruction H(2)(c) of Form 10-Q.
Item 4. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
As required by Rule 13a-15(b) under the Exchange Act, we carried out an evaluation, under the supervision and with the participation of our management, including both the Chief Executive Officer and Chief Investment Officer and the Chief Financial Officer of our sole and managing member, Terra REIT, performing functions equivalent to those a principal executive officer and principal financial officer of our company would perform if we had any officers, of the effectiveness of the design and operation of our disclosure controls and procedures as of March 31, 2024. Based on that evaluation, our management concluded that our disclosure controls and procedures were effective to provide reasonable assurance that we would meet our disclosure obligations.
Changes in Internal Control Over Financial Reporting
During the most recent fiscal quarter, there was no change in our internal controls over financial reporting, as defined under Rule 13a-15(f) under the Exchange Act, that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
PART II
Item 1. Legal Proceedings.
Neither we nor Terra REIT nor the REIT Manager is currently subject to any material legal proceedings, nor, to our knowledge, are material legal proceedings threatened against us, Terra REIT, or the REIT Manager. From time to time, we and individuals employed by Terra REIT may be a party to certain legal proceedings in the ordinary course of business, including proceedings relating to the enforcement of our rights under contracts with our portfolio companies. While the outcome of these legal proceedings cannot be predicted with certainty, we do not expect that these proceedings will have a material effect upon our financial condition or results of operations.
Item 1A. Risk Factors.
For a discussion of the potential risks and uncertainties associated with our business, please see Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2023. You should be aware that those risk factors may not describe every risk facing us. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
This section has been omitted pursuant to General Instruction H(2)(b) of Form 10-Q.
Item 3. Defaults Upon Senior Securities.
This section has been omitted pursuant to General Instruction H(2)(b) of Form 10-Q.
Item 4. Mine Safety Disclosures.
Not applicable.
Item 5. Other Information.
Not applicable.
Item 15. Exhibits and Financial Statement Schedules.
The following exhibits are filed with this report. Documents other than those designated as being filed herewith are incorporated herein by reference.
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Exhibit No. | | Description and Method of Filing |
2.1 | | Agreement and Plan of Merger, dated as of May 2, 2022, by and among Terra Property Trust, Inc., Terra Income Fund 6, Inc., Terra Merger Sub, LLC, Terra Income Advisors, LLC and Terra REIT Advisors, LLC (incorporated by reference to Exhibit 2.1 to the Current Report on Form 8-K filed with the SEC on April 29, 2022.) |
3.1 | | |
3.2 | | |
3.3 | | |
3.4 | | |
3.5 | | |
4.1 | | |
4.2 | | |
4.3 | | |
4.4 | | |
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31.1* | | |
31.2* | | |
32.1** | | |
101.INS | | Inline XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document |
101.SCH | | XBRL Taxonomy Extension Schema Document |
101.CAL | | XBRL Taxonomy Extension Calculation Linkbase Document |
101.LAB | | XBRL Taxonomy Extension Label Linkbase Document |
101.PRE | | XBRL Taxonomy Extension Presentation Linkbase Document |
104 | | Cover Page Interactive Data File Included as Exhibit 101 (embedded within the Inline XBRL document) |
* Filed herewith.
** Furnished herewith.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: May 13, 2024
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| | | |
| | | TERRA INCOME FUND 6, LLC |
| | | By: Terra Property Trust, Inc., its sole and managing member |
| | | |
| | By: | /s/ Vikram S. Uppal |
| | | Vikram S. Uppal |
| | | Chairman of the Board, Chief Executive Officer and Chief Investment Officer |
| | | (Principal Executive Officer) |
| | | |
| | By: | /s/ Gregory M. Pinkus |
| | | Gregory M. Pinkus |
| | | Chief Financial Officer, Treasurer and Secretary |
| | | (Principal Financial and Accounting Officer) |