Note 4 - Mortgage notes receivable

The stated principal amount of loans receivable in the Company’s portfolio represents the Company’s interest in loans secured by first deeds of trust, security agreements or legal title to real estate located in the United States. The Company’s lending standards require that all mortgage notes receivable be first position liens and that the maximum loan to value ratio (“LTV”) be 65%, and prior to funding, all loan packages will include an appraisal by an independent qualified appraiser. The LTV is calculated on an “as-complete” appraised value of the underlying collateral as determined by an independent appraiser at the time of the loan origination. The lending standards also limits the initial outstanding principal balance of the loan to a maximum LTV of up to 65% of the “as-is” appraised value of the underlying collateral as determined by an independent appraiser at the time of the loan origination. Unless otherwise indicated, LTV is measured by the face value of the loan divided by the “as-completed” appraisal. LTVs do not reflect interim loan activity such as construction draws or interest payments capitalized to loans, or partial repayments of the loan. The maximum amount of a single loan may not exceed 10% and the maximum amount to a single borrower may not exceed 15% of the total assets of the Company. The Company considers loan to value ratio as a credit quality indicator about the credit quality of its mortgage notes receivable.

The mortgage notes receivable are recorded at their cost, which approximate their face amounts, and interest rates generally range from 10% to 13%. The mortgage notes receivable are considered to be short-term financings, with the expectation of repayment generally within 5 to 12 months. All loans require monthly interest only payments. Most loans are structured with an interest reserve holdback that covers the interest payments for most of the initial term of the loan. Once the interest reserve is depleted, borrowers are expected to make their monthly interest payment within 10 days of month end.

Mortgage notes receivable are presented net of construction holdbacks, interest reserves, allowance for loans losses and deferred origination and extension fee income in the consolidated balance sheets. The construction holdback represents amounts withheld from the funding of construction loans until the Company’s management deems construction to be sufficiently completed. The interest reserve represents amounts withheld from the funding of certain mortgage notes receivable for the purpose of satisfying monthly interest payments over all or part of the term of the related note. Accrued interest is paid out of the interest reserve and recognized as interest income at the end of each month. The deferred origination and extension fee income represents amounts that will be recognized over the contractual life of the underlying mortgage notes receivable.

A summary of information pertaining to mortgage notes receivable at March 31, 2020 and December 31, 2019 is as follows:



(dollars in thousands)	March 31, 2020		December 31, 2019
Total loan commitments	$	1,099,458	$	1,101,275
Less:
Construction holdbacks (1)		272,274		253,708
Interest reserves (1)		21,703		18,601
Total principal outstanding for mortgage notes, receivable		805,481		828,966
Less:
Allowance for loan losses		7,182		4,096
Deferred fees		6,847		3,281
Private REIT participation (2)		8,700		-
Mortgage notes receivable, net	$	782,752	$	821,589

(1)

Includes construction holdbacks of $4.5 million and interest reserves of $0.7 million on participating interests sold to the Private REIT

(2)

Private REIT was determined to be a voting interest entity for which the Company, through its wholly owned subsidiary acting as manager with no equity interest, does not hold a controlling interest in and does not consolidate the Private REIT. Furthermore, the Private REIT participation in loans originated by the Company meets the characteristics of a participating interest per ASC 860 and therefore, is treated as a sale of mortgage notes receivable and is derecognized from the Company’s unaudited condensed consolidated financial statements.

Defaulted mortgage notes receivable

Loans can be placed in default status if an interest payment is more than 30 days past due; if a note matures and the borrower fails to extend; or if the collateral becomes impaired in such a way that the ultimate collection of the note is doubtful. A loan can be removed from default status if the late interest payments are brought current; if the borrower complies with appropriate re-underwriting to extend the note; or if additional collateral is provided for the note to provide cash flow or bring the loan to collateral value ratio below 65%. The average recorded investment in defaulted and impaired loans was $82.3 and $10.6 million and for the three months ended March 31, 2020 and December 31, 2019, respectively.

Non-accrual on defaulted loans and impaired loans

No interest income is reported on mortgage notes receivable that are in default, unless the interest is paid in cash and collectability of all amounts due is reasonably assured. At March 31, 2020 and December 31, 2019, defaulted and impaired loans total $152.2 million and $32.9 million in principal outstanding and $145.0 and $28.8 million in mortgage notes receivable, net, respectively, and all defaulted and impaired loans were on nonaccrual status. In addition, in certain instances, where the interest reserve on a current loan has been fully depleted and the interest payment is not expected to be collected from the borrower, the Company may place a current loan on nonaccrual status and recognize interest income on a cash-basis. As of March 31, 2020, the Company’s portfolio included four current loans, totaling $31.7 million in principal outstanding, placed on nonaccrual status.

The following table summarizes the activity in the allowance for loan losses for the three months ended March 31, 2020 and March 31, 2019, respectively. All of the allowance for loan losses relates to loans in default.


	Three Months Ended		Three Months Ended
(dollars in thousands)	March 31, 2020		March 31, 2019

Beginning	$	4,096	$	1,704
Provision for loan losses		3,654		(224)
Charge offs		(568)		—
Recoveries		—		—
Ending	$	7,182	$	1,480