NOTE 4 – DIRECT FINANCING LEASES

The components of investments in direct financing leases consist of the following:


	December 31,
	2018		2017
	(in thousands)
Minimum lease payments receivable	$	28,294	$	64,893
Less unearned income		(16,577)		(37,633)
Investment in non-Orianna direct financing leases		11,717		27,260
Investment in Orianna direct financing leases		223,745		509,877
Less allowance for loss on Orianna direct financing leases		(103,200)		(172,172)
Investment in direct financing leases – net	$	132,262	$	364,965

Properties subject to direct financing leases		17		41
Number of direct financing leases		3		5

The following table summarizes our investments in the direct financing leases by operator, net of allowance for loss:


	December 31,
	2018		2017
	(in thousands)
Orianna	$	120,545	$	337,705
Reliance Health Care Management, Inc.		—		15,458
Sun Mar Healthcare		11,491		11,481
Markleysburg Healthcare Investors, LP		226		321
Investment in direct financing leases - net	$	132,262	$	364,965

The following minimum rents are due under our direct financing leases for the next five years (in thousands):


2019 (1)		2020 (1)		2021 (1)		2022 (1)		2023 (1)
$	1,177	$	1,170	$	1,084	$	1,106	$	1,128

(1)Amounts due from Orianna have been excluded from the contractual minimum rent payments due under our direct financing leases. See below for additional information and Note 24 – Subsequent Events.

In 2018, we sold one SNF with a carrying value of approximately $15.4 million subject to a direct financing lease to an unrelated third-party for approximately $15.4 million.

Orianna Direct Financing Lease and Operating Lease

On November 27, 2013, we closed an aggregate $529 million purchase/leaseback transaction in connection with the acquisition of Ark Holding Company, Inc. (“Ark Holding”) by 4 West Holdings Inc. At closing, we acquired 55 SNFs and 1 ALF operated by Ark Holding and leased the facilities back to Ark Holding, now known as New Ark Investment Inc. (“New Ark” which does business as “Orianna Health Systems” and is herein referred to as “Orianna”), pursuant to four 50‑year master leases with rental payments yielding 10.6% per annum over the term of the leases. The purchase/leaseback transaction is being accounted for as a direct financing lease.

In addition to our direct financing leases with Orianna, we own three facilities and had leased them to Orianna under a master lease which was to expire in 2026. The remaining three facility lease is accounted for as an operating lease. Our recorded investment in the three facilities subject to this operating lease was $30.5 million as of December 31, 2018. On October 31, 2018, Orianna rejected the operating lease and as a result we transitioned the remaining three facilities to an existing operator during the first quarter of 2019. As of December 31, 2018, we also have a revolving working capital loan issued to Orianna with a balance outstanding as of December 31, 2018 of $15.2 million.

In 2017, we sold eight facilities subject to direct financing leases with Orianna in the Northwest region and the Southeast region of the U.S. with a carrying value of approximately $36.4 million for approximately $33.3 million to unrelated third parties. These facilities were subject to direct financing leases with Orianna in the Northwest region and the Southeast region. We recorded approximately $3.3 million of impairment related to these sales. In addition, we transitioned nine SNFs, representing all of the facilities subject to another direct financing lease with Orianna in the Texas region, to an existing operator of ours pursuant to an operating lease. In connection with this transaction, we recorded the real estate properties at our original cost basis of approximately $19.0 million, eliminated our investment in the Texas region direct financing lease and recorded an impairment of approximately $1.8 million. In conjunction with this transaction, we also amended our Orianna Southeast region master lease to reduce the outstanding balance by $19.3 million. As a result of the lease amendment in 2017, we recorded impairment on our investment in direct financing lease of approximately $20.8 million in 2017.

In the third quarter of 2017, we recorded an allowance for loss on direct financing leases of $172.2 million with Orianna covering 38 facilities in the Southeast region of the U.S. The amount of the allowance was determined based on the fair value of the facilities subject to the direct financing lease. To estimate the fair value of the underlying collateral, we utilized an income approach and Level 3 inputs. Our estimate of fair value assumed annual rents ranging between $32.0 million and $38.0 million, rental yields between 9% and 10%, current and projected operating performance of the facilities, coverage ratios and bed values. Our recorded investment in these direct financing leases, net of the $172.2 million of allowances, amounted to $337.7 million as of December 31, 2017.

In March 2018, Orianna commenced voluntary Chapter 11 proceedings in the United States Bankruptcy Court for the Northern District of Texas, Dallas Division (the “Bankruptcy Court”). As described in Orianna’s filings with the Bankruptcy Court, we entered into a Restructuring Support Agreement (“RSA”) that was expected to form the basis for Orianna’s restructuring. The RSA provided for the recommencement, in April 2018, of partial rent payments at $1.0 million per month and established a specific timeline for the implementation of Orianna’s planned restructuring. The RSA provided for the transition of 23 facilities to new operators and the potential sale of the remaining 19 facilities subject to the plan of reorganization (the “Plan”), if approved by the Bankruptcy Court.

To provide liquidity to Orianna during their Chapter 11 proceedings, we entered into a senior secured superpriority debtor-in-possession (“DIP”) credit agreement with Orianna for a revolving credit and term loan DIP financing of up to $30 million, which DIP financing was approved by the Bankruptcy Court on an interim basis on March 9, 2018 and on a final basis on May 14, 2018.

On July 23, 2018, we notified Orianna that it was in default under the DIP credit agreement. On July 25, 2018, Omega terminated the RSA with its tenant, 4 West Holdings, and the sponsor of Orianna’s Plan.

During the third quarter of 2018, we transitioned 22 facilities with a net carrying value of approximately $184.5 million from Orianna to five other existing operators with annual contractual rent of approximately $16.8 million. See Note 3 – Properties. In addition, during the second half of 2018, we sold Orianna’s headquarters and one SNF with a carrying value of approximately $5.5 million to unrelated third-parties for approximately $5.5 million.

During the fourth quarter of 2018, the Bankruptcy Court ruled that Orianna’s Plan, if confirmed, would allow Orianna to use the value of Orianna’s remaining facilities to pay the administrative costs of Orianna’s Chapter 11 cases and to pay certain other creditor claims, with the net amount of such value being paid to us. As a result, we recorded $27.2 million in additional allowance for loss to reduce the remaining investment in the direct financing lease covering the remaining 15 facilities located in the Southeast region of the U.S. As of December 31, 2018, our net investment in the Orianna direct financing lease is approximately $120.5 million, net of an allowance of $103.2 million.

On January 11, 2019, pursuant to a Bankruptcy Court order, affiliates of Orianna purchased the remaining 15 SNFs subject to the direct financing lease with Orianna for $176 million of consideration, comprised of $146 million in cash received by Orianna and a $30.0 million seller note held by the Company. The $30.0 million note bears interest at 6% per annum and matures on January 11, 2026. Interest on the unpaid principal balance is due quarterly in arrears. Commencing on January 11, 2022, quarterly principal payments are due based on a 15-year amortization schedule on the then outstanding principal balance of the loan. On the same date, Orianna repaid the DIP financing, including all related interest.

On January 16, 2019, the Bankruptcy Court confirmed Orianna’s Plan, creating a Distribution Trust (the “Trust”) to distribute the proceeds from Orianna’s sale of the remaining 15 SNFs, as well as the Trust’s collections of Orianna’s accounts receivable portfolio. Our remaining investment in the direct financing lease and the revolving working capital loan as of December 31, 2018 is expected to be recovered through liquidating payments made from the Trust. The Trust is comprised of $115.8 million of net cash proceeds from the sale by Orianna of the 15 SNFs on January 11, 2019 after repayment of the DIP financing, cash of $5.6 million, and accounts receivable, net of estimated allowance, of $21.3 million. We expect that the aggregate of such amounts will be used to pay the estimated costs of $26.9 million to other creditors and to wind down the Trust with the remainder paid to us under the direct financing leases and on account of the revolving working capital loan. The amount payable to us is contingent upon the collection of the accounts receivable balances and the estimated costs to wind down the Trust. These amounts are estimated and subject to change. Such changes could be significantly different than the currently estimated amounts and such differences could have a material impact on our financial statements.

On February 13, 2019, we received $78.8 million from the Trust as a partial liquidation of the Trust. We will receive other payments from the Trust when the accounts receivable are collected and as the estimated creditor claims and costs to wind down the Trust are finalized.

As a result of Orianna not satisfying the contractual payments due under the terms of the direct financing leases or the separate operating lease and the uncertainty of collection, we have not recognized any income from Orianna related to the direct financing leases or the operating lease for the period from July 1, 2017 through December 31, 2018.