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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2021
☐
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: 001-35845
LUMENT FINANCE TRUST, INC.
(Exact name of registrant as specified in its charter)
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Maryland |
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45-4966519 |
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(State or other jurisdiction of incorporation or
organization) |
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(I.R.S. Employer Identification No.) |
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230 Park Avenue,
20th Floor, New York, New York
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10169 |
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(Address of principal executive offices) |
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(Zip code) |
Registrant’s Telephone Number, including area code (212)
317-5700
Securities Registered Pursuant to Section 12(b) of the
Act:
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Title of Each Class: |
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Trading Symbol(s) |
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Name of Exchange on Which Registered: |
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Common Stock, par value $0.01 per share |
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LFT |
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New York Stock Exchange |
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7.875% Series A Cumulative Redeemable Preferred Stock, par value
$0.01 per share |
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LFTPrA |
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New York Stock Exchange |
Securities Registered Pursuant to Section 12(g) of the Act:
None.
Indicate by check mark if the registrant is a well-known seasoned
issuer, as defined in Rule 405 of the Securities Act. Yes
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or No
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Indicate by check mark if the registrant is not required to file
reports pursuant to Section 13 or Section 15(d) of the Exchange
Act. Yes
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or No
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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
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or No
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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
☒
or No
☐
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.
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Large accelerated filer ☐ |
Accelerated filer
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Non-accelerated filer ☒
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Smaller reporting company ☒
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Emerging growth company ☐
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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.
☐
Indicate by check mark whether the registrant has filed a report on
and attestation to its management's assessment of the effectiveness
of its internal control over financial reporting under Section
404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the
registered public accounting firm that prepared or issued its audit
report.
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Indicate by check mark whether the registrant is a shell company
(as defined in Rule 12b-2 of the Exchange Act). Yes
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or No ý
The aggregate market value of the registrant’s common stock held by
non-affiliates of the registrant was approximately
$74.0 million as of June 30, 2021 (the last business day of
the registrant's most recently completed second fiscal quarter)
based on the closing sale price on the New York Stock Exchange on
that date.
As of March 14, 2022, there were 52,225,152 outstanding shares
of common stock, $0.01 par value.
TABLE OF CONTENTS
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Page |
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Item 1. |
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Item 1A. |
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Item 1B. |
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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 7. |
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Item 8. |
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Item 9. |
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Item 9A. |
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Item 9B. |
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Item 10. |
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Item 11. |
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Item 12. |
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Item 13. |
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Item 14. |
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Item 15. |
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Item 16. |
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Cautionary Note Regarding Forward-Looking Statements
This Annual Report on Form 10-K contains certain forward-looking
statements intended to qualify for the safe harbor contained in
Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act, as amended. Forward-looking
statements are subject to risks and uncertainties. These
forward-looking statements include information about possible or
assumed future results of our business, financial conditions,
liquidity, results of operations, plans and objectives. In
addition, our management may from time to time make oral
forward-looking statements. You can identify forward-looking
statements by use of words such as "believe," "expect,"
"anticipate," "estimate," "project," "plan," "continue," "intend,"
"should," "may," "will," "seek," "would," "could" or similar
expressions or other comparable terms, or by discussions of
strategy, plans or intentions.
These forward-looking statements are based on our beliefs,
assumptions and expectations of our future performance, taking into
account all information currently available to us. These beliefs,
assumptions and expectations are subject to risks and uncertainties
and change as a result of many possible events or factors, not all
of which are known to us. If a change occurs, our business,
financial condition, liquidity and results of operation may vary
materially from those expressed in our forward-looking statements.
Factors that may cause actual results to vary from our
forward-looking statements include, but are not limited
to:
•the
risks, uncertainties and factors set forth in Part I, Item 1A.
"Risk Factors" in this Annual Report on Form 10-K;
•how
widely utilized COVID-19 vaccines will be, whether they will be
effective in preventing the spread of COVID-19 (including its
variant strains), and their impact on the ultimate severity and
duration of the COVID-19 pandemic;
•potential
risks and uncertainties relating to the ultimate geographic spread
of COVID-19;
•actions
that may be taken by governmental authorities to contain COVID-19
and treat its impact;
•the
potential negative impact of COVID-19 or other public health issues
on our business and financial condition and the global economy in
general;
•the
general political, economic and competitive conditions in the
markets in which we invest;
•the
level and volatility of prevailing interest rates and credit
spreads;
•adverse
changes in the real estate and real estate capital
markets;
•difficulty
in obtaining financing or raising capital;
•reductions
in the yield on our investments and an increase in the cost of our
financing;
•defaults
by borrowers in paying debt service on outstanding
indebtedness;
•adverse
legislative or regulatory developments;
•changes
in our business, investment strategies or target
assets;
•increased
competition from entities engaged in mortgage lending or investing
in our target assets;
•acts
of God such as hurricanes, earthquakes, pandemics such as COVID-19
and other natural disasters, acts of war and/or terrorism and other
events that may cause unanticipated and uninsured performance
declines and/or losses to us or to the owners and operators of the
real estate securing our investments;
•deterioration
in the performance of the property securing our investments that
may cause deterioration in the performance of our investments and,
potentially, principal losses to us;
•difficulty
in redeploying the proceeds from repayment of our existing
investments;
•difficulty
in successfully managing our growth, including integrating new
assets into our existing systems;
•authoritative
generally accepted accounting principles, or GAAP, or policy
changes from such standard-setting bodies as the Financial
Accounting Board, or FASB, the Securities Exchange Commission, or
SEC, the Internal Revenue Service, or IRS, the New York Stock
Exchange, or NYSE, or other authorities that we are subject
to;
•the
potential unavailability of the London Interbank Offered Rate
("LIBOR") after December 31, 2021; and
•our
qualification as a real estate investment trust ("REIT") for U.S.
federal income tax purposes under the Internal Revenue Code of
1986, as amended ("the Code"), and our exclusion from registration
under the Investment Company Act of 1940, as amended (the
"Investment Company Act").
These and other risks, uncertainties and factors, including the
risk factors described in Part 1, Item 1A - "Risk Factors" and Part
2, Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations" of this Annual Report on Form
10-K, could cause our actual results to differ materially from
those projected in any forward-looking statements we make. All
subsequent written and oral forward-looking statements that we
make, or that are attributable to us, are expressly qualified in
their entirety by this cautionary notice. Any forward-looking
statement speaks only as of the date on which it is made. Except as
required by law, we are not obligated to, and do not intend to,
update or revise any forward-looking statements, whether as a
result of new information, future events or otherwise.
PART I
ITEM 1. BUSINESS
References herein to "Lument Finance Trust," "Company," "LFT,"
"we," "us," or "our" refer to Lument Finance Trust, Inc., a
Maryland corporation, and its subsidiaries unless the context
specifically requires otherwise.
Our Company
We are a real estate investment trust ("REIT") focused on investing
in, financing and managing a portfolio of commercial real estate
("CRE") debt investments. We primarily invest in transitional
floating rate CRE mortgage loans with an emphasis on middle-market
multifamily assets. We may also invest in other CRE-related
investments including mezzanine loans, preferred equity, commercial
mortgage-backed securities, fixed rate loans, construction loans
and other CRE debt instruments.
We are externally managed by our manager, OREC Investment
Management, LLC, doing business as Lument Investment Management
(the "Manager" or "Lument IM") pursuant to the terms of our
management agreement. Our Manager is a subsidiary of ORIX Real
Estate Capital Holdings, LLC doing business as Lument ("Lument").
Lument is a subsidiary of ORIX Corporation USA ("ORIX USA"), a
diversified financial company and a subsidiary of ORIX Corporation
("ORIX"). ORIX is a publicly traded, Tokyo-based international
financial services company with assets in excess of $124 billion as
of September 2021 and was ranked number 274 on Forbes 2021 Global
2000: World's Biggest Public Companies..
We are a Maryland corporation that was formed in March 2012 and
commenced operations in May 2012. We have elected to be taxed as a
REIT for U.S. federal income tax purposes. On December 28, 2020, we
changed our name from "Hunt Companies Finance Trust, Inc." to
"Lument Finance Trust, Inc." and our common stock began trading on
the New York Stock Exchange ("NYSE") under the symbol "LFT."
Previously, our common stock traded on the NYSE under the symbol
"HCFT." Our Series Preferred Stock is traded on the NYSE under the
symbol "LFTPrA."
The ORIX Transaction
On January 6, 2020, we announced the entry into a new external
management agreement with Lument IM and the concurrent mutual
termination of our management agreement with our prior manager,
Hunt Investment Management, LLC ("HIM"). Lument IM is part of
Lument, a nationally recognized leader in multifamily and seniors
housing and healthcare finance. The terms of the new management
agreement align with the terms of our prior management agreement
with HIM in all material respects, including a cap on reimbursable
expenses. Pursuant to the terms of the termination agreement
between the Company and HIM, the termination of the management
agreement did not trigger, and HIM was not paid, a termination fee
by the us.
Our Manager and Lument
We are externally managed and advised by our Manager, a subsidiary
of Lument. At December 31, 2021, Lument had over 600 employees
located in over 30 offices throughout the United States. We have
access to an extensive loan origination platform through our
affiliation with Lument, which is a premier national mortgage
originator and asset manager. Lument's origination teams employ a
relationship-focused approach to lending opportunities and focus on
speed and certainty of execution for its borrower clients, thereby
strengthening Lument's reputation as a reliable counterparty and
encouraging repeat business. Lument has originated over $70 billion
of CRE mortgage transactions in its nearly 50 years of continuous
operations (inclusive of predecessor companies).
Our Manager implements our business strategy, performs investment
advisory services with respect to our assets, and is responsible
for performing all of our day-to-day operations. Our Manager is an
investment adviser registered with the Securities and Exchange
Commission ("SEC") and is subject to the supervision and oversight
of our board of directors and has only such functions and authority
as our board of directors delegates to it. Pursuant to a management
agreement between our Manager and us, our Manager is entitled to
receive a base management fee, an incentive fee, and certain
expense reimbursements.
Our Investment Strategy
We invest primarily in transitional floating rate CRE mortgage
loans with an emphasis on middle-market multifamily assets. We may
also invest in other CRE-related investments including mezzanine
loans, preferred equity, commercial mortgage-backed securities,
fixed rate loans, construction loans and other CRE debt
instruments. We finance our current investments in transitional
multifamily and other CRE loans primarily through match term
non-recourse CRE collateralized loan obligations ("CLO"). We may
utilize warehouse repurchase agreements or other forms of financing
in the future. Our primary sources of income are net interest from
our investment portfolio and non-interest income from our mortgage
loan-related activities. Net interest income represents the
interest we earn on investments less the expense of funding these
investments.
Our investments typically have the following
characteristics:
•Sponsors
with experience in particular real estate sectors and geographic
markets;
•Located
in U.S. markets with multiple demand drivers, such as growth in
employment and household formation;
•Fully
funded principal balance greater than $5 million and generally less
than $75 million;
•Loan
to Value ratio up to 85% of as-is value and up to 75% of
as-stabilized value;
•Floating
rate loans historically tied to one-month U.S. denominated LIBOR,
more recently to one-month term SOFR, and/or in the future,
potentially other index replacement; and
•Three-year
term with two one-year extension options.
We believe that our current investment strategy provides
significant opportunities to achieve attractive risk-adjusted
returns for our stockholders over time. However, to capitalize on
the investment opportunities at different points in the economic
and real estate investment cycle, we may modify or expand our
investment strategy. We believe that the flexibility of our
strategy, which is supported by the significant CRE experience of
Lument's investment team, and the extensive resources of ORIX USA,
will allow us to take advantage of changing market conditions to
maximize risk-adjusted returns to our stockholders.
Our Target Assets
Commercial Mortgage Loans.
We intend to continue to focus on selectively acquiring first
mortgage loans sourced by our Manager and its affiliates. These
loans are secured by a first mortgage lien on a commercial
property, may vary in duration, predominantly bear interest at a
floating rate, may provide for regularly scheduled principal
amortization and typically require a balloon payment of principal
at maturity. These investments may encompass a whole commercial
mortgage loan or may include a participation in a portion of a
commercial mortgage loan.
Other Commercial Real-Estate-Related Debt Instruments.
We also expect to opportunistically originate and selectively
acquire other CRE-related debt instruments, subject to maintaining
our qualification as a REIT for U.S. federal income tax purposes
and our exclusion or exemption from regulation under the Investment
Company Act, as amended (the 'Investment Company Act"), including,
but not limited to, the following:
•Mezzanine
Loans.
These are loans made to the owner of a mortgage borrower and
secured by a pledge of the equity interests in the mortgage
borrower. These loans are subordinate to a first mortgage loan but
senior to the borrower’s equity. These loans may be tranched into
senior and junior mezzanine loans, with the junior mezzanine
lenders secured by a pledge of the equity in the senior mezzanine
borrower. Following a default on a mezzanine loan, and subject to
the negotiated terms with the mortgage lender or other senior
lenders, the mezzanine lender generally has the right to foreclose
on its equity interest in the mortgage borrower and become the
owner of the property, directly or indirectly, subject to the lien
of the first mortgage loan and any debt senior to it, including any
outstanding senior mezzanine debt. In addition, the mezzanine
lender typically has additional rights relative to the more senior
lenders, including the right to cure defaults under the mortgage
loan and any senior mezzanine loan and purchase the mortgage loan
and any senior mezzanine loan, in each case under certain
circumstances following a default on the mortgage loan. Unlike a B
Note holder, the mezzanine lender typically has the authority to
administer its own loan, independent from the administration of the
mortgage loan.
•Preferred
Equity.
These are investments subordinate to any mezzanine loan, but senior
to the owners’ common equity. Preferred equity investments
typically pay a dividend, rather than interest payments, and often
provide for the accrual of such dividends if cash flow is
insufficient to pay such amounts on a current basis. Preferred
equity interests are not secured by the underlying real estate, but
upon the occurrence of an issuer’s failure to make payments
required by the terms of the preferred equity instrument or certain
other specified events of default, the preferred equity holder
typically has the right to effectuate a change of control with
respect to the ownership of the property, which would include the
ability of the preferred equity holder to sell the property to
realize its investment. Preferred equity is generally subject to
mandatory redemption by the issuer at the end of a specified
term.
•Secured
Real Estate Securities.
These are securities, which may take the form of CMBS or CLOs that
are collateralized by pools of CRE debt instruments, often first
mortgage loans. The underlying loans are aggregated into a pool and
sold as securities to investors. Under the pooling and servicing
agreements that govern these pools, the loans are administered by a
trustee and servicers, which act on behalf of all investors and
distribute the underlying cash flows from the pools of debt
instruments to the different classes of securities in accordance
with their seniority and ratings.
•Miscellaneous
Debt Instruments.
This would encompass any other CRE-related debt instruments, if
necessary, to maintain our qualification as a REIT for U.S. federal
income tax purposes or our exclusion or exemption from regulation
under the Investment Company Act.
The allocation of our capital among our target assets will depend
on prevailing market conditions at the time we invest and may
change over time in response to different prevailing market
conditions. In the future, we may invest in assets other than our
target assets or change our target assets, in each case subject to
maintaining our qualification as a REIT for U.S. federal income tax
purposes and our exclusion or exemption from regulation under the
Investment Company Act.
Our Portfolio
Transitional Multifamily and Commercial Real Estate
Loans
As of December 31, 2021, our mortgage loan investment
portfolio consisted of 66 senior secured floating rate loans with
an aggregate unpaid principal balance of $1.0 billion, collectively
having a weighted average coupon of 3.9% and a weighted average
term to maturity of 3.7 years. As of December 31, 2021, 66.2%
of the loans in our mortgage loan investment portfolio benefit from
a LIBOR floor, with a weighted average floor of 0.49%. As of
December 31, 2021, 92.0% of the portfolio was supported by
multifamily assets.
During 2021, the Company acquired $983.7 million in loans and
realized $528.4 million of loan repayments. This activity resulted
in net repayments of $455.3 million. The following table details
the overall statistics of our loan portfolio as of
December 31, 2021:
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Weighted Average |
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Loan Type |
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Unpaid Principal Balance |
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Carrying Value |
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Loan Count |
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Floating Rate Loan % |
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Coupon(1)
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Term (Years)(2)
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LTV(3)
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December 31, 2021 |
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Loans held-for-investment |
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Senior secured loans(4)
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$ |
1,001,869,994 |
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$ |
1,001,825,294 |
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66 |
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100.0 |
% |
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3.9 |
% |
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3.7 |
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71.2 |
% |
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$ |
1,001,869,994 |
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$ |
1,001,825,294 |
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66 |
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100.0 |
% |
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3.9 |
% |
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3.7 |
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71.2 |
% |
(1) Weighted average coupon assumes
applicable one-month LIBOR rate of 0.10% as of
December 31, 2021,
and is inclusive of weighted average LIBOR floors of
0.49%.
(2) Weighted average term assumes all
extension options are exercised by the borrower; provided, however,
that our loans may be repaid prior to such date.
(3) LTV as of the date the loan was
originated and is calculated after giving effect to capex and
earnout reserves, if applicable. LTV has not been updated for any
subsequent draws or loan modifications and is not reflective of any
changes in value which may have occurred subsequent to origination
date.
(4) As of December 31, 2021,
$974,025,294 of the outstanding senior secured loans were held in
variable interest entities ("VIEs") and $27,800,000 of the
outstanding senior secured loans were held outside
VIEs.
The charts below present the geographic dispersion of our loan
portfolio and the property types securing our loan portfolio as of
December 31, 2021:
MSRs
As of December 31, 2021, the Company retained the servicing
rights associated with residential mortgage loans having an
aggregate unpaid principal balance of approximately $91.7 million
that we had previously transferred to three residential mortgage
loan securitization trusts. The carrying value of these MSRs at
December 31, 2021 was approximately $0.6 million. HIM, our
prior external manager, ceased the aggregation of residential
mortgage loans in 2016 and other than servicing our existing
portfolio, we do not anticipate any residential loan activity going
forward.
Our Financing Strategy
We use leverage to seek to increase potential returns to our
stockholders. We may use of non-recourse CRE CLOs, secured
revolving repurchase agreements, term loan facilities, warehouse
facilities, asset-specific financing structures and other forms of
leverage. As of December 31, 2021, our assets were financed
with a match term, non-recourse CRE CLO and one senior corporate
credit facility.
The goal of our leverage strategy is to ensure that, at all times,
our leverage ratio is appropriate for the level of risk inherent in
the investment portfolio and that each asset class has individual
leverage targets that we believe are appropriate. We generally
seek, to the extent possible, to match-fund and match-index our
investments by minimizing the differences between the duration and
indices of our investments and those of our liabilities. We also
seek to minimize our exposure to mark-to-market risk.
While our organizational documents and our investment guidelines do
not place any limits on the maximum amount of leverage that we may
use, our financing facilities require us to maintain particular
debt-to-equity leverage ratios. We may change our financing
strategy and leverage without the consent of our
stockholders.
Competition
We are engaged in a competitive business. In our investing
activities, we compete for opportunities with a variety of
institutional investors, including other REITs, specialty finance
companies, public and private funds, commercial and investment
banks, commercial finance and insurance companies and other
financial institutions. Several other REITs and other investment
vehicles have raised significant amounts of capital and may have
investment objectives that overlap with ours, which may create
additional competition for investment opportunities. Some
competitors may have a lower cost of funds and broader access to
funding sources, such as the U.S. Government, that are not
available to us. Many of our competitors are not subject to the
operating constraints associated with REIT compliance or
maintenance of an exclusion from regulation under the Investment
Company Act. We could face increased competition from banks due to
future legislative developments, such as amendments to key
provisions of the Dodd-Frank Act including, provisions setting
forth capital and risk retention requirements. In addition, some of
our competitors may have higher risk tolerances or different risk
assessments, which could allow them to consider a wider variety of
loans and investments and offer more attractive pricing or other
terms than we would. Furthermore, competition for investments we
target may lead to decreasing yields, which may further limit our
ability to generate targeted returns.
We believe access to our Manager's professionals and their industry
expertise and relationships provide us with competitive advantages
in assessing risks and determining appropriate pricing for
potential investments. We believe these relationships will enable
us to compete effectively for attractive investment opportunities.
However, we may not be able to achieve our business goals or
expectations due to the competitive risks that we
face.
Investment Guidelines
Under the management agreement with our Manager, our Manager will
be required to manage our business in accordance with certain
investment guidelines and policies that have been approved by our
board of directors, including each of our independent directors.
Under these investment guidelines and policies:
•We
will not make an investment that would cause us to fail to qualify
as a REIT for U.S. federal income tax purposes.
•We
will not make an investment that would cause us to be regulated as
an “investment company” under the Investment Company
Act.
•We
are permitted to invest residential mortgage-backed securities,
multi-family mortgage-backed securities, commercial mortgage-backed
securities, residential mortgage loans, multi-family mortgage
loans, CRE mortgage loans, mortgage servicing rights and other
mortgage or real estate-related investments.
•Our
Manager may invest the net proceeds of any offerings of our
securities in interest-bearing, short-term investments, including
money market accounts or funds, that are consistent with our
intention to qualify as a REIT for U.S. federal income tax purposes
and maintain an exemption from registration under the Investment
Company Act.
These investment guidelines may be amended, restated, modified,
supplemented or waived by our board of directors (which must
include a majority of the independent directors of our board of
directors) without the approval of our stockholders.
Environmental, Social and Governance
We are committed to responsibly managing risk and preserving value
for our shareholders. We make capital allocation decisions with
environmental, social and governance ("ESG") factors of our
potential collateral and borrowers in mind, and incorporate
diligence practices as part of our investment process to identify
material ESG matters related to a given asset.
Our day-to-day operations are externally managed by our Manager, a
subsidiary of ORIX USA. As such, much of the ESG initiatives
undertaken by ORIX USA impact or apply to us. Key ESG initiatives
we share with ORIX USA include considerations of ESG in the in the
investment process, dedicated resources to ESG governance and
oversight, industry engagement on ESG matters, corporate
sustainability and environmental performance improvements at our
office locations, and certain employee and community engagement and
diversity, equity and inclusion ("DEI") programs.
Government Regulation
Our operations are subject, in certain instances, to supervision
and regulation by U.S. and other governmental authorities, and may
be subject to various laws and judicial and administrative
decisions imposing various requirements and restrictions, which
among other things: (i) regulate credit-granting activities; (ii)
establish maximum interest rates, finance charges and other
charges; (iii) require disclosures to customers; (iv) govern
secured transactions; and (v) set collections, foreclosure,
repossession and claims-handling procedures and other trade
practices. We are also required to comply with certain provisions
of the Equal Credit Opportunity Act that are applicable to
commercial loans. We intend to conduct our business so that neither
we nor any of our subsidiaries are required to register as an
investment company under the Investment Company Act.
In our judgment, existing statutes and regulations have not had a
material adverse effect on our business. In recent years,
legislators in the United States and in other countries have said
that greater regulation of financial services firms is needed,
particularly in areas such as risk management, leverage and
disclosure. While we expect that additional new regulations in
these areas may be adopted and existing ones may change in the
future, it is not possible at this time to forecast the exact
nature of any future legislation, regulations, judicial decisions,
orders or interpretations, nor their impact upon our future
business, financial condition, or results of operations or
prospects.
Taxation of the Company
We elected to be taxed as a REIT commencing with our short taxable
year ended December 31, 2012, and comply with the provisions of the
Code with respect thereto. Accordingly, we are generally not
subject to U.S. federal income tax on the REIT taxable income that
we currently distribute to our stockholders so long as we maintain
our qualification as a REIT. Our continued qualification as a REIT
depends on our ability to meet, on a continuing basis, various
complex requirements under the Code relating to, among other
things, the source of our gross income, the composition and values
of our assets, our distribution levels and the concentration of
ownership of our capital stock. Even if we maintain our
qualification as a REIT, we may be subject to some U.S. federal,
state and local taxes on our income.
Taxable income generated by our taxable REIT subsidiary ("TRS"), is
subject to regular corporate income tax. For the fiscal year 2021,
our TRS did not generate taxable income.
Qualification as a REIT
Continued qualification as a REIT requires that we satisfy a
variety of tests relating to our income, assets, distributions and
ownership. The significant tests are summarized below.
Income Tests.
In order to maintain our REIT qualification, we must satisfy two
gross income requirements on an annual basis. First, at least 75%
of our gross income for each taxable year, excluding gross income
from sales of inventory or dealer property in "prohibited
transactions" (as defined herein), discharge of indebtedness and
certain hedging transactions, generally must be derived from
investments relating to real property or mortgages on real
property, including interest income derived from mortgage loans
secured by real property (including certain types of
mortgage-backed securities), rents from real property, dividends
received from other REITs, and gains from the sale of designated
real estate assets, as well as specified income from temporary
investments. Second, at least 95% of our gross income in each
taxable year, excluding gross income from "prohibited
transactions", discharge of indebtedness and certain hedging
transactions, must be derived from some combination of income that
qualifies under the 75% gross income test described above, as well
as other dividends, interest, and gain from the sale or disposition
of stock or securities, which need not have any relation to real
property. Income and gain from certain hedging transactions will be
excluded from both the numerator and the denominator for purposes
of both the 75% and 95% gross income tests.
Asset Tests.
At the close of each calendar quarter, we must also satisfy five
tests relating to the nature of our assets. First, at least 75% of
the value of our total assets must be represented by some
combination of designated real estate assets, cash, cash items,
U.S. Government securities and, under some circumstances, stock or
debt instruments purchased with new capital. Second, the value of
any one issuer’s securities that we own may not exceed 5% of the
value of our total assets. Third, we may not own more than 10% of
any one issuer’s outstanding securities, as measured by either
value (the "10% of value asset test") or voting power. The 5% and
10% asset tests do not apply to securities that qualify under the
75% asset test or to securities of a TRS and qualified REIT
subsidiaries, and the 10% of value asset test does not apply to
"straight debt" having specified characteristics and to certain
other securities. Fourth, the aggregate value of all securities of
TRSs that we hold may not exceed 20% of the value of our total
assets. Fifth, not more than 25% of the value of our total assets
may be represented by debt instruments of publicly offered REITs to
the extent those debt instruments would not be real estate assets
but for the inclusion of debt instruments of publicly offered REITs
in the meaning of real estate assets.
Distribution Requirements.
In order to maintain our REIT qualification, we are required to
distribute dividends, other than capital gain dividends, to our
stockholders in an amount at least equal to: (1) the sum of (a) 90%
of our REIT taxable income computed without regard to our net
capital gains and the deduction for dividends paid, and (b) 90% of
our net income, if any, (after tax) from foreclosure property;
minus (2) the sum of specified items of non-cash income that
exceeds a certain percentage of our income.
Ownership.
In order to maintain our REIT status, we must not be deemed to be
closely held and must have more than 100 stockholders. The closely
held prohibition requires that not more than 50% of the value of
our outstanding shares be owned by five or fewer "individuals" (as
defined for this purpose to
include certain trusts and foundations) during the last half of our
taxable year. The "more than 100 stockholders" rule requires that
we have at least 100 stockholders for at least 335 days of a
taxable year. Failure to satisfy either of these rules would cause
us to fail to maintain our qualification for taxation as a REIT
unless certain relief provisions are available.
Taxation of REIT Dividends
REIT dividends (other than capital gain dividends) received by
non-corporate taxpayers may be eligible for a 20% deduction. This
deduction is only applicable to investors of LFT that receive
dividends and does not have any impact on us. Without further
legislation, the deduction would sunset after 2025. Investors
should consult their own tax advisors regarding the effect of this
change on their effective tax rate with respect to REIT
dividends.
Corporate Offices and Personnel
We were formed as a Maryland corporation in 2012. With effect from
January 18, 2018, our corporate headquarters are located at 230
Park Avenue, 20th Floor, New York, NY 10169 and our telephone
number is (212) 317-5700. We are externally managed by our Manager
pursuant to the management agreement between us and our Manager. We
have no employees. Our executive officers, all of whom were
provided by our Manager, are employees of Lument.
As of March 13, 2020, our Manager and its affiliates implemented a
work from home ("WFH") policy for employees in all locations. As of
October 1, 2021, our Manager has begun reopening offices on a
limited basis with certain staff returning to the office on a
staggered partial schedule. Our Manager's highly experienced senior
team and dedicated employees are fully operational during this
ongoing disruption and are continuing to execute on all investment
management, asset management, servicing, portfolio monitoring,
financial reporting and related control activities. Our Manager's
and affiliates' employees are in constant communication to ensure
timely coordination and early identification of issues. We continue
to engage in ongoing active dialogue with the borrowers in our
commercial loan portfolio to understand what is taking place at the
properties collateralizing our investments.
Access to our Periodic SEC Reports and Other Corporate
Information
Our internet website address is
www.lumentfinancetrust.com.
We make available free of charge, through our website, our annual
report on Form 10-K, our quarterly reports on Form 10-Q, current
reports on Form 8-K and any amendments thereto that we file
pursuant to Section 13(a) or 15(d) of the Securities Exchange Act
of 1934, as amended, or the Exchange Act, as soon as reasonably
practicable after such material is electronically filed with or
furnished to the SEC. Our Code of Business Conduct and Ethics and
Policy Against Insider Trading and our Corporate Governance
Guidelines along with the charters of our Audit, Compensation and
Nominating and Corporate Governance Committees are also available
on our website. Information on our website is neither part of nor
incorporated into this Annual Report on Form 10-K.
Website Disclosure
We use our website (www.lumentfinancetrust.com)
as a channel of distribution of company information. The
information we post through this channel may be deemed material.
Accordingly, investors should monitor this channel, in addition to
following our press releases, SEC filings, public conference calls,
and webcasts. In addition you may automatically receive email
alerts and other information about Lument Finance Trust, Inc. when
you enroll your email address by visiting "Investor Relations &
Email Alerts" section of our website at
https://www.lumentfinancetrust.com/investor-relations/email-alerts/.
The contents of our website and any alerts are not, however, a part
of this report.
ITEM 1A. RISK FACTORS
Set forth below are the risks that we believe are material to
stockholders. You should carefully consider the following risk
factors identified in or incorporated by reference into any other
documents filed by us with the SEC in evaluating our company and
our business. If any of the following risks occur, our business,
financial condition, results of operations and our ability to make
distributions to our stockholders could be adversely affected. In
that case, the trading price of our stock could decline. The risk
factors described below are not the only risks that may affect us.
Additional risks and uncertainties not presently known to us also
may adversely affect our business, financial condition, results of
operations and our ability to make distributions to our
stockholders.
Summary Risk Factors
Our business is subject to a number of risks, including risks that
may prevent us from achieving our business objectives or may
adversely affect our business, financial condition, results of
operations, cash flows, and prospects. These risks are discussed
more fully below and include, but are not limited to, risks related
to:
Risks Related to the Ongoing COVID-19 Pandemic
•The
ongoing outbreak of COVID-19 could have an adverse impact on our
financial condition and results of operations.
Risks Related to Our Investment Strategy and Our
Businesses
•We
may be unable to operate our business successfully or generate
sufficient revenue to make or sustain distributions to our
stockholders.
•We
may change business policies without shareholder
approval.
•Our
floating-rate commercial mortgage loans are subject to various
risks, such as interest rate risk, prepayment risk, real estate
risk and credit risk.
•Transitional
mortgage involve greater risk than conventional mortgage
loans.
•Certain
actions by the U.S. Federal Reserve could cause a change in the
expected level of interest rates, which could adversely affect our
business, financial conditions, results of operations and our
ability to make distributions to our stockholders.
•If
we are unable to implement and maintain effective internal controls
over financial reporting in the future, investors may lose
confidence in the accuracy and completeness of our financial
reports and the market price of our common stock may be negatively
affected.
•An
increase in interest rates may cause a decrease in the volume of
certain of our target assets, which could adversely affect our
ability to acquire assets that satisfy our investment objectives
and to generate income and make distributions to our
stockholders.
•Increases
in interest rates typically adversely affect the value of certain
of our investments and cause our interest expense to increase,
which could result in reduced earnings or losses and negatively
affect our profitability as well as the cash available for
distribution to our stockholders.
•Changes
to the method of determining LIBOR or the selection of a
replacement for LIBOR may affect the value of the financial
obligations to he held or issued by us that are linked to LIBOR and
could affect our results of operations and financial
results.
•We
may invest or spend the net proceeds for our equity or debt
offerings in ways with which our investors may not agree and in
ways that may not earn a profit.
•Changes
in laws and regulations governing our operations, changes in the
interpretation thereof or newly enacted laws or regulations and any
failure by us to comply with these laws or regulations, could
require changes in certain of business practices, negatively impact
our operations, cash flow or financial condition, impose additional
costs on us, subject us to increased competition or otherwise
adversely affect our business.
Risks Related to Financing and Hedging
•Our
strategy involves leverage, which may amplify losses and there is
no specific limit on the amount of leverage we may
use.
•We
may incur significant additional debt in the future, which will
subject us to increased risk of loss and may reduce cash available
for distributions to our stockholders.
•There
can be no assurance that our Manager will be able to prevent
mismatches in the maturities of our assets and
liabilities.
•Lenders
generally require us to enter into restrictive covenants relating
to our operations.
•An
increase in our borrowing costs relative to the interest that we
receive on investments in our mortgage related investments may
adversely affect our profitability and cash available for
distributions to our stockholders.
•We
have utilized and may utilize in the future non-recourse
securitizations to finance our loans and investments, which may
expose us to risks that could result in losses.
•Our
loans and investments may be subject to fluctuations in interest
rates that may not be adequately protected, or protected at all, by
our hedging strategies.
Risks Associated with Our Relationship with Our
Manager
•Our
board of directors has approved very broad investment guidelines
for our Manager and will not approve each investment and financing
decision made by our Manager.
•We
are dependent on our Manager and its key personnel for our
success.
•There
are conflicts of interest in our relationship with ORIX, including
with our Manager and in the allocation of investment opportunities
to ORIX affiliates and us, which could result in decisions that are
not in the best interests of our stockholders.
Risks Related to Our Securities
•An
increase in interest rates may have an adverse effect on the market
price of our stock and our abilities to make distributions to
stockholders.
•We
have not established a minimum distribution payment level on our
common stock and we cannot assure you of our ability to make
distributions in the future, or that our board of directors will
not reduce distributions in the future regardless of such
ability.
•Future
offerings of debt or equity securities that rank senior to our
common stock may adversely the market price of our common
stock.
Risks Related to Our Organization and Structure
•Maintenance
of our exclusion from the Investment Company Act will impose limits
on our business.
•Because
of their significant ownership of our common stock, OREC Investment
Holdings, LLC, an affiliate of our Manager, and Hunt Investors (as
described herein) have the ability to influence the outcome of
matters that require a vote of stockholders, including change of
control.
•Stockholders
have limited control over changes in our policies and
procedures.
•Ownership
limitations may restrict change of control or business combination
opportunities in which our stockholders might receive a premium for
their shares.
Tax Risks
•If
we failed to qualify as a REIT, we would be taxed at corporate
rates and would not be able to take certain deductions when
computing our taxable income.
•If
we failed to qualify as a REIT, we may default on our current
financing facilities and be required to liquidate our assets, and
we may face delays or inabilities to procure future
financing.
•Complying
with REIT requirements may cause us to forgo otherwise attractive
opportunities and may require us to dispose of our target assets
sooner than originally anticipated.
•Qualifying
as a REIT involves highly technical and complex provisions of the
Code.
Risks Related to the Ongoing COVID-19 Pandemic
The ongoing outbreak of COVID-19 could have an adverse impact on
our financial performance and results of operations.
As the COVID-19 pandemic has evolved from its emergence in early
2020, so has its global impact. Many countries have re-instituted,
or strongly encouraged, varying levels of quarantines and
restrictions on travel and in some cases have at times limited
operations of certain businesses and taken other restrictive
measures designed to help slow the spread of COVID-19 and its
variants. Governments and businesses have also instituted vaccine
mandates and testing requirements for employees. While vaccine
availability and uptake has increased, the longer-term
macro-economic effects on global supply chains, inflation, labor
shortages and wage increases continue to impact many industries.
Moreover, with the potential for new strains of COVID-19 to emerge,
governments and businesses may re-impose aggressive measures to
help slow its spread in the future. For this reason, among others,
as the COVID-19 pandemic continues, the potential global impacts
are uncertain and difficult to assess.
The outbreak of COVID-19 may have a material adverse impact on our
financial condition, liquidity, results of operations and the
market price of our common stock, among other things. We expect
these impacts are likely to continue to some extent as the outbreak
persists and potentially even longer. Although our business has
been or could be impacted by COVID-19, we currently believe the
following to be among the most material to us:
•COVID-19
could have a significant long-term impact on the broader economy
and the CRE market generally, which would continue to negatively
impact the value of the assets collateralizing our loans. Our
portfolio includes loan that are collateralized by retail and other
asset classes that are particularly negatively impacted by supply
and labor issues. While we believe the principal amount of our
loans are protected by the underlying value of the collateral
securing the loans, deterioration in the performance of the
properties securing our investments may cause deterioration in the
performance of our investments and, potentially, principal losses
to us.
•We
are actively engaged in discussions with our borrowers to monitor
their ability to pay principal and interest..
•Economic
and market conditions may limit our ability to redeploy proceeds
from payment of our existing investments in commercial mortgage
loans with similar spreads which may reduce future interest
income.
•Inflation,
Interest rates and credit spreads have been significantly impacted
since the outbreak of COVID-19.
The immediately preceding outcomes are those we consider to be most
material as a result of the pandemic. We have also experienced and
may experience other negative impacts to our business that could
exacerbate other risks described herein, including:
•lack
of liquidity in certain of our assets;
•risks
associated with loans to properties in transition or
construction;
•impairment
of our investments and harm to our operation form a prolonged
economic slowdown, a lengthy or severs recession or declining real
estate values;
•the
concentration of our loans and investments in terms of geography,
asset types and sponsors;
•losses
resulting from foreclosing on certain of the loans we
acquire;
•our
corporate debt;
•risks
associated with non-recourse securitizations which we use to
finance our assets;
•borrower
and counterparty risks;
•operational
impacts on ourselves and our third-party advisors, service
providers, vendors and counterparties, including operating
partners, property managers, other independent third-party
appraisal firms that provide appraisals of properties
collateralizing our loans, our lenders and other providers of
financing, and legal and diligence professional that we rely on for
acquiring our investments;
•limitation
on our ability to ensure business continuity in the event our, or
our third-party advisors' and service providers', continuity of
operations plan is not effective or improperly implemented or
deployed during a disruption;
•the
availability of key personnel of the Manager and our service
providers as they face changes circumstances and potential illness
during the pandemic; and
•other
risks described herein.
The ongoing fluidity of this situation precludes any prediction as
to the ultimate adverse impact of COVID-19 on economic and market
conditions, and, as a result, presents material uncertainty and
risk with respect to us and the performance of our investments. The
full extent of the impact and effects of COVID-19 will depend on
future developments, including, among other factors, the duration
and spread of the virus and its variants, availability, acceptance
and effectiveness of vaccines along with related travel advisories,
quarantines and restrictions, the recovery time of disrupted supply
chains and industries, the impact of labor market interruptions,
the impact of government interventions, and uncertainty with
respect to the duration of the global economic slowdown. COVID-19
and the current financial, economic and capital markets environment
and future developments in these and other areas present
uncertainty and risk with respect to our performance, results of
operations and ability to pay distributions.
Risks Related to Our Investment Strategies and Our
Businesses
We may not be able to operate our businesses successfully or
generate sufficient revenue to make or sustain distributions to our
stockholders.
We cannot assure you that we will be able to operate our businesses
successfully or implement our operating policies and strategies.
Our Manager may not be able to successfully execute our investment
and financing strategies as described in this Annual Report on Form
10-K, which could result in a loss of some or all of your
investment. Our results of operations depend on several factors,
including our Manager's ability to execute on our investment and
financing strategies, the availability of opportunities for the
acquisition of target assets, the level and volatility of interest
rates, the availability of adequate short and long-term financing,
conditions in the financial markets and economic conditions. Our
revenues will depend, in large part, on our Manager's ability to
execute on our investment and financing strategies, and our ability
to acquire assets at favorable spreads over our borrowing costs. If
our Manager is unable to execute on our investment and financing
strategies, or we are unable to acquire assets that generate
favorable spreads, our results of operations may be adversely
affected, which could adversely affect our ability to make or
sustain distributions to our stockholders.
If we fail to develop, enhance and implement strategies to adapt to
changing conditions in the mortgage industry and capital markets,
our business, financial condition, results of operations and our
ability to make distributions to our stockholders may be adversely
affected.
The manner in which we compete and the products for which we
compete are affected by changing conditions, which can take the
form of trends or sudden changes in our industry, regulatory
environment, changes in the role of GSEs, changes in the role of
credit rating agencies or their rating criteria or process, or the
U.S. economy more generally. If we do not effectively respond to
these changes, or if our strategies to respond to these changes are
not successful, our business, financial condition, results of
operations and our ability to make distributions to our
stockholders may be adversely affected.
We may not realize gains or income from our assets.
We seek to generate current income and attractive risk-adjusted
returns for our stockholders. However, the assets that we acquire
may not appreciate in value and, in fact, may decline in value, and
the assets that we acquire may experience defaults of interest
and/or principal payments. Accordingly, we may not be able to
realize gains or income from our assets. Any income that we do
realize may not be sufficient to offset other losses that we
experience.
We may change our target assets, investment or financing strategies
and other operational policies without stockholder consent, which
may adversely affect our business, financial condition, results of
operations and our ability to make distributions to our
stockholders.
We may change any of our strategies, policies or procedures with
respect to investments, acquisitions, growth, operations,
indebtedness, capitalization, distributions, financing strategy and
leverage at any time without the consent of our stockholders, which
could result in an investment portfolio with a different, and
possibly greater, risk profile. A change in our target assets,
investment strategy or guidelines, financing strategy or other
operational policies may increase our exposure to interest rate
risk, default risk and real estate market fluctuations.
Furthermore, a change in our asset allocation could result in our
making investments in asset categories different from those
described in this Annual Report on Form 10-K. In addition, our
charter provides that our board of directors may revoke or
otherwise terminate our REIT election, without approval of our
stockholders, if it determines that it is no longer in our best
interests to maintain our REIT qualification. These changes could
adversely affect our business, financial condition, results of
operations and our ability to make distributions to our
stockholders.
Our portfolio of assets may be concentrated in terms of credit
risk.
Although as a general policy we seek to acquire and hold a diverse
portfolio of assets, we are not required to observe specific
diversification criteria, except as may be set forth in the
investment guidelines adopted by our board of directors. Therefore,
our asset portfolio may at times be concentrated in certain
property types that are subject to higher risk of foreclosure or
secured by properties concentrated in a limited number of
geographic locations. To the extent that our portfolio is
concentrated in any one region or type of security, downturns
relating generally to such region or type of security may result in
defaults on a number of our assets within a short time period,
which could have a material adverse effect on our business,
financial condition, results of operations and our ability to make
distributions to our stockholders. Our portfolio may contain other
concentrations of risk, and we may fail to identify, detect or
hedge against those risks, resulting in large or unexpected losses.
Lack of diversification can increase the correlation of
non-performance and foreclosure risks among our
investments.
The impact of any future terrorist attacks, the occurrence of a
natural disaster, a significant climate change, health concerns
regarding pandemic diseases (such as the continued outbreak of
novel coronavirus) or changes in laws and regulations expose us to
certain risks.
Terrorist attacks, the anticipation of any such attacks, and the
consequences of any military or other response by the United States
and its allies may have an adverse impact on the U.S. financial
markets and the economy in general. We cannot predict the severity
of the effect that any such future events would have on the U.S.
financial markets, the economy or our business. Any future
terrorist attacks could adversely affect the credit quality of some
of our loans and investments. Some of our loans and investments
will be more susceptible to such adverse effects than others,
particularly those secured by properties in major cities or
properties that are prominent landmarks or public attractions. We
may suffer losses as a result of the adverse impact of any future
terrorist attacks and these losses may adversely impact our results
of operations.
Moreover, the enactment of the Terrorism Risk Insurance Act of
2002, or TRIA, requires insurers to make terrorism insurance
available under their property and casualty insurance policies and
provides federal compensation to insurers for insured losses. TRIA
was scheduled to expire at the end of 2020 but was reauthorized,
with some adjustments to its provisions, in December 2019 for seven
years through December 31, 2027. However, this legislation does not
regulate the pricing of such insurance and there is no assurance
that this legislation will be extended beyond 2027. The absence of
affordable insurance coverage may adversely affect the general real
estate lending market, lending volume and the market’s overall
liquidity and may reduce the number of suitable investment
opportunities available to us and the pace at which we are able to
make investments. If the properties that we invest in are unable to
obtain affordable insurance coverage, the value of those
investments could decline and in the event of an uninsured loss, we
could lose all or a portion of our investment.
In addition, the occurrence of a natural disaster (such as an
earthquake, tornado, hurricane, or a flood) or a significant
adverse climate change may cause a sudden decrease in the value of
real estate in the area or areas affected and would likely reduce
the value of the properties securing debt instruments that we
purchase. Because certain natural disasters are not typically
covered by the standard hazard insurance policies maintained by
borrowers, the affected borrowers may have to pay for any repairs
themselves. Borrowers may decide not to repair their property or
may stop paying their mortgages under those circumstances. This
would likely cause defaults and credit loss severities to
increase.
The occurrence of unforeseen or catastrophic events, including the
emergence of a pandemic, such as coronavirus, or other widespread
health emergency (or concerns over the possibility of such
emergency) could create economic and financial disruptions, and
could lead to operational difficulties that could impair our
ability to manage our business.
Lack of diversification in the number of assets we acquire would
increase our dependence on relatively few individual
assets.
Our management objectives and policies do not place a limit on the
size of the amount of capital used to support, or the exposure to
(by any other measure), any individual asset or any group of assets
with similar characteristics or risks. In addition, because we are
a small company, we may be unable to sufficiently deploy capital
into a number of assets or asset groups. As a result, our portfolio
may be concentrated in a small number of assets or may be otherwise
undiversified, increasing the risk of loss and the magnitude of
potential losses to us and our stockholders if one or more of these
assets perform poorly.
Our floating-rate commercial mortgage loans are subject to various
risks, such as interest rate risk, prepayment risk, real estate
risk and credit risk.
Generally, our business model is such that rising interest rates
will generally increase our net interest income, while declining
rates will generally decrease our net interest income. Our net
interest income currently benefits from in-the-money USD LIBOR
floors in our loan portfolio, which benefit is expected to
initially decrease as LIBOR increases. There can be no assurance
that we will continue to utilize USD LIBOR floors. As of December
31, 2021, one-month USD LIBOR was 0.10%, as compared to 0.08% as of
September 30, 2021. There can be no assurance of how our net income
may be affected in future quarters, which will depend on, among
other things, the interest rate environment and our-then-current
portfolio. As of December 31, 2021, 100.0% of our loans by
principal balance earned a floating rate of interest indexed to
one-month USD LIBOR. The interest rates we pay under our current
financing arrangements are floating rate. Accordingly, our interest
expense will generally increase as interest rates increase and
decrease as interest rates decline.
As discussed below under "Changes to the method of LIBOR or the
selection of a replacement for LIBOR may affect the value of the
financial obligations to be held or issued by us that are linked to
LIBOR and could affect our results operations and financial
results," one-month USD LIBOR will cease to be published after June
30, 2023. Loans originated by the Manager or its affiliates as of
January 1, 2022 that have been acquired or any be acquired by us
have been indexed to the 30-day tenor CME Term SOFR. With respect
to loans originated prior to such date, all loans have index
fallback language that, when USD LIBOR ceases to be published (a)
follows the Alternative Reference Rate Committee ("ARRC")
recommendation for replacement floating rate index (noting the ARRC
already identifies SOFR as the recommended replacement index), or
(b) allows Lender discretion to identify the appropriate
replacement index, to the extent reasonably possible, calculated in
substantially the same manner and upon the same economic basis as
one-month USD LIBOR.
We are subject to prepayment risk associated with the terms of our
CLOs. Due to the generally short-term nature of transitional
floating-commercial mortgage loans, our CLOs include a reinvestment
period during which principal repayments and prepayments on our
commercial mortgage loans may be reinvested in similar assets,
subject to meeting certain eligibility criteria. While the
interest-rate spreads of our collateralized loan obligations are
fixed until they are repaid, the terms, including spreads, of newly
originated loans are subject to uncertainty based on a variety of
factors, including market and competitive conditions. To the extent
that such conditions result in lower spreads on the assets in which
we reinvest, we may be subject to a reduction in interest income in
the future. It is expected that in 2022 the U.S. Federal Reserve
will raise benchmark overnight interest rates on multiple
occasions. Any such increases would increase our borrowers interest
payments and for certain borrowers may lead to defaults and losses
to us. Such increases could also adversely affect CRE property
values.
The market values of commercial mortgage assets are subject to
volatility and may be adversely affected by real estate risks,
including, but not limited to, national, regional and local
economic conditions (which may be adversely affected by industry
slowdowns and other factors); local real estate conditions; changes
or continued weakness in specific industry segments; construction
quality, age and design; demographic factors; and retroactive
changes to building or similar codes. In addition, decreases in
property values reduce the value of the collateral and potential
proceeds available to a borrower to repay the underlying loans,
which could also cause us to suffer losses.
Our commercial mortgage loans and other investments are also
subject to credit risk. The performance and value of our loans and
other investments depend upon the sponsor's ability to operate
properties that serve as our collateral so that they produce cash
flows adequate to pay interest and principal to us. To monitor this
risk, the Manager's asset management team reviews our portfolio and
maintains regular contact with borrowers, co-lenders and local
market experts to monitor the performance of the underlying
collateral, anticipate borrower, property and market issues and, to
the extent necessary or appropriate, enforce our rights as
lender.
Transitional mortgage loans involve greater risk than conventional
mortgage loans.
The typical borrower in a transitional mortgage loan has usually
identified an asset which the borrower believes is undervalued or
that has been under-managed, or is undergoing a repositioning plan
including a potential capital improvement. If the market in which
the asset is located fails to perform according to the borrower's
projections, or if the borrower fails to improve the quality of the
asset's management and/or value of the asset, the borrower may not
receive a sufficient return on the asset to satisfy the
transitional mortgage loan, and we bear the risk that we may not
recover some or all of our investment.
In addition, borrowers typically use the proceeds of a conventional
mortgage to repay a transitional mortgage loan. Transitional
mortgage loans therefore are subject to the risk of a borrower's
inability to obtain permanent financing to repay the transitional
mortgage loan. Risks of cost overruns and renovations of properties
in transition may result in significant losses. The renovation,
refurbishment or expansion of a property by a borrower involves
risks of cost overruns and non-completion. Estimates of the costs
of improvements to bring an acquired property up to the standards
established for the market position intended for the property may
prove inaccurate. Other risks may include rehabilitation costs
exceeding original estimates, possibly making a project
uneconomical, environmental risks, delays in legal and other
approvals (e.g., for condominiums) and rehabilitation and
subsequent leasing of the property not being completed on schedule.
If such renovation is not completed in a timely manner, or if it
costs more than expected, the borrower may experience a prolonged
impairment of net operating income and may not be able to make
payments on our investment on a timely basis or at all. In the
event of any default under transitional mortgage loans that may be
held by us, we bear the risk of loss of principal and non-payment
of interest and fees to the extent of any deficiency between the
value of the mortgage collateral and the principal amount and
unpaid interest on the transitional loan. To the extent we suffer
such losses with respect to these transitional mortgage loans, it
could adversely affect our results of operations and financial
condition.
Investments in non-conforming and non-investment grade rated CRE
loans or securities involve increased risk of loss.
Certain CRE debt investments may not conform to conventional loan
standards applied by traditional lenders and either will not be
rated (as is typically the case for private loans) or will be rated
as non-investment grade by the rating agencies. Private loans often
are not rated by credit rating agencies. Non-
investment grade ratings typically result from the overall leverage
of the loans, the lack of a strong operating history for the
properties underlying the loans, the borrowers’ credit history, the
underlying properties’ cash flow or other factors. As a result,
these investments should be expected to have a higher risk of
default and loss than investment-grade rated assets. Any loss we
incur may be significant and may adversely affect our results of
operations and financial condition. There are no limits on the
percentage of unrated or non-investment grade rated assets we may
hold in our investment portfolio.
We may invest in transitional multifamily loans, CRE loans, CRE
debt securities and other similar structured finance investments,
which are secured by income producing properties. Such loans are
typically made to single-asset entities, and the repayment of the
loan is dependent principally on the net operating income from the
performance and value of the underlying property. The volatility of
income performance results and property values may adversely affect
our transitional multifamily loans, CRE loans and CRE debt
securities and similar structured finance investments.
Our transitional multifamily and CRE loans are secured by the
underlying commercial property and, in each case are subject to
risks of delinquency, foreclosure and loss. Transitional
multifamily loans, CRE loans, CRE debt securities and other similar
structured finance investments generally have a higher principal
balance and the ability of a borrower to repay a loan secured by an
income-producing property typically is dependent upon the
successful operation of the property rather than upon the existence
of independent income or assets of the borrower. If the net
operating income of the property is reduced, the borrower’s ability
to repay the loan may be impaired. Net operating income of an
income-producing property can be affected by, among other things:
tenant mix, success of tenant businesses, property management
decisions, property location and condition, competition from
comparable types of properties, changes in laws that increase
operating expenses or limit rents that may be charged, any need to
address environmental contamination at the property, changes in
national, regional or local economic conditions and/or specific
industry segments, declines in regional or local real estate values
and declines in regional or local rental or occupancy rates,
increases in interest rates, real estate tax rates and other
operating expenses, changes in governmental rules, regulations and
fiscal policies, including environmental and/or tax legislation,
and acts of God, terrorism, social unrest and civil
disturbances.
Multifamily and CRE property values and net operating income
derived therefrom are subject to volatility and may be affected
adversely by a number of factors, including, but not limited to,
national, regional and local economic conditions; changes in tax
laws; local real estate conditions; changes or continued weakness
in specific industry segments; perceptions by prospective tenants,
retailers and shoppers of the safety, convenience, services and
attractiveness of the property; the willingness and ability of the
property’s owner to provide capable management and adequate
maintenance; construction quality, age and design; demographic
factors; retroactive changes to building or similar codes; and
increases in operating expenses (such as energy
costs).
Declines in the borrowers’ net operating income and/or declines in
property values of collateral securing transitional multifamily
loans, CRE loans or CRE debt securities and other similar
structured finance investments could result in defaults on such
loans, declines in our book value from reduced earnings and/or
reductions to the market value of the investment.
Our target assets may include CRE loans which are funded with
interest reserves and borrowers may be unable to replenish such
interest reserves once they run out.
We invest in transitional CRE and we expect that borrowers may be
required to post reserves to cover interest and operating expenses
until the property cash flows are projected to increase
sufficiently to cover debt service costs. We may also require the
borrower to replenish reserves if they become depleted due to
underperformance or if the borrower wishes to exercise extension
options under the loan. Revenues on the properties underlying any
CRE loan investments may decrease in an economic downturn which
would make it more difficult for borrowers to meet their payment
obligations to us. Some borrowers may have difficulty servicing our
debt and may not have sufficient capital to replenish reserves,
which could have a significant impact on our operating results and
cash flows.
We may not have control over certain of our loans and
investments.
Our ability to manage our portfolio of loans and investments may be
limited by the form in which they are made. In certain situations,
we may:
•acquire
investments subject to rights of senior classes, special servicers
or collateral managers under intercreditor, servicing agreements or
securitization documents;
•pledge
our investments as collateral for financing
arrangements;
•acquire
only a minority and/or non-controlling participation in an
underlying investment;
•co-invest
with others through partnership, joint ventures or other entities,
thereby acquiring non-controlling interests; or
•rely
on independent third party management or servicing with respect to
the management of an asset.
Therefore, we may not be able to exercise control over all aspects
of our loans or investments. Such financial assets may involve
risks not present in investments where senior creditors, junior
creditors, servicers or third-party controlling investors are not
involved. Our rights to control the process following a borrower
default may be subject to the rights of senior or junior creditors
or servicers whose interests may not be aligned with ours. A
partner or co-venturer may have financial difficulties resulting in
a negative impact on such asset, may have economic or business
interests or goals that are inconsistent with ours, or may be in a
position to take action contrary to our investment
objectives.
Certain actions by the U.S. Federal Reserve could cause a change in
the expected level of interest rates, which could adversely affect
our business, financial condition, results of operations and our
ability to make distributions.
On January 26, 2022, the Federal Reserve announced that it will end
its monthly asset purchases, including its purchases of agency
mortgage-backed securities, in March and signaled that it is likely
to begin increasing the federal funds rate this year. This
announcement indicates that the Federal Reserve will likely
continue to reverse the policies it adopted in response to the
macro-economic effects of the 2020 COVID-pandemic. In response to
the COVID-pandemic, the Federal Reserve adopted a policy of
quantitative easing whereby it purchased each month significant
amounts of U.S. Treasury securities and agency mortgage-backed
securities. The Federal Reserve also reduced the federal funds rate
target to 0 to ¼ percent, established a series of emergency lending
programs, reduced the discount rate and encouraged depository
institutions to borrow from the discount window, and took
regulatory actions to ease capital and liquidity requirements at
depository institutions. The purpose of these actions was to
stabilize financial markets and reduce both interest rates
generally and the spread between long-term and short-term interest
rates. The Federal Reserve’s balance sheet increased by more than
$4.5 trillion to nearly $9 trillion, including $2.5 trillion in
agency mortgage-backed securities. Due to the reduction in interest
rates, prepayment speeds and mortgage refinancing activity
increased. The Federal Reserve took similar actions during the 2008
financial crisis. The Federal Reserve has already terminated most
of the emergency lending facilities established in
2020.
The Federal Reserve’s shift in policy is likely to result in higher
interest rates, including for agency mortgage-backed securities.
The Federal Reserve has already begun to reduce its asset purchases
and has stated that it intends to hold, in the longer run,
primarily Treasury securities on its balance sheet. These actions
may decrease spreads on interest rates, reducing our net interest
income. They may also negatively impact our results as we have
certain assets and liabilities that are sensitive to changes in
interest rates. In addition, increases in interest rates may result
in lower refinancing activity and therefore decrease the rate of
prepayment on loans underlying our assets, which could have a
material adverse effect on our result of operations.
There is still considerable uncertainty concerning the speed at
which the Federal Reserve will continue to adjust rates. Changes in
the federal funds rate as well as the other policies of the Federal
Reserve affect interest rates, which have a significant impact on
the demand for CRE loans. Such uncertainty and volatility often
leads to asset price volatility, changes in interest rate spreads
and increased hedging costs, which in turn could adversely affect
our business, financial condition, results of operation and our
ability to make distributions to our stockholders.
Changes in laws or regulations governing our operations, changes in
the interpretation thereof or newly enacted laws or regulations and
any failure by us to comply with these laws or regulations, could
require changes to certain of our business practices, negatively
impact our operations, cash flow or financial condition, impose
additional costs on us, subject us to increased competition or
otherwise adversely affect our business.
The laws and regulations governing our operations, as well as their
interpretation, may change from time to time, and new laws and
regulations may be enacted. Accordingly, any change in these laws
or regulations, changes in their interpretation, or newly enacted
laws or regulations and any failure by us to comply with these laws
or regulations, could require changes to certain of our business
practices, negatively impact our operations, cash flow or financial
condition, impose additional costs on us or otherwise adversely
affect our business. For example, from time to time the market for
real estate debt transactions has been adversely affected by a
decrease in the availability of senior and subordinated financing
for transactions, in part in response to regulatory pressures on
providers of financing to reduce or eliminate their exposure to
such transactions. Furthermore, if regulatory capital
requirements-whether under the Dodd-Frank Act, Basel III (i.e., the
framework for a comprehensive set of capital and liquidity
standards for internationally active banking organizations, which
was adopted in June 2011 by the Basel Committee on Banking
Supervision, an international body comprised of senior
representatives of bank supervisory authorities and central banks
from 27 countries, including the United States) or other regulatory
action-are imposed on private lenders that provide us with funds,
or were to be imposed on us, they or we may be required to limit,
or increase the cost of, financing they provide to us or that we
provide to others. Among other things, this could potentially
increase our financing costs, reduce our ability to originate or
acquire loans and reduce our liquidity or require us to sell assets
at an inopportune time or price.
Various laws and regulations currently exist that restrict the
investment activities of banks and certain other financial
institutions but do not apply to us, which we believe creates
opportunities for us to participate in certain investments that are
not available to these more regulated institutions. Any
deregulation of the financial industry, including by amending the
Dodd-Frank Act, may decrease the restrictions on banks and other
financial institutions and would create more competition for
investment opportunities that were previously not available to the
financial industry. For example, in 2018, a bill was signed into
law that eased the regulation and oversight of certain banks under
the Dodd-Frank Act.
There has been increasing commentary amongst regulators and
intergovernmental institutions on the role of nonbank institutions
in providing credit and, particularly, so-called “shadow banking,”
a term generally taken to refer to credit intermediation involving
entities and activities outside the regulated banking system. For
example, in August 2013, the Financial Stability Board issued a
policy framework for strengthening oversight and regulation of
“shadow banking” entities. The report outlined initial steps to
define the scope of the shadow banking system and proposed general
governing principles for a monitoring and regulatory framework. A
number of other regulators, such as the Federal Reserve, and
international organizations, such as the International Organization
of Securities Commissions, are studying the shadow banking system.
At this time, it is too early to assess whether any rules or
regulations will be proposed or to what extent any finalized rules
or regulations will have on the nonbank lending market. If rules or
regulations were to extend to us or our affiliates the regulatory
and supervisory requirements, such as capital and liquidity
standards, currently applicable to banks, then the regulatory and
operating costs associated therewith could adversely impact the
implementation of our investment strategy and our returns. In an
extreme eventuality, it is possible that such regulations could
render the continued operation of our company
unviable.
In the United States, the process established by the Dodd-Frank Act
for designation of systemically important nonbank firms has
provided a means for ensuring that the perimeter of prudential
regulation can be extended as appropriate to cover large shadow
banking institutions. The Dodd-Frank Act established the Financial
Stability Oversight Council (the “FSOC”), which is comprised of
representatives of all the major U.S. financial regulators, to act
as the financial system’s systemic risk regulator. The FSOC has the
authority to review the activities of nonbank financial companies
predominantly engaged in financial activities and designate those
companies as “systematically important financial institutions”
(“SIFIs”) for supervision by the Federal Reserve. Such designation
is applicable to companies where material distress or failure could
pose risk to the financial stability of the United States. On
December 18, 2014, the FSOC released a notice seeking public
comment on the potential risks posed by aspects of the asset
management industry, including whether asset management products
and activities may pose potential risks to the U.S. financial
system in the areas of liquidity and redemptions, leverage,
operational functions, and resolution, or in other areas. On April
18, 2016, the FSOC released an update on its multi-year review of
asset management products and activities and created an interagency
working group to assess potential risks associated with certain
leveraged funds. On December 4, 2019, the FSOC issued final
guidance regarding the FSOC’s procedures for designating nonbank
financial companies as SIFIs. This guidance implemented a number of
reforms to the FSOC’s prior SIFI designation approach by shifting
from an “entity-based” approach to an “activities-based” approach
whereby the FSOC will primarily focus on regulating activities that
pose systematic risk to the financial stability of the United
States, rather than designations of individual firms. Under the
guidance, designation of a nonbank financial company as a SIFI
would only occur if the FSOC determined that the expected benefits
justify the expected costs of the designation. While the impact of
this guidance cannot be known at this time, increased regulation of
nonbank credit extension could negatively impact our operations,
cash flows or financial condition, impose additional costs on us,
intensify the regulatory supervision of us or otherwise adversely
affect our business.
The U.K.’s exit from the E.U. could adversely affect
us.
The United Kingdom left the E.U. on January 31, 2020. On May 1,
2021, the E.U.-U.K. Trade and Cooperation Agreement (the “TCA”)
became effective. The TCA provides the United Kingdom and E.U.
members with preferential access to each other’s markets, without
tariffs or quotas on imported products between the jurisdictions,
provided that certain rules of origin requirements are complied
with. However, economic relations between the United Kingdom and
the E.U. will now be on more restricted terms than existed prior to
Brexit. The long-term effects of Brexit are expected to depend on,
among other things, any agreements the U.K. has made, or makes to
retain access to E.U. markets. Brexit could adversely affect
European or worldwide economic or market conditions and could
contribute to instability in global financial and real estate
markets. In addition, Brexit could lead to legal uncertainty and
potentially divergent national laws and regulations as the U.K.
determines which E.U. laws to replace or replicate. Any of these
effects of Brexit, and others we cannot anticipate, could adversely
affect our business, business opportunities, results of operations,
financial condition and cash flows. Likewise, similar actions taken
by other European and other countries in which we operate could
have a similar or even more profound impact.
Changes in laws or regulations governing the operations of
borrowers could affect our returns with respect to those
borrowers.
Government counterparties or agencies may have the discretion to
change or increase regulation of a borrower’s operations, or
implement laws or regulations affecting a borrower’s operations,
separate from any contractual rights it may have. A borrower could
also be materially and adversely affected as a result of statutory
or regulatory changes or judicial or administrative interpretations
of existing laws and regulations that impose more comprehensive or
stringent requirements on such company. Governments have
considerable discretion in implementing regulations, for example,
the possible imposition or increase of taxes on income earned by a
borrower or gains recognized by us on our investment in such
borrower, that could impact a borrower’s business as well as our
return on our investment with respect to such borrower. Changes in
government rules, regulations and fiscal policies, including
increases in property taxes, changes in zoning laws and increasing
costs to comply with environmental law could increase operating
expenses for our borrowers. Likewise, changes in rent control or
rent stabilization laws or other residential landlord/tenant laws
could result in lower revenue growth or significant unanticipated
expenditures for our borrowers. These initiatives and any other
future enactments of rent control or rent stabilization laws or
other laws regulating multifamily housing may reduce our borrowers’
rental revenues or increase their operating costs. Such laws and
regulations may limit our borrowers’ ability to charge market
rents, increase rents, evict tenants or recover increases in their
operating costs, which may, in turn, impact our return on our
investment with respect to such borrowers.
The impacts of climate-related initiatives at the U.S. federal and
state levels remain uncertain at this time but could result in
increased operating costs for us and our borrowers.
Government authorities and various interest groups are promoting
laws and regulations that could limit greenhouse gas (“GHG”)
emissions due to concerns over contributions to climate change. The
United States Environmental Protection Agency, (“EPA”) has moved to
regulate GHG emissions using its existing authority under the Clean
Air Act. Moreover, certain state and regional programs are being
implemented to require reductions in GHG emissions. Any additional
taxation or regulation of energy use, including as a result of (i)
the regulations that EPA has proposed or may propose in the future,
(ii) state programs and regulations, or (iii) renewed GHG
legislative efforts by future Congresses, could result in increased
operating costs for us or our borrowers. Any such increased costs
could impact the financial condition of our borrowers and their
ability to meet their loan obligations to us.
We may be subject to lender liability claims, and if we are held
liable under such claims, we could be subject to
losses.
In recent years, a number of judicial decisions have upheld the
right of borrowers to sue lending institutions on the basis of
various evolving legal theories, collectively termed "lender
liability." Generally, lender liability is founded on the premise
that a lender has either violated a duty, whether implied or
contractual, of good faith and fair dealing owed to the borrower or
has assumed a degree of control over the borrower resulting in the
creation of a fiduciary duty owed to the borrower or its other
creditors or stockholders. We cannot assure prospective investors
that such claims will not arise or that we will not be subject to
significant liability if a claim of this type did
arise.
Our investments in commercial mortgage backed securities, CLOs and
other similar structured finance investments, as well as those we
structure, sponsor or arrange, pose additional risks, including the
risks of the securitization process and the risk that the special
servicer, ORIX Real Estate Capital, LLC ("OREC"), an affiliate of
our Manager, may take actions that could adversely affect our
interests.
We have invested in, and may from time to time invest in,
commercial mortgage-backed securities, including in the most
subordinated classes of such commercial mortgage-backed securities,
CLOs and other similar securities, which may be subordinated
classes of securities in a structure of securities secured by a
pool of mortgages or loans. Accordingly, such securities may be the
first or among the first to bear the loss upon a restructuring or
liquidation of the underlying collateral and the last to receive
payment of interest and principal, with only a nominal amount of
equity or other debt securities junior to such positions. The
estimated fair values of such subordinated interests tend to be
much more sensitive to adverse economic downturns and underlying
borrower developments than more senior securities. A projection of
an economic downturn, for example, could cause a decline in the
price of lower credit quality commercial mortgage-backed securities
or CLOs because the ability of borrowers to make principal and
interest payments on the mortgages or loans underlying such
securities may be impaired.
Interests such as commercial mortgage-backed securities, CLOs and
similar structured finance investments generally are not actively
traded and are relatively illiquid investments. Volatility in
commercial mortgage-backed securities and CLO trading markets may
cause the value of these investments to decline. In addition, if
the underlying mortgage portfolio has been overvalued by the
originator, or if the values subsequently decline and, as a result,
less collateral value is available to satisfy interest and
principal payments and any other fees in connection with the trust
or other conduit arrangement for such securities, we may incur
significant losses.
With respect to the commercial mortgage-backed securities and CLOs
in which we have invested and may invest in the future, overall
control over the special servicing of the related underlying
mortgage loans will be exercised by OREC or another special
servicer or collateral manager designated by a "directing
certificate holder" or a "controlling class representative," which
is appointed by the holders of the most subordinated class of
commercial mortgage-backed securities in such series. Unless we
acquire the subordinate classes of existing series of commercial
mortgage-backed securities and CLOs, we will not have the right to
appoint the directing certificate holder. In connection with the
servicing of the specially serviced mortgage loans, the related
special servicer may, at the direction of the directing certificate
holder, take actions with respect to the specially serviced
mortgage loans that could adversely affect our
interests.
If the loans that we originate or acquire do not comply with
applicable laws, we may be subject to penalties, which could
materially and adversely affect us.
Loans that we may originate or acquire may be directly or
indirectly subject to U.S. federal, state or local governmental
laws. Real estate lenders and borrowers may be responsible for
compliance with a wide range of laws intended to protect the public
interest, including, without limitation, the Truth in Lending,
Equal Credit Opportunity, Fair Housing and American with
Disabilities Acts and local zoning laws (including, but not limited
to, zoning laws that allow permitted non-conforming uses). If we or
any other person fails to comply with such laws in relation to a
loan that we have originated or acquired, legal penalties may be
imposed, which could materially and adversely affect us.
Additionally, jurisdictions with "one action," "security first"
and/or "antideficiency rules" may limit our ability to foreclose on
a real property or to realize on obligations secured by a real
property. In the future, new laws may be enacted or imposed by U.S.
federal, state or local governmental entities, and such laws could
have a material adverse effect on us.
If we are unable to implement and maintain effective internal
controls over financial reporting in the future, investors may lose
confidence in the accuracy and completeness of our financial
reports and the market price of our common stock may be negatively
affected.
As a public company, we are required to maintain internal controls
over financial reporting and to report any material weaknesses in
such internal controls. In addition, we are required to furnish a
report by management on the effectiveness of our internal controls
over financial reporting, pursuant to Section 404 of the
Sarbanes-Oxley Act. Once we are no longer a smaller reporting
company, our independent registered public accounting firm will be
required to formally attest to the effectiveness of our internal
controls over financial reporting on an annual basis. The process
of designing, implementing and testing the internal controls over
financial reporting required to comply with this obligation is time
consuming, costly and complicated. If we identify a material
weakness in our internal controls over financial reporting, if we
are unable to comply with the requirements of Section 404 of the
Sarbanes-Oxley Act in a timely manner or to asset that our internal
controls over financial reporting is effective or if, once we are
no longer a smaller reporting company, our independent registered
public accounting firm is unable to express an opinion as to the
effectiveness of our internal controls over financial reporting,
investors may lose confidence in the accuracy and completeness of
our financial reports and the market price of our common stock
could be negatively affected. We could also become subject to
investigations by the stock exchange on which our securities are
listed, the SEC or other regulatory authorities, which could
require additional financial and management resources.
We depend on our accounting services provider for assistance with
the preparation of our financial statements, access to appropriate
accounting technology and assistance with portfolio valuation.
Pursuant to our agreement with SS&C Technologies (SS&C"),
SS&C currently maintains our general ledger and all related
accounting records, reconciles all broker and custodial statements
we routinely receive, provides us with monthly portfolio, cash and
position reports, assists us with portfolio valuations, prepares
draft quarterly financial statements for our review and provides us
with access to data and technology services to facilitate the
preparation of our annual financial statements. If our
agreement with SS&C were to be terminated and no suitable
replacement can be timely engaged, we may not be able to timely and
accurately prepare our financial statements.
We may be required to make servicing advances and may be exposed to
a risk of loss if such advances become non-recoverable and such
advances and risk could adversely affect our liquidity or cash
flow.
In connection with securitization transactions wherein Five Oaks
Acquisition Corp. ("FOAC") sold mortgage loans to the
securitization trust and holds the MSRs with respect to those
mortgage loans, FOAC entered into sub-servicing agreements with one
or more sub-servicers. Pursuant to the terms of the sub-servicing
agreements, FOAC is required to refund or to fund any servicing
advances that are obligated to be made by the sub-servicers. FOAC
is therefore exposed to the potential loss of any servicing advance
that becomes non-recoverable. Such advances and exposure going
forward could adversely affect our liquidity or cash flow during a
financial period.
We operate in a highly competitive market for investment
opportunities and competition may limit our ability to acquire
desirable investments in assets we target and could also affect the
pricing of these securities.
We are engaged in a competitive business. In our investing
activities, we compete for opportunities with a variety of
institutional investors, including other REITs, specialty finance
companies, public and private funds (including other funds managed
by Lument IM and its affiliates), commercial and investment banks,
commercial finance and insurance companies and other financial
institutions. Several other REITs and other investment vehicles
have raised significant amounts of capital, and may have investment
objectives that overlap with ours, which may create additional
competition for investment opportunities. Some competitors may have
a lower cost of funds and broader access to funding sources, such
as the U.S. Government, that are not available to us. Many of our
competitors are not subject to the operating constraints associated
with REIT compliance or maintenance of an exclusion from regulation
under the Investment Company Act. We could face increased
competition from banks due to future legislative developments, such
as amendments to key provisions of the Dodd-Frank Act, including,
provisions setting forth capital and risk retention requirements.
In addition, some of our competitors may have higher risk
tolerances or different risk assessments, which could allow them to
consider a wider variety of loans and investments and offer more
attractive pricing or other terms than we would. Furthermore,
competition for investments we target may lead to decreasing
yields, which may further limit our ability to generate targeted
returns. We cannot assure you that the competitive pressures we
face will not have a material adverse effect on our business,
financial condition, results of operations and our ability to make
distributions to our stockholders. Also, as a result of this
competition, desirable investments in these assets may be limited
in the future and we may not be able to take advantage of
attractive investment opportunities from time to time, as we can
provide no assurance that we will be able to identify and make
investments that are consistent with our investment
objectives.
A prolonged economic recession and declining real estate values
could impair our assets and harm our operations.
The risks associated with our business are more severe during
economic recessions and are compounded by declining real estate
values. The transitional multifamily and other CRE loans in which
we may invest will be particularly sensitive to these risks.
Declining real estate values will likely reduce the level of new
mortgage loan originations since borrowers often use appreciation
in the value of their existing properties to support the purchase
of additional properties. Borrowers will also be less able to pay
principal and interest on loans underlying the securities in which
we invest if the value of residential real estate weakens further.
Further, declining real estate values significantly increase the
likelihood that we will incur losses on the transitional
multifamily and other CRE loans in the event of default because the
value of collateral on the mortgages underlying such securities may
be insufficient to cover the outstanding principal amount of the
loan. Any sustained period of increased payment delinquencies,
foreclosures or losses could have an adverse effect on our
business, financial condition, results of operations and our
ability to make distributions to our stockholders.
The lack of liquidity in our investments may adversely affect our
business.
We acquire assets that are not liquid or publicly traded. A lack of
liquidity may result from the absence of a willing buyer or an
established market for these assets, as well as legal or
contractual restrictions on resale or the unavailability of
financing for these assets. In addition, mortgage-related assets
generally experience periods of illiquidity. Further, validating
third-party pricing for illiquid assets may be more subjective than
for liquid assets. Any illiquidity of our investments may make it
difficult for us to sell such investments if the need or desire
arises. In addition, if we are required to liquidate all or a
portion of our portfolio quickly, we may realize significantly less
than the value at which we have previously recorded our
investments. Further, we may face other restrictions on our ability
to liquidate an investment in a business entity to the extent that
we or our Manager has or could be attributed with material,
non-public information regarding such business entity. If we are
unable to sell our assets at favorable prices or at all, it could
adversely affect our business, financial condition and results of
operations and our ability to make distributions to our
stockholders. Assets that are illiquid are more difficult to
finance, and to the extent that we use leverage to finance assets
that become illiquid, we may lose that leverage or have it reduced.
Assets tend to become less liquid during times of financial stress,
which is often the time that liquidity is most needed. As a result,
our ability to vary our portfolio in response to changes in
economic and other conditions may be relatively limited, which
could adversely affect our business, financial condition, results
of operations and our ability to make distributions to our
stockholders.
Our investment in CRE debt securities and other similar structured
finance investments may be subject to losses.
We may acquire CRE debt securities and other similar structured
finance investments. In general, losses on a mortgaged property
securing a mortgage loan included in a securitization will be borne
first by the equity holder of the property, then by a cash reserve
fund or letter of credit, if any, then by the holder of a mezzanine
loan or B-Note, if any, then by the "first loss" subordinated
security holder and then by the holder of a higher-rated security.
In the event of default and the exhaustion of any equity support,
reserve fund, letter of credit, mezzanine loans or B-Notes, and any
classes of securities junior to those in which we invest, we will
not be able to recover all of our investment in the securities we
purchase. In addition, if the underlying mortgage portfolio has
been overvalued by the originator, or if the values subsequently
decline, less collateral is available to satisfy interest and
principal payments due on the related CRE debt securities and other
similar structured finance investments. The prices of lower credit
quality securities are generally less sensitive to interest rate
changes than more highly rated investments, but more sensitive to
adverse economic downturns or individual issuer
developments.
To the extent that due diligence is conducted on potential assets,
such due diligence may not reveal all of the risks associated with
such assets and may not reveal other weaknesses in such assets,
which could lead to losses.
Before acquiring certain assets, such as transitional multifamily
and other CRE loans or other mortgage-related assets, our Manager
conducts (either directly or using third parties) due diligence.
Such due diligence may include (1) an assessment of the strengths
and weaknesses of the asset’s credit profile, (2) a review of all
or merely a subset of the documentation related to the asset, or
(3) other reviews that we or our Manager may deem appropriate to
conduct. There can be no assurance that we or our Manager will
conduct any specific level of due diligence, or that, among other
things, the due diligence process will uncover all relevant facts
and potential liabilities or that any purchase will be successful,
which could result in losses on these assets, which, in turn, could
adversely affect our financial condition and results of
operations.
Our Manager utilizes analytical models and data in connection with
the valuation of certain of our assets, and any incorrect,
misleading or incomplete information used in connection therewith
would subject us to potential risks.
Given the complexity of certain of our target assets, our Manager
may rely heavily on analytical models and information and data
supplied by third parties. Models and data are used to value
potential target assets, potential credit risks and reserves and
also in connection with hedging our acquisitions. Many of the
models are based on historical trends. These trends may not be
indicative of future results. Furthermore, the assumptions
underlying the models may prove to be inaccurate, causing the
models to also be incorrect. In the event models and data prove to
be incorrect, misleading or incomplete, any decisions made in
reliance thereon expose us to potential risks. For example, by
relying on incorrect models and data, especially valuation models,
our Manager may be induced to buy for us certain target assets at
prices that are too high, to sell certain other assets at prices
that are too low or to miss favorable opportunities altogether.
Similarly, any hedging based on faulty models and data may prove to
be unsuccessful.
Any credit ratings assigned to our investments will be subject to
ongoing evaluations and revisions and we cannot assure you that
those ratings will not be downgraded.
Some of our investments may be rated by Moody’s Investors Service,
Fitch Ratings, Standard & Poor’s, Kroll Bond Rating Agency,
DBRS, Inc., Egan Jones, or other rating agencies. Any credit
ratings on our investments are subject to ongoing evaluation by
credit rating agencies, and we cannot assure you that any such
ratings will not be changed or withdrawn by a rating agency in the
future if, in its judgment, circumstances warrant. If rating
agencies assign a lower-than-expected rating or reduce or withdraw,
or indicate that they may reduce or withdraw, their ratings of our
investments in the future, the value of these investments could
significantly decline, which would adversely affect the value of
our investment portfolio and could result in losses upon
disposition or the failure of borrowers to satisfy their debt
service obligations to us.
Our real estate investments are subject to risks particular to real
property. These risks may result in a reduction or elimination of,
or return from, a loan secured by a particular
property.
Real estate investments are subject to various risks,
including:
•adverse
changes in national and local economic and market
conditions;
•changes
in governmental laws and regulations, fiscal policies and zoning
ordinances and the related costs of compliance with laws and
regulations, fiscal policies and ordinances;
•costs
of remediation and liabilities associated with environmental
conditions such as indoor mold;
•the
potential for uninsured or under-insured property
losses;
•acts
of God, including earthquakes, floods and other natural disasters,
which may result in uninsured losses;
•acts
of war or terrorism, including the consequences of terrorist
attacks; and
•social
unrest and civil disturbances.
In the event any of these or similar events occurs, we may not
realize our anticipated return on our investments and we may incur
a loss on these investments. The ability of a borrower to repay
these loans or other financial assets is dependent upon the income
or assets of these borrowers.
We may be exposed to environmental liabilities with respect to
properties to which we take title.
In the course of our business, we may take title to real estate,
and, if we do take title, we could be subject to environmental
liabilities with respect to these properties. In such a
circumstance, we may be held liable to a governmental entity or to
third parties for property damage, personal injury, investigation
and clean-up costs incurred by these parties in connection with
environmental contamination, or we may be required to investigate
or clean up hazardous or toxic substances or chemical releases at a
property. The costs associated with investigation or remediation
activities could be substantial. If we ever become subject to
significant environmental liabilities, our business, financial
condition, results of operations and our ability to make
distributions to our stockholders could be adversely
affected.
The properties underlying our CRE loans may be subject to other
unknown liabilities that could adversely affect the value of these
properties, and as a result, our investments.
Properties underlying our commercial real estate loans may be
subject to other unknown or unquantifiable liabilities that may
adversely affect the value of our investments. Such defects or
deficiencies may include title defects, title disputes, liens or
other encumbrances on the mortgaged properties. The
discovery
of such unknown defects, deficiencies and liabilities could affect
the ability of our borrowers to make payments to us or could affect
our ability to foreclose and sell the underlying properties, which
could adversely affect our results of operations and financial
condition.
We may be affected by deficiencies in foreclosure practices of
third parties, as well as related delays in the foreclosure
process.
There continues to be uncertainty around the timing and ability of
servicers to remove delinquent borrowers from their homes, so that
they can liquidate the underlying properties and ultimately pass
the liquidation proceeds through to owners of the mortgage loans.
Given the magnitude of the housing crisis, and in response to the
well-publicized failures of many servicers to follow proper
foreclosure procedures (such as "robo-signing"), mortgage servicers
are being held to much higher foreclosure-related documentation
standards than they previously were. However, because many
mortgages have been transferred and assigned multiple times (and by
means of varying assignment procedures) throughout the origination,
warehouse and securitization processes, mortgage servicers may have
difficulty furnishing the requisite documentation to initiate or
complete foreclosures. This leads to stalled or suspended
foreclosure proceedings, and ultimately additional
foreclosure-related costs. Foreclosure-related delays also tend to
increase ultimate loan loss severities as a result of property
deterioration, amplified legal and other costs, and other factors.
Many factors delaying foreclosure, such as borrower lawsuits and
judicial backlog and scrutiny, are outside of servicers’ control
and have delayed, and will likely continue to delay, foreclosure
processing in both judicial states (where foreclosures require
court involvement) and non-judicial states.
We may find it necessary or desirable to foreclose on certain of
the loans we acquire. Whether or not we have participated in the
negotiation of the terms of any such loans, we cannot assure you as
to the adequacy of the protection of the terms of the applicable
loan, including the validity or enforceability of the loan and the
maintenance of the anticipated priority and perfection of the
applicable security interests. Furthermore, claims may be asserted
by lenders or borrowers that might interfere with enforcement of
our rights. Borrowers may resist foreclosure actions by asserting
numerous claims, counterclaims and defenses against us, including,
without limitation, lender liability claims and defenses, even when
the assertions may have no basis in fact, in an effort to prolong
the foreclosure action and seek to force the lender into a
modification of the loan or a favorable buy-out of the borrower's
position in the loan. In some states, foreclosure actions can take
several years or more to litigate. A servicer’s failure to remove
delinquent borrowers from their homes in a timely manner could
increase our costs, adversely affect the value of the property and
mortgage loans and have an adverse effect on our results of
operations and business. In addition, foreclosure may create a
negative public perception of the collateral property, resulting in
a diminution of its value. Even if we are successful in foreclosing
on a mortgage loan, the liquidation proceeds upon sale of the
underlying real estate may not be sufficient to recover our
investment. Any costs or delays involved in the foreclosure of the
loan or a liquidation of the underlying property will reduce the
net proceeds realized and, thus, increase the potential for
loss.
Insurance on mortgage loans and real estate securities collateral
may not cover all losses.
There are certain types of losses, generally of a catastrophic
nature, such as earthquakes, floods, hurricanes, terrorism or acts
of war, which may be uninsurable or not economically insurable.
Inflation, changes in building codes and ordinances, environmental
considerations and other factors, including terrorism or acts of
war, also might result in insurance proceeds insufficient to repair
or replace a property if it is damaged or destroyed. Under these
circumstances, the insurance proceeds received with respect to a
property relating to one of our investments might not be adequate
to restore our economic position with respect to our investment.
Any uninsured loss could result in the loss of cash flow from, and
the asset value of, the affected property and the value of our
investment related to such property.
The allocation of the net proceeds of any equity offering among our
target assets, and the timing of the deployment of these proceeds
is subject to, among other things, then prevailing market
conditions and the availability of target assets.
Our allocation of the net proceeds from any equity offering among
our target assets is subject to our investment guidelines and
maintenance of our REIT qualification. Our Manager will make
determinations as to the percentage of our equity that will be
invested in each of our target assets and the timing of the
deployment of the net proceeds of our equity offerings. These
determinations will depend on then prevailing market conditions and
may change over time in response to opportunities available in
different interest rate, economic and credit environments. Until
appropriate assets can be identified, our Manager may decide to use
the net proceeds of our offerings to pay down our short-term debt
or to invest the net proceeds in interest-bearing short-term
investments, including funds, which are consistent with maintenance
of our REIT qualification. These investments are expected to
provide a lower net return than we seek to achieve from our target
assets. Prior to the time we have fully used the net proceeds of
our offerings to acquire our target assets, we may fund our monthly
and/or quarterly distributions out of such net
proceeds.
Real estate valuation is inherently subjective and
uncertain.
The valuation of real estate and therefore the valuation of any
collateral underlying our loans is inherently subjective due to,
among other factors, the individual nature of each property, its
location, the expected future rental revenues from that particular
property and the valuation methodology adopted. As a result, the
valuations of the real estate assets against which we will make or
acquire loans are subject to a large degree of uncertainty and are
made on the basis of assumptions and methodologies that may not
prove to be accurate, particularly in periods of volatility, low
transaction flow or restricted debt availability in the commercial
or residential real estate markets.
An increase in interest rates may cause a decrease in the volume of
certain of our target assets, which could adversely affect our
ability to acquire assets that satisfy our investment objectives
and to generate income and make distributions to our
stockholders.
Rising interest rates generally reduce the demand for mortgage
loans due to the higher cost of borrowing. A reduction in the
volume of mortgage loans originated may affect the volume of
transitional floating-rate multifamily and CRE loans and other
mortgage related investments available to us, which could adversely
affect our ability to acquire assets that satisfy our investment
objectives. Rising interest rates may also cause our assets that
were issued prior to an interest rate increase to provide yields
that are below prevailing market interest rates. If rising interest
rates cause us to be unable to acquire a sufficient volume of
transitional floating-rate multifamily and CRE loans and other
mortgage related investments with a yield that is above our
borrowing cost, our ability to satisfy our investment objectives
and to generate income and make distributions to our stockholders
may be adversely affected.
The relationship between short-term and longer-term interest rates
is often referred to as the "yield curve." Ordinarily, short-term
interest rates are lower than longer-term interest rates. If
short-term interest rates rise disproportionately relative to
longer-term interest rates (a flattening of the yield curve), our
borrowing costs may increase more rapidly than the interest income
earned on our assets. Because some of our future investments may
bear interest based on longer-term rates than our borrowings, a
flattening of the yield curve would tend to decrease our net income
and the market value of our net assets. Additionally, to the extent
cash flows from investments that return scheduled and unscheduled
principal are reinvested, the spread between the yields on the new
investments and available borrowing rates may decline, which would
likely decrease our net income. It is also possible that short-term
interest rates may
exceed longer-term interest rates (a yield curve inversion), in
which event our borrowing costs may exceed our interest income and
we could incur operating losses. Given the current state of the
U.S. economy due to the ongoing COVID-19 pandemic, there can be no
guarantee that the yield curve will not become and/or remain
inverted.
Increases in interest rates typically adversely affect the value of
certain of our investments and cause our interest expense to
increase, which could result in reduced earnings or losses and
negatively affect our profitability as well as the cash available
for distribution to our stockholders.
We invest in transitional multifamily and other CRE loans, as well
as other mortgage related investments. In a normal yield curve
environment, an investment in the fixed-rate component of such
assets will generally decline in value if future long-term interest
rates increase. Declines in market value may ultimately reduce
earnings or result in losses to us, which may negatively affect
cash available for distribution to our stockholders.
A significant risk associated with our target assets is the risk
that both long-term and short-term interest rates will increase
significantly. If long-term rates increased significantly, the
market value of these investments would decline, and the duration
and weighted average life of the investments would increase. We
could realize a loss if the securities were sold. At the same time,
an increase in short-term interest rates would increase the amount
of interest owed on any repurchase agreements we may enter
into.
Our business model is such that rising interest rates will
generally increase our net interest income, while declining rates
will generally decrease our net interest income. As of
December 31, 2021, 100% of our loans by unpaid principal
balance earned a floating rate of interest and were financed with
liabilities that require interest payments based on floating rates,
which resulted in an amount of net equity that is positively
correlated to rising interest rates.
Market values of our investments may decline without any general
increase in interest rates for a number of reasons, such as
increases or expected increases in defaults, or increases or
expected increases in voluntary prepayments for those investments
that are subject to prepayment risk or widening of credit
spreads.
In addition, in a period of rising interest rates, our operating
results will depend in large part on the difference between the
income from our assets and our financing costs. We anticipate that,
in most cases, the income from such assets will respond more slowly
to interest rate fluctuations than the cost of our borrowings.
Consequently, changes in interest rates, particularly short-term
interest rates, may significantly influence our net income.
Increases in these rates will tend to decrease our net income and
market value of our assets.
Changes to the method of determining the LIBOR or the selection of
a replacement for LIBOR may affect the value of the financial
obligations to be held or issued by us that are linked to LIBOR and
could affect our results of operations and financial
results.
On July 27, 2017, and in a subsequent speech by its chief executive
on July 12, 2018, the U.K. Financial Conduct Authority (the “FCA”),
which regulates LIBOR, confirmed that it will no longer persuade or
compel banks to submit rates for the calculation of the LIBOR
benchmark after 2021. On March 5, 2021, ICE Benchmark
Administration Limited, the LIBOR administrator, and the FCA issued
an announcement on the future cessation and loss of
representativeness of the LIBOR benchmarks. For one-month USD
LIBOR, this will occur immediately after June 30, 2023. In
addition, U.S. banking regulators have made clear that USD LIBOR
originations are not permitted after December 31,
2021.
The Alternative Reference Rates Committee, a steering committee
comprised of large U.S. financial institutions convened by the
Federal Reserve, has recommended SOFR as a more robust reference
rate alternative to USD LIBOR. The International Swaps and
Derivatives Association, Inc. adopted fallback language for USD
LIBOR-referencing derivatives contracts that provides for SOFR as
the primary replacement rate in the event of a LIBOR cessation.
SOFR is calculated based on overnight transactions under repurchase
agreements, backed by Treasury securities. SOFR is observed on a
daily basis and backward looking, which stands in contrast with
LIBOR under the current methodology, which is an estimated
forward-looking rate for specified tenors. Due to SOFR being a
secured rate backed by government securities, it does not take into
account bank credit risk (as is the case with LIBOR). SOFR is
therefore likely to be lower than LIBOR and is less likely to
correlate with the funding costs of financial institutions. As a
result, parties may seek to adjust spreads relative to such
reference rate in underlying contractual arrangements.
We are unable to predict the effect of any changes to USD LIBOR or
the establishment and success of any alternative reference rates,
such as SOFR. Such changes, reforms or replacements relating to USD
LIBOR could have an adverse impact on the market for or value of
any USD LIBOR-linked securities, loans, derivatives or other
financial instruments or extensions of credit held by or due to us
or our funds. Furthermore, a significant number of our financing
obligations are USD LIBOR-linked and may be negatively impacted by
any changes to LIBOR and any replacement of USD LIBOR with SOFR in
those obligations. As such, LIBOR-related changes could negatively
affect our overall results of operations and financial
condition.
We may invest in CMBS which are subordinate in right of payment to
more senior securities.
Our investments may include subordinated tranches of CMBS, which
are a subordinated class of security in a structure of securities
collateralized by a pool of mortgage loans and, accordingly, is the
first or among the first to bear the loss upon a restructuring or
liquidation of the underlying collateral and the last to receive
payment of interest and principal. Additionally, estimated fair
value of these subordinated interests tend to be more sensitive to
changes in economic conditions than more senior securities. As a
result, such subordinated interests generally are not actively
traded and may not provide holders thereof with liquid
investments.
Changes in prepayment rates may adversely affect our
profitability.
Our business is primarily focused on investing in, financing and
managing floating-rate mortgage loans secured by multifamily
properties and other CRE assets. Generally, our mortgage loan
borrowers may repay their loans prior to their stated maturities.
Prepayment rates generally increase when interest rates fall and
decrease when interest rates rise, but changes in prepayment rates
are difficult to predict. Prepayments can also occur when borrowers
default on their mortgages and the mortgages are prepaid from the
proceeds of a foreclosure sale of the property, or when borrowers
sell the property and use the sale proceeds to prepay the mortgage.
Prepayment rates may also be affected by conditions in the
financial markets, general economic conditions and the relative
interest rates on commercial mortgages, which could lead to an
acceleration of the payment of the related principal. While we will
seek to manage prepayment risk, in selecting our real estate
investments we must balance prepayment risk against other risks,
the potential returns of each investment and the cost of hedging
our risks. Additionally, we are subject to prepayment risk
associated with the terms of our CLOs. Due to the generally
short-term nature of transitional floating-rate commercial mortgage
loans, our CLOs include a reinvestment period during which
principal repayments and prepayments on our commercial mortgage
loans may be reinvested in similar assets, subject to meeting
certain eligibility criteria. While the interest-rate spreads of
our CLOs are fixed until they are repaid, the terms, including
spreads, of newly originated loans are subject to uncertainty based
on a variety of factors, including market and competitive
conditions. To the
extent that such conditions result in lower spreads on the assets
in which we reinvest, we may be subject to a reduction in interest
income in the future. No strategy can completely insulate us from
prepayment or other such risks, and we may deliberately retain
exposure to prepayment or other risks.
We are highly dependent on communications and information systems.
Systems failures could significantly disrupt our operations, which
may, in turn, negatively affect the market price of our equity
securities and our ability to make distributions.
Our business is highly dependent on the communications and
information systems of our Manager. Any failure or interruption of
our Manager’s systems could have a material adverse effect on our
operating results and negatively affect the market price of our
equity securities and our ability to make
distributions.
The occurrence of cyber-incidents, or a deficiency in our Manager's
cybersecurity or in those of any of our third party service
providers, could negatively impact our business by causing a
disruption to our operations, a compromise of our confidential
information or damage to our business relationships or reputation,
all of which could negatively impact our business and results of
operations.
A cyber-incident is considered to be any adverse event that
threatens the confidentiality, integrity or availability of our or
our Manager's information resources or those of our third party
service providers. A cyber-incident can be an intentional attack or
an unintentional event and can include gaining unauthorized access
to a system to disrupt operations, corrupt data or steal
confidential information. The primary risks that could directly
result from a cyber-incident include operational interruption and
private data exposure. Our Manager has implemented processes,
procedures and controls to help mitigate these risks, but these
measures, as well as our increased awareness of the risk of a
cyber-incident, do not guarantee that our business and results of
operations will not be negatively impacted by such an
incident.
Any downgrades, or perceived potential of downgrades, of the credit
ratings of the U.S. Government, GSEs or certain European countries
may adversely affect our business, financial condition, results of
operations and our ability to make distributions to our
stockholders.
On August 5, 2011, Standard & Poor’s downgraded the U.S.
Government’s credit rating for the first time in history, and on
October 15, 2013, Fitch Ratings placed the ratings of all
outstanding U.S. sovereign debt securities on Rating Watch
Negative. Downgrades of the credit ratings of the U.S. Government,
GSEs and certain European countries could create broader financial
turmoil and uncertainty, which could weigh heavily on the global
banking system. Therefore, any downgrades of the credit ratings of
the U.S. Government, GSEs or certain European countries may
adversely affect the value of our target assets and our business,
financial condition, results of operations and our ability to make
distributions to our stockholders.
Social, political, and economic instability, unrest, and other
circumstances beyond our control could adversely affect our
business operations.
Our business may be adversely affected by social, political, and
economic instability, unrest, or disruption, including protests,
demonstrations, strikes, riots, civil disturbance, disobedience,
insurrection and looting in geographic regions where the properties
securing our investments are located. Such events may result in
property damage and destruction and in restrictions, curfews, or
other governmental actions that could give rise to significant
changes in regional and global economic conditions and cycles,
which may adversely affect our financial condition and
operations.
There have been demonstrations and protests, some of which involved
violence, looting, arson and property destruction, in cities
throughout the U.S., including Atlanta, Seattle, Los Angeles,
Washington D.C., New York City, Minneapolis and Portland, as well
as globally, including in Hong Kong. While protests have been
peaceful in many locations, looting vandalism and fires have taken
place in cities, which led to the imposition of mandatory curfews,
and, in some locations, deployment of the U.S. National Guard.
Governmental actions taken place to protect people and property,
including curfews and restrictions on business operations, may
disrupt operations, harm perceptions of personal well-being and
increase the need for additional expenditures on security
resources. The effect and duration of demonstrations, protests or
other factors is uncertain, and we cannot assure there will not be
further political or social unrest in the future or that there will
not be other events that could lead to further social, political
and economic instability. If such events or disruptions persist for
a prolonged period of time, our overall business and results of
operations may be adversely affected.
Any or all of the foregoing could have material adverse effect on
our financial condition, results of operations and cash flows, or
the market price of our common stock. Additional risks and
uncertainties not currently known to us, or that we presently deem
to be immaterial , may also have potential to materially adversely
affect our business, financial condition and results of
operations.
Risks Related to Financing and Hedging
Our strategy involves leverage, which may amplify losses and there
is no specific limit on the amount of leverage that we may
use.
We leverage our portfolio investments in our target assets
principally through borrowings under collateralized loan
obligations. Our leverage (on both a GAAP and non-GAAP basis)
currently ranges, and we expect that it will continue to range,
between three and six times the amount of our stockholders’ equity.
We will incur this leverage by borrowing against a substantial
portion of the market or face value of our assets. Our leverage,
which is fundamental to our investment strategy, creates
significant risks.
To the extent that we incur leverage, we may incur substantial
losses if our borrowing costs increase. Our borrowing costs may
increase for any of the following, or other, reasons:
•short-term
interest rates increase;
•the
market value of our securities decreases;
•interest
rate volatility increases;
•the
availability of financing in the market decreases; or
•changes
in advance rates.
Our return on our investments and cash available for distributions
may be reduced if market conditions cause the cost of our financing
to increase relative to the income that can be derived from the
assets acquired, which could adversely affect the price of our
equity securities. In addition, our debt service payments will
reduce cash flow available for distributions to stockholders. In
addition, if the cost of our financing increases, we may not be
able to meet our debt service obligations. To the extent that we
cannot meet our debt service obligations, we risk the loss of some
or all of our assets to satisfy our debt obligations. To the extent
we are compelled to liquidate qualified REIT assets to repay debts,
our compliance with the REIT rules regarding our assets and
our
sources of income could be negatively affected, which would
jeopardize our qualification as a REIT. Losing our REIT status
would cause us to lose tax advantages applicable to REITs and would
decrease our overall profitability and distributions to our
stockholders.
We may incur significant additional debt in the future, which will
subject us to increased risk of loss and may reduce cash available
for distributions to our stockholders.
Subject to market conditions and availability, we may incur
significant additional debt in the future. Although we are not
required by our board of directors to maintain any particular
assets-to-equity leverage ratio, the amount of leverage we may
deploy for particular assets will depend upon our Manager’s
assessment of the credit and other risks of those assets. Our board
of directors may establish and change our leverage policy at any
time without stockholder approval. Incurring debt could subject us
to many risks that, if realized, would adversely affect us,
including the risk that:
•our
cash flow from operations may be insufficient to make required
payments of principal and interest on the debt or we may fail to
comply with all of the other covenants contained in the debt, which
is likely to result in (1) acceleration of such debt (and any other
debt containing a cross-default or cross-acceleration provision)
that we may be unable to repay from internal funds or to refinance
on favorable terms, or at all, (2) our inability to borrow unused
amounts under our financing arrangements, even if we are current in
payments on borrowings under those arrangements, and/or (3) the
loss of some or all of our assets to foreclosure or
sale;
•our
debt may increase our vulnerability to adverse economic and
industry conditions with no assurance that investment yields will
increase with higher financing costs;
•we
may be required to dedicate a substantial portion of our cash flow
from operations to payments on our debt, thereby reducing funds
available for operations, investments, stockholder distributions or
other purposes; and
•we
may not be able to refinance debt that matures prior to the
investment it was used to finance on favorable terms or at
all.
There can be no assurance that our Manager will be able to prevent
mismatches in the maturities of our assets and
liabilities.
Because we employ financial leverage in funding our portfolio,
mismatches in the maturities of our assets and liabilities can
create risk in the need to continually renew or otherwise refinance
our liabilities. Our net interest margins will be dependent upon a
positive spread between the returns on our asset portfolio and our
overall cost of funding. Our Manager’s risk management tools
include software and services licensed or purchased from third
parties, in addition to proprietary systems and analytical methods
developed internally. There can be no assurance that these tools
and the other risk management techniques described above will
protect us from asset/liability risks.
Lenders generally require us to enter into restrictive covenants
relating to our operations.
When we obtain financing, lenders typically impose restrictions on
us that would affect our ability to incur additional debt, our
capability to make distributions to stockholders and our
flexibility to determine our operating policies. Loan documents we
execute may contain negative covenants that limit, among other
things, our ability to repurchase stock, distribute more than a
certain amount of our funds from operations and employ leverage
beyond certain amounts.
Our inability to meet certain financial covenants related to our
credit agreements could adversely affect our business, financial
condition and results.
In connection with our credit and guaranty agreement, we are
required to maintain certain financial covenants with respect to
our net worth, asset values, loan portfolio composition, leverage
ratios and debt service coverage levels. Compliance with these
financial covenants will depend on market factors and the strength
of our business and operating results. Various risks, uncertainties
and events beyond our control could affect our ability to comply
with our financial covenants. Failure to comply with our financial
covenants could result in an event of default, termination of the
credit facility and acceleration of all amounts owing under our
credit facility and gives the counterparty the right to exercise
certain other remedies under the credit agreement, unless we were
able to negotiate a waiver. Any such waiver could be conditioned on
an amendment to our credit facility and any related guaranty
agreement on terms that may be unfavorable to us. If we are unable
to negotiate a covenant waiver or replace or refinance our assets
under a new credit facility on favorable terms or at all, our
financial condition, results of operations and cash flows could be
adversely affected.
We may enter into repurchase agreements, and our rights under such
repurchase agreements may be subject to the effects of the
bankruptcy laws in the event of the bankruptcy or insolvency of us
or our counterparties under the repurchase agreements.
In the event of our insolvency or bankruptcy, certain repurchase
agreements may qualify for special treatment under Title 11 of the
United States Code, as amended, or the U.S. Bankruptcy Code, the
effect of which, among other things, would be to allow the lender
under the applicable repurchase agreement to avoid the automatic
stay provisions of the U.S. Bankruptcy Code and to take possession
of and liquidate the assets that we have pledged under their
repurchase agreements. In the event of the insolvency or bankruptcy
of a lender during the term of a repurchase agreement, the lender
may be permitted, under applicable insolvency laws, to repudiate
the contract, and our claim against the lender for damages may be
treated simply as an unsecured creditor. In addition, if the lender
is a broker or dealer subject to the Securities Investor Protection
Act of 1970, or an insured depository institution subject to the
Federal Deposit Insurance Act, our ability to exercise our rights
to recover our securities under a repurchase agreement or to be
compensated for any damages resulting from the lender’s insolvency
may be further limited by those statutes. These claims would be
subject to significant delay and, if and when received, may be
substantially less than the damages we actually incur.
An increase in our borrowing costs relative to the interest that we
receive on investments in our mortgage related investments may
adversely affect our profitability and cash available for
distribution to our stockholders.
As our financings mature, we will be required either to enter into
new borrowings or to sell certain of our investments. An increase
in short-term interest rates at the time that we seek to enter into
new borrowings would reduce the spread between our returns on our
assets and the cost of our borrowings. This would adversely affect
our returns on our assets, which might reduce earnings and, in
turn, cash available for distribution to our
stockholders.
We have utilized and may utilize in the future non-recourse
securitizations to finance our loans and investments, which may
expose us to risks that could result in losses.
We have utilized and may utilize in the future, non-recourse
securitizations of our portfolio investment to generate cash for
funding new loans and investments and other purposes. These
transactions generally involve creating a special-purpose entity,
contributing a pool of our assets to the entity, and selling
interest in the entity on a non-recourse basis to purchasers (whom
we would expect to be willing to accept a lower interest to invest
in investment-grade loan pools). We would expect to retain all or a
portion of the equity and potentially other tranches in the
securitized pool of loans or investments. In addition, we have
retained in the past and may in the future retain a pari passu
participation in the securitized pool of loans.
Prior to any such financing, we may use short-term facilities to
finance the acquisition of assets until a sufficient quantity of
investments had been accumulated, at which time we would refinance
these facilities through a securitization, such as a CMBS, or
issuance of CLOs, or the private placement of loan participations
or other long-term financing. As a result, we would be subject to
the risk that we would not be able to acquire, during the period
that our short-term facilities are available, a sufficient amount
of eligible investment to maximize the efficiency of a CMBS, CLO or
other private placement issuance. We also would be subject to the
risk that we would not be able to obtain short-term credit
facilities or would not be able to renew any short-term credit
facilities after they expire should we find it necessary to extend
our short-term credit facilities to allow more time to seek and
acquire the necessary eligible investment for a long-term
financing. The inability to consummate securitizations of our
portfolio to finance our loans and investments on a long-term basis
could require us to seek other forms of potentially less attractive
financing or to liquidate assets at an inopportune time or price,
which could adversely affect or performance and our ability to grow
our business. Moreover, conditions in the capital markets,
including volatility and disruption in the capital and credit
markets, may not permit a non-recourse securitization at any
particular time or may make the issuance of any such securitization
less attractive to us even when we do have sufficient eligible
assets. We may also suffer losses if the value of the mortgage
loans we acquire declines prior to securitization. Declines in the
value of a mortgage loan can be due to, among other things, changes
in interest rates and changes in the credit quality of the loan. In
addition, we may suffer a loss due to the incurrence of transaction
costs related to executing these transactions. To the extent that
we incur a loss executing or participating in future
securitizations for the reasons described above or for other
reasons, it could materially and adversely impact our business and
financial condition. In addition, the inability to securitize our
portfolio may hurt our performance and our ability to grow our
business.
In addition, the securitization of our portfolio might magnify our
exposure to losses because any equity interest or other subordinate
interest we retain in the issuing entity would be subordinate to
the notes issued to investors and we would, therefore, absorb all
of the losses sustained with respect to a securitized pool of
assets before the owners of the notes experience any losses.
Moreover, the Dodd-Frank Wall Street Reform and Consumer Protection
Act of 2010, or Dodd-Frank Act, contains a risk retention
requirement for all asset-backed securities, which requires both
public and private securitizers to retain not less than 5% of the
credit risk of the assets collateralizing any asset-backed
issuance. Significant restrictions exist, and additional
restrictions may be added in the future, regarding who may hold
risk retention interest, the structure of the entities that hold
risk retention interest and when and how such risk retention
interests may be transferred. Therefore such risk retention
interests will generally be illiquid. As result of the risk
retention requirements, we have and may in the future be required
to purchase and retain certain interests in a securitization into
which we sell mortgage loans and/or when we act as an issuer, may
be required to sell certain interests in a securitization at prices
below levels that such interests have historically yielded and/or
may be required to enter into certain arrangements related to risk
retention that we have not historically been required to enter
into. Accordingly, the risk retention rules may increase our
potential liabilities and/or reduce our potential profits in
connections with securitization of mortgage loans. It is likely,
therefore, that these risk retentions rules will increase the
administrative and operational cost of asset
securitizations.
We may enter into hedging transactions that expose us to contingent
liabilities in the future, which may adversely affect our financial
results or cash available for distribution to
stockholders.
We may engage in hedging transactions intended to hedge various
risks to our portfolio, including the exposure to adverse changes
in interest rates. Our hedging activity varies in scope based on,
among other things, the level and volatility of interest rates, the
type of assets held and other changing market conditions. Although
these transactions are intended to reduce our exposure to various
risks, hedging may fail to protect or could adversely affect us
because, among other things:
•hedging
can be expensive, particularly during periods of volatile or
rapidly changing interest rates;
•available
hedges may not correspond directly with the risks for which
protection is sought;
•the
duration of the hedge may not match the duration of the related
liability;
•the
amount of income that a REIT may earn from certain hedging
transactions is limited by U.S. federal income tax provisions
governing REITs;
•the
credit quality of a hedging counterparty may be downgraded to such
an extent that it impairs our ability to sell or assign our side of
the hedging transaction; and
•the
hedging counterparty may default on its obligation to
pay.
Subject to maintaining our qualification as a REIT, there are no
current limitations on the hedging transactions that we may
undertake. However, our Manager’s reliance on the CFTC’s December
7, 2012 no action letter relieving CPOs of mortgage REITs from the
obligation to register with the CFTC as CPOs depends on the
satisfaction of several conditions, including that we comply with
additional limitations on our hedging activity. The letter limits
the initial margin and premiums required to establish our Manager’s
commodity interest positions to no more than 5% of the fair market
value of our total assets and limits the net income derived
annually from our commodity interest positions that are not
qualifying hedging transactions to less than 5% of our gross
income.
Therefore, our and our Manager’s reliance on this no action letter
places additional restrictions on our hedging activity. Our hedging
transactions could require us to fund large cash payments in
certain circumstances (e.g., the early termination of the hedging
instrument caused by an event of default or other early termination
event or a demand by a counterparty that we make increased margin
payments). Our ability to fund these obligations will depend on the
liquidity of our assets and access to capital at the time. The need
to fund these obligations could adversely affect our financial
condition. Further, hedging transactions, which are intended to
limit losses, may actually result in losses, which would adversely
affect our earnings and could in turn reduce cash available for
distribution to stockholders.
Hedging instruments involve various kinds of risk because
they are not always traded on regulated exchanges, guaranteed by an
exchange or its clearinghouse or regulated by any U.S. or foreign
governmental authorities. The CFTC is still in the process of
proposing rules under the Dodd-Frank Act that may make our hedging
more difficult or increase our costs. Furthermore, the
enforceability of agreements underlying hedging transactions may
depend on compliance with applicable statutory and commodity and
other regulatory requirements and, depending on the identity of the
counterparty, applicable international requirements. The business
failure of a hedging counterparty will most likely result in its
default. Default by a hedging counterparty may result in the loss
of unrealized profits and force us to cover our commitments, if
any, at the then current market price. Although we generally seek
to reserve the right to terminate our hedging positions, it may not
always be possible to dispose of or close out a hedging position
without the consent of the hedging counterparty, and we may not be
able to enter into an offsetting contract in order to cover our
risk. We cannot assure you that a liquid secondary market will
exist for hedging instruments purchased or sold, and we may be
required to maintain a position until exercise or expiration, which
could result in losses.
Hedging against interest rate exposure may adversely affect our
earnings, which could reduce our cash available for distribution to
our stockholders, and such transactions may fail to protect us from
the losses that they were designed to offset.
Subject to maintaining our qualification as a REIT and exemption
from registration under the Investment Company Act, we may employ
techniques that limit the adverse effects of rising interest rates
on a portion of our short-term repurchase agreements and on a
portion of the value of our assets. In general, our interest rate
risk mitigation strategy depends on our view of our entire
portfolio, consisting of assets, liabilities and derivative
instruments, in light of prevailing market conditions. We could
misjudge the condition of our portfolio or the market. Our interest
rate risk mitigation activity varies in scope based on the level
and volatility of interest rates and principal repayments, the type
of securities held and other changing market conditions. Our actual
interest rate risk mitigation decisions are determined in light of
the facts and circumstances existing at the time and may differ
from our currently anticipated strategy. These techniques may
include purchasing or selling futures contracts, entering into
interest rate swap, interest rate cap or interest rate floor
agreements, swaptions, purchasing put and call options on
securities or securities underlying futures contracts, or entering
into forward rate agreements.
Because a mortgage borrower typically has no restrictions on when a
loan may be paid off either partially or in full, there are no
perfect interest rate risk mitigation strategies, and interest rate
risk mitigation may fail to protect us from loss. Alternatively, we
may fail to properly assess a risk to our portfolio or may fail to
recognize a risk entirely leaving us exposed to losses without the
benefit of any offsetting interest rate mitigation activities. The
derivative instruments we select may not have the effect of
reducing our interest rate risk. The nature and timing of interest
rate risk mitigation transactions may influence the effectiveness
of these strategies. Poorly designed strategies or improperly
executed transactions could actually increase our risk and losses.
In addition, interest rate risk mitigation activities could result
in losses if the event against which we mitigate does not
occur.
Our loans and investments may be subject to fluctuations in
interest rates that may not be adequately protected, or protected
at all, by our hedging strategies.
Our assets include loans with either floating interest rates or
fixed interest rates. Floating rate loans earn interest at rates
that adjust from time to time based upon an index (typically
LIBOR). These floating rate loans are insulated from changes in
value specifically due to changes in interest rates; however, the
coupons they earn fluctuate based upon interest rates and, in a
declining and/or low interest rate environment, these loans will
earn lower rates of interest and this will impact our operating
performance. For more information about our risks related to
changes to, or the elimination of, LIBOR, see "Risk
Factors—Risks Related to Our Investment Strategies and Our
Businesses—Changes in the method for determining LIBOR or a
replacement of LIBOR may affect the value of the financial
obligations to be held or issued by us that are linked to LIBOR and
could affect our results of operations or financial
condition."
Fixed interest rate loans, however, do not have adjusting interest
rates and the relative value of the fixed cash flows from these
loans will decrease as prevailing interest rates rise or increase
as prevailing interest rates fall, causing potentially significant
changes in value. We may employ various hedging strategies to limit
the effects of changes in interest rates (and in some cases credit
spreads), including engaging in interest rate swaps, caps, floors
and other interest rate derivative products. We believe that no
strategy can completely insulate us from the risks associated with
interest rate changes and there is a risk that such strategies may
provide no protection at all and potentially compound the impact of
changes in interest rates. Hedging transactions involve certain
additional risks such as counterparty risk, leverage risk, the
legal enforceability of hedging contracts, the early repayment of
hedged transactions and the risk that unanticipated and significant
changes in interest rates may cause a significant loss of basis in
the contract and a change in current period expense. We cannot make
assurances that we will be able to enter into hedging transactions
or that such hedging transactions will adequately protect us
against the foregoing risks.
Accounting for derivatives under GAAP may be complicated. Any
failure by us to meet the requirements for applying hedge
accounting in accordance with GAAP could adversely affect our
earnings. In particular, derivatives are required to be highly
effective in offsetting changes in the value or cash flows of the
hedged items (and appropriately designated and/or documented as
such). If it is determined that a derivative is not highly
effective at hedging the designated exposure, hedge accounting is
discontinued and the changes in fair value of the instrument are
included in our reported net income.
Risks Associated with Our Relationship with Our
Manager
Our board of directors has approved very broad investment
guidelines for our Manager and will not approve each investment and
financing decision made by our Manager.
Our Manager is authorized to follow very broad investment
guidelines. Our board of directors periodically reviews and updates
our investment guidelines and also reviews our investment portfolio
but does not generally review or approve specific investments. In
addition, in conducting periodic reviews, our board of directors
may rely primarily on information provided to them by our Manager.
Furthermore, our Manager may use complex strategies, and
transactions entered into by our Manager may be costly, difficult
or impossible to unwind by the time they are reviewed by our board
of directors. Our Manager will have great latitude within the broad
parameters of our investment guidelines in determining the types
and amounts of mortgage related investments it may decide are
attractive investments for us, which could result in investment
returns that are substantially below expectations or that result in
losses, which would adversely affect our business operations and
results. In addition, our Manager may invest up to $75 million in
any investment on our behalf without restriction and generally
without prior approval of our board of directors. Our Manager is
generally permitted to invest our assets in its discretion,
provided that such investments comply with our investment
guidelines. Our Manager’s failure to generate attractive
risk-adjusted returns on an investment which represents a
significant dollar amount would adversely affect us. Further,
decisions made and investments and financing arrangements entered
into by our Manager may not fully reflect the best interests of our
stockholders.
We are dependent on our Manager and its key personnel for our
success.
We have no separate facilities and are completely reliant on our
Manager. All of our officers are employees of an affiliate of our
Manager. Our Manager has significant discretion as to the
implementation of our investment and operating policies and
strategies. Accordingly, we believe that our success will depend to
a significant extent upon the efforts, experience, diligence, skill
and network of business contacts of the officers and key personnel
of our Manager. The officers and key personnel of our Manager
evaluate, negotiate, close and monitor our investments; therefore,
our success will depend on their continued service. The departure
of any of the officers or key personnel of our Manager could have a
material adverse effect on our performance. In addition, there can
be no assurance that our Manager will remain our investment manager
or that we will continue to have access to our Manager’s officers
and professionals. The initial term of our management agreement
with our Manager only extends until January 3, 2023, with automatic
one-year renewals thereafter. If the management agreement is
terminated and no suitable replacement is found to manage us, we
may not be able to execute our business plan.
There are conflicts of interest in our relationship with ORIX,
including with our Manager and in the allocation of investment
opportunities to ORIX affiliates and us, which could result in
decisions that are not in the best interests of our
stockholders.
We are subject to conflicts of interests arising out of our
relationship with ORIX, including our Manager and its affiliates.
In addition, we are managed by our Manager, an ORIX affiliate, and
our executive officers are employees of an affiliate of our Manager
or one or more of its affiliates. There is no guarantee that the
policies and procedures adopted by us, the terms and conditions of
the Management Agreement or the policies and procedures adopted by
our Manager, ORIX and their respective affiliates, will enable us
to identify, adequately address or mitigate all potential conflicts
of interest. Some examples of conflicts of interest that may arise
by virtue of our relationship with our Manager and ORIX
includes:
•Allocation
of Investment Opportunities.
Certain conflicts of interest may arise from the fact that ORIX,
its affiliates, and our Manager may provide investment management
and other services both to us and to other persons or entities,
whether or not the investment objectives or policies of such other
person or entity are similar to those of ours, including without
limitation, the sponsoring, closing and/or managing of any Lument
IM fund.
•ORIX's
Investment Advisory and Proprietary Activities.
ORIX makes investments pursuant to an investment strategy that is
similar to the investment strategy implemented by Lument IM with
respect to LFT, on behalf of itself and its own investment
vehicles. Further, certain affiliates of ORIX originate investment
opportunities that may be suitable for LFT but which are allocated
to other investment funds managed by an affiliate of ORIX.
Therefore ORIX or an affiliate may originate opportunities that are
suitable for LFT but are allocated to entities primarily owned by
ORIX or its affiliates.
•In
addition, we are expected, from time to time, to make an investment
in, or a loan to, a company in which ORIX and its affiliates (each,
an “Investing Party”) are also expected to invest, or already have
invested, in a different part of the capital structure, which may
mean that one investor’s interest in that company may have
different rights, preferences and privileges than the company
interests held by us. There may be instances where such a company
may become insolvent or bankrupt and where an Investing Party’s
interests in such company may otherwise conflict with the interests
of other Investing Parties. To the extent that we hold securities
or other financial interests (e.g., bank debt) in a company with
rights, preferences and privileges that are different than
interests held by an Investing Party in the same company, the
Manager and its affiliates may be presented with decisions when
and/or where our interests and the interests of the Investing
Parties are in conflict. It is possible that our interest may be
subordinated or otherwise adversely affected by virtue of other
Investing Parties’ involvement and actions relating to such
investment, in a bankruptcy proceeding or otherwise. In addition,
we can be expected, from time to time, to hold an interest in the
more senior portion of an issuer’s capital structure while another
Investing Party holds a more junior security of that issuer.
Because ORIX is the owner of the Manager, the Manager would
experience a conflict of interest in making determinations
regarding the senior securities we held, as decisions on behalf of
such entity to enforce remedies or take other actions against the
obligors under such senior securities or the related collateral
could adversely impact the value of the more junior securities held
by another Investing Party. In such situation, the Manager is
incentivized to decline to enforce such remedies or take such
actions on behalf of the senior securities we held in order to
protect the value of the junior securities held by the other
Investing Party, which could adversely affect the our returns. To
address such conflicts, an Investing Party would generally not take
a control position in one part of an issuer’s capital structure
while another affiliated entity takes a control position in another
part of the same issuer’s capital structure.
The incentive fee payable to our Manager under the management
agreement is payable quarterly and is based on our core earnings
and, therefore, may cause our Manager to select investments in more
risky assets to increase its incentive compensation.
Our Manager is entitled to receive incentive compensation based
upon our achievement of targeted levels of core earnings. In
evaluating investments and other management strategies, the
opportunity to earn incentive compensation based on core earnings
may lead our Manager to place undue emphasis on the maximization of
core earnings at the expense of other criteria, such as
preservation of capital, in order to achieve higher incentive
compensation. Investments with higher yield potential are generally
riskier or more speculative. This could result in increased risk to
the value of our investment portfolio.
Core earnings is not a measure calculated in accordance with
accounting principles generally accepted in the United States of
America ("GAAP") and is defined in our management agreement in this
Annual Report on Form 10-K.
The management agreement with our Manager may be costly and
difficult to terminate, including for our Manager’s poor
performance.
The Management Agreement automatically renews for successive one
year terms beginning January 3, 2023 and each January 3 thereafter,
unless it is sooner terminated upon written notice delivered to the
Company or Manager, as applicable, no later than 180 days prior to
a renewal date either (i) by the Company upon the affirmative vote
of at least two-thirds (2/3) of the independent directors of the
Board or by a vote of at least two-thirds of the Company's
outstanding shares of common stock, based upon a determination that
(a) the Manager’s performance is unsatisfactory and materially
detrimental to the Company or (b) the compensation payable to the
Manager under the Management Agreement is not fair to the Company
(provided that in the instance of (b), we shall not have the right
to terminate the Management Agreement if the Manager agrees to
continue to provide services under the Management Agreement at fees
that at least two-thirds of the independent directors of the Board
determine to be fair, provided further that in the instance of (b),
the Manager will be afforded the opportunity to renegotiate its
compensation prior to termination) or (ii) by the Manager. We may
also terminate the Management Agreement at any time, including
during the initial term, without the payment of any termination
fee, with at least 30 days’ prior written notice from us "for
cause" as described in the Management Agreement. In the event of a
termination of the Manager other than a termination for cause, we
are required to pay a termination fee to the Manager. The
termination fee is equal to three times the sum of (a) the average
annual Base Management Fee and (b) the average annual Incentive
Compensation, in each case, earned by the Manager during the
twenty-four month period immediately preceding the effective date
of termination, calculated as of the end of the most recently
completed fiscal quarter before the effective date of termination.
Our Manager may terminate the Management Agreement upon written
notice delivered no later than 180 days prior to a renewal
date.
Our Manager’s liability is limited under the management agreement
and we have agreed to indemnify our Manager and its affiliates
against certain liabilities. As a result, we could experience poor
performance or losses for which our Manager would not be
liable.
Pursuant to the management agreement, our Manager does not assume
any responsibility other than to render the services called for
thereunder and will not be responsible for any action of our board
of directors in following or declining to follow its advice or
recommendations. Our Manager maintains a contractual as opposed to
a fiduciary relationship with us, although our officers who are
also employees of an affiliate of our Manager will have a fiduciary
duty to us under Maryland Law, as our officers. Under the terms of
the management agreement, our Manager, its officers, members,
managers, directors, personnel, trustees, partners, stockholders,
equity holders, any person controlling or controlled by our Manager
and any person providing sub-advisory services to our Manager will
not be liable to us, our directors, our stockholders or any
partners for acts or omissions performed in accordance with and
pursuant to the management agreement, except because of acts or
omissions constituting bad faith, willful misconduct, gross
negligence or reckless disregard of their duties under the
management agreement, as determined by a final non-appealable order
of a court of competent jurisdiction. In addition, we have agreed
to indemnify our Manager, its officers, stockholders, members,
managers, directors, personnel, trustees, partners, stockholders,
equity holders, any person controlling or controlled by our Manager
and any person providing sub-advisory services to our Manager with
respect to all expenses, losses, damages, liabilities, demands,
charges and claims arising from acts or omissions of our Manager
not constituting bad faith, willful misconduct, gross negligence or
reckless disregard of
duties, performed in good faith in accordance with and pursuant to
the management agreement. As a result, we could experience poor
performance or losses for which our Manager would not be
liable.
Our Manager is subject to extensive regulation as an investment
adviser, which could adversely affect its ability to manage our
business.
Our Manager is an investment adviser registered with the SEC and is
subject to regulation by various regulatory authorities that are
charged with protecting the interests of its clients, including us.
Our Manager could be subject to civil liability, criminal liability
or sanction, including revocation or denial of its registration as
an investment adviser, revocation of the licenses of its employees,
censures, fines or temporary suspension or permanent bar from
conducting business, if it is found to have violated any of laws or
regulations applicable to it. Any such liability or sanction could
adversely affect its ability to manage our business.
Employee litigation and unfavorable publicity could negatively
affect our future business.
Employees may, from time to time, bring lawsuits against us or our
Manager regarding injury, creation of a hostile work place,
discrimination, wage and hour, sexual harassment and other
employment issues. In recent years there has been an increase in
the number of discrimination and harassment claims generally.
Coupled with the expansion of social media platforms and similar
devices that allow individuals access to a broad audience, these
claims have had a significant negative impact on some businesses.
Companies that have faced employment or harassment related lawsuits
have had to terminate management or other key personnel and have
suffered reputational harm that has negatively impacted their
sales. If we were to face any employment related claims, our
business could be negatively affected.
Risks Related to Our Securities
The market price and trading volume of our securities may vary
substantially.
Our common stock is listed on the NYSE under the symbol "LFT."
Stock markets, including the NYSE, have experienced significant
price and volume fluctuations over the past several years. As a
result, the market price of our securities has been and is likely
to continue to be similarly volatile, and investors in our
securities have experienced since the initial offering of our
securities and may continue to experience a decrease in the value
of their securities. Accordingly, no assurance can be given as to
the ability of our stockholders to sell their securities or the
price that our stockholders may obtain for their
securities.
Some of the factors that negatively affect the market price of our
securities include:
•changes
in our dividend rates or frequency of payments
thereof;
•actual
or anticipated variations in our quarterly operating
results;
•changes
in our earnings estimates or publication of research reports about
us or the real estate industry;
•changes
in market valuations of similar companies;
•adverse
market reaction to any increased indebtedness we incur in the
future;
•additions
to or departures of our Manager’s key personnel;
•actions
by our stockholders;
•speculation
in the press or investment community;
•trading
prices of common and preferred equity securities issued by REITs
and other similar companies;
•failure
to satisfy REIT requirements;
•general
economic and financial conditions;
•government
action or regulation; and
•our
issuance of additional preferred equity or debt
securities.
Market factors unrelated to our performance could negatively impact
the market price of our securities, and broad market fluctuations
could also negatively impact the market price of our
securities.
Market factors unrelated to our performance could negatively impact
the market price of our securities. One of the factors that
investors may consider in deciding whether to buy or sell our
securities is our distribution rate as a percentage of our stock
price relative to market interest rates. If market interest rates
increase, prospective investors may demand a higher distribution
rate or seek alternative investments paying higher distributions or
interest. As a result, interest rate fluctuations and conditions in
the capital markets can affect the market value of our securities.
In addition, the stock market has experienced extreme price and
volume fluctuations that have affected the market price of many
companies in industries similar or related to ours and that have
been unrelated to these companies’ operating performances. These
broad market fluctuations could reduce the market price of our
securities. Furthermore, our operating results and prospects may be
below the expectations of public market analysts and investors or
may be lower than those of companies with comparable market
capitalizations, which could lead to a material decline in the
market price of our securities.
The performance of our securities may be affected by the
performance of our investments, which may be speculative and
aggressive compared to other types of investments.
The investments we make in accordance with our investment
objectives may result in a greater amount of risk as compared to
alternative investment options, including relatively higher risk of
volatility or loss of principal. Our investments may be speculative
and aggressive, and therefore an investment in our securities may
not be suitable for someone with lower risk tolerance.
One of the factors that investors may consider in deciding whether
to buy or sell shares of our securities is our distribution rate as
a percentage of the trading price of our securities relative to
market interest rates and distribution rates of our competitors. If
the market price of our securities is based primarily on the
earnings and return that we derive from our investments and income
with respect to our investments and our related distributions to
stockholders, and not from the market value of the investments
themselves, then interest rate fluctuations and capital market
conditions are likely to adversely affect the market price of our
securities. For instance, if market rates rise without an increase
in our distribution rate, the market price of our securities could
decrease as potential investors may require a higher distribution
yield on our securities or seek other securities paying higher
distributions or interest. In addition, rising interest rates would
result in increased interest expense on our variable rate debt,
thereby reducing cash flow and our ability to service our
indebtedness and make distributions to our
stockholders.
An increase in interest rates may have an adverse effect on the
market price of our stock and our ability to make distributions to
our stockholders.
One of the factors that investors may consider in deciding whether
to buy or sell shares of our stock is our dividend rate, or our
future expected dividend rate, as a percentage of our common stock
price, relative to market interest rates. If market interest rates
increase, prospective investors may demand a higher dividend rate
on our shares or seek alternative investments paying higher
dividends or interest. As a result, interest rate fluctuations and
capital market conditions can affect the market price of our stock
independent of the effects such conditions may have on our
portfolio.
We have not established a minimum distribution payment level on our
common stock and we cannot assure you of our ability to make
distributions in the future, or that our board of directors will
not reduce distributions in the future regardless of such
ability.
We intend to announce quarterly dividends in arrears on a quarterly
basis to holders of our common stock. If substantially all of our
taxable income has not been paid by the close of any calendar year,
we intend to declare a special dividend to holders of our common
stock prior to December 31st of the current year, to achieve this
result.
We have not established a minimum distribution payment level on our
common stock and our ability to make distributions may be adversely
affected by the risk factors described in this Annual Report on
Form 10-K. All distributions to our common stockholders will be
made at the discretion of our board of directors and will depend on
our earnings, our financial condition, maintenance of our REIT
status and such other factors as our board of directors may deem
relevant from time to time. There can be no assurance of our
ability to make distributions to our common stockholders, or that
our board of directors will not determine to reduce such
distributions, in the future. In addition, some of our
distributions to our common stockholders may continue to include a
return of capital.
Future offerings of debt or equity securities that rank senior to
our common stock may adversely affect the market price of our
common stock.
If we decide to issue additional equity securities or to issue debt
in the future that rank senior to our common stock, it is likely
that they will be governed by an indenture or other instrument
containing covenants restricting our operating flexibility.
Additionally, any convertible or exchangeable securities that we
issue in the future may have rights, preferences and privileges
more favorable than those of our common stock and may result in
dilution to owners of our common stock. We and, indirectly, our
stockholders, will bear the cost of issuing and servicing such
securities. Because our decision to issue debt or equity securities
in any future offering will depend on market conditions and other
factors beyond our control, we cannot predict or estimate the
amount, timing or nature of our future offerings. Thus holders of
our common stock will bear the risk of our future offerings
reducing the market price of our common stock and diluting the
value of their stock holdings in us. Furthermore, the compensation
payable to our Manager will increase as a result of future
issuances of our equity securities even if the issuances are
dilutive to existing stockholders.
Risks Related to Our Organization and Structure
Maintenance of our exclusion from the Investment Company Act will
impose limits on our business; we have not sought formal guidance
from the staff of the SEC as to our treatment of loans in
securitization trusts and there can be no assurance that the staff
will not adopt a contrary interpretation which could cause us to
sell material amounts of our assets and to change our investment
strategy.
We intend to conduct our operations so that neither we nor our
subsidiaries are required to register as investment companies under
the Investment Company Act. Section 3(a)(1)(A) of the Investment
Company Act defines an investment company as any issuer that is or
holds itself out as being engaged primarily in the business of
investing, reinvesting or trading in securities. We believe that we
do not meet the definition of investment company under Section
3(a)(1)(A) of the Investment Company Act because we do not engage
primarily, or hold ourselves out as being engaged primarily, in the
business of investing, reinvesting or trading in securities.
Rather, we are primarily engaged in a non-investment company
businesses related to real estate.
Section 3(a)(1)(C) of the Investment Company Act defines an
investment company as any issuer that is engaged or proposes to
engage in the business of investing, reinvesting, owning, holding
or trading in securities and owns or proposes to acquire investment
securities having a value exceeding 40% of the value of the
issuer’s total assets (exclusive of U.S. Government securities and
cash items) on an unconsolidated basis. Excluded from the term
“investment securities,” among other things, are U.S. Government
securities and securities issued by majority-owned subsidiaries
that are not themselves investment companies and are not relying on
the exception from the definition of investment company set forth
in Section 3(c)(1) or Section 3(c)(7) of the Investment Company
Act. We intend to conduct our operations so that we do not come
within the definition of an investment company under Section
3(a)(1)(C) of the Investment Company Act, or we otherwise qualify
for an exclusion from the definition. We generally rely on guidance
published by the SEC or its staff or on our own analyses to
determine whether we fall outside of this definition, including,
for example, whether a particular subsidiary is a “majority-owned
subsidiary” or “wholly-owned subsidiary” (as those terms are
defined in and interpreted under the Investment Company Act) for
this purpose.
We hold our assets primarily through our direct or indirect
subsidiaries, certain of which we believe are excluded from the
definitions of investment company pursuant to Section 3(c)(5)(C) of
the Investment Company Act. As interpreted by the SEC staff, this
exception generally requires that at least 55% of the subsidiary’s
total assets be comprised of certain qualifying real estate
interests, and at least 80% of the subsidiary’s total assets be
comprised of qualifying real estate interests and, as needed,
certain real estate-related assets. We generally rely on guidance
published by the SEC or its staff, or on our own analyses, to
determine which assets are qualifying real estate assets and real
estate-related assets.
Certain of our subsidiaries [may] seek to rely on Rule 3a-7 under
the Investment Company Act. Rule 3a-7 under the Investment Company
Act is available to certain structured financing vehicles that are
engaged in the business of holding financial assets that, by their
terms, convert into cash within a finite time period and that issue
fixed income securities entitling holders to receive payments that
depend primarily on the cash flows from these assets, provided
that, among other things, the structured finance vehicle does not
engage in certain portfolio management practices resembling those
employed by management investment companies (e.g., mutual funds).
Accordingly, each such subsidiary’s ability to acquire and dispose
of assets is limited. As a result of this limitation as well as
others imposed by the rule, these subsidiaries may suffer losses on
their assets and we may in turn suffer losses.
We and/or certain of our subsidiaries may seek to rely on the
exclusion from the definition of investment company provided by
Section 3(c)(6). As a general matter, this section excepts any
company primarily engaged, directly or through majority-owned
subsidiaries, in one or more other business excepted under the
Investment Company Act (including Section 3(c)(5)(C)) or in one or
more of such businesses together with an additional business or
businesses other than investing, reinvesting, owning, holding, or
trading in securities. Little interpretive guidance has been issued
by the SEC or its staff with respect to Section
3(c)(6).
SEC and staff no-action and other guidance under the Investment
Company Act is based in large part on specific factual situations,
some of which differ from the factual situations we and our
subsidiaries face from time to time. As a result, we apply SEC or
staff guidance that relates to other factual situations by analogy.
A number of the staff no-action positions were issued more than
twenty years ago. There may be no guidance from the SEC staff that
applies directly to our factual situations. No assurance can be
given that the SEC or its staff will concur with our analysis,
conclusions or approach. In addition, the SEC or its staff may, in
the future, issue further guidance that may require us and/or our
subsidiaries to re-classify our assets; modify our organizational
structure; acquire or sell assets; or make other changes for
purposes of the Investment Company Act, any or all of which could
materially and adversely affect us. For example, on August 31,
2011, the SEC issued a concept release and request for comments
regarding the Section 3(c)(5)(C) exclusion (Release No. IC-29778)
in which it solicited public comment on a wide range of issues
relating to Section 3(c)(5)(C), including the nature of the assets
that qualify for purposes of the exclusion and whether mortgage
REITs should be regulated in a manner similar to registered
investment companies.
Conducting our business so that we are not required to register
under the Investment Company Act limits, among other things: the
types of businesses in which we may engage through our
subsidiaries; our organizational structure and business strategy;
and the types of assets we and our subsidiaries originate, acquire
or sell; and the timing of such originations, acquisitions and
dispositions (including doing so when we would not otherwise choose
to do so). We cannot assure you that we would be able to complete
any such originations, acquisitions or on favorable terms, or at
all. Any or all of the above could materially and adversely affect
us.
Although we monitor our holdings and organizational structure for
ongoing compliance with the above, there can be no assurance that
we will be able to continue to avoid registration as an investment
company, or that the laws and regulations governing, or regulatory
guidance pertaining to, investment company status will not change
in a manner that materially and adversely affects us. If the fair
market value or income potential of our assets changes, we may need
to increase or decrease our holdings of certain of our assets to
maintain our exclusion from the Investment Company
Act.
If it were established that we were an unregistered investment
company, there would be a risk that we would be subject to monetary
penalties and injunctive relief in an action brought by the SEC,
that we would be unable to enforce contracts with third parties,
that third parties could seek to obtain rescission of transactions
undertaken during the period for which it was established that we
were an unregistered investment company. In addition, in this case,
we would need to register as an investment company under the
Investment Company Act, modify our operations, perhaps
significantly, to seek to continue to avoid being require to
register under the Investment Company Act, or seek some form of
exemptive or other relief from the SEC or its staff. If we were
required to register as an investment company under the Investment
Company Act, we would become subject to substantial regulation with
respect to our capital structure (including our ability to use
borrowings), management, operations, transactions with affiliated
persons (as defined in the Investment Company Act) and portfolio
composition, including disclosure requirements and restrictions
with respect to diversification and industry concentration and
other matters. Compliance with the Investment Company Act would,
accordingly, limit our ability to make certain investments and
require us to significantly restructure our business strategy. Any
of the foregoing results would have a material adverse effect on
us.
Since we are not expected to be subject to the Investment Company
Act and the rules and regulations promulgated thereunder, we will
not be subject to its substantive provisions, and thus investors
will not receive the protections that the Investment Company Act
provides to investors in registered investment
companies.
Our authorized but unissued shares of common and preferred stock
may prevent a change in our control.
Our charter authorizes us to issue additional authorized but
unissued shares of common or preferred stock. In addition, our
board of directors may, without stockholder approval, amend our
charter to increase the aggregate number of our shares of stock or
the number of shares of stock of any class or series that we have
authority to issue and classify or reclassify any unissued shares
of common or preferred stock and set the preferences, rights and
other terms of the classified or reclassified shares. As a result,
our board of directors may establish a series of common or
preferred stock that could delay or prevent a transaction or a
change in control that might involve a premium price for our share
class or of common stock or otherwise be in the best interest of
our stockholders.
Ownership limitations may restrict change of control or business
combination opportunities in which our stockholders might receive a
premium for their shares.
In order for us to maintain our REIT qualification for each taxable
year after December 31, 2012, during the last half of any taxable
year no more than 50% in value of our outstanding capital stock may
be owned, directly or indirectly, by five or fewer individuals.
"Individuals" for this purpose include natural persons, private
foundations, some employee benefit plans and trusts, and some
charitable trusts. To assist us in maintaining our qualification as
a REIT among other purposes and subject to certain exceptions, our
charter generally prohibits any person from directly or indirectly
owning more than 9.8% in value or in number of shares, whichever is
more restrictive, of the outstanding shares of our common stock or
more than 9.8% in value or in number of shares, whichever is more
restrictive, of the outstanding shares of our capital stock. On
February 17, 2022, in connection with the closing of our rights
offering, in which we issued and sold an aggregate of 27,277,269
shares of our common stock, our board of directors adopted
resolutions decreasing the common stock ownership limit and the
aggregate stock ownership limit from 9.8% to 8.75% for all
stockholders who are not excepted holders. The ownership
limitations in our charter could have the effect of discouraging a
takeover or other transaction in which holders of our equity
securities might receive a premium for their shares over the then
prevailing market price or which holders might believe to be
otherwise in their best interests.
Our board of directors has granted exemptions to the aggregate
stock ownership limit and the common stock ownership limit in our
charter to (i) XL Bermuda Ltd, (ii) OREC Investment Holdings, LLC,
an affiliate of our Manager, and (iii) James C. Hunt, a member of
our board of directors and Hunt Company Equity Holdings,
LLC.
Certain provisions of Maryland law may limit the ability of a
third-party to acquire control of our company.
Certain provisions of the Maryland General Corporation Law ("MGCL")
may have the effect of delaying, deferring or preventing a
transaction or a change of control of our company that might
involve a premium price for holders of our equity securities or
otherwise be in their best interests.
Subject to certain limitations, provisions of the MGCL prohibit
certain business combinations between us and an "interested
stockholder" (defined generally as any person who beneficially owns
10% or more of the voting power of our outstanding voting stock or
an affiliate or associate of ours who beneficially owned 10% or
more of the voting power of our then outstanding stock during the
two-year period immediately prior to the date in question) or an
affiliate of the interested stockholder for five years after the
most recent date on which the stockholder became an interested
stockholder. After the five-year period, business combinations
between us and an interested stockholder or an affiliate of the
interested stockholder must generally either provide a minimum
price to our stockholders (as defined in the MGCL) in the form of
cash or other consideration in the same form as previously paid by
the interested stockholder or be recommended by our board of
directors and approved by the affirmative vote of at least 80% of
the votes entitled to be cast by holders of our
outstanding
shares of voting stock and at least two-thirds of the votes
entitled to be cast by stockholders other than the interested
stockholder and its affiliates and associates. These provisions of
the MGCL relating to business combinations do not apply, however,
to business combinations that are approved or exempted by our board
of directors prior to the time that the interested stockholder
becomes an interested stockholder. Pursuant to the statute, our
board of directors has by resolution exempted business combinations
between us and the XL Companies and certain affiliates thereof, the
parent of which is AXA SA, between us and Hunt Investors and
affiliates thereof and between us and OREC Investment Holdings and
affiliates thereof.. Consequently, the five-year prohibition and
the supermajority vote requirements will not apply to business
combinations between us and the exempted parties. As a result, the
exempted companies may be able to enter into business combinations
with us that may not be in the best interest of our stockholders
without compliance by us with the supermajority vote requirements
and other provisions of the statute. However, our board of
directors may repeal or modify these exemptions at any time in the
future, in which case the applicable provisions of this statute
will become applicable to business combinations between us and the
previously exempted parties.
The "control share" provisions of the MGCL provide that holders of
"control shares" of a Maryland corporation (defined as shares
which, when aggregated with other shares controlled by the
stockholder (except solely by virtue of a revocable proxy), entitle
the stockholder to exercise one of three increasing ranges of
voting power in electing directors) acquired in a "control share
acquisition" (defined as the direct or indirect acquisition of
ownership or control of "control shares") have no voting rights
with respect to such shares except to the extent approved by our
stockholders by the affirmative vote of at least two-thirds of all
the votes entitled to be cast on the matter, excluding votes
entitled to be cast by the acquirer of control shares, our officers
and our employees who are also our directors. Our bylaws contain a
provision exempting from the control share acquisition statute any
and all acquisitions by any person of shares of our stock. There
can be no assurance that this provision will not be amended or
eliminated at any time in the future.
Additionally, Title 3, Subtitle 8 of the MGCL permits our board of
directors, without stockholder approval and regardless of what is
currently provided in our charter or bylaws, to elect to be subject
to certain provisions relating to corporate governance that may
have the effect of delaying, deferring or preventing a transaction
or a change of control of our company that might involve a premium
to the market price of our equity securities or otherwise be in our
stockholders’ best interests. Those provisions are (i) a classified
board; (ii) a two-thirds vote requirement for removing a director;
(iii) a requirement that the number of directors be fixed only by
vote of the directors; (iv) a requirement that a vacancy on the
board be filled only by affirmative vote of a majority of the
remaining directors in office and for the remainder of the full
term of the class of directors in which the vacancy occurred; (v)
and a majority requirement for the calling of a special meeting of
stockholders. We are subject to all of those provisions except for
a classified board, either by provisions of our charter and bylaws
unrelated to Subtitle 8 or by reason of an election in our charter
to be subject to certain provisions of Subtitle 8.
Stockholders have limited control over changes in our policies and
operations.
Our board of directors determines our major policies, including
with regard to financing, growth, debt capitalization, REIT
qualification and distributions. Our board of directors may amend
or revise these and other policies without a vote of the
stockholders. Under our charter and the MGCL, our common
stockholders generally have a right to vote only on the following
matters:
•the
election or removal of directors;
•the
amendment of our charter, except that our board of directors may
amend our charter without stockholder approval to:
◦change
our name;
◦change
the name or other designation or the par value of any class or
series of stock and the aggregate par value of our
stock;
◦increase
or decrease the aggregate number of shares of stock that we have
the authority to issue; and
◦increase
or decrease the number of our shares of any class or series of
stock that we have the authority to issue;
•our
liquidation and dissolution; and
•our
being a party to a merger, consolidation, sale or other disposition
of all or substantially all of our assets or statutory share
exchange.
All other matters are subject to the discretion of our board of
directors.
Our charter contains provisions that make removal of our directors
difficult, which could make it difficult for stockholders to effect
changes in management.
Our charter provides that, subject to the rights of any class or
series of preferred stock, a director may be removed only by the
affirmative vote of at least two-thirds of all the votes entitled
to be cast generally in the election of directors. Our charter and
bylaws provide that vacancies generally may be filled only by a
majority of the remaining directors in office, even if less than a
quorum. These requirements make it more difficult to change
management by removing and replacing directors and may prevent a
change in control that is in the best interests of
stockholders.
Our rights and stockholders’ rights to take action against
directors and officers are limited, which could limit recourse in
the event of actions not in the best interests of
stockholders.
As permitted by Maryland law, our charter eliminates the liability
of our directors and officers to us and our stockholders for money
damages, except for liability resulting from:
•actual
receipt of an improper benefit or profit in money, property or
services; or
•a
final judgment based upon a finding of active and deliberate
dishonesty by the director or officer that was material to the
cause of action adjudicated.
In addition, our charter requires us, to the maximum extent
permitted by Maryland law, to indemnify and, without requiring a
preliminary determination of the ultimate entitlement to
indemnification, pay or reimburse reasonable expenses in advance of
final disposition of a proceeding to any individual who is a
present or former director or officer and who is made or threatened
to be made a party to the proceeding by reason of his or her
service in that capacity or any individual who, while a director or
officer and at our request, serves or has served as a director,
officer, partner, trustee of another corporation, REIT,
partnership, joint venture, trust, employee benefit plan or any
other enterprise and who is made or threatened to be made a party
to the proceeding by reason of his or her service in that capacity.
Maryland law permits indemnification of our directors and officers
in connection with a proceeding, unless it is established that (i)
the act or omission of the individual was material to the
proceeding and was committed in bad faith or was the result of
active and deliberate dishonesty, or the individual actually
received an improper personal benefit in money, property or
services, or (ii) in the case of a criminal proceeding, the
individual had reasonable cause to believe that the act or omission
was unlawful. As part of these indemnification obligations, we may
be obligated to fund the defense costs incurred by our directors
and officers.
We also are permitted to purchase and maintain insurance or provide
similar protection on behalf of any directors, officers, employees
and agents, including our Manager and its affiliates, against any
liability asserted which was incurred in any such capacity with us
or arising out of such status. This may result in us having to
expend significant funds, which will reduce the available cash for
distribution to our stockholders.
We have made, and in the future may make, distributions of offering
proceeds, borrowings or the sale of assets to the extent that
distributions exceed earnings or cash flow from our
operations.
We have made, and in the future may make, distributions of offering
proceeds, borrowings or the sale of assets to the extent that
distributions exceed earnings or cash flow from our operations.
Such distributions reduce the amount of cash we have available for
investing and other purposes and could be dilutive to our financial
results. In addition, funding our distributions from our net
proceeds may constitute a return of capital to our investors, which
would have the effect of reducing each stockholder’s basis in its
shares of equity securities.
Because of their significant ownership of our common stock, OREC
Investment Holdings, an affiliate of our Manager, and the Hunt
Investors have the ability to influence the outcome of matters that
require a vote of our stockholders, including a change of
control.
OREC Investment Holdings and the Hunt Investors hold a significant
interest in our outstanding common stock. As of March 1, 2022, OREC
Investment Holdings owned 27.4% of our outstanding common stock and
the Hunt Investors owned 12.1% of our outstanding common stock. In
addition, James C. Hunt, one of the Hunt Investors, is a member of
our board of directors. As a result, each of OREC Investment
Holdings and the Hunt Investors has the ability to influence the
outcome of matters that require a vote of our stockholders,
including election of our board of directors and other corporate
transactions, regardless of whether others believe that the
transaction is in our best interests.
We are a "smaller reporting company” and we may avail ourselves of
the reduced disclosure requirements, which may make the Company’s
securities less attractive to investors.
As a "smaller reporting company," the Company has relied on
exemptions from certain disclosure requirements that are applicable
to other public companies. The Company may continue to rely on such
exemptions for so long as the Company remains a "smaller reporting
company." These exemptions include reduced financial disclosure and
reduced disclosure obligations regarding executive compensation. We
may continue to rely on such exemptions for so long as we remain a
smaller reporting company under applicable SEC rules and
regulations. The Company’s reliance on these exemptions may result
in the public finding the Company’s securities to be less
attractive and adversely impact the market price of the Company’s
securities or the trading market thereof.
We are subject to financial reporting and other requirements for
which our accounting, internal audit and other management systems
and resources may not be adequately prepared.
We are subject to reporting and other obligations under the
Exchange Act, including the requirements of Section 404 of the
Sarbanes-Oxley Act. These reporting and other obligations may place
significant demands on our management, administrative, operational,
internal audit and accounting resources and cause us to incur
significant expenses. We may need to upgrade our systems or create
new systems, implement additional financial and management
controls, reporting systems and procedures, expand or outsource our
internal audit function and hire additional accounting, internal
audit and finance staff. If we are unable to accomplish these
objectives in a timely and effective fashion, our ability to comply
with the financial reporting requirements and other rules that
apply to reporting companies could be impaired. Any failure to
maintain effective internal controls could have a material adverse
effect on our business, financial condition and results of
operations and our ability to make distributions to our
stockholders.
We are required to make critical accounting estimates and
judgments, and our financial statements may be materially affected
if our estimates or judgments prove to be inaccurate.
Financial statements prepared in accordance with GAAP require the
use of estimates, judgments and assumptions that affect the
reported amounts. Different estimates, judgments and assumptions
reasonably could be used that would have a material effect on our
financial statements, and changes in these estimates, judgments and
assumptions are likely to occur from period to period in the
future. Significant areas of accounting requiring the application
of management’s judgment include, but are not limited to (1)
determining the fair value of our investments, (2) assessing the
adequacy of the allowance for loan losses or credit reserves and
(3) appropriately consolidating VIEs for which we have determined
we are the primary beneficiary. These estimates, judgments and
assumptions are inherently uncertain, and, if they prove to be
inaccurate, then we face the risk that charges to income will be
required. In addition, because we have limited operating history in
some of these areas and limited experience in making these
estimates, judgments and assumptions, the risk of future charges to
income may be greater than if we had more experience in these
areas. Any such charges could significantly harm our business,
financial condition, results of operations and our ability to make
distributions to our stockholders. See "Management’s Discussion and
Analysis of Financial Condition and Results of Operations-Critical
Accounting Policies" for a discussion of the accounting estimates,
judgments and assumptions that we believe are the most critical to
an understanding of our business, financial condition and results
of operations.
Tax Risks
If we fail to remain qualified as a REIT, we will be subject to
U.S. federal income tax as a regular corporation and could face a
substantial tax liability, which would reduce the amount of cash
available for distribution to our stockholders.
We elected to be taxed as a REIT commencing with our short taxable
year ended December 31, 2012, and our subsidiary, Lument Commercial
Mortgage Trust, Inc. elected to be taxed as a REIT commencing with
its short taxable year ended December 31, 2018 and in each case to
comply with the provisions of the Internal Revenue Code with
respect thereto. Our and its continued qualification as a REIT will
depend on our and its satisfaction of certain asset, income,
organizational, distribution, stockholder ownership and other
requirements on a continuing basis. Our and its ability to satisfy
the asset tests depends upon our analysis of the characterization
and fair market values of our assets, some of which are not
susceptible to a precise determination, and for which we will not
obtain independent appraisals. Our compliance with the REIT income
and quarterly asset requirements also depends upon our ability to
successfully manage the composition of our income and assets on an
ongoing basis. Further, there can be no assurance that the U.S.
Internal Revenue Service, or the IRS, will not contend that our
interests in subsidiaries or in securities of other issuers will
not cause a violation of the REIT requirements.
If we were to fail to maintain our REIT qualification in any
taxable year and were not able to qualify for, or fail to satisfy
the requirements of certain statutory relief provisions, we would
be subject to U.S. federal income tax, including any applicable
alternative minimum tax, on our taxable income at regular corporate
rates, and dividends paid to our stockholders would not be
deductible by us in computing our taxable income. Any resulting
corporate tax liability
could be substantial and would reduce the amount of cash available
for distribution to our stockholders, which in turn could have an
adverse impact on the value of our equity securities. Unless we
were entitled to relief under certain Internal Revenue Code
provisions, we also would be disqualified from re-electing to be
taxed as a REIT for the four taxable years following the year in
which we failed to qualify as a REIT.
Furthermore, any REIT in which we invest directly or indirectly,
including Lument Commercial Mortgage Trust, Inc., the REIT through
which we own our interests in our CLOs, is independently subject
to, and must comply with, the same REIT requirements that we must
satisfy in order to qualify as a REIT. If the subsidiary fails to
qualify as a REIT and certain statutory relief provisions do not
apply, then (a) the subsidiary REIT would become subject to U.S.
federal income tax, (b) the subsidiary REIT will be disqualified
from treatment as a REIT for the four taxable years following the
year during which qualification was lost, (c) our investment in the
subsidiary REIT could cease to be a qualifying asset for purposes
of the asset tests applicable to REITs and any dividend income or
gains derived by us from such subsidiary REIT may cease to be
treated as income that qualifies for purposes of the 75% gross
income test, and (d) we may fail certain of the asset or income
tests applicable to REITs, in which event we will fail to qualify
as REIT unless we are able to avail ourselves of certain statutory
relief provisions.
If we fail to remain qualified as REIT, we may default on our
current financing facilities and be required to liquidate our
assets, and we may face delays or inabilities to procure future
financing.
Failure to maintain qualified as a REIT could result in an event of
default under our credit facility and CLOs, and we may be required
to liquidate all or substantially all of our assets, unless we were
able to negotiate a waiver. Any such waiver could be conditioned on
an amendment to our CLOs or credit facility and any related
guaranty agreements on terms that may be unfavorable to us. If we
are unable to negotiate a waiver or replace or refinance our assets
under a new credit facility or CLO on favorable terms or at all,
our financial conditions, results of operations and cash flows
could be adversely affected.
Dividends payable by REITs do not qualify for the reduced tax rates
available for some dividends.
The maximum tax rate applicable to income from "qualified
dividends" payable to U.S. stockholders that are individuals,
trusts and estates is 20%, exclusive of a 3.8% investment tax
surcharge. Dividends payable by REITs, however, generally are not
eligible for the reduced rates. Thus, the more favorable rates
applicable to regular corporate qualified dividends could cause
investors who are individuals, trusts and estates to perceive
investments in REITs to be relatively less attractive than
investments in the stocks of non-REIT corporations that pay
dividends, which could adversely affect the value of the stock of
REITs, including our equity securities. However, REIT dividends
(other than capital gain dividends) received by non-corporate
taxpayers may be eligible for a 20% deduction. This deduction is
only applicable to investors of LFT that receive dividends and does
not have any impact on us. Without further legislation, the
deduction would sunset after 2025. Investors should consult their
own tax advisors regarding the effect of this change on their
effective tax rate with respect to REIT dividends.
REIT distribution requirements could adversely affect our ability
to execute our business plan.
We generally must distribute annually at least 90% of our REIT
taxable income determined without regard to the deduction for
dividends paid and excluding net capital gain and 90% of our net
income, if any, (after tax) from foreclosure property, in order for
us to maintain our REIT qualification. To the extent that we
satisfy such distribution requirements but distribute less than
100% of our REIT taxable income we will be subject to U.S. federal
income tax on our undistributed taxable income. In addition, we
will be subject to a 4% nondeductible excise tax if the actual
amount that we pay out to our stockholders in a calendar year is
less than a minimum amount specified under U.S. federal income tax
laws. We intend to make distributions to our stockholders to comply
with the REIT requirements of the Internal Revenue
Code.
From time to time, differences in timing between our recognition of
taxable income and our actual receipt of cash may occur. If we do
not have other funds available in these situations we could be
required to borrow funds on unfavorable terms, sell investments at
disadvantageous prices or distribute amounts that would otherwise
be invested in future acquisitions, capital expenditures or
repayment of debt, make a taxable distribution of our shares as
part of a distribution in which stockholders may elect to receive
shares or (subject to certain limits) cash or use cash reserves, in
order to make distributions sufficient to enable us to pay out
enough of our taxable income to satisfy the REIT distribution
requirement and to avoid the U.S. federal income tax and the 4%
excise tax in a particular year. These alternatives could increase
our costs or reduce our equity. Thus, compliance with the REIT
requirements may hinder our ability to grow, which could adversely
affect the value of our equity securities.
Even if we remain qualified as a REIT, we may face other tax
liabilities that reduce our cash flow.
Even if we remain qualified for taxation as a REIT, we may be
subject to certain U.S. federal, state and local taxes on our
income and assets, including taxes on any undistributed income, tax
on certain types of income including as a result of a foreclosure,
and state or local income, property and transfer taxes, such as
mortgage recording taxes. Any of these taxes would decrease cash
available for distribution to our stockholders.
Complying with REIT requirements may cause us to forgo otherwise
attractive opportunities and may require us to dispose of our
target assets sooner than originally anticipated.
To maintain our qualification as a REIT, we must satisfy five tests
relating to the nature of our assets at the end of each calendar
quarter. First, at least 75% of the value of our total assets must
consist of cash, cash items, government securities and real estate
assets, including certain mortgage loans and securities and debt
instruments issued by publicly offered REITs. Second, we may not
own more than 10% of any one issuer’s outstanding securities, as
measured by either value or voting power. Third, no more than 5% of
the value of our total assets can consist of the securities of any
one issuer. Fourth, no more than 20% of our total assets can be
represented by securities of one or more TRSs. Fifth, not more than
25% of our assets may consist of debt instruments issued by
publicly offered REITs to the extent that such debt instruments
constitute "real estate assets" for purposes of the 75% asset test
described above only because of the express inclusion of "debt
instruments issued by publicly offered REITs" in the definition. If
we fail to comply with these requirements at the end of any
calendar quarter, we will lose our REIT qualification unless we are
able to qualify for certain statutory relief provisions, which may
involve paying taxes and penalties. In order to comply with the
asset tests, we may be required to liquidate from our investment
portfolio otherwise attractive investments. These actions could
have the effect of reducing our income and the amount available for
distribution to our stockholders.
In addition to the asset tests set forth above, to maintain our
REIT qualification, we must continually satisfy tests concerning,
among other things, the sources of our income, the amounts we
distribute to our stockholders and the ownership of our stock. We
may be unable to pursue investments that would be otherwise
advantageous to us in order to satisfy the income test, the asset
tests, and the other REIT requirements. Thus, compliance with the
REIT requirements
may hinder our ability to make certain attractive investments. If
we fail to comply with any of these other REIT requirements at the
end of any fiscal year, we will lose our REIT qualification unless
we are able to satisfy or qualify for certain statutory relief
provisions which may involve paying taxes and
penalties.
We may be required to report taxable income for certain investments
in excess of the economic income we ultimately realize from
them.
We may continue to acquire mortgage-backed securities in the
secondary market for less than their face amount. In addition, as a
result of our ownership of certain mortgage-backed securities, we
may be treated for tax purposes as holding certain debt instruments
acquired in the secondary market for less than their face amount.
The discount at which such securities or debt instruments are
acquired may reflect doubts about their ultimate collectability
rather than current market interest rates. The amount of such
discount will nevertheless generally be treated as "market
discount" for U.S. federal income tax purposes. Accrued market
discount is generally reported as income when, and to the extent
that, any payment of principal of the mortgage-backed security or
debt instrument is made. If we collect less on the mortgage-backed
security or debt instrument than our purchase price plus the market
discount we had previously reported as income, we may not be able
to benefit from any offsetting loss deductions.
In addition, as a result of our ownership of certain
mortgage-backed securities, we may be treated for tax purposes as
holding distressed debt investments that are subsequently modified
by agreement with the borrower. If the amendments to the
outstanding debt are "significant modifications" under applicable
U.S. Treasury Department regulations, the modified debt may be
considered to have been reissued to us at a gain in a debt-for-debt
exchange with the borrower. In that event, we may be required to
recognize taxable gain to the extent the principal amount of the
modified debt exceeds our adjusted tax basis in the unmodified
debt, even if the value of the debt or the payment expectations
have not changed.
Moreover, some of the mortgage-backed securities that we acquire
may have been issued with original issue discount. We will be
required to report such original issue discount based on a constant
yield method and will be taxed based on the assumption that all
future projected payments due on such mortgage-backed securities
will be made. If such mortgage-backed securities turn out not to be
fully collectible, an offsetting loss deduction will become
available only in the later year that lack of collectability is
provable.
Finally, in the event that any debt instruments or mortgage-backed
securities acquired by us are delinquent as to mandatory principal
and interest payments, or in the event a borrower with respect to a
particular debt instrument acquired by us encounters financial
difficulty rendering it unable to pay stated interest as due, we
may nonetheless be required to continue to recognize the unpaid
interest as taxable income as it accrues, despite doubt as to its
ultimate collectability. Similarly, we may be required to accrue
interest income with respect to subordinate mortgage-backed
securities at the stated rate regardless of whether corresponding
cash payments are received or are ultimately collectible. In each
case, while we would in general ultimately have an offsetting loss
deduction available to us when such interest was determined to be
uncollectable, the utility of that deduction could depend on our
having taxable income in that later year or
thereafter.
The "taxable mortgage pool" rules may increase the taxes that we or
our stockholders may incur, and may limit the manner in which we
effect future securitizations.
Securitizations by us or our subsidiaries could result in the
creation of taxable mortgage pools for U.S. federal income tax
purposes, resulting in "excess inclusion income." As a REIT, so
long as we own 100% of the equity interests in a taxable mortgage
pool, we generally would not be adversely affected by the
characterization of the securitization as a taxable mortgage pool.
Certain categories of stockholders, however, such as non-U.S.
stockholders eligible for treaty or other benefits, stockholders
with net operating losses, and certain tax-exempt U.S. stockholders
that are subject to unrelated business income tax, could be subject
to increased taxes on a portion of their dividend income from us
that is attributable to the excess inclusion income. In the case of
a stockholder that is a REIT, a regulated investment company, or
RIC, common trust fund or other pass-through entity, our allocable
share of our excess inclusion income could be considered excess
inclusion income of such entity. In addition, to the extent that
our stock is owned by tax-exempt "disqualified organizations," such
as certain government-related entities and charitable remainder
trusts that are not subject to tax on unrelated business income, we
may incur a corporate level tax on a portion of any excess
inclusion income. Because this tax generally would be imposed on
us, all of our stockholders, including stockholders that are not
disqualified organizations, generally would bear a portion of the
tax cost associated with the classification of us or a portion of
our assets as a taxable mortgage pool. A RIC, or other pass-through
entity owning our stock in record name will be subject to tax at
the highest U.S. federal corporate tax rate on any excess inclusion
income allocated to their owners that are disqualified
organizations. Moreover, we could face limitations in selling
equity interests in these securitizations to outside investors, or
selling any debt securities issued in connection with these
securitizations that might be considered to be equity interests for
tax purposes. Finally, if we were to fail to maintain our REIT
qualification, any taxable mortgage pool securitizations would be
treated as separate taxable corporations for U.S. federal income
tax purposes that could not be included in any consolidated U.S.
federal income tax return. These limitations may prevent us from
using certain techniques to maximize our returns from
securitization transactions.
Liquidation of our assets may jeopardize our REIT
qualification.
To maintain our qualification as a REIT, we must comply with
requirements regarding our assets and our sources of income. If we
liquidate our investments including to repay obligations to our
lenders, we may be unable to comply with these requirements,
ultimately jeopardizing our qualification as a REIT, or we may be
subject to a 100% tax on any resultant gain if we sell assets that
are treated as dealer property or inventory.
Complying with REIT requirements may limit our ability to hedge
effectively and may cause us to incur tax liabilities.
The REIT provisions of the Internal Revenue Code substantially
limit our ability to hedge our assets and liabilities. Under these
provisions, any income from a hedging transaction we enter into to
manage risk of interest rate changes with respect to borrowings
made or to be made to acquire or carry real estate assets does not
constitute "gross income" for purposes of the 75% or 95% gross
income tests, if certain requirements are met. To the extent that
we enter into other types of hedging transactions, the income from
those transactions is likely to be treated as non-qualifying income
for purposes of both of the REIT gross income tests.
Qualifying as a REIT involves highly technical and complex
provisions of the Internal Revenue Code.
Qualification as a REIT involves the application of highly
technical and complex Internal Revenue Code provisions for which
only limited judicial and administrative authorities exist. Even a
technical or inadvertent violation could jeopardize our REIT
qualification. Our qualification as a REIT will depend on our
satisfaction of certain asset, income, organizational,
distribution, stockholder ownership and other requirements on a
continuing basis. In addition, our ability to satisfy the
requirements to maintain our REIT qualification depends in part on
the actions of third parties over which we have no control or only
limited influence, including in cases where we own an equity
interest in an entity that is classified as a partnership for U.S.
federal income tax purposes. Thus,
while we intend to continue to operate so that we will qualify as a
REIT, given the highly complex nature of the rules governing REITs,
the ongoing importance of factual determinations, and the
possibility of future changes in our circumstances, no assurance
can be given that we will maintain our qualification for any
particular year.
We may incur a significant tax liability as a result of selling
assets that might be subject to the prohibited transactions tax if
sold directly by us.
A REIT’s net income from "prohibited transactions" is subject to a
100% tax. In general, "prohibited transactions" are sales or other
dispositions of assets held primarily for sale to customers in the
ordinary course of business. There is a risk that certain loans
that we are treating as owning for U.S. federal income tax purposes
and certain property received upon foreclosure of these loans will
be treated as held primarily for sale to customers in the ordinary
course of business. Although we expect to avoid the prohibited
transactions tax by contributing those assets to one of our TRSs
and conducting the marketing and sale of those assets through that
TRS, no assurance can be given that the IRS will respect the
transaction by which those assets are contributed to our TRS. Even
if those contribution transactions are respected, our TRS will be
subject to U.S. federal, state and local corporate income tax and
may incur a significant tax liability as a result of those
sales.
We may be subject to adverse legislative or regulatory tax changes
that could reduce the market price of shares of our equity
securities.
At any time, the U.S. federal income tax laws or regulations
governing REITs or the administrative interpretations of those laws
or regulations may be changed, possibly with retroactive effect. We
cannot predict if or when any new U.S. federal income tax law,
regulation or administrative interpretation, or any amendment to
any existing U.S. federal income tax law, regulation or
administrative interpretation, will be adopted, promulgated or
become effective or whether any such law, regulation or
interpretation may take effect retroactively. We and our
stockholders could be adversely affected by any such change in, or
any new, U.S. federal income tax law, regulation or administrative
interpretation.
Distributions to tax-exempt investors may be classified as
unrelated business taxable income, or UBTI, as defined under
Section 512(a) of the Internal Revenue Code.
Neither ordinary nor capital gain distributions with respect to our
stock nor gain from the sale of stock should generally constitute
UBTI to a tax-exempt investor. However, there are certain
exceptions to this rule, including: (1) part of the income and gain
recognized by certain qualified employee pension trusts with
respect to our stock may be treated as UBTI if shares of our stock
are predominantly held by qualified employee pension trusts, and we
are required to rely on a special look-through rule for purposes of
meeting one of the REIT ownership tests, and we are not operated in
a manner to avoid treatment of such income or gain as UBTI; (2)
part of the income and gain recognized by a tax-exempt investor
with respect to our stock would constitute UBTI if the investor
incurs debt in order to acquire the stock; (3) part or all of the
income or gain recognized with respect to our stock by social
clubs, voluntary employee benefit associations, supplemental
unemployment benefit trusts and qualified group legal services
plans which are exempt from U.S. federal income taxation under the
Internal Revenue Code may be treated as UBTI; and (4) to the extent
that we are (or a part of us, or a disregarded subsidiary of ours,
is) a "taxable mortgage pool," or if we hold residual interests in
a REMIC, a portion of the distributions paid to a tax-exempt
stockholder that is allocable to excess inclusion income may be
treated as UBTI.
The value of our assets represented by our TRS is required to be
limited and a failure to comply with this and certain other rules
governing transactions between a REIT and its TRSs would jeopardize
our REIT qualification and may result in the application of a 100%
excise tax.
A REIT may own up to 100% of the stock of one or more TRSs. Other
than certain activities relating to lodging and healthcare
facilities, a TRS generally may engage in any business and may hold
assets and earn income that would not be qualifying assets or
income if held or earned directly by a REIT. No more than 20% of
the value of a REIT’s assets may consist of stock or securities of
one or more TRSs. In addition, the TRS rules limit the
deductibility of interest paid or accrued by a TRS to its parent
REIT to assure that the TRS is subject to an appropriate level of
corporate taxation. The rules also impose a 100% excise tax on
certain transactions between a TRS and its parent REIT, or by a TRS
on behalf of its parent REIT, that are not conducted on an
arm’s-length basis.
Our current TRS, and any future TRSs, will pay U.S. federal, state
and local income tax on their respective taxable incomes, if any.
We anticipate that the aggregate value of the securities of our TRS
will be less than 20% of the value of our total assets (including
our TRS securities). Furthermore, we intend to monitor the value of
our investments in our TRS for the purpose of ensuring compliance
with TRS-ownership limitations. In addition, we will review all our
transactions with our TRS to ensure that they are entered into on
arm’s-length terms to avoid incurring the 100% excise tax described
above. There can be no assurance, however, that we will be able to
continue to comply with the TRS-ownership limitation or to avoid
application of the 100% excise tax discussed above.
Your investment has various U.S. federal income tax
risks.
We urge you to consult your tax advisor concerning the effects of
U.S. federal, state, local and foreign tax laws to you with regard
to an investment in shares of our stock.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
We do not own any real estate or other physical properties. We
maintain our corporate headquarters at 230 Park Avenue, 20th Floor,
New York, NY 10169 in office space furnished to us by our Manager.
We reimburse our Manager under the management agreement between us
for lease and other related expenses incurred in furnishing us with
our offices. We believe that our property is maintained in good
condition and is suitable and adequate for our
purposes.
ITEM 3. LEGAL PROCEEDINGS
As of the date of this filing, we are not party to any litigation
or legal proceeding or, to the best of our knowledge, any
threatened litigation or legal proceeding.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
On March 14, 2022, the last reported sales price for our
common stock on the New York Stock Exchange under symbol "LFT" was
$3.03.
Holders
At December 31, 2021, there were 24,947,883 shares of our
common stock outstanding. As of March 14, 2022, there were 16
registered holders. The number of beneficial stockholders is
substantially greater than the number of holders of record as a
large portion of our stock is held in "street name" through banks
or broker dealers.
Dividends
Dividends on our common stock are paid on a quarterly
basis.
All dividend distributions are made with the authorization of the
board of directors at its discretion and depend on such items as
our REIT taxable earnings, financial condition, maintenance of REIT
status, and other factors that the board of directors may deem
relevant from time to time.
The holders of our common stock share proportionally on a per share
basis in all declared dividends on our common stock. We are
required to distribute to our stockholders as dividends at least
90% of our REIT taxable income, computed without regard to our net
capital gains and the deduction for dividends paid, and 90% of our
net income, if any (after tax) from foreclosure property in order
to maintain our qualification as a REIT. See Item 1A, "Risk
Factors," and Item 7, “Management’s Discussion and Analysis of
Financial Conditions and Results of Operations," of this Annual
Report on Form 10-K, for information regarding the sources of funds
used for dividends and for a discussion of factors, if any, which
may adversely affect our ability to pay dividends at the same level
in 2021 and thereafter.
The following table presents cash dividends declared on our common
stock from January 1, 2020 through December 31,
2021:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common Dividends Declared per Share |
|
|
|
Declaration Date |
|
Amount |
|
Record Date |
|
Date of Payment |
|
March 12, 2020 |
|
$ |
0.075 |
|
|
March 31, 2020 |
|
April 15, 2020 |
|
June 17, 2020 |
|
$ |
0.075 |
|
|
June 30, 2020 |
|
July 15, 2020 |
|
September 17, 2020 |
|
$ |
0.085 |
|
|
September 30, 2020 |
|
October 15, 2020 |
|
December 18, 2020 |
|
$ |
0.090 |
|
|
December 31, 2020 |
|
January 15, 2021 |
|
December 21, 2020 |
|
$ |
0.040 |
|
|
December 31, 2020 |
|
January 15, 2021 |
|
March 15, 2021 |
|
$ |
0.090 |
|
|
March 31, 2021 |
|
April 15, 2021 |
|
June 15, 2021 |
|
$ |
0.090 |
|
|
June 30, 2021 |
|
July 15, 2021 |
|
September 15, 2021 |
|
$ |
0.090 |
|
|
September 30, 2021 |
|
October 15, 2021 |
|
December 15, 2021 |
|
$ |
0.090 |
|
|
December 31, 2021 |
|
January 15, 2022 |
Purchases of Equity Securities by the Issuer and Affiliated
Purchasers
On December 16, 2015, we announced a share repurchase program,
pursuant to which our Board authorized us to repurchase up to $10
million of our common shares. Under this program, we have
discretion to determine the dollar amount of common shares to be
repurchased and the timing of any repurchases in compliance with
applicable law and regulations. The program does not have an
expiration date.
The Company did not purchase any common shares under the plan
during the twelve months ended December 31, 2021.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with our
consolidated financial statements and the accompanying notes
included in this Annual Report on Form 10-K. The following
discussion contains forward-looking statements that reflect our
current expectations, estimates, forecasts and
projections.
Overview
We are a Maryland corporation that is focused on investing in,
financing and managing a portfolio of commercial real estate
("CRE") debt investments.
In January 2020, we entered into a series of transactions with
subsidiaries of ORIX Corporation USA ("ORIX USA"), a diversified
financial company with the ability to provide investment capital
and asset management services to clients in the corporate, real
estate and municipal finance sectors. We entered into a new
management agreement with OREC Investment Management, LLC doing
business as Lument Investment Management (the "Manager" or "Lument
IM"), while another affiliate of ORIX USA purchased an ownership
stake of approximately 5.0% through a privately-placed stock
issuance. The transactions are expected to enhance the scale of LFT
and generate shareholder value through leveraging ORIX USA's
expansive originations, asset management and servicing
platform.
Lument IM is an affiliate of Lument, a nationally recognized leader
in multifamily and seniors housing and care finance. The Company
leverages Lument's broad platform and significant expertise when
originating and underwriting investments.
We invest primarily in transitional floating rate CRE mortgage
loans with an emphasis on middle market multifamily assets. We may
also invest in other CRE-related investments including mezzanine
loans, preferred equity, commercial mortgage-backed securities,
fixed rate loans, construction loans and other CRE debt
instruments. We finance our current investments in transitional
multifamily and other CRE loans primarily through match term
non-recourse CRE collateralized loan obligations ("CLOs"). We may
utilize warehouse repurchase agreements or other forms of financing
in the future. Our primary sources of income are net interest from
our investment portfolio and non-interest income from our mortgage
loan-related activities. Net interest income represents the
interest income we earn on investments less the expense of funding
these investments.
Our investments typically have the following
characteristics:
•Sponsors
with experience in particular real estate sectors and geographic
markets;
•Located
in U.S. markets with multiple demand drivers, such as growth in
employment and household formation;
•Fully
funded principal balance greater than $5 million and generally less
than $75 million;
•Loan
to Value ratio up to 85% of as-is value and up to 75% of as
stabilized value;
•Floating
rate loans historically tied to one-month U.S. denominated LIBOR,
more recently to one-month term SOFR, and/or in the future
potentially other index replacement;
•Three-year
term with two one-year extension options.
We believe that our current investment strategy provides
significant opportunities to achieve attractive risk-adjusted
returns for our stockholders over time. However, to capitalize on
the investment opportunities at different points in the economic
and real estate investment cycle, we may modify or expand our
investment strategy. We believe that the flexibility of our
strategy, which is supported by significant CRE experience of
Lument's investment team, and the extensive resources of ORIX USA,
will allow us to take advantage of changing market conditions to
maximize risk-adjusted returns to our stockholders.
We have elected to be taxed as a REIT and comply with the
provisions of the Internal Revenue Code with respect thereto.
Accordingly, we are generally not subject to federal income tax on
our REIT taxable income that we currently distribute to our
stockholders so long as we maintain our qualification as a REIT.
Our continued qualification as a REIT depends on our ability to
meet, on a continuing basis, various complex requirements under the
Internal Revenue Code relating to, among other things, the source
of our gross income, the composition and values of our assets, our
distribution levels and the concentration of ownership of our
capital stock. Even if we maintain our qualification as a REIT, we
may become subject to some federal, state and local taxes on our
income generated in our wholly owned taxable REIT subsidiary
("TRS"), Five Oaks Acquisition Corp. ("FOAC").
Recent Developments
As the COVID-19 pandemic has evolved from its emergence in early
2020, so has its global impact. Many countries have re-instituted,
or strongly encouraged, varying levels of quarantines and
restrictions on travel and in some cases have at times limited
operations of certain businesses and taken other restrictive
measures designed to help slow the spread of COVID-19 and its
variants. Governments and businesses have also instituted vaccine
mandates and testing requirements for employees. While vaccine
availability and uptake has increased, the longer-term
macro-economic effects on global supply chains, inflation, labor
shortages and wage increases continue to impact many industries.
Moreover, with the potential for new strains of COVID-19 to emerge,
governments and businesses may re-impose aggressive measures to
help slow its spread in the future. For this reason, among others,
as the COVID-19 pandemic continues, the potential global impacts
are uncertain and difficult to assess.
The effects of the COVID-19 pandemic did not significantly impact
our operating results for the year ended December 31, 2021.
However, the prolonged duration and impact of the COVID-19 pandemic
could materially disrupt our business operations and negatively
impact our business, financial performance and operating results
for the year ending December 31, 2022 and potentially
longer.
On February 22, 2022, the Company closed a transferable common
stock rights offering. The Company issued and sold 27,277,269
shares of common stock for gross proceeds of approximately $83.5
million.
On February 22, 2022, the Company, together with its Credit
Parties, entered into an amendment (the "Fourth Amendment") to the
Credit and Guaranty Agreement. This amendment amends the maximum
total net leverage financial covenant.
2021 Highlights
•Net
income attributable to common stockholders of $7.4 million, or
$0.30 per share of common stock, and Distributable Earnings of $9.7
million, or $0.39 per share of common stock, with common dividends
declared of $9.0 million, or $0.36 per share of common stock.
Distributable Earnings is a non-GAAP
financial measure. For a definition of Distributable Earnings and a
reconciliation of our Distributable Earnings to our net income
attributable to common stockholders, see "Key Financial Measure and
Indicators."
•Book
value per share of common stock was $109.3 million, or $4.38 per
share of common stock.
•Acquired
sixty-four loans and acquired eighteen loan advances with an
initial unpaid principal balance of $983.3 million with a weighted
average interest rate of one month U.S. LIBOR plus 3.46% and a
weighted average LIBOR floor of 0.46%.
•On
April 21, 2021, the Company, together with its FOAC and Lument CMT
Equity subsidiaries (together with the Company, the "Credit
Parties"), entered into an amendment (the "Third Amendment") to the
Credit and Guaranty Agreement dated January 15, 2019, as amended on
February 13, 2019 and July 9, 2020 with Cortland Capital Market
Services, LLC as the administrative agent and collateral agent (the
"Administrative Agent") and the lenders party thereto. The Third
Amendment amended the Credit and Guaranty Agreement to, among other
things (i) provide the Company with an incremental secured term
loan in the aggregate principal amount of $7.5 million
("Incremental Secured Term Loan"); (ii) extend the maturity of the
Secured Term Loan from February 14, 2025 to February 14, 2026;
(iii) amend certain asset concentration limits and (iv) amend
certain financial covenants. Pursuant to the terms of the Amended
Credit and Guaranty Agreement, borrowings under the Secured Term
Loan bear interest at a fixed rate of 7.25% per annum, which is
subject to step up by 0.25% per annum for the first four months
after February 14, 2025, then by 0.375% per annum for the following
four months and then by 0.50% for the last four months until
maturity date. On May 5, 2021 the Third Amendment became effective.
On August 23, 2021, we drew $7.5 million in incremental secured
term loans as provided by the Third Amendment.
•On
May 5, 2021, LFT issued 2,400,000 shared of 7.875% Series A
Cumulative Redeemable Preferred Stock (the "Series A Preferred
Stock") and received net proceeds, after underwriting discounts and
commissions but before offering expenses payable by the Company, of
$58.1 million. The Series A Preferred Stock is redeemable, at LFT's
option, at a liquidation preference price of $25.00 per share plus
accrued dividends commencing in May 2026. Dividends on the Series A
Preferred Stock are payable quarterly in arrears.
•On
June 14, 2021, the Company closed LFT CRE 2021-FL1, a
collateralized loan obligation, totaling $1.0 billion of real
estate related assets and cash, of which $833.75 million of
investment-grade notes were issued to third party investors and $70
million of below investment-grade notes and $96.25 million equity
interest in the portfolio were retained by us.
•In
relation to the closing of LFT CRE 2021-FL1, on June 14, 2021, the
Company unwound Hunt CRE 2017-FL1 and Hunt CRE 2018-FL2, redeeming
$388.2 million of outstanding notes which were repaid primarily
from refinancing the assets within Hunt CRE 2017-FL1 and Hunt CRE
2018-FL2.
The ORIX Transaction
On January 6, 2020, we announced the entry into a new external
management agreement with Lument IM and the concurrent mutual
termination of our management agreement with HIM. Lument IM is part
of Lument, a nationally recognized leader in multifamily and
seniors housing and healthcare finance. The terms of the new
management agreement align with the terms of our prior management
agreement with HIM in all material respects, including a cap on
reimbursable expenses. Pursuant to the terms of the termination
agreement between the Company and HIM, the termination of the
management agreement did not trigger, and HIM was not paid, a
termination fee by the Company.
Factors Impacting Our Operating Results
Market conditions. The
results of our operations are and will continue to be affected by a
number of factors and primarily depend on, among other things, the
level of our net interest income, the market value of our assets
and the supply of, and demand for, our target assets in the
marketplace. Our net interest income, will vary primarily as a
result of changes in market interest rates and prepayment speeds,
and by the ability of the borrowers underlying our commercial
mortgage loans to continue making payments in accordance with the
contractual terms of their loans, which may be impacted by
unanticipated credit events experienced by such borrowers, such as
the ongoing COVID-19 pandemic. Interest rates vary according to the
type of investment, conditions in the financial markets,
competition and other factors, none of which can be predicted with
any certainty, and have most recently been impacted by the ongoing
COVID-19 pandemic. Our operating results will also be affected by
general U.S. real estate fundamentals and the overall U.S. economic
environment, including the pace and degree of recovery from the
ongoing COVID-19 pandemic. In particular, our strategy is
influenced by the specific characteristics of the underlying real
estate markets, including prepayment rates, credit market
conditions and interest rate levels.
Changes in market interest rates. Generally,
our business model is such that rising interest rates will
generally increase our net interest income, while declining
interest rates will decrease our net interest income. Substantially
all of our investments and all of our collateralized loan
obligations are indexed to 30-day LIBOR, and as a result we are
less sensitive to variability in our net interest income resulting
from interest rate changes. Our net interest income currently
benefits from in-the-money LIBOR floors in our commercial loan
portfolio, with a weighted average LIBOR floor of 0.49% as of
December 31, 2021. As of December 31, 2021, 99.0% of the loans in
our commercial loan portfolio benefitted from LIBOR floors, 66.2%
of which had a LIBOR floor greater than the current spot LIBOR
rate. When interest rates are below our average LIBOR floor, an
increase in interest rates will decrease our net interest until
such time as interest rates rise above our average LIBOR floor.
While we expect low LIBOR rates to persist as the economy continues
to recover from the current COVID-19 pandemic, no assurance can be
made that our current portfolio profile will be maintained.
Additionally, there can be no assurance that will continue to
obtain LIBOR floors as current market conditions reflect
transactions with lower or no floors. Similarly, net interest
income is also impacted by the spread in our commercial loan
portfolio. As of December 31, 2021, the weighted average spread of
our commercial loan portfolio was 3.41%, but there is no assurance
that these spreads will be maintained as market environments
fluctuate. Current market conditions have reflected a tightening
trend in commercial mortgage loan credit spreads. A decrease to the
weighted average LIBOR floor and/or spread would result in a
decrease to net interest income. Additionally, a simultaneous
decrease in both weighted average LIBOR floor and portfolio spread
would exacerbate the impact to net interest income.
In addition to the risk related to fluctuations in cash flows
associated with movement in interest rates, there is also the risk
of non-performance on floating rate assets. In the case of
significant increase in interest rates, the additional debt service
payments due from our borrowers may strain the operating cash flows
of the real estate assets underlying our mortgages and/or impact
their ability to be refinanced at such higher interest rates,
potentially, contribute to non-performance or, in severe cases,
default.
On November 30, 2020, the ICE Benchmark Administration ("IBA"),
with the support of the United States Federal Reserve and United
Kingdom's Financial Conduct Authority ("FCA"), announced plans to
consult on ceasing publication of LIBOR on December 31, 2021 for
only one week and two month LIBOR tenors, and on June 30, 2023 for
all other LIBOR tenors. While this announcement extends the
transition period to June 2023, the United States
Federal Reserve concurrently issued a statements advising banks to
stop new LIBOR issuance by the end of 2021. On March 5, 2021, the
FCA confirmed that all LIBOR settings will either cease to be
provided by any administrator or no longer be representative" (a)
immediately after December 31, 2021, in the case of the one week
and two month U.S, dollar settings; and (b) immediately after June
30, 2023, in the case of the remaining U.S. dollar settings. The
ARRC, a committee convened by the Federal Reserve that includes
major market participants, has proposed an alternative rate to
replace U.S. Dollar LIBOR: the Secured Overnight Financing Rate
("SOFR"). On July 29, 2021 the RRC ratified term rates for the
one-, three- and six-month tenors based on SOFR futures traded.
This announcement is expected to expedite the transition from LIBOR
to SOFR. The outcome of these reforms is uncertain and any changes
on the methods by which LIBOR is determined or regulatory activity
related to LIBOR's phase-out could cause LIBOR to preform
differently than in the past.
As of December 31, 2021, 100% of our commercial loans by principal
balance and 100% of our collateralized loan obligations bear
interest related to one-month U.S. LIBOR. All of these arrangements
provide procedures for determining an alternative base rate in the
event that LIBOR is discontinued. Regardless, there can be no
assurances as to what alternative base rates may be and whether
such base rate will be more or less favorable than LIBOR and any
other unforeseen impacts of the discontinuation of LIBOR. We are
monitoring the developments with respect to the phasing out of
LIBOR and are working with our lenders and borrowers to minimize
the impact of any LIBOR transitions on our financial condition and
results of operations, but can provide no assurances regarding the
impact of the discontinuation of LIBOR.
Credit risk. Our
commercial mortgage loans and other investments are also subject to
credit risk. The performance and value of our loans and other
investments depend upon the sponsor's ability to operate properties
that serve as our collateral so that they produce cash flows
adequate to pay interest and principal due to us. To monitor this
risk, the Manager's asset management team reviews our portfolio and
maintains regular contact with borrowers, co-lenders and local
market experts to monitor the performance of the underlying
collateral, anticipate borrower, property and market issues and, to
the extent necessary or appropriate, enforce our rights as lender.
The market values of commercial mortgage assets are subject to
volatility and may be adversely affected by a number of factors,
including, but not limited to, national, regional and local
economic conditions (which may be adversely affected by industry
slowdowns and other factors); local real estate conditions; changes
or continued weakness in specific industry segments; construction
quality, age and design; demographic factors; and retroactive
changes to building or similar codes. In addition, decreases in
property values reduce the value of the collateral and potential
proceeds available to a borrower to repay the underlying loans,
which could also cause us to suffer losses. As of December 31,
2021, 100% of the commercial mortgage loans in our portfolio were
current as to principal and interest. Additionally, we have
reviewed the loans designated as High Risk for impairment.
Impairment of these loans, which are collateral dependent, is
measured by comparing the estimated fair value of the underlying
collateral, less costs to sell, to the book value of the respective
loan. As of December 31, 2021, the Company has not recognized any
impairments on its loan portfolio. However, due to the continued
widespread impact of the COVID-19 pandemic we consider there to be
heightened credit risk associated with our commercial mortgage loan
portfolio. Uncertainty about the severity and duration of the
economic impact of the COVID-19 pandemic, as exacerbated by events
related to virus strains, persist and potential exists for the
credit risk of our portfolio to heighten further. We can provide no
assurances that our borrowers will remain current as to principal
and interest, or that we will not enter into forbearance agreements
or loan modifications in order to protect the value of our
commercial mortgage loan assets. Should that occur, it could have a
material negative impact on our results of operations.
Liquidity and financing markets.
Liquidity is a measurement of our ability to meet potential cash
requirements, including ongoing commitments to pay dividends, fund
investments and repay borrowings and other general business needs.
Our primary sources of liquidity have been proceeds of common or
preferred stock issuance, net proceeds from corporate debt
obligations, net cash provided by operating activities and other
financing arrangements. We finance our commercial mortgage loans
primarily with collateralized loan obligations, the maturities of
which are matched to the maturities of the loans, and which are not
subject to margin calls or additional collateralization
requirements. However, to the extent that we seek to invest in
additional commercial mortgage loans, outside of our CLO, we will
in part be dependent on our ability to issue additional
collateralized loan obligations, to secure alternative financing
facilities or to raise additional common or preferred
equity.
Prepayment speeds. Prepayment
risk is the risk that principal will be repaid at a different rate
than anticipated, causing the return on certain investments to be
less than expected. As we receive prepayments of principal on our
assets, any premiums paid on such assets are amortized against
interest income. In general, an increase in prepayment rates
accelerates the amortization of purchase premiums, thereby reducing
the interest income earned on the assets. Conversely, discounts on
such assets are accreted into interest income. In general, an
increase in prepayment rates accelerates the accretion of purchase
discounts, thereby increasing the interest earned on the assets.
With the exception of nine loans acquired with an initial aggregate
unpaid principal balance of $117.0 million with an aggregate
purchase premium of $538,146 and aggregate purchase discount of
$171,186, all of our commercial mortgage loans were acquired at
par. As of December 31, 2021, our aggregate unamortized purchase
premium was $80,397 and our aggregate unamortized purchase discount
was $125,098, and accordingly we do not believe this to be a
material risk for us at present. Additionally, we are subject to
prepayment risk associated with the terms of our collateralized
loan obligations. Due to the generally short-term nature of
transitional floating-rate commercial mortgage loans, our CLOs
include a reinvestment period during which principal repayments and
prepayments on our commercial mortgage loans may be reinvested in
similar assets, subject to meeting certain eligibility criteria.
The reinvestment period for LFT 2021-FL1 remains in place through
December 2023. While the interest rate spreads of our
collateralized loan obligations are fixed until they are repaid,
the terms, including spreads, of newly originated loans are subject
to uncertainty based on a variety of factors, including market and
competitive conditions, which remain uncertain and volatile in
light of the COVID-19 pandemic. To the extent that such conditions
result in lower spreads on the assets in which we reinvest, we may
be subject to a reduction in interest income in the future.
However, our loan agreements provide for prepayment penalties which
are intended to offset any potential reduction in future interest
income.
Changes in market value of our assets. We
account for our commercial mortgage loans at amortized cost. As
such, our earnings will generally not be directly impacted by
changes in the market values of these loans. However, if a loan is
considered to be impaired as the result of adverse credit
performance, an allowance is recorded to reduce the carrying value
through a charge to the provision for loan losses. Impairment is
measured by comparing the estimated fair value of the underlying
collateral, less costs to sell, to the book value of the respective
loan. Provisions for loan losses will directly impact our earnings.
Given the widespread impact of COVID-19 pandemic, we consider there
to be a heightened credit risk associated with our commercial
mortgage loan portfolio.
Governmental actions.
Since 2008, when both Fannie Mae and Freddie Mac were placed under
the conservatorship of the U.S. government, there have been a
number of proposals to reform the U.S. housing finance system in
general, and Fannie Mae and Freddie Mac in particular. We
anticipate debate on residential housing and mortgage reform to
continue through 2022 and beyond, but a deep divide persists
between factions in Congress and as such it remains unclear what
shape any reform would take and what impact, if any, reform would
have on mortgage REITs.
Managing Our Business Through COVID-19
As of March 13, 2020, our Manager and its affiliates, implemented a
work from home, or WFH, policy for employees in all locations. As
of October 1, 2021, our Manager has begun reopening offices on a
limited basis with certain staff returning to the office on a
staggered partial schedule. Our Manager's highly experienced senior
team and dedicated employees are fully operational during this
ongoing disruption and are continuing to execute on all
investment
management, asset management, servicing, portfolio monitoring,
financial reporting and related control activities. Our Manager's
and affiliates employees are in constant communication to ensure
timely coordination and early identification of issues. We continue
to engage in ongoing active dialogue with the borrowers in our
commercial mortgage loan portfolio to understand what is taking
place at the properties collateralizing our
investments.
Considering the current economic environment caused by COVID-19 we
are mindful of constraints on landlord enforcement rights and
continue to monitor the impact of fiscal stimulus on our loan
portfolio. From September 4, 2020 through August 26, 2021, when the
Centers for Disease Control ("CDC") Agency Order was overturned by
the U.S. Supreme Court, residential landlords and those with
similar eviction rights could not evict "covered persons" for
nonpayment of rent in any U.S. state or territory. Covered persons
(a) use best efforts to obtain government assistance; (b) make less
than $99,000 or $198,000 jointly; (c) have suffered loss of income
or extraordinary medical expenses; (d) use the best efforts to make
partial payments; and (e) have no other housing options. In the
last month before the Supreme Court lifted the order, the
moratorium added to the definition of "covered persons" to include
(f) the individual resides in a U.S. county experiencing
substantial or high rates of community transmission levels of
SARS-COV-2 as defined by the CDC. As a result of the national
restriction, multifamily apartment borrowers had less ability to
address nonpayment of tenants, which in turn may have negatively
impacted a property's cash flow coverage of the debt service of
their loans. Additionally, due to COVID-19, there have been
potential challenges facing third-party providers, such as
appraisers, environmental and engineering consultants we rely on to
make new investments which may make it more difficult to make these
investments. Currently, despite the Supreme Court having lifted the
CDC order, individual states and localities continue to maintain
limited evictions restrictions. New York, Washington D.C.,
Massachusetts, Minnesota, Oregon and Nevada all have some form of
limited or prohibited residential evictions while the tenant
applies for rental assistance. California has local eviction
moratoriums that may extend beyond that in difference
municipalities, but not statewide.
Key Financial Measure and Indicators
As a real estate investment trust, we believe the key financial
measures and indicators for our business are earnings per share,
dividends declared, Distributable Earnings, and book value per
share of common stock. For the three months ended December 31,
2021, we recorded earnings per share of $0.09, declared a quarterly
common dividend of $0.09 per share, and reported $0.11 per share of
Distributable Earnings. In addition, our book value per share was
$4.38 per share. For the year ended December 31, 2021, we recorded
earnings per share of $0.30, declared aggregate common dividends of
$0.36 per share, and reported $0.39 per share of Distributable
Earnings.
As further described below, Distributable Earnings is a measure
that is not prepared in accordance with accounting principles
generally accepted in the United States of America, or GAAP, which
helps us to evaluate our performance excluding the effects of
certain transactions and GAAP adjustments that we believe are not
necessarily indicative of our current loan portfolio and
operations. In addition, Distributable Earnings is a performance
metric we consider when declaring our dividends.
Earnings Per Share and Dividends Declared
The following table sets forth the calculation of basic and diluted
net income per share and dividends declared per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
December 31, |
|
Year Ended
December 31, |
|
|
2021 |
|
2021 |
|
2020 |
|
Net income(1)
|
|
$ |
2,478,911 |
|
|
$ |
7,414,722 |
|
|
$ |
8,434,770 |
|
|
Weighted-average shares outstanding, basic and diluted |
|
24,947,883 |
|
|
24,945,824 |
|
|
24,934,505 |
|
|
Net income per share, basic and diluted |
|
$ |
0.10 |
|
|
$ |
0.30 |
|
|
$ |
0.34 |
|
|
Dividends declared per share |
|
$ |
0.09 |
|
|
$ |
0.36 |
|
|
$ |
0.37 |
|
(1) Represents net income attributable to
Lument Finance Trust, Inc.
Distributable Earnings
Distributable Earnings is a non-GAAP financial measure, which we
define as GAAP net income (loss) attributable to holders of common
stock, or, without duplication, owners of our subsidiaries,
computed in accordance with GAAP, including realized losses not
otherwise included in GAAP net income (loss) and excluding (i)
non-cash equity compensation, (ii) depreciation and amortization,
(iii) any unrealized gains or losses or other similar non-cash
items that are included in net income for that applicable reporting
period, regardless of whether such items are included in other
comprehensive income (loss) or net income (loss), and (iv) one-time
events pursuant to changes in GAAP and certain material non-cash
income or expense items after discussions with the Company's board
of directors and approved by a majority of the Company's
independent directors.
While Distributable Earnings excludes the impact of any unrealized
provisions for credit losses, any loan losses are charged off and
realized through Distributable Earnings when deemed
non-recoverable. Non-recoverability is determined (i) upon the
resolution of a loan (i.e. when the loan is repaid, fully or
partially, or in the case of foreclosures, when the underlying
asset is sold), or (ii) with respect to any amount due under any
loan, when such amount is determined to be
non-collectible.
We believe that Distributable Earnings provides meaningful
information to consider in addition to our net income (loss) and
cash flows from operating activities determined in accordance with
GAAP. We believe Distributable Earnings is a useful financial
metric for existing and potential future holders of our common
stock as historically, over time, Distributable Earnings has been a
strong indicator of our dividends per share. As a REIT, we
generally must distribute annually at least 90% of our taxable
income, subject to certain adjustments, and therefore we believe
our dividends are one of the principal reasons stockholders may
invest in our common stock. Refer to Note 16 to our consolidated
financial statements for further discussion of our distribution
requirements as a REIT. Furthermore, Distributable Earnings help us
to evaluate our performance excluding the effects of certain
transactions and GAAP adjustments that we believe are not
necessarily indicative of our current loan portfolio and
operations, and is a performance metric we consider when declaring
our dividends.
Distributable Earnings does not represent net income (loss) or cash
generated from operating activities and should not be considered as
an alternative to GAAP net income (loss), or an indication of GAAP
cash flows from operations, a measure of our liquidity, or an
indication of funds available for our cash needs. In addition, our
methodology for calculating Distributable Earnings may differ from
the methodologies employed by other companies to calculate
the
same or similar performance measures, and accordingly, our reported
Distributable Earnings may not be comparable to the Distributable
Earnings reported by other companies.
The following table provides a reconciliation of Distributable
Earnings to GAAP net income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
December 31, |
|
Year Ended
December 31, |
|
|
2021 |
|
2021 |
|
2020 |
|
Net income(1)
|
|
$ |
2,478,911 |
|
|
$ |
7,414,722 |
|
|
$ |
8,434,770 |
|
|
Unrealized gain (loss) on mortgage servicing rights |
|
56,106 |
|
|
356,772 |
|
|
1,780,528 |
|
|
Purchase premium payoffs |
|
— |
|
|
150,990 |
|
|
— |
|
|
Loss on extinguishment of debt |
|
— |
|
|
1,663,926 |
|
|
— |
|
|
Recognized compensation expense related to restricted common
stock |
|
4,741 |
|
|
15,608 |
|
|
20,292 |
|
|
Adjustment for (provision for) income taxes |
|
109,336 |
|
|
77,894 |
|
|
(476,248) |
|
|
Distributable Earnings |
|
$ |
2,649,094 |
|
|
$ |
9,679,912 |
|
|
$ |
9,759,342 |
|
|
Weighted-average shares outstanding, basic and diluted |
|
24,947,883 |
|
|
24,945,824 |
|
|
24,934,505 |
|
|
Distributable Earnings per share, basic and diluted |
|
$ |
0.11 |
|
|
$ |
0.39 |
|
|
$ |
0.39 |
|
(1) Represents net income attributable to
common stockholders of Lument Finance Trust, Inc.
Book Value Per Share
The following table calculates our book value per
share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2021 |
|
December 31, 2020 |
|
Total stockholders' equity |
|
$ |
169,276,000 |
|
|
$ |
113,703,152 |
|
|
Less preferred stock (liquidation preference of $25.00 per
share) |
|
(60,000,000) |
|
|
— |
|
|
Total common stockholders' equity |
|
109,276,000 |
|
|
113,703,152 |
|
|
Common stock outstanding |
|
24,947,883 |
|
|
24,943,383 |
|
|
Book value per share |
|
$ |
4.38 |
|
|
$ |
4.56 |
|
As of December 31, 2021, our common stockholders' equity was
$109.3 million, and our book value per common share was $4.38 on a
basic and fully diluted basis. Our equity decreased by $4.4 million
compared to our stockholders’ equity as of December 31, 2020
primarily as a result of the $1.7 million loss on extinguishment of
debt and $2.7 million of preferred offering costs related to the
issuance of the Series A Preferred Stock.
Investment Portfolio
Commercial Mortgage Loans
As of December 31, 2021, we have determined that we are the
primary beneficiary of LFT CRE 2021-FL1, Ltd. based on our
obligation to absorb losses derived from ownership of our residual
interests. Accordingly, the Company consolidated the assets,
liabilities, income and expenses of the underlying issuing
entities, collateralized loan obligations.
The following table details our loan activity by unpaid principal
balance:
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, 2021 |
|
Balance at December 31, 2020 |
|
$ |
547,345,334 |
|
|
Purchases and advances |
|
983,694,326 |
|
|
Proceeds from principal repayments |
|
(528,802,705) |
|
|
Accretion of purchase discount |
|
$ |
46,088 |
|
|
Amortization of purchase discount |
|
$ |
(457,749) |
|
|
Balance at December 31, 2021 |
|
$ |
1,001,825,294 |
|
The following table details overall statistics for our loan
portfolio as of December 31, 2021 and December 31,
2020:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted Average |
|
Loan Type |
|
Unpaid Principal Balance |
|
Carrying Value |
|
Loan Count |
|
Floating Rate Loan % |
|
Coupon(1)
|
|
Term (Years)(2)
|
|
LTV(3)
|
|
December 31, 2021 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans held-for-investment |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Senior secured loans(4)
|
|
$ |
1,001,869,994 |
|
|
$ |
1,001,825,294 |
|
|
66 |
|
|
100.0 |
% |
|
3.9 |
% |
|
3.7 |
|
71.2 |
% |
|
|
|
$ |
1,001,869,994 |
|
|
$ |
1,001,825,294 |
|
|
66 |
|
|
100.0 |
% |
|
3.9 |
% |
|
3.7 |
|
71.2 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted Average |
|
Loan Type |
|
Unpaid Principal Balance |
|
Carrying Value |
|
Loan Count |
|
Floating Rate Loan % |
|
Coupon(1)
|
|
Term (Years)(2)
|
|
LTV(3)
|
|
December 31, 2020 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans held-for-investment |
|
$ |
547,345,334 |
|
|
$ |
547,345,334 |
|
|
40 |
|
|
100.0 |
% |
|
5.1 |
% |
|
3.1 |
|
73.6 |
% |
|
Senior secured loans(3) |
|
$ |
547,345,334 |
|
|
$ |
547,345,334 |
|
|
40 |
|
|
100.0 |
% |
|
5.1 |
% |
|
3.1 |
|
73.6 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) Weighted average coupon assumes
applicable one-month LIBOR of 0.10% and 0.14% as of
December 31, 2021 and December 31, 2020, respectively,
and weighted average LIBOR floors of 0.49% and 1.64%,
respectively.
(2) Weighted average term assumes all
extension options are exercised by the borrower; provided, however,
that our loans may be repaid prior to such date.
(3) LTV as of the date the loan was
originated and is calculated after giving effect to capex and
earnout reserves, if applicable. LTV has not been updated for any
subsequent draws or loan modifications and is not reflective of any
changes in value which may have occurred subsequent to origination
date.
(4) As of December 31, 2021,
$974,025,294 of the outstanding senior secured loans were held in
VIEs and $27,800,000 of the outstanding senior secured loans were
held outside VIEs. As of December 31, 2020, $531,363,401 of
the outstanding senior secured loans were held in VIEs and
$15,981,933 of the outstanding senior secured loans were held
outside VIEs.
The table below sets forth additional information relating to the
Company's portfolio as of December 31, 2021:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loan # |
|
Form of Investment |
|
Origination Date |
|
Total Loan Commitment(1)
|
|
Current Principal Amount |
|
Location |
|
Property Type |
|
Coupon |
|
Max Remaining Term (Years) |
|
LTV(2)
|
|
1 |
|
|
Senior secured |
|
November 22, 2019 |
|
39,500,000 |
|
|
36,781,588 |
|
|
Virginia Beach, VA |
|
Multi-Family |
|
1mL + 2.8 |
|
3.0 |
|
77.1 |
% |
|
2 |
|
|
Senior secured |
|
June 28, 2021 |
|
39,263,000 |
|
|
34,690,000 |
|
|
Barrington, NJ |
|
Multi-Family |
|
1mL + 3.1 |
|
4.6 |
|
78.1 |
% |
|
3 |
|
|
Senior secured |
|
November 2, 2021 |
|
33,500,000 |
|
|
33,500,000 |
|
|
Warner Robbins, GA |
|
Multi-Family |
|
1mL + 3.0 |
|
2.9 |
|
51.4 |
% |
|
4 |
|
|
Senior secured |
|
June 8, 2021 |
|
35,877,500 |
|
|
33,360,000 |
|
|
Chattanooga, TN |
|
Multi-Family |
|
1mL + 3.7 |
|
4.6 |
|
79.8 |
% |
|
5 |
|
|
Senior secured |
|
June 8, 2021 |
|
32,500,000 |
|
|
30,576,666 |
|
|
Miami, FL |
|
Multi-Family |
|
1mL + 3.2 |
|
4.6 |
|
74.3 |
% |
|
6 |
|
|
Senior secured |
|
June 30, 2021 |
|
32,250,000 |
|
|
28,650,000 |
|
|
Porter, TX |
|
Multi-Family |
|
1mL + 3.3 |
|
4.6 |
|
71.6 |
% |
|
7 |
|
|
Senior secured |
|
February 25, 2021 |
|
28,000,000 |
|
|
28,000,000 |
|
|
Sacramento, CA |
|
Multi-Family |
|
1mL + 3.5 |
|
0.3 |
|
63.6 |
% |
|
8 |
|
|
Senior secured |
|
May 20, 2021 |
|
33,000,000 |
|
|
27,803,800 |
|
|
Marietta, GA |
|
Multi-Family |
|
1mL + 3.1 |
|
4.5 |
|
77.0 |
% |
|
9 |
|
|
Senior secured |
|
April 22, 2021 |
|
27,750,000 |
|
|
27,750,000 |
|
|
Los Angeles, CA |
|
Multi-Family |
|
1mL + 3.3 |
|
0.9 |
|
55.0 |
% |
|
10 |
|
|
Senior secured |
|
December 10, 2019 |
|
37,046,136 |
|
|
27,411,724 |
|
|
San Antonio, TX |
|
Multi-Family |
|
1mL + 3.2 |
|
3.1 |
|
71.9 |
% |
|
11 |
|
|
Senior secured |
|
June 7, 2021 |
|
29,400,000 |
|
|
26,400,000 |
|
|
San Antonio, TX |
|
Multi-Family |
|
1mL + 3.4 |
|
4.6 |
|
80.0 |
% |
|
12 |
|
|
Senior secured |
|
December 16, 2021 |
|
25,000,000 |
|
|
25,000,000 |
|
|
Daytona, FL |
|
Multi-Family |
|
1mL + 3.1 |
|
5.1 |
|
71.7 |
% |
|
13 |
|
|
Senior secured |
|
August 26, 2021 |
|
27,268,000 |
|
|
24,832,000 |
|
|
Clarkston, GA |
|
Multi-Family |
|
1mL + 3.5 |
|
4.7 |
|
79.0 |
% |
|
14 |
|
|
Senior secured |
|
November 15, 2021 |
|
26,003,000 |
|
|
24,330,000 |
|
|
El Paso, TX |
|
Multi-Family |
|
1mL + 3.1 |
|
5.0 |
|
76.0 |
% |
|
15 |
|
|
Senior secured |
|
October 18, 2021 |
|
28,250,000 |
|
|
23,348,000 |
|
|
Cherry Hill, NJ |
|
Multi-Family |
|
1mL + 3.0 |
|
4.9 |
|
72.4 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
16 |
|
|
Senior secured |
|
August 26, 2021 |
|
23,370,000 |
|
|
21,957,240 |
|
|
Union City, GA |
|
Multi-Family |
|
1mL + 3.4 |
|
4.8 |
|
70.4 |
% |
|
17 |
|
|
Senior secured |
|
November 16, 2021 |
|
21,975,000 |
|
|
20,960,000 |
|
|
Dallas, TX |
|
Multi-Family |
|
1mL + 3.2 |
|
5.0 |
|
73.5 |
% |
|
18 |
|
|
Senior secured |
|
August 31, 2021 |
|
21,750,000 |
|
|
20,700,000 |
|
|
Houston, TX |
|
Multi-Family |
|
1mL + 3.3 |
|
4.8 |
|
74.2 |
% |
|
19 |
|
|
Senior secured |
|
October 29, 2021 |
|
20,500,000 |
|
|
20,500,000 |
|
|
Knoxville, TN |
|
Multi-Family |
|
1mL + 3.8 |
|
4.9 |
|
70.0 |
% |
|
20 |
|
|
Senior secured |
|
June 30, 2021 |
|
21,968,000 |
|
|
20,188,700 |
|
|
Jacksonville, FL |
|
Multi-Family |
|
1mL + 3.5 |
|
4.6 |
|
77.1 |
% |
|
21 |
|
|
Senior secured |
|
October 13, 2017 |
|
20,000,000 |
|
|
19,648,818 |
|
|
Seattle, WA |
|
Self Storage |
|
1mL + 3.6 |
|
2.9 |
|
46.5 |
% |
|
22 |
|
|
Senior secured |
|
November 5, 2021 |
|
20,965,000 |
|
|
19,200,000 |
|
|
Orlando, FL |
|
Multi-Family |
|
1mL + 3.0 |
|
4.9 |
|
78.1 |
% |
|
23 |
|
|
Senior secured |
|
October 12, 2021 |
|
17,500,000 |
|
|
17,500,000 |
|
|
Atlanta, GA |
|
Multi-Family |
|
1mL + 3.2 |
|
2.8 |
|
42.9 |
% |
|
24 |
|
|
Senior secured |
|
December 28, 2018 |
|
24,123,000 |
|
|
17,172,623 |
|
|
Austin, TX |
|
Retail |
|
1mL + 4.1 |
|
1.1 |
|
60.5 |
% |
|
25 |
|
|
Senior secured |
|
July 8, 2021 |
|
17,000,000 |
|
|
17,000,000 |
|
|
Knoxville, TN |
|
Multi-Family |
|
1mL + 4.0 |
|
2.7 |
|
69.7 |
% |
|
26 |
|
|
Senior secured |
|
September 30, 2021 |
|
17,583,000 |
|
|
16,663,000 |
|
|
Hanahan, SC |
|
Multi-Family |
|
1mL + 3.2 |
|
4.8 |
|
76.4 |
% |
|
27 |
|
|
Senior secured |
|
April 12, 2021 |
|
17,000,000 |
|
|
15,000,000 |
|
|
Cedar Park, TX |
|
Multi-Family |
|
1mL + 3.8 |
|
4.4 |
|
66.7 |
% |
|
28 |
|
|
Senior secured |
|
October 11, 2019 |
|
17,000,000 |
|
|
14,500,000 |
|
|
Pompano Beach, FL |
|
Self Storage |
|
1mL + 3.8 |
|
2.8 |
|
75.0 |
% |
|
29 |
|
|
Senior secured |
|
February 28, 2018 |
|
14,550,000 |
|
|
14,230,100 |
|
|
Portland, OR |
|
Multi-Family |
|
1mL + 7.5 |
|
1.2 |
|
75.9 |
% |
|
30 |
|
|
Senior secured |
|
November 3, 2021 |
|
13,870,000 |
|
|
13,720,000 |
|
|
Louisville, KY |
|
Multi-Family |
|
1mL + 3.4 |
|
4.9 |
|
75.4 |
% |
|
31 |
|
|
Senior secured |
|
October 14, 2021 |
|
13,440,000 |
|
|
13,440,000 |
|
|
Bridgeton, NJ |
|
Multi-Family |
|
1mL + 3.3 |
|
1.4 |
|
70.0 |
% |
|
32 |
|
|
Senior secured |
|
May 28, 2021 |
|
13,675,000 |
|
|
13,332,734 |
|
|
Houston, TX |
|
Multi-Family |
|
1mL + 3.4 |
|
2.5 |
|
73.8 |
% |
|
33 |
|
|
Senior secured |
|
May 12, 2021 |
|
13,930,000 |
|
|
13,026,000 |
|
|
Fort Worth, TX |
|
Multi-Family |
|
1mL + 3.4 |
|
4.5 |
|
74.9 |
% |
|
34 |
|
|
Senior secured |
|
August 16, 2021 |
|
15,886,000 |
|
|
12,750,000 |
|
|
Columbus, OH |
|
Multi-Family |
|
1mL + 3.7 |
|
4.8 |
|
75.0 |
% |
|
35 |
|
|
Senior secured |
|
March 12, 2021 |
|
13,703,000 |
|
|
12,375,000 |
|
|
Mesa, AZ |
|
Multi-Family |
|
1mL + 3.6 |
|
4.3 |
|
75.0 |
% |
|
36 |
|
|
Senior secured |
|
October 1, 2021 |
|
13,775,000 |
|
|
12,100,000 |
|
|
East Nashville, TN |
|
Multi-Family |
|
1mL + 3.4 |
|
4.8 |
|
79.1 |
% |
|
37 |
|
|
Senior secured |
|
July 23, 2018 |
|
16,200,000 |
|
|
11,748,199 |
|
|
Chicago, IL |
|
Office |
|
1mL + 3.8 |
|
1.7 |
|
72.7 |
% |
|
38 |
|
|
Senior secured |
|
October 28, 2021 |
|
12,250,000 |
|
|
11,202,535 |
|
|
Tampa, FL |
|
Multi-Family |
|
1mL + 3.0 |
|
4.9 |
|
75.7 |
% |
|
39 |
|
|
Senior secured |
|
September 30, 2021 |
|
11,300,000 |
|
|
10,795,000 |
|
|
Clearfield, UT |
|
Multi-Family |
|
1mL + 3.2 |
|
4.8 |
|
68.0 |
% |
|
40 |
|
|
Senior secured |
|
February 8, 2019 |
|
12,625,000 |
|
|
10,676,822 |
|
|
Federal Way, WA |
|
Self Storage |
|
1mL + 4.8 |
|
2.2 |
|
65.8 |
% |
|
41 |
|
|
Senior secured |
|
April 23, 2021 |
|
11,600,000 |
|
|
10,497,000 |
|
|
Tualatin, OR |
|
Multi-Family |
|
1mL + 3.2 |
|
4.4 |
|
73.9 |
% |
|
42 |
|
|
Senior secured |
|
March 26, 2021 |
|
9,623,000 |
|
|
9,623,000 |
|
|
Alhambra, CA |
|
Multi-Family |
|
1mL + 3.3 |
|
0.8 |
|
49.0 |
% |
|
43 |
|
|
Senior secured |
|
October 21, 2021 |
|
11,500,000 |
|
|
9,100,000 |
|
|
Madison, TN |
|
Multi-Family |
|
1mL + 3.2 |
|
4.9 |
|
68.4 |
% |
|
44 |
|
|
Senior secured |
|
November 13, 2019 |
|
9,310,000 |
|
|
8,620,367 |
|
|
Holly Hill, FL |
|
Multi-Family |
|
1mL + 2.9 |
|
1.0 |
|
77.8 |
% |
|
45 |
|
|
Senior secured |
|
May 12, 2021 |
|
8,950,000 |
|
|
8,220,000 |
|
|
Lakeland, FL |
|
Multi-Family |
|
1mL + 3.4 |
|
4.5 |
|
76.8 |
% |
|
46 |
|
|
Senior secured |
|
January 13, 2020 |
|
8,510,000 |
|
|
8,037,399 |
|
|
Fort Lauderdale, FL |
|
Multi-Family |
|
1mL + 3.2 |
|
3.2 |
|
78.4 |
% |
|
47 |
|
|
Senior secured |
|
April 7, 2021 |
|
10,152,000 |
|
|
7,963,794 |
|
|
Phoenix, AZ |
|
Multi-Family |
|
1mL + 3.6 |
|
4.4 |
|
69.5 |
% |
|
48 |
|
|
Senior secured |
|
October 29, 2021 |
|
9,000,000 |
|
|
7,934,000 |
|
|
Riverside, MO |
|
Multi-Family |
|
1mL + 3.4 |
|
4.9 |
|
76.6 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
49 |
|
|
Senior secured |
|
March 12, 2018 |
|
9,112,000 |
|
|
7,912,000 |
|
|
Waco, TX |
|
Multi-Family |
|
1mL + 4.8 |
|
1.3 |
|
72.9 |
% |
|
50 |
|
|
Senior secured |
|
November 16, 2021 |
|
7,680,000 |
|
|
7,680,000 |
|
|
Cape Coral, FL |
|
Multi-Family |
|
1mL + 3.3 |
|
3.0 |
|
79.2 |
% |
|
51 |
|
|
Senior secured |
|
October 27, 2021 |
|
9,300,000 |
|
|
7,624,400 |
|
|
Ambler, PA |
|
Multi-Family |
|
1mL + 3.3 |
|
4.9 |
|
79.9 |
% |
|
52 |
|
|
Senior secured |
|
March 19, 2021 |
|
8,348,000 |
|
|
7,513,000 |
|
|
Glendora, CA |
|
Multi-Family |
|
1mL + 3.6 |
|
4.3 |
|
72.2 |
% |
|
53 |
|
|
Senior secured |
|
September 28, 2021 |
|
8,125,000 |
|
|
7,286,000 |
|
|
Chicago, IL |
|
Multi-Family |
|
1mL + 3.7 |
|
4.8 |
|
75.9 |
% |
|
54 |
|
|
Senior secured |
|
February 3, 2020 |
|
7,250,000 |
|
|
6,959,953 |
|
|
Fort Worth, TX |
|
Self Storage |
|
1mL + 3.8 |
|
3.3 |
|
63.8 |
% |
|
55 |
|
|
Senior secured |
|
March 31, 2021 |
|
8,432,000 |
|
|
6,893,000 |
|
|
Tucson, AZ |
|
Multi-Family |
|
1mL + 3.6 |
|
4.3 |
|
72.8 |
% |
|
56 |
|
|
Senior secured |
|
July 1, 2021 |
|
7,285,000 |
|
|
6,290,000 |
|
|
Harker Heights, TX |
|
Multi-Family |
|
1mL + 3.6 |
|
4.6 |
|
72.3 |
% |
|
57 |
|
|
Senior secured |
|
August 28, 2019 |
|
6,250,000 |
|
|
6,054,427 |
|
|
Austin, TX |
|
Multi-Family |
|
1mL + 3.3 |
|
2.8 |
|
69.9 |
% |
|
58 |
|
|
Senior secured |
|
May 21, 2021 |
|
7,172,000 |
|
|
5,994,000 |
|
|
Youngtown, AZ |
|
Multi-Family |
|
1mL + 3.7 |
|
4.5 |
|
71.4 |
% |
|
59 |
|
|
Senior secured |
|
October 26, 2021 |
|
6,807,000 |
|
|
5,812,000 |
|
|
Indianapolis, IN |
|
Multi-Family |
|
1mL + 3.9 |
|
4.9 |
|
77.1 |
% |
|
60 |
|
|
Senior secured |
|
June 10, 2019 |
|
6,000,000 |
|
|
5,295,605 |
|
|
San Antonio, TX |
|
Multi-Family |
|
1mL + 2.9 |
|
2.6 |
|
62.9 |
% |
|
61 |
|
|
Senior secured |
|
April 30, 2021 |
|
5,472,000 |
|
|
5,285,500 |
|
|
Daytona Beach, FL |
|
Multi-Family |
|
1mL + 3.7 |
|
4.4 |
|
77.4 |
% |
|
62 |
|
|
Senior secured |
|
July 14, 2021 |
|
6,048,000 |
|
|
5,248,000 |
|
|
Birmingham, AL |
|
Multi-Family |
|
1mL + 3.7 |
|
4.7 |
|
71.7 |
% |
|
63 |
|
|
Senior secured |
|
November 19, 2021 |
|
6,453,000 |
|
|
5,040,000 |
|
|
Huntsville, AL |
|
Multi-Family |
|
1mL + 3.8 |
|
5.0 |
|
78.8 |
% |
|
64 |
|
|
Senior secured |
|
December 29, 2020 |
|
4,920,000 |
|
|
4,920,000 |
|
|
Fayetteville, NC |
|
Multi-Family |
|
1mL + 4.0 |
|
0.6 |
|
70.3 |
% |
|
65 |
|
|
Senior secured |
|
November 30, 2018 |
|
4,446,000 |
|
|
4,446,000 |
|
|
Anderson, SC |
|
Multi-Family |
|
1mL + 3.3 |
|
0.9 |
|
53.7 |
% |
|
66 |
|
|
Senior secured |
|
December 28, 2021 |
|
2,800,000 |
|
|
2,800,000 |
|
|
Houston, TX |
|
Multi-Family |
|
1mL + 3.2 |
|
5.1 |
|
71.2 |
% |
(1) See Note 11 Commitments and
Contingencies to our consolidated financial statements for further
discussion of unfunded commitments.
(2) LTV as of the date the loan was
originated by a Hunt/ORIX affiliate and is calculated after giving
effect to capex and earnout reserves, if applicable. LTV has not
been updated for any subsequent draws or loan modifications and is
not reflective of any changes in value which may have occurred
subsequent to origination date.
Our loan portfolio is 100% performing with no loan impairments,
loan defaults, or non-accrual loans as of December 31,
2021.
We maintain strong relationships with our borrowers and utilized
those relationships to address potential impacts of the COVID-19
pandemic on loans secured by properties experiencing cash flow
pressure. All of our loans are current with respect to principal
and interest, however, some of our borrowers have expressed concern
on delays in the implementation of business plans due to the
prolonged impact of the COVID-19 pandemic. Accordingly, we will
continue to engage in discussions with them to work towards the
maximization of cash flows and values of our commercial mortgage
loan assets should these difficulties arise.
We have not entered into any forbearance agreements or loan
modifications to date. However, due to the widespread economic
impact of the COVID-19 pandemic we consider there to be heightened
credit risk associated with our commercial mortgage loan portfolio.
As such, we can provide no assurances that our borrowers will
remain current as to principal and interest, or that we will not
enter into any forbearance agreements or loan modifications on
order to protect the value of our commercial mortgage loan
assets.
As discussed in Note 2 to our consolidated financial statements,
our Manager performs a quarterly review of our loan portfolio,
assesses the performance of each loan, and assigns a risk rating
between "1" and "5," from less risk to greater risk. The weighted
average risk rating of our total loan exposure was 2.3 and 3.1 as
of December 31, 2021 and December 31, 2020, respectively. The
decrease in risk ratings is primarily the result of commercial
mortgage loans that paid off with a risk rating of "2" of
$133.6 million, a risk rating of "3" of $276.1 million
and a risk rating of "4" of $17.8 million, offset by purchases
of commercial mortgage loans with a risk rating of "2" of
$599.0 million, a risk rating of "3" of $283.0 million
and a risk rating of '4" of $0.1 million during the year ended
December 31, 2021. The following table presents the principal
balance and net book value based on our internal risk
ratings:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2021 |
|
Risk Rating |
|
Number of Loans |
|
Unpaid Principal Balance |
|
Net Carrying Value |
|
1 |
|
— |
|
|
$ |
— |
|
|
— |
|
|
2 |
|
40 |
|
|
634,438,386 |
|
|
634,438,386 |
|
|
3 |
|
23 |
|
|
342,350,405 |
|
|
342,305,705 |
|
|
4 |
|
3 |
|
|
25,081,203 |
|
|
25,081,203 |
|
|
5 |
|
— |
|
|
— |
|
|
— |
|
|
|
|
66 |
|
|
1,001,869,994 |
|
|
1,001,825,294 |
|
Collateralized Loan Obligations
We may seek to enhance returns on our commercial mortgage loan
investments through securitizations, or CLOs, if available, as well
as the utilization of warehouse or repurchase agreement financing.
To the extent available, we intend to securitize the senior portion
of some of our loans, while retaining the subordinate securities in
our investment portfolio. The securitizations of this senior
portion will be accounted for as either a "sale" or as a
"financing." If they are accounted for as a sale, the loan will be
removed from the balance sheet and if they are accounted for as a
financing the loans will be classified as "commercial mortgage
loans held-for-investment" in our consolidated balance sheets,
depending on the structure of the securitization. As of
December 31, 2021, the carrying amounts and outstanding
principal balances of our collateralized loan obligations were
$826.8 million and $833.8 million, respectively. See Note 4 to our
consolidated financial statements included in this Annual Report on
Form 10-K for additional terms and details of our
CLOs.
FOAC and Changes to Our Residential Mortgage Loan
Business
In June 2013, we established FOAC as a Taxable REIT Subsidiary, or
TRS, to increase the range of our investments in mortgage-related
assets. Until August 1, 2016, FOAC aggregated mortgage loans
primarily for sale into securitization transactions, with the
expectation that we would purchase the subordinated tranches issued
by the related securitization trusts, and that these would
represent high quality credit investments for our portfolio.
Residential mortgage loans for which FOAC owns the MSRs continue to
be directly serviced by two licensed sub-servicers since FOAC does
not directly service any residential mortgage loans.
As noted above, we previously determined to cease the aggregation
of prime jumbo loans for the foreseeable future, and therefore no
longer maintain warehouse financing to acquire prime jumbo loans.
We do not expect the previous changes to our mortgage loan business
strategy to impact the existing MSRs that we own, nor the
securitizations we have sponsored to date.
Pursuant to a Master Agreement dated June 15, 2016, as amended on
August 29, 2016, January 30, 2017 and June 27, 2018, among MAXEX,
LLC ("MAXEX"), MAXEX Clearing LLC, MAXEX's wholly-owned
clearinghouse subsidiary and FOAC, FOAC provided seller eligibility
review services under which it reviewed, approved and monitored
sellers that sold loans via MAXEX Clearing LLC. To the extent that
a seller approved by FOAC fails to honor its obligations to
repurchase a loan based on an arbitration finding that it breached
its representations and warranties, FOAC was obligated to backstop
the seller's repurchase obligation. The term of such backstop
guarantee was the earlier of the contractual maturity of the
underlying mortgage and its repayment in full. However, the
incidence of claims for breaches of representations and warranties
over time is considered unlikely to occur more than five years from
the sale of a mortgage. FOAC's obligations to provide such seller
eligibility review and backstop guarantee services terminated on
November 28, 2018. Pursuant to an Assumption Agreement dated
December 31, 2018, among MAXEX Clearing LLC and FOAC, MAXEX
Clearing LLC assumed all of FOAC's obligations under its backstop
guarantees and agreed to indemnify and hold FOAC harmless against
any losses, liabilities, costs, expenses and obligations under the
backstop guarantee. FOAC paid MAXEX Clearing LLC, as the
replacement backstop provider, a fee of $426,770 (the "Alternative
Backstop Fee"). MAXEX Clearing LLC represented to FOAC in the
Assumption Agreement that it (i) is rated at least "A" (or
equivalent) by at least one nationally recognized statistical
rating agency or (ii) has (a) adjusted tangible net worth of at
least $20.0 million and (b) minimum available liquidity equal to
the greater of (x) $5.0 million and (y) 0.1% multiplied by the
scheduled unpaid principal balance of each outstanding loan covered
by the backstop guarantees. MAXEX's chief financial officer is
required to certify ongoing compliance by MAXEX Clearing LLC with
the aforementioned criteria on a quarterly basis and if MAXEX
Clearing LLC fails to satisfy such criteria, MAXEX Clearing LLC is
required to deposit into an escrow account for FOAC's benefit an
amount equal to the greater of (A) the unamortized Alternative
Backstop Fee for each outstanding loan covered by the backstop
guarantee and (B) the product of 0.01% multiplied by the scheduled
unpaid principal balance of each outstanding loan covered by the
backstop guarantees. See Notes 13 and 14 to our consolidated
financial statements included in this Annual Report for a further
description of MAXEX.
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance
with GAAP, which requires the use of estimates and assumptions that
involve the exercise of judgment and use of assumptions as to
future uncertainties. Accounting estimates and assumptions
discussed in this section are those that we consider to be the most
critical to understanding our financial statements because they
involve significant judgments and uncertainties that could affect
our reported assets and liabilities, as well as our reported
revenues and expenses. All of these estimates reflect our best
judgments about current, and for some estimates, future economic
and market conditions and their effects based on information
available as of the date of the financial statements. If conditions
change from those expected, it is possible that the judgments and
estimates described below could change, which may result in a
change in our interest income recognition, allowance for loan
losses, future impairment of our investments, and valuation of our
investment portfolio, among other effects. We believe that the
following accounting policies are among the most important to the
portrayal of our financial condition and results of operations and
require the most difficult, subjective or complex
judgments:
Commercial Mortgage Loans Held-for-Investment
Commercial mortgage loans held-for-investment represent
floating-rate transitional loans and other commercial mortgage
loans purchased by the Company. These loans include loans sold into
securitizations that the Company consolidates. Commercial mortgage
loans held-for-investment are intended to be held-to-maturity and,
accordingly, are carried at their unpaid principal balances,
adjusted for net unamortized loan fees and costs (in respect of
originated loans), premiums and discounts (in respect of purchased
loans) and impairment, if any.
Interest income is recognized as revenue using the effective
interest method and is recorded on the accrual basis according to
the terms of the underlying loan agreement. Any fees, costs,
premiums and discounts associated with these loan investments are
deferred and amortized over the term of the loan using
the
effective interest method, or on a straight line basis when it
approximates the effective interest method. Income accrual is
generally suspended and loans are placed on non-accrual status on
the earlier of the date at which payment has become 90 days past
due or when full and timely collection of interest and principal is
considered not probable. The Company may return a loan to accrual
status when repayment of principal and interest is reasonably
assured under the terms of the underlying loan agreement. As of
December 31, 2021, the Company did not hold any loans placed
in non-accrual status.
Quarterly, the Company assesses the risk factors of each loan
classified as held-for-investment and assigns a risk rating based
on a variety of factors, including, without limitation,
debt-service coverage ratio ("DSCR"), loan-to-value ratio ("LTV"),
property type, geographic and local market dynamics, physical
condition, leasing and tenant profile, adherence to business plan
and exit plan, maturity default risk and project sponsorship. The
Company's loans are rated on a 5-point scale, from least risk to
greatest risk, respectively, which ratings are described as
follows:
1.Very
Low Risk:
exceeds expectations and is outperforming underwriting or it is
very likely that the underlying loan can be refinanced easily in
the period's prevailing capital market conditions
2.Low
Risk:
meeting or exceeding underwritten expectations
3.Moderate
Risk:
in-line with underwritten expectations or the sponsor may be in the
early stages of executing the business plan and the loan structure
appropriately mitigates additional risks
4.High
Risk:
potential risk of default, a loss may occur in the event of
default
5.Default
Risk:
imminent risk of default, a loss is likely in the event of
default
The Company evaluates each loan rated High Risk or above as to
whether it is impaired on a quarterly basis. Impairment occurs when
the Company determines that the facts and circumstances of the loan
deem it probable that the Company will not be able to collect all
amounts due in accordance with the contractual terms of the loan.
If a loan is considered to be impaired, an allowance is recorded to
reduce the carrying value of the loan through a charge to the
provision for loan losses. Impairment of these loans, which are
collateral dependent, is measured by comparing the estimated fair
value of the underlying collateral, less costs to sell, to the book
value of the respective loan. These valuations require significant
judgments, which include assumptions regarding capitalization
rates, leasing, creditworthiness of major tenants, occupancy rates,
availability of financing, exit plan, actions of other lenders, and
other factors deemed necessary by the Manager. Actual losses, if
any, could ultimately differ from estimated losses.
In addition, the Company evaluates the entire portfolio to
determine whether the portfolio has any impairment that requires a
valuation allowance on the remainder of the loan portfolio. As of
December 31, 2021, the Company has not recognized any
impairments on its loans held-for-investment. We also assessed the
remainder of the loan portfolio, considering the absence of
delinquencies and current market conditions, and, as such has not
recorded any allowance for loan losses.
See Note 2 to our consolidated financial statements for the
complete listing of our significant accounting
policies.
Capital Allocation
The following tables set forth our allocated capital by investment
type at December 31, 2021 and December 31,
2020:
This information constitutes non-GAAP financial measures within the
meaning of Item 10(e) of Regulation S-K, as promulgated by the SEC.
We believe that this non-GAAP information enhances the ability of
investors to better understand the capital necessary to support
each income-earning asset category, and thus our ability to
generate operating earnings. While we believe that the non-GAAP
information included in this report provides supplemental
information to assist investors in analyzing our portfolio, these
measures are not in accordance with GAAP, and they should not be
considered a substitute for, or superior to, our financial
information calculated in accordance with GAAP.
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December 31, 2021 |
|
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Commercial Mortgage Loans |
|
MSRs |
|
Unrestricted Cash(1)
|
|
Total(2)
|
|
Market Value |
|
1,001,825,294 |
|
|
551,997 |
|
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14,749,046 |
|
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1,017,126,337 |
|
|
Collateralized Loan Obligations |
|
(826,782,543) |
|
|
— |
|
|
— |
|
|
(826,782,543) |
|
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Other(3)
|
|
25,769,860 |
|
|
— |
|
|
(3,422,658) |
|
|
22,347,202 |
|
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Restricted Cash |
|
3,530,006 |
|
|
— |
|
|
— |
|
|
3,530,006 |
|
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Capital Allocated |
|
204,342,617 |
|
|
551,997 |
|
|
11,326,388 |
|
|
216,221,002 |
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% Capital |
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94.5 |
% |
|
0.3 |
% |
|
5.2 |
% |
|
100.0 |
% |
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December 31, 2020 |
|
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Commercial Mortgage Loans |
|
MSRs |
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Unrestricted Cash(1)
|
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Total(2)
|
|
Market Value |
|
$ |
547,345,334 |
|
|
$ |
919,678 |
|
|
$ |
11,375,960 |
|
|
$ |
559,640,972 |
|
|
Collateralized Loan Obligations |
|
(463,060,090) |
|
|
— |
|
|
— |
|
|
(463,060,090) |
|
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Other(3)
|
|
1,663,740 |
|
|
— |
|
|
(2,984,668) |
|
|
(1,320,928) |
|
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Restricted Cash |
|
57,999,396 |
|
|
— |
|
|
— |
|
|
57,999,396 |
|
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Capital Allocated |
|
$ |
143,948,380 |
|
|
$ |
919,678 |
|
|
$ |
8,391,292 |
|
|
$ |
153,259,350 |
|
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% Capital |
|
93.9 |
% |
|
0.6 |
% |
|
5.5 |
% |
|
100.0 |
% |
1.Includes
cash and cash equivalents.
2.Includes
the carrying value of our Secured Term Loan.
3.Includes
principal and interest receivable, prepaid and other assets,
interest payable, dividends payable and accrued expenses and other
liabilities.
Results of Operations
As of December 31, 2021, we consolidated the assets and
liabilities of one CRE CLO, LFT CRE 202-FL1, Ltd. Additionally,
although the COVID-19 pandemic did not significantly impact our
operating results for the year ended December 31, 2021, should the
pandemic and resulting economic deterioration persist, we expect it
may affect our business, financial condition, results of operations
and cash flows going forward, including but not limited to,
interest income credit losses and commercial mortgage loan
reinvestment, in ways that may vary widely depending on the
duration and magnitude of the COVID-19 pandemic and ensuing
economic turmoil, as well as numerous other factors, many of which
are outside of our control.
Further in May 2021, we issued 2,400,000 shares of 7.875% Series A
Cumulative Redeemable Preferred Stock resulting in net proceeds
(after underwriting discount and commission but before operating
expenses) of $58.1 million. On August 23, 2021, the Incremental
Secured Term Loan of $7.5 million provided for in the Third
Amendment to the Credit and Guaranty Agreement was funded. We
believe that Lument IM and its affiliates continue to identify
attractive CRE lending opportunities, which we expect will allow us
to deploy our capital base into assets that are consistent with our
investment strategy. The deployment of these proceeds into our
target assets took time and as such, and resulted in a temporary
decline in net interest income. Additionally, as a result of the
Series A Preferred Stock issuances, Stockholders' Equity as
calculated per our management agreement will increase, resulting in
increased management fees, changes to the core earnings hurdle over
which incentive fees are due and payable to our Manager and
increase the reimbursable expense cap.
The table below presents certain information from our Statement of
Operations for the years ended December 31, 2021 and
December 31, 2020:
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Year Ended
December 31,
|
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|
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2021 |
|
2020 |
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Revenues: |
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Interest income: |
|
|
|
|
|
Commercial mortgage loans held-for-investment |
|
36,162,050 |
|
|
33,570,949 |
|
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Cash and cash equivalents |
|
28,779 |
|
|
45,782 |
|
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Interest expense: |
|
|
|
|
|
Collateralized loan obligations |
|
(12,178,545) |
|
|
(12,047,300) |
|
|
Secured term loan |
|
(3,333,536) |
|
|
(3,138,917) |
|
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Net interest income |
|
20,678,748 |
|
|
18,430,514 |
|
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Other income: |
|
|
|
|
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Realized loss on mortgage servicing rights |
|
(10,910) |
|
|
— |
|
|
Change in unrealized (loss) on mortgage servicing
rights |
|
(356,772) |
|
|
(1,780,528) |
|
|
Loss on extinguishment of debt |
|
(1,663,926) |
|
|
— |
|
|
Servicing income, net |
|
398,939 |
|
|
709,565 |
|
|
Other income |
|
— |
|
|
2 |
|
|
Total other (loss) |
|
(1,632,669) |
|
|
(1,070,961) |
|
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Expenses: |
|
|
|
|
|
Management fee |
|
3,041,600 |
|