Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Executive Overview
Business and Investment Strategy
We are a real estate investment trust (“REIT”) that invests in seniors housing and health care properties through sale-leasebacks, mortgage financing, joint ventures and structured finance solutions including preferred equity and mezzanine lending. We seek to create, sustain and enhance stockholder equity value and provide current income for distribution to stockholders through real estate investments in seniors housing and health care properties managed by experienced operators. Our primary seniors housing and health care property classifications include skilled nursing facilities (“SNF”), assisted living facilities (“ALF”), independent living facilities (“ILF”), memory care communities (“MC”) and combinations thereof. We also invest in other (“OTH”) types of properties, such as land parcels, projects under development (“UDP”) and behavioral health care hospitals. To meet these objectives, we attempt to invest in properties that provide opportunity for additional value and current returns to our stockholders and diversify our investment portfolio by geographic location, operator, property classification and form of investment.
We conduct and manage our business as one operating segment for internal reporting and internal decision-making purposes. For purposes of this Annual Report on Form 10-K and other presentations, we generally include ALF, ILF, and MC in the ALF property classification. We have been operating since August 1992.
The following graph summarizes our gross investments as of December 31, 2021:
Substantially all of our revenues and sources of cash flows from operations are derived from operating lease rentals, interest earned on outstanding loans receivable and income from investments in unconsolidated joint ventures. Our investments in owned properties, mortgage loans, mezzanine loans and preferred equity investments represent our primary source of liquidity to fund distributions and are dependent upon the performance of the operators on their lease and loan obligations and the rates earned thereon. To the extent that the operators experience operating difficulties and are unable to generate sufficient cash to make payments to us, there could be a material adverse impact on our consolidated results of operations, liquidity and/or financial condition. To mitigate this risk, we monitor our investments through a variety of methods determined by property type and operator. Our monitoring process includes periodic review of financial statements for each facility, periodic review of operator credit, scheduled property inspections and review of covenant compliance.
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In addition to our monitoring and research efforts, we also structure our investments to help mitigate payment risk. Some operating leases and loans are credit enhanced by guaranties and/or letters of credit. In addition, operating leases are typically structured as master leases and loans are generally cross-defaulted and cross-collateralized with other loans, operating leases or agreements between us and the operator and its affiliates.
Depending upon the availability and cost of external capital, we anticipate making additional investments in health care related properties. New investments are generally funded from cash on hand, temporary borrowings under our unsecured revolving line of credit and internally generated cash flows. Our investments generate internal cash from rent and interest receipts and principal payments on mortgage loans receivable. Permanent financing for future investments, which replaces funds drawn under our unsecured revolving line of credit, is expected to be provided through a combination of public and private offerings of debt and equity securities and secured and unsecured debt financing. The timing, source and amount of cash flows provided by financing activities and used in investing activities are sensitive to the capital markets’ environment, especially to changes in interest rates. Changes in the capital markets’ environment may impact the availability of cost-effective capital.
We believe our business model has enabled and will continue to enable us to maintain the integrity of our property investments, including in response to financial difficulties that may be experienced by operators. Traditionally, we have taken a conservative approach to managing our business, choosing to maintain liquidity and exercise patience until favorable investment opportunities arise.
COVID-19
On March 11, 2020, the World Health Organization declared the outbreak of coronavirus (“COVID-19”) as a pandemic, and on March 13, 2020, the United States declared a national emergency with regard to COVID-19. The COVID-19 pandemic has had repercussions across regional and global economies and financial markets. The outbreak of COVID-19 in many countries, including the United States, has significantly and adversely impacted public health and economic activity, and has contributed to significant volatility, dislocations and liquidity disruptions in financial markets.
The operations and occupancy levels at our properties have been adversely affected by COVID-19 and could be further adversely affected by COVID-19 or another pandemic especially if there are infections on a large scale at our properties. The impact of COVID-19 has included, and another pandemic could include, early resident move-outs, our operators delaying accepting new residents due to quarantines, potential occupants postponing moves to our operators’ facilities, and/or hospitals cancelling or significantly reducing elective surgeries thereby creating fewer people in need of skilled nursing care. Additionally, as our operators have responded to the pandemic, operating costs have begun to rise. A decrease in occupancy, ability to collect rents from residents and/or increase in operating costs could have a material adverse effect on the ability of our operators to meet their financial and other contractual obligations to us, including the payment of rent. In recognition of the pandemic impact affecting our operators, we have agreed to rent abatements totaling $4.5 million and rent deferrals for certain operators totaling $7.4 million between April 2020 and December 2021, of which $1.7 million subsequently has been paid. The $10.2 million in rent abatements and deferrals, net with repayments, represented approximately 4% of our April 2020 through December 2021 contractual rent, excluding Senior Lifestyle Corporation (“Senior Lifestyle”), Senior Care, LLC (“Senior Care”) and Senior Care’s parent company Abri Health, LLC (“Abri Health”). The remaining balance of deferred rent is due to LTC over the next 36 months or upon receipt of government funds from the U.S. Coronavirus Aid, Relief, and Economic Security (the “CARES Act”).
During 2021, we proactively provided additional financial support to the majority of our operators by reducing by 50% 2021 rent escalations. This support was provided in the form of a credit to the majority of our operating partners. The one time rent escalation reduction had an approximate $0.5 million impact on our 2021 Generally Accepted Accounting Principles (“GAAP”) revenue and $1.3 million impact on cash revenue.
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Portfolio Overview
The following tables summarize our real estate investment portfolio as of December 31, 2021 (dollar amounts in thousands):
Twelve Months Ended
December 31, 2021
Number of Percentage Percentage
Number of SNF ALF Gross of Rental of Total
Number of Percentage Interest Income Percentage
Number of SNF ALF Gross of from Mortgage of Total
Other (4) — — — 1,780 0.1 % 34 — %
Number of Percentage Interest Percentage
Number of SNF ALF Gross of and other of Total
Skilled Nursing (7) — — — 10,037 0.6 % 105 0.1 %
Number of Percentage Income from Percentage
Number of SNF ALF Gross of Unconsolidated of Total
Under Development (9) — — — 13,000 0.7 % 967 0.7 %
Number Number of Percentage
of SNF ALF Gross of
Under Development — — — 13,000 0.7 %
(2) See Item 2. Properties for discussion of bed/unit count.
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As of December 31, 2021, we had $1.4 billion in carrying value of net investments, consisting of $1.0 billion or 72.5% invested in owned properties, $0.3 billion or 24.2% invested in mortgage loans secured by first mortgages, $28.3 million or 2.0% in notes receivable and $19.3 million or 1.3% in unconsolidated joint ventures.
Rental income and interest income from mortgage loans represented 78.0% and 21.1%, respectively, of Total revenues on the Consolidated Statements of Income for the year ended December 31, 2021. In most instances, our lease structure contains annual rental escalations. Our leases that contain fixed annual rental escalations and/or have annual rental escalations that are contingent upon changes in the Consumer Price Index, are generally recognized on a straight-line basis over the minimum lease period. Certain leases have annual rental escalations that are contingent upon changes in the gross operating revenues of the property. This revenue is not recognized until the appropriate contingencies have been resolved. For the year ended December 31, 2021, we recognized $0.5 million in straight-line rental income and $0.6 million in amortization of lease incentives. For the remaining leases in place at December 31, 2021, assuming no modification or replacement of existing leases and no new leased investments are added to our portfolio, except for the potential subsequent lease extensions and the leases reported below under Update on Certain Operators, we currently expect that the non-cash straight-line rent portion of rental income will decrease from $0.5 million in 2021 to negative $1.3 million for projected annual 2022 which represents higher cash rent received than recorded as rental income. Our cash rental income is projected to increase from $122.0 million in 2021 to $126.9 million for projected annual 2022. At December 31, 2021, the straight-line rent receivable balance on the consolidated balance sheet was $24.1 million.
Many of our existing leases contain renewal options that, if exercised, could result in the amount of rent payable upon renewal being greater or less than that currently being paid. During the year ended December 31, 2021, we extended the Brookdale Senior Living Communities, Inc. (“Brookdale”) master lease by one year. See below under Update on Certain Operators and Former Operators below for further discussion of the Brookdale master lease.
Some of our lease agreements provide purchase options allowing the lessees to purchase the properties they currently lease from us. See Item 8. FINANCIAL STATEMENTS— Note 5. Real Estate Investments. Owned Properties for a table that includes information about purchase options included in our lease agreements.
Update on Certain Operators and Former Operators
Senior Care Centers, LLC – Former Operator
Senior Care and affiliates and subsidiaries filed for Chapter 11 bankruptcy in December 2018. During 2019, while in bankruptcy, Senior Care assumed LTC’s master lease and, in March 2020, Senior Care emerged from bankruptcy. Concurrent with their emergence from bankruptcy, in accordance with the order confirming Senior Care’s plan of reorganization, Abri Health was formed as the parent company of reorganized Senior Care and became co-tenant and co-obligor with reorganized Senior Care under our master lease. In March 2021, Senior Care and Abri Health (collectively, “Lessee”) defaulted the lease due to failure to pay rent and additional obligations owed under the master lease. Accordingly, we sent a notice of default and applied proceeds from letter of credit to certain obligations owed under the master lease. Furthermore, we sent the Lessee a notice of termination of the master lease to be effective April 17, 2021. On April 16, 2021, the Lessee filed for Chapter 11 bankruptcy. In August 2021, the United States Bankruptcy Court approved a settlement agreement between Lessee and LTC. The settlement provided for, among other things, a one-time payment of $3.3 million from LTC to the affiliates of Lessee in exchange for cooperation and assistance in facilitating an orderly transition of the 11 skilled nursing centers from the Lessee and its affiliates to affiliates of HMG Healthcare, LLC which occurred on October 1, 2021. At December 31, 2021, Senior Care and Abri Health do not operate any properties in our portfolio.
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Senior Lifestyle Corporation
During 2020, an affiliate of Senior Lifestyle paid us $13.8 million of their $18.4 million contractual rent and we applied their letter of credit and deposits totaling $3.7 million to past due rent of $3.6 million and to their outstanding notes receivable of $0.1 million. Accordingly, we wrote-off a total of $17.7 million of straight-line rent receivable and lease incentives related to this master lease and transitioned rental revenue recognition to cash basis effective July 2020. During 2020, we recognized $17.4 million of rental revenue from Senior Lifestyle. In 2021, Senior Lifestyle defaulted on all rent obligations under the master lease. During 2021, we transitioned 18 assisted living communities previously leased to Senior Lifestyle to five operators. These communities are located in Illinois, Ohio, Wisconsin, Colorado, Pennsylvania and Nebraska. Also, during 2021, we sold three Wisconsin communities and a closed community in Nebraska previously leased to Senior Lifestyle for a combined total of $35.9 million. We received total proceeds of $34.8 million and recorded a net gain on sale of $5.4 million.
Brookdale Senior Living Communities, Inc
Brookdale’s master lease was scheduled to mature on December 31, 2021. During the first quarter of 2021, we extended their term by one year through an amended master lease, with a new maturity date of December 31, 2022. Also, the renewal options under the amended master lease remained the same which provides three renewal options consisting of a three-year renewal option, a five-year renewal option and a 10-year renewal option. The notice period for the first renewal option is January 1, 2022 to April 30, 2022. During 2020, we extended a $4.0 million capital commitment to Brookdale at a 7% yield. During 2021, we fully funded the $4.0 million and extended an additional $2.0 million to Brookdale at a 7% yield, which is available through December 31, 2022. As of December 31, 2021, nothing was funded under this additional agreement and our remaining commitment is $2.0 million. Brookdale is current on rent payments through February 2022.
Genesis Healthcare, Inc
Genesis reported doubt regarding its ability to continue as a going concern on its Quarterly Report on Form 10-Q filed in August 2020. As a result, we wrote-off $4.3 million of straight-line rent receivable related to this master lease during the third quarter of 2020 and transitioned rental revenue recognition to cash basis effective September 2020. During the first quarter of 2021, Genesis delisted its Class A common stock from the New York Stock Exchange. Genesis is current on rent payments through February 2022.
Other Operators
During the third quarter of 2020, an operator failed to pay its full contractual rent. Accordingly, we wrote-off $1.2 million of straight-line rent receivable related to this master lease. During 2020, we consolidated our two master leases with this operator into one combined master lease and agreed to abate $0.7 million of rent and allow the operator to defer rent as needed through March 31, 2021. During 2021 and 2022, the combined master lease was amended to extend the rent deferral period through March 31, 2022. The operator deferred rent of $4.6 million for the year ended December 31, 2021, and $0.9 million for January through February 2022. The operator can defer rent up to $0.5 million for March 2022.
Additionally, subsequent to December 31, 2021, an operator of two assisted living communities in California with a total of 232 units exercised the purchase option under their lease for approximately $43.7 million. The communities have a gross book value of $31.8 million and a net book value of $17.0 million. As a result of this transaction, we anticipate recognizing approximately $26.0 million of gain on sale of real estate in the second quarter of 2022. Also, we entered into an agreement with the current operator to sell a 74-unit assisted living community in Virginia for $16.9 million. The community has a gross book value of $16.9 million and a net book value of $15.7 million. As a result of this transaction, we anticipate recognizing approximately $1.3 million of gain on sale of real estate in the second quarter of 2022. In connection with the sale, the current operator will pay a $1.2 million lease termination fee.
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2021 Transactions Overview
The following tables summarizes our transactions in 2021 (dollar amounts in thousand):
Investment in Improvement Projects
Amount
Assisted Living Communities $ 5,846
Skilled Nursing Centers 452
Sold Properties
Type Number Number
of of of Sales Carrying Net
2021 n/a n/a — — $ — $ — $ 363 (3)
(2) Calculation of net gain (loss) includes cost of sales.
Investment in Mortgage Loans
Originations and funding under mortgage loans receivable $ 88,955 (1)
Application of interest reserves 298
Scheduled principal payments received (1,175)
Mortgage loan premium amortization (6)
Provision for loan loss reserve (881)
Net increase in mortgage loans receivable $ 87,191
(1) During 2021, we funded the following:
e. $540 additional capital funding under our existing mortgage loans.
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Investment in Notes Receivable
Advances under notes receivable $ 16,353 (1)
Interest reserve withheld 353
Principal payments received under notes receivable (2,694)
Notes receivable reserve (140)
Net increase in notes receivable $ 13,872
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Key Performance Indicators, Trends and Uncertainties
We utilize several key performance indicators to evaluate the various aspects of our business. These indicators are discussed below and relate to concentration risk and credit strength. Management uses these key performance indicators to facilitate internal and external comparisons to our historical operating results in making operating decisions and for budget planning purposes.
Concentration Risk. We evaluate by gross real estate investment our concentration risk in terms of asset mix, real estate investment mix, operator mix and geographic mix. Concentration risk is valuable to understand what portion of our real estate investments could be at risk if certain sectors were to experience downturns. Asset mix measures the portion of our real estate investments that are real property or mortgage loans. Investment mix measures the portion of our investments that relate to our various property types. Operator mix measures the portion of our real estate investments that relate to our top five operators. Geographic mix measures the portion of our real estate investment that relate to our top five states.
The following table reflects our recent historical trends of concentration risk (gross investment, in thousands):
Asset mix:
Real estate investment mix:
Operator mix:
Geographic mix:
Credit Strength. We measure our credit strength both in terms of leverage ratios and coverage ratios. Our leverage ratios include debt to gross asset value and debt to market capitalization. The leverage ratios indicate how much of our Consolidated Balance Sheet capitalization is related to long-term obligations. Our coverage ratios include interest coverage ratio and fixed charge coverage ratio. The coverage ratios indicate our ability to service interest and fixed charges (interest). The coverage ratios are based on earnings before interest, taxes, depreciation and amortization for real estate (“EBITDAre”) as defined by National Association of Real Estate Investment Trusts (“NAREIT”). EBITDAre is calculated as net income available to common stockholders (computed in accordance with GAAP) excluding (i) interest expense, (ii) income tax expense, (iii) real estate depreciation and amortization, (iv) impairment write-downs of depreciable real estate, (v) gains or losses on the sale of depreciable real estate, and (vi) adjustments for unconsolidated
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partnerships and joint ventures. Adjusted EBITDAre is calculated as EBITDAre adjusted for non-recurring items. Leverage ratios and coverage ratios are widely used by investors, analysts and rating agencies in the valuation, comparison, rating and investment recommendations of companies. The following table reflects the recent historical trends for our credit strength measures:
Balance Sheet Metrics
Year Ended Quarter Ended
Interest coverage ratio (7) 4.4 x 4.3 x 4.3 x 4.3 x (5) 4.7 x (5) 5.3 x
Year to Date Quarter Ended
Add: Impairment loss — — — — — 3,036
Interest coverage ratio 4.4 x 4.3 x 4.3 x 4.3 x 4.7 x 5.3 x
Fixed charge coverage ratio 4.4 x 4.3 x 4.3 x 4.3 x 4.7 x 5.3 x
(1) Represents sum of (2) to (5) below.
(3) Represents the Senior Care and Abri Health settlement.
(4) Represents the 50% reduction of rent escalations.
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We evaluate our key performance indicators in conjunction with current expectations to determine if historical trends are indicative of future results. Our expected results may not be achieved and actual results may differ materially from our expectations. This may be a result of various factors, including, but not limited to:
● The status of the economy;
● The status of capital markets, including prevailing interest rates;
● Changes in financing terms;
● Competition within the health care and seniors housing industries;
● Changes in federal, state and local legislation;
● The duration, spread and severity of the COVID-19 outbreak.
Management regularly monitors the economic and other factors listed above. We develop strategic and tactical plans designed to improve performance and maximize our competitive position. Our ability to achieve our financial objectives is dependent upon our ability to effectively execute these plans and to appropriately respond to emerging economic and company-specific trends.
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Operating Results
Year ended December 31, 2021 compared to year ended December 31, 2020 (in thousands):
Years ended December 31,
Revenues:
Expenses:
Impairment loss from real estate investments — 3,977 (5) 3,977
Provision (recovery) for credit losses 1,021 (3) (1,024) (6)
Other operating income:
Gain from property insurance proceeds — 373 (11) (373)
Loss on unconsolidated joint ventures — (758) (12) 758
Income from unconsolidated joint ventures 1,417 432 985 (13)
Income allocated to non-controlling interests (363) (384) 21
Income allocated to participating securities (458) (422) (36)
Net income available to common stockholders $ 55,403 $ 94,871 $ (39,468)
(7) Increased due to Senior Care and Abri Health settlement and related fees.
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Year ended December 31, 2020 compared to year ended December 31, 2019 (in thousands):
Years ended December 31,
Revenues:
Expenses:
Impairment on real estate for sale 3,977 — (3,977) (5)
(Recovery) provision for credit losses (3) 166 169
Transaction costs 299 365 66
Other operating income:
Gain from property insurance proceeds 373 (10) 2,111 (10) (1,738)
Loss on unconsolidated joint ventures (758) (11) — (758)
Income from unconsolidated joint ventures 432 2,388 (1,956) (13)
Income allocated to non-controlling interests (384) (346) (38)
Net income attributable to LTC Properties, Inc. 95,293 80,526 14,767
Income allocated to participating securities (422) (391) (31)
Net income available to common stockholders $ 94,871 $ 80,135 $ 14,736
(3) Decreased primarily due to the partial paydown of a mezzanine loan.
(10) Relates to insurance proceeds related to properties sold.
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Funds From Operations
Funds from Operations (“FFO”) attributable to common stockholders, basic FFO attributable to common stockholders per share and diluted FFO attributable to common stockholders per share are supplemental measures of a REIT’s financial performance that are not defined by GAAP. Real estate values historically rise and fall with market conditions, but cost accounting for real estate assets in accordance with GAAP assumes that the value of real estate assets diminishes predictably over time. We believe that by excluding the effect of historical cost depreciation, which may be of limited relevance in evaluating current performance, FFO facilitates comparisons of operating performance between periods.
We use FFO as a supplemental performance measurement of our cash flow generated by operations. FFO does not represent cash generated from operating activities in accordance with GAAP, and is not necessarily indicative of cash available to fund cash needs and should not be considered an alternative to net income available to common stockholders.
We calculate and report FFO in accordance with the definition and interpretive guidelines issued by NAREIT. FFO, as defined by NAREIT, means net income available to common stockholders (computed in accordance with GAAP) excluding gains or losses on the sale of real estate and impairment write-downs of depreciable real estate plus real estate depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. Our calculation of FFO may not be comparable to FFO reported by other REITs that do not define the term in accordance with the current NAREIT definition or that have a different interpretation of the current NAREIT definition from us; therefore, caution should be exercised when comparing our FFO to that of other REITs.
The following table reconciles net income available to common stockholders to FFO attributable to common stockholders (unaudited, amounts in thousands, except per share amounts):
For the year ended December 31,
GAAP net income available to common stockholders $ 55,403 $ 94,871 $ 80,135
Add: Impairment loss from investments — 3,977 5,500
Add: Loss on unconsolidated joint ventures — 758 —
Less: Gain on sale of real estate, net (7,462) (44,117) (2,106)
NAREIT FFO attributable to common stockholders per share:
(1) Includes the effect of participating securities.
Critical Accounting Policies and Estimates
Our accounting policies are more fully described under Item 8. FINANCIAL STATEMENTS—Footnote 2. Summary of Significant Accounting Policies. As discussed in Footnote 2, the preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions about future events that affect the amounts reported in our consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Listed below are those policies and estimates that we believe are critical and require the use of significant judgement in their application.
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Impairment of Long-Lived Assets
Assets that are classified as held-for-use are periodically evaluated for impairment when events or changes in circumstances indicate that the asset may be impaired or the carrying amount of the asset may not be recoverable through future undiscounted cash flows. The expected future undiscounted cash flows reflect external market factors and are probability weighted to reflect multiple possible cash flow scenarios. Additionally, the estimated future undiscounted cash flows are calculated utilizing the lowest level of identifiable cash flows that are largely independent of the cash flows of other assets and liabilities. In order to review our real estate assets for recoverability, we make assumptions regarding external market conditions (including capitalization rates and growth rates), forecasted cash flows and sales prices, whether the management modifies the lease with the existing operator versus identifying a replacement operator and our intent with respect to holding or disposing of the asset. If our analysis indicates that the carrying value of the real estate assets is not recoverable on an undiscounted cash flow basis, we recognize an impairment charge for the amount by which the carrying value exceeds the fair value of the real estate asset. Our ability to accurately predict operating results and projected cash flows impacts the timing and recognition of impairments. While we believe our assumptions are reasonable, changes in these assumptions may have a material impact on our consolidated financial statements.
Collectibility of operator obligations
We assess the collectibility of substantially all our lease payments through maturity. If collectibility is not probable, all or a portion of our straight-line rent receivables and other lease receivables may be written-off. In order to assess our lease payments for collectibility, we make assumptions that include evaluating lessee’s payment history, the financial strength of the lessee, future market conditions and contractual rents, and timing of expected payments. Our ability to accurately predict collectibility of substantially all of our lease payments impacts the timing of straight-line rent and other lease receivable write-offs, if any. While we believe our assumptions are reasonable, changes in these assumptions may have a material impact on our consolidated financial statements.
Liquidity and Capital Resources
Sources and Uses of Cash
As of December 31, 2021, we had a total of$5.2 million of cash and cash equivalents, $289.1 million available under our unsecured revolving line of credit and the potential ability to access the capital markets through the issuance of $200.0 million of common stock under our Equity Distribution Agreements. Furthermore, we have the ability to access the capital markets through the issuance of debt and/or equity securities under an automatic shelf registration statement.
We believe that our current cash balance, cash flow from operations available for distribution or reinvestment, our borrowing capacity and our potential ability to access the capital markets are sufficient to provide for payment of our current operating costs, meet debt obligations and pay common dividends at least sufficient to maintain our REIT status and repay borrowings at, or prior to, their maturity. The timing, source and amount of cash flows used by financing and investing activities are sensitive to the capital markets’ environment, especially to changes in interest rates. In addition, COVID-19 has adversely affected and is expected to continue to adversely affect our operators’ business, results of operations, cash flows and financial condition which could, in turn, adversely affect our financial position.
The operating results of the properties will be impacted by various factors over which the operators/owners may have no control. Those factors include, without limitation, the health of the economy, changes in supply of or demand for competing seniors housing and health care properties, ability to hire and maintain qualified staff, ability to control rising operating costs, the potential for significant reforms in the health care industry, and the impact of COVID-19. In addition, our future growth in net income and cash flow may be adversely impacted by various proposals for changes in the governmental regulations and financing of the health care industry, and the impact of COVID-19 or other pandemic level viruses. We cannot presently predict what impact these potential events may have, if any. We believe that adequate provision has been made for the possibility of loans proving uncollectible but we will continually evaluate the financial status of the operations of the seniors housing and health care properties. In addition, we will monitor our borrowers and the underlying collateral for mortgage loans and will make future revisions to the provision, if considered necessary.
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Depending on the duration, spread and the severity of the COVID-19 outbreak, our borrowing capacity, compliance with financial covenants, ability to access the capital markets, and the payment of dividends may be negatively impacted. We continuously evaluate the availability of cost-effective capital and believe we have sufficient liquidity for our current dividend, corporate expenses and additional capital investments in 2022.
Our investments, principally our investments in owned properties and mortgage loans, are subject to the possibility of loss of their carrying values as a result of changes in market prices, interest rates and inflationary expectations. The effects on interest rates may affect our costs of financing our operations and the fair market value of our financial assets. Generally, our leases have agreed upon annual increases and our loans have predetermined increases in interest rates. Inasmuch as we may initially fund some of our investments with variable interest rate debt, we would be at risk of net interest margin deterioration if medium and long-term rates were to increase.
Our primary sources of cash include rent and interest receipts, borrowings under our unsecured credit facility, public and private issuance of debt and equity securities, proceeds from investment dispositions and principal payments on loans receivable. Our primary uses of cash include dividend distributions, debt service payments (including principal and interest), real property investments (including acquisitions, capital expenditures and construction advances), loan advances and general and administrative expenses. These sources and uses of cash are reflected in our Consolidated Statements of Cash Flows as summarized below (in thousands):
Year Ended December 31, Change
Cash provided by (used in): 2021 2020 $
Debt Obligations
Unsecured Credit Facility. We had an unsecured credit agreement (the “Original Credit Agreement”) that provided for a revolving aggregate commitment of the lenders of up to $600.0 million with the opportunity to increase the commitment size of the credit agreement up to a total of $1.0 billion. The Original Credit Agreement’s maturity was on June 27, 2022 and provided for a one-year extension option at our discretion, subject to customary conditions.
In advance of expiration of the Original Credit Agreement, during the fourth quarter of 2021, we entered into the Third Amended and Restated credit agreement (the “Credit Agreement”) to replace the Original Credit Agreement. The Credit Agreement decreased the aggregate commitment of the lenders under the Original Credit Agreement to $500.0 million comprised of a $400.0 million revolving credit facility (the “Revolving Line of Credit”) and two $50.0 million term loans (the “Term Loans”). The Credit Agreement permits us to request increases to the Revolving Line of Credit and Term Loans commitments up to a total of $1.0 billion, extends the maturity of the Revolving Line of Credit to November 19, 2025 and provides for a one-year extension option at our discretion, subject to customary conditions. The Term Loans mature on November 19, 2025 and November 19, 2026. Based on our leverage at December 31, 2021, the Revolving Line of Credit provides for interest annually at LIBOR plus 115 points and a facility fee of 20 basis point and the Term Loans provide for interest annually at LIBOR plus 135 points.
Interest Rate Swap Agreement. In connection with entering into the Term Loans as discussed above, we entered into two receive variable/pay fixed interest rate swap agreements (“Interest Rate Swaps”) with maturities of November 19, 2025 and November 19, 2026, respectively, that will effectively lock-in the forecasted interest payments on the Term Loan borrowings over the four and five year terms of the loans. The Interest Rate Swaps are considered cash flow hedges and are recorded on our Consolidated Balance Sheets at fair value, with changes in the fair value of these instruments recognized in Accumulated other comprehensive income (loss) on our Consolidated Balance Sheets. During the three months ended December 31, 2021, we recorded a $0.2 million decrease in fair value of Interest Rate Swaps.
Senior Unsecured Notes. We have senior unsecured notes held by institutional investors with interest rates ranging from 3.85% to 5.03%. The senior unsecured notes mature between 2024 and 2032.
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The debt obligations by component as of December 31, 2021 are as follows (dollar amounts in thousands):
Applicable Available
Interest Outstanding for
Debt Obligations Rate (1) Balance Borrowing
Term loans, net of debt issue costs 2.63% 99,363 —
Senior unsecured notes, net of debt issue costs (3) 4.35% 512,456 —
(1) Represents weighted average of interest rate as of December 31, 2021.
Our debt borrowings and repayments during the year ended December 31, 2021, are as follows (in thousands):
Debt Obligations Borrowings Repayments
Senior unsecured notes — (47,160) (2)
Equity
Non-controlling Interests. We may, enter into partnerships to develop and/or own real estate. Given that our limited members do not have substantive kick-out rights, liquidation rights, or participation rights, we have concluded that the partnerships are VIEs. Since we exercise power over and receive benefits from the VIEs, we are considered the primary beneficiary. Accordingly, we consolidate the VIEs and record the non-controlling interests at cost.
At December 31, 2021, we had 39,374,044 shares of common stock outstanding, equity on our balance sheet totaled $745.1 million and our equity securities had a market value of $1.3 billion. During the year ended December 31, 2021, we declared and paid $90.5 million of cash dividends.
Common Stock. We have an equity distribution agreement with sales agents to issue and sell, from time to time, up to $200.0 million in aggregate offering price of our common shares. The equity distribution agreement provides for sales of common shares to be made by means of ordinary brokers’ transactions, which may include block trades, or transactions that are deemed to be “at the market” offerings. At December 31, 2021, we had $200.0 million available under our equity distribution agreement.
During 2021, we acquired 87,249 shares of common stock held by employees who tendered owned shares to satisfy tax withholding obligations. Subsequent to December 31, 2021, we declared a monthly cash dividend of $0.19 per share on our common stock for the months of January, February and March 2022, payable on January 31, February 28 and March 31, 2022, respectively, to stockholders of record on January 21, February 18, and March 23, 2022, respectively.
Stock Based Compensation Plans. During 2021, we adopted, and our shareholders approved the 2021 Equity Participation Plan (the “2021 Plan”) which replaces the 2015 Equity Participation Plan (the “2015 Plan”). Under the 2021 Plan, 1,900,000 shares of common stock have been authorized and reserved for awards, less one share for every one share that was subject to an award granted under the 2015 Plan after December 31, 2020 and prior to adoption. In addition, any shares that are not issued under outstanding awards under the 2015 Plan because the shares were forfeited
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or cancelled after December 31, 2020 will be added to and again be available for awards under the 2021 Plan. Under the 2021 Plan, the shares were authorized and reserved for awards to officers, employees, non-employee directors and consultants. The terms of the awards granted under the 2021 Plan and the 2015 Plan are set by our compensation committee at its discretion.
Restricted Stock and Performance-based Stock Units. During 2021, we granted 182,240 shares of restricted common stock and performance-based stock units under the 2021 Plan as follows:
No. of Price per
Shares Share Vesting Period
At December 31, 2021, the total number of restricted common stock shares that are scheduled to vest, and performance-based stock units that could possibly vest and remaining compensation expense to be recognized related to the future service period of unvested outstanding restricted common stock and performance-based stock units are as follows (dollar amounts in thousands):
Number Remaining
of Compensation
Vesting Date Awards Expense
Stock Options. We did not issue any stock options during the year ended December 31, 2021. At December 31, 2021, we have 15,000 stock options outstanding and exercisable.
Material Cash Requirements
We monitor our contractual obligations and commitments detailed above to ensure funds are available to meet obligations when due. The following table represents our long-term contractual obligations (scheduled principal payments and amounts due at maturity) as of December 31, 2021, excluding the effects of interest and debt issue costs (in thousands):
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The following table represents our projected interest expense, excluding capitalized interest, amortization of debt issue costs and bank fees, as of December 31, 2021 (in thousands):
Also, see Item 8. FINANCIAL STATEMENTS— Note 11. Commitments and Contingencies for additional information regarding our contractual commitments.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risks associated with changes in interest rates as they relate to our mortgage loans receivable and debt. Interest rate risk is sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors that are beyond our control.
We do not utilize forward or option contracts, or foreign currencies or commodities, or other types of derivative financial instruments-with exception of interest rate swaps- nor do we engage in “off-balance sheet” transactions. The purpose of the following disclosure is to provide a framework to understand our sensitivity to hypothetical changes in interest rates as of December 31, 2021.
Our future earnings, cash flows and estimated fair values relating to financial instruments are dependent upon prevalent market rates of interest, such as LIBOR or term rates of U.S. Treasury Notes. Changes in interest rates generally impact the fair value, but not future earnings or cash flows, of mortgage loans receivable and fixed rate debt. Our mortgage loans receivable and debt, such as our senior unsecured notes, are primarily fixed-rate instruments. Also, we entered into interest rate swap agreements to effectively lock-in the forecasted interest payments on our term loans which are based on LIBOR. For variable rate debt, such as our revolving line of credit, changes in interest rates generally do not impact the fair value, but do affect future earnings and cash flows.
At December 31, 2021, the fair value of our mortgage loans receivable using a 9.5% discount rate was approximately $405.2 million. A 1% increase in such rate would decrease the estimated fair value of our mortgage loans by approximately $30.0 million while a 1% decrease in such rate would increase their estimated fair value by approximately $34.4 million. At December 31, 2021, the fair value of our senior unsecured notes using a 3.0% discount rate for those maturing before year 2030 and 3.25% discount rate for those maturing at or beyond year 2030 was approximately $540.0 million. A 1% increase in such rate would decrease the estimated fair value of our senior unsecured notes by approximately $23.1 million while a 1% decrease in such rate would increase their estimated fair value by approximately $24.7 million. At December 31, 2021, the fair value of our notes receivable using a 5.6% discount rate approximately $28.7 million. A 1% increase in such rate would decrease the estimated fair value of our notes receivable by approximately $0.6 million. while a 1% decrease in such rate would increase their estimated fair value by approximately $0.7 million. These discount rates were measured based upon management’s estimates of rates currently prevailing for comparable loans available to us and instruments of comparable maturities.
The estimated impact of changes in interest rates discussed above are determined by considering the impact of the hypothetical interest rates on our borrowing costs, lending rates and current U.S. Treasury rates from which our financial instruments may be priced. We do not believe that future market rate risks related to our financial instruments will be material to our financial position or results of operations. These analyses do not consider the effects of industry specific events, changes in the real estate markets, or other overall economic activities that could increase or decrease the fair value of our financial instruments. If such events or changes were to occur, we would consider taking actions to mitigate and/or reduce any negative exposure to such changes. However, due to the uncertainty of the specific actions that would be taken and their possible effects, the sensitivity analysis assumes no changes in our capital structure.
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ITEM 8. FINANCIAL STATEMENTS
LTC Properties, Inc.
Index to Consolidated Financial Statements
and Financial Statements Schedules
Page
Report of Independent Registered Public Accounting Firm (PCAOB ID: 42) 51
Consolidated Balance Sheets as of December 31, 2021and 2020 54
Notes to Consolidated Financial Statements 59
Consolidated Financial Statement Schedules
Schedule II—Valuation and Qualifying Accounts 86
Schedule III—Real Estate and Accumulated Depreciation 87
Schedule IV—Mortgage Loans on Real Estate 92
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and the Board of Directors of LTC Properties, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of LTC Properties, Inc. (the “Company”) as of December 31, 2021 and 2020, and the related consolidated statements of income, comprehensive income, equity and cash flows for each of the three years in the period ended December 31, 2021, and the related notes and the financial statement schedules listed in the Index at Item 15(a) (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2021, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 17, 2022, expressed an unqualified opinion thereon.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of the critical audit matters does not alter
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in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing a separate opinion on the critical audit matters or on the accounts or disclosures to which they relate.
Impairment of Real Property Investments
Collectability of Lease Payments
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/s/ Ernst & Young LLP
We have served as the Company’s auditor since 1992.
Los Angeles, California
February 17, 2022
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LTC PROPERTIES, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
December 31,
ASSETS
Investments:
Accumulated depreciation and amortization (374,606) (349,643)
Investments in unconsolidated joint ventures 19,340 11,340
Other assets:
Cash and cash equivalents 5,161 7,772
Debt issue costs related to bank borrowings 3,057 1,324
Prepaid expenses and other assets 4,191 5,316
LIABILITIES
Accrued expenses and other liabilities 33,234 30,082
EQUITY
Stockholders’ equity:
Accumulated other comprehensive loss (172) —
Total LTC Properties, Inc. stockholders’ equity 736,714 767,402
Non-controlling interests 8,413 8,404
See accompanying notes.
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LTC PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
Year Ended December 31,
Revenues:
Expenses:
Impairment charges — 3,977 —
Provision (recovery) for credit losses 1,021 (3) 166
Other operating income:
Gain from property insurance proceeds — 373 2,111
Loss on unconsolidated joint ventures — (758) —
Income from unconsolidated joint ventures 1,417 432 2,388
Income allocated to non-controlling interests (363) (384) (346)
Net income attributable to LTC Properties, Inc. 55,861 95,293 80,526
Income allocated to participating securities (458) (422) (391)
Net income available to common stockholders $ 55,403 $ 94,871 $ 80,135
Earnings per common share:
See accompanying notes.
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LTC PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
Year Ended December 31,
Unrealized loss on cash flow hedges (172) — —
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LTC PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF EQUITY
(In thousands, except per share amounts)
Capital in Cumulative Total Non-
shares Amount Par Value Income OCI Distributions Equity Interests Equity
Stock option exercises 5 1 122 — — — 123 — 123
Other (44) — (2,047) — — — (2,047) — (2,047)
Issuance of restricted stock — — — — — — — — —
Other 110 1 (71) — — — (70) — (70)
See accompanying notes.
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LTC PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Year Ended December 31,
OPERATING ACTIVITIES:
Impairment charges — 3,977 5,500
Loss on unconsolidated joint ventures — 758 —
Income from unconsolidated joint ventures (1,417) (432) (2,388)
Straight-line rental income (467) (1,778) (4,487)
Lease incentives funded (824) (220) (387)
Amortization of lease incentives 608 426 385
Provision (recovery) for credit losses 1,021 (3) 166
Increase in interest receivable (6,776) (6,161) (5,854)
(Decrease) increase in accrued interest payable (471) (767) 803
Net change in other assets and liabilities 2,962 (2,021) (1,750)
INVESTING ACTIVITIES:
Investment in real estate properties — (13,581) (58,414)
Investment in real estate developments — (16,699) (20,524)
Investment in real estate capital improvements (6,298) (6,913) (2,839)
Capitalized interest — (354) (608)
Investments in unconsolidated joint ventures (5,676) (8,520) (472)
Principal payments received on notes receivable 2,694 5,275 3,503
FINANCING ACTIVITIES:
Borrowings from term loans 100,000 — —
Proceeds from issuance of senior unsecured notes — — 100,000
Stock repurchase plan — (18,012) —
Stock option exercises — — 123
Contribution from non-controlling interests 9 — 965
Distributions paid to non-controlling interests (363) (463) (309)
Financing costs paid (3,358) (35) (61)
Other (70) (8) (6)
Supplemental disclosure of cash flow information:
See accompanying notes.
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1. The Company
LTC Properties, Inc. (“LTC”), a Maryland corporation, commenced operations on August 25, 1992. LTC is a real estate investment trust (“REIT”) that invests primarily in seniors housing and health care properties primarily through sale-leasebacks, mortgage financing, joint ventures and structured finance solutions including preferred equity and mezzanine lending. We conduct and manage our business as one operating segment, rather than multiple operating segments, for internal reporting and internal decision-making purposes. Our primary objectives are to create, sustain and enhance stockholder equity value and provide current income for distribution to stockholders through real estate investments in seniors housing and health care properties managed by experienced operators. Our primary seniors housing and health care property classifications include skilled nursing centers (“SNF”), assisted living communities (“ALF”), independent living communities (“ILF”), memory care communities (“MC”) and combinations thereof. We also invest in other (“OTH”) types of properties, such as land parcels, projects under development (“UDP”) and behavioral health care hospitals. ILF, ALF, MC and combinations thereof are included in the ALF classification.
2. Summary of Significant Accounting Policies
Basis of Presentation. The accompanying consolidated financial statements include the accounts of LTC, our wholly-owned subsidiaries, and our consolidated companies. All intercompany investments, accounts and transactions have been eliminated.
Any reference to the number of properties or facilities, number of units, number of beds, number of operators, and yield on investments in real estate are unaudited and outside the scope of our independent registered public accounting firm’s audit of our consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board.
Consolidation. At inception, and on an ongoing basis, as circumstances indicate the need for reconsideration, we evaluate each legal entity that is not wholly-owned by us for consolidation, first under the variable interest entity (“VIE”), then under the voting model. Our evaluation considers all of our variable interests, including common or preferred equity ownership, loans, and other participating instruments. The variable interest model applies to entities that meet both of the following criteria:
If an entity does meet the above criteria and does not qualify for a scope exception from the VIE model, we will determine whether the entity is a VIE.
A legal entity is determined to be a VIE if it has any of the following three characteristics:
● The obligation to absorb the entity's expected losses;
● The right to receive the entity's expected residual returns; or
If any of the three characteristics of a VIE are met, we conclude that the entity is a VIE and evaluate it for consolidation under the variable interest model.
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If an entity is determined to be a VIE, we evaluate whether we are the primary beneficiary. The primary beneficiary analysis is a qualitative analysis based on power and benefits. We consolidate a VIE if we have both power and benefits - that is (i) we have the power to direct the activities of a VIE that most significantly impact the VIE's economic performance (power), and (ii) we have the obligation to absorb losses of the VIE that could potentially be significant to the VIE, or the right to receive benefits from the VIE that potentially could be significant to the VIE (benefits). If we have a variable interest in a VIE but we are not the primary beneficiary, we account for our investment using the equity method of accounting.
If a legal entity fails to meet any of the three of the characteristics of a VIE, we evaluate such entity under the voting interest model. Under the voting interest model, we consolidate the entity if we determine that we, directly or indirectly, have greater than 50% of the voting shares or if we are the general partner or managing member of the entity and the limited partners or non-managing members do not have substantive participating, liquidation, or kick-out rights that preclude our presumption of control.
The FASB requires the classification of non-controlling interests as a component of consolidated equity in the consolidated balance sheet subject to the provisions of the rules governing classification and measurement of redeemable securities. The guidance requires consolidated net income to be reported at the amounts attributable to both the controlling and non-controlling interests. The calculation of earnings per share will be based on income amounts attributable to the controlling interest.
Use of Estimates. Preparation of the consolidated financial statements in conformity with Generally Accepted Accounting Principles (“GAAP”) requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Our most significant assumptions and estimates are related to the valuation of real estate, revenue recognition including the collectibility of tenant receivables and asset impairment.
Reference Rate Reform. In March 2020, the FASB issued the Accounting Standard Update (“ASU”) No. 2020-04, Reference Rate Reform: Facilitation of the Effects of Reference Rate Reform on Financial Reporting (“ASU 2020-04”). This ASU provides practical expedients for contract modifications and certain hedging relationships associated with the transition from reference rates that are expected to be discontinued. This guidance is applicable for our borrowing instruments which use the London Interbank Offered Rate (“LIBOR”) as a reference rate and is effective immediately, however is only available through December 31, 2022. We have not adopted any of the optional expedients through December 31, 2021 but will continue to evaluate the possible adoption (including potential impact) of any such expedients or exceptions during the effective period as circumstances evolve.
Cash Equivalents. Cash equivalents consist of highly liquid investments with a maturity of three months or less when purchased and are stated at cost which approximates market.
Owned Properties. We make estimates as part of our allocation of the purchase price of acquisitions to the various components of the acquisition based upon the fair value of each component. In determining fair value, we use current appraisals or other third-party opinions of value. The most significant components of our allocations are typically the allocation of fair value to land and buildings and, for certain of our acquisitions, in-place leases and other intangible assets. In the case of the fair value of buildings and the allocation of value to land and other intangibles, the estimates of the values of these components will affect the amount of depreciation and amortization we record over the estimated useful life of the property acquired or the remaining lease term. In the case of the value of in-place leases, we make best estimates based on the evaluation of the specific characteristics of each tenant’s lease. Factors considered include estimates of carrying costs during hypothetical expected lease-up periods, market conditions and costs to execute similar leases. These assumptions affect the amount of future revenue that we will recognize over the remaining lease term for the acquired in-place leases. We evaluate each purchase transaction to determine whether the acquired assets meet the definition of an asset acquisition or a business combination. Transaction costs related to acquisitions that are not deemed to be businesses are included in the cost basis of the acquired assets, while transaction costs related to acquisitions that are deemed to be businesses are expensed as incurred.
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We capitalize direct construction and development costs, including predevelopment costs, interest, property taxes, insurance and other costs directly related and essential to the acquisition, development or construction of a real estate asset. We capitalize construction and development costs while substantive activities are ongoing to prepare an asset for its intended use. We consider a construction project as substantially complete and held available for occupancy upon the issuance of the certificate of occupancy. Costs incurred after a project is substantially complete and ready for its intended use, or after development activities have ceased, are expensed as incurred. For redevelopment, renovation and expansion of existing operating properties, we capitalize the cost for the construction and improvement incurred in connection with the redevelopment, renovation and expansion. Costs previously capitalized related to abandoned acquisitions or developments are charged to earnings. Expenditures for repairs and maintenance are expensed as incurred.
Depreciation is computed principally by the straight-line method for financial reporting purposes over the estimated useful lives of the assets, which range from 3 to 5 years for computers, 5 to 15 years for furniture and equipment, 35 to 50 years for buildings, 10 to 20 years for site improvements, 10 to 50 years for building improvements and the respective lease term for acquired lease intangibles.
During the fourth quarter of 2019 we sold a 170-bed skilled nursing center in our portfolio which was under a triple net master lease agreement. The property was evacuated in 2017 due to damages caused by hurricane and our operator provided us with insurance proceeds for remediation of the property. Upon sale of the property, we released our operator from its contractual obligation under the master lease to return the property back to its original condition, took possession of the remaining insurance proceeds of $2,111,000 and recorded this amount as Gain from property insurance proceeds on the Consolidated Statements of Income during the year ended December 31, 2019. Additionally, during 2020, we sold a 114-bed skilled nursing center in Texas and recorded a gain of $373,000 from insurance proceeds related to the property’s roof damage.
Mortgage Loans Receivable, Net of Loan Loss Reserve. Mortgage loans receivable we originate are recorded on an amortized cost basis.
Mezzanine Loans. In 2015 we strategically decided to allocate a portion of our capital deployment toward mezzanine loans to grow relationships with operating companies that have not typically utilized sale leaseback financing as a component of their capital structure. Mezzanine financing sits between senior debt and common equity in the capital structure, and typically is used to finance development projects or value-add opportunities on existing operational properties. We seek market-based, risk-adjusted rates of return typically between 7-12% with the loan term typically four to five years. Security for mezzanine loans can include all or a portion of the following credit enhancements; secured second mortgage, pledge of equity interests and personal/corporate guarantees. Mezzanine loans are recorded for GAAP purposes as either a loan, under notes receivable, or joint venture, under investment in unconsolidated JVs, depending upon specifics of the loan terms and related credit enhancements.
Investments in unconsolidated joint ventures. From time to time, we provide funding to third-party operators for the acquisition, development and construction (“ADC”) of a property. Under an ADC arrangement, we may participate in the residual profits of the project through the sale or refinancing of the property. These ADC arrangements can have characteristics similar to a loan or similar to a joint venture (“JV”) or partnership such as participating in the risks and rewards of the project as an owner or an investment partner. If the ADC arrangement characteristics are more similar to a jointly-owned investment or partnership, we account for the ADC arrangement as an investment in an unconsolidated JV under the equity method of accounting or a direct investment (consolidated basis of accounting) instead of applying loan accounting.
We evaluate our ADC arrangements first pursuant to Accounting Standard Codification (“ASC”) 810, Consolidation, to determine whether the ADC arrangement meets the definition of a VIE, as explained above, and whether we are the primary beneficiary. If the ADC arrangement is deemed to be a VIE but we are not the primary beneficiary, or if it is deemed to be a voting interest entity but we do not have a controlling financial interest, we account for our investment in the ADC arrangement using the equity method. Under the equity method, we initially record our investment at cost and subsequently recognize our share of net earnings or losses and other comprehensive income or loss, cash contributions made and distributions received, and other adjustments, as appropriate. Allocations of net
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income or loss may be subject to preferred returns or allocation formulas defined in operating agreements and may not be according to percentage ownership interests. In certain circumstances where we have a substantive profit-sharing arrangement which provides a priority return on our investment, a portion of our equity in earnings may consist of a change in our claim on the net assets of the underlying JV. Distributions of operating profit from the JVs are reported as part of operating cash flows, while distributions related to a capital transaction, such as a refinancing transaction or sale, are reported as investing activities. Currently we do not have any ADC arrangements.
We periodically perform evaluation of our investment in unconsolidated JVs to determine whether the fair value of each investment is less than the carrying value, and, if such decrease in value is deemed to be other-than-temporary, we write the investment down to its estimated fair value as of the measurement date.
Loan Loss Reserve. ASC 326, Financial Instruments- Credit Losses requires a forward looking “expected loss” model to be used for receivables, held-to-maturity debt, loans, and other instruments. When shared risk characteristics exist, ASC 326 requires a collective basis measurement of expected credit losses of the financial assets.
We adopted ASC 326 on January 1, 2020 and determined our Mortgage loans receivable and Notes receivable are within the scope of this ASU. We utilize the probability of default and discounted cash flow methods to estimate expected credit losses. Additionally, we stress-test the results to reflect the impact of unknown adverse future events including recessions. Upon adoption, we concluded that the adoption of ASC 326 did not have a material impact on our financial statements.
We elected not to measure an allowance for expected credit losses on accrued interest receivable under the expected credit loss standard as we have a policy in place to reserve or write off accrued interest receivable in a timely manner through our quarterly review of the loan and property performance. Therefore, we elected the policy to write off accrued interest receivable by reversing interest income and/or recognizing credit loss expense. As of December 31, 2021, the total balance of accrued interest receivable of $39,522,000 was not included in the measurement of expected credit loss. For the years ended December 31, 2021, 2020 and 2019, Company did not recognize any write-off related to accrued interest receivable.
Accrued incentives. As part of our acquisitions and/or amendments, we may commit to provide contingent payments to our sellers or lessees, upon the properties achieving certain rent coverage ratios. Typically, when the contingent payments are funded, cash rent will increase by the amount funded multiplied by a rate stipulated in the agreement. If it is deemed probable, the contingent payment is recorded as a liability at the estimate fair value calculated using a discounted cash flow analysis and accreted to the settlement amount of the estimated payment date. If the contingent payment is provided to the lessee, the estimated fair value is recorded as a lease incentive included in the Prepaid expenses and otherassets line item in our Consolidated Balance Sheets and is amortized as a yield adjustment over the life of the lease. This fair value measurement is based on significant inputs not observable in the market and thus represents a Level 3 measurement. The fair value of these contingent liabilities are evaluated on a quarterly basis based on changes in estimates of future operating results and changes in market discount rates.
Impairments. Assets that are classified as held-for-use are periodically evaluated for impairment when events or changes in circumstances indicate that the asset may be impaired or the carrying amount of the asset may not be recoverable through future undiscounted cash flows. Where indicators of impairment exist, the estimation required in the undiscounted future cash flow assumption includes management’s probability-weighting of various scenarios including whether the management modifies the lease with the existing operator versus identifying a replacement operator and the assumed market lease rate underlying projected future rental cash flows. In determining fair value, we use current appraisals or other third-party opinions of value and other estimates of fair value such as estimated discounted future cash flows. Based on our assessment, during the years ended December 31, 2021, 2020 and 2019, we recognized impairment charges of $0, $3,977,000 and $0, respectively, related to our real property investments.
Fair Value of Financial Instruments. The FASB requires the disclosure of fair value information about financial instruments for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that
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