MMA CAPITAL HOLDINGS, INC. SUMMARY OF FINANCIAL PERFORMANCE
Common shareholders' equity ("Book Value") increased $8.8 million in 2020 to
$289.9 million at December 31, 2020 . This change was driven by $8.4 million of
comprehensive income and $0.4 million of other increases in common shareholders'
equity.
Book Value per share increased
Book Value adjusted to exclude the carrying value of our net DTAs ("Adjusted
Book Value") increased $7.4 million in 2020 to $230.8 million at December 31,
2020 . This change was driven by $7.1 million of "Net income from continuing
operations before income taxes" and $0.3 million of other increases in Book
Value.
Adjusted Book Value per share increased
Refer to "Use of Non-GAAP Measures" for more information regarding the reconciliation of Adjusted Book Value and Adjusted Book Value per share to our most comparable GAAP measures.
Comprehensive Income
We recognized comprehensive income of$8.4 million during the year endedDecember 31, 2020 , which included$8.4 million of net income and$0.0 million of other comprehensive income. In comparison, we recognized$70.9 million of comprehensive income during the year endedDecember 31, 2019 , which consisted of$101.0 million of net income and$30.1 million of other comprehensive loss.
The
Net income from continuing operations before income taxes for the year endedDecember 31, 2020 was$7.1 million , or$1.23 per share, as compared to$40.5 million of net income, or$6.89 per share, for the year endedDecember 31 ,
2019.
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CONSOLIDATED BALANCE SHEET ANALYSIS
This section provides an overview of changes in our assets, liabilities and equity and should be read together with our consolidated financial statements, including the accompanying notes to the financial statements.
Table 4 provides Consolidated Balance Sheets for the periods presented.
Table 4: Consolidated Balance Sheets
At At
December 31 , December 31,
(in thousands, except per share data) 2020 2019
Change
Assets
Cash and cash equivalents $ 28,644 $ 8,555 $ 20,089
Restricted cash 17,617 4,250 13,367
Investments in debt securities 31,038 31,365 (327)
Investments in partnerships 376,198 316,677 59,521
Deferred tax assets, net 59,083 57,711 1,372
Loans held for investment - 54,100 (54,100)
Other assets 20,482 12,984 7,498
Total assets $ 533,062 $ 485,642 $ 47,420
Liabilities
Debt $ 237,805 $ 201,816 $ 35,989
Accounts payable and accrued expenses 2,845 2,527 318
Other liabilities 2,528 174 2,354
Total liabilities $ 243,178 $ 204,517 $ 38,661
Book Value: Basic and Diluted $ 289,884 $
281,125
Less: Deferred tax assets, net 59,083
57,711 1,372
Adjusted Book Value: Basic and Diluted (1)
Common shares outstanding: Basic and Diluted 5,820 5,805 15 Book Value per common share: Basic and Diluted$ 49.81 $
48.43
Adjusted Book Value per common share: Basic and Diluted (1)$ 39.66 $ 38.49 $ 1.17
(1) Adjusted Book Value and Adjusted Book Value per common share are financial
measures that are determined other than in accordance with GAAP. These
non-GAAP financial measures are used to show the amount of our net worth in
the aggregate and on a per-share basis, without giving effect to changes in
Book Value due to the partial release of our deferred tax asset valuation
allowance as of
Non-GAAP Measures" for more information, including a reconciliation of these
non-GAAP financial measures to the most directly comparable historical
measures determined under GAAP.
Cash and cash equivalents increased primarily due to the Company's financing
activities. Refer to the summary of cash flows within the "Liquidity and Capital
Resources" section of Item 7. "Management's Discussion and Analysis of Financial
Condition and Results of Operations" for additional information.
Restricted cash increased primarily as a result of cash collateral required by our counterparty in connection with the financing transaction involving the Company's Infrastructure Bond investment.
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Investments in debt securities decreased primarily due to principal payments received on the Company's Infrastructure Bond investment during the year endedDecember 31, 2020 . Investments in partnerships increased primarily as a result of net capital contributions of$34.4 million that we made to theSolar Ventures and the recognition of$39.6 million of equity in income of our investees. The impact of these items was partially offset by the effects of (i)$12.7 million of impairment losses recognized for the year endedDecember 31, 2020 , related to our equity investment in the SF Venture; and (ii) a distribution from SAWHF of 7.2 million common shares of a listed residential REIT that reduced the book value of our equity investment in such fund by$2.9 million .
Deferred tax assets, net increased
Loans held for investment decreased primarily due to the repayment of the
Company's
Other Assets increased primarily as a result of$7.1 million of land improvement costs that were capitalized in connection with a real estate investment that is in process of development and the aforementioned distribution from SAWHF of REIT common shares. Debt increased primarily as a result of proceeds received in the second quarter of 2020 related to the financing transactions involving the Company's Infrastructure Bond investment and direct investment in real estate. Additional amounts drawn on our revolving credit facility during the year endedDecember 31, 2020 , was also a contributing factor. 27
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CONSOLIDATED RESULTS OF OPERATIONS
This section provides a comparative discussion of our Consolidated Results of Operations and should be read in conjunction with our consolidated financial statements, including the accompanying notes. See "Critical Accounting Policies and Estimates," for more information concerning the most significant accounting policies and estimates applied in determining our results of operations.
Net Income
Table 5 summarizes net income for the periods presented.
Table 5: Net Income
For the year ended
December 31,
(in thousands) 2020 2019 Change
Net interest income $ 1,800 $ 8,716 $ (6,916)
Non-interest income
Equity in income from unconsolidated
funds and ventures 43,519 21,904 21,615
Net (losses) gains (3,758) 26,490 (30,248)
Other income 72 424 (352)
Other expenses
Other interest expense (8,954) (5,774) (3,180)
Impairment losses (12,731) - (12,731)
Operating expenses (12,803) (11,257) (1,546)
Net income from continuingoperations before income taxes 7,145 40,503
(33,358) Income tax benefit 1,229 60,482 (59,253) Net loss from discontinued operations, net of tax - (8) 8 Net income$ 8,374 $ 100,977 $ (92,603) Net Interest Income
Net interest income represents interest income earned on our investments in bonds, loans and other interest-earning assets less our cost of funding associated with the debt that we use to finance these assets.
Net interest income for the year endedDecember 31, 2020 , declined compared to that reported for the year endedDecember 31, 2019 , primarily due to: (i) the full repayment of the Hunt Note in the first quarter of 2020; (ii) the recharacterization in the fourth quarter of 2019 of an interest-bearing loan receivable from Hunt into an equity investment in SDL; and (iii) the disposition and redemption of various bond-related investments throughout 2019.
Equity in Income from Unconsolidated Funds and Ventures
Equity in income from unconsolidated funds and ventures includes our allocable share of the earnings or losses from the funds and ventures in which we have an equity interest.
Table 6 summarizes equity in income from unconsolidated funds and ventures for the periods presented.
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Table 6: Equity in Income from Unconsolidated Funds and Ventures
For the year ended
December 31,
(in thousands) 2020 2019 Change
Solar Ventures $ 39,560 $ 20,758 $ 18,802 U.S. real estate partnerships 3,126 1,058
2,068
SAWHF 833 88
745
Equity in income from unconsolidated funds and ventures$ 43,519 $ 21,904 $ 21,615 Equity in income from theSolar Ventures for the year endedDecember 31, 2020 , increased compared to that reported for the year endedDecember 31, 2019 , primarily as a result of an increase in both the amount of equity contributed into theSolar Ventures and weighted-average UPB of loans made by theSolar Ventures . However, as further discussed in Part I, Item 1. "Business," the amount of equity in income of theSolar Ventures that will be recognized in the first quarter of 2021 is expected to be adversely impacted by losses borne by theSolar Ventures in connection with various advances and other loss mitigation actions taken by theSolar Ventures . Equity in income fromU.S. real estate partnerships for the year endedDecember 31, 2020 , increased compared to that reported for the year endedDecember 31, 2019 , primarily due to the recognition of nonrecurring net income at the SF Venture in the fourth quarter of 2020 that stemmed primarily from the termination of a lease with an anchor tenant, which accelerated the amortization of a below-market lease intangible liability into rental income. We anticipate that we will continue to recognize equity in losses from the SF Venture for the foreseeable future. Equity in income from the Company's equity investment in SAWHF for the year endedDecember 31, 2020 , increased compared to that reported for the year endedDecember 31, 2019 , primarily as a result of an increase in the amount of fair value gains recognized by SAWHF in connection with its investment holdings.
Net (Losses) Gains
Net (losses) gains may include net realized and unrealized gains or losses relating to bonds, loans, derivatives, other assets, real estate and other investments as well as gains or losses realized by the Company in connection with the extinguishment of debt obligations.
The Company recognized net losses for the year endedDecember 31, 2020 , compared to net gains reported for the year endedDecember 31, 2019 , primarily due to nonrecurring gains of$28.6 million that were recognized in 2019 in connection with the sale or redemption of bond investments.
Other Interest Expense
Other interest expense for the year endedDecember 31, 2020 , increased compared to that reported for the year endedDecember 31, 2019 , primarily due to the recognition of a full year of interest expense in 2020 associated with advances on the Company's revolving credit facility. The increase in interest expense was partially offset by a reduction in interest expense associated with subordinated debt that was attributable to a decrease in three-month LIBOR.
Impairment Losses
Impairment losses for the year ended
Operating Expenses
Operating expenses include management fees and reimbursable expenses payable to
our External Manager, general and administrative expense, professional fees and
other miscellaneous expenses.
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Table 7 summarizes operating expenses for the periods presented.
Table 7: Operating Expenses
For the year ended
December 31,
(in thousands) 2020 2019 Change
External management fees and reimbursable expenses $ (8,260) $ (7,248) $ (1,012)
General and administrative (1,512) (1,304) (208)
Professional fees (2,783) (2,472) (311)
Other expenses (248) (233) (15)
Total operating expenses $ (12,803) $ (11,257) $ (1,546) Operating expenses for the year endedDecember 31, 2020 , increased compared to that reported for the year endedDecember 31, 2019 , primarily due to: (i) an increase in the amount of compensation-related expense reimbursements that were payable to the External Manager as the reimbursement cap increased by$1.0 million for 2020; (ii) an increase in general and administrative expense associated with director fees that stemmed from the addition of two independent directors during the first quarter of 2020 and our former Chief Executive Officer becoming a non-employee director during the third quarter of 2020; and (iii) an increase in legal and consulting fees associated with business strategy and related matters. Income Tax Benefit
Income tax benefit for the year endedDecember 31, 2020 , decreased compared to that reported for the year endedDecember 31, 2019 , primarily due to a decrease in the magnitude of recognized releases of the DTA valuation allowance. 30
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LIQUIDITY AND CAPITAL RESOURCES
Liquidity
Liquidity is a measure of our ability to meet potential short-term (within one year) and long-term cash requirements, including ongoing commitments to repay borrowings, fund and maintain our current and future assets and other general business needs. Our sources of liquidity include: (i) cash and cash equivalents; (ii) cash flows from operating activities; (iii) cash flows from investing activities; and (iv) cash flows from financing activities.
Summary of Cash Flows
Table 8 provides a consolidated view of the change in cash, cash equivalents and restricted cash of the Company for the periods presented. AtDecember 31, 2020 andDecember 31, 2019 ,$17.6 million and$4.3 million , respectively, of amounts presented below represented restricted cash.
Table 8: Net Increase in Cash, Cash Equivalents and Restricted Cash
For the year ended
(in thousands) December 31, 2020 Cash, cash equivalents and restricted cash at beginning of period $
12,805
Net cash provided by (used in): Operating activities 17,967 Investing activities (21,232) Financing activities 36,721
Net increase in cash, cash equivalents and restricted cash
33,456
Cash, cash equivalents and restricted cash at end of period $
46,261
For the year ended
(in thousands) December 31, 2019 Cash, cash equivalents and restricted cash at beginning of period $
33,878
Net cash provided by (used in): Operating activities 8,901 Investing activities (114,662) Financing activities 84,688
Net decrease in cash, cash equivalents and restricted cash
(21,073)
Cash, cash equivalents and restricted cash at end of period $
12,805
Operating Activities
Cash flows from operating activities include, but are not limited to, interest income on our investments, and income distributions from our investments in unconsolidated funds and ventures.
Net cash flows provided by operating activities during the year endedDecember 31, 2020 , increased$9.1 million compared to such net cash flows during the year endedDecember 31, 2019 . This net increase was primarily driven by (i) a$18.7 million increase in distributions received from the Company's investment in theSolar Ventures and (ii) a$1.3 million decline in interest expense associated with the subordinated debt that was primarily attributable to a decrease in three-month LIBOR (the weighted average interest pay rate on the outstanding debt was 2.9% and 4.4% for the years endedDecember 31, 2020 andDecember 31, 2019 , respectively). The impact of these increases was partially offset by: (i) a$4.8 million decline in interest received due to the disposition and redemption of various bond investments during 2019 and the full repayment of the Hunt Note in the first quarter of 2020; (ii) a$4.3 million increase in interest expense due to the recognition of a full year of interest expense in 2020 associated with advances on the Company's revolving credit facility; and (iii) a$1.1 million increase in management fees and expense reimbursements paid to
our
External Manager.
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Investing Activities
Net cash flows associated with investing activities include, but are not limited
to, principal payments; capital contributions and distributions; advance of
loans held for investment; and sales proceeds from the sale of bonds, loans and
real estate and other investments.
Net cash flows used in investing activities during the year ended December 31,
2020 decreased $93.4 million compared to such net cash flows during the year
ended December 31, 2019 . This net decrease was primarily driven by: (i) a $100.6
million increase in capital distributions received from the Company's
investments in partnerships during 2020 that almost exclusively related to the
Solar Ventures ; (ii) the full repayment of the $53.6 million Hunt Note during
the first quarter of 2020, which represented a $9.4 million increase in net
principal payments received in 2020 as compared to the amount of bond-related
sales proceeds and Hunt Note principal payments received in 2019; and (iii) an
$11.0 million decrease in cash used for advances on, and originations of, loans
held for investment. The effects of these items were partially offset by a $25.5
million increase in 2020 in capital contributions to the Company's investments
in partnerships that primarily related to the Solar Ventures .
Financing Activities
Net cash flows provided by financing activities during the year endedDecember 31, 2020 decreased$48.0 million compared to such net cash flows during the year endedDecember 31, 2019 . This decrease was primarily attributable to an$85.3 million decrease in net advances from the revolving credit facility in 2020. This decrease was partially offset by: (i)$33.0 million of proceeds associated with second quarter 2020 financing transactions associated with the Company's Infrastructure Bond investment and direct investment in real estate that is in process of being developed; (ii) a$2.7 million decrease in cash used during 2020 to repurchase the Company's common shares; and (iii) a$2.2 million decrease in debt issuance costs incurred in 2020 associated with debt issuances in the second quarter of 2020 as compared to such costs incurred in 2019 in connection with the revolving credit facility.
Capital Resources
Our debt obligations include liabilities that we recognized in connection with our subordinated debt, revolving credit facility debt and other notes payable. The major types of debt obligations of the Company are further discussed below. We use the revolving credit facility to finance our investments in theSolar Ventures . See Notes to Consolidated Financial Statements - Note 6, "Debt," for more information. Table 9 summarizes the carrying values and weighted-average effective interest rates of the Company's debt obligations that were outstanding atDecember 31, 2020 andDecember 31, 2019 . Table 9: Debt At At December 31, 2020 December 31, 2019 Wtd. Avg. Wtd. Avg. Effective Effective Carrying Interest Carrying Interest (dollars in thousands) Value (1) Rate (1) Value (1) Rate (1) Subordinated debt$ 93,212 1.5 %$ 95,488 3.2 %
Revolving credit facility debt obligations 103,700 5.6
94,500 5.6
Notes payable and other debt 17,739 7.2 8,328 13.0
Asset related debt 23,154 2.5 3,500 5.0
Total debt $ 237,805 3.8 % $ 201,816 4.8 %
(1) Carrying value amounts and weighted-average interest rates reported in this
table include the effects of any discounts, premiums and other cost basis
adjustments. An effective interest rate represents an internal rate of return
of a debt instrument that makes the net present value of all cash flows,
inclusive of cash flows that give rise to cost basis adjustments, equal zero
and in the case of (i) fixed rate instruments, is measured as of an
instrument's issuance date and (ii) variable rate instruments, is measured as
of each date that a reference interest rate resets.
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Subordinated Debt
At December 31, 2020 and December 31, 2019 , the Company had subordinated debt
obligations that had a total UPB of $86.3 million and $88.0 million ,
respectively. This debt included four tranches that amortize 2.0% per annum over
their contractual lives, are due to mature with balloon payments between March
2035 and July 2035 and require the Company to pay interest based upon
three-month LIBOR plus a fixed spread of 2.0%. At December 31, 2020 the weighted
average interest pay rate on the outstanding debt was 2.2%.
Revolving Credit Facility Debt Obligations
AtDecember 31, 2020 andDecember 31, 2019 , MEH, a wholly owned subsidiary of the Company, had borrowed$103.7 million and$94.5 million , respectively, from the revolving credit facility. This debt obligation, which is guaranteed by the Company and secured by (i) specific assets of the Borrower and (ii) a pledge of all of the Company's equity interest in the Borrower, which in turn owns our equity investments in theSolar Ventures , matures onSeptember 19, 2022 , and is subject to a 12-month extension solely to allow refinancing or orderly repayment of the debt obligation. This debt obligation bears interest equal to one-month LIBOR (subject to a 1.5% floor) plus a fixed spread of 2.75%, which, atDecember 31, 2020 was 4.25%. Notes Payable and Other Debt
At
AtDecember 31, 2020 andDecember 31, 2019 ,$4.0 million and$6.8 million , respectively, of this debt relates to financing that was obtained to complete the purchase of the Company's 11.85% ownership interest in SAWHF. This debt, which is denominated in South African rand, has a maturity date ofDecember 24, 2021 , and requires the Company to pay interest based upon theJohannesburg Interbank Agreed Rate ("JIBAR") plus a fixed spread of 5.15%. AtDecember 31, 2020 , the interest rate on this debt was 8.7%. AtDecember 31, 2020 andDecember 31, 2019 ,$4.3 million and$1.5 million , respectively, of the notes payable and other debt relates to debt obligations to theMorrison Grove Management, LLC principals ("MGM Principals "). This debt bears interest at 5.0%. The$2.8 million debt obligation amortizes over its contractual life and is due to mature onJanuary 1, 2026 . The$1.5 million debt obligation is interest only untilMarch 31, 2026 and then amortizes in three equal installments until its maturity date ofJanuary 1, 2027 . OnJune 1, 2020 , the Company entered into a$10.0 million construction loan that is secured by our direct investment in real estate that is in the process of development. The initial advance from this debt was$9.3 million and$0.5 million of capacity has been reserved for interest payments. The total amount advanced by the lender will not exceed 65% of the value of the pledged real estate plus 75% of the total development allowable hard costs incurred by the borrower. The loan is prepayable at any time without penalty, with all net proceeds realized from the sale of any portion of the real property required to be used to repay the outstanding UPB of the loan. Construction draws may not exceed a total principal sum of$11.1 million over the life of the facility, with the maximum outstanding UPB at any point in time not to exceed$10.0 million . The contractual maturity date of this facility isJune 1, 2023 , although the facility is subject to three extension options (at the discretion of the borrower and lender): (i) the first extension term would expire onNovember 1, 2023 ; (ii) the second extension term would expire onMay 1, 2024 and (iii) the final amortized term would expire three years after the initial term, first extension term and second extension term, as applicable. Amounts drawn from this debt facility are repayable on an interest only basis at a rate of 4.85% with all outstanding principal due at maturity during the initial term, first extension term and second extension term. However, during the final extension term the debt bears interest at a rate of three-month LIBOR plus 3.0% per annum, subject to a 5.0% floor with principal amortization required monthly over the three-year extension term. Obligations associated with this debt are guaranteed by the Company. AtDecember 31, 2020 , this debt obligation had a carrying value of$9.4 million .
Asset Related Debt
Asset related debt is debt that finances interest-bearing assets of the Company.
The interest expense associated with this debt is included within "Net interest
income" on the Company's Consolidated Statements of Operations.
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Bond Related Debt
On June 5, 2020 , the Company entered into a TRS agreement involving our
Infrastructure Bond, which was sold concurrently to our TRS counterparty.
Proceeds received in connection with the conveyance of such bond investment were
reported as a secured borrowing. The TRS agreement has a maturity date of June
6, 2022 , and requires the Company to pay interest based upon the Securities
Industry and Financial Markets Association index rate, subject to a 0.5% floor,
plus a spread of 2.0%, which, at December 31, 2020 , was 2.5%. These payment
terms are used to accrue interest expense related to the secured borrowing that
was recognized upon conveyance of the Company's bond investment. Additionally,
as required under the terms of the TRS agreement, the Company pledged cash
collateral of $10.0 million representing 37.5% of the referenced bond's UPB. At
December 31, 2020 , this debt obligation had a UPB of $23.3 million .
Additionally, under the terms of the TRS, the Company's TRS counterparty is
entitled to share in 10% of the increase in fair value, if any, of the
Infrastructure Bond between the trade and termination dates of the TRS
agreement. For reporting purposes, this provision is treated as a freestanding
derivative instrument that is reported on a fair value basis.
Non-bond Related Debt
AtDecember 31, 2019 , the Company had a debt obligation toMGM Principals with a UPB of$3.5 million . Upon the full redemption of the Hunt Note onJanuary 3, 2020 , this asset related debt obligation to theMGM Principals was reclassified to notes payable and other debt.
Covenant Compliance
At
Off-Balance Sheet Arrangements
At
Other Contractual Commitments The Company is committed to make additional capital contributions to certain of its investments in partnerships and ventures. Refer to Notes to Consolidated Financial Statements - Note 3, "Investments in Partnerships," for more information. AtDecember 31, 2019 , the Company, through its wholly owned subsidiary REL, had unfunded loan commitments of$1.6 million . OnDecember 30, 2020 , this loan was repaid in full. Refer to Notes to Consolidated Financial Statements - Note 4, "Loans Held for Investment ("HFI")" for more information. The Company uses derivative instruments to hedge interest rate and foreign currency risks. Depending upon movements in reference interest and foreign exchange rates, the Company may be required to make payments to the counterparties to these agreements. Refer to Notes to Consolidated Financial Statements - Note 7, "Derivative Instruments," for more information about these instruments. Other Capital Resources
Dividend and Share Buyback Policy
The Board makes the final determination regarding dividends and share buyback plans based on our External Manager's recommendation, which is based on an evaluation of a number of factors, including our financial condition, business prospects, the predictability of recurring cash flows from operations and available cash, as well as other factors the Board deems relevant. The Board does not believe paying a dividend or repurchasing shares is appropriate at
the
current time.
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Tax Benefits Rights Agreement
EffectiveMay 5, 2015 , the Company adopted a Tax Benefits Rights Agreement (the "Rights Plan") designed to help preserve the Company's NOLs. In connection with adopting the Rights Plan, the Company declared a distribution of one right per common share to shareholders of record as ofMay 15, 2015 . The rights do not trade apart from the current common shares until the distribution date, as defined in the Rights Plan. Under the Rights Plan, the acquisition by an investor (or group of related investors) of greater than a 4.9% stake in the Company, could result in all existing shareholders other than the new 4.9% holder having the right to acquire new shares for a nominal cost, thereby significantly diluting the ownership interest of the acquiring person. OnMarch 11, 2020 , the Board approved an extension of the original five-year term of the Rights Plan untilMay 5, 2023 , or until the Board determines that the plan is no longer needed, whichever comes first. Subsequently, shareholders ratified the Board's decision to extend the Rights Plan at the Company's 2020 annual meeting of shareholders. OnJanuary 3, 2018 , the Board approved a waiver of the 4.9% ownership limitation with respect to Hunt, increasing the limitation to 9.9% of the Company's issued and outstanding shares in any rolling 12-month period without causing a triggering event. AtDecember 31, 2020 , the Company had two shareholders who held greater than a 4.9% interest in the Company, one of whom is its former Chief Executive Officer and current Chairman of the Board,Michael L. Falcone . OnMarch 11, 2020 , the Board namedMr. Falcone an exempted person in accordance with the Rights Plan for open-market share purchases of up to an additional 7,500 common shares made on or beforeDecember 31, 2020 , with the Board reserving all of its rights under the Rights Plan for any subsequent purchase. UponMr. Falcone's resignation as Chief Executive Officer onAugust 12, 2020 , he became eligible for Board compensation. Pursuant to the policy of our Governance Committee, each Board member receives one-half of his or her Board compensation in common shares. OnNovember 5, 2020 , the Board adopted an Amended and Restated 2012 Non-Employee Directors' Compensation Plan to coordinate elements of the Rights Plan and share compensation for directors. In addition, the Board namedMr. Falcone an exempted person in accordance with the Rights Plan for purposes of his share-based Board compensation. 35 Table of Contents
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of our consolidated financial statements is based on the application of GAAP, which requires us to make certain estimates and assumptions that affect the reported amounts and classification of the amounts in our consolidated financial statements. These estimates and assumptions require us to make difficult, complex and subjective judgments involving matters that are inherently uncertain. We base our accounting estimates and assumptions on historical experience and on judgments that we believe to be reasonable under the circumstances known to us at the time. Actual results could differ materially from these estimates. We applied our critical accounting policies and estimation methods consistently in all material respects and for all periods presented and have discussed those policies with our Audit Committee. We evaluate our critical accounting estimates and judgments required by our policies on an ongoing basis and update them as necessary based on changing conditions. Management has discussed any significant changes in judgments and assumptions in applying our critical accounting policies with the Audit Committee of our Board. See Part I, Item 1A. "Risk Factors" of this Report for a discussion of the risks associated with the need for management to make judgments and estimates in applying our accounting policies and methods. We have identified three of our accounting policies as critical because they involve significant judgments and assumptions about highly complex and inherently uncertain matters, and the use of reasonably different estimates and assumptions could have a material impact on our reported results of operations or financial condition. These policies govern:
? Income taxes;
? fair value measurement of financial instruments; and
? consolidation. Income Taxes All of our business activities, with the exception of our foreign investments, are conducted by entities included in our consolidated corporate federal income tax return. To determine the financial statement impact of accounting for income taxes, including the provision for income tax expense and unrecognized tax benefits, the Company must make assumptions and judgments about how to interpret and apply these complex tax laws to numerous transactions and business events, as well as make judgments regarding the timing of when certain items may affect taxable income in theU.S. and non-U.S. tax jurisdictions. Our interpretations of tax laws are subject to review and examination by the various taxing authorities in the jurisdictions where we operate, and disputes may occur regarding our view on a tax position. These disputes over interpretations with the various taxing authorities may be settled by audit, administrative appeals or adjudication in the court systems of the tax jurisdictions in which we operate. We regularly review whether additional income taxes may be assessed as a result of the resolution of these matters, and we record additional reserves as appropriate. In addition, we may revise our estimate of income taxes due to changes in income tax laws, legal interpretations, and business strategies. It is possible that revisions in our estimate of income taxes may materially affect our results of operations in any reporting period. The Company's provision for income taxes is composed of current and deferred taxes. Deferred taxes arise from differences between assets and liabilities measured for financial reporting versus income tax return purposes. DTAs are recognized if, in management's judgment, it is more likely than not that tax benefits, including NOLs and other tax attributes, will be realized prior to their expiration. We perform regular reviews to ascertain whether our DTAs are realizable. These reviews include management's estimates and assumptions regarding future taxable income, which also incorporates various tax planning strategies, including strategies that may be available to utilize NOLs before they expire. In connection with these reviews, if it is determined that a DTA is not realizable, a valuation allowance is established. Management's estimates and assumptions, which generally reflect objectively verifiable expectations, involve significant judgment and are inherently uncertain. Risks to our forward-looking estimates of pretax book income include, but are not limited to, changes in market rates of return, additional competitors entering the marketplace (which would reduce rates of return due to competition for new borrowers), limits on access to investible capital that would limit new investments that could be made by the Company, changes in the law and the Company's dependence on a small, specialized team of the External Manager for origination and underwriting activities. Given these risks, our forward-looking estimates could materially differ from actual results. 36 Table of Contents AtDecember 31, 2020 , we maintained a valuation allowance against that portion of our DTAs that relate to federal and state NOL carryforwards that we expect will expire prior to utilization based on our forecast of pretax book income. Refer to Notes to Consolidated Financial Statements - Note 14, "Income Taxes," for more information about the Company's DTAs and other considerations associated with the Company's income taxes.
Fair Value Measurement of Financial Instruments
Fair value measurement is a critical accounting estimate because we account, or provide disclosures, for a portion of our assets and liabilities based upon their fair value. The techniques that we use to determine fair value are described in Notes to Consolidated Financial Statements - Note 8, "Fair Value."
Applicable accounting standards that govern fair value measurements provide a framework for measuring fair value and establishes a three-level fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value based on the assumptions a market participant would use at the measurement date. The three levels of the fair value hierarchy are described below:
? Level 1: Quoted prices (unadjusted) in active markets for identical assets or
liabilities.
? Level 2: Observable market-based inputs, other than quoted prices in active
markets for identical assets or liabilities.
? Level 3: Unobservable inputs
The measurement of fair value requires management to make judgments and assumptions. The type and level of judgment required is largely dependent on the amount of observable market information available to the Company. For instruments valued using internally developed valuation models and other valuation techniques that use significant unobservable inputs and are therefore classified within level 3 of the valuation hierarchy, judgments used to estimate fair value are more significant than those required when estimating the fair value of instruments classified within levels 1 and 2. These judgments and assumptions may have a significant effect on our measurements of fair value, and the use of different judgments and assumptions, as well as changes in market conditions, could have a material effect on our Consolidated Statements of Comprehensive Income and Consolidated Balance Sheets.
In arriving at an estimate of fair value for an instrument within level 3, management must first determine the appropriate valuation technique to use. Second, the lack of observability of certain significant inputs requires management to assess all relevant empirical data in deriving valuation inputs including, for example, market yields of thinly-traded investments, capitalization rates and NOI annual growth rates.
For further discussion of the valuation of level 3 instruments, including unobservable inputs used, refer to Notes to Consolidated Financial Statements - Note 8, "Fair Value."
Imprecision in estimating unobservable market inputs or other factors can affect the amount of gain or loss recorded for a particular position. Furthermore, while we believe that our valuation methods are appropriate and consistent with those of other market participants, the methods and assumptions used reflect management judgment and may vary across the Company's businesses and portfolios.
Consolidation
We have equity investments in partnerships and other entities to which we apply
Accounting Standards Codification ("ASC") Topic No. 810, "Consolidation" in
order to determine if we need to consolidate any of these entities. There is
considerable judgment in assessing whether to consolidate an entity under these
accounting principles. Some of the criteria we are required to consider include:
? The determination as to whether an entity is a variable interest entity
("VIE").
If the entity is considered a VIE, then a determination of whether the Company
would be assessed to be the primary beneficiary of the VIE is needed and
? requires us to make judgments regarding (i) our power to direct the activities
of the VIE that most significantly impact the VIE's economic performance and
(ii) our obligation to
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absorb losses of the VIE that could potentially be significant to the VIE or our
right to receive benefits from the VIE that could potentially be significant to
the VIE. These assessments require a significant analysis of all of the variable
interests in an entity, any related party considerations and other features that
make this analysis difficult and highly judgmental.
If the entity is required to be consolidated, then upon initial consolidation,
we record the assets, liabilities and noncontrolling interests at fair value.
Consequently, we would be required to make various judgments in connection with
the fair value measurement of these items at the time an entity is first
? consolidated. For example, since certain of our equity investments are in
partnerships that own real estate or are real estate related investments, we
would be required to make judgments related to the forecasted cash flows to be
generated from the investments such as rental revenue and operating expenses,
vacancy, replacement reserves and tax benefits, if any. In addition, we would
be required to make judgments about discount rates and capitalization rates.
As of
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ACCOUNTING AND REPORTING DEVELOPMENTS
We identify and discuss the expected impact on our consolidated financial statements of recently issued accounting guidance in Notes to Consolidated Financial Statements - Note 1, "Summary of Significant Accounting Policies."
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USE OF NON-GAAP MEASURES
We present certain non-GAAP financial measures that supplement the financial
measures we disclose that are calculated under GAAP. Non-GAAP financial measures
are those that include or exclude certain items that are otherwise excluded or
included, respectively, from the most directly comparable measures calculated in
accordance with GAAP. The non-GAAP financial measures that we disclose are not
intended as a substitute for GAAP financial measures and may not be defined or
calculated the same way as similar non-GAAP financial measures used by other
companies.
Adjusted Book Value represents Book Value reduced by the carrying value of the
Company's DTAs. We believe this measure is useful to investors in assessing the
Company's underlying fundamental performance and trends in our business because
it eliminates potential volatility in results brought on by tax considerations
in a given year. As a result, reporting upon, and measuring changes in, Adjusted
Book Value enables a better comparison of period-to-period operating
performance.
Adjusted Book Value per common share represents Adjusted Book Value at the period end divided by the common shares outstanding at the period end.
Management intends to continually evaluate the usefulness, relevance, limitations and calculations of our reported non-GAAP performance measures to determine how best to provide relevant information to the public.
Table 10 provides reconciliations of the non-GAAP financial measures that are included in this Report to the most directly comparable GAAP financial measures.
Table 10: Non-GAAP Reconciliations
At At
December 31 , December 31 ,(in thousands, except per share data) 2020
2019
Reconciliation of Book Value to Adjusted Book Value
Book Value (total shareholders' equity), as reported
$ 281,125 Less: DTAs, net 59,083 57,711 Adjusted Book Value$ 230,801 $ 223,414 Common shares outstanding 5,820 5,805
Reconciliation of Book Value per share to Adjusted Book Value per common share Book Value (total shareholders' equity) per common share, as reported
$ 49.81 $ 48.43 Less: DTAs, net per common share 10.15 9.94 Adjusted Book Value per common share$ 39.66
$ 38.49 40 Table of Contents
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