Claros Mortgage Trust, Inc. (CMTG) FY 2021 MD&A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion should be read in conjunction with our consolidated financial statements and notes thereto appearing elsewhere in this Annual Report on Form 10-K.  In addition to historical data, this discussion contains forward-looking statements about our business, operations and financial performance based on current expectations that involve risks, uncertainties and assumptions.  Our actual results may differ materially from those in this discussion as a result of various factors, including but not limited to those discussed in Part 1. Item 1A, “Risk Factors” in this Annual Report on Form 10-K.

Introduction

We are a CRE finance company focused primarily on originating senior and subordinate loans on transitional CRE assets located primarily in major U.S. markets, including mortgage loans secured by a first priority or subordinate mortgage on transitional CRE assets, and subordinate loans including mezzanine loans secured by a pledge of equity ownership interests in the direct or indirect property owner rather than directly in the underlying commercial properties. These loans are subordinate to a mortgage loan but senior to the property owner’s equity ownership interests. Transitional CRE assets are properties that require repositioning, renovation, rehabilitation, leasing, development or redevelopment or other value-added elements in order to maximize value. We believe our Sponsor’s real estate development, ownership and operations experience and infrastructure differentiates us in lending on these transitional CRE assets. Our objective is to be a premier provider of debt capital for transitional CRE assets and, in doing so, to generate attractive risk-adjusted returns for our stockholders over time, primarily through dividends. We strive to create a diversified investment portfolio of CRE loans that we generally intend to hold to maturity. We focus primarily on originating loans ranging from $50 million to $300 million on transitional CRE assets located in major U.S. markets with attractive fundamental characteristics supported by macroeconomic tailwinds.

We were organized as a Maryland corporation on April 29, 2015 and commenced operations on August 25, 2015, and are traded on the New York Stock Exchange, or NYSE, under the symbol “CMTG”. We have elected and believe we have qualified to be taxed as a REIT for U.S. federal income tax purposes commencing with our taxable year ended December 31, 2015. We are externally managed and advised by our Manager, an investment adviser registered with the SEC pursuant to the Advisers Act. We operate our business in a manner that permits us to maintain our exclusion from registration under the 1940 Act.

Recent Market Conditions

Since the onset of COVID-19, the global impact of the outbreak has rapidly evolved, and more normalized activities have resumed. However, despite federal and state government intervention, including economic stimulus measures, and vaccine availability, the prolonged duration and the severity of the COVID-19 pandemic and its impact remain highly uncertain and could have a material adverse effect on our business. Such impacts include supply chain disruptions, labor shortages, return-to-work, inflation, and are highly uncertain and cannot be predicted at this time. For additional information on the factors that impacted us to date, and which may continue to, see Item 1A, “Risk Factors”.

I. Key Financial Measures and Indicators

As a CRE finance company, we believe the key financial measures and indicators for our business are net income per share, dividends declared per share, Distributable Earnings per share, Net Distributable Earnings per share, book value per share, adjusted book value per share, Net Debt-to-Equity Ratio and Total Leverage Ratio. During the year ended December 31, 2021, we had net income per share of $1.27, declared dividends of $1.48 per share, had Distributable Earnings per share of $1.25, and had Net Distributable Earnings of $1.25 per share. As of December 31, 2021, our book value per share was $18.35, our adjusted book value per share was $18.88, our Net-Debt-to-Equity Ratio was 1.7x, and our Total Leverage Ratio was 2.1x. We use Net Debt-to-Equity Ratio and Total Leverage Ratio, financial measures which are not prepared in accordance with GAAP, to evaluate our financial leverage, which in the case of our Total Leverage Ratio, makes certain adjustments that we believe provide a more conservative measure of our financial condition.

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Net Income Per Share and Dividends Declared Per Share

The following table sets forth the calculation of basic and diluted net income per share and dividends declared per share (in thousands, except share and per share data):

Distributable Earnings and Net Distributable Earnings

Distributable Earnings and Net Distributable Earnings are non-GAAP measures used to evaluate our performance excluding the effects of certain transactions, non-cash items and GAAP adjustments, as determined by our Manager, that we believe are not necessarily indicative of our current performance and operations. Distributable Earnings is a non-GAAP measure, which we define as net income as determined in accordance with GAAP, excluding (i) non-cash equity compensation expense (income), (ii) incentive fees, (iii) real estate depreciation and amortization, (iv) any unrealized gains or losses from mark-to-market valuation changes (other than permanent impairments) that are included in net income for the applicable period, (v) one-time events pursuant to changes in GAAP and (vi) certain non-cash items, which in the judgment of our Manager, should not be included in Distributable Earnings. Net Distributable Earnings is Distributable Earnings less incentive fees due to our Manager. Pursuant to the Management Agreement, we use Core Earnings, which is substantially the same as Distributable Earnings, to determine the incentive fees we pay our Manager. Distributable Earnings is substantially the same as Core Earnings, as defined in the Management Agreement, for the periods presented.

We believe that Distributable Earnings and Net Distributable Earnings provide meaningful information to consider in addition to our net income and cash flows from operating activities determined in accordance with GAAP. We believe the Distributable Earnings and Net Distributable Earnings measures help us to evaluate our performance excluding the effects of certain transactions, non-cash items and GAAP adjustments, as determined by our Manager, that we believe are not necessarily indicative of our current performance and operations. Distributable Earnings and Net Distributable Earnings do not represent net income or cash flows from operating activities and should not be considered as an alternative to GAAP net income, an indication of our cash flows from operating activities, a measure of our liquidity or an indication of funds available for our cash needs. In addition, our methodology for calculating Distributable Earnings and Net Distributable Earnings may differ from the methodologies employed by other companies to calculate the same or similar supplemental performance measures and, accordingly, our reported Distributable Earnings and Net Distributable Earnings may not be comparable to the Distributable Earnings and Net Distributable Earnings reported by other companies.

In order to maintain our status as a REIT, we are required to distribute at least 90% of our REIT taxable income, determined without regard to the deduction for dividends paid and excluding net capital gain, as dividends. Net Distributable Earnings, and other similar measures, have historically been a useful indicator of mortgage REITs’ ability to cover their dividends, and to mortgage REITs themselves in determining the amount of any dividends. Net Distributable Earnings is a key factor, among others, considered by the board of directors in setting the dividend and as such we believe Net Distributable Earnings is useful to investors. Accordingly, we believe providing Net Distributable Earnings on a supplemental basis to our net income as determined in accordance with GAAP is helpful to our stockholders in assessing the overall performance of our business.

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While Distributable Earnings and Net Distributable Earnings excludes the impact of our unrealized current provision for credit losses, loan losses are charged off and recognized through Distributable Earnings when deemed non-recoverable. Non-recoverability is determined (i) upon the resolution of a loan (i.e. when the loan is repaid, fully or partially, or in the case of foreclosure, when the underlying asset is sold), or (ii) with respect to any amount due under any loan, when such amount is determined to be non-collectible.

The following table provides a reconciliation of net income attributable to common stock to Distributable Earnings and Net Distributable Earnings (in thousands, except share and per share data):

Book Value Per Share

The following table sets forth the calculation of our book value per share (in thousands, except share and per share data):

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We believe that presenting book value per share adjusted for the general allowance for loan losses and accumulated depreciation is useful for investors as it enhances the comparability to prior years. Our lenders consider book value per share prior to the general allowance for loan losses and accumulated depreciation as an important metric related to our overall capitalization and we believe disclosing book value per share prior to the general allowance for loan losses and accumulated depreciation is important to investors such that they have the same visibility.

The following table sets forth the calculation of our adjusted book value per share (in thousands):

II. Our Portfolio

The below table summarizes our loan portfolio as of December 31, 2021 (dollars in thousands):

(7)    LTV represents “loan-to-value” or “loan-to-cost”, which is calculated as our total loan commitment from time to time, as if fully funded, plus any financings that are pari passu with or senior to our loan, divided by our estimate of either (1) the value of the underlying real estate, determined in accordance with our underwriting process (typically consistent with, if not less than, the value set forth in a third-party appraisal) or (2) the borrower’s projected, fully funded cost basis in the asset, in each case as we deem appropriate for the relevant loan and other loans with similar characteristics. Underwritten values and projected costs should not be assumed to reflect our judgment of current market values or project costs, which may have changed materially since the

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date of origination including, without limitation, as a result of the COVID-19 pandemic. LTV is updated only in connection with a partial loan paydown and/or release of collateral, material changes to expected project costs, the receipt of a new appraisal (typically in connection with financing or refinancing activity) or a change in our loan commitment.

Loan Portfolio Activity and Overview

The following table summarizes changes in unpaid principal balance within our loan portfolio, for both our loans and for our interests in loans (i.e., loans in which we have acquired an interest in a loan for which the transferor did not account for the transaction as a sale under GAAP) (dollars in thousands):

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The following table details our loan investments individually based on unpaid principal balances as of December 31, 2021 (in thousands):

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Real Estate Owned, Net

On February 8, 2021, we foreclosed on the portfolio of hotel properties through a Uniform Commercial Code foreclosure. Prior to February 8, 2021, the hotel portfolio represented the collateral for the $103.9 million mezzanine loan that we held, which was in default as a result of the borrower failing to pay debt service. The hotel portfolio appears as real estate owned, net on our balance sheet and, as of December 31, 2021, was encumbered by a $290.0 million securitized senior mortgage, which is included as a liability on our balance sheet. Refer to Note 4 to our consolidated financial statements for additional details.

Asset Management

Our Manager proactively manages the loans in our portfolio from closing to final repayment and our Sponsor has dedicated asset management employees to perform asset management services. Following the closing of an investment, the asset management team rigorously monitors the loan, with an emphasis on ongoing financial, legal, market condition and quantitative analyses. Through the final repayment of a loan, the asset management team maintains regular contact with borrowers, servicers and local market experts monitoring performance of the collateral, anticipating borrower, property and market issues, and enforcing our rights and remedies when appropriate.

Due to the impact of COVID-19, some of our borrowers have experienced delays in the execution of their business plans. As a result, we have worked with borrowers to execute loan modifications which typically include additional equity contributions from borrowers, repurposing of reserves, temporary deferrals of interest or principal, and partial deferral of coupon interest as payment-in-kind interest. While we have completed a number of loan modifications to date, we also may continue to make additional modifications depending on the duration of the COVID-19 pandemic and its impact on our borrowers’ business plans and our borrowers’ financial condition, liquidity and results of operations.

Our Manager reviews our entire loan portfolio at least quarterly, undertakes an assessment of the performance of each loan, and assigns it a risk rating between “1” and “5,” from least risk to greatest risk, respectively. The weighted average risk rating of our total loan exposure was 3.1 at December 31, 2021.

Current Expected Credit Losses and Loan Risk Ratings

On January 1, 2021, we adopted ASU 2016-13, which implemented the CECL accounting model. Following adoption, we recorded a $78.3 million cumulative effect adjustment to retained earnings.

During year ended December 31, 2021, the Company recorded net current expected credit loss reserve reversals of $9.0 million, which included a principal charge-off of $1.8 million, thus reducing the total allowance for loan losses to $73.5 million as of December 31, 2021. The decline was primarily attributable to expectations of improving macroeconomic conditions and actual improvements in operating results for many collateral properties adversely affected by COVID-19, as well as principal repayments on loans with allowances for credit losses and changes in unfunded commitments, offset in part by the impact of newly originated loans in the fourth quarter of 2021.

In December 2021, the Company received principal repayments of $81.7 million on a senior loan with an outstanding principal balance of $95.0 million, and a maturity date of May 31, 2021, and recorded a principal charge-off of $1.8 million. Following the repayment the maturity date of the loan was extended to January 1, 2023. As of December 31, 2021, the loan had a specific loan loss allowance of $0.3 million, which represents additional collectible interest through the extended maturity date as the loan remains on non-accrual status.

Prior to the adoption of ASU 2016-13, the Company had recorded a $6.0 million provision for loan losses against a loan to the personal estate of a former borrower, which had an outstanding principal balance and a carrying value of $15.0 million. The loan is on non-accrual status and is in maturity default. The amount of the loan loss provision is based on the difference between the net present value of the projected cash flows of the loan and its carrying value. We continue to actively pursue a resolution to this loan.

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Portfolio Financing

Our portfolio financing arrangements include repurchase facilities, asset-specific financing structures, mortgages on real estate owned and Secured Term Loan borrowings.

The following table summarizes our loan portfolio financing (dollars in thousands):

Refer to Note 5 to our consolidated financial statements for additional details on financings.

Repurchase Agreements

We finance certain of our loans using secured revolving repurchase facilities. As of December 31, 2021, aggregate borrowings outstanding under our secured revolving repurchase facilities totaled $3.5 billion, with a weighted average coupon of one-month LIBOR plus 2.16% per annum. All weighted averages are based on unpaid principal balance. As of December 31, 2021, outstanding borrowings under these facilities had a weighted average term to fully extended maturity (assuming we exercise all extension options and our counterparty agrees to such extension options) of 3.3 years.

Each of the secured revolving repurchase facilities involves “margin maintenance” provisions, which are designed to allow the repurchase lender to maintain a certain margin of credit enhancement against the loan assets which serve as collateral. The lender’s margin amount is typically based on a percentage of the market value of the loan asset and/or mortgaged property collateral. However, certain of our repurchase facilities permit valuation adjustments solely as a result of collateral-specific credit events, while other repurchase facilities contain provisions also allowing our lenders to make margin calls or require additional collateral upon the occurrence of adverse changes in the markets or interest rate or spread fluctuations, subject to minimum thresholds, among other factors. Since inception through December 31, 2021, we have not received any margin calls under any of our repurchase facilities.

Loan Participations Sold

We finance certain investments via the sale of a participation in the loans we own, however we present the loan participation sold as a liability on our consolidated balance sheet because such arrangement does not qualify as a sale under GAAP. In instances where we have multiple loan participations with the same lender, the financings are generally not cross-collateralized. Each of our loan participations sold is generally match-termed to its corresponding loan collateral. As of December 31, 2021, we had two loans financed with separate participations sold to two counterparties.

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Notes Payable

We finance certain investments on a match-term, non-recourse basis with such financings collateralized by our loans, which we refer to as notes payable. Each of our notes payable is generally match-termed to its corresponding loan collateral. As of December 31, 2021, one of our loans was financed with notes payable.

At December 31, 2021, we have one note payable with a par value and a carrying value of $48.0 million collateralized by an investment and cash collateral with a combined carrying value of $116.5 million. The note accrues interest at LIBOR plus 4.00%, subject to a LIBOR floor of 2.43%, and reached its extended maturity on January 4, 2022, at which point the initial maturity was further extended to July 5, 2022 and the maximum maturity was extended to January 4, 2023.  We have incurred $1.0 million in financing costs related to this note payable as of December 31, 2021.

Secured Term Loan

On August 9, 2019, we entered into our Secured Term Loan of $450.0 million. Our Secured Term Loan is collateralized by a pledge of equity in certain subsidiaries and their related assets, as well as a first priority security interest in selected assets. On December 1, 2020, our Secured Term Loan was modified to increase the aggregate principal amount by $325.0 million, increase the interest rate, and increase the quarterly amortization payment. Our Secured Term Loan is presented net of any original issue discount and transaction expenses which are deferred and recognized as a component of interest expense over the life of the loan using the effective interest method.

On December 2, 2021, we entered into a modification of our Secured Term Loan which reduced the interest rate to the greater of (i) 1-month SOFR plus a 0.10% credit spread adjustment and (ii) 0.50%, plus a credit spread of 4.50%.  As of December 31, 2021, our Secured Term Loan has an unpaid principal balance of $762.7 million and a carrying value of $739.8 million.  The Secured Term matures on August 9, 2026.  We have incurred $29.8 million in financing costs related to the Secured Term Loan.

Our Secured Term Loan includes various customary affirmative and negative covenants, including, but not limited to, reporting requirements and certain operational restrictions, including restrictions on dividends, distributions or other payment from our subsidiaries.

Debt Related to Real Estate Owned

On February 8, 2021 we assumed a $300.0 million securitized senior mortgage in connection with a Uniform Commercial Code foreclosure on a portfolio of seven limited service hotels located in New York, New York. In June 2021, we modified the securitized senior mortgage, which resulted in an extension of the contractual maturity date to February 9, 2024, a principal repayment of $10.0 million, and the payment of $7.6 million of fees and modification costs, among other items. The securitized senior mortgage is non-recourse to us. Our debt related to real estate owned as of December 31, 2021 has an outstanding principal balance of $290.0 million, a carrying value of $289.8 million and a stated rate of L+2.78%, subject to a LIBOR floor of 0.75%. We have incurred $0.2 million in financing costs related to this debt.

For the period from February 8, 2021 through December 31, 2021, we recognized $15.6 million of interest expense related to our debt related to real estate owned, net, $6.3 million of which was in connection with the modification of the securitized senior mortgage.

As of December 31, 2021, we were in compliance with all financial covenants under our financings.

Non-Consolidated Senior Interests Sold and Non-Consolidated Senior Interests Held by Third Parties

In certain instances, we use structural leverage through the non-recourse syndication of a match-term senior loan interest to a third party which qualifies for sale accounting under GAAP, or through the acquisition of a subordinate loan for which a non-recourse senior interest is retained by a third party. In such instances, the senior loan is not included on our balance sheet.

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The following table summarizes non-consolidated senior interests and related retained subordinate interests as of December 31, 2021 (dollars in thousands):

Floating and Fixed Rate Portfolio

Our business model seeks to minimize our exposure to changing interest rates by originating floating rate loans and as much as possible, match-funding the duration of our financing of such loans and using the same benchmark indices, typically one-month LIBOR. As of December 31, 2021, 96.6% of our loans based on unpaid principal balance were floating rate, and 85.4% of our floating rate loans based on unpaid principal balance had interest rate floors tied to LIBOR, providing protection against certain decreases in prevailing interest rates, and our floating rate loans were all financed with liabilities that require interest payments based on floating rates also determined by reference to one-month LIBOR plus a spread, which resulted in approximately $1.6 billion of net floating rate exposure.

The following table details our net floating rate exposure as of December 31, 2021 (dollars in thousands):

In addition, certain of our loans and financings have floors associated with the benchmark indices that determine the applicable rate on such loans and financings. As of December 31, 2021, 85.4% of our floating rate loans were subject to a one-month LIBOR floor, while 44.6% of our floating rate financings were subject to one-month LIBOR or SOFR floors. As of December 31, 2021, all of the loans held in our portfolio which are subject to a one-month LIBOR floor had one-month LIBOR floors greater than one-month LIBOR. The weighted average one-month LIBOR floor of our floating rate loans based on December 31, 2021 unpaid principal balance was 1.1%. The weighted average one-month LIBOR or SOFR floor of our financings based on December 31, 2021 unpaid principal balance was 0.3%. The LIBOR or SOFR floor on all of our financings which are subject to floors, all had a floors greater than one-month LIBOR or SOFR of 0.10% or 0.05%, respectively, as of December 31, 2021.

LIBOR and certain other floating rate benchmark indices to which our floating rate loans and other loan agreements are tied to, are the subject of recent national, international and regulatory guidance and proposals for reform. On March 5, 2021, the Financial Conduct Authority of the United Kingdom, or the FCA, which regulates

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LIBOR’s administrator, ICE Benchmark Administration Limited, or IBA, announced that all LIBOR tenors

relevant to us will cease to be published or will no longer be representative after June 30, 2023 (and that all other

LIBOR tenors will cease to be published or will no longer be representative either after December 31, 2021 or after June 30, 2023). The U.S. Federal Reserve, in conjunction with the Alternative Reference Rates Committee, a steering committee comprised of large U.S. financial institutions, has identified the Secured Overnight Financing Rate, or SOFR, a new index calculated using short-term repurchase agreements backed by Treasury securities, as its preferred alternative rate for USD LIBOR

Our agreements generally allow for a new interest rate index to be used if LIBOR is no longer available.  While the impact that the phasing out of LIBOR will have on the Company is not yet determinable, we have begun and expect to continue to utilize alternative rates referenced in our agreements or negotiate a replacement reference rate for LIBOR.

Refer to “Quantitative and Qualitative Disclosures About Market Risk—LIBOR as our Reference Rate” below for additional information.

As of December 31, 2021, one-month LIBOR was 0.10% and our loan portfolio by one-month LIBOR floor level, including fixed rate loans for which LIBOR is not applicable, was as follows (dollars in thousands):

As of December 31, 2021, we held five fixed rate investments with unpaid principal balances totaling $188.5 million and a weighted average coupon of 9.02% based on unpaid principal balance. Additionally, an investment that we classify as floating rate has a fixed component with an unpaid principal balance of $33.5 and coupon of 17.4%. We do not employ interest rate derivatives (interest rate swaps, caps, collars or swaptions) to hedge our loan portfolio’s cash flow or fair value exposure to increases in interest rates, but we may do so in the future.

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Results of Operations – Years Ended December 31, 2021 and 2020:

Comparison of the years ended December 31, 2021 and 2020

Revenue

Revenue decreased $26.7 million during the year ended December 31, 2021, as compared to the year ended December 31, 2020. The decrease is primarily due to a decrease in net interest income of $54.7 million, offset by an increase in revenue from real estate owned during the year ended December 31, 2021, as compared to the year ended December 31, 2020.

The decrease in net interest income was driven by (i) a decrease in interest and related income of $30.7 million primarily due to the repayment of loans with an outstanding principal balance of $2.9 billion, the impact of non-accrual loans, as well as, greater prepayment fees earned during the year ended December 31, 2020; offset in part, by (ii) interest and related income earned on newly originated loans of $2.3 billion, and (iii) an increase in interest and related expense of $24.0 million during the year ended December 31, 2021, as compared to the year ended December 31, 2020, arising from a net increase in our secured financings, including the impact of increasing our term loan’s interest rate on December 1, 2020, partially offset by (iv) an increase of $28.0 million of revenue from real estate owned earned in connection with our real estate owned which we acquired legal title to on February 8, 2021.

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Expenses

Expenses are primarily comprised of base management fees payable to our Manager, incentive fees payable to our Manager, equity compensation expense, general and administrative expenses, and expenses from real estate owned. Expenses increased by $31.3 million, net, during the year ended December 31, 2021, as compared to the year ended December 31, 2020 primarily due to increases in:

(i) Expenses from real estate owned of $32.2 million incurred during the year ended December 31, 2021, due to operating expenses and depreciation incurred by the portfolio of hotels on which we acquired legal title to on February 8, 2021. These expenses include depreciation expense of $7.1 million. Similar expenses were not incurred during the year ended December 31, 2020 as we did not own any real estate assets during such period;

(ii) General and administrative expenses increased $3.6 million during the year ended December 31, 2021, as compared to the year ended December 31, 2020, primarily due to one-time general and administrative expenses incurred relating to the modification of our secured term loan and the modification of our debt related to real estate owned totaling $4.7 million,  $0.8 million of professional fees incurred in connection with our non-accrual loans, and an increase in general operating expenses incurred in connection with being a newly public company of $3.3 million. This was partially offset by $5.2 million of expenses relating to dead deals that were incurred during the year ended December 31, 2020.

(iii) Equity compensation expense increased $3.1 million during the year ended December 31, 2021, as compared to the year ended December 31, 2020, due to RSUs becoming immediately vested upon our initial public offering, offset by a decrease in equity compensation expense due to the impact of 525,206 performance-based awards being forfeited prior to vesting.

Such increases were offset in part by:

(i) a decrease in Incentive fees—affiliate of $7.8 million as no incentive fee was incurred during the year ended December 31, 2021.

Realized loss on sale of investments

During the year ended December 31, 2021, we recognized a loss of $0.2 million in connection with a sale of a loan with an unpaid principal balance of $48.6 million. During the year ended December 31, 2020, we recognized a loss of $0.6 million in connection with two sales, with an unpaid principal balance of $20.0 million and $132.0 million, respectively.

Gain on foreclosure of real estate owned

During the year ended December 31, 2021, we recognized a gain of $1.4 million on the foreclosure of a portfolio of seven limited-service hotel properties located in New York, New York. This gain is based upon the estimated fair value of the hotel properties of $414.0 million as determined by a third-party appraisal, and our assumption of working capital and debt related to real estate owned, relative to our basis in the investment at the time of foreclosure. The fair value was determined using discount rates ranging from 8.50% to 8.75% and a terminal capitalization rate of 6.00% on projected net operating profits on the hotels.

Other income

During the year ended December 31, 2021 292,731 fully-vested time-based RSU awards were forfeited prior to their delivery pursuant to the terms of the RSU award documents, resulting in us reversing previously recognized compensation expense associated with these RSU awards.

Reversal of current expected credit loss reserve (CECL)

During the year ended December 31, 2021, we reversed $9.0 million of previously recognized CECL reserves, which was based upon improvements in the credit profile our loan portfolio, as well as improvements in macroeconomic conditions, offset by an increase in our loan portfolio based on unpaid principal balance. During the

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year ended December 31, 2020, prior to the adoption of ASU 2016-13, there was a provision for loan losses of $6.0 million on a loan made to the personal estate of a former borrower, which had an outstanding principal balance and a carrying value of $15.0 million.

Non-controlling interests

We own a 51% interest in the JV, which we control. As a result, we consolidate the activities of the JV and account for the 49% interest owned by a third party as income attributable to non-controlling interests. Net income attributable to non-controlling interests decreased by $3.4 million during the year ended December 31, 2021 as compared to the year ended December 31, 2020 as a result of one investment being repaid in full during the year ended December 31, 2020 and the remaining investment held in the JV being on non-accrual status.

See “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations —Results of Operations — Year Ended December 31, 2020 and 2019” in our prospectus comprising a part of our Registration Statement on Form S-11 (File No. 333-260140) (the "Prospectus"), which is accessible on the SEC’s website at www.sec.gov, for a comparison of year ended December 2020 and 2019.

Liquidity and Capital Resources

Capitalization

We have capitalized our business to date primarily through the issuance of shares of our common stock and borrowings under our secured financings and our Secured Term Loan. As of December 31, 2021, we had 139,840,088 shares of our common stock outstanding representing $2.6 billion of stockholders’ equity and we also had $4.8 billion of outstanding borrowings under our secured financings, our Secured Term Loan, and our debt related to real estate owned. As of December 31, 2021, our secured financings consisted of six secured revolving repurchase facilities for loan investments with capacity of $4.3 billion and an outstanding balance of $3.5 billion, and three asset-specific financings for loan investments with an outstanding balance of $216.3 million. As of December 31, 2021, our Secured Term Loan had an outstanding balance of $762.7 million and our debt related to real estate owned had an outstanding balance of $290.0 million.

Subsequent to December 31, 2021, we increased the capacity on two repurchase facilities by a combined $700 million, increasing our aggregate repurchase facility capacity to $5.0 billion

Debt to Equity Ratio and Total Leverage Ratio

Net Debt-to-Equity Ratio and Total Leverage Ratio are non-GAAP measures that we use to evaluate our financial leverage, which in the case of our Total Leverage Ratio, makes certain adjustments that we believe provide a more conservative measure of our financial condition.

Net Debt-to-Equity Ratio is calculated as the ratio of (i) the sum of (a) repurchase agreements, (b) loan participations sold, net, (c) notes payable, net, (d) Secured Term Loan, net, and (e) debt related to real estate owned, less cash and cash equivalents to (ii) total equity.

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The following table presents our Net Debt-to-Equity Ratios and reconciles net debt to total liabilities, the most directly comparable GAAP measure as of December 31, 2021 and December 31, 2020 (dollars in thousands):

Total Leverage Ratio is a non-GAAP measure used to evaluate our financial leverage and ability to recover our assets after satisfying all liabilities associated with our collateral in the event of a downturn.  Total Leverage Ratio is similar to Net Debt-to-Equity Ratio, however it includes non-consolidated senior interests sold and non-consolidated senior interests held by third parties. Non-consolidated senior interests sold and non-consolidated senior interests held by third parties, as applicable, are secured by the same collateral as our loan and are structurally senior in repayment priority relative to our loan. We believe the inclusion of non-consolidated senior interests sold and non-consolidated senior interests held by third parties provides a meaningful measure of our financial leverage.

Total Leverage Ratio is calculated as the ratio of (i) the sum of (a) repurchase agreements, (b) loan participations sold, net, (c) notes payable, net, (d) Secured Term Loan, net, (e) non-consolidated senior interests sold, (f) non-consolidated senior interests held by third parties, and (g) debt related to real estate owned, less cash and cash equivalents to (ii) total equity.

The following table presents our Total Leverage Ratios and reconciles net total leverage to total liabilities, the most directly comparable GAAP measure as of December 31, 2021 and December 31, 2020 (dollars in thousands):

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Sources of Liquidity

Our primary sources of liquidity include cash and cash equivalents, interest income from our loans, loan repayments, available borrowings under our secured revolving repurchase facilities and identified borrowing capacity related to our notes payable and loan participations sold, borrowings under our Secured Term Loan, and proceeds from the issuance of our common stock. The following table sets forth, as of December 31, 2021 and 2020, our sources of available liquidity (dollars in thousands):

Liquidity Needs

In addition to our ongoing loan origination and acquisition activity, our primary liquidity needs include future fundings to our borrowers on our unfunded loan commitments, interest and principal payments on outstanding borrowings under our financings, operating expenses and dividend payments to our stockholders necessary to satisfy REIT dividend requirements. Additionally, our financing, repurchase and term loan agreements require us to maintain minimum levels of liquidity in order to satisfy certain financial covenants. We currently maintain, and seek to maintain, excess cash and liquidity to comply with minimum liquidity requirements under our financings, and if necessary, to reduce borrowings under our secured financings, including our repurchase agreements.

As of December 31, 2021, we had aggregate unfunded loan commitments of $1.1 billion across 25 investments, and $584.3 million of committed or identified financings for those commitments. The unfunded commitments comprise funding for capital expenditures and construction, leasing costs, and interest and carry costs, and their funding will vary depending on the progress of capital projects, leasing, and cash flows at the properties securing our loans. Therefore, the exact timing and amounts of such future loan fundings are uncertain and will depend on the current and future performance of the underlying collateral assets. We expect to fund our loan commitments over the remaining maximum term of the related loans, which have a weighted-average future funding period of 3.0 years.

Contractual Obligations and Commitments

Our contractual obligations and commitments as of December 31, 2021 were as follows (dollars in thousands):

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We are required to pay our Manager, in cash, a base management fee and incentive fees (to the extent earned) on a quarterly basis in arrears. The tables above do not include the amounts payable to our Manager under the Management Agreement as they are not fixed and determinable.

As a REIT, we generally must distribute substantially all of our taxable income to stockholders in the form of dividends to comply with certain of the provisions of the Code. Our REIT taxable income does not necessarily equal our net income as calculated in accordance with GAAP or our Net Distributable Earnings as described previously.

Loan Maturities

The following table summarizes the future scheduled repayments of principal based on initial maturity dates for the loan portfolio as of December 31, 2021 (dollars in thousands):

Cash Flows

The following table provides a breakdown of the net change in our cash and cash equivalents and restricted cash for the years ended December 31, 2021 and 2020 (dollars in thousands):

We experienced a net decrease in cash and cash equivalents and restricted cash of $96.8 million during the year ended December 31, 2021, compared to a net increase of $93.0 million during the year ended December 31, 2020.

During the year ended December 31, 2021, we made initial fundings of $2.3 billion of new loans and $813.7 million of advances on existing loans and made repayments on financings arrangements of $1.8 billion. We received $2.0 billion of borrowings under our financing arrangements, and $2.9 billion from repayment of loan principal.

During the year ended December 31, 2020, we made initial fundings of $226.7 million of new loans and $791.2 million of advances on existing loans and made repayments on financings arrangements of $785.0 million. We

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received $1.1 billion of borrowings under our financing arrangements, and $581.3 million from repayment of loan principal.

Income Taxes

We have elected and believe we have qualified to be taxed as a REIT for U.S. federal income tax purposes, commencing with our initial taxable year ended December 31, 2015. We generally must distribute annually at least 90% of our REIT taxable income, determined without regard to the deduction for dividends paid and excluding net capital gain, to maintain our REIT status. To the extent that we satisfy this distribution requirement, but distribute less than 100% of our REIT taxable income, we will be subject to U.S. federal income tax on our undistributed REIT taxable income. In addition, we will be subject to a 4% nondeductible excise tax if the actual amount that we pay out to our stockholders in a calendar year is less than a minimum amount specified under U.S. federal tax laws. The Company’s real estate owned is held in a TRS. The Company’s TRS is not consolidated for U.S. federal income tax purposes and is taxed separately as a corporation. For financial reporting purposes, a provision or benefit for current and deferred taxes is established for the portion of earnings or expense recognized by the Company with respect to its TRS.

Our qualification as a REIT also depends on our ability to meet various other requirements imposed by the Code, which relate to organizational structure, diversity of stock ownership and certain restrictions with regard to the nature of our assets and the sources of our income. Even if we qualify as a REIT, we may be subject to certain U.S. federal income and excise taxes and state and local taxes on our income and assets. If we fail to maintain our qualification as a REIT for any taxable year, we may be subject to material penalties as well as federal, state and local income tax on our REIT taxable income at regular corporate rates and we would not be able to qualify as a REIT for the subsequent four full taxable years. As of December 31, 2021 we were in compliance with all REIT requirements.

Refer to Note 12 to our consolidated financial statements for additional information about our income taxes.

Off-Balance Sheet Arrangements

As of December 31, 2021, we had no off-balance sheet arrangements.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires our Manager to make estimates, judgements and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. We believe that all of the decisions and estimates are reasonable, based upon the information available to us. We believe that the following accounting policies are those most critical to the judgments and estimates used in the preparation of our financial statements.

Refer to Note 2 to our consolidated financial statements for a description of our significant accounting policies.

Current Expected Credit Losses (“CECL”)

The CECL reserve required under ASU 2016-13 “Financial Instruments – Credit Losses – Measurement of Credit Losses on Financial Instruments (Topic 326)” (“ASU 2016-13”), reflects our current estimate of potential credit losses related to our loan portfolio. The initial CECL allowance recorded on January 1, 2021 is reflected as a direct charge to retained earnings on the Company’s consolidated statements of changes in redeemable common stock and stockholders’ equity.

For our loan portfolio, we, with assistance from a third-party service provider, performed a quantitative assessment of the impact of CECL using the Expected Loss, or EL, approach and the Lifetime Loss Rate, or LLR, method depending on the allocated bucket. For transitional loans, steady & improving loans and stabilized loans, we have applied an EL approach because of the consistency in assessing credit risks and estimating expected credit losses.

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Due to the nature of construction loans, where repayment does not depend on the operating performance of the underlying property, we have applied a LLR approach to estimate the CECL impacts. In certain circumstances we may determine that a loan is no longer suited for the model-based approach due to its unique risk characteristics, or because the repayment of the loan’s principal is collateral-dependent. We may instead elect to employ different methods to estimate loan losses that also conform to ASU 2016-13 and related guidance. If the recovery of that loan’s principal balance is entirely collateral-dependent, we may assess such an asset individually and elect to apply a practical expedient in accordance with ASU 2016-13. Our allowance for loan losses reflects our estimation of the current and future economic conditions that impact the performance of the commercial real estate assets securing our loans. These estimations include unemployment rates, interest rates, price indices for commercial property, and other macroeconomic factors that may influence the likelihood and magnitude of potential credit losses for our loans during their anticipated term. We license certain macroeconomic financial forecasts to inform our view of the potential future impact that broader economic conditions may have on its loan portfolio’s performance. The forecasts are embedded in the licensed model that we use to estimate our allowance for loan losses as discussed below. Selection of these economic forecasts require significant judgement about future events that, while based on the information available to us as of the respective balance sheet dates, are ultimately unknowable with certainty, and the actual economic conditions impacting our loan portfolio could vary significantly from the estimates we made for the periods presented. Additionally, we assess the obligation to extend credit through our unfunded loan commitments over each loan’s contractual period, which is considered in the estimation of the allowance for loan losses.

Real estate owned, net

We may assume legal title or physical possession of the underlying collateral of a defaulted loan through foreclosure. Foreclosed real estate owned, net is initially recorded at estimated fair value and is presented net of accumulated depreciation and impairment charges and the assets and liabilities are presented separately when legal title or physical possession is assumed. If the fair value of the real estate is lower than the carrying value of the loan, the difference, along with any previously recorded Specific CECL Allowances, are recorded as a realized loss on investments in the consolidated statement of operations. Conversely, if the fair value of the real estate is greater than the carrying value of the loan, the difference, along with any previously recorded Specific CECL Allowances, are recorded as a realized gain on investments in the consolidated statement of operations.

Acquisition of real estate is accounted for using the acquisition method under Accounting Standards Codification ("ASC") Topic 805, "Business Combinations." We recognize and measure identifiable assets acquired, liabilities assumed and any noncontrolling interest in the acquiree, if applicable, based on their relative fair values. If applicable, we recognize and measure intangible assets and expense acquisition-related costs in the periods in which the costs are incurred and the services are received.

Real estate assets that are acquired for investment are assumed at their estimated fair value at acquisition and presented net of accumulated depreciation and impairment charges, if any. Upon acquisition, we allocate the value of acquired real estate assets based on the fair value of the acquired land, building, furniture, fixtures and equipment, and intangible assets, if applicable. Real estate assets are depreciated using the straight-line method over estimated useful lives of up to 40 years for buildings and up to 8 years for furniture, fixtures and equipment. Renovations and/or replacements that improve or extend the life of the real estate asset are capitalized and depreciated over their estimated useful lives. The cost of ordinary repairs and maintenance are expensed as incurred.

Real estate assets are evaluated for indicators of impairment on a quarterly basis. Factors that we may consider in its impairment analysis include, among others: (1) significant underperformance relative to historical or anticipated operating results; (2) significant negative industry or economic trends; (3) costs necessary to extend the life or improve the real estate asset; (4) significant increase in competition; and (5) ability to hold and dispose of the real estate asset in the ordinary course of business. A real estate asset is considered impaired when the sum of estimated future undiscounted cash flows expected to be generated by the real estate asset over the estimated remaining holding period is less than the carrying amount of such real estate asset. Cash flows include operating cash flows and anticipated capital proceeds generated by the real estate asset. An impairment charge is recorded equal to the excess of the carrying value of the real estate asset over the fair value.

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When determining the fair value of a real estate asset, we make certain assumptions including, but not limited to, consideration of projected operating cash flows, comparable selling prices and projected cash flows from the eventual disposition of the real estate asset based upon our estimate of a capitalization rate and discount rate.