Transcontinental Realty Investors, Inc. — Q2 2014 Form 10-Q
Reporting period: Three and six months ended June 30, 2014. Figures below are in millions of dollars unless stated otherwise. TCI invests in apartments, commercial real estate, development land and mortgage notes; it is externally advised, and ARL subsidiaries own approximately 83.8% of its common stock.
Key financial results
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Rental and other property revenue | $19.86 | $19.56 | $39.48 | $38.95 |
| Net operating income, as reported | $0.98 | $2.74 | $2.72 | $5.26 |
| Continuing-operations income (loss) | $(1.26) | $2.44 | $(0.13) | $(4.89) |
| Net income attributable to TCI | $2.39 | $12.03 | $6.94 | $8.92 |
| Net income applicable to common shares | $2.11 | $11.75 | $6.39 | $8.37 |
| Basic EPS | $0.25 | $1.39 | $0.75 | $1.00 |
Q2 and first-half common earnings were substantially supported by gains on property sales reported in discontinued operations: $7.00 million in Q2 and $13.06 million year to date. Discontinued operations contributed net income of $3.78 million and $7.28 million, respectively, after related tax expense. Thus, continuing operations were loss-making in 2014 despite positive total net income.
For the six months, operating expenses rose to $36.76 million from $33.69 million. Property operating costs increased by $1.11 million, depreciation and amortization by $0.84 million, and general and administrative costs by $1.06 million. Management cited real estate taxes, repairs, professional fees and franchise taxes. Rental revenue increased modestly; apartment revenue improved, while commercial revenue declined.
Cash flow, balance sheet and debt
- Cash flow (six months): Operating activities used $15.69 million, compared with $15.44 million used in 2013. Investing activities provided $31.07 million, down from $74.04 million, primarily reflecting lower property-sale proceeds and note receivable advances. Financing activities used $18.09 million, versus $66.22 million used in 2013. Cash declined $2.70 million to $13.38 million; restricted cash was $25.05 million. Cash paid for interest was $15.15 million.
- June 30 balance sheet: Total assets were $881.22 million, total liabilities $683.07 million and shareholders’ equity $198.16 million. The balance-sheet line for notes and interest payable was $569.20 million; additional debt classified with real estate held for sale and subject to sales contracts was $3.01 million and $20.76 million, respectively. The notes payable detail reports total debt of $592.96 million, including those categories.
- Liquidity: Management said property cash generation in 2014 would not be sufficient to meet all obligations as due. Its plan relies on property and land sales, refinancing or extending debt, and additional real-estate-secured borrowing. The filing reports $74.41 million receivable from related parties, compared with $52.38 million at year-end.
- Debt and interest risk: A $40 million loan obtained in March carries a 12% rate, is interest-only for its first year, and is secured by residential apartment equity interests. Variable-rate debt was $63.93 million; management estimated a 1 percentage-point rate increase would reduce annual net income by about $0.64 million, or $0.08 per share.
Material changes, outlook and risks
- TCI sold Pecan Pointe apartments for $23.1 million and 1010 Common commercial property for $16.6 million; it also sold land parcels. First-half proceeds from income-producing property sales were $41.43 million. The portfolio had 43 income-producing properties at June 30, versus 55 a year earlier.
- Management reported apartment occupancy averaging above 95% and rising rents. It expected benefits from new commercial leases over the next 12 months, but provided no quantified earnings or revenue guidance.
- Some related-party transfers of an apartment complex, commercial building and land remain recorded as subject to sales contracts, not completed sales. The related borrowers are in mortgage default, and the company notes continuing involvement, potential shortfalls and guarantees; sale recognition remains deferred.
- TCI is negotiating modifications or extensions on certain land mortgages. It reported deficiency claims related to foreclosed assets, with estimated maximum aggregate exposure of approximately $20 million, potentially in future years. In the Dynex litigation, an appeals court ruling was favorable to TCI, but further challenges and trial-court proceedings remain possible.
- The company reported a $89.8 million deferred tax asset fully offset by a valuation allowance. It also disclosed substantial related-party lending: approximately $65.4 million of junior mortgage loans and accrued interest, net of allowances, and $4.8 million of related interest income. Management’s estimates of real estate values, note collections and impairment are important uncertainties.
- After quarter-end, the holder converted all 30,000 Series C preferred shares into 304,298 common shares. TCI also disclosed subsequent investments in notes receivable and a mortgage refinancing.
Important facts to verify
- The MD&A says Q2 2013 common-share results were a net loss of $11.8 million, while the financial statements report net income applicable to common shares of $11.75 million and EPS of $1.39. Confirm which description is correct.
- Reconcile the $3.75 million litigation-settlement line reported as income in the statements with the MD&A discussion describing settlement expenses and the $3.5 million Amoco-related debt forgiveness.
- Assess liquidity against upcoming maturities, the company’s reliance on sales and refinancing, and the status of land-loan extensions and defaults.
- Review collectability and valuation of related-party receivables and notes, including UHF-related interest accruals, collateral, guarantees and the deferred related-party property transactions.
- Evaluate whether recurring property operations can support debt service and capital needs without gains from asset sales; distinguish those gains from continuing operating performance.