Transcontinental Realty Investors, Inc. — Q3 2013 Form 10-Q
Reporting period: Three and nine months ended September 30, 2013. Financial amounts below are in millions unless otherwise noted. The company invests in apartments, commercial real estate, development land, and mortgage loans; it is externally advised and has no employees.
Financial performance and position
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Rental and other property revenue | $26.6 | $26.9 | $78.9 | $79.1 |
| Net operating income | $4.2 | $5.4 | $14.3 | $15.1 |
| Net income (loss) applicable to common shares | $(6.2) | $(0.5) | $2.1 | $(3.0) |
| Basic and diluted EPS | $(0.74) | $(0.07) | $0.25 | $(0.36) |
| Operating cash flow | Not provided for the quarter | $(16.5) | $(41.0) |
Nine-month 2013 continuing operations generated a $12.5 million loss; discontinued operations contributed $15.7 million of net income, including $24.4 million of property-sale gains and an $8.5 million income tax expense. The filing therefore attributes the positive year-to-date common-share result largely to sales and discontinued operations, rather than continuing operations.
- Balance sheet at September 30: Assets were $971.2 million, down from $1,045.3 million at December 31, 2012. Cash and cash equivalents were $9.1 million, down from $16.6 million; shareholders’ equity was $135.6 million.
- Debt: Notes and interest payable on the balance sheet were $712.7 million, versus $730.9 million at year-end 2012. The debt note reports total debt of $745.5 million, including stock-secured loans and accrued interest. Debt and liquidity remain significant concerns.
- Cash flows, nine months: Investing activities provided $70.9 million, principally from property sales; financing activities used $62.0 million. Cash declined $7.5 million to $9.1 million. Cash paid for interest was $18.3 million.
- Portfolio: At quarter-end the company reported 45 apartment communities with 8,033 units, 10 commercial properties, and 4,105 acres of land. Apartment occupancy averaged nearly 94%, according to management.
Changes versus prior comparable periods
- Q3 common-share loss widened to $6.2 million from $0.5 million. Revenue decreased slightly; lower mortgage interest expense was outweighed by higher G&A, a $2.7 million litigation-settlement expense, and the absence of prior-year land-sale gains.
- Nine-month common-share results improved to $2.1 million income from a $3.0 million loss, principally because discontinued-operation property-sale gains rose to $24.4 million from $5.2 million. Continuing-operations loss widened to $12.5 million from $4.3 million.
- Nine-month revenue was nearly flat. Apartment revenue improved, but commercial revenue declined as larger tenants downsized or vacated space. Mortgage interest expense fell by $4.5 million, partly reflecting apartment refinancings at lower rates; refinancing also contributed to $7.2 million in loan charges and prepayment penalties.
- Operating cash outflow improved by $24.6 million year over year, but remained negative. Property-sale proceeds were $76.0 million, compared with $40.0 million in the prior-year period.
Outlook, risks, contingencies, and unusual items
- Management expects excess cash from property operations in 2013, but says it will not be sufficient to discharge all obligations as they come due. The company plans to sell land and income-producing properties, refinance or extend debt, and obtain additional real-estate-secured borrowing. No quantified earnings or revenue guidance is provided.
- Various land mortgages were being modified or extended. A proposed sale of nine apartment complexes remained subject to HUD approval and was not classified as held for sale at September 30.
- Variable-rate debt was $114.7 million at a weighted average 4.33%; management estimated a 1 percentage-point rate increase would reduce annual net income by $1.1 million, or $0.14 per share.
- Management estimates potential aggregate exposure from deficiency claims on foreclosed assets at no more than approximately $20 million, if any, in future years. A separate long-running Dynex dispute received a favorable appellate ruling for TCI, including prior jury damages of about $12.1 million plus an additional $0.3 million, but further challenges, a retrial of attorneys’ fees, and recalculation of interest remain possible.
- Q3 included $2.7 million of litigation-settlement expense related to deficiencies on previously foreclosed land. The company also recorded a $0.2 million impairment provision in the nine-month period.
- Related-party relationships are substantial: ARL subsidiaries owned approximately 83.8% of TCI’s common stock; TCI reported $59.4 million of performing notes receivable from related parties. The filing cautions that related-party transactions may not be on arm’s-length terms.
- TCI reported a $72.4 million net deferred tax asset with a 100% valuation allowance because realization was not considered more likely than not. Subsequent events included a $41.0 million refinancing on October 11 and transfer of the Ergon property and Jackson land to a lender on October 15.
Important facts for investors to verify
- Near-term debt maturities, extensions, refinancing terms, and whether asset sales can meet obligations given low cash and negative operating cash flow.
- Progress and final economics of the proposed nine-property sale, including HUD approval and any effects on rental income and debt.
- Occupancy, leasing trends, and tenant retention in commercial properties, where management cited revenue declines from tenant downsizing and departures.
- Outcomes and potential costs of Dynex litigation and deficiency claims, as well as settlement-payment obligations.
- Collectability of related-party notes and receivables, and the terms and oversight of transactions with affiliates and the external advisor.
- How much of reported earnings depends on property-sale gains and discontinued operations, versus recurring continuing operations.