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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

 

 

For the quarterly period ended June 30, 2014.

 

OR

 

 

For the transition period from             to             

 

Commission file number 001-08895

 

 

HCP, INC.

(Exact name of registrant as specified in its charter)

 

Maryland		33-0091377
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

 

1920 Main Street, Suite 1200

Irvine, CA 92614

(Address of principal executive offices)

 

(949) 407-0700

(Registrant’s telephone number, including area code)

 

 

(Former name, former address and former fiscal year, if changed since last report)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  YES  x  NO  o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or such shorter period that the registrant was required to submit and post such files).  YES  x  NO  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large Accelerated Filer  x		Accelerated Filer  o
Non-accelerated Filer  o		Smaller Reporting Company  o
(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)  YES  o  NO  x

 

As of July 31, 2014, there were 458,820,961 shares of the registrant’s $1.00 par value common stock outstanding.

 

 

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HCP, INC.

INDEX

 

PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements:
	Condensed Consolidated Balance Sheets	3
	Condensed Consolidated Statements of Income	4
	Condensed Consolidated Statements of Comprehensive Income	5
	Condensed Consolidated Statements of Equity	6
	Condensed Consolidated Statements of Cash Flows	7
	Notes to the Condensed Consolidated Financial Statements	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	26
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	42
Item 4.	Controls and Procedures	43
PART II. OTHER INFORMATION
Item 1A.	Risk Factors	43
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	43
Item 6.	Exhibits	44
Signatures		46

 

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HCP, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)

(Unaudited)

 

		June 30,			December 31,
		2014			2013
ASSETS
Real estate:
Buildings and improvements		$	10,783,296		$	10,544,110
Development costs and construction in progress		251,400			225,869
Land		1,880,408			1,822,862
Accumulated depreciation and amortization		(2,100,223		)	(1,965,592		)
Net real estate		10,814,881			10,627,249
Net investment in direct financing leases		7,223,878			7,153,399
Loans receivable, net		375,717			366,001
Investments in and advances to unconsolidated joint ventures		190,730			196,576
Accounts receivable, net of allowance of $3,052 and $1,529, respectively		32,719			27,494
Cash and cash equivalents		54,070			300,556
Restricted cash		34,329			37,229
Intangible assets, net		477,837			489,842
Real estate assets held for sale, net		—			9,819
Other assets, net		940,008			867,705
Total assets (1)		$	20,144,169		$	20,075,870
LIABILITIES AND EQUITY
Bank line of credit		$	310,000		$	—
Term loan		234,352			226,858
Senior unsecured notes		6,826,884			6,963,375
Mortgage debt		1,229,773			1,396,485
Other debt		73,020			74,909
Intangible liabilities, net		90,426			98,810
Accounts payable and accrued liabilities		339,364			318,427
Deferred revenue		67,756			65,872
Total liabilities (2)		9,171,575			9,144,736
Commitments and contingencies
Common stock, $1.00 par value: 750,000,000 shares authorized; 458,742,070 and 456,960,648 shares issued and outstanding, respectively		458,742			456,961
Additional paid-in capital		11,388,641			11,334,041
Cumulative dividends in excess of earnings		(1,075,583		)	(1,053,215		)
Accumulated other comprehensive loss		(11,669		)	(14,487		)
Total stockholders’ equity		10,760,131			10,723,300
Joint venture partners		23,391			23,729
Non-managing member unitholders		189,072			184,105
Total noncontrolling interests		212,463			207,834
Total equity		10,972,594			10,931,134
Total liabilities and equity		$	20,144,169		$	20,075,870

 

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(1)       The Company’s consolidated total assets at June 30, 2014 and December 31, 2013 each include $1 million of other assets of certain variable interest entities (“VIEs”) that can only be used to settle the liabilities of those VIEs. See Note 16 to the Condensed Consolidated Financial Statements for additional information.

(2)       The Company’s consolidated total liabilities at June 30, 2014 and December 31, 2013 each include $9 million of accounts payable and accrued liabilities of certain VIEs for which the VIE creditors do not have recourse to HCP, Inc.  See Note 16 to the Condensed Consolidated Financial Statements for additional information.

 

See accompanying Notes to the Condensed Consolidated Financial Statements.

 

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HCP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share data)

(Unaudited)

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2014			2013			2014			2013
Revenues:
Rental and related revenues		$	288,191		$	277,769		$	573,014		$	559,308
Tenant recoveries		27,110			25,144			52,544			49,346
Resident fees and services		37,939			36,394			75,992			72,139
Income from direct financing leases		165,500			158,286			330,037			315,156
Interest income		16,937			14,147			33,633			26,533
Investment management fee income		444			499			893			942
Total revenues		536,121			512,239			1,066,113			1,023,424
Costs and expenses:
Interest expense		106,842			108,452			213,480			217,562
Depreciation and amortization		113,133			109,210			220,521			212,389
Operating		78,867			73,887			154,574			146,573
General and administrative		29,062			24,062			50,456			44,717
Total costs and expenses		327,904			315,611			639,031			621,241
Other income, net		709			3,288			2,639			15,400
Income before income taxes and equity income from unconsolidated joint ventures		208,926			199,916			429,721			417,583
Income taxes		(1,339		)	(1,604		)	(2,785		)	(2,519		)
Equity income from unconsolidated joint ventures		14,692			15,585			29,220			30,386
Income from continuing operations		222,279			213,897			456,156			445,450
Discontinued operations:
Income before gain on sales of real estate, net of income taxes		—			1,941			1,736			4,172
Gain on sales of real estate, net of income taxes		—			887			28,010			887
Total discontinued operations		—			2,828			29,746			5,059
Net income		222,279			216,725			485,902			450,509
Noncontrolling interests’ share in earnings		(3,394		)	(3,324		)	(7,906		)	(6,523		)
Net income attributable to HCP, Inc.		218,885			213,401			477,996			443,986
Participating securities’ share in earnings		(489		)	(378		)	(1,552		)	(856		)
Net income applicable to common shares		$	218,396		$	213,023		$	476,444		$	443,130
Basic earnings per common share:
Continuing operations		$	0.48		$	0.46		$	0.98		$	0.96
Discontinued operations		—			0.01			0.06			0.02
Net income applicable to common shares		$	0.48		$	0.47		$	1.04		$	0.98
Diluted earnings per common share:
Continuing operations		$	0.48		$	0.46		$	0.98		$	0.96
Discontinued operations		—			0.01			0.06			0.01
Net income applicable to common shares		$	0.48		$	0.47		$	1.04		$	0.97
Weighted average shares used to calculate earnings per common share:
Basic		458,247			454,618			457,773			454,137
Diluted		458,588			455,431			458,134			455,024
Dividends declared per common share		$	0.545		$	0.525		$	1.09		1.05

 

See accompanying Notes to the Condensed Consolidated Financial Statements.

 

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HCP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands)

(Unaudited)

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2014			2013			2014			2013
Net income		$	222,279		$	216,725		$	485,902		$	450,509
Other comprehensive income (loss):
Change in net unrealized gains (losses) on securities:
Unrealized gains (losses)		(7		)	—			(4		)	1,355
Reclassification adjustment realized in net income		—			—			—			(9,131		)
Change in net unrealized gains (losses) on cash flow hedges:
Unrealized gains (losses)		3			4,025			(692		)	9,345
Reclassification adjustment realized in net income		38			288			643			560
Change in Supplemental Executive Retirement Plan obligation		54			55			108			111
Foreign currency translation adjustment		2,813			(125		)	2,763			53
Total other comprehensive income		2,901			4,243			2,818			2,293
Total comprehensive income		225,180			220,968			488,720			452,802
Total comprehensive income attributable to noncontrolling interests		(3,394		)	(3,324		)	(7,906		)	(6,523		)
Total comprehensive income attributable to HCP, Inc.		$	221,786		$	217,644		$	480,814		$	446,279

 

See accompanying Notes to the Condensed Consolidated Financial Statements.

 

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HCP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF EQUITY

(In thousands, except per share data)

(Unaudited)

 

										Cumulative			Accumulated
							Additional			Dividends			Other			Total			Total
		Common Stock					Paid-In			In Excess			Comprehensive			Stockholders’			Noncontrolling			Total
		Shares		Amount			Capital			Of Earnings			Income (Loss)			Equity			Interests			Equity
January 1, 2014		456,961		$	456,961		$	11,334,041		$	(1,053,215	)	$	(14,487	)	$	10,723,300		$	207,834		$	10,931,134
Net income		—		—			—			477,996			—			477,996			7,906			485,902
Other comprehensive income		—		—			—			—			2,818			2,818			—			2,818
Issuance of common stock, net		1,954		1,954			51,728			—			—			53,682			(73		)	53,609
Repurchase of common stock		(284	)	(284		)	(10,802		)	—			—			(11,086		)	—			(11,086		)
Exercise of stock options		111		111			2,681			—			—			2,792			—			2,792
Amortization of deferred compensation		—		—			11,006			—			—			11,006			—			11,006
Common dividends ($1.09 per share)		—		—			—			(500,364		)	—			(500,364		)	—			(500,364		)
Distributions to noncontrolling interests		—		—			—			—			—			—			(7,967		)	(7,967		)
Issuance of noncontrolling interests		—		—			—			—			—			—			6,434			6,434
Purchase of noncontrolling interests		—		—			(13		)	—			—			(13		)	(1,671		)	(1,684		)
June 30, 2014		458,742		$	458,742		$	11,388,641		$	(1,075,583	)	$	(11,669	)	$	10,760,131		$	212,463		$	10,972,594

 

										Cumulative			Accumulated
							Additional			Dividends			Other			Total			Total
		Common Stock					Paid-In			In Excess			Comprehensive			Stockholders’			Noncontrolling			Total
		Shares		Amount			Capital			Of Earnings			Income (Loss)			Equity			Interests			Equity
January 1, 2013		453,191		$	453,191		$	11,180,066		$	(1,067,367	)	$	(14,653	)	$	10,551,237		$	202,540		$	10,753,777
Net income		—		—			—			443,986			—			443,986			6,523			450,509
Other comprehensive income		—		—			—			—			2,293			2,293			—			2,293
Issuance of common stock, net		1,097		1,097			49,221			—			—			50,318			(2,997		)	47,321
Repurchase of common stock		(46	)	(46		)	(2,224		)	—			—			(2,270		)	—			(2,270		)
Exercise of stock options		852		852			15,957			—			—			16,809			—			16,809
Amortization of deferred compensation		—		—			11,638			—			—			11,638			—			11,638
Common dividends ($1.05 per share)		—		—			—			(477,453		)	—			(477,453		)	—			(477,453		)
Distributions to noncontrolling interests		—		—			—			—			—			—			(7,506		)	(7,506		)
Issuance of noncontrolling interests		—		—			—			—			—			—			3,141			3,141
June 30, 2013		455,094		$	455,094		$	11,254,658		$	(1,100,834	)	$	(12,360	)	$	10,596,558		$	201,701		$	10,798,259

 

See accompanying Notes to the Condensed Consolidated Financial Statements.

 

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HCP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

		Six Months Ended June 30,
		2014			2013
Cash flows from operating activities:
Net income		485,902			$	450,509
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization of real estate, in-place lease and other intangibles:
Continuing operations		220,521			212,389
Discontinued operations		—			3,095
Amortization of above and below market lease intangibles, net		(343		)	(6,068		)
Amortization of deferred compensation		11,006			11,638
Amortization of deferred financing costs, net		9,474			9,440
Straight-line rents		(26,455		)	(15,955		)
Loan and direct financing lease interest accretion		(39,401		)	(45,539		)
Deferred rental revenues		(515		)	(965		)
Equity income from unconsolidated joint ventures		(29,220		)	(30,386		)
Distributions of earnings from unconsolidated joint ventures		2,655			1,624
Gain on sales of real estate		(28,010		)	(887		)
Marketable securities and other (gains) losses, net		58			(10,197		)
Changes in:
Accounts receivable, net		(5,225		)	462
Other assets		(6,136		)	(12,852		)
Accounts payable and accrued liabilities		13,394			5,294
Net cash provided by operating activities		607,705			571,602
Cash flows from investing activities:
Acquisitions of real estate		(285,429		)	(60,353		)
Development of real estate		(72,334		)	(67,983		)
Leasing costs and tenant and capital improvements		(27,458		)	(19,938		)
Proceeds from sales of real estate, net		36,897			3,777
Distributions in excess of earnings from unconsolidated joint ventures		1,113			904
Purchases of marketable debt securities		—			(16,706		)
Proceeds from the sales of marketable securities		—			28,030
Principal repayments on loans receivable		5,547			19,112
Investments in loans receivable and other		(46,434		)	(300,673		)
(Increase) decrease in restricted cash		2,900			(7,105		)
Net cash used in investing activities		(385,198		)	(420,935		)
Cash flows from financing activities:
Net borrowings under bank line of credit		310,000			265,049
Issuance of senior unsecured notes		350,000			—
Repayments of senior unsecured notes		(487,000		)	(150,000		)
Repayments of mortgage debt		(169,843		)	(40,380		)
Deferred financing costs		(9,239		)	—
Issuance of common stock and exercise of options		56,401			61,860
Repurchase of common stock		(11,086		)	—
Dividends paid on common stock		(500,364		)	(477,453		)
Issuance of noncontrolling interests		113			3,141
Distributions to and purchase of noncontrolling interests		(7,980		)	(7,506		)
Net cash used in financing activities		(468,998		)	(345,289		)
Effect of foreign exchange on cash and cash equivalents		5			63
Net decrease in cash and cash equivalents		(246,486		)	(194,559		)
Cash and cash equivalents, beginning of period		300,556			247,673
Cash and cash equivalents, end of period		$	54,070		$	53,114

 

See accompanying Notes to the Condensed Consolidated Financial Statements.

 

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HCP, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

(1)          Business

 

HCP, Inc., a Standard & Poor’s (“S&P”) 500 company, together with its consolidated entities (collectively, “HCP” or the “Company”), invests primarily in real estate serving the healthcare industry in the United States (“U.S.”). The Company is a Maryland corporation and was organized to qualify as a self-administered real estate investment trust (“REIT”) in 1985. The Company is headquartered in Irvine, California, with offices in Nashville, Tennessee and San Francisco, California. The Company acquires, develops, leases, manages and disposes of healthcare real estate, and provides financing to healthcare providers. The Company’s portfolio is comprised of investments in the following five healthcare segments: (i) senior housing, (ii) post-acute/skilled nursing, (iii) life science, (iv) medical office and (v) hospital. The Company makes investments within the healthcare segments using the following five investment products: (i) properties under lease, (ii) debt investments, (iii) developments and redevelopments, (iv) investment management and (v) investments in senior housing operations utilizing the structure permitted by the Housing and Economic Recovery Act of 2008, which is commonly referred to as “RIDEA.”

 

(2)          Summary of Significant Accounting Policies

 

Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information. Management is required to make estimates and assumptions in the preparation of financial statements in conformity with GAAP. These estimates and assumptions 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 revenues and expenses during the reporting period. Actual results could differ from management’s estimates.

 

The condensed consolidated financial statements include the accounts of HCP, Inc., its wholly-owned subsidiaries, joint ventures and variable interest entities (“VIEs”) that it controls through voting rights or other means. Intercompany transactions and balances have been eliminated upon consolidation. In the opinion of management, all adjustments (consisting of normal recurring adjustments) necessary to present fairly the Company’s financial position, results of operations and cash flows have been included. Operating results for the six months ended June 30, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014. The accompanying unaudited interim financial information should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2013 included in the Company’s Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission (the “SEC”).

 

Certain amounts in the Company’s condensed consolidated financial statements have been reclassified for prior periods to conform to the current period presentation. For periods through March 31, 2014, operating results for real estate assets sold have been reclassified from continuing to discontinued operations on the condensed consolidated statements of income (see Note 4).

 

Allowance for Doubtful Accounts

 

The Company maintains an allowance for doubtful accounts, including an allowance for straight-line rent receivables, for estimated losses resulting from tenant defaults or the inability of tenants to make contractual rent and tenant recovery payments. For straight-line rent amounts, the Company’s assessment is based on amounts estimated to be recoverable over the term of the lease.

 

The Company evaluates the liquidity and creditworthiness of its tenants, operators and borrowers on a monthly and quarterly basis. The Company’s evaluation considers industry and economic conditions, individual and portfolio property performance, credit enhancements, liquidity and other factors. The Company’s tenants, borrowers and operators furnish property, portfolio and guarantor/operator-level financial statements, among other information, on a monthly or quarterly basis; the Company utilizes this financial information to calculate the lease or debt service coverages that it uses as a primary credit quality indicator. Lease and debt service coverage information is evaluated together with other property, portfolio and operator performance information, including revenue, expense, net operating income, occupancy, rental rate, reimbursement trends, capital expenditures and EBITDA, along with liquidity. The Company evaluates, on a monthly basis or immediately upon a change in circumstances, its tenants’, operators’ and borrowers’ ability to service their obligations with the Company.

 

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In connection with the Company’s quarterly loans receivable and direct financing leases (“DFLs”) (collectively, “Finance Receivables”) review process, Finance Receivables are assigned an internal rating of Performing, Watch List or Workout. Finance Receivables that are deemed Performing meet all present contractual obligations, and collection and timing of all amounts owed is reasonably assured. Watch List Finance Receivables meet all present contractual obligations; however, the timing and/or collection of all amounts owed may not be reasonably assured. Workout Finance Receivables are defined as Finance Receivables where the Company has determined, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the agreement.

 

Finance Receivables are placed on nonaccrual status when management determines that the collectibility of contractual amounts is not reasonably assured. If the ultimate collectibility of the recorded nonaccrual Finance Receivable balance is in doubt, the cost recovery method is used, and cash collected is applied to first reduce the carrying value of the Finance Receivable. Otherwise, the cash basis method is used, whereby income may be recognized to the extent cash is received. Generally, the Company returns a Finance Receivable to accrual status when all delinquent payments become current under the terms of the loan or lease agreements and collectibility of remaining loan or lease payments is no longer in doubt.

 

Allowances are established for Finance Receivables based upon an estimate of probable losses on an individual basis, if they are determined to be impaired. Finance Receivables are impaired when it is deemed probable that the Company will be unable to collect all amounts due in accordance with the contractual terms of the loan or lease. An allowance is based upon the Company’s assessment of the borrower’s or lessee’s overall financial condition, economic resources, payment record, the prospects for support from any financially responsible guarantors and, if appropriate, the net realizable value of any collateral. These estimates consider all available evidence, including the expected future cash flows discounted at the Finance Receivable’s effective interest rate, fair value of collateral, general economic conditions and trends, historical and industry loss experience, and other relevant factors, as appropriate.

 

Recent Accounting Pronouncements

 

In April 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity (“ASU 2014-08”). This update changes the requirements for reporting and the definition of discontinued operations. Based on the current revisions, the disposal of a component of an entity, or a group of components of an entity, is required to be reported in discontinued operations if the disposal represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results when certain defined criteria are met. ASU 2014-08 is effective for fiscal years and interim periods ending after December 15, 2014 and shall be applied prospectively. Early adoption is permitted, but only for disposals (or classifications as held for sale) that have not been reported in financial statements previously issued or available for issuance. On April 1, 2014, the Company early adopted ASU 2014-08; the adoption of ASU 2014-08 did not have a material impact on the Company’s consolidated financial position or results of operations.

 

In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”). This update changes the guidance for recognizing revenue. ASU 2014-09 provides guidance for revenue recognition to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 is effective for fiscal years and interim periods ending after December 15, 2016, including interim periods. Early adoption is not permitted. The Company is evaluating the impact of the adoption of ASU 2014-09 on January 1, 2017 to the Company’s consolidated financial position or results of operations.

 

(3)          Real Estate Property Investments

 

On June 6, 2014, the Company acquired a portfolio of 20 care homes for $127 million (£75.8 million) subject to long-term triple-net leases. These facilities are located throughout the United Kingdom (“UK”) and are leased to Maria Mallaband Care Group. The triple-net leases have initial terms of 15 years, plus two 10-year extension options and provide for initial annual rent of $9.7 million (£5.8 million). The cross-defaulted contractual rents will increase annually based on the Retail Price Index (UK measure of inflation), subject to a floor of 2% and a ceiling of 4.5%.

 

A summary of real estate acquisitions for the six months ended June 30, 2014 follows (in thousands):

 

		Consideration									Assets Acquired
Segment		Cash Paid			Debt and Other Liabilities Assumed			Noncontrolling Interest			Real Estate			Net Intangibles
Senior housing		$	215,381	(1)	$	1		$	6,321	(2)	$	204,758		$	16,945
Life science		43,500			250			—			41,281			2,469
Medical office		26,548			272			—			22,820			4,000
		$	285,429		$	523		$	6,321		$	268,859		$	23,414

 

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(1)           Includes £75.8 million translated into U.S. dollars.

(2)           Includes $5 million of non-managing member limited liability company units.

 

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During the six months ended June 30, 2013, the Company acquired four senior housing communities from a joint venture between Emeritus Corporation (“Emeritus”) and Blackstone Real Estate Partners VI for $38 million, acquired a senior housing facility for $18 million, exercised its purchase option for a senior housing facility it previously leased for $16 million and acquired 38 acres of land in the post-acute/skilled nursing segment for $408,000.

 

During the six months ended June 30, 2014 and 2013, the Company funded an aggregate of $101 million and $76 million, respectively, for construction, tenant and other capital improvement projects, primarily in its senior housing, life science and medical office segments.

 

(4)    Dispositions of Real Estate and Discontinued Operations

 

During the six months ended June 30, 2014, the Company sold two post-acute/skilled nursing facilities for $22 million, a hospital for $17 million and a medical office building (“MOB”) for $145,000. During the six months ended June 30, 2013, the Company sold a senior housing facility for $4 million.

 

There were no assets classified as held for sale at June 30, 2014. At December 31, 2013, one hospital and two post-acute/skilled nursing facilities were classified as held for sale, with a carrying value of $10 million.

 

The following table summarizes operating income from discontinued operations and gain on sales of real estate included in discontinued operations (dollars in thousands):

 

		Three Months Ended June 30,			Six Months Ended June 30,
		2013			2014			2013
Rental and related revenues		$	4,824		$	1,810		$	9,908
Depreciation and amortization expenses		1,557			—			3,095
Operating expenses		927			54			1,846
Other expenses, net		399			20			795
Income before gain on sales of real estate, net of income taxes		$	1,941		$	1,736		$	4,172
Gain on sales of real estate, net of income taxes		$	887		$	28,010		$	887
Number of properties included in discontinued operations		16			2			16

 

(5)         Net Investment in Direct Financing Leases

 

The components of net investment in DFLs consisted of the following (dollars in thousands):

 

		June 30,			December 31,
		2014			2013
Minimum lease payments receivable		$	24,517,865		$	24,808,386
Estimated residual values		4,134,405			4,134,405
Less unearned income		(21,428,392		)	(21,789,392		)
Net investment in direct financing leases		$	7,223,878		$	7,153,399
Properties subject to direct financing leases		364			364

 

The minimum lease payments receivable are primarily attributable to HCR ManorCare, Inc. (“HCR ManorCare”) ($23.3 billion and $23.5 billion at June 30, 2014 and December 31, 2013, respectively). The triple-net master lease with HCR ManorCare provides for annual rent of $524 million beginning April 1, 2014 (prior to April 1, 2014, annual rent was $506 million). The rent increases by 3.5% per year over the next two years and by 3% for the remaining portion of the initial lease term. The properties are grouped into four pools, and HCR ManorCare has a one-time extension option for each pool with rent increased for the first year of the extension option to the greater of fair market rent or a 3% increase over the rent for the prior year. Including the extension options, which the Company determined to be bargain renewal options, the four leased pools had total initial available terms ranging from 23 to 35 years.

 

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The following table summarizes the Company’s internal ratings for net investment in DFLs at June 30, 2014 (in thousands):

 

		Carrying			Percentage of DFL		Internal Ratings
Investment Type		Amount			Portfolio		Performing DFLs			Watch List DFLs			Workout DFLs
Senior housing		$	1,488,704		20		$	1,116,401		$	372,303		$	—
Post-acute/skilled nursing		5,611,283			78		5,611,283			—			—
Hospital		123,891			2		123,891			—			—
		$	7,223,878		100		$	6,851,575		$	372,303		$	—

 

During the quarter ended September 30, 2013, the Company placed a 14-property senior housing DFL (the “DFL Portfolio”) on non-accrual status. Based on the Company’s determination that the timing of the collection of all rental payments was no longer reasonably assured, rental revenue for the DFL Portfolio is recognized on a cash basis. Furthermore, the Company determined that the DFL Portfolio was not impaired at September 30, 2013, based on its belief that: (i) it was not probable that it will not collect all of the rental payments under the terms of the lease; and (ii) the fair value of the underlying collateral exceeded the DFL Portfolio’s $376 million carrying amount. The fair value of the DFL Portfolio was estimated based on a discounted cash flow model, which inputs are considered to be a Level 3 measurement within the fair value hierarchy. Inputs to this valuation model include real estate capitalization rates, industry growth rates and operating margins, some of which influence the Company’s expectation of future cash flows from the DFL Portfolio and, accordingly, the fair value of its investment. During the three months ended June 30, 2014 and 2013, the Company recognized DFL income of $5 million and $7 million, respectively, and received cash payments of $6 million in each period, respectively, from the DFL Portfolio. During the six months ended June 30, 2014 and 2013, the Company recognized DFL income of $10 million and $14 million, respectively, and received cash payments of $12 million in each period from the DFL Portfolio. The carrying value of the DFL Portfolio was $372 million and $374 million at June 30, 2014 and December 31, 2013, respectively. At June 30, 2014, the Company believes the fair value of the collateral supporting this loan is in excess of its carrying value.

 

(6)    Loans Receivable

 

The following table summarizes the Company’s loans receivable (in thousands):

 

		June 30, 2014									December 31, 2013
		Real Estate Secured			Other Secured			Total			Real Estate Secured			Other Secured			Total
Mezzanine		$	—		$	233,854		$	233,854		$	—		$	234,455		$	234,455
Other (1)		157,819			—			157,819			147,669			—			147,669
Unamortized discounts, fees and costs		—			(2,546		)	(2,546		)	—			(2,713		)	(2,713		)
Allowance for loan losses		—			(13,410		)	(13,410		)	—			(13,410		)	(13,410		)
		$	157,819		$	217,898		$	375,717		$	147,669		$	218,332		$	366,001

 

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(1)           Includes $128 million and $117 million at June 30, 2014 and December 31, 2013, respectively, of construction loans outstanding related to senior housing development projects.  At June 30, 2014, the Company had $19.5 million remaining under its commitments to fund development projects.

 

The following table summarizes the Company’s internal ratings for loans receivable at June 30, 2014 (in thousands):

 

		Carrying			Percentage of Loan		Internal Ratings
Investment Type		Amount			Portfolio		Performing Loans			Watch List Loans			Workout Loans
Real estate secured		$	157,819		42		$	157,819		$	—		$	—
Other secured		217,898			58		200,428			—			17,470
		$	375,717		100		$	358,247		$	—		$	17,470

 

Other Secured Loans

 

Barchester Loan.  On May 2, 2013, the Company acquired £121 million ($188 million) of subordinated debt at a discount for £109 million ($170 million). The loan was secured by an interest in 160 facilities leased and operated by Barchester Healthcare (“Barchester”). On August 23, 2013, the Company acquired an additional investment in this loan of £9 million ($14 million) at a discount for £5 million ($8 million). This loan accrued interest on its face value at a floating rate of LIBOR plus a weighted-average margin of 3.14%. This loan investment was financed by a GBP denominated draw on the Company’s revolving line of credit facility that is discussed in Note 10. On September 6, 2013, the Company received £129 million ($202 million) from the par payoff of its Barchester debt investments. As a result, the Company recognized interest income of $24 million primarily representing the debt investment’s unamortized discounts. A portion of the proceeds from the Barchester repayment were used to repay the total outstanding amount of the Company’s GBP denominated draw on its revolving line of credit facility.

 

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