Seven Hills Realty Trust — Q1 2023 Form 10-Q Summary
Business Context and Reporting Period
Seven Hills Realty Trust is a Maryland REIT that originates and invests in floating-rate first mortgage loans secured by middle-market and transitional commercial real estate. This unaudited Form 10-Q covers the three months ended March 31, 2023, with comparisons to March 31, 2022 and, where relevant, December 31, 2022.
Key Financial Metrics
| Metric | Q1 2023 | Comparable Period |
|---|---|---|
| Interest and related income | $15.856 million | $9.579 million in Q1 2022 |
| Income from investments, net | $9.347 million | $13.777 million in Q1 2022 |
| Net income | $7.803 million | $11.126 million in Q1 2022 |
| Basic and diluted earnings per share | $0.53 | $0.76 in Q1 2022 |
| Distributable Earnings | $5.751 million | $5.367 million in Q4 2022 |
| Distributable Earnings per share | $0.39 | $0.37 in Q4 2022 |
| Net cash provided by operating activities | $6.577 million | $3.085 million in Q1 2022 |
| Cash and cash equivalents | $84.300 million | $71.057 million at December 31, 2022 |
| Loans held for investment, net | $617.935 million | $669.929 million at December 31, 2022 |
| Secured financing facilities, carrying value | $433.385 million | $471.521 million at December 31, 2022 |
| Shareholders’ equity | $267.747 million | $271.579 million at December 31, 2022 |
Interest and related income increased year over year primarily because of higher benchmark interest rates, while interest expense also rose. Purchase discount accretion declined to $1.185 million from $5.935 million in Q1 2022, materially reducing investment income. The filing does not provide a separately stated operating margin.
Portfolio, Debt and Liquidity
- The loan portfolio included 25 first mortgage loans with aggregate commitments of $674.475 million, principal balances of $628.696 million and unfunded commitments of $45.779 million.
- Weighted average coupon was 8.57%, weighted average all-in yield was 9.06%, weighted average loan-to-value was 67%, and weighted average risk rating was 2.9.
- Portfolio exposure was 39% office, 32% multifamily, 18% retail and 11% industrial by amortized cost. The Midwest represented 38% of the portfolio, followed by the West at 24%, South at 21% and East at 17%.
- Secured financing facilities had $435.490 million of outstanding principal, a 6.76% weighted average coupon and $246.510 million of unused capacity against total facility size of $682.000 million.
- Debt principal payments totaled $435.490 million, including $87.237 million due in 2023 and $237.996 million due in 2024, based on the filing’s maturity schedule.
- Management stated that the company was in compliance with all financing covenants and believed available liquidity and expected cash flows would be sufficient for operations, debt service, distributions and commitments for the next 12 months.
Material Changes Versus Prior Periods
- Compared with Q1 2022, net income decreased 29.9% and earnings per share decreased from $0.76 to $0.53, primarily because of lower purchase discount accretion and higher interest expense.
- Compared with Q4 2022, net income increased 15.4% to $7.803 million and distributable earnings increased 7.2% to $5.751 million. The improvement included a $0.987 million reversal of credit losses.
- Loan carrying value decreased by $51.994 million from year-end, principally reflecting approximately $51.918 million of loan repayments, partially offset by additional funding and fee accretion.
- Secured financing carrying value declined by $38.136 million from year-end due primarily to repayments.
- On January 1, 2023, the company adopted CECL accounting under ASU 2016-13. The adoption produced a $6.595 million cumulative reduction to cumulative net income, including a $4.893 million allowance for loan credit losses and a $1.702 million liability for unfunded commitments. At March 31, 2023, total related allowances were $5.608 million.
- The company paid a quarterly distribution of $0.35 per common share, or $5.147 million, and declared another $0.35 per share distribution payable in May 2023.
Outlook, Risks and Unusual Items
No formal earnings or portfolio guidance was provided. Management indicated that alternative lenders with available liquidity may find opportunities as traditional lenders face tighter underwriting, higher funding costs and banking-sector volatility. Management also expects CRE transaction activity could improve as market uncertainty subsides.
- All borrowers had paid debt service obligations owed and due as of March 31 and April 20, 2023; there were no past-due or nonaccrual loans at March 31.
- Management identified inflation, high interest rates, supply-chain disruptions, recession risk, declining CRE values, tighter credit markets and banking-sector stress as potential threats to borrower liquidity, property performance and loan repayments.
- Rising rates benefit the company’s floating-rate loan income but also increase borrowing costs and may impair borrowers’ ability to service debt or obtain replacement interest-rate caps and swaps.
- The portfolio remains exposed to office and retail properties, which management said continue to face effects from pandemic-related changes and broader market conditions.
- Repurchase facilities may require margin calls, cash-flow sweeps or accelerated asset repurchases. The company also faces refinancing and maturity concentration, particularly in 2023 and 2024.
- Management and shared-services arrangements with Tremont and RMR create related-party expenses and potential conflicts of interest. Base management fees were $1.072 million and shared-services reimbursements were $0.643 million in Q1 2023.
- All pre-existing LIBOR-based loan contracts had been amended to use SOFR as of April 20, 2023.
Important Facts for Investors to Verify
- Whether office and retail collateral performance deteriorates and causes higher CECL reserves, nonaccruals or realized credit losses.
- The timing and funding requirements of the $45.779 million of unfunded loan commitments.
- Repayment or refinancing capacity for the $87.237 million of debt due in 2023 and $237.996 million due in 2024.
- Whether floating-rate income continues to exceed the increase in floating-rate financing costs.
- The sustainability of the $0.35-per-share quarterly distribution relative to distributable earnings and cash flows.
- The effect of loan repayments and limited new originations on portfolio scale, diversification and future interest income.
- The assumptions supporting the CECL allowance, including CRE pricing forecasts, loan-level risk ratings and collateral values.
- The company’s continuing compliance with secured financing covenants and availability of unused borrowing capacity.