Seven Hills Realty Trust quarterly report, Q3 FY2021

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Seven Hills Realty Trust — Q3 2021 Form 10-Q Summary

Business context and reporting period

For the quarter and nine months ended September 30, 2021, Seven Hills Realty Trust operated as a mortgage REIT focused primarily on originating and investing in first mortgage loans secured by middle-market and transitional commercial real estate. The SEC approved deregistration under the Investment Company Act on January 5, 2021, resulting in a transition from an investment-company structure to a reporting-company and REIT structure.

On September 30, 2021, the Trust completed its merger with Tremont Mortgage Trust. The transaction added 10 loans with an aggregate principal balance of $204.7 million, assumed $129.0 million of Citibank repurchase debt, and resulted in the issuance of 4.285 million SEVN shares. Because the merger became effective after the close of trading, acquired assets and liabilities were included in the September 30 balance sheet, but TRMT operating results were not included in the income statement.

Financial position and operating metrics

  • Assets and equity: Total assets were $456.2 million, including $434.5 million of loans held for investment, $19.3 million of cash and cash equivalents, and $0.5 million of restricted cash. Shareholders’ equity was $236.6 million.
  • Loan portfolio: The portfolio consisted of 22 loans with $525.9 million of commitments, $472.0 million of principal balance, and $54.0 million of unfunded commitments. Weighted-average coupon was 4.86%, all-in yield was 5.43%, maximum maturity was 3.7 years, weighted-average LTV was 68%, and weighted-average risk rating was 3.0.
  • Revenue and profit: Third-quarter interest income was $4.5 million and net income was $2.5 million, or $0.24 per basic and diluted share. Nine-month interest income was $9.6 million and net income was $4.0 million, or $0.39 per share.
  • Net investment income: Income from investments, net of interest and related expenses, was $4.0 million in the third quarter and $8.9 million for the first nine months.
  • Expenses: Third-quarter expenses were $1.5 million, comprising $0.7 million of base management fees, $0.4 million of general and administrative expenses, and $0.3 million of shared-services reimbursements.
  • Distributable earnings: Distributable earnings were $2.5 million, or $0.24 per share, in the third quarter and $4.2 million, or $0.41 per share, for the nine months.
  • Book value: Book value was $16.32 per share. Adjusted book value, excluding the $36.4 million unaccreted purchase discount on merger-acquired loans, was $18.83 per share.
  • Cash flow: Nine-month operating cash flow was $1.3 million. Investing cash flow was negative $167.1 million, principally due to loan originations, additional fundings, merger costs, and acquired assets. Financing cash flow was positive $82.1 million. Cash, cash equivalents and restricted cash declined from $103.6 million to $19.8 million.
  • Debt and liquidity: Repurchase debt had a September 30 principal balance of $216.3 million and carrying value of $215.7 million. Total facility capacity was $405.5 million, with $189.1 million of unused capacity. The UBS facility had a $87.4 million balance and matures in February 2024; the Citibank facility had a $129.0 million balance and matures in November 2022.
  • Distributions: The Trust declared and paid $0.15 per share for each of three 2021 distributions, totaling $4.6 million. Management stated that no further 2021 dividends were expected unless required for tax purposes.

Material changes versus comparable periods

  • The filing does not provide a meaningful year-over-year comparison because 2020 results reflect the predecessor investment-company business, including dividend income, realized gains and unrealized investment losses.
  • Compared with the second quarter of 2021, third-quarter interest income increased 47.6% to $4.5 million, net income increased 114.1% to $2.5 million, and EPS increased from $0.11 to $0.24. The increases reflected a full quarter of income from previously originated loans, four additional third-quarter originations, and portfolio growth.
  • Third-quarter net interest and investment income increased 40.5% sequentially to $4.0 million, while interest expense increased to $0.5 million due to greater UBS facility borrowings.
  • Compared with December 31, 2020, loans increased from five to 22, carrying value increased from $91.9 million to $434.5 million, and the portfolio shifted from the predecessor’s investment-company assets to a substantially larger commercial mortgage portfolio.
  • The merger added significant scale but also introduced Citibank repurchase debt and a $36.4 million purchase discount that will be accreted into income over the remaining loan terms.

Outlook, risks, contingencies and unusual items

Management described CRE debt markets as improved and generally stable in 2021, with strong transaction activity and opportunities for alternative lenders. Management expects continued demand for flexible CRE debt capital but noted substantial competition, particularly for multifamily and industrial assets.

  • COVID-19 continues to pose risks to borrowers and tenants, especially in retail, hospitality and office properties. Management expects some business plans may take longer than anticipated and borrowers could become unable to meet debt-service obligations.
  • As of September 30, 2021, there were no impaired, nonaccrual or defaulted loans and no loan-loss allowance was recorded. As of October 29, 2021, all borrowers had paid amounts due and no portfolio loans were in default.
  • The filing identifies three higher-risk loans. The notes state these represented approximately 11% of portfolio carrying value, while the MD&A states approximately 14%; the difference should be verified.
  • Repurchase facilities are floating-rate and subject to margin maintenance, cash sweeps, acceleration and margin calls. The Trust was in compliance with all covenants at September 30, 2021, had not received a Citibank margin call, and had not experienced lender cash sweeps.
  • LIBOR transition creates uncertainty for both loan assets and repurchase facilities. LIBOR was expected to be phased out for new contracts after December 31, 2021 and for existing contracts after June 30, 2023.
  • Unfunded loan commitments totaled $54.0 million, and total contractual obligations, including repurchase principal, projected interest and unfunded commitments, were $276.6 million.
  • Eight merger-related shareholder lawsuits were disclosed; all listed cases were voluntarily dismissed between September 27 and October 15, 2021.
  • Management stated that available cash, loan repayments, operating cash flow and unused borrowing capacity should be sufficient for operating needs, debt service and distributions for the next 12 months, subject to pandemic and borrower-performance risks.

Investor verification points

  • Verify the appropriate comparable-period analysis because 2021 successor-basis results are not directly comparable with 2020 predecessor-basis results.
  • Reconcile the reported higher-risk loan concentration of approximately 11% in the notes versus approximately 14% in the MD&A.
  • Assess the sustainability of distributions after management’s statement that no further 2021 dividends were expected absent tax requirements.
  • Review the $36.4 million merger-related loan purchase discount, its expected accretion schedule and its effect on reported earnings versus distributable earnings.
  • Evaluate refinancing and margin-call exposure related to the $129.0 million Citibank facility maturing in November 2022 and the $216.3 million total repurchase balance.
  • Monitor higher-risk retail, hospitality and office exposures, unfunded commitments, COVID-19 effects, interest-rate sensitivity and the transition away from LIBOR.