Seven Hills Realty Trust quarterly report, Q2 FY2022

Seven Hills Realty Trust — Form 10-Q Summary

Business Context and Reporting Period

Seven Hills Realty Trust is a Maryland REIT focused on originating and investing in floating-rate first mortgage loans secured by middle-market and transitional commercial real estate. This unaudited Form 10-Q covers the three and six months ended June 30, 2022, filed July 27, 2022. The company had 14,638,063 common shares outstanding as of July 25, 2022.

Key Financial Metrics

Metric	Q2 2022	Q2 2021	Six Months 2022	Six Months 2021
Interest income from investments	$8.9 million	$3.1 million	$18.4 million	$5.1 million
Purchase discount accretion	$1.6 million	—	$7.6 million	—
Net income	$4.6 million	$1.2 million	$15.7 million	$1.5 million
Net income per share	$0.31	$0.11	$1.08	$0.15
Distributable earnings per share	$0.24	Not provided	$0.60	$0.17
Adjusted distributable earnings per share	$0.24	Not provided	$0.61	$0.17
Net cash provided by operating activities	Not separately provided	Not separately provided	$6.3 million	$(2.1) million

Q2 2022 net income was $4.6 million, compared with $1.2 million in Q2 2021. Net income margin, calculated as net income divided by total income from investments before interest expense, was approximately 43.6% in Q2 2022 versus 37.9% in Q2 2021; the filing does not present a standard operating margin. Six-month net income increased 940% year over year, primarily reflecting the larger loan portfolio following the September 2021 Tremont Mortgage Trust merger, purchase discount accretion, and higher interest income.

Loans held for investment, net, totaled $670.2 million at June 30, 2022, versus $570.8 million at December 31, 2021.
The portfolio comprised 28 loans with $682.3 million of principal balance and $734.9 million of total commitments.
Weighted average coupon was 5.14%, weighted average all-in yield was 5.64%, and weighted average loan-to-value ratio was 68%.
Cash and cash equivalents were $48.2 million, with total cash, cash equivalents and restricted cash of $48.4 million.
Shareholders’ equity was $266.7 million, compared with $257.7 million at December 31, 2021. Book value per share was $18.22 and adjusted book value per share was $18.89.
Secured financing facilities had $455.0 million of outstanding principal and a $452.7 million carrying value, versus $340.9 million and $339.6 million, respectively, at December 31, 2021.
The weighted average borrowing rate was 3.36%, compared with 2.06% at December 31, 2021; weighted average remaining maturity was 1.9 years.
Aggregate unused secured financing capacity was $227.0 million at June 30, 2022.
The company paid $7.3 million of distributions during the first six months, or $0.50 per share, and declared an additional $0.25 per share distribution payable in August 2022.

Cash Flow, Leverage and Liquidity

During the first six months of 2022, operating activities generated $6.3 million of cash, investing activities used $89.5 million, and financing activities provided $105.3 million. The company originated $141.3 million of loans, funded $8.0 million of additional loan advances, received $59.8 million of loan repayments, borrowed $223.9 million under secured financing facilities and repaid $109.8 million.

Management stated that available cash, investment proceeds and unused borrowing capacity are expected to be sufficient to meet operating expenses, debt service, loan funding commitments and distributions for the next 12 months and the foreseeable future. Contractual obligations included $52.7 million of unfunded loan commitments, $455.0 million of secured financing principal payments and $29.1 million of projected interest payments based on rates at June 30, 2022.

Material Changes Versus Comparable Periods

Six-month interest income increased $13.4 million, or 264.9%, to $18.4 million, reflecting 17 loans originated or acquired since July 1, 2021 and certain repayment-related fees.
Six-month net income increased $14.2 million to $15.7 million, while net income per share increased to $1.08 from $0.15.
Six-month distributable earnings increased to $8.8 million from $1.7 million, although 2022 results included $7.6 million of non-cash purchase discount accretion that was excluded from distributable earnings.
Interest and related expenses increased to $4.7 million from $0.2 million as borrowings and benchmark rates increased.
Total other expenses increased 64.1% to $5.5 million, driven by higher management fees, general and administrative expenses, shared services reimbursements and merger-related costs.
Compared with March 31, 2022, Q2 net income declined 58.9% to $4.6 million. The decrease primarily reflected lower purchase discount accretion after two loans were repaid in the first quarter, higher interest expense and higher general and administrative expenses.
The company added Wells Fargo as a financing counterparty, increased the BMO facility maximum from $100 million to $150 million, increased Citibank facility capacity to $215 million and amended financing arrangements to use SOFR in place of LIBOR.

Guidance, Outlook, Risks and Unusual Items

No formal earnings or portfolio guidance was provided. Management expects continued opportunities for alternative CRE lenders but noted that higher interest rates, wider credit spreads, inflation, geopolitical uncertainty and recession concerns are slowing transaction activity and tightening underwriting standards.
Office and retail collateral remain exposed to lingering COVID-19 effects, work-from-home trends, weaker discretionary spending and potential recessionary conditions. Transitional properties may take longer than expected to execute their business plans.
As of June 30, 2022, two loans, representing approximately 4% of portfolio carrying value, had a risk rating of 4 or higher. There were no impaired, nonaccrual or defaulted loans, and no loan-loss reserve was recorded.
The February 2022 modification of the Yardley, Pennsylvania office loan increased the commitment by $1.6 million and extended maturity by one year. The modification was not a troubled debt restructuring but was treated as an extinguishment; $1.7 million of unaccreted purchase discount was recognized as interest income in the first quarter.
Secured financing agreements include margin maintenance provisions, cash-flow sweeps, guarantees, financial covenants and potential acceleration upon defaults or certain change-of-control events. The company was in compliance with all covenants at June 30, 2022.
Rising rates increase both income on floating-rate loans and interest expense on floating-rate borrowings, while potentially impairing borrowers’ ability to service debt. LIBOR-related loan agreements were expected to transition to SOFR by June 30, 2023.
The company will adopt the current expected credit loss standard and related amendments on January 1, 2023. The filing states that the resulting allowance is still being assessed and could reduce equity through a cumulative-effect adjustment.
The company has no employees and depends on Tremont and RMR for management and shared services. Related-party transactions and conflicts of interest remain relevant investor considerations.

Most Important Facts for Investors to Verify

Whether portfolio growth and floating-rate resets offset rising financing costs and higher credit risk.
The quality, performance and collateral value of the two higher-risk loans representing approximately 4% of portfolio value.
The expected effect of adopting the current expected credit loss standard on shareholders’ equity and loan-loss reserves.
Available liquidity after considering $52.7 million of unfunded loan commitments, margin-call exposure and secured financing maturities.
The sustainability of the $0.25 per share quarterly distribution relative to distributable earnings and cash flows.
The impact of office-market weakness, retail conditions, recession risk and borrowers’ ability to execute transitional-property business plans.
The terms, capacity and covenant requirements of the amended Citibank, UBS, Wells Fargo and BMO financing facilities.