Seven Hills Realty Trust — Q1 2022 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. The filing covers the unaudited three months ended March 31, 2022.
At quarter-end, the portfolio comprised 27 loans with $684.5 million of total commitments and $636.8 million of principal balance. The carrying value was $622.7 million, with a weighted-average coupon of 4.57%, all-in yield of 5.10%, loan-to-value ratio of 68%, and risk rating of 2.8.
Financial Performance and Key Metrics
| Metric | Q1 2022 | Q1 2021 |
|---|---|---|
| Interest income from investments | $9.6 million | $2.0 million |
| Purchase discount accretion | $5.9 million | — |
| Income from investments, net | $13.8 million | $2.0 million |
| Total other expenses | $2.6 million | $1.6 million |
| Net income | $11.1 million | $0.4 million |
| Net income per diluted share | $0.76 | $0.03 |
| Adjusted Distributable Earnings | $5.3 million | Not provided in the filing for Q1 2021 |
| Adjusted Distributable Earnings per share | $0.37 | Not provided in the filing for Q1 2021 |
Net income included $5.9 million of non-cash purchase discount accretion related to loans acquired in the September 2021 merger with Tremont Mortgage Trust. Distributable Earnings were $5.3 million, or $0.36 per diluted share, after excluding purchase discount accretion and non-cash equity compensation.
Net cash provided by operating activities was $3.1 million, compared with cash used of $1.4 million in Q1 2021. Investing activities used $44.6 million, primarily reflecting $90.0 million of loan originations and $3.2 million of additional loan funding, partly offset by $48.6 million of loan repayments. Financing activities provided $24.2 million from net secured-facility borrowings, after distributions.
Cash, cash equivalents and restricted cash declined to $9.0 million at March 31, 2022 from $26.3 million at December 31, 2021. Shareholders’ equity was $265.3 million, and book value was $18.17 per common share. Adjusted book value was $18.95 per share.
Debt, Liquidity and Distributions
- Secured financing facilities had $369.4 million of outstanding principal and a $367.7 million carrying value at March 31, 2022.
- The weighted-average borrowing rate was 2.32%, and total facility capacity was $632.0 million, leaving $262.6 million of stated unused capacity, subject to lender approval and applicable conditions.
- Debt maturities included $31.4 million in 2022, $87.0 million in 2023, $219.3 million in 2024 and $31.7 million in 2025.
- Unfunded loan commitments totaled $47.8 million, including $6.5 million due within one year and $41.4 million due within one to three years.
- The company paid a quarterly distribution of $0.25 per share, or $3.6 million, during the quarter and declared another $0.25 per share distribution payable May 19, 2022.
- Management stated that available cash, investment cash flows and unused financing capacity are expected to be sufficient for operating needs, debt service, commitments and distributions for the next 12 months, subject to borrower performance and broader economic conditions.
Material Changes Versus Prior Comparable Period
- Loan carrying value increased to $622.7 million from $147.2 million at March 31, 2021, reflecting portfolio expansion and the Tremont Mortgage Trust merger.
- Interest income increased substantially as a result of the larger portfolio, prepayment premiums and accelerated deferred-fee amortization on two repaid loans.
- Net income increased to $11.1 million from $0.4 million; however, the comparison is significantly affected by merger-related purchase discount accretion.
- Operating cash flow improved to $3.1 million from negative $1.4 million, while the company began using secured financing facilities to fund portfolio growth.
- During the quarter, the company entered into a new Wells Fargo repurchase facility with up to $125.0 million of advances, amended and expanded its Citibank facility to $215.0 million, and subsequently increased the BMO facility from $100.0 million to $150.0 million on April 25, 2022.
- Compared with the preceding quarter, Q1 2022 net income declined 46.1% to $11.1 million because Q4 2021 included $18.9 million of purchase discount accretion, including accretion triggered by loan repayments.
Guidance, Outlook, Commentary and Risks
The filing does not provide formal earnings or distribution guidance. Management expects continued opportunities for alternative CRE lenders but notes that inflation, higher interest rates, supply-chain disruptions, geopolitical uncertainty and the Federal Reserve’s tightening policy are increasing borrowing and transaction costs.
All borrowers had paid debt service due as of March 31 and April 25, 2022. There were no impaired, nonaccrual or defaulted loans at quarter-end, and no loan-loss reserve was recorded. Two loans, representing approximately 4% of portfolio carrying value, were rated “4” or higher risk.
COVID-19 effects had not materially affected the company to date, but management identified continuing risks to retail, hospitality and certain office properties. Borrower business-plan delays or reduced property cash flows could lead to defaults, impairments, nonaccrual income and additional reserves.
The portfolio and borrowings are primarily floating rate. Higher benchmark rates may increase both loan income and borrowing costs, while borrower refinancing and repayment capacity may weaken. Repurchase facilities also include margin maintenance provisions, cash sweeps, guarantees and financial covenants. The company was in compliance with all facility covenants at March 31, 2022.
The company expects to adopt the current expected credit loss standard, ASU 2016-13, and related ASU 2022-02, on January 1, 2023. The potential effect has not yet been determined.
Important Facts for Investors to Verify
- Reconcile GAAP net income with Distributable Earnings and Adjusted Distributable Earnings, particularly the sustainability of earnings excluding purchase discount accretion.
- Review debt maturities, floating-rate exposure, margin-call provisions and covenant requirements as interest rates rise.
- Monitor the $47.8 million of unfunded loan commitments and the company’s relatively low $9.0 million of cash and restricted cash.
- Assess credit performance of the two higher-risk loans and exposure to retail, office and other pandemic-sensitive collateral.
- Evaluate the effect of the 2023 expected-credit-loss adoption on equity and earnings.
- Review related-party management and shared-service fees paid to Tremont and RMR, as well as the company’s dependence on those entities.
- Confirm the timing and funding of declared distributions and whether future distributions remain supported by recurring distributable earnings and liquidity.