Seven Hills Realty Trust 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion should be read in conjunction with our condensed consolidated financial statements and accompanying notes included elsewhere in this Quarterly Report on Form 10-Q and in our 2021 Annual Report. OVERVIEW (dollars in thousands, except share data) We are a Maryland REIT. Our business strategy is focused on originating and investing in floating rate first mortgage loans secured by middle market and transitional commercial real estate, or CRE. We define middle market CRE as commercial properties that have values up to $100,000 and transitional CRE as commercial properties subject to redevelopment or repositioning activities that are expected to increase the value of the properties. These mortgage loans are classified as loans held for investment in our condensed consolidated balance sheets. Loans held for investment are reported at cost, net of any unamortized loan fees, origination costs, premiums or discounts, as applicable, unless the assets are deemed impaired. Tremont is registered with the Securities and Exchange Commission, or SEC, as an investment adviser under the Investment Advisers Act of 1940, as amended. We believe that Tremont provides us with significant experience and expertise in investing in middle market and transitional CRE. We operate our business in a manner consistent with our qualification for taxation as a REIT under the IRC. As such, we generally are not subject to U.S. federal income tax, provided that we meet certain distribution and other requirements. We also operate our business in a manner that permits us to maintain our exemption from registration under the Investment Company Act of 1940, as amended, or the 1940 Act. COVID-19 Pandemic The COVID-19 pandemic and the various governmental and market responses intended to contain and mitigate the spread of the virus and its detrimental public health impact have had a significant impact on the global economy, including the U.S. economy. Many of the restrictions that had been imposed in the U.S. during the pandemic have been lifted and commercial activity in the U.S. has increasingly returned to pre-pandemic practices and operations. To date, the COVID-19 pandemic has not had a significant impact on our business. There remains uncertainty as to the ultimate duration and severity of the COVID-19 pandemic, including risks that may arise from mutations or related strains of the virus, the ability to successfully administer vaccinations to a sufficient number of persons or attain immunity to the virus by natural or other means to achieve herd immunity or otherwise render the virus reasonably manageable, and the impact on the U.S. economy that may result from the inability of other countries to administer vaccinations to their citizens or their citizens’ ability to otherwise achieve immunity to the virus. As a result, we are unable to determine what the ultimate impact will be on our borrowers’ and other stakeholders’ businesses, operations, financial results and financial position. For further information and risks relating to the COVID-19 pandemic on us and our business, see "Warning Concerning Forward-Looking Statements" elsewhere in this Quarterly Report on Form 10-Q and Part 1, Item 1A, "Risk Factors", of our 2021 Annual Report. Non-GAAP Financial Measures We present Distributable Earnings, Distributable Earnings per common share, Adjusted Distributable Earnings, Adjusted Distributable Earnings per common share and Adjusted Book Value per common share, which are considered “non-GAAP financial measures” within the meaning of the applicable SEC rules. These non-GAAP financial measures do not represent net income, net income per common share or cash generated from operating activities and should not be considered as an alternative to net income or net income per common share determined in accordance with GAAP or as an indication of our cash flows from operations determined in accordance with GAAP, measures of our liquidity or operating performance or an indication of funds available for our cash needs. In addition, our methodologies for calculating these non-GAAP financial measures may differ from the methodologies employed by other companies to calculate the same or similar supplemental performance measures; therefore, our reported Distributable Earnings, Distributable Earnings per common share, Adjusted Distributable Earnings and Adjusted Distributable Earnings per common share may not be comparable to non-GAAP financial measures as reported by other companies. 15 Table of Contents We believe that Adjusted Book Value per common share is a meaningful measure of our capital adequacy because it excludes the unaccreted purchase discount resulting from the excess of the fair value of the loans TRMT then held for investment and that we acquired as a result of the Merger over the consideration we paid in the Merger. Adjusted Book Value per common share does not represent book value per common share or alternative measures determined in accordance with GAAP. Our methodology for calculating Adjusted Book Value per common share may differ from the methodologies employed by other companies to calculate the same or similar supplemental capital adequacy measures; therefore, our Adjusted Book Value per common share may not be comparable to the adjusted book value per common share reported by other companies. In order to maintain our qualification for taxation as a REIT, we are generally required to distribute substantially all of our taxable income, subject to certain adjustments, to our shareholders. We believe that one of the factors that investors consider important in deciding whether to buy or sell securities of a REIT is its distribution rate. Over time, Distributable Earnings, Distributable Earnings per common share, Adjusted Distributable Earnings and Adjusted Distributable Earnings per common share may be useful indicators of distributions to our shareholders and are measures that are considered by our Board of Trustees when determining the amount of distributions. We believe that Distributable Earnings, Distributable Earnings per common share, Adjusted Distributable Earnings and Adjusted Distributable Earnings per common share provide meaningful information to consider in addition to net income, net income per common share and cash flows from operating activities determined in accordance with GAAP. These measures help us to evaluate our performance excluding the effects of certain transactions, the variability of any management incentive fees that may be paid or payable and GAAP adjustments that we believe are not necessarily indicative of our current loan portfolio and operations. In addition, Distributable Earnings is used in determining the amount of base management and management incentive fees payable by us to Tremont under our management agreement. Distributable Earnings and Adjusted Distributable Earnings We calculate Distributable Earnings and Distributable Earnings per common share as net income and net income per common share, respectively, computed in accordance with GAAP, including realized losses not otherwise included in net income determined in accordance with GAAP, and excluding: (a) the management incentive fees earned by Tremont, if any; (b) depreciation and amortization, if any; (c) non-cash equity compensation expense; (d) unrealized gains, losses and other similar non-cash items that are included in net income for the period of the calculation (regardless of whether such items are included in or deducted from net income or in other comprehensive income under GAAP), if any; and (e) one-time events pursuant to changes in GAAP and certain non-cash items, if any. Distributable Earnings are reduced for realized losses on loan investments when amounts are deemed uncollectable. We define Adjusted Distributable Earnings and Adjusted Distributable Earnings per common share as Distributable Earnings and Distributable Earnings per common share, respectively, excluding the effects of certain non-recurring transactions. Reconciliation of Book Value per Common Share to Adjusted Book Value per Common Share The table below calculates our book value per common share and demonstrates how we calculate Adjusted Book Value per common share: March 31, 2022 December 31, 2021 Shareholders' equity $ 265,253 $ 257,694 Total outstanding common shares 14,597 14,597 Book value per common share 18.17 17.65 Unaccreted purchase discount per common share 0.78 1.20 Adjusted Book Value per common share (1) $ 18.95 $ 18.85 (1) Adjusted Book Value per common share is a non-GAAP financial measure that excludes the impact of the unaccreted purchase discount resulting from the excess of the fair value of the loans TRMT then held for investment and that we acquired as a result of the Merger over the consideration we paid in the Merger. The purchase discount of $36,443 was allocated to each acquired loan and is being accreted into income over the remaining term of the respective loan. As of March 31, 2022 and December 31, 2021, the unaccreted purchase discount was $11,458 and $17,391. 16 Table of Contents Our Loan Portfolio The table below details overall statistics for our loan portfolio as of March 31, 2022 and December 31, 2021: As of March 31, 2022 As of December 31, 2021 Number of loans 27 26 Total loan commitments $ 684,547 $ 648,266 Unfunded loan commitments (1) $ 47,812 $ 57,772 Principal balance $ 636,831 $ 590,590 Carrying value $ 622,710 $ 570,780 Weighted average coupon rate 4.57 % 4.54 % Weighted average all in yield (2) 5.10 % 5.08 % Weighted average floor 0.61 % 0.68 % Weighted average maximum maturity (years) (3) 3.7 3.8 Weighted average risk rating 2.8 2.9 Weighted average LTV (4) 68 % 68 % (1) Unfunded loan commitments are primarily used to finance property and building improvements and leasing capital and are generally funded over the term of the loan. (2) All in yield represents the yield on a loan, including amortization of deferred fees over the initial term of the loan and excluding any purchase discount accretion. (3) Maximum maturity assumes all borrower loan extension options have been exercised, which options are subject to the borrower meeting certain conditions. (4) LTV represents the initial loan amount divided by the underwritten in-place value of the underlying collateral at closing. 17 Table of Contents Loan Portfolio Details The table below details our loan portfolio as of March 31, 2022: Location Property Type Origination Date Committed Principal Amount Principal Balance Coupon Rate All in Yield (1) Maximum Maturity (2) (date) LTV (3) Risk Rating First mortgage loans St. Louis, MO Office 12/19/2018 $ 29,500 $ 28,917 L + 3.25% L + 3.74% 12/19/2023 72 % 2 Coppell, TX Retail 02/05/2019 19,365 19,365 L + 3.50% L + 4.24% 08/12/2022 73 % 3 Yardley, PA Office 12/19/2019 16,500 14,687 L + 4.58% L + 5.80% 12/19/2024 75 % 4 Allentown, PA Industrial 01/24/2020 10,270 10,270 L + 3.50% L + 4.03% 01/24/2025 67 % 2 Dublin, OH Office 02/18/2020 22,820 22,507 S + 3.75% S + 4.95% 02/18/2023 33 % 2 Downers Grove, IL Office 09/25/2020 30,000 29,499 L + 4.25% L + 4.69% 11/25/2024 67 % 3 Los Angeles, CA Retail 12/17/2020 24,600 19,142 L + 4.25% L + 5.05% 12/17/2024 67 % 3 Aurora, IL Office / Industrial 12/18/2020 16,500 14,710 L + 4.35% L + 5.04% 12/18/2024 73 % 2 Miami, FL Office 01/19/2021 10,900 10,900 L + 4.50% L + 5.47% 01/19/2025 68 % 2 Olmstead Falls, OH Multifamily 01/28/2021 54,575 46,084 L + 4.00% L + 4.64% 01/28/2026 63 % 3 Colorado Springs, CO Office / Industrial 04/06/2021 34,275 29,642 L + 4.50% L + 5.03% 04/06/2025 73 % 3 Westminster, CO Office 05/25/2021 15,250 13,759 L + 3.75% L + 4.20% 05/25/2026 66 % 2 Plano, TX Office 07/01/2021 27,385 25,209 L + 4.75% L + 5.17% 07/01/2026 78 % 3 Portland, OR Multifamily 07/09/2021 19,689 19,688 L + 3.57% L + 3.97% 07/09/2026 75 % 3 Portland, OR Multifamily 07/30/2021 13,400 13,400 L + 3.57% L + 3.98% 07/30/2026 71 % 4 Seattle, WA Multifamily 08/16/2021 12,500 12,259 L + 3.55% L + 3.89% 08/16/2026 70 % 3 Dallas, TX Office 08/25/2021 50,000 43,450 L + 3.25% L + 3.61% 08/25/2026 72 % 3 Sandy Springs, GA Retail 09/23/2021 16,488 14,821 L + 3.75% L + 4.11% 09/23/2026 72 % 2 Carlsbad, CA Office 10/27/2021 24,750 23,740 L + 3.25% L + 3.59% 10/27/2026 78 % 3 Bellevue, WA Office 11/05/2021 21,000 20,000 L + 3.85% L + 4.19% 11/05/2026 68 % 3 Ames, IA Multifamily 11/15/2021 18,000 17,680 L + 3.80% L + 4.13% 11/15/2026 71 % 3 Downers Grove, IL Office 12/09/2021 23,530 23,530 L + 4.25% L + 4.57% 12/09/2026 72 % 3 West Bloomfield, MI Retail 12/16/2021 42,500 37,388 L + 3.85% L + 4.66% 12/16/2024 59 % 3 Summerville, SC Industrial 12/20/2021 35,000 35,000 L + 3.50% L + 3.82% 12/20/2026 70 % 2 Delray Beach, FL Retail 03/18/2022 16,000 13,034 S + 4.25% S + 5.00% 03/18/2026 56 % 3 Starkville, MS Multifamily 03/22/2022 37,250 35,950 S + 4.00% S + 4.33% 03/22/2027 70 % 3 Brandywine, MD Retail 03/29/2022 42,500 42,200 S + 3.85% S + 4.25% 03/29/2027 62 % 3 Total/weighted average $ 684,547 $ 636,831 + 3.87% + 4.40% 68 % 2.8 (1) All in yield represents the yield on a loan, including amortization of deferred fees over the initial term of the loan and excluding any purchase discount accretion. (2) Maximum maturity assumes all borrower loan extension options have been exercised, which options are subject to the borrower meeting certain conditions. (3) LTV represents the initial loan amount divided by the underwritten in-place value of the underlying collateral at closing. As of March 31, 2022, we had $684,547 in aggregate loan commitments, consisting of a diverse portfolio, geographically and by property type, of 27 first mortgage loans. The impact from the COVID-19 pandemic has negatively impacted some of our borrowers’ business operations or tenants, particularly in the cases of our retail and hospitality collateral, which are some of the types of properties that have been most negatively impacted by the pandemic. We expect that those negative impacts may continue and may apply to other borrowers and/or their tenants. Further, although economic activity in the U.S. has improved significantly from the low points during the pandemic to date, certain industries have not recovered to their pre-pandemic positions. Therefore, certain of our borrowers’ business plans will likely take longer to execute than initially expected and certain of our borrowers may be unable to pay their debt service obligation owed and due to us as currently scheduled. As of March 31, 2022, we had two loan representing approximately 4% of the carrying value of our loan portfolio with a loan risk rating of “4” or “higher risk”. 18 Table of Contents All of the loans in our portfolio are structured with risk mitigation mechanisms, such as cash flow sweeps or interest reserves, to help protect us against investment losses. In addition, we continue to actively engage with our borrowers regarding their execution of the business plans for the underlying collateral, among other things. As of March 31, 2022 and April 25, 2022, all of our borrowers had paid all of their debt service obligations owed and due to us and none of the loans included in our investment portfolio were in default. We did not have any impaired loans, non-accrual loans or loans in default as of March 31, 2022; thus, we did not record a reserve for loan loss as of that date. However, depending on the duration and severity of the COVID-19 pandemic and any resulting economic downturn, our borrowers' businesses, operations and liquidity may be materially adversely impacted. As a result, they may become unable to pay their debt service obligations owed and due to us, which may result in the impairment of those loans, and our recording loan loss reserves with respect to those loans and recording of any income with respect to those loans on a nonaccrual basis. For further information regarding our loan portfolio and the risks associated with it, see Note 3 to our Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q and the risk factors identified in Part I, Item 1A, “Risk Factors”, of our 2021 Annual Report. Financing Activities On March 11, 2022, one of our wholly owned subsidiaries entered into our Wells Fargo Master Repurchase Agreement for the Wells Fargo Master Repurchase Facility. The Wells Fargo Master Repurchase Facility provides up to $125,000 in advances, with an option to increase the maximum facility to $250,000, subject to certain terms and conditions. We expect to use the Wells Fargo Master Repurchase Facility to finance the acquisition or origination of floating rate commercial mortgage loans. The expiration date of the Wells Fargo Master Repurchase Agreement is March 11, 2025, unless extended or earlier terminated in accordance with the terms of the Wells Fargo Master Repurchase Agreement. The Wells Fargo Master Repurchase Facility acts in the manner of a revolving credit facility that can be repaid as our loan investments are repaid and re-drawn as we fund new or additional loan investments. On March 15, 2022, we amended and restated our Citibank Master Repurchase Agreement, which governs the Citibank Master Repurchase Facility. The amended and restated Citibank Master Repurchase Agreement extended the stated maturity date of the Citibank Master Repurchase Facility to March 15, 2025, and made certain other changes to the agreement and related fee letter, including replacing LIBOR with SOFR for interest rate calculations on advancements under the Citibank Master Repurchase Facility and modifying certain pricing terms. On April 25, 2022, we amended and restated our BMO Loan Program Agreement, which increased the maximum facility amount from $100,000 to $150,000. For further information regarding our Secured Financing Facilities, see Note 4 to our Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q. The table below is an overview of our Secured Financing Facilities as of March 31, 2022: Maturity Date Principal Balance Unused Capacity Maximum Facility Size Collateral Principal Balance UBS Master Repurchase Facility 02/18/2024 $ 127,278 $ 64,722 $ 192,000 $ 192,044 Citibank Master Repurchase Facility 03/15/2025 159,878 55,122 215,000 223,744 Wells Fargo Master Repurchase Facility 03/11/2025 — 125,000 125,000 — BMO Facility Various 82,276 17,724 100,000 109,701 Total $ 369,432 $ 262,568 $ 632,000 $ 525,489 19 Table of Contents The table below details our Secured Financing Facilities activities during the three months ended March 31, 2022: Carrying Value Balance as of December 31, 2021 $ 339,627 Borrowings 130,160 Repayments (101,597) Deferred fees (720) Amortization of deferred fees 209 Balance as of March 31, 2022 $ 367,679 As of March 31, 2022, outstanding advancements under our Secured Financing Facilities had a weighted average interest rate of 2.32% per annum, excluding associated fees and expenses. As of March 31, 2022 and April 25, 2022, we had a $369,432 and a $378,905, respectively, aggregate outstanding principal balance under our Secured Financing Facilities. As of March 31, 2022, we were in compliance with all covenants and other terms under our Secured Financing Facilities. RESULTS OF OPERATIONS (amounts in thousands, except per share data) Three Months Ended March 31, 2022 Compared to Three Months Ended December 31, 2021: Three Months Ended March 31, 2022 December 31, 2021 Change % Change INCOME FROM INVESTMENTS: Interest income from investments $ 9,579 $ 7,209 $ 2,370 32.9 % Purchase discount accretion 5,935 18,932 (12,997) (68.7 %) Less: interest and related expenses (1,737) (1,573) (164) 10.4 % Income from investments, net 13,777 24,568 (10,791) (43.9 %) OTHER EXPENSES: Base management fees 1,063 1,054 9 0.9 % General and administrative expenses 946 1,352 (406) (30.0 %) Reimbursement of shared services expenses 560 615 (55) (8.9 %) Other transaction related costs 37 589 (552) (93.7 %) Total expenses 2,606 3,610 (1,004) (27.8 %) Income before income tax expense 11,171 20,958 (9,787) (46.7 %) Income tax expense (45) (302) 257 (85.1 %) Net income $ 11,126 $ 20,656 $ (9,530) (46.1 %) Weighted average common shares outstanding - basic 14,505 14,506 (1) — % Weighted average common shares outstanding - diluted 14,519 14,507 12 0.1 % Net income per common share - basic and diluted $ 0.76 $ 1.42 $ (0.66) (46.5 %) 20 Table of Contents Interest income from investments . The increase in interest income from investments was primarily the result of prepayment premiums and accelerated amortization of the deferred fees of $2,402 on two loans repaid during the three months ended March 31, 2022, as well as a full quarter of interest income from investments on six loan investments that were originated during the three months ended December 31, 2021 and the interest income from the origination of three loan investments during the three months ended March 31, 2022. Purchase discount accretion. The fair value of the loans acquired in the Merger exceeded the purchase price of the loans. In accordance with GAAP, a purchase discount was recorded for the difference between the fair value and purchase price of the loans acquired. The purchase discount was allocated to each acquired TRMT loan and is being accreted into income over the remaining term of the respective loan. During the three months ended December 31, 2021, three loans acquired in the Merger were repaid, resulting in the respective allocated purchase discount being fully accreted. No loans acquired in the Merger were repaid during the three months ended March 31, 2022; therefore, purchase discount accretion decreased. Interest and related expenses. The increase in interest and related expenses was primarily the result of an increase in advances made to us under our Secured Financing Facilities and an increase in interest rates on those advances during the three months ended March 31, 2022 as compared to the three months ended December 31, 2021. General and administrative expenses . The decrease in general and administrative expenses was primarily due to a decrease in share-based compensation and professional fees during the three months ended March 31, 2022 as compared to the three months ended December 31, 2021. Reimbursement of shared services expenses. Reimbursement of shared services expenses represents reimbursement of the costs for the services that Tremont arranges on our behalf from RMR. The decrease in reimbursement of shared services expenses was primarily the result of an adjustment recognized during the three months ended December 31, 2021 to increase our estimate of costs for the usage of shared services from RMR for the year ended December 31, 2021 to reflect actual costs incurred. Other transaction related costs. The decrease in other transaction related costs was primarily the result of a decrease in the costs associated with the final settlement of legal complaints filed in connection with the Merger and our conversion from a Maryland statutory trust to a Maryland REIT during the three months ended December 31, 2021. Income tax expense. Income tax expense represents income taxes paid or payable by us in certain jurisdictions where we are subject to state income taxes. The decrease in income tax expense was primarily the result of income tax expense incurred during the three months ended December 31, 2021 on realized gains on the disposition of our securities portfolio upon our conversion from an investment company under the 1940 Act to a mortgage REIT. Net income . The decrease in net income was due to the changes noted above. 21 Table of Contents Reconciliation of Net Income to Distributable Earnings and Adjusted Distributable Earnings The table below demonstrates how we calculate Distributable Earnings, Distributable Earnings per common share, Adjusted Distributable Earnings and Adjusted Distributable Earnings per common share, which are non-GAAP measures, and provides a reconciliation of these non-GAAP measures to net income: Three Months Ended March 31, 2022 Three Months Ended December 31, 2021 Reconciliation of net income to Distributable Earnings and Adjusted Distributable Earnings: Net income $ 11,126 $ 20,656 Non-cash equity compensation expense 82 446 Non-cash accretion of purchase discount (5,935) (18,932) Distributable Earnings 5,273 2,170 Other transaction related costs (1) 37 589 Income tax expense (2) — 282 Adjusted Distributable Earnings $ 5,310 $ 3,041 Weighted average common shares outstanding - basic 14,505 14,506 Weighted average common shares outstanding - diluted 14,519 14,507 Distributable Earnings per common share - basic and diluted $ 0.36 $ 0.15 Adjusted Distributable Earnings per common share - basic and diluted $ 0.37 $ 0.21 (1) Other transaction related costs for the three months ended March 31, 2022 include expenses related to the Merger and to our conversion from a Maryland statutory trust to a Maryland REIT. For the three months ended December 31, 2021, other transaction related costs include expenses related to our conversion from a Maryland statutory trust to a Maryland REIT and the final settlement of legal complaints filed in connection with the Merger. (2) Income tax expense represents the portion of our income tax expense incurred on realized gains on the disposition of our securities portfolio upon our conversion from an investment company under the 1940 Act to a mortgage REIT. Factors Affecting Operating Results Our results of operations are impacted by a number of factors and primarily depend on the interest income from our investments and the financing and other costs associated with our business. Our operating results are also impacted by general CRE market conditions and unanticipated defaults by our borrowers. For further information regarding the risks associated with our loan portfolio, see the risk factors identified in Part I, Item 1A, “Risk Factors”, of our 2021 Annual Report. Credit Risk . We are subject to the credit risk of our borrowers in connection with our investments. We seek to mitigate this risk by utilizing a comprehensive underwriting, diligence and investment selection process and by ongoing monitoring of our investments. Nevertheless, unanticipated credit losses could occur that could adversely impact our operating results. Changes in Fair Value of our Assets . We generally intend to hold our investments for their contractual terms, unless repaid earlier by the borrowers. We evaluate our investments for impairment at least quarterly. Impairments occur when it is probable that we will not be able to collect all amounts due according to the applicable contractual terms. If we determine that a loan is impaired, we will record an allowance to reduce the carrying value of the loan to an amount that takes into account both the present value of expected future cash flows discounted at the loan's contractual effective interest rate and the fair value of any available collateral, net of any costs we expect to incur to realize that value. Although we intend to generally hold our investments for their contractual terms or until repaid earlier by the borrowers, we may occasionally classify some of our investments as held for sale. Investments held for sale will be carried at the lower of their amortized cost or fair value less costs to sell within loans held for sale on our condensed consolidated balance sheets, with changes in fair value recorded through earnings. Fees received from our borrowers on any loans held for sale will be recognized as part of the gain or loss on sale. Currently, we do not expect to hold any of our investments for trading purposes. 22 Table of Contents Availability of Leverage and Equity . We use leverage to make additional investments that may increase our returns. We may not be able to obtain the expected amount of leverage we desire or its cost may exceed our expectation and, consequently, the returns generated from our investments may be reduced. Our ability to further grow our loan portfolio over time will depend, to a significant degree, upon our ability to obtain additional capital. However, our access to additional capital depends on many factors including the price at which our common shares trade relative to their book value and market lending conditions. See "—Market Conditions" below. Market Conditions. CRE transaction total volume for 2021 exceeded the previous annual high watermark of 2019. Investor demand for CRE assets, historically low interest rates and strong property fundamentals, particularly for multifamily and industrial assets, have caused CRE valuations to continue to grow. These conditions continue to drive significant demand for CRE debt. CRE loan originations, driven by property acquisitions and refinancing activities of borrowers capitalizing on increasing property values, reached a record high in 2021. Investor demand for the relative risk adjusted returns offered by CRE debt investments has also contributed to the growth of the CRE mortgage loan market. This increased demand has allowed alternative lenders, like us, to continue to gain market share, as borrowers seek flexible capital to complete value add business plans to optimize property values or to have the option to sell or refinance in short to medium term time frames. However, significant inflation experienced in 2022 and Russia's invasion of Ukraine, along with the additional supply chain issues and overall geopolitical risks have caused recent increased uncertainty in the CRE debt markets. The U.S. Federal Reserve's reaction to inflationary pressures has resulted in increased borrowing and transaction costs for both borrowers and lenders alike. Despite the recent increase in borrowing costs, nominal interest rates remain low, and CRE investors continue to see strength in the fundamentals of the U.S. CRE markets, especially in the multifamily and industrial sectors. Transaction activity and loan origination opportunities continue to be strong, as CRE investors are seemingly willing to accept higher borrowing costs in the short term as they perceive longer term upside to rent growth resulting from continued demand for affordable rental housing and industrial space. Recovery from the impact of the COVID-19 pandemic on the hospitality and retail sectors continues to improve. Hotels located in destinations that can be driven to, select service hotels that offer services and amenities in moderation and extended stay hotels continue to see improvements in performance, along with increased investor and lender demand. Retail has performed better than many expected and investors continue to favor grocery anchored, service oriented and neighborhood shopping centers over larger shopping centers anchored by big box retailers, regional malls or lifestyle centers. However, the office sector continues to pose underwriting challenges, especially for older suburban assets, and there continues to be uncertainty surrounding the long term impacts of work-from-home and flexible work schedules on demand for office space. While the debt capital markets experienced strong performance in 2021 and into the first quarter of 2022, we believe challenges remain. The longer term impact of the COVID-19 pandemic and the risk of future variants of the virus is still uncertain. Supply chain issues remain and inflation has started to impact the broader markets. The U.S. Federal Reserve raised interest rates in March 2022 and has indicated that it expects to raise interest rates several more times during 2022, which will continue to increase borrowing costs for property owners. Despite these challenges, we believe that if and as the U.S. economy continues to grow, there will continue to be significant opportunities for alternative lenders like us to provide creative, flexible debt capital for a wide array of circumstances and business plans. Changes in Market Interest Rates. With respect to our business operations, increases in interest rates, in general, may cause: (a) the interest expense associated with our variable rate borrowings, to increase; (b) the value of our fixed rate investments, if any, to decline; (c) the coupon rates on our variable rate investments, to reset, perhaps on a delayed basis, to higher rates; and (d) it to become more difficult and costly for our borrowers, which may negatively impact their ability to repay our investments. See "—Market Conditions" above for a discussion of the current market including interest rates. Conversely, decreases in interest rates, in general, may cause: (a) the interest expense associated with our variable rate borrowings, to decrease; (b) the value of our fixed rate investments, if any, to increase; (c) the coupon rates on our variable rate investments, to reset, perhaps on a delayed basis, to lower rates; and (d) it to become easier and more affordable for our borrowers to refinance, and as a result, repay our loans, but may negatively impact our future returns if any such repayment proceeds were to be reinvested in lower yielding investments. 23 Table of Contents The interest income on our loans and interest expense on our borrowings float with benchmark rates, such as LIBOR and SOFR. Because we generally intend to leverage approximately 75% of our investments, as benchmark rates increase above the floors of our loans, our income from investments, net of interest and related expenses, will increase. Decreases in benchmark rates are mitigated by interest rate floor provisions in all but one of our loan agreements with borrowers; therefore, changes to income from investments, net, may not move proportionately with the increase or decrease in benchmark rates. As of March 31, 2022, LIBOR and SOFR were 0.45% and 0.30%, respectively, and would have to exceed the floor established by any of our loans, which currently range from 0.10% to 2.32%, for us to realize an increase in interest income. Interest rates under our loan agreements with borrowers entered into prior to January 1, 2022 have been or are expected to be amended to replace LIBOR with SOFR prior to June 30, 2023, the date LIBOR is expected to no longer be available. Since January 1, 2022, interest rates under our new loan agreements with borrowers are based on SOFR. Our Citibank Master Repurchase Agreement was amended and restated in March 2022 to, among other things, replace LIBOR with SOFR for interest rate calculations on advances. Interest rates on advances under our BMO Facility and Wells Fargo Master Repurchase Facility have been based on SOFR since we entered into the agreements governing these facilities. Size of Portfolio . The size of our loan portfolio, as measured both by the aggregate principal balance and the number of our CRE loans and our other investments, is also an important factor in determining our operating results. Generally, if the size of our loan portfolio grows, the amount of interest income we receive would increase and we may achieve certain economies of scale and diversify risk within our loan portfolio. A larger portfolio, however, may result in increased expenses; for example, we may incur additional interest expense or other costs to finance our investments. Also, if the aggregate principal balance of our loan portfolio grows but the number of our loans or the number of our borrowers does not grow, we could face increased risk by reason of the concentration of our investments. LIQUIDITY AND CAPITAL RESOURCES (dollars in thousands, except per share data) Liquidity is a measure of our ability to meet potential cash requirements, including ongoing commitments to fund our lending commitments, repay or meet margin calls resulting from our borrowings, if any, fund and maintain our assets and operations, make distributions to our shareholders and fund other business operating requirements. Our sources of cash flows include cash on hand, payments of principal, interest and fees we receive on our investments, other cash we may generate from our business and operations and any unused borrowing capacity, including under our Secured Financing Facilities or other repurchase agreements or financing arrangements we may obtain, which may also include bank loans or public or private issuances of debt or equity securities. We believe that these sources of funds will be sufficient to meet our operating and capital expenses, pay our debt service obligations owed and make any distributions to our shareholders for the next 12 months and for the foreseeable future, subject to the duration and severity of the COVID-19 pandemic and its economic impact on our borrowers and their ability to fund their debt service obligations owed to us. For further information regarding the risks associated with our loan portfolio, see Part I, Item 1A, "Risk Factors" of our 2021 Annual Report. Pursuant to the terms of our UBS Master Repurchase Facility and our Citibank Master Repurchase Facility, we may sell to, and later repurchase from, UBS and Citibank, the purchased assets related to the applicable facility. The initial purchase price paid by UBS or Citibank of each purchased asset is up to 75% of the lesser of the market value of the purchased asset or the unpaid principal balance of such purchased asset, subject to UBS’s or Citibank's approval. Upon the repurchase of a purchased asset, we are required to pay UBS or Citibank, as applicable, the outstanding purchase price of the purchased asset, accrued interest and all accrued and unpaid expenses of UBS or Citibank, as applicable, relating to such purchased asset. The interest rate relating to an existing UBS purchased asset is equal to one month LIBOR plus a premium within a fixed range, determined by the debt yield and property type of the purchased asset’s real estate collateral. The interest rate related to our Citibank purchased assets was amended March 15, 2022 as part of the amendment to the Citibank Master Repurchase Agreement to replace one month LIBOR with one month SOFR plus a premium within a fixed range, determined by the debt yield and property type of the purchased asset’s real estate collateral. UBS and Citibank each has the discretion to make advancements at margins higher than 75%. Loans issued under the BMO Facility are coterminous with the corresponding pledged mortgage loan investments, are not subject to margin calls and allow for up to an 80% advance rate, subject to certain loan to cost and LTV limits. Interest on advancements under the BMO Facility are calculated at SOFR plus a premium. Loans issued under the BMO Facility are secured by a security interest and collateral assignment of the underlying loans to our borrowers which are secured by real property underlying such loans. We are required to pay an upfront fee equal to a percentage of the aggregate amount of the facility loan, such percentage to be determined at the time of approval of the separate facility loan agreements with BMO, or the BMO Facility Loan Agreements. 24 Table of Contents On March 11, 2022, one of our wholly owned subsidiaries entered into the Wells Fargo Master Repurchase Agreement for the Wells Fargo Master Repurchase Facility, pursuant to which we may sell to, and later repurchase from Wells Fargo, the purchased assets related to the facility. The initial purchase price paid by Wells Fargo for each purchased asset is up to 75% or 80%, depending on the property type of the purchased asset’s real estate collateral, of the lesser of the market value of the purchased asset or the unpaid principal balance of such purchased asset, and subject to Wells Fargo’s approval. Upon the repurchase of a purchased asset, we are required to pay Wells Fargo the outstanding purchase price of the purchased asset, accrued interest and all accrued and unpaid expenses of Wells Fargo relating to such purchased asset. Interest on advancements under the Wells Fargo Master Repurchase Facility is calculated at SOFR plus a premium. For further information regarding our Secured Financing Facilities, see Note 4 to the Unaudited Condensed Consolidated Financial Statements included in Part I Item 1 of this Quarterly Report on Form 10-Q and "—Overview-Financing Activities" above. The following is a summary of our sources and uses of cash flows for the periods presented: Three Months Ended March 31, 2022 2021 Cash, cash equivalents and restricted cash at beginning of period $ 26,295 $ 103,564 Net cash provided by (used in): Operating activities 3,085 (1,385) Investing activities (44,612) (55,044) Financing activities 24,194 (76) Cash, cash equivalents and restricted cash at end of period $ 8,962 $ 47,059 The increase in cash provided by operating activities for the 2022 period compared to the 2021 period was primarily the result of our origination activities since April 1, 2021. Since April 1, 2021, we have increased the size of our loan portfolio from 7 loans to 27 loans as of March 31, 2022. The decrease in cash used in investing activities in the 2022 period compared to the 2021 period is primarily due to the repayment of loans in the 2022 period, partially offset by an increase in origination activity in the 2022 period. The increase in cash used in financing activities in the 2022 period compared to the 2021 period is primarily due to proceeds received from our Secured Financing Facilities, partially offset by repayments on our Secured Financing Facilities for the 2022 period. As of March 31, 2021, we had not yet borrowed any funds under our Secured Financing Facilities. Distributions During the three months ended March 31, 2022, we paid distributions to our common shareholders totaling $3,649, or $0.25 per common share, using cash on hand. On April 14, 2022, we declared a quarterly distribution of $0.25 per common share, or $3,649, to shareholders of record on April 25, 2022. We expect to pay this distribution to our common shareholders on May 19, 2022 using cash on hand. For further information regarding distributions, see Note 6 to the Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q. 25 Table of Contents Contractual Obligations and Commitments Our contractual obligations and commitments as of March 31, 2022 were as follows: Payment Due by Period Total Less than 1 Year 1 - 3 Years 3 - 5 Years More than 5 years Unfunded loan commitments (1) $ 47,812 $ 6,450 $ 41,362 $ — $ — Principal payments on Secured Financing Facilities (2) 369,432 63,687 305,745 — — Interest payments (3) 17,495 8,512 8,983 — — $ 434,739 $ 78,649 $ 356,090 $ — $ — (1) The allocation of our unfunded loan commitments is based on the current loan maturity date to which the individual commitments relate. (2) The allocation of outstanding advancements under our Secured Financing Facilities is based on the earlier of the current maturity date of each loan investment with respect to which the individual borrowing relates or the maturity date of the respective Secured Financing Facilities. (3) Projected interest payments are attributable only to our debt service obligations at existing rates as of March 31, 2022 and are not intended to estimate future interest costs which may result from debt prepayments, additional borrowings, new debt issuances or changes in interest rates. Debt Covenants Our principal debt obligations as of March 31, 2022 were the outstanding balances under our Secured Financing Facilities. The agreements governing our Master Repurchase Facilities, or our Master Repurchase Agreements, provide for acceleration of the date of repurchase of any then purchased assets and the liquidation of the purchased assets by UBS, Citibank or Wells Fargo, as applicable, upon the occurrence and continuation of certain events of default, including a change of control of us, which includes Tremont ceasing to act as our sole manager or to be a wholly owned subsidiary of RMR. Our Master Repurchase Agreements also provide that upon the repurchase of any then purchased asset, we are required to pay UBS, Citibank or Wells Fargo the outstanding purchase price of such purchased asset and accrued interest and any and all accrued and unpaid expenses of UBS, Citibank or Wells Fargo, as applicable, relating to such purchased asset. In connection with our Master Repurchase Agreements, we entered into our guarantees, or the Master Repurchase Guarantees, which require us to guarantee 25% of the aggregate repurchase price, and 100% of losses in the event of certain bad acts as well as any costs and expenses of UBS, Citibank and Wells Fargo, as applicable, related to our Master Repurchase Agreements. The Master Repurchase Guarantees contain financial covenants, which require us to maintain a minimum tangible net worth, a minimum liquidity and a minimum interest coverage ratio and to satisfy a total indebtedness to stockholders' equity ratio. In connection with the BMO Loan Program Agreement, we have agreed to guarantee certain of the obligations under the BMO Loan Program Agreement and the BMO Facility Loan Agreements pursuant to a limited guaranty from us to and for the benefit of the administrative agent for itself and such other lenders, or the BMO Guaranty. Specifically, the BMO Guaranty requires us to guarantee 25% of the then current outstanding principal balance of the facility loans and 100% of losses or the entire indebtedness in the event of certain bad acts as well as any costs and expenses of the administrative agent or lenders related to the BMO Loan Program Agreement. In addition, the BMO Guaranty contains financial covenants that require us to maintain a minimum tangible net worth and a minimum liquidity and to satisfy a total indebtedness to stockholders’ equity ratio. The BMO Loan Program Agreement and the BMO Guaranty contain representations, warranties, covenants, conditions precedent to funding, events of default and indemnities that are customary for agreements of these types. As of March 31, 2022, we had a $287,156 aggregate outstanding principal balance under our Master Repurchase Facilities. Our Master Repurchase Agreements are structured with risk mitigation mechanisms, including a cash flow sweep, which would allow UBS, Citibank and Wells Fargo, as applicable, to control interest payments from our borrowers under our loans that are financed under our respective Master Repurchase Facilities, and the ability to accelerate dates of repurchase and institute margin calls, which may require us to pay down balances associated with one or more of our loans that are financed under our Master Repurchase Facilities. As of March 31, 2022, we had a $82,276 aggregate outstanding principal balance under the BMO Facility. As of March 31, 2022, we were in compliance with all covenants and other terms under our Secured Financing Facilities. 26 Table of Contents Related Person Transactions We have relationships and historical and continuing transactions with Tremont, RMR, RMR Inc. and others related to them. For further information about these and other such relationships and related person transactions, see Notes 7 and 8 to the Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, our 2021 Annual Report, our definitive Proxy Statement for our 2022 Annual Meeting of Shareholders and our other filings with the SEC. In addition, see the section captioned “Risk Factors” of our 2021 Annual Report for a description of risks that may arise as a result of these and other related person transactions and relationships. We may engage in additional transactions with related persons, including businesses to which RMR, Tremont or their respective subsidiaries provide management services. 27 Table of Contents Item 3. Quantitative and Qualitative Disclosures About Market Risk Not applicable.