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 2022 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 in the $15,000 to $75,000 range, secured by middle market and transitional CRE properties that have values up to $100,000. We define transitional CRE as commercial properties subject to redevelopment or repositioning activities that are expected to increase the value of the properties. Our mortgage loans are classified as loans held for investment in our condensed consolidated balance sheets. 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 that is 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. Non-GAAP Financial Measures We present Distributable Earnings, 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 alternatives 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, a measure 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 may not be comparable to distributable earnings and distributable earnings per common share as reported by other companies. We believe that Adjusted Book Value per common share is a meaningful measure of our capital adequacy because it excludes the impact of certain non-cash estimates or adjustments, including the unaccreted purchase discount resulting from the excess of the fair value of the loans Tremont Mortgage Trust, or TRMT, then held for investment and that we acquired as a result of our merger with TRMT on September 30, 2021, or the Merger, over the consideration we paid in the Merger and our allowance for credit losses for our loan portfolio and unfunded loan commitments. 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 and 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 and 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. 14 Table of Contents 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. This is generally at the time a loan is repaid, or in the case of foreclosure, when the underlying asset is sold, but may also be when, in our determination, it is nearly certain that all amounts due will not be collected. The realized loss amount reflected in Distributable Earnings will equal the difference between the cash received or expected to be received and the carrying value of the asset. Adjusted Book Value per Common Share The table below calculates our book value per common share: March 31, 2023 December 31, 2022 Shareholders' equity $ 267,747 $ 271,579 Total outstanding common shares 14,707 14,709 Book value per common share 18.21 18.46 Unaccreted purchase discount per common share (1) 0.38 0.46 Allowance for credit losses per common share (2) 0.38 — Adjusted Book Value per common share $ 18.97 $ 18.92 (1) 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 our 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, 2023 and December 31, 2022, the unaccreted purchase discount was $5,519 and $6,703, respectively. (2) Excludes the impact of our allowance for credit losses. As of March 31, 2023, our allowance for credit losses for our loan portfolio and unfunded loan commitments was $5,608. As of December 31, 2022, we did not have an allowance for credit losses. For further information on our adoption of ASU No. 2016-13, see Notes 2 and 3 to our Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q. 15 Table of Contents Our Loan Portfolio The table below details overall statistics for our loan portfolio as of March 31, 2023 and December 31, 2022: As of March 31, 2023 As of December 31, 2022 Number of loans 25 27 Total loan commitments $ 674,475 $ 727,562 Unfunded loan commitments (1) $ 45,779 $ 49,007 Principal balance $ 628,696 $ 678,555 Carrying value $ 617,935 $ 669,929 Weighted average coupon rate 8.57 % 8.07 % Weighted average all in yield (2) 9.06 % 8.57 % Weighted average floor 0.65 % 0.62 % Weighted average maximum maturity (years) (3) 3.1 3.3 Weighted average risk rating 2.9 2.9 Weighted average LTV (4) 67 % 68 % (1) Unfunded loan commitments are primarily used to finance property 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. 16 Table of Contents Loan Portfolio Details The table below details our loan portfolio as of March 31, 2023: # Location Property Type Origination Date Committed Principal Amount Principal Balance Coupon Rate All in Yield (1) Maximum Maturity (date) (2) LTV (3) Risk Rating First mortgage loans 1 Olmsted Falls, OH Multifamily 01/28/2021 $ 54,575 $ 46,084 L + 4.00% L + 4.64% 01/28/2026 63 % 3 2 Dallas, TX Office 08/25/2021 50,000 43,450 L + 3.25% L + 3.61% 08/25/2026 72 % 4 3 Passaic, NJ Industrial 09/08/2022 47,000 38,440 S + 3.85% S + 4.22% 09/08/2027 69 % 3 4 Brandywine, MD Retail 03/29/2022 42,500 42,200 S + 3.85% S + 4.25% 03/29/2027 62 % 2 5 West Bloomfield, MI Retail 12/16/2021 42,500 37,594 L + 3.85% L + 4.66% 12/16/2024 59 % 3 6 Starkville, MS Multifamily 03/22/2022 37,250 36,787 S + 4.00% S + 4.32% 03/22/2027 70 % 4 7 Farmington Hills, MI Multifamily 05/24/2022 31,520 28,859 S + 3.15% S + 3.50% 05/24/2027 75 % 3 8 Downers Grove, IL Office 09/25/2020 30,000 29,500 L + 4.25% L + 4.69% 11/25/2024 67 % 2 9 Las Vegas, NV Multifamily 06/10/2022 28,950 24,729 S + 3.30% S + 4.03% 06/10/2027 60 % 3 10 St. Louis, MO Office 12/19/2018 28,866 28,866 L + 3.25% L + 3.74% 06/20/2023 72 % 3 11 Plano, TX Office 07/01/2021 27,385 26,307 L + 4.75% L + 5.16% 07/01/2026 78 % 3 12 Carlsbad, CA Office 10/27/2021 24,750 23,825 L + 3.25% L + 3.58% 10/27/2026 78 % 3 13 Fontana, CA Industrial 11/18/2022 24,355 22,000 S + 3.75% S + 4.28% 11/18/2026 72 % 3 14 Downers Grove, IL Office 12/09/2021 23,530 23,530 L + 4.25% L + 4.57% 12/09/2026 72 % 3 15 Dublin, OH Office 02/18/2020 22,507 22,507 S + 4.25% S + 4.75% 08/16/2023 33 % 2 16 Bellevue, WA Office 11/05/2021 21,000 20,000 L + 3.85% L + 4.19% 11/05/2026 68 % 3 17 Portland, OR Multifamily 07/09/2021 19,687 19,687 L + 3.57% L + 3.97% 07/09/2026 75 % 3 18 Ames, IA Multifamily 11/15/2021 18,000 17,820 L + 3.80% L + 4.13% 11/15/2026 71 % 2 19 Yardley, PA Office 12/19/2019 16,500 15,865 L + 4.58% L + 5.97% 12/19/2024 75 % 4 20 Sandy Springs, GA Retail 09/23/2021 16,489 15,287 L + 3.75% L + 4.10% 09/23/2026 72 % 3 21 Delray Beach, FL Retail 03/18/2022 16,000 15,362 S + 4.25% S + 4.91% 03/18/2026 56 % 3 22 Westminster, CO Office 05/25/2021 15,750 14,739 L + 3.75% L + 4.25% 05/25/2026 66 % 2 23 Portland, OR Multifamily 07/30/2021 13,400 13,400 L + 3.57% L + 3.98% 07/30/2026 71 % 3 24 Seattle, WA Multifamily 08/16/2021 12,500 12,397 L + 3.55% L + 3.89% 08/16/2026 70 % 3 25 Allentown, PA Industrial 01/24/2020 9,461 9,461 S + 3.50% S + 4.03% 01/24/2025 67 % 1 Total/weighted average $ 674,475 $ 628,696 + 3.80% + 4.28% 67 % 2.9 (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, 2023, we had $674,475 in aggregate loan commitments, consisting of a diverse portfolio, geographically and by property type, of 25 first mortgage loans. As of March 31, 2023, we had three loans representing approximately 15% of the amortized cost of our loan portfolio with a loan risk rating of “4” or “higher risk”. 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 actively engage with our borrowers regarding their execution of the business plans for the underlying collateral, among other things. As of March 31, 2023 and April 20, 2023, all of our borrowers had paid all of their debt service obligations owed and due to us. We did not have any past due loans or nonaccrual loans as of March 31, 2023. However, our borrowers' businesses, operations and liquidity may be materially adversely impacted by current inflationary pressures, rising or sustained high interest rates, supply chain issues or a prolonged economic slowdown or recession could amplify those negative impacts. As a result, they may become unable to pay their debt service obligations owed and due to us, which may result in an increased allowance for credit losses and/or recognition of income on a nonaccrual basis. For further information regarding our loan portfolio and risk rating policy, see Note 3 to our Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1, "—Factors Affecting our Operating Results" and "Warning Concerning Forward-Looking Statements" elsewhere in this Quarterly Report on Form 10-Q and the risk factors identified in Part I, Item 1A, “Risk Factors”, of our 2022 Annual Report. 17 Table of Contents Financing Activities The table below is an overview of our Secured Financing Facilities as of March 31, 2023: Facility Maturity Date Principal Balance Unused Capacity Maximum Facility Size Collateral Principal Balance Citibank Master Repurchase Facility 03/15/2025 $ 150,101 $ 64,899 $ 215,000 $ 205,380 UBS Master Repurchase Facility 02/18/2024 133,108 58,892 192,000 182,530 BMO Facility Various 84,855 65,145 150,000 113,745 Wells Fargo Master Repurchase Facility 03/11/2025 67,426 57,574 125,000 89,177 Total $ 435,490 $ 246,510 $ 682,000 $ 590,832 The table below details our Secured Financing Facilities activities during the three months ended March 31, 2023: Carrying Value Balance at December 31, 2022 $ 471,521 Repayments (38,125) Deferred fees (318) Amortization of deferred fees 307 Balance at March 31, 2023 $ 433,385 As of March 31, 2023, outstanding advancements under our Secured Financing Facilities had a weighted average interest rate of 6.76% per annum, excluding associated fees and expenses. As of March 31, 2023 and April 20, 2023, we had a $435,490 and $426,340, respectively, aggregate outstanding principal balance under our Secured Financing Facilities. As of March 31, 2023, we were in compliance with all covenants and other terms under our Secured Financing Facilities. 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. 18 Table of Contents RESULTS OF OPERATIONS (amounts in thousands, except per share data) Three Months Ended March 31, 2023 Compared to Three Months Ended December 31, 2022: Three Months Ended March 31, 2023 December 31, 2022 Change % Change INCOME FROM INVESTMENTS: Interest and related income $ 15,856 $ 15,205 $ 651 4.3 % Purchase discount accretion 1,185 1,522 (337) (22.1 %) Less: interest and related expenses (7,694) (7,439) (255) 3.4 % Income from investments, net 9,347 9,288 59 0.6 % OTHER EXPENSES: Base management fees 1,072 1,070 2 0.2 % General and administrative expenses 796 719 77 10.7 % Reimbursement of shared services expenses 643 733 (90) (12.3 %) Reversal of credit losses (987) — (987) n/m Total other expenses 1,524 2,522 (998) (39.6 %) Income before income taxes 7,823 6,766 1,057 15.6 % Income tax expense (20) (6) (14) n/m Net income $ 7,803 $ 6,760 $ 1,043 15.4 % Weighted average common shares outstanding - basic and diluted 14,582 14,579 3 — % Net income per common share - basic and diluted $ 0.53 $ 0.46 $ 0.07 15.2 % n/m - not meaningful Interest and related income . The increase in interest and related income was primarily the result of higher benchmark interest rates, partially offset by loan repayments. The weighted average benchmark interest rate was 4.77% as of March 31, 2023 as compared to 4.29% as of December 31, 2022. Purchase discount accretion. The decrease in purchase discount accretion was primarily the result of less amounts outstanding on acquired loans during the three months ended March 31, 2023 as compared to the three months ended December 31, 2022. Interest and related expenses. The increase in interest and related expenses was primarily the result of higher benchmark interest rates. The weighted average benchmark interest rate was 4.75% as of March 31, 2023 as compared to 4.33% as of December 31, 2022, partially offset by loan repayments. General and administrative expenses . The increase in general and administrative expenses was primarily due to increases in professional fees during the three months ended March 31, 2023 as compared to the three months ended December 31, 2022. 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, 2022 to increase our estimate of costs for the usage of shared services from RMR for the year ended December 31, 2022 to reflect actual costs incurred. Reversal of credit losses. The reversal of credit losses represents the decrease in the allowance for credit losses on our loan portfolio and unfunded commitments. The decrease in the allowance for credit losses during the three months ended March 31, 2023 was primarily attributable to favorable changes in the current macroeconomic outlook, most notably in near-term CRE pricing forecasts, and loan repayments. 19 Table of Contents 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. Net income. The increase in net income was due to the changes noted above. Reconciliation of Net Income to Distributable Earnings The table below demonstrates how we calculate Distributable Earnings and Distributable Earnings per common share and provides a reconciliation of these non-GAAP measures to net income: Three Months Ended March 31, 2023 December 31, 2022 Net income $ 7,803 $ 6,760 Non-cash equity compensation expense 120 129 Non-cash accretion of purchase discount (1,185) (1,522) Reversal of credit losses (987) — Distributable Earnings $ 5,751 $ 5,367 Weighted average common shares outstanding - basic and diluted 14,582 14,579 Net income per common share - basic and diluted $ 0.53 $ 0.46 Distributable Earnings per common share - basic and diluted $ 0.39 $ 0.37 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 generally and in the sectors relating to our loans and unanticipated defaults by our borrowers, if any. For further information regarding the risks associated with our loan portfolio, see Note 3 to the Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 and elsewhere in this Management Discussion and Analysis of Financial Condition and Results of Operations of this Quarterly Report on Form 10-Q and Part I, Item 1A, "Risk Factors" of our 2022 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 may 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 the credit quality of each of our loans at least quarterly. If a loan is determined to be collateral dependent (because the repayment of the loan is expected to be provided substantially through the operation or sale of the underlying collateral property) and the borrower is experiencing financial difficulties, but foreclosure is not probable, we will record an allowance for credit losses by comparing the collateral's fair value to the amortized cost basis of the loan. For collateral-dependent loans for which foreclosure is probable, the related allowance for credit losses is determined using the fair value of the collateral compared to the loan's amortized cost. 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. 20 Table of Contents Market Conditions. In response to inflationary pressures the Federal Open Market Committee of the U.S. Federal Reserve has increased the federal funds rate by 450 basis points since March 2022 and has indicated that there may be additional increases. These inflationary pressures and interest rate increases have contributed and continue to contribute to macroeconomic uncertainty and volatility in the United States and in the CRE debt markets. Additionally, increased borrowing costs and concerns of a possible economic recession have resulted in tighter underwriting standards and an overall decline in CRE transactions. Many CRE debt providers have become less willing, or able, to extend credit to borrowers, and those that are extending credit are doing so at lower leverage levels and often with higher credit spreads. Market volatility and the increase in interest rates has not affected all lenders equally. Banks and life insurance companies have reduced their leverage ratios and increased credit spreads, but continued to originate new loans. However, concerns about the capital adequacy and liquidity of the banking sector caused by recent failures of certain banks in March 2023 may result in decreased lending activity from such traditional sources. Lenders that rely on secondary markets to finance their lending activities have also experienced challenges. Credit spreads in the secondary market for commercial mortgage-backed securities, or CMBS, and CRE collateralized loan obligations, or CLO, bonds have widened substantially due to competing demand for alternative fixed income investments and a corresponding decrease in the demand for CRE CLO bonds. As a result, some lenders who originate and sell loans into the CRE CLO market as a means of financing have chosen to wait to issue bonds until market volatility subsides and credit spreads stabilize. In addition to tighter underwriting standards and increased overall borrowing costs, lenders may experience certain challenges from increasing interest rates on floating rate loan portfolios. While rising interest rates generally result in increased income on floating rate portfolios, the borrowers of floating rate loans may find it more difficult to service their debt. Floating rate lenders often require borrowers to obtain interest rate caps or swaps to help mitigate this risk. While interest rate caps and swaps on loans protect lenders in periods of rising interest rates, the cost to borrowers to obtain new or replace existing interest rate caps or swaps may be prohibitive. These challenges could cause floating rate portfolio amounts overall to decrease and/or losses to be incurred if borrowers are unable to obtain interest rate caps or swaps or service their debt and, as a result, could offset the increase in interest income generated from higher benchmark rates. Despite the current market conditions and headwinds experienced in the overall CRE lending market, we believe certain alternative lenders, like us, are uniquely positioned to face these challenges. We believe there will be significant opportunities for alternative lenders that do not finance their lending activities through the use of CMBS or CRE CLOs, and with available liquidity, to capitalize on challenges that traditional lenders may experience. Capital remains available for investment in CRE assets, and certain favored assets, such as multifamily and industrial, continue to transact. Additionally, we believe overall CRE transaction activity will improve once market uncertainty and volatility subside and there are, and will continue to be, opportunities for alternative lenders, like us, to provide creative, flexible debt capital for a wide array of circumstances and business plans. Changes in Interest Rates. With respect to our business operations, increases in interest rates, in general, may cause: (a) the coupon rates on our variable rate investments to reset, perhaps on a delayed basis, to higher rates; (b) it to become more difficult and costly for our borrowers, which may negatively impact their ability to repay our investments; and (c) the interest expense associated with our variable rate borrowings to increase. 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 coupon rates on our variable rate investments to reset, perhaps on a delayed basis, to lower rates; (b) 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; and (c) the interest expense associated with our variable rate borrowings to decrease. 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 the amount 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, ranging from 0.10% to 3.87%; therefore, changes to income from investments, net, may not move proportionately with the increase or decrease in benchmark rates. As of March 31, 2023, the London Interbank Offered Rate, or LIBOR, and SOFR were 4.86% and 4.80%, respectively, both of which exceed the floors established by all of our loans, and as a result none of our loan investments currently have active interest rate floors. 21 Table of Contents Certain of our loan agreements entered into prior to January 1, 2022 required the borrowers to pay us interest at floating rates based upon LIBOR. LIBOR was phased out for new contracts as of December 31, 2021 and is expected to no longer be available by June 30, 2023. As of April 20, 2023, all of our pre-existing contracts have been amended to replace LIBOR with SOFR. 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. Prepayment Risk. We are subject to risk that our loan investments will be repaid at an earlier date than anticipated, which may reduce the returns realized on those loans as less interest income may be received over time. Additionally, we may not be able to reinvest the principal repaid at a similar or higher yield of the original loan investment. We seek to limit this risk by structuring our loan agreements with fees required to be paid to us upon prepayment of a loan within a specified period of time before the loan’s maturity; however, unanticipated prepayments could negatively impact our operating results. 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. For further information regarding the risks associated with our loan portfolio, see Note 3 to our Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 and elsewhere in this Management Discussion and Analysis of Financial Condition and Results of Operations of this Quarterly Report on Form 10-Q and Part I, Item 1A, "Risk Factors" of our 2022 Annual Report. Pursuant to the terms of our UBS Master Repurchase Facility, our Citibank Master Repurchase Facility and Wells Fargo Master Repurchase Facility, we may sell to, and later repurchase from, UBS, Citibank and Wells Fargo, 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. 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 UBS, Citibank or Wells Fargo, as applicable, the outstanding purchase price of the purchased asset, accrued interest and all accrued and unpaid expenses of UBS, Citibank or Wells Fargo, as applicable, relating to such purchased asset. The interest rates related to our Citibank, UBS and Wells Fargo purchased assets are calculated at 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% and Wells Fargo has discretion to make advancements higher than 80%. 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. 22 Table of Contents 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 a summary of our sources and uses of cash flows for the periods presented: Three Months Ended March 31, 2023 2022 Cash, cash equivalents and restricted cash at beginning of period $ 71,067 $ 26,295 Net cash provided by (used in): Operating activities 6,577 3,085 Investing activities 50,267 (44,612) Financing activities (43,603) 24,194 Cash, cash equivalents and restricted cash at end of period $ 84,308 $ 8,962 The increase in cash provided by operating activities for the 2023 period compared to the 2022 period was primarily the result of higher benchmark interest rates, partially offset by the impact of loan repayments. The increase in cash provided by investing activities is primarily due to higher loan repayments in the 2023 period. The increase in cash used in financing activities is primarily due to decreased proceeds received from our Secured Financing Facilities during the 2023 period, repayments on our Secured Financing Facilities and an increase in distributions to our common shareholders for the 2023 period. Distributions During the three months ended March 31, 2023, we declared and paid regular quarterly distributions to our common shareholders totaling $5,147, or $0.35 per common share, using cash on hand. On April 13, 2023, we declared a regular quarterly distribution of $0.35 per common share, or $5,147, to shareholders of record on April 24, 2023. We expect to pay this distribution to our common shareholders on or about May 18, 2023 using cash on hand. For further information regarding distributions, see Note 6 to our Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q. Contractual Obligations and Commitments Our contractual obligations and commitments as of March 31, 2023 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) $ 45,779 $ 15,170 $ 30,609 $ — $ — Principal payments on Secured Financing Facilities (2) 435,490 215,442 220,048 — — Interest payments (3) 38,677 26,258 12,419 — — $ 519,946 $ 256,870 $ 263,076 $ — $ — (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, 2023 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. 23 Table of Contents Debt Covenants Our principal debt obligations as of March 31, 2023 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 our facility loan program agreement and the security agreement with BMO Harris Bank N.A., or 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. As of March 31, 2023, we had a $350,635 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, 2023, we had a $84,855 aggregate outstanding principal balance under the BMO Facility. As of March 31, 2023, we were in compliance with all covenants and other terms under our Secured Financing Facilities. 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 our Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, our 2022 Annual Report, our definitive Proxy Statement for our 2023 Annual Meeting of Shareholders and our other filings with the SEC. In addition, see the section captioned “Risk Factors” of our 2022 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. Critical Accounting Policies A summary of our critical accounting policies is included in Part II, Item 7 of our 2022 Annual Report. There have been no material changes to our critical accounting policies described in our 2022 Annual Report other than the adoption of ASU No. 2016-13, as described in Note 2 to our Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q. 24 Table of Contents Item 3. Quantitative and Qualitative Disclosures About Market Risk Not applicable.