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 2023 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. 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 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 2023 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. Market Conditions . During 2023, the CRE industry continued to experience extreme volatility. In response to inflationary pressures, the Federal Open Market Committee of the U.S. Federal Reserve, or the FOMC, increased the federal funds rate by 525 basis points over a 16-month period beginning in March 2022. The pace of the interest rate increases in 2022 and 2023 coupled with macroeconomic and geopolitical uncertainty negatively impacted CRE acquisition and financing transaction activity. By the end of the year, CRE investors seemed cautiously optimistic that inflation had peaked, that the U.S. economy was likely headed for a “soft-landing” and that the FOMC would be poised to reduce the federal funds rate by 125 to 150 basis points as a result of five or six rate cuts in 2024. 15 Table of Contents Despite this cautious optimism heading into 2024, overall CRE investment and transaction volume continued to decline over the first quarter of 2024 as investors chose to delay sale or refinancing decisions with the anticipation of lower interest rates in the future. Since that time, the narrative on declining interest rates has shifted. The U.S. economy continues to be strong and recent employment reports, coupled with stronger than expected inflationary measures, suggest that the FOMC will likely consider fewer rate cuts in 2024 than originally anticipated, if any. As such, it is becoming apparent that CRE investors will likely have to adapt to a “higher for longer” interest rate environment. This could negatively impact property values and put further strain on borrowers seeking to refinance debt that was originated in a much lower interest rate environment. With lower prospects for near term interest rate reductions, property fundamentals and durability of cash flows will be in greater focus and will have a greater impact on refinancing activity going forward. Those CRE owners that are more reliant on rate reductions to qualify for a refinance are more likely to be forced to sell properties, while borrowers with well performing, lower leveraged cash flowing assets will have greater optionality with regards to financing options. Despite strong U.S. economic growth, certain segments of the CRE industry are beginning to encounter erosion in operating fundamentals. Despite strong employment figures, the U.S. office market continues to suffer from the post pandemic shift in work habits and weak demand for office space in general. Retail assets, particularly needs based and grocery anchored retail, continue to benefit from a strong consumer and employment market. The apartment and industrial sectors remain the most coveted property types amongst lenders and investors, but have recently started to experience challenges due to excess supply. The lack of affordable housing in the United States and the rent versus buy dynamic favor the apartment sector. New industrial development has slowed considerably but continues to benefit from strong demand. Although new development absorption may take longer than originally expected, both sectors are expected to eventually reach equilibrium and rents will begin to increase again. Despite current market conditions and headwinds facing the CRE industry, we believe the CRE lending market remains well positioned to handle these challenges given that there is ample liquidity available to borrowers with well performing properties. National banks have curtailed lending activity somewhat, but regional and local banks are continuing to evaluate transactions for borrowers with healthy balance sheets. The CMBS market has started to see increased activity given recent spread tightening, while the larger, more established CRE collateralized loan obligation lenders are increasing new originations for eventual securitization. Life insurance companies continue to expand their product offerings to borrowers, offering both low leverage, fixed rate term debt as well as floating rate transitional loans, which were once reserved for banks and alternative lenders, like us. This has resulted in greater optionality for borrowers and increased competition amongst lenders to finance quality properties in today’s environment. 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 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 5.20%; therefore, changes to income from investments, net, may not move proportionately with the increase or decrease in benchmark rates. As of March 31, 2024, SOFR was 5.33%, which exceeds the floors established by all of our loans, and as a result none of our loan investments currently had active interest rate floors. 16 Table of Contents 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. 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 and 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, excluding incentive fees, is used in determining the amount of base management and management incentive fees payable by us to Tremont under our management agreement. 17 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) depreciation and amortization of real estate owned and related intangible assets, if any; (b) non-cash equity compensation expense; (c) 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 (d) 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, 2024 December 31, 2023 Shareholders' equity $ 271,558 $ 271,248 Total outstanding common shares 14,805 14,811 Book value per common share 18.34 18.31 Unaccreted purchase discount per common share (1) 0.08 0.16 Allowance for credit losses per common share (2) 0.44 0.40 Adjusted Book Value per common share $ 18.86 $ 18.87 (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 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, 2024 and December 31, 2023, the unaccreted purchase discount was $1,202 and $2,347, respectively. (2) Excludes the impact of our allowance for credit losses. As of March 31, 2024 and December 31, 2023, our allowance for credit losses for our loan portfolio and unfunded loan commitments was $6,525 and $5,828, respectively. Our Loan Portfolio The table below details overall statistics for our loan portfolio as of March 31, 2024 and December 31, 2023: As of March 31, 2024 As of December 31, 2023 Number of loans 21 24 Total loan commitments $ 628,891 $ 670,293 Unfunded loan commitments (1) $ 38,259 $ 40,401 Principal balance $ 590,632 $ 629,892 Carrying value $ 583,486 $ 622,086 Weighted average coupon rate 9.14 % 9.19 % Weighted average all in yield (2) 9.58 % 9.64 % Weighted average floor 1.41 % 1.36 % Weighted average maximum maturity (years) (3) 2.8 3.0 Weighted average risk rating 3.0 3.0 Weighted average LTV (4) 68 % 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. 18 Table of Contents Loan Portfolio Details The table below details our loan portfolio as of March 31, 2024: # 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 $ 46,083 S + 4.00% S + 4.33% 01/28/2026 63 % 3 2 Dallas, TX Office 08/25/2021 50,000 43,511 S + 3.25% S + 3.60% 08/25/2026 72 % 4 3 Passaic, NJ Industrial 09/08/2022 47,000 39,348 S + 3.85% S + 4.26% 09/08/2027 69 % 3 4 Brandywine, MD Retail 03/29/2022 42,500 42,200 S + 3.85% S + 4.26% 03/29/2027 62 % 3 5 Auburn, AL Multifamily 05/11/2023 37,500 37,500 S + 3.25% S + 4.08% 11/11/2026 67 % 2 6 Starkville, MS Multifamily 03/22/2022 37,250 37,250 S + 4.00% S + 4.33% 03/22/2027 70 % 3 7 Farmington Hills, MI Multifamily 05/24/2022 31,520 29,248 S + 3.15% S + 3.52% 05/24/2027 75 % 3 8 Downers Grove, IL Office 09/25/2020 30,000 29,500 S + 4.25% S + 4.64% 11/25/2024 67 % 3 9 Anaheim, CA Hotel 11/29/2023 29,000 29,000 S + 4.00% S + 4.56% 11/29/2028 55 % 2 10 Las Vegas, NV Multifamily 06/10/2022 28,950 25,333 S + 3.30% S + 4.08% 06/10/2027 60 % 3 11 Fountain Inn, SC Industrial 07/13/2023 27,500 24,300 S + 4.25% S + 4.85% 07/13/2026 76 % 3 12 Plano, TX Office 07/01/2021 27,385 26,537 S + 4.75% S + 5.14% 07/01/2026 78 % 3 13 Fayetteville, GA Industrial 10/06/2023 25,250 25,250 S + 3.35% S + 3.73% 10/06/2028 55 % 3 14 Carlsbad, CA Office 10/27/2021 24,750 24,417 S + 3.25% S + 3.58% 10/27/2026 78 % 4 15 Fontana, CA Industrial 11/18/2022 24,355 22,000 S + 3.75% S + 4.29% 11/18/2026 72 % 3 16 Downers Grove, IL Office 12/09/2021 23,530 23,530 S + 4.25% S + 4.58% 12/09/2026 72 % 3 17 Bellevue, WA Office 11/05/2021 21,000 20,000 S + 3.85% S + 4.19% 11/05/2026 68 % 4 18 Portland, OR Multifamily 07/09/2021 19,688 19,688 S + 3.57% S + 3.95% 07/09/2026 75 % 3 19 Scottsdale, AZ Hotel 09/27/2023 17,250 17,250 S + 4.25% S + 4.65% 09/27/2028 57 % 2 20 Sandy Springs, GA Retail 09/23/2021 16,488 15,287 S + 3.75% S + 4.10% 09/23/2026 72 % 3 21 Portland, OR Multifamily 07/30/2021 13,400 13,400 S + 3.57% S + 3.96% 07/30/2026 71 % 3 Total/weighted average $ 628,891 $ 590,632 S + 3.77% S + 4.21% 68 % 3.0 (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, 2024, we had $628,891 in aggregate loan commitments, consisting of a diverse portfolio, geographically and by property type, of 21 first mortgage loans. As of March 31, 2024, 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, 2024 and April 25, 2024, all of our borrowers had paid their debt service obligations owed and due to us. We did not have any outstanding past due loans or nonaccrual loans as of March 31, 2024. 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 2023 Annual Report. 19 Table of Contents Financing Activities The table below is an overview of our Secured Financing Facilities as of March 31, 2024: Facility Maturity Date Principal Balance Unused Capacity Maximum Facility Size Collateral Principal Balance Citibank Master Repurchase Facility 03/15/2025 $ 57,893 $ 157,107 $ 215,000 $ 102,161 UBS Master Repurchase Facility 02/18/2025 181,381 23,619 205,000 242,110 BMO Facility Various 87,767 62,233 150,000 118,835 Wells Fargo Master Repurchase Facility 03/11/2025 95,551 29,449 125,000 127,526 Total $ 422,592 $ 272,408 $ 695,000 $ 590,632 The table below details our Secured Financing Facilities activities during the three months ended March 31, 2024: Carrying Value Balance at December 31, 2023 $ 454,422 Repayments (33,224) Deferred fees (352) Amortization of deferred fees 325 Balance at March 31, 2024 $ 421,171 As of March 31, 2024, outstanding advancements under our Secured Financing Facilities had a weighted average interest rate of 7.50% per annum, excluding associated fees and expenses. As of March 31, 2024 and April 25, 2024, we had a $422,592 aggregate outstanding principal balance under our Secured Financing Facilities. As of March 31, 2024, 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 5 to our Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q. 20 Table of Contents RESULTS OF OPERATIONS (amounts in thousands, except per share data) Three Months Ended March 31, 2024 Compared to Three Months Ended December 31, 2023: Three Months Ended March 31, 2024 December 31, 2023 Change % Change INCOME FROM INVESTMENTS: Interest and related income $ 16,311 $ 17,523 $ (1,212) (6.9 %) Purchase discount accretion 1,145 821 324 39.5 % Less: interest and related expenses (8,673) (8,918) 245 (2.7 %) Income from loan investments, net 8,783 9,426 (643) (6.8 %) Revenue from real estate owned 579 574 5 0.9 % Total revenue 9,362 10,000 (638) (6.4 %) OTHER EXPENSES: Base management fees 1,080 1,080 — — % Incentive fees 50 307 (257) (83.7 %) General and administrative expenses 963 929 34 3.7 % Reimbursement of shared services expenses 691 683 8 1.2 % Provision for credit losses 697 500 197 39.4 % Expenses from real estate owned 645 559 86 15.4 % Total other expenses 4,126 4,058 68 1.7 % Income before income taxes 5,236 5,942 (706) (11.9 %) Income tax (expense) benefit (3) 103 (106) (102.9 %) Net income $ 5,233 $ 6,045 $ (812) (13.4 %) Weighted average common shares outstanding - basic and diluted 14,675 14,673 2 — % Net income per common share - basic and diluted $ 0.35 $ 0.41 $ (0.06) (14.6 %) Interest and related income . The decrease in interest and related income was primarily the result of lower outstanding principal balances under our loan investment portfolio during the three months ended March 31, 2024. The weighted average aggregate principal balance of our loan investments was approximately $613,000 for the three months ended March 31, 2024 as compared to approximately $646,000 for the three months ended December 31, 2023. Purchase discount accretion. The increase in purchase discount accretion was primarily due to accelerated accretion of a loan prepayment during the three months ended March 31, 2024. Interest and related expenses. The decrease in interest and related expenses was primarily the result of lower outstanding principal balances under our Secured Financing Facilities during the three months ended March 31, 2024. The weighted average principal balance was approximately $439,000 for the three months ended March 31, 2024 as compared to approximately $448,000 for the three months ended December 31, 2023. Revenue from real estate owned. Revenue from real estate owned represents revenue from the operations of an office property located in Yardley, PA that was transferred to real estate owned through a deed in lieu of foreclosure in June 2023. Incentive fees. We recognize management incentive fees payable to Tremont in accordance with our management agreement. The decrease in management incentive fees was due to lower "core earnings," as defined in our management agreement, for the three months ended March 31, 2024 as compared to the three months ended December 31, 2023. 21 Table of Contents General and administrative expenses . The increase in general and administrative expenses was primarily due to increases in share based compensation, partially offset by decreases in professional fees during the three months ended March 31, 2024 as compared to the three months ended December 31, 2023. 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. Provision for credit losses. The provision for credit losses represents the increase in the allowance for credit losses on our loan portfolio and unfunded commitments. The increase in the allowance for credit losses during the three months ended March 31, 2024 was primarily attributable to declining values for CRE and unfavorable CRE pricing forecasts used in our CECL model. Expenses from real estate owned. Expenses from real estate owned represent expenses from the operations of an office property located in Yardley, PA that was transferred to real estate owned through a deed in lieu of foreclosure in June 2023. The increase in expenses from real estate owned was primarily due to increases in depreciation and utility expense. Income tax (expense) benefit. Income tax (expense) benefit represents income taxes paid or payable by us or refunded or refundable to us in certain jurisdictions where we are subject to state income taxes. Net income. The decrease 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, which are non-GAAP measures, and provides a reconciliation of these non-GAAP measures to net income: Three Months Ended March 31, 2024 December 31, 2023 Net income $ 5,233 $ 6,045 Non-cash equity compensation expense 336 151 Non-cash accretion of purchase discount (1,145) (821) Provision for credit losses 697 500 Depreciation and amortization of real estate owned 357 289 Exit fees collected on loans acquired in Merger (1) 90 148 Distributable Earnings $ 5,568 $ 6,312 Weighted average common shares outstanding - basic and diluted 14,675 14,673 Net income per common share - basic and diluted $ 0.35 $ 0.41 Distributable Earnings per common share - basic and diluted $ 0.38 $ 0.43 (1) Exit fees collected on loans acquired in the Merger represent fees collected upon repayment of loans for which no income has previously been recognized in Distributable Earnings. In accordance with GAAP, exit fees payable with respect to loans acquired in the Merger were accreted as a component of the purchase discount and were excluded from Distributable Earnings as a non-cash item. Accordingly, these exit fees have been recognized in Distributable Earnings upon collection. 22 Table of Contents 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, 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, and proceeds from any sale of real estate owned. 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 2023 Annual Report. Pursuant to the terms of our Citibank Master Repurchase Facility, our UBS 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 of each purchased asset is up to 80% of the lesser of the market value of the purchased asset or the unpaid principal balance of such purchased asset, subject to UBS's approval. The initial purchase price paid by 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 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. Citibank has the discretion to make advancements at margins higher than 75%, and UBS and Wells Fargo each have 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. For further information regarding our Secured Financing Facilities, see Note 5 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, 2024 2023 Cash and cash equivalents at beginning of period $ 87,855 $ 71,067 Net cash provided by (used in): Operating activities 4,724 6,577 Investing activities 39,554 50,267 Financing activities (38,835) (43,603) Cash and cash equivalents at end of period $ 93,298 $ 84,308 23 Table of Contents The decrease in cash provided by operating activities for the 2024 period compared to the 2023 period was primarily the result of a lower average loan investment balance in the 2024 period, partially offset by higher benchmark interest rates. The decrease in cash provided by investing activities is primarily due to decreased loan repayments in the 2024 period. The decrease in cash used in financing activities is primarily due to decreased repayments on our Secured Financing Facilities during the 2024 period. Distributions During the three months ended March 31, 2024, we declared and paid regular quarterly distributions to our common shareholders totaling $5,184, or $0.35 per common share, using cash on hand. On April 11, 2024, we declared a regular quarterly distribution of $0.35 per common share, or $5,182, to shareholders of record on April 22, 2024. We expect to pay this distribution to our common shareholders on or about May 16, 2024 using cash on hand. For further information regarding distributions, see Note 7 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, 2024 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) $ 38,259 $ 21,219 $ 17,040 $ — $ — Principal payments on Secured Financing Facilities (2) 422,592 393,762 28,830 — — Interest payments on Secured Financing Facilities (3) 25,682 24,744 938 — — Lease related costs (4) 361 361 — — — $ 486,894 $ 440,086 $ 46,808 $ — $ — (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, 2024 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. (4) Lease related costs include capital expenditures used to improve tenants' spaces pursuant to lease agreements or leasing related costs, such as brokerage commissions, related to the Yardley, PA property. Debt Covenants Our principal debt obligations as of March 31, 2024 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. 24 Table of Contents In connection with our facility loan program agreement and the security agreement with BMO, 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. Our BMO Loan Program Agreement provides for acceleration of all payment obligations due under the BMO Facility Loan Agreements 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. As of March 31, 2024, we had a $334,825 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, 2024, we had a $87,767 aggregate outstanding principal balance under the BMO Facility. As of March 31, 2024, 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 8 and 9 to the Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, our 2023 Annual Report, our definitive Proxy Statement for our 2024 Annual Meeting of Shareholders and our other filings with the SEC. In addition, see the section captioned “Risk Factors” of our 2023 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. 25 Table of Contents Item 3. Quantitative and Qualitative Disclosures About Market Risk Not applicable.