UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549 

FORM 10-Q

 

☒			QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2023

OR

☐			TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 001-34383

 

Seven Hills Realty Trust

(Exact Name of Registrant as Specified in Its Charter)

Maryland			20-4649929
(State of Organization)			(IRS Employer Identification No.)

 

Two Newton Place, 255 Washington Street, Suite 300, Newton, MA 02458-1634

(Address of Principal Executive Offices)                            (Zip Code)

Registrant’s Telephone Number, Including Area Code 617-332-9530

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class

Trading Symbol

Name of each exchange on which registered

Common Shares of Beneficial Interest

SEVN

The Nasdaq Stock Market LLC

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ☒   No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  Yes ☒   No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer

☐

Accelerated filer

☐

Non-accelerated filer

☒

Smaller reporting company

☒

Emerging growth company

☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided in Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐  No ☒

Number of registrant's common shares of beneficial interest, $0.001 par value per share, outstanding as of July 27, 2023: 14,744,827.

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Table of Contents

SEVEN HILLS REALTY TRUST

FORM 10-Q

June 30, 2023

 

INDEX

						Page
PART I			Financial Information
Item 1.			Financial Statements (unaudited)
			Condensed Consolidated Balance Sheets — June 30, 2023 and December 31, 2022			1
			Condensed Consolidated Statements of Operations — Three and Six Months Ended June 30, 2023 and 2022			2
			Condensed Consolidated Statements of Shareholders’ Equity — Three and Six Months Ended June 30, 2023 and 2022			3
			Condensed Consolidated Statements of Cash Flows — Six Months Ended June 30, 2023 and 2022			4
			Notes to Unaudited Condensed Consolidated Financial Statements			6
Item 2.			Management’s Discussion and Analysis of Financial Condition and Results of Operations			17
Item 3.			Quantitative and Qualitative Disclosures About Market Risk			31
Item 4.			Controls and Procedures			31
			Warning Concerning Forward-Looking Statements			32
PART II			Other Information			34
Item 1A.			Risk Factors			34
Item 2.			Unregistered Sales of Equity Securities and Use of Proceeds			34
Item 6.			Exhibits			34
			Signatures			35

References in this Quarterly Report on Form 10-Q to "SEVN", "we", "us" or "our" mean Seven Hills Realty Trust and its consolidated subsidiaries unless otherwise expressly stated or the context indicates otherwise.

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Table of Contents

PART I. Financial Information

Item 1. Financial Statements

SEVEN HILLS REALTY TRUST

CONDENSED CONSOLIDATED BALANCE SHEETS

(dollars in thousands, except per share data)

(unaudited)

						June 30,						December 31,
						2023						2022
ASSETS
Cash and cash equivalents						$	81,806					$	71,057
Restricted cash						238						10
Loans held for investment						629,525						669,929
Allowance for credit losses						(4,201)						—
Loans held for investment, net						625,324						669,929
Real estate owned						15,592						—
Accrued interest receivable						3,417						3,354
Prepaid expenses and other assets						1,537						2,497
Total assets						$	727,914					$	746,847
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable, accrued liabilities and other liabilities						$	4,287					$	1,903
Secured financing facilities, net						452,690						471,521
Due to related persons						3,139						1,844
Total liabilities						460,116						475,268
Commitments and contingencies
Shareholders' equity:
Common shares of beneficial interest, $0.001 par value, 25,000,000 shares authorized; 14,745,486 and 14,709,165 shares issued and outstanding, respectively						15						15
Additional paid in capital						239,167						238,505
Cumulative net income						58,142						52,290
Cumulative distributions						(29,526)						(19,231)
Total shareholders' equity						267,798						271,579
Total liabilities and shareholders' equity						$	727,914					$	746,847

See accompanying notes.

1

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SEVEN HILLS REALTY TRUST

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(amounts in thousands, except per share data)

(unaudited)

						Three Months Ended June 30,												Six Months Ended June 30,
						2023						2022						2023						2022
INCOME FROM INVESTMENTS:
Interest and related income						$	15,821					$	8,869					$	31,677					$	18,448
Purchase discount accretion						1,047						1,636						2,232						7,571
Less: interest and related expenses						(7,927)						(3,007)						(15,621)						(4,744)
Income from loan investments, net						8,941						7,498						18,288						21,275
Revenue from real estate owned						149						—						149						—
Total revenue						9,090						7,498						18,437						21,275
OTHER EXPENSES:
Base management fees						1,074						1,063						2,146						2,126
Incentive fees						192						—						192						—
General and administrative expenses						1,281						1,304						2,077						2,176
Reimbursement of shared services expenses						628						514						1,271						1,148
Provision for credit losses						1,026						—						39						—
Expenses from real estate owned						218						—						218						—
Other transaction related costs						—						—						—						37
Total other expenses						4,419						2,881						5,943						5,487
Income before income taxes						4,671						4,617						12,494						15,788
Income tax expense						(27)						(39)						(47)						(84)
Net income						$	4,644					$	4,578					$	12,447					$	15,704
Weighted average common shares outstanding - basic and diluted						14,605						14,521						14,594						14,514
Net income per common share - basic and diluted						$	0.32					$	0.31					$	0.85					$	1.08

See accompanying notes.

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SEVEN HILLS REALTY TRUST

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(amounts in thousands)

(unaudited)

						Number of												Additional
						Common						Common						Paid In						Cumulative						Cumulative
						Shares						Shares						Capital						Net Income						Distributions						Total
Balance at December 31, 2022						14,709						$	15					$	238,505					$	52,290					$	(19,231)					$	271,579
Cumulative-effect adjustment upon adoption of ASU No. 2016-13 (Note 2)						—						—						—						(6,595)						—						(6,595)
Share grants						—						—						121						—						—						121
Share repurchases						(1)						—						(13)						—						—						(13)
Share forfeitures						(1)						—						(1)						—						—						(1)
Net income						—						—						—						7,803						—						7,803
Distributions						—						—						—						—						(5,147)						(5,147)
Balance at March 31, 2023						14,707						15						238,612						53,498						(24,378)						267,747
Share grants						42						—						579						—						—						579
Share repurchases						(3)						—						(24)						—						—						(24)
Share forfeitures						(1)						—						—						—						—						—
Net income						—						—						—						4,644						—						4,644
Distributions						—						—						—						—						(5,148)						(5,148)
Balance at June 30, 2023						14,745						$	15					$	239,167					$	58,142					$	(29,526)					$	267,798

Balance at December 31, 2021						14,597						$	15					$	237,624					$	24,650					$	(4,595)					$	257,694
Share grants						—						—						82						—						—						82
Net income						—						—						—						11,126						—						11,126
Distributions						—						—						—						—						(3,649)						(3,649)
Balance at March 31, 2022						14,597						15						237,706						35,776						(8,244)						265,253
Share grants						42						—						548						—						—						548
Share forfeitures						(1)						—						—						—						—						—
Net income						—						—						—						4,578						—						4,578
Distributions						—						—						—						—						(3,649)						(3,649)
Balance at June 30, 2022						14,638						$	15					$	238,254					$	40,354					$	(11,893)					$	266,730

See accompanying notes.

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SEVEN HILLS REALTY TRUST

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in thousands)

(unaudited)

						Six Months Ended June 30,
						2023						2022
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income						$	12,447					$	15,704
Adjustments to reconcile net income to net cash provided by operating activities:
Accretion of purchase discount						(2,232)						(7,571)
Provision for credit losses						39						—
Amortization of loan origination and exit fees						(1,767)						(2,112)
Amortization of deferred financing costs						643						474
Share based compensation						699						630
Changes in operating assets and liabilities:
Accrued interest receivable						(283)						(570)
Prepaid expenses and other assets						1,014						170
Accounts payable, accrued liabilities and other liabilities						(249)						(370)
Due to related persons						1,295						(48)
Net cash provided by operating activities						11,606						6,307
CASH FLOWS FROM INVESTING ACTIVITIES:
Origination of loans held for investment						(37,016)						(141,335)
Additional funding of loans held for investment						(3,790)						(8,020)
Repayment of loans held for investment						69,469						59,843
Cash assumed from transfer of loans held for investment to real estate owned						1,742						—
Real estate owned improvements						(1,228)						—
Net cash provided by (used in) investing activities						29,177						(89,512)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from secured financing facilities						28,125						223,948
Repayments under secured financing facilities						(47,275)						(109,773)
Payments of deferred financing costs						(324)						(1,571)
Repurchase of common shares						(37)						—
Distributions						(10,295)						(7,298)
Net cash (used in) provided by financing activities						(29,806)						105,306
Increase in cash, cash equivalents and restricted cash						10,977						22,101
Cash, cash equivalents and restricted cash at beginning of period						71,067						26,295
Cash, cash equivalents and restricted cash at end of period						$	82,044					$	48,396
SUPPLEMENTAL DISCLOSURES:
Interest paid						$	14,993					$	4,074
Income taxes paid						$	125					$	92
NON-CASH INVESTING ACTIVITIES:
Transfer of loans held for investment to real estate owned						$	14,060					$	—

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SUPPLEMENTAL DISCLOSURE OF CASH, CASH EQUIVALENTS AND RESTRICTED CASH:

The table below provides a reconciliation of cash, cash equivalents and restricted cash reported within the condensed consolidated balance sheets to the amounts shown in the condensed consolidated statements of cash flows:

						As of June 30,
						2023						2022
Cash and cash equivalents						$	81,806					$	48,230
Restricted cash						238						166
Total cash, cash equivalents and restricted cash shown in the condensed consolidated statements of cash flows						$	82,044					$	48,396

See accompanying notes.

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SEVEN HILLS REALTY TRUST

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data)

Note 1. Basis of Presentation

The accompanying condensed consolidated financial statements are unaudited. Certain information and disclosures required by U.S. generally accepted accounting principles, or GAAP, for complete financial statements have been condensed or omitted. We believe the disclosures made are adequate to make the information presented not misleading. However, the accompanying condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes contained in our Annual Report on Form 10-K for the year ended December 31, 2022, or our 2022 Annual Report. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair statement of results for the interim periods have been included. All intercompany transactions and balances with or among our consolidated subsidiaries have been eliminated. Operating results for interim periods are not necessarily indicative of the results that may be expected for the full year.

The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect reported amounts. Actual results could differ from those estimates. Significant estimates in the accompanying condensed consolidated financial statements include the allowance for credit losses, the valuation of real estate owned and the fair value of financial instruments.

Certain prior year amounts have been reclassified to conform to current year presentation.

Note 2. Recently Adopted Accounting Pronouncements

On January 1, 2023, we adopted Accounting Standards Update, or ASU, No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which replaces the “incurred loss” model for recognizing credit losses with a forward-looking “expected loss” model that generally will result in the earlier recognition of credit losses. The measurement of current expected credit losses, or CECL, is based upon historical experience, current conditions, and reasonable and supportable forecasts incorporating forward-looking information that affect the collectability of the reported amount. ASU No. 2016-13 is applicable to financial assets measured at amortized cost and off-balance sheet credit exposures, such as unfunded loan commitments.

The allowance for credit losses required under ASU No. 2016-13 is a valuation account that is deducted from the related loans’ amortized cost basis in our condensed consolidated balance sheets. Our loans typically include commitments to fund incremental proceeds to borrowers over the life of the loan; these future funding commitments are also subject to the CECL model. The allowance for credit losses related to unfunded loan commitments is included in accounts payable, accrued liabilities and other liabilities in our condensed consolidated balance sheets.

Given the lack of historical loss data related to our loan portfolio, we elected to estimate our expected losses using an analytical model that considers the likelihood of default and loss given default for each individual loan. This analytical model incorporates data from a third party database with historical loan loss information for commercial mortgage-backed securities, or CMBS, and commercial real estate, or CRE, loans since 1998. We estimate the allowance for credit losses for our loan portfolio, including unfunded loan commitments, at the individual loan level. Significant inputs to the model include certain loan specific data, such as loan to value, or LTV, property type, geographic location, occupancy, vintage year, remaining loan term, net operating income, expected timing and amounts of future loan fundings, and macroeconomic forecast assumptions, including the performance of CRE assets, unemployment rates, interest rates and other factors. We utilize the model to estimate credit losses over a reasonable and supportable economic forecast period, followed by a straight-line reversion period to average historical losses. Average historical losses are established using a population of third party historical loss data that approximates our portfolio as of the measurement date. We evaluate the estimated allowance for each of our loans individually and we consider our internal loan risk rating as the primary credit quality indicator underlying our assessment.

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 may elect to apply a practical expedient to determine the loan's 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.

6

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SEVEN HILLS REALTY TRUST

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data)

Upon adoption of ASU No. 2016-13 using the modified retrospective transition method and, based on our loan portfolio, the then current economic environment and expectations for future conditions, we recorded a cumulative-effect adjustment reducing our cumulative net income in our condensed consolidated balance sheets by $6,595, establishing an allowance for credit losses of $4,893 with respect to our then outstanding loans held for investment and increasing accounts payable, accrued liabilities and other liabilities by $1,702 with respect to our then unfunded loan commitments. No reserve for loan losses or allowance for credit losses was recognized within our consolidated financial statements prior to our adoption of ASU No. 2016-13.

Concurrent with our adoption of ASU No. 2016-13, on January 1, 2023, we adopted ASU No. 2022-02, Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures, which eliminated the guidance for and recognitions of troubled debt restructurings for all entities that adopted ASU No. 2016-13. Instead, an entity must determine whether a modification results in a new loan or continuation of an existing loan under Accounting Standards Codification, or ASC, 310, Receivables (Topic 310). If a borrower is experiencing financial difficulty, enhanced disclosures are required. ASU No. 2022-02 also requires disclosure of current period gross write-offs by year of origination. The adoption of ASU No. 2022-02 using the prospective transition method did not have a material impact on our condensed consolidated financial statements.

See Note 2 to our Consolidated Financial Statements included in Part IV, Item 15 of our 2022 Annual Report for further information regarding our measurement of reserves for loan losses prior to our adoption of ASU No. 2016-13 and our internal loan risk rating policy.

Note 3. Loans Held for Investment, net

We originate first mortgage loans secured by middle market and transitional CRE, which are generally to be held as long term investments. We fund our loan portfolio using cash on hand and advancements under our Secured Financing Facilities, as defined in Note 5. See Note 5 for further information regarding our secured financing agreements.

The table below provides overall statistics for our loan portfolio as of June 30, 2023 and December 31, 2022:    

						As of June 30, 2023						As of December 31, 2022
Number of loans						24						27
Total loan commitments						$	677,822					$	727,562
Unfunded loan commitments (1)						$	42,902					$	49,007
Principal balance						$	634,920					$	678,555
Carrying value						$	625,324					$	669,929
Weighted average coupon rate						9.01		%				8.07		%
Weighted average all in yield (2)						9.47		%				8.57		%
Weighted average floor						0.87		%				0.62		%
Weighted average maximum maturity (years) (3)						3.0						3.3
Weighted average risk rating						3.0						2.9

(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.

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SEVEN HILLS REALTY TRUST

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data)

The tables below represent our loan activities during the three months ended June 30, 2023 and 2022:

						Principal Balance						Deferred Fees and Other Items						Amortized Cost
Balance at March 31, 2023						$	628,696					$	(6,626)					$	622,070
Additional funding						2,140						—						2,140
Originations						37,500						(484)						37,016
Repayments						(17,551)						—						(17,551)
Transfer to real estate owned						(15,865)						(95)						(15,960)
Net amortization of deferred fees						—						763						763
Purchase discount accretion						—						1,047						1,047
Balance at June 30, 2023						$	634,920					$	(5,395)					$	629,525

						Principal Balance						Deferred Fees and Other Items						Amortized Cost
Balance at March 31, 2022						$	636,831					$	(14,121)					$	622,710
Additional funding						4,926						—						4,926
Originations						51,620						(321)						51,299
Repayments						(11,092)						(108)						(11,200)
Net amortization of deferred fees						—						814						814
Purchase discount accretion						—						1,636						1,636
Balance at June 30, 2022						$	682,285					$	(12,100)					$	670,185

The tables below represent our loan activities during the six months ended June 30, 2023 and 2022:

						Principal Balance						Deferred Fees and Other Items						Amortized Cost
Balance at December 31, 2022						$	678,555					$	(8,626)					$	669,929
Additional funding						4,024						(14)						4,010
Originations						37,500						(484)						37,016
Repayments						(69,294)						(175)						(69,469)
Transfer to real estate owned						(15,865)						(95)						(15,960)
Net amortization of deferred fees						—						1,767						1,767
Purchase discount accretion						—						2,232						2,232
Balance at June 30, 2023						$	634,920					$	(5,395)					$	629,525

						Principal Balance						Deferred Fees and Other Items						Amortized Cost
Balance at December 31, 2021						$	590,590					$	(19,810)					$	570,780
Additional funding						8,230						—						8,230
Originations						142,804						(1,469)						141,335
Repayments						(59,339)						(504)						(59,843)
Net amortization of deferred fees						—						2,112						2,112
Purchase discount accretion						—						7,571						7,571
Balance at June 30, 2022						$	682,285					$	(12,100)					$	670,185

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SEVEN HILLS REALTY TRUST

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data)

The tables below detail the property type and geographic location of the properties securing the loans in our portfolio as of June 30, 2023 and December 31, 2022:

						June 30, 2023																		December 31, 2022
Property Type						Number of Loans						Amortized Cost						Percentage of Value						Number of Loans						Amortized Cost						Percentage of Value
Office (1)						9						$	225,745					36		%				11						$	252,796					38		%
Multifamily						8						224,002						36		%				8						197,229						29		%
Retail						4						110,509						17		%				4						109,248						16		%
Industrial (1)						3						69,269						11		%				4						110,656						17		%
						24						$	629,525					100		%				27						$	669,929					100		%

(1)    As of December 31, 2022, one loan investment secured by a mixed use property consisting of office space and an industrial warehouse in Aurora, IL was classified as office for the purpose of counting the number of loans in our portfolio because the majority of the square footage of the property consisted of office space. The amortized cost of this loan investment was reflected in office and industrial based on the fair value of the building at the time of origination relative to the total fair value of the property. During the six months ended June 30, 2023, our loan investment in Aurora, IL was repaid.

						June 30, 2023																		December 31, 2022
Geographic Location						Number of Loans						Amortized Cost						Percentage of Value						Number of Loans						Amortized Cost						Percentage of Value
Midwest						8						$	230,793					37		%				9						$	251,208					37		%
South						6						171,681						27		%				6						166,616						25		%
West						7						137,610						22		%				8						146,837						22		%
East						3						89,441						14		%				4						105,268						16		%
						24						$	629,525					100		%				27						$	669,929					100		%

Credit Quality Information

We evaluate the credit quality of each of our loans at least quarterly by assessing a variety of risk factors in relation to each loan and assigning a risk rating to each loan based on those factors. The higher the number, the greater the risk level. See our 2022 Annual Report for more information regarding our loan risk ratings.

As of June 30, 2023 and December 31, 2022, the amortized cost of our loan portfolio within each internal risk rating by year of origination was as follows:

June 30, 2023
Risk Rating						Number of Loans						Percentage of Portfolio						2023						2022						2021						Prior						Total
1						—						—		%				$	—					$	—					$	—					$	—					$	—
2						4						17		%				—						41,998						32,812						29,595						104,405
3						18						71		%				37,157						129,224						225,385						56,032						447,798
4						2						12		%				—						36,702						40,620						—						77,322
5						—						—		%				—						—						—						—						—
						24						100		%				$	37,157					$	207,924					$	298,817					$	85,627					$	629,525

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SEVEN HILLS REALTY TRUST

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data)

December 31, 2022
Risk Rating						Number of Loans						Percentage of Portfolio						2022						2021						2020						Prior						Total
1						1						1		%				$	—					$	—					$	9,708					$	—					$	9,708
2						6						20		%				—						65,902						68,740						—						134,642
3						17						65		%				169,516						235,602						—						28,998						434,116
4						3						14		%				36,506						39,314						—						15,643						91,463
5						—						—		%				—						—						—						—						—
						27						100		%				$	206,022					$	340,818					$	78,448					$	44,641					$	669,929

The weighted average risk rating of our loans by amortized cost was 3.0 and 2.9 as of June 30, 2023 and December 31, 2022, respectively. Certain of our borrowers' business operations or tenants, particularly certain office and retail properties, were negatively impacted by the COVID-19 pandemic and continue to be impacted by market conditions that arose or intensified during or in response to the pandemic. Current inflationary pressures, rising or sustained high interest rates, supply chain issues or a prolonged economic slowdown or recession could amplify those negative impacts. Therefore, certain of our borrowers’ business plans have taken or will likely take longer to execute than initially expected, and as a result, certain of our borrowers may be unable to pay their debt service obligations owed and due to us as currently scheduled or at all.

The borrower of our loan secured by an office property located in Yardley, PA did not pay its debt service obligations due in May 2023, resulting in an event of default. In June 2023, we assumed legal title to the property through a deed in lieu of foreclosure. See Note 4 for further information.

The tables below represent the changes to the allowance for credit losses during the three and six months ended June 30, 2023:

						Loans Held for Investment, net						Unfunded Loan Commitments						Total
Balance at March 31, 2023						$	4,135					$	1,473					$	5,608
Provision for credit losses						774						252						1,026
Write offs						(708)						—						(708)
Balance at June 30, 2023						$	4,201					$	1,725					$	5,926

						Loans Held for Investment, net						Unfunded Loan Commitments						Total
Balance at December 31, 2022						$	—					$	—					$	—
Cumulative-effect adjustment upon adoption of ASU No. 2016-13						4,893						1,702						6,595
Provision for credit losses						16						23						39
Write offs						(708)						—						(708)
Balance at June 30, 2023						$	4,201					$	1,725					$	5,926

We estimate credit losses over a reasonable and supportable forecast period of 12 months, followed by a straight-line reversion period of 12 months back to average historical losses. The increase in the allowance for credit losses during the three months ended June 30, 2023 is primarily attributable to unfavorable changes in the macroeconomic outlook, most notably in CRE pricing forecasts, partially offset by a write off related to the loan transferred to real estate owned in June 2023. The decrease in the allowance for credit losses during the six months ended June 30, 2023, compared to the January 1, 2023 cumulative-effect adjustment upon adoption of ASU No. 2016-13, is primarily attributable to a write off related to the loan transferred to real estate owned in June 2023 and loan repayments, partially offset by the unfavorable changes in CRE pricing forecasts mentioned above.

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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data)

We may enter into loan modifications that include, among other changes, extensions of maturity dates, repurposing or required replenishment of reserves, increases or decreases in loan commitments and required pay downs of principal amounts outstanding. Loan modifications are evaluated to determine whether a modification results in a new loan or a continuation of an existing loan under ASC 310.

In June 2023, we amended the agreement governing our loan secured by an office property in St. Louis, MO. As part of this amendment, the borrower repaid $5,000 of the outstanding principal amount and the maturity date was extended by six months to December 19, 2023. As of June 30, 2023, this loan had an amortized cost of $23,956 and a risk rating of 3. We accounted for the amendment as a modification to the existing loan because the changes to the terms were determined to be minor. There were no other modifications to our loan portfolio for borrowers experiencing financial difficulties during the six months ended June 30, 2023.

We have elected to exclude accrued interest receivable from amortized cost and not to measure an allowance for credit losses on accrued interest receivable. Accrued interest receivables are generally written off when payments are 120 days past due. Such amounts are reversed against interest income and no further interest will be recorded until it is collected. During the three and six months ended June 30, 2023, we reversed $88 of accrued interest related to the loan transferred to real estate owned in June 2023.

We did not have any outstanding past due loans or nonaccrual loans as of June 30, 2023 or December 31, 2022. As of June 30, 2023 and July 27, 2023, all of our borrowers with outstanding loans had paid their debt service obligations owed and due to us. See our 2022 Annual Report for more information regarding our nonaccrual policy.

Note 4. Real Estate Owned

Real estate owned is property acquired in full or partial settlement of loan obligations generally through foreclosure or by deed in lieu of foreclosure. We generally expect to sell real estate owned within one year of acquisition and expect to meet the held for sale criteria required by ASC 360, Impairments and Disposals of Long-Lived Assets, within a short period of time following the acquisition. As such, we classify real estate owned as held for sale.

Real estate owned is recognized at the lesser of the fair value of the property less estimated costs to sell and the amortized cost of the loan secured by the property at the time of acquisition. The fair value of the property is determined using Level III inputs and standard industry valuation methods, including discounted cash flow analyses and sales comparisons. If the amortized cost of the loan exceeds the fair value of the property less estimated costs to sell, the difference is recorded through the allowance for credit losses as a write off. Conversely, if the fair value of the property less estimated costs to sell exceeds the amortized cost of the loan, the difference is recorded through the allowance for credit losses as a recovery. Any related shortfall or excess of previously established allowances for credit losses is recognized in the condensed consolidated statements of operations as a provision for or reversal of credit losses, respectively. After acquisition, costs incurred related to improvements to the property are capitalized to the extent they do not cause the carrying value of the property to exceed net realizable value and costs related to the operation and disposition of the property are expensed as incurred. Any subsequent declines in the fair value of the property less estimated costs to sell are recognized as impairment losses in the condensed consolidated statements of operations.

In June 2023, we assumed legal title to an office property located in Yardley, PA through a deed in lieu of foreclosure. The amortized cost basis of $15,960 of the related loan exceeded the fair value of the property, including cash assumed of $1,742 and net liabilities assumed of $550, less estimated costs to sell of $740, by $708. The previously established allowance for credit losses for the related loan was $1,335, resulting in a decrease to our provision for credit losses of $627 recorded in our condensed consolidated statements of operations for the three and six months ended June 30, 2023. Upon assumption of legal title of the property, we also assumed $2,258 of outstanding commitments for lease related costs pursuant to previously executed tenant leases.

Other assets related to real estate owned of $202, including $67 of straight line rent receivables, are included in prepaid expenses and other assets in our condensed consolidated balance sheets at June 30, 2023. Accrued expenses and other liabilities related to real estate owned of $689 are included in accounts payable, accrued liabilities and other liabilities in our condensed consolidated balance sheets at June 30, 2023. There were no other assets or accrued expenses and other liabilities related to real estate owned at December 31, 2022. Revenue from real estate owned represents rental income from operating leases with tenants and is recognized on a straight line basis over the lease term. Expenses from real estate owned represents costs related to the acquisition of the property and costs to operate and dispose of the property.

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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data)

Note 5. Secured Financing Agreements

Our secured financing agreements at June 30, 2023 consisted of agreements that govern: our master repurchase facility with Wells Fargo, National Association, or Wells Fargo, or the Wells Fargo Master Repurchase Facility; our master repurchase facility with Citibank, N.A., or Citibank, or the Citibank Master Repurchase Facility; our facility loan program with BMO Harris Bank N.A., or BMO, or the BMO Facility, and our master repurchase facility with UBS AG, or UBS, or the UBS Master Repurchase Facility. We refer to the Wells Fargo Master Repurchase Facility, Citibank Master Repurchase Facility and UBS Master Repurchase Facility, collectively, as our Master Repurchase Facilities. We refer to the Master Repurchase Facilities and the BMO Facility, collectively, as our Secured Financing Facilities. See our 2022 Annual Report for more information regarding our Secured Financing Facilities.

In July 2023, we amended and restated our master repurchase agreement with UBS, or the UBS Master Repurchase Agreement. The amended and restated UBS Master Repurchase Agreement made certain changes to the agreement and related fee letter, including extending the stated maturity date to February 18, 2025.

As of June 30, 2023, we were in compliance with the covenants and other terms of the agreements that govern our Secured Financing Facilities.

As of June 30, 2023 and July 27, 2023, we had a $454,465 and $441,786, respectively, aggregate outstanding principal balance under our Secured Financing Facilities.

The table below summarizes our Secured Financing Facilities as of June 30, 2023 and December 31, 2022:

						Debt Obligation
																								Weighted Average															Collateral
						Maximum Facility Size						Principal Balance						Carrying Value						Coupon Rate (1)						Remaining Maturity (years) (2)									Principal Balance
June 30, 2023:
Citibank Master Repurchase Facility						$	215,000					$	150,101					$	149,878					7.20		%				0.8									$	201,543
UBS Master Repurchase Facility						192,000						123,958						123,651						7.26		%				0.6									170,594
BMO Facility						150,000						84,855						84,371						7.05		%				1.8									113,851
Wells Fargo Master Repurchase Facility						125,000						95,551						94,790						7.18		%				1.7									126,932
Total/weighted average						$	682,000					$	454,465					$	452,690					7.19		%				1.1									$	612,920

December 31, 2022:
Citibank Master Repurchase Facility						$	215,000					$	150,647					$	150,360					6.34		%				1.1									$	205,234
UBS Master Repurchase Facility						192,000						144,437						143,887						6.48		%				1.1									198,254
BMO Facility						150,000						111,105						110,473						6.22		%				2.2									148,476
Wells Fargo Master Repurchase Facility						125,000						67,426						66,801						6.23		%				2.1									89,008
Total/weighted average						$	682,000					$	473,615					$	471,521					6.34		%				1.5									$	640,972

(1)The weighted average coupon rate is determined using the Secured Overnight Financing Rate, or SOFR, plus a spread ranging from 1.83% to 2.51%, as applicable, for the respective borrowings under our Secured Financing Facilities as of the applicable date.

(2)The weighted average remaining maturity is determined using the current maturity date of our corresponding loan investments, assuming no borrower loan extension options have been exercised. As of June 30, 2023, our Citibank Master Repurchase Facility, UBS Master Repurchase Facility and Wells Fargo Master Repurchase Facility mature on March 15, 2025, February 18, 2024 and March 11, 2025, respectively. Our BMO Facility matures at various dates based on the respective underlying loans held for investment.

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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data)

As of June 30, 2023, our outstanding borrowings under our Secured Financing Facilities had the following remaining maturities:

Year						Principal Payments on Secured Financing Facilities
2023						$	87,237
2024						228,846
2025						138,382
2026 and thereafter						—
						$	454,465

Note 6. Fair Value Measurements

The carrying values of cash and cash equivalents, restricted cash and accounts payable approximate their fair values due to the short term nature of these financial instruments.

We estimate the fair values of our loans held for investment and outstanding principal balances under our Secured Financing Facilities by using Level III inputs, including discounted cash flow analyses and currently prevailing market terms as of the reporting date. See our 2022 Annual Report for further information regarding the fair value of financial instruments.

The table below provides information regarding financial assets and liabilities not carried at fair value in our condensed consolidated balance sheets:

						June 30, 2023												December 31, 2022
						Carrying Value						Fair Value						Carrying Value						Fair Value
Financial assets
Loans held for investment						$	625,324					$	636,860					$	669,929					$	679,911
Financial liabilities
Secured Financing Facilities						$	452,690					$	452,299					$	471,521					$	471,362

There were no transfers of financial assets or liabilities within the fair value hierarchy during the six months ended June 30, 2023.

Note 7. Shareholders' Equity

Common Share Awards

On May 23, 2023, in accordance with our Trustee compensation arrangements, we awarded to each of our seven Trustees 6,000 of our common shares, valued at the closing price of our common shares on The Nasdaq Stock Market LLC, or Nasdaq on that day. The aggregate value of common shares awarded was $387.

Common Share Purchases

During the six months ended June 30, 2023, we purchased 4,079 of our common shares from a former officer of ours and former officers and employees of The RMR Group LLC, or RMR, in satisfaction of tax withholding and payment obligations in connection with the vesting of awards of our common shares, valued at the closing price of our common shares on Nasdaq on the applicable purchase date. The aggregate value of common shares purchased was $37.

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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data)

Distributions

For the six months ended June 30, 2023, we declared and paid regular quarterly distributions to common shareholders, using cash on hand, as follows:

Record Date						Payment Date						Distribution per Share						Total Distribution
January 23, 2023						February 16, 2023						$	0.35					$	5,147
April 24, 2023						May 18, 2023						0.35						5,148
												$	0.70					$	10,295

On July 13, 2023, we declared a quarterly distribution of $0.35 per common share, or $5,161, to shareholders of record on July 24, 2023. We expect to pay this distribution on or about August 17, 2023, using cash on hand.

Note 8. Management Agreement with Tremont

We have no employees. The personnel and various services we require to operate our business are provided to us by Tremont Realty Capital LLC, or Tremont, pursuant to a management agreement, which provides for the day to day management of our operations by Tremont, subject to the oversight and direction of our Board of Trustees.

We pay Tremont an annual base management fee payable quarterly (0.375% per quarter) in arrears equal to 1.5% of our “Equity,” as defined under our management agreement. We include these amounts in base management fees in our condensed consolidated statements of operations. Pursuant to the terms of our management agreement, we also pay Tremont management incentive fees, subject to Tremont earning those fees in accordance with the management agreement. We include these amounts in incentive fees in our condensed consolidated statements of operations.

Tremont, and not us, is responsible for the costs of its employees who provide services to us, unless any such payment or reimbursement is specifically approved by a majority of our Independent Trustees, is a shared services cost or relates to awards made under any equity compensation plan adopted by us. We are required to pay or to reimburse Tremont and its affiliates for all other costs and expenses of our operations. Some of these overhead, professional and other services are provided by RMR, pursuant to a shared services agreement between Tremont and RMR. These reimbursements include an allocation of the cost of personnel employed by RMR. These shared services costs are subject to approval by a majority of our Independent Trustees at least annually. We include these amounts in reimbursement of shared services expenses in our condensed consolidated statements of operations. See our 2022 Annual Report for further information regarding our management agreement with Tremont.

Note 9. Related Person Transactions

We have relationships and historical and continuing transactions with Tremont, The RMR Group Inc., or RMR Inc., and others related to them, including other companies to which RMR or its subsidiaries provide management services and some of which have trustees or officers who are also our Trustees or officers. Tremont is a subsidiary of RMR, which is a majority owned subsidiary of RMR Inc., and RMR Inc. is the managing member of RMR. RMR provides certain shared services to Tremont that are applicable to us, and we reimburse Tremont or pay RMR for the amounts Tremont or RMR pays for those services. One of our Managing Trustees and Chair of our Board of Trustees, Adam D. Portnoy, is the sole trustee, an officer and the controlling shareholder of ABP Trust, which is the controlling shareholder of RMR Inc., and he is also a director of Tremont, the chair of the board of directors, a managing director, the president and chief executive officer of RMR Inc., and an officer and employee of RMR. Matthew P. Jordan, our other Managing Trustee, is a director and the president and chief executive officer of Tremont. Mr. Jordan is also an officer of RMR Inc. and an officer and employee of RMR, and our executive officers are officers and employees of Tremont and/or RMR.

Some of our Independent Trustees also serve as independent trustees of other public companies to which RMR provides management services. Adam D. Portnoy serves as the chair of the board and as a managing trustee of those companies. Other officers of RMR and Tremont serve as managing trustees or officers of certain of these companies.

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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data)

Our Manager, Tremont Realty Capital LLC. We have a management agreement with Tremont to provide management services to us. See Note 8 for further information regarding our management agreement with Tremont. On May 11, 2022, Tremont purchased 882,407 of our common shares from Diane Portnoy, the mother of Adam D. Portnoy. Tremont paid an aggregate purchase price of $9,469 for these shares. As of June 30, 2023, Tremont owned 1,708,058 of our common shares, and Mr. Portnoy beneficially owned (including through Tremont and ABP Trust) 13.5% of our outstanding common shares.

Acceleration of Unvested Shares of Former Officer. G. Douglas Lanois resigned as our Chief Financial Officer and Treasurer, effective September 30, 2022. Our Compensation Committee approved the acceleration of all 3,648 of our unvested common shares owned by Mr. Lanois as of his separation date, January 1, 2023.

Property Management Agreement with RMR. We entered into a new property management agreement with RMR in July 2023 with respect to the real estate owned in Yardley, PA. Pursuant to this agreement, RMR will provide property management services and we will pay management fees equal to 3.0% of gross collected rents. Also under the terms of this property management agreement, we will pay RMR additional fees for construction supervision services equal to 5.0% of the cost of such construction. Either we or RMR may terminate this agreement upon 30 days' prior notice. No termination fee would be payable as a result of terminating the agreement. We did not incur property management or construction supervision fees during the three or six months ended June 30, 2023 or 2022.

For further information about these and other such relationships and certain other related person transactions, refer to our definitive Proxy Statement for our 2023 Annual Meeting of Shareholders and to our 2022 Annual Report.

Note 10. Income Taxes

We have elected to be taxed as a real estate investment trust, or REIT, under the Internal Revenue Code of 1986, as amended, or the IRC. Accordingly, we generally are not, and will not be, subject to U.S. federal income tax, provided that we meet certain distribution and other requirements. We are subject to certain state and local taxes, certain of which amounts are or will be reported as income taxes in our condensed consolidated statements of operations.

Note 11. Weighted Average Common Shares

We calculate net income per common share - basic using the two class method. We calculate net income per common share - diluted using the more dilutive of the two class or treasury stock method. Unvested share awards are considered participating securities and the related impact on earnings are considered when calculating net income per common share - basic and net income per common share - diluted.

The calculation of net income per common share - basic and diluted is as follows (amounts in thousands, except per share data):

						Three Months Ended June 30,												Six Months Ended June 30,
						2023						2022						2023						2022
Numerators:
Net income						$	4,644					$	4,578					$	12,447					$	15,704
Net income attributable to unvested share awards						(43)						(29)						(105)						(99)
Net income used in calculating net income per common share - basic and diluted						$	4,601					$	4,549					$	12,342					$	15,605
Denominators
Weighted average common shares outstanding - basic and diluted						14,605						14,521						14,594						14,514
Net income per common share - basic and diluted						$	0.32					$	0.31					$	0.85					$	1.08

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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data)

Note 12. Commitments and Contingencies

As of June 30, 2023, we had unfunded loan commitments of $42,902 related to our loans held for investment that are not reflected in our condensed consolidated balance sheets. These unfunded loan commitments had a weighted average initial maturity of 1.3 years as of June 30, 2023. See Note 3 for further information related to our loans held for investment.

As of June 30, 2023, we had estimated unspent lease related costs of $726.

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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.

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 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.

Market Conditions. In response to inflationary pressures, the Federal Open Market Committee of the U.S. Federal Reserve, or the FOMC, has increased the federal funds rate by 525 basis points since March 2022 and while the FOMC paused interest rate increases at its June 2023 meeting, it raised rates by 25 basis points at its July 2023 meeting and has indicated additional increases may be necessary to combat inflation. 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.

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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 higher interest rates has not affected all lenders equally. Life insurance companies have reduced their leverage ratios and increased credit spreads, but continue to originate new loans. Concerns about the capital adequacy and liquidity of the banking sector caused by the failures of certain banks in March 2023 has significantly decreased lending activity from such traditional sources. Lenders that rely on secondary markets to finance their lending activities continue to experience challenges. Credit spreads in the secondary market for CMBS and CRE collateralized loan obligations, or CLO, bonds have widened substantially and demand for such bonds as fixed income investments has declined due to increasing concerns about the underlying loans' credit quality and/or their ability to be refinanced in the current interest rate environment. As a result, the liquidity of some lenders who originate and sell loans into the CRE CLO market as a means of financing has been negatively impacted.

In addition to tighter underwriting standards and increased overall borrowing costs, lenders may be impacted by challenges experienced by their borrowers. 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. Additionally, continued uncertainty surrounding the demand for office space and recent increases in nonperforming office loans in CMBS bonds have made loans secured by office properties less attractive to originate. As a result, borrowers of certain office loans may have difficulties refinancing and repaying their maturing debt obligations. 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, service their debt or repay their debt obligations as they become due, and as a result, could offset the increase in interest income generated from higher interest 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. Capital remains available for investment in CRE assets, and certain favored asset types, such as multifamily and industrial, continue to transact. We believe there will be significant opportunities for alternative lenders with available liquidity, to capitalize on challenges that traditional lenders may experience. 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 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 5.05%; therefore, changes to income from investments, net, may not move proportionately with the increase or decrease in benchmark rates. As of June 30, 2023, SOFR was 5.14%, 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.

Certain of our loan agreements entered into prior to January 1, 2022 required the borrowers to pay us interest at floating rates based upon the London Interbank Offered Rate, or LIBOR. LIBOR was phased out for new contracts as of December 31, 2021 and is no longer available effective June 30, 2023. As of June 30, 2023, all of our pre-existing contracts have been amended to replace LIBOR with SOFR.

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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, 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 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, Adjusted Distributable Earnings and Adjusted Distributable Earnings per common share may not be comparable to distributable earnings and distributable earnings per common share, adjusted distributable earnings and adjusted 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, 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.

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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 of real estate owned and related intangible assets, 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.

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 and revenues and expenses from real estate owned.

Adjusted Book Value per Common Share

The table below calculates our book value per common share:

			June 30, 2023						December 31, 2022
Shareholders' equity			$	267,798					$	271,579
Total outstanding common shares			14,745						14,709
Book value per common share			18.16						18.46
Unaccreted purchase discount per common share (1)			0.31						0.46
Allowance for credit losses per common share (2)			0.40						—
Adjusted Book Value per common share			$	18.87					$	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 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 June 30, 2023 and December 31, 2022, the unaccreted purchase discount was $4,471 and $6,703, respectively.

(2)Excludes the impact of our allowance for credit losses. As of June 30, 2023, our allowance for credit losses for our loan portfolio and unfunded loan commitments was $5,926. 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.

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Our Loan Portfolio

The table below details overall statistics for our loan portfolio as of June 30, 2023 and December 31, 2022:

						As of June 30, 2023						As of December 31, 2022
Number of loans						24						27
Total loan commitments						$	677,822					$	727,562
Unfunded loan commitments (1)						$	42,902					$	49,007
Principal balance						$	634,920					$	678,555
Carrying value						$	625,324					$	669,929
Weighted average coupon rate						9.01		%				8.07		%
Weighted average all in yield (2)						9.47		%				8.57		%
Weighted average floor						0.87		%				0.62		%
Weighted average maximum maturity (years) (3)						3.0						3.3
Weighted average risk rating						3.0						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.

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Loan Portfolio Details

The table below details our loan portfolio as of June 30, 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					$	46,085					S + 4.00%						S + 4.64%						01/28/2026						63		%				3
2						Dallas, TX						Office						08/25/2021						50,000						43,450						S + 3.25%						S + 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						37,659						S + 3.85%						S + 4.66%						12/16/2024						59		%				3
6						Auburn, AL						Multifamily						05/11/2023						37,500						37,500						S + 3.25%						S + 3.96%						11/11/2026						67		%				3
7						Starkville, MS						Multifamily						03/22/2022						37,250						36,918						S + 4.00%						S + 4.32%						03/22/2027						70		%				4
8						Farmington Hills, MI						Multifamily						05/24/2022						31,520						28,983						S + 3.15%						S + 3.50%						05/24/2027						75		%				3
9						Downers Grove, IL						Office						09/25/2020						30,000						29,500						S + 4.25%						S + 4.69%						11/25/2024						67		%				2
10						Las Vegas, NV						Multifamily						06/10/2022						28,950						24,729						S + 3.30%						S + 4.03%						06/10/2027						60		%				3
11						Plano, TX						Office						07/01/2021						27,385						26,463						S + 4.75%						S + 5.16%						07/01/2026						78		%				3
12						Carlsbad, CA						Office						10/27/2021						24,750						24,130						S + 3.25%						S + 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						St. Louis, MO						Office						12/19/2018						23,867						23,867						S + 3.25%						S + 3.74%						12/19/2023						72		%				3
15						Downers Grove, IL						Office						12/09/2021						23,530						23,530						S + 4.25%						S + 4.57%						12/09/2026						72		%				3
16						Dublin, OH						Office						02/18/2020						22,507						22,507						S + 5.25%						S + 5.31%						08/16/2023						33		%				3
17						Bellevue, WA						Office						11/05/2021						21,000						20,000						S + 3.85%						S + 4.19%						11/05/2026						68		%				3
18						Portland, OR						Multifamily						07/09/2021						19,688						19,688						S + 3.57%						S + 3.97%						07/09/2026						75		%				3
19						Ames, IA						Multifamily						11/15/2021						18,000						17,925						S + 3.80%						S + 4.13%						11/15/2026						71		%				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						Delray Beach, FL						Retail						03/18/2022						16,000						15,602						S + 4.25%						S + 4.91%						03/18/2026						56		%				3
22						Westminster, CO						Office						05/25/2021						15,750						15,750						S + 3.75%						S + 4.25%						05/25/2026						66		%				2
23						Portland, OR						Multifamily						07/30/2021						13,400						13,400						S + 3.57%						S + 3.98%						07/30/2026						71		%				3
24						Allentown, PA						Industrial						01/24/2020						9,307						9,307						S + 3.50%						S + 4.03%						01/24/2025						67		%				3
						Total/weighted average																		$	677,822					$	634,920					S + 3.80%						S + 4.26%												67		%				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 June 30, 2023, we had $677,822 in aggregate loan commitments, consisting of a diverse portfolio, geographically and by property type, of 24 first mortgage loans. As of June 30, 2023, we had two loans representing approximately 12% 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.

The borrower of our loan secured by an office property located in Yardley, PA did not pay its debt service obligations due in May 2023, resulting in an event of default. In June 2023, we assumed legal title to the property through a deed in lieu of foreclosure. For further information regarding real estate owned, see Note 4 to our Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.

As of June 30, 2023 and July 27, 2023, all of our borrowers with outstanding loans had paid their debt service obligations owed and due to us.

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We did not have any outstanding past due loans or nonaccrual loans as of June 30, 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.

Financing Activities

The table below is an overview of our Secured Financing Facilities as of June 30, 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					$	201,543
UBS Master Repurchase Facility						02/18/2024						123,958						68,042						192,000						170,594
BMO Facility						Various						84,855						65,145						150,000						113,851
Wells Fargo Master Repurchase Facility						03/11/2025						95,551						29,449						125,000						126,932
Total												$	454,465					$	227,535					$	682,000					$	612,920

The table below details our Secured Financing Facilities activities during the three months ended June 30, 2023:

			Carrying Value
Balance at March 31, 2023			$	433,385
Borrowings			28,125
Repayments			(9,150)
Deferred fees			(6)
Amortization of deferred fees			336
Balance at June 30, 2023			$	452,690

The table below details our Secured Financing Facilities activities during the six months ended June 30, 2023:

			Carrying Value
Balance at December 31, 2022			$	471,521
Borrowings			28,125
Repayments			(47,275)
Deferred fees			(324)
Amortization of deferred fees			643
Balance at June 30, 2023			$	452,690

As of June 30, 2023, outstanding advancements under our Secured Financing Facilities had a weighted average interest rate of 7.19% per annum, excluding associated fees and expenses. As of June 30, 2023 and July 27, 2023, we had a $454,465 and $441,786, respectively, aggregate outstanding principal balance under our Secured Financing Facilities.

As of June 30, 2023, we were in compliance with all covenants and other terms under our Secured Financing Facilities.

In July 2023, we amended and restated the UBS Master Repurchase Agreement. The amended and restated UBS Master Repurchase Agreement made certain changes to the agreement and related fee letter, including extending the stated maturity date to February 18, 2025.

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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.

RESULTS OF OPERATIONS (amounts in thousands, except per share data)

Three Months Ended June 30, 2023 Compared to Three Months Ended March 31, 2023:

						Three Months Ended
						June 30, 2023						March 31, 2023						Change						% Change
INCOME FROM INVESTMENTS:
Interest and related income						$	15,821					$	15,856					$	(35)					(0.2		%)
Purchase discount accretion						1,047						1,185						(138)						(11.6		%)
Less: interest and related expenses						(7,927)						(7,694)						(233)						3.0		%
Income from loan investments, net						8,941						9,347						(406)						(4.3		%)
Revenue from real estate owned						149						—						149						n/m
Total revenue						9,090						9,347						(257)						(2.7		%)
OTHER EXPENSES:
Base management fees						1,074						1,072						2						0.2		%
Incentive fees						192						—						192						n/m
General and administrative expenses						1,281						796						485						60.9		%
Reimbursement of shared services expenses						628						643						(15)						(2.3		%)
Provision for (reversal of) credit losses						1,026						(987)						2,013						(204.0		%)
Expenses from real estate owned						218						—						218						n/m
Total other expenses						4,419						1,524						2,895						190.0		%
Income before income taxes						4,671						7,823						(3,152)						(40.3		%)
Income tax expense						(27)						(20)						(7)						35.0		%
Net income						$	4,644					$	7,803					$	(3,159)					(40.5		%)
Weighted average common shares outstanding - basic and diluted						14,605						14,582						23						0.2		%
Net income per common share - basic and diluted						$	0.32					$	0.53					$	(0.21)					(40.0		%)

n/m - not meaningful

Interest and related income. The decrease in interest and related income was primarily the result of loan repayments, partially offset by higher benchmark interest rates and one new loan origination during the three months ended June 30, 2023. The weighted average benchmark interest rate was 5.21% as of June 30, 2023 as compared to 4.77% as of March 31, 2023.

Purchase discount accretion. The decrease in purchase discount accretion was primarily the result of less amounts outstanding on loans acquired in the Merger during the three months ended June 30, 2023 as compared to the three months ended March 31, 2023.

Interest and related expenses. The increase in interest and related expenses was primarily the result of higher benchmark interest rates, partially offset by repayments. The weighted average benchmark interest rate was 5.15% as of June 30, 2023 as compared to 4.75% as of March 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. In accordance with our management agreement, we recognized management incentive fees payable to Tremont for the three months ended June 30, 2023. We did not incur management incentive fees for the three months ended March 31, 2023.

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General and administrative expenses. The increase in general and administrative expenses was primarily due to an increase in share based compensation resulting from shares awarded to our Trustees during the three months ended June 30, 2023 as compared to the three months ended March 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. The decrease in reimbursement of shared services expenses was primarily the result of an adjustment recognized during the three months ended June 30, 2023 to decrease our estimated usage of shared services from RMR for the year ending December 31, 2023.

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 June 30, 2023 was primarily attributable to unfavorable changes in the current macroeconomic outlook, most notably in CRE pricing forecasts, partially offset by a recovery in our previously recorded allowance for credit losses for our loan secured by an office property in Yardley, PA that was transferred to real estate owned through a deed in lieu of foreclosure in June 2023.

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.

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 decrease in net income was due to the changes noted above.

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Six Months Ended June 30, 2023 Compared to Six Months Ended June 30, 2022:

						Six Months Ended June 30,
						2023						2022						Change						% Change
INCOME FROM INVESTMENTS:
Interest and related income						$	31,677					$	18,448					$	13,229					71.7		%
Purchase discount accretion						2,232						7,571						(5,339)						(70.5		%)
Less: interest and related expenses						(15,621)						(4,744)						(10,877)						229.3		%
Income from loan investments, net						18,288						21,275						(2,987)						(14.0		%)
Revenue from real estate owned						149						—						149						n/m
Total revenue						18,437						21,275						(2,838)						(13.3		%)
OTHER EXPENSES:
Base management fees						2,146						2,126						20						0.9		%
Incentive fees						192						—						192						n/m
General and administrative expenses						2,077						2,176						(99)						(4.5		%)
Reimbursement of shared services expenses						1,271						1,148						123						10.7		%
Provision for credit losses						39						—						39						n/m
Expenses from real estate owned						218						—						218						n/m
Other transaction related costs						—						37						(37)						(100.0		%)
Total other expenses						5,943						5,487						456						8.3		%
Income before income taxes						12,494						15,788						(3,294)						(20.9		%)
Income tax expense						(47)						(84)						37						(44.0		%)
Net income						$	12,447					$	15,704					$	(3,257)					(20.7		%)
Weighted average common shares outstanding - basic and diluted						14,594						14,514						80						0.6		%
Net income per common share - basic and diluted						$	0.85					$	1.08					$	(0.23)					(21.0)		%

n/m - not meaningful

Interest and related income. The increase in interest and related income was primarily the result of higher benchmark interest rates and interest on three loans originated since July 1, 2022, partially offset by six loan repayments since July 1, 2022. The weighted average benchmark interest rate was 5.21% as of June 30, 2023 as compared to 1.32% as of June 30, 2022.

Purchase discount accretion. The decrease in purchase discount accretion was primarily the result of less amounts outstanding on loans acquired in the Merger during the six month period ended June 30, 2023 as compared to the six month period ended June 30, 2022.

Interest and related expenses. The increase in interest and related expenses was primarily the result of higher benchmark interest rates, partially offset by a lower average outstanding balance under our Secured Financing Facilities during the six months ended June 30, 2023, as compared to the six months ended June 30, 2022. The weighted average benchmark interest rate was 5.15% as of June 30, 2023 as compared to 1.47% as of June 30, 2022.

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. In accordance with our management agreement, we recognized management incentive fees payable to Tremont for the six months ended June 30, 2023. We did not incur management incentive fees for the six months ended June 30, 2022.

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General and administrative expenses. The decrease in general and administrative expenses was primarily due to decreases in professional fees, partially offset by an increase in share based compensation during the six months ended June 30, 2023 as compared to the six months ended June 30, 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 increase in reimbursement of shared services expenses was primarily the result of higher usage of shared services 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 six months ended June 30, 2023 was primarily attributable to unfavorable changes in the current macroeconomic outlook, most notably in CRE pricing forecasts, partially offset by a recovery in our previously recorded allowance for credit losses for our loan secured by an office property in Yardley, PA that was transferred to real estate owned through a deed in lieu of foreclosure in June 2023.

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.

Other transaction related costs. Other transaction related costs for the six months ended June 30, 2022 include expenses related to the Merger.

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 decrease in net income was due to the changes noted above.

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												Six Months Ended
						June 30, 2023						March 31, 2023						June 30, 2023						June 30, 2022
Net income						$	4,644					$	7,803					$	12,447					$	15,704
Incentive fees						192						—						192						—
Non-cash equity compensation expense						579						120						699						630
Non-cash accretion of purchase discount						(1,047)						(1,185)						(2,232)						(7,571)
Provision for (reversal of) credit losses						1,026						(987)						39						—
Distributable Earnings						$	5,394					$	5,751					$	11,145					$	8,763
Other transaction related costs (1)						—						—						—						37
Revenue from real estate owned						(149)						—						(149)						—
Expenses from real estate owned						218						—						218						—
Adjusted Distributable Earnings						$	5,463					$	5,751					$	11,214					$	8,800
Weighted average common shares outstanding - basic and diluted						14,605						14,582						14,594						14,514
Net income per common share - basic and diluted						$	0.32					$	0.53					$	0.85					$	1.08
Distributable Earnings per common share - basic and diluted						$	0.37					$	0.39					$	0.76					$	0.60
Adjusted Distributable Earnings per common share - basic and diluted						$	0.37					$	0.39					$	0.77					$	0.61

(1)Other transaction related costs for the six months ended June 30, 2022 include expenses related to the Merger.

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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.

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:

						Six Months Ended June 30,
						2023						2022
Cash, cash equivalents and restricted cash at beginning of period						$	71,067					$	26,295
Net cash provided by (used in):
Operating activities						11,606						6,307
Investing activities						29,177						(89,512)
Financing activities						(29,806)						105,306
Cash, cash equivalents and restricted cash at end of period						$	82,044					$	48,396

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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 and decreased loan originations. The increase in cash provided by investing activities is primarily due to higher loan repayments and decreased loan originations 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 and an increase in distributions to our common shareholders for the 2023 period, partially offset by decreased repayments on our Secured Financing Facilities during the 2023 period.

Distributions

During the six months ended June 30, 2023, we declared and paid regular quarterly distributions to our common shareholders totaling $10,295, or $0.70 per common share, using cash on hand.

On July 13, 2023, we declared a regular quarterly distribution of $0.35 per common share, or $5,161, to shareholders of record on July 24, 2023. We expect to pay this distribution to our common shareholders on or about August 17, 2023 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 June 30, 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)						$	42,902					$	14,230					$	28,672					$	—					$	—
Principal payments on Secured Financing Facilities (2)						454,465						216,421						238,044						—						—
Interest payments (3)						37,218						26,512						10,706						—						—
Lease related costs (4)						726						726						—						—						—
						$	535,311					$	257,889					$	277,422					$	—					$	—

(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 June 30, 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.

(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 June 30, 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.

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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.

As of June 30, 2023, we had a $369,610 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 June 30, 2023, we had a $84,855 aggregate outstanding principal balance under the BMO Facility.

As of June 30, 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 8 and 9 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.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

Not applicable.

Item 4. Controls and Procedures

As of the end of the period covered by this Quarterly Report on Form 10-Q, our management carried out an evaluation, under the supervision and with the participation of our Managing Trustees, our President and Chief Investment Officer and our Chief Financial Officer and Treasurer, of the effectiveness of our disclosure controls and procedures pursuant to Rules 13a-15 and 15d-15 under the Securities Exchange Act of 1934, as amended. Based upon that evaluation, our Managing Trustees, our President and our Chief Financial Officer and Treasurer concluded that our disclosure controls and procedures are effective.

There have been no changes in our internal control over financial reporting during the quarter ended June 30, 2023 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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Warning Concerning Forward-Looking Statements

This Quarterly Report on Form 10-Q contains statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws. These statements include words such as “believe”, “expect”, “anticipate”, “intend”, “plan”, “estimate”, “will”, “may” and negatives or derivatives of these or similar expressions. These forward-looking statements include, among others, statements about: the disposition of our real estate owned; economic, market and industry conditions; demand for CRE debt and opportunities that may exist for alternative lenders like us; our future lending activity; the ability of our borrowers to achieve their business plans; our leverage levels and possible future financings; our liquidity needs and sources; and the amount and timing of future distributions.

Forward-looking statements reflect our current expectations, are based on judgments and assumptions, are inherently uncertain and are subject to risks, uncertainties and other factors, which could cause our actual results, performance or achievements to differ materially from expected future results, performance or achievements expressed or implied in any forward-looking statements. Some of the risks, uncertainties and other factors that may cause our actual results, performance or achievements to differ materially from those expressed or implied by forward-looking statements include, but are not limited to, the following:

•Our borrowers’ ability to successfully execute their business plans, including our borrowers' ability to manage and stabilize properties;

•Whether the diversity and other characteristics of our loan portfolio will benefit us to the extent we expect;

•Our ability to carry out our business strategy and take advantage of opportunities for our business that we believe exist;

•The impact of inflation, geopolitical instability, interest rates and economic recession or downturn on the CRE industry generally and specific CRE sectors applicable to our investments and lending markets, us and our borrowers;

•Fluctuations in interest rates and credit spreads may reduce the returns we may receive on our investments and increase our borrowing costs;

•Fluctuations in market demand for CRE debt and the volume of transactions and available opportunities in the CRE debt market, including the middle market;

•Dislocations and volatility in the capital markets;

•Our ability to utilize our Secured Financing Facilities and to obtain additional capital to enable us to attain our target leverage, to make additional investments and to increase our potential returns, and the cost of that capital;

•Our ability to pay distributions to our shareholders and sustain or increase the amount of such distributions;

•Our ability to successfully execute, achieve and benefit from our operating and investment targets, investment and financing strategies and leverage policies;

•The amount and timing of cash flows we receive from our investments;

•The ability of Tremont to make suitable investments for us, to monitor, service and administer our existing investments and to otherwise implement our investment strategy and successfully manage us;

•Our ability to maintain and improve a favorable net interest spread between the interest we earn on our investments and the interest we pay on our borrowings;

•The extent to which we earn and receive origination, extension, exit, prepayment or other fees we may earn from our investments;

•Yields that may be available to us from mortgages on middle market and transitional CRE;

•The duration and other terms of our loan agreements with borrowers;

•The credit qualities of our borrowers;

•The ability and willingness of our borrowers to repay our investments in a timely manner or at all;

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•The extent to which our borrowers' sponsors provide support to our borrowers or us regarding our loans;

•Our qualification for taxation as a REIT;

•Our ability to maintain our exemption from registration under the 1940 Act;

•Events giving rise to increases in our credit loss reserves;

•Our ability to diversify our investment portfolio based on industry and market conditions;

•The ability of our manager to arrange for the successful management of real estate owned and our ability to sell those properties at prices that allow us to recover amounts we invested;

•Our ability to successfully compete;

•Market trends in our industry or with respect to interest rates, real estate values, the debt securities markets or the economy generally;

•Reduced demand for office or retail space;

•Regulatory requirements and the effect they may have on us or our competitors;

•Competition within the CRE lending industry;

•Changes in the availability, sourcing and structuring of CRE lending;

•Defaults by our borrowers;

•Compliance with, and changes to, federal, state or local laws or regulations, accounting rules, tax laws or similar matters;

•Limitations imposed on our business and our ability to satisfy complex rules in order for us to maintain our qualification for taxation as a REIT for U.S. federal income tax purposes;

•Actual and potential conflicts of interest with our related parties, including our Managing Trustees, Tremont, RMR, and others affiliated with them;

•Acts of God, earthquakes, hurricanes, outbreaks or continuation of pandemics, or other public health safety events or conditions, supply chain disruptions, climate change and other man-made or natural disasters or acts of war, terrorism, social unrest or civil disturbances; and

•Other matters.

These risks, uncertainties and other factors are not exhaustive and should be read in conjunction with other cautionary statements that are included in our periodic filings. The information contained in our filings with the SEC, including under the caption “Risk Factors” in our periodic reports, or incorporated therein, identifies important factors that could cause differences from the forward-looking statements in this Quarterly Report on Form 10-Q. Our filings with the SEC are available on the SEC’s website at www.sec.gov.

You should not place undue reliance upon our forward-looking statements.

Except as required by law, we undertake no obligation to update or change any forward-looking statements as a result of new information, future events or otherwise.

Statement Concerning Limited Liability

The Declaration of Trust of Seven Hills Realty Trust, a copy of which, together with any amendments or supplements thereto, is duly filed with the State Department of Assessments and Taxation of Maryland, provide that the name Seven Hills Realty Trust refers to the trustees collectively as trustees, but not individually or personally. No trustee, officer, shareholder, employee or agent of Seven Hills Realty Trust shall be held to any personal liability, jointly or severally, for any obligation of, or claim against, Seven Hills Realty Trust. All persons or entities dealing with Seven Hills Realty Trust, in any way, shall look only to the assets of Seven Hills Realty Trust for the payment of any sum or the performance of any obligation.

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Part II. Other Information

Item 1A. Risk Factors

There have been no material changes to the risk factors previously disclosed in our 2022 Annual Report.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Issuer purchases of equity securities. The table below provides information about our purchases of our equity securities during the quarter ended June 30, 2023.

Calendar Month						Number of Shares Purchased (1)						Average Price Paid per Share						Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs						Maximum Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs
May 2023						2,576						$	9.21					—						$			—
Total/weighted average						2,576						$	9.21					—						$			—

(1)These common share withholdings and purchases were made to satisfy the tax withholding and payment obligations of former officers and employees of RMR in connection with the vesting of awards of our common shares. We withheld and purchased these shares at their fair market value based upon the trading price of our common shares at the close of trading on Nasdaq on the purchase date.

Item 6. Exhibits

Exhibit Number						Description
3.1						Declaration of Trust of the Company, dated December 21, 2021. (Incorporated by reference to Exhibit 3.1 of the Current Report on Form 8-K filed by the Company on December 22, 2021.)
3.2						Bylaws of the Company, dated December 22, 2021. (Incorporated by reference to Exhibit 3.2 of the Current Report on Form 8-K filed by the Company on December 22, 2021.)
4.1						Form of Common Share Certificate. (Filed herewith.)
10.1						Property Management Agreement, dated as of July 8, 2023, between The RMR Group LLC and Floral Vale LLC, a subsidiary of the Company. (Filed herewith.)
31.1						Rule 13a-14(a) Certification. (Filed herewith.)
31.2						Rule 13a-14(a) Certification. (Filed herewith.)
31.3						Rule 13a-14(a) Certification. (Filed herewith.)
31.4						Rule 13a-14(a) Certification. (Filed herewith.)
32.1						Section 1350 Certification. (Furnished herewith.)
101.INS						XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
101.SCH						XBRL Taxonomy Extension Schema Document. (Filed herewith.)
101.CAL						XBRL Taxonomy Extension Calculation Linkbase Document. (Filed herewith.)
101.DEF						XBRL Taxonomy Extension Definition Linkbase Document. (Filed herewith.)
101.LAB						XBRL Taxonomy Extension Label Linkbase Document. (Filed herewith.)
101.PRE						XBRL Taxonomy Extension Presentation Linkbase Document. (Filed herewith.)
104						Cover Page Interactive Data File. (Formatted as Inline XBRL and contained in Exhibit 101.)

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

			SEVEN HILLS REALTY TRUST
			By:			/s/ Thomas J. Lorenzini
						Thomas J. Lorenzini President and Chief Investment Officer
						Dated: July 31, 2023
			By:			/s/ Tiffany R. Sy
						Tiffany R. Sy Chief Financial Officer and Treasurer (principal financial and accounting officer)
						Dated: July 31, 2023

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