The following discussion should be read in conjunction with our condensed consolidated financial statements and accompanying notes included elsewhere in this Quarterly Report on Form 10-Q and in our 2021 Annual Report.
OVERVIEW (dollars in thousands, except share data)
We are a Maryland REIT. Our business strategy is focused on originating and investing in floating rate first mortgage loans secured by middle market and transitional CRE. We define middle market CRE as commercial properties that have values up to$100,000 and transitional CRE as commercial properties subject to redevelopment or repositioning activities that are expected to increase the value of the properties. These mortgage loans are classified as loans held for investment in our condensed consolidated balance sheets. Loans held for investment are reported at cost, net of any unamortized loan fees, origination costs, premiums, discounts or reserves for loan losses, as applicable.Tremont is registered with theSecurities and Exchange Commission , orSEC , as an investment adviser under the Investment Advisers Act of 1940, as amended. We believe thatTremont provides us with significant experience and expertise in investing in middle market and transitional CRE. We operate our business in a manner consistent with our qualification for taxation as a REIT under the IRC. As such, we generally are not subject toU.S. federal income tax, provided that we meet certain distribution and other requirements. We also operate our business in a manner that permits us to maintain our exemption from registration under the Investment Company Act of 1940, as amended, or the 1940 Act.
Non-GAAP Financial Measures
We present Distributable Earnings, Distributable Earnings per common share, 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 applicableSEC rules. These non-GAAP financial measures do not represent net income, net income per common share or cash generated from operating activities and should not be considered as an alternative to net income or net income per common share determined in accordance with GAAP or as an indication of our cash flows from operations determined in accordance with GAAP, measures of our liquidity or operating performance or an indication of funds available for our cash needs. In addition, our methodologies for calculating these non-GAAP financial measures may differ from the methodologies employed by other companies to calculate the same or similar supplemental performance measures; therefore, our reported Distributable Earnings, Distributable Earnings per common share, Adjusted Distributable Earnings and Adjusted Distributable Earnings per common share may not be comparable to distributable earnings, 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 unaccreted purchase discount resulting from the excess of the fair value of the loans TRMT then held for investment and that we acquired as a result of the Merger over the consideration we paid in the Merger. Adjusted Book Value per common share does not represent book value per common share or alternative measures determined in accordance with GAAP. Our methodology for calculating Adjusted Book Value per common share may differ from the methodologies employed by other companies to calculate the same or similar supplemental capital adequacy measures; therefore, our Adjusted Book Value per common share may not be comparable to the adjusted book value per common share reported by other companies. 16 -------------------------------------------------------------------------------- Table of Contents 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 ourBoard 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 toTremont under our management agreement.
Distributable Earnings and Adjusted Distributable Earnings
We calculate Distributable Earnings and Distributable Earnings per common share as net income and net income per common share, respectively, computed in accordance with GAAP, including realized losses not otherwise included in net income determined in accordance with GAAP, and excluding: (a) the management incentive fees earned byTremont , if any; (b) depreciation and amortization, if any; (c) non-cash equity compensation expense; (d) unrealized gains, losses and other similar non-cash items that are included in net income for the period of the calculation (regardless of whether such items are included in or deducted from net income or in other comprehensive income under GAAP), if any; and (e) one-time events pursuant to changes in GAAP and certain non-cash items, if any. Distributable Earnings are reduced for realized losses on loan investments when amounts are deemed uncollectable. We define Adjusted Distributable Earnings and Adjusted Distributable Earnings per common share as Distributable Earnings and Distributable Earnings per common share, respectively, excluding the effects of certain non-recurring transactions.
Reconciliation of Book Value per Common Share to Adjusted Book Value per Common Share
The table below calculates our book value per common share and demonstrates how we calculate Adjusted Book Value per common share:
June 30, 2022 December 31, 2021 Shareholders' equity$ 266,730 $
257,694
Total outstanding common shares 14,638
14,597
Book value per common share 18.22
17.65
Unaccreted purchase discount per common share 0.67
1.20
Adjusted Book Value per common share (1)
18.85
(1)Adjusted Book Value per common share is a non-GAAP financial measure that excludes the impact of the unaccreted purchase discount resulting from the excess of the fair value of the loans TRMT then held for investment and that we acquired as a result of the Merger over the consideration we paid in the Merger. The purchase discount of$36,443 was allocated to each acquired loan and is being accreted into income over the remaining term of the respective loan. As ofJune 30, 2022 andDecember 31, 2021 , the unaccreted purchase discount was$9,820 and$17,391 , respectively. 17 -------------------------------------------------------------------------------- Table of Contents Our Loan Portfolio
The table below details overall statistics for our loan portfolio as of
As of June 30, 2022 As of December 31, 2021 Number of loans 28 26 Total loan commitments $ 734,883 $ 648,266 Unfunded loan commitments (1) $ 52,694 $ 57,772 Principal balance $ 682,285 $ 590,590 Carrying value $ 670,185 $ 570,780 Weighted average coupon rate 5.14 % 4.54 % Weighted average all in yield (2) 5.64 % 5.08 % Weighted average floor 0.61 % 0.68 % Weighted average maximum maturity (years) (3) 3.6 3.8 Weighted average risk rating 2.7 2.9 Weighted average LTV (4) 68 % 68 % (1) Unfunded loan commitments are primarily used to finance property and building improvements and leasing capital and are generally funded over the term of the loan. (2) All in yield represents the yield on a loan, including amortization of deferred fees over the initial term of the loan and excluding any purchase discount accretion. (3) Maximum maturity assumes all borrower loan extension options have been exercised, which options are subject to the borrower meeting certain conditions. (4) LTV represents the initial loan amount divided by the underwritten in-place value of the underlying collateral at closing. 18 -------------------------------------------------------------------------------- Table of Contents Loan Portfolio Details
The table below details our loan portfolio as of
Committed Principal Principal All in Maximum Maturity (2) Location Property Type Origination Date Amount Balance Coupon Rate Yield (1) (date) LTV(3) Risk Rating First mortgage loansSt. Louis, MO Office12/19/2018 $ 29,500 $ 28,917 L + 3.25% L + 3.74%12/19/2023 72 % 2Coppell, TX Retail02/05/2019 19,365 19,365 L + 3.50% L + 4.24%08/12/2022 73 % 3Yardley, PA Office12/19/2019 16,500 14,972 L + 4.97% L + 5.67%12/19/2024 75 % 4Allentown, PA Industrial01/24/2020 10,078 10,078 L + 3.50% L + 4.03%01/24/2025 67 % 2Dublin, OH Office02/18/2020 22,820 22,507 S + 3.75% S + 4.95%02/18/2023 33 % 2Downers Grove, IL Office09/25/2020 30,000 29,500 L + 4.25% L + 4.69%11/25/2024 67 % 3Los Angeles, CA Retail12/17/2020 24,600 21,040 L + 4.25% L + 5.03%12/17/2024 67 % 2Aurora, IL Office / Industrial12/18/2020 17,460 15,105 L + 4.35% L + 5.03%12/18/2024 73 % 2Olmstead Falls , OH Multifamily01/28/2021 54,575 46,083 L + 4.00% L + 4.64%01/28/2026 63 % 3Colorado Springs, CO Office / Industrial04/06/2021 34,275 30,210 L + 4.50% L + 5.02%04/06/2025 73 % 2Westminster, CO Office05/25/2021 15,250 13,894 L + 3.75% L + 4.20%05/25/2026 66 % 2Plano, TX Office07/01/2021 27,385 25,209 L + 4.75% L + 5.17%07/01/2026 78 % 3Portland, OR Multifamily07/09/2021 19,687 19,687 L + 3.57% L + 3.97%07/09/2026 75 % 3Portland, OR Multifamily07/30/2021 13,400 13,400 L + 3.57% L + 3.98%07/30/2026 71 % 4Seattle, WA Multifamily08/16/2021 12,500 12,265 L + 3.55% L + 3.89%08/16/2026 70 % 3Dallas, TX Office08/25/2021 50,000 43,450 L + 3.25% L + 3.61%08/25/2026 72 % 3Sandy Springs, GA Retail09/23/2021 16,488 15,017 L + 3.75% L + 4.11%09/23/2026 72 % 2Carlsbad, CA Office10/27/2021 24,750 23,825 L + 3.25% L + 3.58%10/27/2026 78 % 3Bellevue, WA Office11/05/2021 21,000 20,000 L + 3.85% L + 4.19%11/05/2026 68 % 3Ames, IA Multifamily11/15/2021 18,000 17,680 L + 3.80% L + 4.13%11/15/2026 71 % 2Downers Grove, IL Office12/09/2021 23,530 23,530 L + 4.25% L + 4.57%12/09/2026 72 % 3West Bloomfield, MI Retail12/16/2021 42,500 37,388 L + 3.85% L + 4.66%12/16/2024 59 % 3Summerville, SC Industrial12/20/2021 35,000 35,000 L + 3.50% L + 3.82%12/20/2026 70 % 2Delray Beach, FL Retail03/18/2022 16,000 13,947 S + 4.25% S + 4.96%03/18/2026 56 % 3Starkville, MS Multifamily03/22/2022 37,250 36,396 S + 4.00% S + 4.33%03/22/2027 70 % 3Brandywine, MD Retail03/29/2022 42,500 42,200 S + 3.85% S + 4.25%03/29/2027 62 % 3Farmington Hills, MI Multifamily05/24/2022 31,520 28,520 S + 3.15% S + 3.50%05/24/2027 75 % 3Las Vegas, NV Multifamily06/10/2022 28,950 23,100 S + 3.30% S + 4.08%06/10/2027 60 % 3 Total/weighted average$ 734,883 $ 682,285 + 3.82% + 4.33% 68 % 2.7 (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 ofJune 30, 2022 , we had$734,883 in aggregate loan commitments, consisting of a diverse portfolio, geographically and by property type, of 28 first mortgage loans. The impact from the COVID-19 pandemic has negatively impacted some of our borrowers' business operations or tenants, particularly in the cases of certain of our office and retail collateral, which are some of the types of properties that have been most negatively impacted by the pandemic. We expect that those negative impacts may continue and may apply to other borrowers and/or their tenants. Further, although economic activity in theU.S. has improved significantly from the low points during the pandemic to date, certain industries have not recovered to their pre-pandemic positions, certain industries have not recovered to their pre-pandemic positions, and current inflationary pressures and the possibility that theU.S. economy may now be in, or will soon enter into, a recession or downturn may amplify those, or introduce additional, negative impacts. Therefore, certain of our borrowers' business plans will likely take longer to execute than initially expected and certain of our borrowers may be unable to pay their debt service obligation owed and due to us as currently scheduled. As ofJune 30, 2022 , we had two loan representing approximately 4% of the carrying value of our loan portfolio with a loan risk rating of "4" or "higher risk". For further information and risks relating to the COVID-19 pandemic and current economic conditions on us and our business, see "-Factors Affecting our Operating Results" below and "Warning 19 -------------------------------------------------------------------------------- Table of Contents Concerning Forward-Looking Statements" elsewhere in this Quarterly Report on Form 10-Q and Part I, Item 1A, "Risk Factors", of our 2021 Annual Report. All of the loans in our portfolio are structured with risk mitigation mechanisms, such as cash flow sweeps or interest reserves, to help protect us against investment losses. In addition, we continue to actively engage with our borrowers regarding their execution of the business plans for the underlying collateral, among other things.
As of
We did not have any impaired loans, non-accrual loans or loans in default as ofJune 30, 2022 ; thus, we did not record a reserve for loan loss as of that date. However, depending on the duration and severity of the COVID-19 pandemic and any resulting economic downturn, our borrowers' businesses, operations and liquidity may be materially adversely impacted. As a result, they may become unable to pay their debt service obligations owed and due to us, which may result in the impairment of those loans, and our recording loan loss reserves with respect to those loans and recording of any income with respect to those loans on a nonaccrual basis. For further information regarding our loan portfolio and the risks associated with it, see Note 3 to our Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q and the risk factors identified in Part I, Item 1A, "Risk Factors", of our 2021 Annual Report. Financing Activities OnMarch 11, 2022 , one of our wholly owned subsidiaries entered into our Wells Fargo Master Repurchase Agreement for the Wells Fargo Master Repurchase Facility. The Wells Fargo Master Repurchase Facility provides up to$125,000 in advances, with an option to increase the maximum facility to$250,000 , subject to certain terms and conditions. We expect to use the Wells Fargo Master Repurchase Facility to finance the acquisition or origination of floating rate commercial mortgage loans. The expiration date of the Wells Fargo Master Repurchase Agreement isMarch 11, 2025 , unless extended or earlier terminated in accordance with the terms of the Wells Fargo Master Repurchase Agreement. OnMarch 15, 2022 , we amended and restated our Citibank Master Repurchase Agreement, which governs the Citibank Master Repurchase Facility. The amended and restated Citibank Master Repurchase Agreement extended the stated maturity date of the Citibank Master Repurchase Facility toMarch 15, 2025 , and made certain other changes to the agreement and related fee letter, including replacing LIBOR with SOFR for interest rate calculations on advancements under the Citibank Master Repurchase Facility and modifying certain pricing terms.
On
OnMay 4, 2022 , we amended and restated our UBS Master Repurchase Agreement. The amended and restated UBS Master Repurchase Agreement, which was effectiveMarch 9, 2022 , made certain changes to the agreement and related fee letter, including replacing LIBOR with SOFR for interest rate calculations on advancements under the UBS Master Repurchase Facility and modifying certain pricing terms. For further information regarding our Secured Financing Facilities, see Note 4 to our Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q. The table below is an overview of our Secured Financing Facilities as ofJune 30, 2022 : Collateral Principal Unused Maximum Principal Secured Financing Facility Maturity Date Balance Capacity Facility Size Balance Citibank Master Repurchase Facility 03/15/2025$ 170,338
02/18/2024 135,003 56,997 192,000 182,198 Wells Fargo Master Repurchase Facility 03/11/2025 67,427 57,573 125,000 88,446 BMO Facility Various 82,276 67,724 150,000 109,897 Total$ 455,044 $ 226,956 $ 682,000 $ 618,458 20
-------------------------------------------------------------------------------- Table of Contents The table below details our Secured Financing Facilities activities during the three months endedJune 30, 2022 : Carrying Value Balance at March 31, 2022$ 367,679 Borrowings 93,788 Repayments (8,176) Deferred fees (851) Amortization of deferred fees 265 Balance at June 30, 2022$ 452,705
The table below details our Secured Financing Facilities activities during the
six months ended
Carrying Value Balance at December 31, 2021$ 339,627 Borrowings 223,948 Repayments (109,773) Deferred fees (1,571) Amortization of deferred fees 474 Balance at June 30, 2022$ 452,705 As ofJune 30, 2022 , outstanding advancements under our Secured Financing Facilities had a weighted average interest rate of 3.36% per annum, excluding associated fees and expenses. As ofJune 30, 2022 andJuly 25, 2022 , we had a$455,044 and a$469,810 , respectively, aggregate outstanding principal balance under our Secured Financing Facilities.
As of
21 -------------------------------------------------------------------------------- Table of Contents RESULTS OF OPERATIONS (amounts in thousands, except per share data) Three Months EndedJune 30, 2022 Compared to Three Months EndedMarch 31, 2022 : Three Months Ended June 30, 2022 March 31, 2022 Change % Change INCOME FROM INVESTMENTS: Interest income from investments$ 8,869 $ 9,579$ (710) (7.4 %) Purchase discount accretion 1,636 5,935 (4,299) (72.4 %) Less: interest and related expenses (3,007) (1,737) (1,270) 73.1 % Income from investments, net 7,498 13,777 (6,279) (45.6 %) OTHER EXPENSES: Base management fees 1,063 1,063 - - % General and administrative expenses 1,378 946 432 45.7 % Reimbursement of shared services expenses 440 560 (120) (21.4 %) Other transaction related costs - 37 (37) (100.0 %) Total expenses 2,881 2,606 275 10.6 % Income before income taxes 4,617 11,171 (6,554) (58.7 %) Income tax expense (39) (45) 6 (13.3 %) Net income$ 4,578 $ 11,126 $ (6,548) (58.9 %) Weighted average common shares outstanding - basic 14,521 14,505 16 0.1 % Weighted average common shares outstanding - diluted 14,521 14,519 2 - % Net income per common share - basic and diluted $ 0.31 $ 0.76$ (0.45) (59.2 %) Interest income from investments. The decrease in interest income from investments was primarily the result of prepayment premiums and accelerated amortization of deferred fees on two loans repaid during the three months endedMarch 31, 2022 of$2,402 , partially offset by the impact of three loan investments originated during the first quarter of 2022, two loan investments originated during the second quarter of 2022 and higher interest rates sinceApril 1, 2022 . Purchase discount accretion. The fair value of the loans acquired in the Merger exceeded the purchase price of the loans. In accordance with GAAP, a purchase discount was recorded for the difference between the fair value and purchase price of the loans acquired. The purchase discount was allocated to each acquired TRMT loan and is being accreted into income over the remaining term of the respective loan. Two loans were fully amortized during the three months endedMarch 31, 2022 as a result of their repayment; therefore, purchase discount accretion decreased quarter over quarter. Interest and related expenses. The increase in interest and related expenses was primarily the result of an increase in advances made to us under our Secured Financing Facilities and higher interest rates during the three months endedJune 30, 2022 as compared to the three months endedMarch 31, 2022 . General and administrative expenses. The increase in general and administrative expenses was primarily due to an increase in share based compensation of$448 resulting from common shares awarded to our Trustees during the second quarter of 2022, partially offset by a reduction in professional fees during the three months endedJune 30, 2022 as compared to the three months endedMarch 31, 2022 . Reimbursement of shared services expenses. Reimbursement of shared services expenses represents reimbursement of the costs for the services thatTremont arranges on our behalf from RMR. The decrease in reimbursement of shared services expenses was primarily the result of an adjustment to our estimate of costs for the usage of shared services from RMR. Other transaction related costs. Other transaction related costs incurred during the three months endedMarch 31, 2022 primarily consisted of audit fees relate to the Merger. 22 -------------------------------------------------------------------------------- Table of Contents Income tax expense. Income tax expense represents income taxes paid or payable by us in certain jurisdictions where we are subject to state income taxes.
Net income. The decrease in net income was due to the changes noted above.
Six Months Ended
Six Months Ended June 30, 2022 2021 Change % Change INCOME FROM INVESTMENTS: Interest income from investments$ 18,448 $ 5,056 $ 13,392 264.9 % Purchase discount accretion 7,571 - 7,571 n/m Less: interest and related expenses (4,744) (192) (4,552) n/m Income from investments, net 21,275 4,864 16,411 337.4 % OTHER EXPENSES: Base management fees 2,126 1,436 690 48.1 % General and administrative expenses 2,324 1,306 1,018 77.9 % Reimbursement of shared services expenses 1,000 601 399 66.4 % Other transaction related costs 37 - 37 n/m Total expenses 5,487 3,343 2,144 64.1 % Income before income taxes 15,788 1,521 14,267 938.0 % Income tax expense (84) (11) (73) 663.6 % Net income$ 15,704 $ 1,510 $ 14,194 940.0 % Weighted average common shares outstanding - basic and diluted 14,514 10,205 4,309 42.2 % Net income per common share - basic and diluted$ 1.08 $ 0.15 $ 0.93 620.0 % n/m - not meaningful Interest income from investments. The increase in interest income from investments was primarily the result of interest income generated from the 17 loans originated or acquired sinceJuly 1, 2021 and prepayment premiums and accelerated amortization of deferred fees on two loans repaid during the six months endedJune 30, 2022 of$2,402 . Purchase discount accretion. The fair value of the loans acquired in the Merger onSeptember 30, 2021 exceeded the purchase price of the loans. In accordance with GAAP, a purchase discount was recorded for the difference between the fair value and purchase price of the loans acquired. The purchase discount was allocated to each acquired TRMT loan and is being accreted into income over the remaining term of the respective loan. Interest and related expenses. The increase in interest and related expenses was primarily the result of an increase in advances made to us under our Secured Financing Facilities and higher interest rates during the six months endedJune 30, 2022 as compared to the six months endedJune 30, 2021 . Base management fees. The increase in base management fees was primarily due to the Merger. As a result of the Merger, the net book value of TRMT, as ofSeptember 30, 2021 , was included as "Equity" for purposes of determining the base management fee and incentive fee, if any, under the management agreement. General and administrative expenses. The increase in general and administrative expenses was primarily due to increases in share based compensation, insurance, professional fees and fees paid to our Trustees for their services during the six months endedJune 30, 2022 as compared to the six months endedJune 30, 2021 . Reimbursement of shared services expenses. Reimbursement of shared services expenses represents reimbursement of the costs for the services thatTremont arranges on our behalf from RMR. The increase in reimbursement of shared services expenses was primarily the result of increased usage of shared services after the Merger onSeptember 30, 2021 . 23
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Other transaction related costs. Other transaction related costs primarily
consisted of audit fees related to the Merger during the six months ended
Income tax expense. Income tax expense represents income taxes paid or payable by us in certain jurisdictions where we are subject to state income taxes.
Net income. The increase in net income was due to the changes noted above.
Reconciliation of Net Income to Distributable Earnings 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, 2022 March 31, 2022 June 30, 2022 June 30, 2021 Reconciliation of net income to Distributable Earnings and Adjusted Distributable Earnings: Net income$ 4,578 $
11,126
Non-cash equity compensation expense 548 82 630 182 Non-cash accretion of purchase discount (1,636) (5,935) (7,571) - Distributable Earnings 3,490 5,273 8,763 1,692 Other transaction related costs (1) - 37 37 - Adjusted Distributable Earnings$ 3,490 $
5,310
Weighted average common shares outstanding - basic 14,521 14,505 14,514 10,205 Weighted average common shares outstanding - diluted 14,521 14,519 14,514 10,205 Net income per common share - basic and diluted $ 0.31 $
0.76 $ 1.08 $ 0.15 Distributable Earnings per common share - basic and diluted
$ 0.24 $ 0.36 $ 0.60 $ 0.17 Adjusted Distributable Earnings per common share - basic and diluted $ 0.24 $ 0.37 $ 0.61 $ 0.17
(1)Other transaction related costs for the three months ended
Factors Affecting Operating Results
Our results of operations are impacted by a number of factors and primarily depend on the interest income from our investments and the financing and other costs associated with our business. Our operating results are also impacted by general CRE market conditions and unanticipated defaults by our borrowers. For further information regarding the risks associated with our loan portfolio, see the risk factors identified in Part I, Item 1A, "Risk Factors", of our 2021 Annual Report. Credit Risk. We are subject to the credit risk of our borrowers in connection with our investments. We seek to mitigate this risk by utilizing a comprehensive underwriting, diligence and investment selection process and by ongoing monitoring of our investments. Nevertheless, unanticipated credit losses could occur that could adversely impact our operating results. Changes in Fair Value of our Assets. We generally intend to hold our investments for their contractual terms, unless repaid earlier by the borrowers. We evaluate our investments for impairment at least quarterly. Impairments occur when it is probable that we will not be able to collect all amounts due according to the applicable contractual terms. If we determine that a loan is impaired, we will record a reserve to reduce the carrying value of the loan to an amount that takes into account both the present value of expected future cash flows discounted at the loan's contractual effective interest rate and the fair value of any available collateral, net of any costs we expect to incur to realize that value. 24 -------------------------------------------------------------------------------- Table of Contents Although we intend to generally hold our investments for their contractual terms or until repaid earlier by the borrowers, we may occasionally classify some of our investments as held for sale. Investments held for sale will be carried at the lower of their amortized cost or fair value less costs to sell within loans held for sale on our condensed consolidated balance sheets, with changes in fair value recorded through earnings. Fees received from our borrowers on any loans held for sale will be recognized as part of the gain or loss on sale. Currently, we do not expect to hold any of our investments for trading purposes. Availability of Leverage and Equity. We use leverage to make additional investments that may increase our returns. We may not be able to obtain the expected amount of leverage we desire or its cost may exceed our expectation and, consequently, the returns generated from our investments may be reduced. Our ability to further grow our loan portfolio over time will depend, to a significant degree, upon our ability to obtain additional capital. However, our access to additional capital depends on many factors including the price at which our common shares trade relative to their book value and market lending conditions. See "-Market Conditions" below. Market Conditions. CRE transactions for 2021 exceeded the previous annual high watermark of 2019. Investor demand for CRE assets, historically low interest rates and strong property fundamentals resulted in increased CRE valuations. Record transaction volumes and increasing CRE valuations continued into 2022; however, inflationary pressures and geopolitical concerns caused widespread macroeconomic uncertainty and volatility. In response to inflationary pressures, theU.S. Federal Reserve increased the federal funds rate by 25 basis points inMarch 2022 , 50 basis points inMay 2022 and 75 basis points inJune 2022 , the largest single increase in nearly 30 years, and has signaled that further large increases are likely to occur. TheU.S. Federal Reserve's actions have caused increased borrowing costs and volatility in the CRE debt markets, while concerns of a possible recession have caused increased credit spreads. Combined, these factors are resulting in increased conservatism in underwriting standards in the CRE debt markets. Tighter underwriting standards, which are resulting in lower leveraged loans, have caused some buyers to seek to reprice, or in some circumstances, cancel pending transactions entirely. As a result, CRE transaction total volume for the second quarter of 2022 has slowed but is still expected to meet or exceed transaction volumes for the same period of each of the five years prior to the COVID-19 pandemic. The CRE industry is traditionally a lagging indicator of economic conditions and CRE assets have historically tended to perform well in periods of inflation. Despite the recent increase in borrowing costs and macroeconomic and geopolitical uncertainties, CRE investors continue to see strength in the fundamentals of theU.S. CRE markets. We believe that we are in a period of price resetting, as buyers and sellers of CRE assets recalibrate their expectations and CRE investors and lenders reprice and reconsider risk in the current higher interest rate environment. Some investors have in the past viewed CRE as a hedge against inflation, with long term earnings potential from rent growth resulting from continued demand for certain CRE asset classes, such as affordable rental housing and industrial space, and acquisition and financing opportunities may continue to exist for borrowers able to accept higher borrowing costs in the short term. Recovery from the impact of the COVID-19 pandemic continues to vary among different market sectors. Hotels located in destinations that can be driven to, select service hotels that offer services and amenities in moderation and extended stay hotels continue to see improvements in performance, along with increased investor and lender demand. Additionally, hotel assets are uniquely positioned to reprice daily and take advantage of inflationary pressures, provided demand remains strong and challenges related to increased labor costs can be managed effectively. Retail has performed better than many expected thus far, but recession concerns and reductions in discretionary spending in response to inflation may have a negative impact on certain retailers. Investors have continued to favor grocery anchored, service oriented and neighborhood shopping centers over larger shopping centers anchored by big box retailers, regional malls or lifestyle centers. The office sector continues to pose underwriting challenges, especially for older urban assets, and there continues to be uncertainty surrounding the long term impacts of work-from-home and flexible work schedules on demand for office space. The debt capital markets experienced strong performance in 2021 and into the first quarter of 2022. CRE debt providers continue to be willing and able to extend credit to borrowers, albeit at lower leverage levels and with higher credit spreads. Market volatility and the increase in interest rates has not affected all lenders equally. Banks and life insurance companies have reduced their leverage ratios and increased credit spreads, but continue to originate new loans, while lenders that rely on secondary markets to finance their lending activities have experienced other challenges. Credit spreads in the secondary market for commercial mortgage-backed securities, or CMBS, and CRE collateralized loan obligations, or CLO, bonds have widened substantially due to competing demand for alternative fixed income investments. As a result, some lenders who originate and sell loans into the CRE CLO market as a means of financing have been forced to sell their loans at a discount or have chosen to wait until market volatility subsides and credit spreads stabilize, causing a slowdown in loan originations. 25 -------------------------------------------------------------------------------- Table of Contents In addition to increased overall borrowing costs, lenders may experience challenges due to increasing interest rates on floating rate loan portfolios. Floating rate loans are often used to finance transitional properties with a business plan to increase cash flows, allowing for increasing debt costs to be serviced. Lenders are impacted by the ability of their borrowers to service their debt while implementing their business plans and, as a result, lenders' underwriting criteria may become more conservative. Additionally, floating rate lenders typically limit interest rate risk by requiring borrowers to obtain interest rate caps or swaps to limit the impact of rising rates on a property's ability to service its debt. While interest rate caps and swaps on existing loans protect lenders in periods of rising interest rates, the cost to the borrower to obtain interest rate caps or swaps on new loans may result in decreased loan amounts. We believe the CRE lending industry is well positioned to face these challenges. Unlike in the years leading up to the financial crisis of 2008, underwriting standards have remained consistent and there continues to be significant sources of liquidity, both in the form of debt and equity capital, for the CRE sector. We believe there will continue to be significant opportunities for alternative lenders like us to provide creative, flexible debt capital for a wide array of circumstances and business plans. Changes in Market Interest Rates. With respect to our business operations, increases in interest rates, in general, may cause: (a) the interest expense associated with our variable rate borrowings, to increase; (b) the value of our fixed rate investments, if any, to decline; (c) the coupon rates on our variable rate investments to reset, perhaps on a delayed basis, to higher rates; and (d) it to become more difficult and costly for our borrowers, which may negatively impact their ability to repay our investments. See "-Market Conditions" above for a discussion of the current market including interest rates. Conversely, decreases in interest rates, in general, may cause: (a) the interest expense associated with our variable rate borrowings, to decrease; (b) the value of our fixed rate investments, if any, to increase; (c) the coupon rates on our variable rate investments to reset, perhaps on a delayed basis, to lower rates; and (d) it to become easier and more affordable for our borrowers to refinance, and as a result, repay our loans, but may negatively impact our future returns if any such repayment proceeds were to be reinvested in lower yielding investments. The interest income on our loans and interest expense on our borrowings float with benchmark rates, such as LIBOR and SOFR. Because we generally intend to leverage approximately 75% of our investments, as benchmark rates increase above the floors of our loans, our income from investments, net of interest and related expenses, will increase. Decreases in benchmark rates are mitigated by interest rate floor provisions in all but one of our loan agreements with borrowers; therefore, changes to income from investments, net, may not move proportionately with the increase or decrease in benchmark rates. As ofJune 30, 2022 , LIBOR and SOFR were 1.79% and 1.69%, respectively, and would have to exceed the floor established by any of our loans, which currently range from 0.10% to 2.32%, for us to realize an increase in interest income. Interest rates under our loan agreements with borrowers entered into prior toJanuary 1, 2022 have been or are expected to be amended to replace LIBOR with SOFR prior toJune 30, 2023 , the date LIBOR is expected to no longer be available. SinceJanuary 1, 2022 , interest rates under our new loan agreements with borrowers are based on SOFR. Our Citibank Master Repurchase Agreement and UBS Master Repurchase Agreement were amended and restated effectiveMarch 2022 to, among other things, replace LIBOR with SOFR for interest rate calculations on advances. Interest rates on advances under our BMO Facility and Wells Fargo Master Repurchase Facility have been based on SOFR since we entered into the agreements governing these facilities. Size of Portfolio. The size of our loan portfolio, as measured both by the aggregate principal balance and the number of our CRE loans and our other investments, is also an important factor in determining our operating results. Generally, if the size of our loan portfolio grows, the amount of interest income we receive would increase and we may achieve certain economies of scale and diversify risk within our loan portfolio. A larger portfolio, however, may result in increased expenses; for example, we may incur additional interest expense or other costs to finance our investments. Also, if the aggregate principal balance of our loan portfolio grows but the number of our loans or the number of our borrowers does not grow, we could face increased risk by reason of the concentration of our investments. 26
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Table of Contents LIQUIDITY AND CAPITAL RESOURCES (dollars in thousands, except per share data)
Liquidity is a measure of our ability to meet potential cash requirements, including ongoing commitments to fund our lending commitments, repay or meet margin calls resulting from our borrowings, if any, fund and maintain our assets and operations, make distributions to our shareholders and fund other business operating requirements. Our sources of cash flows include cash on hand, payments of principal, interest and fees we receive on our investments, other cash we may generate from our business and operations 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 Part I, Item 1A, "Risk Factors" of our 2021 Annual Report and elsewhere in this Management Discussion and Analysis of Financial Condition and Operating Results. Pursuant to the terms of our UBS Master Repurchase Facility and our Citibank Master Repurchase Facility, we may sell to, and later repurchase from,UBS and Citibank, the purchased assets related to the applicable facility. The initial purchase price paid byUBS 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 toUBS's or Citibank's approval. Upon the repurchase of a purchased asset, we are required to payUBS or Citibank, as applicable, the outstanding purchase price of the purchased asset, accrued interest and all accrued and unpaid expenses ofUBS or Citibank, as applicable, relating to such purchased asset. The interest rate relating to an existingUBS purchased asset is equal to one month LIBOR plus a premium within a fixed range, determined by the debt yield and property type of the purchased asset's real estate collateral. The interest rates related to our Citibank andUBS purchased assets were amended earlier this year as part of the amendments to the Citibank Master Repurchase Agreement and UBS Master Repurchase Agreement to replace one month LIBOR with one month SOFR plus a premium within a fixed range, determined by the debt yield and property type of the purchased asset's real estate collateral.UBS and Citibank each has the discretion to make advancements at margins higher than 75%. Loans issued under the BMO Facility are coterminous with the corresponding pledged mortgage loan investments, are not subject to margin calls and allow for up to an 80% advance rate, subject to certain loan to cost and LTV limits. Interest on advancements under the BMO Facility are calculated at SOFR plus a premium. Loans issued under the BMO Facility are secured by a security interest and collateral assignment of the underlying loans to our borrowers which are secured by real property underlying such loans. We are required to pay an upfront fee equal to a percentage of the aggregate amount of the facility loan, such percentage to be determined at the time of approval of the separate facility loan agreements with BMO, or the BMO Facility Loan Agreements. OnMarch 11, 2022 , one of our wholly owned subsidiaries entered into the Wells Fargo Master Repurchase Agreement for the Wells Fargo Master Repurchase Facility, pursuant to which we may sell to, and later repurchase from Wells Fargo, the purchased assets related to the facility. The initial purchase price paid by Wells Fargo for each purchased asset is up to 75% or 80%, depending on the property type of the purchased asset's real estate collateral, of the lesser of the market value of the purchased asset or the unpaid principal balance of such purchased asset, and subject to Wells Fargo's approval. Upon the repurchase of a purchased asset, we are required to pay Wells Fargo the outstanding purchase price of the purchased asset, accrued interest and all accrued and unpaid expenses of Wells Fargo relating to such purchased asset. Interest on advancements under the Wells Fargo Master Repurchase Facility is calculated at SOFR plus a premium. For further information regarding our Secured Financing Facilities, see Note 4 to the Unaudited Condensed Consolidated Financial Statements included in Part I Item 1, of this Quarterly Report on Form 10-Q and "-Overview-Financing Activities" above. 27 -------------------------------------------------------------------------------- Table of Contents The following is a summary of our sources and uses of cash flows for the periods presented: Six Months EndedJune 30, 2022 2021
Cash, cash equivalents and restricted cash at beginning of period
$ 26,295 $ 103,564 Net cash provided by (used in): Operating activities 6,307 (2,093) Investing activities (89,512) (118,075) Financing activities 105,306 47,211 Cash, cash equivalents and restricted cash at end of period$ 48,396 $ 30,607 The increase in cash provided by operating activities for the 2022 period compared to the 2021 period was primarily the result of our origination activities. As ofJune 30, 2022 , we have increased the size of our loan portfolio from 9 loans to 28 loans sinceJuly 1, 2021 . The decrease in cash used in investing activities is primarily due to the repayment of loans in the 2022 period, partially offset by an increase in origination activity in the 2022 period. The increase in cash used in financing activities is primarily due to increased proceeds received from our Secured Financing Facilities during the 2022 period, partially offset by repayments on our Secured Financing Facilities and an increase in distributions to our common shareholders for the 2022 period.
Distributions
During the six months ended
OnJuly 14, 2022 , we declared a quarterly distribution of$0.25 per common share, or$3,660 , to shareholders of record onJuly 25, 2022 . We expect to pay this distribution to our common shareholders onAugust 18, 2022 using cash on hand. For further information regarding distributions, see Note 6 to the Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.
Contractual Obligations and Commitments
Our contractual obligations and commitments as of
Payment Due by Period Less than 1 More than 5 Total Year 1 - 3 Years 3 - 5 Years years Unfunded loan commitments (1)$ 52,694 $
4,551
455,044 55,512 399,532 - - Interest payments (3) 29,061 14,547 14,514 - -$ 536,799 $ 74,610 $ 462,189 $ - $ -
(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
Debt Covenants
Our principal debt obligations as ofJune 30, 2022 were the outstanding balances under our Secured Financing Facilities. The agreements governing our Master Repurchase Facilities, or our Master Repurchase Agreements, provide for acceleration of the date of repurchase of any then purchased assets and the liquidation of the purchased assets byUBS , Citibank or Wells Fargo, as applicable, upon the occurrence and continuation of certain events of default, including a change of control of us, which includesTremont 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 payUBS , 28 -------------------------------------------------------------------------------- Table of Contents Citibank or Wells Fargo the outstanding purchase price of such purchased asset and accrued interest and any and all accrued and unpaid expenses ofUBS , 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 ofUBS , Citibank and Wells Fargo, as applicable, related to our Master Repurchase Agreements. The Master Repurchase Guarantees contain financial covenants, which require us to maintain a minimum tangible net worth, a minimum liquidity and a minimum interest coverage ratio and to satisfy a total indebtedness to stockholders' equity ratio. In connection with the BMO Loan Program Agreement, we have agreed to guarantee certain of the obligations under the BMO Loan Program Agreement and the BMO Facility Loan Agreements pursuant to a limited guaranty from us to and for the benefit of the administrative agent for itself and such other lenders, or the BMO Guaranty. Specifically, the BMO Guaranty requires us to guarantee 25% of the then current outstanding principal balance of the facility loans and 100% of losses or the entire indebtedness in the event of certain bad acts as well as any costs and expenses of the administrative agent or lenders related to the BMO Loan Program Agreement. In addition, the BMO Guaranty contains financial covenants that require us to maintain a minimum tangible net worth and a minimum liquidity and to satisfy a total indebtedness to stockholders' equity ratio. The BMO Loan Program Agreement and the BMO Guaranty contain representations, warranties, covenants, conditions precedent to funding, events of default and indemnities that are customary for agreements of these types. As ofJune 30, 2022 , we had a$372,768 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 allowUBS , 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
As of
Related Person Transactions
We have relationships and historical and continuing transactions withTremont , RMR,RMR Inc. and others related to them. For further information about these and other such relationships and related person transactions, see Notes 7 and 8 to the Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, our 2021 Annual Report, our definitive Proxy Statement for our 2022 Annual Meeting of Shareholders and our other filings with theSEC . In addition, see the section captioned "Risk Factors" of our 2021 Annual Report for a description of risks that may arise as a result of these and other related person transactions and relationships. We may engage in additional transactions with related persons, including businesses to which RMR,Tremont or their respective subsidiaries provide management services. 29
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