Seven Hills Realty Trust (SEVN) Q1 2022 Earnings Report, Transcript and Summary

Good morning, and welcome to the Seven Hills Realty Trust First Quarter 2022 Earnings Conference Call. [Operator Instructions]. Please note, this event is being recorded. I would now like to turn the call over to Kevin Barry, Director of Investor Relations. Please go ahead.

Thank you, and good morning, everyone. Thanks for joining us today. With me on the call are our President, Tom Lorenzini; the Chief Financial Officer and Treasurer, Doug Lanois. In just a moment, they will provide details about our business and our performance for the first quarter of 2022. We will then open the call to a question-and-answer session with sell-side analysts. First, I would like to note that the recording and retransmission of today's conference call is strictly prohibited without Seven Hills Realty Trust's prior written consent. Also note that today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws. These forward-looking statements are based on Seven Hill's beliefs and expectations as of today, Thursday, April 28, 2022, and actual results may differ materially from those that we project. The company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's conference call. Additional information concerning factors that could cause those differences is contained in our filings with the Securities and Exchange Commission or SEC, which can be accessed from the SEC's website. Investors are cautioned not to place undue reliance upon any forward-looking statements. In addition, we will be discussing non-GAAP numbers during this call, including distributable earnings, distributable earnings per share, adjusted distributable earnings, adjusted distributable earnings per share and adjusted book value per share. For a reconciliation of GAAP to non-GAAP financial measures, please see our quarterly earnings release, which is available on our website. I will now turn the call over to Tom.

Thank you, Kevin. Good morning, everyone, and welcome to the first quarter earnings call for Seven Hills Realty Trust. After a productive and transformative year for our company in 2021, we continue to build on our momentum and execute against our key priorities, focused on fully deploying our capital to nearly $1 billion in assets, increasing and diversifying our capital base with additional debt capacity and increasing returns to our shareholders. I'm pleased to report that we are off to a great start this year, making progress in each of these areas. During the first quarter, we closed nearly $100 million of new loans, which outpaced loan repayments during the period and total committed capital increased to a record $685 million. Our deal pipeline has never been stronger and has increased to more than $1 billion, positioning Seven Hills to accelerate originations in the months ahead. We entered new financing arrangements and increased and extended existing facilities to support continued earnings growth. And first quarter adjusted distributable earnings increased significantly on both a sequential and year-over-year basis. Our primary goal is to deliver strong returns to our shareholders. To that end, in January, we announced a 67% increase in our quarterly dividend to $0.25 per share, which we have maintained for our May distribution, and we remain focused on further enhancing returns. We also continue to strengthen Seven Hill's corporate governance. In March, we welcomed Phyllis Hollis as the newest member of our Board of Trustees. Phyllis has more than 30 years of financial services industry experience, with a strong background in fixed income investments, investment banking and capital raising. We look forward to drawing on her perspective as we continue our work to create value for our shareholders. Turning to our first quarter investment activity and loan book at quarter end. Our manager, Tremont Realty Capital, originated 3 new loans for approximately $96 million of committed capital and funded an additional $3 million of follow-on fundings. Consistent with the prior quarter, the percentage of initial fundings to total new loan commitments was approximately 95%, allowing us to put more capital to work at the inception of each loan. Our Q1 investment activity continues to demonstrate our ability to originate accretive loans secured by high-quality assets by leveraging our strong network of industry relationships. The borrowers on 2 loans were repeat sponsors, while the third was a new relationship added to our portfolio. These investments are secured by multifamily, grocery or drug store-anchored retail properties with a weighted average loan-to-value of 64%. The loans carry attractive return profiles with spreads ranging from 385 basis points to 425 basis points with an average loan size of approximately $32 million, in line with our target investment focus. As part of our asset management process, we actively monitor our portfolio and proactively communicate with our borrowers regarding the plans for their property and our loan. In February, we increased the loan commitment on our Yardley, Pennsylvania office loan by $1.6 million and extended the initial maturity date by 1 year, allowing the sponsor to further execute their business plan. We also received $48 million from 2 loan repayments during the first quarter. Although this activity partially offset our portfolio growth, we realized relatively significant prepayment fee income, highlighting our ability to thoughtfully structure our investments in a manner designed to protect the cash flow produced by our portfolio. We ended the first quarter with 27 first mortgage loans, with an aggregate commitment of $685 million, representing a new high watermark for Seven Hills loan book. Our investments are 100% floating rate with a weighted average coupon of 4.6% and an all-in yield of 5.1%. In aggregate, the portfolio has a weighted average loan-to-value of 68% and a weighted average maximum maturity of 3.7 years when including extension options. Our loan book has the added benefit of relatively recent underwriting, with more than 80% of the principal balance underwritten post the onset of the COVID pandemic. The credit quality of our portfolio remains strong, with all of our loans current on debt service, no loans in default and our portfolio risk rating has further improved quarter-to-quarter to 2.8. We continue to see many attractive opportunities to deploy our available capital and reach nearly $1 billion in assets this summer. We currently have 40 deals in our pipeline, consisting of potential transactions totaling more than $1.2 billion in various stages of review, underwriting and diligence. This volume is indicative of the strong demand for commercial real estate debt and the attractive market opportunity for Seven Hills to continue to gain scale and to execute on our plan to fully deploy our capital. Despite rising interest rates, the economic environment remains healthy, with ample liquidity in the market continuing to drive demand for commercial real estate investments. Given that our portfolio is 100% floating rate, Seven Hills shareholders can expect to see increased interest income from our investments. In summary, for the full year operating as a mortgage REIT behind us, we are thrilled with the progress we are making at Seven Hills and the opportunity in front of us to continue to build momentum. We are confident that our strategy will enable us to accelerate our growth and deliver attractive returns to our shareholders, including further dividend growth later this year. And with that, I will now turn the call over to Doug.

Thank you, Tom, and good morning, everyone. Over the next few minutes, I will discuss our financial performance as well as our capitalization and liquidity. As we discussed on prior calls, our financial results include purchase discount accretion related to loans that we acquired from our merger with Tremont Mortgage Trust last fall. We recognized this noncash accretion in net income and deduct it from our calculation of distributable earnings. Our supplemental financial package contains further details on our estimate of purchase discount accretion in the coming quarters. Turning to our financial performance for the first quarter. Seven Hills reported GAAP net income of $11.1 million or $0.76 per share, including noncash accretion of $5.9 million or $0.41 per share. Adjusted distributable earnings came in at $5.3 million or $0.37 per share, which was well in excess of our quarterly dividend. Our earnings include prepayment income of approximately $2.3 million or $0.16 per share, driven by 2 loan prepayments ahead of their initial maturity. Interest income from investments was $9.6 million, an increase of 33% on a sequential quarter basis, primarily driven by prepayment income during the first quarter. Seven Hills adjusted book value increased to $18.95 per share at the end of the first quarter. Now turning to our balance sheet. We ended the quarter with approximately $369 million drawn on our secured financing facilities and unused but available capacity of $263 million. Our capital position was strong, with a debt-to-equity ratio of approximately 1.4x. We expect to achieve a target leverage of 2 -- of 2.5 to 3x as we deploy our available capital. As Tom mentioned earlier, we have made significant progress on our strategic priority of further diversifying and expanding our investment capital with competitive sources of financing. During the quarter, we closed a repurchase facility with Wells Fargo. And in April, we upsized our non-mark-to-market facility with BMO Harris Bank, raising our maximum borrowing capacity to more than $800 million. We also extended our Citibank repurchase facility by 3 years, which we believe reflects our strong working relationship with them. We currently have sufficient liquidity to originate an additional $260 million of loans. With respect to interest rates, our earnings have benefited from interest floors on our loans. Our weighted average floor was 61 basis points at quarter end. 1-month term SOFR and LIBOR currently exceed our weighted average interest floor. With expectations that the Federal Reserve will continue to raise rates throughout 2022, higher interest rates will directly benefit our net interest income, given that 100% of our portfolio and 100% of our funding liabilities are floating rate. As of today, each 50 basis point increase in the interest rate index equates to an incremental $0.06 of distributable earnings per share annually. Earlier this month, we announced our quarterly dividend of $0.25 per share. On an annualized basis, this translates to an attractive dividend yield of approximately 9% on our current stock price. As we expand loan production and increase our operating leverage, we expect run rate adjusted distributable earnings to significantly exceed our dividend. Based on this outlook, we are well positioned to deliver enhanced returns to our shareholders in the back half of 2022. That concludes our prepared remarks. Operator, please open up the lines for questions.

[Operator Instructions]. And our first question will come from Chris Muller of JMP Securities.

Congrats on a great start to the year. I just wanted to hit on the interest sensitivity a little bit just to make sure I'm understanding correctly. So looking at the Slide 11 with the chart you guys have there, that was done March 31, I believe. So that was -- LIBOR was 30, 40 bps lower than we're currently sitting at. So your comments on every 50 bps increase is $0.06, I think you said in earnings. We're currently sitting at that almost 50 -- 0.50% mark on that chart today. Is that the right way to look at that?

That's correct. You've got it right. Yes. We're really through the -- we're over the hump in terms of any dampening of our earnings from our floors. So at this point, we're -- we've got really, a direct connect direct correlation between interest rate increases in our earnings.

Got it. And then just the other one I had. It's nice to see the new credit facilities there, obviously, expanding the financing base. Do you guys have any time line that you're looking at on how quickly leverage will ramp up? I think you're at 1.4 now. And so we're -- you're talking about getting almost double that. Is that like a year-end type time line there?

No, we expect that really to be this summer, Chris, as we fully deploy the remainder of the capital here.

[Operator Instructions]. And the next question will come from Jason Stewart of JonesTrading.

It's Matthew Erdner filling in for Jason. You mentioned deploying the capital this summer. So I'm guessing the pipeline is there. Is there a specific asset within that that's kind of more so centered around than others? And what does that look like?

No individual asset, Matt, but certainly, we're looking at more multifamily transactions now than we have historically, which I think is just a function of the market. Current pipeline is about $1.2 billion. So we have our opportunities to choose those transactions that we wish to pursue. So we're feeling very comfortable with the pipeline right now.

Got you. And then with the multifamily, is there a specific geographic region that you guys are targeting or trying to increase your share in?

Certainly, Sun Belt markets are attractive to us. We're seeing much more rental growth there, along with some of the other secondary non-gateway cities in the Carolinas, certainly all over Florida, certainly in Texas. We're seeing tremendous growth there, and that's where the opportunities lie right now.

Right. That's good. And then in terms of competition, are you guys seeing a lot of that? Or is it kind of -- you guys are kind of in your own bucket and other people are in different ones?

No, it's a competitive landscape for sure. What we've seen as of late, really, which is a little bit of the backup in the securitization in the CLO markets, we've actually -- we're seeing increased flow because some of the smaller CLO shops, I think, are sitting on the sidelines right now until they can clear their decks. So it's really been an opportunity for us to pick up some market share.

This concludes our question-and-answer session. I would like to turn the conference back over to Tom Lorenzini, President, for any closing remarks.

Thank you, Andrea, and thank you for joining us today and for your interest in Seven Hills Realty Trust. We look forward to speaking with you all again soon and seeing many of you at the upcoming Nareit Conference.

The conference has now concluded. Thank you for attending today's presentation, and you may now disconnect.