Seven Hills Realty Trust (NASDAQ:SEVN) Q4 2021 Earnings Conference Call February 18, 2022 10:00 AM ET
Kevin Barry – Director, IR
Thomas Lorenzini – President
Douglas Lanois – CFO and Treasurer
Conference Call Participants
Chris Muller – JMP Securities
Good morning, and welcome to the Seven Hills Realty Trust Fourth Quarter 2021 Earnings Conference Call.
All participants will be in a listen-only mode. [Operator instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator instructions] Please note, this event is being recorded.
I’d 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 President, Tom Lorenzini and Chief Financial Officer and Treasurer, Doug Illinois. In just a moment, they’ll provide details about our business and our performance for the fourth quarter of 2021. We will then open the call to a question-and-session with sell side analysts.
First, I would like to note the recording and retransmission of today’s conference call is strictly prohibited without Seven Hills Realty Trusts 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 Hills’ beliefs and expectations as of today, Friday, February 18, 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, adjusted distributable earnings and adjusted book value. For a reconciliation of GAAP to non-GAAP financial measures, please see our quarterly earnings release which is available on our website.
With that, I will now turn the call over to Tom.
Thank you, Kevin. Good morning, everyone. And welcome to the fourth quarter earnings call for Seven Hills Realty Trust. On today’s call, I will begin with an update on our fourth quarter investment activity and deal pipeline before turning the call over to Doug to review our financial results and balance sheet.
2021 was a transformative view year for our company. After completing our transition to a commercial mortgage rate at the beginning of the year, we intensified our focus on new business — on our new business plan investing in first mortgage floating rate loans.
We reached a key milestone in our company’s expansion with the acquisition of TRMT Mortgage Trust at the end of the third quarter, which provided a tremendous opportunity to quickly achieve scale. We continued to build upon this momentum during the fourth quarter with strong sequential growth and investment income and another record quarter of loan originations at Seven Hills. We ended the year with total loan commitments of nearly $650 million compared to approximately $100 million one year ago.
Based on our strong operating performance and our positive outlook for the long term growth of our business, we were pleased to announce a 67% increase in our quarterly dividend in January to $0.25 per share or $1 annually. We are excited about the progress we are making at Seven Hills and the opportunity in front of us to continue to grow our business and further increase returns to our shareholders in the year ahead.
We have substantial runway to build on our momentum and take advantage of attractive investment opportunities in the middle market commercial real estate debt space. Over the course of 2021, our manager Tremont Realty Capital increased their market presence and accelerated loan production, originating 17 loans for approximately $450 million over 70% of which were originated in the second half of the year.
We also recently grew and diversified our borrowing capacity with an additional financing facility as Doug will discuss in more detail shortly. With ample capital available for investment and a robust and growing pipeline and potential loan opportunities, we remain enthusiastic about our ability to continue to implement our business strategy and further increase profitability as we grow the company in 2022 and beyond.
Considering the current share price of Seven Hills and our positive outlook and the long term growth of our business, we believe that Seven Hills is tremendously undervalued. We are intensely focused on reducing this discount as we continue to execute on our business plan, further ramp up loan production and demonstrate the strength of our lending platform to the investment community.
We believe that our current valuation combined with the attractive market opportunity for Seven Hills to expand and generate higher risk adjusted returns in the year ahead, provides a compelling rationale to invest in our stock.
Turning now to our fourth quarter investment activity and loan book at year end. It was an active period for us on the originations front. Our manager originated a record loans for approximately $165 million and committed capital representing 18% growth quarter over quarter. The percentage of initial funding to total new loan commitments for the quarter was 95% or $159 million allowing us to put more capital to work at the inception of each loan.
Our fourth quarter originations were geographically diverse and secured by various property types, including multifamily, industrial, grocery to retail and office properties. The loans carry attractive return profiles with spreads ranging from 325 basis points to 425 basis points and ranging loan size from $21 million to $43 million consistent with our target investment focus.
We also received loan payments on our hospital loan in Atlanta, Georgia and our retail loan in Omaha, Nebraska for a combined outstanding principle balance of approximately $37 million. We ended the fourth quarter with 26 first mortgage loan loans with an aggregate commitment of $648 million. Our investments are 100% floating rate with a weighted average coupon of 4.5% and an all in yield to 5.1%.
In aggregate the portfolio has a weighted average loan to value of 68% and a weighted average maximum maturity of 3.8 years when including extension options. By property type, our portfolio was waited towards multifamily, industrial and office real estate. The portfolio was also well diversified geographically with investments distributed across the US.
Our investments continue to perform well with all our loans current on debt service and from a credit quality perspective the portfolio weighted average risk rating improved quarter over to quarter to 2.9. None of our loans are in default and we’ve not recorded any credit losses.
Looking ahead to 2022, we believe there will be significant opportunities for Seven Hills to find ample investment opportunities. Our manager, has broad relationships across the commercial real estate industry built on decades of real estate lending that enable us to generate strong lending opportunities.
Our approach to originating loans through a differentiated client focus process allows us to be selective and pick the best investments for our portfolio. We customize each financing structure to meet the specific business plans of our borrowers while maintaining disciplined underwriting standards. We spent considerable time and energy ensuring that our loan closing process is efficient for our borrowers and that post closing our loan servicing and asset management is responsive.
As discussed last quarter, we plan to reach nearly $1 billion in assets by midyear 2022 and we remain on track with our plans. After record originate, during the fourth quarter, we do anticipate transaction volumes to decelerate in Q1, which is not atypical after the holidays before reaccelerating during Q2.
Our average loan size has increased for the past few quarters approaching $30 million and we expect to maintain this level near term investment opportunities in our pipeline. We have three loans under application, totalling $97 million, which we expect to close during the first quarter subject to our final diligence. Overall, our pipeline currently consists of potential transactions, totalling more than $500 million.
In summary, we continue to see a robust flow of investment opportunities that fit our strategy and investment criteria and we feel great about our growth going forward. Our increased loan origination volumes, attractive loan pricing and strong credit profile clearly demonstrate the quality and strength of our platform. As such, we are confident that we’ll be able to continue to scale our portfolio in a discipline manner and look forward to updating you on our ongoing growth.
With that, I’ll turn the call over to Doug.
Thank you, Tom. Good morning, everyone. As a reminder, we closed our acquisition of Tremont Mortgage Trust on September 30, 2021. I will compare our fourth quarter results to our third quarter results on a pro forma basis as if the merger had occurred on July 1. Additionally, as we discussed last quarter, the TRMT loans acquired generated a purchase discount that will accrete into income over the remaining term of the individual loans. We recognize this accretion in net income. However, we deduct this non-cash item in our calculation of distributable earnings. Our supplemental financial package contains further detail on our estimate of purchase discount accretion in the coming quarters.
Turning to our financial performance for the fourth quarter. Seven Hills posted GAAP net income of $20.7 million or $1.42 per share, including non-cash accretion of $18.9 million or $1.31 per share. Adjusted distributable earnings came in at $3 million or $0.21 per share.
Our earnings continued to benefit from strong portfolio performance and into money LIBOR floors embedded in our loans. Interest income from investments was $7.2 million up 12% compared to the prior quarter, which reflects partial quarter interest payments on six new loans and two loan repayments during the quarter. Interest and related expenses and current from our borrowings on our secured financing facilities grew to $1.6 million due to increased borrowings to support our portfolio growth.
As of December 31, our weighted average all-in yield on our investments was 5.1%, which consisted of a weighted average LIBOR floor of 68 basis points, a weighted average spread of 386 basis points, plus the amortization of our loan fees. D&A expense was approximately $906,000 after excluding non-cash stock compensation expense. This came in above our quarterly G&A run rate in the $700,000 range due to incremental professional services fees. At the end of the quarter, Seven Hills adjusted book value increased sequentially to $18.85 per share.
Now turning to our balance sheet, at year end, we had $26 million in cash available to further fund loan obligations and meet our liquidity requirements. Loans held for investment net was $571 million. Since quarter end, we received early payoffs from our loans in Durham, North Carolina and London area, New Hampshire for a combined outstanding principle balance of approximately $48 million.
Please note these prepayments ahead of their initial maturity generated prepayment income of approximately $2.3 million or $0.16 per share, which we will recognize during Q1. With respect to our borrowings, we ended the fourth quarter with approximately $341 million drawn on our secured financing facilities and unused but available capacity of $165 million. At year end, our capital position was strong with a debt to equity ratio of 1.3 times. We anticipate our total leverage to stabilize in the three to one range after investing our available capital.
As Tom mentioned earlier, we are executing on our plans to increase and diversify our capital sources that will support the continued growth of our business and enhance our return on equity. During the fourth quarter, we added a $100 million non-mark to market match funded facility with BMO Harris Bank. This note on note facility provides us with attractively priced capital that matches the term of the underlying loans and will not subject us to mark-to-market provisions.
We are also in discussions with banking partners to add another master repurchase facility that we anticipate will provide an additional $250 million of financing giving us ample runway to expand our portfolio to nearly $1 billion. As we continue to originate new loans and deploy our excess liquidity, we aim to further optimize our cost of capital and diversify our funding sources.
With respect to interest rates, since our last call, expectations that the federal reserve will raise rates in 2022 have risen considerably given that 100% of our portfolio and 100% of our funding liabilities are floating rate and increase in interest rates is typically favorable for our business. However, our recent earnings have benefited from floors on our loans while our borrowings have not been subject to interest rate floors. As a result, initially, an increase in rates may impact our net interest income until the index rate exceeds the 68 basis point weighted average floor on our portfolio.
Finally, in January, we increased our quarterly dividend by $0.10 to $0.25 per share. On an annualized basis, this translates to an attractive dividend yield of approximately 9% on our current stock price. Based on our expectations for continued strong portfolio performance and earnings growth, we are well positioned to further increase our dividend during the back half of the year.
That concludes our prepared remarks. Operator, please open up the lines for questions.
[Operator instructions] And the first question will come from Chris Muller with JMP Securities. Please go ahead.
Hey guys, thanks for taking the questions and congrats on closing out the year and starting off 2022 with some more scale. So it’s nice to see the dividend increase. And I guess my question is with distributable EPS running below that and you guys talking about being able to possibly raise that dividend in the back half of the year, I guess it’s fair to assume that in the first quarter and second quarter, you should be covering that dividend. How much of that is coming from fees from the repayments versus just interest income. Thanks.
Hey Chris, it’s Doug Lanois. Thanks for joining us today. We substantially cover that with regular interest income. The fees — our expectation that in Q1 the fees will obviously be a spike in income. But when we exclude those fees, we expect to substantially cover that dividend. So it doesn’t — and then further into the year as we deploy additional capital it will more than cover that dividend.
Got it. Thank you. That’s helpful. And then the other one I have is on the creation of the purchase discount, do you guys have visibility into how long you expect that to flow through the earning statement? Is that something by the end of 2022, or is that something that could hit the bulk in the first quarter? Just some expectations on timing of that.
Yeah, Chris it’s Doug again. The big hit was this quarter fourth quarter at almost $19 million. It ramps down to — and I’m looking at Page 34 of the supplements. So it’s all laid out there for you. In Q1 ’22, it’s going to be about $4.5 million and then it runs out — it actually runs out to 2024, but in much smaller amounts and it’s really dependent on when those loans the TRMT loans repay right, because it’s very specific to those loans only, and it’s not any reflection of a concern about the value of those loans. It’s strictly an accounting purchase price requirement.
Got it. That’s helpful. Thanks a lot, guys.
[Operator instructions] Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Thomas Lorenzini for any close remarks.
Thank you, Chad, and thank you all for joining us today and for your interest in Seven Hills Realty Trust. We look forward to speaking with you all again soon.
And thank you, sir. The conference has now concluded. Thank you for attending today’s presentation. You may not disconnect.