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 Annual Report. OVERVIEW (dollars in thousands, except share data) We are a REIT that was organized underMaryland law in 2017. Our business strategy is focused on originating and investing in 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. We classify our assets 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 and origination costs as applicable, unless the assets are deemed impaired. Our Manager is registered with theSEC as an investment adviser under the Investment Advisers Act of 1940, as amended. We believe that our Manager 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 Investment Company Act. As noted earlier in this Quarterly Report on Form 10-Q, onApril 26, 2021 , we entered into the Merger Agreement with RMRM pursuant to which we have agreed, on the terms and subject to the conditions set forth therein, to consummate the Merger and the other Transactions, subject to the satisfaction or waiver of certain conditions. Pursuant to the terms and subject to the conditions set forth in the Merger Agreement, at the Effective Time, each of our common shares issued and outstanding immediately prior to the Effective Time will be converted into the right to receive the Exchange Ratio of one newly issued RMRM Common Share, subject to adjustment as described in the Merger Agreement, with cash paid in lieu of fractional shares. Under the Merger Agreement, the Exchange Ratio is fixed and will not be adjusted to reflect changes in the market price of our common shares or the RMRM Common Shares prior to the Effective Time. Pursuant to the Merger Agreement, at the Effective Time, any unvested common share awards outstanding under our equity compensation plan generally will be converted into an unvested RMRM Common Share award under RMRM's equity compensation plan, subject to substantially similar vesting requirements and other terms and conditions, determined by multiplying the number of our unvested common shares subject to such award by the Exchange Ratio (rounded down to the nearest whole number). Pursuant to the Merger Agreement, effective upon consummation of the Merger, RMRM's declaration of trust will be amended to, among other things, change its name to "SevenHills Realty Capital Trust " and provide its board of trustees authority to effect the conversion of RMRM into aMaryland real estate investment trust without shareholder approval. Following the consummation of the Merger, the RMRM Common Shares will continue to trade on Nasdaq under the new ticker symbol "SHRC". The completion of the Merger is subject to the satisfaction or waiver of various conditions, including, among other things: (1) approval of the Merger and the other Transactions to which we are a party by at least a majority of all the votes entitled to be cast by holders of our outstanding common shares at the special meeting of our shareholders scheduled to be held onSeptember 17, 2021 for that purpose; (2) approval of the Merger Share Issuance by at least a majority of all the votes cast by the holders of outstanding RMRM Common Shares entitled to vote at the special meeting of RMRM's shareholders scheduled to be held onSeptember 17, 2021 for that purpose; (3) the absence of any law or order by any governmental authority prohibiting, making illegal, enjoining or otherwise restricting, preventing or prohibiting the consummation of the Merger and the other Transactions; (4) the effectiveness of the registration statement on Form S-4, or the Form S-4, to be filed by RMRM with theSEC to register the RMRM Common Shares to be issued in the Merger; (5) Nasdaq's approval of the listing of the RMRM Common Shares to be issued in the Merger, subject to official notice of issuance; and (6) the receipt of certain tax opinions from each party's tax counsel. The Form S-4 was declared effective by theSEC onJuly 26, 2021 . The Merger is expected to close in the third quarter of 2021, and the Merger Agreement provides that either party may terminate the agreement if the Merger is not consummated byDecember 31, 2021 . The Merger is intended to qualify as a tax-free reorganization under the IRC and to provide a tax-free exchange for our shareholders for the RMRM Common Share consideration they receive in the Merger, except that our shareholders generally may recognize gain or loss with respect to cash received in lieu of fractional shares of RMRM Common Shares. 15 -------------------------------------------------------------------------------- Table of Contents The Merger Agreement contains certain customary representations, warranties and covenants, including, among others, covenants with respect to the conduct of our and RMRM's respective businesses prior to closing, subject to certain consent rights by us and RMRM, respectively, and covenants prohibiting us and RMRM from soliciting, providing information or entering into discussions concerning competing proposals (generally defined as proposals for 20% or more of the assets, revenues or earnings or equity of the applicable party), subject to certain exceptions. The Merger Agreement contains certain termination rights for both us and RMRM, including that under specified circumstances, either party is entitled to terminate the Merger Agreement to accept a superior proposal (generally defined as proposals for 75% or more of the assets, revenues or earnings or equity of such party, which proposal such party's board of trustees (or an authorized committee thereof) has determined in good faith, after consultation with outside financial advisors and outside legal counsel, (1) would, if consummated, result in a transaction that is more favorable to the shareholders of such party from a financial point of view than the Merger and the other Transactions, (2) for which the third party has demonstrated that the financing for such superior proposal is fully committed or is reasonably likely to be obtained, and (3) which is reasonably likely to receive all required approvals from any governmental authority and otherwise reasonably likely to be consummated on the terms proposed); provided that we may only terminate the Merger Agreement after we have held the special meeting of our shareholders scheduled to be held onSeptember 17, 2021 for the purpose of approving the Merger. Each party is required to pay the other party a termination fee of$2,156 plus the other party's reasonable fees and expenses under certain circumstances related to such party's change in recommendation, breach or termination in connection with a superior proposal. Except with respect to the foregoing, all fees and expenses incurred in connection with the Merger and the other Transactions will be paid by the party incurring those expenses, except that we and RMRM will share equally any filing fees incurred in connection with the filing of the Form S-4 and the related joint proxy statement/prospectus. The Merger, the Merger Share Issuance and the other Transactions and the terms thereof were evaluated, negotiated and recommended, as applicable, to each of our and RMRM's board of trustees by special committees of our and RMRM's board of trustees, respectively, each comprised solely of our and RMRM's disinterested, independent trustees, respectively, and were separately unanimously approved and adopted by our and RMRM's independent trustees and by our and RMRM's board of trustees, with independent trustees unanimously approving the Merger, the Merger Share Issuance and the other Transactions, as applicable.Citigroup Global Markets Inc. acted as financial advisor to the special committee of our Board of Trustees andUBS Securities LLC acted as financial advisor to the special committee of RMRM's board of trustees. For further information regarding the Merger and the other Transactions, see Notes 1, 7 and 8 to the Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q and "Management's Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources-Our Investment and Financing Liquidity and Resources" of this Quarterly Report on Form 10-Q. COVID-19 Pandemic The COVID-19 pandemic and the various governmental and market responses intended to contain and mitigate the spread of the virus and its detrimental public health impact have had a significant impact on the global economy, including theU.S. economy. Many of the restrictions that had been imposed inthe United States during the pandemic have been lifted and commercial activity inthe United States has increasingly returned to pre-pandemic practices and operations. To date, the COVID-19 pandemic has not had a significant impact on our business. There remains uncertainty as to the ultimate duration and severity of the COVID-19 pandemic, including risks that may arise from mutations or related strains of the virus, the ability to successfully administer vaccinations to a sufficient number of persons or attain immunity to the virus by natural or other means to achieve herd immunity, and the impact on theU.S. economy that may result from the inability of other countries to administer vaccinations to their citizens or their citizens' ability to otherwise achieve immunity to the virus. As a result, we are unable to determine what the ultimate impact will be on our borrowers' and other stakeholders' businesses, operations, financial results and financial position. For further information and risks relating to the COVID-19 pandemic on us and our business, and the related actions our Manager has taken in response to the pandemic, see "COVID-19 Pandemic" in Part I, Item 1 and "Risk Factors" in Part I, Item 1A of our Annual Report. 16 -------------------------------------------------------------------------------- Table of Contents Book Value per Common Share The table below calculates our book value per common share: June 30, 2021 December 31, 2020 Shareholders' equity$ 89,873 $ 88,903 Total outstanding common shares 8,312 8,303 Book value per common share$ 10.81 $ 10.71
Our Loan Portfolio
The table below provides overall statistics for our loan portfolio as of
As of June 30, 2021 As of December 31, 2020 Number of loans 13 14 Total loan commitments $ 246,029 $ 293,890 Unfunded loan commitments (1) $ 9,085 $ 12,236 Principal balance $ 236,944 $ 281,654 Unamortized net deferred origination and exit fees $ 753 $ 592 Carrying value $ 237,697 $ 282,246 Weighted average coupon rate 5.61 % 5.70 % Weighted average all in yield (2) 6.36 % 6.39 % Weighted average LIBOR floor 1.94 % 2.10 % Weighted average maximum maturity (years) (3) 2.2 2.6 Weighted average loan rating 3.0 3.2 Weighted average LTV (4) 65 % 67 % (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, excluding any repurchase debt funding applicable to the loan and including amortization of deferred fees over the initial term of the loan. (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. 17 -------------------------------------------------------------------------------- Table of Contents Loan Portfolio Details The table below provides details of our loan investments as ofJune 30, 2021 : Committed Principal Principal All in Maturity Maximum Maturity (2) Location Property Type Origination Date Amount Balance Coupon Rate Yield (1) (date) (date) LTV (3) Risk Rating First mortgage loansHouston, TX Office06/26/2018 $ 15,200 $ 14,489 L + 4.00% L + 4.57%08/10/2021 08/10/2021 69 % 3Coppell, TX Retail02/05/2019 19,865 19,865 L + 3.50% L + 4.24%08/12/2021 02/12/2022 73 % 4Metairie, LA Office04/11/2018 18,102 17,351 L + 5.00% L + 5.65%10/11/2021 10/11/2021 79 % 3Houston, TX Multifamily05/10/2019 27,929 27,929 L + 3.50% L + 4.52%11/10/2021 11/10/2022 56 % 3Paradise Valley, AZ Retail11/30/2018 11,853 11,197 L + 4.25% L + 5.71%11/30/2021 11/30/2022 48 % 3St. Louis, MO Office12/19/2018 29,500 27,763 L + 3.25% L + 3.74%12/19/2021 12/19/2023 72 % 2Atlanta, GA Hotel12/21/2018 24,000 23,904 L + 3.25% L + 3.72%12/21/2021 12/21/2023 62 % 4Dublin, OH Office02/18/2020 22,820 21,556 L + 3.75% L + 4.83%02/18/2022 02/18/2023 33 % 2Omaha, NE Retail06/14/2019 14,500 13,054 L + 3.65% L + 4.05%06/14/2022 06/14/2024 77 % 4Yardley, PA Office12/19/2019 14,900 14,264 L + 3.75% L + 4.47%12/19/2022 12/19/2024 75 % 4Orono, ME Multifamily12/20/2019 18,110 18,066 L + 3.25% L + 3.85%12/20/2022 12/20/2024 72 % 2Allentown, PA Industrial01/24/2020 14,000 14,000 L + 3.50% L + 4.02%01/24/2023 01/24/2025 67 % 3Westminster, CO Office05/24/2021 15,250 13,506 L + 3.75% L + 5.09%05/24/2024 05/24/2026 66 % 3 Total/weighted average$ 246,029 $ 236,944 L + 3.66% L + 4.42% 65 % 3.0 (1)All in yield represents the yield on a loan, excluding any repurchase debt funding applicable to the loan and including amortization of deferred fees over the initial term of the loan. (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, 2021 , we had$246,029 in aggregate loan commitments, consisting of a diverse portfolio, geographically and by property type, of 13 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 our retail and hospitality 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 inthe United States has improved significantly from the low points during the pandemic to date, certain industries have not recovered to their pre-pandemic positions. 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, 2021 , we had four loans representing 30% of the carrying value of our loan portfolio with a loan risk rating of "4" or "higher risk". One of these loans was downgraded from a risk rating of "3" or "acceptable risk" during the six months endedJune 30, 2021 . Four loans with a loan risk rating of "4" or "higher risk" as ofDecember 31, 2020 were upgraded to a risk rating of "3" or "acceptable risk" during the six months endedJune 30, 2021 . 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 ofJuly 26, 2021 , all of our borrowers had paid all of their debt service obligations owed and due to us and none of the loans included in our investment portfolio were in default. We did not have any impaired loans, non-accrual loans or loans in default as ofJune 30, 2021 ; 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, 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 risk rating policy and the risks associated with our loan portfolio, see our Annual Report. 18 -------------------------------------------------------------------------------- Table of Contents Financing Activities The table below is an overview of our Master Repurchase Facility, which provided financing for our loans held for investment, as ofJune 30, 2021 andDecember 31, 2020 : Collateral Principal Unused Maximum Principal Maturity Date Balance Capacity Facility Size Balance June 30, 2021: Master Repurchase Facility 11/06/2022
11/06/2022
The table below details our Master Repurchase Facility activities during the
three months ended
Total Balance atMarch 31, 2021 $ 180,040 Advancements 13,500 Repayments (38,085) Amortization of deferred fees 107 Balance atJune 30, 2021 $ 155,562 The table below details our Master Repurchase Facility activities during the six months endedJune 30, 2021 : Total Balance atDecember 31, 2020 $ 200,233 Advancements 17,112 Repayments (61,997) Amortization of deferred fees 214 Balance atJune 30, 2021 $ 155,562 As ofJune 30, 2021 , outstanding advancements under our Master Repurchase Facility had a weighted average interest rate of LIBOR plus 200 basis points per annum, excluding associated fees and expenses. For further information regarding our Master Repurchase Agreement, see Note 4 to the Notes to Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q. As ofJune 30, 2021 , we had a$156,167 aggregate outstanding principal balance under our Master Repurchase Agreement. Our Master Repurchase Agreement is structured with risk mitigation mechanisms, including a cash flow sweep, which would allow Citibank to control interest payments from our borrowers under our loans that are financed under our Master Repurchase Facility, 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 Facility. As ofJuly 26, 2021 , we believe we were in compliance with all the covenants and other terms under our Master Repurchase Agreement and, to date, Citibank has not utilized any such risk mitigation mechanisms under our Master Repurchase Agreement. We could experience a loss on repurchase transactions under our Master Repurchase Agreement if a counterparty to these transactions defaults on its obligation to resell the underlying collateral back to us at the end of the transaction term, or if the value of the underlying assets has declined as of the end of that term, or if we default on our obligations under the applicable agreement governing any such arrangement. Our ability to obtain additional financing advancements under our Master Repurchase Facility is contingent upon our making additional advancements to our existing borrowers or our ability to effectively reinvest any additional capital, including any loan repayment proceeds, that we may obtain or receive. However, we cannot be sure that we will be able to obtain additional cost-effective capital or additional financing advancements under our Master Repurchase Facility. It may take an 19 -------------------------------------------------------------------------------- Table of Contents extended period for us to reinvest any additional capital we may receive, and any reinvestments we may be able to make may not provide us with similar returns or comparable risks as those of our current investments. See "-Factors Affecting Operating Results-Market Conditions" below for information regarding the impact of the current market conditions on the access of capital for CRE lenders such as us. 20
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Table of Contents RESULTS OF OPERATIONS (dollars in thousands, except share data) Three Months EndedJune 30, 2021 Compared to Three Months EndedJune 30, 2020 : Three Months Ended June 30, 2021 2020 Change % Change INCOME FROM INVESTMENTS: Interest income from investments$ 4,148 $ 4,496 $ (348) (7.7 %) Less: interest and related expenses (988) (1,368) 380 (27.8 %) Income from investments, net 3,160 3,128 32 1.0 % OTHER EXPENSES: Base management fees 341 - 341 n/m General and administrative expenses 685 524 161 30.7 % Reimbursement of shared services expenses 206 242 (36) (14.9 %) Transaction related expenses 1,822 - 1,822 n/m Total expenses 3,054 766 2,288 298.6 % Income before income tax expense 106 2,362 (2,256) (95.5 %) Income tax expense (8) - (8) n/m Net income$ 98 $ 2,362 $ (2,264) (95.8 %) Weighted average common shares outstanding - basic 8,218 8,177 41 0.5 % Weighted average common shares outstanding - diluted 8,266 8,177 89 1.1 % Net income per common share - basic and diluted$ 0.01 $ 0.29 $ (0.28) (96.6 %)
n/m - not meaningful
Interest income from investments. The decrease in interest income from investments was primarily the result of the repayment of two loan investments during the three months endedJune 30, 2021 , partially offset by the origination of one loan investment during the three months endedJune 30, 2021 . Interest and related expenses. The decrease in interest and related expenses was primarily the result of a decline in LIBOR sinceJune 30, 2020 and the repayment of outstanding balances under our Master Repurchase Facility during three months endedJune 30, 2021 . Base management fees. Our Manager waived any base management fees that would otherwise have been due and payable by us under our management agreement for the period beginningJuly 1, 2018 untilDecember 31, 2020 . If our Manager had not waived these base management fees, we would have recognized$323 of base management fees for the three months endedJune 30, 2020 . General and administrative expenses. The increase in general and administrative expenses was primarily due to increases in professional fees and insurance costs. Reimbursement of shared services expenses. Reimbursement of shared services expenses represents reimbursement of the costs for the services that our Manager arranges on our behalf fromRMR LLC . The decrease in reimbursement of shared services expenses was primarily the result of our Manager's increased cost effectiveness resulting from the increased sharing of services provided byRMR LLC as a result of our Manager also providing services to RMRM during the three months endedJune 30, 2021 . Transaction related expenses. Transaction related expenses represent costs we have incurred related to the Merger and the other Transactions. Income tax expense. Income tax expense represents income taxes paid or payable by us in certain jurisdictions where we are subject to state income taxes. 21
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Table of Contents
Net income. The decrease in net income was due to the changes noted above.
Six Months Ended
Six Months Ended June 30, 2021 2020 Change % Change INCOME FROM INVESTMENTS: Interest income from investments$ 8,634 $ 8,780 $ (146) (1.7 %) Less: interest and related expenses (2,123) (3,125) 1,002 (32.1 %) Income from investments, net 6,511 5,655 856 15.1 % OTHER EXPENSES: Base management fees 682 - 682 n/m Management incentive fees 620 - 620 n/m General and administrative expenses 1,328 1,064 264 24.8 % Reimbursement of shared services expenses 344 563 (219) (38.9 %) Transaction related expenses 1,849 - 1,849 n/m Total expenses 4,823 1,627 3,196 196.5 % Income before income tax expense 1,688 4,028 (2,340) (58.1 %) Income tax expense (15) - (15) n/m Net income$ 1,673 $ 4,028 $ (2,355) (58.5 %) Weighted average common shares outstanding - basic and diluted 8,215 8,173 42 0.5 % Weighted average common shares outstanding - diluted 8,253 8,173 80 1.0 %
Net income per common share - basic and diluted
(59.2 %) n/m - not meaningful Interest income from investments. The decrease in interest income from investments was primarily the result of the repayment of two loan investments during the six months endedJune 30, 2021 , partially offset by additional interest income recognized from one loan investment originated during the six months endedJune 30, 2021 and additional interest income recognized during the six months endedJune 30, 2021 related to two loan investments that were originated during the six months endedJune 30, 2020 . Interest and related expenses. The decrease in interest and related expenses was primarily the result of a decline in LIBOR sinceJune 30, 2020 and the repayment of outstanding balances under our Master Repurchase Facility during the six months endedJune 30, 2021 . Base management fees. Our Manager waived any base management fees that would otherwise have been due and payable by us under our management agreement for the period beginningJuly 1, 2018 untilDecember 31, 2020 . If our Manager had not waived these base management fees, we would have recognized$643 of base management fees for the six months endedJune 30, 2020 . Management incentive fees. Our Manager waived any management incentive fees that would otherwise have been due and payable by us under our management agreement for the period beginningJuly 1, 2018 untilDecember 31, 2020 . If our Manager had not waived these management incentive fees,$36 in management incentive fees would have been paid or payable by us for the six months endedJune 30, 2020 . General and administrative expenses. The increase in general and administrative expenses was primarily due to increases in professional fees and insurance costs. Reimbursement of shared services expenses. Reimbursement of shared services expenses represents reimbursement of the costs for the services that our Manager arranges on our behalf fromRMR LLC . The decrease in reimbursement of shared 22 -------------------------------------------------------------------------------- Table of Contents services expenses was primarily the result of our Manager's increased cost effectiveness resulting from the increased sharing of services provided byRMR LLC as a result of our Manager also providing services to RMRM during the six months endedJune 30, 2021 and our reduced usage of shared services due to our loan portfolio being fully invested throughFebruary 2021 . Transaction related expenses. Transaction related expenses represent costs we have incurred related to the Merger and the other Transactions. 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. Non-GAAP Financial Measures We present Distributable Earnings and Adjusted Distributable Earnings, which are considered "non-GAAP financial measures" within the meaning of the applicableSEC rules. Distributable Earnings and Adjusted Distributable Earnings do not represent net income or cash generated from operating activities and should not be considered as alternatives to net income determined in accordance with GAAP or indications of our cash flows from operations determined in accordance with GAAP, measures of our liquidity or operating performance or indications of funds available for our cash needs. In addition, our methodologies for calculating Distributable Earnings and Adjusted Distributable Earnings may differ from the methodologies employed by other companies to calculate the same or similar supplemental performance measures; therefore, our reported Distributable Earnings and Adjusted Distributable Earnings may not be comparable to the distributable earnings and adjusted distributable earnings as 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 has been a useful indicator of distributions to our shareholders and is a measure that is considered by ourBoard of Trustees when determining the amount of such distributions. We believe that Distributable Earnings and Adjusted Distributable Earnings provide meaningful information to consider in addition to net income 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 our Manager under our management agreement. Distributable Earnings and Adjusted Distributable Earnings We calculate Distributable Earnings as net income, 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 our Manager, 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 as Distributable Earnings excluding certain non-recurring expenses, such as transaction expenses related to the Merger and the other Transactions. 23
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Table of Contents Three Months Ended June 30, Six Months Ended June 30, 2021 2020 2021 2020 Reconciliation of net income to Distributable Earnings and Adjusted Distributable Earnings: Net income $ 98$ 2,362 $ 1,673 $ 4,028 Management incentive fees - - 620 - Non-cash equity compensation expense 128 71 179 113 Distributable Earnings 226 2,433 2,472 4,141 Transaction related expenses 1,822 - 1,849 - Adjusted Distributable Earnings$ 2,048
Weighted average common shares outstanding - basic 8,218 8,177 8,215 8,173 Weighted average common shares outstanding - diluted 8,266 8,177 8,253 8,173 Adjusted Distributable Earnings per common share - basic $ 0.25
$ 0.25
Factors Affecting Operating Results Our results of our 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 IA, "Risk Factors" of our 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 hold our investments for their contractual terms, unless repaid earlier by the borrower. We evaluate our investments for impairment 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 an allowance 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. Although we generally hold our investments for their contractual terms or until repaid earlier by the borrower, 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 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. We do not currently 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. In order to grow our loan portfolio, we will need to obtain additional cost-effective capital. However, our access to additional cost-effective 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. We have experienced, and may continue to experience in the future, challenges raising equity capital. Market Conditions. The outbreak of the COVID-19 pandemic in the first quarter of 2020 led to a sharp decline in economic activity over the first half of 2020. The closing of non-essential businesses, "shelter-in-place" orders, restrictions on travel, cancellations of events and gatherings and limitations on building occupancies implemented to stop or slow the spread of the virus had a substantial negative impact on the CRE market. Many property owners granted lease forbearance to tenants unable or, in some cases, unwilling to make rent payments which, in turn, increased the number of loan forbearance requests by property owners. In addition, volatility in the capital markets resulted in a substantial widening of credit spreads of commercial mortgage-backed securities, or CMBS, contributing to increased overall borrowing costs for banks and alternative lenders. Further, uncertainty surrounding the depth and duration of the economic downturn resulted in a severe decline in overall CRE 24 -------------------------------------------------------------------------------- Table of Contents transaction volume, and the financial burdens resulting from margin calls imposed on lenders, as a result of increased borrowing costs and declining collateral values, and many lenders' shift in focus to manage large volumes of forbearance requests from borrowers caused new loan originations to significantly decline. The CRE debt markets began to rebound in the third quarter of 2020 and are continuing to stabilize. CMBS credit spreads have declined such that newly issued AAA rated, investment grade bonds for conservatively underwritten loan pools with high quality collateral are trading at credit spreads less than those seen prior to the COVID-19 pandemic. In addition, issuance of CRE collateralized loan obligations, or CLOs (financial instruments secured by a pool of loans and used by lenders as a source of funding), has increased while CLO credit spreads have declined, providing additional liquidity to alternative lenders, like us. While CRE transaction volume has improved recently, it has not returned to the average levels experienced prior to the COVID-19 pandemic. The decline in property transaction volume and increased liquidity available to lenders has caused greater competition among lenders, including banks and alternative lenders, like us, to fund new loans. We believe that this increased competition amongst lenders, along with significant declines in the LIBOR andU.S. treasury index rates, has benefited borrowers seeking loans to refinance high quality properties, particularly multifamily, industrial, life science or research and development/laboratory properties, that are either stabilized or near stabilization. Alternative lenders, like us, can provide flexible, shorter term financing to borrowers that may not be seeking longer term financing options because of economic uncertainty caused by the COVID-19 pandemic. However, despite the improvement of the securitization markets and the increase in lending activity, we believe challenges remain. The hospitality and retail sectors are among those that have been most negatively impacted by the economic downturn related to the COVID-19 pandemic. However, with reduced restrictions and increased vaccination rates inthe United States , retail sales and leisure travel have experienced improvement during the second quarter of 2021, while business travel remains at levels significantly lower than prior to the COVID-19 pandemic. It is unclear how consumer and travel habits will be impacted over the long term during and after the COVID-19 pandemic; if consumer and travel activity does not substantially rebound, we believe that this uncertainty will continue to burden these sectors and lenders with significant exposure to these property types will continue to face challenges. It is still unclear how the shift to flexible work-from-home schedules will impact the office sector and demand for office space going forward. As such, lenders will continue to face underwriting challenges with respect to assumptions related to new leasing, tenant renewal probabilities and occupancy rates for office properties, especially assets located in downtown or central business district markets. As vaccination rates increase and companies re-evaluate their work-from-home policies, there should be increased clarity on the demand for office properties. Multifamily properties are expected to continue to be a preferred asset class by most lenders and investors for the near term due to the stability of cash flows and the liquidity available from government sponsored enterprises, such as Fannie Mae or Freddie Mac; however, it is unclear what the impact of theU.S. Centers for Disease Control and Prevention moratorium on tenant evictions will have on the sector and how rent collections will be impacted. Industrial properties continue to perform well and benefit from the shift in consumers' behavior to increased levels of e-commerce, which accelerated during the COVID-19 pandemic. Lastly, competition among lenders has caused alternative lenders, like us, to expand their loan portfolios to include certain asset types within these asset classes, such as data centers, manufactured housing, cold storage and self-storage, to achieve favorable yields on high quality properties that have been and may continue to be less susceptible to the impact of the COVID-19 pandemic. The longer-term impact of the COVID-19 pandemic is still uncertain. However, we believe that as theU.S. economy continues to improve and returns to a more stable state, there will 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, if any, to increase; (b) the value of our fixed rate investments, if any, to decline; (c) the coupon rates on our variable rate investments, if any, 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, if any, to decrease; (b) the value of our fixed rate investments, if any, to increase; (c) the coupon rates on our variable rate investments, if any, 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 one month LIBOR. Because we generally leverage approximately 75% of our investments, as LIBOR increases, our income from investments, net of interest and related expenses, will increase. LIBOR decreases are mitigated by interest rate floor provisions in our loan agreements with 25 -------------------------------------------------------------------------------- Table of Contents borrowers; therefore, changes to income from investments, net, may not move proportionately with the increase or decrease in LIBOR. Based on our loan portfolio atJune 30, 2021 , LIBOR was 0.08% and would have to exceed the floor established by any of our loans, which currently range from 0.50% to 2.49%, to realize an increase in interest income from increases in LIBOR. LIBOR is currently expected to be phased out for new contracts byDecember 31, 2021 and for pre-existing contracts byJune 30, 2023 . OnOctober 30, 2020 , we amended our Master Repurchase Agreement to, among other things, provide that at such time as LIBOR is no longer available as a base rate to calculate interest payable on amounts outstanding under our Master Repurchase Facility, the replacement base rate shall be the secured overnight financing rate, or SOFR, or if SOFR is not available, such other rate as may be determined by Citibank in accordance with the terms of our Master Repurchase Agreement. We also currently expect that, as a result of any phase out of LIBOR, the interest rates under our loan agreements with borrowers would be revised as provided under the agreements or amended as necessary to provide for an interest rate that approximates the existing interest rate as calculated in accordance with LIBOR. 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. Excepting the pending Merger, we believe our growth is limited by our ability to obtain additional cost-effective capital. LIQUIDITY AND CAPITAL RESOURCES (dollars in thousands, except per share data) Under the Merger Agreement, we have agreed to conduct our business in all material respects in the ordinary course of business consistent with past practice. The Merger Agreement contains certain operating covenants that could affect our liquidity and capital resources, but we do not expect any material changes to our liquidity and capital resources prior to consummation of the Merger or, if applicable, the termination of the Merger Agreement, other than those which may occur in the ordinary course of our business. See Note 1 to the Notes to Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for further information regarding the Merger Agreement. 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, fund and maintain our assets and operations, make distributions to our shareholders and fund other business operating requirements. We require a significant amount of cash to originate, purchase and invest in our target investments, make additional unfunded loan commitment payments, repay principal and interest on our borrowings, make distributions to our shareholders and fund other business operating requirements. We have been limited in our ability to access cost-effective capital and, as a result, we have limited capital to invest. The long-term impact of the COVID-19 pandemic and its aftermath on financial markets is uncertain. To the extent that impact is significant, negative and sustained for an extended period, we expect that we may continue to be challenged in accessing capital, and we may continue to be challenged in accessing capital even if the financial markets are not negatively impacted by the COVID-19 pandemic for an extended period or otherwise. Our sources of cash flows include 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 Master Repurchase Facility or other repurchase agreements or financing arrangements, and 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 and pay our debt service obligations owed and make any distributions to our shareholders for the next 12 months and for the foreseeable future, subject to the duration and severity of the COVID-19 pandemic and economic impact on our borrowers and their ability to fund their debt service obligations owed to us. For further information regarding the risks associated with our loan portfolio, see the risk factors identified in Part I, Item IA, "Risk Factors" of our Annual Report. Pursuant to our Master Repurchase Agreement, we may sell to, and later repurchase from, Citibank floating rate mortgage loans and other related assets, or purchased assets. The initial purchase price paid by Citibank for each purchased asset is up to 75% of the lesser of the market value of the purchased asset or the unpaid principal balance of such purchased asset, subject to Citibank's approval. Upon the repurchase of a purchased asset, we are required to pay Citibank the outstanding purchase price of the purchased asset, accrued interest and all accrued and unpaid expenses of Citibank relating to such purchased asset. The price differential (or interest rate) relating to a purchased asset is equal to one month LIBOR plus a premium of 200 to 250 basis points, determined by the yield of the purchased asset and the property type of the purchased asset's real estate collateral. Citibank has the discretion under our Master Repurchase Agreement to make advancements at margins higher than 75% and at 26 -------------------------------------------------------------------------------- Table of Contents premiums of less than 200 basis points. If LIBOR is no longer available as a base rate, the replacement base rate shall be SOFR, or if SOFR is not available, such other rate as may be determined by Citibank in accordance with the terms of our Master Repurchase Agreement, plus a premium of basis points that approximates the existing interest rate as calculated in accordance with LIBOR. As ofJune 30, 2021 , the maximum amount available for advancement under our Master Repurchase Facility was$213,482 , of which we had a$156,167 aggregate outstanding principal balance, and the weighted average interest rate of advancements under our Master Repurchase Facility was 2.18% for the six months endedJune 30, 2021 . Our Master Repurchase Facility is scheduled to expire onNovember 6, 2022 . For further information regarding our Master Repurchase Facility, see Note 4 to the Notes to Unaudited Condensed Consolidated Financial Statements included in Part I Item 1 of this Quarterly Report on Form 10-Q and "-Overview-Financing Activities" above.
The following is a summary of our sources and uses of cash flows for the periods presented (dollars in thousands):
Six
Months Ended
2021 2020 Cash, cash equivalents and restricted cash at beginning of period$ 10,521 $ 8,875 Net cash provided by (used in): Operating activities 2,727 2,931 Investing activities 45,288 (34,805) Financing activities (50,168) 33,632 Cash, cash equivalents and restricted cash at end of period $ 8,368$ 10,633 The decrease in cash provided by operating activities was primarily the result of a decrease in net income for the six months endedJune 30, 2021 compared to the six months endedJune 30, 2020 , partially offset by favorable changes in working capital. The increase in cash provided by investing activities was primarily due to the repayment of two loan investments, a decrease in loan origination activity and additional fundings on our existing loan investments during the six months endedJune 30, 2021 compared to the six months endedJune 30, 2020 . The increase in cash used in financing activities was primarily due to the repayment of outstanding balances under our Master Repurchase Facility and the payment of a one-time cash distribution to our common shareholders to satisfy our 2020 REIT distribution requirements during the six months endedJune 30, 2021 . Our ability to obtain additional financing advancements under our Master Repurchase Facility is contingent upon our making additional fundings to our existing borrowers or our ability to effectively reinvest any additional capital, including any loan repayment proceeds, that we may obtain or receive. However, we cannot be sure that we will be able to obtain additional cost-effective capital or additional financing advancements under our Master Repurchase Facility. It may take an extended period for us to reinvest any additional capital we may receive, and any reinvestments we may be able to make may not provide us with similar returns or comparable risks as those of our current investments. Distributions During the six months endedJune 30, 2021 , we paid distributions to our common shareholders aggregating$5,232 , or$0.63 per common share, using cash on hand. For further information regarding distributions, see Note 6 to the Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q. OnJuly 15, 2021 , we declared a quarterly distribution for the second quarter of 2021 payable to our common shareholders of record as ofJuly 26, 2021 of$0.10 per common share, or approximately$831 in aggregate. We expect to pay this distribution on or aboutAugust 19, 2021 . 27 -------------------------------------------------------------------------------- Table of Contents Contractual Obligations and Commitments Our contractual obligations and commitments as ofJune 30, 2021 were as follows: Payment Due by Period Less than 1 More than 5 Total Year 1 - 3 Years 3 - 5 Years years Unfunded loan commitments (1)$ 9,085 $ 6,660 $ 2,425 $ - $ - Principal payments on Master Repurchase Facility (2) 156,167 122,383 33,784 - - Interest payments (3) 2,151 1,879 272 - -$ 167,403 $ 130,922 $ 36,481 $ - $ - (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 Master Repurchase Facility is based on the current maturity date of each loan investment with respect to which the individual borrowing relates. (3)Projected interest payments are attributable only to our debt service obligations at existing rates as ofJune 30, 2021 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. Off-Balance Sheet Arrangements As ofJune 30, 2021 , we had no off-balance sheet arrangements that have had or that we expect would be reasonably likely to have a material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. Debt Covenants Our principal debt obligations atJune 30, 2021 were the outstanding balances under our Master Repurchase Facility. Our Master Repurchase Agreement provides for acceleration of the date of repurchase of any then purchased assets and Citibank's liquidation of the purchased assets upon the occurrence and continuation of certain events of default, including a change of control of us, which includes our Manager ceasing to act as our sole manager or to be a wholly owned subsidiary ofRMR LLC . Our Master Repurchase Agreement also provides that upon the repurchase of any then purchased asset, we are required to pay Citibank the outstanding purchase price of such purchased asset and accrued interest and any and all accrued and unpaid expenses of Citibank relating to such purchased asset. In connection with our Master Repurchase Agreement, we entered into the Guaranty, which requires us to guarantee 25% of our subsidiary's prompt and complete payment of the purchase price, purchase price differential and any costs and expenses of Citibank related to our Master Repurchase Agreement. The Guaranty also requires us to comply with customary financial covenants, which include the maintenance of a minimum tangible net worth, minimum cash liquidity, a total indebtedness to tangible net worth ratio and a minimum interest coverage ratio. As ofJune 30, 2021 , we had a$156,167 aggregate outstanding principal balance under our Master Repurchase Facility. Our Master Repurchase Agreement is structured with risk mitigation mechanisms, including a cash flow sweep, which would allow Citibank to control interest payments from our borrowers under our loans that are financed under our Master Repurchase Facility, 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 Facility. As ofJune 30, 2021 , we believe we were in compliance with all the covenants and other terms under our Master Repurchase Agreement and, to date, Citibank has not utilized any such risk mitigation mechanisms under our Master Repurchase Agreement. Related Person Transactions We have relationships and historical and continuing transactions with our Manager,RMR LLC ,RMR Inc. and others related to them. For example, as noted earlier in this Quarterly Report on Form 10-Q, we entered into the Merger Agreement with RMRM pursuant to which we have agreed, on the terms and subject to the conditions set forth therein, to consummate the Merger and the other Transactions, subject to the satisfaction or waiver of certain conditions. For further information about these and other such relationships and related person transactions, see Notes 1, 7 and 8 to the Notes to Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, our Current Report on Form 8-K datedApril 26, 2021 , our Annual Report, our Proxy Statement for our 2021 Annual Meeting of Shareholders and our other filings with theSEC . In addition, see the section captioned "Risk Factors" of this Quarterly Report on Form 10-Q and our 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 whichRMR LLC or its subsidiaries provide management services. 28
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