Ares Commercial Real Estate Corporation — Q1 2021 Form 10-Q Summary
Business Context and Reporting Period
Ares Commercial Real Estate Corporation is an externally managed REIT and specialty finance company that originates and invests primarily in commercial real estate loans and related investments. The filing reports unaudited results for the three months ended March 31, 2021, compared with the three months ended March 31, 2020. The company held 53 loans with approximately $1.9 billion of outstanding principal at quarter-end.
Key Financial Metrics
| Metric | Q1 2021 | Q1 2020 |
|---|---|---|
| Total revenue | $21.2 million | $21.1 million |
| Net interest margin | $18.6 million | $15.9 million |
| Net income attributable to common stockholders | $15.7 million | $(17.3) million |
| Diluted earnings per share | $0.45 | $(0.54) |
| Operating cash flow | $9.9 million | $8.3 million |
| Cash, cash equivalents and restricted cash | $97.9 million | $74.9 million |
| Loans held for investment, net | $1.887 billion | $1.792 billion at December 31, 2020 |
| Current expected credit loss reserve | $20.9 million on funded loans; $1.1 million on unfunded commitments | $23.6 million on funded loans at December 31, 2020 |
| Total stockholders’ equity | $576.0 million | $473.0 million at December 31, 2020 |
| Dividends declared per share | $0.35 | $0.33 |
Interest income was $30.7 million and interest expense was $12.1 million. The improvement in net interest margin reflected the benefit of LIBOR floors and lower-cost securitization financing. The loan portfolio had a weighted-average unleveraged effective yield of 6.0% based on total loans and 6.2% based on accruing loans. Net income was significantly affected by the change in the CECL provision: a $3.2 million benefit in Q1 2021 compared with a $27.1 million provision in Q1 2020.
Material Changes Versus the Prior Comparable Period
- Net income improved by approximately $33.0 million, from a $17.3 million loss to $15.7 million of income, primarily due to the materially lower CECL provision and lower real-estate-owned expenses.
- Net interest margin increased approximately 17% to $18.6 million despite slightly lower interest income, as interest expense declined by approximately $3.4 million.
- Revenue from the company-owned hotel declined to $2.7 million from $5.2 million, while hotel-related expenses declined to $3.3 million from $6.7 million, reflecting continuing COVID-19 effects on occupancy and operations.
- Loans held for investment increased $92.8 million from December 31, 2020. The company funded approximately $223.4 million and received approximately $130.7 million of principal repayments during the quarter.
- The company issued 7.0 million common shares in March 2021, generating approximately $100.7 million of net proceeds. Shares outstanding increased to 40.5 million as of May 3, 2021.
- The company completed the FL4 collateralized loan obligation, issuing approximately $603.0 million of secured floating-rate notes and retaining approximately $126.8 million of subordinated notes and preferred equity.
- Financing-agreement borrowings declined to $451.0 million from $928.7 million at year-end, primarily due to repayments of secured funding agreements, a $50.0 million secured term loan repayment and repayment of a $27.9 million note.
Debt, Liquidity and Capital Resources
Total financing-agreement commitments were $1.167 billion, with $451.0 million outstanding at March 31, 2021. In addition, the balance sheet included $979.3 million of collateralized loan obligation securitization debt and $59.8 million of secured borrowings. Management stated that the company was in compliance with all financial covenants at quarter-end.
As of May 3, 2021, management reported approximately $36 million of liquidity, consisting of $4 million of unrestricted cash and $32 million of availability under secured funding agreements. Total unfunded loan commitments were $159.8 million at March 31, 2021. The company stated that leverage is currently expected not to exceed a 4-to-1 debt-to-equity ratio, although its charter and bylaws do not impose a leverage limit.
Cash increased by $23.2 million during the quarter. Investing activities used $131.4 million, while financing activities provided $144.6 million. Financing cash inflows included $540.5 million of CLO debt issuance and $100.9 million from the common stock offering, partially offset by debt repayments and dividends.
Guidance, Outlook, Management Commentary, Risks and Unusual Items
- No formal earnings or portfolio guidance was provided. Management emphasized preserving liquidity, funding existing commitments, originating new loans and maintaining REIT and Investment Company Act exemption requirements.
- COVID-19 continued to create uncertainty for borrowers, particularly in hospitality, student housing and retail. Four loan modifications totaling $183.3 million of aggregate principal were completed during the quarter, including extensions, interest deferrals or capitalization, covenant waivers and other amendments.
- Three loans with a carrying value of $66.8 million were on non-accrual status at March 31, 2021, although management stated that all loans were paying in accordance with contractual terms.
- The CECL reserve decreased primarily because of an improved macroeconomic outlook, but management noted that estimates remain inherently uncertain and could increase if economic or property-level conditions deteriorate.
- Financing facilities contain margin-call, covenant, cross-default and acceleration provisions. Defaults or collateral-value declines could require additional cash or collateral, debt repayments or asset sales.
- CLO cash flows are subordinate to senior note payments. Failure to satisfy overcollateralization tests could divert cash otherwise payable to the company’s subordinate interests and could result in significant losses.
- The company uses interest-rate hedges, including an $870 million LIBOR swap and a $275 million LIBOR cap, but remains exposed to interest-rate, basis, prepayment, refinancing and counterparty risks. The filing estimates that a 100-basis-point increase in 30-day LIBOR would reduce annual net income by approximately $1.9 million under stated assumptions.
- Subsequent to quarter-end, the company extended the FL3 CLO reinvestment period to March 31, 2024 and announced additional loan originations and purchases totaling at least $67.8 million of stated commitments or purchases, subject to the filing’s differing funded-balance disclosures.
- The board declared a second-quarter 2021 dividend of $0.35 per share, consisting of a regular $0.33 dividend and a supplemental $0.02 dividend.
Important Facts for Investors to Verify
- Whether the $36 million of reported liquidity is sufficient relative to $159.8 million of unfunded commitments, upcoming debt maturities and potential margin calls.
- The performance, collateral values and ultimate collectability of the three non-accrual loans totaling $66.8 million.
- Future changes in the $22.0 million aggregate CECL reserve and the sensitivity of reserves to COVID-19, property values and borrower performance.
- Compliance with CLO overcollateralization tests and the timing of cash distributions from the FL3 and FL4 securitizations.
- Refinancing and extension risk for facilities maturing beginning in 2021, including the Citibank facility and secured term loan.
- The effect of LIBOR replacement and related contract amendments on loan yields, borrowing costs and hedge effectiveness.
- The sustainability of the $0.35 quarterly dividend relative to taxable income, recurring earnings, operating cash flow and liquidity.
- Related-party loan purchases and management, incentive and expense-reimbursement fees paid to affiliates.