Ares Commercial Real Estate Corporation — Q1 2022 Form 10-Q Summary
Business context and reporting period
Ares Commercial Real Estate Corporation is an externally managed REIT focused on originating and investing in commercial real estate debt, primarily senior mortgage loans. This report covers the unaudited three months ended March 31, 2022, compared with the three months ended March 31, 2021.
Key financial metrics
| Metric | Q1 2022 | Q1 2021 | Change |
|---|---|---|---|
| Total revenue | $24.0 million | $21.2 million | +13.2% |
| Interest income | $33.4 million | $30.7 million | +8.7% |
| Net interest margin | $21.4 million | $18.6 million | +15.0% |
| Total expenses | $10.5 million | $8.5 million | +23.1% |
| Provision for expected credit losses | $0.6 million | $3.2 million | Lower provision |
| Net income | $16.2 million | $15.7 million | +2.9% |
| Basic EPS | $0.34 | $0.46 | Down due primarily to higher share count |
| Dividends declared per share | $0.35 | $0.35 | Unchanged |
| Operating cash flow | $16.2 million | $9.9 million | Improved |
| Ending cash and cash equivalents | $13.8 million | $97.9 million | Down $84.2 million year over year |
Net interest margin represented approximately 88.9% of total revenue in Q1 2022, compared with 87.5% in Q1 2021. Net income margin was approximately 67.4%, compared with 74.2%, reflecting higher expenses and the differing impact of real estate operations and unusual items.
- Loans held for investment totaled $2.42 billion before the $20.5 million funded-loan CECL reserve, versus $2.41 billion at December 31, 2021.
- The portfolio included 77 loans, with $2.44 billion of outstanding principal and a weighted-average unleveraged effective yield of 5.5%.
- Approximately 91.6% of loans had LIBOR or SOFR floors, with a weighted-average floor of 0.98%.
- Two loans totaling $44.8 million were on non-accrual status at March 31, 2022. All other loans were reported as paying according to contractual terms.
- Total CECL reserves were $24.7 million, or 92 basis points of total loan commitments, including $20.5 million for funded balances and $4.2 million for unfunded commitments.
- Total assets were $2.52 billion and stockholders’ equity was $689.3 million at March 31, 2022.
- Financing agreements had $912.9 million outstanding against $1.45 billion of commitments. Additional debt included $861.8 million of CLO securitization debt and $22.6 million of secured borrowings.
- As of May 2, 2022, management reported approximately $93 million of liquidity, consisting of $18 million of unrestricted cash and $75 million of availability under secured funding agreements.
Material changes versus the prior comparable period
- Net interest margin increased by $2.8 million, primarily because weighted-average earning assets and borrowings increased.
- Net income increased only modestly despite higher revenue, as total expenses rose by $2.0 million. Management fees increased with the larger equity base, general and administrative expense increased, and hotel-related expenses were higher.
- Basic weighted-average shares increased to 47.2 million from 34.4 million, following 2021 equity offerings. The company sold 190,369 shares through its at-the-market program in Q1 2022 for approximately $2.9 million of net proceeds.
- The expected credit loss provision declined to $0.6 million from $3.2 million, reflecting forecasted macroeconomic improvement, loan payoffs and shorter remaining loan terms, partially offset by portfolio growth.
- The company sold its New York hotel real estate-owned asset on March 1, 2022, for $40.0 million, recognized a $2.2 million gain, repaid the related $28.3 million note, and ceased reporting the property as real estate owned.
- Investing cash flow was positive $89.7 million, compared with negative $131.4 million in Q1 2021, because loan repayments and hotel-sale proceeds exceeded new loan fundings.
- Financing cash flow was negative $142.8 million, primarily due to repayments of secured funding agreements, the hotel-related note and dividends.
- The company terminated a $170 million interest-rate cap and recognized a $2.0 million realized gain in other comprehensive income; the gain is expected to be recognized in earnings over the remaining original hedge term.
Outlook, risks and unusual items
Management stated that available funding sources are expected to be sufficient for operating activities and cash commitments for at least the next 12 months and thereafter for the foreseeable future. No quantitative earnings or portfolio guidance was provided.
- The company expects to continue originating and acquiring CRE loans, using secured financing, CLO reinvestment capacity, equity offerings and asset sales as available.
- Management declared a Q2 2022 dividend of $0.35 per share, consisting of a regular $0.33 dividend and a supplemental $0.02 dividend, payable July 15, 2022.
- Subsequent to quarter-end, the company originated an office loan in Massachusetts and purchased several self-storage loans totaling the disclosed funded amounts.
- COVID-19-related effects remain uncertain, particularly for hospitality, student housing and retail borrowers. Supply-chain disruption, labor shortages and inflation could impair property cash flows and collateral values.
- Rising interest rates could increase borrowing costs, pressure borrower debt-service coverage and reduce investment values. The company estimated that a 100-basis-point increase in 30-day LIBOR or SOFR would increase annual net income by approximately $2.1 million under the stated assumptions.
- Secured facilities contain margin-call, covenant, cross-default and acceleration provisions. Failure to meet requirements could result in additional collateral demands, repayment acceleration or enforcement against pledged assets.
- CLO cash flows may be diverted to senior note repayment if overcollateralization tests are not satisfied, reducing cash available to the company.
- One California residential loan was in maturity default and on non-accrual status; management reported no impairment charge as of March 31, 2022. A second loan was also non-accrual.
- The company remained exposed to LIBOR transition risk and was evaluating the accounting impact of reference-rate-reform guidance.
- The company reported no material pending legal proceedings, no defaults under senior securities and no material changes to previously disclosed risk factors.
Important facts for investors to verify
- Reconcile the $0.34 GAAP EPS with any company-reported core earnings or distributable earnings measure, including the treatment of the hotel-sale gain and interest-cap gain.
- Review the two non-accrual loans, especially the California maturity-default loan, collateral values, guarantees and potential impairment exposure.
- Assess liquidity relative to $243.6 million of unfunded loan commitments and upcoming facility maturities, including the September 2022 note and August 2022 MetLife facility.
- Evaluate sensitivity to rising rates, borrower defaults, delayed repayments, margin calls and refinancing risk.
- Review CLO overcollateralization tests and the company’s $238.2 million maximum stated risk of loss in the consolidated CLO structures.
- Confirm the sustainability of the $0.35 quarterly dividend against core earnings, cash flow, REIT distribution requirements and financing covenants.
- Consider external management fees, expense reimbursements and the April 25, 2022 amendment affecting incentive-fee Core Earnings calculations.