Ares Commercial Real Estate Corporation — Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2021. The filing is an annual report and does not provide a separate standalone fourth-quarter income statement.
Business context
ACRE is an externally managed specialty finance company and REIT focused primarily on originating and investing in commercial real estate debt. Its portfolio includes senior mortgage loans, subordinated debt, preferred equity, mezzanine loans and related investments. Ares Commercial Real Estate Management LLC, an affiliate of Ares Management Corporation, manages the company; ACRE has no employees.
At December 31, 2021, the loan portfolio comprised 72 loans with $2.4 billion of outstanding principal and $2.4 billion of carrying value before the CECL reserve. The weighted-average unleveraged effective yield was 5.4% on the total portfolio, with a weighted-average remaining life of 1.6 years. Approximately 93.1% of loans had LIBOR floors.
Key financial metrics
| Metric | 2021 | 2020 | Change |
|---|---|---|---|
| Total revenue | $102.1 million | $82.7 million | 24% |
| Net interest margin | $83.6 million | $69.1 million | 21% |
| Total expenses | $40.9 million | $36.3 million | 13% |
| CECL provision | $10 thousand | $20.2 million | Material decrease |
| Realized losses on loans sold | None | $4.0 million | Improved |
| Net income attributable to common stockholders | $60.5 million | $21.8 million | 177% |
| Diluted EPS | $1.42 | $0.66 | 115% |
| Net cash from operating activities | $48.4 million | $31.8 million | 52% |
Net interest margin benefited from growth in weighted-average earning assets to $2.2 billion from $1.8 billion and from issuing lower-cost securitization debt in January 2021. Revenue from the hotel property classified as real estate owned increased to $18.5 million from $13.6 million as operations recovered from COVID-19 effects, while related expenses increased to $18.5 million from $18.1 million.
Total assets were $2.6 billion at year-end, compared with $1.9 billion in 2020. Stockholders’ equity increased to $678.6 million from $473.0 million. Cash and cash equivalents were $50.6 million, down from $74.8 million.
Debt, liquidity and capital resources
- Financing Agreements totaled $1.04 billion outstanding at December 31, 2021, including $840.0 million under secured funding agreements, $51.1 million of notes payable and $150.0 million under the secured term loan.
- CLO securitization debt was $861.2 million, and secured borrowings were $22.6 million. Total debt, including these categories, was approximately $1.95 billion.
- Debt-to-equity leverage was approximately 2.9 times based on reported total debt and year-end equity. Management stated that leverage generally is expected not to exceed 4.5 times debt to equity, subject to market conditions.
- As of February 14, 2022, liquidity was approximately $189 million, consisting of $114 million of unrestricted cash and $75 million of secured funding availability.
- Future loan funding commitments totaled $233.7 million, including $48.8 million due within one year and $165.5 million due in one to three years.
- Cash used in investing activities was $699.7 million, primarily reflecting loan originations and fundings exceeding principal repayments. Financing activities provided $627.2 million.
- ACRE raised approximately $204.8 million net from common stock issuance in 2021, including two underwritten offerings and $2.1 million through its at-the-market program.
Material changes versus the prior comparable period
- The loan portfolio increased from $1.8 billion to $2.4 billion of carrying value, while the number of loans increased from 50 to 72.
- ACRE funded approximately $1.3 billion of loan principal and received $657.2 million of principal repayments during 2021.
- The CECL reserve was $25.2 million at year-end 2021, consisting of $23.9 million for funded loans and $1.3 million for unfunded commitments. The reserve was broadly stable despite portfolio growth.
- Non-accrual loans declined to two loans with a $45.0 million carrying value from three loans with a $67.1 million carrying value.
- In January 2021, ACRE completed the FL4 CLO securitization, issuing approximately $603.0 million of notes and $64.3 million of preferred equity; ACRE retained approximately $62.5 million of the notes.
- The Wells Fargo facility commitment increased to $450 million, the Morgan Stanley facility increased to $250 million, the CNB facility increased to $75 million and the secured term loan was increased and extended to November 2026 at a 4.50% initial fixed rate.
- The company declared 2021 cash dividends of $1.40 per share, consisting of quarterly dividends of $0.33 plus $0.02 supplemental dividends. Dividends declared totaled $64.0 million, exceeding net cash from operating activities of $48.4 million.
Guidance, outlook, commentary and unusual items
Management characterized market conditions as favorable for scaled, disciplined direct lenders, citing active CRE transaction markets and demand for shorter-duration, generally floating-rate loans. No quantitative earnings or portfolio guidance was provided.
The hotel acquired through a 2019 deed in lieu of foreclosure was classified as held for sale at year-end. ACRE entered into an agreement to sell it for $40.0 million, with closing expected in the first quarter of 2022. The property had a net carrying value of $36.6 million and no gain or loss had been recognized on the planned sale.
Two loans with a combined $45.0 million carrying value were on non-accrual status. In addition, certain loans were in maturity default but remained on accrual status based on collateral and expected cash-flow assessments. No loan write-offs occurred in 2021.
LIBOR transition is a significant exposure. At December 31, 2021, approximately $1.9 billion of floating-rate investments and $1.8 billion of floating-rate debt had fully extended maturities beyond June 30, 2023 and were tied to LIBOR. The company had begun converting certain assets and liabilities to SOFR, but stated that the financial impact could not yet be reasonably estimated.
COVID-19 continues to affect borrowers, particularly in hospitality, student housing and retail. Risks include delayed payments, loan modifications, margin calls, collateral deterioration, refinancing difficulty and higher CECL reserves. The company stated that it expected its primary liquidity sources to fund operating activities and commitments for at least the next 12 months, subject to market conditions and lender requirements.
Management and Ernst & Young LLP concluded that internal control over financial reporting was effective as of December 31, 2021. The audit opinion on the financial statements was unqualified. The critical audit matter was the estimation of the CECL reserve.
Most important facts for investors to verify
- Reconcile total leverage, collateralized debt and upcoming facility maturities, particularly the 2022 maturities totaling approximately $636.0 million.
- Review the two non-accrual loans, maturity-defaulted loans, collateral valuations and the assumptions supporting the $25.2 million CECL reserve.
- Assess whether dividends are adequately supported by recurring operating cash flow, given that 2021 distributions exceeded operating cash flow.
- Evaluate exposure to LIBOR-to-SOFR transition risk across approximately $1.9 billion of assets and $1.8 billion of debt.
- Monitor margin-call provisions, CLO overcollateralization tests, lender covenants and available liquidity under stressed CRE valuations.
- Confirm completion and proceeds of the planned $40.0 million hotel sale and the use of proceeds.
- Consider dilution from the increase in shares outstanding to 47.1 million from 33.4 million and the effect of external management fees and related-party transactions.
- Review REIT qualification, Investment Company Act exemption and the continuing ability to meet distribution requirements.