Ares Commercial Real Estate Corporation — Q1 2020 Form 10-Q Summary
Business Context and Reporting Period
Ares Commercial Real Estate Corporation (NYSE: ACRE) is an externally managed REIT focused on originating and investing in commercial real estate loans and related investments. The company primarily invests in senior mortgage loans, subordinated debt, preferred equity and other CRE-related assets. This unaudited Form 10-Q covers the three months ended March 31, 2020, and was filed May 8, 2020.
The quarter was materially affected by the COVID-19 pandemic, including economic shutdowns, financial-market volatility and pressure on borrowers, particularly in hospitality, student housing and retail-related properties.
Financial Metrics
| Metric | Q1 2020 | Q1 2019 |
|---|---|---|
| Total revenue | $21.1 million | $14.2 million |
| Net interest margin | $15.9 million | $12.2 million |
| Total expenses | $11.3 million | $5.5 million |
| CECL provision | $27.1 million | None |
| Net income attributable to common stockholders | $(17.3) million | $8.5 million |
| Basic and diluted EPS | $(0.54) | $0.30 |
| Dividend declared per share | $0.33 | $0.33 |
| Net cash from operating activities | $8.3 million | $6.8 million |
| Net cash used in investing activities | $(274.0) million | $(9.0) million |
| Net cash from financing activities | $334.9 million | $3.9 million |
Interest income increased to $31.4 million from $28.0 million, while interest expense declined slightly to $15.5 million from $15.7 million. Revenue from real estate owned increased to $5.2 million from $1.9 million because Q1 2020 included a full quarter of hotel operations; however, COVID-19 significantly reduced hotel occupancy and revenue.
At March 31, 2020, total assets were $2.10 billion, including $1.87 billion of loans held for investment before the CECL reserve. Cash and cash equivalents were $74.5 million, or $74.9 million including restricted cash. Total liabilities were $1.64 billion and stockholders’ equity was $466.1 million.
The loan portfolio comprised 53 loans with $1.88 billion of outstanding principal and a $2.16 billion total commitment balance. The weighted-average effective yield was 6.2% for the portfolio, with a weighted-average remaining life of 1.6 years. Approximately 93.7% of loans had LIBOR floors, with a weighted-average floor of 1.77%.
The company reported $1.17 billion of outstanding Financing Agreements, excluding $443.6 million of consolidated CLO securitization debt. Financing commitments totaled $1.65 billion, leaving approximately $478.6 million of capacity based on reported commitments and outstanding balances, subject to collateral, covenants and lender approval. Unfunded loan commitments were $275.0 million.
Material Changes Versus the Prior Comparable Period
- Net income declined from $8.5 million to a net loss of $17.3 million, driven primarily by the $27.1 million CECL provision and higher real-estate-owned expenses.
- Net interest margin increased approximately 30% to $15.9 million, principally because of growth in average earning assets and the benefit of LIBOR floors.
- The loan portfolio grew from $1.68 billion of carrying value at December 31, 2019 to $1.87 billion at March 31, 2020. The company funded approximately $297.3 million of principal and received approximately $107.1 million of repayments during the quarter.
- The company adopted the CECL accounting standard on January 1, 2020. The adoption reduced accumulated earnings by $5.1 million, and the quarter-end reserve totaled $32.2 million, comprising $29.1 million for funded loans and $3.0 million for unfunded commitments.
- Four loans were placed on non-accrual status because of COVID-19 impacts. Their carrying value was approximately $104.6 million, although management stated that all loans were paying in accordance with contractual terms at March 31, 2020.
- The company issued 4.6 million common shares in January 2020, generating approximately $72.9 million of net proceeds.
- The company added a $150.0 million Morgan Stanley repurchase facility and extended the CNB facility to March 10, 2021. The BAML facility balance of $36.3 million was extended to July 1, 2020.
Guidance, Outlook, Risks and Unusual Items
The filing does not provide formal earnings guidance. Management stated that the duration and severity of COVID-19 remain uncertain and that future results may be materially affected by borrower defaults, loan modifications, declining collateral values, delayed repayments and additional CECL provisions.
- Borrowers in hospitality, student housing and other affected sectors requested or may request interest deferrals, forbearance, maturity extensions, covenant waivers or other modifications.
- Secured funding agreements contain margin-call, collateral and cross-default provisions. Failure to meet requirements could result in additional collateral postings, accelerated repayment, termination of commitments or enforcement against collateral.
- As of March 31, 2020, management reported compliance with all financial covenants; however, several secured facilities had maturities in 2020 and required extensions or refinancing to avoid near-term funding pressure.
- Management was focused on preserving liquidity and disclosed that future dividends could be reduced, suspended or paid partly in stock, subject to REIT requirements and operating needs.
- The company’s stated leverage objective was not to exceed a 4-to-1 debt-to-equity ratio, although the filing cautioned that leverage may vary based on market conditions and portfolio risk.
- Interest-rate sensitivity analysis estimated that a 100-basis-point increase in 30-day LIBOR could reduce annual net income by approximately $9.9 million, while a 50-basis-point decrease could increase annual net income by approximately $6.3 million, based on the March 31, 2020 balance sheet.
- The company owned a hotel acquired through a deed in lieu of foreclosure. Real estate owned was carried at $37.9 million, and no impairment charge was recorded during the quarter.
- The company consolidated a CLO securitization with $443.6 million of carrying-value debt and reported maximum exposure to loss of $111.4 million, representing its retained investment.
- Management stated that disclosure controls and procedures were effective and that there were no material pending legal proceedings.
Important Facts for Investors to Verify
- Whether COVID-19-related borrower modifications, non-accrual loans and property-level deterioration produce additional credit losses beyond the $32.2 million CECL reserve.
- The status and refinancing or extension terms of secured facilities maturing in 2020, including BAML, U.S. Bank, MetLife, Wells Fargo and the secured term loan.
- Available unrestricted cash and borrowing capacity after accounting for margin requirements, collateral haircuts, lender approvals and the $275.0 million of unfunded loan commitments.
- Whether the $0.33 quarterly dividend remains sustainable given the Q1 net loss, REIT distribution requirements and management’s liquidity-preservation actions.
- Performance and collateral values for the four non-accrual loans totaling approximately $104.6 million, as well as loans rated “4” totaling approximately $290.6 million.
- Hotel operating results and potential impairment risk for the $37.9 million real estate-owned asset.
- The effect of LIBOR transition, interest-rate floors and borrowing costs on future net interest margin.
- Any subsequent filings that update COVID-19 impacts, lender amendments, margin calls, loan restructurings, dividend policy or additional equity or debt issuance.