Ares Commercial Real Estate Corporation — Q1 2018 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 loans and related investments. The filing covers the unaudited three months ended March 31, 2018, compared with the three months ended March 31, 2017. The company had 28,598,916 common shares outstanding as of April 27, 2018.
Financial performance and position
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Interest income | $27.4 million | $21.1 million | +$6.3 million |
| Interest expense | $14.3 million | $10.8 million | +$3.5 million |
| Net interest margin | $13.1 million | $10.3 million | +$2.8 million |
| Total expenses | $3.7 million | $3.8 million | -$0.1 million |
| Net income attributable to common stockholders | $9.3 million | $6.5 million | +$2.9 million |
| Basic and diluted EPS | $0.33 | $0.23 | +$0.10 |
| Dividend per share | $0.28 | $0.27 | +$0.01 |
| Net cash from operating activities | $9.7 million | $6.2 million | +$3.5 million |
At March 31, 2018, total assets were $1.74 billion, including $1.66 billion of loans held for investment. Stockholders’ equity was $420.7 million. Cash and cash equivalents were $5.2 million, or $5.6 million including restricted cash.
The investment portfolio comprised 42 loans with $1.67 billion of outstanding principal and a $1.66 billion carrying amount. Senior mortgage loans represented $1.62 billion of principal, while subordinated debt and preferred equity represented $52.9 million. The portfolio had a weighted-average minimum borrowing spread of 5.0%, an unleveraged effective yield of 6.6%, and a weighted-average remaining life of 1.9 years. Approximately 86.8% of loans had LIBOR floors, with a weighted-average floor of 0.87%.
Total Financing Agreements outstanding were $1.04 billion, supported by $1.54 billion of total commitments. This included $929.5 million of secured funding agreements and $110.0 million of secured term debt. The company also consolidated $271.4 million of CLO securitization debt. The company reported compliance with all financing covenants at quarter-end.
Material changes versus the prior comparable period
- Net income attributable to common stockholders increased 44% to $9.3 million, and EPS increased to $0.33 from $0.23.
- Net interest margin increased 27%, primarily because weighted-average earning assets increased to approximately $1.7 billion from $1.3 billion. Weighted-average borrowings increased to approximately $1.3 billion from $983.9 million.
- Interest expense increased as a result of the higher borrowing base and the consolidated CLO. CLO-related interest expense increased to $2.3 million from $0.6 million.
- Operating expenses were broadly stable. No incentive fee was incurred in Q1 2018 compared with $0.3 million in Q1 2017.
- Loans held for investment declined from $1.73 billion at December 31, 2017 to $1.66 billion at March 31, 2018. The company funded approximately $77.3 million and received approximately $146.1 million of principal repayments during the quarter.
- Cash, cash equivalents and restricted cash declined by $23.1 million, compared with a $2.9 million decline in Q1 2017, primarily due to net financing cash outflows of $36.6 million.
- The company adopted the restricted-cash cash-flow presentation standard retrospectively in the first quarter of 2018.
Guidance, outlook, commentary, risks and unusual items
Management stated that it generally expects leverage not to exceed a 4-to-1 debt-to-equity ratio, although the charter and bylaws do not impose a leverage limit. No earnings or net-interest-margin guidance was provided.
The company declared a $0.28 per share dividend for the second quarter of 2018, payable July 17, 2018 to stockholders of record June 29, 2018. As a REIT, it generally intends to distribute at least 90% of REIT taxable income, subject to operating requirements and debt service.
Subsequent to quarter-end, the company originated a $38.5 million outstanding-principal senior mortgage loan on a South Carolina multifamily property and an $18.9 million outstanding-principal senior mortgage loan on an Illinois hotel property. Both loans carry floating rates based on LIBOR. The company also extended the CNB Facility maturity to March 10, 2019.
- The company had $119.6 million of unfunded loan commitments at March 31, 2018, compared with $110.2 million at December 31, 2017.
- All loans were paying in accordance with contractual terms, and no impairment charges were recorded during Q1 2018 or Q1 2017. However, the portfolio includes loans that previously experienced payment defaults and were modified or extended.
- Credit risk is concentrated in commercial real estate collateral. Declines in property values, borrower defaults, weaker operating cash flows, refinancing difficulties and lower recoveries could reduce earnings and liquidity.
- The business is exposed to LIBOR, financing costs, interest-rate caps and floors, prepayment risk, securitization repayment priorities and lender renewal or extension risk.
- Most borrowings are floating-rate and generally matched to floating-rate assets, but mismatches, rising borrowing costs or borrower stress from higher rates could reduce net interest income.
- The consolidated CLO has a first-loss position retained by the company. The company’s stated maximum risk of loss related to the CLO was $68.2 million.
- The external management agreement ends May 1, 2019 and automatically renews annually thereafter, subject to its terms. Termination under specified circumstances may require a fee.
- No material pending legal proceedings, material changes to previously disclosed risk factors, defaults upon senior securities or material control deficiencies were reported.
Important facts for investors to verify
- Validate the sustainability of the $0.28 quarterly dividend against recurring earnings, taxable income, cash flow and future loan repayments.
- Review upcoming financing maturities, extension conditions and unused capacity, particularly the BAML Facility’s May 24, 2018 availability date and the 2018 maturities of the Wells Fargo, Citibank and UBS facilities.
- Assess the $119.6 million of unfunded commitments and the company’s limited cash balance relative to funding needs and debt obligations.
- Examine collateral performance and modification status for previously delinquent loans, including the self-storage-related loans and other near-term maturities.
- Evaluate the CLO’s first-loss exposure, senior-note repayment priority and the $68.2 million maximum stated risk of loss.
- Reconcile portfolio carrying values, principal balances and Level 3 fair-value estimates, which depend on significant unobservable assumptions.
- Monitor the impact of LIBOR changes, interest-rate floors, prepayments and refinancing conditions on net interest margin and asset values.