Ares Commercial Real Estate Corporation — 3Q 2016 Form 10-Q Summary
Business context and reporting period
ACRE is an externally managed specialty finance company focused primarily on originating and investing in commercial real estate loans and related investments. The company is taxed as a REIT and reports one operating segment following the sale of its mortgage banking subsidiary.
The filing covers the quarter and nine months ended September 30, 2016. Financial statements are unaudited and include consolidated variable interest entities.
Financial performance and key metrics
| Metric | Three months ended September 30 | Nine months ended September 30 |
|---|---|---|
| Interest income | $20.8 million, versus $20.9 million in 2015 | $58.5 million, versus $65.1 million |
| Interest expense | $9.0 million, versus $8.7 million | $26.0 million, versus $27.6 million |
| Net interest margin | $11.8 million, versus $12.2 million | $32.5 million, versus $37.5 million |
| Continuing operations income | $7.7 million, versus $8.7 million | $21.7 million, versus $27.3 million |
| Net income attributable to common stockholders | $18.4 million, or $0.65 per diluted share | $32.3 million, or $1.13 per diluted share |
| Dividends declared per share | $0.26 | $0.78 |
The quarter included $10.2 million of gain on the sale of discontinued operations. Excluding the discontinued-operations gain, continuing-operations earnings were broadly stable on a sequential comparison basis but below the prior-year period. Operating expenses were $3.9 million in the quarter and $10.6 million for the nine months, compared with $3.5 million and $10.3 million, respectively, in 2015. The increase primarily reflected incentive fees and higher professional fees.
Net interest margin as a percentage of interest income was approximately 56.6% for the quarter and 55.6% for the nine months, compared with approximately 58.4% and 57.6% in the respective 2015 periods. These are analytical calculations based on reported figures.
Balance sheet, portfolio, debt and liquidity
- Total assets were $1.57 billion at September 30, 2016, compared with $1.38 billion at December 31, 2015.
- Loans held for investment were $1.47 billion, including $1.43 billion in the company’s portfolio excluding third-party non-controlling interests, versus $1.17 billion at year-end 2015.
- The investment portfolio comprised $1.27 billion of senior mortgage loans and $166.0 million of subordinated debt and preferred equity investments at outstanding principal. The weighted-average interest rate was 5.4% and the weighted-average unleveraged effective yield was 6.1%.
- Approximately 81.2% of loans had LIBOR floors, with a weighted-average floor of 0.36%. All loans were reported as paying according to contractual terms, and no impairment charges were recognized during the quarter or nine-month period.
- Total liabilities were $1.10 billion and total equity was $465.3 million at September 30, 2016.
- Secured funding agreements totaled $879.1 million, secured term-loan debt was $149.3 million carrying value, and consolidated CLO debt was $57.8 million. Total financing-agreement commitments were $1.35 billion, with $1.03 billion outstanding.
- Cash and cash equivalents were $41.8 million, compared with $5.1 million at December 31, 2015. Unfunded portfolio commitments were $94.6 million.
- For the nine months, operating cash flow was $0.2 million, investing cash flow was negative $242.5 million, financing cash flow was positive $275.0 million, and cash increased by $32.8 million.
- As of November 2, 2016, management reported approximately $132 million of capital in cash or approved undrawn borrowing capacity, or approximately $122 million after reserving $10 million for liquidity requirements. Management estimated potential capacity to fund approximately $425 million of additional senior loans, assuming 2.5-to-1 debt-to-equity leverage.
Material changes versus the prior comparable period
- Nine-month net interest margin declined $5.0 million, primarily because of lower weighted-average earning assets and lower interest income attributable to non-controlling interests.
- The loan portfolio expanded materially, with $784.3 million of principal funded and $481.2 million repaid during the nine months.
- ACRE originated several large senior loans during the quarter, including loans secured by diversified, multifamily, office, retail and self-storage properties.
- Financing capacity increased through amendments to the Wells Fargo and BAML facilities, an accordion feature on the Citibank facility, and a new $125 million U.S. Bank facility. ACRE also drew the remaining $80 million under its secured term loan.
- The $75 million July 2014 City National Bank facility was repaid in full, and the December 2014 UBS facility had previously been repaid in full.
- The company repurchased 129,916 common shares for approximately $1.4 million at an average price of $11.06 per share.
Discontinued operations, outlook and risks
On September 30, 2016, ACRE sold ACRE Capital Holdings, the holding company for its mortgage banking subsidiary, to Barings Real Estate Advisers for approximately $93 million in cash, subject to post-closing working-capital adjustments. The company recorded a net gain of approximately $10.2 million. The transaction removed the mortgage banking business, related assets and liabilities from continuing operations and provided capital for reinvestment in the core commercial real estate lending business.
Management declared a fourth-quarter 2016 dividend of $0.26 per common share on November 3, 2016, payable January 17, 2017. The filing does not provide formal earnings or dividend guidance beyond the stated REIT distribution objectives and available-capital commentary.
- Key risks include borrower defaults, declining commercial real estate values, credit losses, loan prepayments, refinancing and extension risk, and concentration in commercial real estate collateral.
- Financing risk includes dependence on secured funding, repurchase facilities and securitizations, lender discretion over eligible collateral, covenant compliance, facility maturities and potentially higher borrowing costs.
- Although assets and liabilities are generally floating-rate and index matched, mismatches in rate floors, caps and funding costs could reduce net interest margin. Management estimated that a 100-basis-point increase in average 30-day LIBOR would increase net interest margin by approximately $0.4 million for the quarter and $1.7 million for the nine months, subject to portfolio composition and applicable floors.
- Principal repayments in the CLO are applied first to senior CLO notes, delaying cash proceeds to ACRE until those notes are repaid.
- The company remains subject to REIT qualification, Investment Company Act exemption, tax, regulatory, market and liquidity risks. No material changes to previously disclosed risk factors were reported.
- The filing reported no material pending legal proceedings, no defaults upon senior securities and effective disclosure controls as of September 30, 2016.
Important facts for investors to verify
- Reconcile reported earnings with recurring continuing-operations performance, excluding the $10.2 million sale gain and other discontinued-operations effects.
- Monitor portfolio credit quality, collateral values, loan maturities, unfunded commitments and the absence or emergence of impairment charges.
- Review facility maturities, extension conditions, advance rates, covenants and the concentration of borrowings under repurchase and secured funding arrangements.
- Assess whether the reported $122 million of deployable capital and estimated $425 million of potential loan capacity are realized without excessive leverage or reduced liquidity.
- Evaluate the sustainability of the $0.26 quarterly dividend against recurring earnings, REIT taxable income, cash flow and debt-service requirements.
- Review related-party management, incentive-fee and expense-reimbursement arrangements, including the 1.5% base management fee and 20% incentive-fee structure.