Business Context and Reporting Period
Ares Commercial Real Estate Corporation is a recently formed, externally managed specialty finance company focused on originating, investing in and managing middle-market commercial real estate loans and related debt investments. The company commenced operations on December 9, 2011 and intends to qualify as a REIT beginning with its 2012 taxable year.
This unaudited Form 10-Q covers the three months ended March 31, 2012. Because operations began during the prior quarter, management states that there is no comparable prior-period operating history.
Financial Results and Position
| Metric | Three months ended March 31, 2012 |
|---|---|
| Interest income | $949 thousand |
| Interest expense | $339 thousand |
| Net interest margin | $610 thousand |
| Total operating expenses | $102 thousand |
| Net income | $508 thousand |
| Preferred dividend and redemption-premium accretion | $624 thousand |
| Net loss allocable to common stockholder | $116 thousand |
| Basic and diluted loss per common share | $0.12 |
| Common dividend declared per share | $0.30 |
| Net cash used in operating activities | $221 thousand |
| Net cash used in investing activities | $72.249 million |
| Net cash provided by financing activities | $75.816 million |
At March 31, 2012, total assets were $84.901 million, including $77.251 million of loans held for investment and $4.586 million of cash and cash equivalents. Total liabilities were $49.335 million and stockholders’ equity was $29.271 million.
The loan portfolio consisted of $69.393 million of senior mortgage loans and $7.858 million of subordinated debt investments, with a weighted-average coupon of 6.5% and weighted-average life of 3.1 years. All loans were paying according to their terms, and no impairments or troubled debt restructurings were reported.
Secured financing totaled $47.289 million against aggregate facility commitments of $125 million: $43.751 million under Wells Fargo and $3.538 million under Citibank. Available borrowing capacity totaled approximately $31.249 million and $46.462 million, respectively. The company reported compliance with all financial covenants.
Material Changes Versus the Prior Comparable Period
- No comparable quarterly operating period exists because the company commenced operations on December 9, 2011.
- Loans held for investment increased from $4.945 million at December 31, 2011 to $77.251 million at March 31, 2012, primarily from $72.945 million of originations and $202 thousand of additional funding.
- Total assets increased from $7.587 million to $84.901 million, while secured financing increased from zero to $47.289 million.
- Common equity increased through the issuance of 1.5 million shares to Ares Investments Holdings LLC for $30 million. The company also issued $5.723 million of Series A convertible preferred stock and recorded $572 thousand of redemption-premium accretion.
- Cash increased from $1.240 million to $4.586 million despite substantial loan funding, supported by equity and secured-financing proceeds.
Guidance, Outlook, Commentary and Risks
Management expects to use leverage, subject to market conditions and covenants, to fund target investments and currently expects debt-to-equity leverage generally not to exceed 4-to-1. The company intends to make regular quarterly distributions, but distributions remain subject to operating needs, debt service, available cash and board authorization.
Subsequent to quarter-end, the company completed its initial public offering on May 1, 2012, selling 7.7 million shares at $18.50 per share for $142.45 million of gross proceeds and approximately $139.4 million of net proceeds. Approximately $47.3 million was used to repay the Wells Fargo and Citibank facilities, and approximately $6.3 million was used to redeem all Series A preferred stock.
Following the IPO, Citibank facility availability was increased to $86.225 million, Wells Fargo facility availability was increased to $172.45 million, and the company entered into a new $50 million Capital One facility. No amounts were outstanding under these facilities as of May 31, 2012.
The company’s principal risks include borrower defaults, declines in commercial real estate values, refinancing and extension risk, interest-rate and LIBOR/index mismatch risk, funding and liquidity constraints, reliance on external management, dependence on investment opportunities, and the ability to maintain REIT qualification and exemption from registration under the Investment Company Act. Failure to qualify as a REIT could result in corporate-level income taxes and jeopardize future qualification.
The company had $20.748 million of unfunded loan commitments at March 31, 2012. It also disclosed potential indemnification obligations that could be unlimited, although no legal proceedings were pending and management reported no known claims.
The post-IPO management agreement provides Ares Commercial Real Estate Management LLC with a base management fee of 1.5% of defined stockholders’ equity, a potential incentive fee equal to 20% of specified excess Core Earnings, expense reimbursements and, under certain circumstances, a termination fee equal to three times the average annual base and incentive fees.
Important Facts for Investors to Verify
- Verify the post-IPO capital deployment plan, including how the approximately $85.8 million remaining after debt repayment and preferred redemption was invested.
- Monitor portfolio credit performance, collateral values, borrower business plans and the $20.748 million of unfunded commitments.
- Review facility covenants, borrowing-base requirements, liquidity minimums, interest-rate spreads and future refinancing obligations.
- Assess the effect of the external management agreement, including base fees, incentive fees, reimbursable expenses and termination provisions.
- Confirm the company’s continuing compliance with REIT distribution, asset, income and ownership requirements.
- Evaluate whether dividends are supported by recurring cash earnings rather than equity proceeds or additional borrowings, particularly given the quarter’s loss allocable to common stockholders.
- Consider that the reported quarter reflects an early-stage portfolio and has no comparable prior-quarter operating results.