Ares Commercial Real Estate Corporation — Q3 2012 Form 10-Q Summary
Business context and reporting period
The filing covers the quarter and nine months ended September 30, 2012. ACRE commenced investment operations on December 9, 2011 and completed its initial public offering on May 1, 2012. The company originates, invests in and manages middle-market commercial real estate loans, including transitional senior, stretch senior, subordinate and mezzanine debt. It is externally managed by Ares Commercial Real Estate Management LLC and intends to qualify as a REIT for the 2012 tax year.
Because the company was recently organized and completed its IPO during the period, management states that there is no comparable prior-period operating history and that current results are not indicative of fully implemented operations.
Key financial metrics
| Metric | Three months ended September 30, 2012 | Nine months ended September 30, 2012 |
|---|---|---|
| Interest income | $1.889 million | $4.397 million |
| Interest expense | $0.398 million | $1.090 million |
| Net interest margin | $1.491 million | $3.307 million |
| Total expenses | $2.045 million | $3.528 million |
| Net income (loss) | $(0.554) million | $(0.221) million |
| Net loss attributable to common stockholders | $(0.554) million | $(0.895) million |
| Loss per diluted common share | $(0.06) | $(0.16) |
| Dividends declared per common share | $0.06 | $0.17 |
| Core earnings (loss), non-GAAP | $(0.418) million | $(0.693) million |
Average earning assets were $98.2 million in the third quarter and $74.2 million for the nine-month period. Average secured funding agreements were $4.3 million and $15.6 million, respectively. No incentive fee was earned during the nine months.
Balance sheet, portfolio and liquidity
- Total assets were $220.3 million at September 30, 2012, compared with $7.6 million at December 31, 2011.
- Cash and cash equivalents were $24.0 million, plus $1.9 million of restricted cash.
- Loans held for investment totaled $190.5 million, up from $4.9 million at year-end 2011. Outstanding principal was $192.5 million, with a weighted-average interest rate of 6.7%, unleveraged effective yield of 7.2% and remaining life of 3.2 years.
- The portfolio comprised $168.4 million of senior mortgage loans and $22.1 million of subordinated and mezzanine debt.
- Secured funding agreements totaled $48.8 million against aggregate commitments of $308.7 million: Wells Fargo $30.0 million, Citibank $4.4 million and Capital One $14.4 million.
- Stockholders’ equity was $166.7 million, compared with $6.4 million at December 31, 2011.
- Operating activities provided $0.3 million of cash. Investing activities used $185.4 million, primarily for loan fundings, while financing activities provided $207.9 million, primarily from equity offerings and secured borrowings. Ending cash increased to $24.0 million.
Material changes versus the prior comparable period
- The loan portfolio expanded substantially through new originations, including loans in Texas, Massachusetts, Florida, New York, Arizona, Georgia and Miami.
- The IPO generated approximately $142.5 million of gross proceeds and $139.1 million of net proceeds. Approximately $47.3 million was used to repay secured borrowings and $6.3 million to redeem all Series A convertible preferred stock.
- Common shares outstanding increased to 9.267 million at September 30, 2012 from none reported at December 31, 2011, reflecting private issuances, the IPO and equity incentive awards.
- Secured funding commitments increased from $125.0 million at year-end 2011 to $308.7 million at September 30, 2012, while outstanding borrowings increased to $48.8 million.
- Unfunded investment commitments increased to $25.9 million from $5.9 million at year-end 2011.
- All loans were reported as paying according to their terms, and no loan impairments were recorded during the three or nine months ended September 30, 2012.
Guidance, outlook, commentary and risks
Management expects to use secured financing, warehouse or repurchase facilities, securitizations and additional equity or debt offerings to fund portfolio growth. Its stated target is to generate returns primarily through dividends and distributions, with potential secondary capital appreciation. Management currently expects leverage not to exceed a 4-to-1 debt-to-equity ratio, subject to market and portfolio conditions.
As of November 6, 2012, management reported approximately $29.9 million of unrestricted cash, $3.6 million of restricted cash and $48.7 million of available, subject to conditions, under approved but undrawn secured funding capacity. Required minimum liquidity was $20.0 million. Management estimated approximately $58.6 million of capital available for investments, unfunded commitments and working capital, with potential capacity to fund approximately $100 million to $150 million of additional senior loans and existing commitments at 1-to-1 to 2-to-1 debt-to-equity.
The board declared a fourth-quarter 2012 dividend of $0.25 per common share, payable January 10, 2013. Subsequent to quarter-end, ACRE originated loans totaling approximately $48.9 million of commitments in Cincinnati and Arlington, Virginia.
- Portfolio concentration is significant: the company held 10 loans, and a default or impairment of a small number of loans could materially affect earnings and book value.
- Credit performance depends on borrower execution, property values, occupancy, leasing, refinancing markets and broader commercial real estate conditions.
- Borrowings generally bear interest at LIBOR-based rates; interest-rate increases, index mismatches, loan-rate floors and caps could reduce net interest income.
- Secured facilities contain financial covenants, including minimum tangible net worth, liquidity and financial ratios. Fixed-charge coverage testing begins no later than the quarter ending June 30, 2013 or earlier if loans held for investment exceed $200 million.
- Distributions may exceed earnings or operating cash flow during the portfolio build-out and could be funded with offering proceeds, borrowings or asset sales.
- Failure to qualify as a REIT could subject the company to corporate-level federal and state taxes and restrict future REIT qualification.
- Ares Investments, an affiliate of the Manager, owned approximately 21.6% of the common stock, creating significant ownership concentration and related-party considerations.
- The company had no pending legal proceedings reported as of the filing, and no defaults upon senior securities.
Most important facts for investors to verify
- Whether loan growth and future originations produce positive Core Earnings and GAAP earnings after management fees, reimbursements and financing costs.
- Portfolio credit quality, property-level performance, loan-to-value ratios and the absence of impairments as the portfolio seasons.
- Compliance with secured-facility covenants and the availability of committed borrowing capacity.
- Whether operating cash flow is sufficient to support the declared dividend, particularly given the nine-month net loss and distributions exceeding operating cash flow.
- The terms and economic impact of the external management agreement, including the 1.5% base management fee, expense reimbursements and potential termination fee.
- Progress toward REIT qualification and compliance with the requirement to distribute at least 90% of REIT taxable income.
- Future leverage, refinancing requirements and sensitivity of net interest income to LIBOR and other interest-rate movements.