Ares Commercial Real Estate Corporation: Q2 2021 Form 10-Q Summary
Business context and reporting period
Ares Commercial Real Estate Corporation is an externally managed REIT and specialty finance company focused on originating and investing in commercial real estate debt, including senior mortgage loans, subordinated debt, preferred equity, mezzanine loans and related investments. The filing covers the quarter and six months ended June 30, 2021; financial statements are unaudited.
Key financial metrics
| Metric | Q2 2021 | Q2 2020 | Six months 2021 | Six months 2020 |
|---|---|---|---|---|
| Total revenue | $23.5 million | $18.0 million | $44.8 million | $39.1 million |
| Net interest margin | $19.8 million | $16.8 million | $38.3 million | $32.7 million |
| Net income attributable to common stockholders | $17.6 million | $9.8 million | $33.4 million | $(7.5) million |
| Diluted earnings per share | $0.43 | $0.29 | $0.88 | $(0.23) |
| Dividends declared per share | $0.35 | $0.33 | $0.70 | $0.66 |
| Net cash provided by operating activities | Not separately presented for the quarter | $19.8 million | $14.2 million |
Q2 revenue increased approximately 31% year over year, while net income increased approximately 80%. The six-month period shifted from a loss to a profit, primarily reflecting lower credit-loss provision expense and the absence of 2020 unrealized losses on loans held for sale. Net income margins were approximately 75% of revenue for both the quarter and six months, although this comparison is affected by credit-loss provisions and other non-operating items.
At June 30, 2021, total assets were $2.26 billion, including $2.03 billion of loans held for investment, net of a $16.9 million funded-loan CECL reserve, and $36.9 million of real estate owned. Stockholders’ equity was $679.0 million, compared with $473.0 million at December 31, 2020. Cash and cash equivalents were $75.7 million.
- The loan portfolio comprised 53 loans with approximately $2.04 billion of outstanding principal and a 6.1% weighted-average unleveraged effective yield.
- Senior mortgage loans represented approximately $2.00 billion of carrying value; subordinated debt and preferred equity represented $30.9 million.
- Approximately 97.2% of loans had LIBOR floors, with a 1.36% weighted-average floor.
- Total debt reflected on the balance sheet was approximately $1.55 billion, including $979.8 million of consolidated CLO securitization debt. Debt-to-equity was approximately 2.3x.
- The total CECL reserve, including unfunded commitments, was $18.1 million, or 81 basis points of total loan commitments. The reserve declined from $23.6 million at December 31, 2020.
- Unfunded loan commitments increased to $193.7 million from $187.8 million at year-end 2020.
Material changes versus prior comparable periods
- Interest income was broadly stable for the six-month period at $61.6 million versus $61.3 million, while interest expense declined to $23.2 million from $28.6 million. Management attributed the improvement to LIBOR floors and the January 2021 securitization, which helped replace higher-cost debt.
- The six-month CECL provision was a $7.1 million benefit or reversal, compared with $23.1 million of provision expense in the prior-year period. Management cited improved macroeconomic forecasts, shorter average loan terms and portfolio payoffs.
- Q2 revenue from the hotel property classified as real estate owned increased to $3.8 million from $1.2 million as occupancy and hotel activity recovered. Six-month hotel revenue remained $6.4 million in both periods.
- Operating expenses increased to $9.4 million in Q2 from $8.1 million, driven primarily by higher management and incentive fees and hotel operating costs. Six-month operating expenses declined to $17.9 million from $19.3 million, mainly because 2020 included higher hotel operating expenses.
- The Company issued 7.0 million common shares in March and 6.5 million shares in June, generating aggregate net proceeds of approximately $202.3 million. Shares outstanding increased to 47.0 million at June 30, 2021 from 33.4 million at year-end 2020.
- Secured funding agreement borrowings declined to $404.2 million from $755.6 million, while CLO securitization debt increased to $979.8 million from $443.9 million. The Company also repaid $50.0 million of its secured term loan and increased the Morgan Stanley facility commitment to $250.0 million.
Guidance, outlook, risks and unusual items
The filing does not provide formal earnings guidance. Management expects to continue originating and acquiring commercial real estate loans and generally expects leverage not to exceed a 4-to-1 debt-to-equity ratio, subject to market conditions, liquidity and portfolio considerations.
- As of July 29, 2021, management reported approximately $57 million of liquidity, consisting of $2 million of unrestricted cash and $55 million of availability under secured funding agreements. This differs from the June 30 balance-sheet cash figure and should be reconciled to restricted cash and subsequent cash activity.
- COVID-19 remains a principal risk. Borrower defaults, delayed repayments, lower property values, slower prepayments, additional CECL reserves and reduced financing availability could adversely affect earnings and liquidity.
- One loan with a $31.3 million carrying value was on non-accrual status at June 30, 2021. Two additional loans were in maturity default but remained on accrual status because management concluded that collateral and other expected recoveries supported collectability.
- Financing agreements contain margin-call, covenant, cross-default and acceleration provisions. Failure to satisfy requirements could lead to additional collateral requirements, debt repayment demands or enforcement against collateral.
- The CLO structures contain senior overcollateralization tests. Failure of those tests could redirect cash otherwise payable to the Company’s subordinate interests toward senior note repayment.
- The Company uses interest-rate hedges, including an $870 million interest-rate swap and a $275 million interest-rate cap. Management estimates that a 100-basis-point immediate increase in 30-day LIBOR would increase annual net income by approximately $0.7 million, while a 50-basis-point increase would reduce it by approximately $0.7 million under the stated assumptions.
- The Company declared a third-quarter 2021 dividend of $0.35 per share, consisting of a regular $0.33 dividend and a supplemental $0.02 dividend, payable October 15, 2021.
- Subsequent to quarter-end, the Company purchased or originated several loans with stated commitments totaling more than $250 million, although actual funded balances were lower for certain transactions.
- The Company reported effective disclosure controls and no material pending legal proceedings or material changes in internal control over financial reporting.
Important facts for investors to verify
- Reconcile the reported $75.7 million of June 30 cash and cash equivalents with the $57 million of liquidity reported as of July 29, including restricted cash and available borrowing capacity.
- Review the maturity, extension and repayment status of the Citibank facility, secured term loan and other financing arrangements, particularly the December 2021 secured term-loan maturity.
- Monitor the $31.3 million non-accrual loan and the two maturity-defaulted loans, including collateral values, modifications and eventual recoveries.
- Assess CECL sensitivity to renewed COVID-19 effects, property-level deterioration, borrower defaults and changes in macroeconomic forecasts.
- Evaluate the effect of the two 2021 equity offerings on per-share earnings, dividends, book value and management fees.
- Review CLO overcollateralization tests, cash-flow priority and the Company’s $238.2 million stated maximum risk of loss related to the consolidated CLO securitizations.
- Assess LIBOR replacement risk, including the effect on loan yields, financing costs, hedges and contractual fallback provisions.