Ares Commercial Real Estate Corporation — Q3 2020 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 company reports one operating segment and is managed by Ares Commercial Real Estate Management LLC, an affiliate of Ares Management Corporation. This filing covers the three and nine months ended September 30, 2020, with comparative periods ended September 30, 2019.
Key financial metrics
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Total revenue | $22.4 million | $19.8 million | $61.5 million | $55.7 million |
| Net interest margin | $18.8 million | $13.1 million | $51.5 million | $38.7 million |
| Net income attributable to common stockholders | $14.9 million | $9.0 million | $7.4 million | $27.3 million |
| Basic EPS | $0.45 | $0.32 | $0.23 | $0.96 |
| Dividends declared per share | $0.33 | $0.33 | $0.99 | $0.99 |
| Net cash from operating activities | Not separately provided | Not separately provided | $22.7 million | $24.9 million |
Q3 net income margin was approximately 66.7%, compared with 45.5% in Q3 2019. The nine-month net income margin was approximately 12.1%, compared with 49.1% in the prior-year period, primarily because of the 2020 CECL provision and loan-sale losses.
- Loans held for investment totaled $1.78 billion at September 30, 2020, before the $25.5 million funded-loan CECL reserve; outstanding principal was $1.79 billion across 49 loans.
- The loan portfolio had a weighted-average unleveraged effective yield of 6.3% and a weighted-average remaining life of 1.3 years. Subordinated debt and preferred equity investments had a 13.4% weighted-average yield.
- Cash and cash equivalents were $81.3 million, compared with $5.3 million at December 31, 2019. Management reported approximately $91 million of unrestricted cash as of October 28, 2020.
- Total stockholders’ equity was $469.3 million, compared with $426.3 million at December 31, 2019. Shares outstanding increased to 33.4 million from 28.9 million.
- Financing Agreements had $960.3 million outstanding against $1.40 billion of commitments. Including CLO debt of $443.9 million and secured borrowings of $54.6 million, reported debt-related obligations totaled approximately $1.46 billion.
- Net cash used in investing activities was $105.3 million, reflecting loan fundings exceeding repayments and loan-sale proceeds. Net cash provided by financing activities was $158.2 million, including $73.2 million from common stock issuance.
Material changes versus the prior comparable period
- Q3 net interest margin increased $5.6 million, or approximately 43%, due primarily to larger earning assets and borrowings and the benefit of LIBOR floors as short-term rates declined.
- Nine-month net interest margin increased $12.7 million, or approximately 33%, while interest expense declined to $40.5 million from $47.5 million.
- Nine-month net income declined $19.9 million because the company recorded a $22.1 million CECL provision and $4.0 million of realized losses on loans sold. The company adopted CECL on January 1, 2020, reducing retained earnings by $5.1 million.
- The Q3 CECL provision was a $1.0 million benefit, reflecting a lower estimated reserve from June 30 to September 30 due to portfolio changes, paydowns, reduced commitments and shorter average loan terms.
- Real estate-owned revenue declined to $3.6 million in Q3 from $6.7 million, and to $10.0 million for nine months from $17.0 million, primarily because COVID-19 materially reduced hotel occupancy and revenue.
- The company sold three loans with aggregate outstanding principal of approximately $101.0 million and recognized a $4.0 million loss. Management stated the sales were intended to rebalance and optimize the portfolio.
- The company raised approximately $72.9 million net from a January 2020 public offering of 4.6 million shares, contributing to higher equity and management fees.
Guidance, outlook, commentary and risks
- No quantitative earnings or dividend guidance was provided. The company continued to declare a quarterly dividend of $0.33 per share.
- COVID-19 created significant uncertainty for borrowers, property values, hotel operations, refinancing, collections and liquidity. Hospitality, student housing and retail exposures were identified as particularly affected.
- Three loans with a carrying value of $68.0 million were on non-accrual status at September 30, 2020, although management stated that all loans were paying in accordance with contractual terms. No loan was classified as risk rating 5; $157.0 million was risk-rated 4.
- The CECL reserve totaled $27.1 million, or 135 basis points of total loan commitments, including $25.5 million for funded balances and $1.7 million for unfunded commitments.
- The company completed four COVID-related loan modifications during Q3 covering approximately $108.0 million of principal. These included interest deferrals or capitalization, maturity extensions, covenant waivers and other amendments; none qualified as troubled debt restructurings.
- Unfunded loan commitments were $212.5 million. Management noted that funding activity could slow, but obligations to fund loans and service debt may continue.
- The Wells Fargo Facility, with $375.3 million outstanding, had an initial maturity date of December 14, 2020, subject to extensions. The $110.0 million Secured Term Loan also had an initial maturity date of December 22, 2020, subject to a one-year extension.
- Financing agreements include margin-call, collateral, covenant, cross-default and acceleration provisions. Management stated that the company was in compliance with all financial covenants at September 30, 2020.
- Approximately 95.2% of loans had LIBOR floors, compared with 18.1% of borrowings. Management estimated that a 100-basis-point immediate increase in 30-day LIBOR would reduce annual net income by approximately $11.9 million, assuming balances remained unchanged.
- The company was evaluating the impact of the planned transition away from LIBOR. Other risks include credit losses, declining collateral values, refinancing risk, reduced financing availability, prepayment and extension risk, hotel underperformance, REIT qualification and reliance on the external manager.
Investor verification checklist
- Verify the status and extension terms of the Wells Fargo Facility and Secured Term Loan, including collateral and covenant requirements.
- Monitor the three non-accrual loans, the $27.1 million CECL reserve and changes in risk ratings as COVID-19 effects evolve.
- Reconcile the $101.0 million of loan sales and $4.0 million realized loss to portfolio carrying values and future interest income.
- Assess liquidity relative to $212.5 million of unfunded commitments, upcoming debt maturities, margin-call exposure and dividend obligations.
- Evaluate hotel performance and the carrying value of the $37.5 million real estate-owned asset, for which no impairment had been recorded at September 30, 2020.
- Review the effect of the January equity issuance on per-share earnings, management fees, leverage and dividend coverage.
- Confirm future LIBOR replacement provisions and the sensitivity of asset yields and borrowing costs to interest-rate changes.