Ares Commercial Real Estate Corporation — Q2 2018 Form 10-Q Summary
Business context and reporting period
Ares Commercial Real Estate Corporation (“ACRE”) is an externally managed REIT focused on originating and investing in commercial real estate debt, including senior mortgage loans, subordinated debt, preferred equity and related investments. This unaudited Form 10-Q covers the three and six months ended June 30, 2018. ACRE had 28,698,600 common shares outstanding as of July 24, 2018.
Key financial metrics
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Interest income | $29.6 million, versus $22.6 million | $57.0 million, versus $43.8 million |
| Interest expense | $16.0 million, versus $12.2 million | $30.3 million, versus $23.0 million |
| Net interest margin | $13.6 million, versus $10.4 million | $26.8 million, versus $20.8 million |
| Net income attributable to common stockholders | $9.3 million, versus $6.7 million | $18.6 million, versus $13.2 million |
| Basic and diluted EPS | $0.33, versus $0.24 | $0.65, versus $0.46 |
| Dividends declared per share | $0.28, versus $0.27 | $0.56, versus $0.54 |
- Net interest margin increased approximately 31% in Q2 and 29% for the six-month period, primarily from higher average earning assets and borrowings.
- Interest income was approximately 46% of interest income in excess of interest expense in Q2 and approximately 47% for the six-month period; net income represented approximately 31% and 33% of interest income, respectively.
- Total assets were $1.82 billion at June 30, 2018, compared with $1.77 billion at December 31, 2017. Stockholders’ equity was $422.2 million, compared with $419.2 million.
- Loans held for investment totaled $1.746 billion carrying value and $1.757 billion outstanding principal, compared with $1.726 billion and $1.737 billion, respectively, at year-end 2017.
- The portfolio consisted of 45 loans, with a weighted-average minimum borrowing spread of 5.1%, unleveraged effective yield of 6.8% and remaining life of 1.8 years. Approximately 91.2% of loans had LIBOR floors, with a weighted-average floor of 1.00%.
- Total financing agreements were $1.111 billion at June 30, 2018, including $1.001 billion of secured funding agreements, $108.0 million of secured term loan debt and $271.4 million of CLO securitization debt. Total financing commitments were $1.541 billion.
- Cash, cash equivalents and restricted cash declined to $5.4 million from $28.7 million at December 31, 2017. Net cash provided by operating activities for the six months was $18.1 million.
- Six-month investing cash flow was negative $67.6 million, reflecting loan fundings exceeding repayments. Financing cash flow was positive $26.2 million.
- Unfunded loan commitments increased to $142.2 million from $110.2 million at year-end 2017.
Material changes versus the prior comparable period
- Q2 net income attributable to common stockholders increased 39% year over year; six-month net income increased 41%.
- Q2 interest income increased 31% and six-month interest income increased 30%, reflecting weighted-average earning assets of approximately $1.7 billion versus $1.4 billion in the comparable periods.
- Interest expense increased 31% in Q2 and 32% for the six-month period as average borrowings rose to approximately $1.4 billion and $1.3 billion, respectively, from approximately $1.0 billion.
- Total operating expenses increased to $4.2 million in Q2 from $3.7 million and to $8.0 million for six months from $7.5 million. The principal driver was higher incentive fees to the external manager; six-month general and administrative expenses also increased due to stock-based compensation.
- ACRE originated several loans during the second quarter, including senior mortgage loans of $39.2 million, $32.9 million, $68.1 million and $59.6 million, plus a $15.3 million mezzanine loan commitment.
- The company amended its BAML facility, extending the loan-request period to May 23, 2019 and the final maturity of individual loans to May 23, 2022. It also exercised a 12-month extension of the CNB facility to March 10, 2019.
- The quarterly dividend increased to $0.28 per share from $0.27. On July 26, 2018, ACRE declared a $0.29 per-share dividend for Q3 2018.
Guidance, outlook, risks and unusual items
- The filing does not provide formal earnings or revenue guidance. Management states that results depend on net interest income, asset values, commercial mortgage supply and demand, credit performance, financing availability and interest rates.
- One $38.6 million senior mortgage loan secured by a New York hotel was in maturity default at June 30, 2018 because the borrower did not repay at maturity. The loan remained current on regular interest payments, was not placed on non-accrual status and had no impairment charge based on collateral value and operating cash flows.
- No loan impairment charges were recognized during the quarter or six-month period. Except for the New York hotel loan, management stated that loans were paying according to contractual terms.
- The company is exposed to credit, commercial real estate, refinancing, prepayment, liquidity, leverage and interest-rate risks. Its financing is primarily floating-rate and generally indexed to LIBOR, while loan assets also commonly have LIBOR floors.
- Management estimates that, for the six-month period, a 100-basis-point increase in average 30-day LIBOR would have increased net interest margin by approximately $2.0 million, while a decline to zero basis points would have increased net interest margin by approximately $3.5 million. Actual effects depend on asset and liability composition and applicable floors and caps.
- Several financing facilities had 2018 or 2019 initial maturity dates, including Wells Fargo and Citibank facilities in December 2018 and the UBS facility in October 2018, although extension options were available subject to conditions and fees.
- The consolidated CLO had $271.4 million of debt and a maximum company risk of loss of $68.2 million, representing ACRE’s retained investment. CLO assets are restricted and the CLO debt generally has no recourse to ACRE’s other consolidated entities.
- ACRE’s external manager is entitled to a 1.5% annual base management fee, incentive fees and expense reimbursements. Q2 incentive fees were $610,000, compared with $113,000 in Q2 2017.
- The filing reports no material pending legal proceedings, no material changes to previously disclosed risk factors and compliance with all financing agreement covenants as of June 30, 2018.
Important facts for investors to verify
- Monitor the New York hotel maturity default, collateral valuation, cash flows and any subsequent modification, repayment or impairment.
- Review the maturity and extension conditions for the Wells Fargo, Citibank and UBS facilities and the company’s ability to refinance or renew them.
- Assess liquidity given only $5.4 million of cash and restricted cash, $142.2 million of unfunded loan commitments and substantial near-term funding obligations.
- Evaluate leverage, including approximately $1.38 billion of secured and CLO debt against $422.2 million of stockholders’ equity.
- Track loan repayments, new originations, portfolio concentration by property type and geography, and the effect of prepayments on future yields.
- Consider the impact of LIBOR movements, loan floors, borrowing costs and potential credit deterioration on net interest margin.
- Review external management fees, incentive fees, expense reimbursements and the management agreement’s termination fee provisions.
- Confirm the sustainability of dividends relative to REIT taxable income, operating cash flow, leverage and required debt service.