Ares Commercial Real Estate Corporation — Q3 2017 Form 10-Q Summary
Business Context and Reporting Period
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. The filing covers the three and nine months ended September 30, 2017. The former mortgage banking subsidiary, ACRE Capital, was sold on September 30, 2016, and is presented as discontinued operations in the 2016 comparative periods.
Key Financial Metrics
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Interest income | $28.6 million | $20.8 million | $72.3 million | $58.5 million |
| Interest expense | $13.8 million | $9.0 million | $36.8 million | $26.0 million |
| Net interest margin | $14.7 million | $11.8 million | $35.5 million | $32.5 million |
| Operating expenses | $3.6 million | $3.9 million | $11.1 million | $10.6 million |
| Net income from continuing operations | $11.1 million | $7.7 million | $24.2 million | $21.7 million |
| Net income attributable to common stockholders | $11.1 million | $18.4 million | $24.2 million | $32.3 million |
| Basic and diluted EPS | $0.39 | $0.65 | $0.85 | $1.13 |
| Dividend per share | $0.27 | $0.26 | $0.81 | $0.78 |
The Q3 2017 net interest margin represented approximately 51.6% of interest income, compared with approximately 56.6% in Q3 2016, reflecting higher funding costs alongside portfolio growth.
- Total assets were $1.59 billion at September 30, 2017, up from $1.37 billion at December 31, 2016.
- Loans held for investment were $1.54 billion carrying value and $1.55 billion outstanding principal, compared with $1.31 billion and $1.32 billion, respectively, at year-end 2016.
- The portfolio contained 36 loans, with a weighted average unleveraged effective yield of 6.2%, weighted average minimum borrowing spread of 5.0% and weighted average remaining life of 1.8 years.
- Cash and cash equivalents were $28.2 million, down from $47.3 million at December 31, 2016. Restricted cash was $0.4 million.
- Total debt was approximately $1.15 billion, consisting of $730.2 million of secured funding agreements, $151.8 million of secured term loan debt and $271.0 million of consolidated CLO debt.
- Total equity was $420.5 million, compared with $429.7 million at December 31, 2016. Stockholders’ equity was $420.5 million, with no remaining third-party non-controlling interest after repayment of the ACRC KA investment in January 2017.
- Net cash provided by operating activities was $23.9 million for the nine months, while investing activities used $224.4 million and financing activities provided $181.5 million. Cash decreased by $19.0 million during the period.
Material Changes Versus Prior Comparable Period
- Q3 net interest margin increased 25.2% year over year, primarily because weighted average earning assets increased to approximately $1.6 billion from $1.2 billion. Interest expense also increased as average borrowings rose to approximately $1.2 billion from $850.9 million.
- Nine-month net interest margin increased 9.2% year over year, while continuing-operations net income increased 11.6%.
- Common-stockholder net income and EPS declined from the 2016 comparative periods because 2016 included $10.2 million of gain on the ACRE Capital sale and income from discontinued mortgage banking operations. No such amounts were recorded in 2017.
- During the first nine months, ACRE funded approximately $504.6 million of loan principal and received approximately $263.4 million of principal repayments, resulting in portfolio expansion.
- Financing capacity increased. Total commitments under the Financing Agreements rose to $1.59 billion from $1.35 billion, principally through expansions of the Wells Fargo and U.S. Bank facilities. MetLife also extended its initial maturity to August 2020 and reduced pricing to LIBOR plus 2.30%.
- Unfunded commitments on existing investments increased to $98.7 million from $69.2 million.
Guidance, Outlook, Risks and Unusual Items
The filing does not provide formal earnings guidance. Management stated that, as of October 31, 2017, approximately $190 million of capital was expected to be available in cash or undrawn secured-funding capacity. After a $10 million liquidity reserve, approximately $180 million was expected to be available for new loans, existing commitments and general corporate purposes. Assuming 2.5-to-1 debt-to-equity leverage, management estimated capacity to fund approximately $630 million of additional senior loans.
- Two senior mortgage loans, with principal balances of $159.2 million and $82.3 million, were in payment default because required property-related repayments were not made in September 2017. Both remained current on interest, and management recorded no impairment or non-accrual because of collateral values, operating cash flows and recourse guarantees.
- The company reported no impairment charges for the three or nine months ended September 30, 2017, but collateral values, borrower performance and recovery of the two defaulted loans remain material credit considerations.
- The March 2017 CLO securitization consolidated approximately $341.2 million of mortgage assets and $270.96 million of debt at September 30, 2017. ACRE retained subordinated notes and preferred equity totaling approximately $68.2 million and identified that amount as its maximum risk of loss from the structure.
- Interest-rate risk is significant. Approximately 89.3% of loans had LIBOR floors, with a weighted average floor of 0.61%. The portfolio is primarily floating-rate and funded with floating-rate liabilities, but mismatches, rate floors, caps and borrower stress could reduce earnings.
- Management expects leverage generally not to exceed a 4-to-1 debt-to-equity ratio, although the October 31, 2017 liquidity estimate assumed 2.5-to-1 leverage for incremental lending capacity.
- Subsequent events included a reduction in BAML Facility pricing to LIBOR plus 2.00%, an $18.3 million initial funding on a new Florida multifamily loan, and declaration of a $0.27 per-share fourth-quarter 2017 dividend.
- Management reported compliance with all financing covenants and no material pending legal proceedings. No material changes were reported to previously disclosed risk factors.
Most Important Facts for Investors to Verify
- Whether the two defaulted loans are resolved through repayment, collateral recovery, restructuring or enforcement, and whether future impairment charges become necessary.
- Portfolio credit quality, property-level operating performance, loan-to-value metrics and exposure to near-term maturities or extensions.
- Availability and terms of secured funding, CLO financing and facility extensions, including covenant compliance and collateral requirements.
- Whether rising short-term rates expand or compress net interest margin after considering LIBOR floors, financing spreads and borrower payment capacity.
- Coverage of the $0.27 quarterly dividend by recurring earnings and cash available for distribution after debt service and unfunded loan commitments.
- Actual deployment of the estimated $180 million of available capital and whether projected incremental loan capacity is achieved.
- The effect of the ACRE Capital sale and other discontinued-operation items when comparing 2017 earnings with 2016 results.