Ares Commercial Real Estate Corporation — Q1 2015 Form 10-Q Summary
Business context and reporting period
Ares Commercial Real Estate Corporation is an externally managed specialty finance company operating through two segments: principal lending in commercial real estate debt and mortgage banking through ACRE Capital. The company is taxed as a REIT and filed its unaudited quarterly report for the three months ended March 31, 2015. The company had 28,584,095 common shares outstanding as of May 6, 2015.
Key financial metrics
| Metric | Q1 2015 | Q1 2014 |
|---|---|---|
| Total revenue | $18.4 million | $13.8 million |
| Net interest margin | $13.0 million | $8.5 million |
| Mortgage banking revenue | $5.4 million | $4.6 million |
| Operating expenses | $9.8 million | $9.7 million |
| Income before taxes | $8.7 million | $4.1 million |
| Net income attributable to ACRE | $9.3 million | $4.8 million |
| Net income attributable to common stockholders | $7.1 million | $4.8 million |
| Basic and diluted EPS | $0.25 | $0.17 |
| Dividends declared per share | $0.25 | $0.25 |
| Net cash provided by operating activities | $125.6 million | $7.7 million |
Total revenue increased approximately 34%, while net income attributable to common stockholders increased approximately 49%. Net income attributable to common stockholders represented approximately 38% of revenue, compared with approximately 35% in the prior-year quarter. Operating income before taxes represented approximately 47% of revenue, compared with approximately 30% previously.
- Loans held for investment were $1.305 billion at March 31, 2015, down from $1.463 billion at December 31, 2014. The investment portfolio excluding third-party non-controlling interests had $1.231 billion of outstanding principal, a 5.4% weighted-average interest rate and a 5.9% weighted-average unleveraged effective yield.
- The company funded approximately $59.2 million of portfolio principal and received approximately $218.1 million of repayments during the quarter. No loan impairments were recorded, and management stated that all loans were paying according to contractual terms.
- Loans held for sale were $146.3 million, down from $203.0 million, while mortgage servicing rights were $58.5 million, broadly comparable with $58.9 million at year-end.
- Total assets were $1.590 billion, compared with $1.868 billion at December 31, 2014. Total equity was $487.2 million, including $84.1 million of non-controlling interests.
- Debt consisted primarily of $504.3 million of secured funding agreements, $139.7 million of warehouse lines, $68.5 million of convertible notes, $83.3 million of CMBS debt and $257.0 million of CLO debt. Aggregate reported debt was approximately $1.053 billion.
- Cash and cash equivalents were $9.0 million, supplemented by $30.3 million of restricted cash. Financing facility commitments totaled $1.292 billion, with $644.0 million outstanding.
Material changes versus the prior comparable period
- Net interest margin rose from $8.5 million to $13.0 million, primarily due to higher average earning assets, lower average borrowing costs following facility amendments and increased leverage. Average earning assets increased to approximately $1.3 billion from $1.1 billion.
- Mortgage banking revenue increased to $5.4 million from $4.6 million. Gains from mortgage banking activities increased to $4.1 million from $1.3 million, while net servicing fees declined to $3.9 million from $5.2 million and the MSR fair-value decline increased to $3.2 million from $1.8 million.
- ACRE Capital rate-locked 16 loans totaling $202.0 million, compared with two loans totaling $28.2 million in the prior-year quarter.
- Compensation and benefits increased to $4.6 million from $4.0 million, primarily due to higher commissions and employee turnover associated with the ACRE Capital restructuring. General and administrative expense declined to $1.8 million from $2.2 million.
- Operating cash flow benefited substantially from mortgage-loan activity: the company originated $162.2 million and sold $216.4 million of loans held for sale. Investing cash flow was $159.8 million, largely reflecting $218.1 million of portfolio loan repayments.
- Financing cash flow was negative $292.9 million, reflecting repayments of secured funding agreements, warehouse lines and consolidated VIE debt. Consolidated securitized debt declined from $527.7 million to $340.3 million.
- The company transferred $5.7 million of its preferred equity investment in ACRC KA Investor LLC to third-party institutional investors and increased the third-party non-controlling interest in that entity.
Guidance, outlook, commentary and unusual items
- No formal earnings guidance was provided. Management stated that leverage is currently expected not to exceed a 4-to-1 debt-to-equity ratio, subject to market conditions and other factors.
- As of May 6, 2015, management expected approximately $56 million of capital in cash or approved undrawn capacity. After reserving $10 million for liquidity requirements, approximately $46 million was expected to be available, supporting estimated capacity for $135 million to $180 million of additional senior loan investments at 2-to-1 to 3-to-1 leverage.
- Existing unfunded commitments for loans held for investment were approximately $135 million as of May 6, 2015.
- Subsequent events included a temporary increase in the BAML warehouse commitment to $185 million, a $36.5 million funded balance on a new New York hotel loan, additional Fannie Mae and Freddie Mac rate locks, and declaration of a $0.25 per-share second-quarter dividend.
- The company recorded $44 thousand of restructuring costs in Q1 2015, compared with $210 thousand in Q1 2014; management stated that the restructuring was otherwise complete at year-end 2014.
- Key risks include borrower defaults and collateral values, refinancing and liquidity risk, dependence on secured financing and securitizations, interest-rate and spread changes, prepayment risk, MSR valuation assumptions, Fannie Mae loss-sharing obligations, REIT qualification and the ability to maintain the 1940 Act exemption.
- The maximum quantifiable Fannie Mae loss-sharing allowance was $1.2 billion, although management stated this does not represent the expected actual loss. The recorded allowance for loss sharing was $11.7 million at March 31, 2015.
- A 100-basis-point change in the MSR discount rate was estimated to change MSR fair value by approximately $1.8 million. The company also disclosed that a single borrower represented approximately 17.6% of consolidated revenue in Q1 2015.
- The company reported compliance in all material respects with its financing facility covenants, no material pending legal proceedings and no material changes to previously disclosed risk factors.
Important facts for investors to verify
- Reconcile reported debt, available borrowing capacity and near-term facility maturities, particularly the July 2014 CNB Facility, the December 2014 UBS Facility, the Wells Fargo Facility and the $69 million convertible notes maturing in December 2015.
- Assess whether the sharp increase in operating cash flow was primarily transactional and therefore sustainable, given the significant loan sales, repayments and restricted-cash release.
- Review credit quality, collateral performance, loan concentrations, upcoming maturities and the absence of impairment charges against potential future losses.
- Evaluate the sensitivity of earnings and MSR values to interest rates, prepayments, discount rates and changes in financing spreads.
- Monitor Fannie Mae DUS loss-sharing exposure, the $11.7 million recorded allowance and the associated indemnification arrangements with the sellers of ACRE Capital.
- Confirm that earnings, taxable income, liquidity and financing capacity support the $0.25 quarterly dividend and future REIT distribution requirements.