Ares Commercial Real Estate Corp quarterly report, Q2 FY2022

Ares Commercial Real Estate Corporation — Q2 2022 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 loans and related investments. The filing covers the quarter and six months ended June 30, 2022; financial statements are unaudited and presented under U.S. GAAP.

At June 30, 2022, the portfolio comprised 78 loans with $2.6 billion of outstanding principal and $2.6 billion of carrying value. Senior mortgage loans represented nearly all of the portfolio. Approximately 91.3% of loans had LIBOR or SOFR floors, with a weighted-average floor of 0.95%.

Financial performance and key metrics

Metric	Q2 2022	Q2 2021	Six months 2022	Six months 2021
Total revenue	$25.1 million	$23.5 million	$49.2 million	$44.8 million
Net interest margin	$25.1 million	$19.8 million	$46.5 million	$38.3 million
Total expenses	$7.2 million	$9.4 million	$17.8 million	$17.9 million
CECL provision	$7.8 million	$(3.9) million	$7.2 million	$(7.1) million
Net income	$10.0 million	$17.6 million	$26.2 million	$33.4 million
Diluted EPS	$0.20	$0.43	$0.53	$0.88
Dividend declared per share	$0.35	$0.35	$0.70	$0.70

Q2 net interest margin increased primarily because of larger earning assets and borrowings, benefits from interest-rate hedges, and accelerated recognition of deferred fees and prepayment penalties on repaid loans. The higher CECL provision and the absence of hotel operating income reduced net income and EPS.

Six-month net cash provided by operating activities was $29.2 million, compared with $19.8 million in the prior-year period. Investing cash flow was $(76.2) million, reflecting $523.7 million of loan fundings partly offset by $400.4 million of principal repayments and $38.2 million of hotel-sale proceeds. Financing cash flow was $22.1 million.

Cash and cash equivalents declined to $25.6 million from $50.6 million at December 31, 2021. Total assets were $2.70 billion and stockholders’ equity was $786.0 million at June 30, 2022.

Debt, liquidity and capital structure

Financing Agreements had $1.003 billion outstanding against $1.430 billion of total commitments, excluding consolidated CLO debt and secured borrowings.
Secured funding agreements totaled $853.1 million outstanding against $1.280 billion of commitments.
Secured term loan principal was $150.0 million, bearing a fixed rate of 4.50% through May 2025 and maturing in November 2026.
Consolidated CLO securitization debt had a carrying value of $851.3 million and outstanding principal of approximately $853.8 million.
Secured borrowings had a carrying value of $22.6 million.
Total unfunded loan commitments were $285.1 million, compared with $233.7 million at December 31, 2021.
Management reported approximately $192 million of liquidity as of July 28, 2022, comprising $117 million of unrestricted cash and $75 million of secured-funding availability.
The company stated that it was in compliance with all financing covenants at June 30, 2022 and expected primary liquidity sources to cover operating and cash commitments for at least the next 12 months.

Material changes versus prior periods

Loans held for investment increased to $2.606 billion from $2.414 billion at year-end 2021, driven by new originations and acquisitions exceeding repayments.
The CECL reserve for funded loan balances increased to $27.6 million from $23.9 million at year-end 2021. Including the $4.8 million reserve for unfunded commitments, total CECL reserves were $32.4 million, or 111 basis points of total loan commitments.
Two loans with a carrying value of $44.8 million were on non-accrual status at June 30, 2022. The filing states that all other loans were paying according to contractual terms, except for disclosed defaults and modifications.
Real estate owned declined to zero after the company sold its New York hotel property on March 1, 2022, recognizing a $2.2 million gain for the six-month period.
The company issued 7.0 million common shares in May 2022, generating approximately $103.2 million of net proceeds. It also sold 190,369 shares through its at-the-market program for approximately $2.9 million.
Net income declined 43% year over year in Q2 and 21% for the six-month period, despite higher net interest margin, primarily because of the CECL provision, the prior-year benefit from a CECL reversal, and the absence of hotel income.
Comprehensive income was $12.0 million in Q2 2022 and $35.8 million for the six-month period, including derivative-related other comprehensive income of $1.9 million and $9.5 million, respectively.

Guidance, outlook, risks and unusual items

The company provided no quantitative earnings guidance. It expects to continue using financing, equity offerings, loan repayments and operating cash flow to fund investments, distributions and other obligations. Its stated leverage objective is not to exceed approximately 4.5-to-1 debt-to-equity, although its charter and bylaws do not impose a leverage limit.

Management’s CECL estimate incorporates a recessionary macroeconomic scenario and remains subject to significant uncertainty.
Key risks include higher interest rates, inflation, recession, declining commercial real estate values, borrower defaults, delayed refinancings, slower prepayments, liquidity constraints and margin calls.
Two loans were non-accrual. One California residential loan was in maturity default, and one Illinois hotel loan was in default because required reserve deposits were not made, although contractual interest payments were current on that loan.
The company’s CLO investments retain first-loss exposure; maximum risk of loss related to the consolidated CLO structures was $238.2 million at June 30, 2022.
Rising rates may increase borrowing costs and pressure borrowers’ debt-service capacity. A hypothetical 100-basis-point increase in 30-day LIBOR or SOFR was estimated to increase annual net income by $12.0 million, while a zero-rate scenario was estimated to reduce annual net income by $3.2 million, assuming other conditions remained unchanged.
Subsequent to quarter-end, the company extended the MetLife Facility to August 13, 2023, approved a potential $50 million share-repurchase program, entered into a $105 million recourse loan secured by a $133 million multifamily mortgage loan, and declared a Q3 dividend of $0.35 per share.
The company reported no material pending legal proceedings, no material changes to previously disclosed risk factors, and effective disclosure controls as of June 30, 2022.

Important facts for investors to verify

Whether the two non-accrual loans and the disclosed maturity or covenant defaults result in additional impairments, modifications or realized losses.
Changes in the $32.4 million CECL reserve as macroeconomic conditions and commercial real estate performance evolve.
Refinancing and extension risk for secured facilities, particularly facilities with near-term maturities and margin-call provisions.
The effect of rising LIBOR/SOFR, borrower interest-rate caps and floors, and hedge performance on net interest margin and distributable earnings.
Whether cash flow, available financing and equity-market access remain sufficient to fund $285.1 million of unfunded commitments while maintaining dividends.
The economic impact of the external management agreement, including base and incentive fees and the July 2022 amendments.
The conditions and financial effects of the $50 million repurchase authorization and the subsequent $105 million recourse financing.