Ares Commercial Real Estate Corporation — 2021 Q3 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 debt, including senior mortgage loans, subordinated debt, preferred equity and mezzanine investments. The filing covers the unaudited quarter and nine months ended September 30, 2021, compared with the same periods in 2020. The company reported 47,001,821 common shares outstanding as of November 2, 2021.
Key financial metrics
| Metric | Q3 2021 | Q3 2020 | Nine months 2021 | Nine months 2020 |
|---|---|---|---|---|
| Total revenue | $27.2 million | $22.4 million | $72.0 million | $61.5 million |
| Net interest margin | $21.4 million | $18.8 million | $59.7 million | $51.5 million |
| Net income attributable to common stockholders | $10.0 million | $14.9 million | $43.3 million | $7.4 million |
| Diluted earnings per share | $0.21 | $0.44 | $1.05 | $0.22 |
| Dividends declared per share | $0.35 | $0.33 | $1.05 | $0.99 |
| Net cash from operating activities | Not separately presented | Not separately presented | $30.3 million | $22.7 million |
As of September 30, 2021, total assets were $2.47 billion, including $2.34 billion of loans held for investment net of CECL reserves. Stockholders’ equity was $672.7 million, compared with $473.0 million at December 31, 2020. Cash and cash equivalents were $15.8 million, compared with $74.8 million at year-end 2020.
The loan portfolio comprised 64 loans with $2.4 billion of outstanding principal and a $2.36 billion carrying amount. The portfolio’s weighted-average unleveraged effective yield was 5.7%, or 5.8% for interest-accruing loans, with a weighted-average remaining life of 1.4 years. Approximately 94.8% of loans had LIBOR floors, with a weighted-average floor of 1.17%.
The CECL reserve totaled $24.5 million, consisting of a $22.7 million reserve against funded loans and a $1.8 million liability for unfunded commitments. The reserve represented 93 basis points of total loan commitments. Two loans with a combined carrying value of $45.3 million were on non-accrual status.
Debt, liquidity and capital
Total debt and financing obligations included $656.0 million of secured funding agreements, $47.4 million of notes payable, a $60.0 million secured term loan, $940.1 million of CLO securitization debt and $60.0 million of secured borrowings. Financing Agreement borrowings totaled $764.3 million against total commitments of $1.27 billion. The company stated that it was in compliance with all financial covenants as of September 30, 2021.
During the first nine months, the company funded approximately $891.3 million of loan principal and received approximately $340.4 million of principal repayments. Investing activities used $575.1 million of cash, while financing activities provided $485.8 million. Cash decreased by $59.0 million to $15.8 million at September 30, 2021.
As of November 2, 2021, management reported approximately $62 million of liquidity, consisting of approximately $3 million of unrestricted cash and $59 million of availability under secured funding agreements. Unfunded loan commitments were $256.8 million at September 30, 2021.
The company raised approximately $202.7 million through two public common-stock offerings: $100.7 million from 7.0 million shares issued in March 2021 and $101.6 million from 6.5 million shares issued in June 2021. It also issued approximately $540.5 million of CLO debt in January 2021 and repaid $50.0 million of its secured term loan in March 2021.
Material changes versus prior comparable periods
- Q3 total revenue increased 21.6% year over year, primarily because of higher interest income, a larger earning-asset base and improved hotel revenue.
- Q3 net interest margin increased to $21.4 million from $18.8 million, reflecting higher weighted-average earning assets and borrowings and the use of lower-cost securitization debt to repay more expensive financing.
- Q3 net income declined to $10.0 million from $14.9 million, and diluted EPS declined to $0.21 from $0.44. The principal offset was a $6.4 million CECL provision in Q3 2021 versus a $1.0 million CECL benefit in Q3 2020, together with higher operating and affiliate fees.
- Nine-month net income increased to $43.3 million from $7.4 million because the 2020 period included a $22.1 million CECL provision and $4.0 million of realized loan-sale losses, while the 2021 period recorded a $0.8 million CECL benefit.
- The loan portfolio expanded materially from a $1.82 billion carrying amount at December 31, 2020 to $2.36 billion at September 30, 2021. Total assets increased 27.8%, while stockholders’ equity increased 42.2%, primarily due to the two equity offerings and retained earnings.
- Management and incentive fees increased to $3.2 million in Q3 and $8.7 million for the first nine months, compared with $1.8 million and $5.8 million, respectively, in the comparable periods. The increase primarily reflected higher equity and incentive fees.
- Dividends increased to $0.35 per share per quarter, consisting of a regular $0.33 dividend and a $0.02 supplemental dividend, from $0.33 per share in Q3 2020.
Guidance, outlook, risks and unusual items
The filing does not provide specific earnings or revenue guidance. Management stated that it currently expects leverage generally not to exceed a 4-to-1 debt-to-equity ratio, subject to market conditions, liquidity, asset quality and financing availability.
The company continued to identify COVID-19, including the Delta variant, as a significant source of uncertainty. Hospitality, student housing and retail borrowers have experienced business disruption, cash-flow pressure and requests for interest deferrals, forbearance or other modifications. During Q3, the company modified three loans with aggregate principal of $110.7 million.
Three loans were in maturity default as of September 30, 2021: a $53.6 million New York residential condominium loan, a $14.3 million California residential loan and an $11.5 million subordinated Hawaii loan. Management concluded that no impairment charge was required for these loans as of the reporting date, although the California loan was on non-accrual status. A separate $32.9 million Illinois hotel loan was also on non-accrual status.
Key risks include borrower defaults, declining collateral values, delayed repayments, slower prepayments, future CECL increases, margin calls, covenant breaches, refinancing risk and the availability and cost of secured financing. CLO overcollateralization tests could redirect cash flows to senior noteholders and reduce cash available to the company. The company also remains exposed to LIBOR replacement and interest-rate risk, although it uses index-matched floating-rate financing and derivatives. Outstanding cash-flow hedges included an $870 million interest-rate swap and a $275 million interest-rate cap.
The company owns a hotel classified as real estate owned, carried at $36.7 million net. Q3 hotel revenue was $5.9 million and hotel-related expenses were $5.3 million; no impairment charge had been recognized as of September 30, 2021. No material legal proceedings were reported, and management concluded that disclosure controls were effective.
Subsequent to quarter-end, the company originated three loans totaling approximately $35.1 million of initial outstanding principal. The board also declared a $0.35-per-share fourth-quarter 2021 dividend, payable January 19, 2022.
Most important facts for investors to verify
- Whether the three maturity-defaulted loans and the two non-accrual loans generate additional losses, require further reserves or result in collateral enforcement.
- Whether the $24.5 million CECL reserve remains adequate as COVID-19 effects, property performance and macroeconomic forecasts change.
- The company’s ability to fund $256.8 million of unfunded commitments while maintaining adequate liquidity and satisfying margin-call and covenant requirements.
- The refinancing or extension status of near-term debt maturities, including the secured term loan maturing December 22, 2021 and the Citibank Facility’s December 13, 2021 initial maturity date.
- The sustainability of the $0.35-per-share quarterly dividend relative to recurring earnings, taxable income, liquidity and financing requirements.
- The effect of continued equity issuance and portfolio growth on per-share earnings, leverage and management fees.
- Future cash-flow restrictions or losses arising from CLO overcollateralization tests and the company’s retained first-loss positions.