Ares Commercial Real Estate Corporation — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; comparative period is the three months ended March 31, 2018. ACRE is an externally managed REIT focused on originating and investing in commercial real estate loans and related investments.
Financial performance and key metrics
- Total revenue: $14.2 million, up from $13.1 million.
- Interest income: $28.0 million, compared with $27.4 million.
- Net interest margin: $12.2 million, down from $13.1 million, primarily because higher LIBOR increased both interest income and borrowing costs while average earning assets and borrowings declined.
- Real estate owned revenue: $1.9 million from a New York hotel acquired through a deed in lieu of foreclosure.
- Total expenses: $5.5 million, up from $3.7 million, primarily due to $1.6 million of hotel operating expenses and $54,000 of depreciation, as well as higher general and administrative expenses.
- Net income: $8.5 million, down from $9.3 million.
- Earnings per share: $0.30 basic and diluted, compared with $0.33.
- Net income margin: approximately 60.3% of revenue, compared with approximately 70.9% in the prior-year quarter.
- Dividend declared: $0.33 per share, compared with $0.28 per share.
- Operating cash flow: $6.8 million, down from $9.7 million.
- Investing cash flow: $(9.0) million, reflecting loan fundings exceeding principal repayments.
- Financing cash flow: $3.9 million, including $172.7 million of CLO debt issuance proceeds and $263.4 million of secured funding repayments.
- Ending cash, cash equivalents and restricted cash: $13.2 million, up from $5.6 million at March 31, 2018.
Portfolio, balance sheet and leverage
- Loans held for investment totaled $1.548 billion carrying value and $1.559 billion outstanding principal, compared with $1.525 billion and $1.535 billion, respectively, at December 31, 2018.
- The portfolio included 45 loans, with a weighted average unleveraged effective yield of 7.2% and weighted average remaining life of 1.7 years. Senior mortgage loans represented $1.500 billion of carrying value; subordinated debt and preferred equity represented $47.9 million.
- Approximately 92.2% of loans had LIBOR floors, with a weighted average floor of 1.48%.
- All loans were reported as paying according to contractual terms, and no loan impairment charges were recognized during the quarter.
- Total assets were $1.618 billion, compared with $1.603 billion at December 31, 2018. Stockholders’ equity was $425.1 million, compared with $425.6 million.
- Debt included $621.5 million of secured funding agreements, a $108.5 million secured term loan and $442.2 million of CLO securitization debt. Total reported debt was approximately $1.172 billion, excluding other liabilities.
- Financing commitments totaled $1.476 billion, of which $731.5 million was outstanding at March 31, 2019. The company stated that it was in compliance with all financial covenants.
- Unfunded loan commitments increased to $254.2 million from $142.9 million at year-end 2018.
Material changes and unusual items
- ACRE acquired a New York hotel through a deed in lieu of foreclosure after a $38.6 million senior mortgage loan reached maturity default. The loan was derecognized and replaced with real estate owned carried at approximately $36.8 million net; no gain or loss was recognized at acquisition.
- The hotel generated $1.9 million of revenue and $1.6 million of operating expenses during the quarter. The filing identifies new hotel ownership as an additional risk exposure, including lodging demand, operating costs, property values and potential write-downs.
- On January 11, 2019, ACRE amended and restated its CLO securitization. The CLO was collateralized by 17 mortgage assets with $557.0 million of principal, compared with approximately $289.6 million of mortgage assets and $51.6 million of related receivables at December 31, 2018. CLO debt increased to $442.2 million from $270.7 million.
- ACRE retained approximately $58.5 million of CLO notes and $52.9 million of preferred equity, for a stated maximum CLO loss exposure of $111.4 million.
- ACRE funded approximately $121.2 million of loan principal, received $58.3 million of repayments and converted one $38.6 million loan to real estate owned.
- The company exercised a 12-month extension of its CNB facility, moving its maturity date to March 10, 2020.
- Management fees were $1.6 million in both periods. No incentive fees were incurred in either quarter.
Outlook, risks and contingencies
- Management stated that it intends to use prudent leverage and currently expects leverage not to exceed a 4-to-1 debt-to-equity ratio, although the charter and bylaws do not impose a leverage limit.
- The company expects to distribute at least 90% of REIT taxable income annually, subject to operating requirements, debt service and other liquidity needs. The filing does not provide formal earnings or dividend guidance beyond the declared quarterly dividend.
- On May 1, 2019, ACRE declared a second-quarter dividend of $0.33 per share, payable July 16, 2019.
- Key risks include credit losses, borrower defaults, declining commercial real estate values, refinancing and financing availability, changes in LIBOR and interest-rate spreads, loan prepayments, liquidity constraints, CLO subordination and the ability to maintain REIT and Investment Company Act exemptions.
- The portfolio and financing are predominantly floating rate and generally index-matched, but changes in interest rates could affect net interest margin, borrower performance, collateral values and financing costs. A 100-basis-point increase in average 30-day LIBOR was estimated to increase quarterly net interest margin by approximately $0.9 million, subject to portfolio composition and interest-rate floors.
- The company had $254.2 million of unfunded investment commitments, which may require additional liquidity or financing.
- The company reported no material pending legal proceedings and no material changes to previously disclosed risk factors except risks related to owning hotel properties.
- Management concluded that disclosure controls and procedures were effective as of March 31, 2019, with no material changes in internal control over financial reporting.
Important facts for investors to verify
- Whether the increased CLO leverage and retained $111.4 million first-loss exposure improve earnings without materially increasing credit risk.
- The operating performance, valuation and disposition prospects of the New York hotel acquired through foreclosure.
- Progress on funding the $254.2 million of unfunded commitments and the availability and pricing of secured financing.
- Loan portfolio credit quality, including maturities, extensions, collateral values and any loans that may move to non-accrual status.
- The sustainability of the $0.33 quarterly dividend relative to net income, taxable income, operating cash flow and debt-service requirements.
- Exposure to LIBOR changes, refinancing risk and the transition from LIBOR to a replacement benchmark.
- The effect of the pending expected-credit-loss accounting standard, which the company was still evaluating as of the filing date.