Ares Commercial Real Estate Corporation — Form 10-Q Summary
Business context and reporting period
This unaudited Form 10-Q covers the quarter and six months ended June 30, 2012. Ares Commercial Real Estate Corporation commenced investment operations on December 9, 2011 and completed its initial public offering on May 1, 2012. The company originates, invests in and manages middle-market commercial real estate loans and related investments, including transitional senior loans, stretch senior loans, B-notes and mezzanine loans. It is externally managed by Ares Commercial Real Estate Management LLC and intends to qualify as a REIT beginning with the 2012 tax year.
Financial performance and key metrics
| Metric | Three months ended June 30, 2012 | Six months ended June 30, 2012 |
|---|---|---|
| Interest income | $1.559 million | $2.508 million |
| Interest expense | $0.353 million | $0.692 million |
| Net interest margin | $1.206 million | $1.816 million |
| Total expenses | $1.381 million | $1.483 million |
| Net income (loss) | $(0.175) million | $0.333 million |
| Net income (loss) attributable to common stockholders | $(0.225) million | $(0.341) million |
| Basic and diluted earnings per share | $(0.03) | $(0.09) |
| Dividends declared per common share | $0.06 | $0.11 |
At June 30, 2012, total assets were $171.259 million, including $87.455 million of cash and cash equivalents and $78.173 million of loans held for investment. Stockholders’ equity was $167.658 million, compared with $6.437 million at December 31, 2011. The loan portfolio had a funded amount of $79.025 million, a carrying value of $78.173 million, a weighted-average coupon of 7.0%, an effective yield of 8.0% and a weighted-average life of 2.6 years.
The portfolio consisted of three senior mortgage investments and one subordinated debt investment, with total commitments of $98.876 million and unfunded commitments of $19.851 million. All loans were performing in accordance with their terms, and no impairments were recorded during the six months.
Net cash used in operating activities was $0.706 million, net cash used in investing activities was $73.152 million, and net cash provided by financing activities was $160.073 million. Cash increased by $86.215 million during the six months.
Material changes versus the prior comparable period
The filing states that there is no comparable prior operating period because the company commenced operations in December 2011 and completed its IPO in May 2012. Results therefore are not indicative of expected full-year performance.
- The IPO issued 7.7 million common shares at $18.50 per share, generating $142.450 million of gross proceeds and approximately $139.1 million of net proceeds.
- IPO proceeds were used to repay approximately $47.3 million of secured financing and redeem all Series A convertible preferred stock for approximately $6.295 million.
- Secured financing availability expanded to approximately $308.7 million across Wells Fargo, Citibank and Capital One facilities, but outstanding borrowings were zero at June 30, 2012.
- Loans held for investment increased from $4.945 million at December 31, 2011 to $78.173 million at June 30, 2012.
- Common stockholders’ equity increased substantially as a result of private issuances and the IPO, partially offset by the accumulated deficit and offering costs.
Guidance, outlook, commentary, risks and unusual items
Management did not provide quantitative earnings guidance. It expects to deploy IPO proceeds into target investments and intends to make regular quarterly distributions. The company currently expects leverage, when used, not to exceed a 4-to-1 debt-to-equity ratio, subject to market conditions and other factors.
Management views the middle-market commercial real estate lending environment as attractive because of limited credit availability, reduced competition from banks and significant refinancing needs. The company cited an estimate of approximately $1.8 trillion of commercial real estate debt maturing from 2012 through 2016.
- Key risks include borrower defaults, declines in collateral values, commercial real estate market weakness, refinancing and extension risk, interest-rate volatility, interest-rate index mismatches and reduced credit-market liquidity.
- Borrowings are expected to be primarily floating-rate and generally indexed to LIBOR. Rising rates could increase funding costs faster than asset yields, particularly where loan-rate caps or floors apply.
- The company relies on external management. The management agreement provides for a base management fee equal to 1.5% of defined stockholders’ equity, incentive fees based on Core Earnings and reimbursement of specified expenses. No incentive fee was earned during the six months.
- Management fees were $0.419 million for both the quarter and six-month period. Related-party general and administrative reimbursements were $0.308 million for the quarter and $0.319 million for the six months.
- The company had $19.851 million of unfunded loan commitments, generally due within one to three years.
- REIT qualification is subject to technical organizational, operational and distribution requirements. Failure to qualify could subject the company to regular corporate income taxes and restrict future REIT qualification.
- The company reported no pending legal proceedings, no defaults upon senior securities and no off-balance-sheet arrangements involving unconsolidated entities.
- Subsequent to quarter-end, the company appointed Tae-Sik Yoon as CFO and originated a $14.3 million Atlanta mezzanine loan, with a $14.157 million carrying amount and an initial effective yield of 10.7%.
Important facts for investors to verify
- Confirm the pace and quality of deployment of the approximately $87.5 million of unrestricted cash remaining at June 30, 2012.
- Monitor the $19.851 million of unfunded commitments and the company’s ability to fund them without unfavorable leverage or equity issuance.
- Review collateral performance, loan-to-value metrics, borrower business plans and impairment indicators for the four-property loan portfolio.
- Assess the effect of external management fees, expense reimbursements, incentive fee provisions and the related-party relationship with Ares affiliates.
- Verify future dividend coverage from recurring Core Earnings and operating cash flow rather than IPO proceeds.
- Evaluate compliance with financing facility covenants as borrowings resume, including liquidity, tangible net worth and fixed-charge coverage requirements.
- Confirm ongoing compliance with REIT qualification and applicable Investment Company Act requirements.