Ares Commercial Real Estate Corporation — FY2012 Form 10-K Summary
Business context and reporting period
Ares Commercial Real Estate Corporation (“ACRE”) is an externally managed commercial real estate finance company focused on originating, investing in and managing middle-market CRE loans. The company commenced investment operations on December 9, 2011, completed its IPO on May 1, 2012 and filed this Form 10-K for the fiscal year ended December 31, 2012. The prior comparable period covers only September 1, 2011 through December 31, 2011 and is not considered meaningful because investment operations began near year-end.
ACRE intends to qualify as a REIT beginning with the 2012 taxable year and seeks to maintain an exemption from registration under the Investment Company Act of 1940. Its portfolio primarily comprises transitional senior, stretch senior and subordinated CRE mortgage loans.
Key financial metrics
| Metric | FY2012 | Prior period |
|---|---|---|
| Interest income | $9.3 million | $3 thousand |
| Interest expense from secured facilities | $2.3 million | $39 thousand |
| Net interest margin | $6.9 million | $(36) thousand |
| Total operating expenses | $6.1 million | $127 thousand |
| Net income | $860 thousand | $(163) thousand |
| Net income attributable to common stockholders | $186 thousand | $(163) thousand |
| Basic and diluted earnings per share | $0.03 | $(8.56) |
| Core Earnings, non-GAAP | $621 thousand, or $0.09 per diluted share | $(163) thousand |
| Cash provided by operating activities | $2.0 million | $418 thousand |
| Cash used in investing activities | $348.2 million | $4.9 million |
| Cash provided by financing activities | $368.4 million | $5.8 million |
Net interest margin was approximately 7.4% of average earning assets based on reported interest income, secured-facility interest expense and average earning assets; the filing does not provide a consolidated GAAP net margin percentage. Interest income was generated from average earning assets of approximately $123.4 million.
At December 31, 2012, cash and cash equivalents were $23.4 million, restricted cash was $3.2 million, loans held for investment were $353.5 million, total assets were $387.9 million and stockholders’ equity was $165.4 million.
Portfolio, debt and liquidity
- ACRE originated or co-originated 15 CRE loans with aggregate commitments of approximately $405.7 million. Outstanding principal was $356.7 million and carrying amount was $353.5 million.
- The portfolio had a weighted-average contractual interest rate of 6.4%, weighted-average unleveraged effective yield of 7.4% and weighted-average remaining life of approximately 2.8 years.
- Senior mortgage loans represented $312.9 million of carrying amount; subordinated and mezzanine loans represented $40.6 million.
- Secured financing totaled $144.3 million: Wells Fargo $98.2 million, Citibank $13.9 million and Capital One $32.2 million. Total commitments under these facilities were $308.7 million.
- The company issued $69.0 million of 7.0% unsecured convertible senior notes due December 15, 2015. The notes had a carrying value of $67.3 million and an effective interest rate of approximately 9.4%.
- Total liabilities were $222.4 million. Contractual obligations totaled approximately $262.1 million, including debt and $48.8 million of unfunded loan commitments.
- Management stated that the company was in material compliance with the Wells Fargo, Citibank and Capital One facility terms at year-end. The Wells Fargo and Capital One fixed-charge coverage tests were scheduled to begin with the quarter ended March 31, 2013 because loans held for investment exceeded $200 million.
- Management generally expected leverage not to exceed 4-to-1 debt-to-equity, although the charter and bylaws did not impose a leverage cap.
Material changes versus the prior comparable period
- The company expanded from approximately $4.9 million of loans held for investment at December 31, 2011 to $353.5 million at December 31, 2012.
- Total assets increased from $7.6 million to $387.9 million, while stockholders’ equity increased from $6.4 million to $165.4 million.
- The May 2012 IPO issued 7.7 million shares at $18.50 per share and generated approximately $139.0 million of net proceeds. Proceeds were used for investments, working capital, debt repayment and redemption of Series A preferred stock.
- Series A preferred stock was fully redeemed in connection with the IPO, including a $572 thousand redemption premium.
- The company entered into or expanded secured funding facilities and issued the 2015 Convertible Notes in December 2012, materially increasing financing capacity and leverage.
- Quarterly results improved materially in the fourth quarter: net interest margin was $3.6 million and net income attributable to common stockholders was $1.1 million, compared with common-stockholder losses in the second and third quarters. Full-year results remained affected by the company’s start-up and public-company costs.
Guidance, outlook, commentary and unusual items
Management viewed U.S. CRE markets as being in the early to middle stages of recovery and believed limited middle-market lending capacity and approximately $1.7 trillion of CRE debt maturities from 2012 through 2016 could support demand for customized financing. Management expected to continue emphasizing directly originated, predominantly floating-rate senior mortgage loans.
Subsequent to year-end, ACRE completed a Miami loan assumption transaction, co-originated an approximately $107.1 million Atlanta transitional first mortgage loan and originated an approximately $25.5 million Overland Park, Kansas transitional loan. It also declared a first-quarter 2013 dividend of $0.25 per share.
ACRE declared $0.67 per share of cash dividends for 2012. The filing states that 2012 distributions exceeded cash flow from operating activities and earnings, reflecting the early stage of portfolio construction. Future distributions were not guaranteed and remained subject to earnings, liquidity, debt covenants, REIT requirements and board approval.
No loan impairments were recorded at December 31, 2012, and management stated that all loans were paying according to their terms. The company had no material legal proceedings and no unconsolidated off-balance-sheet entities or financial partnerships.
Principal risks include concentrated exposure to only 15 loans, transitional-property execution risk, borrower defaults, declining CRE values, interest-rate and LIBOR mismatch risk, refinancing and collateral requirements, restrictive debt covenants, dependence on the external manager, related-party conflicts, potential dilution from convertible notes or future offerings, and failure to maintain REIT or Investment Company Act exemptions.
Most important facts for an investor to verify
- Confirm the audited financial statements and reconcile the $186 thousand of common-stockholder net income with $621 thousand of non-GAAP Core Earnings.
- Review portfolio-level credit quality, property valuations, loan-to-value ratios, unfunded commitments and subsequent loan performance; the filing provides no impairment allowance but the portfolio is concentrated.
- Assess 2014–2015 refinancing exposure, including the Wells Fargo facility, Citibank facility, Capital One facility and $69.0 million of convertible notes due in 2015.
- Verify compliance with fixed-charge coverage, liquidity, tangible-net-worth, debt-to-asset and distribution covenants beginning in 2013.
- Evaluate whether dividends are supported by recurring operating cash flow rather than offering proceeds, borrowings or asset sales.
- Review the external management agreement, 1.5% base management fee, expense reimbursements, potential incentive fee and termination fee.
- Monitor the company’s ability to maintain REIT qualification and its exemption from Investment Company Act registration, particularly as portfolio composition and regulations change.