Ares Commercial Real Estate Corporation — Form 10-Q Summary
Business Context and Reporting Period
The filing covers the three months ended March 31, 2013. ACRE is an externally managed specialty finance company focused on originating, investing in and managing middle-market commercial real estate loans and related investments. It commenced investment operations in December 2011, completed its IPO on May 1, 2012, and intends to qualify as a REIT. The company operated in one business segment and had 9,267,162 common shares outstanding as of May 14, 2013.
Key Financial Metrics
| Metric | Q1 2013 | Comparable Q1 2012 |
|---|---|---|
| Interest income | $6.711 million | $0.949 million |
| Net interest margin | $5.326 million | $0.610 million |
| Total expenses | $4.999 million | $0.102 million |
| Net income | $0.327 million | $0.508 million |
| Net income attributable to common stockholders | $0.327 million | $(0.116) million |
| Basic and diluted earnings per share | $0.04 | $(0.12) |
| Core Earnings, non-GAAP | $0.861 million, or $0.09 per diluted share | $(0.116) million, or $(0.12) per diluted share |
| Cash flow from operating activities | $1.226 million | $(0.221) million |
| Cash flow from investing activities | $(55.704) million | $(72.249) million |
| Cash flow from financing activities | $53.638 million | $75.816 million |
| Ending cash and cash equivalents | $22.550 million | $4.586 million |
At March 31, 2013, total assets were $443.953 million, including $409.943 million of loans held for investment. Total liabilities were $280.369 million and stockholders’ equity was $163.584 million. Secured financing agreements totaled $200.050 million, convertible notes totaled $67.411 million, and the convertible-notes derivative liability was $2.223 million.
The investment portfolio consisted of 17 loans with approximately $470.2 million of total commitments, $413.0 million of outstanding principal and a $409.9 million carrying amount. The weighted-average interest rate was 6.3%, the weighted-average unleveraged effective yield was 7.0%, and the weighted-average remaining life was 2.6 years. No loan impairments were recorded, and management stated that all loans were paying in accordance with their terms.
Common dividends declared were $0.25 per share for the quarter, totaling $2.317 million. The filing does not provide a GAAP net profit margin or a separately labeled operating margin.
Material Changes Versus the Prior Comparable Period
- Interest income increased to $6.711 million from $0.949 million, and net interest margin increased to $5.326 million from $0.610 million, primarily reflecting growth from four loans at March 31, 2012 to 17 loans at March 31, 2013.
- Average earning assets increased to $358.0 million from $41.9 million, while average secured borrowings increased to $149.6 million from $26.7 million.
- Net income declined to $0.327 million from $0.508 million because expenses increased substantially, including $1.950 million of other interest expense, $0.614 million of management fees, $0.640 million of acquisition and investment pursuit costs, and $0.747 million of reimbursed affiliate expenses.
- Net income attributable to common stockholders improved from a $0.116 million loss to $0.327 million of income because the prior-year period included preferred dividends and $0.572 million of preferred-stock redemption premium accretion.
- Loans held for investment increased by $56.443 million from December 31, 2012, while secured financing increased by $55.794 million. Unfunded investment commitments increased to $56.966 million from $48.765 million at year-end.
- Cash declined by $0.840 million during the quarter as loan fundings exceeded operating cash flow and financing proceeds.
Guidance, Outlook, Risks and Unusual Items
Management expects demand for customized CRE financing to remain supported by refinancing needs and property repositioning, and cited an estimated $1.7 trillion of CRE debt maturing between 2012 and 2016. The company stated that it expected approximately $40 million of remaining capital as of May 13, 2013, including cash and approved but undrawn facility capacity. After reserving $20 million for liquidity requirements, management estimated approximately $20 million available for commitments and working capital, with potential capacity to fund approximately $40 million to $60 million of additional senior loan investments at a 1-to-1 to 2-to-1 debt-to-equity ratio.
Key risks include borrower defaults, declining commercial real estate values, concentration and credit risk, interest-rate and LIBOR mismatch risk, extension and prepayment risk, dependence on secured financing, liquidity requirements, covenant compliance, and the ability to maintain REIT and Investment Company Act exemptions. Rising rates could increase borrowing costs and reduce asset values; falling rates could reduce loan yields because of rate floors and could affect derivative valuations.
The company was in material compliance with the Wells Fargo, Citibank and Capital One facilities at March 31, 2013. The facilities include liquidity, leverage, tangible-net-worth, distribution and fixed-charge-coverage covenants. The company began testing specified fixed-charge-coverage requirements during the quarter because loans held for investment exceeded $200 million.
The $69.0 million principal amount of 7.0% convertible senior notes matures December 15, 2015. The notes had an estimated effective interest rate of 9.4%; their conversion feature is accounted for as a Level III derivative, with fair value increasing from $1.825 million to $2.223 million during the quarter. The resulting $0.398 million unrealized loss was included in other interest expense.
Subsequent events include a $14.5 million initial funding on a new Mountain View, California stretch senior mortgage loan, filing of a shelf registration statement for up to $1.5 billion of securities, and a proposed acquisition of Alliant Capital LLC for $52.9 million in cash plus 588,235 common shares. The acquisition was expected to close in the second half of 2013 but remained subject to conditions, and the filing provided no assurance that it would be completed. A $0.25-per-share second-quarter 2013 dividend was declared on May 15, 2013.
Most Important Facts for Investors to Verify
- Verify the quality, geographic concentration, maturity schedule, collateral values and extension conditions of the 17-loan portfolio.
- Assess whether operating cash flow and recurring Core Earnings can support the $0.25 quarterly dividend after debt service, management fees and required liquidity reserves.
- Review secured-facility covenants, borrowing-base requirements, refinancing dates and available unused capacity, particularly the Citibank funding-period end date of December 8, 2013.
- Evaluate the $56.966 million of unfunded loan commitments against available liquidity and financing capacity.
- Monitor the 2015 convertible notes, potential dilution, the derivative liability and the December 2015 maturity.
- Determine whether the proposed Alliant Capital acquisition closes, how it is financed, and whether it changes the company’s investment strategy and risk profile.
- Confirm continued REIT qualification, required taxable-income distributions and compliance with debt-related dividend restrictions.