Ares Commercial Real Estate Corporation — Q1 2023 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 and related investments. The filing covers the three months ended March 31, 2023, with comparative results for the three months ended March 31, 2022.
At March 31, 2023, the company held 53 loans for investment with approximately $2.2 billion of outstanding principal and a weighted-average unleveraged effective yield of 8.5%. The portfolio is primarily senior mortgage loans, with exposure to office, multifamily, industrial, hospitality, mixed-use, self-storage and other property types.
Key Financial Metrics
| Metric | Q1 2023 | Q1 2022 | Change |
|---|---|---|---|
| Total revenue | $26.5 million | $24.0 million | Up $2.5 million |
| Interest income | $49.5 million | $33.4 million | Up $16.1 million |
| Interest expense | $23.0 million | $12.0 million | Up $11.0 million |
| Net interest margin | $26.5 million | $21.4 million | Up $5.2 million |
| Total expenses | $6.2 million | $10.5 million | Down $4.3 million |
| Provision for credit losses | $21.0 million | $(0.6) million | Higher provision |
| Realized losses on loans sold | $5.6 million | — | New item |
| Net income attributable to common stockholders | $(6.4) million | $16.2 million | Decline of $22.6 million |
| Basic and diluted EPS | $(0.12) | $0.34 | Down $0.46 |
| Dividends declared per share | $0.35 | $0.35 | Unchanged |
Interest income benefited from higher LIBOR and SOFR rates and hedging activity, while higher funding costs substantially increased interest expense. The reported loss was primarily driven by the $21.0 million CECL provision and $5.6 million realized loss on a loan sale.
Comprehensive loss was $10.9 million, including a $4.4 million decline in other comprehensive income, primarily from derivative valuation changes.
Balance Sheet, Debt and Liquidity
- Total assets were $2.44 billion, down from $2.52 billion at December 31, 2022.
- Loans held for investment declined to $2.17 billion from $2.26 billion; net loans after the CECL reserve were $2.09 billion.
- Cash and cash equivalents were $153.8 million at March 31, 2023.
- Total stockholders’ equity declined to $718.3 million from $747.5 million, reflecting the quarterly net loss, dividends and other comprehensive loss.
- Total Financing Agreements had $953.2 million outstanding against $1.535 billion of commitments. This consisted of $698.2 million of secured funding agreements, $105.0 million of notes payable and a $150.0 million secured term loan.
- Consolidated CLO securitization debt was $735.8 million carrying value, with $736.9 million of outstanding principal.
- As of May 1, 2023, management reported approximately $220 million of liquidity, consisting of $145 million of unrestricted cash and $75 million of availability under secured funding agreements.
- Management stated that primary liquidity sources were expected to be sufficient for operating and funding needs for at least the next 12 months, subject to market conditions, borrower performance and lender availability.
Material Changes Versus the Prior Comparable Period
- Net interest margin increased 24% to $26.5 million, but the benefit was more than offset by credit-loss provisioning and realized loan-sale losses.
- Net income declined from $16.2 million to a $6.4 million net loss.
- Interest expense increased approximately 92%, reflecting higher benchmark rates and financing costs.
- The CECL provision changed from a $0.6 million benefit in Q1 2022 to a $21.0 million expense in Q1 2023.
- The company recorded five loans on non-accrual status with a carrying value of $173.3 million, compared with three loans totaling $99.1 million at December 31, 2022.
- The CECL reserve for funded loan balances increased to $87.5 million from $66.0 million. Including the $4.8 million reserve for unfunded commitments, total CECL reserves were $92.3 million, or 387 basis points of total loan commitments.
- Two Illinois loans were downgraded to risk rating 5 and received specific reserves totaling $43.9 million.
- Revenue and expenses from the hotel property classified as real estate owned were absent in Q1 2023 because the hotel was sold in March 2022. Q1 2022 included $2.7 million of revenue, $4.3 million of expenses and a $2.2 million gain on sale.
- During Q1 2023, the company funded $26.4 million, received $72.8 million of loan repayments, sold a $14.3 million defaulted loan at a $5.6 million realized loss and transferred a $27.4 million defaulted office loan to held-for-sale status.
Guidance, Outlook, Risks and Unusual Items
The filing does not provide formal earnings guidance. Management expects leverage generally not to exceed 4.5-to-1 debt-to-equity under current conditions and expects the existing dividend policy to continue subject to REIT requirements, operating needs and debt-service obligations. The board declared a second-quarter 2023 dividend of $0.35 per share, payable July 18, 2023.
- Management highlighted continued high inflation, elevated interest rates, recession risk, geopolitical uncertainty and stress in the banking system.
- Borrower defaults, delayed refinancing, declining commercial real estate values and weaker property cash flows could increase credit losses and reduce cash collections.
- Secured funding agreements contain margin-call, collateral and covenant provisions. Defaults could permit lenders to accelerate borrowings, terminate commitments or require additional collateral.
- CLO overcollateralization tests could redirect cash flows from the company’s subordinated interests to senior note repayment, reducing liquidity and potentially increasing losses.
- Five loans were on non-accrual status at quarter-end. Notable issues included maturity defaults, construction milestone failures, reserve-deposit defaults and missed interest payments.
- In April 2023, a Washington multifamily loan with $18.8 million outstanding triggered an event of default after only a partial interest payment was received.
- In April 2023, the company completed the sale of the $27.4 million Illinois office loan at the previously recorded fair value.
- The company’s at-the-market equity program was unavailable and no common shares were sold under it during the quarter. No share repurchases occurred, leaving the full $50 million repurchase authorization available at March 31, 2023.
- The company remained in compliance with all financial covenants at March 31, 2023 and reported no material pending legal proceedings.
Important Facts for Investors to Verify
- Whether non-accrual loans, maturity defaults and the $92.3 million total CECL reserve stabilize or increase in subsequent quarters.
- The performance, collateral values and refinancing prospects of the office and hospitality exposures, particularly the specifically reserved Illinois loans.
- Actual cash availability under secured funding facilities and the impact of any margin calls, collateral requirements or lender haircuts.
- Compliance with CLO overcollateralization tests and the timing of cash distributions from the CLO structures.
- Whether the $0.35 quarterly dividend remains covered by recurring earnings and cash flows after credit provisions and financing costs.
- The effect of benchmark-rate changes, LIBOR transition, hedging performance and higher borrowing costs on net interest margin.
- Subsequent developments concerning the Washington default and the April 2023 sale of the Illinois office loan.