Ares Commercial Real Estate Corporation — 2019 Q2 Form 10-Q Summary
Business Context and Reporting Period
Ares Commercial Real Estate Corporation is an externally managed REIT and specialty finance company that originates and invests primarily in commercial real estate loans and related investments. The filing covers the quarter and six months ended June 30, 2019, with comparative periods ended June 30, 2018.
At June 30, 2019, the portfolio comprised 45 loans with $1.50 billion of outstanding principal and a $1.49 billion carrying amount. The weighted-average unleveraged effective yield was 7.2%, and 91.8% of loans had LIBOR floors.
Key Financial Metrics
| Metric | Three Months Ended June 30, 2019 | Three Months Ended June 30, 2018 | Six Months Ended June 30, 2019 | Six Months Ended June 30, 2018 |
|---|---|---|---|---|
| Total revenue | $21.7 million | $13.6 million | $35.8 million | $26.8 million |
| Net interest margin | $13.3 million | $13.6 million | $25.6 million | $26.8 million |
| Income before taxes | $10.0 million | $9.4 million | $18.6 million | $18.8 million |
| Net income attributable to common stockholders | $9.8 million | $9.3 million | $18.3 million | $18.6 million |
| Diluted earnings per share | $0.34 | $0.33 | $0.63 | $0.65 |
| Dividends declared per share | $0.33 | $0.28 | $0.66 | $0.56 |
Six-month net income was modestly lower year over year despite higher revenue, primarily because of higher interest expense and the addition of hotel operating expenses following the acquisition of real estate owned. The filing does not present a separately defined GAAP operating margin; reported net income represented approximately 45% of second-quarter revenue and 51% of six-month revenue.
- Cash and cash equivalents were $5.2 million, with total cash, cash equivalents and restricted cash of $5.6 million.
- Total assets were $1.67 billion and stockholders’ equity was $425.8 million.
- Balance-sheet debt consisted of $617.5 million of secured funding agreements, $55.0 million of notes payable, $108.7 million of secured term loan debt and $442.7 million of CLO securitization debt.
- Financing Agreements had $783.7 million outstanding against $1.45 billion of total commitments, excluding CLO securitization debt.
- Net cash provided by operating activities was $16.3 million. Investing activities used $67.3 million, while financing activities provided $45.1 million.
- Unfunded loan commitments increased to $205.8 million from $142.9 million at December 31, 2018.
Material Changes Versus the Prior Comparable Period
- Revenue increased $8.0 million, or approximately 59%, in the second quarter and $9.1 million, or approximately 34%, for the six-month period. The increase primarily reflected $8.4 million of second-quarter and $10.3 million of six-month revenue from real estate owned.
- Net interest margin declined approximately 2% in the quarter and 5% for the six-month period, as higher interest income was more than offset by higher borrowing costs and related financing expenses.
- Interest income increased to $30.0 million from $29.6 million in the quarter and to $58.0 million from $57.0 million for the six-month period. Interest expense increased to $16.7 million from $16.0 million in the quarter and to $32.4 million from $30.3 million for the six-month period.
- Operating expenses increased to $11.7 million from $4.2 million in the quarter and to $17.2 million from $8.0 million for the six-month period, primarily due to hotel operating expenses of $7.1 million and $8.8 million, respectively.
- The company acquired a New York hotel through a deed in lieu of foreclosure on March 8, 2019. A $38.6 million loan was converted into real estate owned recorded at $36.9 million at acquisition, with no gain or loss recognized.
- Loan carrying value declined from $1.52 billion at year-end 2018 to $1.49 billion at June 30, 2019, reflecting $248.4 million of repayments, $38.6 million converted to real estate owned and approximately $249.8 million of funded principal.
- Secured funding agreements declined from $778.0 million to $617.5 million, while new notes payable of $55.0 million were added. CLO securitization debt increased from $270.7 million to $442.7 million.
- Dividends declared increased to $0.66 per share for the first six months from $0.56 per share in the prior-year period.
Guidance, Outlook, Commentary, Risks and Unusual Items
- No formal earnings or dividend guidance was provided. Management stated that it intends to distribute at least 90% of REIT taxable income and declared a $0.33-per-share third-quarter 2019 dividend after quarter-end.
- Management expects leverage generally not to exceed 4.0-to-1.0 debt-to-equity, although the charter and bylaws do not impose a leverage limit.
- Management reported that all loans were paying according to contractual terms and that no loan impairment charges were recorded during the quarter or six-month period. The company had no material pending legal proceedings and was in compliance with financing covenants at June 30, 2019.
- The company expects adoption of the current expected credit loss standard, effective for annual periods beginning after December 15, 2019, to increase provisions for potential loan losses. No loan-loss provision was recorded at June 30, 2019.
- Key risks include borrower defaults, commercial real estate values, refinancing and extension risk, financing availability, LIBOR and interest-rate movements, prepayments, securitization cash-flow priority, liquidity, and the ability to maintain REIT and Investment Company Act exemptions.
- The company primarily finances floating-rate assets with floating-rate liabilities, but mismatched floors, caps and borrowing spreads could reduce net interest income. Management estimated that a 100-basis-point increase in 30-day LIBOR would increase annual net interest margin by approximately $2.6 million, while a decline to zero could increase it by approximately $15.4 million, assuming unchanged balances and other conditions.
- The CLO securitization was consolidated as a variable interest entity. The company’s maximum stated risk of loss in the CLO was $111.4 million, representing its retained notes and preferred equity.
- After quarter-end, the company amended the guarantee agreement related to the Citibank Facility and declared the third-quarter dividend.
Important Facts for Investors to Verify
- Assess the credit quality, collateral values and maturity concentrations of the 45-loan portfolio, including loans maturing or subject to extension in 2019 and 2020.
- Review the $205.8 million of unfunded commitments and whether available borrowing capacity is sufficient to fund them while maintaining dividend distributions.
- Verify refinancing and extension plans for the $36.3 million BAML advance maturing September 5, 2019, and other facilities maturing beginning in 2020.
- Evaluate the performance, valuation, operating expenses and construction funding needs of the New York hotel acquired through foreclosure.
- Monitor the effect of higher financing costs, LIBOR changes, loan repayments and CLO cash-flow subordination on net interest income and liquidity.
- Assess the expected impact of the current expected credit loss standard on provisions, book value and distributable earnings.
- Review related-party management and incentive fees, expense reimbursements, co-investments and the purchase of loans from Ares-affiliated vehicles.