Ares Commercial Real Estate Corporation — Q1 2017 Form 10-Q Summary
Business Context and Reporting Period
ACRE is an externally managed specialty finance company focused on originating and investing in commercial real estate loans and related investments. The filing covers the three months ended March 31, 2017, and was filed May 2, 2017. ACRE is taxed as a REIT and completed the sale of its mortgage banking subsidiary, ACRE Capital, on September 30, 2016; prior-period mortgage banking results are presented as discontinued operations.
Key Financial Metrics
| Metric | Q1 2017 | Q1 2016 |
|---|---|---|
| Interest income | $21.1 million | $18.8 million |
| Interest expense | $10.8 million | $8.5 million |
| Net interest margin | $10.3 million | $10.2 million |
| Total expenses | $3.8 million | $3.5 million |
| Net income from continuing operations | $6.5 million | $6.8 million |
| Net income attributable to common stockholders | $6.5 million | $5.1 million |
| Diluted earnings per share | $0.23 | $0.18 |
| Dividends declared per share | $0.27 | $0.26 |
| Net cash provided by operating activities | $6.2 million | $17.8 million |
Net interest margin as a percentage of interest income was approximately 49% in Q1 2017, compared with approximately 55% in Q1 2016. The filing does not provide a clear GAAP net profit margin percentage.
Balance Sheet, Portfolio, Debt and Liquidity
- Total assets were $1.429 billion, including $1.372 billion of loans held for investment and $44.4 million of cash and cash equivalents.
- Total equity was $417.9 million, and stockholders’ equity was $417.9 million.
- Debt consisted of $576.5 million of secured funding agreements, $150.5 million of secured term loan debt and $270.2 million of consolidated CLO debt, for total reported debt of approximately $997.2 million. Reported debt-to-equity was approximately 2.4x.
- The loan portfolio comprised 32 loans with $1.380 billion of outstanding principal, a 5.2% weighted-average interest rate, a 6.4% weighted-average unleveraged effective yield and a 1.9-year weighted-average remaining life.
- Senior mortgage loans represented $1.260 billion of carrying value; subordinated debt and preferred equity represented $112.2 million.
- During the quarter, ACRE funded approximately $133.5 million of loan principal and received approximately $65.0 million of principal repayments. Unfunded loan commitments were $65.1 million.
- As of March 31, 2017, all loans were paying according to contractual terms, and no loan impairment charges were recorded.
- Cash decreased by $2.9 million during the quarter. Investing activities used $56.7 million, while financing activities provided $47.6 million.
Material Changes Versus the Prior Comparable Period
- Interest income increased 12.7%, primarily reflecting higher weighted-average earning assets.
- Interest expense increased 26.5%, partly reflecting higher average borrowings and the new CLO securitization.
- Net interest margin increased only modestly to $10.3 million from $10.2 million because higher interest income was substantially offset by higher funding costs.
- Net income attributable to common stockholders increased to $6.5 million from $5.1 million. The prior period included a $0.3 million loss from discontinued operations and $1.3 million of income attributable to non-controlling interests; the non-controlling interest investment was repaid in full in January 2017.
- Operating expenses increased to $3.8 million from $3.5 million, primarily due to higher management fees and a $0.3 million incentive fee payable to the external manager.
- Operating cash flow declined to $6.2 million from $17.8 million. The prior-year amount benefited from mortgage banking activities that were subsequently sold.
- On March 2, 2017, ACRE completed a CLO securitization involving approximately $341.2 million of mortgage assets, issued approximately $272.9 million of third-party debt and retained approximately $68.2 million of subordinated notes and preferred equity.
Outlook, Commentary, Risks and Unusual Items
- No formal earnings or dividend guidance was provided. Management stated that future results depend on net interest income, asset supply and demand, credit performance, interest rates, financing availability and market conditions.
- Management disclosed approximately $128 million of capital as of April 28, 2017, consisting of cash and approved but undrawn secured funding capacity. After a $10 million liquidity reserve, approximately $118 million was expected to be available for lending and other purposes.
- Assuming use of that capital and 2.5-to-1 debt-to-equity leverage, management estimated capacity to fund approximately $410 million of additional senior loans. This is an estimate, not a commitment or guarantee.
- On May 1, 2017, the Wells Fargo repurchase facility was increased from $325 million to $500 million and its initial maturity was extended to December 14, 2018, with two one-year extension options.
- On April 27, 2017, ACRE originated an approximately $18.4 million funded senior mortgage loan on a Florida office property at LIBOR plus 4.30% plus fees.
- ACRE declared a Q2 2017 dividend of $0.27 per share, payable July 17, 2017.
- Principal repayments from the CLO collateral are applied first to senior notes, so ACRE may not receive repayment proceeds from those assets until senior CLO debt is repaid.
- Key risks include borrower defaults, declines in commercial real estate values, refinancing and prepayment risk, changes in LIBOR and funding costs, warehouse and repurchase facility renewals, liquidity constraints, leverage, concentration and collateral risk, and the ability to maintain REIT and Investment Company Act exemptions.
- ACRE primarily uses floating-rate assets and index-matched floating-rate liabilities, but differing floors, caps and spreads can reduce net interest income. Management estimated that a 100-basis-point increase in average 30-day LIBOR would have increased Q1 2017 net interest margin by approximately $0.9 million; a 100-basis-point decrease to zero would have increased it by approximately $0.2 million.
- Management reported compliance with all financial covenants as of March 31, 2017, no material pending legal proceedings and no material changes to previously disclosed risk factors.
Important Facts for Investors to Verify
- Whether loan credit performance, collateral values and the absence of impairments remain stable as the portfolio expands.
- The maturity and renewal terms of secured funding facilities, particularly facilities with 2017 maturity dates, and the effect of the Wells Fargo refinancing.
- The CLO’s structural subordination, retained $68.2 million first-loss exposure and restrictions on cash distributions.
- Whether funding costs rise faster than yields on ACRE’s floating-rate loan portfolio.
- The sustainability of the $0.27 quarterly dividend relative to taxable income, operating cash flow and required liquidity reserves.
- The accuracy of management’s estimated $118 million of deployable capital and approximately $410 million of potential additional loan capacity.