Ares Commercial Real Estate Corporation — Q3 2013 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2013; filed November 13, 2013. The interim financial statements are unaudited. ACRE operates as a REIT and is externally managed by Ares Commercial Real Estate Management LLC.
Business context
ACRE’s principal lending business originates and holds middle-market commercial real estate loans, including senior, subordinated and mezzanine loans. On August 30, 2013, ACRE acquired ACRE Capital LLC, formerly Alliant Capital, adding mortgage banking and servicing focused primarily on multifamily and housing-related loans originated through Fannie Mae, HUD and Ginnie Mae programs. ACRE Capital’s results are included from September 1, 2013.
Financial results and metrics
| Metric | Q3 2013 | Q3 2012 | 9M 2013 | 9M 2012 |
|---|---|---|---|---|
| Total revenue | $13.1 million | $1.5 million | $24.6 million | $3.3 million |
| Net interest margin | $8.7 million | $1.5 million | $20.2 million | $3.3 million |
| Income from operations before acquisition gain and taxes | $2.9 million | $(0.6) million | $6.5 million | $(0.2) million |
| Gain on acquisition | $5.2 million | — | $5.2 million | — |
| Net income attributable to common stockholders | $7.6 million | $(0.6) million | $11.2 million | $(0.9) million |
| Basic and diluted EPS | $0.27 | $(0.06) | $0.71 | $(0.16) |
| Dividend declared per share | $0.25 | $0.06 | $0.75 | $0.17 |
Q3 2013 revenue included $10.7 million of interest income, $0.5 million of net servicing fees and $3.8 million of mortgage banking gains. Expenses totaled $10.1 million, including $1.6 million of other interest expense, $2.3 million of compensation and benefits, $2.1 million of acquisition and investment pursuit costs, and $2.5 million of management fees and reimbursed affiliate expenses. The effective tax rate for the quarter was 38.7%, primarily attributable to the taxable REIT subsidiary holding ACRE Capital.
Balance sheet, portfolio and liquidity
| Balance sheet item | September 30, 2013 | December 31, 2012 |
|---|---|---|
| Total assets | $839.8 million | $387.9 million |
| Cash and cash equivalents | $12.6 million | $23.4 million |
| Restricted cash | $21.9 million | $3.2 million |
| Loans held for investment | $692.3 million | $353.5 million |
| Loans held for sale | $24.5 million | — |
| Mortgage servicing rights | $60.9 million | — |
| Secured funding agreements | $294.0 million | $144.3 million |
| Warehouse lines of credit | $13.8 million | — |
| Convertible notes | $67.7 million | $67.3 million |
| Stockholders’ equity | $410.6 million | $165.4 million |
The principal lending portfolio comprised 24 loans with $697.4 million of outstanding principal and a $692.3 million carrying value. The weighted average interest rate was 5.9%, weighted average effective yield was 6.4%, and weighted average remaining life was 2.6 years. No loan impairments were recorded, and management stated that all loans were paying according to their terms.
For the first nine months, operating activities provided $5.3 million of cash, investing activities used $395.2 million, and financing activities provided $379.1 million. Cash and cash equivalents declined by $10.8 million to $12.6 million. The company raised approximately $242.3 million net from its June and July common stock offerings.
Secured funding commitments totaled $450.0 million, of which $294.0 million was outstanding. Warehouse commitments totaled $185.0 million, of which $13.8 million was outstanding. The company reported compliance in all material respects with the Wells Fargo, Citibank, Capital One and BAML facilities.
Material changes versus prior comparable periods
- Loans held for investment nearly doubled from $353.5 million at year-end 2012 to $692.3 million at September 30, 2013, reflecting $388.9 million of new fundings and $48.2 million of repayments during the nine months.
- ACRE completed the ACRE Capital acquisition for approximately $60.9 million of total consideration, consisting of approximately $53.4 million of cash and 588,235 common shares. The transaction generated a preliminary $5.2 million gain on acquisition.
- The acquisition added $60.9 million of mortgage servicing rights, $24.5 million of loans held for sale, mortgage banking revenue and a $19.5 million allowance for Fannie Mae loss sharing.
- Common shares outstanding increased from 9.3 million at December 31, 2012 to 28.5 million at September 30, 2013, primarily from the public offering and acquisition consideration.
- Secured funding commitments increased from $308.7 million to $450.0 million, while outstanding secured funding increased from $144.3 million to $294.0 million.
- On June 26, 2013, stockholder approval allowed the convertible notes’ conversion option to be settled fully in common stock. The related $86 thousand cumulative derivative value was reclassified to additional paid-in capital, eliminating subsequent mark-to-market accounting for that feature.
Outlook, risks and unusual items
Management expressed a favorable view of demand for customized commercial real estate financing, citing constrained lending for transitional properties and substantial commercial real estate debt maturities. The filing does not provide formal earnings or revenue guidance.
- The company expects to use secured credit facilities, warehouse lines, securitizations, private financing and future equity or debt offerings to fund investments and distributions.
- Management currently expects leverage generally not to exceed 4.0 times debt to equity, although the charter does not impose a leverage limit.
- ACRE Capital’s Fannie Mae DUS activities expose the company to loss-sharing obligations. The maximum quantifiable allowance associated with guarantees was $1.3 billion against a $3.8 billion at-risk pool; the filing states this is not an estimate of expected loss.
- Unfunded principal lending commitments were $62.3 million. ACRE Capital also had $107.5 million of commitments to sell loans and $84.0 million of commitments to fund loans.
- Key risks include borrower defaults, declines in commercial real estate values, interest-rate and LIBOR mismatch risk, refinancing and extension risk, funding availability, reliance on the external manager, REIT qualification, and the performance of Fannie Mae and HUD programs.
- As of September 30, 2013, the company reported no material pending legal claims and no loan impairments.
Subsequent events included a $4.9 million preferred equity investment, a planned securitization involving approximately $494 million of mortgage loans and approximately $395 million of third-party CMBS sales, a $15.3 million mezzanine loan commitment, and declaration of a $0.25 per-share fourth-quarter dividend. The securitization remained subject to closing conditions.
Investor verification checklist
- Verify the sustainability of earnings excluding the one-time $5.2 million acquisition gain and acquisition-related costs.
- Assess recurring profitability of the newly acquired ACRE Capital mortgage banking and servicing business beyond its one-month contribution.
- Review credit quality, collateral values, maturities and unfunded commitments in the rapidly expanded $692.3 million loan portfolio.
- Evaluate liquidity after the decline in unrestricted cash and the scheduled January 31, 2014 expiration of the BAML warehouse line.
- Monitor compliance with debt covenants, borrowing-base requirements and the effect of additional leverage or securitization financing.
- Quantify potential Fannie Mae DUS loss-sharing exposure and confirm the adequacy of the $19.5 million allowance.
- Confirm REIT qualification, required distributions and the tax impact of the ACRE Capital taxable REIT subsidiary.