Ares Commercial Real Estate Corporation — Form 10-Q Summary
Reporting period: Quarter and six months ended June 30, 2020; filed August 6, 2020. ACRE is an externally managed REIT focused on originating and investing in commercial real estate debt and related investments.
Business Context and Financial Position
- The portfolio comprised 50 loans held for investment with $1.8 billion of outstanding principal and $2.1 billion of aggregate originated commitments.
- Loans held for investment totaled $1.794 billion before the CECL reserve and $1.768 billion net of the $26.1 million funded-loan reserve. Three loans totaling $100.8 million of principal were transferred to held-for-sale during the first six months.
- Senior mortgage loans represented $1.702 billion of carrying value; subordinated debt and preferred equity represented $91.6 million. Weighted-average effective yield was 6.4%, or 6.7% excluding non-accrual loans, with a 1.5-year weighted-average remaining life.
- Cash and cash equivalents were $73.0 million versus $5.3 million at December 31, 2019. Total assets were $2.021 billion and stockholders’ equity was $465.1 million.
- All loans held for investment were paying according to contractual terms at June 30, 2020, but three loans with a carrying value of $68.7 million were on non-accrual status due to COVID-19 impacts.
Key Financial Metrics
| Metric | Three Months Ended June 30, 2020 | Three Months Ended June 30, 2019 | Six Months Ended June 30, 2020 | Six Months Ended June 30, 2019 |
|---|---|---|---|---|
| Total revenue | $18.0 million | $21.7 million | $39.1 million | $35.8 million |
| Net interest margin | $16.8 million | $13.3 million | $32.7 million | $25.6 million |
| Total expenses | $8.1 million | $11.7 million | $19.3 million | $17.2 million |
| CECL provision/(benefit) | $4.0 million benefit | — | $23.1 million provision | — |
| Unrealized losses on loans held for sale | $4.0 million | — | $4.0 million | — |
| Net income/(loss) attributable to common stockholders | $9.8 million | $9.8 million | $(7.5) million | $18.3 million |
| Basic EPS | $0.29 | $0.34 | $(0.23) | $0.64 |
| Dividends declared per share | $0.33 | $0.33 | $0.66 | $0.66 |
Debt, Liquidity and Cash Flow
- Total liabilities were $1.556 billion at June 30, 2020, including $876.8 million of secured funding agreements, $109.6 million of secured term-loan debt, $443.5 million of CLO securitization debt and $47.5 million of secured borrowings.
- Financing Agreements had $1.043 billion outstanding against total commitments of $1.585 billion. Management reported compliance with all financial covenants at quarter-end.
- Unfunded loan commitments increased to $252.8 million from $216.2 million at December 31, 2019.
- Six-month operating cash flow was $14.2 million. Investing cash flow was $(193.0) million, primarily reflecting loan originations and fundings. Financing cash flow was $246.2 million, including debt proceeds and $73.2 million of common-stock issuance proceeds.
- Cash, cash equivalents and restricted cash increased by $67.4 million during the first six months. Management reported approximately $80 million of unrestricted cash as of August 5, 2020.
- In January 2020, ACRE issued 4.6 million common shares for aggregate net proceeds of approximately $72.9 million.
Material Changes Versus Prior Comparable Period
- Second-quarter net interest margin increased 26% to $16.8 million, primarily from larger average earning assets and borrowings and the benefit of LIBOR floors.
- Six-month net interest margin increased 28% to $32.7 million, but net income declined to a $7.5 million loss because of the $23.1 million CECL provision, $4.0 million of held-for-sale valuation losses and weaker hotel operations.
- Second-quarter revenue from real estate owned declined to $1.2 million from $8.4 million, primarily because COVID-19 materially reduced hotel occupancy and revenue.
- ACRE adopted CECL on January 1, 2020, recording a cumulative after-tax retained-earnings reduction of approximately $5.1 million. The total CECL reserve was $28.2 million at June 30, 2020, including $26.1 million for funded balances and $2.1 million for unfunded commitments.
- Management fees increased year over year due primarily to the January equity offering, while incentive fees declined to $0.3 million for the quarter from $0.7 million.
- ACRE originated a $91.8 million Florida multifamily loan and purchased a $46.7 million Florida multifamily loan from an Ares-affiliated warehouse vehicle. Related subordinated participations were transferred to third parties but accounted for as secured financings rather than sales.
Outlook, Risks and Unusual Items
- COVID-19 adversely affected borrowers, particularly in hospitality, student housing and retail. Six loan modifications covering $292.3 million of aggregate principal were completed during the second quarter; none qualified as troubled debt restructurings.
- Management warned that additional borrower payment delays, defaults, loan modifications, higher CECL reserves, reduced prepayments, declining collateral values and lower liquidity could result from a prolonged pandemic or recession.
- Secured funding agreements contain margin-call, covenant, cross-default and acceleration provisions. Failure to satisfy requirements could result in additional collateral postings, repayment demands or enforcement against collateral.
- ACRE’s stated leverage expectation is generally no more than 4-to-1 debt to equity, although its charter and bylaws do not impose a leverage limit.
- Interest-rate sensitivity analysis estimated a $12.1 million reduction in annual net income from an immediate 100-basis-point increase in 30-day LIBOR, and a $6.2 million reduction from a 50-basis-point increase, assuming the June 30 balance sheet remained unchanged.
- Three loans were classified as held for sale at June 30, 2020, with a carrying value of $96.4 million and aggregate unrealized losses of $4.0 million. All three were subsequently sold by August 5, 2020 for stated proceeds of $96.4 million.
- Subsequent to quarter-end, the U.S. Bank Facility matured and was repaid in full on July 31, 2020. The MetLife Facility was amended on August 4, 2020 to extend its initial maturity to August 13, 2022, subject to extension options.
- The filing provides no formal earnings or dividend guidance. Management indicated that future dividends could be reduced, suspended or partly paid in stock if liquidity or REIT distribution requirements warrant.
Important Facts for Investors to Verify
- Whether COVID-19-related non-accrual loans, modifications and property-level deterioration lead to additional realized losses or CECL increases.
- Liquidity available after the U.S. Bank Facility repayment, upcoming financing maturities and potential margin calls.
- Performance and refinancing prospects for loans maturing in 2020 and 2021, particularly hospitality, student housing and retail exposures.
- Whether the $28.2 million CECL reserve adequately reflects the pandemic’s evolving impact on collateral values and borrower cash flows.
- Sustainability of the $0.33 quarterly dividend relative to taxable income, recurring earnings, cash flow and financing requirements.
- Exposure to LIBOR transition, financing spread changes and mismatches between asset floors and borrowing floors.
- Effects of external management fees, incentive fees, reimbursements and related-party loan purchases on shareholder returns.