Ares Commercial Real Estate Corporation — 3Q 2019 Form 10-Q Summary
Business Context and Reporting Period
Unaudited quarterly report for the three and nine months ended September 30, 2019. ACRE is an externally managed REIT focused on originating and investing in commercial real estate loans and related investments. Its portfolio includes senior mortgage loans, subordinated debt, preferred equity and a consolidated collateralized loan obligation.
Financial Performance and Key Metrics
| Metric | Three Months Ended September 30 | Nine Months Ended September 30 |
|---|---|---|
| Total revenue | $19.8 million vs. $14.0 million | $55.7 million vs. $40.8 million |
| Net interest margin | $13.1 million vs. $14.0 million | $38.7 million vs. $40.8 million |
| Net income | $9.0 million vs. $10.0 million | $27.3 million vs. $28.6 million |
| Diluted EPS | $0.31 vs. $0.35 | $0.95 vs. $1.00 |
| Dividends declared per share | $0.33 vs. $0.29 | $0.99 vs. $0.85 |
Revenue from real estate owned contributed $6.7 million in the third quarter and $17.0 million year to date, but related expenses were $6.8 million and $15.6 million, respectively. Approximate net income margins were 45.5% in the third quarter and 49.1% year to date, compared with approximately 71.2% and 70.1% in the prior-year periods, primarily because of the hotel property’s operating expenses.
- Loans held for investment were $1.538 billion carrying value and $1.548 billion outstanding principal at September 30, 2019, comprising 47 loans with a weighted-average unleveraged effective yield of 6.9% and weighted-average remaining life of 1.6 years.
- During the first nine months, ACRE funded approximately $419.2 million, received $367.0 million of principal repayments and converted a $38.6 million loan to real estate owned.
- Cash and cash equivalents were $6.0 million; cash, cash equivalents and restricted cash totaled $6.3 million.
- Stockholders’ equity was $425.7 million, compared with $425.6 million at December 31, 2018.
- Operating cash flow was $24.9 million, compared with $28.3 million in the prior-year period. Investing cash flow was negative $67.8 million, while financing cash flow was positive $37.8 million.
Debt, Liquidity and Capital Resources
- Secured funding agreements totaled $620.0 million, notes payable totaled $55.0 million, and the secured term loan totaled $108.9 million at September 30, 2019.
- Collateralized loan obligation securitization debt was $442.9 million. Total liabilities were $1.249 billion.
- Total commitments under financing agreements were $1.448 billion, with $786.2 million outstanding before debt issuance costs. Availability is subject to collateral, borrowing-base and other conditions.
- Total unfunded loan commitments increased to $227.2 million from $142.9 million at December 31, 2018.
- Management stated that financing-agreement covenants were satisfied at September 30, 2019. The company generally matches floating-rate assets with floating-rate liabilities and currently expects leverage not to exceed 4-to-1 debt-to-equity.
- Cash dividends paid during the first nine months were $28.0 million. A fourth-quarter dividend of $0.33 per share was declared on November 8, 2019.
Material Changes Versus the Prior Comparable Period
- Total revenue increased because of the addition of hotel operating revenue following the March 2019 acquisition of real estate owned.
- Net interest margin declined $0.8 million in the third quarter and $2.0 million year to date. Management attributed the decline primarily to lower weighted-average earning assets, partially offset by higher LIBOR; year-to-date interest expense also increased with higher LIBOR.
- Net income and diluted EPS declined despite higher total revenue because hotel expenses and other operating expenses increased materially.
- Loans held for investment increased modestly from $1.525 billion to $1.538 billion, while total financing-agreement borrowings declined from $888.0 million to $786.2 million.
- ACRE added $56.2 million of notes payable and $172.7 million of debt from consolidated VIEs during the first nine months. It also repaid $573.4 million of secured funding agreements.
- The quarterly dividend increased from $0.29 to $0.33 per share, although third-quarter diluted EPS of $0.31 was below the declared dividend.
Guidance, Outlook, Commentary, Risks and Unusual Items
- No specific earnings or portfolio guidance was provided. Management expects to continue originating CRE loans and using secured facilities, securitizations, private financing and potentially public capital markets to fund investments.
- In October 2019, ACRE originated or fully funded three additional loans with commitments of $52.5 million, $35.8 million and $37.2 million, respectively; the California loan had $30.9 million outstanding at closing.
- A hotel property was acquired through a deed in lieu of foreclosure after a $38.6 million senior mortgage loan matured in default. The property was recorded at approximately $36.9 million fair value, with no gain or loss recognized at acquisition, and generated $17.0 million of revenue year to date.
- All loans were reported as paying according to contractual terms, and no loan impairment charges were recorded. However, the company expects adoption of the current expected credit loss standard in 2020 to increase provisions for potential loan losses.
- Key risks include borrower defaults, commercial real estate valuation declines, refinancing and extension risk, financing-counterparty availability, LIBOR changes and replacement, interest-rate mismatches, prepayments, limited cash liquidity, and the ability to maintain REIT and Investment Company Act exemptions.
- Principal repayments in the consolidated CLO are applied first to senior notes; ACRE may not receive repayments on its subordinate interests until senior notes are fully repaid. ACRE’s reported maximum risk of loss from the CLO was $111.4 million.
- The management agreement expires May 1, 2020 and automatically renews annually thereafter, subject to its terms. A termination generally could require a fee equal to three times recent average annual management and incentive fees.
- On November 7, 2019, Bryan P. Donohoe was appointed CEO effective December 5, 2019. James A. Henderson will step down as CEO and chief investment officer but remain a director.
Most Important Facts for Investors to Verify
- Whether the $0.33 quarterly dividend is sustainably covered by recurring net interest income and earnings excluding the hotel’s unusual contribution.
- The hotel property’s operating performance, valuation, debt service and potential disposition or impairment exposure.
- The $227.2 million of unfunded loan commitments and the company’s available borrowing capacity after collateral and covenant limitations.
- Near-term refinancing and extension requirements, including the $36.3 million BAML balance maturing December 4, 2019 and other 2020 facility maturities.
- Credit quality of the 47-loan portfolio, particularly loans with near-term maturities, subordinated exposures and loans requiring modifications or extensions.
- The potential effect of expected-credit-loss accounting, LIBOR replacement, rising funding costs and changes in commercial real estate values.
- The effect of the CEO transition and renewal terms of the external management agreement.