Ares Commercial Real Estate Corporation — Form 10-Q Summary
Business context and reporting period
ACRE is a specialty finance company operating through two segments: Principal Lending, which originates and holds commercial real estate debt investments, and Mortgage Banking, which originates, sells and services primarily multifamily and senior-living loans through GSE and HUD programs. The company is externally managed by Ares Commercial Real Estate Management LLC, an Ares Management subsidiary, and has elected REIT status.
This unaudited filing covers the three months ended March 31, 2016, compared with the three months ended March 31, 2015. At March 31, 2016, ACRE had 28.6 million common shares outstanding.
Financial performance and key metrics
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Total revenue | $15.0 million | $18.4 million | Down 18.6% |
| Net interest margin | $10.2 million | $13.0 million | Down 21.3% |
| Mortgage banking revenue | $4.8 million | $5.4 million | Down 12.2% |
| Total expenses | $9.3 million | $9.8 million | Down 4.6% |
| Income before taxes | $5.7 million | $8.7 million | Down 34.4% |
| Net income attributable to common stockholders | $5.1 million | $7.1 million | Down 27.3% |
| Diluted EPS | $0.18 | $0.25 | Down $0.07 |
| Dividends declared per share | $0.26 | $0.25 | Up $0.01 |
- Net income attributable to ACRE was $6.4 million, including a $0.7 million income tax benefit. Net income attributable to non-controlling interests was $1.3 million.
- Revenue declined primarily because of lower earning assets in Principal Lending and reduced mortgage loan originations. The implied income-before-tax margin was approximately 37.8%, versus 47.0% in the prior-year quarter; net income attributable to common stockholders was approximately 34.2% of revenue, versus 38.3%.
- Interest income declined to $18.8 million from $23.2 million, while interest expense declined to $8.5 million from $10.2 million. Weighted-average borrowings declined to approximately $845 million from $1.0 billion.
- Mortgage banking servicing fees increased to $4.0 million from $3.9 million, but gains from mortgage banking activities declined to $2.4 million from $4.1 million. The fair value reduction in mortgage servicing rights improved to $1.8 million from $3.2 million.
Balance sheet, portfolio, cash flow and liquidity
- Total assets were $1.42 billion at March 31, 2016, up from $1.38 billion at December 31, 2015. Total equity was $454.0 million, compared with $456.5 million.
- Loans held for investment were $1.210 billion, up from $1.174 billion. Excluding third-party non-controlling interests, the portfolio had $1.170 billion of outstanding principal, a 5.3% weighted-average interest rate, a 6.0% weighted-average unleveraged effective yield and a 1.9-year weighted-average remaining life.
- The portfolio consisted primarily of senior mortgage loans with a carrying amount of $992.2 million and subordinated debt and preferred equity investments with a carrying amount of $171.1 million. Approximately 66.7% of loans had LIBOR floors, with a 0.23% weighted-average floor.
- Management reported that all loans were paying according to contractual terms and that no impairment charges were recognized during the quarter.
- Cash and cash equivalents were $6.2 million, down from $9.0 million. Restricted cash was $25.6 million, down from $30.4 million.
- Net cash provided by operating activities was $17.8 million, compared with $125.6 million in Q1 2015. Investing activities used $59.9 million, primarily reflecting $108.1 million of loan fundings versus $47.9 million of principal repayments. Financing activities provided $39.2 million.
- Total financing-agreement commitments were $1.397 billion, with $740.0 million outstanding at March 31, 2016. This included $615.4 million of secured funding agreements, $49.6 million of warehouse lines and $75.0 million under the secured term loan.
- Consolidated CMBS and CLO debt totaled $185.4 million carrying value, down from $254.3 million at December 31, 2015.
- Unfunded commitments on loans held for investment were $86.5 million. Mortgage banking commitments to sell loans were $131.2 million and commitments to fund loans were $76.6 million.
Material changes, outlook and unusual items
- During the quarter, ACRE originated a $56.0 million hotel portfolio first mortgage, a $25.5 million Kansas office first mortgage and a $17.0 million New Jersey office mezzanine loan. It funded approximately $109.2 million and received approximately $73.3 million of principal repayments.
- ACRE Capital rate-locked six loan commitments totaling $38.9 million, compared with 16 commitments totaling $202.0 million in Q1 2015, indicating substantially lower mortgage banking volume.
- The company increased its stock repurchase authorization from $20 million to $30 million and extended the program through March 31, 2017. It repurchased 34,854 shares for approximately $0.4 million during the quarter.
- As of May 3, 2016, management reported approximately $140 million of cash or approved undrawn borrowing capacity. After a $10 million reserve, approximately $130 million was expected to be available for new loans, existing commitments, share repurchases and general purposes. Management estimated potential capacity to fund approximately $450 million of additional senior loans if that capital were leveraged at 2.5-to-1.
- On April 27, 2016, ACRE originated a $76.0 million New York mixed-use first mortgage; the funded principal at closing was approximately $65.6 million at LIBOR plus 4.16%, plus fees.
- On May 5, 2016, the company declared a $0.26 per-share dividend for Q2 2016, payable July 15, 2016.
- The filing provides no formal earnings or revenue guidance. Management’s stated strategy is to continue originating CRE loans, maintain financing access and use prudent leverage, with a stated expectation that debt-to-equity leverage would generally not exceed 4-to-1.
- Material risks include borrower defaults, commercial real estate values, refinancing and prepayment risk, financing availability and covenant compliance, interest-rate movements, LIBOR floors and caps, mortgage servicing-rights valuation, GSE/HUD program changes, Fannie Mae loss-sharing obligations, REIT qualification and continued exemption from the Investment Company Act.
- Under the Fannie Mae DUS program, the maximum quantifiable loss-sharing allowance was $1.1 billion against a $3.1 billion recourse-at-risk pool; management stated this amount does not represent expected losses. The recorded allowance for loss sharing was $8.7 million.
- A 100-basis-point change in the MSR discount rate would change the fair value of MSRs by approximately $1.9 million. The company also estimated that a 100-basis-point increase in average 30-day LIBOR would increase quarterly net interest margin by approximately $0.7 million, subject to portfolio composition and interest-rate floors.
Important facts for investors to verify
- Whether the decline in earning assets and mortgage banking originations persists and affects recurring net interest margin and dividend coverage.
- The maturity and refinancing status of facilities due or subject to renewal in 2016, including the BAML Line of Credit, July 2014 CNB Facility, December 2014 UBS Facility, Wells Fargo Facility and Citibank Facility.
- Credit performance and collateral values of the CRE portfolio, including loans approaching contractual maturity and the absence of impairments reported in this quarter.
- Actual availability and borrowing capacity relative to the $86.5 million of unfunded investment commitments and other mortgage banking commitments.
- Exposure to Fannie Mae loss-sharing obligations, GSE/HUD program changes and potential claims under the DUS arrangements.
- Valuation sensitivity of the $61.0 million MSR portfolio and the impact of prepayments, delinquency rates and discount rates.
- Dividend sustainability relative to taxable income, operating cash flow, financing costs and required debt repayments.
- Related-party economics, including the 1.5% base management fee, expense reimbursements and the externally managed structure.