Ares Commercial Real Estate Corporation — Q1 2014 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 loans, and mortgage banking, conducted through ACRE Capital, which originates, sells and services primarily multifamily and senior-living loans under Fannie Mae and HUD programs. The company is externally managed by Ares Commercial Real Estate Management LLC and has elected REIT status. This report covers the three months ended March 31, 2014; comparative results are for the three months ended March 31, 2013.
Financial performance and key metrics
| Metric | Q1 2014 | Q1 2013 |
|---|---|---|
| Total revenue | $15.4 million | $5.3 million |
| Net interest margin | $10.1 million | $5.3 million |
| Mortgage banking revenue | $4.7 million | Not applicable; ACRE Capital was acquired in August 2013 |
| Total expenses | $11.4 million | $4.6 million |
| Income before taxes | $4.1 million | $0.3 million |
| Net income | $4.8 million | $0.3 million |
| Basic and diluted EPS | $0.17 | $0.04 |
| Dividend declared per share | $0.25 | $0.25 |
| Net cash from operating activities | $7.7 million | $1.2 million |
- Net interest margin represented approximately 65% of total revenue. Total revenue less total expenses produced an operating margin of approximately 26% before tax and 31% after tax; these ratios are derived from reported figures and are not company-defined margins.
- Interest income from loans held for investment was $15.2 million, offset by $5.1 million of related interest expense. Weighted-average earning assets increased to approximately $1.1 billion from $358.0 million.
- Mortgage banking revenue included $5.3 million of net servicing fees, $1.4 million of gains from mortgage banking activities, a $1.8 million decrease in MSR fair value and $0.1 million of loss-sharing provision.
- At March 31, 2014, loans held for investment were $1.110 billion, consisting primarily of senior mortgage loans, with a weighted-average interest rate of 5.3% and weighted-average unleveraged effective yield of 5.8%. The portfolio included 39 loans and had $130.9 million of unfunded commitments.
- Mortgage servicing rights were $60.1 million, supporting a servicing portfolio of 989 loans with approximately $3.8 billion of unpaid principal balance.
- Total assets were $1.258 billion and stockholders’ equity was $404.1 million. Cash and cash equivalents were $30.4 million, plus $23.1 million of restricted cash.
- Secured funding agreements were $341.5 million, convertible notes were $67.9 million and consolidated CMBS debt was $395.0 million. Total reported liabilities were $853.8 million.
Material changes versus the prior comparable period
- Net income increased to $4.8 million from $0.3 million, principally reflecting the larger loan portfolio and the inclusion of ACRE Capital’s mortgage banking operations for the first time.
- Loans held for investment increased 16% from $958.5 million at December 31, 2013 to $1.110 billion at March 31, 2014. The company funded approximately $152.6 million during the quarter and reported no repayments.
- Secured funding agreements increased to $341.5 million from $264.4 million. The company added a $50.0 million City National Bank facility and had $45.0 million outstanding under it at quarter-end.
- Cash increased by $10.3 million during the quarter, as $7.7 million of operating cash flow and $69.1 million of financing cash flow exceeded $66.5 million of investing cash uses and dividend payments.
- Expenses increased substantially, including $4.0 million of compensation and benefits and $2.2 million of general and administrative expenses, largely because ACRE Capital was not included in the 2013 comparable period.
- The company recorded $0.2 million of restructuring costs related to centralizing and relocating ACRE Capital support services. An additional $0.7 million was expected, for projected total restructuring costs of $0.9 million.
Guidance, outlook, risks and unusual items
- Management stated that demand remained strong for customized transitional and flexible commercial real estate financing, particularly for properties undergoing repositioning or refinancing. No formal earnings or revenue guidance was provided.
- As of May 6, 2014, management expected approximately $68 million of remaining capital, including cash and approved undrawn facility capacity, subject to financing commitments. After reserving $10 million for liquidity requirements, approximately $58 million was expected to be available for new loans, existing commitments and working capital. At a targeted 2.5-to-1 debt-to-equity ratio, management estimated capacity to fund approximately $200 million of additional senior loans.
- Subsequent to quarter-end, ACRE entered into a $195 million UBS revolving repurchase facility, increased the Citibank facility to $250 million, originated three additional loans with aggregate outstanding balances of approximately $73.1 million, and amended the ACRE Capital warehouse line to $80 million maturing April 15, 2015.
- Interest-rate risk remains material. The company primarily matches floating-rate assets with floating-rate liabilities, but a 100-basis-point increase in average 30-day LIBOR was estimated to increase quarterly net interest margin by approximately $0.3 million; a decline in LIBOR to zero was estimated to increase it by approximately $0.2 million.
- Credit risk is concentrated in commercial real estate collateral and borrower performance. No loan impairments were recorded, and management stated that all loans were paying according to their terms at March 31, 2014.
- ACRE Capital’s Fannie Mae DUS loss-sharing exposure had a maximum quantifiable allowance of approximately $1.3 billion, although the filing states this does not represent the expected or probable loss. The recorded allowance for loss sharing was $16.6 million.
- MSR valuation is sensitive to discount rates: a 100-basis-point change in the weighted-average discount rate was estimated to change MSR fair value by approximately $1.8 million.
- The $69.0 million 7% convertible notes mature December 15, 2015 and are senior unsecured obligations. The notes are effectively junior to secured debt and structurally junior to subsidiary liabilities.
- The company reported compliance in all material respects with the Wells Fargo, Citibank, Capital One and City National Bank facilities, and reported no material pending legal proceedings or material changes to previously disclosed risk factors.
Most important facts for investors to verify
- Whether loan growth and planned leverage remain supported by borrower credit quality, collateral values and sufficient financing capacity.
- The sustainability of mortgage banking revenue, servicing fees and MSR valuations following the ACRE Capital acquisition.
- Actual losses under the Fannie Mae DUS loss-sharing arrangements relative to the recorded allowance and maximum exposure.
- Compliance with debt covenants, refinancing needs and maturity dates, particularly the Wells Fargo facility’s December 2014 initial maturity and the 2015 convertible notes.
- Completion and final cost of the ACRE Capital restructuring and relocation.
- Ability to maintain REIT qualification, satisfy required distributions and preserve adequate liquidity while funding unfunded commitments.