Ares Commercial Real Estate Corporation — FY2019 Form 10-K Summary
Business context and reporting period
The filing covers the fiscal year ended December 31, 2019, with quarterly data including the fourth quarter. ACRE is an externally managed specialty finance company and REIT focused primarily on originating and investing in commercial real estate loans, including senior mortgage loans, subordinated debt, preferred equity and mezzanine loans. It is managed by Ares Commercial Real Estate Management LLC, an affiliate of Ares Management Corporation.
At year-end, the investment portfolio comprised 50 loans held for investment with $1.7 billion of outstanding principal and $1.682 billion of carrying value. The portfolio had a weighted-average unleveraged effective yield of 6.8% and weighted-average remaining life of 1.6 years. All loans were reported as performing under their contractual terms, and no loan impairments were recorded during 2019.
Financial performance and key metrics
| Metric | 2019 | 2018 | Change |
|---|---|---|---|
| Total revenue | $77.3 million | $55.3 million | +$22.0 million |
| Net interest margin | $52.2 million | $55.3 million | -$3.1 million |
| Total expenses | $39.8 million | $16.2 million | +$23.5 million |
| Net income attributable to common stockholders | $37.0 million | $38.6 million | -$1.6 million |
| Diluted earnings per share | $1.28 | $1.35 | -$0.07 |
| Dividends declared per share | $1.32 | $1.16 | +$0.16 |
| Net cash from operating activities | $32.5 million | $39.2 million | -$6.8 million |
Revenue increased primarily because ACRE acquired a New York hotel through a deed in lieu of foreclosure and reported $25.1 million of hotel revenue. Net interest margin declined as interest income and average earning assets decreased, partially offset by higher 30-day LIBOR. Based on reported revenue and net income, net margin was approximately 48% in 2019, although the result benefited from the addition of hotel operations.
Cash, cash equivalents and restricted cash totaled $5.6 million at year-end, down from $11.5 million. Investing activities used $174.4 million, primarily because loan originations and fundings exceeded principal repayments. Financing activities provided $136.1 million, including new secured funding, notes payable and CLO-related debt issuance. Dividends paid were $37.5 million, exceeding operating cash flow of $32.5 million.
Balance sheet, debt and liquidity
| Metric at December 31, 2019 | Amount |
|---|---|
| Total assets | $1.784 billion |
| Loans held for investment | $1.682 billion |
| Real estate owned, net | $37.9 million |
| Financing Agreements | $894.7 million |
| CLO securitization debt | $443.2 million carrying value; $445.6 million principal |
| Total liabilities | $1.358 billion |
| Stockholders’ equity | $426.3 million |
| Unfunded loan commitments | $216.2 million |
Financing Agreements consisted principally of secured funding facilities, a $110.0 million secured term loan and $56.2 million of notes payable. Approximately $712.0 million of Financing Agreements matured in 2020 based on contractual maturities, including the Wells Fargo, BAML, CNB, MetLife and U.S. Bank facilities and the secured term loan. Extension options were available for several facilities, subject to conditions and fees. Management stated that ACRE was in compliance with all financial covenants at year-end and generally targets debt-to-equity leverage of no more than 4-to-1.
Material changes versus the prior comparable period
- Loans held for investment increased from $1.525 billion to $1.682 billion, while the number of loans increased from 44 to 50.
- ACRE funded approximately $679.2 million of loan principal, received $482.4 million of principal repayments and converted a $38.6 million maturity-defaulted loan into real estate owned.
- The New York hotel acquired through foreclosure generated $25.1 million of revenue and $23.0 million of expenses in 2019, including $21.4 million of hotel operating expenses.
- Total debt increased primarily because CLO securitization debt rose from $270.7 million to $443.2 million and $56.2 million of notes payable were added.
- The CLO securitization was amended and expanded in January 2019. ACRE retained approximately $111.4 million of subordinated notes and preferred equity and remained exposed to the CLO’s first-loss position.
- Quarterly dividends increased from $0.28 per share in early 2018 to $0.33 per share in each quarter of 2019.
Guidance, outlook, commentary and unusual items
Management described demand for customized, shorter-duration and generally floating-rate CRE financing as favorable, supported by active commercial real estate markets and demand from value-added and opportunistic real estate funds. The filing does not provide formal earnings guidance.
ACRE expects to use leverage and may access secured facilities, securitizations, warehouse or repurchase facilities and equity or debt offerings. Subsequent to year-end, it entered into a $150.0 million Morgan Stanley repurchase facility, completed a common stock offering that generated approximately $72.8 million of net proceeds including the underwriters’ option, purchased a $132.6 million office loan commitment from an Ares-affiliated warehouse vehicle and originated additional loans.
On January 1, 2020, ACRE adopted the CECL credit-loss standard. Management expected an initial allowance for credit losses of approximately $4.8 million to $6.7 million, or 0.25% to 0.35% of total loan commitments, subject to change as economic conditions and portfolio assumptions develop.
Principal risks include borrower defaults, real estate valuation declines, concentration in a limited number of loans and property types, refinancing and margin-call risk, floating-rate funding costs, LIBOR transition, illiquidity, reliance on the external manager, conflicts of interest, REIT qualification, maintenance of the Investment Company Act exemption and the ability to refinance or extend 2020 maturities. The Management Agreement term expired May 1, 2020 and automatically renews annually unless terminated under its terms; termination without cause may require a fee equal to three times specified trailing management and incentive fees.
Important facts for investors to verify
- Liquidity and maturities: Verify available borrowing capacity, extensions or refinancing for the approximately $712.0 million of Financing Agreements contractually maturing in 2020.
- Distribution coverage: Reconcile dividends paid and declared with operating cash flow, taxable income and any reliance on borrowings or asset sales.
- Credit quality: Review the CECL opening adjustment, subsequent allowance changes, loan modifications, maturity extensions and any loans becoming non-accrual.
- Hotel exposure: Assess operating performance, capital requirements, debt service and potential valuation changes for the foreclosed New York hotel.
- Leverage and CLO risk: Monitor covenant headroom, collateral values, margin-call provisions and ACRE’s first-loss exposure in the CLO securitization.
- Related-party transactions: Review management fees, incentive fees, expense reimbursements and the January 2020 purchase from the Ares-affiliated warehouse vehicle.
- Interest-rate and LIBOR risk: Evaluate asset floors, debt repricing, hedging effectiveness and the transition from LIBOR to an alternative reference rate.