Ares Commercial Real Estate Corporation — 2018 Q3 Form 10-Q Summary
Business context and reporting period
Ares Commercial Real Estate Corporation is an externally managed REIT and specialty finance company focused on originating and investing in commercial real estate loans and related investments. This unaudited Form 10-Q covers the three and nine months ended September 30, 2018, with comparisons to the corresponding 2017 periods.
Financial performance and key metrics
- Third-quarter 2018: Interest income was $30.4 million, interest expense was $16.4 million, and net interest margin was $14.0 million, compared with $14.7 million in the third quarter of 2017.
- Net income attributable to common stockholders was $10.0 million, or $0.35 per diluted share, compared with $11.1 million, or $0.39 per share, in the prior-year quarter.
- Total expenses were $3.8 million versus $3.6 million. Income tax expense, including excise tax, was $0.2 million versus $0.1 million.
- Nine months ended September 30, 2018: Interest income was $87.4 million, net interest margin was $40.8 million, and net income attributable to common stockholders was $28.6 million, or $1.00 per diluted share. Comparable 2017 amounts were $72.3 million, $35.5 million, and $24.2 million, or $0.85 per share.
- Dividends declared were $0.29 per share in the third quarter and $0.85 per share for the first nine months, compared with $0.27 and $0.81, respectively, in 2017.
- At September 30, 2018, total assets were $1.732 billion, loans held for investment were $1.659 billion, total liabilities were $1.307 billion, and stockholders’ equity was $424.2 million.
- Cash and cash equivalents were $5.0 million; cash, cash equivalents and restricted cash totaled $5.4 million.
- Financing-agreement debt totaled $1.022 billion, consisting of $912.4 million of secured funding agreements and $110.0 million of secured term-loan borrowings. Consolidated CLO debt was $271.3 million.
- Loan commitments totaled $1.815 billion, of which $1.668 billion was funded, leaving $146.5 million of unfunded commitments. Financing facilities had aggregate commitments of approximately $1.541 billion, subject to collateral and other conditions.
- The portfolio comprised 44 loans with approximately $1.7 billion of outstanding principal. The weighted-average minimum borrowing spread was 5.2%, weighted-average unleveraged effective yield was 6.9%, and weighted-average remaining life was 1.7 years.
Material changes versus the prior comparable period
- Third-quarter net interest margin decreased approximately 5% year over year, as higher interest income was more than offset by higher interest expense, unused fees and financing-cost amortization.
- Nine-month net interest margin increased approximately 15%, and nine-month net income attributable to common stockholders increased approximately 18%, primarily reflecting larger average earning assets and borrowings and higher 30-day LIBOR.
- Loans held for investment declined from $1.726 billion at December 31, 2017 to $1.659 billion at September 30, 2018. During the first nine months, the Company funded approximately $367.4 million and received approximately $436.4 million of principal repayments.
- Financing-agreement debt declined from $1.068 billion at year-end 2017 to $1.022 billion at September 30, 2018. Cash declined from $28.3 million to $5.0 million.
- Nine-month operating cash flow increased to $28.3 million from $23.9 million. Investing activities provided $18.6 million, compared with $224.4 million used in 2017, while financing activities used $70.2 million, compared with $181.5 million provided in 2017.
- Management and incentive fees increased to $5.3 million for the first nine months from $5.0 million; incentive fees were $0.6 million versus $0.4 million in 2017.
Guidance, outlook, risks and unusual items
- Management expects leverage, subject to market conditions and regulatory requirements, generally not to exceed a 4-to-1 debt-to-equity ratio. The filing does not provide earnings guidance.
- All loans were reported as paying according to contractual terms at September 30, 2018, and no impairment charges were recorded. However, two self-storage-related loans had prior payment defaults and were subsequently modified; their repayment obligations were extended to November 2018 after quarter-end.
- A $38.6 million New York hotel loan had been in maturity default before being modified in September 2018 to extend repayment to December 2018. Other loans also had extensions or prior maturity-related modifications.
- The portfolio is predominantly floating-rate, and 90.4% of loans had LIBOR floors with a weighted-average floor of 1.11%. Management generally matches floating-rate assets with floating-rate liabilities, but changes in LIBOR, credit spreads, borrower performance, property values and financing availability could affect earnings and liquidity.
- The Company’s UBS Facility, with a $140.0 million commitment, matured on October 21, 2018 and had been repaid in full without extension. The filing should be reviewed for the effect on future financing capacity and liquidity.
- The consolidated CLO’s mortgage assets had approximately $286.3 million of principal and $271.3 million of related debt at September 30, 2018. The Company’s maximum stated risk of loss from the CLO was $68.2 million.
- Subsequent to quarter-end, the Company originated or funded several loans, including a $17.5 million Florida senior mortgage loan, a New York mezzanine loan with approximately $10.6 million funded at closing, and a North Carolina senior mortgage loan with approximately $8.0 million funded at closing.
- The Company declared a fourth-quarter 2018 dividend of $0.31 per share, payable January 15, 2019.
- Key risks include borrower defaults, declining commercial real estate values, refinancing and extension risk, rising borrowing costs, interest-rate mismatches, prepayments, financing-counterparty risk, availability of capital, REIT qualification and reliance on the external Manager.
Important facts for investors to verify
- How the October 2018 repayment or refinancing of the UBS Facility affected liquidity, leverage and available borrowing capacity.
- The resolution and collateral performance of the self-storage-related loans extended to November 2018 and the New York hotel loan extended to December 2018.
- Whether unfunded loan commitments of $146.5 million can be funded from operating cash flow, repayments and available financing without increasing leverage materially.
- The sensitivity of net interest margin and dividend coverage to LIBOR movements, financing spreads and the Company’s LIBOR floors.
- The adequacy of credit reserves under the then-current incurred-loss methodology and the potential effect of adopting the expected-credit-loss standard in future periods.
- The sustainability of the $0.31 per-share dividend relative to taxable income, operating cash flow, debt service and required REIT distributions.