Business Context and Reporting Period
Ares Commercial Real Estate Corporation filed an unaudited Form 10-Q for the quarter and six months ended June 30, 2015. ACRE is an externally managed specialty finance company with two reportable segments: principal lending in commercial real estate debt and mortgage banking through ACRE Capital, which originates, sells and services primarily multifamily and senior-living loans for GSE and HUD programs. The company is taxed as a REIT.
Financial Performance and Position
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Total revenue | $22.1 million, versus $17.4 million | $40.6 million, versus $31.2 million |
| Net interest margin | $12.3 million, versus $9.3 million | $25.3 million, versus $17.8 million |
| Mortgage banking revenue | $9.8 million, versus $8.1 million | $15.3 million, versus $12.6 million |
| Income from operations before taxes | $12.0 million, versus $6.7 million | $20.7 million, versus $10.8 million |
| Net income attributable to common stockholders | $9.0 million, versus $6.6 million | $16.0 million, versus $11.4 million |
| Basic and diluted EPS | $0.31, versus $0.23 | $0.56, versus $0.40 |
| Dividends declared per share | $0.25, versus $0.25 | $0.50, versus $0.50 |
Six-month revenue increased approximately 30% year over year, while net income attributable to common stockholders increased approximately 41%. The implied net income margin was approximately 40.5%, compared with approximately 36.5% in the prior-year period.
- Loans held for investment were $1.279 billion at June 30, 2015, compared with $1.463 billion at December 31, 2014. Excluding third-party non-controlling interests, the portfolio had $1.204 billion of outstanding principal, a 5.4% weighted-average interest rate and a 6.0% weighted-average unleveraged effective yield.
- During the first six months, ACRE funded approximately $117.2 million of principal and received approximately $228.1 million of repayments. Management reported that all loans were paying according to contractual terms and that no impairments were recorded.
- Mortgage servicing rights were $60.1 million, compared with $58.9 million at year-end 2014. The servicing portfolio included 973 loans with approximately $4.4 billion of unpaid principal balance.
- Total assets were $1.545 billion and total equity was $489.2 million at June 30, 2015. Stockholders’ equity was $405.1 million and non-controlling interests were $84.1 million.
- Debt included $560.8 million of secured funding agreements, $51.9 million of warehouse lines, $68.7 million of convertible notes, $83.3 million of CMBS debt and $247.0 million of CLO debt. Total liabilities were $1.056 billion.
- Six-month cash flow from operating activities was $223.0 million and investing activities provided $112.6 million, while financing activities used $344.0 million. Cash and cash equivalents declined from $16.6 million to $8.1 million; restricted cash was $26.9 million.
Material Changes Versus the Prior Comparable Period
- Net interest margin rose 42% for the six-month period, primarily due to higher weighted-average earning assets, lower average borrowing costs following facility amendments and greater leverage.
- Mortgage banking revenue increased 21% for the quarter and 21% for the six months. Gains from mortgage banking activities increased to $7.5 million for the quarter and $11.6 million for the six months, supported by higher loan originations.
- ACRE Capital rate-locked 47 loans totaling $435.0 million in the first six months, versus 10 loans totaling $131.3 million in the prior-year period.
- Net servicing fees declined to $7.8 million from $8.7 million for the six months, while compensation and benefits increased to $10.1 million from $8.5 million, primarily due to higher commissions and employee turnover associated with the ACRE Capital restructuring.
- Operating expenses declined to $19.9 million from $20.4 million, primarily because ACRE Capital restructuring costs and related expenses decreased. Six-month restructuring costs were $44 thousand, versus $555 thousand in the prior-year period.
- Secured funding commitments were $1.027 billion with $560.8 million outstanding, versus $1.077 billion and $552.8 million, respectively, at December 31, 2014. Warehouse-line commitments declined to $215.0 million from $260.0 million, and outstanding balances declined to $51.9 million from $193.2 million.
Guidance, Outlook, Risks and Unusual Items
The filing does not provide formal earnings guidance. Management stated that, as of July 29, 2015, the company expected approximately $63 million of capital in cash or approved undrawn secured-funding capacity. After reserving $10 million for liquidity requirements, approximately $53 million was expected to be available for lending, existing commitments and working capital. At a targeted debt-to-equity ratio of 2:1 to 3:1, management estimated capacity to fund approximately $155 million to $210 million of additional senior loans.
- Unfunded commitments on existing loans were approximately $124 million as of July 29, 2015.
- The company’s stated leverage expectation was not to exceed a 4:1 debt-to-equity ratio, although its charter and bylaws do not impose a leverage limit.
- The 7.00% convertible senior notes, with approximately $68.7 million carrying value, were scheduled to mature on December 15, 2015 unless converted or repurchased.
- The July 2014 City National Bank facility was extended after quarter-end to July 31, 2016. The Capital One facility matured and was not extended.
- Principal risks include borrower defaults, commercial real estate values, refinancing and liquidity risk, availability and cost of financing, interest-rate and spread movements, prepayments, GSE and HUD program changes, mortgage servicing-rights valuation, REIT qualification and reliance on the external manager.
- ACRE Capital’s maximum quantifiable Fannie Mae loss-sharing exposure was $1.2 billion, although management stated this amount is not representative of expected actual losses. The recorded allowance for loss sharing was $11.2 million.
- A 100-basis-point change in the MSR discount rate would have changed MSR fair value by approximately $1.9 million as of June 30, 2015.
- Two principal-lending borrowers represented approximately 26.5% of second-quarter revenue, indicating material borrower concentration.
- Subsequent events included a $22.1 million Arizona multifamily loan origination, the July sale of a $75.0 million California office loan at par, $61.9 million of quarter-to-date GSE or HUD loan commitments as of July 29, and declaration of a $0.25 per-share third-quarter dividend.
Important Facts for Investors to Verify
- Confirm the repayment, refinancing or conversion of the $69 million convertible notes due December 15, 2015.
- Assess liquidity after reserving funds for approximately $124 million of unfunded existing commitments and other operating requirements.
- Review the sustainability of mortgage banking gains, MSR valuations and Fannie Mae loss-sharing exposure.
- Monitor portfolio repayments, new originations, borrower concentrations and the absence of impairment charges.
- Verify compliance with all financing covenants and the availability of secured, warehouse and securitization capacity.
- Evaluate the effect of interest-rate changes on net interest margin, financing costs, asset values and borrower credit performance.
- Review the external management agreement, related-party fees and the company’s ability to maintain REIT and Investment Company Act exemptions.