Ares Commercial Real Estate Corporation — FY2014 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2014; filed March 5, 2015. The filing also presents unaudited fourth-quarter 2014 results. ACRE is an externally managed REIT and specialty finance company focused on commercial real estate debt and mortgage banking.
Business context
- Principal lending: Originates and holds senior mortgage loans, bridge loans, subordinated debt, preferred equity and other commercial real estate investments.
- Mortgage banking: Through ACRE Capital, originates, sells and services multifamily and senior-living loans under Fannie Mae, Freddie Mac, Ginnie Mae and HUD programs. Revenue includes origination fees, loan-sale premiums and mortgage-servicing fees.
- The principal lending portfolio comprised 46 loans at year-end, with approximately $1.5 billion of outstanding principal and $1.385 billion of carrying value excluding third-party non-controlling interests.
- The company is taxed as a REIT and operates to maintain its exemption from registration under the Investment Company Act of 1940.
Key financial metrics
| Metric | 2014 | 2013 | Change |
|---|---|---|---|
| Total revenue | $65.1 million | $32.0 million | Approximately +103% |
| Net interest margin | $36.9 million | $22.6 million | Approximately +63% |
| Mortgage banking revenue | $27.6 million | $8.1 million | Approximately +242% |
| Total expenses | $41.6 million | $24.3 million | Approximately +71% |
| Net income | $24.6 million | $13.8 million | Approximately +79% |
| Net income attributable to common stockholders | $24.4 million | $13.8 million | Approximately +77% |
| Diluted earnings per share | $0.85 | $0.72 | +18% |
| Dividends declared per share | $1.00 | $1.00 | Unchanged |
Margins: Net income was approximately 37.8% of total revenue, compared with approximately 43.0% in 2013. Net interest margin represented approximately 52.3% of interest income from loans held for investment. These percentages are calculated from the reported amounts and are not company-defined operating margins.
Fourth-quarter 2014
| Metric | Q4 2014 |
|---|---|
| Total revenue | $20.8 million |
| Net income | $9.1 million |
| Net income attributable to common stockholders | $8.9 million |
| Basic and diluted EPS | $0.31 |
Balance sheet, portfolio and liquidity
- Total assets increased to $1.868 billion from $1.177 billion. Loans held for investment increased to $1.463 billion from $958.5 million; loans held for sale were $203.0 million.
- Mortgage servicing rights were $58.9 million, compared with $59.6 million in 2013. The servicing portfolio included 976 loans with approximately $4.1 billion of unpaid principal balance.
- Total stockholders’ equity was $403.0 million; total equity, including non-controlling interests, was $480.9 million. Cash and cash equivalents were $16.6 million, and restricted cash was $66.1 million.
- At December 31, 2014, financing-facility borrowings were $746.0 million, including $552.8 million of secured funding and $193.2 million of warehouse lines. Additional debt included $68.4 million of convertible notes and $527.7 million of securitization debt.
- Aggregate debt identified above was approximately $1.34 billion, or approximately 2.8 times total equity and 3.3 times stockholders’ equity, based on reported balances.
- As of March 2, 2015, management expected approximately $64 million of capital in cash or approved undrawn capacity; after a $10 million liquidity reserve, approximately $54 million was available for investments, existing commitments and working capital.
Cash flow
| Cash flow item | 2014 | 2013 |
|---|---|---|
| Operating activities | $(222.9) million | $25.4 million |
| Investing activities | $(433.1) million | $(745.7) million |
| Financing activities | $652.4 million | $717.0 million |
| Ending cash | $16.6 million | $20.1 million |
The operating cash outflow primarily reflected the funding of mortgage loans held for sale and increases in restricted cash. Investing cash outflows primarily reflected originations of loans held for investment. Financing inflows primarily reflected new secured funding, securitization debt and warehouse borrowings, partly offset by repayments.
Material changes versus the prior comparable period
- Results benefited from a full year of ACRE Capital operations in 2014 versus approximately four months in 2013 following its August 2013 acquisition.
- The principal lending portfolio expanded from 33 loans at year-end 2013 to 46 loans at year-end 2014. During 2014, the company funded approximately $717.4 million and received approximately $210.0 million of principal repayments.
- ACRE Capital rate-locked 36 loans totaling $496.6 million of commitments in 2014, versus 20 loans totaling $131.3 million in 2013.
- Financing-facility borrowings increased from $264.4 million to $746.0 million. Securitization debt increased from $395.0 million of CMBS debt to $527.7 million, consisting of $219.0 million of CMBS debt and $308.7 million of CLO debt.
- Mortgage servicing rights declined modestly because additions and the Freddie Mac MSR acquisition were offset by fair-value declines and prepayments. The company recorded a $7.7 million decrease in MSR fair value in 2014.
- There were no impairments on loans held for investment in 2014, 2013 or 2012, and all loans were reported as paying according to contractual terms at year-end 2014.
- ACRE Capital received Freddie Mac Program Plus Seller/Servicer approval and acquired servicing rights on 46 Freddie Mac multifamily loans with approximately $370.6 million of unpaid principal balance.
- The company incurred $799 thousand of restructuring costs related primarily to employee termination and relocation activities; an additional $44 thousand was expected after year-end.
Outlook, contingencies and principal risks
- Management viewed market conditions as favorable for disciplined direct lending, but noted increasing competition, greater refinancing activity and higher prepayment rates.
- Management estimated that substantial commercial real estate debt maturities over the following three years could support borrower demand for financing. No formal earnings or dividend guidance was provided.
- The company expects leverage generally not to exceed 4-to-1 debt-to-equity, although its charter does not impose a leverage limit. Financing agreements contain leverage, liquidity, fixed-charge coverage, asset-value and distribution covenants.
- The $69 million of 7% convertible senior notes mature December 15, 2015. At year-end, approximately $458 million of listed debt obligations were scheduled for 2015, including the convertible notes, certain secured facilities and warehouse lines.
- Unfunded commitments for principal lending investments were $169.8 million at year-end. ACRE Capital also had $249.8 million of commitments to sell loans and $51.1 million of commitments to fund loans.
- ACRE Capital had approximately $3.2 billion of Fannie Mae DUS loans subject to risk-sharing, with approximately $1.1 billion of at-risk exposure and $12.3 million of allowance for loss sharing. The maximum quantifiable exposure was not an estimate of expected loss.
- Material risks include borrower defaults, declining commercial real estate values, concentration in a limited number of loans, interest-rate and prepayment risk, margin calls, refinancing and securitization availability, and counterparty or funding failures.
- Mortgage banking risks include loss or modification of Fannie Mae, Freddie Mac or HUD approvals, loan-delivery failures, repurchase or indemnification obligations, servicing errors, required advances on delinquent loans and changes in GSE policy.
- The company depends heavily on its external manager and Ares Management personnel. Related-party costs in 2014 included $5.9 million of management fees and $4.0 million of reimbursed general and administrative expenses. No incentive fee was earned in 2014, 2013 or 2012.
- The company must distribute at least 90% of REIT taxable income to maintain REIT status, but distributions are discretionary and may exceed operating cash flow. 2014 distributions exceeded cash flow from operating activities.
- As of December 31, 2014, the company reported no material pending legal proceedings and stated that it was in material compliance with its financing-facility covenants.
Subsequent events
- On January 1, 2015, the company originated a $41.6 million transitional first mortgage loan at LIBOR plus 5.0%, subject to a 0.25% LIBOR floor.
- Primary servicing of the company’s investments transferred to ACRE Capital effective January 1, 2015.
- The BAML Line of Credit was amended on February 27, 2015 to provide a $135 million commitment and extend maturity to June 30, 2016.
- The company transferred portions of its ACRC KA preferred-equity investment to third-party investors; its controlling interest declined to 51.0% as of March 5, 2015.
- A $0.25-per-share first-quarter 2015 dividend was declared on March 5, 2015.
Investor verification checklist
- Reconcile reported debt, collateral, maturity dates, extension options and covenant headroom, particularly the 2015 maturities and convertible notes.
- Assess liquidity after the $169.8 million of unfunded principal-lending commitments and mortgage-banking commitments.
- Review the credit quality, property and geographic concentration, loan-to-value metrics, maturity extensions and prepayment assumptions of the 46-loan portfolio.
- Evaluate the sustainability of mortgage banking revenue, MSR valuations and Fannie Mae DUS loss-sharing reserves.
- Confirm whether operating cash flow and taxable income support the $1.00 annual dividend without reliance on additional borrowings, asset sales or equity issuance.
- Monitor interest-rate sensitivity, including the reported impact of LIBOR changes and the approximately $1.8 million MSR sensitivity to a 100-basis-point change in the discount rate.
- Review related-party management fees, expense reimbursements, credit-support fees and potential conflicts associated with the external management structure.