Business Context and Reporting Period
Ares Commercial Real Estate Corporation filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2013. The company is an externally managed specialty finance company focused on originating, investing in and managing middle-market commercial real estate loans and related investments. It intends to qualify as a REIT and generally distribute taxable income to shareholders.
As of June 30, 2013, the company held 21 commercial real estate loans with approximately $529.7 million of outstanding principal and $526.0 million of carrying value. The portfolio had a weighted-average unleveraged effective yield of 6.8% and a weighted-average remaining life of 2.5 years. Management reported that all loans were paying according to their terms and that no portfolio impairments had been recorded.
Financial Performance and Position
| Metric | Three Months Ended June 30 | Six Months Ended June 30 |
|---|---|---|
| Interest income | $8.1 million | $14.8 million |
| Net interest margin | $6.2 million | $11.5 million |
| Total expenses | $5.1 million | $9.7 million |
| Unrealized gain on derivative | $2.1 million | $1.7 million |
| Net income attributable to common stockholders | $3.3 million | $3.6 million |
| Basic and diluted earnings per share | $0.32 | $0.37 |
| Common dividends declared per share | $0.25 | $0.50 |
| Core Earnings | $1.2 million, or $0.12 per share | $2.1 million, or $0.22 per share |
The reported net income included a non-cash unrealized derivative gain related to the convertible notes. Excluding this gain and adding back non-cash stock compensation, Core Earnings were $1.2 million for the quarter and $2.1 million for the six-month period.
| Balance Sheet Metric | June 30, 2013 | December 31, 2012 |
|---|---|---|
| Total assets | $581.1 million | $387.9 million |
| Loans held for investment | $526.0 million | $353.5 million |
| Cash and cash equivalents | $40.2 million | $23.4 million |
| Restricted cash | $4.7 million | $3.2 million |
| Secured financing agreements | $101.3 million | $144.3 million |
| Convertible notes | $67.5 million | $67.3 million |
| Total liabilities | $186.2 million | $222.4 million |
| Stockholders’ equity | $394.9 million | $165.4 million |
Six-month operating cash flow was $2.0 million, compared with cash used in operations of $0.7 million in the prior-year period. Investing cash outflow was $172.2 million, primarily reflecting loan fundings. Financing cash inflow was $187.1 million, primarily reflecting the June common-stock offering, partly offset by secured debt repayments and common dividends.
At June 30, secured facilities had total commitments of $361.2 million and outstanding borrowings of $101.3 million, implying approximately $259.9 million of undrawn commitments before considering borrowing conditions and collateral availability. Total debt, including convertible notes, was approximately $168.8 million.
Material Changes Versus the Prior Comparable Period
- Quarterly interest income increased to $8.1 million from $1.6 million, and six-month interest income increased to $14.8 million from $2.5 million, primarily because the loan portfolio expanded from four loans to 21 loans.
- Quarterly net income attributable to common stockholders improved from a $0.2 million loss to $3.3 million of income; six-month results improved from a $0.3 million loss to $3.6 million of income.
- Core Earnings improved from a $0.2 million loss in the prior-year quarter to $1.2 million, and from a $0.3 million loss to $2.1 million for the six-month period.
- The company issued 18.0 million common shares at $13.50 per share in June 2013, generating $234.7 million of net proceeds. Common shares outstanding increased to 27.3 million at June 30, 2013 from 9.3 million at December 31, 2012.
- Loans held for investment increased by $172.5 million from year-end, while secured financing borrowings declined by $43.0 million.
- On June 26, 2013, shareholder approval allowed the company to settle conversions of its 2015 Convertible Notes entirely in shares. The $1.8 million derivative liability recorded at December 31, 2012 was eliminated; a $2.1 million quarterly unrealized gain and $1.7 million six-month gain were recognized before the remaining $86 thousand value was reclassified to additional paid-in capital.
- Management fees and reimbursed general and administrative expenses increased materially as capital-markets and acquisition activity expanded.
Guidance, Outlook, Risks and Unusual Items
The filing does not provide quantitative earnings guidance. Management expects demand for customized commercial real estate financing to remain supported by property repositioning needs and substantial CRE debt maturities, but emphasizes that results depend on credit conditions, financing availability, interest rates, property values and borrower performance.
- The company agreed to acquire Alliant Capital LLC’s multifamily mortgage loan origination and servicing business for $52.9 million in cash plus 588,235 common shares. Closing was expected in the second half of 2013 but remained subject to conditions, and the filing states that completion was not assured.
- Unfunded commitments on existing loans were $59.5 million at June 30, 2013. Management subsequently reported approximately $66 million of unfunded commitments as of August 6, 2013.
- As of August 6, 2013, management expected approximately $180 million of capital to be available after a $10 million liquidity reserve, subject to financing commitments for recently originated loans.
- Subsequent to quarter-end, the company originated several loans, including approximately $14.7 million in Irvine, California, $75.0 million in Orange County, California, and approximately $70.0 million in Chicago, Illinois.
- Subsequent amendments increased the Citibank facility to $125.0 million and the Capital One facility to $100.0 million, while reducing their stated pricing ranges.
- The company declared a third-quarter 2013 dividend of $0.25 per common share.
- Principal risks include borrower defaults, declining collateral values, refinancing and extension risk, interest-rate and LIBOR mismatch risk, funding and liquidity risk, covenant compliance, dependence on the external manager, REIT qualification, the pending Alliant acquisition, and changes in regulation or credit-market liquidity.
- The company reported compliance in all material respects with the covenants of its Wells Fargo, Citibank and Capital One facilities as of June 30, 2013, and reported no pending legal proceedings or defaults.
Most Important Facts for Investors to Verify
- Whether the Alliant Capital acquisition closed and the resulting purchase price, financing, dilution and operating contribution.
- Subsequent loan originations, funding commitments, portfolio concentrations and borrower performance, particularly as the portfolio expanded rapidly.
- Availability of secured financing capacity, compliance with liquidity, leverage and fixed-charge coverage covenants, and facility maturity or extension terms.
- Core Earnings and recurring cash earnings excluding the non-recurring derivative gain, compared with the $0.25 quarterly dividend.
- Credit quality, collateral valuations and any later impairments, delinquencies, restructurings or realized losses.
- The company’s continuing ability to qualify as a REIT and satisfy distribution requirements while funding portfolio growth.
- The potential dilution and cash or share settlement implications of the $69.0 million principal amount of 2015 Convertible Notes.