Ares mercial Real Estate (ACRE) - 2020 Q2 - Quarterly Report

Part I. Financial Information Consolidated Financial Statements The consolidated financial statements reflect the company's financial position, operational results, and cash flows, significantly impacted by CECL adoption, COVID-19 related credit losses, and a common stock offering Consolidated Balance Sheets Total assets grew to $2.02 billion by June 30, 2020, driven by loans and cash, while liabilities and equity also increased due to financing and a stock offering Consolidated Balance Sheet Highlights (in thousands) | Account | June 30, 2020 (unaudited) | December 31, 2019 | | :--- | :--- | :--- | | Total Assets | $2,021,233 | $1,784,134 | | Cash and cash equivalents | $72,987 | $5,256 | | Loans held for investment, net | $1,767,986 | $1,682,498 | | Current expected credit loss reserve | $(26,063) | — | | Total Liabilities | $1,556,107 | $1,357,795 | | Secured funding agreements | $876,842 | $728,589 | | Collateralized loan obligation debt | $443,467 | $443,177 | | Total Stockholders' Equity | $465,126 | $426,339 | Consolidated Statements of Operations The company reported a net loss of $7.5 million for the first half of 2020, a reversal from prior year income, primarily due to a $23.1 million provision for credit losses and unrealized losses on loans held for sale Statement of Operations Summary (in thousands, except per share data) | Metric | Q2 2020 | Q2 2019 | H1 2020 | H1 2019 | | :--- | :--- | :--- | :--- | :--- | | Total Revenue | $17,982 | $21,675 | $39,116 | $35,831 | | Net Interest Margin | $16,793 | $13,318 | $32,707 | $25,564 | | Provision for credit losses | $(4,007) | — | $23,111 | — | | Unrealized losses on loans held for sale | $3,998 | — | $3,998 | — | | Net Income (Loss) | $9,768 | $9,755 | $(7,495) | $18,296 | | Diluted EPS | $0.29 | $0.34 | $(0.23) | $0.63 | Consolidated Statements of Cash Flows Net cash from financing activities totaled $246.2 million for the first half of 2020, primarily from secured funding and a stock sale, leading to a $67.4 million increase in cash and equivalents Cash Flow Summary for Six Months Ended June 30 (in thousands) | Activity | 2020 | 2019 | | :--- | :--- | :--- | | Net cash provided by operating activities | $14,163 | $16,335 | | Net cash used in investing activities | $(193,035) | $(67,276) | | Net cash provided by financing activities | $246,224 | $45,067 | | Change in cash, cash equivalents and restricted cash | $67,352 | $(5,874) | Notes to Consolidated Financial Statements The notes detail significant accounting policies, including CECL adoption, the $1.8 billion loan portfolio, $28.2 million CECL reserve due to COVID-19, a $72.9 million stock offering, and subsequent loan sales - The company adopted the CECL standard on January 1, 2020, resulting in a cumulative-effect adjustment to retained earnings of $5.1 million[36] - As of June 30, 2020, the loan portfolio consisted of 50 loans with an outstanding principal of $1.8 billion. During the first six months, the company funded $458.2 million, received $244.1 million in repayments, and transferred three loans totaling $100.8 million to held for sale[52] - Due to the impact of the COVID-19 pandemic, the company made six loan modifications totaling $292.3 million in Q2 2020, including interest deferrals and maturity extensions. Three loans with a carrying value of $68.7 million were on non-accrual status[59][63] - In January 2020, the company completed a public offering of 4.6 million shares of common stock, generating net proceeds of approximately $72.9 million[107] - Subsequent to quarter-end, the company sold three senior mortgage loans previously classified as held for sale, with a combined outstanding principal of $100.8 million. The company also extended its MetLife Facility to August 2022[155][156][157][158] Management's Discussion and Analysis of Financial Condition and Results of Operations Management discusses the significant impact of the COVID-19 pandemic on operations, financial condition, and liquidity, highlighting a net loss driven by CECL, increased net interest margin, and proactive liquidity management - The company's loan portfolio grew to $1.8 billion in outstanding principal as of June 30, 2020, with 93.4% of loans having LIBOR floors, providing a benefit in the declining interest rate environment[169] - The company is focused on preserving liquidity to meet obligations, including funding commitments and debt service. Primary sources of liquidity include financing facilities, equity/debt offerings, and potential asset sales[195] - The company adopted the CECL accounting standard on January 1, 2020, and recorded a provision for credit losses of $23.1 million for the first six months of 2020, reflecting the macroeconomic impact of the COVID-19 pandemic[188][189] - In June 2020, three senior mortgage loans with a combined outstanding principal of $100.8 million were reclassified to held for sale, resulting in a $4.0 million unrealized loss[190] Results of Operations The company reported a net loss of $7.5 million for the first half of 2020, primarily due to a $23.1 million provision for credit losses and unrealized losses, despite an increased net interest margin Net Interest Margin Comparison (in thousands) | Period | H1 2020 | H1 2019 | | :--- | :--- | :--- | | Interest income from loans | $61,283 | $57,979 | | Interest expense | $(28,576) | $(32,415) | | Net interest margin | $32,707 | $25,564 | - Revenue from the company's real estate owned (a hotel property) decreased to $6.4 million in H1 2020 from $10.3 million in H1 2019, primarily due to significantly reduced occupancy caused by the COVID-19 pandemic[178] - Related party expenses for H1 2020 included $3.6 million in management fees and $0.3 million in incentive fees paid to the Manager, ACREM[182] Liquidity and Capital Resources The company's liquidity is a primary focus due to COVID-19, with $80 million in unrestricted cash as of August 5, 2020, supported by a $72.9 million stock offering and active management of $1.59 billion in financing commitments - As of August 5, 2020, the company had approximately $80 million in unrestricted cash[196] - The company's financing agreements contain margin call provisions. To mitigate this risk, the company has proactively engaged with lenders to modify borrowing terms on certain assets[194] Summary of Financing Agreements as of June 30, 2020 (in thousands) | Facility Type | Total Commitment | Outstanding Balance | | :--- | :--- | :--- | | Secured Funding Agreements | $1,390,989 | $876,842 | | Notes Payable | $84,155 | $56,155 | | Secured Term Loan | $110,000 | $110,000 | | Total | $1,585,144 | $1,042,997 | Quantitative and Qualitative Disclosures About Market Risk The company faces heightened market risks due to COVID-19, including credit, interest rate, and financing risks, with a 100 basis point LIBOR increase potentially decreasing net income by $12.1 million annually - Credit risk is elevated due to the COVID-19 pandemic, which may slow prepayments and increase defaults as tenants struggle to pay rent, impacting borrowers' ability to service their loans[224] - The company primarily originates floating-rate assets and finances them with index-matched floating-rate liabilities to reduce interest rate exposure. However, risks from interest rate caps and floors remain[225][230] Hypothetical Impact of LIBOR Change on Net Income (in millions) | Change in 30-Day LIBOR | Increase/(Decrease) in Net Income (Loss) | | :--- | :--- | | Up 100 basis points | $(12.1) | | Up 50 basis points | $(6.2) | | LIBOR at 0 basis points | $1.9 | - Financing risk has increased due to market volatility. The company's secured funding agreements contain margin call provisions, and the company has proactively engaged with lenders to modify terms and mitigate this risk[233][235] Controls and Procedures Management concluded that the company's disclosure controls and procedures were effective as of June 30, 2020, with no material changes to internal control over financial reporting during the quarter - The Principal Executive Officer and Principal Financial Officer concluded that the company's disclosure controls and procedures were effective as of June 30, 2020[238] - No changes occurred during the quarter ended June 30, 2020, that materially affected, or are reasonably likely to materially affect, the company's internal control over financial reporting[239] Part II. Other Information Legal Proceedings As of June 30, 2020, the company was not subject to any material pending legal proceedings, though future litigation may increase with worsening market conditions - The company is not currently subject to any material pending legal proceedings[240] Risk Factors The company faces significant risks from the COVID-19 pandemic, including increased credit risk from borrower defaults, heightened liquidity risk from potential margin calls, and challenges in accessing capital markets - The COVID-19 pandemic has caused severe disruptions, negatively impacting borrowers' ability to make payments, increasing the likelihood of loan losses, and straining the company's liquidity[243][245] - Financing agreements contain margin call provisions that could be triggered by credit events. The company may not have funds to satisfy these calls, which could lead to defaults[247] - The company has increased its Current Expected Credit Loss (CECL) reserve to account for the macroeconomic impact of the pandemic, and this reserve may fluctuate as the situation develops[251] - The illiquidity of the company's loan investments may make it difficult to sell them to access capital if required, potentially resulting in realizing significantly less than their recorded value[250] Unregistered Sales of Equity Securities and Use of Proceeds No unregistered sales of equity securities occurred during the reporting period - None[253] Defaults Upon Senior Securities No defaults upon senior securities occurred during the reporting period - None[253] Other Information No other material information is reported for the period - None[253] Exhibits The report includes various exhibits, such as CEO and CFO certifications under Sarbanes-Oxley Act and XBRL data files - Exhibits filed include CEO/CFO certifications under SOX Sections 302 and 906, and XBRL Interactive Data Files[254]