Ares mercial Real Estate (ACRE) - 2022 Q3 - Quarterly Report

FORM 10-Q Filing Information The document is a Quarterly Report on Form 10-Q for the period ended September 30, 2022, filed by Ares Commercial Real Estate Corporation (ACRE) - The document is a Quarterly Report on Form 10-Q for the period ended September 30, 2022, filed by Ares Commercial Real Estate Corporation (ACRE)[2] Outstanding Common Stock at November 1, 2022 | Class | Outstanding at November 1, 2022 | | :-------------------------- | :------------------------------ | | Common stock, $0.01 par value | 54,442,649 shares | - ACRE is an accelerated filer and has filed all required reports and interactive data files during the preceding 12 months[2] Forward-Looking Statements This report contains forward-looking statements subject to risks and uncertainties, including those related to business strategy, operating results, investment returns, global economic trends, and financing arrangements - This report contains forward-looking statements subject to risks and uncertainties, including those related to business strategy, operating results, investment returns, global economic trends (inflation, interest rates, recession), the COVID-19 pandemic, the Russia-Ukraine conflict, credit losses, and financing arrangements[5][6][7] - Actual results may differ materially from these statements due to factors detailed in the 'Risk Factors' section of the 2021 Annual Report on Form 10-K and other disclosures[5][8] - The company assumes no obligation to update any forward-looking statements, advising readers to consult additional SEC filings[9][10] Part I. Financial Information This section presents the unaudited consolidated financial statements of Ares Commercial Real Estate Corporation, detailing its financial position, performance, and cash flows, along with explanatory notes Item 1. Consolidated Financial Statements This section provides the unaudited consolidated financial statements, including balance sheets, statements of operations, comprehensive income, stockholders' equity, and cash flows, with accompanying notes Consolidated Balance Sheets This section presents the unaudited consolidated balance sheets as of September 30, 2022, and December 31, 2021, detailing assets, liabilities, and stockholders' equity Consolidated Balance Sheet Highlights (in thousands) | Metric | Sep 30, 2022 (unaudited) | Dec 31, 2021 | | :------------------------------------------------ | :----------------------- | :----------- | | Cash and cash equivalents | $77,297 | $50,615 | | Loans held for investment, net | $2,462,549 | $2,390,444 | | Total assets | $2,727,186 | $2,631,838 | | Total liabilities | $1,960,109 | $1,953,210 | | Total stockholders' equity | $767,077 | $678,628 | - Total assets increased by $95.3 million (3.6%) from December 31, 2021, to September 30, 2022, primarily driven by an increase in loans held for investment[13] - The current expected credit loss reserve increased significantly from $23.9 million at December 31, 2021, to $46.1 million at September 30, 2022[13] Consolidated Statements of Operations This section presents the unaudited consolidated statements of operations for the three and nine months ended September 30, 2022, and 2021, detailing revenues, expenses, and net income Consolidated Statements of Operations Highlights (in thousands, except per share data) | Metric | 3 Months Ended Sep 30, 2022 | 3 Months Ended Sep 30, 2021 | 9 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2021 | | :----------------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | Total revenue | $27,271 | $27,204 | $76,440 | $71,958 | | Net interest margin | $27,271 | $21,354 | $73,768 | $59,687 | | Total expenses | $7,137 | $10,886 | $24,895 | $28,814 | | Provision for current expected credit losses | $19,485 | $6,367 | $26,659 | $(756) | | Net income attributable to common stockholders | $644 | $9,951 | $26,875 | $43,307 | | Basic earnings per common share | $0.01 | $0.21 | $0.53 | $1.06 | | Diluted earnings per common share | $0.01 | $0.21 | $0.52 | $1.05 | | Dividends declared per share | $0.35 | $0.35 | $1.05 | $1.05 | - Net income attributable to common stockholders decreased significantly for both the three-month (from $9.95 million to $0.64 million) and nine-month periods (from $43.31 million to $26.88 million) year-over-year, primarily due to a substantial increase in the provision for current expected credit losses[16] - The provision for current expected credit losses increased from $6.37 million to $19.49 million for the three months ended September 30, 2022, and from a $(0.76) million recovery to a $26.66 million expense for the nine months ended September 30, 2022[16] Consolidated Statements of Comprehensive Income This section presents the unaudited consolidated statements of comprehensive income for the three and nine months ended September 30, 2022, and 2021, including net income and other comprehensive income items Consolidated Statements of Comprehensive Income Highlights (in thousands) | Metric | 3 Months Ended Sep 30, 2022 | 3 Months Ended Sep 30, 2021 | 9 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2021 | | :--------------------------------------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | Net income attributable to common stockholders | $644 | $9,951 | $26,875 | $43,307 | | Realized and unrealized gains (losses) on derivative financial instruments | $(866) | $(98) | $8,679 | $19 | | Unrealized gains (losses) on available-for-sale debt securities | $(144) | — | $(144) | — | | Comprehensive income | $(366) | $9,853 | $35,410 | $43,326 | - Comprehensive income decreased significantly for the three months ended September 30, 2022, to $(366) thousand from $9.85 million in the prior year, primarily due to net income decline and unrealized losses on derivatives and available-for-sale debt securities[19] - For the nine months ended September 30, 2022, comprehensive income was $35.41 million, supported by realized and unrealized gains on derivative financial instruments, despite a lower net income compared to the prior year[19] Consolidated Statements of Stockholders' Equity This section presents the unaudited consolidated statements of stockholders' equity for the nine months ended September 30, 2022, and the year ended December 31, 2021, detailing changes in equity components Stockholders' Equity Changes (in thousands) | Metric | Dec 31, 2021 | Sep 30, 2022 | | :-------------------------- | :----------- | :----------- | | Common Shares | 47,144,058 | 54,438,363 | | Common Stock Amount | $465 | $537 | | Additional Paid-in Capital | $703,950 | $812,050 | | Accumulated Other Comprehensive Income | $2,844 | $11,379 | | Accumulated Earnings (Deficit) | $(28,631) | $(56,889) | | Total Stockholders' Equity | $678,628 | $767,077 | - Total stockholders' equity increased by $88.45 million from December 31, 2021, to September 30, 2022, primarily due to sales of common stock and an increase in accumulated other comprehensive income, partially offset by accumulated earnings deficit[22] - The company issued 7,000,000 common shares in May 2022, contributing to a significant increase in additional paid-in capital[22] Consolidated Statements of Cash Flows This section presents the unaudited consolidated statements of cash flows for the nine months ended September 30, 2022, and 2021, categorizing cash movements from operating, investing, and financing activities Consolidated Statements of Cash Flows Highlights (in thousands) | Activity | 9 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2021 | | :------------------------------------------ | :-------------------------- | :-------------------------- | | Net cash provided by operating activities | $42,067 | $30,280 | | Net cash provided by (used in) investing activities | $(63,954) | $(575,079) | | Net cash provided by (used in) financing activities | $48,569 | $485,810 | | Change in cash and cash equivalents | $26,682 | $(58,989) | | Cash and cash equivalents, end of period | $77,297 | $15,787 | - Net cash provided by operating activities increased to $42.07 million for the nine months ended September 30, 2022, from $30.28 million in the prior year[23] - Net cash used in investing activities significantly decreased from $(575.08) million in 2021 to $(63.95) million in 2022, while net cash provided by financing activities decreased from $485.81 million to $48.57 million[23] Notes to Consolidated Financial Statements This section provides detailed notes explaining the company's organization, significant accounting policies, and specific financial line items presented in the consolidated financial statements 1. Organization Ares Commercial Real Estate Corporation (ACRE) is a specialty finance company focused on originating and investing in commercial real estate (CRE) loans, externally managed by ACREM, and operates as a REIT - ACRE is a specialty finance company primarily engaged in originating and investing in commercial real estate loans and related investments[26] - The company is externally managed by ACREM, a subsidiary of Ares Management Corporation, and has elected to be taxed as a REIT for U.S. federal income tax purposes since December 31, 2012[26][28] - ACRE operates as one segment, focusing on a diversified portfolio of CRE debt-related investments including senior mortgage loans, subordinated debt, preferred equity, and mezzanine loans[27] 2. Significant Accounting Policies This section outlines the company's significant accounting policies, including the basis of presentation under GAAP, the use of estimates, consolidation of Variable Interest Entities (VIEs), and accounting for various financial instruments and assets - Financial statements are prepared in conformity with GAAP, requiring management to make estimates and assumptions, which are subject to uncertainty due to global macroeconomic conditions, inflation, interest rates, and the COVID-19 pandemic[30][33][34] - The company consolidates Variable Interest Entities (VIEs) where it is determined to be the primary beneficiary, possessing both the power to direct significant activities and the obligation to absorb losses or right to receive significant benefits[35][38] - The company adopted ASU No. 2020-04 (Reference Rate Reform) and ASU 2022-02 (Troubled Debt Restructurings), with no material impact from the former and prospective application for the latter[63][64] 3. Loans Held for Investment This note details the company's portfolio of loans held for investment, including their carrying amounts, outstanding principal, effective yields, remaining life, and a breakdown by loan type and location - As of September 30, 2022, the company's portfolio included 70 loans held for investment with an aggregate originated commitment of approximately $2.9 billion and outstanding principal of $2.5 billion[65] Loans Held for Investment Portfolio Summary (in thousands) | Metric | Sep 30, 2022 | Dec 31, 2021 | | :------------------------------------ | :----------- | :----------- | | Total Carrying Amount | $2,508,609 | $2,414,383 | | Total Outstanding Principal | $2,527,033 | $2,429,112 | | Weighted Average Unleveraged Effective Yield | 7.4% | 5.4% | | Weighted Average Remaining Life (Years) | 1.4 | 1.6 | - During the nine months ended September 30, 2022, the company funded $601.8 million and received repayments of $503.9 million in outstanding principal[65] - As of September 30, 2022, three loans with a carrying value of $100.8 million were on non-accrual status[79] 4. Current Expected Credit Losses This note details the methodology for estimating the Current Expected Credit Loss (CECL) Reserve, which considers macroeconomic conditions and loan-specific factors, and provides reserve amounts for funded and unfunded commitments - The CECL Reserve is estimated using a probability-weighted model considering default likelihood, loss given default, loan-specific data, and macroeconomic conditions (recession, inflation, rising interest rates, COVID-19)[80] CECL Reserve for Funded and Unfunded Loan Commitments (in thousands) | Metric | Sep 30, 2022 | | :---------------------------------------------------------------- | :----------- | | CECL Reserve for outstanding balances on loans held for investment | $46,060 | | CECL Reserve for unfunded commitments on loans held for investment | $5,846 | | Total CECL Reserve | $51,906 | - A specific CECL reserve of $2.4 million was assigned to a $14.3 million senior mortgage loan on a California residential property, which was downgraded to a risk rating of '5' (Impaired/Loss Likely) during Q3 2022[82][84][91] 5. Real Estate Owned This note describes the company's acquisition of a hotel property through foreclosure, its classification as held for sale, and its subsequent sale in March 2022, resulting in a $2.2 million gain - The company acquired a hotel property in New York via deed in lieu of foreclosure in March 2019, which was subsequently classified as real estate owned held for sale as of December 31, 2021[93][94] - The hotel property was sold on March 1, 2022, for $40.0 million, resulting in a $2.2 million gain on sale recognized in the first quarter of 2022[94] Real Estate Owned, Net (in thousands) | Component | Dec 31, 2021 | | :-------------------------- | :----------- | | Land | $10,200 | | Buildings and improvements | $24,281 | | Furniture, fixtures and equipment | $4,506 | | Less: Accumulated depreciation | $(2,385) | | Real estate owned, net | $36,602 | 6. Debt This note provides a detailed overview of the company's financing agreements, including Secured Funding Agreements, Notes Payable, and a Secured Term Loan, outlining their commitments, outstanding balances, interest rates, and maturity dates Financing Agreements Summary (in thousands) | Agreement Type | Sep 30, 2022 Outstanding Balance | Sep 30, 2022 Total Commitment | Dec 31, 2021 Outstanding Balance | Dec 31, 2021 Total Commitment | | :-------------------------- | :------------------------------- | :---------------------------- | :------------------------------- | :---------------------------- | | Secured Funding Agreements | $847,697 | $1,280,000 | $840,047 | $1,280,000 | | Notes Payable | $105,000 | $105,000 | $51,110 | $51,755 | | Secured Term Loan | $150,000 | $150,000 | $150,000 | $150,000 | | Total | $1,102,697 | $1,535,000 | $1,041,157 | $1,481,755 | - The company entered into a new $105.0 million recourse note in July 2022, secured by a multifamily property loan, with an initial maturity date of July 28, 2025, accruing interest at one-month SOFR plus 2.00%[110][112] - The Secured Term Loan was amended in November 2021, increasing the commitment to $150.0 million and extending the maturity date to November 12, 2026, with fixed interest rates starting at 4.50% per annum[113] 7. Secured Borrowings This note describes a secured borrowing arrangement related to a transferred senior mortgage loan that did not qualify as a sale, which was fully repaid in July 2022 - A $24.4 million secured borrowing, originating from a transferred senior mortgage loan in February 2020, was fully repaid in July 2022[115] - The transfer of the senior mortgage loan was treated as a financing transaction because it did not meet the criteria for sale accounting under FASB ASC Topic 860[115] 8. Derivative Financial Instruments This note outlines the company's use of derivative financial instruments, specifically interest rate swaps and caps, to manage interest rate risk, detailing their notional amounts, rates, and maturities - The company uses interest rate swaps and interest rate caps to manage net exposure to interest rate changes and reduce borrowing costs, without engaging in speculative trading[116][117] Outstanding Interest Rate Derivatives (Notional Amount in thousands) | Derivative Type | Sep 30, 2022 Notional Amount | Sep 30, 2022 Fixed/Strike Rate | Dec 31, 2021 Notional Amount | Dec 31, 2021 Fixed/Strike Rate | | :-------------------- | :--------------------------- | :----------------------------- | :--------------------------- | :----------------------------- | | Interest rate swaps | $460,000 | 0.2075% | $700,000 | 0.2075% | | Interest rate caps | — | — | $220,000 | 0.5000% | - In March 2022, the company terminated an interest rate cap derivative, recognizing a $2.0 million realized gain within OCI, which will be recognized in current earnings over the original term[119] 9. Commitments and Contingencies This note details the company's unfunded loan commitments and addresses potential impacts from macroeconomic and geopolitical conditions, as well as legal proceedings Total Unfunded Commitments (in thousands) | Metric | Sep 30, 2022 | Dec 31, 2021 | | :-------------------------- | :----------- | :----------- | | Total commitments | $2,784,902 | $2,662,853 | | Less: funded commitments | $(2,527,033) | $(2,429,112) | | Total unfunded commitments | $257,869 | $233,741 | - The company's unfunded commitments increased by $24.1 million from December 31, 2021, to September 30, 2022[123] - As of September 30, 2022, there were no material legal claims, but the company acknowledges that worsening global market conditions could adversely affect its business and potentially increase litigation[121][123] 10. Stockholders' Equity This note details changes in stockholders' equity, including the 'at the market' stock offering program, a new $50.0 million stock repurchase program, and the equity incentive plan - During the nine months ended September 30, 2022, the company sold 190,369 shares of common stock under its 'at the market' offering program, generating approximately $2.9 million in net proceeds[124] - A $50.0 million stock repurchase program was approved on July 26, 2022, effective until July 26, 2023, but no repurchases were conducted during the three months ended September 30, 2022[125] - The Amended and Restated 2012 Equity Incentive Plan was amended in February 2022 to increase the total number of authorized common stock shares for grants to 2,490,000[127] 11. Earnings Per Share This note provides the computation of basic and diluted earnings per common share for the three and nine months ended September 30, 2022 and 2021, detailing net income and weighted average shares outstanding Earnings Per Common Share (in thousands, except per share data) | Metric | 3 Months Ended Sep 30, 2022 | 3 Months Ended Sep 30, 2021 | 9 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2021 | | :------------------------------------------ | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | Net income attributable to common stockholders | $644 | $9,951 | $26,875 | $43,307 | | Basic earnings per common share | $0.01 | $0.21 | $0.53 | $1.06 | | Diluted earnings per common share | $0.01 | $0.21 | $0.52 | $1.05 | | Basic weighted average shares outstanding | 54,415,545 | 46,957,339 | 50,753,915 | 40,840,453 | | Diluted weighted average shares outstanding | 54,846,756 | 47,209,469 | 51,193,238 | 41,120,751 | - Basic and diluted EPS significantly decreased for the three months ended September 30, 2022, to $0.01 from $0.21 in the prior year, reflecting the lower net income[132] - For the nine months ended September 30, 2022, basic EPS was $0.53 and diluted EPS was $0.52, down from $1.06 and $1.05 respectively in the prior year[132] 12. Income Tax This note details the company's income tax provision, including excise tax, for its taxable REIT subsidiaries (TRSs), highlighting its REIT status and tax examination status - The company wholly owns several Taxable REIT Subsidiaries (TRSs) for specific activities, such as holding loans for sale, managing CLO securitizations, and operating real estate owned[133][134] Income Tax Expense, Including Excise Tax (in thousands) | Metric | 3 Months Ended Sep 30, 2022 | 3 Months Ended Sep 30, 2021 | 9 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2021 | | :----------------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | Current | $5 | $(35) | $28 | $437 | | Deferred | — | — | — | — | | Excise tax | — | $35 | $180 | $156 | | Total income tax expense, including excise tax | $5 | — | $208 | $593 | - The company incurred $180 thousand in U.S. federal excise tax for the nine months ended September 30, 2022, a 4% tax on undistributed REIT taxable income[135] 13. Fair Value This note describes the company's fair value measurement practices, categorizing inputs into Level 1, 2, and 3, and detailing recurring and nonrecurring fair value measurements for financial instruments and assets - The company categorizes fair value measurements into a three-level hierarchy: Level 1 (quoted prices in active markets), Level 2 (significant observable inputs), and Level 3 (significant unobservable inputs)[137][138] Fair Value of Financial Assets (in thousands) | Financial Asset | Sep 30, 2022 Fair Value | Dec 31, 2021 Fair Value | | :-------------------------------- | :---------------------- | :---------------------- | | Interest rate derivatives | $10,181 | $2,979 | | Available-for-sale debt securities | $27,730 | — | - Loans held for investment, notes payable, secured term loan, and collateralized loan obligation securitization debt are not measured at fair value on a recurring basis but have fair value estimates determined using discounted cash flow methodologies (Level 3 inputs)[148][149] 14. Related Party Transactions This note details the company's related party transactions, primarily with its Manager, ACREM, under the Management Agreement, outlining base management fees, incentive fees, and expense reimbursements - The company pays ACREM a base management fee (1.5% of stockholders' equity per annum) and an incentive fee (20% of Core Earnings exceeding an 8% minimum return)[153] Related Party Costs Incurred (in thousands) | Metric | 3 Months Ended Sep 30, 2022 | 3 Months Ended Sep 30, 2021 | 9 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2021 | | :-------------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | Management fees | $3,013 | $2,602 | $8,430 | $6,770 | | Incentive fees | $855 | $572 | $2,178 | $1,923 | | General and administrative expenses | $1,011 | $773 | $2,641 | $2,313 | | Total | $4,880 | $3,951 | $13,289 | $11,003 | - The company co-invests with other Ares Management vehicles on a pari-passu basis, with total outstanding principal for co-investments at $209.0 million as of September 30, 2022[161] 15. Dividends and Distributions This note summarizes the cash dividends declared by the company during the nine months ended September 30, 2022 and 2021, including regular and supplemental dividends Cash Dividends Declared (in thousands, except per share data) | Period | Per Share Amount | Total Amount | | :--------------------------------------------------- | :--------------- | :----------- | | 9 Months Ended Sep 30, 2022 | $1.05 | $55,134 | | 9 Months Ended Sep 30, 2021 | $1.05 | $47,299 | - The company declared a total of $1.05 per common share in cash dividends for both the nine months ended September 30, 2022, and 2021, consisting of regular and supplemental dividends[164] 16. Variable Interest Entities This note details the company's involvement with Consolidated Variable Interest Entities (VIEs), specifically the FL3 and FL4 CLO Securitizations, explaining the basis for consolidation and limited risk exposure - The company consolidates the FL3 and FL4 CLO Securitizations because it is deemed the primary beneficiary, holding subordinated notes and preferred equity, giving it a first-loss position and the ability to direct significant activities[169][174][175] - As of September 30, 2022, the FL3 Notes were collateralized by 15 mortgage assets totaling $427.2 million, and the FL4 Notes by 13 mortgage assets totaling $503.4 million[167][171] - The company's maximum risk of loss from its involvement in the CLO Securitizations is limited to the carrying value of its investments in these entities, which was $238.2 million as of September 30, 2022[177] 17. Subsequent Events This note discloses subsequent events, specifically the declaration of fourth-quarter 2022 dividends by the Board of Directors - The Board of Directors declared a regular cash dividend of $0.33 per common share and a supplemental cash dividend of $0.02 per common share for Q4 2022, payable on January 18, 2023[178] Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations This section provides an overview of the company's business, recent developments, and trends affecting its operations, including detailed analysis of financial results, liquidity, and capital resources Overview ACRE is a specialty finance company focused on originating and investing in CRE loans, externally managed by ACREM, and operates as a REIT - ACRE is a specialty finance company focused on originating and investing in CRE loans, externally managed by ACREM, and operates as a REIT[181][182] - Key developments in Q3 2022 included purchasing $29.1 million in senior mortgage loans and $18.0 million in AAA-rated CRE debt securities, originating a $20.6 million mezzanine loan, closing a $105.0 million note financing, and approving a $50.0 million stock repurchase program[183] Trends Affecting Our Business Global markets experienced volatility in Q3 2022 due to monetary policy tightening and geopolitical uncertainty, with the Federal Reserve raising interest rates in response to heightened inflation - Global markets experienced volatility in Q3 2022 due to monetary policy tightening and geopolitical uncertainty, with the Federal Reserve raising interest rates in response to heightened inflation[184] - These macroeconomic conditions could lead to an economic slowdown or recession, with the full impact on the company's business remaining uncertain[184] Factors Impacting Our Operating Results Operating results are primarily influenced by net interest income, the market value of assets, and the supply/demand for commercial mortgage loans and other financial assets - Operating results are primarily influenced by net interest income, the market value of assets, and the supply/demand for commercial mortgage loans and other financial assets[185] - Net interest income is recognized based on contractual rates and outstanding principal, with interest rates varying due to market conditions, borrower creditworthiness, and competition[185] - Operating results can also be impacted by credit losses exceeding initial expectations or unanticipated credit events[185] Stock Repurchase Program The Board of Directors approved a $50.0 million stock repurchase program on July 26, 2022, effective until July 26, 2023, with no repurchases conducted during Q3 2022 - The Board of Directors approved a $50.0 million stock repurchase program on July 26, 2022, effective until July 26, 2023[187] - No repurchases were conducted under this program during the three months ended September 30, 2022[187] Loans Held for Investment Portfolio As of September 30, 2022, the portfolio comprised 70 loans with an outstanding principal of $2.5 billion, having funded $601.8 million and received $503.9 million in repayments during the nine months ended September 30, 2022 - As of September 30, 2022, the portfolio comprised 70 loans with an outstanding principal of $2.5 billion, having funded $601.8 million and received $503.9 million in repayments during the nine months ended September 30, 2022[188] - 90.8% of the loans have LIBOR or SOFR floors, with a weighted average floor of 0.92%[188] Loans Held for Investment Portfolio Summary (in thousands) | Metric | Sep 30, 2022 | | :------------------------------------ | :----------- | | Senior mortgage loans (Carrying Amount) | $2,470,545 | | Subordinated debt and preferred equity investments (Carrying Amount) | $38,064 | | Total loans held for investment portfolio (Carrying Amount) | $2,508,609 | | Weighted Average Unleveraged Effective Yield | 7.4% | | Weighted Average Remaining Life (Years) | 1.4 | Critical Accounting Estimates The company's financial statements rely on management's estimates and assumptions, which are subject to uncertainty from global macroeconomic conditions, including inflation and interest rate changes - The company's financial statements rely on management's estimates and assumptions, which are subject to uncertainty from global macroeconomic conditions, including inflation and interest rate changes[191][192] - No significant changes to critical accounting estimates were reported since the 2021 Annual Report on Form 10-K, but management continues to monitor factors impacting these estimates[192] Recent Developments The Board of Directors declared a regular cash dividend of $0.33 per common share and a supplemental cash dividend of $0.02 per common share for Q4 2022, payable on January 18, 2023 - The Board of Directors declared a regular cash dividend of $0.33 per common share and a supplemental cash dividend of $0.02 per common share for Q4 2022, payable on January 18, 2023[193] Results of Operations This section analyzes the company's financial performance, focusing on net interest margin, revenue and expenses from real estate owned, provision for credit losses, and gain on sale of real estate Net Interest Margin Net interest margin increased for both the three-month and nine-month periods ended September 30, 2022, primarily due to higher earning assets, hedging benefits, and increased LIBOR/SOFR rates Net Interest Margin (in thousands) | Metric | 3 Months Ended Sep 30, 2022 | 3 Months Ended Sep 30, 2021 | 9 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2021 | | :---------------- | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | Interest income | $45,633 | $34,023 | $117,619 | $95,587 | | Interest expense | $(18,362) | $(12,669) | $(43,851) | $(35,900) | | Net interest margin | $27,271 | $21,354 | $73,768 | $59,687 | - Net interest margin increased by $5.9 million (27.7%) for the three months ended September 30, 2022, and by $14.08 million (23.6%) for the nine months ended September 30, 2022, compared to the prior year periods[196][197] - The increase was primarily driven by higher weighted average earning assets, benefits from interest rate hedging, and increased LIBOR and SOFR rates on loans, along with accelerated recognition of deferred fees and prepayment penalties[196][197] Revenue From Real Estate Owned No revenue from real estate owned was recognized for the three months ended September 30, 2022, due to the sale of the hotel property on March 1, 2022, leading to a significant decrease year-over-year - No revenue from real estate owned was recognized for the three months ended September 30, 2022, due to the sale of the hotel property on March 1, 2022[198] - Revenue from real estate owned decreased from $12.3 million for the nine months ended September 30, 2021, to $2.7 million for the same period in 2022, reflecting only two months of hotel operations prior to the sale[198] Operating Expenses This section details the company's operating expenses, including related party expenses, professional fees, general and administrative expenses, and expenses from real estate owned Related Party Expenses Management and incentive fees to affiliates, along with general and administrative expenses reimbursed to the Manager, increased due to higher equity, core earnings, and allocated employee time Related Party Expenses (in thousands) | Expense Type | 3 Months Ended Sep 30, 2022 | 3 Months Ended Sep 30, 2021 | 9 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2021 | | :------------------------------------------ | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | Management and incentive fees to affiliate | $3,868 | $3,175 | $10,608 | $8,693 | | General and administrative expenses reimbursed to affiliate | $1,011 | $773 | $2,641 | $2,313 | - Management fees increased due to higher weighted average stockholders' equity from public offerings, while incentive fees rose as Core Earnings exceeded the 8% minimum return by a greater margin[200][203] - Allocable general and administrative expenses reimbursed to the Manager increased due to higher allocated employee time and additional eligible expense reimbursements under the amended Management Agreement[202][203] Other Expenses Professional fees and general and administrative expenses increased due to higher use of third-party professionals and increased stock-based compensation expense Other Expenses (in thousands) | Expense Type | 3 Months Ended Sep 30, 2022 | 3 Months Ended Sep 30, 2021 | 9 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2021 | | :-------------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | Professional fees | $842 | $480 | $2,720 | $1,880 | | General and administrative expenses | $1,416 | $1,119 | $4,617 | $3,470 | - Professional fees increased for both periods due to higher use of third-party professionals driven by changes in transaction activity[204][205] - General and administrative expenses increased primarily due to higher stock-based compensation expense from new restricted stock and RSU grants[204][205] Expenses From Real Estate Owned No expenses from real estate owned were incurred for the three months ended September 30, 2022, due to the sale of the hotel property in March 2022, resulting in a significant decrease for the nine-month period Expenses From Real Estate Owned (in thousands) | Expense Type | 3 Months Ended Sep 30, 2022 | 3 Months Ended Sep 30, 2021 | 9 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2021 | | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | Hotel operating expenses | — | $4,694 | $3,631 | $10,539 | | Interest expense on note payable | — | $420 | $678 | $1,245 | | Depreciation expense | — | $225 | — | $674 | | Total expenses from real estate owned | — | $5,339 | $4,309 | $12,458 | - No expenses from real estate owned were incurred for the three months ended September 30, 2022, due to the sale of the hotel property in March 2022[209] - For the nine months ended September 30, 2022, expenses from real estate owned decreased significantly due to only two months of hotel operations prior to the sale[209] Provision for Current Expected Credit Losses The provision for current expected credit losses increased significantly year-over-year, primarily due to changes in the loan portfolio and the impact of the current macroeconomic environment Provision for Current Expected Credit Losses (in thousands) | Period | Provision for Current Expected Credit Losses | | :-------------------------- | :----------------------------------------- | | 3 Months Ended Sep 30, 2022 | $19,485 | | 3 Months Ended Sep 30, 2021 | $6,367 | | 9 Months Ended Sep 30, 2022 | $26,659 | | 9 Months Ended Sep 30, 2021 | $(756) | - The provision for current expected credit losses increased significantly for both the three-month (from $6.4 million to $19.5 million) and nine-month periods (from a $(0.8) million recovery to a $26.7 million expense) year-over-year[210][211] - This increase is primarily attributed to changes in the loan portfolio and the impact of the current macroeconomic environment, including rising inflation, geopolitical uncertainty, rapidly rising interest rates, and ongoing effects of the COVID-19 pandemic[210][211] Gain on Sale of Real Estate Owned For the nine months ended September 30, 2022, the company recognized a $2.2 million gain on the sale of the hotel property, as its net carrying value was lower than the net sales proceeds - For the nine months ended September 30, 2022, the company recognized a $2.2 million gain on the sale of the hotel property, as its net carrying value was lower than the net sales proceeds[213] Liquidity and Capital Resources This section discusses the company's sources and uses of cash, including stock offerings, cash flow activities, financing agreements, securitizations, leverage policies, and dividend distributions At the Market Stock Offering Program During the nine months ended September 30, 2022, the company sold 190,369 shares of common stock under its 'at the market' program, generating approximately $2.9 million in net proceeds - During the nine months ended September 30, 2022, the company sold 190,369 shares of common stock under its 'at the market' program, generating approximately $2.9 million in net proceeds[124][221] - The 'at the market' offering program is currently unavailable following the filing of a new registration statement on Form S-3 in June 2022[221] Equity Offerings In May 2022, the company completed a public offering of 7,000,000 shares of common stock, generating approximately $103.2 million in net proceeds - In May 2022, the company completed a public offering of 7,000,000 shares of common stock, generating approximately $103.2 million in net proceeds[222] Cash Flows This section analyzes the company's cash flows from operating, investing, and financing activities for the nine months ended September 30, 2022, and 2021 Operating Activities Net cash provided by operating activities increased to $42.1 million for the nine months ended September 30, 2022, from $30.3 million in the prior year, driven by various adjustments Net Cash Provided by Operating Activities (in thousands) | Period | Net Cash Provided by Operating Activities | | :-------------------------- | :---------------------------------------- | | 9 Months Ended Sep 30, 2022 | $42,067 | | 9 Months Ended Sep 30, 2021 | $30,280 | - Net cash provided by operating activities increased to $42.1 million for the nine months ended September 30, 2022, from $30.3 million in the prior year[224] - Key adjustments included a $26.7 million provision for current expected credit losses, $7.9 million accretion of discounts, and $5.7 million amortization of deferred financing costs[224] Investing Activities Net cash used in investing activities significantly decreased to $64.0 million for the nine months ended September 30, 2022, from $575.1 million in the prior year, primarily due to loan originations and repayments Net Cash Used in Investing Activities (in thousands) | Period | Net Cash Used in Investing Activities | | :-------------------------- | :------------------------------------ | | 9 Months Ended Sep 30, 2022 | $(63,954) | | 9 Months Ended Sep 30, 2021 | $(575,079) | - Net cash used in investing activities significantly decreased to $64.0 million for the nine months ended September 30, 2022, from $575.1 million in the prior year[225] - This change was primarily due to cash used for loan originations and available-for-sale debt security purchases exceeding cash received from loan principal repayments and real estate sales[225] Financing Activities Net cash provided by financing activities decreased to $48.6 million for the nine months ended September 30, 2022, from $485.8 million in the prior year, influenced by various debt and equity transactions Net Cash Provided by Financing Activities (in thousands) | Period | Net Cash Provided by Financing Activities | | :-------------------------- | :---------------------------------------- | | 9 Months Ended Sep 30, 2022 | $48,569 | | 9 Months Ended Sep 30, 2021 | $485,810 | - Net cash provided by financing activities decreased to $48.6 million for the nine months ended September 30, 2022, from $485.8 million in the prior year[226] - Major sources included proceeds from Secured Funding Agreements ($225.2 million), Notes Payable ($105.0 million), and common stock sales ($106.3 million), offset by repayments of Secured Funding Agreements ($217.5 million), Notes Payable ($51.1 million), and dividends paid ($52.6 million)[226] Summary of Financing Agreements This section summarizes the company's financing agreements, including Secured Funding Agreements, Notes Payable, and a Secured Term Loan, detailing outstanding balances, commitments, and compliance with covenants Financing Agreements Summary (in thousands) | Agreement Type | Sep 30, 2022 Outstanding Balance | Sep 30, 2022 Total Commitment | Dec 31, 2021 Outstanding Balance | Dec 31, 2021 Total Commitment | | :-------------------------- | :------------------------------- | :---------------------------- | :------------------------------- | :---------------------------- | | Secured Funding Agreements | $847,697 | $1,280,000 | $840,047 | $1,280,000 | | Notes Payable | $105,000 | $105,000 | $51,110 | $51,755 | | Secured Term Loan | $150,000 | $150,000 | $150,000 | $150,000 | | Total | $1,102,697 | $1,535,000 | $1,041,157 | $1,481,755 | - The company was in compliance with all financial covenants of its Financing Agreements as of September 30, 2022[230] - Financing agreements include Wells Fargo, Citibank, CNB, MetLife, and Morgan Stanley Facilities, with various interest rates (LIBOR/SOFR plus spread) and maturity dates, some with extension options[227][229] Securitizations As of September 30, 2022, the carrying amount of the company's CLO Securitizations was $822.3 million, with an outstanding principal of $824.1 million - As of September 30, 2022, the carrying amount of the company's CLO Securitizations was $822.3 million, with an outstanding principal of $824.1 million[231] Leverage Policies The company intends to use prudent leverage, not exceeding a 4.5-to-1 debt-to-equity ratio, to enhance stockholder returns, subject to REIT qualification and 1940 Act exemption - The company intends to use prudent leverage, not exceeding a 4.5-to-1 debt-to-equity ratio, to enhance stockholder returns, subject to REIT qualification and 1940 Act exemption[232] - Leverage deployment depends on factors like liquidity, asset volatility, potential losses, asset/liability duration, financing costs, creditworthiness of counterparties, macroeconomic conditions, and interest rate outlook[232][233] Dividends As a REIT, the company anticipates distributing at least 90% of its REIT taxable income annually to stockholders, with potential tax implications for insufficient distributions - As a REIT, the company anticipates distributing at least 90% of its REIT taxable income annually to stockholders[235] - Failure to distribute the required amount could result in corporate income tax and a 4% non-deductible excise tax[235] - If cash for distribution is insufficient, the company may need to sell assets, borrow funds, or make taxable stock distributions[236] Item 3. Quantitative and Qualitative Disclosures About Market Risk This section details the company's risk management strategy and its exposure to various market risks, including credit risk, interest rate risk, market risk, prepayment and securitization repayment risk, financing risk, real estate risk, and inflation risk Credit Risk The company manages credit risk through due diligence, non-recourse financing, and ongoing portfolio review, while macroeconomic conditions may increase default risk - The company manages credit risk through due diligence, non-recourse financing, and ongoing portfolio review by its Manager[238] - Macroeconomic and geopolitical conditions, including rising interest rates and the COVID-19 pandemic, may slow prepayments or lead to borrower defaults, increasing credit risk[239] Interest Rate Risk This section analyzes the company's exposure to interest rate fluctuations, including the hypothetical impact on net income and the risks associated with interest rate floors Interest Rate Effect on Net Income Net income is sensitive to changes in index rates, with a hypothetical 100 basis point increase in LIBOR or SOFR estimated to increase net income by $11.0 million over twelve months Hypothetical Impact of 30-Day LIBOR or SOFR Change on Net Income (in millions) | Change in 30-Day LIBOR or SOFR | Increase/(Decrease) in Net Income | | :------------------------------ | :-------------------------------- | | Up 100 basis points | $11.0 | | Up 50 basis points | $5.5 | | LIBOR or SOFR at 0 basis points | $(14.9) | - Net income is sensitive to changes in index rates, with a hypothetical 100 basis point increase in LIBOR or SOFR estimated to increase net income by $11.0 million over twelve months[244][245] Interest Rate Floor Risk In a decreasing interest rate environment, interest rate floors on floating rate mortgage assets could lead to lower net interest income or a net loss if borrowing costs are fixed at a higher floor - In a decreasing interest rate environment, interest rate floors on floating rate mortgage assets could lead to lower net interest income or a net loss if borrowing costs are fixed at a higher floor[246] Market Risk The fair values of investments fluctuate due to changes in index rates, credit spreads, and market volatility, with rising interest rates generally decreasing fixed-rate investment values - The fair values of investments fluctuate due to changes in index rates, credit spreads, and market volatility[247][249] - Rising interest rates generally decrease the fair value of fixed-rate investments, while widening credit spreads generally decrease the fair value of floating-rate investments[247] Prepayment and Securitizations Repayment Risk Prepayment rates on CRE loans can affect net income, and decreased prepayment rates or loan extensions could extend loan lives beyond financing terms, impacting CLO securitizations - Prepayment rates on CRE loans can affect net income; faster prepayments may lead to lower yields if new loans cannot match prior returns[250] - Decreased prepayment rates or loan extensions in a rising interest rate environment could extend loan lives beyond financing terms, potentially requiring additional collateral or asset sales[250] - In CLO Securitizations, principal repayments are applied sequentially to senior notes first, delaying proceeds to the company's subordinate securities[250] Financing Risk Secured Funding Agreements contain margin call provisions and covenants, and failure to meet CLO overcollateralization tests could divert payments, while weak financial markets may impact financing availability - Secured Funding Agreements contain margin call provisions and covenants; default could lead to accelerated payments, termination of commitments, or demands for additional collateral[251] - CLO Securitizations have senior note overcollateralization ratio tests; failure to meet these could divert payments from subordinate securities to repay senior notes, leading to significant losses[251] - Weakness in financial markets could impact lenders' willingness or ability to provide financing or increase its cost[251] Real Estate Risk Real estate investments are subject to volatility from national, regional, and local economic conditions, with the COVID-19 pandemic particularly impacting office properties due to work-from-home trends - Real estate investments are subject to volatility from national, regional, and local economic conditions, including industry slowdowns, local market dynamics, and demographic shifts[252] - The COVID-19 pandemic has particularly impacted industries like office properties due to increased work-from-home trends, potentially reducing property values and borrower repayment capacity[252] Inflation Risk The company's performance is more influenced by interest rates than inflation, though adverse changes in inflation or expectations can lead to lower investment returns - The company's performance is more influenced by interest rates than inflation, though adverse changes in inflation or expectations can lead to lower investment returns[253] Item 4. Controls and Procedures This section confirms the effectiveness of the company's disclosure controls and procedures and reports no material changes in internal control over financial reporting during the quarter ended September 30, 2022 Evaluation of Disclosure Controls and Procedures Management concluded that the company's disclosure controls and procedures were effective as of September 30, 2022 - Management, including the principal executive and financial officers, concluded that the company's disclosure controls and procedures were effective as of September 30, 2022[255] Changes in Internal Control over Financial Reporting There have been no material changes in the company's internal control over financial reporting during the quarter ended September 30, 2022 - There have been no material changes in the company's internal control over financial reporting during the quarter ended September 30, 2022[256] Part II. Other Information This section covers other information, including legal proceedings, risk factors, unregistered sales of equity securities, defaults upon senior securities, mine safety disclosures, and a list of exhibits Item 1. Legal Proceedings This section states that the company is not currently subject to any material pending legal proceedings, but acknowledges the potential for increased litigation if macroeconomic conditions worsen - As of September 30, 2022, the company was not subject to any material pending legal proceedings[257] - Worsening macroeconomic and geopolitical conditions could lead to increased litigation related to loan defaults and enforcement of remedies[257] Item 1A. Risk Factors This section indicates that there have been no material changes to the risk factors previously disclosed in the company's Annual Report on Form 10-K for the year ended December 31, 2021, and advises readers to consult that report for a comprehensive understanding of potential risks - No material changes to the risk factors previously disclosed in the Annual Report on Form 10-K for the year ended December 31, 2021, were identified[258] - Readers are advised to carefully consider the risk factors in the 2021 Annual Report on Form 10-K, as additional unknown or immaterial risks could also adversely affect the business[258] Item 2. Unregistered Sales of Equity Securities and Use of Proceeds This section reports on the company's stock repurchase program, noting that no shares were repurchased during the three months ended September 30, 2022, and the full $50.0 million authorized amount remains available - The company's Board of Directors approved a $50.0 million stock repurchase program on July 26, 2022, which is expected to be in effect until July 26, 2023[259] - No shares were purchased under the repurchase program during the three months ended September 30, 2022, leaving the full $50.0 million available for future purchases[259][260] Item 3. Defaults Upon Senior Securities This section states that there were no defaults upon senior securities - There were no defaults upon senior securities[261] Item 4. Mine Safety Disclosures This section indicates that mine safety disclosures are not applicable to the company - Mine safety disclosures are not applicable to the company[261] Item 5. Other Information This section states that there is no other information to report - No other information is reported in this section[261] Item 6. Exhibits This section provides a comprehensive list of exhibits filed as part of the Form 10-Q, including organizational documents, management agreements, credit agreements, certifications, and XBRL data files - The exhibit index includes Articles of Amendment and Restatement, Amended and Restated Bylaws, Amended and Restated Management Agreement, Credit and Security Agreement, Guaranty of Recourse Obligations, CEO/CFO Certifications, and various XBRL documents[264]