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acre:quarter


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
___________________________________________________________________ 
FORM 10-Q
      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 
For the quarterly period ended June 30, 2020
 OR
        TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 
For the transition period from _____ to _____

Commission File No. 001-35517
acre05.jpg
 ARES COMMERCIAL REAL ESTATE CORPORATION
(Exact name of Registrant as specified in its charter) 
Maryland
 
45-3148087
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification Number)
 
245 Park Avenue, 42nd Floor, New York, NY 10167
(Address of principal executive offices) (Zip Code)
 
(212750-7300
(Registrant’s telephone number, including area code)
 
N/A
(Former name, former address and former fiscal year, if changed since last report)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common stock, $0.01 par value per share
ACRE
New York Stock Exchange
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:   Yes ý  No o
 
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).   Yes ý  No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one): 
Large accelerated filer
 
Accelerated filer
Non-accelerated filer
 
Smaller reporting company
Emerging growth company
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes   No
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class
 
Outstanding at August 5, 2020
Common stock, $0.01 par value
 
33,441,937
 




ARES COMMERCIAL REAL ESTATE CORPORATION

INDEX

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 






PART I — FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements
 
ARES COMMERCIAL REAL ESTATE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)

 
As of
 
June 30, 2020

December 31, 2019
 
(unaudited)
 

ASSETS
 
 
 
Cash and cash equivalents
$
72,987

 
$
5,256

Restricted cash

 
379

Loans held for investment ($525,817 and $515,896 related to consolidated VIEs, respectively)
1,794,049

 
1,682,498

Current expected credit loss reserve
(26,063
)
 

Loans held for investment, net of current expected credit loss reserve
1,767,986

 
1,682,498

Loans held for sale, at fair value
96,404

 

Real estate owned, net
37,693

 
37,901

Other assets ($996 and $1,309 of interest receivable related to consolidated VIEs, respectively; $31,183 and $41,104 of other receivables related to consolidated VIEs, respectively)
46,163

 
58,100

Total assets
$
2,021,233

 
$
1,784,134

LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
LIABILITIES
 
 
 
Secured funding agreements
$
876,842

 
$
728,589

Notes payable
54,819

 
54,708

Secured term loan
109,588

 
109,149

Collateralized loan obligation securitization debt (consolidated VIE)
443,467

 
443,177

Secured borrowings
47,533

 

Due to affiliate
3,217

 
2,761

Dividends payable
11,072

 
9,546

Other liabilities ($371 and $718 of interest payable related to consolidated VIEs, respectively)
9,569

 
9,865

Total liabilities
1,556,107

 
1,357,795

Commitments and contingencies (Note 8)


 


STOCKHOLDERS' EQUITY
 
 
 
Common stock, par value $0.01 per share, 450,000,000 shares authorized at June 30, 2020 and December 31, 2019 and 33,441,937 and 28,865,610 shares issued and outstanding at June 30, 2020 and December 31, 2019, respectively
329

 
283

Additional paid-in capital
497,054

 
423,619

Accumulated earnings (deficit)
(32,257
)
 
2,437

Total stockholders' equity
465,126

 
426,339

Total liabilities and stockholders' equity
$
2,021,233

 
$
1,784,134


   See accompanying notes to consolidated financial statements.

2




ARES COMMERCIAL REAL ESTATE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)

 
For the three months ended June 30,

For the six months ended June 30,
 
2020

2019

2020

2019

(unaudited)

(unaudited)

(unaudited)

(unaudited)
Revenue:







Interest income from loans held for investment
$
29,835


$
29,993


$
61,283


$
57,979

Interest expense
(13,042
)

(16,675
)

(28,576
)

(32,415
)
Net interest margin
16,793


13,318


32,707


25,564

Revenue from real estate owned
1,189


8,357


6,409


10,267

Total revenue
17,982


21,675


39,116


35,831

Expenses:








Management and incentive fees to affiliate
2,152


2,252


3,924


3,826

Professional fees
660


532


1,563


1,011

General and administrative expenses
959


1,029


1,827


2,148

General and administrative expenses reimbursed to affiliate
1,038


771


2,089


1,430

Expenses from real estate owned
3,254


7,118


9,930


8,806

Total expenses
8,063


11,702


19,333


17,221

  Provision for current expected credit losses
(4,007
)
 

 
23,111

 

  Unrealized losses on loans held for sale
3,998

 

 
3,998

 

Income (loss) before income taxes
9,928


9,973


(7,326
)

18,610

Income tax expense, including excise tax
160


218


169


314

Net income (loss) attributable to common stockholders
$
9,768


$
9,755


$
(7,495
)

$
18,296

Earnings (loss) per common share:











Basic earnings (loss) per common share
$
0.29


$
0.34


$
(0.23
)

$
0.64

Diluted earnings (loss) per common share
$
0.29

 
$
0.34

 
$
(0.23
)
 
$
0.63

Weighted average number of common shares outstanding:








Basic weighted average shares of common stock outstanding
33,316,933


28,599,282


32,607,442


28,580,658

Diluted weighted average shares of common stock outstanding
33,539,580


28,863,765


32,607,442


28,822,601

Dividends declared per share of common stock
$
0.33


$
0.33


$
0.66


$
0.66





   See accompanying notes to consolidated financial statements.

3




ARES COMMERCIAL REAL ESTATE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands, except share and per share data)
(unaudited)

 
Common Stock
 
Additional
Paid-in
Capital
 
Accumulated
Earnings (Deficit)
 
Total Stockholders’ Equity
 
Shares
 
Amount
Balance at December 31, 2018
28,755,665

 
$
283

 
$
421,739

 
$
3,565

 
$
425,587

Stock-based compensation
93,405

 

 
492

 

 
492

Net income

 

 

 
8,543

 
8,543

Dividends declared

 

 

 
(9,520
)
 
(9,520
)
Balance at March 31, 2019
28,849,070

 
$
283

 
$
422,231

 
$
2,588

 
$
425,102

Stock-based compensation
19,665

 

 
427

 

 
427

Net income

 

 

 
9,755

 
9,755

Dividends declared

 

 

 
(9,527
)
 
(9,527
)
Balance at June 30, 2019
28,868,735

 
$
283

 
$
422,658

 
$
2,816

 
$
425,757

Stock-based compensation
(3,125
)
 

 
479

 

 
479

Net income

 

 

 
9,034

 
9,034

Dividends declared

 

 

 
(9,526
)
 
(9,526
)
Balance at September 30, 2019
28,865,610

 
$
283

 
$
423,137

 
$
2,324

 
$
425,744

Stock-based compensation

 

 
482

 

 
482

Net income

 

 

 
9,660

 
9,660

Dividends declared

 

 

 
(9,547
)
 
(9,547
)
Balance at December 31, 2019
28,865,610

 
$
283

 
$
423,619

 
$
2,437

 
$
426,339

Sale of common stock
4,600,000

 
46

 
73,186

 

 
73,232

Offering costs

 

 
(341
)
 

 
(341
)
Stock-based compensation
(66,658
)
 

 
225

 

 
225

Net loss

 

 

 
(17,263
)
 
(17,263
)
Dividends declared

 

 

 
(11,076
)
 
(11,076
)
Impact of adoption of CECL (Note 2)

 

 

 
(5,051
)
 
(5,051
)
Balance at March 31, 2020
33,398,952

 
$
329

 
$
496,689

 
$
(30,953
)
 
$
466,065

Stock-based compensation
42,985

 

 
365

 

 
365

Net income

 

 

 
9,768

 
9,768

Dividends declared

 

 

 
(11,072
)
 
(11,072
)
Balance at June 30, 2020
33,441,937

 
$
329

 
$
497,054

 
$
(32,257
)
 
$
465,126

   
See accompanying notes to consolidated financial statements.


4




ARES COMMERCIAL REAL ESTATE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

 
For the six months ended June 30,
 
2020
 
2019
 
(unaudited)
 
(unaudited)
Operating activities:
 
 
 
Net income (loss)
$
(7,495
)
 
$
18,296

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
 
 
 
Amortization of deferred financing costs
3,257

 
3,317

Accretion of deferred loan origination fees and costs
(3,643
)
 
(3,232
)
Stock-based compensation
590

 
919

Depreciation of real estate owned
445

 
242

Provision for current expected credit losses
23,111

 

Unrealized losses on loans held for sale
3,998

 

Changes in operating assets and liabilities:
 
 
 
Other assets
(4,689
)
 
(3,103
)
Due to affiliate
456

 

Other liabilities
(1,867
)
 
(104
)
Net cash provided by (used in) operating activities
14,163

 
16,335

Investing activities:
 
 
 
Issuance of and fundings on loans held for investment
(451,805
)
 
(247,313
)
Principal repayment of loans held for investment
255,119

 
177,131

Receipt of origination fees
3,888

 
3,158

Purchases of capitalized additions to real estate owned
(237
)
 
(252
)
Net cash provided by (used in) investing activities
(193,035
)
 
(67,276
)
Financing activities:
 
 
 
Proceeds from secured funding agreements
355,083

 
279,398

Repayments of secured funding agreements
(206,830
)
 
(439,848
)
Proceeds from notes payable

 
56,155

Proceeds from secured borrowings
48,055

 

Payment of secured funding costs
(2,393
)
 
(4,877
)
Proceeds from issuance of debt of consolidated VIEs

 
172,673

Dividends paid
(20,622
)
 
(18,434
)
Proceeds from sale of common stock
73,232

 

Payment of offering costs
(301
)
 

Net cash provided by (used in) financing activities
246,224

 
45,067

Change in cash, cash equivalents and restricted cash
67,352

 
(5,874
)
Cash, cash equivalents and restricted cash, beginning of period
5,635

 
11,468

Cash, cash equivalents and restricted cash, end of period
$
72,987

 
$
5,594

   
See accompanying notes to consolidated financial statements.

5




ARES COMMERCIAL REAL ESTATE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of June 30, 2020
(in thousands, except share and per share data, percentages and as otherwise indicated)
(unaudited)

1.   ORGANIZATION

Ares Commercial Real Estate Corporation (together with its consolidated subsidiaries, the “Company” or “ACRE”) is a specialty finance company primarily engaged in originating and investing in commercial real estate loans and related investments. Through Ares Commercial Real Estate Management LLC (“ACREM” or the Company’s “Manager”), a Securities and Exchange Commission (“SEC”) registered investment adviser and a subsidiary of Ares Management Corporation (NYSE: ARES) (“Ares Management” or “Ares”), a publicly traded, leading global alternative investment manager, it has investment professionals strategically located across the United States and Europe who directly source new loan opportunities for the Company with owners, operators and sponsors of commercial real estate (“CRE”) properties. The Company was formed and commenced operations in late 2011. The Company is a Maryland corporation and completed its initial public offering (the “IPO”) in May 2012. The Company is externally managed by its Manager, pursuant to the terms of a management agreement (the “Management Agreement”).
 
The Company operates as one operating segment and is primarily focused on directly originating and managing a diversified portfolio of CRE debt-related investments for the Company’s own account. The Company’s target investments include senior mortgage loans, subordinated debt, preferred equity, mezzanine loans and other CRE investments, including commercial mortgage backed securities. These investments are generally held for investment and are secured, directly or indirectly, by office, multifamily, retail, industrial, lodging, senior-living, self storage, student housing, residential and other commercial real estate properties, or by ownership interests therein.

The Company has elected and qualified to be taxed as a real estate investment trust (“REIT”) for United States federal income tax purposes under the Internal Revenue Code of 1986, as amended (the “Code”), commencing with its taxable year ended December 31, 2012. The Company generally will not be subject to United States federal income taxes on its REIT taxable income as long as it annually distributes all of its REIT taxable income prior to the deduction for dividends paid to stockholders and complies with various other requirements as a REIT.

2.   SIGNIFICANT ACCOUNTING POLICIES

The accompanying unaudited consolidated interim financial statements should be read in conjunction with the audited consolidated financial statements and the related management's discussion and analysis of financial condition and results of operations included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2019 filed with the SEC.

Refer to the Company’s Annual Report on Form 10-K for a description of the Company’s recurring accounting policies. The Company has included disclosure below regarding basis of presentation and other accounting policies that (i) are required to be disclosed quarterly or (ii) the Company views as critical as of the date of this report.

Basis of Presentation

The accompanying consolidated financial statements have been prepared on the accrual basis of accounting in conformity with United States generally accepted accounting principles (“GAAP”) and include the accounts of the Company, the consolidated variable interest entities (“VIEs”) that the Company controls and of which the Company is the primary beneficiary, and the Company’s wholly-owned subsidiaries. The consolidated financial statements reflect all adjustments and reclassifications that, in the opinion of management, are necessary for the fair presentation of the Company’s results of operations and financial condition as of and for the periods presented. All intercompany balances and transactions have been eliminated.

Interim financial statements are prepared in accordance with GAAP and pursuant to the requirements for reporting on Form 10-Q and Article 10 of Regulation S-X. The current period’s results of operations will not necessarily be indicative of results that ultimately may be achieved for the year ending December 31, 2020.


6




Use of Estimates in the Preparation of Financial Statements

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect certain reported amounts and disclosures. As of the filing date of this Quarterly Report, there is an outbreak of a novel and highly contagious form of coronavirus (“COVID-19”), which the World Health Organization has declared a global pandemic, the United States has declared a national emergency and every state in the United States is under a federal disaster declaration. Many states, including those in which the Company and its borrowers operate, have issued orders requiring the closure of non-essential businesses and/or requiring residents to stay at home. The COVID-19 pandemic and preventative measures taken to contain or mitigate its spread have caused, and are continuing to cause, business shutdowns or the re-introduction of business shutdowns, cancellations of events and restrictions on travel, significant reductions in demand for certain goods and services, reductions in business activity and financial transactions, supply chain interruptions and overall economic and financial market instability both globally and in the United States. Such effects will likely continue for the duration of the pandemic, which is uncertain, and for some period thereafter, which could adversely affect the Company’s business, financial condition and results of operations. The Company believes the estimates and assumptions underlying its consolidated financial statements are reasonable and supportable based on the information available as of June 30, 2020, however, uncertainty over the ultimate impact the COVID-19 pandemic will have on the global economy and the Company’s business, makes any estimates and assumptions as of June 30, 2020 inherently less certain than they would be absent the current and potential impacts of the COVID-19 pandemic. Actual results could differ from those estimates.

Variable Interest Entities

The Company evaluates all of its interests in VIEs for consolidation. When the Company’s interests are determined to be variable interests, the Company assesses whether it is deemed to be the primary beneficiary of the VIE. The primary beneficiary of a VIE is required to consolidate the VIE. Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 810, Consolidation, defines the primary beneficiary as the party that has both (i) the power to direct the activities of the VIE that most significantly impact its economic performance, and (ii) the obligation to absorb losses and the right to receive benefits from the VIE which could be potentially significant. The Company considers its variable interests, as well as any variable interests of its related parties in making this determination. Where both of these factors are present, the Company is deemed to be the primary beneficiary and it consolidates the VIE. Where either one of these factors is not present, the Company is not the primary beneficiary and it does not consolidate the VIE.
 
To assess whether the Company has the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance, the Company considers all facts and circumstances, including its role in establishing the VIE and its ongoing rights and responsibilities. This assessment includes first, identifying the activities that most significantly impact the VIE’s economic performance; and second, identifying which party, if any, has power over those activities. In general, the parties that make the most significant decisions affecting the VIE or have the right to unilaterally remove those decision makers are deemed to have the power to direct the activities of a VIE.

To assess whether the Company has the obligation to absorb losses of the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE, the Company considers all of its economic interests, including debt and equity investments, servicing fees, and other arrangements deemed to be variable interests in the VIE. This assessment requires that the Company applies judgment in determining whether these interests, in the aggregate, are considered potentially significant to the VIE. Factors considered in assessing significance include: the design of the VIE, including its capitalization structure; subordination of interests; payment priority; relative share of interests held across various classes within the VIE’s capital structure; and the reasons why the interests are held by the Company.
 
For VIEs of which the Company is determined to be the primary beneficiary, all of the underlying assets, liabilities, equity, revenue and expenses of the structures are consolidated into the Company’s consolidated financial statements.
 
The Company performs an ongoing reassessment of: (1) whether any entities previously evaluated under the majority voting interest framework have become VIEs, based on certain events, and therefore are subject to the VIE consolidation framework, and (2) whether changes in the facts and circumstances regarding its involvement with a VIE cause the Company’s consolidation conclusion regarding the VIE to change. See Note 15 included in these consolidated financial statements for further discussion of the Company’s VIEs.


7




Cash, Cash Equivalents and Restricted Cash

Cash and cash equivalents include funds on deposit with financial institutions, including demand deposits with financial institutions. Cash and short‑term investments with an original maturity of three months or less when acquired are considered cash and cash equivalents for the purpose of the consolidated balance sheets and statements of cash flows.

Restricted cash includes deposits required under certain Secured Funding Agreements (each individually defined in Note 6 included in these consolidated financial statements).

The following table provides a reconciliation of cash, cash equivalents and restricted cash in the consolidated balance sheets to the total amount shown in the consolidated statements of cash flows ($ in thousands):
 
As of June 30,
 
2020
 
2019
Cash and cash equivalents
$
72,987

 
$
5,215

Restricted cash

 
379

Total cash, cash equivalents and restricted cash shown in the Company's consolidated statements of cash flows
$
72,987

 
$
5,594



Loans Held for Investment

The Company originates CRE debt and related instruments generally to be held for investment. Loans that are held for investment are carried at cost, net of unamortized loan fees and origination costs (the “carrying value”). Loans are generally collateralized by real estate. The extent of any credit deterioration associated with the performance and/or value of the underlying collateral property and the financial and operating capability of the borrower could impact the expected amounts received. The Company monitors performance of its loans held for investment portfolio under the following methodology: (1) borrower review, which analyzes the borrower’s ability to execute on its original business plan, reviews its financial condition, assesses pending litigation and considers its general level of responsiveness and cooperation; (2) economic review, which considers underlying collateral (i.e. leasing performance, unit sales and cash flow of the collateral and its ability to cover debt service, as well as the residual loan balance at maturity); (3) property review, which considers current environmental risks, changes in insurance costs or coverage, current site visibility, capital expenditures and market perception; and (4) market review, which analyzes the collateral from a supply and demand perspective of similar property types, as well as from a capital markets perspective. Such analyses are completed and reviewed by asset management and finance personnel who utilize various data sources, including periodic financial data such as property occupancy, tenant profile, rental rates, operating expenses, and the borrower’s exit plan, among other factors.

Loans are generally placed on non-accrual status when principal or interest payments are past due 30 days or more or when there is reasonable doubt that principal or interest will be collected in full. Accrued and unpaid interest is generally reversed against interest income in the period the loan is placed on non-accrual status. Interest payments received on non-accrual loans may be recognized as income or applied to principal depending upon management’s judgment regarding the borrower’s ability to make pending principal and interest payments. Non-accrual loans are restored to accrual status when past due principal and interest are paid and, in management’s judgment, are likely to remain current. The Company may make exceptions to placing a loan on non-accrual status if the loan has sufficient collateral value and is in the process of collection.

Loan balances that are deemed to be uncollectible are written off as a realized loss and are deducted from the current expected credit loss reserve. The write-offs are recorded in the period in which the loan balance is deemed uncollectible based on management’s judgment.

8




Current Expected Credit Losses
    
In June 2016, the FASB issued Accounting Standards Update (“ASU”) No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The standard replaced the incurred loss impairment methodology pursuant to GAAP with a methodology that reflects current expected credit losses (“CECL”) on both the outstanding balances and unfunded commitments on loans held for investment and requires consideration of a broader range of historical experience adjusted for current conditions and reasonable and supportable forecast information to inform credit loss estimates (the “CECL Reserve”). ASU No. 2016-13 was effective for annual reporting periods beginning after December 15, 2019, including interim periods within that reporting period. ASU No. 2016-13 was adopted by the Company on a modified retrospective basis through a cumulative-effect adjustment to retained earnings as of January 1, 2020. Subsequent period increases and decreases to expected credit losses will impact earnings and are recorded within provision for current expected credit losses in the Company’s consolidated statements of operations. The CECL Reserve related to outstanding balances on loans held for investment required under ASU No. 2016-13 is a valuation account that is deducted from the amortized cost basis of the Company’s loans held for investment in the Company’s consolidated balance sheets. The CECL Reserve related to unfunded commitments on loans held for investment is recorded within other liabilities in the Company's consolidated balance sheets. See Note 4 included in these consolidated financial statements for CECL related disclosures.

Loans Held for Sale
Although the Company generally holds its target investments as long-term investments, the Company may occasionally classify some of its investments as held for sale. Investments held for sale are carried at fair value within loans held for sale, at fair value in the Company’s consolidated balance sheets, with changes in fair value recorded through earnings.
Real Estate Owned

Real estate assets are carried at their estimated fair value at acquisition and are presented net of accumulated depreciation and impairment charges. The Company allocates the purchase price of acquired real estate assets based on the fair value of the acquired land, building, furniture, fixtures and equipment.

Real estate assets are depreciated using the straight-line method over estimated useful lives of up to 40 years for buildings and improvements and up to 15 years for furniture, fixtures and equipment. Renovations and/or replacements that improve or extend the life of the real estate asset are capitalized and depreciated over their estimated useful lives. The cost of ordinary repairs and maintenance are expensed as incurred.

Real estate assets are evaluated for indicators of impairment on a quarterly basis. Factors that the Company may consider in its impairment analysis include, among others: (1) significant underperformance relative to historical or anticipated operating results; (2) significant negative industry or economic trends; (3) costs necessary to extend the life or improve the real estate asset; (4) significant increase in competition; and (5) ability to hold and dispose of the real estate asset in the ordinary course of business. A real estate asset is considered impaired when the sum of estimated future undiscounted cash flows expected to be generated by the real estate asset over the estimated remaining holding period is less than the carrying amount of such real estate asset. Cash flows include operating cash flows and anticipated capital proceeds generated by the real estate asset. An impairment charge is recorded equal to the excess of the carrying value of the real estate asset over the fair value. When determining the fair value of a real estate asset, the Company makes certain assumptions including, but not limited to, consideration of projected operating cash flows, comparable selling prices and projected cash flows from the eventual disposition of the real estate asset based upon the Company’s estimate of a capitalization rate and discount rate.

The Company reviews its real estate assets, from time to time, in order to determine whether to sell such assets. Real estate assets are classified as held for sale when the Company commits to a plan to sell the asset, when the asset is being marketed for sale at a reasonable price and the sale of the asset is probable and the transfer of the asset is expected to qualify for recognition as a completed sale within one year. Real estate assets that are held for sale are carried at the lower of the asset’s carrying amount or its fair value less costs to sell.

Debt Issuance Costs

Debt issuance costs under the Company’s indebtedness are capitalized and amortized over the term of the respective debt instrument. Unamortized debt issuance costs are expensed when the associated debt is repaid prior to maturity. Debt issuance costs related to debt securitizations are capitalized and amortized over the term of the underlying loans using the effective interest method. When an underlying loan is prepaid in a debt securitization and the outstanding principal balance of the securitization debt is reduced, the related unamortized debt issuance costs are charged to expense based on a pro‑rata share

9




of the debt issuance costs being allocated to the specific loans that were prepaid. Amortization of debt issuance costs is included within interest expense, except as noted below, in the Company’s consolidated statements of operations while the unamortized balance on (i) Secured Funding Agreements (each individually defined in Note 6 included in these consolidated financial statements) is included within other assets and (ii) Notes Payable, the Secured Term Loan (each defined in Note 6 included in these consolidated financial statements) and Secured Borrowings (defined in Note 7 included in these consolidated financial statements) and debt securitizations are each included as a reduction to the carrying amount of the liability, in the Company’s consolidated balance sheets. Amortization of debt issuance costs for the note payable on the hotel property that is recognized as real estate owned in the Company’s consolidated balance sheets (see Note 6 included in these consolidated financial statements for additional information on the note payable) is included within expenses from real estate owned in the Company’s consolidated statements of operations.

The original issue discount (“OID”) on amounts drawn under the Company’s Secured Term Loan represents a discount to the face amount of the drawn debt obligations. The OID is amortized over the term of the Secured Term Loan using the effective interest method and is included within interest expense in the Company’s consolidated statements of operations while the unamortized balance is included as a reduction to the carrying amount of the Secured Term Loan in the Company’s consolidated balance sheets.

Revenue Recognition

Interest income from loans held for investment is accrued based on the outstanding principal amount and the contractual terms of each loan. For loans held for investment, origination fees, contractual exit fees and direct loan origination costs are also recognized in interest income from loans held for investment over the initial loan term as a yield adjustment using the effective interest method.

Revenue from real estate owned represents revenue associated with the operations of a hotel property classified as real estate owned. Revenue from the operation of the hotel property is recognized when guestrooms are occupied, services have been rendered or fees have been earned. Revenues are recorded net of any discounts and sales and other taxes collected from customers. Revenues consist of room sales, food and beverage sales and other hotel revenues.

Net Interest Margin and Interest Expense
Net interest margin in the Company’s consolidated statements of operations serves to measure the performance of the Company’s loans held for investment as compared to its use of debt leverage. The Company includes interest income from its loans held for investment and interest expense related to its Secured Funding Agreements, Notes Payable, securitization debt, the Secured Term Loan (each individually defined in Note 6 included in these consolidated financial statements) and Secured Borrowings (defined in Note 7 included in these consolidated financial statements) in net interest margin. For the three and six months ended June 30, 2020 and 2019, interest expense is comprised of the following ($ in thousands):
 
For the three months ended June 30,
 
For the six months ended June 30,
 
2020
 
2019
 
2020

2019
Secured funding agreements
$
7,600

 
$
8,972

 
$
16,448

 
$
17,430

Notes payable (1)
304

 
181

 
616

 
181

Securitization debt
3,104

 
5,246

 
7,360

 
10,272

Secured term loan
1,737

 
2,276

 
3,802

 
4,532

Secured borrowings
297

 

 
350

 

Interest expense
$
13,042

 
$
16,675

 
$
28,576

 
$
32,415


_______________________________________________________________________________

(1)
Excludes interest expense on the $28.3 million note payable, which is secured by a hotel property that is recognized as real estate owned in the Company’s consolidated balance sheets (see Note 6 included in these consolidated financial statements for additional information on the note payable). Interest expense on the $28.3 million note payable is included within expenses from real estate owned in the Company’s consolidated statements of operations.



10




Comprehensive Income
For the three and six months ended June 30, 2020 and 2019, comprehensive income (loss) equaled net income (loss); therefore, a separate consolidated statement of comprehensive income (loss) is not included in the accompanying consolidated financial statements.

Recent Accounting Pronouncements

In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting, which provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The amendments apply only to contracts, hedging relationships, and other transactions that reference the London Interbank Offered Rate (“LIBOR”) or another reference rate expected to be discontinued because of reference rate reform. ASU No. 2020-04 is effective for all entities as of March 12, 2020 through December 31, 2022. The Company is currently evaluating the impact of adopting this ASU on its consolidated financial statements.

3.   LOANS HELD FOR INVESTMENT

As of June 30, 2020, the Company’s portfolio included 50 loans held for investment, excluding 97 loans that were repaid, sold, converted to real estate owned or transferred to held for sale since inception. The aggregate originated commitment under these loans at closing was approximately $2.1 billion and outstanding principal was $1.8 billion as of June 30, 2020. During the six months ended June 30, 2020, the Company funded approximately $458.2 million of outstanding principal, received repayments of $244.1 million of outstanding principal and transferred three loans to held for sale with outstanding principal of $100.8 million as described in more detail in the tables below. As of June 30, 2020, 93.4% of the Company’s loans have LIBOR floors, with a weighted average floor of 1.77%, calculated based on loans with LIBOR floors. References to LIBOR or “L” are to 30-day LIBOR (unless otherwise specifically stated).
 
The Company’s investments in loans held for investment are accounted for at amortized cost. The following tables summarize the Company’s loans held for investment as of June 30, 2020 and December 31, 2019 ($ in thousands):

 
As of June 30, 2020

Carrying Amount (1)
 
Outstanding Principal (1)
 
Weighted Average Unleveraged Effective Yield
 
Weighted Average Remaining Life (Years)
Senior mortgage loans
$
1,702,425

 
$
1,713,456

 
6.0
%
(2)
6.3
%
(3)
 
1.5
Subordinated debt and preferred equity investments
91,624

 
92,814

 
13.6
%
(2)
13.6
%
(3)
 
2.3
Total loans held for investment portfolio
$
1,794,049

 
$
1,806,270

 
6.4
%
(2)
6.7
%
(3)
 
1.5

 
As of December 31, 2019
 
Carrying Amount (1)
 
Outstanding Principal (1)
 
Weighted Average Unleveraged Effective Yield (2)
 
Weighted Average Remaining Life (Years)
Senior mortgage loans
$
1,622,666

 
$
1,632,164

 
6.5%
 
1.5
Subordinated debt and preferred equity investments
59,832

 
60,730

 
15.1%
 
2.6
Total loans held for investment portfolio
$
1,682,498

 
$
1,692,894

 
6.8%
 
1.6
_______________________________________________________________________________

(1)
The difference between the Carrying Amount and the Outstanding Principal amount of the loans held for investment consists of unamortized purchase discount, deferred loan fees and loan origination costs.
(2)
Unleveraged Effective Yield is the compounded effective rate of return that would be earned over the life of the investment based on the contractual interest rate (adjusted for any deferred loan fees, costs, premiums or discounts) and assumes no dispositions, early prepayments or defaults. The total Weighted Average Unleveraged Effective Yield is calculated based on the average of Unleveraged Effective Yield of all loans held by the Company as of June 30, 2020 and December 31, 2019 as weighted by the outstanding principal balance of each loan.

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(3)
Unleveraged Effective Yield is the compounded effective rate of return that would be earned over the life of the investment based on the contractual interest rate (adjusted for any deferred loan fees, costs, premiums or discounts) and assumes no dispositions, early prepayments or defaults. The total Weighted Average Unleveraged Effective Yield is calculated based on the average of Unleveraged Effective Yield of all interest accruing loans held by the Company as of June 30, 2020 as weighted by the total outstanding principal balance of each interest accruing loan (excludes loans on non-accrual status as of June 30, 2020).



12




A more detailed listing of the Company’s loans held for investment portfolio based on information available as of June 30, 2020 is as follows ($ in millions, except percentages):
Loan Type
 
Location
 
Outstanding Principal (1)
 
Carrying Amount (1)
 
Interest Rate
 
Unleveraged Effective Yield (2)
 
Maturity Date (3)
 
Payment Terms (4)
 
Senior Mortgage Loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Office
 
Diversified
 
$107.9

$107.4
 
L+3.65%

5.7%
 
Jan 2023

I/O

Mixed-use
 
FL
 
100.6

100.2
 
L+4.25%

7.8%
 
Feb 2021

I/O

Multifamily
 
FL
 
91.3

90.6
 
L+5.00%

6.7%
 
Jun 2022

I/O

Multifamily
 
TX
 
75.0

74.7
 
L+2.85%

5.0%
 
Oct 2022

I/O

Office
 
IL
 
69.6

69.5
 
L+3.75%

5.6%
 
Dec 2020

I/O

Hotel
 
OR/WA
 
68.1

67.7
 
L+3.45%

4.6%
(7)
May 2021

I/O

Hotel
 
Diversified
 
60.8

60.6
 
L+3.60%

6.2%
 
Sep 2021

I/O

Office
 
NC
 
59.4

59.1
 
L+4.25%

8.4%
 
Mar 2021

I/O

Office
 
IL
 
57.3

57.2
 
L+3.95%

6.3%
 
Jun 2021

I/O

Industrial
 
FL
 
52.5

52.1
 
L+6.10%

8.8%
 
Oct 2022

I/O

Mixed-use
 
CA