Ares Commercial Real Estate Corp - Quarter Report: 2016 March (Form 10-Q)

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2016

 

OR

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period                   to                  

 

Commission File No. 001-35517

 

ARES COMMERCIAL REAL ESTATE CORPORATION

(Exact name of Registrant as specified in its charter)

 

 

245 Park Avenue, 42nd Floor, New York, NY 10167

(Address of principal executive offices) (Zip Code)

 

(212) 750-7300

(Registrant’s telephone number, including area code)

 

N/A

(Former name, former address and former fiscal year, if changed since last report)

 

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 x No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files). Yes x No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

 

 

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ARES COMMERCIAL REAL ESTATE CORPORATION

 

INDEX

 

Part I.	Financial Information
Item 1.	Consolidated Financial Statements
	Consolidated Balance Sheets as of March 31, 2016 (unaudited) and December 31, 2015	2
	Consolidated Statements of Operations for the three months ended March 31, 2016 and 2015 (unaudited)	3
	Consolidated Statement of Equity for the three months ended March 31, 2016 (unaudited)	4
	Consolidated Statements of Cash Flows for the three months ended March 31, 2016 and 2015 (unaudited)	5
	Notes to Consolidated Financial Statements (unaudited)	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	36
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	47
Item 4.	Controls and Procedures	49
Part II.	Other Information
Item 1.	Legal Proceedings	49
Item 1A.	Risk Factors	49
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	50
Item 3.	Defaults Upon Senior Securities	50
Item 4.	Mine Safety Disclosures	50
Item 5.	Other Information	50
Item 6.	Exhibits	50

 

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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
		March 31, 2016			December 31, 2015
		(unaudited)
ASSETS
Cash and cash equivalents ($2 and $8 related to consolidated VIEs, respectively)		$	6,164		$	8,995
Restricted cash		25,632			30,380
Loans held for investment ($424,555 and $483,572 related to consolidated VIEs, respectively)		1,209,800			1,174,391
Loans held for sale, at fair value		58,171			30,612
Mortgage servicing rights, at fair value		60,978			61,800
Other assets ($2,256 and $2,695 of interest receivable related to consolidated VIEs, respectively; $25,411 and $35,607 of other receivables related to consolidated VIEs, respectively)		61,370			72,804
Total assets		$	1,422,115		$	1,378,982
LIABILITIES AND EQUITY
LIABILITIES
Secured funding agreements		$	615,397		$	522,775
Warehouse lines of credit		49,578			24,806
Secured term loan		69,978			69,762
Commercial mortgage-backed securitization debt (consolidated VIE)		28,406			61,815
Collateralized loan obligation securitization debt (consolidated VIE)		156,959			192,528
Allowance for loss sharing		8,741			8,969
Due to affiliate		2,671			2,658
Dividends payable		7,429			7,152
Other liabilities ($232 and $299 of interest payable related to consolidated VIEs, respectively)		28,955			32,029
Total liabilities		968,114			922,494
Commitments and contingencies (Note 7)
EQUITY
Common stock, par value $0.01 per share, 450,000,000 shares authorized at March 31, 2016 and December 31, 2015, 28,573,519 and 28,609,650 shares issued and outstanding at March 31, 2016 and December 31, 2015, respectively		284			284
Additional paid-in capital		420,983			421,179
Accumulated deficit		(14,285		)	(11,992		)
Total stockholders’ equity		406,982			409,471
Non-controlling interests in consolidated VIEs		47,019			47,017
Total equity		454,001			456,488
Total liabilities and equity		$	1,422,115		$	1,378,982

 

See accompanying notes to consolidated financial statements.

 

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ARES COMMERCIAL REAL ESTATE CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except share and per share data)

 

		For the three months ended March 31,
		2016			2015
		(unaudited)			(unaudited)
Net interest margin:
Interest income from loans held for investment		$	18,750		$	23,170
Interest expense		(8,525		)	(10,178		)
Net interest margin		10,225			12,992
Mortgage banking revenue:
Servicing fees, net		4,042			3,916
Gains from mortgage banking activities		2,359			4,144
Provision for loss sharing		228			566
Change in fair value of mortgage servicing rights		(1,848		)	(3,181		)
Mortgage banking revenue		4,781			5,445
Total revenue		15,006			18,437
Expenses:
Management fees to affiliate		1,499			1,476
Professional fees		699			775
Compensation and benefits		4,284			4,637
General and administrative expenses		1,819			1,831
General and administrative expenses reimbursed to affiliate		1,028			1,065
Total expenses		9,329			9,784
Income before income taxes		5,677			8,653
Income tax expense (benefit)		(748		)	(642		)
Net income attributable to ACRE		6,425			9,295
Less: Net income attributable to non-controlling interests		(1,289		)	(2,233		)
Net income attributable to common stockholders		$	5,136		$	7,062
Net income per common share:
Basic earnings per common share		$	0.18		$	0.25
Diluted earnings per common share		$	0.18		$	0.25
Weighted average number of common shares outstanding:
Basic weighted average shares of common stock outstanding		28,529,328			28,484,293
Diluted weighted average shares of common stock outstanding		28,602,054			28,584,784
Dividends declared per share of common stock		$	0.26		$	0.25

 

See accompanying notes to consolidated financial statements.

 

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ARES COMMERCIAL REAL ESTATE CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF EQUITY

(in thousands, except share and per share data)

(unaudited)

 

							Additional						Total			Non-
		Common Stock					Paid-in			Accumulated			Stockholders’			Controlling			Total
		Shares		Amount			Capital			Deficit			Equity			Interests			Equity
Balance at December 31, 2015		28,609,650		$	284		$	421,179		$	(11,992	)	$	409,471		$	47,017		$	456,488
Stock-based compensation		(1,277	)	—			162			—			162			—			162
Repurchase and retirement of common stock		(34,854	)	—			(358		)	—			(358		)	—			(358		)
Net income		—		—			—			5,136			5,136			1,289			6,425
Dividends declared		—		—			—			(7,429		)	(7,429		)	—			(7,429		)
Contributions from non-controlling interests		—		—			—			—			—			2			2
Distributions to non-controlling interests		—		—			—			—			—			(1,289		)	(1,289		)
Balance at March 31, 2016		28,573,519		$	284		$	420,983		$	(14,285	)	$	406,982		$	47,019		$	454,001

 

See accompanying notes to consolidated financial statements.

 

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ARES COMMERCIAL REAL ESTATE CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

		For the three months ended March 31,
		2016			2015
		(unaudited)			(unaudited)
Operating activities:
Net income		$	6,425		$	9,295
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Amortization of deferred financing costs		1,534			3,158
Change in mortgage banking activities		277			(1,194		)
Change in fair value of mortgage servicing rights		1,848			3,181
Accretion of deferred loan origination fees and costs		(953		)	(1,525		)
Provision for loss sharing		(228		)	(566		)
Originations of mortgage loans held for sale		(169,886		)	(162,175		)
Sale of mortgage loans held for sale to third parties		145,114			216,394
Stock-based compensation		162			199
Depreciation expense		55			54
Deferred tax benefit		(477		)	(15		)
Changes in operating assets and liabilities:
Restricted cash		2,687			38,680
Other assets		36,696			18,217
Due to affiliate		13			28
Other liabilities		(5,459		)	1,823
Net cash provided by (used in) operating activities		17,808			125,554
Investing activities:
Issuance of and fundings on loans held for investment		(108,054		)	(58,669		)
Principal repayment of loans held for investment		47,850			218,094
Receipt of origination fees		680			398
Purchases of other assets		(339		)	(56		)
Net cash provided by (used in) investing activities		(59,863		)	159,767
Financing activities:
Proceeds from secured funding agreements		204,190			20,870
Repayments of secured funding agreements		(111,568		)	(69,324		)
Payment of secured funding costs		(161		)	(248		)
Repayments of debt of consolidated VIEs		(69,212		)	(187,463		)
Proceeds from warehouse lines of credit		191,226			175,689
Repayments of warehouse lines of credit		(166,454		)	(229,165		)
Repurchase of common stock		(358		)	—
Dividends paid		(7,152		)	(7,147		)
Contributions from non-controlling interests		2			5,685
Distributions to non-controlling interests		(1,289		)	(1,764		)
Net cash provided by (used in) financing activities		39,224			(292,867		)
Change in cash and cash equivalents		(2,831		)	(7,546		)
Cash and cash equivalents, beginning of period		8,995			16,551
Cash and cash equivalents, end of period		$	6,164		$	9,005

 

See accompanying notes to consolidated financial statements.

 

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ARES COMMERCIAL REAL ESTATE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

As of March 31, 2016

(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 that operates both as a principal lender and a mortgage banker (with respect to loans collateralized by multifamily and senior-living properties). 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 L.P. (NYSE: ARES) (“Ares Management”), a publicly traded, leading global alternative asset 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”).

 

In the Company’s principal lending business, it is primarily focused on directly originating, managing and servicing a diversified portfolio of CRE debt-related investments for the Company’s own account. The Company’s target investments in its principal lending business include senior mortgage loans, subordinated debt, preferred equity, mezzanine loans and other CRE investments. These investments, which are referred to as the Company’s “principal lending target investments,” are generally held for investment and are secured, directly or indirectly, by office, multifamily, retail, industrial, lodging, senior-living and other commercial real estate properties, or by ownership interests therein.

 

The Company is also engaged in the mortgage banking business through its wholly owned subsidiary, ACRE Capital LLC (“ACRE Capital”), which the Company believes is complementary to its principal lending business. In this business segment, the Company primarily originates, sells and services multifamily and senior-living related loans under programs offered by government-sponsored enterprises (“GSEs”), such as the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”) and by government agencies, such as the Government National Mortgage Association (“Ginnie Mae”) and the Federal Housing Administration, a division of the U.S. Department of Housing and Urban Development (together with Ginnie Mae, “HUD”). ACRE Capital is approved as a Fannie Mae Delegated Underwriting and Servicing (“DUS”) lender, a Freddie Mac Program Plus® Seller/Servicer, a Multifamily Accelerated Processing and Section 232 LEAN lender for HUD, and a Ginnie Mae issuer. While the Company earns little interest income from these activities as it generally only holds loans for short periods, the Company receives origination fees when it closes loans and sale premiums when it sells loans. The Company also retains the rights to service the loans, which are known as mortgage servicing rights (“MSRs”) and receives fees for such servicing during the life of the loans, which generally last ten years or more.

 

The Company has elected and qualified to be taxed as a real estate investment trust (“REIT”) for U.S. federal income tax purposes under the Internal Revenue Code of 1986, as amended, commencing with its taxable year ended December 31, 2012. The Company generally will not be subject to U.S. federal income taxes on its REIT taxable income, determined without regard to the deduction for dividends paid and excluding net capital gains, to the extent that it annually distributes all of its REIT taxable income 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, 2015 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.

 

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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, 2016.

 

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.

 

Segment Reporting

 

The Company has two reportable business segments: Principal Lending and Mortgage Banking. See Note 16 included in these consolidated financial statements for further discussion of the Company’s reportable business segments.

 

Reclassifications

 

Certain prior period amounts have been reclassified to conform to the current period presentation. Amortization of convertible notes issuance costs and accretion of convertible notes have been reclassified into amortization of deferred financing costs in the consolidated statements of cash flows. As of March 31, 2016 and December 31, 2015, the Company no

 

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longer presents amortization of convertible notes issuance costs and accretion of convertible notes in its consolidated statements of cash flows.

 

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, unless the loans are deemed impaired. Impairment occurs when it is deemed probable that the Company will not be able to collect all amounts due according to the contractual terms of the loan. If a loan is considered to be impaired, the Company will record an allowance to reduce the carrying value of the loan to the present value of expected future cash flows discounted at the loan’s contractual effective rate.

 

Each loan classified as held for investment is evaluated for impairment on a quarterly basis. Loans are 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 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 impairment 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.

 

In addition, the Company evaluates the entire portfolio to determine whether the portfolio has any impairment that requires a valuation allowance on the remainder of the loan portfolio. As of March 31, 2016 and December 31, 2015, the Company did not recognize any impairment charges with respect to its loans held for investment.

 

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.

 

Preferred equity investments, which are subordinate to any loans but senior to common equity, are accounted for as loans held for investment and are carried at cost, net of unamortized loan fees and origination costs, unless the loans are deemed impaired, and are included within loans held for investment in the Company’s consolidated balance sheets.  The Company accretes or amortizes any discounts or premiums over the life of the related loan held for investment utilizing the effective interest method.

 

Loans Held for Sale

 

Through its subsidiaries, including ACRE Capital, ACRC Lender W TRS LLC (“ACRC W TRS”) and ACRC Lender U TRS LLC (“ACRC U TRS”), the Company originates mortgage loans held for sale, which are recorded at fair value and accounted for under FASB ASC Topic 860, Transfers and Servicing. The holding period for loans originated by ACRE Capital is approximately 30 days. The carrying value of the mortgage loans sold is reduced by the value allocated to the associated retained MSRs based on relative fair value at the time of the sale. Gains or losses on sales of mortgage loans are recognized based on the difference between the selling price and the adjusted value of the related mortgage loans sold.

 

Although the Company generally holds its target investments as long-term investments within its principal lending business, the Company may occasionally classify some of its investments as held for sale. Investments held for sale will be carried at fair value within loans held for sale in the Company’s consolidated balance sheets, with changes in fair value recorded through earnings. The fees received are deferred and recognized as part of the gain or loss on sale. As of March 31, 2016 and December 31, 2015, the Company did not have any loans held for sale in its principal lending business.

 

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Mortgage Servicing Rights

 

When a mortgage loan is sold, ACRE Capital retains the right to service the loan and recognizes the MSR at fair value. The initial fair value represents expected net cash flows from servicing, as well as interest earnings on escrows and interim cash balances, borrower prepayment penalties, delinquency rates, late charges along with ancillary fees that are discounted at a rate that reflects the credit and liquidity risk of the MSR over the estimated life of the underlying loan. After initial recognition, changes in the MSR fair value are included within change in fair value of mortgage servicing rights in the Company’s consolidated statements of operations for the period in which the change occurs.

 

Allowance for Loss Sharing

 

When a loan is sold under the Fannie Mae DUS program, ACRE Capital undertakes an obligation to partially guarantee the performance of the loan. The date ACRE Capital commits to make a loan to a borrower, a liability for the fair value of the obligation undertaken in issuing the guarantee is recognized. Subsequent to the initial commitment date, the Company monitors the performance of each loan for events or circumstances which may signal an additional liability to be recognized if there is a probable and estimable loss. The initial fair value of the guarantee is estimated by examining historical loss share experienced in the ACRE Capital Fannie Mae DUS portfolio over the most recent ten-year period. The initial fair value of the guarantee is included within the provision for loss sharing in the Company’s consolidated statements of operations. These historical loss shares serve as a basis to derive a loss share rate which is then applied to the current ACRE Capital DUS portfolio (net of specifically identified impaired loans that are subject to a separate loss share reserve analysis).

 

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.

 

A reconciliation of the Company’s interest income from loans held for investment, excluding non-controlling interests, to the Company’s interest income from loans held for investment as included within its consolidated statements of operations is as follows ($ in thousands):

 

		For the three months ended March 31,
		2016			2015
Interest income from loans held for investment, excluding non-controlling interests		$	17,461		$	20,927
Interest income from non-controlling interest investment held by third parties		1,289			2,243
Interest income from loans held for investment		$	18,750		$	23,170

 

Servicing fees are earned for servicing mortgage loans, including all activities related to servicing the loans, and are recognized as services are provided over the life of the related mortgage loan. Also included in servicing fees are the net fees earned on borrower prepayment penalties and interest earned on borrowers’ escrow payments and interim cash balances, along with other ancillary fees and reduced by write-offs of MSRs for loans that are prepaid, changes in the fair value of the servicing fee payable (defined below) and interest expense related to escrow accounts. ACRE Capital provides additional payments to certain personnel by providing them with a percentage of the servicing fee revenue that is earned by ACRE Capital, which is initially recorded as a liability when ACRE Capital commits to make a loan to a borrower (the “servicing fee payable”).

 

Gains from mortgage banking activities includes the initial fair value of MSRs, loan origination fees, gain on the sale of loans originated, interest income and fees earned on loans held for sale, changes to the fair value of derivative financial instruments attributable to the loan commitments and forward sale commitments and reduced by the expense related to the initial fair value of the servicing fee payable and the interest expense related to the Warehouse Lines of Credit (as defined in Note 5 included in these consolidated financial statements). The initial fair value of MSRs, loan origination fees, gain on the sale of loans originated, certain direct loan origination costs for loans held for sale and the expenses related to the initial fair value of the servicing fee payable are recognized when ACRE Capital commits to make a loan to a borrower. When the Company settles a sale agreement and transfers the mortgage loan to the buyer, the Company recognizes a MSR asset equal to the present value of the expected net cash flows associated with the servicing of loans sold.

 

Net Interest Margin and Interest Expense

 

Net interest margin within the consolidated statements of operations is a measure that is specific to the Company’s principal lending business and serves to measure the performance of the Principal Lending segment’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

 

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expense related to its Secured Funding Agreements, securitizations debt, the Secured Term Loan and the 2015 Convertible Notes (individually defined in Note 5 included in these consolidated financial statements) in net interest margin. For the three months ended March 31, 2016 and 2015, interest expense is comprised of the following ($ in thousands):

 

		For the three months ended March 31,
		2016			2015
Secured funding agreements and securitizations debt		$	6,768		$	8,589
Secured term loan		1,757			—
Convertible notes		—			1,589
Interest expense		$	8,525		$	10,178

 

Comprehensive Income

 

For the three months ended March 31, 2016 and 2015, comprehensive income equaled net income; therefore, a separate consolidated statement of comprehensive income is not included in the accompanying consolidated financial statements.

 

Recent Accounting Pronouncements

 

In May 2014, the FASB issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers (Topic 606).’’ The guidance in this ASU supersedes the revenue recognition requirements in Topic 605, “Revenue Recognition.” Under the new guidance, an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The amendments in ASU No. 2014-09 are effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. In March 2016, the FASB issued ASU No. 2016-08, “Revenue from Contracts with Customers (Topic 606): Principal Versus Agent Considerations,” which clarifies the guidance in ASU No. 2014-09 and has the same effective date as the original standard. Early application is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. The Company is currently evaluating the impact of adopting this ASU on its consolidated financial statements.

 

In February 2016, the FASB issued ASU No. 2016-02, ‘‘Leases (Topic 842).’’ The guidance in this ASU supersedes the leasing guidance in Topic 840, ‘‘Leases.’’ Under the new guidance, lessees are required to recognize lease assets and lease liabilities on the balance sheet for those leases previously classified as operating leases. The amendments in ASU No. 2016-02 are effective for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period, with early adoption permitted. The Company is currently evaluating the impact of adopting this ASU on its consolidated financial statements.

 

In March 2016, the FASB issued ASU No. 2016-09, “Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting.” The standard is intended to simplify several areas of accounting for share-based compensation arrangements, including the income tax impact, classification on the statement of cash flows and forfeitures. ASU No. 2016-09 is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period, with early adoption permitted. The Company is currently evaluating the impact of adopting this ASU on its consolidated financial statements.

 

In February 2015, the FASB issued ASU No. 2015-02, “Consolidation: Amendments to the Consolidation Analysis (Topic 810).” The guidance in this ASU includes amendments to Topic 810, “Consolidation.” The new guidance modified the consolidation analysis for limited and general partnerships and similar type entities, as well as variable interests in a VIE, particularly those that have fee arrangements and related party relationships. Additionally, it provides a scope exception to the consolidation guidance for certain entities. The amendments in ASU No. 2015-02 are effective for annual reporting periods beginning after December 15, 2015. There was no impact of adopting this ASU on the Company’s consolidated financial statements.

 

In April 2015, the FASB issued ASU No. 2015-03, “Interest-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs.” The new guidance modified the requirements for reporting debt issuance costs. Under the amendments in ASU No. 2015-03, debt issuance costs related to a recognized debt liability are no longer recorded as a separate asset, but are presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by ASU No. 2015-03. In addition, in August 2015, the FASB issued ASU No. 2015-15, “Interest-Imputation of Interest (Subtopic 835-30).” The

 

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additional guidance reiterates that the SEC would not object to an entity deferring and presenting debt issuance costs related to a line of credit arrangement as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line of credit arrangement, regardless of whether there are any outstanding borrowings. ASU No. 2015-03 and ASU No. 2015-15 are required to be applied retrospectively for periods beginning after December 15, 2015. The Company early adopted this guidance retrospectively during the fourth quarter of 2015.

 

3.     LOANS HELD FOR INVESTMENT

 

As of March 31, 2016, the Company had originated or co-originated 38 loans held for investment, excluding 27 loans that were repaid or sold since inception. The aggregate originated commitment under these loans at closing was approximately $1.3 billion and outstanding principal was $1.2 billion, excluding non-controlling interests held by third parties, as of March 31, 2016. During the three months ended March 31, 2016, the Company funded approximately $109.2 million of outstanding principal and received repayments of $73.3 million of outstanding principal, excluding non-controlling interests held by third parties, as described in more detail in the tables below. Such investments are referred to herein as the Company’s “investment portfolio.” As of March 31, 2016, 66.7% of the Company’s loans have London Interbank Offered Rates (“LIBOR”) floors, with a weighted average floor of 0.23%, 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 mortgages and loans held for investment are accounted for at amortized cost. The following tables summarize the Company’s loans held for investment as of March 31, 2016 and December 31, 2015 ($ in thousands):

 

		As of March 31, 2016
		Carrying Amount (1)			Outstanding Principal (1)			Weighted Average Interest Rate		Weighted Average Unleveraged Effective Yield (2)		Weighted Average Remaining Life (Years)
Senior mortgage loans		$	992,166		$	996,308		4.4%		5.1%		1.3
Subordinated debt and preferred equity investments		171,055			173,441			10.7%		11.3%		5.3
Total loans held for investment portfolio (excluding non-controlling interests held by third parties)		$	1,163,221		$	1,169,749		5.3%		6.0%		1.9

 

		As of December 31, 2015
		Carrying Amount (1)			Outstanding Principal (1)			Weighted Average Interest Rate		Weighted Average Unleveraged Effective Yield (2)		Weighted Average Remaining Life (Years)
Senior mortgage loans		$	961,395		$	965,578		4.4%		5.1%		1.4
Subordinated debt and preferred equity investments		166,417			168,264			10.6%		11.2%		5.1
Total loans held for investment portfolio (excluding non-controlling interests held by third parties)		$	1,127,812		$	1,133,842		5.3%		6.0%		1.9

 

(1)                                 The difference between the Carrying Amount and the Outstanding Principal face amount of the loans held for investment consists of unamortized purchase discount, deferred loan fees and loan origination costs. The tables above exclude non-controlling interests held by third parties. A reconciliation of the Carrying Amount of loans held for investment portfolio, excluding non-controlling interests, to the Carrying Amount of loans held for investment, as included within the Company’s consolidated balance sheets, is presented below.

(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, premium or discount) 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 March 31, 2016 and December 31, 2015 as weighted by the Outstanding Principal balance of each loan.

 

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A reconciliation of the Company’s loans held for investment portfolio, excluding non-controlling interests held by third parties, to the Company’s loans held for investment as included within its consolidated balance sheets is as follows ($ in thousands):

 

		As of March 31, 2016
		Carrying Amount			Outstanding Principal
Total loans held for investment portfolio (excluding non-controlling interests held by third parties)		$	1,163,221		$	1,169,749
Non-controlling interest investment held by third parties		46,579			46,579
Loans held for investment		$	1,209,800		$	1,216,328

 

		As of December 31, 2015
		Carrying Amount			Outstanding Principal
Total loans held for investment portfolio (excluding non-controlling interests held by third parties)		$	1,127,812		$	1,133,842
Non-controlling interest investment held by third parties		46,579			46,579
Loans held for investment		$	1,174,391		$	1,180,421

 

A more detailed listing of the Company’s investment portfolio, excluding non-controlling interests, based on information available as of March 31, 2016 is as follows ($ in millions, except percentages):

 

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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		TX		$	81.8		$	81.4		L+5.00%		6.3%		Jan 2017		I/O
Retail		IL		75.9			75.6			L+4.00%		4.8%		Aug 2017		I/O
Hotel		CA		56.0			55.5			L+4.75%		5.9%		Feb 2019		I/O
Mixed-use		IL		56.9			56.4			L+3.60%		4.4%		Oct 2018		I/O
Office		FL		47.3			47.3			L+5.25%		5.6%		Apr 2016		I/O
Multifamily		TX		44.7			44.7			L+3.75%		4.7%		July 2016		I/O
Healthcare		NY		41.6			41.4			L+5.00%		5.9%		Dec 2016		I/O
Industrial		MO/KS		37.2			37.2			L+4.30%		5.3%		Jan 2017		P/I	(5)
Hotel		NY		36.5			36.2			L+4.75%		5.6%		June 2018		I/O
Hotel		MI		35.2			35.1			L+4.15%		4.8%		July 2017		I/O
Multifamily		TX		35.0			35.0			L+3.75%		4.7%		July 2016		I/O
Office		FL		34.0			33.9			L+3.65%		4.3%		Oct 2017		I/O
Industrial		OH		32.5			32.4			L+4.20%		5.0%		May 2018		I/O	(5)
Retail		IL		30.4			30.2			L+3.25%		4.1%		Sep 2018		I/O
Multifamily		NY		28.7			28.5			L+3.75%		4.7%		Oct 2017		I/O
Multifamily		TX		27.5			27.5			L+3.65%		4.6%		Jan 2017		I/O
Office		OR		28.6			28.4			L+3.75%		4.6%		Oct 2018		I/O
Mixed-use		NY		28.3			28.2			L+4.25%		5.0%		Aug 2017		I/O
Office		KS		25.5			25.4			L+5.00%		6.1%		Oct 2017		I/O
Multifamily		TX		25.0			24.9			L+3.65%		4.6%		Jan 2017		I/O
Multifamily		TX		23.9			23.8			L+3.80%		4.4%		Jan 2019		I/O
Multifamily		GA		23.1			23.0			L+3.85%		5.0%		May 2017		I/O
Multifamily		AZ		22.1			22.1			L+4.25%		5.5%		Sep 2016		I/O
Office		CO		19.5			19.4			L+3.95%		4.9%		Dec 2017		I/O
Office		CA		15.9			15.9			L+3.75%		4.6%		July 2016		I/O
Multifamily		NC		16.3			16.3			L+4.00%		5.0%		Apr 2017		I/O
Office		CA		14.9			14.9			L+4.50%		5.5%		July 2016		I/O
Multifamily		NY		15.0			15.0			L+3.85%		4.7%		Nov 2017		I/O
Mixed-use		NY		14.4			14.3			L+3.95%		5.0%		Sep 2017		I/O
Multifamily		FL		12.4			12.3			L+3.75%		4.8%		Apr 2017		I/O
Industrial		CA		10.1			10.0			L+5.25%		6.5%		May 2017		I/O
Subordinated Debt and Preferred Equity Investments:
Multifamily		GA/FL		38.8			38.4			L+11.85%	(6)	12.5%		June 2021		I/O
Multifamily		NY		33.3			33.2			L+8.07%		8.8%		Jan 2019		I/O
Office		NJ		17.0			16.2			12.00%		12.8%		Jan 2026		I/O	(5)
Office		GA		14.3			14.3			9.50%		9.5%		Aug 2017		I/O
Mixed-use		NY		16.7			16.7			11.50%	(7)	12.1%		Nov 2016		I/O
Multifamily		TX		4.9			4.8			L+11.00%	(8)	11.8%		Oct 2016		I/O
Various		Diversified	(9)	48.5			47.4			10.95%		11.7%		Dec 2024		I/O
Total/Weighted Average				$	1,169.7		$	1,163.2				6.0%

 

(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, premium or discount) and assumes no dispositions, early prepayments or defaults. Unleveraged Effective Yield for each loan is calculated based on LIBOR as of March 31, 2016 or the LIBOR floor, as applicable. The Weighted Average Unleveraged Effective Yield is calculated based on the average of Unleveraged Effective Yield of all loans held by the Company as of March 31, 2016 as weighted by the Outstanding Principal balance of each loan.

(3)                                  Certain loans are subject to contractual extension options that vary between one and two 12-month extensions and may be subject to performance based or other conditions as stipulated in the loan agreement. Actual maturities may differ from contractual maturities stated herein as certain borrowers may have the right to prepay with or without paying a prepayment penalty. The Company may also extend contractual maturities in connection with loan modifications.

(4)                                  I/O = interest only, P/I = principal and interest.

(5)                                  In January 2015, amortization began on the senior Missouri/Kansas loan, which had an outstanding principal balance of $37.2 million as of March 31, 2016. In May 2017, amortization will begin on the senior Ohio loan, which had an

 

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outstanding principal balance of $32.5 million as of March 31, 2016. In February 2021, amortization will begin on the subordinated New Jersey loan, which had an outstanding principal balance of $17.0 million as of March 31, 2016. The remainder of the loans in the Company’s principal lending portfolio are non-amortizing through their primary terms.

(6)                                  The preferred return is L+11.85% with 2.00% as payment-in-kind (“PIK”), to the extent cash flow is not available. There is no capped dollar amount on accrued PIK.

(7)                                  The interest rate is 11.50% with a 9.00% current pay and up to a capped dollar amount as PIK based on the borrower’s election. In July 2015, the Company entered into an amendment to increase the loan commitment and outstanding principal by $650 thousand at an interest rate of 15.00% on the increased commitment and outstanding principal only.

(8)                                  The preferred return is L+11.00% with a L+9.00% current pay and up to a capped dollar amount as PIK.

(9)                                  The preferred equity investment is in an entity whose assets are comprised of multifamily, student housing and medical office properties.

 

For the three months ended March 31, 2016, the activity in the Company’s loan portfolio was as follows ($ in thousands):

 

Balance at December 31, 2015		$	1,174,391
Initial funding		98,500
Origination fees and discounts, net of costs		(1,452		)
Additional funding		10,669
Amortizing payments		(156		)
Loan payoffs		(73,105		)
Origination fee accretion		953
Balance at March 31, 2016		$	1,209,800

 

No impairment charges have been recognized during the three months ended March 31, 2016 and 2015.

 

4.   MORTGAGE SERVICING RIGHTS

 

MSRs represent servicing rights retained by ACRE Capital for loans it originates and sells. The servicing fees are collected from the monthly payments made by the borrowers. ACRE Capital generally receives other remuneration including rights to various loan fees such as late charges, collateral re-conveyance charges, loan prepayment penalties, and other ancillary fees. In addition, ACRE Capital is also generally entitled to retain the interest earned on funds held pending remittance related to its collection of loan principal and escrow balances. As of March 31, 2016, ACRE Capital had a servicing portfolio (excluding ACRE’s loans held for investment portfolio; see Note 13 included in these consolidated financial statements) consisting of 971 loans with an unpaid principal balance of $5.0 billion, which includes 950 GSE / HUD loans with an unpaid principal balance of $4.4 billion and 21 other loans (managed by an affiliate of the manager of ACRE) with an unpaid principal balance of $567.6 million.  As of December 31, 2015, ACRE Capital had a servicing portfolio (excluding ACRE’s loans held for investment portfolio; see Note 13 included in these consolidated financial statements) consisting of 973 loans with an unpaid principal balance of $4.9 billion, which includes 953 GSE / HUD loans with an unpaid principal balance of $4.3 billion and 20 other loans (managed by an affiliate of the manager of ACRE) with an unpaid principal balance of $554.8 million.  As of March 31, 2016 and December 31, 2015, the carrying value of ACRE Capital’s MSRs for the GSE and HUD loan portfolio was approximately $61.0 million and $61.8 million, respectively.

 

Activity related to MSRs as of and for the three months ended March 31, 2016 and 2015 was as follows ($ in thousands):

 

Balance at December 31, 2015		$	61,800
MSRs purchased		323
Additions, following sale of loan		1,490
Changes in fair value		(1,848		)
Prepayments and write-offs		(787		)
Balance at March 31, 2016		$	60,978

 

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Balance at December 31, 2014		$	58,889
Additions, following sale of loan		3,144
Changes in fair value		(3,181		)
Prepayments and write-offs		(327		)
Balance at March 31, 2015		$	58,525

 

As discussed in Note 2 included in these consolidated financial statements, the Company determines the fair values of the MSRs based on discounted cash flow models that calculate the present value of estimated future net servicing income. The fair values of ACRE Capital’s MSRs are subject to changes in discount rates. For example, a 100 basis point increase or decrease in the weighted average discount rate would decrease or increase, respectively, the fair value of ACRE Capital’s MSRs outstanding as of March 31, 2016 and December 31, 2015 by approximately $1.9 million and $2.0 million, respectively.

 

5.   DEBT

 

Financing Agreements

 

The Company, through its subsidiary ACRE Capital, borrows funds under the ASAP Line of Credit and the BAML Line of Credit (individually defined below and together, the “Warehouse Lines of Credit”). The Company also borrows funds under the Wells Fargo Facility, the Citibank Facility, the BAML Facility, the CNB Facilities, the MetLife Facility and the UBS Facilities (individually defined below and collectively, the “Secured Funding Agreements”) and the Secured Term Loan (defined below). The Company refers to the Warehouse Lines of Credit, the Secured Funding Agreements and the Secured Term Loan as the “Financing Agreements.” As of March 31, 2016 and December 31, 2015, the outstanding balances and total commitments under the Financing Agreements consisted of the following ($ in thousands):

 

		As of
		March 31, 2016						December 31, 2015
		Outstanding Balance			Total Commitment			Outstanding Balance			Total Commitment
Wells Fargo Facility		$	124,958		$	225,000		$	101,473		$	225,000
Citibank Facility		152,643			250,000			112,827			250,000
BAML Facility		—			50,000			—			50,000
March 2014 CNB Facility		50,000			50,000			—			50,000
July 2014 CNB Facility		37,900			75,000			66,200			75,000
MetLife Facility		110,359			180,000			109,474			180,000
April 2014 UBS Facility		82,294			140,000			75,558			140,000
December 2014 UBS Facility		57,243			57,243			57,243			57,243
Secured Term Loan		75,000			155,000			75,000			155,000
ASAP Line of Credit		—			80,000		(1)	—			80,000		(1)
BAML Line of Credit		49,578			135,000			24,806			135,000
Total		$	739,975		$	1,397,243		$	622,581		$	1,397,243

 

(1)                                 The commitment amount is subject to change at any time at Fannie Mae’s discretion.

 

Some of the Company’s Financing Agreements are collateralized by (i) assignments of specific loans, preferred equity or a pool of loans held for investment or loans held for sale owned by the Company, (ii) interests in the subordinated portion of the Company’s securitization debt, or (iii) interests in wholly owned entity subsidiaries that hold the Company’s loans held for investment. The Company is the borrower or guarantor under each of the Financing Agreements (excluding the Warehouse Lines of Credit, where ACRE Capital is the borrower). Generally, the Company partially offsets interest rate risk by matching the interest index of loans held for investment with the Secured Funding Agreements used to fund them. The Company’s Financing Agreements contain various affirmative and negative covenants, including negative pledges, and provisions regarding events of default that are normal and customary for similar financing arrangements.

 

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Wells Fargo Facility

 

The Company is party to a master repurchase funding facility arranged by Wells Fargo Bank, National Association (“Wells Fargo”) (as amended and restated, the “Wells Fargo Facility”), which allows the Company to borrow up to $225.0 million. The maturity date of the Wells Fargo Facility is December 14, 2016, subject to two 12-month extensions at the Company’s option assuming no existing defaults under the Wells Fargo Facility and applicable extension fees are paid. Under the Wells Fargo Facility, the Company is permitted to sell, and later repurchase, certain qualifying senior commercial mortgage loans, A-Notes, pari passu participations in commercial mortgage loans and mezzanine loans under certain circumstances, subject to available collateral approved by Wells Fargo in its sole discretion. Beginning on December 14, 2015, new advances under the Wells Fargo Facility accrue interest at a per annum rate equal to the sum of (i) 30 day LIBOR plus (ii) a pricing margin range of 1.75% to 2.35%.  Advances on loans made prior to December 14, 2015 under the Wells Fargo Facility continue to accrue interest at a per annum rate equal to the sum of (i) 30 day LIBOR plus (ii) a pricing margin range of 2.00% to 2.50%.  The Company incurs a non-utilization fee of 25 basis points on the daily available balance of the Wells Fargo Facility to the extent less than 75% of the Wells Fargo Facility is utilized. For the three months ended March 31, 2016, the Company incurred a non-utilization fee of $66 thousand. For the three months ended March 31, 2015, the Company did not incur a non-utilization fee.

 

Citibank Facility

 

The Company is party to a $250.0 million master repurchase facility (the “Citibank Facility”) with Citibank, N.A. Under the Citibank Facility, the Company is permitted to sell and later repurchase certain qualifying senior commercial mortgage loans and A-Notes approved by Citibank, N.A. in its sole discretion. Advances under the Citibank Facility accrue interest at a per annum rate equal to 30 day LIBOR plus a pricing margin of 2.00% to 2.50%, subject to certain exceptions. The maturity date of the Citibank Facility is December 8, 2016, subject to three 12-month extensions at the Company’s option assuming no existing defaults under the Citibank Facility and applicable extension fees are paid. The Company incurs a non-utilization fee of 25 basis points on the daily available balance of the Citibank Facility. For the three months ended March 31, 2016 and 2015, the Company incurred a non-utilization fee of $68 thousand and $97 thousand, respectively.

 

BAML Facility

 

The Company is party to a $50.0 million Bridge Loan Warehousing Credit and Security Agreement (the “BAML Facility”) with Bank of America, N.A. Under the BAML Facility, the Company may obtain advances secured by eligible commercial mortgage loans collateralized by healthcare facilities and other multifamily properties. In February 2016, the Company amended the BAML Facility to expand the eligible assets to include loans secured by general and affordable multifamily properties. Bank of America, N.A. may approve the loans on which advances are made under the BAML Facility in its sole discretion. The Company may request individual loans under the BAML Facility through May 26, 2016. Individual advances under the BAML Facility generally have a two-year maturity, subject to one 12-month extension at the Company’s option upon the satisfaction of certain conditions and applicable extension fees being paid. The final maturity date of individual loans under the BAML Facility is May 26, 2019. Advances under the BAML Facility accrue interest at a per annum rate equal to one-month LIBOR plus a spread ranging from 2.25% to 2.75% depending upon the type of asset securing such advance. The Company incurs a non-utilization fee of 12.5 basis points on the average daily available balance of the BAML Facility. For the three months ended March 31, 2016, the Company incurred a non-utilization fee of $16 thousand.

 

City National Bank Facilities

 

March 2014 CNB Facility

 

The Company is party to a $50.0 million secured revolving funding facility with City National Bank (the “March 2014 CNB Facility”). The Company is permitted to borrow funds under the March 2014 CNB Facility to finance investments and for other working capital and general corporate needs. In February 2016, the Company amended the March 2014 CNB Facility to extend the maturity date to March 11, 2017. The Company has one 12-month extension at its option provided that certain conditions are met and applicable extension fees are paid, which, if exercised, would extend the final maturity of the March 2014 CNB Facility to March 10, 2018. Advances under the March 2014 CNB Facility accrue interest at a per annum rate equal to the sum of, at the Company’s option, either (a) LIBOR for a one, two, three, six or, if available to all lenders, 12-month interest period plus 3.00% or (b) a base rate (which is the highest of a prime rate, the federal funds rate plus 0.50%, or one month LIBOR plus 1.00%) plus 1.25%; provided that in no event shall the interest rate be less than 3.00%. Unless at least 75% of the March 2014 CNB Facility is used on average, unused commitments under the March 2014 CNB Facility accrue unused line fees at the rate of 0.375% per annum. For the three months ended March 31, 2016 and 2015, the Company incurred a non-utilization fee of $43 thousand and $37 thousand, respectively.

 

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July 2014 CNB Facility

 

The Company and certain of its subsidiaries are party to a $75.0 million revolving funding facility (the “July 2014 CNB Facility” and together with the March 2014 CNB Facility, the “CNB Facilities”) with City National Bank. The Company is permitted to borrow funds under the July 2014 CNB Facility to finance investments and for other working capital and general corporate needs. The maturity date of the July 2014 CNB Facility is July 31, 2016. Advances under the July 2014 CNB Facility accrue interest at a per annum rate equal, at the Company’s option, to either (a) LIBOR for a one, two, three, six or, if available to all lenders, 12-month interest period plus 1.50% or (b) a base rate (which is the highest of a prime rate, the federal funds rate plus 0.50%, or one month LIBOR plus 1.00%) plus 0.25%; provided that in no event shall the interest rate be less than 1.50%. Unless at least 75% of the July 2014 CNB Facility is used on average, unused commitments under the July 2014 CNB Facility accrue unused line fees at the rate of 0.125% per annum. For the three months ended March 31, 2016, the Company incurred a non-utilization fee of $7 thousand. For the three months ended March 31, 2015, the Company did not incur a non-utilization fee. See Note 13 included in these consolidated financial statements for more information on a credit support fee agreement with respect to the July 2014 CNB Facility.

 

MetLife Facility

 

The Company and certain of its subsidiaries are party to a $180.0 million revolving master repurchase facility (the “MetLife Facility”) with Metropolitan Life Insurance Company (“MetLife”), pursuant to which the Company may sell, and later repurchase, commercial mortgage loans meeting defined eligibility criteria which are approved by MetLife in its sole discretion. The maturity date of the MetLife Facility is August 12, 2017, subject to two 12-month extensions at the Company’s option provided that certain conditions are met and applicable extension fees are paid. Advances under the MetLife Facility accrue interest at a per annum rate of 30 day LIBOR plus 2.35%. The Company will pay MetLife, if applicable, an annual make-whole fee equal to the amount by which the aggregate price differential paid over the term of the MetLife Facility is less than the defined minimum price differential, unless certain conditions are met.

 

UBS Facilities

 

April 2014 UBS Facility

 

The Company is party to a $140.0 million revolving master repurchase facility (the “April 2014 UBS Facility”) with UBS Real Estate Securities Inc. (“UBS”), pursuant to which the Company may sell, and later repurchase, commercial mortgage loans and, under certain circumstances, other assets meeting defined eligibility criteria that are approved by UBS in its sole discretion. The maturity date of the April 2014 UBS Facility is October 21, 2018, subject to annual extensions in UBS’ sole discretion. The price differential (or interest rate) on the April 2014 UBS Facility is one-month LIBOR plus (a) 1.88% per annum, for assets that are subject to an advance for one year or less, (b) 2.08% per annum, for assets that are subject to an advance in excess of one year but less than two years, and (c) 2.28% per annum, for assets that are subject to an advance for greater than two years; in each case, excluding amortization of commitment and exit fees. Upon termination of the April 2014 UBS Facility, the Company will pay UBS, if applicable, the amount by which the aggregate price differential paid over the term of the April 2014 UBS Facility is less than the defined minimum price differential and an exit fee, in each case, unless certain conditions are met.

 

December 2014 UBS Facility

 

The Company is party to a global master repurchase agreement (the “December 2014 UBS Facility,” and together with the April 2014 UBS Facility, the “UBS Facilities”) with UBS AG, pursuant to which the Company will sell, and later repurchase, certain retained subordinate notes in the Company’s commercial mortgage-backed securities (“CMBS”) securitization (the “Purchased Securities”) for an aggregate purchase price equal to $57.2 million. The scheduled repurchase date of the December 2014 UBS Facility is July 6, 2016 (the “Repurchase Date”). The transaction fee (or interest rate), which is payable monthly on the December 2014 UBS Facility, is equal to one-month LIBOR plus 2.74% per annum on the outstanding amount. The Purchased Securities may be purchased by the Company in whole, but not in part, prior to the Repurchase Date. If the outstanding amount of the Purchased Securities subject to the December 2014 UBS Facility is reduced or repaid prior to the Repurchase Date, UBS AG shall be entitled to a termination fee.

 

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Warehouse Lines of Credit

 

ASAP Line of Credit

 

ACRE Capital is party to a multifamily as soon as pooled (“ASAP”) sale agreement with Fannie Mae (the “ASAP Line of Credit”) to finance installments received from Fannie Mae. To the extent the ASAP Line of Credit remains active through utilization, there is no expiration date. The commitment amount is subject to change at any time at Fannie Mae’s discretion. Fannie Mae advances payment to ACRE Capital in two separate installments according to the terms as set forth in the ASAP sale agreement. The first installment is considered an advance to ACRE Capital from Fannie Mae and not a sale until the second advance and settlement is made.

 

BAML Line of Credit

 

ACRE Capital is party to a $135.0 million line of credit agreement with Bank of America, N.A. (as amended and restated, the “BAML Line of Credit”), which is used to finance mortgage loans originated by ACRE Capital. The stated interest rate on the BAML Line of Credit is LIBOR Daily Floating Rate plus 1.60%. The BAML Line of Credit has a maturity date of June 30, 2016. ACRE Capital incurs a non-utilization fee of 12.5 basis points on the daily available balance of the BAML Line of Credit to the extent less than 40% of the BAML Line of Credit is utilized. For the three months ended March 31, 2016 and 2015, the Company incurred a non-utilization fee of $23 thousand and $15 thousand, respectively.

 

Secured Term Loan

 

The Company and certain of its subsidiaries are party to a $155.0 million Credit and Guaranty Agreement (the “Secured Term Loan”) with Highbridge Principal Strategies, LLC, as administrative agent, and DBD Credit Funding LLC, as collateral agent. The Company made an initial draw of $75.0 million on December 9, 2015, the closing date. The remaining $80.0 million of the Secured Term Loan may be borrowed during the nine-month commitment period following the closing date, subject to the satisfaction of certain conditions. The Secured Term Loan carries a coupon of LIBOR + 6.0% with a LIBOR floor of 1.0% on drawn amounts. The Secured Term Loan has a maturity date of December 9, 2018. The Company is subject to a monthly non-utilization fee equal to 1.0% per annum on the unused commitment amount during the nine month commitment period following the closing date. For the three months ended March 31, 2016, the Company incurred a non-utilization fee of $202 thousand. The original issue discount on the initial draw was $1.1 million, which represented a discount to the debt cost to be amortized into interest expense using the effective interest method over the term of the Secured Term Loan. The estimated effective interest rate of the Secured Term Loan, which is equal to LIBOR (subject to a floor of 1.0%) plus the stated rate of 6.0% plus the accretion of the original issue discount and associated costs, was 8.5% for the three months ended March 31, 2016.

 

2015 Convertible Notes

 

In December 2012, the Company issued $69.0 million aggregate principal amount of unsecured 7.000% Convertible Senior Notes due 2015 (the “2015 Convertible Notes”). The 2015 Convertible Notes bore interest at a rate of 7.00% per year, payable semiannually in arrears on June 15 and December 15 of each year, beginning on June 15, 2013. The effective interest rate of the 2015 Convertible Notes, which was equal to the stated rate of 7.00% plus the accretion of the original issue discount and associated costs, was 9.4% for the three months ended March 31, 2015. For the three months ended March 31, 2015, the interest expense incurred on this indebtedness was $1.6 million. The 2015 Convertible Notes matured on December 15, 2015 and were fully repaid at par.

 

6.     ALLOWANCE FOR LOSS SHARING

 

Loans originated and sold by ACRE Capital to Fannie Mae under the Fannie Mae DUS program are subject to the terms and conditions of a Master Loss Sharing Agreement, which was amended and restated during 2012. Under the Master Loss Sharing Agreement, ACRE Capital is responsible for absorbing certain losses incurred by Fannie Mae with respect to loans originated under the DUS program, as described below in more detail. The compensation for this risk of loss is a component of servicing fees on the loan.

 

The losses incurred with respect to individual loans are allocated between ACRE Capital and Fannie Mae based on the loss level designation (“Loss Level”) for the particular loan. Loans are designated as Loss Level I, Loss Level II or Loss Level III. All loans are designated Loss Level I unless Fannie Mae and ACRE Capital agree upon a different Loss Level for a particular loan at the time of the loan commitment, or if Fannie Mae determines that the loan was not underwritten, processed or serviced according to Fannie Mae guidelines.

 

Losses on Loss Level I loans are shared 33.33% by ACRE Capital and 66.67% by Fannie Mae. The maximum amount of ACRE Capital’s risk-sharing obligation with respect to any Loss Level I loan is 33.33% of the original principal amount of the loan. Losses incurred in connection with Loss Level II and Loss Level III loans are allocated disproportionately to ACRE

 

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Capital until ACRE Capital has absorbed the maximum level of its risk-sharing obligation with respect to the particular loan. The maximum loss allocable to ACRE Capital for Loss Level II loans is 30% of the original principal amount of the loan, and for Loss Level III loans is 40% of the original principal amount of the loan.

 

According to the Master Loss Sharing Agreement, Fannie Mae may unilaterally increase the amount of the risk-sharing obligation of ACRE Capital with respect to individual loans without regard to a particular Loss Level if (a) the loan does not meet specific underwriting criteria, (b) the loan is defaulted within twelve (12) months after it is purchased by Fannie Mae, or (c) Fannie Mae determines that there was fraud, material misrepresentation or gross negligence by ACRE Capital in its underwriting, closing, delivery or servicing of the loan. Under certain limited circumstances, Fannie Mae may require ACRE Capital to absorb 100% of the losses incurred on a loan by requiring ACRE Capital to repurchase the loan.

 

The amount of loss incurred on a particular loan is determined at the time the loss is incurred, for example, at the time a property is foreclosed by Fannie Mae (whether acquired by Fannie Mae or a third party) or at the time a loan is modified in connection with a default. Losses may be determined by reference to the price paid by a third party at a foreclosure sale or by reference to an appraisal obtained by Fannie Mae in connection with the default on the loan.

 

In connection with the Company’s acquisition of ACRE Capital, Alliant, Inc., a Florida corporation, and The Alliant Company, LLC, a Florida limited liability company (the “Sellers”), are jointly and severally obligated to fund directly (if permitted) or to reimburse ACRE Capital for amounts due and owing after the closing date to Fannie Mae pursuant to ACRE Capital’s allowance for loss sharing with respect to settlement of certain DUS program mortgage loans originated and serviced by ACRE Capital, subject to certain limitations. In addition, the Sellers are jointly and severally obligated to indemnify ACRE Capital for, among other things, certain losses arising from Sellers’ failure to fulfill the funding or reimbursement obligations described above. As of both March 31, 2016 and December 31, 2015, the preliminary estimate of the portion of such contributions towards such losses relating to the allowance for loss sharing of ACRE Capital was $377 thousand and is included within other assets in the consolidated balance sheets. Additionally, with respect to the settlement of certain non-designated DUS program mortgage loans originated and serviced by ACRE Capital, the Sellers are jointly and severally obligated to fund directly (if permitted) or to reimburse ACRE Capital in each of the three 12 month periods following the closing date for eighty percent (80%) of amounts due and owing after the closing date to Fannie Mae pursuant to ACRE Capital’s allowance for loss sharing in excess of $2.0 million during such 12 month period; provided that in no event shall Sellers obligations exceed in the aggregate $3.0 million for the entire three year period.

 

ACRE Capital uses several tools to manage its risk-sharing obligation, including maintenance of disciplined underwriting and approval processes and procedures, and periodic review and evaluation of underwriting criteria based on underlying multifamily housing market data and limitation of exposure to particular geographic markets and submarkets and to individual borrowers. In situations where payment under the guarantee is probable and estimable on a specific loan, the Company records an additional liability through a charge to the provision for loss sharing in the consolidated statements of operations. The amount of the provision reflects the Company’s assessment of the likelihood of payment by the borrower, the estimated disposition value of the underlying collateral and the level of risk-sharing. Historically, among other factors, the loss recognition occurs at or before the loan becoming 60 days delinquent.

 

A summary of the Company’s allowance for loss sharing as of and for the three months ended March 31, 2016 and 2015 is as follows ($ in thousands):

 

Balance at December 31, 2015		$	8,969
Current period provision for loss sharing		(228		)
Settlements/Writeoffs		—
Balance at March 31, 2016		$	8,741

 

Balance at December 31, 2014		$	12,349
Current period provision for loss sharing		(566		)
Settlements/Writeoffs		(38		)
Balance at March 31, 2015		$	11,745

 

As of both March 31, 2016 and December 31, 2015, the maximum quantifiable allowance for loss sharing associated with the Company’s guarantees under the Fannie Mae DUS agreement was $1.1 billion, from a total recourse at risk pool of

 

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