Q2 2020 Ares Commercial Real Estate Corp Earnings Call
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Good afternoon, and welcome to the Aries commercial real estate Corporation's conference call to discuss the company's second quarter 2020 financial results.
As a reminder, this conference is being recorded on August six 2020, I'll now turn the call I've heard from somewhere from Investor Relations. Please go ahead.
Good afternoon. Thank you for joining us on today's conference call I'm joined today by our CEO, Brian Gotta, how David <unk> due to you in our CFO and Carl Drake, our had a public company Investor Relations.
Turning to our press release in the country that Weve filed with the FCC. We have posted earnings presentation under the Investor resources section of our website at Www Dot Aries CRT Dot com.
Before we begin I want to remind everyone that comments made during the course of this conference call and webcast and accompanying documents contain forward looking statements and are subject to risks and uncertainties.
Many of these forward looking statements can be identified by the use of words such as anticipated.
He expects intend well should may and similar expressions.
These forward looking statements are based on management's current expectations of market conditions and management structure.
These statements are not guarantees of future performance condition or results involve a number of risks and uncertainties.
The company's actual results could differ materially from those expressed in these forward looking statements as a result of a number of factors, including those listed in a D.C. filings.
Aries commercial real estate Corporation assumes no obligation to update any such forward looking C.
During this conference call, we will refer to certain non-GAAP financial measures. We use these measures of operating performance and these measures should not be considered in isolation from where I can substitute for measures prepared in accordance with generally accepted accounting principles.
These measures may not be comparable to like titled measures used by other companies.
That I will now turn the call over to Brian.
Thanks, Rocco and good afternoon, everyone.
At the onset of the covert 19 pandemic and its disruptions to the real estate markets.
Immediately said several goals and objectives.
I am to maintain stable earnings and use our asset management capabilities to preserve our strong credit quality.
We also sought out opportunities to selectively divest certain assets to enhance our liquidity and manage risk exposure.
With respect to the balance sheet, we focused on managing our lender relationships and reducing overall leverage.
Our overarching goal.
What's to execute on these objectives and protect shareholder value and I'm pleased to say that we've made progress and all of these areas during the second quarter and into this current quarter.
The work that we completed leading into 2020 has given us a very strong foundation to weather significant economic headwinds.
For example over the last few years, we strategically positioned our portfolio to be conservative and well diversified the.
The portfolio is comprised of 95% senior loans across 50 investments in 17 different markets with limited exposure to gateway cities.
We focused our originations primarily on multifamily office and industrial properties with limited exposure to hotels and retail.
We also built in LIBOR floors to protect our earnings and low interest rate environments.
Furthermore, we maintained diversified sources of funding, particularly with respect to hotel loans, and we refused to finance our loans with spread based mark to market facilities.
As a result, we are proud that our portfolio has performed well and that our balance sheet remains sound.
We have not made any fundamental changes to our business, but rather we have focused on opportunities to enhance our possession and we're excited about the outlook for our company.
Let me now walk through our financial results at a high level and some of the specific progress we made.
This morning.
We reported consistent core EPS of 32 cents per share and GAAP EPS of 29 cents.
Our earnings continue to benefit from our diversified portfolio and the LIBOR floor protection on nearly all of our loans.
During the second quarter, our portfolio quality improved at the number of loans on non accrual status declined and our overall internal credit risk ratings improved.
100% of our loans held for investment made their contractual debt service payments through July including the three loans that remain on nonaccrual status.
Two loans, representing 2% of our loans held for investment as measured by outstanding principal balance are under short term contractual forbearance agreements.
Our internal risk ratings also improved.
On a one to five rating scale with one being the lowest and five being the highest 91% of our loans rated a three or better versus 84% last quarter.
Our non accruing loans declined from 6% of unpaid principal balance to 4%, including the removal of one hotel, where we extended the upcoming maturities alone in exchange for partial debt pay down and the funding of substantial interest in operating reserves from the sponsor.
During the second quarter and subsequent to quarter end. We also took steps to increase our liquidity and manage our risk by prudently divesting selected assets through five transactions.
First we refinanced two loans secured by multifamily properties in Florida totaling $138 million.
Oh, just closing we transferred the subordinate interest in the two loves to a third party and subsequently financed our senior position through our securitization.
On a net basis. This transaction resulted in a $35 million in cash.
Well at the same time de risking our position.
We enhanced our liquidity, while creating attractive interest, earning loans backed by multifamily properties.
Subsequent to quarter end, we sold three laws to secured by multifamily properties and one by a hotel property.
These five transaction totaled $238 million, an unpaid principal balance and generated $60 million net cash.
The average price for the five loans was 97% of par value.
Which included three loans at par.
95% of par and one nonperforming hotel loan at 92.5% apart.
Following the sale of the hotel, while our overall hotel want exposure decreased by $31 million to 237 million an outstanding principal balance across five wells.
In total the five loan transactions helped improve our cash position to $80 million as of August 2020, net of paying our second quarter cash dividend of 33 cents per share on July 15.
We also reduced our overall balance sheet leverage tastic will discuss.
Our dedicated asset management team has worked diligently over the last few months and this can be seen by the credit improvement our portfolio and our enhanced liquidity.
We continue to have constructive dialogue with each of our borrowers, allowing us to navigate uncertainties in the market and to seek to address issues proactively that occur that could occur in the portfolio.
Going forward, while we continue to actively manage our existing portfolio at our balance sheet liquidity. We believe we have the financial flexibility to go on offense and take advantage of attractive financing opportunities.
We are using our extensive relationships and leveraging the power of the Aries platform to see off market higher spread attractive investment opportunities, albeit with less senior leverage available.
We are primarily focusing on multifamily properties industrial properties offices with long term leases as well as self storage assets, which have historically had less volatility and are more consistently financeable.
Our goal is to rigorously preserve our strong credit quality.
And that's the every investment is being highly scrutinized for safety and attractive deals.
With that I will turn the call over to taste.
Great. Thank you, Brian and good afternoon, everyone.
Earlier today, we reported consistent core earnings of 10.7 billion worth 32 cents per common share.
In part that's 94% of alone Subodh work floors at a weighted average rate of 1.77% an additional 2% of our loans are fixed rate.
GAAP net income was 9.8 million or 29 cents per common share.
Our GAAP earnings were impacted in the second quarter, primarily due to an unrealized loss of $4 million from approximately 12 cents per common share in connection with marking to market three loans held for sale that was subsequently sold in the third quarter.
In addition, our Oreo property Westchester Mariano a loss of approximately 2.2 million.
Or six cents in the second quarter.
Oh, the watch while the Americas, Westchester had been adversely impacted by that and like most of its hotels focused on business travelers.
We have taken numerous initiatives to lend it expenses and start to rebuild its revenue base.
And now since we did effectively converted the hotel to a limited service model, we have focused our sales and marketing team to solicit governments and other in central workers.
We're also benefiting from a significant reduction in competition. There's a few neighboring hotels are closed or closing some in which we understand maybe permanent.
Our problem is expected to be seen in the third quarter, what's expected losses be materially hotel.
Turning now to our liquidity as of yesterday's close we'd approximately $80 million an unrestricted cash.
In addition, we believe that we have available to watch further sources of liquidity should the need arrives.
For example, we have remaining on funding capacity under our ethanol re securitization, we believe that we could monetize additional loans, particularly those backlog multifamily properties that are more close to par.
Now, let me discuss our liabilities facilities.
We have said in the past we have.
So we pursued a strategy of diversified sources of financing and match funding absence of my bodies.
In the past few months, we've begun to reduce our overall leverage ratios and the share of our liabilities subject to credit based margin calls.
First.
Following the sale or other monetization of the five loans that bride personally and stuff.
Moving those like close after the second quarter, we reduced our debt equity ratio from 3.2 times as of March 31st 2020.
0.9 times currently.
Both measured excluded our Cecil reserves.
On a recourse basis, our debt to equity leverage has been reduced to less than 1.9 times.
We will continue to pursue opportunities to reduce our laboratory.
And second with respect to reducing our liabilities subject the credit base margin calls.
We have looked a further term out our financing.
And have also employed senior subordinate loan structures.
Working capital well, the two multifamily loans totaling 138 million outstanding principle that we refinanced shortly after closing we transferred 38 million of subordinate participations to what third party Barbara changing the 100 million interest.
You will note in our financials that although the 38 million subordinate participations, our junior towards senior positions and not indebtedness to watch the transaction did not qualify as syndications, but that the entire 138 million loan means consolidated hasn't happened on our balance sheet.
The 38 million subordinate ventures presented as a liability.
Yeah, and we bear no obligation to repay the 38 million junior participations, and such interest or subordinate to our hundred million and senior participations.
Also as a reminder, none of our warehouse financing facility can pay mark to market read barging provisions are based on changes in Marquis bond spreads.
Instead, our warehouse lines of remarketing provisions based on the credit performance of our loans.
Finally.
Our seasonal reserve was at 28 million other quarter ended June Thirtyth down approximately 4 million in the previous quarter.
This reduction in the provision was primarily attributable the threed loans that were transferred to loans held for sale, which reduced starts pizza reserves by approximately 1.2 million.
One additional loan that was repaid that's further reduced I'm seasonal reserves by <unk> point 5 million.
Reduction and be average remaining term, but the overall loan portfolio.
And with that I will now turn the call back over to Brian for some closing remarks.
Thanks, Dave.
To sum it up we're really proud and a significant progress we've made with respect to our objectives of enhancing liquidity.
Maintaining strong profitability and improving credit quality.
While protecting shareholder value.
We're pleased with the performance of our portfolio in the hard work and dedication of our entire team. We are all stronger for persisting through the last five months together, which makes us better position to navigate the road ahead and to take advantage of the opportunities. We believe we all five in the market going forward.
With that I'd like to ask the operator to open the line for questions.
We will now begin the question answer session Classic question might press Star then one on their Touchtone phone.
If you used to speakerphone, please pick up your hands up before personalities.
Anytime.
Your question, it's been a trust me would like to withdraw your question. Please press Star then too.
At this time, a pause momentarily there was some more often.
Our first question comes from Stephen Laws Raymond James. Please proceed.
Hi, good morning.
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No I guess just to start takes like you talked a little bit about leverage your prepared remarks and that you know it will you. The company was going to continue to look for ways to reduce it from here.
Is there target you have in mind or what do you think about is the right leverage level.
To operate the business going forward and how does that maybe target move around based on the mix of mark to market versus non mark to market financing facilities that you have.
Sure a good afternoon Stephen Thanks, So much for your question no. It's like that's a great question, while we don't have I would tell you a target per se.
Yes, we had sort of mentioned 3.0, that's equity that's what are the right balance between you don't between leverage and earnings on I think we have been successful and you know staying within the plus or minus that 3.0, that's likely ratio now I would say right. Now you know were underneath that 3.0.
Want to call approximately two and a half to 275, Israel that target range overall, but having said that I think it's important to point out that you had it'll depend on a multitude of factor you. I think you suggested wanted them, which is really important which is our you know our recourse leverage.
Those that are subject to potential margin calls even if there are simply credit they said not spread days.
What is termed out what is left termed out what is the rate of financing what is the maturity of the financing. So there's a multitude of factors that were 10, new account I would say generically.
And then given current market conditions, you know, we would like to see to reduce our mothers further from the 2.9 total I'm grateful that we have today, the 1.9 recourse leverage ratio today tweak it down a little further but again it'll be an evolving situation. A you know based upon the totality of what our.
Our liabilities and of course assay performance looks like.
And of course, you know, it's the fact that we are down <unk> percent senior right thing you know when you compare our leverage ratio to maybe some of our peers, who may not be as focus on senior that leverage ratio really needs to take into account you know something maybe the off balance sheet leverage that others may have on.
You know on their loans. So again I just want to emphasize that you know we are 95% senior and therefore, we have a leverage ratio to really be taking into consideration with that into account.
Great and then unfunded commitments I think I saw the total in the fund its about 250 million the I think.
Please correct me if that's not right, but can you talk a little bit out of the 250, you know how much of that is available be drawn down now how much of milestones or completions attached to it or for leasing up assets can you talk about.
How do you expect that to 50 to be funded over time.
Sure you know as you know a type of loans that we have historically now you are you know transitional loans, where you know we saw mandate you know majority of the commitment upfront. We certainly haven't most of our loans a component of the commitment that we believe will be funded over time.
The primary use of that funding over time, you know the unfunded commitments.
Really what we call good news money like the news money associated with leasing assets. So that for the dollars are necessary for tenant improvements for leasing commissions.
Capital expenditures that may be necessary or part of that and so when we put money out no for the most part we think that's a very positive that means that there's been very positive progress.
The business plans of the underlying underlying properties themselves, obviously, you're right. We do have approximately 250 million outstanding I think they can't just simply Walden money like these are not unfettered credit lines, where a borrower can just simply do a draw down notice and ask about 200 million.
They have to meet milestones they have to hit the good news that we've talked about it has to be in accordance with business plan. So there are <unk> loan by loan different milestones that are necessary to be bad in order for those dollars to be to be gone down, but I would say you know the most part again Ah you know the majority of that.
50 is for positive events that have happened in the underlying property and obviously, we're prepared to fund those dollars because we believe it enhances the underlying collateral values of the other properties themselves did it increases the cash flow.
Great last question.
For me I think ask every quarter, but the Aries facility at all it's been a pre funding facility, but you're not really doing the new originations data to prefund. The portfolio I don't think as they are being developed note that facility is there any optionality to it that you could use that financing for for something else for you know how do you think about that but.
Guilty as far as being there if you do do into a rate origination are you looking for stuff that you may like to put on that are kind of any update around the theories.
No absolutely you know that every facility has been a tremendous benefit too you know to acre Oh, you know pretty pandemic add joined depends I mean, so one of the potential uses is you know given.
You know given the liquidity of acre given the balance sheet of acre. If we found a very attractive investment that we.
At this moment don't want to take onto acres balance sheet, but do wanted to ask future inventory and it certainly.
Something we can do using the theories warehouse the other potential use of it varies warehouse in this current market environment is that and I think we mentioned there is little bit in our first quarter and calls well is that we can use it sort of in a reverse direction that maybe the primary purpose in other words, we could take alone bad.
It's already on acreage balance sheet.
Salad today, Aries warehouse to free up capital on acres balance sheet.
You know with the potential and with the option to buy back in the future.
I would you say all of that would be down at fair market values.
But again it does provide an additional source of potential liquidity for acre isn't as needed.
That's great appreciate the color on that up thank you for taking my questions. This morning.
Thanks, Steven Thanks, so much.
Our next question comes from Doug Harter Credit Suisse. Doug. Please proceed.
Hey, guys. This is actually Josh bolting on for Doug.
You talked about in your prepared remarks talking about going on all fence or the ability to start going on offense. I'm wondering if you can talk a little bit about the pipeline that you're seeing or the opportunities you're seeing currently.
And how spreads available today compared to what you are seeing pre coated thanks.
Yeah, absolutely I think what we've seen over the last 45 to 60 days is a pretty significant expansion in the pipeline of opportunities I'd still say, that's coming off of a relatively low bar during the more acute portion of the koby crisis, but we've been very pleased with what we're starting to see.
So I'd say, a small percentage of those would fall in the actionable category.
But we would expect that during the tail end of the third and into the fourth quarter will be fine and just following the trend lines over the last 60 days as I said I think we'll try to.
We will be successful in churning up some opportunities that are actionable.
With respect to your latter question regarding spreads what we've seen is significant movement.
Beyond the decline in LIBOR. So obviously over the last 18 months, we've seen a decline in library in the neighborhood of 150 basis points.
I would say that spreads are now.
Wider bye bye greater.
Margin than that so think about and average loan just if I'm thinking apples to apples in at LIBOR, plus 350 to 375.
Six eight months ago that same loan today is probably for 75 to 500 over so still an attractive all in coupon for a bar, which I think is an important part to make sure we end up with willing buyers and sellers at the transaction table, but what it allows for US is to have the underlying assets alone itself.
We'll provide a much greater portion of all in yields relative to some of the financial engineering and Levered returns that that we've seen in the marketplace over the past 18 months. So all in all we feel the expansion of the pipeline has been significant.
We're pretty bullish on what the fourth quarter in first quarter of next year looks like.
Great appreciate the comments thank you.
As a reminder, if you ever question. Please press Star then one our next question comes from Jade Rahmani of KBW Jade. Please proceed.
Thank you very much can you say.
Give some indication as to whether you expect the current level of earnings to be maintained you mentioned, a few positives I could bolster earnings including LIBOR floors as well as some recent improvement in credit.
And expense curtailment on the West Chester Hotel property on the other hand, the portfolios a little bit smaller post some of the actions you've taken so just wondering directionally what you're thinking.
Sure. Jason This is taste like I can start without question. So I think you know the asset.
Transaction that you know that we've talked about the fog and we talked about you know while that we'll have some impact on earnings going forward.
We do think it'll be a mitigated by some of the other aspects that we talked about right. So you know we do think that the loss on west Chester Marianne having into third quarter looks like it's going to be materially mitigated versus even second quarter.
We do think that the full impact of LIBOR floors.
We'll continue to be felt in the third quarter second quarter, we certainly had a very material impact <unk> as libel continue to fall in the second quarter. It wasn't where I would call up full quarters impact of where libel ended up as of June thirtyth Ah, but so far.
Third quarter, you know we benefited from you know a much smaller impact a for the LIBOR floors or third as you said you know we are doing what we can to minimize DNA expenses overall, and so I'll say that sort of without some you know actual ordinary or somewhat one time events.
Oh, we do think operating earnings will remain very consistent you know for acre heading into third quarter and not materially impacted due to the five loan transactions that we that we spoke about.
And then what thanks very much Oh go ahead, just a quick add on I think.
If you think about a normal capital markets environment, where in.
LIBOR floors at the weighted average of 1.7 or thereabouts that we have relative to underlying library in the.
Low double digits normally that would be in inducement for accelerated repayments and as long as well some of the capital markets have return to normalcy, there's still a disruption such that that inducement people would love to lower their their borrowing costs were not seeing that accelerated repayments.
So I think we have some stickier loans, there, where we will continue to benefit from those LIBOR floors, while being able to.
Continue to stabilize the Marriott Westchester as well as pursue some.
One off idiosyncratic risk situations that that will provide higher yield so we're pretty happy with the portfolio in and.
What it's been generating in what we expected to continue to generate.
Yeah in the one <unk> go ahead, sorry about that change yeah, I'm, sorry, one I think I just want to add to ER to your question is in terms of core earnings for the third quarter.
I think there should be apparent, but just to just to make sure that the 4 billion mark to market loss that we took in the second quarter that impacted a GAAP earnings I did not impact Corning since the definition of Corning's would add back you know unrealized gains and losses third quarter, you know as we mentioned those transaction did.
Close and so the impact of that 4 million will go through core earnings in the third quarter.
So I think you're probably already whereby all that but I just wanted to.
Like that out.
Right.
And would there be somewhat of an offset in the reserve based on that.
You mean see some reserves.
Yeah, the I mean provision for loan losses inclusive of diesel.
You know for third quarter, obviously, it's a little too early to tell but you know as we mentioned in our you know our Q and you know and.
I remarked that you know of that Cecil reserve that change that we had in the second quarter.
About 1.2 million or that was due to yeah due to the transactions that resulted in the sales in the you don't but their quarter. So that's already in essence been take into account you know the Cesar.
Because when you transfer alone from held for investment to available for sale. You then our marking that mark to market and so you're taking off you know the previously held Cecil reserve against it so.
So there may be additional movements, a third quarter bought in connection with the actual transactions themselves those have already been accounted for in the second quarter.
Okay got it so the core earnings.
Operating earnings could be consistent but there is the realization of that loss.
That would run through core earnings in the.
Third quarter.
Correct.
Okay in terms of the second quarter away from a loan sale activity did you what was the magnitude of a loan repayments ordinary course loan repayments.
Okay.
So for second quarter out you know, we we really did not have a in a material loan repayments. We obviously did refinance yeah. The 138 only know alone that no doubt brine referred to so that technically the repayment and a new origination, but obviously it was really a refinancing of our own loan.
You know subsequent to second quarter in early July we did have a repayment or approximately 50 million Oh and this was you know an ordinary longer payment or actually happened earlier than the stated maturity and so we did have you know we did have that.
Loan repayment about happen early third quarter now checkpoint.
Got it to pacing any additional repayments.
In the third quarter and should we expect the fundings or previous commitments to be similar to what took place in the second quarter.
Oh sure I think you know, we're obviously closely monitoring business find progress and availability of capital that would you know that would permit refinancings or pay offs of our loans and right. Now I think you know we don't expect there to be material amounts, but you know there.
Could be some level repayment and the you know in the third quarter. It certainly would not be commensurate with its pretty pandemic levels, there could be some repayments and a in the third quarter.
And then you know as far as future funding is concerned.
I think you know as we mentioned we have about 250 million of unfunded commitments that is over the remaining you know expected life of all 50 loans held for investment Ah. So it's spread out across quite a few investments you know, there's very but spoke loan by loan situation by situation.
Transaction by transaction of Windows money, you get drawn I would say you know we have historically had call it plus or minus 25 million per quarter.
Again that is a very very general numbers, so I wouldn't count on that being the number for any specific quarter, but that's caught it then you know what we've seen.
The past.
Thank you very much so taking the questions.
Great. Thank you good.
Hi, My final question comes from Chris Me or JMP Securities. Chris. Please proceed.
Hey, guys on for Steve today, Thanks for taking the question I want to see if you could just give some general commentary about the student housing in the portfolio.
We've heard some positive trends from from some other people not in the space. So it's fun to see what you guys I'd say about it.
Yeah, we would probably echo that they think it's been a very positive last 90 days in the space, owing a little bit to less folks being housed on campus and pushing some demand off campus, but universally we've seen occupancy and rate outpace 12.
Months ago, and importantly to add on their early in the cobot crisis. When do you saw with the leasing at these properties was that they effectively have now clause, if if ER schools didn't open or scope. It caused some resurgence there and almost universally we've seen that clause in the leases go away so that.
Their binding and their maintaining the same amount or a similar amount I should say of parental guarantees on those leases. So in in some we think the loans the lease structures are positive and.
Again far outpacing last years or last year's pace.
Leasing and rate.
Great Super helpful and thanks for taking the question.
Thank you.
This concludes our question answer session I'll now, let's turn the conference back over Brian <unk> for any closing remarks.
Yeah. Thanks, Thanks, everyone for joining today and spending time with us.
We really appreciate your continued support a baker and we look forward to speaking to again on the next earnings will be well. Thank you.
Ladies and gentlemen, this concludes our conference call for today, if you Miss any part of today's call. An archive replay of this conference call real favorable approximately one hour. After the end of this call through August Twentyth 2020.
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