Q3 2020 Ares Commercial Real Estate Corp Earnings Call
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Good afternoon, and welcome to areas commercial real estate Corporation's conference call to discuss the company's third quarter 2020 financial results. As a reminder, this conference is being recorded on October 29, 2020, I will now turn the call over to Veronica Mayer from Investor Relations.
Good afternoon, and thank you for joining us on today's conference call I am joined today by our CEO, Brian Donahoe, David Roth, Our President basic you and our CFO and called Drake, Our head of public company Investor Relations.
In addition to our press release and the 10-Q that we filed with the FTC. We have posted an earnings presentation under the Investor resources section of our web site at Www Dot Aries CR eat dotcom beef.
Before we begin I want to remind everyone that comments made during the course of this conference call and webcast and the accompanying documents contain forward looking statements and are subject to risks and uncertainties. Many.
Many of these forward looking statements can be identified by the use of words, such as anticipates believes expects intends will should may and similar expressions.
Forward looking statements are based on management's current expectations of market conditions and management's judgment. These.
Statements are not guarantees of future performance condition or results and involve a number of risks and uncertainties.
The company's actual results could differ materially from those expressed in the forward looking statements as a result of a number of factors, including those listed in its SEC filings.
Various commercial real estate Corporation assumes no obligation to update any such forward looking statements.
During this conference call, we will refer to certain non-GAAP financial measures. We use these as measures of operating performance and these measures should not be considered in isolation from or as a 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.
With that I will now turn the call over to Brian Dot Hill.
Thanks, Jonathan and thanks, everyone for joining today.
As you can see from our earnings release, our business continues to perform well despite conditions brought on by the pandemic.
In order to understand how we are positioned today I think it's important to first remind everyone that since the inception of acre we have focused on defensively positioning our portfolio to withstand market downturns.
For example, we carefully structured our loans with meaningful covenant protections to make sure we can protect our rights we.
We held firm and our deal negotiations to ensure that we are protected from falling interest rates by getting LIBOR floors.
We maintained a portfolio with a 94% allocation of senior mortgage loans.
We purposefully avoided marketable securities.
We shied away from what we viewed as overprice gateway markets and pivoted more and more to multifamily office properties with long term leases and industrial properties and focused on areas with lower cost of living lower state taxes and growing demographics.
We diversified our funding sources, especially with respect to more volatile asset classes such as hospitality.
And structured our financing so that we do not have margin calls based on changes in market spreads.
We believe our ability to successfully navigate this cycle is in part due to these strategic decisions.
As a result, our portfolio quality earnings and dividends have all remained relatively stable.
This stability can be seen through our third quarter core earnings per share of 31 cents, which is consistent with our second quarter levels.
It can also be seen in the credit performance of our portfolio in the quarter.
Our portfolio has a number of attributes that drive the stability.
It's very well diversified across 49 different loans and is primarily collateralized by multifamily.
Office and industrial properties.
We have a total of five hotel loans, all of which are limited or operated to select service models and no loans that are collateralized by Standalone retail centers.
Our 49, those are spread across 17 different markets with minimal exposure to the gateway cities and with no full service lodging assets in any of these gateway cities.
Within on multifamily and office portfolio, we focus on light transitional properties, where there are generally increasing cash flows and growing tendency.
Which we believe counteracts some macro headwinds that may exist.
Our office portfolio is primarily comprised of class a properties in their respective markets with institutional quality tenants and long term leases in fact, the average remaining lease for a top 30 tenants by the percentage of leased area is five and a half years longer than the fully extended the average term of our loans.
We have less than 2% exposure to co working tenants in our office portfolio.
Similarly in our multifamily portfolio, we have avoided major cities and luxury high rises.
In both our multifamily and office properties, we're continuing to see positive trends in underlying tenant rent collections in the mid 90% range and the average occupancy rate for our multifamily portfolio is at approximately 90%.
The work of our dedicated asset management team has been exceptional and is also reflected in the performance of our portfolio.
This is a real strength of our platform.
The third quarter, there were no changes to the number of loans on nonaccrual status and 100% of our loans held for investment made their contractual debt service payments for the quarter and for the October payment date.
Our internal loan risk ratings also remain study.
On a one to five rating scale with one being the lowest resting five being the highest 91% of our loans rated a three or better with an average rating of 3.0.
In addition.
Our liquidity position remained stable at approximately $91 million.
We have also taken initiatives to further reduce our leverage we.
We now sit at 2.8 times debt to equity overall, and 1.8 times on a recourse basis levels that we believe are appropriate financing investment portfolio, consisting of 94% senior loans.
As we've navigated this pandemic with improving liquidity. We believe we are in a position to begin selectively making new investments, albeit with a high bar for safety and appropriate returns.
Our team has been active in other parts of our business. We are seeing a substantial pick up in both the quantity and quality of transactions.
This is especially true in property types that have historically had less volatility like multifamily industrial self storage and in states benefiting from tax migration.
Our goal remains to rigorously preserve our credit quality, while having the optionality to go on offense based on the opportunity set up which we're really excited about.
Overall, we are proud of our team and efforts to date, which have resulted in makers ability to pay a stable and consistent dividend to shareholders.
I'm going to now turn the call over to case it for some additional details on our third quarter results and financial position.
Great. Thank you, Brian and good afternoon, everyone earlier.
Earlier today, we reported GAAP net income of 14.9 million or 44 cents per common share.
Core earnings of 10.5 million or 31 cents per common share largely consistent with our prior quarter results.
Our earnings continued to benefit from LIBOR floors, with 95% of our loans, having such built in protection at a weighted average rate of 1.74%.
As discussed on our last earnings call during the second and third quarters, we sold or monetized five loans have an average of 97% of par, including one hotel.
These transactions improved our cash position reduced our hotel exposure and lower our overall leverage that.
Difference between our GAAP and core earnings in the third quarter reflects the 4 million or 12 cents per common share and loss associated with the sale of two of these loans.
With respect to Westchester marry our performance continue to improve in the third quarter we.
We are seeing the positive impact of our plan to reduce expenses and rebuild our revenue base.
Our sales and marketing team successfully solicited government and other essential workers at our hotel has benefited from less competition from other properties in the area that have either temporarily or permanently close.
As of September Thirtyth 2020, we continue to build book value up to $14.03 per common share versus $13 or 91 cents at the end of the second quarter of 2020.
Turning to our liquidity as of yesterday's close we had approximately $91 million in unrestricted cash.
Given our earnings from operations outlook and current cash flow needs, we believe that our liquidity levels are appropriate.
However, should the need for further liquidity arise we had additional sources of cash available to us, including reinvestment capacity under the Aries warehouse.
Now, let me discuss our liabilities and debt facilities.
We continue to reduce our debt to equity ratio to 2.8 times versus three times at the end of the second quarter and 3.2 times as of the end of the first quarter, all of which excludes seats or reserves.
On a recourse leases our debt to equity leverage is 1.8 times.
And as a reminder, none of our warehouse financing facilities contain mark to market remarketing provisions that are based on changes in market borrowing spreads.
Finally, our see some reserve was at 27 million at the end of the third quarter.
Lower by approximately 1 million from the prior quarter.
This reduction in the seats are reserve was primarily attributable to contractual reductions in loan commitments and pay downs and the shorter average remaining term of the overall loan portfolio.
And with that I will now turn the call back over to Brian for some closing remarks.
Thanks, Dave.
In conclusion, we believe we're very well positioned based on the differentiate actions we took to structure our portfolio defensively prior to the pandemic.
All of the actions, we have taken to defensively positioned our portfolio diversify our loans geographically and by market and spread out our funding sources has positioned us to deliver consistent earnings and dividends.
Our current liquidity position, we expect to be in a position to selectively take advantage of the more attractive investment opportunities, which we believe we will continue to see in the market going forward.
We appreciate the support from our shareholders and employees and thank you for the time today.
With that I'll ask the operator to open the line for questions. Thank you.
At this time, if you would like to ask a question. Please press Star then one on your Touchtone phone.
If you would like to withdraw your question. Please press Star then two.
The first question will be from Doug Harter of credit Suisse.
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Thanks can you talk about your current liquidity I'm holding its kind of how how do you think that that progress is over over the coming quarters, and you know and assuming that that number comes down how you would prioritize or deploying that liquidity.
Sure Doug This is Ah taesa.
Liquidity is obviously, a paramount important importance and we have been building the amount of liquidity over the past few quarters as you can see a as of even.
Just the last couple of days were up to about 91 million.
Which was if you look at it as a percentage of our equity look at as a percentage of our overall loans a potential needs. We think we're at a very appropriate level. Today. Obviously were also take into consideration what we anticipate our cash flow from operations to be on a go forward basis, having said all that.
We we remain cautious you know the markets are quite volatile. So we want to make sure that we continue to have pro.
Appropriate levels of liquidity to support the business at this point, we do feel we're in a good position. So we are evaluating uses of that capital, including deploying that capital into new investments, but.
But no firm decisions have been made on that but we do believe that liquidity is at a at a good level, where we can start to look at some offerings opportunities.
While at the same time, making sure that we have the appropriate amount of defensive liquidity and that we have other plans in place that we can move very quickly on to actually add additional cash onto the balance sheet if necessary.
Got it and take it looked like you know kind of the average asset yield.
Ticked up during the quarter.
Yeah was there anything kind of that would you would kind of call out in there that we should be aware of.
[noise], Doug I mean, not really I think you'll see a little bit of changes in asset yields.
Based upon the portfolio composition based upon potentially some modifications potentially on some partial repayments.
Or full repayments, but no it's not really due to changes in.
No big Big significant change in the portfolio I think it's fine tuning of the portfolio one of the nice things again about our portfolio is that you know 90, 597% of our portfolio is either floating rate with a fixed LIBOR floor. We also mix and a small amount of fixed rate loans, so even with.
The sharp changes in drop in library that Weve seen you have not seen a change in our overall average effective yield. So we do expect this to be relatively steady and whatever's changes you see so far sort of quarter to quarter over quarter to quarter are not due to any significant changes in the portfolio.
Great. Thank you.
Yeah. Thank you Doug.
The next question is from Steve Delaney of JMP Securities.
Hi, everybody congratulations on the quarter I'm wondering if you could give us an update on your west Chester Hotel on any strategy any changes there from a strategy standpoint, and if you could estimate sort of the quarterly cash stream or that you're now seeing on the property. Thanks.
Yeah. Thanks for the question I think the strategy you took at the outset with the Westchester Marriott and there is a lot of the way we thought about the overall portfolio, which was to take a long term view.
And I think that served us well in the portfolio and certainly with respect to Westchester Marissa.
As toxic indicated in his remarks, we benefited from the fact that a good portion of our competitive set has closed either temporarily or permanently so as you've seen this national uptick in demand and all while about what it's certainly less than prior years as you all know we've been able to kind of.
Harness more of that demand into our assets. So.
And there's been some one off events that have continued to benefit us. It obviously, it's still relatively opaque to book group business on a go forward basis, but we are seeing the benefits of staying open of containing our costs and really in <unk> and.
Minimized any downside with respect to that asset.
And Brian in terms of just quarter to quarter operating results approximately what would you say the impact currently is on your on your earnings.
Really relatively flat overall.
I think it's obviously the risk in new and lodging assets generally is the daily Mark to market of revenues I'm sure, but it but you know so it's tough to say how consistent that will be but we've been extremely pleased with the decisions that we've made at the asset I mean to to have created this cost contained to ask.
Said and still be able to successfully manage it and like I said harness as much revenue as possible given 40% reduction in our competitive set.
We're really pleased with the with what we've done there.
Thanks for that and then follow up we noticed this morning that Blackstone announced they had done a billion dollars yellow in the fourth quarter. Your 2017, COO I think I believe the reinvestment expires in March just curious how you're seeing that market that financing market. These days and if you have.
The flexibility to to call up your your COO, either before or you know when it a win win reinvestment expires. What your plan is for next spring. Thanks, Yeah. When we look at a lot of different options with respect to our financing as as we indicated earlier on the call I think the fee.
If the capital markets have returned for CLL isn't on the CMBS generally I think a couple of positives right first and foremost that fluid really helps stick to allow for willing buyers and sellers to come back to the table and so I think over the long term those types of markets being open should allow for more repayments over time.
Just in general right, and allowing a more normal course of business.
We evaluate on a constant basis, the most efficient way to finance our assets and the and obviously as we've said in prior quarters. Our partners on the financing side has been extremely constructive, but certainly there's there's accretive solutions and the CLL market today relative to certain financings warehouse lines and the like.
So it's something we're going to continue to look into like we do in the normal course.
Okay great.
Thank you for the comments.
Thank you.
The next question will be from Stephen laws of Raymond James.
Hi, Good morning, you noted in your remarks, you know leverage continues to decline and you're certainly benefiting from LIBOR floors I'm thinking about the valuation.
How do you evaluate potential stock repurchases against the though the leverage declines you've made is that something you'd consider here given the the price to book.
In a pretty small amount of unfunded commitments I guess relative to the total portfolio size. So can you maybe comment on valuation and how you think about returning capital shareholders, possibly through a stock repurchase.
Yeah sure sure basically Yeah go ahead go ahead.
Great great.
Sure Stephen so in terms of share.
Share repurchases as you know several years ago. During a you know what about capital markets.
I mean, we did go ahead and repurchased some shares and you know we continue to evaluate.
The attractiveness of doing so I mean, obviously with our shares trading at current levels you know a significant.
Significant discount to our book value a it would certainly be accretive from a book value per share perspective to do a meaningful share buyback.
At the same time, we obviously have other uses of capital, including some of the things that we just talked about in terms of having some offense opportunities as well as making sure that we have enough cash and liquidity for defense purposes, as well just given the great volunteer the market itself, we haven't obviously done a share buyback recently.
Okay, but it is certainly something that we will continue to evaluate and the considerations that we will take into account. It was certainly no accretion to book value per share, but also making sure that again, we sustain a sufficient level of liquidity and also sustain a level of market capitalization.
That will continue to make our shares liquidity in the market as you know one of the challenges we have at acre as just the small size of our overall balance sheet, including equity capital and to the extent that we do share buybacks that will obviously decrease that share capital further.
Which is something again won't stop us from doing it certainly, but it's certainly one of the factors that we would want to take into into consideration.
Great and I guess you know your published just started with the leverage side that you know you brought leverage now, though almost half a turn over the last couple of quarters now where do you see that near term is there a level where you start to make.
Make new investments are focused on their target that you'd like to get to the 2.5 or somewhere else, maybe talk about where you.
You'd like to see leverage trend over the next six to 12 months.
Yeah, No great question, and we have been we have been very focused on reducing our leverage and were balancing our leverage with all of the other important factors right. All the other important factors about Joe.
Generating attractive or are we used to our investors.
Turning to pay a consistent cash dividend to our investors.
You know it would be so called easy enough for us to further de lever and de lever the balance sheet to make it more conservative and safe on a relative basis, but obviously that has its knock on effect of reducing earnings and reducing our ability to pay dividends and so we're trying to find the right balance and so I would say we have been.
You know helped by the fact that we have our LIBOR floors. So that we can continue to generate very attractive returns.
With $91 million liquidity and with lower leverage and so we'll continue to evaluate it you know our leverage levels in the overall context, having said all that I think we are still comfortable saying that the target leverage that we are looking at right now is right around call. It 2.75, plus or minus 25. So.
Range of two and a half to three is kind of where we think given today's market conditions that we want to target to be so we're right there.
And you know again, it'll it'll be fluid depending on what happens with.
With market conditions, what happens with pipeline what happens with.
Our overall loan performance. So we're always looking to potentially change it but for the snapshot right now it's somewhere between that two and a half to three with a midpoint of 2.75.
Great. Thanks, a lot.
Thank you, saying.
The next question comes from Jade Rahmani of KBW.
Thank you very much areas management participated through a fund in a single family rental transaction with Pareteum.
Partners, an active participant in that sector and are one of the other commercial mortgage Reits called address cited.
That space has attractive on the debt side.
Is that an area that potentially could be earmarked for new investment.
Yeah.
Yeah. Thanks for that David John If you want to give a little bit of an extra there.
Yeah, I was going to say.
We are involved with the equity side of the business as well.
And we did announce a transaction obviously its a public.
Company transaction, so I can't really comment on that but needless.
Needless to say when you do something like that.
You view it reflects that you find the cash flows.
And the sector attractive.
I.
Spent a long time in the sector I was in my prior life at Blackstone was.
Responsible for the initial investment invitation homes. So have a lot of expertise was on the public company board for a long time.
And so I would just say that as a concept.
We like the space.
And obviously work.
And with our partners on the debt side.
To help them understand opportunities that might exist in that space.
Yeah, and Jay that just add I mean, obviously, David speaks to the collaboration between the groups and our our own involvement in between debt and equity and investments are in different sectors like that I think one of the phenomenon. We're seeing right as you as you've kind of Red Lion retailing and certainly at least temporarily.
Being extremely cautious on lodging assets today with that that reduction in the denominator of effectively makes you look outside the normal.
Four or five food groups of our investment universe, right and I think when you look around what you see is extremely consistent.
Rental collections, despite this downturn in that sector and.
And so I do think it's an attractive place to play and I think it's also an asset that becomes very leverageable by our counterpart. So I think it is something that we'll see an increased share of the pie going forward.
Thank you and can you give a flavor for some of the other or.
Types of transactions in the pipeline you said, you're very excited about the potential to deploy capital.
Yes, I mean, what we've seen is as certain banks have pulled back from the markets were.
Seeing attractive opportunities in industrial that have typically been more well backed by by the Super regional banks and the like and certainly in the multifamily space. The continued liquidity being provided by Fannie and Freddie has really been an anchor for that market and so we can step into assets that are in.
Lease up in the markets that we cited some of those tax migration areas mid rise buildings that have been just almost uniformly less affected by the virus all out from the virus.
And really attach a interesting levels and create a meaningfully higher spreads relative to where these same assets would have traded 12 months ago beyond.
Beyond that I think there's certainly cannot continue to be a smattering of more esoteric asset classes that you've seen become a.
More income than in a in the real estate equity markets, but the primary focus is going to remain in cash flowing multifamily industrial and the like.
Thanks in terms of the nonaccrual loans, what's the aggregate number of individual loans on non accrual.
And are there any additional loans targeted for sale.
Sure Jade so the number of loans in nonaccrual status is three.
Early this year right at the onset of the pandemic I think we had four loans, we have taken one off non accrual status based upon some modifications that we were able to get on with the borrower, which resulted in both a partial pay down and some funding of reserves that really say.
Yes can we increase the likelihood of interest payments. So we took the one loan off of nonaccrual. So as of Threeq here. We have three loans that are that are on non accrual.
And in terms of loans for sale now as of 930, we had no loans held for sale as the second quarter. As we mentioned we had a couple of loans that were held for sale. We took the marks through unrealized loss in the second quarter and obviously it.
Reverse that in the third quarter. So you will see some activities there, but as a third quarter. There is no loans available for sale.
And in terms of the outlook for those three loans, what do you anticipate happening.
I think with respect to those three loans and really the entire portfolio conversations have remained very constructive with our borrowers and no. We've continued to maintain dialogue on a weekly basis with them and we're seeing increased collections throughout the portfolio.
So as we mentioned trade if we look at the trend line, we've been picking up a point or two on rent collections underlying the portfolio through out yeah, certainly for the last three four months and that progress and the fact that these borrowers in most cases have continued to infuse equity into the assets makes us.
Feel pretty confident that that resolution I will be positive ultimately and I think like a lot of.
Borrowers today, I think they need more time to execute their business plan, but we still feel feel confident in the ultimate outcome.
And Jeff just to add to that Jay.
Just to add to that I think again, it's important to note that the three loans that are on nonaccrual are unique in that in that they continue to pay current interest. So they are not behind on interest and yet I think we took a step to put them on non accrual and start amortizing down our carrying value.
As we are receiving the interest payments, but again I just want to make sure you.
This is not the typical nonaccruals situation, where you're not accruing and youre not receiving the interest payments and these all three situations, we're actually receiving the interest payments and yet we're still maintaining them on non accrual status.
Thanks very much.
Thank you Jay.
Once again, if you have a question. Please press Star then one.
The next question is from Charlie a receipt of JP Morgan.
Hi, good afternoon, everybody. Thanks for taking the questions I noticed in the Q. There was four loan modifications that happened in the quarter can you talk to the nature of those modifications and I'm wondering if those were all met with additional equity contributions from the sponsors.
Yes, certainly a good question.
I think as a backdrop given the types of assets, we financing and especially if you compare what we do relative to CMBS, where it's really kind of a closed circuit loan modifications can be done in the normal course as business plans progress accelerate decelerate in the like and obviously the impact of Kobin has caused both fix.
Acceleration in certain business plans and deceleration in others.
In general the things that we will tweak or going to the maturity date.
Certain a deferral of covenants.
And in almost every instance, we're getting something.
In return for that that that makes sense based on that specific business plan that situation. So and in many cases that that does include an equity infusion as I can as I indicated earlier, we think that equity infusion that has been made in the normal course by these borrowers speaks to their own belief in their in their equity investor.
And I think speaks positively to ultimate outcome for the debt investment as well.
Okay got it and.
Then if you could just specifically provide any additional color on the.
Alabama student housing loan I think the maturity was extended to December of this year, just wondering how things are progressing on that asset.
Yeah, that's an asset that that's certainly fits into that category of the business plan interrupted by co that and the plan is for that asset to be sold by by the current owner.
I think the extension just gives a really a runway for that sale to occur.
Got it okay. Thanks, very much for taking the question.
And this concludes our question and answer session I'd now like to turn the conference back over to Brian Donahoe for any closing remarks.
Thank you.
I just want to thank everybody for their time today certainly appreciate the continued support of acre and look forward to speaking with you again on our next earnings call and if you have any additional questions. Please reach out to our IR team. Thank you.
Thank you ladies and gentlemen, this concludes our conference call for today. If you missed any part of today's call an archived replay of this conference call will be available approximately one hour. After the end of this call through November five 2020 to domestic callers by dialing 187734475.
Five to nine and to international callers by dialing 1412317 008 for.
For all replays, please reference conference number 10148188.
An archive replay will also be available on a webcast link located on the homepage of the Investor Relations resources section of our website.
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