Q4 2023 Ares Commercial Real Estate Corp Earnings Call
[music].
Operator: Please stand by. Your program is about to begin. If you need assistance during today's conference, please press star zero. Good morning. Welcome to Ares Commercial Real Estate Corporation's fourth quarter and year-end December 31, 2023 earnings conference call. At this time, all participants are in a listen-only mode.
Please stand by your program is about to begin if you need assistance on today's conference. Please press start Z rap.
Good morning, welcome to Aries commercial real estate corporations fourth quarter and you're in December 31st 2023 earnings Conference call.
At this time, all participants or any listen only mode.
Operator: As a reminder, this conference is being recorded on Thursday, February 22, 2024. I will now turn the call over to Mr. John Stilmar, partner of Public Market Investor Relations. Good morning, and thank you for joining us on today's conference call. I'm joined today by our CEO, Brian Dalho, our CFO, Tasek Youn, and other members of the management team. In addition to our press release and the 10K that we filed with the SEC, we've posted an earnings presentation under the investor resources section of our website at www.arescre.com. Before we begin, I want to remind everyone that comments made during the course of this conference call and webcast, as well as the accompanying documents, contain forward-looking statements and are subject to risks and uncertainty. 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 such expressions.
As a reminder, this conference is being recorded on Thursday February 22nd 2024.
Now I'll turn the call over to Mister John still Mar partner public markets Investor Relations.
Good morning, and thank you for joining us on today's conference call.
Today by RC probably downhill.
<unk> other members of the management team and.
In addition to our press release to the temperature.
Posted in earnings presentation under the Investor Resources section of our website Www Dot <unk> dot com.
Before we begin I want to remind everyone that Thomas day during the course of this conference call.
As well as accompanying documents contains forward looking statements are subject to risks and uncertainties.
Many of these forward looking statements can be identified by the use of words, such as participates believes expects.
Oh sure.
Similar such expression.
John Stilmar: These forward-looking statements are based on managers' 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 filing. Ares Commercial Real Estate assumes no obligation to update any such forward-looking comments.
These forward looking statements are based on current expectations market's condition and management judgment.
Statements are not gonna change the future performance condition or results and if all the number of risks and uncertainties.
The company's actual results could differ materially from those expressed and forward looking statements as a result of a number of factors including.
Violent areas.
Commercial real estate it seems no obligation to update any such forward.
John Stilmar: During this conference call, we'll refer to certain non-GAAP financial measures. We use these as measures of operating performance. 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-channel measures used by other companies.
During this conference call will refer to certain non-GAAP financial measures.
Use the easiest measures of operating performance at.
These measures should not be considered in isolation from where did you substitute for measures prepared in accordance with generally accepted accounting principles.
Measures may not be comparable to like I hope that your company.
Companies.
Now I'd like to turn the call over Garcia Bryan Bryan.
Brian Donahoe: Thanks, John. Good morning, everyone, and thank you for joining our fourth quarter 2023 earnings call. As I'm sure you're aware, we continue to see higher interest rates, higher rates of inflation, as well as certain cultural shifts such as work-from-home trends adversely impacting operating performance and the Economic Values of Commercial Real Estate. This is particularly evident from any office property.
Thanks, John.
Morning, everyone and thank you for joining our fourth 2023 earnings call.
As I'm sure you're aware, we continue to see higher interest rates higher rates of inflation as well as certain cultural shifts such as work from home.
Firstly impacting the operating performance.
And the economic values of commercial real estate.
This is particularly evident from any office properties.
In addition, many <unk>.
He's requiring significant capital expenditures.
Impacted by higher labor and material costs.
Unfortunately.
Brian Donahoe: In addition, many properties requiring significant capital expenditures have been impacted by higher labor and material costs. Unfortunately, we are not immune to these macroeconomic challenges, and our results for 2023 and the fourth quarter are partially a reflection of these conditions. For the fourth quarter, we had a gap loss of $0.73 per common share, driven by a $47 million or $0.87 per common share increase in our CECL reserve, most of which is related to loans collateralized by office properties or a residential condominium construction project. In addition, for the fourth quarter, we placed six additional loans on non-accrual status, which impacted both our gap and distributable earnings by approximately $0.12 per common share versus what these As a result, our distributable earnings for the fourth quarter were $0.20 per common share.
<unk> to these macroeconomic challenges and our results for 2023.
I'm personally a reflection of these conditions.
For the fourth quarter, we had a gap loss of 73 cents per common sure driven.
Driven by a $47 million.87.
Sure increase <unk>.
Which is related to loans collateralized by office properties or a residential condominium construction project.
In addition, the fourth quarter.
Six additional burdens on non accrual status.
Both are gap and distribute them on her next by approximately 12 cents.
Sure versus what the six flags contributed and the third corner.
2023.
As a result.
<unk>, thanks for the fourth corner or 20 cents per common sure.
Fortunately.
Starting to see some positive trends in the macroeconomic environment, we believe are likely to benefit commercial real estate.
Potential for declining short term interest rates.
Specifically declining spreads on C. M B S and C. R E C L S.
During the past six months.
Strengthening capital markets conditions.
Positive leasing momentum in certain sectors, including industrial and self storage.
<unk> healthy demand transfer multifamily assets underscore someone will be opportunities <unk>.
Brian Donahoe: Fortunately, we're starting to see some positive trends in the macroeconomic environment that we believe are likely to benefit commercial real estate, including the potential for declining short-term interest rates. Specifically, declining spreads on CMBS and CRE CLOs, particularly during the past six months, reflect strengthened capital markets conditions. Positive leasing momentum in certain sectors, including industrial and self-storage, and continued healthy demand trends for multifamily assets, underscore some of the opportunities we see in today's market. These trends play out across our portfolio, particularly for loans that are risk rated 1 to 3, which total about $1.6 billion in outstanding principal balance. This risk-rated one through three portfolio is focused on senior first lane positions and is diversified across 37 loans. The majority of these loans are collateralized by multifamily, industrial, and self-storage properties, with the largest focus on multifamily properties at 34%.
These trends play out across our portfolio.
Check your only.
One to three total.
Total about 1.6 billion.
Standing principal balance.
This risk raided one through three portfolio.
Senior firstly possessions and his.
Diversified across 37 months.
The majority of these loans are collateralized by multifamily industrial and self storage properties, but the largest focus on multifamily properties at 34%.
As a positive indication of Rs commitment to properties.
Properties and contributed more than $150 million of capital.
Resenting about 10%.
6 billion principal balance of these plans.
A portion of this $150 million is used to renew all interest rate caps that expired in 2023 at their prior strike rate and economically.
After considering additional reserves.
Let's now turn to our strategic plans.
Solve the nine remaining risk rated four or five months.
About $539 million, an outstanding principal balance and one line held for sale with the carrying value of $39 million as.
You're out of 2023.
As we mentioned these phones are primarily collateralized by office properties and one residential condo property.
First.
<unk> management capabilities theories real estate.
As we have discussed previously areas real estate groups more than 250 investment professionals and currently manages more than 500 investments totaling approximately $50 billion in assets under.
Brian Donahoe: As a positive indication of borrowers' commitment to the properties, they contributed more than $150 million of capital, representing about 10% of the $1.6 billion in principal balance of these loans. A portion of this $150 million was used to renew all interest rate caps that expired in 2023 at their prior strike rates or at an economically equivalent amount after considering additional reserves. Let's now turn to our strategic plans to resolve the nine remaining risk-rated 4 or 5 loans that comprise about $539 million in outstanding principal balance and one loan held for sale with a carrying value of $39 million as of year-end 2023. As we mentioned, these loans are primarily collateralized by office properties and one residential condo property. First, we will fully leverage the management capabilities of the Ares Real Estate Group. As we have discussed previously, Ares Real Estate Group has more than 250 investment professionals and currently manages more than 500 investments globally, totaling approximately $50 billion in assets under management.
The match.
Intend to use these capabilities to resolve underperforming loans.
Second.
Significant loss reserves against these four and five risk.
As of December 31st 2023, 91% of our total of $163 million <unk>.
149 million is related to these nine months.
28% of the 539 million outstanding principal balance.
Finally.
Highly purposeful positioning a balance sheet over the past few years to provide us with greater flexibility and time to resolve these underperforming labs.
For example.
That's true equity has declined from 2.6 times at your end of 2021 to 1.9 times at your end of 2023.
Both cases for the impact of Cecil reserves on our shareholder equity.
In addition, we have a <unk>.
Accumulated additional available capital, which told the $185 million.
All of these measures and capabilities physician best to work through our underperforming gloves.
Balancing the Gulf of maximizing proceeds accelerating the time frame for resolution.
So far we've made some notable progress towards these calls.
First at the end of January 2024, we successfully solved the 39 million dollar senior loan held for sale at a price equal to its.
2023 carrying value.
Second, although we did not close on the sale of the apples office property in Illinois.
$57 million senior long before year end in 2023.
Barbara was under an agreement to sell the underlying property in the coming weeks.
Third we are working diligently to resolve three additional loans in the next few months.
And will likely be resolved through the sale of the underlying property.
Brian Donahoe: We intend to use these capabilities to resolve underperforming loans held by Second, we have built significant loss reserves against these four and five risk-rated lows. As of December 31st, 2023, 91% of our total 163 million in CECL, or $149 million, is related to these nine loans, which is about 28% of the $539 million in outstanding principal balance for the year. Finally, we have been highly purposeful in positioning our balance sheet over the past few years to provide us with greater flexibility and time to resolve these underperforming loans. For example, our net debt to equity has declined from 2.6 times at year-end 2021 to 1.9 times at year-end 2023, taking into account the impact of CECL reserves on our shareholder equity. In addition, we have accumulated additional available capital, which totaled $185 million. All of these measures and capabilities have positioned us to work through our underperforming rate of flow while balancing the goals of maximizing proceeds and accelerating the timeframe for resolution. So far, we've made some notable progress towards these goals.
The other two.
Restructuring in terms of the loan so that we can return a significant portion of the principal balance to accrual status.
Having the borrower contribute additional capital to the properties.
Yeah, let me provide some additional background on a dividend twenty-five cents per share.
Out of directors has declared for the first quarter 2024.
Since our initial public offering nearly 12 years ago.
Operated with a framework that can centers are distributed power when setting the quarterly dividend.
Up until this time, we have not reduced or delayed accordingly.
In fact, we provided two cents per share supplemental dividends for $10.
In this current market environment. However, we believe it is in the best interest of an acre and its stakeholders to reduce the accordingly dividend to help preserve value at the clinic.
To pay out of an amount more in line with our expected near term quarterly distribute both headaches before I realised losses.
Ultimately, we get through this cycle.
We execute on our earnings opportunities I've discussed we expect we can return to high levels of profitability.
Turn the call over to Jason.
Thank you, Brian and good morning, everyone.
For the fourth quarter of 2023.
The gap net loss of 39.4 million.
73 cents per common sure.
As Brian mentioned.
Income adversely impacted by a 47.5 million dollar increase in our system condition or about 87 cents per gallon sure.
For full year 2023.
GAAP net loss of $39 million or 72 cents per common sure.
And distributable earnings.
8.4 million or a dollar six.
Brian Donahoe: First, at the end of January 2024, we successfully sold the $39 million senior loan held for sale at a price equal to its year-end 2023 carrying value. Second, although we did not close on the sale of the office property in Illinois that backed our $57 million senior loan before year-end 2023. Our borrower is under an agreement to sell the underlying property in the coming months. Third, we are working diligently to resolve three additional loans in the next few months. One loan will likely be resolved through the sale of the underlying property. The other two may involve restructuring terms of the loan so that we can return a significant portion of the principal balance to accrual status, including having the borrower contribute additional capital to the property.
Sure.
Are both value or common sharing now stands at $11.56 for $14.57, excluding a $3.01 per share C. So reserves.
Distributable earnings for the fourth quarter of 2023.
$10.8 million or 20 cents for common shera.
Which was adversely impacted by the six additional loans replaced.
Rule in the fourth quarter.
Our overall Cecil reserve now stands at $163 million, representing 7.6% of the <unk>.
Standing principal balance of our loans held for investment.
91% of our total of $163 million and <unk>.
$149 million.
To our risk rated four and five loans.
Quoting 57 million loss reserves on our three brisk rate is five months.
And $92 million loss reserves on our six.
Right.
Those.
Overall $149 million of reserves represents 28% of the outstanding principal balance of risk rated four and five loans held for investment.
Brian Donahoe: Now let me provide some additional background on our dividend of 25 cents per share that our board of directors has declared for the first quarter of 2024. Since our initial public offer nearly 12 years ago, we have operated with a framework that considers our distributable earnings power when setting the quarterly dividend. Up until this time, we have not reduced or delayed our quarterly dividends.
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We continue to further bolster our liquidity and capital position.
We maintain significant liquidity.
Moderate net debt to.
Equity ratio of 1.9 times at year end 2023.
Occluding, adding back R C. So reserves to shareholder equity.
Our financing sources aren't diverse and accordingly.
Tasek Youn: In fact, we provided $0.02 per share in supplemental dividends for 10 quarters. In this current market environment, however, we believe it is in the best interest of ACRE and its stakeholders to reduce the quarterly dividend to help preserve book value and liquidity and to pay out an amount more in line with our expected near-term quarterly distributable earnings before a realized loss. Ultimately, as we get through this cycle and as we execute on our earnings opportunities, as discussed, we expect we can return to higher levels of profitability. With that, let me turn the call over to Brian. Thank you, Brian, and good morning, everyone. For the fourth quarter of 2023, we reported a net loss of 39.4 million, or 73 cents per common share.
Spread days Mark to market prohibitions.
December 31 2023.
Had over $185 million in cash and Undrawn availability under are working capital facility.
This amount does not include other pretentious.
Sources of additional capital including.
Loans and properties.
During the year.
Quiddity was further supported by 280 million of repayments and bone sales.
<unk> realized losses of 2023 10.
$10.5 million.
It's R I P O in 2012.
Close over 8 billion in commercial real estate bounce.
31st 2023.
A total of $14.5 million and realize losses.
And finally, as Brian mentioned, we declared a regular cash dividend.
25 cents per common share.
First quarter of 2024.
This first quarter dividend will be payable on April 16th 2024 a.
Common stock holders of record as of March 2020.
2024.
So with that I will turn the call backwards, Brian for some closing remarks.
Thank you take sick.
We recognize the challenges that we face with these new nonaccrual bonds and the impact that they had on our financial results for the fourth quarter.
Based on the progress that we're making with respect to these new problem Mountains, we do expect to improve our run rate distributed earnings in the near term as we seek to recapture portion of the lost earnings that we experienced in our fourth quarter.
Tasek Youn: As Brian mentioned, our gap net income was adversely impacted by a $47.5 million increase in our CISO provision, or about 87 cents per common share. For full year 2023, we reported a gap net loss of $38.9 million, or $0.72 per common share, and distributable earnings of $58.4 million, or $1.06 per common share. Our book value for the common share now stands at $11.56 or $14.57, excluding the $3.01 per share CISO reserves. Distributable earnings for the fourth quarter of 2023 were $10.8 million or $0.20 per common share, which was adversely impacted by the six additional loans that were placed on non-accrual in the fourth quarter. Our overall CESO reserve now stands at $163 million, representing 7.6% of the outstanding principal balance of our loans held for investment.
Our new quarterly dividend up 25 cents per share.
Our go forward with Ya.
Near term quarterly run rate distributable earnings excluding losses, assuming we achieved the earnings enhancements from our contemplated reservations.
Longer term, we believe the real estate capabilities repossessed areas, coupled with our capital liquidity and reserves.
To maximize credit outcomes and enhance our earnings from these situations.
We are cautiously optimistic about the increasing level of transaction activity and improving market liquidity conserved gradually provide more confidence for market participants over time.
This can service position us to return to a higher level of earnings in the future.
As always we appreciate you joining our call today.
Be happy to open the line for questions.
Okay.
At this time, if you would like to ask a question. Please press Star then one on your telephone keypad.
I'd like to withdraw your question. Please press Star then too.
You.
We'll take a question from Sarah Barcomb B T I G.
Good morning, everyone. Thank you for taking my question I'm, hoping you could walk us through your go forward earnings power relative to this new 25 cent dividend just a taxi 40, he coming in cause of the 20th.
I'm, hoping you can help us breaks that gap for coverage.
Tasek Youn: 91% of our total $163 million in CESA reserves, or $149 million, relates to our risk-rated four and five loans, including $57 million of loss reserves on our three risk-rated five loans and $92 million of loss reserves on our six risk-rated loans. Overall, the $149 million of reserves represents 28% of the outstanding principal balance of risk-rated four and five loans held for investment. We continue to further bolster our liquidity and capital position. We maintain significant liquidity and a moderate net debt to equity ratio of 1.9 times at year-end 2023, including adding back our CESA reserves to shareholder equity. Our financing sources are diverse and, importantly, have no spread-based mark-to-market provision.
Sure a good morning.
Thank you very much for your questions here.
Mentioned on her prepared remarks that the impact of putting six new loans on non accrual.
[noise] about a 12 set in that from what those same loans.
<unk> the third quarter.
It's Brian also mentioned we are working very hard to resolve you know a number of those loans that number of those six two nonaccrual loans as well as wounded.
It is.
Place on non accrual as we mentioned.
Mentioned, one of those loans, but 39 million dollar home in California that has been successfully resolved.
As we continue to resolve additional loans.
We're making good progress on resolving by number of those nodded loans.
And.
You mentioned kind of setting our dividend.
The 25 cent level for the first quarter of 2024.
We did take into account what we believe we can achieve in terms of disturb earnings you know <unk> been able to successfully resolve some of these loans so without getting too specific you know I think we are we are targeting to resolve these loans somebody bones as soon as we can and we do believe that once we are.
Tasek Youn: On December 31st, 2023, we had over $185 million in cash and undrawn availability under our working capital facility. This amount does not include other potential sources of additional capital, including unlevered loans and property. During the year, our liquidity was further supported by $218 million of repayments and loan sales. Our net realized losses for 2023 were $10.5 million. Since our IPO in 2012, we have closed over $8 billion in commercial real estate loans and through December 31st, 2023, we have recognized a total of $14.5 million in real-life losses. And finally, as Brian mentioned, we declared a regular cash dividend of 25 cents per common share for the first quarter of 2024. This first quarter dividend will be payable on April 16, 2024 to common stockholders of record as of March 28, 2024. So with that, I will turn the call back over to Brian for some closing remarks. Thank you, Jason.
Able to resolve the bones and that's why I mentioned the resolution will come in a couple of different forms in some cases.
With a loan in some cases, the underlying collateral in some cases restructuring of the loans with existing borrowers.
So the resolutions are gonna come in different forms we do believe that our earnings power.
Will go up from the 20 cents that we recognize and 22 in the fourth quarter of 2020.
Because that was impacted by you know again, a significant increase in Monaco loans. So that is really our goal is to resolve these loans and increase our earnings power. So.
So that we can continue to cover the dividend that'd be upset.
Thank you and yeah I appreciate you walking us through property as long by my own you're expected resolution, Sir so thanks for that it sounds a bit more backward smoking, but I'm, hoping you could walk us through what happened on the ground with those new nonaccrual mountains, whether it with an issue at the sponsored level with.
<unk>, a new rate-cap or something else, maybe leasing related any color for out there.
Yeah I can.
Hello, Sir I would say that each interest somebody idiosyncratic, but certainly butter behavior shifting sentiment around an asset and support for that as well as just really crystallizing some of the valuations as we've seen.
Bit more activity troops you for.
Brian Donahoe: We recognize the challenges that we face with these new non-accrual loans and the impact that they had on our financial results for the fourth quarter. Based on the progress that we are making with respect to these new problem loans, we do expect to improve our run rate distributable earnings in the near term, as we seek to recapture a portion of the lost earnings that we experienced in our fourth quarter. Our new quarterly dividend of $0.25 per share reflects our go-forward view of our near-term quarterly run rate distributable earnings, excluding losses, assuming we achieve the earnings enhancements from our contemplated residency.
There there was more data 0.2 as well as <unk>.
Certain events within each of the specific assets.
The borrowers approach to two continuing those those payments was marines out so nothing overarching just a few events that made us revisit some of the approach.
Great. Thank you.
Thanks, Sir.
We'll take our next question from Stephen laws of Raymond James.
Hi, good morning.
Follow up a little bit on Sarah question, you know when you think about the potential earnings.
Benefit as some of the Nonaccruals are resolved.
Is that really suddenly related to paying off the financing associated with these loans or is it also includes some assumptions around redeploying capital investments.
Sure Great questions Davis.
And the answer really is it's a combination of a number of things, including the two examples that you mentioned so yes in some cases b b.
Brian Donahoe: Longer term, we believe the real estate capabilities we possess at Ares, coupled with our capital, liquidity, and reserves, will enable us to maximize credit outcomes and enhance our earnings from these situations. We are cautiously optimistic that the increasing level of transaction activity and improving market liquidity could serve to gradually provide more confidence for market participants over time. In turn, this could serve to position us to return to a higher level of earnings in the future. As always, we appreciate you joining our call today, and we'd be happy to open the line for questions. Operator.
The.
The benefit that we would see an earnings comes from being.
Being able to pay down either part or in full associated liability.
<unk>.
Clearly the loans are already on non accrual so, but unfortunately, we are still paying interest that'd be associated liability so to the extent that we can.
All these loans and get a full or partial repayment of the associate liability.
Obviously, a result in a higher net income the others. You mentioned is that some of the resolutions that we believe will result in some cash.
Cash coming to US again, we haven't really built in the appointment of that cash to to necessarily increase earnings going forward, but we also you can utilize that cash for a number of different purposes.
Operator: At this time, if you would like to ask a question, please press star then 1 on your telephone keypad. If you would like to withdraw your question, please press star then 2. Thank you. We'll take a question from Sarah Barkham of BTIT. Hey, good morning, everyone.
I would say another example, along the same lines is that.
As I mentioned some of the resolutions we're working on is restructuring of the loan with the existing borrowers.
We believe it and some of those situations you know we believe we can restructure the loan.
Sarah Barkham: Thank you for taking the question. I'm hoping you could walk us through your go forward earnings power relative to this new 25 cent dividend. Just with the Q4 DE coming in closer to 20 cents, I'm hoping you can help us bridge that gap for coverage in the coming quarter. Sure. Good morning.
Which would potentially include some new cash from the borrower coming into the property.
That would then allow us to begin to recognize interest on some or all of the existing boat itself I think that'll be good.
Examples of how.
Earnings can be increased going forward upon resolving.
Tasek Youn: Thank you very much for your question, Sarah. You know, as we mentioned in our prepared remarks that, you know, the impact of putting six new loans on non-accrual had about a 12 cent impact from what those same loans earned in the prior quarter, the third quarter. As Brian also mentioned, you know, we are working very hard to resolve a number of those loans, a number of those six new non-equal loans, as well as loans that have been previously placed on non-equal. As we mentioned, one of those loans, the $39 million loan in California, has been successfully resolved.
Resolved in somebody's nonaccrual loans.
<unk>, but I think those are three good examples of how resolving belongs cat increase earnings going forward.
I appreciate the color on that tastes like you know the.
To continue with interesting <unk> would be six new nonaccrual loans, so not a cool for the entire fourth quarter or did they contribute some interest and come in the early part of the corner.
Sure Great question I appreciate.
The the distinction there so our policy is that we put alone.
For the entire quarter. So we talked about the 12 sudden impact that meant that.
From you know for the fourth quarter.
For the entire fourth quarter at the sixth did not recognize any interest revenue interest income for the entirety of the fourth quarter.
Tasek Youn: And as we continue to resolve additional loans, you know, I think we're making good progress on resolving a number of those non-equal loans. And really, as we mentioned, kind of setting our dividend at the 25-cent level for the first quarter of 2024, we did take into account what we believe we can achieve in terms of distributable earnings once we're able to successfully resolve some of these loans. So without getting too specific, you know, I think we are targeting to resolve these loans, some of these loans, as soon as we can. And we do believe that once we are able to resolve these loans, and as Ryan mentioned, the resolution will come in a couple of different forms. In some cases, you know, a sale of the loan, in some cases, sale of the underlying collateral, in some cases, restructuring of the loans with existing borrowers.
Okay. Thank you for clarifying that and then you know as we think about the interest coverage test I think it's a 12 months look back but can you update us and apologies I haven't had a chance to get through the whole filing. This morning, but can you update us on.
Where you stand on that whether you'll need waivers for for lower interest coverage test metrics or you know how all counterparty discussions are going around the developments with these these loans.
Sure Steven I, just want to clarify your question, let's say interest coverage tests are you talking about the specific loans or are you talking about.
With your <unk> your <unk> your Counterparties I believe it's typically you know similar to that one three in one five interest coverage test with your bank lines for your other financing facility so any any.
Covenants that needs to be considered or discussed around news nonaccrual developments.
Sure he doesn't.
We are obviously, we have always closely monitored all of the covenant that we have on our own facilities as well as those up.
As well as you know those where we hold it in assets.
Terms of interest coverage. We are we are clearly meeting begin to separate chest in all of our you know all of our debt facilities I think one of the very proactive steps that we have taken now for the past several years is delevering our balance sheet.
Tasek Youn: So the resolutions are going to come in different forms. We do believe that our earnings power, you know, will go up from the 20 cents that we recognized in the fourth quarter of 2020, largely because that was impacted by, you know, again, the significant increase in non-accrual loans. So that is really our goal, to resolve these loans and increase our earnings power so that we can continue to pay the dividend that we have set. Thank you.
Alright, So we have about 1 billion six of you know.
The dancing.
That is materially download a coupla years ago, and so we've been very mindful of making sure that we have the right balance sheet.
And she's more challenging market conditions, we have increased our liquidity you know we have done a number of measures and all of that is obviously helped not only in terms of maintaining the flexibility and the balance sheet, we need to work through some of the underperforming loans, but overall it has put a little less stress on.
Tasek Youn: And yeah, I appreciate you walking us through property loan by loan, your expected resolutions there. So thanks for that. This one's a bit more backwards looking, but I'm hoping you could walk us through what happened on the ground with those new non-accrual loans, whether it was an issue at the sponsor level with buying a new rate cap or something else, maybe leasing-related. Any color for us there?
You know meeting our coverage. So for example, we were levered three to one.
No I think that is coverage does could be a bit tighter but.
As we mentioned you know we have worked very hard to deliver a balance sheet significantly over the past several years and that has helped.
Help significantly on our on our loan covenants themselves.
Tasek Youn: Yeah, I can give you a bit more color. So I would say that each was somewhat idiosyncratic, but certainly borrower behavior, shifting sentiment around an asset and support for that asset, as well as just really crystallizing some of the valuations as we've seen, a bit more activity through Q4. That was the There was more data to point to as well as certain events within each of the specific assets where the borrower's approach to continuing those payments was more in doubt. So nothing overarching, just a few events that made us revisit some of the approaches. Great. Thank you. Thank you, sir. We'll take our next question from Steven Laws of Raymond, Jane. Hi, good morning.
Great I appreciate the comments this morning, I look forward to hearing about some of these resolutions in the next couple of quarters.
We'll take our next question from Rick Shane of J P. Morgan.
Thanks, everybody for taking my questions. This morning, but most have really been.
<unk> answered, but just want to make sure. The loan that was held for sale sold at your carrying value. So no hit to book value by our calculations that represents about a 2.6 million dollar realized loss is that correct.
Yes, good morning break so we sold the be sold alone as we mentioned at $39 million.
That is really a net proceeds re received a sale and that was the stated fair value. So one thing just to maybe distinguish here does that because we were under contract to solve this loan in your head.
We put this loan under available for sale. It was not held for investment. So it is not part of our help for investment portfolio. We did holders at fair value that fair value beamed at $39 million carrying value.
There is no impact on book value as you said I forget the actual.
Steven Cole DeLaney: To follow up a little bit on Sarah's question, you know, when you think about the potential earnings and Benefit as some of the non-accruals are resolved, is that really solely related to paying off the financing associated with these loans, or does it also include some assumptions around redeploying capital in a new investment? Sure. Great question, Steven.
I I'm not I wasn't quite familiar with the 2.6 million you mentioned, but I I was yeah I hit the wrong.
I apologize you're Gonna give me a better number I.
Read that out.
Okay, Yeah, but I think the important point you were making is that again. It was sold added stated fair value at your at $39.
Got it and when we look at the call it $150 million specific C. So reserve.
Could the assumption the particularly because I think at this point you guys have incentive to resolve this quickly and be able to redeploy to capital in order to achieve the distributable earnings run right that you're targeting that you will really.
Tasek Youn: And the answer really is a combination of a number of things, including the two examples that you mentioned. So, yes, in some cases, the benefit that we would see in earnings comes from being able to pay down either in part or in full the associated liability of some of the non-accrual loans. So, clearly, the loans are already non-accrual, but unfortunately, we are still paying interest on the associated liability. So, to the extent that we can resolve these loans and get a full or partial repayment of the associated liability, that would obviously result in higher net income. The other, as you mentioned, is that some of the resolutions, we believe, will result in some net cash coming to us. Again, we haven't really built in redeployment of that cash to necessarily increase earnings going forward, but we obviously can utilize that cash for a number of different purposes.
That those losses will largely come through in the first half the cadence of realized losses is going to be very front loaded and 24.
Yeah, So maybe I can get in Brian. Please please wait.
You know again.
We go through our you know our process to determine.
Covid amount of <unk>.
I don't think it's necessarily reflective of what will ultimately be realize because you know.
Most all situations these are very.
Very dynamic markets and so they realized losses can be more or less.
In terms of timing.
Again, as we mentioned, we're working very hard on all of the phones I think some are more near term opportunities.
So far more opportunities that would come out in later quarters later periods I would not expect all of you used to be realized in the first half for example, I do think we are always bouncing as we say <unk>.
Tasek Youn: I would say another example along the same lines is that, again, as I mentioned, some of the solutions we're working on involve restructuring the loan with the existing borrower. In some of those situations, we believe we can restructure the loan, which would potentially include some new cash from the borrower coming into the property and into the loan that would then allow us to then begin to recognize interest on some or all of the existing loan itself.
Maximizing proceeds as well as accelerating timeframe, but there is a balance between those two.
There are some situations where retail holding on if you want to call it or maintaining our position or a little bit longer position resolved in greater value that day. When you think it's worth doing some situations, we are pushing very hard to.
Something realized immediately because we don't think future value will be will be materially greater so it's you know, it's it's lots of different situations, but I would not say all of these would be realized in the first half and again.
Would not I would not equate.
We will be realized losses with the reserve the reserve.
Tasek Youn: I think those are just three examples of how, you know, earnings can be increased going forward upon, you know, resolving some of these non-accrual loans. That's not an exhaustive list, but I think those are, you know, three good examples of how resolving the loans can increase earnings going forward. Appreciate the color on that, Kasic.
You know kind of like a different analysis unless I get it's a very near term resolution where for example in assets already under contract or a specific price and obviously those two members.
Come together, but for longer term resolution's assets there can be.
There is between what the actual realized value is or the losses versus the sea. So reserve.
Tasek Youn: You know, to continue with interest income, were these six new non-equal loans still non-equal for the entire fourth quarter, or did they contribute some interest income in the early part of the quarter? Sure. Great question.
I'll just I'll just add to that I think that.
The leverage ratio that tasted cuts done earlier gives us that flexibility.
Certainly hear your point and I think velocity is something it's certainly part of the equation, but.
I'll take that with ultimate resolution, we certainly <unk>, we absolutely look forward to.
Tasek Youn: I appreciate, you know, the distinction there. So our policy is that we put a loan on a non-equivalent for the entire quarter. So when we talk about the 12 cent impact, that means that from, you know, for the fourth quarter, overall, for the entire fourth quarter, these six loans did not recognize any interest revenue for the entirety of the fourth quarter. Okay, thank you for clarifying that. And then, you know, as we think about the interest coverage test, I think it's a 12 month look back, but can you update us, and sorry, I haven't had a chance to get through the whole filing this morning. But can you update us on where you stand on that? Whether you'll need waivers for for lower interest coverage test metrics, or you know, how counterparty discussions are going around the developments with these loans. Sure. Steven, I just want to clarify your question. When you say interest coverage test, are you talking about these specific loans, or are you talking about your counterparties?
Getting back on offense when available and I think that.
Escalation of somebody's assets will be indicative of that but.
But I I think ultimate reservation has a balance of price plus plus timeline.
And.
Question.
I think we see the logic here in terms of where the dividend has been struck.
If we think about where book value is today.
And looking at book excluding reserves because.
I think realistically that will be reasonably close to the amount of book value you have on a go forward basis, the dividend equates to <unk>.
Return of just over 8.5% I think that's pretty consistent with mid cycle returns for your company out of scale basis over a long.
Over the long term is is that the right way to be thinking of these things.
Yeah, it's excellent observation I, certainly think that is one way to.
[noise] triangulate too.
To sort of a yield that makes sense you know again I would just caution. However that we are in as I mentioned very dynamic market times.
For example, in one sense, we're enjoying very high interest rates.
Tasek Youn: I believe it's typically, you know, somewhere between a 1.3 and 1.5 interest coverage test with your bank lines, your other financing facilities, and any debt covenants that need to be considered or discussed around these non-accrual developments. As you can imagine, we have always closely monitored all of the covenants that we have on our own debt facilities, as well as those where we hold it as an asset. In terms of interest coverage, we are clearly meeting the end-use coverage test in all of our debt facilities.
<unk> with silver being at 5354 level.
5354, so far is causing significant.
So you're gonna get an adverse impact on real estate operating performance of values.
And so there's a lot of components that go into you know our overall returns. So certainly credits certainly interest rates certainly leverage certainly deployment. There's a lot of factors that go into it but I do agree with your observation dad you know.
The 25 cent dividend for the fourth quarter I'm, sorry for the first quarter of 2024, if you were to annualize that to one dollar dollar being devoted by the 11 52 book value equates to that I think about 8.7 per cent deal I do think that's a great way to triangulate maybe that sensibility of it.
Tasek Youn: I think one of the very proactive steps that we have taken now for the past several years is de-levering our balance sheet. So we have about a billion dollars of financing that is materially down from a couple of years ago. And so we've been very mindful of making sure that we have the right balance sheet in these more challenging market conditions. We have increased our liquidity. We have done a number of measures, and all of that has obviously helped not only in terms of maintaining the flexibility and the balance sheet we need to work through some of the underperforming loans. But overall, it has put a little less stress on meeting our covenants. So, for example, if we were levered three to one, you know, I think those coverage stats would be a bit tighter.
But I would also caution that you know the story isn't fully told yet, but I guess, we've mentioned we have set a given level based upon what we believe we can earn by resolving some of the nonaccrual loans not all of the Nonequivalence. So we do have potential for adding in more hurting.
Same time without going through the full list I mean, there are lots of other factors that.
And there are likely to impact our earnings going forward as well. So that is that is part of the part of the equation. That's certainly not the only part of the question.
Got it look I I it it's an interesting observation from.
Rick Shane: But, you know, as we mentioned, we have worked very hard to deliver a significantly improved balance sheet over the past several years, and that has, you know, helped significantly on our loan covenants themselves. Great, I appreciate the comments this morning and look forward to hearing about some of these resolutions in the next couple of quarters. We'll take our next question from Rick Shane of J.P. Morgan. Thanks, everybody, for taking my questions this morning.
That you make an <unk>.
In terms of sort of the longterm.
I I would agree with you.
On average over time, but that's probably six years out of 10 minute that eight range two years out of 10 above it in two years out of 10 below and we're probably in the midst of in the thick of those two or three years that are below that eight and a half per cent target.
Yes.
Thank you guys.
Thank you.
We'll take our next question from Dan <unk> of Wells Fargo. Your line is open.
Oh, perfect I guess I'm trying to just get a sense of your confidence like if you think about the short term.
How are you feeling about the ability for just a replay of a desk and Q1, where you have cut on non accrual migration. Another big reserve build I know there's uncertainty.
Tasek Youn: Most have really been, I just want to make sure the loan that was held for sale sold at your carrying value, so no hit to book value. By our calculations, that represents about a $2.6 million realized loss, is that correct? Good morning, Rick.
Intermediate longer term like how are you thinking about it in the short term.
Sure.
Again R short term objectives is.
Part of a longer term plan of course, but are short term objective as we mentioned is to remain very very focused.
Tasek Youn: So we sold the loan, as we mentioned, at $39 million. And that is really the net amount we received in the sale. And that was the stated fair value.
You know the <unk>.
Performing loans.
Very very focused on continuing to.
But you can monitor all of our loans overall.
Tasek Youn: So one thing just to maybe distinguish here is that because we were under contract to sell this loan at year end, you know, we put this loan on the market for sale; it was not held for investment. So it is not part of our held for investment portfolio. We did hold it at fair value, that fair value being the $39 million carrying value.
We are in a state as of the fourth quarter as of year end, where we have a significant portion of our capital.
No in Nonaccruals out and so that is clearly the impact.
Our current current income.
Having said that so you mentioned a number of our loans, even though they're on non accrual continued to pay interest in that interest did not being recognized I think I'm that interested is being used to.
Reduce the carrying value of the loan itself. So we think all of that helps too no further.
Further.
Tasek Youn: And so there is no impact on book value, as you said. I forget the actual, I'm not, I wasn't quite familiar with the $2.6 million you mentioned. But I apologize. You're going to give me a better number. I screwed that up.
Further improve the balance sheet overall.
Alright, yet again to answer your question short term, we made we remain very focused on growing our our income base in our overall to sherbourne earnings.
We we want to continue to.
Did you already work out any of the problem assets. So that we can either monetize the capital that we have in the asset we can pay down the data associated with those with those assets what the liabilities associated with the nonperforming loans and then redeploy some capital you know we have a significant moment.
Tasek Youn: Okay, yeah, but no. I think the important point you're making is that, again, it was sold at its stated fair value, which you are correct on, $39 million. And when we look at the, call it $150 million specific CECL reserve, should the assumption be, particularly because I think at this point you guys have incentives to resolve this quickly and be able to redeploy the capital in order to achieve the distributable earnings run rate that you're targeting, that you will realize that those losses will largely come through in the first half. The cadence of realized losses is going to be very front-loaded in 2020. Yeah, so maybe I can get in. Fine. Please, please weigh in.
Quiddity.
We will hopefully generate more capital from the house resolution if somebody phones.
One of the things. We mentioned is you know we are working very closely with any of our borrowers.
To continue to check more directly into the amongst themselves.
But short term I would tell you also that we continue to see some volatility in the markets and in our portfolio.
I think one of the subsequent events that we had mentioned in our public filings. This morning.
We had two loans go into default at <unk> after here and.
One one bone was the is at 57 million dollar loan back line office properties that matured, obviously that loan has been ready to five that's the loan that Brian mentioned, we are pushing to sell before year end, we continue to push to sell that loan. So the resolution of that loan that will be.
Tasek Youn: You know, again, we go through our process to determine the appropriate amount of a CESA reserve. I don't think it's necessarily reflective of what will ultimately be realized because, you know, in almost all situations, these are, you know, these are very dynamic markets. And so the realized losses could be more or they could be less. In terms of timing, you know, again, as we mentioned, we're working very hard on all of these funds. I think some are, you know, more near-term opportunities. Some are, you know, opportunities that will come out in later quarters or later periods. I would not expect all of these to be realized in the first half, for example.
Eight eight a material part of the visit by going forward. The utmost that'd be mentioned as the 18, a half million dollar doesn't mean, new Jersey loan.
That one also went into default as a result of the borrower not making it's January interest payment.
Fortunately that loan remains in default and the January and now February payment has not been made.
That loan. So you mentioned has been on non accrual you know for the past couple of quarters, so going into default, while it's very disappointing obviously.
You know has already been on non accrual has been read it a four.
So there there continues to be moving to in the portfolio.
Okay got it thank you.
We'll take our next question from Steve Delaney of citizens JMP. Your line is open.
Tasek Youn: I do think, you know, we are always balancing, as we say, maximizing proceeds as well as accelerating the time frame, but there is a balance between those two. There are some situations where we feel holding on, if you want to call it, or, you know, maintaining our position for a little bit longer results in, you know, greater value that we think it's worth doing. In some situations, we are pushing very hard to, you know, get something realized immediately because we don't think future value will be materially greater. So, you know, there are lots of different situations, but I would not say all of these would be realized in the first half.
Thank you good morning, Brian and Tae Sik, we're starting to see something interesting this quarter adhering anecdotes that there are a number of that funds or even hedge funds that are starting to.
Look around for opportunities to kind of opportunistically by loans from I'm sure, they're talking to the banks, but we've seen evidence that they've been talking to the commercial mortgage rates as well I'm curious if you're receiving any if you can just say generally are you receiving these types of inquiries.
By third parties looking to kind of step in so that you can avoid foreclosure and all that mess and and actually just lay off the loan to somebody who works.
You know more but not in a public company environment and can can operate a little differently. Just curious if you're seeing this secondary market and distress loans picking up at all.
Tasek Youn: And again, I would not equate, you know, what will be realized losses with the reserve, the reserve, you know, contemplating different analyses, unless, again, it's a very near-term resolution where, for example, an asset's already under contract or at a specific price. Then, obviously, those two numbers, you know, come together, but for longer-term resolution assets, there can be, you know, there can be variance between what the actual realized value is or the losses versus the CSO reserve. And I'll just add to that. I think that the leverage ratio that Tasek touched on earlier gives us that flexibility. So I can certainly hear your point, and I think velocity is something that's certainly part of the equation, but we're balancing that with ultimate resolution.
Yeah. That's a great question, Steve I think the <unk> you and what is a good example of executed yes, just that strategy I think there's two major narratives in commercial real estate, but probably more but one of which is this wallet maturities and the others his wallet capital and.
Certainly.
Touched on a little bit of the macro.
Irony shifting and part of that is that the capital on the offensive side being dislodged and becoming more.
Pro business I would say, so I think that you're seeing a good reflection throughout the space of deal activity and in general the the the first market opportunity in commercial real estate will come in the form of credit whether that too.
New loans that are attractive.
Basis or purchasing.
Either for control therefore yield so I I think you're spot on the activity is here and I think it will continue to progress, but the the amount of capital that's out there that needs to be spent in the spaces significant so the trend that you see it or you're hearing about I would expect it to continue.
I appreciate that and I would have to think you know the fed is kind of gift, giving us a head fake here, but I'd have to think if we start getting into the middle of this year and there is more of an expectation for cuts in the second half of the year that that may make those potential buyers more <unk>.
Tasek Youn: We absolutely look forward to getting back on offense when available, and I think the resolution of some of these assets will be indicative of that. But I think the ultimate resolution is a balance of price plus time and question. And I think we see the logic here in terms of where the dividend has been struck. If we think about where book value is today and look at book excluding reserves, because, I think, realistically, that will be reasonably close to the amount of book value you have on a go-forward basis. The dividend equates to a return of just over 8.5%.
Because you're you're creating a more positive sentiment you know.
For the market generally and people that there'll be less willing to sell at large discount. So I could see that this interest at this opportunistic money really picking up as the year goes along and then the second thought I have is I've I've been hearing this about the banks, we all know what the capital issues are with the.
Tasek Youn: I think that's pretty consistent with mid-cycle returns for your company on a scale basis over the long term. But is that the right way to be thinking of these things? Yeah, it's an excellent observation. I certainly think that is one way to, I would say, triangulate to, you know, to sort of a yield that makes sense. You know, again, I would just caution, however, that we are in, you know, as I mentioned, very dynamic market times. You know, for example, in one sense, we're enjoying, you know, very high interest rates, you know, with SOFR being at the 5354 level. On the other hand, you know, 5354 SOFR is causing, you know, a significant, you know, significant and adverse impact on, you know, real estate operating performance and values.
Banks, but we're hearing that you know construction loans at the banks that the the banks are gonna manage through those but probably will be less likely to move into a bridge lending phase and that that would be you know maybe when we get to late twenty-four early 25, we could find a new <unk>.
Wave of lending opportunities for the commercial mortgage rates with with paper coming off the banks' balance sheet is do you see that type of opportunity as well or am I getting ahead of myself there.
Okay, I think cause if.
If you think about the concentration of the commercial real estate got within the banks.
Pretty big through the risk based capital treatment for the bank balance sheet of CIA Mississippi the overlay that.
Regulators said to focus on the banking sector.
It doesn't take a large shift of the allocation of real estate that from banks going into the private markets to create.
Pretty substantial opportunity to invest in too. So that's certainly what I think areas.
Areas in our peers said is playing for is that continued shift and it's going to be a great opportunity to partner with the banks.
Tasek Youn: And so there are a lot of components that go into, you know, our overall returns. So certainly credit, certainly interest rates, certainly leverage, certainly deployment. There's a lot of factors that go into it, but I do agree with your observation that, you know, the 25 cent dividend for the fourth quarter, sorry, for the first quarter of 2024, if you were to annualize that to a dollar, the dollar being divided by the 1152 book value equates to that, I think about 8.7 percent yield. I do think that's a great way to triangulate maybe the sensibility of But I would also caution that, you know, the story isn't fully told yet, right?
Next evolution of the real estate market. So I would certainly look towards that I think I got kind of your <unk>.
Wow.
Congratulations.
Since about progress you're making it I know, it's a slog, but.
Think we have better days ahead for for acre and for the group as a whole. So thank you for your time this morning.
I appreciate it that's all these days thank you.
We'll take our next question from Doug harder of UBS.
Thanks, I was just hoping you give a little more update on on the multifamily portfolio and and kind of have given the moving right. How do you think that that portfolio is going to be able to handle refinancing.
Yeah, absolutely I think let's see.
One of the benefits of the multifamily market is the continued capital markets participation of Fannie and Freddie.
Well is it being more.
Friendly bank acid as well I'd say that we've seen supply uptick nationally estate market's market, that's being received differently largely speaking within our portfolio we've seen positive progress.
Tasek Youn: As we mentioned, we have set our dividend level based upon what we believe we can earn by resolving some of the non-equitable loans, not all of the non-equitable loans. So we do have the potential for, you know, adding in more earnings. You know, at the same time, without going through the full list, I mean, there are lots of other factors that can and are likely to impact our earnings going forward as well. So that is part of the equation, but certainly not the only part of the equation. Got it. Look, it's an interesting observation that you make in terms of sort of the long-term. I would agree with you on average over time, but that's probably 6 years out of 10 in that 8 range, 2 years out of 10 above it, and 2 years out of 10 below.
On the leasing side so.
It's I think it will be.
Opportunity set for the foreseeable future I think when we think about it structurally.
You're still going to be short despite the supply headwind that have been fairly well publicized we're still gonna be short over the next five years.
Four or five 6 million residences in the United States, especially if you look at the macro level of immigration returning right.
So what we're in terms of liquidity.
The buyers the owners of multifamily real estate assets are seeing that short short term supply issues are dwarfed by the longterm fundamental shortage and you're starting to see the performance of the underlying assets reflect that.
So.
Short answer is relatively stable performance within our portfolio.
Think that'd be the capital markets functionality will continue to support these assets in the equity markets private equity markets for multifamily will continue to expand.
Rick Shane: And we're probably in the midst of, or in the thick of those 2 or 3 years that are below that 8.5% target. Yes. Thank you, guys. Thank you. We'll take our next question from Don Fandetti of Wells Fargo. Your line is open.
Great.
Thank you.
And once again, if you would like to ask a question that is star one on your telephone keypad will move next to Jade money, that's K E. W.
Thank you very much just to follow up on your answer to Doug's question.
Green Street estimates multifamily values are down around 28 per cent from the peak.
Don Fandetti: I guess I'm trying to just get a sense of your confidence, like, as you think about the shorter term, like, how are you feeling about the ability for just a replay of this in Q1, where you have kind of non-accrual migration and other big reserve build? I know there's uncertainty in the intermediate and longer term. Like, how are you thinking about it in the short term? Sure.
I mean when me here.
Answers like that it says if that's a non event.
So either we disagree with Green Street, or we need to recognize that there is capital stress and a lot of the multifamily deals that was record issuance in 2021 and 2022.
So just to ask it another way how do you expect this to be reconciled over the next year in multifamily.
Tasek Youn: Again, our short-term objectives are part of a longer-term plan, of course, but our short-term objective, as we mentioned, is to remain very, very focused on the non-performing loans. It's to remain very, very focused on continuing to digitally monitor all of our loans overall. We are in a state, as of the fourth quarter, as of year-end, where we have a significant portion of our capital in non-equal loans, and so that is clearly impacting our current income. Having said that, as we've mentioned, a number of our loans, even though they're nonaccrual, continue to pay interest, and that interest is not being recognized as income. That interest is being used to, you know, reduce the carrying value of the loan itself.
Secondly, I would like to ask about to.
Multifamily then which areas was involved I think that they are likely in the acre portfolio, but wanted to check one with a large Chicago multifamily and another is Dallas and those look like based on the real deal. There are you know performance issues there.
Yeah tell you that I guess.
Yes represent I think that if you go back to certain market 70, you were in the spring of 22 purchasing I'd say Tromp Catherine's.
There is probably value decline and access over 28 per cent your sighting Green Street.
And many of the <unk> <unk>.
<unk> and I think those buyers.
The procedure and growth in certain markets, continuing unabated with with expenses that didn't necessarily go into with that so.
Tasek Youn: So we think all of that helps to, you know, further improve the balance sheet overall. But again, to answer your question short term, we remain very focused on growing our, you know, income base and our overall distributable earnings. You know, we want to continue to, you know, digitally work out any of the problem assets so that we can either monetize the capital that we have in the asset; we can pay down the debt associated with those assets, with the liabilities associated with the non-performing loans, and then, you know, redeploy some capital. We have a significant amount of liquidity. You know, we will hopefully generate more capital from the resolution of some of these loans.
But largely speaking as a lender even if you subscribe to the Green Street number.
Leverage there's still equity to protect you.
And those athletes I think you will see some transfer of value from equity to death. So it's not that there won't be distressed I just think that when you consider.
Overall loss severity in the space to the lending to the lender community I think that will be muted relative to.
If you look at the office sector for instance, so it's not to say that there won't be transfers of assets.
Given that value decline in certain if you gossip into drawn if you've got the expense, but it wrong. There there will be distress and I think the two assets.
We're talking about.
Reside in different vehicles.
The press doesn't always get the the lender correct there so.
Areas is associated with those assets, but they are not take her assets specifically.
Thanks, I appreciate that so in terms of the transfer of assets within a portfolio such as you know mortgage REIT portfolio. If you don't expect ultimately significant loss of burly to the lenders.
Tasek Youn: You know, one of the things we mentioned is that we are working very closely with many of our borrowers to continue to, you know, inject more equity into the loans themselves. But in the short term, I would also tell you that, you know, we continue to see some volatility in the markets and in our portfolio. I think, you know, one of the subsequent events that we had mentioned in our public filing this morning is that, you know, we had two loans go into default at year-end, after year-end. One, you know, was a $57 million loan backed by an office property that matured. Obviously, that loan has been rated at five.
How do you expect this to play out do you see the mortgage rates being active in bringing in.
Additional capital to Recapitalise transactions.
I think that's certainly a possibility I think despite the technology oglaigh, we've seen in the multifamily sector specific asset management capabilities within the borrower community has never been more important when you think about some of the issues around.
Otherwise it in in the apartment sector. How you manage these assets is is a good bit of the value creation.
And I do think to your point of view, there's ample liquidity to come in on the private side alongside existing lenders recapitalizing, an asset in bringing to bear improved asset management or property management from there. So.
Tasek Youn: That's the loan that Brian mentioned. We were pushing to sell it before year-end. We continue to push to sell that loan. The resolution of that loan will be, you know, a material part of this deal going forward. The other loan that we mentioned is the $18.5 million Designated New Jersey loan. That loan also went into default as a result of the borrower not making its January interest payment.
I think.
You're spot on that this might take the form of partnership rather than outright sales to to kind of stabilize the valuations and I think.
To the earlier appointment on the decline in rates or even the stability around rates.
Multifamily over the next five years will be.
Fairly well correlated to the right.
<unk>.
Thank you and then lastly, if I could squeeze one more and there was an industrial.
Property.
I can't recall off hand, you've previously discussed this but it was moved to Nonaccruals status, it's relatively small compared to the average at 19 million, but we haven't seen much pressure there. So could you comment on that situation.
Tasek Youn: You know, unfortunately, that loan remains in default, and the January and now February payments have not been made. That loan, you know, as we mentioned, has been on non-accrual for the past couple of quarters. So, you know, that loan going into default, while it's, you know, very disappointing, obviously, has already been on non-accrual, and has been rated a four. So there, you know, there continues to be movement in the portfolio. Okay, I got it.
Yeah, that's just a redeveloped asset on the West Coast I think.
Yeah, we we've.
Basically you know in the <unk>.
<unk>, so bad of that property the dialogue with the borrowers dynamic.
And it is a relatively small asset however.
[noise], so active discussions with that got away with it kept coming up is really the catalyst for.
The analysis.
So the <unk> the nonaccrual was due to the right cat not you.
You know leasing outlook or supply competition or anything.
Steve DeLaney: We'll take our next question from Steve DeLaney of Citizens JMP. Your line is open. Thank you. Good morning, Brian and Tasek.
Of that nature.
I think it was slower than expected leasing velocity alongside of near term of the right account.
Okay. Thanks.
Thanks, a lot.
I gotcha.
Brian Donahoe: We're starting to see something interesting this quarter and hearing anecdotes that there are a number of debt funds or even hedge funds that are starting to look around for opportunities to kind of opportunistically buy loans from. I'm sure they're talking to the banks, but we've seen evidence that they've been talking to the commercial mortgage REITs as well. I'm curious if you're receiving any, if you can just say generally, are you receiving these types of inquiries by third parties looking to kind of step in so that you can avoid foreclosure and all that mess and actually just lay off the loan to somebody who works, you know, more, not in a public company environment and can operate a little differently? Just curious if you're seeing this secondary market for distress loans picking up at all. Yeah, it's a great question, Steve.
And there are no further questions at this time I'd be happy to return the call to Brian Donahoe Foreclosing comments.
Yeah. Thank you operator, and I just want to thank everybody for the time today. We appreciate the continued support of areas commercial real estate and we look forward to speaking to you again on our next door didn't call. Thank you.
Ladies and gentlemen, this concludes our conference call for today, if you missed any part of today's call and archived replay of this conference call will be available approximately one hour. After the end of this call through March 21st 2020.
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2202656 Goodbye.
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Brian Donahoe: I think the loan held for sale at year end was a good example of executing on just that strategy. I think, you know, there are two major narratives in commercial real estate, probably more, but one of which is this wall of maturities, and the other is this wall of capital. I think you've touched on a little bit of the macro environment shifting. And part of that is that capital on the offensive side is being dislodged and becoming more pro-business, I would say. So I think that you're seeing a good reflection throughout the space of deal activities. And, in general, the first market opportunity in commercial real estate will come in the form of credit, whether that's new loans that are attracted on a relative value basis or purchasing loans either for control or for yield.
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Brian Donahoe: So I think you're spot on. The activity is here, and I think it will continue to progress. But the amount of capital that's out there that needs to be spent in the space is significant. So the trend that you've seen or you're hearing about, I would expect it to be.
Steve DeLaney: And I would have to think the Fed is kind of giving us a head fake here, but I'd have to think if we start getting into the middle of this year, and there is more of an expectation for cuts in the second half of the year, that may make those potential buyers more aggressive because you're creating a more positive sentiment for the market generally, and people are going to be less willing to sell at large discounts. So I can see that this interest of this opportunistic money is really picking up as the year goes along. And then the second thought I have is that I've been hearing this about the banks. We all know what the capital issues are with the banks, but we're hearing that, you know, construction loans at the banks that the banks are going to manage through those, but probably will be less likely to move into a bridge lending phase.
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Steve DeLaney: And that that would be, you know, maybe when we get to late 24, early 25, we could find a new wave of lending opportunities for commercial mortgage rates with paper coming off the bank's balance sheet. Do you see that type of opportunity as well, or am I getting ahead of myself there? Okay, I think there's, if you think about the concentration of commercial real estate debt within the banks, and certainly, when you dig through the risk-based capital treatment for the bank balance sheet of CRE, and if you overlay that regulator's said focus on the banking sector, it doesn't take a large shift of the allocation of real estate debt from banks going into the private markets to create pretty substantial opportunities to invest in. So that's certainly what I think.
Brian Donahoe: Ares, and our peers said, is playing for that continued shift, and it's going to be a great opportunity to partner with the banks in this next evolution of the real estate debt market. So I would certainly look forward to that. I think I'd echo your sentiment.
Steve DeLaney: Wow. Congratulations on the progress you're making. I know it's a slog, but I think we have better days ahead for Acre and for the group as a whole. So, thank you for your time this morning. I appreciate it, as always, Steve. Thank you. We'll take our next question from Doug Harter of UBS. Thanks. I was just hoping you could give a little more update on the multifamily portfolio and kind of how, given the move in rates, how you think that that portfolio is going to be able to handle refinancing. Yeah, absolutely.
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Doug Harter: I think one of the benefits of the multifamily market is the continued capital markets participation of Fannie and Freddie, as well as it being a more friendly bank asset. I'd say that, you know, we've seen supply uptick nationally, but I think the market that's being received differently. Largely speaking, within our portfolio, we've seen positive progress on the leasing side. So, you know, it's I think it will be an opportunity set for the foreseeable future. I think when we think about it structurally, you're still going to be short, despite the supply headwinds that have been fairly well publicized. We're still going to be short over the next five years, four or five, six million residences in the United States, especially if you look at a macro level of immigration returning, right.
Brian Donahoe: So, in terms of liquidity, the buyers, the owners of multifamily real estate assets, are seeing the short-term supply issues dwarfed by the long-term fundamental shortage, and you're starting to see the performance of the underlying assets reflected. So the short answer is relatively stable performance within our portfolio. I think that the capital market. Functionality will continue to support these assets, and the equity markets; private equity markets for multifamily will continue to expand.
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Doug Harter: Thank you. And once again, if you would like to ask a question, that is star 1 on your telephone keypad. We'll move next to Jade Rahmani of KBW.
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Jade Rahmani: Thank you very much. Just to follow up on your answer to Doug's question. Green Street estimates that multifamily values are down around 28% from the, I mean, when we hear answers like that, it's as if that's a non-event. So either we disagree with Green Street, or we need to recognize that there's capital stress in a lot of the multifamily deals that were recorded as record issuance in 2021 and 2022. So just to ask it another way, how do you expect this to be reconciled over the next year in multifamily? Secondly, I would like to ask about two multifamily developments in which Ares was involved.
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Jade Rahmani: I think that they are likely in the Acre portfolio, but wanted to check. One was a large Chicago multifamily, and another is in Dallas. And those look like, based on the real deal, there are performance issues there. Yeah, Jade, I guess I don't want to... misrepresent.
Brian Donahoe: I think that if you go back to certain markets and you were in the spring of 22, purchasing at I'd say Trout, Catharine, Now there is probably a value decline in excess of the 28% you're citing through Green Street and many of the associates teams, rent growth, and I think those buyers saw Steve DeLaney, Jade Rahmani, Charles Nabhan, John Stilmar, Ryan Tomasello, Doug Harter So it's not like there won't be distress. I just think that when you consider overall loss severity in the space, to the lending community, I think that will be muted relative to when you look at the office sector. So it's not to say that there won't be transfers of assets, given that value declines. And certainly, if you get the vintage wrong, if you get the expense load wrong, there will be distress. And I think the two aspects you're talking about reside in different vehicles.
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Brian Donahoe: The press doesn't always get the lender correct there. So, Ares is associated with those assets, but they are not acre assets. Thanks. I appreciate that. So in terms of the transfer of assets within a portfolio such as, you know, a mortgage REIT portfolio, if you don't expect ultimately significant loss severity to the lenders, how do you expect this to play out?
Jade Rahmani: Do you see the mortgage REITs being active in bringing in additional capital to recapitalize transactions? I think that's certainly a possibility.
Brian Donahoe: I think, despite the technology overlay we've seen in the multifamily sector, specific asset management capabilities within the borrower community have never been more important when you think about some of the issues around fraud and otherwise in the apartment sector. How you manage these assets is a good bit of the value creation. And I do think, to your point, Jade, there's ample liquidity to come in on the private side alongside existing lenders, recapitalizing an asset and bringing to bear improved asset management or property management from there. So I think you're spot on that this might take the form of partnerships rather than outright sales to kind of stabilize the valuations. To the earlier point on the decline in rates or even the stability around rates, multifamily over the next five years will be fairly well correlated to the rate environment. Thank you. And then lastly, if I could squeeze one more in, there was an industrial property. I can't recall offhand if you've previously discussed this, but it was moved to non-accrual status. It's relatively small compared to the average, at 19 million, but we haven't seen much pressure there.
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Brian Donahoe: So could you comment on that situation? Yeah, this is a redeveloped asset on the West Coast, I think. You know, we basically, in the analysis of that property, the dialogue with the buyer is dynamic. And it is a relatively small asset, however.
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Brian Donahoe: So active discussions with that borrower with a rate cap coming up were really the catalyst for the analysis. So the non-accrual was due to the rate cap, not, you know, the leasing outlook or supply competition or anything of that nature. I think it was slower than expected leasing velocity alongside a near-term death of the rate cap.
Jade Rahmani: Okay, thanks a lot. Thank you, Jade. And there are no further questions at this time. I'd be happy to return the call to Brian Donahoe for closing comments. Yeah, thank you, operator. And I just want to thank everybody for their time today. We appreciate the continued support of Ares Commercial Real Estate, and we look forward to speaking to you again on our next call. 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 March 21, 2024 to domestic callers by dialing 1-800-723-0544 and to international callers by dialing area code 402. 220-2656.
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