Q3 2024 Ares Commercial Real Estate Corp Earnings Call
Please stand by, we're about to begin.
Good afternoon, everyone. Welcome to the Aries Commercial Real Estate Corporation's third quarter earnings conference call. At this time, all participants are in a listen-only mode. Later, you will have the opportunity to ask questions during the question and answer session. You may register to ask a question at any time by pressing star 1 on your telephone keypad.
Speaker Change: As a reminder, this conference is being recorded on Thursday, November 7, 2024. I will now turn the call over to Mr. John Stilmar, Partner of Public Markets Investor Relations. Please go ahead, sir.
Speaker Change: Good afternoon, and thank you for joining us on today's conference call. In addition to our press release and the 10Q that we filed with the SEC, we've posted an earnings presentation under the Investor Resources section of our website at www.ariescre.com.
Speaker Change: 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 uncertainties.
Many forward-looking statements can be identified by the use of words such as anticipates, believes, expects, intends, will, should, may, and similar such expressions. These 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. Aries Commercial Real Estate Corporation assumes no obligation to update any such forward-looking statements.
Speaker Change: During this conference call, we'll refer to certain non-GAAP financial measures. We use these 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.
Speaker Change: Now I would like to turn the call over to Bryan Donohoe. Bryan?
Bryan Donohoe: Thank you, John. Good afternoon, everyone, and thank you for joining our third quarter 2024 earnings call. I'm joined today by Jeff Gonzales, our Chief Financial Officer, Tasek Youn, our Chief Operating Officer, as well as other members of the Management and Investor Relations team.
Speaker Change: As we began discussing approximately two years ago at the beginning of the Fed's tightening cycle and entering the period of distress and uncertainty in the commercial real estate market, we set forth two primary goals.
Speaker Change: The second goal was to prudently and expeditiously resolve those same assets and reinvest the resulting available capital to reshape our portfolio into more stable assets.
Speaker Change: With the more positive backdrop for commercial real estate and the progress we have made in positioning our balance sheet, we expect to accomplish our first goal by year end and accelerate our second goal.
Supporting this plan are the encouraging signs of improvement in the commercial real estate market, evidenced by increasing transaction activity and stabilizing to slightly increasing property values.
Speaker Change: For us, this overall more constructive market environment is supporting both our goals for the company.
Speaker Change: During the quarter we reduced our risk rated four and five loans by approximately 33 percent or 157 million dollars compared to last quarter.
Speaker Change: Our risk-rated 4 and 5 loans now account for 17% of our total loan portfolio at the end of the third quarter.
Speaker Change: The progress in reducing our risk-rated 4 and 5 loans during the third quarter was driven primarily by the resolution of two risk-rated 5 loans.
Speaker Change: The first was a full repayment of a 98 million dollar risk rated five Texas multi-family loan where net proceeds were 6.5 million greater than our carrying value net of the Cecil Reserve held against this loan.
The second was a completed deed-in-lieu of foreclosure of a 69 million dollar risk-rated five North Carolina office loan for which we incurred a realized loss that was in line with our prior quarter CECL reserve.
It is worth noting that the North Carolina office phone was previously on non-accrual.
Speaker Change: By owning the property, we expect to earn a relatively attractive cash return on the asset at our carrying value.
Our risk-rated four and five assets are down more than 40% since year-end 2023.
Speaker Change: However, the 163 million dollar Illinois office loan was downgraded from a risk rated 4 to a risk rated 5.
Despite the property being well leased and the borrower supporting the asset to date, recent indications are that the borrower may not support the asset beyond the upcoming maturity in March of 2025.
This revised view alongside overall weak conditions for the office market led us to change the rating of this loan.
Speaker Change: Shifting to the loans with a risk rating of 3 or lower, borrowers are continuing to support these underlying business plans by contributing $37 million.
Speaker Change: in the third quarter, or $138 million in the past 12 months.
of Capitalist Paydowns of Loans, Funding of Reserves, Capital Expenditures, Leasing Expenses, Purchase of Interest Rate Caps, or Other Purposes.
Speaker Change: To date, we received $340 million of repayments, with more than 75% of repayment volume received since the beginning of the third quarter. We expect further repayments to continue in fourth quarter and into the first quarter of next year.
Speaker Change: These repayment trends, the positive shift in market sentiment, and the progress we made in the positioning of the balance sheet should allow us to accomplish our goal of delevering the balance sheet and bolstering liquidity by year-end 2024.
Speaker Change: As we look into 2025, we believe our progress this year will position us to accelerate the resolution of our risk-rated 4 and 5 loans, enabling us to prove out book value and opportunistically reinvest repayments to reshape our portfolio.
Speaker Change: And with that, I'll turn the call over to Jeff, who will provide more details on our third quarter earnings and capital positions. This is Jeff's first call since being named CFO in September. So over to you, Jeff.
Jeff Gonzales: Thank you, Bryan, and I'm excited for the opportunity to serve as the company's CFO. I look forward to working with you all over the coming months and years ahead.
Speaker Change: Turning to our results for the third quarter of 2024, we reported a gap net loss of approximately 5.9 million or 11 cents per common share.
Speaker Change: Our distributable earnings for the third quarter of 2024 was approximately $3.7 million, or $0.07 per common share.
Speaker Change: which includes a realized loss of $5.8 million or $0.10 per common share upon taking title to the North Carolina office property as REO that Bryan mentioned.
Speaker Change: The realized loss was in line with the CECL Reserve level as of the end of the second quarter.
Speaker Change: Distributable earnings, excluding this $5.8 million realized loss, was $9.5 million, or $0.17 per common share, for the third quarter.
Speaker Change: It is important to note that we received over $4 million during the quarter, or approximately $0.08 per common share, of interest payments in cash from loans that have been placed on nonaccrual, and thus these payments were not reflected in our third quarter earnings.
Speaker Change: Our overall CECL reserve now stands at approximately $146 million, or about $8 million higher than the approximately $138 million dollar reserve as of June 30, 2024.
Speaker Change: This increase was due to a $21 million combined increase in reserves on existing loans held for investment, primarily driven by increases in reserves on two office loans.
Speaker Change: The $21 million increase was partially offset by a $13 million reversal of previous reserves associated with the conversion.
Speaker Change: of a previously risk-graded five loan to REO and a better than expected outcome on the previously risk-graded five multi-family loan, which fully repaid in excess of our carrying value.
The overall feesal reserve of approximately $146 million at quarter end represents about 8% of the total outstanding principal balance of our loans held for investment.
Speaker Change: 87% of our total CESA reserve, or around $128 million, relates to our risk-graded 4 or 5 loans, representing approximately 40% of the $320 million in outstanding principal balance of risk-graded 4 and 5 loans held for investment.
Speaker Change: As Bryan mentioned, we have been focused on strengthening our balance sheet to maintain financial flexibility in order to support future loan resolutions and portfolio positioning.
Speaker Change: In the third quarter and into the fourth quarter, we continue to build our available liquidity.
Speaker Change: As of November 5, 2024, our available capital, which includes $42 million of available but undrawn sources of financing, was $134 million, an increase of 11% compared to the second quarter.
Speaker Change: We also continue to drive further financial flexibility by reducing leverage in the third quarter.
Speaker Change: We reduced our financial leverage to $1.3 billion, down 8% from $1.5 billion last quarter.
Speaker Change: Our net debt-to-equity ratio, excluding CECL, declined to 1.8 times at the end of the third quarter, down from 1.9 times in the second quarter.
Speaker Change: To conclude, we declared a regular cash dividend of $0.25 per common share for the fourth quarter of 2024.
Speaker Change: The fourth quarter dividend will be payable on January 15th, 2025 to common stockholders of record as of December 31st, 2024.
Bryan Donohoe: With that, I will now turn the call back over to Bryan for some closing remarks.
Bryan Donohoe: Thanks, Jeff. We are proud of our accomplishments in the third quarter, and we believe we will end the year having achieved our goals with respect to strengthening our balance sheet and liquidity.
Bryan Donohoe: Although there is still work ahead, we feel confident that we have positioned our company to execute across our most important goal of addressing our problem assets and seeing continued progress in the overall portfolio.
Bryan Donohoe: We remain committed to maximizing shareholder value, particularly through our dividend strategy and the crystallization of book value. By doing so, we aim to enhance overall shareholder returns.
Speaker Change: As always, we appreciate you joining our call today, and we'd be happy to open the line for questions.
Bryan Stilmar, Bryan Donohoe
Speaker Change: Thank you. Ladies and gentlemen, at this time, if you would like to ask a question, please press star 1. If you find your question has been addressed, you may remove yourself from the queue by pressing star 2. Once again, star 1, please, for questions. We go first today to Rick Shane of J.P. Morgan.
Rick Shane: Hey guys, thanks for taking my question. Look, I think we're we've we're approaching an inflection point that the
Speaker Change: industry is starting to be able to dimensionalize the scope of defaults or certainly narrow the range of outcomes. Can you help us think about how long it will actually take to work through that? I think that in my mind that's probably the
most misunderstood issue.
Yeah, I appreciate the question, Rick. I think...
Speaker Change: Obviously the virtuous cycle that exists in commercial real estate where assets kind of are developed and then mature and lease up and then move forward with more stable long-term financing has been interrupted as you cite for the last last couple years and I think we're starting to see that cycle
Speaker Change: accelerate for many asset classes with the backdrop we mentioned on the call on the prepared remarks earlier about leasing velocity and rates.
Speaker Change: I think the office market, which was such a large component of the overall real estate market historically, that's just taking longer and remains a little bit uncertain in terms of ability to predict.
Speaker Change: So, as you can tell, thematically, we've been trying to isolate those assets that are in focus for us, work with those borrowers towards an expeditious resolution, but also maintaining that relationship of debt versus equity and making sure that we remain in the priority area.
Speaker Change: So a little difficult to fully predict, but the signs have been more positive over the last couple of quarters, as you can see.
Yeah, look, I mean, the reality is that
Bryan Stilmar, Bryan Donohoe
Speaker Change: Thank you. We go next now to Steve Delaney at Citizens JMP.
Hello, everyone. Thanks for taking the question.
I noticed on page 12 of your deck,
that you have these three REO properties.
two of my offices.
Speaker Change: The income yields look fairly decent, so it seems they have some leasing in place. Just curious on your strategy as far as the hold period. Do you have any of these listed for sale at this time?
Yeah, I appreciate the question and certainly...
Speaker Change: I'd say we would opportunistically look to exit these assets, and I think obviously that's a goal of ours over the next period of time. But what makes it easier to be patient and find the right buyer and the right capital structure
Speaker Change: into finding that exit, it gets a lot easier with the yields that you see on this page.
Speaker Change: The instability of the rate market over the past, obviously this week's been fairly volatile as well, but the movements over the past couple of years.
Speaker Change: and the lack of liquidity in the sector has made us take a more patient approach to this to make sure that we're maximizing value but we're getting paid along the way as you can see here.
Speaker Change: Yeah, and I'll just add on top of that, I was gonna...
Hello.
Go ahead, Steve.
Speaker Change: Although, I was going to move to another question, so if you wanted to add to that reply, because I have a second follow-up, another question.
Speaker Change: Yeah, I was just going to add on top of Bryan on that, just as, you know, evidence is most recently from the North Carolina office loan that we took back, you know, you saw stable cash flows that we disclosed can have a positive impact on our earnings. That loan was on non-accrual, so taking that back is going to be accretive to our earnings on a go-forward basis.
Speaker Change: And in this falling interest rate environment, you know, it can be a benefit to have a property being on our balance sheet that's producing stable cash flows and not impacted by falling interest rates.
Speaker Change: And last thing, just to close it out, Steve, is that the office asset mentioned in California is held for sale currently.
Speaker Change: You had a payment, you had a loan payoff, I guess, or, uh, and...
Speaker Change: in the third quarter, but you had not, in the fourth quarter, excuse me, but you had not accrued interest, and I read that you received $8 million of cash interest.
[inaudible]
Hello.
Speaker Change: Yeah, I think what you're referring to is the number that we disclosed in our EP of four million of cash that we received this quarter on non-accrual loans so that that's really the loans that we had on. Sorry, go ahead.
Speaker Change: No, I hear you. I think you said it was $4 million in the third quarter on loans on non-accrual, correct?
Speaker Change: Correct. I thought there was an $8 million of cash interest paid in the fourth quarter that you had not accrued at 9.30. At least I may have written it down wrong.
Yeah, that number is $4 million.
That's 4, not 8. Okay. Very good.
Thank you for that.
Appreciate the comment.
Speaker Change: Thank you. We go next now to Jade Rahmani at KBW.
Jade Rahmani: Some of them presumably would look to refinance stabilized into a fixed rate loan. Do you see that as creating challenges for the portfolio potentially next year?
International Co-op International Co-op
Speaker Change: Look I think as we've touched and it's a good question Jayden obviously a lot of volatility in that market as I said earlier I think
Jade Rahmani: This entire real estate market or the majority of it does rely on leverage and the cost of that leverage impacts
values kind of like a gravitational pull to some degree.
I think what we've seen is the capital flows have
Speaker Change: I think that if you take the events of this week, the reduced regulation...
Speaker Change: that is likely to come with the change in presidency and government.
may offset some of those.
factors.
Speaker Change: that come from the cost of funding. I think that in the asset classes in which we are focused, largely speaking, if you think about multifamily and industrial
Speaker Change: I think that what this will lead to is certainly higher inflation of rent as the supply picture, which was already muted going forward, will become more so. So certainly the cost of funds will be impactful, but I think the growth in those sectors should more than offset it.
Bryan Stilmar, Bryan Donohoe
Speaker Change: Thanks. And then just looking at the office portfolio, have you looked at the 2025?
Speaker Change: maturity profile and, you know, the loans that are not already risk-graded four or five, you know, what the implications are for when those maturity dates come up.
Speaker Change: Yeah, as you'd expect Jade we're in constant dialogue with with these sponsors across the entirety of the portfolio
Speaker Change: but on the office assets in particular. And as I mentioned a little bit, I think what we're seeing is some improvement in leasing holistically throughout the office market. And, but there are business plans that are taking longer to achieve. So we'll work through those in due course, but at least.
Speaker Change: Seeing the fundamental backdrop for the office the office market improve at this time
Speaker Change: And within the portfolio at Acre, is that positive leasing trend translating?
Are you seeing positive leasing in your own assets?
Speaker Change: Yeah, certainly more conversations, more interest level. Obviously the difficulty is translating these leases and you know the discussions into actual leases, but we've seen positive migration there.
Thanks a lot.
Thanks, Chet.
Speaker Change: Thank you. We go next now to Doug Sharder at UBS.
Doug Sharder: Thanks. I know you guys already declared the 4Q dividend, but how are you thinking about your comfort in the dividend with the current level of earnings excluding losses?
Yeah, it's a good question. I'll share the mic with...
Doug Sharder: As we've covered in the past, that's something that we discuss with the board regularly. And the form of returns to investors can take a lot of different channels, with that dividend being one of them.
Jeff Gonzales: of the company in the portfolio over a longer period of time. But Jeff, feel free to add any color there.
Jeff Gonzales: Yeah, no, I'll just add on top of that the priority of our board has always been to enhance shareholder returns.
Speaker Change: It is a quarter by quarter analysis and we're looking at our balance sheet position which we've created has provided optionality and flexibility for us when it comes to our dividend policy.
Great, thank you.
Speaker Change: Thank you, and just a quick reminder ladies and gentlemen, please press star one for any questions today. We'll go next now to Eric Dre, Bank of America.
Speaker Change: Hi everyone. I wanted to ask about kind of your view on the portfolio and kind of the three risk rated bucket. Good to see no negative credit migration. We're just curious about your thoughts on that. Do you feel like you kind of have everything kind of fenced in or are there any specific assets that you know we could kind of see a little bit more of a negative migration in the coming quarters?
Speaker Change: do our best to ascertain exactly what we're seeing on the ground and in conversations with with these sponsors. I think if we've learned anything as an industry over the last
Speaker Change: 24 months. I don't think it's a never say never approach, but based on what we're seeing broadly, we feel we've encapsulated many of the risks in the portfolio and the backdrop.
Speaker Change: has been more positive and more accretive to real estate owners. So I think that gets passed through to the loan portfolio as well.
Speaker Change: So, as you'd expect, constant dialogue with each of these sponsors around where they sit.
Speaker Change: but we've seen certainly fundamentals improve across the board and we did our best to describe that throughout the earnings presentation.
Okay, great. Yeah, that's good to hear.
Speaker Change: Question was just about the deployment outlook. Kind of sounds like maybe a first half of a 25-story, if I was understanding that prepared remarks correctly.
Speaker Change: several quarter lag or are you guys already kind of starting to build up a pipeline now kind of I guess just a timing question on when we'll see originations kind of pick up again.
Speaker Change: Absolutely. We've been very active throughout our broader real estate lending book. Obviously, Acre has not to date participated.
Speaker Change: in that, but the engine's been running where we've seen throughout, through the third quarter, north of 3 billion of originations for the platform, which is more than 2X where we sat last year at the same time, and really don't see that.
Bryan Stilmar, Bryan Donohoe
Speaker Change: that can and should be available for ACRE when the balance sheet and the rest of our positioning...
Bryan Stilmar, Bryan Donohoe
Good to hear. All right, thank you.
Speaker Change: And gentlemen, it appears we have no further questions today. Mr. Donohoe, I'd like to turn the call back to you, sir, for any closing comments.
Bryan Donohoe: Yeah, I appreciate it. I just want to thank everybody for their their time today. Certainly continue to appreciate your support of Aries Commercial Real Estate and we look forward to speaking with you again on our next earnings call. Thanks everybody.
Bryan Donohoe: 2200464. An archived replay will also be available on the webcast link located on the homepage of the Investor Resources section of our website. Again, thanks so much for joining us everyone and we wish you all a great day. Goodbye.
