Q4 2024 Ares Commercial Real Estate Corp Earnings Call
Speaker Change: [music]. Please standby your conference is about to begin should you require operator assistance today, you're simply press Star zero.
Good afternoon, ladies and gentlemen.
Good afternoon, ladies and gentlemen, and welcome to Ares commercial real estate Corporation's fourth quarter earnings Conference call. At this time all participants are in a listen only mode. As a reminder, this conference call is being recorded on Wednesday February 12, two.
John Mark: 25, I will now turn the call over to Mr. John still Mark partner of public markets Investor Relations. Please go ahead Sir.
Good morning, everyone and thank you for joining us on today's conference call. In addition to our press release and the 10-K that we filed with the SEC, we posted an earnings presentation under the Investor resources section of our website at Www Dot Aries CRE Dot 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.
Speaker Change: Many of these forward looking statements can be identified by the 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.
Speaker Change: These statements are not guarantees of future performance condition or results involve a number of risks and uncertainties. The company's actual results could differ materially from those expressed in the forward looking statements as a result of a number of factors, including those listed in its SEC filings Ares.
Speaker Change: Ares commercial real estate Corporation assumes no obligation to update any such forward looking statements.
Speaker Change: During this conference call today, we will refer to certain non-GAAP financial measures. We use these as measures of operating performance and 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: With that I'd like to turn the call over to our CEO Bryan Donohoe Brian.
Speaker Change: Thank you John Good morning, everyone and thank you for joining us I'm here with Jeff Gonzales, Our Chief Financial Officer, Tae Sik, Yoon, our chief operating officer as well as other members of the management and Investor Relations team.
Speaker Change: Today, we'll start off with some market commentary and review of our accomplishments throughout 2024, and where we're focused going forward.
Speaker Change: Jeff will then take us through our fourth quarter and full year results in detail.
Speaker Change: In 2024, we witnessed a moderate recovery in the commercial real estate market with a particular acceleration of these positive trends in the second half of the year.
Speaker Change: The industry saw increased transaction volumes and stable to improving property values and fundamentals across almost the full spectrum of property types.
Speaker Change: While the office market remains challenged we are seeing some green shoots and greater signs of stabilization, including including positive net absorption in the U S for the fourth quarter, a first since pre COVID-19.
Speaker Change: The stronger level of commercial real estate transaction activity and capital market stability aligns well with our continued focus on resolving our underperforming assets.
Speaker Change: As discussed throughout 2024, our primary objective was to address our underperforming four and five risk rated loans and to reduce our overall office exposure.
Speaker Change: We made solid progress in this area and acknowledge there is still more work to do.
Speaker Change: For the full year 2024, we reduced our risk rated four and five loans by approximately 34% or $182 million.
Speaker Change: As of year end, we had five loans risk rated four and five remaining in our portfolio totaling $357 million of outstanding principal balance.
Speaker Change: During 2024, we also reduce our office exposure, including oreos by $151 million, representing a decline of 18% year over year and exited one of our three Oreo assets.
Speaker Change: In our view these actions improved the overall quality of our portfolio.
Speaker Change: In addition, we collected equity contributions on a risk rated one to three loans of $38 million in the fourth quarter and $118 million for the full year in the form of loan Paydowns funding of reserves capital expenditures leasing expenses.
Speaker Change: <unk> have interest rate caps or other purposes.
Speaker Change: The improving commercial real estate market transaction activity and rate dynamics also led to a more normalized pace of repayments, particularly in the second half of the year.
Speaker Change: In the fourth quarter, we collected $147 million of repayments and $350 million of repayments for the full year nearly double versus 2023.
Speaker Change: Further supporting our primary objective to address underperforming assets, we enhance the flexibility of our balance sheet throughout 2024 with lower leverage and additional liquidity.
Speaker Change: In the fourth quarter of 2024, we reduced our outstanding borrowings by $172 million, which led to a 444 million or 27% reduction for the full year of 2024.
Speaker Change: By year end, we had a net debt to equity ratio, excluding CSO of one six times, which was 16% lower than at year end 2023.
Speaker Change: We believe this is an important achievement as it positions us to maximize the resolution of our underperforming assets.
Speaker Change: For 2025, we remain focused on further reducing our risk rated four and five loans office loans in REO properties with the specific goal of proving out book value.
Speaker Change: We continue to experience further momentum with respect to our positioning against this objective.
So far in 2025, we've collected $166 million of loan repayments generating an additional $100 million of cash.
It is worth pointing out that our cash balance now represents approximately 40% of the current market value of the stock.
Speaker Change: These repayments now position us with over $200 million of available capital, which we believe provides us the opportunity to accelerate and drive positive outcomes and resolving our remaining underperforming assets.
Speaker Change: However, maintaining higher levels of liquidity and lower amounts of financial leverage does have an impact on our current earnings.
Speaker Change: In this context, our board of directors together with our management team have elected to adjust our quarterly dividend to <unk> 15 per share a level that more closely aligns with our strategic objective.
Speaker Change: As we have noted before while we continue to resolve our underperforming loans and Oreo properties, our earnings may vary quarter to quarter and at times may be less than our newly adjusted dividend.
Before turning the call over to Jeff.
Speaker Change: I want to acknowledge the unimaginable tragedy that unfolded in Los Angeles caused by the wildfires.
Speaker Change: While our portfolio is not directly impacted this tragedy has unfortunately impacted the lives of many of our clients and colleagues and our thoughts are with them and their loved ones. During this challenging time.
Speaker Change: <unk> is working to diligently support them and the entire area in the recovery.
Speaker Change: And with that I'll turn the call over to Jeff who will provide more details on our fourth quarter and full year results Jeff.
Jeff Gonzales: Thank you Brian for the fourth quarter of 2024, we reported a GAAP net loss of $10 7 million or <unk> 20 per common share.
Jeff Gonzales: Our distributable earnings for the fourth quarter of 2024 with a net loss of $8 3 million or <unk> 15 cents per common share, which includes realized losses of $18 million or <unk> 33 per common share.
Jeff Gonzales: This includes both the full write off of the subordinated loan on the New Jersey office property as well as the loss on the sale of our California Rio office property.
Jeff Gonzales: Our full year 2024, we reported a GAAP net loss of 35 million or <unk> 64 per common share and the distributable earnings loss of $44 6 million or <unk> 82 per common share.
Jeff Gonzales: Focusing on the fourth quarter results distributable earnings excluding the realized losses of $18 million was $9 7 million or <unk> 18 per common share.
Jeff Gonzales: We also collected 3 million or <unk> <unk> per common share up interest in cash on loans that were on non accrual during the fourth quarter and thus was not recognized as income during the quarter and instead was applied to reduce our cost basis in the lungs.
Jeff Gonzales: As Brian mentioned, we had strong repayments in the back half of 'twenty 'twenty four, particularly in the fourth quarter.
Jeff Gonzales: Throughout 2024, we collected $350 million in repayments nearly double what we collect it as compared to 2023.
Jeff Gonzales: Importantly, reflecting the pace of recovery in commercial real estate activity, we collected $147 million of repayments in the fourth quarter of 2024, resulting in over 75% of the annual repayments for 2024 being collected after June 32024.
Jeff Gonzales: In terms of our loan risk ratings, the outstanding principal balance of loans with the risk rating of four or five increased 12% or $37 million in the fourth quarter.
This was largely due to a $51 million senior loan collateralized by a life Science office property in Massachusetts migrating from a risk rated three loans to our risk weighted far alone.
Jeff Gonzales: The increase in total risk rated four and five loans were partly offset by the restructuring of our previous risk weighted $520 million senior loan collateralized by an industrial property in California.
Jeff Gonzales: The loan was split into a $7 million senior note with the risk rating of three <unk>.
Jeff Gonzales: And a $13 million subordinate note with a risk rating of four.
Jeff Gonzales: In addition, we fully wrote off an $18 million subordinated loan collateralized by an office property in New Jersey, which was previously risk rated a five and was fully reserved for through our <unk> reserve.
Jeff Gonzales: We also further reduced our office exposure and the number of properties held in Oreo in the fourth quarter as we sold a $15 million of California, Rio Office property, which was previously held for sale.
Jeff Gonzales: We now have two Oreo properties remaining totaling $139 million in carrying value.
Jeff Gonzales: It is worth pointing out the cash yield on the carrying value of these underlying REO properties is over 8%.
Continuing with our portfolio our overall <unk> reserve remained relatively stable at $145 million.
Jeff Gonzales: A decrease of approximately $1 million from the <unk> reserve as of September 32024.
Jeff Gonzales: The decrease was due to the write off of the $80 million in New Jersey Office loan mentioned earlier, partially offset by a net increase in <unk> reserves for existing loans, particularly the Massachusetts office life Science loan.
Jeff Gonzales: The overall seasonal reserve of approximately $145 million at the end of the fourth quarter represents approximately eight 5% of the total outstanding principal balance of our loans held for investment.
Jeff Gonzales: Our seasonal reserve is lower on a dollar basis, but higher as a percentage of the portfolio basis, driven by the purposeful Derisking actions, we took in the quarter, leading to a smaller portfolio size in the near term.
Jeff Gonzales: It should be noted that 91% of our total CCR reserve or approximately 132 million relates to our risk rated four or five loans.
Jeff Gonzales: With strong repayments and purposeful execution, we continued to drive additional financial flexibility by reducing our leverage even further in the fourth quarter.
Jeff Gonzales: We reduced our leverage at the end of the fourth quarter to $1 2 billion down 13% from the prior quarter and down 27% from the prior year.
Jeff Gonzales: Our net debt to equity ratio, excluding seasonal declined to one six times at the end of the fourth quarter down from one eight times in the third quarter and one nine times at the end of 2023.
Speaker Change: Before turning the call back over to Brian and as we have discussed we declared a regular cash dividend of <unk> 15 per common share for the first quarter of 'twenty five.
Speaker Change: The first quarter dividend will be payable on April 15th 2025 to common stockholders of record as of March 31 2025.
Speaker Change: At our current stock price on February 10, 2025, the annualized dividend yield on our new first quarter dividend is above 10%.
Brian: With that I will turn the call back over to Brian for some closing remarks.
Brian: Thanks, Jeff.
Brian: We've made meaningful progress on many of our goals and we believe we have positioned our company strategically for a successful 2025, we are a stronger and healthier balance sheet, which will allow us to be in an even stronger position to address and resolve our remaining higher risk rated loans and an improving real estate market environment.
Brian: We remain committed to being responsible stewards of shareholder capital and we will seek to bring crystallization to our book value in order to enhance shareholder returns.
Brian: As always we appreciate you joining our call today and we'd be happy to open the line for questions.
Brian: Ladies and gentlemen at this time, if you would like to ask a question. Please press star and then one on your Touchtone phone.
Brian: I would like to withdraw your question simply press Star and then two once again, ladies and gentlemen that is star in one if you would like to ask a question.
Speaker Change: We'll hear first today from the line of Rick Shane Jpmorgan.
Brian: Okay.
Speaker Change: Hey, guys. Thanks for taking my questions. This morning.
Speaker Change: Look 2025 is going to be a year of transition.
Speaker Change: Some accelerant acceleration of repayments increase in deal activity realized losses does seem to be the three big.
Speaker Change:
Speaker Change: Things to consider is I realize you can't give us specificity in terms of what each of those is going to look like but if you can help us think about the contours in terms of timing front half back half of the year for each of those three.
Speaker Change: That would be really helpful.
Speaker Change: Yes, Rick I'll start and I. Appreciate the question I'll, certainly share that Mike with with Pacer and Jeff a little bit I think.
Speaker Change: Our opening remarks, we talked about the pace of market recovery, how that accelerated into year end, obviously rate rise towards the back half and beginning of this year, a little bit of a headwind, but really going in the face of capital flows that I think are positive.
Speaker Change: Not just the amount of capital coming into real estate, but the type so you've got.
Speaker Change: More rational buyers entering versus kind of the vulture structure that we would typically see in down cycles.
Speaker Change: In terms of timeline I mean, I think we touched on the 34% reduction in our four and fives throughout last year and I think with the capital flows. We're seeing we would expect to maintain that pace in the first half of the year to move to a more tangible allocation towards those risk rated four and five.
Speaker Change: And all of that kind of comes together with with neutral or more neutral rate environment and those capital flows I mentioned, so when we think about more active participation on the deployment side I think we will like to see first that that continued pace of reduction in the four and fives that we were successful on.
Speaker Change: Wishing throughout the last 12 months.
Speaker Change: Got it Thats helpful.
Speaker Change: Appreciate the answer thank you guys.
Doug Harter: Our next question comes from Doug Harter at UBS.
Speaker Change: Mr. Harder. Your line is open Sir you may have us on mute.
Doug Harter: Hello can you talk about what type of environment would be needed to pick up the pace of originations stabilize the leverage level and possibly increase the size of the portfolio.
Doug Harter: Yes, certainly appreciate.
Doug Harter: I appreciate the question I think.
Doug Harter: As I mentioned in response to <unk> question I think the continued reduction of those four and five will be catalytic to that deployment as a platform.
Doug Harter: We were.
Doug Harter: Fairly active with almost $5 billion of originations last year and other non acre vehicles. So I think.
Take away there Doug.
Doug Harter: I guess the engine is running and we see a market opportunity that.
Doug Harter: We can and will participate in.
Doug Harter: And as we bring further clarity to some of the asset management issues. We touched on I think we'll we'll look to begin growing the portfolio again.
Doug Harter: Given the scale of the portfolio.
Doug Harter: We're not talking about a huge number of assets that will perform or behave like an index that's really.
Doug Harter: As we have experienced some idiosyncratic.
Doug Harter: <unk> with assets and there is fewer and fewer of them too to asset manage actively.
Doug Harter: But the goals that we set forth at the beginning of last year to create a larger cash this cash position reduce those allocations are those assets that are higher on the risk spectrum I think we've accomplished those goals with with a good degree of success and we see a trend line that's positive that will certainly allow us.
Doug Harter: Us too.
Doug Harter: To have the company of acre participate in the market opportunity that we're seeing in real time.
Speaker Change: And I will just add to that we've been very purposeful with our balance sheet positioning to give us that flexibility to resolve our four and five rated loans. So thats continuing to be our main focus and as Brian mentioned once that bucket of underperforming loans is resolved. We will we are going to be in a position to.
Doug Harter: Find accretive opportunities for us.
Speaker Change: Great. Thank you.
Speaker Change: Our next question will come from Jade Rahmani at K B W.
Jade Rahmani: Thank you very much could you. Please discuss the Boston life Science deal the dynamics that are going on there is it a vacant.
Speaker Change: The project is completed.
Speaker Change: And what would be the outlook there I know life Sciences challenge and Theres still quite a lot of supply.
Yes, it's a good good question Jade we appreciate it I think what we've seen is a pivoting of some business plans and you can apply that to this asset where given the supply glut that you've seen accelerated over the past call. It 36 months in that.
Speaker Change: Boston Life Science market and you can trace it obviously back all the way to VC funding, but the change in that dynamic in the business plan from a full life science used to a more traditional office use obviously is impactful on the.
Speaker Change: One hand with respect to the tenant improvement allowance and the spend but also ultimately on rents and valuation. So that was the catalyst for the change in discourse around that loan.
Speaker Change: The good part is with the supply of life science being an issue some of the <unk> seen negative supply of some degree.
Speaker Change: In traditional office utilization, so we're working with that borrower to effectuate the best outcome, but certainly the macro environment around that sector is much less positive than it was.
Speaker Change: As our industry groups out here three odd years ago.
And in terms of the basis that the loan is since its risk for us and theres not a meaningful reserve, but the current carrying.
Speaker Change: Adding value does it work.
Speaker Change: With this change in business plan or is that a discussion. That's currently underway and is there any additional life science exposure.
Speaker Change: That's the.
Speaker Change: We've got some mixed use asset that's really the life science exposure in the portfolio Jed I would say that.
Speaker Change: The situation remains fairly fluid with with the sponsorship group I think what Youre seeing is that while there is long term opportunity in enterprise value in this sector.
Speaker Change: Matter of what can get accomplished in the face of that supply that you mentioned so I think the answer is more to come on this asset, but we're in active dialogue.
Speaker Change: And Jay just to add onto that as far as the reserve you mentioned, we did increase the reserve on that asset this quarter. So we do feel we're adequately reserved as is.
Speaker Change: Okay.
Speaker Change: And then if I could ask another question just on multifamily broader trends.
Speaker Change: The performance of multifamily this cycle has been pretty phenomenal.
Speaker Change: New exceptions, but generally it's held in really well.
Speaker Change: I think that the changes in interest rates and the outlook.
Speaker Change: Have any implications for multifamily credit or do you expect.
Speaker Change: Pretty resilient credit there.
Speaker Change: Yes, I would say Jayson we touched on this I think in your Q&A last quarter to some degree the fundamentals from a leasing perspective have been extremely positive absorption rent growth across all the major markets in the U S.
Speaker Change: Last quarter, we were pretty remarkable as you state I think the rate rise had two impacts and I think that they're really how is more on the equity side rather than the.
Speaker Change: The debt side of the ledger, but muted transaction volume right, where you had given those fundamentals sellers that were less willing to part with assets given.
Speaker Change: The change in valuations just on on a direct cap basis, owing to rates and also that fundamentals with that falloff in supply I think the statistic of the ratio between.
Speaker Change: Apartment deliveries in new starts has never been wider so you've positively absorbed a huge amount of supply and supply falls off a cliff from here. So positive fundamentals really have no signs of abating.
Speaker Change: Going forward, but the impact of rates was was certainly to mute transaction volume in the immediate term pause the valuation growth in the sector, but I think we still feel as a lender very well protected in the capital structure today.
Speaker Change: Thanks, a lot.
Thank you.
Speaker Change: Next question will come from Chris Mueller at citizens JMP.
Chris Mueller: Hey, guys. Thanks for taking my question so.
Chris Mueller: So we saw in our recent commercial mortgage alert that you as an area is expect to issue somewhere in the range of 500 million to a $1 billion CLO is in 2025.
Chris Mueller: Most of that would come through the REIT here, So I'm curious.
Speaker Change: You guys have any thoughts on the timing there and if it is that more billion dollar number or even I guess on the 500 million is that something that would be split into two or more transactions or would you be able to get enough collateral for our larger CLO.
Speaker Change: Yes, Im not sure that we were as specific around which vehicles would participate necessarily.
That said, we've traditionally thought about the CLO market as an opportunistic way to term out the leverage I think as an industry group, we've seen a lot of constructive movement in terms of repo providers and really narrowing the gap between.
Speaker Change: The leverage advance rate structures that you might find in a CLO execution versus traditional bank repo.
Speaker Change: And our partnership with those banks is a huge part of what we do.
Speaker Change: Across areas and certainly within real estate and real estate credit.
Speaker Change: I think in terms of things, we would like to see should we pursue with CLO execution clearly the market wants to see some degree of scale and diversification.
Speaker Change: In terms of asset types vintages and things like that.
Speaker Change: And in order to pay the freight associated with the CLO youre going to want to have that scale to defray those costs a little bit so.
Speaker Change: Clearly the capital markets movement has been positive for our sector and if as and when the CLO market becomes attractive to us in our portfolios, we'll judiciously use it but it is a.
Speaker Change: I think that mechanism is a nice to have not a must have for us and the majority of our peers.
Speaker Change: Yeah, and I'll just add we are seeing very competitive pricing from our warehouse lenders that is a market that they are really participate in as opposed to directly originating.
Speaker Change: So we arent that if we do see that right now is the most attractive financing option for us.
Speaker Change: Got it that's very helpful. And then I think I, probably know the answer to this one but.
Speaker Change: Given the pickup in <unk> in the fourth quarter, and then into the first quarter does the magnitude of those coming in impact the timing of any new lending and I guess, what I'm trying to get at is what are you guys locked.
Speaker Change: Replace any of that run off with new lending or is it purely just waiting to get through some of those problem assets.
Speaker Change: It certainly works in tandem I think the cash position that we've generated and candidly we think it's it's an enviable place to be.
Speaker Change: Especially given what we mentioned in the opening remarks regarding that.
Speaker Change: At discount to book and the amount of cash that kind of comprises our our market value today, but as we work through the remaining smaller number of risk rated four and five assets alongside that very strong cash position and more moderate leverage than the industry as a whole I think.
Speaker Change: Those two things together will be the prompt for further deployment in getting back to portfolio growth.
Speaker Change: Got it that's very helpful. Thanks for taking my questions.
Speaker Change: And once <unk> clients today that is star and one on your telephone keypad. If you would like to ask a question. Our next question comes from Jon Nicodemus at <unk>.
Speaker Change: Good morning, everyone and thanks, so much for taking the question somewhat similar to what Chris Just mentioned, obviously fourth quarter brought your highest repayment volume of last year. Brian you mentioned during your remarks that year to date repayments have already exceeded that quarterly level as well so just with that in mind and based on what visibility do you have how should we think about your.
Speaker Change: Repayment trajectory for the rest of 2025.
Speaker Change: Yes, it's a great question and as I mentioned earlier.
Speaker Change: Each of these assets behave unto themselves to some degree, but if you think about.
Speaker Change: Our industry and this floating rate loan origination schematic generally we would expect to see a three year weighted average life on each of these assets and those types of tenors are interrupted by.
Speaker Change: Dynamic market environments right. So we saw with the rate rise with the change in office, so a little bit longer duration and certain.
Speaker Change: Assets and I think collectively throughout our portfolio. So theres, probably some potential energy that will lead to an acceleration of those repayments.
Speaker Change: And so I think if we were to move.
Speaker Change: Move over time to get back to that normalized three year life of an investment we might see as we saw in Q4, and thus far in Q1, a little bit more acceleration of that.
Speaker Change: So our.
Speaker Change: Discussions with borrowers and the fact that you are seeing more capital come into the space should see a little bit of an unnatural acceleration of those repayments throughout the course of this year and a return to more normalized cadence for new originations of assets going forward.
Speaker Change: Great. That's all for me. Thank you so much.
Speaker Change: Okay.
Speaker Change: Okay.
Speaker Change: And that is all the questions we have for today gentlemen.
Speaker Change: Great well I will just close with just.
Speaker Change: Expression of gratitude I appreciate everybody's time today and your continued support of Ares commercial real estate and we look forward to.
Speaker Change: Speaking with you again on our next earnings call. Thanks, everybody.
Speaker Change: Yeah.
Speaker Change: 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 the call through March 12, 2025 to domestic callers by dialing 883 nine to $3 <unk>.
Speaker Change: And to international callers by dialing 402 area code 2207201, an archived replay will also be available on a webcast link located on the homepage of the Investor resources section of our website. Thank you for joining you may now disconnect.
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