Ares Commercial Real Estate Corporation (NYSE:ACRE) Q1 2024 Earnings Call Transcript May 9, 2024
Ares Commercial Real Estate Corporation beats earnings expectations. Reported EPS is $-0.22654, expectations were $-0.3. Ares Commercial Real Estate Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good morning and welcome to the Ares Commercial Real Estate Corporation’s First Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded on Thursday, May 9, 2024. I will now turn the call over to Mr. John Stilmar, Partner of Public Markets Investor Relations. Please go ahead.
John Stilmar: Good morning, and thank you for joining us on today’s conference call. I’m joined today by our CEO, Bryan Donohoe; our CFO, Tae-Sik Yoon, and other members of the management team. In addition to our press release and the 10-Q 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 that are subject to risks and uncertainties. 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.
These forward-looking statements are based on management’s current expectation of market conditions and management’s judgment. The 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 Commercial Real Estate assumes no obligation to update any such forward-looking statements. During this call, we will refer to certain non-GAAP financial measures. We use these as a measure 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 titled measures used by other companies. Now I’d like to turn the call over to our CEO, Bryan Donohoe. Bryan?
Bryan Donohoe: Thank you, John. During the first quarter, we made meaningful progress towards our goal of resolving underperforming loans, reducing the outstanding principal balance of nonaccrual loans by $133 million, as well as reducing our exposure to the commercial office property sector by $70 million, or 8% of our total loans backed by office properties. By addressing a total of 4 nonaccrual loans during the first quarter, we increased our distributable earnings, excluding losses, compared to the prior quarter, by approximately $0.02 per common share, and further delevered our balance sheet by $138 million to an outstanding balance of less than $1.5 billion at the end of the first quarter. Our focus remains on returning ACRE to its core business of originating loans and managing a portfolio of loans backed by commercial real estate properties in order to earn consistent income to support an attractive level of dividends for our shareholders.
Let me now provide more details on the loans that were resolved during the first quarter. First, we sold a $38 million loan that we held for sale at year end 2023 that was backed by a mixed-use property located in California that was on nonaccrual. Second, we agreed to a discounted loan payoff of a $19 million loan backed by a multifamily property located in the state of Washington that was on nonaccrual at the end of 2023. As a result of these initiatives, we realized a loss consistent with the fair value mark and loss reserves held on our balance sheet at year end 2023 and paid down $54 million of debt in our FL4 securitization. Third, we exited a $57 million Chicago risk rated 5 loan collateralized by a commercial office property that was also on nonaccrual at year end 2023.
As a result of this disposition, we realized a loss that was $3 million higher than the loss reserve held against this loan at year end 2023. And finally, we restructured a $74 million loan backed by a Class A newly rebuilt office building located in New York City. At closing of this restructure, the borrower paid down $5 million of principal, reducing the balance to $69 million, which was split between a $59 million A Note and a $10 million B Note. In addition, it is anticipated that the borrower will contribute additional capital into the building for additional new leasing costs, including tenant improvement allowances. To incentivize the contribution of additional capital, including the initial $5 million repayment of the loan, we have agreed to subordinate our $10 million B note to new equity contributed by the sponsor.
This restructuring resulted in returning the $59 million A Note to interest-earnings status while the B note remains on nonaccrual. As a result of addressing these 4 loans, the outstanding principal balance of loans on nonaccrual was reduced by 31% and our distributable earnings, excluding losses, increased by $0.02 per common share for the first quarter of 2024. Shifting now to our overall portfolio. We ended the quarter with 2 billion of outstanding principal balance across 44 loans. 36 loans totaling $1.5 billion, or 75% of our loan portfolio, had a risk rating of 3 or better. The majority of these loans are collateralized by multifamily, industrial, self-storage, and hospitality properties. As a reflection of the quality of our risk rated 3 or better loans, borrowers continue to be committed to these underlying properties.
Over the past 12 months, borrowers have contributed more than $130 million in additional capital relating to loans risk rated 3 or better and during the same time period all interest rate caps have been renewed at their prior strike or economically equivalent amounts have been deposited into reserves. Going forward, we will continue to focus on resolving our remaining 4 and 5 risk rated loans and to reduce our office exposure. During the second quarter, we expect to take a $33 million risk rated 5 loan, backed by an office building in California, as REO that is currently on nonaccrual. At this time, we believe that our loss reserve on this loan is substantially in line with our current estimate of a potential realized loss. Additionally, despite ongoing negotiations with the borrower, a $69 million loan to an office property located in North Carolina currently on nonaccrual defaulted after quarter end.
We’ve begun the process of taking title of the office property and importantly, this property is cash flowing such that if and when the property becomes REO, property level earnings will be recognized. With that, let me turn the call over to Tae-Sik to provide more details on our financial results and balance sheet positioning.
Tae-Sik Yoon: Thank you, Bryan, and good morning, everyone. For the first quarter of 2024, we reported a GAAP net loss of $12.3 million, or $0.23 per common share. Our distributable earnings loss for the first quarter of 2024 was $33.5 million, or $0.62 per common share and was driven by a realized loss of $45.7 million, or $0.84 cents per common share, due to exiting the 3 loans that Bryan mentioned earlier. Distributable earnings, excluding these realized losses, were $12.2 million, or $0.22 per common share, for the first quarter. Our overall CECL reserve now stands at $141 million, which declined by $22 million versus the $163 million CECL reserve we held as of December 31, 2023. This reduction was driven by a $42 million reversal of existing reserves associated with the realization of losses, partially offset by approximately $20 million of additional reserves on existing loans in the portfolio.
The overall CECl reserve of $141 million at quarter end represents 6.9% of the outstanding principal balance of our loans held for investment, which is down from 7.6% as of the prior quarter. 89% of our total CECL reserve, or $125 million, relates to our risk rated 4 or 5 loans, including $31 million of loss reserves on our 2 risk rated 5 loans and $94 million of loss reserves on our 6 risk rated 4 loans. Overall, the $125 million of reserves on our risk rated 4 or 5 loans represents 25% of the outstanding principal balance of such loans. Further, with respect to our loans that are risk rated 4 or 5 at quarter end, there were 8 loans totaling $503 million in outstanding principal balance. 77% of the outstanding principal balance of our risk rated 4 or 5 loans are collateralized by office and 1 residential condominium property.
We did downgrade 1 $97.5 million Texas multifamily loan to a risk rating of 4 from 3 during the first quarter as the timeline and process of the sale of the underlying property by the borrower has been extended. Before concluding, I want to provide more background on managing our balance sheet. Consistent with our goals, we continue to maintain significant liquidity and further reduced our third-party debt. Driven by the loan exit activities during the first quarter, we reduced our outstanding borrowings by $138 million, resulting in total third-party debt of less than $1.5 billion at March 31, 2024. And finally, we declared a regular cash dividend of $0.25 per common share for the second quarter of 2024. The second quarter dividend will be payable on July 16, 2024, to common stockholders of record as of June 28, 2024.
With that, I will turn the call back over to Bryan for some closing remarks.
Bryan Donohoe: Thank you, Tae-Sik. We are cautiously optimistic about the modest recovery we are seeing in the commercial real estate markets and tightening spreads in the CMBS capital markets will be supportive in the execution of our near-term goals. We are firmly focused on addressing our underperforming loans and further building liquidity in order to maximize outcomes as we seek to shift our focus from asset management to investing. The timing and path to resolving some of our current 4 and 5 risk rated loans may make our quarterly earnings trajectory uneven this year, including in the second quarter due to loan resolutions. We remain focused on resolving a number of the identified risk rated 4 and 5 loans in 2024, which we believe will enable us to achieve higher distributable earnings. As always, we appreciate you joining our call today, and we’d be happy to open the line for questions. Operator?
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