Ares Commercial Real Estate Corp Q3 FY2024 earnings call

• Set goals to improve balance sheet flexibility/liquidity and resolve risky assets to reshape the portfolio.
• Reduced risk rated 4 and 5 loans by 33% ($157 million) during the quarter; risk rated Form 5 loans now 17% of total portfolio.
• Resolved two risk rated 5 loans: full repayment of a $98 million Texas multifamily loan with net proceeds > carrying value, and completed demo foreclosure of a $69 million North Carolina office loan with realized loss in line with prior CECL reserve.
• CECL reserve increased by $8 million to $146 million, with a $21 million combined increase in reserves on existing loans partially offset by a $30 million reversal of previous reserves.
• Increased available liquidity to $134 million as of November 5, 2024, reduced financial leverage to $1.3 billion (down 8% from last quarter), and net debt-to-equity ratio (excluding CECL) declined to 1.8x.
• Declared a regular cash dividend of $0.25 per common share for the fourth quarter of 2024, payable January 15, 2025, to common stockholders of record as of December 31, 2024.

During the third quarter, Ares reduced its risk rated 4 and 5 loans by approximately 33% or $157 million. Risk rated Form 5 loans now account for 17% of the total loan portfolio. The CECL reserve stood at approximately $146 million at quarter end, representing about 8% of the total outstanding principal balance of loans held for investment. 87% of the CECL reserve relates to risk rated 4 or 5 loans, which make up approximately 40% of the $320 million in outstanding principal balance of risk rated 4 and 5 loans held for investment.

• Aim to delever the balance sheet and bolster liquidity by year-end 2024.
• Expect further repayments in the fourth quarter and into the first quarter of next year.
• Plan to accelerate the resolution of risk rated 4 and 5 loans in 2025, enabling book value proofing and opportunistic reinvestment of repayments.

• The office market remains challenged with an uncertain outlook, potentially leading to longer resolution times for related loans.
• Volatility in the treasury market could impact the ability of deals to refinance or obtain financing, affecting the portfolio in the future.
• Potential negative migration of assets if business plans for certain loans do not materialize as expected.

Q: Rick Shane asked about how long it will take to work through the commercial real estate default cycle.

A: Bryan Donohoe responded that the virtuous cycle in commercial real estate is interrupted, with the office market taking longer. They are working to resolve assets expeditiously while maintaining priority, with signs of improvement in leasing velocity and rates.

Q: Steven Delaney inquired about cash interest received on nonaccrual loans and the status of certain properties.

A: Jeff Gonzales explained that $4 million of cash interest was received on nonaccrual loans, and the North Carolina office loan taken back is accretive to earnings. The California office asset is held for sale.

Q: Jade Rahmani asked about the treasury market's implications for financing and the office portfolio's 2025 maturity profile.

A: Bryan Donohoe said the treasury market's volatility impacts leverage, but capital flows have improved. Leasing trends in the office market are improving, though business plans take longer, and they are in constant dialogue with sponsors.

Q: Doug Harter asked about comfort with the dividend given current earnings excluding losses.

A: Bryan Donohoe and Jeff Gonzales stated the dividend is discussed with the board regularly, considering balance sheet flexibility and earnings power, with a focus on providing a stable dividend.

Q: Eric Dray asked about credit migration and deployment outlook.

A: Bryan Donohoe said they've encapsulated risks, and the team is building a pipeline, with the market constructive for capital providers like Ares.