Ares Commercial Real Estate Corp Q2 FY2025 earnings call

Key Points

• Maintained a strong balance sheet, driving progress on risk-rated 4 and 5 loans and reducing office loans.
• Exited a $51 million office life sciences loan, removing significant unfunded commitments and creating greater portfolio stability. Future funding commitments decreased from $73 million in 1Q 2025 to $36.5 million as of June 30, 2025.
• Changed the risk rating of an $81 million senior loan collateralized by an Arizona office property from risk-rated 3 to 4.
• Risk-rated 1 to 3 loans, primarily multifamily, industrial, and self-storage, performed well with a risk-rated 3 hotel loan upgraded to risk-rated 2.
• Successfully executed first investment commitments of the year, closing 4 senior loans totaling $43 million in self-storage property loan commitments.

During the second quarter, office loans were reduced to $524 million, a 10% quarter-over-quarter decrease and 30% year-over-year decrease. An $51 million office life sciences loan was exited with a $33 million realized loss. Risk-rated 4 and 5 loans included 1 risk-rated 5 loan and 4 risk-rated 4 loans, with 2 of the 5 loans making up 75% of the outstanding principal balance. The risk-rated 1 to 3 loans, primarily collateralized by multifamily, industrial and self-storage properties, performed well, with a risk-rated 3 $56 million hotel loan upgraded to a risk-rated 2 loan. In the second quarter, 4 senior loans totaling $43 million in loan commitments collateralized by self-storage properties were closed as initial deployments into new loans in 2025.

Forward-Looking Statements

• Expect origination activity to increase as they collect repayments and address risk-rated 4 and 5 loans, with the portfolio expected to be equal to or larger than the second quarter 2025 level over the next 12 months.
• The Board declared a regular cash dividend of $0.15 per common share for the third quarter of 2025, payable on October 15, 2025, to common stockholders of record as of September 30, 2025.

Risks Discussed

• Reductions in federal funding for life science research led to erosions in tenant demand and elevated supply-demand imbalance for life science properties.
• Challenges in the office sector including depth of investor demand, financing availability, and valuations.
• Economic noise, tariffs, and other uncertainties impacting the commercial real estate market.

Q: Looked at from a balance sheet perspective, is the second quarter the trough for net revenue and net interest income, or should we expect sequential down again before rebuilding?

A: Yes, they reached balance sheet positioning goals allowing resolution of 4 and 5 loans and starting to invest in loans, expecting the portfolio to be at current level or higher 12 months from now and net interest income to start rebuilding.

Q: Given low debt levels, could they lever up equity from repayments to ramp originations beyond repayment levels?

A: Yes, there is opportunity to lever up as seen in the Morgan Stanley facility's accordion option, feeling good about gross deployment and net interest margin from borrowing.

Q: There's economic noise and peers characterize CRE lending market as frothy, what's your view on real estate fundamentals and CRE lending markets?

A: Seen relative stability, forward supply-demand in multifamily, industrial, and self-storage favorable for rent growth in medium term, current income profile of lending attractive with reset in asset values.

Q: Thought process on repurchasing stock vs deploying into new loans?

A: Currently in favor of investing in new loans to reposition portfolio and recharacterize book, considering practical size, scale of portfolio, covenants, and growth prospects before repurchasing.

Q: Walked through mechanics of $33 million realized loss and loan sizing on new originations?

A: $51 million loan had a $19 million reserve, resulting in a $14 million net impact on GAAP earnings; new originations may be smaller in size due to self-storage assets being smaller, broader origination opportunities, and potential to split loans, maintaining bias towards institutional asset class.