ACRES Commercial Realty Corp.

Good day, ladies and gentlemen, and welcome to the Q3 2019 Exantus Capital Corp. Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session, and instructions will follow at that time. If anyone should require assistance during the conference, please press star then zero on your touchtone telephone. As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, Steve Landgraber, Senior Vice President of Corporate Finance. Sir, you may begin.

Good morning, and thank you for joining the call. Before we begin, I'd like to remind everyone that certain statements made in the course of this call are not based on historical information and may constitute forward-looking statements. When used in this conference call, the words believes, anticipates, expects, and similar expressions are intended to identify forward-looking statements. Although the company believes that these forward-looking statements are based on reasonable assumptions, such statements are based on management's current expectations and beliefs and are subject to a number of trends, risks, and uncertainties that could cause actual results that differ materially from those contained in the forward-looking statements. These risks and uncertainties are discussed in the company's reports filed with the SEC, including its reports on forms 8K, 10Q, and 10K, and in particular, the risk factors section of our Form 10-K. Listeners are cautioned not to place undue reliance on these forward-looking statements, which speak only as the date hereof. The company undertakes no obligation to update any of these forward-looking statements. Furthermore, certain non-GAAP financial measures will be discussed on this conference call. Our presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. Reconciliations of these non-GAAP financial measures to the most comparable measures prepared in accordance with generally accepted accounting principles are contained in our earnings release for the past quarter. I will now turn over to the chairman of Exantus Capital Corp., Andrew Farkas, for opening remarks.

Good morning, everyone. Thank you for joining. With me today are Bob Lieber, our CEO, Matt Stern, our president, Dave Bryant, our CFO, Paul Hewson, head of commercial real estate lending, and Steve Landgraber, from whom you've already heard. We're pleased with our third quarter results, as we once again increased net income and realized the full benefits of our last quarter's loan portfolio acquisition. This quarter, we achieved our highest yet quarterly core earnings with 31 cents. Our business plan primary focus is to achieve full deployment while pursuing attractive risk-adjusted returns. Based on our current pipeline and ongoing earnings power, we expect to increase our quarterly dividend for the fourth quarter of 2019 to 27.5 cents, or a 10% increase over our third quarter of 2019. For some details about all of this and the driving factors behind it, let me turn this over to our CEO, Bob Lieber. Bob?

Thank you, Andrew, and good morning, everybody. A little more on those details. For the third quarter of 2019, we're reporting core earnings of 31 cents per share, up 10.7% from core earnings of 28 cents per share last quarter, and up 30% from the 24 cents per share reported in the third quarter of 2018. Our gross commercial real estate debt investments were $138.6 million for the third quarter of 2019, and as of September 30th, 2019, commercial real estate loan portfolio balance was 1.8 billion and our CMBS portfolio balance at par was 506 million. Matt will go through more of those details shortly. For the third quarter, payoffs exceeded investment activity by 131.7 million compared to net deployment of 100.8 million during the third quarter of 2018. Payoffs of 266 million this quarter were disproportionately higher than usual due to the borrowers achieving their business plans and taking advantage of the lower interest rate environment. During the quarter, we recorded net interest income of $16.6 million or $0.52 per share compared to $15.6 million or $0.49 per share during the second quarter of 2019. Net interest income this quarter fully reflected our portfolio acquisition in the second quarter. From a credit and underwriting perspective, there are a couple things to note. One is we're pleased to see the borrower business plans continuing to perform, sometimes faster than we'd planned, which means some of the loans are paying off sooner than we anticipated. And number two, credit reserves have come down. With the net reduction in the balance of our portfolio, we expect interest income to be slightly lower next quarter, but expect to return to net interest income growth in the first quarter of 2020. We strive to retain our credit discipline and return targets amidst this very competitive market, and we did have a couple of loans we expected to close trade away from us this quarter, and a few other loan opportunities were pushed into the fourth quarter of 2019. Our fourth quarter pipeline is strong, even when considering that the fourth quarter is typically our best quarter for originations. Therefore, we expect the fourth quarter to be substantially higher than our third quarter, and we have ample liquidity of over $180 million to fund this pipeline and grow net interest income. This translates to roughly 500 to 500 million of incremental capital deployment activity. Turning for a moment to book value, our GAAP book value per share increased to 14.12, up 4.3%, a 6% increase from the second quarter, and economic book value increased to 13.71 compared to 13.63 last quarter. Third quarter economic book value was the highest we've recorded since the 13.72 recorded during the third quarter of 2018. Gap net income was $10 million or $0.31 per share compared to $6.3 million or $0.20 per share during the second quarter, and core earnings exceeded our quarterly dividend. After that, I'd like to turn this over to Matt.

Thank you, Bob, and good morning, everyone. At September 30th, 2019, our commercial real estate loan portfolio balance is $1.8 billion and consists of 98% floating rate assets. The composition of the portfolio remained consistent both by property type and region. During the third quarter, we originated nine commercial real estate floating rate loans, totaling $105.1 million, with an average commitment of $11.7 million and a weighted average spread of 310 basis points over a 30-day LIBOR. The weighted average unlevered yield on new loan originations decreased by nine basis points, to 5.75% during the third quarter, compared to 5.84% during the third quarter of 2018. The loans we closed in the third quarter were consistent with our overall portfolio, with multifamily comprising 73% of the total. Total CRE loan asset financing was $1.4 billion at quarter end. with a weighted average spread of 1.53% compared to a spread of 1.62% during the third quarter of 2018. Our CRE loan portfolio decreased by $155.7 million during the third quarter as outsized payoffs and paydowns of $256.9 million exceeded new loan originations. As discussed in prior quarters, loan repayments can be difficult to predict and have been greater than we initially expected for 2019. We had 11 loan payoffs in the third quarter, totaling $255 million, seven of which, totaling $163 million, were paid off within 25 months of origination. Of the seven, five were paid off with fixed-rate financing, and one asset was sold, demonstrating that these properties had sufficiently achieved their business plan to exit the transitional market. The decrease in rates certainly informed our borrower's decision to refinance these loans, as did spread tightening since 2017. But it also serves as a reminder that our portfolio is substantially light transitional loans. where assets can achieve their business plans prior to maturity, and we believe this is a positive reflection of our credit underwriting. Given the payoff activity this quarter, we now expect to reach full deployment in the first half of 2020. At the same time, we are affirming our 2019 deployment guidance and are introducing 2020 guidance of CRE capital deployment of $850 million to $1 billion. Turning now to our CMBS portfolio, during the third quarter, we acquired $33.5 million in face amount of CMBS bonds at a spread of LIBOR plus 2.6%. This was partially offset by $9.3 million in sales and paydowns, resulting in net CMBS acquisitions of $24 million at a weighted average coupon of 4.66%. At September 30th, 2019, our $506 million CMBS portfolio at par, which has a carrying value of $471.8 million, was comprised of $347 million of floating rate bonds and $125 million of fixed rate bonds. We recognize the net decrease from last quarter of $0.02 per common share to book value from our CMBS portfolio, including the impact of mark-to-market on our interest rate swaps. We are pleased to announce our expectation of a seventh consecutive increase in our quarterly dividend for the fourth quarter of 2019 to 27.5 cents, or a 10% increase over the third quarter of 2019. This is representative of an annualized dividend payment of $1.10 per year. With that, I'd like to turn it over to Dave Bryant to discuss our financials.

Thank you, Matt. Good morning. Our GAAP net income, allocable to common shares for the three months ended September 30, 2019, was $10 million, or $0.31 per share, and $21.8 million, or $0.69 per share, for the nine months ended September 30. Core earnings were $9.9 million, or $0.31 per share, for Q3 2019, for an increase of $1.1 million, or 12% over Q2. Core earnings were $26.6 million or $0.84 per share for the nine months ended September 30th, 2019 for an increase of $11.7 million or 79% over the same period in 2018. The growth in our core earnings is being driven primarily by our year-to-date net investment production. Accordingly, we saw net interest income increase by $1 million, where 7% is compared to the second quarter of 2019, and by $7.1 million, where 18% for the nine-month period over the same time in 2018. We have also seen our general and administrative costs decline by $785,000, where 10% through the same nine-month period year over year. The growth in our dividends paid for the nine months represents an increase of 125% over the same nine-month period in 2018. In terms of significant items impacting GAAP earnings, we recovered $1.1 million, or four cents per share, of general loan loss reserves this period as a result from the payoffs of four loans with an aggregate balance of $72.6 million, which were risk-rated three prior to paying off. In addition, as a result of the increased loan payoffs this period, we recorded additional interest income of 5 cents per share from the acceleration of loan origination and exit fees. This acceleration of fees was partially offset by the accelerated recognition of financing costs of 3 cents per share, which is reflected in interest expense. The net impact was 2 cents of positive net interest income per share during the quarter. Gap net income adjusted for the reversal of our general reserve and net impact from these one-time fee adjustments would have been $0.25 per share, and core earnings adjusted for the accelerated fees and costs would have been $0.29 per share. Gap of value increased at September 30 to $14.12 per share, common share, from June 30th of 1406 and represents a 10 cent increase from December 31st, 2018. We began reporting economic book value and non-GAAP metric at December 31, 2018 in an effort to improve consistency and transparency for our shareholders and the analyst community. GAAP book value per common share of 1412 less the adjustment for unamortized discounts on our convertible notes and redemption value of our preferred stock, both totaling $0.41 per share, yields an economic book value of $13.71 per common share on September 30. As a point of comparison, the economic book value of December 31, 2017 was $13.63 per common share and highlights our book value stability. Our GAAP debt-to-equity ratio declined slightly to 3.4 times at September 30th, down from 3.5 times at June 30th. Asset-specific debt declined by $48.8 million during the quarter, due primarily to redemption of our 2017-CRV-5 CLO in July and second from paydowns on our 2018-RSO-6 CLO Those were offset by a net increase in our CRE term facilities as we financed a portion of our loan pipeline during the period. Swapholders' equity increased by $2.1 million as GAAP earnings exceeded our dividend and were offset by a net decrease in our bond and corresponding swap mark-to-market valuations, which is, of course, reflected in other comprehensive incomes. As an experienced issuer in the CRA CLO markets, having issued nine deals totaling $3.7 billion of real estate CLO notes since inception, we have now issued and repaid seven CLO financing vehicles totaling $2.5 billion, with every investor receiving 100% of their principal and interest payments due. We find the CLO market an attractive source of non-market-to-market cost-efficient financing and expect to engage the marketplace when we are ready to launch our next transaction. While we saw a decline in the net deployment this quarter, our trailing 12-month gross production of $1.2 billion, inclusive of the portfolio acquisition, and $1 billion excluding the portfolio acquisition, is indicative of our lending platform's evolution. Loan payoffs and paydowns were $256.9 million, on loans with a spread of LIBOR plus 4.22%, and an average life of 31 months. At September 30th, our $1.8 billion floating rate commercial real estate loan portfolio at par has a weighted average LIBOR floor of 1.87%, and a weighted average spread over LIBOR of 3.64%. To mitigate the impact of the decline in LIBOR, we have historically included LIBOR floors on our loans, along with minimum interest period protection. At the end of September, we had $967 million, or 55% of our loan bulk, with floors that are in the money, as LIBOR dipped below 2% in early October. We'll expect to see a benefit to net interest income during the fourth quarter as LIBOR curve projects a further decrease in rates. We have LIBOR floors on substantially all of our loans, most of which maintain a minimum interest rate protection period of 18 months and nearly all having at least 12 months of protection from the time of origination. Looking ahead, We expect to redeem the remaining $21 million of our 8% convertible notes when they mature in January 2020. And we have sufficient liquidity of $183 million at October 30th to fund that redemption and to continue to fund what is now a robust commercial real estate debt investment pipeline. With that, I'll turn the call back to Bob for final comments.

Thanks, Dave. As you can see, our long-term operating strategy remains on track. We will continue to grow our portfolio and strategically deploy our capital. We now expect to reach full deployment in the first half of 2020. We experienced the full accretive benefit from our second quarter loan portfolio acquisitions, which drove core earnings of $0.31 per share. Economic book value increased from last quarter. And as you've heard, we are recommending that our board raise our dividend to 27.5 cents for the fourth quarter of 2019. Based on this progress, we remain optimistic about the platform as we approach the end of the year and look forward to updating you on our next call. With that, I'll ask the operator to open up the call to any potential questions.

Thank you. At this time, I would like to inform everyone, in order to ask an audio question, please press star to the number one on your touchtone phone. Your first question comes from the line of Steve Delaney of JMP Securities.

Thank you. I appreciate you taking the question, and congratulations on another strong quarter. I'd like to start off with Dave Bryant. Dave, we're accustomed to seeing the acceleration of fees and the $0.05 a share you alluded to. Thank you for also pointing out the $0.03 on financing costs. Should we assume that is largely related to the payoff on CRE-5 that occurred back in July?

It's partially related to that. It's also partially related or probably more so related to the accelerated payoffs, the high level of payoffs that we had during the quarter more than anything else.

So are you saying that like on your bank facilities that you have, your bank repo lines where you would have senior floating rate loans, if you put loans on those lines and then they're paid off within 18 months, are you paying some sort of a fee to the bank in addition to the interest that you pay over LIBOR?

It's not a fee paid to the bank. There's a cost to arrange the financing at inception. But more so than that, we had loans pay off that were financed in our 18-6 CLO. And so those also had deal costs. And that, we estimate how long we think that deal is going to be outstanding. By this acceleration of payoffs, it accelerates the period of time over which we advertise those costs, and as a result, we had accelerated costs and the recognition of those financing costs in the third quarter.

Okay, that helps because I understand what you're saying now. You have your fees that you recognize, but then you're setting up deferred cost of origination as well. So we really need to think about what the net impact is, which is really two cents. And thank you for clarifying that on the banks because I understand about CLO costs, but I had misinterpreted that because we had not previously heard about any bank-related fees on the financing side.

We can look at that for you, Steve, but it's substantially tied to the CLO cost that you made reference to. When you get an early pay down within the CLO, the expenses that were capitalized associated with that execution are amortized into interest expense on an expedited basis when you have loan payoffs. And as Dave said, that's the primary driver.

Great. And on the three-rated loans that would pay off, Matt, I wonder from just a credit standpoint and general market conditions, if you could just comment on the conditions that allowed those loans that you had three-rated to find either a new buyer of the property or refinance or whatever. But I'd like to kind of know a little background about how those problems, if you will, or potential problems went away. and then if there are any additional three-rated loans that you have on your books that might be covered by that $1.46 million general reserve. Thanks.

Paul, do you want to take that? First, I think you need to understand exactly what the three means. Three doesn't mean impairment. Three doesn't mean we think we're not going to get our money back. Three doesn't mean eminently non-refinanceable. What three means is they're lagging their business plan. So that if it was a property that projected that it would renovate 100 units in the first year and 100 units in the second year and pop rents on their apartment complex by $150 and they are behind their plan, then it would be a three. So we had two loans in Houston that were rated three that refinanced into Freddie Mac. So yeah, they were refinanceable at the proceeds. They just weren't meeting the original underwriting plan. There are fits and starts oftentimes with light transitional loans. Some get out of the box a little slower than others. And we like to think that we are appropriate in how we mark and vigilant into monitoring these assets. So three doesn't mean we think there's going to be a problem. Three just means It's behind the original plan.

Got it. That's helpful. So you're I do. Is it correct that you are on a three point scale? Some people are on a five point scale.

No, we are. Right.

So you are on a five.

Yes.

Oh, my my bad. Then I apologize. I was thinking the fact, you know,

Most loans generally sit at three, and I misunderstood that these – Most of our portfolio sits at two, and two means performing substantially in accordance with its underwriting plan. And plan.

Okay, that's good clarity.

When we do our quarterly review of all of the assets, we reevaluate how they're doing per their original underwriting plan and rate them accordingly.

Appreciate that clarity. And one final thing from me, we noted that the weighted average floors on the 3Q originations were set at 234. Obviously, LIBOR has moved lower. Is that simply a function of locking in terms with borrowers ahead of the Fed cuts in July and September? Or Is there some anomaly going on now in the market that because LIBOR has moved so low that the floors are actually being set slightly above LIBOR?

So the answer to that is it depends, although it's not really a case of floors being set above LIBOR. That's not what's happening. But floors are generally set somewhere between where LIBOR currently is and 25 basis points below LIBOR. So my guess, and Dave and Matt may know more precisely, is we probably shake out roughly 15 basis points below LIBOR on average for when the loan was made. Got it.

Okay. Well, thank you very much for the comments. They're helpful.

Thanks, Dave. Again, to ask an audio question, please press star 1 on your telephone keypad. Your next question comes from the line of Stephan Laws of Raymond James.

Hi, good morning. Good morning, Steve. I guess I want to follow up kind of where Steve left off, but maybe from a little bit of the competition angle. I think, Bob, in your prepared remarks, you mentioned some originations in Q3. I think you used the phrase pulled away, but maybe won by competitors. Can you talk about where they're competing? Are they willing to do lower LIBOR floors? Are there other points where they're competing against you guys and you're not willing to bend on your terms? Or can you talk about that competitive landscape and how it's impacting origination volumes and the outlook for that?

Paul? I think there is competition as it relates to floors. There are Certain lenders, although a distinct minority, who would be willing to lend some without a LIBOR floor or with maybe a 1% LIBOR floor, which is not an avenue that we've decided to go down. I don't think our stance on floors is hurting our volume. Although it's a competitive marketplace, that's just one of the pressure points. Floors, spread, proceeds, terms. Those are kind of always the pressure points, and it's just exacerbated in an environment like this where LIBOR is so low.

Great. I appreciate the color there. And, Dave, another point you touched on, I appreciate the color, but it looks like positive two-cent impact of kind of the accelerated income and expenses in the quarter is Can you maybe talk about that in context versus maybe Q2 or Q1? Is two cents a normal contribution? Was that one cent higher than normal? Can you frame that as far as what prior quarters have been on a net one-time item benefit or accelerated benefit?

Sure. It definitely was higher. It's not normal because the level of payoffs were certainly higher. And it was at least a penny higher maybe a little bit more. I'd have to go back and look, but as I said, at least a penny higher than the previous quarter.

Great. That's helpful. And Matt, if you could clarify, I think I just missed it writing some stuff down, but I think you said a 2020 volume guidance of $850 million to $1 billion. Is that Is that gross originations? Is that net of prepays? And can you maybe provide a little bit of clarification there? Because I think I missed it in your prepared remarks.

Sure. That's an aggregate capital deployment number, both for loans and CMBS for the year. It's anticipated to be aggregate gross. Okay.

But not including the purchase.

Yeah. And so, and Paul is pointing out, and correctly, the guidance discussed on the call was relative to 2020. I would point out, as Paul just mentioned, that we are projecting that for 2019 exclusive of The loan portfolio acquisition of roughly $200 million that we did this year, it's not inclusive of that. So as I think Dave mentioned in his comments, if you look at LTM, I think we're about $1.2 billion LTM inclusive of the portfolio acquisition and about $1 billion LTM 930 exclusive of that. Great. Appreciate the reminder on the acquisition there. It's a little difficult, as we've mentioned before, to put a pin in exactly how much will be loans or CMBS. It really depends upon just the way the market prices and where we see risk-adjusted opportunity. Great. Thank you.

Looks like, you know, under the strategic plan that's largely completed at this point, two loans left, about $30 million. Can you give us an update on those or thoughts on resolution or progress on resolving those two at this point?

I'd say that the resolution plans are in progress. It's difficult to project at this time. when exactly they'll close, but resolution plans around both are in progress.

Okay, great. We'll look for more information on that in the coming quarters then. Lastly, Dave, kind of a small point, but from a modeling standpoint, it looks like G&A expenses were lower this quarter than we've seen in at least the last six I'm looking at. Is the $2.1 million kind of a good run rate, or are there some one-time items that cause 3Q expenses to be lower. How should we think about that moving forward?

There is a little bit of seasonality in G&A, Stephen, so that could be reflected in Q3. I can tell you that, for instance, our audit costs are primarily recognized in Q4 and Q1 when that work is actually done. So that is one example of the seasonality in Q3. But as we're largely through the strategic plan, some costs have come down, such as payroll allocations and certain legal costs with cleaning up these non-core assets and disposing of them.

If you're looking for a general guide there, I think it's page 13 of our investor presentation, speaks to what we think G&A will look like on a prospective basis. I would say probably there, hopefully a little bit inside of there is where we would expect it to shake out. And I think that's consistent with what David's saying.

Yeah, great. And I see that third quarter last year was a trough for the year as well, kind of pointing to that seasonality comment. So great. Well, I appreciate you taking my questions. And congratulations on, I believe, an indication of a seventh consecutive dividend increase. So nicely done on that. Thanks, Steve. Thank you.

Your next question comes from the line of Jade Rahan of KBW.

Thanks very much. Can you just comment generally on where levered returns on equity are on a current basis in the lending market, your core business?

Yeah, I think we try to give an indication there, Jade. I think it's roughly the same. We give ranges in our investor presentation, but I would say as a general matter, it's in the low double-digit range. It's asset by asset, but you see I think it's on page 12 of our investor presentation. I don't have it in front of me, but I think that's where it is. where you're seeing levered returns on the loan side. In some cases, in the most competitive, it might fall a slight bit around 10 or even a little bit lower. And then on other loans, we're able to do a little bit better in other product types on a levered basis. And on the CMBS side, you see the same thing where we're getting attractive credit-oriented terms and very attractive underlying. It might be a little bit lower in the current market, but then there are opportunities that we like. We're able to get a little bit of extra return. But on average, across both of the primary asset classes, it remains as reflected in the investor presentation.

And so when the board decided about the fourth quarter dividend increase, how did you balance that against... the consideration of potential lower forward returns and uncertainties regarding the interest rate outlook.

Yeah, we have looked at that. Obviously, we're not making dividend policy necessarily just one quarter at a time. We're looking at what we think the aggregate return profile is going to look like going forward for the company. Obviously, this quarter, there was slight net deployment decline. But in general, inclusive of sensitizing what happens to LIBOR, what happens to payoffs, We've accounted for that in our determination of what a prudent dividend policy looks like and an effort to forward-looking, make sure there's a sustainability to that.

Thanks for taking the questions.

Sure.

Thank you.

Thank you. There are no further questions at this time. I would now like to turn the floor back over to management for any additional closing comments.

We want to thank you all for participating, and we look forward to following up with you on our next earnings call.

Thank you. That does conclude today's Exantus Capital Corporation's third quarter 2019 earnings call. You may now disconnect your lines.