ACRES Commercial Realty Corp.

Good day, ladies and gentlemen, and welcome to the second quarter 2021 Acres Commercial Realty Corp earnings conference call. Currently, all participants are in a listen only mode. Later, we will conduct a question and answer session with instructions to follow at that time. If anyone requires assistance during the conference, please press star then zero on your touch tone telephone. As a reminder, this call is being recorded. I would now like to introduce your host for today's conference, Jacqueline Jesberger, General Counsel. You may begin.

Good afternoon, and thank you for joining our call. Before we begin, I want to remind everyone that certain statements made during 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 several trends, risks, and uncertainties that could cause actual results to 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 10K and Form 10Q. Listeners are cautioned not to place undue reliance on these forward-looking statements, which speak only as of 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 to 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 presentation for the past quarter. With me on the call today are Mark Fogel, President and CEO, and Dave Bryant, our CFO. Also available for Q&A is Andrew Fentress, Chairman of Acres. I will now turn the call over to Mark.

Good afternoon, everyone, and thank you for joining our call. Today I will provide an overview of our strategic initiatives and updates on our portfolio and loan originations, while Dave Bryant will discuss our financial statements and operating results for the second quarter. And of course, we look forward to your questions at the end of our prepared remarks. This week marks one year since Acres Capital acquired the management contract for what was then known as Exantis and is now Acres Commercial Realty. Since acquiring the management contract, we have sought to stabilize the legacy loan portfolio, grow loan originations, and enhance our funding sources. During the second quarter, we were able to make market progress in all three areas. Our aggressive asset management process has resulted in a healthy portfolio, including a net reduction of $133 million of loans risk rated a four or five during the second quarter of 2021. There are 177.8 million of loans risk rated a four or five at the end of the second quarter of 2021 from the peak of $410.8 million at the onset of the pandemic at the end of the second quarter of 2020. From a capitalization standpoint, we successfully executed on the largest CLO in our history and completed a preferred stock offering during the quarter. By doing so, we have positioned the company to fund a robust and attractive pipeline of opportunities. Loan origination volume in the second quarter was up over three times the prior quarter. This is a direct result of the hard work by our entire team in creating and executing on unique financing solutions for the marketplace. We expect that hard work to provide for continued expansion of our portfolio for the remainder of this year. The portfolio has continued to perform, demonstrating sound and consistent underwriting and asset management. We ended the quarter with $1.6 billion in loan assets across 88 individual investments, with all but two performing in current contractual payments. Additionally, we realized incremental improvements in our loan portfolio risk ratings as certain loans that were lower on our risk rating scale have paid off, and we are issuing new loans in line with our core target ratings of a two. We believe we have a well-diversified nationwide portfolio with a concentration in the high-growth southern region of the United States. In addition, nearly 60% of the loan book is backed by multifamily properties, a particularly durable sector of real estate assets. We continued to maintain a solid balance sheet and liquidity position, and during the quarter, we took additional steps to further strengthen our funding sources. In May, we executed the company's 10th CLO. This was the second ACRE-sponsored transaction and the first managed CLO in the company's history. The transaction was backed by $803 million of commercial real estate loans, and we issued $675.2 million of non-recourse floating rate notes at an average cost of 149 basis points over LIBOR. This CLO is structured with a 24-month reinvestment period during which we can use principal proceeds to acquire additional mortgage loans. Simultaneously, we liquidated the remaining $344 million of notes from a prior CLO. In May, we completed a preferred stock offering and fulfilled a follow-on offering in June. We issued 4.6 million new Series D preferred shares and received net proceeds of approximately $111 million. At the end of the second quarter, our total leverage ratio was 3.0 times debt to total equity, down almost a full turn from the prior quarter. In terms of recourse debt, leverage was 0.7 times, down from 1.2 times. As of the end of July, ACRES had $243 million of net liquidity over our working capital reserve target of $40 million to deploy into additional commercial real estate loans. At the end of the quarter, we had approximately $1 billion of financing capacity on our term warehousing financing facilities, a senior secured financing facility, and senior unsecured notes. We are pleased with the continued acceleration of our new loan production. During the quarter, we closed 18 commercial real estate whole loans for $470 million, more than three times the volume we produced in the first quarter. Fourteen of the loans are collateralized by multifamily properties, and the remainder are hotel, office, and self-storage. The weighted average coupon on these loans is one month LIBOR, 17 of which have floors with a weighted average of 0.22%, plus 3.81%. and the LTV is 70%. New commitments outpace loan paydowns and payoffs. During the second quarter, we received proceeds of $353 million from the repayment of 22 loans. We believe the ability of our borrowers to refinance indicates the equality of the sponsors and assets underlying our loan portfolio. Looking ahead, we anticipate continued paydowns from the current portfolio, offset by ongoing acceleration of new loan production. Our pipeline continues to include multifamily opportunities along with other segments, such as hospitality and office, where spreads are a bit wider, but we believe these spreads may begin to compress. We will remain selective and focus on credit quality, markets, and sponsors to originate accretive new loans for the portfolio. In additional news, I would like to publicly welcome two new members to the Acres Commercial Realty Board, Cameron Edwards and Dewana Williams. Karen brings 30 years of experience in the financial services industry, including 13 years serving on the board of a commercial mortgagery. Dawana has 20 years of real estate experience and provides valuable insights into current and future developments in the industry through her executive real estate development and strategic advisor experience. We appreciate the insights, experience, and diversity of thought these women bring to our board. We look forward to their contributions in years ahead. In summary, we are continuing to execute on our business plan, further diversify our funding sources, and originate high-quality investments as we continue our focus on growing earnings and book value for our shareholders. We will now have our CFO, Dave Bryant, discuss our financial statements and operating results during the quarter.

Thank you, and good afternoon. Our second quarter results reflect our continued positive progress. Our gap net income allocable to common shares for the three months ended June 30th, 2021, was $10.1 million, or $1.04 per share, compared to $10.5 million, or $1.03 per share in the first quarter. These results reflect the contributions from the new loan production and accelerated fees from increased payoff activity. Offset by lower interest spreads, due to loan payoffs as well as accelerations in amortization of deferred debt issuance costs from the 2019 CLO redemption and paydown of CLO notes. The quarter-to-quarter change also includes a higher level of CECL reserve recoveries compared to last quarter. Second quarter GAAP net income includes $10.3 million, or $1.06 per share, in CECL reserve recoveries, primarily due to ongoing improved macroeconomic factors, a significant amount of loan payoffs of riskier loans, and improved property-level operations in the loan portfolio. Net interest income was $7.1 million, or 73 cents per share, down from $11 million, or $1.08 per share, for the first quarter, as higher interest income was offset by an acceleration of deferred debt issuance costs of 4.5 million from the termination of a legacy CLO and the significant loan payoff volume that resulted in existing CLO debt pay downs. The weighted average spread of the floating rate loans in our 1.6 billion loan portfolio expanded to 3.78% over one month LIBOR. all but one of which had a floor with a weighted average of 1.31% at quarter end. These LIBOR floors are in the money on all our floating rate loans with one month LIBOR at approximately nine basis points at the end of July. We expect to continue to see a benefit to net interest income as the forward LIBOR curve projects rates to remain low in the near term. The implementation of CECL on loan loss reserves, which applies to all mortgage REITs and other financial institutions, requires us to estimate expected credit losses over the life of our loans. The impact of CECL reserved in a total allowance credit losses at June 30th of 18.3 million, which now represents 1.17% of our 1.6 billion loan portfolio. Gap book value per share, calculated over vested common shares outstanding, including warrants, rose to 23.56 at June 30th from 22.27 at March 31st. The increase to book value per share was driven primarily by $1.05 of net income, along with 18 cents related to accretive common share repurchases that were completed in the quarter. We were active in the authorized share repurchase program during the quarter and repurchased an additional 274,000 shares of common stock for $4.3 million this quarter. In July, we purchased an additional 53,000 in common shares and have now completed and fully utilized to 20 million of authorization under the buyback plan. Our gap debt to equity leverage ratio declined to 3.0 times at June 30th, primarily as a result of the Series D preferred stock issuance during the quarter. The company had approximately 1 billion of combined availability on its commercial real estate term warehouse and senior secured financing facilities and senior unsecured notes. The company's available liquidity at the end of July was approximately $243 million, including $90 million of unrestricted cash, $118 million of projected financing available on unlevered assets, and $75 million of availability on our senior unsecured notes. These components were offset by our working capital reserve target of $40 million. With enhanced financing sources and improved liquidity, along with acceleration of loan originations and a robust pipeline, we look forward to updating you on our ongoing growth. Now I will turn the call to Andrew Fentress for closing remarks.

Thank you, David. As Mark mentioned, this week is the one year anniversary of Acres managing this REIT. We are proud of the progress we've made as we continue to secure new capital, source, underwrite, close, and asset manage loans, and grow the company's earnings power. I want to thank the entire team for their ongoing hard work, and to our stakeholders for their continued support. This concludes our opening remarks, and I will now turn the call back to the operator for questions.

Thank you. We will now begin the question and answer session. To join the question queue, you may press star then 1 on your telephone keypad. You will hear a tone acknowledging your request. If you are using a speakerphone, please pick up your handset before pressing any keys. To withdraw your question, please press star then 2. We will pause for a moment as callers join the queue.

the first question comes from stephen laws with raymond james please go ahead hi good afternoon um i guess uh to everybody mark dave andrew congratulations on a first year that uh heck of a time to step in but you've accomplished a lot with against a difficult backdrop um One of those things, you should be complimented for the $20 million repurchase. A lot of companies have not repurchased stock to that level. With that completed in July, can you maybe give us an update on how you think about use of capital, either additional buybacks, a common dividend, or retain against some type of NOL to use to fund new investments?

Sure, Stephen. This is Andrew. I'd be happy to answer that. And thanks for the support and the questions. So with respect to capital allocation, as we mentioned, we did complete the authorized repurchase program of $20 million. And the way the board and the management team are viewing share repurchases is that when we believe there's an opportunity to repurchase shares at a greater than 25% discount to book value, that's when we would be interested in revisiting that conversation. At the current levels, we're inside of that, and so we believe the return on equity that we can generate for shareholders through new originations is a more compelling use of capital. And as you'll note, or as we noted in the remarks and in the release, the company issued preferred shares to continue the loan book origination. And so that's the first step. That's the first use of capital that we have as a priority at the moment is to continue to grow the loan book and get the company back to being fully invested using those proceeds to invest in the areas that we believe are most compelling today. We also, as we've noted and as you just mentioned, do have a tax asset in the amount of about $60 million that enables a company to retain that capital and hold it for the benefit of shareholders. And until we've gotten through that, the view is at the moment that we will continue to refrain from a common dividend while we're retaining that capital and then turn that dividend back on once the capital has been fully earned. Does that answer your question?

It does, and it's helpful to prioritize it and to quantify the buyback levels. Thank you for that. Mark, thinking about originations, you know, congratulations on the CLO. It's a great enhancement to the liability side of the balance sheet. You know, that said, you've now got non-market-to-market financing, I think I read, at 94% in your deck. You know, when we think about originations from here, you can kind of look at yields on multifamily and things that fit into a CLO versus some of the yields on maybe hotels or others that have some limits or restrictions around CLO You know, where would you like to see that mix shake of kind of maybe higher ROE or higher spread investments that have to be funded with financing that has credit mark exposure versus kind of more middle of the fairway CLO type originations? You know, how do you see that mix playing out in the coming quarters as you put this recently raised capital to work?

Yeah, Steve, thank you. You know, our basis will always be multifamily. I think for the most part, we'll always hover around that 60% level on the multifamily side. So we'll continue to originate, you know, down the fairway multifamily that fits neatly into the CLOs. We also have capacity within the existing CLO for office product. However, you know, as you mentioned, hospitality and other asset classes are not really welcome in those vehicles. But we do see some really compelling opportunities in those asset classes. So we're looking at them on a one-off basis to determine which ones we like the best. We're not going to take any crazy risks. I think the pandemic really hasn't played out with respect to some of those asset classes yet. And so we're being really careful. We're not going to take a risk that seems and certainly the warehouse lenders that we have are looking at it the same way. So, you know, we're all in the same place where nobody's going to take a risk that makes no sense, and we're just going to have to be really careful about what we do with those other asset classes going forward. But we're certainly interested in them, but we're just going to be really picky and choosy.

Great. And then lastly, could you touch on, I think, 86 of your 88 loans are current, but maybe could you provide us with an update on the two that aren't? I don't think they're material, but would love to get an update there, and I appreciate your time this afternoon.

Sure. Thanks, Steve. So one is actually current now. It was not current at the end of the quarter, but it is currently current, if that's the right way to say it. And the other is an REO asset on a hospitality property in Philadelphia.

Great. I appreciate you identifying those for us and updating us on the one that's now current. Thanks for your time. Thank you.

The next question comes from Steve Delaney with JMP Securities. Please go ahead.

Hi. Good evening, everyone. I guess I echo Steve's comments. Congratulations on the obvious lending momentum and also on what I think I heard you say, Mark, is your first managed CLO. I'm curious, given that it's actively managed, do you have a – can you talk about the reinvestment period? Is it the standard two-year reinvestment period on that facility, that structure?

That's correct, 24 months.

Okay, good. Thank you. And then looking at kind of the actual reported gap in core versus my number and Stephen's number, it depends. Just going through it, it all comes down to interest expense, and we had sort of identified like a $5 million difference in interest expense, both sequentially 1Q to 2Q, but also in our own model. And now I think I know now that that $4.5 million in accelerated expenses from the 2019 CLO was actually run through the interest expense line. Is that correct, Dave Bryant?

That is correct, Steve. Absolutely.

Okay. Well, it makes me feel a little better about my modeling ability because that was 46 cents a share. That's a pretty big, lumpy item, right? But net-net, the MPV of the CLO swap, I'm sure, is very much net positive over the long term. So we'll make sure that we highlight that in terms of the delta between estimates and the 10-cent reported. So no problem there. And then just a little cleanup on the, you know, the facility, I guess I'd call it that, with the seven-year notes with Oak Tree and MassMutual. You know, you took down 50. We know, you know, what that looks like on the balance sheet and the income statement and, you know, related warrants. Can you comment on the, one, how long do you have to call the remaining 75? And more importantly, you know, Your balance sheet and capital structure looks pretty good now. You've got the press. Are you willing to comment on the possibility that you would draw that remaining $75 million, and how much time do you have to make that decision?

Yeah, this is Andrew. I'll give you the answer. We have a year remaining to be able to call the remaining $75 million if we so chose. We have no current plan to call it, and we view it as very much of a sort of a standby piece of liquidity, which has no ongoing cost associated with it. There's no utilization fees or anything like that. So it's really an option that the company has in the event that it may need it, but there's no current plans to use it.

Thanks. Okay, makes sense. Now, as you continue to make your balance sheet more efficient and have other sources of capital, the existing $50 million. What would come into play, just like we saw with the CLO, what would you be facing with make-up fees or minimum interest payments? What is your flexibility to pay off the 12%, $50 million, and what kind of lumpy one-time costs might you incur if you ever decided to do that?

There are some stipulated prepayment premiums that are due in the event that those notes were retired ahead of their scheduled maturity. And to the extent that we go to explore repaying those, we expect we have a robust dialogue with those capital providers to understand whether or not we could get to a mutual agreement on what those might look like. Okay.

Thank you for the comments, everyone, and good luck for the second half of the year. Thank you.

This concludes the question and answer session. I would like to turn the conference back over to Andrew Frentis for any closing remarks.

Well, I just want to say thank you again to the ACRES team and to all of our stakeholders for your support over this first year. We look forward to working with you in the coming quarters and years ahead. And if there's nothing else, we'll conclude the call, operator. Thank you very much.

This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.