Ares Commercial Real Estate Corporation

Good morning, everyone, and thank you for joining us on today's conference call. I'm joined today by our CEO, Brian Donahoe, our CFO, Taysa Keene, and other members of the management team. In addition to our press release and the 10Q that we filed with the SEC, we've posted an earnings presentation under the investor resources section of our website at www.arecre.com. Before we begin, I want to remind everyone that comments made during the course of this conference call and webcast and the accompanying documents contain forward-looking statements and are subject to risks and uncertainties. Many of these forward-looking statements can be identified by the use of words such as anticipate, believe, expects, intends, will, should, and similar such expressions. These forward-looking statements are based on management's current expectations of market conditions and management's judgment. These statements are not guarantees of future performance, conditional results, and involve a number of risks and uncertainties. The company's actual results could differ materially from those expressed in the forward-looking and as a result of a number of factors, including those listed in the SEC filing. Aries Commercial Real Estate assumes no obligation to update any such forward-looking statements. During this conference call, we will refer to certain non-GAAP financial measures. We use these measures of operating performance, and these measures should not be considered in isolation from, or to substitute for, measures prepared in accordance with generally accepted accounting principles. These measures may not be comparable to like-title measures by other companies. Now I'd like to turn the call over to our CEO, Brian Donohue.

Thanks, and good morning, everyone. During the third quarter, we continued to execute on three primary goals we've discussed previously. First, we intended to maintain strong levels of liquidity and moderate leverage. Secondly, we wanted to take advantage of the lending market and our liability structure to selectively originate new loans that would be accretive to our earnings. And finally, we wanted to continue to maximize the value of our underperforming assets. In general, we are pleased with the progress we have made executing against these goals. With respect to the portfolio, we experienced general stability in credit performance as our level of defaults and the universe of risk-rated four and five loans modestly declined quarter over quarter. While the benefit of today's rate environment has served to enhance our net interest income, the impact of the higher for longer interest rate environment has resulted in greater economic uncertainty and further headwinds to commercial real estate values. This higher cost of capital is also leading to dramatic reductions in new construction, which we ultimately believe will result in favorable supply dynamics and drive support for commercial real estate fundamentals and values in the future. Specific to ACRE, we believe our deliberate approach of operating with moderate leverage while still generating attractive earnings is the best strategy for navigating today's market. We believe the strength of our balance sheet and capabilities of the broader ARIES platform gives us a distinct advantage in addressing our underperforming investments as well as selectively investing in today's attractive lending market. Now let me spend some time discussing some of the actions we took this quarter and our approach in maximizing value of our underperforming loans. This quarter, we foreclosed on the $83 million loan collateralized by a mixed-use facility located in Florida. This loan is now held as REO on our balance sheet. As a reminder, this is an office and retail mixed-use property in Tallahassee that is over 90% leased and continues to generate cash flow that is roughly equivalent to the interest income we earned as a loan. 100% of the office space is leased to a AAA-rated tenant that has approximately a nine-year weighted average lease term remaining. The retail space is also well leased with approximately 85% occupancy and a weighted average term of about seven years. This is where we at ARIES will continue to actively manage the property with the aim of pushing retail occupancy even higher. It's important to point out that we did not recognize an impairment when foreclosing on the property and currently hold the property unlevered. As one of the leading value-add and opportunistic real estate managers, the capabilities of ARIES supports our ability to own and execute this business plan. Given our balance sheet position, strong operational capabilities, and the cash flow profile of the property, we are optimistic about the long-term value of this asset. We also exited a $35 million hospitality loan through a discounted loan payoff this quarter. Given the volatile cash flow profile of this property, the capital required to complete the business plan, as well as our view of the future value, we believed it was in ACRE's best interest to exit the loan and redeploy this capital into higher earning investments. As both of these loans illustrate, our platform capabilities and balance sheet position allow us to take unique strategies to each asset with the goal of maximizing value. Our balance sheet position also allows us to opportunistically invest in today's market. We remain focused on financing strong, performing property classes with secular demand drivers, such as industrial, multifamily, and self-storage. For example, this past quarter, we originated a $58 million senior loan backed by a newly built Class A multifamily property located in Cincinnati, Ohio, that is 95% leased. This property is well located in an affluent part of the city with compelling local supply and demand dynamics. We finance this property at historically lower levels of loan-to-value, modestly wider spreads, and reset property valuations. Looking forward into the fourth quarter and year end, we expect to make further progress on reducing our exposure to office loans. Through a combination of principal paydowns and exits, We are targeting more than $70 million in outstanding principal balance of office loans to be cleared out in the fourth quarter, but that may well extend into the first quarter of next year. With that, Tasik, let's walk through some of our financial highlights and further details on our portfolio and capital position.

Thank you, Brian, and good morning, everyone. For the third quarter of 2023, we reported GAAP net income of $9.2 million or 17 cents per common share. Our gap net income was impacted by a $3.2 million net increase in our CECL provision or about 6 cents per common share. Distributable earnings for the third quarter of 2023 was 13.5 million or 25 cents per common share, which was impacted by the 4.9 million or 9 cents per common share realized loss on the defaulted hospitality loan that was resolved in the third quarter. Turning to our portfolio, we ended the quarter with a diversified portfolio of 49 loans held for investment with an outstanding principal balance of $2.2 billion, 98% of which were senior loans. During the third quarter, we received $48 million of total loan repayments, including 25 million of proceeds from the hospitality loan, as well as loans backed by self-storage and industrial properties that were repaid at par. In terms of credit quality metrics, 78% of our loan portfolio had a risk rating of three or better, which improved from 74% in the second quarter. The improvement was driven by the reduction of our risk-rated four and five rated loans as two such loans were either resolved or converted to REO. During the third quarter, no new loans originated from a risk rating three to a risk rating of four or five in the quarter. We did downgrade one office loan from a four to a five risk rating with a total unpaid parental balance of $33 million and established a specific reserve of $14.4 million. Inclusive of this specific reserve, we increase our overall CESA reserve by a net $3.2 million in the third quarter of 2023. Our total CESA reserve now stands at $116 million, or about 5.25% of our outstanding principal balance. Let me provide some further details around the components of our $116 million CESA reserve, which equates to $2.14 per common share total reserve and impacted our book value per common share of $12.62 as of September 30, 2023. As previously mentioned, we have specific reserves of $55 million, representing 61% of the $90 million in outstanding principal balance on the two risk-rated five loans. Of the remaining $61 million of reserves, $46 million is accrued against $388 million in outstanding principal balance of risk-rated IV loans, which equates to approximately 12% of the total risk-rated IV loan balance and compares to 10% in the quarter prior. The final $15 million of our total reserve is held against the $1.7 billion of loans rated III or better. for an average reserve ratio of about 86 basis points of loans held for investment with a risk rating of 3 or better. While the market remains challenged, we believe that our CISO reserve level appropriately takes into account current market conditions and the macroeconomic outlook for our loans held for investment as of September 30, 2023. With respect to the $57 million office loan that is risk rated five, we continue to be on target to resolve this property, which would result in approximately a $41 million realized loss in the fourth quarter of 2023, or possibly first quarter of 2024. As Brian referenced earlier, we maintain significant liquidity and moderate net debt to equity ratio of 2.0 at quarter end. At quarter end, we had over $130 million in cash and amounts available for us to draw under our working capital facility. In addition, we are holding our REO unlevered, which we believe can be financed to further increase our liquidity. Finally, we declared our fourth quarter dividend of 33 cents per share. So with that, let me turn the call back over to Brian for some closing remarks. Thank you, Tasif.