Good day and welcome to the Ares Commercial Real Estate Company’s First Quarter 2021 Earnings Conference Call. Please note this event is being recorded. I would now like to turn the conference over to John Stilmar of Investor Relations. Please go ahead.

Good afternoon, everybody and thank you for joining us on today’s conference call. I am joined today by our CEO, Bryan Donohoe; Tae-Sik Yoon, our CFO; and Carl Drake, our Head of Public Company Investor Relations. In addition to our press release and the 10-Q that were filed this morning with the SEC, we have posted an earnings presentation under the Investor Resources section of our website at www.arescre.com.

Thanks and good afternoon everybody. This morning, we announced another strong quarter with distributable earnings of $0.40 per share for the first quarter of 2021, up 25% year-over-year and well in excess of our combined regular and supplemental dividends. We are pleased with our performance, which was driven by our portfolio of strong credit quality, healthy level of high-quality new investment activity, the actions we have taken to reduce our financing costs and the benefits from our LIBOR floors. Our portfolio and our real estate platform continue to benefit from an improving economy and a more active real estate market, which is enhancing our already strong competitive position as a reliable and stable capital provider. With some legacy market participants narrowing their underwriting criteria or not yet returning to the market, we are finding an attractive competitive landscape. As a result, we continue to see new loans with all-in spreads roughly in line with or greater than pre-pandemic levels in our primary areas of focus, with more attractive attachment points in addition to more friendly lender terms. These factors have led to an improved pipeline of attractive investment opportunities that are diverse across property types and geographies. We continue to target loans to high-quality sponsors, primarily secured by multifamily, industrial, self-storage and select office properties in markets with strong demographics and favorable real estate fundamentals. Our playbook remains consistent to originate short term, primarily senior loans with strong covenant protections in support of value-creating business plans. Against this backdrop, we closed $205 million in new commitments across multiple property types in the first quarter of 2021.

Great. Thank you, Bryan and good afternoon everyone. Earlier today, we reported GAAP net income of $15.7 million or $0.45 per common share and distributable earnings of $13.9 million or $0.40 per common share. Our distributable earnings for the quarter more than fully covered our $0.33 per common share regular dividend as well as our supplemental quarterly dividend of $0.02 per share. Supported by our strong earnings and a slightly accretive $7 million common equity offering that Bryan mentioned earlier, our book value per share increased by $0.09 per share to $14.23. This is the third consecutive quarter of improving our book value per share. Our earnings also continued to benefit from LIBOR floors. The weighted average 1-month LIBOR rate on our loan portfolio at the end of the first quarter of 2021 was 1.56%, which compares favorably to the 1-month LIBOR rate of approximately 11 basis points. Furthermore, during the first quarter, we executed approximately $1.1 billion of notional interest rate swaps and caps, which we believe provide a significant protection against rising interest rates over the next few years. Our first quarter GAAP earnings also benefited from a $3.2 million reduction of our CECL reserve. This 13% decline in our CECL reserve was primarily driven by improved macroeconomic forecast. While we have reduced this balance over the past few quarters, our CECL reserve balance as of March 31, 2021, remained at about 4x pre-pandemic levels at $22 million. Now let me highlight some of the further enhancements that we have made to the liability side of our balance sheet during the past 12 months. As you know, heading into the pandemic last year, we were in a very good position. And certainly, the past 12 months tested our liquidity levels, our financing vehicles and our overall capital structure. Despite that success, however, we have pushed even harder to further strengthen our balance sheet. First, our debt-to-equity ratio, excluding the CECL reserve, is significantly lower at 2.4x as of the first quarter 2021 versus 3.2x as of the first quarter of 2020. Second, as we continue to shift our funding mix towards termed-out non-recourse sources and with the successful execution of our fourth CLO and the extension of the reinvestment period of our third CLO, our percent of non-recourse liabilities more than doubled to 71% as of the first quarter 2021 versus 32% as of the same period last year. And finally, we increased our common capital base by more than 20% through our recent 7 million share offering in March 2021. So despite challenging capital market conditions, the liability side of our balance sheet is in a stronger position today than it was at pre-pandemic levels.

That’s great. Thanks, Tae-Sik. In summary, we are off to a very good start to 2021, with strong quarterly earnings, healthy and improving credit quality in the portfolio. With attractive sources of financing, including incremental equity, we are well positioned to more fully invest in the market opportunities we see in front of us. We expect future quarters will benefit from the resulting increased diversification of the portfolio and greater expense efficiencies that come with the deployment of this capital. Importantly, we are actively and prudently investing our available capital against this attractive market opportunity. As a result, we remain on track to deliver distributable earnings that meet or exceed dividends paid for the year. We greatly appreciate the support of our investors and your time today. With that, I will ask the operator to open the line for questions.

And the first question comes from Tim Hayes with BTIG. Please go ahead.

Hey, good morning guys. Congrats on a nice quarter. First question here, just, Bryan, circling back on your comments about spreads on new loans, I can appreciate that spreads are at or maybe a little bit wide than pre-pandemic levels. But curious how all-in levered returns look relative to pre-pandemic levels. I know you got great execution on the fourth CLO and it helps that you have extended the reinvestment period for the third one. But going forward just based on where your funding costs are and maybe the direction they are going versus the all-in coupons on new loans, just curious how ROEs look to be relative to pre-pandemic levels?

Yes, it’s a good question. What I’d say is I think there is certainly differentiation in asset classes across the board. I think we see ROEs in keeping with pre-pandemic levels. However, there’s certainly been compression in the industry and multifamily space and some tightening there. So how the portfolio construction comes together, we’ll take into account the ROEs available on an asset-by-asset basis. Thus far, we’ve been very pleased with the lower leverage attachment points that have been available to us, with again all-in yields that are satisfactory to pre-pandemic levels.

Got it. That’s helpful. And then just on liquidity, the update you provided as of May 3, it sounds like you have been busy originating some new loans in the second quarter as well, which is great to see. But your available liquidity has also come down quite a bit as well. And I think there was maybe $40 million of additional liquidity expected. I don’t know if that’s just a loan repayment that you guys expect or maybe a couple. But curious how you feel about your current liquidity position versus the pipeline today and what you believe you can support at this time?

Absolutely. I think I’ll let Tae-Sik get into more detail. I think it is difficult to take just a snapshot moment in time given how dynamic the portfolio is from a financing and origination standpoint. But Tae-Sik, why don’t you take it away?

Sure. Tim, that’s a great question. I mean, obviously, at quarter end, we had significantly more liquidity over $140 million at least the way we define liquidity versus the smaller amount that we announced as of yesterday, the $36 million. But as Bryan mentioned, these are very specific moments in time, and we’re always dynamically moving our capital position. So we felt it was important to note that we are expecting about $40 million of financing proceeds to be available to us very shortly. We’re moving some loans around into various financing vehicles, particularly our FL3 Securitization vehicle, which you noted that we extended the reinvestment period. So that gives us tremendous flexibility there. But basically, we have been very active in originating new loans. So as we mentioned, we have closed a number of loans since quarter end. And certainly, a significant portion of the capital that we had available as of March 31, including the $100 million that we have raised through our common equity offering, a significant portion of that has been invested and will continue to be deployed, particularly against the loans that we have initially closed in the Ares Warehouse line, which we will then work very hard over the next couple of weeks to bring on to ACRE’s balance sheet with the liquidity that we have, the $36 million plus the $40 million.

Okay. But with – so Tae-Sik, do you believe that given I guess the $36 million plus the $40 million, $76 million versus – I think it was about $180 million or so of loans in the pipeline. Do you believe that you will be able to kind of take those all on given your available liquidity or are you going to need to hopefully absent loan repayments or some other sources of capital coming to close those loans?

No. In fact, I would say, with respect to the $36 million plus $40 million, we will use approximately half of that to bring on the loans that are currently closed in the Ares Warehouse line. So again, the Ares Warehouse line, we showed the commitment amount. But really, the funded amount in the Ares Warehouse line is just over $130 million. And together with leverage that we will obtain, we will have sufficient liquidity in the $36 million plus $40 million to bring that $130 million of outstanding principal balance from the Ares Warehouse line on to ACRE’s balance sheet.

Okay, got it. That’s helpful. I am going to hop back into queue. Thanks for taking my questions.

Absolutely. Thank you, Tim.

The next question comes from Doug Harter with Credit Suisse. Please go ahead.

Thanks. So I was wondering if you could give us an update on the three non-accrual loans and kind of how they are progressing?

Absolutely, Doug. Well, first and foremost, I think what we are seeing throughout the lodging landscape is continued uptick in occupancy, not necessarily echoing pre-pandemic levels or even regularity in terms of weekdays versus weekends, but out now positive trend lines there. And then as we did mention, we did resolve one of the student housing properties that was on non-accrual last quarter post quarter-end, where the asset was sold above our carrying value. We were also able to secure the financing at a lower basis than where we were previously. So – and we expect continued progress on the remaining two assets over the next quarter as we work through that with very constructive borrower dialogue.

Got it. I guess on the property that was sold, I guess, was there a reserve against that, that gets released, given the favorable outcome?

Tae-Sik, do you want to walk through the mechanics there?

Sure. Absolutely. So Doug, I think there is not a so-called reserve. But because we put that loan on non-accrual status, if I recall, at the beginning of the pandemic, we have been basically amortizing down, reducing effectively the actual interest that we’ve received against the principal balance. So that, as Bryan mentioned, that carrying value that we had as of March 31 was actually lower than the amount that we got repaid on that loan. So that what you will see for the second quarter is we will show a slight gain on the disposition of that loan since we got repaid more than our carrying value because of the fact that we had been amortizing it down with respect to interest payments because of the non-accrual standards. So it’s not effectively release of a reserve, but the carrying value was lower than the repayment amount.

I guess just on that is I guess how would the repayment amount that you got compared to kind of the initial principal of the loan?

So basically, net, it was slightly lower than, if you want to call it, the legal outstanding amount only because of some expenses that were incurred as part of the transaction. But importantly, the amount that we were repaid was above the carrying value.

Alright. Thank you.

And the one thing I’d add to that too is – and we mentioned this on the call. But from an ROE perspective, taking this from beginning to end, it was still a very positive return in keeping with the overall portfolio.

Makes sense. Thanks Bryan. Thanks, Tae-Sik.

Thank you, Doug.

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

Hello everyone. Happy springtime. Just wondered if you could talk a little bit about prepays. First quarter was pretty light, about $130 million. We normally think about somewhere in the area of maybe 33-some percent of the portfolio repaying each year. And I guess that would put you near $600 million. So any comments or color you could give us about what the second quarter – what you’re seeing near-term? I assume you have some visibility there. And then what a good expectation might be for the full year? Thank you.

I think what we expect – and it’s a good question. I think what we expect is a return to that equilibrium you mentioned towards the latter half of this year. Candidly, we’re spending a lot of time with our borrowers to understand where they sit in their business plan and get out in front of any potential repayments. But we do expect to get back to that normal course operations of loans coming in and out in that normal 25 to 30-month tenor towards the latter half of this year, which is why, obviously, we’re really pleased with the origination pipeline that we see in front of us to manage those in concert with one another. Tae-Sik, I don’t know if you have anything to add specifically to that.

Yes. No, I think that’s very consistent with our views. So I see that’s exactly right. I think pre-pandemic what you saw was about third to 40% of our portfolio basically repaid each year. So call that, on average, $600 million to $700 million per year. Obviously, the past 12 to 15 months was significantly less than that. But what we are seeing is we’re starting to see our borrowers start to achieve their business plans. And certainly, the markets for them to be able to either realize the value that they create in their asset and/or seek more permanent financing is starting to open more and more. So I think that’s right. I think what we’re forecasting is really second half of the year that we would start to see a more normal, if you want to call it, that pre-pandemic level of repayments.

Got it. Got it. Okay, thanks. That’s helpful. And on the CECL reserve, can you talk about $22 million and 4x pre-COVID. In the $22 million today, are there specific reserves that are in there? Or is that just reflecting sort of the general macro outlook?

Yes. It’s all general macro outlook, if you want to talk in terms of what really caused the change quarter-to-quarter from year-end 2020 to first quarter 2021. We didn’t really have any meaningful change in the credit profile of our loans. And so some change right, but not as material a change as the general economic outlook. I think what we’re finding from the economic forecast – a third-party economic forecast that we rely upon to really determine our CECL reserve is that they have certainly pointed to a much more positive direction than the situation 12 months ago, 9 months ago, 6 months ago. And so we wanted to show that really the change in the CECL portfolio this quarter was primarily due to the economic outlook going forward as opposed to the data metrics or credit metrics of the loan portfolio itself.

Got it. So going forward, obviously, a plus to book GAAP book value, but no impact on distributable EPS, I would assume, so as you recover more of that over time, so…

I think that’s right. Yes. Just like we saw – that’s exactly what we’ve seen in the last two quarters or so. And certainly, for the first 30, 35 days of the quarter, I think that’s what we continue to see so far in the quarter.

Great. Thank you for the comment.

Thank you, Steve.

The next question comes from Jade Rahmani with KBW. Please go ahead.

Thank you very much. Are there any M&A opportunities that are top of mind for management at this point?

Jade, nothing specifically. Obviously, as we touched on last quarter and in prior quarters, we clearly see the benefits of scaling the business, hence the raise a few months ago. So we certainly have our eyes and ears open to opportunities, but there is nothing specific that we have a target on right now.

Okay. One of your peers, I guess, they probably don’t qualify as a peer anymore, but they used to be a mortgage REIT. Now they are a ground lease REIT, and their stock is trading at a really large premium to book value. In terms of cash flow, they are probably cash neutral, because ground leases, as I’m sure you’re completely aware, the upfront yields are very low, but they grow over time. So the stock is called SAFE. It’s one of the best-performing REITs over the last 2 years. And I did see that Ares launched a strategy in the ground lease space with a company called Regis, which created invitation homes. I happen to know the management team. So I’m just curious if that is an area of the capital in which Ares or ACRE Commercial Real Estate may participate in? And overall, what your thoughts are on that sector, that growing sector?

I think the technology that they have put in place is really interesting. I think the CPI adjustments you mentioned and the duration and stability of the assets that they have invested in do make it a very attractive place to invest. And hence, the investment you mentioned made by our opportunity fund – real estate opportunity fund team alongside the Regis folks and our alternative credit team, I think it’s a great – continues to be a very good relative value in the space, specifically because of the duration of those assets that they are investing in. I think that would be a fairly significant pivot for ACRE and not something that we envision, but agree with you that it’s an interesting place to be investing today.

And they do have a program in which iStar provides construction loans alongside ground lease takeout financing. Is that something you think ACRE might participate in?

We certainly talk to them a good bit. David Roth, who led the investment for us, and I sit next to one another and talk frequently about the ways we could work together. Candidly, Jade, we think the bar will be pretty high, just because we could potentially be in the same capital structure and want to be mindful of any potential conflicts. But I can tell you, we certainly benefit from a good bit of deal flow that may or may not fit in either one of our investment vehicles, and the crossover there is pretty significant. So whether or not there is a direct way to work together, I think, is TBD. But certainly, there are benefits of being on the same platform.

Thank you. And then just lastly, an entry that’s come up in the is through 1031 exchanges. I wanted to find out, given ACRE’s middle market focus, what you think either the impact on origination volumes or on the underlying asset valuations might be if there were a curtailment of the tax benefits that 1031 exchanges afford real estate investors?

I don’t think it will be that impactful to ACRE. Candidly, the way we’ve traditionally looked at it is with a negative view. The 1031 exchange market, while it certainly has some value, I think it also induces some investors to potentially overpay. So we would always discount the value ascribed to a 1031 investor and underwrite it more conservatively, because it’s kind of – it’s a little bit of found money for that investor, right? And definitionally, you’re paying more than market in order to secure that ongoing tax benefit. How it affects us, though, I think minimal if at all.

Thank you for the questions.

Thank you.

The next question comes from Stephen Laws with Raymond James. Please go ahead.

Hi, good morning. It’s good afternoon to you guys on the East Coast. Two questions. A lot has been covered. I appreciate the commentary. It looks like office was about half of originations in the quarter, not that atypical, I think, from a typical portfolio mix. But can you talk about what type of office assets you’re doing on the new originations? And any type you’re staying away from or kind of how have your underwriting standards changed in the office segment versus 18 months ago? Thanks.

Yes, great question. And I think we’ve always been fairly provincial in our outlook and underwriting of office opportunities, and that remains so today. What’s changed probably for the most market participants, ourselves included, is I think we’re going to look to see a flight to quality of tenants and so therefore the outdated business models or offices that are not in premier locations are going to be shunned by tenants and ultimately by the capital markets. So we are certainly taking that into account as we look to make somewhat contrarian investments there. And I think there are some really interesting attributes, right. If you think about being able to invest in an office asset with long-term strong credit tenancy in these core locations that have access to mass transit and the things that have always been attractive to tenants and to do so on a reset basis, so I think 20%, 25% decline in value for office properties in some of the core markets and to be able to then write a 65% loan against that asset, we think that overall attachment point, that decline in attachment point presents a really interesting opportunity set. We will still manage the portfolio and still have a high concentration in the industrial and multifamily world, as I said prior. But office will present some opportunities, and we will continue to be provincial with the manner in which we invest in them.

Great. I appreciate the color on that, Bryan. I thought the extended reinvestment period, I think, on CLO 3 is interesting. It certainly gives you guys a lot more runway and you know your financing costs, I guess, going in. And it helps you from that standpoint, not to mention just the non-recourse term financing. So can you talk about that? Is that something that could continue to occur with other deals or extending further? Kind of how does that process play out? I’m not that familiar with the extension on the reinvest period here?

Sure. I’ll start, and then I’ll let Tae-Sik walk into some of the details. But one of the things that we have always talked about is the value of being the incumbent lender participant, right? We benefit so much from the opportunity set that we see from borrowers that we’ve lent to previously. And I think there is also – the least amount of friction for our liability side is to continue to work with our counterparties, who have been great partners to us in the past. And I think this extension was a prime example of that. Tae-Sik, maybe you can walk through some of the benefits from a quantitative standpoint?

Sure. Stephen, that’s an excellent question. One of the big benefits of doing a securitization, of course, is that you enjoy very strong leverage, non-mark-to-market, nonrecourse, match-funded strategy. And when you compare CLO financing versus Warehouse or note-on-note type financing, there are clearly advantages. One of the big disadvantages of CLO, particularly a so-called static CLO, where you don’t get to reinvest proceeds that are paid off when a loan within the securitization pays down, is that it can de-lever itself relatively quickly. That’s the first big disadvantage, right? And then the second big disadvantage is the costs associated with doing a securitization because of all of the legal work and all of the placement work that is done. So those are really the two biggest disadvantages of the securitization. I think we feel very fortunate with FL3 in particular that we’ve been able to really manage both of those disadvantages quite well by having now the second extension of the reinvestment period. So this securitization was actually done back in, I believe, second quarter of 2017. And so we’ve had this thing outstanding already for 4 years. So we had an initial 2-year investment period, extended that in 2019 to 2021. And now we’ve extended it 3 years to 2024. So effectively, we will have, if you want to call it, the full leverage. It won’t amortize now, but as long as we continue to find appropriate and applicable replacement assets, we will be able to continue to enjoy the benefits of the securitization for nearly a 7-year period in which we will be fully levered as well as amortize down the cost of initially setting this up over a much, much longer period than a typical static pool CLO. So we think this is a significant advantage. We were able to do this, because as you’ll recall, the 2017 FL3 securitization was done with one single purchaser of all of the investment-grade notes. And so we have been able to go back to that single investor and negotiate the terms of the reinvestment period extension. And as you also recall, one of the big things we were able to save even back in 2017 is because that placement was done directly through relationships that we had here at Ares, we did not have to pay a significant placement fee to the typical placement agent for that securitization. So in both ways, I think we have significantly extended the useful life of the securitization as well as significantly lowered the cost of typically doing a securitization.

Great. Those are helpful comments. Thanks Tae-Sik. Appreciate the time today.

Thank you, Stephen.

The next question comes from Charlie Arestia with JPMorgan. Please go ahead.

Hi guys. Thanks for taking the questions today. We’ve covered most of them, but just a few small items from me. Looking at the new originations, I see the office property in Illinois and the self-storage in Florida. I’m just curious on the California mixed-use. What are the actual components of that property? And I’m curious if there is any retail component there.

Tae-Sik, you want to take this?

Sure. I think the mixed-use does have a retail component of it. It’s really office and retail component. We find that we have, as we mentioned, not – very purposely not lent against stand-alone retail centers. But we do believe that when you do mix – when you have a mixed-use situation that retail can actually enhance the desirability of the other commercial users in that facility. So it does have a retail component to it. It’s really a mixture of office and retail.

Okay, got it. And I appreciate the color there. And then lastly, just a housekeeping item basically, but wondering how we should think about the run rate going forward for the Westchester Marriott? It seems like both revenues and expenses dipped this quarter. Again, I realize this isn’t probably going to be a long-term asset for you guys. And I’m sure there is some seasonality combined with everything else that’s going on with the broader reopening, but I just wanted to make sure that I am really capturing the – what’s happening there?

Yes. I think it sounds like you’re on the right track certainly. I think seasonality for the first quarter is an issue for that geography of hotel. So January was a lower month. Continue to benefit from all the things we’ve talked about in prior quarters, specifically the closing of a good part of the competitive set. So if you look at the trend lines, it’s very similar to prior years, but we are also continuing to harvest more of the demand that does exist in the market due to the closures. So trend lines are positive. It remains a relatively small part of our balance sheet, obviously, and we continue to monitor to find the best time to exit the investment.

Thanks very much for taking the questions.

As we have no further questions, this concludes our question-and-answer session. I’ll now turn the conference back over to Bryan Donohoe for any closing remarks.

Thank you, and thanks to everyone for their time today. We appreciate your continued support of ACRE and we look forward to talking to you again on our next quarterly earnings call. Thank you and be well.

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.