Ares Commercial Real Estate - Earnings Call - Q4 2024

Executive Summary

• Q4 2024 results reflected continued de-risking but remained loss-making: GAAP net loss $(10.7)M ($(0.20)/sh) and Distributable Earnings (DE) loss $(8.3)M ($(0.15)/sh), driven by $18M realized losses tied to a New Jersey office loan write-off and a California REO office sale.
• Balance sheet flexibility improved: net debt-to-equity ex-CECL fell to 1.6x (from 1.8x in Q3 and 1.9x YE23), and available capital rose to ~$201M by Q4, with >$200M as of Feb 10, 2025 on the back of $166M additional repayments year-to-date.
• Dividend reset: Board cut the quarterly dividend to $0.15/sh for Q1 2025 from $0.25/sh in Q4 2024 to align with lower near-term earnings while the company prioritizes liquidity and resolutions.
• Underperforming assets: risk-rated 4/5 loans declined ~34% YoY to ~$357M outstanding by YE24, but increased $37M QoQ in Q4 as a Massachusetts life science/office loan migrated to risk 4; CECL was stable at ~$145M (~8.5% of loans) with 91% on 4/5-rated loans.
• Potential stock-catalyst narrative: accelerated repayments ($147M in Q4, $350M FY), higher liquidity, and progress on resolving 4/5-rated and REO assets; management highlighted cash now approximates ~40% of market cap, underscoring option value for resolutions and deployment.

What Went Well and What Went Wrong

• What Went Well

  • Deleveraging and liquidity: net debt-to-equity ex-CECL improved to 1.6x, with available capital ~$201M by Q4 and >$200M by Feb 10, 2025 after $166M of YTD repayments.
  • Repayment momentum: $147M of repayments in Q4 and $350M for FY 2024 (over 75% in H2), supporting balance sheet flexibility and funding future resolutions.
  • REO cash yields: two remaining REOs totaling $139M of carrying value with cash yield “over 8%,” helping offset pressure from non-accruals.
  • Management tone: “made significant progress… resolving our risk rated 4 and 5 loans,” and “positioned… to accelerate and drive positive outcomes in resolving our remaining underperforming assets”.

• What Went Wrong

  • Earnings pressure: GAAP loss $(10.7)M ($(0.20)/sh) and DE loss $(8.3)M ($(0.15)/sh) in Q4, including $18M realized losses (NJ office loan write-off; CA REO office sale).
  • Credit migration: risk-rated 4/5 loans rose $37M QoQ in Q4 due to a $51M Massachusetts life science/office loan migrating to risk 4; CECL increased on that asset.
  • Dividend cut: Q1 2025 dividend reduced to $0.15/sh vs $0.25/sh in Q4 2024 given plan to maintain higher liquidity and lower leverage while resolving underperformers.

Transcript

Operator (participant)

Good afternoon, ladies and gentlemen, and welcome to Ares Commercial Real Estate Corporation's Q4 Earnings Conference Call. At this time, all participants are in a listen-only mode. As a reminder, this conference call is being recorded on Wednesday, February 12th, 2025. I will now turn the call over to Mr. John Stilmar, Partner of Public Markets Investor Relations. Please go ahead, sir.

John Stilmar (Partner of Public Markets Investor Relations)

Good morning, everyone, and thank you for joining us on today's conference call. In addition to our press release and the 10-K that we filed with the SEC, we post an earnings presentation under the investor resources section of our website at www.arescre.com. Before we begin, I want to remind everyone that comments made during the course of this conference call and webcast, as well as 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 words such as anticipates, believes, expects, intends, will, should, may, 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, condition, or results and involve a number of risks and uncertainties.

The company's actual results could differ materially from those expressed in the forward-looking statements as a result of a number of factors, including those listed in its SEC filings. Ares Commercial Real Estate Corporation assumes no obligation to update any such forward-looking statements. During this conference call today, we will refer to certain non-GAAP financial measures. We use these as measures of operating performance and they 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-titled measures used by other companies. With that, I'd like to turn the call over to our CEO, Bryan Donohoe. Bryan.

Bryan Donohoe (CEO)

Thank you, John. Good morning, everyone, and thank you for joining us. I'm here with Jeff Gonzales, our Chief Financial Officer; Tae-Sik Yoon, our Chief Operating Officer, as well as other members of the management and investor relations team. Today, we'll start off with some market commentary, a review of our accomplishments throughout 2024, and where we are focused going forward. Jeff will then take us through our Q4 and full year results in detail. In 2024, we witnessed a moderate recovery in the commercial real estate market, with a particular acceleration of these positive trends in the second half of the year. The industry saw increased transaction volumes and stable to improving property values and fundamentals across almost the full spectrum of property types.

While the office market remains challenged, we are seeing some green shoots and greater signs of stabilization, including positive net absorption in the U.S. for the Q4, a first since pre-COVID.

The stronger level of commercial real estate transaction activity and capital market stability aligns well with our continued focus on resolving our underperforming assets. As discussed throughout 2024, our primary objective was to address our underperforming four and five risk-rated loans and to reduce our overall office exposure. We made solid progress in this area and acknowledge there is still more work to do. For the full year 2024, we reduced our risk-rated four and five loans by approximately 34%, or $182 million. As of year-end, we had five loans, risk-rated four and five, remaining in our portfolio, totaling $357 million of outstanding principal balance. During 2024, we also reduced our office exposure, including REOs, by $151 million, representing a decline of 18% year-over-year, and exited one of our three REO assets.

In our view, these actions improved the overall quality of our portfolio. In addition, we collected equity contributions on our risk-rated one to three loans of $38 million in the Q4 and $118 million for the full year in the form of loan paydowns, funding of reserves, capital expenditures, leasing expenses, purchase of interest rate caps, or other purposes. The improving commercial real estate market transaction activity and rate dynamics also led to a more normalized pace of repayments, particularly in the second half of the year. In the Q4, we collected $147 million of repayments and $350 million of repayments for the full year, nearly double versus 2023. Further supporting our primary objective to address underperforming assets, we enhanced the flexibility of our balance sheet throughout 2024 with lower leverage and additional liquidity.

In the Q4 of 2024, we reduced our outstanding borrowings by $172 million, which led to a $444 million, or 27% reduction, for the full year of 2024. By year-end, we had a net debt-to-equity ratio, excluding CECL of 1.6x, which was 16% lower than at year-end 2023. We believe this is an important achievement as it positions us to maximize the resolution of our underperforming assets. For 2025, we remain focused on further reducing our risk-rated four and five loans, office loans, and REO properties, with the specific goal of proving out book value. We continue to experience further momentum with respect to our positioning against this objective. So far, in 2025, we've collected $166 million of loan repayments, generating an additional $100 million of cash. It is worth pointing out that our cash balance now represents approximately 40% of the current market value of the stock.

These repayments now position us with over $200 million of available capital, which we believe provides us the opportunity to accelerate and drive positive outcomes in resolving our remaining underperforming assets. However, maintaining higher levels of liquidity and lower amounts of financial leverage does have an impact on our current earnings. In this context, our board of directors, together with our management team, have elected to adjust our quarterly dividend to $0.15 per share, a level that more closely aligns with our strategic objective. As we have noted before, while we continue to resolve our underperforming loans and REO properties, our earnings may vary quarter to quarter and at times may be less than our newly adjusted dividend. Before turning the call over to Jeff, I want to acknowledge the unimaginable tragedy that unfolded in Los Angeles caused by the wildfires.

While our portfolio is not directly impacted, this tragedy has unfortunately impacted the lives of many of our clients and colleagues, and our thoughts are with them and their loved ones during this challenging time. Ares is working to diligently support them and the entire area in the recovery. With that, I'll turn the call over to Jeff, who will provide more details on our Q4 and full year results. Jeff?

Jeff Gonzales (CFO)

Thank you, Bryan. For the Q4 of 2024, we reported a GAAP net loss of $10.7 million, or $0.20 per common share. Our distributable earnings for the Q4 of 2024 were a net loss of $8.3 million, or $0.15 per common share, which includes realized losses of $18 million, or $0.33 per common share. This includes both the full write-off of the subordinated loan on the New Jersey office property as well as the loss on the sale of our California REO office property. For full year 2024, we reported a GAAP net loss of $35 million, or $0.64 per common share, and a distributable earnings loss of $44.6 million, or $0.82 per common share. Focusing on the Q4 results, distributable earnings, excluding the realized losses of $18 million, was $9.7 million, or $0.18 per common share.

We also collected $3 million, or $0.06 per common share, of interest in cash on loans that were on non-accrual during the Q4 and thus was not recognized as income during the quarter and instead was applied to reduce our cost basis in the loans. As Bryan mentioned, we had strong repayments in the back half of 2024, particularly in the Q4. Throughout 2024, we collected $350 million in repayments, nearly double what we collected as compared to 2023. Importantly, reflecting the pace of recovery in commercial real estate activity, we collected $147 million of repayments in the Q4 of 2024, resulting in over 75% of the annual repayments for 2024 being collected after June 30th, 2024. In terms of our loan risk ratings, the outstanding principal balance of loans with a risk rating of four or five increased 12%, or $37 million in the Q4.

This was largely due to a $51 million senior loan collateralized by a life science office property in Massachusetts migrating from a risk-rated three loan to a risk-rated four loan. The increase in total risk-rated four and five loans was partly offset by the restructuring of a previous risk-rated five $20 million senior loan collateralized by an industrial property in California. The loan was split into a $7 million senior note with a risk rating of three and a $13 million subordinate note with a risk rating of four. In addition, we fully wrote off an $18 million subordinated loan collateralized by an office property in New Jersey, which was previously risk-rated a five and was fully reserved for through our CESO reserve.

We also further reduced our office exposure and the number of properties held as REO in the Q4 as we sold a $15 million California REO office property, which was previously held for sale. We now have two REO properties remaining totaling $139 million in carrying value. It is worth pointing out the cash yield on the carrying value of these underlying REO properties is over 8%. Continuing with our portfolio, our overall CESO reserve remained relatively stable at $145 million, a decrease of approximately $1 million from the CESO reserve as of September 30th, 2024. The decrease was due to the write-off of the $18 million New Jersey office loan mentioned earlier, partially offset by a net increase in CESO reserves for existing loans, particularly the Massachusetts office life science loan.

The overall CESO reserve of approximately $145 million at the end of the Q4 represents approximately 8.5% of the total outstanding principal balance of our loans held for investment. Our CESO reserve is lower on a dollar basis, but higher as a percentage of the portfolio basis driven by the purposeful de-risking actions we took in the quarter leading to a smaller portfolio size in the near term. It should be noted that 91% of our total CESO reserve, or approximately $132 million, relates to our risk-rated four or five loans. With strong repayments and purposeful execution, we continued to drive additional financial flexibility by reducing our leverage even further in the Q4. We reduced our leverage at the end of the Q4 to $1.2 billion, down 13% from the prior quarter and down 27% from the prior year.

Our net debt-to-equity ratio, excluding CESO, declined to 1.6x at the end of the Q4, down from 1.8x in the Q3 and 1.9x at the end of 2023. Before turning the call back over to Bryan, and as we have discussed, we declared a regular cash dividend of $0.15 per common share for the Q1 of 2025. The Q1 dividend will be payable on April 15th, 2025, to common stockholders of record as of March 31st, 2025. At our current stock price on February 10th, 2025, the annualized dividend yield on our new Q1 dividend is above 10%. With that, I will turn the call back over to Bryan for some closing remarks.

Bryan Donohoe (CEO)

Thanks, Jeff. We've made meaningful progress on many of our goals. We believe we've positioned our company strategically for a successful 2025. We have a stronger and healthier balance sheet, which will allow us to be in an even stronger position to address and resolve our remaining higher risk-rated loans in an improving real estate market environment. We remain committed to being responsible stewards of shareholder capital, and we will seek to bring crystallization to our book value in order to enhance shareholder returns. As always, we appreciate you joining our call today, and we'd be happy to open the line for questions.

Operator (participant)

Ladies and gentlemen, at this time, if you would like to ask a question, please press star and then one on your touch-tone phone. If you would like to withdraw your question, simply press star and then two. Once again, ladies and gentlemen, that is star and one if you would like to ask a question. We'll hear first today from the line of Rick Shane, JP Morgan.

Rick Shane (Senior Equity Research Analyst)

Hey, guys. Thanks for taking my questions this morning. Look, you know, 2025 is going to be a year of transition, some acceleration of repayments, increase in deal activity, realized losses. Those seem to be the three big things to consider. I realize you can't give us specificity in terms of what each of those is going to look like, but if you can help us think about the contours in terms of timing front half, back half of the year for each of those three, that would be really helpful.

Bryan Donohoe (CEO)

Yeah, Rick, I'll start and appreciate the question. I'll certainly share the mic with Tae-Sik and Jeff a little bit. I think in our opening remarks, we talked about the pace of market recovery, how that accelerated into year-end. Obviously, rate rise towards the back half and beginning of this year, a little bit of headwind, but really going in the face of capital flows that I think are positive, not just the amount of capital coming into real estate, but the type. You have more rational buyers entering versus kind of a vulture structure that we would typically see in down cycles. In terms of timeline, I mean, I think we touched on the 34% reduction in our four and fives throughout last year.

I think with the capital flows we're seeing, we would expect to maintain that pace in the first half of the year to move to a more tenable allocation towards those risk-rated four and fives. All of that kind of comes together with neutral or more neutral rate environment and those capital flows I mentioned. When we think about more active participation on the deployment side, I think we will like to see first that continued pace of reduction in the four and fives that we were successful in accomplishing throughout the last 12-odd months.

Rick Shane (Senior Equity Research Analyst)

Got it. That's helpful. I appreciate the answer. Thank you, guys.

Operator (participant)

Our next question comes from Doug Harter at UBS. Mr. Harter, your line is open, sir. You may have us on mute.

Doug Harter (Equity Research Analyst)

Hello. Can you talk about what type of environment would be needed to pick up the pace of originations, stabilize the leverage level, and possibly increase the size of the portfolio?

Bryan Donohoe (CEO)

Yeah, certainly appreciate the question. I think, as I mentioned in response to Rick's question, I think the continued reduction of those four and fives will be catalytic to that deployment. As a platform, we were fairly active with almost $5 billion of originations last year in other non-ACRE vehicles. I think the takeaway there is the engine's running and we see a market opportunity that we can and will participate in. As we bring further clarity to some of the asset management issues we touched on, I think we'll look to begin growing the portfolio again. Given the scale of the portfolio, though, we're not talking about a huge number of assets that will perform or behave like an index. It's really, as we've experienced some idiosyncratic events with assets, and there's fewer and fewer of them to asset manage actively.

The goals that we set forth at the beginning of last year to create a larger cash position, reduce those allocations or those assets that are higher on the risk spectrum, I think we've accomplished those goals with a good degree of success. We see a trend line that's positive that will certainly allow us to have the company of Ares Commercial Real Estate Corporation participate in the market opportunity that we're seeing in real time.

Jeff Gonzales (CFO)

I'll just add to that, we've been very purposeful with our balance sheet positioning to give us that flexibility to resolve our four and five rated loans. That's continuing to be our main focus. As Bryan mentioned, once that bucket of underperforming loans is resolved, we are going to be in a position to find accretive opportunities for us.

Doug Harter (Equity Research Analyst)

Great. Thank you.

Operator (participant)

Our next question will come from Jade Rahmani at KBW.

Jade Rahmani (Managing Director of Commercial Real Estate Finance)

Thank you very much. Could you please discuss the Boston life science deal, the dynamics that are going on there? Is it a vacant project? Is it completed? What would be the outlook there? I know life science is challenged and there's still quite a lot of supply.

Bryan Donohoe (CEO)

Yeah, it's a good question, Jade. We appreciate it. I think what we've seen is a pivoting of some business plans, and you could apply that to this asset where, given the supply glut that you've seen accelerate over the past, call it 36 months in that Boston life science market, and you can trace it obviously back all the way to VC funding. The change in that dynamic and the business plan from a full life science use to a more traditional office use obviously is impactful on the one hand with respect to the tenant improvement allowance and the spend, but also ultimately on rents and valuation. That was the catalyst for the change in discourse around that loan. The good part is with the supply of life science being an issue, some of the, we've seen negative supply to some degree in traditional office utilization.

We're working with that borrower to effectuate the best outcome, but certainly the macro environment around that sector is much less positive than it was as our industry group sat here three-odd years ago.

Jade Rahmani (Managing Director of Commercial Real Estate Finance)

In terms of the basis that the loan is, since it's risk for us and there's not a meaningful reserve, but the current carrying value, does it work with this change in business plan, or is that a discussion that's currently underway? Is there any additional life science exposure?

Bryan Donohoe (CEO)

That's the, I mean, we've got some mixed-use assets. That's really the life science exposure in the portfolio, Jade. I'd say that the situation remains fairly fluid with the sponsorship group. I think what we're seeing is that while there's long-term opportunity and enterprise value in this sector, it's a matter of what can get accomplished in the face of that supply that you mentioned. I think the answer is more to come on this asset, but we're in active dialogue.

Jeff Gonzales (CFO)

Jade, just to add on to that, as far as the reserve you mentioned, we did increase the reserve on that asset this quarter, so we do feel we're adequately reserved as is.

Jade Rahmani (Managing Director of Commercial Real Estate Finance)

Okay. If I could ask another question just on multifamily, broader trends. I mean, the performance of multifamily this cycle has been pretty phenomenal with a few exceptions, but generally it's held in really well. Do you think that the changes in interest rates and the outlook have any implications for multifamily credit, or do you expect pretty resilient credit there?

Bryan Donohoe (CEO)

Yeah, I'd say, Jade, and we touched on this, I think, in your Q&A last quarter to some degree. The fundamentals from a leasing perspective have been extremely positive. Absorption rent growth across all the major markets in the U.S. last quarter were pretty remarkable, as you state. I think the rate rise had two impacts, and I think they're really housed more on the equity side rather than the debt side of the ledger, but muted transaction volume, right, where you had, given those fundamentals, sellers that were less willing to part with assets given the change in valuations just on a direct cap basis owing to rates. Also that fundamentals with that falloff in supply, I think the statistic of the ratio between apartment deliveries and new starts has never been wider.

You've positively absorbed a huge amount of supply, and supply falls off a cliff from here. Positive fundamentals really have no signs of abating going forward. The impact of rates was certainly to mute transaction volume and in the immediate term pause the valuation growth in the sector. I think we still feel as a lender very well protected in the capital structure today.

Jade Rahmani (Managing Director of Commercial Real Estate Finance)

Thanks a lot.

Bryan Donohoe (CEO)

Thank you.

Operator (participant)

Our next question will come from Chris Muller at Citizens JMP.

Chris Muller (Director of Equity Research)

Hey, guys. Thanks for taking my question. We saw in a recent Commercial Mortgage Alert that you as an Ares expect to issue somewhere in the range of $500 million to 1 billion of CLOs in 2025, and most of that would come through the REIT here. I'm curious, do you guys have any thoughts on the timing there? If it is that more billion-dollar number, or even I guess on the $500 million, is that something that would be split into two or more transactions, or would you be able to get enough collateral for a larger CLO?

Bryan Donohoe (CEO)

Yeah, I'm not sure that we were as specific around which vehicles would participate necessarily. That said, we've traditionally thought about the CLO market as an opportunistic way to term out the leverage. I think as an industry group, we've seen a lot of constructive movement in terms of repo providers and really narrowing the gap between the leverage advance rate structures that you might find in a CLO execution versus traditional bank repo. Our partnership with those banks is a huge part of what we do across Ares and certainly within real estate and real estate credit. I think in terms of things we would like to see, should we pursue a CLO execution? Clearly, the market wants to see some degree of scale and diversification, both in terms of asset types, vintages, and things like that.

In order to pay the freight associated with a CLO, you're going to want to have that scale to fray those costs a little bit. Clearly, the capital markets movement has been positive for our sector. If, as and when the CLO market becomes attractive to us in our portfolios, we'll judiciously use it. It is a, I think that mechanism is a nice-to-have, not a must-have for us and the majority of our peers.

Jeff Gonzales (CFO)

Yeah, and obviously, we are seeing very competitive pricing from our warehouse lenders. That is a market that they are really participating in as opposed to directly originating. We do see that right now as the most attractive financing option for us.

Chris Muller (Director of Equity Research)

Got it. That's very helpful. I think I probably know the answer to this one, but given the pickup in repairs in the Q4 and then into the Q1, does the magnitude of those coming in impact the timing of any new lending? I guess what I'm trying to get at is, will you guys look to replace any of that runoff with new lending, or is it purely just waiting to get through some of those problem assets?

Bryan Donohoe (CEO)

It certainly works in tandem, I think. The cash position that we've generated, candidly, we think it's an enviable place to be, especially given what we mentioned in the opening remarks regarding that discount to book and the amount of cash that kind of comprises our market value today. As we work through the remaining smaller number of risk-rated four and five assets alongside that very strong cash position and more moderate leverage than the industry as a whole, I think those two things together will be the prompt for further deployment and getting back to portfolio growth.

Chris Muller (Director of Equity Research)

Got it. That's very helpful. Thanks for taking the questions.

Operator (participant)

Once more to my audience today, that is star and one on your telephone keypad if you would like to ask a question. Our next question comes from John Nickodemus at BTIG.

John Nickodemus (VP of Equity Research)

Good morning, everyone, and thanks so much for taking the question. Somewhat similar to what Chris just mentioned, obviously Q4 brought your highest repayment volume of last year. Bryan, you mentioned during your remarks that year-to-date repayments have already exceeded that quarterly level as well. Just with that in mind, and based on what visibility you do have, how should we think about your repayment trajectory for the rest of 2025?

Bryan Donohoe (CEO)

Yeah, it's a great question. As I mentioned earlier, each of these assets behave unto themselves to some degree. If you think about our industry in this floating-rate loan origination schematic, generally we would expect to see a three-year weighted average life on each of these assets. Those types of tenors are interrupted by dynamic market environments, right? We saw with the rate rise, with the change in office, a little bit longer duration in certain assets, and I think collectively throughout our portfolios. There's probably some potential energy that'll lead to an acceleration of those repayments. I think if we were to move over time to get back to that normalized three-year life of an investment, we might see, as we saw in Q4 and thus far in Q1, a little bit more acceleration of that.

Our discussions with borrowers and the fact that you're seeing more capital come into the space should see a little bit of an unnatural acceleration of those repayments throughout the course of this year and a return to more normalized cadence for new originations of assets going forward.

John Nickodemus (VP of Equity Research)

Great. That's all for me. Thank you so much.

Operator (participant)

That is all the questions we have for today, gentlemen.

Bryan Donohoe (CEO)

Great. I'll just close with just an expression of gratitude. I appreciate everybody's time today and your continued support of Ares Commercial Real Estate, and we look forward to speaking with you again on our next earnings call. Thanks, everybody.

Operator (participant)

Ladies and gentlemen, this concludes our conference call for today. If you missed any part of today's call, an archived replay of this conference call will be available approximately one hour after the end of the call through March 12th, 2025, to domestic callers by dialing 800-839-2382 and to international callers by dialing 402 area code 220-7201. An archived replay will also be available on a webcast link located on the homepage of the Investor Resources section of our website. Thank you for joining. You may now disconnect.