Ares Commercial Real Estate Corp Q1 FY2020 Earnings Call

Good afternoon and welcome to the Ares Commercial Real Estate Corporation's Conference Call to discuss the Company's First Quarter 2020 Financial Results. As a reminder, this conference call is being recorded on May 8, 2020. I will now turn the call over to Veronica Mayer from Investor Relations.

Good afternoon, and thank you for joining us on today's conference call. We apologize for the short delays as we were experiencing a few technical difficulties. I am joined today by our CEO, Bryan Donohoe, David Roth, our President, 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 we filed with the SEC, we have posted 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 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 anticipates, believes, expects, intends, will, should, may, and similar 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, we will refer to certain non-GAAP financial measures. We use these as measures of operating performance and these measures should not be considered in isolation from or as 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. And now, I will now turn the call over to Bryan Donohoe.

Thanks, Veronica, and good afternoon everyone. We wish everyone well during these difficult and challenging times and we appreciate you joining us today. We hope you and your families are safe and healthy and our thoughts are with our front-line responders and all of those impacted by this virus. I also want to thank the team at ACRE and the Greater Ares platform for seamlessly working from home and working so diligently to drive our company forward. We issued our earnings release this morning which showed relatively consistent quarterly core EPS of $0.32 and a GAAP EPS loss of $0.54. Our net GAAP loss primarily reflects the adoption of the current expected credit loss or CECL accounting standard and does not reflect impairment to the loans in our portfolio. I'm going to put these results in context by walking you through our actions since the outbreak of COVID-19 and how our portfolio is currently positioned. After my comments, Tae-Sik will walk you through our earnings, liquidity position and impact of CECL on our earnings in more detail. First, let's discuss what we accomplished during the first quarter prior to the outbreak. Supported by favorable real estate fundamentals and sound leverage levels, we originated $356 million in loans during the first two and a half months of the year. We also raised $73 million in net proceeds from an equity offering in late January completed at a significant premium to book value per share. When the impact of the outbreak became clear, we curtailed new investment activity and worked to further enhance our liquidity position. We redeployed the team to underwrite each asset in our portfolio. Through dynamic and constructive discussions with our borrowers, we focused on the near-term impact on cash flows and the long-term impact on property values. And we're pleased to say that we believe our portfolio is holding up relatively well with all of our loans paying their contractual interest in April. As part of Ares, we received great market insights from our investments in over 1500 companies and approximately 250 property investments across North America and Europe. These insights informed our already cautious view of certain segments during the first quarter. We consciously avoided investments and loans that were solely collateralized by hotels or retail properties throughout all of 2019 and the beginning of 2020. We strategically structured our portfolio to be 95% senior loans and highly diversified with 53 loans across 17 states. Additionally, the majority of our portfolio is in either multifamily, office, or industrial properties. That being said, no asset or portfolio is immune to the economic impact of a prolonged shelter-in-place order like we are experiencing today. Our portfolio includes six senior loans on hotel properties that make up 14% of our outstanding principal balance. The majority of these loans are secured by limited or select service nationally branded properties or portfolios of property, and we're optimistic that these types of hotels will recover faster than certain full-service hotels due in part to lower expense loads. In addition, we have a $10 million equity position in a Marriott hotel in Westchester, New York. This property performed ahead of plan in 2019 and was well positioned heading into 2020. Since the outbreak, we've been actively managing and creating a cost containment plan that will minimize operating expenses for this hotel until the recovery. While we do not have any loans solely collateralized by shopping centers, some of our multi-use properties do have retail components and one has a hotel component. We're working with each of our borrowers that have expressed concerns around their ability to execute on their business plans in a timely manner. We're evaluating each loan on a case-by-case basis and considering certain modifications including extensions of maturity dates and deferrals of interest payments. While we continue to actively manage our existing portfolio, we're also prepared to take advantage of attractive financing opportunities at the appropriate time. We communicate on a daily basis with our real estate equity colleagues, as well as the Greater Ares platform to gain real-time insight into consumer and tenant behavior. As we look at a refreshed investment environment, we expect a continued focus on multifamily properties, offices with long-term leases, self-storage assets, as well as an increasing opportunity set in the retail and industrial sectors. With that, I'll turn it over to Tae-Sik.

Great. Thank you, Bryan, and good afternoon everyone. Earlier today we reported a consistent core earnings of $10.3 million or $0.32 per common share despite many challenges of operating in this environment, as 100% of our loans were current on their debt service payments through the April 2020 payment date. Our GAAP net income, however, was significantly impacted by non-cash losses that we recognized due to the implementation of CECL, resulting in an overall quarterly loss for the first quarter of 2020 of $17.3 million or $0.54 per common share. At March 31, 2020 we reported a book value of 13.95 per common share, down from 14.77 at year-end 2019 inclusive of an accumulative $0.96 per common share impact under CECL. I will discuss our implementation of CECL in greater detail in a few minutes. Prior to mid-March when we started to see the economic impact of COVID-19, we closed seven new loans totaling $356 million in new commitments. Of these loans, a $132 million loan that was originated in the Ares warehouse in the fourth quarter of 2019 was purchased by ACRE in January 2020. Total fundings for the first quarter were $297 million which included initial fundings of $284 million on the seven new loans and $13 million on prior existing loans. With respect to repayments, four loans paid off in the first quarter totaling $107 million in principal balance, a number of which occurred in late March. As of March 31st, our loan portfolio included 53 loans with total loan commitments of approximately $2.2 billion and an outstanding principal balance of approximately $1.9 billion. Turning to our liquidity, as of May 7th we had approximately $50 million in unrestricted cash. In addition, we have $131 million in unfunded capacity under our FL3 Securitization and further capacity under the Ares warehouse line, both of which are available subject to respective lender and third-party approvals. If we are able to fully utilize both capacities, we believe we would generate approximately $20 million to $25 million of additional unrestricted cash. Furthermore, we believe that we could also monetize certain loans without significantly impacting future earnings and book value. In total, if all of these options were fully executed, our total cash position would be approximately $70 million to $75 million on a pro-forma basis plus any net proceeds from the sale of assets. Now let me discuss our liabilities and financings. As we have consistently stated in the past, we have very purposely pursued a strategy of diversifying both our sources of financing as well as the composition of loans that we place with each of our lenders. Our focus is also on match funding our assets and liabilities. With respect to diversification, our $1.6 billion in liabilities at quarter end was comprised of ten different sources of capital. This means that we have six different warehouse lenders, a separate working capital line with City National Bank, a term loan, asset level notes payable with three separate lenders, and our FL3 Securitization. This allows us to spread our counterparty risk and ensure that no single lender has concentrations of loans that we financed with them. For example, as we mentioned in a recent announcement, of the six hotels we have, three are financed within FL3, and the remaining three hotel loans are financed with three different warehouse lenders. In other words, no warehouse lender has more than one hotel loan among the many other loans they are financing for us. Also, we have ten different sources of financing. Other than Wells Fargo and our FL3 Securitization, no other single financing source represents more than 10% of our borrowings at March 31, 2020. As far as our strategy of match funding our assets and liabilities, it's important to note that none of our six warehouse financing facilities contain mark-to-market remargin provisions that are based on changes in market borrowing spreads. Instead, our warehouse lines have remargin provisions based only on the actual credit quality of our loans. Finally, we can't emphasize enough the importance of the continuing strong relationships that we have with each of our warehouse lenders, both at the ACRE level as well as at the Ares management level. We have been working closely with each of them, particularly over the past few weeks. Since mid-March 2020 we have not been formally asked to make any margin calls under any of our six warehouse lines and we are in compliance with all of our loan covenants. However, we did elect to voluntarily make asset-specific pay downs of less than $10 million in total during the past few weeks as part of our ongoing discussions and in light of our overall relationships with our lenders. I would now like to provide an update on our implementation of CECL during and as of the first quarter of 2020. Our initial adoption of the new CECL accounting standards resulted in an initial reserve of $5.1 million as of January 1, 2020, which was recorded on our balance sheet as a reduction of stockholders' equity. It's important to note that this initial reserve amount did not take into account the impact of COVID-19. However, during the first quarter and most notably during the last two to three weeks of March 2020, the economic outlook for the U.S. economy dramatically and adversely changed due to COVID-19. In assessing estimated losses under CECL, we engaged a third-party economic forecasting company to provide us with macroeconomic metrics which we incorporated into our CECL model. The macroeconomic forecast assumes significant declines in GDP, LIBOR rates, and commercial real estate values, along with sharp increases in unemployment. As a result, at March 31, 2020, we increased our CECL reserves significantly by $27.1 million or $0.85 per common share for the first quarter of 2020, which is included in our net income and resulted in our overall GAAP net loss. Similarly, at March 31, 2020, our CECL Reserve stands at $32.2 million or $0.96 decrease in book value per share and represents approximately 1.5% of our loan commitment balance and 1.7% of the unpaid principal balance of our loans. It's important to note that while CECL has a significant impact on our GAAP earnings and book value per common share, CECL reserves are a non-cash item and do not directly impact our actual cash flows or liquidity position. Furthermore, we have not incurred any actual losses or recognized any impairments in our loan portfolio. Additionally, as we mentioned at the outset, 100% of our loans were current and made debt service payments through the April 2020 payment date. Of four loans, although they are two current and we did receive interest until the April 2020 payment date, we made a prudent decision to place them on non-accrual status. These four loans total $105 million in unpaid principal balance and represent 6% of our total portfolio, and include three loans secured by hotel properties and one loan secured by student housing. We made this decision as we believe that the COVID-19 pandemic may put particular pressure on these borrowers and property cash flows. And with that, I will now turn the call back over to Bryan for some closing remarks.

Thanks, Tae-Sik. As you can see from our discussion today, we're incredibly focused on preserving liquidity during this period of disruption and the reopening of our economy. We recognize that dividends are important to our shareholders and we believe there is a strong alignment of interest with shareholders as executives and employees collectively owned approximately 11% of ACRE. In order to have the most information available to us, we expect to announce our decision regarding our second quarter dividend by mid-June following the meeting of our board of directors. This will allow us more time to evaluate cash and liquidity, market conditions, and loan performance among other factors. Importantly, the silver lining that we anticipate, there will be an improved real estate market for investing as the economy starts to reopen and recover. While we remain focused on preserving capital at ACRE, we remain active through complementary funds on the Ares estate debt platform, which we believe will lead to deal flow and future opportunities for ACRE over the long term. At this point, I would like to ask the operator to open the line for questions.

Thank you. We will now begin the question and answer session. [Operator Instructions] Our first question today will come from Steve DeLaney with JMP Securities. Please go ahead.

Thank you. Hello everyone. Nice to be on with you this afternoon. Tae-Sik, the four loans on non-accrual, I did not find that in the deck. I must have missed something. Can I find it in the deck or is that something in the 10-Q?

Sure, Steve. Thanks again for being on our earnings call. I think it is more detailed in the 10-Q. However, in the deck what you will see is in the appendix where we list all of our loans held for investment.

Sure.

You will see that there are four loans plus there is one senior loan under hotels that is identified with a dash effectively and a zero for unlevered effective yield. So the reason we get a zero on unlevered effective yield is because they are put on non-accrual status. And what you'll see is that it's basically made up of three loans that are backed by hotels and one that is backed by student housing, as I just had mentioned. And again, it's important to note that we actually did receive interest on these loans for the April payment date, but these are certainly loans that we expect to experience problems going forward on potentially meeting current debt service.

Got it. Okay. Yes. I did glance at the list there for property types and I just - I didn't pick up the zeros, but thank you for pointing me to that.

Sure. Excellent question. And again, I think it's important to differentiate the different types of mark-to-market or non-mark-to-market types, so this right. And generally put them in two categories. One is that a lender can do a mark-to-market remargining of the facility based upon changes in borrowing spreads. And probably if you have a loan financed with them and your loan pays L plus 350, but under different market conditions maybe that market bond spread for a similar type of loan has increased on L plus 350 to L plus 550, in that situation a warehouse lender could say your loan is worth less than par and therefore we're going to remargin the loan. Our point is, we don't have that type of mark-to-market provisions in any of our facilities. The second type of mark-to-market versions that we talked about is that if you have a deterioration in the credit of the underlying collateral. So let's say of a loan backed by an office building, an apartment building, and those assets in particular suffer an actual credit deterioration. So they lost a major tenant. There was a problem leasing those assets and there's a significant drop in cash flows. If there's an actual credit deterioration and therefore the lender believes that the loan is worth less because the LTV has gone up, the DSCR has gone down, whatever the right credit metrics are, they can then reassess the value of the loan and remargin the loan in that situation. Those are common, I would say, and certainly the type of remargining mark-to-market provisions that we have under our various warehouse lines.

Right. Well, it's good to know. It does not - does not appear that all of your peers have avoided spread base marks from the best we can tell. So thanks for confirming that. And then just lastly for me. Things have changed, and I was wondering if you could give us an update on your repayment outlook. We just used 30%, 35% a year, but I guess we should expect more extensions in this market? Thank you.

Sure. And maybe I can start with that and Bryan certainly to the extent that you have other thoughts on this. But I would tell you that for our cash planning purposes we have taken a pretty conservative viewpoint and assumed for cash planning purposes that little to no repayments will occur over the next call it six to eight months throughout the rest of 2020. Obviously, we do have contractual maturities coming up and we are working very closely with each of the borrowers. But just given the challenges of the capital markets, we have assumed again for cash planning purposes that we do not receive any repayments, but again, I think the important thing is we are working with each of our borrowers. We certainly expect a slowdown, but I don't think the reality is that there will be none. I think that for cash planning purposes that is the prudent assumption to make.

Okay. And I guess if you have a multi - yes, Bryan.

Steve, the only thing I'd add there is with respect to we have a large portfolio of multifamily assets and as one of those factors that will go into repayment velocity as the availability of replacement capital obviously at with respect to cash-flowing multifamily assets which comprises 25 plus percent of our portfolio. The attractiveness of the GSE financings and the continued liquidity in that space may induce probably a higher repayment velocity than some other asset classes, so we'll be well served by that subset of our portfolio.

I'm sure Walker & Dunlop would be glad to take the loan off your hands and give it to Freddie or Fannie. Thank you both very much for your comments.

Okay. Thank you, Steve.

Our next question today will come from Doug Harter of Credit Suisse. Please go ahead.

Thanks. Can you just help put that cash balance you have in context? What you might expect from future funding needs and just again just kind of what normal cash balances you would hold so we can frame that liquidity balance?

Sure Doug. Thank you for your question. To maybe answer your second question first. I mean, clearly prior to mid-March we looked at cash as an important part of our balance sheet. However, having cash and a balance sheet meant that we weren't putting as many dollars to work in terms of our GAAP earnings and our core earnings. So our strategy was to maintain liquidity but try to maintain as little cash balance as possible, so that whenever we have cash balances, we would use to pay down our various revolving credit lines in our warehouse line. Historically, we try to maintain as little cash as possible, I think like most of our peers. Right now, clearly cash is paramount and we want to make sure that we maintain a very, very sufficient level of liquidity in the form of the media cash. At the same time, I think we want to make sure that we do maintain and we anticipate needs of cash, but that we don't overreact and put too much cash on the balance sheet and really strain both our earnings and other important aspects of the company. So what we have done is we have put in place plans to raise additional liquidity on top of the $50 million of cash that we have to make sure that we will have the liquidity needs for things like future funding. If you look at the total, there's about $275 million of future funding that we have. So if you look at the difference between our commitment and our funded amount at March 31st, its about a $275 million difference. Obviously, all of that is not going to become immediately hold in the short term plus there are different uses of that future funding. Some is for continuing the progress of the investment, a lot of it is for what we call good news money in the sense that this is for tenant improvement dollars, this is for leasing commissions when new tenants, new renting tenants come on board. But we are managing both our cash position, the $50 million additional sources liquidity. We mentioned the $20 million to $25 million that we could get from further leveraging our FL3 and our Ares warehouse line. In addition to that, we have additional assets that we could look to monetize. We are balancing our cash position with the potential use of the capital including what we think will be call it $55 million to $60 million future funding over the course of 2020.

Great. And then Tae-Sik, if you could just talk about kind of how the four non-accrual loans kind of fit into the CECL reserves just in kind of how that was contemplated in the amount.

Sure. So in terms of the CECL reserve, even the four loans that replaced non-accrual were part of our CECL reserve. Just to clarify that non-accrual does not mean impairment or specific reserve, so that the four non-accrual loans were part of our overall CECL reserve. It's also important to again reiterate that the four non-accrual loans did in fact make their interest payment for the April 2020 payment date, but we believe that these four loans we identified as ones where we felt that the financial condition of the asset had a direct impact that COVID-19 is having on these four borrowers and these four assets were particular and we felt that it was a prudent thing to do to put them on non-accrual status again, despite us actually having received the cash. And so I think that's really the genesis and background. So again they are included in our CECL reserve, but we thought in addition to a higher level of CECL reserve that putting it on non-accrual status was the prudent decision at this moment.

Thanks Tae-Sik.

Thank you, Doug.

Our next question today will come from Rick Shane of J.P. Morgan. Please go ahead.

Hey guys. Thanks for taking my questions. And I basically have three different topics I'd like to cover. In the student lending portfolio, I'm curious how we think about the underlying equity. Who are your counterparty generally? Are these universities or are these more typical private sponsors?

In our portfolio, it's not directly on campus affiliated with the university, so it's private owners with access to additional capital in most cases.

Got it. And the non or the student loan that you have on non-accrual is that really a function of the pending maturity?

That's correct. Yes. I mean, there's a lot of factors obviously that go into that designation. But what was unique about it was obviously some of the unknowns that we have with respect to student housing. Many of our assets were performing very well year-over-year. But given the maturity of that specific asset as Tae-Sik pointed out, we made the conservative and prudent decision to move it to non-accrual.

Got it. Okay. That's helpful. It certainly makes sense in light of what we're seeing. Second topic, you do show in the multifamily portfolio two main maturities, they're significant, they are fully accruing, that's obviously a good sign. Should we think of those two loans as a source of liquidity given their status and the timing on them?

I'd say, I think overall we view the multifamily portfolio as I said earlier as a potential source of liquidity. I can't comment specifically on that situation, but given the consistency of performance and the secular growth in the apartment sub-sector I think we feel good about using that as a liquidity source in certain instances, but I can't really weigh in specifically on those two assets.

Understood. I appreciate that. I got asked the question though. The last topic on the three non-accruals I am curious, because I think our view is that we're moving through three stages, and the second stage is going to be largely about sponsors buffering properties for these short-term issues. On the three non-accruals what are the conversations you're having with the sponsors? And specifically I'm curious, do you see these as either sponsors sort of a little bit of brinksmanship with you? Do you see these sponsors who are strategically willing to walk away because those particular properties are so underwater or the sponsors who just may not be in a position in order to provide that buffer that I'm describing?

It's a good question. I think what I'd point to is, one, we've had very constructive dialogue with each of our sponsors and we're trying to work as I think we've seen the edict from government or similar entities of trying to just get through what we're seeing as the near-term liquidity crunch that we're seeing at a macro level. But specifically as it relates to lodging and I guess secondarily retail assets, the conversations on these loans are no different. It's been constructive at the appropriate attachment points foreseeing the ability of sponsors to reinvest in certain circumstances and we're working through the unique attributes of each situation. But thematically, there's nothing that I could point to as uniform among the three assets that we're discussing here.

Okay, great. Thank you for taking my questions. And I really hope you and your families are all well.

Thank you, Rick.

Our next question today will come from Jade Rahmani of KBW. Please go ahead.

Thanks very much. Nice to hear from all of you and hope you're all doing well. I wanted to ask about the amount of cash that you are targeting to hold down the balance sheet?

Sure Jade. Thanks again for your participation and question. As I mentioned, we want to be anticipatory of how much cash will be necessary to meet all of our uses, whether that's future funding, whether that's rebalancing any loans, whether it's for any other reason. Right now, we feel we have that adequate amount of cash. Having said that, we absolutely want to be anticipatory, and so we have lined up a number of options to raise more additional cash if and when necessary. Obviously, we're not going to wait till the last moment in any way, but at the same time we don't want to overreact and do things that longer-term would not be beneficial to the company. So just to mention a few things, as I mentioned in my prepared remarks we do have about $20 million to $25 million of additional cash that we're currently working on to free up in terms of utilizing capacity we have in FL3 which is very important, as well as our Ares warehouse line. In addition to that, as Bryan mentioned, I think we have a very strong focus on senior multifamily loans. If you look at our portfolio snapshot at March 31st, you'll see that we have about 13 loans totaling over $500 million of unpaid principal balance. We do believe on a relative basis, senior multifamily loans probably offer the most liquidity if and should that time come to potentially monetize some of our assets. To maybe add a little bit more color, of those 13 loans totaling a little more than 500, 10 of those again totaling a little more than $400 million of unpaid principal balances are not in our FL3 Securitization; in other words, they are financed with different warehouse parties. And so they would be relatively easy to get out of those warehouse facilities again if we were to look to potentially monetize those loans in some way. We also have about nine loans consisting of eight mezzanine positions and one senior position that are not financed under either FL3 or any of our warehouse lines. Again the balance on these eight positions is about $116 million and again they don't have any specific warehouse debt or FL3 financing associated with it, so that would again be another source of liquidity if and should that need arise. So to answer your question, we have $50 million today. We are very focused on liquidity. We're very focused on anticipating capital needs. We want to make sure we have all of the options at the table if and when they are needed. But we don't feel that we want to pull the trigger too early if those needs don't arise. So we're very anticipatory. We're ready. But we're going to do it if and when the right moment arises.

Thank you. Turning to repayment expectations. What are you expecting as sort of minimum levels of repayment? Are you expecting any repayments? What's a range to think about? And a related question would be whether you are talking to any borrowers about any discounted payoffs?

Sure. Maybe I can start and Bryan please chime in. In terms of anticipated repayment of loans, we certainly do have a number of loans that have maturity dates coming up in 2020. Those are loans in particular that we are working very closely with the borrowers to see what their specific situations are. We do think that in the multifamily sector without getting into any particular loan, we do have a number of loans that have 2020 maturity dates and we do believe those are loans that we will be working most closely with to see what their refinancing and/or sale process would be to meet the maturity dates of the loans. Alternatively, we could again as we talked about, sell any of these loans as well, again, as a way to monetize the value we have in these loans. I don't think I have a specific answer for you in terms of is there a minimum pay down, as I mentioned before, for liquidity planning purposes we're making the very conservative assumptions that essentially little to no repayments occur in 2020. That is obviously a very conservative viewpoint, but we think one that's prudent to take in this environment. So that when we plan our liquidity over the next eight months that's the underlying assumption that we're making. But having said all that, we are working very closely with each of our borrowers to make sure that if they're able to refinance, even if it's not under ideal terms, but they're able to finance that, they pursue those strategies to make that happen.

And the last thing I'd add there, Jade and Tae-Sik is this book is also comprised primarily of loans to bridge the improvement of the underlying assets. So as assets have gone through their lifecycle and our borrowers and our capital has provided the cash in order to improve upon these assets and that's in many cases resulted in improved leasing to either improve occupancy in multifamily assets or in certain instances get credit tenancy with long-duration leases as with the original business plan. As those investments come to the normal course of their life cycle and mature those sponsors want to realize the value that they have created. While capital markets may not be perfect across the board, we still see liquidity for credit tenancy and liquidity for multifamily assets and while it's difficult to predict, we do believe that in certain instances that will induce repayment.

Thanks. I want to ask one last question sort of a high-level question, but just touching on ACRE's historical focus do you expect number one, secondary markets to come back faster than gateway cities based on less density and being quicker to move beyond lockdown? Secondly, what gives you confidence that multifamily credit will hold up this cycle where in the last cycle we had access home ownership that spilled back into the apartment space and bolstered occupancy there?

With respect to your first question regarding gateway cities, I think you've got a little bit of a push and pull in which capital flows have historically moved towards those cities. But obviously the population concentration given what's occurring today could potentially run counter to that. The thesis that we've always had at ACRE and will continue to have is that we don't expect to be an index of property values in any given market or throughout the broader landscape. We think that we've selected and will continue to select assets that will outperform a given market, whether it's a gateway city or secondary. If you've seen where we've invested over the previous quarters, it's largely been in areas that will benefit from tax migration, so lower-cost areas. That was a response to that secular shift of the population and the companies that are tracing that population movement, and also just the fact that those gateway cities were also priced to perfection in many instances. So we've been moving away from them historically and we would expect that to continue.

Thanks for taking the questions.

Of course.

Our next question today will come from Stephen Laws with Raymond James. Please go ahead.

Hi. Good afternoon. I'm glad to hear from everybody, hope all are well. I want to start maybe with I think with page six from the deck with the LIBOR breakout, appreciate the color on the LIBOR floors. Can you help me think about, obviously there's been a tremendous benefit there with the LIBOR decline since quarter end. But on the opposite side, take how do we think about that the recurring, non-recurring items, origination fees, or repayment fees? How much of Q1 looks from that? Or how much of a decline do we expect with that largely going to go away? And how much of then you'll be offset by modification fees that you may charge them the modification?

Sure Stephen. Thanks for that question. Now I think, number one I think our LIBOR flows have served us well in a very volatile LIBOR environment. And one that right now has been very beneficial to ACRE in terms of maintaining a very strong overall unlevered effective yield again despite very challenging conditions. In terms of origination fees, as you mentioned, clearly that's been a nice part of our earning stream in the past. The way we recognize origination fees is that we amortize it over the expected life of the loan. If we receive a one-point origination fee on a three-year loan, we're not going to recognize it upfront. We're not going to recognize it as a whole 1% upfront. We're going to recognize it and amortize it over the three years. You will still see the benefit of origination fees and originations that we have done in the past come through our earnings. Similarly, I would say that if you look at our financing costs, when we borrow money from our lenders, we also pay origination fees on those loans on those liabilities. Again, those are also amortized over the expected life of those financing facilities. So in many ways, from a cash perspective, as well as from an earnings perspective, both GAAP and core, those two tend to not exactly firm by any means, but those tend to offset each other to a pretty good extent. I don't think origination fees or origination expenses that we would have are going to be a meaningful differentiator between cash flow and our earnings.

Great. Appreciate the color on that. Shifting to the hotels and looking at the ones that you're still accruing interest for. So pretty unique locations across the four. So I guess a couple of questions here just trying to get a gauge on this asset class and your exposure. What is your feedback from those four borrowers that are still paying given their specific locations and what they're experiencing? Any modification discussions you're having with them? And on the other side, I know in your prepared remarks you talked about no one counterparty I think has more than one hotel loan. If you do need to modify one of these loans do you already have approval from your counterparties to do so? If so, what are some examples of what that encompasses? I'm trying to get an idea of where the ones that you're still accruing interest for our performance standpoint and what your options are to address that if they are in a distressed environment?

Sure. Thanks, Stephen. Again, it's tough to point to any overarching theme other than obviously the economic downturn and lodging being somewhat tip of the spear for the risk that we're seeing. Overall though, as I pointed out in my prepared remarks, these are generally limited or select service hotels. The reason that's important is the expense load in a full-service hotel specifically in some of the gateway cities we mentioned earlier will have a very high expense list. So beyond just debt service, operating expenses will create a pretty significant hole in the income statement that will have to be filled somewhere. The fact that we've invested one in certain portfolios so that diversity within our specific investment and the optionality in terms of the way you potentially restructure those types of transactions and the limited drag from ongoing expenses is an important factor to take into account. With respect to your question regarding correspondence or how we then work with our senior lenders. Not to speak about anything specific. But to the extent that we're agreeing with a sponsor to restructure in any way, then that's done in concert with our senior lender. And as you know we've got a full Capital Markets team to manage that communication and the overall relationships that we have and the fact that we're very forthcoming and communicate regularly with our partners on the finance side positions us very well there. But specifically to the extent we were to extend the maturity date of a loan for instance, that might be done in concert with a payment from the sponsor guided for a pay down of some kind of alike. And to the extent that was the case then that would be passed along in many instances to the senior lender to kind of go along with that restructure. But all of those conversations to date have been extremely constructive.

Great. And then to tie that back to the first question if you were to do that and extend the duration, would you then slow down the amortization of the original origination fee because it's now over a longer period of time?

We would, yes. But we thought the loan was going to extend and in fact particularly if we modify the loan so that it doesn't extend, we would amortize the remaining balance to see over a longer time.

Great. And then my final question. I appreciate the time. The pre-funding facility, something unique that others don't have. Can you maybe give us any details? I mean, I know it was there to help manage cash flow and availability. At what point do you see liquidity or is there a leverage level or you get comfort around payoffs that you start to pre-fund loans on that facility? Is there a maximum length you can leave them there? Could you go out and do a bunch of L plus 15 loans now and pull them down in six or twelve months? And then for a risk standpoint can we go the other way, if you have financing problems in your portfolio can you go backwards and move a loan back there temporarily or is it simply for pre-funding only? Any color around that would be great, but do you think this is a unique feature of ACRE that others don't have?

Sure. Thanks for pointing it out, Stephen. We do think the Ares warehouse line is an incredibly important and advantageous tool that we have at ACRE and certainly one of the huge benefits that we at ACRE get from being managed by Ares management is Ares warehouse line. We have traditionally, and certainly the primary purpose of the Ares warehouse line was to do what you stated Stephen which was to allow us to originate loans that exceeded the balance sheet capacity of ACRE at that moment, put that on the Ares warehouse line, so that when a loan paid off within ACRE or other liquidity was available on ACRE, there would be a readily stable of loans that we could pull down and not incur the drag of cash on the balance sheet that would not deploy. Having said all that, I do think we are looking to, if you want to call it reverse engineer the use so that if ACRE is looking for more liquidity rather than trying to invest this liquidity, trying to create more liquidity, there is a possibility of reversing the directions so that a balance sheet loan that ACRE holds directly today could be sold to the Ares warehouse vehicle and thereby free up capacity and liquidity within ACRE. So that is certainly a possibility and certainly something that we are absolutely looking into.

Well, that's great color. I've been wondering if that was potentially an option and it sounds like it's something you guys have been working on or at least considering. So that's good to hear and at some point coming out of this, I feel it's going to be really attractive to shift that. So I think that will allow you guys to do it faster than others even if your stock valuation may be lagging that term. So thank you for the comments and have a good weekend.

Terrific. Thanks so much, Stephen.

Showing no further questions, this will conclude the question and answer session. At this time, I'd like to turn the conference back over to Bryan Donohoe for closing remarks.

Thank you. I want to thank everybody for joining the call today, and I also want to thank the team at ACRE that's working so hard to best position us moving forward. I'm very proud of the team. To all of you, we appreciate your continued support at ACRE throughout this unprecedented disruption and we look forward to speaking to you again soon on our next earnings call. Thank you all for joining.

This concludes the 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 this call through May 21, 2020 to domestic callers by dialing 1-877-344-7529 and to international callers by dialing 1412-317-0088. For a replay, please reference conference number 101-41-810. An archived replay will also be available on a webcast link located on the homepage of the investor resources section of our website. The conference is now concluded and you may now disconnect your lines.