Good morning and welcome to the Ares Commercial Real Estate Corporation's First Quarter Earnings Conference Call. As a reminder, this conference is being recorded on Thursday, May 9, 2024. I will now turn the call over to Mr. John Stilmar, Partner of Public Markets Investor Relations. Please go ahead.

Good morning, and thank you for joining us on today's conference call. I'm joined today by our CEO, Bryan Donohoe; our CFO, Tae-Sik Yoon, and other members of the management team. In addition to our press release and the 10-Q that we filed with the SEC, we've posted an earnings presentation under the Investor Resources section of our website. 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 that 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 expectation of market conditions and management's judgment. The 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 assumes no obligation to update any such forward-looking statements. During this call, we will refer to certain non-GAAP financial measures. We use these as a measure of operating performance. These measures should not be considered in isolation from or as a substitute for measures prepared in accordance with generally accepted accounting principles.

Thank you, John. During the first quarter, we made meaningful progress towards our goal of resolving underperforming loans, reducing the outstanding principal balance of nonaccrual loans by $133 million, as well as reducing our exposure to the commercial office property sector by $70 million, or 8% of our total loans backed by office properties. By addressing a total of four nonaccrual loans during the first quarter, we increased our distributable earnings, excluding losses, compared to the prior quarter, by approximately $0.02 per common share, and further delevered our balance sheet by $138 million to an outstanding balance of less than $1.5 billion at the end of the first quarter. Our focus remains on returning ACRE to its core business of originating loans and managing a portfolio of loans backed by commercial real estate properties in order to earn consistent income to support an attractive level of dividends for our shareholders. Let me now provide more details on the loans that were resolved during the first quarter. First, we sold a $38 million loan that we held for sale at year end 2023 that was backed by a mixed-use property located in California that was on nonaccrual. Second, we agreed to a discounted loan payoff of a $19 million loan backed by a multifamily property located in Washington that was on nonaccrual at the end of 2023. As a result of these initiatives, we realized a loss consistent with the fair value mark and loss reserves held on our balance sheet at year end 2023 and paid down $54 million of debt in our FL4 securitization. Third, we exited a $57 million Chicago risk-rated 5 loan collateralized by a commercial office property that was also on nonaccrual at year end 2023. As a result of this disposition, we realized a loss that was $3 million higher than the loss reserve held against this loan at year end 2023. And finally, we restructured a $74 million loan backed by a Class A newly rebuilt office building located in New York City. At the closing of this restructure, the borrower paid down $5 million of principal, reducing the balance to $69 million, which was split between a $59 million A Note and a $10 million B Note. In addition, it is anticipated that the borrower will contribute additional capital into the building for additional new leasing costs, including tenant improvement allowances. To incentivize the contribution of additional capital, including the initial $5 million repayment of the loan, we have agreed to subordinate our $10 million B note to new equity contributed by the sponsor. This restructuring resulted in returning the $59 million A Note to interest-earnings status while the B note remains on nonaccrual. As a result of addressing these four loans, the outstanding principal balance of loans on nonaccrual was reduced by 31% and our distributable earnings, excluding losses, increased by $0.02 per common share for the first quarter of 2024. Shifting now to our overall portfolio. We ended the quarter with $2 billion of outstanding principal balance across 44 loans. Thirty-six loans totaling $1.5 billion, or 75% of our loan portfolio, had a risk rating of 3 or better. The majority of these loans are collateralized by multifamily, industrial, self-storage, and hospitality properties. As a reflection of the quality of our risk-rated 3 or better loans, borrowers continue to be committed to these underlying properties. Over the past 12 months, borrowers have contributed more than $130 million in additional capital relating to loans risk-rated 3 or better and during the same time period all interest rate caps have been renewed at their prior strike or economically equivalent amounts have been deposited into reserves. Going forward, we will continue to focus on resolving our remaining risk-rated 4 and 5 loans and to reduce our office exposure. During the second quarter, we expect to take a $33 million risk-rated 5 loan, backed by an office building in California, as REO that is currently on nonaccrual. At this time, we believe that our loss reserve on this loan is substantially in line with our current estimate of a potential realized loss. Additionally, despite ongoing negotiations with the borrower, a $69 million loan to an office property located in North Carolina currently on nonaccrual defaulted after the quarter end. We've begun the process of taking title of the office property and importantly, this property is cash flowing such that if and when the property becomes REO, property level earnings will be recognized. With that, let me turn the call over to Tae-Sik to provide more details on our financial results and balance sheet positioning.

Thank you, Bryan, and good morning, everyone. For the first quarter of 2024, we reported a GAAP net loss of $12.3 million, or $0.23 per common share. Our distributable earnings loss for the first quarter of 2024 was $33.5 million, or $0.62 per common share, and was driven by a realized loss of $45.7 million, or $0.84 cents per common share, due to exiting the three loans that Bryan mentioned earlier. Distributable earnings, excluding these realized losses, were $12.2 million, or $0.22 per common share, for the first quarter. Our overall CECL reserve now stands at $141 million, which declined by $22 million versus the $163 million CECL reserve we held as of December 31, 2023. This reduction was driven by a $42 million reversal of existing reserves associated with the realization of losses, partially offset by approximately $20 million of additional reserves on existing loans in the portfolio. The overall CECL reserve of $141 million at quarter end represents 6.9% of the outstanding principal balance of our loans held for investment, which is down from 7.6% as of the prior quarter. Eighty-nine percent of our total CECL reserve, or $125 million, relates to our risk-rated 4 or 5 loans, including $31 million of loss reserves on our two risk-rated 5 loans and $94 million of loss reserves on our six risk-rated 4 loans. Overall, the $125 million of reserves on our risk rated 4 or 5 loans represents 25% of the outstanding principal balance of such loans. Further, with respect to our loans that are risk-rated 4 or 5 at quarter end, there were eight loans totaling $503 million in outstanding principal balance. Seventy-seven percent of the outstanding principal balance of our risk-rated 4 or 5 loans are collateralized by office and one residential condominium property. We did downgrade one $97.5 million Texas multifamily loan to a risk rating of 4 from 3 during the first quarter as the timeline and process of the sale of the underlying property by the borrower has been extended. Before concluding, I want to provide more background on managing our balance sheet. Consistent with our goals, we continue to maintain significant liquidity and further reduced our third-party debt. Driven by the loan exit activities during the first quarter, we reduced our outstanding borrowings by $138 million, resulting in total third-party debt of less than $1.5 billion at March 31, 2024. And finally, we declared a regular cash dividend of $0.25 per common share for the second quarter of 2024. The second quarter dividend will be payable on July 16, 2024, to common stockholders of record as of June 28, 2024.

Thank you, Tae-Sik. We are cautiously optimistic about the modest recovery we are seeing in the commercial real estate markets and tightening spreads in the CMBS capital markets will be supportive in the execution of our near-term goals. We are firmly focused on addressing our underperforming loans and further building liquidity in order to maximize outcomes as we seek to shift our focus from asset management to investing. The timing and path to resolving some of our current risk-rated 4 and 5 loans may make our quarterly earnings trajectory uneven this year, including in the second quarter due to loan resolutions. We remain focused on resolving a number of the identified risk-rated 4 and 5 loans in 2024, which we believe will enable us to achieve higher distributable earnings. As always, we appreciate you joining our call today, and we'd be happy to open the line for questions.

And our first question will come from Doug Harter with UBS.

You talked about using the potentially moving back to investing this quarter. You used the resolution proceeds to pay down debt. Just how should we think about when you might pivot to investing versus continuing to delever the balance sheet?

Yes, I appreciate the question, Doug. Good to hear from you. I think the playbook remains fairly similar to what we've said in prior quarters, which is a multipronged path towards resolution, where we're considering a lot of options with the pursuit of generating more liquidity, which will give us then the optionality as to when we see the opportunities, which have started to present themselves beginning in Q4 with some stability in rates. We saw a bit of a pause with the rate movement over the past six or eight weeks, but ultimately, we are seeing more liquidity, and more acceptance of revised asset values, and ultimately, as we work through the coming quarters, we would intend to get back to that offensive side of the ledger once we've crystallized some more liquidity on the balance sheet. So, the primary goal is to continue to resolve those risk-rated 4 and 5 loans, and the liquidity that should come with those types of resolutions will allow us that flexibility.

Appreciate that, Bryan. And Tae-Sik, can you give us some sense of what sort of drag the four resolved loans, excluding the losses, had on earnings during the first quarter and how to think about the path back towards the dividend?

Sure. As we mentioned, the four loans that were either exited or restructured this quarter added around $0.02 of distributable earnings during the first quarter. That run rate, if you want to call it that, the full quarter impact of that will be higher than the $0.02. But for the first quarter, I think it was roughly $0.02 positive impact.

Our next question will come from Jade Rahmani with KBW.

This is actually Jason Sabshon for Jade Rahmani. It would be helpful to hear an update on how things are going with your repo lenders and on the term loan.

Tae-Sik, do you want to kick off?

Yes. I think we've always maintained what we think is a very strong relationship with all of our lenders, warehouse lenders, term loan lenders, and revolving credit facility lenders. In fact, as you'll notice in our filing this morning, we have continued to work with them, and we greatly appreciate the partnership we have with all of our lenders. But you can see that we continue to amend our credit facility so that we can, again, as part of our overall goal to resolve underperforming loans, optimize the balance sheet with flexibility. So, flexibility is very important to us. And again, we appreciate all the partnership we've had, our lenders who have been willing to work with us to create that additional flexibility on our balance sheet.

Also, on the North Carolina office loan default, it would be helpful to hear more color on how you see that playing out.

Yes, I'll give that a shot. I think, look, we obviously were attempting to work with the borrower. However, the capital necessary for us to restructure that loan and in keeping with what we accomplished on the New York loan we covered in the prepared remarks didn't necessarily make it rational. It's also an asset, as we mentioned, that has positive cash flow, and probably has some occupancy upside in a market that has seen some positive flows of corporate tenancy. So, we think there's some value to be added with a functional ownership group. So, I think the timeline for resolution there will be what it will be. I don't think it's a one to two quarter resolution necessarily. But when we look at situations like this, clearly, we want to see both expertise and capital come to bear on those assets. And as you see in our earnings deck, we feel that we're in a position to bring both of those as a fallback position to having attempted to work with the borrower. So, the timeline will be determined over the next 60 to 90 days. And I think when we chat with you all in 90 days, we'll have a more concrete plan there.

And as a final question, understanding that each asset is unique, but generally, in your book, how have loss severities compared to your expectations specifically for office and multifamily loans, and general commentary on what you're seeing in the market with respect to loss severities would be helpful as well?

I'll start. Look, I think what we've attempted to do over the prior quarters has been to give our best estimate of where we expect to resolve assets and really limit surprises on these calls or dramatic changes in our outlook. And I think we've had some success doing that. As an industry, I would put forth that what's gone on in the office sector has surprised many to the downside in terms of resolutions. That said, we've been as transparent as possible as we've worked through those. I think the lack of transparency generally in the market has probably delayed some resolutions throughout the broader space. And I think, as I said earlier, we're starting to see that crystallize to some degree with stability in rates. So, I think over the coming quarters, you'll see more resolutions in keeping with expectations.

Our next question comes from Stephen Laws with Raymond James.

At the risk of asking something you already mentioned, Bryan, I was a few minutes late, but can you talk about the nonaccruals? I believe it's $292 million remaining. I know you guys made a lot of progress, but is there a goal on some near-term resolution? Some are longer term, but maybe if you look to year end, do you have, say, an idea of where you'd like to exit the year on that number?

Yes. Stephen, I'll start, and I'll let Tae-Sik chime in as well. I think part of the challenge of the industry is measuring a lot of what we do by quarter, but certainly year-end is a good hallmark date to turn the page, so to speak, philosophically and financially. I think what we see is, especially with the offensive side of the market being so compelling, that while managing resolution price, we're going to balance that with resolution timing. So, our conversations with borrowers, if you were to go back to what feels like a long time ago, three-plus years, where extending duration of assets on the book was really the primary playbook. As we sit here today, we'd like to resolve assets and crystallize a lot of those resolutions and get back to the offensive side as soon as possible. So, tough to put demarcation lines in terms of the calendar. However, certainly when we look forward the three quarters to year end, that's a pretty good place to plant a flag. But Tae-Sik, feel free to add some color there.

Yes, Bryan, I think you covered it well. Stephen, I think you probably heard from our opening remarks that resolving our underperforming loans, certainly including the nonaccrual loans, is really one of our top priorities. We're hyper-focused on that effort. We think that will bring a lot better clarity to our balance sheet as well as be accretive to our earnings, as we mentioned. But as Bryan said, I think it's very difficult to provide precise numbers. We did resolve, as we mentioned, about four loans this past quarter, and we hope to continue to report some news on further resolutions in the quarters coming ahead.

Our next question will come from Steve Delaney with Citizens JMP.

Busy quarter for you, and it sounds like it's continuing. With the four nonaccrual loans that you worked on and resolved in the first quarter, and then the two office REOs in the second quarter, I'm having a little trouble rolling all this through. But after these second quarter REOs, can you tell us what is left at this point in five rated loans after the two REOs?

Sure. I can see if I can try to take a shot at that. Yes. So, as we mentioned, there are eight loans that are risk-rated 4 and 5 as of quarter end. This includes the two office properties that we anticipate going REO in the future. We also mentioned a new 4-rated loan, a $97.5 million multifamily loan. And as we mentioned in our closing remarks, the reason it was downgraded from 3 to 4 is that the sale process of the underlying property is just taking a bit longer than we had originally anticipated. This covers three of the eight loans: the two REO plus the one multifamily loan. The remainder consists of loans that have been on our balance sheet for a while, including a mezzanine loan that we put on nonaccrual, a condominium development in New York, and a large office loan in Illinois, along with an industrial asset out in California, the $20 million loan.

Five loans, as we sit today, less than 4 and 5. And I understand this is fluid and things are going to be coming and going, but nice to see some resolutions and some progress there. Bryan, I know this is a decision the Board goes through probably every month or certainly every quarter. But the issue of your current $0.25 dividend and working to maintain that and the opportunity for share buybacks, I guess even with the loss of book value, you're still probably a little below 70% of book. How are you thinking about that in this market where everybody is having problems and you're looking at your stock with a mid-teens dividend yield? Just your thoughts on how the company or shareholders are best served between paying out that cash or buying back your shares here. I didn't notice that you bought any shares in the first quarter. If I overlooked that, please let me know.

No, appreciate the question, Steven. As you said in your prior comment, the market is fairly fluid, and it is something that the Board and management considers each quarter. As we characterized when we chatted 60 to 90 days ago, what we established with the dividend at $0.25 was what we felt was attainable over the near- to medium- to long-term, right? And I think that's something that we will continue to evaluate. Over the past 18 months, I think we as an industry have contemplated the best way to serve our shareholders. That is a combination of dividend, which is the core charge of the mortgage REIT business, as well as the relative value of buying back shares, which we've done previously. So, it's a balanced approach alongside managing liquidity and ultimately crystallizing the best returns possible for our investors. So, I would put forth that I think we'll continue to evaluate that in the coming quarters based on the results of that fluid market.

And our next question will come from Rick Shane with JPMorgan.

I apologize if some of this has been covered. First, as you move from paying down, shrinking the balance sheet to moving back to offense, curious if there are any covenants that you need to be aware of or any limitations related to your debt that could make that more challenging?

Yes. Rick, as we mentioned in response to some of the prior questions, we have been actively in dialogue with our lenders. As you'll notice in our filing this morning in the Q, we are starting to make some amendments to those facilities to ensure that we have the flexibility to implement the strategy that we talked about. So far, our strategy, as Bryan mentioned, is to focus on resolving our underperforming loans, and to do that, we want to make sure we optimize the balance sheet to provide that flexibility. Deleveraging has been a big part of that strategy, as well as maintaining good levels of liquidity. We continue to focus on those two elements. Again, we're proactively working with our lenders to ensure that the covenants and the loan facilities provide us that flexibility to attain the overall objective of resolving underperforming loans. The answer to your question is yes, we are definitely proactively working with our lenders on this.

Yes, I did a search of the Q for covenant and amendment, and I got $150 million of each. So, I wasn't able to find my answer. I'm sure it's in there. Second question, look, if we look at the forward curve and compare one month forward SOFR for '25 today versus where it was in January, expectations are rates are up 100 to 125 basis points from where expectations were in January. I am curious in your conversations with borrowers, or what you're seeing if that expectation that rates are going to be so much higher for longer. Is that driving capitulation? Is it driving people's behaviors to change in a material way from what sentiment was even at the beginning of this year?

Yes, good question, Rick, and a few questions in there. I would say summarily, yes. I think that the stability in rates in Q4 was catalytic in terms of causing some transactions to be consummated. We saw a good pop of activity in Q1, much of which was in the headlines in terms of apartment and industrial trades, and fairly sizable ones. I think that started the process. I don't know, maybe capitulation isn't a perfect word, but for the real estate market to get back to forward looking into consummate transactions. While the rise in rates since that period of time has not been accretive to values, it's clearly in the public and private markets; you'll see a strong correlation to rates in terms of the prints. I do think that the train started to leave the station to some degree, and therefore we expect people to either realize that their assets are worth what they are worth and therefore move on. There's a financial capitulation, but also the time allocation for legacy holders of assets may no longer be worthwhile. On the other side of that positive tone, higher for longer means the yields available as a lender continue to be high and widely publicized. When there is this level of duress in the market, it can be a generational opportunity to invest in equities and structured debt. I think that the stability in rates and then the backing up will lead to more resolutions, whether it's characterized as capitulation or great opportunities.

And with no further questions, I would like to turn the conference back to Bryan Donohoe for any additional or closing remarks.

Appreciate that, operator. Yes, I just want to thank everyone for their time today. We appreciate the continued support of Ares Commercial Real Estate, and we look forward to speaking to you again on our next earnings call. Thank you.

And, ladies and gentlemen, this concludes our conference for today. If you missed any portion of today's call, an archived replay of this conference will be available approximately one hour after the end of this call through June 9, 2024, to domestic callers by dialing 1-800-759-0728 and to international callers by dialing 1-40-220-7229. An archived replay will also be available on a webcast link located on the homepage of the Investor Resources section of our website.