Participants

John Stilmar; Partner, Co-Head of Public Markets Investor Relations; Ares Commercial Real Estate Corp

Bryan Donohoe; Chief Executive Officer; Ares Commercial Real Estate Corp

Jeffrey Gonzales; Chief Financial Officer & Treasurer; Ares Ares Commercial Real Estate Corp

Richard Shane; Analyst; JPMorgan

Douglas Harter; Analyst; UBS

Jade Rahmani; Analyst; KBW

Chris Muller; Analyst; Citizens JMP

John Nicodemus; Analyst; BTIG

Presentation

Operator

Good afternoon, ladies and gentlemen, and welcome to Ares Commercial Real Estate Corporation's fourth quarter 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 12, 2025.
I will now turn the call over to Mr. John Stilmar, Partner of Public Markets Investor Relations. Please go ahead, sir.

John Stilmar

Good morning, everyone, and thank you for joining us on today's conference call. In addition to our press release in the 10K that we filed with the SEC, we 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, 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 should not be considered an isolation from or as a 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

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 fourth quarter 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 US for the fourth quarter, 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 4 and 5 risk graded loans and to reduce our overall office exposure. We made solid progress in this area and acknowledge there's still more work to do.
For the full year 2024, we reduced our risk rated 4 and 5 loans by approximately 34% or $182 million. As of year-end, we had five loans risk graded 4 and 5 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 improve the overall quality of our portfolio.
In addition, we collected equity contributions on our risk rated 1 to 3 loans of $38 million in the fourth quarter and $118 million for the full year in the form of loan pay downs, 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 fourth quarter, 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 enhance the flexibility of our balance sheet throughout 2024 with lower leverage and additional liquidity. In the fourth quarter 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 1.6 times, 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 graded 4 in 5 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 dividends 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 our yield 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.
And with that, I'll turn the call over to Jeff, who'll provide more details on our fourth quarter and full year results. Jeff?

Jeffrey Gonzales

Thank you, Bryan. For the fourth quarter of 2024, we reported a GAAP net loss of $10.7 million or $0.20 per common share. Our distributable earnings for the fourth quarter of 2024 was a net loss of $8.3 million or $0.15 per common share, which includes realized losses of $18 million or $0.33 per 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 the distributable earnings loss of $44.6 million or $0.82 per share. Focusing on the fourth quarter 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 fourth quarter 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 fourth quarter. 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 fourth quarter of 2024, resulting in over 75% of the annual repayments for 2024 being collected after June 30, 2024.
In terms of our loan risk ratings, the outstanding principal balance of loans with the risk rating of 4 or 5 increased 12% or $37 million in the fourth quarter. This was largely due to a $51 million senior loan collateralized by a life science office property in Massachusetts migrating from a risk graded 3 loan to a risk graded 4 loan. The increase in total risk graded 4 and 5 loans was partly offset by the restructuring of a previous risk graded 5 $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 3 and a $13 million subordinate note with a risk rating of 4.
In addition, we fully wrote off an $18 million subordinated loan collateralized by an office property in New Jersey which was previously risk rated to 5 and was fully reserved for through our CECL reserve. We also further reduced our office exposure and the number of properties held as REO in the fourth quarter 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 CECL reserve remained relatively stable at $145 million, a decrease of approximately $1 million from the CECL reserve as of September 30, 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 CECL reserves for existing loans, particularly the Massachusetts office life science loan.
The overall CECL reserve of approximately $145 million at the end of the fourth quarter represents approximately 8.5% of the total outstanding principal balance of our loans held for investment. Our CECL reserve is lower on a dollar basis, but higher as a percentage of the portfolio basis driven by the purposeful derisking 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 CECL reserve or approximately $132 million relates to our risk rated 4 or 5 loans.
With strong repayments and purposeful execution, we continue to drive additional financial flexibility by reducing our leverage even further in the fourth quarter. We reduced our leverage at the end of the fourth quarter to $1.2 billion, down 13% from the prior quarter and down 27% from the prior year. Our net-debt-to-equity ratio, excluding CECL, declined to 1.6 times at the end of the fourth quarter, down from 1.8 times in the third quarter and 1.9 times 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 first quarter of '25. The first quarter dividend will be payable on April 15, 2025, to common stockholders of record as of March 31, 2025. At our current stock price on February 10, 2025, the annualized dividend yield on our new first quarter dividend is above 10%.
With that, I will turn the call back over to Bryan for some closing remarks.

Bryan Donohoe

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.

Question and Answer Session

Operator

(Operator Instructions) Rick Shane, JPMorgan.

Richard Shane

Look, 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

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. So you've got more rational buyers entering versus kind of the vulture structure that we would typically see in down cycles.
In terms of timeline, I mean, I think we touched on the 34%-odd reduction in our 4 and 5s throughout last year. And 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 4 and 5s. And all of that kind of comes together with neutral or more neutral rate environment and those capital flows I mentioned. So 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 4 and 5s that we were successful in accomplishing throughout the last 12 odd months.

Operator

Doug Harter, UBS.

Douglas Harter

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

Yeah, certainly and I appreciate the question. I think as I mentioned in response to Rick's question, I think the continued reduction of those 4 and 5s will be catalytic to that deployment. As a platform, we were fairly active with almost 5 billion of originations last year and other non-acre vehicles. So I think the takeaway there, the engine's running and we see a market opportunity that we can and will participate in. And 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, but 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, and we see a trend line that's positive that will certainly allow us to have the company of Acre participate in the market opportunity that we're seeing in real time.

Jeffrey Gonzales

And I'll just add to that, we've been very purposeful with our balance sheet positioning to give us that flexibility to resolve our 4 and 5 averted loans, so that's continuing to be our main focus. And 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.

Operator

Jade Rahmani, KBW.

Jade Rahmani

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

Bryan Donohoe

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 can 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. But 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. So 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 -- you've seen negative supply of some degree in traditional office utilization. So 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

And in terms of the basis that the loan is, since it's risk 4, I assume there's not a meaningful reserve, but the current carrying value, does it work with this change of business plan or is that a discussion that's currently underway? And is there any additional life science exposure?

Bryan Donohoe

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 you'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. So I think the answer is more to come on this asset, but we're in active dialogue.

Jeffrey Gonzales

And 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 [out of] the reserve as is.

Jade Rahmani

And then if I can ask another question just on multi-family, broader trends. I mean the performance of multi-family 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 multi-family credit or do you expect pretty resilient credit there?

Bryan Donohoe

I'd say, Jade, 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 US 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 fundamental sellers that were less willing to part with assets given the change in valuations just on a direct cap basis owing to rates. And also, that fundamentals with that fall off in supply, I think the statistic of the ratio between apartment deliveries and new starts has never been wider.
So you've positively absorbed a huge amount of supply and supply falls off a cliff from here. So positive fundamentals really have no signs of abating going forward, but the impact of rates was certainly to mute transaction volume and the immediate term paused the valuation growth in the sector. But I think we still feel, as a lender, very well protected in the capital structure today.

Operator

Chris Mueller, Citizens JMP.

Chris Muller

So we saw on a recent commercial mortgage alert that you, as in Ares, expect to issue somewhere in the range of $500 million to a $1 billion of CLOs in 2025 and most of that would come through the REIT here. So I'm curious, do you guys have any thoughts on the timing there and if it is that more $1billion number or 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

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

Jeffrey Gonzales

And I'll just add, we are seeing very competitive pricing from our warehouse lenders. That is a market that they're really participating in as opposed to directly originating. So we are -- so we do see that right now is the most attractive financing option for us.

Chris Muller

And then I think I probably know the answer to this one, but given the pickup and repays in the fourth quarter and then into the first quarter, does the magnitude of those coming in impact the timing of any new lending? And 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

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, the book and the amount of cash that kind of comprises our market value today. But as we work through the remaining smaller number of risk rated 4 and 5 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.

Operator

(Operator Instructions) John Nicodemus, BTIG.

John Nicodemus

Somewhat similar to what Chris just mentioned, obviously fourth quarter about 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. So 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

It's a great question and as I mentioned earlier, each of these assets behave unto themselves to some degree, but if you think about our industry in this floating rate loan origination schematic, generally we'd expect to see a three-year weighted average life on each of these assets, and those types of tenors are interrupted by dynamic market environments, right? So 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 will lead to an acceleration of those repayments. And so 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. So our discussions with borrowers and the fact that you're seeing more capital coming 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.

Operator

And that is all the questions we have for today, gentlemen.

Bryan Donohoe

Great. Well, 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

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 12, 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.