Ares Commercial Real Estate Corporation (ACRE) Earnings Call Transcript

Good afternoon. Welcome to the Ares Commercial Real Estate Corporation's Second Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded on Tuesday, August 4th, 2026 I would now like to turn the call over to Mr. John Stilmar, Partner of Public Markets Investor Relations. Please go ahead, sir.

Good afternoon, and thank you for joining us on today's conference call. 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 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, conditions or results and do involve a number of risks and uncertainties. The company's actual results could differ materially from those expressed in 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 for or a substitute for measures prepared in accordance with generally accepted accounting principles. These measures may not be comparable to like-kind measures used by other companies. Now I'd like to turn the call over to our CEO, Brian Donohoe. Brian?

Thank you, John. Good afternoon, everyone, and thank you for joining us. I'm here today with Jeff Gonzales, our CFO; Tae-Sik Yoon, our COO; as well as other members of the management and Investor Relations teams. During the second quarter, we saw the commercial real estate market exhibit relative stability despite broader macroeconomic and geopolitical uncertainty. Property prices appreciated modestly financing markets remained open and liquidity continued to improve. While sales transaction activity did moderate somewhat during the second quarter, we see compelling opportunities driven by refinancing needs and a robust pipeline of floating rate lending opportunities, offering attractive risk-adjusted returns. Consistent with recent trends, private real estate capital continues to increase its role in the market. Today, debt funds have become the second largest source of commercial real estate lending behind banks according to MSCI, reflecting both the continued evolution of the lending market and the growing importance of alternative asset managers. We continue to believe that the scale of the Ares Real Estate platform is a key differentiator in allowing us to access greater institutional quality assets in a diversified manner and efficiently deploying our available capital. The strength of the platform allowed ACRE to deploy over $900 million in new loan commitments in the past 12 months, which represents more than 40% of our current loan portfolio. Supported by these platform benefits and the progress we have made in executing our business plan, we believe ACRE is well positioned to capitalize on market opportunities while continuing to advance our portfolio repositioning strategy. To this end, we have continued to make meaningful progress in addressing risk-weighted 4 and 5 loans while further reducing office loans and REO properties. At the same time, we are strategically redeploying capital into high-quality new investments, largely to support growth in earnings and achieve our long-term portfolio objectives. We believe our second quarter results reflect the continued execution against that strategy. Importantly, key portfolio and financial metrics remain consistent quarter-over-quarter as reflected by our relatively stable CECL reserve. Additionally, for the third consecutive quarter, no risk-weighted 1 through 3 loans migrated to risk rated 4 or 5 ones. We also have no new REO properties and the operating performance across our existing REO assets remain stable. Supported by these metrics, the depth of the Ares platform and a supportive commercial real estate market, ACRE saw another quarter of steady portfolio growth. As of June 30, 2026, we increased the outstanding principal balance of the total portfolio by 36% year-over-year, while improving portfolio diversification and reducing the office loan portfolio. During the second quarter, we closed 3 new loan commitments totaling $130 million across multifamily, self-storage and hotel properties. Consistent with last quarter, all 3 new loan commitments were part of co-investment opportunities alongside other Ares management affiliated vehicles. We believe ACRE's ability to selectively co-invest alongside Ares managed vehicles allows us to reduce asset concentration risk while participating in institutional properties in major markets, which would otherwise be beyond our stand-alone capital base. Loans originated over the past 12 months now account for 42% of the total portfolio of loans held for investment. These loans contribute to broader diversification across vintage, sector, geography and credit while providing gross levered returns in the low double digits. These zones also reinforce the solid foundation of the underlying portfolio. By number of loans, 89% of the loan portfolio is risk rated 1 to 3 and primarily consist of loans collateralized by multifamily, industrial and self-storage loans. These loans continue to execute their business plan in line with expectations. In order to achieve the goals of the business over the past several years, we proactively strengthened our balance sheet to address identified assets within our portfolio that were adversely affected by changing market dynamics or property-specific challenges. The progress we have made in repositioning the portfolio is a direct result of the continued focus on addressing risk-weighted Form 5 loans and REO properties and further reducing our office investments. We believe that resolving these assets and redeploying that capital into yielding new investments remains an important driver of future earnings growth. Let me now dive a bit deeper into the specific investments we continue to focus on and provide an update on the progress we're making towards resolutions. Starting with our risk-rated 4 and 5 loans, similar to last quarter for our 4 loans outstanding. Looking at the largest risk-graded 5 loan in the portfolio, the Chicago office loan remains on nonaccrual, but continues to make its contractual interest payments. Fundamentals at the property remains steady. Occupancy is above 90%, with a weighted average lease term of over 7 years and positive net cash flow. Further, while Chicago remains challenged, there have been positive signs of a nascent recovery in the market. As mentioned in our previous quarter's call, we remain engaged with the borrower on their ongoing sales process. Although the time line has extended beyond our original expectations, we remain encouraged by the negotiations, which continue to advance towards a resolution. We note that post quarter end, the loan was extended from July 2026 by 3 months to support the virus business plan and continued efforts to reach a conclusion in the sales process. Turning to the second largest risk-weighted Form 5 loan. The Brooklyn residential condo remains on nonaccrual, but advancements in the business plan continued during the quarter. Construction on this building is now substantially complete. Our CECL reserve takes into account estimated future costs with remaining cost larger limits of settling payables from completed work and completing punch list items. Early marketing and presales efforts remain ongoing, supporting a more visible path towards resolution. Next, I want to address the $13 million subordinate loan collateralized by a California industrial property adjusted to a risk-weighted 5 from a risk-weighted 4 during the quarter. As a reminder, this subordinate loan is part of the larger capital structure. We continue to receive sponsor support as well as growing interest from prospective tenants alongside positive trends in this submarket. However, with the maturity of the loan in January 2027 we adjusted the risk rating to reflect the higher probability of a near-term realized loss. These updates underscore the highly asset-specific nature of our 4 remaining risk rated 4 and 5 loans. Throughout this cycle, we have proactively identified challenges, deleveraged the balance sheet and enhance liquidity, enabling us to resolve underperforming assets, while positioning the company to address these remaining investments. We believe that our work to date has narrowed the potential outcomes, in part reflected in the stability of CECL this quarter. During the quarter, and consistent with our goals to change the complexion of our investment portfolio, office loans decreased to $442 million or less than 25% of the total loan portfolio as compared to 39% of the total loan portfolio at the end of Q2 2025. As of June 30, 2026, there were 5 risk-rated once 3 office loans remaining, further demonstrating the execution of our strategy to reduce our office investments. Last quarter, we launched the sale of the North Carolina office REO asset. Market interest in this property has been strong, and we continue to work towards the sale of this asset. With regard to our other remaining REO, the Florida mixed-use property continues to exhibit consistent occupancy with an income yield of 10%. While we do not intend to be long-term owners of this property, we believe the current yield of this investment is attractive while we evaluate the optimal path to exit this investment. In closing, we continue to execute the strategy we've outlined over the past several quarters. We are making steady progress resolving underperforming assets while selectively investing alongside the broader Ares platform in high-quality new originations. Although there is still work ahead, the portfolio today is materially different than it was a year ago. It is larger more diversified and increasingly comprised of new investments originated in today's attractive lending environment. With more than $150 million in carrying value of loans, net of CECL not accruing interest, we are squarely focused on resolving these assets and capturing the potential earnings power of our future balance sheet. Looking ahead, we expect repayments to continue advancing our portfolio repositioning efforts while successful asset resolutions will provide additional capacity to support future growth. We are encouraged by the progress achieved thus far and remain confident that the actions we're taking today are building a high-quality portfolio enhancing future earnings power and creating a clear path back to increased levels of profitability. With that, I'll turn the call over to Jeff, who will walk you through our second quarter financial results.

Thank you, Brian. For the second quarter of 2026, we reported GAAP net income of approximately $4.4 million or $0.08 per diluted common share. Our distributor earnings for the second quarter of 2026 was approximately $6.9 million or $0.12 per diluted common share, and there were no realized gains or losses recognized in the quarter. Additionally, during the second quarter, we collected $1.7 million or $0.03 per diluted common share of cash interest on loans that were on nonaccrual and was accounted for as a reduction in our loan basis. We continue to maintain our strong balance sheet position with moderate leverage, which supports further resolution of underperforming loans and future growth. We ended the second quarter with a net debt-to-equity ratio, excluding CECL, of 2.0x. Our portfolio of loans held for investment reached $1.8 billion as of June 30, 2026. An increase of $129 million quarter-over-quarter and $484 million year-over-year. During the quarter, we sold the $69 million loan that correspond to a larger $144 million retail loan that was originated and classified as held for sale in Q1 2026. This short-term hold led to additional earnings from accrued interest and fee income during the second quarter. We anticipate utilizing this strategy opportunistically in the future in order for ACRE to selectively deploy its available liquidity on a short-term basis while capturing attractive economics on high conviction loans. As we continue to reposition the portfolio, we remain focused on maintaining balance sheet flexibility through strong liquidity and disciplined liability management. In the first half of 2026 of repayment, while repayments in the second quarter slowed from the first quarter, we expect repayment activity in the second half to be driven by natural portfolio turnover as well as further resolution. In addition, we continue to maintain liquidity of over $100 million in order to support asset resolutions and new investing activity. As of June 30, 2026, our available capital was $106 million. Supported by our strong liquidity position, deep lender relationships, access to financing and the resources of the Ares Real Estate platform, we believe we are well positioned to continue to execute on our portfolio objectives and future growth initiatives. Turning to our CECL reserve. The total CECL reserve increased marginally to $139 million as of June 30, 2026, an increase of approximately $900,000 from the CECL reserve as of March 31, 2026. This increase was primarily driven by a reserve increase of $1 million related to the new loans closed in the quarter while the CECL reserve for our previously existing loan portfolio was largely flat quarter-over-quarter. The total CECL reserve at the end of the second quarter of $139 million represents approximately 8% of the total outstanding principal balance of our loans held for investment. 94% of our total fees reserve or a $130 million related to our risk-rated 4 and 5 loan and nearly half of the total CECL reserve is attributed to the risk-rated 5 Chicago office loan. Overall, the $130 million of reserves attributable to our risk rated 4 and 5 loans represents approximately 34% of the outstanding principal balance of those risk rated 4 and 5 loans. Our book value remained relatively stable at $8.82 per share. While we still have work to do, we believe that the relative stability of our book value and reserve level reflects the progress we have made in repositioning the portfolio and underlines the strength of the overall portfolio. We believe this foundation, combined with our liquidity and financial flexibility positions us well for the opportunities ahead. Subsequent to quarter end and as part of our ongoing capital allocation framework, our Board of Directors reauthorized our share repurchase program for an additional year through July 31, 2027, authorizing the repurchase of up to $50 million of our common back. We will continue to assess share repurchases relative to other capital deployment opportunities. To conclude, the Board declared a regular cash dividend of $0.15 per common share for the third quarter of 2026. The third quarter dividend will be payable on October 15, 2026, to common stockholders of record as of September 30, 2026. At our current stock price on July 30, 2026, the annualized dividend yield on our third quarter dividend is approximately 14%. With that, I will turn the call back over to Bryan for some closing remarks.

Thanks, Jeff. Before we begin Q&A, we'd like to take a moment to comment on the leadership transition that we announced this morning. Tae-Sik Yoon will be stepping down as our Chief Operating Officer and expect to transition from his day-to-day executive role to serve as a senior adviser to Ares management, including continuing to work with ACRE. . We believe this transition will allow ACRE to continue benefiting from Tae-Sik's deep industry expertise and experience. He will remain a valued adviser to me and the rest of our team as we continue executing on our strategy. On behalf of our Board of Directors and everyone at ACRE, I want to sincerely thank Tae-Sik's for his 14 years of dedication, leadership and significant contributions to the company. One of Tae-Sik's strength has been the active mentorship of the team around him, which has created a deep bench of talent, positioning us well for the future. We at ACRE look forward to his continued guidance in friendship as we move forward together. As always, we appreciate you joining our call today, and we'd be happy to open the line for questions. Operator?

[Operator Instructions] Our first question will come from Jade Rahmani with KBW.

We started the year with investors seeming optimistic around the commercial real estate cycle, yet something most people didn't expect has been the spike in interest rates and the shifting outlook. . Can you comment on your thoughts as to where we are in the cycle, if you're seeing any new pressures emerge either in the existing risk 4 to 5 loan bucket or in the risk 3 area? And also, if you could share a broader perspective about how Ares is viewing the world from a real estate perspective and also within that from his own equity investing perspective.

Yes. Thanks for the question, Jade. I'll start with overall market view and then come back to your question on portfolio a little bit. I guess to start with in terms of where we are in the cycle and what we see out there, it feels like we're somewhere in the fourth in probably in a bit of a rain delay, if that makes sense. With the idea being the digestion of the higher rate seems to be on the come. I think that people still have a viewpoint out there that there may be reason in the future for rates to either stabilize or come down some bit but the inflationary pressures are real. What that leads us to is to continue to avoid heavy CapEx-intensive assets. And while there's always something to do in the addressable universe of real estate, it isn't always the same thing, right? So whether it's equity or credit that we dig into more or less, I think humbly recognizing the cyclicality of our business is a really important attribute of what we've created at Ares in terms of our participation in real estate. So look, I think there's still growth to create out there on the equity side of the ledger, but it is much more intensive at the actual asset level. So the operating expertise is more important than it was in prior cycles. And I think we additionally humbly recognize that the disparity of outcomes on certain assets is candidly broader than it was in prior cycles. So I think there's still plenty to do as we reflect in the refinancing side. Acquisitions certainly slowed for the broader market as a whole in end of Q1 and into Q2. But we're still in a digestion phase for geopolitics and where rates are. And I was looking at the yen versus dollar chart last night. There's more questions out there that I think we as an industry and as an economy needs to answer.

And just the follow-up would be any pressure on the risk-free side. It didn't sound like you had seen anything. Maybe you could also comment on the industrial since we haven't really seen pressure in that space.

Yes. I think, look, we have consistently team around what we think is as of the moment going on in the market and our portfolio, and that is reflected in the risk ratings that you see today. That takes into account market rates, borrower behavior, loan structure and the like. And I think as I said a minute ago, it does recognize or we positioned the balance sheet to be able to allow for changes in that, right? Because I think there has been a very dynamic marketplace for us to digest over the past 3 years. So absolutely, the risk rated wants to. But I wouldn't say any loan is not impacted by the change in rates, but those impacts are part of the calculation for what goes into that risk rating. In terms of logistics, I think it is still asset to asset and market to market. We have been extremely active across the board, equity and debt in the sector. But given the higher rates, which equates to higher carry costs, I would say that the time line that one might be willing to wait to mark-to-market rents. If you start with the premise that rents have gone up over the past 5 to 7 years, the capture of that mark-to-market is going to be shorter in nature than it would have been with lower rates, if that makes sense. There are pressures in an Empire in certain submarkets. But largely speaking, we still very -- still feel very comfortable with the reduction in supply in that marketplace and the long-term viability of Class A industrial around the country.

Our next question will come from Rick Shane with JPMorgan.

First of all, and I'm not big on compliments on earnings calls, but I will throw one out here. Finding a twist on Wall Street's favorite metaphor of what [indiscernible] I got to give you credit for that one. So thank you for making smile with that. In terms of real question. A year ago, you guys had $120 million worth of reserves. In the last 12 months, I think you've realized about $5 million of actual losses. The reserve has gone up to about $140 million since then, again, very conservative. But ultimately, the opportunity here is to recycle the capital that is tied up in the nonaccruing loans. It sounds like Chicago, which represents about 30% of the reserve should be resolved fairly quickly. What is the cadence that we should expect for recycling of the remaining 4 and 5 rated loans over the next, call it, 12 to 18 months?

Yes, it's a great question, Rick, I'd say that look, I think we've said we have narrowed these, we feel like we've narrowed these potential outcomes, but we've consistently over the past few years to position the balance sheet to allow for something unforeseen to occur because I feel like that has occurred in the broader real estate market over the past few years. So I'm going to start with that. You're right that the redeployment of -- if all goes to plan and you're able to resolve that loan, you reduce the office allocation by another 50% or thereabouts and free up capital to reinvest. That is the charge. That's what we set for it to do years ago, and we addressed that in the prepared remarks. So I think in terms of the build back, Jeff, maybe you want to opine in terms of what that leads to but the conditions present, and I think we did a good job framing Rick, in terms of getting through those assets over the period of time that they allow for.

Yes. So I think we have a significant earnings potential tied up in those foreign 5-year loans. I think we said in our prepared remarks, it was about $150-ish million. So I think it happen stages as we resolve these foreign fiber loans that we will increase our earnings to -- up to the dividend level and eventually beyond it. So we are hyper focused on resolving those as efficiently as possible in getting that capital back to deploying an interest-earning loans.

Yes. And I think, Rick, here, right, is the -- if you had a much larger granular portfolio, you'd point to averages and kind of run things off over a period of time. We have isolated these loans and they are somewhat idiosyncratic. So what we've attempted to do is not count it until it's done, but work very hard to accelerate those resolutions. So it's tough to point to a regular cadence. Obviously, we wish it was faster, but a lot of what we're going to deal with over the coming quarters is how can we accelerate those resolutions. And then how quickly can we redeploy. But it's difficult to point to a consistent cadence given almost the idiosyncratic nature of each of them and the behaviors that sit behind those assets.

Fair enough. And again, look, having them fully reserved is the foundation for being able to achieve that. And Bryan, you made a comment that I thought was interesting. You talked about sort of the dispersion in terms of valuations across the industry. When we think about loan types isn't the right word, but transaction types, whether it is a new development, a sort of traditional refi or a workout resolution is that dispersion particularly pronounced? Is that one of the things that sort of drives the slower time line on resolutions right now?

Well, it certainly drove our approach to the balance sheet, right? We felt like I think if I go back in history, the loss severity of certain assets in this cycle has been more broad than typical reserves would have provided for, right? We saw an orphaning of life science assets given what went on with the credits, underlying the tenancy there as well as very heavy CapEx. We see massive dispersion from Park at to Third Avenue on office sector. And so based on that higher loss severity, we wanted to position the balance sheet to allow for those outcomes. But certainly, to your specific question, absolutely, that dispersion will impact velocity.

Got it. And then very last question. implicitly, it looks like the new fundings in the quarter were put on with about a 75 basis point CECL reserve. Is that correct? And is that sort of what we should expect for new originations in this environment as you start to build the balance sheet again?

Typically, you should expect to see on a standard 3-year floating rate loan, around 100 basis points reserve at closing. That's typically what we see that it's usually is lower if it's not -- if it's below a 3-year term.

Got it. And is that what drove it lower this quarter? .