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Edited Transcript of ACRE earnings conference call or presentation 21-Feb-19 4:00pm GMT

Q4 2018 Ares Commercial Real Estate Corp Earnings Call

Chicago Mar 7, 2019 (Thomson StreetEvents) -- Edited Transcript of Ares Commercial Real Estate Corp earnings conference call or presentation Thursday, February 21, 2019 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* James Alan Henderson

Ares Commercial Real Estate Corporation - President, CEO, CIO & Director

* Tae-Sik Yoon

Ares Commercial Real Estate Corporation - Partner, CFO & Treasurer

* Veronica Mendiola Mayer

Ares Commercial Real Estate Corporation - VP of Public IR & Communications

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Conference Call Participants

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* Benjamin Ira Zucker

BTIG, LLC, Research Division - Analyst

* Douglas Michael Harter

Crédit Suisse AG, Research Division - Director

* Jade Joseph Rahmani

Keefe, Bruyette, & Woods, Inc., Research Division - Director

* Kenneth Matthew Bruce

BofA Merrill Lynch, Research Division - MD

* Stephen Albert Laws

Raymond James & Associates, Inc., Research Division - Research Analyst

* Steven Cole Delaney

JMP Securities LLC, Research Division - MD, Director of Specialty Finance Research and Senior Research Analyst

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Presentation

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Operator [1]

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Welcome to Ares Commercial Real Estate Corporation's Fourth Quarter and Year Ended December 31, 2018 Earnings Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded on Thursday, February 21, 2019.

I will now turn the call over to Veronica Mayer from Investor Relations.

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Veronica Mendiola Mayer, Ares Commercial Real Estate Corporation - VP of Public IR & Communications [2]

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Thank you, Allison. Good morning, and thank you for joining us on today's conference call. I'm joined today by our CEO, Jamie Henderson; our CFO, Tae-Sik Yoon; Carl Drake and other members of Investor Relations. In addition to our press release and the 10-K that we filed with the SEC, we have posted an earnings presentation under the Investor Resources section at 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 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 a substitute for measures prepared in accordance with the generally accepted accounting principles. These measures may not be comparable to like titled measures used by other companies.

I will now turn the call over to Jamie Henderson, who will begin with our fourth quarter and full year 2018 highlights.

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James Alan Henderson, Ares Commercial Real Estate Corporation - President, CEO, CIO & Director [3]

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Thank you, Veronica. Good morning, everyone, and thanks for joining our call today. I would like to start the call today by recapping some 2018 highlights for our business, including a review of the initiatives that we put in place to enhance our profitability. I will then discuss our 2019 outlook and address the latest increase to our quarterly dividend.

As you can see from our earnings release this morning, we closed 2018 on a very high note with $0.35 and $0.38 of GAAP and core earnings per share, respectively. This capped off a great year for ACRE with GAAP earnings of $1.35 per share and record core earnings of $1.43 per share, up 27% from 2017. Additionally, our return on equity from core earnings increased to approximately 9.7% for 2018, from 7.7% for 2017.

Our strong quarterly and annual earnings are the result of very deliberate steps that we took over the course of the year to achieve a higher and more sustainable level of earnings, including improving our deal sourcing and operational capabilities, continuing our rigorous credit processes with a portfolio comprised almost entirely of senior loans and further reducing the borrowing spreads on our liabilities.

Let me now spend a little time discussing each of these efforts. Early in 2018, we set out to enhance our origination capabilities in order to broaden our investment scope. We also focused on further aligning ACRE with the broader Ares Management platform and our U.S. real estate private equity business in particular. As a result of these enhancements, the number of opportunities that we evaluated more than doubled with over 1,000 potential transactions reviewed in 2018. The growth in our pipeline of opportunities enabled us to remain highly selective closing less than 5% of the transactions we reviewed.

By expanding our origination capabilities and broadening our investment scope, we're able to improve the average amount of capital deployed throughout the year, which helped drive higher profits. For example, we held about 12% more in average earning assets during 2018 as compared to 2017. As you may recall, we also announced that Ares Management recently closed a $200 million real estate debt warehousing vehicle that will hold Ares originated real estate loans. Going forward, we believe that this warehouse provides us with the ability to better match the timing of our repayments with new loan originations and will further enhance our ability to remain more fully invested.

We also focused on positioning our portfolio to benefit from market conditions. With approximately 99% of our portfolio in floating-rate loans at the beginning in the year, we benefited throughout the year as our weighted average unlevered effective yield increased from 6.3% at the end of 2017 to 7.1% at the end of 2018.

Finally, we continued to reduce the borrowing spread on our liabilities. During 2018, we renewed or extended over $900 million of revolving facilities with similar or improved financing terms. In 2019, we continued to enhance the efficiency of our financing sources by expanding the size of our existing securitization to $445.6 million and reducing the initial borrowing spread.

Turning to recent investment activity. Despite the capital market volatility that began in Q4, commercial real estate fundamentals remain stable in our view with continued strength in rental growth, occupancy rates and transaction volumes amongst other factors. In the fourth quarter, we originated $182 million of new commitments in 6 senior loans and 1 subordinate loan across multifamily office and residential condo sectors. These loans were also geographically diversified across 6 different markets.

For all of 2018, we originated $609 million in new commitments across 18 loans in 24 different markets. Year-to-date, we have closed over $130 million of new commitments, and we have a strong and building pipeline of investment opportunities that we expect will enable us to be nearly fully invested within the next 30 days.

As we look forward, we believe that ACRE is well positioned with a stable, primarily senior-oriented portfolio and we see levers in place for driving additional earnings upside potential for ACRE. We remain laser focused on further optimizing the returns from our capital base by increasing the average amount of capital deployed in loans throughout the year. In particular, we believe that the availability of the Ares warehouse is a significant competitive advantage to allow us to be more fully deployed and drive higher earnings. Given our confidence in the stability of our earnings and the further upside potential generated from the strategic initiatives that we have discussed, we have declared a first quarter 2019 dividend of $0.33 per share. Since the beginning of 2018, we have now declared 4 dividend increases totaling $0.06 per share over our fourth quarter 2017 dividend. We have also fully covered our dividends from core earnings by more than 120%.

I will now turn the call over to Tae-Sik to discuss our fourth quarter and full year results in further detail.

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Tae-Sik Yoon, Ares Commercial Real Estate Corporation - Partner, CFO & Treasurer [4]

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Thank you, Jamie, and good morning everybody. This morning, we reported GAAP net income of $10 million or $0.35 per share and core earnings of $10.9 million or $0.38 per share for the fourth quarter of 2018. For full year 2018, we reported GAAP earnings of $38.6 million or $1.35 per share and core earnings of $40.8 million or $1.43 per share.

During the fourth quarter, we continue to benefit from a higher amount of our capital put to work in investments, from rising short-term interest rates and from further reduced borrowing spreads. We also received additional interest income that was specifically built in, in connection with the repayment of certain loans that I will cover in a little bit more detail.

On the dividend front, in 2018, we paid an annual dividend of $1.16 per share and as you just heard, declared a $0.33 dividend for the first quarter of 2019, which represents an attractive 9.4% annualized dividend yield based on yesterday's closing price of $14.03 per share. This is also the third consecutive year that we have fully covered our dividend from core earnings.

As expected, we experienced a greater-than-average level of repayments during 2018 totaling $747 million. This included the repayment of 2 loans totaling approximately $199 million at the end of November comprised mostly of self-storage properties. As part of the repayment process, we purposely built in and received additional interest income during the quarter amounting to approximately $0.04 per common share in the fourth quarter of 2018.

During 2018, we continued to improve our borrowing spreads on our debt facilities. We renewed or extended over $900 million of bank facilities, all with similar or improved terms. At the same time, we continue to match fund our assets and liabilities where our liabilities have longer maturities than our assets. For example, as of December 31, 2018, we had a weighted average remaining term of 4 years on our funding facilities including extensions. This exceeds the approximate 2-year average remaining life of our aggregate loans held for investment.

A few weeks ago, in early January, we announced that we upsized, refinanced and extended the investment period of our existing $272.9 million privately placed securitization. Together with the investment grade notes issued in March 2017, the securitization now totals $445.6 million in senior notes held by third parties. This transaction further strengthens our balance sheet and supports a higher level of earnings by reducing our overall borrowing spread and providing a more efficient, match funded, nonrecourse source of financing.

By using the capabilities of Ares Management to structure and execute the transaction internally, we are able to significantly save on cost with no placement or structuring fees. Our relationship with a single high-quality investor allowed us to privately place the transaction reducing market risk and achieving better terms. We were also able to extend the reinvestment period by an additional 2 years giving us the ability to replace repaid loans in the pool rather than using proceeds to repay the loans upon maturity. We also improved our borrowing spread as the newly issued notes now have a blended initial weighted average coupon of LIBOR plus 1.7%, representing a 15 basis point decrease in the cost of funds, which we expect to add more than $0.02 per share of earnings per year.

Overall, our investment portfolio continues to perform well as demonstrated by no losses or impairments, stable occupancy rates and debt yields. We continue to believe that our direct origination platform and the broader Ares resources, along with our deep asset management capabilities, provide many operational and informational advantages in our investment process. For example, for the $2.7 billion of loans that we have exited since inception, our borrowers have increased the property cash flows by approximately 18%, which highlights the value creation of partnering with quality sponsors with achievable business plans.

Before turning the call back over to Jamie, I wanted to bring your attention to one loan we have discussed in the past, a $38.6 million senior loan collateralized by a nationally branded full-service hotel in the New York area. At year-end, the loan was in maturity default as noted in our 2018 10-K. The hotel property, however, continues to demonstrate year-over-year stable to growing performance in terms of occupancy, daily rate and net operating income from 2017 to 2018. Most importantly, the hotel property continues to generate sufficient cash flows to fully cover regular interest payments and all regular interest payments on this loan are current as of this time.

In addition, a cash trap has been in place so that no excess cash is being distributed to the borrowers. As we mentioned previously, the hotel was recently renovated and is managed and branded by a well-known national hotel company. Our in-house asset management team has spent many hours extensively reviewing this property and the market in which it operates. We also engaged an appraiser to provide us an updated third-party valuation. Based on all the information we have and the analysis we performed, we have not put this $38.6 million senior loan on nonaccrual status and have not taken an impairment on this loan as of year-end 2018. We continue to have discussions with the borrower regarding our options under the loan documents.

And so with that, I will now turn the call back over to Jamie for some closing remarks.

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James Alan Henderson, Ares Commercial Real Estate Corporation - President, CEO, CIO & Director [5]

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Thanks, Tae-Sik. In closing, I want to thank the team for all of their hard work this year. 2018 was a very good year for ACRE, one in which we generated record core earnings and attractive returns on equity resulting in 4 dividend increases since the beginning of 2018. Given the steps that we have implemented to remain more fully invested and to continue our rigorous credit selection and portfolio management process across a diverse portfolio of assets, we believe that we are very well positioned for another good year in 2019.

Going forward, we believe that we have achieved a higher and more sustainable level of earnings, and our objective is to continue to earn and pay a stable and growing dividend as we execute on our plan to achieve greater scale and to reward our shareholders.

With that, I would like to ask the operator to open the line for questions. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question will come from Steve Delaney of JMP Securities.

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Steven Cole Delaney, JMP Securities LLC, Research Division - MD, Director of Specialty Finance Research and Senior Research Analyst [2]

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Congratulations on a strong finish to the year. I guess, I'd like to start thinking about repayments. Obviously, the portfolio has grown to about $1.5 billion in outstanding. If we were to think about trying to project out in 2019 on a percentage basis based on, I guess, the year-end portfolio or the average for 2019, could you give us a sense of what the range of expected prepayments or repayments might be and near term as far as the first quarter if you're expecting or seeing anything there that could give us a little insight into what we might expect?

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Tae-Sik Yoon, Ares Commercial Real Estate Corporation - Partner, CFO & Treasurer [3]

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Sure, Steve, this is Tae-Sik. Thanks very much for your question. So in terms of repayments, I think, in 2018, we did a higher than what we would call our 3- to 4-year average. I think the last 3 to 4 years, we have averaged right around $600 million to $650 million. Last year, as we mentioned, we had $747 million. But again, just want to note that it was partly impacted by the fact that we had the 2 large loans totaling $199 million, the self-storage loans that was paid off in November. So those were obviously lumpy components of the overall portfolio.

I think in 2019, I think we're expecting probably right around average to above average. So call it $600 million to $700 million. I don't think we're expecting what we did experience in 2018. Obviously, this will depend upon execution of the borrowers business plans, it will depend upon overall market conditions, but our -- sort of, our forward-looking estimates on repayments is sort of in that slightly higher than 3- to 4-year historical average in the $600 million to $700 million level for 2019.

First quarter, I don't think we expect anything unusual. Good news again is that there isn't a huge lumpy loan that we had in the past. So I think you'll see it smooth out a little bit quarter-to-quarter. But obviously, we keep a very close forecast on this.

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Steven Cole Delaney, JMP Securities LLC, Research Division - MD, Director of Specialty Finance Research and Senior Research Analyst [4]

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Okay, very helpful. And Jamie, there were 2 mezz loans made in the quarter. Not that you don't make those, but a little departure from the obvious focus on senior loans. And they were on condo properties in New York and Florida. Could you just comment if there was anything unique about those properties or the borrower relationships that made them attractive to the team?

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James Alan Henderson, Ares Commercial Real Estate Corporation - President, CEO, CIO & Director [5]

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Steve, this is Jamie Henderson. So good question. And I think it comes back to the approach we use to any of our investments. I think I mentioned previously huge focus on the borrower, the building and the basis. These are what we consider really, really strong investment opportunities in really good locations at a basis that we feel really comfortable with. And we feel we're getting compensated really well for the risk.

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Operator [6]

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Our next question will come from Stephen Laws of Raymond James.

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Stephen Albert Laws, Raymond James & Associates, Inc., Research Division - Research Analyst [7]

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Tae-Sik, following up on Steve's questions on prepayments. Looking at the portfolio breakout in the K, looks like scheduled maturities is somewhere between $300 million and $325 million. So is your prepayment -- do you expect some unscheduled maturities? How closely are you guys able to watch these loans to get timing for early repayments? Can you maybe shed a little light on reconciling the scheduled maturities in '19 versus the prepayment expectations.

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Tae-Sik Yoon, Ares Commercial Real Estate Corporation - Partner, CFO & Treasurer [8]

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Sure, great question. And thanks for dialing in, Steve. So historically, our loans have been in a typical sense of a 3-year loan with some potential extensions beyond that. The average life for a loan has really been just over 2 years. So you can tell that most of our loans have actually repaid prior to their stated maturity. I think what drives it is really the success of the borrowers' business plans and naturally what we monitor the most closely. We are a light transitional lender. And I think when we see properties progressing towards the success of their business plans, I think that is probably to us the best indication that the borrower will then either refinance or more typically sell their assets in which both cases results in an early repayment.

So we certainly take into account, the stated contractual maturity part of our expected maturity schedule, but we really do look at the loans one-off, one by one to make sure that we have a good sense internally of -- and of course, we're always constantly dialoguing with our borrowers to, sort of, better understand. So it's really a very customized loan-by-loan analysis that we do to come up with our analysis of when loans are expected to be repaid.

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Stephen Albert Laws, Raymond James & Associates, Inc., Research Division - Research Analyst [9]

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Great. I appreciate the color on that. And I guess Tae-Sik on the financing cost, you guys obviously have done a very good job of reducing the financing costs in some of your warehouse facilities. Can you talk to -- and the securitization. But can you talk to where you see that going? How much more room is there you think that you can push down those expenses, your borrowing cost or maybe, kind of, where you see that trending over the course of this year?

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Tae-Sik Yoon, Ares Commercial Real Estate Corporation - Partner, CFO & Treasurer [10]

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Sure. Excellent question. And I think what we've said in the past is that we've done a -- I think we've done a very good job in terms of continuing to match fund our assets and liabilities and that's true in terms of maturities, that's in terms of interest rate risk and over time, we believe it's also been true in terms of borrowing spreads. And so there is a bit of a timing difference. So when we see asset spreads on our loans either rise or decline, we don't get an immediate reaction on our warehouse facilities and our borrowing facilities, but we do see that there is probably, call it, a 6- to 9-month lag. And then we do see our ability to price down our borrowing costs, maybe not to the exact same levels both up or down, but directionally there is some correlation with a bit of a lag effect.

And so right now I would tell you that we're catching up in terms of borrowing cost to what we experienced in terms of asset spreads declining in 2018. And I think what we would say in terms of further changes in our borrowing cost will be somewhat dictated by what we see going forward the spreads on our loans and assets. So if we see further decline or changes in our asset spread, then I think we'll see similarly a commensurate change in our borrowing costs.

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Stephen Albert Laws, Raymond James & Associates, Inc., Research Division - Research Analyst [11]

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Great. That's helpful. And Jamie, regarding the Ares facility and I guess the current portfolio leverage. Looks like leverage at year-end was down a little bit just given the repayments in Q4. So not surprising over the year you guys have operated 3 to 3.25 turns of leverage. Should we expect the portfolio leverage to get back to that level before you start utilizing the aggregation facility or the facility at the parent of Ares? Or have you already started using that facility to fund some investments that you'll take down later? Can you maybe guide us through where you think you'll operate leverage and -- with the company before you really start using that $200 million facility?

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James Alan Henderson, Ares Commercial Real Estate Corporation - President, CEO, CIO & Director [12]

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Sure. That's a great question, Steve. It's a little bit of both. Honestly, the objective is to maintain a steady pace of originations and to kind of remove the variability caused by timing. And so sometimes even if you know you have the leverage coming from one of the facility provider, sometimes the timing isn't exactly perfect with regards to a new origination. So I think the goal is to not only optimize leverage, which is an ongoing daily activity, but also optimize the amount or percent invested. And that's really where the warehouse comes into play. It allows you to effectively slightly over originate in anticipation of capacity coming free. The percent invested is one of the largest drivers of profitability.

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Stephen Albert Laws, Raymond James & Associates, Inc., Research Division - Research Analyst [13]

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Great. That's helpful. And certainly eliminating that cash drag should certainly flow through and drive higher ROE. So looking forward to seeing you guys utilize that. I appreciate the color.

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Operator [14]

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Our next question will come from Jade Rahmani of KBW.

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Jade Joseph Rahmani, Keefe, Bruyette, & Woods, Inc., Research Division - Director [15]

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With respect to the dividend, do you expect core earnings after the incentive fee to cover the dividend for 2019?

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Tae-Sik Yoon, Ares Commercial Real Estate Corporation - Partner, CFO & Treasurer [16]

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So Jade, I think in the past when we talked about core earnings covering our dividends even when you subtract out the incentive fee, we have done so. And so we do really look at our dividend as our ability to cover from a cash basis. So we have been very careful in terms of making sure that we have the cash available -- the net cash available to cover our dividends.

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Jade Joseph Rahmani, Keefe, Bruyette, & Woods, Inc., Research Division - Director [17]

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I do acknowledge that cash flow from operations has been about 111% of dividends. So you're clearly covering the dividend from a cash basis. Just a friendly suggestion. I think that you might want to introduce a core earnings metric after the incentive fees like some of the peers are doing including BXMT and KREF.

Secondly, I wanted to ask if you could provide any color on the outsized interest income that you said contributed $0.04. Was that fee related due to the restructured self-storage loans that repaid? What was the source of that outsized income?

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Tae-Sik Yoon, Ares Commercial Real Estate Corporation - Partner, CFO & Treasurer [18]

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Sure. So as a lender of transitional assets, we carefully document our loans so that, obviously, number one, we have all the protections we believe we are needed. And secondly, in the event that there are modifications made to the loan whether there are loan modifications or there are extensions or there are covenant issues, we do generate -- we do build in fees both upfront as well as upon modifications to make sure that we get paid for taking those types of incremental changes and potentially incremental risks.

The $0.04 that I referred to is what we would see -- what is sort of beyond the regular interest payment that we have built in, right? So the $0.04 is -- that's what we call sort of additional interest because it's beyond the normal regular interest that is due on a loan. And so we were able to generate as we mentioned an amount that basically equates to about $0.04 per common share in the fourth quarter.

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Jade Joseph Rahmani, Keefe, Bruyette, & Woods, Inc., Research Division - Director [19]

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In terms of the self-storage loans, can you give any additional color on how you use structure as a protective mechanism to protect your principal? And can you comment on how prevalent those same structural attributes are with respect to the rest of the portfolio?

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James Alan Henderson, Ares Commercial Real Estate Corporation - President, CEO, CIO & Director [20]

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Jade, it's Jamie Henderson. So if you roll back the tapes a little bit to some of our previous calls where we spoke in detail about those loans, I think you found that we reiterated over and over again that the way we originate the deals and document the deals and structure the deals has a whole series of protections in them. In this case, we had really good structure. Those structures are very common in most, if not all of our loans. And they're designed to protect us in the event that a deal goes off track. So I think this was a great outcome. I think it was a testament to the way we do the -- the way we originate loans and structure the loans and it worked.

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Jade Joseph Rahmani, Keefe, Bruyette, & Woods, Inc., Research Division - Director [21]

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In terms of the broader market, have you seen any impact from the December volatility in terms of how loans are pricing or deal flow? Anything that's changed based on what took place in December?

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James Alan Henderson, Ares Commercial Real Estate Corporation - President, CEO, CIO & Director [22]

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Not really. I think there was a little blip. I think the folks that are heavily dependent on public CLOs probably experienced a little bit of anxiety during that time period. It really -- that vol really didn't translate rapidly into the private market spreads, so not much. It's a strange time of the year for the industry as well, kind of, December is -- you're basically digesting loans you'd already signed up and then coming into January, the whole industry pauses just a little bit to go to a series of conferences. So really didn't see much.

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Jade Joseph Rahmani, Keefe, Bruyette, & Woods, Inc., Research Division - Director [23]

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And just lastly, on the M&A front the topic's come up in the past. Are you seeing anything of interests maybe in the private debt platform side or potentially some smallish mortgage REITs?

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James Alan Henderson, Ares Commercial Real Estate Corporation - President, CEO, CIO & Director [24]

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So as we've mentioned previously, Ares has exceptional reach into that world, and we think we see most everything that's in the marketplace. We're always looking, but we're cautious and diligent. And we're not going to transact just for the sake of transacting, we're going to transact in a way that would be beneficial to our shareholders.

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Operator [25]

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Our next question will come from Ken Bruce of Bank of America Merrill Lynch.

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Kenneth Matthew Bruce, BofA Merrill Lynch, Research Division - MD [26]

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Congrats on a very good quarter. I'd like to ask a question that really kind of builds off of one that Jade just asked relating to the fourth quarter volatility. I understand it didn't impact price or anything in the quarter. But as we kind of look forward and begin to kind of anticipate any further spread widening in liquid credit markets, how long would you expect that to take to kind of work into the private markets, if it does at all?

And I know there's a lot of kind of discourse back and forth as to kind of what may happen from a macro perspective but are you seeing any kind of change in tenor from the conversations you're having with borrowers as to kind of how their business plans are looking?

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James Alan Henderson, Ares Commercial Real Estate Corporation - President, CEO, CIO & Director [27]

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Kenneth, it's Jamie. And that's a really good question. It's really hard to predict how vol like works its way into any given market. And it really comes down to the source of the vol and how long it persists. So look, we would love some mild volatility. We think our portfolio is super well positioned to endure it. And we would love to be in a position to take advantage of it if it comes. How long it takes and how long it lasts, that's a really hard question to answer. I think it -- I think the most important thing is being -- having a really durable portfolio where you feel -- that allows you to be forward facing when those moments in time come and to take advantage of it.

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Kenneth Matthew Bruce, BofA Merrill Lynch, Research Division - MD [28]

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And maybe just flipping that around. I mean, is there -- are there ways for you to either protect yourselves or lock in effectively the financing rates or spreads that you're able to get to; a, obviously, you've kind of talked about just the improvement over the course of the years has been very helpful for driving the economics in your business. And is there any way to in a sense lock that in?

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Tae-Sik Yoon, Ares Commercial Real Estate Corporation - Partner, CFO & Treasurer [29]

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Ken, this is Tae-Sik. I think that's an excellent thought in terms of how do we take advantage of sort of current financing markets. I think we've done that to some extent by expanding our latest FL3 securitization. We took advantage of that opportunity and not only increased the size of that by about $170 million but also obviously extended the reinvestment term and lowered our borrowing spread and locked that in. And that obviously is a very strong nonrecourse match funded termed out type of financing.

I think we'll look to more strategies like that. I won't be more specific than that. But I think we are definitely looking to take advantage of the financing markets and lock in today's cost of capital, to lock in today's financing terms and really looking to further sort of even better match upon our assets and liabilities than we have in the past.

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James Alan Henderson, Ares Commercial Real Estate Corporation - President, CEO, CIO & Director [30]

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And I think it's a real [Fed] execution. It's a real testament to the power of the Ares platform that we are able to get that done privately at scale during a time of a lot of market volatility.

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Kenneth Matthew Bruce, BofA Merrill Lynch, Research Division - MD [31]

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Right. And maybe just lastly, and I guess maybe also kind of plays into the first question. From the -- from the -- what we had heard from the fourth quarter volatility that it forced or kind of led to borrowers more or less sitting on their hands. I don't know if you experienced that yourselves. And if so, you mentioned that first quarter is always a little slower, but are you seeing maybe some of that consternation that had been in the market begin to reverse?

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James Alan Henderson, Ares Commercial Real Estate Corporation - President, CEO, CIO & Director [32]

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I think the immediate reaction during times of volatility is bid-ask spread opens up between buyers and sellers. And I think that certainly happened on the equity side of the house. With regards to financing, I mean, we certainly observed a little bit of temerity in terms of sponsors and how they're coming to market and their choice of the form of financing. But it really -- it didn't last long. And I think the impact was pretty small in our marketplace. So we think that just based on our pipeline, volumes feel pretty good.

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Operator [33]

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Our next question will come from Doug Harter of Credit Suisse.

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Douglas Michael Harter, Crédit Suisse AG, Research Division - Director [34]

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Just following up on Steven's question earlier. Can you just say whether -- talk about whether you've started utilizing the Ares facility? And I guess, it's kind of where -- how should we think about kind of when those benefits will start to accrue to ACRE?

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Tae-Sik Yoon, Ares Commercial Real Estate Corporation - Partner, CFO & Treasurer [35]

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Sure, Doug, thanks for your question. I think you heard from part of our prepared remarks, particularly from Jamie that we do expect to be nearly fully deployed towards the end of this quarter. And when we're fully deployed, that's when we'll start to obviously utilize the Ares warehouse line to make sure that we build up that inventory of loans that would be available for then us to draw upon as existing loans pay off. So right now, there are no ACRE-designated loans under the warehouse line -- under the Ares warehouse line. But our expectation and our intent is to start to utilize it in the near future here.

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Douglas Michael Harter, Crédit Suisse AG, Research Division - Director [36]

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Great. And then could you just talk about kind of how you see the outlook for spreads kind of as we go through 2019? Or more specifically, asset yields if the Fed is in fact done, and kind of how you see those trending?

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James Alan Henderson, Ares Commercial Real Estate Corporation - President, CEO, CIO & Director [37]

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So our sense is that spreads have -- feel like they've stabilized. It's -- there's a pretty big scatter plot of information that we base that sentiment on. Once again, it's really hard to say what's going to happen in the future with spreads and particularly as it relates to central bank activity. It feels pretty good right now. The market feels reasonably stable. Once again, we like a little bit of volatility. We think it makes market better and healthier.

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Operator [38]

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(Operator Instructions) Our next question will come from Ben Zucker of BTIG.

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Benjamin Ira Zucker, BTIG, LLC, Research Division - Analyst [39]

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Jamie, did I hear you right that you expect to be at full deployment in the next 30 days or so?

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James Alan Henderson, Ares Commercial Real Estate Corporation - President, CEO, CIO & Director [40]

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That's correct. I mean the timing, it's often very challenging to time exactly when deals are going to close. But we were pretty close based on what we think is in the pipeline to being fully invested. And at that point in time -- I'm sorry, go ahead.

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Benjamin Ira Zucker, BTIG, LLC, Research Division - Analyst [41]

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No, no, go ahead, please, Jamie, continue.

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James Alan Henderson, Ares Commercial Real Estate Corporation - President, CEO, CIO & Director [42]

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That's when we think that the Ares warehouse becomes a real strategic differentiator for ACRE.

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Benjamin Ira Zucker, BTIG, LLC, Research Division - Analyst [43]

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Absolutely. So understanding that the timing can push and pull a little bit, but on the term full deployment. When I look back at your balance sheet and see where it's been before, we've seen it hold a portfolio of about $1.75 billion in loans in 2018. And that was even before you increased your CLO financing, which I'm assuming comes at a higher advance rate. So is it safe to assume that when you're using terms like full deployment, is that $1.75 billion portfolio? Are we speaking the same language right now or am I getting a little ahead of myself?

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Tae-Sik Yoon, Ares Commercial Real Estate Corporation - Partner, CFO & Treasurer [44]

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Ben, this is Tae-Sik. I think in terms of looking at the portfolio, it will depend on a couple of things, right? One is the senior versus mezzanine mix, right? Because if it's a 100% senior, you'll see a higher overall volume of loans, outstanding principal balance of loans. If it's more subordinate loans, you'll see something lower. The second primary consideration is the type of senior loan that we are financing and the type of financing we have. As you mentioned, if we have more CLO-type financing, I think, as a team, we're more comfortable increasing the leverage beyond that 3, 3.25 target that we mentioned in the past. If it's the more typical warehouse lines, then we'll stick to our 3, 3.25 range itself.

Plus then you also have to look at the underlying asset. So while we sort of have a general leverage policy debt to equity policy, it really is much more customized on a loan by loan basis. So that if we have a strong cash flowing asset, particularly multi-family for example, we may feel more comfortable levering that type of loan higher versus something that has maybe a more transitional business plan itself. So there's a lot of factors. And so when Jamie talks about being fully deployed, I think there is a multitude of factors to take into account. I think for us, we really look at it as how much more equity capital do we have available to invest rather than do we have a $1.6 billion of loans or $1.75 billion of loans, it's really based upon the equity capital that we have to deploy.

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Benjamin Ira Zucker, BTIG, LLC, Research Division - Analyst [45]

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Okay, that's all helpful, Tae-Sik. And then really this is just my last one and it's a higher level. In prior years, maybe a little while ago, when you raised the dividend, you mentioned that you might not cover it in the first quarter of the year, but there are quarterly swings and on a full year basis you expected coverage to be there. You didn't say anything to that effect this time around. But I'm wondering is there a chance that that dynamic might be at play just kind of looking at where the portfolio ended the year, your subsequent funding and then maybe some back end weighted closings coming? Or is the under-earn in 1Q '19 a possibility or you don't think so?

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Tae-Sik Yoon, Ares Commercial Real Estate Corporation - Partner, CFO & Treasurer [46]

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Right. Now it's a great observation, Ben. And I think as we've said in the past, we do believe that we should be looked at and we frankly do look at our business on an annual basis. So the dividends are quarterly obviously. But we do set our dividends based upon what we see our ability to earn in cash the annual type of number. So we didn't say it specifically this time, I'm glad you pointed that out. But I do think it is important to reiterate that we do look at our business and we do look at dividends and we do look at our ability to generate the cash to pay the dividends really on an annual basis.

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Benjamin Ira Zucker, BTIG, LLC, Research Division - Analyst [47]

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That's helpful. And I think everyone on this call would agree that annual is the only way to look at these businesses. So that's it from me guys. Congrats on the dividend raise. And we'll talk soon.

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Operator [48]

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Our next question is a follow up from Jade Rahmani of KBW.

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Jade Joseph Rahmani, Keefe, Bruyette, & Woods, Inc., Research Division - Director [49]

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Was wondering if you can give any more color on the hotel loan that's in maturity default? Can you give a sense of what the submarket is that it's in? I think previously, you said that it was in -- it was a suburb of New York. So wondering if that's Westchester or if that's Brooklyn, Queens? Then you mentioned a major full-service nationally flagged operator is managing the building. Can you give any color on that? And I think that the renovations were done several years ago because the loan was originated in the second quarter of 2015. So I guess why has it taken so long for the property to hit stabilization?

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Tae-Sik Yoon, Ares Commercial Real Estate Corporation - Partner, CFO & Treasurer [50]

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Sure, Jade, this is Tae-Sik. In terms of more specifically identifying the hotel, again, I think, for a lot of reasons, we're not specific about the exact location or the exact property itself. I think what you reiterated in terms of being here in the New York Metro area is correct. What you said about being both branded and managed by a very well-known nationally branded management company is correct as well. In terms of why it's taking longer to fulfill the business plan, again, as a transition lender, we do find often that our business plan -- our borrowers do execute their business plans faster than what they anticipate and what we anticipate. And therefore, we have historically seen that many of our loans are paid off earlier than the stated maturity.

They are going to be occasions and this is certainly one of them where the execution of that business plan and the fulfillment of that business plan does take longer than either we or the borrower expected. As I mentioned, we are seeing positive growth in this property. So results between 2017 versus 2018, we saw some positive trends in terms of occupancy, in terms of daily rate, in terms of overall net operating income. So it's on a positive trend.

Obviously, it's not at a level where we would have expected it when we underwrote the loan 3 years ago in 2015 as you mentioned. There are many reasons for that. There's nothing anything specific other than the hotel had just been renovated. I think more time does -- is needed for this hotel to sort of fully realize the benefits of that. Plus we do think that the submarket itself has shown overall improvement. And there's been some lift from that as well.

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Jade Joseph Rahmani, Keefe, Bruyette, & Woods, Inc., Research Division - Director [51]

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And from your vantage point at this stage, do you anticipate staying in the deal? Do you anticipate foreclosing on the asset? Or more likely would you believe that another bridge lender would refinance the loan?

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Tae-Sik Yoon, Ares Commercial Real Estate Corporation - Partner, CFO & Treasurer [52]

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Yes, so again, just given the nature of this call, and nature of the discussion, we really can't get into the details of what our plans are. As we mentioned, I think, we do build in a lot of protections into loan documents to make sure that we are well protected. So, for example, I mentioned that the hotel is operating very well. It's producing cash flow. The regular interest is fully current. We're trapping all cash. So we're building up even a little bit of further reserves. So we do have the mechanisms built in to protect us during the interim and for the eventual outcome. But just again, given the nature of this call, we really can't speak specifically about exactly the remedies that we're currently pursuing. But just suffice it to say that we feel that we have very good documents and that most importantly that we have very, very strong capabilities in-house at Ares no matter what direction this hotel takes to manage this both as a loan or as an asset itself.

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Operator [53]

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Ladies and gentlemen, this will conclude the question-and-answer session. At this time, I'd like to turn the conference back over to Jamie Henderson.

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James Alan Henderson, Ares Commercial Real Estate Corporation - President, CEO, CIO & Director [54]

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I want to thank everyone for their time today. We look forward to speaking with you again in a few months on our next earnings call. Thank you.

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Operator [55]

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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 through March 7, 2019, by dialing (877) 344-7529 and to international callers by dialing 1 (412) 317-0088. For all replays, please reference conference number 10127187. An archived replay will also be available on the webcast link located on the homepage of the Investor Relations section of our website. The conference has now concluded. Thank you for joining us. You may now disconnect your lines.