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Edited Transcript of ACRE earnings conference call or presentation 30-Oct-18 3:00pm GMT

Q3 2018 Ares Commercial Real Estate Corp Earnings Call

Chicago Nov 1, 2018 (Thomson StreetEvents) -- Edited Transcript of Ares Commercial Real Estate Corp earnings conference call or presentation Tuesday, October 30, 2018 at 3:00:00pm 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

* John W. Stilmar

Ares Commercial Real Estate Corporation - Principal

* Tae-Sik Yoon

Ares Commercial Real Estate Corporation - Partner, CFO & Treasurer

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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

* Richard Barry Shane

JP Morgan Chase & Co, Research Division - Senior Equity Analyst

* 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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Good morning, and welcome to the Ares Commercial Real Estate Corporation's Conference Call to discuss the company's third quarter 2018 earnings results. As a reminder, this conference is being recorded on October 30, 2018. I will now turn the call over to John Stilmar from Investor Relations.

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John W. Stilmar, Ares Commercial Real Estate Corporation - Principal [2]

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Thank you, Denise. Good morning, everyone, and thank you for joining us on today's conference call. I am joined today by our CEO, Jamie Henderson; our CFO Tae-Sik Yoon; and Carl Drake and Cameron Rudd from 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 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 use of words such as anticipates, believes, expects, intend, 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, 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 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.

I will now turn the call over to Jamie Henderson who will begin with our third quarter highlights and recent investment activity.

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

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Thank you, John. Good morning, everyone, and thanks for joining our call today. Let me start with some high-level commentary on our third quarter results.

We reported another strong quarter as we continue to benefit from recent profitability improvement initiatives. For the third quarter, we generated GAAP and core earnings of $0.35 and $0.36 per share respectively. For the first nine months of 2018, our core earnings of $1.05 per share were up 20% year over year and were well in excess of the $0.85 year to date dividends paid.

Our strong earnings continue to benefit from comparatively higher levels of invested capital, reduced funding costs and higher LIBOR rates. Since the drivers of our higher earnings in 2018 are expected to continue, we have even greater confidence in our long-term earnings prospects. As a result, we are again increasing our quarterly dividend to $0.31 per share, which is a 15% increase in our quarterly dividends since year-end 2017.

Another driver of our positive view is our continued progress in expanding our product mix and leveraging our national coverage model in market segments that we believe are less sufficiently covered by the competition. For example, the amount of transactions that we have reviewed and soft quoted with preliminary terms have both increased over 120% for the first nine months of this year versus the same period in 2017.

Clearly, this strong increase in our pipeline allows to remain highly selective in the deals that we close. During the third quarter, we originated new loan commitments totaling $118 million with another $45 million closing shortly after quarter end.

Looking forward, US economic fundamentals remain strong, with robust GDP growth, which support commercial real estate rents and occupancy levels. Transaction activity for us is picking up and I am pleased to say that we are off to a very strong start to the fourth quarter. In addition to the $45 million of closed loans, we have executed term sheets on approximately $277 million of commitments that are expected to close in the fourth quarter.

Finally, we are pleased to announce a significant new initiative to mitigate what has been a historical challenge for ACRE, officially matching the timing of our originations with capital made available from repayments.

Ares management is working with a third party capital provider to establish a $200 million real estate debt warehouse facility for the benefit of ACRE and other Ares real estates debt clients. This will allow us to originate and inventory loans in the warehouse facility that can be drawn upon by ACRE in order to better match the timing of repayments with new originations.

We expect that this warehouse facility has the potential to enhance and provide further stability to our earnings and is yet another example of Ares support for the ACRE business.

I will now turn the call over to Tae-Sik to discuss our third quarter 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, everyone. Earlier today, we reported GAAP net income of $10 million or $0.35 per common share, and core earnings of $10.3 million or $0.36 per common share for the third quarter of 2018.

Our earnings continue to benefit from three primary drivers. First, we remain more fully invested as evidenced by having approximately $230 million more in average interest earning assets in 2018 to the end of the third quarter versus the comparable period last year. Second, we continue to lower our borrowing costs, highlighted most recently by 180 basis point reduction in the all-in borrowing spread of our $110 million term loan. And third, we benefited from rising short-term rates. As we have demonstrated previously, as 98% of our assets are floating rate loans, when one month LIBOR increases, our net income increases.

Let me know briefly touch upon the impact of potential repayments and new originations and the timing of these events may have on fourth quarter earnings. As we indicated, we are expecting significant repayments in the fourth quarter, estimated to be approximately $300 million. This will bring total repayments for 2018 to more than $700 million. While we have a robust pipeline to reinvest the proceeds we do expect some timing differences between when we receive repayments and when we fund new originations. Therefore, depending on the actual timing and outcome of events, we do expect a modest temporary dip in our fourth quarter earnings as compared to our year-to-date 2018 quarterly average.

Going forward, we expect to better match the timing of repayments and reinvestments, utilizing the warehouse line, the Ares Warehouse line that Jamie just previously discussed.

Finally, as you may have noticed from our third quarter 2018 10-Q filing, we provided short-term extensions on our self-storage portfolio loans and the full-service hotel New York that we discussed on our last quarterly call. Importantly, these loans remain current on regular monthly interest payments, continue to experience stable property level performance and no impairment was recognized as of the end of the third quarter.

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, we have generated three consecutive quarters of strong earnings and our portfolio is performing well. We have increased our dividends 3 times in 2018 to reflect our progress and a strong future earnings outlook for our company. We believe that this new warehouse facility can help enhance our earnings and provide increased stability in helping us to manage and optimize our available capital in future periods.

Looking forward, we believe that we are a well-positioned middle market lender with a diversified portfolio of nearly all senior floating rate loans that we anticipate will perform well over different economic environments.

With that, I would now like to ask the operator to please open the line for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question will be from Steve Delaney of JMP Securities. Please go ahead.

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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 another strong quarter. I'd like to ask first on the good news about this new warehouse facility. When might it become effective and do you contemplate that the advance rates on this facility versus what you normally get from your bank lenders, would they potentially be higher, such that you may be able to improve your overall leverage situation? Thank you.

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

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Good morning, Steve. This is Tae-Sik. Thanks very much for your question. We believe that the new warehouse facility, again, this is an Ares sponsored warehouse facility, will be in place very short-term, hopefully in the next several weeks. And that we will begin to benefit and realize the benefits in the short-term.

In terms of advance rate, as far as ACRE is concerned, it's a little less relevant because again, this warehouse facility that Jamie discussed will really be an Ares sponsored warehouse facility and so Ares on its balance sheet will be holding the loans. And so when ACRE has a repayment, for example, and has capital available to invest, rather than having a 30, 45 day delay in terms of the reinvested proceeds, the goal is to have loans already in place in this Ares warehouse sponsored vehicle so that we can immediately have ACRE pull it down. And then ACRE will itself then leverage that loan, that senior loan, under its own existing warehouse facilities.

So it won't use the Ares warehouse facility as a long-term financing vehicle, but the Ares warehouse vehicle is really a warehouse, if you want to call it that, so ACRE can pull down loans when capital becomes available for ACRE.

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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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Thank you, Tae-Sik. That's very helpful because I now get it clearly. And there's the concept of just in time capital, it sounds like what you might have is something that's like just in time call on interest earnings loans to put into your portfolio.

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Tae-Sik Yoon, Ares Commercial Real Estate Corporation - Partner, CFO & Treasurer [5]

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That's exactly right.

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Steven Cole Delaney, JMP Securities LLC, Research Division - MD, Director of Specialty Finance Research and Senior Research Analyst [6]

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My second follow-up is that I noticed in the new originations in October you mentioned a residential loan in Florida. Could you tell us what market that was in and whether the property is single family detached or whether it is a condo project?

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James Alan Henderson, Ares Commercial Real Estate Corporation - President, CEO, CIO & Director [7]

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It's Jamie Henderson responding to your call. Thank you. It's a small condo development in what we think is a super high barrier to entry market in Southeast Florida.

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Operator [8]

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The next question is from Stephen Laws of Raymond James.

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

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Congratulations on a nice quarter and the dividend increase as well. To follow up on Steve's question regarding the new facility, can you maybe provide a little more detail? Is it going to be a like a first in, first out as far as clearing loans on that? Will there be any kind of mark to market or will you take those down at the original cost? Can you maybe provide some color on that?

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

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I think it probably would behoove us to maybe not get into too much detail just because it isn't final yet. As Jamie mentioned, we're very excited about what this is going to do for ACRE and as we sort of discussed in response to Steve's question, this really will allow ACRE to better manage, again the timing of repayments and reinvestment. Exactly how it's going to work in terms of the questions you asked, first in, first out, is it going to be called at par, is it going to be called at a mark to market basis? We're working through all those details to make sure that this is done all on a very fair and arm’s length basis.

So if you can give us a little bit more time to kind of work through all those details, we're very excited about this warehouse facility, we think it'll very much improve our ability to manage the lumpiness, if you want to call that, of repayments, particularly as we discussed the impact that it could have here just on the fourth quarter. So we're very excited about the positive aspects that it's going to have for ACRE and for us to be able to so-called just in time invest our capital. But we are still working through some of the final details that you asked about. So if you can give us a little bit more time, we'll come out and give you a full explanation of exactly how this will work.

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

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Looking forward to getting that update maybe the next time you guys address the public markets. But certainly sounds like a nice way to keep capital fully deployed for as many days in a quarter as possible.

I hate to -- I'm not going to read too much into these individual investments, so maybe at a larger level, can you talk about what you're seeing on asset yields, so new investments for both the first mortgages and also the mezz loan. You did one new investment here subsequently quarter end. But can you maybe comment towards competition you're seeing, how pricing compares to 3 or 12 months ago, whatever you think the appropriate timing is as far as yield spreads on new investments? And any other points of maybe where competition's creeping in on LTVs or covenants or anything like that.

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

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I think the pipeline feels really good. We're off to a great start to the fourth quarter. As you know, our portfolio is 90% senior and almost entirely floating rate. We feel great about that.

The market is competitive in terms of spreads. It feels like the spread environment has started to stabilize over the course of the last quarter and we're still generating what we consider great returns and attractive relative value across both our senior loan originations and the small amount of sub debt that we have in our portfolio are also generating very attractive returns. So the market's competitive. We think we have a pretty significant advantage in the way Areas has built out the real estate debt platform with our regional office system and the coverage that we get. We've materially increased the number of touches that we have with the borrower community and the brokerage community and we've more than doubled the amount of loans that we're quoting. That being said, we're super selective and are closing less than 5% of what we see.

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Operator [13]

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The next question will be from Jade Rahmani of KBW. Please go ahead.

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Jade Joseph Rahmani, Keefe, Bruyette, & Woods, Inc., Research Division - Director [14]

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I'm not sure if you saw the Rialto transaction, but was wondering if you could comment on whether you looked at that, if that could have been something of interest, leaving aside any of the financial terms. But just strategically is that something that you would have looked at and M&A is an interesting opportunity for the company to pursue.

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Tae-Sik Yoon, Ares Commercial Real Estate Corporation - Partner, CFO & Treasurer [15]

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Just at a high level, we certainly are very interested in M&A opportunities and being part of Ares management, again without being specific about the transaction that you referred to, we do think we get a very good look at virtually all of the deals that are certainly marketed and many of the deals that are sort of brought privately.

Second, I can't really comment specifically on any particular deal, but rest assured that I think us being part of Ares we do get a very, very good look at just about every transaction out there. We do find the M&A market to be very interesting, particularly for ACRE. As we mentioned, we do spend a significant amount of our time and effort looking for that opportunity. We obviously haven't announced anything recently. We did obviously acquire the GSE lender several years ago, but sold that a couple of years ago as well. We continue to search for the right opportunity. We're obviously only going to do it if it's meaningful, if it's additive, it's accretive to ACRE itself. But again, to answer your question, we do get a shot at looking at virtually every opportunity out there.

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Jade Joseph Rahmani, Keefe, Bruyette, & Woods, Inc., Research Division - Director [16]

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And would you say in terms of characterizing the types of situations you might look at, is it say in the case of a mortgage REIT trading below book value, where you could liquidate the assets at a higher price than market trading and redeploy that capital into the core business? Is that the main thrust of what is interesting to ACRE? Or is it complementary business lines that, for example, you could provide potentially longer-term financing once the project is stabilized? Or something in the servicing realm. Is it complementary business lines?

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Tae-Sik Yoon, Ares Commercial Real Estate Corporation - Partner, CFO & Treasurer [17]

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I think the answer is really both. As you mentioned, we are looking at opportunities that provide a strategic fit for ACRE. Strategic fit that would allow us to add different businesses that would be complementary, particularly complementary to our direct origination. Complementary to our network of boots that we have on the ground across the country, as well as our underwriting and asset managing experience. We're certainly looking for strategic opportunities.

At the same time, we are looking for I guess a different type of opportunity, which really would be a so-called synthetic way to raise capital, as you mentioned. There are a number of other financial services firms, including mortgage REITs, that are trading at significant discounts to book value. So those do represent potential opportunities to acquire them. Essentially liquidate their assets and then redeploy it into ACRE type of assets. So that would be more of a synthetic way to raise capital. So to answer your question, we're really looking at both types of opportunities.

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Jade Joseph Rahmani, Keefe, Bruyette, & Woods, Inc., Research Division - Director [18]

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Just in terms of the $300 million of fourth quarter anticipated repayments, does that include repayment of the self-storage loans and the hotel loan that was modified?

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Tae-Sik Yoon, Ares Commercial Real Estate Corporation - Partner, CFO & Treasurer [19]

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It does. Again, just to reiterate, it's plus or minus $300 million. We're one month into the quarter, so there's obviously two more months to go. Fourth quarter tends to be a very heavy month in terms of transaction, but that $300 million plus or minus does include repayment of the self-storage facility loan, as well as the New York Hotel.

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Jade Joseph Rahmani, Keefe, Bruyette, & Woods, Inc., Research Division - Director [20]

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And is there, I guess at this point, how confident are you in those repayments taking place?

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Tae-Sik Yoon, Ares Commercial Real Estate Corporation - Partner, CFO & Treasurer [21]

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Let me just say this. I think in terms of most importantly asset performance, as we mentioned the properties under lie both the self-storage loans, as well as the New York Hotel continue to perform stably and well. All the regular interest payments are current. Obviously all of the operating expenses are current.

In the case of the self-storage properties, our understanding is that the borrower is in discussions with a lender for refinancing. That loan was extended a very short-term period, as you know, just from October to November.

In terms of the hotel, I think that has a little bit longer outlook. We did extend that from the original maturity date in June to December. We are obviously in regular contact with the borrower. Our understanding is that the borrower is seeking both a refinancing and or possibly a sale of the hotel. I would say that one is longer term in terms of when we expect the repayments to occur. That's why we extended self storage to November and the hotel to December.

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Jade Joseph Rahmani, Keefe, Bruyette, & Woods, Inc., Research Division - Director [22]

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The pipeline and just in terms of the origination. The originations for the quarter seem to have a mezz preferred equity subordinate debt bend to them. I'm wondering if you could explain that. Are those just specific deals or are you trying to push the capital that way?

And then in terms of the pipeline for the fourth quarter that you cited, just any color on those $277 million of commitments, how maybe it's split out by location, property type or position in the capital structure.

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James Alan Henderson, Ares Commercial Real Estate Corporation - President, CEO, CIO & Director [23]

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This is Jamie Henderson. So the deals that we closed in Q3, several of those were subordinates and I think had very attractive yields. They're really kind of granular deals, smaller deals and I think are a great byproduct of the Ares platform. You see a lot of these deals in conjunction with the equity side of the business and they're a great resource for us when we're underwriting these deals because we're an owner operator of like kinds of real estate.

That being said, as you know, 98% of our portfolio is senior. I can say that the deals that we anticipate closing in the fourth quarter are entirely senior at this stage. They're pretty well diversified geographically in terms of East Coast/West Coast. And about half of them are multi-family. So we feel really good about the mix. A very small percentage of our book is in subordinates and I think overall the exposures that we're adding are not only accretive, but are great real estate.

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Jade Joseph Rahmani, Keefe, Bruyette, & Woods, Inc., Research Division - Director [24]

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And just the $277 million, how does that shake out between initial fundings and future commitments?

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Tae-Sik Yoon, Ares Commercial Real Estate Corporation - Partner, CFO & Treasurer [25]

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I think in terms of initial commitments versus funding, I think as you noticed, we have generally had about 10% to 20% of our loans are committed balance in future funding. And I think if you look at the pipeline of those deals, I think you'll find something similar again. Not to be too specific, but historically we've had about 10% to 20% of our committed amount remain unfunded at closing and available for future funding. Future funding is everything from capital expenditures to tenant allowances to leasing commissions. And so it's been generally about 10% to 20%.

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Operator [26]

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The next question will be from Ben Zucker of BTIG. Please go ahead.

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Benjamin Ira Zucker, BTIG, LLC, Research Division - Analyst [27]

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Congrats on the EPS speed and dividend raise, as people have commented already. Real quickly, can you talk about pre-construction loans a little bit? I saw that term popup in your 3Q originations and also in the subsequent activity and I'm not too familiar with it. Are these loans taken out by construction financing or is this type of loan in lieu of it? I just want to have a little better understanding of this kind of product.

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James Alan Henderson, Ares Commercial Real Estate Corporation - President, CEO, CIO & Director [28]

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It's Jamie Henderson. So these are fully entitled projects where we will be taken out by a construction lender. So we won't be financing the construction phase.

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Benjamin Ira Zucker, BTIG, LLC, Research Division - Analyst [29]

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And is that why you're able to fund maybe a higher balance of that loan than we would see with a typical construction loan?

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

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Yes.

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Benjamin Ira Zucker, BTIG, LLC, Research Division - Analyst [31]

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The last point I want to make is that this new Ares sponsored warehouse facility just sounds really beneficial, given the positioning that you guys are in and for the analysts that have come on these calls asking what kind of broader Ares platform due to benefit ACRE I think you just gave them a pretty good answer. So we look forward to seeing how this thing comes through in the final terms there.

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

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Thanks very much, Ben. We think this is a great development and we're really excited about it.

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Operator [33]

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The next question will be from Rick Shane of JPMorgan. Please go ahead.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [34]

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First, are there any repayment fees in the third quarter that are significant that we should be aware of? And when we look forward to the $300 million of principle payments in the fourth quarter, anything we should be thinking about there?

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

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In the third quarter, I think we did experience some higher than what I would call normal accelerated amortization of fees. These aren't so-called repayment fees, but when we do originate loans, we generally charge an upfront fee, and in many cases we also have an exit fee. And we will amortize that over the contractual life of the loan itself. So when we experience an early repayment, which has been the normal course of business for ACRE, we will accelerate what is then the remaining unamortized remaining portion of those fees?

And so for the fourth quarter, I believe we had -- I'm sorry, for the third quarter, we had approximately $1.1 million of such fees, which equates to approximately $0.04 for the quarter. I would say on a normal quarter, if you want to call it that, we've had some quarters, like for example in the fourth quarter of 2017 where it was zero, some quarters where it's higher. I think most quarters I think on average, you sort of see plus or minus $0.02 per quarter. And so we did experience, I would say, a little higher than what would be our average accelerated fees.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [36]

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The context around the normal quarter is very helpful. And I'd like to delve in a little bit more to this Ares facility as well. The way I'm envisioning this is that these are loans that ACRE sources and basically stores on the Ares balance sheet until you decide to -- that there's an opportunity to move them to your regular bank facilities. Is that correct?

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Tae-Sik Yoon, Ares Commercial Real Estate Corporation - Partner, CFO & Treasurer [37]

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That is largely correct, Rick. So as you can imagine, when we have a finite full of capital and our goal is to remain as fully invested as possible, it's a very difficult challenge to remain 95%, even 100% fully invested because of the timing and a little bit of uncertainty in terms of when repayments occur, versus the timing delay it takes you to reinvest that capital.

So the goal here is to have loans that we can put into this Ares sponsored vehicle so that when we have repayments in ACRE, rather than having that 30, 45 day drag in terms of replenishing or reinvesting our capital, we can immediately draw down upon one of those loans. So it's more or less just in time loans that we can pull from this Ares sponsored warehouse line and then use the ACRE capital, its equity and its own warehouse funds to fund that new loan.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [38]

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And who owns the risk until it's transferred? Is that on Ares' balance sheet or is that on ACRE'S balance sheet?

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Tae-Sik Yoon, Ares Commercial Real Estate Corporation - Partner, CFO & Treasurer [39]

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On Ares'.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [40]

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And what are the reps and warranties associated with that?

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Tae-Sik Yoon, Ares Commercial Real Estate Corporation - Partner, CFO & Treasurer [41]

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I'm not sure if I 100% understand about that, but as we referred to, all of the details of this has not been fully worked out. We do intend to stay closing this in the near-term and I think once we have it closed and once we have all the details worked out, we can certainly provide more details of exactly the mechanism of reps and warranties, the mechanism of pricing, the mechanism of timing. I'm sure there's going to be a hand full of other questions and issues, but we'll think through that and we are thinking through that. And we'll come back to you all with a more fulsome explanation.

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

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And just to elaborate a little bit, Rick, the nice thing about these floating rate loans, first of all the intention is to have them in a warehouse for a very short amount of time. So say 3 to 6 months. There's not a tremendous mark to market consequence with this type of loan. So I think we're hopeful that these will be par transactions, but as Tae-Sik mentioned, by virtue of the fact that this is an Ares warehouse, to the extent that there is a mark to market consequence, that would be borne by Ares.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [43]

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And I'm obviously like everybody else very intrigued by this. Like to ask a follow-up question about the beginning of the life of these loans and the transfer. How will origination fees be -- how will the economics on origination fees be shared? So for example, if you were to originate a loan, put it in this facility, it takes 6 months to transfer and there is during that time 25 basis points of accretion of origination fee, does Ares get that or does ACRE get that?

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

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It's a great question, Rick, and I think at this point it'd probably be best if we again come back to you all with a fulsome explanation of exactly how the mechanics are going to work. I mean it's obvious that we will make sure that it's a fair, reasonable and arm’s length approach between ACRE and Ares to make sure it's mutually beneficial to both sides and fair and reasonable to both sides. I mean the questions you're asking are all very, very good questions. We're working through all those details, but I think it'd be best if we came back to you with a more fulsome explanation of all the details.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [45]

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And with that in mind, I realize you're not going to answer this question, but I'll ask it so that we can get it in the queue for when it is appropriate. If we were to take the extreme example of what we saw in 2007, 2008 where the challenge for the space was substantial extension of loans, and we were to really take that to an extreme case related to this facility where there was no additional capacity freed up on the ACRE balance sheet. What would happen? Is there a moment in time where Ares could actually force ACRE to take those loans? And again, I know you're not going to be able to answer this now, but love to hear that when it is an appropriate time as well.

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

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Sure. No, that's a very valid question and we will make sure that we address that.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [47]

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And again realize it's a work in progress and just want to get the questions out there so that we can talk about them appropriately down the road. Thank you, guys.

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Operator [48]

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The next question will be from Doug Harter of Credit Suisse. Please go ahead.

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Douglas Michael Harter, Crédit Suisse AG, Research Division - Director [49]

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On the loans you extended, can you talk, were there any extra fees or any changes in the terms, other than the maturity date?

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

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Doug, this is Tae-Sik. Thanks for your question. Again, because these are still loans in process, it'd probably be best if we don't talk exactly about the economics of such extensions. I think once the loan pays off, I think we can be a little bit more open and maybe in retrospect provide those details. But since these loans are still outstanding it'd probably be best if we don't get into too many details about the extensions.

As we mentioned, these extensions were done to again accommodate the borrower's request for more time in terms of either refinancing the assets and/or possibly selling the assets. Again, the properties are performing a very stable basis, all interest is current, all regular interest is current. And if the extensions are unsuccessful, we will then reevaluate our options at that time. But right now we should probably not get into too much details about other conditions in terms of what was required.

I can tell you, for example, that when we did the original modification of the self-storage loans, for example, we built in some additional protections to us, including personal recourse on a portion of the loan. So for example, there is a recourse portion of the smaller portfolio loan. That continues to remain in place. So I can certainly share with you that we did not give up any rights, and we certainly did not modify against us in any way, other than of course extending the time period. But in terms of other changes in economics, it'd probably be best if we discuss that more in retrospect.

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Douglas Michael Harter, Crédit Suisse AG, Research Division - Director [51]

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And then this one can be kind of more philosophical, but kind of along the line, just the thoughts around timing of extensions and these extensions were kind of done kind of after an initial maturity default and just kind of how you think about kind of when is the appropriate time to make or grant an extension to a borrower and kind of the optics of that timing?

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James Alan Henderson, Ares Commercial Real Estate Corporation - President, CEO, CIO & Director [52]

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It's Jamie Henderson. I guess the way I'd answer that is all of these are oneoffs. There's really no rule of thumb per se on when and how or if you grant an extension. I think we look very carefully at how well secured we are and the odds of achieving the optimal outcome via extension. Or if we needed to exercise our remedies. Every single deal -- I mean part of this business is borrowers come to us in order to facilitate the effectuation of a business plan. Sometimes those business plans take longer, sometimes they take shorter. Oftentimes we get repaid early. Occasionally we get repaid a little bit later than we thought we would. It's somewhat the nature of this business.

To Tae-Sik's point, in both cases we feel well secured and these cases we decided that some short-term extensions were in the best interest of ACRE.

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Operator [53]

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The next question will be from Ken Bruce of Bank of American Merrill Lynch. Please go ahead.

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Kenneth Matthew Bruce, BofA Merrill Lynch, Research Division - MD [54]

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My first question relates to the facility that you're putting together with Ares, this is a very exciting development of course. I'm hoping maybe you would take a stab at providing some sense as to what kind of ROE lift you think that you will be able to get from essentially making the balance sheet more efficient through this vehicle.

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Tae-Sik Yoon, Ares Commercial Real Estate Corporation - Partner, CFO & Treasurer [55]

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I think the math behind it is such that when you look at each dollar of uninvested equity, we're trying to earn, as we mentioned, sort of an average, call it 9% ROE on each dollar of equity. That is the target that we have set for ourselves and have shared with you all. And I think for the first 3 quarters of this year, I think we've been successful in being in that 9% net ROE zone.

So if you can imagine having 5% of our equity capital or 10% of our equity capital uninvested, that's obviously a pretty big drag in terms of our earnings. So I think we can all kind of do the math there. So I think the goal of this is so that we can remain more fully invested at all times. I don't think, and I don't think we're promising that we're going to be at 100% because of this warehouse facility, but it certainly allows us to be much more fully invested than where we are today.

So when we have a $40 million loan coming due and that has anywhere from $10 million to $15 million of equity associated with it, when that loan gets paid off, you have that $10 million to $15 million drag for 30 to 45 days. That's the kind of drag we're trying to eliminate during that 30 to 45 day average reinvestment period. It's really assumption driven, as you can imagine, but I think that gives you some idea of the type of dilution that we're trying to minimize by having this warehouse facility available to us.

Just one other thing to mention about the warehouse facility, the Ares sponsored warehouse facility is that again, there's going to be about $200 million of capacity, as Jamie mentioned. We do think the loans in that warehouse facility will turn over pretty quickly. I think that warehouse facility will also be used for other Ares sponsored debt vehicles and entities. But we do think it'll be very helpful for us to again manage that matching of timing of repayments and new investment activities.

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Kenneth Matthew Bruce, BofA Merrill Lynch, Research Division - MD [56]

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And then on Jade's question regarding M&A, it kind of gets into an interesting topic for a lot of different reasons. But I guess if you look at some of those mortgage REITs that are trading below book value, a lot of them have some external contracts that need to be kind of dealt with. What kind of discounts do you think are necessary before some target would look interesting for purposes of a synthetic capital raise?

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Tae-Sik Yoon, Ares Commercial Real Estate Corporation - Partner, CFO & Treasurer [57]

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Sure, and again I'll just talk very high level here. But there are a number of things you have to look at and one is, is the company trading at a discount because of illiquidity of the assets because of the structural impediments that the company imposes? Or is there an issue with the assets themselves? So that's the first and foremost question that we ask ourselves.

And then the second question as you mentioned is more of the frictional cost actually getting to this capital. So in some cases you have external management contracts that need to be terminated. Sometimes you have compensation arrangements that need to be taken care of. And then there's always the frictional costs of just transaction expenses. Any sort of public to public deals are generally pretty expensive in terms of all of the execution costs associated with it, including legal, including banking, including solicitation of shareholder votes. So those are not inexpensive processes themselves.

But I think at Ares we have tremendous amount of experience doing that, both in real estate and outside of real estate. We actually have a team at Ares fully dedicated to looking at these type of M&A efforts, so Jamie and I work very closely with that dedicated team here at Ares and it's been very extremely helpful to have that in-house capability, in-house expertise so that we can look at opportunities, like a synthetic capital raise, but make sure that we're not just underwriting the real estate and the assets, but also all of the transactional costs that are associated with that.

So without giving you a number, I can tell you that they are quite substantial in terms of all the costs I mentioned. Transaction expenses, payments to terminate the management agreements, payments to sometimes end employment agreements. Sometimes payments to end credit relationships as well. So all of those things are viewed very carefully.

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Operator [58]

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(Operator Instructions) The next question will be follow-up from Jade Rahmani of KBW. Please go ahead.

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Jade Joseph Rahmani, Keefe, Bruyette, & Woods, Inc., Research Division - Director [59]

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What do you think is a reasonable assumption on loan spreads, all in, blended on new originations on the first mortgage side?

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James Alan Henderson, Ares Commercial Real Estate Corporation - President, CEO, CIO & Director [60]

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It's Jamie Henderson. It wanders around a bit, but I think our target is in the mid to high 3s.

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Jade Joseph Rahmani, Keefe, Bruyette, & Woods, Inc., Research Division - Director [61]

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Are you seeing any compression competitive pressures on origination fees?

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James Alan Henderson, Ares Commercial Real Estate Corporation - President, CEO, CIO & Director [62]

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De minimis. Those have held up pretty nicely.

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Jade Joseph Rahmani, Keefe, Bruyette, & Woods, Inc., Research Division - Director [63]

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Do you expect a sequential dip in 1Q earnings based on the timing of getting these $277 million of commitments on the books and when you anticipate repayments? You mentioned fourth quarter earnings with debt.

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Tae-Sik Yoon, Ares Commercial Real Estate Corporation - Partner, CFO & Treasurer [64]

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Yes, so I think being one month into the quarter and having a pretty good sense of originations activity and repayment activity, and again, we will even further caveat by saying there's a significant amount of both activities and the timing of repayments and the timing of originations, not just the volume, will certainly have an impact on fourth quarter. So we wanted to give an early read into fourth quarter that maybe again, temporary lower than what we've experienced for the first three quarters of 2018.

I would just say first quarter 2019 is a little too early to tell. We'll certainly give a little bit more color when we get on our next call. But considering that it's two months out from even starting and five months out from ending, I think it's a little premature to really give too much color. And again, what I would really want to emphasize is the way we view our business plan and the way we view our execution is we're really looking at it on an annual basis. So we mentioned our goal is to hit that 9% net ROE target on an annual basis and we are trying to, through for example, this Ares sponsored vehicle to smooth out, if you want to call it that, the quarter-to-quarter numbers. But clearly, there will be some differences and some volatility, if you want to call it that, between quarter-to-quarter results. So rather than speaking about any particular quarter, I think the outlook that we have for 2019 is very positive. That's one of the reasons, as Jamie mentioned, we increased our dividend from $0.29 to $0.31, but again I think it's a little too far off for us to talk specifically about first quarter 2019.

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Jade Joseph Rahmani, Keefe, Bruyette, & Woods, Inc., Research Division - Director [65]

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And just on the repayment side for 2019, what do you think is a reasonable assumption to make? I think assuming something like a three-year average duration would suggest about $600 million of repayments, which is well in excess of scheduled 2019 maturities. So just curious if you can comment on that.

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Tae-Sik Yoon, Ares Commercial Real Estate Corporation - Partner, CFO & Treasurer [66]

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I think you have a good sense of it. With $1.7 billion portfolio, you would expect to have repayments of call it $500 million, $600 million, $700 million per year and that's sort of the range that we've experienced the last several years. There is some -- again, there is some lumpiness to that. 2018 will be a little higher than what we normally experience, something in excess of $700 million. Some of that is just due to some of these larger loans, including the self-storage loans, paying off.

I would say the early, early forecast is that we do expect to be a little bit lower than 2018, so something under $700 million. A little bit more typical year. We don't have as much contractual maturities, but as we mentioned, the majority of our loans actually prepay earlier than this date of maturity.

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Operator [67]

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Ladies and gentlemen, that will conclude our question and answer session. I would like to hand the conference back over to Jamie Henderson for his closing remarks.

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James Alan Henderson, Ares Commercial Real Estate Corporation - President, CEO, CIO & Director [68]

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

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Operator [69]

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Thank you. Ladies and gentlemen, this concludes our conference for today. If you missed any part of today's call, an archived replay of this conference call will be available approximately 1 hour after the end of this call through November 14, 2018, to domestic callers by dialing 1 (877) 344-7529 and to international callers by dialing 1 (412) 317-0088. For all replays, please reference conference number 10124527. An archived replay will also be available on a webcast link located on the homepage of the Investor Resources section of our website. And the conference has now concluded. Thank you for attending today's presentation. At this time, you may disconnect your lines.