Ares Commercial Real Estate Corporation 2026 Q2 Earnings Call

Thank you for joining us on today's conference call. In addition to our press release and the 10-Q that we filed with the SEC, we have posted an earnings presentation under the investor resources section of our website at www.arescre.com. Before we begin, I want to remind everyone that comments made during the course of this conference call and webcast, and the accompanying documents contain forward-looking statements and are subject to risks and uncertainties. Many of these forward-looking statements can be identified by the use of words such as anticipates, believes, expects, intends, will, should, may, and similar such expressions. These forward-looking statements are based on management's current expectation of market conditions and management's judgment. These statements are not guarantees of future performance, conditions, or results and do involve a number of risks and uncertainties.

The company's actual results could differ materially from those expressed in forward-looking statements as a result of a number of factors, including those listed in its SEC filings. Ares Commercial Real Estate Corporation assumes no obligation to update any such forward-looking statements. During this conference call, we will refer to certain non-GAAP financial measures. We use these as measures of operating performance, and these measures should not be considered in isolation for or as a substitute for measures prepared in accordance with generally accepted accounting principles. These measures may not be comparable to like-kind measures used by other companies. Now I'd like to turn the call over to our CEO, Bryan Donohoe.

Bryan? Thank you, John. Good afternoon, everyone.

Thank you for joining us. I'm here today with Jeff Gonzales, our CFO, Tae-Sik Yoon, our COO, as well as other members of the management and investor relations teams. During the second quarter, we saw the commercial real estate market exhibit relative stability despite broader macroeconomic and geopolitical uncertainty. Property prices appreciated modestly, financing markets remained open, and liquidity continued to improve. While sales transaction activity did moderate somewhat during the second quarter, we see compelling opportunities driven by refinancing needs and a robust pipeline of floating rate lending opportunities offering attractive risk-adjusted returns. Consistent with recent trends, private real estate capital continues to increase its role in the market.

Today, debt funds have become the second-largest source of commercial real estate lending behind banks, according to MSCI, reflecting both the continued evolution of the lending market and the growing importance of alternative asset managers. We continue to believe that the scale of the Ares real estate platform is a key differentiator in allowing us to access greater institutional quality assets in a diversified manner and efficiently deploying our available capital. The strength of the platform allowed ACRE to deploy over $900 million in new loan commitments in the past 12 months, which represents more than 40% of our current loan portfolio. Supported by these platform benefits and the progress we have made in executing our business plan, we believe ACRE is well positioned to capitalize on market opportunities while continuing to advance our portfolio repositioning strategy.

To this end, we have continued to make meaningful progress in addressing risk-rated four and five loans while further reducing office loans and REO properties. At the same time, we are strategically redeploying capital into high-quality new investments, largely to support growth in earnings and achieve our long-term portfolio objectives. We believe our second quarter results reflect the continued execution against that strategy. Importantly, key portfolio and financial metrics remain consistent quarter-over-quarter, as reflected by our relatively stable CECL reserve. Additionally, for the third consecutive quarter, no risk-rated one through three loans migrated to risk-rated four or five loans. We also had no new REO properties, and the operating performance across our existing REO assets remained stable. Supported by these metrics, the depth of the Ares platform and a supportive commercial real estate market, ACRE saw another quarter of steady portfolio growth.

As of June 30th, 2026, we increased the outstanding principal balance of the total portfolio by 36% year-over-year while improving portfolio diversification and reducing the office loan portfolio. During the second quarter, we closed three new loan commitments totaling $130 million across multi-family, self-storage, and hotel properties. Consistent with last quarter, all three new loan commitments were part of co-investment opportunities alongside other Ares Management affiliated vehicles. We believe ACRE's ability to selectively co-invest alongside Ares managed vehicles allows us to reduce asset concentration risk while participating in institutional properties in major markets which would otherwise be beyond our standalone capital base. Loans originated over the past 12 months now account for 42% of the total portfolio of loans held for investment. These loans contribute to broader diversification across vintage, sector, geography, and credit while providing gross levered returns in the low double digits.

These loans also reinforce the solid foundation of the underlying portfolio. By number of loans, 89% of the loan portfolio is risk rated one to three and primarily consists of loans collateralized by multifamily, industrial, and self-storage loans. These loans continue to execute their business plan in line with expectations. In order to achieve the goals of the business over the past several years, we proactively strengthened our balance sheet to address identified assets within our portfolio that were adversely affected by changing market dynamics or property-specific challenges. The progress we have made in repositioning the portfolio is a direct result of the continued focus in addressing risk-rated four and five loans and REO properties and further reducing our office investments. We believe that resolving these assets and redeploying that capital into yielding new investments remains an important driver of future earnings growth.

Let me now dive a bit deeper into the specific investments we continue to focus on and provide an update on the progress we're making towards resolutions. Starting with our risk-rated four and five loans. Similar to last quarter, there are four loans outstanding. Looking at the largest risk-rated five loan in the portfolio, the Chicago office loan remains on non-accrual but continues to make its contractual interest payments. Fundamentals at the property remain steady. Occupancy is above 90% with a weighted average lease term of over seven years and positive net cash flow. Further, while Chicago remains challenged, there have been positive signs of a nascent recovery in the market. As mentioned on our previous quarter's call, we remain engaged with the borrower on their ongoing sales process.

Although the timeline has extended beyond our original expectations, we remain encouraged by the negotiations, which continue to advance towards a resolution. We note that post quarter end, the loan was extended from July 2026 by three months to support the borrower's business plan and continued efforts to reach a conclusion in the sales process. Turning to the second-largest risk-rated four and five loan. The Brooklyn residential condo remains on non-accrual, but advancements in the business plan continued during the quarter. Construction on this building is now substantially complete. Our CECL reserve takes into account estimated future costs, with remaining costs largely limited to settling payables from completed work and completing punch list items. Early marketing and pre-sales efforts remain ongoing, supporting a more visible path towards resolution.

Next, I want to address the $13 million subordinate loan collateralized by a California industrial property, adjusted to a risk rated five from a risk rated four during the quarter. As a reminder, this subordinate loan is part of a larger capital structure. We continue to receive sponsor support as well as growing interest from prospective tenants alongside positive trends in this sub-market. However, with the maturity of the loan in January 2027, we adjusted the risk rating to reflect the higher probability of a near-term realized loss. These updates underscore the highly asset-specific nature of our four remaining risk-rated four and five loans. Throughout this cycle, we have proactively identified challenges, de-leveraged the balance sheet, and enhanced liquidity, enabling us to resolve underperforming assets while positioning the company to address these remaining investments.

We believe that our work to date has narrowed the potential outcomes, in part reflected in the stability of CECL this quarter. During the quarter, and consistent with our goals to change the complexion of our investment portfolio, office loans decreased to $442 million, or less than 25% of the total loan portfolio, as compared to 39% of the total loan portfolio at the end of Q2 2025. As of June 30th, 2026, there were five risk-rated one to three office loans remaining. Further demonstrating the execution of our strategy to reduce our office investments, last quarter we launched the sale of the North Carolina office REO asset. Market interest in this property has been strong, and we continue to work towards the sale of this asset. With regard to our other remaining REO, the Florida mixed-use property continues to exhibit consistent occupancy with an income yield of 10%.

While we do not intend to be long-term owners of this property, we believe the current yield of this investment is attractive while we evaluate the optimal path to exit this investment. In closing, we continue to execute the strategy we've outlined over the past several quarters. We are making steady progress resolving underperforming assets while selectively investing alongside the broader Ares platform in high-quality new originations. Although there is still work ahead, the portfolio today is materially different than it was a year ago. It is larger, more diversified, and increasingly comprised of newer investments originated in today's attractive lending environment. With more than $150 million in carrying value of loans, net of CECL not accruing interest, we are squarely focused on resolving these assets and capturing the potential earnings power of our future balance sheet.