Ares Capital's CEO Discusses Q2 2013 Results - Earnings Call Transcript

| About: Ares Commercial (ACRE)

Ares Capital Corporation (NYSE:ACRE)

Q2 2013 Earnings Conference Call

August 7, 2013 12:00 PM ET


John Bartling – Co-Chief Executive Officer

Todd Schuster – Co-Chief Executive Officer

Tae-SikYoon – Chief Financial Officer


Jade J. Rahmani – Keefe, Bruyette & Woods Inc.

Joel J. Houck – Wells Fargo Securities LLC

Richard B. Shane – JPMorgan Securities LLC

Ken Bruce – Bank of America Merrill Lynch


Welcome to Ares Commercial Real Estate Corporation’s Conference Call to discuss the Company’s Second Quarter Earnings. At this time, all participants are in a listen-only mode. As a reminder, this conference is being recorded on Wednesday August 7, 2013.

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 the words such as anticipates, believes, expects, intends, will, should, may and similar expressions.

The company’s actual results could differ materially from those expressed in the forward-looking statements for any reason including those listed in its SEC filings. Ares Commercial Real Estate Corporation assumes no obligation to update any such forward-looking statements.

Please also note the past performance or market information is not a guarantee of future results. During this conference call, the company may discuss core earnings which is a non-GAAP financial measure as defined by SEC Regulations G.

Core earnings is used among other things to compute incentive fees to the company’s manager and the company believes it provides useful information to investors regarding financial performance, because it is one method the company uses to measure financial conditions and results of operations.

Core earnings should not be considered in isolation or as a substitute for financial results compared in accordance with GAAP. For these purposes the company defines core earnings as GAAP net income/loss excluding non-cash equity compensation expense, the incentive fee, depreciation and amortization, related to targeted investments that are structured as debt to the extent of the company forecloses on any properties underlying such debt, any unrealized gains, losses or other non-cash items recorded in net income are loss for the period, regardless of whether such items are included in other comprehensive income or loss, or in net income or loss.

The amount will be adjusted to exclude one-time events pursuant to changes in GAAP and certain other non-cash charges as determined by and approved by a majority of the independent directors of the company.

A reconciliation of core earnings to net income/loss attributable to common shareholders to most directly comparable GAAP financial measure can be found in the company’s earnings release issued earlier this morning and posted on the company’s website at

I would now like to turn the call over to Mr. John Bartling, Ares Commercial Real Estate Corporation’s Co-CEO. Please go ahead.

John Bartling

Thank you, operator. Good morning and thank you for joining us for our Q2 earnings call. On the call with me today is Michael Arougheti, our Chairman; Todd Schuster, who is Co-CEO of the REIT with me; Bruce Cohen our President; and Tae-Sik Yoon, our CFO.

Let me start with some opening remarks and then we will turn the call over to Todd and Tae-Sik for a discussion on market conditions, recent investment activity, and our second quarter financial results.

We are excited to update you on the significant progress we have made towards our goal of building a world-class real estate platform at Ares, and a leading commercial real estate financial services company in ACRE. We have taken many important steps towards scaling the company and positioning us for future profitable growth, while at the same time directly originating a very high quality portfolio for investors.

Let me highlight each of these steps and provide you with some updates. First, as many of you know, in the second quarter, we entered into an agreement to acquire Alliant Capital, a multi-family focused commercial real estate services company, originating and servicing loans for various Government and Government-sponsored entities.

We believe Alliant which going forward will be known as ACRE capital, is an excellent platform that will strengthen our product suite and multi-family and also provide investment opportunities for balance sheet.

Although no assurance can be provided, we expect the transaction to close within the next 45 days to 60 days, on the early side of the closing range, we previously provided.

Next, on July 1, Ares management completed its acquisition of AREA Property Partners, a global real estate investment firm that has successfully invested approximately $14 billion real estate capital in a wide array of property types. The transaction scaled the Ares Real Estate Group to now have approximately 170 employees and $8 billion of committed capital under management. ACRE is already benefiting from this acquisition.

In terms of transaction referrals, due diligence, expertise, greater market recognition from intermediaries, field sourcing, and the relationships with other market participants that comes with having such a large footprint.

AREA also provides us with a unique opportunity for proprietary deal flow, as we plan to offer stable financings to perspective purchasers of commercial properties that are being managed by AREA. Furthermore, consistent with AREA’s unique culture of cost pollinating it’s investment (inaudible) with professionals assessing multiple asset class experience.

We’re adding former AREA of senior professionals to the ACRE managers investment committee. At the same time certain existing members of ACRE’s managers’ investment committee will join other real estate related investment committees, to enhance the information flow and monitor real estate trends across the platform.

With the AREA transaction closing a little over month ago, the Alliant transaction or acquisition expected to close in the near-term. We believe we are only scratching the surface in terms of the potential synergies, these great and exciting opportunities have provided us. Third, we scaled our capital base in rates $242 million in net proceeds in a common stock offering.

Our stronger equity base has enabled us to expand our credit lines and improve our funding cost. We have now up sized all of our existing credit facilities in an aggregate by approximately $140 million to $450 million of committed financing with lower pricing and improved terms. Also, given our larger equity base and enhanced liquidity in our stock, many more efficient ways of raising capital are now available to us.

Demonstrating confidence in the future of ACRE, members of the ACRE management team and the other areas affiliated entities purchased roughly 9% of the newly issued common stock. Ares collectively with this affiliate still remains ACRE’s largest shareholder with more than 13% stake.

We’ve made excellent progress investing the proceeds from our equity raise. In the first 40 days after our common stock offering, we have already closed $267 million of loans. About 84% of the $316 million in loans under executed term sheets disclosed on June 14. Furthermore, with greater than $2 billion of loans under various stages of valuation, we feel very good about the current investment climate and our ability to maintain pricing discipline as a result of having one of the largest direct origination platforms in the business.

Finally, one of the questions that we get most often from our shareholders is our sensitivity to interest rates. In short, rising interest rates drives higher earnings for us, a very valuable option for potential future earnings growth. I believe that many investors have yet to fully appreciate the asset sensitivity to our business model. And we believe that provides meaningful differentiation from other mortgage rates.

As you can see from our second quarter’s results, our underlying core earnings per share adjusted for the Alliant acquisition expense showed continued improvement as our recent investment activities have driven enhanced profitability. However, our improved quarterly earnings do not fully reflect the opportunity from converting that pipeline, closing the Alliant transaction and lowering our cost of funds to drive expanded earnings.

With that, I’ll now turn call over to Todd.

Todd Schuster

As we discussed on our last earnings call real estate transaction activity in the first quarter was seasonally slow, but we indicated that we expected a pickup in activity as we progress through the year. This is played out as commercial property sales, increased 13% year-over-year in the second quarter according to the most recent data from Real Capital Analytics providing a healthy market for loan activity.

Fundamentals in commercial real estate market continue to reflect the broadening recovery as capital flows increased outside of the gateway cities and into suburban areas and across a more diverse set of properties. This broadening of capital plays into our strength as a truly national originator since we can invest in assets with optimal relative value from a broader pool of opportunities and property types.

This past quarter the real estate credit and equity markets experienced meaningful volatility from Fed commentary around QE programs as the 10-year jumps over 100 basis points and sharp increases in intermediate and long-term rates had material impacts on fixed rate credit markets and longer duration high yielding equities.

In addition, lower rated investment grade securities in CMBS transactions widened 100 basis points or more during this period. However, in our core business this volatility ended up not having a material impact on lending spreads, transaction volumes or even property values to date.

Our core business model of providing floating rate senior and subordinated loans is about capturing premium risk adjusted returns from a broad origination platform with a liability structure that is well match funded. In fact, the short-term rates do start rising. Our return on equity on both are levered and unlevered investments would correspondingly increase.

As John highlighted, we believe our accomplishments over the past 90 days are already having a material positive impact. The recent acceleration in our origination activity along with our strength and platform from the area of transaction is translating into greater market recognition for our platform and greater leverage with market participants.

We can already point to multiple origination opportunities in Ares’ pipeline that are the result of the ongoing integration of the AREA Team into Ares management. Furthermore, even though we have a closely aligned transaction, employees of the future ACRE capital are already sourcing balance sheet opportunities that reside in our pipeline further validating our business case for [align].

Turning to recent activity, in the second quarter we originated $132 million of senior loans and since quarter end we have originated an additional $166 million of senior loans, including two loans of $75 million or more. Let me make a few observations about our recent investments. Two of the multifamily loans that we closed towards the end of second quarter involved an existing sponsor client of ours. We believe that we capture the first look at these financing as a result of the value we provided in our previous transaction. These two loans highlighted key benefit of our origination platform and the advantages of having incumbent relationships with sponsors.

Some of the office loans we made after quarter end where our first loans collateralized by properties in Orange County providing additional geographic diversification to our portfolio. And finally our most recent investment, a senior loan collateralized by real estate attractively located on the Magnificent Mile, Chicago’s premier shopping district, represented our first retail transaction.

With these closings we have originated and closed more than $280 million of loans in the past two months and have originated or cooriginated more than $478 million of loan commitments year-to-date. While we have diversified our portfolio by geography with 24 loans in 19 markets across the United States, we have been highly selective in our originations with a clear focus on less volatile office and multifamily property types.

As you can see from our recent activity we are broadening our approach and seeing good relative value in other asset property types including retail and industrial as well as hospitality, student housing and self storage among others.

As John mentioned earlier, with over $2 billion of investments under various stages of evaluation, the breath of our platform is uncovering compelling investment opportunities. Having completed my first two months as Co-CEO, I remain convinced that we are building a successful full service real estate financing company that is very well positioned for long-term benefits to shareholders.

And now, I’d like to turn the call over to Tae-Sik.

Tae-Sik Yoon

Great, thanks Todd. Hopefully everyone has had the opportunity to review our earnings release and Form 10-K, both of which were filed early this morning. Let me cover in detail, a number of the items that were covered in those filings. First, I’ll be discussing a summary of our earnings for the quarter; second, going over a short review of our investment loan portfolio; third, we’ll outline some of the recent capital market activities that we had and finally a snapshot of our balance sheet and liquidity position.

So let me begin with earnings for the quarter. Net income attributable to common stockholders was $3.3 million or $0.32 per basic and diluted common share for the second quarter 2013. Net income for the quarter was impacted by two material nonrecurring items. First we incurred $1.1 million in transaction expense related to the pending acquisition of Alliant Capital; and second, we recognized $2.1 million in non-cash unrealized mark-to-market gains and the derivative liability relating to our 2015 convertible notes. We will cover this in a little bit more detail little later in the discussion.

Core earnings for the second quarter, which again excludes certain non-cash items were $1.2 million or $0.12 per basic and diluted common share. Adjustments made to net income to determine core earnings include non-cash items such as approximately $100,000 of non-cash stock-based compensation as well as the $2.1 million mark-to-market gain on the derivative liability.

At the back of this morning’s earnings release and Form 8-K is a reconciliation between net income and core earnings. Also as stated in the earnings release, core earnings would have been $2.3 million or $0.23 per basic and diluted common shares when we add back the $1.1 million in nonrecurring expense related to the acquisition of Alliant Capital.

Let me cover in a little bit more detail the $2.1 million in non-cash unrealized mark-to-market gain on the derivative liability relating to again our convertible notes and how we will treat the convertible notes going forward from our balance sheet and income statement perspective.

As many of you already known, as part of the company’s annual stockholders meeting that we had back in June 26, the company received approval to issue common shares in excess of 20% of the company’s common stock outstanding in order to fully settle conversions of the 2015 convertible notes.

Therefore, the embedded conversion option of the convertible notes is no longer separately valued and accounted for as a derivative liability starting with the shareholder [vote date] June 26, 2013.

So going forward we will no longer present a derivative liability on our balance sheet and we will no longer mark-to-market gains and losses on the derivative liability through our statement of operations.

With respect to the $2.1 million again, unrealized non-cash gain we recognized on the derivative liability this quarter that amount represented a change in the value of the derivative liability from March 31, 2013 to June 26, 2013, again the date of our shareholder vote.

And again, since now the company has ability to fully settle the conversion of the convertible notes either in cash, shares or a combination of the two, the derivative liability is no longer on our balance sheet and mark-to-market unrealized gains and losses will no longer run through our statement of operations.

Turning to the investment portfolio, we ended the second quarter of 2013 with 21 loans totaling $589.4 million in commitments and $529.7 million in outstanding principal. 87% of our loan portfolio was measured by outstanding principal or 17 of our 21 loans were senior loans and only 13% or four of the 21 loans were subordinated loans.

The weighted average life for the overall portfolio is approximately 2.5 years and the weighted average unleveraged yield is 6.8% consisting 6% for our 17 senior loans and 11.6% for our four subordinated loans.

Our portfolio continues to perform well. As of June 30, 2013, all of the investments in a portfolio we’re paying in accordance with their terms and we had no impairments. As far as interest rate risk is concerned, as John noted, 20 out of the 21 loans we held at quarter end, again, representing more than 97% of our outstanding principal are floating rate loans based on one-month LIBOR. And similarly, all of our liabilities under our three funding facilities are also floating rate based upon one-month LIBOR. As a result, we believe that we are well match funded in terms of interest rates risk on our assets and liabilities.

As Todd also highlighted, so far after the end of the second quarter, we have closed three additional loans totaling $166.1 million in loan commitments of which of $159.7 million was funded at closing. This brings the total portfolio to approximately $755.5 million in commitments and $689.4 million in outstanding principal as of August 6, 2013.

As far as capital markets activities, we had a very busy few months. First, on the equity side, we issued a total of 18.6 million new primary common shares raising 242.4 million in net proceeds. This increases our total stockholders equity to approximately $400 million, including the approximately 600,000 shares that we issued after June 30th, pursuant to the underwriters over allotment option.

We have also made significant improvements of our three funding facilities. Overall, we expanded our bank borrowing capacity by approximately $140 million from $309 million to $450 million while simultaneously improving pricing, as well as modifying certain financial test and covenants to allow for greater balance sheet efficiency.

Let me walk you through some of the details. On June 27, we amended our secured credit facility with Wells Fargo. Among other important changes, we increased our facility from a $172.5 million to $225 million and reduced the pricing by about 25 to 50 basis points to a range of LIBOR plus a margin of 2% to 2.5%. Couple of weeks after on July 12, we amended our secured funding facility with Citibank. This facility was also increased from $86.2 million to $125 million and again, like the Wells facility, we reduced the pricing range by 25 to 75 basis points to a range of LIBOR plus a margin of 2.25% to 2.75%.

And then just a weeks ago on July 26, we amended the Capital One funding facility, doubling the size of the facility from $50 million to $100 million and just like Citibank and Wells Fargo, we were also successful in reducing the pricing range by about 50 basis points to a range of LIBROR plus a margin of 2% to 3.5%.

In addition to increasing the capacity of reducing pricing, we also successfully negotiated changes to key financial covenants under each of the three funding facilities. In April, we reduced minimum liquidity requirements in for two to three facilities lower the fixed charge coverage ratios.

Let me now provide an update of our cash position and liquidity. As of August 6 and assuming we obtained financing for three recently originated senior loans that we closed since quarter end, we expect to have about a $190 million in remaining capital either in cash or undrawn capacity under our funding facilities.

After holding about $10 million of reserve to meet liquidity requirements, we expect to have either in cash or approved, but undrawn capacity approximately $180 million investable and leveragable capital. We expect to deploy this capital to fund new investments both senior and subordinated loans to fund outstanding commitments on our existing loans, to fund the cash component of the purchase price of Alliant Capital and for other working capital purposes. And as we mentioned in our prior call to shareholders, we are in active discussions with other financing sources, including banks and insurance companies for additional funding facilities and other forms of borrowing capacity.

We are also looking at the securitization market as an alternative source of financing as a way to freed up capacity under our existing funding facilities. While we cannot assure you that we will enter into any new banking facilities or pursue securitized financing, we are encouraged by the positive signs that these are viable financing sources available for ACRE.

With respect to our balance sheet, at the end of June 2013, we had $581.1 million in total assets, including $40.2 million in unrestricted cash. Total liabilities were $186.2 million, down from prior periods due to the pay down in debt using proceeds of our June 2013 equity offering. And our stockholders equity was approximately $394.9 million or about 14.47 per diluted common share at June 30, 2013.

And finally, turning to our dividend, this morning we declared a third quarter dividend of $0.25 per common share payable on October 17, 2013 to stockholders of record on September 30, 2013. Our goal continues to be either earn and grow our quarterly dividend as we optimize our capital structure and invest our capital over time.

And with that, I will turn it now back over to John Bartling.

John Bartling

Thank you, Tae-Sik. Summary, we’ve been busy. The real estate team has executed well thus far on our pipeline, improved our financing, and began to realize real synergies from AREA and our other pending acquisition with Alliant. With an $8 billion global real estate platform, one of the largest direct origination teams in the specialty finance space, a stronger equity base, and greater scale at ACRE. We’re very well positioned for our future growth. Unlike many ways, we have an asset sensitive balance sheet and attractive portfolio of largely floating rate senior loans that positions us well and rising interest rate environment.

On behalf of the entire management team and our dedicated group of investment professionals, we want to thank our existing and new shareholders for their support. We believe the future of our company is very bright and plan to continue to deliver on all of our goals.

Operator, would you please open up the line for question and answers?

Question-and-Answer Session

Thank you. (Operator Instructions) And our first question comes from Steven DeLaney of JMP Securities. Please go ahead.

Steve C. DeLaney – JMP Securities LLC

Thank you for taking my question, and congrats guys on the progress with the origination front, and also on the credit facilities. I guess a couple of housekeeping things, may be Tae-Sik, you could help on this. I recall when we had a special conference call to discuss the Alliant deal at least back in May, and some of the information provided there, there was a number of about $2.2 million that was put out for expected Alliant transaction expenses, and obviously you only had $1.1 million. So my question is if we still expect cumulative expenses of about $2.2 million and will the difference come in the third quarter?

Tae-Sik Yoon

Sure, Steve. That’s a good question, and we appreciate you participating in this morning’s call. Yeah, so for our pro forma balance sheet that we have put out with respect to the Alliant transaction, we had shown as part of that transaction about $2.2 million in remaining transaction expenses that we had incurred but not had already recognized in the first quarter, so the $1.1 million that you see that we incurred in the second quarter as part of that $2.2 million and we certainly do expect more transaction expenses that we are incurring in the third quarter towards the closing of the transaction.

We think it’ll be probably slightly higher than $2.2 million overall, so in other words the remaining transaction expenses we would expect to be little bit higher than the remaining balance of $1.1 million, because when we put out the $2.2 million again under the rules about ProForma financials you only include expenses that you had already known about or heard at that point, so have now known and incurred more expenses beyond that $2.2 million original estimate but the $1.1 million, just to answer your question is part of that $2.2 million estimate.

Steve C. DeLaney – JMP Securities LLC

Okay, that’s helpful. And John, you gave us a little more color or at least a more optimistic view I guess of the potential closing date sometime possibly in early October. Could you comment on just generally, is there a specific hurdle whether its regulatory approvals or the DUS program or whatever, what is the from a timing standpoint what could prevent from instead of closing in say October not closing until December or January and what would be the sort of the outside date you would sort of put on this?

John Bartling

Well, anytime. Thank you, Steve. By the way I too thank you for being here today. Anytime you are dealing with government entities or entity sponsored by the government I would never want to handicap an outside date, but this being said as we sit today it appears we have most of our approvals we are working to documentation hopefully this is something that will close at or around Labor Day maybe even slip into the middle part of September, but as we have said today, we are very optimistic about moving on expedited basis for closing.

Steve C. DeLaney – JMP Securities LLC

Okay, great. Well, we had assumed that total 1 in our model, so I think sounds like that’s going to happen, so thank you for that. And just one final thing; you guys give us great details for modeling purposes and for the loan portfolio and you give us a 6.8% effective yield, which I assume you’re putting in fees expected administrational fees et cetera on the funding side though, even with the new lower rates we got kind of a wide range here I guess whether it’s the LTV loan or whatever and say Wells Fargo can charge you either LIBOR plus 200 or anywhere up to LIBOR 250 and I assume there is some fees on those facilities as well, so is there anyway to kind of since you don’t give us a like effective cost to funds for the prior period, is there some way to kind of tighten in just for modeling purposes, is there a tighter range you can give us or gives us some sense of what you expect your sort of blended cost to borrowing would be on these three facilities over the next couple of quarters with LIBOR sort of stable around say 18, 19 basis points?

Tae-Sik Yoon

Sure Steve. This is Tae-Sik. Each of the funding facilities are set up so that in fact there is a range of borrowing spreads and that’s based upon the bank’s perception of the risk of the loan itself, so higher LTV loans or different types of assets will demand a different pricing with immigrate and in fact that range has also provided and has also and really used as a guidance grid and we on occasion on sort of off the grid to get these a better pricing or to get different terms as well.

So those are certainly ranges that we have stayed well within but on a occasions we even though outside of it and you are right, there is expenses associated with each of the alliance particularly in terms of what it costs for us to set it up in terms of transaction fees as well as origination fees. And then there is some fees related to unused fees and monitoring fees going forward and we have not included in our prior disclosures the weighted average cost of debt.

We do include in our 10-Q if you notice there we do include the weighted average balance of the loans. So I think if you looked at the weighted average balance of loans and then you looked at the net interest costs that we have experienced during that time period, you could probably get a rough approximation of what our historical numbers have been.

John Bartling

I think the importance thing to note on that Steve is, as we continued to scale the balance sheet and now we are in a position with more diversification of assets and we continue to grow the business, our ability press them on the liability side to improve our net interest margin is an opportunity that sits in front of us and one that we are very focused on, so I’m not sure how much history is going to be a guidance as we continue to push on that part of our profitability if you will. But it is something that is very near and dear to all of us and one that we are very focused on as we go into the end of the year.

Steve C. DeLaney – JMP Securities LLC

The comments are helpful and in case I had noticed that average outstanding debt balance that will be helpful to back into a number. So thank you all for your comments and the color.

John Bartling

Thanks Steve.

Tae-Sik Yoon

Thanks Steve.


The next question comes from the Jade Rahmani of KBW. Please go ahead.

Jade J. Rahmani – Keefe, Bruyette & Woods Inc.

Hi, thanks for taking the question. Let’s clear the pace of originations has materially increased. I wondered if you could just provide a sense for what the internal sort of mindset is with respect to improved confidence and if you think that that the critical ingredient driving the acceleration has been the capital raise or is it the area deal and what mix of originations do you expect to be sourced out of area relationships?

John Bartling

Jade, thanks very much for participating, this is John. Great to have you on, great question. The great thing about having and I’m going to let (inaudible) this as well, but the great thing about having a larger platform and one that is able to invest up and down the capital stack, we are now in a position as a firm to be able to talk to the market about everything from senior financing to joint venture financing to mezzanine financing, whatever it may be we are in a position to really have a dialog to provide solutions into the market. But importantly it gives you enormous leverage within intermediaries, it gives you a lot of leverage with the borrower base that’s out there, capabilities.

So we are seeing not only the former area partners out there, talking to the market and it gives them an opportunity to be more relevant as well as they talk to the market. We are just being able to leverage off those existing relationships that have been so prevalent over an extended period of time, equally with a portfolio that is very diversified as they are in the market harvesting their own games and selling assets. You are also in a position where you can staple financing on, opportunities for which they sell and that provides us great opportunity.

So I think we are seeing the area, seeing the transaction become very relevant to us, just from a transactional deal flow of pipeline standpoint and deal sourcing, this is a relationship business in all ways and from a market intelligence standpoint it’s been extremely helpful. But I will also not take away one thing from the Alliant transaction which with 90 employees of their own and having the $6 billion portfolio with 1000 loans, the opportunity to go and the harvest to offer that portfolio is as equally relevant to us and so as the AREA transaction. (inaudible)I’m sorry.

Todd Schuster

Jade, this is Todd Schuster. Just really want to echo what John said. I think that both AREA and Alliant are really giving just additional leverage to our direct sales force in the marketplace and so we are just seeing better coverage, better flow, more interesting transactions and I think it is pretty much as simple as that.

Jade J. Rahmani – Keefe, Bruyette & Woods Inc.

Great thanks. On your investment capacity discussion, I wanted to find out based on your existing available capital and capacity whether you expect – and the conversations you having around future credit facilities, whether you are still expecting to get to a target of 2 times to 2.5 times leverage?

John Bartling

Absolutely, we fully intend to – we’re now getting to that stage where we can start to optimize our portfolio and take advantage of leverage more effectively. We think that running a risk adjusted return is not the combination of investing in high-quality ROA which as you know from our portfolio we try to get a lot of detail around, we believe we’re continuing to originate with a lot of price discipline. And I would stay on top of that it’s just financing, it’s taking advantage of the leverage markets in the most efficient way. And when you’re targeting 2.5 times, there will be times when you are little above that and times you’re little bit below it, but we’re now at that stage in our life cycle where we are heading towards better utilization of our liability side of the balance sheet.

Jade J. Rahmani – Keefe, Bruyette & Woods Inc.

Great, thanks a lot.

John Bartling

Thank you Jay. We all appreciate it.


The next question comes from Joel Houck of Wells Fargo. Please go ahead.

Joel J. Houck – Wells Fargo Securities LLC

Thanks, and again nice to see the pace of origination picking up. Just to kind of continue on the last question or comment, if you look at the $160 million it’s been originated post Q2 and the $180 million available, that’s about $340 million of additional, assuming it’s financed on a debt basis, which you’ll put the leverage ratio at about 1.3 times. So I guess the question is, how will you get from there I’m assuming all of the existing facilities are kind of efficiently being used with respect to advance rates and other things related to availability. How you go from one 1.3 to two, 2.5 are you landing on unsecured financing overtime, or is there, as you get bigger does advance rates become more flexible, kind of walk us through that if you don’t mind.

John Bartling

Thanks Joel. Yeah great, thanks for being on the phone call today, too. Good question. Managing the liability side and how you balance is a combination as you know at this stage both asset-based financing, as well as you are also aware we did a convert last year at the end of the year. So it is the combination of as we continue to scale the balance sheet, and as we look at different ways to tap the market for how we best optimize our own financing side, it will be a combination of asset base financing there will be combination of securitized financing of the more in likely combination of corporate finance as well as in the form of either unsecured lines or secured line or other convert opportunities that may present themselves to us as we think about how the best manage that part of our business.

John Bartling

That we certainly targeted, Tae-Sik, which you add anything.

Tae-Sik Yoon

Sure, I think it’s great John, one thing that we’re positive that was in perfect clear just to – maybe just add little more color. As when we look at the $160 million or so, that we’ve closed sine June 30, begin all three of those were senior loans right so. If those get leverage once we do expect deleverage on that. We would have $50 million to $60 million of equity and $100 million to $110 million of debt. That’s how we are going to get to the 2% to 2.5% on leverage on that. And, when you look at the $180 million of remaining capital we’ve available again just theoretically if we were to use that to do just senior loans. That will give capacity to do three times that number of senior loan.

So, we could do call it $540 million of transactions on senior loans using the $180 million of leveragable capital. So, that’s really the math, I hope that – that hopefully add some color into how dramatically we can just 2% to 2.5% on leverage based upon $160 million that we close in the third quarter so far. As well as the remaining $180 million capital we’re going-forward.

John Bartling

(inaudible) just not to overkill the point and Mike is on the phone as well, I think have done a very good job at accessing the capital markets, as witnessed with ARCC and over time how we’ve expanded our various facilities and the types of financing on ARCC, no different here. We will continue to pressing on our relationships in the capital markets to make sure we optimize how our financing and our capital stack is run with ACRE.

Joel J. Houck – Wells Fargo Securities LLC

Yeah, that’s helpful. And again as I just misread the $180 million abd did not I thought that was just the amounts you could drafted, which you can lever that up, with senior loans three times and that gets you closer to two times. So I don’t know if you just kind of last question in terms of pipeline, and if you make comments and I missed earlier, but it would seem that there is lot of momentum on the origination side and given the current investment capacities well over the $180 million in total, what does the pipeline look like in terms of kind of where, and I appreciate that leverage is going to fluctuate around a number, but where do you kind of see the business that the timing of which is more of a kind of a run rate in terms of appropriate leverage, is it near the end of the year, or could it be quicker than that?

John Bartling

Obviously. It could be quicker than that, we are on pace, we have a very healthy pipeline, we are running into a very active time of the year, which is always the fourth quarter, and we are on a good position with the expanded balance sheet to really pick through the assets that we want to invest in.

So our fairway continues to be that I’ll call it $30 million to a $125 million whole sized, and we are continuing to see robust opportunities in and around the sort of the investment target that we’re looking for. It’s if anything we’re really now in good position between now and end of the year to fully utilized the capital.

Joel J. Houck – Wells Fargo Securities LLC

Okay. Now I appreciate the comments and in case again congratulations on the solid quarter and looking for even better things to come.

John Bartling

Thank you, Joel we are to appreciate the support.


The next question comes from Rich Shane of JPMorgan. Please go ahead.

Richard B. Shane – JPMorgan Securities LLC

Hey, guys thanks for taking my question. I was primarily interested and understanding the liability structure and the capital that you just answered. But, why don’t you just on touch on one last thing, which is that when we look at the dividend now, it basically implies about 7% ROE in order to meet that dividend. As you layer in the acquisition developed a little bit of operating efficiency. And I actually I think the interesting element in this call is potentially the capital efficiency as well, where do you think ROE can go over the long-term. Should we look at ROE as scale to LIBOR given the asset sensitivity?

John Bartling

Rich thanks for joining. Without giving guidance kind of few questions in there. Really in a raising interest rate market, you heard us whether it was my comment preferred comments (inaudible) we’ve over emphasized probably the fact based on LIBOR, investments and LIBOR liabilities. We’re very well matched funded and to the extent that we rising interest rate market will actually be a beneficiary of that.

So, I think earnings depending on your future interest rates, our ROE will only improve. I think what else is interesting about our business right now is we’re about to take in $4 billion of MSRs and as we continue to look at those opportunities and originate, which is a very efficient business by adding fee-based business and tune that to a balance sheet business and interest business. I think we’ll see depending on our origination pace with the ACRE capital transaction we’ll continue to see improved and enhanced ROE.

So I really do think we’re in a great position to enjoy so that the sort of ROEs that are consistent with where we are today. My only concern about overly growing out a number is [free] to anything we do whether it’s projections or volumes or otherwise, because we’re less, we always focus on making solid investments, the best risk adjusted investments and we don’t want to be chasing risk and we don’t want to be chasing yield for the sake of taking on risk that’s inappropriate. We’re very disciplined about our pricing risk, and so my caution on going beyond that is just really doing something out there that might be mistaken.

Richard B. Shane – JPMorgan Securities LLC

No, look I think that’s fair. That’s been a hallmark of the organization for a long time that you are willing in some environments to take lower absolute returns based on your view that it’s actually better risk.

Unidentified Management Speaker

Yeah, right now it’s benign credit market and it’s great origination market and we’re in a great place to really enhance ROE. I think we’re in great place to really meet and exceed expectations in that regard.

Richard B. Shane – JPMorgan Securities LLC

Okay. Thank you, guys.


We have time for one more question. Our next question comes from Ken Bruce of Bank of America Merrill Lynch.

Ken Bruce – Bank of America Merrill Lynch

Thank you good afternoon. I’d like to pickup the conversation where you left off around the discussion around leverage and capital. Obviously it’s very good to see that pick up in origination activity and that momentum looks very strong here for the near-term. And just in terms of to a degree that you are at an optimal leverage position and the stock continues to be let just stay at a significant discount to book, what might you consider in terms of alternatives to try to ensure that you got adequate capital to essentially fund the pipeline of loans that you’ve got in place and how do we think how that would play out in kind of current market backdrop.

Unidentified Company Representative

Hi, Ken. Thanks for joining to. I appreciate the question. We continue to do the muscle building that we think makes a lot of sense for our shareholders. We’ve spend a lot this year to really build what I would like to think the best specialty finance company in this space. And if I step back for a second and answer your question, I would say – as I answer it, I want everyone to keep context. We have added significant strengthen in our board. We’ve brought in Brett White, who is the former CEO of CBRE to help strategies and build relationships in the intermediated market.

We’ve obviously expanded our footprint as a manager to the area transaction which both adds relevance and opportunity in terms of sourcing deals and being able to lean into the market and find the best investment opportunities for investors. We’ve also brought in a company through Alliant, which I believe personally will have a lot of relevance to enhancing ROE whether it’s by adding the MSR’s or its been able to mine without the loans or it’s the ability to generate new fee income and help source new transactions and be more relevant in the multifamily market from beginning to end, whether its bridging in to GSE, construction to GSE or adding new product lines, new nursing homes, student housing, other areas where you really have more relevance.

I think, we have done all of the muscle building more importantly even bringing Todd Schuster who built one of the largest specialty finance companies in this business, formally CWCapital. Hopefully, all of this along with the expanded balance sheet, I believe in part, your question on the discount to book is one of execution.

And the three things I believe that we need to do to really show our shareholders the value proportion, despite what I just talked about is really, we’ve done two of the three and we are about to do the third. The first is execute on our pipeline, we are doing that and in the process of on pace.

The second thing is to improve our cost of funds and expand our lines, we’ve done that and we’re continuing to do that. And the third is close aligned and bring that in to the fold and show the value proportion of that. And as we go into the remaining part of the year, I believe all of these things together will continue to hopefully demonstrate to the market the value of our enterprise and that will translate into the stock price.

Ken Bruce – Bank of America Merrill Lynch

Yeah, I share your optimism in terms of to the degree executing against your plan that that could occur. I guess, really what I’m asking is would you be willing to take up leverage in the absence of the market being conducive to equity capital raising and to the degree that you think that you can do that. What are maybe the boundaries around increased leverage that you will consider?

Unidentified Company Representative

Now, clearly one of the nice attributes of having Ares as manager for this company as we access to a lot of capital marketed options. And I believe which is an unsecured line which could help bridge into an equity offering, so that you don’t have to drag. You’d otherwise have if you have to be sporadic about it. So we are looking at those opportunities and to the extent of that moves are sort of optimize leverage a little bit or not. We are very sensitive to how we best do any future rates as both in terms of what it is to book value, as well as how you time and you manage that into the market.

Ken Bruce – Bank of America Merrill Lynch

Okay, thank you. And then maybe just lastly, there has been a – there’s a lot of things moving around in the market. And specifically, you’ve got the potential for if any to be less active in the multifamily market, there has been a number of participants from a lending standpoint that has discussed moving into the sector. Can you just give us maybe some thoughts as to how you see the market opportunity evolving in that particular area, knowing that you’ve got now, assume to be a franchise that’s directly looking at that part of the market?

Todd Schuster

Yeah, that’s a great question especially after Obama’s comments yesterday about what he would like to see with housing. We have a very active footprint in the multifamily sector, here at Ares, whether it’s direct investing through what was the AREA platform, or I believe we have something like 30,000 apartments that were invested in, whether it’s our own portfolio in ACRE where we’re very active in that space, Alliant obviously is the U.S. lender. And as I think we’ve said in previous comments, the government will be in our opinion slow to walk out of whatever they do and this isn’t going to happen over night.

We didn’t pay anything for the franchise of Alliant. We bought in (inaudible) if you will. What we had is great option value on it. This being said, I can’t imagine personally a better time to want to be incumbent in that conversation. Have been the U.S. lender as your – to the extend that we move into the Freddie and with FHA, being at the table as they reorganize their businesses, as they go forward with those businesses and how they develop that. You want to be there and you want to be part of that dialogue and you want to have the incumbency around it.

I think I would say, is while I do think it will take time for the government to actually decide what they are going to do and how to do it. You might also note in their comments one of things that they always focus on now is a shift away from over emphasizing direct home ownership and more into rental housing especially affordable housing and having that sort of prioritization and continued prioritization of supporting at the GSE level, affordable housing I think again because of the incumbency that will have at the table as a result of Alliant, we would look for our ability to support that part of the business as being unique too.

Ken Bruce – Bank of America Merrill Lynch

Great, thank you for your comments today.

Unidentified Company Representative

Thank you Ken. Really appreciate it.

Unidentified Company Representative

Well, thank you everybody for joining us today.

John Bartling

And we want to again, Operator, I’ll let you close this off, but I want to thank everybody for joining us and all your continued support on behalf of all of the Ares team. Thank you.


Ladies and gentlemen, this concludes our conference call for today. If you missed any part of today’s call, an archived replay of this conference call will be available approximately one hour after the end of this call through August 20, 2013 to domestic callers by dialing 877-344-7529, and to international callers by dialing +1-412-317-0088. For all replays, please reference conference number 10031264. An archived replay will also be available on a webcast link located on the home page of the Investor Resources section of our website. Thank you. You may now disconnect.

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