ACRES Commercial Realty Corp's (ACR) CEO Mark Fogel on Q4 2021 Results - Earnings Call Transcript

ACRES Commercial Realty Corp. (NYSE:ACR) Q4 2021 Earnings Conference Call March 3, 2022 5:00 PM ET

Company Participants

Kyle Brengel – Vice President

Mark Fogel – President and Chief Executive Officer

Dave Bryant – Chief Financial Officer

Andrew Fentress – Chairman

Conference Call Participants

Steve Delaney – JMP

Operator

Thank you. Good day, ladies and gentlemen, and welcome to the Fourth Quarter 2021 ACRES Commercial Realty Corp Earnings Conference Call. Currently, all participants are in a listen-only mode. Later we will conduct a question-and-answer session with instructions to follow at that time. [Operator Instructions] As a reminder, this call is being recorded.

I would now like to introduce your host for today's conference, Mr. Kyle Brengel, Vice President. You may begin.

Kyle Brengel

Good afternoon and thank you for joining our call. Before we begin, I want to remind everyone that certain statements made during this call are not based on historical information and may constitute forward-looking statements. When used in this conference call, the word believes, anticipates, expects and similar expressions are intended to identify forward-looking statements. Although the company believes that these forward-looking statements are based on reasonable assumptions, such statements are based on management's current expectations and beliefs and are subject to several trends, risks and uncertainties that could cause actual results to differ materially from those contained in the forward-looking statements.

These risks and uncertainties are discussed in the company's reports filed with the SEC, including its reports on Forms 8-K, 10-Q and 10-K and in particular the Risk Factors section of its Form 10-K and Form 10-Q. Listeners are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The company undertakes no obligation to update any of these forward-looking statements.

Furthermore, certain non-GAAP financial measures may be discussed on this conference call. Our presentation of this information is not intended to be considered in isolation or as a substitute to the financial information presented in accordance with GAAP. Reconciliations of non-GAAP financial measures to the most comparable measures prepared in accordance with generally accepted accounting principles are contained in the earnings presentation for the past quarter. With me on the call today are Mark Fogel, President and CEO; and Dave Bryant, ACR's CFO. Also available for Q&A is Andrew Fentress, Chairman of ACR.

I will now turn the call over to Mark.

Mark Fogel

Good afternoon everyone and thank you for joining our call. Today, I will provide an overview of the company's loan originations, real estate investments, capitalization and the health of the investment portfolio while Dave Bryant will discuss the financial statements, liquidity condition and operating results for the fourth quarter. In addition, we have added two important disclosures for shareholders in our presentation; the first, a presentation on the earnings potential of the company based on certain assumptions around leverage and returns; and the second, a list of the REOs the company currently has along with our strategy for each. And of course, we look forward to your questions at the end of our prepared remarks.

In the fourth quarter, we continued to grow and manage the loan portfolio. We closed two equity investments in real estate. We closed the company's 11th CLO, which will reduce its cost of capital and extend duration of the financing, all while continuing to offer our sponsors outstanding service. The ACRES origination team delivered $447 million of new loan commitments in the quarter. This brings loan production volume for 2021 to approximately $1.5 billion, a record year for the company. Additionally, the team completed $29 million of initial equity investments on two properties in the northeast region in the quarter, which we expect will deliver capital gains in future years. These results reflect the efforts of the entire ACRES team in identifying, processing and executing on opportunities nationwide with our unique financing solutions in target asset classes.

From a capitalization standpoint, the company successfully executed its second managed CLO of 2021, bringing its total loan financing capacity to over $1.5 billion from the two CLOs. Additionally, after December 31, 2021, the company repurchased a portion of its convertible senior notes and executed the optional redemption of the senior notes of the 2020 RSO9 CLO. Portfolio quality remains high and is improving. The watchlist loans comprising those risk rated a 4 or a 5 reflect 8% of the total commercial real estate loan portfolio as of December 31st as compared to 10% as of September 30th and 23% when Acres took over the REIT in July 2020. We expect to continue expanding the commercial real estate loan portfolio in 2022 in order to continue delivering on our strategic initiatives to maximize earnings and build book value for the company's shareholders.

Returning to loan production. We closed 15 commercial real estate whole loans for $447 million during the fourth quarter. These loans pay coupon interest at the one month benchmark rates, which comprise LIBOR and SOFR, plus a weighted average spread of 3.53%. Each loan originated this quarter carries benchmark rate floor protection, which has a weighted average up 10 basis points. Approximately $375 million or 84% of the originated loans in the fourth quarter are collateralized by multifamily properties while the remainder are collateralized by office, self-storage and hotel properties. These loans had a total weighted average LTV of 72% based on the underlying property valuations available at the time of each loan's origination.

The company received sale, payoff and paydown proceeds of $363 million from the sale of one loan and full or partial repayment of 15 loans during the fourth quarter. Total sale payoff and paydown proceeds in 2021 were $1 billion. For both the quarter and the year, loan originations exceeded proceeds received producing net portfolio growth. We believe that the borrowers' ability to refinance or sell indicates the quality of the sponsors and assets underlying the portfolio, along with improved market conditions for refinancing our sales activities.

During the quarter, the company made initial investments totaling $29 million to acquire two commercial real estate properties. The investments included a 99,000 square foot Class A office building, which is expected to be redeveloped into life science and lab space; and a 12-acre parcel of land, which was preliminarily approved for development into a 300-unit multifamily building. Each property is located in the northeast region of the United States. We believe that these properties will generate untaxed capital gains in the future through the use of the company's tax loss carry forwards and create returns that can be reinvested into the loan origination pipeline when realized.

Looking ahead, we expect to target asset classes nationwide consistent with the company's origination history and the loan pipeline, including a primary focus on multifamily properties, along with other segments such as select opportunities in office, hospitality and self-storage. The credit markets continue to be competitive, which as a result has accelerated spread compression, particularly in the multifamily sector. In addition, lower benchmark floor rates means lower all-in rates for the company. While ACR is well positioned for growth, we will remain selective and focus on credit quality, targeted markets and strong sponsors to originate accretive new loans for the portfolio.

The company is in a strong liquidity position with a diverse array of financing sources. We continue to manage the balance sheet to optimize for the lowest cost of capital structure while extending duration. In December, the company executed its second managed CLO of 2021. The transaction can finance up to $700 million of commercial real estate loans with the $567 million of non-request floating rate notes issued at an average cost of 180 basis points over one-month LIBOR. Approximately $518 million of commercial real estate loans collateralized the CLO at closing. In accordance with the terms of the transaction, the company may ramp up the CLO with the $181 million of unused proceeds within 180 days of closing, subject to the acquired loan satisfying certain eligibility criteria.

As of February 28, approximately $181 million of the proceeds have been utilized to acquire additional collateral. In total, the two managed CLOs executed in 2021 give the company the ability to finance over $1.5 billion of commercial real estate loans using $1.2 billion of non-recourse floating rate notes at an average cost of 163 basis points over one-month LIBOR. Additionally, each of the 2021 CLOs contain a 24-month reinvestment period commencing on respective closing date of each CLO. That is, the company may reinvest principal proceeds received on its collateral to acquire additional commercial real estate loans, our participations in commercial real estate loans that satisfy certain eligibility criteria.

Our intent is to use the reinvestment proceed – periods available to invest proceeds from the CLOs to finance the company's growing commercial real estate loan pipeline. In February, the company repurchased $39.8 million of principal of the 4.5% convertible senior notes and redeemed the remaining $69 million of principal of the senior notes of the 2020 RSO9 CLO. The portfolio has continued to perform, demonstrating sound and consistent underwriting and asset management. The company ended the quarter with $1.9 billion of commercial real estate loans across 94 individual investments, of which only three comprising 2% of the portfolio were delinquent and one comprising less than 1% of the portfolio were performing in accordance with a forbearance agreement. At the time of our acquisition of the company, it had 23 watchlist loans representing 23% of the portfolio. As of December 31, the number of watchlist loans has reduced to 10, representing 8% of the portfolio.

In January, the company received payoff proceeds on two watchlist loans, which comprised 1% of the portfolio at December 31st and included the remaining legacy CRE loans. We believe that the company has a well-diversified nationwide portfolio with 66% of the loans concentrated in the high-growth southeast, southwest and mountain regions of the United States. Our target asset classes are projected to provide sustainable cash flow, including the multifamily class, which is particularly durable and represents 70% of the loan portfolio.

In addition, the ACRES platform has over $250 million of loans in its development portfolio that will be eligible for the company's book in the coming quarters. This unique sourcing opportunity provides the company with curated sponsor relationships and Class A newly-constructed assets at attractive returns. In summary, the ACRES team is pleased with the growth and quality of the investment portfolio, including investments in real estate, along with the improved balance sheet profile and the prospects for new originations and capital appreciation going forward. We will continue to execute on our business plan by originating high-quality investments, actively managing the portfolio and continuing to focus on growing earnings and book value for the company's shareholders.

We will now have ACR's CFO, Dave Bryant, discuss the financial statements and the operating results during the fourth quarter.

Dave Bryant

Thank you, and good afternoon. GAAP net income allocable to common shares in the fourth quarter was $7.3 million or $0.76 per share compared to a GAAP net loss of $9.8 million or $1.03 per share in the third quarter. In the fourth quarter, we recorded a reversal of the CECL provision for credit losses, $5.8 million or $0.61 per share compared to a $537,000 increase in the CECL provision in the third quarter. The fourth quarter CECL reserve reversal was primarily due to continued improvements in property level operations of the underlying loan collateral, improvements in macroeconomic conditions and decreases in reserves on individually evaluated loans.

Additionally, the company recorded $4.2 million of charge-offs against the CECL reserve from three loans that settled during the quarter or after quarter end. The impact of the CECL estimate and the charge-offs resulted in a total allowance for credit losses at December 31st of $8.8 million, which now represents 0.46% of the $1.9 billion loan portfolio at par.

Net interest income was $11.9 million or $1.25 per share in the fourth quarter, up from $9.5 million or $0.99 per share in the third quarter. The fourth quarter results included $2.2 million of loan minimum interest payments, an increase of $1.5 million over the third quarter. The fourth quarter results also reflects $1.1 million of deferred fee income accelerated due to the increased loan payoffs, an increase of $849,000 over the third quarter. These increases helped offset the impact of loan payoffs that carried higher coupons compared with rates on new loan originations.

The weighted average spread of floating rate loans in the company's $1.9 billion commercial real estate loan portfolio compressed slightly to 3.67% over the one-month benchmark rates, all but one of which had a floor with a weighted average of 75 basis points at December 31st. Since December 31, 2020, the weighted average benchmark rate floor has declined from 1.88% to 0.75% or by 113 basis points as the loan portfolio mix has shifted to be predominantly made up of loans with lower floors as recent loan originations with lower floors have replaced older loans with higher floors that have since paid off.

However, with one third of loans benchmark to rates with floors in excess of 1%, the company continues to receive some asset yield protection in the current rate environment. If financing rates were increased compared to the conditions at December 31st, net interest margin would be negatively impacted. We expect that as the loan portfolio mix continues to shift towards lower floors, the direct relationship between rising rates and positive net interest margin sensitivity will be turned by late 2022 into early 2023.

GAAP book value per share, which is calculated over vesting common shares outstanding including warrants, increased to $23.87 at December 31, 2021 from $22.68 at September 30, 2021, a 5% increase; and from $20.57 at December 31, 2020, a 16% increase. The increase to book value per share for the fourth quarter was driven primarily by $0.79 of GAAP net income per share and $0.27 of per share accretion from common stock repurchases. The company's board reauthorized a share repurchase program and approved repurchase of an additional $20 million. Combined, with the previously utilized allotment, the company has been authorized to repurchase 40 million since its acquisition by ACRES. In the fourth quarter, the company repurchased 275,000 shares for $3.7 million, which represented a 56% discount to book value at December 31.

The GAAP debt-to-equity leverage ratio increased from 3.6x at September 30th to 4.0x at December 31st. The recourse debt leverage ratio decreased from 1.4x at September 30th to 0.8x at December 31st. The increase to the leverage ratio and the decrease to the recourse debt leverage ratio were primarily due to the close of the new CLO in December, which increased nonrecourse debt through the issuance of notes while simultaneously decreasing recourse debt from the paydown of CRE warehouse financing. The company had approximately $929 million of combined availability on each CRE term warehouse facilities and senior secured financing facility and $75 million of availability on its 12% senior unsecured notes.

Available liquidity at the end of February was approximately $178 million. including approximately $78 million of unrestricted cash, $65 million of projected financing available on unlevered assets and $75 million of availability on the 12% senior unsecured notes. These components were offset by a working capital reserve target of $40 million. Looking ahead, we currently project that the company will incur GAAP losses of between $0.30 and $0.45 per share for the year ended December 31, 2022. This projected loss is primarily caused by depreciation and amortization related to the company's investments in commercial real estate properties, which came through debt converted to equity and through direct acquisitions. We expect the majority of the GAAP loss to be incurred in the first quarter of 2022 and that the company's earnings will begin to grow and stabilize in subsequent quarters.

The first quarter projection includes nonrecurring charges of approximately $500,000 related to the retirement of convertible note debt and approximately $900,000 for charges related to the termination of CLOs and a recurring charge of $1.5 million for real estate depreciation. In addition, loans that are expected to pay off in the first quarter of 2022 had rate floors of 1.9%, contrasted with newly originated loans that had rate floors of 10 basis points. Because we do not expect meaningful net loan growth in the first quarter, this rate pressure is expected to reduce our net interest margin by approximately $500,000 in the first quarter of 2022.

New loan production is expected to improve in the second quarter and in the back half of the year. This expected loan production, together with anticipated base rate growth will mitigate this rate pressure and begin to result in positive earnings growth. The company continues to see growth in its loan origination pipeline, producing quality assets. Together with the continued improvement in the credit quality of the legacy portfolio, this has led to a reduction in the company's loan loss reserve. With the additional financing capacity provided by the close of the new CLO, we expect the company's net loan growth to continue for 2022. We will also selectively seek additional equity investments in real estate in order to maximize the utilization of the company's tax loss carry-forwards, thereby growing earnings and book value in future quarters and years.

Now I will turn the call to Andrew Fentress for closing remarks.

Andrew Fentress

Thank you, David. As Mark discussed, we're proud to have achieved a record-setting year for the loan originations at ACR in our first full year as manager of the company. Equally as important, the asset management team has done an exceptional work to address the credit issues and the company has now a high-quality book. Additionally, the capital transactions that were closed during the year give the company the capacity to continue to build on the success and take advantage of the attractive financing rates in the years to come. Our mission is to deliver shareholders' value over the long-term. We are focused on maximizing earnings, investing in high-quality assets and strategically returning to capital through share repurchases and dividends over time.

This concludes our opening remarks. I'll now turn the call back over to the operator and look forward to everyone's questions. Thank you.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question comes from the line of Steve Delaney with JMP. Please proceed with your question.

Steve Delaney

Thanks. Good evening everyone and thank you for taking my questions. I'd like to probably – also the deck is great and especially the new pages 26 and 27. My first question is on 26. And Mark, the maximum portfolio size, you ended the year at $1.9 billion. So if we take the midpoint there at $2.3 million or call it $400,000, can you achieve that growth with your existing capital structure? I realize you'll need financing. But do you have the capital base to achieve, say, that midpoint $400,000 of loan growth to push the portfolio up to 2.3% by the end of this year 2022? Thanks.

Mark Fogel

Yes, Steve. Thanks for the question. Yes, we do have the capital base to grow the portfolio to that level between cash on hand and our financing sources.

Steve Delaney

Okay, good. So – and the – okay. Got it. So the other question ahead would be the CLO market. Your timing of your executions was excellent and I'm sure you've noticed weakness there. If CLOs – let's just say worst case with all – everything going on in the world, let's just say the CLOs, you looked at or this kind of locks up a little bit, can you – would you return to commercial bank financing? And I guess if you do, is there non-mark-to-market other than for credit – true credit available from the banks for financing lines? And if not that, I mean, is there even the thought of, at some point, you're back to the old school A note concept, where you don't really worry about borrowing money?

Mark Fogel

Yes, a couple of points on that. As we alluded to in our remarks, we have 24-month reinvestment periods in our two CLOs.

Steve Delaney

Sure.

Mark Fogel

There's a great opportunity to – as loans pay off to reinvest those proceeds back into new loans. We do have obviously a lot of capacity available on our lines. But outside of that, at this juncture, I can't point to any other non-mark-to-market situations, which we could access, but we do have the line capacity and the revolvers.

Steve Delaney

Right. And as you look at the market – at the CLO market today, if you had ample collateral and you just called an old CLO, do you feel the market is – the CLO market is viable for new issuance? It would just be maybe at a compressed return on equity compared to which you did – deals you did in 2021.

Mark Fogel

I think it's viable. I mean the spreads have widened while a little bit, but it's certainly viable. And it's – as you know, over the course of time, the CLO market changes, and you can't really time the market. And if you're a serial issuer, sometimes it's good, sometimes it's bad. And you just have to use that market while it's available to finance your business.

Steve Delaney

Yes, I hope it will average out over time.

Mark Fogel

That's right.

Steve Delaney

Thank you pretty much for your comments. That's it.

Mark Fogel

Thank you.

Operator

[Operator Instructions] Your next question comes from the line of Fred Bets [ph] with Private Investor. Please proceed with your question.

Unidentified Analyst

Yes. I was just wondering, does the company have a plan for the reinstatement of the common dividend?

Andrew Fentress

Thank you, Fred. This is Andrew Fentress answering your question. Currently, the company does not have a plan to reinstate the common dividend. As we stated in our remarks, and hopefully, as you'll be able to see from the shareholder presentation, which was posted to the website this evening, that the capital of the company would otherwise pay a dividend that is being retained inside of the business and being used to grow book value. So as a shareholder, you're receiving the benefit of that capital, you're just receiving it in stock appreciation versus the receipt of a cash dividend. Does that answer your question?

Unidentified Analyst

Yes, and I have a second question. The book value, like you said, was like $23, and yet the share price is so low. Now, I'm not an accountant or anything, but is there a reason for that? The company sounds like it's doing well, but yet the share price seems to have been going down in the past few months. And can you give me an answer for why that is probably happening?

Andrew Fentress

Fred, I'm not going to speculate on why the market is – has a disconnect between those – between the share price and the book value. But what I will say is that the company's actions of repurchasing shares, the company has an authorized repurchase program and has been active in that plan to repurchase shares, I should tell you, hopefully, what you need to know about what the company thinks about the share price at these levels.

Unidentified Analyst

I think it's great that you're buying it back. That's for sure. And – but I don't know. I said I'm not an accountant or an expert in this and – but I was just always wondering why if the common book is $23, that the price was so low, the daily price. But I know people got their reasons, I'm sure. Okay. Thank you very much. I appreciate it.

Andrew Fentress

You're welcome.

Operator

Ladies and gentlemen, we have reached the end of the question-and-answer session, and I would like to turn the call back to Mr. Andrew Fentress for closing remarks.

Andrew Fentress

Thank you, everyone, for joining our call. As always, we look forward to any follow-up questions you have and to speaking with you again at the end of the next quarter. Thanks, everyone.

Operator

This concludes today's conference. You may disconnect your lines at this time. Thank you all for your participation.