Ares Commercial Real Estate Corp (ACRE) 2014 Q4 法說會逐字稿

Good morning and welcome to the Ares Commercial Real Estate Corporation's conference call to discuss the Company's fourth-quarter and year-end 2014 earnings results. During today's presentation, all callers will be placed in a listen-only mode.

Following Management's prepared remarks, the conference call will be opened up for questions. As a reminder, this conference is being recorded on March 5, 2015. 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 such words as anticipates, believes, expects, intends, will, should, may, and similar expressions.

These forward-looking statements are based on Management's current expectations of the market conditions and Management's judgment. These statements are not guarantees of future performance, conditions 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 the SEC filings. Ares Commercial Real Estate Corporation assumes no obligation to update any such forward-looking statements.

Please also note that past performance or market information is not a guarantee of future results. I will now turn to call over to Mr. Todd Schuster, ACRE's President and CEO. Mr. Schuster, the floor is yours, sir.

Thanks, Mike. Good morning, everyone. I'm joined today by Tae-Sik Yoon, ACRE's Chief Financial Officer and Carl Drake and John Stilmar from our Investor Relations.

This morning, we reported record earnings in the fourth quarter of $8.9 million, or $0.31 per common share, well in excess of our $0.25 per share fourth quarter dividend. As we have discussed on prior calls, we spent 2014 building our Principal Lending portfolio and repositioning our Mortgage Banking business. Q4, in our opinion, is a reflection of our accomplishments over the past years and of the potential earnings power of our asset base and Mortgage Banking platform as we move into 2015.

I would like to touch on a few of our major accomplishments in 2014. For starters, we have now reached critical scale with a $1.4 billion portfolio of self-originated, (technical difficulty) without any incidents of default. Second, we successfully expanded our product suite, as evidenced by a significant preferred equity investment in the fourth quarter. We have chosen to invest in preferred equity investments as we believe they can provide attractive risk-adjusted returns. More on this later.

Third, we have continued to optimize the right side of our balance sheet by increasing our debt capacity from diverse sources while simultaneously lowering our cost of funding. As an example, we completed our second securitization at a higher advance rate and with cost of funding that was approximately 44 basis points lower than the securitization we had executed in 2013.

Lastly, we successfully repositioned our Mortgage Banking business in 2014, as illustrated by our strong, fourth-quarter production activity of $313 million versus the $200 million to $250 million estimate we had provided in last quarter's earnings release. While the progress in Mortgage Banking took longer than initially expected, we are confident that we have the right team in place and a healthy pipeline going into 2015.

I would like to come back for a minute to the preferred equity investment that I mentioned earlier because it's instructive for several reasons. First, the investment is supported by a portfolio of student housing, multifamily, medical office and self-storage properties and as such, reveals our breadth of expertise around and access to a wide array of property types and investment structures.

Second, this was a $170 million investment and for risk management and capital optimization purposes, we were able to leverage Ares' investor network to bring in an institutional investor to fund a non-controlling minority stake and thereby leaving us with an $87 million controlling interest in this investment. This illustrates one of the many benefits of being affiliated with Ares. That is, we can effectively punch above our weight class by pursuing opportunities that perhaps other similarly-sized vehicles cannot. Among other things, we believe this limits the universe of potential competitors for these larger, more complex opportunities while allowing us to significantly widen ACRE's investment aperture.

Third, as assets spreads have compressed, we have been able to maintain or increase our ROEs. Regardless, our view is that we don't always need to sail towards the wind. Sometimes, it makes sense to go with it, in this case, embracing the trend of lower assets spreads for first mortgage loans. In making this preferred equity investment, we were able to take advantage of aggressive, low-cost first mortgage financing to protect our position and help generate an 11%-plus return.

Fourth, highlighting the synergy between our Principal Lending and Mortgage Banking businesses, ACRE Capital was able to provide some of the underlying first mortgage debt in this transaction. Overall, we believe that this transaction demonstrates the breadth, sophistication, and adaptability of our platform, the benefit of being part of the Ares system and the synergies that exist between ACREs to businesses. We expect to see similar preferred equity opportunities as we move into 2015.

Before turning the call over to Tae-Sik, I want to take this opportunity to say that we believe that we have in place the assets and platform that we expect to enable us to further grow earnings in 2015 without the need for additional external capital. As we have stated on prior calls, we will not raise capital by issuing stock below book value. That being said, the opportunity set remains larger than our current capital and we feel strongly that there are opportunities to further grow earnings should accretive capital become available.

I will now turn the call over to Tae-Sik.

Great. Thank you, Todd, and good morning, everybody. Thanks again for joining our year-end 2014 earnings call. I'm going to begin this morning with a quick recap of our fourth quarter and full-year 2014 financial results, but really planing to utilize most of the time this morning to talk in detail about how we are continuing to optimize our balance sheet and how we are managing our remaining liquidity and investable capital.

So to recap, we are obviously very pleased with our fourth quarter 2014 results. Net income was $8.9 million, or $0.31 per diluted common share. This consisted of $6.7 million in our Principal Lending business and $2.2 million in our Mortgage Banking business. These fourth quarter results contributed to the full-year 2014 earnings of $24.4 million, or $0.85 per diluted common share. Again, comprised of $22.5 million from Principal Lending and $1.9 million from our Mortgage Banking operations.

At year end, in our Principal Lending segment, we had 46 investments totaling $1.6 billion in commitments and $1.4 billion of outstanding principal, excluding non-controlling interest held by third parties. All of our loans continue to perform in accordance with our terms and we have no delinquencies, defaults, or impairments as of December 31, 2014.

We also continued to match-fund our assets and liabilities with respect to interest rate exposure in our Principal Lending segment. As such, approximately 89% of our $1.4 billion in loans, as measured by outstanding principal earned interest based on LIBOR, which compares well to approximate 94% of our $1.1 billion in outstanding debt liabilities on which we pay interest, also based on LIBOR. Due to our match-funding strategy, we believe that we are well-positioned to benefit in a rising interest rate environment so that if LIBOR rises, we expect our net income to rise commensurately.

Turning now to our Mortgage Banking business. We had a very successful fourth quarter in which we rate locked $313 million of new loans. This total is comprised of $131 million in Fannie Mae DUS loans, $128 million in Freddie Mac loans, and $55 million in FHA HUD loans. This pick-up in loan production led to our Mortgage Banking segment contributing $2.2 million in net income for the fourth quarter of 2014.

Now, let me get into the details of our continued focus on further optimizing our balance sheet. First, we continue to expand and diversify our sources of debt capital. In 2014 alone, we put in place five new facilities, totaling approximately $500 million in total commitments and in August of 2014, completed our second securitization where we issued more than $300 million in senior certificates. This $800 million in new commitments increased in total debt capacity to approximately $1.7 billion at year-end 2014.

Second, we continued to lower our cost to debt funding. On the Citibank facility, for example, which we renewed in December 2014, we were able to decrease our funding cost by approximately 25 basis points. We also closed on a new facility with the relationship bank in 2014, which had an interest rate of LIBOR plus 188 basis points, is our least expensive financing facility. And as Todd discussed earlier, our second securitization in 2014 was priced approximately 40 basis points less than our first securitization which closed in 2013.

And finally, we have been mitigating the impact of prepayments of loans in our securitizations. As of year-end 2014, for example, in our first securitization that we issued about a year ago in late 2013, we have had $176 million in loan prepayments which reduced the outstanding balance of senior certificates from $395 million to $219 million. To partly mitigate the deleveraging impact of loan prepayments, we successfully entered into a new debt facility in which we pledged our approximate $99 million retained interest in our first securitization and received $57 million in proceeds at an interest rate of LIBOR plus 274 basis points.

This strategy essentially provided us an additional $57 million of an investable and leverageable capital at year-end and partly mitigates at the leveraging impact of loan prepayments on our first securitization. And as far as liquidity, as of March 2, 2015, we had approximately $54 million of investable and leverageable capital in the form of cash or approved and undrawn capacity under our financing facilities.

This amount of liquidity is due in part to our continued efforts to optimize our balance sheet and extract further dollars out of our existing asset base without the need to raise additional accounting capital. This $54 million, together with leverage, gives us capacity to originate approximately $160 million to $250 million of additional senior loans assuming a 2-to-1 to 3-to-1 debt-to-equity ratio.

Before I turn the call over back to Todd, I wanted to provide some color on our exposure to a much talked about energy sector. Due to our continued efforts to build a diversified portfolio of loans in our Principal Lending business, we have limited exposure to geographic markets commonly known to have concentration of energy-related businesses.

For example, in the Houston, Texas metropolitan area, we currently have three multifamily loans totaling $67 million in outstanding principal, each of which are performing well in accordance with the terms of the loan agreement. In fact, a few weeks ago in January, another loan we held that was also backed by a multifamily property in Houston in the same market, for the principal balance of over $35 million was, in fact, repaid earlier by the borrower.

And similarly, in our Mortgage Banking business, the loans in which we share risk of loss, our total exposures were approximately $50 million across eight loans located in the Houston metropolitan area. This compares to a total servicing portfolio of more than $4 billion. And finally, on a housekeeping matter, I wanted to mention the specific change we made in the reclassification of our interest statement. Previously, under the heading, Other Interest Expense, we included two material items.

First, interest expense for our $69 million convertible note, and second, interest expense relating to our warehouse lines using the Mortgage Banking business. Starting with our 2014 10K, we have re-classed the interest expense on the convertible note to interest expense included in net interest margin, which for the fourth quarter of 2014 was approximately $1.6 million and the interest expense relating to warehouse lines used in the Mortgage Banking business, in gains for Mortgage Banking activities, which for the fourth quarter 2014 was $400,000. I'd also refer you to our 2014 10K which was filed this morning for further details.

I will now turn the call back over to Todd for some closing remarks.

Thanks, Tae-Sik. As you may have seen from our earnings release that we issued this morning, we have provided earnings guidance for the full-year 2015 and for the first quarter. Specifically, we expect improved profitability in 2015, with earnings ranging from $1.02 to $1.14 per diluted share.

Importantly, among the many assumptions we detail in our earnings release, our outlook assumes no incremental equity in 2015. Accretive raises, if available, would likely enhance these earnings, especially in light of our $125 million of working capital facilities which enable us to draw and repay capital as needed, therefore minimizing the drag associated with [array] should it become available to us.

Additionally, while we expect significantly higher full-year earnings for 2015, first quarter tends to be the low period for Mortgage Banking production. In order to provide transparency for our investors around this issue, we are providing first-quarter earnings estimates of $0.21 to $0.24 per diluted share.

Lastly, I just wanted to remind everybody that with approximately 9% of the Company owned by affiliates of Ares Management, the Board, and specifically ACRE Senior Management, we have strong shareholder alignment and fervently believe in the opportunity for our Company. I want to thank our investors and employees that have supported the Company's expansion in 2014 and I look forward to a prosperous 2015 and beyond at ACRE.

This concludes our prepared remarks. Operator, please open up the lines for Q&A.

Yes, sir. We will now begin the question-and-answer session.

(Operator Instructions)

At this time, we will just pause momentarily to assemble our roster. The first question we have comes from Steve Delaney of JMP Securities. Please go ahead.

Thanks. Good morning, everyone, and congratulations on a strong close to 2014. So Todd, given the comments about that you made about capital strategy and what you would and wouldn't do and Tae-Sik's remarks about capacity, should we expect, if we look at 2015, I think last year, where you did $1.3 billion total and maybe $500 million of that was in Mortgage Banking.

Given that, that Mortgage Banking business is less capital intensive, should we think, when we think about total originations, is it likely that volume is going to be greater in Mortgage Banking than principal lending as you see 2015 unfold?

This clearly -- thanks, Steve first of all, for the certainly kind comments.

There are -- I mean, we certainly expect to see Mortgage Banking pick up meaningfully in 2015 as a result of all the work and effort and investment that we put into ACRE cap. And as you mentioned, right now, our plans are not to raise capital valuation by issuing stock the (inaudible) or issuing stock below book value. So as a result, we are going to have certain limits on our capital availability and so it makes perfect sense to me that Mortgage Banking production could potentially exceed the production that comes out of the Principal Lending side of the portfolio.

Right. That's helpful. Just in terms of thinking about our model. And could you let us know the total number of loan originators that you currently have in each segment today in Principal and Mortgage Banking?

In Mortgage Banking, the numbers move around. I'd say between 12 and 15. On the Principal Lending side, it's probably around 4 to 6, somewhere in that range.

So 18 --

(multiple speakers) Originators with 14 behind.

Right. When we talk about originators, we have teams of analysts and underwriters, et cetera, who support these folks and closes, et cetera.

Yes, the numbers I wanted were sort of the senior analysts, the real producers. Yes. So 18 to 20 across the platform. I guess, just to pick up on your comments about all the repositioning, if you had to guess out of that 18 to 20 people, what percentage of those people were with ACRE, say, at the end of 2013?

Low.

Low.

Low percentage of folks. We've done a substantial turnover of the production side of that business and is something we've been discussing for a while here. And in fact, several of those new hires didn't even come on into the middle, if you will, of 2014, or second quarter 2014. So we have not -- in 2014, we did not get the full benefit, if you will, of the stabilized year out of a lot of those folks.

Okay.

At ACRE cap.

Right. Right. Understood. Thanks for those figures. That's helpful.

And just to mention as a follow-up, on the Principal Lending side of our business, we had very little turnover of folks. That's a much more kind of established entrenched group of folks that we have on that side of business.

Got it. Okay, thanks. And Tae-Sik, that was -- I noticed what you did in about leveraging some of your retained bonds. How far down in the structure or in terms of -- this is your CMBS deals, so I guess they rate everything pretty far down. How far down, in terms of ratings, are you able to assign that collateral?

Sure, Steve. We were able to take the $99 million retained interest which were all the bonds that were initially rated below investment grade, obviously, we will retain all of those bonds and that is really what we have used as collateral for the $57 million in financing we received. The other thing I should mention is that we also received an upgrade of the senior certificates that were issued in that securitization; the lower rated tranches were not re-rated. The senior certificates where re-rated.

Can you -- you basically just pledged everything that you had below the senior notes and received the $57.2 million?

Correct. And --

Okay.

And, again, that was one of our strategies to make sure that as our first securitization starts to deleverage with the principal repayments that we had in the loans, --

Right.

This is a way to partly mitigate the impact of that deleveraging was to lever our retained certificates.

Totally get it. Makes a lot of sense. Now on that same line, I know CMBS structures are a little bit different than CLOs, but are you exploring, is there the way a CLO is structure, is there any possibility to do something similar to leverage your subordinate position in your CLO?

Yes, I mean there's really nothing structurally that would prohibit us from doing so. Obviously, our second securitization, the one we issued back in August of 2014, that obviously has not experienced the same degree of deleveraging. And so at some point, I think we will continue to explore the idea of potentially leveraging that second retained securitization interest.

Guys, thank you. Appreciate the comments.

Thank you so much, Steve.

The next question we have comes from Rick Shane from JPMorgan.

Thanks, guys, for taking my question. Just want to circle back on the preferred investment a little bit. So what is the actual hold size here?

The hold size on the preferred is -- we were left with an $87 million investment in the transaction. Controlling --

Got it. And you said that you have an 11% unlevered yield on that?

In excess.

In excess. Okay. And how should we think about how you fund that? Is there -- are you using leverage on your $87 million hold or should we think of these investments going forward to the extent that you do additional ones as a levered investments on your balance sheet?

Yes, great question. Generally speaking, our leverage is applied to our first mortgage books and our subordinated book or preferred equity book, we tend not to leverage. So as a general matter going forward, yes, you can expect that preferred equity investments are likely as we originate them to come on the books without kind of explicit leverage on them.

Yes, I realize ultimately, the leverage is a little bit fungible, but you answered the question exactly the way we wanted to understand it to the extent -- if, for example, and this is entirely hypothetical, if you were to run the book only owning these types of investments, there would be no leverage?

Taking my comments to the extreme, yes. Absolutely.

Got it. And what are the economics -- are there any beneficial economics other than diversification from syndicating out the other portion? (multiple speakers) in CLO, are there any fees that you capture upfront related to that?

There was an origination fee that we captured. The -- as we do with most of our loans. But, yes, there was -- the net impact was we were left with our $87 million investment with a yield of excess of $11 million. It's -- was done again for the purpose of kind of optimizing our capital structure and importantly diversifying risk. I mean, that was (multiple speakers) --

Got it. And then last question, when we think about that 11%-plus yield was, is that basically accreting in the origination fee on the whole $170 million over the expected life of your $87 million hold?

Yes.

Okay. Got it. Thank you very much guys.

Thank you.

Next, we have Jade Rahmani of KBW.

Yes, hi. I wanted to ask another question around investment capital. Do you think that the manager could consider upping its stake or making a direct investment in ACRE at book value after fees in order to help accelerate earnings signal confidence in the business outlook which you guys seem positive on and while also not diluting existing shareholders?

I hate to -- I don't love the questions about what's possible because, of course, anything's possible, but look, we think Ares has been incredibly supportive of this vehicle in a whole host of ways. As I pointed out in my scripted remarks, there is an alignment of interest by virtue of service-side ownership here at 9%.

Ares, of course, came through with a guarantee of one of our working capital facilities not so long ago. We're picking up all sorts of benefits as it relates to relationships on the capital and capital market side, as evidenced by what we did on the preferred equity investment, bringing in an investor that has strong relationship of Ares. So I firmly believe that Ares has been incredibly supportive to date.

Okay. I mean, it just seems that the Company on the Principal Lending side is in somewhat of a tenuous position with respect to access to capital and -- you know, we know the impact that can have on originators so that would seem to be one alternative. What about --

Hold on, just for second, Jade. Let me just interject there for a second because I have a couple thoughts around that. I guess I'd object to the concept of the Principal Lending business is in a tenuous state. I mean, the Principal Lending business is as solid as it's been. It's set up to generate a fairly predictable and stable flow of earnings for us over the next year.

And as it relates to the origination staff being concerned about our lack of capital, keep in mind that -- and again, this is an example, another benefit of being affiliated with Ares and I think we actually announced this.

We raised, or we created a $700 million separate account with an insurance company to invest money in floating rate and fixed rate loans in the US. We've also got a smaller SMA in Europe to originate loans over there.

So from our perspective, the production staff is being kept busy by these other products which is great. So and these products don't necessarily compete with what ACRE would do it if ACRE, in fact, did have much more capital.

Okay. I wanted to ask also about alternatives, such as they convert and also whether the previously said range for financial leverage is being reconsidered. What kind of on balance sheet leverage would you be comfortable with?

Sure. Good morning, Jade. This is Tae-Sik.

With respect to a potential convertible note, we are always examining different capital options available for the Company. We are always seeking opportunities to optimize our balance sheet, as we've talked about. I think we have been very successful, as we also mentioned of extracting more capital out of our existing assets so that we don't have a need to raise common capital.

As I mentioned in my remarks, I think in 2014 alone, we raised more than $200 million of investable capital out of our existing asset base. And we will continue to do that.

So the idea of a convertible note is certainly something that we will continue and we have looked at. I think the market is fairly strong. It wasn't -- our understanding is that it's not as strong as it was sort of in the late summer, early fall of last year, but is off to a good start in 2015.

We obviously have a convertible that is expiring, that is coming due at the end of this year. So we will also be looking to refinance that convertible note.

And we think the good news is that if we were to look at pricing of convertible notes today, it would be materially lower than the convertible note that we have outstanding. So we look at it as a -- in fact, an opportunity to lower our cost of funding if we were to issue a new convert.

And as far as total debt to equity, I think we have said that we expect to be sort of in the low to mid 3% debt to equity range. And I think you will see us in that range throughout 2015.

Okay. Regarding the servicing transfer that was mentioned, is it reasonable to expect this to have a modest reduction in G&A?

Yes. I would say -- I wouldn't call it a modest reduction in G&A. I think it's -- a servicing transfer, actually, of loans that were previously being serviced by a third-party to ACRE Capitals. Actually, what you will see is a small pick-up in servicing revenue for the Mortgage Banking sector.

Okay. And then just on the ACRE Capital side, can you talk to where gain on sale margins are running and what your expectations are for the year?

So I -- in our numbers for the quarter, I think we were showing gain on sale, Tae-Sik, of around 2.6, 2.7? So that's probably a reasonable maybe low-end of the range kind of margin that we think we could achieve over the course of the next, over the course of 2015.

Jade, it will be driven primarily by the product mix obviously, as well as market conditions so the product mix between Frannie, Freddie, FHA HUD. Obviously, the great news is that we have capabilities in all three of those sectors and so the margin will be determined both by market conditions as well as the mix of those three product base.

Okay. And on the servicing fee, I think that's been coming in around -- between I would say 28 and 30 basis points. Is that a reasonable to expect or do you still expect to see some benefit from Fannie Mae DUS business driving that higher?

Yes, I mean generally, it's been call it 35 to 40 basis points on UPD. And again, it will change over time, albeit slowly, because most of our servicing book will be based on MSRs that we already have in place but obviously we will be putting in place new MSRs that will have different servicing fee margins going forward. So that mix will change over time. But currently, it's about 35 to 40 basis points.

Okay. And then just finally on prepayments, within the Principal Lending segment, they came in pretty low this quarter. What would be your expectations for 2015?

Look, you know, we fully anticipate that we're going to have prepayments, especially in some of the loans that are kind of the older loans in our book. I don't know that we are putting out specific numbers as it relates to projections on prepayments for the year.

But we clearly anticipate that we will see some additional prepayments. By the way, that actually kind of can cut both ways because if prepayments are low, that's obviously a benefit for us and if prepayments are high, it does kind of give us an opportunity to unlock some of the value for example, that's in SL1.

Because when we get to a certain point there, we will be able to unwind the trust and basically more efficiently use those remaining assets to our advantage. So high prepayments, low prepayments, we still think we generate a fairly predictable and stable level of earnings out of the Principal Lending book.

Thanks very much for taking my questions.

Thank you, Jade.

Thanks, Jade.

Next to Doug Harter of Credit Suisse.

Thanks. Can you just help us understand the difference in gain on sale margins across the different channels of DUS and Freddie and HUD?

Yes. So look, we have three products. I would say in order, FHA is our highest margin product, followed closely by Fannie DUS, and then sort of a distant third is Freddie Mac. So of our three products, two are what I would call higher-margin products.

I would say and Tae-Sik, correct me if I'm wrong here, but I would say that the HUD product is probably kind of a 4-ish point margin and the Fannie DUS is slightly lower that and Fannie Mae is probably around 1 point, Freddie Mac -- I'm sorry, Freddie Mac is around 1 point. So 4 at the high-end for HUD, 1 at the low-end for Freddie, and then Fannie, somewhere in the middle but closer to the FHA product.

And as we think about the mix going forward, what are going to be the key drivers that kind of drive the mix between Freddie and HUD and Fannie?

Well, FHA is sort of its own kind of in its own space so it's hard to compare it to Fannie and Freddie. Fannie and Freddie are often compared to each other. Right now, I think it's fair to say, at least if you look at our kind of pipeline, that Freddie is probably a touch more aggressive right now.

We're seeing a little more production on the Freddie side but I think it's important to understand that one is always more aggressive than the other at any given point in time. So over the course of the year, we expect to see that kind of go back and forth. Freddie actually has a $30 billion lending cap as does Fannie.

I think Freddie is actually closer to hitting their lending cap right now than Fannie is. So over the course of the year, we expect to see those -- that relationship move around back and forth.

So and in FHA, it's kind of a longer lead-time business. And it's got very different kind of metrics and timing associated with it and volumes.

Great. Thank you.

Dan Altscher, FBR.

Hey. Thanks. Good morning, everyone. Appreciate you taking my questions. Tae-Sik, you provided some good disclosure around Houston exposure but just wondered if you could just give us any sense if there's anything in the Dakotas, Bakken Shale region that maybe we should also be maybe aware of?

Sure. Good morning, Dan. Thanks for your question. Yes, I should have mentioned sort of North Dakota, Montana. So for our Principal Lending business, we do not have any loans located in those geographic markets. And in our Mortgage Banking business, I believe we have less than 10 loans on the Fannie Mae side that are on -- that are in either of those markets and I think that is primarily in the Montana market, not in the North Dakota market.

Okay. Cool. That's helpful. Can you give us a little bit of sense as towards, I guess timing throughout the year of future funding commitments on loans that have already been committed to?

Sure. Obviously, we have a significant amount of funding commitments on existing loans. We work very actively with the borrowers to make sure we understand when they're going to be drawing the capital. I would say our historical experience is that now the 100% of the capital that they have committed to and paid for in the form of origination fees are fully drawn.

But we do work very carefully. I can't really share with you any specific numbers only because it is really a loan by loan analysis that we do. But we are certainly on top of it, our asset management team does regularly talk with our borrowers to make sure that we fully anticipate their capital needs going forward.

Okay. That's helpful. Todd, a question for you. We -- I know in the past, we've chatted a little bit about the European opportunity coming along. Didn't hear any mention of it this quarter in terms of, I guess, the Principal Lending business. Is that kind of just not interested right now or is it just that there's other things that are maybe more exciting whether it's on preferred side and lending or maybe, I guess, you had to revamp of the Mortgage Banking business?

Yes. I would -- It's a great question and I would say two things.

One, yes, as it relates to more compelling interesting opportunities that we're seeing, that's definitely going on in the US, we are starting to see that. Europe has gotten more competitive and as we were starting to get into our pipeline, the volatility around the currency, in particular, we would hedge our exposures in our European loan book, if we had one.

And given the volatility around the currencies, it kind of took out a lot of the extra yield that we were seeing in that market. And so kind of had backed off of a bit as a result.

The current -- the hedge would gave been much more expensive as it relate -- the tie because of the volatility of the currency.

Okay. Got it. That's helpful. And then definitely heard your comments before, Todd, about the insurance mandate won by the parent and saw that (inaudible) actually but are there any expectations that's going to maybe drive some incremental buying or sharing of volume at the ACRE level? Or is that totally its own other silo and it doesn't probably have any bleed through in terms of activities?

Well, the bleed through is a little more nuanced than that. So if you think about the way we are constructing our business, our view is that if we can provide our sales team and production forces with kind of a wide array of really competitive products, then the dialogue they're happened -- they're having with their clients is deeper and wider.

They can -- they're talking to them about more opportunities and if they are talking to them about more opportunities, we're seeing more and if we are seeing more, we can afford to be more selective. So it feeds on itself that way.

The product, the mandate that we've got the $700 million mandate is not a product that really overlaps, per se, with what ACRE offers. It's much more complementary. It's a little more lower, than the lower loan-to-value, lower loan to spread product then what ACRE typically offers.

Okay, that's helpful. Thank you much.

Next with Charles Needham of Wells Fargo.

Hi, guys. Could you help us understand the mix of fixed versus floating originations within ACRE Capital, and maybe comment on the differences in economics between the fixed versus floating rate product?

In 2014, I'm just trying to think of the total $500 million of production. We can get you an exact number but I'm thinking the number on floating rate might have been around $100 million, maybe less.

And as a general matter, floating rate loans -- where you see a difference in the economics tends to be around the MSRs because they tend to be shorter duration and they have more optionality around prepayment which kind of impacts the MSR valuations.

Okay. And staying with ACRE Capital, I was wondering if you could comment on the expense base. Obviously, there's going to be some seasonality for originations within the business, but to what extent is that expense base variable and that will reset downward as you have seasonally weak quarters such as the first quarter, for example?

Sure. Charles, good question. I think the biggest variability you can see in Mortgage Banking sort of quarter to quarter or year to year is really based upon the commissions that our originators earn on production. So I can just to make a very generic statement and give you all the warnings related to generic statements, but certainly appears in what you see higher volume, higher margins, higher revenue of Mortgage Banking income, due to higher originations, you will see compensation benefits line item go up because of the commissions and bonus structures that we have built in that are tied to revenue and production numbers.

The other thing that you'll see is for 2015 and you saw some of this, in fact, a lot of it reflected in the fourth quarter results, is you will see that G&A has declined significantly versus the first three quarters of 2014 because as we mentioned, we spent the first nine months of 2014 restructuring and reorganizing the ACRE Capital team. One of the biggest expenses we incurred in 2014 was to really move a servicing and F&A office up in Michigan to our headquarters building in Plano, Texas.

And so the move and the restructuring costs there were really reflected primarily in the first three quarters of 2014. So you will see a significant decline in G&A starting with the fourth quarter and continuing to go into 2015.

Okay. That's helpful. Thank you very much.

Sure. Thanks, Charles.

The next question we have is from Don Destino of Harvest Capital.

Hi, guys. I got a list here so bear with me. Jade did a good job of introducing a couple of my questions.

Todd, you guys definitely went out of your way to say you don't want to issue common equity below book, but you got all these opportunities for capital. Just so you know how I think, common shareholders feel, we would not want to see equity tied issuance either.

Just, let's just improve the returns on capital and get the stock above book before we raise capital, not start issuing converts below book and bring in all the shorts and all that volatility and muck up the balance sheet. I think that would not be viewed positively by most of your common shareholders like (multiple speakers) --

Again, if you look at our annual guidance that we issued of $1.02 to $1.14, that assumes no external capital raises.

No, and I appreciate that. And I just -- I'm just giving you an opinion and maybe it's not shared, but I would rather get the stock back up on the merits then issue equity linked capital.

The -- when it comes down to it, it really does feel like the expense load here is just too high. I mean, I know it's not apples to apples and you've got different businesses and you got the Mortgage Banking business, but on kind of any measure, if you look across other externally managed mortgage REITs, commercial mortgage REITs, the -- on an efficiency ratio basis or an expense load as a percentage of equity, you guys are just -- I mean, you stand out, not as greater than average, but as kind of the highest fee load or expense load Mortgage REIT out there.

Is there anything that can be done there? Has Ares looked at the contract and decided that maybe we overreached here or have you ever thought about cutting expenses for some period of time until you can get the ROE to a healthy double-digit level and can support a higher expense base?

So, a couple of things. First of all, I think we did have an expense cap, if you will, in place that Ares was providing. So it was a sponsor Ares was actually absorbing some of the expenses that would otherwise be attributable to the vehicle to the REIT. And look, our cost structure, in part, reflects our size and scale. And --

I mean, you know that, right? The justifications for externally managed is that or one of the justifications, I should say is that it provides scale for something that is not going to be at scale. So I would hope that, that wasn't a reason why the expense load was so high because that's why it's one of the reasons we pay Ares is that they're an asset manager and they provide the scale that a smaller vehicle needs.

So, we are getting a variety of benefits from Ares right now and in terms of justifying why we are externally managed. We think the external management structure brings all sorts of value and benefits to the REIT that would not otherwise exist if we were internally managed. The connectivity back to the parent, just as an example in that preferred equity investment that we talked about earlier is a huge benefit.

And as I noted in my scripted comments, allows us to sort of play in a field that we would not otherwise be able to play in and see opportunities that we would not otherwise be able to see. So we think the external management structure adds a tremendous amount of value and as it relates to the cost structure, if you look at again in our guidance for the year and in the implied ROEs, and the additional strategies we have to enhance ROEs beyond that over the longer term, we think we stack up pretty favorably right now relative to the peer group.

Okay. What's -- in your guidance, what is the -- what is your assumption for what Mortgage Banking is going to contribute to that guidance?

So we haven't provided that level of specificity. But I will say that we clearly see Mortgage Banking picking up a nice head of steam. We saw it coming out of Q4 where we kind of beat the production guidance we gave.

The pipeline in Q1 looks quite good. The longer-term pipeline, which we tend to see is more of an FHA thing, is also looking quite good. So we do expect the Mortgage Banking business to pick up and contribute significantly more than it did in 2014.

So is that -- is 2015 the year that it kind of -- it earns its cost of capital?

Yes, I think that's a fair statement.

What do you think the ROE is kind of on incremental capital right now? You talk about what you think what your available equity capital -- leverage of equity capital is on the margin with where you think the ROE of that capital should be?

Well, I guess the easiest thing for me to point to is one of the last transactions that we closed in Q4 which was that preferred equity investment which is a 11%-plus return, expected return. So that is probably as good as an example, as you're going to get is the most current example.

Okay. Well, I mean 11% expected return, I mean, there again, the problem is that we're running at-- we're running a, and again, I understand that the marginal return so that should all kind of follow the -- that should all be leverageable on the expense base.

But the expense load of 7%, 8%, 9% ROE on equity is just -- it makes it difficult particularly if you're kind of getting close to your -- what is it, you're coming close to being capital constrained. (multiple speakers)

Again, I've seen what Jade suggested before and I think it's very effective. If Ares thinks that this is a really good opportunity then you should have a really good IRR on putting capital in at book value and generating return on that and then increasing the earnings and getting the perpetuity of increasing capital and earnings fees on that for years and years and years.

Or cutting fees for some period of time and figuring out what the IRR and that is to get the earnings and stock up but I do definitely think there is kind of an expense problem here and that's something that should be looked at carefully. Thank you very much.

One important thing. I don't know if you're on the line, but I just wanted to mention is something that you just alluded to which is that it's incremental revenue, incremental expense concept which is a lot of our expense is and this is particularly true for the Principal Lending side and primarily true for the Mortgage Banking side, is that a lot of our expenses are fixed.

Because you see that we have reached critical scale, as Todd mentioned in our Principal Lending book, as we continue to grow the asset base of the Company. I think, again, we do not expect expenses to rise measurably so that incrementally, as we add new assets on our balance sheet, you will see that flow through being captured in a much higher percentage.

I appreciate that. Thanks.

Thanks, Don.

Well, at this time, we're showing no further questions. We will go ahead and conclude today's question-and-answer session. I would now like to turn the conference back over to Mr. Todd Schuster for any closing remarks. Sir?

Thanks, and we have no further remarks, so just want to thank everybody. Appreciate your time today, and look forward to catching up with you all on the next call.

And we thank you, sir, and to the rest of the management team for your time today. 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 March 18, 2015, to domestic callers by dialing 1-877-344-7529, and to international callers by dialing area code 412-317-0088. For all replays, please reference conference number 1005-8540. Again, that's conference number 1005-8540.

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