Ares Commercial Real Estate Corp (ACRE) 2020 Q1 法說會逐字稿

Good afternoon, and welcome to the Ares Commercial Real Estate Corporation's conference call to discuss the company's first quarter 2020 financial results. As a reminder, this conference call is being recorded on May 8, 2020.

I will now turn the call over to Veronica Mayer from Investor Relations.

Good afternoon, and thank you for joining us on today's conference call. We apologize for the short delay as we were experiencing a few technical difficulties. I am joined remotely today by our CEO, Bryan Donohoe; David Roth, our President; Tae-Sik Yoon, our CFO; and Carl Drake, our Head of Public Company Investor Relations.

In addition to our press release and the 10-Q that we filed with the SEC, we have posted an earnings presentation under the Investor Resources section of our website at www.arescre.com.

Before we begin, I want to remind everyone that comments made during the course of this conference call and webcast and the accompanying documents contain forward-looking statements and are subject to risks and uncertainties. Many of these forward-looking statements can be identified by the use of words such as anticipates, believes, expects, intends, will, should, may and similar expressions. These forward-looking statements are based on management's current expectations of market conditions and management's judgment. These statements are not guarantees of future performance, condition or results and involve a number of risks and uncertainties. The company's actual results could differ materially from those expressed in the forward-looking statements as a result of a number of factors, including those listed in its SEC filings. Ares Commercial Real Estate Corporation assumes no obligation to update any such forward-looking statements.

During this conference call, we will refer to certain non-GAAP financial measures. We use these as measures of operating performance, and these measures should not be considered in isolation from or as a substitute for, measures prepared in accordance with generally accepted accounting principles. These measures may not be comparable to like-titled measures used by other companies.

And now I will turn the call over to Bryan Donohoe.

Thank you, Veronica, and good afternoon, everyone. We wish everyone well during these difficult and challenging times, and we appreciate you joining us today. We hope you and your families are safe and healthy, and our thoughts are with our first-line responders and all those impacted by this virus. I also want to thank the team at ACRE and the greater Ares platform for seamlessly working from home and working so diligently to drive our company forward.

We issued our earnings release this morning, which showed relatively consistent quarterly core EPS of $0.32 and a GAAP EPS loss of $0.54. Our net GAAP loss primarily reflects the adoption of the current expected credit loss, or CECL accounting standard, and does not reflect impairments to the loans in our portfolio. I'm going to put these results in context by walking you through our actions since the outbreak of COVID-19 and how our portfolio is currently positioned. After my comments, Tae-Sik will walk you through our earnings, liquidity position and impact of CECL on our earnings in more detail.

First, let's discuss what we accomplished during the first quarter prior to the outbreak. Supported by favorable real estate fundamentals and sound leverage levels, we originated $356 million in loans during the first 2.5 months of the year. We also raised $73 million in net proceeds from an equity offering in late January, completed at a significant premium to book value per share. When the impacts of the outbreak became clear, we curtailed new investment activity and worked to further enhance our liquidity position. We've redeployed the team to underwrite each asset in our portfolio. Through dynamic and constructive discussions with our borrowers, we focused on the near-term impacts on cash flows and the long-term impacts on property values. And we're pleased to say that we believe our portfolio is holding up relatively well, with all of our loans paying their contractual interest in April.

As part of Ares, we received great market insights from our investments in over 1,500 companies and approximately 250 property investments across North America and Europe. These insights informed our already cautious view of certain segments during the first quarter. We consciously avoided investments and loans that were solely collateralized by hotels or retail properties throughout all of 2019 and the beginning of 2020. We strategically structured our portfolio to be comprised of 95% senior loans and highly diversified with 53 loans across 17 states.

Additionally, the majority of our portfolio is in either multifamily, office or industrial properties. That being said, no asset or portfolio is immune to the economic impact of a prolonged shelter-in-place order like we are experiencing today. Our portfolio includes 6 senior loans on hotel properties that make up 14% of our outstanding principal balance. The majority of these loans are secured by limited or select service, nationally branded properties or portfolios of properties. And we're optimistic that these types of hotels will recover faster than certain full-service hotels due in part to lower expense loads.

In addition, we have a $10 million equity position in a Marriott hotel in Westchester, New York. This property performed ahead of plan in 2019 and is well positioned heading into 2020. Since the outbreak, we've been actively managing and creating a cost containment plan that will minimize operating expenses for this hotel until the recovery. While we do not have any loans solely collateralized by shopping centers, some of our multiuse properties do have retail components and 1 has a hotel component.

We're working with each of our borrowers that have expressed concerns around their ability to execute on their business plans in a timely manner. We're evaluating each loan on a case-by-case basis and considering certain modifications, including extensions of maturity dates and deferral of interest payments. While we continue to actively manage our existing portfolio, we're also prepared to take advantage of attractive financing opportunities at the appropriate time. We communicate on a daily basis with our real estate equity colleagues as well as the greater Ares platform to gain real-time insight into consumer and tenant behavior.

As we look at a refreshed investment environment, we expect a continued focus on multifamily properties, offices with long-term leases, self-storage assets as well as an increasing opportunity set in the retail -- in the industrial sector.

With that, I'll turn it over to Tae-Sik.

Great. Thank you, Bryan, and good afternoon, everyone. Earlier today, despite the many challenges of operating in this environment, we reported consistent core earnings of $10.3 million or $0.32 per common share, as 100% of our loans were current on their debt service payments through the April 2020 payment date. Our GAAP net income, however, was significantly impacted by noncash losses that we recognized due to the implementation of CECL, resulting in an overall quarterly loss for the first quarter of 2020 of $17.3 million or $0.54 per common share. At March 31, 2020, we reported a book value of $13.95 per common share, down from $14.77 at year-end 2019, inclusive of a cumulative $0.96 per common share impact under CECL. I will discuss our implementation of CECL in greater detail in a few minutes.

Prior to mid-March, when we started to see the economic impact of COVID-19, we closed 7 new loans, totaling $356 million in new commitments. Of these loans, a $132 million loan that was originated in the Ares Warehouse in the fourth quarter of 2019 was purchased by ACRE in January 2020. Total fundings for the first quarter were $297 million, which included initial fundings of $284 million on the 7 new loans and $13 million on prior existing loans. With respect to repayments, 4 loans paid off in the first quarter, totaling $107 million in principal balance, a number of which occurred in late March. As of March 31, our loan portfolio included 53 loans with total loan commitments of approximately $2.2 billion and an outstanding principal balance of approximately $1.9 billion.

Turning to our liquidity. As of May 7, we had approximately $50 million in unrestricted cash. In addition, we have $131 million in unfunded capacity under our FL3 securitization and further capacity under the Ares Warehouse line, both of which are available subject to respective lender and third-party approvals. If we are able to fully utilize both capacities, we believe we would generate approximately $20 million to $25 million of additional unrestricted cash. Furthermore, we believe that we could also monetize certain loans without significantly impacting future earnings and book value. In total, if all of these options were fully executed, our total cash position would be approximately $70 million to $75 million on a pro forma basis, plus any note -- any net proceeds from the sale of assets.

Now let me discuss our liabilities and financings. As we have consistently stated in the past, we have very purposely pursued a strategy of first, diversifying both our sources of financing as well as the composition of loans that we place with each of our lenders; and second, our focus on match funding our assets and liabilities. With respect to diversification, our $1.6 billion in liabilities at quarter end was (technical difficulty) of 10 different sources of capital. This means that we have 6 different warehouse lenders, a separate working capital line with City National Bank, a term loan, asset-level notes payable with 3 separate lenders and our FL3 securitization. This allows us to spread our counterparty risk and make sure that no single lender has concentrations of loans that we finance with them. So for example, as we mentioned in the recent announcement, of the 6 hotels that we have, 3 are financed within FL3, and the remaining 3 hotel loans are financed with 3 different warehouse lenders. In other words, no warehouse lender has more than 1 hotel loan among the many other loans that they are financing for us. Also, we have 10 different sources of financing. Other than Wells Fargo and our FL3 securitization, no other single financing source represents more than 10% of our borrowings at March 31, 2020.

As far as our strategy of match funding our assets and liabilities, we think it is important to note that none of our 6 warehouse financing facilities contain mark-to-market remargining provisions that are based on changes in market borrowing spreads. Instead, our warehouse lines have remargining provisions based only on the actual credit quality of our loans.

And finally, we can't emphasize enough the importance of our continuing strong relationships that we have with each of our warehouse lenders, both at the ACRE level as well as at the Ares management level. We have been working closely with each of them, particularly over the past few weeks. Since mid-March 2020, we have not been formally asked to make any margin calls under any of our 6 warehouse lines, and we are in compliance with all of our loan covenants. However, we did elect to voluntarily make asset-specific paydowns of less than $10 million in total during the past few weeks as part of our ongoing discussions and in light of our overall relationships with our lenders.

I would now like to provide an update of our implementation of CECL during and as of the first quarter of 2020. Our adoption -- our initial adoption of the new CECL accounting standards resulted in an initial reserve of $5.1 million as of January 1, 2020, which was recorded on our balance sheet as a reduction of stockholders' equity. It is important to note that this initial reserve amount did not take into account the impact of COVID-19. However, as we all know, during the first quarter, and most notably, during the last 2 to 3 weeks of March 2020, the impact of COVID-19 dramatically and adversely changed the economic outlook for the U.S. economy.

In assessing estimated losses under CECL, we engaged a third-party economic forecasting company to provide us with macroeconomic metrics, which we incorporated into our CECL model. In general, the macroeconomic forecast assumes significant declines in GDP, LIBOR rates and commercial real estate values as well as sharp increases in unemployment. As a result, at March 31, 2020, we increased our CECL reserve significantly by $27.1 million or $0.85 per common share for the first quarter of 2020, which is included in our net income and resulted in our overall GAAP net loss. Cumulatively, at March 31, 2020, our CECL reserve stands at $32.2 million or a $0.96 decrease in book value per share and represents approximately 1.5% of our loan commitment balance and 1.7% of the unpaid principal balance of our loans.

It is important to note that while CECL has a significant impact on our GAAP earnings and book value per common share, CECL reserves are a noncash item, and CECL does not directly impact our actual cash flows or liquidity position. To note further, we have not incurred any actual losses or recognized any impairments in our loan portfolio. And in addition, as we mentioned at the outset, 100% of our loans were current and made debt service payments through the April 2020 payment date.

The 4 loans, although they too are current, and we did receive interest through the April 2020 payment date, we made the prudent decision to place them on nonaccrual status. These 4 loans totaled $105 million in unpaid principal balance and represents 6% of our total portfolio and includes 3 loans secured by hotel properties and 1 loan secured by student housing. We made this decision as we believe that the COVID-19 pandemic may put particular pressure on these powers and property cash flows.

And with that, I will now turn the call back over to Bryan for some closing remarks.

Thanks, Tae-Sik. As you can see from our discussion today, we're incredibly focused on preserving liquidity during this period of disruption and the reopening of our economy. We recognize that dividends are important to our shareholders, and we believe there is a strong alignment of interest with shareholders as executives and employees collectively own approximately 11% of ACRE. In order to have the most information available to us, we expect to announce our decision regarding our second quarter dividend by mid-June, following the meeting of our Board of Directors. This will allow us more time to evaluate cash and liquidity, market conditions and loan performance, amongst other factors.

Importantly, the silver lining is that we anticipate there will be an improved real estate market for investing as the economy starts to reopen and recover. While we remain focused on preserving capital at ACRE, we remain active through complementary funds on the Ares real estate debt platform, which we believe will lead to deal flow and future opportunities for ACRE over the long term.

At this point, I would like to ask the operator to open the line for questions.

(Operator Instructions) Our first question today will come from Steve Delaney with JMP Securities.

Tae-Sik, the 4 loans on nonaccrual, I did not find that in the deck. I must have been -- I must have missed something. Is it -- can I find it in the deck? Or is that something that's in the 10-Q?

Sure, Steve. It is -- I think it is more detailed in the 10-Q. However, in the deck, what you will see is, in the appendix, where we list all of our loans held for investment, you will see that there are 4 loans, plus there is 1 senior loan under hotels that you will see, that is identified with a dash effectively and a 0 for unlevered effective yield. So the reason, again, we shift here on unlevered effective yield is because they are put on nonaccrual status. And what you'll see is that it's basically made up of 3 loans that are backed by hotels, 1 backed by student housing, as I just had mentioned. And again, it's important to note that we actually did receive interest on these loans for the April payment date. But these are certainly loans that we expect to experience problems going forward on potentially meeting current debt service.

Got it. Okay. Yes, I did glance at the list there for property types, and I just -- I didn't pick up the zeros, but thank you for pointing me to that. Okay. This obviously, on the financing side, I think those of us on -- in their position as analysts, we've really gotten a crash course in the nuances of the different types of bank-provided financing. The CLOs are obvious as to the terms of the CLO. But the concept of non mark-to-market lending facilities versus revolving or other types of loan facilities, I'm just curious if there are only a limited number of lenders that will actually do non mark-to-market, maybe such as your life co lender. And when you are negotiating those types of facilities, is the cost materially higher and possibly the leverage lower on a non mark-to-market facility?

Sure. No, excellent question. And again, I think it's important to differentiate the different types of mark-to-market or non mark-to-market type facilities, right? And I generally put them in 2 categories. One is that a lender can do a mark-to-market remargining of the facility based upon changes in borrowing spreads, right? If you have a loan financed with them and your loan pays L-plus 3.50%, but under different market conditions, maybe that market borrowing spread for a similar type of loan has increased from L-plus 3.50% to L-plus 5.50%. And in that situation, a warehouse lender could say, your loan is worth less than par, and therefore, we're going to remargin the loan. And our point is, we don't have that type of mark-to-market provisions in any of our facilities.

The second type of mark-to-market versions that we talked about is, is that if you have a deterioration in the credit of the underlying collateral. So let's say you have a loan backed by an office building, an apartment building. And those assets in particular, suffer an actual credit deterioration. So they lost a major tenant. There was a problem leasing those assets, and there's a significant drop in cash flows. And so if there's an actual credit deterioration, and therefore, the lender believes that the loan is worth less because the LTV has gone up, the DSCR has gone down, whatever the right credit metrics are, they can then reassess the value of the loan and remargin loan in that situation. And those are common, I would say, and those are certainly the type of remargining mark-to-market provisions that we have under our various warehouse lines.

Right. Well, that's good to know. It does not -- it's not pure that all of your peers have avoided spread-based marks from best we can tell. So thanks for confirming that. And then just lastly for me. Things have changed, and I was wondering if you could give us an update on your repayment outlook. We used to use 30%, 35% a year, but I guess we should expect more extensions in this market.

Sure. And maybe I can start with that, and Bryan, certainly to the extent that you have other thoughts on this. But I would tell you that for our cash planning purposes, we have taken a pretty conservative viewpoint and assume for cash planning purposes that, little to no repayments will occur over the next, call it, 6 to 8 months throughout the rest of 2020. Obviously, we do have contractual maturities coming up, and we are working very closely with each of the borrowers. But just given the challenges of the capital markets, we have assumed, again, for cash planning purposes that we do not receive any repayments. But again, I think the important thing is we are working with each of our borrowers. We certainly expect a slowdown, but I think -- I don't think the reality is that there will be none. But I do think for our cash planning purposes that it's the prudent assumption to make.

Okay. And I guess if you have a multi -- yes, Bryan.

The only thing I'd add there is with respect to -- we have a large portfolio of multifamily assets. And as one of the factors that will go into repayment, velocity is the availability of replacement capital, obviously. And with respect to cash flow in multifamily assets, which comprises 25-plus percent of our portfolio, the attractiveness of the GSE financings and the continued liquidity in that space may induce probably a higher repayment velocity than some other asset classes. So we'll be well served by that subset of our portfolio.

I'm sure Walker & Dunlop would be glad to take the loan off your hands and give it to Freddie or Fannie.

Our next question today will come from Doug Harter of Crédit Suisse.

Can you just help put that cash balance you have in context? What you might expect from future funding, future funding needs? And just, again, just kind of what normal cash balances you would hold on just so we can frame that liquidity balance?

Sure, Doug. Thank you for your question. So to maybe answer your second question first. I mean, clearly, prior to mid-March, we looked at cash as an important part of our balance sheet. However, having cash on our balance sheet meant that we weren't putting as many dollars to work in terms of our GAAP earnings and our core earnings. So our strategy was to maintain liquidity, but try to maintain as minimum of a cash balance as possible. So whenever we have cash balances, we would use to pay down our various revolving credit lines and our warehouse lines. So historically, we try to maintain as little cash as possible, I think, like most of our peers. Right now, clearly, cash is paramount, and we want to make sure that we maintain a very, very sufficient level of liquidity in the form of immediate cash. At the same time, I think we want to make sure that we do maintain and we anticipate needs of cash, but that we don't overreact and put too much cash on balance sheet and really strain both our earnings and other important aspects of the company. So what we have done is, we have put in place plans to raise additional liquidity on top of the $50 million of cash that we have to make sure that we will have the liquidity needs for things like future funding.

And so for future funding, for example, if you look at the total, there's about $275 million of future funding that we have. So if you look at the difference between our commitment and our funded amount at March 31, there's about a $275 million difference. Obviously, all of that is not going to become immediately called in the short term, plus there are different uses of that future funding. Some is for continuing the progress of the investments, a lot of it is for what we call good news money in the sense that this is for tenant improvement dollars. This is where leasing commissions win new tenants, new rent-paying tenants come on board. But we are managing both our cash position, the $50 million additional sources of liquidity. We mentioned the $20 million to $25 million that we could get from further leveraging our FL3 and our Ares warehouse line. In addition to that, we have additional assets that we could look to monetize. So we are balancing our cash position with the potential uses of capital, including what we think will be, call it, $55 million to $60 million of future funding over the course of 2020.

Great. And then, Tae-Sik, if you could just talk about kind of how the 4 nonaccrual loans kind of fit into the CECL reserve, just kind of how that was contemplated and the amount to arrive there.

Sure. So in terms of the CECL reserve, so even the 4 loans that are placed on nonaccrual were part of our CECL reserve. Just to clarify that nonaccrual does not mean impairment or specific reserve, so that the 4 nonaccrual loans were part of our overall CECL reserve. It's also important to, again, reiterate that the 4 nonaccrual loans did, in fact, make their interest payment for the April 2020 payment date. But we believe that these 4 loans we identified as ones where we felt that the financial condition of the asset, the direct impact that COVID-19 is having on these 4 borrowers and these 4 assets were particular, and we felt that it was the prudent thing to do, to put them on nonaccrual status, again, despite us actually having received the cash. And so I think that's really the genesis and background. So again, they are included in our CECL reserve, but we thought in addition to a higher level of CECL reserve that putting it on nonaccrual status was the prudent decision at this moment.

Our next question today will come from Rick Shane of JPMorgan.

I basically have 3 different topics I'd like to cover. In the student lending portfolio, I'm curious how we think about the underlying equity. Who are your counterparties, generally? Are these universities? Or are these more typical private sponsors?

In our portfolio, it's not directly on-campus affiliated with the university. So it's private owners with access to additional capital in most cases.

Got it. And the non -- or excuse me, the student loan that you have on nonaccrual, is that really a function of the pending maturity?

That's correct. Yes. I mean there's a lot of factors, obviously, that go into that designation. What was unique about it was, obviously, some of the unknowns that we have with respect to student housing. Many of our assets were performing very well year-over-year. But given the maturity of that specific asset, as Tae-Sik pointed out, we made the conservative and prudent decision to move it to nonaccrual.

Got it. Okay. That's helpful. And it certainly makes sense in light of what we're seeing. Second topic, you do show in the multifamily portfolio 2 main maturities that are significant. They are fully accruing. That's obviously a good sign. Should we think of those 2 loans as a source of liquidity, given their status and the timing on them?

I'd say, I think that overall, we view the multifamily portfolio, as I said earlier, as a potential source of liquidity. I can't comment specifically on that situation. But given the consistency of performance and the secular growth in the apartment subsector, I think we feel good about using that as a liquidity source in certain instances. But I can't really weigh in specifically on those 2 assets.

Understood. I appreciate that. I got to ask the question though.

Totally fair.

Last topic. On the 3 nonaccruals, I am curious because I think our view is that, we're moving through 3 stages. And the second stage is going to be largely about sponsors buffering properties for these short-term issues. On the 3 nonaccruals, what are the conversations you're having with the sponsors? And specifically, I'm curious, do you see these as either sponsor sort of a little bit of brinksmanship with you? Do you see these as sponsors who are strategically willing to walk away because those particular properties are so underwater? Or these sponsors who just may not be in a position in order to provide that buffer that I'm describing?

It's a good question. I think what I'd point to is, one, we've had very constructive dialogue with each of our sponsors, and we're trying to work as I think we've seen the edict from government or similar entities of trying to just get through what we're seeing as the near-term liquidity crunch that we're seeing at a macro level, but specifically, as it relates to lodging and I guess, secondarily, retail assets. The conversations on these loans is no different. We've -- it's been constructive at the appropriate attachment points. We're seeing the ability of sponsors to reinvest in certain circumstances, and we're working through the unique attributes of each situation. But thematically, there's nothing that I could point to as uniform among the 3 assets that we're discussing here.

Our next question today will come from Jade Rahmani of KBW.

Hope you're all doing well. Wanted to ask about the amount of cash that you are targeting to hold on the balance sheet.

Sure. Jade, thanks again for your participation and question. So as I mentioned, we want to be anticipatory of how much cash will be necessary to meet all of our uses, whether that's future funding, whether that's rebalancing any loans, whether it's for any other reason. Right now, we feel we have that adequate amount of cash. Having said that, we absolutely want to be anticipatory and so we have lined up a number of options to raise more additional cash, if and when necessary. Obviously, we're not going to wait until the last moment in any way. But at the same time, we don't want to overreact and do things that longer term, would not be beneficial to the company.

So just to mention a few things. As I mentioned in my prepared remarks, we do have about $20 million to $25 million of additional cash that we're currently working on to free up in terms of utilizing capacity we have in FL3, which is very important as well as our Ares Warehouse line. In addition to that, as Bryan mentioned, I think we have a very strong focus on senior multifamily loans. And if you look at our portfolio snapshot at March 31, you'll see that we have about 13 loans, totaling over $500 million of unpaid principal balance. And we do believe on a relative basis, senior multifamily loans probably do offer the most liquidity, if and should that time come to potentially monetize some of our assets. And to maybe add a little bit more color, of the 13 loans totaling a little more than $500 million, 10 of those, again, totaling a little more than $400 million of unpaid principal balances are not in our FL3 securitization. In other words, they're financed with different warehouse parties, and so they would be relatively easy to get out of those warehouse facilities. Again, if we were to look to potentially monetize those loans in some way.

And then, also in addition to that, we have about 9 loans, and they consist of 8 mezzanine positions and 1 senior position that are not financed under either FL3 or on any of our warehouse lines. Again, the balance on these 8 positions is about $116 million. And again, they don't have any specific warehouse debt or FL3 financing associated with it. So that would, again, be another source of liquidity, if and should that need arise.

So to answer your question, we have $50 million today. We're very focused on liquidity. We're very focused on anticipating capital needs. We want to make sure we have all of the options at the table if and when they are needed. But we don't feel that we want to pull the trigger too early if those needs don't arise. So we're very anticipatory. We're ready. But we're going to do it, if and when the right moment arises.

Turning to repayment expectations. What are you expecting as sort of minimum levels of repayments? Are you expecting any repayments? What's a range to think about? And a related question would be, whether you are talking to any borrowers about any discounted payoffs.

Sure. Maybe I can start, and Bryan, please chime in. So in terms of, again, anticipated repayments of loans, we certainly do have a number of loans that have maturity dates coming up in 2020, and those are loans in particular that we are working very closely with the borrowers to see what their specific situations are. I think as we mentioned, we do think that in the multifamily sector, without getting into any particular loan, we do have a number of loans that do have 2020 maturity dates. And we do believe those are loans that we will be working most closely with to see what their refinancing and/or sale process would be to meet the maturity dates of the loans. Alternatively, we could, again, as we've talked about, sell any of these loans as well, again, as a way to monetize the value we have in these loans.

So again, I don't think I have a specific answer for you in terms of, is there a minimum paydown. As I mentioned before, for liquidity planning purposes, we're making the very conservative assumptions that essentially little to no repayments occur in 2020. That is obviously a very conservative viewpoint, but we think one that's prudent to take in this environment. So that when we plan our liquidity over the next 8 months, that, that's the underlying assumption that we're making. But having said all that, we are working very closely with each of our borrowers to make sure that if they're able to refinance, even if it's not under ideal terms, but they're able to finance, that they produce -- that they pursue those strategies to make that happen.

And the last thing I'd add there, Jade and Tae-Sik, is this book is also comprised primarily of loans to bridge the improvement of the underlying assets. So as assets have gone through their life cycle and our borrowers and our capital has provided the cash in order to improve upon these assets. And that's, in many cases, resulted in improved leasing to either improve occupancy and multifamily assets or in certain instances, get credit tenancy with long duration leases, as was the original business plan. And so as that -- those investments come to the -- through the normal course of their life cycle and mature, those sponsors also want to realize on the value that they have created. And while capital markets may not be perfect across the board, we still see liquidity for credit tenancy, and we still see liquidity for multifamily assets. And while difficult to predict, we do believe in certain instances that will induce repayment.

I wanted to ask one last question, sort of a high-level question. But just touching on ACRE's historical focus, do you expect, number one, secondary markets to come back faster than gateway cities, based on less density and being quicker to move beyond lockdown? Secondly, what gives you the confidence that multifamily credit will hold up this cycle, where in the last cycle, we had the access homeownership that's spilled back into the apartment space and bolstered occupancy there?

With respect to your first question regarding gateway cities, I think you've got a little bit of a push and pull, right, in which capital flows have historically moved towards and been more consistent in those cities. But obviously, the population concentration, given what's occurring today could potentially run counter to that. I think that the thesis that we've always had at ACRE and will continue to have is that we don't expect to be an index of property values in any given market, or throughout the broader landscape. We think that we've selected and we'll continue to select assets that will outperform a given market, whether it's a gateway city or secondary.

If you've seen where we've invested over the previous quarters, it's largely been in areas that will benefit from tax migration, so lower cost areas. And that was a response to that secular shift in the population and the companies that are tracing that population movement, and also just the fact that those gateway cities were also priced to perfection in many instances. So we've been moving away from them historically, and we would expect that to continue.

Our next question today will come from Stephen Laws with Raymond James.

Hope all are well. I want to start maybe with -- I think it was Page 6 in the deck with the LIBOR breakout. Appreciate the color on the LIBOR floors. Can you maybe help me think about -- obviously, there's been a tremendous benefit there with the LIBOR decline since quarter end. But on the opposite side, Tae-Sik, how do we think about the recurring, nonrecurring items, origination fees, the repayment fees? How much of Q1 was from that? Or how much of a decline do we expect would that largely go away? And how much, if any, will be offset by modification fees that you may charge on new modifications?

Sure, Stephen. Thanks for that question. I think, number one, I think our LIBOR floors have served us well in a very volatile LIBOR environment. And one that right now has been very beneficial to ACRE in terms of maintaining a very strong overall unlevered effective yield, again, despite very challenging conditions. In terms of origination fees, as you mentioned, clearly, that's been a nice part of our earnings stream in the past. And the way we recognize origination fees is that we amortize it over the expected life of the loan. So if we receive a 1 point origination fee on a 3-year loan, we're not going to recognize it upfront. We're not going to recognize the whole 1% upfront. We're going to recognize it and amortize it over the 3 years. And so you'll still see the benefit of origination fees of originations that we have done in the past come through our earnings.

Similarly, I would say that if you look at our financing costs, our financing costs, when we borrow monies from our lenders, we also pay origination fees on those loans on those liabilities. And again, those are also amortized over the expected life of those financing facilities. So in many ways, from both a cash perspective as well as from an earnings perspective, both GAAP and core, those 2 tend to not exactly certainly by any means, but those tend to offset each other to a pretty good extent. And therefore, I don't think origination fees or origination expenses that we would have are going to be a meaningful differentiator between cash flow versus our earnings.

Great. Appreciate the color on that. Shifting to the hotels and looking at the ones that you're still accruing interest for. So pretty unique locations across the 4. So I guess a couple of questions here, just trying to get a gauge on this asset class and your exposure. What is your feedback from those 4 borrowers that are still paying, given their specific locations and what they're experiencing? Any modification discussions you're having with them? And on the other side, I know in your prepared remarks, you talked about no 1 counterparty, I think, has more than 1 hotel loan. If you do need to modify one of these loans, do you already have approval from your counterparties to do so? If so, what are some examples of what that encompasses? I'm trying to get an idea of where the ones you're still accruing interest for are on a performance standpoint and what your options are to address it if they're in a stressed environment.

Sure. Thanks, Stephen. Again, it's tough to point to any overarching theme other than, obviously, the economic downturn in lodging being somewhat tip of the spear for the risk that we're seeing. Overall, though, as I pointed out in my prepared remarks, these are generally limited or select service hotels. And the reason that's important is the expense load in a full service hotel, specifically in some of the gateway cities we mentioned earlier, will have a very high expense with. So beyond just debt service, operating expenses will create a pretty significant hole in the income statement that will have to be filled somewhere. So the fact that we've invested one in certain portfolios. So that diversity, just within our specific investment, and the optionality in terms of the way you potentially restructure those types of transactions and the limited drag from ongoing expenses, I think, is an important factor to take into account.

With respect to your question regarding correspondence or how we then work with our senior lenders, not to speak about anything specifically, but to the extent that we're agreeing with a sponsor to a restructure in any way, then that's done in concert with our senior lenders. And as you know, we've got full capital markets team to manage that communication and the overall relationships that we have. And the fact that we're very forthcoming and communicate regularly with our partners on the finance side positions us very well there. But specifically, to the extent we were to extend the maturity date of a loan, for instance, that might be done in concert with a payment from the sponsor, right, a paydown of some kind and the like. And to the extent that was the case, then that would be passed on, in many instances to the senior lender to kind of go along with that restructure. But all of those conversations to date have been extremely constructive.

Great. And then to tie that back to the first question, if you were to do that and extend the duration, would you then slow down the amortization of the original origination fee because it's now over a longer period of time?

We would, yes. Yes. We thought the loan was going to extend. And in fact, particularly if we modify the loan so that it doesn't, in fact, extend, we would amortize the original remaining balances here over a longer time.

Great. And then my final question, appreciate the time. The prefunding facility, something unique that others don't have. Can you maybe give us any details? I mean, I know it was there to help manage cash flow and availability. At what point do you see liquidity? Or is there a leverage level? Or do you get comfort around payoffs that you start to prefund loans on that facility? Is there a maximum link you can leave them there? Could you go out and do a bunch of L-plus 15 loans now and pull them down in 6 or 12 months? And then from a risk standpoint, could it go the other way? If you have financing problems in your portfolio, can you go backwards and move along back there temporarily? Or is it simply for prefunding only? And anyway, any color around that would be great because I do think this is a unique feature of ACRE that others don't have.

Sure. No, thanks for pointing that out, Steve. And we do think that Ares Warehouse line is an incredibly important and advantageous tool that we have at ACRE. And certainly one of the huge benefits that we at ACRE get from being managed by Ares management is the Ares Warehouse line. So we have -- traditionally and certainly, the primary purpose of the Ares Warehouse line was to do what you stated, Stephen, which was to allow us to originate loans that exceeded the balance sheet capacity of ACRE at that moment, put that under the Ares Warehouse line so that when a loan paid off within ACRE or other liquidity was available in ACRE, there would be a readily stable of loans that we could pull down and not incur the drag of cash on the balance sheet that was not deployed.

Having said all that, I do think we are looking to, if you want to call it, reverse engineer the use. So that if ACRE is looking for more liquidity rather than trying to invest its liquidity, trying to create more liquidity, there is a possibility of reversing the direction so that a balance sheet loan that ACRE holds directly today could be sold to the Ares Warehouse vehicle, and thereby free up capacity and free up liquidity within ACRE. So that is certainly a possibility and certainly something that we are absolutely looking into.

Well, that's great color, Bryan (sic) [Tae-Sik]. I've been wondering if that was potentially an option, and it sounds like it's something you guys have been working on or at least considering. So that's good to hear. And at some point, coming out of this, I feel it's going to be really attractive to shift to offense. And I think that will allow you guys to do it faster than others, even if your stock valuation may be lagging that term.

Showing no further questions, this will conclude the question-and-answer session. At this time, I'd like to turn the conference back over to Bryan Donohoe for closing remarks.

Thank you, and I want to thank everybody for joining the call today. And I also want to thank the team at ACRE that's working so hard to best position us moving forward. I'm very proud of the team.

To all of you, we appreciate your continued support of ACRE throughout this unprecedented disruption. And we look forward to speaking to you again soon on our next earnings call or in the interim. Thank you all for joining.

This concludes the conference call for today. If you missed any part of today's call, an archived replay of this conference call will be available approximately 1 hour after the end of this call through May 21, 2020, to domestic callers by dialing 1 (877) 344-7529 and to international callers by dialing 1 (412) 317-0088. For our replays, please reference conference number 10141810. An archived replay will also be available on a webcast link located on the home page of the Investor Resources section of our website.

The conference has now concluded, and you may now disconnect your lines.