Apollo Commercial Real Estate Finance, Inc. — Q2 2018 Form 10-Q
Business context and period. ARI is an externally managed REIT that originates, acquires and manages commercial real estate debt investments. This unaudited report covers the quarter and six months ended June 30, 2018; comparisons are with the corresponding 2017 periods.
Financial and operating performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net interest income | $70.8 million | $62.2 million | $134.0 million | $120.0 million |
| Net income | $55.3 million | $36.2 million | $104.8 million | $83.4 million |
| Net income available to common stockholders | $48.5 million | $26.9 million | $91.1 million | $64.7 million |
| GAAP diluted and basic EPS reported | $0.39 | $0.28 | $0.78 | $0.68 |
| Common dividend declared per share | $0.46 | $0.46 | $0.92 | $0.92 |
Net interest income grew about 14% for the quarter and 12% for the six-month period, principally reflecting loan portfolio growth and higher benchmark rates, partly offset by higher interest expense. Management reported portfolio weighted-average coupon of 8.1%, all-in yield of 9.1%, and cost of funds of 4.1% at June 30. Non-GAAP Operating Earnings were $54.9 million ($0.44 per share) for Q2 and $102.7 million ($0.87 per share) for the six months; these measures exclude specified items and are not substitutes for GAAP results.
Balance sheet and liquidity. At June 30, total assets were $4.981 billion, including $4.867 billion of net commercial mortgage and subordinate loans; cash was $76.4 million. Total liabilities were $2.638 billion and stockholders’ equity was $2.343 billion. Secured debt arrangements were $1.981 billion outstanding; convertible notes had $599.8 million principal and $587.1 million net carrying value. The stated debt-to-common-equity ratio was 1.2x, up from 0.9x at year-end 2017. The loan portfolio comprised 70 loans, 91% floating-rate by amortized cost, and included $818.1 million of unfunded commitments.
For the first six months, operating cash flow was $171.6 million, investing cash outflow was $952.9 million and financing cash inflow was $780.0 million; cash declined $1.3 million. The company completed a common-stock offering in Q1, raising approximately $275.9 million net. Management stated it believed liquidity and access to additional liquidity were sufficient for financial obligations over at least the next 12 months. It expects leverage, depending on portfolio composition, to remain below 2.0x.
Material changes and notable items
- Net loan carrying value increased from $3.680 billion at December 31, 2017 to $4.867 billion. During the first half, ARI committed $1.9 billion to loans, funded $1.5 billion of new loans, and received $375.7 million in loan repayments.
- Q2 included a $5.0 million loan-loss provision. The portfolio carried $22.0 million of aggregate loan-loss provisions at quarter-end. Two loans totaling approximately $65.1 million were rated 5 (impaired/loss likely); an additional $170.7 million was rated 4 (high risk/potential for loss).
- A $169.0 million commercial mortgage loan modification was treated as a troubled debt restructuring; its spread was reduced from 5.5% to 3.0% over LIBOR. The loan was risk-rated 4.
- Foreign-currency losses were $29.6 million in Q2, while derivative instruments generated a $33.5 million gain. These items materially affected GAAP earnings; ARI’s foreign-exchange forwards are not designated as accounting hedges, so fair-value changes flow through earnings.
- ARI amended or added financing arrangements during the quarter, including a new Credit Suisse facility with $145.9 million drawn at quarter-end. Secured facilities permit margin calls, and some asset-specific financings mature in 2018–2019. The company reported compliance with facility financial covenants at June 30.
- After quarter-end, ARI committed and funded $87.0 million of first mortgage loans, funded a further $18.9 million on previously closed loans, and received approximately $52.3 million in loan repayments.
Outlook, risks and contingencies
Management cited commercial real estate debt maturities and market uncertainty as potential sources of attractive risk-adjusted lending opportunities, while emphasizing underlying real estate value and complex transactions. The filing gives no quantitative earnings or investment guidance. A hypothetical immediate 50-basis-point increase in benchmark rates was estimated to increase following-12-month net interest income by $12.4 million, or $0.10 per share, before considering potential management actions or broader economic effects.
Key risks include borrower and collateral credit deterioration, property-value declines, refinancing and prepayment risk, floating-rate exposure, foreign-exchange movements, financing availability and margin calls, and the substantial unfunded loan commitments. A lawsuit filed June 28, 2018 alleges interference and related claims involving a Manhattan development; plaintiffs allege $700 million in total damages, including punitive damages. ARI said it believes the claims are without merit and will defend them. The Department of Justice notified ARI in May 2018 that it did not intend to take further action regarding its former residential portfolio. The filing reported no material changes to the risk factors in the 2017 Form 10-K.
Important facts for investors to verify
- Loan-level credit quality and collateral performance, particularly the risk-rated 4 and 5 exposures, the Bethesda loan provision, and the modified $169 million loan.
- Funding needs and timing for the $818.1 million of unfunded loan commitments, alongside facility maturities, extension conditions and margin-call terms.
- How interest-rate and currency movements affect net interest income and reported earnings, including the distinction between GAAP results and Operating Earnings.
- The status and potential financial impact of the AmBase litigation; the stated damages are plaintiffs’ allegations, not an established liability.
- Dividend sustainability in light of GAAP earnings, cash flows, REIT distribution requirements, preferred dividends and management’s external-management fee structure.