Apollo Commercial Real Estate Finance, Inc. — Q2 2017 Form 10-Q
Business context and reporting period. Apollo Commercial Real Estate Finance, Inc. (ARI) is an externally managed REIT focused on commercial real estate debt, including first-mortgage and subordinate loans and CMBS. This unaudited filing covers the quarter and six months ended June 30, 2017; balance-sheet comparisons are with December 31, 2016. Unless otherwise noted, financial amounts below are in millions of dollars.
Financial performance and position
- Q2 revenue and earnings: Net interest income was $62.2 million, up from $46.9 million in Q2 2016. Net income was $36.2 million versus $10.3 million; net income available to common stockholders was $26.9 million, or $0.28 per diluted share, versus $4.5 million, or $0.06 per share.
- First-half results: Net interest income was $120.0 million, up from $93.7 million. Net income was $83.4 million versus $29.0 million; net income available to common stockholders was $64.7 million, or $0.68 per diluted share, versus $17.3 million, or $0.24 per share.
- Non-GAAP measure: Operating Earnings were $44.6 million, or $0.46 per share, in Q2 and $83.2 million, or $0.88 per share, for the first half. These were below the comparable 2016 per-share figures of $0.49 and $0.93, respectively. The company cautions that this measure excludes realized and unrealized investment gains and losses and is not comparable necessarily with similarly titled measures at other companies.
- Portfolio and returns: Net carrying value of loans held for investment rose to $3,278.3 million from $2,693.1 million; the portfolio comprised 52 loans versus 45. The weighted-average cash coupon was 8.55%, compared with 8.88% at year-end. Management reported a 9.2% weighted-average yield and 13.3% fully levered weighted-average underwritten IRR for investments; these are underwriting estimates, not guaranteed realized returns.
- Cash flow: For the first half, operating activities provided $71.5 million, investing activities used $308.4 million, and financing activities provided $245.2 million. Cash, cash equivalents and restricted cash totaled $271.7 million at June 30, 2017, including $214.0 million of cash and cash equivalents and $57.7 million of restricted cash.
- Debt and equity: Repurchase-agreement borrowings were $1,340.3 million gross at quarter-end, compared with $1,146.6 million at year-end; the balance sheet reports $1,330.9 million net of deferred financing costs. Convertible notes had a net carrying value of $250.9 million and mature in 2019. Total liabilities were $1,663.8 million and stockholders’ equity was $2,162.7 million. The company issued 13.8 million common shares in a follow-on offering, generating approximately $248.9 million net proceeds.
- Dividends: Common dividends declared were $0.46 per share in each of the first two quarters, or $0.92 for the first half. Preferred dividends were also declared on Series A, B and C shares.
Material changes versus the comparable period
- Higher loan balances and higher LIBOR contributed to increased net interest income; interest expense also rose as debt increased, while securities interest income declined as the CMBS portfolio contracted.
- Q2 GAAP earnings improved substantially year over year, partly reflecting a smaller securities fair-value loss and a foreign-currency gain compared with the prior-year quarter. Derivative results swung to a loss: $7.4 million in Q2 2017 versus a $13.3 million gain in Q2 2016. Management reported the combined net effect of foreign-currency and derivative results was a loss of $0.5 million in Q2 2017.
- The company recorded a $5.0 million loan-loss provision and impairment in Q2 2017, versus a $15.0 million provision in Q2 2016. The 2017 charge related to a Bethesda, Maryland condominium loan and a related investment; interest accrual on the loan ceased effective April 1, 2017, and it is accounted for on a cost-recovery basis.
- The company sold its remaining interest in Champ LP in May 2017 for $24.5 million, recording a $3.3 million loss. It also completed repayment of a previously held-to-maturity CMBS investment and associated participation in May.
- All $254.5 million of fair-value-option CMBS were classified as Level III at quarter-end because management concluded market illiquidity made broker quotes insufficiently observable. The portfolio had $39.0 million of gross unrealized losses against amortized cost of $293.3 million.
Outlook, risks and unusual items
- Management cited commercial real estate debt maturities and uncertainty in lending markets as potential sources of attractive risk-adjusted investment opportunities. It expects to continue pursuing first-mortgage and mezzanine financings, including complex transactions. The filing provides no earnings or dividend guidance.
- Management said it believed available liquidity and access to additional liquidity were sufficient for obligations over at least the next 12 months. It expects borrowings on loans to be approximately 35% of the value of the total loan portfolio, consistent with its stated leverage approach.
- Floating-rate exposure is material: the company reported $2,969.2 million of floating-rate assets and net variable-rate exposure of $1,873.1 million. Its sensitivity estimate was that a 50-basis-point LIBOR increase would raise quarterly net interest income by approximately $3.5 million, assuming no changes in financial structure or other economic effects.
- Repurchase financing exposes ARI to margin calls and refinancing risk. At June 30, $638.5 million of borrowings were scheduled to mature in less than one year and $701.7 million in one to three years, assuming stated extensions where applicable. Unfunded loan commitments were $119.8 million.
- After quarter-end, ARI announced redemption of all 3.45 million Series A preferred shares on August 2, 2017, at $25.00 per share plus accrued unpaid dividends. It also reported approximately $60 million of CMBS sale and principal-paydown proceeds, new loan commitments, and approximately $50.4 million of loan repayments.
- Contingencies include shareholder litigation relating to the 2016 AMTG merger and a Department of Justice request for information concerning AMTG’s former residential real estate portfolio. ARI said it was cooperating with the DOJ. The filing reports no material change to previously disclosed risk factors and states that the company was in compliance with borrowing-agreement financial covenants.
Important facts for investors to verify
- Whether loan credit quality, particularly the Bethesda loan on non-accrual/cost-recovery accounting and the previously impaired Williston, North Dakota loans, changes further.
- The valuation assumptions and potential sensitivity of the $254.5 million Level III CMBS portfolio, given illiquid markets and significant unobservable inputs.
- Repurchase-facility renewal, extension and margin-call terms, as well as the company’s ability to meet near-term maturities and fund $119.8 million of commitments.
- Whether reported Operating Earnings and underwritten returns translate into realized results and support future common and preferred distributions.
- The outcome and potential financial impact of the merger-related litigation and DOJ inquiry; the filing does not provide a clear estimate of possible losses.