Apollo Commercial Real Estate Finance, Inc. — Q2 2014 Form 10-Q
Business context and reporting period
For the quarter and six months ended June 30, 2014. Apollo Commercial Real Estate Finance is an externally managed REIT that invests in commercial mortgage loans, subordinate loans, commercial mortgage-backed securities (CMBS) and related real estate debt. Unless otherwise noted, amounts below are in millions of dollars; the filing presents financial statements in thousands.
Financial performance and position
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net interest income | $23.8 | $17.2 | $43.2 | $34.3 |
| Net income | $24.0 | $11.8 | $41.5 | $23.7 |
| Net income available to common stockholders | $22.1 | $9.9 | $37.8 | $20.0 |
| GAAP diluted earnings per common share | $0.51 | $0.27 | $0.94 | $0.59 |
| Operating Earnings per common share (non-GAAP) | $0.42 | $0.31 | $0.80 | $0.70 |
| Common dividend per share declared | $0.40 | $0.40 | $0.80 | $0.80 |
Year-over-year net interest income rose 38.0% for Q2 and 25.9% for the first half, primarily as new mortgage and subordinate loan investments increased interest income; higher financing costs partly offset the increase. Q2 earnings also included a $4.7 million unrealized securities gain, a $1.0 million foreign currency gain and a $1.1 million unrealized derivative loss. Operating Earnings excludes certain unrealized and non-cash items and is not a GAAP measure or a substitute for GAAP net income.
At June 30, total assets were $1.55 billion, versus $907.5 million at December 31, 2013. The portfolio included $343.8 million of commercial mortgage loans, $748.2 million of subordinate loans and $348.0 million of CMBS at estimated fair value. Management reported no required loan-loss allowance. Cash was $63.3 million and restricted cash was $30.1 million. Stockholders’ equity was $850.0 million.
Repurchase borrowings were $446.2 million, up from $202.0 million at year-end; the company also had $139.4 million carrying value of 5.50% convertible notes due 2019 and $89.2 million of participations sold recorded as non-recourse liabilities. Repurchase borrowings had a 2.9% weighted-average rate and 2.7-year weighted-average remaining maturity. The portfolio’s reported weighted-average yield was 9.6%, against a 2.9% cost of funds; these are portfolio statistics, not a reported net interest margin.
First-half operating cash flow was $27.1 million, compared with $23.2 million a year earlier. Investing activities used $579.9 million, principally for new investments; financing activities provided $596.0 million, including equity and debt proceeds. Cash increased $43.2 million to $63.3 million. In Q2, the company raised approximately $158.4 million net from a follow-on offering of 9.706 million common shares.
Material changes versus the prior comparable period
- Net interest income and common earnings increased, supported by portfolio expansion. Interest income from commercial mortgage and subordinate loans rose substantially, while interest expense increased as borrowings and the weighted-average cost of funds grew.
- Investments expanded with new originations and CMBS purchases. First-half funding included $181.6 million of commercial mortgage loans, $318.9 million of subordinate loans and $174.0 million of securities.
- The company issued $143.75 million principal amount of 5.50% convertible notes due 2019 and entered into a new Deutsche Bank CMBS repurchase facility. It also syndicated a $90 million senior participation in its Aruba hotel loan.
- Common shares outstanding increased to 46.85 million from 36.89 million at year-end, largely reflecting the follow-on offering and equity-award activity.
Outlook, commentary, risks and contingencies
- Management stated it believed liquidity and access to additional liquidity were sufficient for obligations over at least the next 12 months. At quarter-end, it reported $28.3 million of available JPMorgan borrowing capacity and $61.1 million of DB capacity, subject to collateral and facility terms.
- Management cited commercial real estate debt maturities through 2017 and ongoing refinancing and lending activity as investment opportunities. The company expects loan borrowings to be approximately 35% of the value of its total loan portfolio; this is a policy expectation, not a guarantee.
- The JPMorgan facility’s minimum-liquidity covenant was temporarily waived during the quarter and its borrowing limit was temporarily increased. The June 12 amendment reset the facility limit to $175 million, set a minimum-liquidity requirement of the greater of 5% of recourse debt or $15 million, and extended the facility to January 2015. The company reported compliance with its repurchase-agreement financial covenants at June 30.
- Unfunded loan commitments were $100.1 million. A separate commitment of up to approximately $50 million for an investment connected with KBC Bank Deutschland remained subject to regulatory approval, with no assurance it would close.
- Key risks include borrower and collateral credit performance, property-value declines, interest-rate and funding-cost changes, CMBS fair-value volatility, liquidity and refinancing needs, and reliance on repurchase financing. A 50-basis-point LIBOR increase was estimated to increase net interest income on reported net variable-rate exposure by $267,000, assuming no structural changes.
- The company declared a $0.40 common dividend for payment in October 2014. Dividends remain subject to board discretion, operating results and liquidity. Management reported no material legal proceedings, no material change in previously disclosed risk factors, and effective disclosure controls.
Important facts for investors to verify
- Whether new investments earn their underwritten returns: the filing cautions that actual IRRs may differ and depend on assumptions including no defaults and certain extensions.
- Liquidity, collateral values, margin-call exposure, covenant compliance and refinancing plans for facilities, particularly the JPMorgan facility maturing in January 2015.
- Repayment and funding progress on the $100.1 million of unfunded loan commitments and status of the KBC-related investment commitment.
- Credit quality and concentration in the loan and CMBS portfolios, including the absence of a loan-loss allowance and the valuation assumptions for fair-value assets.
- Coverage and sustainability of common and preferred dividends, considering distributions, funding costs and the company’s REIT distribution requirements.