Apollo Commercial Real Estate Finance, Inc. — FY2014 Form 10-K
Reporting period: Fiscal year ended December 31, 2014; quarterly results include the three months ended December 31, 2014. Unless noted otherwise, dollar amounts below are in millions. The filing reports financial statements in thousands.
Business context
ARI is an externally managed REIT investing primarily in commercial mortgage loans, subordinate financings and commercial mortgage-backed securities (CMBS). Its stated objective is to generate long-term risk-adjusted returns principally through dividends. At year-end, the portfolio included commercial mortgage loans, subordinate loans and CMBS, alongside an investment in a German bank through a joint venture.
Financial performance and position
| Metric | FY2014 | Comparison or year-end position |
|---|---|---|
| Interest income | $123.3 | Up from $77.5 in 2013 |
| Interest expense | $26.5 | Up from $4.4 in 2013 |
| Net interest income | $96.8 | Up 32.4% from $73.1 in 2013 |
| Net income | $82.7 | Up from $52.5 in 2013 |
| Net income available to common stockholders | $75.3; $1.72 per share | Compared with $45.0; $1.26 per share in 2013 |
| Operating Earnings, non-GAAP | $74.0; $1.69 per share | Compared with $51.4; $1.44 per share in 2013; management presents it as an approximation of cash available for distribution |
| Cash flow from operations | $67.0 | Compared with $46.0 in 2013 |
| Cash and restricted cash | $40.6 and $30.1 | Restricted cash was collateral and unavailable for general corporate purposes |
| Total assets / liabilities / stockholders’ equity | $1,845.1 / $990.1 / $855.1 | At December 31, 2014 |
At year-end, commercial mortgage loans were $458.5, subordinate loans $561.2, and CMBS carried at fair value $539.8. The balance sheet also reported $154.3 of securities held to maturity associated with the Aruba loan securitization and an $89.6 non-recourse participation liability. Management reported a 9.2% weighted-average portfolio yield and 3.2% weighted-average cost of funds in its investment summary.
Repurchase borrowings were $622.2, up from $202.0 a year earlier. The company also issued $254.8 aggregate principal amount of 5.50% convertible notes due 2019; their year-end carrying value was $246.5. Total liabilities also included $89.6 of participations sold. Management stated that existing liquidity and access to additional liquidity were sufficient to meet obligations for at least the following 12 months.
Common dividends remained $0.40 per share quarterly, or $1.60 for 2014. The company declared $7.4 of preferred dividends; its Series A preferred stock carries an 8.625% annual dividend rate on a $25 liquidation preference.
Changes versus prior periods
- Net interest income increased as the company expanded loan and CMBS investments; the increase was partly offset by higher financing costs.
- Interest expense rose substantially, reflecting convertible-note issuance, a higher average repurchase-borrowing balance and a higher reported weighted-average cost of funds.
- Total assets more than doubled from $907.5 million to $1,845.1 million, while common shares outstanding increased from 36.9 million to 46.9 million, following a 9.7-million-share offering that generated approximately $158.4 million net.
- Net income included $4.1 million of unrealized securities gains and a $4.1 million unrealized foreign-currency loss, offset in reported earnings by a $4.1 million derivative gain. The foreign-currency exposure related to a foreign-denominated loan.
- Cash from operations increased, while investing activities used $886.7 million, largely reflecting new loan and securities funding and the joint-venture investment. Financing activities provided $840.2 million, including borrowings and capital issuance.
Outlook, risks and notable matters
- Management saw commercial real estate debt maturities through 2017 as an investment opportunity and expected refinancing and acquisition activity to support lending opportunities in 2015. It expected low interest rates to remain supportive, while noting that these views are not guarantees of results.
- The company reported no loan-loss reserve at December 31, 2014 and said it believed contractual loan payments were likely to be received. Credit deterioration, collateral values, refinancing capacity and borrower performance remain material risks.
- Financing exposure is significant: repurchase arrangements can require additional collateral or repayment after asset-value declines, and some facilities have near-term maturities, covenants and margin-call provisions. The Wells Fargo facility was scheduled to expire in March 2015; subsequent to year-end, ARI amended and expanded its JPMorgan facility and entered a Goldman Sachs repurchase agreement.
- Interest-rate changes can affect asset values, floating-rate income and borrowing costs. At year-end, management estimated that a 50-basis-point LIBOR increase would raise quarterly net interest income by approximately $570, assuming no changes in the company’s financial structure.
- ARI depends on Apollo’s external manager and faces related-party conflicts, management-fee and termination provisions, competition for investments and financing, and risks to REIT qualification and exclusion from Investment Company Act regulation. The independent directors reviewed management performance and fees in February 2015 and elected not to terminate the agreement.
- Unfunded loan commitments were $246.6 million for commercial mortgage loans and $32.5 million for subordinate loans at year-end. The company had no legal proceedings as of December 31, 2014.
- After year-end, the board declared a $0.44 common dividend payable April 15, 2015. The filing also disclosed several 2015 loan investments and the sale of approximately 48% of ARI’s Champ LP interest to an Apollo-managed account at cost.
Deloitte & Touche issued unqualified opinions on the consolidated financial statements and internal control over financial reporting. Management also concluded that disclosure controls were effective.
Investor verification priorities
- Confirm the composition and valuation of CMBS and the Aruba securitization-related asset and participation liability; distinguish carrying value from principal and fair value.
- Assess whether loan yields and investment returns can persist after funding commitments, repayments, extensions and changes in financing costs; underwritten IRRs are assumptions, not realized returns.
- Review repurchase-facility maturities, covenant headroom, collateral haircuts and potential margin calls, including the terms and utilization of facilities amended or added after year-end.
- Reconcile GAAP net income, Operating Earnings and cash available for dividends; Operating Earnings excludes realized and unrealized investment gains or losses and is not a GAAP liquidity measure.
- Evaluate the sustainability of common and preferred dividends against earnings, operating cash flow, REIT distribution requirements and the substantial unfunded loan commitments.
- Review dilution from equity and convertible-note issuance, as well as related-party management fees, expense reimbursements and the manager’s termination provisions.