Apollo Commercial Real Estate Finance, Inc. — Q3 2019 Form 10-Q
Business context and reporting period. ARI is an externally managed REIT that originates, acquires and manages commercial real estate loans and related debt investments. This unaudited report covers the quarter and nine months ended September 30, 2019; the company reports one segment.
Key financial results
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net interest income | $85.2 million | $77.5 million | $253.0 million | $211.5 million |
| Net income | $29.1 million | $62.2 million | $158.3 million | $167.0 million |
| Net income available to common stockholders | $25.7 million | $55.4 million | $143.1 million | $146.5 million |
| GAAP diluted EPS | $0.16 | $0.40 | $0.97 | $1.14 |
| Operating Earnings per diluted share (non-GAAP) | $0.47 | $0.45 | $1.35 | $1.31 |
| Common dividend declared per share | $0.46 | $0.46 | $1.38 | $1.38 |
Balance sheet and liquidity at September 30, 2019: Total assets were $6.35 billion, including $6.11 billion of net loan investments and $160.9 million of cash. Total liabilities were $3.72 billion and stockholders’ equity was $2.63 billion. Secured debt arrangements were $2.54 billion net, the senior secured term loan was $488.9 million net, and convertible notes were $560.6 million net. Debt-to-equity, as defined by the company after subtracting cash and loan proceeds held by the servicer, was 1.3x, up from 0.9x at December 31, 2018. Management said it believed liquidity and access to additional liquidity were sufficient for at least the next 12 months.
Cash flow and portfolio: Nine-month operating cash flow was $188.3 million, versus $221.1 million in 2018; investing cash outflow was $1.23 billion, versus $907.4 million. Financing provided $1.09 billion, and cash increased by $51.1 million to $160.9 million. The loan portfolio comprised 74 loans, with $6.19 billion principal balance, $1.07 billion of unfunded commitments, a 7.5% weighted-average cash coupon and a 3.1-year weighted-average remaining term. 94% of loans, by amortized cost, were floating rate. The portfolio’s weighted-average all-in yield was 8.2%; commercial mortgage loans yielded 6.8% and subordinate loans 13.2%.
Material changes versus comparable periods
- Net interest income increased $7.7 million in Q3 and $41.6 million for the nine-month period, primarily reflecting portfolio growth and, for the year-to-date period, higher average LIBOR; higher financing costs partly offset the gains.
- Q3 net income available to common shareholders fell by $29.7 million year over year. The quarter included a $35.0 million loan-loss provision, a $19.1 million foreign currency loss and a $10.3 million unrealized interest-rate-swap loss. Q3 2018 had no loan-loss provision and included a smaller foreign currency loss and no swap loss.
- Year-to-date net income declined $8.7 million. The period included $20.0 million of net provisions, a $12.5 million realized investment loss and $23.4 million of unrealized swap losses; 2018 included $5.0 million of provisions and no swap loss.
- Loan investments increased to $6.11 billion from $4.93 billion at year-end 2018. Gross secured borrowings rose to $2.56 billion from $1.90 billion; ARI also issued $500 million of senior secured term debt in May and raised $314.8 million net through a common-stock offering.
- Book value per common share was $16.02, down from $16.20 at year-end 2018. The company redeemed all Series C preferred shares in June 2019; Series B preferred shares remained outstanding.
Outlook, risks and unusual items
- Management commentary: ARI cited commercial real estate debt maturities and uncertainty around property values and pricing as potential sources of attractive risk-adjusted investment opportunities. It expected continued opportunities in first-mortgage and subordinate lending. No quantified earnings or dividend guidance was provided.
- Credit: The Cincinnati retail-center loan received an additional $32 million provision in Q3, bringing its cumulative provision to $47 million; it was placed on cost-recovery accounting effective September 30. A Bethesda condominium loan received a further $3 million provision. The filing reports $57 million of aggregate loan-loss provisions at quarter-end, plus impairment recorded against an asset. Two loans, totaling $141.8 million carrying value, had the lowest internal risk rating (rating 5); the portfolio weighted-average rating was 3.0.
- Funding and rate exposure: $1.07 billion of loan commitments remained unfunded. Repurchase facilities are subject to margin calls; several facilities had near-term contractual maturities, including HSBC GBP in December 2019 and Credit Suisse facilities callable on notice. The company reported covenant compliance at quarter-end. Its sensitivity analysis estimated that an immediate 50-basis-point rate increase would raise next-12-month net interest income by $12.8 million, while a 50-basis-point decrease would reduce it by $6.8 million, subject to stated assumptions.
- Foreign exchange and hedging: Foreign currency forwards economically hedge foreign-currency loan cash flows, but derivative fair-value movements are recorded in earnings. Q3 reported a $24.2 million gain on forwards against a $19.1 million foreign currency loss; the new interest-rate swap generated a $23.4 million year-to-date unrealized loss.
- Commitments, legal matter and subsequent activity: Unfunded loan commitments totaled $1.07 billion. A lawsuit alleging damages of up to $700 million was dismissed on October 23, 2019, subject to appeal; management said it did not expect a material adverse financial effect. After quarter-end, ARI committed $548.3 million to first-mortgage loans, of which $464.3 million was funded at closing, funded $26.7 million on prior commitments and received $60.2 million of repayments.
- Accounting and distributions: ARI expected adoption of the expected-credit-loss standard in 2020 to result in higher loan-loss provisions. As a REIT, it must generally distribute at least 90% of taxable income; the board retains discretion over dividends. The management agreement with Apollo’s affiliate carries a 1.5% annual fee based on defined stockholders’ equity and was renewed through September 2020.
Most important facts for investors to verify
- Whether the Cincinnati retail loan’s collateral value, recovery prospects and cost-recovery treatment support the $126.1 million carrying value, and whether additional provisions are needed.
- How the $1.07 billion in unfunded commitments, facility maturities and potential margin calls affect liquidity and leverage as loans are funded or repaid.
- Whether Operating Earnings growth is sustainable: this non-GAAP measure excludes provisions and certain unrealized items, while GAAP diluted EPS fell materially in Q3.
- The effect of floating-rate exposure, LIBOR floors, financing costs and derivative fair-value volatility on earnings, book value and dividend coverage.
- Portfolio concentration and credit developments, including the 37.4% exposure to Manhattan and the 25.8% hotel concentration; also monitor any appeal of the dismissed lawsuit.
- Confirm subsequent investment funding and repayments, dividend declarations, and any reported changes in credit ratings, covenants or liquidity.