Apollo Commercial Real Estate Finance, Inc. — 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018; the filing also reports fourth-quarter results. The company is an externally managed mortgage REIT that originates and invests primarily in commercial mortgage loans and subordinate real estate debt.
Financial and portfolio summary
| Metric | 2018 | 2017 |
|---|---|---|
| Interest income | $403.9 million | $338.5 million |
| Interest expense | $114.6 million | $78.1 million |
| Net interest income | $289.3 million | $260.5 million |
| Net income | $220.0 million | $193.0 million |
| Net income available to common stockholders | $192.6 million | $156.3 million |
| GAAP diluted earnings per common share | $1.48 | $1.54 |
| Operating Earnings, non-GAAP, per share | $1.78 | $1.46 |
| Operating cash flow | $266.0 million | $154.9 million |
| Cash and cash equivalents at year-end | $109.8 million | $77.7 million |
At year-end, total assets were $5.10 billion, total liabilities $2.59 billion and stockholders’ equity $2.51 billion. The loan portfolio totaled $4.93 billion: $3.88 billion in commercial mortgage loans and $1.05 billion in subordinate loans. Weighted-average coupon was 8.4% and weighted-average all-in yield was 9.3%; secured debt cost was 4.3%. These portfolio measures are not a consolidated net interest margin.
Secured borrowings were $1.90 billion gross, with $17.6 million of deferred financing costs deducted on the balance sheet. Convertible notes had $609.5 million aggregate principal outstanding. The reported debt-to-common-equity ratio was 1.1x, up from 0.9x. The company reported $109.8 million of cash and approximately $1.10 billion of unfunded loan commitments. Management said it believed liquidity and access to additional liquidity were sufficient for obligations over at least the next 12 months; facility capacity is subject to collateral, covenant and other terms.
Common dividends declared were $1.84 per share for the year. Series B and Series C preferred dividends were $2.00 per share each. The company noted that $0.46 of the January 2019 common distribution was treated as a 2019 distribution for federal tax purposes.
Material changes versus the prior period
- Net interest income rose $28.8 million, primarily reflecting portfolio growth and higher average LIBOR, partly offset by increased interest expense. The loan portfolio grew from $3.68 billion to $4.93 billion.
- Common net income increased, but GAAP diluted EPS declined from $1.54 to $1.48. The 2018 diluted-share calculation included potential conversion shares after the company changed its settlement intent for convertible notes.
- The company recorded $20.0 million of loan-loss provisions and impairments, versus $5.0 million in 2017. This included a $15.0 million fourth-quarter provision on a Cincinnati retail-center loan; that loan had been modified as a troubled debt restructuring. Three loans totaling $215.6 million, or 4% of the portfolio, were rated risk category 5 at year-end.
- Foreign-currency loss was $30.3 million, while derivative instruments generated a $39.1 million gain. The company reported a combined net benefit of $8.7 million from foreign-currency and derivative effects.
- The company issued $230.0 million principal of 5.375% convertible notes due 2023 and received approximately $223.7 million net proceeds. It exchanged or converted $220.3 million principal of 2019 notes, issuing 10.8 million common shares in total across those transactions and paying cash consideration. A $2.6 million early-extinguishment loss was recorded.
- A $275.9 million net common-stock offering and note exchanges increased common shares outstanding. Management fees increased to $36.4 million from $31.7 million, primarily as stockholders’ equity under the management agreement increased.
Fourth-quarter net interest income was $77.8 million versus $69.2 million in fourth-quarter 2017. Net income was $53.0 million versus $41.3 million, and diluted EPS was $0.34 versus $0.32. Fourth-quarter 2018 included the $15.0 million loan provision.
Outlook, risks, contingencies and unusual items
- Outlook: Management expected to continue originating and acquiring senior mortgage loans, subordinate financings and other real estate debt at attractive risk-adjusted yields. It cited upcoming commercial real estate debt maturities as an investment opportunity. No numerical earnings or dividend guidance was provided.
- Interest-rate exposure: 91% of loans were floating-rate. The filing estimates that an immediate 50-basis-point increase would raise 12-month net interest income by $13.1 million, while a 50-basis-point decrease would reduce it by $12.2 million, before any management response or broader economic effects. LIBOR transition, rate floors and asset-liability mismatches remain risks.
- Credit and concentration: Manhattan represented 33.9% of the portfolio; the United Kingdom represented 14.2%. Residential-for-sale inventory and construction together represented 22.4%. Borrower performance, collateral values, refinancing and property-market conditions could affect collections and recoveries.
- Liquidity and leverage: $1.10 billion of unfunded loan commitments and secured facilities with margin-call provisions create funding and collateral demands. Near-term facility maturities and refinancing access are important, particularly if asset values or financing markets weaken.
- Non-cash income: Payment-in-kind interest was $43.5 million in 2018. This interest is recognized as income but is not necessarily received in cash in the same period.
- Legal matter: Plaintiffs in a New York action involving a Manhattan development mezzanine loan allege damages of $700 million, including punitive damages, and identify a $70 million investment loss. The company said it considers the claims without merit and intends to defend them. The filing does not state a quantified probable loss or reserve for this case. A separate Department of Justice inquiry concerning the former residential portfolio ended with notice in May 2018 that no further action was intended as to the company.
- Management and structure: The manager is an Apollo affiliate; the base fee is 1.5% annually of contractually defined stockholders’ equity. Termination without cause is restricted and may trigger a fee equal to three times average annual base management fees. REIT qualification and continued exclusion from Investment Company Act registration are also material conditions and risks.
- Audit and controls: The independent auditor issued unqualified opinions on the financial statements and internal control over financial reporting; management also concluded controls were effective.
Key facts investors should verify
- Review the Cincinnati retail loan’s collateral valuation, modified terms, risk rating and subsequent repayment or performance, along with the Bethesda non-accrual loan status.
- Assess whether operating cash generation supports dividends and the $1.10 billion of unfunded commitments, noting the material PIK-interest component.
- Check current borrowing availability, collateral requirements, margin-call exposure, covenant compliance and refinancing of facilities and the 2019 notes.
- Evaluate GAAP diluted EPS alongside non-GAAP Operating Earnings and its adjustments; the two measures moved differently in 2018.
- Monitor the Manhattan litigation, portfolio concentrations, UK currency exposure, and the company’s ability to maintain REIT and Investment Company Act status.