Apollo Commercial Real Estate Finance, Inc. — Q3 2018 Form 10-Q
Business context and reporting period
ARI is an externally managed REIT that originates, acquires and manages commercial mortgage loans, subordinate financings and other commercial real estate debt. This filing covers the quarter and nine months ended September 30, 2018; balance-sheet comparisons are with December 31, 2017.
Financial and operating highlights
| Metric | Q3 2018 / September 30, 2018 | Comparison |
|---|---|---|
| Net interest income | $77.5 million for Q3; $211.5 million for nine months | Up $6.2 million and $20.2 million, respectively, year over year |
| Net income | $62.2 million for Q3; $167.0 million for nine months | Q3 down from $68.4 million; nine months up from $151.7 million |
| Net income available to common shareholders | $55.4 million for Q3; $146.5 million for nine months | Q3 down from $57.2 million; nine months up from $121.9 million |
| GAAP diluted EPS | $0.40 for Q3; $1.14 for nine months | Down from $0.54 and $1.23, respectively |
| Operating Earnings, non-GAAP | $58.3 million ($0.45/share) for Q3; $161.0 million ($1.31/share) for nine months | Compared with $49.8 million ($0.47/share) and $133.0 million ($1.34/share) |
| Loan portfolio | $4.83 billion carrying value; 68 loans; 90% floating-rate | Up from $3.68 billion and 59 loans at year-end 2017 |
| Cash and total assets | $99.2 million cash; $4.97 billion total assets | Cash up from $77.7 million; assets up from $4.09 billion |
| Debt and leverage | $2.01 billion secured borrowings outstanding and $370.2 million carrying value of convertible notes; debt-to-common-equity ratio 1.0x | Secured debt was $1.35 billion and the ratio 0.9x at year-end 2017 |
| Cash flow, nine months | $221.1 million operating cash flow; $907.4 million investing outflow; $707.8 million financing inflow | Cash increased $21.5 million to $99.2 million |
Portfolio weighted-average cash coupon was 8.2%; weighted-average all-in yield was 9.2%, against a 4.2% cost of secured funds. These are portfolio measures, not a reported net interest margin. The common dividend was $0.46 per share in each 2018 quarter, or $1.38 for the nine months.
Material changes versus the comparable period
- Net interest income grew as the loan portfolio expanded and LIBOR rose; higher interest expense and larger net debt partly offset the benefit.
- Commercial mortgage interest income rose, while subordinate-loan interest income fell; the company no longer held CMBS, which had contributed interest income and unrealized gains in 2017.
- GAAP diluted EPS fell despite higher nine-month net income. In Q3, ARI stopped asserting intent to settle convertible-note principal entirely in cash, so potential conversion shares entered diluted EPS calculations.
- ARI issued 15.5 million common shares in a follow-on offering, raising approximately $275.9 million net, and exchanged or converted $218.8 million principal of 2019 notes for shares and cash. Common shares outstanding rose to 133.8 million from 107.1 million at year-end.
- Secured borrowings increased, and the company added Credit Suisse and HSBC financing facilities. It also reported a $2.6 million loss on early extinguishment of debt.
Outlook, risks and unusual items
- Management cited commercial real estate debt maturities and uncertainty around property values and pricing as potential sources of attractive risk-adjusted lending opportunities. It gave no specific earnings or dividend guidance and said it expects to continue regular quarterly distributions, subject to board approval and results.
- Management believed available liquidity and access to additional funding were sufficient for obligations over at least the next 12 months. Unfunded loan commitments were $884.2 million. The company expects leverage, depending on portfolio composition, to remain below 2.0x debt-to-common equity.
- A hypothetical immediate 50-basis-point benchmark-rate increase was estimated to add $11.9 million, or $0.09 per share, to net interest income over the following 12 months; the analysis assumes no changes in financial structure and excludes broader economic effects.
- Credit exposure includes two risk-rating-5 loans, representing 1% of portfolio carrying value, and one rating-4 loan, representing 4%. The filing reports a $5.0 million loan-loss provision for the first nine months of 2018. A $169.0 million loan modification was treated as a troubled debt restructuring after its spread was reduced from 5.5% to 3.0% over LIBOR.
- ARI faces a lawsuit concerning a Manhattan development loan. Plaintiffs allege damages of $700 million, including punitive damages; ARI disputes the claims and is defending the case. The Department of Justice advised in May 2018 that it would take no further action concerning the former residential portfolio.
- After quarter-end, ARI committed $387.0 million of first mortgage loans, received about $180.9 million in repayments, and issued $230.0 million of 5.375% convertible notes due 2023, generating approximately $223.7 million net.
- ARI expects adoption of the new expected-credit-loss accounting standard to result in higher provisions for potential loan losses. Its REIT status also requires distribution of at least 90% of taxable income, limiting retained capital.
Most important facts for investors to verify
- Whether loan growth, portfolio yields and funding costs sustain net interest income, and how rising rates affect asset and liability cash flows.
- Credit performance of the rating-4 and rating-5 loans, the restructured loan, and the adequacy of reserves and collateral valuations.
- Capacity to fund $884.2 million of loan commitments while managing secured-facility maturities, margin-call provisions and the increased leverage ratio.
- How convertible-note dilution affects per-share earnings and whether dividends remain supported by taxable income and liquidity.
- Developments in the Manhattan litigation and execution and funding of post-quarter loan commitments.