Apollo Commercial Real Estate Finance, Inc. — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016. ARI is an externally managed REIT that originates and invests in commercial mortgage loans, subordinate financings, CMBS and related debt. Unless otherwise stated, financial amounts below are in thousands of dollars.
Financial performance and position
| Metric | Q1 2016 / March 31, 2016 | Comparable period / prior year-end |
|---|---|---|
| Net interest income | $46,805 | $28,554 in Q1 2015; up 63.9% |
| Net income | $18,616 | $25,513 in Q1 2015 |
| Net income available to common stockholders | $12,801; $0.18 per diluted share | $23,653; $0.47 per diluted share |
| Operating Earnings, non-GAAP | $29,819; $0.44 per share | $22,222; $0.44 per share |
| Common dividend declared | $0.46 per share | $0.44 per share in Q1 2015 |
| Total assets | $2,856,496 | $2,712,590 at Dec. 31, 2015 |
| Stockholders’ equity | $1,357,050 | $1,375,424 at Dec. 31, 2015 |
| Cash and restricted cash | $23,035 cash; $55,781 restricted | $67,415 cash; $30,127 restricted at Dec. 31, 2015 |
| Repurchase-agreement borrowings | $1,091,316 gross facility balances; $1,083,665 carrying value net of financing costs | $925,774 gross at Dec. 31, 2015 |
Interest income increased substantially as loan investments expanded; interest expense also rose 27.5% with higher average borrowings, partly offset by a lower weighted-average cost of funds (2.9% versus 3.1% at March 31, 2015). The investment schedule reports a 9.1% weighted-average yield and 2.9% cost of funds. A conventional operating margin is not presented and is not particularly informative for this lending-focused REIT.
GAAP common earnings fell despite higher net interest income, chiefly amid a $15,074 unrealized loss on fair-value-option securities, $4,474 foreign-currency loss, increased operating expenses and higher preferred dividends. Q1 2016 operating expenses were $13,414, including $5,073 of merger-related costs; Q1 2015 expenses were $5,696. Operating Earnings, a company-defined non-GAAP measure that excludes certain valuation and other items, was $0.44 per share in both periods and should not be treated as GAAP earnings or a liquidity measure.
Cash provided by operating activities was $13,598, compared with $17,411 in Q1 2015. Investing activities used $183,097 and financing activities provided $125,119, resulting in a $44,380 decrease in cash during the quarter. Total liabilities were $1,499,446, including $248,617 of convertible notes and $116,952 of participations sold, in addition to repurchase financing. The company reported covenant compliance and $79,699 of available borrowing capacity under the JPMorgan facility. Management said it believed liquidity and access to additional liquidity were sufficient for at least 12 months.
Portfolio changes and comparison
- Commercial mortgage loans held for investment rose to $1,173,185 from $994,301 at year-end; subordinate loans were $930,401 versus $931,351. First-quarter originations included a $177.5 million funded portion of a Miami redevelopment loan, a $21.9 million initial funding of a $77 million mezzanine loan, and a $28.5 million initial funding of a Boston loan.
- CMBS at estimated fair value declined to $472,464 from $493,149. The reported unrealized loss on securities was $15,074, versus a $3,409 unrealized gain in Q1 2015.
- Repurchase borrowings rose by about $165.5 million from year-end. Gross facility balances had a 2.9% weighted-average rate and 2.5-year weighted-average remaining maturity at quarter-end.
- Common weighted-average shares increased to 67.4 million from 49.6 million, while preferred dividends rose to $5,815 from $1,860, contributing to lower GAAP earnings per common share.
Outlook, material events and risks
- Merger: On February 26, 2016, ARI agreed to acquire Apollo Residential Mortgage, Inc. for 89.25% of AMTG book value at a future pricing date, plus assumption of $172.5 million of AMTG preferred stock. Common consideration includes up to 13.4 million ARI shares valued at $16.75 per share, with the remainder in cash. Closing remained subject to customary conditions and AMTG shareholder approval; the actual purchase price was not yet fixed.
- Merger financing and related-party arrangements: Athene committed up to $200 million in bridge financing; ARI also agreed to sell Athene up to approximately $1.2 billion of primarily non-Agency residential mortgage-backed securities after closing, subject to the agreement’s terms. Athene separately committed to potential open-market purchases of up to $20 million of ARI common stock under specified price conditions. ARI agreed to pay its Manager up to $500 for merger-related services.
- Litigation: Two putative class actions challenged the proposed merger, alleging fiduciary-duty breaches and inadequate consideration/process, among other claims. Plaintiffs sought injunctive relief and unspecified damages. Defendants said they believed the claims lacked merit and intended to defend them.
- Management outlook: Management described commercial real estate lending and refinancing demand as supportive of investment opportunities, while noting first-quarter fixed-income volatility, subdued 2016 CMBS issuance and uncertainty ahead of December 2016 risk-retention requirements. It expected the low-rate environment to remain attractive to borrowers. No quantified earnings or dividend guidance was provided.
- Key exposures: Credit and property-value deterioration, refinancing and prepayment outcomes, market valuation and liquidity of CMBS, foreign-currency movements, interest-rate mismatches, reliance on repurchase financing and margin calls, and merger execution, litigation and integration risks. A 50-basis-point LIBOR increase was estimated to raise quarterly net interest income by approximately $1,485 on the stated net variable-rate exposure, assuming no change in financial structure.
- Unfunded commitments at March 31 totaled $108,883 for commercial mortgage loans and $99,850 for subordinate loans. The filing reported no loan-loss allowance was needed at quarter-end. Disclosure controls were assessed as effective, with no material change in internal control over financial reporting reported.
Important facts for investors to verify
- Track merger approval, final AMTG book value and consideration, Athene financing and asset-sale terms, and any litigation developments.
- Reconcile the MD&A statement that stockholders’ equity increased from $855,069 at Dec. 31, 2015 to $1,357,050 at March 31, 2016: the balance sheet instead reports $1,375,424 at Dec. 31, 2015 and $1,357,050 at March 31, 2016.
- Assess the quality and valuation sensitivity of CMBS, the effect of the $15.1 million quarterly unrealized loss, and any later changes in collateral or market liquidity.
- Monitor repurchase-facility capacity, collateral and margin-call terms, maturity concentrations, and the ability to fund approximately $208.7 million of loan commitments while maintaining distributions.
- Compare GAAP earnings and cash generation with the $0.46 common dividend and the company’s non-GAAP Operating Earnings, noting that Operating Earnings excludes realized and unrealized investment gains or losses.