Business context and reporting period
Apollo Commercial Real Estate Finance, Inc. (ARI) filed this 10-K for the fiscal year ended December 31, 2013. ARI is an externally managed REIT that originates, acquires and manages commercial real estate debt investments. Amounts below are in U.S. dollars; financial statement figures are in thousands unless otherwise noted.
At year-end, the portfolio included $161.1 million of commercial mortgage loans, $497.5 million of subordinate loans and $191.4 million of CMBS. The portfolio’s weighted-average yield was 10.3%, with a 3.3-year remaining weighted-average life. ARI reported $850.3 million of investment face amount and $676.9 million of equity at cost supporting those investments.
Financial performance, cash flow and liquidity
| Metric | 2013 | 2012 |
|---|---|---|
| Interest income | $77.5 million | $57.1 million |
| Net interest income | $73.1 million | $48.7 million |
| Net income | $52.5 million | $40.2 million |
| Net income available to common stockholders | $45.0 million | $37.1 million |
| GAAP diluted earnings per common share | $1.26 | $1.64 |
| Operating Earnings, non-GAAP | $51.4 million; $1.44 per diluted share | $33.9 million; $1.50 per diluted share |
| Net cash from operating activities | $46.0 million | $40.1 million |
| Total assets / stockholders’ equity | $907.5 million / $683.0 million | $788.4 million / $546.9 million |
Net interest income was 50.2% higher year over year, principally from increased commercial mortgage and subordinate loan income and lower borrowing costs. Net income increased 30.6%, while common EPS fell 23.2%, reflecting a substantially larger weighted-average share count following equity issuance and higher preferred dividends. Operating Earnings increased 51.7%, but diluted Operating Earnings per share declined from $1.50 to $1.44. Operating Earnings is a company-defined non-GAAP measure and excludes unrealized gains and losses and equity-based compensation.
Total operating expenses rose 19.7% to $17.6 million; management fees increased 63.1% to $10.0 million, largely reflecting higher stockholders’ equity used in the fee calculation. The filing does not provide a conventional net profit margin percentage.
Cash and cash equivalents were $20.1 million at year-end, down from $108.6 million; an additional $30.1 million was restricted as collateral and was not available for general purposes. Operating cash flow was $46.0 million, investing cash flow was negative $165.8 million, and financing cash flow was positive $31.3 million, producing an $88.5 million decrease in cash.
Repurchase-agreement borrowings totaled $202.0 million, down from $225.2 million, at a 2.4% weighted-average rate and 3.3-year weighted-average remaining maturity (assuming extension options). Year-end balances were $133.9 million under UBS, $47.8 million under Wells Fargo and $20.4 million under JPMorgan. ARI said it had sufficient liquidity and access to liquidity for at least the next 12 months and was in compliance with financing covenants. It also reported $79.6 million of unused JPMorgan capacity, subject to eligible asset availability.
ARI declared common dividends of $1.60 per share for 2013, unchanged from 2012. The 3.45 million Series A preferred shares carry an 8.625% annual dividend rate on a $25 liquidation preference.
Material changes versus the prior comparable period
- Subordinate loans more than doubled, from $246.2 million to $497.5 million; commercial mortgage loans rose to $161.1 million from $142.9 million.
- CMBS declined to $191.4 million from $278.9 million in fair value, while the portfolio mix and financing changed with new CMBS purchases financed through the UBS facility.
- Interest expense fell 48.2%, to $4.4 million, as average borrowings declined and facility pricing was reduced.
- ARI issued 8.805 million common shares in March 2013, generating approximately $148.3 million of net proceeds. Common shares outstanding increased to 36.9 million from 28.0 million.
- Unrealized securities results shifted from a $6.5 million gain in 2012 to a $3.1 million loss in 2013. The filing attributes these changes to fair-value movements; no loan-loss reserve was recorded at either year-end.
Outlook, management commentary, risks and unusual items
Management cited more than $1 trillion of commercial real estate debt maturing through 2017 as an investment opportunity. It expected low interest rates and refinancing activity to support lending in 2014, while noting that commercial property lending and CMBS issuance remained below pre-crisis peaks. These are expectations, not assured outcomes.
Key risks include borrower defaults and collateral-value declines; interest-rate, refinancing and repurchase-facility margin-call exposure; reliance on short-term financing and lender counterparties; illiquid and fair-value-sensitive assets; and the possibility that financing spreads compress. REIT qualification and exclusion from Investment Company Act registration also depend on ongoing compliance with technical requirements.
ARI committed up to approximately $50 million for an investment representing about 21% of KBC Bank Deutschland AG, subject to regulatory approval; closing was not assured. The company also had $29.1 million of unfunded loan commitments at year-end. In February 2014, Wells Fargo extended its facility to March 2015 and reduced the stated spread to LIBOR plus 80 basis points; JPMorgan’s facility was extended for 364 days. ARI declared a further $0.40 common dividend in February 2014 and made a new $80 million mortgage loan commitment, of which $25 million was funded at closing.
The Manager receives a base fee of 1.5% annually of contractually defined stockholders’ equity, regardless of performance; management fees were $10.0 million in 2013. The independent directors reviewed the Manager’s performance and fees in February 2014 and decided not to terminate the agreement. The filing reports no legal proceedings at December 31, 2013 and no loan-loss allowance. Deloitte issued an unqualified audit opinion and concluded internal control over financial reporting was effective. Separately, the filing disclosed Iran-related transactions by CEVA, an Apollo-affiliated company; ARI stated the transactions did not involve ARI, its management or its Manager, and it had not independently verified the disclosure.
Important facts for investors to verify
- Whether loan growth and underwriting returns are translating into sustainable cash earnings and distributions; underwritten IRRs depend on assumptions, including extensions and no defaults.
- How the enlarged subordinate-loan portfolio performs, including borrower repayment, collateral values, unfunded commitments and exposure to development or conversion projects.
- Availability, renewal terms, collateral requirements and covenant headroom under Wells, UBS and JPMorgan facilities, including restricted cash and potential margin calls.
- The drivers of the gap between rising total earnings and declining GAAP and Operating Earnings per share, including share issuance, preferred dividends and management fees.
- Whether the KBCD investment receives approval and closes, and the eventual funding and risk implications.
- Fair-value assumptions for CMBS and the potential sensitivity of earnings and equity to market prices and interest rates.
- REIT and Investment Company Act compliance, and any material developments relating to Apollo-affiliate conflicts or the CEVA Iran-related disclosure.