Apollo Commercial Real Estate Finance, Inc. (ARI) — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020. ARI is an externally managed REIT focused on commercial real estate debt investments. Results reflect significant disruption and uncertainty from the COVID-19 pandemic.
Financial position and performance
- Portfolio and assets: Loan portfolio carrying value was $6.39 billion, versus $6.38 billion at December 31, 2019; total assets were $6.97 billion and stockholders’ equity was $2.37 billion. About 95% of loans were floating-rate. Hotels represented 24.1% and offices 27.4% of portfolio carrying value; New York City represented 36.7%.
- Q2 earnings: Net interest income was $70.8 million, down from $85.0 million a year earlier. GAAP net income was $60.2 million, or $0.36 per diluted share, compared with $61.4 million, or $0.37, in Q2 2019. The quarter included a $25.2 million reversal of loan-loss provisions and $16.4 million of realized investment losses.
- First-half results: Net interest income was $145.4 million, down from $167.8 million. GAAP net loss was $67.6 million, or $0.50 per share, versus net income of $129.2 million, or $0.80 per diluted share, in the first half of 2019. The 2020 loss chiefly reflected $158.3 million of loan-loss provisions, including specific CECL allowances.
- Cash flow: Six-month operating cash flow was $53.5 million, down from $109.9 million. Investing activities used $208.9 million, while financing activities provided $190.4 million. Cash rose to $487.2 million from $452.3 million at year-end.
- Debt and liquidity: Secured debt borrowings were $3.44 billion; the senior secured term loan had $495 million principal outstanding, and convertible notes had $575 million aggregate principal. Management reported $1.1 billion of corporate debt and $3.4 billion of asset-specific financing, $31.4 million of approved undrawn capacity, and $1.1 billion of unencumbered loan assets. Debt-to-equity was 1.7, up from 1.4 at year-end. Management said liquidity and access to additional liquidity were sufficient for obligations for at least 12 months.
- Book value and distributions: Book value per common share was $14.81, down from $16.03 at year-end. The Q2 common dividend declared was $0.35 per share, versus $0.46 a year earlier; first-half dividends were $0.75 versus $0.92.
Material changes and unusual items
- ARI adopted the CECL expected-credit-loss standard on January 1, 2020, recording a $30.9 million opening adjustment to retained earnings. At June 30, total CECL allowances were $246.1 million, including $197.5 million of specific allowances, $44.5 million of general funded-loan allowances, and $4.1 million for unfunded commitments. The general allowance increased $17.8 million from adoption through June, despite a Q2 reversal.
- Loans on cost-recovery or non-accrual status totaled $583.8 million at June 30, versus $199.1 million a year earlier. Six loans, totaling $390.1 million of amortized cost, were rated risk 5, or 6.1% of the portfolio; the weighted-average risk rating increased to 3.1 from 3.0 at year-end.
- Q2 net interest income fell amid lower LIBOR, more loans on cost recovery or non-accrual, higher net debt, and cash balances earning relatively little. Subordinate-loan interest income was $32.6 million, down from $41.0 million.
- ARI terminated its interest-rate swap and recorded a $53.9 million realized loss, then entered a three-year interest-rate cap intended to limit LIBOR to 0.75% on the term loan. Foreign-exchange and interest-rate derivative fair-value changes also affected reported earnings.
- In June, ARI completed a $782 million Barclays private securitization, refinancing loans previously financed under Barclays facilities. The transaction eliminates daily margining and allows certain loan-term modifications; it includes loan-to-value covenants with a six-month holiday through December 2020. ARI paid down $18.5 million of prior financing and accepted a 0.25 percentage-point spread increase.
- ARI repurchased 5.80 million common shares during the first half at a weighted-average $7.96 per share. It also sold construction-loan interests to entities managed by Manager affiliates, recognizing losses and providing limited, conditional loss indemnities.
Outlook, risks and contingencies
- Management provided no quantified earnings or portfolio guidance. It said the ultimate effects of COVID-19 could not be estimated and may materially affect borrowers, property values, cash flows, operations, and financial results.
- Key risks include hotel and other property-sector stress; borrower payment deferrals or defaults; reduced collateral values and lender margin calls; refinancing and financing availability; and substantial unfunded loan commitments of approximately $1.46 billion. The company’s secured facilities include mark-to-market provisions, though the new Barclays securitization has different protections and covenants.
- One New York City hotel loan was restructured as a troubled debt restructuring: the borrower contributed $15 million of equity and ARI wrote down $15 million of principal previously covered by a specific allowance. The loan remained on accrual status and was rated risk 3 at quarter-end.
- A lawsuit alleging up to $700 million in damages was dismissed in 2019; plaintiffs appealed, and ARI said it planned to defend the case and did not expect a material adverse financial effect.
- Management reported compliance with financing covenants at June 30, 2020. The filing also notes that the management agreement automatically renews annually absent specified termination action and provides for a termination fee under certain circumstances.
Important facts for investors to verify
- Whether borrower performance, delinquencies, restructurings, and collateral valuations—especially in hotel, office, and New York City exposures—support the CECL allowances and risk ratings.
- Whether cash, available financing, and unencumbered assets remain adequate for margin calls, debt maturities, and the timing of unfunded commitments.
- How the Barclays securitization performs under its covenants, and whether other secured lenders change advance rates, pricing, or collateral requirements.
- Whether recurring net interest income and cash earnings can support the common dividend; note that reported GAAP earnings were materially affected by credit allowances and derivative-related items.
- Potential related-party implications of loan sales to Manager affiliates, associated indemnities, and the management agreement’s fees and renewal terms.