Apollo Commercial Real Estate Finance, Inc. — Q3 2011 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2011. The company is an externally managed REIT investing in commercial real estate debt, including CMBS, first mortgages, subordinate loans and other real estate-related investments. Unless stated otherwise, dollar amounts below are in millions.
Financial performance and position
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net interest income | $10.236 | $5.501 | $27.518 | $14.459 |
| Operating expenses | $2.538 | $2.121 | $7.519 | $6.377 |
| Net income | $5.512 | $2.356 | $17.212 | $7.033 |
| Basic and diluted earnings per share | $0.28 | $0.21 | $0.93 | $0.64 |
| Comprehensive income | $3.157 | $5.875 | $11.340 | $15.990 |
- Q3 net interest income increased 86.1% year over year; nine-month net interest income rose 90.3%. Management attributed the growth primarily to investment of capital from the IPO and follow-on offerings.
- Q3 net income included $1.511 million of unrealized securities losses and $0.677 million of derivative losses. For the nine months, derivative losses were $2.679 million; unrealized securities losses were $0.118 million.
- Cash from operating activities was $24.545 million for the nine months, versus $11.301 million a year earlier. Investing activities used $55.434 million and financing activities provided $37.445 million. Cash increased $6.556 million to $44.450 million.
- At September 30, total assets were $910.611 million, total liabilities $574.566 million and stockholders’ equity $336.045 million. Cash was $44.450 million; CMBS securities totaled $574.584 million at fair value, and commercial and subordinate loans were $109.192 million and $123.960 million, respectively.
- Total borrowings were $560.906 million: $264.101 million of TALF debt and $296.805 million under repurchase agreements. Weighted-average borrowing cost was 2.3%, and weighted-average remaining maturity was 1.6 years. The filing’s debt-maturity schedule places $337.309 million due in under one year, assuming facility extensions.
- The company declared dividends of $0.40 per share for each of the first three 2011 quarterly distributions. A further $0.40 dividend was declared November 3, payable January 12, 2012.
Changes versus prior comparable periods
- Net income and earnings per share improved year over year, alongside higher income from securities, subordinate loans and a newly funded repurchase-facility investment. Interest expense also increased, by 26.8% in Q3 and 48.6% for the nine months.
- Operating expenses rose 19.7% in Q3 and 17.9% for the nine months, mainly due to higher related-party management fees. Nine-month management fees increased 54.5% to $3.430 million.
- Subordinate loans grew to $123.960 million from $58.985 million at year-end 2010, including a $40 million California ski-resort loan and a $25 million New York hotel mezzanine loan. The $47.439 million repurchase-facility investment was also new in 2011.
- CMBS fair value declined to $574.584 million from $642.784 million at year-end 2010. Available-for-sale securities’ accumulated other comprehensive income fell to $0.487 million from $6.359 million, contributing to lower comprehensive income despite higher net income.
- In July, the company issued 3 million shares for $49.980 million gross proceeds ($48.980 million before offering expenses), increasing shares outstanding to 20,561,032 at September 30. It paid the $10 million deferred underwriting fee during Q3 after meeting the contractual earnings hurdle.
Outlook, risks and notable items
- Management said commercial real estate lending remained unsettled: market volatility in July and August widened CMBS spreads and slowed new loan originations. It cited more than $1 trillion of commercial real estate debt scheduled to mature from 2012 through 2015 as a potential investment opportunity, while noting that loan extensions temper refinancing demand.
- Management believed available liquidity and financing access were sufficient for at least 12 months. The company reported $30.986 million of unused capacity under its JPMorgan facility, subject to acquiring eligible assets. Its stated leverage strategy targets borrowings of approximately 35% of the value of its total loan portfolio.
- Key risks include collateral credit and real estate values, CMBS valuation and liquidity, interest-rate mismatches, prepayments, financing renewals and margin calls. The Wells and JPMorgan facilities include financial covenants; the Wells facility also has a limited guarantee of up to $37.5 million. The filing states the company was in compliance with repurchase-agreement covenants.
- Floating-rate debt exposure remained despite swaps and caps. The filing estimates a 50-basis-point LIBOR increase would raise quarterly interest expense by $68,000 on the stated net variable-rate debt exposure; the calculation assumes no changes in financial structure.
- CMBS and derivatives were valued using Level 2 inputs, including dealer quotes and observable market data. Management said available-for-sale unrealized losses were principally market-related, had been present for less than 12 months, and were not considered other-than-temporary; no loan-loss allowance was recorded.
- Subsequent to quarter-end, the company closed a $25 million preferred-equity investment in a Virginia retail center, bearing 14% interest (10% current pay and 4% accrued). The reported underwritten IRR was approximately 15%; actual returns are not assured.
- The REIT distribution requirement limits retained earnings. The manager receives a base fee of 1.5% per annum of defined stockholders’ equity, and the company reimburses certain manager expenses. Management identified no material risk-factor changes, no legal proceedings at quarter-end, and no material control changes; disclosure controls were deemed effective.
Important facts for investors to verify
- Debt maturities, extension options, covenant headroom, collateral requirements and potential margin calls, particularly around the JPMorgan facility’s January 2012 maturity.
- CMBS fair values, market liquidity and the sensitivity of reported earnings and equity to further spread widening or valuation changes.
- Performance and credit quality of the expanded subordinate-loan portfolio and the CDO bond exposure underlying the $47.439 million repurchase-facility investment; that bond’s rating had fallen from AAA/Aaa originally to A-/Baa1.
- Whether portfolio income and liquidity support continuing $0.40-per-share quarterly dividends, considering debt service, REIT distribution requirements and future investment needs.
- Growth in related-party fees and reimbursements, the terms of the July share issuance and related registration rights, and the potential effect of outstanding equity awards.