Apollo Commercial Real Estate Finance, Inc. — 2020 Form 10-K
Reporting period: Fiscal year ended December 31, 2020. Amounts below are in U.S. dollars; financial amounts are rounded to millions unless otherwise stated.
Business context
ARI is an externally managed REIT that originates, acquires and manages commercial real estate loans and related debt investments. At year-end, its loan portfolio had $6.50 billion of carrying value: $5.45 billion of commercial mortgage loans and $1.05 billion of subordinate loans and other lending assets. Apollo managed ARI through an affiliate.
Financial and operating results
| Metric | 2020 | 2019 |
|---|---|---|
| Interest income | $427.6 million | $487.4 million |
| Net interest income | $278.7 million | $334.5 million |
| Net income | $18.4 million | $230.2 million |
| Net income available to common stockholders | $4.8 million; $0.01 per diluted share | $211.6 million; $1.40 per diluted share |
| Cash provided by operating activities | $164.1 million | $273.4 million |
| Dividends declared per common share | $1.45 | $1.84 |
| Period-end total assets | $6.94 billion | $6.89 billion |
| Period-end stockholders’ equity | $2.27 billion | $2.63 billion |
Net interest income fell 17% year over year. Management attributed the decline mainly to lower LIBOR, a larger balance of loans on cost-recovery or non-accrual status, and increased average debt balances. The portfolio’s weighted-average coupon was 5.7%, all-in yield 6.3%, and secured financing cost 2.2% at year-end. The portfolio was 95% floating rate.
Net income included $125.6 million of loan-loss provisions and impairments, $47.6 million of realized investment losses, and a $39.2 million loss on interest-rate hedging instruments. Distributable Earnings, a non-GAAP measure, were $125.6 million, or $0.84 per share, compared with $268.4 million, or $1.80 per share, in 2019. Distributable Earnings before realized losses on investments and the interest-rate swap were $227.1 million, or $1.51 per share. The company cautions that this measure is not a substitute for GAAP earnings or liquidity measures.
Cash and cash equivalents were $325.5 million, down from $452.3 million. Investing activities used $215.7 million and financing activities used $75.1 million. Book value per common share was $15.08, versus $16.03 a year earlier.
Material changes and credit developments
- ARI adopted the CECL expected-credit-loss standard on January 1, 2020, recording a $30.9 million opening adjustment to accumulated deficit. At year-end, funded specific and general allowances totaled $213.1 million; a further $3.4 million general allowance covered unfunded commitments.
- Four loans carried the company’s highest-risk rating, rating 5, representing 5.7% of the portfolio before the general allowance; the portfolio’s weighted-average risk rating rose to 3.1 from 3.0. Loans on cost-recovery status had $373.5 million of amortized cost, compared with $136.3 million a year earlier.
- A London urban-retail loan was in default and past due at year-end. ARI reported that it continued to accrue contractual and default interest and did not record a specific CECL allowance for that loan.
- ARI completed restructurings and recapitalizations, sold or repaid loans, and foreclosed on a hotel loan, recording $42.9 million of real estate held for sale and $33.0 million of related debt. Borrower equity contributions accompanied certain modifications.
- ARI repurchased 14.8 million common shares during 2020 for approximately $128.0 million. Common stockholders’ equity declined, while the reported debt-to-equity ratio increased to 1.8 from 1.4.
Debt, liquidity and outlook
Year-end debt included $3.45 billion of secured debt arrangements, $492.5 million principal on the senior secured term loan, and $575.0 million principal of convertible notes due 2022 and 2023. The term loan matures in 2026. The company reported $325.5 million of cash, $18.4 million of approved undrawn secured borrowing capacity and $1.1 billion of unencumbered loan assets. It stated that it believed liquidity and access to additional liquidity were sufficient for obligations over at least the following 12 months. No formal earnings or dividend guidance was provided.
Secured facilities expose ARI to collateral marks, margin calls and refinancing risk; approximately 55% of secured borrowings were recourse to the company. ARI was in compliance with its debt covenants at year-end. It had $1.4 billion of unfunded loan commitments, with funding timing dependent on underlying projects and borrower performance. In 2020, it committed $562.0 million to loans and received $683.3 million in repayments and sales.
COVID-19 materially affected borrower operations, asset values, financing markets and credit-loss estimates. ARI modified loans, including through reserve repurposing, temporary payment deferrals and payment-in-kind interest. Management highlighted uncertainty about the pandemic’s duration and effects and said it would continue monitoring liquidity and obligations. The filing also identifies property concentration, illiquid assets, foreign-currency exposure, LIBOR transition, reliance on Apollo, related-party conflicts and REIT qualification as risks. The UK represented 19.3% of portfolio carrying value.
ARI terminated its interest-rate swap in 2020 and recognized a $53.9 million realized loss; it later entered a three-year cap limiting LIBOR on the term loan to 0.75%. Foreign-currency forwards are used to hedge certain GBP- and EUR-denominated loan cash flows. Subsequent to year-end, ARI committed £165.0 million to a UK commercial mortgage loan and funded approximately $43.2 million of previously closed loans. The board also authorized an additional $150.0 million share-repurchase authorization.
The board declared $1.45 per common share for 2020, while Distributable Earnings were $0.84 per share. The board retains discretion over future dividends. In February 2021, independent directors reviewed the Manager’s performance and fees and decided not to terminate the management agreement. Deloitte & Touche LLP gave an unqualified audit opinion and concluded internal control over financial reporting was effective; the audit identified CECL estimation as a critical audit matter.
Most important facts for investors to verify
- Whether the elevated credit-loss provisions, cost-recovery balances and troubled exposures—particularly the London retail default—lead to further impairment, restructuring or cash-collection effects.
- Whether cash, unencumbered assets and available facilities remain adequate to meet debt maturities, margin calls and $1.4 billion of unfunded commitments as conditions evolve.
- How the $1.45 common dividend is supported by taxable income and recurring cash generation given 2020 GAAP earnings and Distributable Earnings per share.
- How the $213.1 million funded CECL allowance and its assumptions respond to updated collateral values and macroeconomic forecasts.
- Whether related-party loan transactions, manager fees and investment allocation practices are on terms that protect public stockholders; also monitor the pending appeal in the AmBase litigation, which ARI said it believes is without merit.