Apollo Commercial Real Estate Finance, Inc. — FY 2015 Form 10-K
Reporting period: Year ended December 31, 2015; amounts below are in U.S. dollars, generally millions unless stated otherwise. This is an annual filing, not a standalone quarterly filing. Q4 figures are identified separately where available. The company is an externally managed REIT investing mainly in commercial mortgage loans, subordinate loans and commercial mortgage-backed securities (CMBS).
Financial performance and position
| Metric | FY 2015 | FY 2014 |
|---|---|---|
| Interest income | $192.2 | $123.3 |
| Interest expense | $48.9 | $26.5 |
| Net interest income | $143.3 | $96.8 |
| Operating expenses | $26.1 | $18.1 |
| Net income | $103.3 | $82.7 |
| Net income available to common stockholders | $91.4 | $75.3 |
| GAAP diluted earnings per common share | $1.54 | $1.72 |
| Non-GAAP Operating Earnings | $112.7; $1.90 per share | $74.0; $1.69 per share |
| Net cash provided by operating activities | $88.1 | $67.0 |
| Common dividends declared per share | $1.78 | $1.60 |
Interest income and net interest income grew substantially with portfolio expansion. Common-stockholder income increased, but GAAP earnings per share fell, reflecting a larger share count and significant non-cash fair-value and currency losses. Operating Earnings is management’s non-GAAP measure and excludes, among other items, unrealized investment gains and losses; it is not a substitute for GAAP earnings or liquidity.
Q4 2015: Net interest income was $43.2 million, net income was $27.2 million, net income available to common stockholders was $21.4 million, and diluted EPS was $0.32. The quarter included an $11.6 million unrealized loss on securities. Common dividends declared were $0.46 per share.
Year-end balance sheet: Total assets were $2,719.9 million, liabilities $1,344.5 million and stockholders’ equity $1,375.4 million. Cash was $67.4 million; an additional $30.1 million was restricted as collateral and was not available for general use. The portfolio included $994.3 million of commercial mortgage loans, $931.4 million of subordinate loans, $493.1 million of CMBS carried at fair value and $153.2 million of CMBS held to maturity.
Funding and liquidity: Repurchase-agreement borrowings totaled $925.8 million; the company also reported $248.2 million carrying value of convertible notes and $118.2 million of participations sold. The $254.75 million principal amount of 5.50% convertible notes is due in 2019. Cash and operating cash flow were supplemented by financing activity, including 2015 common and preferred stock issuances. Management stated that available liquidity and access to additional liquidity were sufficient for obligations over at least the following 12 months. The filing reports $128.0 million of unfunded loan commitments.
The weighted-average yield on the commercial real estate debt portfolio was 9.3%, with a 3.1-year remaining weighted-average life. Management’s underwritten portfolio IRR of 13.8% assumes, among other things, no defaults, dispositions or early prepayments and stable borrowing costs; actual returns may differ. A 50-basis-point increase in LIBOR was estimated to increase quarterly net interest income by approximately $1.5 million, before considering broader economic effects or management actions.
Material changes versus the prior year
- Total assets increased from $1,845.1 million to $2,719.9 million, and equity rose from $855.1 million to $1,375.4 million, reflecting portfolio growth and equity financing.
- Net interest income increased 48.0% to $143.3 million. Average repurchase borrowings rose, while year-end weighted-average borrowing cost declined to 2.9% from 3.2%.
- Net income increased 24.8%, but common EPS declined from $1.72 to $1.54. Interest expense rose 84.1%, operating expenses rose 44.2%, and unrealized securities losses were $17.4 million versus a $4.1 million gain in 2014.
- Common dividends declared increased to $1.78 per share from $1.60. The company also issued $193.1 million net proceeds from a common offering and approximately $346.9 million net proceeds in a private placement of common and Series B preferred stock.
- CMBS fair-value ratings and marks warrant attention: the filing reports a weighted-average credit rating of BB-D at year-end 2015 versus AAA-CCC- a year earlier, alongside a shorter weighted-average life. CMBS fair values were $493.1 million versus $522.7 million in 2014.
Outlook, risks and unusual items
Management saw investment opportunities from commercial real estate debt maturities, refinancing demand and uncertainty around new CMBS risk-retention rules taking effect in December 2016. It expected historically low interest rates to persist and anticipated refinancing and acquisition activity during 2016. These are expectations, not guidance with quantified earnings or dividend targets; the filing provides no clear formal earnings forecast.
- Proposed merger after year-end: On February 26, 2016, the company agreed to acquire Apollo Residential Mortgage, Inc. (AMTG) for 89.25% of AMTG book value at a future pricing date, plus assumption of $172.5 million of AMTG preferred stock. The transaction remained subject to closing conditions and AMTG stockholder approval; ARI stockholder approval was not required.
- Merger financing arrangements: Athene committed up to $200 million of bridge financing; ARI also agreed to sell Athene up to approximately $1.2 billion of primarily non-Agency residential mortgage-backed securities after closing. Transaction completion, final consideration and financing terms remained contingent.
- Investment and valuation risk: Loans are illiquid and exposed to borrower defaults, property-value declines, refinancing risk and losses on subordinate positions. CMBS fair value is sensitive to market conditions and relies on dealer quotations and management analysis. No loan-loss reserve was recorded at year-end.
- Funding and rate risk: Repurchase facilities can require additional collateral or repayment after asset-value declines, and short-term funding may become more costly or unavailable. Borrowing costs and asset yields may reset at different speeds; hedges may not fully offset these risks.
- REIT and regulatory constraints: Maintaining REIT tax status and exclusion from the Investment Company Act imposes asset, income and distribution limits. The filing also identifies derivative regulation and CMBS risk-retention changes as uncertainties.
- Manager and related-party risk: The company is externally managed by an Apollo affiliate, pays a 1.5% annual base management fee on contractually defined equity, and disclosed potential allocation and other conflicts. Independent directors discussed performance and fees in February 2016 and decided not to terminate the management agreement.
- Other items: The company reported no legal proceedings at December 31, 2015. Deloitte issued unqualified opinions on the financial statements and internal control over financial reporting; management also concluded disclosure controls and internal controls were effective.
Investor verification priorities
- Reconcile GAAP EPS of $1.54 with Operating Earnings of $1.90 per share, including the $17.4 million securities mark loss, foreign-currency loss and derivative results.
- Assess dividend sustainability: common dividends declared of $1.78 per share exceeded GAAP EPS, and confirm the relevant taxable-income and cash-distribution measures.
- Review CMBS credit quality, collateral concentration, valuation assumptions and the reasons for the reported rating mix and fair-value decline.
- Examine repurchase-facility covenants, collateral requirements, maturity schedule and liquidity available after excluding restricted cash; stress-test refinancing and rate exposure.
- Verify the final AMTG merger price, closing conditions, Athene financing and asset-sale terms, share issuance and resulting leverage and earnings effects.
- Confirm the status and funding of the $128.0 million unfunded loan commitments, and monitor borrower performance, extensions, repayments and any subsequent credit deterioration.