Apollo Commercial Real Estate Finance, Inc. — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014. Unless stated otherwise, financial amounts below are in millions of dollars. ARI is an externally managed REIT investing primarily in commercial mortgage loans, subordinate loans and commercial mortgage-backed securities (CMBS).
Financial performance and position
- Q3 earnings: Net income was $19.2 million and net income available to common stockholders was $17.3 million, or $0.37 per diluted share, versus $12.9 million and $11.0 million, or $0.29 per share, in Q3 2013.
- Nine-month earnings: Net income available to common stockholders was $55.1 million, or $1.30 per diluted share, versus $31.0 million, or $0.88 per share, in 2013.
- Net interest income: $26.6 million in Q3, up 41.4% year over year; $69.8 million for nine months, up 31.4%. Increased investment income was partly offset by higher financing costs. The filing does not provide a clear operating-margin measure.
- Operating Earnings (non-GAAP): $20.8 million, or $0.44 per share, in Q3 versus $13.3 million, or $0.35, in 2013; $52.8 million, or $1.24 per share, for nine months versus $37.0 million, or $1.05. The company describes this measure as an approximation of cash available for distribution; it excludes, among other items, unrealized investment gains and losses.
- Cash flow, nine months: Operating activities provided $40.5 million versus $33.9 million in 2013. Investing used $778.5 million versus $143.1 million; financing provided $776.6 million versus $87.4 million. Cash increased $38.6 million to $58.6 million. Restricted cash was an additional $30.1 million.
- Balance sheet: Total assets were $1,783.0 million, total liabilities $927.3 million and stockholders’ equity $855.7 million at September 30. At year-end 2013, these were $907.5 million, $224.5 million and $683.0 million, respectively.
- Investment portfolio: Commercial first-mortgage loans had a $369.9 million carrying value; subordinate loans, $585.5 million; and CMBS, including held-to-maturity securities, approximately $671.6 million. The portfolio table reported a 9.4% weighted-average yield and 3.0-year weighted-average life. Management reported no loan-loss allowance was needed at September 30.
- Debt and funding: Repurchase-agreement borrowings were $537.8 million, at a 3.2% weighted-average rate and 2.8-year weighted-average remaining maturity. Convertible notes had $246.1 million carrying value; $254.8 million aggregate principal was issued in 2014, with a 5.50% coupon and 2019 maturity. The company also reported $89.4 million of participations sold, accounted for as a non-recourse liability rather than a sale.
- Distributions and equity: Common dividends declared were $0.40 per share each quarter; a further $0.40 dividend was declared October 28, payable January 15, 2015. The company completed a 9.706 million-share offering in Q2 at $16.35 per share, generating approximately $158.4 million net proceeds. Common shares outstanding were 46,848,675 at September 30.
Changes versus prior comparable periods
- Portfolio expansion drove higher interest income: nine-month interest income rose across securities, commercial mortgage loans and subordinate loans. The company funded $325.961 million of securities, $211.738 million of commercial mortgage loans and $353.386 million of subordinate loans during the nine months.
- Interest expense increased to $15.8 million for nine months from $2.9 million in 2013, reflecting higher average repo borrowings, higher funding costs and the new convertible notes. Weighted-average funding cost was 3.2% at September 30, versus 1.9% a year earlier.
- Unrealized securities results improved to a $4.8 million gain for nine months from a $4.0 million loss in 2013, but Q3 2014 included a $2.1 million loss. Q3 also included a $3.6 million foreign-currency loss and a $3.0 million unrealized gain on a forward currency contract.
- Assets and liabilities increased substantially alongside investment activity, the share offering, new convertible notes and increased repo financing. Management fees also rose, to $8.7 million for nine months from $7.4 million, primarily reflecting higher stockholders’ equity.
Outlook, risks and unusual items
- Management cited an expected commercial real-estate debt maturity cycle through 2017 and continuing opportunities to originate loans and invest in CMBS. It expected low interest rates to support refinancing activity and anticipated increased European lending opportunities. These are expectations, not formal earnings guidance; no numerical earnings or dividend guidance was provided.
- Management said available liquidity and access to additional liquidity should meet obligations for at least the next 12 months. Sources included $58.6 million of cash, investment cash flows and financing facilities; $52.3 million of JPMorgan borrowing capacity was available, subject to collateral needs and facility terms.
- ARI’s repo facilities include financial covenants, collateral and margin-call provisions. During Q2, JPMorgan temporarily waived a minimum-liquidity covenant and temporarily increased permitted borrowing; the facility was amended in June, and the company reported compliance with repo covenants at September 30. JPMorgan borrowings mature in January 2015. Monitor refinancing and covenant headroom.
- The company reported $104.6 million in unfunded loan commitments and had committed up to $50 million to its KBC Bank investment, of which $39.5 million was funded by September 30. It acquired an indirect approximately 21% interest in the bank through Champ LP.
- Interest-rate, credit, real-estate valuation, liquidity, prepayment and foreign-exchange risks could affect results. A 50-basis-point LIBOR increase was estimated to raise quarterly net interest income by approximately $0.4 million on the disclosed net variable-rate exposure, assuming no other changes. Securities fair values rely on Level II observable inputs; loan and repo fair values are Level III estimates.
- The management agreement automatically renewed for successive one-year terms. The manager receives a base fee of 1.5% per year of defined stockholders’ equity and expense reimbursements; termination requires specified independent-director approval and may trigger a fee. The filing reported no material legal proceedings and no material changes to the risk factors in the 2013 Form 10-K.
- Subsequent to quarter-end, the DB facility limit increased from $275 million to $300 million. The company also acquired $23.3 million of CMBS using $18.6 million of facility borrowings; management underwrote the investment to an approximately 15% IRR, which is not assured.
Key facts for investors to verify
- Whether portfolio growth and reported loan yields translate into sustainable distributable cash after higher financing costs and management fees.
- Upcoming financing maturities, repo covenant compliance, collateral requirements and actual availability of stated borrowing capacity.
- Performance and credit quality of new loans, CMBS and the KBC Bank investment; confirm unfunded commitments and realized repayments.
- Reconciliation of GAAP earnings to Operating Earnings, including unrealized securities and currency movements, and the dividend’s coverage by recurring cash generation.
- Terms and carrying value of the convertible notes and participation sold, and the effect of any future conversion or refinancing.