Apollo Commercial Real Estate Finance, Inc. quarterly report, Q1 FY2013

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Apollo Commercial Real Estate Finance, Inc. — Q1 2013 Form 10-Q

Reporting period: Three months ended March 31, 2013; balance-sheet comparisons are to December 31, 2012. Unaudited consolidated figures are in millions of dollars unless noted. ARI is a REIT that invests in commercial mortgage loans, subordinate financings, CMBS and related real-estate debt.

Financial performance and position

  • Net interest income was $17.1 million, up 52.6% from $11.2 million. Interest income increased on commercial mortgage loans ($3.6 million, up 60.8%) and subordinate loans ($11.5 million, up 115.6%); lower securities and repurchase-agreement income partly offset the gains.
  • Net income was $11.9 million versus $9.1 million. After $1.9 million of preferred dividends, net income available to common stockholders was $10.1 million versus $9.1 million. Reported GAAP basic and diluted EPS was $0.33 versus $0.43; the share count rose materially after the common-stock offering. The filing also reports distributable earnings of $0.49 per share and non-GAAP Operating Earnings of $12.0 million, or $0.39 per share, versus $8.8 million, or $0.42 per share, in Q1 2012.
  • Expenses and valuation items: Operating expenses increased 22.0% to $4.1 million, mainly as management fees rose 67.6% to $2.2 million. Securities generated a $1.1 million unrealized loss, compared with a $1.4 million gain a year earlier. No net derivative gain or loss was reported for the quarter.
  • Cash flow: Operating activities provided $11.9 million, compared with $11.8 million. Investing activities used $16.5 million, principally reflecting $91.3 million of subordinate-loan fundings, partly offset by $52.3 million of subordinate-loan repayments. Financing activities provided $121.7 million, including $148.8 million of common-stock proceeds. Cash rose to $225.7 million from $108.6 million.
  • Balance sheet and portfolio: Total assets were $923.5 million and stockholders’ equity was $691.2 million. Commercial mortgage loans were carried at $142.8 million and subordinate loans at $286.6 million; securities totaled $262.7 million at fair value. The investment table reports $692.2 million of face amount and $688.1 million of amortized cost, with a 9.4% weighted-average yield and 3.0-year remaining weighted-average life.
  • Debt and liquidity: Repurchase-agreement borrowings were $211.9 million, down from $225.2 million; the weighted-average rate was 1.4% and weighted-average remaining maturity was 1.3 years. Cash exceeded reported borrowings by about $13.8 million. Management said it believed liquidity and access to additional liquidity were sufficient for financial obligations over at least the next 12 months. The company reported compliance with repurchase-facility covenants.
  • Dividends: The company declared a $0.40-per-share common dividend for Q1 and a $0.5391-per-share Series A preferred dividend. On May 1, it declared another $0.40 common dividend, payable July 12, 2013.

Material changes from the prior comparable period

  • Net interest income rose 52.6% and net income rose 31.2%, while common-stock EPS declined to $0.33 from $0.43. The filing attributes the earnings growth primarily to increased mortgage and subordinate-loan income and lower interest expense; the EPS comparison also reflects preferred dividends and a larger weighted-average common share count.
  • In March, ARI issued 8.805 million common shares at $16.90 per share, raising approximately $148.4 million net. Shares outstanding increased to 36.9 million at quarter-end from 28.0 million at year-end.
  • Subordinate-loan carrying value increased to $286.6 million from $246.2 million. In February, two mezzanine loans totaling $50 million were repaid, generating a $2.5 million yield-maintenance payment; ARI reported a 15% realized IRR on that investment.
  • Borrowings declined, and February amendments reduced borrowing spreads under the Wells facility. The AAA-CMBS financing rate was reduced to LIBOR plus 1.05%; the Hilton-CMBS rate was reduced to LIBOR plus 1.75%. The AAA-CMBS facility maturity was extended to March 2014.

Outlook, commentary, and risks

  • The filing gives no specific earnings or portfolio-growth guidance. Management described a commercial real-estate refinancing opportunity from more than $1 trillion of debt scheduled to mature during 2013–2017, while noting that lender extensions defer some maturities. ARI reported approximately $23 billion of U.S. CMBS issuance in Q1 2013 and expected opportunities in mezzanine financing to continue.
  • Management expects regular quarterly common distributions, subject to board discretion and operating results. REIT status generally requires distribution of at least 90% of taxable income; preferred dividends are cumulative at an annual rate of 8.625% of the $25 liquidation preference.
  • Portfolio investments include subordinate and development-related loans, which carry borrower, collateral, property-market and repayment risks. ARI had $45.5 million of unfunded loan commitments at March 31, 2013. It reported no loan-loss allowance, concluding one was not necessary at quarter-end.
  • All repurchase borrowings were floating-rate. ARI estimated that a 50-basis-point LIBOR increase would raise quarterly interest expense by $75,000 on its stated net variable-rate exposure of $60.4 million, before any management actions or broader economic effects. Hedging may not fully protect against rate changes.
  • Fair values of securities and derivatives were based on Level II observable inputs; loan fair values were classified as Level III. Broker quotes may be indicative rather than executable, and actual values may differ. ARI cautioned that underwritten investment IRRs are assumptions, not assured returns.
  • The external management agreement charges a base fee of 1.5% per year of defined stockholders’ equity. Management fees increased to $2.2 million for the quarter. After reviewing the agreement and fees, independent directors decided not to terminate it; termination is subject to restrictions and may involve a fee.
  • Management reported effective disclosure controls and no material change in internal control over financial reporting. The company reported no material legal proceedings and no material changes to risk factors during the quarter.

Important facts for investors to verify

  • Reconcile GAAP EPS of $0.33 with distributable earnings of $0.49 and non-GAAP Operating Earnings of $0.39 per share; assess the effects of preferred dividends, unrealized marks and share issuance.
  • Review the performance, collateral values, maturity and extension terms of subordinate loans, including the development and conversion exposures, and the $45.5 million of remaining commitments.
  • Assess liquidity and refinancing exposure under the Wells and JPMorgan facilities, including maturity extensions, collateral requirements, covenants and potential margin calls.
  • Evaluate whether portfolio income and cash generation support common and cumulative preferred dividends, particularly given REIT distribution requirements and the external management fee structure.
  • Test management’s underwritten IRRs and fair-value estimates against actual repayment, market and credit outcomes; the filing states that actual returns may differ materially from underwritten returns.