Apollo Commercial Real Estate Finance, Inc. quarterly report, Q1 FY2012

Apollo Commercial Real Estate Finance, Inc. — Q1 2012 Form 10-Q

Reporting period: Three months ended March 31, 2012; balance-sheet comparisons are with December 31, 2011. The filing is unaudited. Apollo Commercial Real Estate Finance is an externally managed REIT investing in commercial real estate debt, including CMBS, first mortgages and subordinate loans. Amounts below are in millions except per-share data.

Financial results and position

Metric	Q1 2012 / March 31, 2012	Comparable period / year-end
Net interest income	$11.2	$7.6 in Q1 2011; up 47.2%
Net income	$9.1	$5.2 in Q1 2011
Net income per common share, basic and diluted	$0.43	$0.29 in Q1 2011
Dividend declared per common share	$0.40	$0.40 in Q1 2011
Operating cash flow	$11.8	$5.8 in Q1 2011
Cash	$31.5	$21.6 at December 31, 2011
Total assets	$705.2	$891.2 at December 31, 2011
Total borrowings	$355.3	$542.0 at December 31, 2011
Stockholders’ equity	$338.4	$337.0 at December 31, 2011

Net income growth reflected higher interest income from subordinate loans and the company’s investment structured as a repurchase facility, partly offset by lower securities income. Operating expenses were $3.3 million versus $2.5 million in Q1 2011, including $1.1 million of non-cash stock compensation and $1.3 million of management fees. The filing’s MD&A expense table presents inconsistent subtotals; the income statement reports total operating expenses of $3.325 million.
Cash from investing activities was a net inflow of $193.9 million, principally reflecting securities sales and principal repayments. Financing activities used $195.8 million, including repayment of $251.3 million of TALF borrowings. Cash increased $9.9 million during the quarter.
At quarter-end, the company held $330.9 million of CMBS and had $355.3 million of borrowings, all under repurchase facilities; the remaining TALF balance was zero. Reported weighted-average borrowing cost was 1.9%, and weighted-average remaining maturity was 1.2 years.
Portfolio investments totaled $660.4 million face amount. Management reported a weighted-average yield of 7.8% and underwritten weighted-average IRR of 14.7%; the filing cautions actual returns may differ and its IRR assumptions exclude dispositions, early prepayments and defaults.
The filing does not provide a stated net interest margin. It reports net interest income and portfolio yield separately.

Material changes and developments

The company refinanced its TALF debt with increased Wells Fargo facility capacity in January. Wells borrowings rose to $286.7 million from $222.0 million at year-end; JPMorgan borrowings were $68.6 million. Total borrowings declined substantially, primarily after the TALF repayment and subsequent CMBS sale and paydowns.
In March, the company sold CMBS with $137.4 million amortized cost, recording a $0.3 million realized gain and receiving $14.6 million net proceeds after repaying related Wells facility debt.
Subordinate loans grew to $179.3 million from $149.1 million at year-end, including two $15 million Manhattan hotel mezzanine investments. Securities declined to $330.9 million from $554.0 million at year-end.
In April, the company bought senior sub-participation interests with $23.8 million aggregate face amount for $18.6 million. They are secured by land in South Boston, carry a LIBOR-based rate and mature in December 2012, subject to extension conditions. Management estimated a 21.9% IRR assuming extension; this is not a guaranteed return.
Also in April, the JPMorgan facility spread was reduced to LIBOR plus 2.50%; management estimated annual interest savings of approximately $0.25 million. A $24.0 million Manhattan hotel mortgage was repaid, with $15.4 million of related JPMorgan borrowings repaid.

Outlook, risks and unusual items

Management said it believed liquidity and access to additional liquidity were sufficient for at least the next 12 months. At March 31, cash was $31.5 million, and $31.4 million of JPMorgan capacity remained, subject to collateral and facility terms. The Wells facility had a stated maximum of $506 million and a maturity in August 2012, with an extension option for eligible assets subject to conditions.
Management described a commercial real estate debt maturity opportunity of more than $1 trillion from 2012 to 2015, while noting market volatility, loan extensions and slower transaction activity. No specific earnings or investment guidance was provided.
Management expected borrowings to be approximately 35% of the value of its total loan portfolio. The filing also notes REIT distribution requirements constrain retained capital; the board retains discretion over future dividends. A $0.40-per-share dividend was declared in May for payment in July.
Key risks include real estate collateral values and borrower credit, floating-rate funding costs, margin calls and facility renewal or refinancing, securities fair-value volatility, prepayment risk, and the effectiveness of derivatives. All repurchase borrowings were floating-rate. Management estimated a 50-basis-point LIBOR increase would add about $0.134 million in quarterly interest expense on net variable-rate debt, before any management response.
CMBS and derivatives were valued using Level II inputs; the company noted dealer quotes are indicative and may not equal realizable sale prices. No loan-loss allowance was recorded. Management judged available-for-sale CMBS unrealized losses not other-than-temporary and said it did not intend, or expect to be forced, to sell those securities before cost recovery.
The independent directors reviewed the management agreement in March and did not give notice of termination. The agreement provides for a 1.5% annual base fee on defined stockholders’ equity and a potential termination fee. The company reported no legal proceedings, no material changes to previously disclosed risk factors, and no material control changes.

Most important facts for investors to verify

Whether the Wells facility was extended or refinanced before its August 2012 maturity, and the collateral, covenant and margin-call requirements then in effect.
Performance and credit quality of the subordinate loan portfolio, including the new hotel mezzanine loans, the downgraded CDO bond underlying the 13% repurchase-facility investment, and the South Boston participation’s extension and repayment conditions.
Whether the reported portfolio yields and underwritten IRRs are realized; they rely on assumptions and are not assured.
The expense presentation in MD&A: reconcile its reported operating-expense subtotals with the income statement’s $3.325 million total.
Future dividend coverage by taxable income and available cash, and the effect of REIT distribution requirements on liquidity and capital for investment.