Apollo Commercial Real Estate Finance, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017. Amounts below are in U.S. dollars; financial statement amounts are generally in thousands unless stated otherwise. ARI is an externally managed REIT focused on commercial real estate loans, subordinate financings and CMBS. Comparisons are with Q1 2016, before the August 2016 AMTG merger; the company says AMTG’s acquired assets had been sold by year-end 2016.
Financial performance and position
| Metric | Q1 2017 / March 31, 2017 | Comparable / prior date |
|---|---|---|
| Net interest income | $57.8 million | $46.8 million in Q1 2016; up 23.5% |
| Net income | $47.1 million | $18.6 million in Q1 2016 |
| Net income available to common stockholders; GAAP EPS | $37.8 million; $0.41 per share | $12.8 million; $0.18 per share |
| Operating Earnings, a company-defined non-GAAP measure | $38.6 million; $0.41 per share | $29.8 million; $0.44 per share |
| Common dividend declared | $0.46 per share | $0.46 per share in Q1 2016 |
| Cash and restricted cash | $197.6 million combined | $263.5 million combined at December 31, 2016 |
| Loans held for investment, net | $3.151 billion | $2.693 billion at December 31, 2016 |
| Repurchase borrowings, net of financing costs | $1.477 billion on the balance sheet; $1.487 billion gross outstanding | $1.140 billion net at December 31, 2016 |
| Convertible senior notes, net | $250.5 million; 5.50% notes due 2019 | $250.0 million at December 31, 2016 |
| Total assets / total liabilities / stockholders’ equity | $3.809 billion / $1.880 billion / $1.929 billion | $3.483 billion / $1.551 billion / $1.932 billion at December 31, 2016 |
Interest income from commercial mortgage loans rose 62.8% and subordinate loans rose 17.1%, principally reflecting portfolio growth and higher LIBOR. Higher average repurchase borrowings and funding costs partly offset the increase in asset income: interest expense rose 16.3%, and weighted-average cost of funds increased to 3.4% from 2.9%. CMBS interest income fell 59.5%, largely due to prior-period sales and repayments.
Operating cash flow was $25.7 million, versus $13.6 million in Q1 2016. Investing activities used $367.3 million, mainly for loan fundings; financing activities provided $283.5 million, largely from net repurchase-agreement borrowings. Cash and cash equivalents decreased $58.1 million during the quarter to $142.9 million. The filing does not provide a clear net interest margin value.
Portfolio, changes and capital
- ARI reported 51 loans with $3.179 billion principal balance, compared with 45 loans and $2.720 billion at year-end 2016. Weighted-average cash coupon was 8.82%, versus 8.88%.
- During Q1, ARI committed $332.8 million to first mortgages, funding $259.0 million; committed and funded $117.5 million of subordinate loans; and funded about $115.8 million on previously closed loans. Loan repayments were $44.1 million.
- Loan exposure is concentrated geographically: New York City represented 39.1% of loan carrying value. Hotels were 22.0% of loan carrying value. The company reported $121.5 million of unfunded loan commitments in the portfolio note; its contractual-obligations schedule gives $124.5 million based on estimated funding timing.
- Net interest income and common GAAP earnings increased year over year, while Operating Earnings per share declined from $0.44 to $0.41. Management attributes the per-share comparison in part to a larger share count following the AMTG merger and subsequent equity issuance. GAAP results also benefited from a favorable swing in securities marks and foreign currency results compared with Q1 2016.
- The loan-loss allowance remained $15.0 million, related to two Williston, North Dakota multifamily loans; ARI said it had stopped accruing PIK interest on the affected loan. No new loan-loss provision is shown for Q1 2017.
Outlook, liquidity, risks and unusual items
- Management said liquidity and access to additional liquidity were sufficient to meet financial obligations for at least the next 12 months. The company’s primary sources are cash, investment repayments and income, and available financing. Its stated strategy is to use leverage to finance the portfolio and to target borrowings on loans of approximately 35% of total loan-portfolio value.
- In April 2017, ARI amended its Deutsche Bank repurchase facility, increasing capacity from $300 million to $450 million plus £45 million and extending the maturity, including extension options, to March 2020. At March 31, gross repurchase borrowings were $1.487 billion. The company reported compliance with financing covenants.
- Financing risks include floating-rate borrowing costs, collateral valuation and margin calls, refinancing and facility maturity exposure. The UBS CMBS facility was scheduled to mature in September 2017, subject to an extension option; the DB CMBS facility was scheduled to mature in April 2018. The JPMorgan facility was amended at quarter-end and provides for maturity in March 2019 plus an extension option.
- Fair-value and foreign-exchange movements were significant: Q1 included a $2.9 million unrealized securities gain, a $3.2 million foreign-currency gain and a $3.0 million net derivative loss, as well as a $1.0 million realized loss on asset sales. Most derivatives are not designated as accounting hedges, so fair-value changes flow through earnings.
- The $0.46 common dividend exceeded both reported GAAP EPS and Operating Earnings per share of $0.41 for the quarter. The company intends to continue regular quarterly distributions, but future dividends remain subject to board discretion, results, cash availability and REIT requirements.
- Risks include commercial real estate credit and collateral values, interest rates, financing availability, prepayments, market liquidity, and REIT qualification. Management described potential commercial lending opportunities from subdued CMBS issuance and upcoming debt maturities, but provided no numerical earnings or investment guidance.
- ARI is cooperating with a Department of Justice request for information in a preliminary investigation concerning aspects of the former residential real estate portfolio acquired in the AMTG merger and sold in 2016. Related shareholder litigation challenging the merger remained pending; motions to dismiss had been briefed and oral argument held. The filing does not quantify any potential liability.
- The external manager’s quarterly fee was $7.4 million, up from $5.2 million, reflecting higher stockholders’ equity. The management agreement runs through September 2018 and includes a termination fee; independent directors discussed performance and fees in February 2017 and decided not to seek termination.
Important facts for investors to verify
- Whether portfolio expansion can sustain net interest income and per-share earnings after accounting for higher financing costs, preferred dividends and share-based compensation.
- The dividend’s coverage by recurring earnings and cash generation, particularly given the $0.46 quarterly common dividend versus $0.41 GAAP EPS and Operating Earnings per share.
- Loan-level credit performance, collateral values and the status of the $15 million allowance, including developments on the Williston loans and unfunded commitments.
- Availability, pricing, covenants, collateral requirements and maturity or extension terms across repurchase facilities; assess sensitivity to LIBOR changes and margin calls. The market-risk section contains unresolved “$?” placeholders for floating-rate exposure and the estimated effect of a 50-basis-point LIBOR increase, so it does not provide a clear sensitivity value.
- Developments in the DOJ inquiry and merger-related litigation, and any resulting costs, claims or disclosures.
- The company’s non-GAAP Operating Earnings reconciliation and its assumptions for underwritten investment returns; ARI cautions that actual returns may differ materially.