Apollo Commercial Real Estate Finance, Inc. — 2011 Form 10-K
Reporting period: Fiscal year ended December 31, 2011. The filing is an annual report, not a standalone fourth-quarter filing. Amounts below are in thousands of dollars except per-share data.
Business context and portfolio
Apollo Commercial Real Estate Finance is an externally managed REIT that originates, acquires and manages commercial real estate debt investments, including commercial mortgage-backed securities (CMBS), first mortgage loans and mezzanine loans. At year-end, the portfolio included $554.0 million of AAA-rated CMBS, $109.0 million of first mortgage loans, $149.1 million of subordinate loans and $47.4 million invested in a repurchase agreement. The company’s stated objective is to generate long-term risk-adjusted returns primarily through dividends.
Financial and operating performance
| Metric | 2011 | 2010 |
|---|---|---|
| Interest income | $52.9 million | $32.5 million |
| Interest expense | $14.5 million | $10.7 million |
| Net interest income | $38.5 million | $21.8 million |
| Operating expenses | $10.4 million | $8.9 million |
| Net income | $25.9 million | $11.0 million |
| Basic and diluted earnings per share | $1.35 | $0.87 |
| Dividends declared per share | $1.60 | $1.50 |
Net interest income increased 76.7%, which management attributed mainly to deployment of capital raised through equity offerings. Interest income from subordinate loans rose 86.4%; management fees increased 41.6%, partly reflecting the larger equity base. The company recorded $2.7 million of derivative losses, including realized and unrealized items, and a $0.5 million unrealized gain on securities. No loan-loss allowance was recorded at year-end. The filing does not provide a conventional operating-margin figure.
Fourth-quarter 2011 net interest income was $10.9 million and net income was $8.7 million, compared with $7.3 million and $4.0 million, respectively, in fourth-quarter 2010. Quarterly EPS was $0.41 versus $0.22.
Operating cash flow was $35.5 million; investing cash flow was negative $60.9 million and financing cash flow was positive $9.1 million. Cash declined by $16.3 million to $21.6 million. Total assets were $891.2 million, liabilities $554.3 million and stockholders’ equity $337.0 million. Borrowings totaled $542.0 million, with a weighted-average rate of 2.3% and remaining maturity of 1.3 years, as reported at December 31.
The investment table reported a 6.8% weighted-average yield and 2.6% cost of funds, with underwritten weighted-average IRR of 14.2%. These are portfolio measures and underwritten returns, not realized company-wide margins or guaranteed outcomes.
Material changes and financing
- Subordinate loans grew from $59.0 million to $149.1 million; a $47.4 million repurchase-agreement investment was added. The company also originated or acquired loans tied to a California ski resort, a New York hotel portfolio and a Virginia retail center.
- In July 2011, the company issued 3.0 million shares in a private offering, generating about $49.0 million in proceeds before offering expenses. Shares outstanding rose to 20.6 million at year-end from 17.6 million a year earlier.
- In December 2011, the Wells Fargo facility’s maximum capacity was increased from $250 million to $506 million. In January 2012, the company used the expanded facility to refinance all outstanding TALF debt. The refinancing carried a 30-day LIBOR plus 1.5% rate, generated $14.1 million of investable proceeds, and reduced the reported current weighted-average funding cost on the refinanced collateral from 2.8% to approximately 1.9%. This is a subsequent event, not the year-end debt structure.
- At year-end, borrowings included $251.3 million under TALF, $222.0 million under the Wells facility and $68.7 million under the JPMorgan facility. The company reported $21.6 million cash and, before the January refinancing, $31.3 million of JPMorgan capacity and $284.0 million of Wells capacity; use of JPMorgan capacity required additional eligible assets. The JPMorgan facility was extended in January 2012 to January 4, 2013.
Outlook, risks and other notable items
Management said it expected to continue investing in performing commercial real estate debt. It cited an estimated roughly $1 trillion of commercial real estate loans scheduled to mature from 2012 through 2015 and anticipated a substantial refinancing gap as traditional lending and CMBS issuance remained constrained. These are management estimates and market expectations, not earnings or dividend guidance. The company stated that it believed it had sufficient liquidity and access to liquidity for at least the next 12 months and intended to continue quarterly distributions, subject to board discretion and operating results.
- Key risks include real estate credit deterioration, borrower defaults, collateral-value declines, illiquid investments and concentration exposure; mezzanine and preferred-equity investments are structurally subordinate to senior debt.
- Leverage and short-term secured funding create refinancing, covenant, margin-call and collateral risks. Debt service, higher funding costs or loss of financing access could reduce distributions or force asset sales.
- Interest-rate exposure is managed partly with swaps and caps, but hedging may be imperfect and derivative fair-value changes affect earnings. At year-end, management estimated that a 50-basis-point LIBOR increase would add about $61,000 to quarterly interest expense on net variable-rate debt, absent other changes.
- As an externally managed REIT, the company faces conflicts and related-party risks. The Manager receives a quarterly base fee equal to 1.5% annually of contract-defined stockholders’ equity, and termination without cause is difficult and costly.
- Maintaining REIT tax status and an exemption from the Investment Company Act is important to the business model. Regulatory, tax and accounting changes could constrain investments, financing or distributions.
- The company reported no legal proceedings as of year-end. Deloitte & Touche gave an unqualified audit opinion and concluded internal control over financial reporting was effective.
Important facts for investors to verify
- Review the January 2012 TALF refinancing terms, hedges, maturity profile and any subsequent changes in borrowing capacity and liquidity.
- Assess asset-level credit quality, collateral valuations, concentrations, subordinate-loan exposures and the status of the CDO bond investment, which had been downgraded from AAA/Aaa to A-/Baa1.
- Compare the $1.60 per-share 2011 dividend with reported EPS of $1.35 and the filing’s separately presented distributable earnings measure; confirm the cash and tax basis for future distributions.
- Monitor compliance with financing covenants, margin-call exposure, debt maturities and the effects of interest-rate movements on net interest income.
- Review management-fee calculations, expense reimbursements, related-party transactions and the terms of the externally managed structure.