Apollo Commercial Real Estate Finance, Inc. — Q2 2023 Form 10-Q
Reporting period: Three and six months ended June 30, 2023. ARI is an externally managed REIT focused primarily on commercial real estate mortgage loans and other real estate debt investments. Amounts below are in U.S. dollars; financial statement figures are generally in millions unless stated otherwise.
Financial results and position
| Metric | Q2 2023 / June 30, 2023 | Comparable period / prior year-end |
|---|---|---|
| Total net revenue | $92.2 | $76.0 in Q2 2022 |
| Net interest income | $63.0 | $57.4 in Q2 2022 |
| Net income (loss) | $(83.4); common-stockholder loss $(86.5), or $(0.62) per diluted share | Q2 2022 net income $71.0; common-stockholder income $67.9, or $0.44 per diluted share |
| Six-month net income (loss) | $(34.5); common-stockholder loss $(40.6), or $(0.30) per diluted share | Six months 2022 net income $86.2; common-stockholder income $80.1, or $0.55 per diluted share |
| Distributable Earnings, a non-GAAP measure | Q2: $(15.9), or $(0.11) per share; first half: $53.3, or $0.37 per share | Q2 2022: $49.5, or $0.35 per share; first half 2022: $99.0, or $0.69 per share |
| Operating cash flow | $159.6 for the first half | $99.4 for the first half of 2022 |
| Cash and cash equivalents | $308.1 | $222.0 at December 31, 2022 |
| Loan portfolio, net | $8,295.4; 53 loans | $8,682.0; 61 loans at December 31, 2022 |
| Total liabilities / stockholders’ equity | $7,145.4 / $2,215.0 | $7,213.8 / $2,354.5 at December 31, 2022 |
| Debt-to-equity ratio | 2.9 | 2.8 at December 31, 2022 |
| Book value per common share | $14.47 | $15.54 at December 31, 2022 |
| Common dividend declared | $0.35 per share for Q2 | $0.35 per share in Q2 2022 |
The filing does not provide a single conventional operating-margin measure. For the first half, cash used in financing activities was $188.3 million, including $107.2 million of common and preferred dividends and $43.5 million to repurchase convertible notes.
Material changes and key drivers
- Q2 net interest income rose year over year, but fell $8.0 million from Q1 2023. Management attributed the sequential decrease primarily to placing a first mortgage loan and a mezzanine loan tied to the same Manhattan ultra-luxury residential project on non-accrual.
- Higher benchmark rates increased first-half commercial mortgage interest income, but also increased interest expense. The loan portfolio was 99% floating-rate at June 30, 2023; its weighted-average cash coupon was 8.1%, compared with 7.2% at year-end 2022.
- Q2 results included an $81.98 million realized investment loss, principally the write-off of an allowance on the most junior Manhattan mezzanine loan, and a $59.5 million net increase in specific CECL allowance. The company also reported a $2.1 million increase in general CECL allowance. These credit items were major contributors to the quarterly loss.
- Total CECL allowance was $230.1 million at quarter-end, including $193.0 million of specific allowance and $37.1 million of general allowance, of which $4.8 million related to unfunded commitments. The allowance increased from $164.1 million at December 31, 2022. Non-accrual loan amortized cost increased to $711.6 million from $468.0 million.
- Real estate owned revenue was $29.2 million in Q2, compared with $18.6 million a year earlier. ARI owned the D.C. Hotel and Brooklyn Development as held-for-investment assets, and acquired an Atlanta hotel through deed-in-lieu foreclosure in March 2023; the Atlanta property was classified as held for sale at June 30.
- The company repurchased $43.9 million aggregate principal of its 5.375% convertible notes during the first half, leaving $186.1 million principal outstanding, due October 2023. It reported $600 million of combined additional capacity from new secured financing arrangements and a new facility, and had no borrowings outstanding under its $170 million revolving facility at quarter-end.
Liquidity, debt and risk
At June 30, ARI reported $308.1 million cash and approximately $625.7 million of unencumbered assets. It had $780.0 million of unfunded loan commitments, of which management expected approximately $453.3 million to be funded in the short term; commitment timing depends on underlying property and loan performance. The filing also anticipates $365.3 million of secured debt repayments in the short term. Management reported compliance with applicable financing covenants.
Principal borrowings were $6.84 billion, including $5.38 billion of secured debt arrangements, $773.3 million of term loans, $500.0 million of senior secured notes and $186.1 million of convertible notes. Separately, $160.9 million of net construction financing was associated with the Brooklyn Development. Secured debt borrowing costs and asset yields are exposed to benchmark rates, credit spreads, collateral values and financing availability. The company estimates that an immediate 50-basis-point rate move would change next-12-month net interest income by approximately $7.3 million, or $0.05 per share, in either direction, subject to stated assumptions.
Outlook, contingencies and unusual items
- The filing provides no quantitative earnings or dividend guidance. Management says distributions depend on results, cash availability and board approval; the quarterly common dividend remained $0.35 per share. REIT status generally requires annual distribution of at least 90% of taxable income, subject to tax rules.
- Management highlights uncertainty from inflation, rising interest rates, economic conditions, property-market weakness, limited lending and market liquidity, and continuing effects of COVID-19 and geopolitical events. Credit losses and collateral valuations depend on estimates and assumptions that may differ materially from actual outcomes.
- The Manhattan ultra-luxury property’s sales continued to trail the borrower’s plan. ARI ceased accruing interest on the related senior loan and senior mezzanine loan as of May 1, 2023, and downgraded the Junior Mezzanine A loan to risk rating 5. It wrote off the $82.0 million Junior Mezzanine B allowance as unrecoverable. These loans are secured by the same property.
- ARI received an unsolicited offer for the Atlanta Hotel and expected a sale in the second half of 2023, subject to diligence; this is an expectation, not a completed transaction. Subsequent to quarter-end, ARI funded approximately $31.7 million on previously closed loans, capitalized $4.8 million of property costs, and received approximately $42.5 million of loan repayments.
- A pending lawsuit includes claims against an ARI subsidiary relating to a Manhattan condominium development. The company says the claims are without merit, but states that a possible loss cannot reasonably be estimated. The complaint in a separate related action against ARI and Apollo Global Management was dismissed, subject to appeal.
Important facts for investors to verify
- Updated sales, valuations, borrower performance and recovery prospects for the Manhattan property and its remaining loans, including the status of non-accrual interest and potential further credit losses.
- How ARI will repay or refinance the $186.1 million principal amount of convertible notes due in October 2023, and the impact on liquidity and financing costs.
- Actual funding needs and timing for the $780.0 million of unfunded commitments, alongside near-term secured debt repayments and the stated liquidity sources.
- Whether the proposed Atlanta Hotel sale closes, at what proceeds, and how the property’s operating results and sale affect reported earnings.
- Coverage of the $0.35 quarterly common dividend by recurring earnings and cash generation. In particular, compare GAAP results and Distributable Earnings with the separate non-GAAP measure before realized investment losses.
- Developments in CECL allowances, non-accrual loans, collateral valuations, foreign-exchange hedges and the pending litigation; these are areas of material estimation or uncertainty.