Apollo Commercial Real Estate Finance, Inc. — 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. Unless otherwise noted, financial amounts below are in millions of dollars. The filing reports a full-year 10-K, not a standalone fourth-quarter filing.
Business context and portfolio
ARI is an externally managed mortgage REIT focused on commercial real estate debt, including first mortgages, subordinate loans and commercial mortgage-backed securities (CMBS). On August 31, 2016, ARI acquired Apollo Residential Mortgage, Inc. (AMTG); by year-end, it had sold all assets acquired from AMTG.
- At December 31, the portfolio included $1,641.9 of commercial mortgage loans, $1,051.2 of subordinate loans, $331.1 of CMBS carried at estimated fair value and $146.4 of CMBS held to maturity.
- Management reported $1.2 billion of commercial real estate debt investments completed during 2016 and an additional $141.9 funded on previously closed loans.
- Underwritten weighted-average IRR was 12.8% current and 13.8% fully levered. These are estimates based on assumptions including no defaults, prepayments or dispositions; actual returns may differ.
Financial performance and condition
| Metric | 2016 | 2015 |
|---|---|---|
| Interest income | $264.4 | $192.2 |
| Interest expense | $63.8 | $48.9 |
| Net interest income | $200.6 | $143.3 |
| Operating expenses | $48.4 | $26.1 |
| Net income | $157.9 | $103.3 |
| Net income available to common stockholders | $127.6 | $91.4 |
| GAAP net income per common share | $1.74 | $1.54 |
| Operating Earnings per common share (non-GAAP) | $1.87 | $1.90 |
| Cash provided by operating activities | $118.9 | $88.1 |
Net interest income increased 40.0%, primarily as commercial and subordinate loan balances and interest income grew; higher average repurchase borrowings and funding costs partly offset that growth. Interest income rose 37.6%. The filing does not present a standard net interest margin measure.
- At year-end, total assets were $3,483.0, total liabilities $1,550.8 and stockholders’ equity $1,932.2, compared with $2,712.6, $1,337.2 and $1,375.4, respectively, in 2015.
- Repurchase borrowings were $1,146.6 principal outstanding ($1,139.8 net of deferred financing costs); convertible notes had $254.8 aggregate principal and $250.0 carrying value. The notes bear a 5.50% coupon and mature in 2019.
- Cash was $201.0, with a further $62.5 of restricted cash pledged as collateral and not available for general corporate use. Management stated it believed available liquidity and access to additional liquidity were sufficient for obligations over the next 12 months.
- Operating cash flow was $118.9. Investing cash flow was positive $1,039.2, principally reflecting proceeds from AMTG asset sales; financing cash flow was negative $1,024.5, including debt repayments and distributions.
- ARI declared common dividends of $1.84 per share for 2016, up from $1.78 in 2015. The fourth-quarter declaration was $0.46 per share. Dividends remain subject to board discretion and cash availability.
Material changes and unusual items
- The AMTG acquisition materially expanded the balance sheet and capital base. ARI issued 13.4 million common shares and 6.9 million Series C preferred shares in the merger, and completed a separate 10.5 million-share common offering in the fourth quarter for approximately $177.8 net proceeds.
- Reported 2016 net income included a $40.0 bargain-purchase gain related to AMTG. Merger-related expenses were $11.4. Excluding those expenses, non-GAAP Operating Earnings were $148.3, or $2.02 per share; the measure excludes various non-cash and valuation items and is not a substitute for GAAP results.
- Other significant 2016 items included a $15.0 loan-loss provision on two Williston, North Dakota multifamily exposures, $26.1 of unrealized securities losses and $29.3 of foreign-currency losses. Derivative gains were $31.2, primarily realized gains on currency contracts.
- Fourth-quarter 2016 net income available to common stockholders was $49.7, or $0.60 per share, versus $21.4, or $0.32 per share, in fourth-quarter 2015. The 2016 quarter included a $10.5 unrealized securities gain and $4.1 realized gain on asset sales; results are affected by non-recurring and mark-to-market items.
- Operating Earnings per share declined from $1.90 to $1.87 despite higher full-year earnings; excluding AMTG merger-related expenses, 2016 Operating Earnings per share was $2.02. Common shares outstanding increased to 91.4 million from 67.2 million.
Outlook, risks and contingencies
Management described commercial real estate debt maturities, borrower refinancing activity and complexity in transactions as continuing investment opportunities, and expected to keep originating and acquiring commercial mortgage and subordinate debt. The filing provides no specific numerical earnings or dividend guidance. Subsequent to year-end, ARI closed approximately $193.5 of investments, funded $190.3 of them and funded a further $67.7 on previously closed loans; it received approximately $41.5 in loan repayments.
- Interest-rate exposure is material: the company reported $1,572.2 of net variable-rate exposure and estimated that a 50-basis-point increase in LIBOR would raise annual net interest income by approximately $7.9, before potential management actions or wider economic effects.
- Repurchase financing creates refinancing, collateral and margin-call risks. ARI had five repurchase agreements with aggregate borrowing capacity of approximately $1,594.8 and reported compliance with applicable financial covenants at year-end. Contractual obligations included $170.4 of unfunded loan commitments.
- Two Williston loans were impaired and placed on non-accrual; the company recorded a combined $15.0 provision. Portfolio credit quality, collateral valuations and borrower refinancing capacity remain important uncertainties.
- Merger-related shareholder litigation remained pending; motions to dismiss had been briefed and oral argument occurred in December 2016. In January 2017, the Department of Justice requested information concerning AMTG’s former residential real estate portfolio. ARI said it was cooperating.
- Other risks include fair-value estimation, illiquid and subordinate investments, foreign-currency exposure, REIT qualification and 1940 Act exclusion, reliance on the Apollo-affiliated manager, related-party conflicts, and the non-performance-based management fee. The independent directors discussed manager performance and fees in February 2017 and decided not to terminate the management agreement.
Investor verification priorities
- Verify the AMTG bargain-purchase accounting, sale proceeds and the extent to which reported earnings depend on merger-related and other unusual items.
- Review the status and expected financial exposure, if any, from the AMTG shareholder litigation and DOJ information request.
- Assess the Williston loan impairments, non-accrual status, collateral assumptions and any subsequent recovery or loss developments.
- Check repurchase-facility maturities, extension conditions, margin-call terms, remaining capacity and compliance with covenants; distinguish restricted collateral cash from available liquidity.
- Evaluate dividend coverage against taxable income and cash generation, while accounting for preferred dividends, share issuance and the increase in common shares outstanding.