Apollo Commercial Real Estate Finance, Inc. — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016. ARI is an externally managed REIT investing primarily in commercial mortgage loans, subordinate debt and commercial mortgage-backed securities (CMBS). Unless otherwise stated, dollar amounts below are in millions.
Financial performance and position
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net interest income | $46.9 | $32.8 | $93.7 | $61.4 |
| Net income | $10.3 | $24.7 | $29.0 | $50.2 |
| Net income available to common stockholders | $4.5 | $22.8 | $17.3 | $46.4 |
| GAAP diluted EPS | $0.06 | $0.39 | $0.24 | $0.85 |
| Operating Earnings, non-GAAP | $33.4 / $0.49 per share | $26.4 / $0.45 per share | $63.3 / $0.93 per share | $48.6 / $0.89 per share |
Higher net interest income reflected growth in commercial mortgage and subordinate loan balances, as well as higher LIBOR. It was partly offset by greater financing costs. Operating expenses increased to $10.2 million in Q2 and $23.6 million for the half-year, including merger-related costs of $1.3 million and $6.4 million, respectively. Operating Earnings is a company-defined non-GAAP measure; ARI cautions that it excludes realized and unrealized investment gains and losses and is not comparable necessarily to similarly titled measures.
- Assets and equity: Total assets were $2,979 million at June 30, versus $2,713 million at year-end 2015. Stockholders’ equity was $1,332 million, down from $1,375 million. The portfolio included $1,278 million of commercial mortgage loans, $923 million of subordinate loans, $453 million of CMBS at fair value and $152 million of held-to-maturity securities.
- Debt and liquidity: Repurchase borrowings were $1,218 million net of deferred financing costs; convertible notes were $249 million and participations sold were $114 million. The weighted-average repo borrowing rate was 3.10%, versus 2.92% at year-end. Cash was $38.6 million and restricted cash $67.4 million. Subject to conditions, unused JPMorgan facility capacity was $168.5 million. Management said it believed liquidity and access to additional liquidity were sufficient for obligations for at least 12 months; the company reported compliance with borrowing covenants.
- Cash flow: Six-month operating cash flow was $45.1 million, compared with $40.5 million in 2015. Investing used $294.3 million and financing provided $220.4 million; cash declined $28.8 million to $38.6 million. Common and preferred cash dividends paid were $63.2 million and $12.8 million, respectively.
- Dividends: ARI declared common dividends of $0.46 per share in each of the first two quarters ($0.92 for the half-year), versus $0.88 for the comparable 2015 period. Series A and B preferred dividends were also declared.
Changes versus the prior comparable period
- Net interest income rose 43% in Q2 and 53% for the first half, driven principally by loan portfolio growth. Commercial mortgage interest income more than doubled year over year for both periods; subordinate-loan interest income also increased.
- GAAP net income and EPS fell substantially despite higher net interest income. Q2 included a $15.0 million loan-loss provision, $11.7 million of unrealized securities losses and a $13.1 million foreign-currency loss; for the first half, those items were $15.0 million, $26.8 million and $17.6 million, respectively. Derivative gains partly offset these items.
- Repurchase borrowings increased from $918 million at December 31, 2015 to $1,218 million net at June 30, alongside growth in assets. The company funded $313.6 million of commercial mortgage loans during the first half.
- Preferred dividends charged against income available to common stockholders rose to $11.7 million for the half-year from $3.7 million in 2015. Weighted-average common shares outstanding also increased.
Outlook, material items and risks
- Portfolio credit: ARI recorded a $10 million provision on a Williston, North Dakota multifamily mortgage loan and a separate $5 million provision on a subordinate loan on the same property. It ceased accruing PIK interest on both exposures. The filing describes quarterly loan impairment reviews but does not provide a broader quantified loss outlook.
- Market commentary: Management cited commercial real estate refinancing and acquisition demand, upcoming debt maturities and potential opportunities for non-CMBS lenders. It noted subdued 2016 CMBS issuance and uncertainty around Dodd-Frank risk-retention rules. No specific earnings or dividend guidance was provided. The company’s stated leverage expectation was borrowings on loans of approximately 35% of the value of its total loan portfolio.
- Rate exposure: ARI reported $910.3 million of net variable-rate exposure. A 50-basis-point increase in LIBOR was estimated to raise quarterly net interest income by approximately $1.1 million, assuming no changes in financial structure. The estimate does not account for potential changes in economic activity or management actions.
- Proposed AMTG merger: The agreement contemplated acquiring Apollo Residential Mortgage, Inc. for 89.25% of AMTG book value plus assumption of $172.5 million of preferred stock. Per AMTG common share, consideration was 0.417571 ARI shares and $6.86 cash, subject to adjustments; common stock issuance was capped at 13.4 million shares valued at $16.75 each. Closing remained subject to customary conditions, including AMTG shareholder approval. Athene committed up to $200 million in bridge financing and agreed to purchase approximately $1.2 billion of primarily non-Agency residential mortgage-backed securities after closing. The filing does not establish that the merger closed.
- Litigation and contingencies: Consolidated shareholder lawsuits challenged the proposed merger and related Athene transactions, alleging, among other things, inadequate consideration and disclosure. Plaintiffs sought injunctive relief and unspecified damages; defendants said they considered the claims without merit and intended to defend them. At quarter-end, loan funding commitments totaled $155.1 million.
- Other risks: Fair-value losses on CMBS, credit deterioration, real estate values, repo financing and margin calls, interest-rate mismatch, foreign-currency exposure and merger execution could affect results. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- Subsequent merger status, final consideration and funding arrangements, including the Athene asset sale and bridge commitment.
- Performance and recoverability of the two Williston loans, including the effect of halted PIK accruals and the adequacy of loss provisions.
- CMBS valuation sensitivity: the filing reports $39.0 million of gross unrealized losses on fair-value-option CMBS at June 30, compared with $13.7 million at year-end.
- Liquidity after planned loan commitments, dividends and any merger-related cash requirements; verify unused facility capacity and covenant headroom.
- Coverage and sustainability of the $0.46 quarterly common dividend using both GAAP results and the company’s non-GAAP Operating Earnings, recognizing their different treatment of valuation and credit items.
- Progress and potential costs of merger litigation, and the final terms and timing of any required approvals.