Apollo Commercial Real Estate Finance, Inc. — 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017. Amounts are in thousands of dollars except per-share data. This is an annual report; the filing also presents unaudited quarterly results, including fourth-quarter figures.
Business context
Apollo Commercial Real Estate Finance, Inc. (ARI) is an externally managed REIT that originates and invests primarily in commercial first-mortgage loans, subordinate loans and other commercial real estate debt. At year-end, its loan portfolio totaled $3.680 billion across 59 loans. The company’s stated objective is to generate long-term risk-adjusted returns primarily through dividends.
Financial and operating results
| Metric | 2017 | 2016 |
|---|---|---|
| Interest income | $338.5 million | $264.4 million |
| Interest expense | $78.1 million | $63.8 million |
| Net interest income | $260.5 million | $200.6 million |
| Net income | $193.0 million | $157.9 million |
| Net income available to common stockholders | $156.3 million | $127.6 million |
| GAAP diluted EPS | $1.54 | $1.74 |
| Common dividends declared per share | $1.84 | $1.84 |
| Operating cash flow | $154.9 million | $118.9 million |
| Total assets | $4.089 billion | $3.483 billion |
| Total stockholders’ equity | $2.088 billion | $1.932 billion |
- Net interest income rose $59.8 million, principally from portfolio growth and higher LIBOR, partly offset by higher financing costs and lower securities balances. Interest income included $25.2 million of payment-in-kind interest.
- GAAP net income included a $42.7 million realized loss on sales of remaining CMBS, substantially offset by reversal of $37.2 million in previously recorded unrealized losses, and a $1.9 million loss on early debt extinguishment. The company also recorded $5.0 million in loan-loss provisions and impairments.
- Non-GAAP Operating Earnings were $146.8 million, or $1.45 per share; excluding CMBS-sale losses and related costs, the company reported $191.4 million, or $1.89 per share. Management cautions that this measure is not GAAP and may not be comparable with other companies’ measures.
- Cash and cash equivalents were $77.7 million at year-end; an additional $302.8 million of loan proceeds was held by a servicer. Net cash decreased by $185.8 million during the year, reflecting investment activity, financing and distributions.
- Secured debt arrangements had $1.345 billion of gross borrowings outstanding before $14.3 million of deferred financing costs. Convertible notes had $599.8 million aggregate principal outstanding: $254.8 million of 5.50% notes due 2019 and $345.0 million of 4.75% notes due 2022. Reported debt-to-equity was 0.9x, using the company’s stated assumption regarding loan proceeds held by the servicer.
- Unfunded loan commitments were $435.6 million. The company reported $2.250 billion of contractual obligations, including estimated interest and those commitments. It said it had sufficient liquidity and access to additional liquidity for at least 12 months and was in compliance with secured-debt covenants at year-end.
Material changes and portfolio developments
- Loan carrying value increased to $3.680 billion from $2.693 billion. During 2017, ARI committed $2.043 billion to loans, funded $1.598 billion at closing, funded $193.1 million on earlier commitments and received $891.8 million in repayments.
- The company sold all remaining securities, including CMBS, during 2017 and exited its investment in Champ LP, recording a $3.3 million loss on that sale.
- Common shares outstanding increased to 107.1 million from 91.4 million. A June 2017 common-stock offering generated approximately $248.9 million in net proceeds; ARI also issued $345.0 million of 2022 convertible notes.
- ARI redeemed all 3.45 million shares of 8.625% Series A preferred stock in August 2017. At year-end, it had 6.77 million Series B and 6.90 million Series C preferred shares outstanding; each had an 8.00% stated dividend rate, subject to the Series B terms after September 2020.
- Common dividends remained $0.46 per share each quarter, or $1.84 for the year. Distributions declared exceeded earnings and profits for tax purposes; $0.4211 of the January 2018 distribution was treated as a 2018 distribution for federal tax purposes.
Outlook, risks and unusual matters
- Management expected continued deployment into senior performing commercial mortgage loans, subordinate financings and other real estate debt. It cited commercial real estate debt maturities and opportunities for complex transactions as supporting investment prospects. This is commentary, not quantified earnings or dividend guidance.
- Management expects total borrowings on loans to be approximately 35% of the value of the total loan portfolio. All secured borrowings at year-end were floating-rate; a hypothetical 100-basis-point LIBOR increase was estimated to raise annual net interest income by approximately $22.1 million, or $0.20 per share, assuming no structural changes.
- Key risks include borrower defaults and collateral-value declines; leverage, refinancing and margin-call exposure; interest-rate and foreign-currency movements; illiquid or subjective asset valuations; and reliance on short-term secured financing. The loan portfolio was concentrated in Manhattan, representing 31.9% of carrying value. Internal risk ratings classified 7% of loans as high risk or impaired/loss likely (ratings 4 and 5); 83% were rated moderate/average risk.
- The Department of Justice requested information in January 2017 for a preliminary investigation concerning aspects of the former residential portfolio acquired in the AMTG merger and sold in 2016. ARI stated that it was cooperating; the filing does not state an outcome or quantify a potential exposure.
- The Tax Cuts and Jobs Act was enacted in December 2017. Management did not expect a significant impact on consolidated financial statements but noted that earlier tax recognition of some income could affect REIT distribution requirements. The company also identified expected higher provisions for potential loan losses under a future accounting standard, while its impact was still under evaluation.
- ARI is externally managed under a fee arrangement based on stockholders’ equity, with a 1.5% annual base fee and reimbursable expenses. The agreement’s term ran through September 2018, with automatic renewals; termination without cause is restricted and may require a payment. Independent directors reviewed the agreement in February 2018 and the company decided not to terminate it.
- Deloitte & Touche issued unqualified opinions on the financial statements and internal control over financial reporting. Management also concluded disclosure controls and internal control over financial reporting were effective as of year-end.
Important facts for investors to verify
- Whether loan repayments, future commitment funding and portfolio growth sustain net interest income and cash available for distributions, particularly given PIK interest and the gap between GAAP EPS and the $1.84 annual common dividend.
- Credit performance and recoverability of the two loans rated 5, including the Bethesda condominium exposure and the Williston, North Dakota multifamily exposure; also track the $16.981 million year-end aggregate loan-loss provision.
- Facility extensions, refinancing terms, borrowing costs and collateral requirements, especially for the Deutsche Bank facility with a March 2018 stated maturity and extension options, and the company’s capacity to fund $435.6 million of commitments.
- Actual results versus management’s interest-rate sensitivity estimate, and the effects of derivatives, foreign exchange and floating-rate funding on earnings and liquidity.
- Any developments in the DOJ inquiry, related-party transactions and management-fee terms, and the effects of tax-law and REIT qualification requirements on future distributions.