Apollo Commercial Real Estate Finance, Inc. — Q2 2015 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2015. Amounts are in U.S. dollars; financial statement amounts are shown in millions unless otherwise stated.
Business context
Apollo Commercial Real Estate Finance is an externally managed REIT that originates, acquires, invests in and manages commercial mortgage loans, subordinate financings, commercial mortgage-backed securities (CMBS) and other commercial real estate debt investments.
Financial performance and position
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Net interest income | $32.8 | $23.8 | $61.4 | $43.2 |
| Net income | $24.7 | $24.0 | $50.2 | $41.5 |
| Net income available to common stockholders | $22.8 | $22.1 | $46.4 | $37.8 |
| GAAP diluted net income per common share | $0.39 | $0.51 | $0.85 | $0.94 |
| Operating Earnings per common share (non-GAAP) | $0.45 | $0.42 | $0.89 | $0.80 |
| Common dividend declared per share | $0.44 | $0.40 | $0.88 | $0.80 |
- Net interest income increased 38% for the quarter and 42% for the first half, primarily reflecting growth in invested capital and loan and CMBS holdings. Interest expense also rose substantially, reflecting higher repo borrowings and a higher reported average funding cost.
- For the quarter, net income was slightly higher year over year, while GAAP earnings per share declined. The company completed a 11.5 million-share offering in March 2015, increasing shares outstanding; weighted-average basic shares for Q2 rose to 58.4 million from 42.9 million.
- Operating Earnings, a company-defined non-GAAP measure intended to approximate cash available for distribution, increased to $26.4 million ($0.45 per share) in Q2 from $18.0 million ($0.42 per share). The company cautions that this measure excludes realized and unrealized investment gains and losses and is not a substitute for GAAP results.
- At June 30, total assets were $2,333.4 million, compared with $1,845.1 million at December 31, 2014. Stockholders’ equity was $1,044.8 million, compared with $855.1 million.
- Investment balances included $704.0 million of commercial mortgage loans, $830.2 million of subordinate loans, and $673.2 million of CMBS at carrying value. The investment summary reported a 9.5% weighted-average yield across its portfolio; this is not a reported net interest margin.
- Cash was $48.8 million and restricted cash was $34.5 million. Six-month operating cash flow was $40.5 million; investing cash outflow was $460.1 million and financing cash inflow was $427.8 million. Cash increased $8.2 million to $48.8 million.
- Repurchase borrowings totaled $878.4 million, up from $622.2 million at year-end. Convertible senior notes had a $247.3 million carrying value, and participations sold were $121.0 million. Total liabilities were $1,288.6 million.
- Management stated it believed liquidity, including access to additional financing, was sufficient for obligations for at least the next 12 months. Available borrowing capacity under the JPMorgan facility was $4.4 million at quarter-end. Unfunded loan commitments totaled $444.4 million.
Material changes and unusual items
- Commercial mortgage loans increased from $458.5 million at year-end to $704.0 million; subordinate loans rose from $561.2 million to $830.2 million. The company funded new investments and commitments, including a large Manhattan condominium development mezzanine loan.
- The company issued 11.5 million common shares in a follow-on offering for approximately $193.1 million net proceeds. It also entered into a Goldman financing and amended its JPMorgan facility, increasing its maximum aggregate purchase price from $300 million to $400 million.
- Q2 included a $2.3 million unrealized loss on securities, a $2.9 million foreign currency gain and a $3.2 million derivative loss. For the first half, those items were a $1.1 million unrealized securities gain, a $5.6 million foreign currency gain and a $6.2 million derivative loss. Derivative fair-value changes are recognized in earnings; the derivatives were not designated as GAAP hedges.
- The company sold about 48% of its interest in Champ LP to an Apollo-managed fund at cost for approximately $20.8 million, reducing its remaining unfunded commitment to approximately $3.6 million. Related-party relationships and management fees are disclosed in the filing.
- No loan-loss allowance was considered necessary at June 30, 2015. The filing reported no material legal proceedings and no material changes to the risk factors disclosed in the 2014 Form 10-K.
Outlook, risks and contingencies
- The company provided no specific earnings or investment guidance. Management described commercial real estate lending opportunities as supported by debt maturities expected through 2017 and anticipated continued refinancing and acquisition activity. It noted that the Federal Reserve might raise interest rates before the end of 2015.
- Management generally expects borrowings on loans to be approximately 35% of the value of its total loan portfolio. At June 30, the filing reported $1,202.2 million of floating-rate assets and net variable-rate exposure of $716.3 million; a 50-basis-point LIBOR increase was estimated to increase quarterly net interest income by approximately $0.8 million, before any resulting business or financing changes.
- Key risks include borrower and property credit deterioration, changes in real estate values, interest-rate and funding-cost movements, CMBS fair-value volatility, prepayments, liquidity and refinancing needs, and margin calls or covenant requirements under repurchase financing. The company also faces foreign-currency exposure on non-U.S.-dollar loans.
- Repo facilities contain financial covenants and collateral terms; certain agreements permit margin calls. The company said it was in compliance with its repo financial covenants at quarter-end. Contractual borrowing obligations, including estimated interest, totaled $937.5 million.
- The company declared a $0.44-per-share common dividend payable in October 2015 after quarter-end. Future distributions remain subject to board discretion, operating results and liquidity; REIT status generally requires distribution of at least 90% of taxable income.
- Subsequent to quarter-end, the company closed a $50 million mezzanine loan for a New York City condominium development and funded $21.7 million on previously closed loans.
Important facts for investors to verify
- Whether loan growth and reported underwritten returns translate into realized returns, particularly given $444.4 million of unfunded loan commitments and the concentration of investments in real estate collateral.
- Available liquidity after funding commitments, dividends and debt service, and the company’s ability to renew or replace repo financing as facilities mature or collateral values change.
- Compliance with financing covenants, collateral advance rates and potential margin-call exposure; distinguish restricted cash from cash available for general use.
- The drivers of GAAP per-share earnings versus Operating Earnings, including share-count growth, fair-value marks, currency movements, derivative costs and non-cash convertible-note amortization.
- The sustainability of the $0.44 quarterly common dividend relative to taxable income, cash generation and financing needs.
- Related-party governance and costs, including the external manager’s 1.5% annual base fee on defined stockholders’ equity, expense reimbursements and the management agreement’s renewal and termination terms.