Apollo Commercial Real Estate Finance, Inc. annual report, FY2019

Apollo Commercial Real Estate Finance, Inc. — 2019 Form 10-K

Reporting period: Fiscal year ended December 31, 2019. This is an annual filing; selected fourth-quarter comparisons are included below. Dollar amounts are in U.S. dollars unless noted.

Business context

ARI is an externally managed mortgage REIT that originates, acquires and manages commercial real estate debt, primarily first mortgage loans and subordinate financings. At year-end, its loan portfolio had $6.38 billion carrying value across 72 loans. Management’s stated objective is to generate long-term risk-adjusted returns, primarily through dividends.

Financial and operating performance

Metric	2019	2018
Interest income	$487.4 million	$403.9 million
Net interest income	$334.5 million	$289.3 million
Net income	$230.2 million	$220.0 million
Net income available to common stockholders	$211.6 million	$192.6 million
Diluted GAAP earnings per common share	$1.40	$1.48
Operating Earnings per share, non-GAAP	$1.80	$1.78
Common dividends declared per share	$1.84	$1.84

Net interest income grew $45.2 million, mainly from portfolio expansion; higher financing expense partly offset the increase. Interest expense rose to $152.9 million from $114.6 million.
Net income included $20.0 million of net loan-loss provisions, a $12.5 million realized investment loss, $19.8 million of foreign-currency gains, a $14.4 million loss on currency forwards and a $14.5 million unrealized interest-rate-swap loss.
Operating Earnings is a company-defined non-GAAP measure. It excludes specified items, including loan-loss provisions and certain unrealized gains and losses; it should not be treated as a substitute for GAAP results.
Fourth-quarter net interest income was $81.4 million versus $77.8 million in Q4 2018; net income was $71.9 million versus $53.0 million, and diluted EPS was $0.42 versus $0.34.

Balance sheet, funding and liquidity

Total assets were $6.89 billion, up from $5.10 billion; total liabilities were $4.26 billion, up from $2.59 billion; stockholders’ equity was $2.63 billion, up from $2.51 billion.
Year-end loan balances comprised $5.33 billion of commercial mortgage loans and $1.05 billion of subordinate loans and other lending assets. Portfolio weighted-average coupon was 6.5% and all-in yield was 7.4%; stated secured-debt cost of funds for the commercial mortgage portfolio was 3.3%.
Cash and cash equivalents were $452.3 million, compared with $109.8 million a year earlier. Operating cash flow was $273.4 million, versus $266.0 million. Investing activities used $1.44 billion; financing activities provided $1.50 billion.
Secured borrowings were $3.10 billion, alongside $575.0 million principal of convertible notes and a $497.5 million senior secured term loan. Reported debt-to-equity was 1.4x, up from 0.9x; the filing’s ratio is net of cash and loan proceeds held by the servicer.
Unfunded loan commitments totaled $1.95 billion. Management said it believed liquidity and access to additional liquidity were sufficient for obligations for at least the next 12 months. The filing notes secured facilities can involve margin calls, covenant restrictions and refinancing risk.
Common dividends remained $1.84 per share. GAAP diluted EPS was below the annual dividend per share; the board determines distributions, and REIT distribution requirements apply to taxable income, not GAAP earnings.

Material changes and notable items

The loan portfolio expanded to $6.38 billion from $4.93 billion. During 2019, ARI committed $4.2 billion to loans, funded $3.0 billion of those commitments and received $2.0 billion in repayments.
ARI raised $314.8 million net from a common-stock offering of 17.25 million shares. It also issued a $500 million senior secured term loan in May 2019, bearing LIBOR plus 2.75% and maturing in 2026; a swap fixed LIBOR at 2.12%, producing a stated effective coupon of 4.87%.
Debt-to-equity increased as borrowings grew to support the larger portfolio. Management expected the ratio could increase further as capital is deployed into mortgage loans.
Book value per common share declined to $16.03 from $16.20. The equity offering increased book value per share, while loan provisions and swap losses weighed on it.
ARI redeemed all Series C preferred shares in June 2019. Series B preferred shares remained outstanding, with an 8.00% initial dividend rate through September 2020, after which the rate is subject to a fixed-to-floating formula.

Outlook, risks and contingencies

Management expected to continue originating and acquiring performing commercial mortgage and subordinate loans. It cited commercial real estate debt maturities and lending opportunities, but provided no quantitative earnings or dividend guidance.
Credit quality warrants attention: 90% of loan carrying value was rated moderate/average risk (rating 3), 3% high risk/potential for loss (rating 4), and 2% impaired/loss likely (rating 5). A $182.9 million Miami predevelopment loan was transferred to non-accrual in December 2019; management said it was not impaired and the properties were being marketed for sale.
ARI recorded a cumulative $47.0 million provision against a Cincinnati retail loan, ceased accruing interest on it in September 2019 and applied cash receipts to carrying value. A Bethesda residential loan also had a $13.0 million cumulative provision and impairment. A Williston, North Dakota loan disposition generated a $12.5 million realized loss.
ARI estimated a $31.0 million general CECL reserve at December 31, 2019, expected to reduce common equity by about $0.20 per share upon adoption on January 1, 2020. Management did not expect CECL to affect operating cash flows, investments or financing decisions.
Foreign assets represented 30% of portfolio carrying value; the U.K. alone represented 20%. Currency volatility, Brexit-related uncertainty, property-market conditions and foreign-law risks could affect performance. The portfolio was 95% floating-rate, and sensitivity estimates showed a 50-basis-point rate increase would raise annual net interest income by $9.5 million, while a 50-basis-point decrease would reduce it by $2.4 million, subject to stated assumptions.
Other principal risks include borrower defaults and collateral-value declines, refinancing and short-term repo-facility dependence, margin calls, interest-rate and currency mismatch, LIBOR transition, portfolio concentration, and Apollo/Manager conflicts and dependence. The Manager’s base fee is 1.5% annually of contractually defined stockholders’ equity; independent directors reviewed performance and fees in February 2020 and elected not to terminate the management agreement.
A lawsuit alleging interference with a project-related equity put right sought $700 million in damages. The complaint was dismissed in full in November 2019; plaintiffs appealed, and ARI said it would defend the case and did not expect a material financial-statement effect.
The independent auditor gave an unqualified opinion on the financial statements and internal control over financial reporting. Loan impairment estimates were identified as a critical audit matter.

Important facts for investors to verify

Subsequent performance and repayment status of the Miami non-accrual loan, the Cincinnati retail exposure and the Bethesda residential loan.
Actual CECL adoption adjustment compared with the estimated $31.0 million reserve and $0.20 per-share equity impact.
Renewal, extension and collateral requirements for secured facilities, especially facilities with near-term maturities, and compliance with all financial covenants.
Dividend sustainability against taxable income, cash generation, credit losses, unfunded commitments and financing costs.
Portfolio concentrations by geography and property type, including U.K. exposure, and the progress of the $1.95 billion unfunded commitment schedule.
Future dilution, convertible-note treatment and related-party transactions, including asset sales to Apollo-affiliated funds and management-fee arrangements.