Apollo Commercial Real Estate Finance, Inc. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. Unless otherwise noted, financial amounts below are in millions of dollars. The filing reports in thousands.
Business context and reporting period
Apollo Commercial Real Estate Finance, Inc. (ARI) is an externally managed REIT investing primarily in commercial first-mortgage loans, subordinate loans and commercial mortgage-backed securities (CMBS). On August 31, 2016, ARI completed its merger with Apollo Residential Mortgage, Inc. (AMTG); results include AMTG only from the acquisition date. ARI subsequently sold substantially all of the acquired assets, primarily residential mortgage-backed securities.
Financial performance and position
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net interest income | $53.3 | $38.7 | $147.0 | $100.1 |
| Net income | $69.9 | $25.8 | $98.8 | $76.0 |
| Net income available to common stockholders | $60.6 | $23.5 | $77.9 | $70.0 |
| GAAP diluted EPS | $0.83 | $0.39 | $1.11 | $1.24 |
| Operating Earnings, non-GAAP | $32.7 | $31.7 | $96.0 | $80.3 |
| Operating Earnings per share, non-GAAP | $0.45 | $0.53 | $1.38 | $1.42 |
- Net interest income increased 37.8% for the quarter and 46.9% for the nine-month period, principally due to growth in commercial mortgage and subordinate loan income. Higher average repo borrowings increased interest expense.
- Q3 GAAP earnings included a $40.0 million bargain purchase gain from the AMTG merger. Nine-month results also included $15.0 million of loan-loss provisions, $36.6 million of unrealized CMBS losses and $21.9 million of foreign-currency losses. These items help explain why GAAP EPS and Operating Earnings moved differently.
- Merger-related costs were $4.9 million for Q3 and $11.4 million for the nine months. Operating Earnings excluding those costs were $37.7 million, or $0.52 per share, in Q3 and $107.4 million, or $1.54 per share, for the nine months.
- No conventional operating margin is presented; the filing focuses on net interest income and earnings measures.
Balance sheet, cash flow and liquidity
- At September 30, 2016, total assets were $3.199 billion, stockholders’ equity was $1.747 billion, cash was $254.6 million and restricted cash was $62.3 million. Commercial mortgage loans were $1.427 billion and subordinate loans were $882.2 million.
- Repurchase-agreement borrowings were $1.021 billion before deferred financing costs; convertible notes had a $249.5 million carrying value, and participations sold were $110.9 million. Repo borrowings had a 3.01% weighted-average rate. Management reported covenant compliance.
- Nine-month operating cash flow was $79.7 million. Investing activities provided $1.388 billion, principally reflecting AMTG asset-sale proceeds; financing activities used $1.280 billion. Cash and cash equivalents increased $187.2 million to $254.6 million.
- Management said available liquidity and access to additional liquidity were sufficient for obligations over at least the next 12 months. ARI reported $294.9 million of unused capacity under its JPMorgan facility and had entered a new $300 million Deutsche Bank repurchase facility, with no borrowings drawn at quarter-end.
- Unfunded loan commitments totaled $173.7 million. Contractual obligations, including estimated interest and commitments, were reported as $1.535 billion; scheduled amounts depend in part on assumptions about extensions and funding timing.
- The common dividend declared was $0.46 per share for the quarter. The filing states ARI intends to continue regular quarterly distributions, subject to board discretion and operating results.
Material changes and management commentary
- Compared with year-end 2015, the commercial mortgage loan portfolio grew from $994.3 million to $1.427 billion, while subordinate loans declined from $931.4 million to $882.2 million and fair-value CMBS declined from $493.1 million to $347.5 million.
- The merger issued 13.4 million common shares and 6.9 million Series C preferred shares. Common shares outstanding increased to 80.8 million from 67.2 million at year-end 2015.
- Management described commercial real estate lending opportunities as attractive, citing upcoming property-debt maturities, subdued 2016 CMBS issuance and the expected effect of new CMBS risk-retention rules. ARI said it would continue to focus on property value and complex financing transactions. Its stated leverage expectation was borrowings of approximately 35% of the value of its total loan portfolio.
- Subsequent to quarter-end, ARI reported closing an $80 million first-mortgage loan, a $130 million junior mezzanine loan and a $30 million preferred-equity investment, and increasing its London mezzanine-loan exposure.
Risks, contingencies and unusual items
- ARI recorded $10 million of provision on a Williston, North Dakota multifamily first-mortgage loan and $5 million on a related subordinate loan during the nine months. It ceased accruing PIK interest on both exposures; no provision was recorded in Q3.
- Three consolidated lawsuits challenged the AMTG merger and sought injunctive relief and unspecified damages and fees. Defendants moved to dismiss; plaintiffs filed an opposition. ARI said it considered the claims meritless and intended to defend them.
- As AMTG’s successor, ARI received subpoenas from the New York Department of Financial Services concerning an inquiry into seller-financed real estate contracts. ARI said it intended to cooperate and believed AMTG’s program complied with law.
- Floating-rate assets and borrowings, collateral values, repo margin calls, refinancing, foreign-currency exposure and credit performance are material risks. ARI estimated that a 50-basis-point LIBOR increase would increase quarterly net interest income by approximately $1.5 million, assuming no changes to its financial structure.
- Management’s investment-return figures are underwritten estimates, not forecasts or guarantees. The filing cautions that actual returns may differ, including if financing terms, funding, repayments, extensions or credit performance vary from assumptions.
Important facts for investors to verify
- How much of Q3 GAAP earnings depended on the $40.0 million merger bargain-purchase gain, and how recurring earnings compare using Operating Earnings and merger-cost adjustments.
- Current performance, collateral coverage and recovery prospects for the Williston loans, including the effect of suspending PIK interest.
- Post-merger portfolio composition and realized results from the sale of acquired AMTG assets, alongside the merger’s dilution and preferred-dividend burden.
- Availability and terms of repo financing, covenant headroom, margin-call exposure, near-term maturities and capacity to fund $173.7 million of commitments while maintaining distributions.
- Developments in the merger litigation and the New York regulatory inquiry, including any material costs, liabilities or outcomes.