Apollo Commercial Real Estate Finance Inc (ARI) 2021 Q4 法說會逐字稿

I'd like to remind everyone that today's call and webcast are being recorded. Please note that they are from the property of Apollo Commercial Real Estate Finance, Inc. and that any unauthorized broadcast in any form is strictly prohibited. Information about the audio replay of this call is available in our earnings press release.

I'd also like to call your attention to the customary safe harbor disclosure in our press release regarding forward-looking statements. Today's conference call and webcast may include forward-looking statements and projections, and we ask that you refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from these statements and projections.

In addition, we will be discussing certain non-GAAP measures on this call, which management believes are relevant to assessing the company's financial performance. These measures are reconciled to GAAP figures in our earnings presentation, which is available on the Stockholders section of our website. We do not undertake any obligation to update our forward-looking statements or projections unless required by law.

To obtain copies of our latest SEC filings, please visit our website at www.apolloreit.com or call us at (212) 515-3200.

At this time, I'd like to turn the call over to company's Chief Executive Officer, Stuart Rothstein.

Thank you, operator. Good morning and thank you all for joining us on the Apollo Commercial Real Estate Finance Year-end 2021 Earnings Call. I'm joined today, as usual, by Scott Weiner, our Chief Investment Officer.

ARI delivered strong operational and financial results in 2021, and I am extremely proud of the effort and performance of our team. We committed to $3.2 billion of new mortgages on behalf of ARI and grew its mortgage portfolio to $7.9 billion at year-end, a 20% annual increase. Apollo continued to invest in talent, growing the commercial real estate credit team to 40 investment professionals in the U.S. and Europe, broadening both originations and asset management capabilities. We fortified the balance sheet through the addition of $800 million of term leverage throughout the year, extending maturities at an attractive cost and increasing the pool of unencumbered assets to $1.9 billion at year-end. Most importantly, our efforts resulted in a well-covered dividend to ARI shareholders.

2021 was a record year for real estate transaction volume, leading to a record year for commercial real estate loan originations. As discussed throughout the year, there was robust competition in the lending market and a variety of financing options available to borrowers from CMBS, banks and insurance companies, debt funds and mortgage REITs. In this market environment, relationships, reputation and track record are critical components of success, and we believe ARI's strong performance is reflective of the core advantages that Apollo's commercial real estate credit platform continues to provide the company.

Across commercial real estate credit, Apollo completed $13 billion of transactions in 2021 and strengthened its position as a leading global provider of commercial real estate financing. There are a few themes from our originations activity in 2021 worth mentioning. First, the scale and expertise of Apollo's commercial real estate credit platform enables ARI to participate in several larger transactions that were cooriginated alongside other Apollo funds, which led to meaningful deployment on behalf of ARI. Next, I again want to highlight the success we achieved in Europe. Over 60% of ARI's 2021 origination volume was for transactions in Western Europe as our well-established European commercial real estate credit team continues to do an excellent job disintermediating traditional financial institutions and capturing market share. The types of transactions, quality of equity sponsorship and deal structures for ARI's European loans are very similar to the transactions we complete in the United States, and we expect to remain active in Europe in 2022.

Lastly, I want to highlight that 60% of our 2021 deals were with repeat borrowers, many of whom are top-tier global sponsors. ARI also closed transactions with 8 new borrower relationships totaling $1.3 billion, and we are very focused on converting those new borrowers into repeat clients.

Importantly, our investment momentum has carried into 2022. To date, we have already closed approximately $275 million new loan commitments, and I anticipate that we will close approximately another $2 billion of commitments prior to the end of the first quarter. While ARI's pace of originations and deployment is benefiting from the strength of the real estate capital markets, that strength is also reflected in the significant amount of repayment activity in ARI's portfolio.

During 2021, ARI received $1.9 billion of repayments, with over 40% of the total occurring in the fourth quarter. Notably, ARI received repayments from over $300 million of hotel loans, approximately $560 million of loans collateralized by for-sale residential projects and over $850 million from loan exposures across a variety of property types in New York City. As a result, our overall net exposure to New York City was reduced to 25% as compared to 36% at the end of 2020.

Pivoting to the portfolio, we remain focused on proactive asset management. Our loan portfolio totaled $7.9 billion at year-end, and there were no material changes to the credit quality of the portfolio or to our credit outlook since our last call. Notably, subsequent to quarter end, the Oxford Circus retail property collateralizing one of ARI's largest outstanding loans was sold for an amount well in excess of basis, resulting in full repayment of principal, plus all accrued contractual and default interest.

Shifting to financial performance. ARI reported distributable earnings per share for the year of $1.48 per share, resulting in a dividend coverage ratio of 106% for the $1.40 common stock dividend. As I have discussed previously, the Board of Directors looks at multiple factors when setting the dividend, including asset level returns and the return on equity from new originations, factoring in financing costs and the appropriate leverage level for the company. The Board also seeks to take a longer-term view on achievable distributable earnings and seeks to limit the impact of quarterly fluctuations. Our goal is to provide a stable dividend without deploying capital into loans with a higher risk profile or using excessive leverage.

At present, we anticipate the annual dividend for 2022 will be consistent with the existing dividend run rate, subject to the Board's approval. As is customary, our first quarter dividend for 2022 will be announced in March. I also want to highlight some of our capital market achievements in 2021. Throughout the year, we acted opportunistically to strengthen ARI's balance sheet and term out leverage when economically feasible. We added $800 million of term leverage during the year with successful issuances of both the Term Loan B and secured notes. ARI ended the year with $1.9 billion of unencumbered assets, which we believe is one of the highest levels amongst our peer set.

Importantly, we remain conservative with respect to leverage with the company's debt-to-equity ratio at 2.4x at year-end, consistent with the ongoing portfolio shift into first mortgages.

Finally, we announced the appointment of Anastasia Mironova, a seasoned mortgage REIT professional, to the position of Chief Financial Officer of ARI, and she will join us early in the second quarter. I want to thank the team at Apollo dedicated to ARI for all of their hard work this past year, and I look forward to reporting on ARI's achievements as we progress into 2022.

And with that, we will open the call up for questions. Operator?

(Operator Instructions) Our first question comes from the line of Doug Harter from Credit Suisse.

Just on the repayment of the U.K. retail loan, will that create any kind of catch-up income in the first quarter with the repayments?

No. We were accruing the default interest along the way, Doug, as we were highly confident that we were going to get it paid back.

Great. And then just any update you can give us around some of the other watch list assets and where you might be as being able to kind of free up some of that capital for redeployment?

Yes. Obviously, nothing's happened yet of a material nature. Otherwise, I probably would have included it in my comments. But I would say anecdotally, at a high level, in Brooklyn on the Fulton Street asset where we've articulated our strategy to go forward with the development of a multifamily asset there. We are effectively approaching the market now for a construction loan. And we are also exploring, though, having committed to the possibility of bringing in a partner on the equity side that would free up some of the capital that ARI has invested into the transaction in order to deploy at least a portion of that capital productively in the short term.

I think other near-term possibilities for freeing up some of the nonperforming capital today are around our hotel asset in Washington, D.C., which I think we are exploring options for selling that asset. Those are probably the 2 nearest terms paths towards freeing up some of the nonperforming capital. And then on the other, call them, focused assets continuing to score different possibilities on the Miami asset and grinding through the asset management on the Liberty Center asset in Ohio.

And I would say with respect to the Steinway project here in New York, certainly better foot traffic, definitely more interest from potential buyers. A few additional contracts have been signed, but definitely more work to be done in terms of finishing construction and then progress on the sales side.

Our next question comes from the line of Tim Hayes from BTIG.

Appreciate the comments around the dividend in your prepared remarks. Just kind of want to maybe touch on that a little bit more given -- obviously, not earning it this quarter. There was what I saw to be net contraction so far in the first quarter, but it sounds like the pipeline is very robust, and I mean I don't know what payments are going to look like, but maybe you get back to net growth before the end of the quarter. But as I think about kind of where the portfolio is today, funding costs have also kind of shifted a little bit higher as you brought on more corporate debt. What gives you the confidence that you believe you can cover the dividend on an annual basis? And where do you think kind of that coverage comes from? Is it growth and a little bit higher leverage? Or is some of it dependent on kind of the expectations for higher rates this year? Any comments on that would be helpful.

Yes. Look, I think we -- let me start sort of where you ended and then work through the question. We certainly run a version of the model internally that reflects some of what people are expecting on the short end of the curve, which would clearly be beneficial from an earnings perspective and obviously saw the piece you put out. Recently, it sort of alludes to the potential pickup across the sector if short-term rates rose.

I would say my comment with respect to covering the dividend is not dependent on, call it, the expectations of the short end of the curve. It's really just -- I think a lot of what took place in the fourth quarter was really timing between when repayments occurred and sort of the closing of deals. And I've spoken for years on the challenges of committing capital to deals that we know are ours. But at the end of the day, these are privately negotiated transactions. And we oftentimes are not in control of timing when it comes to forcing things to close. But I would say just given the pace of the pipeline, what I think we can earn on the pipeline on a ROE basis given returns at the asset level and then really not doing anything unexpected with respect to leverage, which is to say we typically to the extent we're using asset-specific leverage, typically financing things at roughly 70% on a secured borrowing facility and then not changing the overall corporate leverage as it exists today. Recognize we have some of that corporate leverage that matures later on this year in the form of a convertible note, and we will certainly focus on getting that repaid and replaced, but I don't envision increasing corporate leverage.

So it's really -- from our perspective, the ROEs we're generating at the asset level on new deployment work. I think we are obviously very focused on being as efficient as -- from a capital deployment perspective as we can be vis-a-vis timing and trying to line up repayments and new deployments as best as we can. There might be some leakage. And I think my comments were meant to indicate that if there is a quarter where things didn't line up as best as we would have hoped from a timing perspective, and it indicates we're a penny light here or there, that's not going to impact dividend policy at the end of the day.

And then to reference back to Doug's question, if we are successful in turning some of the nonearning capital into capital that can be deployed and achieve our typical ROEs, I think there's pickup in earnings from that as well that we're sort of taking a cautious view on but are certainly optimistic that we'll succeed on some of that this year as well.

Right. No, that's super helpful kind of breakdown of how you're thinking about it. And just a good segue since you kind of brought up the convert this year. And I just wanted to kind of touch on liquidity because it looks like you extended some of your credit facilities, but it looks like maybe the total commitments from some counterparties also came in a bit. So not as much to draw there as you had in the last quarter. It sounds like you're -- you might be expecting some growth this quarter, but you also have that maturity coming up. So just how do you balance -- how do you think about your liquidity position? How do you balance growth with kind of these capital needs?

Yes. Look, I think we sort of separate them in some respects, which is to say, to me, what we decide to do on the convert ties into the access to capital we've created for the company in a variety of, call it, corporate level debt markets, i.e. term loan, convertible notes, secured notes. We'll explore all of those as we think about how to address the convertible notes, and we'll focus on the best combination of cost and duration. But I think given what we've done in those markets previously, absent any significant upheaval in the markets, I think we'll have an ability to access there. But away from those markets, constant dialogue with banks around our secured lending relationships. I would say there has been some movement in terms of banks and who we are increasing our relationships with and sort of reducing some other relationships but also active dialogue on bringing in some new relationships as well, and obviously very cognizant of the interplay between what we do on an asset level and what we do at the corporate level.

I would say net-net of all of that is we have a version of our model internally that if for whatever reason the corporate style financing markets break down, we have a path to addressing the converts with existing available asset leverage to the extent we need it.

Our next question comes from the line of Stephen Laws from Raymond James.

Stuart, you touched a little bit on your comments, especially on the loan sales in New York now 25%. U.K. is up pretty substantially. And international is now, I believe, 45% of the portfolio. And you talked about your team there. But can you maybe go into a little bit more about Europe and why you find that attractive? You certainly have the highest mix of exposure relative to the peer group.

Yes. I mean I think -- and let me approach it differently than I've done in the past because I think our team in Europe is probably tired of me referring to it as a less competitive market because it makes their job seem easier than it really is. I think a couple of things going on from a dynamic perspective. And I do want to -- I think it's important to reiterate this notion that what we do in Europe is a mirror image of what we do in the U.S. in terms of type of sponsorship, type of transaction and most importantly as a lender. As we think about the markets we're active in, in Europe, we're very comfortable that from a legal system perspective, we are as well protected as a lender there as we are in the U.S. So that is why I think we approach much of our pipeline from a someone agnostic perspective in that there -- if a deal works and it's in Europe, it's no different than a deal working here in the U.S., particularly the ability to finance in local currency and then hedge whatever residual is there back to U.S. dollars.

I think it's fair to say in Europe, while there is a CMBS market, it is not as robust the market as exists here in the U.S. So affords us a little bit more opportunity to get things done there. I think we have also found, in some respects, larger deals in the U.S. actually trade tighter often, particularly given the depth -- due to the depth of the single asset, single borrower CMBS market here, a somewhat different dynamic in Europe where there's less who are willing to do really large deals in Europe. And you will often find a lot of what we do of size in Europe ends up being deals where we partner with others, either other Apollo capital or oftentimes partnering with firms that would be perceived as competitors. So I think we've created a very nice niche for ourselves there.

And then economically, it's not the driver of doing things. But as you think about hedging from euro back to USD due to interest rate differentials, there actually is an economic benefit to doing deals in Europe and then hedging back to USD, which, again, it's not the reason to do a deal. But economically, it makes those deals look pretty attractive.

And then the last thing I'd say is one of the reasons we benefit our real estate credit business benefits so much in Europe is that Apollo as a firm has a very active real estate equity business in Europe, and it provides a lot of data, relationships and connectivity for the real estate credit team over there, which is based in London. And I think as a result, it has definitely helped in terms of underwriting capability but also using relationships to source transactions. So I think we've executed really well in Europe.

As I look at the pipeline, it continues to be a mix of Europe and the U.S. And I'm not going to predict percentages, but is Europe going to continue to be a meaningful part of the portfolio, certainly sitting here today, that would be the case.

Our next question comes from the line of Jade Rahmani from KBW.

One of your peers acquired a loan portfolio from a bank, and it seems that this is the first such acquisition in some time. I know from a bank analyst that the stress test recently increased, assumed loss rates on commercial real estate, which could have a negative impact on bank allocation of capital towards CRE lending. So wondering if you see that as an opportunity in this space. And perhaps is some reduction in bank originations partly explaining the surge in originations that the mortgage REITs have evidenced?

Great question. Let me comment on both parts of it because I think there were 2 parts. But I think with respect to the first part, I would say, clearly, one of the benefits of sitting inside a place like Apollo is there's broadly a lot of connectivity with banks, generally speaking, and always looking for ways to transact with each other. That being said, I would put the concept of buying portfolios in the banks, at least from our perspective, as potential that something episodically happens but certainly not viewed as a primary driver of deployment for us as we look forward in 2022. I would say our activities will still be very much deal-specific originations. So to your first question.

Then I think to the second part of your question, I would still say that the primary source of activity for the mortgage REITs these days is the combination of the amount of dry powder available in value-add and opportunistic funds that has been getting deployed from the fall of 2020 continuing into this year creating opportunities for us and our peers to lend in situations where assets are not stabilized. There is a business story around what somebody wants to do with the asset. And I would say this notion of borrowers in transitional assets wanting to borrow from institutions where they're dealing principal to principal, and to the extent things don't go according to business plan or things go better than business plan. There's a direct dialogue with someone who can pick up the phone and react as needed to adjust the financing to what's going on at the asset. So I think that's been the primary driver of why you've seen continued percentage growth in terms of the mortgage REIT part of the lending sector.

We still see the banks being on par, pretty active here in the U.S. So I don't think any pullback from the banks yet has been reflected in terms of a lack of competition from that sector as we see it overall.

And credit -- historically, ARI has veered toward -- I don't know how you want to characterize it, but within the mortgage REIT space, probably at the higher end of the credit risk spectrum, partly due to structure rather than basis, mezzanine construction loans, et cetera. But how do you see credit on new originations versus prior? And if it is a lower credit risk product, what would you say is the primary reason for that?

I mean I think what you've seen shift in our portfolio actually started prepandemic. If you go back to some of my comments from even early 2019, at that point, as we had gotten larger as a company and also as the real estate cycle at that point was 10 years into a recovery, we had clearly shifted more of what we were doing to senior loans from a structural perspective. Though, I would say, at that point, we were still comfortable taking more -- putting ourselves in more situations where more was being done to the real estate, whether it was construction, heavy redevelopment, renovation, et cetera.

I think coming out of the other side of the pandemic, I would say structurally, everything we are doing at this point is a senior loan. I don't see that changing meaningfully episodically. We look at mezz transactions from time to time, but really don't expect much to happen there. So structurally, I would expect to see us continue to remain in first mortgages.

And then in terms of what is being done to the real estate, I would put construction now more in the episodic bucket as opposed to something that we were a little bit more focused on in the '17, '18, '19 time frame. And I think we're really focused on those situations where assets are being upgraded, things are being renovated, so maybe taking the asset-level risk down a bit. But I still think, generally speaking, we're probably going to be in more situations where something is being done to the real estate as opposed to just a lease-up play for lack of a better phrase.

And just on those 2 changing attributes, structural as well as execution, is it a function of lessons learned? Is it a function of you feel that maybe the real estate correction did really happen falling out from COVID because of the way the market reacted and all the government support? Or is it really just a relative value calculus where you feel what you're doing now, first mortgages, but less construction is where the best relative value is?

I mean I think it's a little bit of a few things. I think from a risk-adjusted return perspective, I mean, to the extent we can generate ROEs that work without taking ground-up construction risk, I think it's the prudent way to think about deployment for the vehicle. I also think to where you started the question, there was a 1 quarter hiccup in the real estate market. I realize there are still certain property types that might be more challenged than others. But what occurred during the pandemic, at least to date, was really not about real estate, and there was really no cleansing downturn, whatever you want to call it in real estate.

I do think one of the other thing that -- one of the other things that certainly influences our thinking, though, is one of the impacts of the pandemic was it certainly did delay delivery of things that were in construction during the pandemic, either due to shutdowns due to safety mandates, delivery of materials, challenges with labor, et cetera. So a lot of what was in the development pipeline is being delivered later, which means you're getting that development supply delivered later. And I would say we -- it causes us to take a more conservative view with respect to newly created product now because you still need to absorb what is being delivered later.

But ultimately, the answer is where I started, which is to the extent we can generate the ROEs we want to generate without having to take that asset-level risk, we think it's the right way to think about deployment.

Our next question comes from the line of Steve Delaney from JMP Securities.

Jade touched on the -- we noticed the mezz loan payoffs, too, and that's always positive, so a good sign of the market. I wanted to touch on hotel because at the end of the -- of last year, it was 24% of the portfolio. And in terms of new commitments in the first quarter, it looked that between urban at 18% and leisure 21%, almost 40% of commitments. Can you just comment briefly -- well, one, and specifically, are those U.S.-based loans? Or were they Europe? But regardless of geography, how are you feeling about the hotel sector at this time? And exactly kind of what specific kinds of hotel situations are you finding attractive?

Yes. I appreciate the question, Steve. Look, obviously, as part of the pandemic, we started breaking things out between, call it, urban and leisure or destination in urban. Look, I think the performance of things that fall in the category of leisure or destination has been remarkably strong. We're very comfortable with the existing portfolio and would certainly seek to add additional of those types of hotels to the portfolio because I think one of the things that's been proven as a result of the pandemic is you lock people up with their families for long enough and they definitely want to get on vacation and go somewhere.

I think the urban is a bit more mixed. We were actually seeing a nice pickup in performance across the existing portfolio pretty much through the fall and then Omicron hit, which obviously was a bit of a hiccup for everyone. That being said, despite some choppiness on the operating performance side, there's actually been a pretty robust market in terms of just purchase and sale activities on urban hotels, which does tie back to my earlier comment on perhaps something happening this year with our Washington, D.C., hotel. Certainly, a much more cautious view with respect to deploying additional capital into hotels that we would define as urban at this point. But we like the hotel space in general. We think it is poised to recover pretty strongly once we get to the other side of this pandemic. So we will continue to look for those opportunities where we think we're getting paid for the risk.

Great. And that's good color. And when you commented earlier about real estate funds, dry powder and a lot of it with an opportunistic bent. Hotels are so specialized. In terms of those particular real estate investors. Are there pools of money that you've run into potential borrowers that are specifically targeting hotels as an asset class, whether that's here in the U.S. or abroad? Are you seeing the flow of opportunistic money creating the purchase and sale activity, is some of that specifically focused on the hotel industry?

Yes. I couldn't give you an exact percentage, but I could tell you that there were definitely vehicles formed during the pandemic to target hospitality opportunities specifically. And there are also -- there have definitely been ventures formed between capital and managers as well as capital and those who seek to pick off assets through CMBS, et cetera. So there's definitely hotel-focused capital looking at what took place as a very opportunistic scenario.

Our next question comes from the line of Rick Shane from JPMorgan.

Can you talk a little bit about the trajectory and run rate? When we look at distributable earnings prior to realized losses continued to be under pressure, you have commented on your confidence in the ability to retain the dividend or expectations to retain the dividend into 2022. I'm curious, when we think about the fourth quarter, how we should put into context the timing of everything that happened? You mentioned, for example, that a lot of the repayments were late in the quarter. So what does that imply for an NII run rate? And where do you need to get to in order to start covering the dividend out of distributable earnings?

Yes. I'd say a couple of things. So first of all, I think as you think about the fourth quarter, Rick, there was definitely a pickup in G&A for the fourth quarter, which was probably about $0.01 of impact, which was due to some things we did on our term loan to effectively change the amendments on the term loan. So there's probably a $0.01 of impact there in the fourth quarter. And then I think what I did say in my comments was, I think what actually took place to some extent in the fourth quarter was that you had the repayments taking place sooner than some of the redeployment. So we knew the capital was coming back. We knew we had deals that spoke for a lot of the redeployment, but it sort of happened a little quicker on the repayment side than the redeployment side of things.

I think from a run rate perspective, as you think about net interest income, I think we expect to be pretty close to run rate in the first quarter. It might lag a little bit between the first and second quarter. But ultimately, you're getting to a net interest income that is in the high 50s, low $60 million range from a run rate perspective. As we present, call it, net interest income, we think about it after the preferred dividend as well.

Stuart, 2 things. First of all, I clearly misunderstood the timing I reversed it. So that's helpful. And thank you for the clarity in terms of the NII. That helps us set expectations appropriately. Really appreciate both.

Thank you. At this time, I'm showing no further questions. I would like to turn the call back over to Stuart Rothstein for closing remarks.

Thank you, operator, and thanks to everybody who participated this morning. We will speak to you in another couple of months. Thanks all.

This concludes today's conference call. Thank you for participating. You may now disconnect.