Apollo Commercial Real Estate Finance Inc (ARI) 2010 Q2 法說會逐字稿

Good morning. My name is Cynthia and I will be your conference operator today. At this time I would like to welcome everyone to the Apollo Commercial Real Estate Finance, Incorporated, second-quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question and answer session. (Operator Instructions)

I would like to remind everyone that today's call and webcast are being recorded. Please note that they are property of Apollo Commercial Real Estate Finance, Incorporated, 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 would also like to call your attention to the customary Safe Harbor disclosure in our press release regarding the forward-looking statements. Today's conference call and webcast may include forward-looking statements and projections, and we ask you that you refer to our Company's most recent filings with the SEC for important factors that could cause actual results to differ materially from these statements and projections.

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 would like to hand the call over to our Chief Executive Officer, Joseph Azrack. Please go ahead.

Thank you, operator. Good morning, everyone, and think you for joining us in the Apollo Commercial Real Estate Finance earnings call. With me this morning are Stuart Rothstein, our Chief Financial Officer, and Scott Weiner, our Chief Investment Officer.

Before I turn the call over to Stuart to discuss our financial results today, I would like to take a few minutes for some introductory comments.

Since our last call we have witnessed increased volatility and uncertainty in the capital markets. We have had a sharp downturn due to the European sovereign debt crisis, as well as a recent rally in the equity markets which has seen indices rebound off their year-to-date lows and move into positive territory. More recently, we have seen increasing concern over the risk of disinflation or even deflation in the economy.

The one constant during the year has been the strong bid for performing yield instruments across the credit spectrum, which is reflected in historically low benchmark yields, with the 10-year Treasury now in the range of 2.75%; also continued spread tightening; and currently the Fed plans to purchase long Treasury bonds to further flatten the curve.

Our view on the commercial real estate market is influenced by a sense that while the economic recovery may be underway it is moving at a snail's pace. There is still much work to be done in order to put the economy on a stable footing and to recapitalize the commercial real estate that changed hands or was financed from 2005 through 2007, which was a period of unprecedented transaction volume.

That being said, within the real estate business we are seeing modest signs of operational improvement across certain property types. Specifically, for the first six months of 2010, on a national basis both hotels and apartment sector occupancy and rental rates have improved. In many markets, occupancy levels are up, and owners and operators are starting to have some pricing power.

We have also started to see a modest pickup off a very low base in leasing activity for office and retail properties in certain markets and price points, though net effective rents are basically flat, as prospective tenants still have many choices.

Our view of the recovery remains cautious, and in underwriting potential investments we are still taking a conservative approach to evaluating future cash flows. It has now been over two years since the commercial real estate financing market seized up. The recapitalization of commercial real estate finance has been slow to evolve, but is finally beginning -- albeit, to use a baseball analogy, we are probably in the second or third inning of the game.

In some ways, the market today is right out of a novel by Dickens, a Tale of Two Cities, indeed. High-quality income assets with long-term leases and located in 24/7 markets trade at premium values, and cap rates and financing rates at or approaching historic lows. On the other hand, there are rapidly increasing delinquency and default rates affecting loans to weaker and/or overlevered properties. There remains hundreds of billions of dollars of loans that need to be refinanced and recapitalized or written down.

We have seen a pickup in deal flow over the past three months. Foreign banks have proven to be much more willing sellers of assets at market clearing prices than domestic banks, which continue to use accommodative government policies to push potential problems into the future. Furthermore, the restructurings of Hilton, GGP, and Extended Stay are complete or moving to closure. There also continue to be bulk FDIC sales and other foreclosure-related transactions. In general, deal volume is increasing.

The recent news in the commercial real estate financing market is the successful completion of several multi-borrower CMBS transactions and several more likely before year-end. The conduits are back, looking to make loans. And in an environment where investors are desperate for yield, there is likely to be continued demand for CMBS paper.

But, to keep things in perspective, our best guess is that for the full-year 2010 we will see something in the range of $10 billion of CMBS issuance, which is still a fraction of what the market was producing during the first seven years of the decade.

With respect to ARI, it has now been approximately 11 months since our IPO. We continue to steadily grow our portfolio and remain disciplined in our approach to underwriting and adding assets. We have a long-term commitment, and it is a long-term process to build ARI into a leading commercial real estate portfolio lender.

As of the end of June our portfolio consisted of the following assets. We have first mortgages with net equity of approximately $68 million or 35% of our total equity, which in turn is about $85 million of gross asset value. The weighted average coupon on the gross asset value is about 8.4%, with a weighted average life of 56 months.

We have about 30% of our portfolio or $59 million in mezzanine loans, with an average coupon of 13.2% and a weighted average life of 114 months.

Finally, we have commercial mortgage-backed securities with a net equity of $68 million, plus $306 million of debt, for 35% of our net equity. These have a weighted average coupon of 5.6% and an average life of 25 months.

Since quarter-end we have closed an additional $24 million first mortgage on a recently constructed hotel located in Manhattan, with an interest rate of 8%. Overall, we have a gross yield on our portfolio approaching 13%, which we expect will increase as our investments grow in the coming months.

Given our current pipeline we remain confident in our ability to find investments which meet our risk-adjusted return objectives. I would now like to turn the call over to Stuart Rothstein for a few comments on our financial results and our recent S-11 filing. Stuart?

Thanks, Joe. Just very quickly, first off on the balance sheet. As we mentioned in our earnings release, our book value per share increased slightly from $18.49 to $18.62 a share. I just want to reiterate for people that that is only based on marking our CMBS securities to market.

We have approximately $140 million of commercial mortgage loan and mezzanine loans on our balance sheet that are long-term in nature, fixed-rate, call-protected assets that we do not mark to market for financial statement purposes. But certainly based on reverse inquiry we have received about potentially selling pieces of those assets, as well as just seeing recent comps in the market, we feel confident that those assets have also increased in value since we put them on our books.

The other item I will mention briefly is from a dividend policy perspective. We have now announced two dividends year to date, $0.35 a share, both at the end of the first quarter and the second quarter. We have a Board meeting scheduled for later today, and you should fully expect an announcement on third-quarter dividend after market closes today, once our Board has met and we are in a position to announce the third-quarter dividend.

Lastly, Joe mentioned the S-11 which we filed about two months ago now, just to really start the SEC process to the extent we were going to need to raise additional equity capital in the future. Certainly based on some of the research that has been written recently, the whole topic of raising additional equity is one that is on many minds.

From our perspective, while we are certainly not pleased with the way the stock has traded since the IPO in light of what we considered to be very good progress in getting our proceeds of IPO invested and ramping up our dividend basically according to plan, as we told people on the IPO roadshow, we do continue to believe there is an opportunity to build a successful commercial real estate lending platform over the long term. We think it is going to be a multiyear opportunity. And in order to do that, at some point in the future we will need to raise additional equity capital to grow the business.

As we sit here today, we have about $60-plus-million worth of availability on our JPMorgan financing facility. That facility is solely for the borrowing against first mortgages as collateral. And we still have some first mortgages on our books that have not been levered as of yet. So we would envision using that capital as we see opportunities.

But at some point in time, to the extent we see attractive opportunities -- and I think it is important to note that if and when we do decide to raise additional equity capital, it will be premised on our view that we see attractive opportunities both in our pipeline as well as on the horizon. And by attractive opportunities, it is both risk-adjusted returns as well as returns that, in light of what we assume the cost of capital to be to make those investments, we will still be in a position to both grow our earnings and grow the dividend over time.

Obviously, when it comes time to raise additional equity capital, we will need to come to market and we will need to tell our story to people about why we see attractive investment opportunities. And we will be prepared to do so at the right time.

With that, I will turn it back to the operator for any questions.

(Operator Instructions) Jason Arnold, RBC Capital Markets.

Hi, yes, good morning, guys. Just a quick question on where you expect to see most of your capital deployed here going forward. I know it is kind of opportunistic and perhaps not a fair question, but what are you seeing out there right now? Is it more mezzanine-style opportunities? Or maybe you can just give us some color there.

Hi, Jason. It is Scott Weiner. Yes, it continues to be all our major asset groups -- mezzanine, first mortgage, and CMBS. What has really happened is, as Joe referenced, the CMBS market is up and running. And that caused the last quarter to be a little slower than we would have expected, because borrowers saw that coming and really wanted to wait on the sidelines to see what would happen there.

They heard it was happening; the brokers were telling them; and so people really kind of waited. But now that they are up and running, the pipeline of deals we are seeing as a result of that, it just grew immensely.

Really what that is is, as the conduits are feeling their way and investors are feeling their way, bigger loans -- kind of beyond investment grade -- are still very challenging for the Street to take down, for the rating agencies to get their arms around. And for us, that is a perfect opportunity to put on well-structured mezzanine loans.

The one deal that we had done before the mezzanine, that was a deal where the first got securitized; our last dollars were 70% leverage; and we got a 13% yield. And we are in dialogue with numerous firms on a daily basis quoting deals with them, quote originating.

We have a bunch of deals in the works where we are looking at doing five- to 10-year mezzanine positions, I would say in the 12% plus or minus interest rate area. So we do see that as a very large opportunity.

The fact that we can go out 10 years is a competitive advantage. A lot of other players don't have that ability or capital.

As Stuart referenced we're getting fixed-rate, call-protected yields in the teens. So that is very attractive to us.

On the first mortgage side, where we are seeing opportunities for us is where there are holes in the market. So there still is really no shorter-term floating-rate market. And so to the extent there is a mortgage loan where, for whatever reason, a new -- a borrower does not want a five-year call-protected deal, there is an opportunity for us.

Which is what happened on the hotel deal we recently did; it was a deal where for a variety of reasons the borrower wanted a shorter term loan. So we did a two-year loan, and that product doesn't exist.

We also are seeing opportunities -- again, as Joe referenced -- to buy loans in the secondary market that will not fit for securitization, most likely just due to duration or how it is set up.

And then lastly on the CMBS side, we are continuing to look at different opportunities. We are very pleased with our TALF investment and the performance to date of the securities that we have had. Those spreads have come in, but we continue to look at other ways to invest in CMBS, in some ways replicating the TALF transaction that we did with matched funding repo, which we believe is out there, and some other products where we can be buying AAA securities and create double-digit returns.

Okay. Terrific. Then I guess just a big picture question. We have seen some modest improvement in CRE market pricing, judging by the Moody's CRE Index. Just curious if you think the transactions in the markets have been realistic, that have gone off; or perhaps biased by not that much volume going through the system right now.

Jason, it's Joe. We think the volume really is not sufficiently wide or deep enough to really be reflective of an established or settled market pricing. I think you really have to differentiate between the very high-quality assets with longer-term leases, as I mentioned in my opening remarks, that are trading at historically high values and low cap rates, and the broader market, which is still going through the recapitalization process.

So I guess we would not draw any conclusions as to where the clearing price is going to be for the market as a whole just yet. Although as I mentioned, we are seeing increased recapitalization and transaction and financing volume that is beginning to reflect the rental and occupancy fundamentals. So we think that that will probably play out over the next, I don't know, 12 to 18 months and we will have a better handle on the market clearing prices.

Okay. Terrific. Thank you very much for the color.

R.J. Milligan, Raymond James.

Good morning, guys. Joe, you touched on, I guess, the supply side for investments. Can you talk about the demand side in terms of people coming back into the market, looking to lend or structure these first mortgages? I guess, what is the demand side for the mezzanine debt? And where do you guys fit into that?

I think Scott can probably speak to that best of all.

Sure, so you are talking just on the lending side. Not every conduit has come back in the market. Clearly folks like Lehman and Bear Stearns are not coming back. Credit Suisse, who was active, is not back.

But there are maybe eight to 10 active conduits who are originating things for securitization. They are generally all pretty much looking at the same product -- cash-flowing major food groups. We have started to see them do smaller loans.

For the most part, the first bunch of deals that were done I would say were quasi-large loan deals. I think you will start to see them doing kind of smaller deals maybe in the $10 million to $15 million size.

So for a cash-flowing institutional property, there is a very strong bid from the Street, generally up to 65-ish, maybe even 70 LTV. I would say in the 6% area.

The insurance companies are also active in looking to put stuff back on. They are choosing to go lower leverage, lower rate. So you have seen some deals in the news where insurance companies actually doing stuff in the 5% area with generally lower leverage. And for the most part, just given the nature of borrowers, probably higher quality properties.

Then you are in certain cities seeing some of the foreign banks. Clearly there was the articles around China coming back in.

So I would say for C, B, D, and other types of properties, clearly a very strong bid. There are still certain property types -- hotel being one -- where there is not as strong a bid. Suburban office, other things, it is a bit weaker.

Multifamily, you still very much have the GSEs. If you look at the composition of the conduits that have been done, there is pretty much no multifamily. There is also really no hotel. They have been predominantly retail, a lot of malls and other power centers.

As far as the mezzanine side, the market that we are focused on, clearly there is competition. But what we are focused on, on a yield basis, is lower than what the mezzanine funds had raised in terms of promising investors high teens.

The fact that we have the permanent capital means that we can go out for 10 years, which is the majority of the commercial mortgage market is 10 years. So you would need 10-year mezz. So that is another area where there's fewer people.

And then there is also clearly the certainty of execution and being able to commit and team up with a firm as they are taking down the loan. A lot of the firms cannot take down beyond investment-grade or that mezzanine piece, if you will, and they need to know that someone is there. They're putting out a term sheet or a quote to a relationship, and they want to know they can close the deal.

So the fact that we understand real estate and whatnot, it differentiates us from, say, a hedge fund who may just be looking to put on a piece of paper.

Okay. Thanks for the color.

James Shanahan, Wells Fargo.

Good morning. Thank you for taking my question. I'm trying to get a handle on your liquidity.

In addition to the $60 million or so remaining on the $100 million JPMorgan facility, do you anticipate any principal repayment or prepayment activity within the loan portfolio at any time in the second half of 2010?

Nothing. I mean, there is some amortization, but nothing material, Jim.

Okay. With regards to your amortization as well, on the CMBS book the amortization has been minuscule up to this point. But you mentioned it had a 24-month weighted average life. How should we anticipate those assets and nonrecourse liabilities to run off over the course of the next, say, six to eight quarters?

I would say certainly in the next year I would expect very little and then in the second year a little more. We actually as we underwrote it expect those bonds to go out beyond two years. As you remember, we did three-year TALF financing. We built in cushion.

The way we are showing the GAAP IRRs is assuming the two-year repayment. But as we have underwritten -- and I think we alluded to it earlier -- we actually are expecting extensions. So that return will actually be higher because we had paid a slight premium for those bonds; the longer they are out, the better the return.

But I would expect very little in the way of repayment in the near term. These were the original five-year bonds, the A2 classes. So what you are seeing is the source of repayment for those bonds are clearly refinancing of loans, but also loans going through the workout and resolution process -- i.e., foreclosure and other things. And as you have been hearing and reading, that is on average an 18-month process.

So that has commenced for a lot of properties and going on. So we think in that 24-month plus or minus area is really when you will start to see repayment. But again you also have to pay off the financing that came along with it.

One final question, if you don't mind, and thanks for your patience. With regards to the credit facility and your cash liquidity, it's about $15 million in cash and $60 million remaining capacity. If we were to assume that the share price didn't rise sufficiently in the coming months for you and for the Board to be comfortable raising equity capital, how much of that cash and available borrowing capacity do you think you would utilize while you wait to see the improvement that you need before raising more equity?

You know, it is somewhat dependent on what we see in terms of deal pipeline and deal flow, Jim. But to the extent we can put good assets on the books that allow us to grow the dividend, I think we would push the limit in terms of usage. And at the same time be thinking somewhat creatively about ways to bring additional equity capital into the business.

Our view right now is, particularly given the yield environment we are in, if we can put these type of risk-adjusted yields on the books at the type of levered returns that we are generating, we're going to put the assets on the books and continue to push earnings and both the dividend.

Okay, thank you.

Joshua Barber, Stifel Nicolaus.

Good morning. I was wondering if you guys could give a little bit more detail on the Troy mezzanine loan that you guys did in the quarter. It seems that most conduits and a lot of lenders are generally staying away from the Michigan area. Can you talk a little bit more about the sponsorship there, debt yields, anything else that might have made that investment a little bit more attractive?

Sure. No, look, I think on the surface, for good or for bad, Michigan is a state that -- given the auto industry and other things -- people are wary of. But this is a transaction that we went into open eyes. We teamed up with a Street firm who we know very well and co-originated the deal.

It is a Class A office building in Troy, one of the best buildings if not the best building in the market. We confirmed that with other folks in the real estate community who we know well. In this transaction, one partner was buying out another partner, so there was approximately $19 million of fresh equity went into the deal representing about a 70% loan to purchase, and the appraisal was also 70%.

Our dollars per foot are $83. It amoritizes on a 25-year schedule. And there are substantial reserves both upfront and ongoing for leasing.

Based on 2009 actual NOI, our debt yield was 19%. On our underwritten cash flow, which was taking the building down on an occupancy and rental basis to market, we were still at 15%.

The type of tenants in this building are ones that you would know. They are national tenants. Regional offices for consulting firms, investment banks. If you went there, you would see Bentleys and other cars of that ilk, in terms of law firms and hedge funds based in Michigan.

So we spent an inordinate amount of time visiting the property, going through it, going through the sponsorship. And for all those reasons we got comfortable. We clearly think it is an attractive return. But we did not take lightly the fact that it was Michigan and Troy.

Okay. Thanks for that detail.

One other follow-up. Is there a possibility of obtaining any additional financing facilities to supplement what you currently have? I know that it's probably going to be tougher to lever your assets a whole lot more than $100 million.

But is there a possibility for levering maybe the senior mezz piece on Inland? Or do you want to stay away from that as much as possible?

I mean I would say we are in discussions around facilities to purchase CMBS on a levered basis. The repo market is active. For us one of the necessities there would be having the duration and effectively the match fundings; we don't want to do one month repo and have it go away.

So we are in discussions with that. That would be to be used for new investments, and we are in active discussions on that front.

There is the ability, given the CMBS market has come back, to sell pieces of our mortgage loans into that. We were actually approached to contribute loans into the deals.

For now we have held off. The cost of financing the JPMorgan facility and the leverage return is actually better than we would get in the CMBS market. So we have held off on doing that.

That would be one way to create capacity. At the same time, we would need to find new mortgages that fit that bill, kind of matching up with what we had discussed before. And we are working on some first mortgages.

There are, unlike when we started the IPO process, there is more corporate availability, if you will. I think we have had some discussions around that, where we would not actually be directly leveraging mezz, but more of a corporate type facility. We are holding off on that.

We have paid some fees to JPMorgan. Clearly the facility works well. We don't need it at this point in time; but I would think over time as we grow the Company both -- and optimize the capital structure, we are going to be focused on both sides of the balance sheet, both the equity and debt. And I would expect that you will see some change in the future on the debt side.

But today, we are very happy. On the first mortgage side, we are creating ourselves 16% plus or minus levered returns on that.

Thanks very much.

[Doug Rothschild], Scoggin.

Good morning. I apologize if you already addressed this, but I came a minute or two late to the call. I had two questions.

The first is on the dividend. Now that you are getting closer to fully invested, is there any plans or do you see the ability to pay a higher dividend?

As we mentioned earlier, Doug, we've actually got a Board meeting leader today, which will announce the third-quarter dividend. So you will see a press release probably after market closes today with an updated dividend for Q3.

Okay, great. Then the second question is in terms of capital raising. You had spoken about you would look at the cost of capital and the opportunity. I think some people think of it as simply book value per share. I'm just curious if you guys look at it that way, if you have any thoughts of whether or not you would issue new capital below book value.

Because my opinion at least is there is some overhang in the stock where people -- the stock won't get to book value until people get comfort that you wouldn't issue equity below book value.

Yes, I mean look, we have addressed this I think on each of our three quarterly calls. While book value is certainly one of the things we would consider, it is not the only factor.

To be perfectly blunt, we have been unwilling to draw a line in the sand and say we're just not going to issue below book. We would certainly be thoughtful about it and try and be as creative and as prudent as possible, to the extent we did see a compelling reason to raise additional equity below book, to minimize the dilution as much as possible.

But from our perspective, if we see attractive investments that allow us to grow the vehicle, to allow us to grow earnings and allow us to grow the dividend over time, it is certainly on the radar screen. But certainly I have heard from you and others about the sensitivity to book value.

Okay. Thank you very much.

Doug, at the same time -- this is Scott, hi -- other investors have said kind of what you said, which is -- there is this overhang. The stock is never going to move. We are focused on growing the dividend and getting the expenses done. Just issue the equity as long as you can get the returns and maintain or grow the dividend.

So we're kind of hearing both sides from our investors in terms of their view.

Okay, thank you.

(Operator Instructions) Jim Young, West Family.

You had mentioned that the $140 million plus of first mortgage and mezzanine are not marked to market. Can you give us a ballpark feel as to what the market value would be? Is it up like 1%, is it up 10%? But could you just give us a ballpark range? Thank you.

This is Scott again. To give you an idea, aside from the mortgage loan we just closed they were all five-year loans at an average, call it around 8% plus or minus. One was 9%, some are 8.25%, but let's just use 8 for a round number.

You know, today, those loans would be 6% with the [Congress back]. So you would have 2 -- you have 8.40%, excuse me, was the average of the five-year ones.

So you have over 2 points a year for five years PV back. That gives you an idea, if we just went and sold those loans in the CMBS market, the premium that you would get there.

On the mezzanine loans, the average is about 13%. 10 years, I would say that today on average is at least 1 point tighter, if not more. Again, you have a, call it a 9.5-year duration. So substantial premiums.

Okay, thank you.

At this time there are no further questions. I would like the turn the call back over to Mr. Azrack for closing remarks.

Okay, well thank you, operator, and thank you all for your very good questions. Hopefully we have addressed them satisfactorily.

And we look forward to talking with you next quarter and continuing to grow the Company, and taking advantage of the deal flow that we have. So we are happy to chat with anybody off-line at any time, should you have further questions for us. So thanks very much for participating.

Ladies and gentlemen, this concludes today's Apollo Commercial Real Estate Finance, Incorporated, second-quarter earnings call. You may now disconnect.