Apollo Commercial Real Estate Finance Inc (ARI) 2010 Q4 法說會逐字稿

Good morning. My name is Stephanie and I will be your conference operator today. At this time I would like to welcome everyone to the ARI fourth-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 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 would 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. 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 turn the call over to our Chief Executive Officer, Joseph Azrack.

Thank you, operator. Good morning, everybody. This is Joe Azrack, appreciate your taking the time to participate in the Apollo Commercial Real Estate Finance earnings call. With me this morning, as usual, is Stuart Rothstein, our Chief Financial Officer, and Scott Weiner, our Chief Investment Officer.

Before I turn the call over to Scott to talk about our portfolio and pipeline, I want to make a few introductory comments on the market and on our investments today.

To paraphrase Winston Churchill, in 2010 the commercial real estate mortgage market experienced the end of the beginning. Now what do I mean by that? The securitization market is clearly healing as spreads tighten and volume increases. During 2010, the generic on the run AAA CMBS spreads tightened by almost 250 basis points. So far in 2011, these spreads have tightened by almost an additional 50 basis points.

The CMBS volume last year was approximately $12 billion excluding the agency securities. Market expectations for this year are that volume will be in the $40 billion to $60 billion range. This is good news for those of us like ARI who purchased high-quality CMBS during 2010 but in our view, the AAA CMBS are less attractive as a new investment today.

The new whole loan first mortgage spreads have also tightened although by no means as much. The commercial real estate loan delinquencies finally appear to have stabilized. Moreover, the supply and demand fundamentals in most sectors of the commercial real estate market have begun to turn the corner. Occupancies are rising, rental rates are stable or improving and we believe net operating income will follow the upward trend albeit slowly.

Not surprisingly, in light of these circumstances, transaction volume increased significantly in 2010 to approximately $77 billion, up from the moribund $28 billion in 2009.

Transaction volume is likely to increase further this year creating more demand for fresh mortgage debt financing capital. However, the vast majority of loans originated prior to 2008 have yet to be refinanced and recapitalized. Amend and extend has been the overriding strategy endorsed by regulators and adopted by lenders and servicers for the past two years. Thus over the next several years, there remains $1 trillion of loans that will still come due. As Yogi Berra said, it is deja vu all over again.

As a result, loan maturities remain a serious issue for the commercial real estate market. Analysts estimate that even in today's low interest rate environment approximately 60% of these trillion dollars of loans can be refinanced at current market terms and underwriting and the balance will need to be equitized.

At the same time, the 10-year treasury rate has risen in recent months to the range of 3.4% to 3.5% and the forward curve is pricing in another 75 to 100 basis point increase over the next 12 to 18 months. In our opinion, the market data is sending a clear message that the volume of real estate and mortgage financing transactions will rise significantly in 2011 creating many more loan opportunities in the coming year for ARI. Certainly our deal pipeline is indicative of this compared to a year ago.

Furthermore, there is a good probability that the absolute volume of demand for real estate debt, coupled with upward pressure on interest rates as the economy recovers will lead to upward pressure on mortgage loan yields during the course of the year.

In anticipation of the increased volume, we have increased our loan origination and management resources in recent months so that we are prepared to deal with this opportunity as the year develops.

Turning now to our existing investment portfolio and transaction pipeline. As of December 31, 2010, our portfolio consisted of the following, $643 million of CMBS financed with either fixed rate TALF or fully hedged Wells Fargo debt, $110 million of first mortgages and $59 million of mezzanine loans. We ended the year with approximately $90 million of capital remaining to be invested in order to be fully deployed.

While at the time we can't yet disclose the details, we are currently working on several transactions which represent the deployment of a significant piece of our remaining capital at returns consistent with what we have previously stated for mezzanine type financings. Scott will talk more about this in a minute.

There is still work to be done in order to get these transactions completed and when closed we will provide a more detailed analysis.

Assuming we close these transactions and given our current pipeline of potential other deals, we are confident in our ability to be fully deployed by the end of the first quarter or early part of the second quarter. So, while the market has become more competitive, we are effectively using our relationships and our ability to underwrite credit and creatively structure transactions to move towards full deployment of our capital, consistent with the guidance on timing we have previously provided.

It is also worth noting that as market underwriting and pricing have continued to tighten, the loans we closed in early 2010 have risen in value. However, this increase in value is not reflected in the financial statements as loans are carried at cost for financial statement purposes. But we believe there is a least another $0.80 per share of book value using conservative assumptions in estimating the current market value of our first mortgage and mezzanine loans.

Finally, before passing it on to Scott, I am sure everyone is wondering if we intend to issue more equity when we have invested our remaining capital. I will tell you that we do not expect to raise capital again via a secondary offering at less than our book value. Hopefully, the market will recognize the value of our existing portfolio and those investments that we expect to make in the coming months.

Now I would like to turn it over to Scott Weiner for his comments on the ARI portfolio and deal pipeline. Scott?

Thanks, Joe. Let me start off with talking a little about the existing portfolio where you will find more detail in the 10-K when filed. As previously discussed, our focus at ARI is purely on the performing area of the market. We have chosen not to participate nor do our investment guidelines allow us to participate in the nonperforming or sub-performing areas of the market or for that matter, the loan-to-own market.

As a result, we have constructed a portfolio where our weighted average loan to value on our first mortgages and mezzanine loans is approximately 59% and that is based on appraisals at time of origination. Given the improvement in the market as well as more transparency on values, those loan to values are actually quite conservative.

Then also as previously discussed, all of our CMBS is AAA. So clearly a very high quality portfolio of investments, very senior in a capital structure. We have been very pleased with the underlying performance of our assets. To give you an idea, our hotel loans currently have an approximately 17%, 18% debt yield and the conduits today are financing those loans at approximately 13%. So quite slow leverage even on our hospitality loans.

The other area where we are benefiting from is our decision philosophically to take advantage of where the markets were and lock in very attractive interest rates for long term with call protection. So as opposed to doing floating-rate loans where the borrower has the option just to pay us off, whether it be the Inland, Western Mezz or our first mortgages, we have fixed rate call protected loans and those loans, as Joe have referenced, have dramatically increased in value given where credit spreads have moved in the CMBS and other markets.

With respect to our pipeline, yes, things are lumpy, but we are actively closing two transactions which will approximate in excess of approximately $75 million of total proceeds at returns actually above where we had talked about previously so kind of a low teen type return.

I don't want to go into too much detail because they are closing, but we are in definitive documentation negotiating the deals. One of the deals we have actually been working on since the time of the secondary is a subordinate piece behind a syndicated traditional kind of bank loan style deal that has just taken a bit longer to close, given that, but I think we are following in the home stretch there.

And the other one is, like I said, independent documentation. We do expect both to close by the end of the month.

Away from those transactions, we do have quite an active pipeline. We are not getting right now into the conduit business. We are working with folks in the conduit business, looking at subdebt, subordinate debt pieces as well as actively originating first mortgages that do not fit the conduit template, if you will, where we can still get very attractive first mortgage rates.

As Joe mentioned, the CMBS market has come in quite dramatically on a spread basis so we do not see the value that we had previously seen in buying legacy CMBS nor do we see value in the CMBS 2.0 new issuance whether it be on the investment grade bonds or in the B pieces. So I think you will continue to see our pipeline consisting of first mortgages as well as a subordinate debt pieces.

So with that, operator, I guess we would like to open it up for questions.

(Operator Instructions). Jim Young, West Family.

You mentioned that you wouldn't raise equity below book value. Were you referencing GAAP book or economic book?

We tend to think of it in terms of GAAP book value, Jim. Obviously at the time we did anything -- if we did anything, we would consider both GAAP and economic book value. But I think in terms of the statement and thinking about adding to the bottom line as a Company, we think more in terms of GAAP book value.

But depending on what is embedded at the time, we'd evaluate it at that point in time.

Okay, thank you.

Joshua Barber, Stifel Nicolaus.

Hi, good morning. Following up a little bit on your equity comments, I guess given that most of the -- most of your capital, if not all of it, would hopefully be spent by the end of the month. What other alternatives do you really have besides equity? Would you look at preferred, would you look to buy back shares? Would you look to just essentially sit on your hands for a few months until the market recognizes the asset value that you have to today?

Actually, hi, Josh. It's Scott. I would say actually none of the above, really what our plan would be to take advantage of the first mortgage loans that we have and recycle that capital. As I mentioned, those are fixed rate loans that we could sell into a CMBS deal today, either creating a capital gain or a very attractive lever, not even lever, a good rematched funding effectively, but junior piece. And we can actually actually increase the proceeds on those and still sell them off and do that.

So I think first off, we would be recycling the capital, whether it be the Hilton Garden Inn or the Silver Spring Health Inn to name two deals where that would give us substantial capital as well as creating gains and kind of shrinking the gap between GAAP book value and market book value.

We also have the ability to recycle the CMBS, clearly a highly liquid instrument. We still love it because we are getting teen yields for AAA risk, but that is another area where if we saw ability to extend the duration at attractive yields, we could sell the CMBS and redeploy that capital.

And then lastly, there is unlike when we went public, there is much more corporate leverage available, different facilities. We currently have the $100 million facility with JPMorgan for our first mortgage loans. We will be tapping into that as we finish deploying the cash for these new investments. But there are different ways to get advances on things like that.

But I think first and foremost after we make these investments, I would expect to see -- you should expect to see us doing stuff with our first mortgages.

Would you be comfortable, I guess, selling your first mortgages and keeping your portfolio somewhere about 85% CMBS or would you rather look to some of your CMBS today to try to invest it and get longer duration yields even though those might be slightly lower returns on equity?

I think if we could extend out the duration as comparability, we would do that all day long. I just think that we would be challenged to find on a relative value those type of mid-teen returns for that type of risk, but I think to extend the duration, yes, we would probably give up a little on the yield to extend the duration.

Okay. One last question regarding your Wells Fargo repo line for the CMBS. You mentioned that that is fully hedged. Is that on a rate basis or a duration basis? Is that on both? How could you describe fully the hedging mechanisms that are in place?

It is hedged for both rate and duration, Josh. We basically used a mix of caps and swaps since the duration is somewhat unknown given that there might be extension on the underlying collateral. We worked with Wells Fargo as well as the consultants we work with on hedging to use a combination of swaps and caps that allow us to fully hedge the interest rate through the expected duration as well as to the extent there is any extension of duration from the underlying collateral extending. So we are fully hedged.

So if you were to extend the CMBS or if you were able to get a maturity extension on your underlying asset CMBS there for I don't know, call it three years past the point of maturity, would that still be fully hedged?

The facility only goes out three years so if you'll recall, we basically bought collateral that has about two years weighted [average] maturity and we put a three-year financing in place. What I basically meant to say is that to the extent the two-year collateral extends out so we use the facility for the full three years, we are hedged out through the three years.

Okay, but if you would look to extend those out, you would have to hedge them again?

If we look to -- first of all, we would have to get Wells Fargo to extend the facility beyond three years.

Understood. Thanks very much. Good luck, guys.

(Operator Instructions) R.J. Milligan, Raymond James.

Good morning, guys. Yes, I was just curious to follow up on Scott's comments about recycling the CMBS's to what sort of yields you would recycle those in or where you are seeing the market if you were to go back into CMBS?

Well, I mean -- you are saying -- we wouldn't be recycling it into CMBS but are you asking today given the market movement where this trade would be today? Is that what you are asking?

Yes, that's correct.

If we were to do a levered CMBS trade today given where CMBS has gone, you would be earning approximately a 9% IRR versus the midteens when we did the deal.

Okay, and so then if you did recycle the CMBS, you would just look to the first mortgages? What is the B piece market? How is that developing?

Well, we would be -- it would be first mortgages where you would be originating loans in kind of call it the 7% to 8% area whether fixed or floating, depending on what we thought about the prospects of being able to ultimately securitize that loan. If that is a loan we felt with some little work at the property we could securitize, we would put a fixed rate loan on it. Otherwise we would probably put a floating rate on it and then we would lever that up, use that on the JP facility and that would be -- generate a kind of a low to mid teens type return, given our advances.

The subordinate debt market, from what we are seeing, continues to be 11% to 13%. We actually were just working on a co-origination yesterday where we are pricing the subordinate debt piece at 12%. And like I mentioned before, the deals that we have in closing, one of which is a subordinate debt, the other one is actually a senior piece but more of a structure or at the high end of that range.

With respect to the CMBS market, 2.0 BBB minuses are yielding approximately 6%. The below investment grade is less of a current cash type return and much more of a buying at a discount and a back-ended but that market is a midteens type IRR, although that is without any losses. And I think our view has been difficult given the composition of this portfolio to really underwrite and say you are not going to have any losses over that 10-year period.

And as a result of those deals being somewhat lumpier than historically, you are also taking somewhat binary risk where if one of the deal goes bad, the losses are somewhat catastrophic. So again philosophically, not a market we -- we would much rather be on a single asset specific or a portfolio of assets that we can underwrite.

I will say that one development that continues where we do see opportunities is on the larger deals, the CMBS market has not come back to allowing originators to put say a $2 billion loan into five different deals. So the larger transactions are being done on a stand-alone basis where they are putting an investment grade piece of the loan into CMBS and selling subordinate debt and then those, that subordinate debt will range from say 8% for very senior subdebt down to something in the low teens. And so that is an area of opportunity that we are also spending time on as well.

Great. Thank you for the color.

(Operator Instructions). At this time there are no additional questions.

Okay, thank you, operator, and thank you, everyone, for joining us today.

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