Apollo Commercial Real Estate Finance Inc (ARI) 2012 Q2 法說會逐字稿

Good morning to everybody and thank you for joining us on the Apollo Commercial Real Estate Finance, Inc. second quarter 2012 earnings call. Joining me this morning in New York are Scott Weiner, our Chief Investment Officer, and Megan Gaul, our Controller, who will review ARI's financial results after my remarks.

The commercial real estate finance market maintained its moderate pace throughout the second quarter as capital continued to flow into the sector. The combination of the historically low interest rate environment coupled with a large number of commercial mortgages reaching their stated maturities has led to a modest uptick in property recapitalization particularly for stabilized, cash flowing assets in primary markets.

The conduit market has picked up its pace as reflected in the issuance -- as the increase in CMBS issuance over the quarter. For the first six months of the year US CMBS issuance was $18.2 billion as compared to $17.1 billion for the first six months of 2011. New issue spreads on benchmark bonds have been on a roller coaster ride this year, hitting a low of 105 basis points in early March and peaking at 160 basis points in late June.

There has been some improvement in market pricing in recent weeks as fixed-rate CMBS still seem relatively inexpensive next to comparable asset-backed securities and corporate bonds and we believe that new issuance in the CMBS market will continue at a measured pace for the remainder of the year.

With respect to ARI, our focus remains on identifying debt investments on performing loans within our target asset classes. We continue to see a diversified range of opportunities across a broad spectrum of property types and geographies.

In April we acquired two senior sub participation interests with an aggregate face value of $23.8 million, part of a $120 million first mortgage loan secured by 20 acres of land in the South Boston Waterfront District, which is entitled for over 5.8 million buildable square feet and is currently used as parking with approximately 3,325 spaces. The aggregate purchase price of the senior sub participation interest was $17.9 million or 75% of face value and we expect our investment to generate an IRR of 21.7%.

Just to note, as part of this transaction we incurred one-time expenses of approximately $750,000 which were recognized in the second quarter. In June we purchased $70.7 million of CMBS for which the obligors are certain special purpose entities formed to hold substantially all of the assets of Hilton Worldwide, Inc.

The Hilton CMBS' LTV is estimated to be in the range of 35% to 45% and have a current interest rate of one month LIBOR plus 1.75%, which increases annually beginning in November and culminates at LIBOR plus 3.8% in November 2014.

The Hilton CMBS investment is expected to generate an IRR of approximately 11.7%. We deployed $21.2 million of equity to purchase the Hilton CMBS and the remainder of the acquisition was financed utilizing borrowings under our repurchase facility with Wells Fargo Bank which was amended to provide additional financing for the Hilton CMBS.

The $49.5 million of debt drawn from the Wells Facility for the acquisition is coterminous with the Hilton CMBS, assuming full extension, and bears interest at LIBOR plus 235 basis points. We continue to proactively manage our liability and, as we mentioned on the call last quarter, in April, we amended our JPMorgan credit facility to reduce the interest rate by 50 basis points to LIBOR plus 2.5%.

With respect to our investment portfolio, at June 30, 2012 we had a total invested portfolio of $676 million with a weighted average underwritten IRR of 15%. We continue to actively monitor each of our investments and the credit quality of our portfolio remains stable.

We take complete one loan modification in the second quarter on a $40 million subordinated loan secured by a ski resort in California. Due to the unseasonably warm winter operating revenues were down at the resort and the borrower sought financial covenant relief for both the senior and junior loan. In connection with the loan modification ARI received a 50 basis points fee and will receive both a slightly higher interest rates and an exit fee upon repayment.

As a result of the earnings generated from our high-quality investment portfolio, as well as our diligent efforts to lower our cost of funding and prudently reinvest our capital, our operating earnings per share increased 2.5% as compared to the second quarter of 2011.

Consequently, our Board of Directors declared a $0.40 dividend per share for shareholders of record as of September 28, 2012 representing the ninth consecutive quarter we have maintained this dividend level. Based upon our closing share price on August 3, 2012 and annualizing the dividend, our stock currently offers an attractive dividend yield of 9.6%.

Please keep in mind when our Board of Directors evaluates our dividend policy they do so by considering a number of factors including the annual operating earnings forecasts, realized gains and losses, an internal estimate of taxable income and compliance with REIT distribution requirements, as well as a desire to minimize the volatility in quarter over quarter dividend levels.

Lastly, before I turn the call over to Megan to review our financial performance, I would like to discuss the preferred stock offering we completed last week. On August 1, 2012 the Company completed an underwritten public offering of 3,450,000 shares of its 8.625% Series A cumulative redeemable perpetual preferred stock with a liquidation preference of $25 per share, which includes the exercise of the underwriter's option to purchase additional shares.

Net proceeds from the offering, after the underwriting discount and payment of estimated offering expenses, were approximately $83.2 million. In the short-term we will use of the net proceeds to repay any amounts outstanding under our JPMorgan facility and then we will use the remaining cash, as well as the capacity we've created on the JPMorgan facility, to invest in investments in our investment pipeline which remains robust.

We were extremely pleased with our ability to raise attractively priced capital and we believe we will be able to deploy the proceeds into accretive investments with attractive risk adjusted returns. At this point I would like to turn the call over to Megan.

Thank you, Stuart. Before I discuss our financial results I want to remind everyone that we have posted our supplemental financial information package on our website, which contains detailed information about the portfolio as well as ARI's financial performance.

Turning to our financial results, for the quarter ended June 30, 2012 we announced operating earnings of $8.5 million or $0.41 per share, which represents a 2.5% increase over our operating earnings per share from the same period a year ago. This was driven by a 23% increase in net interest income which rose to $12 million in the second quarter of 2012 from $9.7 million in the second quarter of 2011.

For the six months ended June 30, 2012 the Company recorded operating of $17.3 million, or $0.83 per share, representing a per share increase of 20% as compared with operating earnings of $12.1 million or $0.69 per share for the same period in 2011. A reconciliation of operating earnings and operating earnings per share to GAAP net income and GAAP net income per share can be found in our earnings release contained in the Investor Relations section of our website, www.apolloreit.com.

It is worth noting that operating earnings for the second quarter included a few nonrecurring items. As Stuart mentioned, we recognized approximately $750,000 of brokerage and other fees related to the closing of the South Boston transaction. Separately we recognized approximately $500,000 of income during the second quarter resulting from a make whole provision upon the repayment of a portion of our repurchase agreement investment.

While both of these items were recognized in the second quarter, in accordance with GAAP the additional fees and interest resulting from the loan modification, as Stuart mentioned earlier, will be recognized over the remaining life of that loan.

Turning to the balance sheet, ARI's leverage continued to decrease in the second-quarter and the Company's debt service coverage, which we calculate as EBITDA divided by interest expense, increased from 5.4 at March 31 to 6.9 at June 30.

As we highlighted in our earnings release, GAAP book value per share at June 30, 2012 was $16.59, a $0.15 increase from the prior quarter. This increase was primarily the result of our net -- of net unrealized mark to market gains on our CMBS portfolio.

As a reminder, we do not mark our loans to market for financial statement purposes. We currently estimate that there is another $0.63 per share of value when our loans are mark to market. And as such estimate our market value per share to be $17.22 at June 30, 2012. Based on our closing share price on August 3 of $16.75 we are trading at a 1% premium to GAAP book value per share and a 2.9% discount to fair market value per share.

Our investment portfolio as of June 30, 2012 had an amortized cost basis of $676 million with a weighted average underwritten IRR of 15%, an increase of 21 basis points since last quarter. And the weighted average duration of our investments was 2.9 years. We continue to lengthen our duration as we recycle our capital from our shorter duration CMBS expected to partially repay during the remainder of the year into longer duration investments.

In July we acquired a $6.5 million mezzanine loan secured by a pledge of the equity interest and a borrower that owns a mixed use project in Chapel Hill, North Carolina. The project consists of approximately 55,000 square feet of Class A retail and 114,000 square feet of Class A office space.

The mezzanine loan is part of a new $40 million 10-year fixed-rate financing comprised of a $33.5 million first mortgage and a $6.5 million mezzanine loan. The mezzanine loan is an interest only fixed rate loan that has an interest rate of 11.1%, an appraised LTV of approximately 70% and is underwritten to generate an IRR of approximately 12%.

Finally, we do expect that given the ramp-up period needed to invest the capital raise last week, our operating earnings per share in the third quarter will be slightly below our previously expected run rate. However, as Stuart mentioned, our pipeline is strong and we expect to deploy the proceeds into accretive investments. As we get the newly raised capital deployed we expect to raise -- we expect our earnings rate to increase.

And with that we would like to open the line for questions. Operator?

(Operator Instructions). Steve Delaney, JMP Securities.

Stuart, it seems in the capital markets there has been this mad rush for fixed income and for yield really in every sector. And you commented on CMBS spreads tightening and it is happening all over. I was just curious if you could comment, you or Scott, on sort of your competitive landscape.

Who are you running up against, maybe not specific names, but just the types of competitors? And given this rush for yield are you seeing anyone becoming more aggressive on terms and pricing? It sounds like you've got a good pipeline, but I'm trying to get a sense for whether you are going to be -- still be a price setter if you will or is it becoming more of a price taker type of market? Thank you.

It's Scott; I think I will answer that. Clearly the products that are more what I will say tradable on a Bloomberg or if you will are more than any one kind of without real estate expertise so various hedge funds or other institutions combined, those are clearly where you are seeing the greatest tightening.

So the most liquid, obviously CMBS remain healthy and even, for example, we bought at 94.375%, it is now trading over 96. You don't have to be a real estate expert to do that, (multiple speakers) people make market and people can do that.

Where if you move to the other end of the spectrum where one needs to do real estate underwriting, one needs to have an ability to diligence and close and document deals, that is where -- and it's more of a spoke -- that is where you see more opportunities. You also see more opportunities on products that don't fit the securitization or really the capital market.

So whether it be a first mortgage loan on condo inventory or a lease up property or even mezzanine deals we are doing, those are where we can really add value to the process certainty of closing and understand the real estate and where you get more attractive yields than you would on just kind of a run-of-the-mill product that people make markets and [in] trades.

So, Scott, it sounds like it is still very much the landscape you guys -- it is a very specialized and it is mortgage REITs, specialized debt funds -- you are not seeing what I would call like fast or macro type money getting in the way?

No, absolutely not.

Okay, good.

Again in the last cycle that was driven a lot by the CDO market which, again, commoditized mezz and other products. We are not seeing that. I will say on -- the other part where we are seeing it is clearly on the CMBS market, that is where there are a lot of folks competing and getting more aggressive, which is why you don't see us doing many deals behind conduit loans, if you will, it's just not attractive.

The one deal we closed in Chapel Hill was somewhat of a special deal. We really liked it; we thought it was well structured. To get 10 year duration of that type of yield was attractive. But what we are seeing in the conduits overall pushing more what they can put into their deals.

Yes, we had heard that, that some of the easier mezz was getting squeezed out because the CMBS deals were being written a little more aggressively and there wasn't as much need for the mezz behind CMBS.

Correct.

Thanks for the comments. Appreciate it.

Joshua Barber, Stifel Nicolaus.

Would you be able to talk a little more about the Boston -- the development loan there and I guess what the plans are in terms of any extension options? You guys bought it at obviously a pretty decent discount and it matures at the end of this year. Have you begun any conversations with the borrower? Is there potential there to extend that loan or do you expect it to pay off?

Well, yes, I mean I think we thought we were pretty clearly. While the loan matures in December 2012 the borrower does have an extension option as a right by paying a small, I think it is a high point fee and there is some required amortization. So the borrower does have that right.

The -- what attracted it to us was our basis and clearly the discount kind of generates 20 plus IRRs at that leverage is obviously attractive. Right now it is cash flowing, we are well covered by the income coming off the parking garage, it is the borrower's intent to continue to sell off parcels to end-users.

Obviously Boston -- this part of Boston is going through a renaissance with biotech and other uses. So they have already sold off some parcels and the type of uses is everything from multi-family development, hotels, offices are all being developed there. And so, over time we would expect to see pay downs of the loan.

Our IRR assumes they just make the required amortization at the end of this year, which pays us down a few million dollars and then it goes all the way to the end of next year. We don't necessarily think that is the most likely scenario, but that is the way we have to account for it. And I know they are in active discussions now to sell some parcels, it's just they haven't consummated them since we have closed.

Okay, thanks. That's very helpful. Can you talk also about what you are assuming on the Hilton loan for purposes of that underwriting? Because obviously there has been a lot of talk about them potentially going public and having to basically get rid of that particular loan.

Yes, again, given the accounting standards we have underwritten that based on the forward LIBOR curve both for our borrowings which are floating rate, but also the loan and assume it goes out to full maturity. I think clearly Blackstone as sponsor, given the capital structure here, most likely will not wait until the last day to refinance this capital structure whether they go public; obviously there is a lot of speculation.

So I think there is upside to the IRR from what we are showing. Given the discount, any kind of early repayment will improve the IRR, but for now we are assuming it goes all the way out to full maturity.

Was that actually purchased at a discount?

Yes.

Yes. And it's -- we purchased it I think about 94.375%. And like I said, today it is trading above 96%. And for GAAP purposes like the other AAA CMBS that we own, that change in market value will be reflected in our GAAP book value.

All right, great. Thank you very much, guys.

Gabe Poggi, FBR.

Two quick questions. Scott, kind of piggybacking what you said earlier answering Steve's question, has there been any generic tightening in mezz? Have you had -- I know that the market is still pretty specialized, there is not as much fast money in it, but just on the margin has there been any tightening for 75-ish LTV product? That is question one.

Then question two, Stuart, I don't know if you guys provided timing for deployment from the preferred capital if you guys have a scheduled timing you would like to get that out the door or if it's just kind of hit pitches as you see them? Thank you.

I would say on the first point the type of mezz or preferred (inaudible) that ARI is doing, we really haven't seen tightening. I will say we do manage money for an insurance company and that does kind of lower leverage, lower return mezz and we have seen some tightening in that market as insurance companies and others, pension funds from Canada and others, have come into that market.

That is really a lower leverage kind of 60%-ish leverage mark and MetLife and other insurance companies, as they look to go yield, you do see some shifting out from them doing first mortgages at 3% to kind of doing lower leverage mezz at 7%, call it. But again, that is kind of a different market than clearly what we are focused on at ARI.

That is helpful, thank you.

I think, Gabe, from a timing perspective the preferred was raised now based on the fact that we have got deals in the pipeline that I would say are in the likely category where we like the returns. It would certainly be accretive to the cost of the preferred.

I think the challenge with getting too specific on timing is that everything we do is ultimately a privately negotiated transaction, so you can't be completely certain with timing. But I would say the timing of the race was based on having some -- a fairly robust pipeline where we think there will be some closings late Q3 into Q4 and get the capital deployed fairly quickly.

Perfect, thanks, guys. Good quarter.

(Operator Instructions). [Bic Agarwal], Wells Fargo.

With the new capital that has been raised with the preferred are you going to look to add duration in the portfolio?

I think consistent with previous comments that we have made, we have been working for the last call it six to nine months to try and find deals with good duration. It is always a balance between things that we think are attractive risk-adjusted returns and those that allow us to lengthen the duration of the portfolio overall. We are at about three years today.

The market is generally a mix of call it three to seven year deals. The Chapel Hill deal was obviously attractive because it allowed us to get money out for 10 years. But, look, in the environment we are in today, if we could get call it good double-digit returns that allow us to extend the portfolio we are comfortable taking that duration for those types of returns and are certainly working on a handful of transactions that would allow us to extend the duration.

Okay, thank you.

(Operator Instructions). There are no further questions at this time.

Thank you very much, Operator, and thanks, everybody, for joining the call this morning.