Apollo Commercial Real Estate Finance Inc (ARI) 2012 Q3 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 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 like to also call your attention to the customer Safe Harbor Disclosure in our press release regarding forward-looking statements.

Today's conference call and webcast may include forward-looking statements and projects. 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'd like to turn the call over to the Company's Chief Executive Officer, Stuart Rothstein.

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

Fundamentals in the commercial real estate debt market continue to strengthen in the third quarter, and were bolstered by the Fed's QE3 announcement at quarter end. Following the announcement, we saw spreads in the CMBS market tighten to levels not seen since the pre-Lehmann Brother's crash in 2008.

The repricing of risks and securities has had a meaningful impact on the commercial real estate loan market, and has greatly improved borrowers' ability to successfully refinance legacy transactions and finance new investments. As a result, there continues to be a healthy level of activity creating financing opportunities throughout the capital stack.

With respect to ARI, our focus remains on identifying opportunities across our target asset classes that provide attractive risk adjusted returns.

As we have stated in the past, we have tremendous confidence in our ability to effectively underwrite, appropriately structure and quickly execute transactions. Whether considering investments in CMBS, first mortgages or subordinated debt, we undergo a rigorous underwriting and due diligence process consistent with the manner in which Apollo conducts business across its various investment vehicles.

We have worked very diligently to enhance our deal sourcing capabilities by making sure we are a first-call relationship for many of the conduit lenders, balance sheet lenders, and mortgage brokers, effectively becoming a co-originator of choice for pieces of larger financings.

In addition, we believe ARI continues to benefit from the deep relationships that Apollo has built with many of the key players in the Real Estate Finance Market.

Given the uptick in financing activity in the commercial real estate debt market, as well as our efforts to expand our deal sourcing channels, we have been working through an active pipeline of financial transactions throughout the year.

Year-to-date, ARI has deployed $85.6 million of equity into $135 million of investments with a weighted average IRR of 14.5%. Funding for new transactions has come from a combination of capital recycling from older investments, debt and the proceeds from our two recent capital raises.

The third quarter was a significant one for ARI as it marked the first quarter of considerable capital formation since our initial public offering in 2009. In August, we completed an underwritten public offering of 3.4 million shares of the Company's eight and five-eighths percent series A cumulative redeemable perpetual preferred stock, generating net proceeds of approximately $83 million.

As with all capital raises, our strategy to access the preferred market was based upon the combination of a strong pipeline of attractive potential investments, coupled with attractive pricing in the preferred marketplace.

We expect ARI will be able to invest the proceeds accretively, which we believe will result in growth for ARI's earnings run rate. To date, we have made substantial progress in identifying new investments. And during the quarter, we closed two Mezzanine Loans totaling $16.5 million.

The first was a $6.5 million Mezzanine Loan secured by a pledge of the equity interest in a borrower that owns a mixed use project, which consists of 55,000 square feet of Class A retail, and 114,000 square feet of Class A office in Chapel Hill, North Carolina. The Mezzanine Loan was underwritten to generate an IRR of approximately 12%.

The second loan we closed was a $10 million Mezzanine Loan secured by a pledge of the equity interest in a borrower that owns an 845,000 square foot Class A office tower complex in downtown Kansas City. The Mezzanine Loan has been underwritten to generate an IRR of approximately 12.6%. Importantly, in both instances, both deals are 10-year deals fixed rate with call protection.

Currently, we are working on closing $125 million of transactions in our pipeline. Each transaction that we are working on we believe will generate a very attractive risk adjusted return for the Company. Though a cautionary note. Obviously, there are no assurances that all of the deals will ultimately close. We feel very good about each transaction at this time.

In addition to the transactions in closing, we are working on a number of other potential investments. And the pipeline has remained strong throughout the year.

As such, in October we completed a common equity offering issuing 7.4 million shares of stock, including a partial exercise of the underwriter's option to purchase additional shares and raise proceeds of $124 million.

As a reminder, most transactions we enter into are negotiated transactions. And the average life cycle from identifying a potential investment to underwriting and closing can take anywhere from four to 12 weeks.

Therefore, while we are working diligently to deploy the proceeds from the preferred and common raises into well-structured investments with attractive risk-adjusted returns, the ultimate timing of full deployment is somewhat uncertain. And we expect a ramp-up investment period will have an impact on both our Q4 and Q1 2013 operating results.

Megan will provide more details on the specific impacts to Q4. And we will certainly issues press releases as material investment transactions close. And will provide further updates on deployment as is warranted.

As noted in our earnings press release, our board of directors declared a $0.40 dividend for the fourth quarter of 2012. Our board understands the importance of the consistent dividend paid by ARI for the past 10 quarters, and we are confident in ARI's ability to maintain the current dividend through our investment ramp up period.

Lastly, turning our attention to our investment portfolio, at September 30, 2012, we had a total investment portfolio of $606 million with a leveraged weighted average underwritten IRR of 14.9%. We continue to actively monitor each of our investment, and the credit quality of our portfolio remains stable.

At this point, I would like to turn the call over to Megan to review our financial performance.

Thanks, 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 September 30, 2012, we announced operating earnings of $9.2 million, or $0.44 per share, which represents a 16% increase over operating earnings per share from the same period a year ago. This is driven by a 29% increase in net interest income, which rose to $13.2 million in the third quarter of 2012, from $10.2 million in the third quarter of 2011.

In addition, during the quarter we received $30.7 million of principle repayments from our investment structured as a repurchase agreement backed by [CDL] bonds. Due to the [Macko] provision in this facility, we effectively pulled forward approximately $1 million of interest income from Q4 to Q3.

For the nine months ended September 30, 2012, the Company reported operating earnings of $26.5 million, or $1.27 per share, representing a per-share increase of 11% as compared with operating earnings of $19.8 million, or $1.07 per share for the nine months ended September 30, 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 released contained in the Investor Relations section of our website, www.apolloreit.com.

Turning to the balance sheet, ARI's leverage continued to decrease in the third quarter as we used the proceeds from the preferred offering to temporarily pay down the balance on our JPMorgan facility. We are in the process of renewing this facility, which expires in three months, and have received term sheets from JPMorgan and another global bank.

We expect the terms of our new facility will be similar to the existing one, which has a current interest rate of LIBOR plus 250 basis points. And as we close new investments, we expect the balance on this facility will increase.

As I related in our earnings release, GAAP book value per share at September 30, 2012, was $16.58, a one-cent decline from the prior quarter. As a reminder, we do not mark our loans to market for financial statement purposes. We currently estimate that there is another $0.58 per share of value when our loans are marked to market. And, as such, estimate our market value per share to be $17.16 at September 30, 2012.

Based on our closing price per share on October 31, 2012, of $16.91, we are trading at a 2% premium to GAAP book value per share.

As Stuart mentioned, our investment portfolio, as of September 30, 2012, had an amortized cost basis of $606 million with a levered weighted average underwritten IRR of 14.9%. The weighted average of our investments was 3.3 years, as compared to 2.9 years at the end of the second quarter.

Finally, given the impact of [bolts] to make whole payment I referred to earlier, as well as the ramp up involved with getting the recently raised capital deployed, we expect our operating earnings per share in the fourth quarter of 2012 and the first quarter of 2013 will be below our prior quarters' run rate.

Specifically, we would expect Q4 to be in the range of $0.28 to $0.32 per common share, though that may change based on the timing of transaction closing. More importantly, as Stuart stated, our investment pipeline is strong. And as we get the newly raised capital deployed, we expect the new investments will be accretive to earnings.

And with that, I'd like to open the line for questions. Operator?

Thank you. (Operator instructions). Your first question comes from Ken Bruce with the Bank of America.

First, I hope everybody has been, hopefully, relatively unaffected by Sandy. But as far as my questions, I guess the first one I'd like to start with is - Stuart, you'd kind of bring up the fact that you've got much better activity levels - you know - that have occurred. You've seen some spread compression that is coming into the market just - the CMBS market has picked up and volume levels have improved.

How do we think about this tradeoff between, maybe, the increase in activity levels and modestly lower returns - you know. Clearly, things still look good on a relative basis versus a lot of different credit benchmarks. But - you know - just how do we think about this slippage, if you will, in terms of returns in the market?

Yes. I mean, from a macro perspective, I think - you know - if you're waiting things, so to speak, I think from the Company's perspective the increased activity level certainly outweighs the fact that on specific deals or transaction here or there things might be marginally more competitive as capital is looking for a place to find a home.

I mean, the reality is from ARI's perspective, despite the fact that we're very proud of our recent ability to grow the capital and increase the size of the Company, overall we're still a fairly small player in the market. And as a result have the ability to be fairly selective and find specific niches where we can put capital to work at returns that we think are very attractive for the vehicle.

So the fact that we have more to choose from, more is going on in the market, more to look at, in general, I think that's a very positive development for the Company.

It is clearly somewhat more competitive today. Obviously, everybody looks at Triple A spreads on CMBS and sees where those spreads have gone. Certainly, first mortgage rates have come in dramatically, not just recently but over the - you know - over the three years since we started the vehicle.

And - you know - from my perspective, I think - you know - where it's gotten most competitively recently is what I would describe as senior mezz product, which is really not where ARI has chosen to play historically. But it's sort of that - you know - slice of debt right behind the First Mortgage but not necessarily the last dollar of risk.

Where I think - you know - it's fairly easy for a traditional first mortgage lender, like an insurance company, to say "you know what. I'm going to back up from the first mortgage and stretch to get that senior mezz piece just because I think there's better economics." And I think you also get some capital that has traditionally not chased real estate deals, looking at the nominal yield on those pieces of paper and finding them interesting in the yield environment we live in today.

But all things considered, we feel good about the pipeline. And we feel - you know - pretty good about deal flow in general. And - you know - are pretty confident with getting the capital deployed. I don't know if, Scott, you want to add anything to that.

I think that's all accurate. I mean, I would say - you know - one of the other benefits there, I guess, is as the senior lenders get that much more aggressive and their cost of funds goes down, again, that allows the mezz to have the same or wider pricing. Because from the borrower's perspective, they're looking at their cost of funds.

And so we're still seeing plenty of opportunities that come from, whether it be a senior CMBS lender or a - you know - a balance sheet lender. And we're also still seeing opportunities for deals that - you know - don't fit the traditional CMBS bucket. Or for that matter, some of the - you know - some of the more balanced balance sheet lenders - you know.

When you look into the for sale residential market, whether it be conversions to for sale condos or condo inventory loans, that's the market that we've been spending - you know - a lot of time in.

And then even on the CMBS side, while CMBS spreads have come in a lot, the availability of attractive financing has also increasing something we took advantage of with TALF. And then post-TALF with the Wells Fargo facility. There is - you know - increasing interest from banks and other lenders to provide what I would say is term financing to buy CMBS.

Okay. That's helpful. And is it fair to assume that at this point in the market you're going to really rely on - you know - being in a somewhat originator of choice or having - you know - a preferred relationship in terms of being able to have access to the deal flow that you want to be involved in? I mean obviously anybody can price and do volume. But that's not - that's really not your mo at this point, I would think.

Scott, do you want to comment on that?

Yes. I think we have a very active dialogue and relationship, both with borrowers, brokers and intermediaries, and the various - and senior lenders. So - you know - we are not looking to compete with those parties and turn around and try and sell stuff - you know - back to them to the extent we're originating a first mortgage loan.

The reason we can't originate that first mortgage loan is because our traditional relationships don't do loans like that, which is why we can get our spreads. But it is still very much - you know - a first call and relationship - you know - business for us - you know - where we show we can execute and people like working with us. And then when they're working the next deal - you know - we get that - you know - we get that call.

Again, whether that be from a borrower or from a lender who just wants to do the senior - the senior piece of it.

Okay. Thank you. That's all been very helpful. I'll turn the floor over to whoever might be next in the queue. Thank you very much. And good quarter.

Thank you. Your next question comes from Joshua Farmer with Stifel Nicolaus.

I was wondering - just one maintenance question first. Did you mention what your total line capacity is today?

We've paid off the $100 million facility with JP Morgan, Josh. So, it's obviously subject to having collateral that supports it. But the full $100 million is available.

And after you've raised the preferred and the equity, would you anticipate getting additional facilities?

You know - I think part of it depends on the mix of transactions we end up doing. You know - we've stuck - you know - very close to the strategy. We'll certainly consider leverage for first mortgages and DMDS investments. But we will certainly not put any leverage on our subordinated debt position.

It's fair to say that we're looking at opportunities across all three of those target asset classes. And I would also say that relative to when we put our initial facility in place, capital is more available today than it was three years ago. So, the opportunity to put facilities is in place.

But it'll really depend on the mix of assets as we go forward.

Okay. That's helpful. Sort of along those lines, especially on the balance sheet. You know - we've seen some of your - you know - older competitors perhaps - you know - get into the securitization market. Is that something that you guys think you can do today? I mean, assuming even with the smaller balance sheet, there's deals, the $100 million or $200 million securitization size. Is that something that ARI might be interested in at some point? Or not really?

Not at this point. I think we've been pretty clear that - you know - we're not going to try and become a conduit lender and sell pieces off. I think - you know - just given our size and also where we're positioned and just the competitive nature of that business, that that's doing something we said we wouldn't.

Clearly, one of the legacy mortgage REITs recently did a securitization of some of the more transitional mortgage loans. You know. We closely followed that. The financing that we had in place - you know - is very efficient for us. And that works. And so we're not looking to do any type of - you know - using any type of securitization kind of financing, if you will.

Okay. Great. Thanks very much.

Thank you. Your next question comes from Chris York with JMP Securities.

Good morning, guys. Most of my questions have been asked at this point. But I wanted to get a little bit more color on the improvement in your weighted average yield within your first mortgage portfolio. Looks like it improved to about 11.3% in this quarter, up from 7.2%. Can you guys comment on that a little bit?

Yes. Scott, do you want me to answer that or do you want to handle that?

Sure, Stuart. Go ahead.

(inaudible) I think that's really driven by - you know - we bought a piece of a first mortgage on a Boston deal that had a pretty high IRR. We bought it at a discount. So, that's really what's driving the uptick in weighted average yield during the year.

I mean, traditionally, the first mortgages we've done, most of which were 2009, early 2010 vintage, were sort of in the 8%, 9% unlevered return basis. And then we were able to buy this attractive piece on the Boston seaport land, which we've talked about previously, at a pretty attractive discount.

Okay. That's helpful. And then my last one here is it looks like your $24 million loan to a property in South Boston is going to be maturing here. Have you guys had any preliminary discussions with the borrower there about maturity?

Yes. That's the deal that Stuart was referring to that we bought it at a deep discount as part of the - they do have a one-year extension. As part of that extension, they do need to pay down the loan, either through equity or a sale of - you know - releasing part of the property. And talking to them, they will clearly be making that payment, is what they've told us.

And so - you know - we expect to receive that payment, which has obviously given our discount is a good thing, given that we bought it at a huge discount.

And then during the course of next year, they'll continue to execute their business plan. At some point next year, we would expect to be fully paid off. And the way we're calculating the IRR is assuming it goes all the way out to the full maturity. So any kind of earlier pre-payment would boost the IRR.

Okay. That's what I thought. Great. That's it for me. Thanks.

Thank you.

Thank you. Your next question comes from Joel Hawks with Wells Fargo.

Good morning, Joel.

I'm just looking at slide number 10 in your slide deck. And you have a - you know - the current weighted IRR is 13.1% and then the levered 14.9%. You know, even the 13.1% kind of nets down if you look at kind of your dividend and your operating earnings. It's kind of about a 9% yield to investors.

I understand you're not running an optimal leverage at this point. But even at 13.1% - you know - there's kind of a 400 basis point drag or dilution, if you will, relative to the gross returns versus what the net returns the investors receive.

Can you kind of speak about where that 400 basis points - you know - gets lost or eaten up inside of Apollo? I mean, is it expenses? Are there things that - you know - other items that we're not accounting for?

You've got the point and a half management fee. And you've got - call it - you know - somewhere in the high ones - or just call it the cost of running a public company - you know - insurance, audit, legal fees. Just being in business. So, that accounts for about - you know - between that and the management fee, you're eating up somewhere between - you know - 3.25% to 3.50% of the gap that you talked about.

Okay.

And then we've been running, from an operating perspective, slightly ahead of our dividend level this year. So, we haven't fully distributed everything as you think about the full 400 basis point gap that you're talking about.

Okay.

Look, we've been pretty public, I think, all along that as we can get bigger and that as we can raise capital at prices that make sense, there's operating leverage in the Company that we can continue to grind on. Because whether I'm running a - you know - $400 million company or an $800 million, DNO, audit, legal. Those sorts of things just don't move around much.

Right. Right.

But we get more and more operating leverage out of the platform.

Okay. And I guess - you know - to kind of expand on that further, if I look at the levered weighted IRR, what do you think - you know - is there a timeframe for when we would see you guys run this public entity at more optimal levels of leverage, too? Because that's a 180 basis point delta right there if you can run more optimally on the leverage front.

Go ahead, Scott.

I was going to say that that is driven by - you know - obviously the investment pipeline because right now we've paid down the JPM facility.

As we make our new investments - you know - we will put those first mortgage loans back on the facility - you know - generating that leverage is approximately $53 million, I think, of leverage available. And then, based on our pipeline, what we're seeing - what we're consistently seeing are deals whether levered or unlevered that generate that mid-teen return.

So we would expect over the next few months, as we deploy the recently raised capital, that our run rate will get back into that - you now - that mid-teen, mid to low-teen return range. IRR range.

Okay. So, I guess kind of wrap up - I mean - at least looking out into 2013. If you're able to get bigger and obviously re-lever a bit of first mortgage, we might be able to see - you know - more of a low double digit type of operating. Or is that correct in thinking?

Well, yes. Look, I think we've tried to say in the prepared comments and maybe it got lost. But I think, despite the fact that we might take a little bit of time in Q4 and Q1 to ramp up, to the extent that we've been working off this - call it $0.40 per share earnings and dividend level - we certainly feel good when the capital is fully invested, given the returns we expect to achieve, we think there's definitely some earnings accretion in the Company.

Okay. Thank you very much.

You're welcome.

Thank you. Your next question comes from Gabe Poggi with FBR.

Hi, Gabe.

(Technical difficulty) been asked. Nice quarter.

Thanks, Gabe.

That concludes the questions.

Yes. Thanks, everybody, for participating.

Thank you. Your next question comes from Rick Shane with JPMorgan.

Hey, Rick.

We appreciate the guidance and outlook in terms of how the recent capital raise impacts near term earnings. One thing you haven't talked about, and this might help us - can you talk a little bit about what you expect in terms of seasonality for originations?

It strikes me that fourth quarter you may see a lift as folks clean up their balance sheets and that gives you an additional opportunity. Is that contemplated in your outlook?

No. We really --

I would say rather than - you know - August and the last week or so of December, just because of vacation schedules - I mean. That's really the only seasonality - you know - that you see in the business. I mean - you know - given the kind of six to eight weeks that it generally takes to close - you know - commercial real estate financing kind of from the time - you know - the borrower starts seeking financing till the time it takes to close.

You know - what just really drives the closing is things come up on deals that delay it. Obviously, this week - you now - we basically lost a week in terms of documentation and lawyers on one deal in particular, no one can get in touch with each other, no one can get into the office. But, really, no seasonality.

I would say the pipeline - you know - is really driven by deals we've been working on for a while. I mean, there's one deal that we have in closing that we've been working on for six months. There's another one that we thought would close in September, then October. Now we feel really good it's going to close - you know - in November.

I think we've talked about it before. Unfortunately, we can't - you know - control - you know - when these deals close. Some are acquisitions. Some are refinancing. I think we are trying to give as accurate a view as we could of the 125 that's in closing.

We have a bunch more transactions which are coming right behind that we're optimistic will come in. We have handshakes and we're going back and forth finalizing term sheets. So, technically, we wouldn't call it in closing. We don't have a deposit yet, for instance. And we're not - you know - drafting loan docs. But we feel behind the 125 is a good number of additional deals that will deploy the remaining capital.

Terrific. What you're saying is and I'm - I guess probably misunderstood this. But there's no sort of year-end rush - you folks try to get deals done - you know - before December 31?

Yes. I would say no. I mean, I would say no. You know, if anything, it's more of a kind of end of November, beginning of December rush just also because - you know - for the banks in particular and the CMBS shops. They don't want to be carrying stuff over the year-end balance sheet. So, they're looking - you know - to be getting stuff done - you know - done earlier.

Okay. Great. Thank you guys very much.

Thanks, Rick.

Thank you. We have a follow-up question or comment from Ken Bruce, Bank of America Merrill Lynch.

Thanks again. So, my follow-up question is really more - I'm looking for some thoughts around - really, if you look at the stock today, it's trading at a little bit discount to your existing stated book. Obviously, you would like to grow the Company and get leveraged to a point where maybe the economics and the portfolio help to support a higher valuation.

But if you look at it relative to the fair value book, you're actually at a more meaningful discount. And I'm wondering if there are any strategies to be able to allow you to bring in some of that - if you will - those gains and the fair value into book and maybe help to underpin book value? Or if that's just going to - it's lost economics because you're going to earn that over time.

So, any thoughts about strategies on - you know - just as it relates to valuation, please?

You know, I think at the end of the day, Ken, I think we provide the fair value, as I think others in this space do. In some respects to give people a sense of the asset protection that they have around the Company.

Ultimately, if you hold things to maturity, which is really what the vehicle is set up to do, it's really not a trading vehicle, per se, you're really earning the excess spread over what's available in the market over time. And, really, the only time you'd really sort of bring that gain onto balance sheets, so to speak, is if you saw a compelling reason to sell out of something and trade into something else.

And, to be honest with you, given the stuff we put in place in 2009 and 2010, which has a lot of the theoretical fair market value built into it, much more inclined to hold that to maturity, earn the excess spread over time, and continue to grow - you know.

Again, with new capital to the extent that we can find it at a price that makes sense. And we were fortunate to do that earlier this year. You know. Saw the stock down a little bit this morning. It's come back somewhat. Not something - you know - that's terribly relevant to us today, given that there's certainly no need to raise capital. And I think we've been pretty public in our comments about - you know - defending book value as we go forward.

So - you know - there's nothing on the horizon that would necessarily bring some of that gain - you know - onto the P&L, so to speak.

Okay. Well, that all seems reasonable. I just wanted to get your thoughts around it. Thank you very much.

Thank you. (Operator instructions). Your next question comes from Jim Young with West Family Investments.

How much in undistributed taxable income do you have at the end of the third quarter? And could you just clarify how does the tax treatment work for year-end 2012 going into 2013?

Hey, Jim. To be - you know - not to avoid your first question, but historically we've not disclosed our taxable income number. And we're not going to start doing that now.

There are some book tax differences with respect to GAAP accounting and tax accounting. The REIT rules require that you distribute at least 90% of your income to meet the REIT requirements. And then for practical reasons we're attempting to distribute 100% of our taxable income because we certainly don't want to pay corporate taxes on what hasn't been distributed.

I would say right now, relative to the residential REITs, we deal with a lot of these issues. There's nothing with respect to our tax situation that will - you know - that we envision right now causing us to need to do something out of the ordinary with respect to distribution policy as we approach Q4.

Okay. Does that conclude your question?

Yes. Thank you.

You're welcome. At this time, there are no further questions. I will turn it back over to the presenters.

Nothing further at this time, operator. Appreciate everybody joining the call and participating with questions. Thank you.

Ladies and gentlemen, thank you for joining today's conference. Thank you for your participation. You may now disconnect.