Apollo Commercial Real Estate Finance Inc (ARI) 2014 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Apollo Commercial Real Estate Finance, Inc., second-quarter 2014 earnings conference call. (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 the Company's Chief Executive Officer, Stuart Rothstein. Sir, please go ahead.

Good morning and thank you for joining us on the ARI second-quarter earnings call. Joining me this morning in New York are Scott Weiner, our Chief Investment Officer, and Megan Gaul, our Chief Financial Officer, who will review ARI's financial results after my remarks.

Even though we are fast approaching the five-year anniversary of ARI's IPO and reporting on ARI's most active and successful quarter to date, I would like to take a few minutes -- a few moments to comment on ARI's strategy and the real estate finance platform we have built here at Apollo.

ARI was created in the fall of 2009 to be an opportunistic investor in performing real estate credit. Over the last five years, the real estate finance markets have certainly recovered, as evidenced by the fully functioning CMBS market, the appetite of insurance companies and banks for real estate assets, and the market's ability to refinance and restructure much of the highly anticipated 2010 to 2012 maturity wall.

During the recovery that has taken place, we have not wavered from our core strategy, and as the recovery has created various pockets of opportunity, we have consistently demonstrated an ability to find investments throughout the capital stack with attractive, risk-adjusted returns. Since going public, we have completed over $2.5 billion of transactions.

Also during the last five years, Apollo has continued to invest in building out a robust commercial real estate credit platform, and today, that platform is responsible for managing over $6 billion of capital, which has financed approximately $10 billion of real estate transactions across multiple property types and geographies.

We feel very strongly that the depth and breadth of Apollo's overall real estate platform has been and will continue to be critically important to ARI's success. Significantly, that platform has created best-in-class relationships with brokers, senior lenders, and borrowers and has cemented a reputation for being a reliable counterparty that is highly thoughtful and creative around underwriting, pricing, and structuring.

As a result, ARI is able to effectively differentiate itself when competing with other commercial real estate capital providers.

With respect to the state of the overall commercial real estate market, consistent with prior quarters, there continues to be robust transaction activity and improving operating fundamentals throughout most property types and markets. Sales prices for core properties in major markets have eclipsed their 2006-2007 averages.

The June statistics for the Moody's Real Capital Analytics Commercial Property Price Indices showed continued steady growth in prices across markets and property types, bringing the overall index to within 5% of its November 2007 peak. Notably, non-core or non-gateway city markets, which have lagged the major markets, have begun a steady recovery with the non-core index up 15% over the past 12 months.

The real estate finance markets remain extremely active as well, with capital flows, number of participants, and competition steadily increasing. While CMBS volume declined 8% in the first half of 2014, when compared to last year, the lack of issuance was mostly due to increased competition for conduit-eligible loans from insurance companies and community and regional banks intent on retaining commercial real estate loans on their balance sheets. As a result, owners and acquirers of assets are benefiting from the more robust lending market.

As I mentioned, the second quarter was a record quarter for ARI, as the Company completed over $576 million of transactions, and year to date, we have committed to invest over $730 million.

The breadth of ARI's origination capabilities is evidenced by the diversity of the transactions completed thus far in 2014. The Company deployed capital into each of ARI's target asset classes, including first mortgages, mezzanine loans, and investments in legacy CMBS, and closed transactions involving a broad range of deal structures and underlying asset type.

Notably, as ARI has grown its capital base, the Company now has the ability to both hold larger positions and, notably, to principal larger loans and then syndicate portions of those loans to third parties. ARI completed two such loans in the second quarter. The first was a large loan on a resort hotel in Aruba, where ARI syndicated a senior piece and retained a high-yielding junior piece, and the second was a first mortgage on a portfolio of destination homes, where ARI retained a controlling interest in the first mortgage and syndicated pari passu interest to other investors.

ARI also continues to identify synergies within and benefit from the broader Apollo platform, which provides ARI with valuable underwriting information and deal flow. During the quarter, ARI participated in refinancing an existing loan on a healthcare portfolio, which had been presented to ARI through an affiliated healthcare lender acquired by an affiliate of Apollo in 2013. And another investment source through the Apollo platform is our pending investment in KBC Bank, which is on track to close in the third quarter of this year.

In addition, given Apollo's dedicated team of CMBS professionals who are in the market on a daily basis, ARI has the ability to selectively invest in attractively priced CMBS strategies. Since ARI went public in 2009, the Company has deployed approximately $200 million of equity into $1.1 billion of CMBS, which have generated a mid-teens IRR.

Most recently, in the second quarter of this year, we deployed approximately $35 million of equity into roughly $175 million of legacy CMBS and financed the balance using the Company's recently upsized $200 million term repurchase facility.

While CMBS represents only 8% of our net equity at June 30, 2014, given our ability to identify these assets and the Company's ability to source and structure match term financing, the result is an attractive risk-adjusted return which supplements our earnings and dividend-paying ability. The newly purchased CMBS have been underwritten to generate an IRR of approximately 17%.

Another area of success for ARI has been the financing of a broad mix of for-sale condo projects, including both conversions and new development. Since 2012, ARI has committed to invest over $348 million into five transactions, representing 310 condo units across varying price points. Many of the traditional providers of this type of financing exited the business during the financial crisis, thereby enabling ARI to capitalize on the void left in the market and generate attractive returns.

ARI has taken a very selective approach to transactions in markets, as evidenced by the investments completed to date, which have been either in New York City or metropolitan Washington, DC, arguably two of the strongest housing markets in the nation.

At all times, we carefully monitor our exposure to this strategy. Some important metrics to note include the fact that the two most recently completed investments in DC have future funding components, which are not expected to fund until after we receive the repayment on our largest New York City condo exposure, which is nearing completion.

Furthermore, in our two largest New York City condo transactions, contracts with aggregate net sales proceeds have been executed in excess of our basis in the respective deals. As such, the market risk condo exposure of our investments in this strategy is approximately 21% of our book value and about 11% of our assets.

Lastly on this topic, it is important to note that across our condo portfolio, the weighted average loan to net sellout was 52% at June 30.

We are extremely comfortable with the approach we have taken to underwriting these deals and price the risk in these transactions, and across our for-sale condo investments, we expect to generate a weighted average underwritten IRR in excess of 13.5%.

With respect to the Company's overall investment portfolio, at June 30, 2014, the portfolio had an amortized cost of $1.3 billion, a leverage weighted average underwritten IRR of 13.9%, and a weighted average duration of a little bit more than three years. Across our first mortgage and mezzanine loan portfolio, the weighted average loan to value was 58% at quarter-end.

Importantly, the credit quality of our loan portfolio remains stable. In the five years the Company has been public, ARI has never realized a loss, which is something we are very proud to report. Our focus remains on investing in performing loans and making sure that, throughout our deal underwriting and structuring, we are focused on protecting principal.

Before I turn the call over to Megan to discuss our financials in detail, I would like to highlight that our operating earnings per share this quarter exceeded our dividend per share. For the past few quarters, we said we believed the earnings potential of our portfolio on an invested basis could meet or surpass our dividend. Historically, we have experienced a cash drag in the quarters following a capital raise, which impacted our operating earnings.

This past quarter, we were able to better manage the timing of our capital raising efforts with our capital deployment efforts, which resulted in solid operating and financial performance. Our pipeline for future investments remains robust and we will continue to be thoughtful around the timing of capital raises and deployment.

And with that, I will turn the call over to Megan.

Thanks, Stuart. 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.

For the second quarter of 2014, we announced operating earnings of $18 million, or $0.42 per share, representing a per-share increase of 35% as compared to operating earnings of $11.7 million, or $0.31 per share, for the second quarter of 2013.

Net income available to common stockholders for the same period was $22.1 million in 2014, or $0.51 per share, as compared to $9.9 million, or $0.27 per share, for 2013.

The Company reported operating earnings of $32 million, or $0.80 per share, for the six months ended June 30, 2014, representing a 14% share increase -- per-share increase as compared to operating earnings of $23.7 million, or $0.70 per share, for 2013.

Net income available to common stockholders for the six months ended June 30, 2014, was $37.8 million, or $0.94 per share, as compared to net income available to common stockholders of twelve (technical difficulty) $0.59 per share for 2013.

A reconciliation of operating earnings to GAAP net income can be found in our earnings release contained in the investor relations section of our website, www.apolloreit.com.

GAAP book value per share at June 30 was $16.30, which is a slight increase from $16.21 at March 31. As a reminder, we do not mark our loans to market for financial statement purposes. We currently estimate there is another $0.21 per share of value when our loans are marked to market and estimate our market value per share to be $16.51 at June 30.

With respect to repayments, as Stuart mentioned earlier, in the second quarter we received a $47 million principal repayment from a mezzanine loan secured by a portfolio of healthcare properties. The Company realized a 12% IRR on this investment and participated in the refinancing of this loan.

To fund our recent investment activity, the Company completed a 9.7 million share offering during the second quarter, raising net proceeds of $158.4 million. In addition, we expanded two of our credit facilities. The borrowing capacity under the Company's JPMorgan facility was expanded to $175 million from $100 million and the borrowing capacity for the Deutsche Bank facility was upsized to $200 million from $100 million.

We continue to believe that our business model remains favorable in this interest rate environment and are confident ARI is well positioned if interest rates rise.

In addition to the minimal use of leverage, 52% of our loan portfolio had floating interest rates at June 30.

Finally, as indicated in our press release, the Board of Directors announced a common dividend for the third quarter of $0.40 per common share. This is the 17th consecutive quarter of a $0.40 common dividend. Based on Monday's closing price, ARI's stock offers an attractive 9.8% yield.

And with that, we would like to open the line to the operator.

(Operator Instructions). Dan Altscher, FBR Capital Markets.

I appreciate you taking my call. Looked like a pretty good quarter. I was wondering on the JPMorgan facility, you said you upsized it, which looks like a pretty good move here, but it seems like it might be brushing up against the limit once again. Are there thoughts to maybe try to pay that line down or up it again or maybe get a new facility for the first mortgages?

I think generally speaking, we have been in discussions with both JPMorgan, as well as a couple other banks, to either redo the facility in total or split it into a couple different facilities. And those conversations are ongoing at this point in time.

So I think what you are seeing right now is just managing through the process in terms of the discussions we're having, and JPMorgan has been a great partner in terms of working with us in the interim as we have needs to finance deals that are happening real time. But I think as we move through the end of the year and the early part of next year, you will either see a full redo of the JPMorgan facility or you'll see other facilities, which break it into its disparate parts.

Okay, we will be on the lookout for that.

On the $210 million loan that was, I guess, syndicated up to bigger parent Apollo, it seems like Apollo has done -- or the bigger parent has done a pretty good job of sourcing deals or maybe acting as a partner there. Do you see that going forward, trying to use maybe some of those funds that are managed by the parent as a way to lay off risk or use as a partner for capital sources? Is this like a one-off sort of thing or is this going to be maybe more of a continual trend?

Hi, it's Scott. To be clear, the other participants is not Apollo Global itself, but other vehicles and funds managed by Apollo, just to clarify.

Right, right, right.

But yes, look, it is certainly an ongoing strategy.

As Stuart mentioned in his opening remarks, we have a much larger real estate debt platform. ARI is a vehicle, whether through leverage or without leverage, looking for the higher yield type stuff. We have other vehicles where they are looking for what I will call more senior mezz or lower yielding or lower yielding CMBS.

So, this was a situation where the yield worked on an unlevered basis for certain vehicles. It was a large deal that allowed us to have a competitive advantage. Then from ARI's perspective, it was an asset that we were able to put leverage on to get to our yield.

So I would say we continue to look for opportunities like that. We also see opportunities where we can speak for a large part of a capital structure, let's say, example, a mezzanine loan. That's a very thick piece, and where we can put a senior piece into a vehicle looking for that type of risk and return and ARI can take a more junior piece looking for that type of risk and return, so we do do that a bit.

Obviously, it goes through Apollo's kind of conflict and allocations processes to make sure everything is done on arm's length and things like that, but that is a big competitive advantage that I think we have where we do have multiple pockets of capital looking for different yields and risk deals.

Okay, and then maybe just a quick numbers question. On the Aruba loan, the $90 million that was syndicated out and you guys kept the $65 million, can you maybe just give the representative yields that were -- that accompanied the senior and the junior portion? The asset yields?

Sure, the senior was participated out to a bank who will most likely include it in a CMBS deal. There, yield was out with a four handle, and then our mezz was -- our B note, if you will, was double-digit L over 1,000.

Okay, that's really helpful. Great, thank you.

And there are obviously fees and floating rate and stuff like that, but to give you an idea.

Great, thanks.

Steve DeLaney, JMP Securities.

Congrats on an outstanding quarter. I was wondering, Stuart, if you could comment on if you now see yourself as pretty much fully invested from the early May raise, and try to estimate for us how much additional loan origination capacity do you see yourself having now with the June cash and remaining funding under the bank facilities for senior loans?

Look, I wouldn't describe us as effectively fully invested, particularly given the two deals we announced after the quarter closed. So we did go -- ended the quarter with a little bit of capital, announced two deals earlier in the quarter.

As I mentioned in my comments, we do expect to get -- start getting paid off the latter part of this year on one of our large New York City condo deals, so that is viewed as an inflow of capital from our perspective. We also have another deal that will get refinanced; though given the way the deal is structured, we will have a look at putting our capital back into the refinancing. So, I think we have got --

And that was the shorter deal that we had bought that we announced that matures at the end of this year, so that's a deal where we figured it was a very safe piece of the capital structure, better than cash, earning, I think it was, an 8%, 9% type return that we either -- we will look at the refinancing, but it's a source of proceeds for new deals.

Got it.

So all things considered, I would say we have less than $50 million of, call it, free capital right now, but I do think we have some options to add a little bit more leverage to the Company, if we wanted to, in order to pursue transactions and complete transactions before doing anything significantly in the capital market.

Got it, and that's -- your last comment there, Stuart, touched on what I was trying to get to, that incremental to the $50 million of which you would call free capital, when I look at how your senior loans were levered at June 30, your advanced rate of about $147 million on $344 million, you are only about 42%. So it would appear just on that collateral before you even add -- I think you had, what, the third-quarter loans, one of those was a senior loan, right? I believe.

So, it would seem that there is some additional borrowing capacity and I assume that's what you were referring to when you were talking about incremental leverage?

Yes.

Got it.

For example, the home loan that we just discussed where we participated with other parts of Apollo, that, as we have said, is unlevered. We are in the process of levering that, but, again, that is more capacity to make new deals.

Great, okay, that's helpful. And Scott, I am looking at your legacy CMBS and, obviously, very attractive funding markets there. You give us an average maturity of 2.8 years. I was wondering if you could comment on how are the wings of that average look? How the longest pieces, maybe how long are they in terms of duration?

We are buying 2006/2007 paper. That was 10 years at the time. Obviously, certain deals have -- loans underlying the CMBS have defaulted and gone through resolutions. Others have been extended and we do our own underwriting. But I would say it is within a tight band. It is not like there is a one-year and a 10-year in there.

Right.

That is a true average, if you will. The financing we have in place is longer than that to give ourselves room, as these things tend to go out longer. But the model would tell you the 2.8, but yes, it's around (multiple speakers)

But the financing would be -- while it is committed longer, it would be floating rate, though, right?

The financing is floating rate, but we swapped it effectively. So we are buying fixed-rate bonds and using fixed-rate financing. So (multiple speakers)

You have swapped it.

So we have taken out that interest-rate risk, and the IRRs we are showing are based on our modeling around any kind of -- not to say we expect the bonds we are buying to take losses, but to the extent we do expect them to take a loss, that's modeling to our IRRs.

Great, that's very helpful. I was specifically going to ask if you had put swaps on those, so I appreciate that.

And again, congratulations, guys, great quarter, and looks like you are off to a good start here in the third quarter, as well. So, good job.

Jade Rahmani, KBW.

This is actually Ryan Tomasello on for Jade. Thanks for taking my question. Was wondering if you can discuss the competitive environment a bit more. What are you seeing in terms of increased competition for yield and have there been any changes in underwriting standards that particularly concern you, whether it be on certain deal types or geographies or property types?

Look, and as we would continue to say, the markets are robust. There is an abundance of cash out in the world looking for yield. I think that's clearly manifested itself across all asset classes. It's not commercial real estate credit.

In some ways, I do think commercial real estate credit is, in some ways, what I will call the tallest midget, where I think when you look at high yield and some other asset classes, we do still offer some attractive relative value.

I would say where we are seeing the most competition is in what I will call the most liquid parts of the market, so loans intended for securitization or mezzanine debt that is in a large liquid form being syndicated widely by the Street to where maybe the underlying assets look like a company. So people without necessarily real estate knowledge can do that, and again, those people will more comp to high yield who have seen -- that could be a limited service hotel portfolio or things like that. So you have seen compression.

Also, as we stated earlier, the availability of financing is very high for first mortgage loans. You have not seen it come back for mezz or CLOs or things like that, but clearly, borrowers -- it is a cycle, right? There is more leverage to do first mortgage loans, so that's -- for spreads on first mortgage loans are coming down, thus the cost of funds are lower, so people are paying more for properties.

As far as concerns and bad habits, yes, look, I think the capital markets, they will compete on both a spread or a yield perspective, but they will also compete on a credit perspective, and so you are seeing a little bit of originate to distribute model where people are giving up on terms. We are still not back to the peak 2007, but yes, lots of competition, I think.

We pick and choose our battles and really look to areas of the market when you do need more real estate expertise or, for example, you are doing a loan with a bank who is holding on their balance sheet who very much cares who is behind them. Or a borrower who is not necessarily focused on the last basis point spread, but looking for someone who is going to be there and hold the deal on their balance sheet and someone they can come talk to.

And we have been able to do it really across all property types, whether it be hotel, multi-family, other types. It is just finding deals.

But we certainly are passing on a lot more deals today than we did last year at this time, because I think it's two things. One, deal volume is up dramatically, but also there is just a lot of -- there is no shame in asking. People will ask for anything these days, and if they get it, they get it, and if not, there is no detriment to them for asking.

Got it, thanks. And then, secondly, can you talk about the type of deal flow you are seeing recently as far as a mix between first mortgages and mezz? And if there has been a change, what do you think is driving this? And are you increasingly looking to originate more first mortgages or do you think you will continue to focus more on the mezz space?

I think we're actively looking at both. For the first mortgages for us, again not looking to compete with the capital markets. There needs to be some sort of transition and not necessarily construction.

So the deal that we announced post-quarter was a brand-new multi-family building that had retail leases signed, but the multi-family component wasn't occupied, so it wasn't well suited to capital markets, so that was a very nice deal, a kind of deal that we are able to do.

As we have grown in size and also the availability of capital, we are able to do bigger deals now, where we could take something down and either use leverage or sell off a senior, i.e., what we did in Aruba.

We've also added to the team, quite honestly, and so we have brought on some people who historically have focused on that segment of the market, so we're actively working on a few other deals in that segment. We do find first mortgages with leverage attractive, but at the same time, the mezzanine loans we are doing, effectively we have term financing because the senior is -- the senior that matches the same term as us is another way to think about it.

And so, sometimes it is more effective for us to partner with a large bank and co-originate a deal. They will do the senior, we will do the mezz, as opposed to us taking the risk on the financing or the syndication.

Great, thanks. And then just one last question, switching gears to the dividends. Great to see that you guys were able to earn the dividend this quarter. Going forward, trying to get a sense of what your current thinking is, do you expect to continue to outearn the dividends like this quarter, implying that dividends could potentially increase from here?

Not to get too far ahead of ourselves, I think, look, we are virtually fully invested today, based on my response to the earlier question. Certainly at that level of capital deployment, we are comfortable in earning the dividend.

I think if someone is taking a view towards 2014, I think as long as we can earn it, the dividend will stay where it is. And to the extent we could lower the payout ratio a little bit with the same dividend, that is certainly the desire. And as we have said many times before, as long as we're efficient in using our capital, given what the pipeline looks like today and given what we are seeing in terms of deal flow, we feel pretty confident about our ability to earn the dividend.

Great. Congrats on a good quarter and thanks for taking my questions.

(Operator Instructions). [Charles Neiband], Wells Fargo.

Good morning and thank you for taking my question. Most of my questions have already been asked, but I was hoping to get some color on deal flow in terms of fixed versus floating. If you look at the portfolio, it's about 52% floating versus 48% fixed. And given the renewed focus on interest rates, I was wondering how you think about that balance and what you are seeing in terms of deal flow?

This is Scott, I was say for the most part, it is really floating rate, with the exceptions of if we can do a mezzanine loan with a teen interest rate, clearly, yes, the 10-year might go up from [2.50] to 4 or 5. Obviously, if we're in the teens, we are very happy with that, and I think if you look at our weighted average fixed interest rate, it is very high. We are not looking to do 5% or 4% loans and then put floating-rate leverage on them. That obviously doesn't work.

Clearly, the large deal that we did in the quarter as a first mortgage was fixed, but again, that coupon was approximately 8%, so again much higher than you are seeing now for traditional first mortgages done today.

So I would say certainly the floaters that we are going to be -- the first mortgages that we're going to be doing generally will be floating rate. The mezz, I think, will be a mix, really, just depending on whether if -- say we can get 13% today versus LIBOR 1000, maybe depending on the borrower's view of the curve and our view of the curve, we might take the fixed rate at 13% as opposed to hoping that LIBOR goes up.

Okay. And as a follow-up, I was wondering if you could -- could you give us a sense for where you are running asset-level leverage on the fixed and the mezzanine portfolio, and maybe how we should think about that in terms of the overall consolidated balance sheet?

We don't put any leverage on our mezzanine loans, right? So from a leverage perspective, we use term financing for the CMBS, which we have talked about. There is no leverage on the mezzanine loans, and then under the JPMorgan facility, we have various advanced rates on our first mortgages. I would say it is approximately at par like a 65 type advance, ballpark, on average, against the first mortgage loans.

Okay, thanks, guys. I appreciate the color.

That concludes our question-and-answer session for today. I would like to turn the conference back to Mr. Stuart Rothstein for any closing comments.

Thank you, Operator, and thank you, everybody, for participating on the call this morning.

Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program and you may now disconnect. Everyone, have a good day.