Apollo Commercial Real Estate Finance Inc (ARI) 2014 Q4 法說會逐字稿

Good day, ladies and gentlemen, thank you for standing by and welcome to the Apollo Commercial Real Estate Finance fourth quarter earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time.

(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 Incorporated and that any unauthorized broadcast in any form is strictly prohibited. Information about the audio replay of this call is available in our earnings press release.

I'd also like to call your attention to the customary Safe Harbor disclosure in our press release regarding forward-looking statement. 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'd like to turn the call over to the Company's Chief Executive Officer, Stuart Rothstein.

Thank you, operator. Good morning and thanks to all of you for joining us on the ARI fourth quarter and full-year 2014 earnings call. As usual, joining me this morning in New York are Scott Weiner, our Chief Investment Officer; and Megan Gaul, our Chief Financial Officer, who'll review ARI's financial results after my remarks.

Clearly, 2014 was a very successful year for ARI in all areas of our business. The Company committed to invest over $1 billion of equity into over $1.5 billion of commercial real estate debt investments, by far our most active year-to-date.

Beyond just the volume of capital deployed during the year, it is worth noting several important metrics about our investment activity. We directly originated approximately 90% of our loan transactions as opposed to purchasing the loans in the secondary market, and over 50% of our loan transactions were with repeat borrowers. We believe this clearly speaks to the depth and quality of our originations platform and the value borrowers see and our ability to structure and execute transaction. Also notable in 2014 was the establishment of an international presence for ARI, as we moved one of our managing directors to London and subsequently during the year closed two transactions in the United Kingdom.

ARI's investment success was complemented by our efforts in managing and optimizing the Company's capital structure. Early in the year, we completed a $158 million common equity raise and followed that with two successful issuances of convertible notes totaling over $250 million. As a result of our efforts, ARI reported operating earnings of $1.69 per share for 2014, a 17% increase over the prior year and comfortably in excess of the $1.60 annual dividend. At year-end, our portfolio totaled over $1.6 billion in carrying value at a weighted average IRR of north of 13% and a weighted average duration in excess of three years.

Also worth noting, the weighted average loan to value of our loan portfolio was 62%. The credit quality of our portfolio has remained stable, and I am proud to say that after five years of operations, ARI has not recorded any principal losses. Notably, as many investors and the markets continue to anticipate a rise in short-term rates, over the last few years, we have strategically increased the floating rate exposure in the Company's loan portfolio such that at year-end, approximately 60% of our loans were LIBOR floaters. Said differently, at year-end, there is roughly $0.10 per share of earnings embedded in the portfolio for 100 basis point increase in LIBOR.

Turning to the year ahead, we began 2015 by continuing to successfully deploy capital and optimize the Company's capital structure. Specifically, we have closed three loan transactions to date totaling $165 million. And beyond these transactions, there is over $250 million of future fundings from previously completed investments embedded in ARI's portfolio as well as a healthy pipeline of potential transactions comprised of both first mortgage and mezzanine loans.

Focusing on the balance sheet and capital availability, we ended the year with a debt-to-equity ratio of 1.2 times, which is still below the target range of 1.3 to 1.5 times that we've indicated we are comfortable with. To increase financial flexibility, ARI amended and restated the Company's primary financing facility and increased the borrowing capacity to $300 million, while simultaneously lowering the interest rate and extending the maturity date. The Company also took advantage of a favorable financing market and closed an asset-specific credit facility with Goldman Sachs with a four-year term that is consistent with the underlying collateral, generating $52 million of additional proceeds. In addition, we also would expect that during the year, several loans within ARI's current portfolio will either partially or fully pay off during the year.

When we put these pieces together, the combination of ARI's robust investment activity during 2014 and the early part of this year and the ongoing optimization of the Company's balance sheet in line with target leverage has resulted in a significant increase in the operating earnings run rate of the Company. The increase was partially realized during 2014, as evidenced by the rising quarterly operating earnings throughout the year; and management expects the positive trend in operating earnings to continue during 2015. As such, our Board of Directors has voted to increase our dividend per common share of common stock by 10% to $0.44 per share for the first quarter of 2015. Given our prior comments around the importance of earning the dividend and seeking to maintain a consistent quarterly dividend as well as a healthy payout ratio, we believe this action by our Board is reflective of confidence in the current ARI portfolio and the business plan for 2015.

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

Thank you, Stuart. And good morning, everyone. As Stuart mentioned, ARI had a strong year of financial results across all operating metrics. For the fourth quarter, the Company announced operating earnings of $21.2 million or $0.45 per share, representing a per share increase of 15% as compared to operating earnings of $14.5 million or $0.39 per share for the fourth quarter of 2013. Net income available to common stockholders for the same period was $20.2 million in 2014 or $0.43 per share as compared to $14 million or $0.37 per share for 2013.

The Company reported operating earnings of $74 million or $1.69 per share for the 12 months ended December 31, 2014, representing a 17% per share increase as compared to operating earnings of $51.4 million or $1.44 per share for 2013. Net income available to common stockholders for the 12 months ended December 31, 2014, was $75.3 million or $1.72 per share as compared to net income available to common stockholders of $45 million or $1.26 per share for 2013. A reconciliation of operating earnings and GAAP net income can be found in our earnings release contained in the Investor Relations section of our website, www.apolloreit.com.

During the fourth quarter, we completed $446 million of commercial real estate debt investments. Our activity during the quarter was funded through a combination of loan prepayments, which totaled $168 million as well as leverage [marketability]. At year-end, our debt-to-equity ratio was 1.2 times and our GAAP book value per share was $16.39.

As a reminder, we do not mark our loans to market for financial statement purposes and currently estimate that the fair value of our loan portfolio at December 31 was approximately $12.5 million greater than the carrying value as of the same date. It is important to note that as we have expanded our capital base, our G&A expense has essentially remained constant, creating better leverage for our operating platform. Annualized G&A as a percentage of common book value was 68 basis points at the end of the fourth quarter, which continues to be one of the lowest percentages among ARI's peer group.

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

(Operator Instructions) Dan Altshcer, FBR Capital Markets.

Thanks. Good morning, everyone, and congratulations on the dividend increase; definitely a very positive announcement, I thought. Stuart, your comments, I thought, were pretty bullish for the outlook there, for at least the rest of this year and we're seeing it in the numbers, but I guess just to maybe reaffirm or confirm $0.44 current run rate, I assume you currently expect you can consistently earn or maybe even overearn that on maybe a quarterly or annual basis?

That is clearly the way we feel about it right now.

Okay. Now, that's definitely good to hear. You talked a little bit about Europe being again still an emerging opportunity. We're seeing it clearly in the UK, I guess. [Among the recent] transactions done at a 10% type IRR, nothing to be ashamed of and maybe a little bit lower than what maybe some of the more of the US product is looking like. So can you just talk about that opportunity a little bit there, what you're seeing there? Are 10% IRRs kind of the right return or is it maybe that deal-specific or maybe is a little bit more core versus core plus versus transitional, opportunistic, that might have different return profiles?

I'll let Scott comment.

No, I would say just like the US, there are different returns for different risk profiles. The first deal that we did in the UK was slightly higher return. This was a portfolio of cash-flowing, stabilized properties with fresh equity that we liked; it was in the healthcare sector, which is a sector that we've been spending more time on given Apollo has expanded that and brought on a healthcare specialist team in Company. So for us, this was not transitional construction. We felt that return was appropriate. We also felt that it was going to be out for a long time. So it's a five-year deal, also floating rate. So there's uptime on the floating rate. So it was a combination of things. I think as we look at Europe, clearly, I think we've seen more opportunities in the UK. Apollo overall does have a large team in Europe doing real estate and other activities. So we do look at other jurisdictions. We do like the UK from our rule of law and obviously liquidity. But we do spend time in other markets. And I would say in Europe, we continue to look at transitional first mortgages like we do here and as part of our recently amended repo facility, we have a capability to do first mortgages in Europe and put leverage on it. So we're looking at that sector as well, continuing to look at mezzanine deals.

No, that's helpful, that's good color. I mean just one other follow-up, just on the CMBS opportunity, and I understand you guys are looking at coupon by coupon by CUSIP and see where the opportunities arise, but I guess at least in the new issue market, it seems like you've seen a little bit of spread widening there, but it seems like you guys have actually put on maybe a little bit less exposure in that trade than you had previously. And so, just maybe is that not the right way to think about the opportunity set going forward?

Yes. I think when we came to CMBS, we really were opportunistic and really focused more on the legacy space. And I think what's really important to us is the match duration. We've never been one to do borrow a 30-day repo and have that continue overall. If you see in the resi market and by longer-term asset. So for us, the match term funding was always very important. It is also we're taking out interest rate risks and so that worked well when we were buying three, four-year duration CMBS.

On the new issue front, we've stated we are not fans of the multi-borrower conduit market. We think that originate to distribute model and what's going on there with 40 conduit originators all competing. While they compete on price, they also compete on credit. So we're not at BP's fire nor are we investor in that. We do look at the single-asset, single-borrower markets. As we talked about before, variety of different vehicles, we managed a few billion dollars of CMBS across different product types but again those yields are lower than what we would want to do for ARI. And while there is leverage available, there is a huge mismatch, which we're not comfortable with.

Clearly, on the CMBS floating rate market, you did see at the end of the last year a real widening on some of those single-borrower or multi-borrower floating rate deals to where you got to maybe [L-500]; and I do think some people probably, hedge funds and others, took advantage of that and put leverage on. That's really a trade. So for us, with CMBS right now, we don't see the opportunities. I think CMBS right now is about 10% of the equity of our portfolio and that will continue to shrink as we get some repayments in CMBS and obviously grow the loan book. So going forward, we're not really expecting a new CMBS deal this year. We still look at it and we're active in that market. So something happens opportunistically, we will do it, but we're not really anticipating CMBS going forward.

Great. Now, that's a fantastic answer. Thanks for all the color, Scott.

Steve DeLaney, JMP Securities.

Thanks. Good morning, everyone, and congratulations on a strong quarter and year. I guess I'd like to start with the floating rate characteristics of the portfolio, given that I think we just heard Janet Yellen on TV for a couple of days and seems inevitable they could do something here. So your 57% total floating rate, I'm looking at page 9 on slide deck, as of year-end, but obviously fourth quarter, floaters were 86% of production. So I'm just curious, this appears to be a conscious effort. However, I'm not sure whether it's more of an effort to get into senior loans versus mezz or whether you really are trying to improve your interest sensitivity. Just wondered if you could comment on that aspect of the portfolio.

I mean we're always obviously [confident] and we like the floaters, but one of the things that does come with floaters is generally less call protection. So I think when you look at our fixed rate portfolio, it is important to understand a lot of our fixed rate loans are high-single-digit if not double-digit yields, that came with nice call protections. So to the extent we feel we're getting a very attractive fixed rate yield, that coupled with call protection, yes. We kind of constantly talked about it, but there are trade bumps, right. So as we talked about before, we're not in the conduit business. We're not making 4% or 5% fixed rate loans, but if I could make a loan at 8% with five years of call protection, that versus doing a floater where I'm hoping that LIBOR goes up, which has happened by the way over the past few years and only getting 12 months of call protection, that's after trade, a little bit of it's the type of lending that we're doing, clearly in the more transitional space because of the business plan of the borrower, that's going to be more of a floating rate loan of shorter duration to the extent we're doing some more stabilized stuff. Maybe there is a potential to do fixed rate. One of the deals we announced for the first quarter was a five-year fixed rate call-protected loan at a double-digit yield and we like that. And we have five years of call protection.

That's helpful, and I understand the issue we're seeing it with a lot of people now with prepayments and they're having to run really fast, just to maintain their portfolio. When you do a floater, what type of typical LIBOR floors do you put in?

The market today is kind of no floor to 25 BPs; it's different than the corporate market in that corporate market is more of a point floor. The mortgage market is 15 BPs, 25 BPs, kind of where it is.

So you're going to get a pretty -- with any kind of meaningful increase in short rates, it's going to kick in pretty quickly for you?

Yes.

Yes, absolutely. Okay. And then, just kind of a house-keeping thing. I just hadn't focused on it before, but the foreign currency marks, I'm assuming all of those are non-cash. And is that correct?

Yes. There is margin posted back and forth, but ultimately on what we've done in Europe where effectively, perfectly hedged between the asset cash flows and the hedge cash flows. (multiple speakers).

Actually, that's what I was going to ask you is, are you actually trying to hedge your exposure there and (multiple speakers)?

Yes. Certainly, for our loans, we've done [somewhat rather] kind of taken the view that they're always going to be doing stuff in Europe and aren't hedging it. We've taken a different approach. I mean it is very efficient to hedge surrounding the pound today, where we've been spending. So why wouldn't you hedge it given that you can do it pretty efficiently?

Got it. And it just gives you more flexibility if you ever want to repatriate that, those investment dollars, I guess if you are hedged.

Yes, [absolutely].

Okay. And Scott, you may have anticipated this question. I feel like I need to ask it. Back in November, you guys announced that you made a $58 million loan in North Dakota, and it was in the energy-centric market. I just wondered if you would comment on your thought process when you made that loan and certainly you, I'm sure, underwrote it with some sensitivity to lower oil prices and just curious what comments you can give us on that particular loan.

Yes, certainly. Absolutely. And I'd say, that's really our only exposure to oil. We're not really long Houston or anything like that. That's a first mortgage loan on a multifamily property with a good sponsor who had a real equity in the deal, brand-new property that has recently been expanded. We did the loan after oil had started to fall, it was not at $50. As I'm sure you know, Apollo is very active in the energy sector, both in the equity side as well as the credit side, so we spend a lot of time. And we are focused on that part of the oil [down in] shale, where oil needs to go to and all that kind of stuff. And we really looked at it as an opportunistic way to make a loan and we structured it with a 16-year AM schedule, so a $58 million loan, where we get $2.5 million of AM a year. We had a going-in debt yield of double digit, so it was 10% when the property -- it just opened a second phase. We're now north of 13% debt yield, trending up to we think 15%, 16% debt yield, just to put numbers in perspective.

The property is in a full cash flow sweep until they achieve a 15.5% debt yield, so we continue to build up cash. The sponsor is very committed to it. There's actually leasing activity. What we're seeing in the market is obviously new construction which is always kind of the biggest concern there, is really grind to a halt, given lack of availability of construction financing, which is great. And the municipalities are doing what we thought they would do which is closing the [MAN] camps and kind of moving people out of hotels. So our playdough has been we don't need new people to move there. We just need the people that are already working there to want housing and we're continuing to see that. So I guess, where a team debt yield is at 80% or so occupancy, and we think multi-family properties in the market continue to be nearly fully occupied. They're negotiating a big lease right now with a corporate user, who is at another property, and that property is 100% and they need to expand. They're going be put people in the units. And so we like it. We're able to leverage it on our credit facility and get an attractive risk-adjusted return.

Okay. Thanks, folks. I appreciate the comments.

Thanks, Steve.

Jade Rahmani, KBW.

Thanks for taking my questions. Can you talk about what quarterly pace of originations you think is sustainable?

Yes, I mean Jade, and we've had this discussion before, I think the business is lumpy enough and I know everybody always tries to model it on a quarterly basis. We tend not to think about it on a quarterly basis, right. I would say, given where we sit today, given the volume we did last year, given what we know is embedded in the portfolio, just from future fundings this year, and we're very comfortable thinking that we could put out, call it $750 million to $1 billion on an annual basis, that is always subject to sort of constant changes in the market on returns as well as a constant analysis of where we are in terms of managing our capital base and deals we expect to get paid back on and things that might get extended a little longer. So I don't want to -- I'm not trying to avoid the quarterly analysis, but to be perfectly candid, we don't think about the business on a quarterly basis.

Okay. And in that number, what do you contemplate as a likely mix between first mortgages or whole loans and mezzanines?

I would say that given the mortgages tend to be larger, you probably would see -- receive more mortgages and as we talk about, we've expanded the repo capacity and we have the ability to grow that more. So I think as we see attractive first mortgages, we will do both of those. So it's [something in] exact spread and within our future fundings, most of that is in the first mortgage space, actually pretty much all of that. So you'll continue to see the first mortgage side of book grow as those future fundings get funded.

And can you just discuss unlevered yields on first mortgages and mezzanine loans? What do you think you can see on incremental originations and just overall, if you think aggregate yields should decline as the mix shifts to first mortgages?

I mean, to the extent we shift and continue to do more in the first mortgage and when we're looking at it on an unlevered basis, yes, and by definition, those yields because we don't lever our mezzanine, but I think on an overall portfolio, we're still comfortable on a blended basis, we're continuing to get into that teen, 13% plus or minus levered return. I think within first mortgages, there are different types that there is what I would say lightly transitional or it's maybe something in [neat] stuff or a hotel coming on for renovation, that's kind of in the 400, just total it over LIBOR; and then, as you move up, more transitional predevelopment and it goes wider all the way to construction which is even wider. And then, on the mezzanine side, we obviously focused on double-digit returns for our mezzanine book.

And just on the predevelopment, all the way to construction, what do you think the range is? Is it from L plus 600 up to L plus 800 or can it go higher than that?

I think it can go higher than that, really just depending on kind of the leverage and what you're doing, but I would say six to high single digits. With the high single digits really being one that you have to look at on an unlevered basis, that's how I think about it, which is why the yields are where they are.

For prepayments, is there an outsized quarter that you might expect this year and also just in aggregate what level would you expect the prepayment rate of say 30% or less than that?

I think it's going to be less than 30%. I think it will be somewhat lumpy if you look at some of our older New York for-sale condo transactions. Again, there has been I would say in general, typically based on earliest prepayment date or earliest maturity date, I would say the experience to date has been things end up dragging on a little longer than we would envision. So you end up with three to six-month extension. But there is no one quarter sitting here today that's going to be of a total outlier.

Thank you very much for taking the questions.

Thanks, Jade.

Charles Nabhan, Wells Fargo.

Hi. Good morning and thanks for taking my question.

[Good morning].

How should we think about the $245 million of future funding commitments in 2015 from a timing standpoint? And does that $245 million include the portfolio of international destination homes that will be funded by the Goldman lot loan?

No, that international and that was already fully funded and we already had that funding. So that's not included in that. The future fundings are really kind of on the -- as I said, the majority of that comes from first mortgage construction loans that we did. As you remember, we did a large retail project out in Ohio as well as two for-sale condos outside of DC, that's really the majority of that. I would say that money will come out, I think the majority of it, over the next six months.

Nine months.

Yes. Six to nine months.

Okay. And if I could follow up with Jade's question on yields, I know you alluded to some of the variability in first mortgages, but we're still in a low rate competitive environment. Now, I was wondering if you would comment on some of the offsets to potential yield compression such as lower funding costs.

I think for ARI, from the beginning, we've tried to block and tackle and find more of a (inaudible) highly structured transactions.

As we've stated in the past, we are not trying to compete with the Wells Fargos of the world. And so the deals that we're looking at are often highly complex, maybe with repeat borrowers, where they need someone who can understand it, they want someone who is going to continue to be there for that, so they're highly interactive loans.

So I would say, we stay out of that most liquid part of the capital structure where you're seeing the most competition. I would say with repo financing and also with the nascent [scale of] market, there is more financing available. But that type of financing is really focused on I would say the next layer of loan that Wells Fargo, maybe it's a little more leveraged than Wells Fargo wants to do. Using them as an example of a commercial bank who was active, I'd say just Wells Fargo, or has a little more transition to it.

I think that's where we started. We're not focused on that most competitive sector of the market. And to the extent that we are focused on that, our model to date has really been teaming up with a bank who can provide a very aggressive senior. We provide the subordinate piece and everyone is very happy. From time to time, we do the whole loan and sell off a senior. So we can do it both ways.

Okay. Appreciate the color. Thank you.

Thanks.

Amrita Ganguly, JPMorgan.

Hi, I'm on for Rich Shane this morning. I just wanted to ask about the competitive market. On the one hand, we keep hearing about the $1 trillion to $1.5 trillion of maturities coming up over the next few years. But on the other hand, there has been a lot of specifically REIT entrants into the market space lately. So presumably, they all have the benefit of being able to lend on a non-recourse basis unlike banks. And we have seen, over the past four quarters, your leverage yields go from 14.1% to 13.4%, at the same time as your leverage has crept up. So how do you view the opportunity in light of the fact that other, a lot of REIT money has entered the space lately and some of your competitors have seen a -- some of your competitors who kind of came out of the gate with very strong originations, I have seen a bit of a slowdown? So how should we think about your kind of run rate, unlevered yields and leverage, and how do you view the opportunity?

Yes, look, I think as I mentioned before, I think we're still comfortable in that 13% area. I think with the yield changing, part of that is a function of the mix. I think some of our brethren have been very focused almost exclusively on the first mortgage space, maybe particularly as competitive vehicles, so they've kind of said they only can do first mortgages. And look, in the markets we rewarded them for that because they are earning a lower yield, but the market rewards them with kind of require a lower dividend yield. So I think it's just what people are focused on. We have the ability, I think one of the things that makes us better in the market that we can do a $20 million mortgage or we can do a $150 million mortgage and both are important to us and both kind of help with the portfolio diversification.

I think the most competitive parts of the market, which is where we're not in, is the competitive conduit market. There are public vehicles that are in the conduit market, as well as the big banks. There are 40-plus people doing that, that's kind of a market that we're in. Also, we've talked about the [Alt-250] type floating rate market; it's also something that we're not in. But there is plenty of capital out there. Stuart mentioned our $1 billion number. We are still decimal points of the total market size. So I think there is plenty enough to go around. I mean yes, there is that law of maturities. I think history has shown that the special servicers like to extend that and get their fees and do that and a lot of that will get taken out with new fixed-rate loans, just given the interest rate environment.

Okay. Excellent. Thank you.

Welcome.

Jade Rahmani, JBW (sic - see Analyst Coverage).

Hi, this is actually Ryan on for Jade. Thanks for taking the follow up. Could you please elaborate a bit on current investment capacity?

Yes. Look, I think as I mentioned, we've got still the ability to add some leverage to the Company. We're running at about 1.2 turns leverage now as I've said for multiple quarters in a row; we'll be comfortable taking that somewhere between 1.3 to 1.5 and I think the financing is clearly available. We also expect some repayments throughout the year. So I would say, working the portfolio and just given what we expect in the portfolio, there is call it $250 million to $500 million worth of capacity depending on how we decide to work the portfolio, finance it and create availability of capital within the portfolio.

Great, that's helpful. Thank you.

(Operator Instructions) And I show no further questions at this time. I'd like to turn it back to Stuart Rothstein for closing remarks.

Thank you, operator, and thanks to everybody for participating this morning.

Ladies and gentlemen, this does conclude today's conference. Thank you for your attendance. You may now disconnect. Everyone, have a great day.