Apollo Commercial Real Estate Finance Inc (ARI) 2015 Q2 法說會逐字稿

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, 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 the 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, you may begin.

Thank you, operator. Good morning and thank you all for joining us on the Apollo Commercial Real Estate Finance second-quarter 2015 earnings call. As usual, joining me this morning are Scott Weiner, our Chief Investment Officer, and Megan Gaul, our Chief Financial Officer who will review ARI's financial results after my remarks.

By all measures, ARI has had a very successful start to 2015. Consistent with the Board's decision to increase the dividend by 10% in the first quarter, operating earnings per share for the first six months of the year increased 11% as compared to the first six months of 2014. We believe the growth in earnings and the dividend continues to be driven by the strength of ARI's origination efforts and the Company's ability to underwrite and structure transactions that provide attractive risk-adjusted returns while maintaining our stringent credit standards.

The Company is committed to invest in approximately $550 million of transactions year to date across multiple markets and property types, further evidencing the strength and breadth of our platform. Specifically, during the second quarter we completed a total of nine transactions totaling $446 million in commitments. Notably, 94% of the new transactions have floating interest rates and approximately one-third of the transactions were completed with repeat borrowers.

To date, our origination efforts continue to be primarily focused on the US where transaction velocity remains robust and underlying property fundamentals continue to show strength. The recently completed transactions include loans in attractive markets such as New York, Miami and Washington, DC, and varied property types including retail, hotel, industrial, multifamily and for-sale condo.

The final deal we completed during the quarter was the origination of a $325 million mezzanine loan to finance the construction of a new residential condominium tower on West 57th Street in New York City. The floating-rate mezzanine loan is part of a $725 million financing, consisting of a $400 million first mortgage and a $325 million mezzanine loan.

As disclosed when we announced the transaction, ARI funded $41 million at closing alongside $50 million that was funded by another vehicle managed by an affiliate of Apollo. The loan has a four-year term, and we anticipate that the future fundings will occur over the next several years. It is our expectation that ARI will syndicate additional participations of the mezzanine loan, and we anticipate that at any given time our maximum exposure to this loan will be around $75 million to $100 million.

ARI has been an active financing participant in the New York City condo market since 2012. Consistent with prior transactions, we ultimately were attracted to this transaction based upon the loan being well structured, the development team being highly experienced, and our comfort level with ARI's loan basis and LTV based on our estimate of net sellout value.

We view our last dollar of exposure at less than $2500 a square foot, and the loan's appraised loan to net sellout value is less than 50%. We have underwritten this transaction to generate an IRR of approximately 16%.

Given our activity in the condo market, I wanted to give you a quick update on our strategy in this space and talk a little bit about ARI's current condo exposure. As we have previously stated on prior calls, ARI identified the opportunity to provide financing for condo projects early in the cycle and as a result, we have been able to capitalize on the opportunity to invest capital at very attractive returns.

Since making our first investment, ARI has taken a very selective approach to transactions and markets, and investments completed to date have only been in New York City and Metropolitan Washington, DC. At all times, we carefully monitor our exposure to this strategy and we are very hands-on in the asset management oversight of each project.

At quarter end, we had approximately $330 million in net condo exposure spread across five investments. Based upon appraisals, the weighted average loan to net sellout value on the condos representing the net exposure is approximately 58%. In addition, in those projects that are actually in the process of currently selling units, we have been pleased with both the pace of sales to date and the price per square foot achieved on sales relative to our underwritten expectations.

Before turning the call over to Megan, let me comment briefly on the balance sheet and capital availability. ARI ended the quarter with a debt to equity ratio of approximately 1.2 times, which reflects the expansion of our JPMorgan facility. As stated previously, we believe ARI can operate comfortably with a debt to equity ratio of 1.3 to 1.5 times and, therefore, we have the ability to add some incremental leverage to the balance sheet.

In addition, we also expect several loans within our current portfolio to partially or fully pay off, providing us with capital that will need to be redeployed. As always, we are consistently reviewing and discussing our pipeline of opportunities as compared to our capital availability, and we will continue to be thoughtful and prudent around balancing growth opportunities with the cost of available capital.

With that, I will turn the call over to Megan.

Thank you, Stuart. Good morning, everyone. ARI had a strong quarter of financial results across all operating metrics. For the second quarter of 2015, the Company announced operating earnings of $26.4 million or $0.45 per share, representing a per share increase of 7.1% as compared to operating earnings of $18 million or $0.42 per share for the second quarter of 2014.

Net income available to common stockholders for the same period was $22.8 million in 2015 or $0.39 per share, as compared to $22.1 million or $0.51 per share for 2014. The Company reported operating earnings of $48.6 million or $0.89 per share for the six months ended June 30, 2015, representing a per share increase of 11.3% as compared to operating earnings of $32 million or $0.80 per share for 2014.

Net income available to common stockholders for the six months ended June 30, 2015, was $46.4 million or $0.85 per share, as compared to net income available to common stockholders of $37.8 million or $0.94 per share for 2014.

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, apolloreit.com. GAAP book value per share at June 30 was $16.41. 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 June 30 was approximately $12 million greater than the carrying value as of that date.

We continue to focus on expanding ARI's floating-rate loan exposure, and at quarter end 69% of our loan portfolio had interest rates that floated over LIBOR. We estimate that a 50 basis point increase in LIBOR would increase ARI's operating earnings by approximately $0.05 per common share on an annual basis.

With respect to ARI's capital sources, during the quarter we expanded the capacity of our credit facility with JPMorgan from $300 million to $400 million. In addition, we announced that through a subsidiary, ARI became a member of the Federal Home Loan Bank of Indianapolis, providing us with additional diversity for funding. We began the process of joining the FHLB prior to the FHFA imposed moratorium put in place for captive insurers in 2014, at which point the process was halted.

While the moratorium was lifted and ARI was invited to join, there is still not clarity as to the final ruling for captive insurers remaining members. Therefore, at the end of the quarter we had not used the FHLB facility yet, and anticipate remaining cautious with pledging collateral until there is additional guidance from the FHFA.

As I did last quarter, I also want to highlight that our G&A expense has essentially remained constant. Annualized G&A as a percentage of common book value was 52 basis points at the end of the second quarter, which continues to be one of the lowest percentages among ARI's peer group.

Finally, as indicated in our press release, the Board of Directors announced a common stock dividend for the third quarter of 2015 of $0.44 per share. This is the third consecutive quarter of a $0.44 per common share dividend, and we are confident ARI will earn the dividend in 2015. Based on Monday's closing stock price, ARI stock offers an attractive 10.7% yield.

With that, we would like to open the line for questions. Operator?

(Operator Instructions) Steve DeLaney, JMP Securities.

Good morning, everyone, and thanks for taking the question. Stuart, thanks for the comments about the new New York Tower and also your exposure to condos generally. Just curious, they are advertising this as the tallest building in the city, I guess. Is this really kind of just they are looking at 432 Park and the success there?

It feels a little bit like the developers just trying to one-up that project that's being in sellout now. Any thoughts there as to how -- is this going to be positioned the same kind of upscale, very high-end type of property as 432 Park?

It is a mix. I mean if you think about the actual project, Steve, there is actually a retail condo on the base. There are sort of lower-priced condos in the middle, and I say lower-priced in quotes because we are still talking about New York City condo prices. And then there is, I would say, the highest end units at the top of the tower.

I think 432 Park Avenue -- I don't want to comment on anybody's projects -- is just a different location. I think being the location of this project, the views of the park, I think they are probably more looking at the success of 157 and Vornado's project on Central Park South in terms of where units are selling there, and seeing continued demand for units in that location with views of the park.

But I think from our perspective, we were able to create a basis that we are comfortable with. They are obviously expecting to sell units significantly higher than what our basis is, but at least based on the data in the market today, there seems to be plenty of comps to support those levels.

Okay, great. That is helpful. And as far as interesting the way you structured it in terms of, obviously, this is a buildout and you are looking to be putting money out, I guess, over the next couple of years. Just to be clear, so you have funded $41 million, another Apollo fund took down $50 million, but I was reading footnotes.

It sounds like ARI's commitment is for the full $275 million; that it is ARI's job to get this syndicated, not Apollo corporately or the other Apollo fund. Am I correct there?

You are correct in that vein, and you should expect that we will have further announcements on the syndication of it between now and the next time we are speaking. We've sort of made pretty good progress on that front.

All right, great. And those would be like pari passu type of participations. And should we assume that the 16% modeled IRR will hold up regardless of what you are offering out in terms of participations; is that accurate?

Yes, that is the right way to think about it.

Okay, okay, fantastic. And Megan, got your comments on Home Loan Bank of Indy; understand the obvious, you don't want to walk away from existing facilities and then have the Home Loan Bank pulled away from you. But I am just curious, I am looking at your whole loan facilities at Deutsche and Goldman, and those are up out 3.7% it looks like, all-in cost of borrowing.

Just curious from your modeling and your talking to Indy if, in fact, the captive insurers are allowed to remain in. Do you anticipate a fairly significant cost of funds benefit if you were able to put senior first mortgages on the line there?

Yes, it is a much less expensive cost of funds, and you can choose the term to match the asset you are financing. So it is definitely very attractive, but until those rules are clear, it doesn't make sense to go in that direction just yet.

I get that, but maybe something we should think about as this plays out and we think about our modeling for 2016. It is just something I guess to circle back with you there. We will obviously all be monitoring the progress.

Just one last little quick thing. Ben pointed out to me that you have a new line item in the income statement, $384,000 from a joint venture. Is that related to the German bank?

Yes, that is related to the German bank.

Okay, very good. And you are just accounting for that as earnings come through on sort of the equity method approach?

Yes, but that is just an equity pickup. We haven't received any cash distributions and that is why we've -- yet, and that is why we've backed it out of the operating earnings definition as well.

Thanks, everyone. Good quarter.

Thanks, Steve.

Dan Altscher, FBR Capital Markets.

Thanks and good morning, everyone. I just wanted to try to triangulate one of your comments, Stuart, around the potential for incremental debt financing or debt leverage. It looked like in the presentation, obviously, the current weighted average IRRs are equal to the fully levered IRR. So I just wanted to make sure, A, that is correct.

And around that statement also then, it seems like from what's at least on balance sheet today, everything is kind of running at full steam in terms of the potential. So it would seem as if additional leverage capacity would be maybe not at the asset level but more at the corporate level.

I think it is -- I think you are correct in your initial assumption, in terms of the way the levers are running and how we finance things to date. I think, yes, we think about it at the corporate level, but I think you also need to think in terms of to the extent we are deploying new capital in terms of assets that might be leverageable. The equity commitment for those deals would be lower to the extent we just finance them sort of real-time as we are actually completing the transactions.

So I think it sort of depends on asset mix in terms of what we add asset specifically, but then we are also obviously spending time thinking about things at the corporate level.

Got it. Okay, thanks, Stuart. That is helpful.

It is Scott. Actually, one more thing is that as some of our projects transition from construction to completion, we would then be able to lever them. So a perfect example is our retail projects in Ohio where it is completely unlevered now. It is going to have its grand opening in October, at which point we would be able to lever it. But we are not modeling any kind of higher IRR, but once we are obviously able to put leverage on it, the IRR would go up.

Okay, that is a good clarification. So those projects, the potential leverage, is not really being captured in the displayed IRRs.

Correct.

The same thing with a condo project, we are not financing our condo projects generally. But once something was completed and effectively became an inventory loan, we then would also be able to put leverage on that, like our projects down in suburban DC.

Okay, cool. That is good clarification. Thank you. Kind of in that same vein at least in the condos, Stuart, you mentioned that the projects there are currently in the process of being sold out or having some good results. Can you maybe help quantify maybe how much of those are actually now in process of being sold out, and what maybe you are seeing on the sales front versus what your basis is?

Look, I mean the first project that we sort of did in this space that I think everybody recalls was 56 Leonard, which is down in Tribeca which we underwrote that at a last dollar of exposure at, call it, $1500 to $1600 a foot, sort of assuming they would sell at roughly $3000 a foot on average. So that project is effectively sold out at, call it, comfortably north of $3000 a foot.

And basically, our loan will be outstanding either until the building is finished being completed and they wait to pay us off at the end or they decide to sort of refinance us out. But as of right now, we are assuming the loan is going to be outstanding for a while.

I would say the newest projects in which we have started to see good sales activity are the actual, the two in Bethesda, Maryland, that Scott referred to where we have now started to see sales activity. And I would say the numbers have been slightly above what our per square foot assumptions were. And then at 1212 East 13th Street in New York -- easy for me to say -- which is really sort of a dual box building with a small number of condos, but large condos. We have had three executed contracts during the first half of the year and good discussions on a few others as well.

So across the board, we are seeing good sales activity. Obviously, way too early to know about 111 West 57th Street which was our large commitment during the second quarter but that will obviously be one that we'll update on a go-forward basis. But for all the deals we're in, and I tried to get it across in the comments, we are literally getting weekly updates on what is going on.

We are seeing the projects on a regular basis and tracking what is going on with respect to both completion of development as well as sales contracts on a real-time basis, to know where we stand vis-a-vis our underwriting.

Great, that is really good color. And just one quick one for me, a final one. The first half of the year has been nothing short of very strong in terms of getting capital out the door and racking up a huge amount of future funding commitments to lock in some earnings into the next couple of years.

But as we approach the third quarter and kind of the summer period, are you expecting kind of a little bit of a seasonal slowdown now for maybe the new activity and maybe just letting some of those future funding commitments just roll on, as opposed to trying to remain really, really active like the first half of the year was, at least for third quarter?

Look, we are active in the market and there is a lot to look at. I think it is one of those things where given the broader Apollo footprint where we are always trying to stay active in the market and find ways to play at different price points. I would say from ARI's perspective what we're trying to balance right now is capital availability, both in terms of what we expect from repayments as well as cost of putting new financings in place, versus remaining active and trying to take down deals that we think fit with the overall ARI strategy and portfolio.

There is a lot to look at. I think you are correct in that we will certainly go into a summer slowdown period where not a lot will get closed, so to speak, but there is still a lot to look at, underwrite and potentially commit to. And I think for us right now, the challenge is just balancing sort of pace of growth with cost of capital.

And I think what we have done over the first six months of the year actually puts us in a very good position for the remaining six months of this year and the early part of next year, such that I think we can be fairly selective in what we choose to do and make sure we are appropriately balancing growth with deployment, and make sure we don't get out over our skis.

Okay, that is perfect. I will drop back into the queue. Thanks so much.

Jade Rahmani, KBW.

Thanks for taking the question. I wanted to see if you could provide any sense of where the market is. Definitely have seen a lot of volatility in the commercial mortgage REIT sector, the way the equities are trading. But just on the lending side, say starting at the back half of June, did you see any spread widening on loans and any increased caution for borrowers or sponsors regarding the state of the market, potential frothiness, concerns about where we are in the cycle?

I would say no, and I would actually come at it not from what we see for ARI, but I will come at it from the perspective that we also run a real estate private equity fund here that is a borrower in the market for various deals that we are doing. And I would say when we are trying to finance things where we are the equity through one of our funds, I would say there has been plenty of capital availability in some respects.

I would say still very competitive amongst lenders on the front end of deals. So for stabilized cash flowing assets, there is still healthy competition amongst both banks and conduit shops for those types of deals, particularly on a fixed rate basis.

I would say there has been no notable widening despite the volatility in the equity market and in the REIT market over the last month, in terms of doing real estate deals. There has been no significant shift today from our perspective.

Okay, thanks for that. Regarding the multifamily development in North Dakota, can you give an update on how that is performing? Are you seeing any issues there? We have heard about a couple of potential projects in North Dakota that could have issues.

I think from our perspective, the project is performing consistent with I would say the low end of our expectation, so it is leasing up. One of the key aspects of a deal from our perspective was that there is a lot of fresh equity in front of us in the deal and a well-capitalized equity investor. And we also have a cash trap up to a 15% debt yield, so the project is performing as we would have expected.

We are trapping a fair bit of excess cash and actually got to the point where we actually as the lender were able to pull out some of that excess cash for our benefit. So it is a challenging market, no denying that. I think the deal is well structured and I think we are monitoring closely, but it is performing as we would have expected it would be performing sort of in the environment we are in right now.

And to put it in perspective, we are at a double-digit debt yield. So I mean, we are not at all concerned -- I mean, Stuart mentioned the property is leasing. It is on the lower end of rents as companies pull back with their packages that they are giving employees and stuff. But still very pleased with the leasing momentum, and between the cash flow sweep and the scheduled amortization, the loan is amortized substantially already.

So the current LTV is 71%?

Yes.

And what level of occupancy is the building at right now?

I think the last I checked it was running in the 80%s, but we can get you a more specific number. I think it was high 80%s, low 90%s, but we will get you a more specific number post call.

To Scott's point, the units are getting occupied. You are at the lower end of the rent range vis-a-vis what was thought from the equity investors' perspective at the time of underwriting. But there is demand for real multifamily units relative to what many people have been living in during the boom in North Dakota.

And how much more duration is there on this loan?

Off the top of my head, I would say three or four more years.

Okay. Just on the 111 West 57th deal, I think previously you had made cautious or somewhat cautious remarks regarding that 57th Street ultra-luxury corridor, and this seems like it was a special situation. So just wanted to find out if your view has changed with respect to that area, and what gives you confidence in projected demand, given what has happened with the currency market and also the pipeline of new projects projected to come online in that same area over, say, the next two plus years?

Certainly guilty as charged with respect to past comments on the super high-end corridor on 57th Street. I think overall, we continue to remain cautious. I think, as I indicated in my comments, a lot of this from our perspective came down to being able to create a financing at a basis that we were very comfortable with. If you think about units in that corridor door, depending on the deal, probably being marketed somewhere between $7,500 to $10,000 a foot. For us to be able to create a last dollar of exposure at roughly $2,500 a foot gave us a lot of confidence.

But I think it is safe to say this is our bet along that corridor and we like our basis, but generally speaking, remain cautious at anything that would lead us to being a lender at a basis much higher than where we are in this deal.

Okay. And just lastly I guess, LTV, I think some of your statistics for 2Q showed a weighted average 54%, yet the mix of subordinated mortgages was close to 90% and the weighted average IRR was 15%. So I think that it would be helpful if you could provide some color on either how loan to cost would be or loan on current appraised value, how that would compare to that LTV of 54%.

I think the best way to look at it is if you look in our supplemental, you see first mortgages and in an LTV of 61%, and subordinated loans are at 64%. If you are talking specifically about what we did just during the quarter, again 54% as I have commented on some of the condo deals. Loan to net sellout value is specifically lower than that. But we are happy to talk about more detail to date.

So the 54%, is that based on projected (multiple speakers)?

Yes, I mean if you think about the size of the 111 West 57th project and loan to net sellout value, which I implied was less than 50% in my comments, that brings the average down significantly.

Okay, great. Well, thanks very much for taking my questions. Appreciate it.

You got it. Sure.

Rick Shane, JPMorgan.

Thanks, guys, for taking my questions. Two, one on New York and one on Williston. First, in terms of the condo project in New York, what are your concentration limits as that is drawn down? Will you continue to build your position, or is the expectation that you will syndicate out most of the dollars coming in?

In terms of the 111 West 57th project, look, the project is -- we have syndicated out $50 million of $325 million today, so we are down to $275 million. I think at any given point, we will end up holding $75 million to $100 million, and we will syndicate out the rest.

Great, that is very clear and helpful. Thank you. In terms of Williston, it is a project that is a combination of apartment buildings and single-family homes. You talked about 80% occupancy. Is there any meaningful difference between the units and the homes in terms of occupancy?

And you alluded to the fact that it's sort of performing at the low end of your range with that 80% occupancy. Are you seeing rent concessions versus your expectations as well?

Just to clarify, I think it is leased in the high 80%s, so better than 80%. I think you are seeing lower starting rents than would have been anticipated six months ago. I would say most of the economics if you just think about the project is predicated on what happens with the multifamily units. And again to Scott's point, even with the lower rental rates, we are currently lending against a project that based on our basis is generating a double-digit debt yield. And we get all of the cash until they achieve a 15% debt yield plus amortization.

So I feel pretty well protected at this point, and it is sort of performing at the low end of expectations but still comfortably from a lender's perspective, we feel fine as to where we are.

Got it. And then just circling back on the first question which is, any meaningful difference between the single families and the multis?

Not at this point, no.

Okay. Thank you, Stuart.

Thanks, Rick.

Joel Houck, Wells Fargo.

Thanks for taking the question. The proprietary origination strategy that you guys have now kind of fully developed is working quite well, as evidenced by the higher returns and earnings power of the Company. I am wondering, given kind of where you are, and I'm talking about ARI's perspective, if we start to see volatility in CMBS spread widening as the Fed tightens, is that something you would look at? Or is it something in the past where you have better opportunities on the origination front and there is no need to introduce undue volatility in book value from higher exposure to CMBS?

I think the bar is set pretty high for something being interesting enough in the CMBS space relative to what we see in either the first mortgage or mezz side these days, Joel. We are in, away from ARI, we are in the CMBS market anyway. We have a CMBS trading group here at Apollo, so we will look at the market.

But I would say from a return perspective and also I think given some of the issues you highlighted in your question, I would say the bar is set pretty high at this point in terms of anything from a securities perspective that might be attractive to ARI.

Okay, that is what I thought; I just wanted to clarify. The last one just really has to do with or deal with certain, I guess, exposure limits by property type. From ARI's perspective, are there certain limits of how much you will invest in say condos or retailer-specific property or geography?

There is nothing formally stated, but I would say as you think about our discussions with our investment committee and then ultimately in presenting our portfolio to, obviously, analysts, investors. Internally, we spend a lot of time thinking about exposures. The two we probably focused on most today, not surprisingly, if you look at our portfolio are both exposure to for-sale condo, which I commented on earlier, and then exposure to New York City in general.

There is no stated limits, but we sort of review exposures on a real-time basis; and certainly as part of our investment committee process around any new deal, consider where that puts us across the portfolio.

Although as part of our investment guidelines with our board, we do have a limit of a 15% of equity in any single deal. So we did discuss at length the 57th Street deal with our board and our syndication plan, given while we were making a large commitment we were only funding smaller dollars. So we do have a limit per deal.

Again, congratulations on a great quarter.

Thanks, Joel.

(Operator Instructions) At this time, I'm showing no further questions. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everyone, have a great day.