Apollo Commercial Real Estate Finance Inc (ARI) 2016 Q3 法說會逐字稿

Good day, ladies and gentlemen and welcome to the Apollo Commercial Real Estate Finance Incorporated Third quarter 2016 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 be given at that time. (Operator Instructions) I'd like to remind everyone that today's call and webcast are being recorded.

Please note that they are the property of Apollo Commercial Real Estate Finance 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.

In addition, we will be discussing certain non-GAAP measures on this call, which management believes are relevant to assessing the Company's financial performance and are reconciled to GAAP figures in our earnings press release which is available on the Investor Relations section of our website. 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.

Good morning, and thank you for joining us on the Apollo Commercial Real Estate Finance third quarter 2016 earnings call. As usual, joining me this morning are Scott Weiner, the Chief Investment Officer of our Manager and Jai Agarwal, our Chief Financial Officer who will review ARI's financial results after my remarks.

As was highlighted in the ARI earnings release, I'm extremely proud of ARI's accomplishments over the past few months. Specifically, the acquisition of AMTG closed at the end of August, and in September, we successfully sold the bulk of AMTG's assets which generated approximately $400 million of investable capital for ARI.

In connection with the acquisition, ARI issued 13.4 million shares of common stock at a valuation of $16.75 per share, which represents an approximately

8% premium to our June 30 book value per common share and approximately 3% premium to ARI stock price on the transaction closing date.

Importantly, between the stock issuance and our effective execution on the sale of AMTG assets, the acquisition was approximately 3.5% accretive to ARI's pre-acquisition book value per share. Just as importantly, following the closing we've been busy deploying the capital into new commercial real estate debt transactions. I want to highlight and commend our investment team for being able to efficiently manage our transaction pipeline such that ARI was in a position to quickly deploy the new capital raise.

Following the acquisition closing and prior to quarter-end, ARI completed three floating-rate first-mortgage transactions totaling $245 million. And subsequent to quarter-end, ARI closed an additional $236 million of new investments bringing our year-to-date capital commitment and deployment to $1.1 billion which includes funding of previously closed ones.

Consistent with prior quarters, the transactions closed during the third quarter were predominantly floating-rate first-mortgage loans, and as Jay will detail later in his remarks, we expanded our capacity to finance these loans with a new $300 million credit facility from Deutsche Bank. Beyond just the volume of capital deployed recently, it is worth noting several important metrics with respect to our investment activity.

Since we closed the AMTG transaction, we have directly originated 100% of our new investments and over 60% of our transactions were with repeat borrowers. We've spoken often about the depth and quality of our originations platform and the benefit borrowers see in our ability to structure and execute transaction. And as we enter our eighth year of operations, we believe these metrics demonstrate the value of the platform we've built. Our average investment size continues to increase and our new investments were diversified across property types and markets.

Turning to our portfolio, at quarter-end, ARI's commercial real estate debt portfolio totaled $2.7 billion, representing 17% growth on a year-over-year basis and we were generating a levered weighted average IRR of 13.3%. The weighted average loan-to-value of the portfolio was consistent at 64% and the portfolio remains diversified both geographically and across property sectors. And for the third quarter in a row, our asset mix has shifted to reflect an increase in first mortgage loans.

During the quarter, we took advantage of favorable market conditions and sold four of our legacy AJ CMBS bonds at prices above where the bonds had previously been marked. Our investment in CMBS continues to wind down and as bonds continue to repay, we will continue to opportunistically pursue sales transactions if market conditions warrant.

Lastly, as we look forward to 2017, we believe ARI is well positioned to continue finding attractive investments and delivering solid financial performance. In addition to the $1.1 billion of capital commitments and deployment year-to-date, we have a robust pipeline, driven by the continued healthy pace of commercial real estate transaction activity.

We are extremely confident in our ability to keep our $1.8 billion of capital efficiently deployed and we have leverage capacity within the balance sheet. So we maintain the ability to add incremental debt to fund new investments as warranted. We believe our current size will allow us to stay active in the market, keep the Company's capital invested and continue to adequately earn the dividend.

We will look to grow opportunistically, and as always, we will seek to ensure a balance between the investment opportunity and our ability to access attractively priced capital. It is worth noting that due to the funding schedules of some of the investments closed over the past two months, I do expect ARIs Q4 operating earnings per share will be lower than Q3. As I have stated previously, when we think about ARI's quarterly dividend per share of common stock and management's recommendation to the Board each quarter, our focus is on an annual run rate dividend coverage.

ARI's operating earnings per share for the first nine months of 2016, including any one-time merger-related expenses totaled $1.54, which is $0.16 per share above our year-to-date dividends of $1.38.

And with that, I will turn the call over to Jai to review our financial results.

Thank you Stuart, and good morning everyone. For the third quarter of 2016 our operating earnings were $32.7 million or $0.45 per share. Excluding one-time merger expenses of $4.9 million, operating earnings was $0.52 per share compared to $0.53 for the September 2015 quarter. GAAP net income for the same period in 2016 was $60.6 million or $0.83 per share as compared to $23.5 million or $0.39 per share in 2015. Included in net income and operating earnings is a $4 million one-time prepayment penalty received from a $9 million fixed rate loans that had a maturity date of June 2020.

A reconciliation of operating earnings to GAAP net income is available in our earnings release in the Investor Relations section of our website. As Stuart mentioned, GAAP book value increased $0.43 per share from last quarter to $15.94 a share at quarter end. The increase was driven primarily by the merger where we issued 13.4 million shares at $16.75 per share and acquired AMTG at a discount-to-book value.

With respect to leverage, we ended the quarter with a 1.0 times debt-to-equity ratio. With the cash proceeds from the AMTG transaction, we paid down our JPMorgan facility. During the quarter, we also closed a three-year $300 million financing with Deutsche Bank for advances against first-mortgage loans. At quarter-end, in addition to $255 million of cash, we had available capacity on our facilities. At September 30, 88% of the loans in our portfolio had floating interest rates. We anticipate that a 50 basis point increase in LIBOR would generate an additional $0.07 per share in annual operating earnings.

Finally, I wanted to highlight our dividend yield. Based on Monday's closing price, our stock offers an attractive 11.1% yield. Given the strength of our results to-date and our previously stated goals to establish a consistent quarterly dividend that is covered by operating earnings and meets the REIT distribution requirements, we have confidence in our ability to earn the quarterly dividend in 2016. Our Board will meet again in mid-December to discuss the Q4 dividend and we will make an announcement shortly thereafter.

And with that, we like to open the line for questions. Operator, please go ahead.

(Operator Instructions) Steve DeLaney, JMP Securities.

Good morning and congratulations on AMTG and another strong quarter. Jai, I really appreciated your comment about this prepayment penalty. I heard you say $4 million, I apologize, but I missed the loan that that was related to. Could you fill me in on that?

Sure, yes. It was $4 million against $9 million fixed rate loan that had an original maturity of June 2020 that was prepaid in July of this past year.

It was related to one of the first deals we ever did out of the box Steve. It was a 10-year deal back in 2010. One of those situations where the market has moved enough, the property is performing well enough that it made sense for the borrower to deal with the yield maintenance, the payment penalty.

So I -- actually before Jai mentioned that, one of my questions was going to be $0.52 in the quarter beat consensus of $0.47 and I look back the last three, four quarters, you guys have consistently beaten our estimate and the consensus. And I was focusing on fees related to pay-offs, yield maintenance that type of thing and as the portfolio starts to season, is it something that we're going to see from time-to-time and maybe as analysts, we need to start building -- while it's unpredictable, we need to start building something into our model for revenue at the time to pay off.

Let me answer that in a couple of ways. Yes, as the portfolio gets bigger, I would say there are always opportunities for us to either create incremental economics because you might extend a transaction, restructure a deal or you get surprise with the prepayment and you end up with an unexpected prepayment penalty. So I do think, as the portfolio grows, the opportunities for those unforeseen economic events certainly increases.

It is awfully hard to model (multiple speakers) get in the mind of a borrower and my preference would always be for you guys not to get ahead of yourselves in terms of modeling those unexpected events and continue to give us an opportunity to surprise you on the upside, on a quarterly basis.

That's probably not a bad thing to have happen for both of us. Is there any difference in terms of those types of revenue opportunities? Is it different first mortgages and subordinate loans? Are you more likely to get enhanced economics on subordinate loans or is it about the same?

It is deal-by-deal, transaction-by-transaction, obviously, as you think about where our portfolio has gone there was more prepayment protection built in for longer periods of time when we were doing fixed rate product and as we shifted more towards floating rate product. Typically, your prepayment restrictions are shorter because they're transitional loans and you are less likely to have a significant yield maintenance penalty that exists for a significant period of time.

That being said, I think regardless of whether it's a first mortgage or a subordinate loan, when you are lending against assets that have some transitional component to them, things happen in deals that people can't foresee and I think as long as we're maintaining a productive dialog with our borrowers, maybe not true prepayment penalty so to speak, but the opportunity is to blend and extend, restructure whatever it might be, continue to exist in the portfolio.

And my follow-up question, I noticed you had some payoffs in the third quarter, but the nature of two of the payoffs, you had pre-development condo loans in both New York and London pay off. So my question is sort of the read through there, there has obviously been concern about the kind of market. I'm curious kind of the borrower circumstances and the take out. Are these situations where you had funded development cost and the loan is being flipped into a more traditional construction loan? Help me understand what was going on with the borrower that allowed you to be taken out of those projects.

Yes, this is Scott. I would say that both of those loans were given to allow the borrower to work on their plans, construction cost, things like that. Both of them were secured by existing buildings, we were comfortable. So we were not underwriting to the condo, (inaudible). We were looking at the existing collateral kind of like how we do our pre-development loans.

In both of those cases the borrowers were ready for the next stage to get the development financing. They had already commenced pre-sales. Both cases, we were actually -- where we have the ability to do the construction financing and opted not to for a variety of reasons and so both deals were taken out by others in the industry, who want to do those deals.

And just to highlight the points Scott made, Steve. Typically, if we're doing pre-development, entitlement loan whatever it is, we will more often than not give ourselves the opportunity to step up for the follow-up loan. It creates an option for us. We may choose to use that option, we may choose not to, but certainly we create an ability for us to have a seat at the table to figure out what's going to go on next.

Great. And you have one remaining $70 million pre-development loan in London, can you comment on your comfort level with that property and relative to (multiple speakers)

It's actually larger -- it's a GBP100 million loan Steve. So that one deal, we're extremely comfortable with our basis. It's one of the best sites in London. We included the updated appraisal value in our statement. I mean, that was just done, substantial equity, the loan-to-cost is actually lower than that loan-to value. So very comfortable and like I said, by all measures it's one of the best sites in London.

There has been a dramatic increase in the amount of equity underneath our position since when we first made the loan to to-date. So I would say our comfort level has only increased with the transaction.

Jade Rahmani, KBW.

Thank you very much. Some of the commercial real estate brokers have been talking about property sales volumes waning and the number of bidders on large transactions declining. Can you comment on what you're seeing in terms of your pipeline and deal flow, maybe in terms of volumes and also perhaps quality and how that compares with say, a year ago?

Yes I mean, I would say, it continues to be robust. I've seen some of those stats in transaction activities which are generally more national and obviously, some smaller deals and obviously the bigger deals we more focused on. But I would say, we're still seeing a lot of acquisition opportunities as well as just refinancing.

So I mean, I would say, we have not seen any noticeable change in either quality or volume. Obviously it's still a great time to be a borrower. We are still seeing enormous capital flows into commercial real estate both foreign and domestic. So from our perspective, it's really business as usual.

And in terms of the mix between acquisitions and refinancing, how is that tracking, say year-to-date versus maybe a year ago?

Again it's deal-by-deal. I mean the deal we did recently in Chicago, which is our first deal in Chicago. That was an acquisition. The healthcare deal we did was a refi that we actually were involved in. So I mean I would say, while we obviously love acquisitions and fresh equities, there are still good opportunities in refinancing. So I would say it's a good mix.

Yes. I mean, I think if you looked at our pipeline today Jade, again, the comment we've consistently made over time is, it's clearly more floating rate biased than fixed rate biased. But I think in terms of acquisitions and refinancings, there is a healthy mix of both. And I think just to reiterate Scott's earlier point; we are not at all feeling as if we're worried about our pipeline, if anything. Our standard comment these days is that there is far more demand for our type of capital than that type of capital actually exists today. So we're pretty excited about the pipeline.

I was just coming back to the earlier point around passing on opportunities. We basically had last looks on deals and could have done those and just given the availability of capital on how we're constructing the portfolio, we pass. So we're seeing -- we have plenty of choices and we're trying to pick the best deals that we can in the portfolio, because it's not -- we're not a large bank, if you will, with unlimited capital trying to put up billions and billions of dollars a year. So we were very selective in the deals that we do.

On price on the pricing side, how are spreads tracking? Is there compression on spreads or are there enough players pulling back or being a little bit more cautious to allow spreads to hold constant?

Again, I think it depends on what part or the market you're in. I mean, clearly high-quality cash flowing long-term fixed rate, it's still very attractive whether you're borrowing from an insurance company or a CMBS in the area that we play in. I would say spreads and rates have held pretty steady, if anything rates have gone up with LIBOR going up. We have not adjusted our spreads down even though LIBOR has gone up. So we're getting a better rate and maybe the forward curve will materialize.

But again, going back to the comments we made in the past, the people we compete against have capital at a similar cost to us and so we're looking at similar returns. There is no -- this is not stuff down on Bloomberg, right, where someone can kind of just decide, hey I want to get out of the corporate world and come into the commercial real estate world and drive down yields. And so we've had, I would say they've been holding steady. And if you look at our returns, I think you'll see that.

Just on the North Dakota loan, can you give an update; was that loan evaluated for impairment this quarter and I guess what have your conversations been with sponsor?

It was evaluated as it will be every quarter for impairment. Obviously, we didn't change the level of impairment. At the asset level, occupancy continues to tick up slightly. So we're now north of 80% as the asset rents are still effectively where I've described them previously, so basically flat over the preceding months. We've had an ongoing dialog with the borrower. There is nothing material that's coming out of those discussions that we'd be comfortable disclosing at this point in time.

And I think on last quarter's call you mentioned that the interest reserve could be exhausted by year-end. Is that still your expectation and what do you think the implications are beyond that?

Nothing has changed with respect to that view and I think the implications are that obviously gets factored into the discussions with the borrower and when there's something to comment further on, we will.

Okay. And then, just on the commentary you made about 4Q dipping, do you think it's reasonable, based on capital deployment to-date and the full impact of the AMPG transaction to expect earnings to match the dividend in 4Q?

It's possible. I think you could probably infer for my comments that we might be $0.01 or $0.02 below it if things break one way and we might earn it if things break the other way. I think what I was trying to blunt with my comment was that if we happen to fall a $0.01 or $0.02 short on a quarterly basis in the fourth quarter, we've way over earned it for the year. So that's the way we think about it. So that's generally the range we're in.

Charles Nabhan, Wells Fargo.

I was wondering if you could talk about your expectations for cash flows within the CMBS portfolio and specifically touch on whether your expectations for principal repayment continue to exceed the marks on the book right now?

Yes, I mean the simple answer is yes. Our view of what we will recover from the bonds is in excess of where the bonds are trading on a marked basis these days. So that assumption remains. It's tough to be overly specific on cash flows but we tend to look at a couple different scenarios both in terms of loss assumptions as well as timing of when we'll get payments and obviously there are various scenarios where losses might tick up but you actually end up holding the bonds longer so you're receiving more interest along the way.

What I would say at a high level is, to your initial point, we still have a more optimistic view based on our analysis that would be indicated by the marks. But certainly, if you look at the updated IRR disclosures in our supplemental, we have altered our view of cash flows in some respects that result in a lower go forward IRR at this point.

Great. And as a follow-up, could you talk about when you expect -- with the $400 million in capital from AMTG and the expected repayments and maturities over the next few quarters, when you expect to be fully deployed?

I think realistically we'll get somewhere between first quarter, second quarter of next year right now based on what's in the pipeline, what we expect to get repaid on and what we know we have in terms of future fundings. So I think we always viewed AMTG as call it, two to three quarters worth of capital and I would say that basic assumptions still exists.

Ric Shane, JP Morgan.

Thank you, guys. Thanks for taking my questions. Most have been asked and answered, but I'm going to ask the last question -- Charles' question in a slightly different way just so that we make sure we have it right in our model. When you think about the capital base, the $1.8 billion capital base now, what do you think is the sustainable level of assets against that, just so we make sure we scale the business properly?

Yeah, I mean it's tough to know, because we use leverage on part of our business, we don't use leverage on another part of our business. I think, depending on what you want to assume Ric for a guess between first mortgages and sub-debt and obviously on first mortgages we're typically levering, call it two times to one.

I think you're going to end up somewhere in the neighborhood of plus or minus $3 billion worth of assets. It could be a little less if we do more mezz and less first mortgage. Could be a little higher if it continues the trend of tilting towards first mortgage and we're using more leverage on the portfolio.

Got it, that's helpful. And I actually thought about asking the question in the context of, if you were a 100% mezz or a 100% first mortgage, so we could [see it] that way. Second question, and again, this is mostly germane because of the strange distortion we're seeing between one and three month LIBOR, when we think about your assets and liabilities where is the sensitivity? Is it to one or three or is there any basis risk that we need to be considering?

It's to a one month LIBOR and anything we provided in the supplemental takes into account any LIBOR floors or anything baked into our loans, when we give you that sort of what happens if there is a 25 basis point or 50 basis point move. We're looking at one month LIBOR and we're factoring in any LIBOR floors in our loans where we might have an increase on the borrowing side, but not an increase in what we're receiving from one of our borrowers.

Got it. And just so that we're not surprised by anything, there is no thesis mismatch between one and three month LIBOR on the liability and asset side that we need to think about?

No.

Okay guys. That's it for me. Thank you, guys.

(Operator Instructions) Rick Murray, Midwest Advisors.

Could you just help us understand the change that was made to the operating earnings calculation and any associated impact was in the quarter?

Yes, you're talking about our modest change with respect to things that we've hedged for the currency. The way we've always treated foreign currency movements in the past, so first of all, when we make a loan in foreign currency, we attempt to fully hedge both principal as well as periodic interest payments. The way our definition was written previously, we were ignoring all gains or losses on those hedges, whether they were just unrealized mark-to-market with respect to hedges that we wanted to keep outstanding for a while or if they were realized on hedges that were no longer required because they were related to a current quarter interest payment, for example.

What we've basically done is change the definition such that to the extent we realize a gain on a hedge with respect to an interest payment that was received in the quarter thereby no longer needing the hedge going forward, and I should have said realize a gain or loss on an interest payment that is received in a quarter and therefore we no longer need that hedge on a go forward basis. We are taking that realized gain or loss into operating earnings. The effect is, as long as our hedges are working properly, we are basically minimizing any fluctuation in the US dollar interest received with respect to foreign dollar denominated loans.

Okay, that's helpful and what was the impact of that in the quarter?

Jai, do you have the number?

Yes, it was about $500,000.

Okay. Thank you.

And I'm showing no further question at this time, I would like to turn the call back over to Stuart Rothstein for closing remarks.

Thank you operator and thanks for everybody participating this morning.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Everyone have a great day.