Apollo Commercial Real Estate Finance Inc (ARI) 2016 Q4 法說會逐字稿

I'd like to remind everyone that today's call and webcast are being recorded. Please note that they are the property of Apollo Commercial Real Estate Finance, Inc., and that any unauthorized broadcast in any form is strictly prohibited. Information about the audio replay of this call is available in our earnings press release.

I'd 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 filing 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 obligations 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 the time, I'd like to turn the call over to the Company's Chief Executive Officer, Stuart Rothstein.

Thank you, Operator. Good morning, and thank you all for joining us on the ARI fourth-quarter 2016 earnings call. Joining me this morning are Scott Weiner, our Chief Investment Officer of our Manager, and Jai Agarwal, our Chief Financial Officer, who will review ARI's financial results after my remarks.

2016 was an extremely active year for ARI, highlighted by completing the acquisition of Apollo Residential Mortgage, originating and funding over $1.4 billion of investments, and successfully growing our equity market capitalization to over $2 billion. Our ability to continue to find attractive investments and to be strategic and creative in sourcing accretive capital resulted in ARI once again delivering strong operating results and a well-covered, attractive common stock dividend to our investors.

Specifically, ARI's operating earnings for the year ended December 31, 2016, excluding the expenses associated with the AMTG transaction totaled $148 million, a 32% increase over the prior year. On a per-share basis, operating earnings for 2016, also excluding the merger expenses, were $2.02 per share, which represents a 6% increase over 2015 and resulted in strong 1.1 times coverage of ARI's $1.84 dividend per share of common stock.

As I mentioned, ARI completed over $1.2 billion of new investments and funded an incremental $140 million during the year for previously closed loans. As a result of this record level of activity, ARI's portfolio grew 27% from the prior year end and ended the year north of $3 billion. Notably, 87% of the portfolio is comprised of floating-rate loans, which leaves ARI well positioned for rising short-term interest rates. Jai will comment specifically on the increased earnings potential from increases in LIBOR during his remarks.

Further, the weighted average loan to value on the portfolio remained consistent at 63%, and the expected weighted average levered IRR is a robust 13.8%. In short, we are finding investments that meet our risk-adjusted return expectations, while constructing a portfolio that is diversified both geographically and across property sectors and maintains a stable credit profile.

Beyond just the volume of capital deployed in 2016, it is worth noting several important trends with respect to our investment activity and our growing portfolio. Notably, over the past 12 months, ARI significantly increased the Company's first mortgage loan portfolio, which totaled $1.6 billion at year end, as compared to less than $1 billion at the end of 2015. I think it is somewhat underappreciated that approximately 60% of ARI's loan portfolio is comprised of senior loans.

As ARI has grown its capital base, the Company has become more active in the larger floating-rate first mortgage loan market. During 2016, we originated 10 floating-rate first mortgage loan transactions at an average size of approximately $85 million and an average rate of LIBOR plus just under 600 basis points. Using modest leverage from ARI's attractive in-place bank financing facilities, we are able to generate IRRs on these investments in the low- to mid-teens.

You have heard me speak often about the depth and quality of our originations platform and the benefit borrowers see in our ability to structure and execute transactions. We believe our results in 2016 clearly demonstrate the value of the platform we have built. During the year, we directly originated approximately 83% of our loans, and over 60% of our transactions were with repeat borrowers.

A few quick highlights from the portfolio. Two of ARI's condominium loans were repaid in full during the quarter. The first transaction, a $62 million first mortgage loan for the conversion of an existing commercial building in the Greenwich Village submarket of New York City, generated a gross unlevered realized IRR of just north of 11%.

The second deal, a $65 million first mortgage loan for the construction of a new luxury condominium in Bethesda, Maryland, generated a gross unrealized IRR of 13.5%. The remainder of our for sale residential portfolio, which is now six assets totaling about $440 million of commitments, continues to perform well and has a weighted average loan-to-net sellout of approximately 60%.

Away from the loan portfolio, we continue to trim our CMBS holdings. During the quarter, we took advantage of favorable market conditions and sold one of our legacy AJ bonds at a price above where the bond had previously been marked. In addition, we received a partial pay down at par on one of our bonds which was marked at 73. Our investment in CMBS continues to wind down as bonds repay, and we will continue to opportunistically pursue sales transactions if market conditions warrant.

During 2016, our CMBS holdings decreased by over $135 million, or approximately 27%, and totaled only $368 million at year end. This represents only 12% of ARI's assets and just 5% of our net equity. More specifically, AJ bonds represent just 7% of ARI's assets and less than 4% of net equity.

In order to finance our investment pipeline, in December, ARI completed an offering of 10.5 million shares of common stock, raising net proceeds of approximately $180 million. ARI issued the stock at a 6% premium over our 9/30 book value per share. The capital raised in both this offering and the AMTG transaction represents over $600 million of accretively issued new equity in 2016. Notably, including our preferred stock, ARI's equity market capitalization has surpassed the $2 billion mark.

We also expanded and diversified our funding capacity in 2016. We upsized our main credit facility with JPMorgan to $800 million, and we entered into a new $300 million facility with Deutsche Bank to finance first mortgage loans.

As we look to the year ahead, we believe the current economic climate remains very favorable for a business model. 2017 is a peak year for commercial real estate loan maturities with close to $400 billion of loans maturing. In addition, there continues to be a surplus of dry powder to invest from real estate private equity funds, many of which will target transitional assets that will be in need of flexible structured financing.

Since January, ARI has already closed close to $200 million of new investments, and we are optimistic about our current pipeline. Our relatively low level of leverage gives us the ability to add incremental debt to fund new loans. We believe the combination of our platform, pipeline, and financial flexibility will enable ARI to continue to provide a well-covered, attractive dividend to our investors in 2017. And with that, I will turn the call over to Jai review our financial results.

Thank you, Stuart, and good morning, everyone. For the fourth quarter of 2016, our operating earnings were $41 million, or $0.49 a share, compared to $32.4 million, or $0.48 a share in 2015. GAAP net income for the same period in 2016 was $49.7 million, or $0.60 a share, as compared to $21.4 million, or $0.32 a share in 2015.

During the quarter, we sold the remainder of the AMTG assets for $34 million in proceeds. The sale was at a premium to the carrying value and resulted in a realized gain of $5.3 million or $0.06 a share. This gain was partially offset by a loss of $1.2 million, or $0.01, from the sale of the CMBS bond sold above the September 30 mark. So while the bond was a positive -- while the sale was a positive to book value, it did result in a modest loss based on cost basis.

For the full year 2016, our operating earnings, excluding merger expenses, were $148 million, or $2.02 a share, compared to $113 million, or $1.90 a share for 2015. A reconciliation of operating earnings to GAAP net income is available in our earnings release in the investor relations section of our website.

GAAP book value increased from $15.94 to $16.12 a share at quarter end. The increase primarily was due to an accretive capital raise, gain on sale of assets, and slightly higher marks on our CMBS bonds.

With respect to leverage, we ended the quarter with a 1.0 times debt-to-common equity ratio. At this level, we believe we have the ability to prudently use leverage to fund future investment growth and still maintain a conservative leverage level. Given that in the short term, we used proceeds from our December capital rate to pay down our JPMorgan facility. We enter 2017 with capacity on both the JP and the Deutsche Bank lines. We anticipate using both facilities to fund our investment pipeline.

While our capital base continues to grow, our G&A expense ratio has essentially remained flat. Annualized G&A for Q4 as a percentage of equity was 40 basis points, which continues to be one of the lower percentages amongst our peer group.

As Stuart mentioned, at December 31, 87% of the loans in our portfolio had floating-interest rates. We anticipate that a 100 basis point increase in LIBOR will generate an additional $0.17 a share in annual operating earnings. Given our positive outlook for 2017, we are confident in ARI's ability to generate annual operating earnings in excess of the dividend. We expect operating earnings for Q1 to be impacted by the December capital raise and ramp-up during the year.

Finally, I wanted to highlight our dividend. Based on Monday's closing price, our stock offers an attractive 10.2% yield. Our Board will meet again in mid-March to discuss the Q1 dividend, and we will make an announcement shortly thereafter.

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

(Operator Instructions)

Steve DeLaney, JMP Securities.

Good morning, and thanks for taking my questions. I noticed in the press release -- good morning, Stuart. In the press release, when you reviewed fourth-quarter lending activity, under the $330 million of senior first mortgages, the leverage IRR was 14.7%. That struck me as being higher than normal, and I wondered if you could comment on what percentage of the $330 million were construction or development in nature, maybe such as the LA retail loan that you made. Thanks.

None of them were construction specifically, Steve.

Okay.

So it's pretty clean from that perspective. Again, not to over analyze a particular quarter, right, we -- the business is somewhat lumpy. Some deals might have more structure than others, but I would say from a risk perspective, what we did in the fourth quarter is consistent with what we've been doing all along.

Okay.

There's nothing unique in that vein.

Okay. Thank you. We know you do the residential for sale, and you mentioned the Bethesda project earlier. Do you know off the top of your head, if you were to classify your portfolio between senior subordinate, you give us geo, you give us property type. Do you have a feel, Stuart, that you could give us an estimate of how much of the total -- we are at $2.8 billion or so now. How much of the total would you classify as construction or development on a percentage basis?

I have got it at my fingertips here somewhere. At a high level, if you think about it from a construction perspective, it is probably today on a funded basis somewhere between $350 million to $400 million. 15% to 20%, depending.

That's helpful.

One thing to clarify, in the fourth quarter, we do have one first mortgage that got funded in the fourth quarter that is a construction loan, but it is pre-leased to a very highly rated credit, so it's not -- when you talk often about our construction is more condo or more speculative, this was a pre-let, high -- it's a AA credit type thing. It was a data center which we did (inaudible).

(Multiple speakers) Thanks.

It wasn't originated in the quarter. We had a big funding in the quarter, so that was some of the numbers in there, but it wasn't actually one of the loans that we originated. I just want to make it clear, because we did have a big funding in the quarter for that loan.

Appreciate that, Scott. Okay, thanks. And could you provide us with an update on the interest accrual status on the North Dakota multifamily loan?

Yes. So as we intimated on our last earnings call, we had an interest reserve that ran through the end of last year. There is no longer an interest reserve in place. The loan is effectively through our earnings. We are basically taking the estimated cash flow for the year. So while we are still entitled to the full interest to the extent it can be paid at some point in the future at this point, from an earnings perspective, we are just taking expected cash during the year.

Okay. Do you have a sweep -- you are sweeping that, I assume?

Yes.

Okay, got it. Whatever comes in less operating expenses is what your return's going to be?

Yes.

Got it. So we are now in more of an NOI rather than an NII, kind of scenario.

Correct.

And just one final. Your series A preferred has a relatively high coupon 8 5/8. I was just curious if that issue has a five-year call feature.

It is callable starting in August of this year, Steve. So it does have a call feature, and without over-promising, I would say we have already started a dialogue, and I would say we are paying close attention to both the preferred market as well as just, other sources of capital that would allow us to at some point replace that with a [HE performing] capital.

Got it. Thank you for the comments this morning.

Thanks, Steve.

Jade Rahmani, KBW.

Good morning. This is actually Ryan on for Jade. Thanks for taking my questions. Just wondering if you could just comment on overall credit trends on a sequential or perhaps a year-over-year basis both for ARI's portfolio and what you are seeing in the market overall.

I will let Scott comment.

Obviously, with commercial real estate, there's different markets and pockets, which are stronger and weaker at any one time. Obviously, we've talked about, for example, the Miami condo market which we had avoided having gone through some weakness. I would say overall, given our size, we are very much able to pick and choose our battles. And so while we don't necessarily concentrate or focus on market, there are certain things that we avoid, such as (inaudible) regional malls and things where there is binary risks like pure land. So we've been able to find deals that we find attractive. I would say positively from a competitive sense, not seeing anyone doing crazy things or irrational things. Obviously, everyone might take a different view on an asset, if you will or maybe a little bit on pricing.

We don't necessarily sit back and shake our heads, I can't believe someone is giving that much leverage and things like that. I will say for higher leverage than we would do an ARI, we have seen what I would call more traditional equity players coming in. As equity funds, now that others who are looking for mid- to high-teen returns, which is a higher return than we are looking for an ARI, is they're [meeting] more challenge finding it on the peer-equity side.

They are offering on certain deals to go higher leverage, so there are some deals that we are doing where we are having capital be behind us at a higher return, which I would say is new. From a -- I'm not going to say again competitive. I would say it's more complementary. So we're not competing with them, and they are coming in behind us on deals.

Got it. That's helpful.

The only thing I'd add, Ryan, just to -- and I know part of your role is to ask about what's going on macro wise. Again, it's just important to realize that at any given point in time, our portfolio is 35 to 40 the spoke position. While macro trends are always interesting and, certainly, we think about them as we are doing things, at the end of the day, we are a bottoms up, deal-by-deal investor. And given our size and the size of the overall market, as macro trends ebb and flow, we've proven over the last seven plus years our ability to find, one-off deals that make sense for what we are trying to do with our capital.

Right. Thanks. And just specifically, you have some decent exposure to the retail market in Florida. Are those -- I'm referring to two senior loans. Are those loans in Miami, and can you say if they are with repeat borrowers and just perhaps what your overall view of that market is for retail with those loans?

Yes, they are with a borrower that we have had an extensive relationship with. I would describe them as, from a lender's perspective, assets that work all day long as retail. And from an underwriting perspective, we are very comfortable with the assets at retail. I would say the equity in the transaction on a longer term basis views the aggregation of those retail assets as a site that they are acquiring for redevelopment at some point in the future.

Whether we decide to play in the redevelopment or not will be a decision made when they are ready to move on what their longer term plans are. So it's really, I'd call it neighborhood street retail as opposed to, any type of mall retail, and we are very comfortable with the way that retail works in the neighborhood in which it's located.

And that was our large view we've done historically. The deal that we announced in the press release, that's actually with a new borrower who we've developed a relationship with, and that is a made and main, ground-floor, retail condo similar to what you'd see in Manhattan and other markets. Tremendous traffic -- walking traffic and things like that. It's right off the beach in South Beach.

Great. Just moving on to loan yield trends. Given the moving rates we have seen, how would you characterize spreads, stable, compressing, or perhaps widening at all with rates?

Again, going back to [map], it very much depends on the product. I would say, where we don't play the trophy cash [loitered] property, [we're well into] some others, I would say, yes, those are probably, if anything, those spreads have come down a little bit. I would say on the lightly transitional stuff that we play in, pretty consistent. Again, it's the same players.

The floating rate CMBS market or smaller deals has not come back. Maybe it will, but for now it hasn't. We are competing with others who have a similar cost of capital and similar return aspirations.

I would say on construction lending, to the extent people are looking at senior construction loans, that has widened. I would say that is an area where there are fewer banks willing to do that. So people like us and others have found stepping into that occasionally. But I would say to the extent a bank is willing to do it, they've noticed they have pricing power and have widened out their pricing a little bit.

Just one last when, if I could. Could you comment on potential M& A in the specialty finance space? Is this something you view as attractive, and would you potentially look to adding other business lines such as, say, CMBS or special servicing?

Look, before I talk specifically about special servicing or CMBS, at a high level M&A is always on the radar screen as we think to grow our business and, certainly, to the extent we can use an attractive currency to buy something at an attractive return. It's something we spent a lot of time looking at. So I would say, the hit rate or the ability to get something done is always challenging. I would say, specifically to your questions on the CMBS side, I would say we have no immediate desires whatsoever to be in the conduit lending space or the CMBS business. And I would say on the servicing side, kudos to those who acquired platforms five, six years ago, which ended up being very attractive financial transactions given the ongoing fee streams. But I would say there is nothing on our radar screen today, vis-a-vis special servicing. But to your broader question, we certainly do think about various M&A possibilities for growing the platform, but nothing immediately on the horizon.

Great. Thanks for taking my questions.

You got it, Ryan.

(Operator Instructions)

David Anderson, Anderson Partners.

Good morning, guys. Thanks for taking the call. I was just wondering if you could provide any more color on the project at 111 West 57th Street, and if you had any information you could share about anticipated closings and when those might take place in the future.

I mean, look at a high level, construction is continuing as expected and the project is, on track to be completed sometime next year from a construction perspective. From a closings perspective or a marketing perspective, there's really nothing we can update on at this point.

Great. Thank you very much.

You got it.

And I'm showing no further questions at this time. I will now turn the call back over to Stuart Rothstein for closing remarks.

Thank you, operator, and thanks for those who participated this morning.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Everyone have a great day.