Apollo Commercial Real Estate Finance Inc (ARI) 2017 Q3 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Third Quarter 2017 Apollo Commercial Real Estate Finance Earnings Conference Call. (Operator Instructions) I would like to remind everyone that today's call and webcast are being recorded. Please note that they are the property of Apollo Commercial Real Estate Finance, Inc. and that any unauthorized broadcast in any form is strictly prohibited. Information about the audio replay of this call is available in our earnings press release.

I also like to call your attention to the customary safe harbor disclosure in our press release regarding forward-looking statements. Today's conference call and webcast may include forward-looking statements and projections, and we ask that you refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from these statements and projections.

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. Please go ahead.

Thank you, operator. Good morning and thank you all for joining us on the ARI Third Quarter 2017 Earnings Call. As usual joining me this morning are Scott Weiner, the Chief Investment Officer of our Manager, and Jai Agarwal, our CFO.

With ARI's third quarter performance we believe the company continues to demonstrate the depth of its originations platform and the strength of its capital markets capabilities. ARI originated over $420 million of new loans during the quarter, bringing total originations for the first 9 months of the year to north of $900 million. Subsequent to quarter end ARI committed to an additional $300 million of commercial real estate loans, bringing year-to-date originations and fundings to over $1.3 billion.

We continue to find investments that meet our risk adjusted return expectations while constructing a portfolio that is diversified both geographically and across property sectors. At quarter end ARI's loan portfolio totaled $3.6 billion with a weighted average unlevered all-in yield of 9.5% and a weighted average LTV of 62%. At quarter end 89% of the loans in the portfolio had floating interest rates and the portfolio had a remaining weighted average term of 2.5 years.

At present we believe ARI has a strong pipeline focused predominantly on floating rate first mortgage loans, consisting of both new opportunities as well as the option to participate in the refinancing of some existing transactions. Of note, 2/3 of our originations for the first 9 months of the year were with repeat borrowers, including 2 transactions which were refinancings of existing loans within the ARI portfolio. We believe ARI continues to benefit from the breadth of the broader Apollo commercial real estate platform and as such ARI is on track for a record year of originations.

ARI's ability to co-originate loans with other investment funds managed by Apollo enables the company to win mandates while offering the borrower a seamless execution in dealing with 1 financing source. As I noted, ARI has already closed approximately $300 million of transactions in Q4 and we anticipate this quarter will be one of ARI's most active to date with several large transactions currently in the pipeline and expected to close.

Turning now to CMBS, consistent with prior quarters we continued to reduce our exposure by selling 3 AJ bonds at prices in excess of where the bonds were marked which with principal paydowns generated $71 million of proceeds. In addition, subsequent to quarter end we received approximately $48 million of proceeds from principal paydowns on and the sale of another 4 AJ bonds at $2.5 million above their 9/30 marks. As CMBS is no longer a core focus for ARI, the sales allow us to redeploy the proceeds generated into higher yielding commercial real estate loans.

In thinking about the CMBS sales it is worth reiterating that the sale of CMBS in excess of the marks is accretive to book value, but given that ARI's balance sheet still reflects the bond's historical cost basis, there is a non-cash recognized loss that flows through GAAP earnings and is reflected in operating earnings. Said differently, while the sale of the CMBS generated a $7.4 million realized loss, which will be reflected in Q4 financial results, that realized loss will not impact ARI's ability to pay the common stock dividend. In addition to our investment and portfolio activity during the quarter the company completed its successful $230 million convertible senior notes offering.

The 5-year notes bear interest at 4.75%, 75 basis points lower than the coupon on the convertible notes offering ARI completed in 2014 with a 10% conversion premium, equating to $19.91 convertible price. ARI also redeemed its 8.625% Series A preferred stock during the quarter, which have the highest dividend rate of the outstanding preferreds. Subsequent to quarter end we repurchased $30 million of ARI's 8% Series B preferred stock from an investor and subsequently issued $30 million of common stock to the same investor which we anticipate will be approximately $0.03 per share accretive to book value.

Lastly with respect to capital availability, the company recently increased the capacity on its repurchased facility with JPMorgan to $1.4 billion. We continue to focus on expanding ARI's capital sources and optimizing the balance sheet with a focus on diversifying our financing providers, extending the term of the company's debt when possible and lowering (inaudible).

Before I turn the call over to Jai I would like to take a minute to provide an update on the condo development at 111 West 57 Street in New York City, commonly known as the Steinway Building. At the end of the second quarter, ARI, along with other investment funds managed by Apollo, split off a [$25.5] million junior mezzanine piece of the existing mezzanine loan and sold it at par to

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to subsequently call the new mezzanine loan into default and filed for foreclosure. The foreclosure was completed at the end of August at which time the new sponsorship group invested new equity towards recapitalizing the development. Construction on the property has continued unabated and we remain comfortable with the progress of the project towards completion. The tower will top out at 85 floors and as of the date of this call construction has now reached the 42nd floor.

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 2017 our operating earnings were $49.8 million or $0.47 per share. This compares to $32.7 million or $0.45 per share in 2016. GAAP net income for the same period in 2017 was $57.2 million or $0.54 per share. This compares to $60.6 million or $0.83 per share in 2016. As noted in the press release, both GAAP and operating earnings this quarter included $3.6 million repayment income received with the early repayment of a mezzanine loan.

I want to highlight a few enhancements we made to our disclosure this quarter. We expanded our portfolio diversification chart to illustrate asset class exposure within each geography. This quarter both the geographic diversification and property type charts are based on the amortized cost of our loan portfolio. Previously these charts were based on net equity. Also we've included a new loan chart in a supplemental with detailed information on each of our loans. We hope that you find these disclosures helpful and as always appreciate any additional feedback.

With respect to leverage we ended the quarter with a 1.0x debt to common equity ratio. During the quarter we repaid the remaining outstanding balance on our UBS CMBS facility and now have 1 remaining CMBS facility with Deutsche Bank. As Stuart mentioned, subsequent to quarter end we increased our borrowing capacity on our JPMorgan facility to $1.4 billion which enables us to fund additional first mortgage loans. Our book value per common share increased to $16.36 at September 30 from $16.16 at June 30 and $15.94 at September 30 of last year.

As Stuart mentioned, one factor contributing to the increase was the sale of CMBS during the quarter at prices above where they were previously marked.

Finally I wanted to highlight our dividend. Based on Tuesday's closing price and our recent dividend run rate of $0.46 per quarter our stock offers an attractive 10.2% yield. 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'd like to open the lines for questions. Operator, please go ahead.

(Operator Instructions) And our first question is from the line of Rick Shane with JPMorgan.

This is Melissa Wedel for Rick Shane. I had a question about a comment you made regarding opportunities to refi some existing loans in the portfolio. I noticed that you guys had a prepayment fee in this quarter that you recognized. I'm wondering if the refi opportunities that are still in the pipeline also include prepayment penalties.

It's deal by deal. Some certainly do. In any discussion with a borrower I would say to the extent a prepayment penalty is due it is part of the overall discussion as to whether or not we -- what the structure of our new transaction will be. But I would say there are certainly other opportunities within the portfolio where prepayment penalties would be due, but it's tough to predict or project with any real accuracy as to whether or not we will receive those or not just given sort of the fluid nature of discussions and sort of borrowers' ability to control timing.

Okay. Got it. And then you mentioned that the pipeline, if I understood you correctly, the pipeline going forward is heavily first lien oriented, although the 3Q originations were I think more than half were mezz. And so I am wondering if this is a shift in the sort of risk reward profile between those different points in the capital structure or if you're trying to make an overall shift up cap for the whole portfolio?

I don't think there's an overall shift going on. I think somewhat is just sort of the lumpy nature of what we've been working on. And sort of as I've said many times before it's always a little bit uncertain around timing. So it's tough to read too much into quarterly shifts. I would say we continue to be active in pursuing both first mortgage and mezzanine opportunities and whatever color we provided around what is likely to happen in Q4 wasn't meant to indicate any sort of broader strategic shift.

And our next question is from the line of Steve Delaney with JMP Securities.

Stuart, could you comment generally on the -- you gave us an update on 111 West 57th, we appreciate that and I think there was a news article yesterday that the real deal had to put an update. But beyond that highly visible project, just looking at the rest of the portfolio could you comment if there were any material changes in any of the other assets you've commented on in the past. I would note the Bethesda condos, the multi-family in North Dakota and your retail project in Ohio. If you could just give us a general update on how things are going elsewhere in the portfolio that would be great.

Yes. Sure. So just to directly answer your question and then I'll provide some additional color. I would say generally speaking there have been no material changes. Things are progressing as we would have hoped.

Maybe going west to east geographically on the project in North Dakota which I think by now everybody is aware is a mix of a garden style multi-family project that is 330 units, 36 single family homes and then some excess entitled land. I would say 2 positive developments on that front. I would say on the garden style multi-family occupancy has increased from call it the mid-70s to now the mid 80s. So we're seeing good demand for the product, rents are still flat. So again to the extent we're playing for time on the multi-family it's great to see the occupancy increase. I think what we would hope to see now is sustained higher occupancy which ultimately leads to at some point a move up in rents.

The other positive news around that project is we have undertaken a strategy to sell the single-family homes on a one-off basis to either existing renters or the market at large. Those homes have stayed virtually 95% to 100% occupied for their existence. So we're now strategically in the market trying to sell the homes. We have sold 3 to-date, I believe there is a fourth under contract, and sort of we're intentionally making sure we've always got 2 to 3 vacant so we have something to offer to the market.

Those homes sell for, broadly speaking, $275,000 to $300,000 a home. So if we sold all 36 of them you're talking about net of costs and fees probably $9 million to $10 million that would be generated to sort of continue to amortize down the loan, but that's a positive development. And I think both the higher occupancy rate on the multi-family as well as the success of selling the homes I think just speaks to generally a more positive tone around Williston overall. Certainly oil at $50 a barrel has created a measure of stability. There continues to be activity, continues to be demand for employment. So generally we've always been playing for time on that transaction but I would say the last 6 to 9 months have generally been positive.

Moving further east, I know I had commented last quarter on our retail center, 20 miles or so north of Cincinnati, I would say no real change, the project continues to move along at call it mid to high 80s occupancy. A few new leases signed. I was out there about 6 days ago, just sort of touring the asset. Physically it was spot on in terms of the execution. I would say the Stuart Rothstein inexact science of anecdotally talking to a bunch of the shops there and employees there I would say foot traffic appears to be picking up, I would say people are optimistic about the upcoming holiday season, but there is still work to be done from the asset management perspective in terms of continuing to drive more leasing activity, more occupancy overall, but no real change from our last conversation.

And then moving to the condo project in Bethesda. I believe when we last spoke at the end of Q2, it's a 50-unit project overall. At that time there were 28 projects either sold or under contract. We continue to chip away at it. Today there are now 31 condos that have either been sold or are under contract. So we've got 19 left. I would say on the margin foot traffic has picked up a little bit. We continue to remain cautiously optimistic that we will continue to just chip away with it, with sales.

And again, nobody has anything bad to say about the physical construction of the product, it was executed flawlessly in terms of actually delivering what was expected. And it's just a matter of moving quickly and being thoughtful around pricing as we do get foot traffic in there. But we're sort of chipping away at it which is sort of the strategy we envisioned all along.

Got it. And you indicated you -- are you -- you're needing to make some price concessions too for the current market?

I would say nothing that's material. I think what we're trying to do is maintain a very active dialog with the folks on the ground just to make sure that we don't miss an opportunity to get a deal done, broadly speaking. But generally speaking at this point I would say we've got it priced appropriately given what we're hearing from people coming in the door.

That's great. And one last if I could, you have a sort of a unique situation, I think you're doing an assemblage with a developer down in Miami for high-end retail. Obviously with the Hurricane Irma, any impact there that either affected the buildings to the plan for the developer?

No, I would say, look, given the recent hurricane activity there's been various things we've looked at. Miami specifically ended up being quite lucky vis-a-vis the hurricane. So no impact on what's going on. And just to be clear, the assemblage that's being created will ultimately be envisioned as a mix of office, hotel, high-end retail, a real mixed-use asset.

As we do in these assemblages we've created the options to participate on a go-forward basis. We will make that decision at the appropriate time. But as of now I would say the activity around the site that's being assembled has been positive and we still feel very good about that investment.

(Operator Instructions) Our next question is from the line of Jade Rahmani with KBW.

This is actually Ryan on for Jade. Just first, can you say what drove the repayments in the quarter, which came in pretty strongly, and what you anticipate for the balance of the year?

I mean again we try and predict out repayments and I think we show what is coming to you based on maturity date. I think oftentimes, particularly given the nature of what we do things end up being a little longer dated that we would have envisioned either because something at the asset takes longer to affect or someone wants a little bit more time to find the spot-on refinancing.

Again I think the nature of the business is lumpy. And as Jade and I have talked about many times before, it's tough to draw too many conclusions from quarterly activity. I think we've again provided what we expect to happen over the coming quarters from a modeling perspective. I think on par things to the extent they change they move a little later they rarely happen sooner. But what we provide is sort of best estimate based on current documents as they are written.

And in the current environment with the amount of liquidity that we're seeing in the debt capital markets, do you worry about adverse selection if repayments continue to accelerate? Since presumably your highest quality assets would have the easiest time refinancing with a lower cost of capital provider.

No, I mean generally no. I appreciate the point. I think it's important to sort of think through our portfolio and recognize that a lot of what we do is sort of multiple stages to what's happening to the asset. And typically what we do is not a straightforward, hey, we're going to take an office building from 80% to 90% leased and once it gets to 90% we'll just go refinance it somewhere else. And ARI will be left with the ones that never got to the leasing. The stories and credits tend to be more complicated than that.

So as of today based on what we've seen in the portfolio I appreciate the question, but I would say there's been no -- nothing that indicates that sort of we're being left with the ones you wouldn't want to hold and we're being paid off on the ones you would want to hold. I think it sort of has played out as we would have expected based on original underwriting to be quite candid.

There are some that we've done pre-development loans where people are then putting a construction loan in place, we've given ourselves the option to participate in the construction and have chosen not to participate in the constructions. There are others where the nature of a transitional asset has changed. It's still not ready for a more traditional financing and we have sort of been impressed with what's taken place at the asset and we've decided to stay in the transaction on a go-forward basis. But so far I would say nothing, no broader conclusions that I would draw vis-a-vis what's going on in the market right now.

And then just switching gears to credit, I appreciate the commentary on the North Dakota loan. Looking at the loan level disclosure, looks like the amortized costs declined by about $10 million from 2Q. You mentioned some of the single-family sales, but just was wondering what drove the reduction in the carrying value.

That's net of the provision that we had recorded last year in Q2, which is $10 million.

So there's been nothing significant from a principle side with respect to the North Dakota loans, just the way we presented it and maybe Hilary or Jai could walk you through it post call, but certainly nothing significant has happened yet. If we succeed on the home sales, yes, you'll see it come down, but nothing to-date.

And then you gave some commentary on the exposure down in Miami, just was wondering if you can give a bit more color on the retail exposure in the Miami Design District loans in terms of how the overall project is proceeding with the sponsor and how you see rents and cap rates trending in that market.

Yes, I mean keep in mind what we lend against today is still a bunch of somewhat dated single tenant for the most part street retail which to be perfectly candid works as what it is today. The plans by the equity investor/developer obviously call for taking down what exists there today putting up high-end retail with hotel, office above it.

I'd say what's going on in a very positive way around the site that we lend against, is the continued opening of other high-end stores, other restaurants, more foot traffic, which sort of validates the design district as a location overall. And we continue to have a very productive dialog with the existing investor who continues to evidence their support of the site by putting more equity in as needed to either acquire additional sites or pursuant to the loan.

There will ultimately be a conversation with the developer, once their plans are finalized in terms of what they want to do and based on whatever pre-leasing they've achieved as to whether or not we want to stay into the construction loan or not. But for now I would say our view of what they've assembled has only increased based on the activity that's taken place around the site thereby validating the Design District overall as a location long-term in Miami.

And just lastly, can you provide a similar update on the Brooklyn retail predevelopment loan?

Yes, I mean -- yes, similar story, I mean I think what they've created in Brooklyn is a incredible location. I think the story in Brooklyn is they've literally acquired -- I'll get the number wrong, but a significant number of parcels. There are literally 2 more parcels that they would hope to acquire that would allow them to literally create a completely solid block. They continue to work on that. Again, what is envisioned for Brooklyn is a mixed use of some sort. Again, property types as I've described previously.

Given their assemblage, given the basis they created, we and they both remain very optimistic about the future success of that project. And I give credit to them as real estate investors/developers in their ability to, in an exhaustive effort, create an assemblage that is very valuable given what's gone on in Brooklyn overall.

And ladies and gentlemen this concludes our Q&A session for today. I would like to turn the call back to Stuart Rothstein for his final remarks.

Thank you, operator, and thanks for those of you for participating this morning.

And ladies and gentlemen with that we conclude our conference. You may all disconnect. Have a wonderful day.