Apollo Commercial Real Estate Finance Inc (ARI) 2018 Q2 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, 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.

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At this time, I'd like to turn the call over to the company's Chief Executive Officer, Stuart Rothstein.

Thank you, operator, and good morning, and thank you to those of you joining us on the Apollo Commercial Real Estate Finance Second Quarter 2018 Earnings Call. As usual, joining me in New York this morning are Scott Weiner and Jai Agarwal. I'll keep my comments fairly brief so we can get to questions fairly quickly. But let me just highlight a few things.

ARI had another very strong quarter of originations, making significant progress deploying the capital raise at the end of Q1. During the quarter, ARI committed to approximately $970 million of new investments, bringing 2018 year-to-date originations to $1.9 billion across 19 transactions.

To put that into perspective, year-to-date originations for ARI are already equal to full year production for 2017, and we remain optimistic with respect to both additional transactions currently in closing and the continued strength of the pipeline.

After 9 years, we have established ARI as a reliable commercial real estate lender, offering creative financing solutions for bespoke real estate transactions. Commercial real estate lending is a relationship business and we continue to find new investments through our strong relationships with real estate owners and operators as well as brokers and like-minded senior lenders.

While the market remains competitive, we believe our success is due more to qualitative than quantitative factors. Said differently, we do not compete solely on price or proceeds. We invest in transactions where borrowers value responsiveness, diligence and understanding the value proposition and a creative and thoughtful approach to structure and economics. Consistent with our overall strategy, we remain focused on loans secured by institutional quality assets in primary markets. Our business continues to benefit from generally stable underlying real estate fundamentals, continued strong transaction volume and ongoing fundraising and investment by opportunistic and value-add real estate funds.

At quarter end, our portfolio had an amortized cost of approximately $4.9 billion, a weighted average all-in unlevered yield of approximately 9.1% and a weighted average remaining term of just under 3 years. And consistent with where we've been taking the portfolio, 91% of the loans in the portfolio had a floating interest rate.

As we look ahead, we believe the current economic climate remains favorable for our business model, and as I previously mentioned, our pipeline remains robust. We are confident in our ability to find investments with attractive risk-adjusted profiles, while maintaining our discipline with respect to underwriting and credit. As always, we will also continue to focus on the right side of our balance sheet and remain thoughtful and proactive with respect to the diversity of sources for, and the cost of, our capital as we efficiently fund the growth in our portfolio.

With that, I'll turn the call over to Jai to review our financial results.

Thank you, Stuart, and good morning, everyone. For the second quarter of 2018, our operating earnings were $54.9 million, or $0.44 per share, as compared to $44.6 million, or $0.46 a share in 2017.

GAAP net income for the same period in 2018 was $48.5 million, or $0.39 a share. This compares to $26.9 million, or $0.28 a share in 2017. In our consolidation of operating earnings to GAAP net income is available in our earnings release in Investor Relations section of our website. We continue to optimize the right side of our balance sheet and to that end, had an active quarter with respect to our credit facilities.

First, we extended and upsized our facility with Deutsche Bank to $800 million and added the ability to borrow in pounds and euros. Second, we extended the term of our $1.4 billion JPMorgan Facility to 3 years. And lastly, we entered into a new asset-specific financing with Crédit Suisse to fund a European loan. And as of quarter end, we had over $200 million of liquidity on our secured facilities.

Our book value per common share at June 30 was $16.26 a share, as compared to $16.31 at the end of Q1, and $16.16 at June 30 of last year. Book value this quarter was impacted by the $5 million additional reserve against a $34 million loan. This loan is secured by the remaining 15 condominium units in Bethesda, Maryland, where 35 of the 50 units have either been sold or are under contract as of today.

While our capital base continues to grow, our G&A expense ratio has essentially remained flat. Annualized Q2 G&A, as a percentage of equity, was only 30 basis points, which we believe continues to be one of the lowest percentages amongst our peer group.

Finally, I wanted to highlight our dividend. Based on Wednesday's closing price and our recent dividend run rate of $0.46 a quarter, our stock offers an attractive 9.8% pretax yield. Our board will meet again in mid-September to discuss the Q3 dividend and we will make an announcement shortly thereafter.

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

(Operator Instructions) Our first question comes from Steve Delaney with JMP Securities.

Noting on the page where you list each loan, there seems to be a concentration in new hotel loans and especially also condo inventory loans. I'm just curious, if you could offer a little more color on the inventory loans? And whether you see inventory loan -- condo inventory loans is a different risk than your condo development projects that you have? And maybe just some general color about how your loan bases in these inventory loans might compare to sellout and sale prices?

Yes, sure, Steve. Yes, so certainly, there is a different risk, right. You're not taking construction risk, so you're lending against fully finished product and oftentimes, you're lending in situations where there have been initial sales that have taken place. So relative to a ground up construction transaction there, certainly, I would say fewer risks with respect to an inventory loan as pertain to a ground up construction loan. Though ultimately, in some respects, your take out is the same which is the sale of units either begin. No different than we've talked about previously as we think about anything we do in the condo space, our focus is on how we see value ultimately to the buyer and then where we size our loan relative to that expected sale price. We tend to focus on a loan to net sellout somewhere in the 50% to 60% range, which is consistent with what we've done historically when we also tend to be very focused on both price per foot as well as nominal value of units that need to be sold. And given the experience we've had, both in New York, London and other markets to-date, we certainly, from our existing portfolio, get a fair bit of current information on the market which we certainly factor in to anything that comes into the pipeline in the condominium space that we consider on a go-forward basis.

Stuart, how was interest handled on these inventory loans? Is there any actual interest being paid by the developer? Or does it all just come out of sales proceeds?

Scott, you want to?

Hey, Steve. I would say that general market is you're capitalizing carry costs so it's part of our loan. There is money in there that cover interests, taxes, insurance. So generally, when they sell a condo, we get paid down with 100% of net sale proceeds after you are paying brokers, commissions and stuff on the deal.

So said differently, take interest, which is typically run anywhere from 5% to 10% of our interest income on a quarterly basis over the last few years.

Okay. And these -- terms of these loans, you should make a transitional loan, you're looking at a 2 to 3 year maturity. How long do you set these loans, the inventory loans?

They're generally, I would say, again, it's probably 2 to 3 years with general huddles along the way to make sure that they're selling.

Okay, that's helpful. And just one final thing on your additional loss provision. Thanks for clarifying. We've kind of assumed it was Bethesda, but wanted to hear that. Could you just comment on whether the additional reserve was a function of lower observed sale prices? Or is it just slower pace of sales from what you saw a year ago when you set the original reserve?

Well, look at a high-level in doing the accounting analysis, you run a bunch of different scenarios which factor in both pricing and pacing. I would say the reality is, pacing has more of an impact than pricing at this point. And I would say that's also been our experience in terms of units that have sold or said differently. When we've had a real prospect, someone who's interested in purchasing a unit, I think the units have been priced appropriately to get a transaction done. I think as we've commented on prior calls, foot traffic is not as high as we would like. And as a result, that impacts certainly a conservative yield of what pacing may be in the future.

Our next question comes from Stephen Laws with Raymond James.

I guess to touch base first on a couple of straightforward questions. So leverage, very strong origination quarter looks like 1.2 at quarter end. And I realized it's a function of mix of senior versus subordinated. But can you talk about target leverage, July origination seemed like they're just shy of $100 million, maybe some comments about where we should think about the total portfolio size going as we move to the balance of the year?

Sure. Keeping in mind that everything I say about leverage needs to be coveted by the fact that we've never actually hit the leverage targets I've established. Right. The goalpost as you sort of alluded to in your question is it, it's the first mortgage, it's levered 2x to 2.5x. If it's a mezzanine loan, we use no asset specific leverage. So if we -- that sort of sets the goalpost. We've tended to be somewhere between 0.9 to 1.3 historically with a comment that we'd always be comfortable running this company at closer to 2x leverage if the asset mix supported it. I think if you look at what we've done over the last few quarters, you've certainly noticed a greater preponderance of first mortgages relative to mezzanine loans, which I think just leads to a natural rise up in leverage. And I think you'll continue to see a slow modest tick up in leverage. But the reality is I think we're -- this is a company that runs somewhere between 1 2 to 1 5. I think 2 is something that I don't envision us getting to and I think the desire is to always keep a decent amount of dry powder in the form of leverage capacity within the company.

Great. And kind of to the point on originations, construction loans versus transitional demands with construction cost increasing, are you seeing a shift in interest or people delaying construction project starts at all? Is that pushing a higher demand for transitional assets, or maybe higher valuation on some of those assets? But kind of how is -- how we're shifting construction costs or increasing construction costs changing demand?

It's Scott. Yes, I mean, yes, look, I would say certain markets. I think you're certainly seeing some increased cost, obviously, a lot going on in trade, but it's administration. But I would say, it's certainly getting factored in, but I'm not sure it's really delaying. If someone owns a piece of land or building that they want to develop, right, there is cost involved. So I would say, if someone is delaying a project, maybe the increased cost are one factor. It's probably more of a market -- more of a market timing where they don't think they would actually want to bring a property to market given what's going on. But not really seeing that impacting. I mean we are still seeing a lot of demand in really the major markets we follow, whether it'd be New York or the West Coast, Miami. So still a lot of demand. I would say on this transitional side, clearly, we talked about pour lots of money in the opportunistic value-add equity side looking at deals. We don't really, I think, focus on that office lease-up where it's transitional. I mean, I think from our perspective, we really view that, that market is pretty mispriced, to be honest. Given the risk you're taking and the market that those deals generally are, so that's not -- we really haven't been playing that heavy lease-up office transitional loan part.

Great. And to follow-up on maybe some comments last quarter, you guys talked about London being attractive in the Q&A. Certainly, you've made a few loans there, December, March and June loans, I think on the senior portfolio total now 10% of that portfolio just those 3 loans in London May till December. Can you talk about what you're seeing there? How the opportunity is today versus 3 months ago when you -- when we last had comments?

Yes, look, I would say, we continue to see opportunities there. We've been focused on both before sales as well as office. We're in the process of closing another office transaction, but at the same time, some of the stuff that we have done are more in the predevelopment area. It's going to be in the process of being refinanced. I would say, not actually 3 months, it will probably versus 6 months ago. I would say, probably less opportunities there than we had seen. I think there is a window that we jumped into post regs and other things where we could find some attractive deals. I would say the market is somewhat pivoted back where you're more a traditional, commercial bank than others have really come back into the market with a vengeance. So I think we're still seeing opportunities, but it's not as, not as good as it was at the beginning of the year.

Great, thanks for that color. And then one final question on the retail asset in Ohio. Looks like you reduced the rate, I think, I saw in the queue. It is still set to mature, I think, in September. Do you expect a resolution there? Will it be extended? I think you did a TDR on that. If you can maybe comment on that investment?

Yes, I think we alluded to this on our last earnings call. Certainly, our expectation is not that we get paid off in maturity. This is an ongoing dialogue between us and the sponsor. I think, it's been a very productive dialogue to-date. I think we are clearly very much to the extent we can be as a lender involved in the focus on asset management vis-a-vis leasing strategies and merchandising decisions and out parcel decisions. And I think this will, much likely, we've experienced with our asset in Harvest Hills which seems to be turning around. This will be an ongoing focus of our [Hershman] asset management perspective. We don't expect a loan to pay off at maturity but we do expect to continue to work through it. And again, you've got a center that's somewhere in the 80s percent occupied, the location clearly works the mixed use assets that were part of the broader development, are working. I think, it's just given the ever-changing retail landscape. This is about coming up with a merchandising plan or strategy that works for the long-term and not just haphazardly putting tenants in spaces just to sort of create the illusion of greater occupancy, but actually, coming up with a strategy that continues to make this a vibrant center on a go-forward basis which will certainly enhance our ability to get out as a lender and hopefully, create value for the sponsor on a go-forward basis.

Our next question comes from Jade Rahmani with KBW.

Would you characterize ROIs in the market as stable? I think that you've mentioned improved ability to finance first mortgages so spreads there have also compressed as well as what we're seeing on the yield side.

Yes, I think, broadly speaking as we think about investing our capital from an ROE perspective, we've talked on the last few calls about spread compression. But by the same token, benefiting from both a higher starting LIBOR as well as improved financing to the extent we do use leverage. So generally speaking, I would say we continue to remain comfortable in our ability to generate ROEs consistent with what we've done previously.

In terms of the overall business mix, can you give any color on what percentage of the business is from repeat borrowers? And perhaps, what percent is the portfolio is with, say, your largest single borrower?

Yes, I think on the repeat side, look, it fluctuates quarter-to-quarter, year-to-year but I think we've generally found over the last few years that we're sort of doing repeat business represents about 40% to 50% of borrowers that we've had some relationship with in the past. In terms of...

And also remember, that can be across the platform, right, not necessarily just what we do with ARI. We do have borrowers who may want a long-term fixed rate loan that we do with an insurance company or other products.

And then I think, look, I think across the $5 billion plus or minus of assets, I think, our single largest borrower represents 3% to 4% of that total. I don't think we've ever aggregated sort of across the 5 largest or 10 largest, so we can obviously do that offline if that was necessary. But that sort of the -- that would be the largest.

In terms of the 2018 remaining maturities, you mentioned Cincinnati. I'm assuming that you'll modify that loan. I don't know if it will be amortizing or not, but I'm assuming that gets a maturity extension. Just on the Brooklyn retail, urban predevelopment and also the Manhattan and then predevelopment, and I think there's an office project in Brooklyn. How do you feel about those loans ability to repay at maturity?

The Brooklyn predevelopment, we're in the process -- the borrower continues to work on their ultimate development plan and acquiring additional adjacent parcels. So we are working with them to continue if that loan will be or it has been extended. As they continue to execute their business plan and continue to effectively reduce our bases as they keep adding to the property. That was one. There was a -- the Brooklyn office loan, we expect -- there is a major leasing that happened there. We expect that to get paid off prior to maturities that we know they're in the process of refinancing it. And then, was there a third question?

There was a Manhattan $65 million urban predevelopment.

That is also in the process of being refinanced. It was extended but in the process of being refinanced.

Okay. The Brooklyn retail predevelopment, you say that they're acquiring properties and that reduces your basis. Is there actual retail revenues currently being generated on that project? What is the status of the project?

You saw that the ultimate highs in that use is a larger redevelopment that will have retail where they're active. We've been talking to tenants on leasing and then above that, given Brooklyn will be residential whether that most likely whether it'd for rent or for sale. They've also contemplated office. There's different zoning benefits. They do office versus stuff. So we're very comfortable so far and continues to put additional equity and I know they said as a site gets bigger, you can do more with it, it gets even more valuable.

Okay. The Bethesda project, is it about 2 years of remaining absorptions to sell out of that project? And then, are there any concentrations in remaining units that could cause further loss provisions?

I mean, there's 15 remaining units just to be perfectly candid. They are all 3 bedroom remaining units. I think part of the question you asked, Jade, in terms of how much time is there, that's part of the analysis from an accounting perspective. Is it 18 months? Is it 24 months? Is it 36 months? We ran a handful of different scenarios. If you think about what we've done since we took the original reserve, which was about a year ago, we sold 9 units in that time period. We would hope to make additional progress this summer and fall which tends to be good selling seasons. But look, I think the reserve we took, we believe is adequate to address both pacing, pricing and any other externalities that may arise as we get to the finish line.

The -- I think that there is a CMBS technical default maturity on the [Sava] skilled nursing loan and I believe ARI has a mezzanine loan. I think that might be technically related. So I was wondering if you could provide a commentary there. I know skilled nursing has been in the -- facing a lot of headwinds in the news recently.

Yes, look, I think the overall skilled nursing industry does face headwinds from an operating perspective. You are correct that the CMBS loan was put into special servicing for what I would describe as a technical issue. I think as we look at our mezzanine position, the property is still generating net cash flow through our mezz basis in the mid-double-digit. So we view -- we feel very comfortable that we are well protected from a cash flow perspective. Our loan is also covered on a debt service coverage basis, very comfortably. The borrowers actually recently launched a refinancing effort and it would not surprise us at all if we were paid off on our loan towards the end of the year when the prepayment window opens up.

Okay. And do you think that there is adequate liquidity in that space for them to refinance?

Absolutely.

Okay. And then lastly, could you give an update on 111, West 57th ?

62nd floor, I think, and continues to go up at the pace of about a floor every 7 to 14 days. It is capitalized to be completed. It is, the materials and trades have been contracted to complete it. It continues to move at pace. I think we commented on an earlier call that there were at least 4 sales without much of a marketing effort to-date. And given where our last dollar of basis will be when it's completed, which is call it $2,800, $2,900 a foot, we continue to be very comfortable that as long as it's completed, we're comfortable with our basis, comfortable with our collateral. And again, this is a loan that's generating an L plus mid-15s sort of return to us. Again, it's one of those loans that I wouldn't be surprised when it's ultimately completed and there is the ability to pay us off, which goes for another almost 2 years on an inventory basis. Someone could take us out with much cheaper financing. So we're quite happy to have it in place for the next couple of years.

Our next question comes from Rick Shane with JPMorgan.

First, in terms of the unfunded commitment. Obviously, that was -- really grew at the end of last year. And this quarter, we saw you draw $113 million on that, which basically suggests a run rate on the draw of about 2 years. When we build our models, is that a reasonable way to think of that?

Yes, look, I think it's reflective of the increased representation of call it, construction and/or significant redevelopment projects in the portfolio. And I think spreading something over the next 6 to 8 quarters is probably appropriate.

Okay. And when we think about the spread on that loan both given the timing and the nature of it, is it fair to say that given where spreads have moved in the market, that is an above market yield versus rest of your portfolio?

Yes, I wouldn't necessarily -- I wouldn't necessarily say that. I think one of the reasons we find that area attractive is that spreads and on returns have helped generally pretty steady because it's not really -- because people can't see a load or CMBS and then generally can't repo it. So people are kind of looking to absolute yield. So you haven't seen the compression that you found like in the likely transitional market that we've talked about before. So I would say, you really haven't seen as much really.

This is little, but obviously, LIBOR going up. But it's certainly not as dramatic as you saw in some of the other manifest.

Got it. So I think your answer suggests you're agreeing with the premise of my question, which is that the spread on that is likely above where most of the paper that you're originating right now is?

Depends on the type of transaction.

Yes, depends on like for like. I mean...

Okay. Second question is related -- or second topic is just related to repayments. And Jade went through a number of loans that had repaid, but I am curious in general, would you expect that durations are going to be extended or we're going to see more extensions in the current environment given the favorable nature of your financing?

I think consistent with what we've talked about in the past, given the underlying business trends of our sponsors, that's really what drive the refinancing. So if it is someone who is obviously doing the development, they're selling the property over someone doing leasing or things like that, so I mean, that's really what's driving it. Obviously, if they're a holder of the property as opposed to seller and they think they can get more financing that's attractive, hopefully, they will come talk to us and we'll talk about redoing the loan or something like that. But that's really more driving it, is what's going on in the underlying property less so than the overall market financing division.

Got it. So it's still sort of regular way at this point in terms of being a function of meeting the benchmarks and the development?

Yes.

(Operator Instructions) Our next question comes from Ben Zucker with BTIG.

Based on Slide 13 that shows your quarter end liquidity, it looks like there's room to grow the portfolio another 15% or so. And I was curious how long you thought it might take to reach kind of that full deployment level? I know we're in the slower summer months right now and we can see your subsequent activity to-date. But do you think this is something that you could hit by year-end?

Look, we certainly had a good 6 months and certainly, I meant from my comments in the speech to indicate that both based on what's in closing as well as pipeline remains fairly robust. You've talked -- you've spoken to me enough to know I'm always a little hesitant to try and predict things on a quarterly or sort of year end basis just given that a lot of what we do is tie-up transactions. And then it's a fight to get to the finish line, so to speak. But look, I think given what we did during the first half of the year, we feel pretty good about getting that capital deployed. But let's also recognize that as we think about our business plan going forward, we're also aware of what we think is likely to repay between now and the end of the year. So you might not see that. Even if we invested enough to meet what you just described as call it a growth target, we know there's deals coming back the other way that are going to pay us off.

That's a great point, I think. We always need to remember how quickly the capital can come back. Well, since someone asked about -- we just spoke about dry powder and we've also spoken about maybe the ability to pick leverage up a little bit. Kind of, what are your current thoughts on the dividend level that you guys are paying relative to the rest of the peer group? I'm not sure if you think based off your outlook, in the current capital base you could support a dividend increase. But any kind of thoughts or color you have there about kind of where your stock is yielding relative to peers in the market might be helpful.

Yes, we're -- we wish our yield was lower like everybody else. We're very comfortable with the dividend we're paying and very comfortable with the portfolio. I'll call it a steady-state invested basis covering that dividend comfortably. I think I've said publicly before, our desire is not to grow the dividend at this point. I think we're paying a healthy dividend and we are confident in our ability to continue to cover that dividend.

Very helpful. And then lastly, I know we touched on Bethesda condo and the retail center in Cincinnati, but could you provide a quick update on that Williston, North Dakota multifamily loan?

Yes, certainly, the story is better in Williston these days as everybody can surmise given where oil prices are these days. If you again remember the components of our Williston collateral are 36 single-family homes and 3 -- a garden-style 330 unit multifamily projects and then north of 200 finished and unfinished lots. We have been actively selling the single-family homes. I think when last I looked at the report, we have sold or have under contract 20 of the 36 single-family homes and would expect to make further progress there. And as we sell a home, we're just paying ourselves down. And those homes sell anywhere from $250,000 to $350,000, sort of as a range. On the multifamily, rents probably got as low in that market as probably somewhere in the call it $0.80 to $0.85 a foot market. Rents are now north of a buck a foot with no concessions and occupancy levels are solidly in the 90s. More importantly, I would say the market overall for multifamily is solidly in the 90s. So that allows us to continue to hopefully push rent. And as we push rent, we generate more cash flow from the asset. And while the capital is still under-earning what we would like it to earn, that cash flow is a benefit to us. And the more we can stay at those levels, I think the more optimistic we are about some sort of overall exit at some point in the future, but I don't want to get ahead of ourselves. I would say after battling this asset for the last couple of years, the market generally has a better tone to it, overall. And we, like everyone in Williston, is probably hoping that oil stays at these levels because it creates a nice level of economic activity in Williston.

That is great color. Yes, it's probably nice in Williston in July with $75 oil. Appreciate your comments, guys.

You got it.

At this time, I'm showing no further questions. I'd like to turn the call back over to Stuart for closing remarks.

Well, thank you for everybody for participating. Operator, thank you. We're done.

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.