Apollo Commercial Real Estate Finance, Inc

I'd like to remind everyone that today's call and webcast are being recorded. Please note that they are the property of the 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 filings with the SEC for important factors that could cause actual results to differ materially from these statements and projections. In addition, we will discuss 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 press release, which is available on the investor section of our website. We do not undertake any obligation to update forward-looking statements or projections unless required by law. To obtain copies of last SEC filings, please visit our website at www.apolloreet.com or call us at 212-515-3200. At this time, I would now like to turn the call over to the company's Chief Executive Officer, Stuart Rothstein. Sir, you may begin. Thank you.

Thank you and good morning and thank you to those of us who are joining on the Apollo Commercial Real Estate Finance first quarter 2019 earnings call. As usual, joining me in New York this morning are Scott Wiener and Jay Agarwal. Given that we recently spoke on our Q4 earnings call, I'm going to keep my prepared remarks brief and we can move to Q&A quickly following Jay's financial summary. The overall tenor of the commercial real estate market generally remains positive. The continued growth in the economy combined with consistently low interest rates has created a favorable environment for real estate operating performance and ongoing real estate investment. Given the importance of continued real estate transaction activity in generating opportunities for ARI, We believe the combination of low interest rates and historically high levels of equity capital embedded within real estate funds and other investment vehicles should bode well for our business going forward. It is worth noting that the capital markets volatility evident in December did lead to a slightly slower start to the real estate market overall in 2019 as equity investors and providers of credit took a somewhat cautious approach early in the new year. However, given the rapid recovery in the capital markets and the record level of dry powder that needs to be invested, we have seen a notable increase in activity and are tracking a number of interesting opportunities in our pipeline. 2018 was a record year for ARI in terms of commitments, and despite a pause in the overall market, we did close four transactions in the first quarter and, as planned, funded capital into previous closed loans, the combination of which has created a portfolio of over $5.2 billion, underwritten to generate what we believe are very attractive risk-adjusted returns. Importantly, our pipeline remains robust, and we are well-positioned to continue adding attractive investments to the portfolio. In addition, credit remains stable, and we continue to see our borrowers achieve their business plans. At the end of last year, we looked at the repayments we received across the portfolio, and in over 90 percent of the transactions, as expected, borrowers repaid the loans because properties achieved their business plans. Before I turn the call over to Jay, I wanted to highlight that during the quarter, we entered into a contract to sell the multifamily property and additional land collateral securing our loan in Williston, North Dakota. While there are no assurances that the sale will be consummated, we are confident that the outcome will be positive for ARI, and we expect to be able to provide additional detail on our Q2 earnings call. With that, I will turn the call over to Jay to review our financial results. Thank you, Stuart.

For the first quarter of 2019, earnings were 68.4 million or 50 cents per share, and GAAP net income was 60.9 million or 43 cents per share. These numbers include $3.7 million or $0.03 per share in prepayment income. During the first quarter, we closed four loan transactions totaling $450 million and funded an additional $110 million for previously closed loans. As of quarter end, our portfolio had an amortized cost of $5.2 billion, which is a 28% increase over Q1 of last year. The portfolio is comprised of 69 loans with a weighted average all-in, unlevered yield of 9.3% and a weighted average remaining term of just under three years. Ninety-three percent of the loans in the portfolio had a floating interest rate. Lastly, with respect to financing, we increased our capacity under the Goldman Sachs facility to 500 million, bringing our total capacity to 3.2 billion from five lenders. We also converted the remaining 5.5% notes and issued 2 million in common shares. And as of quarter end, we had over 360 million of available capital in the form of cash and availability on our credit lines. And with that, we'd like to open the line for questions. Operator, please go ahead.

Thank you, sir. Ladies and gentlemen, if you have a question at this time, please press the star, then the one key on your touched home telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Again, if you have a question, please press star, then the one key on your touchtone telephone. Our first question comes from Steve Delaney from JMP Securities. Your line is now open.

Good morning, and thanks for taking the question. Stuart, positive news, your remarks there. I couldn't write fast enough. Could you clarify exactly what is being sold? I knew there were some lots. There were also some single-family detached houses. I'd like a little more clarity there. Thank you.

Yeah, sure. So we've been, as I think you and most of those on the call know, we've been selling the 36 single-family homes as we've been able to vacate them. And at this point, we've sold roughly 90% of those homes and would expect to clean up the rest of that over the next couple months. Away from that, the bulk of the collateral is really a 330-unit garden-style multifamily complex and then a bunch of finished and unfinished lots in and around it. That package of the multi-family apartment building plus the unfinished lots is what I was referring to in my comments.

Great. Okay. So I wasn't clear whether the multi-family was the main part of the multi-family was part of that. Excellent. So we'll look forward to that in the second quarter. Just curious, the first quarter had some nice unplanned revenue in terms of early prepayment fees. I know those can't be easily predicted, but sort of setting aside prepayments, what percent of your $5 billion-plus portfolio should we expect might normally repay over the next 12 months just for modeling purposes? Thank you.

Yeah, look, I think it's a bit of a guess, but I think the way we think about it is, right, the portfolio for as long as we've been doing this has typically had a a base duration of call it three years, which would imply roughly a third turning over on an annual basis. And I think the actual experiences tended to be somewhere in the 20 to 25% per annum, Steve. So while it's an inexact science, if I was, you know, ballparking it, I would say it's roughly call it, you know, 20-ish, percent a year is going to pay off. So we call it plus or minus a billion bucks, just thinking about it, high level.

That's helpful. And some of that, I assume, is because you might sit down with a borrower and do an extension. Is that correct? So instead of it being more like 30, 35, some of those loans that may have matured, you might extend.

Yeah, look, we're always thinking proactively. And there have been a handful of situations where someone has achieved business plan and we're in discussions sooner rather than later, effectively trying to trade a little bit of spread because they've achieved business plan sooner in exchange for extension, more call protection. And I think that is, in many respects, and some of you have heard me say this before, I think one of the reasons there is an opportunity for us and our peers to continue to grow our platforms is I think borrowers in general appreciate the ability to talk to someone principle to principle and adjust on the fly as things change with the underlying real estate. So definitely looking for opportunities to do that.

Great. Thank you, Stuart.

You got it. Thank you. And our next question comes from Stephen Laws from Raymond James. Sir, your line is now open.

Hi, good morning. Hi, Stuart. To follow up maybe a little bit on the prepayments, just two specific ones I wanted to ask about. It looks like maturity is in July and September on two of your larger loans this year, or at least that's the fully extended maturity date in the debt. Can you maybe comment on those two loans? Do you expect those to extend? What kind of discussions are you currently having with those borrowers?

Yeah, I would expect, I'm just looking at the biggest one is the Miami loan, which we've talked to previously. That one has already started to amortize down. So if you looked year end to the end of Q1, we've already started to receive some amortization in exchange from the borrower in exchange for a little bit more time on their end. And that trend has continued somewhat into the second quarter. I would expect on that loan in specific, specifically, we would continue to stay in the loan in some fashion with additional amortization occurring. We will continue to de-lever our position and they will continue to put more equity in the transaction. And then the other one you referred to, the September maturity, which is a London a London-based condominium project. That's one where they sell units. We get delevered along the way. I would expect that – oh, excuse me. I'm confusing projects. Excuse me. This is one where they're actually in the market on their financing right now. They're actually getting traction for a construction loan. Our loan was a pre-development loan. As we do in most of our pre-development loans, we give ourselves an option to participate in the construction financing. And I would say, given what they've achieved on pre-leasing and given what we think the prospects are for the project, no guarantees, but I think there is at least a reasonable chance that our loan will get paid off, but we may stay associated with the project in some form as part of the construction financing.

Great. Thanks for the color there, Stuart. To think about originations, we saw a little bit of a shift in Q1. I think second half last year mainly saw senior loans originated, saw actually more MES than senior, I think, in Q1. How do you see that playing out? Was that a trend that will continue or just kind of happenstance based on what closed during the quarter? Can you maybe hit on that? And then to tack on and I'll drop off, but if we hold the current mix of senior and sub constant, you know, what leverage level, Jay, are you guys comfortable operating a portfolio with?

Yeah, look, I think, you know, I think to use the phrasing from your question, I think I think the weighting toward MES and Q1 was somewhat happenstance. Look, we're always open to either MES or senior loan positions, so we continue to look at both. But if you actually looked at our pipeline today of what we're working on and what we think is likely to close sometime during the year, much more heavily weighted toward first mortgage opportunities than MES opportunities, and I think that is reflective of of what is sort of interesting and what is available in the market today. And then, Jay, if you want to comment on that.

Oh, yeah. 1.5 to two times is kind of what we're comfortable with, as we've said in the past. And we continue to be comfortable at those levels, you know, despite being at 1.0 times today, you know, and for the last three or four years.

Okay, great. Thanks, Jay. One last question. You know, I appreciate the disclosure around live horse sensitivity. Can you talk about LIBOR floors, where you're able to put those in place in new deals, and kind of how that discussion takes place with your borrowers? Thank you.

Yeah, they're in deals. LIBOR floors tend to go up and down, given where sort of LIBOR is and sort of what expectations for LIBOR are. I think if you looked at our portfolio today, The weighted average LIBOR floor is sort of, on a dollar-weighted basis, roughly 1%. And again, some deals have lower LIBOR floors, some deals have higher LIBOR floors, but there's definitely floors in every deal. And I would say LIBOR floors are, you know, today roughly 2% for most deals that we're doing.

Great. Thanks for the call there.

Sure.

Thank you. And our next question is going to come from Jay Marani from KBW. Your line is now open.

Thanks very much. Just on the North Dakota, you said we entered into a contract, and I was wondering if that's ARI or if that's KKR, because I don't believe you foreclosed on the asset.

It's the group that is... affiliated with the asset, they're still in it. So collectively, we all needed to agree to the contract, and as part of the sale, we all needed to execute documents and be part of the process.

And when you say you expect a favorable outcome for ARI, does that imply proceeds in excess of the, I think the slides are 32 million, is your carrying value?

One could infer that, yes.

Okay. Thanks for that. Could you give an update on Bethesda? And I just wanted to confirm that that loan is on both the Lauren and the Quarry Springs properties, or is one of those completely sold out of units at this point?

The Lauren's gone. This is just Quarry Springs, and we're down to 11 units at this point.

Lauren's gone a long time ago, more than 18 months ago.

So we're just grinding through it. Okay. Okay, and so what's the, I guess, current absorption pace, or what do you anticipate for those remaining 11 units?

Look, I think the optimistic view is that we could be out of those 11 units in 9 to 12 months, and we'll know a lot about that given the current selling season, which has sort of just kicked off. And the pessimistic view is it takes longer than 9 to 12 months.

I guess, how many units did you have last quarter?

The project started at 50. I think a year ago we had 25 units, so we've sold 14 in the last year. Most everything that's happened in the first quarter of this year were really things that were signed up towards the end of the selling season last year, because not a lot happens in the January through March timeframe. So that's sort of where we sit today. We've got 11 units sort of aggressively pushing them as we start the spring selling season.

Okay. In terms of the deal flow that you're seeing and your originations, have you seen a pickup in bridge-to-bridge financings where borrowers are underperforming? on their business plans, and there's a lot of debt fund capital at better terms than their existing loans, so that's a key trend. Could you give any indication as to what percentage of your originations those kinds of deals are?

I would say, generally speaking, we're not seeing a lot of that, Jade. I think the one place you are seeing pricing come in and guys looking for ways to refinance themselves out is on the condo side of things, particularly on the inventory side of things. So less relevant to product that's being created, but once the product has been created, there's a pretty healthy bid on the inventory side for guys to take out bridge loans at more attractive inventory financing. But generally speaking in the market, and I'm giving you both the perspective from our business as well as the perspective from our what we do on the real estate equity side of things. There's not a lot of ARB in terms of taking a bridge loan from 18 months ago and replacing it with a new bridge loan today and dramatically changing financing.

Thanks. And lastly, on leverage, on a common equity basis, I think the ratio is a little higher than what Jay said. It's 1.23 times. And just looking back historically, that's kind of the strike zone in which you've issued equity. So And I know that you've run the balance sheet always at, you know, the lower end of the spectrum versus peers on leverage. Has anything changed there in terms of how you think about target leverage?

I mean, look, to be fair, and I understand the math you're doing, we do think of the prep as equity given that it's permanent capital. So that definitely factors in to our thinking here. I think at a high level, not a lot has changed the way we think about it. It's ultimately driven by opportunity and pipeline as we think about where the balance sheet needs to be. And there is a natural trend higher in leverage just as we do first mortgages, but nothing broadly has changed from a corporate finance perspective.

Thanks very much for taking the questions. Thank you. And our next question comes from Rick Shane from J.P. Morgan. Your line is now open.

Good morning, guys. Thanks for taking my question. Look, I understand that the quarterly fluctuations between subs and first mortgages is really, you know, to your words and, you know, a function of happenstance. But I am curious the competitive dynamics there. Obviously, when we look at most of the peers, they're concentrated on first mortgages. Do you run into less competition for subordinates? And When you think about terms and risk-adjusted returns, can you give us some context comparing the two loan types in this environment?

Yeah. Look, I think it's a different set of competitors, Rick. I think generally speaking, what I would say is on the subordinate side, you probably run up against more private competition than public competition, but I'd like to tell you there's no competition anywhere, but the reality is we're in a competitive business and think we've built a platform that can compete very effectively in either side of the business, if you want to divide it between, call it, first mortgages and MES. Look, I think we've always taken the view that if I do a first mortgage and finance away the senior piece under a repurchase facility, or I just do a originate a mezzanine loan position. Ultimately, if you think about where I am in terms of attachment points and what I'm earning from an ROE perspective, I'm in a very similar place. There are just differences in the way I'm protecting myself under a senior mortgage with a partner financing the repo for me and a mezzanine loan where I'm in an inter-creditor agreement with another senior lender. I think the reality of the marketplace today is what we're now, call it 10 years into a recovery cycle. I think what we've just seen is a trend in the market over time where in order to control situations, in order to win business, lenders in general are more comfortable speaking for the entire capital stack, which means you're ending up You know, winning mandates vis-a-vis the senior loan position in terms of competition and the amount of just pure requests for MES have shrunk over time, but we're still, from a business perspective, you know, our team broadly is always looking at both opportunities and very comfortable from an attachment point and risk-adjusted ROE perspective in both situations.

Okay, that's interesting. So you don't really see that there's a relative value arbitrage between the two products at this point?

No.

Great. Thank you very much.

Sure. Thank you. And again, ladies and gentlemen, if you have a question, please press star, then the one key on your touchtone telephone. Again, if you have a question, please press star, then the one key on your touchtone telephone. Our next question comes from Ben Zucker from BP IG. Your line is now open.

Good morning, guys, and thanks for taking my question. I wanted to start out by saying congrats on getting the leverage up to 1.0 or 1.2, whatever you call it. I know it's been a goal of yours, and it's up a bit year over year, and it's up more than senior loan growth, so you've done a nice job managing that.

Thanks, Ben.

It feels like you guys are kind of close to fully deployed. You had $100 million of cash on the balance sheet, and it looks like your subsequent activity is net deployment. So I guess now that you're not flush with capital and maybe can be a little more choosy or selective with your allocations, what is it that you're liking in the market right now? Maybe senior versus mes, but also property types or international markets, just anything that gets you particularly jazzed up?

I'll answer the question two ways. And my first part of the answer will be the, you know, as expected sort of commentary that we look at everything from a bottomed up perspective and really expect deals to stand on their own and sort of, you know, don't come in with any preconceived notions about what's great, what's not great. We sort of underwrite business plans, underwrite borrowers. and then underwrite what we believe we're getting paid vis-a-vis the risk we're taking. That being said, certainly it's evident in our portfolio, but we have certainly created a lot of traction and momentum in the European side of our business. I think generally speaking, London is about 14 or 15% of our portfolio today, and I would say on the back of what we've achieved in London, I would say our pipeline has some interesting broader European opportunities. I'm not sure any of them will get to the finish line, which I think is the standard caveat. But that being said, I think we're seeing some pretty interesting things in Europe overall, and I think we continue to believe that on a risk-adjusted basis, you get paid slightly better for your capital in Europe today than you do in the US, and there's a positive pickup on the hedging side. I think within the US, again, I think we continue to be more and more focused on what I would describe as major cities, top MSAs, however you want to describe it. The portfolio is somewhat weighted towards hotel and office, and I think that is reflective of what the opportunity set is for those focused on transitional assets today. No bias one way or the other. In that particular case, it becomes very deal-specific, very borrower-specific, very business plan-specific, but finding some things in both cases that are interesting. And I think, you know, as we've said before, and I'll say it again, I think in terms of condo exposure, where we've certainly, I think, very effectively been an active player, I think, you know, very major MSA focused. I think in terms of our primary exposure, which is in New York, very comfortable with all our credits at this point, but not really actively looking to add to that mix right now. And other than that, again, comes back to bottoms up, deal by deal, trying to find things that are interesting.

That's really helpful, Stuart. And then just lastly, and maybe this is higher level, you know, a lot of your peers kind of always came out as floating rate only lenders. And if I recall correctly, it doesn't seem like too many years ago where you guys were pretty balanced with like 50% of the book floating rate, 50% fixed rate or something like that. And where I'm going with this is you guys were able to pivot to floating rate ahead of the Fed hikes. And would you be willing if you had a view on where the Fed was moving to maybe start adding back, you know, a fixed rate loan exposure to kind of switch around your exposure to rates? I'm just, you know, just kind of wondering how you guys view that because you obviously have the borrower relationships where you were able to source fixed rate loans and still kind of a transitional space.

Yeah, look, we're not averse to fixed rates, so I think the view on fixed rates has always been, you know, if you could fix something in the double digits, you're sort of in a very comfortable position, and unless you think we're going back to, you know, the 1970s, a low double-digit fixed rate works. That being said, if you look back at our book, historically, most of what was done on the fixed rate side tended to be Mezloans. There's not a lot of asks for fixed-rate product today, to be perfectly candid. So in some respects, the best we can do is be available to the market. I would say in terms of our business, we are a player in the longer-dated fixed-rate market on behalf of our affiliated relationships, which I think you're all aware of. which I do think helps our volume and it helps our reputation in the market overall. But generally speaking, those sorts of fixed rates don't work for this vehicle overall. But we're not averse to putting fixed rates in. It's just the math needs to work at some level.

Gotcha. Well, that was it for me. So thanks for taking my questions, guys.

Sure. Thank you, sir. And I'm showing no further questions. I'd now like to turn the call over to Chief Executive Officer Stuart Rothstein.

Thank you, Operator, and thank you for those participating this morning.

Thank you, ladies and gentlemen, for participating in today's conference. This concludes today's program. You may all disconnect. Everyone have a great day.