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 Apollo Commercial Real Estate, 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'll 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 website 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 the 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 a call over to the company's Chief Executive Officer, Stuart Rothstein. You may begin, sir.

Thank you, Operator. Good morning, and thank you to those of us joining us on the ARI second quarter 2019 earnings call. Joining me in New York this morning are Scott Wiener and Jay Argyle. Before I discuss ARI's success year-to-date, I want to take a few minutes to provide an update on our perspective on the current state of the commercial real estate lending market. After a slow start to the year in the U.S., the market quickly returned to being highly competitive with a mix of both public and private lenders chasing transactions and creating generally favorable conditions for borrowers. Spreads have remained tight, and with expectations for LIBOR to decrease in the future, nominal yields on new transactions have come in. We continue to be active in pursuing transactions in the U.S., but it is clear from our activity year to date, we are taking a somewhat cautious approach to the market and finding more compelling opportunities to invest ARI's capital in Europe. As I have mentioned before, Apollo, on behalf of various forms of capital, is one of the more active players in both European real estate equity and debt transactions. Apollo's London-based CRE debt team is well-known and highly regarded in the markets. which enables ARI to benefit from their extensive reach and access to deal flow. Over the past five years, the team has completed over $3 billion of transactions throughout the continent on behalf of ARI and other managed accounts. The team has successfully formed first-call relationships with high-quality real estate owners and sponsors throughout Europe and has completed a significant number of transactions with repeat clients. In approaching the deployment of ARI's capital, we remain agnostic as to investing in the US or Europe. As such, in evaluating transactions and reviewing our pipeline, we regularly compare potential opportunities in both regions. At present, we believe there are opportunities to generate more interesting risk-adjusted returns by completing transactions in Europe, which are further enhanced from the attractive cost of currency hedging driven by regional interest rate differentials, as well as our ability to source low-cost financing in local currency. For the first six months of the year, ARI has committed capital to nine transactions totaling $1 billion and has funded approximately $190 million for previously closed loans. Given the record year we had in 2018 – which included a number of transactions with future funding components, we have been able to both keep our capital invested and have the luxury of being somewhat selective in our pursuit of new transactions. There have been several transactions in our own portfolio that have sought to refinance for additional proceeds or obtain extensions or have transitioned from construction loans to inventory loans, and we have chosen not to participate in the refinancings because we felt the returns were not commensurate with the increased risk profile. I would like to conclude my comments on investing by reiterating a general philosophy I have discussed with many of you at conference presentations or non-deal roadshow meetings. Regardless of geography, our fundamental approach to managing ARI's capital and investing in new transactions is to focus on protecting principle and And then we seek the most attractive risk-adjusted returns available consistent with our view of the appropriate attachment point in any specific transaction. Turning now to our capital markets activities, the second quarter was highlighted by our efforts to opportunistically capitalize on favorable market conditions and enhance ARI's balance sheet. In May, we completed both another accretive common stock offering as well as ARI's very successful debut offering in the term loan B market. Both transactions further strengthened ARI's capital structure and provided the company with ample liquidity for future investment activity. The debut term loan B offering totaled $500 million and has a seven-year term. ARI received a BA3 BB- corporate rating from Moody's and S&P, respectively. and the term loan was rated BA2BB-. The loan was priced at LIBOR plus 275 basis points, and subsequent to closing, we swapped the floating rate loan to fixed at an all-in cost for seven-year money of 4.87%. By all accounts, the transaction was extremely successful and enabled ARI to add non-mark-to-market term leverage to our capital structure. Before I turn the call over to Jay, I wanted to mention that the multifamily property in Williston, North Dakota underlying an ARI loan was sold during the quarter for approximately $33 million, which was approximately $2 million in excess of ARI's GAAP cost basis. While the investment underperformed, I am proud of the efforts of the investment and asset management teams who diligently focused on achieving the most favorable outcome and allowed ARI to recoup some of the initial impairment. And with that, I will turn the call over to Jay to review our financial results.

Thank you, Stuart. For the second quarter of 2019, our operating earnings were $69.1 million, or $0.47 per share. These numbers exclude the realized loss associated with a North Dakota loan of $12.5 million, or $0.09 per share. Gap net income for the quarter was $56.5 million, or $0.37 per share. During the second quarter, we closed five loan transactions, totaling $564 million, and funded an additional $78 million on previously closed loans. Repayments during the quarter totaled $168 million. At quarter end, our portfolio had an amortized cost of $5.4 billion, which is a 12% year-over-year increase. The portfolio is comprised of 71 loans with a weighted average unlevered yield of 9% and a remaining term of just under three years. And 93% of the loans in the portfolio had a floating interest rate. As Stuart mentioned, in May, we completed a common stock offering of 17.2 million shares at a net price of $18.25, which is a 1.13 times book value multiple. The shares generated a net proceeds of approximately 315 million, and we used 172.5 million of those proceeds to redeem the 8% Series C preferred stock at par. And at quarter end, our total common equity market cap was over 2.8 billion. The offering was accretive to book value per share, which increased to $16.30 from $16.13 at the end of Q1. Lastly, with respect to liquidity and leverage, as of quarter end, we had over 900 million of available capital in the form of cash and availability on our credit lines. And we ended the quarter with a one times debt to equity ratio, which continues to be the lowest amongst our peer group. And with that, we'd like to open the line for questions. Operator, please go ahead.

Thank you. Ladies and gentlemen, if you have any questions or comments at this time, please press the star and then the one key on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Once again, if you have any questions or comments, please press star, then 1. And our first question comes from Steve Delaney with J&P Securities. You may proceed.

Good morning, and thank you for taking the question. Hi, Stuart. So we noticed looking through the portfolio detail that, you upgraded, from a risk standpoint, a large $170 million Manhattan office construction loan to a two from a three. So just curious if you could give us some color on what event drove you to view that loan in a higher quality fashion. Thanks.

Yeah, I mean, the history with the loan is we actually participated in the pre-development loan, and then we are now partners in the construction loan. It was a spec office building where the sponsors have achieved significant amount of pre-leasing with high quality tenants. So based on the amount of pre-leasing that's in place today, it's significantly de-risked the transaction. And it's also apparent that in light of the pre-leasing in place today that when they have the opportunity to, they will certainly take us out of our loan.

And the construction is also nearly done also. So the combination of the construction being nearly done with the TCO over the next few months and the pre-leasing, we thought it made sense to upgrade the risk rating.

Yeah. Well, the good news is it worked better, probably better than you thought. And the bad news is you're going to get your money back. So you've got to put it back to work. But I guess that's never a bad outcome.

Not a bad outcome. Thanks.

No, that's for sure. So shifting to the other side, and congrats on North Dakota. I know you're glad to have that in the past. But switching down the other end, you know, you've been trying to work through this Bethesda thing for a long time, the condo situation there. I'd just like to have a brief update on activity, pricing, sort of there's been any spring-summer pickup there.

Yeah, I'll cover actually Bethesda and Liberty Center. This way it'll save someone else from asking that question. Look, on Bethesda, you know, our gap basis on Bethesda is $20 million and heading down at this point. There are now, based on what is under contract or recently closed, there are nine units left. There's a decent amount of activity on more than half of those. nine units, we continue to chip away at it. And I know it's my responsibility to keep providing updates on it. But I think it's sort of on the path that it's on, which is to say, you know, we're regular dialogue with the people on site, trying to make deals as best we can. And I think the, you know, the economic or future economic impact of that asset is pretty muted. And we're just sort of moving towards the finish line. So sort of where I guess we expect it to be and just sort of working deals as best we can. I think, you know, from an asset management perspective, Liberty Center is more of a challenge these days. It continues to operate in the, call it, you know, low 80s from an occupancy perspective, which is it's functioning, it exists, but it's certainly not where We would like to see it be to sort of get us on a path to getting out of the investment. There are several things we're working on that are somewhat binary in their outcome in terms of their ability to jumpstart what's going on at the asset. I'm actually going out there next week. I think other members of our team are heading out there. later on this summer. You know, that continues to be the primary focus from an asset management perspective, and we're still grinding away as best we can.

Okay. Well, thank you for the comments, Stuart.

You got it.

And our next question comes from Jade Ramani with KBW.

You may proceed. Thanks very much. What are the main factors driving your somewhat cautious approach to the market, as you described in your initial comments?

Look, I think it's just pricing, relative value, sort of, you know, what do we perceive, you know, what can we get paid for our capital at an attachment point that we're comfortable with? And, look, we're certainly seeing it in our existing portfolio where there are, loans we've ended up extending by coming to, I would say, a somewhat middle ground with the borrower, where they're happy to keep the loan in place with us, don't want to go through the effort of a refinancing, and maybe they're not grinding away to get every last, you know, bit of spread in their favor out of a deal. And there are other transactions where, look, there's capital chasing things. If you're willing to turn over every stone or rock, you could arguably find cheaper capital than ours. And in those situations where, you know, given what we did last year, given what we see in Europe, given some other things that we know sort of coming up, we think that will come our way, we're certainly not feeling the pressure to chase anything today. And, you know, unlike some of our peers, and this is not meant to be a positive or negative comment, we've tended never to compete at the tightest end of the market. We've always tended to seek things that had a little bit more complexity, a little bit more of a credit story to them in order to get paid more for our capital. And we're grinding away, but on a relative basis, it's more competitive today than it was nine months ago.

Just in terms of interest rate sensitivity, I think you've disclosed about a $0.07 impact from a 50 basis point decline in rates. If that were to happen, would you anticipate that to play out, which is about a 4% decline in earnings, or do you believe that the company's lack of relatively lower financial leverage would be one area in which you could address that?

I guess I would say this. I would say our desire is to keep our capital fully invested within the leverage ranges we have always talked about historically, which is sort of our comfort level from a leverage perspective, which is call it ultimately one and a half to two times, which is obviously, you know, in some respects a relevant part of our dialogue in the whole term loan B marketing process as well. So, I think there's capital for us to invest in. I think we have some room on the leverage side, but I don't think leverage is the answer if ultimately the market shifts down. But, you know, let's also keep in mind that we're talking about futures in a year ago. We were talking about LIBOR going up and that being a positive for earnings. So we'll see how it ultimately plays out. But I don't think leverage is necessarily the answer on a go-forward basis.

And in terms of the mix of deals, I think this quarter is the highest percentage of first mortgages that I believe you've originated in some time. You know, on a levered basis, are those investments similar to where you would have made subordinate investments? Or if the company does begin to do a disproportionate share of first mortgages, will that also create downward pressure on earnings?

I think in the world in which we're operating today, I think levered firsts actually provide better ROEs than MES. So I think on a risk-adjusted return basis, and I'd also factor in the impact of Europe where we tend to just do first mortgages as well. You know, I think that will impact the ROEs, generally speaking. You know, getting to what I think is the crux of your question, if you look at some of the legacy mezzanine loans on our books, those sorts of ROEs for mezz loans don't exist in the market today. Certainly not at risk levels that we would be comfortable taking.

Okay. Well, thanks very much for taking the question. Sure.

And our next question comes from Rick Shane with JPMorgan. You may proceed.

Hey, guys. Thanks for taking my questions this morning. In looking at the maturity schedule, it looks like you had a multifamily property in Brooklyn mature in June and another multifamily in Manhattan mature in July or scheduled to mature in June and July, and each has been extended. one to September, one to November. I'm just curious what you sort of see as an outcome there. Was there any incremental economics picked up associated with the extensions on those loans?

No, I mean, June was just a simple extension. The loans paid off, so it's not an issue, and we would expect in New York, again, it's, you know, we're just being, you know, working with our borrower, but not a situation where we're creating any sort of material economics for ourselves.

Got it. And any impact? Obviously, you know, we have seen some loan categorization movement from a peer related to New York multifamily any impact there on that? Because the loan, the Manhattan loan is a sub loan.

Now, I mean, we've generally across the board sort of avoided the rent stabilization to marketplace. So while we certainly read the headlines with interest and think this will play out over a long period of time, it has not had any meaningful impact on our portfolio. Terrific. Thank you for that commentary.

Sure. Once again, ladies and gentlemen, if you have any questions or comments, please press star, then 1. And our next question comes from Stephen Laws with Raymond James. You may proceed.

Thank you. Good morning, Stuart and Jayde. I appreciate the color you guys have provided already on the loans, and then obviously, you know, Rick's question was about New York multifamily that you just addressed. Kind of flipping to the liability side of the balance sheet, you guys have really done a good job of diversifying your capital structure and adding the term loan B. You know, can you talk about other opportunities there to further diversify? Are there opportunities to grow the term loan facility and increase that as a a fixed-rate financing source, or maybe talk about where you plan to go from here now that that term loan is in place.

Yeah, look, I think the term loan was important because it sort of activated our ratings with the rating agencies and now made us an issuer of rated paper, which certainly also opens us up to a significant number of investors who will now follow us. There's obviously, given what we did previously, You know, there's no immediate plans to do anything today, but I think we will, like we do with all our potential capital market strategies, sort of keep an open dialogue with investors, and obviously other peers in the space have done things in the traditional high-yield notes market, and there's other things for us to explore. I think separately, you know, I think, too, is credit, you know, One of Jay's roles here is to keep a very active dialogue with all of our various relationship banks on the repo side of things. And I think both in terms of the U.S. and what we've done in Europe on literally a deal-by-deal basis, there's a very active dialogue around creating the right source of capital and the right structure and the right pricing for us to allow us to get business done going forward. So I think the term Loan B was important because it sort of gave us a new avenue and a new dialogue with investors. But I don't think there's anything today specifically that we're focused on that will be called another new avenue.

Okay. Great. Appreciate the color there. Thanks a lot, Stuart.

Sure. Thank you, ladies and gentlemen. This now concludes our Q&A portion of today's conference. I would now like to turn the call back over to Stuart Rothstein for closing remarks. You may proceed, sir.

Thank you, operator, and thanks for those of you for participating on the call.

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