Apollo Commercial Real Estate Finance Inc
NYSE:ARI
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Apollo Commercial Real Estate Finance Inc
Earnings Call Analysis
Q2-2024 Analysis
Apollo Commercial Real Estate Finance Inc
Apollo Commercial Real Estate Finance, Inc. (ARI) reported its financial results for the second quarter of 2024, displaying solid performance. Distributable earnings were $0.35 per share, while GAAP net income attributable to common stockholders stood at $33 million, equivalent to $0.23 per diluted share. The portfolio's carrying value reached $8.3 billion, with an unleveraged yield of 8.9%. These figures indicate a healthy profitability level despite prevailing market uncertainties.
In the first half of 2024, ARI recorded significant loan repayments, totaling $759 million. Additionally, in the second quarter alone, the company completed $116 million in gross add-on fundings, contributing to a year-to-date total of $438 million. Notably, ARI managed to redeploy $505 million of capital into four new transactions during this period, evidencing an active approach to capital management and loan acquisition.
A significant point of concern is ARI's exposure to a loan secured by eight hospitals in Massachusetts, amounting to $379 million. After Steward Healthcare, the operator, filed for Chapter 11 bankruptcy, ARI indicated the need to record an expected CECL allowance of approximately $90 million. The loan’s risk rating was downgraded from 3 to 4, reflecting the current economic uncertainties and operational challenges in the healthcare sector.
As of June 30, 2024, ARI's book value per share, excluding reserves, increased slightly to $13.62, up from $13.58. The company repurchased $38 million of its common stock during the quarter at an average price of $10.16 per share, resulting in a boost of $0.11 to the book value. This share buyback program reflects ARI's confidence in its valuation and commitment to returning value to shareholders.
Looking forward, ARI anticipates a steady portfolio size, with expectations to maintain its $8.3 billion portfolio through new capital deployment as repayments occur. The company has forecasted an active market for 2025, especially if interest rates stabilize, giving them a better platform to pursue new initiatives. They expect a robust investment pipeline and continue optimism for capital returns from ongoing transactions, particularly the 111 West 57th project.
In addition to their healthcare initiatives, ARI is exploring opportunities within the multifamily sector, notably a historically less emphasized area for them. The company showcased potential in two recent multifamily loans under low loan-to-value ratios, indicating willingness to adapt strategies to capitalize on changing market conditions while maintaining a focus on risk management.
ARI holds a solid liquidity position with $193 million available, comprising cash, undrawn credit facilities, and proceeds from loan servicing. Furthermore, they have unencumbered assets valued at $507 million, showcasing the company’s ability to navigate financial challenges while supporting future initiatives.
The current dividend rate suggests an ROE of approximately 10.5%, with pro forma estimates indicating a potential rise to over 11% after accounting for the anticipated CECL reserve. Management expressed confidence in sustaining dividends, contingent upon maintaining earnings growth and managing the capital trajectory effectively.
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I'd like to remind everyone that today's call and webcast are being recorded. Please note that they are the property of Apollo Commercial Real Estate Finance, Inc. and that any unauthorized broadcast in any form is strictly prohibited. Information about the audio replay of this call is available in our earnings press release. I'd also like to call your attention to the customary safe harbor disclosure in our press release regarding forward-looking statements. Today's conference call and webcast may include forward-looking statements and projections, and we ask that you refer to our most recent 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, these measures are reconciled to the GAAP figures in our earnings presentation, which is available in the Stockholders 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 our latest SEC filings, please visit our website at www.apollocref.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.
Thank you, operator, and good morning, and thank you to those of us for joining us on the Apollo Commercial Real Estate Finance Second Quarter 2024 Earnings Call. As usual, I am joined today by Scott Weiner, our Chief Investment Officer; and Anastasia Mironova, our Chief Financial Officer. Before I speak about ARI's second quarter performance and portfolio updates, I would like to provide an update on the subsequent event disclosed in the 10-Q filed yesterday.
In March of 2022, ARI and other Apollo-managed entities co-originated a 55% loan-to-cost first mortgage loan secured by 8 hospitals in Massachusetts. In origination, ARI's portion of the loan totaled $379 million. The loan was made in connection with the capitalization of the joint venture between 2 parties to own the hospitals. That joint venture then leased the properties to Steward Healthcare, who also served as the operator of the hospitals. Apollo did not lend to Steward and does not have any involvement in Steward's operations of the hospitals or performance under the lease.
The structure and covenants in the loan have provided for cash collateral and amortization since origination that represents approximately 11% of the original loan balance and ARI's amortized cost was $342 million as of June 30, 2024. As of today, the loan remains current on all contractual interest payments. Steward filed for Chapter 11 bankruptcy in May 2024.
During the second quarter, the loan's risk rating was downgraded from 3 to 4 subsequent to quarter end, bids received and the bid process and negotiations are continuing to evolve with multiple constituencies. While there is still a high degree of uncertainty, based upon the information available as of the 10-Q filing and taking into account Steward's bankruptcy court documents made publicly available on July 30, we currently anticipate recording a specific CECL allowance in a subsequent quarter, which we currently estimate to be approximately $90 million. The actual specific CECL allowance may differ materially based on continuing development.
Shifting to second quarter performance, ARI continued to receive a healthy level of loan repayments which totaled $759 million for the first 6 months of the year. During the quarter, ARI redeployed approximately $505 million of capital into 4 new transactions and following quarter end, we completed 2 additional transactions in the United Kingdom totaling approximately GBP 270 million. All of these new vintage transactions have lower attachment points and wider spreads than the legacy loans in our portfolio and are structured to enable ARI to earn attractive levered ROEs on newly deployed capital.
As we continue to receive capital back, we benefit from the broader pipeline of Apollo's real estate credit platform, which continues to gain market share and fill the void in the market as traditional capital sources retrench.
Turning now to the portfolio. At quarter end, ARI's portfolio was comprised of 50 loans totaling $8.3 billion. During the quarter, there was significant sales momentum at 111 West 57th Street with 6 units closing totaling approximately $74 million of gross proceeds which were used to pay down the senior mortgage that is currently held by a third party. Notably, subsequent to quarter end, an additional 2 units went into contract, including 1 of the penthouses. Following the paydown and inclusive of what is under contract, the senior loan will have a balance of approximately $70 million once those units close.
There has been a renewed marketing effort through the hiring of a new sales brokerage team renowned for their global luxury market leadership. Their dedicated focus on this property, coupled with their international reach has already proven successful, and we are confident this momentum will continue.
With that, I will turn the call over to Anastasia to review ARI's financial results for the quarter.
Thank you, Stuart, and good morning, everyone. ARI reported distributable earnings of $0.35 per share of common stock for the second quarter. GAAP net income attributable to common stockholders was $33 million or $0.23 per diluted share of common stock. ARI portfolio ended the quarter with a carrying value of $8.3 billion and the weighted average unleveraged yield of 8.9%. In addition to the new investments Stuart discussed, during the quarter, we completed $116 million of gross add-on fundings from previously closed loans, bringing year-to-date gross add on funding to $438 million.
For the first 6 months of 2024, ARI received $759 million of proceeds from loan repayments and sales. Subsequent to quarter end, we received an additional $421 million from the repayment of 3 senior and 1 subordinate loan. During the quarter, ARI recorded $7.5 million specific CECL allowance when a subordinate loan secured by our interest in a Class A office building in Troy, Michigan that has previously been risk rated 4. In conjunction with recording a specific CECL allowance for this loan, we downgraded the risk rating at 5. It is worth noting that this loan is current on all its contractual debt service payments. The general CECL allowance stood at 47 basis points of the loan portfolios amortized cost at June 30, a 3 basis point increase as compared to the end of Q1. This increase was primarily attributable to new loan originations as well as a more adverse outlook for certain property types.
Our total CECL allowance was 440 basis points of the loan portfolio's amortized cost basis at June 30, which represents $2.47 per share of book value. ARI book value per share, excluding general CECL reserves and depreciation, was $13.62, up from $13.58 at the end of last quarter. We repurchased $38 million of our common stock during the quarter at a weighted average price of $10.16 per share which was $0.11 accretive to book value and generated 15.3% ROE.
Post quarter end, we acquired an additional $2 million of our common stock at the weighted average price of $9.92 per share. With respect to our borrowings, a rise in compliance with all covenants. The company ended the quarter with $193 million of total liquidity comprised of cash on hand, undrawn credit capacity on existing facilities and loan proceeds held by the servicer.
At June 30, we also held $507 million of unencumbered assets. During the quarter, ARI put in place a $74 million of accretive financing for the Mayflower Hotel in Washington, D.C, enabling ARI to earn an enhanced leverage return on equity as we continue to monitor the market to determine the optimal time to sell the hotel. We also upsized our secured credit facility with Barclays during the quarter, provide ARI with an additional $300 million of additional capacity. Our debt-to-equity ratio at quarter end was 3.4x. As a reminder, we have no corporate debt maturities until May 2026. And with that, we would ask the operator to open the line for questions.
[Operator Instructions]
Our first question comes from Doug Harter with UBS.
On the hospital loan, just wondering if you have any recourse or obligations to the ultimate borrower and the operator of the hospitals?
No, we do not.
Got it. So it's just real estate?
We have -- I mean it's a real estate loan from our perspective, Doug, and we'll do what we can to protect our rights as a lender.
Great. And I guess just as you think about that asset class, how do you think about recovery values or to the extent that some of those hospitals are ultimately closed.
Look, I think while we lent against it as a portfolio of 8 hospitals, I would say we look at them each as 8 individual assets right now and there's -- things are somewhat in flux, but I would say we're sort of doing the work necessary to think about each piece of collateral individually. And how we recover as much value while also keeping in mind the concerns of other constituents in the process as well.
Our next question comes from Rick Shane with JPMorgan.
Look, world has evolved a great deal in the last month in terms of interest rate outlook. And I'm curious, I think over the next few years, we're going to operate on 2 timelines. One is the emergence of additional challenges within the portfolio. And the other is the resolution of existing problematic loans. Can you just talk a little bit -- do you feel like we are now sort of reaching the end of the emergence period that you have a pretty good idea of where the risk is within the portfolio and that going forward, it's going to be about the resolution. Can you sort of tell us what inning we're in each of those?
Yes. I think I agree with the general premise of your question, Rick, which I feel like we sort of know what our focus list is or what our hotspots are. And I think at this point, we're focused on a path towards resolution, which could play out over some time. And I think we've all been around the sector long enough to know that just because there is a stated maturity date or a target resolution date. Sometimes things can go through an iterative process where it plays out over time.
I think we are encouraged by the fact that the market in general, there seems to be more activity, which I think that leads to some enhanced clarity around where value is and where things can get resolved. But I would say sitting here today, given where you started the question, I feel like we've got a good sense of what those things are that we need to focus on. And it's really a matter of getting to resolution on the things that are on our focus list, while at the same time, making sure we're doing a good job of getting capital that comes back to us redeployed into transact is we're excited about.
Got it. And look, there's a concept of rational expectations. And I'm curious how quickly you see the rate outlook impacting sentiment and behavior amongst your borrowers? I mean, again, we're just weeks into this in terms of a pretty seismic shift in terms of rate outlook. But you guys are in the market every day, you're having conversations. Are you seeing the tenor of things change that quickly? Or what should we expect in terms of how you think borrowers are going to potentially become more aggressive about defending their positions given the carrying costs are likely to go down over the next 12 to 24 months?
Yes. I mean I think it's -- I think you're asking the right question. I think it is anecdotal at best right now as things are occurring fairly quickly, and it's also arguably a month where people sort of get somewhat dis-attached for a period of time, but I could say certainly, anecdotally, I would say, both in terms of existing borrowers as well as potential new transaction in the market. Anecdotally, it feels like there's renewed interest on the equity side of the real estate business in general for people feeling like if they can sort of step into assets today, they might end up in a fairly attractive financing market from a rate perspective sooner than they might have thought.
Our next question comes from Stephen Laws with Raymond James.
Stuart, just first to follow up on Doug's question around the hospital. Any thoughts on how timing plays out? Or do you expect the loan to go nonperforming. I know you said it's current as of today. And will that specific reserve hit in Q3? Or are there events that happen further out in the future that drive that?
Best guess today is that the reserve should be coming in the second half of the year. There's just a lot of moving pieces, a lot of constituents involved and we don't want to sound nonresponsive, but it is playing out daily, and it's tough to give any more clarity right now.
Understood. Shifting gears to the investment pipeline, a pretty active quarter there with a lot of originations. That's continued in July. I think it's coincidental, but Q2 had 4 U.S. loans. July had 2 Europe loans. But can you talk about your pipeline what you expect as far as portfolio turning over with repayments coming in, in the back half and being recycled into new investments. And should we take this recent pace over the last 4 months and expect that to continue over the remainder of the year?
Look, as I indicated in my response to the question from Rick. I mean, it's a pretty active market right now, I think, those equity investors and lenders are finding ways to get transactions done. And I would say, if anything, the volatility around the economy over the last week or so and what that certainly implies for certain people vis-a-vis rate movements probably only add to the positive momentum behind transactional activity.
So broadly speaking, across the real estate credit business at Apollo, the pipeline is robust, and we're looking at a lot of things, and we're going to have a pretty robust year in terms of overall deployment. And I think we remain optimistic about ARI getting paid back on the things we anticipated to be repaid this year. And as a result, we think we're well positioned to get that capital redeployed as capital comes back to us.
Great. And then finally, I wanted to touch on the dividend. The current dividend rate implies about a 10.5% ROE on book and then pro forma for the specific reserve coming on the hospital loan, it would be a little over 11% return on book, do you view that as sustainable given your outlook for portfolio returns and kind of what you're seeing on the new investment side?
I mean I think as I implied in my remarks, I think -- we're generating ROEs consistent with what we've done historically. So that feels good. I think as always, we'll handle the dividend through our quarterly discussion with the Board, which is plus or minus 5 weeks from now. I think for us, we just want to make sure we are being mindful of what the earnings trajectory looks like over time. Obviously, there's positive momentum for us as we do that and hope for some of the underperforming capital, but we might see interest rate curve environment. So a lot of factors will go into the dialogue overall. But just in terms of the ROEs we're generating on new transactions, they're pretty consistent with where they've been historically.
Our next question comes from Steve Delaney with Citizens JMP Securities.
Congrats on your full dividend coverage in a challenging market for the second quarter. My question is to piggyback Stephen, just a bit. But looking back to the first half of the year, ironically, or maybe it's by design, but your portfolio was $8.3 billion, including the subs and the seniors at year-end '23, and it's right on the same number within $100 million, it rounded at June 30. As you look forward to the second half of this year, would you think the best approach from the analysts in modeling would be to maybe stick with a kind of flattish portfolio as we look for the rest of the year?
It sounds like you are seeing opportunities that would prevent like material shrinkage, but just curious about your thoughts, can you maintain the portfolio. And given that it feels -- sorry for the long question, but I want to just have to answer one question, not two, given what appears to be more of a lender's market developing over the next 1 to 2 years beyond the second half of this year, could 2025 be a pretty active and new equity coming into CRE, what's your expectation and hope for 2025 after we get through the end of this year?
So I'd say a few things. I think your notion of 2024 sort of moving sideways in terms of portfolio side is a reasonable assumption. We'll get capital back, we'll put capital out. But there's really not a catalyst for growth per se. So again, don't give me a hard time if we're talking about [ $400 million ] in either direction, but that feels pretty good. I think sitting here today, and I'm looking at it both through the lens of what we're seeing in our real estate credit business, but also what we and others are thinking about vis-a-vis various pools of real estate equity capital.
I do think 2025 could be a pretty active year. Obviously, there's sort of an overall economic overlay around that. But if we achieve the hope for soft landing with some moderation of interest rates with the economy hanging in there. I do think there's still a lot of capital looking to be active and 2025 could be pretty busy. I think the greatest opportunity for us to be growing and more active in 2025 is around turning some of our more challenging asset management situations into resolutions, which give us back capital with which to deploy.
So if you go back to my comments, harping on getting the senior paid back on 111 West 57th because once the senior is paid back, every incremental dollar of unit sales comes back to us directly, which provides capital to put to work offensively. And then, obviously, I think everybody is around some of the other situations we're involved in as well.
That's helpful. And of course, if we get something close to a 3% Fed funds rate, I guess that doesn't do anything but help that scenario, right, for 2025?
I think you are right, yes.
Our next question comes from Jade Rahmani with KBW.
Starting with 111 West 57th, if we could just summarize the deal and ARI's position. Could you give the remaining units left to be sold at this stage?
I'd rather not be specific on the number of units, but to start the question, Jade, as I sort of indicated in remarks, we ended the first quarter with there being a $200 million senior loan in front of ARI's position. That has been paid down to about $140 million, and there's roughly another $70 million of units under contract. So we think we are in short order down to $70 million in front of us with confidence around continued sales on that front.
So the $70 million that's under contract, over what time frame will that close?
It will close during the second half of the year.
Okay. And as of the second quarter, ARI's position included $261 million of senior med and $74 million and $28 million of junior meds for a total of $363 million?
Yes.
Okay. I just wanted to make sure that was clear. Turning to the health care situation. Can you say whether this will be an REO property because it's quite complicated. The owner of the real estate is in a joint venture, 50-50, and then there was an operator. There's media reports that the operator rejected the lease. There's reports that there weren't bids on at least 2 of the hospitals and also that the rent payments are too high, complicated the situation. So I don't know there's ongoing negotiations with the state and such. But do you anticipate this will be an REO.
I think I'll refer back to what I said to, I think, was Doug's question, which is, at this point, I think you need to think about is 8 individual assets as opposed to 1 consolidated portfolio. And I think it is certainly possible that there will be differentiated outcomes for different hospitals.
Okay. And then the adequacy of the $90 million reserve, sorry to say this about the industry, but mortgage REITs don't tend to be overly conservative when it comes to reserves. Anything you could talk about as to how you got to the $90 million? I know it is about 26% of ARI's loan exposure, but any color on that?
I think the process we went through for this reserve was consistent with the process we've been through for every other specific CECL reserve we've taken.
Okay. And then on the new origination front, I've always appreciated ARI's differentiated perspective on multifamily. And so now I see 2 multifamily loans, which are refinanced loans at quite a low LTV as well. So I'm not sure if that's a future projected stabilized LTV or what the basis is, but how are you thinking about approaching the multifamily space something historically ARI has not really played in?
Yes. Look, I think the perspective at the macro level is that Long term, there is still need for and demand for high-quality multifamilies. So we like the space in general, our historic reticence with respect to multifamily has been a combination of concerns over valuations, competition in certain situations from et cetera. I think sitting here today, we've been in a window whereby on the margin. There's been for a brief period of time, maybe less competition on certain transactions we pursued, we like the long-term macro positioning of multifamily, and we found some situations that work for us.
As always, we continue to run the portfolio on a bottoms-up deal-by-deal basis. So I would not read into this any change in sort of overall thesis or a desire to create something at a certain percentage. We'll continue to look deal by deal, but for a moment in time, given the volatility in the marketplace, the team was able to source some pretty interesting opportunities. We've always had a positive macro thesis about this space. It's really been about sort of valuations at a moment in time. And how we thought about the ROEs on a risk-adjusted basis for multifamily deals versus other opportunities?
And the 2 deals in the slide deck, are these -- at least one of them in California looks like a new build, Class A, perhaps luxury, but what are you going after? Are these recently completed construction deals and you're doing the lease-up financing or...
Yes. It's new product lease-up place.
I think, Jade, the one in D.C. was recently built, I think it was like 2016. That was -- it's not a, I guess, lease-up play in the normal one, if you recall, D.C. had some pretty liberal laws in terms of -- with tenants and stuff with COVID and stuff like that. So had some disruptions with tenants in terms of evictions and things like that. That's the sponsor we've been working through. So now when it was a refinance for this, the sponsor invested substantial equity pay down the loan, and they're working on cleaning up the rent roll, if you will.
Our next question comes from Eric Dray with Bank of America.
Jade covered most of my questions. But just one, I guess, is can you talk a little bit about the opportunity in Europe and kind of what you're seeing over there in terms of the pipeline. And also, I was just curious about kind of the office trends there, most of the upcoming office maturities in your portfolio are in Europe. So any color you could kind of give on that would be interesting as well.
Yes, sure. So I'll start -- I'll go back -- I'll start with the office question. I would say, look, similar to the U.S., every market in city is a little different. I would say, thankfully, most of our exposure is in London, which continues to be one of the better tighter markets, people going back to the office. I would say the other phenomenon, if you will, in London and Europe, much more so than here in the U.S. is the importance of lead and environmentally friendly offices. It's taken much more seriously by occupiers. And so you have -- you see a real need for tenants to be in new modern green space. And at the same time, I think London is viewed as a safe place for capital. So you continue to see international capital going there. So I would say you're seeing in London, in particular, people being back in the office occupiers signing leases at the newer buildings, and you also see capital both financing is available as well as acquisitions.
Thankfully, for us, our largest office exposure is in London and it also is a long-term lease headquarters building. So we have a 20-year lease to a large financial institution as their headquarters. So that's our largest one, and that will continue to fund up over time. So that's why you're seeing our office exposure going up because that continues to fund. But obviously, we're very comfortable on that deal. But I would say generally seeing positive trends in London and other markets in Europe.
As far as deal opportunity, I would say, Europe, given [ Solvency II ] or not for other reasons, really has never had a large CMBS market or capital market that way. They did have, I would say, a much more robust corporate bond market that the REITs over there took advantage of, but CMBS really never took root. So whereas in the U.S., everything seems to be getting done by the SASB market.
That doesn't really exist in Europe. And so for us, we've really seen opportunity where you're getting the pan-European deals because they're having to go multi-jurisdictional, the banks there don't like as much. We have some good technology there, acquisition facilities in industrial or other property types and then also just larger deals where we can marry Apollo capital across vehicles, right, and basically not have a bar or not take syndication risk.
Those have all been things where we've had a competitive advantage. And then I would say, similar to the U.S., the loan on loan or warehouse financing business is very much alive in Europe. So we're able to get very attractive terms in terms of non-mark-to-market stuff, advance rate spread, so we're able to create an attractive absolute return.
And then I would say on the hedging basis, things obviously shift. I would say there's not much of a pickup right now from pound or any pickup really from pound to dollar. There does continue to be a little bit of a pickup from euro to dollar.
Thank you. I would now like to turn the call back over to Mr. Rothstein for any closing remarks.
Thank you all for participating.
Thank you. This concludes the conference. Thank you for your participation. You may now disconnect.