Apollo Commercial Real Estate Finance Inc
NYSE:ARI
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Apollo Commercial Real Estate Finance Inc
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Good morning. My name is Tasha, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Q4 2017 Apollo Commercial Real Estate Finance, Inc. Earnings Conference Call. [Operator Instructions]. 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 and are reconciled to GAAP figures in our earnings press release, which is available on the Investor Relations section of our website. We do not undertake any obligation to update our forward-looking statements or projections unless required by law. To obtain copies of our latest SEC filings, please visit our website at www.apolloreit.com, or call us at 212-515-3200.
At this time, I'd like to turn the call over to the company's Chief Executive Officer, Stuart Rothstein. Please go ahead.
Thank you, operator, and good morning to everyone joining us on the call this morning. Once again, joining me in New York is Jai Agarwal, our CFO.
2017 was a record year for ARI, highlighted by the origination and funding of over $2 billion of investments. Our ability to continue to source attractive investments via reliable, strategic and creative source of financing for our borrowers and to raise accretive growth capital resulted in ARI once again delivering successful operating results and strong returns for our stakeholders. I am pleased to report ARI's total return to common stockholders in 2017 was 22.4%.
During the year, ARI closed 28 loan transactions. 69% of the loans closed were first mortgages and 92% of the total originations had a floating interest rate. At year-end, ARI's loan portfolio held 59 loans totaling $3.7 billion with a weighted average all-in yield of 9.1%. Importantly, 88% of the loans in the portfolio had floating interest rates and the portfolio had a remaining weighted average term of 2.8 years.
As detailed in the press release, ARI sold the remainder of the company's CMBS portfolio in Q4. CMBS has become less of a core focus for ARI, and we have found the risk-return profile less compelling than investing in commercial real estate loans, coupled with the volatility to book value caused by the quarterly mark-to-market of the bonds. We felt it was the appropriate time to simplify our investment portfolio and free up the remaining equity allocated to CMBS for redeployment into commercial real estate loans. I would like to highlight that since ARI's inception in 2009, the company's investments in CMBS have generated a levered IRR of approximately 12%.
Shifting now to the other side of the balance sheet. ARI had a very successful year with respect to capital formation and diversification. During 2017, we focused on expanding ARI's capital sources and optimizing the balance sheet, with a focus on diversifying our financing providers, extending the term of the company's debt when possible and lowering ARI's overall cost of capital. In the fourth quarter, we reopened our 4 3/4% convertible notes and issued an additional $115 million of notes, bringing the total outstanding to $345 million. In addition, we closed a new $300 million financing facility for our first mortgage loans with Goldman Sachs, providing ARI with increased capacity to fund our investment pipeline. As we look to the year ahead, we remain optimistic with respect to ARI's business model and market position. Since January, ARI has already closed an excess of $350 million of new investments and our pipeline remains healthy. Importantly, we estimate over $250 million of future fundings scheduled for 2018, which will help counterbalance loan repayments during the year. The continued increases to LIBOR bode well for our portfolio as 88% of the loans have floating interest rates. We believe the combination of our platform, pipeline and financial flexibility will enable ARI to continue to provide a well-covered attractive dividend to our investors in 2018.
And with that, I will turn the call over to Jai to review our financial results.
Thank you, Stuart, and good morning, everyone. For the fourth quarter of 2017, our operating earnings were $13.8 million or $0.12 per share, which reflects the realized losses and costs associated with the sale of our CMBS portfolio. Adjusting for these items, our operating earnings were $53.3 million or $0.49 per share as compared to $42.2 million or $0.51 per share in 2016.
GAAP net income for the same period in 2017 was $34.3 million or $0.32 per share. This compares to $49.7 million or $0.60 per share in 2016. As noted in the press release, earnings for the fourth quarter includes $3 million of prepayment income in connection with the repayment of four mezzanine loans against one of our larger New York City condo construction projects. A reconciliation of operating earnings to GAAP net income is available in our earnings release in the Investor Relations section of our website.
You will notice that we started to disclose risk ratings for each loan in our portfolio. The ratings are on a scale of 1 to 5 and will be reviewed quarterly. This is designed to highlight credit transfers in the portfolio and to provide a framework to assess credit risk. At year-end, the weighted average risk rating was at 3.0. Given the transitional nature of our lending business, most loans in the portfolio are assigned a rating of three at closing. Consequently, we will only report loan-to-value, or LTVs, when loans are originated and will no longer disclose the weighted average LTV for the entire portfolio at quarter-end. As the LTVs reported were from the date the loan was originated and not updated to reflect the positive or negative trends associated with the underlying property, we felt that it was not a meaningful metric in assessing ongoing credit risk in the existing portfolio and that the newly implemented risk rating system provides a better framework.
With respect to leverage, we ended the quarter with a 0.9x debt-to-common equity ratio. During the quarter, we terminated the remaining CMBS facility with Deutsche Bank and entered into a new $300 million facility with Goldman Sachs to fund first mortgage loans. As of today, we have over $500 million of capacity on our secured debt facilities.
Turning to book value. Our book value per common share was $16.30 at December 31 compared to $16.36 at the end of Q3 and $16.12 at Q4 2016. I wanted to highlight that the accretive issuance of both the common stock and the convertible notes during the fourth quarter helped offset loss from the sale of the CMBS portfolio. Going forward, we anticipate book value to be less volatile following our CMBS sale.
Finally, I wanted to highlight our dividend. Based on Wednesday's closing price and our recent dividend run rate of $0.46 per quarter, our stock offers an attractive 10.3% yield. And for the Tax Cuts and Jobs Acts of 2017, individual investors now receive the benefit of a 20% deduction on ordinary REIT dividends. Our board will meet again in mid-March to discuss the Q1 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]. Your first question comes from the line of Ben Zucker from JMP Securities.
First of all, I appreciate the new risk rating disclosure in your earnings supplement. That's very helpful, so thank you for that. I guess, from a big picture, can you guys comment just on the current market environment and borrower sentiment? Obviously, tenure keeps marching higher and I'm just wondering if that's impacting demand at all, negatively or positively, because, I guess, it could be pulling some business forward. So just curious what you guys are seeing and hearing out there right now.
Yes. I mean, I think at a high level, Ben, there hasn't been a dramatic shift in either direction. I think there's clearly a healthy level of activity. Folks are still active. I think you are probably right that on the margin, if you were thinking about refinancing something sometime during this year, you're a little bit more focused on thinking about it now, keeping in mind that most of what we do these days is more LIBOR-based as opposed to fixed rate tenure based. So I think, on the margin, you might be seeing a little of that. But generally speaking, I would describe the market as sort of status quo in terms of healthy level of activity, clearly competitive on the borrowing side. So I would say still biased towards the borrower versus the lender in terms of attractive financing options. But overall, nothing dramatic or nothing sort of headline in terms of an overreaction, one way or the other, given what's gone on with rates recently.
Well, that's definitely helpful. Thinking about your financing sources. As I'm sure you're aware, some of your peers that also target the large loan segment have recently tapped the floating rate CLO market. And I don't think we've seen you guys use the CLO or CMBS market as a financing tool yet. I was wondering if this is something you guys might look to take advantage of in 2018 and are your loans good collateral for these types of products, in general?
I mean, look, we certainly engage in an active dialogue with those who would be the likely underwriter of a CLO. If we chose to go down that path, I think the executions by our competitors, certainly from a headline perspective, have been impressive. I think if you actually dig into the all-in cost of what that debt is actually costing someone, I don't think the headline numbers actually reflect the overall cost of the financing. And I think when you look at the overall cost, the difference between that cost versus our repo borrowings today is not that dissimilar, to be honest with you. I also - while I think we have initial collateral that would work in a CLO financing, again, the CLO financing, in some respects, is more attractive the longer you think your loans are going to be outstanding. And with an average book of, call it, 2.5 to 3 years, if you get surprised on the repayment side, the all-in cost of that financing actually goes up. So we look at it.
We're engaged in active discussions on it. I think we do have collateral where it's a viable option. But I wouldn't be - I'd be overreaching if I said we will do a CLO at some point in 2018. I think, again, it's one of several options we're looking at and just sort of engaged in dialogue at this point.
Okay. Well, that's helpful. Maybe turning quickly to the pace of capital deployment. I appreciate your comments about the future fundings of over $250 million that you guys had at year-end. But based on the subsequent origination data provided, it looks like there's an - like a - now an additional $300 million-plus of future funding commitments that aren't captured in your funding schedule on Page 12 of the deck. I'm just curious if you guys would be willing to throw some thoughts out as to when these subsequent originations might fund just given the magnitude of the future funding commitments they have created. And maybe you could provide this on an annual basis, understanding that this is just your best guess and very hard to predict on a quarterly basis.
Yes. Obviously, what we provided, it was what we feel highly confident about for this year. The magnitude that you referred to, $300 million, is sort of what is planned for beyond the scope of this year. And again, as we're doing on the margin more construction lending, the timing is a little uncertain at this stage. But I think, following up on the call, I think we can certainly provide a little more dialogue and a little bit more color in terms of annual expectations just to give you a sense of when we think that capital is going to go out.
Great. And maybe lastly, if I can. Real quickly on that multifamily loan in North Dakota. I was just wondering if your outlook for that asset has changed or maybe even improved at all. I think crude prices are up a bit since the last earnings call and think the rig count is almost double in the area what it was when you first took that loss provision in 2016. So I was wondering how things are looking from your seat right now.
Yes. Look, I think on the margin, our outlook's improved. I don't want to get - paint too rosy a picture. But yes, oil sort of in this $60 a barrel range has certainly been reflected in the Williston economy. I think in terms of our particular collateral, I think, on the multifamily asset, which is 330 units, occupancies are now steadily running above 90%. And I think that's consistent with the multifamily market in Williston, in general. Rents have still not moved much, but I would say there's just generally a stronger tone on the multifamily leasing side. And then on the 36 single-family homes that were part of the rental pool, we have sold four of them. Another four are under contract. And I would say, to be able to do that in the winter months in Williston, actually, leaves us somewhat optimistic about what the spring will be.
And I think the more progress we can make on selling those single-family homes, it probably just puts us further down the path of then being able to think more realistically about perhaps monetizing some of the excess lots, both finished and unfinished, that we have as collateral. So yes, I would say there's generally a better tone to Williston. I think to the extent you read what's written in the media about job growth, rig count, it's clearly got a better tone to it. To be fair, I think we're still in that asset for the long haul, but I think there's a better tone and I think selling the single-family homes, I think, is the appropriate strategy for us just to continue to sort of amortize our position down. So generally, a little bit better in terms of where we were, call it, 12 to 18 months ago.
Great. Well, appreciate all your comments, Stuart, and congrats also on getting rid of the CMBS portfolio. I think the income statement will be a lot simpler going forward without looking at those marks.
[Operator Instructions]. Our next question comes from the line of Jade Rahmani from KBW.
I was wondering if you could comment as to your expectations this year in terms of mix between first mortgages and mezzanine loans?
It's always a little bit tough to predict, Jade, just because we don't go into the year with any preconceived plans, so to speak. We very much look at it on a deal-by-deal basis. I think that being said, given our increased size, given our ability to be a little bit more in control of situations as we're pursuing transactions, and also given some of the relationships we have formed with, I'll call them, partners both in lending as well as those who lend capital to us, I do think it'll be a little bit more weighted toward the first mortgage side of things, which, if you - as you know, if you look at the trend over 2017 and the early part of 2018, that's sort of been where the portfolio has been moving, and I think you'll see that trend continue.
And as a result, should we expect your leverage expectations to increase?
Yes. Look, I think we're - right, if you just took it from a purely theoretical perspective, if we were 100% first mortgages, we'd be about two turns levered as an entity. And if we were all mezz loans, we'd have zero leverage. Today, I think we're right around 1x debt to equity. Oftentimes, we've said we're very comfortable at running the company at, call it, 1.5 turns of leverage. We've never actually approached that. But I do think the natural trend, consistent with doing more first mortgages, would be some incremental leverage in the company.
Can you comment on where incremental yields are or perhaps spreads are on first mortgages and mezzanine loans distinctly? I think that compared to other commercial mortgage REITs, your incremental spreads seem a bit higher than what we had been projecting.
Yes. Look, I think a lot of it depends on what you're actually lending against. And obviously, a first mortgage on a construction project or heavy redevelopment project is going to have a different and higher return than some sort of more stabilized asset or one where there's, at least, perceived to be less risk in the execution of a business plan. I think what we announced in the - for the fourth quarter of 2017 and what we've done in the first quarter of 2018, I don't think there's been a lot of movement in spreads, so to speak, in terms of what we've been able to do. But I do think, if you looked at the market broadly, it's probably 25 to 50 basis points tighter for first mortgages generally and that tends to be driven more up by what's perceived as a little bit more stable or a little bit less risky.
I think on the mezz side, again, it's deal-by-deal but there's certainly more competition in the world today, not to say there hasn't historically been competition. But again, I think that competition is 25 to 50 basis points on a transaction, no more than that. And again, I'll remind you and everybody else listening, right, at the end of the day, our business is finding things where we're comfortable with the risk-adjusted return, and we might be able to get paid a little bit more because we've been able to figure things out from a structuring perspective, been able to dig in on the diligence side and get comfortable with what the true risk is and what the business plan execution will be. And I think to the extent your view is that we're generating slightly higher spreads on what we're doing, I think it's - because, at the end of the day, we're still just trying to find, in a fairly large market, a handful of transactions where we think we can generate excess return by being a little bit more creative on deal structure.
In terms of your originations so far this quarter and just looking back historically, quarterly fundings average something in the $300 million to $400 million range and there were a few outsized quarters but a couple of quarters where fundings dipped to $150 million. And you did disclose so far only $51 million of fundings and $84 million of repayment. So should we expect fundings to pick up in the second half of this quarter? Or do you expect 1Q to be a lag and perhaps earnings run below the dividend and then to reaccelerate later in the year?
Again, sort of my standard refrain. The portfolio is definitely lumpy. Deals sort of have a life of their own, and ultimately, you're talking about private placements that are tied to legal work, diligence work and everything sort of coming together. That being said, if I look at our pipeline now and what I expect to happen between now and the end of the first quarter, there are some things that are fairly lumpy that I would expect to happen between now and the end of the quarter. That will, I think, quickly get the numbers back in line with what you're historically used to seeing. But then I'll just add my standard disclaimer that I think it's pretty tough to think about this business on a quarterly basis.
And can you comment as to whether the $45 million urban retail Miami deal with the January 2018 maturities, did that repay as scheduled? I think it was still in that table showing your - each one of your loans.
Yes, it repaid.
Okay. So that's no longer outstanding?
Correct.
And then, could you also just provide an update on the Liberty Center retail loan in Ohio, which you guys have as a - rated as a four?
Yes. I mean, operationally, again, it's, call it, a low 80s percent leased asset. It is covering debt service but not by a wide margin. I think there are - there's still work to be done in terms of the leasing and overall marketing strategy. And I think given the size of the asset and given where retail may or may not be headed in this country, I think it's one that we spend a lot of time focusing on from an asset management perspective. I think there's some interesting conversations going on that could change our view. But at this point, I think it is one - the four is reflective of something that is very much on the radar screen, work still to be done, and we'd like to see a little bit more leasing progress and a little bit more leasing success as we move through the year and one - I think it's one that we'll be monitoring closely from an asset management perspective throughout the year.
[Operator Instructions]. Our next question comes from the line of Rick Shane from JPMorgan.
This is Melissa Wedel for Rick Shane today. A follow-up question on the unfunded commitments. As we think about that capital mean deployed, is it fair to think about that as previously unfunded commitments being funded this quarter, would receive kind of the old spread and pricing versus a more compressed spread that we may be seeing in the current environment?
That's right.
Okay. And then as you go forward with new business, are you altering your origination parameters at all given the sort of evolving risk-reward prospects and spreads in CRE generally?
I mean, I think, again, back to my earlier comments, we've certainly done more that puts us senior in the capital structure. I think if - you'll see some things later on this year where I think we'll probably, on certain large transactions, will move higher in the capital structure, lower in terms of nominal loan-to-cost or loan-to-value at the time we originate something. But I don't want to draw too many bright lines in the sense that fundamentally, the business is about looking at things from very much a granular bottoms-up perspective and seeing if we could find a place in the capital stacked on any transaction where we think we're being paid appropriately for the risk we're taking.
I think that generally speaking, our originations today is reflective of the fact that we are nine years into our recovery cycle, which is certainly long-dated. But it's equally reflective of the fact that overall economic activity is actually very strong and that is being reflected in the operating performance of a lot of the assets that we are either looking to lend against or are which the - or which are the logical comps for the assets that we are willing to lend against. So I think it cuts both ways and I think we're just trying to make sure that whenever we're looking at transactions, our underwriting and our analysis is reflective of what we perceive to be both the most current as well as the most relevant information to the situation at the time.
Okay. I guess, just to follow up on that. As you look at the operating environment over the next couple of years, are you assuming any moderation in sort of the macro tailwinds that you're seeing? Or are you assuming a more persistent economic environment?
I think to the extent we're able to look out two years, I think we've always taken a fairly - and this goes back even 4, 5 years ago, I think we've always been fairly pessimistic in terms of where cap rates go, where residual values go, where prices per square foot go, where prices per key go. So I think we retain our skepticism and pessimism, which I think we're supposed to do as lenders. But I don't think that view has gotten any more negative in terms of what's going on right now. I think it's generally consistent with the approach we've always used historically because in some respects, it feels like, at least for the last three years, we've been talking about the fact that this is a long-dated recovery and we need to be thoughtful about how quickly things might change.
Our next question comes from the line of Jade Rahmani from KBW.
The Bethesda, Maryland condo project matures in April. Could you just give an update on your expectations there?
Yes. I think it's unrealistic that we're getting paid off in April. I think if you'll recall, at the time we took the impairment, this is a 50 condo unit project. I think there were roughly 24 or 25 unsold condos at the time we took the impairment. Today, we're down to 17 unsold condos. So again, chipping away at it sort of unit-by-unit, continue to be, generally speaking, pleased with the reaction of those who come in and tour the project. I think the challenge at the asset is really about getting more foot traffic in because I would say the hit rate has actually been pretty good, both in terms of price paid and success in getting people to step up when you - when we actually get the right level of foot traffic. But I think this is going to be one that we sort of just chip away at throughout the year.
And within the 17 remaining, is there concentration? Like, what's in a handful of units at an extreme price point that would be prohibitive and cause the project to last a lot - longer than 2018?
I don't think there's a concentration. I'd make a general comment that on par, the project was a mix of two and three-bedroom units. I think on par, there's more three-bedroom units left than two-bedroom units. So on the margin, slightly higher price point, but it's not as if there's a bunch of value in our remaining penthouse or anything like that. It's all from a price per square foot perspective and nominal dollar value, all within a reasonable range. But if you gave me my choice, I'd rather have more two-bedroom units than three-bedroom units. That's not where we are at this point in the life cycle of the project.
And looking back historically, I was wondering, do you happen to have a date available as to what percentage of your loans extended at maturity or refinanced with you versus a simple payoff?
I don't have it at my fingertips, Jade, but we can certainly pull it together and follow up post call.
There are no further questions at this time. I'd now like to turn the call over to Mr. Stuart Rothstein for any further comments.
Thanks, operator, and thanks everybody for participating this morning.
Ladies and gentlemen, this concludes today's conference. Thank you for your participation. Have a wonderful day. You may all disconnect.