Apollo Commercial Real Estate Finance, Inc. (NYSE:ARI) Q3 2023 Earnings Call Transcript

Apollo Commercial Real Estate Finance, Inc. (NYSE:ARI) Q3 2023 Earnings Call Transcript October 31, 2023

Operator: I would 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 GAAP figures in our earnings presentation, which is available in the Stockholders 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.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.

Stuart A. Rothstein: Good morning, and thank you for joining us on the Apollo Commercial Real Estate Finance, Inc. third quarter 2023 earnings call. I am joined today by Chief Investment Officer, Scott Weiner; and Anastasia Mironova, ARI’s Chief Financial Officer. ARI had another quarter of distributable earnings in excess of the common stock dividend, benefiting from elevated base rates in the company’s $8 billion floating rate loan portfolio. For the first nine months of 2023, ARI reported distributable earnings prior to net realized loss on investments and realized gain on extinguishment of debt of $1.33 resulting in a dividend per share covered ratio of approximately 1.3 times. The higher rate environment continues to impact all aspects of the real estate market.

For most of the year, the dialogue has focused on the Fed’s use of short-term rate hikes to reduce the rate of inflation. However, more notable today is the recent sharp increase in five and ten year treasury rates. Over the past several weeks, the ten year treasury has neared 5%, and since ARI’s Q1 earnings call, the yield on five year and ten year treasuries has risen 139 and 126 basis points, respectively. While the market is still adjusting to this quick move upwards in longer rates, the historical relationship between cap rate and long-term interest rates would indicate that property values are biased towards adjusting downward in light of the elevated interest rate environment. In addition to rates, uncertainty with respect to the short and medium term trajectory of the economy is also weighing on valuations.

Recent earnings reports from bellwether companies have been mixed. The employment market remains robust and the Q3 GDP print was actually quite strong. However, there have been multiple other measures of economic activity that indicate the economy is in fact slowing. As such, the narrative around commercial real estate remains focused on underlying property valuations, borrower’s ability to refinance and the potential impact on property level operating performance, if in fact, the economy is slowing and moving towards a potential recession. While the debate within the industry on these topics continues, the general sentiment around the industry remains bearish. Until such time that rates are perceived as somewhat stable, and valuations adjust accordingly, we expect that transaction volumes will stay well below prior levels.

In light of this backdrop, ARI strategy and focus have remained consistent throughout 2023 with an emphasis on active balance sheet and asset management. Year-to-date ARI has received $1 billion from loan repayments, including $286 million in the third quarter. Of the $1 billion approximately $520 million was from the full repayment of eight loans in the portfolio, a $140 million came from asset sales and the remainder mostly reflects partial pay downs from borrowers in exchange for extensions in loan term. We continue to have a productive dialogue with our borrowers many of whom are some of the largest and most well capitalized real estate sponsors in the world. Their willingness and ability to support their properties has led to constructive conversations for loan modifications and extensions.

Importantly, we have dealt with the near-term maturities in our office loan portfolio with no significant office maturity until 2025. As a reminder, office loans make up only 19% of ARI’s portfolio with more than half the loans secured by properties in Europe, where we are seeing better operating fundamentals across the asset class. Beyond office exposures, the credit quality of ARI’s portfolio remained stable and during the quarter ARI did not record any incremental asset specific CECL reserves. With respect to the Steinway project, during the quarter, ARI received $45 million from condo sales. At present, there are additional units under contract that we expect will close in the coming months. More importantly, there is an active dialogue, including contract negotiation on another handful of units, and consistent foot track on a weekly basis.

While there is still much to be done, we are encouraged by the recent level of interest and activity. Shifting to the right side of the company’s balance sheet, in October, ARI utilized on hand liquidity to repay the remaining $176 million of principle of the convertible notes that matured at par. ARI ended the quarter with approximately $480 million of total liquidity, which we believe provides ample cushion to manage a range of economic outcomes in the broader macro landscape as well as have dry powder to capitalize on interesting or unique opportunities that ARI has the benefit of seeing as part of the broader Apollo platform. With that, I will turn the call over to Anastasia to review our financial results.

Anastasia Mironova: Thank you, Stuart, and good morning, everyone. ARI produced another consistent quarter of financial results in Q3, with distributable earnings of $52.7 million or $0.37 per share. We declared a common stock dividend of $0.35 per share, which translates to an annualized dividend yield of approximately 15% used in yesterday’s closing price. GAAP net income available to common stockholders was $43 million or $0.30 per diluted share of common stock. ARI’s portfolio ended the quarter with an amortized cost basis of $8 billion and the weighted average unlevered yield of 8.9%. During the quarter, we funded $97 million of add-on fundings from previously closed loans and received $286 million in loan repayments, including $170 million of full repayments across four transactions.

There was no incremental specific CECL allowance taken during the quarter. General CECL allowance declined by $5.8 million and stands at 40 basis points of the loan portfolio’s amortized cost basis, as of September 30. The decrease in the general CECL allowance is primarily attributable to loan repayment activity outpacing fundings and overall portfolio seasoning. Our total CECL allowance as of September 30 is a 274 basis points of the loan portfolio’s amortized cost basis, four basis points increase compared to June 30. ARI’s book value per share excluding general CECL reserves and depreciation was $14.74, relatively flat to last quarter end. With respect to ARI’s borrowings, we are in compliance with all covenants, and continue to maintain strong liquidity.

As Stuart mentioned, ARI repaid the $176 million of convertible notes that came due in October with cash on hand. With this repayment, our next corporate debt maturity is not until 2026. At the end of the quarter, we had $805 million of unencumbered real estate assets and $480 million of total liquidity. Total liquidity comprised of cash on hand, cash proceeds held by the servicer and undrawn credit capacity on existing facilities. Our debt to equity ratio at quarter end was 2.8 times. And with that, we would like to open the line for questions. Operator, please go ahead.

See also 12 Best Free Accounting Software in 2023 and 25 Most Generous Countries in the World.

Q&A Session

Operator: [Operator Instructions] Our first question comes from Sarah Barcomb with BTIG. You may proceed.

Sarah Barcomb: Hey, everyone. Thanks for taking the question. I was hoping you could talk about the opportunity set that’s out there to put money to work given liquidity is looking good. There weren’t meaningful risk migrations during the quarter, maybe opportunities in your own capital structure or in the new loan origination market?

Stuart A. Rothstein: Yes, look, I would say, Sarah, to be fair, over the last four weeks, plus or minus, I would say we’ve been earnest started, looking at opportunities that might work for ARI and are actually, sort of actively thinking about things for ARI. I would say at a high level, as we think about opportunities for ARI today, I think there are things broadly speaking in the U.S. that would be, sort of, in the sulfur plus call it, four to mid fours range in property types. There’s industrial, there’s hotel, some construction maybe though not likely and certainly no office exposure. I would say similar type of opportunities potentially in Europe. As a firm, broadly speaking, year-to-date, we’ve probably done close to $6.5 billion to $7 billion worth of commitments.

So we’re in the market on a daily basis and certainly have a sense of where things, are available to us. And I would say the change over the last four weeks or so have been less about what’s taking place in terms of opportunities and us getting a little bit more comfortable in terms of where we are both in terms of the existing portfolio and the liquidity profile on a go-forward basis.

Sarah Barcomb: Okay. Thank you. And then we’ll see what happens at the at the Fed meeting this week, but currently the forward curve is calling for a bit of a pivot in the first half of next year. I’m just curious how your outlook for those one to three rated assets, the stronger credits in your portfolio. How does your outlook for those change, if we are in the hire for longer camp and we see so far stay at these levels for longer next year?

Stuart A. Rothstein: Yes, I mean, I think, as we think about the world, it’s almost in some respects less about the shorter end of the curve and more about some stability at the longer end of the curve. If you think about this year during the first half of this year, there was a pretty robust fixed rate financing market around 6% when the five year was lower than it is today and people felt like things had, sort of, were range bound in some respects, that shifted a bit, given the move upward in the, call it the medium to long end of the curve. I think from our perspective, as I think about transaction activity, capital coming back into the market, people getting more confident around what cap rates or valuations may be. It’s more about some level of confidence that the five to ten year is somewhat range bound, and then people can start underwriting, valuations around those levels and think about what financings are at those levels.

So, not to dismiss what the impact of a Fed move may or may not be on the, sort of, the short-term volatility in the market. I think what the market is actually looking for from a real estate perspective, it’s some sense that rates are sort of, on the five to ten year level range bound. And then people can start looking to historical relationships between the cap rates and five and ten year treasuries as they think about value.

Sarah Barcomb: Thanks for the comments.

Stuart A. Rothstein: Sure.

Operator: Thank you. Our next question comes from Stephen Laws with Raymond James. You may proceed.

Stephen Laws: Hi, good morning. Appreciate the breakout on the office metrics and Stuart, your comments about the over half your exposures in Europe. Can you spend some time talking about the difference in the two markets, kind of at a higher level, but also maybe the difference within your portfolio, is it lower attachment points in Europe? Is it something different inside the loan outside of just the larger macro environment around better work in the office trends in Europe?

Stuart A. Rothstein: Yes, look, I think the high level comment or the obviously the biggest factor from our perspective is obviously just the use case for office space in Europe versus the U.S, right. There’s no, there’s not the same debate in Europe in terms of return to office that we’ve experienced here in certain markets in the U.S. I think the other thing I would say about Europe is that, unlike the U.S. where there is clearly a transition going on between what we would traditionally call the legacy gateway city markets to other markets that may be more in favor long-term due to cost of living, tax policy, etcetera. I think the markets in Europe are still the markets in Europe that we are sort of are the bellwether markets.

We’ve tended to stick to the major markets, in Western Europe. And then I think the other thing that is relevant in Europe that really impacts the viability of an asset, and furthers the need for more modern assets is the much more serious impact of ESG around leasing concerns, financing concerns, equity concerns in Europe that exists here in the U.S.

Stephen Laws: Appreciate those comments. And as a follow-up, I wanted to switch over to the REO assets. Can you talk about the outlook for those from both the timing of potential resolutions, but also seasonality and how we should expect to see any seasonal impacts in the coming quarters?

Stuart A. Rothstein: Yes. So, start with the DC Hotel. As you’ve heard me say on prior earnings calls, the performance of the hotel for this year has, well exceeded expectations and the hotel is performing at levels in excess of where it was performing pre-pandemic. We continue to remain optimistic about the performance of the hotel looking out to next year as we start to go through the budgeting cycle and forecasting cycle for next year. That being said, there’s certainly some seasonality component around the hotel. Obviously, right now, we’re at a one of the slower periods of the hotel. There’ll obviously be a pickup around holiday time. Then you’ll get a slowdown in the early part of next year, and then it will ramp through the spring and summer tourist season.

But very encouraged by the performance of the DC Hotel. I would say the Atlanta Hotel performance has improved, but it is not improved at the same rate as we’re seeing in the DC Hotel. I think as you all know from my past comments. That is a hotel that historically was a little bit more based on business as well as convention traffic flow. That being said, we have continued to remain in dialogue with a couple of potential parties around, the sale of the hotel, certainly no guarantees that a sale of the hotel occurs, but I would say the dialogue we’re having around the hotel certainly gives us confident with respect to where the hotel is marked in our portfolio at this point. And then obviously only other REO asset is the development in Brooklyn, which continues apace, but that will be a multiyear process to get that hotel built and then leased up but it is moving along nicely at this point.

Stephen Laws: Great. Appreciate the comments this morning Stuart.