Apollo Commercial Real Estate Finance, Inc. Q3 FY2020 Earnings Call

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 to your attention to the customary safe harbor disclosures 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 still 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 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.

Thank you, operator. Good morning, and thank you for joining us on the Apollo Commercial Real Estate Finance Third Quarter 2020 Earnings Call. Joining me this morning is Jai Agarwal, our CFO; and Scott Weiner, the Chief Investment Officer of our manager. We hope that everyone listening continues to be safe and healthy as we all continue to navigate the challenging circumstances of the global COVID-19 pandemic. Before my comments with respect to ARI, it is worth spending a few minutes on what we are seeing in the market overall. Since our last earnings call, there has been a modest uptick in the overall level of commercial real estate transaction activity. Real estate has traditionally been a lagging indicator. And as such, the long-term impact of the pandemic-driven economic slowdown on the commercial real estate is evolving slowly. Consistent with the broader capital markets, we believe that at present, there is ample liquidity in the real estate market. Real estate private equity funds are seeking to deploy record levels of dry powder while at the same time, banks, insurance companies, credit funds and other real estate lenders are open for business as capital searches for yield in a low rate environment. It is also worth noting that the extremely low interest rate environment is enabling property owners that might be considered likely sellers to continue to cover debt service and play for time with respect to their assets. Even with excess capital in the system, transaction activity is recovering at a modest pace as potential buyers and sellers work through the process of price discovery, which continues to be affected by unknown timing with respect to the end of the pandemic, varying views on the potential long-term impact to various property types and the potential for elevated market volatility around the upcoming election. At this point, we believe the ultimate pace and path of the recovery will continue to be very much linked with the overall recovery of the overall economy. It is fair to say that 6-plus months into the pandemic, there are strong views emerging with respect to a few property types but in general, market uncertainty and differing views remain around most asset types and geographies. Ultimately, as we have always done, we will continue to take a bottoms-up approach to working through potential new transactions and addressing asset management issues. Turning to ARI's third quarter results. The company had another solid quarter as earnings covered the $0.35 per share of common stock dividend, while we continue to preserve excess liquidity and maintain a thoughtful approach to evaluating new investment opportunities. Consistent with my prior comments, as we evaluate originating new loans, we measure that opportunity against the value we see in the current price of our common stock, which has been trading at approximately 60% of book value. As such, during the third quarter, we repurchased over 5 million shares of common stock and subsequent to quarter end, we repurchased an additional 3 million shares, bringing our year-to-date total investment in common stock repurchases to $119 million, representing 13.8 million shares repurchased. With respect to the portfolio, conversations with our borrowers and equity sponsors generally remain constructive. Our borrowers are predominantly sophisticated, well-capitalized institutions, and our ability to partner with them and offer well-structured capital solutions will continue to benefit us as we get to the other side of this pandemic and markets normalize. Our near-term strategy for ARI continues to emphasize ensuring adequate liquidity, fortifying the balance sheet and opportunistically investing capital. Our efforts are greatly enhanced by the management and expertise brought to ARI from the broader Apollo platform and specifically from the commercial real estate debt team, which has continued to be active in the market. With respect to liquidity, ARI ended the quarter with over $450 million of cash and undrawn credit capacity in addition to over $1 billion of unencumbered loan assets. The balance sheet remains strong with our nearest corporate debt maturity in the third quarter of 2022 and healthy ongoing dialogues with our bank lenders. In terms of investing, I mentioned that our commercial real estate debt team is in the market, looking at opportunities, and we will continue to consider transactions that offer attractive risk-adjusted returns while also continuing to consider the economic benefits of repurchasing our stock or other parts of our capital structure. It is also worth noting that some of ARI's investable capital is being invested into previously closed attractive investments, which have future funding components. As a result, we have the benefit of known uses of capital within the portfolio, and we are not forced to be overly aggressive in pursuing new loans. Year-to-date, we have invested $343 million through future funding with approximately $100 million of that invested during the third quarter. As always, all potential future uses of capital will be evaluated with a focus on maximizing shareholder value. Before I turn the call over to Jai, I again want to take a moment to thank the entire team focused on ARI who have worked tirelessly and have shown immense dedication and determination in unprecedented circumstances. This is our third earnings call from home, and our team continues to work seamlessly. Given our excess liquidity and low leverage, our strong borrower and lender relationships and the power, scale and expertise of the entire Apollo platform, we believe ARI is well-situated to navigate whatever lies ahead and we'll continue to communicate to our fellow stockholders when the situation warrants it. And with that, I will turn the call over to Jai to review our financial results.

Thank you, Stuart. For the third quarter, our operating earnings, excluding realized loss on investments, were $53.9 million or $0.36 per share of common stock. GAAP net income available to common stockholders was $46 million or $0.31 per share. Our dividend payout ratio for the quarter was 97%. GAAP book value per share prior to the General CECL Reserve was $15.30 as compared to $15.14 at the end of the second quarter. This increase was primarily related to the accretive share repurchases Stuart mentioned earlier. Our General CECL Reserve decreased $5.8 million quarter-over-quarter and our total CECL reserve now stands at 3.6% of our portfolio. This decrease was primarily related to an improved outlook on macroeconomic conditions compared to our last review in July. At quarter end, our $6.4 billion loan portfolio had a weighted average unlevered yield of 6.2% and a remaining fully extended term of just under 3 years. Approximately 90% of our floating rate U.S. loans have LIBOR floors that are in the money today with a weighted average floor of 1.48%. During the quarter, we sold a GBP 97 million mortgage loan secured by our only residential-for-sale property in London to a third party at 99.5% of par. In addition, we refinanced a $68 million New York City condo construction mezzanine loan into a mortgage loan of the same amount. This loan was subsequently financed for $44 million in proceeds. And lastly, with respect to our borrowings, we are in compliance with all covenants and continue to maintain strong liquidity. As of today, we have $334 million of cash on hand, $19 million of approved and undrawn credit capacity and $1 billion in unfinanced loan assets. And with that, we'd like to open the line for questions. Operator, please go ahead.

Our first question comes from Doug Harter with Crédit Suisse.

Just wanted to touch on the last point. You brought up about liquidity. You guys have been effective at deploying it into share repurchase. How do you view your excess liquidity position today? How much more of that could you use versus how much do you kind of need to hang on given the ongoing uncertainty?

I mean I think it's fair to say, Doug, that given where we sort of are today, given Jai's most recent comments, I think we're generally around the range that we want to be in. It's fair to say we also have information on what we might expect to get repaid either through a refinancing or through the sell-down of a specific asset. So we'll, at various times, be call it, slightly on either side of that as we might be anticipating events. And if we're confident of capital coming in, we might get a little lower on the liquidity front. But I think given where we are today, given Jai's comments about not just the end of the quarter, but sort of a more current update, I think we're generally in the range where we want to be from a liquidity perspective going forward.

And I guess around that, can you just give us an update as to kind of, I guess, where you stand on deleveraging your credit facilities? Kind of how you're thinking about how those might trend in the next several months?

Yes, there are currently no significant discussions that raise concern. We maintain regular communication with all the banks and strive to stay proactive in these discussions. I don't anticipate any significant developments in the next few months. There may be minor adjustments, but nothing that would substantially alter our approach to managing liquidity at this time.

Our next question comes from Steve Delaney with JMP Securities.

Good work on the buyback. The thing, I guess, that jumped out of the deck the most for me in the quarter was the drop in the weighted average loan yield to 6.2% from 6.7% at June. So I was just wondering, Stuart, if you could comment on that in terms of the primary drivers. Were they nonaccruals, modifications, loan sales? What was primarily going on there?

At a high level, the main factors contributing to the changes were some loan modifications, especially related to one or two of our larger mezzanine loans. We believe this approach was appropriate considering our focus on long-term returns and protecting our principal. Modifications were the primary issue, with a minor contribution from some loan sales, including one substantial loan sale in Europe.

Regarding the loan sale of the London residential property, when we observed the decrease in the CECL reserve, the initial thought was that this might be related to that. However, based on Jai's comments, it seems that the reasoning was more about macro modifications. Could you provide some clarification on this? Was it a combination of both factors?

No. It's for the most part, macro factors. Obviously, shorter duration works one way, changing path of the economy work the other way. But specifically to the asset you referenced, we've always been, I would say, fairly comfortable in terms of where our position was in this asset in terms of being principal protected. And it was really sort of in again, being in the market an opportunistic ability to sell down some exposure that was the right decision for the company.

Got it. And to wrap up, I have one last question for Jai. There seems to be some confusion in the market since the beginning of the year when the CECL reserves increased. For companies that report a core or operating EPS like yours and many of your peers, it's unclear when actual realized losses or impairments will impact operating EPS. We've also heard that the SEC might require that any definition of core operating reflects CECL. This adds to the confusion, which may worsen. Jai, could you share any insights for investors through the analyst community regarding when core or operating EPS will be impacted by real credit issues or losses?

Yes. I believe there will be more developments on this topic in light of the SEC's recent stance. What has occurred in the past may not necessarily indicate future actions. I expect that more companies will update their definitions. However, we do not have core earnings because there is no incentive fee involved, which may set us apart from others who do have an incentive fee and where core earnings are defined by the management contract. Overall, I anticipate more information on this issue in the fourth quarter as we collaborate to determine the best way to report it.

Our next question comes from Jade Rahmani with KBW. In the past, what has happened may not necessarily predict the future. I believe more companies will change their definitions. However, we do not report core earnings as we do not have an incentive fee. This could differentiate us from others that do have an incentive fee and define core earnings according to their management contracts. Overall, we will provide more information on this topic in Q4 as we collaborate on the best way to report it.

Can you provide an update on the company's exposure to New York City, which is about 37% of the portfolio, particularly regarding the loans related to hotels? Overall, investors are eager for an update on the outlook for New York City loans.

Yes. What we reported for the third quarter indicates that we are generally comfortable with our New York portfolio. In terms of property types, hotels currently have the most activity regarding price discovery. There has been significant capital gathered on both the equity and credit sides to explore opportunities in hotels, which adjust income levels the quickest. Consequently, we are beginning to see transaction activity in hotels, providing a clearer outlook on future value. We had an asset-specific reserve on one hotel in the first quarter, which was addressed in the second quarter with additional equity from sponsors and a partial loan write-off on our part. Since then, there have been no major changes with any hotel assets in New York, and we feel confident about our overall New York exposure. Regarding the for-sale residential market, we have noticed a slight increase in activity recently, with some sales occurring and an uptick in showings. While prices on the condo side are slightly down, we remain focused on pacing, which will be slower than expected. However, considering our loan-to-value ratios across the condo portfolio, we are still comfortable with our position there.

And on 111 West 57th, is the aggregate exposure around $304 million?

I think approximately, that's pretty close.

Okay. I saw the joint venture disclosure on the Miami Design District deal. Can you touch on that?

I believe at a high level, the Miami Design District is part of a planned redevelopment, but there are existing assets there currently. Our focus is on mitigating the near-term impact by leasing some of the existing buildings. This was the main reason for the partnership or joint venture that was reported. In the long term, the goal for the Miami Design District is to redevelop the site. It's still too early to decide if we will be involved in that long-term or if we will sell that opportunity to someone else. In the short term, we believe there are ways to reduce our losses through a stronger leasing effort, which was the main motivation behind the announcement.

And lastly, it seems like the stock repurchases continued post quarter end. Just wondering how you're thinking about capital management, continued stock repurchases and even whether you would consider perhaps repurchasing some of the convert.

Yes. So as I mentioned to Doug, we're definitely still biased towards keeping excess liquidity, even with the view of keeping excess liquidity, we do have some capital to deploy, whether it gets deployed into repurchase of common stock or new transactions. We still source transactions. We still look at them. And then as we underwrite them, we compare them to the opportunity to buy back the stock. Certainly, at these levels, buying back the stock is the more compelling economic use of capital right now. We do look at other parts of the capital structure. The reality is, given where the converts are trading right now, Jade, again, economically not as appealing to do something on the convert side as it is relative to common right now.

Our next question comes from Charlie Arestia with JPMorgan.

I noticed some of the interest payments were deferred under forbearance agreements, which was trending a little bit lower in October. Could you guys just give us an update on kind of what portion of the loan portfolio is under those kinds of agreements and how the conversations are going with borrowers on that?

Yes. Look, I think the conversations have not changed much. I think they continue to be fairly productive for lack of a better phrase, which is we are perfectly happy to engage with borrowers on discussions around the use of reserves, potential deferral. And to the extent there's a forbearance, forbearance is typically coming with an additional equity contribution from an equity sponsor as well. So the nature of the conversations has not changed much. If you think about our $6.5 billion portfolio, I would say, we've agreed to forbearance agreements with plus or minus loans representing about 10% of that portfolio.

Okay. Great. That's very helpful. And then I apologize I hopped on the call a little bit late. So if you've covered this, go ahead and tell me. But any updates specifically on the Liberty Center asset?

No specific material updates. The good news is most of the tenancy is open for business now. Things are obviously, again, keep this in perspective, better today than they were 6 months ago. But there's still a long way to go for that asset, and we are very much engaged and focused on the asset management challenge there and exploring a lot of different alternatives.

I am not showing any further questions at this time. I would now like to turn the call back over to Stuart Rothstein for closing remarks.

Thank you, operator. Thanks to those of you that participated. And obviously, to the extent there are questions post-call, myself, Hilary, Jai are available to speak as needed. Thanks, everybody.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.