Apollo Commercial Real Estate Finance, Inc. (NYSE:ARI) Q4 2023 Earnings Call Transcript February 7, 2024
Apollo Commercial Real Estate Finance, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: 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 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 Rothstein: Thank you, operator. Good morning and thank you to those of you joining us on the Apollo Commercial Real Estate Finance fourth quarter 2023 earnings call. I am joined as usual today by Scott Weiner, our Chief Investment Officer; and Anastasia Mironova, our Chief Financial Officer. In many ways, the start of 2024 feels very much like where we were at the start of 2023 for the commercial real estate sector. If you recall, entering 2023, there was significant negative sentiment concerning commercial real estate, fueled by concerns over the impact of elevated interest rates on valuations and pending debt maturities, uncertainty on the long-term use case for office properties and a lot of consensus with respect to both the path of the economy and the future trajectory of interest rates.
The Fed continuing to raise rates in the first half of 2023 and the notable volatility in the 10-year treasury rates further added to the concern and uncertainty in the market. In addition, the failure of several notable regional banks, coupled with increased reserves and negative commentary from money center banks regarding their real estate portfolios further added to the generally pessimistic perspective. While there were some notable transactions throughout 2023, which started the process of revaluing real estate in a higher interest rate environment, but overall transaction volume was significantly lower than recent years as market participants, including owners, lenders, potential buyers and sellers all chose to play for time and remain cautious in the face of an uncertain economic and interest rate environment.
As we enter 2024, there is increasing confidence in the Fed’s ability to engineer some type of soft landing and expectations of 100 to 150 bps of Fed rate cuts throughout the year. On the long end, the 10-year is essentially exactly where it was at the beginning of 2023. And at present, fears of that rate moving higher, as it quickly did last year, are muted. However, while there may be more optimism with respect to the economy and rates, the narrative around commercial real estate continues to focus on further asset value degradation. There is still much to be done to address loan maturities and asset level capital structures in a higher rate environment in addition to the lingering uncertainty over the long-term use case for certain assets.
Pivoting away from the value debate, operating performance across much of commercial real estate has remained stable to positive. Notable exceptions include certain office markets as well as pockets of the multifamily sector that have begun to experience declining rent growth in the face of elevated supply. Over the long-term, we expect that property level operating performance will be closely aligned with the broader macroeconomic climate, and many property sectors will benefit from a notable decrease in new supply over the last few years. With respect to ARI, 2023 was a year focused on proactive asset management and maintaining excess liquidity while expanding and diversifying financing sources. Given the tailwinds from higher base rates, ARI achieved strong distributable earnings, which comfortably covered the dividend and demonstrated the earnings power of the company’s floating rate loan portfolio.
During the fourth quarter, ARI strategically pivoted and deployed $536 million into two new loan transactions and the upsizing of an existing loan as we identified compelling opportunities to originate loans at attractive pricing with recent valuation, strong credit structures and lower LTVs. All three of these loans secured properties in Europe. Shifting to the portfolio. At year-end, ARI had 50 loans, totaling $8.4 billion. ARI received $1.2 billion in loan repayments and sales during 2023, including $270 million from office loans. Throughout the year, our team remained actively engaged with ARI’s borrowers, negotiating and completing paydowns and extensions where appropriate. For ARI’s focus assets, the 2 REO hotels produced stable cash flow throughout the year, with the Washington, D.C. asset generating NOI from hotel operations above pre-pandemic levels.
An aerial view of a REIT operated commercial building.
With respect to Steinway, we closed on the sale of 1 unit in the fourth quarter, and there are 2 more units under contract. There are also active negotiations on a handful of additional units. However, nothing is done until it is done. Based on recent activity at the building, our views have not changed with respect to the nominal achievable value on sellout. But as a reminder, accounting does require a present value assessment of achievable value. Recent activity was generally consistent with previous estimates, and as such, no additional reserve was recorded during the fourth quarter. Any future change to the reserve level will be based upon assessment of both the potential nominal value of remaining units as well as the expected timing of realization.
Before I turn the call over to Anastasia, let me make a few comments on ARI’s quarterly dividend. As a reminder, our quarterly dividend run rate is $0.35 per share, and it has been at that level since we proactively reduced the dividend right at the beginning of the pandemic in 2020. As I have stated many times previously, the dividend is ultimately dependent on board action, and it is reviewed and discussed and ultimately declared by the Board on a quarterly basis. While it is subject to that Board approval, at present, our current modeling for the future indicates that we remain comfortable with the current dividend level of $0.35 per share. We will obviously review it with the Board on a go-forward basis, but in light of questions that we anticipated, I wanted to provide that context at this time.
With that, I will turn the question over to Anastasia.
Anastasia Mironova: Thank you, Stuart, and good morning, everyone. ARI had a strong year of operating results in 2023. Reported distributable earnings of $244 million or $1.69 per share, which resulted in dividend coverage of 1.21x. GAAP net income available to common stockholders was $46 million or $0.29 per diluted share of common stock. ARI portfolio ended the year with a carrying value of $8.4 billion, with a weighted average unlevered yield of 8.7%, 110 basis points higher than at the end of 2022, and notably, 380 basis points higher than at the end of 2021. As Stuart mentioned, during the quarter, we closed $536 million of new commitments across three deals. $275 million of these commitments was funded during the quarter.
$212 million was funded subsequent to quarter end, and the rest will be funded in the future. We also completed $131 million of add-on fundings from previously closed loans and received $205 million in loan repayments. As of year-end, approximately 81% of the principal balance of our portfolio was covered by interest rate caps. Important to note that most cap expirations are tied to the initial of final maturity of loans, where a part of the extension conditions for the loans include putting a new cap in place. We closely monitor pending expirations and engage with our borrowers to ensure new caps are put in place upon expiration. Currently, there are not any loans in our portfolio in which we are concerned with the borrower’s ability to replace an expiring cap.
In addition to interest rate caps, other structural protections for the loans in our portfolio include interest reserves and interest and carry guarantees. As of year-end, the weighted average risk rating of the portfolio was a 3.0. There was no incremental specific CECL allowance taken during the quarter. The general CECL loans stood at 38 basis points of the loan portfolio’s amortized cost basis at December 31, a 2 basis points increase as compared to a year ago. The increase in general CECL allowance was primarily attributable to a more adverse macroeconomic outlook, particularly in relation to certain asset classes. The negative impact from the macroeconomic outlook was partially offset by overall portfolio seasoning and loan repayment activity outpacing loan fundings.
Notably, the outstanding principal balance of the loan portfolio decreased from $8.9 billion to $8.6 billion over the course of the year. As of December 31, our total CECL allowance was 261 basis points of the loan portfolios amortized cost basis. ARI book value per share, excluding general CECL reserves and depreciation, was $14.73, relatively flat to last quarter. With respect to our borrowings, we are in compliance with all covenants and continue to maintain strong liquidity. ARI repeated $176 million of the remaining outstanding principal balance of convertible notes that came due in October with cash on hand. With this repayment, our next corporate debt maturity is not until 2026. Picking up on Stuart’s remarks with regards to our Washington D.C. hotel, as we continue to monitor the market to determine the optimal time to sell the asset, the hotel was recently pledged to our revolving credit facility, generating an incremental leverage return for ARI.
ARI ended the quarter with $278 million of total liquidity comprised of cash on hand on drawing credit capacity on existing facilities and loan proceeds held by the servicer. ARI’s debt-to-equity ratio at quarter end was at 3.0x. And with that, we’d like to open the line for questions. Operator, please go ahead.
