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ARI > SEC Filings for ARI > Form 10-Q on 3-May-2013All Recent SEC Filings

Show all filings for APOLLO COMMERCIAL REAL ESTATE FINANCE, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for APOLLO COMMERCIAL REAL ESTATE FINANCE, INC.


3-May-2013

Quarterly Report


ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

FORWARD-LOOKING INFORMATION

The Company makes forward-looking statements herein and will make forward-looking statements in future filings with the Securities and Exchange Commission ("SEC"), press releases or other written or oral communications within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act), and Section 21E of the Securities Exchange Act of 1934, as amended, (the "Exchange Act"). For these statements, the Company claims the protections of the safe harbor for forward-looking statements contained in such Section. Forward-looking statements are subject to substantial risks and uncertainties, many of which are difficult to predict and are generally beyond the Company's control. These forward-looking statements include information about possible or assumed future results of the Company's business, financial condition, liquidity, results of operations, plans and objectives. When the Company uses the words "believe," "expect," "anticipate," "estimate," "plan," "continue," "intend," "should," "may" or similar expressions, it intends to identify forward-looking statements. Statements regarding the following subjects, among others, may be forward-looking: market trends in the Company's industry, interest rates, real estate values, the debt securities markets or the general economy or the demand for commercial real estate loans; the Company's business and investment strategy; operating results and potential asset performance; actions and initiatives of the U.S. government and changes to U.S. government policies and the execution and impact of these actions, initiatives and policies; the state of the U.S. economy generally or in specific geographic regions; economic trends and economic recoveries; the Company's ability to obtain and maintain financing arrangements, including securitizations; the anticipated shortfall of debt financing from traditional lenders; the volume of short-term loan extensions; the demand for new capital to replace maturing loans; expected leverage; general volatility of the securities markets in which the Company participates; changes in the value of the Company's assets; the scope of the Company's target assets; interest rate mismatches between the Company's target assets and any borrowings used to fund such assets; changes in interest rates and the market value of the Company's target assets; changes in prepayment rates on the Company's target assets; effects of hedging instruments on the Company's target assets; rates of default or decreased recovery rates on the Company's target assets; the degree to which hedging strategies may or may not protect the Company from interest rate volatility; impact of and changes in governmental regulations, tax law and rates, accounting guidance and similar matters; the Company's ability to maintain its qualification as a real estate investment trust ("REIT") for U.S. federal income tax purposes; the Company's ability to maintain its exemption from registration under the Investment Company Act of 1940, as amended (the "1940 Act"); the availability of opportunities to acquire commercial mortgage-related, real estate-related and other securities; the availability of qualified personnel; estimates relating to the Company's ability to make distributions to its stockholders in the future; and the Company's understanding of its competition.

The forward-looking statements are based on the Company's beliefs, assumptions and expectations of its future performance, taking into account all information currently available to it. Forward-looking statements are not predictions of future events. These beliefs, assumptions and expectations can change as a result of many possible events or factors, not all of which are known to the Company. See "Item 1A - Risk Factors" of the Company's Annual Report on Form 10-K for the year ended December 31, 2012. These and other risks, uncertainties and factors, including those described in the annual, quarterly and current reports that the Company files with the SEC, could cause its actual results to differ materially from those included in any forward-looking statements the Company makes. All forward-looking statements speak only as of the date they are made. New risks and uncertainties arise over time and it is not possible to predict those events or how they may affect us. Except as required by law, the Company is not obligated to, and does not intend to, update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Overview

The Company is a REIT that primarily originates, acquires, invests in and manages performing commercial first mortgage loans, CMBS, subordinate financings and other commercial real estate-related debt investments in the United States. These asset classes are referred to as the Company's target assets.

The Company is externally managed and advised by ACREFI Management, LLC (the "Manager"), an indirect subsidiary of Apollo Global Management, LLC, together with its subsidiaries, ("Apollo"), a leading global alternative investment manager with a contrarian and value oriented investment approach in private equity, credit-oriented capital markets and real estate. Apollo had total assets under management of approximately $113 billion as of December 31, 2012.


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The Manager is led by an experienced team of senior real estate professionals who have significant experience in commercial property investing, financing and ownership. The Manager benefits from the investment, finance and managerial expertise of Apollo's private equity, credit-oriented capital markets and real estate investment professionals. The Company believes its relationship with Apollo provides the Company with significant advantages in sourcing, evaluating, underwriting and managing investments in the Company's target assets.

Market Overview

During 2012, the commercial real estate lending market continued to slowly recover from the downturn experienced as part of the correction in the global financial markets which began in mid-2007. The Company estimates that from 2013 to 2017, there is in excess of $1 trillion of commercial real estate debt that is scheduled to mature and this presents a compelling opportunity for the Company to invest capital in its target assets at attractive risk adjusted returns. While the volume of impending maturities and the need for refinancing is significant, the demand for new capital to refinance maturing commercial mortgage debt continues to be somewhat tapered by the granting of extensions by lenders across the commercial mortgage loan industry. The Company believes that the significant long-term opportunity still remains for lenders to capitalize on the impending maturity wall despite the fact that the volume of loan modifications has had a meaningful impact on the timing of the maturities and the related opportunity.

Action by the Federal Reserve has sent spreads across credit products, including CMBS, to post-crisis lows and will likely result in a wave of refinancing and new issuance during 2013. In 2012, approximately $48 billion of CMBS was issued in the United States, an increase of approximately 48% over 2011. In the first quarter of 2013, approximately $23 billion of CMBS was issued, an increase of approximately 2.8 times over the same period during the prior year. Since early 2010, approximately $115 billion of CMBS has been issued in the United States. While this is significantly less than the $229 billion that was issued in 2007, we believe it is evidence that the lending market for commercial real estate has begun to stabilize and continues to grow.

Despite the recent strength of the CMBS market, the pace of CMBS issuance is still moderate relative to the peak of the market, and lenders still appear to be more focused on stabilized cash flowing assets with lower loan-to-value ratios. This should continue to provide the Company with increased opportunities to originate mezzanine financings with respect to those parts of the financing capital structure which are unsuitable to be sold as part of CMBS.

Critical Accounting Policies

A summary of the Company's accounting policies is set forth in its Annual Report on Form 10-K for the year ended December 31, 2012 under "Item 7 - Management Discussion and Analysis of Financial Condition and Results of Operations - Critical accounting policies and use of estimates."

Financial Condition and Results of Operations

(in thousands-except share and per share data)

Investment Activity

Investment activity. In January 2013, the Company provided a $60,000 mezzanine loan commitment ($49,139 of which has been funded to date) secured by a pledge of preferred equity interests in the owner of a to-be-developed 352,624 net saleable square foot, 57-story, 146-unit condominium tower located in the TriBeCa neighborhood of New York City. The Company has funded $49,139 of financing to date and expects to provide an additional $10,861 within six months following the initial loan closing. When fully funded and based upon current presales of units, the Company's loan basis is expected to represent an underwritten loan-to-net sellout of approximately 48%. The mezzanine loan has a term of 54 months with one extension option of 12-months and has been underwritten to generate an IRR of approximately 16%. See "-Investments" below for a discussion of IRR.


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In February 2013, the Company provided an $18,000 mezzanine loan secured by a pledge of the equity interests in the owner of two buildings in midtown Manhattan. The buildings contain a total of 181,637 rentable square feet that is being converted into 215 multifamily rental units. The mezzanine loan is part of a $90,000, three-year (two-year initial term with one one-year extension option) interest-only, floating rate financing comprised of the mezzanine loan and a $72,000 first mortgage loan. When the first mortgage loan is fully funded, the Company expects that the mezzanine loan will have a loan-to-value ("LTV") of approximately 60% and the mezzanine loan has been underwritten to generate an IRR of approximately 13%. See "-Investments" below for a discussion of IRR.

In February 2013, the Company provided a $25,000 mezzanine loan secured by a pledge of the equity interests in the owner of a portfolio of four hotels totaling 1,231 keys located in Rochester, Minnesota. The hotels are within walking distance of the Mayo Clinic, an internationally renowned health care facility that treats over one million patients annually from around the world. The mezzanine loan is part of a $145,000 five-year, fixed rate loan, comprised of a $120,000 first mortgage loan and the mezzanine loan, which was provided in connection with the acquisition of the portfolio. The mezzanine loan has an appraised loan-to-value of approximately 69% and has been underwritten to generate an IRR of approximately 12%. See "-Investments" below for a discussion of IRR.

Investments

The following table sets forth certain information regarding the Company's
investments at March 31, 2013:



                                                                                       Remaining
                                                                                       Weighted                                                                    Current         Levered
                                                                       Weighted         Average                                     Remaining                      Weighted        Weighted
                                           Face        Amortized       Average           Life                        Cost of        Debt Term      Equity at       Average         Average
Description                               Amount          Cost          Yield           (years)         Debt          Funds         (years)*          cost          IRR **         IRR ***
First mortgages                          $ 145,928     $  142,833           10.6 %            2.3     $       3           2.7 %            1.8     $  142,830           10.9 %          15.7 %
Subordinate loans                          287,935        286,569           12.9              4.1            -             -                -         286,569           13.6            13.6
CMBS - AAA                                 185,974        188,824            4.6              1.8       164,204           1.4              0.9         24,620           16.2            16.2
CMBS - Hilton                               72,395         69,912            5.5              2.6        47,737           2.0              2.6         22,175           12.5            12.5

Total                                    $ 692,232     $  688,138            9.4 %            3.0     $ 211,944           1.5 %            1.3     $  476,194           12.9 %          14.2 %

* Assumes extension options on Wells Facility with respect to the Hilton CMBS are exercised. See "-Liquidity and capital resources - Borrowings Under Various Financing Arrangements" below for a discussion of the Wells Facility.

** The internal rates of return ("IRR") for the investments shown in the above table reflect the returns underwritten by the Manager, calculated on a weighted average basis assuming no dispositions, early prepayments or defaults but assuming that extension options are exercised and that the cost of borrowings and derivative instruments under the Wells Facility remains constant over the remaining terms and extension terms under this facility. With respect to the mezzanine loan for the New York City multifamily condominium conversion that closed in December 2012 and the mezzanine loan for the New York City condominium construction that closed in January 2013, the IRR calculation assumes certain estimates with respect to the timing and magnitude of future fundings for the remaining commitments and associated loan repayments, and assumes no defaults. IRR is the annualized effective compounded return rate that accounts for the time-value of money and represents the rate of return on an investment over a holding period expressed as a percentage of the investment. It is the discount rate that makes the net present value of all cash outflows (the costs of investment) equal to the net present value of cash inflows (returns on investment). It is derived from the negative and positive cash flows resulting from or produced by each transaction (or for a transaction involving more than one investment, cash flows resulting from or produced by each of the investments), whether positive, such as investment returns, or negative, such as transaction expenses or other costs of investment, taking into account the dates on which such cash flows occurred or are expected to occur, and compounding interest accordingly. There can be no assurance that the actual IRRs will equal the underwritten IRRs shown in the table. See "Item 1A-Risk Factors-The Company may not achieve its underwritten internal rate of return on its investments which may lead to future returns that may be significantly lower than anticipated" included in the Company's Annual Report on Form 10-K for the year ended December 31, 2012 for a discussion of some of the factors that could adversely impact the returns received by the Company from the investments shown in the table over time.

*** Substantially all of the Company's borrowings under the JPMorgan Facility were repaid upon the closing of the Company's Series A Preferred Stock offering in August 2012. The Company's ability to achieve its underwritten leveraged weighted average IRR with regard to its portfolio of first mortgage loans is additionally dependent upon the Company reborrowing approximately $53,000 under the JPMorgan Facility or any replacement facility. Without such reborrowing, the leveraged weighted average IRRs will be as indicated in the current weighted average IRR column above.


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Net Interest Income

The following table sets forth certain information regarding the Company's net
investment income for the three months ended March 31, 2013 and 2012:



                                              Three months ended March 31,
                                                                Change        Change
                                     2013          2012        (amount)         (%)
       Interest income from:
       Securities                  $  3,087      $  5,323      $  (2,236 )      (42.0 )%
       Commercial mortgage loans      3,592         2,234          1,358         60.8 %
       Subordinate loans             11,454         5,313          6,141        115.6 %
       Repurchase agreements              2         1,559         (1,557 )      (99.9 )%
       Interest expense              (1,068 )      (3,242 )        2,174        (67.1 )%

       Net interest income         $ 17,067      $ 11,187      $   5,880         52.6 %

Net interest income for the three months ended March 31, 2013 increased $5,880, or 52.6%, from the same period in 2012. The increase is primarily the result of additional interest income from commercial mortgage loans and subordinate loans offset by a decline in interest income from securities and repurchase agreements.

The decline in interest income related to securities for the three months ended March 31, 2013 of $2,236, or 42.0%, from the same period in 2012 is attributable to the repayment of these securities as they near maturity as well as the sale of the portion of the Company's securities during March 2012.

The increase in interest income related to commercial mortgage loans for the three months ended March 31, 2013 of $1,358, or 60.8%, from the same period in 2012 is primarily attributable to the funding of $62,490 of commercial mortgage loans net of repayments of $31,300 during 2012.

The increase in interest income related to subordinate loans for the three months ended March 31, 2013 of $6,141, or 115.6%, from the same period in 2012 is primarily attributable to the funding of $91,297 and $96,023 of subordinate loans during 2013 and 2012, respectively. The increase is also attributable to a $2,500 prepayment penalty received upon the repayment of two mezzanine loans in February 2013.

The decrease in interest related to repurchase agreements for the three months ended March 31, 2013 of $1,557, or 99.9% from the same period in 2012 is attributable to the final repayment of the repurchase agreement in January 2013.

Interest expense for the three months ended March 31, 2013 decreased $2,174, or 67.1%, from the same period in 2012. The decrease is primarily the result of the decline in the average balance of the Company's borrowings from $482,323 for the three months ended March 31, 2012 to $216,950 for the three months ended March 31, 2013. In addition to the repayment of debt outstanding under the Wells Facility as the related CMBS have been repaid or sold, the Company repaid substantially all of the borrowings outstanding under the JPMorgan Facility upon the close of the Company's Series A Preferred Stock offering in August 2012. The Company also amended the JPMorgan Facility and the Wells Facility during 2012 and 2013 to reduce the cost of borrowings. See "- Liquidity and capital resources - Borrowings Under Various Financing Arrangements" for a discussion of those amendments.


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Operating Expenses

The following table sets forth the Company's operating expenses for the three
months ended March 31, 2013 and 2012:



                                                  Three months ended March 31,
                                                                   Change        Change
                                          2013        2012        (amount)         (%)
    General and administrative expense   $ 1,012     $   953     $       59          6.2 %
    Stock-based compensation expense         883       1,083           (200 )      (18.5 )%
    Management fee expense                 2,160       1,289            871         67.6 %

    Total operating expense              $ 4,055     $ 3,325     $      730         22.0 %

General and administrative expense for the three months ended March 31, 2013 is relatively unchanged from the same period in 2012. Stock-based compensation expense for the three months ended March 31, 2013 decreased $200, or 18.5%, from the same period in 2012. The decrease is primarily attributable to the fluctuation in the price of the Company's stock since the end of 2011. Share-based payments are discussed further in the accompanying consolidated financial statements, "Note 11-Share-Based Payments."

Management fee expense for the three months ended March 31, 2013 increased $871, or 67.6%, from the same period in 2012. The increase is primarily attributable to increases in the Company's stockholders' equity (as defined in the Management Agreement) as a result of the Company's follow-on common equity offering completed in 2012, the Series A Preferred Stock completed in 2012 and, to a lesser extent, the follow-on common equity offering completed in March 2013. Management fees and the relationship between the Company and the Manager are discussed further in the accompanying consolidated financial statements, "Note 10-Related Party Transactions."

Realized and unrealized gain/loss

The following amounts related to realized and unrealized gains (losses) on the Company's CMBS and derivative instruments are included in the Company's consolidated statement of operations for the three months ended March 31, 2013 and 2012:

                                                                        Amount of gain (loss)
                                                                     recognized in income for the
                                                                    three  months ended March 31,
                       Location of Gain (Loss) Recognized in
                       Income                                         2013                  2012
Securities             Realized gain on sale of securities       $           -          $         262
Securities             Unrealized gain (loss) on securities              (1,080 )               1,385
Interest rate swaps    Loss on derivative instruments -
                       realized *                                           (72 )                (412 )
Interest rate swaps    Gain on derivative instruments -
                       unrealized                                            72                   147
Interest rate caps     Loss on derivative instruments -
                       unrealized                                            -                   (152 )

Total                                                            $       (1,080 )       $       1,230

* Realized losses represent net amounts expensed related to the exchange of fixed and floating rate cash flows for the Company's derivative instruments during the period.

In order to mitigate interest rate risk resulting from the Company's floating-rate borrowings under the Wells Facility, the Company has entered into interest rate swaps and caps which are intended to economically hedge a portion of its floating-rate borrowings through the expected maturity of the underlying collateral as well as the potential extension of the underlying collateral.

The Company has elected not to pursue hedge accounting for these derivative instruments and records the change in estimated fair value related to these interest rate agreements in earnings. The Company also elected to record the change in estimated fair value related to certain CMBS securing the Wells Facility in earnings by electing the fair value option. These elections allow the Company to align the change in the estimated fair value of the Wells Facility collateral and related interest rate derivatives without having to apply complex hedge accounting provisions.

During March 2012, the Company sold CMBS with an amortized cost of $137,423 resulting in net realized gains of $262. The sale generated proceeds of $14,621 after the repayment of $123,064 of debt under the Wells Facility.


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For the three months ended March 31, 2013 and 2012, respectively, the Company recognized an unrealized gain (loss) on securities of $(1,080) and $1,385. These gains (losses) resulted from mark-to-market adjustments related to those securities for which the fair value option has been elected.

Dividends

Dividends. For 2013, the Company declared the following dividends on its common stock:

Declaration Date Record Date Payment Date Amount February 27, 2013 March 28, 2013 April 12, 2013 $ 0.40

For 2013, the Company declared the following dividends on its Series A Preferred Stock:

Declaration Date Record Date Payment Date Amount March 15, 2013 March 28, 2013 April 15, 2013 $ 0.5391

Subsequent Events

Dividends. On May 1, 2013, the Company declared a dividend of $0.40 per share of common stock which is payable on July 12, 2013 to common stockholders of record on June 28, 2013.

Stockholders' Equity. On April 1, 2013, as part of their annual compensation, each of the Company's independent directors was granted 2,826 restricted shares of common stock under the Company's LTIP. The shares will vest ratably over twelve quarters with the initial vesting date scheduled for July 1, 2013 and the final vesting date scheduled for April 1, 2016.

Liquidity and capital resources

Liquidity is a measure of the Company's ability to meet potential cash requirements, including ongoing commitments to repay borrowings, fund and maintain its assets and operations, make distributions to its stockholders and other general business needs. The Company's cash is used to purchase or originate target assets, repay principal and interest on borrowings, make distributions to stockholders and fund operations. The Company's liquidity position is closely monitored and the Company believes it has sufficient current liquidity and access to additional liquidity to meet financial obligations for at least the next twelve months. The Company's primary sources of short-term and long-term liquidity are as follows:

Cash Generated from Operations

Cash from operations is generally comprised of interest income from the Company's investments, net of any associated financing expense, principal repayments from the Company's investments, net of associated financing repayments, proceeds from the sale of investments, and changes in working capital balances. See "-Financial Condition and Results of Operations-Investments" above for a summary of interest rates and weighted average lives related to the Company's investment portfolio at March 31, 2013. While there are no contractual paydowns related to the Company's CMBS, periodic paydowns do occur. Repayments on the debt secured by the Company's CMBS occur in conjunction with the paydowns on the collateral pledged.


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Borrowings Under Various Financing Arrangements

In January 2010, the Company entered into the JPMorgan Facility, pursuant to . . .

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