Q4 2023 Apollo Commercial Real Estate Finance Inc Earnings Call
Participants
Stuart Rothstein; Director, President & CEO; Apollo Commercial Real Estate Finance Inc
Anastasia Mironova; Chief Financial Officer, Treasurer, Secretary; Apollo Commercial Real Estate Finance Inc
Scott Weiner; Chief Investment Officer; Apollo Commercial Real Estate Finance Inc.
Doug Harter; Analyst; UBS
Stephen Laws; Analyst; Raymond James & Associates, Inc.
Jade Rahmani; Analyst; Keefe, Bruyette, & Woods, Inc.
Presentation
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, 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, visit our website at w. w. w. dot Apollo Crest.com or call us at two one two five one five three two zero zero.
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 Meron over our Chief Financial Officer.
In many ways, the start of 2024, it 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 lack 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 2020 for their seat, there is increasing confidence in the Fed's ability to engineer some type of soft landing and expectations of 100 to 100, 50 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 includes 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 macro economic 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 because we identified compelling opportunities to originate loans at attractive pricing with reset 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 remains actively engaged with ARI's borrowers, negotiating and completing paydowns and extensions where appropriate for ARI's focus assets the two REO hotels produced stable cash flows throughout the year with the Washington DC asset generating NOI from hotel operations above pre-pandemic levels.
With respect to Steinway, we closed on the sale of one unit in the fourth quarter and there are two 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 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 1.21 times. GAAP net income available to common stockholders was $46 million, or $0.29 per diluted share of common stock. The right 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 capital explorations are tied to either initial or final maturity of loans. We're part of the extension conditions for the loans include putting a new cap in place. We closely monitor a 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 are the 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 allowance stood at 38 basis points of the loan portfolio's amortized cost basis at December 31st, a two 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 funding. 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 31st, our total CECL allowance was 261 basis points of the loan portfolio at amortized cost, yes, 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 air, I repeat $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 DC 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 generated an incremental levered return for ARI. We ended the quarter with $278 million of total liquidity comprised of cash on hand undrawn credit capacity on existing facilities and loan proceeds held by the servicer, a rise debt to equity ratio at quarter end was at 3.0 times.
And with that, I would like to open the line for questions. Operator, please go ahead.
Question and Answer Session
Operator
(Operator Instructions)
Doug Harter, UBS.
Doug Harter
Thanks and good morning. Hoping you could talk a little bit about the potential timing of resolution of your are your existing problem assets?
Stuart Rothstein
Yes, I think in no particular order, Doug, I think as we've indicated previously, with respect to the Atlanta hotel, there has been some dialogue with potential buyers. I don't know that we'll get to the finish line or not, but I think it's possible that it gets resolved in the first half of this year from in terms of there being a sale. I would say the dialogues we're in now don't result in a sale. We will probably sort of reassess and whether it makes sense to we continue to create more value through operations before bringing it back to market or sort of thinking about relaunching a more formal sales effort. What we're working on now has been sort of shorter some dialogues with local players who knew we might be interested in selling a home with respect to the Mayflower hotel in DC that's actually generating a pretty attractive levered return as Anastasia mentioned in her comments. And I would say at this point, probably want to see where rates and the overall financing market goes before we do anything formal in terms of trying to sell that asset. But from a return perspective, selling that asset is really about just removing ROE. from our our balance sheet. It doesn't change the nature of what we could earn on that capital by a large amount of a pivoting to the retail asset in Ohio. We've made a lot of progress from a leasing perspective. We are in the low 90s from an overall occupancy percentage. And the asset management team has also done some interesting things to lower our bases a little bit or create more value through some outparcel ideas and getting entitlements for some additional density at the site. We've got a little bit of work to be done with some significant tenants from a renewal perspective over the next and I'll say six to 12 months, but is successful on that front. And again, not knowing where the world will be, but assuming a good environment overall, I think we would look to exit it possible sometime in the early part of next year.
And then on the on this time, we are building, it's really unit by unit. There's no there's no way to force anything in terms of anything from a bulk perspective. So it is literally just trying to grind through it over unit unit by unit over unit coming quarters. And several years. And then obviously the breadth, which is an excuse me, the I hope the multifamily development in Brooklyn, yes, that will be built through '24, '25, Lisa we don't call it late '25, '26, and that's when we would envision a chance to exit that asset. We have explored some JV ideas along the way as a way to potentially lower some of our equity commitment. But I would not plan on anything at that time.
Doug Harter
Great. Thank you, sir.
Stuart Rothstein
Sure.
Operator
Stephen Laws, Raymond James.
Stephen Laws
Hi. Good morning. Appreciate the comments on around Doug's question, Stuart, and certainly helpful. As I think about those different assets. I think there's also a Chicago office loan. Maybe you've talked about in the past any update on that?
Stuart Rothstein
We have two office loans in Chicago. So both are well supported by their sponsors. One was a complete, call it redo and Lisa and I would say at this point, we are pretty encouraged by the amount of leasing activity and taking place at the asset. That's $100 million commitments that we've got outstanding. We originated late in 2022, and I would say and based on our basis and based on what we're seeing from initial indication of lease activity. We feel pretty good about that. And then we've got another asset in Chicago that's an older asset that we've had. It in our portfolio since of 2018, I believe we recently received a modest paydown from the sponsorship. We negotiated additional pay down plus additional guarantees. I would expect the sponsor to continue to support the asset based on dialogue. Right now, the building itself is about I'm plus or minus 75% occupied at this point. But sponsorship is given in every indication. They continue and they will continue to support the assets.
Stephen Laws
Thanks. And a couple of questions around originations. Certainly 4Q new investments were above what I was expecting. I think you mentioned that and of the pivot in your prepared remarks as far as deploying that capital kind of on the whole, can you talk about your expectations around new originations and repayments this year, do you expect the portfolio to net grow and increase over '24? Or do you think kind of over or not looking at an isolated one quarter, maybe over the year, you're going to see originations and repayments more in line with each other firm?
Stuart Rothstein
Look, I think we're trying to match them up.
I think what you saw at the end of last year was the fact that we had taken a fairly cautious approach through much of 2023 and had built up some liquidity and sort of felt like we had the opportunity to deploy it into transactions. We felt good about I think for the rest of this year, I certainly wouldn't in any way be assuming we multiply our deployment by four. If anything, I think we got ahead of our deployment needs by doing some things at the end of the year, early in this year.
Is it pacing for the rest of the year is really sort of dependent and in some way, tied to it's the question Doug asked, which is when do we free up capital from, you know, some of the underperforming assets per se. And I think with respect to expected repayments there, we're still going to be a little bit cautious, making sure that repayments actually happen before we get too far out over our skis.
Stephen Laws
Great.
And then lastly, you know, it looks like a little over half of the portfolio is now in Europe and again, trying not to read too much into one quarter, but that's where the new investment activity occurred that.
Can you talk about what you like in the European market versus opportunities you're seeing in the US on Rudi's just kind of unique deals that presented themselves that have that were attractive.
Stuart Rothstein
I mean, certainly, if you look at the asset types, right, which in one was a hostile transaction, i.e., as in hospitals, vacation, not hostile. And then one was a portfolio of pubs, obviously, a little bit off the run in terms of traditional asset classes on larger deals where ARI was able to participate with other parts of Apollo broadly where we had knowledge of the sectors from a business perspective, not just a real estate perspective and I also think the size of the transaction, it afforded us the ability to create some structure and economics that were interesting. We are still active in the US as a business. Overall, the real estate credit team and I again at Apollo, did over $10 billion worth of transactions in 2023. And much of that was in the US So the US continues to be on the radar screen for the business. And overall, we continue to think about it for from ARI's perspective. But in this particular case, as we made the decision to put some of our capital to work. I would say the two things. The two new transactions in Europe certainly were two of the more interesting things we were seeing as we thought about achievable risk-adjusted returns. And then obviously, the upsizing was just on an existing transaction in Europe where and that sponsorship had succeeded from a lease-up perspective.
Stephen Laws
Great. Thanks for the comments on this one, Stuart.
Operator
Jade Rahmani, KBW.
Jade Rahmani
Thank you very much. And just a follow-up to Steve's question around Chicago. On the other office, could you comment on Manhattan and Long Island City since Manhattan?
Clearly bifurcated market, but loan City market where we've seen some pressure there?
Stuart Rothstein
Yes.
On the I think with we did a restructuring on the Long Island City asset in 2023. Significant capital came in behind us. It came in from and someone that was already junior to us in the capital structure and certainly is a strong institution in the space.
Overall, I would say since that is I've been there's been some leasing that's taken place today. I would say there continues to be interest from tenants who look at Long Island City as a lower cost option to Manhattan. I would say now that the transaction that was done last year from a restructuring perspective was certainly from our perspective, set us up to have have several years of runway and capital available for lease up and TI. expenses as they occur, but so generally moving in the right direction --
Stuart, I would add and it's right above the subway stop.
Scott Weiner
So it's really centrally located in terms of access all over the city. And historically, the city has a whole bunch of incentives on the tax side for people to relocate there. So in addition to being kind of centrally located, it's a low cost alternative, and we're really benefiting from a very long lease term. We have like 15, 20 year leases on the three major tenants as well as 100% retail and which is anchored by Target if you're familiar with the center. So as Stuart mentioned, I think us and the sponsorship group is very pleased on a lot of touring, a lot of activities, both by government tenants, which was actually the most recent lease with a large government, New York City tenant obviously have credit there. And then a lot of other folks are looking for that's really a Class A. building on the long term.
Stuart Rothstein
And then in Manhattan, Jade, we've got one exposure with a loan we put in place in the first half of 2022, where the senior mortgage, our last dollar of basis is sub $400 a square foot. There are three levels of mez beneath us more sub debt beneath us. And I would say at this point, we're sort of at a stage in that transaction where I think sponsorship on the equity side is running out of appetite, and we are already in dialogue with and those subordinate ties in the capital structure around and some sort of restructure injection of capital, et cetera, to give at least some maybe not all of the sub-debt a chance to play for time. So seems like a productive dialogue, we should have more than, yes, probably the next time around the phone in terms of specifically what's likely to happen.
Jade Rahmani
So a challenging asset, but there's enough subordination where you feel adequately covered sitting here today.
Okay.
And then just a bigger picture question, but if you can give a sense, we get tons of questions about credit performance and people look, for example, CLOs and they see delinquency issues, they see a lot of modifications. But ultimately, in your mind, what is the driver of whether a loan stays current or goes into the fall? In other words, what percentage of interest is funded out of a reserve VERSUS property level cash flows, as most of it come from an interest reserve that is initially established and later replenished it depends, right.
Stuart Rothstein
So to be clear, right, if you look at our portfolio and you look at our interest, but you also factor in the fact that a lot of what we do on our assets in transitions, whether it is ground-up development or heavy redevelopment?
Yes, I think when last we looked and Hilary could probably give you a more current number after the fact, I think I think approximately 20% of our interest income maybe slightly higher is it paid out of reserves, but it's ordinary way structuring when you're doing a construction deal or a predevelopment loan or a significant redevelopment loan that you are baking in the interest cost into the loan I make I think it's as expected for lack of a better phrase. And obviously, particularly when you're doing things that are development or redevelopment in nature, there are no cash flows to cover interest. So you're effectively baking it into the line Thanks very much, sir.
Operator
Thank you. One moment for questions. Our next question comes from Rick Shane with JP Morgan. You may proceed.
Thanks for taking my questions this morning, everybody, Anastasia Thank you for the additional detail on CAPS, et cetera. I'd love to talk a little bit about the dynamics in terms of your borrowers hedging. Now given we are seemingly approaching an inflection in rates? Is the cost of hedging actually starting to come down as the price of caps coming down. And the second part of this is and does it do borrowers have the alternative instead of buying caps of building up the interest reserve instead our sort of self insurance. So that way, if rates come down, they haven't paid away on the they haven't sort of wasted the payment and they can recapture it through the reserve.
Scott, do you want to just sort of maybe give like unless you have sort of the dialogue with borrowers?
Scott Weiner
Yes, I do think your cap costs have come down, like I think everybody has a different philosophy. We have general and I'm seeing across the broader real estate platform on. Obviously, as we mentioned, we haven't done many new originations. But across our platform, we have borrowers, you're actually buying in the money caps. So effectively pre-pay interest because they want to have more coverage and willing to pay. And we have other borrowers who really want to buy our way out of the money cap and it's time insurance and requiring. And again, part of it also depends on what the coverages and what type of leverage that we're doing. And from our underwriting perspective, what kind of interest rate would we have some. But I would say generally, it's not so much building up an interest reserve. I would say from a credit perspective, if someone wants to buy or spend less money on a cap generally that would be on a deal where you feel very comfortable with the cash flows and the coverage and or you might have some sort of guarantee. So for example, like on construction loans where you're by definition, funding that and you kind of look to the forward and you have, I guess, carry guarantee oftentimes a borrower we'll want to buy a less expensive cap out of the money or somebody with a shorter term. Clearly, if you're financing an asset that is a cash flowing asset and has a lower a lower coverage, if you will, on multi-family, you're going to be very focused on what that cap is because you want to make sure that you that you cover.
Stuart Rothstein
Got it.
Okay.
Scott Weiner
Then I've got some longer borrowing fixed out, right? I mean that's obviously that's the other thing. If borrowers can confidently in the market borrow fixed rate loans, the rebate That's helpful.
And then the follow-up to that is on it in stage, I apologize. I think you've said that 83% of loans have caps at this point, and I don't recall hearing that metric in the past on where is that in historical context, you ended with 81% of the principal balance?
Yes, I think that Australia, again, if we have a strong sponsor, right? And they're willing to in some ways, we're better off having them guarantee interest rate. That's because the capital and gets you there where if someone is willing to give us a full carry guarantee that's only a trade that we can make. So so I would say on the deals where we don't have a cap, it's because we have some form of other supplemental credit enhancement.
So thank you, guys.
Operator
Thank you. And as a reminder, to ask a question, please press star one one on your telephone. One moment for questions.
Our next question comes from Steve Delaney with Citizens Jempy. You may proceed.
Thanks.
Good morning, everyone. I'd like to go back to Stephen Laws. Comment about your on your farm market investments. Clearly, that's the most distinctive feature of Apollo IR. I I'm just noting in your in your deck here, you have 32% of the portfolio in the UK and just 21% in New York City. I'm just a couple of questions around that.
I'm just curious.
I know generally you've had a good performance. Have you had any NPLs are foreclosures in the UK or any of the European markets based on your active lending activity there, but I appreciate you asking that quite you're like an announcer where guys like made 20 facts that we know to date.
We've had very strong performance in Europe, and you've heard me talk multiple times about why we like Europe because in many ways. We think about Europe, the way we do the US in terms of quality of assets, quality of sponsorship, ability to protect ourselves through the legal system. It's not to say we haven't had assets where sponsorship did not achieve business plan, but in those cases, the the value of the underlying real estate relative to our loan was sufficient to make sure we were made whole on our transaction.
Stuart Rothstein
What's that?
Gosh, everything is every loan's unique, everything's story, right? Every borrower has a person different personality, but is there is there one more principle of doing business or custom bet in the UK to give lenders more control over borrowers. Is there anything just technical like that that help make that aim?
Maybe I'll use the word safer lending market than the US?
Scott Weiner
I wouldn't say this is Scott. I wouldn't say Cai, just because obviously people can lose money on loans in Ukraine, London hub just as much as they can here. I would say there are some norms over there around kind of ongoing covenants that you don't really see here. So whereas in the U. S you generally obviously, we've always structure our deals with ongoing cash triggers and maybe extension test in Europe in the UK. What you would often see is in addition to those type of triggers. We actually have financial covenants that if they are breached, bring everyone to the table, I would say rule of law enforcement is obviously very strong there. And I would just say London historically has just been a center of attracting capital. So even even office right now, I think I read somewhere there's a GBP2 billion of office under offer across our portfolio. We recently got refinanced and some office buildings that were outside the ARI portfolio in London. So I just think it's a liquid market that is attracting people from Asia or other parts of Europe, the U.S. and yes, we have a large team there, so somebody like it. But again, also we look across Europe as well.
It's really that for us, the power of the platform, it's really how we look at it while congrats on how you've taken advantage of that and was a solid close to 2023.
Operator
Thank you.
Stuart Rothstein
Thanks for that.
Operator
Thank you. I would now like to turn the call back over to Mr. Rossi for any closing remarks.
Stuart Rothstein
So thank you all who participated on the call this morning.
And obviously to the extent there are follow-up questions, myself, Hilary Anastasia are always available to talk.
Thanks, everybody.
Operator
Thank you.
Thank you for your participation. You may now disconnect.
