Apollo Commercial Real Estate Finance, Inc. (ARI) Q4 2012 Earnings Report, Transcript and Summary

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. 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.

Good morning, and thank you for joining us on the Apollo Commercial Real Estate Finance, Inc. Fourth Quarter 2012 Earnings Call. Joining me this morning in New York are Scott Weiner, our chief Investment Officer; and Megan Gaul, our Controller, who will review ARI's financial results after my remarks. The commercial real estate sector regained its footing in 2012, the year in which we saw a strengthening CMBS market and improving operating fundamentals across the industry. Transaction volume for commercial real estate sales in 2012 reached $147 billion, which while still well off the $243 billion peak in 2007, was robust and was a 20% increase over commercial real estate sales volume in 2011. Investor demand was driven by improving market fundamentals and attractive yields relative to other asset classes. Distressed sales made up only 11.5% of observed traits in December 2012, the lowest level witnessed since the end of 2008. This reduction in distressed deal volume has been driving higher, more consistent pricing. Pricing in the 6 major metropolitan areas of the U.S.: New York, Boston, D.C., Chicago, San Francisco and LA, has returned to peak levels experienced in 2007. And as of the end of 2012, commercial property prices nationally stood 33% above the levels reached in January 2010 trough and 20% below the November 2007 peak. The increase in transaction volume led to an overall increase in financing volume as well. U.S. CMBS issuance in 2012 was $48 billion, a 37% increase over 2011. 2013 is already shaping up to be a strong year, with over $13 billion of CMBS issuance year-to-date, and total issuance is expected to reach $65 billion for the year. The strength in the commercial real estate market witnessed in 2012 enabled ARI to have a very successful year. Our focus remained on…

Thanks, Stuart. Before I discuss our financial results, I want to remind everyone that we have posted our supplemental financial information package on our website, which contains detailed information about the portfolio, as well as ARI's financial performance. Turning to our financial results, for the quarter ended December 31, 2012, we announced operating earnings of $7.4 million or $0.27 per share as compared to operating earnings of $8.3 million or $0.39 per share for the 3 months ended December 31, 2011. The decrease in operating earnings per share primarily was due to the timing of the deployment of the capital raised from the company's common and preferred stock offerings that Stuart mentioned earlier. As Stuart also stated, we have made significant progress with our capital deployment in 2013 thus far, having announced $103 million of new transactions since the beginning of the year. For the year ended December 31, 2012, the company reported operating earnings of $33.9 million, or $1.50 per share, representing a per share increase of 2% as compared to operating earnings of $28.1 million or $1.47 per share for the full year ended December 31, 2011. Net income for 2012 was $37.1 million or $1.64 per share as compared to net income of $25.9 million or $1.35 per share for 2011. A reconciliation of operating earnings and operating earnings per share to GAAP net income and GAAP net income per share can be found in our earnings release contained in the Investor Relations section of our website, www.apolloreit.com. GAAP book value per share at December 31, 2012, was $16.43. As a reminder, we do not mark our loans to market for financial statement purposes. We currently estimate that there's another $0.41 per share value when our loans are marked-to-market, and as such, estimate our market value per…

[Operator Instructions] Your first question comes from Gabe Poggi with FBR. Gabriel J. Poggi - FBR Capital Markets & Co., Research Division: Two just kind of general questions. One, Stuart, I think I ask this every quarter, but about spread, going to get the question of spread compression. Are you guys seeing any material spread compression kind of in the mezzanine area where you guys are focusing? And then secondly, if you could provide any additional color around the pipeline, if there's any specific areas where you're focusing on, looking, asset classes, that would be helpful.

Sure. I'll answer your second question first, Gabe, and then I'll let Scott comment and I'll also comment on your first question. I think in terms of areas of focus, look, I think we tend to continue to be drawn to those transactions that might require deeper underwriting, more structure. I think as we've stated many times before, there's significant confidence in our abilities to underwrite effectively to use the Apollo network to diligence, transactions, and to the extent we can get paid a little bit more around transactions with greater structure, greater complexity. We think at the end of the day, it moves the needle more. But we're still looking across the U.S., we're still looking across property types, and I think we're trying to cast as broad a net as possible in terms of sourcing deals at this point in time.

Scott, I mean, on your spread comment, kind of echoing what Stuart was saying, clearly on the more liquid space, whether it be CMBS or even, I would say, the larger portfolios which might have subordinate debt, yes, you have seen yield and spread compression. Really, anything that can trade on Bloomberg has definitely gotten tighter in sympathy or in correlation with the rest of the credit market's high yield and everything like that. But the stuff that we do, clearly, you can't do it on Bloomberg, whether it be direct origination, co-origination, it's stuff you need to be able to underwrite the real estate. The senior lender wants to know who's in the capital stack with them, as does the borrower, so it does not lend itself to XYZ hedge funds, buying it through their sales force.

Your next question comes from Joel Houck with Wells Fargo.

Just to kind of, I guess, follow on to that question. I mean, in terms of where you guys see incremental value in the mortgage chain as you look out in 2013, your spreads have come down, but it looks like, particularly for a sub product when you're able to do deep due diligence, you're still getting very attractive attachment points. I mean, how do you see the mix between kind of seeing your sub playing out in 2013 with respect to where you guys invest new capital?

Sure. I mean, I would say we talked about we don't really see the opportunity today on the most liquid space. You don't see really, any opportunities with or without leverage on the securities side. I would say, the first mortgage side, we still are seeing opportunities. It would be stuff that does not fit into the securitization bucket or into kind of a lower leverage bank balance sheet, which might be a conversion type deal like we did in Manhattan, maybe an inventory loan on a condominium project that's finished or some sort of property going through a lease up or transition, and those are the type of deals that we can put. Hopefully, the unlevered yield works, but also, to the extent we want to increase the leverage and the yield, we can use our JPMorgan facility for that. On the sub debt space where there's been no mezz or preferred equity, it's really all property types. I mean, we still are working on long-term fixed rate loans, bonds that were the senior mortgage debt securitized. We're looking at loans where the seniors is a balance sheet lender. So I would say it's properties that might be going through some sort of transition or conversion like one of the properties we also did in New York that's being converted to multifamily, or could be a cash loan hotel portfolio or some other property type where, for execution reasons, it makes the most sense to put the senior into a CMBS deal. And when the borrower looks at its blended cost of funds, it's still very attractive, even layering in our mezz.

Okay. And can you just remind us the fact on the JPM facility for the senior stuff, what's -- or the first mortgage loans, what's the advance rate there?

Yes, I mean just to keep it as simple as possible, to the extent we do a first mortgage that is in the 60% to 65% LTV envelope, we're getting 60% to 65% against our 60% to 65%.

Okay. Because one of the reasons I asked is obviously, the leverage weight IRR is much higher than what you're currently carrying on that. And so we're trying to gauge where that could go because I think that's incremental earnings power for you guys if you choose to use that leverage facility.

And we have used it in the past, and I think Megan's comment earlier about us having, call it, $25 million of capital left to deploy that is sort of based on what we know is in closing in our pipeline today, and it also assumes that as cash winds down, we start using the JPMorgan facility. So that $25 million, I would say, is inclusive of us using the JPMorgan facility to the extent we have collateral to support borrowings.

[Operator Instructions] Your next question comes from Rick Shane with JPMorgan. Richard B. Shane - JP Morgan Chase & Co, Research Division: My question for you is just related to the equity compensation in the fourth quarter. We had some variance verses our model, and I want to make sure that we fully understand the drivers there. We've gone back, and obviously, it's related to the LTV program. Can you sort of help us understand how to think about what happened in the fourth quarter, and I mean, if you can sort of walk us through expectations for 2013? And the challenge I have is when we look at, for example, the vesting schedule on the RSUs [ph], those tend to be pretty concentrated in the first quarter, but the expense doesn't seem to be. And there doesn't really seem to be a lot of correlation with the vesting schedule either to the RSUs or the restricted stock throughout the year.

For the expenses, the fluctuation in it is primarily related to the stock price. At the end of the third quarter, the stock price was in the 17s, and at the end of the fourth quarter, it was in the 16s. So you do pick up the cumulative effect of that decline in the stock price over the quarter. Richard B. Shane - JP Morgan Chase & Co, Research Division: And is there a true-up that occurs in the fourth quarter related to what happened throughout the year? Is that the other aspect to this?

Correct. There's a true-up related to, you value that whole pool at the current price. So as the price fluctuates, there will be some true-up in that number for life of to date of the [indiscernible]. Richard B. Shane - JP Morgan Chase & Co, Research Division: And so when we look into 2013, the restricted stock vesting goes way down. It goes down by about 90%, but the RSU vesting only goes down much more modestly. Should we expect a, if the stock price were to stay constant, a pretty significant decline in equity compensation on a year-over-year basis then, because of decline in the restricted stock vesting?

If there are not additional stock grants, that would be the case. But as additional stock grants come into play, that number will increase with those grants.

[Operator Instructions] At this time, I'm not showing any further questions.

Thank you, operator, and thank you, everybody, for participating.

Ladies and gentlemen, thank you for joining today's conference. Thank you for your participation. You may now disconnect.