Apollo Residential Mortgage (NYSE:AMTG)
JMP Securities Financial Services and Real Estate Conference Call
October 1, 2013, 10:30 AM ET
Stuart Rothstein - President and Chief Executive Officer, Apollo Commercial Real Estate Finance, Inc.
Michael Commaroto - President and Chief Executive Officer
Hilary Ginsberg - Investor Relations
Teresa Covello - Controller
Steve DeLaney - JMP Securities
Steve DeLaney - JMP Securities
Good morning, everyone. My name is Steve DeLaney. I'm the Senior Mortgage Finance Analyst at JMP Securities. On behalf of my entire team, it's our pleasure to introduce to you two public mortgage REITs that are managed by Apollo Global Management, ticker APO, a global alternative asset manager with AUM at June 30 of approximately $113 billion.
First, a commercial company, Apollo Commercial Real Estate Finance; ticker, ARI. The stock closed at $15.27 yesterday. This is a $550 million market cap. Both of these companies are based in New York City.
And ARI is a post-crisis commercial mortgage REIT. They completed its IPO in 2009. Four years later, the company has total assets of approximately $900 million, consisting of CMBS, senior CRE loans and mezzanine loans. Presenting for ARI today will be the President and CEO, Stuart Rothstein, to my immediate left.
The second company on the residential side, Apollo Residential Mortgage, Inc.; ticker, AMTG. Their shares closed at $14.59 yesterday. The market cap $475 million. Both companies ironically pay the same quarterly dividend of $0.40 and both offer a yield of approximately 11%.
AMTG is a hybrid residential mortgage REIT. They became public just two years ago in 2011. The company invest in agency MBS, non-agency MBS and also small investment in residential whole loans. The portfolio stood at approximately $3.3 billion at June 30. With us today to discuss the residential strategy at Apollo is the President and CEO, Michael Commaroto.
And also I'd like to introduce two other Apollo officers who are with us today, Hilary Ginsberg, who does Investor Relations for each company; and Teresa Covello, who is the Controller for the residential company. Stuart will kick us off, and then followed by Michael, and we'll do a combined Q&A at the end. Okay. Stuart?
Thanks, Steve, and thank you to those of you for attending today. So as Steve mentioned, went public in 2009, post the financial crisis. We have the equity capitalization today at $650 million, which is both common equity as well as [indiscernible] preferred equity that we managed. We've paid $0.40 a share or $1.60 annually. For the last three years, the dividend yield is just a little north of 10%.
The portfolio today is about $750 million worth of investments across three broad asset classes, CMBS, first mortgages and subordinated debt or mezzanine loans. And throughout the four-year history of the company, the investments we've made have generated an underwritten IRR of about 14.2%.
A quick overview of the company. The company was started in 2009, to be a balance sheet lender in the real estate space. Just to reflect that briefly on the context in '09, the CMBS market was significantly diminished in terms of the capacity at that point in time. Banks had pulled back and those were significant amount, over a $1.5 trillion worth of commercial mortgage debt that needed to be refinanced some time in the next five years.
As we sit here today, there is still over a $1.5 trillion of commercial real estate debt that needs to be refinanced over the next five years. And that's the result of really two things, one is, much of what needed to be refinanced in '09, '10 and '11 was really just pushed out through short-term fixes, either through a blend in extends or other strategies, where either banks or special servicers didn't want to deal with the problems near-term and would rather deal it in the future.
And we're now also getting to the stage in the cycle, where much of the 10-year paper that was originated in '03, '04, '05 and '06 are going to start coming up for refinancing. So the opportunity set still looks pretty attractive for the company.
In terms of the CMBS market, it has come back. Just to put it in perspective for people, in 2006, 2007, north of $200 billion worth of CMBS issuance. In 2009, zero CMBS issuance. Last year, we did about $45 billion as a market. This year that'll be somewhere in the $70 billion to $75 billion. So the market is coming back, deals are getting done. And what's more important is real estate transactions are taking place, which drives financing opportunities for us as a company.
I talked a little bit about the existing portfolio. The one thing I will mention, given that there is a lot of mortgage REITs coming up here today. In terms of exposure to rates, which has obviously been a topic of interest over the last few months, we do a mix of both fixed rate and floating rate lending, about a third of our book today is floating rate.
What's more important, given the potential rise in rates, is that we use less than half a return of leverage across the entire portfolio. We don't lever any of our subordinated debt positions. We do use some leverage against our CMBS in our first mortgage position, but if you look at the book today, there is about 0.4 turns of leverage across the company. So we're not exposed on the financing side to short-term rises in rates.
The overview of the portfolio today. Most recently we've been most active on the subordinated debt side of things. Typically, for us that means an LTV somewhere in the 65% to 75% range. On the floating rate basis, we're doing deals, we call it L plus 9 to L plus 11. And on a fixed rate basis, we're doing on roughly between 12% and 14%. Typical duration on the mezz loan is three to four years. The average life of our portfolio today is a little bit north of four, because we've also layered in some longer-term 10 year fixed rate deals.
On the first mortgage side of things, typically what we look at on the first mortgage side of things are those assets that have some sort of transitional renovation going on, whether it be an office building that needs to be restock, a multi-family assets that's going from rental to for-sale condo and we've also done some deals on commercial buildings that are going from commercial use to residential use particularly here in Manhattan.
And then lastly, on the CMBS side. We are most active in CMBS in the 2009 timeframe, when we bought legacy CMBS with TALF financing. That's what you see here on this Slide, as CMBS AAA's. Most of those investments have runoff. We've since replaced the TALF financing with more attractive repo financing. And we would expect most of those investments to payoff in the next year, as we held in CMBS, given their debt refinancing in advanced of their planned IPO.
In terms of the way we think about competing as well as what we've focused on recently and to describe most of our businesses co-origination. We do mezzanine loans in conjunction with either insurance companies, banks or conduit shops that are providing first mortgages. We're not buying in the secondary market. We are at the table closing the deal, as the financing is getting done.
If you think about the way deals were done in 2007 versus today. In 2007, originators were very comfortable taking down the entire financing stack. Figuring out what they could hold on balance sheet. Figuring out what they could put into a securitization. And then once they got that done, they figure out what to do with the mezz pieces and sell them in the aftermarket.
Given the way most peoples' balance sheets are run today, originators want to know where all the pieces of the stack are spoken for before they complete a deal. So typically we will work with a handful of folks on a financing, to try and figure out where in the stack we would be and give someone comfort that there is someone speaking for that piece at the time they close.
I mentioned we've been active in New York City. We've done approximately $300 million worth of deals in New York City over the last year, most of it focused on the residential space. And everything from rental residential through for-sale condo, we continue to be fairly bullish on the New York market and we'll look to make additional investments in the market.
And then lastly, I'll talk about two other things we have done to add to the strategies we pursue. We announced a JV to explore investments in the net lease real estate space on an equity ownership basis. We structured a partnership whereby we control the investment decisions. We control all the capital decisions. We are working with a group with long history in this space. To the extent we find deal's great. To the extent we don't find deals, it ended up being a cheap option as a way for us to look at what might be out there.
And then last week, we announced that in partnership with Apollo as well as several other strategic investors, we are going to buy a German bank, which is still subject to regulatory approval, but it should close next year. And leave you that as a way to give us a window into what's going on in the European financing markets, which from our perspective we view as being three to four years behind where the U.S. was and there should be opportunities coming out of that market.
With that, I'll turn it over to Michael.
Good morning. Thank you, Stuart, and thank you, Steve, for having us here again. AMTG is our ticker, Apollo Residential Mortgage, went public in 2011. We've done a couple of secondaries. We've done a preferred as well. Market cap right now is roughly $653 million, a combination of preferred and common.
As Steve mentioned, we are hybrid residential mortgage REIT, which means we are focused in the residential space. But in the residential space there's a broad mandate. We're focused on agency, we're focused on non-agency, we can focus on home loans, we can pretty much invest in any type of residential mortgage asset.
Right now, portfolio is roughly $3.3 billion. This brought in our portfolio at 2.1% with a prudently leveraged, getting a levered return of 11.8%. We just paid a $0.40 dividend for the second quarter, annualized at $1.60 a year, and on a yield stock price 10.7%.
So right now we view us as trading [indiscernible] to our peer group. We're trading at 80% of book. So we think first where the peer group, we're achieving to represent good value. In order to think that, let's take a look at the portfolio to tell you what we've been doing with it.
You see, the bottom part of the Slide, you'll see where our portfolio was at the end of March. It typically was a hybrid REIT. We try to do on the business 60-30-10 agency, non-agency and cash. In the second quarter, as REIT started to move up very rapidly in May and June, we made certain changes to the book. The first thing we did is we added more swaps and swaptions to protect our interest rate exposure. We removed our duration gap pretty close to zero and in some cases we're actually a little bit negative.
But not just looking at any swaps and hedges and swaptions, we also said looking to the book, maybe we have to restructure it. So on the agency side of the book we looked that we owned and made a conscious decision to trade some of the assets that we thought had the worse and negative convexity profile that we owned.
So we sold some of our lower coupon, fixed-rate agency paper. We chose not to just invest that money back into agencies, we held them in cash. And in over time, we've invested that cash into sub-prime floaters. So we made a decision to move the book from a fixed rate agency book to book that's much more focused on floating rates sub-prime.
What we've looked at is, is the risk of the book, as having an agency book that was heavily focused on basis risk and spread risk and rate risk. Moving to a business that we believe is much more constructively focused on where the housing market is going and how the borrowers are going to perform.
If you take a look at the right hand side of the Slide, you'll see different size of our portfolio and with returns on how we have them leveraged. And leverage is really important to look at on this Slide, because the agency book leverage is roughly 6 to 1, the non-agency book 2.8 to 1 and the whole loan book 2x.
So once again we've made this conscious decision to take our leverage down. Our agency book historically have been levered closer to 8x. Now, we've chosen not do here is try and chase returns by chasing the leverage in the market. We're trying the prudent use of leverage and they can chose our spots, move away from rate risk and focus on credit risk and focus on borrower risk.
Page 7 tells you why we want to do that. What we see in the market, what we're attracted to. Of course, at the top of the Page, you can look at some of the fundamentals. On the left hand side, just give you a sense of what's going on with borrower performance. You see the delinquent mortgages peaked in 2009 and then trending down ever since, so better cash flows from the underlined borrowers.
On the right hand part of the Slide, you see S&P/Case-Shiller Index, that's the national index. So it shows that right now for the June quarter-end 10% appreciation year-over-year from June to June. If you look at this slightly now over [indiscernible]. So a strong recovery in the housing market. So strong fundamentals across the top of the Page.
On the bottom left-hand side of the Page, it gives you a sense of what's going on just in terms of technical in the market. So how big is a non-agency market? What's outstanding? And you'll see just over the course of the past two years, the market shrunk from $1.2 trillion to now roughly $900 billion of outstandings, so strong fundamentals and obviously strong technical supporting the assets that we're investing in.
And what does that mean for the assets we're investing in? So on the right hand lower quadrant, you will see the ABX 06 2 Series of AAA bond and how that's performed overtime. You'll see it's almost rallied straight up since 2011, since we've gone public. It's at a near-term high in the mid-to-high 70s in early May, trigger off a little bit, when people went risk off in late May and early June. And now it's come back around.
So again, our view of credit is we're incredibly constructive on homeowner credit, on borrower credit, the path of home prices. And we're not making you bet on home prices. If you really look at our assumptions and our model, we're much, much, much more focused on looking at a much more stable recovery in housing, and it's not again a bet on leverage or not a bet on just ramp in home price recovery.
We still have a strong a position in agencies as well because again a big chunk of our capital is still invested in the agency side of the business. So on the REIT side of the business two things to keep in mind. Left-hand side of the Slide, you'll see the performance of the 2-10, which is the blue line. It gives you a sense of how that's flattened, once again since we've gone public in 2011 to earlier this year and now starting to turn back around.
So most spread in the market as the 2-10 part of curve is steepening and also if you look what's going on with mortgage rates, the red line obviously mortgage rates starting to spike up pretty dramatically in the second quarter of this year. So again, more opportunity just in the shape of the curve and what's going on with mortgage yields in that market.
And then beyond that if you look at the right hand part of the Slide that gives you a sense of what's going on with respect to prepayment incentive. One of the big drivers for us when we got into the REITs business was that that there is still a lot of friction in the market that makes it hard for borrowers to prepay, adding more stability to the cash flows. It's more predictability to the assets we're buying.
And you will see that the blue line and the red like converge throughout the cycle, but start to brake upon in 2008, when mortgages go deeply in the money as rates go down, but because there is so many frictions with respect to borrower credit, homeowner values it becomes hard and hard for borrowers to prepay. And obviously prepayment rates start to go down.
So information, what we've done with the book, we believe is moved the book from rate risk to credit risk. A lot of people say, hey, Michael, have you de-risked the book, and the answer is no. We haven't really de-risked, but we've changed our risk. We had a book that's more highly levered with more liquid assets in the agency business. Now, we have a book that's less highly levered, which on one hand is a positive, but we know the reason it's less highly levered because we know the bonds we own are slightly less liquid.
But nonetheless, with our liquidity profile, we like those bonds. We like to do with housing. We like to do with borrower performance. We're moving away from rate risk and spread risk and basis risk, trying to predict where that's going and trying to dynamically hedge our portfolio. We still do that for the risk we own, but I think it's much more constructive to own the sub-prime risk, the borrower risk, the homeowner risk, the housing risk in the context of floating rate assets financed with floating rate liabilities.
So that's our story. We love to talk to you guys about questions, talk to you about what we've done with the book. And turn it over to you. Thank you.
Steve DeLaney - JMP Securities
Somebody in the right.
No, I think the important thing with respect to the portfolio composition is what drives the dividend. It's really a function of when we took off the agencies and we want to cash and then how long it took us to reinvest into non-agencies we like. Because one thing that we're focused on is what do we chose in terms of the asset that we're going to buy, so we don't want to just go into the market and try and buy the ABX Index to go and try and buy whatever bond is on offer, it's a very detailed process that we do. So it's a smaller, thinner market. So we definitely had some cash drag in the second quarter.
Now, with respect to swap valuations and I think the book value has -- [indiscernible] context to this meaning, but I will say, the market has come back. I think a lot of people thought you'd see chasing on behalf on fed and part of fed, which will push rates higher still. Obviously when that didn't happen in the middle of the month, we've seen a pretty incredible rally in the month of September.
Unidentified Company Representative
And we [indiscernible] confirm that especially with last week's rally and the move now down to the mid 260s in the 10 year. I think on both the agency, as a group I think we have the agency REITs up about 3% currently versus June and the hybrid REITs positive. I think pretty much universally, I can't recall. Do we have any companies, agency or hybrids that we actually are modeling down?
Its de minis, so compared to the second quarter when we had agency REITs down 14.5% on average on both and hybrids down about 10%, this is going to be a benign quarter for book, because everyone reacted I think appropriately and either de-levered or hedged, we've seen the dividends come off.
And what our view going forward is that the second quarter was the book value washout, third quarter was sort of the dividend wash out. We kind of like the stability of these dividends going forward, especially in slower prepay environment that we have.
I'll throw one to Stuart if I may. Stuart, you have focused more on the mezzanine loans sub that as you referred to, you do have 140-some million of senior loans. I think you closed in September another -- you had to close a loan of which it had a whole loan of 30-some millions, so you're about a 176 million.
Two things, one would you talk about sort of the pricing at the margin that you see in terms of spreads over LIBOR, and then also since essentially you're un-levered on that senior loan book, at some point would you consider a CLO transaction to put some non-recourse financing?
Sure. Just in general, the first mortgage market to get people some contacts. We went public in 2009, the fixed rate first mortgage market was somewhere around 8% to 9% market, talking about LTV's in the 55% to 60% range. And rates somewhat dependant on asset type, and really there was no floating rate market at the time.
To fast forward to today, with the restarting of the CMBS market some of the banks getting more aggressive on real estate, certainly Wells Fargo leading the way in terms of commercial banks.
The fixed rate market is anywhere from, call it 4.5% to 6% and the LIBOR market is probably L plus 375 to L plus 5 depending on asset. And what I am describing there is generally speaking stabilized collateral, good cash flow, well-leased office buildings, well-leased multifamily retail. Long story short for us, as a company, none of that is really a market we can play in today. We can't compete with the conduits, we can't compete with the commercial banks.
What we do on the first mortgage side typically is more real estate in some sort of transition. In office building that's 80% leased, where the market is 90%, a multifamily rental asset that someone wants to convert to for sale condo. And in those types of transaction, you can create first mortgage pieces that are more L6, L7 or 7% and 7.5% fixed rates. We've got a facility with JP Morgan in place that allows us to borrow on a short-terms basis against our first mortgages to the extent we do a 65% LTV loan we roughly get 65% against our 65%.
I think as assets in our portfolio reach stabilization, we can then think about financing the money more longer-term basis, that as long as there is something transitional going on with the real estate. The financing we've been able to get through the bank market is more attractive than a CLO.
But is it safe to say that given that you've got -- well, let's just talk about June numbers. A $140 million of floating rate senior loans and I think $3 million at debt, can we look at that as a source of liquidity for you to as part of -- yes.
It's a source of investable cap.
So its having to come back to market.
Yes, it's certainly a source of investable cap.
[indiscernible] we have anything for Michael?
With the shift you're making away from rate risk towards credit risk, could maybe talk a little bit what you see in the whole loan space and how you think about the opportunities with the whole loan versus [indiscernible] market?
Yes, sure, I'll have a minute to do that. By the way the simple answer is we spend a lot of time looking at that. We did whole loan trade in February that we liked a lot. It was a re-performing trade that we bought, termed out with respect to securitization, sold the senior bond, sold the M1 and kept the M2 and the equity piece. And once again, we think that was a trade that played our strength. It was liquidating trade from a bank of legacy assets, so we understand very well and those are the type of assets we want to own.
With whole loans typically, we do not spend a lot of time on the jumbo trade. And we wanted to raise I think a lot of our peer group and every guy in our space looking at jumbos. The jumbo market is very efficient. The borrowers have a great propensity to refinance pretty quickly. And the [indiscernible] refinance at the worse time, so they have a worse negative industry profile, I would think of any asset that's out there. And we chosen in to look at credit on the whole loan side, much more from the bottom side up. So we're looking at what I would call kind of second generation sub-prime, maybe second liens, maybe, OREO related loans, but something that's much more credit focused and less focused just interest rate risk embedded around the credit product.
Well, we're out of time. There will be a breakup session directly across in the [indiscernible] room. And I'd like to thank Michael and Stuart for being with us today. Thanks.
Thank you, guys.
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