APOLLO COMMERCIAL REAL ESTATE FINANCE, INC. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Form 10-Q)
We make 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, we claim the protections of the safe harbor for forward-looking statements contained in such Sections. Forward-looking statements are subject to substantial risks and uncertainties, many of which are difficult to predict and are generally beyond our control. These forward-looking statements include information about possible or assumed future results of our business, financial condition, liquidity, results of operations, plans and objectives. When we use 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: the macro- and micro-economic impact of the COVID-19 pandemic, increasing interest rates and inflation; the severity and duration of the COVID-19 pandemic, including the emergence and spread of COVID-19 variants; actions taken by governmental authorities to contain the COVID-19 pandemic or treat its impact; the efficacy of the vaccines or other remedies and the speed of their distribution and administration; the impact of the COVID-19 pandemic on our financial condition, results of operations, liquidity and capital resources; market trends in our industry, interest rates, real estate values, the debt securities markets or the general economy; the demand for commercial real estate loans; our business and investment strategy; our operating results; actions and initiatives of the U.S.government and governments outside of the United States, changes to government policies and the execution and impact of these actions, initiatives and policies; the state of the economy generally or in specific geographic regions; economic trends and economic recoveries; our ability to obtain and maintain financing arrangements, including secured debt arrangements and securitizations; the timing and amount of expected future fundings of unfunded commitments; the availability 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 we participate; changes in the value of our assets; the scope of our target assets; interest rate mismatches between our target assets and any borrowings used to fund such assets; changes in interest rates and the market value of our target assets; changes in prepayment rates on our target assets; effects of hedging instruments on our target assets; rates of default or decreased recovery rates on our target assets; the degree to which hedging strategies may or may not protect us from interest rate volatility; impact of and changes in governmental regulations, tax law and rates, accounting, legal or regulatory issues or guidance and similar matters; our continued maintenance of our qualification as a real estate investment trust ("REIT") for U.S.federal income tax purposes; our continued exclusion 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 our ability to make distributions to our stockholders in the future; our present and potential future competition; and unexpected costs or unexpected liabilities, including those related to litigation. The forward-looking statements are based on our beliefs, assumptions and expectations of our future performance, taking into account all information currently available to us. 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 us. Refer to "Item 1A. Risk Factors" of this Quarterly Report on Form 10-Q and our Annual Report. These and other risks, uncertainties and factors, including those described in the annual, quarterly and current reports that we file with the SEC, could cause our actual results to differ materially from those included in any forward-looking statements we make. 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, we are not obligated to, and do not intend to, update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Overview We are a Marylandcorporation and have elected to be taxed as a REIT for U.S.federal income tax purposes. We primarily originate, acquire, invest in and manage performing commercial first mortgage loans, subordinate financings, and other commercial real estate-related debt investments. These asset classes are referred to as our target assets.
We are externally managed and advised by the Manager, an indirect subsidiary of Apollo, a high-growth global alternative asset manager with assets under management of approximately
The Manager is led by an experienced team of senior real estate professionals
whohave significant expertise in underwriting and structuring commercial real estate financing transactions. We benefit from Apollo's global infrastructure and operating platform, through which we are able to source, evaluate and manage potential investments in our target assets.
Current market conditions
34 -------------------------------------------------------------------------------- During the first quarter of 2020, there was a global outbreak of COVID-19, which was declared by the
World Health Organizationas a pandemic. The ongoing COVID-19 pandemic has adversely impacted global economic activity and has contributed to significant volatility in financial markets. Due to various uncertainties, including the rise of new variants, the severity of such new variants, disparities in vaccination rates and vaccine hesitancy, the ultimate duration of the pandemic, and additional actions that may be taken by governmental authorities, further business risks could arise. Although more normalized activities have resumed and there has been improved global economic activity due to global and domestic vaccination efforts, we are not in a position to estimate the ultimate impact COVID-19 and its variants will have on our business and the economy as a whole, including longer-term macroeconomic effects on supply chains, inflation and labor shortages. For example, in response to recent inflationary pressure, the U.S. Federal Reserveand other global central banks have raised interest rates in 2022 and have indicated likely further interest rate increases. The effects of COVID-19 and its variants have adversely impacted the value of our assets, business, financial condition, results of operations and cash flows, and our ability to operate successfully. Some of the factors that impacted us to date and may continue to affect us are outlined in Item 1A. "Risk Factors."
Significant Accounting Policies and Use of Estimates
A summary of our critical accounting policies is set forth in our Annual Report under "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies and Use of Estimates."
Real estate owned (and related debts)
From time to time, we may obtain legal title to the collateral from our loans due to non-performance. This acquisition of real estate is accounted for using the acquisition method under Accounting Standards Codification ("ASC") Topic 805, "Business Combinations." We recognize and measure identifiable assets acquired, liabilities assumed and any non-controlling interest in the acquiree, if applicable, based on their relative fair values. Once real estate assets have been recorded at fair value they are evaluated for impairment on a quarterly basis. Please refer to "Note 2 - Summary of Significant Accounting Policies," "Note 3 - Fair Value Disclosure," and "Note 5 - Assets and Liabilities Related to Real Estate Owned" for more information regarding real estate owned and our valuation methodology. Real estate assets acquired may include land, building, furniture, fixtures and equipment ("FF&E"), and intangible assets. The fair value of land is determined by utilizing the market or sales comparison approach, which compares the property to similar properties in the marketplace. Although we exercise significant judgment to identify similar properties, and may also consult independent third-party valuation experts to assist, our assessment of fair value is subject to uncertainty and sensitive to our selection of comparable properties. We estimate the fair value of any building and FF&E by the cost approach which measures fair value as the replacement cost of these assets. This approach also requires significant judgment, and our estimate of replacement cost could vary from actual replacements costs. Once real estate assets have been recorded at fair value, they are evaluated for impairment on a quarterly basis. We consider the following factors when performing our impairment analysis: (i) Management, having the authority to approve the action, commits to a plan to sell the asset; (ii) significant negative industry and economic outlook or trends; (iii) expected material costs necessary to extend the life or operate the real estate asset; and (iv) our ability to hold and dispose of the real estate asset in the ordinary course of business. A real estate asset is considered impaired when the sum of estimated future undiscounted cash flows to be generated by the real estate asset over the estimated remaining holding period is less than the carrying value of such real estate asset. An impairment charge is recorded equal to the excess of the carrying value of the real estate asset over the fair value. When determining the fair value of a real estate asset for the purpose of assessing impairment, we make certain assumptions including, but not limited to: consideration of projected operating cash flows, intended holding period of the real estate, comparable selling prices and projected cash flows from the eventual disposition of the real estate based upon our estimate of a capitalization rate and discount rate. While we exercise significant judgment in generating our assumptions, the asset's fair value is subject to uncertainty, as actual operating cash flows and disposition proceeds could differ from those assumed in our valuations. Additionally, the output is sensitive to the assumptions used in calculating any potential impairment. From time to time, real estate assets are classified as held for sale in the period in which the six criteria under ASC Topic 360, "Property, Plant, and Equipment" are met: (1) we commit to a plan and have the authority to sell the asset; (2) the asset is available for sale in its current condition; (3) we have initiated an active marketing plan to locate a buyer for the asset; (4) the sale of the asset is both probable and expected to qualify for full sales recognition within a period of 12 months; (5) the asset is being actively marketed for sale at a price that is reflective of its current fair value; and (6) we do not anticipate changes to our plans to sell the asset. Once a real estate asset is classified as held for sale, depreciation is no longer recorded, and the asset is reported at the lower of its carrying value or fair value less cost to sell. 35 -------------------------------------------------------------------------------- We determine the fair value of the real estate asset classified as held for sale using valuation methodologies appropriate to what is included within the disposal group, such as the market or sales comparison approach for land and the cost approach for any building and FF&E. Although we exercise significant judgment in generating the assumptions employed in these methodologies, ultimately, the real estate asset's fair value is subject to uncertainty, as the actual sales price of the real estate asset could differ from those assumed in our valuations. Further, if it is determined that the asset should be reported at its carrying value, the actual sales price of the real estate asset could also differ from this amount.
Current Expected Credit Losses (“CECL”)
We measure and record potential expected credit losses related to our loan portfolio in accordance with the CECL Standard. The CECL Standard requires an entity to consider historical loss experience, current conditions, and a reasonable and supportable forecast of the macroeconomic environment. The FASB recognizes the WARM method as an acceptable approach for computing current expected credit losses. We have adopted the WARM method to determine the General CECL Allowance for the majority of loans in our portfolio, applied on a collective basis by assets with similar risk characteristics. If we determine that a borrower or sponsor is experiencing financial difficulty, we will record loan-specific allowances (our Specific CECL Allowance). Refer to "Note 2 - Summary of Significant Accounting Policies" to our consolidated financial statements of our most recent annual report on Form 10-K and "Note 4 Commercial Mortgage Loans, Subordinate Loans and Other Lending Assets, Net" for further discussion regarding CECL.
General allowance CECL
There are various significant assumptions required to estimate our General CECL Allowance which include deriving and applying an annual historical loss rate, forecasting and analyzing the impacts of macroeconomic conditions and the timing of expected repayments, satisfactions and future fundings. We derive an annual historical loss rate based on a CMBS database with historical losses from 1998 through the third quarter of 2022 provided by a third party,
Trepp LLC. We apply various filters to arrive at a CMBS dataset most analogous to our current portfolio from which to determine an appropriate historical loss rate. Selecting these filters requires the use of significant judgment. The historical loss rate, and ultimately General CECL Allowance we calculated, is sensitive to the CMBS dataset that we select. We adjust our determined annual historical loss rate based on our outlook of the macroeconomic environment, for a reasonable and supportable forecast period-which we have determined to be one year. We determine our expectations for the macroeconomic environment by analyzing various market factors and assess the potential impact on our portfolio. This assessment requires the use of significant judgment in selecting relevant market factors and our expectations of the future macroeconomic environment. The future macroeconomic environment is subject to uncertainty as the actual future macroeconomic environment could vary from our expectations, which will impact our General CECL Allowance. Additionally, there are assumptions provided to us by the Manager that represent their best estimate as to expected loan maturity dates, future fundings, and timing of loan repayments. These assumptions, although made with the most available information at the time of the estimate, are subjective and actual activity may not follow the estimated schedule. These assumptions impact the future balances that the loss rate will be applied to and as such impact our General CECL Allowance. As we acquire new loans and the Manager monitors loan and sponsor performance, these estimates may change each period.
Specific CECL allowance
When we determine that a borrower or sponsor is experiencing financial difficulty, we evaluate the related loan for loan-specific allowances, under the practical expedient per the guidance. Determining that a borrower or sponsor is experiencing financial difficulty requires the use of significant judgment and can be based on several factors subject to uncertainty. These factors can include, but are not limited to, whether cash from the borrower's operations are sufficient to cover current and future debt service requirements, the borrower's ability to potentially refinance the loan, and other circumstances that can affect the borrower's ability to satisfy their obligations in accordance the terms of the loan. When utilizing the practical expedient for collateral dependent loans, the loan loss provision is determined as the difference between the fair value of the underlying collateral, adjusted for estimated costs to sell when applicable, and the carrying value of the loan (prior to the loan loss provision), as repayment or satisfaction of a loan is dependent on a sale of the underlying collateral. Collateral-dependent loans evaluated for a Specific CECL Allowance are removed from the General CECL pool. The fair value of the underlying collateral is determined by using method(s) such as discounted cash flow, the market approach, or direct capitalization approach. These methods require the use of key unobservable inputs, which are inherently uncertain and subjective. Our estimate of fair value is sensitive to both the valuation methodology selected and inputs used. Determining a suitable valuation method and selecting the appropriate key unobservable inputs and assumptions requires significant judgment and consideration of factors specific to the underlying collateral being assessed. Additionally, the key 36 -------------------------------------------------------------------------------- unobservable inputs and assumptions used may vary depending on the information available to us and market conditions as of the valuation date. As such, the fair value that we derive and use in calculating our Specific CECL Allowance, is subject to uncertainty and any actual losses, if incurred, could differ materially from our provision.
Refer to “Note 2 – Summary of Significant Accounting Policies” to our Consolidated Financial Statements in our most recent Annual Report on Form 10-K for a complete listing and description of our significant accounting policies.
All non-USD denominated assets and liabilities are translated to USD at the exchange rate prevailing at the reporting date and income, expenses, gains, and losses are translated at the prevailing exchange rate on the dates that they were recorded. Loan Portfolio Overview
The following table presents certain information regarding our loan portfolio in
Weighted Average Equity at Weighted-Average Coupon All-in Yield Secured Debt carrying Description Carrying Value (1) (1)(2) Arrangements (3) Cost of Funds(4) value(5) Commercial mortgage loans, net
$ 8,013,4695.7 % 6.5 % $ 5,364,1194.3 % $ 2,649,350Subordinate loans and other lending 717,837 6.5 % 7.1 % - - 717,837 assets, net Total/Weighted-Average $ 8,731,3065.8 % 6.5 % $ 5,364,1194.3 % $ 3,367,187
(1) Weighted-Average Coupon and Weighted-Average All-in Yield are based on the applicable benchmark rates as of
September 30, 2022on the floating rate loans. (2) Weighted-Average All-in Yield includes the amortization of deferred origination fees, loan origination costs and accrual of both extension and exit fees. Weighted-Average All-in Yield excludes the benefit of forward points on currency hedges relating to loans denominated in currencies other than USD. (3) Gross of deferred financing costs of $13.5 million. (4) Cost of funds includes weighted average spread and applicable benchmark rates as of September 30, 2022on secured debt arrangements. (5) Represents loan portfolio at carrying value less secured debt outstanding.
The following table sets out the details of our commercial mortgage portfolio and our portfolio of subordinated loans and other loan assets, on a loan-by-loan basis, at
Commercial Mortgage Portfolio
Construction # Property Type Risk Rating
Date of origination Amortized cost Unfunded commitment Loan
3rd Party Subordinate Debt Fully-extended Maturity
Location 1 Hotel 3 10/2019
$304 $28Y 08/2024 Various, Spain2 Hotel 3 11/2021 186 20 Y 11/2026 Various, UK/ Ireland3 Hotel 3 05/2022 178 25 Y 06/2027 Napa Valley, CA4 Hotel 3 04/2018 152 - 04/2023 Honolulu, HI5 Hotel 3 07/2021 146 33 08/2026 Various, US 6 Hotel 3 09/2015 146 - 06/2024 Manhattan, NY7 Hotel 3 11/2021 123 41 Y 12/2026 St. Thomas, USVI 8 Hotel 3 08/2019 117 - 08/2024 Puglia, Italy9 Hotel 3 10/2021 99 - 11/2026 New Orleans, LA10 Hotel(3)(6) 5 03/2017 98 - 10/2022 Atlanta, GA11 Hotel 3 11/2018 90 - 12/2023 Vail, CO12 Hotel 3 12/2019 60 - 01/2025 Tucson, AZ13 Hotel 3 05/2021 59 2 Y 06/2026 Fort Lauderdale, FL14 Hotel 3 05/2019 52 - 06/2024 Chicago, IL15 Hotel 3 12/2015 42 - 08/2024 St. Thomas, USVI 16 Hotel 3 10/2021 39 39 10/2026 Lake Como, Italy 17 Hotel 3 02/2018 27 - 11/2024 Pittsburgh, PA18 Hotel 3 12/2021 21 28 06/2025 Dublin, Ireland19 Office 3 01/2020 224 66 Y 02/2025 Long Island City, NY20 Office 3 03/2022 218 47 Y 04/2027 Manhattan, NY21 Office 3 02/2020 188 - 02/2025 London, UK22 Office 3 06/2019 183 13 08/2026 Berlin, Germany37
23 Office 3 02/2022 144 - 06/2025 Milan, Italy 24 Office 3 02/2022 128 384 Y 02/2027 London, UK 25 Office 3 11/2017 121 - 01/2023 Chicago, IL 26 Office(1) 3 12/2017 103 - Y 10/2022 London, UK 27 Office 3 06/2022 87 - 06/2025 Rome, Italy 28 Office 3 03/2018 86 - Y 07/2023 Chicago, IL 29 Office 3 11/2021 33 38 Y 11/2025 Milan, Italy 30 Retail 3 04/2022 417 34 04/2027 Various, UK 31 Retail 3 10/2021 362 - 10/2026 Various, UK 32 Retail 3 08/2019 249 - Y 09/2025 Manhattan, NY 33 Retail 3 05/2022 155 - 06/2027 Various, US 34 Retail(3) 5 11/2014 104 - 09/2023 Cincinnati, OH 35 Residential(4) 3 08/2022 354 4 09/2024 Manhattan, NY 36 Residential 3 12/2021 195 15 12/2026 Various, UK 37 Residential 3 12/2018 136 43 Y 12/2023 Manhattan, NY 38 Residential 3 12/2021 101 31 01/2027 Manhattan, NY 39 Residential 3 05/2022 89 4 06/2027 Manhattan, NY 40 Residential 3 05/2021 82 - Y 05/2026 Cleveland, OH 41 Residential 3 12/2019 60 7 Y 11/2025 Boston, MA 42 Residential 3 04/2014 59 - 07/2023 Various 43 Residential 3 11/2014 50 - 06/2023 Various, US 44 Residential 3 12/2021 32 - Y 01/2026 Hallandale Beach, FL 45 Healthcare 3 03/2022 372 - 03/2027 Various, MA 46 Healthcare 3 10/2019 180 - 10/2024 Various, UK 47 Mixed Use 3 12/2019 281 88 Y Y 06/2025 London, UK 48 Mixed Use 3 03/2022 134 42 Y 03/2027 Brooklyn, NY 49 Mixed Use 3 06/2022 59 58 Y Y 06/2026 London, UK 50 Mixed Use 3 12/2019 39 - 09/2023 London, UK 51 Parking Garages 3 05/2021 270 5 05/2026 Various, US 52 Industrial 3 03/2021 232 - 05/2026 Various, Sweden 53 Portfolio(2) 3 06/2021 207 20 06/2026 Various, Germany 54 Caravan Parks 3 02/2021 183 - 02/2028 Various, UK 55 Urban Predevelopment(3) 5 01/2016 176 - 09/2023 Miami, FL General CECL Allowance (19) Subtotal / Weighted-Average Commercial Mortgage Loans 3.1
$8,013 $1,1153.1 Years
Portfolio of subordinated loans and other loan assets
# Property Type Risk Rating
Original date Amortized cost Unfunded commitment Construction loan Third-party subordinated debt Maturity fully extended
Location 1 Residential(4) 3 05/2020
$232$- Y 09/2024 Manhattan, NY2 Residential(4) 3 06/2015 187 13 Y 09/2024 Manhattan, NY3 Residential(3)(4) 5 11/2017 52 - Y 09/2024 Manhattan, NY4 Office 3 01/2019 100 - 12/2025 Manhattan, NY5 Office 3 08/2017 8 - 09/2024 Troy, MI6 Healthcare(5) 3 07/2019 51 - Y 06/2024 Various, US 7 Hotel 3 06/2015 23 - 07/2025 Phoenix, AZ8 Hotel 3 06/2018 20 - 06/2023 Las Vegas, NV9 Industrial 2 05/2013 32 - 05/2023 Various, US 10 Mixed Use 3 02/2019 16 - 10/2022 London, UK General CECL Allowance (3) Subtotal / Weighted-Average Subordinate Loans and Other Lending Assets 3.1 $718 $132.0 Years 38
Total / Weighted-Average Loan Portfolio 3.1
$8,731 $1,1283.0 Years ------- (1)Includes $22.7 millionof a subordinate participation sold accounted for as secured borrowing. (2)Includes portfolio of office, industrial, and retail property types. (3)Amortized cost for these loans is net of the recorded Specific CECL Allowance. (4)Loans are secured by the same property. (5)Single Asset, Single Borrower CMBS. (6)Loan went into maturity default subsequent to the quarter ended September 30, 2022.
Our average asset and debt balances for the nine months ended
were (in thousands of dollars):
balances for the nine months ended
September 30, 2022 Description Assets Related debt Commercial mortgage loans, net $ 7,977,494 $ 5,039,066 Subordinate loans and other lending assets, net 786,893 - Subordinate loans, held for sale 833 - Portfolio Management Due to the impact of COVID-19, including longer-term macroeconomic effects on supply chains, inflation and labor shortages, some of our borrowers have experienced challenges which have prevented the execution of their business plans and in some cases, resulted in temporary closures. As a result, we have worked with borrowers to execute loan modifications which are typically coupled with additional equity contributions from borrowers. Loan modifications to date have included repurposing of reserves, temporary deferrals of interest or principal, and partial deferral of coupon interest as payment-in-kind interest. Investment Activity During the nine months ended
September 30, 2022, we committed $3.5 billionof capital to loans ( $2.8 billionwas funded at closing). In addition, during the nine months ended September 30, 2022, we received $1.5 billionin repayments and funded $0.5 billionfor commitments closed prior to 2022.
Net income available to common shareholders
For the nine months ended
September 30, 2022and 2021, our net income available to common stockholders was $260.0 million, or $1.66per diluted share of common stock, and $176.5 million, or $1.18per diluted share of common stock, respectively.
The following table sets forth information regarding our condensed consolidated results of operations and certain key operating metrics compared to the most recently reported period ($ in thousands): 39 --------------------------------------------------------------------------------
Three months ended September 30, June 30, 2022 Q3'22 vs. Q2'22 2022 Net interest income: Interest income from commercial mortgage loans
$ 120,821 $ 99,386$ 21,435 Interest income from subordinate loans and other 13,354 14,530 (1,176) lending assets Interest expense (72,302) (56,529) (15,773) Net interest income 61,873 57,387 4,486 Operations related to real estate owned: Revenue from real estate owned operations 14,428 18,630 (4,202) Operating expenses related to real estate owned (13,308) (13,134) (174) Net income related to real estate owned 1,120 5,496 (4,376) Operating expenses: General and administrative expenses (7,184) (7,130) (54) Management fees to related party (9,719) (9,632) (87) Total operating expenses (16,903) (16,762) (141) Other income 285 68 217 Realized gain on investments 43,577 - 43,577
Cancellation of loan losses – CECL specific deduction, 53,000
Reversal of (provision for) loan losses - General 2,564 (2,056) 4,620 CECL Allowance, net Gain on foreign currency forward contracts 129,252 105,213 24,039 Foreign currency translation loss (92,782) (84,838) (7,944) Gain on interest rate hedging instruments 1,044 3,443 (2,399) Net income
$183,030 $70,951 $112,079Net Interest Income Net interest income increased by $4.5 millionduring the three months ended September 30, 2022compared to the three months ended June 30, 2022. The increase in interest income was primarily due to higher average index rates in the current period: average U.S.LIBOR increased by 1.48%, average U.S.SOFR increased by 1.50%, average Daily SONIA increased by 0.66% from the three months ended June 30, 2022to the three months ended September 30, 2022. Average EURIBOR increased by 0.49% during three months ended September 30, 2022above the 0.0% floors taken during the three months ended June 30, 2022. The increase in interest expense was primarily due to (i) higher average index rates in the current period, as noted above, and (ii) an increase in the weighted average balance of our outstanding debt facilities by $135.2 millionfor the three months ended September 30, 2022, as compared to three months ended June 30, 2022, which was partially offset by a decrease in interest expense related to the payoff of the 2022 Notes.
Transactions related to real estate held
In 2017, we originated a
$20.0 millionjunior mezzanine loan which was subordinate to: (i) a $110.0 millionmortgage loan, and (ii) a $24.5 millionsenior mezzanine loan, secured by a full-service luxury hotel in Washington, D.C.On May 24, 2021, we acquired legal title to the hotel through a deed-in-lieu of foreclosure and the criteria for held-for-sale classification in ASC Topic 360, "Property, Plant, and Equipment" were not met. The assets and liabilities related to the hotel were assumed at their estimated fair value at acquisition and presented net of accumulated depreciation and impairment charges. As of March 1, 2022, the related assets and liabilities were transferred to assets and liabilities related to real estate owned, held for sale, as due to our marketing efforts on the property, as well as other developments, it now met the criteria for held for sale. Results of operations from the hotel are comprised of operating revenue, expenses and real estate asset depreciation. As of March 1, 2022, we ceased recording depreciation on the building and FF&E on the condensed consolidated statement of operations as the property was transferred to held for sale at such date. The hotel operations generated $1.1 millionof net income during the three months ended September 30, 2022compared to $5.5 millionof net income during the three months ended June 30, 2022. The decrease in net income from hotel operations primarily relates to the decrease in hotel occupancy and events held due to seasonality of hotel operations during the three months ended September 30, 2022compared to the three months ended June 30, 2022.
Refer to “Note 5 – Assets and liabilities related to owned properties” for more information on our impairment and realized losses on owned properties.
General and administrative expenses
General and administrative expenses remained generally the same for the three months ended
Management fees to a related party
Management fees remained generally the same for the three months ended
Other income generally remained the same for the three months ended
Gain realized on investments
During the three months ended
September 30, 2022, a $43.6 millionrealized gain on investments was recorded in connection with the title acquisition for one of our first mortgage loans secured by a multifamily development in Brooklyn, NY. The gain reflects the difference between the fair value of the property and the carrying value of the loan at the time of acquisition.
Refer to “Note 5 – Assets and liabilities related to properties held” for more information on our realized gains on investments.
Loan loss reversals – CECL specific provision, net
Our Specific CECL Allowance decreased by
$53.0 millionduring the three months ended September 30, 2022. We reversed $53.0 millionof previously recorded Specific CECL allowance on an urban predevelopment first mortgage loan in Miami, FL, because the collateral which secures the loan is under contract to be sold in the near term at a higher value than carrying value of the loan pre-reversal. During the three months ended June 30, 2022, we reversed $10.0 millionof previously recorded allowance on a loan related to a multifamily development in Brooklyn, NY, due to market rent growth and value created from development activities, which was partially offset by a $7.0 millionallowance on a loan secured by a hotel in Atlanta, GAresulting from the hotel having a slower than expected recovery from the COVID-19 pandemic. Refer to "Note 2 - Summary of Significant Accounting Policies" and "Note 4 - Commercial Mortgage Loans, Subordinate Loans and Other Lending Assets, Net" for additional information related to our Specific CECL Allowance.
Reversal of (provision for) loan losses – CECL general provision, net
Our General CECL Allowance decreased by
$2.6 millionduring the three months ended September 30, 2022compared to the three months ended June 30, 2022due to portfolio seasoning and sale of unfunded commitments, which was partially offset by one new loan origination and a more adverse macroeconomic outlook.. The General CECL Allowance increased by $2.1 millionduring the three months ended June 30, 2022compared to the three months ended March 31, 2022as a result of new loan originations and a more adverse macroeconomic outlook. Refer to "Note 2 - Summary of Significant Accounting Policies" and "Note 4 - Commercial Mortgage Loans, Subordinate Loans and Other Lending Assets, Net" for additional information related to our General CECL Allowance.
Foreign exchange loss and gain on derivative instruments
We use forward currency contracts to economically hedge interest and principal payments due under our loans denominated in currencies other than USD. When gains and losses on foreign currency translation and derivative instruments are evaluated on a combined basis, the net impact for the three months ended
September 30, 2022and June 30, 2022was a $36.5 millionand $20.4 milliongain, respectively. The increase from the previous quarter represents a timing difference between the valuation on the foreign currency forward contracts, which are valued using spot rates, forward point estimates, and discount factors, and the foreign currency translation calculation which uses only spot rates. Additionally, as rates fell significantly during the quarter our unrealized gain 41 -------------------------------------------------------------------------------- from derivative instruments, including derivative instruments related to our future expected interest cash flow, increased. As derivative instruments related to our future expected interest cash flow have no offset in foreign currency (loss) they are accounting for some of the variance noted above.
Gain on rate hedges
During the second quarter of 2020, we entered into a three-year interest rate cap to cap LIBOR at 0.75%. During the three months ended
September 30, 2022and June 30, 2022, the interest rate cap had an unrealized gain of $1.0 millionand $3.4 million, respectively. The decrease in the unrealized gain is a result of the nearing maturity of the cap offset by the current interest rate forward curve. Subsequent Events
Refer to “Note 20 – Subsequent Events” to the accompanying condensed consolidated financial statements for information on significant transactions that occurred after
Contractual obligations, liquidity and capital resources
Liquidity is a measure of our ability to meet potential cash requirements, including ongoing commitments to fund and maintain our assets and operations, repay borrowings, make distributions to our stockholders and other general business needs. We utilize various sources of cash in order to meet our liquidity needs in the next twelve months, which is considered the short-term, and the longer term. Our current debt obligations consist of
$1.5 billionof corporate debt at face value and $5.4 billionof asset financings. Our corporate debt includes: (i) $779.3 millionof term loan borrowings, (ii) $500.0 millionof senior secured notes, and (iii) $230.0 millionof convertible notes. Our asset specific financings are generally tied to the underlying loans and we anticipate repayments of $765.0 millionof secured debt arrangements in the short term. Specifics about our secured debt arrangements and corporate debt maturities and obligations are discussed below.
In addition to our debts, as of
We have various sources of liquidity that we are able to use to satisfy our short and long term obligations. As of
September 30, 2022, we had $319.3 millionof cash on hand. As of September 30, 2022, we also held approximately $1.1 billionof unencumbered assets, consisting of $517.8 millionof senior mortgages and $534.1 millionof mezzanine loans. Depending on market conditions, we may utilize additional borrowings as a source of cash, which may also include additional secured debt arrangements as well as other borrowings or conduct additional public and private debt and equity offerings.
We maintain policies relating to our use of leverage. See “Leverage Policies” below. In the future, we may seek to raise additional equity or debt capital or incur other forms of debt to fund future investments or refinance maturing debt.
We generally intend to hold our assets for investment purposes, although we may sell some of our investments to manage our interest rate risk and liquidity needs, to meet other business objectives, operation and adapt to market conditions.
To maintain our qualification as a REIT under the Internal Revenue Code, we must distribute annually at least 90% of our REIT taxable income, determined without regard to the deduction for dividends paid and excluding net capital gain. These distribution requirements limit our ability to retain earnings and replenish or increase capital for operations. We also have interests in two unconsolidated joint ventures, each of which owns underlying properties that secure one of our first mortgage loans, respectively and are accounted for as off-balance-sheet arrangements. The unconsolidated joint ventures were deemed to be Variable Interest Entities ("VIEs"), of which we are not the primary beneficiary. Accordingly, the VIEs are not consolidated in our condensed consolidated financial statements as of
September 30, 2022. Our maximum exposure to loss from these commercial mortgage loans is limited to their carrying value, which as of September 30, 2022was $227.2 million. Although there is risk of loss we have no contractual obligation to fund any additional capital into the joint ventures.
Borrowings under various financing agreements
The table below summarizes the unpaid balances and maturities of our various financings:
September 30, 2022 December 31, 2021 Borrowings Maturity (2) Borrowings Maturity (2) Outstanding(1) Outstanding(1) Secured credit facilities
$ 3,648,950January 2026 $ 2,256,646October 2025 Barclays Private Securitization 1,715,169 January 2026 1,902,684 August 2024 Total Secured debt arrangements $ 5,364,119 $ 4,159,330Senior secured term loans $ 779,250January 2027 $ 785,250January 2027 Senior secured notes 500,000 June 2029 500,000 June 2029 Convertible senior notes 230,000 October 2023 575,000 February 2023 Total Borrowings $ 6,873,369 $ 6,019,580------- (1)Borrowings Outstanding represent principal balances as of the respective reporting periods. (2)Maturity dates represent weighted average maturities based on borrowings outstanding and assumes extensions at our option are exercised with consent of financing providers, where applicable.
Secured credit facilities
September 30, 2022, we had entered into secured debt arrangements with seven secured credit facilities through wholly-owned subsidiaries. Terms under various master repurchase agreements vary by secured credit facility.
Refer to “Note 7 – Secured credit arrangements, net” to our condensed consolidated financial statements for additional information regarding our secured credit facilities.
Barclays Private Securitization
June 2020, through a newly formed entity, we entered into a private securitization with Barclays Bank plc. As of September 30, 2022, we had £936.9 million, €491.8 million, and kr2.1 billion ( $1.7 billionassuming conversion into USD) of borrowings outstanding under the Barclays Private Securitization secured by certain of our commercial mortgage loans. Refer to "Note 7 - Secured Debt Arrangements, Net" of our Condensed Consolidated Financial Statements for additional disclosure regarding our Barclays Private Securitization. Senior Secured Term Loans
Refer to "Note 8 - Senior Secured Term Loans, Net" of our Condensed Consolidated Financial Statements for additional disclosure regarding our 2026 Term Loan and 2028 Term Loan." Senior Secured Notes In
June 2021, we issued $500.0 millionof 4.625% Senior Secured Notes due 2029 (the "2029 Notes"), for which we received net proceeds of $495.0 million, after deducting initial purchasers' discounts and commissions. The 2029 Notes had a carrying value of $494.6 millionand $494.1 million, net of deferred financing costs of $5.4 millionand $5.9 million, as of September 30, 2022and December 31, 2021, respectively.
Refer to “Note 9 – Senior Secured Notes, Net” to our condensed consolidated financial statements for additional information regarding our 2029 Notes.
Senior Convertible Bonds
In two separate offerings during 2017, we issued an aggregate principal amount of
$345.0 millionof 4.75% Convertible Senior Notes due 2022 (the "2022 Notes"), for which we received $337.5 million, after deducting the underwriting discount and offering expenses. During the third quarter of 2022, we repaid the $345.0 millionaggregate principal amount of the 2022 Notes. During the fourth quarter of 2018, we issued $230.0 millionof 5.375% Convertible Senior Notes due 2023, for which we received $223.7 millionafter deducting the underwriting discount and offering expenses. At September 30, 2022, the 2023 Notes had a carrying value of $229.2 millionand an unamortized discount of $0.8 million. 43 --------------------------------------------------------------------------------
Refer to “Note 10 – Convertible Senior Notes, Net” to our condensed consolidated financial statements for additional information regarding our convertible notes.
Rate of endettement
The following table shows our debt ratio:
September 30, 2022 December 31, 2021 Debt to Equity Ratio(1) 2.8 2.4 ------- (1)Represents total debt less cash and loan proceeds held by servicer (recorded with Other Assets, refer to "Note 6 - Other Assets" for more information) to total stockholders' equity. Leverage Policies We use leverage for the sole purpose of financing our portfolio and not for the purpose of speculating on changes in interest rates. In addition to our secured debt arrangements and senior secured term loan, we access additional sources of borrowings. Our charter and bylaws do not limit the amount of indebtedness we can incur; however, we are subject to and carefully monitor the limits placed on us by our credit providers and those that assign ratings on our company. At
September 30, 2022, our debt-to-equity ratio was 2.8 and our portfolio was comprised of $8.0 billionof commercial mortgage loans and $717.8 millionof subordinate loans and other lending assets. In order to achieve our return on equity, we generally finance our mortgage loans with 2.0 to 3.0 turns of leverage and generally do not finance our subordinate loans and other lending assets given built-in inherent structural leverage.
Our current investment guidelines, approved by our Board of Directors, include the following:
• no investment will be made that would prevent us from qualifying as a REIT for
•no investment will be made which would require us to register as an investment company under the 1940 Act;
•the investments will be mainly in our target assets;
•no more than 20% of our net equity (on a consolidated basis) will be invested in any single investment at the time of the investment; in determining compliance with the investment guidelines, the amount of the investment is the net equity in the investment (gross investment less amount of third-party financing) plus the amount of any recourse on the financing secured by the investment; and •until appropriate investments can be identified, the Manager may invest the proceeds of any offering in interest bearing, short-term investments, including money market accounts and/or funds, that are consistent with our intention to qualify as a REIT.
The Board of Directors must approve any modification or waiver of these investment guidelines.
Dividends We intend to continue to make regular quarterly distributions to holders of our common stock.
U.S.federal income tax law generally requires that a REIT distribute annually at least 90% of our REIT taxable income, without regard to the deduction for dividends paid and excluding net capital gains, and that we pay tax at regular corporate rates to the extent that we annually distribute less than 100% of our net taxable income. We generally intend over time to pay dividends to our stockholders in an amount equal to our net taxable income, if and to the extent authorized by our board of directors. Any distributions we make are at the discretion of our board of directors and depend upon, among other things, our actual results of operations. These results and our ability to pay distributions are affected by various factors, including the net interest and other income from our portfolio, our operating expenses and any other expenditures. If our cash available for distribution is less than our net taxable income, we could be required to sell assets or borrow funds to make cash distributions or we may make a portion of the required distribution in the form of a taxable stock distribution or distribution of debt securities.
44 -------------------------------------------------------------------------------- Except under certain limited circumstances, the Series B-1 Preferred Stock is generally not convertible into or exchangeable for any other property or any other of our securities at the election of the holders. On and after
July 15, 2026, we may, at our option, redeem the shares at a redemption price of $25.00, plus any accrued unpaid dividends to, but not including, the date of the redemption.
The following table details our dividend activity:
Three months ended Nine months ended Dividends declared per share of: September 30, 2022 September 30, 2021 September 30, 2022 September 30, 2021 Common Stock
$0.35 $0.35 $1.05 $1.05Series B Preferred Stock N/A N/A N/A 1.00 Series B-1 Preferred Stock 0.45 0.45 1.35 0.45 On July 15, 2021, we exchanged all 6,770,393 shares outstanding of our 8.00% Fixed-to-Floating Series B Cumulative Redeemable Perpetual Preferred Stock, par value $0.01per share ("Series B Preferred Stock"), with a liquidation preference of $25.00per share, for 6,770,393 shares of 7.25% Series B-1 Cumulative Redeemable Perpetual Preferred Stock, par value $0.01per share ("Series B-1 Preferred Stock"), with a liquidation preference of $25.00per share, pursuant to an exchange agreement with the two existing shareholders. Non-GAAP Financial Measures Distributable Earnings Distributable Earnings, a non-GAAP financial measure, is defined as net income available to common stockholders, computed in accordance with GAAP, adjusted for (i) equity-based compensation expense (a portion of which may become cash-based upon final vesting and settlement of awards should the holder elect net share settlement to satisfy income tax withholding), (ii) any unrealized gains or losses or other non-cash items (including depreciation and amortization related to real estate owned) included in net income available to common stockholders, (iii) unrealized income from unconsolidated joint ventures, (iv) foreign currency gains (losses), other than (a) realized gains/(losses) related to interest income, and (b) forward point gains/(losses) realized on our foreign currency hedges, (v) the non-cash amortization expense related to the reclassification of a portion of the Convertible Notes to stockholders' equity in accordance with GAAP, and (vi) provision for loan losses. Distributable Earnings may also be adjusted to exclude certain other non-cash items, as determined by the Manager and approved by a majority of our independent directors. For the three and nine months ended September 30, 2022, our Distributable Earnings were $95.9 million, or $0.67per share, and $194.8 million, or $1.36per share, respectively, as compared to $49.2 million, or $0.35per share, and $143.6 million, or $1.01per share, respectively, for the same period in the prior year. The weighted-average diluted shares outstanding used for Distributable Earnings per weighted-average diluted share has been adjusted from weighted-average diluted shares under GAAP to exclude shares issued from a potential conversion of the Convertible Notes. Consistent with the treatment of other unrealized adjustments to Distributable Earnings, these potentially issuable shares are excluded until a conversion occurs, which we believe is a useful presentation for investors. We believe that excluding shares issued in connection with a potential conversion of the Convertible Notes from our computation of Distributable Earnings per weighted average diluted share is useful to investors for various reasons, including the following: (i) conversion of Convertible Notes to shares requires both the holder of a note to elect to convert the Convertible Note and for us to elect to settle the conversion in the form of shares (ii) future conversion decisions by note holders will be based on our stock price in the future, which is presently not determinable; (iii) the exclusion of shares issued in connection with a potential conversion of the Convertible Notes from the computation of Distributable Earnings per weighted-average diluted share is consistent with how we treat other unrealized items in our computation of Distributable Earnings per weighted-average diluted share; and (iv) we believe that when evaluating our operating performance, investors and potential investors consider our Distributable Earnings relative to our actual distributions, which are based on shares outstanding and not shares that might be issued in the future.
The table below summarizes the reconciliation between the GAAP weighted average diluted shares and the weighted average diluted shares used for distributable income:
Three months ended September 30, Nine months ended September 30, 2022 2021 2022 2021 Weighted-Averages Shares Shares Shares Shares Diluted shares - GAAP 164,350,132 170,884,172 169,252,602 170,836,682 Potential shares issued under (21,187,719) (28,533,271) (26,057,847)
conversion of the Convertible Notes Unvested RSUs - - - - Diluted shares - Distributable Earnings 143,162,413 142,350,901 143,194,755 142,303,411 As a REIT,
U.S.federal income tax law generally requires us to distribute annually at least 90% of our REIT taxable income, without regard to the deduction for dividends paid and excluding net capital gains, and that we pay tax at regular corporate rates to the extent that we annually distribute less than 100% of our net taxable income. Given these requirements and our belief that dividends are generally one of the principal reasons stockholders invest in a REIT, we generally intend over time to pay dividends to our stockholders in an amount equal to our net taxable income, if and to the extent authorized by our board of directors. Distributable Earnings is a key factor considered by the board of directors in setting the dividend and as such we believe Distributable Earnings is useful to investors. As discussed in "Note 5 - Assets and Liabilities Related to Real Estate Owned", during the three and nine months ended September 30, 2022, we recorded a $43.6 millionrealized gain on investments reflecting the difference between the fair value of a multifamily development property located in Brooklyn, NYacquired through a deed-in-lieu of foreclosure and the amortized cost of the loan at the time of foreclosure. As discussed in "Note 5 - Assets and Liabilities Related to Real Estate Owned" during the three and nine months ended September 30, 2021, we recorded $20.0 millionrealized loss on investments reflecting the difference between the fair value of a hotel acquired through a deed-in-lieu of foreclosure and the amortized cost of the loan at the time of foreclosure. Additionally, during the nine months ended September 30, 2021, we recorded an impairment of $0.6 millionon our real estate owned, held for sale due to increased costs to sell. We also believe it is useful to our investors to present Distributable Earnings prior to realized gains (losses) and impairments on real estate owned and investments to reflect our operating results because (i) our operating results are primarily comprised of earning interest income on our investments net of borrowing and administrative costs, which comprise our ongoing operations and (ii) it has been a useful factor related to our dividend per share because it is one of the considerations when a dividend is determined. We believe that our investors use Distributable Earnings and Distributable Earnings prior to realized gains (losses) and impairments on real estate owned and investments, or a comparable supplemental performance measure, to evaluate and compare the performance of our company and our peers. A significant limitation associated with Distributable Earnings as a measure of our financial performance over any period is that it excludes unrealized gains (losses) from investments. In addition, our presentation of Distributable Earnings may not be comparable to similarly-titled measures of other companies, that use different calculations. As a result, Distributable Earnings should not be considered as a substitute for our GAAP net income as a measure of our financial performance or any measure of our liquidity under GAAP. Distributable Earnings are reduced for realized losses on loans which include losses that management believes are near certain to be realized. The table below summarizes the reconciliation from net income available to common stockholders to Distributable Earnings and Distributable Earnings prior to realized gains (losses) and impairments on real estate owned and investments ($ in thousands): 46 -------------------------------------------------------------------------------- Three months ended September 30, Nine months ended September 30, 2022 2021 2022 2021 Net income available to common stockholders $ 179,962
Adjustments: stock-based compensation expense
4,518 4,405 13,734 13,149 Gain on foreign currency forwards (129,252) (32,947) (257,227) (39,653) Foreign currency loss, net 92,782 24,413 210,138 27,808 Unrealized loss (gain) on interest rate cap (1,044) 75 (10,808) (171) Realized gains (losses) relating to interest income 2,908 (219) 8,020 (1,558) on foreign currency hedges, net Realized gains relating to forward points on foreign 1,545 63 8,168 75 currency hedges, net Amortization of the convertible senior notes related - 824 - 2,436 to equity reclassification Depreciation and amortization on real estate owned - 1,096 704 1,548
Release of current expected allowance for credit losses, net
(55,564) (5,766) (37,897) (36,590) Realized (gains) losses and impairments on real (43,577) - (43,577) 20,550 estate owned and investments Total adjustments: (127,684) (8,056) (108,745) (12,406) Distributable Earnings prior to realized gains (losses) and impairments on real estate owned and $ 52,278
Realized gains (losses) and impairments on real $ 43,577 $ - $ 43,577
land ownership and investments
Distributable Earnings $ 95,855
Diluted distributable earnings per share before realized gains (losses) and write-downs on real dollars
$ 0.35$ 1.06 $ 1.15estate owned and investments Diluted Distributable Earnings per share of common $ 0.67 $ 0.35$ 1.36 $ 1.01
Weighted-average diluted shares - Distributable 143,162,413 142,350,901 143,194,755 142,303,411 Earnings Book Value Per Share The table below calculates our book value per share ($ in thousands, except per share data): September 30, 2022 December 31, 2021 Stockholders' Equity $ 2,407,685 $ 2,294,626 Series B-1 Preferred Stock (Liquidation Preference) (169,260) (169,260) Common Stockholders' Equity $ 2,238,425 $ 2,125,366 Common Stock 140,595,995 139,894,060 Book value per share $ 15.92 $ 15.19
The table below shows the evolution of our book value per share:
Book value per share Book value per share at December 31, 2021 $ 15.19 General CECL Allowance 0.28
Book value per share at
$ 15.47 Earnings in excess of dividends 0.02 Realized gain on investments 0.31 Net unrealized gain on currency and interest rate hedges 0.29 Reversal of Specific CECL Allowance 0.18 47 --------------------------------------------------------------------------------
Vesting and delivery of RSUs (0.12) Adoption of ASU 2020-06 (0.02) Other (0.01)
Book value per share at
General CECL Allowance and depreciation and amortization
Book value per share at
September 30, 2022$
We believe that presenting book value per share with sub-totals prior to the CECL Allowances and depreciation and amortization is useful for investors for various reasons, including, among other things, analyzing our compliance with financial covenants related to tangible net worth and debt-to-equity under our secured debt arrangements and senior secured term loan, which permit us to add the General CECL Allowance to our GAAP stockholders' equity. Given that our lenders consider book value per share prior to the General CECL Allowance as an important metric related to our debt covenants, we believe disclosing book value per share prior to the General CECL Allowance is important to investors such that they have the same visibility. We further believe that presenting book value before depreciation and amortization is useful to investors since it is a non-cash expense included in net income and is not representative of our core business and ongoing operations. 48
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