Good day, ladies and gentlemen, and welcome to the Q2 2017 Apollo Commercial Real Estate Finance, Inc. Earnings Conference Call. [Operator Instructions] I would like to remind everyone that today’s call and webcast are being recorded. Please note that they are property of Apollo Commercial Real Estate Finance, Inc.

and their 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 disclosures 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.

In addition, we will be discussing certain non-GAAP measures on this call which management believes are relevant for assessing the Company's financial performance and are reconciled to GAAP figures in our earnings press release which is available on our Investor Relations section of our website.

We do not undertake any obligation to update our forward-looking statements or projections unless required by law. To obtain copies of our latest SEC filings, 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.

Please go ahead ..

Thank you, operator. Good morning and thank you for all for joining us on the ARI second quarter 2017 earnings call. As usual, joining me this morning are Scott Weaver, the Chief Investment Officer of our Manager; and Jai Agarwal, our CFO.

Overall as we've been discussing for the past several quarters, the themes with respect to the commercial real estate industry generally remained intact during the second quarter. Positive job growth coupled with the low interest rate environment has resulted in steady to modestly improving operating performance at the asset level.

Importantly for ARI's business, transaction volume remains healthy driven by both a significant amount of capital committed to or targeted for value add real estate equity investment and the availability of various debt financing alternatives.

At present, ARI has a strong pipeline consisting of both new opportunities many of which involve repeat clients, as well as the option and opportunity to participate in the refinancing of some existing transactions.

For example, subsequent to the quarter end we completed the refinance of one of ARI's New York hotel loans in which ARI was able to invest approximately $160 million in the new capital structure as compared to its original $50 million capital deployment.

Based on the strength of the pipeline and the confidence in our investment platform, ARI took advantage of favorable market conditions and completed an accretive $13.8 million comp share common stock offering at the beginning of June issuing stock at north of 1.1 times ARI's book value and raising gross proceeds of over $250 million representing ARI's largest common stock offering today.

Including transactions closed after quarter end, year-to-date ARI has committed to over $800 million of new investments and is funded an incremental $150 million on previously closed transactions.

I would also like to highlight that since the beginning of 2017, ARI has expanded its portfolio in London having completed two large transactions totaling $156 million. When pursuing business in London ARI benefits from the relationships and knowledge gained from Apollo's broadly diversified and sizable real estate presence in Europe.

The two transactions completed were predevelopment loan opportunities with well-capitalized sponsors at an attractive basis with loan-to-value ratios less than 60%.

Turning now to our investment portfolio, at quarter end ARI's portfolio totaled $3.6 billion with a fully levered weighted average underwritten IRR of approximately 13.3% and a weighted average LTV of under 65%.

Consistent with our focus on the potential for increased short-term rates at quarter end 90% of the loans in ARI's portfolio had floating interest rates. Before turning the call over to Jai, I want to comment specifically on two of ARI's investments.

As noted in the press release, this quarter ARI recorded a $5 million provision for loan losses and impairment against our $49 million investment in a newly constructed 50 unit condominium project in Bethesda, Maryland. As a reminder, this investment started as an $80 million construction loan.

To-date 28 of the 50 units have either been sold or under contract and the investment is collateralized by the remaining inventory of units. While the pricing has generally been consistent with our expectations, the pace of sales and foot traffic has not. Beginning with the second quarter ARI is no longer accruing interest on this investment.

We continue to work with the sponsor on strategies to sell the remaining units and over the past six months, 11 units of either been sold or gone into contract.

However, given our conservative view on the timing of the sales of the remaining units and the resulting impact from a present value perspective, it was appropriate to take a modest accounting reserve this quarter.

I would also like to take a minute to provide an update on the condo development at 111 West 57 Street, New York City commonly known as the Steinway building.

As you recall in the third quarter of 2015, ARI and other investment funds managed by Apollo provided a $325 million mez loan for the property behind a $400 million first mortgage construction loan and senior to $130 million of sponsor equity.

As many of you may be aware from the recent public filings of another public company which has an equity investment in the property and from some recent media coverage relating to the public company's ongoing litigation with the other equity investors, over the last few months ARI has entered into certain forbearance agreement with the borrowers as they were lining up additional capital for the project.

At the end of the second quarter, ARI and the other investment funds managed by Apollo split off a $25 million junior mezzanine piece of the existing mezzanine loan and sold it at par to institutional investor with strong experience in the New York City condo market.

We have been advised that the new junior mezzanine lender has begun discussions with potential developers including the existing developer around restructuring and recapitalizing the equity capital which is subordinate to ARI's position.

In addition to such discussions, the junior mezzanine lender has also commenced a strict foreclosure process with the consummation of such process requiring the junior mezzanine lender to invest incremental capital into the property.

While it is not appropriate for me to comment on many of the aspects of the public filings of other companies including any reference to the ongoing litigation between the equity partners it is worth mentioning that our active asset management frequent interaction and dialogue with borrowers, and the willingness and ability to structural solutions if needed over the life of the been investment are very much a part of why we believe borrowers seek to do business with ARI and critical to how ARI competes in the marketplace.

As such from our perspective, the mezzanine loan forbearance arrangements continued construction advances and close cropped cooperation with the mortgage construction lender the creation of a $25 million junior mezzanine loan, component and the subsequent sale of the junior mezzanine loan are consistent with the nature of our business.

Situations will arise when borrowers business plans change and they seek to work with us.

When these situations occur, we view them as an opportunity to highlight the benefits of working with our platform and our ability to assist our borrowers in structuring financial solutions which strike the appropriate balance between protecting ARI's principal and creating opportunities for increased capital investment or enhance returns for ARI while providing the necessary operating flexibility to the borrower.

Lastly on this topic, as we have consistently said since the loans origination, ARI's risk as mezzanine lender on this project today remains that the property gets constructed as expected. While things can change, we are comfortable with the progress of the project towards completion.

As the property is down the street from Apollo's New York City office, I can tell you that construction has continued unabated.

Once completed, ARI's last dollar of exposure in the approximately 305,000 square-foot property comprised of 60 condo units totaling approximately 250,000 square feet and one retail condo totaling approximately 55,000 square feet will be less than $2700 per square foot.

It is worth noting that without formally launching a sales effort, units have been put under contract at prices well north of ARI's basis. And with that, I will turn the call over to Jai to review our financial results..

Thank you, Stuart and good morning everyone. For the second quarter of 2017, our operating earnings were $44.6 million or $0.46 per share. This compares to $23.4 million or $0.49 per share in 2016. GAAP net income for the same period in 2017 was $26.9 or $0.28 per share. This compares to $4.5 million or $0.06 per share in 2016.

I wanted to point out a couple of items this quarter. One, we sold our remaining equity interest in the German bank BKB for a small realized gain. Second, this quarter we changed the methodology we used to report IRRs. From using the forward LIBOR curve to using spot LIBOR at quarter end.

This is consistent with industry factors and did not have a material impact on our results. Turning to leverage. We ended the quarter with a 0.9 times debt to common equity ratio.

We used the proceeds from our June common stock offering to pay down existing debt and as such at quarter end we had 220 million of undrawn capacity on both our JPMorgan and Deutsche Bank lines. Also with respect to our capital structure, today we expect to complete redemption of our 86 million Series A preferred stock which recently became callable.

With respect to book value, our book value per share increased to $16.16 at June 30 from $16.05 at March 31. The increase primarily was due to the accretive common stock offering completed in June and was partially offset by the loan loss reserve and unrealized loss on our legacy CMBS portfolio.

It is worth noting that subsequent to quarter end we significantly reduced our CMBS exposure by selling approximately $60 million of AJ bonds at prices in excess of where they were marked at June 30. Following the sales, our total CMBS exposure is down to $200 million representing approximately 5% of our total asset.

Finally I wanted to highlight our dividend based on Monday's closing price our stock offers an attractive 10.2% yield. Our Board will meet again in mid-September to discuss the Q3 dividend and we will make an announcement shortly thereafter.

As we stated on last quarter's call, we remain confident in ARI's ability to provide a well covered attractive dividend to our investors in 2017. And with that, we’d like to open the lines for questions. Operator, please go ahead..

[Operator Instructions] Our first question comes from the line of Steve Delaney from JMP Securities. Your line is now open..

Stuart I got on a few minutes late but I think I heard most of your commentary on the 111 situation. I believe that the balance at March 31 on your mez, your peak part of the mez loan was about 77 million including this little bit of pick.

When Apollo collectively sold that $25 million junior mez loan did that reduce Apollo commercial ARI's carrying value in your position?.

Yes they really were two things that happened Steve, so at a high level the original $325 million was $75 million ARI, $50 million of other funds within Apollo and $200 million from one large institutional investors who I think everybody knows who it is but I won't say it on the call.

Two things have happened, ARI increased its commitment from $75 million $100 million by picking up $25 million from the large institutional investor. And then collectively the three entities all sold down to 25 proportionately so it is modestly reduced ARI's exposure but net-net ARI's exposure increased due to acquiring the other $25 million..

And then in the 10-Q I believe I noticed in the income statement you had a provision this time $5 million and in the Q we got some detail but that was really two parts and I guess its $3 million was related I believe to a DC area condo loan.

Could you speak to that and then the second, the $2 million general provision was interesting because I think thus far provisions that you have made have been specific.

So that question would be is this something that you were thinking to given where we are in the cycle are you planning to kind of routinely build a general loan loss reserve over time as evidenced by that 2 million? Thanks..

Let me clarify your question, so the entire $5 million was related to the DC condo project which I commented on in my speech and maybe you joined after that and I could give you some more detail after the call after that if you want or Hilary can follow up.

The reason it's broken in two pieces is just given the way we funded dollars into the project over time for tax purpose some was put in as loans for other tax reason, some was put in as pref equity and the way you treat those for GAAP accounting purposes when taking either a reserve against a loan or an impairment are different, but the $5 million is still asset specific or deal specific.

So we haven't gone down the path of taking - reserve with this..

And that would have been about a 10% reserve if I'm reading that right compared to what your balance was at the end of March?.

Correct..

Our next question comes from the line of Rick Shane from JPMorgan. Your line is now open..

Circling back on the mez, two things you said that the loan went on nonaccrual at the end of the second quarter?.

Beginning of the second quarter just to clarify Rick so there's no income in Q2 from the loan..

That was actually the clarification I was looking for, perfect.

Second thing is, you talked about what happened in Bethesda but can you tell us why I mean that seems - what is the challenge with the project given that seems to be pretty strong economy?.

Yes look I think at high level, the fundamental thesis on the project not dissimilar to what we've done here in New York quite successfully a number of times was, I'll call it middle age people selling high-end suburban homes and moving more into an urban setting and if you actually look at the upscale suburbs around Bethesda whether they be in Maryland or Northern Virginia the pace of home price recovery has not been what it has been in other parts of the country coming out of the 2009 downturn and as a result when I referred to the foot traffic being slower than we would have hoped, it's not uncommon to have people who are very interested in the project.

But the refrain you here is that they are still underwater in their home either relative to their legacy basis or relative to their expectations.

And until there are some more underlying strength in the home market in Bethesda and again we’re talking about pretty high end homes, we’re not talking about homes for the masses for lack of a better phrase.

I think people are just - it's a two-sided trade and one side of the trade just isn't working right now, I did reference that we've actually seen a pickup in pace over the last six months and I think that has been to the credit of both the local sponsor, as well as some input from us.

We've now started targeting beyond just call it trade buyers who are in the area already. We've actually gained some traction either with foreign borrowers who want a foothold in the DC market or more in the diplomatic community for people who are more transient in nature, but want a foothold in the DC market.

So we’re broadening the marketing effort, but to your original question ultimately I think these tie is back to just some softness in the broader high-end suburban markets in and around DC..

Curious when you think about the relative value of those condos versus that owns the people are trading out of is your property sort of more accurately mark-to-market?.

I think it is, I think we've done fine from a price perspective. I think to get a little bit more granular like any condo project, it's a mix of units. I think for those willing to downsize the smaller units of the condo project have traded extremely well because you’re just talking about a lower all in nominal cost.

I think the larger units at the condo project again nobody is complaining about the price per pound foot because when you factor in that price per pound foot relative to A) where home sell on a price per pound foot and then B) just the ongoing maintenance of a home versus the condo project it's pretty compelling.

But again I do think we've run into a little sticker shock just because I think people are surprised by the nominal price that their home might sell for.

And as a result less dollars in their pocket to buy a higher price condo, but the product I will say as the construction lender, the product that was created is really well executed, shows extremely well and we think we continue to have confidence in it. I think it's just, you don't convert everybody that walks in the door.

And the amount of foot traffic has been less than we would've hope for..

I guess it’s a macro wish, not a micro wish with the property?.

Correct, I don't think we missed on the execution. I don't think they missed on the desire for the product. I think we - to your point I think we missed on the macros in and around that market..

[Operator Instructions] Our next question comes from the line of Jade Rahmani from KBW. Your line is now open..

Can you share your views of the current competitive environment, and whether you're seeing notable spread compression in the market, and also what you think is driving that?.

Let me comment on in a couple of different ways because I think your question is embedded two questions, which is obviously there's some new recent public companies in the space which from our perspective is really not the driver of competition and I'll talk about the competition admitted.

I think overall we’ve been competing against those companies in their private lives and I think they appropriately in some respects given the strength of the way us and others have been trading in the market, took an opportunity to create public entities around what their businesses have been doing, and I think in many respects having more public companies in the space is a good thing.

I think in terms of competition in general, at a high level or a macro level, Jade, I think the driver of competition in our space continues to be what it's been for most of our existence, which is a surplus of liquidity in the world, our capital in the world, that continues to seek interesting yield in a very low rate environment, and that has effectively been the operating environment for our entire eight years as a public company.

I think as we've seen at various points of time, I think there has been periods of cap rate compression and periods of cap rate sort of softening or spread softening, excuse me, not cap rate.

And I think, over the last 3 to 6 months, I think we've certainly seen some spread compression clearly and what we would describe as the senior mezzanine loan business.

So, call it 55% to 62%, 63% of the capital stack, where we've seen spreads come in and that's a market that has either have senior lenders widening out their expectations or those who look for yield wherever they can find it, jumping into the market.

I think on the senior loan side of things, I think you've seen maybe some modest compression, but nothing significant and I say that from the perspective of both the lender as well as having a clear view into what Apollo does on the real estate equity side and as a borrower. So, I think there's been some compression. It isn't anything noted – notable.

But I think if you look over the last 3 to 6 months, we probably experience some spread compression.

But I think we continue to view our job as investors is finding the right risk-adjusted returns for ARI, and while $1 billion to $1.5 billion a year of investment seems like a lot to accomplish for ARI, and I don't want to minimize the effort it takes to get that done.

In the scheme of the amount of transactions there are in the market to look at, we remain highly confident that we'll get the capital deployed at returns that make sense for ARI..

And can you comment on the lower pace of second quarter originations and conversely the increased pace of loan repayments, with the loan repayments outside of your expectations?.

No. I mean I think look, you and I have had this conversation multiple times before. I think as much as we would like our business to be smooth, it tends to be lumpy. I think with our increased size if you think about between the merger with AMTG last year and our two capital raise is bringing over $800 million of equity into the company.

So, we've gotten larger. I would say we tend to look at bigger things right now, and it's gotten a little lumpier. I think there is no sort of real way to predict timing, when you're dealing with privately negotiated transactions. I think Q1 was a big quarter, Q2 was slower than we thought.

But if you look at what we've now announced subsequent to Q2, we’re already off to a good start on Q3. So, maybe not the perfect answer you want. But you know the business is lumpy. We tend not to look at on a quarterly basis in terms of origination perspective. We tend to look at it in terms of what's in the pipeline, and what are we really working on.

And I would say, feel pretty good from a pipeline perspective right now in terms of what were actively working on and what we think we’re going to end up winning at the end of the day..

Do you guys have an internal risk rating process and can you comment on any notable migrations in the quarter beyond the Bethesda and 111 West 57 slump?.

Yes. We do everything on a loan-by-loan basis, so, we don't have buckets. We don't have numbers. We look at things on a loan-by-loan basis. I would say the only other transaction that we’re spending a lot of time from an asset management perspective today is, a retail loan in suburban Ohio, that is commonly known as Liberty Center.

Obviously, I don't need to sort of regurgitate the headline news around retail for people. This is a newly constructed mixed-use center where we provided the construction loan on the retail component of the mix of hotel, office and retail. The project today is leased in the low 80s.

It is doing, okay, would be the best way to describe it, obviously still has a lot of work to do on the leasing side, and some tenants are doing well, some tenants are doing lease well, and I would say it continues to be high up on our radar screen in terms of loans that we’re spending a lot of time focused on from an asset management perspective..

And is that, I think in your last update which I don’t believe you’re providing any loan specific updates now. But I think that was last, a 55% LTV.

What’s the LTV on the Cincinnati Liberty Center?.

I mean, we don't update and write the LTVs. We've always historically provided. We’re based on appraisal at the time we originated the loan and they only were getting updated to the extent there was a need for a new appraisal, which typically only happens around a refinance – recapitalization. We haven’t.

There hasn't been updated appraisal provided on the assets.

So, we haven't updated the LTV on that?.

And is that still a May 2018 maturity?.

Yes..

So I guess, what are the main sort of pressure points and are you worried about the loan being able to get refinanced?.

I mean, as of today yes, the asset again is sort of low 80s leased. Certainly, the business plan assume the asset would get into the call at 90, low 90s leased on a stabilized basis.

I think to date, the anchors are doing well, the entertainment components of the retail, whether they be movie theaters, restaurant or other entertainment component of the asset are doing fine. The soft goods in line retailers are a mixed bag, some are doing extremely well, some are struggling.

It's really a matter of finding the right merchandising mix and doing what's necessary to get the asset more well leased than it is today. If it stayed where it is leased today, refinancing would be a challenge.

But obviously when I talk about being on the radar screen from an asset management perspective, we are regularly in dialogue with the sponsors and borrower about strategies for improving the occupancy of the asset..

And does the asset have exposure to any of the recent retail bankruptcies and store closings that have been announced Tijuana for example?.

No..

Just on the 111 West 57th, I guess is the loan – is the loan currently accruing interest?.

Yes, absolutely..

And I guess with the legal wranglings going on. What would cause you to put it on non-accrual.

Is it just a judgment, subjective judgment that you think you say the risk is that the asset gets built?.

Again, we do everything on a loan-by-loan basis. I think if you think about it, not to oversimplify. But if you think about it from an accounting perspective, someone was willing to buy the bottom $25 million of my loan at par.

That's pretty compelling from an accounting perspective as to whether or not something is impaired or needs to be put on nonaccrual sets..

Can you give an update on the North Dakota loan?.

Yes from a rental perspective, pretty much status quo which is sort of bumping around high 70s, low 80s. From an occupancy perspective, again I would say, Williston anecdotally is certainly stronger today.

In terms of employment levels, number of rigs that are operating, and certainly oil at $45 to $50 a barrel is better than when it was at $25 a barrel. As we've spent more time with the asset, we really think about it now almost as three components.

There is a 330 unit garden style apartment building that is in the mid to high 70s from a leasing perspective, and rents have been flat for the better part of 12 to 18 months.

There are 36 single-family homes that have always remained somewhere between 90% to 100% leased and I would say that we are now going down a path of thinking about ways to monetize those single-family homes, i.e.

potentially trying to see if there's a structure whereby the renters of those homes would be willing to buy those homes and that would be a way to chip away at the balance of our exposure there. And then lastly, there are about 275 to 300 mostly single-family lots either finished or unfinished. We’re not doing much with the lots at this point.

Though I think to the extent, we’re able to sell the single-family homes, it might then lead to us thinking about doing something with the single-family lots. But for now, it's an unfinanced asset, it is a effectively cash flowing mortgage for purposes of accounting purposes.

We're playing for time, and I think in the near-term, the optimistic view might be that we could reduce our exposure if we’re able to sell some single-family homes..

And just on the Bethesda project, is the LTV now 100%. I think last quarter it was 71%..

I think that's the way to think about it from an accounting perspective. We've sort of written it down to what we perceive there to be on a PV basis. Recovery value, I just want to highlight that within the accounting impairment, there is a present value component.

It is quite possible that over time all the units are sold and we get back all our capital including what was reserved on a nominal basis, but obviously the accounting includes a PV component as well..

And the loans outstanding principal has not been reduced..

That’s right. Correct..

But the 11th sales took place this year, is that correct? The last six months..

Yes, last six month. But keep in mind, there was an $80 million construction loan that has been paid down over time to $49 million. So when you say the loan balance hasn't been reduced, it's been reduced all along as units have been sold..

Yes, I was talking about….

We haven’t forgiven any balance, if that was question..

Yes, that was my question. And so the last six months of sales would suggest roughly like a three-year remaining duration. They don't pick up, if there's 32 units left to be sold..

There's 22 units left to be sold. So we've been averaging a little bit more than almost two a month. That would argue about a year..

Thank you. Our next question comes from the line of Richard Shane from JPMorgan. Your line is now open..

Just a request. Can we go back to including the loan stratification details in the presentation? It's really helpful..

We acknowledge your request..

Thank you. At this time I’m not showing any further questions. I’d like to turn the call back over to Stuart Rothstein for any closing remarks..

Thanks Operator and thanks for everybody participating..

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a great day..