Ivan Kaufman - President & Chief Executive Officer
Paul Elenio - Chief Financial Officer
Stephen Laws - Deutsche Bank
Steven DeLaney - JMP Securities LLC
Arbor Realty Trust, Inc. (ABR) Q4 2012 Earnings Conference Call February 15, 2013 10:00 AM ET
Good day ladies and gentleman and welcome to the Fourth Quarter 2012 Arbor Realty Trust Earnings Conference Call. My name is Cathy and I will be your operator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of the conference. (Operator Instructions)
And now, I would like to turn the call over to Mr. Paul Elenio, Chief Financial Officer. Please proceed, sir.
Okay, thank you, Cathy. Good morning everyone, and welcome to the quarterly earnings call for Arbor Realty Trust. This morning, we’ll discuss the results for the quarter and year ended December 31, 2012. With me on the call today is Ivan Kaufman, our President and Chief Executive Officer. I would like to inform you that Ivan is travelling on business today and has dialed in from his business location. So, we apologize in advance if we run into any technical audio difficulties and if we do we would try to get them corrected as soon as possible.
I do need to inform you that the statements made in this earnings call may be deemed forward-looking statements that are subject to risks and uncertainties, including information about possible or assumed future results of our business, financial condition, liquidity, results of operations, plans and objectives. These statements are based on our beliefs, assumptions, and expectations of our future performance, taking into account the information currently available to us. Factors that could cause actual results to differ materially from Arbor’s expectations in these forward-looking statements are detailed in our SEC reports.
Listeners are cautioned not to place undue reliance on these forward-looking statements, which speak only as of today. Arbor undertakes no obligation to publicly update or revise these forward-looking statements to reflect events or circumstances after today or the occurrence of unanticipated events.
With the safe harbor behind us, I’ll now turn it over to Arbor’s President and CEO, Ivan Kaufman.
Thank you, Paul and thanks to everyone for joining us on today’s call. Before Paul takes you through the financial results, I would like to reflect on how we closed out the year touching on some of our more significant accomplishments, and then turn my focus to our business strategy and outlook for 2013. 2012 was a tremendously successful year for us and this momentum has continued into 2013. We’ve closed out the year with approximately 80% appreciation in our stock price including dividends and we are up approximately another 20% already in 2013. We are extremely pleased with our progress especially in our ability to access the equity and securitization markets to continue to grow our platform and our core earnings and in our ability to grow our dividend over the last three quarters.
We completed two equity offerings in the latter half of 2012 raising approximately $37 million of fresh capital and just recently closed our first perpetual preferred stock offering, raising an additional $37 million of capital in early February. We have also had great success in accessing the securitization markets in the form of two new non-recourse collateralized loan obligation vehicles. One in September of 2012 totaling $125 million and a second just last month with $260 million of collateral. These transactions are already at the forefront of our recent accomplishments and have positioned us very favorably to allow us to continue to execute our business strategy of originating attractive investment opportunities to our deep originations platform and appropriately levering them with low cost non-recourse CLO debt with replenishment rights generating mid teens level of returns on our invested capital.
We continue to remain very active in our core lending business as well as in diversifying our portfolio and revenue sources by investing in residential securities. We are pleased with the opportunities we are seeing in the market to invest our capital and continue to grow our earnings based through our experienced originations team. This has resulted in an increase per earnings and as a result we have increased our dividend to $0.12 a share for the fourth quarter of 9% from the $0.11 a share we paid in the third quarter. In a moment, Paul will elaborate further on how our growth has also translated to increase in our core earnings run rate. Once again we are pleased with the investment opportunity we are seeing to grow our platform, diversify our revenue sources and produce core earnings and dividends growth going forward. In the fourth quarter we originated $91 million of loans with an average yield of 6.7% and a level of return of approximately 14%.
For the full year 2012, we totaled approximately $275 million originations with an average yield of approximately 7.4% and levered returns of approximately 14%. In addition, in the first month and a half of 2013, we originated $75 million of loans with a yield of approximately 6.7% and expected levered returns are around 14%. As I mentioned earlier, our pipeline remains strong and our goal is to continue to deploy our capital into new investment opportunities with mid teens targeted returns.
For 2013, we estimate we will originate an average of approximately $30 million of volume a month which we are confident, we can produce between our extensive sales force in REIT and in our external manager. We also continue to grow our residential investment platform purchased in residential mortgage securities in the fourth quarter totaling $40 million with an weighted average yield of approximately 5% and expected levered returns of nearly 20% to the year we purchased a $158 million of securities with an average yield of 5% and levered returns of around 20%. Additionally, we purchased $25 million of residential securities in 2013 so far with a waited average yield of 5% and expected levered returns of about 20%.
At December 31, 2012 we had a 122 million of residential securities outstanding with corresponding leverage of $98 million. These securities generally have an average expected life of 24 to 36 months and are expected to generate levered returns of approximately 20%.
As I mentioned earlier, our goal is to continue to finance a substantial amount of our investments with non-recourse debt with replenishment rights, allowing us to match the term of our asset with term of our liabilities without being subject to event risk if a credit market dislocation should occur. This philosophy is a critical component of our business strategy and we have had tremendous success in this area over the last several months. We have a very seasoned experienced securitization team with significant capabilities and this has allowed us to be a leader in the commercial mortgage REIT space in accessing the securitization market, through CLO vehicles.
As we mentioned on our last call on September, we were the first commercial mortgage REIT to complete a non-recourse CLO vehicle since the dislocation occurred. We believe this was attributable to our strong reputation and market of effectively managing our three legacy CDO vehicles through the downturn and our ability to originate high quality collateral for our deep originations platform.
The vehicle has a $125 million of collateral and $88 million of leverage and the ability to substitute collateral of a period of two years to a replenishment ship feature. And just last month, we announced the closing of our second non-resource CLO. The details of the CLO were described in our press release, but I would like to highlight some of the significant components and unique features of this transaction.
The vehicle is comprised of approximately $260 million of collateral, including $15 million of additional capacity to fund future investments, known as a ramp up. It contains approximately a $177 million of financing as a weighted average spread excluding fees of 235 of the LIBOR and also provides us with the ability to substitute collateral for a period of two years to a replenishment feature. This vehicle is significant in lodging our first CLO in September and has a ramp up feature to provide additional capacity going forward. It’s also estimated that the all end cost of this vehicle would be approximately a 130 basis points lower than our first CLO, demonstrating the depths of our securitization team, as well as the improving market conditions.
Additionally, we believe the success we have had in accessing the securitization market plus several other long-term benefits to Arbor including greater access to financing lines and equity capital as well as the ability to pull product for potential future securitizations. In fact, in the first month and a half of 2013, we have already increased our short term funding sources by adding a new $50 million warehouse facility and well as by increasing the capacity of our existing debt facilities by $30 million. The new $50 million facility has a one year term with pricing 250 over LIBOR and leverage of up to 75%, depending on the assets that are being financed. As a result we now have approximately a $125 million of capacity in our short term credit facilities and addition to the $50 million of capacity we created in our second CLO to the ramp up feature. And this capacity combined with cash today of approximately $40 million, this is total of approximately $215 million in cash and capacity to fund future investment opportunities.
As we have discussed in the past, we’ve also have been very successful in repurchasing our debt at deep discounts, recording significant gains and increasing our equity value. While we did not purchase any of our CDO bonds in the fourth quarter, we did repurchase a total of $66 million of CDO bonds for gain of $30 million during 2012. And in the first quarter of 2013 we purchased $7.1 million of our CDO bonds for $3.4 million, resulting in a gain of approximately $3.7 million that will be recorded in the first quarter of 2013.
As of today, we own approximately $161million of our original CDO bonds at an $89 million discount to par, which represents significant embedded cash flows that we may realize in the future periods. We will continue to evaluate the repurchase of our CDO debt going forward based on availability, pricing and liquidity.
Now, I would like to update you on our view of the commercial real-estate market and then discuss the credit status of our portfolio. Overall the commercial real estate market continues to recover and asset values are continually improving. There is clearly more liquidity entering this space each day, which has also made the market more competitive, putting some pressure on yields. The availability of liquidity and improving market conditions however has also reduced financing cost and increased available funding sources.
The market we are most active in a multi-family asset class with investment opportunities typically ranging from $5 million to $30 million. We believe we have a significant competitive advantage by levering off our manager who provides with a strong pipeline of flow of multi-family that brings loan opportunities. Our manager is one of the top (unidentified) FHA platforms in the country with a significant sales force and suitable market reach and a strong national presence in commercial lending arena.
Additionally we benefit from significant operating efficiencies as a result of our managers deep infrastructure. As a result we continue to produce significant investment opportunities for us to grow a platform and increase our core earnings. Looking at the credit status of our portfolio in the fourth quarter, we recorded $2.4 of net loan loss reserves related to three assets in our portfolio. We also had a $500,000 recovery of a previously recorded reserved under fourth quarter from a gain on the sale of a real estate owned asset, which was previously written down below the sales price. As of December 31, we had 9 non-performing loans by the UPB of approximately $16 million and the net carrying value of approximately $15 million, which is up from a net carrying value of $10 million as of September 30, due to one additional non-performing loan in the fourth quarter.
Additionally, we believe we have put substantially all our legacy issues behind us and while it is possible, we could have some additional right outs in our portfolio, on our legacy assets, based on market conditions, we remain optimistic that any potential or remaining issues will be minimal. We also believe as the market continues to improve, we could have some recoveries from our assets combined with potential gains from debt repurchase to offset any potential additional losses, however the finding of any potential losses, recovery and gains on a quarterly basis is not something we can predict or control.
In summary, we are extremely pleased with our accomplishments, especially in our ability to access the capital markets through two equity offerings or perpetual preferred offering and two non-recourse CLO vehicles, as well as in our ability to increase our short term lending sources.
We are pleased with the increase in our core earnings and dividend over the last couple of quarters, as well as the appreciation of stock price. We are excited about the growth in our pipeline and are confident our originations network will continue to produce attractive investment opportunities to grow our platform. We will continue to focus on increasing the value to our shareholders by growing our core earnings and dividend over time and further narrowing the gap between where are stock is trading and our adjusted book value which is approximately $10.41 on December 31, which we believe is more representative of our true franchise value.
I will turn the call over to Paul to take you through some of our financial results. Paul?
Okay. Thank you, Ivan. As noted in the press release, we produced FFO for the fourth quarter of approximately $900,000, or $0.03 per share and FFO of $23.5 million or $0.87 per share for 2012. We successfully generated $0.5 million in the fourth quarter and $3.9 million for the full year 2012 of recoveries that previously recorded loan loss reserves in the form of gains from the sale of two of our real estate owned assets. These gains are not included in FFO under its current definition, so adding them back adjusted FFO was $1.4 million or $0.04 per share for the fourth quarter and $27.5 million, or $1.01 per share for the 2012 year.
We also reported a net loss of approximately $300,000 or $0.01 per share for the fourth quarter and an income of $21.5 million or $0.79 per share for the year ended December 31st, 2012. We ended 2012 with an adjusted FFO return on average equity of approximately 13.7%, and an adjusted FFO return on average adjusted equity of 9.2%.
As Ivan mentioned, we recorded $2.4 million in net loan loss reserves in the fourth quarter related to three assets in our portfolio. After these reserves and charge-offs of previously recorded reserves, we now have approximately $162 million of loan loss reserves on 20 loans with a UPB of around $240 million as of December 31st, 2012.
At December 31st, our book value per share stands at $7.34 and our adjusted book value per share is $10.41 adding deferred gains and temporary losses on our swaps. As Ivan mentioned, we believe that our adjusted book value better reflects our true franchise value, as these deferred items will be recognized over time, while the significant economic benefit related to these items has already been realized. Additionally, as Ivan mentioned, we currently have approximately $40 million in cash on hand and $175 million of capacity in our short-term credit facilities, including the ramp up feature in our second CLO to fund our future investments.
Looking at the rest of the results for the quarter, the average balance in our core investments were relatively flat at around $1.6 billion for both the third and fourth quarters. The yield for the fourth quarter on these core investments was around 5.10% compared to 5.03% for the third. This increase in yield was primarily due to higher yields in our fourth quarter originations, combined with the full effect of our third quarter originations, as well as from the acceleration of income from an early pay off which was partially offset by one new non-performing loan during the quarter. Additionally, the weighted average all-in yield in our portfolio increased to around 5.04% at December 31st, compared to around 4.91% at September 30 primarily due to higher yields on our new investments, partially offset by our non-performing loan in the fourth quarter.
The average balance on our debt facilities were also relatively flat at around $1.2 billion for the third and fourth quarters. The average cost of funds on our debt facilities was approximately 3.18% for the fourth quarter compared to 3.11% for the third quarter. Excluding the unusual non-cash impact at certain interest rate hedges which are deemed to be ineffective for accounting purposes had on interest expense, our average cost of funds increased to approximately 3.09% for the fourth quarter compared to around 2.97% for the third quarter, primarily due to the full effect of our first CLO which closed in late September. Additionally, our estimated all-in debt cost was relatively flat at around 3.12% at December 31st compared to around 3.15% at September 30. So overall, normalized net interest spreads in our core assets was approximately 2.01% this quarter compared to approximately 2.06% last quarter. Our net interest spread run rate is now approximately $44 million annually, or 1.91% at December 31st compared to approximately $40 million annually, or 1.76% at September 30. This significant increase is primarily due to the growth in our portfolio and increases in yields from our fourth quarter originations.
NOI related to our REO assets decreased $1.6 million compared to last quarter due to the seasonal nature of income related to our portfolio of hotels that we own combined with some one-time expenses from a change in the property management of these assets. As of December 31st, we have two REO assets we are holding for investment, totaling approximately $124 million, subject to approximately $54 million of assumed debt for a net value of approximately $70 million. As of today, we believe these two assets should produce NOI before depreciation and other non-cash adjustments of approximately $3 million for 2013. This projected income, combined with our net interest spread run rate at December 31st, 2012 of approximately $44 million on our loan and investment portfolio, gives us approximately $47 million of annual estimated core FFO before potential loss reserves and operating expenses looking out 12 months based on our run rate at December 31st, 2012. Clearly, this growth in our core earnings over the last several quarters has contributed greatly to the increases in our dividends and we are optimistic that we will continue to increase our core earnings and dividends over time.
Operating expenses increased compared to the third quarter, largely due to increased employee and operating cost associated with our 2012 accomplishments and our active origination platform and loan restructurings in the fourth quarter. Additionally, as we disclosed in our 10-K this morning, the board has approved the issuance of approximately 200,000 shares of restricted stock to certain of our employees and the employees of our manager. These shares will be granted on February 28, 2013 and have a three-year vesting period.
Next, our average leverage ratios on our core lending assets decreased slightly compared to last quarter to around 65% and 76% including the trust preferred as debt, compared to 66% and 77% respectively. Our overall leverage ratios on our spot basis including the trust preferred as equity was down slightly from 3.0 to 1 at September 30 to 2.9 to 1 at December 31st. This was due to a decrease in total CDO debt outstanding from runoff, partially offset by the financing of our fourth quarter originations.
There are some changes in the balance sheet compared to last quarter that I would like to highlight. Repurchase agreements and credit facilities increased by approximately $50 million, due to the financing of our fourth quarter originations, combined with a lower debt balance in these facilities in the third quarter and the transfer of certain assets into our first CLO vehicle in September. CDO debt decreased approximately $29 million from last quarter due to our third quarter CDO runoff which was used to pay down CDO debt in the fourth quarter. Additionally, total equity increased approximately $19 million this quarter, primarily due to our common stock offering in October.
Lastly, our loan portfolio statistics as of December 31st shows that about 68% of the portfolio was variable rate loans and 32% were fixed. By product type, about 67% were bridge, 19% junior participations, and 14% mezzanine and preferred equity investments. By asset class, 51% of our portfolio was multi-family, 28% is office, 7% hotel, and 10% land. Our loan to value was around 80%, our weighted average median dollars outstanding was 50% and geographically we have around 34% of our portfolio concentrated in the New York City area.
That completes our prepared remarks for this morning. I will now turn it back to the operator to take any questions you may have at this time. Kathy?
(Operator Instructions) Your first question comes from the line of Steve DeLaney, JMP Securities.
Steven DeLaney - JMP Securities LLC
Thank you, good morning. Congratulations on the continued steady progress here in the fourth quarter.
Steven DeLaney - JMP Securities LLC
Ivan, I wanted to thank you for the outlook on production that was one of my questions as to what increase we might see over and above the 275. I guess, I have two questions on the $360 million, or $30 million a month. When you make that projection, should we assume that you are going to maintain, sort of primarily the same focus on multi-family bridge loans, or are you looking to broaden your lending product menu?
I think that a majority of our production will continue to be multi-family, while there is on this exclusively multi-family in 2012, I would expect it to probably represent around 75%. We are looking at some retail deals and some hospitality deals very very selectively and it is our ambition to do probably 25% diversification. If and when we do another securitization we would like to be able to include net asset class, net securitization to diversify our asset classes that we track.
Steven DeLaney - JMP Securities LLC
Your loan pricing, it looks like what you have done so far in the first quarter of this year held up pretty well to the fourth quarter. Do you have a sense on what type of pricing pressure you might see in 2013?
I mean, we have clearly seen the last 90 days pricing tighten up by 50 basis points to as much as 100. I think that some of the benefits of the way we originate, we do get some unique transactions and since we are not looking to do billions of dollars, we can still garner fairly attractive yields. I would say that there will be a continual tightening as there is more liquidity in the markets and we have been able to decrease our borrowing cost, potentially offset that and still deliver consistent mid-teens returns. I would say 2013 is going to be a year of continued spread tightening for the borrower.
Steven DeLaney - JMP Securities LLC
Alright. Hopefully with the financing maybe gaining a little more accommodating and lower rates, you still think you can get sort of this mid-teen type ROI when you leverage --?
Yes, I do. Also, given the fact that we put another CLO in place it’s much more efficient, the transaction costs are much less and we have a ramp up. We could fund directly into our CLO, avoiding duplicate transaction cost for financings. So, we believe that the efficiencies that we are achieving on the financing side should offset the tightening of the spreads on the lending side.
Steven DeLaney - JMP Securities LLC
Okay, that’s helpful. I guess, as you look at the market opportunity out there, obviously you have got your own direct origination channels, so you are not looking to just buy loans in the sector market. When you look at the $275 million in 2012 or the $300 million plus in next year, are you in some way, Ivan, setting those kind of targets based on the capital that you have available or is it a function of – the volume of loans it sort of meet your quality standard. What I am getting at it is, the stock has done very well, if you were to continue to have access to more capital, would it be possible to attract a larger volume of loans to put that capital to work without having to cut your credit standards?
Sure, we can definitely ramp up our originations significantly above where we are at. We monitor a number of things, we monitor our run off, our capacity, our liquidity, and our cost of capital because we don’t want to just raise capital for the sake of raising capital, we are very sensitive to where our stock price has been. It’s more strategic in terms of what we want to accomplish, but there is more capacity in terms of our originations that where we are originating. We are monitoring, it’s based on those factors. If there were certain unique opportunities that increment in yield we would evaluate that accordingly. But it is something that the management is active on a day to day basis in terms of monitoring and measuring the opportunities versus our cost of capital, and as well as access in the securitization market in the debt side.
Steven DeLaney - JMP Securities LLC
Okay, well listen, thanks for the comments and congratulations on a great turnaround year for Arbor.
Thank you very much, Steve.
Thank you for your question. Your next question comes from the line of Stephen Laws of Deutsche Bank, please go ahead.
Stephen Laws - Deutsche Bank
Hi, good morning. Thanks for taking my questions. I always follow Steve, yes a lot of great questions as well. Can you maybe talk a little bit about the modified and extended loans during the quarter? What you are seeing there, what type of terms you are able to get on those and how much more of that do you expect to see kind of going forward as more of the, I guess legacy loans hit kind of an extension or maturity date?
Paul, I am going to turn that to you.
Sure, absolutely. Yes, Steve, I mean, the modifications and the extensions have definitely slowed as the legacy portfolio is on tremendously solid footing. But we do still have some of the same loans that have come after extension and we do have some new modifications. I think that the trend lately though has been more in favor of us. In the past when the dislocation occurred and we were modifying loans, we were normally giving rate concessions to get a better credit quality loan and more predictable earnings and loan performance. Lately what we have seen is a trend the other way when people are coming up for modified and extension unless it is a specific loan that we know we are extending based on a contractual term. We are able to extract a little bit more in the yield. So, this quarter we did extend and modified some loans, but ones we did extend we extract a little more yield out of them. So, we will have some of these going forward as some loans that we have still have extension options on them, but it has been slowing over the last couple of quarters.
Stephen Laws - Deutsche Bank
Great. Thanks for the color on that especially (inaudible) for moving back in your favor there as well. Looking at the over collateralization test, CDO III is fairly close to the limit, although it did improve sequentially from the last quarter when it was 105.64. Can you maybe touch on that a little bit? Do you think that will continue to improve there or is there any risk you have or any concerns you guys have with that CDO III?
I guess we always have concerns when the cushion spend. We’ve effectively managed it. Gene Kilgore manages our securitization and CDO has done a very very good job. We are sensitive to maintaining and making sure that vehicles for cash flows and we’ll work very hard to do so. In terms of concern, given the cushion we do have a level of concern, but we will pay a lot of attention to it and try and operate that as efficiently as we can.
Steven, it is Paul. As Ivan said, we do have a level of concern with the cushion being tight. However, I do want to point out that the third CDO was the more highly levered CDO that we did in the legacy book, so the cushion was never really very large to begin with so it is a tight cushion, but it is the CDO that had the highest leverage and while we do have some concern as loans pay off. We’re hopeful that the cushion could improve with loans paying off. Other things could go the other way and we do have a concern, but as the vehicle continues to delever some of these has to get better over time.
And then the CDO was more of a whole loan CDO with higher quality collateral and that is the part of the reason why it is always operated on a lower cushion.
Stephen Laws - Deutsche Bank
Great. Thanks for that and I think my other couple of question on pipeline and cash flow were addressed even in your prepared remarks are your previous answers and again congrats on a nice year, but also important to nice start to this year with the CLO and some new financing facilities.
Thank you Steve.
I would now like to turn the call over to Ivan Kaufman for closing remarks.
Okay, well thanks for everybody’s support in 2012 and we’re looking forward to an outstanding 2013. As Steve mentioned we are off to a great start in terms of stock performance and (inaudible) and look forward to our next earnings call. Thank you very much.
Ladies and gentlemen, that concludes today’s conference. You may now disconnect and have a great day.
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