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Arbor Realty Trust, Inc. (NYSE:ABR)

Q3 2009 Earnings Call

November 6, 2009 10:00 am ET

Executives

Paul Elenio – Chief Financial Officer

Ivan Kaufman – President and Chief Executive Officer

Analysts

David Fick - Stifel Nicolaus & Company, Inc.

[Michael Petrolock] – Individual Investor

Operator

Good day ladies and gentlemen, and welcome to the third quarter 2009 Arbor Realty Trust earnings conference call. My name is [Shoquana] and I will be your coordinator for today. (Operator Instructions)

I would now like to turn the presentation over to your host for today’s call, Mr. Paul Elenio, Chief Financial Officer for Arbor Realty Trust. Please proceed sir.

Paul Elenio

Okay. Thank you Shoquana, and good morning everyone and welcome to the quarterly earnings call for Arbor Realty Trust. This morning we will discuss the results for the quarter ended September 30, 2009. With me on the call today is Ivan Kaufman, our President and Chief Executive Officer.

Before we begin I need to inform you that 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 performances, 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 occurrences of unanticipated events.

I’ll now turn the call over to Arbor’s President and CEO, Ivan Kaufman.

Ivan Kaufman

Thank you Paul and thanks everyone for joining us on today’s call. Before Paul takes you through the quarterly results, I would like to talk about our views of the market and the strategy and approach we are taking in this difficult environment.

We continue to navigate through this ongoing economic downturn as the market remains severely dislocated with significant liquidity issues throughout our sector. This environment has clearly affected every borrower and real estate values in the personal asset classes and geographic locations. As we have said repeatedly, we are not expecting the situation to improve any time soon and feel that there will be an increase in delinquencies for the remainder of the year which will result in additional losses throughout our sector. Therefore, our total focus remains on preserving liquidity and aggressively managing our portfolio and financial resources.

As we discussed on our last call, we are extremely pleased with our ability to successfully restructure all of our short term debt and trust preferred securities over the last several months. The restructuring of the Wachovia facility has resulted in a three year extension and significantly reduced our financial covenants mark-to-market risk and repayment requirements. The trust preferred securities were restructured by substantially reducing the current pay rate to a fixed rate of 50 basis points for a three year period. Clearly these restructurings were essential and allow us to focus 100% of our time on managing our business in this difficult cycle by creating greater operating flexibility and significantly reducing our risk to financial institutions.

In addition, we continued to de-lever our balance sheet during the third quarter, reducing our notes payable and repurchase agreements by $51 million through a runoff asset monetization and moving assets into our CDO vehicles. This included $12 million payoff of one of our core short term debt facilities and a $39 million pay down on our Wachovia facilities. This reduced our outstanding debt with Wachovia to approximately $334 million at September 30 and greatly reduced our short term loan reduction requirement to only $17 million over the next three years, with the next scheduled payment not due until late 2011.

We also continued to take advantage of the dislocated market by repurchasing our CDO debt at substantial discounts. We recorded a $6 million gain from these repurchases during the quarter and we will evaluate similar transactions in the future based on availability, pricing and liquidity.

Another primary focus has been preserving and maximizing liquidity, which is critical to successfully managing through this significant downturn. We are pleased with our progress in this area and currently have around $40 million in operating cash and around $20 million of cash posted against our swaps. We also have $15 million in cash available in our CDOs for future deployment.

We continue to look for creative opportunities to improve our liquidity positions including working aggressively with our borrowers to repay their loans and monetize our investments. In the third quarter we generated $39 million of payoffs and pay downs and refinanced and modified $215 million of loans. We were also very pleased to have monetized our remaining investment in prime during the quarter, receiving around $10 million in cash and reporting a $10.7 million gain from this investment.

As we have always emphasized, these equity [kickers] are a key part of our business model and we’ve generated significant cash flow and earnings from the monetization of these investments to date.

Now I would like to update you on the credit status of our portfolio. As discussed earlier, we have seen significant reductions in real estate values and the overall commercial real estate market remains very weak. This continues to put stress on our portfolio and as a result we recorded $51 million of loan loss reserves during the third quarter, related to 22 loans with an outstanding balance of approximately $380 million. $31 million of these reserves were on loans that we had previously recorded reserves on while $20 million were new reserves.

We also restructured several loans during the quarter, charging off $15 million against previously recorded reserves. We now have $253 million in loan loss reserves at September 30 related to 28 loans with an outstanding balance of approximately $564 million. Additionally, we recorded $2 million impairment charges on our equity investments and a $5 million loss from a real estate loan during the quarter.

At September 30 the total amount of our non-performing loans was down to around $200 million from $295 million at June 30. This is primarily due to the successful restructuring of a $95 million loan during the third quarter that was previously in bankruptcy.

We remain extremely focused on managing our portfolio and will continue to pursue maximizing our liquidity positions through the monetization of our investments, even if it results in accounting losses. Clearly the significant issues resulting from these market conditions affect everyone and we’ll continue to expect and prepare you for the worst. As we’ve discussed frequently on our last several calls, we do expect real estate values to continue to decline and liquidity available to our borrowers to remain scarce. This will result in additional stress in our portfolio and likely to increase defaults and delinquencies and future losses. However, predicting the amount and timing of these losses will be very difficult.

In summary, these are extremely difficult times and we continue to work exceedingly hard on our core objectives. We believe that companies like ours who can successfully restructure their debt and continue to manage their existing portfolio effectively will be well positioned to take advantage of the many significant opportunities that may lie ahead. We will continue to focus heavily on maximizing our liquidity and monetizing and aggressively managing our portfolio. Success in these critical areas is vital for us to be able to manage through this cycle and allow us to take advantage of the long term growth opportunities that we believe will exist.

I will now turn the call over to Paul to take you through some of our financial results.

Paul Elenio

Okay. Thank you Ivan. As noted in the press release, we had a net loss for the third quarter of $44.1 million or $1.74 per share. As in previous quarters, we did have several large items that affected the third quarter numbers. We recorded $53 million of reserves on our loans and equity investments and a $5 million loss from a real estate owned property during the quarter.

We also recorded a $10.7 million gain from the monetization of our remaining prime investment that was previously disclosed, as well as a $6.3 million gain from our continued success in buying back some of our CDO debt at discounts. In addition, we had a $1.7 million increase in interest expense in the third quarter for a change in the market value of certain interest rate swaps, which GAAP requires us to flow through earnings, compared to an approximately $2.6 million increase in interest expense in the second quarter. These swaps effectively swapped out assets in our CDOs which pay based on one month LIBOR and our CDO debt which is based on three month LIBOR. The value of these swaps, which at September 30 was $2 million, will eventually return to par to maturity of the trades, but if the market outlook for rates and spreads continue to fluctuate greatly, these trades could produce significant changes in value, which would increase or decrease our earnings going forward.

We also paid our external manager $4.1 million during the quarter for the successful restructuring of our debt with Wachovia and our trust preferred securities per the amended management agreement that we discussed last quarter. So our adjusted core EPS would have been around $0.20 per share for the third quarter compared to around $0.28 per share for the second quarter, adjusting for non-recurring items and reserves. This decrease was primarily due to a reduction in the net interest income from portfolio runoff and higher cost of funds due to the debt restructurings we spoke of earlier.

Looking at the rest of the results for the quarter, the average balance in core investments declined about $103 million from last quarter, mainly due to payoffs and pay downs from the second and third quarters. The yield for the quarter on these core investments was around 5.35% compared to 5.40% for the prior quarter. Without some non-recurring items related to non-performing and restructured loans, the yield on these core assets was around 5.40% for both the second and third quarters as LIBOR was relatively flat from quarter-to-quarter. This also resulted in the weighted average fallen yield in our portfolio remaining flat as well at around 5.35% at September 30 and June 30, 2009.

The average balance on our debt facilities decreased by around $65 million from last quarter, which was less than the decrease in our core investments. This was primarily due to a discounted payoff on a large loan at the end of the second quarter. The average cost of funds on our debt facilities was approximately 4.49% for the third quarter compared to 4.45% for the second quarter. Excluding the unusual impact on interest expense from our swaps which I mentioned earlier, our average cost of funds was approximately 4.12% for the third quarter compared to around 3.90% for the second quarter. This increase was primarily due to the impact of the new pricing on the Wachovia deal, partially offset by the benefit of unwinding several interest rate swaps associated with our trust preferred securities, which were converted to a fixed rate.

In addition, our estimated all in debt cost was around 4.20% at September 30 compared to 3.50% at June 30. This again was primarily due to the full impact of the new pricing on the Wachovia debt restructuring.

So overall normalized net interest spreads on our core assets decreased to approximately 1.30% this quarter from 1.50% last quarter, mainly due to higher weighted average interest cost from the increased price in the Wachovia restructuring, partially offset by the benefit of unwinding several interest rate swaps associated with our trust preferred securities.

And as we said earlier and Ivan touched on we are expecting additional defaults and delinquencies through the remainder of 2009 which could continue to reduce our net interest spreads going forward.

Next our overall leverage ratios were around 69% in our core assets and around 81% including the trust preferred as debt for both the second and third quarters. And our overall leverage ratios on a spot basis were also flat at around 3.0 to 1 for both the second and third quarters.

Operating expenses were relatively flat from quarter-to-quarter, primarily due to a $2.1 million reduction in stock-based compensation from the accelerated vesting of all of our remaining restricted stock ramps in the second quarter. And this was largely offset by an increase of approximately $1.7 million of foreclosure related expenses in the third quarter.

There were some changes in the balance sheet compared to last quarter that I’d like to touch on. Notes payable and repurchase agreements decreased $51 million during the quarter. This is primarily due to our continued strategy of reducing short term debt through loan payoffs and moving assets into our CDO vehicles, which also resulted in a $24 million decrease in restricted cash related to our CDOs during the quarter. Of the $51 million reduction notes payable, the restructured term debt and working capital facilities at Wachovia were paid down by $31 million and $8 million respectively.

As previously disclosed, the Wachovia term debt facility requires $48 million in reductions over a three year period. So as Ivan mentioned earlier we are very pleased with our ability to reduce this facility by $31 million during the quarter, which is way ahead of the scheduled required reductions. This now leaves us with only $17 million in reductions remaining in this facility, with the first scheduled reduction not due until June of 2011.

Lastly our portfolio statistics as of September 30 show that about 65% of our portfolio was variable rate and 35% was fixed. By product type, about 61% was bridge, 14% junior participation and 25% mezz and preferred equity. By asset class, 38% was multi-family, 28% was office, 17% hotel, 12% land and 1% were condo conversions. Our loan to value was around 91%, our weight average median dollars outstanding was 64% and geographically we have around 38% of our portfolio concentrated in New York City.

With that I’d like to turn it back to the operator and we’ll be happy to answer any questions you may have at this time.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question comes from David Fick - Stifel Nicolaus & Company, Inc.

David Fick - Stifel Nicolaus & Company, Inc.

Am I correct in saying that you’ve now extracted the remaining value in prime retail through your swap and note transactions?

Paul Elenio

Yes. The remaining interest in prime has been exchanged and there are no more interest in that transaction as we stand.

David Fick - Stifel Nicolaus & Company, Inc.

And extended stay is now essentially [carried] at zero?

Paul Elenio

It’s actually carried right now at about just under $14 million.

David Fick - Stifel Nicolaus & Company, Inc.

Do you still believe that that’s realizable?

Paul Elenio

We do at this point.

David Fick - Stifel Nicolaus & Company, Inc.

Can you walk us through the amendment to the management agreement? And specifically what specifications there are for future incentive payments?

Paul Elenio

Yes. I think last quarter we talked in detail, David, about the amendment to the management agreement which the highlights are the management fee has been changed to a cost basis, a reimbursement of costs as opposed to a percentage of overall equity. There are incentive fees in the management agreement that give the manager the right to earn 25% fee over a hurdle. That hurdle is similar to what it was in the past except for a couple of things changed and one is it’s calculated on a gross price per share of raised capital of $10. That’s a minimum bogey as opposed in the past it was whatever that raised dollar of cash was. And only 60% of any recovered loan loss reserves going forward can be added back to the numbers to come up with the management fee. And that phases in over a three year period.

As far as any other incentives that can be earned, the board has the option in the management agreement to consider from time to time anything that the manager may have worked on that is considered to be above their normal performance or their cost. And that’s done on a specific deal by deal basis in the management agreement, based on the independent board that’s reviewing it, analyzing it and then approving it.

David Fick - Stifel Nicolaus & Company, Inc.

How does one determine what an appropriate additional fee is for accomplishing things like for example the negotiation with Wachovia for which you were paid $4.1 million?

Ivan Kaufman

That’s done by the committee that evaluates the request by management as recommendations.

David Fick - Stifel Nicolaus & Company, Inc.

Can you explain the basis for that $4.1 million?

Paul Elenio

Sure. The comp committee and the independent board evaluated several things. One was the size of the transaction, the success in the transaction, the benefits to the shareholder and to the company of amending those transactions with what they believed were very favorable terms. And also the board looked at the compensation that was paid to certain advisors, other companies and our peers had used financial advisors to negotiate their deals. We did not and that was taken into consideration as well, how much a financial advisor would have cost the company to execute that transaction.

David Fick - Stifel Nicolaus & Company, Inc.

Then how would you guide us as analysts and investors going forward with respect to this significant cost element, considering that it looks like it now has a fair amount of discretion and it doesn’t lend itself to estimation on our part?

Paul Elenio

Yes. It’s tough but I can tell you right now there’s nothing that the manager has worked on that is in front of the board that is up for consideration of any special compensation. The trust preferred and the Wachovia restructurings were the thing that was paid this quarter. We have nothing else in the hopper right now that is being considered. I think it’ll be tough to estimate going forward and we’ll just have to try to disclose any significant transactions that we’re working on going forward so you guys can take a look at what may be in front of the board. But right now there’s nothing in front of the board for future compensation at this point.

David Fick - Stifel Nicolaus & Company, Inc.

What could you anticipate the [onwards] have already submitted to them?

Ivan Kaufman

There’s nothing we’re working on currently. I guess they would be added in the normal course of our daily asset management in managing the business. So I would say at the current time there’s nothing that management is actively engaged in that would be out of the normal course of operations.

Operator

Your next question comes from [Michael Petrolock] – Individual Investor.

[Michael Petrolock] – Individual Investor

I would just like to ask a few simple questions. What is your current GAAP of book value?

Paul Elenio

The current GAAP book value is $8.70.

[Michael Petrolock] – Individual Investor

Have there been any significant insider purchases or sales in the last quarter?

Paul Elenio

Have to go back to the SEC filings. I don’t remember. There were some board members who did purchase some stock. I don’t know if it was in the last quarter or not but you’d have to go back to the filings of the SEC that are required when any insider purchases stock.

Operator

At this time there are no further audio questions. I would now like to turn the call back over to management for closing remarks.

Ivan Kaufman

Thank you for your participation and I look forward to our next call.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect and have a great day.

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Source: Arbor Realty Trust, Inc. Q3 2009 Earnings Call Transcript
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