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Arbor Realty Trust, Inc. (NYSE:ABR)

Q3 2013 Earnings Conference Call

November 8, 2013 10:00 AM ET

Executives

Paul Elenio - Chief Financial Officer, Treasurer

Ivan Kaufman - Chairman, President, Chief Executive Officer

Analysts

Steve Delaney - JMP Securities

Operator

Good day ladies and gentlemen and welcome to the Third Quarter 2013 of Arbor Realty Trust Earnings Conference Call. My name is Shaquena. And I will be your coordinator for today. At this time all participants are in a listen-only mode. We will facilitate a question-and-answer session towards the end of this conference. (Operator Instructions)

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

Paul Elenio

Okay, thank you, Shaquena. Good morning everyone, and welcome to the quarterly earnings call for Arbor Realty Trust. This morning, we'll discuss the results for the quarter-ended September 30, 2013. 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 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 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 to everyone for joining us on today’s call. Before Paul takes you through the financial results, I would like to touch on some of our recent accomplishments and then focus on our business strategy and outlook for the remainder of 2013 and for 2014.

We are very pleased with another successful quarter especially in our ability to deploy our long-term growth capital into high yielding investment opportunities, allowing us to continue to execute our strategy of growing our core earnings and dividends over time.

As we announced recently, we raised an additional $41 million in equity capital at the end of the third quarter and as of today, we have approximately $73 million in cash and $72 million of capacity in our short-term credit facilities.

We believe this cash and capacity combined with expected run-off in our CLO and warehouse facilities provides us with adequate capital and liquidity to fund our pipeline and achieve our goals of continuing to grow our portfolio and further access the securitization market generating mid-teens leverage returns.

Our growing pipeline combined with our success in accessing the debt and equity markets has allowed us to continue to grow our originations rapidly replacing our run-off and continuing to increase our core earnings. We are very pleased with the investment opportunities we continue to see through our external managers expansive multifamily originations platform, which has allowed us to deploy our capital quickly and has increased our pipeline significantly over the last several months.

As a result, we had another strong quarter originating $148 million of loans in the third quarter with an average yield of approximately 7.3% and a leverage return of approximately 14%, which combined with our originations for the first six months of $280 million totaled approximately $428 million of originations for the first nine months of the year with mid-teens leverage returns.

In addition, we expect to have an even stronger fourth quarter as our pipeline continues to grow rapidly closing out the year with expected total originations of approximately $600 million to [$615] [ph] million which is well above our previous estimate for originations. As I mentioned earlier, we are expecting some run-off in the fourth quarter as well mostly in our CLO vehicles and warehouse facilities the proceeds of which will be used to fund our future originations.

As we have discussed in the past, a critical component of our business strategy continues to be finance a substantial amount of our investments with non-recourse debt through CLO vehicles allowing us to match the term of our assets with the term of our liabilities without being subject to [event] [ph] risks.

We have had a tremendous amount of success in this area and have become a leader in the commercial mortgage re-securitization market. We currently have two CLO vehicles in place with $385 million of collateral, $265 million of leverage and the ability to substitute collateral for a period of two years through a replenishment feature in both vehicles. And the capital we have raised over the last several quarters combined with our growing pipeline has positioned us very favorably to originating pool collateral for another securitization vehicle, which we believe will result in increased leverage returns on our invested capital future core earnings growth and a stable funding source for the next few years.

We also believe our success in accessing the securitization market provides us with a significant long-term strategic competitive advantage allowing us to have permanent non-recourse debt facilities from the liabilities structure that matches our asset maturities without being subject to mark-to-market provisions.

This has also resulted in additional access to short-term lending facilities with lower pricing enable us to remain competitive on pricing our investments to adjust when market yields tighten and still remains and have similar effective yields.

And if and when the market backs up again and liquidity becomes an issue, we will benefit substantially from these debt structures by enabling us to maintain stable liability terms with low course debt while assets are priced less competitively resulting in superior leverage returns.

Now, I would like to update you on our view of the commercial real estate market and discuss the credit status of our portfolio. Overall, the commercial real estate market continues to improve as more liquidity is entering the space and asset values are increasing. We continued to see signs of increased stabilization and more rapid growth in certain segments especially in the commercial multifamily lending arena, which is the asset class that we have tremendous amount of experience in and continue to be our primary focus.

As a result, we have seen a significant increase in deal flow which has grown our pipeline substantially and increased our originations. We still believe we are uniquely positioned having a strong competitive advantage in the market by levering off of our managers top Fannie Mae FHA platform with a strong national presence in the multifamily lending arena. And we are very confident in our ability to continue to produce significant investment opportunities for us to grow our platform and increase our earnings all the time.

Looking at the credit status from our portfolio in the third quarter, we recorded $1.5 million of loan loss reserves related to one asset in our portfolio and recorded $750,000 in recoveries of previously recorded reserves. And at September 30th, we had five non-performing loans with the net carrying value of approximately $16 million, which was relatively unchanged from the prior quarter. And although, it is possible we could have some additional write-downs in our portfolio on legacy assets.

Going forward, we continued to remain optimistic that any potential issues will be minimal and we will continue to have future recoveries in other assets combined with potential gains from debt repurchases to offset any potential additional losses. However, the timing of any potential losses, recoveries and gains on a quarterly basis is not something we can predict or control.

In summary, we're extremely pleased with our progress, especially in our ability to successfully deploy our capital into accretive investment opportunities and our ability to continue to utilize our non-core recourse CLO vehicles and warehouse facilities to finance these investments generating mid-teen leverage returns on our capital.

We're also very excited about the growth in our pipeline and the investment opportunities as we continue to see from our deep originations network to grow our platform and our core earnings. And clearly we feel that our current stock price is not reflective of our true franchise value given the depth and strengths of our originations platform and non-recourse securitization expertise combined with our dividend yield and an adjusted book value of $9.26 per share.

While we believe, we have a very attractive value play, we also understand the importance of continuance to grow our dividend and our core earnings and dividend over time, which remains our primary focus. We remain patient in our approach and we are very confident in our ability to achieve our objectives and continue to increase the value to our shareholders over the long-term.

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

Paul Elenio

Thank you, Ivan.

As noted in the press release, FFO for the third quarter was approximately $5.6 million or $0.13 per share and net income was $3.7 million or $0.08 per share. FFO was approximately $6.8 million or $0.155 per share for the quarter excluding approximately $1.2 million in one-time expenses for legal and professional fees related to a potential transaction involving the REIT and this external manager as previously disclosed in our latest offering filing.

Additionally, we continue to repurchase our debt at deep discounts recording $1.2 million in gains from the repurchase of some of our CDO debt in the third quarter and $4.9 million in gains from CDO debt buybacks for the nine months ended September 30, 2013.

We also recorded $1.5 million of loan loss reserves related to one asset in our portfolio and had $750,000 recoveries of previously recorded reserves during the third quarter. And after these reserves, we now have approximately $143 million of loan loss reserves on 18 loans with a UPV of around $239 million as of September 30, 2013.

At September 30, our book value per common shares stands at $7.51 and our adjusted book value per common share is $9.26, adding back deferred gains and temporary losses on our swaps. As we've mentioned before, 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.

Looking at the rest of the results for the quarter, the average balance in our core investments increased marginally to approximately $1.81 billion for the third quarter from approximately $1.78 billion for the second quarter due to our third quarter originations slightly outpacing our third quarter run-off. The yield for the third quarter on these core investments was around 5.62% compared to 5.47% for the second quarter. This increase in yield was primarily due to higher yields in our third quarter originations combined with a full effect of our second quarter originations. And the weighted average all-in yield on our portfolio also increased to around 5.59% at September 30, 2013 compared to around 5.48% at June 30, 2013, again, primarily due to higher yields on our third quarter investments.

The average balance on our debt facilities also increased slightly to approximately $1.36 billion for the third quarter from approximately $1.32 billion for the second quarter primarily due to the financing of some of our second quarter originations in the third quarter. The average cost of funds in our debt facilities was down slightly to approximately 3.10% for the third quarter compared to 3.15% for the second quarter.

Additionally, our estimated all-in debt cost decreased to approximately 3.14% at September 30, 2013, compared to around 3.21% at June 30, 2013 primarily due to a reduced unused fees and our warehouse lines and credit facilities from the financing of some of our second quarter originations in the third quarter.

If you were to include the dividends associated with our two perpetual preferred offering as interest expense, our average cost of funds for the third quarter would be approximately 3.34% compared to 3.36% for the second quarter. And our estimated debt cost would be 3.39% at September 30th compared to 3.46% at June 30th.

So overall, net interest spreads on our core asset on a GAAP basis increased to approximately 2.52% this quarter compared to approximately 2.32% last quarter including the preferred stock dividends debt cost, our net interest spreads also increased to approximately 2.28% for the third quarter compared to approximately 2.11% for the second quarter. And our net interest spread run rate is now approximately $51 million annually at September 30, 2013. This increase in our net interest spread is again due to high yields on our new investments as well as from slightly lower financing costs.

Other income which primarily consists of net interest spread on certain RMBS securities which are deemed to be linked transactions for accounting purposes as well as asset management and miscellaneous fees decreased $850,000 compared to last quarter. The decrease was mainly due to a $750,000 reduction in the fair value of these securities due to the change in interest rates and spread during the third quarter. The net interest spread earned on our linked RMBS securities is not reflected in the net interest spreads I just discussed.

NOI related to our REO assets decreased $200,000 compared to last quarter due to the seasonal nature of income related to our portfolio of hotels that we own. As of today, we believe these two assets should produce NOI before depreciation and other non-cash adjustments of approximately $3 million for 2013 and approximately $3 million to $3.5 million annually going forward.

This projected income combined with approximately $1 million to $2 million in other income related to our RMBS linked transactions and approximately $51 million of net interest spread on our loan and investment portfolio gives us approximately $55 million to $56 million of annual estimated core FFO before potential loss reserves and operating expenses looking out 12 months based on our run rate at September 30, 2013.

Additionally as Ivan mentioned earlier, we’re expecting to produce very strong fourth quarter originations allowing us to continue to deploy the long-term growth capital we raised at the end of September and replaced our expected run off and grow our core earnings over time.

Operating expenses were up compared to last quarter largely due to approximately $1.2 million and one-time expenses to legal and professional fees related to a potential transaction involving the REIT and its external manager partially offset by reduced stock-based compensation expenses from the issuance of 70,000 fully vested shares to independent directors in the second quarter.

Next our average leverage ratios on our core lending assets increased slightly to 66% this quarter compared to 64% last quarter including the trust preferred and perpetual preferred stock as equity which was due to the financing of some of our second quarter originations in the third quarter. And our overall leverage ratio on the spot basis including the trust preferred stock as equity decreased to 2.0 to 1 at September 30th compared to 2.2 to 1 at June 30th largely due to the $41 million of capital we raised at the end of the third quarter.

There are some changes in the balance sheet compared to last quarter that I would like to highlight. Restricted cash increased by approximately $79 million primarily due to CDO run-off in the third quarter that will be used to repay CDO debt in the fourth quarter.

Investment in equity fairly decreased by approximately $54 million mostly due to the redemption of a majority of one of our equity investments which also resulted in the payoff of the non-recourse debt related to this investment accounting for the $50 million decrease in notes payable during the quarter.

Additionally, repurchase agreements in credit facility is increased by approximately $58 million due to the financing of a portion of our second and third quarter originations and total equity increased approximately $42 million this quarter primarily due to our latest common stock offering at the end of the third quarter.

Lastly, our loan portfolio statistics as of September 30th shows at about 70% of the portfolio was variable rate loans and 30% were fixed. Our product type about 71% of our loans are bridge, 15% junior participation and 14% mezzanine and preferred equity, while asset class 63% of our portfolio is multifamily, 22% is office, 8% land and 4% hotel. Our loan to value was around 78%, and geographically we have around 30% of our portfolio concentrated in New York City.

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. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And your first question comes from the line of Steve Delaney presenting JMP Securities. Please proceed.

Steve Delaney - JMP Securities

Thank you. Good morning, Ivan. Good morning, Paul.

Ivan Kaufman

Hey, Steve, good morning.

Steve Delaney - JMP Securities

One of the things we noted you had a fairly large increase in the number and dollar amount of loan payoffs in the third quarter relative to second quarter like 15 loans for $100 million. I’m just curious if you see that as a trend or if there was any kind of unique or one-off development in the third quarter as far as why did the payoffs spike?

Ivan Kaufman

I think that clearly was a little bit of a drop in interest rates. There were people who perhaps were considering it in the prior quarter when rates spiked up, some of the decisions got delayed and when rates came down, you probably had a combination of what would happen in the second quarter will occur in the third quarter. I think that you’ll see more of a consistent trend going forward and that quarter probably will represented two quarters worth of payoffs.

Paul Elenio

Steve, it’s Paul. Certainly as Ivan mentioned rates and value increases I’m sure had played a role in the runoff. We are expecting probably similar or maybe even a little higher runoff in the fourth quarter. However, the difference as we’re trying to lay out in our commentary is the third quarter runoff of roughly $130 million, about $85 million of that were from our legacy CDOs --

Steve Delaney - JMP Securities

Right.

Paul Elenio

Which as you know the cash sits in the CDO delevers the vehicle and then obviously if we return our equity over time. The fourth quarter run-off we’re expecting is largely looks like it’s largely going to be in our CLO vehicles and warehouse facilities which is quite helpful for us as we kept our loan short-term as we talked about in the past. That gives us additional capital and additional capacity to fund new originations and as Ivan mentioned our pipeline is very strong. We’re expecting a very strong fourth quarter. So the run-off in the CLO and warehouse facilities will actually facilitate the ability for us to continue to fund this growing pipeline.

Ivan Kaufman

Yes. A comment on that Steve is that a lot of our loans we originate we deem to be two to three year assets.

Steve Delaney - JMP Securities

Right.

Ivan Kaufman

And a lot of the assets performance is probably better than we’ve expected, so that we’re able to access long-term financing a little bit quicker. So it’s kind of a good sign relative to the credit quality in our portfolio the people can exit -- work more quickly than we anticipated but something that we were well-positioned to manage by increasing our originations to replace that run-off.

Steve Delaney - JMP Securities

Yes. I get the point about 4Q, about obviously a payoff in the new CLO is a lot better for you than a payoff in the legacy CDO as you have that replenishment period and the CDO uses you have in your cash trapped and de-levering the structure. So that’s an important thing first to think about and as we model, payoffs, we’re going have to think about where they might be occurring?

And then a kind of related question, you had quite a few loan extension I think 10 for about $140 million and just a simple question there, I mean that’s a routine thing, I think when a loan is written for a period of time, you will usually have one or two on your extensions kind of built in. But should we think of their being a good when you do an extension, is there a good to Arbor in terms of a fee or rate escalation or is it normally just sort of a neutral event to you, when you –

Ivan Kaufman

I think there is a combination number one, a lot of our extension gives us an opportunity to rebalance a loan and that’s an important credit asset management feature. And from time-to-time, there are extension fees that are paid. So it’s a combination of two things.

Paul Elenio

And Steve, the spike in extensions during the quarter is a little bit deceiving because although its listed as 8 or 10 loans it’s really a bunch of loans related to one project we have and the extension was due and it was extended. So it was expected to be extended, it was extended, it’s not an indication that there was a problem with that asset, it just happens to be a larger asset.

Steve Delaney - JMP Securities

Okay, great. That’s helpful. So just basically a single borrower with multiple pieces of collateral?

Paul Elenio

Correct.

Steve Delaney - JMP Securities

Okay. And the last thing, Paul, we had been advised to the one-time charges, $1.25 million in your prospectus supplement on September 23. I’m looking at the income statement and darn if I can see where it lives, where that item is run through on the income statement, can you help me there?

Paul Elenio

Sure. It’s run through in the selling and administrative portion of the income statement. And if you look, I think the selling and admin expense line item went up about $800,000 and change from quarter-to-quarter, so that $1.2 million is sitting there as well as some reductions in some of our legal and restructuring cost during the quarter.

Steve Delaney - JMP Securities

Yes, must be the reduction in some of the other -- the legal because it - on a net basis it didn’t look like that big a change.

Paul Elenio

Yes. The other items is, you have this stock-based comp which runs through there and as I mentioned in my prepared remarks. We’d like to break it out, but the SEC had us put it in that line item now and we did have a large number of stock-based comp hit the second quarter from the issuance of shares to our directors which immediately vest so its sheltering a little bit of that increase.

Steve Delaney - JMP Securities

Okay. And how much was that stock-based comp, do you have that figure handy?

Paul Elenio

Yes. The stock-based comp from last quarter was 6.80, in this quarter it was 1.82. So that difference – that $500,000 difference is eating up some of that $1.2 million and the rest is being – now, we had a little bit of a decrease in expenses related to some restructuring in this third quarter as compared to the second quarter.

Steve Delaney - JMP Securities

Okay. And lastly, Ivan, I know there – you’re probably limited in what you can say in response to this question. But, the disclosure about the Board’s special committee, is there anything you should be saying to clients about that or is there any update on that - those deliberations, I guess, is the way, anything you can say to us about that at this time?

Ivan Kaufman

Yes, I have no color on it at the moment. It’s in the 10-Q and I think that’s pretty much explains our status. Paul, you have any comment?

Paul Elenio

Yes. Steve, unfortunately our 10-Q is up to-date that is the latest disclosure and that’s all we can really say at this point.

Steve Delaney - JMP Securities

Thanks. I will take a look at that. Thanks for your comments and congratulations on another quarter of good solid progress. Thank you.

Ivan Kaufman

Thank you.

Paul Elenio

Thanks Steve.

Operator

(Operator Instructions) There are no further audio questions. I’d now like to turn the call back over to Mr. Elenio for closing remarks.

Paul Elenio

Okay. Well, thanks for your participation. And it was a very good quarter and look forward to next quarter’s call in the close of the very, very solid year.

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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