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Arbor Realty Trust, Inc. (NYSE:ABR)

Q4 2010 Earnings Call

March 4, 2011 10:00 AM ET

Executives

Paul Elenio – CFO

Ivan Kaufman – CEO

Analysts

Lee Cooperman – Omega Advisors

Eric Berkley – Barclays Capital

Operator

Good day ladies and gentlemen, and welcome to the Fourth Quarter 2010 Arbor Realty Trust Earnings Conference call. My name is Veronica and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will be conducting a question-and-answer session towards the end of today’s conference. (Operator Instructions) I would now like to turn the conference over to your host for today’s call, Mr. Paul Elenio, Chief Financial Officer. Please proceed.

Paul Elenio

Okay. Thank you, Veronica, 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 and year ended December 31, 2010. 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 as of 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 reflect on how we closed out the year, touching on some of our more significant accomplishments, and then turn my focus to our operating philosophy and outlook for 2011.

2010 was a tremendous year and that we were able to successfully complete our goal of transforming our entire balance sheet while retaining substantially amount of our equity value that position ourselves to return into our core lending business. We accomplished these goals by retiring all of our short-term recourse debt, refinancing and modifying at a significant amount of our loan portfolio, monetizing some of our non-performing and unencumbered assets, increasing our liquidity substantially and effectively utilizing our low cost non-recourse CDO vehicles, all without raising additional equity and diluting our shareholders.

Clearly, one of the keys to this success was our ability to roll M&A all of our short-term recourse debts which generated significant gains, reduced our interest expense substantially and greatly increased our liquidity and operating flexibility. As we discussed on our last earnings call, we recorded gains of approximately $228 million from the retirement of our debt at deep discount for 2010 and approximately $285 million from gains since the market dislocation occurred. These gains combined with approximately $80 million in gains from our equity, had greatly mitigated the loss we have taken during the significant downturn, preserving a substantial amount of our equity value.

Additionally in 2010, we had great success in monetizing our non-performing and unencumbered assets contributed greatly to the significant increase in our cash position, which as of today is approximately $100 million, not including approximately $20 million of cash collateral posted against our swaps. We also have around $120 million of net unencumbered assets of which approximately $15 million are currently CDO eligible. These assets combined with our cash on hand and cash posted against our swaps gives us approximately $240 million of value in addition to approximately $240 million of net equity value in our CDO vehicles.

We are also extremely pleased with our ability to manage our CDO vehicles effectively. Receiving all of the cash distribution from these vehicles today, and while there could be no assurances that our CDO vehicles will continue to cash flow in the future, we remain focused on optimizing and utilizing these facilities by transferring assets and originating new loans when available and appropriate.

We will continue to look to bind value from legacy assets, enhance the yield in our portfolio and selectively lend and invest in the appropriate opportunities. One of the advantages that we have is the ability to utilize these low cost CDO vehicles to enhance our returns and increase our core earnings overtime on a quarter-by-quarter basis. As I mentioned earlier, the aim of our strategy was to position ourselves to return to our core lending business, which we actively began over the last few quarters. During the fourth quarter we originated two loans, totaling $15.7 million at an average yield of around 7%. And we finished 2010 with total originations of five loans totaling $26 million with an average on leverage yield of approximately 8.5%. All of these loans were financed through our low course CDO vehicles, greatly increasing our returns on these investments and the other loan is now eligible to be put into CDOs as well.

Additionally, as of today we have a healthy growing pipeline that we are now actively engaged and looking to deploy our capital into the appropriate opportunities and the best retro [ph] returns while seeking to maximize these returns through the utilization of our CDO vehicles and other high potential financial sources. We will continue to remain disciplined and selective. And we are very excited about the opportunities we are seeking in this recovering market to increase our current earnings overtime.

Additionally, as you can see from our financial statements, we will also start to acquire some of the real estate securing our loans and investments. As we’ve discussed on prior calls, we have always invested heavily in the asset management expertise internally to develop and operate real estate which gives us the unique ability to diversify our platform and enhance the value of our investments. As of December 31, 2010, we had two real estate owned assets of approximately $23 million subject to approximately $21 million of debt.

We added number of property in the first quarter of 2011 with all the debt on the asset with a carrying value of around $72 million as of December 31, 2010. Furthermore, we have three additional assets that we believe we will acquire in the next six months. We do believe in addition to these assets, there is a potential for us to continue to add to our real estate owned portfolio in the future. And we are very confident and comfortable in our ability to manage these assets.

We also believe we have the expertise internally to operate these properties effectively, increasing the NOIs overtime and reposition the assets for future disposition with the goal of maximizing the value of our investments. Now, I would like to update you on the credit status of our portfolio and discuss our views on the commercial real estate market. As all of you are aware, commercial real estate fundamentals and real estate values have remained weak for some time, which clearly impacted every borrower in our portfolio. We recorded $36 million of loan loss reserves and impairments in our investments during the fourth quarter of which $24 million was related to one development project.

The loan loss reserves were related to nine loans with an outstanding balance of approximately $262 million. We are very pleased with our ability to recover $13.5 million of previously recorded reserves in the fourth quarter and $18.1 million of recoveries this year. In addition, we received $80 million in loan payoffs and pay downs, refinanced and modified $47 million of loans, and extended a $140 million of loans during the fourth quarter. And for the full-year 2010, we’re able to generate approximately $220 million in cash from payoffs and pay downs.

Additionally, at December 31, we had nine non-performing loans with a net carrying value of approximately $26 million, down from 10 loans and $53 million as of September 30, mainly due to the sale of a $25 million non-performing loan entering the fourth quarter. While you can see from these numbers, the level of our loan loss reserves is down significantly in 2010 as compared to 2009. We believe this is an indication that has been moving towards a stabilization of the overall credit commercial real estate market, and in some segment signs of recovery.

In summary, we are extremely pleased with our accomplishments in 2010 especially in our ability to reposition the company and return to our core lending business. Our operating philosophy going forward will continue to be to aggressively manage our portfolio, bind the value of our legacy assets and actively redeploy our capital into new investments with the appropriate risk reward profiles. We also look to optimize utilization of our non-recourse CDO vehicles as well as, all the potential financing sources to enhance our yield and our core earnings overtime.

We are very focused on the successful execution of this strategy as the primary goal continues to be maximizing the return to our shareholders.

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

Paul Elenio

Thank you Ivan. As noted in the press release, we had a net loss for the fourth quarter of $41.1 million, a $1.62 per share and net income of $112.9 million or $4.39 per share for the year ended 31, 2010. We recorded a total of $23.8 million in net losses from our portfolio for the fourth quarter consisting a $36.2 million in loan loss reserves and losses from restructured loans, a $1.1 million impairment charge related to one of our equity investments, net of $13.5 million in recoveries of previously recorded reserves.

We closed out the year with $91.2 million in net losses from our portfolio for 2010 of which $109.3 million were made up of a combination of loan loss reserves, loss and restructured loans and impairment on our equity investments, partially offset by $18.1 million in recoveries of previous reserves. We were also successful in liquidating one of our real estate held for sale assets in the fourth quarter, recording a gain of $1.3 million from this disposition. Additionally, we continued our success in liquidating several of our non-performing and unencumbered assets during the quarter, resulting in us charging off the loan loss reserves related to those assets.

As a result, we now have $205 million of loan loss reserves on 30 loans with an unpaid principal balance of around $531 million at December 31, 2010. As we’ve mentioned before, we have been very effective over the last few years in executing our strategy of retaining equity value through the retirement of our debt instruments at deep discounts. And although we did not buyback any debt in the fourth quarter, we were very pleased with our success from retiring the Wachovia debt in June as well as some of our trust preferred securities and in our CDO debt of deep discounts during the year.

In fact, we recorded approximately $228 million in total gains from the extinguishment of debt during 2010, and approximately $285 million in gains to-date. As a result, at December 31 our book value per share stands at $8.25 and our adjusted book value per share is $12.59, adding back deferred gains and temporary losses on our swaps. These book value numbers do not take into account any dilution from the potential exercise of the warrants issued to Wachovia as part of the 2009 debt restructuring.

Additionally as Ivan mentioned, we were very successful in the fourth quarter of continuing our strategy of monetizing our non-performing and unencumbered assets resulting in a substantial increase to our cash position which currently stands at approximately $100 million. So between cash on hand, cash posted against our swaps and our unencumbered assets net of reserves as of December 31, we currently have approximately $240 million of value, not including the equity value in our CDOs which today is approximately $240 million, as well net of loan loss reserves as of December 31.

Looking at the rest of the results for the quarter, the average balance in our core investments declined by about $163 million from last quarter, to around $107 billion, mainly due to payoffs and pay downs in the third and fourth quarters. The yields for the fourth quarter on these core investments was around 4.75% compared to 5.29% for the prior quarter. Without some non-recurring items such as additional interest received in both quarters on a loan that exceeds our investment basis in the asset, the yield on these core assets was around 4.60% for the fourth quarter compared to 4.88% for the third quarter.

This decrease was primarily due to our decision to suspend the recognition of the accrual rate of interest on four loans collateralized by one development project partially offset by the payoff of some of our non-performing loans in the fourth quarter. And although we are contractually entitled to an accrual rate of interest above the current pay rate, on several loans in our portfolio, we are now only recording interest income equal to the cash collected on all loans in our portfolio.

Additionally, the weighted average all-in yield in our portfolio was around 4.60% at December 31, 2010 compared to 4.72% at September 30, 2010. This decrease was again mainly due to the reduction of interest income recorded on some loans with an accrual rate of interest, partially offset by the payoff of some of our non-performing loans during the fourth quarter. The average balance in our debt facilities decreased by around $43 million from last quarter to around $1.3 million which was mainly due to the payoff of a $26 million term debt facility and the repayment of a $5 million participation interest related to one of our loans in the fourth quarter, as well as the repurchase of $21 million of CDO bonds at a discount late in the third quarter.

The average cost of funds in our debt facilities was approximately 4.10% for the fourth quarter, compared to 4.47% for the third quarter. Excluding the unusual impact on interest expense from our swaps, our average cost of funds was approximately 3.96% for the fourth quarter, down from around 4.16% for the third quarter. And our estimated all-in debt cost going forward was around 3.90% at December 31, compared to around 4.20% at September 30. This decreases is again primarily due to the payoff of a term debt facility and a participation interest on one of our loans with an interest rate exceeding our overall cost of debt.

The overall normalized net interest spreads in our core assets decreased to approximately 0.64% this quarter from 0.72% last quarter, primarily due to the reduction of interest income recorded on some loans with an accrual rate of interest, partially offset by the payoff of some of our non-performing loans during the fourth quarter and the payoff of term debt facility and a participation interest in one of our loans.

However as Ivan mentioned, we are actively engaged in the redeployment of our capital and utilization of our CDO vehicles with the goal of increasing our net interest spreads overtime. Additionally, we have been acquiring some of the properties that we’re collateralizing certain of our loans in the normal cost of our lending operation. As of December 31, 2010 these assets have not had a significant impact on our financial statements. In the first quarter of 2011, we acquired one property that we have an $85 million performing loan against with a weighted average interest rate of approximately 3.75% and a net carrying value of $71.5 million at December 31, 2010.

As a result, we will record this asset on our books at fair value in the first quarter, eliminate our loan and consolidation and record income or loss from this property including depreciation expense instead of interest income going forward. And as we said earlier, there was a portfolio of assets that we expect to acquire in the next six months, as well as the potential for us to continue to edge for real estate owned assets in the future which could have a more significant impact on our financial statements going forward. As a result, we will report FFO as an additional financial measure going forward to better reflect our operating performance of these assets.

Next our average leverage ratios were around 67% on our core assets and around 77% including the trust preferred as debt for the fourth quarter compared to 63% and 73% respectively in the third quarter. And our overall leverage ratios on a swap basis were 3.2 to 1 at December 31 and 3.1 to 1 at September 30.

The increase in the average leverage ratios was primarily due to the payoff and pay downs of our unlevered assets which contributed greatly to the significant increase in cash on hand at December 31, 2010. Other expenses were relatively flat from quarter-to-quarter with the exception of the $18.8 million incentive management fee recorded in the fourth quarter. As we previously disclosed, Arbor Commercial Mortgage, our manager repaid $3.6 million or half of the prepaid management fee related for the Prime transaction with approximately 701,000 shares of odd stock in the fourth quarter.

In accordance with the management agreement, the remaining amount due of approximately $3.6 million was deducted from the $18.5 million incentive management fee that was earned resulting in a net fee due to our manager of $14.9 million. In accordance with the manager agreement, our manager has elected to receive 25% of the remaining fee or approximately 667,000 shares in odd stock and 75% or approximately $11 million in cash.

There were some changes in the balance sheet compared to last quarter that are worth noting. Cash and cash equivalence increased approximately $75 million from last quarter primarily, due to payoffs and pay downs of our loans and investment portfolio, the return of some of the cash posted as collateral against certain swap contracts from an increase in the value of these instruments, as well as our success in moving some of our unlevered assets into CDO vehicles which also accounted for the majority of the $32 million decrease in restricted cash.

This increase in cash on hand was partially offset by the payoff of a term debt facility and the funding of our originations during the fourth quarter. As Ivan mentioned we are pleased to report that we currently have around $100 million of cash on hand prior to the $11 million of cash will be paid to our manager this month. Other assets also decreased by approximately $10 million, mostly due to the cash received from the increase in the value of certain interest rate swaps.

Notes payable on repurchase agreements decreased $31 million during the quarter due to the payoff of a $26 million term debt facility and a $5 million of participation interest which effectively eliminated all of our remaining short-term recourse debt. In addition other comprehensive loss decreased by about $15 million for the quarter. This again was primarily due to a significant increase in the market value of interest rate swaps from a change in the outlook on interest rates. This also makes up a majority of the increase during the quarter in other liabilities.

GAAP requires us to flow the changes in value of certain of our interest rate swaps through our equity section. And lastly, our portfolio statistics as of December 31 show that about 68% of the portfolio was variable rate loans and 32% was fixed. By product type, about 66% was bridge, 15% junior participation interest, and 19% mezzanine and preferred equity. By asset class, 38% was multifamily, 34% was concentrated in office, 13% hotel, 10% land and 1% condo. Our loan to value was around 89%, our weighted average median dollars outstanding was 60%. And geographically, we have around 38% of our portfolio still concentrated in New York City.

That completes our prepared remarks for this morning. I will now turn it back to the operator to answer any questions you may have at this time. Veronica?

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from the line of Lee Cooperman from Omega Advisors.

Lee Cooperman – Omega Advisors

Yes, thank you and good morning.

Operator

Please proceed.

Lee Cooperman – Omega Advisors

Thank you, good morning and thanks for the good rundown. Just two questions, on your road to achieving respectability, you made a terrific progress in 2010, I think reinstitution of a dividend would probably cap it off, I’m curious as you look at your internal budgets since the business is somewhat predictable, do you anticipate that your end 2011 as a dividend paying company number one. And number two, adjusted book I guess is $12.59, GAAP book $8.25, which numbers do you guys look at as being the more indicative value of the underlying assets of the business? Thank you.

Paul Elenio

Hi Lee, it’s Paul. I’ll handle the book value – adjusted book value question first and then I’ll ask Ivan to weigh in on the dividend. As you mentioned, the adjusted book is $12.59, the book is $8.25. The differences there are obviously the temporary, we’ll call temporary decline in the value of our swaps and a large deferred gain from one of our equity investments we have that is deferred because of a tax deferred strategy we’ve put in place.

We obviously believe that the $12.59 is closer to the real value, and is the real value. It will just take some time for us to get to that $12.59, as we don’t control the timing of when those swaps come back and also when we’re able to bring in the accounting gain from that equity investment. So if you look at some of the commentary we had during the call, if you look it at a different way, we have a $100 million of cash, a $120 million of unencumbered assets net as well as some CDO equity of about $240 million.

We do have trust preferred on our balance sheet as well of about $170 million. If you net all that down, it comes to around $12 or $13 number. So that number which is more of an economic number is clearly closer to the $12.59 adjusted book value and that’s why we feel that number is a solid number.

Ivan Kaufman

Hi Lee, it’s Ivan.

Lee Cooperman – Omega Advisors

Good morning.

Ivan Kaufman

With respect to the dividend, clearly it’s our objective and goal to return to a dividend as soon as possible as we’ve been talking over the last several quarters, we have positioned our company at the end of last year and clean up our balance sheet which I think we’ve done an outstanding job and have begun to refocus on originations and start to redeploy our capital into interest earnings opportunities.

And I think we’ve effectively gotten to that position. We opened up this bigger [ph] short period of time to go out to the market and build our pipeline, our pipeline building at a very, very healthy rate. We’re looking forward to lending – lending effectively redeploying our capital. Also taking the loans have payoff enough CDOs, replacing them with higher yielding loans and also turning some of the loans in our portfolio as they come up for renewal and getting high yield added on those portfolios.

With that in mind, it takes quarter-by-quarter basis, and very optimistic that we’re making significant progress. What I’m very pleased about is returning to originations market and seeing the flow in the pipeline and the quality of business that we’re seeing. So while I can’t give you any promises, it’s clearly our intention to get back to a dividend paying status as quickly as possible.

Lee Cooperman – Omega Advisors

One last question, it seems given some of your low cost liabilities, if you’re looking at over the next two or three years, if the economy remains in improving trend, basically that we ought to be able to earn 10% 12% in our book value?

Paul Elenio

Yes, again Lee, a lot will depend on what the average yields for those investments are and whether we’re able to obtain additional leverage as well as utilize the CDO vehicles. But it’s hard to come up with a return number without having some history over the next couple of quarters to see what the returns in those investments will be, but (inaudible).

Ivan Kaufman

But what we are seeing Lee, is we’re able to effectively lend on bridge loans on first-lien bridge loans and as you can see in the 6% to 8% range. And we can lever those very effectively in our CDOs and create really good yields. We’re also starting to see some very good interest and putting lines of credit in place to leverage that up and get to mid-teens returns on those. So that’s pretty effective.

Just a small statistics, as well as a portfolio was about $1.07 now Paul. We went to a period of three years where we were negotiating with our borrowers and extending and actually lowering the modifying rates in order to mitigate some of the issues that have face the economy. I think the trend is now changing significantly and as loans come up for renewal, if they stay on the books, the rates were actually going the other way. Every 25 basis point increase in our portfolio is a $4 million annual increase in bottom line.

So I’m optimistic that now is our turn rather that the borrowers turn when the loans kind of come up for renewal to be able to increase those rates or if not replace them with higher yield and launch.

Lee Cooperman – Omega Advisors

Thank you very much. Good luck.

Paul Elenio

Thanks Lee.

Ivan Kaufman

Thank you Lee.

Operator

Your next question comes from the line Eric Berkley from Barclays Capital. Please proceed.

Eric Berkley – Barclays Capital

Hi good morning.

Ivan Kaufman

Good morning Eric.

Paul Elenio

Good morning.

Eric Berkley – Barclays Capital

Is that you’re thinking about the trend in portfolio repayments in your pipeline. When would you expect to see growth in the portfolio?

Ivan Kaufman

I think we’re going to begin to see it now, I think we’re going to see it on a quarter-by-quarter. We have significant amount of cash to deploy. We have some loans that are going to be paying off our CDOs which we have a queue of loans lined up in our unencumbered assets to fill those. We’re negotiating now with a few lenders to put the line of credit in place to be able to leverage some of the new originations that are coming in. So we’re pretty pleased. We’re going to see that on a quarter-by-quarter basis starting as we speak.

Eric Berkley – Barclays Capital

Great, thanks.

Operator

At this time, there are no further questions. I would now like to turn the conference over to Ivan Kaufman for closing remarks.

Ivan Kaufman

Okay, well thanks everybody for their time. We’re very pleased with our results for 2010, and we’re very pleased to be able to return to the originations business. And thank you.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Good day.

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