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Arbor Realty Trust, Inc. (NYSE:ABR)

Q1 2012 Earnings Call

May 4, 2012 10:00 am ET

Executives

Paul Elenio – Chief Financial Officer

Ivan Kaufman – President and Chief Executive Officer

Analysts

Lee Cooperman – Omega Advisors

Operator

Good day, ladies and gentlemen, and welcome to the First Quarter 2012 Arbor Realty Trust Earnings Conference Call. My name is Shaquana 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. Please proceed, sir.

Paul Elenio

Thank you, Shaquana, 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 March 31, 2012. 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 risk 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 reflect on some of our recent accomplishments and talk about our operating philosophy and outlook for the remainder of 2012.

First and foremost, as we announced today in our press release, we are extremely pleased to have reinstated our dividend for the first quarter. As we mentioned on our last several calls, one of our primary goals was to return to a dividend-paying stock and continue to grow our core earnings and dividend over time.

The first quarter dividend of $0.075 per common share demonstrates the success we have had in continuing to grow our core lending business and core earnings. In a moment, Paul will elaborate further on how the effectiveness of our franchise has positioned us to increase our projected core earnings run rate.

Clearly, the steps we took over the last several years transformed our entire balance sheet. Ridding ourselves of our short-term recourse legacy debt while retaining a substantial amount of our equity value with liquidity were critical in paving the way for us to once again become an active participant in commercial mortgage lending and increase our core earnings and reinstate our dividend.

We have maintained a very deep and versatile originations platform, both through our manager as well as in the REIT, and we are extremely pleased with the investment opportunities we are seeing to grow our platform, diversify our revenue sources, and produce significant core earnings going forward. Our infrastructure is well-positioned to manage our anticipated growth without significantly increasing our core structure, resulting in direct bottom line profitability.

In the first quarter, we originated seven loans totaling approximately $40 million with a weighted average unleveraged yield of approximately 7.7% and a weighted average leveraged yield of approximately 20%. We also purchased nine residential mortgage securities in the first quarter totaling $46 million with a weighted average yield of approximately 6% and an expected leverage return in excess of 20%.

We continue to diversify our revenue sources by growing our residential investment platform, which we believe will generate outsized returns on our capital. As of March 31, 2012, we had $65 million of residential securities outstanding with corresponding leverage of $55 million. These securities generally have an average expected life of 18 to 24 months and are expected to generate levered returns in excess of 20%.

In addition, in April, we originated three loans totaling $30 million with a weighted average yield of approximately 6% and expected levered returns in excess of 15%, and purchased three residential securities totaling $4 million with a weighted average yield of 6% and expected levered returns in excess of 20%.

Our pipeline remains strong and our goal is to continue to deploy our capital into new investment opportunities with a targeted return of 50% on an unlevered or levered basis. Clearly, this growth and diversification in our production has increased our core earnings run rate and we’re pleased with the opportunities we are seeing in this market to continue to increase and diversify our core earnings in the future.

We’ve also continued our success in recycling our capital through runoff and monetization of our nonperforming and unencumbered assets, which has increased our available liquidity to deploy into new investment opportunities.

In the first quarter, we generated cash runoff of $38 million and $18 million already in the second quarter. Our cash position as of today is approximately $35 million, not including approximately $21 million of cash collateral posted against our swaps.

We also have around $90 million of net unencumbered assets, as well as $145 million of our CDO bonds that we purchased for $64 million, which could produce additional liquidity. These assets, combined with cash on hand and cash posted against our swaps, gives us approximately $220 million of value. This, in addition to approximately $290 million of value between the equity in our CDO vehicles and our real estate-owned assets, for a total value of approximately $500 million.

We have been extremely effective in managing our CDO vehicles, receiving all cash distributions to date while maintaining sufficient cushion in all of our tests, and while there can be no assurances that our CDO vehicles will continue the cash flow in the future, we will remain focused on managing these vehicles effectively. We currently have three vehicles in place which are past their replenishment periods and we’ve utilized all the cash in these vehicles.

We do feel that, based on the terms and the quality of the assets in these vehicles, we will continue to receive the benefits of these nonrecourse low-cost financing facilities for several more years. We will continue to look for additional nonrecourse financing facilities when available and utilize short-term warehousing and credit facilities when appropriate, in addition to our liquidity and portfolio runoff to fund our future growth.

As previously disclosed, we were able to add a $50 million financing facility in 2011, which is fully utilized, and we feel that based on the performance of our CDOs and diversity of our platform, we will have a competitive advantage in accessing the debt and equity market that will continue -- that will become available in the future.

As we’ve discussed in the past, we’ve been very successful in repurchasing our debt at deep discounts, recording significant gains and increasing our equity value. In the first quarter, we repurchased $14 million of our CDO debt for $9 million, recording a gain of $5 million. Additionally, in April, we were successful in repurchasing an additional $43 million of our CDO debt for $22 million, resulting in approximately $20 million of gains that will be recorded in the second quarter.

As of today, we own approximately $145 million of our original CDO bonds at an $81 million discount to par, which represents significant embedded cash flows that we may realize in 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 the credit status of our portfolio and discuss our view of commercial real estate market. During the first quarter, we recorded $7.8 million of loan loss reserves related to two assets in our portfolio. We also had a $3.5 million recovery of a previously recorded reserve during the first quarter from a gain on the sale of real estate-owned, which was previously written down below the sales price, and this recovery, combined with the recoveries we generated in 2010 and ’11, gives us total recoveries on previously recorded loan reserves of approximately $25 million today.

During the first quarter, we refinanced and modified $35 million of loans and extended $129 million of loans. As of March 31st, we had ten nonperforming loans with a UPB of approximately $54 million and a net carrying value of approximately $15 million, which is relatively flat compared to December 31st.

Overall, the commercial real estate market recovery remains uneven, although we continue to see signs of improvement and further stabilization and recovery in certain segments. We believe we have done an outstanding job of modifying and restructuring a substantial amount of our portfolio, significantly improving the quality of our assets and predictability of our income stream.

We also feel that we have put substantially all our legacy issues behind us, and although it is possible, we could have some additional write down in our portfolio in our legacy assets. Based on market conditions, we feel that any potential remaining issues will be immaterial and we are optimistic that we will have recoveries from our assets and gains from debt repurchases to offset any potential additional losses. However, the timing of any potential losses, recovery and gains on a quality basis is not something we can predict or control.

In summary, we are extremely pleased with our accomplishments, especially in our ability to reinstate our dividend and significantly diversify our revenue sources and increase our core earnings run rate. We are excited about the opportunities that exist in our pipeline and are confident that our deep originations network will continue to produce high quality investments with attractive returns for us to grow our platform and increase our core earnings going forward.

Clearly, our primary focus will continue to be to invest our capital into high-yielding opportunities and appropriately leverage these investments with the goal of continuing to increase our net interest rates, core earnings and dividends, and with an adjusted book value of $11.55 per share, combined with our dividend, we feel that our current stock price is not reflective of our true franchise value. We will continue to work exceedingly hard at increasing the value to our shareholders by growing our platform and increasing our core earnings and dividend over time.

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 net income for the first quarter of $4.2 million, or $0.17 per share, and FFO of $1.9 million, or $0.08 per share. As Ivan mentioned, we did have a $3.5 million recovery of a previously recorded loan loss reserve in the form of a gain on the sale of one of our real estate-owned assets during the quarter. This gain is not included in FFO under its current definition, so adding this gain back, adjusted FFO was $5.4 million, or $0.22 per share, for the first quarter.

We recorded $7.8 million in loan loss reserves in two assets in our portfolio in the first quarter, and after these reserves and charge-offs of previously recorded reserves, we now have approximately $190 million of loan loss reserves on 23 loans with a UPB of around $282 million as of March 31, 2012. We also continued to repurchase our debt at deep discounts, recording a $5.3 million gain from the repurchase of some of our CDO debt in the first quarter, and gains of approximately $21 million from CDO debt buybacks in April.

At March 31st, our book value per share stands at $7.40 and our adjusted book value per share is $11.55, getting back deferred gains and temporary losses on our swaps. Additionally, as Ivan mentioned, we currently have approximately $35 million in cash on hand and $21 million of cash posted against our swaps, and between this cash, our REO assets, unencumbered assets, CDO bonds, and equity value in our CDOs, net of reserves as of March 31st, we currently have approximately $500 million of value.

Looking at the rest of the results for the quarter, the average balance in our core investments was relatively flat at around $1.6 billion for both the first and fourth quarters. The yield for the first quarter on these core investments was around 4.82% compared to 4.69% for the fourth quarter. This increase in yield was primarily due to the full effect of higher yields on the fourth quarter origination and security purchases, a bulk of which were originated late in the fourth quarter.

Additionally, the weighted average all-in yield on our portfolio increased slightly to around 4.85% at March 31st compared to around 4.82% at December 31st. The average balance on our debt facilities also remained relatively flat from last quarter at approximately $1.3 billion. The average cost of funds on our debt facilities was approximately 3.54% for the first quarter compared to 3.44% for the fourth quarter.

Excluding the unusual noncash impact of certain interest rate hedges, which are deemed to be ineffective for accounting purposes, had on interest expense, our average cost of funds was approximately 3.42% for the first quarter, compared to around 3.56% for the fourth quarter. This decrease was mainly due to the maturity of certain interest rate swaps in the first quarter, which reduced interest expense.

Additionally, our estimated all-in debt cost was around 3.35% at March 31st, compared to around 3.53% at December 31st. This decrease is again due to the full effect of certain interest rate swaps that matured in the first quarter. The overall normalized net interest spreads in our core assets increased by 24% to approximately 1.40% this quarter from approximately 1.13% last quarter, primarily due to increased yields on our new originations and the maturity of certain of our interest rate swaps.

And more significantly, our interest spread run rate increased 16% to approximately 1.50%, or approximately $35 million annually at March 31st, compared to approximately 1.29%, or approximately $31 million annually at December 31st. This was primarily due to the effect of higher yields in our first quarter originations and the maturity of our swaps.

Additionally, property operating income related to our REO assets increased approximately $4.3 million, and property operating expenses increased approximately $1 million from last quarter, largely due to the seasonal nature of income related to a portfolio of hotels that we own.

As of March 31st, we have two REO assets we are holding for investment totaling approximately $128 million, subject to approximately $54 million of assumed debt for a net value of approximately $74 million. As of today, we believe these two assets should produce NOI before depreciation and other noncash adjustments of approximately $3 million to $4 million annually, the bulk of which will be recognized in the first two quarters due to the seasonal nature of our hotel portfolio.

This projected income, combined with our net interest spread run rate at March 31st, 2012 of approximately $35 million on our loan and investment portfolio, gives us approximately $38 million to $39 million of annual estimated core FFO earnings before loss reserves and operating expenses as of March 31, 2012. Clearly, this growth in our core earnings has contributed to the reinstatement of our dividend and we are optimistic that we will continue to increase these earnings over time.

Operating expenses did decrease compared to last quarter, largely due to employee and operating costs associated with certain loan restructurings last quarter, combined with stock-based compensation issued to certain of our senior management team in the fourth quarter.

Next, our average leverage ratios in our core lending assets were relatively flat compared to last quarter at around 72% and 83%, including the trust preferred as [ph] debt, and our overall leverage ratios on a spot basis were down slightly from 3.9 to 1 at December 31st to 3.7 to 1 at March 31st.

There are some changes in the balance sheet compared to last quarter that are worth noting. Restricted cash in our CDO vehicles decreased approximately $29 million from last quarter to approximately $39 million at March 31, 2012, largely due to fourth quarter runoff that was used to finance some of our unlevered assets and pay down CDO debt in the first quarter.

The purchase agreements in credit facilities increased by approximately $30 million due to the leverage on the residential mortgage securities we purchased during the quarter, and CDO debt decreased approximately $32 million from last quarter due to CDO runoff in the fourth quarter, which was used to pay down CDO debt in the first quarter, and from our first quarter CDO debt repurchases.

In addition, other comprehensive loss decreased by about $4 million for the quarter. This was primarily due to an increase in the market value of interest rate swaps from a change in the outlook on interest rates, and GAAP requires us to flow the changes in value of these interest rate swaps through our equity section.

And lastly, our loan portfolio statistics as of March 31st show that about 67% of the portfolio is variable rate loans and 33% are fixed. By product type, about 63% are bridge loans, 19% junior participation, and 18% mezzanine and preferred equity investments.

By asset class, 45% was multifamily, 33% was office, 9% hotel and 9% land. Our loan to value is around 83%, our weighted average median dollars outstanding was 54%, and geographically, we had around 36% of our portfolio concentrated in New York City.

That completes our prepared remarks for this morning, and I’ll 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) Your first question comes from the line of Lee Cooperman. Please proceed.

Lee Cooperman – Omega Advisors

Thank you. Let me first congratulate you guys. You’re on the way back. It’s very nice to see. I know you worked very hard to accomplish this.

Ivan Kaufman

Thank you.

Paul Elenio

Thanks, Lee.

Lee Cooperman – Omega Advisors

I assume, Ivan, from what you said, the number you referred to in book value was $11.55, so my favorite question is $7.40 GAAP, $11.55 adjusted. Which number you guys believe in, I guess, to the extent that you mentioned the $11.55 as the number that you kind of look at as being more relevant.

I guess the question -- I was just on a call this morning with another financial service company and they talked about, quote, unquote, “their aspirational ROE,” for their business, and so they gave a number for 2015.

What kind of returns do you think that is realistic? If $11.55 adjusted book is the realistic number, as we’re running the business, is this a business that could return 10%, 12% on equity over a few years or is that too much?

Ivan Kaufman

That’s clearly something that we feel is realistic. As you know, we’re turning over the legacy assets, improving the yields on those legacy assets, deploying our new capital at very effective rates, and we’ve also done a very good job in keeping our franchise intact, which has an expense to it.

And as we turn over the assets and redeploy our capital, all yields are very incremental to us, so we think as we turn through that, if it’ll take us quarter to quarter, we’ll increase each quarter and get to those levels.

Lee Cooperman – Omega Advisors

Good, and the second question, I assume because of the REIT ownership rules, that we pretty much exhausted our buyback ability at this point?

Ivan Kaufman

We have two issues on the REIT rules. Number one, we have a restriction on how much I can buy. I’m at pretty much my maximum, and there are a lot of issues. I believe in our proxy -- did we -- is that out yet or not?

Paul Elenio

It is out.

Ivan Kaufman

It is out. I think in our proxy, we’ve actually looked to adjust the maximum ownership rules so I can buy more and some of the insiders can buy more, so it’ll give us some more flexibility for us to increase insider ownership.

Lee Cooperman – Omega Advisors

Good, thank you. Again, congratulations on the performance.

Ivan Kaufman

Thank you, Lee.

Paul Elenio

Thanks, Lee.

Operator

(Operator instructions) 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

Okay, well, we thank everybody for their participation, and we’re very excited about our performance and our ability to reinstate our dividend, and we look forward to future calls. Thank you.

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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