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Arbor Realty Trust, Inc. (NYSE:ABR)

Q2 2012 Earnings Call

August 3, 2012 10:00 am ET

Executives

Paul Elenio – Chief Financial Officer

Ivan Kaufman – Chief Executive Officer

Analysts

Steve DeLaney – JMP Securities

Operator

Good day, ladies and gentlemen, and welcome to the Second Quarter 2012 Arbor Realty Trust Earnings Conference Call. My name is Shanell and I will be your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

I’d now like to turn the conference over to Mr. Paul Elenio, Chief Financial Officer. Please proceed.

Paul Elenio

Okay, thank you, Shanell, 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 June 30, 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 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’d like to reflect on some of our recent accomplishments and talk about our business strategy and outlook for the remainder of 2012. We very pleased with this quarter’s progress and certainly our ability to access to capital markets in June for the first time in five years and it’s at the forefront of our recent accomplishments.

As we have mentioned on our last several earnings calls, we have been very active in our core lending business as well as in diversifying our portfolio and revenue sources by investing in residential securities. This has resulted in increased core earnings and the reinstatement of our dividend last quarter and we’re very pleased with the opportunities we are seeing in this market to invest our capital and continue to grow our core earnings base.

Our pipeline is strong and continues to grow through our deep originations network both in the REIT and through our external manager. We’re accessing approximately $18 million of fresh capital was a very important component in order for us to continue to grow our platform and is a crucial step in positioning us favorably going forward.

We’re very confident in our investment strategies and are quite pleased with our ability to deploy this capital quickly through our core lending originations business, residential securities investments, investing in our legacy assets, and through the repurchase of our CDO debt at significant discounts when available. This success has increased our core earnings, and as a result, we’re very pleased to announce today a 33% increase in our dividend to $0.10 per common share for the second quarter, up from $0.0725 for the first quarter.

In a moment, Paul will elaborate further on how this growth has translated into an increase in our projected core earnings run rate. Once again, we’re extremely pleased with the investment opportunities we’re seeing to grow our platform, diversify our revenue sources and produce significant core earnings and dividend growth going forward.

Additionally, our infrastructure is well positioned to manage this expected growth without significantly increasing our core structure, resulting in direct bottom line profitability. In the second quarter, we originated five loans totaling approximately $58 million with a weighted average unlevered yield of approximately 8% and a weighted average leverage yield of approximately 15%.

We also continue to grow our core residential investment platform purchasing 11 residential mortgage securities in the second quarter totaling $41 million with a weighted average yield of approximately 5% and expected levered returns in excess of 20%. At June 30, 2012, we had $88 million of residential securities outstanding with corresponding leverage of $75 million. These securities generally have an average expected life of 24 to 36 months and are expected to generate levered returns in excess of 20%.

In addition, in July, we originated three loans totaling $32 million with a weighted average yield of approximately 7% and an expected levered return of around 15% and purchased one residential security for $11 million with a weighted average yield of 5% and an expected levered return in excess of 20%.

As I mentioned earlier, 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 a levered basis. The continued growth and diversification in our investments has increased our core earnings run rate, and we believe we will be able to continue to increase our core earnings in the future.

In addition to raising capital this quarter, we’re able to increase our available liquidity to deploy into new investment opportunities by recycling our capital through run-off and a monetization of our non-performing and unencumbered assets, as well as from accessing additional debt facilities.

In the second quarter, we generated cash run-off for reinvestment of approximately $36 million. We also obtained approximately $13 million of additional warehouse financing, and as previously announced in our press release in May, we were successful in closing on a $15 million revolving line of credit, which is collateralized by a portion of our CDO bonds that we repurchased at a discount. This facility provides us with additional source of capital to fund our business and we are also pleased with the flexibility of this facility, as well as in our ability to extract additional value from our investments by leveraging some of our CDO bonds that we repurchased in the market.

As we have 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 second quarter, we’re very active repurchasing $43 million of our CDO debt for $22 million recording a gain of approximately $21 million. And in July, we repurchased an additional $9 million of our CDO debt for $5 million resulting in a gain of $4 million that would be recorded in the third quarter.

As of today, we own approximately $154 million of our original CDO bonds at an $85 million discount to par, which represents significant embedded cash flows that we may realize in future periods. And as I just discussed, we’re able to leverage a portion of these bonds creating $15 million of additional liquidity. We will continue to evaluate the repurchase of our CDO debt going forward based on availability, pricing, and liquidity.

Our cash position as of today is approximately $35 million not including approximately $22 million of cash collateral posted against our swaps. We also have around $125 million of net unencumbered assets, these assets combined with our cash on hand. Cash posted against our swaps gives us approximately $180 million of value. This is in addition to approximately $290 million of value between the equity in our CDO vehicles and our real estate-owned for a total value of approximately $470 million.

We have also been extremely effective in managing our CDO vehicles, receiving all cash distributions to-date while maintaining sufficient cushion in all our tests. And while there can be no assurances that our CDO vehicles will continue to cash flow in the future, we will remain focused on managing these vehicles effectively. We do feel that based on the terms and quality of the assets in these vehicles, we will continue to receive the benefit of these non-recourse low-cost financing facilities for several more years. We also feel that based on our performance of our CDOs and diversity of our platform, we will have a competitive advantage in accessing the debt and equity markets that will be available in the future, which combined with our liquidity, existing credit facilities, and portfolio run-off will be used to fund our future growth.

Now, what I would like to do is update you on the credit status of our portfolio and discuss our view of the commercial real-estate market. During the second quarter, we record $8.6 million of loan loss reserves related to one asset in our portfolio. We also had a 1.8 million in recoveries of previously recorded reserves during the second quarter including the gain on the disposition of a real-estate owned assets and these recoveries combined with the recoveries we generated in 2010 and 2011, gives us total recoveries on previously recorded loan loss reserves of approximately $27 million to date.

During the second quarter, we refinanced and modified 8 million of loans and extended 80 million of loans. At June 30, we had 8 non-performing loans with a UPB of approximately $46 million and a net carrying value of approximately $15 million, which is relatively flat compared to March 31.

Overall, the commercial real estate market continues to recover slowly, although we continue to see signs of more rapid improvements and stabilization in certain segments, especially in commercial multi-family lending arena. This is an asset class that we have a tremendous amount of expectation, which continues to produce significant investment opportunities for us to grow our platform.

Additionally, we believe we have done an outstanding job of managing our legacy portfolio, significantly improving the quality of our assets and predictability of our income stream. We also feel that we have split substantially all our legacy issues behind us, although it is possible we would have some additional write-downs in our portfolio on our legacy assets based on marketing conditions, we feel that any potential remaining issues will be minimal and we are optimistic that we will have recoveries from our assets and gains from us debt repurchase to offset any potential additional losses.

However, the timing of any potential losses, recovering gains on a quarterly basis is not something we can predict or control.

In summary, we’re extremely pleased with our accomplishments, especially in our ability to access to capital markets and increase our current earnings run rate and dividend this quarter. We’re excited about the opportunities that exist in our pipeline, are confident that our originations network will continue to produce investment opportunities with attractive returns for us to invest our capital, grow our platform and increase our core earnings going forward. We’ll also continue to access available debt to appropriately leverage these investments with the goal of continuing to increase our net interest spreads, core earnings and dividends over time.

And clearly with the yield we’re paying on our stock from our growing dividend, combined with an adjusted book value of $11.19 per share, we feel that our current stock price is not reflective of our true franchise value.

Our primary focus will continue to be increasing the value to our shareholders by growing our platform, increasing our core earnings and dividends over time.

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 FFO of $17.1 million or $0.68 per share for the second quarter and net income of $15.5 million or $0.62 per share.

As Ivan mentioned, we continue to repurchase our debt at deep discounts, recording $21 million in gains from the repurchase of some of our CDO debt in the second quarter and a gain of approximately $4 million from CDO debt buybacks in July.

We also recorded $8.6 million loan loss reserve related to one asset in our portfolio and had $1.8 million in recoveries of previously recorded reserves during the second quarter, including a gain on the disposition of a real-estate owned asset. After these reserves and charge-offs of previously recorded reserves, we now have approximately $188 million of loan loss reserves on 20 loans with a UPB of around $272 million as of June 30, 2012.

At June 30, our book value per share stands at $7.58, and our adjusted book value is $11.19 aiming back deferred gains and temporary losses on our swaps.

Additionally, as Ivan mentioned, we currently have approximately $35 million in cash on hand and $22 million of cash posted against our swaps. And between this cash our REO assets, unencumbered assets and equity value in our CDOs, net of reserves recorded as of June 30, we currently have approximately $470 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 second quarters. The yield for the second quarter on these core investments was around 4.91% compared to 4.84% for the first quarter. This increase in yield was primarily due to higher yields in our second quarter originations and security purchases.

Additionally, the weighted average all in yield in our portfolio increased to around 4.95% at June 30, compared to around 4.85% at March 31, again due to the full effect of higher yields on our new investments.

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 3.10% for the second quarter, compared to 3.54% for the first quarter. Excluding the unusual non-cash impact of certain interest rate hedges, which are deemed to be ineffective for accounting purposes, had on interest expenses, our average cost of funds was approximately 3% for the second quarter, compared to around 3.42% for the first quarter. This decrease was mainly due to the maturity of certain interest rate swaps in the second quarter, which reduced interest expense.

Additionally our estimated all-in-debt cost was around 3.05% at June 30 compared to around 3.35% at March 31. This decrease was due to the full effect of certain interest rate swaps that matured in the second quarter partially offset by the addition of the $15 million revolving line of credit in the second quarter.

So overall normalized net interest spreads in our core assets increased by 35% to approximately 1.91% this quarter from approximately 1.42% last quarter, primarily due to increased yields on new originations and the maturity of certain of our interest rate swaps.

And more significantly, our net interest spread run rate increased 27% to approximately 1.90% or approximately $39 million annually at June 30 compared to approximately 1.5% or approximately 35 million annually at March 31. This was primarily due to the effect of high yields in our second quarter originations and the maturity of our swaps.

Additionally, property operating income related to our REO assets decreased approximately 700,000 and property operating expenses increased approximately 250,000 from last quarter, largely due to the seasonal nature of income related to a portfolio of hotels that we own, as well as from some one-time expenses associated with the transition of the managers of the properties and certain capital expenditures.

As of June 30, we have two REO assets we are holding for investment, totaling approximately $127 million, subject to approximately $54 million of assumed debt for a net value of approximately $73 million.

As of today, we believe these two assets should produce NOI before depreciation and other non-cash adjustment of approximately $3 million for 2012 the bulk of which will be recognized in the first two quarters due to the seasonal nature of our hotel portfolio, and $3 million to $4 million annually going forward from these REO assets.

This projected income, combined with our net interest spread run rate at June 30, 2012 of approximately $39 million on our loan and investment portfolio gives us approximately $42 million to $43 million of annual estimated core FFO earnings before potential loss reserves and operating expenses, looking out 12 months based on our run rate at June 30, 2012. Clearly, this growth in our core earnings has contributed greatly to the 33% increase in our dividend this quarter and we are optimistic that we will be able to continue to increase our core earnings and dividends over time.

Operating expenses were relatively flat from last quarter with the exception of an increase of approximately $500,000 in non-cash expenses related to stock-based compensation issued to our independent directors in the second quarter.

Next, our average leverage ratios on our core lending assets decreased compared to last quarter to around 69% and 80%, including the trust preferreds debt compared to 72% and 83% respectively. And our overall leverage ratio on a spot basis including the trust preferred as equity was down from 3.7 to 1 at March 31 to 3.1 to 1 at June 30, due to a decrease in total debt outstanding, combined with an increase in equity from our capital raise and our second quarter earnings. There are some changes in the balance sheet compared to last quarter that are worth noting, restricted cash in our CDO vehicles increased approximately $39 million from last quarter, largely due to second quarter runoff, that will be used to pay down CDO debt in the third quarter.

Repurchase agreements and credit facilities increased by approximately $21 million due to the addition of about $30 million in warehouse financing and the use of $10 million of $15 million revolving line of credit, we closed in the second quarter. And CDO debt decreased approximately $61 million from last quarter, due to our second quarter CDO debt repurchases, and CDO runoff in the first quarter, which was used to pay down CDO debt in the second quarter.

And lastly, our loan portfolio statistics as of June 30 show that about 65% of our portfolio was variable rate loans and 35% are fixed. By product type, about 66% of our loans were bridge loans, 20% junior participation, and 14% mezzanine and preferred equity investments. Our asset class, 45% of our portfolio is multi-family, 31% is office, 10% hotel and 10% land.

Our loan-to-value was around 82%. Our weighted average median dollar outstanding was 52% and geographically, we have around 36% of our portfolio concentrated in the 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.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from the line of Steve DeLaney, JMP Securities.

Steve DeLaney – JMP Securities

Good morning, Ivan. Good morning Paul.

Ivan Kaufman

Good morning, Steve.

Paul Elenio

Good morning, Steve.

Steve DeLaney – JMP Securities

I have a couple of things this morning. Thank you for the details on the growing RMBS portfolio as far as the yield and the ROE, and that 5% yield, and also sort of the leverage that you’re 75% of borrowings suggest, indicates to me these are fairly high quality bonds when we look at the non-agency RMBS spectrum of bonds in terms of yield and leverage. I wondered if you had available, you could share with us sort of the average dollar price your cost basis in these bonds?

Paul Elenio

We don’t have that available as we speak, but we can definitely get, make that available to you.

Steve DeLaney – JMP Securities

Okay, all right. Could you say Ivan, whether these are more say front pay type bonds or more promising quality. I’m just trying to get into the spectrum of whether, where you stand in terms of the credit risk profile in which you’re buying?

Ivan Kaufman

It’s more of a cash flow and a priority of cash flow. So they are high quality cash flow bonds. The underlying quality assets is not as material to us, it’s really the disposition of the assets.

Steve DeLaney – JMP Securities

No, I understand.

Ivan Kaufman

On a granular basis.

Steve DeLaney – JMP Securities

Right. The cash is king, in that respect.

Ivan Kaufman

Yeah.

Steve DeLaney – JMP Securities

Got it.

Paul Elenio

And Steve its Paul. I mean they are, as Ivan said more front pay cash flow and bonds and as far as the cost basis, we did disclose as how much of the bonds we have outstanding as of June, and for the most part these bonds are pretty useful that par maybe slight premiums of discounts here or there, but for the most part they’re pretty much par trades.

Steve DeLaney – JMP Securities

Very important. That’s what I was trying to get at with respect to, we know how the lenders tend to look at bonds and haircuts sort of thing and the market like bonds at traded par. This is the bottom line.

Ivan Kaufman

John I think the key for us to, is the duration is short.

Steve DeLaney – JMP Securities

Yes.

Ivan Kaufman

And in fact, the return on the capital is coming much quicker. So we’re trying to keep the duration between 24 and 36 bonds.

Steve DeLaney – JMP Securities

That’s helpful. Thank you. You guys this morning I’ve heard you mentioned this before and I just make sure I’m understanding it in the, we communicate this properly to investors. When you’re using the concept of value and it seems you’re taking your cash, you’re taking your unlevered assets and you basically sort of carving out the non-recourse part of the balance sheet. And I think you mentioned a figure of $470 million, which works out about $18 per common share. Can you just in plain common English, help me understand when you look at the company and when you look at this concept of value, what you’re really trying to communicate?

Ivan Kaufman

Paul why don’t you walk through the actual analysis, it will be helpful.

Paul Elenio

Absolutely, Steve, we’re trying to do here is a couple of ways to look at the Company’s value. We look at the adjusted book value as the real value, which comes in $11.19, but lots of investors like to look at it and stay away from GAAP and say well economically what do I have? And so we’ve tried to put in front of you guys a kind of an economic value and so we look at our cash and liquid assets, and equity we have in assets over our debt and we say that’s our value. And that $470 million of value does not take into account the trust preferreds. We left that out because certain people feel that they are obviously 30 year equity type paper it may not, it’d appropriate to look at that space. But if you were to do that and took the $470 million that we quote as value and then takeoff the trust preferred to par you get very, very close to that $11.19 actually comes in probably around that number.

Steve DeLaney – JMP Securities

The TruPS are about $150 million?

Paul Elenio

Right, so we say we’re trying to demonstrate here is that not only is book value 758, but more importantly adjusted book value is $11.19, if you are an investor and you just want to look at this is, what’s the economic value from cash and liquid assets above debt, you still get to that number, and that’s what we’re trying to demonstrate.

Steve DeLaney – JMP Securities

Got it the TruPS is the piece that I was missing and that helps me understand how you’re using that concept to building up from the asset side to sort of get up to your adjusted book value.

Paul Elenio

Right.

Steve DeLaney – JMP Securities

The last thing I’ll ask guys, you did congratulations on patting the equity market obviously where the share price is, it’s something you needed to do and you’ve got where the share price is relative to your adjusted book it can be costly. So I guess the question is, we’ve seen I think about 15 preferred stock offerings, and other than the TruPS you don’t have any straight preferreds. Is that an instrument that you would consider to use to as you need incremental capital and just to minimize dilution to the common?

Ivan Kaufman

I think we’ll look at all available options that are out there and based on our lines and our volume I think at that particular time, which is not today, we will evaluate what’s the best execution for us.

Steve DeLaney – JMP Securities

Okay. Well, thank you for the comments and the time this morning.

Ivan Kaufman

Okay. Thanks, Steve.

Paul Elenio

Thank you, Steve.

Operator

(Operator Instructions) And at this time, I am not seeing any questions. I would like to turn the call back over to the management.

Ivan Kaufman

Okay, well, thanks for your participation today. And we look forward to continue to grow our company and your participation in our stock. Thank you.

Operator

Ladies and gentlemen that concludes the presentation. Thank you for your participation. You may now disconnect, have a great day and enjoy your weekend.

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