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Arbor Realty Trust, Inc. (NYSE:ABR)

Q3 2012 Results Earnings Call

November 02, 2012 10:00 AM ET

Executives

Paul Elenio - Chief Financial Officer

Ivan Kaufman - President and CEO

Analysts

Steve DeLaney - JMP Securities

Lee Cooperman - Omega Advisors

Operator

Good day, ladies and gentlemen and welcome to the Third Quarter 2012 Arbor Realty Trust Earnings Conference Call. My name is Brea and I will be your operator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of the conference. (Operator Instructions)

I would like to now turn the conference over to your host for today Mr. Paul Elenio, Chief Financial Officer. Please proceed.

Paul Elenio

Okay, thank you, Brea and 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, 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 I begin I want to take a moment to extend our thoughts and prayers to all those affected by hurricane Sandy. As a New York based company with a significant footprint in the metropolitan area and are close to East Coast, we realize that these are extremely difficult times for many people. We are fortunate to report that all of our employees are safe and our initial assessment has revealed no significant damage to any of the properties supporting our loans in the areas affected by the storm. However we realize others are not as fortunate and again our thoughts and prayers are with them.

Returning back to the quarters’ results, I would like to start off by reflecting on some of our recent accomplishments and talking about our business strategy and outlook for the remainder of 2012 and 2013. We are very pleased with our progress, especially in our ability to access the securitization market in the form of a new non-recourse collateralized loan obligation vehicle in September combined with our second follow-on equity raised in four months in early October. These transactions are clearly 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 a continued growth in our dividend and we are very pleased with the opportunities we’re seeing in the market to invest our capital and continue to grow our earnings base.

Our pipeline is strong and continues to grow through our originations network both in the REIT and through our external manager. So accessing the debt and equity markets through a new CLO vehicle as well as raising approximately $37 million of fresh capital through two equity offerings were crucial steps in providing us with the capital to continue to grow our platform and position us favorably going forward.

We are extremely pleased to be the first conversational mortgage REIT to complete a non-recourse CLO vehicle since the dislocation occurred, which we believe was due to our strong reputation in the market and our ability to originate high quality collateral for our deep origination platform.

As we mentioned several times, we have effectively managed our three CDO vehicles through the downturn without a shutdown in any of our vehicles allowing our bondholders and us as equity holders to receive all cash distributions to-date. Clearly, the success paved the way for us to access securitization market once again. The details of the CLO were described in our press release, but I would like to highlight some of the significant components and benefits to Arbor.

The vehicle is comprised of approximately $125 million of collateral and approximately $88 million of financing or roughly 70% leverage and as a weighted average spread excluding fees of 3.39% of the LIBOR. It’s a non-recourse vehicle with the ability to substitute to collateral of a period of two years to a replenishment feature allowing us to increase the level of returns on our investments.

The closing of the vehicle provided us with approximately $32 million of immediate liquidity from the financing some of our previously unlevered assets and freed up approximately $42 million of capacity in our short-term warehouse facilities. Additionally, we believe accessing the securitization markets will have several other long-term benefits to Arbor including greater access to financing lines and equity capital as well as the ability to pull product for potential future securitization.

The CLO is also a critical component of our business strategy allowing us to match the terms of our assets and the terms of our liabilities in a non-recourse vehicle with replenished the rights. Clearly, we feel that the closing of the first CLO in our space since the crisis has significant benefits to us and demonstrates the depth and strength of our franchise.

As we believe we now have the necessary tools to take advantage of the market opportunities that exist in order to continue to grow our platform and increase our core earnings and dividends over time without being subject to event risk if a market credit dislocation should occur.

As a result our cash position as of today is approximately $55 million not including $42 million of capacity in our short term credit facilities, for total of approximately $97 million of cash and liquidity to fund our future investments. This is in addition to $21 million of cash collateral posted against our swaps and around $105 million of net unencumbered assets.

Our experienced origination team continues to produce attractive investment opportunities to deploy our capital, their success has increased our core earnings and as a result we are very pleased to again announce an increase to our dividend to $0.11 per share for the third quarter a 10% increase from the last quarter and 47% increase in our dividend since we reinstated it in the first quarter. In a moment Paul will elaborate further on how our growth has also translated into an increase in our core earnings run rate going forward.

Once again we’re extremely pleased with the investment opportunities we’re seeing through our platform to diversify our revenues sources and produce significant core earnings and dividend growth going forward.

In third quarter, we originated 12 loans totaling approximately $86 million with a weighted average on leverage yield of approximately 7.5% and a weighted average leverage yield of approximately 15%. We also continue to grow our residential investment platform purchasing five residential mortgage securities in the third quarter totaling $30 million with a weighted average yield of approximately 5% and expected levels of returns of nearly 20%.

At September 30, 2012, we had $98 million of residential securities outstanding with corresponding leverage of $84 million. These securities generally have an average expected life of 24 to 36 months and are expected to generate level of returns of approximately 20%.

In addition in October, we originated 3 loans totaling $20 million with a weighted average yield of approximately 9% and expected level of returns of around 15% and purchased two residential securities for $12 million with a weighted average yield of 5% and expect to level of returns of about 20%.

This brings our total 2012 originations to-date, $203 million and $130 million on residential security purchases. As I mentioned earlier, our pipeline remains strong and our goal is to continue to deploy our capital into new investment opportunities with a target return of 15% on an unlevered or levered basis. This 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 and closing a CLO vehicle over the last two quarters, we’re also 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.

For the nine month ended September 30, 2012 we generated cash run-off for reinvestment of approximately $83 million. We also obtained approximately $28 million of additional short term credit facility this year to finance our loan portfolio including a previously announced $15 million revolving line of credit, which is collateralized by a portion of our CDO bonds, which we repurchased at a discount.

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 third quarter, we repurchased $9 million of our CDO debt for $4.9 million recording a gain of approximately $4.1 million and repurchased a total of $66 million of CDO bonds for gain of $30 million for the first nine months of 2012.

As of today, we own approximately $154 million of our original CDO bonds at $85 million discount to par, which represents significant embedded cash flow that we may realize in the 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 views of the commercial real-estate market. In the third quarter, we recorded $4.9 million of net loan loss reserves related to two assets in our portfolio.

During the third quarter, we refinanced and modified $118 million of loans and extended $43 million of loans. As of September 30, we had nine non-performing loans with a UPB of approximately $85 million and a net carrying value of approximately $10 million, which is down from a net carrying value of approximately $15 million at June 30, due to additional reserves in the third quarter.

Overall, the commercial real estate market continues to recover as more liquidity is entering the space and [option] values were improving slowly. We continue to see signs of increased stabilization and more rapid growth in certain segments, especially in the commercial multi-family lending area. The multi-family asset class is a product that we have a tremendous amount of experience in and continues to be our primary focus, producing significant investment opportunities for us to grow our platform.

Additionally, we believe we have done an outstanding job of managing our legacy portfolio putting substantially all of our legacy issues behind us, while significantly improving the quality of our assets and predictability of our income stream. And although, it is possible we could have some additional write-downs in our portfolio on our legacy assets, based on market condition, we remain optimistic that any potential remaining issues will be minimal and that we will have recoveries from our assets and gains from debt repurchase to offset any potential additional losses. However, the timing of any potential losses, recovery and gains on a quarterly basis is not something we can predict or control.

In summary, we are extremely pleased with our accomplishments, especially in our ability to access the capital markets through two equity offerings and a new non-recourse CLO vehicle. We’re also very pleased with the increase in our core earnings run rate and dividends over the last few quarters. And we’re excited about the growth in our pipeline and are confident our originations network will continue to produce attractive investment opportunities and clearly we feel that our current stock price is not reflective of our true franchise value.

Given the depth and strength of our originations and securities platform combined with our dividend yield and the fact that our adjusted book value is $11.16 per share. Our primary focus will continue to be increasing the values of 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 our financial results.

Paul Elenio

Okay. Thank you, Ivan. As noted in the press release, FFO was $3.7 million or $0.13 per share for the third quarter and net income was $2.1 million or $0.07 per share. As Ivan mentioned, we continue to repurchase our debt at deep discounts, recording $4.1 million in gains from the repurchase of some of our CDO debt in the third quarter and $30.5 million in gains from CDO debt buybacks for the nine months ended September 30, 2012.

We also recorded $4.9 million in net loan loss reserves related to two assets in our portfolio. And after these reserves and charge-offs of previously recorded reserves, we now have approximately $189 million of loan loss reserves on 19 loans with UPB of around $267 million as of September 30, 2012. At September 30, our book value per share stands at $7.58, and our adjusted book value per share is $11.16, adding back deferred gains and temporary losses on our swaps.

Additionally, as Ivan mentioned, we currently have approximately $55 million in cash on hand and $42 million of capacity in our short-term credit facilities after our recent equity raise and CLO closing to fund our future investments. This is an addition to $21 million of cash posted against our swaps and approximately $105 million in unlevered assets net of reserves as of September 30.

We also currently have approximately $250 million of equity value in our non-recourse CDO and CLO vehicles, net of reserves as of September 30 and approximately $73 million of value in our OREO assets. This value combined with our cash on hand, cash posted against our swaps and net unlevered assets totals approximately $505 million in value and approximately $330 million in value after deducting the face amount of our trust preferred securities outstanding.

And based on the shares outstanding after our recent capital raise, we now have approximately $10.54 in net asset value per share.

Looking at the rest of the results for the quarter, the average balancing core investments was relatively flat at around $1.6 billion for both the second and the third quarters. The yield for the third quarter on these core investments was around 5.03% compared to 4.91% for the second quarter. This increase in yield was primarily due to higher yields in our third quarter originations, in addition to the collection of interest on certain loans in our portfolio not previously accrued partially offset by lower rates on a portion of our loan modifications a new non performing loans during the quarter.

Additionally the weighted average all-in yield in our portfolio decreased slightly to around 4.91% at September 30, compared to around 4.95% at June 30 due to the full effect of our third quarter non-performing and modified loans partially offset by high yields on our new investments.

The average balance on our debt facilities were down slightly to approximately $1.2 billion for the third quarter from approximately $1.3 billion for the second quarter. The average cost to funds in our debt facilities was approximately 3.10% for the third quarter compared to 3.11% for the second quarter. Excluding the unusual non-cash impact at certain interest rate hedges which are deemed to be ineffective for accounting purposes had on interest expense, our average cost of funds was relatively flat approximately 2.97% for the third quarter compared to around 3% for the second quarter.

Additionally, our estimated all-in debt cost was around 3.15% at September 30 compared to around 3.05% at June 30. This increase is due to higher rates on new CLO vehicle and revolving line of credit. So overall, normalized net interest spreads in our core assets increased to approximately 2.06% this quarter from approximately 1.91% last quarter. And our net interest spread run rate is now approximately $40 million annually or 1.76% at September 30 compared to approximately $39 million annually or 1.9% at June 30.

Property operating income and expenses related to our REO assets was relatively flat compared to last quarter although we are projecting a net loss from our REO asset operations in the fourth quarter as we’ve mentioned in the past, which is due to the seasonal nature of income related to our portfolio of hotels that we own.

As of September 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 adjustments of approximately $2.5 million for 2012, and approximately $3 million annually going forward.

This projected income, combined with our net interest spread run rate at September 30, 2012 were approximately $40 million on our loan and investment portfolio, gives us approximately $43 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, 2012.

Clearly, this growth in our core earnings over the last several quarters has contributed greatly to the increase in our dividends. We are optimistic that we will continue to increase our core earnings and dividends over time. Operating expenses were relatively flat from last quarter with the exception of a decrease 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 66% and 77% including the trust preferreds as debt, compared to 69% and 80% respectively. And overall leverage ratio on our spot basis including the trust preferreds as equity was down from 3.1 to 1 at June 30, to 3.0 to 1 at September 30. This was due to a decrease in total CDO debt outstanding from runoff and the repurchase of our CDO debt during the quarter.

There are some changes in the balance sheet compared to last quarter that are worth noting, restricted cash in our CDO vehicles decreased to approximately $30 million from last year, largely due to the second quarter runoff that was used to pay down CDO debt in the third quarter, partially offset by third quarter runoff that paid down CDO debt in the fourth quarter.

Repurchase agreements and credit facilities decreased by approximately $46 million, due to the transfer of certain assets into our new CLO vehicle, which combined with previously unlevered assets now financed in the CLO vehicle account for the CLO financing line added during the quarter to the balance sheet. And CDO debt decreased approximately $69 million from last quarter due to our second quarter CDO runoff which was used to pay down CDO debt in the third quarter and from our third quarter CDO debt repurchases.

Lastly, our loan portfolio statistics as of September 30, show that about 67% of the portfolio was variable rate loans and 33% were fixed. By product type about 65% would bridge, 19% junior participation and 16% mezzanine and preferred equity. By asset class 47% was multi-family, 30% office, 9% hotel and 10% land. Our loan to value was around 81%, our weighted average median dollars outstanding was 52% and geographically we have around 36% of our portfolio concentrated in the New York City area.

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

(Operator Instructions) And your first question comes from Steve DeLaney with JMP Securities. Please proceed.

Steve DeLaney - JMP Securities

Thank you. Good morning, Ivan and Paul and congratulations on a very strong quarter.

Ivan Kaufman

Thank you, Steve.

Steve DeLaney - JMP Securities

Making good progress here. I’d like to just talk about the outlook for new loan production. I think you’ve reported 12 new loans of $86 million in the third quarter, 7.5% yield. So, could you give us some color about sort of the size – well I know this has to be an rough number, sort of the pipeline of opportunities that you’re looking at, maybe if you could give us some indication of what has moved from pipeline to of committed or in process just so we can get a sense of what the flow might look like over the next couple of quarters?

Ivan Kaufman

Sure, Steve. And thanks for your comments. First of all, as you’re well aware we have a pretty diverse sales force in the manager and have a very far reach. And in general, a majority of our production is on home loans for multi-family properties. Due to our capital size and our access to capital all lines most of our production was between $5 million and $10 million on our loan size.

Over the last quarter or so, we’ve increased our loan size and we’re seeing a broader array of products now that we have more capital and originating between, maybe $5 million and $25 million. We increased our flow once we increased our capital base in access to CLO market and now have in discussions with additional lines of credit. So, we’re going to look to probably double our flow of originations. Although, it’s extremely competitive out there, we have a long history and deeper relationship. So, we can turn it out pretty easily.

I’m going to turn it over to Paul now, just to give you an idea of what’s in the pipeline and what we anticipate in the next couple of months.

Paul Elenio

Thanks. Yeah, Steve as Ivan said we’re starting to look at some parts, it’s a little bit bigger than we’ve done in the past is the amount of capital we have and the lines we had in place and the discussions we’re having with future lines.

I would say that what transferred from the pipeline to kind of committed to close to someone in the neighborhood of $40 million to $45 million in addition to what we put on out as what we funded in October, which was $20 million already. And we think that we should be able to get to a level that we did in the third quarter or maybe even a little bit better than that over the next couple of quarters. It’s too early to say that we will be able to deliver those kinds of numbers, stronger numbers in the third quarter and the fourth quarter yet. But so far it’s looking good, we have $20 million already closed $40 million to $45 million ready to close and then a significant amount of pipeline behind that.

So, we are expecting to ramp this up over the next couple of quarters it’s a little hard to give you an exact number, but that’s the high points of where we are with the product.

Steve DeLaney - JMP Securities

So, I mean a round number like, a round number like a $100 million per quarter doesn’t sound like it’s a consistent run rate, it doesn’t sound like that out of line or excessive from what you’re saying?

Ivan Kaufman

No, we’re very comfortable with that and we’re also very mindful of ramping up our production in line with what we have available on our securities and lines of credit. And as I mentioned in my prepared remarks what we want to always make sure we have is vehicles available. So if there is a credit dislocation and the bank has run into a problem then we don’t get (Inaudible) by the banks and impacted on mark-to-market issues and things of that nature which happened in the last credit crisis.

So we’ll grow our platform in a very deliberate manner, taking in consideration our ability to securitize and make sure that there’s a proper match of assets and liabilities in non-recourse vehicles.

Steve DeLaney - JMP Securities

Understood. And Ivan you mentioned that it’s an extremely competitive market. I think that’s understandable given that you’re setting a target of 15% leverage return and in this world I mean that’s an attractive portfolio return before expenses, do you see that looking forward that this 7.5% average coupon that might understandably come down a little bit. I mean what are you seeing when you’re making commitments now, how does that compare to which you write where you’re able to price loans in the third quarter?

Ivan Kaufman

It’s definitely gotten a little bit more competitive, but on the offsetting side, I think what you’ll see is our debt cost should come down because when we accessed the CLO market, which we feel fairly comfortable in doing based on the investor appetite in our relationships.

The first one was expensive. We had to break the ice, but we’re extremely comfortable that there will be savings on that side. So we think that if there is a little bit more competition on the originations side, it will be offset on the debt side.

Steve DeLaney - JMP Securities

Great. Well thank you for the comments and I was glad to hear that everyone at Arbor and your properties and all came through the storm in good shape. Thank you.

Paul Elenio

Thank you, Steve.

Ivan Kaufman

Thank you [hurricane] - Steve.

Operator

(Operator Instructions) Your next question comes from the line of Lee Cooperman with Omega Advisors. Please proceed.

Lee Cooperman

Well, thank you. Good morning and I echo Steve’s gracious comments a moment ago. I have the same questions I always ask you guys, but give you a chance to update it every quarter? Which book value do you think is most representative of the company’s value? I think Paul mentioned 10.54 NAV effective it’s offering.

Second, what is a realistic return on equity in your business and the timetable to get there? And third, while I understand the motivation for equity raise-ups, it is somewhat depressing - it’s got to be depressing to you, Ivan only as much as you own that we’re selling stock at half of NAV. Where are we in that process, have we got raised enough money now and between maybe getting access to other sources of capital that the equity raises are behind us or what can you say about that? So, it’s really three questions.

Ivan Kaufman

Sure. I’ll take the last one first and I’ll comment on that. And you’re correct. It is painful to raise equity. But as you know I’m an operator and I understand what it is to build the business and sometimes there are short-term sacrifices for long-term gains in raising the equity. And being able to access stellar market and build our originations we freed up a lot of capital, and a lot of liquidity to continue to build that platform. We believe that the - our core earnings will increase substantially, which will help us to achieve a value closer to what our real NAV is.

So it’s timing and it’s patience. And as you can see on a quarter-by-quarter basis we’re growing our core earnings. And we believe that, that should continue to grow, the rest I’m going to turn over to Paul for his color.

Paul Elenio

Sure, Lee. Thanks Ivan. Lee we’ve talked about this in the past and you’re right we - I put out a number of 10.54 NAV today and that NAV is really basically the adjusted book value as of September 30th performance for the equity raise we did in early October, we think that’s the real number. We think it’s the real number because the only adjustments we’re making to that next to our book value number are items that are just a matter of time before they come into equity and to earnings and they really – one of them as you know is a monetization of an equity ticker that we’ve tax deferred that will no future economic benefit to us but it’ll just eventually turnaround and come into our book value, so we believe that’s real.

And the other is the change in the value of our interest rate swaps with where interest rates have gone those values have obviously declined and they’re starting to improve as they’re getting closer to maturity. So in our eye that’s just a matter of time before the swaps mature and the value creeps back into our balance sheet. So we do look at the 10.54 as a real number.

And having said that you’ve asked several times, what’s a reasonable return on that NAV that we’re posting as the real value, certainly we’d like to get the number higher than it is maybe 10%, which is somewhere around $30 million. Right now we’re at $15 million to $16 million – $16 million to $17 million in the core earnings. And I think it’s important to note that in the last nine months that number has increased substantially back at the yearend, we had this discussion on the yearend earnings call.

Ivan Kaufman

What is really I believe you asked the same question-

Lee Cooperman

I think Ivan I asked the question I said, I ask this every quarter.

Ivan Kaufman

So Paul’s is going to give you the progress from what he stated, where we’re today and hopefully we’ll have the same progress three quarters from now.

Paul Elenio

Yeah. And I think at year end we were talking about our core run rate number of $8 million now nine months later we’re talking about the core run rate of $16 million that’s a pretty significant increase and clearly that’s due to us getting back into the origination business in a very meaningful way. I think the other point is we’re hoping as far as the timeframe of when we can think we can get to a 10% return, it’s hard to peg that, but we are optimistic that this is going to continue to grow quickly especially in light of the ability to access the securitization market, the capital markets are ready twice and now be able to get our originations up to a more meaningful number on a quarterly basis.

When we do that combined with lowering our debt cost as we think we’ll have more cheaper financing available to us in the future, we think it will make a more meaningful impact on the core earnings going forward. So it’s hard for us to give you exact timeframe, but the progress has been substantial and I think we’ll continue to hopefully see that progress.

Ivan Kaufman

And part of that too is as we take a lot of these unencumbered assets that are either OREO or need to be disposed off we redeploy that capital into interest earning assets or the OREO, which was troubled those NOIs will improve over time. In addition we have swaps that are in place that will burn off and will contribute.

So we’re very deliberate we’ve made enormous progress. We will continue to be deliberate and patient and we will get there I’m as anxious as you are giving my holdings. And we will weigh very carefully any future equity raises we have enough power now to continue to grow our platform and generate enough volume to once again access the debt markets and we’re quite comfortable with our ability to function and operate.

Lee Cooperman

Got you. Well my goal for you guys would be in 2015 to be earning a buck of share as 10% on the existing book in the book, and the book of course will be higher than hopefully been.

Ivan Kaufman

I’m pleased that you gave me that much time.

Lee Cooperman

Yeah, I’m a patient guy.

Ivan Kaufman

Okay.

Lee Cooperman

Congratulations guys for moving in the right direction.

Ivan Kaufman

Thanks Lee.

Paul Elenio

Thanks Lee.

Operator

Okay. I’d like to now turn the conference over to Ivan Kaufman for closing remarks.

Ivan Kaufman

Okay, well. We appreciate your participation. We know it’s been a difficult week for the nation and that there are many people who are suffering and having difficulties. We extend our feelings and a helping hand to those who we can. And we hope we recover as quickly as possible. Take care.

Operator

Ladies and gentlemen, that concludes today’s conference. You may now disconnect and have a great day.

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