Arbor Realty Trust

Good day, ladies and gentlemen, and welcome to the second quarter 2019 Arbor Realty Trust earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session, and instructions will be given at that time. Should anyone require assistance during the conference, you may press star then zero on your touchtone phone. As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, Paul Linneo, Chief Financial Officer. Please begin, sir.

Okay. Thank you, Norma. 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 June 30th, 2019. 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'm now turning the call over to Arbor's President and CEO, Ivan Kaufman.

Thank you, Paul, and thanks to everyone for joining us on today's call. As you can see from this morning's press release, we're at another outstanding quarter, which continues to demonstrate the diversity of our operating platform and the value of our franchise. We are very pleased with the growth in our business, which has consistently increased our baseline of predictable and stable earnings, allowing us to once again increase our quarterly dividend to 29 cents a share, which represents our second increase this year and reflects an annual run rate of $1.16 per share up from $1.08 per share. Additionally, the significant growth we experienced in the second quarter reflects continues to increase our run rate of core earnings, making us very confident in our ability to comfortably maintain our current dividend as well as grow it in the future. And based on our new dividend and yesterday's closing price, we are trading at a dividend yield of approximately 9.5%, which we believe is not nearly reflective of our true value. The quality and diversity of our income streams along with the consistency of our earnings, clearly differentiates us from our peers, which is why we believe we should consistently trade at or lower dividend yield than our peer group. To highlight our success further, I would like to talk about the growth we experienced in both our business platforms. In our agency business, we grew our service and portfolio another 3% in the second quarter and 14% over last year, and is now at $19.5 billion. This portfolio generates a servicing fee of 44 basis points and has an average remaining life of nine years, which reflects an 11% increase in duration over the last two years. As a result, we have created a very significant, predictable annuity of income of $85 million gross annually and growing. the majority of which is prepayment protected. And this growth in our servicing portfolio also continues to increase the annuity of income from our escrow balances, further contributing to our growing annual run rate of core earnings. We also had a very strong originations quarter, closing $1.3 billion in agency loans, and our pipeline remains strong, providing us with confidence and our ability to produce significant origination volumes for the balance of the year. We're also very pleased in our ability to continue to generate strong margins on our loan sales, despite the extremely competitive landscape. And these income streams from our agency platform continue to create significant diversity and a high level of certainty in our income sources. With respect to our balance sheet business, we've experienced tremendous growth in our loan book, We grew this portfolio 24% in 2018 and another 20% already for the first six months of this year on record second quarter originations of $1 billion. Our balance sheet portfolio is now a $3.9 billion, and significant growth we experienced in the second quarter will continue to increase our run rate of net interest income going forward. It is also significant to note almost 80% of our portfolio is in multifamily assets, which is clearly one of the safest and best asset classes. We also have a very robust pipeline, which will allow us to continue to grow our loan book for the balance of this year. And as a result of this strong pipeline, we elected to raise $105 million of fresh capital in the second quarter through a common stock issuance, which will be immediately accretive to our core earnings as this capital will be used to fund our growth. And again, the income generated from our loan book is a significant component of our earnings, and we remain very confident in our ability to continue to grow this income stream. In the second quarter, we closed our 11th and largest non-recourse CLO securitization vehicle with $650 million of assets and significantly improved terms, including reduced pricing, increased leverage, and a three-year replenishment feature. The tremendous success we continue to experience in the securitization arena combined with our ability to substantially reduce our debt costs in all of our borrowing facilities has allowed us to achieve significant economies of scale and maintain our margins in a very competitive market. Updating you now on the single-family rental business, We continue to make tremendous progress in developing our platform and building out the appropriate infrastructure as we remain committed to becoming a leader in this space. We are very pleased with the talent we have been able to attract and with the continued growth we have seen in our pipeline of opportunities by leveraging off of our existing originations, capacity, and capabilities. We believe this is a phenomenal business with an enormous opportunity in both the bridge and permanent lending products, and we are confident that we will build this out to be a significant driver of yet another income stream and further diversify our lending platform. Over the past few years, we have outperformed our peers, delivering consistent annual shareholder returns of approximately 30%. We're a complete operating platform with a significant diversified income streams, most of which are long-dated, including income from our servicing portfolio, escrow balances, balance sheet business and single-family rental investments. We are also leaders in the CLO securitization arena and continue to generate significant efficiencies from the right side of our balance sheet. We feel we are significantly undervalued given the stability and diversity of our income streams and that we should be trading substantially higher than our current market price, and we believe there is a significant opportunity for additional appreciation in our stock price to our shareholders. I will now turn the call over to Paul to take you through the financial results.

Okay, thank you, Ivan. As our press release this morning indicated, we had a very strong second quarter generating adjusted AFFO of $39 million, or 34 cents per share. These results reflect an annualized return on average common equity of 15%, which continues to demonstrate the earnings power of our capital light agency businesses as well as significant growth in cost efficiencies we are experiencing as we continue to scale our balance sheet business. As Ivan mentioned, we are very pleased with our ability to once again increase our quarterly dividend to $0.29 a share, reflecting a 16% increase from a year ago, and remain confident in our ability to increase our dividend in the future as our annual run rate of core earnings continues to grow. Looking at our results from our agency business, we generated approximately $20 million of pre-tax income in the second quarter, on approximately $1.3 billion in originations and $923 million in loan sales. The margin on our second quarter sales was 1.54%, including miscellaneous fees, up from 1.49% of an all-in margin on our first quarter sales. We also recorded $19 million of mortgage servicing rights, income related to $1.3 billion of committed loans during the second quarter, representing an average MSR rate of around 1.44%, compared to a 1.68% rate for the first quarter, mostly due to some large deals that we closed in the second quarter, which generally have a lower servicing fee. Our servicing portfolio grew another 3% during the quarter to $19.5 billion at June 30th, with a weighted average servicing fee of 43.6 basis points and an estimated remaining life of nine years. This portfolio will continue to generate a predictable annuity of income going forward of around $85 million gross annually. which is up approximately $5 million on an annual basis from this same time last year. Additionally, early runoff in our servicing book continued to produce prepayment fees related to certain loans that have yield maintenance provisions. This accounted for $3.5 million in prepayment fees in the second quarter, which was down from $5 million in the first quarter. The earnings associated with our escrow balances also continue to grow and contribute meaningfully to our recurring income streams. We currently have approximately $885 million of escrow balances, which are earning approximately 2%, and the earnings associated with these balances are up approximately $7 million on an annual run rate as compared to this time last year. In our balance sheet lending operation, we grew our portfolio another 15% in the second quarter to $3.9 billion, and based on our current pipeline, we remain extremely confident in our ability to continue to grow our balance sheet investment portfolio in the future. Our $3.9 billion investment portfolio had an all-in yield of approximately 7.34% at June 30th compared to 7.71% at March 31st. The average balance in our core investments was up from $3.3 billion last quarter to $3.6 billion this quarter due to our first and second quarter significant growth. And the average yield on these investments was up to 8.24% for the second quarter compared to 7.84% for the first quarter last mainly due to default interest collected on a second quarter loan payoff, as well as more acceleration of fees from early runoff in the second quarter. Total debt on our core assets was approximately $3.6 billion at June 30th, with an all-in debt cost of approximately 4.96%, compared to a debt cost of around 5.22% at March 31st, mainly due to lower cost debt from our new CLO that closed in the second quarter, as well as from reduction in LIBOR. The average balance in our debt facilities was up to approximately $3.4 billion for the second quarter from $3 billion for the first quarter, again, due to financing our portfolio growth. And the average cost of funds in our debt facility increased to approximately 5.35% for the second quarter compared to 5.24% for the first quarter due to $1.2 million of non-cash fees that were accelerated from the early unwind of CLO 6, which was replaced with our new CLO during the quarter with much lower borrowing costs. Overall net interest spreads in our core assets were up significantly to $2.89 this quarter compared to $2.60 last quarter, again, mainly due to interest and more acceleration of fees from early runoff in the second quarter. And our overall spot net interest spread was down to 2.38% at June 30th compared to 2.49% at March 31st, mainly due to higher interest rates on runoff as compared to originations during the quarter. The average leverage ratio on our core lending assets, including the trust-preferred, and perpetual preferred stock as equity was up slightly to 81% in the second quarter as compared to 79% for the first quarter due to the increased leverage we obtained in our new CLO. And our overall debt-to-equity ratio on a spot basis, including the trust preferreds and preferred stock as equity, was also up to 2.6 to 1 at June 30th from 2.4 to 1 at March 31st, mainly due to the timing of the closing of our latest CLO vehicle. Lastly, we also had a very strong quarter from our residential banking joint venture This investment generated $2.6 million of income to us in this quarter compared to $800,000 last quarter, mainly due to the success we continue to have in building out the retail branch network and from the current interest rate environment. And this success continues to demonstrate the diversity of our income streams and the value of our operating franchise. 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. Norma?

Thank you. Ladies and gentlemen, at this time, if you have a question, please press star then 1 on your touch-tone phone. If your question has been answered or you wish to remove yourself from the queue, you may press the pound key. To prevent any background noise, we ask that you please place your line on mute once your question has been stated. Our first question comes from Steve Delaney with JMP Securities. Your line is open.

Thank you. Good morning, guys, and congratulations on the strong quarter. I'd like to start with the bridge portfolio that I mean, that's quite a move up from the last record, which looks like it was $786 million in 4Q17. So didn't just, you know, skip by a little bit. You nailed it. What I'd like to know is we get an average loan size of about $25 million. Is there anything, some big lumpy loans, anything really large in there that caused the volume to be so much higher than it had been previously?

Hey, Steve, thanks for your comment.

Yes.

It's Ivan. We had one large loan in there. I think it was, what was it, Paul, about $250 million? Yes. $265 million. $265 million, which was really a number of multiple properties. But what really happened overall was with our execution and lowering our borrowing costs, we were able to drop our spreads and maintain our margins and be a little bit more competitive in the market. And we also made a little bit of an aggressive move because a lot of our loan book has live-law floors, and we felt that we'd pick up a lot of income in the future. and have a real nice opportunity if we were a little aggressive in the last quarter. And as LIBOR would drop, we'd be able to enhance our margins going forward. So it was a little bit of a strategic decision stimulated by the fact that we were able to have very good execution into the CLO market.

Got it. And is that the largest bridge loan that Arbor's ever made?

I think it's the largest bridge. bridge loan that we've made, but it consists of multiple properties, I think.

A portfolio of financing.

And for us, it was not just a bridge loan. What's attractive is that we'll be executing that portfolio into either Fannie Freddie or CMBS market over a 24-month period. So not only will we have the opportunity to have the spread income but we'll be able to have potential servicing and gain on sale in the future. So it was another strategic move on our part.

Steve, it was our biggest bridge loan, and it is collateralized by 56 properties in multiple states. Wow.

Okay. Thank you. That's good color. And, you know, obviously we noticed possibly because of the large loan, possibly just because of, new loans versus old loans, that the weighted average coupon fell by about 37 basis points down to 734, about 494 over LIBOR, spot LIBOR at June 30. Just curious if the trend in spreads, if you're continuing to see pressure, and if you could comment sort of on what the general range of spreads over LIBOR that you're currently able to achieve on your new bridge loan production.

Sure. I think spreads are generally in the $2.75 to $3.50 range, and that's down from maybe $3 to $3.75, and that's offset by reduced borrowing costs. But as I said, a lot of that is mitigated by having a higher LIBOR floor. I think that spreads probably will maintain that level, but the LIBOR, as you know, is dropping, and our outlook is down to about two and a quarter now. I think you wouldn't be surprised to drop to 200 to 175 over the next six months. So I think that'll keep spreads a little bit, you know, where they are. I don't see that much of a tightening, maybe 25 basis points at best.

Got it. And then just one final thing for me. Chris was looking at the credit risk rating table in the 10Q and We noted that the land bucket appeared to be moved up to special mention from a previous weighted average rating of substandard. On the other hand, the self-storage sector was moved down to special mention from past watch. I was just curious if you could give us any color on what's going on in those buckets, if there were any significant movements there on particular loans.

I don't think on the self-storage I can comment on. I mean, what you're seeing, which is typical, is anything that can be exited to more permanent financing is being exited. So you're perhaps seeing a movement on the self-storage where, you know, the best stuff is moving out, the stuff in the middle is still maturing, and that will be moved out over time. And that probably is what the trend is on the self-storage stuff.

And on the land side, Steve, it's just the product of that's a weighted average rating for all the land deals. And we did a land deal, I think, in the first quarter, which is brand new and performing well. So it just picked up the weighted average to a better rating for that bucket.

Got it. So just sort of the transitioning of stuff. And, you know, when you get weighted averages and something large moves, I get it. I get it. But generally speaking, would you say that in the quarter, were there any – you know, material new credit problems that you identified that, you know, you have some concern about?

No, we're quite comfortable.

Yes, not at all. Thank you both for your comments. Appreciate it.

Thank you. And our next question comes from Jay Ramani of KVW. Your line is open.

Hi, everyone. This is actually Ryan on for Jade. Ivan, just given the strong half of of the year, first half of the year for the GSEs. I was hoping you can give us your thoughts on just your outlook for the GSE market overall in the back half. Have you seen either agency change pricing recently to manage the volumes and the caps? And do you think there's any chance that we see the caps adjusted considering the strong volumes year-to-date?

I think that they are definitely widening their pricing step by step, and they'll continue to do it, to slow the volume a little bit. That, in many ways, is beneficial to us, because I think it'll enhance our margins, because as they compete on margins, that means we also have to compete. And I think they, my prediction is there will not be a raise in the cap at all. A lot of our business is uncapped, so we're not as effective as other people. but I don't predict there'll be any raise in cap whatsoever.

Okay, and then just on the overall multifamily environment fundamentals, any changes with respect to your thoughts on the fundamental environment and underwriting and credit quality? I think, Ivan, in past quarters you've alluded to an increasingly frothy environment and the need to continue sharpening your pencils.

I think that my concern is the amount of liquidity in the market and the competition and what would cause it to be frothy. With respect to the fundamentals of occupancy, they're still very solid. Rent growth seems to be continuing. We're not that active in the luxury end of the market, which I feel is the most vulnerable part of the market. We are more workforce housing, B&C-type housing. and that market continues to be strong. And cap rates are still, especially with a drop in interest rates, still at very tight levels with maybe even a little tightening coming our way given the drop in the 10-year.

And with respect to the New York City rent control legislation, could you give us your thoughts on what you perhaps might think would be the the longer-term impact in the market from that on cap rates and values. And, Paul, maybe if you can let us know if Arbor has any direct exposure there and wondering if you've seen any transactions yet in that space post the legislation. Sure.

Well, if you're dealing in the rent-regulated side of the business, you're going to see some cap rate expansion since you're not going to be able to see significant increases in income. So, you know, the way we've been looking at it, you know, assets for trading in the, you know, cap rates around 3.5 to 4, probably 3.5 more with the opportunity to, you know, raise rates, improve apartments, and get to a stabilized 5 cap. That was the way people were buying. I think that, you know, you'll see rent-regulated apartments being more like in a 4.5 cap. So just if you do the math on an appraised value basis, you'll see a diminution of value for rent. People who are loaned to rent-regulated apartments are around 20%. That's the way we're out. Paul will give you the numbers. We have very, very little exposure to this sector. But, Paul, do you have some numbers?

You're right, Ivan. Ryan, we've done this math, scrubbed our portfolio. We have a $3.9 billion portfolio. balance sheet portfolio. As you know, we're an active multifamily lender in New York City. We have very little exposure to rent control and rent stabilized. In fact, right now, our exposure is probably under $140 million on that $3.9 billion. It's probably two or three deals.

And anything in the servicing book?

On the servicing book, we've looked at that as well. It would just be the Fannie book, obviously. So on the Fannie book of $14.1 billion in we have less than 300 million of those type of assets as well.

And on the balance sheet book, do you have the LTV on those 140 million of loans?

I don't know if I have that with me currently.

Yeah, when we look at them, we don't see any significant impairment. With respect to the Fannie Mae book that we have, loans are underwritten on a current cash flow, not a projected value. So the cash flow that exists has not been impacted. It's really the future growth, and that would be on the bridge portfolio. On our bridge portfolio, the loans that we have, it's not a majority of the units. It's partial units and buildings. So the amount that we have is very negligible.

And I'm seeing an LTV of somewhere around 70%.

Great. Thanks for all that color.

Thank you. As a reminder, ladies and gentlemen, that's star one to ask a question. Our next question comes from Lee Cooperman of Omega Advisors. Your line is open.

Thank you. You guys have done a masterful job of raising new capital and employing it intelligently. You know, Ivan, you seem very enthusiastic about the outlook. You feel your stock is very mispriced. But, you know, we continue to raise capital. So I'm just curious how you look at the cost of capital embedded in your stock price versus the prospective returns of capital you see. And obviously part of that question is how do you feel about capital adequacy currently? If somebody wanted to buy $100 million of stock from you right now at the last sale, would you do it? Can you put that capital to use?

You know, raising capital is a complex matter for us, and there are various ways we've been able to raise capital. And we look at our loan book, we look at our needs to grow the business, and we look at the economies of scale by the way we grow our business. And we look at, you know, what's in the pipeline. So we do it very strategically. And we try and be very stingy about when we do it, and we make sure it's accretive. Right now, we put the capital to use. I think we put it to good use. We think it's going to be extremely accretive. And depending on how the pipeline continues to come in and payoffs are and the other needs to grow our business, we'll dictate what our capital needs are. So if you put $100 million in my hand today, I'd have to evaluate our ability to deploy that, how accretive it would be to our dividend and what it would do to our business. And, you know, these are things that we're consistently evaluating.

So what you're saying is if you do raise capital, you would do it on a basis where you feel it would be accretive to the distribution looking out? We only do it where we feel it's accretive.

Good.

You've done a great job, so I'll rely on that. Thank you. Thank you. Thank you.

Thank you. And our next question comes from Rick Shane of J.P. Morgan. Your line is open.

Hey, guys. Thanks for taking my questions. Two things. One is, obviously, we saw a nice pickup in gain on sale margin this quarter. I'm assuming some of that has to do with the move in rates during the quarter and the value of those loans going up. It is noteworthy, though, that in the quarter your loan sales increased your commitment exceeded your loan sales by more than any other quarter we can track. That suggests that there is a lot of dry powder to sell in the third quarter. Should we continue to see the strength and the gain on sale margin on those incremental loan sales given the movement in rates?

So, hey, Rick, it's Paul. So you're right in one aspect that if you look at the – and the best measure for that is look at the held for sale balance. So you're right. We did have significantly more committed loans than sales, which tells you that our June was a significant quarter. We have $600 million sitting in held for sale, so we did have a very, very strong June agency month. So that will dictate that plus whatever we close in July and August will dictate what your sale volume is. As I said in my commentary, we've been unbelievably impressed with our ability to maintain our margins and actually have our margins grow considering how competitive it is. It's a product of many things, and Ivan will comment on the market, but it's also a product of size as well. And in the second quarter, at the end of the quarter, we did some larger deals, and that's why you saw that my MSR rate had dropped quarter over quarter because we had done some larger portfolio deals in June. Those normally will come with a little lower margin, but they also come with a lower commission. So, you know, based on what I see of June, the margin may come in a little bit. I don't know what July and August are going to show, but that's kind of the indicator that we see, you know, based on where margins will go. And I'll let Ivan comment on what he thinks the market is showing.

Yeah. So in prior calls, we spoke about our strategy to have similar volumes on our agency business as we did last year. And most of the markets, it was going to be showing increases in volume. We could have shown increases in volume, but we elected to manage our margins, manage our volume, and manage our staffing. And I think that is a very good reason as to why we've been able to maintain our margins. Very often, people fight for lead charts. And when you fight for lead charts, you want to do business at less. And it just doesn't affect your incremental business. It affects your entire business. And As a firm, we decided not to go after the leaked charts, not to worry about whether we're the eighth, seventh, or sixth, or fifth largest lender, but to maintain the integrity of our margins, our staffing, and not get sloppy. And I think that is a lot to do with why we were able to maintain it. And as Paul mentioned, in the loan sizes in which we traffic, there's a little less sensitivity on the margin side. As you go to bigger loans, they become more competitive and people are willing to work for a lot less. So I put those two factors together in our ability to maintain our margins in a competitive environment.

Got it. That's helpful. So what I'm hearing, the way I'm understanding this is volume should be, loans sold in the third quarter should be particularly strong given the strength of June volumes, but probably unfair to read through that you would see further margin increases, likely given the larger loan sizes in the month of June, a little bit of compression from the particularly high numbers you saw on gain on sale in Q2.

Yes, that's right, Rick, and as far as your first comment, June was the first month, so We want to believe our sale volume will be very strong in the third quarter, but we've got to see where July and August come in. But we got off to a great start with June being as strong as it was.

Great. Thank you for the clarity, guys. Appreciate it.

Thank you. At this time, I'm showing no other questions in the queue. I'd like to turn the call back over to Mr. Ivan Kaufman for closing comments.

Okay, well, thanks, everybody, for your participation today. It was another fantastic quarter. And as I mentioned in my scripted remarks, the pipeline is strong. We have a lot of momentum, and we're very optimistic about the balance of the year. Everybody have a great weekend and the rest of a nice summer. Take care.

Ladies and gentlemen, thank you for your participation in today's conference. You may now disconnect. Everyone have a wonderful day.

Thank you.