Arbor Realty Trust

Ladies and gentlemen, thank you for standing by, and welcome to the third quarter Arbor Realty Trust Earnings Conference call. At this time, all participant lines are in the listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you'll need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require further assistance, please press star 0. I would now like to turn the call over to your speaker today, Paul Aranio. Please begin, sir.

Okay, thank you, Norma. 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 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 expectation 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.

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 had another outstanding quarter, which continues to demonstrate the diversity of our operating platform and the value of our franchise. We're very pleased with the continued 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 $0.30 a share, which represents our third increase this year and reflects an annual run rate of $1.20 per share, up from $1.08 per share. Additionally, the significant growth we experienced this year 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. Over the last few years, we have clearly outperformed our peers, delivering consistent annual shareholder returns of approximately 30%. And this performance, combined with the quality and diversity of our income streams, along with the consistency of our earnings and our low dividend payout ratio, clearly differentiates us, which is why we believe we should consistently trade at a lower dividend yield and a substantial premium to our peer group. To highlight our success further, I would like to talk about the growth we experience in both of our business platforms. In our agency business, we grew our servicing portfolio another 3% in the second quarter and 12% over last year and is now at $20 billion. This portfolio generates a servicing fee of 44 basis points and has an average remaining life of over nine years, which reflects an 11% increase in duration over the last two years. And as a result, we have created a very significant, predictable annuity of income of $87 million gross annually and growing, the majority of which is prepayment protected. As this growth in our servicing portfolio also continues to increase, the annuity of income from our escrow balances, which are currently earning $19 million annually, for a combined annual run rate of servicing income and ESCO earnings of $106 million. We also had a very strong originations quarter, closing $1.4 billion in agency loans, and our pipeline remains strong, providing us with confidence in our ability to produce consistent origination volumes for the balance of the year. We are also very pleased in our ability to continue to generate strong margins on our loan sales despite the extremely competitive landscape. These income streams from our agency platform continue to create significant diversity and a high level of certainty in our income streams. There's been a lot of talk lately about the potential for the GSE reform and the effect that it has and the new cap could have on GSE lenders in the future. The new cap for 2020 has been increased and represents approximately 40% of the projected 2020 multifamily markets. The new cap also eliminates any exceptions and mandates that 37.5% be directed towards mission-driven business or affordable housing. Our GSE production historically has been mostly in the affordable housing market, and therefore we believe that the increase to the cap, combined with a large portion being dedicated to the affordable housing component, puts us in a favorable position to be able to continue to grow our agency production going forward. In anticipation of a potential reduction in the agency footprint, which did not occur, we launched our Arbor private labor program. In the beginning of the third quarter, the industry experienced a slight disruption as the agency caps were being navigated. In that short period of time, we had a competitive advantage in the market and were able to build a pipeline of $600 to $700 million of this product, which we expect to close and securitize in the first quarter of 2020. And we believe the development of this product line will further diversify our lending platform and act as a mitigant against any further changes to the agencies. With respect to our balance sheet business, we experienced tremendous growth in our loan book. We grew this portfolio 24% in 2018 and another 21% already for the first nine months of this year on nearly $2 billion of originations. Our balance sheet portfolio is now at $4 billion and the significant growth we experienced will continue to increase our run rate of net interest income going forward. It is also significant to note that almost 80% of our portfolio is in multifamily assets, which is clearly the safest asset class. We also have a very robust pipeline, which will allow us to continue to grow our loan book for the balance of the year. And as a result of this strong pipeline, we elected to raise $120 million of fresh capital in October through a four and three quarter unsecured debt issuance that was 100 basis points tighter than than our last debt issuance in March. This was very attractive capital as it will be used to fund our pipeline of new investments and be immediately accretive to our core earnings. We continue to have tremendous success through our securitization expertise and our strong banking relationships in substantially reducing our debt costs, which has allowed us to achieve significant economies of scale and maintain our margins in a very competitive market. And again, the income generated from our balance sheet loan book is a significant component of our earnings, and we remain very confident in our ability to continue to grow this income stream. Updating you now on our single-family rental business, we continue to make considerable progress in developing our platform, and we are committed to becoming a leader in this space. We are very pleased with the continued growth we are seeing in our pipeline of opportunities by leveraging off our existing Originations capacity and capabilities. We have closed approximately $100 million of single-family rental product to date, and we believe this is a phenomenal business with 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 source of income stream and further diversify our lending platform. Overall, we are extremely pleased with our progress and the tremendous success we continue to have in growing our operating platform. The quality and diversity of our income streams makes us very comfortable with the stability of our dividend and confident based on our strong baseline revenues that the current status of our pipeline will be able to consistently grow our dividend in the future and continue to generate outsized returns 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 third quarter generating AFFO of $42.4 million, or $0.36 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 business, as well as the significant growth in cost efficiencies we are experiencing as we continue to scale our balance sheet portfolio. And as Ivan mentioned, we are very pleased with our ability to once again increase our quarterly dividend to $0.30 a share, reflecting an 11% increase from a year ago, and remain confident in our ability to comfortably maintain our current dividend, as well as grow it in the future. Looking at the results from our agency business, we generated $29 million of pre-tax income in the third quarter on approximately $1.4 billion in originations and $1.5 billion in loan sales. The margin on our third quarter sales was 1.43%, including miscellaneous fees, compared to 1.54 all-in margin on our second quarter sales. We also recorded $30 million of mortgage servicing rights income related to $1.5 billion of committed loans during the third quarter, representing an average MSR rate of around 2.02% compared to a 1.44% rate for the second 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 $20 billion at September 30th, with a weighted average servicing fee of 43.5 basis points and an estimated remaining life of 9.2 years. This portfolio will continue to generate a predictable annuity of income going forward of around $87 million gross annually, which is up approximately $5 million on an annual basis from the same time last year. Additionally, early runoff in our servicing book continues to produce prepayment fees related to certain loans that have yield maintenance provisions. This accounted for $5.3 million in prepayment fees in the third quarter, which was up from $3.5 million in the second quarter. The earnings associated with our escrow balances also continues to grow and contribute meaningfully to our recurring income streams. We currently have approximately $950 million of escrow balances, which are earning around 2%, and the earnings associated with these balances are up approximately $4 million, or 29% on an annual run rate as compared to this time last year. In our balance sheet lending operation, we grew our portfolio 21% for the first nine months of the year to $4 billion, and 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 $4 billion investment portfolio had an all-in yield of approximately 7.04% at September 30th compared to 7.34% at June 30th. The average balance in our core investments was up from $3.6 billion last quarter to $3.9 billion this quarter due to our second and third quarter growth. and the average yield in these investments was 7.31% for the third quarter compared to 8.24% for the second quarter, mainly due to default interest collected on our second quarter loan payoff, higher interest rates on runoff as compared to originations, and from a reduction in LIBOR during the third quarter. Total debt on our core assets was approximately $3.5 billion on September 30th, with an all-in debt cost of approximately 4.65% compared to a debt cost of around 4.96% on June 30th mainly due to a reduction in LIBOR during the third quarter. The average balance on our debt facilities was up to approximately $3.5 billion for the third quarter from $3.4 billion for the second quarter due to financing our portfolio growth, and the average cost of funds on our debt facilities decreased to approximately 4.87% for the third quarter compared to 5.35% for the second quarter due to $1.2 million of non-cash fees that were accelerated from the early unwind of CL06 in the second quarter the full effect of lower borrowing costs associated with our new CLO and from a reduction in LIBOR in the third quarter. Overall, net interest spreads in our core assets were down to 2.44% this quarter compared to 2.89% last quarter, again, mainly due to default interest received in the second quarter and higher interest rates on runoff as compared to originations. And our overall spot net interest spread was relatively flat at 2.39%, and 2.38% at September 30th and June 30th, respectfully, mainly due to the positive effect of LIBOR flaws on a portion of our balance sheet portfolio and from reduced borrowing costs from our recent CLO execution. The average leverage ratio on our core lending assets, including the trust-preferred and perpetual preferred stock as equity, was down slightly to 80% in the third quarter as compared to 81% for the second quarter, and our overall debt-to-equity ratio on a spot basis including the trust-preferred and preferred stock as equity, was also down to 2.5 to 1 at September 30th from 2.6 to 1 at June 30th. Lastly, we also had another very strong quarter from our residential banking joint venture. This investment generated $2.6 million of income to us this quarter, mainly due to the success we continue to have in building out the retail branch networks and from the current interest rate environment. We also expect to record additional income from this investment in the fourth quarter, that will be more in line with past fourth quarter performances due to the normal seasonal nature of this residential banking business. And this success continues to demonstrate the diversity of our income stream 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 1. To remove yourself from the queue, you may press the pound key. One moment while we compile the Q&A roster. Our first question comes from Steve Delaney of JMP Securities. The line is open.

Good morning, and thanks for taking the question. The gain-on-sale margin, a little over 2% in the third quarter. You mentioned that, you know, you had a mega deal or large deal in the second quarter. Paul, how do you feel about that as a run rate? And, obviously, I know the Fannie Mae situation, component, which was up to 77%. That's a factor in there, but is 2% a reasonable, given your mix of business, a reasonable level for us to project on the MSR gain?

Sure, Steve. I think you said gain on sale, but I think you meant MSR rate.

I meant MSR, my bad.

Yeah.

The MSR rate was 2.02 for the quarter. It was higher than it was last quarter for the reasons you mentioned. We did have some larger loans that we closed in the second quarter. with lower servicing fees. We didn't have that kind of mix in the third quarter. It also depends on, as you mentioned, the mix of Fannie Mae versus the other products, and it was a little heavier towards Fannie Mae. So it's a tough one to project, but I would say that it should trend on the higher end, maybe not 2% every quarter, but it should trend on the higher end that it has over the last few quarters because the Fannie Mae business has picked up you know, with the new cap and the new developments there, and the servicing fees are staying relatively high in that business. So unless the mix significantly changes to more credit and fanning, which I don't anticipate, we think that MSR rate could be high going forward.

All right, great. That's helpful. And you smoked me out on the – interested in the servicing revenue going up, you know, 10% with the volume only up, the UPD up three, and you mentioned your yield maintenance. You know, do you consider what you saw kind of routine, or was it the drop in the 10-year, you know, from 250 early in the year to 170? Do you think that there are people actually that are bailing out early and refiing their GSE loans?

I'll let Ivan talk about the market, but I do think that it was a little surprising, and it probably had to do with the interest rates. The prepayment fees were trending more, in my opinion, normalized, nevertheless, because it got down to $3.5 million last quarter. That's where I kind of pegged I thought it would be. this quarter and maybe next quarter, but it came in a little higher than I expected. And I think I would attribute that probably to, as you mentioned, Steve, the drop in the interest rates and people refinancing their portfolio. But, you know, we'll get Ivan's view on where he thinks the market is from that perspective.

Sure. I think it's not just the product. Hello? Oh, yeah. Can you hear me? Hello? Yes, I got you now. I got you now. Okay. Yeah, it's not just a product of refinancing. I think when rates do drop, there may be an acceleration of some sale activities and people are willing to, you know, deal with the, you know, yield maintenance issues because their gain on sale and their own assets are more robust. So it's a factor. It's definitely a factor, and it's a consistent factor for us in our earnings. And, you know, sometimes it's higher, sometimes it's lower, but it's always within a certain range. Got it. Thank you both for your comments.

Thank you. Our next question comes from Stephen Loth of Raymond James. Your line is open.

Hi. Good morning, Ivan and Paul. I want to follow up on a couple of things from Ivan. I'm going to leave your prepared remarks. On the private label side, 81 million of originations in Q3, you know, what should we think about as a normal quarter on the private label business and then To that point, what's the difference in the underwriting standard that the loans you'll do there on the private label securitizations yields versus the agency yields, or maybe a little bit of the characteristics that distinguish the two?

I think, first off, the private label was created as a result of the agency's, at least our anticipation that the agencies would be cutting back because they were hitting against their cap. And that's how we created the program. So it was filling an absolute void where the agencies were not quoting. They were backing up their pricing, you know, very, very, very steep. And the private label was actually inside of the agency pricing. So the amount of private label we produce will be a product of how aggressive the agencies will be or will not be. And that's a real primary issue. The secondary issue will be is if they're not fulfilling their mandate on the mission-driven business, which is 37.5%, they'll be more aggressive on the mission-driven business and less aggressive on the non-mission business. So if they're less aggressive on the non-mission-driven business, we'll do more private label business in general. Sometimes the agencies have a concentration in a specific market and they're less aggressive, and that's a void to be filled as well. Sometimes they have a sponsor concentration, and that affects them as well. So there are various number of factors that exist, but we would not expect the amount of private label business we did in a short period of time to be operating at that level on a run rate unless the agencies shy back on their production. They are getting more aggressive now. and I think they're taking more and more of the market. So I would anticipate seeing, as I said, a lower run rate than what we have in the pipeline right now. What we have in the pipeline right now suggested probably about a $2.5 billion securitization level to three for 2020. I'll expect that to be probably half.

Great. I appreciate the color there. It does sound like a good opportunity to fill in when there are gaps in the market. And shifting to follow up on your SFR comments, $100 million to date. I know a lot of expenses have been going in building out the platform. How should we think about top-line growth is really not the right way to think about it, but ROEs associated with ramping that up and what type of ROE expansion or benefits to the bottom line as you leverage those costs that have been put in place building out that platform?

So I think, you know, we've been able to absorb the costs in our operating numbers for 2019, and I believe that for 2020 we'll continue to grow that business. My objective would be able to get to a run rate of both bridge lending and securitization of around $50 million a month on each side. At that level, if we can get there, it will be a substantial contributor to our bottom line. But right now it's not a drag. It's probably somewhat neutral, turning to a positive, as we now have some loans on our balance sheet producing positive earnings.

Fantastic. And then thinking about the competition side, you know, when you look at your competitors, are you seeing more pressure on spreads or on the credit side with underwriting standards? And maybe talk a little bit to each side of that as to how you're addressing that competition in the market.

Yeah, there's constant pressure on spreads on the balance sheet side. Spreads have come in considerably. I'd say they're in another 25 to 35 basis points in the last four months since our last quarterly call. However, we've been able to get a lot of economy scales on the borrowing side to offset that and maintain our spread. So that's been quite positive for us and grow our book at the same time. So we're pretty comfortable with where we are. although our coupons are tighter. Our borrowings have offset that to a large degree. On the agency side, it is a fiercely competitive market, and we've been able to maintain our volume levels and not be ambitious about growing too much and being overly aggressive in what we do and wait up on our overhead. So we've been pretty disciplined about trying to manage our business accordingly and doing a good job. I think that the market will continue to be competitive, but we have a good franchise and we have a good customer base and we've been able to, you know, maintain our business plans fairly effectively.

Great. Thanks a lot for the comments and taking my questions.

Thank you. Again, ladies and gentlemen, to ask a question, that's star one. And I'm currently showing no questions at this time. I'd like to turn the call back over to Mr. Ivan Kaufman for closing comments. Actually, I'm sorry. I have questions. Dave O'Mahony with KVW. Your line is open.

Thanks very much. I was wondering if you would be interested in property management as an additional business line to add. It would seem complementary to the company's increasing focus on the residential market. We know in the single-family rental space there's definitely a need for institutional property management because of the scale requirements and economics in that business. And also I know you've made investments in technology, and technology has been a theme as well. So could you comment on that?

We've evaluated that in the past, and we've declined in going into that area for a number of reasons. It's very people-intensive, requiring a lot of management and a lot of infrastructure, with the margins being very, very low. We're also afraid of some of the headline risk that might come along with that, because property management and some of the negative things that can occur when you're managing properties. There is some headline risk from time to time, whether it's justified or not, that we felt was probably not where we wanted to be as a public company and affect the rest of our businesses. The only real issue for us is whether the synergies from managing properties and creating financing opportunities would have offset all that and create additional revenue streams and We're not sure it does, so we think there are better places to put our capital and management at the present time.

Thanks very much for that. Turning to the overall commercial real estate business, it seems like you have a very positive view toward multifamily as well as single-family rental and lower risk dynamics in residential housing in general. particularly the affordable focus. What's your view toward the rest of the commercial real estate market, and do you expect to continue to originate bridge loans, you know, in other property types such as office or net lease?

So we've, you know, we probably have about 20% to 25% of our originations in portfolio and other asset classes, and we pick our spots. We'll do some hospitality, some retail, some office. certainly some health care. So we're not major players in that area. We're more opportunistic for either servicing our bars or seeing a unique opportunity. But historically, we love the multifamily market. It's been the best performer in and outside of all other markets that we've engaged in. So that will probably be the balance in our book.

And in the commercial real estate asset classes you mentioned away from residential, would you expect an uptick in market-wide loan delinquencies next year?

Our feeling is that, you know, we're at a certain point in the time of the cycle. There's a lot of liquidity. There are a lot of new players. There's a lot of syndicated capital. And you'll have a new entrance into the market. And, you know, with that becomes a level of risk. And I think that... what we'll do is proceed with a lot of caution with the sponsors we do business with and be very cautious in this point in time in the cycle. So we do expect there to be a little bit of an uptick in delinquencies in the industry in general, and a lot we'll do with interest rates as well as rent increases. So you've had a historical run of over 10 years of 3% to 5% rental increases. which has been very, very positive for the multifamily asset performance and a very attractive interest rate environment. Those are two variables that nobody can control right now, but we're very conservative in the way we underwrite our loans with rent growth, as well as exit cap rates and exit interest rates on our loans. But now would be the period of time to be cautious.

And touching on the dividend, what's the decision to, again, raise the dividend just with the factors you mentioned, rates, spreads being an uncertainty? You know, why not choose instead to be more defensive and obtain some additional capital?

Well, number one, we feel we are very conservative. We have a lot of room within our dividend, and our core earnings just continues to grow at tremendous levels. And I think what's worth noting is when our core earnings grows, our baseline grows, It doesn't go down. Our servicing revenues, our escrow balances, our balance sheet, it shows a tremendous baseline from year to year, and we're still at a very low payout ratio. We feel there's a lot of room, and we're very comfortable with it, and it would almost be inappropriate for us to have a lower payout ratio with our quarter earnings growing at such a rapid rate.

Thanks for taking the questions.

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 this morning. I appreciate the commentary on the private label in response to Steve's question. I'd love to talk about it a little bit tactically. Obviously, it's a business that's meant to sort of provide stability when there are fluctuations, in the other parts of the market. But obviously, you can't just sort of be in and out of that based on where the thresholds are. I'm curious, you know, it sounds like the plan is to run this on a steady state basis. How do you look at the economics versus the agency business? How do you decide in periods where there is capacity on the agency side whether or not to do private label loans?

I think what will happen is depending on where the agencies are and how aggressive they are, both on pricing and in markets, I think that footprint will shrink dramatically or grow in a nice way. There may be periods of time where we're just not an effective originator of that product because the agencies are too aggressive. So currently, the pipeline we generated is significant and should lead to really, really good execution. I think now that the agencies are tightening up every week, there may not be space for us to originate that product in the market. So the market will dictate to a large degree with the agencies being the leader in the market for how much room there is. And the agencies continue week by week to tighten their spreads, you know, three basis points, five, ten. They went from being, you know, 250 to 275 over. And now they're actively quoting from 190 to 210 or 215 over, which is right around where we're quoting. And if they get inside of that, there won't be a sufficient enough product. But if they widen, there will be. So right now it's kind of borderline with the agencies probably going to dominate that market again. So we'll have to wait and see how it works.

Great. That's very helpful. And I'm not sure I heard if you answered this to Steve's question or not, but How do the economics compare versus the agency business on a gain-on-sale basis?

So we think that it lies somewhere between the two agencies, between Fannie and Freddie, the economics. So the economics on the Fannie Mae business are stronger than on the Freddie Mac business, and we think it lies right in between.

Okay, great. So it probably will impact gain-on-sale business. margin at the margin.

Paul, what's your feeling on that?

Yeah, I think that's right. I think it will depend on how, as Ivan laid out, Rick, how active we are in that private label business. I think the economics, as Ivan laid out, fall in between the two agencies, obviously Fannie being more robust on the servicing fee side and on the gain-on-sale side than Freddie. So if it falls in between those two, it likely doesn't move the margin that in total significantly unless it's a bigger part of our book than the agency's, you know, regress. So it'll be hard for me to tell you that it won't affect the margin at all, but unless it's a real big part of our business and that means the agencies are, you know, reducing their footprint, I don't think it moves the margin materially.

Yeah, there are some factors on that. The larger deal you do, you can absorb your fixed expenses, and that has a big impact on the market. We originally targeted doing a $350 million deal. We hope to come out somewhere between $600 million and $800 million, which will have a very positive impact on our margins, probably by at least a quarter percent in absorbing those fixed expenses. And the other item which we don't know how much of an impact it will have, we're trying to build a brand given the way we're doing it, and we're hoping we can trade. We're pricing it to trade comparable to the CMBS market. We think with our brand, our expertise in the securitization market, us maintaining part of the B piece and being in the servicing side of the business, perhaps there can be some pricing advantage which hasn't been factored in. So it's a little early to say exactly where we come out, but right now it's looking very favorable.

Okay. Thank you guys again for your time this morning.

Thanks, Rick.

Thank you. Again, ladies and gentlemen, to ask a question, that's star 1. And I'm currently showing no questions at this time, and I'd like to turn the call back over to Mr. Ivan Hoffman.

Well, thank you, everybody, for participating on today's call. Sorry for the technical difficulty that occurred originally on the inception of the call. The third quarter was once again another outstanding quarter, and we're very optimistic to complete the rest of the year in a very positive way. Thank you again. Take care, everybody.

Ladies and gentlemen, this concludes today's conference. You may now disconnect.