Arbor Realty Trust

Ladies and gentlemen, thank you for standing by, and welcome to the fourth quarter 2019 Arbor Realty Trust earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during that portion of the call, you will need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star and 0. Now it's my pleasure to turn the conference over to your Chief Financial Officer, Paul Elenio. Please go ahead.

Okay, thank you, Carmen, 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 and year-end of December 31st, 2019. With me on the call today is Ivan Kaufman, our President and Chief Executive Officer. And before we begin, I just want to inform you that Ivan is in transit due to some unforeseen travel issues this morning, as is Audio sounds clear, but to the extent that we lose him, I'll pick up his prepared remarks, and then we'll get him back. So before we begin, I need to inform you that statements made in the earnings call may be deemed forward-looking statements that are subject to risk and uncertainties, including information about possible 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 occurrence of unanticipated events. I'll now turn the call over to Arbor's President and CEO, Ivan Kaufman.

Thank you, Paul, and thanks, everyone, for joining us on today's call. We are very excited today to discuss the significant success we had in closing out 2019, as well as our plans and outlook for 2020. As you can see from this morning's press release, we had an outstanding fourth quarter with tremendous operating results, which continues to demonstrate the strength of our brand and the value of our operating franchise. Additionally, the significant growth we had experienced in 2019 has provided us with a very strong baseline of predictable and stable core earnings heading into 2020, making us very confident in our ability to comfortably maintain our dividend as well as grow it in the future. Over the last five years, we have delivered annualized shareholder returns of approximately 30%, significantly outperforming our peers in each and every year. And this performance, combined with the quality and diversity of our income streams, along with the consistency of our earnings and low dividend payout ratio, clearly differentiates us, which is why we believe we should consistently create a lower dividend yield and a substantial premium to our peer group. Focusing now on our 2019 accomplishments, some of the more significant highlights include generating substantial growth in our core earnings, allowing us to increase our dividend three times to an annual rate of $1.20 a share up from $1.08 per share, delivering a total return of 54% in 2019, and 175% cumulative relief for the last five years with an annualized return of approximately 30%. Achieving returns on equity of 14.5%, a 35% increase in the last two years. Reducing record originations to $7.6 billion, a 12% increase from our record 2018 numbers. Increasing our balance sheet portfolio 30% in 2019 to $4.3 billion. Lowering our servicing portfolio to $20 billion, an 8% increase from 2018, and a 48% increase over the last three years. Continuing to be a market leader in the non-recourse securitization arena, closing two new CLOs totaling $1.3 billion with improved terms and flexibility, achieving significant economies of scale with substantially reduced debt costs in all of our borrowing facilities, allowing us to maintain our margins in a very competitive market. raising $450 million of accretive growth capital to fund our growing pipeline and increase core earnings, and increasing our market cap to approximately $2 billion, allowing us to access growth capital more efficiently and effectively. To highlight this incredible success further, I would like to talk about the growth we experienced in our business platforms. In our agency business, we grew our service portfolio 8% in 2019 and 20% over the last two years. This servicing portfolio is now over $20 billion with a servicing fee of 44 basis points and has an average remaining life of nine years, which reflects a 10% increase in duration over the last two years. As a result, we have created a very significant, predictable annuity of income of $88 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, which is currently earning $16 million annually for a combined annual run rate of servicing income and escrow earnings of $104 million, which represents approximately 40% of our total annual revenues. We also produce significant origination volumes, causing $1.3 billion in agency loans in the fourth quarter and $4.8 billion for the year, with a strong margin and a very competitive market. And with our diverse origination platform and strong footprint in the multifamily affordable housing market, we are confident we'll be able to increase our origination volumes in 2020. In addition, as we talked about in our last call, we were active with our new Auburn private label product, which we launched as a result of the disruption in the agencies during the third quarter of last year. We closed $400 million of this product in 2019 and expect to close an additional $200 to $300 million in the next few months and issue our first securitization of around $600 to $700 million in the second quarter of this year. We are pleased with our progress to date and believe this product further diversifies our lending platform and will also act as a mitigant against further potential changes and disruptions with the agencies. 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 30% in 2019, on $2.8 billion in originations. Our balance sheet portfolio is now at $4.3 billion, and the significant growth we experience will continue to increase our run rate of net interest and go forward. It is also significant that multifamily assets, which is the

And we also have a very robust pipeline, which we believe will allow us to meaningfully grow our loan book in 2020 and significantly increase our contracts.

In our single-family rental business, we continue to make progress in developing our platform. We have closed approximately $150 million of SFR product to date, and we are pleased with the opportunities we are seeing to meaningfully grow this business in the future, and our pipeline continues to grow significantly. We believe this business provides enormous opportunities in both the bridge and permanent lending products, and we are confident that we will fill this out to a significant driver of yet another income stream and further diversify our lending plan. We also 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, In the fourth quarter, we closed our 12th non-recourse CLO with $635 million of assets and significantly improved terms, including reduced pricing, increased leverage, and a three-year replenishment feature. We're also very successful in the fourth quarter in exchanging our 5.25% convertible debt with a new three-year convertible debt issuance with fixed rate of 4.75%. This transaction had many significant benefits, including reducing our interest costs, resetting both our conversion price and dividend protection on new bonds and much higher levels of generating up to $30 million of additional capital to fund the growth in our business. Overall, we are extremely pleased with our 2019 results and the tremendous success we continue to have growing our operating platform and greatly enhancing the value of our franchise. Our results have been truly remarkable and have consistently outperformed our peers. We are We have created a strong baseline of diversified predictable core earnings heading into 2020, and we are also very excited about the future growth opportunities across our business lines. It is also important to note that we have made a strategic decision to increase our cash position, which currently is approximately $500 million in cash and liquidity on hand for operations. We believe at this point in the cycle, it is very prudent to buy a sufficient amount of cash available to and will put us in a very offensive position as we transition into a different part of the cycle. And even with these high cash balances, we've been able to consistently grow our earnings and dividends and remain very confident in our ability to continue to grow our dividends in the future. I will now turn the call over to Paul to take you through the financial results.

Okay, thank you, Ivan. As the press release this morning indicated, we had a very strong fourth quarter and full year 2019. As a result, AFFO was 42.1 million or 34 cents per share for the fourth quarter, excluding a one-time loss in the early exchange of our convertible debt securities of 7.3 million and 6.1 million in unrealized gains on hedges related to our private label business. We have excluded the hedging gains related to our private label business from AFFO since these loans have not yet been securitized or sold and the earnings process is not yet complete. We intend to adjust AFFO in the future and for any hedging gains or losses associated with these loans in the quarter in which the loans are sold to properly reflect the true economics of these transactions. We also generated ROEs of approximately 14.5% in 2019, representing a significant increase over the last two years, which continues to demonstrate the earnings power of our Capital Light Agency business, as well as the significant growth in cost efficiencies we're experiencing as we continue to scale our balance sheet business. As Ivan mentioned, we're very pleased with our ability to continue to generate core earnings in excess of our current dividend 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 $37 million of pre-tax income in the fourth quarter on approximately $1.3 billion in originations and $900 million in loan sales. The margin on the fourth quarter sales was 1.55% including miscellaneous fees up from 1.43% all in margin on our third quarter sales. We also recorded $28 million in mortgage servicing rights income related to 1.2 billion of committed loans during the quarter, representing an average MSR rate of around 2.32% compared to 2.02% rate for the third quarter, mostly due to a change in the mix of our fourth quarter loan production. Our servicing portfolio also grew another 8% in 2019 to 20 billion at December 31st, with a weighted average fee of approximately 43.8 basis points and an estimated remaining life of 8.8 years. This portfolio will continue to generate a predictable annuity of income going forward of around $88 million gross annually, which is up approximately $4 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 $4.7 million in prepayment fees in the fourth quarter compared to $5.3 million in the third quarter. In our balance sheet lending operation, we grew our portfolio 30%. to $4.3 billion on $2.8 billion in originations in 2019. The significant growth continues to increase our core earnings run rate, and based on our current pipeline and deep origination network, we remain extremely confident in our ability to continue to grow our balance sheet investment portfolio in the future. Our $4.3 billion investment portfolio had an all-in yield of 6.68 percent at December 31st compared to 7.04 percent at September 30th, mainly due to higher rates on runoff as compared to new originations during the quarter, and from a reduction in LIBOR, which was partially offset by LIBOR flaws in a portion of our portfolio. The average balance in our core investments was relatively flat at approximately $4 billion for both the third and fourth quarters, despite our fourth quarter growth, mainly due to the timing of originations and runoff in the fourth quarter, which tended to be later. And the average yield in these investments was 7.18% for the fourth quarter, compared to 7.31% for the third quarter, mainly due to higher interest rates on runoff as compared to originations and from a reduction in LIBOR, which was partially offset by more acceleration of fees from early runoff in the fourth quarter. Total debt on our core assets was approximately $3.9 billion at December 31st, with an all-in debt cost of approximately 4.35%, compared to a debt cost of 4.65% at September 30th, mainly due to a reduction in LIBOR and from reduced borrowing costs on our new CLO in the fourth quarter. The average balance on our debt facilities was up to approximately $3.76 billion for the fourth quarter, from $3.52 billion for the third quarter, mostly due to senior unsecured notes that we issued in the fourth quarter, and the average cost of funds on our debt facilities decreased to approximately 4.60% for the fourth quarter compared to 4.87% for the third quarter due to a reduction in LIBOR and from lower borrowing costs associated with our new CLO, which was partially offset by $1.4 million of non-cash fees that were accelerated from the early unwind of CLO7 in the fourth quarter. Overall, net interest spreads in our core assets increased to 2.58% this quarter compared to 2.44% last quarter, mainly due to the positive effect of LIBOR floors in a portion of our balance sheet portfolio and from reduced borrowing costs from our recent CLO execution. And our spot net interest spread was down slightly to 2.33% at December 31st from 2.39% at September 30th, mainly due to higher interest rates on runoff as compared to originations, partially offset by the positive effect of LIBOR floors on a portion of our balance sheet portfolio and from reduced borrowing costs in CLO 12. And lastly, the average leverage ratios on our core lending assets, including the trust preferreds and perpetual preferred stock as equity, was up to 83% in the fourth quarter from 80% in the third quarter due to our new unsecured debt issuance and increased leverage on CLO 12, and our overall debt-to-equity ratio on a spot basis was flat at 2.5 to 1 at both December 31st and September 30th. That completes our prepared remarks for this morning. I'll now turn it back to the operator to take any questions.

Carmen? Thank you. And as a reminder, ladies and gentlemen, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, press the pound or hash key. Please stand by while we compile the Q&A roster. And our first question comes from Steve Delaney with J&P Securities. Please go ahead.

Good morning, everyone, and happy Valentine's Day. It's probably not a bad thing for all of us to take one day to think more about love than mortgages. So, Ivan, good to have you with us. Can you share with us what your 2019 rankings were with Fannie and Freddie?

I think we were once again for the 13th year in a row a top 10 Fannie Mae lender. I think our ranking came in at nine. We were the number one small balance lender for Fannie Mae. And for Freddie Mac, I think we were the number three small balance lender for their Freddie Mac small balance program.

That's correct.

Okay, thanks.

And then the new caps, everybody kind of focuses on the $20 billion a quarter, but You could only do $20 billion a quarter if 37.5% of that is affordable. Can you comment on that affordable segment and the size of that and how the profile of your customer base versus maybe some other larger lenders might fit in? the prospects that your market share with the GSEs because of that 37.5% might have a tailwind and might go up in 2020.

Well, we do have one of the largest percentages of being affordable and meeting the housing goals for the FHFA, so we're viewed very favorably, and we don't have to scramble like other lenders do in that part. On the other hand, We don't know what's going to happen in the third and fourth quarter if they're not meeting their 37%, but we're being treated very well.

Okay, thank you. And you commented on the private label that you hope to do a securitization in the second quarter. You're 400 at the end of the year. What is sort of that target size to do a securitization?

Well, our minimum target side was $350 million. That was the minimum target. And because the transaction costs get spread out over the volume, so getting to $700 million is a significant achievement for us above what we projected for reducing our transaction costs and being more efficient.

Great. And that kind of cost kind of ties into my last question on that. Can you give us a sense that the – the execution on that and the leverage, how you think the return on your equity in that private label CMBS might compare with the returns you're seeing today on your structured business.

Well, I can't front run the market when I'm permitted to do that. Understood. But everybody on this call can understand that credit spreads are tight and significant since we saw the origination processes. So we're very optimistic, very efficient execution, and we're being viewed very, very favorably in the market for having a multifamily only securitization. And the risk retention part by maintaining our own BPs is what we're uniquely qualified to do based on our capital structure. We look at it from our investors. So our thing is crossed. We're feeling very optimistic and comfortable. and it could set this platform up to really surge well ahead of most other platforms in the market.

And long-duration cash flows as well. So thank you for all those comments. Thanks, Paul.

Thanks, Steve. Thank you. And as a reminder, ladies and gentlemen, to get in the queue, just press star, then 1. And our next question is from Jade Rahamani with KBW.

Good morning, everyone. This is Ryan Tomasello on for Jade. Thanks for taking the questions. Hey, Ryan. Hey, everyone. Just considering the potential tailwind that Ivan was just talking about, given the affordability component on the GSC side and coupled with the ramping of the SFR business on the structured side, can you give us a sense of what you're targeting for originations in 2020 in both of those businesses, maybe on a nominal or just kind of growth rate basis? Sure.

So let me give you an overall on our outlook on the agency business, and it's kind of consistent with my comments last year. What we decided last year was to give flat guidance to our prior originations, and it's pretty similar to this year. And it's not so much that we can't originate more, but we've chosen to maintain our margins and our credit. So we didn't grow our agency business as big as some of the other lenders did, But that was by choice and design. So our guidance would be maybe slightly higher than what we did last year on the agency side. With respect to the SFR business, we are so excited about the opportunities there. It's an enormous market. We're assembling and have assembled quite a staff. It's taking time and expense. And while it didn't contribute economically to last year and probably a drain, we're expecting a positive contribution. We're closing about $150 million today. That space is divided into three components as we see it. Single-family rental to build, which we feel will be the dominant lender in. We're very active in that. We're creating the product in that space. We have a huge pipeline. Then we have the single-family bridge to securitization of the middle market, which is generally people who are buying anywhere between 25 to 250 units. which we've developed a nice loan. We expect that to grow to somewhere between $20 million a month in originations. We're currently operating about $10 million in originations per month. And most significantly, we're working now to figure out the biggest part of the market, and we're assembling the team to do that as well, where you can originate one or all single-family rental loans, which is 80% of the market. So that business we've invested an enormous amount of time. As a management team, we have great history in building platforms with manufacturing capability. So we're extremely excited about it, and we think that's really where a tremendous amount of the growth of the business will come in the future.

That's very helpful color, Ivan. And I guess just following up on the SFR business, how long do you expect that ramping period to take – just giving, I'm assuming, the hiring that's necessary and just building out the infrastructure. And maybe you can give us a sense or remind us of how the returns might vary across those three different buckets that you laid out and how that compares to kind of the typical traditional agency and structured transitional products you originate today.

Yeah, Jed, I think it's a little premature to have that kind of detailed discussion. But like any entry into a business, the margin is generally bigger. And as you enter a business on a competitive basis, you gain a franchise value. So I think as we go quarter to quarter, we'll talk more about the growth in that business as it's evolving and we're getting a footprint in it. So I think it would be a little premature, but we are pleased with the margins we're getting and our relations with developing and the potential opportunities.

And one last one, Ivan, just regarding the environment for multifamily overall, what are you seeing in terms of fundamentals and underwriting? Are you seeing any signs of deteriorating credit performance across the market? And, you know, what do you really see as the biggest risks for multifamily going into 2020?

So we think that – and that's why we've given, you know, guidance of – just very modest growth, if any, in the agency business, that there's an excess use of IO, that cap rates are very compressed, and there's a very aggressive lending environment. We're seeing an increase in taxes across many, many jurisdictions, and we're using a lot of prudence to underwrite the expense side, as well as understand that traditionally there's a level of amortization in assets that and to use caution when we're underwriting loans. So we've put forth, we've put forward, you know, the appropriate measures to protect our origination side. With respect to the asset management side, we've deepened the first bench. We've added to that and we'll continue, continue forward very aggressively to front run, you know, potential changes in the economic environment. and manage our assets and our borrowers accordingly. So we think we're well ahead of the curve to anticipate any changes in the environment.

Thanks for taking the questions.

Thank you. And our next question comes from Henry Coffey with Wetbush.

Yes, good morning, and thank you for taking my question and letting me become part of the small crew here. I do agree with Steve, though. I thought it was nice to hear his voice. When we look at the data, Fannie, Freddie, and recently the FHA have started tightening a little bit in the summer. The FHA sort of jumped into this on the residential side. When you look at the multifamily business, they're not as tempered by past experience there, but have the GSEs started to tighten up a little bit? I mean, given your own insights into what's going on, I'm sure you're in active dialogue with them, but I was wondering if you could give us some thoughts about that.

My answer is they have not. They have not at the moment. Their underwriting standards continue to, you know, to be consistent with their prior year standards. So we'll wait and see what they do. They've been pretty consistent along the line.

And then I'm equally intrigued with the single-family business. It seems to be more of a private than a public market, which is good for you as a lender. Are you looking at the full spectrum, which is what it sounds like, and can you give us some sense of what the lower end of the market looks like in terms of rates and expected losses and risk factors?

Well, it is a private market, and that's why we're uniquely positioned with our permanent capital, our securitization ability, our originations capability to really enter that market effectively. The key to the biggest part of the market, which is the aggregation of individual borrowers and individual units, is where really I think the margin is and the growth will come from. That's 80% of the single-family-to-rent market. So we're working really hard on the technology side to be able to originate that product effectively. If we're successful, if we can combine that with the other originations we do on the single family rental, we'll have significant volume and scale to effectively access the securitization market on a very consistent basis. So, you know, we are in the beginnings. We do have the background, the capability, the franchise, and the names. And we think this is a real significant year for us to combine all the components that I mentioned earlier and build out those platforms. But we're making significant progress on the single-family to rent market, the single-family build to rent market, which we love. We're developing a very loyal customer base to our originations network on the mid-tier borrowers, and now we want to build out the individual aggregation on the individual units. So we're quite pleased, as I mentioned earlier. I think it's a little early to give any kind of projections, but it's going to begin to make a contribution to the farm's earnings even this year.

Listen, thank you very much, and thank you for taking my question.

Thanks, Henry.

And I'm not showing any further questions in the queue. I will turn the call back to Ivan Kaufman for his final remarks.

Okay. Thank you, everybody, for your participation, and it's been a phenomenal 2019. We're extremely optimistic about 2020, and we're very prepared even for a change in the cycle, as you can see on our balance sheet, and the cash we're accumulating will be able to have a very offensive position. So thank you again, and have a good day. Happy Valentine's Day, everybody.

And with that, ladies and gentlemen, we thank you for participating in today's conference, and you may now disconnect.

Thank you.