ABR

Arbor Realty Trust Inc. - 10-Q Summary (Period Ended Sept 30, 2010)

Business Context and Reporting Period

Arbor Realty Trust, Inc. (Arbor) is a Maryland corporation organized as a Real Estate Investment Trust (REIT) that invests in a diversified portfolio of multi-family and commercial real estate-related assets, primarily bridge loans, mezzanine loans, and preferred equity. The company is externally managed by Arbor Commercial Mortgage, LLC (ACM). This report covers the quarterly period ended September 30, 2010, and the nine months ended September 30, 2010, compared to the same periods in 2009.

Key Financial Metrics

Material Changes vs. Prior Period

• Net Income Volatility: The nine-month period ended Sept 30, 2010, reported a net income of $154.1 million, a significant turnaround from a net loss of $96.9 million in the same period in 2009. This is primarily driven by a $229.3 million gain on extinguishment of debt, largely due to a discounted payoff of Wachovia debt ($156.6 million net gain) and repurchases of CDO notes. The three-month period ended Sept 30, 2010, reported a net loss of $1.4 million, compared to a loss of $44.1 million in the prior year quarter.
• Debt Reduction: Total debt decreased significantly. Notes payable dropped from $375.2 million at Dec 31, 2009, to $82.5 million at Sept 30, 2010, following the Wachovia settlement. Junior subordinated notes decreased from $259.5 million to $157.7 million.
• Loan Loss Provisions: Provision for loan losses (net of recoveries) decreased to $61.2 million for the nine months ended Sept 30, 2010, compared to $141.5 million in the prior year period. However, the company recorded $11.3 million in provisions for the third quarter of 2010.
• Portfolio Composition: The loan and investment portfolio balance decreased to $1.50 billion (net) from $1.70 billion at year-end 2009. The weighted average pay rate on the portfolio decreased to 4.57% from 4.93%.
• Real Estate Owned: Real estate owned increased to $23.1 million from $8.2 million, primarily due to a deed-in-lieu of foreclosure transaction in the second quarter. One property was reclassified to held-for-sale in the third quarter.

Guidance, Outlook, and Risks

• Management Commentary: Management highlighted the successful retirement of Wachovia debt as a unique opportunity that significantly impacted 2010 results but is not expected to recur. The company continues to focus on capital preservation, asset restructuring, and repurchasing debt at discounts when feasible.
• Incentive Fee: The $156.6 million gain on the Wachovia transaction exceeds the approximate $39.0 million hurdle for the 2010 incentive fee calculation. However, no installment was payable as of Sept 30, 2010, and the final fee amount depends on full-year results.
• Liquidity: Cash and cash equivalents decreased to $26.3 million from $64.6 million at year-end 2009, primarily due to the Wachovia payoff and collateral postings for swaps. The company maintains a minimum quarterly liquidity covenant of $7.5 million.
• Risks:
  • Market Conditions: Continued volatility in credit and real estate markets may impact asset values and financing availability.
  • CDO Covenants: The company's three CDO vehicles are in compliance with overcollateralization and interest coverage covenants. A breach would divert cash flows to repay bondholders, limiting residual payments to the company.
  • Interest Rate Risk: A 0.25% increase in LIBOR would increase annual net income by approximately $0.8 million, while a decrease would reduce it by the same amount, due to interest rate floors and swap hedges.
  • Concentration: Five unrelated borrowers represented approximately 34% of total assets as of Sept 30, 2010.

Key Facts for Investor Verification

• Debt Extinguishment Gains: Verify the sustainability of earnings given that the $154 million net income for the nine-month period is heavily reliant on one-time gains from debt restructuring ($229 million total gain on extinguishment).
• Loan Loss Reserves: Monitor the $287.8 million allowance for loan losses covering 32 impaired loans with a carrying value of $622.7 million. Assess the adequacy of reserves given the economic environment.
• CDO Compliance: Confirm ongoing compliance with CDO overcollateralization and interest coverage tests, as a breach would severely impact cash flow availability.
• Liquidity Position: Review the $26.3 million cash balance against the $7.5 million minimum liquidity covenant and upcoming debt maturities, including the $26 million term facility (repaid in Oct 2010) and CDO amortization requirements.
• Related Party Transactions: Note the significant relationship with manager ACM, including the purchase of CDO notes from ACM and the potential for a substantial 2010 incentive fee payment.