Arbor Realty Trust, Inc. — Q3 2018 Form 10-Q
Business and period: The company is a REIT operating a Structured Business that invests in commercial and multifamily real estate loans and a GSE/HUD-focused Agency Business that originates, sells and services multifamily mortgages. This unaudited filing covers the quarter and nine months ended September 30, 2018; comparisons are with 2017 unless noted. Amounts below are in U.S. dollars.
Financial performance and position
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Interest income | $67.5 million | $42.1 million | $178.4 million | $110.1 million |
| Net interest income | $28.0 million | $18.3 million | $67.6 million | $46.4 million |
| Total other revenue | $55.6 million | $48.0 million | $155.7 million | $139.1 million |
| Net income | $37.4 million | $24.0 million | $99.1 million | $66.2 million |
| Net income attributable to common stockholders | $27.7 million | $16.4 million | $71.1 million | $44.0 million |
| Diluted EPS | $0.36 | $0.26 | $1.03 | $0.77 |
| Dividends declared per common share | $0.25 | $0.18 | $0.71 | $0.53 |
- Structured Business portfolio reached $3.17 billion, up from $2.65 billion at December 31, 2017. Its weighted-average current pay rate was 6.88%, versus 6.28%; reported weighted-average funding cost, including financing costs, was 5.03%, versus 4.83%.
- For Q3, Structured Business average interest-earning asset yield was 6.99% and average funding cost was 4.93%; a directly comparable consolidated net interest margin is not stated.
- Agency servicing portfolio grew to $17.79 billion from $16.21 billion at year-end 2017. Q3 loan originations were $1.41 billion and sales were $1.19 billion.
- At September 30, total assets were $4.53 billion, total liabilities $3.57 billion and total equity $966.5 million. Credit facilities and repurchase agreements were $1.17 billion; CLOs $1.59 billion; and convertible notes, net, $263.7 million.
- Cash and cash equivalents were $92.6 million and restricted cash $202.7 million. Including restricted cash, cash, cash equivalents and restricted cash totaled $295.3 million. Reported unused commitments under debt facilities were $1.03 billion, subject to facility terms and restrictions.
- Nine-month operating cash flow was negative $195.5 million, investing cash flow negative $550.2 million and financing cash flow positive $797.3 million. The company attributed much of the operating outflow to Agency loan originations exceeding loan sales.
Material changes and notable items
- Q3 net income attributable to common stockholders rose 69% year over year; nine-month earnings rose 62%. Growth reflected higher net interest income and servicing-related revenue alongside a larger loan and servicing portfolio.
- Interest expense increased 66% in Q3 and 74% for the nine-month period, as average debt balances and borrowing costs rose. Nine-month gain on loan sales fell 7% to $51.3 million, while servicing revenue, net, increased 74% to $34.7 million.
- Q3 results included a $10.2 million litigation settlement gain, a $5.0 million loss on extinguishment of debt related to convertible-note exchanges, a $2.2 million impairment of an equity-affiliate investment, and a $4.4 million net loss from changes in derivative fair values. These items affect interpretation of recurring earnings.
- The company issued $264.5 million of 5.25% convertible notes and exchanged substantially all of two older convertible-note issues for cash and 6.8 million common shares. It also issued $125 million of 5.625% senior notes and completed CLO X while unwinding CLO V.
- Common shares outstanding increased to 75.7 million from 61.7 million at year-end 2017, including shares issued in a public offering and debt exchange. The board subsequently declared a $0.27-per-share quarterly dividend, an 8% increase from the prior quarter and 42% above the prior-year comparable quarter.
Outlook, risks and contingencies
- No quantified earnings or origination guidance is provided. Management said it did not anticipate a significant decline in originations or profitability from interest-rate increases to date, but noted that future rate moves and macroeconomic conditions could affect commercial real estate markets.
- Management cited continued reliance on capital markets and financing access, GSE/FHFA origination limits, competition, borrower credit quality, collateral values, loan runoff and the cost of funding as key uncertainties. It noted that rental-rate growth showed signs of stabilizing and that a market downturn could increase delinquencies, modifications and credit losses.
- Credit exposure includes eight higher-risk loans and investments with a pre-reserve carrying value of $128.7 million and weighted-average last-dollar LTV of 92%. Six land-development loans totaling $121.4 million were extended to September 2019; they carry substantial existing reserves and face construction-financing, cost, demand and litigation risks. The loan-loss allowance was $61.0 million.
- Fannie Mae DUS loss-sharing allowance was $33.4 million. Maximum quantifiable exposure under DUS guarantees was $2.38 billion, which the filing says is not a measure of expected loss. The company reported compliance with applicable debt and CLO covenants at quarter-end.
- Unfunded structured-loan commitments were $68.6 million. Additional Fannie Mae restricted liquidity of $29.7 million is expected to be funded over 48 months, assuming no relevant paydowns, prepayments or defaults.
- The filing describes unresolved Extended Stay-related litigation; the company has not accrued a loss because it does not consider a loss probable or reasonably estimable. It also reports related-party lending and investments involving executives and affiliates, including the $280.5 million Lexford loan package, and limited “bad boy” guarantees on other Lexford debt.
- Interest-rate sensitivity analysis estimates a $0.7 million increase in annual net interest income for a 25-basis-point LIBOR increase and a $0.3 million decrease for a 25-basis-point decrease. A 100-basis-point increase in MSR discount rates would reduce estimated MSR fair value by about $10.2 million.
Important facts for investors to verify
- Whether reported earnings growth is sustainable after separating the litigation settlement, derivative valuation changes, debt-exchange loss and equity-affiliate impairment.
- How portfolio growth, rising funding costs and near-term facility maturities affect net interest income, liquidity and refinancing needs. The maturity schedule contains an apparent “$972.0 billion” figure for 2020; verify the intended amount against the original filing.
- Credit performance and recovery prospects for the land-development loans, other higher-risk exposures, DUS loss-sharing obligations and concentrated borrower/property exposures.
- The effect of GSE caps or policy changes on Agency originations, loan-sale margins, servicing income and MSR valuations.
- Potential dilution from common-stock issuance, OP Units and convertible notes, and the capacity to sustain the higher common dividend while meeting REIT distribution requirements.
- Terms, governance and credit protections for related-party transactions and the status and potential exposure of the disclosed litigation and guarantees.