ARBOR REALTY TRUST INC quarterly report, Q1 FY2018

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Business context and reporting period

Arbor Realty Trust, Inc. is a REIT with two businesses: Structured, which invests mainly in multifamily and commercial real estate loans and other assets; and Agency, which originates, sells and services multifamily loans through government-sponsored and other programs. This unaudited Form 10-Q covers the quarter ended March 31, 2018; comparisons are to Q1 2017 unless otherwise noted.

Financial and operating performance

  • Earnings: Net income was $37.1 million, up 55%; net income attributable to common stockholders was $26.2 million, up 68%. Basic and diluted EPS were $0.42 versus $0.30. Q1 2018 included an $8.8 million income tax benefit, while Q1 2017 had a $6.1 million tax provision; the 2018 benefit primarily reflected the January payoff of $50 million in related-party financing. The prior-year quarter also included a $7.1 million debt-extinguishment gain.
  • Revenue and interest: Net interest income rose 29% to $18.2 million. Other revenue increased 15% to $53.2 million; combined net interest income and other revenue was $71.4 million versus $60.4 million. Interest expense rose 72% to $33.4 million, reflecting greater average debt and higher funding costs, including accelerated financing-cost write-offs.
  • Cash flow: Operating cash flow was $20.8 million versus $72.6 million. Investing used $159.0 million, largely for structured loan originations and borrower holdbacks/reserves; financing provided $128.6 million. Cash, cash equivalents and restricted cash totaled $234.2 million at quarter-end, down from $243.8 million at year-end 2017.
  • Assets and liquidity: Total assets were $3.75 billion, up from $3.63 billion at December 31, 2017. Cash and cash equivalents were $102.5 million; restricted cash was $131.7 million. The filing reports $1.17 billion of available capacity across listed debt facilities, subject to facility terms and collateral. Management said existing funding sources and access to additional liquidity were expected to meet needs.
  • Debt and equity: Debt obligations had a carrying value of approximately $2.68 billion, compared with $2.53 billion at year-end. The company issued $100 million of 5.625% senior notes due 2023 and used the proceeds to redeem 7.375% notes due 2021; it also repaid $50 million of related-party financing. Total equity was $887.9 million. The company reported compliance with financial and CLO covenants.
  • Portfolio and distributions: Structured loans and investments had $2.78 billion of unpaid principal balance, with a 6.57% weighted-average current pay rate. Structured originations were $314.2 million; Agency originations and loan sales were $1.05 billion and $1.06 billion, respectively. The Agency servicing portfolio grew to $16.69 billion. The declared common dividend was $0.21 per share for Q1; after quarter-end, the board declared $0.25 per share.
  • Supplemental measures: Diluted FFO per share was $0.42 versus $0.32, while diluted AFFO per share fell to $0.25 from $0.33. AFFO is a non-GAAP measure and the company cautions it is not a measure of operating cash flow or liquidity.

Material changes versus the prior comparable period

  • Net interest income increased as average Structured core interest-earning assets grew 49% and yields rose; funding expense also increased substantially as average interest-bearing liabilities and funding costs rose.
  • Agency loan sales declined to $1.06 billion from $1.36 billion, but the sales margin improved to 1.71% from 1.40%. Net servicing revenue increased to $9.5 million from $4.8 million, supported by growth in the servicing portfolio.
  • Employee compensation and benefits rose 49% to $29.5 million, partly reflecting headcount, commissions, stock compensation and costs previously included in the external management fee. The ACM management agreement had been terminated in May 2017.
  • Net income growth was partly influenced by the tax benefit; AFFO per share declined despite higher GAAP EPS and FFO per share.

Outlook, risks and unusual items

  • Outlook: No formal earnings guidance is provided. Management said it did not anticipate a significant decline in originations or profitability from rate increases to date, but noted uncertainty around further Federal Reserve moves and broader economic conditions. The board’s post-quarter dividend increase was described as 39% above a year earlier and 19% above the prior quarter.
  • Market and funding risks: Performance depends on access to capital and financing, interest rates, real estate values, borrower credit quality and investment deployment. The company highlighted possible effects of higher rates, slower rent growth, weaker property values, and reduced capital-market access.
  • GSE exposure: FHFA set 2018 multifamily origination caps of $35 billion each for Fannie Mae and Freddie Mac, below 2017 caps. Reduced GSE production could affect the profitable Agency origination, sale and servicing business.
  • Credit and concentration: Five borrowers accounted for 23% of total assets. Eight loans identified as higher risk had $126.9 million carrying value before reserves. Six land-development loans with $120.4 million carrying value mature in September 2018; $49.4 million of reserves relates to these loans, whose repayment depends on project and financing conditions. Two loans with aggregate net carrying value of $29.1 million were classified as non-performing.
  • Commitments and contingencies: Unfunded structured-loan commitments were $66.9 million. Fannie Mae DUS guarantees had a maximum quantifiable liability of $2.29 billion, which the filing says is not representative of expected loss; additional restricted liquidity funding of $28.4 million was projected over 48 months, assuming no portfolio changes.
  • Litigation and related parties: The company described ongoing Extended Stay-related litigation seeking approximately $139 million in aggregate from multiple defendants, including affiliates; it recorded no loss accrual because a loss was not considered probable and could not be reasonably estimated. The filing also discloses loans involving executives and affiliates, including a $9.4 million loan originated in April 2018 to a borrower entity 75% owned by certain officers, including the CEO.
  • Interest-rate sensitivity: A 25-basis-point LIBOR increase was estimated to raise annual net interest income by $1.0 million; a 25-basis-point decrease was estimated to reduce it by $0.8 million. A 100-basis-point increase in MSR discount rates was estimated to reduce MSR fair value by $9.6 million.

Important facts for investors to verify

  1. How much of reported earnings growth is sustainable apart from the $8.8 million tax benefit, and why AFFO per share declined.
  2. Performance, collateral values and repayment or refinancing plans for the land-development loans maturing in September 2018 and other higher-risk/non-performing loans.
  3. Actual funding availability, upcoming maturities, borrowing costs and headroom under credit-facility and CLO covenants.
  4. Future GSE origination limits and the effect of lower Agency sales volumes on gains, MSR creation and servicing income.
  5. Developments in the Extended Stay litigation, DUS loss-sharing exposure, and governance and credit protections for related-party loans.
  6. Whether operating cash generation and liquidity can support loan growth, required collateral, debt service and distributions, including the increased common dividend.