ARBOR REALTY TRUST INC quarterly report, Q2 FY2012

Arbor Realty Trust, Inc. — Q2 2012 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2012; unaudited. Arbor is an externally managed REIT focused on commercial real estate loans and investments, with additional income from owned multifamily and hotel properties. Comparisons below are with the corresponding 2011 periods unless noted.

Financial performance and position

Metric	Q2 2012	Six months 2012
Interest income	$19.5 million	$39.1 million
Interest expense	$9.8 million	$21.5 million
Net interest income	$9.7 million	$17.6 million
Net income attributable to Arbor	$15.5 million; $0.62 diluted EPS	$19.7 million; $0.79 diluted EPS
Operating cash flow	Not provided separately for the quarter	$7.2 million

• Q2 total revenue, calculated as interest income plus other revenue, was about $28.2 million; six-month total was about $56.8 million. The filing does not present a conventional operating-margin measure.
• Six-month investing cash flow was $33.8 million and financing cash flow was negative $31.9 million. Cash and cash equivalents ended June at $64.3 million, up from $55.2 million at year-end 2011. Restricted cash was another $77.7 million and is largely committed to CDO and other purposes.
• Total assets were $1.69 billion, total liabilities $1.48 billion, and total equity $212.4 million. Major debt balances included $910.2 million of CDOs, $158.5 million of junior subordinated notes, $127.3 million of repurchase agreements and credit facilities, $53.5 million of notes payable, and $53.8 million of mortgage debt on owned real estate.
• Loans and investments, net, were $1.225 billion. The underlying portfolio had $1.427 billion of unpaid principal, with a $188.3 million loan-loss allowance. The allowance covered 20 impaired loans with $271.7 million of carrying value before reserves.

Material changes versus prior periods

• Q2 net income attributable to Arbor improved from a $10.4 million loss in 2011 to $15.5 million income; six-month results improved from a $10.1 million loss to $19.7 million income.
• Net interest income rose to $9.7 million in Q2 from $2.8 million and to $17.6 million for six months from $7.7 million. Management attributed the improvement to higher asset yields and lower borrowing costs, including the maturity of interest-rate swaps.
• Results included $21.0 million of Q2 and $26.3 million of six-month gains from buying the company’s CDO notes at discounts. These gains were a major contributor to reported profitability, rather than recurring net interest earnings.
• Six-month loan-loss provisions, net of recoveries, increased to $15.7 million from $8.1 million. Net charge-offs were $12.1 million, versus $37.7 million in 2011; the allowance nevertheless increased to $188.3 million from $185.4 million at year-end.
• Loans and investments, net, fell $77.7 million from year-end. CDO debt declined $92.4 million, while repurchase agreements and credit facilities rose $51.2 million. The company sold two held-for-sale properties for a combined $3.5 million gain and surrendered another property in satisfaction of $41.4 million of mortgage debt.
• Arbor issued 3.5 million common shares in June for net proceeds of approximately $17.5 million. Shares outstanding increased to 27.75 million from 24.30 million at year-end.

Outlook, risks and unusual items

• Management said existing funding sources should meet short- and long-term liquidity needs, while noting longer-term requirements depend on access to additional debt and equity financing. No earnings or revenue guidance was provided.
• All three CDOs passed their overcollateralization and interest-coverage tests at the July 2012 determination date. A breach could divert CDO cash flows from Arbor to bondholders, reducing funds available for corporate expenses and distributions. All three CDOs had passed as of June 30 as well.
• All debt covenant requirements were reported as met at June 30. However, repurchase and credit facilities include covenants, collateral requirements, and maturities concentrated in 2012–2013; the filing lists only $5.7 million of unused capacity on those facilities at quarter-end.
• Credit and concentration risks remain material: five unrelated borrowers represented about 29% of total assets, and higher-risk loans had $269.9 million of carrying value before reserves and a 93% weighted-average last-dollar LTV. Management cited uncertain commercial real estate and financing markets, borrower repayment risk, collateral-value declines, and possible additional loan losses.
• Arbor held $20.8 million of cash collateral against interest-rate swaps. Further adverse fair-value movements could require additional collateral; failure to provide it could lead to early termination and greater interest-rate exposure. A 0.25% LIBOR increase was estimated to reduce annual net income and cash flows by about $0.1 million, assuming balances remained unchanged.
• The Extended Stay Litigation Trust lawsuits name company affiliates and seek, among other relief, at least $2.1 billion in damages plus punitive damages and return of more than $50 million. Arbor is defending the claims, has moved to dismiss, and recorded no loss accrual because management said a loss was not probable and could not be reasonably estimated.
• Related-party and governance considerations include ACM’s external management role, common executives and ownership links, and a $10 million management-agreement termination fee. The company recorded $5.0 million of base management fees in the first half; no incentive fee was earned.
• The company declared a $0.10-per-share Q2 dividend after paying $0.075 per share for Q1. The Q2 dividend was declared after quarter-end and was payable August 28, 2012. REIT status generally requires distribution of at least 90% of taxable income.

Important facts for investors to verify

• How much of reported earnings is sustainable without the $26.3 million six-month CDO debt-extinguishment gain, and how loan-loss provisions and recoveries may develop.
• Current status and collateral values for impaired, non-performing, and higher-risk loans; verify the adequacy of the $188.3 million allowance.
• Liquidity available after accounting for restricted cash, collateral-posting needs, unfunded commitments of $13.9 million, and near-term facility maturities and covenants.
• Progress and potential financial exposure from the Extended Stay litigation, and any subsequent developments disclosed after the filing.
• Effects of the June equity issuance on per-share results and the company’s ability to fund dividends and future investments.