ARBOR REALTY TRUST INC quarterly report, Q1 FY2012

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Business context and reporting period

Arbor Realty Trust, Inc. filed this unaudited Form 10-Q for the quarter ended March 31, 2012. The externally managed REIT invests primarily in commercial real estate loans and investments, including bridge, mezzanine and junior participation loans, preferred equity, mortgage securities, and certain real estate acquired through foreclosure or settlement.

Financial performance and position

  • Revenue and earnings: Interest income was $19.6 million, up 9% year over year, while net interest income rose 58% to $7.8 million. Total other revenue was $9.1 million, including $9.0 million of property operating income. Net income attributable to Arbor was $4.2 million, or $0.17 per diluted share, versus $0.3 million, or $0.01 per share, in Q1 2011.
  • Profit drivers and charges: Continuing-operations income was $0.5 million, down from $0.7 million. Results included a $5.3 million gain from discounted CDO debt repurchases, a $1.4 million income-tax benefit from an expected prior-year tax refund, and $3.5 million of gains on sales of held-for-sale real estate. Loan-loss provision was $7.8 million, compared with $0.5 million a year earlier.
  • Margins and portfolio: Management reported a 4.62% weighted average current pay rate on loans, investments and securities, and a 3.35% weighted average funding rate including financing costs. The loan and investment portfolio totaled $1.5 billion in unpaid principal, with a 4.58% weighted average pay rate; net loans and investments were $1.30 billion after unearned revenue and a $189.6 million allowance.
  • Cash flow: Operating cash use was $0.4 million, investing cash use was $13.0 million, and financing provided $11.7 million. Cash and cash equivalents fell $1.8 million during the quarter to $53.5 million. Restricted cash was $38.8 million and is substantially tied to CDOs and related commitments.
  • Debt and liquidity: Total liabilities were $1.57 billion and total equity was $180.6 million at quarter-end. Reported debt included $970.7 million of CDOs, $106.4 million of repurchase and credit-facility borrowings, $158.4 million of junior subordinated notes, and $85.5 million of other notes payable. Management said available funding sources were adequate for anticipated needs, but long-term liquidity depends partly on obtaining additional debt or equity financing. The company reported compliance with its financial covenants; all three CDOs also passed their April 2012 coverage tests.
  • Other measures: GAAP book value was $7.40 per share; management’s adjusted book value was $11.55 per share, a non-GAAP measure. FFO was $1.9 million, or $0.08 per diluted share, versus $0.7 million, or $0.03, in Q1 2011.

Material changes versus Q1 2011

  • Net interest income improved due to higher asset yields and lower average borrowing costs; management cited average asset yield of 4.82% versus 4.52% and average borrowing cost of 3.54% versus 4.08%.
  • Property operating income and expenses increased substantially because two real estate portfolios acquired in Q1 2011 contributed a fuller quarter of operations in 2012. Hotel operations are seasonal, with most revenue in the first two calendar quarters.
  • Loan-loss provision increased to $7.8 million. The allowance rose to $189.6 million from $185.4 million at year-end 2011; 23 loans had reserves, compared with 24 at year-end.
  • Held-to-maturity securities increased to $65.0 million from $29.9 million, largely reflecting RMBS purchases. Repurchase-agreement and credit-facility balances increased $30.3 million, principally to finance those investments.
  • All three CDOs had passed their replenishment dates by January 2012, so repayments on collateral flow toward bond principal rather than replenishment. The company repurchased $14.5 million face amount of its CDO notes for $9.2 million, recognizing a $5.3 million gain.

Outlook, commentary, risks and unusual items

  • No specific earnings or revenue guidance was provided. Management said its existing funding sources should meet short- and long-term needs, while noting that future financing availability and terms depend on market conditions and lender and investor decisions.
  • Management described commercial real estate and credit-market recovery as uncertain. Risks include declining collateral values, borrower delinquencies and defaults, higher financing costs or reduced access to financing, interest-rate movements, and possible additional loan losses.
  • Ten loans with approximately $15.3 million of net carrying value were classified as non-performing, against $54.4 million of gross carrying value before related reserves. The filing also reports $5.0 million of interest reserves across 34 loans and three non-performing loans with $38.4 million of unpaid principal.
  • Interest-rate swaps had a $42.2 million fair-value liability; $20.7 million of cash collateral was posted. Management warned that further adverse swap-value movements could require additional collateral and strain liquidity. It estimated that a 0.25% LIBOR increase would increase 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 and return of more than $50 million. The company moved to dismiss and stated it had not accrued a loss because a loss was not considered probable and could not be reasonably estimated.
  • After quarter-end, the company surrendered a held-for-sale property to its first mortgage lender in full satisfaction of the $41.4 million mortgage. It also announced a $0.075-per-share cash dividend on May 4, payable May 29, 2012. A second-quarter purchase of CDO notes was expected to produce a $21.0 million gain, according to the filing.
  • The company is externally managed by ACM, with disclosed management and ownership ties to company leadership. These related-party relationships, including an affiliated property-management arrangement, present potential conflicts of interest. The 2012 base management fee was estimated at approximately $10.0 million; Q1 base fees were $2.5 million.

Important facts for investors to verify

  1. Whether collateral values and borrower performance support the $189.6 million loan-loss allowance, and how non-performing loans and loan extensions evolve.
  2. Liquidity available after accounting for restricted cash, collateral requirements, unfunded commitments of $14.2 million, and CDO runoff; confirm covenant compliance and refinancing plans for near-term maturities.
  3. The durability of net interest income as swap maturities, LIBOR changes, asset floors, and refinancing costs affect asset yields and funding costs.
  4. The realized outcome and potential financial exposure from the Extended Stay litigation, and the terms and governance of related-party management arrangements.
  5. The treatment and timing of post-quarter transactions, including the CDO note purchase gain, property surrender, and declared dividend.