Arbor Realty Trust, Inc. — Q3 2019 Form 10-Q
Reporting period: Unaudited quarter and nine months ended September 30, 2019; comparisons are with the corresponding 2018 periods unless noted. Arbor operates a Structured Business investing in real-estate loans and related assets, and an Agency Business originating, selling and servicing multifamily loans.
Financial performance and position
- Third quarter: Net interest income was $32.4 million, up 16%; net income was $43.2 million, up 15%; and net income attributable to common stockholders was $34.0 million, up 22%. Diluted EPS was $0.35 versus $0.36, reflecting substantially higher weighted-average shares. Common dividends declared were $0.29 per share.
- Nine months: Net interest income was $95.7 million, up 42%; net income was $110.6 million, up 12%; and net income attributable to common stockholders was $85.5 million, up 20%. Diluted EPS was $0.93 versus $1.03. Dividends declared totaled $0.84 per common share.
- Revenue drivers: Q3 gain on loan sales and fee-based services rose 22% to $21.3 million, and mortgage servicing rights income rose 19% to $29.9 million. Nine-month total other revenue increased 1% to $157.5 million. Other income was negative $4.7 million in Q3, partly reflecting derivative fair-value changes.
- Portfolio and operating yields: Structured loans and investments were $3.97 billion at quarter-end, up from $3.28 billion at year-end 2018. The portfolio’s weighted-average current pay rate was 6.33%, down from 7.02%. For Q3, the Structured Business’s weighted-average yield on core interest-earning assets was 7.31% versus 7.37% a year earlier, while financing cost was 4.87% versus 4.93%.
- Assets, debt and equity: Total assets were $5.40 billion, up from $4.61 billion at December 31, 2018. Total liabilities were $4.20 billion and total equity was $1.20 billion. Debt obligations were approximately $3.94 billion; the filing reports $2.22 billion of available commitments across listed debt facilities. Cash and cash equivalents were $135.3 million and restricted cash was $190.0 million.
- Cash flow, nine months: Operating activities provided $57.2 million, compared with $195.5 million used in 2018; investing activities used $682.5 million; and financing activities provided $610.0 million. Cash, cash equivalents and restricted cash ended at $325.3 million, down $15.3 million from the start of the period.
Material changes versus comparable periods
- Q3 interest income increased 19% to $80.5 million, while interest expense increased 22% to $48.1 million. Management attributed the growth primarily to larger Structured Business assets and related funding.
- Q3 other expenses increased 41% to $48.9 million, including higher employee compensation and benefits. The prior-year quarter included a $10.2 million litigation settlement gain and a $5.0 million debt-extinguishment loss; neither item recurred in Q3 2019.
- For the nine months, common-stockholder income increased 20%, but diluted EPS declined because weighted-average diluted shares rose to 113.0 million from 91.1 million. The prior-year period also included a $10.2 million litigation settlement gain and a $14.5 million deferred tax benefit, compared with a $1.0 million deferred tax benefit in 2019.
- The Agency servicing portfolio grew to $20.0 billion from $18.6 billion at year-end 2018. The Structured portfolio grew as originations exceeded payoffs and paydowns.
- The company issued $90 million of 5.75% senior notes and completed CLO XI, issuing $533 million of investment-grade notes to third parties; it also unwound CLO VI, repaying $250.3 million of notes. A May common-stock offering generated $115.6 million net proceeds, partly used to repurchase shares from the CEO and ACM.
Outlook, risks and unusual items
- No formal earnings or operating guidance is provided. Management said it did not anticipate a significant decline in origination volume or profitability while interest rates remained relatively low, but cautioned that market and policy conditions could change.
- Management cited access to capital and financing, interest-rate movements, borrower credit quality, collateral values, loan pipeline and competition as key uncertainties. FHFA’s revised 2019/2020 multifamily origination caps allow $100 billion for each of Fannie Mae and Freddie Mac; future restrictions could affect profitable Agency originations.
- The company recorded no loan-loss provision in the first nine months of 2019; the allowance for loan losses remained $71.1 million. Eight loans were identified as higher risk, with $128.2 million carrying value before reserves. Six land-development loans with $120.9 million net carrying value were extended from September 2019 to March 2020 and remain exposed to development, financing, demand and litigation risks.
- Fannie Mae DUS loss-sharing allowance was $35.5 million. The stated maximum quantifiable guarantee liability was $2.69 billion, conditional on extreme defaults and collateral loss; this is not management’s estimate of likely loss. The company expected to fund a further $36.0 million of restricted liquidity over four years, assuming no portfolio changes.
- Unfunded loan and investment commitments were $192.8 million. CLO covenant breaches could divert cash flows away from the company; all CLO tests were reported in compliance at September 30 and the most recent October determination dates. Management also reported compliance with financial covenants and Agency liquidity and net-worth requirements.
- A long-running Extended Stay-related lawsuit seeks approximately $139 million in aggregate from multiple defendants, including affiliates. The company made no loss accrual, stating a loss was not considered probable and could not be reasonably estimated.
- Related-party exposures warrant attention: the CEO and family members sponsor and manage AMAC III, in which Arbor committed $30 million and had funded $9 million. The filing also describes loans involving entities with officer or family-member interests, ACM affiliations, and related-party transactions.
- Management expects adoption of the new expected-credit-loss standard in 2020 to increase provisions for potential credit losses, including on Structured loans, held-to-maturity securities and DUS loss-sharing obligations.
- After quarter-end, Arbor issued $110 million of 4.75% notes, sold 2.975 million shares through its at-the-market program for $38.6 million net proceeds, and declared a $0.30 common dividend per share.
Important facts for investors to verify
- Whether portfolio growth and higher net interest income can be sustained as asset pay rates and funding costs change; review the sensitivity to LIBOR and loan floors.
- Credit performance and collateral coverage, particularly the land-development loans, higher-risk loans, delinquent Agency servicing loans and the adequacy of the $71.1 million loan-loss allowance.
- Liquidity after restricted-cash needs, unfunded commitments, debt maturities and the additional DUS collateral requirement; distinguish unrestricted cash from restricted cash and facility availability.
- The effect of share issuance, OP Units and convertible notes on dilution and per-share earnings, and the company’s capacity to maintain distributions.
- Potential costs or developments in the Extended Stay litigation, related-party arrangements and DUS loss-sharing exposure.
- Execution and profitability of the new Private Label loan program, including its planned securitizations, and the effect of GSE production caps on Agency business.