Arbor Realty Trust, Inc. — Q2 2017 Form 10-Q
Business context and reporting period. Unaudited results for the quarter and six months ended June 30, 2017. Arbor operates a Structured Business investing in commercial real estate loans and related assets, and an Agency Business originating, selling and servicing multifamily loans through Fannie Mae, Freddie Mac and HUD programs. Comparisons with 2016 are not fully like-for-like: the Agency platform was acquired in July 2016. Arbor internalized its management team on May 31, 2017.
Key financial metrics
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net interest income | $14.1 million | $17.3 million | $28.1 million | $30.3 million |
| Total other revenue | $44.7 million | $4.6 million | $91.1 million | $10.1 million |
| Net income | $18.3 million | $12.1 million | $42.3 million | $15.2 million |
| Net income attributable to common stockholders | $11.9 million | $10.2 million | $27.5 million | $11.4 million |
| Diluted EPS | $0.21 | $0.20 | $0.50 | $0.22 |
| Common dividends declared per share | $0.18 | $0.15 | $0.35 | $0.30 |
- Agency Business Q2 loan sales were $1.20 billion, with a 1.56% sales margin; MSR income was $17.3 million. Its servicing portfolio totaled $15.02 billion at quarter-end, with a 47.4-basis-point weighted average servicing fee.
- The Structured Business portfolio had $1.89 billion unpaid principal balance and a 6.05% weighted average current pay rate at June 30. For the first half, its average core asset yield was 6.49%, while average financing cost was 4.56%.
- Cash and cash equivalents were $80.8 million; restricted cash was $187.2 million. Total assets were $2.94 billion, total liabilities $2.10 billion and total equity $838.0 million.
- Debt carrying values included $505.8 million of credit facilities and repurchase agreements, $1.00 billion of CLOs, $94.9 million of senior unsecured notes, $94.8 million of convertible notes, $139.2 million of junior subordinated notes and $50.0 million of related-party financing. The filing reports $904.6 million available under debt facilities at June 30.
- For the six months, operating cash flow was $307.9 million, investing cash outflow $126.5 million and financing cash outflow $239.3 million. Operating cash flow included $280.5 million of net inflows from Agency loan sales exceeding originations; it should not be read as recurring earnings cash generation.
Material changes versus the prior comparable period
- Q2 net interest income declined 19%, and first-half net interest income declined 7%. Management attributed the pressure to increased debt balances and funding costs; acquired Agency operations also affect reported comparisons.
- Agency originations and servicing revenues contributed materially in 2017 but were absent from the corresponding 2016 periods. In the first half, Agency originations were $2.31 billion and loan sales were $2.57 billion.
- Common-stockholder net income rose 17% in Q2 and 142% for the first half, but the first-half comparison includes a $7.1 million debt-extinguishment gain in 2017 and $11.6 million of real-estate sale gains in 2016.
- Credit facilities and repurchase agreements fell $400.8 million from year-end, mainly as Agency loan sales reduced warehouse financing. CLO debt increased $276.4 million following the April closing of CLO VII, which issued $279.0 million of notes.
- In May, Arbor issued 9.5 million common shares for net proceeds of $76.2 million and paid $25.0 million to internalize management. Common shares outstanding rose to 61.35 million from 51.40 million at year-end.
Outlook, risks, contingencies and unusual items
- Outlook: No specific earnings or operating guidance is provided. Management said existing funding sources should meet short- and long-term liquidity needs, while noting long-term capital requirements depend on access to debt and equity financing. Management did not anticipate a significant near-term impact from interest-rate increases but cautioned that future rate moves and economic conditions could affect results.
- Market and funding risks: Results are exposed to commercial real estate values, borrower credit quality, interest rates, financing availability and cost, competition, and possible changes to GSE programs or origination limits. GSE loan sales and servicing are significant Agency revenue drivers.
- Credit and property risks: Five loans with a net carrying value of $34.6 million were non-performing at June 30. Six impaired land-development loans had $120.7 million carrying value, $49.1 million of cumulative reserves and September 2017 maturities; interest accrual on most of these loans has been suspended. The owned hotel incurred a further $2.7 million impairment in the first half, and the office building became vacant in April.
- Guarantees and commitments: Fannie Mae DUS loss-sharing allowance was $32.8 million; maximum quantifiable DUS guarantee exposure was $2.18 billion, which the company says is not representative of expected loss. Arbor also had $73.8 million of unfunded loan commitments and expected to fund an additional $26.5 million of DUS restricted liquidity over 48 months, assuming no portfolio changes.
- Debt and liquidity: $444.2 million of debt obligations mature in the remainder of 2017. A $150 million Agency credit facility was extended only to August 2017, with renewal negotiations ongoing at filing; a separate $75 million temporary commitment increase was due to expire in August. CLO covenant breaches could redirect cash to bond repayment and suspend residual payments, although all CLO tests were in compliance at the latest July 2017 determination dates.
- Legal and related-party matters: Arbor affiliates are defendants in litigation connected with the Extended Stay bankruptcy, seeking approximately $139 million in aggregate from multiple defendants. The company recorded no accrual, stating a loss was not considered probable and could not be reasonably estimated. The filing also discloses multiple loans and transactions involving executives, directors, affiliates and the former manager.
- Other items: A 100-basis-point increase in MSR discount rates was estimated to reduce MSR fair value by approximately $8.9 million; a decrease would increase it by approximately $9.4 million. The company reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Investor facts to verify
- Whether Agency loan sale volumes, sales margins and MSR valuations remain resilient, and how much reported profit depends on noncash MSR income.
- Renewal status and terms of near-term maturing or temporarily extended credit facilities, particularly the $150 million facility due in August 2017.
- Performance, collateral values and resolution plans for non-performing and impaired loans, especially the land-development exposures maturing in September 2017.
- Actual DUS loss-sharing requirements and additional restricted-cash needs relative to the stated maximum guarantee exposure.
- Cash generation after separating Agency loan-sale timing and restricted cash movements from recurring operating performance.
- Developments in the Extended Stay litigation and the company’s related-party lending, servicing and governance arrangements.