ARBOR REALTY TRUST INC annual report, FY2016

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Arbor Realty Trust, Inc. — FY 2016 Form 10-K

Reporting period: Year ended December 31, 2016. Results include the acquired Agency Business only from July 14, 2016; comparisons with 2015 are therefore not fully like-for-like.

Business context

Arbor is a REIT with two platforms: a Structured Business investing in commercial real estate loans and related assets, and an Agency Business that originates, sells and services multifamily loans through Fannie Mae, Freddie Mac and HUD programs. The July 2016 acquisition of its manager’s agency platform expanded the company into national agency lending and servicing.

Financial and operating performance

  • Profit: 2016 net income was $62.5 million; net income attributable to common stockholders was $42.8 million, or $0.83 per diluted share, down from $45.9 million, or $0.90, in 2015. FFO was $56.9 million ($0.92 per diluted share), compared with $43.9 million ($0.86) in 2015. AFFO was $49.0 million ($0.79 per diluted share), down from $58.3 million ($1.14).
  • Interest income and spread: Net interest income declined 15% to $55.1 million. Structured Business average core asset yield fell to 6.38% from 6.67%, while average funding cost rose to 4.37% from 4.25%; management cited a higher average debt balance and higher LIBOR-related costs.
  • Agency operations: From the acquisition date, agency originations were $2.15 billion and sales were $1.49 billion, excluding $418.2 million of acquired-loan sales. Sales margin was 165 basis points. The servicing portfolio reached $13.56 billion, generating $9.1 million of net servicing revenue. MSR income was $44.9 million.
  • Portfolio: Structured loans and investments totaled $1.79 billion unpaid principal across 144 investments, with a 5.71% weighted average current pay rate and 16.3 months’ average remaining maturity. Multifamily represented 79% of UPB. The portfolio’s weighted-average internal risk rating was 3.0.
  • Credit quality: The loan-loss allowance was $83.7 million, down from $86.8 million. Eight impaired loans had $187.4 million carrying value before reserves. Three fully reserved loans totaling $22.9 million were non-performing. Six land-development loans totaling $121.1 million were impaired; the company suspended accrued interest recognition on these loans.
  • Cash flow: Operating cash flow was negative $197.6 million, mainly reflecting agency loans originated but not yet sold; $673.4 million of loans held for sale were expected to be sold in Q1 2017. Investing cash flow was negative $201.9 million and financing cash flow was positive $349.5 million. Cash and equivalents ended the year at $138.6 million, down $50.1 million.
  • Balance sheet and leverage: Total assets were $2.97 billion, total equity $747.0 million and reported total debt $2.02 billion. Debt increased from $1.17 billion in 2015, substantially reflecting the acquisition and agency warehouse financing. Restricted cash was $29.3 million. Debt facilities had $868.9 million of stated availability at year-end, subject to facility terms and conditions.
  • Dividends: Common dividends declared totaled $0.62 per share for 2016. In March 2017, the board declared a $0.17 quarterly common dividend, up from $0.15 in the comparable prior-year quarter.

Material changes and unusual items

  • The agency-platform acquisition had a stated purchase price of $275.8 million; the fair value of consideration was approximately $292.5 million. Consideration included $87.8 million cash, 21.23 million OP Units and $50.0 million seller financing. The acquired business contributed $85.6 million of revenue and $41.8 million of pretax income after acquisition.
  • Assets rose from $1.83 billion to $2.97 billion, while loans held for sale, mortgage servicing rights, goodwill and other intangibles were newly reported. Acquisition costs were $10.3 million in 2016.
  • 2016 included an $11.2 million impairment on a hotel property, partly offset by $11.6 million of gains on real estate sales. A 2015 gain from acceleration of deferred income ($19.2 million) and a $4.6 million swap-termination loss did not recur.
  • A change in the estimated amortization period for acquired MSRs reduced 2016 net income by approximately $3.4 million, or $0.07 per diluted share. Management estimated a further $1.4 million reduction to Q1 2017 net income from this estimate change, before the effect of new MSRs.
  • Cash interest-rate sensitivity analysis estimated that a 25-basis-point increase in rates would raise annual net interest income by about $1.0 million; the filing cautions that actual results may differ. A 100-basis-point increase in the MSR discount rate would reduce MSR fair value by about $7.9 million.

Outlook, risks and contingencies

Management said it believed existing funding sources were adequate for short- and long-term needs, while noting continued reliance on debt and equity markets. It described commercial real estate markets as improving, but identified stabilizing multifamily rent growth, economic and political uncertainty, interest-rate changes, refinancing conditions and access to financing as risks. The 2017 GSE multifamily origination caps were $36.5 billion each for Fannie Mae and Freddie Mac; future policy or GSE changes could affect agency origination and servicing revenue. No earnings or revenue guidance was provided.

Agency risks include Fannie Mae DUS loss-sharing, loan-advance obligations, collateral and liquidity requirements, and the possibility of losing GSE or HUD approvals. At year-end, $38.1 million of DUS collateral was required, including a $25.0 million letter of credit; the company expected to fund a further $22.5 million of restricted liquidity over four years, assuming no portfolio changes. The recorded loss-sharing allowance was $32.4 million; the disclosed maximum quantifiable guarantee liability was $2.04 billion, not an estimate of expected loss.

Other risks include leveraged financing and covenant constraints, concentrated real estate credit exposure, and conflicts of interest with the external manager. A related Extended Stay litigation remained unresolved; the company recorded no loss accrual, stating a loss was not considered probable and could not be reasonably estimated. The company reported compliance with debt covenants and agency liquidity requirements at year-end. Auditors issued unqualified opinions on the financial statements and internal controls, and management concluded controls were effective.

Important facts for investors to verify

  • Assess recurring earnings and cash generation separately from acquisition effects, non-cash MSR income and amortization, property-sale gains, impairment charges and equity-affiliate income.
  • Review the timing and sources for refinancing 2017 maturities, including warehouse facilities and CLO obligations, and distinguish stated facility availability from unrestricted liquidity.
  • Monitor Fannie Mae DUS delinquencies, loss-sharing exposure, required collateral funding and the adequacy of the $32.4 million allowance.
  • Evaluate MSR valuation assumptions and the impact of prepayments, discount rates and the revised amortization estimate on reported earnings and servicing revenue.
  • Track loan extensions, impaired land-development loans, non-performing assets, and geographic and borrower concentrations.
  • Consider dilution and governance implications of the OP Units issued to the manager, related-party arrangements, and the option to internalize management by July 2018.