Arbor Realty Trust, Inc. — Q2 2011 Form 10-Q
Business context and reporting period. Arbor is an externally managed REIT focused on commercial real estate loans and investments, including bridge, mezzanine and participation loans, preferred equity, and real estate owned. This unaudited filing covers the quarter and six months ended June 30, 2011; comparisons are with the corresponding 2010 periods unless noted.
Financial performance and position
| Metric | Q2 2011 | Six months 2011 |
|---|---|---|
| Interest income | $18.6 million | $36.6 million |
| Interest expense | $15.8 million | $28.8 million |
| Net interest income | $2.8 million | $7.7 million |
| Net loss attributable to Arbor | $10.4 million; $0.41 per share | $10.1 million; $0.40 per share |
| Cash from operating activities | Six months: cash used of $10.7 million | |
| Cash and cash equivalents | $42.4 million at June 30, 2011, down from $101.1 million at year-end 2010 |
- Q2 property operating income was $8.3 million, largely reflecting newly acquired multifamily and hotel properties; related operating expense was $7.2 million. For the six months, those amounts were $13.7 million and $11.0 million.
- Total assets were $1.764 billion and total liabilities were $1.557 billion at June 30. Total equity was $207.1 million.
- Restricted cash was $65.6 million, primarily held for CDO requirements and loan commitments; it is not equivalent to unrestricted liquidity.
- Debt included $1.038 billion of CDO obligations, $158.0 million of junior subordinated notes, $85.5 million of notes payable, and $115.9 million of mortgage notes payable. The company reported $5.4 million of available capacity under its CDO facilities.
- For the six months, investing activities used $3.8 million and financing activities used $44.3 million; cash decreased by $58.7 million. No common dividend was declared for Q2.
Changes versus prior comparable periods
- Q2 net interest income fell 71% to $2.8 million; six-month net interest income fell 51% to $7.7 million. Management attributed the declines principally to a smaller average loan and investment portfolio, lower asset yields, lower LIBOR, suspended interest on non-performing loans, and reduced rates on modified loans.
- Interest income declined 28% in Q2 and 27% for the six-month period. Interest expense also declined, but by less—2% and 16%, respectively.
- Arbor reported a net loss in 2011 versus substantial net income in 2010. The prior-year periods included a $158.4 million gain from a discounted Wachovia debt payoff, other debt-extinguishment gains, and securities-sale results. These unusual 2010 gains are not indicative of recurring operating performance.
- Loan-loss provision, net of recoveries, was $7.6 million in Q2 and $8.1 million for the six months, versus $24.8 million and $49.8 million in 2010. The allowance for loan losses declined to $171.2 million from $205.5 million at year-end, reflecting charge-offs, reserve recoveries, and loans transferred to real estate owned.
- Real estate owned rose to $151.9 million from $22.8 million, primarily after the first-quarter acquisition of multifamily assets through bankruptcy proceedings and transfer of a hotel portfolio from a creditor trust. Loan and investment balances, before reserves, declined to $1.514 billion from $1.634 billion at year-end.
Outlook, risks, contingencies, and unusual items
- Outlook: No numerical earnings or dividend guidance was provided. Management said existing funding sources were expected to meet short- and long-term liquidity needs, while noting that long-term requirements depend on obtaining additional debt or equity financing. Management expected financing conditions and commercial real estate recovery to remain uncertain.
- Credit and real estate risk: The allowance covered 26 impaired loans with approximately $318.9 million of carrying value before reserves. Ten loans were classified as non-performing in the filing. Management cited collateral values, borrower performance, refinancing availability, and further loan modifications or delinquencies as key risks.
- CDOs and liquidity: All three CDOs passed their overcollateralization and interest-coverage tests at the latest July 2011 determination date. A future breach could divert CDO cash flows to bondholders and restrict residual payments to Arbor; management cautioned it might not have enough liquidity to cure a breach. CDO II’s replenishment period ended in April 2011, and CDO III’s was scheduled to end in January 2012.
- Post-quarter financing: In July 2011, Arbor entered into a two-year, $50 million warehouse facility for multifamily first mortgages, priced at 275 basis points over LIBOR. It includes a $20 million minimum liquidity covenant and other financial and collateral restrictions.
- Legal contingency: Three Extended Stay-related lawsuits filed in June 2011 name company affiliates among numerous defendants. The complaints seek at least $2.1 billion plus punitive damages on a joint-and-several basis and return of more than $50 million allegedly received by preferred-unit holders. Arbor said it intended to vigorously defend the actions; the filing does not provide a clear estimate of Arbor’s potential loss.
- Other notable items: A real estate-owned property impairment of $0.8 million was recorded in Q2. Arbor also recognized $1.9 million of Q2 gain from repurchasing its CDO notes at a discount. An authorized repurchase plan covers up to 1.5 million shares through December 15, 2011; 34,850 shares had been repurchased by June 30.
- Governance and related parties: ACM manages Arbor and has significant ownership and management ties to Arbor’s leadership. The filing describes loans involving property or prior financing connected to ACM, including a $6.2 million loan that Arbor’s independent directors required to be sold within 90 days and that ACM guaranteed pending sale.
Investor verification priorities
- Review the loan-level credit disclosures, non-performing balances, reserve assumptions, charge-offs, and collateral valuations—particularly given the remaining $171.2 million allowance and real estate exposure.
- Reconcile unrestricted cash, restricted cash, upcoming debt maturities, unfunded commitments, and the July warehouse facility’s covenants and availability.
- Assess recurring earnings separately from prior-year debt-extinguishment gains, current-year CDO repurchase gains, and property operating results.
- Track CDO covenant headroom, collateral quality, replenishment-period changes, and the risk that cash flows could be diverted.
- Monitor developments in the Extended Stay litigation, the related-party loan required to be sold, and ACM’s management and ownership conflicts.