Arbor Realty Trust, Inc. — 2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019. The filing was signed February 14, 2020. Amounts are in U.S. dollars; financial statement amounts are generally in millions unless stated otherwise.
Business context
Arbor is a REIT operating through two businesses: Structured, which invests principally in commercial real estate loans and related assets, and Agency, which originates, sells and services multifamily loans through Fannie Mae, Freddie Mac, HUD and other channels. Arbor retains servicing rights on substantially all agency loans sold. It launched a Private Label loan program in the second half of 2019 and began originating single-family rental loans.
Financial performance and position
| Metric | 2019 | 2018 |
|---|---|---|
| Interest income | $315.9 million | $251.8 million |
| Interest expense | $186.4 million | $153.8 million |
| Net interest income | $129.5 million | $98.0 million |
| Total other revenue | $219.8 million | $233.1 million |
| Net income | $155.2 million | $148.1 million |
| Net income attributable to common stockholders | $121.1 million | $108.3 million |
| Diluted EPS | $1.27 | $1.50 |
| Diluted FFO per share | $1.29 | $1.53 |
| Diluted AFFO per share | $1.36 | $1.26* |
Structured Business portfolio yield averaged 7.04% against average borrowing costs of 4.99%, compared with 6.97% and 5.20%, respectively, in 2018. At year-end, the Structured portfolio’s weighted-average pay rate was 5.98%, down from 7.02%; 88% of its loans were floating-rate. Agency loan originations totaled $4.81 billion and sales $4.40 billion; the sales margin was 1.49%, up from 1.42%.
Total assets were $6.24 billion, including $4.19 billion of loans and investments net and $286.4 million of mortgage servicing rights. Total debt was $4.62 billion, versus $3.31 billion a year earlier; total equity was $1.36 billion. Cash and cash equivalents were $299.7 million, with a further $210.9 million restricted. The company reported $2.12 billion of available capacity under listed debt facilities, subject to facility terms and conditions.
Operating cash flow was negative $226.5 million, investing cash flow negative $994.7 million, and financing cash flow positive $1.39 billion. Operating cash use mainly reflected Agency loan originations exceeding sales, including $401.2 million of Private Label loans not yet sold or securitized at year-end. These cash-flow measures should not be treated as earnings or distributable cash.
Material changes versus 2018
- Net interest income increased 32%, supported by a 24% increase in average core interest-earning assets and a higher average yield.
- Common-stockholder net income rose 12%, but diluted EPS fell from $1.50 to $1.27 as the diluted weighted-average share count increased to 116.2 million from 93.6 million.
- Total other revenue decreased 6%. Loan-sale gains and MSR income declined, while net servicing revenue increased 18% as the servicing portfolio grew 8% to $20.06 billion.
- The Structured portfolio grew 30% to $4.28 billion; originations were $2.80 billion and payoffs/paydowns were $1.75 billion.
- Agency originations declined to $4.81 billion from $5.12 billion, and loan sales declined to $4.40 billion from $4.92 billion. Private Label originations contributed $401.2 million of 2019 volume.
- Arbor raised $713.5 million of capital, completed two CLOs totaling $1.29 billion of assets and cash, unwound two older CLOs with $529.3 million of notes, and increased credit-facility and repurchase capacity by about $1.0 billion.
- The quarterly common dividend increased during 2019 from $0.27 to $0.30 per share. Common dividends declared for the year totaled $1.14 per share.
Outlook, risks and unusual items
- Management described commercial real estate markets as strong, while noting uncertainty and signs that multifamily rent growth was stabilizing. It said it did not then anticipate a significant decline in origination volume or profitability at prevailing low interest rates, but cautioned that market and rate developments could change the outcome. No quantitative earnings or portfolio-growth guidance is provided.
- FHFA set combined Fannie Mae and Freddie Mac multifamily origination caps of $200 billion through the end of 2020. Tighter limits or changes to the GSEs could reduce loan-sale gains, MSR additions and servicing revenue.
- Arbor’s Fannie Mae DUS portfolio carries risk-sharing obligations. At year-end, the allowance for loss-sharing was $34.6 million and collateral requirements were met with a $45.0 million letter of credit and $1.9 million cash. The letter-of-credit facility was due to expire in September 2020; renewal or replacement risk is material to liquidity and program compliance.
- CECL adoption was expected January 1, 2020. Management estimated an initial allowance increase of $27 million to $37 million, recorded through accumulated deficit.
- Interest-rate exposure includes LIBOR-linked assets and liabilities and the uncertain transition from LIBOR. Arbor’s sensitivity analysis estimated that a 25-basis-point LIBOR increase would reduce annual net interest income by $5.1 million, while a 25-basis-point decrease would increase it by $5.9 million, based on year-end positions and stated assumptions.
- Six land-development loans had a $120.3 million carrying value and a $61.4 million allowance; they were extended to March 2020, with further extension expected. Arbor also had $163.8 million of unfunded commitments. The filing cites development, financing, cost, demand and litigation risks for the project.
- The Extended Stay-related litigation seeks approximately $139 million in aggregate from multiple defendants, including affiliates. Arbor recorded no loss accrual, stating a loss was not considered probable and could not be reasonably estimated.
- Related-party exposure merits attention: ACM held approximately 15% of Arbor’s voting interest at year-end, and executives have overlapping roles and interests. Arbor disclosed related-party lending and a $30 million commitment to a fund sponsored and managed by its CEO and a family member.
- Other principal risks include leverage and refinancing, collateral calls and covenant compliance, commercial-property credit deterioration, GSE/HUD approval requirements, servicing advances and repurchase claims, REIT qualification, and competition. The company reported compliance with debt covenants at December 31, 2019 and no off-balance-sheet arrangements.
- Reported 2019 results included a $7.4 million loss on extinguishment of debt and $10.6 million of income from equity affiliates. In 2018, results included an $8.4 million net loan-loss provision and a $10.2 million litigation-settlement gain.
Reporting note: The filing’s selected-data table reports 2018 AFFO of $113.1 million, while the detailed AFFO reconciliation reports $118.1 million and $1.26 per diluted share after a definition update. The selected-data table gives $1.21 per diluted share. The 2019 AFFO figure is $158.0 million, or $1.36 per diluted share. Investors should reconcile these presentations and the effect of the revised definition.
Most important facts for investors to verify
- Whether Agency warehouse facilities and the DUS letter-of-credit facility were renewed or replaced on acceptable terms, and how 2020 maturities were addressed.
- Private Label loan securitization timing, execution, retained B Piece exposure and cash conversion of the $401.2 million year-end balance.
- CECL’s actual adoption-date allowance and subsequent credit-loss trends, including performance and extensions of the land-development loans.
- Credit quality, delinquencies and loss-sharing needs: Agency servicing delinquencies were 0.30% of portfolio UPB, versus 0.19% in 2018; the Structured portfolio allowance was $71.1 million.
- Debt growth, refinancing capacity, collateral and covenant headroom, and the sensitivity of net interest income and servicing-rights valuations to rates and prepayments.
- Resolution and financial consequences of the Extended Stay litigation, and governance, approval and economic terms of related-party transactions.
- Whether distributions remain supported by recurring earnings and liquidity; REIT distribution requirements do not assure future dividend levels.
Ernst & Young issued an unqualified opinion on the consolidated financial statements and internal control over financial reporting; management also concluded disclosure controls were effective at year-end.