Arbor Realty Trust, Inc. — Q2 2014 Form 10-Q
Reporting period: Three and six months ended June 30, 2014. The unaudited consolidated filing covers a REIT investing mainly in multifamily and commercial real estate loans and investments, with additional real estate operations. Comparisons below are to the corresponding 2013 periods unless stated otherwise.
Financial performance and position
| Metric | Q2 2014 | Six months 2014 |
|---|---|---|
| Interest income | $25.5 million | $50.4 million |
| Net interest income | $14.3 million, up 2% | $28.6 million, up 9% |
| Net income | $13.4 million | $20.8 million |
| Net income attributable to common stockholders | $11.5 million; $0.23 per diluted share | $17.3 million; $0.35 per diluted share |
| FFO, a non-GAAP measure | $13.7 million; $0.27 per diluted share | $21.7 million; $0.43 per diluted share |
| Common dividend declared per share | $0.13 | $0.26 |
Q2 earnings included a $7.9 million gain on the sale of an equity interest. The six-month results also included a $0.7 million net recovery of loan-loss reserves; the comparable 2013 period included a $3.8 million debt-extinguishment gain. Results are therefore affected by nonrecurring items.
- Revenue and costs: Q2 property operating income was $9.0 million; other expenses totaled $18.0 million. For the six months, property operating income was $18.3 million and other expenses were $35.0 million. Management attributed stronger net interest income mainly to improved yields on new originations, partly offset by higher borrowing costs.
- Portfolio and credit: Loans and investments, net, were $1.50 billion at June 30, versus $1.52 billion at year-end. The gross portfolio unpaid principal balance was $1.63 billion; allowance for loan losses was $115.1 million, down $7.2 million from year-end. Fourteen loans had recorded impairment reserves; two loans with net carrying value of about $6.3 million were classified as non-performing.
- Cash flow: Six-month operating cash flow was $13.5 million, investing cash flow was positive $62.4 million, and financing cash flow was negative $88.5 million. Cash and cash equivalents declined $12.6 million to $47.8 million. Restricted cash rose to $156.8 million, much of it held within consolidated financing vehicles and not freely available for general use.
- Balance sheet and debt: Total assets were $1.90 billion, total liabilities $1.43 billion, and total equity $476.6 million at June 30. Major debt balances included $433.3 million of CDOs, $545.8 million of CLOs, $159.6 million of junior subordinated notes, $58.6 million of senior unsecured notes, and $53.5 million of mortgage debt on real estate owned. Credit facilities and repurchase agreements were $22.2 million, down from $159.1 million at year-end. These amounts include consolidated, non-recourse VIE obligations.
- Portfolio activity: In Q2, Arbor originated 21 loans totaling $170.3 million and received full repayment of 25 loans totaling $239.9 million. At June 30, the portfolio’s weighted-average current pay rate was 5.25%; including certain fees and costs, the rate was 5.93%.
Material changes versus the prior period
- Six-month common-stockholder income increased 80% to $17.3 million, with the $7.9 million equity-sale gain contributing to the increase. Q2 common-stockholder income rose to $11.5 million from $3.0 million.
- Net interest income rose 9% for the first half as the weighted-average yield on core interest-earning assets increased to 6.23% from 5.55%. The average cost of interest-bearing liabilities also increased, to 3.71% from 3.26%.
- Loan-loss expense was a net recovery of $0.7 million for the first half, compared with a $3.3 million provision in 2013. The allowance declined, reflecting charge-offs and recoveries partly offset by new provisions.
- Arbor closed its third CLO in April, issuing $281.3 million of notes; total CLO debt reached $545.8 million. It also issued $58.6 million of 7.375% senior unsecured notes due 2021, and raised $21.6 million through Series C preferred stock and $6.5 million through its ATM common-stock program.
- CDO balances fell by $206.3 million as runoff proceeds repaid bondholders. The sale of RMBS investments reduced available-for-sale securities to $2.8 million from $37.3 million at year-end.
Outlook, risks, contingencies, and unusual items
- Outlook: The filing gives no specific earnings or portfolio-growth guidance. Management said it believed existing funding sources would meet short- and long-term liquidity needs, while noting that long-term requirements depend on continued access to debt and equity financing.
- Subsequent event: In July 2014, refinancing of the 450 West 33rd Street property terminated Arbor’s guarantee and triggered recognition of a previously deferred gain and prepaid incentive fee, producing an estimated net GAAP gain of $58.1 million. Management said this would significantly increase Q3 GAAP book value. This gain was not included in June 30 results.
- Credit and property risks: Seven loans totaling about $113.6 million, secured by a land-development project, matured in September 2014; Arbor had suspended accrual-interest recognition on the impaired loans and recorded cumulative reserves of $45.0 million. Development risks include financing availability, construction costs, demand, and litigation. The filing also cites real estate values, borrower credit, interest rates, and capital-market access as material risks.
- Liquidity and financing: Approximately $245.0 million of debt obligations were scheduled to mature in 2014, including CDO/CLO and mortgage obligations; the mortgage note’s maturity was extended in July 2014. Restricted CDO runoff cash is unavailable for general liquidity. A breach of CDO/CLO coverage tests could divert residual cash flows to debt repayment. All reported debt and CDO/CLO tests were compliant at June 30 and the latest July determination dates.
- Legal and related-party matters: An Extended Stay-related amended complaint seeks $139.0 million in aggregate from certain director designees and affiliates. Arbor disputed the claims, intended to defend them, and recorded no loss accrual because it did not consider a loss probable or reasonably estimable. Arbor is externally managed by ACM, with disclosed management and ownership conflicts and related-party lending and transactions.
- Other unusual items: A multifamily property was reclassified from held-for-sale to real estate owned after a proposed sale failed. The company reported no material changes to risk factors from its 2013 Form 10-K and stated disclosure controls were effective.
Important facts for investors to verify
- How much of reported earnings and book-value movement reflects one-time gains, especially the $7.9 million Q2 equity-sale gain and the $58.1 million post-quarter gain.
- Repayment, refinancing, collateral values, and reserve adequacy for impaired loans, particularly the land-development exposure and September 2014 maturities.
- Availability of unrestricted liquidity after accounting for restricted cash, debt maturities, funding commitments, and potential derivative collateral calls.
- Portfolio yields relative to rising funding costs, and the effect of loan payoffs, originations, and CDO runoff on recurring net interest income.
- CDO/CLO covenant headroom and the consequences of any future test failure, alongside the company’s reliance on capital markets and non-recourse financing.
- Potential outcomes of the Extended Stay litigation and the risks and governance implications of ACM’s management relationship and other related-party transactions.