Arbor Realty Trust Inc (ABR) 2004 Q4 法說會逐字稿

Good day ladies and gentlemen, and welcome to the Fourth Quarter 2004, Arbor Realty Trust Earnings Conference Call. My name is Christie and I will be your call coordinator for today.

[Operator Instructions]

I will now turn the presentation over to Mr. Herbst for today's call. Mr. Rick Herbst, Chief Financial Officer, please proceed sir.

Thank you very much. Good morning everyone and welcome to the fourth quarter earnings call for Arbor Realty Trust. In this call we will discuss the results for the quarter and the year ended December 31st. This is our third quarter as a public company and joining me today on the call is Ivan Kaufman our Chairman and CEO.

Before we begin, I need to inform you, statements made in this earnings call may be deemed forward-looking statements that are subject to risks and uncertainties including information about possible or assumed future results of our business, our financial conditions, liquidity, results of operations plans and objectives. These statements are based on our beliefs, assumptions and expectations of our future performance, taking into account the information currently available to us that could cause the actual results could defer materially from all these expectations in these forward-looking statements are detailed in our SEC reports.

Just as a caution, not to place under-reliance on these forward-looking statements, which speak only as of today. And Arbor undertakes no obligation to publicly update or revise these forward-looking statements, to reflect events or circumstances after today or the occurrences of unanticipated events.

With that behind us, I'll now turn the call over to our Chairman and CEO, Ivan Kaufman.

Thank you, Rick. And I'd also like to thank all of you who have dialed in to today's call. As the press release we issued this morning indicates our results for the fourth quarter, demonstrate the continued success, we have had in deploying the capital we raised in our IPO back in April.

Our diverse portfolio of assets, excellent financial results and expanded finance and facilities are indicative of the great progress we have made in building a premium, real estate finance investment franchise.

Rick will comment on the financial results for the moment, but first I'd like to spend a few minutes discussing our business in today's market place, including some of our most recent achievements.

As many of you already know, we closed our first CDO transaction, in mid-January. It was a $459 million transaction including the issuance of $305 million of non-recourse investment credit debt. This is a significant milestone for our firm with many ongoing advantages.

First, the CDO lowers our borrowed cost by at least 75 basis points on the CDO debt. It speeds up capacity in our warehouse lines and we are already making progress in improving the terms of our existing warehousing facilities.

The CDO provides longer term financing by giving us the ability to finance assets up up 7 years, significantly mitigating the term risk of our current facilities. It gives us greater flexibility in our product offerings including the ability to originate fix rate loans by entering if the interest rate swaps within CDO.

In an environment with the flattening yield curve, we believe borrowers may see more value in locking in today's rate. The CDO enables us to take advantage of this environment.

The CDO is very well received by investors, significantly raising our profile with the investment community. The CDO includes a broad range of collateral and we plan to optimize this structure going forward as we issue additional CDOs.

Over the last 2 months, we have closed 2 additional debt facilities, totaling a $100 million of which $60 is revolving debts.

One of the facilities is unsecured and the other allows for a broader collateral base than our current warehousing facilities. Within the one year anniversary of our IPO, less than 2 months away, we are aware that raising additional capital is certainly an option.

However, we believe current shareholders are better served this time with our strategy of expanding our financing facilities. These facilities allow us to grow the portfolio without compromising our business objectives. We prefer to have the flexibility, rather than raising capital that needs to be deployed quickly to avoid delusion.

Preserving and enhancing shareholder value continues to be our top priority and we believe optimizing our capital structure is critical to maintaining and increasing that value. We regard common equity as the most precious financial resource and will not issue additional common stock, for the sole purpose of growing the portfolio.

In addition, we believe, we've built a fair amount of work (nb) balance sheet as franchise value. We believe addition of additional equity at this time would be diluted to our current shareholders. We will be very strategic in managing our financial sources and capital base and are constantly evaluating this strategy as circumstances dictate.

We continue to see an abundance of capital in the commercial real estate lending market. Increased capital and historically low interest rate have supported current pricing levels. This market creates a unique opportunity for our firm.

One of Arbor's distinguishing characteristics is that we have expertise investing along the entire range of capital stack of the transaction. Being it first mortgage, mezzanine loans, preferred equity, or direct equity interest.

Because of our comfort level in this broad range of product offerings, the current interest rate and competitive environment generates many opportunities for us, therein excellent risk adjusted reoccurrence.

We are very sensitive to current market, in both our underwriting and asset management. Despite changes in the real estate market in which we do business, our philosophy remain unchanged. We will not make a loan unless we are prepared to own the asset if the need arises.

Our pipeline remains strong and we will add to our pipeline only when transactions are accretive to shareholder value, and meet our overall portfolio objectives. With our CDO now in place, we will place particular emphasis on transactions that are appropriate for this vehicle, either to replenish the existing CDO or to use this collateral for the next one.

Our capital positions, portfolio size and financing facilities are at appropriate levels that when we do need to close transactions that self satisfy our company, we do not need to close transactions that fail to satisfy our credit standards, and investment objectives.

In the fourth quarter we funded approximately a $171 million of new loans and investments. Similar to the volume we achieved last quarter. We believe this level of volume is at the upper end of the range of origination activity, we will see in the next few quarters.

We did see a fair amount of (inaudible) this quarter, total of a $142 million which is more that we've had in recent quarters. About 40 million of this was scheduled maturities, and our remainder was from early retirement.

Our early retirements generally result when the underlined property is sold or successfully add position for permanent financing.

You may recall that in the third quarter, we received $657,000 in distributions from one of the investments in which we have an equity participation interest. This distribution represents excess operating cash flows in property of one of our borrowers.

In the fourth quarter we received distributions of approximately 1 million from the same borrower. The asset is performing quite well, and we anticipate distributions from this asset going forward.

As previously announced, our fourth quarter dividend of $0.47 per share of common stock, will be paid on February 15th 2005, and represents a 9% increase over the last quarter's dividend. The dividend was increased for the second time since the company's public offering, and reflects our strong financial performance in 2004 and the strength of our portfolio.

Rick will discuss the details of the management fee in a moment. But I wish to emphasize that our manager, Arbor Commercial Mortgage, has once again elected to take a 100% of its incentive management fee, over $1.1 million this quarter, in stock. As we stated many times in the past, the manageable lease and the value of the stock that is extremely committed to keep its interest aligned with shareholders.

Now that the incentive management fee has kicked in, it makes sense to start to consider internalizing the management structure. Management has discussed this with the board and will commence this analysis in 2005.

Interest rates continue to fluctuate and we investors are generally sensitive to such movements. Overall, we are confident with our interest rate risk profile. We have stated before, our goal is to generate stable returns regardless of interest rates.

As of December 31st, 90% of the assets, in our loan portfolio were variable rates, liable base loans, and all our warehousing funds continue to be a 100% liable base. You will note, we have added a few fixed rate loans. We anticipate, the vast majority of these will pay-off within one year, and the average coupon rate on these loans is nearly 13%.

Given the current interest rate environment, we believe fixed rate loans may become an increasingly desirable product for our bars. As I mentioned earlier, our CDO gives us the ability to offer fixed rate loans on a match funded basis.

As we witness this quarter, an increase in interest rates actually increases our net interest spread, because a portion of the loans is funded with our own equity.

I will now turn the call over to Rick, to take you through some of the financial results.

Thank you Ivan. As noted in the press release, our earnings for the quarter were $0.52 for common share, both on a basic and fully diluted basis, which is an 11% increase over last year's -- last quarter's fully diluted EPS.

The numbers on the press release, are fairly self explanatory, but I want to highlight a few points that I believe may be of interest. First of all, regarding our share outstanding (ph) to remain warrants.

On our last call we noted that as of October 15th, there are about 373,000 warrants, outstanding. Some of those warrants have since been exercised, as of December 31st. They are now approximately 288,000 warrants that remain outstanding.

So there is really not much dilution left as a result of the warrants issued as part of the 144 offering back in 2003.

In addition, as we mentioned on last call, the Manager exercise its warrants for approximately 630,000 operating partnership units, again back in October. So the Manager's ownership as of December 31st is approximately 18.7% as a result of those warrant transactions.

I just saw in the earnings release early both interest income, interest expense, both increased over 20% from the previous quarter. This is reflected of the combined impact of the increase in the average balances during the quarter, a well as an uptake in interest rates.

More meaningful to us though, is the absolute increase in our net interest spread, which is the difference between the interest income and interest expense. Our net interest spread was up from the previous quarter about $1.9 million or 17%.

So, not only do our average balances grow, but also the yield on our assets increased more than our cost of funds. Much of this is because new ones that originated in the quarter have a higher yield than those who paid off during the quarter.

Operating expenses were up a bit from the previous quarter, reflecting the cost of new hires made as well as certain professional recruiting and marketing expenses incurred during the quarter.

And finally (inaudible) management fees, more that double, last quarters' even though incomes did not increase to that extent. As per the management agreement, we have with the Manger, the incentive comp fees calculated quarterly based on the trailing four quarters.

So at the end of the year, there was a true-up on the prior accruals. When earnings are consistently increasing, as ours fortunately have been, the incentive compensation fee, kind of gets back later than -- as the back of the year. And this is because most recent and most profitable quarter in this case, the fourth quarter, '04, replaces the less profitable quarter from a year ago, the fourth quarter of last year.

So it has a bit of a compounding affect.

On the balance sheet, there was some growth but no significant changes since last quarter. The overall leveraging year end was on September 30th. The average leverage during the quarter was a bit higher in the fourth quarter as compared to the third quarter. As we have discussed, we have added a couple of financing facilities over the last several of months. We have been running a bid under 2:1 leverage ratio, and now we anticipate this could creep up a little bit in the coming quarters.

And with that I will turn it over to the Operator. We will be happy to answer any questions anybody might have.

[Operator Instructions]

Your first question comes from Don Destino from JMP Securities. Please proceed, sir.

Hello Ivan, hello Rick. Nice quarter. First question is there -- doesn't look like any (inaudible) transactions came through in the first quarter, or in the fourth quarter and I don't think we were expectation any progress there. Is that still a major initiative?

Can you hear me?

Checking the roster for (inaudible).

Oh sorry.

Our initiative to be in the market by (inaudible). Is that what your question was?

Exactly.

Yes, I mean, I don't know whether you saw the press release, but we recently hired somebody by the name Heidi Silverberg to be active in the market through service appliance on the (inaudible) acquisition side.

I mean that's clearly a market that we are looking at very closely. To the extent that we can develop good relationships with some of the Wall Street houses, and not participate in a bidding process and customize our acquisitions, you could see that -- you could see a flow of business begin to develop perhaps starting at the end of first quarter of this year and to the second quarter.

So, invariably a business that we think has some potential, we will just try and avoid you know being in a very commoditized aspect of that business. So, we are looking to develop few key relationships and that's the business that we think we can penetrate and develop a nice flow.

Got it. And then, quickly the contractual or the scheduled repayments for the fourth quarter were a little higher than we had expected. Is that a pretty good run rate going forward, that kind of 40 million on about 800 million?

No, that was well ahead of what we expected and that was a result of a couple of items, number one, on some of the common (ph) loans that we had out there, the sales were well ahead of schedule and the closure took place a lot quicker so those payments came back fairly quickly.

The second part was that, the continued debt of the permanent financing market is extremely aggressive. So whatever was eligible to be taken out on a permanent basis was taken out well ahead of schedule.

So we think that you know clearly that was well ahead of what we had anticipated. We think a more appropriate range of run-off on our portfolio on an annual basis is between 15% to 25%.

I would also add to that, that with the addition of our CDO and being able to bill out longer term, we look to have more prepayments provisions with our loans, we put on more fixed rate product that is longer term product, we clearly yield maintenance provisions in it. So, certainly strategically, we like to maintain our loans a lot longer and be more sensitive to that issue.

Right, just a point of clarification. I realize the 140 million was a lot higher than you anticipated. But the part of that that was scheduled repayments was that kind of in the range of what you'd expect on a quarterly basis?

You know, it is certainly what we anticipated this quarter, is 40 million was scheduled, about a 100 million, was unscheduled. It varies based on the portfolio as it is spread out over the next few years. But that's the --

There is --

It is a little higher than what is in the portfolio now.

Got it. That's the question. Perfect. Thank you very much.

Your next question comes from Donald Fandetti of Wachovia Securities. Please proceed sir.

Good morning everyone. Ivan, could you talk a little bit about the deal flow in the quarter from a geographic or property type perspective.

We will just take a quick look at -- yes.

Clearly we have - have a significant sensitivity to increase our concentration in the New York City market, so that we believe you know Manhattan and the general tri-state area, to be the best real estate market in the country. We are constantly looking to expand our capability outside of this geographic range.

And I believe that we have been so much successful in being able to do that. We have a good mix of bridge and mezzanine and some direct equity investments. We had a couple of nice strategic opportunities with people tapping additional equity out of some existing loans, and we are very successful in putting out capital in a very secure way.

Our yield was fairly significant and I think that had a lot to do with you know basically having our hands around a lot over the bars, collateral, lot of appreciation, of performance in that collateral and the bars having to come back to us to have that equity. And basically, us being in the tremendous control position in terms of yield.

But we have been able to be fairly diverse in terms of multi-family office and you know we also continue to be very effective on the (inaudible) conversion side, in putting our money out. So, I think it is good representation of very geographical as well as asset diversification.

OK. And just from a company perspective, how much visibility or time do you have in terms of knowing or getting some sense that you have got some larger prepayments coming. What typically happens operationally to give you that indication?

Well, certainly when there is a loan that is getting ready (inaudible) and touch with the bar, and you know we will usually have a third to 60 day notice, bar will, of course sometime contract that come to us that we have the opportunity to place that financing where we just have a tremendous relationship with them.

So we generally have a 30 to 60 day notice period. On (inaudible) sales, you know, clearly, we generally know what the closings are 60 days ahead of time as the units are sold in they are scheduled to close. So we have good notification on that as well. So, we can do a little bit of a better job, anticipating and communicating what our effective payouts are going to be, probably 60 days ahead of time.

OK. And Rick, if I could ask a question or two, from an accounting perspective, Rick, if you had a million dollars of income from Prime (ph), can you just walk through why part of it was interest income and the other part was equity method accounting income and there'd be cash flow at the property level. Why there is that difference and -- why did it changed from 600,000 last quarter?

We actually have 2 different separate participating interests in property, one of which pertains to the loan which is about a 16 and two thirds percent interest and one of which pertains to the direct equity investment, which is a 7.5% interest. So we probably thought -- in the past we said we have a 24% in a, participating interest, which really broken up into 2 components.

So depending on the nature of the funds that come in, whether it pertains to the loan or the capital is if the capital were to fall and the cash were to fall for excess distribution, we have to account for in accordance with that. So, the part that pertains to the loan, is interest income, the part that pertains to the equity, is the equity from affiliates.

OK, so does that mean that last quarter all of open (ph) interest income why would that number have gone down 667,000 to 500,000 this quarter.

Last quarter, again, this is little bit due to the work load (ph) last quarter, the total distribution was 667, this quarter it was a million. So, we kind of really look at it in total. But there was no distribution on the equity portion last quarter.

And what derives the distribution on the equity portion.

It is again, a waterfall of cash and excess cash flows as they come through the system.

OK. Fair enough. What is your debt service coverage on the portfolio at the end of the quarter versus Q3?

We are actually still getting those numbers in. The LTV is about 79%. We anticipate the debt service coverage to be about a 140 level, maybe a little higher, but we are still waiting on a few year-end numbers but typically a little slower to come in that the quarterly numbers.

OK. Great. Good quarter. Thank you.

Your next question comes from Steve DeLaney of Ryan Beck. Please proceed sir.

Thanks. Good quarter. Looks like leverage at the end of the year was about 2.2 times and I was just curious if you guys have set sort of an absolute max for your core leverage and also within that, now that you have the experience with the first CDO, do you expect to set a separate leverage ratio for assets held within a CDO structure? You see that with some of the REITs.

I will take the first part of that on the 2.2. That does include this MBS facility we have which is highly leveraged. We kind of take that out because that's not our normal business.

Right, I just -- I used to consolidate.

Yes, excludes the value little less that 2:1 which is always been our advertised business model. I think we probably had to take it up a little bit about a 2.5:1. I know contractually within our board, charter banks (ph), the maximum is 4:1, we've never approach that. So we don't have -- I guess to answer your question, the absolute maximum but the business plan is probably going to go at about (inaudible) 2.5:1 or so.

Yes.

On the CDO, we didn't get an additional leverage, the advance rates was similar to what we had in our existing facilities but in future CDOs. We'll probably do a little bit more on the leverage side on this.

Yes, we can increase our leverage on the CDOs, specifically because our borrowed costs are significantly less and we did actually go after a little bit of a different kind of collateral, maybe you will see more bridge loans and home loans which yield a little bit lower, little bit more served long so we may leverage those up to get through an effective yield. And the CDO is a good platform to originate those, which we can borrow, significantly less than we were in the past.

So those were loans, we were in this competitive loan and that would be a lot more competitive, so if you see more home loans originated, you may see, our leverage go up specifically in the CDO.

I would anticipate that you know, perhaps, that the CDO, in terms of I think, the leverage on the less (ph) was around 65% and they go up to may be the mid-70s, where they leverage 8 (ph) more home loans competitively.

OK, and what would you consider an appropriate minimum size to do a second in the CDO trust.

The target is fabout400 million.

In assets.

But that is in total assets. But a lot of that has to do with concentration because you have to have big enough to get your average loans in there. So, you know our average loan is 25 million bucks for the CDO too small it will be too big for the CDO. So, you have to get it to a certain size in order to get our average loans in there, so, to do it too small, and have an average loan of 15 million which is not big enough for us.

OK. And I guess the last point, I think the answer to the first question helps explain this, but in the bottom of page 2, when you talk about your, loan and investment portfolio and the spreads, it obviously excludes the MBS, and the associated REPOs. So, I guess the question there is should we expect the MBS just to kind of run off over the next year as your other assets grow.

Yes, we have no plans to purchase future MBS.

OK.

I should probably ask you just-- when you do your equity ratio, we include the minority interest based on your 2.2, I think you probably did not. The minority interest which is the managers' equity ownership in the REIT is really quasi equity for those kind of calculations.

Great. Good point. I did not include that, so thanks for pointing that out. OK. Thanks a lot gentlemen.

Your next question comes from Jim Larkins of Wasatch. Please proceed sir.

Yes, I wondered if you could just put a little bit color on the statement of when you would raise equity, you thought it would be diluted to shareholders now and does that mean that you want to wait for a better evaluation on the stock, or until you are more fully leverage. Could you just talk about that a little bit more?

Clearly, this is a very sensitive item for you, and particularly for me personally. And You know we have been very successful, number one, in raising about a $100 million of additional facilities over the last 90 (ph) days, which kind of mitigated on me to raise equity immediately. In addition, one of our facilities, in (inaudible) helps us manage our business very effectively.

I think it is part of our philosophy, of generating loans and creating, you know, additional balance sheet assets and value as part of our loans, we feel that we will push this as far as we can before we have to go back to the equity markets and only raise additional equity if we think that additional capital base will create additional opportunities for us beyond what our existing capital base can handle.

So, I don't see raising equity within the next 6 months is material for our business. We have been able to manage the growth of our portfolio and our run off, you know quite effectively, and we are not missing any particular opportunities today. So we have to see where the environment is going to go over the next several months. And in addition, some of our off balance sheet assets create value. We may be able to borrow against those off balance sheet assets or monetize them effectively.

So that's just a path we walk very slowly now.

OK. That's helpful. A question on the CDO, just on the way these are structured. Are you -- are the CDOs done specifically to an asset pool and therefore those assets run off, the CDO gets collapsed or you have substitution rights, where you can fill those back up as assets run off.

Well, that's a great question. Because we have a pretty unique CDO, we absolutely have substitution rights and when an asset does pretty average life of the loan on CDO, I think it is 27 months. We can go out as long as 7 years, as an actively managed CDO.

And when loans do pay off, we will substitute loans and that effect the critical part of the way we did our structure.

OK. Thank you. Good Luck.

OK. Thank you.

[Operator Instructions]

Your next question comes from Joe Jolson from JMP Securities. Please proceed sir.

Hey guys. Another great quarter. Ivan, couple of questions, one is the old contribution assets, what percent are those now of your book of business?

Good question Joe. I know it is not allowed. We contributed about 220 million. I am looking at the list here.

He is going to tell you but I am going to tell you from the top of my head, it is got to be about 10% or less.

So is it fair for us to assume that you have been disciplined in your kind of minimum bogie IRR on the -- you have been able to get that on new investments in the last 6 to 12 months?

Yes, absolutely, I think for this quarter, the portfolio on the whole, it was about 17.5% leveraged return. You know we talked about in our meetings, the minimum being 14% to 15% on occasion with a little bit below that but more often than that we are above that. And as I said, it is around 17%.

Great. Now just on this management contract. I mean at least in most people's experience, when that gets internalized for each (ph), it usually is in a very shareholder friendly deal. You might want to elaborate on when we set the company up, that was already set up. You might want to give some information on that.

Yes, it is relatively straightforward. It is a one time, whatever the last, 12 months of payment were on the management fees, that is a one time payment to the manager of that amount.

So there is no need to have any kind of process authority been pre-agreed to because I think from the beginning you guys have always anticipated rolling this in once the -- you know once it made sense for shareholders right.

Once it becomes cheaper for the REIT then the manger in fact has been subsidized in the REIT, now that the incentive management fees have kicked in, slightly more expensive for the REIT and once it causes the threshold where it becomes cheaper for the REIT to be internal, that's when it will get done.

Joe, certainly you guys did a great job on that item for shareholders but certainly, I am going to work my butt off this year to make sure that that one time payment should be pretty good.

Why don't we do it now, Ivan?

(inaudible) for this too.

Why don't we do it now on the trailing 12 months now?

We are just not ready yet.

OK, congratulations.

This concludes today's Q&A session. Mr. Ivan Kaufman, please proceed to closing remarks.

OK, clearly we are very excited about the development of our franchise here. It has been very exciting for me personally, very rewarding. We are well ahead of schedule, the issuance of our CDO is a tremendous milestone, something talked about for a long time and it has a significant impact on the operation of this company both in reducing our financing cost, legitimizing (ph) our collateral and as well as giving us a competitive edge in the marketplace in terms of flexibility, and the terms in which we are able offer our customers. We continue to build a great borrowing base. Our ability to operate throughout the capital structure in our transactions has given us an unbelievable advantage in the marketplace.

Clearly when there is so much liquidity in one sector, it has created opportunities, in other sectors, which has given us really premium yield, well risk to adjust in return opportunities.

So, I am very excited and pleased with our progress and look forward to talk with all of you in the near future. Thank you.

Thank you for your participation in today's conference. That concludes the presentation. You may now disconnect. Good day!