Arbor Realty Trust Inc (ABR) 2005 Q3 法說會逐字稿

Good day ladies and gentlemen and welcome to the third quarter 2005 Arbor Realty Trust Earnings Conference call. My name is Colby and I will be your coordinator for today.

(Operator Instructions)

I would now like to turn the presentation over to your host for today's call Mr. Paul Elenio, Chief Financial Officer. Please proceed sir.

Thank you Colby. Good morning everyone and welcome to the quarterly earnings calls for Arbor Realty Trust. This morning we will discuss the results for the quarter and 9 months ended September 30th 2005. with me on the call today is Ivan Kaufman, our President and Chief Executive Officer.

Before we begin I need to inform you that statements made in this earnings call may begin (ph) forward looking statement that are subject to risks and uncertainties including information about possible or assumed future results of our business and our financial condition, liquidity, results of operation, claims and objectives. These statements are based on beliefs, assumptions and expectations of future performance, taking into account the information currently available to us.

Factors that could actual results to differ materially from Arbor's expectations in these forward-looking statements are detailed in our SEC reports.

Listeners are cautioned not to place undue reliance in these forward-looking statements, which speak only as of today. 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 Arbor's President and CEO, Ivan Kaufman.

Thank you Paul and thanks to all of you who are joining us on today's call. We are pleased with the operating results for the third quarter, which we believe demonstrate our ability to deliver positive earns momentum in the short come. And even more importantly we have successfully implemented several strategies with the goal of increasing the long-term value of our company and franchise.

Paul will review the financial results in a moment but first I'll comment on some of the strategies we are employing and how we are faring in today's marketplace. We continue to se an abundance of capital in the commercial real estate lending market, which has increased the competitive landscape. Despite the increased competition we achieve record originations during the quarter and our pipeline remains strong.

Our success is attributable to several factors. First, a large number of our transactions continue to be with repeat borrowers. In addition, we've a diverse originations network with the ability to originate highly structured transactions, which differentiate us from any of our competitors. With the growth of the company and the changes in the market and our funding sources we have elected to diversify our portfolio into a longer term fixed rate product.

In addition we continue to originate transactions at a position lower in the capital structure that is with lower risk. although these transactions result in tighter spreads, our goal is to preserve similar margins on our investments to increase (inaudible) and to reduce borrowing costs with our current and future financing sources where available. While these decisions may put some pressure on short-term earnings, we believe this strategy serves us far better over the long run.

The fixed rate product, which we generally hedge in our CEO, allows us to lock in spreads for a longer period of time. Although spreads earned fixed rate product may not be as wide on those earned on variable rate products. Fixed rate loans are attractive to us because they generally include prepayment protection.

While we are comfortable with the level of prepayments we have experienced, the fixed rate product offers greater stability going forward, particularly in a rising rate environment. As of September 30th, 20% of our portfolio was fixed rate product.

In certain situations we believe we are uniquely positioned to take advantage of the aggressive capital markets. That is, we are comfortable providing debt and certain transactions and investing equity in others and in some cases we are comfortable with providing both debt and equity. While we are on the equity side of transactions, we seek to take advantage of the aggressive capital markets by optimizing the debt structure often by using outside debt providers. These equity investments effectively act as a hedge in the event of debt markets in which we do most of our business becomes overly competitive. Although we did not receive any distributions that contributed to earnings from our equity participation interest this quarter. We did receive a $1.3 million distribution from one of our equity interests, which was deferred for accounting purposes because we participated in the refinance.

In addition, we are still benefiting from the $30 million distribution -- $36 million distribution we received in the second quarter and remain steadfast in their overall contribution to our business model.

Overall we believe monetizing these equity interests, which are well within our control, we have longer-term benefits that will more than offset any short-term negative impact on earnings.

Our pipeline remains strong and our origination network remains active. In fact, this quarter we achieved the highest origination volume in our history, closing approximately $303 million of new loans and investments of which 300 million was funded. Although 77 million of the loan volume was hold over from the second quarter this is still impressive volume given the increasingly competitive market.

We have clearly demonstrated our ability to generate substantial new volume at attractive and risk adjusted returns.

As you know, we have recently announced a quarterly dividend of 65 cents per share common stock. A 40% increase over last quarter's dividend and our fifth consecutive dividend increase. The funds we received from the prime distribution in the second quarter support the payment of dividends in excess of the quarter's earnings.

Management and our board of directors with to emphasize that we recognize the importance of a stable and growing dividend to our investors. We have made great progress in proving our capital structure to future enhance long term shareholder value. We continue to believe that common equity is our most value financial resource and will not issue additional common stock for the sole purpose of growing a portfolio.

During the quarter we started to realize the financial benefit of the pool trust preferred securities we issued in the second quarter as well as the utilization of the funds received from the prime distribution. These securities were issued at historically low spreads and we have used these funds to support new loan originations. Deployment of these funds contribute to a $2.4 million increase in our core net interest margin over last quarter.

On our last call we mentioned a new CBO. (inaudible) initiatives are actively underway, however because we are in a quiet period with respect to the CBO we are unable to provide details at this time. I wish to emphasize that our manager, Arbor Commercial Mortgage, LLC, has elected to once again take 100% of its incentive fee in stock. Although we've stated many times in the past the manager believes in this long-term value of the Arbor's common stock and is extremely committed to keep his interest in line with shareholders.

For those of you who may not have seen it during the quarter, one of our directors purchased an additional 500,000 shares of common stock in the open market, doubling his investment. While we are not yet in the position to comment on specific timing, management is continuing is analysis on internalizing the management structure and is working closely with the board of directors on this effort. I will now turn the calls to Paul to take you through some of the financial results.

Thank you Ivan and good morning again everybody. As the press release indicates our earnings for the quarter were 50 cents per common share on both a basis and fully diluted basis. As Ivan explained this is the first quarter in the last 5 that we did not receive any contribution to earnings from an equity participation interest.

However, I think it is important to note, that if we do not monetize the punch(ph) transaction last quarter, we would have received a recurring quarterly distribution of excess cash flows. In addition, as Ivan mentioned, we did receive a $1.3 million distribution from one of our equity interests during the quarter, concurrent within Arbor refinance. This distribution was deferred for accounting purposes until our new loan is repaid. As we pointed out on last quarter's call, these equity interests may cause our earnings to be lumpy, as part of our business model we believe in the long term (inaudible) participate and interest and a positive contribution to earnings over time.

The numbers in the press release are fairly self-explanatory but I'll highlight a few points I believe may benefit from some clarification. First, and very significantly, our average balance in core investments grew about $173 million from last quarter. This growth expressed the deployment of funds raised in the trust-deferred security issued last quarter. As a result, our poor interest margin increased by 2.4 million, a 20% increase from the second quarter.

In addition, yield for the quarter on this poor investments rose 26 basis points to 10.11% this increase is the result of increased interest rates in the third quarter as compared to the second.

The impact of increased interest rates was partially offset by 2 factors. First, you may recall that in the second quarter, the yield on the loans that paid off were higher than the yield on the new loans we put on. We saw the full impact of this during the third quarter. Second, we now have 20% of our portfolio in fixed rate assets. Although we generally lock in earnings spread on these assets using hedge transactions, obviously the rates do not reset on these loans when rates rise.

The average balance in our debt facilities grew about 107 million from last quarter. This means that our core assets grew 66 million more than our core debt facilities. This is primarily due to putting the trust deferred funds to work as well as reducing the amount of cash balance within the CEO by investing such cash in interest earning core assets. Our average leverage on core assets for the quarter was 72%. Our average cost to funds did move up 60 basis points, primarily due to the rise in LIBOR (ph).

Operating expenses were fairly flat as compared to the previous quarter with 2 exceptions. First, the incentive management fee was significantly less than last quarter because the second quarter included a large provision due to the client distribution. Backing that our, the incentive management fee increased 0.3 million. Once again our managers opted to take the entire amount of this fee in stock.

Stock based compensation expense, which is a non-cash expense totaled 0.8 million or nearly 3 cents per share and is largely the result of stock ramps issued to key employees in May and July of this year.

On the balance sheet I'd like to point out a few changes since the last quarter. You may recall that it was 103 million of cash on hand as of June 30th. As we indicated last quarter, this was a timing issue as a result of needing to have cash on hand to fund loans expected to close by quarter end. The bulk of this amount was re-deployed shortly after quarter end, which shifted cash was 53 million, down from 73 million of June 30th. This balance consists primarily of funds received when loans in the CDO pay off, which are not yet redeployed. The reduction reflects our success and more efficiently investing this cash in interest earning assets.

The overall leverage ratio as of September 30th, is 2.5 to one as compared to 2.4 to one. As of June 30th. Assuming the trust deferred to treat as debt in this calculation. If one were to consider the trust deferred as equity, the ratio would be 1.7 in one as of September 30th as compared to 1.6 and one at the end of June.

We do not include the schedule of the equity participation interest this quarter largely because there were no significant changes during the period. The press release did describe 2 new assets with R over effects originally since the previous disclosure and this R over effects are not being accrued at this time.

With that I will turn it back to the operator and we will be happy to answer any questions you may have at this time.

(Operator Instructions)

Your first question comes from the line of Don Bestino (ph) with J&P Securities. Please proceed.

Hey guys, I have a couple questions. First Ivan, your discussion about, I guess somewhat sacrificing some short-term margin for duration. I guess, first is that a fair way to explain the strategic shift. Secondly, is there any way to quantify or qualify the short-term impact that has on earnings?

And thirdly, would it be safe to assume that a fixed rate asset is one that is not going through any, some kind of a transition and therefore at the outset may be a better quality asset than the average asset, floating rate collateral.

Let me comment on a number of those things. Number 1, last year at this time I believe we had 0% of fixed rate product in our portfolio, now we're up to 20%, which is very important to us. It does provide longer term and more stability. The spreads are a little bit tighter you have to swap them out for about 40 to 50 basis points off of swap rate so that effects your margins a little bit.

The credit quality is generally better because they're longer terms stable assets to the risk profiles lower. So, I don't know if I hit on all your points, but those are generally the factors looking at fixed rate. It is our intention to increase that percentage in our portfolio. And the third piece which I want to comment on, is that when rates do move up unlike LIBOR, while the leverage part is fully hedged, so there's no interest rate risk we don't get the unhedged part is fixed so that is a little bit of a drag on our earnings more than anything else.

Right so, its fair to, its fair to just characterize this as you guys taking a look at the world and making a strategic decision to give a little bit up on the short end - speaking of time, over the next couple of quarters, with that stabilized portfolio for the next couple of years.

That's correct. And also keep in mind that regenerating assets and also having variable rate assets or repositioning assets requires a lot of labor, by having these loans in our portfolio it requires less reorigination, generally stable, better credit risk, so we think that even to margin - any margin compression, some of it is off set by a reduced labor costs as well.

Got you. And then 2 questions about the prime gain. There was a component of the prime gain that you did not recognize because you had participated in the re-fi, any progress there on when or if you'll recognize that prior to the financing that you participated in paying off.

Well, 2 comments, I'm very optimistic about the results. Shortly it was just more of a technical issue than anything else. On the outside date of that being resolved is in the first quarter when the, when the bridge loan is totally taken out. so, I'm pretty comfortable it will be done shortly, and it should be at this quarter event on the outside of the worst case it will be first quarter.

And remind me, it was like $9 million.

9.2 million Don, and obviously when those issues are resolved we will record the accounting appropriately and immediately issue a press release because that's a significant number.

Right. And then finally, this 65-cent dividend, which you acknowledge contains some portion of the prime gain. Is that to be read as that once you - that at some point the dividend will come back down to operating earnings level or should we assume that you think that operating earnings will come up to meet the current level of the dividends.

I guess we look at it in a multiple of ways. Number 1, we look at it, we had been if we hadn't refinanced, what would the distributions have been and why pay the alliance of company and if you are wrong for that, but that's a portion of it. Number 2, the numbers are so significant that just a small subsidy is not that big of a factor. The subsidy is management's users or the board's users so it can be ongoing. In addition, we had a significant number of additional equity figures what we feel the reserve tanks might be pretty strong. And the last part is, that as these funds get deployed and leveraged properly the return on that invested capital should offset the lack of distribution from the asset, which the funds were taken from.

So, what I read from all of that, that there's no reason to think necessarily that the dividend will ever have to be cut from 65 cents to a normalized level because the prime gain has been used up.

Right - well, as I stated in my comment that the management and the board is committed to a long-term stable growing dividend. If you can do the math you'll take a look at what's in the reserve tank just from that distribution and you can calculate going forward how much is available at our discretion. And that, as I say, is just one of, of many that we have.

Great, thank you. Very, very helpful.

Your next question comes from the line of Steve Delany (ph) with Brian Beck. Please proceed.

Good morning, thanks for taking the question. Paul, first, one quick thing, on the additional prime distribution that may be recognized here in the next 2 quarters. When you first received that I think I recall you all stated that because it was part of a refinance transaction it was your believe that none of that would be tax - subject to income tax and I just wanted to clarify that that still is your position with respect to the incremental 9 million.

Thank is correct Steve, we did receive $36 million in Q2 as a result of refinancing some of the debt in the portfolio, it's a tax deferred distribution and we have all the cash currently, the recognition of the 9.2 million of income is just really and accounting treatment once the closing conditions are met, but from a standpoint of the game, that's not a taxable event.

Okay, thank you. And Ivan, I know you mentioned that you're in a quiet period with respect to the next CDO, so I respect the fact this question may be getting on thin ice, but when you did your first CDO, I remember discussions that talked about that that represented a cost - an all in cost savings relative to your next best cost of funds, that if I'm recalling correctly was somewhere in the neighborhood of 60 to 75 basis points. Could you, could you as to whether it would be reasonable for us to expect that if and when you get another CDA done, that given your other borrowing costs currently in terms of repos and lines of credit, would it be reasonable to expect some incremental cost saves in the average cost to funds.

I cant give you exact guidance on that right now, especially since we're finalizing a list of assets and for the CDO, but I think that it will be a positive impact on the company. Especially since there's certain aspects Steve that are not less expensive, CDO wont allow us to leverage but more importantly on a longer term basis it puts us in a position to have about 70% of our assets leveraged through CDO execution which is far superior than through existing lines. Both on a flexibility stand point as well as a rate standpoint. But I really can't get into a lot of detail on that at this juncture.

Okay thank you. I understand that. Back to the, one final question on the fixed versus variable lending. Could you give us any sense as far as, I think you talked about 26% of year to date originations and 20% of the portfolio. Do you have any sense of where that percentage might go if we look out 6 months or a year? and I guess, part of that is does the market still afford the opportunity for the LIBOR index variable lending and do you see basically a mixture of both types of products going forward?

I think we do see a mixture of all those types of products and some of the things that we're doing is on some of the LIBOR based stuff once its stabilized we're actually assisting in putting the fixed rate product on that. But I see that as a growing part of our portfolio especially utilizing our CDO execution and maybe that growing over the next 12 months to around 40% of our portfolio, that's how I would see it.

Okay. And could you give us one specific example of say a loan booked, a fixed rate loan booked in terms of the coupon on the loan versus the, the after swap cost within the CDO so we get some sense of what the representative spread might be on one of these loans and I assume that the term is somewhere out to about 5 years.

Yes, I can give you a perfect one that kind of speak to a few of them. It was probably been about 6 weeks ago so I'm not as up on the details but one of the properties what we have the equity factor property in Brooklyn which was an industrial property, 930 Flushing Avenue. The property stabilized in the long term tenants that were put in and were able to put on a $25 million, five year fixed rate at that point, 6.45 were able to swap it out and I believe our leverage return that we calculated was somewhere around 14 or 15%.t hats the loan were we had to defer a significant gain of $1.3 million gain. So that's not atypical of the type of transaction. So I don't know where the 5 year was when we did it, but -

It was at actually 406 when we entered into that hedge scheme on that particular loan.

Okay.

So there's a spread over the 5 year and the 5 year was at - actually the 5 year was less than 406, the spread all in, we were paying 406 and we swapped our the variable to fixed, we were paying 406 and receiving variable -

Yes, but you also have to note on that that was a small mezzanine loan which was pretty good. This is a whole loan of 25 million, very low credit risk. We're $0 to I think -

So, this is the first view to trust?

Yes, absolutely.

Okay.

So the credit profile is outstanding in the 5% loan. And I think that there is somewhat of a trade off and we're not seeing. We're seeing great risk adjusted returns in terms of getting low to mid teens as opposed to mid to high teens, but getting whole loans and first seeds of trust which across the period will only become assts.

Right. Okay thank you very much.

Thanks Steve.

Your next question comes form the line of Don Pendetti (ph) with CitiGroup. Please proceed.

Hi Ivan, quick question. Have you seen any change in appetite among your customers in terms of their interest in terms of buying assets or repositioning, any change there with a higher rate environment?

Not at all, I mean we're still seeing buyers extremely aggressive, its still, for whatever reason, especially in the New York market, still a huge shortage of product. I would have thought that with the move up in LIBOR over the last 12 months that not many people have paid attention to that it would have affected people's ability to buy and create positive leverage. Remember the 10-year really hasn't moved up that significant, we're just at the top of the range. We're not, we haven't blow out of that. And the 5-year as well. So I think, if anything, the spreads are much tighter than they were a year to 2 years ago, we're at the top of the range, but if you look at the tightening of spreads we're really not that out of balance. It's really the short term rates which have impacted things but I haven't seen, I haven't seen the rising short term rates that tremendously impact people's ability to buy. I also think equity is readily available in the market so people are able to borrow equity cheaper so perhaps that is also offset some of the higher debt rates, but I haven't seen a significant impact in the marketplace in terms of cap rates or anything like that.

Okay, and Paul, if you happen to figure, can you tell us what your debt service average was in the third quarter?

Sure, as of 9/30 the debt service coverage was 121, LTD was 75%. If you recall from last quarter's call, the debt cover was 125 with LTD as 76% and I think we said if we shock the portfolio 100 basis points last quarter it would have come down to 113. well, if you shock the portfolio now 100 basis points, as of September 30th, it comes to 112, and I think that's significant because the stock in rates has not maybe impacted the LT - the debt cover ratio as maybe as much as you would think and that's been offset by 2 factors, 1 the additional performance of the loans in the portfolio and 2 we've been more and more, on certain deals we've been requiring that borrowers purchase interest rate caps depending on the deal structure and as the interest rates rise, those caps are becoming more valuable and are kicking in and preserving that debt cover ratio.

Okay, and on the fixed rate assets, do you ever have a mismatch in terms of your CDO financing versus the maturity of the debt on the loan.

No, we can match those perfectly, I mean we just custom tailor them to have exact swaps. And the, we pass on whatever it is to pare out of those in prepayments so we don't have any prepayment issue if they get prepaid.

Okay. Thank you.

Your next question comes from the line of Mark Devries with Lehman Brothers. Please proceed.

Hey, good morning. Most of my questions have been asked and answered, I know your credit quality has been pristine, any sign that there's any change in credit quality this quarter?

Not at all, in fact I'm going to go back to Don's question about where we stand on our assets and people bidding on them. I mean a lot of the loans that we're involved in, a lot of the equity takers we have, there's not a day that goes by that I don't get calls from people to buy our assets at, just unbelievable levels and its not just from 1 or 2 buyers so there's just an abundance of people buying assets out there and we see no deterioration on any of our assets and we have no issues about any of our assets in our portfolio.

Okay, great, thanks,

Your next question comes from the line of James Shanahan with Wachovia. Please proceed.

thank you very much and good morning everyone.

Morning.

Good morning.

I'd like to follow up on Mark's question with the loans with kickers, you said you're being called frequently with bids for those loans. What kind of investors are bidding on those products that are in your portfolio?

You're just seeing a whole host of investors, there're a lot of equity funds out there so you have a lot of develops with access to a lot of these equity funds. You have a lot of equity funds that you're just looking to buy. There's a whole broad spectrum of people there's no shortage.

And then to follow up on Don's earlier question about the match funding and the CDO, how actually does that work as a fixed rate loan that's been swapped ex-prepays, how does that work from a funding perspective.

I'm not, I'm not sure -

Yes, I'm not sure I understand the question Jim.

Well, I'm interested in trying to understand better, if you have a, if you swap within the CDO fixed rate loan and net loan prepays, how does that effect the swap counterpart?

Well, you just pass on whatever the - whatever the counting party risk is to your borrower, which is pretty substantial.

Right.

Oh, I see. Okay. And then the questions I gotten on to ask, the call conference said earlier about expenses in the quarter and there was this smooth in plus 31% on a sequential quarter basis and selling of administrative expenses, about 300,000 what was that item.

Yes, Jim, what that related to is - as you know, this year we are required to be Sarbane's Oxley compliant and there's a tremendous amount of effort that goes into, on the internal audit side, meeting those 404 requirements, the bulk of that work has been performed in the third and will continue into the fourth and first quarter. So that expense increase is really predominantly due to the Sarbane's Oxley effort in getting compliance from an internal audit standpoint.

Okay, thank you. And the with regards to prepayment penalties. You mentioned your structure in a lot of these fixed rate loans with prepayment penalties. Are those, if they're actually earned are those kept by the REIT or are they earned by the manager.

They're kept by the REIT.

They're kept by the REIT.

Okay, and then one final question, you've been very patient. There have been some concerns about management departures in recent quarters, can you comment on the number of employees at Arbor Commercial Mortgage and the REIT and how this has changed in the last few quarters and also, are there any key positions right now that you would say are vacant or are in need of being filled or upgraded?

Okay, let me give you a little bit of an overview on that because when it comes to talking about management, I can talk for quite a bit of time.

First of all, I think we're one of the deepest management teams in the industry and my management style is to make sure our culture is always correct and that management is productive. And fortunately for us, there's no individual here who we're dependant on and if somebody doesn't fit we have no problem in moving them out.

I guess in the public format that sometimes creates a little bit of a wrinkle and I'm hoping we can use this opportunity to talk about the depth of management and maybe you can appreciate my management style to really be steadfast to really have a tremendous productive team.

On a senior level basis we have 15 EVPs and SVPs. One level below that we have 20 VPs. Of the EVPs and SPVs, there are 7 EVPs and 8 SVPs. Since our public offering we're up 4, a total of 4 senior executives. We've had, I believe, 2 deletions and a couple of promotions and 3 new people over that period of time. So I believe that the management team is extremely, extremely deep. Overall there are, I believe 160 employees between the REIT and the manager, so that's the overall team. And generally what you'll see in our structure, you'll see match impaired EVPs and SVPs and generally there'll be an EVP who will oversee certain SVP responsibilities and the general structure here is create an organizational structure where even below the SVPs or the VPs we'll groom for the SVP spots and SVPs will groom for the EVP spots. And that's the overall structure of the company. I don't know if that helped at all.

No, it does help very much. Thank you very much.

Thanks Jim.

At this time there are no further questions in the queue so I will now return the call to management for closing remarks.

Okay, well we appreciate all those questions and we hope we shed some light in terms of where the market is and how we're positioned. We think this was an outstanding quarter for the company, especially in the light of some perception in terms of the hedges of the market. We think we've positioned ourselves extremely well and are very comfortable with our originations, with our margins, with our management and look forward to continue our performance from quarter to quarter. Thank you very much.

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