Arbor Realty Trust Inc (ABR) 2006 Q1 法說會逐字稿

Good day and welcome, ladies and gentlemen, to the first quarter 2006 Arbor Realty Trust earnings conference call. My name is Audrey and I will be your conference coordinator for today.

[OPERATOR INSTRUCTIONS]

I would now like to turn the call over to Mr. Paul Elenio, Chief Financial Officer. Sir, you may proceed.

Thank you, Audrey. Good morning everyone, and welcome to the quarterly earnings call for Arbor Realty Trust. This morning, we will discuss the results for the quarter ended March 31st. 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 be deemed forward-looking statements that are subject to risks and uncertainties including information about possible or assumed future results of our business, financial condition, liquidity, results of operations, plans 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 cause 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 on 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 will now turn the call over Arbor's President and CEO, Ivan Kaufman.

Thank you, Paul, and thanks to all of you who are joining us on today's call. As the press release we issued this morning indicates, our first quarter results demonstrate the continued success we have had. In addition to our earnings growth, we have implemented several key strategies to support our ongoing commitment and goal of increasing the long-term value of our company and franchise.

Paul will review the financial results in a moment, but first I would like to comment on some of the strategies we have employed and how we are faring in today's market. As previously announced in the first quarter, we recorded the remaining 9.2 million of income that was deferred from the Prime transaction.

Prime refinanced the debt related to 10 of the 28 properties in the portfolio and our guarantee on a portion of that debt was eliminated. It is important to note that there is additional value on these properties above the outstanding debt amounts.

As the existing debt agreements mature, there may be additional opportunities to refinance or sell properties within the portfolio, and we would participate in those economics as well. These equity interests continue to be an important part of our business model and we believe in the long-term value and the positive impact they will have on our earnings over time.

The closing of our second CDO in mid-January was a significant accomplishment, especially considering the market conditions. The economics of these transactions were laid out in the CDO press release, but I would like to emphasize the importance of these facilities.

The addition of our second CDO now gives us the ability to fund the majority of our business with CDO debt, trust preferred securities, and our own equity. There are long-term funding sources that give us the capability to finance assets up to seven years, significantly mitigating the term risk of our current facilities.

They also provide us with a more stable funding base by reducing our reliance on traditional warehousing lines. These facilities have many ongoing advantages including reduced borrowing cost and increased leverage resulting in increased returns on our investments. The second CDO gives us greater flexibility in our product offerings including more capacity by product type and the ability to originate more fixed rate loans.

I will point out that we did have an unusually high average balance of restricted cash outstanding related to our CDOs this quarter which had an impact on short-term earnings. This was a result of several factors. First, the combination of increased loan pay-offs during the quarter and the need to have sufficient collateral to fund our second CDO resulted in an increase in the balance of unfunded cash outstanding in our first CDO.

Second, we did have a ramp-up feature in our second CDO and we made a strategic decision to evaluate our pipeline along with the loans in our portfolio to determine the optimum mix of investments for those vehicles. This allows us to maximize the leverage return over the life of these investments rather than focus on short-term earnings.

As of today, all of these funds have been allocated and the majority of these funds have been deployed resulting in positive impact on earnings and increased capacity in our warehousing facilities. We continue to regard common equity as our most valuable financial resource and we will not issue additional common stock for the sole purpose of growing our portfolio.

In the last 12 months, we have issued 155 million of full trust securities. These securities were issued in the low 300 over LIBOR on a blended basis and provide us with a lower cost alternative to raising equity, which we believe is accretive to shareholders for several reasons.

First, by keeping our equity base at the current level, we can operate our portfolio at optimum leverage ratios and still maintain adequate growth. Second, we believe that we have a fair amount of off-balance sheet value associated with certain investments and issuing additional equity with a linked value to current shareholders.

As you know, we recently announced the quarterly dividend of $0.72 per share of common stock, a $0.02 increase over last quarter's dividend and our seventh consecutive dividend increase.

As in prior quarters, a portion of the distribution received from our equity participation interest we used to pay part of this quarter's dividend. Management and our Board of Directors wish to emphasize that we continue to recognize the importance of a stable and growing dividend to our shareholders.

The abundance of capital combined with the rise in short-term interest rates in the commercial real estate lending market continues to compress spreads. In some cases, transactions are getting down at levels we are not comfortable with and we have concerns about some values in today's market.

We are very sensitive to these issues in both our underwriting and asset management functions. We have made a conscious effort to improve credit quality of our portfolio by continuing to focus on originating loans with significantly lower loan-to-values.

Although this strategy may slightly impact margins, we believe that these assets create additional stability in our portfolio. This combined with the improvements we have made on our debt facilities by reducing borrowing cost and increasing our leverage has enabled us to effectively generate investments, which we believe have superior risk-adjusted returns.

In fact, during the quarter, we originated loans with an average loan-to-value of 67%, the lowest in the firm's history reducing the overall loan-to-value in our portfolio from 72% at December 31 to 70% at March 31.

I mentioned the CDO gives us a greater flexibility in our product offerings. This includes the ability to originate long-term fixed rate loans. As of March 31st, approximately 20% of our portfolio was fixed rate product and our goal is to increase this percentage going forward.

These loans are attractive to us because they generally include prepayment protection. We are able to lock in spreads by swapping out the rates on our CDOs and we believe they offer a more stable return and are far better suited for us over the long-term.

Despite the aggressive markets, our origination networks remain active and we continue to focus on transactions that are appropriate for our financing facilities. In the quarter, we closed approximately 254 million of new loans and investments, of which 245 million was funded. We experienced 157 million of run-off during this quarter.

Of this amount, 20 million was retained in new loans and 137 million were either sold or refinanced outside of Arbor. This resulted in net growth in our portfolio of $94 million or 7.5% for the quarter. This growth was weighted towards the end of the first quarter and we will receive the full benefit of the net spread of these investments going forward.

Our manager, Arbor Commercial Mortgage, has elected to take over $1.7 million of its incentive management fee in stock, which represents 50% of the incentive comps for the quarter. The remaining fee will be paid in cash to cover the management tax liability on incentive fees earned in this and prior quarters.

As we've stated many times in the past, the management believes in the long-term value of Arbor's common stock and is extremely committed to keep its interests aligned with shareholders.

While we are not yet in the position to comment on specifics, management is continuing its analysis on the potential internalization of the management structure and is working closely with the Board of Directors on this effort.

Finally, I am delighted to welcome Archie Dykes as the new independent Director. Archie brings tremendous board experience, especially in the area of corporate governance. We look forward to his guidance and the contribution he will make to our company. I will now turn the call over to Paul to take you through some of the financial results.

Thank you, Ivan, and good morning again everybody. As noted in the press release, our earnings for the quarter were $0.90 per common share on both a basic and fully diluted basis. Obviously, there was a big impact from the 9.2 million of income that we recorded from the Prime investment.

This is the seventh quarter in a row that we've had a positive impact from one or more of our equity investments and in five of the last seven quarters, we have recorded income from these investments. The details of the accounting related to this transaction were laid out in the press release.

As we've said before, these equity interests may cause our earnings to be lumpy and these investments are a significant component of our business model, and we believe in their long-term value and the positive contributions to earnings they may have over time.

In addition, because the Prime distribution back in June 2005 was funded from excess proceeds from the refinance of some of the properties in the portfolio, the 9.2 million of income is not taxable at this time. Therefore, we are not required to distribute these earnings to shareholders immediately.

As we've said before, we understand that a steady increasing dividend is important to our investors and distributions from our equity investments have supported the payment of dividends in excess of earnings.

The numbers in the press release are fairly self-explanatory and I'll highlight a few points I believe may benefit from some clarification. First, our average balance in core investments grew 73 million from last quarter.

As Ivan mentioned, our portfolio growth of 94 million was weighted towards the end of the first quarter, which means we will receive the full economic effect of this growth in the second and future quarters. In addition, the yields for the quarter on these core investments increased 23 basis points to 10.63%.

Those of you who were on last quarter's earnings call may recall that our yield for the fourth quarter included income from the acceleration of fees and IRR lookbacks, which happens frequently and are part of the normal cost of business. This held true again this quarter. However, the impact of these items was greater in this period.

So for comparative purposes, the yield on core investments before these items was approximately 10.05% for this quarter, compared to around 10.30% for the prior quarter.

You may recall that the yield on the loans that paid off in the fourth quarter was higher than the yield of the new loans we put on. We saw the full impact of this during the quarter. This situation occurred again in the first quarter and this was partially offset by increased interest rates on our floating rate portfolio due to the rise in LIBOR.

Last quarter, our average cost of funds was around 6.89% before capitalized interest on one of our equity investments. Excluding capitalized interest this quarter, our average cost of funds was approximately 7.01%.

I would like to point out that in December, we entered into a participation agreement on one of our loans, which was required to be recorded as debt. Absence this arrangement, the cost of funds would have been 6.83% in the fourth quarter compared to 6.81% this quarter. The decrease was due to reduced borrowing cost as a result of our second CDO, offset by the rise in LIBOR.

In addition, the average balance in our debt facilities grew by 166 million from last quarter, 93 million more than the increase in our average core investments. This increase is primarily a result of increased leverage on our core assets during the quarter.

The average leverage on core assets was 71% compared to 65% for the fourth quarter. Including the trust preferred's debt, the average leverage was 84% compared to 75% for the fourth quarter. This was primarily the result of two factors. First, we continued to deploy the funds from the trust preferred securities issued in previous quarters.

Second, as Ivan mentioned, our average restricted cash balance increased 77 million from 35 million in the fourth quarter to 112 million in the first quarter due to the ramp-up of our second CDO and the timing of our first quarter loan activity. The effect of this increase on interest expense was partially offset by earnings in the restricted balances, which are included in interest income.

Including restricted cash, our average leverage for the first quarter was around 65% and 77% including the trust preferred's debt. At March 31st, restricted cash was $148 million. As of today, these funds have been fully allocated and the majority of these funds have been deployed, although it will impact second quarter earnings for the period of time these balances were outstanding.

Our overall leverage ratio was 2.0 to 1 at March 31st as compared to 1.7 to 1 at December 31st. If you include the trust preferred securities' debt, the overall leverage ratio was 3.4 to 1 at March 31st and 2.9 to 1 at December 31st.

Operating expenses were less than the previous quarter with the exception of the incentive management fee. This reflects professional fees related to the 2005 Sarbanes-Oxley requirement incurred in the fourth quarter.

We did not include the schedule on equity participation interests this quarter largely because there were no significant changes. As the press release described, we did record income on IRR lookbacks related to two of our loans during the quarter, Harbor Island and James Hotel, totaling approximately $1.5 million.

Harbor Island paid off early and we received the IRR lookback during the quarter. We accrued the James Hotel IRR lookback earned through March 31, 2006, because of an increase in the value of the two properties securing the loan. In May, one of the James properties was sold and the proceeds we used to pay-down a portion of the first lien debt on the remaining properties securing our loan.

We expect the debt on the remaining properties to be refinanced in the near future at which time our loan will be repaid. The realization of these IRR lookbacks continued to demonstrate our ability to consistently generate additional value from our investments.

Finally, on an unrelated note, you may have seen our proxy filing that we issued additional restricted stock grants of approximately 89,000 shares on April 3, 2006. These shares were issued to certain of our employees and the employees of our manager, one-fifth vest immediately and the remaining four-fifths vest ratably over the ensuing four years.

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

Thank you, sir. [OPERATOR INSTRUCTIONS]

Our first question will come from the line of Don Destino with JMP Securities. Please proceed.

Hey guys, nice quarter. A few questions, most of them housekeeping. Paul, can you tell us what the average restricted cash balance was during the first quarter?

Yes, it was 112 million Don and it was compared to 35 million from the fourth quarter, so the average increased 77 million for the quarter.

Okay. And is that a -- and is there kind of a, well, something we could think of as a working capital requirement, restricted cash cannot be drawn down to zero or negligible amount?

It's Ivan, I believe that that number should be growing down to a very negligible amount and we should operate with just a couple of million bucks of restricted cash. Right out of the box, you are talking about a ramp-up of 50 million for CDO 2.

And then you have a --a series of pay-offs and when you are ramping up this type of CDO, you don't have the extra collateral lying around to fill in. It's our strategy and our position to always have loans ready to pop-in, but yes that's sufficient collateral to do that when you are creating a new loan and ramping up, you kind of have a gap for about 90 days which is what we had.

Hey Don, just to add further to that question, everything Ivan said is correct on the unfunded amount that we are able to use to fund new loans, but the restricted cash balance on the balance sheet and the numbers I gave you include some cash that stays in that account when the loans pay interest during the quarter, it accumulates and then there's a waterfall that's paid out every quarter.

So to answer your question, I think there will be roughly $10 million to $20 million of restricted cash on the books every quarter which doesn't represent proceeds that we can be used to fund new loans, but it does represent proceeds that stay in the CDO until the waterfall of proceeds is given out at the end of the three months.

Understood, thank you, that's very helpful. Next, my question again housekeeping, is it a reasonable thing to do to if we wanted to estimate the earnings excluding the $9.2 million gain, just pull out 75% of that $9.2 million gain, just promote affecting it?

Yes, I think...

Is there anything else to think about that any other line that's affected?

No, not really, that's a pretty accurate number.

Okay. And then Ivan, how do you think about what the trust preferred capacity is of Arbor and of your portfolio, obviously it's incredibly attractive capital? When you think about leverage, do you think about -- how do you think about the trust preferreds in terms of capital or debt?

Yes, I mean I clearly look at it as equity, better than equity because we have an option to get rid of it, but I -- so after five years depending on how market looks in terms of overall capacity, I think we still have the capacity to add more and we will be looking at that on a strategic basis in the short-term.

And I think Don on that is it's become more widely accepted obviously in the market. We see firms putting on more and more trust preferred and some people look at it as a percentage of their equity, some people look at it as a percentage of their overall capital structure including debt, and I just think Ivan is right, it's still very widely accepted and very attractive.

Yes, we give our ratios with both as you know in the way we present. So we'll give you guys the option to have a look at it both ways.

So, would this be a fair statement that Arbor Management would put as much on as possible and the arbiter is going to be the trust preferred in the equity markets and how much they are comfortable with?

I think given the current climate, we will look to increase that, but things change depending on spreads and depending on the yield curve and factors of that nature. So, I think given the current climate and given where the trust preferred price in our balance sheet, we'd certainly look to add.

Got you, all right, thank you very much.

Our next question will come from the line Don Fandetti with Citigroup. Please proceed.

Hi. Good morning. Couple of quick questions. Ivan, I was wondering, if you could just comment on your thoughts on the condo market and might that create some opportunities for just trust over the next year or two?

Clearly we've spent a lot of time talking about the condo market distinguishing between New York and outside of New York and proceeding very, very carefully and making sure that new loans are real structured. I mean, we could do billion dollars today of business in today's climate, there is just not much condo business out there. But we will proceed carefully.

Our portfolio is in outstanding shapes. So in essence that everything in our backyard is well taken care of. I think that there could be some real good opportunities on restructuring some existing product out there, and we will look to if we get to take advantage of that. New York City in particular is an interesting market.

The prices have not dipped, but sales have slowed. So we haven't seen the kind of softness in the New York City market to begin to take advantage of restructuring opportunities, but I think that may come outside of New York I think especially in Florida or in Vegas and markets like that.

We are beginning to see significant slowdowns, in particular added to ground new construction in Florida, specifically in the downtown Miami market is extremely slow right now, and I think there could be some good restructuring opportunities, and I think they will look for some outstanding yield opportunities when that does occur.

Okay great, thanks for the detail. And just lastly, where do you think your net assets -- what's a good run rate for net asset growth over the next three or four quarters?

I think Don, we spent a lot of time thinking about that and we -- the guidance we'd like to give is a net portfolio growth of around 15 to 25% annually, so that translates to 50 to 75 million a quarter. This quarter, we had 7.5% net growth, so that translates to about 30%. But repayments are not always predictable and they are lumpy. So, I think we'd guide towards a $50 million to $75 million net growth number each quarter.

Okay. Thanks Paul, take care.

Our next question will come from the line of Jim Shanahan with Wachovia. Please proceed.

Continues to baffle me how Don and Don can get in the queue before any of us every time. Good morning everyone, I just wanted to ask one quick question. Can you comment what the dollar value was of undistributed Prime gains at quarter-end?

Jim, are you referring to the amount of cash that was received initially and how much has been distributed above the core earnings?

Yes, that's right.

Okay. I think at this point, we are probably at about all-in with Prime. We look at it all-in. We look at the reserve tank as Prime and any other tickets we may have received.

Okay.

We did get a couple in the last couple of quarters. I think all in, we have probably about $19 million to $20 million left in that tank.

Okay, terrific. And, is there anything new regarding, say, occupancy et cetera that you can -- that has been developed over the course of the last couple months on the [Toy] property?

I think the most significant aspect of the Toy property is we will receive full rezoning, 100% rezoning to residential, and that was done last week I believe and that's probably 9 months ahead of the schedule that we had anticipated. I don't have the exact percentage of tenant relocations, but that's well ahead of schedule as well. So that project is well on its way.

Okay, thank you.

[OPERATOR INSTRUCTIONS]

And our next question will come from the line of Martin Shafiroff with Lehman Brothers. Please proceed.

Hi, guys. It's Samuel Kosloff for Martin Shafiroff's office at Lehman Brothers. Just had one question directed toward Ivan. Ivan, which product areas are you most excited about and specifically which geographic regions?

Look, we are still extremely excited about the New York metropolitan area. It's extremely strong, extremely healthy and continues to show a tremendous amount of strength. While we had a large level of concern about the condo market given the amount of product going on, we are pleasantly surprised at how strong and healthy that is.

But I think, from an origination standpoint, we continue to originate not only in New York, but throughout the United States and grow our franchise. And we are starting to go after the West Coast a little bit, see some product out there. So we are excited about our growth opportunities out there and some real healthy markets and that's looking very strong for us.

Great. Thanks.

[OPERATOR INSTRUCTIONS]

Our next question will come from the line of David Boardman with Wachovia Securities. Please proceed.

How are you doing Paul and Ivan?

Good.

Hey, David.

I just had one question. Some other peer companies in your space as they've done more CDOs, are they able to go back and restructure some of their repurchase facilities and credit lines? I was wondering what sort of availability you guys might see in that regard?

I think there is and has been the ability to go back and talk to -- if you are referring to after you complete a CDO, go back to your warehouse lines and see if you can talk about different terms, reduce rates, and sometimes even higher advance rates, there is the opportunity to do that. We have done some of that and there will continue to be the opportunity to do that as we move forward.

Okay, thanks Paul.

Our next question will come from the line of Chris Faems with Flagstone Securities. Please proceed.

Hi, good morning. Thanks for taking my question. Paul, a couple of quick housekeeping ones. Do you have a breakdown of the loan portfolio of 331 available or should I just wait for the Q on that?

How do you want to break it down?

Let's say between mezz B-notes, bridge loans and preferred equity, and then addition to securities, of course?

Yes, I think that right now where the portfolio stands, we are probably 40 to 50% bridge and 50 to 60% mezz. However, the junior participation, you have to look at them. Some of them are junior participations in first [lien] position. So that slightly ramps up in my eyes at 40%, so a little bit higher number, and there is a small amount of preferred equity as well.

Okay. And then, did you receive any prepay penalty income apart from the two IRR lookbacks? Is there anything else to liquidate your interest income there?

Yes. We did have one loan that prepaid early, that we accelerated the - you get these exit fees and origination fees, and when something prepays early, you get a little bit of yield boost by bringing that number in earlier than expected. We did have a little bit of that as well.

And was it negligible or how can [inaudible]?

On the one loan that I am speaking of, it was $300,000.

Okay, thank you very much. And then Ivan, if you could comment a little further on the LTV on first quarter originations, would you say the lower LTVs, is that idiosyncratic to just what you had done in the first quarter or is it more of changed across the landscape in general or in what you are looking at or where the most attractive opportunities are, if you could just comment a little bit further that would be great.

Sure. I think that's a real significant item because I'd say around three quarters ago given the state of the market, we were really concerned with where real estate guys were and also the amount of what we are lending that was done out there.

So we made a conscious effort to participate more in the middle of the capital structure on transactions, then on the junior part of the capital structure. And what really enabled us to do that was putting our CDOs into place and properly leveraging those pieces. So, we were able to achieve a similar leverage return but on a superior risk-adjusted basis.

So while we were changing our strategy and originating higher quality credit loans which will be able to deliver similar yields, and a lot of that has to do with our capability with our CDOs and our leverage capabilities. So that's not an accident. That's been a tremendous strategy.

I don't know where it was a year ago, but I would venture to say that our LTV is probably 8 points lower than it was. So the credit posture of the firm that we were a little bit higher in the real estate cycle than we were comfortable with. So we positioned ourselves much lower in the credit profile of each loan and we have been extremely effective, and I think on a long-term basis that will serve us very well.

Let's put it this way. I had a meeting this morning with our asset management group and the most amazing thing is when you could sit down in a portfolio of ours which is well over $1 billion and maybe have one or two loans to talk about and even if the one or two loans is almost nothing to talk about, and that gives me great comfort.

That's just great. That's [inaudible] color. I appreciate it. If you are seeing more attractive risk-adjusted returns kind of a little lower in the capital stack, where is -- I am sorry a little lower-end of the LTV, so a little higher in capital stack.

Is the rest of the market focusing on-- maybe a little bit higher LTV or higher yield or I'd say lower risk-adjusted returns? Where is the rest of the market focusing that that's able to open up some opportunities for you in your more attractive areas?

I clearly -- this has definitely been more compression on a junior part of a capital structure than on the middle part of the capital structure, and there are not as many participants on the middle part, because it requires more capability of leveraging those assets and investments. So, while there has been compression, it hasn't been significant.

And I think there are many people looking to get yield to get their earnings, but yet are making poor credit decisions for short-term gain, but yet on a long-term basis, I think they'll have some credit risk.

But clearly, that was at LIBOR plus 700, 650 is probably condensed down to 500, 250 basis point compression, whereas stuff in the middle of the capital structure has only served us basically maybe 150 basis point compression over the last twelve months.

Great.

[Inaudible] middle part of the capital structure if you are able to originate it and leverage it appropriately, you are getting a much better risk-adjusted investment.

Good, thank you very much, appreciate it.

Ladies and gentlemen, at this time, that does finalize our Q&A. I would now like to turn it back over to the managers for closing remarks.

Okay. Well, once again, thanks for your patience and your support to the company. And we look forward to continue to execute our strategy and communicating with everybody effectively. Have a good weekend everybody.

Ladies and gentlemen, this does conclude your presentation. At this time, you all may disconnect and have a wonderful day.