Arbor Realty Trust Inc (ABR) 2006 Q4 法說會逐字稿

Good day ladies and gentlemen and welcome to the Fourth Quarter 2006 Arbor Realty Trust Earnings Conference Call. My name is Katina 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.

Thank you, Katina. Good morning everyone and welcome to the quarterly earnings call for Arbor Realty Trust. This morning we will discuss the results for the quarter and the year ended December 31, 2006. 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 risk and uncertainties. Including information about possible or assumed future results of our business, 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. 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'll now turn the call over to Arbor's President and CEO, Ivan Kaufman.

Thank you, Paul, and thanks to everybody on today's call for joining us. As you know, we released our fourth quarter earnings this morning and the results reflect the continued financial success we have had and our unwavering commitment to enhancing the long-term value of our company and franchise.

In a moment Paul will review the financial results, but first I'd like to spend a few minutes summarizing some of our 2006 accomplishments before discussing our quarterly achievements and business approach in today's marketplace.

2006 was a year marked with many significant accomplishments, which has positioned us well for 2007. Our continued focus on improving the right side of our balance sheet and our capital structure has created a foundation to operate more efficiently and with greater flexibility.

In 2006 we completed two new CDO's issued of approximately 900 million of debt, and issued approximately 65 million of trust preferred securities in lieu of raising equity. To date we have issued three CDO's with approximately $1.2 billion of debt and have developed a premier CDO platform which has transformed the way we approach our business.

This platform has given us the ability to enhance our product offerings, originate loans throughout the capital structure more efficiently and to significantly reduce our borrowing costs and increase leverage where appropriate, resulting in superior risk adjustment returns.

This platform has also enabled us to reduce our reliance on warehousing facilities, create additional financing opportunities with new institutions, and negotiate more favorable terms on our existing facilities.

2006 also demonstrated the depth and versatility of our originations network. We originated $1.5 billion of new loans for investments and our portfolio has reached the $2 billion mark. This resulted in net growth of our portfolio of 60% despite high levels of repayment during the year due to greater liquidity in the financial markets. Equally as important, we've delivered this record growth while continuing to improve the credit quality of our portfolio, generating superior risk adjusted returns.

We continue to view our significant borrower relationships as key components to our franchise value. In fact, over 70% of our 2006 originations were with repeat borrowers. Additionally, we have stated many times one of our goals is to increase the amount of fixed rate loans in our portfolio. In 2006 we added around $265 million of new fixed rate product, bringing the total fixed rate portion of our portfolio to around $500 million.

We are very pleased with our overall 2006 results and how these accomplishments have positioned us to continue executing our strategy in 2007. We have spent a significant amount of time developing funding sources that best mirror our business model and are very confident in our deep originations network and the quality of our portfolio.

I would like to spend sometime focusing on how we closed out 2006 by discussing our fourth quarter achievements before turning it over to Paul to take you through the financial results.

As mentioned in the press release, we received a $6 million distribution during the quarter from our investment in the prime portfolio. In a moment, Paul, will explain the account [intriguement], but beyond the impact on the quarterly results, this distribution validates the continued performance of our equity investments, one of the key differentiators of our business model.

Prime refinanced a portion of the properties in the portfolio and the excess proceeds were distributed, 6 million of which came to us. To date we have received four distributions totally approximately 44 million in cash and have recorded approximately 42 million of income from these distributions. This is a significant return by anyone's standards and currently there is additional volume in the portfolio above the outstanding debt.

As existing debt agreements mature there will be additional opportunities in the portfolio to refinance ourselves in those properties and will participate in those economics as well. In addition, the distribution for prime were tax deferred, allowing us to reinvest a significant portion of this capital into new investments, creating consistent core earnings growth. We currently have 11 of these investments in our portfolio of various sizes and values.

As previously discussed, given current market values, our objective is to monetize our equity kickers where appropriate and a prime investment is a perfect example how these equity and interest can contribute to our bottom line, increase our book value and capital base, and further enhance franchise value.

As many of you already know, we've closed our third CDO in mid-December and we were very excited about the latest print. The third CDO was a $600 million transaction, including the issuance of 548 million of non-recourse investment grade debt, resulting in leverage of approximately 91%.

The notes have an initial weighted average spread of approximately 44 basis points over three month LIBOR and have a five year replenishment period. The $548 million of debt included $100 million revolving credit facility, which allows us to deploy the CDO cash more efficiently increasing the returns on our equity.

As mentioned earlier, the CDO financing platform has transformed the way we approach our business, giving us the ability to enhance our product offerings and fund the majority of our investments with CDO debt. They have also reduced our bond costs and increased leverage where appropriate, resulting in superior returns on our investment.

In the fourth quarter we hit a new milestone by achieving the highest quarterly loan volume in our company's history. We closed $593 million of new loans and investments of which 560 million was funded. We experienced 197 million of run-off this quarter, of which 14 million was obtained in new loans and 183 million were either sold or refinanced outside of Arbor. This resulted in net growth in our portfolio of 24% for the quarter and 60% for the year which is above and beyond the 50% portfolio growth we experienced in 2005.

We believe that the significant growth in our portfolio over the last two years reflects the strength of our originations network and the expanded product offerings available to us a result of our CDO's.

The overall targeted annual net growth rate in our portfolio is 15 to 25% which we have significantly exceeded in the last two years. With a portfolio balance in excess of $2 billion, we believe our targeted range, which translates to net growth in our portfolio of 75 to 125 million a quarter is appropriate for 2007.

Over the last few quarters we've received questions about the condo concentration in our portfolio. As of December 31, 2006, our condo concentration was approximately 21%, with 15% in New York. With plans to potentially redevelop the Toy property in New York City as an [oft] to multi-family property and a change in strategy with one our Florida condo properties, back from multi-family building, our condo concentration will be approximately 12%. 10% of this concentration is in New York City, which continues to be a stable market.

And we now have no outstanding condo projects in Florida. Furthermore, of the 10% concentration in New York, 75% of our at risk loan balances are secured by pre-sold units, with significant non-refundable deposits, leaving only approximately 2.5% exposed to the market.

As mentioned in the press release, we do have one loan in our portfolio that is currently not performing. It is an $8.5 million participation in a first mortgage loan on a multi-family property located in Michigan. The fair market value of the property is currently in excess of all outstanding debt and included interest. And we feel confident in our ability to resolve the issues, resulting in full recovery of the loan balances, including any unpaid interest.

Overall our portfolio remains extremely healthy, a direct result of our disciplined underwriting philosophy and dedicated asset management function. We continue to add depth and experience in our asset management department which currently consists of 21 employees who we believe grow in this function in line with the portfolio growth to believe to be a vital component in assuring a profitable performance of our loan investment portfolio.

We continue to see a abundance of capital in the commercial real estate lending market, which remains extremely competitive. We remain committed to our strategy of originating transactions more in the middle of the capital stack, thus improving the credit quality of our portfolio.

In fact, at December 31, 2006 approximately 65% of our portfolio consists of loan of first lien positions, up from around 50% at the same time a year ago and a loan to value of our portfolio was 69% at December 31, 2006 compared to 72% a year earlier.

More significantly, our weighted average median dollar outstanding in our portfolio has declined 16% from 57% at December 31, 2005 to 49% at December 31, 2006. Although this strategy has put some pressure on our margins, these assets create additional stability in our portfolio and through reduced borrowing costs increase leverage where appropriate and provide us superior risk adjuster returns.

Consistent with this strategy with increased the amount of longer term fixed rate loans in our portfolio to approximately 25% at December 31, 2006 from approximately 20% at the same time last year. This increase reflects nearly $265 million of new fixed rate loans in 2006.

These loans generally include pre-payment protection and by swapping out the rates in our CDO's we're apply to lock in spreads creating a more stable return for our portfolio. Our goal is to continue to increase the fixed rate portion of our portfolio in the future.

Lastly, I wish to emphasize that our manager, Arbor Commercial Mortgage, has once again elected to take 100% of its incentive management fee in stock coming out of pocket to pay the taxes related to this compensation. To date, the manager has approximately 20% ownership interest in Arbor and increased its ownership interest from 2% from the prior year.

As we've stated many times, the manager believes in the long term value of Arbor's common stock and is extremely committed in keeping interest aligned with the shareholders.

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 $0.84 per common share on both the basic and fully diluted basis. Obviously there was a big impact on the $6 million of income we recorded from the Prime investment. The details of the accounting related to this transaction were laid out in the release.

As Ivan mentioned, we have now received approximately 44 million in cash and recorded approximately 42 million of income from this one investment. As we've stated many times, 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 have over time.

In addition, the Prime distribution is not taxable at this time and is therefore not required to be distributed to shareholders immediately. We will reinvest these funds and create a steady earnings stream which is consistent with our philosophy of creating long term shareholder and franchise value.

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 348 million from last quarter. As a result, our core interest margin increased 1.1 million, a 7% increase from the third quarter.

The yield for the quarter on these core investments is around 10.15% compared to 10.63% for the third quarter. As you may recall, our yield on core investments is approximately 10.44% for the third quarter, excluding income from the acceleration of fees and IRR lookbacks, which happen frequently and are part of the normal cost of our business. Comparatively, our yield on core investments is around 9.93% this quarter, excluding similar items.

You may recall that the yield on the loans paid off in the third quarter were higher than the yield on the new loans we put on. We saw the full impact of this during the fourth quarter and this situation occurred again on our new guidance.

Our average cost of funds decreased 13 basis points from 7.24% for the third quarter to 7.11% for the fourth quarter. This was primarily due to reduced borrowing costs as a result of the closing our third CDO in mid-December.

When fully utilized we expect the addition of our third CDO to reduce our borrowing costs by approximately 50 basis points on these CDO assets. We are also in the process of negotiating a reduction of our borrowing costs on the existing facility and expect to finalize this agreement by the end of the first quarter.

In addition, the average balance in our debt facilities grew by 357 million from last quarter. The average leverage in core assets was around 77% for the fourth quarter, up from 71% for the third quarter. Including the trust referred to as debt, the average leverage was 89% for the fourth quarter, as compared to 85% for the third quarter.

Our overall leverage ratio was 2.7 to 1 at December 31st as compared to 2.1 to 1 at September 30th. If you include the trust referred securities as debt, the overall leverage ratio was 5.0 to 1 at December 31st and 4.0 to 1 at September 30th.

The increased leverage is predominantly due to our ability to effectively originate higher credit quality loans more in the middle of the capital stack. This allows us to reduce borrowing costs and increase leverage where appropriate, generating superior risk adjusted returns.

On the last few calls we have spent some time discussing the restricted cash balances related to our CDO's and the impact they've had on short term earnings. With the addition of our third CDO we now have total outstanding assets in our CDO vehicles of approximately $1.5 billion.

We believe the optimum level of restricted cash on average to be around 6 to 10% of the outstanding assets in our CDO's, which translate to around 90 to 150 million a quarter. The average balance of restricted cash was approximately 110 million during the fourth quarter compared to around 90 million for the third quarter.

We anticipate our average restricted cash balance for the first quarter of 2007 to be within that optimum range. This would be a tremendous accomplishment considering our third CDO had a cash ramp up feature of approximately $134 million and closed late in the fourth quarter.

We are extremely focused on managing the restricted cash balances in our CDO's and with the addition of $100 million revolver in our weighted CDO, we feel confident in our ability to maintain the excess cash balances at the appropriate levels.

Operating expenses were fairly flat as compared to the previous quarter, with the exception of the incentive management fee which was significantly higher than last quarter due to the gains in the Prime transaction. Our manager has opted to take the entire fee in stocks, which represents more than two times the amount they took in previous quarter.

Finally, I'd like to point out we did include the schedule summarizing our equity participation interest and our [facts] this quarter. As the press release described, we recorded approximately $700,000 of income on an IRR lookback related to one of our loans during the quarter.

We accrued the IRR lookback through December 31, 2006 because it was deemed collectible. On January 2, 2007 the loan paid off and we received the IRR lookback in full.

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

Thank you for that presentation. [OPERATOR INSTRUCTIONS]. The first question comes from the line of Don Fandetti representing CitiGroup. Please proceed.

Good morning. Question on this non-performing loan. Can you provide a little bit more color on what the asset, what the property type was when you put the loan on and also are there fees that you've accrued on this asset and some of your balance sheet items that could be at risk if the asset is written off?

Hey Don, its Ivan, how are you?

Fine, thanks.

First of all, the asset's a multi-family asset in Michigan and it's probably a C+, B- asset. A very well known sponsor came in and tried to invest a considerable amount of dollars and change it to a A asset, which was a very, very poor strategy. And we positioned ourself in the capital structure where regardless of whether their plan was successful or not, we'd still be well in the money on an equity basis.

From a strategic standpoint, these are the kind of assets and these are the kind of positions that we look for because in the event that they're successful, we get paid the deal we bargained for and in the event they're not, we get to position ourselves to control the asset in debt and actually controlling the debt is really puts us in a favorable position.

There is no at-risk dollars at all on our balance sheet. We are fully in the money and we look forward to these type of opportunities to control the debt, restructure the debt, and charge significant fees and lock in long-term spreads.

So we're actually find these to be the kind of opportunities we like to look for. We know the outfit extremely well and what we're exactly where we want to be, we'd like to have 15 more of these.

Alright. When did you put the loan on the Boston, was it a watch list asset?

I'm not sure exactly when we put the loan the books, Don. I'd have to go back and look. We were watching this asset over the last couple of months, not from a standpoint of value, but as Ivan mentioned, from a standpoint of them being able to execute their business plan.

But the assets value has never been an issue and that's why we do not have a loan loss reserve for this asset. There's plenty of value there. But I'm not recalling when exactly we put the loan on our books.

I've been paying attention to it for the last two months or so, three months.

Was it, I'm just trying to get a sense. Was it something you did, maybe within the last year? Or was it pre-IPO?

No, no, no; it's probably, off the top of my head, we'll get an exact answer, probably 12 to 15 months.

Okay

Somewhere in that range. On this particular asset we have three different sponsor operators who are prepared to come re-capitalize the project and allow us to lock in a debt spread we want. It's now our decision to decide who we want to bring in and how much equity we want to retain since we're going to, hopefully, be in position to control the assets.

I guess this wouldn't be the bar or you don't have other exposure to them. Is that a fair statement?

That's correct.

Okay. Alright, if I could just ask for an update on your current watch list and sort of how you think about credit in general, today versus a year ago?

Yes, we don't have a single loan on our watch list. Portfolio continues to improve. One of the key indicators which we now added to the information we're providing is where our median dollar is. And our median dollar is probably -- could be one of the best indicators. We dropped our median dollar almost 16% and that's really considerable.

So, our average dollar on lending is around 49%. We're really, really comfortable with our portfolio. There's no loan, other than this loan, that is currently at any level on senior management's desk being reviewed and evaluated.

There's nothing that has come to that attention. This Lake in the Woods has gotten senior management attention. And on all levels we're extremely comfortable with it. And our portfolio is in far superior position than ever before.

And I say that, and it should be taken into consideration, that we also feel that there is some declining fundamentals in the market. So even with that we're stronger than when it was a healthier market. So we really anticipated what we felt the market, where it would be and how we should be structured.

And, Don, just this is Paul to add, as well as the median dollars outstanding and the loan to value another good metric is debt cover. And our debt service cover is at 127 the end of December; back in September it was at 124. The market's been pretty flat, but we've seen improvements both in the credit quality of the portfolio from a standpoint of origination and in increased values on the properties.

Okay. Thanks a lot.

The next question will come from the line David Fick representing Stifel Nicolaus. Please proceed.

Good morning. Can you give us a little bit more detail on the Florida condo conversion that apparently still out to an operating status instead? What market are we talking about and what kind of coverage do you have there, is it cash flow positive against your debt and so forth?

Sure. That actually was a fairly similar circumstance to the one we just talked about, where it was extremely strong sponsorship. Our position was underwritten on a multi-family basis. It was a condo in, I believe Clearwater, Tampa, which is Tampa. So our lending dollars worked as a multi-family. The sponsors tried to execute a condo strategy, which was not going successful and they had to re-trench.

And given the significant dollars they had in, they had to come back to us to restructure our debt. And I believe we actually went out and bought the first debt. Took our debt, combined them and made a first mortgage loan, locked in a significant spread on a fixed rate basis, got the sponsor to enhance our position. And I believe on a fully stabilized basis we should be at about 115 cover on our debt.

But we locked in a real nice spread and I think put on a five year fixed rate loan. So, that's a really great example of our ability to take control over the asset, control the debt, enhance the, enhance our returns by locking in good spreads by controlling the position.

That's been financed out internally. Is that the kind of thing that you could dump into your CDO pool?

It's in.

Okay. Great. The next question is on your kickers. And I know this is always difficult for you and it's frustrating to all of us that, as far as for the street to place value there. Specifically with respect to the Prime remaining kickers.

Do they still have outstanding then what they previously referred to as their mega-loan with all the cross collateralizations they can still, I think they looked to be freed up in early '08. Is that correct?

I believe the mega-loan was freed up a while ago.

Okay. So, how would you categorize sort of the timing and magnitude of the remaining kicker out of Prime?

Well, the Prime is a significant operating company and there's a lot of growth within that company. So, a lot of our centers have opportunity to expand and improve. And I guess a function of value is how quickly that [outer] line grows, number one.

And the other item is there are certain debt [confidences] that when they come off, the assets can be refinanced. I can't really predict what the distributions will be, they'll be distributions from operating profits and they'll be distributions from re-fi. So that is something that is hard to predict.

I can only say that we've gotten over $40 million in distributions. Some out of operating, some out of re-fi. And I'm very optimistic in terms of growth potential of that enterprise. I think we're second or third leading factory outlet centers in the country and we continue to grow, claiming market share and improve all our centers. So it's just a great operating enterprise with a lot of upside potential.

I agree, we think you guys have done a great job with that portfolio. Along those lines, have you been or are you currently actively involved in underwriting activities with respect to a portion or all of the Mills Corp?

The Mills, the mills, mills. Which mills? That's the private to public deal?

Yes. Well the Mills Corporation. I know that Life Stone was one of the bidders.

Yes, we bid on that deal with Life Stone. So we're not looking at any of the debt on that company. But that's a portfolio we're actually joint venturing with them and we came short of what the ultimate price was.

So as far as you're concerned, you're out of that and they're out of it?

That's correct.

Okay, thank you.

You're next question will come from the line James Shanahan representing Wachovia. Please proceed.

Thank you, good morning. In recent weeks there's been some banter in the marketplace related to 450 West 33rd and Toy, that these buildings are being shopped, etc. We're hearing just yesterday that West 33rd had sold for $700 million.

If that were true, can you comment on what the gain would likely be to Arbor shareholders? Because I guess [we need] an education here on how it works with the $2.7 million equity investment and the 28% profit participation interest.

Just a quick comment on a few of those items. First of all, clearly if the assets were sold at that level, the gains would be extremely material. And if there was a material event of this magnitude, we would schedule a conference call and discuss the impact and as soon as we'd be in a position to do that we'd schedule that call.

It's interesting because there's a lot of bad dirt in the news and everybody's been listening to my conference call, it is our objective to monetize our division with active trading at these kind of cap rates. We would love to do that, where appropriate.

In terms of what the potential gain would be, at that kind of level, I'll turn that over to Paul.

James, just to clarify on the 2.7 million I think you referred to. That was a preferred equity slug that we had in the deal. We're entitled to a 12.5% return on that $2.7 million and in addition to that, we have 28% profit interests in the deal. So certainly if something was to happen, depending on the structure, that would be the way the economics would break out.

[Do you have more basis on the deal?]

Our equity basis is 2.7 million.

What's the total basis of the property?

The total debt on the property is 350 million.

And the total equity invested is in the 225 range. Is that right?

225 what?

Is the equity, the common equity investment in the property, what is that number?

There's about 5 million.

That's total common equity investment is 5 million.

At this point. If you remember, we did a refinance back in 2005 and a bunch of the equity was returned to all the partners.

So $700 million dollars, almost $350 million gain?

That would be the gross gain. Of course you have extension of taxes, the fees and pre-payment penalties, transaction costs which would probably be around 60 or $70 million.

Okay, thank you very much. May I ask a follow up actually?

Sure.

There is a discussion of this change in strategy; you were talking about the condo conversion loan to multi-family. This is the loan to which David Fick was referring, is that correct?

That's correct.

Okay great. Just to clarify. Thank you very much.

That's already been accomplished.

Yes that actually happened yesterday so we were able to get that deal done yesterday.

Thank you.

[OPERATOR INSTRUCTIONS] Your next question will come from the line of [Dean Chuxley] representing Lehman Brothers. Please proceed.

I have a question around the origination. It looks like the average size of your loans increased. Any sort of dynamic going on in there?

Yes, I think what you will see is our ability to do, number one, compete more effectively on the senior loan side and do larger loans more effectively [as part] of our CDO's. So we've increased the percentage of our first mortgage loans. And because of our leverage ability and our CDO's and our cost of funds we can more effectively compete for a portion of business that we weren't that active in in the past.

And that's consistent with the guidance of 50 to 75 million?

Dean, as you've heard the remarks, we've talked about how the portfolio is grown now to $2 billion and our guidance of 15 to 25%, which we're still comfortable with, that translates to around 75 to 125 million in net growth a quarter. Obviously as the portfolio grows that [FOE] grows as well.

Okay. Thank you

There are no further questions at this time. I would like to turn the call back over to Mr. Ivan Kaufman for closing remarks.

Okay, well it's been a fantastic year for us and we look forward to 2007. Thank you, everybody, for participating in today's call.

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