Arbor Realty Trust Inc (ABR) 2007 Q1 法說會逐字稿

Good day ladies and gentlemen, and welcome to the First Quarter 2007 Arbor Realty Trust Earnings Conference Call. My name is Eric, and I will be your coordinator for today.

(OPERATOR INSTRUCTIONS)

At this time, I would like turn the presentation over to our host, Paul Elenio, Chief Financial Officer. Please proceed.

Thank you Eric, and 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, 2007. 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 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 the 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 replace undue reliance on these forward-looking statements that 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'd now like to turn the call over to Arbor's President and CEO, Ivan Kaufman.

Thank you Paul, and welcome everybody.

As you take a look at our press release this morning, the strong operating results for the first quarter reflect a solid execution of our business strategy and the focused objective of our company.

We are, first and foremost, committed to enhancing the long-term value of our franchise and maximizing shareholder value.

Paul will review the financial results with you in a few minutes. In the meantime, I'd like to update you on the progress we're making in building and growing our franchise.

It has been well over a year now since we established some very critical objectives that were imperative for us to achieve.

They were imperative, because we needed to execute them properly in order for us to appropriately position our company in a very dynamic and competitive environment, and environment that is growing increasingly competitive, marked by increased liquidity in the marketplace.

So, achieving these objectives was very important for us to be able to execute our strategy appropriately.

Some of these objectives were, given the market values -- to monetize our equity kickers where appropriate and recycle as much of that capital as possible to fund the growth of our business; to transition our portfolio to higher quality credit more stable assets by originating a substantial amount of fixed rate loans and whole loan product; to focus on improving the right side of our balance sheet and capital base, allowing us to originate loans throughout the capital structure more efficiently and with greater flexibility; and to decrease the amount of condo concentration in our portfolio.

I'm pleased to report that we've accomplished many of these objectives while continuing to grow our EPS and dividends. So, I want to take a moment to review how we've achieved some of these objectives and the continued progress we are making in these areas.

I will start with one of the key elements of our business model, our equity kickers. We've always used these investments as a critical component of our business and one of the unique ways we've truly distinguished ourselves from our peers.

As I've mentioned several times, we would look to monetize these equity kickers where appropriate. To help demonstrate the success we've had in this area, I'd like to review some of these transactions.

First, we've received four distributions totaling approximately $44 million from investment in prime retail portfolio. And we believe this portfolio has significant value and appreciation above what we've received to date.

Second, we created another equity kicker in June 2005 derived from a highly structured transaction with one of our repeat customers. This was on an upscale boutique hotel in Manhattan known as On the Avenue.

In addition to receiving strong returns on our mezzanine and preferred-equity loans, we also received a $16 million distribution during the first quarter relating to our 33% profits interest in this transaction.

And recently, we've announced that we've entered into contract to sell one of the Toy Buildings as well as the 450 West 33rd Street building in Manhattan.

These contracts are expected to close in the second quarter and when complete, will result in us receiving around $100 million in capital from these kickers in a six-month period and about $140 million of capital since we transitioned to a public company in 2004.

This is a clear illustration of the significant value we've generated from these investments.

We were also able to add a new equity kicker to our portfolio during the quarter. This equity kicker is in the form of a 25% profits interest as part of a $7 million loan we originated on a multi-family property in Indianapolis.

The borrower is an experienced owner/operator and one of our repeat clients. This brings the total number of equity kickers in our portfolio to 11.

In addition, we have others in our pipeline including a potential 50% kicker on the Lake in the Woods deal, which is currently being restructured.

This demonstrates our unique ability to add transactions to our portfolio that will allow us to share in the upside of real estate while -- which continues to be a major component of our business model.

Overall, our equity kickers have had several benefits to us. First, they contribute greatly to our earnings and book value per share.

And in fact, the On the Avenue, Toy and 450 West transactions alone will contribute around $4 per share to our book value.

Second, they generate significant tax-deferred cash proceeds, which allow us to grow our business by investing these funds, and new loans and investments create a consistent earnings growth.

Finally, these cash distributions greatly increase our capital base without diluting our current shareholders, which allows us to be very selective in issuing additional equity.

The market remains extremely competitive, and we continue to execute our goal of transitioning our portfolio by originating loans more in the middle of our -- the capital structure.

In doing so, we are constantly improving the overall credit quality of our portfolio, further insulating us from credit deterioration in this volatile market.

In fact, loans in first lien position represented around 75% of our first quarter originations and about 55% of our portfolio as at March 31, 2007, compared to around 30% of our portfolio on the same date in 2006 and 2005.

And the loan to value of our portfolio was 60/70 -- 67% March 31, 2007, compared to 69% the previous year and 70% -- 69% in December 31, '06, and 70% at March 31, '06.

Even more significant is that our weighted average median dollars outstanding in our portfolio has declined 18% from 57% at March 31, '06, to 47% at March 31, '07.

The duration of our portfolio has also increased considerably from 26 months at December 31, '06, to 31 months at March 31, '07.

This strategy has reduced the yield in our portfolio, which we expect to continue over the next several quarters as some of our higher-risk, higher-yielding loans continue to prepay.

We'd much rather sacrifice some yield for higher credit quality, especially in today's tenuous environment.

We believe transitioning our portfolio to higher credit quality and more stable assets serves us far better over the long term.

As a result, we continue to reduce borrowing costs and increase leverage where appropriate, providing us with superior adjusted returns.

We remain focused on increasing the amount of longer-term, fixed-rate loans, which represent approximately 27% of our portfolio at March 31, '07, up 2% from December 31, '06. This quarter, we originated $178 million of new, fixed-rate loans.

These loans create a more stable return for our portfolio, because they generally include prepayment protection. And by swapping out the rates in our CDOs, we're able to lock in attractive spreads. Our goal is to continue to increase the fixed-rate cost of our portfolio.

We also continue focus on improving the right side of our balance sheet and our capital structure, clearly laying the foundation to allow us to operate more efficiently and with greater flexibility.

With $1.2 billion of debt outstanding in three CDOs, we have enhanced our product offerings and can originate loans throughout the capital structure more efficiently.

We've also reduced our borrowing costs and increased leverage where appropriate, resulting in superior returns on our investments.

And market permitting, we will look forward to issuing another CDO some time in the fourth quarter of this year.

In April, we increased the capacity with one of our warehouse facilities by $275 million. We improved our advance rates and reduced borrowing cost by 25 to 50 basis points in this facility.

We also issued approximately $52 million of trust-preferred securities at 2.43% over LIBOR. To date, we've issued approximately $270 million of trust-preferred securities, which continued to provide us with a lower-cost alternative to raising equity.

Our originations network is very deep and versatile. This quarter, we added $570 million of new loans and investments, of which about $530 million was funded.

We experienced $270 million of runoff this quarter, of which $115 million was retained in new loans and $154 million was either sold or refinanced outside Arbor.

This result in net growth in our portfolio of 14% for the quarter.

Once again, we achieved a significant growth while continuing to prove the credit quality of our portfolio, generating superior risk-adjusted returns.

Since this growth was heavily weighted towards the end of the fourth quarter, we will receive the full benefit of the income on these investments going forward.

We do not expect payoffs in the second and third quarter to be -- we do expect payoffs in the second and third quarter to be higher than in the first quarter but feel confident, based on the strength of our originations network, upping our guidance from an annual net growth rate of 15% to 25% to 25% to 40% for 2007.

This translates to net growth in the portfolio at $75 million to $175 million a quarter for the remaining three quarters of '07.

With the contract we entered into to sell one of the Toy Buildings and the plans to either redevelop the remaining buildings into rentals or marketers for sale, our condo concentration is now approximately 10%, with 9% in New York.

Of the 9% concentration in New York, approximately 90% of our risk loan balance is secured by pre-sold units with significant, non-refundable deposits, leaving only around 1% exposed to the market.

And in April, a $37 million loan on a condo project in New York paid off, reducing our condo concentration to approximately 9%.

This reduction in our condo concentration will allow us to take advantage of a lack of liquidity in that sector and pursue some very good [alt] opportunities going forward.

Overall, our portfolio remains extremely healthy, and we continue to add depth and experience to our dedicated 21-person asset management team. We are firm believers in growing this area in line with our portfolio.

We know this function is a critical part of our business to ensure the profitable performance of our loans and investment portfolio.

Last quarter, we spoke about an $8.5 million non-performing loan in our portfolio known as Lake in the Woods.

In line with our plans to take control, take control and recapitalize this asset, we purchased the remaining portion of the first mortgage debt of approximately $36 million in the first quarter.

In April, we accepted a deed in lieu of foreclosure and identified a group of experience operators who will purchase roughly a 50% interest in exchange for approximately $3 million of new equity.

Our intention is to restructure and retain the first mortgage debt and an approximately 50% profits interest in the property.

The ability to reposition its assets and create a loan with a strong risk-adjusted return while retaining potential upside in the real estate is a direct result of our underwriting this asset initially at the right levels and having experienced hands-on asset managers and real estate professionals in-house. We've maintained our basic credit philosophy.

We will not make a loan unless we are prepared to own the asset if the need arises, as in fact we did with this transaction.

I wish to emphasize that our manager, Arbor Commercial Mortgage has, once again, elected to take 100% of its incentive management fee in stock.

To date, the manager has an approximate 21% ownership interest in Arbor and believes in the long-term value of Arbor's common stock. And it is extremely committed to keeping its interests aligned with shareholders.

And finally, I want to take a moment to welcome John Bishar to our Board as a new independent Director.

John currently holds a very significant position of Executive Vice President, General Counsel and Chief Governance Officer of KeySpan Corporation, an S&P 500 company and long been a distributor of natural gas in the northeast.

I've had the privilege of working with John as a Board member on another public company in the past and am very pleased he is joining us. John brings tremendous Board experience, especially in areas of real estate governance and compliance matters.

We look forward to his guidance and am sure he will make a very significant contribution to the company.

Now, I am pleased to turn over -- turn you over to Paul to review 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 $0.97 per common share on a fully diluted basis.

Obviously, there was a big impact from the $16 million distribution we received from our equity kicker in the On the Avenue property.

This equity interest was owned through a corporate subsidiary, and the income is subject to corporate tax.

After providing for a tax provision and the incentive management fee paid to the manger, we recorded approximately $7.4 million in income during the quarter related to this transaction.

We have had a positive impact from one or more of our equity kickers in ten quarters now and have recorded income from these investments in seven quarters.

In addition, as Ivan mentioned, once we close the Toy and 450 West 33rd Street deals, we estimate that we will receive around $100 million of capital in a rather short period of time from these investments.

We estimate that this will increase our economic book value per share to approximately $21 from around $17.

Our equity kickers will have contributed about $6 in book value per share since we have been a public company.

Equally important has been our ability to structure these deals in a tax-efficient manner, which allows us to retain a substantial amount of this capital to invest in new loans and investments creating a steady earnings stream.

We realize that the monetization of these equity kickers may cause our earnings to be lumpy, however, these investments are clearly a significant part of our business model and have contributed greatly to our bottom line, capital base and liquidity, 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 $221 million from last quarter, primarily due to the significant growth we achieved in the fourth quarter.

As Ivan mentioned, our portfolio growth of $278 million was heavily weighted towards the end of the first quarter, which means we will receive the full economic effect of this growth in future quarters.

The yield for the quarter on these core investments was around 9.68% compared to 10.15% for the fourth quarter.

Our yield on core investments was approximately 9.93% for the fourth quarter excluding income from the acceleration of fees and IRR look-backs as compared to a yield of around 9.47% this quarter excluding similar items.

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

In addition, the weighted average all-in yield on our portfolio was 9.07% at March 31, 2007, down from around 9.56% at December 31, 2006.

As we've mentioned several times, we continue to improve the credit quality and stability of our portfolio by focusing on loans more in the middle of the capital structure.

Our unique ability to garner equity kickers has not only significantly increased our bottom line and capital base, but it has also allowed us to improve the credit quality of our portfolio while continuing to grow earnings.

This strategy has resulted in lower yields in our portfolio as some of our higher-yielding loans continue to prepay. The first quarter yields reflect our disciplined approach of increasing the credit quality and stability of our portfolio.

This is based on the opportunities we are seeing in the market from a risk-adjusted basis, and with 75% of our first quarter volume being first lien loans clearly reflects our view in today's market.

As we've mentioned, we do expect this trend to continue over the next few quarters. But, with the increases in our leverage and reduced borrowing costs, these higher credit quality investments generate excellent risk-adjusted returns.

In line with this strategy, we continue to focus on reducing our borrowing cost, which decreased 22 basis points this quarter from 711 for the fourth quarter to 689 for the first quarter.

This was primarily due to realizing the full effect of the reduced borrowing cost from our third CDO, which closed in mid-December.

In addition, as Ivan mentioned, in April, we successfully negotiated a reduction in our borrowing cost on one of our existing warehouse facilities by 25 to 50 basis points, depending on the type of investment financed.

The average balance on our debt facility grew by $258 million from last quarter, $37 million more than the increase in our average core investments.

This was primarily due to a $28 million increase in the average restricted cash balance in our CDOs from $109 million in the fourth quarter to $137 million in the first quarter.

The average leverage on core assets was around 81% for the first quarter, up from 77% from the fourth quarter.

Including the trust preferreds as debt, the average leverage was 92% for the first quarter as compared to 89% for the fourth quarter.

Our overall leverage ratio was 3.1 to 1 at March 31st as compared to 2.7 to 1 at December 31st. If you include the trust preferred securities as debt, the overall leverage ratio is 5.6 to 1 at March 31st and 5.0 to 1 at December 31st.

The increased leverage is 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.

We do expect our leverage ratios to decline in the second quarter due to the $51.5 million of trust preferred securities we issued in April and the monetization of the Toy and 450 West 33rd Street equity kickers, which will add significant capital to our equity base.

There were no other significant changes on the balance sheet, but I'd like to point out that we did sell our MBS pools during the quarter as they were no longer needed for the regulatory purposes they were purchased for.

Operating expenses were fairly flat as compared to previous quarters with the exception of the incentive management fee, which was higher than last quarter due to the gain from the On the Avenue transaction.

Once again, our managers offered to take the entire fee in stock. We did include the schedule summarizing our equity participation interest in IRR look-backs this quarter.

As Ivan stated, we originated another investment with an equity kicker. This brings the total number of equity kickers in our portfolio to 11.

As we've stated many times, these investments have contributed greatly to our bottom line liquidity and capital base and are a significant component of our business model.

Finally, on an unrelated note, you may have seen in our proxy filing that we issued additional restricted stock grants of approximately 111,000 shares on April 2nd, 2007.

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 ensuring four years.

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

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Jim Shanahan with Wachovia.

Thank you, good morning.

Hi.

Good morning, Jim.

I've got some questions about funding, and I appreciate the comments about the renegotiation of the financing agreement.

But, we calculate your weighted average cost of funds near about 688, 690 or 156 basis points over LIBOR in the first quarter. And meanwhile, a comparable company, Grammercy, is closer to about 105 over. It's about 50 basis points cheaper all-in.

Are there other steps that you can take over the next two to four quarters to drive down those funding costs? It looks like you have additional repurchase agreements, bridge loan, warehousing facilities, credit facilities that are up for renewal throughout this calendar year.

But, I'm also referring to CDOs, older, higher-cost, trust preferreds or loan participation agreements. Are -- is there any opportunity to renegotiate or call in those debt and loans, et cetera?

I think one of the things that you have to be aware of is that sometimes, the type of collateral that you have drives your cost of funds. And one of the benefits that we have in our first two CDOs, even though they were a little bit higher cost of funds, we have the ability to do more B notes and mezzanine and preferred equity in those two CDOs.

And it's our intention, even though they may be pre-payable in a short period of time, to leave them outstanding because one of the things that's happened in the market, it's harder and harder to finance B notes, mezzanine and preferred equity, given some of the dislocation that's occurred in those markets.

So, we think that even though our cost of funds may be higher in certain areas, it affords us the ability to do some higher off-paying loans in the future. So, we'll be a little cautious about that.

But, as we do originate more whole loans, I think that relative to the financing cost on those whole loans, it will be a little cheaper. And you'll see some level of decrease overall, cost of funds as the proportion of whole loans becomes greater and greater.

Can we assume then that the CDO you referred to in your prepared remarks, Ivan, that that will resemble more CDO III with the level of leverage and the funding costs that you achieved in the CDO?

Yes. As I came in the market today, it will -- it'll be even a little bit more towards whole loans. The market, if you do a CDO today, is not really accepting a lot of B notes. Mezzanine is purely a whole-loan market CDO. So, I think that assumption's absolutely correct.

Okay. And one question, then I'll be happy to get back in the queue. But, the Toy and -- building, the remaining property there, you've talked about turning it into a rental. It's also being rumored in the marketplace to also still be for sale.

Do you -- what else can you tell us about that? And what is -- maybe put some probabilities on whether that will be retained as a rental or sold during the course of 2007?

Hey look, we really comment on that. But, to the extent that the market's aggressive, we'd certainly entertain similar execution that we've had on other assets. And it just becomes an analysis for us with our tax basis, which is best execution, which is stuff that we're evaluating now.

I think our focus clearly is executing the tremendous task of getting these major assets closed in this environment. And as you know, the capital markets environment is a little tenuous. So, our focus really is on completing the execution that we set forth several quarters ago.

Thank you.

Your next question comes from the line of David Fick with Stifel Nicolaus. Please proceed.

Good morning. As you guys have moved up that quality stack in your lending profile, you're obviously taking on more debt. And you can do that because of the nature of the security underlying the debt.

How far though -- to some extent, you're trading off balance sheet risk for credit risk. And obviously, that's probably smart in this environment. But, how far are you willing to go with that in terms of your leverage and debt to equity?

I think -- David, it's Paul. I think that, in my remarks, we talked about how we've done a -- I think a real good job of recycling capital from these equity kickers. And we have a bunch that are monetizing this quarter.

We talked about Toy and 450, and that and the trust preferreds, we've been able to access that market very effectively with what we think are very good rates in the sector.

I think that we'll be able to decline that leverage a bit in the second and third quarters by recycling all that capital and using that capital to fund into our loans instead of increasing the debt side.

So I think, at least over the next couple of quarters, we'll do a real good job of recycling that capital and continue to have that as part of our strategy. And then, we'll take it from there.

Okay. You guys participated in the Lightstone deal to buy extended stay. And I was just wondering if you could talk about the scope of the deal and the nature of any equity kickers? Is this going to be like the prime retail deal? Or, is it different?

Well, we really can't comment on that at this moment. Hopefully, we'll be able to have a comment on that in the near future.

Okay. And then, I guess lastly, your dividend policy for the balance of the year, where do you see it going? And do you see any potential for any special dividends out of these equity kickers?

I think the dividend policy has been to distribute out more in line with the earnings. Absent some of the equity kickers, we -- again, we've done a good job at recycling the capital.

The dividend we have currently right now does have a small component of return of capital in it.

So, we are able to monetize some of these equity kickers that may be taxable and offset them against that return of capital and keep the dividend pretty steady. As far as there being potential for a special dividend at the end of the year, that -- we still need to go through the numbers.

A lot is going to depend on how much of the Toy is a taxable gain, how much of 450 would be taxable at all. A piece of that could be taxable, and I think we're still putting those numbers together.

So, it's tough for us to discuss what would happen at the end of the year. It's really going to come down to what our taxable income looks like and what we've distributed out to date in a dividend.

Do you think you'll have a better handle on that next quarter?

I think we will. I think we'll have a much better handle on that next quarter after the Toy transaction and the 450 transaction close.

We'll also be a little bit deeper into the year, and we'll have a better understanding of what some of the book tax differences, the shelters we get from the other equity kickers that we have in the portfolio. I think we'll be in a much better position to talk about it.

Okay, great. Thank you.

(OPERATOR INSTRUCTIONS) Your next question comes from the line of Don Fandetti with Citigroup. Please proceed.

Hi, good morning everyone.

Hi.

A couple of quick questions Ivan, it seems like over the last year or two, the banks have been very aggressive in providing and cutting their costs on their warehouse loans as they have a good exit through the CDO market.

Is there any risk that that could go the other way? Or, are the banks effectively still very aggressive on that front, any thought process there?

I think that as long as you have CDO shelves up and running that I think that those cuts will remain in place. And I think to the extent that you don't have that CDO exit, those could be in jeopardy.

So, we're fairly confident that the savings that we've been able to achieve, we should be able to maintain because we have the CDO shelves outstanding as exits for all our loans that come in.

So, I would be more concerned with companies who aggregate in collateral to create a CDO that has not put a CDO off yet and don't have any exit for that collateral. I think that -- that's an appropriate comment for the marketplace to consider.

And for companies like ours and Grammercy and some of the other ones, we have more than that of a capacity within our CDOs and enough to fund our volume and provide our significant outlet for the warehousing market.

Okay, great. And just on the Q1 production, can you just provide the mix of direct versus bought from the street?

Don, I think those numbers are about 50% direct and 50% purchased for the quarter.

Okay, great. Thank you, very much.

Your next question comes from the line of [Dean Chopli] with Lehman Brothers. Please proceed.

Can you kind of talk about what your future equity kickers look like? I guess, and kind of how the composition by asset and geography has changed over the last couple of years?

Dean, are you referring to the equity kickers that are in the portfolio currently?

I guess, yes. The last few that you've done have been as multifamily apartments in the Midwest. Is that where you're seeing the opportunities for the equity kickers, where in '05, it was more, I guess, office buildings, more on the East Coast?

Is there -- what the dynamic is there and kind of what we should look for going forward?

It's hard to comment on that, I think that we've -- we'll add one for the Lake in the Woods transaction, which is a multifamily.

We added one on another multi transaction. I think we're looking at the pipeline as some that are -- somewhat consistent with some of the earlier ones that we put on, which I can't go into too much detail.

But, I think the composition of what exists in the portfolio is not inconsistent with what we're capable of adding. And I would say that there are always different opportunities that present themselves, and we'll probably add anywhere from one to four a year.

And I think overall, our composition would be somewhat consistent, some monetizing go away, and we'll add it on.

And I'm fairly comfortable saying that that composition should be somewhat across the board, a few multifamily, a couple of ski resorts here and there, some retail, some office and some small, some large. But, we're constantly seeing a variety of different ones.

We've -- I can't isolate exactly what's going to come on board, but I think that there'll be a variety of different types.

Great, thanks.

Ladies and gentlemen, we're showing no more questions in queue. I would like to turn the call over to management for closing remarks.

Okay. Well, it's been a tremendous quarter for us here. Not only have we had significant volumes, but it's clearly executing and monetizing a lot of our equity kickers and achieving the kind of growth we have on our dividend [and if we as well] transition our portfolio has been a tremendous achievement for us.

And we're very pleased to take the time and perhaps we'll have a little more lengthy of a call to walk through some of these accomplishments and talk about all the things we've kind of brought to bear over the last several quarters on the calls.

And management is extremely pleased with the ability to execute its strategy in what I would call somewhat of a tenuous environment, have the foresight several quarters ago to really appropriately position ourselves, have the foundation that we can take advantage of what we think are going to be some great opportunities going forward.

So, thanks for your time and patience and support and look forward to working with everybody.

Thank you, for participation in today's conference. This concludes our presentation. You may now disconnect. Have a good day.