Arbor Realty Trust Inc (ABR) 2008 Q4 法說會逐字稿

Good day ladies and gentlemen and welcome to the fourth quarter 2008 Arbor Realty Trust earnings conference call. I will be your Operator for today. At this time all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of this conference.

(Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

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

Okay, thank you, Operator.

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 year ended December 31, 2008. 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 his 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 our beliefs, assumptions and expectation 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 undo reliance on these forward-looking statements, which speak only as of today. Arbor undertakes no obligation to publicly update or revise these to reflect events or circumstances after today, or the occurrences of unanticipated events.

And now that the Safe Harbor is behind us, I would like to turn the call over to Arbor's President and CEO, Mr. Ivan Kaufman.

Thank you, Paul, and good morning, everyone. Thank you for joining us on today's call.

By now I hope everyone has had a chance to review the fourth quarter earnings release that was issued earlier this morning. Paul will take you through the quarter's results in a moment, but first I would like to spend some time talking about our view of the market and our strategy and approach going forward in this extremely difficult environment, and then touch on some of our overall achievements in 2008 and how we closed out the year.

Clearly these are unprecedented times, and the financial crisis continues to worsen, with no signs of recovery in the immediate future. Companies in our space continue to face significant challenges. This is very -- there is very little liquidity available, and we believe there will be increases in delinquencies and defaults, and we will continue to see declining real estate values through 2009. And as we said before, no one is immune to the effects of this market, and this will likely result in additional losses throughout our sector.

We will continue to operate our business in the best possible way to successfully navigate through this extremely difficult cycle. Our main focus will be to retain and preserve as much liquidity as possible, and aggressively manage our credit and financing sources. In this type of environment, it is absolutely critical to have an experienced management team that will spend 100% of its time focusing on these issues ,and I can't say enough about our management team's effort, commitment and expertise.

We did have some notable accomplishments in 2008 that I would like to mention, despite the major dislocation that occurred. We've been very focused on reducing our exposure to short-term debt by deleveraging our balance sheet, which is critical in this environment. In 2008, we significantly reduced our short-term debt by around $310 million through runoff and by proactively moving our assets into our CDO vehicles. We were also able to extend two of our short-term facilities, and amend certain others in 2008. We generated nearly $600 million of runoff in our portfolio in 2008 as well, despite the clear lack of liquidity available to our borrowers. We also refinanced and modified loans, enhancing our yields. This continues to be a significant focus in 2009, which will continue to generate liquidity and reduce our exposure to short-term debt.

Another significant achievement was our ability to increase our overall net interest income on core investments in 2008, despite the significant decline in interest rates. This was from, as I mentioned, refinancing and modifying loans, deleveraging the balance sheet, and from having a significant amount of our portfolio protected with LIBOR floors and fixed rates while a majority of our debt is floating.

We also were successful in monetizing some of our equity kickers, despite the difficult environment in 2008. We received almost $35 million in cash and recorded $1.7 million in income from these investments. As we've said before, these equity kickers are a key part of our model, and we've generated around $250 million in cash from the monetization of these investments since 2004, which has contributed greatly to our capital base.

I would now like to spend some time focusing on how we closed out 2008, before turning it over to Paul to take you through the financial results. Clearly, liquidity continues to be the primary concern and focus for our sector. As you can see from our balance sheet at December 31, our operating cash was reduced greatly from last quarter, due to having posted around $30 million more in cash collateral from a significant decline in the value of our interest rate swaps.

I will point out that these changes in value are temporary, and these swaps will return to par by their maturity. But as of 12/31/08, we had almost $55 million in cash posted against them. This also resulted in [a manager] lending $4.2 million to the REIT as of 12/31. However, since then these swaps have started to come back in value, and we've recovered some of that cash and repaid the loan to the manager in full. So currently we have $12 million in operating cash and around $60 million in cash available in our CDOs, as well as $40 million in cash posted against our swaps, which as I mentioned will come back to us by their maturity.

We're working extremely hard to preserve and maximize liquidity wherever possible, which is clearly one of the keys to successfully managing through this significant downturn. We'll continue to look to improve our liquidity by working aggressively with our borrowers to repay their loans, and by being very selective when modifying and refinancing loans, as well as deploying capital into new investments. In fact, in the fourth quarter, we were able to produce $130 million of runoff while originating only $6 million of new investments. We also refinanced and modified $130 million of loans and extended $90 million of loans in accordance with their extension options. It's will be very tough to accurately predict repayments in this environment, but our best guess continues to be in the range of around $50 million to $100 million of runoff in each of the next few quarters.

We also continue to manage our funding sources aggressively, significantly reducing our exposure to short-term debt through runoff and by proactively moving our assets into our CDO vehicles. We reduced our short-term debt by $117 million during the fourth quarter, and by another $25 million already in the first quarter of '09. This continued deleveraging of our portfolio is absolutely critical in this environment.

Additionally, as previously disclosed, we were successful in extending one of our warehouse facilities during the quarter to November 2009. So currently, we are now down to around $500 million of short-term debt; $300 million are term debt facilities, most of which have automatic extension features until November 2010, and another $70 million will be around until at least late 2009. And with $275 million of trust-preferred securities, $1.2 billion in CDO debt and $300 million in term debt facilities, we now have around 94% of our committed debt non mark-to-market as relates to interest rate spreads.

Now I would like to spend some time updating you on our credit. As you can see from our press release, we recorded $124 million of loan losses during the fourth quarter. These reserves related to six loans with an outstanding balance of approximately $330 million. We now have $130 million in loan loss reserves related to ten assets, with an outstanding balance totaling approximately $440 million as of December 31st.

I would like to talk about two of the larger reserves, as they relate to assets we have been watching and talking about for a while. The first is related to our ESH investment. Clearly, this has been an investment we have been monitoring closely. There has been a significant, continued reduction in RevPAR, and talk of potential restructuring of the company. Based on these factors, we felt it was prudent to reserve against this investment to a point where we are not reliant on cash flow related to the operations of the ESH portfolio to pay us off. So we wrote our investment down by $83 million to a $30 million value during the quarter. We believe this is the amount of cash flow we will receive from the remaining life of the investment from the interest reserve and other features associated with this investment. We have applied all cash received in the fourth quarter against this investment, and will continue to do so until we have recovered our remaining investment. I do want to point out that even though we have substantially reserved against this asset, we will continue to work very hard to preserve and maximize as much value as we can from this investment.

The second reserve relates to the 303 East 51st Street project. As previously disclosed, we started the foreclosure process and are aggressively pursuing obtaining the fee interest in the property. However, given the issues surrounding this project, combined with the recent decline in the market, we thought it was appropriate to reduce the carrying value of this asset by $15 million to a $55 million value as of 12/31. We will continue to work aggressively with our outside advisers to protect the integrity and value of this asset, and monetize the value as quickly as possible. The remaining $26 million of loan loss reserves for the quarter relate to four assets, two of which we recorded reserves on last quarter. These reserves were based on the value of the operating status of these properties.

There is very little liquidity available, and borrowers are having an extremely difficult time securing new financing. No one is immune to this market, and we continue to operate our business expecting the worst. As I said before, we are expecting an increase in loan defaults and delinquencies. This will likely result in continued stress on some of our assets, and could result in additional losses. However, predicting the amount and timing will be very difficult. We still believe that a significant portion of our portfolio consists of high-quality real estate, and is backed by good sponsorship. However, given the environment, we remain extremely focused on managing our portfolio with the goal of minimizing losses and revolving issues quickly.

In summary, these continue to be very difficult times, and may be the worst of operating environments. Our management team has worked extremely hard, and I believe has the experience and poise to face the significant challenges that lie ahead. We continue to focus heavily on the key significant areas, which again are liquidity, capital retention, reducing our short-term borrowers, and aggressively managing our legacy issues and credit facilities. Achieving success in these areas will be the key for us to manage through this environment.

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

Thank you, Ivan.

As noted in the press release, we had a loss for the fourth quarter of $4.30 per share and an FFO loss of $4.28 per share. Clearly this loss was predominantly due to, as Ivan spoke about in more detail, recording $124 million of loan loss reserves on certain assets in our portfolio during the quarter. We now have $130.5 million of loan loss reserves on ten loans, with an unpaid principal balance of around $440 million at December 31, 2008. As we've said before, no one is immune to the effects of this market, and we'll continue to take a proactive approach in evaluating our portfolio, recording reserves where we think it's appropriate, and remain aggressive in managing our assets.

GAAP also required us to write down our equity investment in the CBRE stock during the quarter by another $3.4 million to $0.18 per share, which was that stock's closing price on December 31, 2008. We also wrote down one of the CDO bonds we bought from other issuer by $1.4 million during the quarter as well. In addition, the fourth quarter included a $4.2 million reduction in interest expense for a change in the market value of certain interest rate swaps, which GAAP requires us to flow through our earnings. These swaps effectively swap out assets in our CDOs, which pay based on one-month LIBOR, and our CDO debt, which is based on three-month LIBOR.

The large increase in the market value of these swaps was due to a change in the market outlook on interest rates and spreads as of December 31, 2008. The value of these swaps will eventually decline, returning to par at the maturity of the trades, but there have been significant changes lately related to the outlook for interest rates, resulting in large swings in value. In fact as of yesterday, these values have declined by approximately $1.2 million, which will increase interest expense in the first quarter of 2009. If the market outlook for rates and spreads continue to fluctuate greatly, these trades could produce significant changes in value, which could increase or decrease our earnings going forward.

We also recorded a $900,000 loss during the quarter from our equity interest in the Alpine Meadow Ski Resort, including $225,000 of depreciation expense. As we mentioned several times, this business is seasonal and is not part of our core operations, and therefore there will be fluctuations in our earnings related to this investment, as there are losses in the summer months and income in the winter months. We are estimating that we will have income in the range of $2 million to $3 million for the first quarter of 2009, but believe our share of the operations for the full year going forward will be about break even, including the depreciation expense.

As noted in the press release, we did have some activity related to two of our equity kickers during the fourth quarter. We received $415,000 from the monetization of our 8.7% equity interest in York Avenue through a sale of the property, and received cash distributions of $967,000 from operations on our 24.17% interest in prime. This resulted in the recognition of $1.4 million of income for the fourth quarter. Clearly, our equity kickers have been a key component of our business model, and we've generated approximately $250 million in cash from these investments to date, which has contributed greatly to our liquidity and capital base. So if you were to add back these items that I just mentioned, our adjusted core EPS would have been around $0.47 per share for the fourth quarter compared to $0.59 per share for the third quarter, adjusting for similar items. This decrease was predominantly due to our ESH investment, which Ivan elaborated on earlier.

I would now like to take you through the rest of the results for the quarter. First, our average balance in our core investments declined by about $100 million from last quarter, mainly due to our net runoff in the fourth quarter. The yield for the quarter on these core investments was around 7.08% compared to 7.82% for the prior year. Without the acceleration of fees, the yields in these core assets was around 7% for the fourth quarter and around 7.62% for the third quarter. This decrease was primarily due to recording the fourth quarter dividend payment received on our ESH investment as a reduction of the principal balance rather than interest income, and from some of our non-accrual -- accrued loans. This was partially offset by an increase in yield in our portfolio from refinanced and modified loans.

We did also benefit from a slight increase in the average LIBOR rate on the portfolio during the quarter, despite an overall decrease in LIBOR due to the timing of certain reset dates on our loans. Additionally, the weighted average all-in yield on our portfolio was around 6.33% at December 31, 2008, compared to 8.03% at September 30, 2008. This decrease was primarily due to the reallocation of the payment related to our ESH investment, and around a 350 basis point decrease in LIBOR for the comparable dates. This decrease in LIBOR was partially offset by fixed rate loans and loans with LIBOR floors above the December 31st rate, representing approximately 70% of our portfolio.

The average balance on our debt facilities decreased by around $119 million from last quarter, which was more than the decrease in our core investments. As Ivan mentioned, this was primarily due to our continued focus on reducing our exposure to short-term debt by moving loans out of our warehouse and term debt facilities into our CDO vehicle. The average cost of funds in our debt facilities was approximately 4.10% for the fourth quarter compared to 5.14% for the third quarter. Excluding the unusual impact on interest expense from our swaps, our average cost of funds was approximately 4.94% for the fourth quarter compared to around 5.10% for the third quarter. This reduction was primarily due to the decline in the average LIBOR rate during the quarter.

In addition, our estimated all-in debt cost was around 3.80% at December 31, 2008, down from 6% at September 30, 2008, due to the significant decrease in LIBOR related to 55% of our debt that is floating. This 3.8% estimate does not include any increases to interest expense from our interest rate swaps, which as I noted earlier would increase interest expense by approximately $1.2 million in the first quarter based on market values as of yesterday. So overall, the fourth quarter normalized net interest spreads on our core assets decreased to about 2.06% from around 2.52%, mainly due to the ESH investment and some non-accrual loans, partially offset by increased spreads from refinanced and modified loans, as well as loans with LIBOR floors above the average LIBOR rate for the quarter.

Next, our average leverage ratios were around 72% on our core assets and around 84% including the trust preferreds as debt for the fourth quarter, down from 74% and 85% for the third quarter. This reflects the continued delevering of our balance sheet through runoff and moving assets into our CDOs. Our overall leverage ratio on a spot basis increased to around 3.2 to 1 for the fourth quarter from 2.5 to 1 for the third quarter, quarter primarily due to loan loss reserves and a significant decline in the value of our interest rate swaps during the fourth quarter. This was partially offset by a reduction in our outstanding debt from runoff, and moving assets into our CDOs during the quarter.

There are some changes in the balance sheet compared to last quarter that are worth noting. Cash and cash equivalents decreased $22 million from last quarter, largely due to the cash that was posted from the decline in the market value of our interest rate swaps. This also accounts for a significant amount of the increase during the quarter in other assets. Notes payable and repurchase agreements decreased $117 million during the quarter, primarily due to our strategy of reduction short-term debt through loan payoffs, and moving assets into our CDO vehicles. And restricted cash related to our CDOs increased $25 million on a spot basis, mainly due to runoff in our CDOs during the fourth quarter.

In addition, other comprehensive losses increased by about $64 million for the quarter. This again was primarily due to a significant decline in the market value of our interest rate swaps, from a change in the outlook on interest rates. This also makes up a majority of the increase during the quarter in other liabilities. GAAP requires us to flow the changes in value of certain interest rate swaps through our equity section, which to date has reduced our book value by almost $4 per share. Our book value per share was $11.18 as of December 31, 2008, and adding back these unrealized losses on our interest rate swaps and deferred gains from our equity kickers, our adjusted book value per share was $17.33 at December 31, 2008.

And lastly, our portfolio statistics show that at December 31st, about 65% of portfolio was variable rate loans and 35% was fixed. By product type, about 62% was bridge, 13% junior participation, and 25% was mezzanine and preferred equity. By asset class, 36% is multi-family, 25% is office, 17% hotel, 11% land, and 4% condo. Our loan to value was around 80% and our weighted average median dollars outstanding was 57%, and our portfolio had an average duration of around 32 months. Our debt service coverage ratio was around [1.47] this quarter, and geographically we have around 40% of our portfolio concentrated in New York City.

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

(Operator Instructions)

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

Good morning, gentlemen. Ivan, can you address the source of funding for the rolloffs that you experienced last quarter, as well as your anticipated rolloffs for 2009?

I'll address some of it, and and Paul will address some of the others. We did have -- we do have some concentration of multi-family, and there continues to be liquidity in the multi-family market due to Fannie Mae, Freddie Mac and FHA, and we're predicting that some of the future rolloffs are going to come from refining some of the loans in our portfolio that are eligible for those programs.

And David, it's Paul. That's going forward. For the fourth quarter we did have, like we said, $130 million of runoff and paydown. Around $100 million of that came from actually new equity that was funded into deals, which was able to take us out. $20 million was a refinance that a borrower was able to get done, and the other $10 million were partial paydowns on loans from equity being kicked in from the borrowers during quarter.

Okay. That gets to my second question, and that is your re-underwriting on your extensions. Obviously, that is where you're focusing lot of your time right now, but what are you looking for? Are you insisting on new equity? Are you readjusting LTVs? And what kind of new spreads are you looking at?

I think every single transaction is into its own, and clearly what we're looking to make sure is with these declining values that we protect the integrity of the value of that asset, and to the extent that we can alter the terms and bring in additional equity and secure a better asset we will, but every circumstance is different. So we're actively looking to manage down the debt we have in exchange for new equity, and in certain circumstances if we can get a paydown, we can give some concessions on interest rates if it's appropriate. So every circumstance is to really evaluate how we can put our asset into a better form going forward, with the lack of liquidity and declining values.

Okay, my last question is the hardest one, and that gets to accountability for ESH. This investment has cost you roughly half the cumulative value of all of your equity kickers to date, and obviously was a failure of underwriting, and I'm just wondering on how you look at accountability for this underwriting loss?

Yes, I mean, I guess for us it was an outsized investment. We had it syndicated out prior to closing, and with the market collapse we lost a lot of our syndicated partners. We had originally intended to take around $40 million of the investment, and we had our syndicates back out, and I guess that was a market timing issue and a lack of execution, number one. I will look at the extended stay investment when it's all over; it's far from being over. We're working very hard on recovery. Keep in mind we have collected, come June, around 20% of the principal value in dividends. So when it's all over in a year from now we will see what the ultimate damage in collection is, but we're far from being finished with our efforts to recover our investment.

Okay. Thank you.

And your next question comes from the line of David Chiaverini from BMO Capital Markets. Please proceed.

Good morning, guys. A couple of questions. The first is which part of your portfolio are you seeing the most stress, and where do you anticipate the most stress going forward in terms of asset classes? Is it multi-family, office? Could you talk about that a little bit?

I would say it's across-the-board. It really -- clearly hospitality is an issue, because you're having a significant drop in RevPAR. Land has been significantly impacted, but I think there's stress all across the spectrum. One of the things that has affected a lot of our deals is the lack of liquidity that borrowers themselves have. Once borrowers -- you know, borrowers who had tremendous net worth and liquidity, they're seeing their liquidity tapped as the banking system is really squeezing down on everybody, and taking their liquidity. So I wouldn't say it's any specific area; it's spread across every asset class and every borrower.

Okay. And regarding your liquidity position, how confident are you that you will be able to meet your liquidity needs this year? I know that you have that facility that's coming due, I believe in June, and there's just a small balance remaining on that, but what about later this year? How do you plan on meeting that obligation?

Well, we're working actively with our lenders, and as all of you know, a lot of our lenders have either been taken over or gone out of business. It has handicapped us a little bit, in the sense that we haven't had anybody to talk to, but we're very confident now that Wachovia is in new hands and there's new management, that we can actively work with them to continue to amend those facilities to reflect what's appropriate in these times. Keep in mind that they have worked with us even despite the fact that they've gone through a takeover, and all indications are that they'll continue to work with us and move forward.

With respect to the other facilities we have with the other institutions, they're not large facilities, they're all pretty small, and all indications are that they'll move forward and work with us. In terms of overall liquidity, clearly liquidity is an issue, and we'll watch that and monitor that very carefully. Keep in mind that we do have a number of unencumbered assets which are going through the foreclosure process, and we've gone through that foreclosure process hopefully that will be another source of liquidity that will help assist us through 2009 and 2010.

Okay, and on that note of going through the foreclosure process, and you mentioned that you're anticipating more delinquencies and defaults, when you do foreclose on a property do you plan on holding it and operating it, and taking advantage of that income, or do you plan on selling those properties?

I think every circumstance is different. If it's an asset that's in shape and readily marketable, and we can maximize our value by selling it and retrieve the cash, that's certainly something that we'll consider. In other circumstances, if the asset need to be brought up to speed, we have the capability to improve that asset and get it in better form, and in other circumstances we have a lot of operating partners who still have cash and we would consider joint ventures as well. So we're pretty flexible, with the eye towards liquidity and maximizing value.

Okay, my last question is do you have a rough estimate as to how many of your loans you've modified over the past, say, three to six months?

Sure, David, it's Paul. We've modified for the year around $350 million of product. Over the last two quarters, we did around $130 million this quarter and a similar number last quarter. And as Ivan said, we're very careful in which loans we refinance and modify, putting these loans in the best shape we can put them in for ourselves and borrowers, but $350 million was the year-to-date number on what we refinanced and modified, about $120 million each quarter.

Okay. Thanks, guys.

(Operator Instructions)

And your next question comes from the line of James Shanahan from Wachovia. Please proceed.

Thank you, good morning. Are there any liquidity needs or potential covenant issues within your CDOs that you're monitoring or that might be required to address at any point during 2009?

Gene Kilgore, are you on the phone?

Yes.

Jim, we have Gene Kilgore, our Senior Vice President of Securitization for the CDOs, I think I'll let him answer that question.

Sure, hi Jim. We're currently passing all coverage tests in all of our CDOs. We always have done so. We've never not passed a coverage test. We currently have cushions in each of our tests. I would also just highlight that on our first two CDOs, we have three CDOs our first two, we actually structured one or two fairly novel features, which has provided more cushion to our coverage test over time during the reinvestment period, because they have a turbo feature which actually reduces some of the debt, which provides more cushion to the equity. So we feel we've designed the vehicles to have maximum flexibility. So I think that's the good news.

I mean to the extent that there's rapid asset deterioration, clearly that's something that, as Ivan and Paul pointed out, we're not immune to, but we're currently passing and we do have cushion in all of those tests.

Okay. As a follow-up, I'm interested -- I've been hearing in the marketplace that the value of your outstanding CDO debt is trading at pretty weak levels. Is there -- has anything changed to the extent with regards to if some liquidity were to be available in the marketplace, is there any interest internally in buying back any of your CDO bonds?

Clearly, Jim, the decline in asset values that we have is certainly difficult in this environment, and it's something everybody's suffering. I think the opportunity, if you have liquidity, is that you can actually buy back your debt at deeper discounts than your assets are falling, so there's a natural arbitrage that may exist, and with the change of tax laws that was just passed, and Paul can go through them in a little bit more detail, it is actually very advantageous to do so. We do fell that our CDO values and our trust preferreds will continue to decline, and there's no rush to buy that back, and there's not a lot of buyers for it. So that is something that is available that is out there, and it is a way for us to significantly offset our losses, and clearly having liquidity can give us that opportunity at the appropriate time.

Jim, as Ivan referred to the tax ramifications of that, I think it was passed yesterday, it was supposed to, I don't know if it actually got done. But part of the stimulus package, as I'm sure you've seen, is that there's a pretty big tax relief on buying back your own debt. If you buy back your qualified debt, CDO and trust preferred securities in 2009 and 2010, you get to elect a deferral of any tax related to that forgiveness of debt, and that's how the tax rules work, until 2014. So you get a five-year tax deferral, and then you can bring that tax liability in over the remaining five years, 2014 to 2019. So a pretty big incentive for people out there who have liquidity to buy back their debt at deep discounts, because you also don't have the tax burden right now that's normally associated with that.

Thank you.

At this time, there are no questions in queue. I will now turn the call back over to management for closing remarks.

Well, thanks for taking the time to -- for the call today. We all know it's a very stressful and difficult environment. Our management team is extremely focused on navigating through these difficult times, and we appreciate your support. Thank you.

Thank you for your participation in today's conference. This concludes your presentation. You may now disconnect and have a wonderful day.