Arbor Realty Trust Inc (ABR) 2009 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter 2009 Arbor Realty Trust earnings conference call. My name is Dan and I'll be your coordinator for today. At this time, all participants are in listen-only mode. (Operator instructions.) As a reminder, this conference is being recorded for replay purposes.

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

Thank you, Dan, 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 June 30th, 2009. 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 condition, 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.

Now that the Safe Harbor is behind us, I'd like to turn the call over to Arbor's President and CEO, Ivan Kaufman.

Thank you, Paul. Good morning, everyone, and thanks for joining us on today's call. In a moment, Paul will take you through the financial results for the quarter, but first, I would like to talk about our view of the market and the strategy and approach we're taking, as well as some of our more significant accomplishments in the last few months.

As we've discussed repeatedly on our earnings calls, the market is severely dislocated with significant liquidity issues throughout the financial sector. The clear lack of liquidity, combined with declining real estate values, have posed significant challenges for companies in our space. As we've said before, no one is immune to the effects of this market and we believe there will be increases in delinquencies throughout 2009, which will result in additional losses throughout our sector.

We continue to operate our business in the best possible way to successfully navigate this turbulent environment. Our total focus remains on preserving liquidity and aggressively managing our portfolio and finding [new sources].

Clearly, the most significant accomplishment we've achieved over the last few months has been our ability to restructure all of our short-term debt. We have worked very hard and are extremely pleased with our success in this area. Just recently, we closed on restructuring of 374 million of debt with Wachovia, extending these facilities for three years and virtually eliminating all mark-to-market provisions, while substantially reducing our financial covenants.

Certainly, this transaction was essential and its completion allows us greater operating flexibility in a time of widespread economic weakness. Prior to this restructuring, we also continued to delever our balance sheet, reducing our short-term debt by 52 million through runoff and by proactively moving assets into our CDO vehicles. We continued our strategy of taking advantage of the dislocated markets by repurchasing our own debt at substantial discounts.

We recorded a 21 million gain from these repurchases during the quarter and improved our cash flow going forward by reducing debt-service payments. We will continue to evaluate similar transactions in the future based on availability, pricing and liquidity.

We were also successful during the quarter in extending two of our short-term facilities totaling 15 million until around June 2010 with one-year extension option and satisfying the only other short-term facility we had at a discount, paying 23 million in cash to satisfy 37 million of debt. This left us with 15 million of short-term debt, 12 million of which we paid down last week, resulting in the de minimus amount of only 3 million remaining.

Additionally, as I mentioned on our last call, we were successful modifying 247 million of our trust-preferred securities, reducing the interest rate for three years to a fixed rate of 50 basis points and in July, we restructured the remaining 20 million of trust-preferred securities with the same terms.

As I mentioned earlier, managing our funding sources aggressively has been critical in this environment and we are very pleased with our success in restructuring all of our non-CDO debt which has significantly improved our operating flexibility. This will allow us to focus 100% of our time on running the business and managing our portfolio while greatly reducing our risk to financial institutions.

We've also worked extremely hard at improving our operating cash balances and we currently have around 40 million in cash and around 70 -- 17 million of cash posted against our swaps. We also have 30 million in cash available in our CDOs for future deployment. Clearly, preserving and maximizing liquidity is critical to successfully managing throughout this significant downturn and we are pleased with our progress in this area.

We'll continue to look for creative opportunities to improve our liquidity position, including working aggressively with our borrowers to repay their loans.

In the second quarter, we generated 42 million of runoff and paydowns and refinanced and modified 375 million of loans. It will continue to be difficult to accurately predict repayments in this environment, but our guess is a range of around 25 to $50 million of runoff a quarter going forward.

Now, I would like to update you -- the credit status of our portfolio. As noted in our press release, we recorded 23 million of loan-loss reserves during the second quarter related to 12 loans with an outstanding balance of approximately $200 million. 19 million of these reserves were on loans that we previously recorded reserves on, which reflects the continued decline in real estate values and the overall weakness in the commercial real estate market.

We now have 220 million in loan-loss reserves at June 30th relating to 22 loans with an outstanding balance totaling approximately $606 million. Additionally, we did record a 12 million impairment on our equity investment in the Alpine Meadows Ski Resort during the quarter. This reflects a continued decline in the values of land and predevelopment deals.

Although we felt it was prudent, given the current market conditions, to record a reserve at this time, we do believe that this is a long-term project with potential upside and we'll actively manage this project to maximize the value of this investment.

We also recorded a $24 million loss during the quarter related to early payoff of one loan in our portfolio. We initiated this reduced early payoff as part of a strategy to use most of the cash to retire the debt related to the asset at a discount, recording a $14 million gain from its extinguishment. This resulted in a net accounting loss of $8 million related to this transaction, but created around 5 million of additional operating cash flow.

We remain extremely focused on managing our portfolio, looking to minimize losses and monetize as many assets as we can. We will continue to be aggressive in pursuing loan monetization strategies, even if it results in an accounting loss to create [precious] liquidity and resolve any and all issues as quickly as possible.

Market conditions have also increased defaults and delinquencies in our portfolio and as I said before, this is a trend we expect to continue throughout 2009. The second quarter closed with approximately 290 million of non-performing loans, up slightly from 285 million last quarter, which continued to reduce net interest spread on our portfolio. However, subsequent to quarter end, we did restructure a $95 million non-performing loan that was in bankruptcy which has reduced our non-performing loan to approximately $195 million currently.

Clearly, no one can hide from the significant issues resulting from these market conditions and we will continue to -- and prepare for the worst. Real estate values are expected to decline further and the liquidity available to our borrowers, we believe we will see ongoing stress on our portfolio, resulting in additional defaults and delinquency losses. However, predicting the amounts and timing of these losses will be very difficult.

In summary, these are extremely difficult times and we continue to work exceedingly hard on our core objectives which again are preserving and maximizing our liquidity position and aggressively managing our portfolio. We are very pleased with our ability to restructure all of our short-term debt on what we believe are very favorable terms and significantly improve our liquidity position.

I can't say enough about how hard our management team has worked to accomplish this significant objective. I believe our executive team has never been more focused and has the experience and discipline to face the significant challenges ahead of us.

We know that success in the critical areas we spoke about is vital for us to manage through the cycle and position ourselves to take advantage of the opportunities that lie ahead.

Lastly, I would like to touch on the amendment to our management agreement which we announced recently. We believe the new management agreement is more reflective of the current environment and the effort and costs that are associated with managing the REIT. Clearly, the old management agreement was more geared towards the significant originations platform and resulted in our manager not being able to cover its cost to operate the REIT in this environment.

We think the cost reimbursement concept, as well as the appropriate incentive bonuses reflected in the new agreement, more properly reflect the change in the market and allow our manager to more effectively manage our business in this environment.

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

Okay. Thank you, Ivan. As noted in the press release, we had a loss for the second quarter of $1.92 per share and an FFO loss of $1.90 per share. We did have several large items that affected the second quarter numbers. We recorded 23 million of loan-loss reserves and a $24 million loss from the early payoff of an asset. This was partially offset by our continued success in buying back some of our CDO debt and retiring one of our financing facilities at a substantial discount, recording approximately 21 million of gains during the quarter from these transactions.

Additionally, we also recorded approximately $900,000 in losses from our equity interest in the Alpine Meadow Ski Resort and recorded an impairment charge of approximately 12 million, reserving against the remaining equity portion of this investment.

In addition, the second quarter included an $8.7 million expense related to the termination of interest rate swaps associated with the restructuring of our trust preferred securities. Although the termination of these swaps resulted in a large one-time charge, we will recover a majority of this amount over time for a reduced interest expense, as these swaps are no longer necessary because we restructured our trust preferreds to a fixed rate of 50 basis points for three years.

We also had a $2.6 million increase in interest expense for a change in the market value of certain interest rate swaps, which GAAP requires us to flow through earnings during the quarter compared to approximately a $750,000 increase in interest expense in the first quarter. 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 value of these swaps will eventually return to par at the maturity of the trades, but if the market outlook for rates and spreads continue to fluctuate greatly, these trades could produce significant changes in value, which would increase or decrease our earnings going forward.

As Ivan mentioned, we amended the management agreement with our external manager going to a cost reimbursement based management fee, retroactive back to January 1st, 2009. We also agreed to pay a $3 million one-time fee to partially reimburse the manager for unreimbursed costs and other services associated with the 2007 calendar year.

This resulted in an increase to the management fee expense line item of approximately 5.5 million during the second quarter. As we mentioned in our press release, we estimate the base management fee to be around 8 to 9 million for 2009, or 2 to 2.5 million per quarter for the remainder of the year.

So our adjusted core EPS would have been around $0.28 per share for the second quarter compared to around $0.38 per share for the first quarter, adjusting for non-recurring items and loan-loss reserves. This decrease was primarily due to reduced rates on our refinanced and modified loans, as well as the impact of our non-performing loans in the second quarter.

I'll now take you through the rest of the results for the quarter. Our average balance in core investments declined about 53 million from last quarter mainly due to runoff and paydowns from the first and second quarter. The yield for the quarter on these core investments was around 5.40% compared to 5.12% for the prior quarter. Without some non-recurring items related to non-performing and restructured loans, as well as the acceleration of fees, the yield in these core assets was around 5.40% for the second quarter and around 5.90 for the first quarter.

This decrease was primarily due to reduced rates on refinanced and modified loans, as well as the impact of our non-performing loans in the second quarter.

Additionally, the weighted average all-in yield on our portfolio was around 5.35% at June 30th, 2009, compared to 5.82% at March 31st, 2009. And again, this decrease was due to lower rates on refinanced and modified loans and a slight increase in non-performing loans during the quarter.

The average balance on our debt facilities decreased by around 72 million from last quarter, which was more than the decrease in our core investments. This was primarily due to the continued reduction of our short-term debt by moving loans our of our warehouse and term-debt facilities into our CDO vehicles.

The average cost of funds in our debt facilities was around 4.45% for the second quarter compared to 3.94% for the first quarter. Excluding the unusual impact on interest expense from our swaps, our average cost of funds was approximately 3.90% for the second quarter compared to around 3.78% for the first quarter. This increase was primarily due to the cost of some of our interest-rate swaps combined with the greater impact on the average rate for financing fees due to a decline in the average debt balance during the quarter.

In addition, our estimated all-in debt cost was around 3.50% at June 30th, 2009, compared to 4% at March 31st, 2009. However, at July 31st, 2009, our estimated all-in debt cost was around 4%. This was due to the impact of the new pricing on the Wachovia deal, offset by the benefit of unwinding several interest rate swaps associated with our trust preferred securities which have been converted to a fixed rate.

So overall, normalized net interest spreads on our core assets decreased to approximately 1.50% this quarter from 2.12% last quarter due to lower rates and refinanced and modified loans, the impact of our non-performing loans and additional costs related to our interest-rate swaps.

As we said earlier, we are expecting additional defaults and delinquencies for the remainder of 2009 which would reduce our net interest spreads going forward.

Next, our average leverage ratios were around 69% on our core assets and around 81% including the trust preferreds as debt for the second quarter, down from 71% and 82% for the first quarter. This reflects the continued delevering of our balance sheet for runoff and moving assets into our CDOs.

Our overall leverage ratio on a spot basis were also down slightly to around 3.0 to 1 for the second quarter from 3.1 to 1 for the first quarter.

Operating expenses did come in higher than the previous quarter, mostly due to around 1.7 million of non-cash expense related to stock grants issued to key employees and from accelerating divesting of all our previously issued restricted stock grants.

There are some changes in the balance sheet compared to last quarter that are worth noting. Cash and cash equivalents increased 15 million from last quarter to 30 million at June 30th, 2009, largely due to cash received from an increase in the market value of our interest-rate swaps. This, combined with the termination of some of our interest-rate swaps, also accounts for a significant amount of the increase during the quarter in other assets.

Notes payable and repurchase agreements decreased 101 million during the quarter primarily due to our strategy of reducing short-term debt for loan payoffs and moving assets into our CDO vehicles and from retiring some of our debt at significant discounts. [Unrestricted] cash related to our CDOs decreased 16 million mainly due to again moving assets from our financing facilities into our CDOs.

In addition, other comprehensive losses decreased by about 32 million for the quarter. This again was primarily due to a significant increase 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 change in value of our interest-rate swaps through our equity section and our book value per share was $10.64 at June 30th, 2009, and adding back unrealized losses on our interest-rate swaps and deferred gains from our equity kickers, our adjusted book value per share was $15.18.

Lastly, our portfolio statistics as of June 30th show that about 65% of the portfolio was variable-rate loans and 35% were fixed. Our product type, about 61% was bridge, 14% junior participations and 25% mezzanine and preferred equity. By asset class, 37% is multi-family, 27% is office, 17% is hospitality, 12% land, and 1% condo.

Our loan to value was around 90% and our weighted average median dollars outstanding was 63%. Our debt service coverage ratio was around 138 this quarter and geographically, we have had around 38% of our portfolio concentrated in New York City.

Now, that completes our prepared remarks for today and we'd like to turn it back to the operator and answer any questions anyone has at this time.

(Operator instructions.) Your first question comes from the line of David Fick from Stifel Nicolaus. Please proceed.

Good morning.

Morning, Dave.

Can you walk us through the process for adjusting the manager's fee, how that was negotiated and what the Board's role and involvement was?

The Board assembled a special committee to evaluate the management fee, David, and the management contract, and given the environment that we're in and have been in for the last two years, the management fee contract was not consistent with the work and effort and costs associated with the manager managing the business.

So the special committee ran a process where they hired an analyst, a financial analyst, and a law firm, and ran a process, and had come to a decision with the manager on the revised agreement to more reflect -- more correctly reflect the environment that we're in and the cost and time associated with the manager's efforts.

And the retroactive fee for 2008 was something that wasn't previously [crude] or disclosed as being under discussion. How did you get to that number -- simply off the P&L at the manager level?

It was a combination. It was all part of a complete package that the Board looked at, but it was a combination of reimbursement of some of the costs that the manager had absorbed in 2008, that it was short, and the $4.2 million loan that the manager had given the REIT at the end of the year when the cash flow position of the REIT was very low. And had the manager not given that loan, we could have had a margin call on certain swaps that we would have lost cash flow from. So those two and some other items were really the considerations that went into the $3 million that was paid back to 2008.

That loan is still outstanding. It will be repaid, is that correct?

The loan has been repaid.

Right, okay. And was there any consideration of prior incentive fees that were paid to the manager for the transactions that are now blowing up?

I'm not sure I understand your question. You want to rephrase that?

Well, the manager originated the portfolio that is now in distress and is naturally -- did experience some losses, but the losses at the shareholder level inside of Arbor are much greater. And there have been incentive fees paid over the years to the advisor. And I'm just wondering if there should be a consideration of clawback on those fees in light of the portfolio performance?

Well, the only good news, I guess, for the Company, and bad news for the manager was that a significant portion of the incentive fees were paid in stock. So there's clearly a lot of alignment with respect to that.

In addition, David, what was considered is the -- somewhat you were talking about the Board did put into the new management agreement some additional hurdles on incentive fees going forward where, if you saw in the release that any reversals or -- of any reserves that were previously recorded would not be fully credited to the incentive fee calculation for the manager. And the hurdle rate on the return would rise to a minimum [bogey] of $10 per share of raised capital as opposed to now, where it's just wherever the average is.

Okay. And so what -- I guess now that this fee is in place, there's a known run rate. What should we model going forward?

Yes, I think we're estimating for '09 to be 8 to $9 million in the base fee and obviously, the incentive fee is still based on a hurdle rate of return which has not been hit, but I would say that that's the appropriate model going forward for the base fee. In addition, as you know, the new management agreement lays out that no origination fees -- origination fees that are up to 1% used to go to the manager and now, all origination fees will be retained within the Company going forward.

All right. Okay. I understand what you did with the fee and why you did with it, and I don't think anybody should have to run their business at a loss, but I think you understand where I'm coming from with the questions. Ivan, could you review for us the status of sort of the biggest disclosed investments that are out there that are obviously the focus of most of your time, and in particular, the extended-stay investment?

Well, the extended-stay investment is probably in bankruptcy and it's going through the bankruptcy process. My guess is it'll be in bankruptcy for quite some time. It was filed, I believe, around four to six weeks ago and is still in the initial stages of sorting itself out. The extended stay, like many of our other transactions, have multiple parties. When there are multiple parties, it just has a tremendous number of issues related to competing interests and trying to get to a resolution, which ends up involving a lot of time, effort and negotiations to get to the next step.

I can't even begin to tell you how long that will take from the senior lenders to the different group of mezzanine lenders to the different groups within each section of those lenders. It's going to take a while for that stuff to sort out.

And your current reserves against that investment and the book value of that investment, if you could just refresh our memory?

Yes, the investment is, from a real estate perspective, is fully reserved. We have about [audio drop].

Yes, I think we have about $16 million remaining against the investment. The rest has been fully reserved against.

Right. So there's 16 million left from the complete investment that was originally 115 million.

And what do you have left in prime retail at this point?

We still have a 7.5% interest remaining in prime retail.

And your counter-parties' interest there was pledged under the loan facilities on extended stay, is that correct, but not sub -- you don't have an interest in their equity with respect to the extended -- your extended-stay investment?

I'm not sure exactly what the counter-party (inaudible), but our interest is not pledged until free and clear.

Okay, great. Those are all my questions. Thank you.

Thanks, David.

(Operator instructions.) Your next question comes from the line of Leon Cooperman from Omega Advisors. Please proceed.

Thank you. Good morning.

Good morning, Lee.

Three questions, basically -- how do you feel about the adequacy of your loan-loss reserves that is reflected in your book value? And kind of adjacent to that question is your best judgment as you look at the business, and I think, Ivan, you own about 20% of the equity, do you think that the GAAP book value or the adjusted book value -- there's a big difference between the two, obviously -- in that range is a realistic reflection of the value of the business?

And finally, from a cash flow standpoint, do you expect to generate cash over the next 12 months that would come into the till net of expenses?

I'll take your last question first. We significantly increased our cash balances here and a lot of our cash flow balances are a direct result of the distributions that come out of our CDOs. So far, we've been fortunate to continue to get our distributions out of our CDOs. We have good cushions in our CDOs going forward and I feel that I -- we have a good likelihood next quarter of getting those distributions, although I can't give you any assurances. And those distributions range, I believe, somewhere between 12 to 15 million per quarter.

With respect to the fourth quarter, it's hard to look forward. It all depends on the performance of the loans that are in the portfolio. The problem is, Lee -- and I'm going to back into your last question -- is lots of times when loans default, it's not necessarily because the loan is not performing. It could be a borrower issue; it could be issues beyond our control; it could be a mezzanine lender putting something into bankruptcy; etc., etc. And that could affect our cash flow distributions.

With respect to the adequacy of our reserves, it's clearly our intent to continue to reserve against our loans if the market declines. If the market doesn't decline anymore, then our reserves are adequate, but I'm not optimistic that we're not going to have further declines and rent declines and occupancy declines. So I would think that third and fourth quarter, we'll continue to show additional reserves as we see declines in the market.

And I'm hoping that most of the damage in the market will be done in 2009 and 2010 will look a little bit better, but it's hard to say. I mean, clearly, you saw the announcements today. The unemployment news was better than expected. I was a little surprised. If their market turns around, we'll have less reserves; if the market declines, we'll continue to have the kind of reserves that we've shown.

Paul, you want to answer his second question?

No. I think that was the --

On the book value.

I mean, it's hard to, as Ivan said, look to the future and determine what the range of book value will be. Clearly, the 221 million, which is a little more than 10% of the portfolio, are adequate reserves today. However, if we see the market continue to decline and we have more defaults, then we'll have more reserves, which will shrink that book value number.

However, that will be somewhat offset by the positive cash earnings we have from our core business each quarter offsetting that, but it's really hard to say what the range of book value is going to be from a value standpoint until we see what the market does for the rest of the year.

Yes, I wasn't actually asking that question. I was asking as a large owner of the equity in the business, when you look at the business -- we have a $2.00 stock price and we have a gap of a value of 10 and an adjusted book value of 15. I'm just curious, do you have a view of those numbers in terms of what the actual value of the business is? Obviously, if we had to go into liquidation today, it's academic (inaudible) market for things.

But the extent and the fullness of time, the economy's bottoming out, the stock market is suggesting that you have a view as to which of those two numbers is a more realistic value, or is the $2.00 value more realistic -- just an opinion, not a forecast.

Our book value is our book value. I mean, we believe if we work hard enough over time, that eventually, we'll achieve monetization of our book value over a period of time.

Thank you. One other question -- is the cash flow and this new agreement with Wachovia give you the ability to create value for the shareholders through buying back a piece of the capital structure at significant discounts?

Yes, we certainly have that capability of doing it and that was part of our agreement to allow us to do that. So the question is, is our debt going to be available and priced at the right level to buy it back? And sometimes it is; sometimes it isn't. And we'll take advantage of those opportunities when it's out there, but we have enough cash flow to be able to do that.

Good luck and thank you for the call.

Thank you.

You have a follow-up question from the line of David Fick from Stifel Nicolaus. Please proceed.

Yes, I was just wondering. Ivan, I'm sure you've looked at and are aware of the filings, sort of the next wave of commercial finance REITs that are planned. And I was wondering if you can comment in two respects -- first of all, how Arbor at some point might get back into sort of an offensive posture in terms of excess capital and deploying it in distressed opportunities that are at least in theory out there, given what these business plans look like.

And then second, related to that, do you actually think the opportunity is there or has spread compression been so strong and for good reasons that these guys won't get the money put out?

I think, David, that's a very good question and clearly, we had to clean things up in a significant way in order to be able to potentially attract new capital. And that was first on our agenda and I think we put ourselves in that position. Clearly, without squaring away all our short-term debt, we [wouldn't] now be able to attract short-term capital -- I mean, be able to raise capital and we just completed that. So our thoughts will be how can we raise additional capital and take advantage of potential opportunities?

So I do believe that we really cleaned up our legacy issues in the sense that most of our legacy issues are outside our current business. They are located within our non-recourse vehicles, which are not CDOs. So it allows us to go out into the market like other people are going into the market. Even the way we structured our facilities, we've put in a vehicle in order to raise additional capital on a certain basis, so that was factored into our lines.

In terms of the opportunities that are out there, I still think it's early. I still think that debt is not trading at the right level. Prices have not reset, so in terms of buying existing defaulted debt, I think people are a little bit early. I also think a lot of the players who are stepping into the market may not understand the complexities that are involved in buying bad debt, entering into creditor agreements and have that level of expertise, which clearly, we do, which could put us as a leg up to be able to take advantage of that.

In terms of new opportunities, I think that the new opportunities that we'll see will be very similar to the opportunities that we saw when we got involved in this business in '95 to 2001, where stuff was done on a non-levered basis, on a highly structured basis. And I think there will be significant returns to those highly structured deals and what we will look to do over time is find the right capital structure or capital partner or joint venture partner to be able to take advantage of those opportunities. And that's how we were very successful and able to develop those equity kickers and good returns.

And if you go back to those times, the business was run on an unlevered basis of 12 to 15% providing mezzanine money, and I think we're going to see a return to that. If we don't see a return to that, then I don't think it'll be an overly attractive business to get into.

Thank you.

At this time, there are no further questions in queue. I would now like to turn the call back over to Mr. Ivan Kaufman for closing remarks.

Okay. Well, thanks for your questions and appreciate your time and thanks for following us during these very difficult times. Enjoy. Bye.

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