Arbor Realty Trust Inc (ABR) 2010 Q2 法說會逐字稿

Good day, ladies and gentleman, and welcome to the second quarter 2010 Arbor Realty Trust earnings conference call. My name is Chanelle and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will be facilitating a question and answer session towards the end of this conference. (Operator Instructions). I would now like to turn the presentation over to your host for today's call, Mr. Paul Elenio, Chief Financial Officer. Please proceed.

Okay, thank you, Chenelle. 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 30, 2010. With me on the call today is Ivan Kaufman, our President and Chief Executive Officer. Before we begin, I need to inform you that statements made in this earnings call may be deemed forward-looking statements that are subject to risks and uncertainties, including information about possible or assumed future results of our business, financial conditions, liquidity, results of operations, plans and objectives.

These statements are based on our beliefs, assumptions and expectations of future performance, taking into account the information currently available to us. Factors that could cause actual results to differ materially from Arbor's expectations in these forward-looking statements are detailed in our SEC reports. Listeners are cautioned not to place undue reliance on these forward-looking statements, which speak only as of today. Arbor undertakes no obligation to publicly update or revise these forward-looking statements to reflect events or circumstances after today or the occurrences of unanticipated events. 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, and thanks to everyone for joining us on today's call. Before Paul takes you through the second quarter results, I'd like to talk about some of our significant accomplishments during the quarter and how the successful execution of our strategy has positioned the Company favorably for the future. Throughout the past three years and especially over the last several quarters, we have worked diligently to execute our strategy of managing our portfolio, maximizing our liquidity and repurchasing our debt at deep discounts when available. As announced last month and discussed in detail on our July 12 call, the completion of the retirement of our debt with Wachovia at a discount for a gain of $157 million was a critical component in completing our goal of restructuring a significant amount of our balance sheet. This milestone transaction has eliminated nearly all of our short-term recourse debt, and it generated a significant gain and increase in book value per share.

It has also increased our core earnings substantially to a significant reduction in our interest expense, increased our operating flexibility and positioned the firm well to actively participate in the accretive opportunities that are becoming available in the markets. We're extremely pleased with the way we strategically managed the completion of the Wachovia debt retirement through a combination of corporate liquidity and the utilization of other debt facilities. This eliminated the need to raise capital or obtain significant additional long-term recourse debts in order to complete the transaction and allowed us to retain a substantial amount of value in the form of unencumbered assets. During the quarter, we also continued to selectively repurchase our CDO debt at discount, purchasing approximately $19 million of bonds for a price of approximately $6 million, resulting in a net gain on early extinguishment of this debt of nearly $13 million.

This adds to a string of success on these transactions that we have had, recording $54 million of gains from the debt repurchases in 2009 and another $47 million in the first quarter of 2010, including the gain from the retirement of our trust preferred debt. We believe there may be similar opportunities for us to repurchase our debt at discounts going forward, and we will continue to evaluate these transactions based on availability, pricing, and liquidity. We continue to focus on maximizing liquidity and using that liquidity strategically to meet corporate objectives. As of today, we have approximately $40 million of cash on hand, around $25 million of cash post -- collateral posted against our swaps, and approximately $195 million of unencumbered assets. We are also pleased with our ability to manage our CDO vehicles effectively, receiving all of the cash distributions from these vehicles in 2009 and the first two quarters of 2010.

And while there can be no assurances that our CDO vehicles will continue to cash flow in the future, we will remain focused on optimizing and utilizing these facilities by transferring assets and originating new loans when available and appropriate. As we have stated in the past several calls, the aim of our strategy, culminating with Wachovia's debt retirement, has been to improve the right side of our balance sheet and substantially reduce leverage in recourse debt, all to position ourselves to return to our core commercial lending business and take advantage of opportunities in the market. During the second quarter, we originated two loans totaling $5 million with a weighted average unleveraged yield of approximately 11%; have committed to fund approximately $10 million of additional loans with an average yield of around 10%; and continue to build our pipeline for new investments.

Clearly, the last three years have been extremely challenging, and we're very happy to have made an entrance back into the core commercial lending business. Our experienced management team worked exceedingly hard in the face of an unprecedented crisis, and we're extremely pleased with our ability to persevere. Now I would like to update you on our view of the market and the credit status of our portfolio. The environment over the last three years has clearly had an impact on every borrower in our portfolio, as the commercial real estate fundamentals and real estate guys have remained weak for some time. We recorded $26 million of loan loss reserves during the quarter relating to 12 loans with an average outstanding balance of approximately $284 million. Of that amount, $14 million were on loans which we had previously recorded reserves, while $12 million were new reserves.

In addition, we recorded a recovery of approximately $1 million in full satisfaction of a loan that was previously written off. We now have $331 million in loan loss reserves at June 30 related to 33 loans with an outstanding balance of approximately $739 million. We also refinanced and modified $19 million of loans and extended $101 million of loans during the second quarter. At June 30, we had approximately $175 million of nonperforming loans with a carrying value of approximately $75 million net of reserves, down from $200 million at March 31, with a carrying value of around $80 million net of reserves. Of the $75 million of net of nonperforming loans on June 30, $6 million were sold in July and another $28 million of net assets are on the contract to be sold. As you can see, the level of our loan reserves is down from last year's pace for the second consecutive quarter, primarily due to what we believe are some further signs that the market for commercial real estate is stabilizing.

While we believe we are adequately reserved at this time, if real estate values and fundamentals decline for the remainder of 2010, this will likely result in additional delinquencies and losses. Accordingly, we will continue our strategy of focusing on strengthening our balance sheet, preserving liquidity and aggressively managing our portfolio. In summary, we are extremely pleased with our ability during this unprecedented crisis to restructure a significant amount of our balance sheet. This again includes maximizing our liquidity, restructuring a substantial amount of our portfolio, effectively managing our CDO vehicles and retiring a significant amount of our debt at deep discounts.

These significant accomplishments have produced large gains and increases in our equity value, have nearly eliminated all of our short-term recourse debt and increased our core earnings going forward significantly. We have also retained substantial value in the form of unencumbered assets and improved our operating flexibility greatly. This has positioned us well to return to our core lending business, which we already started this quarter, and to evaluate the opportunities that exist in the market and explore potential new sources of capital to grow our business. Although this is still a difficult market, we are very excited about the challenges and opportunities that lie ahead for the Company. 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 net income from the second quarter of $129.1 million or $5.05 per share. As in previous quarters, we did have a few large items that affected the numbers, the most significant of which is the $157 million gain net of fees and certain expenses from the retirement of $336 million of debt with Wachovia for a discounted payoff amount of $176 million. As Ivan mentioned, we were also successful in repurchasing some of our CDO debt at significant discounts during the second quarter, recording a gain of approximately $13 million from these transactions as well.

In accordance with the management agreement with our manager, these gains and all other gains recorded as a result of discounted debt repurchases during 2010 are included in the calculation of the incentive management fee. The calculation of the incentive management fee for 2010 will not be finalized until the end of the year, and as a result no incentive fee was recorded in the second quarter. During the quarter, we strategically sold approximately $47 million of our available for sale securities held on our balance sheet as of March 31 for $36 million in cash, resulting in a loss of around $10 million. The cash generated from these sales was used as part of the amount needed to close on the debt repurchase with Wachovia on June 30.

We also recorded an impairment charge during the quarter of approximately $7 million related to the one remaining available for sale security we did us sell during the quarter, which is now being carried on our balance sheet at June 30 at a value of $1 million. As we disclosed previously in the first quarter, we reclassified these securities to held for sale from held to maturity, and recorded these market value changes as a reduction of our equity and other comprehensive loss. So although the sale and write-down of these securities in the second quarter resulted in a loss of approximately $17 million, this had no impact on our book value during the quarter, and again generated a substantial amount of cash that was used to facilitate the Wachovia debt repurchase.

We also recorded $25 million of loan loss reserves, net of a $1 million recovery during the quarter, and we now have $331 million of loan loss reserves on 33 loans with a UPB of around $739 million at June 30. As Ivan mentioned, this environment has clearly had an impact on every borrower and on our portfolio, and we will continue to take a proactive approach in evaluating our portfolio and actively managing and monetizing our assets. Additionally, we continued to effectively execute our strategy of retaining equity value through the retirement of our debt instruments at deep discounts. We're very pleased with our success in retiring the Wachovia debt and more CDO debt this quarter on the heels of retiring $114 million of trust preferred debt and repurchasing $28 million of CDO debt at significant discounts in the first quarter.

Further, we were able to complete the Wachovia transaction with a combination of corporate liquidity and the utilization of other debt facilities. As a result, our current cash position is approximately $40 million, and we now have approximately $195 million of unincumbered assets net of loan loss reserves recorded as of June 30. We did obtain $26 million of new term debt with a rate of 500 basis points over LIBOR for a term of six month, which is secured by two of our loans. We do expect the two loans securing this facility to payoff prior to the maturity of the facility, and such proceeds will be used to repay the debt. We believe there may be similar opportunities for us to repurchase our debt at discounts going forward, and we will continue to evaluate these transactions based on availability, pricing and liquidity. The completion of these transactions has significantly improved our balance sheet and increased book value per share. As a result of the second quarter debt retirements, our book value per share increased to $9.46 at June 30 from $4 from March 31, 2010.

Adjusted book value per share also increased to $14.08 at June 30, up from $8.28 at March 31, 2010, adding back deferred gains and temporary losses on our swaps. These book value numbers do not take into account any dilution from the potential exercise of the warrants issued to Wachovia as part of the 2009 debt restructuring. Additionally, we have between cash on hand, cash posted against our swaps and our unencumbered assets net of reserves as of June 30 approximately $260 million of equity, and in our CDOs as of June 30 of approximately $250 million net of loan loss reserves. Looking at the rest of the results for the quarter, the average balance in our core investments declined by about $103 million from last quarter to around $2 billion, mainly due to pay offs, pay downs and the sale of some of our bonds during the first and second quarter. The yield for the quarter on these core investments was around 5.20% compared to 4.67% for the prior quarter.

Without some nonrecurring items such as additional interest received in the second quarter on a loan that exceeded our investment basis in the asset, and reductions in interest income related to the uncollectibility of interest on impaired, nonperforming and restructured loans in the first quarter, the yield on these core assets was flat at around 4.90% for both the first and second quarters. Additionally, the weighted average all-in yield on our portfolio was around 4.81% at June 30, 2010 compared to 4.75% at March 31, 2010. This increase was mainly due to the payoff of a nonperforming loan in the second quarter with a UPB of approximately $70 million, which had a net carrying value of approximately $35 million. The average balance in our debt facilities decreased by around $105 million from last quarter to around $1.6 billion, which was mainly due to the completion of the retirement of our trust preferred debt in the first quarter combined with additional payoffs and pay downs in the second quarter.

The average cost of funds in our debt facilities was approximately 4.04% for the second quarter, compared to 4.28% for the first quarter. Excluding the unusual impact on interest expense from our swaps, our average cost of funds remained relatively flat from quarter to quarter at approximately 4.29% for the second quarter, compared to around 4.23% for the first quarter. In addition, our estimated all-in debt cost was around 4.17% at June 30, compared to around 4.25% at March 31. This decrease in debt cost is mainly due to the reduction in interest expense going forward from the retirement of the Wachovia debt facility on June 30. So overall, normalized net interest spreads on our core assets decreased to approximately 0.60% this quarter from 0.65% last quarter, primarily due to the full impact of reduced interest rates on refinanced and modified loans in the first quarter, partially offset by higher rates on second originations and the decrease in our nonperforming loans.

As we mentioned several times, the retirement of the Wachovia debt at a significant discount will have a substantial effect on our net interest income going forward, and we estimate a reduction in interest expense of around $7 million to $8 million annually from this transaction. Next, our overall leverage ratios were around 72% on our core assets, and around 81% including the trust preferreds as debt for the second quarter compared to 70% and 82%, respectively, in the first quarter. And our overall leverage ratios on a spot basis were 3.1 to 1 at June 30, compared to 5.8 to 1 at March 31. This significant decrease is due to the reduction in debt from the successful retirement of the Wachovia facilities. Other expenses were up from last quarter, primarily due to increased professional fees and stock based competition from the issuance of 90,000 fully vested shares to our independent directors in April.

Looking at the balance sheet, there were no significant changes compared to last quarter, other than -- as we mentioned earlier -- the reduction in cash available for sale securities and notes payable, all of which are largely due to the successful retirement of the Wachovia debt. Lastly, our portfolio statistics as of June 30 show that about 63% of the portfolio was variable rate loans and 37% are fixed. Our product type, about 59% are bridge loans, 13% junior participations, and 28% of the portfolio is made up of mezzanine and preferred equity. By asset class, 37% is multifamily, 30% is office, 18% hotel, 9% land, and 1% condo, all of which are relatively unchanged from the prior quarter.

Our loan to value is around 92%, and our weighted average median dollars outstanding was 65%, and geographically we have around 35% of our portfolio concentrated in New York City. That completes our prepared remarks for this morning. I will now turn it back to the operator to answer any questions you may have at this time. Operator?

(Operator Instructions). Your first question comes from the line of David Chiaverini of BMO Capital Markets.

Good morning. Well done with the debt payoff. That was very accretive to book value, so congrats there. Related to that, how much will the incentive fee be at the end of the year? I assume that's going to be recorded in the quarter?

Hi, David, its Paul. As we said earlier and we stated in our press release this morning, the incentive fee, if any, is calculated on the basis of a full-year's earnings for 2010. So until we get to the end of the year, any consideration of the amount of the incentive fee, or for that matter whether an incentive fee will be earned, is somewhat speculative. What we've told people, though, and what you'll see on our Q that will be filed today, is obviously the gain of the Wachovia transaction is an import part of that calculation. We believe the hurdle rate on the incentive fee to be around $40 million as of today, if it plays out that way for the rest of the year. So it's hard for us to speculate on what the incentive fee could be, if any, because a lot depends on what the remaining results will be for the rest of the year. And some of the things that obviously factor into that are whether there will be any or how much in loan loss reserves we'd have, and what effect the market could have with continuing decline in real estate on our performance of our assets as well.

So it's formula based, and you mentioned the hurdle rate is $40 million. Now is that $40 million of earnings -- any amount of earnings above $40 million will then be subject to -- could you just remind me what that formula is?

Sure. The formula is the manager earns an incentive fee equal to 25% of every dollar over the hurdle rate. So if the hurdle rate is $40 million at the end of the year, we're saying that's what it is as of June 30. If it stays at $40 million until the end of the year, adjusted FFO that's calculated in the management agreement -- which is really your net income, just adding back some depreciation -- to the extent that that number for the year exceeds the $40 million, then the difference between those two numbers at 25% would be what the manager would earn in an incentive fee.

Got you, got you. And it's based on net income? Like when you said over $40 million, we're checking about net income to common?

Yes. It's really adjusted FFO, but the only adjustment, really is depreciation. So you can look at net income, add back depreciation, and that will be close to your number.

Got you. Yes, that depreciation is pretty low. Okay, and how much recourse debt remains, and when does it mature?

Sure. The short-term recourse debt -- all we have left in short-term recourse debt is the $26 million of new term debt facility we put on as part of the completion of the Wachovia facility. That expires at the end of the year. It was temporary debt that was used to finance a few assets that we believe we have a government take-out lined up for. So we expect that those assets will repay from now until the end of the year, hopefully in the September/October range, and that there will be more than enough cash from those refinances to pay off that line. So we expect that we won't have any short-term recourse debt left on our balance sheet by the end of the year once we're to able to payoff those lines. Additionally, those two loans have an equity value of somewhere between $10 million to $15 million above the hair cut that we got on the debt. So if we're successful in getting the takeout at the proceed level we think we can, we could also not only pay off the $26 million of debt, but recover somewhere of $10 million to $15 million of equity value from those assets.

Okay. And what recourse debt -- aside from the $26 million, what recourse debt is -- ?

The only other recourse debt on the balance sheet, which we view as equity capital, are the trust preferred securities, which as of the balance sheet are about $157 million. But again, those are 30-year instruments with really no covenants, and really we view it -- and I think most of the investment community views -- is that is equity-like capital.

Okay. And then on the new originations, the two loans with the 11% yield and the one loan with the 10% yield, are those bridge loans?

Yes, a few of them are bridge loans and a couple of them are mezzanine loans.

And what's the average term length?

I believe the -- I believe they're between two and three years.

Okay. Thanks lot.

Thanks, Dave.

Your next question comes from the line of Steve DeLaney of JMP Securities.

Thank you, and good morning. And Ivan and Paul, congrats on what looks to be like a transformational type of quarter for Arbor.

Thanks.

Thank you, Steve.

Back on David's question with the two new CRE loans, were those made within the CDOs using restricted cash, or were they outside of the CDOs?

One of the loans was actually made in the manager when we weren't in a position in the REIT to make the loan a couple of months ago, and then we had an opportunity to acquire it. When the REIT acquired it, it acquired it, I believe, directly into the CDO. So the manager owned it for probably 60 days, and then the REIT bought it, and the vehicle they used to buy it was right into the CDO.

Okay.

I believe some of the other loans that we originated were -- are unlevered --

Right.

-- may be moved into the CDO as we free up some room in the CDO. So clearly, it is our strategy to originate loans, and either get leverage outside the CDOs when available and also to use our cash as a warehouse facility in a sense until there's room in the CDOs, which we are anticipating some pay offs, and when there are pay offs, we'll slide these into the CDOs.

Okay, great. So that's a segue into the unencumbered assets. You mentioned, Ivan, $195 million, I think $22 million of that at June was cash. So should we assume the other $170 million is -- are basically commercial real estate loans rather than -- I think Paul said you'd pretty much cleaned up your free securities.

Yes, they are all real-estate loans; and as Paul has mentioned, some are under contract to be sold and liquidated. And as we do have availability in our CDOs, we will look to move some of those into the CDOs where it's as applicable as well.

Steve, just to clear up, the whole $195 million are real-estate loans.

They are? You have your cash plus you have your unencumbered loans?

Right.

Am I reading that right?

That's absolutely correct. So, what we're saying that cash today is $40 million and we have $195 million of unencumbered assets net of the reserves, and we recorded on those assets as of June 30, and we've got $28 million of those assets already under contract to be sold.

And turned into -- converted into cash.

Okay, great. And then looking at the test -- the CDO cash flow test -- you're blowing out the interest coverage. That does not appear to be an issue but the OC test on a percentage basis looked to be rather tight, and just mechanically, the way these CDOs work -- you obviously have collateral you could contribute. But is it basically your policy or the terms of the CDOs that until you fall below the test, you'd prefer to just keep the collateral -- the excess collateral that gives you the flexibility -- you keep that outside of the trust rather than putting it in there earlier to boost up those percentages?

Well, managing the CDOs is a real complicated task, and depending on the collateral we have available -- also depending on the loans that are in the CDOs, if they were defaulted, if they got cured and they got recontributed -- there's a whole myriad of techniques that we use in order to effectively manage those, and we do have collateral that we can contribute from time to time and rebuild some of those cushions. We can buy securities from time to time to rebuild some of those cushions, and we can cure some of our loans from time to time, and we have done a pretty good job at it. It's not easy. But it's something that we will continue to work on.

Okay. And just the final thing -- I appreciate the time you've given me. Paul, could you remind us on what the remaining reinvestment periods are for the three CDOs.

Sure. On CDO I, the reinvestment period had ended last April. On CDO II, the reinvestment period goes until April of 2011. And on CDO III, the reinvestment period goes until January of 2012.

Okay, thanks a lot.

Thanks, Steve.

Your next question comes from the line of the Lee Cooperman of Omega Advisors.

A couple of my questions have been answered, but just on this issue of unencumbered assets and cash, I think you said $90 million in cash, $195 million in unencumbered assets. I'm curious as to what you see in the way of new investment opportunities where you could recycle that capital? And secondly, the book value of $9.46, adjusted book value of $14.08, I'm curious if you guys have a view of which number or what number you like to focus in as might be the true underlying value of the business, assuming you execute your business plan?

Sure, Lee. It's Paul. First of all, the cash position as of today is $40 million. So $40 million, we have $25 million of cash as collateral posted against our swaps, that's about $65 million in total, and then $195 million of the encumbered assets. I'll let Ivan just speak quickly to your question about being able to convert some of that into cash in new originations, and then I'll talk about the intrinsic value I think you asked about.

Yes, clearly it's our strategy to take on nonperforming loans which don't contribute any interest income to us to convert them into cash and then to redeploy the cash into interest earning loans. We began to get active in the market, again to start originating. Lee, we've been a very active originator in the marketplace for the last several years through the manager. We're one of the leading multifamily originators in this country, originating over $1 billion of business. So we still have a very active salesforce, see a lot of opportunities. And what we're very fortunate is to have a good portfolio for our (inaudible) good yield, and we don't need to originate that much. So what we'd like to do is be able to originate between $5 million and $20 million per month depending on the runoff, and what we're very fortunate here to have is the ability to do smaller loans where it's not as competitive.

So if we do $2 million, $3 million, $4 million, $5 million, $6 million, $7 million loans and do a couple of them a month, which we have a great infrastructure for, we think we can convert a lot of that noninterest earning -- noninterest earning assets into interest earning assets at very favorable yields, so we're thinking between -- somewhere between 8% and 15% depending on whether its bridge or mezzanine. And then on top of that, as we free up some capacity in our CDOs, we'll move those loans into our CDOs and even get higher leverage yields. So that's clearly what our strategy is, and it's good to be back to our core business to be able to produce those kind of increased core earnings.

And Lee, clearly we give both numbers the book value and the adjusted book value. We believe the adjusted book value is a real number. It will take some time to get -- as you said, execute the business plan and get that value in, because a big part of that number are the decline in the value of our swaps that we believe we have the ability to wait to maturity of those swaps and get that number to come back to zero, picking up that book value; as well as one of our equity kickers that was monetized on a tax-deferred basis, we need some time to bring that back into income. So believe it's obviously much closer to the adjusted book value. It will take time to get up to that number for the items I just mentioned.

Another way you could look at this is between cash on hand, cash posted against our swaps and the unencumbered assets as of June 30. As we said in our prepared remarks, we have about $260 million of value. Additionally, we have another -- right now, as of June 30 -- about $215 million of value or equity in our CDOs, with the reserves through June 30 those numbers don't take into consideration our trust preferred debt securities, but that's just another way to look at the value.

Good, very helpful. Thank you very much.

Thank you, Lee.

And your final question comes from the line of Bruce Harting of Barclays Capital.

Yes, summing that all up, are you prepared to give any guidance for next year, helping us model out growth, overall size, yield or operating earnings? Anything along those lines?

Bruce, hi, it's Paul. I think it's a little early yet. We want to see where the balance of the remainder of the year comes out obviously. It's still a difficult market. We have made a reentrance into the market, as we mentioned, and we'll be selective. I think one of the things we can do is you can look at the balance sheet as of June 30. We have about $1.9 billion of assets -- interest earning assets -- at a rate of about 4.81%, which is what we told you today in the call, and then we have a debt of $1.3 billion at a rate of about 4.17%. That factors in the $7 million to $8 million of savings we believe we'll have from the Wachovia debt repurchase. If you model that out and you layer in what our expense load has been, what you think you'd be -- you can come up with a pretty good core earnings. What we can't guide to is whether there will be any further deterioration in the market and in our portfolio and what those originations will be going forward. But I think we'll be in a better position to do that over the next couple of quarters.

Ladies and gentlemen, that concludes the Q&A session. I would now like to turn the call back over to your Chief Financial Officer, Mr. Paul Elenio.

Okay, well, thank you for participating on today's call. We are very pleased to be able to return to our core lending business, and look forward to our next quarterly call. Thank you.

Ladies and gentlemen, that concludes the presentation. Thank you for your participation. You may now disconnect. Have a great day.