Arbor Realty Trust Inc (ABR) 2016 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q3 2016 Arbor Realty Trust Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to introduce your first speaker for today, Chief Financial Officer Mr. Paul Elenio. Please go ahead.

Okay. Thank you. 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 September 30, 2016.

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 and 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.

I'll now 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. We're extremely excited to be discussing our results and accomplishments for the first time as a new company, now have that we have successfully completed the acquisition of the agency platform.

As we have discussed in the past, we believe this acquisition will be transformational to our franchise future growth and success. And we are very excited about the many benefits we will realize from this combination.

As you can see from this morning's press release, we had a very strong third quarter, already realizing many of the benefits of this combination, including immediate accretion to AFFO and a significant diversification of predictability to our earnings streams and significantly increasing our equity base and market cap.

There were many other achievements during the third quarter as well. So I would like to take the time to walk you through our significant accomplishments in our two distinct, but complementary, and cohesive business platforms.

First I would like to discuss our agency origination and servicing platform. This platform is extremely important to our overall business strategy and outlook going forward, as it allows us to transition the REIT from a monoline-dependent entity into a fully integrated franchise with a significant originations business with high barriers to entry; thereby, providing a natural limitation on competition.

It will also enhance our presence in the multifamily sector and provide a strong foothold in the GSE portion in particular. As we have expressed many times, we find the multifamily sector to be an extremely attractive market due to its solid fundamentals, significant borrower demand and strong performance through all cycles.

This agency business also produces significantly [reoccur] and predictable earnings and longer duration assets, and it is also less capital intensive and generates a higher ROE than our current business operating on a more of a self-funding basis, providing a durable growth platform while minimizing the potential impact of the capital market and interest rate volatility.

The newly acquired agency business is a leading national loan origination and servicing platform with over 230 direct employees, including 20 originators operating all throughout the country, with 17 sales and support offices in 8 states.

We have over 20 years' experience in the multifamily agency business, having originated in excess of $20 billion in loans since inception and over $3 billion in loans in 2015.

As we've mentioned on our last call, 2015 has also been another strong year-to-date with $850 million in originations in the third quarter and $2.5 billion in originations for the first 9 months. And we do expect to close out 2016 as our strongest origination year-to-date, which we estimate could exceed 2015 originations by as much as 10%.

This growth has resulted in immediate accretion to our AFFO, which was $0.21 for the third quarter and $0.59 for the first 9 months, substantially in excess of our $0.47 of dividends through September 30.

We also believe that we have a very strong fourth quarter, which will allow us to continue to grow our earnings and dividends in the future.

This platform also contains a very large and profitable servicing portfolio. The portfolio, when acquired, was just under $12 billion, and through our strong third quarter production, has grown to approximately $12.6 billion at September 30.

This servicing portfolio contains approximately 48 basis points of servicing fees, has an estimated remaining life of approximately 7 years, and contains $400 million in escrow balances. The earnings on these escrow balances are currently around 1 month LIBOR, which provides a natural hedge against rising interest rates, as these balances have significant additional earnings power as rates rise.

Additionally, the majority of the servicing portfolio is prepayment protected, which translates into a significant valued asset, which has added diversity, duration and stability to our earnings stream. This is also a very scalable business that will provide significant growth and economies of scale.

So overall, we are very pleased with our third quarter results. And we anticipate closing out 2016 with a strong fourth quarter from our agency platform, which we are confident will allow us to continue to grow our earnings and dividends going forward.

Now I would like to focus on our third quarter accomplishments from our transitional balance sheet lending business. We continue to focus on -- focus heavily on growing our balance sheet originations business while remaining extremely disciplined in our lending approach by investing in senior debt. This has allowed us to generate levered returns in excess of what we would achieve by lending in the subordinate areas of the capital structure.

We originated $266 million of loans and experienced run-off of approximately $118 million in the third quarter, resulting in $148 million of growth in our portfolio for the third quarter, and our pipeline remains strong.

Our third quarter originations had an average yield of approximately 6.4% and we generated levered returns in excess of 14% on these investments. Additionally, with a heavy focus on senior multifamily loans, our portfolio is now comprised of 89% senior debt, with 86% of that being multifamily assets, which clearly have proven to be the most resilient asset class and product type in all economic cycles.

And with the significant improvements we have made in our financing facilities, we are generating strong returns on our capital and a very secure part of the capital structure.

We also continue to provide impressive results from the investment we made in the residential mortgage banking business in 2015. Last year, we talked about how this business had picked up dramatically as a result of the current interest rate environment, which allowed us to up our guidance significantly for the balance of the year.

The third quarter was even stronger than we expected, recording nearly $4 million of income from this investment, which is well above our previous estimates. As we have generated $8.6 million of income from this investment for the first 9 months of this year, resulting in return on our invested capital of greater than 100% for 2016.

Additionally, we also generated $700,000 of additional income in the third quarter from one of our equity interests. And we expect these two investments to generate a consistent annuity going forward of around $2 million to $2.5 million of income per quarter.

These strong results continue to demonstrate our unique ability to create significant additional earnings through new business ventures and from structured transactions, which we view as an important part of our franchise and an additional means of diversifying our income streams and adding to our earnings capabilities.

As I highlighted earlier, the acquisition of our manager's agency platform has also added significant additional income streams and it extended the duration of our earning sources through long-dated prepayment protected servicing income from our significant agency servicing portfolio.

We have also continued to focus heavily on enhancing our debt structures, which is one of the keys to our success and remains a critical component of our business strategy. The successful execution of this strategy has allowed us to generate superior levered returns in a very safe and stable part of the capital stack through the continued use of non-recourse securitization vehicles. We have a tremendous amount of experience and capability in the securitization arena and continue to be a market leader in this space.

In the third quarter, we closed our sixth non-recourse CLO securitization vehicle since the financial crisis, and currently have in excess of $1 billion of non-recourse debt through four vehicles, with replenishment periods going out as far as 3 years. This non-recourse debt represents nearly 75% of our total financing, allowing us to appropriately match-fund our assets with non-recourse liability and generate strong levered returns on our capital.

Additionally, in October, we successfully raised $85 million of accretive capital in the form of a convertible note instrument with very attractive terms. The note carries an interest rate of 6.5% which is more than 200 basis points inside our common dividend yield, and contains an initial convert price of $8.38, which is above both our current stock market and tangible book value per share.

This was a very important capital raise, which will allow us to deploy this capital into our growing pipeline of investment and earn mid-teens returns on our invested capital without diluting our book value. As a result of our recent success in the capital markets, we are very pleased with our strong liquidity position.

We currently have approximately $150 million of cash on hand, combined with over $75 million of investable cash in our CLO vehicles to fund our future investment opportunities.

Overall, we are very pleased with our third quarter results and in our ability to successfully complete the acquisition of the agency platform. We believe the combination of our two significant business platforms will enhance our current platform, expand our market presence and broaden our products and create longer duration assets, which will create value for our franchise.

This is clearly a transformational combination that will allow us to significantly diversify and create more stable, predictable, long-dated earnings streams and grow our current core earnings and diverse -- and dividend substantially.

We also believe we are now uniquely positioned as one of the only pubic mortgage REITS with the ability to originate and service GSE loans combined with a balance sheet to carry those loans, allowing us to continue to expand and grow out our platform and franchise value. And we are very excited and confident in our ability to continue to increase the value to our shareholders.

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

Okay. Thank you, Ivan. As Ivan mentioned, we are extremely pleased to have completed the acquisition of the agency business, which we believe will be transformational to our platform. As our press release this morning indicated, we had a very strong third quarter and have already started to realize many of the financial benefits of the combination.

As a result, AFFO was $15 million, or $0.21 per share, for the third quarter, and $33.9 million or $0.59 per share for the 9 months ended September 30. This is above our dividend to date of $0.47 per share and we do believe we will have a strong fourth quarter from the agency business, which should result in continued growth in our earnings and dividends going forward.

We have provided a substantial amount of financial information regarding our two significant business platforms, as well as some key metrics and data to assist our shareholders in better understanding our performance in the agency business.

The press release also includes a detailed reconciliation from GAAP net income to AFFO, indicating the new adjustments from our agency business, which include noncash items such as mortgage servicing rights, amortization of mortgage servicing rights and amortization of intangible assets from the acquisition accounting.

Our AFFO for the quarter and year-to-date ended September 30 translated into a return on common equity of 10.8% and 8.8% respectively. This is up from last quarter due to the higher ROEs associated with the agency business, which is less capital intensive and operates more on a self-funded basis.

For the quarter, we generated approximately $14 million of net income and approximately $6.8 million of AFFO from the agency business. A portion of the income from this business is subject to federal and state taxes inside a taxable REIT subsidiary.

For the third quarter, we reported only a current state tax provision of $300,000 related to this income, as we have federal tax NOLs from prior taxable REIT investment, a portion of which were applied against the third quarter income.

After utilizing these NOLs, we still have remaining NOLs that could shelter federal taxes from our agency business for maybe one more quarter. If we did not have these NOLs, our current federal tax provision would've been approximately $1 million for the third quarter, resulting in a current federal and state tax expense of approximately $1.3 million for the third quarter from the agency business.

We also had a very strong origination quarter agency platform closing $850 million of loans since July's acquisition, with approximately $2.5 billion originations for the first 9 months of the year.

For the quarter, $669 million were Fannie Mae DUS originations and for the 9 months, we originated $1.67 billion in Fannie Mae loans.

Origination fees and gains on sales of originated loans are recorded upon settlement or sale of the underlying mortgage loan, which normally occurs anywhere from 30 to 60 days after closing. At that time, any commissions earned related to the origination of the loan are recorded as compensation expense.

Therefore, one important metric for tracking quarterly fee income is our loan sale volume, which was approximately $969 million for the third quarter, excluding the first 13 days of July prior to the acquisition.

However, the acquisition accounting requires to book the acquired loans held for sale of approximately $418 million at their fair value on the balance sheet, including fees and gains on sale, less commission expense, which resulted in us not being able to record the net income related to the sale of these loans during the quarter.

This had the effect of us recording net margins relating to only $552 million of loans during the quarter instead of the reported sales of $969 million.

The third quarter margins on these sales was 1.76% including miscellaneous fees, which can range anywhere from 5 to 15 basis points per quarter.

We also recorded $16 million of mortgage servicing rights income related to $715 million of committed loans during the third quarter. This represents an average mortgage servicing rights rate on committed loans of 2.23% for the third quarter.

Sale margins and MSR rates fluctuate primarily by GSE loan type and size. Therefore, changes in the mix of loan origination volumes may increase or decrease these percentages in the future.

The agency business also includes a significant servicing portfolio and has a balance of $12.6 billion at September 30, with a weighted average servicing fee of approximately 48 basis points and an estimated remaining life of 7 years. This portfolio was up 5.5% since the acquisition date and will generate significant predictable annuity of income going forward in excess of $60 million annually.

This annuity will significantly diversify our revenue stream and provide us with long-dated stable, predictable earnings streams that are prepayment protected and less sensitive to rates and market cycles.

Additionally, as Ivan mentioned earlier, this is a very scalable business that will provide significant growth and economies of scale in the future.

The acquisition of the agency platform has also increased our total equity to in excess of $700 million and has also increased our market cap to over $500 million, including annuity issued OP units, creating a larger balance sheet and a more efficient vehicle to access capital in the future.

Now I'd like to talk about the third quarter results from our transitional balance sheet lending operation. We had a very strong quarter, generating net income of $7.8 million and AFFO of approximately $9 million, excluding depreciation expense, noncash stock compensation expense and acquisition costs.

As Ivan mentioned, we were also able to continue to generate significant additional income streams, recording $4.9 million of income from our equity investments in the third quarter, which was up from $4.4 million we generated from these investments last quarter. And we are estimating our equity investments to generate $2 million to $2.5 million of income for the fourth quarter as well.

We also had a strong origination quarter, closing $266 million of new investments, with just $118 million of run-off, which resulted in net growth in our portfolio of $148 million. And we now have an investment portfolio of approximately $1.76 billion at September 30, earning an all-in yield of approximately 6.14%, which is up slightly from a yield of around 6.11% at June 30.

And with our primary focus in multifamily bridge loans, our portfolio now consists of 89% bridge loans and 80% multifamily assets.

The average balance in core investments was up from $1.64 billion last quarter to $1.73 billion this quarter, largely due to the growth in our loan book during the quarter. The average yield on these core investments did decrease to 6.15% for the third quarter from 6.76% for the second quarter, largely due to $2 million more in accelerated fees from early run-off recorded in the second quarter.

Our total debt on core assets was approximately $1.42 billion at September 30, with an all-in debt cost of approximately 4.09%, which is up from a debt cost of around 4.01% at June 30, mainly due to increase in LIBOR during the quarter.

The average balance on our debt facilities was also up to approximately $1.37 billion for the third quarter from approximately $1.25 billion for the second quarter. And the average cost of funds in our debt facilities decreased slightly to approximately 4.19% for the third quarter compared to 4.24% for the second quarter, mainly due to our new CLO vehicle, which carries a lower debt rate than our overall debt cost.

Overall, net interest spreads on our core assets on a GAAP basis did decrease to 1.96% this quarter compared to 2.52% last quarter, again largely due to significantly more accelerated fees from run-off in the second quarter compared to the third.

And our overall spot net interest spreads decreased to 2.05% at September 30 from 2.10% at June 30, mainly due to higher costs associated with certain fees related to our warehouse line due to the timing of moving assets into our new CLO vehicle in the third quarter.

Additionally, as Ivan mentioned, we currently have approximately $75 million of undeployed capital in our CLO vehicles combined with $150 million of cash on hand that, when fully deployed, should increase our net interest spreads substantially.

Our average leverage ratio on our core lending assets, including the trust preferred and perpetual preferred stock as equity, were up slightly to approximately 69% this quarter, compared to 66% last quarter. And our overall debt-to-equity ratio on a spot basis, including the trust preferreds and preferred stock as equity, was also up to 1.71 at September 30 from 1.51 at June 30 due to the ramp-up feature in our new CLO vehicle, the cash of which had not been fully deployed as of September 30.

Lastly, operating expenses related to our structured business appear to be down significantly from last quarter. However, most of this decrease is due to allocating certain public company costs among our two business platforms as a result of the acquisition of the agency business.

Therefore, next quarter's results should be more comparable to this quarter when looking at each of our business units' expenses individually.

As far as our agency business operating expenses, we generally have one significant variable expense related to commissions earned on sold loans, which normally averages between 35% and 45% of our gains on sales, with the remaining operating expenses containing mostly fixed expenses that will stay fairly consistent quarter-to-quarter, other than additions to staffing for the growth of our origination and servicing platform.

Additionally, as I mentioned earlier, the third quarter expenses did not include the first 13 days of July, as we closed on the acquisition of the agency platform on July 14.

That completes our prepared remarks for this morning, and I'll now turn it back to the operator to take any questions you may have at this time. Operator?

Thank you. (Operator Instructions) Steve DeLaney, JMP Securities.

Congrats on a good start for the combined Company.

Thank you.

Ivan, I was wondering if you mind commenting a little bit on your smaller balance agency multifamily approach. Could you talk a little bit about your platform and your -- how your source loans on these smaller loans; maybe compared to a company like Walker Dunlop that goes after larger loans?

And in that, if you would talk about your technology platform? I've seen some ads in CMA about your ALEX system and just be curious just to hear some comments about organically, how the business runs when you come in every day. Thank you.

Sure. I think that's a good question and it speaks a lot about our franchise. Given my background in running residential businesses and being able to develop and build processes, we focused initially, when we're building our business, on smaller loans. That was an area of the market that people were not focused on. So it was a little bit of a strategic approach to go where nobody else was. The problem is to do it efficiently and profitably was not an easy thing to do.

Right.

So we developed a lot of internal processes. We trained our originators in a specific way. And a recent implementation, we developed the ALEX system, which is the Arbor Loan Express system, to be able to take the origination all the way through closing on an automated basis, which reduces our cost significantly. We think it reduces -- to date, we still have room to improve. We save about 26 hours of -- 26 to 30 hours per loan originations and got our originations' costs down significantly and we still have more room to grow.

Just as importantly, many of our borrowers do multiple transactions. It's very common for somebody to do 5, 10 transactions with us a year. So to the extent that they're able to use this automated system for our originators, it allows them to handle more production and communicate more effectively and take on a bigger load. A lot of originators do not like to originate these small loans because they're very cumbersome.

With the implementation of our ALEX program, and the training of not only our originators and internal people, but our borrowers, just importantly, they're able to handle a greater number of transactions and not shy away from what would be smaller transactions when they can, in fact, think they can work on larger transactions. So that's been a cornerstone for us in the way we built our Company.

And clearly, from small transactions become larger transactions, whether it be the borrower growing or whether the borrower just has access to other transactions. So our average loan balance actually continues to grow significantly even though we're a dominant force within the small loan business.

We are the number one provider for Freddie Mac on small loans and Fannie Mae. I believe last year -- and it should be this year -- we've done more loan units with Fannie and Freddie than any other lender. That's a tremendous accomplishment. It gives us a tremendous footprint and a tremendous presence, and it gives us a huge amount of repeat business.

And what we found is if somebody is doing multiple transactions, they'll want to go back to us because of the consistency of the service and the reliability of our communication. And it's a little less price-sensitive, but more service-oriented.

That's very helpful. Thank you. Thank you, Ivan, for that. We're seeing a lot about loan caps. Citi actually, I saw something on Bloomberg 2 days ago, that Citi is actually saying that maybe the FHFA will raise the caps yet again. I guess that would be the third time for multifamily caps.

Practically speaking, Ivan, given your focus on the smaller loans and some larger loans, but do the caps have a practical limit on your ability to originate? How do you see the discussion or noise about the caps affecting ACM?

I think we're less affected by the cap because we focus on smaller loans, which are excluded. And we also focus on the affordability aspect of lending, so we're less affected. But the caps, it could be a little bit of an issue if the market continues to grow.

I think the agencies did get a bump this year. I think that some of our loan production is going to be pushed to next year because everybody is bumped up. So we'll see a little flow into the first quarter of next year. I think if the market is larger in 2017 than it is in 2016, in order for the agencies to continue to hold the same markets they have now, they'll need a little bit of a bump-up.

So at worst, we'll maintain the same level we did last year, plus the growth, because a lot of what we do is outside of the cap. I'm not sure what the FHFA is going to do next year, but I think they will have to be cognizant of a larger market and see how they want to react accordingly. But it will have less impact on us than anybody else.

Appreciate it. Thank you for the comments this morning, Ivan.

(Operator Instructions) Jade Rahmani, KBW.

Just a high-level question -- what are your thoughts about potential M&A in the space as a tool to grow the platform? Are you interested in any potential opportunities to combine with other entities, private or public?

So that's a good question and I'm going to answer that in two ways. First, we'll continue to see what other business operations we can start organically, like our residential business, which has contributed significantly and other lines of business. And we'll always keen to do that, given our entrepreneurial nature. We do have a history of having acquisitions to grow various businesses. I think that that's something we'll evaluate very, very carefully and look to use our currency and/or cash to expand our businesses.

We think that valuations for different businesses over the last 36 months have been extremely high. We were fortunate to have a related party transaction, which had a lot of economies to it, to be able to pull off that transaction. I think if the market has a little dislocation, we'll be uniquely positioned to be able to do that.

Make no mistake about it, we are specifically focused in the multifamily sector, all part of the capital structure, all forms of origination. And we will do what we can to find complementary businesses within that space to continue to grow that space, but we'll also look at other opportunities outside of that. So it is certainly a key management discussion here and we will be well positioned if there is some dislocation.

I was wondering if you could comment on the crowd funding initiative that I think is through a separate vehicle. Is there any potential affiliation or joint venture, some kind of arrangement that ABR could have with that?

So ABR will be a big beneficiary of that. It has to be kept as a separate unrelated entity due to certain requirements with the agencies. We have gotten a tremendous amount of requests from many of our paid sponsors if they could access that kind of funding into some of their deals. And that is something that we feel could provide additional new sponsors to come in as well as enhance our relationships. So we feel that ABR will be a real beneficiary of that product line.

In terms of borrower demand, it seems like the JFC business is still very strong, but overall, what are you seeing right now? Are you seeing any diminution? Transaction volumes are off somewhat modestly. And also I was wondering if you could comment on your level of visibility at this point into deals that may close early in the first quarter of 2017?

I think from the prepared remarks, we were very clear that our fourth quarter is very strong and we're going to finish the year strong. Our pipeline is strong; our presence and brand in the market is getting stronger. We're the number one lender for small balance loans far and above anybody else. And I think we continue to grow our market share and grab a bigger part of the market.

We believe 2017 should be as good, if not better, than 2016 because of all the loans on CMBS properties that are up for balloon. I think 2017 could be the biggest refinance year in the market. If interest rates remain in this region, I think acquisition activity will remain strong. So we're very optimistic for 2017.

Can you just clarify what your average loan size is for the agency business?

Sure. Ivan, do you want me to take that? So currently for the quarter, we had an average loan size -- as Ivan said, it's been moving up. So if you look at our portfolio of $12.6 billion, we had roughly 2,700 loans. That translates to an average loan size in the low 5s and it was probably around there in the third quarter. It was probably in the low 6s in the third quarter.

But as Ivan mentioned, and on the Fannie Mae side of the business, our average loan size has started to creep up. And I think of late -- Ivan, correct me if I'm wrong -- our average loan size on the Fannie side has crept up to about $8 million. Generally, we're in the $5 million to $6 million range, although lately, we have seen some larger loan opportunities and our average loan size has started to creep up.

And just finally, in terms of credit, are you seeing any changes sequentially that could suggest a deterioration? I think that's one of the market's fears about the [series] cycle right now.

Well, clearly, we've had almost 24 quarters of rent growth in our multifamily properties, which is unprecedented. We're very cautious in terms of how we're looking at future rent growth and future occupancies. So we've taken a more conservative posture in the market than some other lenders and backed up our own credit underwriting standards.

There are certain markets that were oil tax related where about 2 years ago, we started (inaudible) our credit philosophy. The fundamentals for renters and new housing starts statistically still work in favor of good occupancy and solid rent-stabilized markets, but we're cautious about rent growth.

Thanks for taking the questions.

(Operator Instructions) And at this time, I'm showing no further questions. So with that said, I'd like to turn the conference back over to CEO Ivan Kaufman for any further remarks.

Well, as there are no more questions, I'd just like to thank everybody for their participation. This has been a fantastic quarter and we're looking forward to a very successful fourth quarter and year-end. Everybody, enjoy the news of the day and we look forward to our next call. Thank you.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Everyone, have a wonderful day.