Arbor Realty Trust, Inc. (NYSE:ABR) Q3 2023 Earnings Call Transcript

Arbor Realty Trust, Inc. (NYSE:ABR) Q3 2023 Earnings Call Transcript October 27, 2023

Arbor Realty Trust, Inc. beats earnings expectations. Reported EPS is $0.55, expectations were $0.48.

Operator: Good morning, ladies and gentlemen, and welcome to the Third Quarter 2023 Arbor Realty Trust’s Earnings Conference Call. [Operator Instructions]. I would now like to turn the call over to your speaker today, Paul Elenio, Chief Financial Officer. Please go ahead.

Paul Elenio: Okay. Thank you, Mike, and good morning, everyone, and welcome to the quarterly earnings call for Arbor Realty Trust. This morning, we’ll discuss the results for the quarter ended September 30, 2023. With me on the call today is Ivan Kaufman, our President and Chief Executive Officer. Before we begin, I need to inform you statements made in this earnings call may be deemed forward-looking statements and are subject to risks and uncertainties, including information about possible or assumed future results of our business, financial condition, liquidity, results of operations, plans and objectives. These statements are based on our beliefs, assumptions and 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. I’ll now turn the call over to Arbor’s President and CEO, Ivan Kaufman.

Ivan Kaufman: Thank you, Paul, and thanks to everyone for joining us on today’s call. As you can see from this morning’s press release, we had another outstanding quarter as our diverse business model continues to generate earnings that are well in excess of our dividend. This has allowed us to maintain one of the lowest dividend payout ratios in the industry, which was 78% in the third quarter. Additionally and very significantly despite being in a very challenging environment over the last several quarters, we’ve managed to maintain our book value while reporting reserves with potential future losses, which clearly differentiates us from every one of our peers. In fact, we are one of the only companies in our space who have experienced significant book value appreciation over the last 3 years with roughly 40% growth from around $9 a share to nearly $13 a share.

As we discussed on our last call, we feel we are right in the thick of this dislocation. Operating our business with the expectation that the next 2 or 3 quarters will be the most challenging part of this cycle. We have been laser focused over the last 2 years preparing for this environment. One of our primary focuses has been and continues to be preserving and building up a strong liquidity position. We’re very pleased to report that we currently have approximately $1 billion in cash what gives us tremendous amount of flexibility to manage through this downturn and provides us with the unique ability to take advantage of the opportunities that will exist to generate superior returns on our capital. Clearly, given the current interest rate environment, we expect to experience additional stress.

We need a tremendous amount of discipline and expertise to successfully navigate this market. And we’re very pleased to have a tenured senior management team with a track record of managing through multiple cycles as well as what I consider to the best asset management team in the industry. This is an extremely challenging environment, and I’m very pleased with the level of success we’ve had to date in managing through this downturn, which is a real testament to the quality of our franchise and the extraordinary efforts being put forth by our entire organization. As we have said before, we feel we are very well positioned compared to our peers given our strong liquidity position, multifamily-centric portfolio, the depth and skill of our management team and the strength of our balance sheet and the versatility of franchise.

We also believe we are uniquely positioned to step back into the lending market and done some very accretive opportunities to continue to grow our platform. While others in the space will be dealing with significant internal issues, we feel we are well positioned which allows us to reenter the lending market at a time when there was a great opportunity to put some of the high-quality loans with attractive returns while the competition is less active. In addition, we recently launched our first construction lending business, which is something we are very excited about, and we believe we can generate 10% to 12% unlevered returns on our capital and eventually leverage this business and produce mid- to high teens returns. We also believe this product is a very appropriate for our platform as it offers us returns on our capital through construction, bridge and permanent agency lending opportunities.

We are very committed to this business. And as a result, we went out and hired some of the best and top people in the construction lending field. We are extremely pleased with how quickly we’re able to roll out this product and get ahead of the market and build an incredibly talented team to execute this strategy. Turning now to our third quarter performance. As Paul will discuss in more detail, our quarterly financial results were once again remarkable. We’ve produced distributable earnings of $0.55 per share, which is well in excess of our current dividend, representing a payout ratio of around 78%. The dividend policy that we have implemented with our Board of keeping such a wide disparity between our earnings and dividend has provided us with a large cushion and was very strategic knowing full well that we’re entering to a market dislocation.

And we certainly could have raised our dividend again this quarter based on a substantial cushion and continue to show earnings, the Board decided to keep it flat since we believe we are not getting credit for raising it in this environment and will be more prudent to preserve a large cushion as we head into the most challenging part of the cycle. We’re also the only company in this space that has been able to consistently grow our dividend with approximately 40% growth over the last 3 years, all while maintaining the lowest dividend payout ratio in the industry. Just as importantly, in a time of tremendous test, we’ve managed to maintain a book value of our according reserves for future losses, which clearly differentiates us from our peers.

And we believe our diverse business model uniquely positions us as one of the only companies in the space with the ability to preserve our book value and continue to provide a very stable protected dividend even in this extremely challenging environment. In our balance sheet lending business, we remain focused on converting on multifamily bridge loans into agency product allow us to recapture a substantial amount of our invested capital and produce significant long-dated constraints. In the third quarter, we continued to have success in this area with another $665 million of balance sheet runoff, $350 million or 53%, which was captured into new agency loan originations. As a result, we’re able to recoup approximately $100 million of capital and continue to build up our cash position, which again currently sits at around $1 billion.

And again, we’re excited about the opportunities. We think we’ll be — available to us over the next 3 to 6 months to reenter the market, grow our balance sheet loan book and generate very attractive returns on our capital while continuing to build up our pipeline for future Agency Business. In our GSE/Agency Business, we had another solid quarter, originated $1.1 billion of loss in the third quarter, and our pipeline remains strong. Despite the significant recent rise in the tenure, we are poised to complete the year roughly in line with our 2022 originations numbers, which is a tremendous accomplishment in light of the fact that the agencies are down 20% to 25% production year-over-year. We have done a great job in continuing to gain market share and in converting our balance sheet loans into agency product which has always been one of our key strategies and a significant differentiator from our peers.

This Agency Business offers a premium value as it requires limited capital and generates significant long-dated, predictable in countries and produces significant annual cash flow. To this point, our $30 billion fee-based servicing portfolio, which grew another 2% in the third quarter and a 11% year-over-year, generates approximately $119 million a year in recurring cash flow. We also generate significant earnings on our escrow and cash balances, which acts as a natural hedge against interest rates. In fact, we are now earning almost 5% and around billion of balances, roughly $140 million annually, which combined with our servicing income annuity, totaled approximately $260 million of annual gross cash earnings or $1.25 a share. This is in addition to the strong gain on sale margins we generate for our origination platform.

And again, it’s something that is completely unique to platform, providing a significant strategic advantage over our peers. We remain very committed to our single-family rental business as we are one of the only remaining lenders in the space, allowing us to aggressively grow the platform. We had a strong third quarter with approximately $140 million of fundings and up $430 million of new commitments signed up, and we also have a very large pipeline. We love this business as it offers 3 turns on our capital through construction, bridge and permanent lending opportunities and generate strong levered returns in the short term while providing significant long-term benefits by further diversifying our income streams and allowing us to continue to build our franchise.

In summary, we had another great quarter, and we believe our unique business model clearly demonstrates our ability to generate strong earnings and dividends in all cycles. We understand very well the challenges that lie ahead, and we are very well positioned to manage through this cycle. Our earnings significantly exceed our dividend run rate. We invested in the right asset class with very stable liability structures, highlighted by a significant amount of nonrecourse non-mark-to-market CLO debt with pricing that is well below the current market. We are well capitalized with significant liquidity, which has put us in a unique position to be able to manage through the downturn and take advantage of accretive opportunities that will exist in this environment.

And again, with our best-in-class asset management capabilities and seasoned executive team, we are confident that we’ll continue to be one of the top-performing companies in our space. I will now turn the call over to Paul to take you through the financial results.

Paul Elenio: Thank you, Ivan. As Ivan mentioned, we had another very strong quarter, producing distributable earnings of $112 million or $0.55 per share. These results translated into industry high ROEs again, of approximately 18% for the third quarter, resulting in a dividend to earnings payout ratio of around 78%. Our quarterly results were slightly higher than our internal projections largely due to increased earnings on our cash and escrow balances from higher interest rates, combined with stronger gain on sale income from slightly higher agency sold loan volumes than we anticipated. As Ivan mentioned, we do expect to continue to experience some level of stress as we manage through this very challenging environment. As a result, we recorded an additional $15 million in CECL reserves in our balance sheet loan book during the quarter.

Additionally, we did see a slight net increase in delinquencies in the third quarter of approximately $28 million. We experienced $98 million of new delinquent loans and resolved a $70 million delinquent loan from last quarter through a successful restructuring. As Ivan said earlier, we are in the most challenging part of the cycle and new issues arise each day. We are very pleased with the level of success we’ve had to date and believe we are well positioned to manage through this downturn given our multifamily focused, strong liquidity position and our best-in-class dedicated asset management team with extensive experience in loan workouts and debt restructurings. It’s very important to reiterate that despite booking approximately $70 million in CECL reserves across our platform over the last 9 months, we still grew our book value per share almost 2%, to $12.73 a share at 9/30 from $12.53 a share at 12/31/2022.

And we are one of the only companies in our space that have seen significant book value appreciation over the last 3 years. In our GSE/Agency Business, we had a strong third quarter of $1.1 billion in originations and $1.2 billion in loan sales. The margins on these loan sales came in at 1.48% this quarter compared to 1.67% last quarter, largely due to significantly more FHA loan sales in the second quarter. We are very pleased with the margins we’ve been able to generate over the first 9 months of the year, which are well ahead of last year’s pace. We also recorded $14.1 million of mortgage servicing rights income related to $1.2 billion of committed loans in the third quarter, representing an average MSR rate of around 1.16% compared to 1.46% last quarter, mainly due to a higher percentage of Freddie Mac loan originations, combined with a greater mix of larger loans in the third quarter, both of which contain lower servicing fees.

Our fee-based servicing portfolio grew another 2% in the third quarter to approximately $30 billion at September 30, with a weighted average servicing fee of 40 basis points and an estimated remaining life of 8.3 years. This portfolio will continue to generate a predictable annuity of income going forward of around $119 million gross annually. In the third quarter, we also received $1 million in prepayment fees as compared to $3 million last quarter. And given the current rate environment, we are estimating the prepayment fees will likely remain nominal at around $1 million a quarter going forward. In our balance sheet lending operation, our $13.1 billion investment portfolio had an all-in yield of 9.12% at September 30 compared to 9.07% at June 30, mainly due to increases in the benchmark interest rates, which was largely offset by an increase in nonperforming loans in the third quarter.

The average balance in our core investments was $13.4 billion this quarter as compared to $13.6 billion last quarter due to runoff exceeding originations in the second and third quarter. The average yield on these assets increased slightly to 9.25% from 9.19% last quarter, mainly due to increases in the benchmark index rates which was largely offset by an increase in nonperforming loans. The total on our core assets was approximately $11.9 billion at September 30, with an all-in debt cost of approximately 7.41% which was up from a debt cost of around 7.25% at June 30, mainly due to the increase in the benchmark rates. The average balance on our debt facilities was approximately $12 billion for the third quarter compared to $12.5 billion last quarter.

The average cost of funds in our debt facilities was 7.37% for the third quarter compared to 7.11% for the second quarter, again, primarily due to the increase in benchmark index rates. Our overall net interest spreads in our core assets decreased to 1.88% this quarter compared to 2.08 last quarter, and our overall spot net interest spreads were 1.71% at September 30 and 1.82% at June 30. Lastly, we believe it’s important to continue to emphasize some of the significant advantages of our business model, which gives us comfort in our ability to continue to generate high-quality, long-dated recurring earnings. We have several diverse and countercyclical income streams that allow us to produce strong earnings in all cycles. The most significant of which is our agency platform, which is capital-light and generates very high ROEs through strong gain on sale margins, long-dated service and annuity income, increased escrow balances that are on significantly more income in today’s higher interest rate environment.

Additionally, we are multifamily-centric and have a substantial amount of non-mark-to-market, nonrecourse CLO debt outstanding with pricing that is well below the current market. We are also well capitalized with significant liquidity and have a best-in-class asset management and senior management team that have tremendous experience and expertise in operating through multiple cycles. And we believe these features are unique to our platform, giving us confidence in our ability to continue to outperform our peers. That completes our prepared remarks for this morning. I’ll now turn it back to the operator to take any questions you may have at this time. Mike?

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Q&A Session

Operator: [Operator Instructions]. And we will take our first question from Steve Delaney with JMP Securities.

Steven Delaney: Congrats on another solid quarter, guys. The number that jumped out in the report to me was the $500 million of cash sitting in the CLOs. My thought there is — and you did put $240 million to work in new structured loans I noted in the third quarter. So I guess the question is, first, the $240 million, were they done within the CLOs or outside of the CLOs? And what are your thoughts about how can you reduce or do you plan to reduce that $500 million meaningfully over the next couple of quarters?

Ivan Kaufman: We’ve done a really good job in managing our cash balances in our CLOs and keeping them well. What we’re seeing is a lot of payoffs coming at the end of the month. So when they come at the end of the month, it takes time to redeploy that money. It used to come more evenly over a period of time. So that’s kind of what we’re seeing. So there’s probably a large number of payoffs. We are constantly looking at our inventory and moving stuff out of our bank lines into it and keeping that cash balance as low as possible, but it’s a process, it’s not always perfect.

Paul Elenio: Yes. Steve, it’s Paul. Ivan is 100% correct. We did have some late runoff in the third quarter. To answer the rest of your questions of the $240 million we funded during the quarter, $140 million, as we said in our commentary, we’re funding of prior commitments on our SFR business. So that all gets funded through our warehouse lines. And that business has been tremendously accretive for us. We’re generating almost a 17% levered return on that business for the quarter. Of the other $100 million that was funded, $92 million were bridge loans and $8 million were mezz and PE behind our agency business. So the mezz and PE is obviously not financed and it’s 13% yield on your money. And the other $92 million, I think $62 million of it went into one of our CLOs and the other ones on a bank line.

So that’s kind of the breakout of how we financed our business. But as Ivan said, we’ve got $6.2 billion of replenishable CLOs at 170 over. We’ve got a nice amount of cash in those vehicles to reinvest. And as loans run off, it’s a process of moving around and being efficient. But we’ve got a lot of dry powder to be able to execute very well going forward.

Steven Delaney: Got it. That leads into my follow-up. Ivan, — which — in terms of the new loan demand on the structured side, are you seeing long-term Arbor borrowers, people that you guys have had relationships for 10, 20 years, stepping up and looking to take on new projects, new multifamily projects in this environment? Or is it everything you’re looking at really just refi-ying existing projects?

Ivan Kaufman: We’ve done some purchase activity, especially on the agency side. And I think that you still don’t have the price discovery in the market and the buyers and sellers meeting of the eyes to have active transactions. So I don’t think it’s a very active part of the market. You are seeing some refis in the market, and you’re seeing the existing bridge loss from time to time, get refi, perhaps some cash or restructure deals. But we’re – we’ve been real cautious. We’ve been spending more of our time on the build to rent, where we feel the opportunities are a little greater. And now as I mentioned, we just launched a construction lending business, which we think is great, all the banks are kind of out of the market. While there’s concern about new deliveries, we think our timing is outstanding because the lending we’re going to be doing now deliveries are going to be in about 36 to 48 months from now, where we think the absorption here and the lack of opportunities will create a good opportunity and our yields would be outsized, and that’s kind of where we’re putting the use of our capital.