Arbor Realty Trust Inc Q2 FY2021 Earnings Call

Good morning, ladies and gentlemen. And welcome to the Second Quarter 2021 Arbor Realty Trust Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that this conference is being recorded. I would now like to turn the call over to your speaker today, Paul Elenio, Chief Financial Officer. Please begin, sir.

Thank you, Brittany, 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 June 30, 2021. 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 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.

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 with many significant accomplishments, including exceptional operating results, which continue to demonstrate our unique ability to consistently generate high quarterly earnings and deliver outsized returns in every market cycle. I can't stress enough the importance of having multiple products with diverse income streams, which allow us to consistently grow our earnings and dividends, while others in our space have experienced little or no growth at all. We have a much higher quality of earnings with consistent dividend growth and a very low dividend payout ratio, which is why we strongly believe we should consistently trade at a substantial premium and much lower dividend yield than our peer group. We also remain extremely well positioned for continued success, giving us great confidence that we will produce outstanding results for the balance of 2021. Our tremendous operating results combined with our strong outlook has allowed us to once again increase our dividend to $0.35 per share. This is our fifth consecutive quarterly dividend increase and our ninth increase in the last 12 quarters, all while continuing to maintain the lowest dividend payout ratio in the industry. We've built a premium operating platform focusing on the right asset classes with very stable liability structures, an active balance sheet, GSE agency business, private label program, and single-family rental platform producing a long track record of exceptional performance with consistent earnings and dividend growth. As a result, we have been the top-performing REIT in our space for each and every one of the last five years. Before we dive into the details of our quarterly results and the significant growth we continued to experience in all areas of our business, I want to highlight some of our more notable second quarter accomplishments. We had a very active and successful quarter in many areas of our business. We produced tremendous transaction volumes, originating in excess of $3 billion in new loans and investments this quarter, including over $1.8 billion of balance sheet loan originations, which is a new record. And just as importantly, our pipeline is currently at all-time highs. As a result, we were very active in the capital markets, successfully raising approximately $400 million of accretive capital in the second quarter to fund this growth. We issued $140 million of common equity, $175 million of five-year 5% unsecured debt, and $230 million of new 6.38% perpetual preferred equity which will allow us to fund our growing pipeline of loans and investments and be extremely accretive to future earnings and dividends. This capital is $0.08 to $0.10 accretive in our annual earnings run rate, allowing us to increase our dividend again this quarter. Every time we raise capital, it is to fund our growing balance sheet loan business, which is not only highly accretive to our current earnings and dividends, but also allows us to build a pipeline for two to three years of new GSE agency loans, showing the long-term growth of our platform and creating higher quality earnings and dividends in the future. We were also very successful in continuing to access the CLO securitization market in the second quarter, closing our 15th largest CLO to date, totaling $815 million with very favorable terms and pricing. We have consistently been a leader in the CLO securitization market as financing our high-quality balance sheet portfolio with the appropriate liability structures continues to be one of our key business strategies. The utilization of these vehicles has contributed greatly to our success by allowing us to appropriately match fund our assets with non-recourse, non-mark-to-market long-term debt and generate very attractive levered returns on our capital and provide us with a rock-solid balance sheet. And in the second quarter, we are very pleased to have closed our second private-label securitization totaling $450 million with very effective execution, which contributed greatly to our second-quarter earnings and continues to demonstrate the strength and diversity of our versatile lending platform. Turning now to our second-quarter performance, as Paul will discuss in more detail. Our quarterly financial results were once again truly remarkable. We produced distributable earnings of $0.45 per share, which is an incredible accomplishment and well in excess of our current dividend, representing a payout ratio of around 78%. Our ability to consistently generate exceptional results and increase our dividends is a true testament to the value of our franchise and the many diverse income streams we have created. We continue to realize significant benefits from many areas of our diverse operating platform, continued growth in our GSE agency platform which produces strong margins and increased servicing fees, significant contributions from our private label program, record growth, and significant benefits from the size and scale of our balance sheet business, as well as superior execution on liability structures, strong performance of our multi-family focused portfolio with very few delinquencies and substantial income from our residential businesses. These reoccurring benefits combined with our versatile origination platform, strong pipeline, and credit quality of our portfolio puts us in the unique position to continue to produce significant distributable earnings going forward, as we are extremely well-positioned for future growth and success. On our balance sheet business, we are seeing tremendous growth as deal flows continue to really exceed our expectations. We grew our balance sheet loan book another 18% in the second quarter and record quarterly volume of $1.8 billion and have grown at 35% already this year to $7.4 billion as of June 30. Our pipeline is also at an all-time high, which will allow us to meaningfully grow our loan book for the balance of the year. This unprecedented growth has significantly increased our run rate of net interest income going forward and again, very importantly, these balance sheet loans also create a substantial pipeline of future GSE agency loan origination volume and long-dated servicing revenues, further increasing our future earnings and dividends. It is also very important to stress that over 90% of our book, our senior bridge loans and more importantly, 87% of our portfolio is in multifamily assets, which has been the most resilient asset class in all cycles and continues to significantly outperform all asset classes in this cycle as well. Additionally, as we have mentioned in the past, we have very little exposure to the asset classes that have been affected the most by the recession such as retail and hospitality, and we also have adequate reserves against our positions. In the height of the pandemic, we reported $7.5 million specific reserve on one of our hotel assets and subsequently used our own capital to purchase the remaining note at a discount. We worked very hard on the transaction and are pleased to report the successful sale of our position in the second quarter, allowing us to reverse the full $7.5 million reserve, like approximately $3.5 million of unpaid interest and free up approximately $16 million of our invested capital that we will redeploy into our balance sheet lending business and generate strong level returns on this capital. We have always prided ourselves on investing heavily in our asset management function. This incredibly successful workout further demonstrates the value of our unique franchise. We continue to experience growth in our GSE agency platform and we are seeing significant increased momentum in our private label program as well. We originated approximately $925 million in agency loans in the second quarter and $1.3 billion, including our private label business. We are also off to a very good start in the third quarter and we are expecting to close approximately $300 million of agency loans and $400 million of private label business in July. Equally as important, we have a robust pipeline giving us confidence in our ability to produce significant agency and private label volumes with the balance of the year. Our GSE agency platform continues to offer a premium value as it requires limited capital to generate significant long-dated predictable income streams due to significant annual cash flow. Additionally, our $26 billion GSE agencies servicing portfolio, which has grown 20% in the last year, is mostly prepayment protected and generates approximately $120 million a year and growing in recurring cash flow, which is up 25% from $95 million annually last year. This is in addition to the strong gain on sale margins we continue to generate from our origination platform, which combined with new and increased servicing revenues will continue to contribute greatly to our earnings and dividends. We are also very pleased with the significant growth we are seeing in our single-family rental platform. In the second quarter, we closed another $110 million of single-family rental product and we currently have well over $1 billion of additional deals in our pipeline, making us very optimistic about the growth in this segment of our business. We also believe we are a leader in the single-family build-to-rent space, which provides us with the opportunity to originate construction, bridge, and permanent loans on the same transaction. Again, we are very excited about the growth in this platform and confident this business will be a significant driver of yet another source of income further diversifying our lending platform. In summary, we had an exceptional quarter and are well-positioned to have another outstanding second half of the year with a very versatile operating platform that is multifamily-centric with a strong pipeline, significant servicing income, sizable balance sheet portfolio, single-family rental platform, and residential mortgage business providing us with many diverse and growing business lines that position us exceptionally well for continued future success. We are confident that our superior multi-tiered operating platform will allow us to continue to generate high-quality earnings and dividends and preserve our long-term standing as the best-performing company in our space. I'll now turn the call over to Paul to take you through our financial results.

Okay, thank you, Ivan. As Ivan mentioned, we had another exceptional quarter producing distributable earnings of $69 million or $0.45 per share. These results once again translated into industry-high ROEs of approximately 17% for the quarter and have allowed us to increase our dividend to an annual run rate of $1.40 a share. This quarterly dividend increase reflects our fifth consecutive quarterly increase and our 21st increase in the last 10 years. Our financial results continue to benefit greatly from many aspects of our diverse business model, including significant growth in our agency, private label, and balance sheet business platforms that produce substantial gain on sale margins, long-dated servicing income, and strong levered returns on our capital. The income we continue to generate from our residential banking joint venture and the credit quality of our portfolio. As we guided to on our last call, we did see some more normalized results from our residential banking business joint venture as volumes and margins returned to more normalized levels. We recorded approximately $5 million of income from this investment in the second quarter, which contributed approximately $0.03 a share on a tax-effective basis to our distributable earnings. Based on the current market conditions, we expect this trend to continue for the balance of the year, resulting in estimated income from this investment of between $4 million to $5 million a quarter going forward. Our adjusted book value at June 30 was approximately $11.35, adding back roughly $61 million of non-cash general CECL reserves on a tax-effective basis. This is up approximately 5% from $10.86 last quarter, largely due to our second quarter capital raises. The significant earnings we generated in the second quarter in excess of our dividend, as well as from the successful recovery of $7.5 million reserve on a hotel asset during the quarter. As a reminder, we have very little remaining exposure to the asset classes that have been affected the most by the recession, such as retail and hospitality. Our total exposure to these asset classes is approximately $100 million or about 1% of our portfolio, which we believe we have adequately reserved for, giving us great confidence that our adjusted book value accurately reflects the impact of the recession. Looking at the results from our GSE agency business, we originated $925 million in loans and recorded $1 billion in loan sales in the second quarter. The margin on our GSE agency loan sales was up significantly to approximately 1.83% in the second quarter from 1.47% in the first quarter, mainly due to a higher percentage of FHA loan sales in the second quarter, which carry a much higher profit margin. Additionally, as Ivan mentioned, we were very active in our private label program, originating $377 million of new loans in the second quarter, as well as completing our second private-label securitization totaling $450 million with very effective execution, resulting in an all-in margin for the second quarter of 2.37% on our total loan sales. In the second quarter, we also recorded $26 million of mortgage servicing rights income related to $1.2 billion of committed loans, representing an average MSR rate of around 2.20% compared to 2.53% last quarter, mainly due to a higher mix of FHA and private label loans in the second quarter that contained a lower servicing fee. Our servicing portfolio grew another 2% this quarter to $26 billion at June 30, with a weighted average servicing fee of around 46 basis points and an estimated remaining life of nine years. This portfolio will continue to generate a predictable annuity of income going forward of around $120 million gross annually, which is up approximately $25 million or 25% on an annual basis from the same time last year. Additionally, prepayment fees related to certain loans that have yield maintenance provisions did increase this quarter to $4.2 million compared to $2.7 million from last quarter. We also continue to see very positive trends related to our GSE agency business collections, which we believe reflects the strength of our borrowers and the quality of our portfolio. We only have a handful of delinquent loans outstanding and extremely low forbearance numbers in our portfolio through June 30. Loans in forbearance represent less than 23% of our $19.2 billion Fannie loan book and around 2.5% of our $4.7 billion Freddie Mac loan book, which is down substantially from March as we have had no new request for forbearances in the last several months and a significant number of our loans have completed the program and are now current. In our balance sheet lending operation, we grew our portfolio 18% to $7.4 billion in the second quarter and recorded quarterly volume of $1.8 billion. Our $7.4 billion investment portfolio had an all-in yield of 5.33% at June 30, compared to 5.65% at March 31, mainly due to higher rates on runoff as compared to new originations during the quarter. The average balance in our core investments was up to $6.6 billion this quarter from $5.9 billion last quarter, mainly due to the significant growth we experienced in both the first and second quarters. The average yield on these investments was up to 5.85% for the second quarter compared to 5.72% for the first quarter, mainly due to receiving $3.5 million in back interest from the successful workout of a hotel asset and further acceleration of fees from early run-off in the second quarter, which was partially offset by higher interest rates on runoff as compared to originations in the second quarter. Total debt on our core assets was approximately $6.4 billion at June 30, with an all-in debt cost of approximately 2.79%, which was down from a debt cost of around 2.9% at March 31, mainly due to a reduction in the cost of funds from our new CLO vehicle and reduced rates in our warehouse and repurchase agreements during the second quarter. The average balance in our debt facilities was up to approximately $5.9 billion for the second quarter from $5.2 billion for the first quarter, mostly due to financing the growth in our portfolio and issuing $175 million of new unsecured notes during the second quarter. The average cost of funds on our debt facilities decreased to 2.89% for the second quarter from 2.99% for the first quarter. Overall, net interest spreads in our core assets increased to 2.96% this quarter, compared to 2.73% last quarter, again mainly due to interest collected on the sale of our position in a hotel asset and further acceleration of fees from early run-off in the second quarter. Our overall spot net interest spreads were down to 2.54% at June 30 from 2.75% at March 31 due to yield compression on new originations as compared to runoff. Lastly, the average leverage ratio on our core lending assets, including the trust preferred and perpetual preferred stock as equity was up slightly to 84% in the second quarter from 83% in the first quarter, and our overall debt to equity ratio on a spot basis was flat at 2.9 to 1 at both June 30 and March 31, excluding general CECL reserves. 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.

We will take our first question from Steve Delaney with JMP Securities. Your line is now open.

Good morning, Ivan and Paul. And it's getting redundant, but I have to say, congrats on another excellent quarter. The thing that struck me this quarter looking over the results is, not only are you doing the basic blocking and tackling, but the level of sophistication, tapping the capital markets for various transactions just continues to improve. So, props on all that.

Thanks, Steve.

Speaking of the capital markets transaction and I think all of us have been interested in your private label program that you started last summer or that you had your first transaction. Can you comment a little bit? You mentioned better execution, but could you comment a little bit maybe specifically like where you saw AAAs go out relative to swaps? And I think the thing that is I'd really like to know is, how do you estimate what your pre-loss return might be on the approximate 8.5% basis points that you're holding onto? Thanks.

Sure, I don't have it in front of me exactly, where we executed the AAAs so we can furnish that to you. But we had very, very good execution. Our first private label deal came out during the initial aspects of COVID. It was the first of its kind for us. This is our second deal. And of course, we'll be a serial issuer based on our pipeline. The more we issue, the better our execution. So, we're really pleased with where we're trading and with the reception. Both our name and reputation in the multifamily market are strong. The fact that we are a big CLO issuer means there are many crossover buyers, and we expect our execution to improve each time. We're even evaluating whether we want to do a public deal, which would further enhance our execution given the flow that we have. So, we're optimistic about our market participation relative to the expected losses.

Or the return actually, pre-loss return.

Yes, I think we calculate, holding the basis points is that anywhere between a 10% and a 12% return factor.

That's right.

The losses and prepayments, and as you know, our loss history on our multifamily portfolio is nominal, next to nothing. But that's all factored in; we carry it at the proper return, and there are a lot of efficiencies by generating and holding our own basis points with the new Dodd-Frank rules and stuff that gives us a competitive advantage in the market as well.

Yes. And I guess one of the benefits here. I mean, obviously, you still do your CLO business, but these are fixed-rate loans with longer duration than you would see in your bridge portfolio, right? I mean, so, you're putting a 10% and 12% return, but it's something I think you probably are looking at a much longer life to that investment I assume than when you put a CLO together?

Yes, it's an average life of probably nine years on a 10% to 12% coupon, which is very hard to get that kind of return for that kind of term. So, we're pretty pleased with that element of it, and once again, the further long-dated income streams that we're getting, not only on servicing, but on that portion of the basis points which we own, control, and created. Anything we create is considered a superior product with better risk-adjusted returns.

Right, it sounds like based on the July originations, I think you mentioned or Paul did, $400 million. It would seem likely that you'll be doing at least one more of these before the end of 2021, I assume.

We're optimistic based on our pipeline, and we kind of like the market, yes.

And just one final thing, I'll leave the details to others, but obviously, a change at the top of the FHA in the last month or so. Any thoughts on maybe how that policy shift might impact volumes and risk-taking from your perspective?

Yes, I think it's good for the GSE business and for us. In particular, there is going to be more and more of an effort on the affordable side and putting more money towards the affordable aspect of GSE business. We think it's going to be a more favorable environment for firms like us and I think it will be more lucrative.

And we will take our next question from Stephen Laws with Raymond James. Your line is now open.

And to echo Steve's comments, these are very repetitive calls, but for good reasons. So congratulations on other continued growth and another strong quarter. And thinking about the SFR opportunities, what is the pipeline there? What is the competition like? It seems like a number of competitors continue to talk about opportunities there. And kind of as you stand today, when you put a new dollar to work, where do you think those ROEs can go as you scale that business?

The SFR business is a very attractive business segment right now, especially in the build-to-rent communities. We got in early, we got aggressive early, and built up a nice pipeline. Spreads have compressed quite a bit, but then again, our borrowing and our liability structure has gotten more competitive. What we like about the business specifically, on the build-to-rent, the construction component requires more expertise; not everybody is in it. Once you do the construction loan, you'll end up with a bridge loan and a takeout loan. We have locked up and built great relationships with a lot of the key players in the market. There is a lot of new entrants, so you have to proceed with caution. Late entrants into the market are not always the best people to do business with. So, I think we're pretty pleased with the pipeline we have and we're pleased with the opportunities that we have. There will be some compression because it is more competitive and we'll just be selective. We're just thrilled that we were early in, enabling us to develop these great relationships and increase borrower loyalty.

Thanks, Ivan. Paul, to touch on prepayment, I think there were some - I noted in the Q&A that there is some prepay income, but I think it was a historical comparison. So the portfolio growth, I'm not surprised, that's up. But can you talk about the expected repayments? And maybe early income from any early repayments as we think about the portfolio maturing in the next 6 to 12 months?

So, Steve, you're right. Prepayments on the servicing side and run-off were almost double what it was last quarter. As you remember from last quarter, I thought last quarter was surprisingly light at around $400 million; it came in around $800 million this quarter. What was an interesting phenomenon occurred; we did, as you mentioned, get a little bit more prepayment fees than I expected with that remodel, and that we were getting over the last few quarters. When I looked at certain of those transactions, it wasn't that people were refinancing away from us. Again, we're really laser-focused on retaining the business. We want to make sure we get that opportunity. But we saw a little bit in the second quarter, and I don't know if it's a trend that will continue. It's hard to predict. We saw more sales volume at really appreciated values, and people were paying those yield maintenance checks when they were getting significant increases in the value of their properties. That was a little phenomenon we observed. Like Ivan's view, whether we think that continues? It's hard to predict, but that's what we saw in the second quarter.

And we will take our next question from Rick Shane with JPMorgan. Your line is now open.

Thanks for taking my questions this morning. Actually, just one quick detail. You guys have gone through everything thoroughly. When we look at the capitalization rate on the MSR for the quarter, it was down a little bit sequentially. Just curious, when looking at the fees and duration of the servicing rights, I don't see any change there. So, I'm just curious what's driving that? Is that a more conservative assumption or are we missing something?

Rick, it's Paul. Thanks for the question. Good to hear from you again. No, as I mentioned in my commentary, it was just mix. In the quarter, we had more committed loans because that's how we do our MSR capitalization — on committed loans. We had more committed loans on the private label side and on the FHA side of the business. So, they drove higher margins, but they also drove lower MSR rates only because the FHA deals and the private label deals have like a 20 basis point servicing fee, while Fannie is in the 50s. It's just a matter of mix. If that mix changes, and it likely will over time, it will be more normalized. It just happened to be a specific quarter where we had more mix in the lower servicing fee earning assets.

And when we think about the private label, there is nothing from a duration perspective that's materially different than the rest of the portfolio. I know there's a lot of protection on the agency business. I want to make sure I understand the private label business as well in terms of prepayment protections?

It's the same, if not greater prepayment protections. So, we'll have some options on some of the agency business to offer less penalty towards the end of the term. This is a little bit longer in duration, I would say. It's probably 10% to 15% longer in duration.

And we will take our final question from Jade Rahmani with KBW. Your line is now open.

This is Ryan Tomasello on for Jade. Ivan, I was wondering if you can just discuss your general outlook for GSEs in the second half of the year in terms of volumes and overall performance?

I think the GSE business can be stronger in the second half than it was in the first half out of the gate. Specifically, in the second quarter, the GSEs were also dealing with digital collaborative issues. It's my feeling that, based on lower interest rates and wanting to meet their volume target, there will be a little bit more GSE originations in the first half. Everybody's building up their pipeline, and I think you'll see a little bit more activity. I think some of the barriers that Calabria was bringing to the table are being stripped away at this point. The existing regime has been in place, and I think it will go back to a little bit of the historical way of operating. So, I'm very optimistic that the GSE business for the balance of the year will be as strong if not stronger than the first half.

Thanks. And can you talk about some of the technology initiatives that you have been investing behind specifically in the small balance lending space? And I guess just overall, how you're thinking about technology investments generally across the Arbor platform going forward?

I think the way we're approaching technology is that we have a goal of where we want to be in two or three years in terms of eliminating redundancy in functions as well as personnel functions; that's piece-by-piece. I think there's going to be a lot of advance in the servicing side, on the origination side, and the way we use data. We have a three-year plan, and we're doing it piece by piece, making improvements. Technology improvements will increase our ability to implement different processes and smooth out our workflow processes. I believe we can maintain and grow our business and remain very small while building our personnel, taking advantage of those different technologies, but it's not an overnight thing; it's progress made in each segment of the business, combining them all into a whole process.

And then the final one for me regarding the private label business. I was wondering if you see an opportunity, Ivan, to partner with other non-bank lenders on private label CMBS issuance to scale volumes for that platform?

I think that's something that we will look to do in the future. All we wanted to do is get our brand going using our own originations. We work with a lot of brokers, and we can turn it up. We were always cautious of having too big of a pipeline while being very effective. I think once we do our third one and if we end up flipping and doing public deals, we will consider co-originating with a few others. At the end of the day, we will own and hold our own basis points, so we are very particular. We will proceed with caution.

I would now like to turn the program over to Ivan Kaufman for any additional or closing remarks.

Well, thanks again for everybody participating with us and following us. A recurring theme from everybody and what we've been able to do is have some dividend increases, which is really a unique thing in our space. We're the only company, as I mentioned in the prepared statements, not only have a stable dividend - why we think we should be participating at a premium. More importantly, we have exhibited unprecedented growth. Thanks again for your confidence, and I look forward to our earnings call. Thank you very much and have a great day.