Arbor Realty Trust Inc Q2 FY2024 Earnings Call

Good morning, ladies and gentlemen, and welcome to the Second Quarter 2024 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 today's conference is being recorded. I would now like to turn the call over to your speaker today, Paul Elenio, Chief Financial Officer. Please go ahead.

Thank you, Angela. 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, 2024. 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 strong quarter as we continue to effectively navigate through this extremely challenging environment. As we discussed in the past, we started preparing for the cycle well over two years ago, with a plan to appropriately position the company to navigate through and succeed for our investors in this challenging market as we continue to execute in line with our expectations. We have a diversified business model with many cyclical income streams, focused on the right asset class with the appropriate liability structures, and we are well capitalized, which has allowed us to continue outperforming our peers in every major financial metric. Last quarter, we posted some compelling charts on our website demonstrating this outperformance. We updated these slides again this quarter, and we encourage you to review them, as they clearly demonstrate that our total shareholder return, dividend growth, and book value appreciation over the last five years are outperforming everyone else in our peer group. In fact, most of our peers have cut their dividends substantially, experienced significant book value erosion, and generated a negative total shareholder return over the last five years. Clearly, this is not the position we are in, and we have continued to demonstrate over a long period of time that we are a consistent outperformer and a leader in the space. As we have communicated, we expected the first two quarters of this year to be the most challenging part of the cycle, and we have also guided to this period of peak stress affecting the third and fourth quarters as well, if rates remain higher for longer. Even in the most stressful part of the cycle, we continue to post very strong operating results, which we'll discuss more in detail on today's call. We are aware of certain erroneous information in the marketplace, which has been driven by short reports and is inaccurate. While our performance in this quarter speaks for itself, we would be remiss if we didn't point out certain factual inaccuracies, as well as ill-informed and/or inaccurate statements that are causing the most concern. First, there has been a swath of misinformation regarding one transaction in particular called the Westchase portfolio. For example, misinformation started that the transaction should have been reported in the first quarter when, in fact, the transaction closed in the second quarter and was appropriately and timely reflected in the company's financials. We believe that the merits of this deal were of utmost interest to the shareholders. Specifically, we had a $100 million bridge loan collateralized by a portfolio of properties in Houston, Texas, in which the borrower defaulted. We immediately exercised our right to foreclose on these assets as we believe that there was a value above the debt; we simultaneously sold it to a new entity, which was capitalized with $15 million of fresh equity and a $95 million bridge loan at SOFR+ 300 basis points that we provided. Of the $15 million of capital that was invested in this transaction, $6.25 million or 40% was funded by the Austin Walker Fund, which is a private minority-owned real estate fund focusing on affordable housing that we have a 49% non-controlling limited partnership interest in. The rest of the capital came from two independent separate investors, one of which is a borrower that we have a long-standing relationship with and has a tremendous amount of expertise in renovating these types of assets and maximizing their value. We believe the stabilized value of these assets to be around $128 million, which is well above the capital stack of this deal and the deal has now been recapitalized with the appropriate reserves giving us confidence that the new ownership group will be able to hit the targeted business plan over the next few years. Westchase is an outstanding transaction that fits what we want, which is lending to affordable housing communities. We believe this transaction is a very effective workout with sound economics and consistent with our values, yet the short sellers have levied what we believe are baseless criticisms about this transaction. Again, we are extremely pleased with the results of this transaction and the benefit it presents for our stakeholders. We continue to do an effective job in managing through our loan book, and this transaction represents management's capabilities in taking back an asset and replacing it with new sponsorship and having it appropriately recapitalized. Second, certain misinformation has been spread about the redemption of one of our CLOs. We have been a top issuer of CLOs for over 20 years, never once losing a single dollar of principal for our investors, even through the historic financial crisis. We are experts in managing these vehicles and have issued and repaid many vehicles, returning all invested capital to our bondholders. We called the CLO on June 17 in the ordinary course of business, returning the principal investments of each bondholder in full through the outsized returns on our capital and maximizing returns to our shareholders. Additionally, the reports have also stated that we did not give proper notice to our bondholders prior to the redemption, implying that we committed securities fraud. The rules are very clear. We are required to give notice to our bondholders 10 days prior to the redemption, which we did formally through the trustee on May 31, and we are required to file an SEC form on the redemption 45 days after the quarter in which the redemption occurred, which is, in this case, not until August 14. We have collapsed and redeemed over a dozen CLOs in the past 10 years and each time given the proper amount of notice and filed all SEC required documents in a timely manner. Third, we have been criticized for how we've been managing our loan book in this distressed environment. When, in fact, the company has done a very effective job in maximizing returns to our shareholders, which, again, is evidenced in the numbers that we have reported. This quarter, we successfully modified over $730 million of loans with $23 million of fresh capital being injected into these deals from the sponsors. This includes cash to purchase new interest rate caps, fund interest and renovation reserves, bring past due interest current, and pay down loan balances where appropriate. We also continue to make progress on approximately $1 billion of loans that are past due by either modifying these loans for closing and taking them into REO or bringing in new sponsorship either consensually or simultaneously with the foreclosure. In addition, we had an extremely successful quarter given the recent decline in interest rates by generating $630 million of payoffs, with $490 million of these loans being refinanced into fixed-rate agency deals. As I have said in the past, if interest rates go below 4%, as they've done in the last week or so, we expect that this will become more meaningful to our business. Despite these facts, Arbor has been subject to repeated attacks in the reports generated by short sellers, and we expect these attacks will continue. The best response to these attacks, which we believe are unfair and unjustified, are our financial results and our earnings call here today. It has also been widely reported that in the wake of these attacks over an 18-month period, Arbor has received requests for information from government agencies, including the Department of Justice. Arbor consistently has cooperated and will continue to cooperate with any such requests. Likewise, it is our policy not to comment on any such inquiries. That said, I would like to provide more detail about some additional results that have resulted from our execution of strategies to manage the business through an environment that poses market-wide challenges. One of the items I touched on earlier is how important it is to have adequate liquidity and appropriate debt increments for success in these types of markets. As a result, we have focused heavily on maintaining a strong liquidity position. Currently, we have approximately $700 million of liquidity between around $700 million in corporate cash and $200 million of cash in our CLOs, resulting in an additional cash equivalent of approximately $50 million. Having this level of liquidity is crucial in this environment as it provides us the flexibility needed to manage through the rest of the downturn and to take advantage of opportunities that will exist in this market to generate superior returns on our capital. We also continued to do an excellent job in deleveraging our balance sheet and reducing our exposure to short-term bank debt. We are down to approximately $2.8 billion in outstandings from our commercial banks from a peak of approximately $4.2 billion, and we have 67% of our secured indebtedness in non-mark-to-market, non-recourse, low-cost CLO vehicles. The CLO vehicles are a major part of our business strategy as they provide us with a tremendous strategic advantage in times of distress and dislocation due to the nature of their non-mark-to-market, non-recourse elements. Additionally, they contribute significantly to providing a low-cost alternative to warehousing banks, which, in times like this, have fluctuating pricing and leverage point parameters. In fact, one of the significant drivers of our income streams are our low-cost CLO vehicles, as well as the fixed-rate debt and equity REIT instruments we have that make up a big part of our capital structure. We are very strategic in our approach to capitalizing our business with a substantial amount of low-cost long-term funding sources, which has allowed us to continue to generate outsized returns on our capital. Another major component of our unique business model is our significant agency platform, which offers a premium value as it requires limited capital and generates significant long-dated, predictable income streams, producing considerable annual cash flow. In the second quarter, we had strong originations of $1.1 billion despite elevated rates for most of the quarter. The recent drop in the 10-year and 5-year, combined with tighter spreads, has allowed us to continue to build a strong pipeline of future agency deals, giving us confidence in our ability to grow our agency volumes going forward. We have also done a great job in converting our balance sheet loans into agency products which has always been one of our key strategic and significant differentiator from our peers. It is also very important to emphasize that a significant portion of our business is in the workforce housing part of the marketplace. As we all know, Fannie and Freddie have a specific mandate to address workforce affordable housing needs, a major issue in the United States, making Arbor a great partner that continues to fulfill an important mandate for federal agencies as well as the social need for society. Our fee-based servicing portfolio, which grew another 3% this quarter and 4% year-over-year to $32.3 billion, generates approximately $124 million a year in recurring cash flow. We also generate significant earnings on our rest on cash balances, which act as a natural hedge against interest rates. In fact, we are earning 5% on around $2.4 billion of balances or roughly $120 million annually, which combined with our service and income annuity totaled $245 million of annual gross cash earnings or $1.20 a share. This is in addition to the strong gain on sale margins we generate from our origination platform and it is extremely important to emphasize that our Agency business generates 45% of our net revenues, the vast majority of which occurs before we even open our doors each day. This is completely unique to our platform. In our single-family rental business, we continue to be the leader of choice in the premium market we traffic in. We had another strong quarter with $185 million of fundings and another $280 million of combined signed-up commitments. We have a large pipeline and remain committed to this business, offering us returns on our capital through construction, bridge, and permanent lending opportunities generating strong levered returns in the short term while providing significant long-term benefits by further diversifying our income streams. We are also seeing steady progress in our newly added construction lending business. This is a business we believe can produce very accretive returns on our capital by generating 10% to 12% unlevered returns initially and eventually mid to high teens returns on our capital once we leverage this business. We continue to see a nice increase in our portfolio of potential deals with roughly $250 million under application, another $250 million in LOIs outstanding, and $850 million of additional deals we are currently screening. We believe this product is very appropriate for our platform as it offers us returns on our capital through construction, bridge, and permanent agency lending opportunities. In summary, we had another very productive quarter and are working exceptionally hard to manage through this dislocation. We feel we have done an excellent job in managing our loan book and getting borrowers to recap their deals with fresh equity as well as bringing in quality sponsors to manage underperforming assets and working through our non-performing loans. We understand very well the challenges that lie ahead, and I feel we are well positioned. We have a diversified business model, invested in the right asset class with stable liability structures. We're also well capitalized with a best-in-class asset management function and seasoned executive team giving us confidence in our ability to navigate through this distressed environment. Despite the misinformation circulated in the marketplace about our business strategies, we continue to reiterate that we stand by our financials and our disclosures, and we have always conducted our business operations and practices in the best interest of our shareholders. I will now turn the call over to Paul to take you through the financial results.

Okay. Thank you, Ivan. We had another strong quarter, producing distributable earnings of $91.6 million or $0.45 per share, which translated into ROEs of approximately 14% for the second quarter. As Ivan mentioned, we successfully modified 28 loans in the second quarter, totaling $733 million. On approximately $398 million of these loans, we required borrowers to invest additional capital to recap their deals with us providing some form of temporary rate relief through a pay and accrual feature. The pay rates were modified on average to approximately 7.18% with 2.14% of the residual interest due being deferred until maturity. $155 million of these loans were delinquent last quarter and are now current in accordance with their modified terms. Our total delinquencies were $1.05 billion at June 30 compared to $954 million at March 31. These delinquencies are made up of two buckets: loans that are greater than 60-days past due and loans that are less than 60-days past due that we are not recording interest income on unless we believe the cash will be received. The 60-plus day delinquent loans or non-performing loans were approximately $667 million this quarter compared to $465 million last quarter due to approximately $264 million of loans progressing from less than 60-days delinquent to greater than 60-days past due, a $9 million loan that went non-performing this quarter, which was partially offset by $62 million of loans being modified in the second quarter that are now performing. The second bucket, consisting of loans that are less than 60-days past due came down to $368 million this quarter from $489 million last quarter, mostly due to $264 million of loans that progressed to non-performing and $138 million of loans being modified or that paid off during the quarter, which was partially offset by approximately $281 million of new loans this quarter that we did not accrue interest on. While we expect to continue to make progress in resolving these delinquencies, at the same time, we do anticipate that there will be some new delinquencies in this environment. We're currently working through a number of these loans that we expect to resolve by taking back the properties and then working to improve these REO assets to create more of a current income stream. This could take 60 to 120 days, which will likely result in a low order mark for net interest income over the next couple of quarters until we have worked through this portfolio. This is what we expected and is consistent with our previous guidance that this would be the period of peak stress at the bottom of the cycle. We also continue to build our CECL reserves given the difficult market backdrop, recording an additional $29 million on our balance sheet loan book in the second quarter. $7.5 million were specific reserves we took on assets this quarter with the balance in additional general reserves. The increase in general reserves from previous quarters was mainly due to changes in the assumptions in our models on real estate values given the challenging environment. We feel it is very important to emphasize that despite booking approximately $145 million in CECL reserves across our platform in the last 18 months, $117 million of which was in our balance sheet business, we still were able to maintain our book value. This performance is well above our peers, the vast majority of which have experienced significant book value erosion in this market. Additionally, we're one of the only companies in our space that has seen significant book value appreciation over the last five years, with 30% growth during that time period versus our peers whose book values have declined at an average of approximately 20% during that timeframe. As discussed – as Ivan discussed earlier, we're pleased with the success we are having in working through our balance sheet loan book and in resolving our delinquencies. As we've stated many times, we have several recourse provisions in our loan documents that lend value to the resolution process. Last quarter, we realized a $1.6 million loss on an $11.3 million loan that paid off at a discount. We immediately pursued one of our recourse provisions and are pleased to report that we received a $900,000 settlement payment in the second quarter related to this loan. We also had a very successful resolution on the legacy REO office property that we foreclosed on back in the fourth quarter of 2021. Through a lengthy marketing process, we were able to sell this asset above our carrying value, resulting in a second quarter gain of $3.8 million. In our Agency business, we had a strong second quarter with $1.1 billion origination and loan sales. The margins on our loan sales were flat at 1.54% for both the first and second quarters. We also recorded $14.5 million of mortgage servicing rights income related to $1.1 billion of committed loans in the second quarter, representing an average MSR rate of around 1.32%, which was also flat compared to last quarter. Our fee-based servicing portfolio also grew to approximately $32.3 billion at June 30, with a weighted average servicing fee of 38 basis points and an estimated remaining life of 7.5 years. This portfolio will continue to generate a predictable annuity income going forward of around $124 million gross annually. This income stream combined with our earnings on escrows and gain on sale margins represented 45% of our net revenues for the quarter. In our balance sheet lending operation, our $11.9 billion investment portfolio had an all-in yield of 8.60% at June 30, compared to 8.81% at March 31, due to a combination of an increase in non-performing loans and some new loans that we did not make their full payment that we did not accrue interest on, which was partially offset by modifications in the second quarter on some of our previously delinquent loans. The average balance in our core investments was $12.2 billion this quarter compared to $12.5 million last quarter due to runoff exceeding originations in the first and second quarters. The average yield on these assets decreased to 9% from 9.44% last quarter due to substantially more modifications in the first quarter, resulting in the collection of a significant amount of back interest owed combined with an increase in non-performing loans and some new non-accrual loans in the second quarter. Total debt on our core assets decreased to approximately $10.3 billion at June 30 from $11.1 billion at March 31, and mostly due to the unwind of CLO 15 and the paydown of other CLO debt with cash in those vehicles in the second quarter. The all-in cost of debt was up to approximately 7.53% at 6/30, compared to 7.44% at 3/31. The average balance on our debt facilities was approximately $10.8 billion for the first quarter compared to $11.4 million last quarter. The average cost of funds in our debt facility was up slightly to 7.4% for the second quarter compared to 7.50% for the first quarter. Our overall net interest spreads in our core assets decreased to 1.46% this quarter compared to 1.94% last quarter again from a significant amount of back interest collected in the first quarter for modifications. Our overall spot net interest spreads were down to 1.07% at June 30 from 1.37% at March 31, mostly due to an increase in non-performing and non-accrued loans during the quarter. Lastly, as we continue to shrink our balance sheet loan book, we have delevered our business 25% over the last 18 months to a leverage ratio of 3:1 from a peak of around 4:1. Equally as important, our leverage consists of around 67% non-recourse, non-mark-to-market CLO debt with pricing that is below the current market, providing strong levered returns on our capital. That completes our prepared remarks for this morning, and I'll now turn it back to the operator to take any questions you guys may have at this time.

Thank you. We'll take our first question from Steve DeLaney with Citizens JMP. Please go ahead.

Thank you. Good morning, Ivan and Paul. Congratulations on a solid performance in this difficult market. One of the things we noticed, obviously, you're very active on modifying loans of the 60-day or less bucket. We did notice that, in the quarter, 2Q, fewer loans to modify than in the first Q. Looking at the modifications, which I guess so far this year, 67 modifications, $2.5 billion of loans. When we looking at that data and then looking at the NPLs, which increased slightly in the second quarter to 24 loans and $676 million. The question is just in terms of your process. Is it still – once you classify a loan as an NPL, are you still actively working to – could you modify that loan and get it back in a current state or once they go to NPL, is there a much higher probability that it might end up in REO? Thanks.

Thanks, Steve. Let me give you a little overall view of the process. We're talking about an overall number of about $1 billion, give or take. And we believe we're pretty much in the peak part of the cycle with the most stress. As you know, the $1 billion has a negative effect on our financial performance, which is factored in because we're not accounting for the income on that. So it's really incumbent on us to give you a good view of how that $1 billion is going to flow through the system. I'm pretty involved in this stuff. So we look at it this way. Of the $1 billion, we estimate about 30% will go to REO. That's the toughest part of it. Those of you who are ones that are not consensual take a bit of time. They are not income-producing for us during that period. It could take anywhere from three months to a year depending on the jurisdiction and us getting into those assets and bringing them up to speed and then getting them cash flow and selling them. So that’s the stickiest part. There's about another 10% or 15% of that we're working with the existing sponsors to bring in new sponsorship. We believe that over a period of just three to six months, that those assets will have new buyers. We estimate that just to be conservative, it will throw off about a 6% return once that's done. In that $1 billion, we estimate there's going to be about 40% of payoffs just because the assets are being sold. It's just a normal process. The other 40% are in the process of being modified; mods take time. A big part of what we do is we proceed to foreclosure when a loan is not paying. That path to a foreclosure usually leads to a very effective process of getting modified. We would estimate that would be the product that's moved through the system, the quickest — probably an average time of about 90 days, then it returns to an interest-earning asset, and we use about a 7% rate on that. We are in the thick of it. It's about $1 billion. We expect to get it through the system. There will be some new ones coming in. That's what we're expecting. Clearly, this drop in interest rates is extremely favorable for the company and its business model as it will stimulate more multifamily sales and people will be able to buy these assets with more affordable financing.

Got it. Well, what I heard you say there, Ivan, is that because something is currently classified as an NPL, there is still a possibility that those loans could be modified. Did I hear you correctly?

Yes. I'm thinking about 40% of them based on what I see in the portfolio. I'm pretty intimate with the asset management group and the progress they're making. It takes time for a lot of these borrowers to find the capital and get these things brought up to speed. So that would be the approximate number I would be using to get it modified.

Great. And the 30% to REO, Paul, I look on the balance sheet, can you tell us what's in REO currently? And I assume you have that in other assets? We couldn't find...

We do, Steve. We absolutely do. So it is in other assets. REO is $78 million right now on our books. It's sitting in other assets. We sold, as I said, the South Carolina office property for $10 million. So it was $88 million last quarter at $78 million this quarter. And of that $78 million, just to give you a little color, the two biggest ticket items are a $41 million New York City office property we took back in 4Q of 2023 that we disclosed, and that's a building that we brought in new sponsorship and are converting into a condo, and that will take some time. The other big piece is we have about a $30 million multifamily deal in Texas that we took back in the fourth quarter of 2022 that we're working through. There are some little odds and ends, but it's a small number. As Ivan said, we are expecting as we work through this $1 billion that a decent amount more could go REO, and that number will grow, right, Ivan, that's what we're talking about.

Yes, that's the guidance that I gave, about 30%.

Yes. Thank you both for your comments.

Thanks, Steve.

Our next question comes from Stephen Laws with Raymond James. Please go ahead.

Hi. Good morning. Just a follow-up, a minor point on the REO, about how many assets is that? What is – is the average loan size consistent with kind of the $20 million for the portfolio? Or how do you see that $300 million of potential REOs from a property count standpoint?

We'll take a look at the list. I would think yes, but Paul can be more accurate. It's probably an average loan size of around $30 million.

Yes. We have some chunkier stuff we're looking at, Stephen, that was in the $50 million range, maybe even $100 million, but that's not a lot of what we do. Then we have some $10 million and $15 million, and 20 million loans. It's hard to really project where these are all going to end up. But I would say we're thinking it's probably in the $30 million to $40 million average range.

Great. And then, Ivan, I want to go back to something you commented on around interest rates. You said we go below 4%, certainly beneficial. Since the last time we spoke, the long end of the curve is down almost 100 basis points or fairly close. Can you talk about maybe how – and I know that most recently, it's only been a couple of weeks, but can you talk about how that maybe has changed behavior from sponsors? Do you think they're more likely to protect assets, cheaper to buy new caps? How do you think it impacts agency volumes as you move forward?

Let me address the cap issue. The cap issue has been an extremely expensive proposition for many of these sponsors. Assuming for the last three years, they've had to pile in another 6 to 8 points of capital to buy caps. We believe the curve is going to change and the cost of caps is going to go down, which will help them out. But the real meaningful issue is the drop in the five-year and the 10-year. I mean, you could effectively borrow close to 5% off the five-year. Up until now, people were paying close to 6%, 6.5%, but spreads have tightened and rates have come down. So if you have a borrower currently paying on a floating rate basis close to 9%, you can then go ahead and pay 5%. So that's a great option for that particular borrower, even if they put a little more capital into it. They can secure long-term financing, effectively turning a negative cash position into a positive cash position assuming of an asset with a 6%, 6.5% cap rate; all of a sudden, you've created positive cash flow from negative cash flow, and that's becoming very meaningful. The key for people is managing their assets while they stabilize because then we get fixed-rate financing in the 90-plus occupancy somewhere in that range. To the extent people have their assets stabilized, then that becomes a great option for them, relieving the pain of carrying those assets, which has been extremely painful. Make no mistake about it. When you're going to borrow a loan and you're paying 4.5% to 5%, next thing you're paying 9%, and it’s for a prolonged period, you have a lot of capital needs. I think we're at a great inflection point right now for many of these borrowers if their assets are stabilized that they can look through the fixed-rate market and reposition our assets without having a negative trend.

Great. Appreciate those comments, Ivan. One last one, if I may. On portfolio seasoning. Origination volume was strong in 2021, in the first half of 2022, but really lightened up a lot in the second half of 2022. As you think about the seasoning of those loans, is it fair to say that you've covered the $1 billion of NPLs? Should we continue to see the new 60-day delinquency start to decline? I know there will be more and some will move, but are we past the peak of identifying the problem loans, as you think about your portfolio?

I think we've given pretty good guidance that the first quarter and second quarter would be peak stress and if rates remain higher for longer, it would leak into the third and fourth quarters. I believe that with this recent rate decrease, you’ll see the market change a little bit. So perhaps the third quarter may be a little bit tough, but we're seeing a little easing, and if rates remain at this level, I believe there will be a lot of liquidity returning to the multifamily sector and many trades being done. I'm hopeful and optimistic that perhaps the second quarter was the peak, with some leakage into the third, but we're definitely seeing the light at the end of the tunnel.

Well, that's great to hear. Nice job managing our assets in a difficult market. I look forward to next quarter. Thank you.

Thanks, Steve.

Our next question comes from Rick Shane with JPMorgan. Please go ahead.

Hey, guys. Thanks for taking my questions this morning. A couple of different things, just from a bookkeeping perspective, cash balances within the structured business declined by about 50%. I assume some of the decline in the restricted cash is from calling the CLO. But can you just help us understand what's going on there?

Yes, sure. The reason we called our CLO was because we were sitting on excess cash balances, and it was inefficient. It's expensive to be sitting on cash balances which are being deployed. In the normal course of business when we have those excess cash balances and can use them, that's why we call a vehicle. The efficiency of these vehicles is to keep the cash balance as low as possible. So we achieved exactly what we wanted.

And to add to that, Rick, that is a big piece of it. The other piece of it is some of these vehicles, as you know, are out of the replenishment period, so they're naturally delevering as loans are running off. So the restricted cash is paying down debt which is part of the component as well. The third component is that we did pay off $90 million of unsecured debt in April, as you are aware, with cash. So those are kind of the three big components that got you a decrease in cash for the quarter.

Okay. Thank you. Second topic, you talked about modifying $730 million of loans in the second quarter. We've gone through the disclosure in the last Q related to mods. I'm going to be honest; I don't fully understand all of the implications. Can we just walk through clearly the implications of the mods in this quarter in terms of what it means for the difference in cash that you will receive and the difference in interest accrual? So if you do modify the loans, what would you have expected to receive? How much are you giving up in cash over the next year or two? What is the difference in the accrual rate so we understand the implications from an income perspective?

Okay. Let me try to attempt to answer that. It's a little more complicated than that, and our Q will be out early next week, we hope. So you'll get more details on that disclosure. But the way I look at it — I don’t know if it will completely answer your question, but we did modify about $1.9 billion or $2 billion of loans last quarter. I think $1.1 billion had paying accrual features. What we do is we look at each loan we modify on a loan-by-loan basis to determine how strongly we feel the value in the mod has put us in a position to still be able to recover the accrued interest. If we don't feel we're in that position, we won’t accrue interest. For the most part, we accrue it; there are exceptions where we decide not to accrue the interest after the mod if we think it's still a challenging asset. Having said that, in the first quarter, our mods generated about $3 million of accrued interest that hit our P&L that wasn't cash. In the second quarter, those first-quarter mods were now $6 million of accrued interest that didn't hit cash because it was for a full quarter, and the second-quarter mods were $2 million in the second quarter of accrued interest. So our PIK interest for 1Q mods was about $3 million in the first quarter. In the second quarter, the 1Q mods were about $6 million, and the 2Q mods were $2 million for a total of $8 million. This number will obviously grow because the second-quarter mods will be fully affected in the third and fourth quarters, and if we mod new loans. I don't know if that's answering your question, but those are the numbers for the first and second quarter mods of how those accrual rates that we accrued affected income but not cash.

All no, it's a very thoughtful response to a question. I wasn't sure objectively that you would be able to answer. So thank you. It's very helpful. Last question, implicitly, the mods, $23 million of additional capital on $730 million of mods, that's about a 315 basis point contribution of capital. I'd love to understand that in the context of your comment and answer or two ago about caps running 6% to 8% for your borrowers. I'm just curious how we sort of square those two numbers.

Okay. It's 6% to 8% over a two to three-year period. Each year, a cap cost can be anywhere between 1.5% to 3% depending on the loan. So in context, we're looking at more of an annual accumulative on that number. But Paul can give you a good number in terms of the mods and how they work for the second quarter.

Sure, I can. So of the $733 million of loans we modified, $23 million of capital is committed to be injected. About $6 million of that capital went to buy rate caps, and they're at all different strike prices. Rick, some are out of the money strikes, some are way in the money strikes. The average strike was about 3.7%. The rest, we had one loan that paid down the principal balance by $2 million. We had pass-through interest of about $2 million that was collected, and then the rest were to fund rental reserves, interest reserves, and OpEx reserves. Those are how it breaks out, if that helps you.

It does. Very thoughtful answers. I appreciate the time. I would throw in one last request. There are a lot of numbers that get thrown around on these calls. You guys are unique amongst the companies that we follow by not providing a slide deck on the calls. I think given the complexity of what Paul, you've described, it would be really helpful to see the numbers while you walk through slides on the call. So I'm just going to throw that out there, but I appreciate your time, guys.

Sure. Thanks. We appreciate it. We always want to be more transparent and have the best disclosures. We try to be when the Q gets filed; there will be a lot of good information there. We'll always take into consideration whether we can put it in a better form for readers. Thank you for that comment.

The next question comes from Jade Rahmani with KBW.

Thank you very much. Can you please give the second quarter or six-month year-to-date cash flow from operations number?

Yes, it's in the 10 — well, you don't have the 10-Q, obviously, it's not filed yet. So I'll give it to you. The cash flow from operations number is $335 million, but you got to back out changes in the originations and sales of held to sale assets, which is a $220 million swing. Then you've got $90 million in changes in operating assets. So call it $335 million as cash flow from operations for the six months, and then you have a $220 million positive swing on originations less proceeds from sales and $100 million negative swing in the change in operating assets and liabilities.

Okay. That's great. The NPLs of around $1 billion. Do you have any numbers in mind as to where that total balance peaks?

Yes. I'd say we're within the range of the peak right now. Maybe you can go up a little bit more, but we're kind of in the peak period of time. We're pretty optimistic about the number I've given you on the mods because we're close to a conclusion on those mods. That's a good number to ballpark.

Yes. It's a tough one to predict, as you know. Ivan is right; it kind of has gone up a little bit since the first quarter, not significantly from $954 million to $1.05 billion. We expect a few more delinquencies; hopefully, we're at the peak, but we do have our eyes on a bunch of loans that are delinquent that we're going to successfully modify — so hopefully, that number will not peak higher. Some of those loans will transition to REO but will still be nonperforming until we work through them. It's a tough question, but I think Ivan is right; we feel like it shouldn’t be significantly higher.

What I would do is the sticky part is the REO because it takes time to get your hands on the asset. Once you have your hands on the asset, you've got to stabilize that asset. That's a sticky part; the rest is somewhat transition.

That's excellent. Thank you. My last question would just be on the GSEs. We've seen a lot of stories around them being pretty cautious right now. I'm curious if you think they are tightening their underwriting standards, or are those just some select few cases?

I think in every cycle, you always have certain things that happen. In this cycle with all the volume, these types of things occur. Clearly, the agencies have changed their attitude toward brokers. Meridian is just a broker but has played a significant role in garnering a lot of volume. Agencies have changed the guidelines. I think that was a long time coming. Since 2010, basically, we've been on a tremendous run, and many deals have been hidden. This is the first time that there is a prolonged downturn, and now you can see some of the things we've done in the industry that finally caught up. I think that's going to be a healthy change that lenders deal directly with the borrowers and that’s beneficial. Appraisers have always been a sore point within this industry. I believe a big part of AI will significantly improve the valuation process, and appraisers will align better with the processes as technology evolves. When they find a bad actor, it's called to light, and they eliminate that actor.

Thank you very much.

The next question comes from Jay McCanless with Wedbush.

Hey. Good morning. Thanks for taking my question. Congrats again on covering the dividend, but that spread continues to narrow. Could you maybe talk to us about how comfortable you are with the current dividend level, especially if economic conditions worsen from here?

Sure. Jay, it's Paul. Thank you for the question. I think it was clear in my prepared remarks that our spreads have come in, given the fact that we've got $1 billion of loans not paying. One of the things we need to stress is that our business model is diversified, having many different income streams, including our agency and SFR business. We have the ability to take back assets, which allows us to generate income during challenging times. I've guided you to a need for a low watermark in the third and fourth quarters, and our numbers could approach or fall slightly below that level, depending on how successful we are in getting back interest and getting those loans online. However, if the 10-year drops further and our agency business starts to explode, it will offset any negative drag we have on non-performing loans. It's a tough balance, but I assure you we are mindful of these challenges and are prepared.

Okay. Great. Thanks for taking my question.

The next question comes from Crispin Love from Piper Sandler.

Thanks. Good morning. I appreciate you taking my question. Just asking the GSE question from earlier, just a little differently. Can you discuss recent activity with Freddie and Fannie because we did see Fannie originations come down meaningfully in the first quarter, but they bounced back nicely in the second quarter? So could you share any changes in tightening standards in the first quarter versus the second quarter? What do you expect looking ahead?

I think this mirrors our earlier conversation. It’s very much tied to interest rates. The agency volumes will increase significantly as rates drop. Many have been waiting to refinance their loans when they reach a certain rate range. We're currently at that prime time rate range, and I expect that agency volumes will pick up significantly. There hasn’t been much multifamily sales activity either, and that is expected to increase. So, I’m optimistic that agency volumes will see some pronounced increases, and we won't be far off from dealing with the backlog that accompanies that.

And I think to add some color to that, Crispin, we did $360 million of volume in our Agency business in July. That number was around the target we did for the second quarter. We think that, given the recent move in rates, people will move off the sidelines. We expect an increase in volume in August and September.

Great. Thank you. I appreciate you taking my questions.

The next question comes from Lee Cooperman with Omega Family Office.

How are you doing? Finally, let me first give hi. I'm not a pint for you guys, but I just wanted to say I congratulate you on your performance. 1.5 years ago, you told me how negative you were about the environment, and you couldn't have been more right. I detect a real frustration on your part in the beginning part of this call and dealing with the shorts. These are unmerciful and in this case uninformed people, basically. Let me tell you, you're performing. They don't understand the uniqueness of the company and how you position the company. And let me tell you, you've been very right, and I congratulate you and I thank you as a major shareholder. Let me ask your questions in have been more right to me about the environment. Do you think we're heading into a recession, number one? Number two, in terms of the book value, what is our book value at the end of the quarter? And are you a buyer of your stock in the low – in the $10, $11, $12 area?

Yes. You and I have had numerous conversations over the last year or two, and I have told you my view on unemployment and the economy. I've been more right than wrong regarding interest rates, and we’re exactly where I said we’d be. As I've shared before, I believe the first and second quarters would be the most difficult. I've had a good parameter for really the unemployment that impacts the workforce, and I do extensive research. So yes, I think the economy is experiencing recessionary conditions, and I think rates will remain in this range or short-term rates should come down, which is all good for our business.

Our book value was $12.46 at the end of 6/30. To your question about buybacks, we have around $140 million of capacity left in our buyback plan, and I will assess where we think it's appropriate based on our capital. Clearly, at the levels you discussed, we would be interested because it would be very accretive to our book value and our earnings.

Yes, it’s been frustrating. The short guys are unmerciful. They come out with inaccurate accusations on a Friday afternoon when you're in your quiet period, and you can't respond. It's damaging to our public shareholders. But we're all lucky to have you guys in our corner because you've done a terrific job, and I appreciate it. Thank you.

Thank you, guys. This does conclude today's question-and-answer period. I will now turn the program back over to our presenters for any additional or closing remarks.