Earnings Call Transcript - ABR Q1 2022

Operator, Operator

Good morning, everyone, and thank you for joining the First Quarter 2022 Arbor Realty Trust Earnings Conference Call. I will now hand over the call to our speaker today, Paul Elenio, Chief Financial Officer. Please proceed.

Paul Elenio, Chief Financial Officer

Okay. Thank you, Leo. 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 March 31, 2022. 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 assumed future results of our business, financial condition, liquidity, results of operations, plans and objectives. These statements are based on 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 with the occurrences of unanticipated events. I'll now turn the call over to Arbor's President and CEO, Ivan Kaufman.

Ivan Kaufman, President and Chief Executive Officer

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 tremendous quarter, which continues to demonstrate our unique ability to consistently deliver outsized returns through our diverse operating platform. As a result, we're able to once again increase our dividend to $0.38 a share. And this is our eighth consecutive quarterly dividend increase, representing 27% growth over that same time period. We believe it's now more important than ever to continue to stress the many advantages of our unique business model, especially in light of the changing landscape of higher interest rates, continued inflation, and the potential for another recessionary cycle on the horizon. We built a premium operating platform that is focused on the right asset classes with very stable liability structures. We have a thriving balance sheet, GSE, agency private label, and single-family rental business as well as an industry-leading securitization platform which has allowed us to produce a long track record of exceptional performance, consistent earnings, and dividend growth. And we can't emphasize enough the value of having an annuity-based business model with multiple products that produce many diverse income streams. This has allowed us to consistently grow our earnings and dividends in all cycles while maintaining the lowest dividend ratio payout in the industry, creating a substantial cushion between our core earnings and dividends. There are significant differentiating factors from the rest of our peer group, most of which have a monoline business, have struggled to maintain their dividends, and have very little upside for future dividend growth, especially considering an anticipated recessionary environment. And this is why we strongly believe that we're in a class by ourselves, and we should trade at a substantial premium at a much lower dividend yield than anyone else in our peer group. Turning now to our first quarter performance. As Paul will discuss in more detail, our quarterly financial results were once again remarkable. We produced distributable earnings of $0.55 per share, which is well in excess of our current dividend, representing a payout ratio of around 70%. In our balance sheet business, we had another outstanding quarter. As one of the top multifamily balance sheet lenders in the industry, we continue to see opportunities for significant growth. As a result, we grew our balance sheet loan book by another 17% in the first quarter to $14.2 billion on $2.8 billion of new originations. We also have a very robust pipeline, which gives us great confidence in our ability to continue to meaningfully grow our loan book for the balance of the year. And again, these balance sheet loans create significant value for our platform as they are not only accretive to our current earnings and dividends but also allow us to build a pipeline for two to three years of new GSE/Agency and private label loans that produce additional long-term dated income streams, ensuring the long-term growth of our platform and creating high-quality earnings and dividends for the future. We have consistently been a leader in the CLO securitization market as our financing and high-quality balance sheet portfolio with the appropriate liability structures continues to be one of the key business strategies. We were very successful in continuing to access the CLO securitization market in the first quarter, closing another $2 billion CLO. The utilization of these vehicles has contributed greatly to our success by allowing us to appropriately match-fund our assets with nonrecourse, non-mark-to-market, long-term debt and generate attractive leverage on our capital. And again, we are very focused on the right side of our balance sheet with approximately 65% of our first-quarter income impacted by the sharp increase in interest rates. However, more importantly, we are seeing a significant uptick in our pipeline as the market is adjusting to the changing rate environment, and we expect to be able to close the gap substantially by the end of the year and produce relatively similar agency volumes as compared to the prior year. In fact, April's origination volume was much stronger with $475 million of loan closings. Our GSE/Agency platform continues to offer premium value as it requires limited capital and generates significant, long-dated, predictable income streams and produces significant annual cash flow. Additionally, our $27 billion GSE/Agency servicing portfolio, which has grown by 6% in the last year, is mostly prepayment-protected and generates approximately $120 million a year in recurring cash flow. This is in addition to the strong gain on sale margins we continue to generate from our originations platform which will continue to contribute greatly to our earnings and dividends. And as we mentioned on our last call, we also closed our fourth private label securitization totaling $490 million in the first quarter, which continues to demonstrate the strength and diversity of our versatile lending platform and tremendous securitization expertise. We've also built a growing single-family rental platform with a pipeline well in excess of $1 billion, which makes us optimistic about our ability to continue to scale this business going forward. We're a leader in the build-to-rent space, which provides us with the opportunity to originate construction bridge and permanent loans in the same transaction. And again, like our balance sheet business, this platform provides us yet another path to future transactions that will produce additional long-dated income streams. In summary, we had another tremendous quarter, allowing us to once again increase our dividend. We strategically built our platform with multiple products that produce many diverse income streams, providing us with the future annuity of high-quality, long-dated recurring earnings. We're also the premier multifamily originator in this space, and we are invested in the right asset classes with very stable liability structures, which positions us extremely well to succeed in every market cycle and gives us great confidence in our ability to continue to significantly outperform our peers. I will now turn the call over to Paul to take you through the financial results.

Paul Elenio, Chief Financial Officer

Okay. Thank you, Ivan. As Ivan mentioned, we had another exceptional quarter, producing distributable earnings of $93 million or $0.55 per share. These results translated into industry-high ROEs of approximately 18%, allowing us to once again increase our dividend for the eighth consecutive quarter to an annual run rate of $1.52 a share. Our financial results continue to benefit greatly from many aspects of our diverse annuity-based business model that allows us to produce multiple income streams from a single investment, giving us confidence in our ability to continue to generate high-quality, long-dated recurring earnings in the future. In our GSE/Agency Business, we originated $761 million in GSE loans and recorded $1.1 billion in GSE loan sales in the first quarter. We generated margins on those GSE loan sales of 1.39% in the first quarter compared to 1.52% in the fourth quarter. As we mentioned on our last call, with the change in the interest rate environment, we do expect margins to be more normalized in 2022 in the range we previously guided to of 1.30% to 1.50%, depending on the mix of our product. We also recorded $15 million of mortgage servicing rights income related to $975 million of committed loans in the first quarter, representing an average MSR rate of around 1.57% compared to 1.88% last quarter, mainly due to having a greater mix of Fannie Mae loans in the fourth quarter versus the first quarter, and those loans contain higher servicing fees. Our servicing portfolio was approximately $27 billion on March 31, with a weighted average servicing fee of 44 basis points and has an estimated remaining life of 9 years. This portfolio will continue to generate a predictable annuity of income going forward of around $120 million gross annually, which is relatively unchanged from last quarter due to the continued increased runoff in our portfolio. As a result of this runoff, prepayment fees related to certain loans that have prepayment protection provisions continue to be elevated with $16 million in prepayment fees received in the first quarter compared to $20 million in the fourth quarter. In our balance sheet lending operation, we grew our portfolio another 17% to $14.2 billion in the first quarter on volume of $2.8 billion. Our $14.2 billion investment portfolio had an all-in yield of 4.74% at March 31 compared to 4.62% at December 31, mainly due to increases in LIBOR and SOFR rates, largely offset by higher rates on runoff as compared to new originations during the quarter. The average balance in our core investments increased substantially to $13 billion this quarter from $10.5 billion last quarter, mainly due to significant growth we experienced in both the first and fourth quarters. The average yield on these investments was 4.86% for the first quarter compared to 5.03% for the fourth quarter, mainly due to higher interest rates on runoff as compared to originations in the first and fourth quarters, partially offset by the effect of higher SOFR and LIBOR rates in the first quarter, net of the impact of LIBOR floors on our portfolio. Total debt on our core assets was approximately $12.9 billion at March 31, with an all-in debt cost of approximately 2.81%, which was up from debt cost of around 2.61% at December 31, mainly due to increased LIBOR and SOFR rates. The average balance in our debt facility was up to approximately $12 billion for the first quarter from $9.4 billion in the fourth quarter, mostly due to financing the growth in our portfolio. And the average cost of funds on our debt facility was flat at 2.65% for both the first and fourth quarters from slightly higher average interest rates, offset by reduced pricing from our CLO vehicles and warehouse facilities. Our overall net interest spreads in our core assets decreased to 2.21% this quarter compared to 2.38% last quarter, and our overall spot net interest spreads were also down to 1.93% at March 31 from 2.01% at December 31 due to yield compression on new originations as compared to runoff and from debt cost increasing more than asset yields as a result of rising interest rates and LIBOR floors that are still in effect on certain loans in our portfolio. However, it's important to note, as the current LIBOR and SOFR curves are predicted to continue to increase, any further increases in these rates will produce a net positive increase to our net interest income spreads on our balance sheet book due to rates being above the average LIBOR floors in our portfolio. In fact, all things remaining equal, a 1% increase in rates would produce approximately $0.05 a share annually in additional earnings. Additionally, as rates rise, we will begin to earn more income from the significant amount of escrow balances we have from our Agency Business and large balance sheet loan book, which will also increase our earnings going forward and is unique to our business model. That completes our prepared remarks for this morning, and I'll now turn it back to the operator to take any questions you may have at this time. Leo?

Operator, Operator

We'll take our first question from Steve Delaney, JMP Securities.

Steven Delaney, Analyst

There are many positive aspects in your report, but if I had to highlight one thing from the quarter, it would be the Structured Business volume of $2.8 billion, which increased the portfolio by 16%. This achievement wouldn't be possible without access to CLOs, and I believe you agree. Could you elaborate on the latest CLO, CLO 18, which is valued at $2 billion? Additionally, could you compare this execution to CLO 17 that you completed late last year?

Ivan Kaufman, President and Chief Executive Officer

Sure. So clearly, the last CLO we did of $2 billion was very sizable, and it was important for us given the volume. I think if you look in the Commercial Observer or one of the publications, there was a CLO that was just priced. We really can't speak about it, but it's in there. We're an active issuer of CLOs. The pricing of CLOs have changed with the market. And the good news about the way we run our business, we're always on track as to where the market is and adjusting the pricing of our originations to match the CLO execution. So our CLOs continue to change. Our pricing to our customers continues to change. We always like to have somewhere between 50% to 75% of CLO debt to total outstandings. We're currently sitting around 65%, which is a very comfortable rate relative to where we want to be specifically in this cycle. So we're well prepared with our CLOs and our liability structure is pretty much intact, I'm very comfortable with our position.

Steven Delaney, Analyst

Okay. The average spread was LIBOR plus 1.81%, which was consistent with CLO 17. Do you anticipate that the market is currently positioned this way and will likely stay in that near 180 basis point range on a weighted average?

Ivan Kaufman, President and Chief Executive Officer

No, not at all. The markets widened up considerably. In fact, we've raised our pricing to our consumers, I think, five times since December. So we've increased our pricing five times to match where the market is. And basically, each price is an increase of 1/8, and we've also adjusted our credit guidelines considerably over the last nine months as well. So if you take those five increases, we've raised our price by 5/8 to almost 3/4 across the board. We've done it gradually to match how the markets have moved. So that's how our business runs. Usually, there's a lag of a couple of weeks, but not that much of a lag. So we're consistently taking new loan originations, pricing them accordingly to the CLO market. So we're pretty aggressive about it. Some of the people in the market lag a lot more than we do. We're pretty much spot on, given our level of volume and where we are in the market and more specifically, a real clear knowledge of where the CLO market is executing.

Paul Elenio, Chief Financial Officer

Steve, it's Paul. I just wanted to correct you. So yes, we had a 181 pricing on our last CLO. As you mentioned, the one before, it was 168. So things have widened a little bit, as Ivan said and continue to. But as Ivan mentioned, we're totally in tune to what our levered return is. And because we're so active in the CLO market, we're able to adjust our pricing accordingly to get to that targeted levered return, which is something that I think is unique to our platform as we're so in tune to what that market is, and we're a market leader.

Steven Delaney, Analyst

Great. And your SFR product and your BFR product, do I understand that you are putting those loans into the same CLO program that you do with your traditional bridge loans?

Ivan Kaufman, President and Chief Executive Officer

On the exit but not on the aggregation aspects. When it comes to the construction, what we'll do is that's done on a separate line. Some of the loans on the bridge side, once they’re stabilized, they'll be going to our CLOs once they fit multifamily characteristics.

Steven Delaney, Analyst

Got it. But during the interim, because of the complexity of construction draws and everything, that's your takeout once you're past your development construction period.

Ivan Kaufman, President and Chief Executive Officer

Once the units are stable and fully leased, yes.

Operator, Operator

We'll move next to Stephen Laws of Raymond James.

Stephen Laws, Analyst

Ivan and Paul, you guys have both touched on this a number of quarters in a row and would love to get updated thoughts. And I think, Paul, you touched a little bit on your prepared remarks, but kind of early repayments been running pretty high the last few quarters. Kind of curious what you're seeing there, maybe in April. Or is the volatility and maybe changing macro outlook made some people more reluctant to pay those penalties to refinance early?

Paul Elenio, Chief Financial Officer

Sure. So let me give you some numbers, Steve, and then I'll turn it to Ivan for the market color. You did mention, I should address some of that in my prepared remarks. It still continues to surprise me the level of prepayments we're seeing. There's still a lot of sale activity in the market. Prices are still elevated. We'll see where that goes with the changing environment. But we did have another $1.250 billion of agency runoff in the quarter that generated $16 million of prepayment fees. As I've said last quarter, we do think that slows down as interest rates rise. Obviously, naturally, yield maintenance burns off when interest rates rise, although we did say we thought it would be elevated in the first and maybe the second quarter. And we were right, it was elevated in the first quarter. In the second quarter in April, we had $350 million of agency runoff in April, and we generated just over $4 million in prepayment fees from that. So we do think it slows over time. When that happens exactly, it's hard to determine. But obviously, with rising interest rates, those numbers will be more challenging to have higher prepayment fees. But Ivan could give his view on where he thinks runoff goes, given the state of the market and how people view those prepayment fee challenges.

Ivan Kaufman, President and Chief Executive Officer

Yes. I think we'll have another robust quarter next quarter because there's still a lot of assets in the market for sale. However, the prepayment fees could come down a little bit as the yield maintenance is a little less because rates are a little bit higher. Multifamily values still seem to be maintaining themselves. So the substantial gains that a lot of people have in their multifamily assets and a lot of people are monetizing those gains even if they have to pay prepayments because their gains far outweigh the prepayment factor relative to their total gain perspective. So I do think they'll slow a little bit in the third and fourth quarter as the market kind of takes to readjust a little bit, but we certainly expect a reasonable quarter next quarter.

Operator, Operator

We'll take our next question from Crispin Love of Piper Sandler.

Crispin Love, Analyst

My first one is on the originations trajectory in the Structured Business. I think last quarter, you were talking about $1 billion per month or a little bit less than that. So just curious if you could provide an update on what you're seeing currently and then also how that could impact originations in the second quarter and throughout the year.

Ivan Kaufman, President and Chief Executive Officer

Sure. Well, clearly, we're the market leader in providing bridge debt in the multifamily sector. And even as we continue to raise our pricing, I think we had two price increases over the last 14 days. We're still seeing originations at that similar level of about $1 billion a quarter, which is where we're managing to. So for the moment, we're in pretty reasonable shape with our pipeline. I think that through June, August, July, we're at that level, and we haven't seen a slowdown as of this point. I think with the volatility of the 10-year fixed rate markets, people are still very interested in heading towards floating rate deals until they see the market settle out. In addition, I think you still have at least another six months of multifamily properties and still bringing lagging rents to market, and there's like a 10% gap between rents a year ago and today. So I think until you see that full turn of rents, the bridge product will be an attractive financing alternative, especially in this market volatility.

Paul Elenio, Chief Financial Officer

And Crispin, it's Paul. Welcome, by the way, and thank you for your participation. To Ivan's point, I'll just give you a couple of numbers for April because we have them. Obviously, we're in May. So we did close $800 million of bridge product in the month of April. We did have $500 million of runoff in April. But as Ivan said, our clip in our pace is probably between that $800 million and $1 billion a month going forward. Now of the $500 million runoff we did see in our balance sheet book, we were able to recapture 35% of that in our agency product, which is great, and that's our model. As you know, that's what we strive for. And so of the $475 million of agency product we did in April, about 35% of that $500 million that ran off in the balance sheet book went right into the agency product. So that's our model. That's great execution for us. That's what we strive for, but those are some of the numbers around April.

Crispin Love, Analyst

Great. That's helpful. And then just one on gain on sale revenue. It seemed like it was significantly lower in the quarter sequentially. Can you speak to what drove that? Or if there are any noncore items there that's driving that or if there's just something that I'm missing there?

Paul Elenio, Chief Financial Officer

Sure, let me explain that. First, you need to look at it as two separate line items on the profit and loss statement which we combine into distributable earnings for your reference. The gain from sale and fee-based services appeared quite low, but it’s important to also consider the gains on derivatives. In the first quarter, we had an APL securitization of $489 million. Due to changes in interest rates, the value of the assets decreased compared to fixed-rate assets, but the swaps increased in value, making them worthwhile. You need to take approximately $17.1 million out of the $17.3 million from that line item and add it to the gain on sale figure. This results in about $19 million in gain on sale, yielding a margin of 101.18. This is attributed to a slight gap in the APL product, leading to a reduced margin compared to past figures. If you exclude the APL and the $1.1 billion of agency sales, our margin was about 101.39, down from 101.52 previously. As I've mentioned, due to changing interest rates, we expect margins to tighten somewhat. Additionally, this is influenced by the mix of products since we had fewer FHA loan sales in the first quarter compared to the fourth quarter, which is just a matter of timing. Traditionally, the FHA business tends to operate at about a 104 margin, so that affects overall margins. We also have a single-family rental business and a permanent loan product where we originate fixed-rate loans and sell them with no exposure. We didn’t have any sales from this segment in the first quarter due to timing, while we had some in the fourth quarter that registered margins of 102 and 103. Overall, when looking at the general Fannie and Freddie business, margins remain stable and are mainly influenced by the mix of products, which is why we expect margins to be between 101.30 and 101.50 moving forward.

Operator, Operator

We'll move next to Jade Rahmani of KBW. In the first quarter, we did not have sales of fixed-rate loans, which we typically originate and sell into the market without taking on any risk. There was some timing involved, and we had a few of those sales in the fourth quarter, yielding margins around 102 to 103. The overall situation is largely about the mix related to Fannie and Freddie. The margins have remained stable; the variation is due to the mix, which is why we are projecting a margin of 101.30 to 101.50 moving forward.

Jade Rahmani, Analyst

Volumes continue to remain extremely strong in the market. And at this point, do you think that's a function of investors rushing in to capture current interest rates before there's future increases or something else that's driving that?

Ivan Kaufman, President and Chief Executive Officer

I think the multifamily sector seems to be one of the most resilient sectors, and I think there's just a lot of investor demand in this sector. We're seeing that also in the build-to-rent sector as well. Those are just two sectors that continue to drive a lot of equity, and the sales from what I hear in the first quarter and to date are still extremely strong. I do believe there'll be a little bit of a reset as rates change and people take a step back and reevaluate, but we're pretty optimistic in terms of overall multifamily sales opportunities going forward for the balance of the year. Maybe they'll cool off slightly. But even if they do cool off, they'll readjust, and maybe you'll have a gap for about 60 days as the market resets on how they're going to view interest rates and the potential for a recession.

Jade Rahmani, Analyst

And in that gap, do you expect there's going to be multifamily cap rate widening? Could you put some parameters perhaps around the magnitude that you're thinking about?

Ivan Kaufman, President and Chief Executive Officer

Yes. Contrary to everybody else, we've been very much anticipating inflation and a potential recession, and we've underwritten cap rate expansion to about 50 basis points from where it is today, heavily criticized for, but that's our position. We believe that as rates widen and rent growth slows, you'll see a bit of a widening on the cap rate side. Even if you have strong investor demand, you still need to have the kind of returns to their equity, and that's our perspective.

Jade Rahmani, Analyst

On the $500 million of runoff you saw in April, 35% of those went into agency. So those refinanced from a bridge product into a fixed-rate product with longer-term duration. What does the other 65% do in your insight?

Paul Elenio, Chief Financial Officer

Yes. You are correct that 35% went into agency, primarily due to a large deal we transitioned from the bridge side, which is positive. The remainder largely consisted of sales that did not come back to us, predominantly because these were property sales, which we cannot always influence in terms of their outcomes.

Jade Rahmani, Analyst

Just a strategic question. The platform, the company overall has grown tremendously over the last multiple years. There's a cohort of mortgage REITs that you could argue are subscale in the market trading at discounts to net asset value or book value. Would acquisitions, M&A ever be something of interest? Or do you believe Arbor's just got this unique multifamily-focused platform that works well between the structured and the GSE business that not really interested in branching out?

Paul Elenio, Chief Financial Officer

Ivan, are you there?

Ivan Kaufman, President and Chief Executive Officer

Can you repeat the question? I fell off the call. I'm sorry, we're back on.

Jade Rahmani, Analyst

Yes. It's an M&A question, mergers and acquisitions, Arbor has grown tremendously over the last 5 years and has a strong niche within the multifamily small balance as well as bridge lending market. Would the company be interested in M&A in the mortgage REIT space to expand its overall footprint into other products? Or is that not really a focus?

Ivan Kaufman, President and Chief Executive Officer

I think we've always had a history of M&A. We haven't done that much over the last couple of years only because we think the pricing in the market has really been a little bit inappropriate for it to be accretive to the company. I think now as we go into a different cycle, there may be some opportunities to expand our product lines and different ways we do business. So I think given the strength of our balance sheet and our performance and our earnings and our position in the marketplace, there could be some opportunities if there's a bit of a downturn.

Operator, Operator

This concludes our question-and-answer session. I'm happy to return the call to Ivan Kaufman for closing remarks.

Ivan Kaufman, President and Chief Executive Officer

All right. Well, thank you, everybody, for your participation. It's been clearly another great quarter. We've had a great run. And for a long period of time, it is a changing environment, which we believe we're extraordinarily well positioned for, and we look forward to everybody's participation next quarter. Have a great weekend, everybody.

Paul Elenio, Chief Financial Officer

Thank you.

Operator, Operator

This does conclude the First Quarter 2022 Arbor Realty Trust Earnings Conference Call. You may now disconnect your lines. And everyone, have a great day.