Arbor Realty Trust, Inc.
Q4 2018 Earnings Call Transcript

Published: 10 May 2019

[Operator:]

Good day, ladies and gentlemen, and welcome to the First quarter 2019 Arbor Realty Trust Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] And as a reminder, today's conference call is being recorded. I would now like to turn the conference over to Paul Elenio, Chief Financial Officer. Please go ahead.

[Paul Elenio:]

Okay, thank you, 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 March 31, 2019. 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.

[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 a great start to 2019 with strong first quarter results which continues to demonstrate the diversity of our operating platform and the value of our franchise. As we mentioned on our last call, we are very pleased with the continued growth in our business which provided us with a very strong baseline of predictable and favorable earnings heading into 2019. This strong baseline combined with our first quarter success has allowed us to once again increase our quarterly dividend by another 4% to $0.28 per share. At our current stock price, we're operating at a dividend yield of approximately 8.5% which we believe is not reflective of our true value. Additionally, as promised, we did provide a chart in our last investor deck which demonstrates the considerable growth we produced in our servicing revenues, escrow earnings, and net interest income from our balance sheet portfolio last year. It also illustrates the quality and diversity of our income streams which differentiates us from our peers and why we believe we should consistently trade at a lower dividend yield at our peer group. Furthermore, our first quarter growth also continues to increase our run rate of core earnings, making us very confident in our ability to increase our dividend in the future. To highlight this further, I would like to talk about the growth we experienced in both our business platforms. In our agency business, we grow our servicing portfolio another 2% in the first quarter and 13% over last year and is now at 18.9 billion. This portfolio generates a servicing fee of 45 basis points and has an average remaining life of 8.5 year, which reflects a 10% increase in duration over the last two years. As result, we have created a very significant, predictable annuity of income about $80 million now as gross annually and growing the majority of which is prepayment protected. And this growth in our servicing portfolio also continues to increase annuity of income from our escrow balances further contributing to our growing annual run rate of core earnings. We also originated 850 million of agency loans in the first quarter. This was slightly down from last year's first quarter volumes, up approximately 1 billion mainly do as we mentioned on our last call to sum up this year's first quarter volume being pulled into the fourth quarter of last year from the sharp drop in the 10 year at year end. More meaningfully, our pipeline is very strong, providing us with confidence and our ability to continue to grow our origination volume for the balance of the year. We're also very pleased in our ability to generate strong margins in our first quarter loan sales despite the extremely competitive landscape, and income stream from our agency platform continues to create significant diversity and a high-level of certainty in our income sources. With respect to our balance sheet business, we've experienced tremendous growth in our loan book. We grew this portfolio of 24% in 2018 and another 4% in the first quarter on 416 million origination. We've also seen a sizable increase in our pipeline over the last few months which allowed us to continue to increase our run rate of net interest income going forward. We had a very strong start to the second quarter with 250 million originations in April. And as a result of our strong pipeline, we elected to raise 90 million of 5.75% unsecured debt to fund the equity portion of these loans. This was very attractive capital as it will be used to fund our pipeline of new investments and the immediately accretive telco earnings. And again, the income generated from our loan book is a significant component of our earnings; and based on our strong pipeline, we remain very confident in our ability to continue to grow the business stream. Now, I would like to update you on a progress we're making in our single-family rental business. We believe the single-family rental market is as big as the multifamily market and at this point is very fragmented with a lot of unique financing opportunities available on that market. We continue to build out the infrastructure to develop this platform and we are very committed to become a leader in the space. We believe this is a phenomenal business with enormous opportunities in both the bridge and permit lending products, and we're very happy with the pipeline of opportunity we are seeing already. We're clearly believe that by bringing capital to this business we can quickly level both our originations capacity and capabilities and build this out to be a significant driver of another income stream and further diversify our lending platform. Overall, we're very pleased with our first quarter results and then continued growth in our business, which clearly demonstrate diversity and value of our operating platform. We're also very comfortable with the stability of our dividend and optimistic based on our baseline revenues and the status of our pipeline that we will be able to continue to grow our dividend. I will now turn the call over to Paul to take you through the financial results.

[Paul Elenio:]

Okay, thank you, Ivan. As our press release this morning indicated, we have very strong first quarter generating AFFO of 35.5 million or $0.33 per share. These results reflects an annualized return on average common equity of 14.5%, which continues to increase consistently from the substantial portion of our earnings that are being generated by our growing capital-light agency business and from the additional cost efficiencies we're experiencing as we continue to scale our balance sheet business. As Ivan mentioned, we're very pleased with our ability to see increase our quarterly dividend $0.28 a share, reflecting a 12% increase from a year ago and remain confident in our ability to increase our dividend in the future as our annual run rate and core earnings continues to grow. Looking at results from our agency business, we generated approximately 13 million of pretax income in the first quarter of approximately 850 million in originations and 1.1 billion in loan sales. The margins on our first quarter sales was 1.49% including miscellaneous fees compared to 1.13% all in margin in our fourth quarter sale mostly due to some large portfolio deals that we closed in the fourth quarter, which generally have a lower margin. We also recorded 14 million of mortgage servicing rights income related to $847 million of committed loans during the first quarter, representing an average mortgage servicing rights of around 1.68%. Our servicing portfolio also grew another 2% during the quarter to 18.9 billion at March 31st with a weighted average servicing fee of approximately 45 basis points and estimated remaining life of 8.7 years. This portfolio will continue to generate a predictable annuity of income going forward of around $84 million gross annually, which is up approximately $5 million on annual basis from the same time last year. Additionally, early runoff in our servicing book continues to produce prepayment fees related to certain loans that had yield maintenance provisions. This accounted for 5 million prepayment fees in the first quarter which was down from 6 million in the fourth quarter. The earnings associated with our escrow balance is also continued to grow and contributed meaningfully to our growing recurring income streams. We currently have approximately 800 million of escrow balances, which are earnings slightly less than 1 month LIBOR and our earnings associated with these balances are up approximately $9 million on an annual run rate as compared to the same time last year. In our balance sheet lending operation, we grew our portfolio another 4% to 3.4 billion, and based on our current pipeline, we remain extremely confident in our ability to continue to grow our balance sheet investment portfolio in the future. Our 3.4 billion investment portfolio had an all yield of approximately 7.71% at March 31st, compared to 7.66% at December 31st. The average balance in our core investments was up from 3.2 billion last quarter to 3.3 billion this quarter due to our fourth quarter and first quarter growth. And the average yields on these investment was up slightly to 7.84% for the first quarter compared to 7.76% for the fourth quarter, mainly due to an increase in average LIBOR rate, partially offset by less exhilarating fees from early run off this quarter. Total debt on our core assets was approximately 3.1 billion at March 31st with all in debt cost of approximately 5.22% compared to a debt cost of around 5.24% at December 31st. The average balance in our debt facilities was up to approximately 3 billion for the first quarter from 2.9 billion for the fourth quarter due to finance our portfolio growth and the average cost of funds in our debt facilities increased approximately 5.4% for the quarter compared to 5.12% for the fourth quarter due to an increase in the average LIBOR rate. Overall, net interest spreads in our core assets were down slightly to 2.60% this quarter compared to 2.64% last quarter mainly due to more acceleration of fees from early runoff in the fourth quarter and overall spot net interest spread was up to 2.49% at March 31st compared to 2.42% at December 31st. And lastly, the average leverage ratio on our core lending assets including the trust preferred and perpetual preferred stock as equity was flat at approximately 79% for both the first and fourth quarter, and our overall debt to debt to equity ratio on a spot basis including the trust preferred rates and professional preferred stock as equity was up slightly to 2.41 at March 31st from 2.301 at December 31st, mainly due to the 90 million of unsecured debt we issued in March. That completes our prepared remarks for this morning. Now, I'll turn it back to the operator to take any questions you may have at this time. Operator?

[Operator:]

Thank you. [Operator instructions] And our first question comes from Steve Delaney of JMP Securities. Your line is now open.

[Steve Delaney:]

Apologies that I am on the road, so my questions either are going pretty much bigger picture because I haven’t been through the weeds yet. One thing we picked up in the first quarter, Fannie Mae of course has stepped up on small balance and I believe they've raised their loan limit to 6 million. We also heard they were being very aggressive on pricing. You're obviously a big player with Fannie, but I recall that Arbor's like number one was Freddie or has been with Freddy and small balance. So my question is what is Fannie Mae's assertiveness here meaning for your business both near-term and long-term?

[Paul Elenio:]

So Freddie definitely has been much more aggressive as that platform up and you know we were instrumental in helping them develop that platform and have consistently been producing a significant percentage. Fannie Mae has put a greater refer them to it. They will grow that business a little bit more. And I think that will compete to some extent with Freddie, but they're a little bit more effective their 10-year product. So, I think between the two of them, Freddie did a 1 billion last year Fannie Mae may do 2 billion to 3 billion, so maybe there is another 10% within that market will do more with Fannie. I think last year, we were also wanted to believe and provide us with Fannie. We continue to do so. So that market will continue to grow, and as you know, that's also excluded from the cap. And if there is any question on the cap, that’s a component that will continue to grow.

[Steve Delaney:]

It sounds like it's just more opportunities just over broader ways clients too given the difference in product focus et cetera. So, thank you for that. I’m sure you get other questions about this on credit. We've definitely started to see some crack. I think this is the first quarter as the commercial REITs have reported that I can think of one that had no credit issue, but it seems like everybody had something. Hotels in particular seemed to be taken back right and left. I guess you haven't said anything, but your portfolio and Chris has been through the queue. It doesn’t sound like you had any necessarily new credit issues to alert us too. But this is what you're seeing in the market in terms of are you starting to see and hear it more foreclosures properties to struggling? And I don't know whether it's a question of overbuilding or these value-added people just basically overpaying and then the business plans is not working out. But stepping back and just -- for someone who's been a real estate his whole life, I’m just curious, if this increase in foreclosures and loan problems whether that’s surprise issue or did you sort of see it coming?

[Paul Elenio:]

So, the fact is we have seen it coming, and if you go back several quarters, we gave guidance this year on our agency platform to have kind of flat growth over last year's. And we're doing that specifically for two reasons. Number one, as we think credit is an issue and we're being selective and cautious to earn this pivotal period of time. And you will see other lenders perhaps have growth in their agency book. I think they're being aggressive on price and on credit. We chose them to be conservative on credit and also try and preserve our margins, which is a little bit unusual in a market that's a volume driven and is very reflective of that issue. We do believe that there is a level of aggressiveness in the market. There is a lot of liquidity and you have to proceed with extreme caution. And the extreme caution comes from the borrowers having the ability to stretch lenders out. And most importantly is a lot of new sponsors entering the arena and them being able have access to credit without the track record and the credibility and that's what we have a high level of concern. So, I think it's justified and acknowledging that we're in a point in time in the cycle that we should be concerned. And what's bailed people out and will bail people out is a rent growth continues. We've had 10 years of straight rent growth on the multifamily sector. Fundamentals still look fairly good specifically in the areas that we traffic which is the B&C market workforce housing where you can reproduce that product and there is a little bit of supply and I have spoken about in the past. Our concern would be more on the upper end and the bailout did come last year for some people when the 10-year drop from 325 to 350 to 335 to 375 that made a big different to the people, but I would say everybody should proceed with a high level of caution.

[Operator:]

Thank you. And our next question comes from Jade Rahmani of KBW. Your line is now open.

[Ryan Tomasello:]

This is Ryan Tomasello for Jade. Just given the changes at the FHFA with new leadership and the strong start, we've seen to the year with the GSC volumes. Ivan, just wondering, if you're hearing anything on whether the FHFA plans to make any changes to the caps over the next couple of quarters and overall for the market where you expect market-wide volumes to potentially shake out for the year?

[Ivan Kaufman:]

I think that there is an expectation at the FHFA will recognize other to bigger market and we will adjust their caps to reasonable a degree and the market is a little bit bigger. With respect to us, I think, we delivered to Fannie Mae as a percentage more product and the other lender which was excluded from the cap because we focus on small balance because we focus on workforce housing, I think we had 61% on our deliveries were up by the cap, which is pretty good. You have a new leader in the FHFA. I’m not sure how what his reaction going to be. He may not totally accommodate the market, but I believe they are going to acknowledge that the markets a little bit bigger and accordingly should make the adjustments to reflect the bit of a bigger market.

[Ryan Tomasello:]

That’s helpful commentary. And we've also heard from some industry sources that Fannie is trying to dial back their volumes a bit given their strength in the first quarter and increased spreads. Just wondering, if this is commensurate with why you are seeing currently in the market, and if that's true, if you expect the higher mix of the Freddie going forward in the near term?

[Ivan Kaufman:]

I think both agencies are going to dial back, but we applaud them for what they are doing. It's to our benefits and it's to market benefit. We're going to dial back on credit and they are going to dial back on pricing, always was in our benefit and it's in line with our strategy. So, to the extend they dial back, servicing and guarantee fee will be built stronger and we would like them to, and that’s their initial signaling and that would have a positive effect on us.

[Ryan Tomasello:]

And then just following up on Steve's comments on questions on credit, we saw the new disclosure in the queue on your servicing portfolio. Lost to low, it does look like delinquencies did tick up modestly quarter over quarter there. So, I was just wondering if you can just talk about, how those metrics have trended historically, and you know with regards to your servicing portfolio in particular, if you are anticipating the modest seasoning of delinquencies increase as that collateral continues to season/

[Paul Elenio:]

We do not expect that delinquencies are very, very low. The only real delinquencies we have on legacy assets that are in the special asset management part of the Fannie Mae that we settled losses on. We have reserved roughly $3 million for specific reserves related to those loans. Those loans have been outstanding a lot, which is tested due timing in the presentation in the queue, but those loans that’s been outstanding awhile. And we don’t really have any deliquesces to speak up outside those legacy assets that we have on our books for awhile and are working through those loss shares, but in Canada [indiscernible] on our balance sheet at this point. But overall, servicing portfolio is in -- if credit has been super benign as you can see from the numbers and it's been performing quite well.

[Operator:]

Thank you. And our next question comes from Richard Shane from JP Morgan. Your line is now open.

[Richard Shane:]

Just a couple of quick things. We noticed that the stock-based comp expense was up on a percentage basis of overall comp. I’m wondering if that, I realized, there is some seasonality related to divesting. I’m wondering, if that is a function of the stock price or if there's a little bit of a shift in comp structure?

[Paul Elenio:]

No, Richard, it's more related to seasonality. We issue our restricted stock rents to our employees and our directors in the first quarter of every year. So, if you go back and look at the first quarter, it maybe up a little bit because of the size of our staff and the increase in our staff and getting people to come on board an using some of that to attract our talent. But for the most part, it should be pretty consistent with prior year, again up a little bit, as we track more talent and use our currency to do that, but for the most part, it just to seasonality thing.

[Richard Shane:]

Yes, the reason I asked the question is that last year it's about 8.6% comp. This year, it was about 11.8%. So, that’s what I’m trying to figure if it's -- I realized there is a seasonality to it but on a percentage basis it also increased year-over-year?

[Paul Elenio:]

Yes, it has to do with -- as I mentioned, as we've attracted more talent to grow certain areas of our business, we use that currency as what we call sign-on bonuses to get people on and that is growing a little. But it's again, I don’t think it's materially different in the past, but that is some of the reason you are seeing that.

[Richard Shane:]

The other thing we heard was that the MSR cap rate went down a little bit this quarter. Just curious what's driving that?

[Ivan Kaufman:]

Yes, it's just a little bit distorted because yet the break apart, the numbers, so on the committed volume, the committed loans we had in the quarter of 847 million, a 100 million were CMBS conduit deal. So, they have no servicing fee attached to that. So, if you strip that out and do the MRS rate on the agency book that was not CMBS, that ratio would have about 191. And that’s about what we projected it would be going forward. And what I told you probably was on an unadjusted basis in the fourth quarter. So, if we just look at the numbers and dive into them, you will see that the CMBS volume was up in the first quarter more than it was in the four or prior quarter. So, it's just disporting the overall number. But on the non-CMBS agency product, it did come in about 191.

[Richard Shane:]

And then, last question related to that increase. We've seen a steady increase on the CMBS conduit side. Is that going to be something we should continue to model in?

[Paul Elenio:]

No, I just think it's as we service our borrowers from time to time we, they have need to certain products and we execute the product based on their needs, but I would not say that that’s a meaningful part of the business plan going forward.

[Operator:]

Thank you. [Operator instructions] And our next question comes from Leon Cooperman from Omega Advisors. Your line is now open.

[Lee Cooperman:]

I have one question. How do you feel about your capital adequacy? Did you take any more money to run the business so you have adequate capital to run the business as you put to run it?

[Ivan Kaufman:]

I think a lot has to do with our pipeline and the likelihood of our pipeline closing and benefit is as we get more certainty in the growth of our pipeline, we will raise capital whether it be interact with the commence what's so kind. So, our pipeline is pretty robust, but the certainty of closing is what we evaluate. And now, we will dictate our capital needs and clearly when we are closing loans and getting a load of mid-teens return, it'd be very accretive and we will just pick the best combination, and we will see a lot business at the proper time.

[Operator:]

Thank you. And our next question comes from Jade Rahmani from KBW. Your line is now open.

[Ryan Tomasello:]

Thanks for taking the follow up. Just was wondering, if you can discuss the internal approval process with respect to making loans and other investment with related parties in which management has interesting. We've noticed the $30 million that you committed to a related party investment fund and there is also number of other related party lending that they [indiscernible]. So just was wondering, if you can comment on the internal process with respect to that?

[Ivan Kaufman:]

Sure, we have a related party policy that is internally here. I don't have in front of me and ultimately we follow a specific policy and that goes for board approval. And each and every transaction that is related party go to a policy and through board approval and the transactions are evaluated by the board on a quarterly basis at their board meeting for performance and adherence of those policies. And it's done by the independent directors of the board.

[Ryan Tomasello:]

And just one more on technology, one of your agency peers recently acquired a technology company to improve their underwriting and servicing efficiency. So just was wondering, if you guys could highlight some of the investments Arbor is making in technology? And given the size of the servicing book and the history there, if you data as potentially something that you can monetize in the future through some sort of license agreements or otherwise?

[Ivan Kaufman:]

So, we have no intention of monetizing our data to licensing agreements. They are proprietary and the secrecy and privacy of our borrowers are really critical to them and to us. More important, this is our global approach and macro approach for our firm. We invested very heavily in senior executive management and building up the infrastructure to have a complete technology approach from solicitation, capture and these capturing of the data and making sure it's consistent from origination and sales process through underwriting full closing, full servicing and available throughout the organization to create the right information flow, the right data sources. And as significantly as you focused on is the right efficiency in terms of cost of doing business, and we have a five year plan here and it’s a very, very significant component the way we're growing our business.

[Ryan Tomasello:]

And just one last housekeeping item. Paul, what was the commission expense in the quarter for the agency originations?

[Paul Elenio:]

Sure, the commission expense for the quarter was about 37.5%. As you know, we set in the first quarter yearend you total catch up and then figure out where it ends up, it was up a little bit from last quarter obviously because we were resetting into 2019 because our margins were up. So, as our margins increase and we able to hold strong margins as commission rate goes up as well, but it was 37.5%.

[Operator:]

[Operator instructions] And I’m showing no further questions at this time. I would like to turn the conference back over to Ivan Kaufman for closing remarks.

[Ivan Kaufman:]

Okay, thank you everybody for your time today. We’re off to a great start for the year. We are very pleased with the way things are going and the size of our pipeline. And outlook for the rest of the year is very positive. Have a great day everybody.

[Operator:]

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