Arbor Realty Trust: Cautious Management Makes It A Hold (NYSE:ABR)

Arbor Realty Trust’s (NYSE:ABR) Q4 2023 earnings call just came out. With it came an update on its financial results and the health of its multifamily loan portfolio, most of which is coming to maturity soon. I covered it twice in December, the first time giving my long-term view of the business and the second time putting more emphasis on the short attacks against it and discussing some of the concerns about multifamily real estate.

Both times, I rated it a Buy. Since then, the share price has fallen again as concerns about the loans resurfaced. Management addressed these in Friday’s earnings call, but I believe they indicated more caution than before. Consequently, I’m reassessing ABR as HOLD, and I’ll break down why.

Q4 and FY 2023

Results were positive. The company, once again, reported a profitable quarter, with GAAP EPS of $0.49, non-GAAP distributable EPS of $0.51, and a quarterly dividend of $0.43 (for a payout ratio of 84%).

Agency loan originations were up, quarter-over-quarter and year-over-year.

The structured business, meanwhile, showed continued acceleration in the single-family rental, SFR, business for their bridge portfolio. Origination volume was therefore up QoQ, but down YoY.

The Form 8K filed Friday shows the progression of the portfolio through 2023 into a greater share of SFR. With the bulk of maturities in 2024, the multifamily loans are still the lion’s share of the book, however.

Provisions for credit losses were $73.4M for 2023, up from $21.2M in 2022. The quarter and year therefore showed rising delinquencies on the current vintage of multifamily bridge loans, which management had to address in Friday’s earnings call (transcript).

Earnings Call

CEO Ivan Kaufman led by stating 2023 was “one of our best years as a public company,” emphasizing their differentiated business model, strong liquidity position, and continued dividend increases. Yet, he noted that he expected that the next two quarters to be the most challenging yet and that defaults will likely rise. He believes many borrowers will “default first and renegotiate later.” Arbor has been working diligently and expects to continue to work hard to renegotiate loans or potentially find new investors for the properties in default.

He did, however, address their CLO financing, which was the main target in the recent short reports:

As previously discussed, these vehicles provide a tremendous strategic advantage at times of distress and dislocation, like the environment we are in today, due to the nature of that non-mark-to-market, non-recourse elements. In addition, they contribute significantly to providing a low-cost alternative to warehouse banks which in times like this have fluctuating pricing and leverage point parameters.

CFO Paul Elenio later noted they had improved the balance sheet by reducing leverage by 18% in 2023.

Regarding the Agency business, Kaufman noted that originations across the industry were lower, while Arbor was able to capture market share:

We originated 1.3 billion in fourth quarter and 4.8 billion for the full year, representing a 7% increase over our 2022 numbers. This is a tremendous accomplishment in light of the fact that the agencies were down 25% to 30% in production year-over-year.

Similarly, he expanded on the business’s potential to grow with their construction loan business, which offers three turns on capital: construction, bridge financing, and agency financing.

Short Reports and Delinquencies

Kaufman eventually addressed the recent short reports, which he characterized as inaccurate:

And while we will not get into a back and forth on the information in these reports or have detailed discussions on any specific loans, what we will point out is that the short reports state that our CLO delinquencies were 16.5% in December and 26.6% in January, when in reality, the rate of 1.3% for December and 5.6% for this January and as of today.

More importantly, the 30-day delinquency numbers are 0.9% for December and 1.2% for January as of today, which are the numbers the industry focuses on. This is a perfect example of using select data as of a point in time, does not contain the full picture or represent the industry’s focus only to inject fear into the market for personal gain.

Later, during Q&A, Kaufman and Elenio clarified that most of the reported delinquencies were since resolved, hence the updated figures. They also emphasized:

On a lot of loans, there’s no grace period. People pay late, they collect rents late. It’s not a number that we give a lot of credibility to. What we give credibility is 30-plus days…So I would say it’s definitely more challenging times. But our focus is on the 30-plus days, and we work hard to make sure that the borrowers stay within that 30 days.

Regarding loans they repurchased from the vehicles (a potential risk I mentioned in my last article), Elenio explained:

We only bought out a loan for 38 million out of the CLOs in the fourth quarter. We did buy 90 million of loans out of the vehicles in February. But for the year, just to give you some color, Rick, we bought out $453 million of loans out of our vehicles for all of 2023. 95 million of those loans subsequently paid off before the end of the year, 290 million of those loans we modified and restructured and got relevered on. And another 69 million we’re holding on our balance sheet without leverage, but on a bulk of those loans, we’re very close to a satisfactory resolution through a sale in the market.

Kaufman later noted:

So we’re pretty comfortable forecasting ahead what our cash needs are for buying out but buying loans out of very important to maximize economic value. And we do that and we do it within the rules of the CLO and we do it very effectively.

(For folks interested in counterpoints, Gabe Bernarde—one of the co-founders of Viceroy who made the November short report—disputed these claims through live Tweets over X.)

Q&A

I’ll highlight what I think were other key details from the Q&A portion of the call that illuminate for shareholders the nature of Arbor’s lending business.

Workforce Housing

There’s been a lot of talk about the weakness of the multifamily family sector as a whole. New York Community Bancorp (NYCB) recently saw a similar decline in stock price after a dividend cut and fears that the company may lack the liquidity to survive default on its own multifamily loans.

Acknowledging the issues with NYCB, Kaufman believed more nuance needed to be applied to Arbor’s loan portfolio:

I do want to differentiate between the product type that we have, which is a lot of workforce housing, which I think is a huge shortage versus the Class A market, which I think is suffering from different headwinds.

In essence, he doesn’t believe that the everyman’s housing suddenly loses demand that could hurt rents as substantially as a fancier, more upper-income class of housing could. “Multifamily” can mean a lot of things, and it’s important to understand what is specifically true of Arbor.

Bridge to Agency Pipeline

Kaufman was later asked about the quality of the loans (with the analyst referencing the “Slumlord” label used by Viceroy) and if he believed any of those bridge loans would fail to achieve Agency financing. Kaufman clarified that they generally expect 75% to 80% of loans to be a successful benchmark, and that it wouldn’t be odd for other options (besides Agency financing) to be utilized at the end of a loan.

When asked why some borrowers would prefer to default before negotiating, Kaufman stated in his experience that they are likely being counseled this way because it often intimidates lenders but also explained that doing so works out poorly and entitles Arbor to much higher rates of penalty interest and grueling judgments in court.

A Look to the Future

With that recap of Q4, eyes are now on the next two quarters. Kaufman himself observed that these will be tougher for Arbor than Q4 2023 was. Thus, investors largely have to weigh whether or not they want to buy ABR now or wait until the dust has cleared. Given management’s caution about the near future, as the bulk of these bridge loans are coming due and their belief that delinquencies will rise, I’ll reiterate what I wrote last time, that it’s not a problem for the long-term investor to wait.

Realistically, I don’t believe there’s much long-term downside, even if waiting means investors get a slightly higher price. Consider the continued growth of their SFR loans, which will be an incremental improvement and not something that investors would miss by waiting a few months. On Agency originations, Elenio restated:

…we’ve got loans ready to be transitioned over to the agencies and we get our capital back and then we end up generating a long-dated income stream and compounded by the fact that when the rates are down in the agency business just generally picks up as it is.

I think there are multiple, long-term buffers that will outlast the near-term risks. I don’t need to revise my previous valuation of $24 per share, but with the incremental and accretive nature of Arbor’s business, there’s not much risk of missing a bus just by letting the current storm pass, especially since it would probably require rapid rate cuts for ABR’s price to increase significantly in such time.

Moreover, if you look above, you’ll see that the market changes its mind on Arbor a lot. The past year of price fluctuations is in response to some things that are specific to Arbor and to more general news events that may have little relevance to it. It’s been an interesting thing to watch. Suppose Arbor makes it through this period, while other businesses announce failures in their commercial real estate loans. Imagine regional banks (like NYCB) having a round two after the problems of SVB last year (that you can see affected the price). While I don’t want to claim clairvoyance about short-term price moves, I don’t think it’s crazy to read the room and consider that similar or even lower prices could materialize, even after Arbor gets through these quarters, and that missing out on a good buy isn’t very likely.

Overall, I believe management was confident but still guarded about the near-future. I could hear it in their voices, especially compared to more recent conference calls. I don’t think we should diminish their caution.

Conclusion

Arbor has been working diligently to navigate the fallout of the historically rapid rate hikes that followed a peak year of bridge lending in 2021. This creates a unique set of risks for them. They spent 2023 building up a strong, liquid position, have been able to cover their current dividend rate, and have been building on the other prongs of their business model.

Yet, the storm is not over, and while I considered the shares a Buy in the recent past, management’s additional sense of caution in this call is something I intend to take seriously. As such, ABR is a HOLD for me, and I’d at least like to see Q1 results before it’s a Buy again.