Arbor Realty Trust Q4 2024 Earnings Call Transcript

Quartr
Provided by Quartr
February 21, 2025

There are 7 speakers on the call.

Operator

Good morning, ladies and gentlemen, and welcome to the Fourth Quarter and Full Year twenty twenty four 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 Elineo, Chief Financial Officer.

Operator

Please go ahead.

Speaker 1

Okay. Thank you, Madison. Good morning, everyone, and welcome to the quarterly earnings call for Auto Realty Trust. This morning, we'll discuss the results for the quarter and year ended 12/31/2024. With me on our call today is Ivan Kaufman, our President and Chief Executive Officer.

Speaker 1

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 that's 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 absent today or the occurrences of unanticipated events.

Speaker 1

I'll now turn the call over to Arbor's President and CEO, Ivan Kaufman.

Speaker 2

Thank you, Paul. Thanks to everyone for joining us on today's call. As you can see from this morning's press release, we had a solid fourth quarter, closed out 2024 as another very strong year despite an extremely challenging environment. We have executed our business plan very effectively and in line with our expectations. And despite the tremendously volatile and elevated interest rate environment for almost three years now, we have managed to continue to outperform our peers in every major financial category including our dividend, shareholder return and book value preservation.

Speaker 2

We're well positioned for this location. Going into the cycle, we had a large cushion between our earnings and dividends. We're well capitalized, are invested in the right asset class with the appropriate liability structures. This allowed us to outperform our peers and continue to pay our dividend, while mostly all of our peers had to cut their dividend substantially some multiple times during the cycle and also experienced significant book value earlier. One of the guidance we have consistently discussed on our calls is how we felt that this dislocation would persist to result in a much slower recovery as rates remain higher for longer, which is something we were well prepared for.

Speaker 2

However, rates have not just remained elevated, they have actually increased significantly with the ten year rising from three sixty in September to as high as four eighty in January and now it's hovering around four fifty with the current outlook suggesting we remain at these levels for the near term. This is a material change in the market resulting in a significant headwinds that will affect everybody in the space. These elevated rates are creating very challenging environment as it relates to agency origination volumes and where we've experienced success over the last few years in getting borrowers through transition and fixed rate loans and recapped their deals, we expect this environment will create a deceleration in this area as well. We have also seen a 100 basis point decrease in sulfur over the last twelve months, which is reducing the earnings on our escrows and cash balances. Additionally, we expect there will be a temporary drag on earnings from the REO assets that we are repositioning over the next twelve to twenty four months and that I will discuss in later detail.

Speaker 2

However, this will partially be offset by efficiencies we expect to generate from a due to borrowing costs in the securitization market and with our commercial banks as well as growth in our servicing portfolio. As a result of these changing macroeconomic events, we have revised our earning outlook for the foreseeable future until we see improvements in the rate environment. Based on these factors, we are now estimating our earnings for 2025 will be in the range of $0.3 to $0.35 a quarter and will likely reset our dividend starting in the first quarter of this year in accordance with this new guidance. This outlook is reflective of the newly elevated rate environment. However, if there is a material change in short term or long term rates in the future, we will revise our outlook accordingly.

Speaker 2

It is important to note that we were the only firm in our peer group to set our dividend to grow our dividend over the last five years by 43%, while every other company in our space has cut their dividend some multiple times by 40% on average with only one company keeping their dividend flat in the last five years. And we assume that we reset our dividend to the midpoint of our new earnings guidance, our dividend will be up approximately 8%, which again is compared to our peers who are down at an average of 40%. Additionally, over the last five years, we have also grown our book value by 26 while recording significant reserves, which is an incredible accomplishment, especially considering that our peers actually experienced a 25% erosion to unit flow values. We've done a very effective job despite elevated rates importantly to our loan portfolio by getting borrowers to recap the deals and purchase interest rate caps. In 2024, we were able to successfully modify $4,100,000,000 of loans with borrowers committing to inject $130,000,000 of additional capital into their deals.

Speaker 2

We also modified another $600,000,000 of loans in 2023, bringing our total loan modification over the last two years to $4,700,000,000 or roughly 60% of the remaining legacy loan book. This is tremendous progress, especially in light of the elevated rate environment that has resulted in the large portion of our loan book being successfully repositioned performing assets with enhanced collateral values. We've also done an exceptional job of bringing in new sponsors to take over assets even consensually with the foreclosure. In fact, in the last two years, we have brought in new sponsors to recap deals with the potential under equity on approximately $900,000,000 of loans. This is a very important strategy that again successfully repositions assets with the appropriated capital, putting our loans in a much more secure position with experienced sponsors and create more predictable future income streams.

Speaker 2

And again, are reflective of us recording the appropriate level of reserves on these expressed assets. And despite elevated rates, we also generated strong runoff over the last two years with $3,400,000,000 of runoff in 2023 and $2,700,000,000 of 2024, an amazing accomplishment. We also continue to make strong progress despite the unprecedented move up in rates on the approximate $1,000,000,000 of loans that were past due at September 30. In the fourth quarter, we successfully modified $140,000,000 of these loans, generated $151,000,000 of payoffs and took back approximately $120,000,000 of REO assets, all of which we were able to bring in new sponsors to operate and assume our debt. This is strong progress in one quarter and has reduced the $944,000,000 of delinquencies we had at September 30, down to $534,000,000 at December or a 44% decrease.

Speaker 2

We did experience additional delinquencies during the quarter of approximately $286,000,000 bringing our total delinquencies at December 31 to approximately $819,000,000 which is down 13% in the quarter and down 22% from LPE, which is in line with our previous guidance even in the face of rising interest rates. And our plans for resolving our remaining delinquencies, PayFac has already opened and bringing new sponsorship approximately 40 to 50% of this with the other 40% of 40% to 50% of the paying off of being modified in

Speaker 1

the future. This should put our REO assets on

Speaker 2

our balance sheet in the range of $400,000,000 to $500,000,000 with another roughly $150,000,000 to $200,000,000 that we will have brought in new sponsorship to operate. And this $400,000,000 to $500,000,000 of REO assets be upon the heavy lifting portion of our loan book, we estimate will take approximately twelve to twenty four months to reposition. The performance of these assets has been greatly affected by poor management and from being undercapitalized. Today, these properties have an average occupancy of 35% and an estimated NOI of around $7,000,000 which is very low and will temporarily affect our earnings. We believe there is great economic occupancy for us to step in and reposition these assets and significantly grow the asset to around 90% and NOI to approximately $30,000,000 over the next twelve to twenty four months, which will increase our future earnings significantly.

Speaker 2

We are working exceptionally well on resolving our delinquencies, which as I mentioned has been significantly affected by the current rate environment. If rates come down sooner than we expect, it will have a positive impact on our ability to convert non interest earning assets to income producing investments earlier, which will be accretive to our future earnings. This is a challenging and demanding work and despite these increasing headwinds, I am very pleased with the progress we have made to date. In our balance sheet lending platform, we have had an active fourth quarter originating three seventy million dollars of new bridge loans and $36,000,000 of preferred equity investments behind our agency originations. As we said in our last call, we have started to ramp up our bridge lending program to take advantage of the opportunities we are seeing in today's market to originate high quality short term bridge loans and generate strong revenue returns on our capital in the short term, while I'm continuing to build up a significant pipeline in future agency deals, which is a critical part of our strategy.

Speaker 2

Depending on the rate environment, we believe we can originate $1,500,000,000 to $2,000,000,000 on bridge loans product in 2025 and enhance our leverage returns to increase the efficiency we've seen in the securitization model with our commercial banks. Another major component of our unique business model is our capital light agency platform, which provides a strategic advantage allowing us to continue to delever our balance sheet and generate significant long dated income streams, which is a key part of our business strategy. We have been a significant player in the agency business for twenty years and now have been a top 10 Annie Mae dust lender for eighteen years in a row coming in at number six in 2023 and eight for 2024. We had a very strong fourth quarter originating $1,350,000,000 of new agency loss, which as you remember was towards the top end of the range that we guided on last quarter's call. We explained that our origination targets were $1,200,000,000 to $1,500,000,000 of Q4 depending on the rate environment.

Speaker 2

And despite a significant uptick in rates in the fourth quarter, we were well above what we had anticipated. We still managed to produce very strong volumes. We closed out 2024 with $4,300,000,000 of GSV Agency volume despite a volatile rate environment throughout the year. With rates where they are today, we are experiencing a very challenging origination climate and they continue to remain elevated as likely gone forward results in a 10% to 20% decline in our agency production 2025 to a range of $3,500,000,000 to $4,000,000,000 which will again be very independent. We also did a good job converting our balance sheet loans into agency product in 2024 despite elevated rates.

Speaker 2

In the fourth quarter, we generated $900,000,000 of payoffs and $530,000,000 or 59% of these loans being refinanced into fixed rate agency deals for the full year 2024. We recaptured 65% or $1,600,000,000 of the $2,500,000,000 multifamily balance sheet runoff into agency production. This is on top of the $3,000,000,000 of multifamily runoff we generated in 2023 with a 56% recapture rate in agency loans. And as I stated earlier, with rates at these levels, it has certainly become more challenging for borrowers to obtain an agency takeout on our balance sheet loans. We continue to do an excellent job in growing our single family rental business.

Speaker 2

We had a strong quarter with $1,700,000,000 in new loans in 2024, which is our best year yet and was well above our 2023 production of $1,200,000,000 We have now eclipsed $5,000,000,000 of production in this platform to date and we are very excited about the opportunities we are seeing to continue to grow this platform and make it a bigger contributor to our overall business. This is a great business as it offers us free turns on our capital through construction bridge and permanent lending opportunities to generate strong revenue returns in the short term while providing significant long term benefits by further diversifying our income streams. We also continue to make state progress on our newly added construction lending business. We believe this product is very appropriate for our platform as it offers returns on our capital for construction bridge and permanent agency lending opportunities and generates mid to high teens returns on our capital. We closed our first deal in the third quarter for $47,000,000 our second deal in the fourth quarter for $54,000,000 We have a long pipeline of roughly $200,000,000 under applications and $200,000,000 in annualized and $800,000,000 additional deals for the current lease trainings.

Speaker 2

And based on our deal flow, we are confident in our ability to originate $250,000,000 to $500,000,000 of this business in 2025. In summary, we had a strong 2024 once again significantly outperformed our peers. We have executed our business plan very effectively and in line with our objectives. Clearly, the landscape has shifted significantly in the last ninety days and we expect there to be a substantial headwind in the near future. We do believe we will have some positive offsets from reduced product costs on our bank lines and to greater efficiencies in the securitization market as well as we continue to fund up our bridge asset foreign reflection lending business, which generates strong leverage on our capital.

Speaker 2

Additionally, if short term and long term rates decline further, mitigate some of our hedge of our economy experiments and increase our future earnings. In the meantime, we remain heavily focused on working through and managing our loan portfolio of continued growth areas of our business to increase to many diverse countercyclicality countries we have developed. We have a very seasoned experienced management team that has operated effectively through multiple cycles. And our work is with us with the balance of the supply chain and I'm confident we will continue our long standing track rates of being a top performer in this space. I will now turn the call over to Paul to take you through the financial results.

Speaker 1

Okay. Thank you, Ivan. We had a strong fourth quarter and full year 2024 producing distributable earnings of $81,600,000 or $0.4 per share for the fourth quarter and $1.74 for the year, which translates into ROEs of approximately 14% for 2024. As Ivan mentioned, due to the drastic change in the macroeconomic climate, adjusting our forecasted distributable earnings for 2025 to $0.3 to $0.35 per quarter. Clearly, rates have played a big factor in the earnings outlook and future changes in the interest rate environment will most certainly dictate whether we can grow our earnings due to the plan.

Speaker 1

We've also been affected by elevating legal and consulting fees as a direct result of the short sell reports, which is something we expect will continue for the foreseeable future. We estimate these fees will be approximately $0.03 to $0.05 a share going forward, which is reflected in our new guidance. In the fourth quarter, we modified another 15 loans totaling $470,000,000 and approximately $2.00 $6,000,000 of these loans, we required borrowers to invest additional capital to recap their deals and thus providing some form of temporary rate relief to repay in the full future. The pay rates were modified on average to approximately 5% to 9% with 2.3% of the residual interest due being deferred until maturity. $140,000,000 of these loans were delinquent last quarter and now current in accordance with their modified terms.

Speaker 1

In the fourth quarter, we accrued $18,700,000 of interest weighted to all modifications, paid accrual features, $7,600,000 is related to modifications that were completed in years prior to 2024 and $1,000,000 is on mezz and PE loans originated in 2024 behind agency loans that have a pay in a pool feature as part of their normal structure. This leaves $10,000,000 worth of accrued interest in the fourth quarter related to modifications of grid loans in 2024, '1 point '5 million dollars of which is related to our fourth quarter modifications. The table summarizing all of our 2023 and 2024 material modifications and the related accrued interest on these loans is detailed in our 10 ks, which we expect to file later this afternoon. Our total delinquencies are down 13% to $819,000,000 at December 31 compared to $945,000,000 on September 30. These delinquencies are made up of two buckets loans that are greater than 60 past due and loans that are less than sixty days past due who are not reporting interest income on unless we believe the cash will be received.

Speaker 1

The 60 plus delinquent loans or NPLs were approximately $652,000,000 this quarter compared to $625,000,000 last quarter due to approximately $128,000,000 of loans progressing from less than sixty days delinquent to greater than sixty days past due and $153,000,000 of additional defaulted loans during the quarter, which was largely offset by 134,000,000 of payoffs and modifications and $120,000,000 of loans taken back as REO. The second bucket consisting of loans that are less than sixty days past due came down to $167,000,000 this quarter from $319,000,000 last quarter due to $157,000,000 in modifications and runoff, $128,000,000 of loans progressing to greater than sixty days past due, which was partially offset by approximately $133,000,000 of new delinquencies during the quarter. And while we're making good progress in resolving these delinquencies,

Speaker 2

at the

Speaker 1

same time, we do anticipate that we will continue to experience new delinquencies, especially in this current rate environment. In accordance with our plan of resolving certain delinquent loans, we have foreclosed on some real estate and we expect to take back more over the next few quarters as Ivan guided to earlier. The process of taking control and working to improve these assets and create more of a current income stream takes time, which is even more challenging in this climate. Visually, we have been very successful over the last few quarters in collecting back interest owed when we would modify certain loans. A good portion of our remaining delinquencies are more of a heavy lift through the foreclosure and repositioning over time, which will likely result in less back interest being collected going forward on workouts.

Speaker 1

These are some of the reasons we're guiding to reduce earnings in the near term. In the fourth quarter, we took back $120,000,000 of REO assets. We've been highly successful at bringing in new sponsors on certain assets to take over the real estate and assume our debt. This strategy is a very effective tool in turning debt capital into non performing loan into an interest earning asset, which will increase our future earnings. In the fourth quarter, we accomplished this on two REO assets totaling about $70,000,000 which were accounted for as sales and new loans.

Speaker 1

The other $51,000,000 of REO is related to one asset that we took back in the fourth quarter that we subsequently decided to flip to a new sponsor and provide a new loan. We closed on this deal yesterday and the purchase price was at our net carry value of $45,000,000 which is net of $5,700,000 specific reserves that we took on this asset in 'twenty three and 'twenty four. As a result, we will have a one time realized loss in the first quarter of approximately $6,000,000 which we've already reserved for and is reflected in our book value and we will now have a performing loan which will add to our run rate of income. We believe we've done a very effective job of properly reserving for our assets over the last two years.

Speaker 2

We did

Speaker 1

not incur any material losses in 2024. We are expecting to have some realized losses in 2025 through similar executions on REO assets and by repositioning certain loans with new sponsors, which we expect will be in line with our prior reserves on these assets. The timing and magnitude of these losses is hard to predict at this point, but once we know a transaction is likely to occur, we will continue to signal that result ahead of time if possible. And again, please keep in mind that these potential losses reflect the reserves we've already taken, which demonstrates how prudent we've been in recording the right level of reserves on our loan book. As a result of this environment, we continue to build our CECL reserves, record an additional $13,000,000 in specific reserves in our balance sheet loan book in the fourth quarter.

Speaker 1

And again, we feel we've done a good job of putting the right level of reserves in our assets, which is evidenced by transactions we have been able to effectuate to date at or around our carrying values net of reserves. It's also important to emphasize that despite booking approximately $170,000,000 in seasonal reserves across our platform in the last two years, one hundred and thirty five million dollars of which was in our balance sheet business, we saw a very nominal decrease in book value of around 2%. While our peers experienced an average book value decline of approximately 20% over that same time period. Additionally, we are one of the only companies in our space that has seen significant book value appreciation over the last five years with 26% growth during that time period versus our peers whose book value has actually declined an average of approximately 25%. In our agency business, we had exceptional fourth quarter despite headwinds from higher rates.

Speaker 1

We produced $1,400,000,000 in originations and $1,300,000,000 in loan sales with very strong margins of 1.75% for the fourth quarter compared to 1.67% last quarter. We were also incredibly pleased with the margins we generated in 2024 of 1.63%, which exceeds twenty twenty three's pace of 1.48% by 10%. And we recorded $13,300,000 of mortgage servicing rights income related to $1,350,000 of committed loans the fourth quarter, representing an average MSR rate of around 1%, which is down from 1.25% last quarter due to a higher mix of Freddie Mac loans in the fourth quarter, which contained lower servicing fees. Our fee based servicing portfolio also grew 8% year over year to approximately $33,500,000,000 December 30 1 with a weighted average servicing fee of 38 basis points and an estimated remaining length of seven years. This portfolio will continue to generate a predictable annuity income going forward around $127,000,000 gross accrual.

Speaker 1

As Ivan mentioned earlier, a 100 basis point decline in short term rates has reduced the earnings on our cash and escrow balances. We are now at a run rate of between $80,000,000 and $85,000,000 at oneone hundred and $25,000,000 compared to approximately $120,000,000 that we earned in 2024 for a $35,000,000 to $40,000,000 reduction, which will affect our 2025 earnings. In our balance sheet lending operation, our $11,300,000,000 investment portfolio has an all in yield of 7.8% on December 31 compared to 8.16% at September 30, mainly due to a decrease in sulfur during the quarter. The average balance in our core investments was $11,500,000,000 this quarter compared to $11,800,000 last quarter due to runoff exceeding originations in the third and fourth quarters. The average yield on these assets decreased to 8.52% from 9.04% last quarter, mainly due to a reduction in sulfur, which was partially offset by more back interest collected in the fourth quarter on loan modifications and pay downs.

Speaker 1

Total debt on our core assets decreased to approximately $9,500,000,000 at December 31 from $10,000,000,000 at September 30, mostly due to paying down CLO debt with cash in those vehicles in the fourth quarter. The rolling post of debt was down to approximately 6.88% at twelvethirty one versus 7.18% at ninethirty mostly due to a reduction in so far, which was partially offset by lower rate debt tranches being paid down from CLO runoff and the new $100,000,000 unsecured debt issuance we closed in the fourth quarter. The average balance in our debt facilities was down to approximately $9,700,000,000 for the fourth quarter compared to $10,100,000,000 last quarter, mainly due to pay downs in our CLO vehicles from runoff in the fourth quarter. And the average cost of funds in our debt facilities was 7.1% in the fourth quarter compared to 7.58% for the third quarter, again from a decline in silver. Our overall net interest spreads on our core assets was relatively flat at 1.42% this quarter versus 1.46% last quarter and our overall spot net interest spreads were 0.92% at December 30 one and zero point nine eight percent at September 30.

Speaker 1

And lastly and very significantly, we managed to delever our business 38% during this dislocation to a leverage ratio of 2.8:one from a peak of around 4.0:one two years ago. That completes our prepared remarks from this morning. And I'll now turn it back to the operator to take any questions you may have at this time.

Operator

And we'll take our first question from Steve Delaney with Citizens JMP. Please go ahead.

Speaker 2

Good morning, Ivan and Paul. Thanks for taking the question. And look, for starters, just really appreciate you guys being upfront with us today about your expectations for the dividend in 2025. It's just making it a lot easier for the market to hear that today than in March when you have to declare first quarter. So thank you for that clarity.

Speaker 2

Ivan, you talked about some resolutions involving outside money. I'm curious, this opportunity that starts with your stress bridge loans and eventually just it rolls into REO. So I think we're talking about the same investment opportunity. Are you seeing institutional money, big money, fresh money looking at this space as a unique maybe once in a decade opportunity. Is that money coming in?

Speaker 2

And if it's not coming in, do we need that to get this problem cleaned up in the next one to two years? Thank you. So I'm going to bifurcate my response because you have and add a little color to it. Number one, in the third quarter or fourth quarter when the ten year in the five year pop considerably, we're seeing a real level of activity in the space. And then right prior to the election, the ten year jump from March to April, I think everything went on pause.

Speaker 2

So there's a bit of a pause period, but there are two types of collateral that we're looking at, I mentioned in my comments. The ones that we effectively transitioned to these sponsors, there's a lot of demand for that. And there's plenty of capital and plenty of entrepreneurial capital for that. A lot of it is people who have access to institutional money or network, but they're all network. And there's plenty of activity in every county 11 assets, and multiple business on those assets.

Speaker 2

So that would be good. The more difficult part is the ones where the heavy lift are those which is kind of where it takes time to get your hands on those assets, sponsors are kind of rascals, steal the cash flow, don't manage those assets and they get brought down to a level where we need to bring in our own capability, get those up to speed. Once they're up to speed, there'll be a lot of demand for them. But I think there's a little bit of a pause in the market and that's really reflective of our comments. I'm not sure why everybody is so excited.

Speaker 2

And I went to NMAC about a month and a month and a half ago and I was shocked at how people were thinking they're going to have a great year in light of the increased rate environment. So I think a lot will have to do with where rates settle in. Clearly, we're all running off to 50. If you see rates go down to where they were, you'll see tons of money flood back into space and you'll have the exuberance some of our experience on our last quarter's call where the refinance volumes and the activity was stopped and picked up. So it's very much greater in my opinion.

Speaker 2

So I'm hearing you say the outside money right now as you sit today, you rework a bridge loan and there's new sponsors, there's people willing to step in there, the heavier lift if you've got an REO, 30% lease needs further renovation, whatever, that's something you feel like your team at Arbor is better equipped to take that property over, manage the property and then look to sell that property in twelve to twenty four months. Am I hearing you clear on that? That's correct. Every time we get and these are the ones where it's more difficult to pay your hands on. As I said, these sponsors were a bit of bad players in the market using the legal system to lay the process, deal with cash flow and not manage the assets.

Speaker 2

So every single asset that we take back as we're taking it back, we have a twenty four month plan. We're able to really show how we can get it from where it is today, monthly, monthly, monthly increase the NOI, put in the right CapEx to get the stuff to speed. And our guess is we're going to be able to sell those assets somewhere between 12 and 24 months for bank valuation once we stabilize it. Okay, thanks. Paul, a quick one for you to close out.

Speaker 2

In December, since you upgraded Arbor's primary servicing rating to CPF2 plus it looks like a large focus of that was on your agency servicing. But to any extent did that servicing upgrade reflect the work you were doing on the bridge loans in your CLOs?

Speaker 1

I don't have the definitive answer, but I do believe you are correct, Steve, that the majority of that rating is not all that has to do with how we're servicing the agency book. It may have some impact on the balance sheet, but we were just upgraded because of the quality of servicing shop we have. We've made a lot of investment in that division, both from a technology perspective and staffing perspective and our rating just keeps getting better and better, which I think should not be overlooked as you just mentioned. I'm glad you pointed that out. Steve, getting back to your comment that

Speaker 2

was just reflected on in terms of the assets. We tried very well the assets that we've put to the sponsors and the level of improvement is remarkable. The pending assets that were probably having occupancies in the mid-70s and well on their way to 90%. The the cosmetics improvements are remarkable. So when we're able to transition to do ownership, we end up with an aspect that becomes extremely more valuable in a very, very short period of time, because we're able to bring our expertise to the table with that expertise and capital we're lacking.

Speaker 2

The stuff that we retain our goal is to get these assets in that position in twelve, eighteen months or twenty four, whatever it is and then bring in those sponsors, we can get the right valuations more reflective of where we think the values are. We have a great track record on it. In fact, we had a loan we come back two years ago, which was 70% occupied. We're just selling it right now for probably closer more than the debt. We got the occupancy up to 93% and almost where it needs to be.

Speaker 2

So that's kind of standard for how we run our business. Thank you both for the color this morning.

Speaker 1

Thanks, Steve.

Operator

Thank you. And we will take our next question from Stephen Laws with Raymond James. Please go ahead.

Speaker 2

Hi, good morning. Wanted to

Speaker 3

touch on modifications from last year. I think it was around $4,000,000,000 a lot of which was done in early part of the year maybe when borrowers and everybody had a different interest rate outlook. Can you talk about how you expect those modified loans to five? And how do you expect are those modifications typically twelve or six month duration extensions or how do we think about those modified loans maturing over the course of this year?

Speaker 2

I think it's important to have a little bit of an overall view. Keep in mind that we have run off in our portfolio over the last two years of almost $6,100,000,000 and then so we need to do a refinance or sale or all the people taking them out. So the amount has been dramatic. With respect to the modified loans, keep in mind bridge loans are short term loans in nature and they have a lot of tests. So it's very, very normal to modify a loan in this kind of rate environment and give people a little bit more runway to bring more capital.

Speaker 2

There's a period of time when sulfur was sitting at five thirty when it dropped. It was a lot of relief for borrowers to drop by caps and their lifeline to give them more opportunity. So when we look at a modification of the loan, we take a look at whether the sponsor could bring more capital, the sponsor doing a good job and whether he has a capability to improve the performance of those assets. And the majority of those times, the super majority of times, we track that performance and doing extremely well. There are periods of time when they don't quite do what this was doing.

Speaker 2

They could resolve an additional delinquencies and impacts. But on the whole, the strategy has been extremely effective in terms of improving the performance of those collaterals. Keep in mind that almost all our loans have recourse provisions with multiple sponsors. So it's not like people could just hand back the keys as an alternative. They are being put in a position where they have to bring capital to the table.

Speaker 2

And there are many circumstances take over ownership. We still have access to those personal financials and judgments as well. So our goal is always to improve the collateral, get into that position, specifically in markets that were experiencing a little bit of softness or delays in quartz and things of that nature. So for the most part, we are seeing tremendous improvement of the analyzer of the properties that we modify.

Speaker 3

Appreciate the comments there. And Paul, could you touch on the servicing escrow balances again? I think you said $80,000,000

Speaker 1

to $85,000,000 but I

Speaker 3

want to make sure I understand the new level we should think about and kind of what's driving the change in that, what what the components are driving that reduction?

Speaker 1

Sure. So when I speak of earnings on our escrows and cash, it's two components. We lump it into one, we can break it out. So we're sitting with 1,500,000,000 of escrow balances right now and we have at year end we had about $500,000,000 of cash between cash on hand and cash in the CLOs. So that's pulling $2,000,000,000 to and right now so far is that on the $430,000,000 where we're earning slightly below that probably about $415,000,000 is what we're earning currently.

Speaker 1

So if you take that $2,000,000,000 multiply it by $415,000,000 you're probably at $85,000,000 both in earnings on the cash that we have on our balance sheet and in the vehicles and on our escrows. Last year, we earned $120,000,000 between earnings on escrows and earnings on cash for two reasons. One, sulfur was higher throughout the year. Remember, sulfur has been dropping. So the full effect of the drop in sulfur is not in the 24 numbers, it will be in the 25 numbers.

Speaker 1

And our cash has come down obviously as we've used some of our cash to run our business. So that's the two components that are driving the 120 versus the 85. The one thing I will say is that's a number that's bad. The one thing I'll say that will partially offset that is we are expecting even though we're guiding to lower agency volume today if rates stay where they are, we still believe our agency volume will eclipse our runoff in the agency business. So we will have some growth in servicing portfolio that will partially offset that, but that's the math.

Speaker 1

Great.

Speaker 2

I think I want to add to that slightly and reflect on our comments I have given you before. We experienced 3,400,000,000 of runoff in 2024. That was a conservative interest rate environment that existed. In today's interest rate environment, we're forecasting if it remains at this four fifty level to four seventy five or four eighty level. The numbers will be more like 1.5.

Speaker 2

However, if we go back to the interest rate environment that we had, we'll revise up our numbers of runoff to about $3,000,000 That's a material difference. And that material difference will result in a build rise in our agency business as well. So our outlook is really we're expecting this elevated interest rate environment and how it impacts our business. And we would see a similar run rate as we did last year, rates go back to where they were. And the real inflection point is really going to be the five year and ten year.

Speaker 2

If we see the ten year and the five year get back around that 4% level, you'll see the same trend that we were seeing in the third quarter that we were experiencing originations to run off.

Speaker 1

And Steve, one of the things I want to add is we were obviously very aware SOFA was dropping and we knew it would have an impact on our escrows and our cash. But I think that the real fundamental change over the last ninety days that was a little bit surprising to us and we've talked about this on prior calls. We knew you could look at our filings that shows what the shock would be if rates go down or up on our cash and escrows and our portfolio. But we thought there would be a pretty big offset in the fact that the ten year would be low and we'd have significantly more origination volume on the agency side. That is not happening right now.

Speaker 1

It may change as I've said with the rates, but that's the big change. So it's not a surprise to us that escrows and cash earnings go down with silver dropping, but we also thought we'd have a lower ten year, which is where we were last quarter and we'd have a much more robust origination platform to offset that.

Speaker 2

Yes, yes. Appreciate the comments

Speaker 3

on that. And one last question regarding new dividend level being determined, I know the 0.3 to $0.35 guide for the quarterly distributable earnings. Are you going to base the dividend on that or will you look at kind of distributable earnings less pick income and think about the dividend closer to a cash earnings level? How do we think about or how will you and the Board think about determining that

Speaker 2

new dividend level? Thank you.

Speaker 1

Yes. So I think we will look at it as distributable with Pick. But again, we adjust as we go, right? Just to give an example, we've modified $4,700,000,000 of loans in the last two years, as Ivan said in his commentary. Dollars 2,400,000,000.0 of those have paid accrual features, but we're only accruing on $1,700,000,000 of those.

Speaker 1

So there's another $500,000,000 that we've decided not to accrue on. So we make decisions as we go along and we adjust as we go along on whether we think we still should be accruing this or not based on value. But the ones we are accruing, we feel really confident we're going to receive. So we have those in distributor learnings. But again, none of this has been decided yet with the Board.

Speaker 1

We need to see what we've done today is give you as of today where we think the short term guidance would be. We need to see where the first quarter comes in. We need to see a couple of more months of this market. And by May when we're on our first quarter call, we'll have three months in the books and another month of market data and we will base our dividend on what we think it looks like going forward, not just for one quarter. So we'll look at it now twelve months and we'll say, where do we think we get it to and where are we comfortable?

Speaker 1

Today was just a guide of a range of what we're seeing right now.

Speaker 2

I mean, just to give you a concept, we're sitting with 1,000,000,000 worth of loans in our pipeline that are interest rate sensitive. That can't close unless the ten year drops to the four or 4.25 range. So I'm not guidance it can change to the upside with the change in interest rates. But to be realistic, we don't want to mislead anybody. That's right.

Speaker 2

We want to take into consideration with this new elevated rate, they stay There's huge volatility with the election as we know. And it seems like we're in a range whether it be a quarter, two quarters, three quarters, or four quarters, we're not sure. We'll adjust accordingly. We think we're just responsible by laying out where this current interest rate environment is, which is different than where it's been, how that affects our business.

Speaker 3

That makes sense. Appreciate the comments this morning. Thank you.

Speaker 1

Thanks, Steve.

Operator

Thank you. And we will take our next question from Leon Cooperman with Omeka Family Office. Please go ahead.

Speaker 4

I missed most of this call because I had a conflict with another company. I jumped off their call. But unless there's something said differently, let me just say that I think that you guys have done a terrific job in managing through a difficult environment. And I personally am offended by the cost of of dealing with these short sellers, because I think you've been extremely transparent in your dealings with the investors. No surprises here.

Speaker 4

I think you've done a very good job of navigating the environment. But let me ask you some questions rather than give you a shout out. What's your confidence in your book value? Number one. And secondly, were you willing to use liquidity to buyback equity if it drops below state of book value?

Speaker 4

And what kind of return do you think you should earn on a recurring basis on your book in a normal environment?

Speaker 2

So relative to our book value, I'm glad you asked that question because we've had a tremendous success and track record in terms of taking distressed loans, bringing new sponsors and either having proper reserves or even taking back a little bit. So we're really comfortable with it. When we modify our loans, which are always the loans which have that I biggest highlight on them. We're forced by account if any major modifications, reappraisals. Based on those reappraisals, we're forced to take whatever reserves are necessary.

Speaker 2

We've been right on the mark. So I'm extraordinarily comfortable with the reserves that we've taken, but that track record speaks for itself. Paul, you want to address something?

Speaker 1

Yes. I just think the book value where it is today, Lee, if the market stays where it is today, we may have to take some more level of reserves on certain assets as we move through this higher for longer scenario and it may ding book value a little bit, but we don't think it will be material because we think we have provided the right level of reserves to date. So I think it could go down a little bit, but I don't think it goes down significantly in our track record spend that it has moved down significantly over the last two years in a very difficult market. As far as returns on equity, I think, yes, it depends on where we set our dividend. But if you look at our range, on the low end of the range, we're probably 10% or 11%.

Speaker 2

On the high end of the

Speaker 1

range, we're 12% return on equity, right, Ivan, given where it is. So we did a 14% for 2024%. I think we did similar for 2023%. I think 10% to 12% is realistic. And I think there's upside on top of that if this market doesn't stay where it is longer than we're expecting.

Speaker 2

In terms of buying back stock and things that are important, keep in mind that we have a very, very vibrant business specifically on the SFR side generating outside returns. Returns we have to fund that business. Our construction lending business we have to fund in addition we're expected to do $1,500,000,000 to $2,000,000,000 of bridge loans. So we have a $5,000,000,000 worth of growth business which is important to us. Early we'll have about $1,500,000,000 of runoff and we'll use sub capital to not runoff.

Speaker 2

But we have to be sensitive to keep our business growing. We've done an outstanding job of that. And that's where our focus is going to be yield returns on the new business in the mid teens, which is very accretive to the business we're doing. So we'll continue to focus on growing our business and then of course managing some of the legacy issues we have.

Speaker 4

What does it mean? If the stock cut down $10 or $11 you would not buy it?

Speaker 2

We it would be a strong possibility. I think what you have to do is if you ask me if I would buy it, listen to what I say and watch what I do. So I've always been very forward and covered in my own actions, how I'm the largest shareholder of the REIT. And if there's an opportunity, if this stock drops, you will see me and I'm sure plenty of management be active in the spot and in the stock.

Speaker 4

Good luck and congratulations. You did a very good job in the short sellers of your shareholders and better understanding the quality of the earnings and quality of the management.

Speaker 2

Leon, you said a lot more than I could usually say about the short sellers, but anyone who cares to take their time can look up the history of the problems of the short sellers and their founders and take a look at the reports and see the issues they've had with the regulators and the courts around the world and they can take their comments for what they were. You've done your research, I've done mine and we'll make our investments accordingly.

Speaker 4

Got you. Well, good luck. Thank you very much. Appreciate your performance.

Speaker 1

Absolutely.

Operator

Thank you. And we will take our next question from Rick Shane with JPMorgan. Please go ahead.

Speaker 5

Hey guys. Thanks for taking my questions this morning. I sort of two lines. First a little housekeeping. Paul, you mentioned $500,000,000 of non accruing loans.

Speaker 5

Can we just go through in the 0.3 to $0.35 guidance, what's the drag from non accruals? What's the contribution from PIC? And was the $0.03 to $0.05 that you cited for legal and regulatory quarterly? And can you help us sort of understand the context of that expense?

Speaker 1

Yes. No. So the $0.03

Speaker 2

to $0.05

Speaker 1

is annually. We've run probably $0.02 to $0.025 already in 2024 and we're expecting that number will just be the same number, but for a longer period of time because it really wasn't ramping up until the second quarter. So I would say that it's $0.03 to $0.05 for the year on the cost between consulting, legal, administrative related to the short sellers if it continues. That's our view. And then as far as the drag on earnings, I think we have $819,000,000 of loans earning zero.

Speaker 1

What we've commented is that we do think in this environment we'll resolve some and we'll have some new ones. I think our track record has been that we still think even in this rate environment we'll be able to make progress in the 10% range. We did 13% this quarter, which we were impressed with. But it will also impact us on the REO side because I think the big temporary drag, Rick, is that as Ivan alluded to, we already took back $100,000,000 of loans in the first quarter and we have $50,000,000 on our books right now that aren't legacy. We have 100 and if you look at the numbers, we have $176,000,000 in REO on our balance sheet.

Speaker 1

$45,000,000 is a loan we flipped yesterday that I mentioned. So now you're down to $131,000,000 80 million dollars of that are legacy assets we've had on our books before the crisis and we're working through to to dispose of them. So about $50,000,000 to $55,000,000 is due for this crisis. We took back another $100,000,000 in January already, so we're up to $150,000,000 and as Ivan said, we're probably going to end up between $400,000,000 and $500,000,000 So the drag is that $400,000,000 to $500,000,000 has an NOI of about $7,000,000 but certainly not nearly what it would have been had it been paying a current interest rate and then that's going to be temporary until we can reposition those assets and then hopefully we'll have a significant upside in the future, but that's probably twenty four months out. So I think the drags from where we are now to where we're guiding to $0.3 to $0.35 are these are the components.

Speaker 1

Reduced agency origination volumes, which obviously hit earnings, right. The full effect of sulfur on your escrows and your cash balances offset slightly by servicing, the full effect of the delinquencies for a longer period of time than they've been outstanding and the drag in the REO assets. Will we have some positive offsets? Yes. We'll probably be largely more efficient through the securitization markets.

Speaker 1

And obviously if rates change, we can pick up volumes and have a better performance on our assets. But those are kind of the components.

Speaker 5

And how much of the quarterly $0.3 to $0.35 is from pick?

Speaker 1

I don't have those numbers here, but I would say it's probably going to be similar to what we've had. It's probably $10,000,000 to $15,000,000 a quarter.

Speaker 5

Okay, great. Thank you. And then pivoting, that was sort of the housekeeping stuff. In the quarter, you guys did $35,000,000 almost $36,000,000 of prefs and mezz, ninety seven million dollars for the year. Are those part of is that loans on outside investments opportunistically or is that related to the structured portfolio where you're providing additional capital to existing borrowers?

Speaker 5

And I'd love to relate that to some extent to the $130,000,000 of capital contributed on the mods during the quarter during the year?

Speaker 1

Yes. So I think they were a little different. We may be combining concepts. But so the $97,000,000 that you referred to, if not all, the vast majority are not new investment opportunities there. Pratt and mezz were putting behind agency loans that are keeping taken off our balance sheet.

Speaker 1

So what happens? The guy has a balance sheet loan and he wants to convert it to a fixed rate loan and depending where rates are, he'll come to the table, he'll be short capital because of the restrictions in the agencies on the debt cover and the LTV and he'll bring to the table some money and we'll put some money in the form of Mezzan PE behind him, which puts us in a better spot, right, because if we were 80% LTV on a bridge loan that's struggling and now he has a 70% LTV loan on the agencies. He had a kick in 5% and we had a kick in 5%. Our PE in mezz is behind 70% not behind 80% right? So and then they usually get about a 14% return and then there's a pick on it because you have to give you have to have the current pay has to be a debt cover of like 110% through your mezz and PE.

Speaker 1

So it's just a calculation of like some of the ones we did this quarter were 9%, ten %, eleven % pay and the rest was picked because we had good coverage through our PE. I wanted to just add to that. That's been

Speaker 2

a normal course about this.

Speaker 5

I really appreciate the clarification on that. It is helpful. And if I can just pivot to my very last question. So during the year, you guys modded $4,100,000,000 you took in $130,000,000 dollars of additional capital associated with that, which equates to about 3%. Can you put that 3% additional capital in the context of what you see the decline in property values?

Speaker 5

How does that sort of match up in terms of how much property is actually down?

Speaker 2

I don't understand your question.

Speaker 5

So you had borrowers put in 3% in order to modify loans. And I think anecdotally, property values are down substantially more than that. So I'm kind of curious how you think about how much additional capital a borrower needs to put in, in order to maintain an LTV?

Speaker 1

Okay. Every case is different, Rick.

Speaker 2

And not all properties decline, some improve the performance. So I can't answer your question in the macro. We take each situation, we evaluate the capital income put in, how the assets perform and how can improve. So each one is better.

Speaker 5

Okay, got it. Hey guys, thanks. I always appreciate you taking my questions. Thank you.

Speaker 2

Thank you.

Operator

Thank you. And we will take our next question from Jade Rahmani with KBW. Please go ahead.

Speaker 1

Thank you very much. Can you discuss the lower cash balance in the structure of the business? What drove the quarter on quarter decline? And also did you experience any margin calls? Sure.

Speaker 1

So we did not experience any margin calls. We have great relationships with our lenders. In fact, Ivan could probably give some color that the market for commercial banks and securitizations is

Speaker 2

really, really strong right now. So we're not Maybe it's a good time to comment on that. I'm sure you're aware that the CLO market and the bank lending market has improved dramatically and those are some of the benefits that we've offset some of these other factors. The CLO market, I'm sure you've seen deals are getting done in the 150 to 175 range as opposed to deals that two years ago couldn't get done and then spreads were in the $2.75 range. So we've seen huge efficiencies on that side.

Speaker 2

The commercial banks, our partners and relationships we've had, they've been more and more aggressive, higher advance rates and lower spreads. And these things will translate to better margins for us going forward. It's a lagging effect. It's all beginning over the last couple of months and we should have some real positive impact on our income streams going forward, which will be an offset to some of these negative issues.

Speaker 1

And as far as the cash balance dropping, it's math, right? We had put on as you saw $377,000,000 of bridge in our new product that we love. We funded up our SFR business, which continues to grow. So that requires cash and obviously the runoff has partially offset that. There's also timing on cash, right?

Speaker 1

When you are taking back an REO asset, you may have to buy it out of the vehicle and then you re lever it. So there's always timing on why those cash numbers move. But we're sitting at about $450,000,000 of cash and liquidity today. And obviously, we've used some of that cash to grow the platform. And then just the agency business cash balance when you break out the different segments, is that more akin to corporate cash?

Speaker 1

How fungible is that cash? Yes, it's all fungible. You just the agency business obviously generates cash, it's capital light and then it gets moved up to the it's just the way you break out the segments. But when you look at a company like ours and you're managing cash, all of that cash is fungible and all of that is corporate cash. Lastly, just on the GSE side, have you gotten any putbacks?

Speaker 6

I know JLL was one, Walken Dunlop talked about what they've received.

Speaker 1

It would be helpful

Speaker 6

to hear if you've received any loan putbacks.

Speaker 1

We have not. We have not had a putback or had a buyback loan. Thanks a lot. Thanks.

Operator

Thank you. And we will take our next question from Crispin Love with Piper Sandler. Please go ahead.

Speaker 1

Thanks. Good morning, everyone. First, you've had $3.00 $7,000,000 plus of Bridge origination in the fourth quarter, highest level in a long time, in line with your guidance from last quarter. Can you speak to expectations going forward in Bridge as rates have backed up since September? And then do you have an outlook for agency originations for the first quarter?

Speaker 1

Thanks.

Speaker 2

Yes. The three seventy million dollars of Bridge is a good quarter. As I mentioned in my comments, we're expecting to do about $1,500,000,000 to $2,000,000,000 for the year and we expect it to move fairly evenly over the year. I think if short term rates drop, you can see that number going up considerably, but that's the

Speaker 1

question, Chris, but yes, the reason we've given a $0.3 to $0.35 kind of guidance per quarter is it won't be linear, right? Certainly the first quarter or two maybe on the lower end of that range and then it will grow from there and a lot has to do with the fact that the agency business given where rates are is off to a slow start. So we're expecting a much lower first quarter in the agencies and then we expect it to build from there for two reasons. One, historically the first quarter is usually a slower quarter because a lot of people close all their loans at the end of the year and two, the backup of rates put some people on the sidelines, got a big pipeline, we've got a lot of loans ready to go. It's just a matter of convincing borrowers to transact at these levels and a lot of them are still patiently waiting to see where the ten year goes.

Speaker 1

So we are expecting the numbers to be much lighter in the first quarter and then hopefully grow from there. And what you did see is a strong fourth quarter, not only

Speaker 2

with Auburn, but all agency lenders and the agencies themselves. And if you look at the comments I had, we would have even done more, but the agencies were backed up. And when rates jumped, we have this huge pipeline sitting on the side. So the first quarter is going to be a little light because so much was done in the fourth quarter and where the rates are today is just a ton sitting on the side of balance sheet on the pipeline. And if you see a meaningful move for the ten year down, you'll see that number increase substantially.

Speaker 1

Yes. And it wouldn't be surprising if the agency business for the quarter was $600,000,000 to $800,000,000 It all depends on what's going to happen. Great. Thank you. I appreciate all the color there.

Speaker 1

And then just last one for me. Can you provide any update on the DOJ SEC investigations from last year? And you mentioned legal fees related to short seller reports in your prepared remarks. Does that also include legal fees related to these investigations as well?

Speaker 2

Well, as you know, we don't comment on regulatory inquiries. With respect to the elevated costs, we, as you know, go through extended orders and reorders. We had to step up the auditing process, the expense with respect to auditing, our compliance and all those kind of factors. So we are working extremely hard. Our auditors are doing their double and triple and quadruple work.

Speaker 2

We've had to step up our compliance and all our procedures and processes. So that's what we estimate the course they're going to be to work in this environment.

Operator

Thank you. And it appears that we have reached our allotted time for questions. I will now turn the program back to Ivan Kaufman for any additional or closing remarks.

Speaker 1

Okay. Well, thank you everybody for your time.

Speaker 2

2024, we expect next year that we will be able to get in this car rate environment. We appreciate your participation in the call. And so the rates will come on our favor. Things will look a little bit more favorable. However, even with this adjusted interest rate environment, we still expect our performance to be extremely strong and about four more years in the space.

Speaker 2

Thank you. You all and have a great weekend.

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Earnings Conference Call
Arbor Realty Trust Q4 2024
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