Paul Elenio - CFO Ivan Kaufman - President and CEO.

Ryan Tomasello - KBW Rick Shane - JPMorgan Steve Delaney - JMP Securities Ben Zucker - BTIG Jade Rahmani - KBW.

Good day, ladies and gentlemen, and welcome to the First Quarter 2018 Arbor Realty Trust Earnings Conference Call. [Operator Instructions] And as a reminder, this conference is being recorded. I would now like to turn the call over to Mr. Paul Elenio, CFO. Sir, you may begin..

Okay, thank you, and good morning, everyone. Welcome to the quarterly earnings call for Arbor Realty Trust. This morning, we'll discuss the results from the quarter ended March 31, 2018. With me on the call today is Ivan Kaufman, our President and Chief Executive Officer.

Before we begin, I need to inform you that statements made in this earnings call may be deemed forward-looking statements that are subject to risks and uncertainties, including information about possible or assumed future results of our business, financial condition, liquidity, results of operations, plans and objectives.

These statements are based on our beliefs, assumptions and expectations of our future performance, taking into account the information currently available to us. Factors that could cause actual results to differ materially from Arbor's expectations in these forward-looking statements are detailed in our SEC reports.

Listeners are cautioned not to place undue reliance on these forward-looking statements, which speak only as of today. Arbor undertakes no obligation to publicly update or revise these forward-looking statements to reflect events or circumstances after today or the occurrences of unanticipated events.

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

Thank you, Paul, and thanks to everyone for joining us on today’s call. As you can see from this morning's press release, we started off 2018 with another tremendous quarter which continues to demonstrate the strength of our brand and the value of our operating franchise.

As a result, I'm extremely pleased to announce that we increased in our quarterly dividend from $0.21 to $0.25 a share, a $0.04 and 19% increase from the prior quarter and a 32% increase so far in 2018. This also represents our sixth dividend increase in the last eight quarters and a 67% increase over that time period.

Our dividend is now an annual rate of $1 a share and based on our strong results and outlook for the remainder of the year, we intend to pay $0.25 quarterly dividend for the rest of the year and evaluate our earnings performance at that time to determine the timing of our future dividend increases.

This significant increase in our dividend reflects the tremendous success we have achieved from the full integration of our agency business acquisition.

It has been roughly 2 years since we acquired the agency business and during the integration of that business, we purposely chose to be very conservative in our approach to growing our dividend until we could fully evaluate the significant benefit we would achieve from that acquisition.

At this point, as it become very clear that the impact of this business has been exponential and extremely accretive comp earnings which is greatly exceeded our own expectations.

Now, I would want to discuss the reasons why our earnings have been so strong and will continue to grow and where we can maintain our current dividend and evaluate potential opportunities to increase this in the future. We have experienced tremendous growth in our agency originations volume which continues to generate strong margins.

We produced record agency originations of 4.5 billion last year which was an increase of 19% from the prior year with an extremely strong pipeline. We remain confident in our originations volume for the balance of the year.

Additionally our servicing portfolio has grown 40% since the acquisition, while we have been able to maintain a servicing fee of approximately 48 basis points. This portfolio generates a very significant long dated, predictable annuity of income of around 80 million growth annually and growing which is mostly prepayment for taxes.

This income stream from our servicing portfolio combined with the fee income we generate from our originations has created significant diversity and a high level of certainty in our income sources.

Due to the changes in the tax law that have permanently reduced corporate tax rates from 35% to 21%, we will also experience an increase in AFFO of around $0.04 to $0.06 a share annually.

Additionally with respect to assets in our balance sheet, we've experienced tremendous growth while our other lenders have been seeing reductions in their portfolios. We grew our balance sheet investment portfolio 48% in 2017 and another 5% in the first quarter of 2018.

We've also achieved significant economies of scale by substantially reducing our debt cost in all of bond facilities which has allowed us to maintain our margins and generate levered returns in excess of 13% in a very competitive market and outperformed our peers.

And the income generated from these assets is a significant component of our earnings and we're confident in our ability to continue to grow this income stream. In the first quarter, we also executed a very successful trade issuance $100 million of new five-year unsecured debt on a fixed rate of 5.625%.

The proceeds from this issuance we used to repay of 7.375% unsecured debt instrument which will increase our annual AFFO by approximately $0.02 a share. Again, for all these reasons we are very comfortable with our current dividend and we've done a great job of diversifying our income streams and created certainty and growth within our business.

Now I want to tell you why we are extremely undervalued and in great investment opportunity at these levels. First, from a historical perspective prior to the announcement of the acquisition of our agency platform two years ago, we were trading at a dividend yield of approximately 9% based on a quarterly dividend of $0.15 a share.

Today with a $1 per share annual dividend, if you apply the same preacquisition dividend yield analysis, we should be trading at approximately $11 a share. Furthermore, our dividend is even more valuable today after the new tax law change that has substantially reduced the tax rate on REIT dividends.

If you apply this benefit to our historical dividend yield, we should be trading at $12 a share. On top of that, today we are much more valuable company based on a more complete operating franchise, significant and consistent increases to our earnings, our larger market cap, flow and liquidity and more predictable stable and long dated income stream.

We also feel strongly that given a significant operating platform in GSE business we should be valued at a similar P/E ratio to all the public GSE platforms such as Walker & Dunlop, which will result in stock price more in the range of $13 to $15.

We have a highly motivated dedicated senior management team who are fully aligned with over 30% inside ownership. This is clearly the highest level of inside ownership in this space and we're very committed to working extremely hard to continue to increase the value of our franchise and maximize return to our shareholders.

I will now turn the call over to Paul to take you through the financial results..

Okay, thank you Ivan. As our press release this morning indicated, we had a very strong first quarter with adjusted AFFO of $23.7 million or $0.28 per share and our first quarter results reflect an annualized return on average common equity of approximately 12%.

As Ivan mentioned, we continue to put up record results and we are very pleased to have significantly increase our dividend again this quarter another 19% to $0.25 a share. Looking at our results from our agency business, we generated approximately $19 million of income in the first quarter on nearly $1.1 billion in originations and loan sales.

The margins in our first quarter sales were 1.71% including miscellaneous fees compared to a 1.48 all-in margin on our fourth quarter sales largely due to changes in the mix and size of our loan products which include more FHA loan sales in the first quarter that produce a much higher margin than other loan products.

And we recorded commission expense of approximately 39% in the first quarter gain on sale as compared to 38% in our fourth quarter gains.

We also recorded $19.6 million of mortgage servicing rights income related to $1 billion of committed loans during the first quarter representing an average mortgage servicing rights rates of around 1.88% compared to 1.77% on our fourth quarter committed loans of $1.2 billion.

This is mainly due to some larger loans in the fourth quarter that generally have lower servicing fees. Sales margins and MSR rates fluctuate primarily by GSE loan type and size, therefore changes in the mix of loan origination volumes may increase or decrease these percentages in the future.

Our servicing portfolio also grew another 3% during the quarter to $16.7 billion at March 31, with a weighted average servicing fee of approximately 48 basis points and an estimated remaining life of approximately eight years.

This portfolio will continue to generate a significant predictable annuity of income going forward around $80 million growth annually. Additionally early runoff in our servicing book continues to produce prepayment fees related to certain loans that have yield maintenance provisions.

This accounted for $3.7 million in prepayment fees in the first quarter and $4.9 million in the fourth quarter. These fees were recorded in servicing revenue, net of write-off for the corresponding MSR in this loss.

We also continue to increase our interest-earning deposits with nearly 500 million of escrow balances earning slightly less than one month LIBOR. These balances provide a natural hedge against rising interest rate and they will generate significant additional earnings power as rates increase.

In fact for every 1% increase in interest rates, these deposits could earn an additional $5 million annually or approximately $0.05 a share in additional earnings.

We did have a large one-time non-cash income item during the quarter of approximately $12.5 million related to receiving basis on the $50 million of solid financing we repaid which was recorded as a deferred tax benefit in the first quarter.

And as we discussed on our last call, the reduction in corporate tax rates from 35% to 21% will increase our after-tax earnings from the agency business and could contribute as much as an additional $0.04 to $0.06 a share to our AFFO for 2018. We also had another very strong quarter in our balance sheet lending operation.

We grew our investment portfolio of 5% to $2.8 billion on $314 million of new originations, net of approximately $191 million of run-off.

This growth continues to increase our core earnings run rate and we remain extremely confident that through our deep originations network, we will be able to continue to grow our balance sheet investment portfolio in the future.

Our $2.8 billion investment portfolio had an all in yield of approximately 7.28% at March 31, which is up differently from the yield of around 6.99% at December 31, mainly due to an increase in LIBOR.

The average balance in our core investments increased to $2.7 billion for the first quarter from $2.3 billion for the fourth quarter due to the significant growth we experienced in the first and fourth quarters.

And the average yield on these investments were 7.08% for the first quarter compared to 6.94% for the fourth quarter largely due to an increase in LIBOR partially offset by lower rates on fourth quarter originations, the full effect of which is reflected in the first quarter.

The debt in our core assets was approximately $2.5 billion at March 31, with in all-in debt cost of approximately 5.09% compared to debt cost of around 4.83% at December 31 mainly due to an increase in LIBOR.

The average balance in our debt facilities increased to approximately $2.3 billion for the first quarter from approximately $1.9 billion for the fourth quarter primarily due to financing our first quarter growth.

And the average cost of funds in our debt facilities was up to 5.33% for the first quarter compared to 4.66% for the fourth quarter for that's mainly due to $2.4 million of non-cash fees we expensed related to the early payoff of 738 unsecured debt with our new 558 unsecured debt instrument, as well as from an increase in LIBOR during the quarter.

And as Ivan mentioned earlier, we do expect to replacement of our higher cost unsecured debt with our new low-cost instrument to increase our AFFO by approximately $0.02 a share annually.

Overall, net interest spreads in our core assets on a GAAP basis decreased to 1.77% this quarter compared to 2.28% last quarter mainly due to non-cash fees expense in the first quarter from the early payoff for the debt and our overall spot net interest spreads was up to 2.19% at March 31, from 2.16% at December 31, and approximately 88% of our portfolio comprised of floating rate loans we will see an increase in interest income spreads as interest rates continue to rise in the future.

And lastly the average leverage ratio in our core lending assets including the trust preferred and perpetual preferred stock as equity was up to approximately 76% in the first quarter from 72% in the fourth quarter largely due to our new convertible debt offering that closed late in the fourth quarter and our overall debt-to-equity ratio on a spot basis including the trust and preferred stock as equity was up to 2.2:1 at March 31, from 2.1:1 at December 31, all due to the issuance of our new five-year unsecured debt instrument in March, the proceeds of which were used to pay-off our higher rate debt in April.

That completes our prepared remarks for this morning. And I'll now turn it back to the operator to take any questions you may have at this time.

Operator?.

[Operator Instructions] Our first question comes from the line of Jade Rahmani of KBW. Your line is open..

This is actually Ryan on for Jade thanks for taking the questions, and congrats on the strong quarter. Just at a high level in terms of the overall CRE market Ivan.

How many rate hikes do you think that the market can absorb before we start seeing diminishing credit performance and I’m not just talking about for Arbor's portfolio but just your thoughts overall. It seems that we’re seeing a trend of decelerating NOI growth.

So I think some are concerned that with the rate hikes that the market is forecasting we can start to see cap rates widen?.

So what we have in our portfolio seen a deceleration of NOI is actually the NOIs above our underwritten forecasts even for last year. So while we may not see the kind of growth that we've seen historically in the multifamily sector there has been a good level of stabilization. Whether that changes in 2018 or 2019, I’m not sure.

Definitely we’ve seen a bump in the 10 year and there should be some level of corresponding change in cap rates. We haven't seen cap rates widen at all yet and keep in mind - where we are at least I am personally and active buyer of multifamily assets in the market. And there's still a lot of pressure on cap rates it hasn’t materially changed.

So the real question is when on the multifamily sector are we going to see rent softened and vacancies softened, 2018 looks very solid at the moment. The rise in interest rates we bumped over three we settled back down on the 10 year, that's been offset a little bit by tightening of spreads. I think spreads came in about 50 basis points.

So it’s been about a - we estimate about a 50 basis points widening and borrowing costs on fixed rate debt and we haven't seen that much at this point so that’s our overall view..

And just in terms of the overall market for Fannie Mae in the quarter, it looks like, for the marketing end, Fannie Mae delivery volumes were a bit soft, particularly in February and March. It looks like that weakness may have been timing related, partially due to the outsized January volumes a year ago, due to the caps.

But just wondering what your thoughts were on the outlook for Fannie Mae being more competitive for the remainder of the year..

I think what we saw in the first quarter was people were a little bit shock and lot of refis maybe people kicked down the road as rates jumped up and were in the three level. So that might have stalled volume overall the market is extremely competitive.

I do believe the agencies are going to come in maybe the market is 5% to 10% smaller than it was last year. So perhaps the agencies will be 5% to 10% less than they were last year..

And just finally can you discuss the current liquidity position and how you approach capital issuance and maybe just remind us of what target leverage is.

It looks like the way we calculate debt to adjusted common equity is around three times today but looking at the balance sheet for the structured business in particular would imply higher leverage for that business or just wondering what your thoughts are on that and liquidity today?.

I think we evaluated our pipeline, we’ve a pretty good size pipeline but that changes as we move forward and then it also changes based on the leverage that we’re able to obtain in the marketplace. Paul you have any comment on that..

I think that's right. The leverage we’ve been hovering around Ryan it’s pretty much where we had it, we’ve been up a little bit because of the convert we mentioned that we did last quarter, but to me that's more of equity.

But I think the leverage we’ve been obtaining on the borrowing for our assets has been pretty consistent and I think that leverage probably holds. As I think Ivan is right on the rest of the pipeline is where it is, we’ve got some big numbers in the pipeline and then it changes as we go.

So right now we’re in really good shape from a pipeline perspective and from a leverage perspective we really like the leverage we have..

Our next question comes from the line of Rick Shane of JPMorgan. Your line is open..

When looking at our model one place where we see some variances is in terms of the employee expenses in the first quarter. There was a pretty significant jump sequentially.

I’m curious if there was anything seasonal related to bonuses or stock comp that we need to be thinking about there as we’ll find those estimates going forward?.

And there was some things that were seasonal but the biggest item was that every first quarter of the year we do our annual stock grants to our employees and to the board. So that hit the numbers in the first quarter and it ends up in those comp and G&A numbers pretty significantly.

And then also every year at this time you have the FICA reset or the fringe reset for FICA. So FICA was up a lot in the first quarter that we think will settle back in the second quarter as people hit the FICA cap after they get their bonuses after the first quarter.

So that does run up in the first quarter a little bit more than you’ll see in the other quarter. So those are the two items that are kind of seasonal and not really reflective in future quarters..

Our next question comes from the line of Steve Delaney of JMP Securities. Your line is open..

Ivan I'd like to pick up on your conversation with Ryan a minute ago, and its doesn’t seem unreasonable with GSE agency volumes might be down 5% to 10% but I guess the question I would ask to you is, if that’s the case do you think your volumes would be down 5% or so or do you think you have the ability to gain market share and either have flat or possibly even higher agency volumes this year?.

I think that we operate in many different business lines and clearly the growth of our structured business is a little ahead of where we thought. We're pretty confident where our pipeline is, we do a lot of small loans which is little bit more resilient to where volumes are.

Our sales force is pretty engrained, its holding tone and possibly growing market share. We've also started sort of new lines of business we started a single family rental program which I don’t know if you saw we’re one of six people that we approved by Freddie Mac and we entering that marketplace.

So I think given the nature of our business given the fact of how organic our sales people are in finance, we feel pretty comfortable with where our pipeline is even in a shrinking market to be able to outpace the rest of the market..

And kind of ties into my next question, the volume was down a little bit sequentially which you guys actually made more money in the first quarter than we you did in the fourth quarter and the sale margin higher obviously was the driver.

The FHA business and the conduit lending business are those products that you expect some fairly consistent activity in and I am just curious if that activity which we haven’t seen quite as much of in the past is just the result of any new hirers or programs that you’ve put in place in recent quarters?.

I mean we put a big investment into our FHA platform. It takes a long time for those loans to go through the system. We do expect significant growth on a percentage basis over last year.

The CMBS business is not really income driver it’s more on a combination type customers and keeps our sales guys in the fray - in the business sector that’s not something that they contribute dramatically in overall business.

Getting back to your other comment, our business with Fannie Mae as a percentage of where they were off in their first quarter where we're slightly off we’re way ahead of where they were off. So I think they were off maybe 20%, 25% relative to the prior quarter I’ll get those exact numbers..

35% year-over-year..

So if you look at our numbers we are only about 10% so getting to where your market share is for Fannie Mae we’ve grown our market share with them. So the numbers speak for themselves..

And just final thing Paul I had to step away from desk whilst you were talking about escrow balances and if you gave a figure for which your current escrow balances are running, I miss that so if you could share that it will be helpful?.

They're running around $500 million right now so and that’s a number we have and we’ve been hovering around there and we expect that to grow over time.

And as we talked about Steve in the past, it’s a great natural hedge against interest rate rising because we’re earning pretty much a little bit less than LIBOR and as rates continue to rise that could be a meaningful contributor to our earnings..

No question, we’ll make sure we have linked to 30 day LIBR going forward with a little discount. Thank you both for your comments..

Thank you. Our next question comes from the line of Ben Zucker of BTIG. Your line is open..

I think the general consistency in your volumes from the seasonally strong fourth quarter to the seasonally weak 1Q was pretty interesting. We've always heard that the small balance borrowers much less sensitive to changes in interest rates than a larger loan borrower.

So could you comment on what the market feels like right now and specifically I much more interested in your thoughts on the borrower for your GSE SBC loans rather than your comments on bridge loan demand?.

Sure I do believe that our delivery to Freddie Mac for the first quarter are ahead of the pace that they were last year. So that business continues to grow and I believe we’re going to do more of Freddie Mac SPLs in 2018 than we did in 2017.

So I think it speaks to that bar being little bit more consistent in the market, more resilient but more importantly what we’re seeing with the growth to the bar is that we’re continuing to grow that portfolio and their loyalty is very, very deep with Arbor.

So those clients are growing, we’re growing with them a little less sensitive to interest rate movements then other bar. So that's always been our strategy and its payroll for us..

I mean you talk about the first quarter from last year and I think we all know the first quarter from last year has some spill over from the prior year from the cash issues. And so to me I look at the first quarter versus the fourth quarter and they were almost identical a little bit down.

So we're not seeing significant reductions at all right now in the volume. So we are actually pretty pleased to where we are then if we are able to duplicate this number for the next few quarters and time will tell what we do up and down we would come in line may be even above what we did last year. So that’s where we targeted..

Could you quickly talk about the $42 million or so of CRE loans that you originated that were not the typical bridge product. I checked the 10-Q quickly and I guess these were preferred equity type investments.

But could you just give some color on these loans or these standalone preferred equity are they kind of contiguous with the senior loan you guys also provided?.

Yes, we do - as we talked about in the past we’re probably 90% of our book is senior debt, the other 10% is mezzanine and PE. We did have one loan during the quarter that was a PE investment, the rest were all bridge loans as Ivan will tell you we do traffic in that space as well and provide liquidity to our borrowers in those areas.

It’s not a huge part of our book but it is about 10% of our book so this quarter we had less than that but we had one loan that was PE investment..

There were still repeat borrower who we doing business with for 10 years and very comfortable with that particular borrower and New York City assets which were pretty pleased about. So it's not something we do every quarter, its part of our lines of business that we do we’re very active with..

Just part of offering the full suite of products for your borrowers and then just real quickly as clean up I feel like I have to ask this but based on the new dividend level $0.25 per quarter, would it be fair to assume that on a forward full quarter basis that you would expect to earn at least $1 in FFO and I asked us understanding that the GSE business will have its natural fluctuations so the earnings trend might not be linear necessarily but just generally speaking?.

We’re very, very profitable with that on a go forward basis and we still feel there a lot of different avenues with the company just like each quarter we come out with ways that where we save money whether it be through issuing debt or taxes or whatever.

So we're real comfortable with that we’re comfortable with where our pipeline is we’re four months into the year with actually a pipeline. So we kind of know where we are for the next two months which we’ve taken care of half the year.

So, we wouldn't have done that to be aggressive, we did that in the same manner that we raised our dividend historically..

And I want to echo that thought from Ivan that we do not give guidance on our numbers as you know we never would have put the dividend at $0.25 if we didn’t feel extremely confident that we’re earnings at least that number if not more.

So, we certainly are very, very confident in that number that’s not a number we’re growing into that number we have and so very confident with that..

Well, I think that investors should be very happy to hear that so congrats on another strong quarter and impressive dividend increase..

And we do have a follow up question from the line of Jade Rahmani of KBW. Your line is open..

Just on head count, can you say how that’s trended over the past few quarters or a year in both the structured and agency side.

Maybe how many originators you have on the balance sheet business and how many brokers you have on the GSE side?.

Paul would give you the numbers but I want to state my overall philosophy what I'd like to accomplish this year. Up until this year the whole industry has grown dramatically and we've grown at a rate of at least 20% per year. This is going to be the first year where the rest of the industry should be somewhat flat to declining.

I am hoping that we should be able to achieve certain economies through not having to chase our people and pay extraordinary amounts to retain people in an environment.

So the benefit you get to a class of declining industry as the opportunity to really take a look at your payroll, take a look at your expenses, and tighten them up but I'll get the numbers back to Paul to deal with..

So I think the numbers as Ivan said we're really looking this year to generate significant economies of scale we already started that but the numbers are on the structured side we probably added 8% to 10% increase in headcount year-over-year.

On the agency side it’s more like 12% to 14% but a lot of that has to do with the growth in servicing portfolio as well.

So I think the way we look at this is we're going to get significant economies of scale both in the structured business as that portfolio at 2.8 billion grows we will do it obviously with less incremental cost and will get economy of scale there.

And as our servicing portfolio continues to grow, you don't need add one body for every loan you’re originating. So obviously we’ll get economies of scale there. So historically they've been around 8 to 10 on the structured, 12 to 14 on the agency, but I still think will be able to do better than that going forward..

Thank you. And at this time I am showing no further question. I’d like to turn the conference back over to Mr. Ivan Kaufman for closing remarks..

All right. Thank you everybody for participating on our call. And clearly it’s been an extraordinary quarter for us and we look forward to a great year. Have a nice day..

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