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Edited Transcript of ABR earnings conference call or presentation 3-Mar-17 3:00pm GMT

Thomson Reuters StreetEvents

Q4 2016 Arbor Realty Trust Inc Earnings Call

Uniondale Mar 3, 2017 (Thomson StreetEvents) -- Edited Transcript of Arbor Realty Trust Inc earnings conference call or presentation Friday, March 3, 2017 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Paul Elenio

Arbor Realty Trust, Inc. - CFO

* Ivan Kaufman

Arbor Realty Trust, Inc. - Chairman, President, CEO

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Conference Call Participants

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* Steve DeLaney

JMP Securities - Analyst

* Jade Rahmani

Keefe, Bruyette & Woods, Inc. - Analyst

* Ryan Tomasello

Keefe, Bruyette & Woods, Inc. - Analyst

* Lee Cooperman

Omega Advisors - Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to Arbor Realty Trust's fourth-quarter 2016 earnings conference call. (Operator Instructions). As a reminder, today's conference is being recorded.

I would now like to turn the call over to Mr. Paul Elenio, Chief Financial Officer. Sir, you may begin.

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Paul Elenio, Arbor Realty Trust, Inc. - CFO [2]

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Thank you, Chelsea, and good morning, everyone, and welcome to the quarterly earnings call for Arbor Realty Trust. This morning, we'll discuss the results of the quarter and year ended December 31, 2016. 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 conditions, 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 the 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.

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Ivan Kaufman, Arbor Realty Trust, Inc. - Chairman, President, CEO [3]

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Thank you, Paul, and thanks to everyone for joining us on today's call. We're very excited today to discuss the success we had in closing out 2016, as well as our plans for 2017.

As you can see from this morning's press release, we had a very strong fourth quarter, as we continue to benefit greatly from our newly acquired agency platform. This acquisition is transformational to our franchise and will greatly enhance our ability to achieve our goal of becoming a world-class commercial real estate platform.

Before I turn it over to Paul to take you through our financial results, I would like to talk about some of our significant fourth-quarter and full-year accomplishments, as well as our outlook for 2017. Our fourth-quarter and full-year highlights were truly remarkable and exceeded our expectations.

Some of the more significant accomplishments included significant growth in our core earnings, allowing us to increase our dividend run rate to $0.68 per share, representing a 13% increase since the agency business acquisition; achieving a total shareholder return of 13% in 2016 and 28% over the last two years; adding significant diversification, stability, and duration to our income streams from a prepayment protected long-dated servicing portfolio; producing record originations of $4.6 billion, $3.8 billion from our agency business, a 22% increase from the 2015 agency volume; growing our servicing portfolio to $13.6 billion, a 24% increase from 2015 and a 14% increase since the agency business was acquired; increasing our transitional balance sheet portfolio 17% in 2016 to $1.8 billion, generating $15 million of income from equity investments and structured transactions; continuing to focus on new and improved nonrecourse securitization vehicles, closing at a six-year low for $325 million with replenishing capability; increasing our market cap to over $500 million and our equity base by $180 million; and preserved our strong liquidity position with currently $150 million of cash on hand to fund new investment opportunities.

Again, these are truly incredible results, and I would now like to spend a little more time elaborating on some of these accomplishments in our two complementary and cohesive business platforms. First, I would like to discuss our agency origination and servicing platform. We had a tremendous fourth quarter, originated $1.3 billion in loans, with over $700 million of these loans occurring in the month of December alone. We closed out 2016 with approximately $3.8 billion of agency volume, an increase of over 20% from 2015, and both our December and full-year 2016 production numbers were both new records for our agency business.

We also finished as top 10 Fannie Mae DUS lender for the 10th consecutive year in a row, a distinction only one other DUS lender has achieved, and we were the number one small balance lender for Freddie Mac again in 2016 and a top small balance lender for Fannie Mae as well.

We are also extremely positive on our outlook for 2017 and believe that the significant amount of commercial real estate debt that is maturing, combined with our strong brand and dominance in the small balance loan market, we could exceed our 2016 record origination numbers in 2017.

The significant growth in our agency platform has also allowed us to grow our servicing portfolio substantially. At 12/31/2016, we had a servicing portfolio of approximately $13.6 billion, with a 48 basis-point weighted average servicing fee, which will generate a reoccurring, predictable, and long-dated annuity that is mostly prepayment protected and will continue to add significant diversity, duration, and stability to our earnings stream.

The tremendous success we have had over the past two quarters in our agency business has also been extremely accretive to our core earnings and allows us to increase our dividend to $0.17 a share this quarter, or $0.68 a share annual run rate, which is a 13% increase in our dividend since we purchased the agency platform and our second increase since the acquisition of the agency platform, and this is the second increase that we've done, going from $0.60 a share to $0.68 a share.

Additionally, we are expecting a very strong first quarter as well, as a result of approximately $700 million of originations that we closed in December, the gains of which will be recognized in the first quarter upon the sale of these loans, and, again, we are also very positive on our outlook for the rest of 2017.

So overall, we are pleased with the results of our agency platform and are confident that this business will continue to produce significant reoccurring and predictable earnings and longer duration assets, which allow us to continue to grow our earnings and dividends in the future. This business will also provide a very durable growth platform, while minimizing the potential impact of capital markets and interest-rate volatility, and we believe for all of these reasons we should trade at a premium value when compared to other mortgage REITs and specialty finance companies that do not have a significant agency platform.

Now, I would like to focus on our accomplishments in my transitional balance-sheet lending business. We continue to focus heavily on growing our balance-sheet originations business, while remaining extremely disciplined in our lending approach, by primarily investing in senior debt. This has allowed us to generate levered returns in an excess of what we could achieve by lending in the subordinate areas of the capital stack.

In the fourth quarter, we originated approximately $193 million of loans and experienced runoff of approximately $135 million. For the year, we closed $848 million of loans and had $550 million of runoff, resulting in net growth in our portfolio of approximately $300 million, or 17%, in 2016. Our 2016 originations had an average yield of approximately 7% and generated levered returns of approximately 14% on these investments.

We are very pleased with the significant growth we experienced in 2016 and believe that through our deep originations network, we can duplicate or even exceed this level of growth in 2017 while generating similar levered returns on our new investments.

Additionally, with a heavy focus on senior multifamily loans, our loan portfolio of approximately $1.8 billion is now comprised of 90% senior debt, with 85% of that debt being multifamily assets, which clearly have proven to be the most resilient asset class and product type in all economic cycles.

We have also continued to focus on enhancing our debt structures, which is one of the key reasons to our success and remains a critical component of our business strategy. The successful execution of this strategy has allowed us to generate superior levered returns in a very safe and stable part of the capital stack through the continued use of nonrecourse securitization vehicles. We have a tremendous amount of experience and capability in the securitization arena and continue to be a market leader in this space.

We have closed six nonrecourse CLO securitization vehicles since the financial crisis and currently have approximately $750 million of nonrecourse debt through three vehicles, with replenishment periods going out as far as three years, allowing us to appropriately match funds on our assets with nonrecourse liabilities and generate strong levered returns.

Additionally, we were very successful in raising accretive capital in 2016 in the form of convertible note instruments with attractive returns. This allowed us to increase our liquidity position and we now have approximately $150 million of cash on hand to fund our future investment opportunities.

We also produced extremely impressive results from our investments in the residential mortgage banking business and from other equity interests in 2016. In the fourth quarter, we recorded $1.8 million of income, bringing our total income from these investments to $13 million for the full year of 2016. Approximately $9.6 million of this income was from our investment in the residential mortgage business, which resulted in a 100% return on our investment capital for the year.

These results were well in excess of the original expectations for 2016, due to a significant increase in volume as a result of low interest rate environment. And given the recent move in interest rates, we are now expecting to generate between $1 million to $1.5 million of income per quarter from these investments in 2016, which is more in line with our original guidance and reflective of the current interest rate environment.

Overall, we are extremely pleased with our fourth-quarter and full-year results, especially in our ability to complete the agency business acquisition and grow our core earnings and dividends significantly in 2016. We are also excited about the significant growth we have experienced so far in the agency business and our ability to diversify and create more stable, predictable, long-dated earnings streams which are less sensitive to rate and market volatility.

We believe the combination of our two significant businesses will continue to enhance our originations platform, expand our market presence, and broaden our products, which will increase the value of our franchise, and we are very focused and confident in our ability to increase our brand, grow our platform, and continue to increase the value to our shareholders.

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

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Paul Elenio, Arbor Realty Trust, Inc. - CFO [4]

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Thank you, Ivan.

As our press release this morning indicated, we had a very strong fourth quarter as we continue to benefit greatly from the agency business acquisition. As a result, AFFO was $15.1 million or $0.21 per share for the fourth quarter and $49 million or $0.79 per share for the full-year 2016. This translated into an annualized return on average common equity of 9% and we produced a total shareholder return of approximately 13% for 2016.

As Ivan mentioned, the significant results from our agency platform have been very accretive, which has allowed us to increase our dividend to $0.17 a share, or $0.68 share annualized, an increase of approximately 13% since the agency business acquisition. And with AFFO of $0.79 a share for 2016, we more than covered the $0.63 of dividends we paid out this year.

For the quarter, we generated approximately $27 million of income and approximately $12 million of AFFO from the agency business. A portion of this income from business is subject to federal and state taxes inside a taxable REIT subsidiary. For the fourth quarter and full-year 2016, we recorded a current federal and state tax provision of $2.1 million and $2.4 million, respectively, related to this income, as we had NOLs from prior taxable REIT investments that were applied against the third- and fourth-quarter taxable income. If we did not have these NOLs, our current federal and state tax provision would have been approximately $6 million for the fourth quarter, resulting in a current federal and state effective tax rate of approximately 22% for the fourth quarter on our agency business pretax income.

We also had a very strong originations quarter in our agency platform, closing $1.3 billion of loans in Q4 and $3.76 billion for the full-year 2016. This is a 22% increase over our 2015 originations and, as Ivan mentioned, we are very optimistic we can grow these numbers again in 2017.

For the quarter, $1 billion were Fannie Mae DUS originations, and for 2016, we originated $2.7 billion in Fannie Mae loans, a 42% increase over our 2015 Fannie Mae originations. Origination fees and gains on sales of originated loans are recorded upon settlement or sale of the underlying mortgage loan, which normally occurs anywhere from 30 to 60 days after closing. At that time, any commissions earned related to the origination of the loan are recorded as a compensation expense; therefore, one important metric for tracking quarterly fee income is our loan sale volume, which is approximately $941 million for the fourth quarter, with a margin on these sales of 1.58%, including miscellaneous fees which can range from 5 to 15 basis points.

We recorded commission expense of approximately 33% of our gain on sales in the fourth quarter and expect this number to range between 35% and 40% going forward.

We also recorded $29 million of mortgage servicing rights income related to $1.4 billion of committed loans during the fourth quarter. This represents an average mortgage servicing rights rate on committed loans of 2.05% for the fourth quarter. Sales margins and MSR rates fluctuate, primarily by GSE loan type and size, and therefore changes in the mix of loan origination volumes may increase or decrease these percentages in the future.

We also grew our servicing portfolio to approximately $13.6 billion at 12/31/2016, with a weighted average servicing fee of approximately 48 basis points and an estimated remaining life of seven years. This portfolio is up 13.5% since the acquisition date and will continue to generate a significant, predictable annuity of income going forward in excess of $65 million annually. This annuity significantly diversifies our revenue streams and provides us with long-dated, stable, predictable earnings that are mostly prepayment protected and less sensitive to rate and market cycles.

So, clearly, we had a tremendous fourth quarter in our agency business, and as Ivan mentioned, we are also expecting a strong first quarter and are very positive on our outlook for the remainder of 2017.

Now I'd like to talk about the fourth-quarter results from our transitional balance-sheet lending operation. We generated income of $3 million and AFFO of approximately $4.1 million in the fourth quarter. We recorded $1.8 million of income from our equity investments in the fourth quarter, which is down from the $4.9 million we generated from these investments last quarter as a result of less income associated with our residential mortgage banking joint venture, due to a rise in interest rates.

As Ivan discussed earlier, this investment produced $9.6 million of income in 2016 or a 100% return on our invested capital, which was well in excess of our expectations, and given the current interest rate environment, we are now estimating these equity investments to generate on average $1 million to $1.5 million of income a quarter going forward, which is more in line with our original projections.

We also had a strong originations quarter, closing $193 million of new investments, with $135 million of runoff, which resulted in net growth in our portfolio of approximately $300 million or 17% in 2016. Our investment portfolio was approximately $1.8 billion at December 31, earning an all-in yield of approximately 6.39%, which is up from a yield of around 6.14% at September 30, and with our primary focus in multifamily bridge loans, our portfolio now consists of 90% bridge loans and 80% multifamily assets.

The average balance in our core investments was up slightly, from $1.73 billion last quarter to $1.79 billion this quarter, largely due to net growth in our loan book during the quarter. The average yield in these core investments increased to 6.38% for the fourth quarter from 6.15% for the third quarter, largely due to an increase in LIBOR, as well as more accelerated fees from early runoff in the fourth quarter.

Our total debt on core assets was approximately $1.35 billion at December 31, with an all-in debt cost of approximately 4.45%, which is up from a debt cost of around 4.09% at September 30, mainly due to the issuance of our new convertible notes and an increase in LIBOR during the quarter.

The average balance in our debt facilities was also up, to approximately $1.44 billion for the fourth quarter from approximately $1.37 billion for the third quarter, mainly due to the convertible notes we issued in the fourth quarter, and the average cost of funds in our facilities increased to approximately 4.82% for the fourth quarter, compared to 4.19% for the third quarter.

We did unwind one of our CLO vehicles in the fourth quarter and recorded a one-time expense of approximately $1 million related to the acceleration of unamortized fees related to this facility. Without this one-time non-cash expense, our average cost of funds for the quarter was 4.55%, which is up from the third-quarter average mainly due to our new convertible notes, which carry a higher rate, and from an increase in LIBOR.

Overall, net interest spreads in our core assets on a GAAP basis decreased to 1.83% this quarter, compared to 1.96% last quarter, and our overall spot and interest spread decreased to 1.94% at December 31 from 2.05% at September 30, again mainly due to higher cost associated with the convertible notes.

Additionally, as Ivan mentioned, we currently have approximately $150 million of undeployed capital that, when fully utilized, should increase our net interest spreads over time.

Our average leverage ratios on our core lending assets, including the trust preferreds and perpetual preferred stock as equity, were up to approximately 71% this quarter, compared to 69% last quarter, and our overall debt to equity ratio on a spot basis, including the trust preferred and preferred stock as equity, was down to 1.3 to 1 at December 31 from 1.4 to 1 at September 30, largely due to the growth in our equity.

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. Chelsea?

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Questions and Answers

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Operator [1]

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(Operator Instructions). Steve DeLaney, JMP Securities.

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Steve DeLaney, JMP Securities - Analyst [2]

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Thanks. Good morning, gentlemen, and congratulations on a strong close to what was an exciting year.

I'd like to talk about market share a little bit. These are rough numbers, but what we're seeing -- I think the GSEs together did $112 billion in multifamily. So we're seeing your volume at about 3.5% market share combined and maybe your Fannie volume higher at about 5%. I guess the first question is, do you see these numbers about the same as we're calculating them? But more importantly, Ivan, do you guys have any specific goals or targets that over the next year or two that you are hoping to achieve in gaining share? It seems like there's plenty of room for growth.

And the final part of the question would be as you look to grow your platform, should we assume that that will mostly be organic growth or are there any acquisition targets out there that you could consider? Sorry for the long question, but I appreciate your comments.

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Ivan Kaufman, Arbor Realty Trust, Inc. - Chairman, President, CEO [3]

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Sure. I guess I'll take your last comment first, and so I'll try and remember everything you had to say. Listen, we continue to grow our originations platform organically and we do it by increasing the number of products, investing in technology, investing in our current salespeople, as well as having training programs to bring new people around and that's a significant focus.

We have a long history as operators of acquiring other businesses when the climate is right and it's the appropriate kind of enterprise that can have the right integration. We have the expertise and the capital to do it and I believe that those opportunities will present themselves, especially if there's some dislocation in the future and I'm hopeful that will occur.

With respect to the agency business, we continue to grow our agency business. As you know, Steve, we are the leader in the small balance space. We like the small balance space. It's a more difficult space to operate in. We've perfected our expertise. We continue to be the leader, the number one lender for Freddie Mac and an innovator in that program in bringing technology to bear.

So my belief is we can continue to grow in that space and increase our market share. The good news as well is a lot of our business with the agencies is excluded businesses and we're not affected by the caps, so while other enterprises may be restricted in terms of the amount of business they can do, all our business is uncapped business and it's unlimited how much we can grow.

So, we're pretty confident and happy with the level of growth we've had year to year. I think it's over 20% from last year and consistent with prior years, and if we can maintain that growth level, we'd be quite pleased.

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Steve DeLaney, JMP Securities - Analyst [4]

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Ivan, with small balance, you seem to be focused with Freddie there and I think you were involved in helping them set that program up. But does Fannie not have the same emphasis internally on small balance loans? So is that why the production with Freddie is more in that product?

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Ivan Kaufman, Arbor Realty Trust, Inc. - Chairman, President, CEO [5]

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I think that the emphasis comes and goes with the two different agencies. Freddie is clearly right now very committed with a variety of different products, so I think their product offerings are a little broader. They tend to be a little bit more competitive right now, so that's where our emphasis is at the moment. We're still very active with Fannie Mae and I think things -- based on their appetite and their views, sometimes they are a little more active, sometimes they are a little less active.

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Steve DeLaney, JMP Securities - Analyst [6]

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Okay. Thank you. And my follow-up question, I'd like to talk a little bit about credit quality in the structured portfolio. The first thing we always look for for credit is what's going on with the provision, and it looks like 2016 was a very kind of the benign year. You actually had a modest recovery, rather than a net charge, and I guess the prior year was about $4.5 million of charges. So, maybe just some big-picture thoughts on how you see the credit quality generally in the portfolio and then I'd like to ask you some specific questions about the eight loans that you have reserves on. Thanks.

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Ivan Kaufman, Arbor Realty Trust, Inc. - Chairman, President, CEO [7]

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Sure. I'll leave a lot of the numbers to Paul, but any charges that we have are still some residuals from some of the legacy portfolios. Our current portfolio is performing on the agency side and on the balance-sheet side extremely well, so we're pleased with the levels of performance. And, in fact, on the agency side, our underwritten levels for how we originate the loans and the performance of how they are performing today, they are performing well in excess of the way we've underwritten them.

So, we're quite pleased with the credit quality, and especially in light of the fact that we believe that they were kind of a flat rent environment over the last 18 months, so we've had to adjust our underwriting parameters to reflect what our philosophy was on where rights were going in the multifamily assets. Paul, do you have any comment on that?

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Paul Elenio, Arbor Realty Trust, Inc. - CFO [8]

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Yes, so, Steve, to Ivan's point, I think as you said generally the portfolio is performing very well. We've had a lot of improvements in some of the legacy assets, but the only provisions we take at this point are in a handful of legacy assets. We did not have anything, as you said, in 2016. I don't know what 2017 will bring, but for the most part the portfolio is performing very well.

On the loans that we booked reserves on, we feel comfortable those reserves are appropriate. I can't tell you that we'll have recoveries or additional provisions on those loans, but we feel very comfortable. In the past, we've been able to book recoveries. We're hopeful that trend will continue, but right now we think we're adequately reserved on those loans that we have reserves on.

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Steve DeLaney, JMP Securities - Analyst [9]

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So Paul, on the $187 million gross, what percent -- whether it's by loan number -- I guess by dollar amount, what percent of those are actually on nonaccrual? So you have no current income recognition on the loans?

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Paul Elenio, Arbor Realty Trust, Inc. - CFO [10]

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I think there's $27 million of nonperforming loans that are fully reserved and those are not performing, and then the balance of those loans, from the $180 million to the $27 million, would still be performing, but we've put away some credit reserve for impairment on those loans. And overall, Steve, you'll see the numbers, but our reserves represent a little bit less than 5% of the UPB of our portfolio right now.

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Steve DeLaney, JMP Securities - Analyst [11]

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Thank you both for your comments. I appreciate it.

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Operator [12]

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Jade Rahmani, KBW.

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Jade Rahmani, Keefe, Bruyette & Woods, Inc. - Analyst [13]

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Hi, thanks for taking the questions. Solid quarter. Just wanted to ask, you mentioned the pipeline for 1Q is strong. What are you seeing in terms of borrower demand? Is there any diminution due to concerns about interest rates or potentially tax reform impacting commercial real estate?

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Ivan Kaufman, Arbor Realty Trust, Inc. - Chairman, President, CEO [14]

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I think we're seeing very consistent production. I think you have to look at the overall environment. There's a record number of transactions that were written in 2006, 2007, and 2008 that are up for refinancing right now, and those particular loans were written with interest rates that were higher than interest rates are today.

I think some of the additional volume we saw in the fourth quarter was a reaction to the concern that rates would rise, and, in fact, they rose well in excess of what people originated -- were anticipating. I think you saw the 10-year go as high as 2.60%, 2.65%; it's settling down now in the 2.30% to 2.40% range, which is still extremely attractive.

So, we are seeing consistent demand from our borrowers; it's not letting up. And I think the outlook is that rates may rise a little bit, but it's still well within the realm of people being able to refinance their existing debt and be active in the purchase market right now.

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Jade Rahmani, Keefe, Bruyette & Woods, Inc. - Analyst [15]

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And in terms of loan mix on the GSE side, are you seeing an uptick in refinancings versus acquisition loans? It sounds like it, from your comments around the 2006 to 2008 vintage.

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Ivan Kaufman, Arbor Realty Trust, Inc. - Chairman, President, CEO [16]

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I'd have to take a look at the numbers. I think we're seeing a high level of consistency, but we will see a greater level of growth on the refinance side, just due to the amount of loans that are due to be refinanced in that market.

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Jade Rahmani, Keefe, Bruyette & Woods, Inc. - Analyst [17]

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And just on the overall market, I think Freddie Mac is projecting around a 5.5% increase in volume in 2017. Do you agree with that market projection?

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Ivan Kaufman, Arbor Realty Trust, Inc. - Chairman, President, CEO [18]

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Yes, I do. I think it's a bigger market and I think the agencies will get their share, and a great deal of the liquidity is coming from both of the agencies, including FHA as well. So, I think as the market grows, they will be there to provide liquidity in order for the market to have the right efficiencies.

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Jade Rahmani, Keefe, Bruyette & Woods, Inc. - Analyst [19]

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Thanks. And I'm going to pass it onto my colleague, Ryan, who has additional follow-up questions.

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Ryan Tomasello, Keefe, Bruyette & Woods, Inc. - Analyst [20]

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Thanks, Jade. Thanks for taking my questions as well. Just for the balance-sheet portfolio, can you say what drove the increase that was pretty material for the quarter in average loan yields? For example, are you seeing increased spreads on incremental originations?

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Ivan Kaufman, Arbor Realty Trust, Inc. - Chairman, President, CEO [21]

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Are you talking about the growth yield?

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Ryan Tomasello, Keefe, Bruyette & Woods, Inc. - Analyst [22]

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Yes, the gross yield that you disclosed at quarter-end.

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Paul Elenio, Arbor Realty Trust, Inc. - CFO [23]

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Ivan, do you want to take that or do you want me to --

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Ivan Kaufman, Arbor Realty Trust, Inc. - Chairman, President, CEO [24]

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Go ahead, Paul. You've got the numbers in front of you.

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Paul Elenio, Arbor Realty Trust, Inc. - CFO [25]

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Some of it is mixed, Ryan, so we look at things on a levered-return basis, so levered return was 14% on originations for the quarter and that's pretty much consistent all year.

The gross yield on the loans in the fourth quarter was up a little bit from the prior quarter and some of that has to do with mix. We did do a mezzanine loan during the quarter that carries a high gross yield, but then again it's not levered, so all in the mix of levered return is about 14%. Some of the mix, though, on the gross spread has to do with the product and also the increase in LIBOR, but it was a little bit of mix. We did do a larger mezzanine loan this quarter that drove up the gross yield.

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Ryan Tomasello, Keefe, Bruyette & Woods, Inc. - Analyst [26]

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And then, can you provide some color on the current pipeline of loans for the structured business that are in some process of underwriting or closing?

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Ivan Kaufman, Arbor Realty Trust, Inc. - Chairman, President, CEO [27]

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Sure. I think we're seeing that business could run at a similar pace a little bit greater than last year. Given where we are in our liquidity, we can be a little bit more aggressive.

We also think we can lower our cost of funds right now with where the market is and we think our execution on the CLO side is even more and more efficient. So, I'm optimistic that we can grow our originations a little bit ahead of last year, and our activity in the market and the combination of the platforms is giving us a little greater access, so I would like to see that business grow over last year and we're seeing more traction in that line of business.

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Paul Elenio, Arbor Realty Trust, Inc. - CFO [28]

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And Ryan, I think in Ivan's territory we talked about, as Ivan said, we do expect, we hope, that we can grow the origination side of that business right now. We're also hopeful to grow the net growth side of that business.

Now that, obviously, is dependent on runoff, but we did see, as you know, a fair amount of runoff in 2015. We saw substantially less in 2016. We don't know what 2017 will hold for us, but we're hopeful that we can, one, grow our originations on the structured side and maybe see less or the same runoff that would result in net growth in our portfolio maybe a little higher than 2016 as well. That's what we're hopeful for.

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Ryan Tomasello, Keefe, Bruyette & Woods, Inc. - Analyst [29]

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Great. And then just on the agency business, what drove the decline in gain on origination fees for the quarter and what are you expecting for the gain on sale in 2017?

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Paul Elenio, Arbor Realty Trust, Inc. - CFO [30]

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Sure. So there's lots that go into the margin, and in my commentary I tried to give you guys guidance that lots of factors factor into the margin. Obviously, loan size and GSE product is a big piece of it, so depending on the mix, you'll have a higher or lower margin. Depending on the loan size, you will have a higher or lower margin.

In the fourth quarter, we did do a few larger loans and they generally have a lower margin, so we did come in slightly lower on the margin, but not significant, and we do think that -- we can't guide to exactly what 2017 will bring, but we think that 2017 could bring a margin similar to maybe what we did in the fourth quarter. But, again, it will depend on mix, it will depend on loan size, and, as Ivan, I'm sure, will touch on, it will depend on where interest rates are and where spreads are.

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Ryan Tomasello, Keefe, Bruyette & Woods, Inc. - Analyst [31]

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And then, just lastly, for the remaining hotel and office REO assets, is there any expectation of monetizing those in the near term?

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Ivan Kaufman, Arbor Realty Trust, Inc. - Chairman, President, CEO [32]

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I would say we are working hard on monetizing those legacy and residual assets. We've done a good job in Daytona; we're left with one asset right now and we would work hard to try and monetize that over the next 12 months. We're very active in working the remaining asset that we have in Lake Tahoe and having that go through the development process, and we're in discussions and negotiations on aggressively working that as well.

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Ryan Tomasello, Keefe, Bruyette & Woods, Inc. - Analyst [33]

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Great. Thanks for taking my questions.

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Operator [34]

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(Operator Instructions). Lee Cooperman, Omega.

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Lee Cooperman, Omega Advisors - Analyst [35]

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Thank you. Congratulations on a good quarter. I apologize if these questions were addressed, but I got disconnected in the middle of the call so I missed part of the content.

I have three questions. If I said to you over the next two to three years that the economy would grow, say, a couple percent in real terms, that the Fed funds rate would go to 2%, and the 10-year government would go to 4%, but the economy would be growing, is that an interest rate environment that we can do fine in in terms of the balance sheet, how it's structured?

I'll give you all my questions at one time. The second one is I did hear about a 9% ROE for the last year. What's a realistic target to where you want to run the business?

And thirdly, I also heard there was $150 million of additional liquidity on the balance sheet. Could one assume that when we put that to work we could make a four-point spread of that money, and so it's a potential additional earnings that we are not now earning because the money is not being employed? Those three questions.

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Ivan Kaufman, Arbor Realty Trust, Inc. - Chairman, President, CEO [36]

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Sure. Paul, why don't you address the ROE, and then I'll try to remember, and (multiple speakers)

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Paul Elenio, Arbor Realty Trust, Inc. - CFO [37]

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Sure. So, yes, we did a 9% ROE on common equity this year. I think we did about 9.8% in 2015, so obviously we think those are strong numbers. 8% to 10% would be very strong in our mind, and also we generated a 13% return to shareholders with dividends in 2016. So we'd like -- I think, Ivan, you can weigh in, we'd like it anywhere from 8% to 12%, but certainly we think those are strong numbers and we think those are obtainable numbers.

I think the other two questions, Ivan, were what the interest rate environment could be and whether we can succeed in that scenario that we laid out on the interest rate environment and what we think we could do with our $150 million of capital, what that could earn us.

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Ivan Kaufman, Arbor Realty Trust, Inc. - Chairman, President, CEO [38]

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Sure. The $150 million of capital is more than we need to operate the business, so I think we have at least $50 million of that which can be put into loans and investments. We run, on average, between a 12% and a 14% return on the capital we invest, so I believe, you can do the math, it would be very accretive to invest those dollars and show good operating results.

In terms of the interest rate environment, we have a very well-balanced business and I think that interest rate rises present different opportunities for the different lines of business. As we've mentioned before, a raise in interest rate has a real positive impact on our earnings, due to the escrow and reserves that we maintain on our agency business. I think we're well in excess of $400 million and we will earn an increase in earnings commensurate with the rise in interest rates, which will have a direct impact on our earnings.

Volatility is really good for our balance-sheet line. To the extent that there is volatility, it will increase our opportunities for us in terms of using our balance sheet. That dislocation is positive to find interesting opportunities and greater spreads.

With respect to the agency business, I think the agency business will continue to grow. A rise in interest rates may impact that a little bit, but there is still a significant number of loans in 2017 and 2018 which have to be refinanced. Those loans are still well above the levels that you spoke about, and we'll still refi and work and all will have to be re-equitized. There are a lot of different product options today, and if there's a rise in interest rates, you may see borrowers take shorter-term duration products, whether it be a five- or a seven- as opposed to a 10-year loan, or they may take a variable-rate product, which we offer as well.

I think you'll see a little falloff in growth in the agency business if, in fact, rates rise rapidly and people will step back from purchases and it will be very much driven by refis, but aspects of our business will grow and I'd be pretty happy with a little volatility in the market to shake out what's taken place when people have too much liquidity.

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Lee Cooperman, Omega Advisors - Analyst [39]

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Thank you. Congratulations on doing a good job for the shareholders. We appreciate it.

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Operator [40]

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Thank you. And I'm showing no further questions at this time. I would now like to turn the call back to Mr. Ivan Kaufman, Chief Executive Officer, for any closing remarks.

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Ivan Kaufman, Arbor Realty Trust, Inc. - Chairman, President, CEO [41]

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Okay. Thank you, everybody, for participating and your support. It's been an outstanding year in 2016, and equally opportunistic and my outlook is very positive for 2017, and we look forward to your participation going forward. Have a good day, everybody.

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Operator [42]

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