I recently interviewed the CEO of Broadmark Realty (BRMK), gaining valuable insight into the residential construction sector as a result. CEO Jeff Pyatt explained to me:
“We have what we deem to be very conservative underwriting standards. We've got a system in place that allows us to track a project from start to finish to make sure that the borrowers are paying their vendors and that the work is being performed so that, when we get to an end of a project, they have a product that is ready to sell. Or if we have to foreclose on it, we have a product that is ready to sell.”
Broadmark remains a high-conviction Buy in my book, with its shares now yielding 9.4%. I like its risk-reward setup and believe the management team there is well placed to manage today’s increased issues.
That’s part of why I think it worthwhile to look into one of BRMK’s close cousins within the commercial mortgage REIT sector: Arbor Realty Trust (NYSE:ABR).
Arbor is another specialized lender that invests in a diversified portfolio of structured finance assets. While it's involved in commercial real estate, its primary focus is multifamily senior loans that generate strong leveraged returns.
In the best of times, there’s a lot of great things to say about Arbor. It’s just a matter of whether it can withstand the worst of times too.
A Bit About Arbor
Arbor has originated $35 billion in agency loans since inception in 1995. Moreover, it has done so within a highly scalable and difficult-to-replicate platform, focusing on smaller balance loans of $1-$8 million.
(The average size is around $5 million).
We recommended ABR in 2018 and, up until the COVID-19 selloff, shares performed exceptionally well. However, as viewed below, they tanked since to offer a current dividend yield that’s a whopping 18.7%.
Source: Yahoo Finance
I don’t know about you, but when I see a dividend yield north of 10%, I get a bit nauseous. Besides, the list of REITs cutting or suspending their dividend is getting longer by the day, with 48 names at last count.
Yet one of the reasons we’ve remained so bullish with ABR before was its predictable track record of dividend growth. Here’s the stock’s history of dividend growth and its 2020 run-rate estimates as well.
(It was $0.30 per share in Q1-20.)
Source: iREIT on Alpha
That means the million-dollar question of the day is: “Is Arbor’s 16% dividend yield sustainable in these turbulent times?”
The Basic Business Model
First formed in 2003, Arbor currently invests in a diversified portfolio of structured finance assets, primarily consisting of bridge and mezzanine loans. These include junior participating interests in first mortgages as well as preferred and direct equity.
ABR also directly acquires real property and invests in real estate-related notes and certain mortgage-related securities.
Its agency business definitely drives results. Multifamily loan originations for Q1-20 were $1.1 billion and – believe it or not – Q2-20 is showing no signs of a slowdown, with $600 million of loans originated in April.
Management assumes Q2 agency volumes could be in the range of $1.3- $1.5 billion.
Meanwhile, its servicing portfolio is around $20.2 billion, producing about $90 million of annual revenue, which is largely prepayment protected. That stream of predictable, recurring revenue gives management more confidence in being able to sustain the payment of future dividends.
According to ABR's CEO, one of the headwinds for ABR concerns forbearance. However, loans in forbearance in April accounted for just 0.3% of its $15 billion Fannie Mae portfolio. And loans in forbearance in its $5 billion Freddie Mac portfolio totaled 4%.
On the recent earnings call, ABR's CEO explained:
“… there's a bit of a psychology that we didn't expect due to the pandemic… Rent forbearance and evictions (are) something that's out there, but people are really looking to pay their rent…
So the attitude is very, very positive throughout our tenant base and our borrower base. So we're fairly optimistic, and certainly we were prepared for the worst and expecting the best. And we're really getting the best.”
I thought this was an interesting comment as well:
“In this environment, we are realizing more than ever that our homes are castles, which is very relevant to Arbor and our multifamily asset class.”
Also remember that Arbor isn’t required to advance delinquent payments on Freddie Mac loans. That responsibility is borne instead by a bank master servicer.
With that said, while rent forbearance requests were lower than initial expectations, management does expect further headwinds in May and June. Plus, it’s true that Fannie Mae servicing advances are reimbursed after a period up to four months. But the company is obligated to advance payments despite loans entering forbearance.
Still, Arbor has very little exposure to some of the other asset classes that have been affected, with only:
- 2 hotel loans (totaling $91 million)
- 1 material retail loan (for $33 million) that’s unlevered
- 1 unlevered $60 million land development deal.
Liquidity Update
Arbor’s liquidity stands at $350 million. And the company’s paid all-margin calls that it received, mostly on its small securities portfolio, which has been de-risked at this point.
During Q1-20, Arbor closed an $800 million collateralized loan obligation[JD2] with a three-year replenishment period. And in March alone, it issued $275 million of 4.50% seven-year senior notes. Then, in April, it issued another $40 million of 8.0% three-year senior notes.
Additionally, securities financed with mark-to-market facilities have been reduced from $235 million to $75 million. And financing on the remaining securities totals just $40 million, which the company is comfortable managing.
On the recent earnings call, ABR's CEO said:
“…we were very fortunate that we made a strategic decision prior to the spread of the coronavirus to this country to significantly increase our cash position, which put us in a favorable position heading into the pandemic.”
He added that the latest deals have resulted in a “current cash and liquidity position of approximately $350 million.” Arbor believes that provides it “with sufficient liquidity to navigate the current market conditions.”
Unlike other commercial mREITs that are tied heavily to lodging and retail, Arbor has over 90% of its book in senior bridge loans. And approximately 82% of the portfolio is in multifamily assets, which has been the most resilient asset class in all cycles.
The company hasn’t yet provided any loan modifications with rate concessions. Plus, most of its loans do contain interest reserves and/or replenishment obligation by borrowers.
This gives Arbor “the ability to effectively manage” its “portfolio through this dislocation.”
The Earnings Report Card
For Q1-20, Arbor reported core earnings of $0.31 and a generally accepted accounting principles (GAAP) loss of $0.54. This was negatively impacted by the implementation of the company’s new current expected credit losses (or CECL) pronouncements.
Those went into effect for non-bank public companies on Jan. 1 – resulting in an initial reserve of $32 million that was charged against retained earnings. Yet Arbor believes it:
“… will be able to generate consistent quarterly earnings for the balance of the year despite the significant dislocation from the pandemic in large part due to its capital light agency business that generates significant poor earnings and cash flow.”
The company also said it had:
“… reduced overhead and general and administrative expenses by approximately $5 million to $7 million annually, which will increase the core earnings run rate by around $0.04 to $0.05 a share going forward.”
Approximately 80% of Arbor’s balance sheet portfolio have LIBOR floors above 1, which is well above where LIBOR sits today. If nothing changes in that regard, these floors could have a meaningful positive impact on net interest spreads in the future.
Another Cash Is King Pick
After analyzing Arbor’s recent Q1 report card, I’m impressed with its overall risk-management practices.
For instance, it recently came to an agreement for a new lending facility to cover servicing advances at a 100% advance rate. This removes the liquidity constraint servicing advances could potentially bring.
Our $10 12-month price target is based on a price-to-book-ratio multiple of about 1.15x on an adjusted undepreciated tangible book value of $8.60. And though a modest dividend cut in 2020 could be coming, it’s clear the CEO has every intention to keep the growth record intact:
“… we've built a diversified business platform that is multifamily-centric and is capable of generating consistent, sustainable core earnings and dividends in all cycles. We also have sufficient liquidity, the appropriate liability structures, and (the) asset management expertise and track record to successfully operate in this environment.”
To reiterate, Arbor is a commercial mortgage REIT with a market cap above $700 million. That means shares are much more volatile, COVID-19 or not.
However, all things considered, we like this pick because of the significant inside ownership involved (about 20%). That and how ABR's CEO explained, “My primary focus will be to continue to maximize shareholder value.”
We maintain a Strong Speculative Buy rating.
Source: FASTGraphs
Author's note: Brad Thomas is a Wall Street writer, which means he's not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: Written and distributed only to assist in research while providing a forum for second-level thinking.
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