ARBOR REALTY TRUST INC - Quarter Report: 2013 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2013

 

Or

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from          to          

 

Commission file number: 001-32136

 

Arbor Realty Trust, Inc.

(Exact name of registrant as specified in its charter)

 

 

(516) 506-4200

(Registrant’s telephone number, including area code)

 

 

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes  x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes  x  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer	£	Accelerated filer x
Non-accelerated filer	£ (Do not check if a smaller reporting company)	Smaller reporting company £

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

 

APPLICABLE ONLY TO CORPORATE ISSUERS:

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.  Common stock, $0.01 par value per share: 49,136,308 outstanding (excluding 2,650,767 shares held in the treasury) as of November 8, 2013.

 

 

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ARBOR REALTY TRUST, INC.

 

FORM 10-Q

INDEX

 

PART I. FINANCIAL INFORMATION	2
Item 1. Financial Statements	2
Consolidated Balance Sheets at September 30, 2013 (Unaudited) and December 31, 2012	2
Consolidated Statements of Operations (Unaudited) for the Three and Nine Months Ended September 30, 2013 and 2012	3
Consolidated Statements of Comprehensive Income (Unaudited) for the Three and Nine Months Ended September 30, 2013 and 2012	4
Consolidated Statement of Changes in Equity (Unaudited) for the Nine Months Ended September 30, 2013	5
Consolidated Statements of Cash Flows (Unaudited) for the Nine Months Ended September 30, 2013 and 2012	6
Notes to the Consolidated Statements (Unaudited)	8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	56
Item 3. Quantitative and Qualitative Disclosures about Market Risk	85
Item 4. Controls and Procedures	87
PART II. OTHER INFORMATION	87
Item 1. Legal Proceedings	87
Item 1A. Risk Factors	88
Item 2. Unregistered Sale of Equity Securities and Use of Proceeds	88
Item 3. Defaults Upon Senior Securities	88
Item 4. Mine Safety Disclosures	88
Item 5. Other Information	88
Item 6. Exhibits	89
Signatures	90

 

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CAUTIONARY STATEMENTS

 

The information contained in this quarterly report on Form 10-Q is not a complete description of our business or the risks associated with an investment in Arbor Realty Trust, Inc.  We urge you to carefully review and consider the various disclosures made by us in this report.

 

This report contains certain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements relate to, among other things, the operating performance of our investments and financing needs. Forward-looking statements are generally identifiable by use of forward-looking terminology such as “may,” “will,” “should,” “potential,” “intend,” “expect,” “endeavor,” “seek,” “anticipate,” “estimate,” “overestimate,” “underestimate,” “believe,” “could,” “project,” “predict,” “continue” or other similar words or expressions. Forward-looking statements are based on certain assumptions, discuss future expectations, describe future plans and strategies, contain projections of results of operations or of financial condition or state other forward-looking information. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Although we believe that the expectations reflected in such forward-looking statements are based on reasonable assumptions, our actual results and performance could differ materially from those set forth in the forward-looking statements. These forward-looking statements involve risks, uncertainties and other factors that may cause our actual results in future periods to differ materially from forecasted results. Factors that could have a material adverse effect on our operations and future prospects include, but are not limited to, changes in economic conditions generally and the real estate market specifically; adverse changes in the financing markets we access affecting our ability to finance our loan and investment portfolio; changes in interest rates; the quality and size of the investment pipeline and the rate at which we can invest our cash; impairments in the value of the collateral underlying our loans and investments; changes in the markets; legislative/regulatory changes; completion of pending investments; the availability and cost of capital for future investments; competition within the finance and real estate industries; and other risks detailed in our Annual Report on Form 10-K for the year ended December 31, 2012. Readers are cautioned not to place undue reliance on any of these forward-looking statements, which reflect our management’s views as of the date of this report. The factors noted above could cause our actual results to differ significantly from those contained in any forward-looking statement. For a discussion of our critical accounting policies, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations of Arbor Realty Trust, Inc. and Subsidiaries — Significant Accounting Estimates and Critical Accounting Policies” in our Annual Report on Form 10-K for the year ended December 31, 2012.

 

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We are under no duty to update any of the forward-looking statements after the date of this report to conform these statements to actual results.

 

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PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

 

		September 30,			December 31,
		2013			2012
		(Unaudited)
Assets:
Cash and cash equivalents		$	64,658,561		$	29,188,889
Restricted cash (includes $111,640,664 and $41,537,212 from consolidated VIEs, respectively)		113,002,790			42,535,514
Loans and investments, net (includes $1,238,973,709 and $1,113,745,356 from consolidated VIEs, respectively)		1,546,107,405			1,325,667,053
Available-for-sale securities, at fair value (includes $0 and $1,100,000 from consolidated VIEs, respectively)		2,746,682			3,552,736
Securities held-to-maturity, net		41,989,100			42,986,980
Investment in equity affiliates		5,690,169			59,581,242
Real estate owned, net (includes $80,787,215 and $80,787,215 from consolidated VIEs, respectively)		112,417,656			124,148,199
Real estate held-for-sale, net		11,540,649			—
Due from related party (includes $11,970 and $0 from consolidated VIEs, respectively)		53,329			24,094
Prepaid management fee — related party		19,047,949			19,047,949
Other assets (includes $14,329,327 and $11,709,103 from consolidated VIEs, respectively)		59,305,715			55,148,624
Total assets		$	1,976,560,005		$	1,701,881,280
Liabilities and Equity:
Repurchase agreements and credit facilities		$	158,582,338		$	130,661,619
Collateralized debt obligations (includes $736,434,556 and $812,452,845 from consolidated VIEs, respectively)		736,434,556			812,452,845
Collateralized loan obligations (includes $264,500,000 and $87,500,000 from consolidated VIEs, respectively)		264,500,000			87,500,000
Junior subordinated notes to subsidiary trust issuing preferred securities		159,157,643			158,767,145
Notes payable		1,750,000			51,457,708
Mortgage note payable — real estate owned		42,745,650			53,751,004
Mortgage note payable — real estate held-for-sale		11,005,354			—
Due to related party		3,349,516			3,084,627
Due to borrowers (includes $0 and $1,320,943 from consolidated VIEs, respectively)		19,561,570			23,056,640
Deferred revenue		77,123,133			77,123,133
Other liabilities (includes $16,302,638 and $22,013,896 from consolidated VIEs, respectively)		64,598,525			72,765,437
Total liabilities		1,538,808,285			1,470,620,158
Commitments and contingencies		—			—
Equity:
Arbor Realty Trust, Inc. stockholders’ equity:
Preferred stock, $0.01 par value: 100,000,000 shares authorized; 8.25% Series A cumulative redeemable preferred stock, $38,787,500 aggregate liquidation preference; 1,551,500 shares issued and outstanding at September 30, 2013, no shares issued and outstanding at December 31, 2012; 7.75% Series B cumulative redeemable preferred stock, $31,500,000 aggregate liquidation preference; 1,260,000 shares issued and outstanding at September 30, 2013, no shares issued and outstanding at December 31, 2012		67,654,655			—
Common stock, $0.01 par value: 500,000,000 shares authorized; 51,787,075 shares issued, 49,136,308 shares outstanding at September 30, 2013 and 33,899,992 shares issued, 31,249,225 shares outstanding at December 31, 2012		517,870			339,000
Additional paid-in capital		623,825,310			493,211,222
Treasury stock, at cost — 2,650,767 shares at September 30, 2013 and December 31, 2012		(17,100,916		)	(17,100,916		)
Accumulated deficit		(209,207,115		)	(207,558,257		)
Accumulated other comprehensive loss		(28,902,162		)	(39,561,700		)
Total Arbor Realty Trust, Inc. stockholders’ equity		436,787,642			229,329,349
Noncontrolling interest in consolidated entity		964,078			1,931,773
Total equity		437,751,720			231,261,122
Total liabilities and equity		$	1,976,560,005		$	1,701,881,280

 

See Notes to Consolidated Financial Statements.

 

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2013			2012			2013			2012
Interest income		$	25,742,973		$	20,030,595		$	73,060,911		$	59,139,715
Interest expense		10,645,725			9,510,083			31,621,042			31,042,290
Net interest income		15,097,248			10,520,512			41,439,869			28,097,425
Other revenue:
Property operating income		6,939,947			7,142,993			22,920,902			22,985,629
Other (loss) income, net		(251,424		)	334,415			1,733,351			736,054
Total other revenue		6,688,523			7,477,408			24,654,253			23,721,683
Other expenses:
Employee compensation and benefits.		2,995,322			2,301,442			9,047,639			7,168,037
Selling and administrative		3,300,071			1,870,759			8,459,087			5,722,761
Property operating expenses		6,134,739			6,490,903			19,108,578			19,974,259
Depreciation and amortization		1,720,014			1,427,521			4,899,330			3,866,239
Provision for loan losses (net of recoveries)		750,231			4,849,330			4,072,108			20,584,191
Management fee - related party		2,800,000			2,500,000			8,400,000			7,500,000
Total other expenses		17,700,377			19,439,955			53,986,742			64,815,487
Income (loss) from continuing operations before gain on extinguishment of debt, loss from equity affiliates and (provision) benefit for income taxes		4,085,394			(1,442,035		)	12,107,380			(12,996,379		)
Gain on extinguishment of debt		1,167,772			4,144,688			4,930,772			30,459,023
Loss from equity affiliates		(81,723		)	(225,493		)	(245,412		)	(700,203		)
Income before (provision) benefit for income taxes		5,171,443			2,477,160			16,792,740			16,762,441
(Provision) benefit for income taxes		—			(275,000		)	—			526,558
Income from continuing operations		5,171,443			2,202,160			16,792,740			17,288,999
Gain on sale of real estate held-for-sale		—			—			—			3,487,145
(Loss) income from operations of real estate held-for-sale		(79,716		)	(87,855		)	(271,479		)	1,153,581
(Loss) income from discontinued operations		(79,716		)	(87,855		)	(271,479		)	4,640,726
Net income		5,091,727			2,114,305			16,521,261			21,929,725
Preferred stock dividends		1,410,333			—			3,096,278			—
Net income attributable to noncontrolling interest		16,715			53,976			124,199			161,598
Net income attributable to Arbor Realty Trust, Inc. common stockholders		$	3,664,679		$	2,060,329		$	13,300,784		$	21,768,127
Basic earnings per common share:
Income from continuing operations, net of noncontrolling interest and preferred stock dividends		$	0.08		$	0.07		$	0.34		$	0.67
(Loss) income from discontinued operations		—			—			(0.01		)	0.18
Net income attributable to Arbor Realty Trust, Inc. common stockholders		$	0.08		$	0.07		$	0.33		$	0.85
Diluted earnings per common share:
Income from continuing operations, net of noncontrolling interest and preferred stock dividends		$	0.08		$	0.07		$	0.34		$	0.66
(Loss) income from discontinued operations		—			—			(0.01		)	0.18
Net income attributable to Arbor Realty Trust, Inc. common stockholders		$	0.08		$	0.07		$	0.33		$	0.84
Dividends declared per common share		$	0.13		$	0.10		$	0.37		$	0.175
Weighted average number of shares of common stock outstanding:
Basic		43,397,555			27,749,225			40,129,718			25,643,470
Diluted		43,832,271			28,038,044			40,576,633			25,891,083

 

See Notes to Consolidated Financial Statements.

 

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2013			2012			2013			2012
Net income		$	5,091,727		$	2,114,305		$	16,521,261		$	21,929,725
Unrealized gain (loss) on securities available-for-sale, net		235,157			(311,815		)	293,946			(723,632		)
Reclassification of unrealized gain on securities available-for-sale realized into earnings		—			—			(100,000		)	—
Unrealized loss on derivative financial instruments		(1,383,491		)	(2,771,981		)	(98,429		)	(7,506,850		)
Reclassification of net realized loss on derivatives designated as cash flow hedges into earnings		3,551,371			3,735,873			10,564,021			12,882,521
Comprehensive income		7,494,764			2,766,382			27,180,799			26,581,764
Less:
Preferred stock dividends		1,410,333			—			3,096,278			—
Comprehensive income attributable to noncontrolling interest		16,715			53,976			124,199			161,598
Comprehensive income attributable to Arbor Realty Trust, Inc. common stockholders		$	6,067,716		$	2,712,406		$	23,960,322		$	26,420,166

 

See Notes to Consolidated Financial Statements.

 

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY (Unaudited)

 

Nine Months Ended September 30, 2013

 

		Preferred Stock Shares		Preferred Stock Value			Common Stock Shares		Common Stock Par Value			Additional Paid-in Capital			Treasury Stock Shares		Treasury Stock			Accumulated Deficit			Accumulated Other Comprehensive Loss			Total Arbor Realty Trust, Inc. Stockholders’ Equity			Non- controlling Interest			Total
Balance — January 1, 2013		—		$	—		33,899,992		$	339,000		$	493,211,222		(2,650,767	)	$	(17,100,916	)	$	(207,558,257	)	$	(39,561,700	)	$	229,329,349		$	1,931,773		$	231,261,122
Issuance of common stock							17,625,000		176,250			129,184,501														129,360,751						129,360,751
Issuance of 8.25% Series A preferred stock		1,551,500		37,315,694																						37,315,694						37,315,694
Issuance of 7.75% Series B preferred stock		1,260,000		30,338,961																						30,338,961						30,338,961
Stock-based compensation							262,750		2,627			1,429,580														1,432,207						1,432,207
Forfeiture of unvested restricted stock							(667	)	(7		)	7														—						—
Distributions — common stock																				(14,938,797		)				(14,938,797		)				(14,938,797		)
Distributions —preferred stock																				(3,096,278		)				(3,096,278		)				(3,096,278		)
Distributions — preferred stock of private REIT																				(10,845		)				(10,845		)				(10,845		)
Net income																				16,397,062						16,397,062			124,199			16,521,261
Decrease in non-controlling interest																													(1,091,894		)	(1,091,894		)
Unrealized gain on securities available-for-sale																							293,946			293,946						293,946
Reclassification of unrealized gain on securities available-for-sale realized into earnings																							(100,000		)	(100,000		)				(100,000		)
Unrealized gain on derivative financial instruments, net																							(98,429		)	(98,429		)				(98,429		)
Reclassification of net realized loss on derivatives designated as cash flow hedges into earnings																							10,564,021			10,564,021						10,564,021
Balance — September 30, 2013		2,811,500		$	67,654,655		51,787,075		$	517,870		$	623,825,310		(2,650,767	)	$	(17,100,916	)	$	(209,207,115	)	$	(28,902,162	)	$	436,787,642		$	964,078		$	437,751,720

 

See Notes to Consolidated Financial Statements.

 

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

 

		Nine Months Ended September 30,
		2013			2012
Operating activities:
Net income		$	16,521,261		$	21,929,725
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		5,328,396			4,291,484
Stock-based compensation		1,432,207			578,190
Gain on sale of securities		(1,100,000		)	—
Gain on sale of real estate held-for-sale		—			(3,487,145		)
Reversal of liabilities related to discontinued operations		—			(1,175,120		)
Gain on extinguishment of debt		(4,930,772		)	(30,459,023		)
Provision for loan losses (net of recoveries)		4,072,108			20,584,191
Amortization and accretion of interest, fees and intangible assets, net		(1,739,367		)	1,863,590
Change in fair value of non-qualifying swaps		1,711,624			1,159,501
Loss from equity affiliates		245,412			700,203
Changes in operating assets and liabilities:
Other assets		(175,420		)	(3,988,036		)
Distributions of operations from equity affiliates		73,340			73,358
Other liabilities		1,208,113			(331,712		)
Change in restricted cash		(363,824		)	(131,188		)
Due to/from related party		235,654			(155,496		)
Net cash provided by operating activities		$	22,518,732		$	11,452,522
Investing activities:
Loans and investments funded, originated and purchased, net		(431,070,064		)	(168,388,566		)
Payoffs and paydowns of loans and investments		199,325,600			155,142,484
Proceeds from sale of loan		4,424,097			17,945,000
Due to borrowers and reserves		(585,143		)	(505,092		)
Deferred fees		3,371,287			2,406,637
Purchase of securities held-to-maturity, net		(29,024,327		)	(65,542,970		)
Principal collection on securities held-to-maturity, net		30,335,656			44,046,864
Investment in real estate, net		(5,667,915		)	(2,883,866		)
Proceeds from sale of available-for-sale security		2,100,000			—
Redemption of investment in preferred shares, net		2,418,528			—
Proceeds from sale of real estate, net		—			24,131,557
Contributions to equity affiliates		—			(257,505		)
Distributions from equity affiliates		—			52,518
Net cash (used in) / provided by investing activities		$	(224,372,281	)	$	6,147,061
Financing activities:
Proceeds from repurchase agreements, credit facilities and notes payable		159,700,441			94,762,470
Paydowns and payoffs of repurchase agreements and credit facilities		(131,329,722		)	(89,951,970		)
Payoff and paydown of mortgage notes payable		—			(20,750,000		)
Proceeds from collateralized loan obligations		177,000,000			87,500,000
Payoffs and paydowns of collateralized debt obligations		(70,530,260		)	(130,136,917		)
Change in restricted cash		(70,103,452		)	19,700,829
Payments on financial instruments underlying linked transactions		(114,519,321		)	(54,827,399		)
Receipts on financial instruments underlying linked transactions		109,838,852			50,895,732
Payments on swaps and margin calls to counterparties		(71,091,199		)	(3,370,000		)
Receipts on swaps and margin calls from counterparties		73,438,045			4,530,000
Purchases of treasury stock		—			(684,764		)
Distributions paid to noncontrolling interest		(158,844		)	(163,945		)
Proceeds from issuance of common stock		134,176,328			18,900,000
Expenses paid on issuance of common stock		(4,664,741		)	(1,175,746		)
Proceeds from issuance of preferred stock		70,287,500			—
Expenses paid on issuance of preferred stock		(2,632,845		)	—
Distributions paid on common stock		(14,938,797		)	(4,593,614		)
Distributions paid on preferred stock		(2,626,176		)	—
Distributions paid on preferred stock of private REIT		(10,845		)	(8,581		)
Payment of deferred financing costs		(4,511,743		)	(2,613,520		)
Net cash provided by / (used in) financing activities		$	237,323,221		$	(31,987,425	)
Net increase (decrease) in cash and cash equivalents		$	35,469,672		$	(14,387,842	)
Cash and cash equivalents at beginning of period		29,188,889			55,236,479
Cash and cash equivalents at end of period		$	64,658,561		$	40,848,637

 

See Notes to Consolidated Financial Statements.

 

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (Continued)

 

		Nine Months Ended September 30,
		2013			2012
Supplemental cash flow information:
Cash used to pay interest		$	35,543,871		$	29,166,456
Cash used for taxes		$	209,903		$	701,121
Supplemental schedule of non-cash investing and financing activities:
Distributions accrued on 8.25% Series A preferred stock		$	266,664		$	—
Distributions accrued on 7.75% Series B preferred stock		$	203,438		$	—
Accrued and unpaid expenses on common stock offerings		$	150,836		$	—
Accrued and unpaid expenses on CLO offerings		$	500,000		$	—
Investment transferred to real estate held-for-sale, net		$	11,540,649		$	—
Mortgage note payable — real estate owned transferred to held-for-sale		$	11,005,354		$	—
Redemption of preferred limited partnership interest and satisfaction of note payable		$	33,438,472		$	—
Transfer of real estate held-for-sale to first lien holder		$	—		$	41,440,000
Release of mortgage note payable held-for-sale		$	—		$	41,440,000
Satisfaction of participation loan		$	—		$	32,000,000
Retirement of participation liability		$	—		$	32,000,000

 

See Notes to Consolidated Financial Statements.

 

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

September 30, 2013

 

Note 1 —Description of Business

 

Arbor Realty Trust, Inc. (the “Company”) is a Maryland corporation that invests in a diversified portfolio of multi-family and commercial real estate related assets, primarily consisting of bridge loans, mezzanine loans, junior participating interests in first mortgage loans, and preferred and direct equity.  The Company may also directly acquire real property and invest in real estate-related notes and certain mortgage-related securities.  The Company conducts substantially all of its operations through its operating partnership, Arbor Realty Limited Partnership (“ARLP”), and ARLP’s wholly-owned subsidiaries.  The Company is externally managed and advised by Arbor Commercial Mortgage, LLC (“ACM”).

 

The Company is organized and conducts its operations to qualify as a real estate investment trust (“REIT”) for federal income tax purposes.  A REIT is generally not subject to federal income tax on its REIT—taxable income that it distributes to its stockholders, provided that it distributes at least 90% of its REIT—taxable income and meets certain other requirements.  Certain assets of the Company that produce non-qualifying income are owned by its taxable REIT subsidiaries, the income of which is subject to federal and state income taxes.

 

The Company’s charter provides for the issuance of up to 500 million shares of common stock, with a par value of $0.01 per share, and 100 million shares of preferred stock, with a par value of $0.01 per share.  The Company was incorporated in June 2003 and was initially capitalized through the sale of 67 shares of common stock for $1,005.

 

Note 2 — Summary of Significant Accounting Policies

 

Please refer to Note 2 — “Summary of Significant Accounting Policies” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012 for additional discussion of its accounting policies.

 

Basis of Presentation and Principles of Consolidation

 

The accompanying unaudited consolidated interim financial statements have been prepared in accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification™, the authoritative reference for accounting principles generally accepted in the United States (“GAAP”), for interim financial statements and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements, although management believes that the disclosures presented herein are adequate to prevent the accompanying unaudited consolidated interim financial statements presented from being misleading.

 

The accompanying unaudited consolidated financial statements include the financial statements of the Company, its wholly owned subsidiaries, partnerships or other joint ventures in which the Company owns a voting interest of greater than 50 percent, and Variable Interest Entities (“VIEs”) of which the Company is the primary beneficiary.  VIEs are defined as entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties.  A VIE is required to be consolidated by its primary beneficiary, which is the party that (i) has the power to control the activities that most significantly impact the VIE’s economic performance and (ii) has the obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE.  Current accounting guidance requires the Company to present a) assets of a consolidated VIE that can be used only to settle obligations of the consolidated VIE, and b) liabilities of a consolidated VIE for which creditors (or beneficial interest holders) do not have recourse to the general credit of the primary beneficiary.  As a result of this guidance, the Company has separately disclosed parenthetically the assets and liabilities of its three collateralized debt obligation (“CDO”) and two collateralized loan obligation (“CLO”) subsidiaries on its Consolidated Balance Sheets.  Entities in which the Company owns a voting interest of 20 percent to 50 percent are accounted for primarily under the equity method.

 

In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included.  All significant inter-company transactions and balances have been eliminated in consolidation.

 

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

September 30, 2013

 

The preparation of consolidated interim financial statements in conformity with GAAP requires management to make estimates and assumptions in determining the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated interim financial statements and the reported amounts of revenue and expenses during the reporting period.  Actual results could differ from those estimates.  Further, in connection with the preparation of the consolidated interim financial statements, the Company evaluated events subsequent to the balance sheet date of September 30, 2013 through the issuance of the Consolidated Financial Statements.

 

Certain prior year amounts have been reclassified to conform to current period presentation.  During the third quarter of 2013, the Company classified a real estate investment that was part of a portfolio of multifamily properties as held-for-sale and during the fourth quarter of 2012, the Company sold a real estate investment that was part of a portfolio of hotel properties, resulting in reclassifications of property operating activity and related depreciation to discontinued operations for all prior periods presented.

 

The results of operations for the three and nine months ended September 30, 2013 are not necessarily indicative of results that may be expected for the entire year ending December 31, 2013.  The accompanying unaudited consolidated interim financial statements should be read in conjunction with the Company’s audited consolidated annual financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.

 

Loans, Investments and Securities

 

At the time of purchase, the Company designates a security as available-for-sale, held-to-maturity, or trading depending on the Company’s ability and intent to hold it to maturity.  The Company does not have any securities designated as trading as of September 30, 2013.  Securities available-for-sale are reported at fair value with the net unrealized gains or losses reported as a component of accumulated other comprehensive loss, while securities held-to-maturity are reported at amortized cost.  Unrealized losses that are determined to be other-than-temporary are recognized in earnings up to their credit component.  The determination of other-than-temporary impairment is a subjective process requiring judgments and assumptions.  The process may include, but is not limited to, assessment of recent market events and prospects for near-term recovery, assessment of cash flows, internal review of the underlying assets securing the investments, credit of the issuer and the rating of the security, as well as the Company’s ability and intent to hold the investment to maturity.  Management closely monitors market conditions on which it bases such decisions.

 

The Company also assesses certain of its securities, other than those of high credit quality, to determine whether significant changes in estimated cash flows or unrealized losses on these securities, if any, reflect a decline in value that is other-than-temporary and, accordingly, should be written down to their fair value against earnings.  On a quarterly basis, the Company reviews these changes in estimated cash flows, which could occur due to actual prepayment and credit loss experience, to determine if an other-than-temporary impairment is deemed to have occurred.  The determination of other-than-temporary impairment is a subjective process requiring judgments and assumptions and is not necessarily intended to indicate a permanent decline in value.  The Company calculates a revised yield based on the current amortized cost of the investment, including any other-than-temporary impairments recognized to date, and the revised yield is then applied prospectively to recognize interest income.

 

Securities that are purchased at a discount and that are not of high credit quality at the time of purchase are accounted for as debt securities acquired with deteriorated credit quality.  Interest income on these securities is recognized using the effective interest method based on the Company’s estimates of expected cash flows to be received, which include assumptions related to fluctuations in prepayment speeds and the timing and amount of credit losses, which are reviewed on an ongoing basis.

 

Loans held for investment are intended to be held to maturity and, accordingly, are carried at cost, net of unamortized loan origination costs and fees, loan purchase discounts, and net of the allowance for loan losses when such loan or investment is deemed to be impaired.  The Company invests in preferred equity interests that, in some cases, allow the Company to participate in a percentage of the underlying property’s cash flows from operations and proceeds from a sale or refinancing.  At the inception of each such investment, management must determine whether

 

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

September 30, 2013

 

such investment should be accounted for as a loan, joint venture or as real estate.  To date, management has determined that all such investments are properly accounted for and reported as loans.

 

From time to time, the Company may enter into an agreement to sell a loan.  These loans are considered held-for-sale and are valued at the lower of the loan’s carrying amount or fair value less costs to sell.  For the sale of loans, recognition occurs when ownership passes to the buyer.

 

Impaired Loans, Allowance for Loan Losses, Loss on Sale and Restructuring of Loans and Charge-offs

 

The Company considers a loan impaired when, based upon current information and events, it is probable that it will be unable to collect all amounts due for both principal and interest according to the contractual terms of the loan agreement.  The Company evaluates each loan in its portfolio on a quarterly basis.  The Company’s loans are individually specific and unique as it relates to product type, geographic location, and collateral type, as well as to the rights and remedies and the position in the capital structure the Company’s loans and investments have in relation to the underlying collateral.  The Company evaluates all of this information as well as general market trends related to specific classes of assets, collateral type and geographic locations, when determining the appropriate assumptions such as capitalization and market discount rates, as well as the borrower’s operating income and cash flows, in estimating the value of the underlying collateral when determining if a loan is impaired.  The Company utilizes internally developed valuation models and techniques primarily consisting of discounted cash flow and direct capitalization models in determining the fair value of the underlying collateral on an individual loan.  The Company may also obtain a third party appraisal, which may value the collateral through an “as-is” or “stabilized value” methodology.  Such appraisals may be used as an additional source of valuation information only and no adjustments are made to appraisals.  Included in the evaluation of the capitalization and market discount rates, the Company considers not only assumptions specific to the collateral but also considers geographical and industry trends that could impact the collateral’s value.

 

If upon completion of the valuation, the fair value of the underlying collateral securing the impaired loan is less than the net carrying value of the loan, an allowance is created with a corresponding charge to the provision for loan losses.  The allowance for each loan is maintained at a level that is believed to be adequate by management to absorb probable losses.

 

Loan terms may be modified if the Company determines that based on the individual circumstances of a loan and the underlying collateral, a modification would more likely increase the total recovery of the combined principal and interest from the loan.  Any loan modification is predicated upon a goal of maximizing the collection of the loan.  Typical triggers for a modification would include situations where the projected cash flow is insufficient to cover required debt service, when asset performance is lagging the initial projections, where there is a requirement for rebalancing, where there is an impending maturity of the loan, and where there is an actual loan default.  Loan terms that have been modified have included, but are not limited to interest rate, maturity date and in certain cases, principal amount.  Length and amounts of each modification have varied based on individual circumstances and are determined on a case by case basis.  If the loan modification constitutes a concession whereas the Company does not receive ample consideration in return for the modification, and the borrower is experiencing financial difficulties and cannot repay the loan under the current terms, then the modification is considered by the Company to be a troubled debt restructuring.  If the Company receives a benefit, either monetary or strategic, and the above criteria are not met, the modification is not considered to be a troubled debt restructuring.  The Company records interest on modified loans on an accrual basis to the extent that the modified loan is contractually current.

 

Loss on restructured loans is recorded when the Company has granted a concession to the borrower in the form of principal forgiveness related to the payoff or the substitution or addition of a new debtor for the original borrower or when the Company incurs costs on behalf of the borrower related to the modification, payoff or the substitution or addition of a new debtor for the original borrower.  When a loan is restructured, the Company records its investment at net realizable value, taking into account the cost of all concessions at the date of restructuring.  The reduction in the recorded investment is recorded as a charge to the Consolidated Statements of Operations in the period in which the loan is restructured.  In addition, a gain or loss may be recorded upon the sale of a loan to a third party as a charge to the Consolidated Statements of Operations in the period in which the loan was sold.  No loss on sale and restructuring of loans was recorded for the nine months ended September 30, 2013 and 2012.

 

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

September 30, 2013

 

Charge-offs to the allowance for loan losses occur when losses are confirmed through the receipt of cash or other consideration from the completion of a sale; when a modification or restructuring takes place in which the Company grants a concession to a borrower or agrees to a discount in full or partial satisfaction of the loan; when the Company takes ownership and control of the underlying collateral in full satisfaction of the loan; when loans are reclassified as other investments; or when significant collection efforts have ceased and it is highly likely that a loss has been realized.

 

Revenue Recognition

 

Interest income — Interest income is recognized on the accrual basis as it is earned from loans, investments, and securities.  In certain instances, the borrower pays an additional amount of interest at the time the loan is closed, an origination fee, a prepayment fee and/or deferred interest upon maturity.  In some cases, interest income may also include the amortization or accretion of premiums and discounts arising from the purchase or origination of the loan or security.  This additional income, net of any direct loan origination costs incurred, is deferred and accreted into interest income on an effective yield or “interest” method adjusted for actual prepayment activity over the life of the related loan or security as a yield adjustment.  Income recognition is suspended for loans when, in the opinion of management, a full recovery of all contractual principal is not probable.  Income recognition is resumed when the loan becomes contractually current and performance is resumed.  The Company records interest income on certain impaired loans to the extent cash is received, in which a loan loss reserve has been recorded, as the borrower continues to make interest payments.  The Company recorded loan loss reserves related to these loans as it was deemed that full recovery of principal and interest was not probable.

 

Several of the Company’s loans provide for accrual of interest at specified rates, which differ from current payment terms.  Interest is recognized on such loans at the accrual rate subject to management’s determination that accrued interest and outstanding principal are ultimately collectible, based on the underlying collateral and operations of the asset.  If management cannot make this determination, interest income above the current pay rate is recognized only upon actual receipt.

 

Given the transitional nature of some of the Company’s real estate loans, the Company may require funds to be placed into an interest reserve, based on contractual requirements, to cover debt service costs.  The Company will analyze these interest reserves on a periodic basis and determine if any additional interest reserves are needed.  Recognition of income on loans with funded interest reserves are accounted for in the same manner as loans without funded interest reserves.  The Company will not recognize any interest income on loans in which the borrower has failed to make the contractual interest payment due or has not replenished the interest reserve account.  As of September 30, 2013, the Company had total interest reserves of $9.7 million on 46 loans with an aggregate unpaid principal balance of $552.3 million and had two non-performing loans with an aggregate unpaid principal balance of $29.2 million with a funded interest reserve of $0.1 million.  Income from non-performing loans is generally recognized on a cash basis only to the extent it is received.  Full income recognition will resume when the loan becomes contractually current and performance has recommenced.

 

Additionally, interest income is recorded when earned from equity participation interests, referred to as equity kickers.  These equity kickers have the potential to generate additional revenues to the Company as a result of excess cash flow distributions and/or as appreciated properties are sold or refinanced.  The Company did not record interest income from such investments for the three and nine month periods ended September 30, 2013 and 2012.

 

Property operating income — Property operating income represents income associated with the operations of commercial real estate properties classified as real estate owned.  The Company recognizes revenue for these activities when the fees are fixed or determinable, or are evidenced by an arrangement, collection is reasonably assured and the services under the arrangement have been provided.

 

Other income, net — Other income, net represents net interest income and gains and losses recorded on the Company’s linked transactions, as well as loan structuring, defeasance, and miscellaneous asset management fees associated with the Company’s loans and investments portfolio.  The Company recognizes these forms of income

 

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

September 30, 2013

 

when the fees are fixed or determinable, are evidenced by an arrangement, collection is reasonably assured and the services under the arrangement have been provided.

 

Income Taxes

 

The Company is organized and conducts its operations to qualify as a REIT and to comply with the provisions of the Internal Revenue Code with respect thereto.  A REIT is generally not subject to federal income tax on taxable income that is distributed to its stockholders, provided that the Company distributes at least 90% of its taxable income and meets certain other requirements.  Certain REIT income may be subject to state and local income taxes.  The Company’s assets or operations that would not otherwise comply with the REIT requirements are owned or conducted by the Company’s taxable REIT subsidiaries, the income of which is subject to federal and state income tax.  Under current federal tax law, the income and any tax on or distribution requirements attributable to certain debt extinguishment transactions realized in 2009 and 2010 have been deferred to future periods at the Company’s election.

 

Current accounting guidance clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements.  This guidance prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.  This guidance also provides clarity on derecognition, classification, interest and penalties, accounting in interim periods and disclosure.

 

Hedging Activities and Derivatives

 

The Company recognizes all derivatives as either assets or liabilities at fair value and these amounts are recorded in other assets or other liabilities on the Consolidated Balance Sheets.  Additionally, the fair value adjustments will affect either accumulated other comprehensive income (loss) until the hedged item is recognized in earnings, or net income (loss) depending on whether the derivative instrument qualifies as a hedge for accounting purposes and, if so, the nature of the hedging activity.  The Company uses derivatives for hedging purposes rather than speculation.  Fair values are approximated based on current market data received from financial sources that trade such instruments and are based on prevailing market data and derived from third party proprietary models based on well recognized financial principles and reasonable estimates about relevant future market conditions.

 

The Company records all derivatives on the Consolidated Balance Sheets at fair value.  The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting.  Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges.  Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges.  Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge.  The Company may enter into derivative contracts that are intended to economically hedge certain of its risks, even though hedge accounting does not apply or the Company elects not to apply hedge accounting.  The ineffective portion of a derivative’s change in fair value is recognized immediately in earnings.

 

In connection with the Company’s interest rate risk management, the Company periodically hedges a portion of its interest rate risk by entering into derivative financial instrument contracts.  Specifically, the Company’s derivative financial instruments are used to manage differences in the amount, timing, and duration of its expected cash receipts and its expected cash payments principally related to its investments and borrowings.  The Company’s objectives in using interest rate derivatives are to add stability to interest income and to manage its exposure to interest rate movements.  To accomplish this objective, the Company primarily uses interest rate swaps as part of its interest rate risk management strategy.  Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over

 

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September 30, 2013

 

the life of the agreements without exchange of the underlying notional amount.  The Company has entered into various interest rate swap agreements to hedge its exposure to interest rate risk on (i) variable rate borrowings as it relates to fixed rate loans; (ii) the difference between the CDO investor return being based on the three-month LIBOR index while the supporting assets of the CDO are based on the one-month LIBOR index; and (iii) use of LIBOR rate caps in loan agreements.

 

In the normal course of business, the Company may use a variety of derivative financial instruments to manage, or hedge, interest rate risk.  The Company does not use derivatives for trading or speculative purposes.  These derivative financial instruments must be effective in reducing its interest rate risk exposure in order to qualify for hedge accounting.  When the terms of an underlying transaction are modified, or when the underlying hedged item ceases to exist, all changes in the fair value of the instrument are marked-to-market with changes in value included in net income (loss) for each period until the derivative instrument matures or is settled.  Any derivative instrument used for risk management that does not meet the hedging criteria is marked-to-market with the changes in value included in net income (loss).  In cases where a derivative financial instrument is terminated early, any gain or loss is generally amortized over the remaining life of the hedged item.

 

In certain circumstances, the Company may finance the purchase of Residential Mortgage Backed Securities (“RMBS”) investments through a repurchase agreement with the same counterparty, which may qualify as a linked transaction.  If both transactions are entered into contemporaneously or in contemplation of each other, the transactions are presumed to be linked transactions unless certain criteria are met, and the Company accounts for the purchase of such securities and the repurchase agreement on a combined basis as a forward contract derivative at fair value, which is reported in other assets on the Consolidated Balance Sheets with changes in the fair value of the assets and liabilities underlying linked transactions and associated interest income and expense reported in other income on the Consolidated Statements of Operations.  The analysis of transactions under these rules requires management’s judgment and experience.  The fair value of linked transactions reflect the value of the underlying RMBS, linked repurchase agreement borrowings and accrued interest receivable/payable on such instruments.  The Company’s linked transactions are not designated as hedging instruments and, as a result, the change in the fair value and net interest income from linked transactions is reported in other income on the Consolidated Statements of Operations.

 

The Company has no master netting or similar arrangements and does not offset derivatives.

 

Variable Interest Entities

 

The Company has evaluated its loans and investments, mortgage related securities, investments in equity affiliates, junior subordinated notes, CDOs and CLOs, in order to determine if they qualify as VIEs or as variable interests in VIEs.  This evaluation resulted in the Company determining that its bridge loans, junior participation loans, mezzanine loans, preferred equity investments, investments in equity affiliates, junior subordinated notes, CDOs, CLOs, and investments in debt securities were potential VIEs or variable interests in VIEs.  See Note 9 — “Variable Interest Entities” for the Company’s evaluation of the periods presented.

 

Recently Issued Accounting Pronouncements

 

In June 2013, the FASB issued updated guidance on the definition and measurement of investment companies.  The guidance does not address the applicability of investment company accounting for real estate entities and thus does not have a material effect on the Company’s Consolidated Financial Statements.

 

In February 2013, the FASB issued updated guidance on the disclosure of reclassification adjustments related to comprehensive income.  The updated guidance requires the Company to disclose, either on the face of the financial statements or in the notes to the financial statements, the financial statement effects on earnings from items that are reclassified out of other comprehensive income, by component.  This guidance was effective as of the first quarter of 2013 and its adoption did not have a material effect on the Company’s Consolidated Financial Statements.

 

In December 2011, the FASB issued updated guidance on disclosure about offsetting assets and liabilities that amends U.S. GAAP to conform more to the disclosure requirements of International Financial Reporting

 

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September 30, 2013

 

Standards (“IFRS”).  Under the updated guidance, an entity is required to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement.  In January 2013, the FASB issued further guidance clarifying the scope of disclosures about offsetting assets and liabilities.  The scope applies to certain derivatives (including bifurcated embedded derivatives,) repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions.  The guidance was effective as of the first quarter of 2013 and its adoption did not have a material effect on the Company’s Consolidated Financial Statements.

 

Note 3 — Loans and Investments

 

The following table sets forth the composition of the Company’s loan and investment portfolio at September 30, 2013 and December 31, 2012:

 

		September 30, 2013			Percent of Total		Loan Count		Wtd. Avg. Pay Rate (1)		Wtd. Avg. Remaining Months to Maturity		First Dollar LTV Ratio (2)		Last Dollar  LTV Ratio (3)
Bridge loans		$	1,214,659,449		71	%	99		5.13	%	18.9		0	%	76	%
Mezzanine loans		109,871,096			6	%	25		6.19	%	60.6		60	%	85	%
Junior participation loans		249,139,239			15	%	7		4.31	%	22.1		62	%	83	%
Preferred equity investments		129,073,672			8	%	16		7.55	%	51.5		61	%	81	%
		1,702,743,456			100	%	147		5.26	%	24.5		18	%	78	%
Unearned revenue		(13,617,560		)
Allowance for loan losses		(143,018,491		)
Loans and investments, net		$	1,546,107,405

 

		December 31, 2012			Percent  of Total		Loan Count		Wtd. Avg. Pay Rate (1)		Wtd. Avg. Remaining Months to Maturity		First Dollar LTV Ratio (2)		Last Dollar LTV Ratio (3)
Bridge loans		$	1,006,726,838		67	%	83		4.87	%	25.0		0	%	75	%
Mezzanine loans		112,843,639			7	%	24		4.94	%	62.6		59	%	88	%
Junior participation loans		280,662,498			19	%	9		3.90	%	29.1		59	%	79	%
Preferred equity investments		100,823,672			7	%	12		6.04	%	72.2		77	%	97	%
		1,501,056,647			100	%	128		4.77	%	31.8		21	%	80	%
Unearned revenue		(13,683,281		)
Allowance for loan losses		(161,706,313		)
Loans and investments, net		$	1,325,667,053

 

(1)          “Weighted Average Pay Rate” is a weighted average, based on the unpaid principal balances of each loan in the Company’s portfolio, of the interest rate that is required to be paid monthly as stated in the individual loan agreements.  Certain loans and investments that require an additional rate of interest “Accrual Rate” to be paid at the maturity are not included in the weighted average pay rate as shown in the table.

(2)          The “First Dollar LTV Ratio” is calculated by comparing the total of the Company’s senior most dollar and all senior lien positions within the capital stack to the fair value of the underlying collateral to determine the point at which the Company will absorb a total loss of its position.

(3)          The “Last Dollar LTV Ratio” is calculated by comparing the total of the carrying value of the Company’s loan and all senior lien positions within the capital stack to the fair value of the underlying collateral to determine the point at which the Company will initially absorb a loss.

 

Concentration of Credit Risk

 

The Company operates in one portfolio segment, commercial mortgage loans and investments.  Commercial mortgage loans and investments can potentially subject the Company to concentrations of credit risk. The Company is subject to concentration risk in that, as of September 30, 2013, the unpaid principal balance related

 

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