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

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

 

For the quarterly period ended March 31, 2013

 

Or

 

 

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.

 

 

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: 43,136,975 outstanding (excluding 2,650,767 shares held in the treasury) as of May 3, 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 March 31, 2013 (Unaudited) and December 31, 2012	2
Consolidated Statements of Operations (Unaudited) for the Three Months Ended March 31, 2013 and 2012	3
Consolidated Statements of Comprehensive Income (Unaudited) for the Three Months Ended March 31, 2013 and 2012	4
Consolidated Statement of Changes in Equity (Unaudited) for the Three Months Ended March 31, 2013	5
Consolidated Statements of Cash Flows (Unaudited) for the Three Months Ended March 31, 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	65
Item 3. Quantitative and Qualitative Disclosures about Market Risk	96
Item 4. Controls and Procedures	99
PART II. OTHER INFORMATION	99
Item 1. Legal Proceedings	99
Item 1A. Risk Factors	100
Item 2. Unregistered Sale of Equity Securities and Use of Proceeds	100
Item 3. Defaults Upon Senior Securities	100
Item 4. Mine Safety Disclosures	100
Item 5. Other Information	100
Item 6. Exhibits	101
Signatures	107

 

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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

 

		March 31,			December 31,
		2013			2012
		(Unaudited)
Assets:
Cash and cash equivalents		$	77,964,567		$	29,188,889
Restricted cash (includes $71,308,827 and $41,537,212 from consolidated VIEs, respectively)		72,067,155			42,535,514
Loans and investments, net (includes $1,288,284,771 and $1,113,745,356 from consolidated VIEs, respectively)		1,387,920,430			1,325,667,053
Available-for-sale securities, at fair value (includes $1,100,000 and $1,100,000 from consolidated VIEs, respectively)		3,552,736			3,552,736
Securities held-to-maturity, net		55,954,525			42,986,980
Investment in equity affiliates		59,474,992			59,581,242
Real estate owned, net (includes $80,787,215 and $80,787,215 from consolidated VIEs, respectively)		125,139,264			124,148,199
Due from related party		458,876			24,094
Prepaid management fee — related party		19,047,949			19,047,949
Other assets (includes $15,077,666 and $11,709,103 from consolidated VIEs, respectively)		55,369,634			55,148,624
Total assets		$	1,856,950,128		$	1,701,881,280
Liabilities and Equity:
Repurchase agreements and credit facilities		$	49,403,813		$	130,661,619
Collateralized debt obligations (includes $750,376,079 and $812,452,845 from consolidated VIEs, respectively)		750,376,079			812,452,845
Collateralized loan obligation (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		158,894,847			158,767,145
Notes payable		51,457,708			51,457,708
Mortgage note payable — real estate owned		53,751,004			53,751,004
Due to related party		1,329,758			3,084,627
Due to borrowers (includes $555,668 and $1,320,943 from consolidated VIEs, respectively)		20,344,103			23,056,640
Deferred revenue		77,123,133			77,123,133
Other liabilities (includes $20,418,639 and $22,013,896 from consolidated VIEs, respectively)		66,380,663			72,765,437
Total liabilities		1,493,561,108			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 March 31, 2013, no shares issued and outstanding at December 31, 2012		37,315,694			—
Common stock, $0.01 par value: 500,000,000 shares authorized; 45,717,742 shares issued, 43,066,975 shares outstanding at March 31, 2013 and 33,899,992 shares issued, 31,249,225 shares outstanding at December 31, 2012		457,178			339,000
Additional paid-in capital		582,279,426			493,211,222
Treasury stock, at cost — 2,650,767 shares at March 31, 2013 and December 31, 2012		(17,100,916		)	(17,100,916		)
Accumulated deficit		(205,076,703		)	(207,558,257		)
Accumulated other comprehensive loss		(36,420,916		)	(39,561,700		)
Total Arbor Realty Trust, Inc. stockholders’ equity		361,453,763			229,329,349
Noncontrolling interest in consolidated entity		1,935,257			1,931,773
Total equity		363,389,020			231,261,122
Total liabilities and equity		$	1,856,950,128		$	1,701,881,280

 

See Notes to Consolidated Financial Statements.

 

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF OPERATIONS

 

For the Three Months Ended March 31, 2013 and 2012

(Unaudited)

 

		Three Months Ended March 31,
		2013			2012
Interest income		$	22,988,822		$	19,606,407
Interest expense		10,642,244			11,761,400
Net interest income		12,346,578			7,845,007
Other revenue:
Property operating income		8,895,434			9,023,161
Other income		1,379,458			32,030
Total other revenue		10,274,892			9,055,191
Other expenses:
Employee compensation and benefits		3,083,639			2,484,778
Selling and administrative		2,189,283			1,660,233
Property operating expenses		6,870,159			7,325,307
Depreciation and amortization		1,632,131			1,176,755
Provision for loan losses (net of recoveries)		2,500,155			7,789,408
Management fee - related party		2,800,000			2,500,000
Total other expenses		19,075,367			22,936,481
Income (loss) from continuing operations before gain on extinguishment of debt, loss from equity affiliates and benefit from income taxes		3,546,103			(6,036,283		)
Gain on extinguishment of debt		3,763,000			5,346,121
Loss from equity affiliates		(81,885		)	(250,574		)
Income (loss) before benefit from income taxes		7,227,218			(940,736		)
Benefit from income taxes		—			1,401,558
Income from continuing operations		7,227,218			460,822
Gain on sale of real estate held-for-sale		—			3,487,145
Income from operations of real estate held-for-sale		—			267,624
Income from discontinued operations		—			3,754,769
Net income		7,227,218			4,215,591
Preferred stock dividends		533,328			—
Net income attributable to noncontrolling interest		53,651			53,811
Net income attributable to Arbor Realty Trust, Inc. common stockholders		$	6,640,239		$	4,161,780
Basic earnings per common share:
Income from continuing operations, net of noncontrolling interest and preferred stock dividends		$	0.20		$	0.02
Income from discontinued operations		—			0.15
Net income attributable to Arbor Realty Trust, Inc. common stockholders		$	0.20		$	0.17
Diluted earnings per common share:
Income from continuing operations, net of noncontrolling interest and preferred stock dividends		$	0.19		$	0.02
Income from discontinued operations		—			0.15
Net income attributable to Arbor Realty Trust, Inc. common stockholders		$	0.19		$	0.17
Dividends declared per common share		$	0.12		$	—
Weighted average number of shares of common stock outstanding:
Basic		33,771,925			24,180,165
Diluted		34,236,689			24,344,154

 

See Notes to Consolidated Financial Statements.

 

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

For the Three Months Ended March 31, 2013 and 2012

(Unaudited)

 

		Three Months Ended March 31,
		2013			2012
Net income		$	7,227,218		$	4,215,591
Unrealized loss on derivative financial instruments		(354,980		)	(1,266,467		)
Reclassification of net realized loss on derivatives designated as cash flow hedges into earnings		3,495,764			5,196,629
Comprehensive income		10,368,002			8,145,753
Less:
Preferred stock dividends		533,328			—
Comprehensive income attributable to noncontrolling interest		53,651			53,811
Comprehensive income attributable to Arbor Realty Trust, Inc. common stockholders		$	9,781,023		$	8,091,942

 

See Notes to Consolidated Financial Statements.

 

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

 

For the Three Months Ended March 31, 2013

(Unaudited)

 

		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							11,625,000		116,250			88,498,322														88,614,572						88,614,572
Issuance of preferred stock		1,551,500		37,315,694																						37,315,694						37,315,694
Stock-based compensation							192,750		1,928			569,882														571,810						571,810
Distributions — common stock																				(4,154,553		)				(4,154,553		)				(4,154,553		)
Distributions accrued —preferred stock																				(533,328		)				(533,328		)				(533,328		)
Distributions — preferred stock of private REIT																				(4,132		)				(4,132		)				(4,132		)
Net income																				7,173,567						7,173,567			53,651			7,227,218
Distribution to non-controlling interest																													(50,167		)	(50,167		)
Unrealized loss on derivative financial instruments, net																							(354,980		)	(354,980		)				(354,980		)
Reclassification of net realized loss on derivatives designated as cash flow hedges into earnings																							3,495,764			3,495,764						3,495,764
Balance — March 31, 2013		1,551,500		$	37,315,694		45,717,742		$	457,178		$	582,279,426		(2,650,767	)	$	(17,100,916	)	$	(205,076,703	)	$	(36,420,916	)	$	361,453,763		$	1,935,257		$	363,389,020

 

See Notes to Consolidated Financial Statements.

 

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

For the Three Months Ended March 31, 2013 and 2012

(Unaudited)

 

		Three Months Ended March 31,
		2013			2012
Operating activities:
Net income		$	7,227,218		$	4,215,591
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization		1,632,131			1,176,755
Stock-based compensation		571,810			53,600
Gain on sale of real estate held-for-sale		—			(3,487,145		)
Gain on extinguishment of debt		(3,763,000		)	(5,346,121		)
Provision for loan losses (net of recoveries)		2,500,155			7,789,408
Amortization and accretion of interest, fees and intangible assets, net		(214,661		)	1,367,051
Change in fair value of non-qualifying swaps		(107,722		)	379,045
Loss from equity affiliates		81,885			250,574
Changes in operating assets and liabilities:
Other assets		13,998			(1,563,958		)
Distributions of operations from equity affiliates		24,365			24,426
Other liabilities		(4,160,838		)	(3,912,121		)
Change in restricted cash		239,974			424,476
Due to/from related party		(2,189,651		)	(1,223,796		)
Net cash provided by operating activities		$	1,855,664		$	147,785
Investing activities:
Loans and investments funded, originated and purchased, net		(101,354,622		)	(40,567,497		)
Payoffs and paydowns of loans and investments		34,733,621			38,882,249
Due to borrowers and reserves		(585,143		)	(328,890		)
Deferred fees		515,220			813,406
Purchase of securities held-to-maturity, net		(20,500,000		)	(44,969,600		)
Principal collection on securities held-to-maturity, net		7,615,742			9,892,873
Investment in real estate, net		(2,799,667		)	(864,780		)
Proceeds from sale of real estate, net		—			24,131,557
Net cash used in investing activities		$	(82,374,849	)	$	(13,010,682	)
Financing activities:
Proceeds from repurchase agreements and credit facilities		23,704,650			37,515,970
Paydowns and payoffs of repurchase agreements and credit facilities		(104,962,456		)	(7,254,970		)
Payoff and paydown of mortgage notes payable		—			(20,750,000		)
Proceeds from collateralized loan obligation		177,000,000			—
Payoffs and paydowns of collateralized debt obligations		(58,130,055		)	(26,377,248		)
Change in restricted cash		(29,771,615		)	28,054,773
Payments on financial instruments underlying linked transactions		(18,265,294		)	—
Receipts on financial instruments underlying linked transactions		18,939,101			—
Payments on swaps to hedge counterparties		(20,644,853		)	(8,850,234		)
Receipts on swaps from hedge counterparties		22,551,317			9,486,949
Purchases of treasury stock		—			(684,764		)
Distributions paid to noncontrolling interest		(50,167		)	(55,177		)
Proceeds from issuance of common stock		91,696,328			—
Expenses paid on issuance of common stock		(2,974,812		)	—
Proceeds from issuance of preferred stock		38,787,500			—
Expenses paid on issuance of preferred stock		(1,329,526		)	—
Distributions paid on common stock		(4,154,553		)	—
Distributions paid on preferred stock of private REIT		(4,132		)	(3,615		)
Payment of deferred financing costs		(3,096,570		)	—
Net cash provided by financing activities		$	129,294,863		$	11,081,684
Net increase / (decrease) in cash and cash equivalents		$	48,775,678		$	(1,781,213	)
Cash and cash equivalents at beginning of period		29,188,889			55,236,479
Cash and cash equivalents at end of period		$	77,964,567		$	53,455,266

 

See Notes to Consolidated Financial Statements.

 

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

 

For the Three Months Ended March 31, 2013 and 2012

(Unaudited)

 

		Three Months Ended March 31,
		2013			2012
Supplemental cash flow information:
Cash used to pay interest		$	13,094,185		$	10,071,981
Cash used for taxes		$	108,594		$	120,741
Supplemental schedule of non-cash investing and financing activities:
Distributions accrued on 8.25% Series A preferred stock		$	533,328		$	—
Accrued and unpaid expenses on preferred stock offering		$	142,280		$	—
Accrued and unpaid expenses on common stock offering		$	120,000		$	—

 

See Notes to Consolidated Financial Statements.

 

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2013

(Unaudited)

 

Note 1 —Description of Business / Form of Ownership

 

Arbor Realty Trust, Inc. (the “Company”) is a Maryland corporation that was formed in June 2003 to invest 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.

 

In July 2003, ACM contributed $213.1 million of structured finance assets and $169.2 million of borrowings supported by $43.9 million of equity in exchange for a commensurate equity ownership in ARLP.  In addition, certain employees of ACM were transferred to ARLP.  At that time, these assets, liabilities and employees represented a substantial portion of ACM’s structured finance business.  The Company is externally managed and advised by ACM and pays ACM a management fee in accordance with a management agreement.  ACM also sources originations, provides underwriting services, and services all structured finance assets on behalf of ARLP and its wholly owned subsidiaries.

 

In July 2003, the Company completed a private equity offering of 1,610,000 units (including an overallotment option), each consisting of five shares of common stock and one warrant to purchase one share of common stock at $75.00 per unit.  The Company sold 8,050,000 shares of common stock in the offering.  Gross proceeds from the private equity offering totaled $120.2 million.  Gross proceeds from the private equity offering combined with the concurrent equity contribution by ACM totaled approximately $164.1 million in equity capital.  The Company paid and accrued offering expenses of $10.1 million resulting in Arbor Realty Trust, Inc. stockholders’ equity and noncontrolling interest of $154.0 million as a result of the private placement.

 

In April 2004, the Company sold 6,750,000 shares of its common stock in a public offering at a price of $20.00 per share, for net proceeds of approximately $124.4 million after deducting the underwriting discount and other offering expenses.  The Company used the proceeds to pay down its indebtedness.  In May 2004, the underwriters exercised a portion of their over-allotment option, which resulted in the issuance of 524,200 additional shares.  The Company received net proceeds of approximately $9.8 million after deducting the underwriting discount.  In October 2004, ARLP received proceeds of approximately $9.4 million from the exercise of warrants for 629,345 operating partnership units.  Additionally, in 2004 and 2005, the Company issued 973,354 and 282,776 shares of common stock, respectively, from the exercise of warrants under its Warrant Agreement dated July 1, 2003 and received net proceeds of $12.9 million and $4.2 million, respectively.

 

In June 2007, the Company completed a public offering in which it sold 2,700,000 shares of its common stock registered for $27.65 per share, and received net proceeds of approximately $73.6 million after deducting the underwriting discount and other offering expenses.  The Company used the proceeds to pay down debt and finance its loan and investment portfolio.

 

In June 2008, the Company’s external manager exercised its right to redeem its approximate 3.8 million operating partnership units in the Company’s operating partnership for shares of the Company’s common stock on a

 

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2013

(Unaudited)

 

one-for-one basis.  In addition, the special voting preferred shares paired with each operating partnership unit, pursuant to a pairing agreement, were redeemed simultaneously and cancelled by the Company.

 

In June 2010, the Company filed a shelf registration statement on Form S-3 with the Securities and Exchange Commission (“SEC”) under the Securities Act of 1933, as amended (the “1933 Act”) with respect to an aggregate of $500.0 million of debt securities, common stock, preferred stock, depositary shares and warrants that may be sold by the Company from time to time pursuant to Rule 415 of the 1933 Act.  On June 23, 2010, the SEC declared this shelf registration statement effective.

 

In June 2012, the Company completed a public offering in which it sold 3,500,000 shares of its common stock for $5.40 per share, and received net proceeds of approximately $17.5 million after deducting the underwriting discount and other offering expenses.  The Company used the net proceeds from the offering to make investments, to repurchase or pay liabilities and for general corporate purposes.

 

In October 2012, the Company completed another public offering in which it sold 3,500,000 shares of its common stock for $5.80 per share, and received net proceeds of approximately $19.2 million after deducting the underwriting discount and other offering expenses.  The Company used the net proceeds from the offering to make investments, to repurchase or pay liabilities and for general corporate purposes.

 

The Company had 43,066,975 shares of common stock outstanding at March 31, 2013 and 31,249,225 shares of common stock outstanding at December 31, 2012.

 

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2013

(Unaudited)

 

Note 2 — Summary of Significant 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.

 

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 March 31, 2013 through the issuance of the Consolidated Financial Statements.

 

The results of operations for the three months ended March 31, 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.

 

Cash and Cash Equivalents

 

All highly liquid investments with original maturities of three months or less are considered to be cash equivalents.  The Company places its cash and cash equivalents in high quality financial institutions.  The consolidated account balances at each institution periodically exceed Federal Deposit Insurance Corporation (FDIC) insurance coverage and the Company believes that this risk is not significant.

 

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2013

(Unaudited)

 

Restricted Cash

 

At March 31, 2013 and December 31, 2012, the Company had restricted cash of $72.1 million and $42.5 million, respectively.  Restricted cash primarily represents proceeds from the Company’s second CLO which will be used to purchase underlying assets, loan repayments on deposit with the trustees for the Company’s CDOs which will be used for principal repayments, unfunded loan commitments and interest payments received from loans.  As of January 2012, all three of the CDOs have reached their replenishment dates and principal repayments are remitted quarterly to the bond holders and the Company in the month following the quarter.  See Note 7 — “Debt Obligations.”  The Company’s real estate owned assets also had restricted cash balances totaling $0.8 million and $1.0 million as of March 31, 2013 and December 31, 2012, respectively, due to escrow requirements.  See Note 6 — “Real Estate Owned and Held-For-Sale.”

 

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 March 31, 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 which 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 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.

 

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2013

(Unaudited)

 

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.  The Company had an allowance for loan losses of $145.7 million relating to 18 loans with an aggregate carrying value, before loan loss reserves, of approximately $234.9 million at March 31, 2013 and $161.7 million in allowance for loan losses relating to 20 loans with an aggregate carrying value, before loan loss reserves, of approximately $240.2 million at December 31, 2012.

 

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 Statement 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 Statement of Operations in the period in which the loan was sold.  No loss on sale and restructuring of loans was recorded for the three months ended March 31, 2013 and 2012.

 

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

 

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2013

(Unaudited)

 

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.  For the three months ended March 31, 2013 and 2012, the Company recorded charge-offs to the allowance for loan losses of $18.5 million and $3.6 million, respectively.

 

Real Estate Owned and Held-For-Sale

 

Real estate owned, shown net of accumulated depreciation and impairment charges, is comprised of real property acquired by foreclosure or through partial or full settlement of mortgage debt.  The real estate acquired is recorded at the estimated fair value at the time of acquisition.

 

Costs incurred in connection with the foreclosure of the properties collateralizing the real estate loans are expensed as incurred and costs subsequently incurred to extend the life or improve the assets subsequent to foreclosure are capitalized.

 

The Company allocates the purchase price of its operating properties to land, building, tenant improvements, deferred lease costs for the origination costs of the in-place leases, intangibles for the value of the above or below market leases at fair value and to any other identified intangible assets or liabilities.  The Company finalizes its purchase price allocation on these assets within one year of the acquisition date.  The Company amortizes the value allocated to the in-place leases over the remaining lease term.  The value allocated to the above or below market leases are amortized over the remaining lease term as an adjustment to rental income.

 

Real estate assets, including assets acquired by foreclosure or through partial or full settlement of mortgage debt, that are operated for the production of income are depreciated using the straight-line method over their estimated useful lives.  Ordinary repairs and maintenance which are not reimbursed by the tenants are expensed as incurred.  Major replacements and betterments which improve or extend the life of the asset are capitalized and depreciated over their estimated useful life.

 

The Company’s properties are individually reviewed for impairment each quarter, if events or circumstances change indicating that the carrying amount of the assets may not be recoverable.  The Company recognizes impairment if the undiscounted estimated cash flows to be generated by the assets are less than the carrying amount of those assets.  Measurement of impairment is based upon the estimated fair value of the asset.  Upon evaluating a property for impairment, many factors are considered, including estimated current and expected operating cash flows from the property during the projected holding period, costs necessary to extend the life or improve the asset, expected capitalization rates, projected stabilized net operating income, selling costs, and the ability to hold and dispose of such real estate owned in the ordinary course of business.  Valuation adjustments may be necessary in the event that effective interest rates, rent-up periods, future economic conditions, and other relevant factors vary significantly from those assumed in valuing the property.  If future evaluations result in a diminution in the value of the property, the reduction will be recognized as an impairment charge at that time.

 

Real estate is classified as held-for-sale when management commits to a plan of sale, the asset is available for immediate sale, there is an active program to locate a buyer, and it is probable the sale will be completed within one year.  Properties classified as held-for-sale are not depreciated and the results of their operations are shown in discontinued operations.  Real estate assets that are expected to be disposed of are valued, on an individual asset basis, at the lower of their carrying amount or their fair value less costs to sell.

 

The Company recognizes sales of real estate properties upon closing.  Payments received from purchasers prior to closing are recorded as deposits.  Profit on real estate sold is recognized upon closing using the full accrual method when the collectability of the sale price is reasonably assured and the Company is not obligated to perform significant activities after the sale.  Profit may be deferred in whole or in part until collectability of the sales price is reasonably assured and the earnings process is complete.

 

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2013

(Unaudited)

 

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 March 31, 2013, the Company had total interest reserves of $6.3 million on 42 loans with an aggregate unpaid principal balance of $509.2 million and had three non-performing loans with an aggregate unpaid principal balance of $38.4 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 month periods ended March 31, 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.  For the three months ended March 31, 2013, the Company recorded approximately $8.9 million of property operating income relating to its real estate owned properties, as compared to approximately $9.0 million for the three months ended March 31, 2012.  As of March 31, 2013 and 2012, the Company had two real estate owned properties, a portfolio of multifamily assets that was purchased by the Company out of bankruptcy and a portfolio of hotel assets that was transferred to the Company by the owner, a creditor trust.  Both of these portfolios were acquired in the first quarter of 2011.  See Note 6 — “Real Estate Owned and Held-For-Sale” for further details.

 

Other income — Other income 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 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.

 

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2013

(Unaudited)

 

Investment in Equity Affiliates

 

The Company invests in joint ventures that are formed to acquire, develop, and/or sell real estate assets.  These joint ventures are not majority owned or controlled by the Company, or are VIEs for which the Company is not the primary beneficiary, and are not consolidated in its financial statements.  These investments are recorded under either the equity or cost method of accounting as deemed appropriate.  The Company records its share of the net income and losses from the underlying properties of its equity method investments and any other-than-temporary impairment on these investments on a single line item in the Consolidated Statement of Operations as income or losses from equity affiliates.

 

Stock-Based Compensation

 

The Company has granted certain of its employees, directors, and employees of ACM, stock awards consisting of shares of the Company’s common stock that vest immediately or annually over a multi-year period, subject to the recipient’s continued service to the Company.  The Company records stock-based compensation expense at the grant date fair value of the related stock-based award with subsequent remeasurement for any unvested shares granted to non-employees of the Company with such amounts expensed against earnings, at the grant date (for the portion that vests immediately) or ratably over the respective vesting periods.  Dividends are paid on restricted stock as dividends are paid on shares of the Company’s common stock whether or not they are vested.  Stock-based compensation is disclosed in the Company’s Consolidated Statements of Operations under “employee compensation and benefits” for employees and under “selling and administrative” expense for non-employees.

 

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 which 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.

 

Other Comprehensive Income / (Loss)

 

The Company divides comprehensive income or loss into net income (loss) and other comprehensive income (loss), which includes unrealized gains and losses on available-for-sale securities.  In addition, to the extent the Company’s derivative instruments qualify as hedges, net unrealized gains or losses are reported as a component of accumulated other comprehensive income (loss).  See “Derivatives and Hedging Activities” below.  At March 31, 2013, accumulated other comprehensive loss was $36.4 million and consisted of $36.8 million of net unrealized losses on derivatives designated as cash flow hedges and a $0.4 million unrealized gain related to available-for-sale securities.  At December 31, 2012, accumulated other comprehensive loss was $39.6 million and consisted of $40.0 million of net unrealized losses on derivatives designated as cash flow hedges and a $0.4 million unrealized gain related to available-for-sale securities.

 

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2013

(Unaudited)

 

Hedging Activities and Derivatives

 

Hedging Activities

 

The Company recognizes all derivatives as either assets or liabilities at fair value and these amounts are recorded in other assets or other liabilities in 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.

 

Derivatives

 

The Company records all derivatives in 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.

 

In the normal course of business, the Company may use a variety of derivative financial instruments to manage, or hedge, interest rate risk.  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 Sheet 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 Statement of Operations.  The analysis of transactions under these rules requires management’s judgment and experience.  See Note 8 — “Derivative Financial Instruments” for further details.

 

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.  A VIE is defined

 

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2013

(Unaudited)

 

as an entity in which equity investors (i) do not have the characteristics of a controlling financial interest, and/or (ii) do not have sufficient equity at risk for the entity to finance its activities without additional financial support from other parties.  A VIE is required to be consolidated by its primary beneficiary, which is defined as 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.  See Note 9 — “Variable Interest Entities” for further details.

 

Recently Issued Accounting Pronouncements

 

In December 2011, the FASB issued updated guidance on disclosure about offsetting assets and liabilities which amends U.S. GAAP to conform more to the disclosure requirements of International Financial Reporting 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 is 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 June 2011, the FASB issued updated guidance on comprehensive income which amends U.S. GAAP to conform to IFRS disclosure requirements.  The amendment eliminates the option to present components of other comprehensive income as part of the Statement of Changes in Stockholders’ Equity and requires a separate Statement of Comprehensive Income or two consecutive statements in the Statement of Operations and in a separate Statement of Comprehensive Income.  The guidance also requires the presentation of reclassification adjustments for each component of other comprehensive income on the face of the financial statements rather than in the notes to the financial statements.  This guidance was effective as of the first quarter of 2012, except for guidance on the disclosure of reclassification adjustments which was postponed for re-deliberation by the FASB, and early adoption was permitted.  The Company early adopted the guidance in the fourth quarter of 2011, with the exception of the disclosure of reclassification adjustments postponed for re-deliberation by the FASB.  As the guidance only amends existing disclosure requirements, its adoption did 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.  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 is effective as of the first quarter of 2013 and its adoption did not have a material effect on the Company’s Consolidated Financial Statements.

 

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2013

(Unaudited)

 

Note 3 — Loans and Investments

 

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

 

		March 31, 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		$	1,069,059,024		69	%	88		5.02	%	21.9		0	%	75	%
Mezzanine loans		100,263,168			6	%	21		5.37	%	64.5		54	%	86	%
Junior participation loans		276,976,266			18	%	8		4.30	%	25.9		58	%	79	%
Preferred equity investments		100,823,672			7	%	12		6.04	%	69.2		64	%	83	%
		1,547,122,130			100	%	129		4.98	%	28.4		18	%	78	%
Unearned revenue		(13,459,656		)
Allowance for loan losses		(145,742,044		)
Loans and investments, net		$	1,387,920,430
		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.

 

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2013

(Unaudited)

 

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 March 31, 2013, the unpaid principal balance related to 25 loans with five different borrowers represented approximately 29% of total assets.  At December 31, 2012 the unpaid principal balance related to 23 loans with five different borrowers represented approximately 31% of total assets.  As of March 31, 2013 and December 31, 2012, the Company had 129 and 128 loans and investments, respectively.

 

As a result of the loan review process, the Company identified loans and investments that it considers higher-risk loans that had a carrying value, before loan loss reserves, of approximately $219.9 million and a weighted average last dollar loan-to-value (“LTV”) ratio of 90%, compared to lower-risk loans with a carrying value, before loan loss reserves, of $1.3 billion and a weighted average last dollar LTV ratio of 76% at March 31, 2013.

 

The Company measures its relative loss position for its mezzanine loans, junior participation loans, and preferred equity investments by determining the point where the Company will be exposed to losses based on its position in the capital stack as compared to the fair value of the underlying collateral.  The Company determines its loss position on both a first dollar LTV and a last dollar LTV basis.  First dollar LTV 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.  Last dollar LTV 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.

 

As a component of the Company’s policies and procedures for loan valuation and risk assessment, each loan and investment is assigned a credit risk rating.  Individual ratings range from one to five, with one being the lowest risk and five being the highest.  Each credit risk rating has benchmark guidelines which pertain to debt-service coverage ratios, LTV ratios, borrower strength, asset quality, and funded cash reserves.  Other factors such as guarantees, market strength, remaining loan term, and borrower equity are also reviewed and factored into determining the credit risk rating assigned to each loan.  This metric provides a helpful snapshot of portfolio quality and credit risk.  Given the Company’s asset management approach, however, the risk rating process does not result in differing levels of diligence contingent upon credit rating.  That is because all portfolio assets are subject to the level of scrutiny and ongoing analysis consistent with that of a ‘high-risk” loan.  All assets are subject to, at minimum, a thorough quarterly financial evaluation in which historical operating performance is reviewed, and forward-looking projections are created.  Generally speaking, given the Company’s typical loan and investment profile, a risk rating of three suggests that the Company expects the loan to make both principal and interest payments according to the contractual terms of the loan agreement, and is not considered impaired.  A risk rating of four indicates the Company anticipates that the loan will require a modification of some kind.  A risk rating of five indicates the Company expects the loan to underperform over its term, and that there could be loss of interest and/or principal.  Ratings of 3.5 and 4.5 generally indicate loans that have characteristics of both the immediately higher and lower classifications.  Further, while the above are the primary guidelines used in determining a certain risk rating, subjective items such as borrower strength, condition of the market of the underlying collateral, additional collateral or other credit enhancements, or loan terms, may result in a rating that is higher or lower than might be indicated by any risk rating matrix.

 

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2013

(Unaudited)

 

A summary of the loan portfolio’s weighted average internal risk ratings and LTV ratios by asset class as of March 31, 2013 and December 31, 2012 is as follows:

 

		As of March 31, 2013
Asset Class		Unpaid Principal Balance			Percentage of Portfolio		Wtd. Avg. Internal Risk Rating		First Dollar LTV Ratio		Last Dollar LTV Ratio
Multi-family		$	834,513,387		53.9	%	3.3		15	%	77	%
Office		414,756,364			26.8	%	3.2		31	%	81	%
Land		140,514,450			9.1	%	4.7		0	%	85	%
Hotel		101,692,824			6.6	%	3.5		17	%	77	%
Commercial		23,645,105			1.5	%	3.0		0	%	50	%
Retail		16,750,000			1.1	%	2.8		0	%	69	%
Condo		15,250,000			1.0	%	4.0		51	%	80	%
Total		$	1,547,122,130		100.0	%	3.4		18	%	78	%

 

		As of December 31, 2012
Asset Class		Unpaid Principal Balance			Percentage of Portfolio		Wtd. Avg. Internal Risk Rating		First Dollar LTV Ratio		Last Dollar LTV Ratio
Multi-family		$	771,140,021		51.4	%	3.4		19	%	79	%
Office		415,162,338			27.6	%	3.2		31	%	81	%
Land		140,745,980			9.4	%	4.2		0	%	86	%
Hotel		105,613,791			7.0	%	3.6		22	%	78	%
Commercial		23,794,517			1.6	%	3.0		0	%	50	%
Retail		19,350,000			1.3	%	2.9		0	%	61	%
Condo		25,250,000			1.7	%	4.2		58	%	90	%
Total		$	1,501,056,647		100.0	%	3.4		21	%	80	%

 

Geographic Concentration Risk

 

As of March 31, 2013, 32%, 10%, 10% and 9% of the outstanding balance of the Company’s loans and investments portfolio had underlying properties in New York, California, Texas and Florida, respectively.  As of December 31, 2012, 34%, 11%, 10% and 8% of the outstanding balance of the Company’s loans and investments portfolio had underlying properties in New York, California, Texas and Florida, respectively.

 

Impaired Loans and Allowance for Loan Losses

 

The Company performs an evaluation of the loan portfolio quarterly to assess the performance of its loans and whether a reserve for impairment should be recorded.  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.

 

During the three months ended March 31, 2013, the Company determined that the fair value of the underlying collateral securing two impaired loans with an aggregate carrying value of $13.5 million was less than the net carrying value of the loans, resulting in a $2.5 million provision for loan losses.  In addition, during the three months ended March 31, 2013, the Company recorded less than $0.1 million of net recoveries of previously recorded loan loss reserves.  These recoveries were recorded in provision for loan losses on the Consolidated Statement of Operations.  The effect of the recoveries resulted in a provision for loan losses, net of recoveries, of $2.5 million for the three months ended March 31, 2013.  The $2.5 million of loan loss reserves recorded during the three months ended March 31, 2013 was attributable to two loans on which the Company had not previously recorded reserves.  The Company recorded a $7.8 million provision for loan losses for the three months ended March 31, 2012 when it performed an evaluation of its loan portfolio and determined that the fair value of the underlying collateral securing two impaired loans with an aggregate carrying value of $34.8 million were less than the net carrying value of the loans.  In addition, during the three months ended March 31, 2012, the Company recorded less than $0.1 million of net recoveries of previously recorded loan loss reserves.  The effect of these recoveries resulted in a provision for loan losses, net of recoveries, of $7.8 million for the three months ended March 31, 2012.  There were no loans for which the value of the collateral securing the loan was less than the carrying value of the loan for which the Company had not recorded a provision for loan loss as of March 31, 2013 and 2012.

 

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2013

(Unaudited)

 

At March 31, 2013, the Company had a total of 18 loans with an aggregate carrying value, before reserves, of $234.9 million for which impairment reserves have been recorded.  At December 31, 2012, the Company had a total of 20 loans with an aggregate carrying value, before loan loss reserves, of $240.2 million for which impairment reserves have been recorded.  Additionally, the Company has five loans with an unpaid principal balance totaling approximately $111.2 million at March 31, 2013, which mature in July 2013, that are collateralized by a land development project.  The loans do not contain a pay rate of interest, but four of the loans with an unpaid principal balance totaling approximately $101.9 million entitle the Company to a weighted average accrual rate of interest of approximately 9.60%.  During the fourth quarter of 2010, the Company suspended the recording of the accrual rate of interest on these loans, as these loans were impaired and management deemed the collection of this interest to be doubtful.  The Company has recorded cumulative allowances for loan losses of $43.7 million related to these loans as of March 31, 2013.  The loans are subject to certain risks associated with a development project including, but not limited to, availability of construction financing, increases in projected construction costs, demand for the development’s outputs upon completion of the project, and litigation risk.  Additionally, these loans were not classified as non-performing as the borrower is in compliance with all of the terms and conditions of the loans.

 

A summary of the changes in the allowance for loan losses is as follows:

 

		For the Three Months Ended			For the Three Months Ended
		March 31, 2013			March 31, 2012
Allowance at beginning of the period		$	161,706,313		$	185,381,855
Provision for loan losses		2,500,000			7,818,270
Charge-offs		(18,461,330		)	(3,570,000		)
Recoveries of reserves		(2,939		)	(10,000		)
Allowance at end of the period		$	145,742,044		$	189,620,125

 

A summary of charge-offs and recoveries is as follows:

 

		For the Three Months Ended
		March 31, 2013			March 31, 2012
Charge-offs:
Multi-family		$	(4,789,815	)	$	(3,570,000	)
Hotel		(3,671,515		)	—
Condo		(10,000,000		)	—
Total		$	(18,461,330	)	$	(3,570,000	)
Recoveries:
Multi-family		$	(2,939	)	$	(10,000	)
Total		$	(2,939	)	$	(10,000	)
Net Charge-offs		$	(18,458,391	)	$	(3,560,000	)
Ratio of net charge-offs during the period to average loans and investments outstanding during the period		1.2		%	0.2		%

 

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