ARBOR REALTY TRUST INC - Quarter Report: 2016 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, 2016

 

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.

 

 

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

 

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: 51,401,295 outstanding as of November 8, 2016.

 

 

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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, 2016 (Unaudited) and December 31, 2015	2
Consolidated Statements of Income (Unaudited) for the Three and Nine Months Ended September 30, 2016 and 2015	3
Consolidated Statements of Comprehensive Income (Unaudited) for the Three and Nine Months Ended September 30, 2016 and 2015	4
Consolidated Statement of Changes in Equity (Unaudited) for the Nine Months Ended September 30, 2016	5
Consolidated Statements of Cash Flows (Unaudited) for the Nine Months Ended September 30, 2016 and 2015	6
Notes to Consolidated Financial Statements (Unaudited)	8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	54
Item 3. Quantitative and Qualitative Disclosures about Market Risk	73
Item 4. Controls and Procedures	74
PART II. OTHER INFORMATION	74
Item 1. Legal Proceedings	74
Item 1A. Risk Factors	74
Item 6. Exhibits	75
Signatures	77

 

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Forward Looking 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. We use words such as “anticipates,” “expects,” “believes,” “intends,” “should,” “will,” “may” and similar expressions to identify forward-looking statements, although not all forward-looking statements include these words.  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.  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; adverse changes in our status with government-sponsored enterprises (“GSEs”) affecting our ability to originate loans through GSE programs; 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 federal and state laws and regulations, including changes in tax laws; the availability and cost of capital for future investments; and competition. Readers are cautioned not to place undue reliance on any of these forward-looking statements, which reflect 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.

 

Additional information regarding these and other risks and uncertainties we face is contained in our annual report on Form 10-K for the year ended December 31, 2015 (the “2015 Annual Report”), Definitive Proxy Statement on Schedule 14A we filed with the Securities and Exchange Commission (“SEC”) on April 22, 2016 and in our other reports and filings with the SEC.

 

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,
		2016			2015
		(Unaudited)
Assets:
Cash and cash equivalents		$	71,613,974		$	188,708,687
Restricted cash		176,615,179			48,301,244
Loans and investments, net		1,656,748,937			1,450,334,341
Loans held-for-sale, net		310,252,600			—
Capitalized mortgage servicing rights, net		224,297,210			—
Available-for-sale securities, at fair value		5,214,998			2,022,030
Investments in equity affiliates		41,962,338			30,870,235
Real estate owned, net		19,762,787			60,845,509
Real estate held-for-sale, net		—			8,669,203
Due from related party		493,412			8,082,265
Goodwill and other intangible assets		99,932,986			—
Other assets		43,326,307			29,558,430
Total assets		$	2,650,220,728		$	1,827,391,944
Liabilities and Equity:
Credit facilities and repurchase agreements		$	431,060,399		$	136,252,135
Collateralized loan obligations		1,007,736,720			758,899,661
Senior unsecured notes		94,330,797			93,764,994
Junior subordinated notes to subsidiary trust issuing preferred securities		157,662,855			157,117,130
Mortgage note payable - real estate owned		—			27,155,000
Related party financing		50,000,000			—
Due to related party		18,583,192			3,428,333
Due to borrowers		50,823,894			34,629,595
Allowance for loss-sharing obligations		31,113,413			—
Other liabilities		83,477,916			51,054,321
Total liabilities		1,924,789,186			1,262,301,169
Commitments and contingencies (Note 17)
Equity:
Arbor Realty Trust, Inc. stockholders’ equity:
Preferred stock, cumulative, redeemable, $0.01 par value: 100,000,000 shares authorized; special voting preferred shares; 21,230,769 shares issued and outstanding and no shares issued and outstanding, respectively; 8.25% Series A, $38,787,500 aggregate liquidation preference; 1,551,500 shares issued and outstanding; 7.75% Series B, $31,500,000 aggregate liquidation preference; 1,260,000 shares issued and outstanding; 8.50% Series C, $22,500,000 aggregate liquidation preference; 900,000 shares issued and outstanding		89,508,213			89,295,905
Common stock, $0.01 par value: 500,000,000 shares authorized; 51,401,295 and 50,962,516 shares issued and outstanding, respectively		514,013			509,625
Additional paid-in capital		619,179,982			616,244,196
Accumulated deficit		(137,441,120		)	(136,118,001		)
Accumulated other comprehensive loss		(1,142,053		)	(4,840,950		)
Total Arbor Realty Trust, Inc. stockholders’ equity		570,619,035			565,090,775
Noncontrolling interest		154,812,507			—
Total equity		725,431,542			565,090,775
Total liabilities and equity		$	2,650,220,728		$	1,827,391,944

 

See Notes to Consolidated Financial Statements.

 

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2016			2015			2016			2015
Interest income		$	29,636,227		$	26,025,709		$	83,424,190		$	79,575,689
Other interest income, net		—			—			2,539,274			7,884,344
Interest expense		16,966,228			11,885,363			42,958,329			37,405,492
Net interest income		12,669,999			14,140,346			43,005,135			50,054,541
Other revenue:
Fee-based services, including gain on sales, net		9,693,822			—			9,693,822			—
Mortgage servicing rights		15,968,067			—			15,968,067			—
Servicing revenue, net		5,885,884			—			5,885,884			—
Property operating income		2,960,940			7,202,851			12,719,027			22,855,028
Other income, net		359,546			51,633			663,977			164,449
Total other revenue		34,868,259			7,254,484			44,930,777			23,019,477
Other expenses:
Employee compensation and benefits		14,216,679			4,877,059			22,856,433			14,133,403
Selling and administrative		5,903,031			2,063,408			10,277,844			7,442,979
Acquisition costs		6,406,258			1,116,126			10,261,902			1,542,169
Property operating expenses		2,819,004			6,028,585			10,991,823			18,381,317
Depreciation and amortization		1,808,765			1,250,761			3,129,410			4,137,080
Impairment loss on real estate owned		—			—			11,200,000			—
Provision for loss sharing		1,316,862			—			1,316,862			—
Provision for loan losses (net of recoveries)		(54,000		)	277,464			(24,995		)	2,353,688
Management fee - related party		3,325,000			2,725,000			8,875,000			8,075,000
Total other expenses		35,741,599			18,338,403			78,884,279			56,065,636
Income before gain on acceleration of deferred income, loss on termination of swaps, gain on sale of real estate, income from equity affiliates and provision for income taxes		11,796,659			3,056,427			9,051,633			17,008,382
Gain on acceleration of deferred income		—			8,162,720			—			19,171,882
Loss on termination of swaps		—			(340,197		)	—			(4,629,647		)
Gain on sale of real estate		—			—			11,630,687			3,984,364
Income from equity affiliates		4,929,375			6,353,239			11,193,918			10,983,177
Provision for income taxes		(300,000		)	—			(300,000		)	—
Net income		16,426,034			17,232,189			31,576,238			46,518,158
Preferred stock dividends		1,888,430			1,888,430			5,665,290			5,665,290
Net income attributable to noncontrolling interest		3,649,432			—			3,649,432			—
Net income attributable to common stockholders		$	10,888,172		$	15,343,759		$	22,261,516		$	40,852,868
Basic earnings per common share		$	0.21		$	0.30		$	0.43		$	0.80
Diluted earnings per common share		$	0.21		$	0.30		$	0.43		$	0.80
Weighted average shares outstanding:
Basic		51,390,467			50,962,516			51,272,795			50,822,444
Diluted		70,271,796			50,962,516			51,627,550			50,917,442
Dividends declared per common share		$	0.16		$	0.15		$	0.46		$	0.43

 

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,
		2016			2015			2016			2015
Net income		$	16,426,034		$	17,232,189		$	31,576,238		$	46,518,158
Unrealized (loss) gain on securities available-for-sale, at fair value		(88,184		)	(176,368		)	(117,579		)	246,973
Unrealized gain (loss) on derivative financial instruments, net		66,254			(349,012		)	(195,981		)	(1,255,739		)
Reclassification of net realized loss on derivatives designated as cash flow hedges into loss on termination of swaps		—			340,197			—			4,626,192
Reclassification of net realized loss on derivatives designated as cash flow hedges into earnings		1,316,157			1,467,673			4,012,457			4,709,173
Comprehensive income		17,720,261			18,514,679			35,275,135			54,844,757
Less:
Comprehensive income attributable to noncontrolling interest		3,974,327			—			3,974,327			—
Preferred stock dividends		1,888,430			1,888,430			5,665,290			5,665,290
Comprehensive income attributable to common stockholders		$	11,857,504		$	16,626,249		$	25,635,518		$	49,179,467

 

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, 2016

 

		Arbor Realty Trust, Inc. Stockholders’ Equity
		Preferred  Stock Shares		Preferred Stock Value			Common  Stock Shares		Common  Stock Par  Value			Additional Paid- in Capital			Accumulated  Deficit			Accumulated  Other  Comprehensive Loss			Total Arbor  Realty Trust, Inc. Stockholders’ Equity			Noncontrolling  Interest			Total Equity
Balance - January 1, 2016		3,711,500		$	89,295,905		50,962,516		$	509,625		$	616,244,196		$	(136,118,001	)	$	(4,840,950	)	$	565,090,775		$	—		$	565,090,775
Issuance of special voting preferred shares and operating partnership units		21,230,769		212,308																	212,308			154,559,998			154,772,306
Stock-based compensation							439,780		4,398			2,935,776									2,940,174						2,940,174
Forfeiture of unvested restricted stock							(1,001	)	(10		)	10
Distributions - common stock															(23,573,786		)				(23,573,786		)				(23,573,786		)
Distributions - preferred stock															(5,665,290		)				(5,665,290		)				(5,665,290		)
Distributions - preferred stock of private REIT															(10,849		)				(10,849		)				(10,849		)
Distributions - noncontrolling interest																								(3,396,923		)	(3,396,923		)
Net income															27,926,806						27,926,806			3,649,432			31,576,238
Unrealized loss on securities available-for-sale																		(117,579		)	(117,579		)				(117,579		)
Unrealized loss on derivative financial instruments, net																		(195,981		)	(195,981		)				(195,981		)
Reclassification of net realized loss on derivatives designated as cash flow hedges into earnings																		4,012,457			4,012,457						4,012,457
Balance - September 30, 2016		24,942,269		$	89,508,213		51,401,295		$	514,013		$	619,179,982		$	(137,441,120	)	$	(1,142,053	)	$	570,619,035		$	154,812,507		$	725,431,542

 

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,
		2016			2015
Operating activities:
Net income		$	31,576,238		$	46,518,158
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		3,129,410			4,137,080
Stock-based compensation		2,940,174			2,890,581
Amortization and accretion of interest and fees, net		2,539,980			1,709,609
Amortization of capitalized mortgage servicing rights		7,586,524			—
Originations of loans held-for-sale		(853,935,531		)	—
Proceeds from sales of loans held-for-sale, net of gain on sale		975,969,372			—
Mortgage servicing rights		(15,968,067		)	—
Write-off of capitalized mortgage servicing rights from payoffs		1,669,081			—
Impairment loss on real estate owned		11,200,000			—
Provision for loan losses (net of recoveries)		(24,995		)	2,353,688
Provision for loss sharing (net of recoveries)		1,316,862			—
Gain on acceleration of deferred income		—			(19,171,882		)
Allowance for loss-sharing obligations (net of charge-offs)		(2,131,178		)	—
Loss on termination of swaps		—			4,629,647
Gain on sale of real estate		(11,630,687		)	(3,984,364		)
Gain on sale of securities		(15,491		)	—
Income from equity affiliates		(11,193,918		)	(10,983,177		)
Change in fair value of available-for-sale securities		46,021			—
Changes in operating assets and liabilities		5,894,972			7,500,170
Net cash provided by operating activities		148,968,767			35,599,510
Investing Activities:
Loans and investments funded, originated and purchased, net		(725,025,857		)	(734,651,094		)
Payoffs and paydowns of loans and investments		531,874,076			698,138,074
Acquisition of the Agency Business, net of cash acquired		(68,356,323		)	—
Deferred fees		7,412,018			3,707,798
Principal collection on securities, net		—			2,100,000
Investments in real estate, net		(611,497		)	(2,025,366		)
Contributions to equity affiliates		(4,641,973		)	(17,017,972		)
Distributions from equity affiliates		731,942			—
Proceeds from sale of real estate		49,029,780			18,482,352
Proceeds from sale of available-for-sale securities		1,567,207			—
Due to borrowers and reserves		128,492			—
Net cash used in investing activities		(207,892,135		)	(31,266,208		)
Financing activities:
Proceeds from repurchase agreements, credit facilities and notes payable		1,681,492,236			555,589,837
Paydowns and payoffs of repurchase agreements, loan participations and credit facilities		(1,807,884,108		)	(612,512,543		)
Proceeds from mortgage note payable - real estate owned		—			27,155,000
Paydowns and payoffs of mortgage note payable - real estate owned		(27,155,000		)	(30,984,357		)
Proceeds from collateralized loan obligations		250,250,000			486,625,000
Payoffs and paydowns of collateralized debt obligations		—			(312,071,055		)
Payoffs and paydowns of collateralized loan obligations		—			(177,000,000		)
Change in restricted cash		(123,982,753		)	159,223,507
Payments on swaps and margin calls to counterparties		—			(290,000		)
Receipts on swaps and returns of margin calls from counterparties		3,440,049			3,330,000
Distributions paid on common stock		(23,573,786		)	(21,850,942		)
Distributions paid on preferred stock		(5,665,290		)	(5,665,290		)
Distributions paid on preferred stock of private REIT		(10,849		)	(10,566		)
Payment of deferred financing costs		(5,081,844		)	(10,676,809		)
Net cash (used in) provided by financing activities		(58,171,345		)	60,861,782
Net (decrease) increase in cash and cash equivalents		(117,094,713		)	65,195,084
Cash and cash equivalents at beginning of period		188,708,687			50,417,745
Cash and cash equivalents at end of period		$	71,613,974		$	115,612,829

 

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,
		2016			2015
Supplemental cash flow information:
Cash used to pay interest		$	36,287,261		$	32,665,815
Cash used for taxes		$	298,654		$	385,932
Supplemental schedule of non-cash investing and financing activities:
Distributions accrued on 8.25% Series A preferred stock		$	266,664		$	266,664
Distributions accrued on 7.75% Series B preferred stock		$	203,438		$	203,438
Distributions accrued on 8.50% Series C preferred stock		$	159,375		$	159,375
Distributions accrued on special voting preferred shares		$	3,396,923		$	—
Related party financing		$	50,000,000		$	—
Payment due on the acquisition of the Agency Business		$	11,416,610		$	—
Working capital adjustment on the acquisition of the Agency Business		$	7,982,584		$	—
Issuance of special voting preferred shares and operating partnership units in connection with the Acquisition		$	154,772,306		$	—
Investments transferred from real estate owned, net to real estate held-for-sale, net		$	—		$	17,516,488
Loan transferred to real estate owned, net		$	—		$	5,900,000
Satisfaction of participation loan		$	—		$	1,300,000
Retirement of participation liability		$	—		$	1,300,000

 

See Notes to Consolidated Financial Statements.

 

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

September 30, 2016

 

Note 1 — Description of Business

 

Arbor Realty Trust, Inc. (the “Company,” “we,” “us,” or “our”) is a Maryland corporation that was formed in 2003 and is externally managed and advised by Arbor Commercial Mortgage, LLC (“ACM” or our “Manager”).  We invest in a diversified portfolio of structured finance assets in the multifamily and commercial real estate markets, primarily consisting of bridge and mezzanine loans, including junior participating interests in first mortgages, preferred and direct equity. In addition, we may also directly acquire real property and invest in real estate-related notes and certain mortgage-related securities. We refer to this platform as our Structured Loan Origination and Investment Business, or “Structured Business.” As a result of the acquisition of the agency platform of our Manager on July 14, 2016 (the “Acquisition”), we also now originate, sell and service a range of multifamily finance products through the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac,” and together with Fannie Mae, the government-sponsored enterprises, or the “GSEs”), the Government National Mortgage Association (“GNMA”), Federal Housing Authority (“FHA”) and the U.S. Department of Housing and Urban Development ( together with GNMA and FHA, “HUD”) and the conduit/commercial mortgage-backed securities (“CMBS”) programs. We retain the servicing rights and asset management responsibilities on substantially all loans we originate and sell under the GSE and HUD programs. We are approved as a Fannie Mae Delegated Underwriting and Servicing (“DUS”) lender nationally, a Freddie Mac Multifamily Conventional Loan lender, seller/servicer, in New York, New Jersey and Connecticut, a Freddie Mac affordable, manufactured housing, senior housing and small balance loan (“SBL”) lender, seller/servicer, nationally and a HUD Map and Lean senior housing/healthcare lender nationally. We refer to this platform as our Agency Loan Origination and Servicing Business, or “Agency Business.” See Note 3 — Acquisition of Our Manager’s Agency Platform for further details about the Acquisition.

 

Substantially all of our operations are conducted through our operating partnership, Arbor Realty Limited Partnership (“ARLP”), and ARLP’s subsidiaries.  We organize and conduct our operations to qualify as a real estate investment trust (“REIT”) for federal income tax purposes. As a result of the Acquisition, we operate in two segments: Structured Business and Agency Business. See Note 23 — Segment Information for further details.

 

Note 2 — Basis of Presentation

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”), for interim financial statements and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, certain information and footnote disclosures normally included in the consolidated financial statements prepared under GAAP have been condensed or omitted.  In the opinion of management, all adjustments considered necessary for a fair presentation of our financial position, results of operations and cash flows have been included and are of a normal and recurring nature.  The operating results presented for interim periods are not necessarily indicative of the results that may be expected for any other interim period or for the entire year. These consolidated financial statements should be read in conjunction with our consolidated financial statements and notes thereto included in our 2015 Annual Report, which was filed with the SEC.

 

The accompanying unaudited consolidated financial statements include our financial statements, our wholly owned subsidiaries, and partnerships or other joint ventures in which we own a voting interest of greater than 50 percent, and variable interest entities (“VIEs”) of which we are 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 us 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.  Entities in which we have significant influence are accounted for primarily under the equity method.

 

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

September 30, 2016

 

As a REIT, we are generally not subject to U.S. federal income tax to the extent of our distributions to stockholders and as long as certain asset, income, distribution, ownership and administrative tests are met. To maintain our qualification as a REIT, we must annually distribute at least 90% of our REIT taxable income to our stockholders and meet certain other requirements. We may also be subject to certain state, local and franchise taxes. Under certain circumstances, federal income and excise taxes may be due on our undistributed taxable income. If we were to fail to meet these requirements, we would be subject to U.S. federal income tax, which could have a material adverse impact on our results of operations and amounts available for distributions to our stockholders. We believe that all of the criteria to maintain our REIT qualification have been met for the applicable periods, but there can be no assurance that these criteria will continue to be met in subsequent periods.

 

The Agency Business is operated through a taxable REIT subsidiary (“TRS”), which is a part of our TRS consolidated group (the “TRS Consolidated Group”) and may be subject to U.S. federal, state and local income taxes.  In general, our TRS entities may hold assets that the REIT cannot hold directly and may engage in real estate or non-real estate-related business.   Our TRS Consolidated Group has federal net operating losses from prior years which will be applied against the income from the Agency Business.  In the third quarter of 2016, we recorded a tax provision of $0.3 million related to state income tax liability.  Current and deferred taxes are recorded on the portion of earnings (losses) recognized by us with respect to our interest in TRSs. Deferred income tax assets and liabilities are calculated based on temporary differences between our U.S. GAAP consolidated financial statements and the federal, state, local tax basis of assets and liabilities as of the consolidated balance sheets.  We recorded a deferred tax liability of $14.8 million in connection with the Acquisition, which is included in Other liabilities on the consolidated balance sheets. The deferred tax liability is primarily attributable to the seller financing portion of the consideration paid for the Acquisition. We evaluate the realizability of our deferred tax assets (e.g., net operating loss and capital loss carryforwards) and recognize a valuation allowance if, based on the available evidence, it is more likely than not that some portion or all of our deferred tax assets will not be realized. When evaluating the realizability of our deferred tax assets, we consider estimates of expected future taxable income, existing and projected book/tax differences, tax planning strategies available and the general and industry specific economic outlook.

 

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that could materially affect the amounts reported in the consolidated financial statements and accompanying notes.  Actual results could differ from those estimates.

 

Significant Accounting Policies

 

See Item 8 — Financial Statements and Supplementary Data in our 2015 Annual Report for a description of our significant accounting policies. In connection with the Acquisition, we have adopted the following additional significant accounting policies.

 

Loans Held-for-Sale, Net

 

Loans held-for-sale, net represents commercial real estate loans originated in our Agency Business, which are generally transferred or sold within 60 days from the date that the mortgage loan is funded. Such loans are reported at the lower of cost or market on an aggregate basis and include the value allocated to the associated future mortgage servicing rights. During the period prior to its sale, interest income on a loan held-for-sale is calculated in accordance with the terms of the individual loan and the loan origination fees and direct loan origination costs are deferred until the loan is sold.

 

Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated, put presumptively beyond the reach of the entity, even in bankruptcy, (2) the transferee (or if the transferee is an entity whose sole purpose is to engage in securitization and the entity is constrained from pledging or exchanging the assets it receives, each third-party holder of its beneficial interests) has the right to pledge or exchange the transferred financial assets, and (3) we or our agents does not maintain effective control over the transferred financial assets or third-party beneficial interest related to those transferred assets through an agreement to repurchase them before their maturity. We have determined that all loans sold have met these specific conditions and accounts for all transfers of mortgage loans as completed sales.

 

Capitalized Mortgage Servicing Rights

 

We recognize, as separate assets, rights to service mortgage loans for others, including such rights that are created by the origination of mortgage loans that are sold with the servicing rights retained by the originator. Income from mortgage servicing rights (“MSRs”) is recognized when we record a derivative asset upon the commitment to originate a loan with a borrower and sell the loan to an investor. This commitment asset is recognized at fair value, which reflects the estimated fair value of the expected net cash flows associated with the servicing of the loan. When a mortgage loan is sold, we retain the right to service the loan and recognize the MSR at the initial capitalized valuation. We amortize MSRs using the amortization method, which requires the MSRs to be amortized in proportion to and over the period of estimated net servicing

 

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September 30, 2016

 

income or net servicing loss and that the servicing assets or liabilities be assessed for impairment, or increased obligation, based on the fair value at each reporting date. Amortization of MSRs is recorded as a reduction of servicing revenues, net on the consolidated statements of income. The following assumptions were used in calculating each loan’s MSR for the periods presented:

 

Key rates:   We used discount rates ranging from 8% to 18%, representing a weighted average discount rate of 13%, based on management’s best estimate of market discount rates to determine the present value of MSRs. The inflation rate used for adequate compensation was 3%.

 

Servicing Cost:   The estimated future cost to service the loan for the estimated life of the MSR is subtracted from the estimated future cash flows.

 

Estimated Life:   We estimate the life of our MSRs based upon the stated yield maintenance and/or prepayment protection term of the underlying loan and may be reduced by 6 to 12 months based upon the expiration of various types of prepayment penalty and/or lockout provisions prior to that stated maturity date.

 

We carry MSRs at the lower of amortized cost or fair value and evaluate the carrying value for impairment on a portfolio basis quarterly. Fair values are estimated considering market prices for similar MSRs, when available, and by estimating the present value of the future net cash flows of the capitalized MSRs, net of adequate compensation for servicing. Adequate compensation is based on the market rate of similar servicing contracts. We estimate the terms of commercial servicing for each loan by assuming that servicing would not end prior to the yield maintenance date, if applicable, at which point the prepayment penalty expires. MSRs are amortized in proportion to and over the period of estimated net servicing income. We engage an independent third party to assist in determining an estimated fair value of our MSR portfolio on a quarterly basis.

 

We measure the impairment of MSRs based on the difference between the aggregate carrying amount of the MSRs and their aggregate fair value. For purposes of impairment evaluation, the MSRs are stratified based on predominant risk characteristics of the underlying loans, which we have identified as loan type, note rate and yield maintenance provisions. To the extent that the carrying value of the MSRs exceeds fair value, a valuation allowance is established.

 

We record write-offs of MSRs related to the loans that were repaid prior to the expected maturity and loans that have defaulted and determined to be unrecoverable. When this occurs, the write-off is recorded as a direct write-down to the carrying value of MSRs and is included as a component of servicing revenue, net on the statements of income. This direct write-down permanently reduces the carrying value of the MSRs, precluding recognition of subsequent recoveries.

 

Derivative Assets and Liabilities

 

Our rate lock and forward sales commitments associated with the Agency Business meet the definition of a derivative and are recorded at fair value in our consolidated balance sheets. The estimated fair value of rate lock commitments includes the effects of interest rate movements as well as the fair value of the expected net cash flows associated with the servicing of the loan which is recorded as income from mortgage servicing rights on the consolidated statements of income. The estimated fair value of forward sale commitments includes the effects of interest rate movements between the trade date and balance sheet date. Adjustments to the fair value are reflected as a component of other income, net on the consolidated statements of income.

 

Business Combinations

 

Business combinations are accounted for under the acquisition method of accounting, under which the purchase price is allocated to the fair value of the assets acquired and liabilities assumed at the acquisition date. The excess of the purchase price over the amount allocated to the assets acquired and liabilities assumed is recorded as goodwill. Adjustments to the assets acquired and liabilities assumed made during the measurement period are recorded in the period in which the adjustment is identified, with a corresponding adjustment to goodwill. If any adjustments are made subsequent to the measurement period, which could be up to one year after the acquisition date, these adjustments are recorded to the consolidated statements of income. Acquisition related costs are expensed as incurred.

 

Goodwill and Other Intangible Assets

 

Significant judgement is required to estimate the fair value of intangible assets and in assigning their respective estimated useful lives. Accordingly, we typically seek the assistance of independent third party valuation specialists for significant intangible assets. The fair value estimates are based on available historical information and on future expectations and assumptions deemed reasonable by management.

 

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

September 30, 2016

 

We generally use an income based valuation method to estimate the fair value of intangible assets, which discounts expected future cash flows to present value using estimates and assumptions determined and deemed reasonable by management. For intangible assets related to acquired technology, we use the replacement cost method to determine fair value.

 

Determining the estimated useful lives of intangible assets also requires judgment. Certain intangible assets, such as GSE licenses, have been deemed to have indefinite lives while other intangible assets, such as broker and borrower relationships, above/below market rent and acquired technology have been deemed to have finite lives. Our assessment as to which intangible assets are deemed to have finite or indefinite lives is based on several factors including economic barriers of entry for the acquired product lines, scarcity of available GSE licenses, technology life cycles, retention trends and our operating plans, among other factors.

 

Goodwill and indefinite-lived intangible assets are not amortized, while finite-lived intangible assets are amortized over the estimated useful lives of the assets on a straight-line basis.  Indefinite-lived intangible assets, including goodwill, are tested for impairment whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. In addition, with respect to goodwill, an impairment analysis is performed at least annually. We have elected to make the first day of our fiscal fourth quarter the annual impairment assessment date for goodwill. We first assess qualitative factors to determine whether it is more likely than not that the fair value is less than the carrying value. If, based on that assessment, we believe it is more likely than not that the fair value is less than the carrying value, then a two-step goodwill impairment test is performed.

 

Allowance for Loss-Sharing Obligations

 

When a loan is sold under the Fannie Mae DUS program, we undertake an obligation to partially guarantee the performance of the loan. Generally, we are responsible for losses equal to the first 5% of the unpaid principal balance (“UPB”) and a portion of any additional losses to an overall maximum of 20% of the original principal balance. Fannie Mae bears any remaining loss. In addition, under the terms of the master loss-sharing agreement with Fannie Mae, we are responsible for funding 100% of mortgage delinquencies (principal and interest) and servicing advances (taxes, insurance and foreclosure costs) until the amounts advanced exceeds 5% of the UPB at the date of default. Thereafter, we may request interim loss-sharing adjustments which allow us to fund 25% of such advances until final settlement.

 

At inception, a liability for the fair value of the obligation undertaken in issuing the guaranty is recognized. In determining the fair value of the guaranty obligation, we consider the risk profile of the collateral and the historical loss experience in our portfolio. The guaranty obligation is removed only upon either the expiration or settlement of the guaranty.

 

We evaluate the allowance for loss-sharing obligations by monitoring the performance of each loss-sharing loan for events or conditions which may signal a potential default. Historically, initial loss recognition occurs at or before a loan becomes 60 days delinquent. In instances where payment under the guaranty on a specific loan is determined to be probable and estimable (as the loan is probable of foreclosure or is in foreclosure), we record a liability for the estimated allowance for loss-sharing (a “specific reserve”) by transferring the guarantee obligation recorded on the loan to the specific reserve with any adjustments to this reserve amount recorded in provision for loss sharing in the statements of income, along with a write-off of the associated loan-specific MSR. The amount of the allowance considers our assessment of the likelihood of repayment by the borrower or key principal(s), the risk characteristics of the loan, the loan’s risk rating, historical loss experience, adverse situations affecting individual loans, the estimated disposition value of the underlying collateral, and the level of risk sharing. We regularly monitor the specific reserves on all applicable loans and update loss estimates as current information is received.

 

Revenue Recognition

 

Fee-based services related to our Agency Business includes commitment fees, broker fees, loan assumption fees, loan origination fees and gains on sale of loans. In some instances, the borrower pays an additional amount of interest at the time the loan is closed, an origination fee, net of any direct loan origination costs incurred, which is

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

September 30, 2016

 

recognized upon sale of the loan. Revenue recognition occurs when the related services are performed, unless significant contingencies exist, and for the sale of loans, when all the incidence of ownership passes to the buyer. Interest income is recognized on the accrual basis as it is earned from loans held-for-sale.

 

Recently Issued Accounting Pronouncements

 

In August 2016, the Financial Accounting Standards Board (“FASB”) amended its guidance to reflect eight targeted changes to how cash receipts and cash payments are presented and classified in the statement of cash flows. The guidance is effective for us beginning in the first quarter of 2018 and requires adoption on a retrospective basis, unless it is impracticable for us to apply, in which case, we would be required to apply the amendment prospectively as of the earliest date practicable.  We are currently evaluating the impact this guidance may have on our consolidated statement of cash flows.

 

In June 2016, the FASB issued updated guidance which requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Companies will be required to use forward-looking information to better form their credit loss estimates. This updated guidance also requires enhanced disclosures to help financial statement users better understand significant estimates and judgments used in estimating credit losses. The guidance is effective for us beginning in the first quarter of 2020, and early adoption is permitted beginning in the first quarter of 2019. We are currently evaluating the impact this guidance may have on our consolidated financial statements.

 

In March 2016, the FASB amended its guidance on stock compensation, which is intended to simplify several aspects of the accounting for share-based payment award transactions, including income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. The guidance is effective for the first quarter of 2017 and we do not believe the adoption of this guidance will have a material impact on our consolidated financial statements.

 

In March 2016, the FASB amended its guidance on accounting for equity method investments. Among other things, the amended guidance eliminates the requirement that when an investment qualifies for use of the equity method as a result of an increase in the level of ownership interest or degree of influence, an investor must adjust the investment, results of operations, and retained earnings retroactively on a step-by-step basis as if the equity method had been in effect during all previous periods that the investment had been held. The guidance is effective for the first quarter of 2017 and we do not believe the adoption of this guidance will have a material impact on our consolidated financial statements.

 

In February 2016, the FASB amended its guidance on accounting for leases that requires an entity to recognize balance sheet assets and liabilities for leases with terms of more than 12 months and also requires disclosure of key information about an entity’s leasing arrangements. The guidance is effective for the first quarter of 2019 with early adoption permitted. A modified retrospective approach is required. We are currently evaluating the impact this guidance may have on our consolidated financial statements.

 

In January 2016, the FASB amended its guidance on the recognition and measurement of financial assets and liabilities.  The amended guidance requires equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair

 

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September 30, 2016

 

value recognized in net income. This update also, among other things, eliminates the requirement for an entity to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost. The guidance is effective for the first quarter of 2018 and we are currently evaluating the impact it may have on our consolidated financial statements.

 

In May 2014, the FASB amended its revenue recognition guidance. Among other things, the amended guidance outlines a framework for a single comprehensive model that entities can use when accounting for revenue and supersedes most current revenue recognition guidance, including that which pertains to specific industries such as homebuilding (e.g., sales of real estate, etc.). The core principle states that an entity should recognize revenue to depict the transfer of promised goods or services in an amount that reflects the consideration to which the entity expects to be entitled in exchange for such goods and services. It also requires expanded quantitative and qualitative disclosures that will enable the users of an entity’s financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. This guidance is effective for the first quarter of 2018. We are currently evaluating the impact this guidance may have on our consolidated financial statements.

 

Recently Adopted Accounting Pronouncements

 

In September 2015, the FASB amended its guidance on measurement-period adjustments arising from business combinations.  The guidance was effective for the first quarter of 2016 and it did not have an impact on our consolidated financial statements.

 

In February 2015, the FASB amended its guidance on the consolidation analysis of VIEs.  The guidance was effective for the first quarter of 2016 and it did not have a material impact on our consolidated financial statements. See Note 15 — Variable Interest Entities for further details.

 

Note 3 — Acquisition of Our Manager’s Agency Platform

 

On July 14, 2016, we completed the previously announced Acquisition pursuant to an asset purchase agreement (“Purchase Agreement”) dated February 25, 2016. The aggregate purchase price was $275.8 million, which was paid with $138.0 million in stock, $87.8 million in cash and with the issuance of a $50.0 million seller financing instrument. The equity component of the purchase price was paid with 21,230,769 operating partnership units (“OP Units”), which was based on a stock price of $6.50 per share. The closing price of our common stock on the day of the Acquisition was $7.29 per share; therefore, the estimated fair value of the total consideration given to our Manager was $292.5 million.  Each of these OP Units are paired with one share of our Special Voting Preferred Shares, which provides ACM with one vote per share on any matter submitted to a vote of our stockholders. The OP Units are entitled to receive distributions if and when our Board of Directors authorizes and declares future common stock distributions. The OP Units are also redeemable for cash, or at our option, for shares of our common stock on a one-for-one basis. See Note 12 — Debt Obligations for further details about the seller financing and Note 18 — Equity for further details about the OP Units.

 

All ACM employees directly related to the Agency Business (approximately 235) have become our employees as of the Acquisition date. In addition, pursuant to the Purchase Agreement, we have a two year option to purchase the existing management agreement and fully internalize our management structure for $25.0 million (increasing to $27.0 million in the second year). The exercise of this option is at the discretion of the special committee of our Board of Directors, which has no obligation to exercise its option.

 

We performed a preliminary allocation of the purchase price to the underlying assets acquired and liabilities assumed based on their estimated fair values as of the Acquisition date, with the excess of the purchase price allocated to goodwill. We have not finalized the analysis of certain acquired assets and liabilities assumed. However, we are continuing our review of these items during the measurement period and any further changes to the preliminary purchase price allocation will be recognized as the valuations are finalized, which could change the amount of the purchase price allocated to goodwill. The preliminary purchase price allocations are summarized as follows:

 

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September 30, 2016

 

Purchase Price:
Issuance of 21,230,769 OP Units at $7.29 per share (based on the closing stock price at the date of Acquisition)		$	154,772,306
Cash on hand		87,755,517
Borrowings from seller financing - related party		50,000,000
Total consideration		$	292,527,823
Allocated to:
Cash and cash equivalents		$	7,982,584
Restricted cash		5,000,000
Loans held-for-sale, net		424,796,318
Available-for-sale securities, at fair value		4,908,283
Capitalized mortgage servicing rights, net		221,647,421
Fixed assets		5,216,972
Other assets		10,752,173
Finite-lived intangible assets		44,310,000
Infinite-lived intangible assets		29,000,000
Credit facilities and repurchase agrements		(420,889,886		)
Allowance for loss-sharing obligations		(32,616,821		)
Other liabilities		(35,369,251		)
Goodwill		27,790,030
Net assets acquired		$	292,527,823

 

In connection with the Acquisition, we recorded goodwill as a result of the total consideration exceeding the fair value of the assets acquired and liabilities assumed. The Goodwill was attributed to our Agency Business as it relates to the assets we acquired in the Acquisition. See Note 4 — Goodwill and Other Intangible Assets for further details about the identified intangible assets.

 

The total revenues and pre-tax income associated with the Agency Business from the date of Acquisition, which is included in the consolidated statements of income for both the three and nine months ended September 30, 2016, were $34.5 million and $14.3 million, respectively.

 

The following unaudited pro forma financial information presents the revenues and earnings of the combined entity, as if the Acquisition occurred as of January 1, 2015. The unaudited pro forma financial information is not intended to represent or be indicative of the consolidated financial results of operations that would have been reported had the Acquisition been completed as of January 1, 2015 and should not be taken as indicative of our future consolidated results of operations.

 

		Nine Months Ended September 30,
Supplementary Pro Forma Information		2016			2015
Revenues		$	212,136,723		$	198,178,465
Net income attributable to noncontrolling interest		$	18,262,614		$	17,338,814
Net income attributable to common stockholders		$	40,329,043		$	41,543,271
Diluted earnings per common share		$	0.78		$	0.82

 

In connection with the Acquisition, we incurred legal and advisory fees totaling $6.4 million and $10.3 million during the three and nine months ended September 30, 2016, respectively, and fees totaling $14.7 million to date. We do not expect to recognize any significant additional fees in connection with the Acquisition.

 

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September 30, 2016

 

Note 4 — Goodwill and Other Intangible Assets

 

Goodwill

 

The following table sets forth the goodwill activity for the nine months ended September 30, 2016:

 

		As of and for the  Nine Months Ended  September 30, 2016
Beginning balance		$	—
Additions from the Acquisition		27,790,030
Impairment		—
Ending balance		$	27,790,030

 

Other Intangible Assets

 

The following table sets forth the other intangible assets activity for the nine months ended September 30, 2016:

 

		Gross Carrying Value									Accumulated Amortization
		December 31, 2015			Additions			September 30, 2016			December 31, 2015			Additions			September 30, 2016
Finite-lived intangible assets:
Broker relationships		$	—		$	25,000,000		$	25,000,000		$	—		$	651,042		$	651,042
Borrower relationships		—			14,400,000			14,400,000			—			300,000			300,000
Below market leases		—			4,010,000			4,010,000			—			153,502			153,502
Acquired technology		—			900,000			900,000			—			62,500			62,500
Infinite-lived intangible assets:
Fannie Mae DUS license		—			17,100,000			17,100,000			—			—			—
Freddie Mac Program Plus license		—			8,700,000			8,700,000			—			—			—
FHA license		—			3,200,000			3,200,000			—			—			—
		$	—		$	73,310,000		$	73,310,000		$	—		$	1,167,044		$	1,167,044

 

The finite-lived intangible assets recorded in connection with the Acquisition have the following useful lives: broker relationships — 8 years; borrower relationships — 10 years; below market leases — 3.5-10.6 years and acquired technology — 3 years.

 

The weighted average remaining lives of our amortizable finite-lived intangible assets as of September 30, 2016 and the estimated amortization expense for each of the succeeding five years are as follows:

 

		Weighted		Estimated Amortization Expense
		Average  Remaining		Three Months  Ended December 31,			Years Ending December 31,
		Life (in years)		2016			2017			2018			2019			2020			2021
Finite-lived intangible assets:
Broker relationships		7.8		$	781,250		$	3,125,000		$	3,125,000		$	3,125,000		$	3,125,000		$	3,125,000
Borrower relationships		9.8		360,000			1,440,000			1,440,000			1,440,000			1,440,000			1,440,000
Below market leases		6.3		184,203			736,811			736,811			736,811			684,137			126,118
Acquired technology		2.8		75,000			300,000			300,000			162,500			—			—
		8.2		$	1,400,453		$	5,601,811		$	5,601,811		$	5,464,311		$	5,249,137		$	4,691,118

 

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