2023-08-09 09:00:00 ET
Summary
- Arbor Realty has seen a significant increase in stock price despite high short interest, indicating conflicting outlooks.
- Piper Sandler downgraded ABR due to concerns about the operating environment, but maintained a price target above the April lows.
- ABR's financial metrics, including revenue, net interest income, and dividend payout, have been strong, leading to insider buying and a bullish outlook.
Several months back, I added Arbor Realty (ABR) to my Dividend Harvesting Portfolio series. ABR makes up roughly 5% of my REIT allocation and 1.01% of the total value in the Dividend Harvesting Portfolio. ABR is not a large position in this series or in my overall investment portfolio, but it's becoming more interesting to me as time progresses. Shares of ABR have jumped more than 65% since their April 2023 lows of $10.10, yet short interest remains at 23.62%. Somebody is clearly wrong, and only time will tell if the bulls or bears prevail in their outlook. ABR recently received a double downgrade at Piper Sandler , yet the impact was minimal on the share price. While shares have had an impressive move toward the upside, ABR may not be as fragile as the shorts want it to be. I think ABR is an interesting income play as its yield exceeds 10%, and there could be some room left in the tank for further appreciation.
The Piper Sandler downgrade, short interest, and the risks ABR could face
On July 31, Piper Sandler downgraded ABR to underweight from overweight, and shares retraced by -1.5% after the news. Crispin Love from Piper Sandler found Q2 earnings to be favorable but is cautious due to the operating environment over the next several quarters. While Piper Sandler downgraded ABR, its price target remained well above the April lows as they're placing a $16 target on shares. Their view echoes part of the bearish thesis due to the possibility of the short-term credit market worsening.
As 2023 progressed, short interest in ABR increased dramatically. Arbor Realty Trust Short Interest Ratio and Volume finished 2022 with $88 million short interest dollar volume; over the next 6 ½ months, this has increased by 661.36% to $670 million. As interest rates have increased, shorts have piled in, driving short interest in ABR higher. Now, ABR's short interest has exceeded 20%, and there's no indication that the short interest in ABR will decline.
ABR is a mortgage REIT, and much of the bear thesis revolves around higher interest rates being bad for ABR's business. When interest rates increase, so does the cost of capital. When the cost of capital increases, it can negatively impact individuals and business's spending and borrowing money. Below I have put the 10-year charts for interest rates, mortgage market index, mortgage refinancing index, mortgage applications, and mortgage originations. There's a direct correlation between interest rates and these indexes. When interest rates rise, there's less activity in the housing industry, and we see declines in mortgages, refinancing, applications, and originations.
With ABR being a mortgage REIT, my speculation is that the bears and shorts are using conventional wisdom as their investment thesis. They're probably looking at the "macro-environmental" and coming to the conclusion that the combination of higher rates for longer will impede on mortgage activity in both new lending and refinancing while also leading to increased defaults causing a weakening economy. These are valid arguments that investors should be aware of as we have no idea how long the Fed will hold rates above the 5% level.
Despite bearish sentiment, ABR looks very interesting when I look at the numbers and the dividend
In a rising rate environment, conventional wisdom would suggest that mortgage REITs would face significant challenges. I would rather look at the underlying business metrics and see how ABR's management team is dealing with the current economic environment compared to when rates were lower. The aspects I'm looking at are total revenue, net interest income, book value, and the spread between EPS and the dividend.
In Q1 of 2023, ABR increased its YoY revenue by 15.43% from $152.3 million to $175.8 million. This led to increased net interest income rising by 29.13% from $84.1 million to $108.6 million in Q1 2023 YoY. The trend didn't stop at just Q1. As rates rose to over 5% in Q2 2023, ABR increased the amount of revenue it generated in Q2 YoY by $26.1 million (17.17%) to $178.1 million compared to $152 million. This drove another YoY increase in net interest income in Q2 by $14.2 million (15.06%) from $94.3 million to $108.5 million. Management is proving that in a tougher economic environment, its diversified business model is allowing it to flourish rather than remaining stagnant or declining.
These metrics have led to ABR driving its annualized EPS, dividend payout, and book value higher over time. Since the pandemic, ABR has grown its annualized EPS by 22.22% from $1.44 to $1.76. This has led to ABR increasing its dividend by 30.95% to $1.65 since 2020. During what can be considered some of the toughest economic conditions we have seen in the past decade between the pandemic and the rising rate environment, ABR has grown its revenue and net interest income which drove EPS higher, allowing ABR to continuously increase the dividend. On a quarterly basis since Q4 2020, ABR has also seen sequential QoQ growth in its book value as its increased 28.16% from $10.19 in Q4 2020 to $13.06 in Q2 of 2023.
From a dividend perspective, it's hard to be bearish on a company that continues to reward shareholders by continuously increasing the dividend. ABR's ability to drive earnings higher has allowed ABR to provide shareholders with their 12th dividend increase over the past 14 quarters. In Q2, ABR produced $114 million or $0.57 in distributable earnings, allowing ABR to increase the dividend to $1.72, which reflects a 75% payout ratio in Q2. It's hard for me to be bearish when management is delivering these metrics.
Insiders are buying, which is bullish
In addition to strong financial performance and dividend increases, senior leadership is buying shares. In 2023 Ivan Kaufman, who is ABR's president and CEO, has purchased 25,000 shares with $304,030 of his personal capital. William Green, who is a director, also purchased 12,796 shares with $166,871 of his personal capital. I love seeing this because there are many reasons to sell a stock, but only one reason to purchase: Because you feel it will be a profitable transaction. When leadership allocates their personal capital rather than just holding shares they received from options or stock-based compensation, it tells me that their interests align with shareholders and that they believe there is an opportunity in the current valuation.
Conclusion
I think that ABR is an interesting income play as they have provided 12 dividend increases over the past 14 quarters. ABR's yield still exceeds 10% after the current appreciation, and they continue to drive their revenue, net interest income and EPS higher. During the pandemic and the rising rate environment, the dividend grew rather than being suspended or reduced like others in their sector. Based on the financial metrics, and insider buying, I'm bullish on ABR as part of a diversified income portfolio. I plan on adding to my position in ABR in the Dividend Harvesting Portfolio, and there's a chance that I start a larger position in one of my main accounts.
For further details see:
Arbor Realty Is Heavily Shorted, But Earnings Suggest Things Are Good For The 10.29% Yielding REIT