Summary
- Arbor Realty increases dividend for a ninth consecutive quarter.
- Dividend is well covered.
- Consecutive quarterly dividend increases should continue.
New York Yankee great Yogi Berra was a three-time American League Most Valuable Player, an 18-time All Star, and, after his playing days were over, became a manager that took both the Yankees and Mets to the World Series. The Baseball Hall Of Fame catcher was also known almost as much for his use - and misuse - of the English language as he was for his prowess on the baseball diamond. He even wrote a book about his quotes titled "The Yogi Book: I Really Didn't Say Everything I Said".
Those quotes included, "When you come to a fork in the road.... take it.", "You can observe a lot by just watching", and "No one goes there nowadays, it’s too crowded." And, of course, in 1973 there was the response to a question about whether the NY Mets (the team he was managing) were already out of the pennant race when they were more than 11 games behind at the end of July. Baseball lore has it that he replied to that question with the famous line, "It ain't over 'til it's over". Even if he didn't say those exact words, the essence of that phrase could certainly apply to the remarkable run of the quarterly dividend increases by Arbor Realty ( ABR ).
The Arbor Dividend
Have I always been accurate with my predictions about Arbor and the timing of our investments in its stock? Not even close. We originally invested in Arbor back in 2007, attracted by its $2.48 annual dividend. It was a dividend that would soon be decreased, and then disappear altogether during the financial crisis in 2008-09. Arbor would survive that crisis and eventually reinstate the dividend.
By reinvesting all of the dividends, the dollar value of that original position has more than tripled - approximately a 9% compounded annual growth rate. We would add to our positions over the years, and Arbor is currently our third-largest holding. While I try to present unbiased evaluations in the articles I submit to Seeking Alpha, it's certainly possible that my personal investments in the stock, the recent performance and our large positions introduces an unintended bias into this article.
When Arbor released its second quarter earnings that exceeded expectations, it also announced that it
Raised [the] cash dividend on common stock to $0.39 per share, our 9 th consecutive quarterly increase...
The $1.56 annual dividend results in a very attractive double-digit forward yield. Based on comments by management during the company's second quarter conference call, the remarkable run of consecutive quarterly increases probably "ain't over". Arbor CEO, Ivan Kaufman, began the call with a more detailed discussion about that dividend:
As you can see from this morning's press release, we had another tremendous quarter, including producing earnings that were once again well in excess of our dividend. As a result, we're able to increase our dividend to $0.39 a share, and this is our ninth consecutive quarterly dividend increase, representing 30% growth over that time period, all while maintaining the lowest dividend payout ratio in the industry.
Earnings that were well in excess of the dividend, and having the lowest dividend payout ratio in the industry, aren't guarantees about future dividend increases, or even the sustainability of the current dividend. However, when the CEO begins the earnings conference call emphasizing those positives, it's certainly reassuring.
Business Environment
But what about the homeowners or tenants watching food and fuel inflation taking a larger bite out of their monthly budgets? Will renters or home-owners have difficulty paying their rent or making mortgage payments? Will landlords have difficulty making their payments if renters can't make payments and have to trade down? (As a former landlord, I have found that evictions and finding replacement tenants can be a slow process.) Kaufman also addressed a portion of these issues:
As we have mentioned many times, our diverse business model offers several strategic advantages, which is something that needs to be emphasized, especially given the recessionary environment. We have built a premium operating platform that is focused on the right asset classes with very stable liability structures, including over $8 billion in nonrecourse, non-mark-to-market CLO debt, which requires approximately 70% of our outstanding secured indebtedness with pricing that is well below the current market.
Despite "the recessionary environment", Arbor management apparently sees additional opportunities where it can employ those "strategic advantages". Shortly after the release of its Q2 results, it went back to the markets to raise more capital and...
announced the pricing of its upsized offering of $250 million aggregate principal amount of its 7.50% Convertible Senior Notes due 2025 (the “Notes”) in a private placement to qualified institutional buyers. The aggregate principal amount of the offering was increased from the previously announced offering of $200 million aggregate principal amount of Notes.
The company also noted that it could use a portion of the proceeds to redeem its 4.75% notes that will mature later this year. It appears as though there are $261 million worth of the 4.75% bonds outstanding, and it seems borrowing at 7.5% to redeem notes costing 4.75% would be a negative. While there is some validity to that thought, when one compares that to the alternative of raising capital by issuing more stock, it becomes obvious that the potential "cost" of the dividends would be far greater. One other point about these new Notes that was discussed in a press release - they have a conversion option that would allow the holders to redeem the Notes for stock at a redemption price
of approximately $16.71 per share of common stock, representing an approximate 10.00% conversion premium based on the closing price of the Company’s common stock of $15.19 per share on August 2, 2022.
The private placement response by qualified institutional buyers to the 2025 Convertible Notes offering (remember, the offering was upsized by 25%) tells me that those with sharp pencils see significant value.
What About The Risk Of A Repeat Of the 2008-09 Recession?
Wait a minute... Didn't they eliminate the dividend back in 2009-2012? Why won't it happen again? Well, first of all, it's a different business model today. When we made our initial investment, Arbor specialized in bridge loans that included equity participation in apartment buildings. When the real estate market imploded, that equity disappeared.
Then, in the middle of 2016 Arbor completed the acquisition of
Arbor Commercial Mortgage’s (“ACM’s”) agency platform for $276 million...
That platform gave Arbor a stable source of revenue as a top performer in the Federal Government's Delegated Underwriting and Servicing program. During the Q2 earnings call Kaufman stated:
In our GSE/Agency and Private Label programs, we originated $1.2 billion of loans in the second quarter. We also have a robust pipeline what will give us confidence in our ability to produce consistent volumes for the rest of the year. Our GSE/Agency platform continues to offer a premium value as it requires limited capital and generates significant long-dated predictable income streams and produces significant annual cash flow.
Additionally, our $27 billion GSE/Agency servicing portfolio is mostly prepayment-protected and generates approximately $117 million a year in reoccurring cash flow. This is in addition to the strong gain on sale margins we generate from our origination platform and a significant increase in earnings on our escrow balances that we are experiencing as interest rates continue to rise, which is unique to our platform and will continue to greatly enhance our earnings and dividends.
The market isn't convinced, and the stock remains mired near $15 despite the $1.56 dividend.
The Rating
Seeking Alpha requires contributors to assign ratings to the stocks that we write about, ranging from Strong Buy to Strong Sell. As I noted earlier, Arbor is our third-largest equity holding, and we continue to reinvest the dividends on more than two thirds of that position. The other "third" of that holding is a trading position that throws off significant cash, and will be liquidated when the price approaches $20. Even with that potential reduction, Arbor would still be a top five holding.
According to Seeking Alpha, two of the five Wall Street analysts that follow ABR rate it a Hold, with the other three rating it a Buy. From my perspective, it's clearly not a Strong Sell or Sell. Do I consider it a Hold? I think that an equity with a 10% dividend that is well covered, and likely to be increased for a tenth consecutive quarter, deserves more than a Hold. So does Arbor deserve a Strong Buy or just a Buy?
As Yogi once said, "When you come to a fork in the road.... take it." In this case, I have decided to take the one labeled Strong Buy. The combination of a double-digit yield, the likelihood that additional dividend increases "ain't over", and the potential for double-digit capital appreciation tilt the rating to Strong Buy.
End Notes: What about those Yogi Berra-managed NY Mets of 1973? The team finished the regular season with a record of 82 wins and 79 losses to take the National League East title. It wasn't yet over, although it was the fewest wins by any team that made it to the post-season since the schedule was increased to 162 games (not counting seasons that were shortened by strikes or COVID-19). After eliminating the Cincinatti Reds 3 games to 2 to become National League champions, they met the Oakland Athletics in the World Series. Despite the catchphrase "Ya Gotta Believe" of Mets relief pitcher Tug McGraw, the team lost 4 games to 3 to an outstanding Oakland team . It was finally over.
For further details see:
Arbor Realty Trust: Dividend Increases 'Ain't Over'