2023-06-21 08:17:26 ET
Summary
- Arbor Realty Trust (ABR) surges almost 6% in after-hours trading after news of its inclusion in the S&P SmallCap 600 index.
- The firm looks well-capitalized with approximately $785 million in cash and liquidity on hand.
- REITs in general are now trading at a fairly large discount to their NAVs because of fears of a slowdown in the U.S. housing market.
- The Street does not see a feasible recovery in the next few years and the dividend yield of over 11% is given at a valuation far below that of the overall industry.
- I rate ABR stock a Buy this time around and urge people to consider ABR solely as an income investment over the long term.
Arbor Realty Trust ( ABR ) surged ~5.7% in after-hours trading after news of its inclusion in the S&P SmallCap 600 index, according to Seeking Alpha data. The inclusion in the index will take effect before trading begins on Friday, June 23.
But how much potential does ABR still have and does it make sense to chase this positive momentum now? Let's figure it out.
The Company
Arbor Realty Trust, Inc. is a $2.7-billion market cap real estate investment trust ((REIT)) and direct lender established in 2003, operating through 2 business segments: Structured Loan Origination and Investment Business, and Agency Loan Origination and Servicing Business. Through the Structured Business, they invest in a diversified portfolio of structured finance assets, including bridge loans, mezzanine loans, and real estate-related joint ventures. In the Agency Business, they originate, sell, and service multifamily finance products through government-sponsored enterprises and government agencies.
ABR's IR materials
Arbor Realty Trust's diverse business model offered significant advantages over its peers , with a premium operating platform and multiple products that generated countercyclical income streams, according to the CEO's words during the latest earnings call . This allowed them to consistently produce earnings well above their dividend and increase their dividend for the 11th time in the last 13 quarters:
In Q1 FY23, ABR reported distributable earnings of $122 million or $0.62 per share. This resulted in a return on equity ((ROE)) of approximately 19.7% for the quarter, which is 150 basis points higher than for the full-year 2022.
Arbor Realty Trust recorded an additional $20 million in CECL reserves on their balance sheet loan book, using more conservative assumptions in response to a decline in the macroeconomic outlook for commercial real estate. In the GSE/Agency business, ABR had a strong quarter, with $1.1 billion in loan originations and $800 million in loan sales. The company recorded mortgage servicing rights income related to committed loans, and its fee-based servicing portfolio grew by 3%.
The firm looks well-capitalized with approximately $785 million in cash and liquidity on hand. They also have an additional $560 million of deployable cash in their CLO vehicles and over $3.5 billion of availability in their structured warehouse lines.
What About ABR's Valuation?
Arbor Realty Trust had managed to grow its book value per share by 45% over the past three years, but despite this strong performance, ABR stock continued to trade at similar dividend yields and price-to-book values as the rest of the industry, leading Kaufman [the CEO] to believe that the company is undervalued.
As usual, the market is living on expectations and not paying much attention to actual past data - which is why REITs in general are now trading at a fairly large discount to their NAVs because of fears of a slowdown in the U.S. housing market.
BofA [June 16, 2023 - proprietary source]
On June 13, 2023, Goldman Sachs' team published an analysis piece [proprietary source], where analysts noted that mortgage applications experienced a YoY contraction of 32%, with purchase volumes down by 27% and refinancings falling by 42%. Adjustable-rate mortgages (ARMs) accounted for 7% of volumes, down from 8% a year ago. Purchase applications declined sequentially for the fourth consecutive week, down 13% from a month ago, indicating continued pressure on activity due to affordability concerns.
Goldman Sachs [June 13, 2023 - proprietary source]
The decline in mortgage applications and the impact of higher interest rates on affordability may affect demand for mortgage loans and potentially impact Arbor Realty Trust's loan origination and servicing business. However, ABR's diverse business model and strong liquidity position mentioned earlier could help the company navigate the challenging market conditions, in my view.
The earlier research report by the bank [June 1, 2023 - proprietary data] suggests that rent growth is slowing down in the current quarter, and vacancy rates are increasing across all markets, with the sunbelt markets experiencing higher rates than coastal markets.
Goldman Sachs [June 1, 2023 - proprietary source]
Slower rent growth may impact the potential returns on their multifamily and single-family rental properties. Additionally, increasing vacancy rates could indicate potential challenges in filling rental units, which could affect the cash flow and occupancy rates of ABR's properties.
The combination of the aforementioned factors, along with the release of the short seller report , has resulted in a significant increase in the number of shorts:
Depressing momentum has pushed the dividend yield well above the 10-year average:
In terms of the price-earnings ratio, ABR began to trade well below its historical average, and the forwarding multiple prices a slight contraction.
And the most interesting part of this story is that even though analysts have raised their FY2025 EPS forecast by >45% in the last 3 months , the implied P/E for this year is still ~8x.
Seeking Alpha Premium, author's notes
That is, a) the Street does not see a feasible recovery in the next few years and b) the dividend yield of over 11% is given at a valuation far below that of the overall industry.
Bottom Line
Despite the sector's obvious difficulties, I expect that ABR has absorbed enough risk in recent months, and now, with prospective stock market returns matching those of the bond market [based on the market risk premium], ABR's dividend yield looks relatively attractive, given the discount at which this REIT is trading.
As a positive macro point, I'd like to cite data from the aforementioned Goldman Sachs report in which the analysts cited their in-house scale for valuing the housing market. It now reflects historical norms, with a score of 5 indicating average conditions:
Goldman Sachs [June 13, 2023 - proprietary source]
Their analysis suggests that the housing market is unlikely to experience a repeat of the extreme conditions seen during that period due to economic factors and industry-specific dynamics.
So even if there is a recession, the consequences should be different than what the market saw during the GFC period. Quality companies like ABR are probably already priced for the potential consequences of the weakening economy - at least if you look at their valuation multiples. As such, I rate the stock a Buy this time around and urge people to consider ABR solely as an income investment over the long term.
Thank you for reading!
For further details see:
Arbor Realty Trust Soars Big - What's Left?