2023-07-06 04:13:05 ET
Summary
- Arbor is rallying as the market looks past the early 2023 bearish narrative around the health of US commercial real estate.
- We've likely seen the end of further interest rate hikes in 2023 with inflation moderating.
- Any further upside might be limited with the mREIT currently trading above book value.
- The prospect of further dividend hikes against a 147.6% dividend coverage ratio means I'm still bullish on the commons.
Arbor Realty ( ABR ) is currently amidst a rally after a selloff sparked earlier this year saw the common shares of the mortgage REIT drop to around $10 as bears capitalized on macroeconomic pressure. The short interest in ABR still sits a 16.92% against shares that are now up 18% on a total return basis year-to-date. The commons are also up 28.6% since I last covered the ticker after I made the decision to abandon the relative safety of the mREIT's preferred shares ( ABR.PD ) for a fuller position in the commons. Since then most of Arbor's other tradeable preferreds ( ABR.PF ) and ( ABR.PE ) have also rallied as the company stages a redemption against a still uncertain macroeconomic backdrop. Crucially, the Fed has broken with what had been ten consecutive interest rate hikes to pause rates at 5% to 5.25% at their June FOMC meeting.
I think that's the rate range that we're set to see through to the end of the year even against comments by Fed Chair Jerome Powell that they see the possibility of more rate hikes in 2023. The Fed has shifted to an entirely data-dependent decision-making matrix, hence against comments from their June 14th FOMC meeting stating that they're fully committed to reaching their 2% target, we should expect only to see further hikes only if the trendline of headline inflation reverses course.
Moderating Inflation Should Provide Support To The Commons
Consumer price inflation came in at 4% for May with expectations that it will drop to 3.6% when the June reading comes out on the 12th of July next week. Crucially, the FOMC with its June pause showed it's willing to ignore a strong labor market as long as headline CPI continues to decline. I think forward inflation expectation by bears continues to ignore the impact of falling energy on consumer prices. This fall has an incredibly lagging impact with natural gas, the main feedstock for US electricity, seeing record prices above $6 per MMBtu for most of 2022. This only just started seeing its price moderate below $3 per MMBtu in March. The Energy Information Administration now expects wholesale electricity prices to average $51.36 per MWh in 2023, down at least 37% from its 2022 averages.
This is important as peak inflation last year and the subsequent rise in the Fed funds rate saw Arbor's commons shed significant value from their highs. The current rally has been buffeted by the June pause and expectations from bulls of further moderating inflation holding more sway than the bearish narrative. Internally managed Arbor is in the business of providing loans to multifamily projects and other US commercial real estate property types. Critically, whilst office properties face some headwinds, Arbor's core focus on multifamily properties is a distinct niche that hedges the mREIT against the broader uncertainties of US commercial real estate.
The market seems to have painted all CRE with the same brush and Arbor has been swept up with the subsequent selloff from an intensely bearish zeitgeist that took hold earlier this year. However, whilst this zeitgeist has now dumped Arbor whose portfolio was 91% comprised of multifamily loans as of the end of its fiscal 2023 first quarter, multifamily properties could still face headwinds from a possible recession that would see nonperforming loans spike up. This was limited to four loans with a $7.7 million carrying value, against a total loan portfolio of $13.64 billion as of the end of the first quarter.
How The Bears Got It All Wrong
The warnings about US CRE and the impending doom have now become visceral. It's hard to escape it as negative trends tend to be overemphasized and perhaps over-extrapolated. It's easy to see why Arbor, where office property loans only comprised 1% of its total loan portfolio, sold off as these warnings got louder and louder to crowd out rationality. The mREIT's investment portfolio had an all-in yield of 8.83% as of the end of its first quarter, a 41 basis point sequential increase from the prior fourth quarter. Crucially, the growth in dividends has not come at the expense of book value.
Book value came in at around $12.47 per share, up sequentially from $12.38 in the fourth quarter and by $0.58 from the year-ago comp. If the bears had seen the stability of book value and that shares had deeply sold off to below book in early 2023, they would have known their position was untenable. Critically, Arbor is now trading at a premium to book which could limit further upside even against its 147.6% dividend coverage ratio on the back of distributable earnings of $0.62 per share during the first quarter. I'm still expanding my position in the commons so will rate it as a buy but I'd likely expect some moderation of upward positive volatility.
For further details see:
Arbor Realty: Why The Bears Got This One Wrong