In my previous article on Arbor Realty Trust (NYSE:ABR) I explained that the company’s 2Q 2023 results (which were not published back then) are not expected to be as strong as in 1Q 2023. Also, I explained that due to a relatively low payout ratio, the company’s Board of Directors might be able to announce a quarterly dividend of between $0.40 to $0.42 in 2Q 2023, making ABR an attractive investment at prices below $13. Well, for the second quarter of 2023, Arbor Realty Trust reported a net income of $93 million, compared with $102 million in the previous quarter, and the company’s Board of Directors declared a quarterly cash dividend of $0.43 per common stock for the quarter ended 30 June 2023, payable on 31 August 2023, to common stockholders of record on 15 August 2023 (it is important to note that the ex-dividend date is 14 August 2023). Arbor Realty Trust’s stock price increased by 35% since the publication of my article, while the S&P 500 increased by 7% in the same period. Arbor Realty Trust still has a low dividend payout ratio, and even with lower earnings in 2H 2023, might be able to maintain its current quarterly dividend.
The next few quarters are expected to be challenging for REITs as there might be more benchmark interest hikes. Due to the non-favorable macroeconomic outlook, and ABR’s stock price jump in the past 4 months, the short interest on the stock increased from $233 million on 31 March 2023 to $670 million on 15 July 2023, and it might have increased further in the past 3 weeks. Overall, based on the positive and negative factors that can affect ABR’s financial results and operations, a 1-year forward dividend yield of more than 10% is reliable, Thus, if you are looking for a safe dividend at yields around 10%, Arbor is on the table. However, I don’t expect the price rally to continue in the next few months. Thus, if you are looking for the stock price to increase significantly further, it might not be a good time, and it is better to wait until there are signals for interest rate cuts that I expect to emerge in the first quarter of 2024. In a nutshell, for me, ABR is a short-term hold and a long-term but.
Financial position outlook
For the second quarter of 2023, Arbor Realty Trust reported GAAP net income and distributable earnings of $0.41 per diluted common share (down 11%), and $0.57 per diluted common share (down 8% QoQ), respectively. Thus, the company’s payout ratio increased from 68% in 1Q 2023 to 75% in 2Q 2023. The company’s net interest income in 2Q 2023 was almost the same as in the previous quarter as the company’s higher interest income, almost entirely offset higher interest income resulting from the higher interest rates.
The company’s provision for credit losses in 2Q 2023 and 1H 2023 was higher than the same periods last year, as the macroeconomic outlook for the commercial real estate market became less promising (due to hiked interest rates higher unemployment forecasts, inflationary pressures, and potential financial instabilities). In the three months ended 30 June 2023, ABR recorded a provision for credit losses of $16.0 million, compared with $20.5 million in 1Q 2023. An additional $16 million in CECL reserves in the second quarter of 2023 means that the company still believes that in the next few quarters, there might be some challenges. However, as CECL reserves in the second quarter of 2023 were lower than in the previous quarter, we can say that ABR’s management has concluded that the outlook would not be as challenging as it was expected in the first quarter of 2023. “These reserves do not affect distributable earnings as we have not experienced any realized losses on these loans to date,” the CFO explained.
It is worth noting that on 30 June 2023, the company had seven non-performing loans with a carrying value of $122.4 million (before loan loss reserves of $10.1 million). On 31 March 2023, ABR had four non-performing loans with a carrying value of $7.7 million (before loan loss reserves of $5.1 million). I expect the real estate market to improve in the first half of 2024 (due to lower inflationary pressures that may persuade the Federal Reserve to start decreasing interest rates by the beginning of 2024), the number of ABR’s non-performing loans can decrease and the company’s provision for credit losses in 1H 2024 can be lower than in 1H 2023. However, in the second half of 2023, Arbor might add to the number of its non-performing loans as its borrowers may not be able to cover their obligations due to increased expenses, driven by higher insurance costs, higher taxes, and higher labor costs, combined with the negative effect of high interest rates on their financial position.
One might argue that the more non-performing loans might not necessarily affect ABR’s financial results in a negative way. I agree. But even ABR’s expenses have increased in a significant way. In the second quarter of 2023, ABR experienced higher employee compensation and benefits expenses (due to an increase in commissions from higher GSE/Agency loan sales volume), and higher provisions for loss sharing and credit losses (due to continued decline in the macroeconomic outlook for commercial real estate market). Thus, with a more severe financial market condition, which is not impossible, the borrowers may not be able to cover their obligations for a long time, so Arbor may incur losses in reality.
Normally, Arbor Realty Trust doesn’t give a financial outlook. However, according to the company’s CFO in the 2Q 2023 Earnings Call, ABR’s 2Q 2023 and 4Q 2023 distributable earnings may not be as strong as before. With lower net income and lower distributable earnings in the third and fourth quarters of 2023, Arbor might still be able to pay quarterly dividends of about $0.43. However, paying quarterly dividends of about $0.43 with lower distributable earnings can increase its dividend payout ratio to more than 85%. The company’s ability to declare quarterly dividends of about $0.43 in 3Q and 4Q 2023 is not the only important thing. The share of distributable earnings that the company can decide not to distribute (without giving bearish sentiments to investors) is also important for the company’s subsequent operations. A few months ago, the company was able to keep about 35% of its distributable earnings while keeping shareholders happy with attractive dividends. Now it seems that in the third and fourth quarter of 2023, Arbor can keep only 15% of its distributable earnings (if the Board of Directors decides to declare quarterly dividends of about $0.43). In 2024, with higher distributable earnings, this can be changed. But for now, Arbor Realty Trust is not as attractive as it was a few months ago.
The housing market outlook
Home prices may increase further in 2024 as the demand for homes continues to exceed the supply. According to American Enterprise Institute (AEI), given continuing tight supply, and high mortgage rates, home prices in Unites States in 2024 are expected to increase by 7% (according to AEI’s base case scenario). Thus, in 2024, the number of agency purchase loan originations may remain lower than in previous years. However, it is worth noting that there is no consensus among analysts about home prices in 2024. For example, Morgan Stanley expects home prices to decrease by 2% in 2024. According to Fannie Mae’s CEO, only 20% of Americans think that it is a good time to buy a home. The tight monetary policy of the Federal Reserve to combat inflation caused mortgage rates to increase significantly in the past year to around 7%. The average 30-year fixed-rate mortgage in the United States on 3 August was 6.90%, higher than every other week in 2023 so far (see Figure 1). The Federal Reserve may raise interest rates further to reach its 2% inflation target, and a Federal Reserve Governor, Michelle Bowman, has already acknowledged it. Thus, there might be further rate increases for the remainder of the year before the Federal Reserve decides to cut interest rates in 2024. Higher interest rates in the next few months can affect negatively ABR’s financial results through lowering loan originations, increasing credit losses, and forcing the company toward restructuring the loans.
Figure 1 – U.S. average mortgage rates
With a 75% dividend payout ratio, even with lower net income in the third and fourth quarters of 2023, Arbor can maintain its current quarterly dividend, and even increase it. This is so important as due to high interest rates and a non-favorable macroeconomic condition for REITs, if ABR had a relatively higher dividend payout ratio, its Board of Directors could get into a position to either cut the dividend or decide to pay out over 100% of the distributable earnings. Thus, Arbor is in a good position, and if you are looking for reliable quarterly dividends, ABR is the right one to choose. However, I don’t expect the price rally that happened in the past few months to happen again for the remainder of the year. Until there are signals for interest rate cuts, ABR is a hold.