Good day ladies and gentlemen and welcome to the Arbor Realty Second Quarter 2017 Earnings Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded. I would like to introduce your host for today's conference, Mr. Paul Elenio, Chief Financial Officer. Sir, you may begin.

Okay. Thank you, Terence, and good morning everyone, and welcome to the quarterly earnings call for Arbor Realty Trust. This morning, we'll discuss the results for the quarter ended June 30, 2017. With me on the call today is Ivan Kaufman, our President and Chief Executive Officer. Before we begin, I need to inform you that statements made in this earnings call may be deemed forward-looking statements that are subject to risks and uncertainties, including information about possible or assumed future results of our business, financial condition, liquidity, results of operations, plans and objectives. These statements are based on our beliefs, assumptions and expectations of our future performance, taking into account the information currently available to us. Factors that could cause actual results to differ materially from Arbor's expectations in these forward-looking statements are detailed in our SEC reports. Listeners are cautioned not to place undue reliance on these forward-looking statements, which speak only as of today. Arbor undertakes no obligation to publicly update or revise these forward-looking statements to reflect events or circumstances after today or the occurrences of unanticipated events. I'll now turn the call over to Arbor's President and CEO, Ivan Kaufman.

Thank you, Paul, and thanks to everyone for joining us on today's call. As you can see from this morning's press release, we had a very successful second quarter with tremendous operating results, as we continue to benefit greatly from our significant operating franchise. Before I turn it over to Paul to take you through our financial results, I would like to focus on our recent progress and significant accomplishments, as well as our outlook for the remainder of 2017. We continue to have tremendous success in growing our brand and expanding our market presence through our diverse and dynamic originations platform. We had a very strong first half of the year in our agency business, originating $1 billion in loans in the second quarter and $2.3 billion loans in the first six months of 2017, which represents a 40% increase over our six month production volume for 2016. Additionally, we continue to leverage our significant originations platform and strong footprint in the GSE multifamily lending arena to increase our reach and broaden our products, allowing us to garner a larger portion of the overall lending market and greatly enhance the value of our franchise. As a result, our pipeline is at an all time high, and we're extremely positive with our outlook for the remainder of this year and we are very confident that we'll be able to grow our originations platform significantly above our record numbers from 2016. The tremendous growth and success we've experienced in our agency platform has also been extremely accretive to our core earnings and has allowed us to grow our dividends substantially over the last year. This business has also allowed us to significantly diversify and increase the stability and duration of our income streams. In fact, our GSE income represents over 70%…

Thank you, Ivan. As our press release this morning indicated, we had a very strong second quarter and first six months of the year, including tremendous operating results. As a result, AFFO was $17.6 million or $0.22 per share for the second quarter and $42.2 million or $0.55 per share for the six months at the June 30. This translates into an annualized return on average common equity of approximately 10% for the second quarter and 12% for the first six months. As Ivan mentioned, we continue to put up record results from our agency platform, which have been very accretive to our earnings. This has allowed us not only to increase our dividend substantially over the last year, but these earnings have also resulted in more stability and certainty to our dividend. This is again due to the significant portion of our earnings that are coming from the agency business that are long-dated, more predictable and recurring and less sensitive to rate and market volatility. We also believe we will continue to produce strong results in this business going forward, which should allow us to continue to grow our earnings and dividends in the future. For the quarter, we generated approximately $13.5 million of income and AFFO from the agency business. We produced very strong originations in our agency platform, closing $1 billion of loans in Q2, which is a 19% increase over our second quarter volume from last year. And as Ivan mentioned, we are very optimistic we will close out 2017 with another record year. Our second quarter sales volume was $1.2 billion, which was 69% increase over our second quarter 2016 sales, and the margin on our sales for the second quarter was 1.56%, including miscellaneous fees compared to 1.40% all-in margin on our first quarter…

[Operator Instructions]. And our first question comes from Jade Rahmani from KBW. Your line is open.

Thanks very much. I was wondering if you could characterize investor sentiment, and also speak to the mix in your originations between acquisitions and refinance deals?

I don't have the exact numbers on refinance and acquisition deals, but our outlook relative to the refinance market is that a lot of the loans in the multifamily sector are five, seven and 10 years in duration. A very significant part of not only runoff in our portfolio and recapture, but it's a significant part of the business climate that have existing loans constantly refinancing. We're clearly benefiting in 2016, 2017 and 2018 from a lot of loans that were running off from the 10-year loans that we've done in 2007 and 2008 and 2006. But since then, you also have a lot of shorter duration and variable rate loans. So that will remain a very significant part of our business going forward. But we can get you more numbers what the mix currently is if Paul doesn't have it on his hand.

Yes, I do have it on the agency side. On the agency side, the $1 billion of volume we did, Jade, we had -- about 60% of that was refinance and the other 40% was new purchase. So that's been the mix. It's been around that pretty much steadily throughout the year. Sometimes, it may hit 70 to 30 or 65-35, but it's 60-40 right now, for the second quarter.

Thanks. Have you seen any changes in cap rates? And also on the lending side, are you concerned at all by spread compression in the market?

I think that cap rates when the election first took place and rates were starting to rise, we were seeing a little bit of backup with rates being coming back down on the tenure. I think cap rates have remained somewhat consistent, maybe slightly tighter, especially since there is a lot of liquidity in the market on the equity side. On the bridge loan business, no question about it. It's a very, very competitive market. We're very fortunate that we've been able to have far better execution on the CLO side. So we've been able to maintain our spreads because we've been able to reduce our borrowing costs as well, to keep up with where the competition is.

The two loans that went delinquent in the quarter, could you give any color on those? I think one was residential and the other was commercial.

Yes, the one was small, $2.5 million net loan that we're renegotiating now on an extension. So we don't know that, that will be nonperforming for long. The bigger loan that went nonperforming this quarter, we may have talked about in the past, it's a legacy subordinate position, preferred equity position we have on our hospitality asset. It's a $34 million loan that we have written down, so about $31 million, and we entered into a nine month forbearance agreement with the borrower. But we are actively looking at brokering in -- with a broker to look at potentially selling that asset. And if we are successful and we think we can be, we think we'll recover all of our net carrying value of $31 million. And I think what's important to point out is, this is a legacy asset that is earning 4%. So if we are able -- if we're successful -- we got a little short-term pain in the NPL this quarter, but if we're successful in liquidating this asset and recovering our capital, we'll be able to redeploy that capital into our core business, which will generate 12%, 13% levered returns on our capital.

And on the servicing portfolio, has there been any change in credit performance sequentially?

No. In fact, we do a quarterly review, and in our quarterly review, we're consistently seeing an increase in the DSE coverage from the originations in our underwriting. So we're pretty comfortable with the performance of our portfolio versus where we originated our portfolio, the one we had written. So we're constantly seeing quarter-to-quarter improvements.

Thanks. I'm going to pass in my colleague, Ryan Tomasello.

Thanks Jade. Just given the elevating amount of repayments you saw in the quarter on the structure side. Can you give some color on what percentage of repayments were recaptured via refinance in the agency business?

Yes, sure. I can. So we had $264 million, with $263 million runoff in the quarter, all of it was multifamily. Unfortunately, of the $264 million, about $160 million of it were from sales of properties. So as you know, we don't control the refinancing of that when the loan is sold. So the remainder $100 million, we did get $55 million of that factor of Fannie Mae execution, so that's about a 55% recapture rate. In the first quarter, I think it was Steve Delaney who asked that question last quarter, we didn't have the numbers. In the first quarter, we had $190 million of runoff, $153 million of that was multifamily, and after sales of properties, there was $116 million of that multifamily that was refinanced. And we recaptured $111 million of that in the first quarter. So we had a 96% recapture rate on eligible refinancing multifamily properties in the first quarter and $55 million in the second quarter, which is to our strategy we've always talked about, that we normally recapture a significant amount of the refinance opportunities that are available through our agency platform.

Thanks. That was really good color, and in the past, you've highlighted an increase in your average loan size, which could potentially lead to lower gain on sale margins, all else equal. Given the increase that we saw in the gain on sale in the quarter, can you give us some color on how loan sizes have trended, and what your expectations are for gain on sale margins for the balance of the year?

Yeah. I think that's an important -- that's important color there. We did see a flattening of the average loan size during the quarter on our agency business originations, and therefore, our margin was a little higher than we expected. However, I do think if you look at the MSR capitalization rate, the MSR capitalization rate was down and that's on the committed loans, because some of the committed loans we did late, did have larger balances, and therefore, lower servicing fees. So therefore, although the margin was very strong in the second quarter, the indication should be that we may see a little bit of a smaller margin in the third quarter, which is consistent with what we talked about last quarter. We did get a strong margin this quarter because [indiscernible] closed yet that are committed did have larger -- had larger balances and larger servicing fees, and therefore, they'll have a little bit of a smaller margin in the third quarter.

Great. And then just lastly, can you comment on how headcount has trended on a sequential basis or year-over-year basis in the agency business? Are you looking to continue to grow that platform via either M&A or hiring additional brokers?

I think we grow our platform on multiple ways. First of all, we grow it organically through a very intensive training program, which takes years and years to nurture people and a lot of our salespeople are organically homegrown. We're always active in the market adding salespeople and we've been successful in adding a couple, as we go. With respect to acquisition opportunities, we don't have any, right in front of us, but we are actively always looking to grow our franchise by strategic acquisition opportunities., but we are not currently engaged in any at the moment.

And do you have any numbers on the percentage increase in headcount year-over-year that you can provide?

I don't have them in front of me. We did grow our headcount in our agency business, I think, by five people during the quarter. I mean, most of that is, you have a formula when you grow your servicing portfolio, you have a certain amount of capacity each person can handle and you get economies of scale. Obviously, as you grow your servicing portfolio. But we have a set formula, after so many units are added, you have to add maybe one new portfolio manager or one new servicing person. But I don't have the numbers in front of me on the sequential increase.

Great. Thanks for taking the questions.

[Operator Instructions]. And our next question comes from Steve Delaney from JMP Securities. Your line is open.

Good morning and congratulations on the strong quarter. I want to start with the transitional business, $438 million, I believe you said on the first quarter call, there was some spillover. But nevertheless, a big number and looking back, it appears to us it's probably a record quarter for balance sheet lending. I was just curious given that magnitude of loans, were there any unusually large loans in that mix that may have caused the numbers to jump so much?

Let me give you a little color first. We are able to do larger loans, and the reason we're able to do larger loans is our effective execution on the CLO side has been tighter. So with the larger loans, which are more competitively bid, we are in a better position to bid on them. In addition with the capital raises we've done, we have a stronger balance sheet, so we're more comfortable going with some bigger loans, as opposed to being a little bit restricted. So in the past, we were probably comfortable with a $25 million loan, may be stretching to $50 million. Now with the strength of our balance sheet and our effective capability on the CLO side, both pricing and liquidity, we're very comfortable going to the $50 million to $75 million range on a very active basis and competitive. So we're definitely in a better position to grow a high quality book with effective returns.

Okay, that's good color. The average size looks like it was about $20 million. So you think that's a good sort of average for modeling purposes going forward, that something $20 million to $25 million would be appropriate?

Paul, do you want to comment on that?

Yes, I think the question to Ivan was, what we think we're going to be doing going forward on average loan size. The loan size was on average $20 million for the second quarter. We did talk last quarter, Steve, about some larger loans spilling over to April. We had about $100 million of loans that we had targeted in the first quarter, that's spilled over to April, some larger loans. We did have several loans, over $30 million during the quarter that we originated. But Ivan, I think the question from Steve is, that we think that $20 million is a good average going forward, and I guess, we do think we can do the larger loans, and we will continue to do. How it blends with some of the smaller stuff? I can't say though exactly, it will be $20 million. But I think that's probably $15 million to $20 million probably --

Steve, we're comfortable with that given what's in the pipeline and given what we're seeing in the market and how we're competing.

Got it. And the whole portfolio is 80% multifamily. Are you seeing that consistently? Something in that ballpark I'm sure bounces around, but something, say, north of 70%, 75% is continuing to be multifamily?

I think so. I mean, we're definitely opportunistic, and we're -- for the right opportunities, we'll lend. But that's a good mix for us.

Got it. Ryan touched on this a little bit. But just to clarify on the agency margins. On the MSR margin, it went down to 1.57% from 1.74%. We assumed it was more of the Fannie Mae, the smaller Fannie Mae index. But I think I heard you say, Paul, it might have something to do with loan size. Was it loan size or a combination?

It's a combination of having more Freddie Mac business overall, as it compared to the total. So the mix change does impact that number. And then also, we had some loans that we committed to late in the quarter, that have -- larger loans that will lower servicing fee and, obviously, less risk. And they tend to come with smaller margins.

Got it. And the gain on sale margin actually going up, maybe opposite. Was that smaller loans versus first quarter? What would you primarily attribute that to?

Yes, I think we had some larger loans in the first quarter that we had sold. And in the second quarter, we had -- we didn't have as larger loans that we sold, it's just timing. But we did close a bunch of loans late in the second quarter, that were larger that will affect the third quarter margin. But again, this will fluctuate, as we've talked about, it will go from 140 to 150 to 160 to 135, it's in that range. It's hard for us to peg it perfectly. But we had a very strong margin quarter. We're happy with that and as I said, we've guided to somewhere in that range going forward.

Okay. Great. And just one final thing from me. We're continuing to try to distract roughly the amount to put, what we'd call dead or underperforming capital that's just are carryover from the legacy days. Just trying to evaluate, what the upside earnings potential as those things resolve. The REO is clear, and appreciated your color just now about the hotel asset. As far as your loans that have loan loss reserves, which was a count of six loans and your NPL loans are five. Is there -- are all of the NPL loans, which looks like $60 million gross and $34 million net, are they all included in the count of six loans that are classified as with reserves? I just want to know if there is -- the loan loss reserve loans is inclusive of everything in NPL?

There is, but there are loans in the loan loss reserve that are not in the NPL. So the best way to look at it is, there is $184 million of gross loans that are reserved with, call it, $81 million reserves against it. And that's basically two assets. It's basically the hotel asset we just talked about, and I think you commented on our position we have out in Lake Tahoe. Those are the two positions that make up that $100 million.

Yes, we have a big position out on Lake Tahoe. As you know, the Homewood mountain years of entitlement. Now that is entitled. I think there is -- Paul, you can give the round number. But it's basically a non-interest earning asset. We believe we're in a very good position over the next 12 months or so to either do and hold or piece by piece to turn that into an interest earning asset and contribute significantly over the next couple of years to our earnings.

Yes, Paul. Go ahead.

So as to be clear, it's about $71 million net reserves on that, $30 million on the other one, $31 million. So that gives you the $102 million, and that Homewood asset that I've been speaking of, is contractually current, but we're not accruing any interest on it. So it's not in the non-performing bucket that we've disclosed in our Q, that it's not earning any interest.

Got it. Appreciate the color guys. Thank you.

And at this time, I am showing no further questions.

Well, I want to thank everybody for their participation. We had a great quarter and look forward to a very strong balance of 2017. Have a good day everybody.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everyone have a great day.