Arbor Realty Trust Preferreds: Casualties Of War (NYSE:ABR.PR.D)

As we awaited further clarification in the direction of interest rates, Friday, July 12^th began like any other ordinary market day. Not much was happening, but then, at 11:13 CST, Bloomberg released a report that Arbor Realty (ABR) was being investigated by the DOJ over lending practices and accounting elections within its loan book. We had only limited exposure to ABR common stock, but as active fixed income investors we had more meaningful ownership of all three preferred issues; Arbor Realty preferred series D, E, and F [(NYSE:ABR.PR.D), (NYSE:ABR.PR.E), and (NYSE:ABR.PR.F) respectively]. This article will discuss our perspectives on operations at Arbor Realty and what risks and rewards investment in the ABR preferreds present today.

War

As part of a long-running series of reports questioning the propriety/veracity of Arbor’s accounting election of its loan book, on July 11, 2024, Viceroy Research published an open letter to Ernst & Young, ABR’s auditors, drawing numerous Arbor accounting elections into question. This communication was likely a part of what brought the Department of Justice to Arbor’s doorstep the following morning. In July 12^th trading, our streaming quotes showed ABR common down as much as 21% from the prior day’s closing price. More to our interests, the preferreds fell as much as 19.5%.

This situation with Arbor was not new to us; ABR has repeatedly been the target of multiple short selling campaigns. We gathered and reviewed all of our research related to Arbor and revisited how they have previously responded to this same type of adversity. We reanalyzed the breadth, diversity, and extent of ABR’s business operations. We reminded ourselves that the dramatically discounted preferreds sit senior to the common stock in the capital stack. After sufficiently long utterances of expletive streams, we began buying the preferreds in earnest.

Then we waited.

Response

In the August 2^nd earnings release and conference call, ABR’s weary sounding CEO, Ivan Kaufman, acknowledged that recent quarters have been operationally difficult and stressful. He addressed the issues that he believes the short sellers have misrepresented and distorted. He offered that, despite this difficult environment, Arbor has consistently outperformed its mREIT peers in measures of shareholder total return, book value, and dividend growth.

Importantly, with rising interest rates being the source of ABR’s borrowers’ point of pain, CEO Kaufman described that 10Y Treasury yields falling below 4.0% would bring great relief and right ABR’s operating loan portfolio. As of market close, Friday, September 6, 2024, 10Y T-Note yields stood at 3.72% and rates declined further on Monday.

As an occasional adjunct to our normal underwriting of fixed income creditworthiness, we sometimes observe institutional investors posturing relative to a given issue. In the case of Arbor, we have the assurances of legendary value investor Leon Cooperman.

Leon G. Cooperman

Omega Advisors, Inc.

“I know it’s been very frustrating to you. The short guys are unmerciful. They come out with inaccurate accusations on a Friday afternoon when you’re in your quiet period, and you can’t respond. And it’s just terrible with the damage they’re doing to the public shareholders. But we’re all lucky to have you guys in our corner because you’ve done a terrific job, and I appreciate it.”

If you listen to the 1Q24 call, you will hear Lee Cooperman express similar sentiments and this might lead you to believe you are in the presence of a sycophantic, mutual appreciation exchange, but over the course of time we have witnessed Mr. Cooperman also express his displeasure with management performance. Most importantly, Cooperman’s Omega Advisors remains one of ABR’s largest shareholders.

The Preferreds

Arbor Realty has a current issuance of ~$635MM mid-6% coupon preferred stocks. That measures well against the approximately $2.5B capital base of their common stock, but the preferreds are really interesting in that, due to the repeated short-selling threats, they trade at about 73% of par value. In a falling interest rate environment, the sub $18.25 market prices translate to 37% upside appreciation potential to call.

Source: Portfolio Income Solutions

On a current yield consideration, Arbor Realty Trust’s 6.375% Series D Preferred’s $1.59375 annual dividend produces an 8.80% yield at today’s $18.11 closing price. That’s more than 500 basis points higher than today’s 10Y T-Note yield and, more importantly, more than 100 basis points higher than peer set preferred yields.

Risk and Reward

If short sellers’ warnings of Arbor’s financial vulnerability are ultimately realized, the common stock share price might experience significant damage. In that scenario, the preferred stocks’ prices will likely be pressured as well, but, by our measure, the capital base is sufficiently large, diversified, and secure enough to ultimately meet all obligations to the preferred equities.

The Opportunity

Arbor Realty Trust’s common stock at $13.48 is trading at a 6% premium to its 06/30/2024 $12.72 book value. At market price, ABR provides a current dividend yield of 12.76%, almost 400 basis points superior to its preferred shares.

At prices in the $18.00 range, ABR’s preferred shares offer 8.80% dividend yields at prices approximating 75% of par value. 8% yield is less than 12% yield, but the likelihood of a controversial common stock rising to an even higher premium to book is lower than its preferred shares rising to a higher share price equilibrium.

We are sticking with the preferreds.