Arbor Realty Trust Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
August 2, 2024

Key Takeaways

  • Arbor reported a strong second quarter, continuing to outperform peers with superior total shareholder returns, dividend growth and book value appreciation over the past five years.
  • Management navigated the peak stress period by modifying $730 million of loans with $23 million of fresh capital, foreclosing and recapitalizing the Westchase portfolio, and generating $630 million of payoffs including $490 million refinanced into fixed-rate agency loans.
  • The agency platform achieved $1.1 billion of originations in Q2 and grew its servicing portfolio to $32.3 billion (up 12% YoY), which, combined with escrow interest, produces $245 million of predictable annual cash earnings.
  • Strong liquidity and capital structure include approximately $700 million in corporate cash, a reduction of bank debt to $2.8 billion (from $4.2 billion) and 67% of secured debt in low-cost, non-recourse CLOs, lowering leverage to 3:1.
  • Arbor rebutted short-seller allegations, clarifying the timely reporting of the Westchase transaction, proper CLO redemption notices and its ongoing cooperation with regulatory inquiries while standing by its financial disclosures.
AI Generated. May Contain Errors.
Earnings Conference Call
Arbor Realty Trust Q2 2024
00:00 / 00:00

There are 9 speakers on the call.

Operator

Good morning, ladies and gentlemen, and welcome to the Second Quarter 2024 Arbor Realty Trust Earnings Conference Call. At this time, all participants are in a listen only mode. After the speakers' presentation, there will be a question and answer Please be advised that today's conference is being recorded. I would now like to turn the call over to your speaker today, Paul Alenio, Chief Financial Officer.

Operator

Please go ahead.

Speaker 1

Thank you, Angela. Good morning, everyone, and welcome to the quarterly earnings call for Auto Royalty Trust. This morning, we'll discuss the results for the quarter ended June 30, 2024. 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.

Speaker 1

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.

Speaker 1

Thank you, Paul,

Speaker 2

and thanks to everyone for joining us on today's call. As you can see from this morning's press release, we had another strong quarter as we continue to effectively navigate through this extremely challenging environment. As we discussed in the past, we started preparing for the cycle well over 2 years ago and a plan to appropriately position the company to navigate through and succeed for our investors in this challenging market is being executed in line with our expectations. We have a diversified business model with many capital cyclical income streams, our focus on the right asset class with the appropriate liability structures and are well capitalized, which has allowed us to continue to outperform our peers in every major financial metric. Last quarter, we posted some compelling charts on our website demonstrating this outperformance.

Speaker 2

We updated these slides again this quarter and we encourage you to review them as they clearly demonstrate that our total shareholder return, dividend growth and book value appreciation over the last 5 years are outperforming every well else in our peer group. In fact, most of our peers have cut their dividend substantially, have experienced significant book value erosion and have generated a negative total shareholder return over the last 5 years. Clearly, this is not the position we are in and we have continued to demonstrate over a long period of time that we are a consistent outperformer and a leader in the space. As we have communicated, we expected the 1st 2 quarters of this year to be the most challenging part of the cycle and we have also guided to this period of peak stress affecting the 3rd and 4th quarters as well if rates remain higher for longer. Even in

Speaker 1

the most stressful part of the cycle,

Speaker 2

we continue to post very strong operating results, which we'll discuss more in detail on today's call. We are aware of certain erroneous information in the marketplace, which has been driven by short reports and is inaccurate. While our performance in this quarter speaks for itself, we would be remiss if we didn't point out certain factual inaccuracies as well as ill informed and or inaccurate statements that are causing the most concern. First, there has been a swath of misinformation regarding one transaction in particular called the Westchase portfolio. For example, misinformation started that the transaction should have been reported in the Q1 when in fact the transaction closed in the 2nd quarter and was appropriately and timely reflected in the company's financials.

Speaker 2

We believe that the merits of this deal were the ultimate interest of the shareholders. Specifically, we had $100,000,000 bridge loan collateralized by a portfolio of properties in Houston, Texas in which the borrower defaulted. We immediately exercised our right to foreclose on these assets as we believe that there was a value above the debt. We simultaneously sold it to a new entity, which was capitalized with $15,000,000 of fresh equity and a $95,000,000 bridge loan at Solta Plus 300 basis points we provided. Of the $15,000,000 of capital that was invested in the transaction, dollars 6,250,000 or 40% was funded by the Austin Walker Fund, which is a private minority owned real estate fund focusing on affordable housing that we have a 49% non controlling limited partnership interest in.

Speaker 2

The rest of the capital came from 2 independent separate investors, one of which is a bar that we have a long standing relationship, which has a tremendous amount of expertise in renovating these type of assets and maximizing their value. We believe the stabilized value of these assets to be around $128,000,000 which is well above the capital stack of this deal and the deal has now been recapitalized with the appropriate reserves giving us confidence that the new ownership group will be able to hit the targeted business plan over the next few years. Westchase is an outstanding transaction that fits what we want, which is lend to affordable housing communities. We believe this transaction is a very effective workout with sound economics and consistent with our values, yet the short sellers have levied what we believe are baseless criticisms about this transaction. Again, we are extremely pleased with the results of this transaction and the benefit it presents for our stakeholders.

Speaker 2

We continue to do an effective job in managing through our loan book and this transaction represents management's capabilities in taking back an asset and replacing it with new sponsorship and having it appropriately recapitalized. 2nd, certain misinformation has been spread about the redemption of 1 of our CLOs. We have been a top issuer of CLOs for over 20 years, never once losing a single dollar of principal for our investors, even through the historic financial crisis. We are experts in managing these vehicles and have issued and repaid many vehicles returning all invested capital to our bondholders. We called the CLO on June 17 in the ordinary course of business and in doing so, we turned the principal investments of each bondholder in full, drove outsized returns on our capital and maximize returns to our shareholders.

Speaker 2

Additionally, the short reports have also stated that we did not give proper notice to our bondholders prior to the redemption, but timely file the appropriate SEC forms out for the redemption and that we committed securities fraud. The rules are very clear. We are required to give notice to our bondholders 10 days prior to the redemption, which we did formally through the trustee on May 31st and we are required to file an SEC form on after the quarter in which the redemption occurred, which is in this case not until August 14. We have collapsed and redeemed over a dozen CLOs in the past 10 years and each time giving the proper amount of notice and filing all SEC required documents in a timely manner. 3rd, we have been criticized for how we've been managing our book, our loan book in this distressed environment, when in fact the company has done a very effective job in maximizing return to our shareholders, which again are evidenced in the numbers that we have reported.

Speaker 2

This quarter we successfully modified another $730,000,000 of loans with $23,000,000 of capital being injected into these deals from the sponsors. This includes cash to purchase new interest rate caps, fund interest and renovation reserves, bring past due interest current and pay down loan balances where appropriate. We also continue to make progress on approximately $1,000,000,000 of loans that are past due by either modifying these loans, foreclosing and taking them into REO or bringing in new sponsorship either consensually or simultaneously with the foreclosure. In addition, we've an extremely successful quarter given the recent decline in interest rates by generating $630,000,000 of payoffs with $490,000,000 of these loans being refinanced into fixed rate agency deals. And as I have said in the past, if interest rates go below 4%, obviously as they've done in the last week or so, we expect that this will become more meaningful to our business.

Speaker 2

Despite these facts, Arbor has been subject to repeated attacks in the reports generated by short sellers and we expect these attacks will continue. The best response to these attacks and which we believe are unfair and unjustified are our financial results and our earnings call here today. It has also been widely reported that in the wake of these attacks over an 18 month period, Arbor has received requests for information from government agencies, including the Department of Justice. Auber consistently has cooperated and will continue to cooperate with any such requests. Likewise, it is our policy not to comment on any such inquiries.

Speaker 2

That said, I would like to provide more detail about some additional results that have resulted from our execution of strategies to manage the business through an environment that poses market wide challenges. 1 of the items I touched on earlier is how important having adequate liquidity and appropriate debt instruments are to your success in these types of markets. As a result, we have focused heavily on maintaining a strong liquidity position. Currently, we have approximately $700,000,000 of liquidity between around $700,000,000 in corporate cash $200,000,000

Speaker 1

of cash

Speaker 2

in our CLOs that results in additional cash equivalent of approximately $50,000,000 And having this level of liquidity is crucial in this environment as it provides us the flexibility needed to manage through the rest of the downturn and to take advantage of opportunities that will exist in this market to generate superior returns on our capital. We also continue to do an excellent job in deleveraging our balance sheet and reducing our exposure to short term bank debt. We are down to approximately $2,800,000,000 in outstanding with our commercial banks from a peak of approximately $4,200,000,000 and we have 67% of our secured indebtedness in non mark to market, non recourse, low cost CLO vehicles. CLO vehicles are a major part of our business strategy as they provide us with a tremendous strategic advantage in times of this distress and dislocation due to the nature of their non mark to market non recourse elements. In addition, they contribute significantly to providing a low cost alternative to warehousing banks, which in times like this have fluctuating pricing and leverage point parameters.

Speaker 2

In fact, one of the significant drivers of our income streams are low cost CLO vehicles as well as a fixed rate debt and equity instruments that make up a big of our capital structure. We are very strategic in our approach to capitalizing our business with a substantial amount of low cost, long term long dated funding sources, which has allowed us to continue to generate outsized returns on our capital. Another major component of our unique business model is our significant agency platform, which also predictable income streams and produces considerable annual cash flow. In the Q2, we had a strong originations of $1,100,000,000 despite elevated rates for most of the quarter. The recent drop in the 10 year and the 5 year combined with tighter spreads has allowed us to continue to build a strong pipeline of future agency deals, giving us confidence in our ability to grow our agency volumes going forward.

Speaker 2

We've also done a great job in converting our balance sheet loans into agency products, which has always been one of our key strategic and a significant differentiator from our peers. And it's also very important to emphasize that a significant portion of our business is in the workforce housing part of the marketplace. As we all know, Fannie and Freddie have a very specific mandate to address the workforce affordable housing needs, which is a major issue in the United States, making Arbor a great partner that continues to fulfill a very important mandate for the federal agencies as well as the social needs for society. Our fee based servicing portfolio, which grew another 3% this quarter and 12% year over year to $32,300,000,000 generates approximately $124,000,000 a year in reoccurring cash flow. We also generate significant earnings on our escrow and cash balances, which act as a natural hedge against interest rates.

Speaker 2

In fact, we are earning 5% on around $2,400,000,000 of balances or roughly $120,000,000 annually, which combined with our servicing income annuity, totals $245,000,000 of annual gross cash earnings or $1.20 a share. This is in addition to the strong gain on sale margins we generate from our origination platform. And it's extremely important to emphasize that our agency business generates 45% of our net revenues, the vast majority of which occurs before we even open our doors each day. This is completely unique to our platform. In our single family rental business, we continue to be the leader of choice in the premier market we traffic in.

Speaker 2

We had another quarter with $185,000,000 of fundings and another $280,000,000 of combined signed up commitments. We have a large pipeline and remain committed to this business and it offers us returns on our capital through construction, bridge and permanent lending opportunities and generate strong leverage returns in the short term, while providing significant long term benefits by further diversifying our income streams. We're also seeing steady progress in our newly added construction lending business. This is a business we believe can produce very accretive returns on our capital by generating 10% to 12% unlevered returns initially and eventually mid to high returns on our capital once we leverage this business. We continue to see a nice increase in our portfolio of potential deals with roughly $250,000,000 under application, another $250,000,000 in LOIs outstanding and $850,000,000 of additional deals we are currently screening.

Speaker 2

We believe this product is very appropriate for our platform as it offers us returns on our capital through construction, bridge and permanent agency lending opportunities. In summary, we had another very productive quarter and are working exceptionally hard to manage through the teeth of this dislocation. We feel we have done an excellent job in working through our loan book and getting borrowers to recap their deals with fresh equity as well as bringing in quality sponsors to manage underperforming assets and working through our nonperforming loans. We understand very well the challenges that lie ahead and feel we are well positioned. We have a diversified business model.

Speaker 2

We are invested in the right asset class with very stable liability structures. We are also well capitalized and have a best in class asset management function and seasoned executive team giving us confidence in our ability to navigate through this distressed environment. And despite the misinformation circulated in the marketplace about our business strategies, we continue to reiterate that we stand by our financials and our disclosures and we have always conducted our business, operations and practices in the best interest of our shareholders. I will now turn the call over to Paul to take you through the financial results.

Speaker 1

Okay. Thank you, Ivan. We had another strong quarter producing distributable earnings of $91,600,000 or $0.45 share, which translated into ROEs of approximately 14% for the 2nd quarter. As Ivan mentioned, we successfully required borrowers to invest additional capital to recap their deals with us providing some form of temporary rate relief through a pay and accrual feature. Pay rates were modified on average to approximately 7.18 percent with 2.14% of the residual interest due being deferred until maturity.

Speaker 1

$155,000,000 of these loans were delinquent last quarter and are now current in accordance with their modified terms. Our total delinquencies were $1,050,000,000 at June 30 compared to $954,000,000 at March 31. These delinquencies are made up of 2 buckets, loans that are greater than 60 days past due and loans that are less than 60 days past due that we are not recording interest income on unless we believe the cash will be received. The 60 plus day delinquent loans or non performing loans were approximately $667,000,000 this quarter compared to $465,000,000 last quarter due to approximately $264,000,000 of loans progressing from less than 60 days delinquent to greater than 60 days past due, a $9,000,000 loan that went nonperforming this quarter, which was partially offset by $62,000,000 of loans being modified in the 2nd quarter that are now performing. The second bucket consisting of loans that are less than 60 days past due came down to $368,000,000 this quarter from $489,000,000 last quarter, mostly due to $264,000,000 of loans that progressed to non performing and $138,000,000 of loans being modified or that paid off during the quarter, which was partially offset by approximately $281,000,000 of new loans this quarter that we did not accrue interest on.

Speaker 1

And while we expect to continue to make progress in resolving these delinquencies, at the same time, we do anticipate there will be some new delinquencies in this environment. We're currently working through a number of these loans that we expect to resolve by taking back the properties and then working to improve these REO assets to create more of a current income stream. This could take 60 to 120 days, which will likely result in a low watermark for net interest income over the next couple of quarters until we have worked through this portfolio. This is what we expected and is consistent with our previous guidance that this would be the period of peak stress and the bottom of the cycle. We also continue to build our CECL reserves giving the difficult market backdrop, recording an additional $29,000,000 on our balance sheet loan book in the 2nd quarter.

Speaker 1

$7,500,000 were specific reserves we took on assets this quarter with the balance in additional general reserves. The increase in general reserves from previous quarters was mainly due to changes in the assumptions in our models on real estate values given the challenging environment. We feel it is very important to emphasize that despite booking approximately $145,000,000 in CECL reserves across our platform in the last 18 months, $117,000,000 of which was in our balance sheet business, we still were able to maintain our book value. This performance is well above our peers, the vast majority of which have experienced significant book value erosion in this market. Additionally, we're one of the only companies in our space that has seen significant book value appreciation over the last 5 years with 30% growth during that time period versus our peers whose book values have declined an average of approximately 20% in that timeframe.

Speaker 1

As discussed as Ivan discussed earlier, we're pleased with the success we are having in working through our balance sheet loan book and in resolving our delinquencies. As we've stated many times, we have several recourse provisions in our loan documents that lend value to the resolution process. Last quarter, we realized a $1,600,000 loss and $11,300,000 loan that paid off at a discount. We immediately pursued one of our recourse provisions and are pleased to report that we received a $900,000 settlement payment in the 2nd quarter related to this loan. We also had a very successful resolution on a legacy REO office property that we foreclosed on back in the Q4 of 2021.

Speaker 1

Through a lengthy marketing process, we were able to sell this asset above our carrying value resulting in a second quarter gain of $3,800,000 In our agency business, we had a strong second quarter with $1,100,000,000 originations and loan sales. The margins on our loan sales was flat at 1.54% for both the 1st and second quarters. We also recorded $14,500,000 of mortgage servicing rights income related to $1,100,000,000 of committed loans in the 2nd quarter, representing an average MSR rate of around 1.32%, which was also flat compared to last quarter. Our fee based servicing portfolio also grew to approximately $32,300,000,000 at June 30 with a weighted average servicing fee of 38 basis points and an estimated remaining life of 7.5 years. This portfolio will continue

Speaker 2

to generate a predictable annuities income going forward of around $124,000,000

Speaker 1

gross annually. And this income stream combined with our earnings on escrows and gain on sale margins represented 45% of our net revenues for the quarter. In our balance sheet lending operation, our $11,900,000,000 investment portfolio had an all in yield of 8.60 percent at June 30th compared to 8.81% at March 31 due to a combination of an increase in non performing loans and some new loans that we did not make their full payment that we did not accrue interest on, which was partially offset by modifications in the 2nd quarter on some of our previously delinquent loans. The average balance in our core investments was $12,200,000,000 this quarter compared to $12,500,000,000 last quarter due to runoff exceeding originations in the first quarter. The average yield on these assets decreased to 9% from 9.44% last quarter due to substantially more modifications in the Q1 resulting in the collection of a significant amount of back interest owed combined with an increase in non performing loans and some new non accrual loans in Q2.

Speaker 1

Total debt on our core assets decreased to approximately $10,300,000,000 June 30 from $11,100,000,000 at March 31, mostly due to the unwind of CLO 15 and the pay down of other CLO debt with cash in those vehicles in the 2nd quarter. The all in cost of debt was up to approximately 7.53 percent at sixthirty versus 7.44 percent at threethirty 1. The average balance on our debt facilities was approximately $10,800,000,000 for the Q1 compared to $11,400,000,000 last quarter. The average cost of funds in our debt facility was up slightly 7.54% for the 2nd quarter compared to 7.50% for the 1st quarter. Our overall net interest spreads in our core assets decreased to 1.46% this quarter compared to 1.94% last quarter, again from a significant amount of back interest collected in the Q1 from modifications.

Speaker 1

And our overall spot net interest spreads were down to 1.07% at June 30th from 1.37% at March 31st, mostly due to an increase in non performing and non accrued loans during the quarter. Lastly, as we continue to shrink our balance sheet loan book, we have delevered our business 25% over the last 18 months to a leverage ratio of 3 to 1 from a peak of around 4 to 1. Equally as important, our leverage consists of around 67% non recourse, non mark to market CLO debt with pricing that is below the current market, providing strong levered returns on our capital. That completes our prepared remarks for this morning. And I'll now turn it back to the operator to take any questions you guys may have at this time.

Speaker 1

Angela?

Operator

Thank We'll take our first question from Steve DeLaney with Citizens JMP. Please go ahead.

Speaker 3

Thank you. Good morning, Ivan and Paul. Congratulations on a solid performance in this difficult market. One of the things we noticed, obviously, you're very active on modifying loans, the 60 day or less bucket. We did note that that number of loans and the dollar amount declined.

Speaker 3

You know the figures, but in the quarter, 2Q, fewer loans to Q. Looking at the modifications, which I guess so far this year, dollars 67 modifications, dollars 2,500,000,000 of loans. When we looking at taking that data and then looking at the NPLs, which increased slightly in the 2nd quarter to 24 loans and $676,000,000 dollars The question is this in terms of your process, is it still once you classify a loan as an NPL, are you still actively working to could you modify that loan and get it back in a current state or once they go to NPL, is there a much higher probability that it might end up in REO? Thanks.

Speaker 2

Thanks, Steve. Let me give you a little overall view the process. We're talking about an overall number of about $1,000,000,000 give or take and we believe we're pretty much in the peak part of the cycle with the most rest. And as you know, the $1,000,000,000 has a negative effect on our financial performance, which is factored in because we're not accounting for the income on that. So it's really incumbent on us to give you a good view of how that $1,000,000,000 is in a flow through the system.

Speaker 2

I'm pretty involved in this stuff. So we look at it this way. Of the $1,000,000,000 we estimate about 30% of the will go REO. That's the toughest part of it. Those are the ones that are not consensual.

Speaker 2

They take a bit of time and they're non income producing for us for that period of time and it could take anywhere from 3 months to a year depending on the jurisdiction and then us getting into those assets and bring them up to speed and then getting them cash flow and selling them. So that's the stickiest part. There's about another 10% or 15% of that that we're working with the existing sponsors to bring in new sponsorship and we believe that over a period of 3 to 6 months that those assets will have new buyers in them And we estimate that just to be conservative, it will fall off about a 6% return once that's done. In that $1,000,000,000 we estimate is going to be about 40% of payoffs because the assets are being sold. It's just a normal process.

Speaker 2

And then the other 40% are in the process of being modded. That mods take time and a big part of what we do is we proceed to foreclosure when a loan is not paying and that path to a foreclosure usually leads to a very effective process of getting modest. So we would estimate that that's the part that gets moved through the system the quickest and generally the average time is probably 90 days and then it returns to an interest earning asset and we use about a 7% rate on that. So we're in the thick of it, it's about $1,000,000,000 We expect to get it through the system, there'll be some new ones coming in, but that's what we're expecting. Clearly, this drop in interest rates is extremely favorable for the company and its business model as it will stimulate more multifamily sales and people will be able to buy these assets with more affordable financing.

Speaker 2

Got it. Well, what I heard

Speaker 3

you say there Ivan is that because something is currently classified as an NPL, there is still a possibility that those loans could be modified. Did I hear you correctly?

Speaker 2

Yes. I'm thinking about 40% of them me based on what I see in the portfolio. I'm pretty intimate with the asset management group and the progress they're making. It takes time for a lot of these borrowers to find the capital and get these things brought up to speed. So that would be the approximate number I would be using to get them modified.

Speaker 3

Great. And the 30% to REO. Paul, I look on the balance sheet, can you tell us what's in REO currently and I assume you have that in other assets,

Speaker 2

we couldn't find anything. We do, Steve. Thanks. We absolutely do. So it

Speaker 1

is another asset. REO is $78,000,000 right now on our books. It's sitting in other assets. We did sell, I'd say, the South Carolina office property that we had on our books for $10,000,000 So it was $88,000,000 last quarter, it's $78,000,000 this quarter. And of that 78,000,000 just to give you a little color, the 2 biggest ticket items is a $41,000,000 New York City office property we took back in 4Q of 'twenty three that we disclosed and that's a building that we brought in new sponsorship and are converting into a condo and that will take some time.

Speaker 1

And then the other big pieces, we have about a $30,000,000 multifamily deal in Texas that we took back in the Q4 of 'twenty two that we're working through and then there's some little odds and ends. But it's a small number, but as Ivan said, we are expecting as we work through this $1,000,000,000 that a decent amount more could go REO and that number will grow, right, Evan? That's what we're talking about.

Speaker 2

Yes, that's the guidance that we gave you about 30%.

Speaker 3

Yes. Thank you both for your comments.

Speaker 2

Thanks, Steve.

Operator

Our next question comes from Stephen Laws with Raymond James. Please go ahead.

Speaker 4

Hi, good morning. Just to follow-up, a minor point on the REO, about how many assets is that? What is the average loan size consistent with kind of the $20,000,000 for the portfolio? Or how do you see that, I guess, dollars 300,000,000 of potential REOs from a property count standpoint?

Speaker 2

We'll take a look at the list. I would take a yes, but Paul can be more accurate. It's probably an average loan size of around $30,000,000

Speaker 1

Yes, we have some chunkier stuff we're looking at, Stephen, that is in the $50,000,000 maybe even $100,000,000 but that's not a lot of what we do.

Speaker 2

And then

Speaker 1

we have some $10,000,000 $15,000,000 $20,000,000 So it's hard to really project where these are all going to end up, but I would say that we're thinking it's probably in the $30,000,000 to $40,000,000 average range.

Speaker 4

Great. And then Ivan, I want to go back to something you commented on around interest rates and you said we go below 4, certainly beneficial. And I think since the last time we spoke, the long end of the curve is down almost 100 basis points or fairly close. Can you talk about maybe how and I know the most recent move has only been a couple of weeks, but can you talk about how that maybe has changed behavior from sponsors? Do you think they're more likely to protect assets, cheaper to buy new caps?

Speaker 4

And then how do you think it impacts agency volumes as you move forward?

Speaker 2

Well, let me address the cap issue. The cap issue has been an extremely expensive proposition for a lot of these sponsors, assuming for the last 2 years, they've had to pile in another 6 to 8 points of capital to buy caps. We believe the curve is going to change and the cost of caps is going to go down, which believes they're paying a little bit. That's on that side. But the real meaningful issue is the drop in the 5 year and the 10 year.

Speaker 2

I mean, you could effectively borrowed close to 5% off the 5 year. Up till now, people are paying close to 6%, 6.5%, but spreads have tightened, rates have come down. So if you have a borrower currently paying on a floating rate basis, close to 9%, he can then go ahead and pay 5%. So that's a great option for that particular borrower, even if they put a little more capital into it and they can secure long term financing and really put themselves from a negative cash position into a positive cash position assuming you have an asset that's 6, 6.5 cap rate, all of a sudden you've created positive cash flow from negative cash flow and that's becoming very meaningful. The real key for people is that they're managing their assets well and they stabilized because then when you get fixed rate financing you need 90 plus occupancy somewhere in that range.

Speaker 2

So to the extent people have their assets stabilized, then that becomes a great option for them and will relieve the pain of carrying those assets, which has been extremely painful. Make no mistake about it. When you go into borrower alone and you're paying 4.5% to 5% and the next thing you're paying 9% and it's for prolonged period of time, you have a lot of capital needs. So I think we're in rate inflection point right now for many of these borrowers with their assets are stabilized that they can look through the fixed rate market and reposition their assets and not have negative

Speaker 4

Great. Appreciate those comments, Ivan. And one last one, if I may, on portfolio seasoning. Origination volume was very strong in 'twenty one and the first half of 'twenty two, really lightened up a lot in the second half of 'twenty two. As you think about the seasoning of those loans, is it fair to say that you've covered the $1,000,000,000 of NPLs, but should we continue to see kind of the new

Speaker 2

your portfolio? Well, I think that we're giving pretty good guidance that the first and second quarter would be peak stress and if rates remain higher for longer would leak into the 3rd Q4. I believe that with this rate down, I think you'll see the market change a little bit. So perhaps the Q3 maybe a little bit tough, but we're seeing a little bit of easing. And if rates remain in this level, I believe there'll be a lot of liquidity return to the multifamily sector and a lot of trades being done.

Speaker 2

So I'm hopeful and optimistic that perhaps the Q2 was the peak, little leakage into the 3rd, but we're definitely seeing the light at the end of the tunnel.

Speaker 4

Well, that's great to hear and nice job managing your

Operator

Our next Our next question comes from Rick Shane with JPMorgan.

Speaker 5

A couple of different things. Just from a bookkeeping perspective, cash balances within the structured business declined by about 50%. I assume some of the decline in the restricted cash is from calling the CLO, but can you just help us understand what's going on there?

Speaker 2

Yes, sure. I mean the reason we did call our CLO is because we were sitting on excess cash balances and it was inefficient. So that's expensive to be sitting on cash balances, which are being deployed. So in the normal course of business, when we have those excess cash balances and can't use them, that's why we recall a vehicle and the efficiency of these vehicles is to keep the cash balance as low as possible. So it achieves exactly what we wanted.

Speaker 1

Yes, and to add to that Rick, that is a big piece of it. The other piece it is some of these vehicles as you know are out of replenishment period, so they're naturally delevering as loans are running off. So the restricted cash is paying down debt and that's part of the component as well. And then the 3rd component is that we did pay off 90,000,000 of unsecured debt in April, as you were aware, with cash. So those are kind of the 3 big components that guided a decrease in cash for the quarter.

Speaker 5

Okay. Thank you. 2nd topic, you talked about modifying $730,000,000 of loans in the Q2. We've gone through the disclosure in the last Q related to mods. And I'm going to be honest, it's I don't fully understand all of the implications.

Speaker 5

Can we just walk through clearly the implications of the mods in this quarter in terms of what it means for the difference in cash that you will receive and the difference in interest accrual. So if you didn't modify the loans, what would you have expected to receive? How much are you giving up in cash over the next year or 2? And what is the difference in the accrual rate, so we understand the implications from an income perspective?

Speaker 1

Okay. So let me try to attempt to answer that. It's a little more complicated than that and our Q will be out early next week, we hope so you'll get more details on that disclosure. But the way I think I look at it and don't know if it'll completely answer your question is we did mod $1,900,000,000 or $2,000,000,000 of loans last quarter. I think $1,100,000,000 had paying accrual features.

Speaker 1

And so what we did was we what management does is we look at every single loan we modify and we go through it on a loan by loan basis to determine how strongly we feel the value in the mod has put us in a position we'll still be able to recover the accrued interest. If we don't feel in that position, we won't accrue the accrued interest. If we do, we accrue it. For the most part, we accrue it. There are exceptions.

Speaker 1

There are loans that we decide not to accrue the accrual rate after the mod if we think it's still a challenging asset. Having said that, in the Q1, our mods generated about right here, I'm trying to get it in front of me, our mods generated about call it 3,000,000 of accrued interest that hit our P and L that wasn't cash. In the Q2, those 1st quarter mods were now 6,000,000 of accrued interest that didn't hit cash because it was for a full quarter and the 2nd quarter mods were 2,000,000 in the 2nd quarter of accrued interest. So our PIK interest as we'll call it, for 1Q mods was about 3,000,000 in the Q1. In the Q2, the 1Q mods was 6,000,000 and the 2Q mods were 2,000,000 for a total of 8.

Speaker 1

So that number will obviously grow because the 2nd quarter numbers, the mods will be fully affected in the 3rd Q4 and then if we modern the new loans. I don't know if that's answering your question, but that's the numbers for the 1st and second quarter mods of how those accrual rates that we accrued affected interest income, but not cash.

Speaker 5

Paul, no, it's a very thoughtful question to response to a question I wasn't sure objectively that was you would be able to answer and so I was a little bit circumspect about asking that. So thank you. It's very helpful. Last question, implicitly the mods $23,000,000 of additional capital on $730,000,000 of mods, that's about a 3 point 1 or 3 15 basis point contribution of capital. Ivan, I'd love to understand that in the context of your comment, an answer or 2 ago about caps running 6% to 8 percent for your borrowers.

Speaker 5

I'm just curious how we sort of square those two numbers.

Speaker 2

Okay. It's 6% to 8% over 2 to 3 year period. Each year of cap costs can be anywhere between 1.5% to 3 depending on the loan. So in context, we're looking at more of an annual than a cumulative on that number. But Paul can give you a good number in terms of the mods and how they work for the Q2?

Speaker 1

Sure, I can. So of the 733,000,000 of loans we modded and 23,000,000 of capital is committed to be injected, 6,000,000 of that capital went to buy rate caps and they're at all different strike prices, Rick, some are out of the money strikes, some are way in the money strikes, I think the average strike was about 3.7%. And then the rest, we had one loan that paid down the principal balance by 2,000,000. We had past due interest of about 2,000,000 that was collected and then the rest were to fund rental reserves, interest reserves and OpEx reserves. Those are kind of how it breaks out if that helps you.

Speaker 5

It does. Very thoughtful answers. I appreciate the time. I would throw in one last request. There are a lot of numbers that get thrown around on these calls.

Speaker 5

You guys are unique amongst the companies that we follow in not providing a slide deck on the calls. And I think given the complexity of what Paul you've described, it would be really helpful as people could see the numbers and you could be walking through slides on the call.

Speaker 6

So I'm just going to throw that out

Speaker 5

there, but I appreciate the time guys.

Speaker 1

Thanks Rick. We appreciate. We always want to be more transparent and have the best disclosures. We try to be when the Q gets filed, there'll be a lot of good information there and then we'll always take into consideration whether we think

Speaker 2

we can put it in a

Speaker 1

better form for readers. And thank you for that comment.

Speaker 5

Great. Thanks, guys.

Operator

The next question comes from Jade Rahmani with KBW.

Speaker 5

Thank you very much. Can you

Speaker 6

please give the Q2 or 6 month year to date cash flow from operations number?

Speaker 1

Yes, it's in the 10 well, you don't have the 10 Q obviously, it's not filed yet. So I'll give it to you. One second, So the cash flow from operations number is $335,000,000 but you got to back out the changes in the originations and sales of held to sale assets which is a 220 swing. So and then you've got $90,000,000 in changes in operating assets. So call it 335 is cash flow from operations for the 6 months and then you have a 220 positive swing on originations less proceeds from sales and $100,000,000 negative swing in the change in operating assets and liabilities.

Speaker 6

Okay, that's great. The NPLs of around $1,000,000,000 do you have any numbers in mind as to where that total balance peaked?

Speaker 2

I'd say we're within range of the peak right now. I mean, maybe you can go up a little bit more, but we're kind of in the peak period of time. We're pretty optimistic about the number I've given you on the mods because we're pretty close to a conclusion on those mods. So I think that's a good number to ballpark.

Speaker 1

Yes, it's a tough one to predict as you know. I mean I think Ivan is right. It kind of has it's gone up a little bit since the Q1 not significantly $9.54 to 1.050 dollars We do expect a few more delinquencies. Hopefully, we're at the peak, but we do have our eyes on a bunch of loans that are delinquent that we're going to successfully mod. So hopefully that number will not peak higher.

Speaker 1

And then we're going to have some of those loans come out and be REF, right? They'll just be on a different line item, but they'll still be non performing until we work through them. So it's tough to answer, but I think Ivan's right. I think we feel like it shouldn't be significantly.

Speaker 2

I mean, what I would do is the sticky part is the REO because it takes time to get your hands on the asset. And then once you get your hands on the asset, you got to stabilize that asset. That's the sticky part. The rest is somewhat transitional.

Speaker 6

And when you look at the NPL and taking learning what's been going on this cycle, do they have anything in common in terms of maybe one issue that's been driving it? Do you think the main issue is really the borrower's basis than having paid too much, too lower cap rate for the assets? Or do you think on the other hand, perhaps it's sponsorship, maybe leverage ratio or the 3rd category is property underperformance?

Speaker 2

It's a whole slew of activities. And clearly, when interest rates go up as dramatically as they did when everybody believes we've been a low interest rate market forever, That's probably the single biggest driver. I've said in many calls before, the impact of COVID had a very significant impact because people were not able to move out tenants for many, many years. We've had in some of these properties 10% to 15%, even 20% economic occupancy where tenants are living for 3, 4 years without paying rent. That was a big factor.

Speaker 2

That's an unanticipated factor. A third factor, which we spoke about as well as the increase in insurance costs. I mean, they doubled, tripled and quadrupled. They're coming down a little bit now. The insurance costs, the economic you can't predict those.

Speaker 2

So that creates a lot of headwind. I think when people go into a buying frenzy in the top market, they focus on buying and not on management. And that's something that we've certainly learned a lot from because there's one thing to be an effective capital raise or a buyer of an asset, there's another thing to be an effective manager. So management draws a lot of hills and one of the things that's extremely important for us when we're modifying a loan is that if we don't think these assets being managed appropriately, either we won't modify and we'll take it through OREO or we'll insist and make sure they bring in new management. Management is also is a major part.

Speaker 6

That's excellent. Thank you. My last question would just be on the GSEs. We've seen a lot of stories around them being pretty cautious right now, not just the Meridian issue, which started back in maybe Q3 of last year, but there have been others, appraisers, local, small regional title companies. What exactly do you think is going on with the GSEs?

Speaker 6

Are they cracking down? Are they tightening their underwriting standards? Or are those just sort of a select few cases?

Speaker 2

I think in every cycle, you always have certain things that happen. And in this cycle with all the volume, there are certain things that occur. And clearly, the agencies have changed their attitude towards brokers. And Meridian

Speaker 1

is just a broker,

Speaker 2

but brokers have played a major role and were very dominant in garnering a lot of volume. And in garnering a volume, obviously, they control a lot of the source documents. And the industry has changed. Fannie and Freddie have learned that if we have brokers in between that are not direct with them, they can't control the source documents. So they've changed the guidelines.

Speaker 2

I think that was a long time coming. You have to understand that since 20 10 basically we've been on a tremendous run and a lot of deals have been hidden. This is the first time that it's a prolonged downturn and now you can see some of the things that we've done in the industry that finally caught up. So I

Speaker 1

think that's going to be

Speaker 2

a healthy change that the lenders have to deal directly with the borrowers, and that's a very healthy change. Appraisers have always been a sore point within this industry, right. We rely so much on appraisals. I believe that a big part of AI and big part of technology will have a significant impact on improving the valuation process. And appraisers are sometimes aligned, sometimes not aligned.

Speaker 2

It's like any other process, it's human. Within the human process, there are always areas of corruption. And I think it happened to them, not abnormal, it's part of life, every part of life is corruption. So they got hit with a little bit, not a lot, very small relative to the overall thing. And I think when they find a bad actor, it's called to light, they eliminate the bad actor.

Speaker 2

But I think the whole appraisal process, which everybody's relied on valuations extensively. I think with technology that's going to be a much better process going forward.

Speaker 6

Thank you very much.

Operator

The next question comes from Jay McCanless with Wedbush.

Speaker 3

Congrats again on EAB covering the dividend, but that spread continues to narrow. Could you maybe talk to us about how comfortable you are with the current dividend level and especially if economic conditions worsen from here?

Speaker 1

Hey Jay, it's Paul. Thank you for the question. I think it was clear in my prepared remarks that our spreads have come in given the fact that we've got $1,000,000,000 of loans not paying. I think one of the things we really need to stress is that because our business model is so diversified and because we have so many different income streams, the agency business being one specific one, our SFR business being another that we continue to ramp up and get a 15 yield on our money. We have the ability to do things others don't, right.

Speaker 1

We're not afraid to take back an asset, right, Evan, and not afraid to work it through even if it means it's going to be non interest earning for a little bit. So I've guided you guys to a little bit of a low watermark in the 3rd Q4. So it's possible our numbers in the 3rd Q4 could approach that number or be slightly below it. It will depend on how successful we are in getting back interest and getting those loans back online. But what also will affect it is the drop in the 10 year, right?

Speaker 1

If the drop in the 10 year continues and our agency business starts to explode, that will obviously offset any negative drag we have on non performing loans. So it's a tough one. I'd say it's getting tighter. It will continue to get tighter. It may even dip around there or below for a quarter or 2, but we're not concerned because we know that we're going to take this $1,000,000,000 of assets and some good portion of it's going to turn into interest earning at some point.

Speaker 1

And on top of that, our agency business is going to continue to generate sizable returns. And as Ivan said, we are working on a bunch of assets now that we think are going to pay off. And we're going to take that capital on loans that we're earning 0 and we're going to deploy it back into our system even at 10%, 12%, 13%, whatever it is we come up with on an unlevered basis, which will be accretive. So it will be a little bit of a timing issue and that the 3rd Q4 may get tight and we've talked about that. But long term, we're very, very comfortable with the protection.

Speaker 1

Okay, great. Thanks for taking my question.

Operator

The next question comes from Christopher Love from Piper Sandler.

Speaker 1

Thanks. Good morning.

Speaker 7

Appreciate you taking my question. Just asking the GSE question from earlier just a little bit different. Can you discuss recent activity with Freddie and Fannie because we did see Fannie originations come down meaningfully in the Q1, but they bounced back nicely in the second. So curious if there were any changes there on tightening standards in the first versus the second quarter and then just what you expect going forward from

Speaker 2

agencies? I think it kind of mirrors a lot of the conversation we've had and it's very much tied to interest rates. I think that the agency's volumes is going to increase considerably as rates drop. There are a lot of people who've been sitting on the sidelines waiting to refinance their loans when they got to a certain rate range. We're in prime time rate range today with today's drop, rates that have dropped.

Speaker 2

And I think the agency's volumes are going to really, really increase considerably. You have to also keep in mind that there hasn't been that much in multifamily sales activity, very, very low. I think that will pick up and that will feed the agencies as well. So I think I'm very optimistic that the agencies volumes will really benefit off of this and will increase and will grow. And then we'll go back to the same old problem of all of the agencies are back up and sort of taking longer.

Speaker 2

We're not that far away from that. We've experienced that. So I think that the agencies are going to have a very, very, very strong period of time relative to the last couple of quarters.

Speaker 1

Yes, I think to add some color to that, Chris, when we did $360,000,000 of volume in our agency business in July. So that number was actually just around the target we did for the Q2. But we think and as Ivan said, we think given the recent move in rates, some people are going to move off the dime here and I think we're going to see an increase to that volume in August September. That's our view.

Speaker 7

Great. Thank you. I appreciate the July number there as well. And then just one more for me. Can you just talk a little bit how you expect the first couple of rate cuts at the end of the year, assuming they do happen at the end of the year and 2025 could impact you.

Speaker 7

And could it be a net negative to your net interest income over the near term in a structured business, but of course, benefit originations and agency as you mentioned. Just curious on how you think about the impacts there, especially in NII, I'm doing lower yields, lower cost of funds, but unsure how much it would improve the borrower profile just with a couple of rate cuts? Thanks.

Speaker 2

I think we have to look at the rate cuts also in conjunction with what we've been talking about with the 5 10 year coming down. I think if there are rate cuts, 2 things will happen. It'll put the book in a better position, those people can buy rate caps cheaper. I also think there'll be more transaction activity and people will go into floating rate loans on some of these underperforming assets. So I think our book of floating rate loans will increase as well.

Speaker 2

So I think there'll be more volume on that side. I think offset of some revenue drop, I think you'll see the agency business pick up considerably. And I also think it will stimulate some of the modifications and bring some of those modifications more online and create life income producing opportunities on that side to offset some declines in revenue. I think net net, the rate drops are beneficial for the company. That's the way I would look at it from my chair.

Speaker 1

Yes. And I would say, I agree with Ivan, the timing may be something that's hard to predict. You're right, if rate drop your net interest income squeezes, but you've got a $1,000,000,000 of loans not paying, obviously the health of the portfolio will increase with the rate drop and then your agency business will pick up. But it's just a matter of the timing and that's the stuff that's hard to tell, may have a

Speaker 2

little bit of a dip in

Speaker 1

net interest income right away and then it builds back up with your agencies. But long term and as Ivan said globally, that's a positive for us.

Speaker 2

Yes and I want to also point out what we talked about for a long time on the calls is that we put a big investment through our single family, that's a part business, a construction lending business. That's a business that funds up over time. We have these commitments and those commitments and the equity deployed will go up and that should be mid to high teens return. So that will offset some of the runoff in the portfolio and that was clearly by design on our part.

Operator

The next question comes from Lee Cooperman with Omega Family Office.

Speaker 8

Finally, so let me Hey, Mike. How are you doing? Good. Good. Let me first I'm not a pimp for you guys, but I just want to say I congratulate you on your performance.

Speaker 8

A year and a half ago, you told me how negative you were about the and you couldn't have been more right. I detect a real frustration on your part in the beginning part of this call in dealing with the shorts. These are unmerciful and in this case, uninformed people, basically. And I just would tell you, he laughs, laughs, laughs best. And so you're performing.

Speaker 8

They don't understand the uniqueness of the company and how you position the company. And let me tell you, you've been very right and I congratulate you and I thank you as a large shareholder. Let me ask you a question since you've been more right than me about the environment. Do you think we're heading into a recession, number 1? Number 2, in terms of the book value?

Speaker 8

I mean, I'm out on vacation, so I'm dialing in on a cell phone. What is that book value at the end of the quarter? And are you a buyer of your stock in the low in the 10%, 11%, 12% area, if you could write down here?

Speaker 2

So you and I have had a lot of conversations over the last year or 2. And I have told you my view on unemployment and the economy. And obviously, I've been more right than wrong. And my view is we closed interest rates and we're exactly where I said we'd be and we're exactly where I said we'd be almost to the exact timing and what I've said on the calls repeatedly, the first and second quarter being the most difficult. I get a good barometer for really the unemployment more on the workforce type of people and I get a good read and I do a lot of intel.

Speaker 2

So I think that the economy is soft and I also get a good idea from building costs and trades and there's like a 20% differential in the period of post COVID, people were paying 10% to 20% premiums to build their projects. Now they're getting a 10% discount. So you almost have a 20% to 30% differential from the peak in construction costs. People are hiring clues more recently and readily subcontractors are out there bidding and wanting jobs. So I think you've seen a tremendous change.

Speaker 2

So I think we are in a bit of a recession. And I think that you have another big factor here. You have the shadow unemployment being impacted by the 10 plus 1,000,000 immigrants who have been led into this country and they are going to be starting to work. They are only letting about 10000 or 20000 a month working. So that's a big impact on our unemployment.

Speaker 2

So I do think that we're in a period of time where we'll be a little bit recessionary and I think rates will remain in this range and short term rates should come down, which is all good for our business.

Speaker 1

And as far as Lee, it's Paul,

Speaker 2

our book value is 12.46 at

Speaker 1

the end of 6.30 and to your question about buybacks, we certainly have around 140,000,000 of capacity left in our buyback plan and Ivan and I will always assess where we think it's appropriate based on our capital and clearly at levels that you talked about, we'd like to be active because it'd be very accretive to one on book value and also to our earnings, right, Ivan? Yes.

Speaker 8

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 you'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.

Speaker 8

Thank you.

Speaker 2

Thank you, Lee. And as you know, we're in a heavily regulated environment. They're unregulated and we do get frustrated in blackout periods and then we prepare very heavily for these earnings calls where it's our day in court. And as I said on my call, the numbers speak for themselves and the company's performance even in these very stressful times. We are performers who are never really well.

Speaker 2

And when you compare us to our peers, it's not even the same group. We've posted those charts to do a comparison. So we'll continue to work hard, be thorough, navigate these times and appreciate you as a shareholder and all our shareholders who have a lot of confidence in us. So thanks to you and Mark. It's very meaningful to us and to our management staff who have been working extraordinarily hard just to get back to breakeven.

Speaker 2

As an entrepreneur, I always work to grow companies and it's not the most rewarding thing in the world to work to get back to breakeven, but life is life and that's part of our job and we're working hard and we've done a good job and I think the quarter speaks for itself and thank you again Lee for your comments.

Speaker 8

My pleasure. They're well deserved. Congratulations.

Speaker 2

Thanks. Thanks, Lee.

Operator

This does conclude today's question and answer period. I will now turn the program back over to our presenters for any additional or closing remarks.

Speaker 2

All right. Thank you everybody for listening today and for the long call and for your patience. And thank you for your participation in the call. Everybody have a great weekend and enjoy the rest of the summer.

Operator

This does conclude today's program. Thank you for your participation. You may disconnect at any time.

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