Arbor Realty Stock: Another Dilution, Another Opportunity (NYSE:ABR)

On Thursday, March 17th, Arbor Realty (NYSE:ABR) closed the regular session at $17.63. After the market closed the company issued two press releases. The first was

…that it plans to make a public offering of 6,000,000 shares of its common stock. In connection with the offering, the Company intends to grant the underwriters a 30-day option to purchase up to an additional 900,000 shares of its common stock. The Company intends to use the net proceeds from the offering to make investments relating to its business and for general corporate purposes.

A short time later, a second press release disclosed…

that it priced its public offering of 6,500,000 shares of common stock for total expected gross proceeds of approximately $108.9 million before underwriting discounts and commissions and expenses. The offering was upsized from the previously announced offering size of 6,000,000 shares. The Company has also granted the underwriters a 30-day option to purchase up to an additional 975,000 shares of its common stock.

The $108.9 million divided by 6.5 million shares comes to ~$16.75 per share, so it wasn’t too much of a surprise to see the stock trade down to that level during the after-hours session. Justifications for the drop could include:

1. Current shareholders would see their ownership percentage drop,
2. The EPS could decline, and the
3. Dividend coverage would fall.

It was also an excellent opportunity to open a new position or add to one’s current holdings. Unfortunately, I wasn’t paying enough attention at that time and missed an opportunity to open up a new trading position at a nice discount.

Disclosures

Before going further, I wanted to let everyone know that while I try to be even-handed in the articles I write for Seeking Alpha, because of my long history with Arbor, it is likely that some bias will be present in this article. Arbor has been a holding of ours since late 2007 when I opened a small position at $16.52, reinvesting all the dividends. And, yes, it was way too early. I was blinded by the $2.48 annual dividend and the yield of 15%. Although the shares moved to more than $19 within months, it wouldn’t be long before the shares cratered. The quarterly dividend would be slashed from $0.62 to $0.24 within a year, and that $0.24 payment would be the last dividend for several years.

The share price would bottom out below $1.70 per share in late 2009 and it wasn’t until May of 2012 that a quarterly dividend would be restored at a much lower rate – $0.075. Despite the restoration of that small dividend, the yield wasn’t anywhere close to making Arbor attractive enough for me to start committing additional funds and opening new positions. However, I did reinvest the dividends, and those reinvested dividends, along with increases in both the dividend rate and the share price, would be enough to eventually turn that initial investment positive. In fact, the total return from 2007 to 2022 would result in that position showing a total gain of more than 220%.

The steep drop and subsequent total gain explain part of my potential bias in evaluating Arbor. As the dividend rate eventually began to accelerate, I aggressively added to my position. Although my timing was far from perfect, my re-entry point was good enough to generate returns that were well above average, and Arbor has now become our second-largest equity position and an important provider of retirement income.

The Dividend

The dividend increases referenced above were somewhat erratic. Since the dividend was restarted in May of 2012, it has been increased a total of twenty-two times, although the size of the increases and intervals between those increases has been a bit unusual. Following the 7.5 cent dividend, there were consecutive quarterly raises to 10, 11 and 12 cents. After one more quarter at 12, it was increased to 13 cents and remained there for seven quarters. It was then increased to 15 cents in May of 2015. After five payments at 15 cents, the increases became more frequent. Two payments of 16 cents were followed by one of 17, two at 18, and sequential quarterly increases to 19, 21, and 25. After two quarters at 25, it was increased to 27 cents in November of 2018. After one more quarterly payment of 27 cents, there were consecutive quarterly increases to 29 and 30 cents, where it remained for two additional quarters.

Then began a string of seven consecutive one penny quarterly increases, bringing the current annual rate up to $1.42 and a forward yield of more than 8%. Too much focus on the dividend? I don’t think so. It’s the main reason we own the stock, the position has become an important component of our retirement income, and it appears that it still has plenty of room to grow – even with the dilutive effect of the recent capital raise.

Earnings Calls And Leon (Lee) Cooperman

Those of us that listen to corporate earnings calls have often heard Wall Street analysts asking questions and offering congratulations on a good quarter. Occasionally, especially with very small companies, we hear from small investors that manage to get on the call. With Arbor Realty, there is one particular investor that often participates on the calls, and I look forward to his questions.

The investor? Leon (Lee) Cooperman, a billionaire hedge fund manager. An article about Cooperman, which appeared in the Washington Post earlier this year began:

The stock market had been open for only 17 minutes when Leon Cooperman picked up the phone to check how much money he’d made. He dialed a private line to his trading desk in New Jersey, just as he did a dozen times each day.

“Decent start to the morning?” he asked.

“Oh yeah. The market’s shaky, but you’re up.”

“Give me numbers.”

“Looks like six, seven million.”

The article traced his day, and also discussed his background and performance at Goldman Sachs (GS) as well as his returns running the Omega Partners hedge fund, including the following:

Cooperman eventually left Goldman Sachs to start his own hedge fund, Omega, and for two decades he compounded his millions at an average of 14 percent each year as the stock market soared, until he and [his wife] Toby were among the wealthiest few hundred billionaires in the United States.

Each day when the stock market closed at 4 p.m., he checked the final numbers on his 40 stock holdings, reviewed his investment strategy for the next day and then left for a two-mile walk around the palm trees and putting greens of St. Andrews Country Club in Boca Raton.

Based on his presence during these conference calls, and his questions, Arbor is one of his “40 stock holdings”. That’s a fairly strong endorsement from an investor that has consistently generated large returns. He appeared to have dropped off their most recent call before management got to his place in the queue, but I view his being there as a continued endorsement of the company.

During the Q3 call, Cooperman began his comment:

You guys did an outstanding job and you deserve a kudo. And thankfully, I’ve been here almost for the entire run and still there.

and then got down to his questions:

…I noticed you raised from fixed rate money at 4.5% to 6% in the quarter, the stock yield at 7.1%. We’re selling at a significant justified premium-to-book value. So what are you putting money out at? Like, your figure of your cost of capital, what are you putting money out at these days? And you said that there is tremendous opportunities, so I assume with the tremendous opportunities your spread should get wider, right?

CEO Ivan Kaufman’s reply:

So we’re generally putting up, it’s still a competitive market. So I think the range when we put out money on our multi-family bridge loans, we’re generally getting a 10% to 12% yield somewhere in that range. And that doesn’t take into consideration the significant economics we derive when that converts into an agency loan, the gain on sale on the servicing fee. And then the returns become infinite in the sense, because the gain on sales and those long term servicing fees are really what we’re striving for. So it’s a matter of balance of how we raise the different elements of capital to fund that business and we’re very careful on how we do that.

The different elements Kaufman referenced include common stock, preferred stock and debt. Cooperman followed up with a question about what could derail the business and seemed satisfied with the reply, reiterating his congratulations:

Well congratulations on terrific job for all the shareholders, including yourself…

These types of exchanges between Cooperman and management have been taking place for quite some time, and I recommend that anyone thinking of buying (or selling) Arbor shares check out more of these exchanges between Cooperman and Arbor’s CFO Paul Elenio and Kaufman. They are certainly worth reading.

One of those that I found particularly helpful took place a year ago and began with Cooperman’s observation:

…You felt your stock was substantially undervalued yet, you’ve been willing to sell stock to financial growth. So I guess the answer is you sell something cheap, because you think you could reinvest the money [at] even more attractive terms. So maybe you could spend a little time talking about your return on every dollar you raise, what kind of return can you generate on that dollar incrementally? And any thoughts on that would be very interesting to me.

The answers should also be of interest to most other investors.

[Kaufman]: So when we’re raising capital, it’s usually to fund our growth. So in this particular business, we have to evaluate whether we’re going to have run-off on our balance sheet portfolio, what we can add to it, and whether we can add to it accretively. And if we can increase our balance sheet portfolio and get a return north of 12%, and as much as 15% sometimes. We’ll evaluate whether it’s worth raising capital to fund that growth if this growth in our balance sheet.

And it’s really just a mathematical analysis that Paul performs. He makes decisions where we [appraise] our loans and how accretive it is, and whether it’s worthwhile bringing in and growing the balance sheet or the accretive returns. It’s just a mathematical analysis. Paul, you want to comment on that?

[Elenio:] Sure. That’s right. Hi Lee, and yes, so we have a pretty robust pipeline. The only question is where does run-off go? And if run-off is stronger than we have those dollars to fund the growth, if it’s not, then we assess whether we want to do loans that those yields and raise capital at these prices or whatever prices we are. And historically, as you know, Lee, we’ve done, as you said a great job of being real good stewards of capital with high inside ownership.

So it’s an analysis we do. And if we think we can raise capital at accretive prices to fund loans that generate, let’s say a 13% to a 14% ROE or 12% to 15%, as Ivan said, and that’s an analysis we do. And we look at it and say, if it’s accretive, then we go forward. And that’s exactly how the analysis works. And we do think that we can raise capital to fund growth that would be 13% to 15% on an ROE.

There’s much more detail, and again, it’s worthwhile for current and potential investors to read the complete exchanges. I am confident that Elenio and Kaufman have done their analyses and that the latest capital raised by issuing new shares will be quickly put to accretive use and benefit both the current and new shareholders, including Cooperman and myself. I also believe that we will see continued dividend increases as a result of this latest capital raise.

Rating

Under most circumstances, the large and growing dividend would be enough for me to invest in a stock and rate it a minimum of “Hold”. Another positive would be Arbor’s recent history where they have been able to quickly use new cash to improve earnings. Throw in a successful billionaire investor owning the same shares and congratulating management on their performance, and it would seem to be a no-brainer to recommend a “Buy” or even a “Strong Buy.

However, there are a few reasons my choice is more problematic. First, our Arbor position is significantly above our targeted allocation, representing more than 9% of our equity holdings. Second, recent trends in inflation may impact how the market evaluates its yield. Third, recent comments by Fed Chairman Jerome Powell indicate protracted Fed tightening to contain inflation could impact both Arbor’s cost of capital and its customers’ ability to make payments.

Seeking Alpha requires authors to give a rating of Strong Buy, Buy, Hold, Sell or Strong Sell on single ticker articles. I was trying to decide how to rate Arbor, especially considering all of the above and the potential for a recession. So…

On the plus side, there is the attractive dividend and I intend to hold onto – at least – a portion of the shares and use those dividends to pay bills. I also intend to automatically reinvest the dividends in certain accounts I manage for other family members. On the negative side, Arbor has grown to be too large a portion of our equity holdings and it makes sense to sell some shares and reallocate those funds. That move would provide more capital to diversify into other opportunities.

Since one of my next moves is likely to be a sale of some shares to bring Arbor towards a more normal allocation, giving it a Strong Buy seems counter-intuitive. On the other hand, earlier this week I purchased shares in some of our accounts by reinvesting dividends. So, clearly, I don’t consider it a Strong Sell. A Hold? That’s too much like not giving it a rating.

Conclusion? I’m giving it a Buy rating, mostly due to its fat yield and the fact that I am continuing to reinvest dividends to buy more shares for some of our positions. Add in the “fact” that a billionaire investor thinks it’s one of 40 stocks worth owning, and a Buy rating seems to be the only proper recommendation.