Arbor Realty: Buying The Dip And 12.4% Yield

Arbor Realty's (NYSE:ABR) dip over the last few weeks since the Fed sparked volatility by reaffirming a higher for longer stance at its September rate pause has been surprising. My investment position in the mortgage REIT wasn't already at its full position so I took the opportunity to purchase 1,000 shares, a straightforward decision on the back of a double-digit dividend yield and a strong balance sheet. I think this decision will pan out positively over the next year as base rates reach a crescendo and the dividend continues to be raised on the back of a low payout ratio and a healthy credit portfolio. Arbor last declared a quarterly cash dividend of $0.43 per share, a 2.4% increase from the prior dividend for a 12.4% annualized forward yield. The yield is safe with a trendline over the last decade that highlights the intrinsically shareholder-focused profile of the mREIT.

Whether or not the pullback is deserved is not the main question; the market is tanking, and everything gets sold off. This is the proverbial baby being thrown out with the bathwater. The Fed has not backed down from hawkishness despite current inflation angst being driven by supply-driven OPEC cuts to crude oil production. How will raising rates fundamentally address this? No clue, but the continued resilience of the US economy should be interpreted as a positive not met with a selloff. A recession would create a macroeconomic backdrop for Arbor where its current expected credit losses likely spike to place its earnings under pressure. I think that's an infinitely worse scenario than base rates staying higher for another half a year or being hiked another 25 basis points.

Strong Balance Sheet, Multifamily Concentration, And Sunbelt Focus

Arbor held cash and equivalents of $846.4 million as of the end of its last reported fiscal 2023 second quarter, up 148% year-over-year. This was on the back of a net interest income that at $108.54 million grew by 15.1% over its year-ago comp and beat consensus estimates by $9.72 million. Arbor is a direct CRE lender with a near-exclusive focus on providing loan origination and servicing for multifamily and single-family rental properties. It's an internally managed REIT with a multifamily operating platform and a business model that consists of balance sheet loan origination, GSE/agency loan origination, and servicing.

The loan and investment portfolio's unpaid principal balance, excluding CECL, was $13.49 billion with a weighted average current interest pay rate of 8.76%. This was 90% multifamily with single-family rental properties the second largest allocation at 8%. The pay rate was up 16 basis points sequentially with the mREIT originating around $209 million in structured loans during the second quarter. I like the focus on what's arguably one of the best property subsectors with the geographic spread that's highly sunbelt-focused also a plus. These are states experiencing healthy economic and population growth. Further, whilst the short office trade is overdone, the 1% office exposure is also a plus until office vacancies stop rising across the US.

Strong Dividend Coverage As Book Value Retains Upward Momentum

Net income for the second quarter came in at $76.2 million, around $0.41 per share. Bears would be right to highlight that whilst this was up from $69.9 million in the year-ago quarter, it was flat on a per share basis. It drove distributable earnings of $0.57 per share to cover the current dividend by 133%, a 75% payout ratio. Critically, this is a 12.4% dividend yield that's safe with a healthy growth history. Arbor's dividend 5-year compound annual growth rate at 8.2% is in excess of its peer group median. The dividend stands to notch further growth with the underlying credit portfolio built on multifamily properties which would face a comparatively reduced risk profile during a recession. What keeps me up at night? The potential direction of book value.

To be clear, a double-digit yield is great but if book value is declining then the stock will reflect this to hamper total returns. The mREIT's book value has also steadily appreciated over the last decade with Arbor pushing through a 45% growth in book value over the last three years from $9 per share to roughly $13 per share. The mREIT's book value growth, fat dividend yield, and low payout ratio are three core factors that bulls have to support their thesis. The current volatility on the back of strong employment figures and the September rate pause looks like an opportunity against these factors. I'm bullish on Arbor with the ticker forming one of my core REIT positions. I'm rating the shares as a buy.