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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

x                                QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2017

 

or

 

o                                  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission file number: 001-32136

 

Arbor Realty Trust, Inc.

(Exact name of registrant as specified in its charter)

 

Maryland		20-0057959
(State or other jurisdiction of incorporation)		(I.R.S. Employer Identification No.)
333 Earle Ovington Boulevard, Suite 900 Uniondale, NY		11553
(Address of principal executive offices)		(Zip Code)

 

(Registrant’s telephone number, including area code): (516) 506-4200

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes   x       No  o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x      No  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer	o	Accelerated filer      x	Smaller reporting company	o
Non-accelerated filer	o	(Do not check if a smaller reporting company)	Emerging growth company	o

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.   o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes   o           No   x

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.  Common stock, $0.01 par value per share: 61,702,628 outstanding as of October 27, 2017.

 

 

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INDEX

 

PART I. FINANCIAL INFORMATION			2
	Item 1. Financial Statements (Unaudited)		2
		Consolidated Balance Sheets	2
		Consolidated Statements of Income	3
		Consolidated Statements of Comprehensive Income	4
		Consolidated Statement of Changes in Equity	5
		Consolidated Statements of Cash Flows	6
		Notes to Consolidated Financial Statements	8
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		50
	Item 3. Quantitative and Qualitative Disclosures about Market Risk		64
	Item 4. Controls and Procedures		65
PART II. OTHER INFORMATION			65
	Item 1. Legal Proceedings		65
	Item 1A. Risk Factors		65
	Item 6. Exhibits		66
Signatures			67

 

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Forward-Looking Statements

 

The information contained in this quarterly report on Form 10-Q is not a complete description of our business or the risks associated with an investment in Arbor Realty Trust, Inc.  We urge you to carefully review and consider the various disclosures made by us in this report.

 

This report contains certain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements relate to, among other things, the operating performance of our investments and financing needs. We use words such as “anticipate,” “expect,” “believe,” “intend,” “should,” “will,” “may” and similar expressions to identify forward-looking statements, although not all forward-looking statements include these words.  Forward-looking statements are based on certain assumptions, discuss future expectations, describe future plans and strategies, contain projections of results of operations or of financial condition or state other forward-looking information.  Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain.  These forward-looking statements involve risks, uncertainties and other factors that may cause our actual results in future periods to differ materially from forecasted results.  Factors that could have a material adverse effect on our operations and future prospects include, but are not limited to, changes in economic conditions generally and the real estate market specifically; adverse changes in our status with government-sponsored enterprises affecting our ability to originate loans through such programs; changes in interest rates; the quality and size of the investment pipeline and the rate at which we can invest our cash; impairments in the value of the collateral underlying our loans and investments; changes in federal and state laws and regulations, including changes in tax laws; the availability and cost of capital for future investments; and competition. Readers are cautioned not to place undue reliance on any of these forward-looking statements, which reflect management’s views as of the date of this report.  The factors noted above could cause our actual results to differ significantly from those contained in any forward-looking statement.

 

Additional information regarding these and other risks and uncertainties we face is contained in our annual report on Form 10-K for the year ended December 31, 2016 (the “2016 Annual Report”) filed with the Securities and Exchange Commission (“SEC”) on March 3, 2017 and in our other reports and filings with the SEC.

 

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements.  We are under no duty to update any of the forward-looking statements after the date of this report to conform these statements to actual results.

 

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PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 

		September 30,			December 31,
		2017			2016
		(Unaudited)
Assets:
Cash and cash equivalents		$	84,751,397		$	138,645,430
Restricted cash		137,138,389			29,314,929
Loans and investments, net		1,997,555,985			1,695,732,351
Loans held-for-sale, net		333,267,976			673,367,304
Capitalized mortgage servicing rights, net		247,875,659			227,742,986
Available-for-sale securities, at fair value		4,707,085			5,403,463
Securities held-to-maturity, net		18,851,089			—
Investments in equity affiliates		31,330,740			33,948,853
Real estate owned, net		17,354,720			19,491,805
Due from related party		12,613,313			1,464,732
Goodwill and other intangible assets		123,166,816			97,489,884
Other assets		49,564,693			48,184,509
Total assets		$	3,058,177,862		$	2,970,786,246
Liabilities and Equity:
Credit facilities and repurchase agreements		$	562,326,537		$	906,636,790
Collateralized loan obligations		1,066,230,488			728,441,109
Senior unsecured notes		95,088,379			94,521,566
Convertible senior unsecured notes, net		95,381,121			80,660,038
Junior subordinated notes to subsidiary trust issuing preferred securities		139,418,416			157,858,555
Related party financing		50,000,000			50,000,000
Due to related party		—			6,038,707
Due to borrowers		69,357,152			81,019,386
Allowance for loss-sharing obligations		30,158,464			32,407,554
Other liabilities		104,474,096			86,164,613
Total liabilities		2,212,434,653			2,223,748,318
Commitments and contingencies (Note 15)
Equity:
Arbor Realty Trust, Inc. stockholders’ equity:
Preferred stock, cumulative, redeemable, $0.01 par value: 100,000,000 shares authorized; special voting preferred shares; 21,230,769 shares issued and outstanding; 8.25% Series A, $38,787,500 aggregate liquidation preference; 1,551,500 shares issued and outstanding; 7.75% Series B, $31,500,000 aggregate liquidation preference; 1,260,000 shares issued and outstanding; 8.50% Series C, $22,500,000 aggregate liquidation preference; 900,000 shares issued and outstanding		89,508,213			89,508,213
Common stock, $0.01 par value: 500,000,000 shares authorized; 61,702,628 and 51,401,295 shares issued and outstanding, respectively		617,026			514,013
Additional paid-in capital		702,240,622			621,931,995
Accumulated deficit		(112,069,714		)	(125,134,403		)
Accumulated other comprehensive income		205,761			320,917
Total Arbor Realty Trust, Inc. stockholders’ equity		680,501,908			587,140,735
Noncontrolling interest		165,241,301			159,897,193
Total equity		845,743,209			747,037,928
Total liabilities and equity		$	3,058,177,862		$	2,970,786,246

 

See Notes to Consolidated Financial Statements.

 

2

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2017			2016			2017			2016
Interest income		$	42,139,576		$	29,636,227		$	110,132,866		$	83,424,190
Other interest income, net		—			—			—			2,539,274
Interest expense		23,849,417			16,966,228			63,697,641			42,958,329
Net interest income		18,290,159			12,669,999			46,435,225			43,005,135
Other revenue:
Gain on sales, including fee-based services, net		17,126,106			9,693,822			55,127,004			9,693,822
Mortgage servicing rights		18,897,239			15,968,067			56,181,638			15,968,067
Servicing revenue, net		8,520,111			5,885,884			19,922,901			5,885,884
Property operating income		2,668,055			2,960,940			8,754,518			12,719,027
Other income, net		777,656			359,546			(929,893		)	663,977
Total other revenue		47,989,167			34,868,259			139,056,168			44,930,777
Other expenses:
Employee compensation and benefits		25,194,433			14,216,679			66,860,581			22,856,433
Selling and administrative		7,606,936			5,903,031			23,135,750			10,277,844
Acquisition costs		—			6,406,258			—			10,261,902
Property operating expenses		2,582,745			2,819,004			7,842,571			10,991,823
Depreciation and amortization		1,829,016			1,808,765			5,541,991			3,129,410
Impairment loss on real estate owned		—			—			2,700,000			11,200,000
Provision for loss sharing (net of recoveries)		(2,617,064		)	1,316,862			(405,494		)	1,316,862
Provision for loan losses (net of recoveries)		2,000,000			(54,000		)	(455,653		)	(24,995		)
Management fee - related party		—			3,325,000			6,673,260			8,875,000
Total other expenses		36,596,066			35,741,599			111,893,006			78,884,279
Income before gain on extinguishment of debt, gain on sale of real estate, income from equity affiliates and provision for income taxes		29,683,260			11,796,659			73,598,387			9,051,633
Gain on extinguishment of debt		—			—			7,116,243			—
Gain on sale of real estate		—			—			—			11,630,687
Income from equity affiliates		995,312			4,929,375			1,755,145			11,193,918
Provision for income taxes		(6,708,000		)	(300,000		)	(16,244,000		)	(300,000		)
Net income		23,970,572			16,426,034			66,225,775			31,576,238
Preferred stock dividends		1,888,430			1,888,430			5,665,290			5,665,290
Net income attributable to noncontrolling interest		5,661,184			3,649,432			16,596,415			3,649,432
Net income attributable to common stockholders		$	16,420,958		$	10,888,172		$	43,964,070		$	22,261,516
Basic earnings per common share		$	0.27		$	0.21		$	0.78		$	0.43
Diluted earnings per common share		$	0.26		$	0.21		$	0.77		$	0.43
Weighted average shares outstanding:
Basic		61,582,796			51,390,467			56,602,504			51,272,795
Diluted		83,918,117			70,271,796			78,942,919			51,627,550
Dividends declared per common share		$	0.18		$	0.16		$	0.53		$	0.46

 

See Notes to Consolidated Financial Statements.

 

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2017			2016			2017			2016
Net income		$	23,970,572		$	16,426,034		$	66,225,775		$	31,576,238
Unrealized loss on securities available-for-sale, at fair value		(235,158		)	(88,184		)	(352,735		)	(117,579		)
Unrealized gain (loss) on derivative financial instruments, net		—			66,254			202			(195,981		)
Reclassification of net realized loss on derivatives designated as cash flow hedges into earnings		—			1,316,157			237,377			4,012,457
Comprehensive income		23,735,414			17,720,261			66,110,619			35,275,135
Less:
Comprehensive income attributable to noncontrolling interest		5,601,567			3,974,327			16,574,284			3,974,327
Preferred stock dividends		1,888,430			1,888,430			5,665,290			5,665,290
Comprehensive income attributable to common stockholders		$	16,245,417		$	11,857,504		$	43,871,045		$	25,635,518

 

See Notes to Consolidated Financial Statements.

 

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY (Unaudited)

 

Nine Months Ended September 30, 2017

 

		Preferred Stock Shares		Preferred Stock Value			Common Stock Shares		Common Stock Par Value			Additional Paid- in Capital			Accumulated Deficit			Accumulated Other Comprehensive Income			Total Arbor Realty Trust, Inc. Stockholders’ Equity			Noncontrolling Interest			Total Equity
Balance — December 31, 2016		24,942,269		$	89,508,213		51,401,295		$	514,013		$	621,931,995		$	(125,134,403	)	$	320,917		$	587,140,735		$	159,897,193		$	747,037,928
Issuance of common stock							9,500,000		95,000			76,130,000									76,225,000						76,225,000
Stock-based compensation							806,524		8,065			3,825,296									3,833,361						3,833,361
Forfeiture of unvested restricted stock							(5,191	)	(52		)	52									—						—
Issuance of convertible senior unsecured notes, net												353,279									353,279						353,279
Distributions - common stock															(30,888,612		)				(30,888,612		)				(30,888,612		)
Distributions - preferred stock															(5,665,290		)				(5,665,290		)				(5,665,290		)
Distributions - preferred stock of private REIT															(10,769		)				(10,769		)				(10,769		)
Distributions - noncontrolling interest																								(11,252,307		)	(11,252,307		)
Net income															49,629,360						49,629,360			16,596,415			66,225,775
Unrealized loss on securities available-for-sale																		(352,735		)	(352,735		)				(352,735		)
Unrealized gain on derivative financial instruments, net																		202			202						202
Reclassification of net realized loss on derivatives designated as cash flow hedges into earnings																		237,377			237,377						237,377
Balance — September 30, 2017		24,942,269		$	89,508,213		61,702,628		$	617,026		$	702,240,622		$	(112,069,714	)	$	205,761		$	680,501,908		$	165,241,301		$	845,743,209

 

See Notes to Consolidated Financial Statements.

 

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

 

		Nine Months Ended September 30,
		2017			2016
Operating activities:
Net income		$	66,225,775		$	31,576,238
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		5,541,991			3,129,410
Stock-based compensation		3,833,361			2,940,174
Amortization and accretion of interest and fees, net		3,296,464			2,539,980
Amortization of capitalized mortgage servicing rights		35,427,217			7,586,524
Originations of loans held-for-sale		(3,287,578,091		)	(853,935,531		)
Proceeds from sales of loans held-for-sale, net of gain on sale		3,621,276,437			975,969,372
Payoffs and paydowns of loans held-for-sale		116,174			—
Mortgage servicing rights		(56,181,638		)	(15,968,067		)
Write-off of capitalized mortgage servicing rights from payoffs		10,713,274			1,669,081
Impairment loss on real estate owned		2,700,000			11,200,000
Provision for loan losses (net of recoveries)		(455,653		)	(24,995		)
Provision for loss sharing (net of recoveries)		(405,494		)	1,316,862
Net charge-offs for loss sharing obligations		(1,843,596		)	(2,131,178		)
Gain on extinguishment of debt		(7,116,243		)	—
Gain on sale of real estate		—			(11,630,687		)
Gain on sale of securities		—			(15,491		)
Deferred tax provision		15,000			—
Income from equity affiliates		(1,755,145		)	(11,193,918		)
Change in fair value of available-for-sale securities		343,642			46,021
Changes in operating assets and liabilities		(6,252,023		)	5,894,972
Net cash provided by operating activities		387,901,452			148,968,767
Investing Activities:
Loans and investments funded and originated, net		(1,051,445,805		)	(725,025,857		)
Payoffs and paydowns of loans and investments		758,138,665			531,874,076
Internalization of management team		(25,000,000		)	—
Deferred fees		7,213,824			7,412,018
Investments in real estate, net		(562,025		)	(611,497		)
Contributions to equity affiliates		(692,536		)	(4,641,973		)
Distributions from equity affiliates		2,340,710			731,942
Acquisition of the Agency Business, net of cash acquired		—			(68,356,323		)
Proceeds from sale of real estate, net		—			49,029,780
Proceeds from sale of available-for-sale securities		—			1,567,207
Purchase of securities held-to-maturity, net		(18,339,271		)	—
Payoffs and paydowns of securities held-to-maturity		76,300			—
Due to borrowers and reserves		(22,571,250		)	128,492
Net cash used in investing activities		(350,841,388		)	(207,892,135		)
Financing activities:
Proceeds from repurchase agreements, loan participations, credit facilities and notes payable		6,073,385,393			1,681,492,236
Payoffs and paydowns of repurchase agreements, loan participations and credit facilities		(6,417,833,725		)	(1,807,884,108		)
Payoffs of junior subordinated notes to subsidiary trust issuing preferred securities		(12,691,086		)	—
Paydowns and payoffs of mortgage note payable - real estate owned		—			(27,155,000		)
Proceeds from collateralized loan obligations		561,874,000			250,250,000
Payoffs and paydowns of collateralized loan obligations		(219,000,000		)	—
Proceeds from convertible senior unsecured notes		13,750,000			—
Change in restricted cash		(107,793,983		)	(123,982,753		)
Receipts on swaps and returns of margin calls from counterparties		429,539			3,440,049
Distributions paid on common stock		(30,888,612		)	(23,573,786		)
Distributions paid on noncontrolling interest		(11,252,307		)	—
Distributions paid on preferred stock		(5,665,290		)	(5,665,290		)
Distributions paid on preferred stock of private REIT		(10,769		)	(10,849		)
Payment of deferred financing costs		(11,482,257		)	(5,081,844		)
Proceeds from issuance of common stock		76,225,000			—
Net cash used in financing activities		(90,954,097		)	(58,171,345		)
Net decrease in cash and cash equivalents		(53,894,033		)	(117,094,713		)
Cash and cash equivalents at beginning of period		138,645,430			188,708,687
Cash and cash equivalents at end of period		$	84,751,397		$	71,613,974

 

See Notes to Consolidated Financial Statements.

 

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (C ontinued)

 

		Nine Months Ended September 30,
		2017			2016
Supplemental cash flow information:
Cash used to pay interest		$	53,150,362		$	36,287,261
Cash used to pay taxes		$	14,653,499		$	298,654
Supplemental schedule of non-cash investing and financing activities:
Distributions accrued on 8.25% Series A preferred stock		$	266,664		$	266,664
Distributions accrued on 7.75% Series B preferred stock		$	203,438		$	203,438
Distributions accrued on 8.50% Series C preferred stock		$	159,375		$	159,375
Distributions accrued on special voting preferred shares		$	—		$	3,396,923
Related party financing		$	—		$	50,000,000
Payment due on the acquisition of the Agency Business		$	—		$	11,416,610
Working capital adjustment on the acquisition of the Agency Business		$	—		$	7,982,584
Issuance of special voting preferred shares and operating partnership units in connection with the Acquisition		$	—		$	154,772,306

 

See Notes to Consolidated Financial Statements.

 

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ARBOR REALTY TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

September 30, 2017

 

Note 1 — Description of Business

 

Arbor Realty Trust, Inc. (the “Company,” “we,” “us,” or “our”) is a Maryland corporation formed in 2003. Through our Structured Loan Origination and Investment Business, or “Structured Business,” we invest in a diversified portfolio of structured finance assets in the multifamily and commercial real estate markets, primarily consisting of bridge and mezzanine loans, including junior participating interests in first mortgages, preferred and direct equity. We may also directly acquire real property and invest in real estate-related notes and certain mortgage-related securities. Through our Agency Loan Origination and Servicing Business, or “Agency Business,” which was formed as a result of the acquisition of the agency platform of Arbor Commercial Mortgage, LLC (“ACM” or our “Former Manager”) in the third quarter of 2016 (the “Acquisition”), we originate, sell and service a range of multifamily finance products through the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac,” and together with Fannie Mae, the government-sponsored enterprises, or the “GSEs”), the Government National Mortgage Association (“Ginnie Mae”), Federal Housing Authority (“FHA”) and the U.S. Department of Housing and Urban Development (together with Ginnie Mae and FHA, “HUD”) and the conduit/commercial mortgage-backed securities (“CMBS”) programs. We retain the servicing rights and asset management responsibilities on substantially all loans we originate and sell under the GSE and HUD programs.

 

Prior to May 31, 2017, we were externally managed and advised by ACM. Effective May 31, 2017, we exercised our option to fully internalize our management team and terminate the existing management agreement. See Note 3 — Acquisition of Our Former Manager’s Agency Platform for details.

 

Substantially all of our operations are conducted through our operating partnership, Arbor Realty Limited Partnership (“ARLP”), for which we serve as the general partner, and ARLP’s subsidiaries. We are organized to qualify as a real estate investment trust (“REIT”) for U.S. federal income tax purposes. Certain of our assets that produce non-qualifying income, primarily within the Agency Business, are operated through taxable REIT subsidiaries (“TRS”), which is part of our TRS consolidated group (the “TRS Consolidated Group”) and is subject to U.S. federal, state and local income taxes. See Note 18 — Income Taxes for details.

 

Note 2 — Basis of Presentation and Significant Accounting Policies

 

Basis of Presentation

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”), for interim financial statements and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, certain information and footnote disclosures normally included in the consolidated financial statements prepared under GAAP have been condensed or omitted.  In our opinion, all adjustments considered necessary for a fair presentation of our financial position, results of operations and cash flows have been included and are of a normal and recurring nature.  The operating results presented for interim periods are not necessarily indicative of the results that may be expected for any other interim period or for the entire year. These financial statements should be read in conjunction with our financial statements and notes thereto included in our 2016 Annual Report.

 

During the third quarter of 2017, we determined that the purchase price allocation related to the Acquisition in 2016 incorrectly omitted a deferred tax liability related to the book-to-tax difference in the value assigned to certain assets acquired. The impact of this omission to our 2016 consolidated financial statements was a $4.9 million understatement of goodwill and a corresponding understatement of other liabilities in our consolidated balance sheets. This omission had no impact on our results of operations and was corrected in the third quarter of 2017, resulting in a $4.9 million increase to goodwill and a corresponding increase in other liabilities.

 

Principles of Consolidation

 

The accompanying unaudited consolidated financial statements include our financial statements and the financial statements of our wholly owned subsidiaries, partnerships and other joint ventures in which we own a controlling interest, including variable interest entities (“VIEs”) of which we are the primary beneficiary.  Entities in which we

 

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have a significant influence are accounted for under the equity method. See Note 16 — Variable Interest Entities for information about our VIEs. All significant intercompany transactions and balances have been eliminated.

 

Use of Estimates

 

The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that could materially affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

 

Significant Accounting Policies

 

We describe our significant accounting policies in our 2016 Annual Report. There have been no significant changes in our significant accounting policies since December 31, 2016.

 

Recently Adopted Accounting Pronouncements

 

Description		Adoption Date		Effect on Financial Statements
In October 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-17, Consolidation: Interests Held through Related Parties That Are under Common Control. This ASU alters how a decision maker needs to consider indirect interests in a VIE held through an entity under common control and requires consideration of only an entity’s proportionate indirect interest in a VIE held through a common control party.		First quarter of 2017.		The adoption of this guidance did not have a material impact on our consolidated financial statements.
In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation: Improvements to Employee Share-Based Payment Accounting. This ASU is intended to simplify several aspects of the accounting for share-based payment award transactions, including income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows.		First quarter of 2017.		The adoption of this guidance did not have a material impact on our consolidated financial statements.
In March 2016, the FASB issued ASU 2016-07, Investments - Equity Method and Joint Ventures: Simplifying the Transition to the Equity Method of Accounting. This ASU, among other things, eliminates the requirement that when an investment qualifies for use of the equity method as a result of an increase in the level of ownership interest or degree of influence, an investor must adjust the investment, results of operations, and retained earnings retroactively on a step-by-step basis as if the equity method had been in effect during all previous periods the investment was held.		First quarter of 2017.		The adoption of this guidance did not have a material impact on our consolidated financial statements.

 

Recently Issued Accounting Pronouncements

 

The following table is not intended to represent all recently issued accounting pronouncements that are not yet effective and which have not yet been adopted by us. This table should be read in conjunction with the recently issued accounting pronouncements section included in our 2016 Annual Report.

 

Description		Effective Date		Effect on Financial Statements
In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other: Simplifying the Test for Goodwill Impairment. This ASU eliminates step two from the goodwill impairment test, which measures a goodwill impairment loss by comparing the implied fair value with the carrying amount of goodwill.		First quarter of 2020 with early adoption permitted beginning in the first quarter of 2017.		We are evaluating the timing of our adoption and the impact this guidance may have on our consolidated financial statements.

 

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Description		Effective Date		Effect on Financial Statements
In January 2017, the FASB issued ASU 2017-01, Business Combinations: Clarifying the Definition of a Business. This ASU provides a more robust framework to use in determining when a set of assets and activities constitutes a business. It also provides more consistency in applying the guidance, reduces the costs of application and makes the definition of a business more operable.		First quarter of 2018.		The potential impact of this new guidance will be assessed for future acquisitions, but it is not expected to have a material impact on our consolidated financial statements.
Since 2014, the FASB has issued several amendments to its guidance on revenue recognition. The amended guidance, among other things, introduces a new framework for a single comprehensive model that can be used when accounting for revenue and supersedes most current revenue recognition guidance, including that which pertains to specific industries. The core principle states that an entity should recognize revenue to depict the transfer of promised goods or services in an amount that reflects the consideration to which the entity expects to be entitled in exchange for such goods and services. It also requires expanded quantitative and qualitative disclosures that will enable financial statement users to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. Most revenue associated with financial instruments, including interest and loan origination fees, along with gains and losses on investment securities, derivatives and sales of financial instruments are excluded from the scope of the guidance.		First quarter of 2018 and permits the use of either the full retrospective or modified retrospective method.		We have evaluated the new standard and determined that substantially all of our revenue, including interest income, loan origination fees, servicing income and gains on sales of loans and investment securities, are not impacted. This standard may impact the timing of gains on certain sales of real estate, however, we have determined that this standard will not materially impact our total revenues or footnote disclosures. We will adopt this standard in the first quarter of 2018 using the modified retrospective method for any contracts that are not complete as of the adoption date.

 

Note 3 — Acquisition of Our Former Manager’s Agency Platform

 

On July 14, 2016, we completed the previously announced Acquisition of the agency platform of our Former Manager pursuant to an asset purchase agreement dated February 25, 2016 (“Purchase Agreement”). The aggregate purchase price was $275.8 million, which was paid with $138.0 million in stock, $87.8 million in cash and with the issuance of a $50.0 million seller financing instrument. The equity component of the purchase price was paid with 21,230,769 operating partnership units (“OP Units”), which was based on a stock price of $6.50 per share. The closing price of our common stock on the Acquisition date was $7.29 per share; therefore, the estimated fair value of the total consideration was $292.5 million. See Note 11 — Debt Obligations for details about the seller financing and Note 17 — Equity for details about the OP Units.

 

We finalized the purchase price allocation during the first quarter of 2017 based on the estimated fair values of the assets acquired and liabilities assumed as of the Acquisition date. See Note 2 — Basis of Presentation and Significant Accounting Policies for details of an adjustment made to the purchase price allocation in the third quarter of 2017.

 

Internalization of Management Team

 

In connection with the Acquisition, we had the option to fully internalize our management team and terminate the existing management agreement with our Former Manager for $25.0 million.  On May 31, 2017, we exercised that option and fully internalized our management team, which included approximately 100 employees. We incurred expenses of less than $0.1 million in connection with this transaction. We accounted for this transaction as a business combination with the settlement of a preexisting relationship. The total purchase price of $25.0 million was assigned to goodwill since the asset transferred represented an assembled workforce. Goodwill was allocated $12.5 million each to our two reporting segments and is expected to be deductible for tax purposes.

 

Accounting guidance requires the settlement of preexisting relationships to be accounted for separately from the business combination, with the recognition of any corresponding gain or loss through the statement of income upon settlement. Any potential gain or loss is measured based on the favorable or unfavorable terms of the management agreement from the prospective of the acquirer, when compared to current market rates for similar services. Based on this guidance, we performed an analysis and determined that the terminated management agreement contained terms similar to those of arrangements with comparable companies, and therefore no such gain or loss was recorded.

 

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Note 4 — Loans and Investments

 

The following tables set forth the composition of our structured loan and investment portfolio:

 

		September 30, 2017			Percent of Total		Loan Count		Wtd. Avg. Pay Rate (1)		Wtd. Avg. Remaining Months to Maturity		Wtd. Avg. First Dollar LTV Ratio (2)		Wtd. Avg. Last Dollar LTV Ratio (3)
Bridge loans		$	1,841,484,888		88	%	129		5.89	%	19.0		0	%	72	%
Preferred equity investments		155,306,620			7	%	11		6.92	%	68.3		62	%	88	%
Mezzanine loans		72,328,033			4	%	8		10.24	%	26.9		29	%	69	%
Junior participation loan (4)		25,256,582			1	%	1		—		—		100	%	100	%
		2,094,376,123			100	%	149		6.04	%	22.7		7	%	74	%
Allowance for loan losses		(83,255,922		)
Unearned revenue		(13,564,216		)
Loans and investments, net		$	1,997,555,985

 

		December 31, 2016
Bridge loans		$	1,602,658,179		90	%	120		5.59	%	16.4		0	%	73	%
Preferred equity investments		68,120,639			4	%	10		6.83	%	23.8		42	%	91	%
Mezzanine loans		57,124,566			3	%	12		9.09	%	17.9		36	%	75	%
Junior participation loans		62,256,582			3	%	2		4.50	%	4.0		83	%	84	%
		1,790,159,966			100	%	144		5.71	%	16.3		6	%	75	%
Allowance for loan losses		(83,711,575		)
Unearned revenue		(10,716,040		)
Loans and investments, net		$	1,695,732,351

 

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(1)                “Weighted Average Pay Rate” is a weighted average, based on the unpaid principal balance (“UPB”) of each loan in our portfolio, of the interest rate that is required to be paid monthly as stated in the individual loan agreements.  Certain loans and investments that require an additional rate of interest “Accrual Rate” to be paid at maturity are not included in the weighted average pay rate as shown in the table.

(2)                The “First Dollar Loan-to-Value (“LTV”) Ratio” is calculated by comparing the total of our senior most dollar and all senior lien positions within the capital stack to the fair value of the underlying collateral to determine the point at which we will absorb a total loss of our position.

(3)                The “Last Dollar LTV Ratio” is calculated by comparing the total of the carrying value of our loan and all senior lien positions within the capital stack to the fair value of the underlying collateral to determine the point at which we will initially absorb a loss.

(4)                This loan is currently past its maturity and is fully reserved.

 

Concentration of Credit Risk

 

We are subject to concentration risk in that, at September 30, 2017, the UPB related to 32 loans with five different borrowers represented 15% of total assets.  At December 31, 2016, the UPB related to 35 loans with five different borrowers represented 16% of total assets. During both the nine months ended September 30, 2017 and the year ended December 31, 2016, no single loan or investment represented more than 10% of our total assets and no single investor group generated over 10% of our revenue.

 

Effective January 1, 2017, we revised our methodology used to assign a credit risk rating to each loan and investment to be consistent with the method used by our Agency Business. We now assign ratings of pass, pass/watch, special mention, substandard or doubtful to each loan and investment, instead of a one to five rating. Similar to our previous methodology, there are five ratings, each generally consistent with our prior ratings (i.e., pass is equivalent to a one rating, pass/watch is equivalent to a two rating, etc.), with a pass rating being the lowest risk and a doubtful rating being the highest.

 

The benchmark guidelines and other factors used in our revised methodology are substantially the same as our previous methodology. Each credit risk rating has benchmark guidelines that pertain to debt-service coverage ratios, LTV ratios, borrower strength, asset quality, and funded cash reserves.  Other factors such as guarantees, market strength, and remaining loan term and borrower equity are also reviewed and factored into determining the credit risk rating assigned to each loan.  This metric provides a helpful snapshot of portfolio quality and credit risk.  Given our asset management approach, however, the risk rating process does not result in differing levels of diligence

 

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contingent upon credit rating.  That is because all portfolio assets are subject to the level of scrutiny and ongoing analysis consistent with that of a “high-risk” loan.  Assets are subject to, at minimum, a thorough quarterly financial evaluation in which historical operating performance and forward-looking projections are reviewed.

 

Generally speaking, given our typical loan profile, risk ratings of pass, pass/watch and special mention suggest that we expect the loan to make both principal and interest payments according to the contractual terms of the loan agreement, and is not considered impaired.  A risk rating of substandard indicates we anticipate the loan may require a modification of some kind.  A risk rating of doubtful indicates we expect the loan to underperform over its term, and there could be loss of interest and/or principal.  Further, while the above are the primary guidelines used in determining a certain risk rating, subjective items such as borrower strength, market strength or asset quality may result in a rating that is higher or lower than might be indicated by any risk rating matrix.

 

As a result of the loan review process at September 30, 2017 and December 31, 2016, we identified loans and investments that we consider higher-risk loans that had a carrying value, before loan loss reserves, of $147.5 million and $150.5 million, respectively, and a weighted average last dollar LTV ratio of 94% and 95%, respectively.

 

A summary of the loan portfolio’s weighted average internal risk ratings and LTV ratios by asset class is presented below. The internal risk ratings as of December 31, 2016 have been converted to reflect the revised methodology described above.

 

		September 30, 2017
Asset Class		Unpaid Principal Balance			Percentage of Portfolio		Wtd. Avg. Internal Risk Rating		Wtd. Avg. First Dollar LTV Ratio		Wtd. Avg. Last Dollar LTV Ratio
Multifamily		$	1,556,114,399		75	%	pass/watch		5	%	73	%
Land		140,054,798			7	%	substandard		0	%	88	%
Commercial		133,230,000			6	%	pass		1	%	71	%
Office		133,143,446			6	%	pass/watch		19	%	71	%
Hotel		90,725,147			4	%	special mention		39	%	83	%
Retail		36,483,333			2	%	pass/watch		8	%	66	%
Healthcare		4,625,000			<1	%	special mention		0	%	73	%
Total		$	2,094,376,123		100	%	pass/watch		7	%	74	%

 

		December 31, 2016
Multifamily		$	1,421,731,108		79	%	special mention		1	%	73	%
Land		137,255,369			8	%	substandard		2	%	92	%
Commercial		9,205,000			<1	%	special mention		12	%	69	%
Office		141,710,156			8	%	pass/watch		43	%	73	%
Hotel		70,750,000			4	%	special mention		30	%	74	%
Retail		3,958,333			<1	%	special mention		81	%	91	%
Healthcare		5,550,000			<1	%	special mention		0	%	63	%
Total		$	1,790,159,966		100	%	special mention		6	%	75	%

 

Geographic Concentration Risk

 

As of September 30, 2017, 20%, 16%, 11% and 8% of the outstanding balance of our loan and investment portfolio had underlying properties in New York, Texas, California and Georgia, respectively.  As of December 31, 2016, 25%, 15%, 14% and 13% of the outstanding balance of our loan and investment portfolio had underlying properties in New York, California, Florida and Texas, respectively.

 

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