As multifamily syndicators face mounting distress, their favorite lender could be in deep trouble.
Arbor Realty Trust has long been a prominent player in multifamily lending. But the firm’s heavy exposure to the industry and its reliance on floating-rate, CLO-backed debt has landed it in trouble.
The Real Deal’s Deconstruct podcast sat down with Gabriel Bernarde, a researcher at short-seller Viceroy Research, to shed light on Arbor’s precarious situation.
Arbor made a name for itself in recent years by providing floating-rate bridge loans to multifamily syndicators. These syndicators — many of them inexperienced investors — focused on buying transitional properties that needed renovations and rehabilitations, after which they could increase rents.
“At zero percent interest rates, it’s very hard to lose money doing that,” Bernarde noted. “But the problem with all of these bridging loans is that, especially in Arbor’s case, substantially all of them are floating rate.”
The rising interest rates have left many syndicators underwater, thanks in part to slowing rent growth and increased renovation costs.
Arbor’s funding model was based heavily on CLOs, which allowed it to raise additional capital with which it could make those loans.
A CLO is a debt instrument that allows lenders to get financing for commercial real estate loans by selling floating-rate bonds to investors. Investors are paid when the borrowers make payments to their lenders, in this case, Arbor.
Arbor wasn’t the only firm operating in this way. But, as Bernarde explained, they are the “worst of the worst.” The firm failed to diversify its loan book, with around 90 percent exposure to multifamily. Now, its delinquencies are on the rise.
So far, Arbor has been able to protect its CLO investors because only a part of its loan book is backed by CLO debt. CLO lenders can replace troubled debt in their CLO pool if it’s in default or at imminent risk of default. They do this by buying out the debt in favor of investors, and shifting healthier loans into the CLO pool.
Bernarde highlighted the practice of swapping loans within the CLO pool to maintain standards, describing it as “moving deck chairs around the Titanic.” This tactic, while potentially shielding Arbor’s immediate obligations to its investors, fails to address the underlying issues within the loan portfolio.
The severity of Arbor’s predicament becomes apparent when considering the potential consequences of CLO failure. “If the CLO fails and they get a 60 percent recovery, Arbor’s recovery is zero because it all goes to the bondholder,” Bernarde warned.
Despite attempts to downplay concerns, Arbor Realty Trust’s recent earnings call hinted at the mounting challenges. The CEO acknowledged the elevated delinquencies, attributing them to “peak stress” in the current environment. While profitability saw a modest increase, delinquencies surged by $115 million in the fourth quarter.
In response to criticisms from short-sellers, Arbor’s CEO defended the firm, suggesting that delinquencies may not be as dire as portrayed. However, with Viceroy Research estimating that 30 percent of Arbor’s loan book could be overdue by mid-February, the pressure on the company continues to mount.
The looming specter of defaults and the difficulty in raising capital amid market uncertainty only serve to compound Arbor’s woes. As Bernarde put it, “There’s going to be great opportunities for debt funds to pick up multifamily residential properties at a fire sale, at the right price, but it probably won’t be Arbor.”
