Arbor Realty: Is it the build up problem with this 13% yield? (NYSE:ABR)

I last wrote about Arbor Realty (NYSE: ABR) in 2012. At the time, the stock was trading around $5, and I saw some recent insider buying and the yield as reason to be bullish. I do not have I’ve been eyeing this stock for a while, but a number of recent developments have piqued my interest again. This stock recently fell on some negative headlines, and since I like to buy dips, I wanted to take a look at where the bulls and bears seem to be focused, so let’s take a closer look:

Arbor Realty is a popular mortgage real estate investment trust or “mREIT” that invests in a variety of real estate-backed loans. This allows it to provide an income stream that many shareholders find attractive. I appreciate that Arbor Realty’s management team has considerable experience in this industry, and in particular, that Ivan Kaufman, Chairman and President of Arbor Realty Trust has been with the company since 1983, and has a ownership shares. As shown below, many of the other senior executives at this company have been there for 10, 20 and even over 30 years.

Graph

As the chart below shows, this stock was in bullish mode until recently. Shares of Arbor Realty reached around $11 in November and December of 2023. Shares have seen some gains in recent months, apparently as the market had hopes for lower interest rates. These hopeful moments have largely been marred by the Federal Reserve’s continuation of a higher policy on longer-term interest rates. But hopes are rising again that the Fed will cut rates, and that appears to have fueled the recent rally to nearly $16 a share. However, the stock has dipped back into the $12 range on some negative headlines.

The 50-day moving average is $13.80 and the 200-day moving average is $12.97. In June, a bullish “Golden Cross” formed on the chart after the 50-day moving average crossed above the 200-day moving average. If this stock holds at current levels or dips below, this bullish chart formation will be at risk. At the moment, I don’t see the technicals as being as important a factor as they might normally be, because there is important news that seems to be controlling the share price at the moment. However, over the past few months, this stock has fallen several times to the $11 per share mark. So I wouldn’t be surprised if it happens again.

dividend

Arbor Realty pays a quarterly dividend of $0.43 per share, which works out to $1.72 per share on an annualized basis. This provides a yield of more than 13%, which is very attractive to income investors. However, volatility in the share price is obviously not attractive to most income investors who typically seek stability. Another important factor for income investors is whether or not the dividend is safe. Based on current earnings estimates and a payout ratio estimated by Seeking Alpha to be close to 100%, I believe this company will need to start delivering stronger results if it wants to maintain this dividend level.

What caused the share price to fall

In recent days, several reports have surfaced suggesting that Arbor Realty may be under investigation for its lending and disclosure practices. Some short sellers have claimed that this company has a problem with bad loans and, therefore, this is potentially causing the value of its loan portfolio to be overstated. A recent news article detailed these concerns, as well as the response from the company, and stated:

“We routinely cooperate with regulatory investigations and are very confident that we conduct ourselves appropriately,” Arbor said in a statement. “We look forward to our second quarter earnings call.”

I fully see the potential for the shorts to be right about some loans that may not perform and perhaps the company needs to build or maintain current loan loss reserves, but the company has a long history of working and restructuring loans if necessary. Plus, at this point, many are already potentially pricing in the stock, after a big drop. In a best-case scenario, any potential investigation could end up vindicating Arbor Realty and its lending and disclosure practices. In what could be a worst-case scenario, I could see a potential investigation leading to a write-off of some loans and possibly a fine, as well as the need to settle any possible class action lawsuits from shareholders.

The second quarter earnings report and guidance is expected on July 26

The company is expected to report second quarter earnings on Friday, July 26th, according to Earningswhispers.com. Consensus estimates call for earnings of $0.42 per share, on revenue of about $301 million. Arbor Realty beat consensus estimates for the first quarter, and I believe they could meet (or maybe slightly beat) expectations for the second quarter, but I don’t see current earnings as a stock price driver right now. I believe guidance and management commentary addressing the negative headlines is what will drive this stock up or down.

A short squeeze may occur

According to Shortsqueeze.com, there are currently nearly 70 million shares shorted. Based on recent average daily trading volumes of less than 4 million shares, I find this troubling, both for longs and short sellers. It is clear to me that the shorts see something that the talls are not seeing, or at least acknowledging. It’s also clear to me that even if the short sellers are right, they can be vulnerable and help fuel a potentially huge short squeeze.

What I would like to see before buying Arbor property again

For now, I will sit back and wait for additional developments and hope for clarity. I think this stock will be volatile and may remain under pressure. If this stock falls further into the low $11 per share range, or if I see significant insider buying, I would consider buying a small position that I could build on over time. I believe the business model is solid; in my opinion, the only question is whether the loan values ​​have been too aggressive and whether the company has taken enough loan loss provisions. Credit ratings are somewhat subjective, and both shorts and longs should take this into account.

Potential downside risks

I think the risks are equally weighted now for long and short wear. I see the times as potential downside risks coming from more negative headlines. I also see the possibility of a wave of class action lawsuits being announced in the coming days and weeks. I believe that based on support levels over the past few months, this stock could retest the $11 low and that could suggest more downside risks for the long term.

I also see a lot of downside risks for short sellers. This trade looks very crowded right now and the stock has wiped out a significant amount of market cap, which, in itself, helps to address (by pricing in part or maybe even completely) the potential need for a portfolio reduction . Shorting a stock can be very risky, and many market participants are now looking to exploit the weakness that can result from stocks being heavily shorted. This can lead to a short squeeze, even if the short sellers have a logical reason to be short.

It’s possible that the shorts may be right that there are some potentially distressed or overvalued loans, but that may be in the rearview mirror because interest rates are likely to fall later this year. This can lead to higher values ​​for the loans this company owns. A drop in interest rates can bring potentially distressed or problem loans back into the performing category.

In summary

A drop in this stock from nearly $16 per share to less than $13 already leads to a significant amount of bad news. I believe that even if the short sellers are right, the bad news may already be priced in. What could come next is the fact that the Fed could start cutting interest rates later this year, and that would likely result in higher valuations for the asset portfolio that Arbor Realty owns. This can actually reverse the need for any portfolio valuation issues that shorts claim.

This has become a battleground stock and could result in a draw for shorts and longs at current levels, as I see upside and downside risks as weighted at the moment. However, barring any bombshells, I see a stock where many shorts will have to cover at some point, and the potential for lower interest rates to increase portfolio value and operating results for this company. I believe this stock deserves a valuation right now, but could become a buy in the future on additional downside or with additional clarity that may come from management when second-quarter earnings and guidance are released later this month.

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