The 'Short Arbor Realty' Report Nobody Should Read
A report on Arbor Realty Trust, Inc. has surfaced by unknown short-selling outlet "Ningi Research."
In this article, I take a look at some of the claims made in this report, and question its methodology.
I offer my take on Arbor Realty, given the recent drop in the stock price.
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Written by Sam Kovacs.
March has been quite the month so far.
The failure of Silicon Valley Bank of SVB Financial Group (SIVB) has led to renewed fear around the banking system, with the Fed implementing a new emergency backstop to support liquidity concerns.
In the past week, borrowing from the Fed's discount window has reached all-time highs, as banks have borrowed a combined $164bn.
Banks are usually reticent to borrow from the Fed's discount window, because of multiple factors:
The stigma associated: the discount window is perceived as the last resort for a bank to borrow money, after having considered borrowing from other banks and issuing debt.
The cost: The discount rate is higher than the Fed Funds rate, to persuade banks to lend from the market when possible.
The fear that SVB's failure would lead to other runs on regional banks or any bank not perceived as "too big to fail" has led to a migration in deposits.
This has forced banks to borrow from the Fed, presumably at the secondary credit rate of 5.25%, vs. the current effective Fed rate of 4.57%.
Bank runs are a peculiar beast.
Bad news about a bank's solvency led to depositors withdrawing their cash.
If everyone does this, the bank cannot honor all deposits, as these are tied up in loans, treasuries, and other assets.
In the current high rate environment, a lot of bonds held by banks are carrying unrealized losses, which only materialize if the bank is forced to sell their assets. If the bonds are held to maturity, no harm is done (other than the missed opportunity cost).
When it became obvious that SVB was overweight bonds which had lost too much value, that its VC backed depositors were bleeding cash, it led to a panic and the failure of the bank.
When it became obvious that fraud was going on at FTX, clients went on a withdrawal frenzy, which forced the company into liquidation.
When there were runs on Binance, the company honored withdrawals, so everyone calmed down, and returned to normal.
As worried depositors are withdrawing assets from regional banks to migrate them to big banks, it is essential that these banks are able to honor withdrawals.
Instead of realizing forced losses on their liquid treasuries, it is more desirable to borrow from the Fed to honor withdrawals, even if it is at a somewhat less advantageous rate.
There is a lot of fear in the sector right now, as the fragility of the system (which is an inherent part of it) has once again come to our attention.
What does any of this have to do with Arbor Realty Trust, Inc. (ABR)?
Not much, other than we are currently operating in an environment led by fear, whereby investors are on edge for any news of mismanagement, fraud, or malice of any stock in the financial sector.
This is the perfect environment for someone to leverage this fear, by picking a company which many investors struggle to fully understand, and create a narrative by cherry picking information to push a short report.
As we'll see, this is exactly what has happened with a short report published by "Ningi Research."
The short report by Ningi Research
A report was published by a firm which I have never heard of, Ningi Research, which claimed that:
Arbor hid its toxic mobile homes portfolio to manipulate its stock price and avoid insolvency, $599 million of Arbor's escrows evaporated overnight, the company's escrow balances and revenue are fake, in an Archegos-like situation $2.5 billion of repo facilities are subject to margin call provisions, Arbor's funding through repo desks is drying up, the CECL allowances and provisions have been severely understated to boost earnings, Arbor's financial statements for the last twelve years cannot be trusted, and auditors, as well as the board, turned a blind eye on misstatements and misconduct. We estimate a median downside of 52% and, at worst a 67 percent downside for Arbor's stock.
That sounds bad.
But after having gone through the report, it is obvious to me that most of its claims come with no evidence, or are misleading.
For example, the research states:
For its $13 billion multifamily loan portfolio, the company recorded an allowance of $37 million, and that is just $1.5 million higher than in 2020 when Arbor's multifamily loan portfolio amounted to only $3.8 billion.
This shows a clear lack of understanding of Arbor's Agency takeout model.
The following snippet comes from CEO Ivan Kaufman's answer to a question in the latest earnings call:
So as you know, our business model on every loan we do is for an Agency takeout. That's how we are built, that's how we are structured, that's how the economics of the firm really flows and that's the value of our franchise. So each and every loan that's in our portfolio was underwritten accordingly. So in this kind of yield environment, when you have an inverted yield curve, many of the borrowers have the decision to make. Did they pay higher interest costs when their caps burn off? Can they cash in their caps and use that as equity and recapitalize some of their assets? Go with a fixed rate? If you're a floating rate individual, you are paying anywhere between low of 8% and high of 9.5% and you factor in the capital costs of -- or cap costs, you may have a great opportunity to go into a 10 year fixed rate. And we were putting people onto 10 year fixed rates in the low-5s on an [IO] basis and the savings are so considerable. And the stability is so significant that people are willing to come out of pocket with cash, lower their principal balance and go into Agency debt.
And so, in accordance of those circumstances, we have laid on some preference on mez, which has been very accretive for us as well. So that's our business model. It works very, very well. Some borrowers like to write it out. I think borrowers are more conservative. So it's a whole mixture. But unlike our competitors, our model is built in that manner, it's multifamily debt, it's Agency eligible. And that's one of the primary exits every time we do a loan.
Let me explain this in simple terms.
Because of the current inverted yield curve, it is in clients' interest to convert their multifamily bridge loans into agency loans. In doing so, Arbor gets predictable long term cashflows, which are backed by government-sponsored agencies.
In so doing, this reduces the risk, as the bridge loans are not agency backed. This reduces the need for allowances.
Either the writers of the report do not understand this, or they chose to overlook it to make their case.
Why would they have picked Arbor Realty as a target?
In comparison, Realty Income Corporation (O) has 81% institutional ownership, Iron Mountain Incorporated (IRM) has 79%.
Comparables such Annaly Capital Management, Inc. (NLY) and Blackstone Mortgage Trust, Inc. (BXMT) have institutional ownership rates between 50% and 55%.
Knowing that Arbor has a heavy retail investor base makes it easy prey for short sellers to stir the pot with misleading information.
The Ningi report on Arbor Realty has very little merit in my opinion.
They state that the auditor Ernst & Young ("EY") has failed in its capacity. This wouldn't be the first EY scandal. In 2020, EY failed to notice $1.9bn missing from Wirecard's --a German payment processor-- accounts.
EY was also Lehman's auditor and was blamed of not noticing risky financial lending activity.
In the former case, the firm says they were victims of an elaborate alleged fraud. In the latter, well, I believe the vast majority of the world was in over their head with the state of the banking system.
Let's not forget that other members of the big four also had their own share of scandals in the past decade:
Deloitte was the auditor of Taylon, Bean & Whitaker, which was involved in a massive alleged fraud scheme.
KPMG was Carillon's auditor.
PWC was the auditor for Satyam Computer, which was involved in alleged fraud.
For the most part auditors do their job well. It does happen that they significantly overlook certain issues.
This does not seem to be the case here. Of course, I'm only working with public information, but Ningi's claims seem to be rather hollow.
Finally, Ningi's downside estimate is based on a very shallow P/B comparables table.
As fellow SA author Brad Thomas said in his last (and excellent) article on Arbor in September last year, addressing Arbor's premium to book value:
I won't spend much time here because it's mostly irrelevant. Cash flow yield per share and the growth of that metric is all that matters for Arbor or any of its mREIT peers. In fact, one could argue that's all that matters for any high yield or dividend growth investment.
Additionally, comparing book values between companies with different business models is apples to oranges at best. You'd have to adjust for the risk and return profile of those underlying net assets to make a fair comparison, and nobody does that (at least not on Seeking Alpha or in any other free research).
Undepreciated book value per share is a good metric for some mREITs, but it isn't terribly useful for Arbor. It doesn't matter anyways because cash flow is king.
Ningi's valuation is an amateur, freshman college student at the investment club level, at best.
Who is Ningi research anyway?
I am always very wary of anonymous short research firms that pop up from nowhere.
Whatever page you go to on Ningi's website, you have to agree to a disclaimer again and again, which is poorly written.
This snippet really tells it all (emphasis in original):
Every document, information, data, analysis and statement on this website and/or our reports is expressed for educational purposes only and is expressed as an opinion not a statement of fact. To the best of our ability and belief, all materials contained herein are accurate and reliable. All statements are based on a strict due diligence process, but all information on this website and/or in our publications is provided "as is" without warranties of any kind. We explicitly do not take responsibility and/or warranty with respect to the fitness of the information for any usage.
As seen above, "strict" due diligence seems up for debate, as it took me all of 5 minutes to realize that the firm was making some claims that highlighted a lack of understanding in the business model.
The text quoted also suggests that everything they say is "opinion not fact."
Not exactly what you want from investigative research.
This reminds me of when I was a student and launched a small business reselling secondhand branded clothes I picked up in thrift stores. I had a small storefront, and for the legal disclaimer, I just rewrote and spun other retailers legal disclaimers, so that it wouldn't be copyright infringement.
Of course, I was 18, couldn't afford a lawyer, and wasn't really hurting anyone by selling secondhand Ralph Lauren shirts for $30.
Any serious research firm would have properly written legal disclaimers.
Unlike Hindenburg, which is a well-known short selling research shop founded by Nate Anderson, CFA, CAIA, and is an American LLC headquartered in New York, Ningi is anonymous, based god knows where, and backed by god knows who.
If you have 10 seconds to spare, you'll learn everything there is to know about the firm on its About Us page:
NINGI Research was founded in the beginning of 2022. After years witnessing fraudulent behavior in public companies, equity research and portfolio management, NINGI Research decided to use its experience in the public interest.
Now, I don't know about you, folks, but Robert & I put our names behind our research because it is done in good faith.
I'm sure there are some valid reasons to stay anonymous, but poor quality research, grammatical errors, and a lack of transparency are a few too many red flags in my opinion.
Arbor's reaction to the report.
Arbor was quick to publish a short press release, which you can read below:
Arbor Realty Trust (NYSE: ABR), announced today that the Company is in receipt of the purported "research" report that was published earlier today by Ningi Research, a short seller of Arbor stock. The report lacks merit and contains numerous inaccuracies, misstatements, and otherwise misleading allegations. This false and inflammatory report is a transparent effort to mislead the public for the purpose of enabling Ningi and its affiliates to profit from short positions on Arbor's stock. Contrary to this report, Arbor is committed to maintaining its books and records in accordance with generally accepted accounting principles in the U.S. and adhering to the highest standards of corporate governance and internal controls.
This is the traditional boilerplate response you'd expect.
Arbor management can talk the talk, but can they walk the walk?
Yes, on the very day that Ningi published their report, CEO Ivan Kaufman purchased 10,000 shares. Director William Green purchased 4,200 shares.
It would be unusual for a fraudster CEO who realizes that he has been caught, to double down by purchasing more shares in the company.
Where does this leave Arbor Realty?
Since the report, ABR has tumbled from $13 to $11.5.
How much of this was due to the report is debatable, as the company had been on the way down since the 8th of March, concurrent with the SVB fallout.
What we're left with, is a stock which is yielding 13.9%.
This is considerably more than the 10-year median of 8.5%, and is clearly reflected by the fact that the market is jittery that the SVB situation is another "Lehman moment."
I don't believe it is.
Banks are well capitalized, and once investors notice that banks are honoring their withdrawals, the attempted runs will stop.
The real estate market, while in a contraction, is nowhere near the situation it was preceding the Great Financial Crisis.
Investing in ABR now makes a lot of sense.
I was marginally disappointed when management decided to not increase their dividend this quarter, breaking a 10 quarter streak of consecutive increases, but like they mentioned in their Q4 earnings call (emphasis added):
Listen, we always have tremendous discussions of maintaining, raising and how much we have raised. And we have had such a huge cushion and our performance has been outstanding. I think the Board in discussions and Paul can comment it on as well as, we just don't get the credit in the market and at this period of time, there is really no upside in the market to raising the dividend. Everybody else is lowering their dividend. And the Board felt the credit is really -- everybody's dropping their dividend or paying it out of capital. And clearly the cushion we have and the thought was there is no real benefit to it.
With the current market price, a dividend increase wouldn't do much to turn pessimism regarding Arbor into optimism.
As such, management decided that even though they could increase the dividend (which was at a 70% payout ratio in 2022 vs 100%+ for peers), they wouldn't.
When you can get a 13.9% yield, you don't really need an increase every quarter for your income to compound.
I recognize this article was quite long, but I feel like it is important to address the report which has caused some confusion among members of the DFT, and I'm sure the investing community at large.
While nothing is ever 100%, I don't believe in coincidences. The "research" by Ningi is timely because it coincides with fear around financial stocks, but makes claims which are either unfounded, outright wrong, or lack serious substance.
I am taking this opportunity to top up my position in Arbor Realty Trust, Inc., as I believe it offers really good risk reward, has great management in a complex niche.