UNITED STATES SECURITIES AND EXCHANGE COMMISSION
AMENDMENT NO. 1
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
Arbor Realty Trust, Inc.
333 Earle Ovington Boulevard
Frederick C. Herbst
Copies to:
Approximate date of commencement of proposed sale to the public: As soon as practicable after this registration statement becomes effective.
If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o
If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o
If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o
If delivery of the prospectus is expected to be made pursuant to Rule 434, check the following box. o
CALCULATION OF REGISTRATION FEE
Proposed Maximum | ||||||||
Amount Being | Proposed Maximum | Aggregate | Amount of | |||||
Title of Securities Being Registered | Registered | Offering Price(1) | Offering Price | Registration Fee | ||||
Units, each consisting of five shares of Common
Stock, par value $.01 per share, and one Warrant to purchase one
share of Common Stock
|
1,602,833 | $75.00 | $120,212,475 | $9,725.19(3) | ||||
Common Stock, par value $.01 per share,
comprising a portion of the Units
|
8,014,165 | (2) | (2) | (2) | ||||
Warrants, comprising a portion of the Units
|
1,602,833 | (2) | (2) | (2) | ||||
Common Stock, $.01 par value per share, issuable
upon exercise of the Warrants
|
1,602,833 | $15.00 | $24,042,495 | $1,945.04(3) | ||||
Total
|
$144,254,970 | $11,670.23(3) | ||||||
(1) | Estimated based on a bona fide estimate of the maximum aggregate offering price solely for the purposes of calculating the registration fee pursuant to Rule 457(a) of the Securities Act of 1933. |
(2) | Such securities will be offered at no additional cost. As a result, no additional registration fee is required with respect therein. |
(3) | Previously paid in connection with the initial filing of the Registration Statement (No. 333-110472) on November 13, 2003. |
The registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the registration statement shall become effective on such date as the Securities and Exchange Commission acting, pursuant to said Section 8(a), may determine.
The information in this
prospectus is not complete and may be changed or supplemented.
The securities described in this prospectus cannot be sold until
the registration statement that we have filed to cover the
securities has become effective under the rules of the
Securities and Exchange Commission. This prospectus is not an
offer to sell the securities, nor is it a solicitation of an
offer to buy the securities in any jurisdiction where an offer
or sale is not permitted. |
SUBJECT TO COMPLETION, DATED DECEMBER 30, 2003
PROSPECTUS
Arbor Realty Trust, Inc.
1,602,833 Units
This prospectus relates to the resale by our stockholders of up to (i) 1,602,833 units of Arbor Realty Trust, Inc., each unit consisting of five shares of our common stock, $.01 par value per share, and one warrant to purchase an additional share of common stock, (ii) 8,014,165 shares of common stock comprising the units, (iii) 1,602,833 warrants comprising the units, and (iv) 1,602,833 shares of common stock underlying the warrants, collectively, the offered securities. The warrants have an initial exercise price of $15 and are exercisable until 5:00 p.m. New York City time on July 1, 2005. The warrants comprising the units do not become exercisable, detachable and freely tradable until after the shares of the common stock comprising the units are registered under the Securities Act and either listed on a national securities exchange or The Nasdaq Stock Market, Inc. The shares of common stock and the warrants comprising the units may not be traded separately until such listing.
We issued and sold 1,610,000 units in the original offering on July 1, 2003 in transactions exempt from the registration requirements of the Securities Act of 1933.
As soon as practicable after the registration statement of which this prospectus is a part is declared effective, we intend to apply to list the units, shares of common stock comprising the units, warrants and shares of common stock underlying the warrants on The Nasdaq Stock Market.
Investing in our securities involves risks. See Risk Factors beginning on page 16 for a discussion of these risks.
| We have a limited operating history and may not operate successfully. |
| Historical consolidated financial statements included in this prospectus include expenses that would not have been incurred had we operated as a separate entity during the periods presented and exclude the management fees payable pursuant to the management agreement. | |
| We are substantially controlled by Arbor Commercial Mortgage and its controlling equity owner, Mr. Kaufman. | |
| We are dependent on our manager with whom we have conflicts of interest. | |
| Our directors have approved very broad investment guidelines for our manager and do not approve each investment decision made by our manager. | |
| We depend on key personnel with long standing business relationships, the loss of whom could threaten our ability to operate our business successfully. | |
| We may be unable to generate sufficient revenue from operations to pay our operating expenses and to pay dividends to our stockholders. | |
| If Arbor Commercial Mortgage ceases to be our manager, the financial institutions providing our credit facilities may not provide future financing to us. | |
| If we do not qualify as a REIT or fail to remain qualified as a REIT, we will be subject to tax as a regular corporation and could face substantial tax liability. | |
| There is no public market for the offered securities, and there may be no market for the offered securities after the completion of this offering. | |
| Our charter generally does not permit ownership in excess of 9.6% of our common or capital stock, and attempts to acquire our capital stock in excess of these limits are ineffective without prior approval from our board of directors. |
Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense.
The date of this prospectus is , 2004
You should rely only on the information contained in this prospectus. We have not authorized anyone to provide you with different or additional information. This prospectus does not constitute an offer to sell, or a solicitation of an offer to purchase, the securities offered by this prospectus in any jurisdiction to or from any person to whom or from whom it is unlawful to make such offer or solicitation of an offer in such jurisdiction. You should not assume that the information contained in this prospectus is accurate as of any date other than the date on the front cover of this prospectus. Neither the delivery of this prospectus nor any distribution of securities pursuant to this prospectus shall, under any circumstances, create any implication that there has been no change in the information set forth in this prospectus or in our affairs since the date of this prospectus.
TABLE OF CONTENTS
Page | |||||
PROSPECTUS SUMMARY
|
1 | ||||
Arbor Realty Trust, Inc.
|
1 | ||||
Our Manager
|
4 | ||||
Our Structure
|
6 | ||||
Summary Risk Factors
|
7 | ||||
Restrictions on Ownership of Stock
|
9 | ||||
Distribution Policy
|
9 | ||||
Preferred Stock
|
9 | ||||
Tax Status
|
10 | ||||
Conflicts of Interest
|
10 | ||||
Original Offering
|
11 | ||||
The Offering
|
12 | ||||
Summary Selected Unaudited Consolidated Financial
Information of Arbor Realty Trust, Inc. and Subsidiaries
|
13 | ||||
Summary Selected Consolidated Financial
Information of the Structured Finance Business of Arbor
Commercial Mortgage, LLC and Subsidiaries
|
14 | ||||
RISK FACTORS
|
16 | ||||
Risks Related to Our Business
|
16 | ||||
Risks Related to Conflicts of Interest
|
24 | ||||
Risks Related to Our Status as a REIT
|
26 | ||||
Risk Factors Related to the Offering
|
29 | ||||
FORWARD LOOKING STATEMENTS
|
33 | ||||
USE OF PROCEEDS
|
34 | ||||
DISTRIBUTION POLICY
|
34 | ||||
PRICE RANGE OF UNITS
|
36 | ||||
SELECTED UNAUDITED CONSOLIDATED FINANCIAL
INFORMATION OF ARBOR REALTY TRUST, INC. AND SUBSIDIARIES
|
37 | ||||
SELECTED CONSOLIDATED FINANCIAL INFORMATION OF
THE STRUCTURED FINANCE BUSINESS OF ARBOR COMMERCIAL MORTGAGE,
LLC AND SUBSIDIARIES
|
38 | ||||
MANAGEMENTS DISCUSSION & ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF ARBOR REALTY
TRUST, INC. AND SUBSIDIARIES
|
40 | ||||
Overview
|
40 | ||||
Sources of Operating Revenues
|
40 | ||||
Gain on Sale of Loans and Real Estate and Income
from Equity Affiliates
|
40 |
i
Page | |||||
Significant Accounting Estimates and Critical
Accounting Policies
|
41 | ||||
Recently Issued Accounting Pronouncements
|
41 | ||||
Results of Operations
|
42 | ||||
Liquidity and Capital Resources
|
43 | ||||
Related Party Transactions
|
47 | ||||
Recent Developments
|
49 | ||||
Quantitative and Qualitative Disclosures about
Market Risk
|
49 | ||||
MANAGEMENTS DISCUSSION & ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF THE STRUCTURED
FINANCE BUSINESS OF ARBOR COMMERCIAL MORTGAGE, LLC AND
SUBSIDIARIES
|
51 | ||||
Overview and Basis of Presentation
|
51 | ||||
Sources of Operating Revenues
|
52 | ||||
Gain on Sale of Loans and Real Estate and Income
from Equity Affiliates
|
52 | ||||
Significant Accounting Estimates and Critical
Accounting Policies
|
52 | ||||
Results of Operations
|
53 | ||||
Liquidity and Capital Resources
|
59 | ||||
Related Party Transactions
|
59 | ||||
Quantitative and Qualitative Disclosures about
Market Risk
|
61 | ||||
ARBOR REALTY TRUST, INC
|
62 | ||||
Industry Overview
|
63 | ||||
Our Business Strategy
|
63 | ||||
Our Investment Guidelines
|
64 | ||||
Our Investment Strategy
|
64 | ||||
Our Assets
|
66 | ||||
Arbor Commercial Mortgages Retained
Interests in Our Investments
|
78 | ||||
Operations
|
79 | ||||
Our Asset Management Operations
|
81 | ||||
Operating Policies and Strategies
|
82 | ||||
Policies With Respect to Certain Other Activities
|
84 | ||||
Our Operating Partnership
|
84 | ||||
Competition
|
85 | ||||
Employees
|
85 | ||||
Legal Proceedings
|
85 | ||||
OUR MANAGER AND THE MANAGEMENT AGREEMENT
|
86 | ||||
Manager
|
86 | ||||
Officers of Our Manager
|
87 | ||||
The Management Agreement
|
88 | ||||
Management Services
|
88 | ||||
Management Fees and Incentive Compensation
|
91 | ||||
Rights of First Refusal
|
95 | ||||
Mr. Kaufmans Non-Competition Agreement
|
96 | ||||
Origination Period
|
96 | ||||
MANAGEMENT
|
98 | ||||
Our Directors and Executive Officers
|
98 | ||||
Corporate Governance Board of
Directors and Committees
|
99 |
ii
Page | |||||
Executive Compensation
|
101 | ||||
Mr. Kaufmans Non-Competition Agreement
|
102 | ||||
Stock Incentive Plan
|
102 | ||||
REGISTRATION RIGHTS AND LOCK-UP AGREEMENTS
|
104 | ||||
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
|
106 | ||||
Conflicts of Interest with Our Manager
|
106 | ||||
Formation Transactions
|
106 | ||||
Related Party Loans and Investments
|
108 | ||||
Other Relationships and Related Transactions
|
109 | ||||
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT
|
110 | ||||
DESCRIPTION OF STOCK
|
112 | ||||
General
|
112 | ||||
Authorized Stock
|
112 | ||||
Common Stock
|
112 | ||||
Preferred Stock
|
113 | ||||
Special Voting Preferred Stock
|
113 | ||||
Warrants
|
113 | ||||
Power to Increase Authorized Stock and Issue
Additional Shares of our Common Stock and Preferred Stock
|
114 | ||||
Restrictions on Transfer
|
114 | ||||
Transfer Agent and Registrar
|
117 | ||||
SECURITIES ELIGIBLE FOR FUTURE SALE
|
118 | ||||
BOOK ENTRY ISSUANCE; THE DEPOSITORY TRUST COMPANY
|
120 | ||||
IMPORTANT PROVISIONS OF MARYLAND LAW AND OF OUR
CHARTER AND BYLAWS
|
122 | ||||
The Board of Directors
|
122 | ||||
Removal of Directors
|
122 | ||||
Liability and Indemnification of Officers and
Directors
|
122 | ||||
Business Combinations
|
123 | ||||
Control Share Acquisitions
|
124 | ||||
Amendment to Our Charter
|
125 | ||||
Advance Notice of Director Nominations and New
Business
|
125 | ||||
Anti-Takeover Effect of Certain Provisions of
Maryland Law and of Our Charter and Bylaws
|
125 | ||||
OUR OPERATING PARTNERSHIP AGREEMENT
|
126 | ||||
Management
|
126 | ||||
Transferability of Interests
|
126 | ||||
Capital Contributions and Borrowings
|
127 | ||||
Redemption Rights
|
128 | ||||
Operations
|
128 | ||||
Allocations
|
129 | ||||
Distributions
|
129 | ||||
Amendments
|
129 | ||||
Exculpation and Indemnification of the General
Partner
|
130 |
iii
Page | |||||
Term
|
130 | ||||
Tax Matters
|
130 | ||||
FEDERAL INCOME TAX CONSIDERATIONS
|
131 | ||||
Taxation of Arbor Realty
|
131 | ||||
Tax Aspects of Investments in Partnerships
|
141 | ||||
Taxation of Taxable U.S. Stockholders
|
142 | ||||
Other Tax Considerations
|
147 | ||||
ERISA CONSIDERATIONS
|
149 | ||||
SELLING STOCKHOLDERS
|
151 | ||||
PLAN OF DISTRIBUTION
|
159 | ||||
LEGAL MATTERS
|
160 | ||||
EXPERTS
|
160 | ||||
WHERE YOU CAN FIND MORE INFORMATION
|
161 | ||||
INDEX TO THE UNAUDITED CONSOLIDATED FINANCIAL
STATEMENTS OF ARBOR REALTY TRUST, INC. AND SUBSIDIARIES
|
F-1 | ||||
INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS OF
THE STRUCTURED FINANCE BUSINESS OF ARBOR COMMERCIAL MORTGAGE,
LLC AND SUBSIDIARIES
|
F-17 |
iv
PROSPECTUS SUMMARY
This summary highlights information more fully described elsewhere in this prospectus and contains the material terms of this offering. However, you should read this entire prospectus carefully before deciding to invest in our securities. Unless otherwise mentioned or unless the context otherwise requires, all references in this prospectus to (a) we, us, our, or similar references mean Arbor Realty Trust, Inc. and its subsidiaries, including Arbor Realty Limited Partnership, our operating partnership, and (b) Arbor Commercial Mortgage, or our manager means Arbor Commercial Mortgage, LLC.
Arbor Realty Trust, Inc.
We commenced operations in July 2003. We invest in real estate related bridge and mezzanine loans, preferred equity and, in limited cases, discounted mortgage notes and other real estate related assets, which we collectively refer to as structured finance investments. We conduct substantially all of our operations through our operating partnership, Arbor Realty Limited Partnership. We intend to elect to be taxed as a real estate investment trust, or REIT, under the Internal Revenue Code and generally will not be subject to federal taxes on our income to the extent we distribute our income to our stockholders and maintain our qualification as a REIT.
On July 1, 2003, Arbor Commercial Mortgage, LLC contributed the majority of its structured finance portfolio to our operating partnership. These initial assets, consisting of 12 bridge loans, five mezzanine loans, five preferred equity investments and two other real estate related investments, were transferred at book value, which approximates fair value, that, at June 30, 2003, represented $213.1 million in assets financed by $169.2 million borrowed under Arbor Commercial Mortgages credit facilities and supported by $43.9 million in equity. Simultaneously with Arbor Commercial Mortgages contribution of assets, we issued and sold 1,610,000 of our units in a private offering.
We are externally managed and advised by Arbor Commercial Mortgage. Our manager is a national commercial real estate finance company operating through 15 regional offices in the United States, specializing in debt and equity financing for multi-family and commercial real estate. We believe Arbor Commercial Mortgages experience and reputation positions it to originate attractive investment opportunities for us. Our management agreement with Arbor Commercial Mortgage was developed to capitalize on synergies with Arbor Commercial Mortgages origination infrastructure, existing business relationships and management expertise.
We believe the financing of multi-family and commercial real estate offers significant growth opportunities that demand customized financing solutions. Arbor Commercial Mortgage has granted us a right of first refusal to pursue all structured finance investment opportunities identified by Arbor Commercial Mortgage. In addition, Arbor Commercial Mortgage will continue to provide and service multi-family and commercial mortgage loans under Fannie Mae, Federal Housing Administration and conduit commercial lending programs, which we believe will offer customer relationship synergies to our business. Our portfolio currently contains loans and investments that we originated and loans and investments that we purchased from third parties or from affiliates.
We have a strong senior management team with significant industry experience. Mr. Ivan Kaufman, the chief executive officer of Arbor Commercial Mortgage, and Mr. Frederick Herbst, the chief financial officer of Arbor Commercial Mortgage, also serve as our chief executive officer and chief financial officer, respectively. Mr. Fred Weber, the head of the structured finance group at Arbor Commercial Mortgage since 1999, is our executive vice president of structured finance. Mr. Daniel M. Palmier, the head of Arbor Commercial Mortgages asset management group since 1997, is our executive vice president of asset management, and the eight additional employees who comprised the asset management group of Arbor Commercial Mortgage have also joined us. In October 2003, we hired Mr. John C. Kovarik as our chief credit officer. Messrs. Kaufman, Weber, Palmier and Kovarik serve as members of our credit committee, which has the authority to decide whether we will invest in an individual loan or security originated by Arbor Commercial Mortgage.
1
We believe the asset management groups involvement in our credit underwriting process helps to mitigate investment risk after the closing of a transaction. The asset management group is integrated into the underwriting and structuring process for all transactions in order to enhance the credit quality of our originations before a transaction closes. After the closing of transactions, the asset management groups experience in managing complex restructurings, refinancings and asset dispositions is used to improve the credit quality and yield on managed investments.
In connection with its contribution of the initial assets, Arbor Commercial Mortgage arranged for us to have substantially similar credit facilities as those used by Arbor Commercial Mortgage to finance these assets. In exchange for the asset contribution, we issued to Arbor Commercial Mortgage approximately 3.1 million operating partnership units, each of which Arbor Commercial Mortgage may redeem for one share of our common stock or an equivalent amount in cash, at our election, and approximately 629,000 warrants, each of which entitles Arbor Commercial Mortgage to purchase one additional operating partnership unit at an initial exercise price of $15. The operating partnership units and warrants for additional operating partnership units issued to Arbor Commercial Mortgage were valued at approximately $43.9 million at July 1, 2003, based on the price offered to investors in our units in the original offering. Each of the approximately 3.1 million operating partnership units received by Arbor Commercial Mortgage is paired with one share of our special voting preferred stock that entitles the holder to one vote on all matters submitted to a vote of our stockholders. As operating partnership units are redeemed for shares of our common stock or cash, an equivalent number of shares of special voting preferred stock will be redeemed and cancelled. See Description of Stock Special Voting Preferred Stock. As a result of Arbor Commercial Mortgages asset contribution and the related formation transactions, Arbor Commercial Mortgage owns approximately a 28% limited partnership interest in our operating partnership and the remaining 72% interest in our operating partnership is owned by us. In addition, Arbor Commercial Mortgage has approximately 28% of the voting power of our outstanding stock (without giving effect to the exercise of Arbor Commercial Mortgages warrants for additional operating partnership units).
Our Business Strategy
We believe there is strong growth potential in customized financing of multi-family and commercial real estate. In the past decade, the commercial mortgage industry has experienced significant change, due in part to increasingly standardized underwriting requirements, more demanding borrowers and lenders and the growth of a market for securitized commercial real estate pools.
We believe we have the necessary levels of capital and financial flexibility to compete effectively in todays rapidly changing market. Our borrowers, who in the past relied on banks and life insurance companies as their primary source for commercial real estate financing, have benefited from our flexible underwriting standards. This flexibility has created significant demand for bridge, mezzanine and other forms of innovative financing.
We capitalize on this demand by investing in a diversified portfolio of structured finance assets in the multi-family and commercial real estate market. Our principal business objectives are to invest in bridge and mezzanine loans, preferred equity and other real estate related assets and actively manage this portfolio in order to generate cash available for distribution, facilitate capital appreciation and maximize total return to our stockholders. We believe we can achieve these objectives through the following business and growth strategies:
| Provide customized financing; | |
| Use Arbor Commercial Mortgages relationships with existing borrowers; | |
| Offer broader products and expand customer base; | |
| Leverage our experience and the experience of Arbor Commercial Mortgage; | |
| Manage and maintain credit quality; | |
2
| Focus on a niche market in smaller loan balances; and | |
| Execute transactions rapidly. | |
Our Investment Strategy
We actively pursue lending and investment opportunities with property owners and developers who need interim financing until permanent financing can be obtained. Our structured finance investments generally have maturities of two to five years, depending on the type, have extension options when appropriate, and generally require a balloon payment of principal at maturity. Borrowers in the market for these types of loans include owners or developers who seek either to acquire or refurbish real estate or pay down debt and reposition a property for permanent financing.
Our investment program emphasizes the following general categories of real estate related activities:
Bridge Financing. We offer bridge financing products to borrowers who are typically seeking short term capital to be used in an acquisition of property. The borrower has usually identified an undervalued asset that has been under-managed or is located in a recovering market. From the borrowers perspective, shorter term bridge financing is advantageous because it allows time to improve the property value through repositioning the property without encumbering it with restrictive long term debt. The bridge loans we make are secured by first lien mortgages on the property. Borrowers usually use the proceeds of a conventional mortgage loan to repay a bridge loan. | |
Mezzanine Financing. We offer mezzanine loans, which are loans subordinate to a conventional first mortgage loan and senior to the borrowers equity in a transaction. Our mezzanine financing may take the form of pledges of ownership interests in entities that directly or indirectly control the real property or subordinated loans secured by second mortgages. We may also require additional collateral such as personal guarantees, letters of credit and/or additional collateral unrelated to the property. | |
Preferred Equity Investments. We provide financing by making preferred equity investments in entities that directly or indirectly own real property. In cases where the terms of a first mortgage prohibit additional liens on the ownership entity, investments structured as preferred equity interests in the entity owning the property serve as viable financing substitutes. With preferred equity investments, we typically become a special limited partner or member in the ownership entity. | |
Other Investments. We may engage in other investment activities, including the purchase of discounted first lien mortgage notes from other lenders and opportunistic investments including the acquisition of properties. Typically, these transactions, which may be conducted through taxable subsidiaries, are analyzed with the expectation that, upon property repositioning or renovation, they will be sold to achieve a significant return on invested capital. |
We borrow against or leverage our investments to the extent consistent with our investment guidelines in order to increase the size of our portfolio and potential returns to our stockholders. We have a $250.0 million warehouse credit agreement with a financial institution, with a term of three years. We also have a $100.0 million master repurchase agreement with another financial institution, with a one-year term, renewable annually and a $50.0 million master repurchase agreement with a third financial institution with a term of three years. We may also sell participating interests in our investments.
3
Our Manager
Arbor Commercial Mortgage is a national commercial real estate finance company founded in 1993 as a subsidiary of Arbor National Holdings, Inc., an originator and servicer of single-family residential mortgage loans. Our chief executive officer, Mr. Ivan Kaufman, is also Arbor Commercial Mortgages chief executive officer and its controlling equity owner, and was the co-founder, chairman and majority shareholder of Arbor National Holdings. Under Mr. Kaufmans direction, Arbor National Holdings grew to 25 branches in 11 states and funded more than $4 billion in loans in its last full year of operations. Arbor National Holdings became a public company in 1992 and was sold to BankAmerica in 1995.
In connection with the sale of Arbor National Holdings, Mr. Kaufman purchased its commercial mortgage lending operations and the rights to the Arbor name and retained a significant portion of Arbor National Holdings senior management team. This senior management team has guided Arbor Commercial Mortgages growth from a company originally capitalized with approximately $8 million to its equity value, including its partnership interest in Arbor Realty Limited Partnership, of approximately $69 million as of September 30, 2003. Arbor Commercial Mortgage is now a full service provider of financial services to owners and developers of multi-family and commercial real estate properties. Arbor Commercial Mortgage has derived revenue from the origination for sale and servicing of government-sponsored and conduit mortgage loans for commercial and multi-family real estate properties as well as from the origination of structured finance loans and investments. Our primary business will be investing in structured finance loans and investments. Arbor Commercial Mortgage, which has been profitable every year since 1995, originated over $600 million in new loans in 2002 and is currently servicing a portfolio with a principal balance of $2.9 billion, including loans serviced for Arbor Realty Limited Partnership.
Arbor Commercial Mortgages executive officers and employees have extensive experience in originating and managing structured commercial real estate investments. The senior management team has an average of over 20 years experience in the financial services industry. Arbor Commercial Mortgage currently has 130 employees spread among its corporate headquarters in Uniondale, New York, 14 other sales offices located throughout the United States and the servicing administration office in Buffalo, NY.
We and our operating partnership have entered into a management agreement with Arbor Commercial Mortgage pursuant to which Arbor Commercial Mortgage has agreed to provide us with structured finance investment opportunities and loan servicing as well as other services necessary to operate our business.
We pay our manager an annual base management fee based on the equity of our operating partnership, as further discussed below. The amount of the base management fee does not depend on the performance of the services provided by our manager or the types of assets its selects for our investment, but the value of our operating partnerships equity will be affected by the performance of these assets. We also pay our manager incentive compensation each fiscal quarter. We have paid $492,729 in base management fees to Arbor Commercial Mortgage for management services rendered for the five months ended November 30, 2003. Our manager did not earn incentive compensation for the quarter ended September 30, 2003.
4
The table summarizes the calculation of the base management fee, incentive compensation and other fees and expenses payable to our manager pursuant to the management agreement.
Type | Description and Method of Computation | Payable | ||
Base management fee(1)
|
(1) 0.75% per annum of the first $400 million of our operating partnerships equity, plus | Monthly in arrears in cash | ||
(2) 0.625% per annum of our operating partnerships equity between $400 million, and $800 million and 0.50% per annum of the equity in excess of $800 million. | ||||
Incentive
compensation(2) |
(1) 25% of the amount by which: (a) our operating partnerships funds from operations per operating partnership unit, adjusted for certain gains and losses, exceeds (b) the product of (x) 9.5% per annum or the 10-year Treasury Rate plus 3.5%, whichever is greater, and (y) the weighted average of the book value of the net assets contributed by Arbor Commercial Mortgage to our operating partnership per operating partnership unit, $15 (representing the offering price per share of our common stock in the original offering), the offering price per share of our common stock in any subsequent offerings and the issue price per operating partnership unit for subsequent contributions to our operating partnership, multiplied by |
Each fiscal quarter, with at least 25% paid in our common stock | ||
(2) the weighted average of our operating partnerships outstanding operating partnership units. | ||||
Overhead expenses
|
Compensation of our independent directors, legal, accounting, due diligence tasks and other services that outside professionals perform for us. | Each fiscal quarter in cash | ||
Origination
fee income(3) |
An amount equal to 100% of the origination fees paid by the borrower to us with respect to each bridge loan and mezzanine loan we originate, up to 1% of the loans principal amount. | Upon closing of each loan | ||
Termination fee(4)
|
If we terminate or elect not to renew the management agreement in order to manage our portfolio internally, we are required to pay a termination fee equal to the base management fee and incentive compensation for the 12-month period preceding the termination. | Upon termination | ||
If, without cause, we terminate or elect not to renew the management agreement for any other reason, including a change of control of us, we are required to pay a termination fee equal to two times the base management fee and incentive compensation paid for the 12-month period preceding the termination. |
(1) | For purposes of calculating the base management fee, our operating partnerships equity equals the month-end value computed in accordance with generally accepted accounting principles of total partners equity in our operating partnership, plus or minus any unrealized gains, losses or other items that do not affect realized net income. |
(2) | At least 25% of the incentive compensation paid to our manager will be in the form of shares of our common stock, subject to ownership limitations in our charter. Beginning on January 1, 2004, the incentive compensation will be measured over a full fiscal year, subject to recalculation and potential reconciliation at the end of each fiscal year. We intend to pay our manager each installment of the incentive compensation within sixty (60) days following the last day of the fiscal quarter with respect to which such incentive compensation payment is payable. |
(3) | 100% of the origination fees paid by the borrower in excess of 1% of the loans principal amount are retained by us. |
(4) | The management agreement has an initial term of two years and is renewable automatically for an additional one year period every year thereafter, unless terminated with six months prior written notice. |
5
Our Structure
The following chart shows our structure following completion of the original offering and the transactions in connection with our formation:
(1) | Purchasers of our units in the original offering hold 96% of our outstanding common stock. Pursuant to our stock incentive plan, we have granted shares of restricted common stock, constituting the remaining 4% of our outstanding common stock, to our directors, executive officers, and certain of our employees and employees of our manager. |
(2) | Holders of Class A and Class B membership interests of Arbor Commercial Mortgage have the same voting rights and are both entitled to distributions in accordance with their percentage ownership interests in the company. However, holders of Class B membership interests cannot transfer their interests or compete with Arbor Commercial Mortgage without the consent of the managing member, Arbor Management, LLC, an entity wholly owned by Mr. Ivan Kaufman and his wife. |
(3) | Mr. Kaufman, the Ivan and Lisa Kaufman Family Trust, a trust created by Mr. Kaufman for the benefit of Mr. Kaufmans family and Arbor Management collectively hold all the outstanding Class A membership interests which constitute 64% of the outstanding membership interests of Arbor Commercial Mortgage. 24% of the outstanding membership interests of Arbor Commercial Mortgage previously held by Mr. Kaufman and the Ivan Kaufman Grantor Retained Trust, of which Mr. Kaufman is a co-trustee, as Class A membership interests have been reclassified as Class B membership interests, effective as of January 1, 2003. Mr. Kaufman, together with the Kaufman entities which include the Ivan and Lisa Kaufman Family Trust, the Ivan Kaufman Grantor Retained Trust and Arbor Management, beneficially own approximately 88% of the outstanding membership interests of Arbor Commercial Mortgage. See Security Ownership of Beneficial Owners and Management. |
(4) | Messrs. Herbst, Palmier and Weber and Messrs. Martello and Horn, two of our directors, collectively hold 5% of the outstanding membership interests in Arbor Commercial Mortgage as Class B membership interests. In addition, Mr. Martello also serves as (a) trustee of the Ivan and Lisa Kaufman Family Trust and (b) co-trustee, along with Mr. Kaufman, of the Ivan Kaufman Grantor Retained Annuity Trust. |
6
(5) | Arbor Commercial Mortgage holds 3,146,724 shares of our special voting preferred stock which entitle it to 28% of the voting power of our outstanding stock. These shares of special voting preferred stock are paired with 3,146,724 operating partnership units held by Arbor Commercial Mortgage and will be cancelled upon redemption of these operating partnership units. Assuming the redemption of all Arbor Commercial Mortgages operating partnership units for shares of our common stock, Arbor Commercial Mortgage would retain 28% of the voting power of our outstanding stock. The 28% figure does not give effect to the exercise of Arbor Commercial Mortgages 629,345 warrants for additional operating partnership units, each of which is exercisable for an additional partnership unit that will be paired with one share of our special voting preferred stock. |
(6) | We hold our 72% partnership interests in Arbor Realty Limited Partnership through two wholly-owned subsidiaries, Arbor Realty GPOP, Inc., the holder of a 0.1% general partner interest, and Arbor Realty LPOP, Inc., the holder of a 71.9% limited partner interest. Our only material subsidiaries are Arbor Realty Limited Partnership, Arbor Realty GPOP and Arbor Realty LPOP. |
(7) | The 28% figure does not give effect to the exercise of Arbor Commercial Mortgages 629,345 warrants for additional operating partnership units, each of which is exercisable for an additional partnership unit that will be paired with one share of our special voting preferred stock. Arbor Commercial Mortgage may acquire up to 3,776,069 shares of our common stock upon redemption of its operating partnership units (including 629,345 operating partnership units issuable upon exercise of warrants for additional operating partnership units) should we elect to issue shares of our common stock upon such redemption. |
Summary Risk Factors
An investment in our securities involves a number of risks. You should consider carefully the risks discussed below and under Risk Factors beginning on page 16 before purchasing our securities.
| We have a limited operating history and may not operate successfully. | |
| Historical consolidated financial statements included in this prospectus include expenses that would not have been incurred had we operated as a separate entity during the periods presented and exclude the management fees payable pursuant to the management agreement. | |
| We are substantially controlled by Arbor Commercial Mortgage and its controlling equity owner, Mr. Kaufman. | |
| We are dependent on our manager with whom we have conflicts of interest. | |
| Our directors have approved very broad investment guidelines for our manager and do not approve each investment decision made by our manager. | |
| Our manager has broad discretion to invest funds and may acquire structured finance assets where the investment returns are substantially below expectations or that result in net operating losses. | |
| We depend on key personnel with long standing business relationships, the loss of whom could threaten our ability to operate our business successfully. | |
| We may be unable to invest excess equity capital on acceptable terms or at all, which would adversely affect our operating results. | |
| We invest in multi-family and commercial real estate loans, which involve a greater risk of loss than single family loans. | |
| Volatility of values of multi-family and commercial properties may adversely affect our loans and investments. | |
| We may be unable to generate sufficient revenue from operations to pay our operating expenses and to pay dividends to our stockholders. |
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| If Arbor Commercial Mortgage ceases to be our manager pursuant to the management agreement, the financial institutions providing our credit facilities may not provide future financing to us. | |
| If we do not qualify as a REIT or fail to remain qualified as a REIT, we will be subject to tax as a regular corporation and could face substantial tax liability. | |
| There is no public market for the offered securities, and there may be no market for the offered securities after the completion of this offering. | |
| Our charter generally does not permit ownership in excess of 9.6% of our common or capital stock, and attempts to acquire our capital stock in excess of these limits are ineffective without prior approval from our board of directors. |
8
Restrictions on Ownership of Stock
In order for us to maintain our qualification as a REIT under the Code, not more than 50% (by value) of our outstanding shares of capital stock may be owned, directly or indirectly, by five or fewer individuals (as defined in the Internal Revenue Code to include certain entities). For the purpose of preserving our REIT qualification, our charter generally prohibits direct or indirect ownership of more than 9.6% of the outstanding shares of capital stock. Our board of directors may, however, in its discretion, exempt a person from this ownership limitation, and, as a condition to such exemption, may require a satisfactory ruling from the Internal Revenue Service, or IRS, an opinion of counsel (as to our continued REIT status) and/or certain representations and undertakings from such person.
Distribution Policy
To maintain our qualification as a REIT, we intend to make regular quarterly distributions to our stockholders of at least 90% of our taxable income, which does not necessarily equal net income as calculated in accordance with generally accepted accounting principles. Distributions are authorized by our board of directors and declared by us based upon a variety of factors deemed relevant by our directors, and our distribution policy may change in the future. Our ability to make distributions to our stockholders depends, in part, upon our receipt of distributions from our operating partnership, Arbor Realty Limited Partnership, which may depend, in part, upon the performance of our investment portfolio, and, in turn, upon Arbor Commercial Mortgages management of our business. If cash available for distribution is insufficient, we may be required to borrow funds or sell assets in order to meet our REIT distribution requirements. Distributions to our stockholders are generally taxable to our stockholders as ordinary income, although a portion of these distributions may be designated by us as long term capital gain to the extent they are attributable to capital gain income recognized by us, or may constitute a return of capital to the extent they exceed our earnings and profits as determined for tax purposes.
Our charter allows us to issue preferred stock with a preference on distributions. We currently have no intention to issue any such preferred stock with a preference on distributions but if we do, the dividend preference on the preferred stock could limit our ability to make a dividend distribution to our common stockholders.
On November 5, 2003, we declared a dividend of $.25 per share of common stock, payable with respect to the quarter ending September 30, 2003, to stockholders of record at the close of business on November 5, 2003. We distributed this dividend on November 18, 2003. On December 19, 2003, our board of directors authorized a dividend of $.25 per share of common stock, payable with respect to the quarter ending December 31, 2003, to stockholders of record at the close of business on December 19, 2003. We plan to distribute this dividend on December 30, 2003.
Preferred Stock
Pursuant to a pairing agreement that we entered into with our operating partnership and our manager, each operating partnership unit issued to Arbor Commercial Mortgage and its affiliates in connection with the contribution of the initial assets (including operating partnership units issuable upon the exercise of Arbor Commercial Mortgages warrants) is paired with one share of our special voting preferred stock. No operating partnership unit that is paired with a share of special voting preferred stock may be transferred unless accompanied by such special voting share. A holder of special voting preferred stock is not entitled to any regular or special dividend payments or other distributions, other than a $.01 per share liquidation preference.
Each share of special voting preferred stock entitles the holder to one vote on all matters submitted to a vote of our stockholders. Therefore, through its ownership of the paired special voting preferred stock, Arbor Commercial Mortgage is currently entitled to a number of votes representing approximately 28% of the voting power of all shares entitled to vote on matters submitted to a vote of our stockholders (without giving effect to the exercise of Arbor Commercial Mortgages warrants). The holders of special voting preferred stock have no separate class voting rights except as provided by our charter.
9
Upon redemption of any operating partnership unit that is paired with a share of special voting preferred stock, the share of special voting preferred stock will be redeemed and cancelled by us. Other than the shares of special voting preferred stock to be issued to Arbor Commercial Mortgage upon exercise of its warrants for additional operating partnership units, we do not intend to issue operating partnership units that would be paired with shares of our special preferred voting stock in the future.
Tax Status
We intend to elect to be treated as a REIT for federal income tax purposes. To qualify as a REIT, we must meet various tax law requirements, including, among others, requirements relating to the nature of our assets, the sources of our income, the timing and amount of distributions that we make and the composition of our stockholders. As a REIT, we generally are not subject to federal income tax on income that we distribute to our stockholders. If we fail to qualify as a REIT in any taxable year, we will be subject to federal income tax at regular corporate rates, and we may be precluded from qualifying as a REIT for the subsequent four taxable years following the year during which we lost our qualification. Further, even to the extent that we qualify as a REIT, we will be subject to tax at normal corporate rates on net income or capital gains not distributed to our stockholders, and we may be subject to other taxes, including payroll taxes, and state and local income, franchise, property, sales and other taxes. Moreover, we may have subsidiary entities that are subject to federal income taxation and to various other taxes. Any dividends received from us will generally, with limited exceptions, not be eligible for taxation at the preferred capital gain rates that currently apply, pursuant to recently enacted legislation, to dividends received by individuals from taxable corporations. See Federal Income Tax Considerations.
Conflicts of Interest
We, our executive officers and Arbor Commercial Mortgage face conflicts of interest because of our relationships with each other. Mr. Ivan Kaufman is our chief executive officer and the chief executive officer of Arbor Commercial Mortgage. Mr. Kaufman and entities controlled by him, or the Kaufman entities, together beneficially own approximately 88% of the outstanding membership interests of Arbor Commercial Mortgage. Mr. Frederick C. Herbst is our chief financial officer and the chief financial officer of Arbor Commercial Mortgage. Mr. Herbst, two of our executive vice presidents, Messrs. Dan Palmier and Fred Weber, and two of our directors, Mr. Joseph Martello and Mr. Walter Horn, collectively, have a minority ownership interest in Arbor Commercial Mortgage. In addition, Mr. Martello serves as trustee of one of the Kaufman entities that owns a majority of the outstanding membership interests in Arbor Commercial Mortgage and co-trustee of another Kaufman entity.
Arbor Commercial Mortgage will continue, among other activities, to originate, acquire and service multi-family and commercial mortgage loans that meet the underwriting and approval guidelines of Fannie Mae, the Federal Housing Administration and conduit commercial lending programs secured by first liens on real property. Accordingly, Messrs. Kaufman and Herbst will devote substantial amounts of their time to operating portions of Arbor Commercial Mortgages business that do not involve managing us. Further conflicts of interest may arise because Arbor Commercial Mortgage may also provide permanent mortgage financing to real estate concerns to which we have made temporary loans, or because Arbor Commercial Mortgage may have equity interests in real estate concerns that borrow money from us. In addition, Messrs. Palmier and Weber will continue to provide services to Arbor Commercial Mortgage as members of Arbor Commercial Mortgages executive committee, and may receive fees for originating loans on behalf of Arbor Commercial Mortgage.
Arbor Commercial Mortgage holds a 28% limited partnership interest in our operating partnership as a result of the contribution of the initial assets. Arbor Commercial Mortgage also owns approximately 3.1 million shares of our special voting preferred stock that entitle it to 28% of the voting power of our outstanding stock (without giving effect to the exercise of Arbor Commercial Mortgages warrants).
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We were formed by Arbor Commercial Mortgage and the terms of our management agreement and the contribution of the initial assets were not negotiated at arms length. To address some of these conflicts of interest, our charter requires that a majority of our board of directors be independent directors and that a majority of our independent directors make any determinations on our behalf with respect to the relationships or transactions that present a conflict of interest for our directors or officers. Our board of directors has adopted a specific policy that decisions concerning our management agreement, including termination, renewal and enforcement of the management agreement, or our participation in any transactions with Arbor Commercial Mortgage or its affiliates outside of the management agreement, including our ability to purchase securities and mortgage or other assets from or to sell securities and assets to Arbor Commercial Mortgage must be reviewed and approved by a majority of our independent directors. Finally, our independent directors will periodically review the general investment standards established for the manager under the management agreement.
On July 1, 2003, we issued and sold 1,610,000 of our units, each consisting of five shares of our common stock, $.01 par value per share, and one warrant to purchase an additional share of common stock. 1,327,989 of these units were sold to JMP Securities LLC, or JMP Securities, as initial purchaser, and were simultaneously resold by JMP Securities in transactions exempt from the registration requirements of the Securities Act of 1933, as amended, to persons reasonably believed by JMP Securities to be qualified institutional buyers (as defined in Rule 144A under the Securities Act) and to a limited number of institutional accredited investors (as defined in Rule 501 under the Securities Act). The remaining 282,011 units were sold directly by us to individual accredited investors. Certain investors in the original offering included institutions and individuals affiliated with us and JMP Securities.
Registration Rights |
In connection with the original offering we entered into a registration rights agreement with JMP Securities. Pursuant to that agreement, we have filed a shelf registration statement of which this prospectus is a part, covering the resale of the offered securities. The shelf registration statement includes the offered securities listed under The Offering.
At the time of the original offering we also entered into a registration rights agreement with Arbor Commercial Mortgage whereby we granted Arbor Commercial Mortgage certain demand and other registration rights with respect to shares of common stock that may be issued to Arbor Commercial Mortgage upon redemption of the 3.1 million operating partnership units issued to Arbor Commercial Mortgage and issuable to Arbor Commercial Mortgage upon exercise of the 629,000 warrants for additional operating partnership units.
Lock-Up Agreements |
In connection with the original offering, Arbor Commercial Mortgage, members of our senior management and board of directors and certain members of the senior management of Arbor Commercial Mortgage agreed not to offer, pledge, sell contract to sell, sell any option or contract to purchase or otherwise transfer or dispose of, directly or indirectly, any shares of our common stock, or any securities convertible into or exercisable for any of our common stock or any right to acquire our common stock, until the earlier of:
| 180 days from the effective date of the shelf registration statement; and | |
| two years from the consummation of the original offering, subject to certain exceptions. |
We also agreed not to offer to sell, contract to sell, or otherwise dispose of, loan, pledge or grant any rights with respect to any shares of our common stock, any options or warrants to purchase any shares of our common stock or any securities convertible into or exercisable for any of our common stock, including our units, for a period of 180 days following the completion of the original offering, subject to certain exceptions.
JMP Securities, at any time, and without notice, may release all or any portion of the common stock subject to the foregoing lock-up agreements.
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The Offering
Securities Offered | The selling stockholders may, from time to time, sell the offered securities which include: | |
1,602,833 units sold in the original offering; | ||
8,014,165 shares of common stock comprising the units; | ||
1,602,833 warrants comprising the units; and | ||
1,602,833 shares of common stock underlying the warrants. | ||
The warrants have an initial exercise price of $15 and are exercisable until 5:00 p.m. New York City time on July 1, 2005. The warrants comprising the units do not become exercisable, detachable and freely tradable until after the shares of the common stock comprising the units are registered under the Securities Act and either listed on a national securities exchange or The Nasdaq Stock Market, Inc. The shares of common stock and the warrants comprising the units may not be traded separately until such listing. | ||
Offering Price | The selling stockholders are offering, from time to time, the securities being offered by this prospectus at the then current market price. | |
Use of Proceeds | The selling stockholders will receive all of the proceeds from the sale of the securities. We will not receive any proceeds from the sale of the securities. | |
Listing | We have agreed to use our best efforts to list or include the offered securities on The Nasdaq Stock Market, including The Nasdaq SmallCap Market, or the New York Stock Exchange, in our discretion, as soon as practicable after we are able to satisfy the applicable listing requirements for the offered securities, which will not occur for an indefinite period of time, if at all, after the registration statement of which this prospectus is a part is declared effective. If and when we apply for listing of the offered securities under the applicable listing requirements, we cannot guarantee that we will have the minimum number of holders required in order to list or include the offered securities on either The Nasdaq Stock Market, including The Nasdaq SmallCap Market, or the New York Stock Exchange. |
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Summary Selected Unaudited Consolidated Financial Information
The following tables present selected historical consolidated financial information for the three months ended September 30, 2003. The selected historical consolidated financial information presented below under the captions Consolidated Statement of Operations Data and Consolidated Balance Sheet Data have been derived from our unaudited, interim consolidated financial statements and include all adjustments, consisting only of normal recurring accruals, which management considers necessary for a fair presentation of the historical consolidated financial statements for such period. The information presented under the caption Statement of Operations Data for the three months ended September 30, 2003 is not necessarily indicative of any other interim period or of the year ended December 31, 2003. In addition, since the information presented below is only a summary and does not provide all of the information contained in our historical consolidated financial statements, including the related notes, you should read it in conjunction with Managements Discussion and Analysis of Financial Condition and Results of Operations of Arbor Realty Trust, Inc. and Subsidiaries and our historical consolidated financial statements, including the related notes, included elsewhere in this prospectus.
Three Months Ended | ||||
September 30, 2003 | ||||
(Unaudited) | ||||
Consolidated Statement of Operations
Data:
|
||||
Interest Income
|
$ | 4,669,990 | ||
Other income
|
500 | |||
Total revenue
|
4,670,490 | |||
Total expenses
|
3,183,411 | |||
Net income
|
1,074,587 | |||
Earnings per share, basic and
diluted(1)
|
.13 | |||
Dividends declared per common share(2)
|
.25 |
At September 30, | ||||
2003 | ||||
(Unaudited) | ||||
Consolidated Balance Sheet Data:
|
||||
Loans and investments, net
|
$ | 214,237,458 | ||
Related party loans, net
|
26,000,000 | |||
Total assets
|
255,389,573 | |||
Notes payable and repurchase agreements
|
91,913,811 | |||
Total liabilities
|
97,831,411 | |||
Minority interest
|
44,309,289 | |||
Total stockholders equity
|
$ | 113,248,873 |
Three Months Ended | ||||
September 30, 2003 | ||||
(Unaudited) | ||||
Other Data:
|
||||
Total originations
|
$ | 39,014,922 |
(1) | The warrants underlying the units issued in the original offering at $75.00 per unit have an exercise price of $15.00 per share and expire on July 1, 2005. This exercise price is equal to the price per share of common stock in the original offering and approximates the market value of our common stock at September 30, 2003. Therefore, the assumed exercise of the warrants were not considered to be dilutive for purposes of calculating diluted earnings per share. |
(2) | On November 5, 2003, we declared a dividend of $.25 per share of common stock, payable with respect to the quarter ending September 30, 2003, to common stockholders of record at the close of business on November 5, 2003. We distributed this dividend on November 18, 2003. |
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Summary Selected Consolidated Financial Information
On July 1, 2003, Arbor Commercial Mortgage contributed a portfolio of structured finance investments and related liabilities to our operating partnership. In addition, certain employees of Arbor Commercial Mortgage became our employees. These assets, liabilities and employees represented a substantial portion of Arbor Commercial Mortgages structured finance business.
The tables on the following page present selected historical consolidated financial information of the structured finance business of Arbor Commercial Mortgage at the dates and for the periods indicated. The structured finance business did not operate as a separate legal entity or business division or segment of Arbor Commercial Mortgage, but as an integrated part of Arbor Commercial Mortgages consolidated business. Accordingly, the statements of revenue and direct operating expenses do not include charges from Arbor Commercial Mortgage for corporate general and administrative expense because Arbor Commercial Mortgage considered such items to be corporate expenses and did not allocate them to individual business units. These expenses included costs for Arbor Commercial Mortgages executive management, corporate facilities and overhead costs, corporate accounting and treasury functions, corporate legal matters and other similar costs. The selected consolidated financial information presented under the caption Consolidated Statement of Revenue and Direct Operating Expenses Data for the years ended December 31, 2002, 2001 and 2000 and under the caption Consolidated Statement of Assets and Liabilities Data as of December 31, 2002 and 2001 have been derived from the audited consolidated financial statements of the structured finance business of Arbor Commercial Mortgage included elsewhere in this prospectus. The selected consolidated financial information presented under the caption Consolidated Statement of Revenue and Direct Operating Expenses Data for the years ended December 31, 1999 and 1998 and the caption Consolidated Statement of Assets and Liabilities Data as of December 31, 2000, 1999 and 1998 have been derived from the unaudited consolidated financial statements of the structured finance business of Arbor Commercial Mortgage.
The selected consolidated financial information presented under the caption Consolidated Statement of Revenue and Direct Operating Expenses Data for the six months ended June 30, 2003 and 2002 and the nine months ended September 30, 2002 and under the caption Consolidated Statement of Assets and Liabilities Data at June 30, 2003 have been derived from the unaudited interim consolidated financial statements of Arbor Commercial Mortgages structured finance business and include all adjustments, consisting only of normal recurring accruals, which management considers necessary for a fair presentation of the historical consolidated financial information for such periods. The selected historical consolidated financial information presented under the caption Consolidated Statement of Revenue and Direct Operating Expenses Data for the six month period ended June 30, 2003 is not necessarily indicative of the results of any other interim period or the year ended December 31, 2003. The selected historical consolidated financial information presented under the caption Consolidated Statement of Revenue and Direct Operating Expenses Data for the six month period ended June 30, 2002 and the nine month period ended September 30, 2002 are not necessarily indicative of the results of any other interim period or the year ended December 31, 2002.
The consolidated financial statements of Arbor Commercial Mortgages structured finance business included in this prospectus represent the consolidated financial position and results of operations of Arbor Commercial Mortgages structured finance business during certain periods and at certain dates when Arbor Commercial Mortgage previously held our initial assets, as well as several other structured finance investments that we did not acquire in connection with our formation transactions. See Arbor Realty Trust, Inc. Accordingly, the historical financial results of Arbor Commercial Mortgages structured finance business are not indicative of our future performance. In addition, since the information presented is only a summary and does not provide all of the information contained in the consolidated financial statements of Arbor Commercial Mortgages structured finance business, including related notes, you should read it in conjunction with Managements Discussion and Analysis of Financial Condition and Results of Operations of the Structured Finance Business of Arbor Commercial Mortgage, LLC and Subsidiaries and the consolidated financial statements of Arbor Commercial Mortgages structured finance business, including related notes, contained elsewhere in this prospectus.
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Consolidated Statement of Revenue and Direct Operating Expenses Data:
Nine Months | ||||||||||||||||||||||||||||||||||
Six Months | Ended | |||||||||||||||||||||||||||||||||
Ended June 30, | September 30, | Year Ended December 31, | ||||||||||||||||||||||||||||||||
2003 | 2002 | 2002 | 2002 | 2001(1) | 2000(1) | 1999(1) | 1998(1) | |||||||||||||||||||||||||||
(Unaudited) | (Unaudited) | |||||||||||||||||||||||||||||||||
Interest Income
|
$ | 7,688,465 | $ | 7,482,750 | $ | 10,798,414 | $ | 14,532,504 | $ | 14,667,916 | $ | 10,707,551 | $ | 6,964,873 | $ | 6,807,617 | ||||||||||||||||||
Income from real estate held for sale, net of
operating expenses
|
| | | | | | 925,999 | 1,608,172 | ||||||||||||||||||||||||||
Other income
|
1,552,414 | 553,625 | 572,161 | 1,090,106 | 1,668,215 | 652,970 | 2,838,639 | 7,064,294 | ||||||||||||||||||||||||||
Total revenue
|
9,240,879 | 8,036,375 | 11,370,575 | 15,622,610 | 16,336,131 | 11,360,521 | 10,729,511 | 15,480,083 | ||||||||||||||||||||||||||
Total direct operating expenses
|
5,737,688 | 8,344,302 | 10,775,555 | 13,639,755 | 10,997,800 | 9,227,274 | 7,145,469 | 6,589,274 | ||||||||||||||||||||||||||
Revenue in excess of direct operating expenses
before gain on sale of loans and real estate and income from
equity affiliates
|
3,503,191 | (307,927 | ) | 595,020 | 1,982,855 | 5,338,331 | 2,133,247 | 3,584,042 | 8,890,809 | |||||||||||||||||||||||||
Gain on sale of loans and real estate
|
1,024,268 | 7,006,432 | 7,006,432 | 7,470,999 | 3,226,648 | 1,880,825 | 1,818,299 | 1,898,558 | ||||||||||||||||||||||||||
Income from equity affiliates
|
| 601,100 | 632,350 | 632,350 | 1,403,014 | 5,028,835 | 3,592,398 | 567,006 | ||||||||||||||||||||||||||
Revenue, gain on sale of loans and real estate
and income from equity affiliates in excess of direct operating
expenses
|
4,527,459 | 7,299,605 | 8,233,802 | 10,086,204 | 9,967,993 | 9,042,907 | 8,994,739 | 11,356,373 |
Consolidated Statement of Assets and Liabilities Data:
At June 30, | At December 31, | |||||||||||||||||||||||
2003 | 2002 | 2001 | 2000 | 1999 | 1998 | |||||||||||||||||||
(Unaudited) | ||||||||||||||||||||||||
Loans and investments, net
|
$ | 204,561,578 | $ | 172,142,511 | $ | 160,183,066 | $ | 85,547,323 | $ | 50,156,022 | $ | 75,604,351 | ||||||||||||
Related party loans, net
|
23,277,041 | 15,952,078 | 15,880,207 | | | | ||||||||||||||||||
Investment in equity affiliates
|
3,654,573 | 2,586,026 | 2,957,072 | 20,506,417 | 23,459,586 | 20,092,793 | ||||||||||||||||||
Total assets
|
241,667,960 | 200,563,236 | 183,713,747 | 119,110,446 | 84,751,032 | 96,537,674 | ||||||||||||||||||
Notes payable and repurchase agreements
|
171,045,404 | 141,836,477 | 132,409,735 | 70,473,501 | 47,154,530 | 58,678,062 | ||||||||||||||||||
Total liabilities
|
172,686,366 | 144,280,806 | 134,086,301 | 72,266,700 | 48,025,934 | 59,193,306 | ||||||||||||||||||
Net assets
|
68,981,594 | 56,282,430 | 49,627,446 | 46,843,746 | 36,725,098 | 37,344,368 |
Other Data:
Nine Months | ||||||||||||||||||||||||||||||||
Six Months Ended June 30, | Ended | Year Ended December 31, | ||||||||||||||||||||||||||||||
September 30, | ||||||||||||||||||||||||||||||||
2003 | 2002 | 2002 | 2002 | 2001 | 2000 | 1999 | 1998 | |||||||||||||||||||||||||
Total originations
|
$ | 117,965,000 | $ | 30,660,000 | $ | 49,510,000 | $ | 130,043,000 | $ | 86,700,000 | $ | 108,378,000 | (2) | $ | 120,378,900 | (2) | $ | 230,718,353 | (2) |
(1) | In June 1998, Arbor Commercial Mortgage entered into a joint venture with SFG I, an affiliate of Nomura Asset Capital Corp., for the purpose of acquiring up to $250 million of structured finance investments. Arbor Commercial Mortgage and SFG I each made 50% of the capital contributions to the joint venture and shared profits equally. Nomura Asset Capital Corp. provided financing to the joint venture in the form of a repurchase agreement. On July 31, 2001, Arbor Commercial Mortgage purchased SFG Is interest in this venture. This buyout was accounted for by the purchase accounting method. Prior to the purchase, net income from this venture was recorded in income from equity affiliates. The activities of the former joint venture have been included in the statements of revenue and direct operating expenses from the date of acquisition, August 2001. See the consolidated financial statements of Arbor Commercial Mortgages structured finance business and the related notes to the consolidated financial statements included elsewhere in this prospectus for further information. |
(2) | Total originations for 1998, 1999 and 2000 include originations from Arbor Commercial Mortgages joint venture with SFG I discussed in footnote 1. |
Arbor Realty Trust, Inc. was incorporated in the State of Maryland in June 2003. Our principal executive offices are located at 333 Earle Ovington Boulevard, Suite 900, Uniondale, New York 11553. Our telephone number is (516) 832-8002.
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RISK FACTORS
An investment in our securities involves a number of risks. Before making an investment decision, you should carefully consider all of the risks described below and the other information contained in this prospectus. If any of the risks discussed in this prospectus actually occur, our business, financial condition and results of operations could be materially adversely affected. If this were to occur, the value of our securities could decline and you may lose all or part of your investment.
Risks Related to Our Business
We have a limited operating history and may not operate successfully. |
We were organized in June 2003 and have a limited operating history. The results of our operations depend on many factors, including the performance of the initial assets, the availability of opportunities for the acquisition of additional assets, the level and volatility of interest rates, readily accessible short and long term financing, conditions in the financial markets and economic conditions, and we may not operate successfully. We face substantial competition in acquiring suitable investments, which could adversely impact our yields.
Historical consolidated financial statements included in this prospectus include expenses that would not have been incurred had we operated as a separate entity during the periods presented and exclude the management fees payable pursuant to the management agreement. |
The historical consolidated financial statements included in this prospectus for the three years ending December 31, 2002, the six months ending June 30, 2002 and the nine months ending September 30, 2002 relate to the structured finance business of Arbor Commercial Mortgage and may not reflect what our results of operations, financial condition and cash flows would have been had we operated as a separate, stand-alone entity during the periods presented. This historical financial information includes assets in the structured finance portfolio of Arbor Commercial Mortgage that were not contributed to us. It also includes employee compensation and benefit expenses for the costs of originations, underwriting services and the servicing of all our contributed assets that we would not have incurred had we operated as a separate entity during the periods presented because they would have been borne by Arbor Commercial Mortgage under the terms of the management agreement. This historical financial information does not include the management fees that we pay our manager.
Historical consolidated financial statements included in this prospectus present historical financial information for the structured finance business of Arbor Commercial Mortgage which never operated as a separate business division of Arbor Commercial Mortgage during the periods presented. |
The structured finance business of Arbor Commercial Mortgage has never operated as a separate business division or segment of Arbor Commercial Mortgage. The historical consolidated financial statements of the structured finance business of Arbor Commercial Mortgage presented in this prospectus do not reflect the historical financial information of Arbor Commercial Mortgages entire business because it operates two business lines in addition to the structured finance business that was contributed to us. These other business lines generate revenues and expenses, which are included in Arbor Commercial Mortgages historical financial statements, but are not included in the historical financial information included in this prospectus. We prepared the historical consolidated financial statements included in this prospectus for the three years ending December 31, 2002, the six months ending June 30, 2002 and the nine months ending September 30, 2002 from Arbor Commercial Mortgages historical accounting records. The revenues, expenses, assets, liabilities and cash flows during each respective period that pertained to Arbor Commercial Mortgages structured finance business were allocated to us. All of these allocations are based on assumptions that management believes are reasonable under the circumstances. However, these allocations may not be indicative of the revenues, expenses, assets, liabilities and cash flows that would have existed or resulted if we had operated as a separate entity during the periods presented.
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We may be unable to invest excess equity capital on acceptable terms or at all, which would adversely affect our operating results. |
We may not be able to identify investments that meet our investment criteria and we may not be successful in closing the investments that we identify. Unless and until we identify structured finance investments consistent with our investment criteria, any excess equity capital may be used to repay borrowings under our warehouse credit facility and repurchase agreements, which would not produce a return on capital. In addition, the investments that we acquire with our equity capital may not produce a return on capital. There can be no assurance that we will be able to identify attractive opportunities to invest our equity capital which would adversely affect our results of operations.
We may change our investment strategy without stockholder consent, which may result in riskier investments than our current investments. |
We may change our investment strategy and guidelines at any time without the consent of our stockholders, which could result in our making investments that are different from, and possibly riskier than, the investments described in this prospectus. A change in our investment strategy or guidelines may increase our exposure to interest rate and real estate market fluctuations.
We depend on key personnel with long standing business relationships, the loss of whom could threaten our ability to operate our business successfully. |
Our future success depends, to a significant extent, upon the continued services of our manager and our employees. In particular, the mortgage lending experience of Mr. Ivan Kaufman and Mr. Fred Weber and the extent and nature of the relationships they have developed with developers of multi-family and commercial properties and other financial institutions are critical to the success of our business. We cannot assure you of their continued employment with Arbor Commercial Mortgage or us. The loss of services of one or more members of our managers officers or our officers could harm our business and our prospects.
If we cannot obtain additional financing substantially similar to the credit facilities we currently have, our growth will be limited. |
We are generally required to distribute to our stockholders at least 90% of our taxable income each year to continue to qualify as a REIT, and we must distribute all of our taxable income in order to avert any corporate income taxes on retained income. As a result, our retained earnings available to fund origination of new loans are nominal, and we rely upon the availability of additional debt or equity capital to fund these activities. Our long term ability to grow through investment in structured finance assets will be limited if we cannot obtain additional financing substantially similar to the credit facilities we currently have, including interest rates and advance rates. Market conditions may make it difficult to obtain financing on favorable terms or at all.
If Arbor Commercial Mortgage ceases to be our manager pursuant to the management agreement, the financial institutions providing our credit facilities may not provide future financing to us. |
The financial institutions that finance our investments pursuant to our existing credit facilities require that Arbor Commercial Mortgage manage our operations pursuant to the management agreement as a condition to making advances to us under these credit facilities. Additionally, if Arbor Commercial Mortgage ceases to be our manager, each of the financial institutions under these credit facilities has the right to terminate their facility and their obligation to advance funds to us in order to finance our future investments. If Arbor Commercial Mortgage ceases to be our manager for any reason and we are not able to obtain financing under our existing credit facilities, our growth may be limited.
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The repurchase agreements and credit facilities that we use to finance our investments may require us to provide additional collateral and may leave us without funding should our funding sources file for bankruptcy. |
Credit facilities, including repurchase agreements, involve the risk that the market value of the loans pledged or sold by us to the funding source may decline in value, in which case the lending institution may require us to provide additional collateral to pay down a portion of the funds advanced. In addition, in the event that the funding source files for bankruptcy or becomes insolvent, our loans may become subject to the bankruptcy or insolvency proceedings, thus depriving us, at least temporarily, of the benefit of these assets. Such an event could materially adversely affect our results of operations.
Mezzanine loans involve greater risks of loss than senior loans secured by income producing properties. |
We invest in mezzanine loans that take the form of subordinated loans secured by second mortgages on the underlying property or loans secured by a pledge of the ownership interests of either the entity owning the property or a pledge of the ownership interests of the entity that owns the interest in the entity owning the property. Although an intercreditor agreement may provide some protections to the holder of the mezzanine loan, these types of investments involve a higher degree of risk than long term senior mortgage lending secured by income producing real property because the investment may become unsecured as a result of foreclosure by the senior lender. In the event of a bankruptcy of the entity providing the pledge of its ownership interests as security, we may not have full recourse to the assets of such entity, or the assets of the entity may not be sufficient to satisfy our mezzanine loan. If a borrower defaults on our mezzanine loan or debt senior to our loan, or in the event of a borrower bankruptcy, our mezzanine loan will be satisfied only after the senior debt. As a result, we may not recover some or all of our investment. In addition, mezzanine loans may have higher loan to value ratios than conventional mortgage loans, resulting in less equity in the property and increasing the risk of loss of principal.
Preferred equity investments involve a greater risk of loss than traditional debt financing. |
We invest in preferred equity investments, which involve a higher degree of risk than traditional debt financing due to a variety of factors, including that such investments are subordinate to other loans and are not secured by property underlying the investment. Furthermore, should the issuer default on our investment, we would only be able to proceed against the partnership in which we have an interest, and not the property underlying our investment. As a result, we may not recover some or all of our investment.
Mortgage investments that are not United States government insured and non-investment grade mortgage assets involve risk of loss. |
We originate and acquire uninsured and non-investment grade mortgage loans and mortgage assets as part of our investment strategy. Such loans and assets include mezzanine loans and bridge loans. While holding such interests, we are subject to risks of borrower defaults, bankruptcies, fraud, losses and special hazard losses that are not covered by standard hazard insurance. In the event of any default under mortgage loans held by us, we bear the risk of loss of principal and non-payment of interest and fees to the extent of any deficiency between the value of the mortgage collateral and the principal amount of the mortgage loan. To the extent we suffer such losses with respect to our investments in mortgage loans, the value of our company and the price of our common stock may be adversely affected.
We invest in multi-family and commercial real estate loans, which involve a greater risk of loss than single family loans. |
Our investments include multi-family and commercial real estate loans that are considered to involve a higher degree of risk than single family residential lending because of a variety of factors, including generally larger loan balances, dependency for repayment on successful operation of the mortgaged property and tenant businesses operating therein, and loan terms that include amortization schedules longer than the stated maturity and provide for balloon payments at stated maturity rather than periodic principal payments. In
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We may invest in direct ownership of real estate, the value of which may fluctuate. |
We may make investments in the direct ownership of real property. In addition, our loans held for investment are generally directly or indirectly secured by a lien on real property that, upon the occurrence of a default on the loan, could result in our acquiring ownership of the property. Investments in real property or real property related assets are subject to varying degrees of risk. The value of each property is affected significantly by its ability to generate cash flow and net income, which in turn depends on the amount of rental income that can be generated net of expenses required to be incurred with respect to the property. The rental income from these properties may be adversely affected by a number of factors, including general economic climate and local real estate conditions, an oversupply of (or a reduction in demand for) space in properties in the areas where particular properties are located and the attractiveness of particular properties to prospective tenants. Net income from properties also is affected by such factors as the cost of compliance with government regulations, including zoning and tax laws, and the potential for liability under applicable laws. Many expenditures associated with properties (such as operating expenses and capital expenditures) cannot be reduced when there is a reduction in income from the properties. Adverse changes in these factors may have a material adverse effect on the ability of our borrowers to pay their loans, as well as on the value that we can realize from properties we own or acquire.
Risks of cost overruns and noncompletion of renovation of the properties underlying rehabilitation loans may materially adversely affect our investment. |
The renovation, refurbishment or expansion by a borrower under a mortgaged property involves risks of cost overruns and noncompletion. Estimates of the costs of improvements to bring an acquired property up to standards established for the market position intended for that property may prove inaccurate. Other risks may include rehabilitation costs exceeding original estimates, possibly making a project uneconomical, environmental risks and rehabilitation and subsequent leasing of the property not being completed on schedule. If such renovation is not completed in a timely manner, or if it costs more than expected, the borrower may experience a prolonged impairment of net operating income and may not be able to make payments on our investment.
Participating interests may not be available and, even if obtained, may not be realized. |
In connection with the acquisition and origination of certain structured finance assets, we may obtain participating interests, or equity kickers, in the owner of the property that entitle us to payments based upon a developments cash flow, profits or any increase in the value of the development that would be realized upon a refinancing or sale of the development. Competition for participating interests is dependent to a large degree upon market conditions. Participating interests are more difficult to obtain when multi-family and commercial real estate financing is available at relatively low interest rates. In the current interest rate environment, we may have greater difficulty obtaining participating interests. Participating interests are not government insured or guaranteed and are therefore subject to the general risks inherent in real estate investments. Therefore, even if we are successful in originating mortgage loans that provide for participating interests, there can be no assurance that such interests will result in additional payments to us.
Competition in acquiring desirable investments may limit their availability, which could, in turn, negatively affect our ability to maintain our dividend distribution. |
We compete in investing in structured finance assets with numerous public and private real estate investment vehicles, such as other REITs, mortgage banks, pension funds, institutional investors and individuals. Structured finance assets are often obtained through a competitive bidding process. Many of our competitors are larger than us, have access to greater capital and other resources, have management personnel with more experience than our officers or our manager and have other advantages over us and our manager in conducting certain business and providing certain services. Competition may result in higher prices for
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Interest rate fluctuations may adversely affect the value of our assets, net income and common stock. |
Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond our control. Interest rate fluctuations present a variety of risks including the risk of a mismatch between asset yields and borrowing rates, variances in the yield curve and fluctuating prepayment rates and may adversely affect our income and value of our common stock.
Prepayment rates can increase, thus adversely affecting yields. |
The value of our assets may be affected by prepayment rates on mortgage loans. Prepayment rates on loans are influenced by changes in current interest rates and a variety of economic, geographic and other factors beyond our control, and consequently, such prepayment rates cannot be predicted with certainty. In periods of declining interest rates, prepayments on loans generally increase. If general interest rates decline as well, the proceeds of such prepayments received during such periods are likely to be reinvested by us in assets yielding less than the yields on the assets that were prepaid. In addition, the market value of the structured finance assets may, because of the risk of prepayment, benefit less than other fixed income securities from declining interest rates. Under certain interest rate and prepayment scenarios we may fail to recoup fully our cost of acquisition of certain investments. A portion of our investments require payments of deferred interest upon prepayment or maturity of the investment. This deferred interest will generally discourage a borrower from repaying an investment ahead of its scheduled maturity. We may not be able to structure future investments that contain similar deferred interest payments.
All of the initial assets contributed by Arbor Commercial Mortgage and substantially all of the assets currently in our portfolio do not have prepayment protection. Since September 30, 2003, six of the investments contributed by Arbor Commercial Mortgage, totaling $49.3 million, were repaid in full prior to maturity.
Refinancing our credit facilities may materially adversely affect our results of operations. |
Our loans held for investment may have maturities that are different from the maturities for the funds we borrow to finance them. If the funds we borrow mature before the loans we make, we would have to seek new financing that may not be on as favorable terms and our net income would be adversely affected.
Changes in market conditions may adversely affect our credit facilities and repurchase agreements. |
Credit facilities, including repurchase agreements, involve the risk that the market value of the loans pledged or sold to the funding source by us may decline, in which case the lending institution may require us to provide additional collateral or pay down a portion of the funds advanced. In addition, in the event the funding source files for bankruptcy or becomes insolvent, our loans may become subject to the bankruptcy or insolvency proceedings, thus depriving us, at least temporarily, of the benefit of these assets. Such an event could materially adversely affect our business.
In order to close transactions in a time frame that meets our customers needs we may perform underwriting analyses in a very short period of time, which may result in credit decisions based on limited information. |
From time to time, we gain a competitive advantage by being able to analyze and close transactions within a very short period of time. Our underwriting guidelines require a thorough analysis of many factors, including the underlying propertys financial performance and condition, geographic market assessment, experience and financial strength of the borrower and future prospects of the property within the market. If we
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The geographic concentration of the properties underlying our investments may increase our risk of loss. |
We have not established any limit upon the geographic concentration of properties underlying our investments. As a result, properties underlying our investments may be overly concentrated in certain geographic areas, and we may experience losses as a result. As of September 30, 2003, 22%, 20%, 16%, 10% and 10% of the outstanding balance of the structured finance investments we hold had underlying properties in Florida, New York, Maryland, Nevada and New Jersey, respectively. A worsening of economic conditions in these states could have an adverse effect on our business, including reducing the demand for new financings, limiting the ability of customers to pay financed amounts and impairing the value of our collateral.
Volatility of values of multi-family and commercial properties may adversely affect our loans and investments. |
Multi-family and commercial property values and net operating income derived from such properties are subject to volatility and may be affected adversely by a number of factors, including, but not limited to, national, regional and local economic conditions (which may be adversely affected by industry slowdowns and other factors); local real estate conditions (such as an oversupply of housing, retail, industrial, office or other commercial space); changes or continued weakness in specific industry segments; construction quality, age and design; demographic factors; retroactive changes to building or similar codes; and increases in operating expenses (such as energy costs). In the event a propertys net operating income decreases, a borrower may have difficulty paying our loan, which could result in losses to us. In addition, decreases in property values reduce the value of the collateral and the potential proceeds available to a borrower to repay our loans, which could also cause us to suffer losses.
We may be unable to generate sufficient revenue from operations to pay our operating expenses and to pay dividends to our stockholders. |
As a REIT, we are generally required to distribute at least 90% of our taxable income each year to our stockholders. In order to qualify for the tax benefits accorded to REITs, we intend to pay quarterly dividends and to make distributions to our stockholders in amounts such that we distribute all or substantially all of our taxable income each year, subject to certain adjustments. However, our ability to make distributions may be adversely affected by the risk factors described in this prospectus. In the event of a downturn in our operating results and financial performance or unanticipated declines in the value of our asset portfolio, we may be unable to declare or pay quarterly dividends or make distributions to our stockholders. The timing and amount of dividends are in the sole discretion of our board of directors, which considers, among other factors, our earnings, financial condition, debt service obligations and applicable debt covenants, REIT qualification requirements and other tax considerations and capital expenditure requirements as our board may deem relevant from time to time.
Among the factors that could adversely affect our results of operations and impair our ability to make distributions to our stockholders are:
| the profitability of the investment of the net proceeds of the original offering; | |
| our ability to make profitable structured finance investments; | |
| defaults in our asset portfolio or decreases in the value of our portfolio; | |
| the fact that anticipated operating expense levels may not prove accurate, as actual results may vary from estimates; and | |
| increased debt service requirements, including those resulting from higher interest rates on variable rate indebtedness. | |
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A change in any one of these factors could affect our ability to make distributions. If we are not able to comply with the restrictive covenants and financial ratios contained in our credit facilities, our ability to make distributions to our stockholders may also be impaired. We cannot assure you that we will be able to make distributions to our stockholders in the future or that the level of any distributions we make will increase over time.
In addition, distributions to stockholders are generally taxable to our stockholders as ordinary income, but a portion of these distributions may be designated by us as long term capital gain to the extent they are attributable to capital gain income recognized by us, or may constitute a return of capital to the extent they exceed our earnings and profits as determined for tax purposes.
We may need to borrow funds under our credit facilities in order to satisfy our REIT distribution requirements. |
We may need to borrow funds to meet the REIT requirement that we distribute at least 90% of our taxable income each year to our stockholders if our cash flows from operations are not sufficient to cover the distribution requirements or because there are differences in timing between the recognition of taxable income and the actual receipt of income. Our warehouse credit facility and master repurchase agreements allow us to borrow up to a maximum amount against each of our investments financed under these credit facilities. If we have not borrowed the maximum allowable amount against any of these investments, we may borrow funds under our credit facilities up to these maximum amounts in order to satisfy REIT distribution requirements.
Failure to maintain an exemption from the Investment Company Act would adversely affect our results of operations. |
We believe that we conduct our business in a manner that allows us to avoid being regulated as an investment company under the Investment Company Act of 1940, as amended, or the Investment Company Act. Under Section 3(c) (5) (C), the Investment Company Act exempts entities that are primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate. The staff of the SEC has provided guidance on the availability of this exemption. Specifically, the staffs position generally requires us to maintain at least 55% of our assets directly in qualifying real estate interests. To constitute a qualifying real estate interest under this 55% requirement, a real estate interest must meet various criteria. Loans that are secured by equity interests in the owners of real property rather than the property itself, direct equity interests in entities that own real property and certain mortgage backed securities may not qualify for purposes of the 55% requirement depending upon the type of entity. Our ownership of these equity interests, therefore, is limited by the provisions of the Investment Company Act.
We are subject to various risks related to our use of, and dependence on, debt. |
The amount we have to pay on variable rate debt increases as interest rates increase, which may decrease cash available for distribution to stockholders. All of our outstanding debt, which as of September 30, 2003, was $91.9 million, consists of variable rate debt under the warehouse credit agreement and the two master repurchase agreements that we use to finance our loans and other investments. We cannot assure you that we will be able to meet our debt service obligations. If we do not meet our debt service obligations, we risk the loss of some or all of our assets. Changes in economic conditions or our financial results or prospects could (1) result in higher interest rates on variable rate debt, (2) reduce the availability of debt financing generally or debt financing at favorable rates, (3) reduce cash available for distribution to stockholders and (4) increase the risk that we could be forced to liquidate assets to repay debt, any of which could have a material adverse affect on us.
Our warehouse credit agreement and master repurchase agreements contain covenants which prohibit us from effecting a change in control or disposing of or encumbering assets being financed and restrict us from making any material amendment to our underwriting guidelines without approval of the lender. We are also required to maintain financial ratios under these agreements including minimum net worth, debt-to-equity and minimum liquidity ratios. If we violate these covenants in any of these agreements, we could be required to
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In any event, financial covenants under our current or future debt obligations could impair our business strategies by limiting our ability to borrow beyond certain amounts or for certain purposes.
We leverage our portfolio, which may adversely affect our return on our investments and may reduce cash available for distribution. |
We leverage our portfolio through borrowings, generally through the use of warehouse credit facilities and repurchase agreements. The percentage of our leverage varies depending on our ability to obtain credit facilities and the lenders estimate of the stability of the portfolios cash flow. We currently have a policy limiting our leverage to 80% of the value of our assets on an aggregate basis unless approval to exceed the 80% limit is obtained from our board of directors. Our return on our investments and cash available for distribution to our stockholders may be reduced to the extent that changes in market conditions cause the cost of our financing to increase relative to the income that can be derived from the assets acquired.
Our debt service payments reduce the net income available for distributions to stockholders. We may not be able to meet our debt service obligations and, to the extent that we cannot, we risk the loss of some or all of our assets to foreclosure or sale to satisfy our debt obligations.
A decrease in the value of the assets may lead to a requirement that we repay certain borrowings. We may not have the funds available to satisfy such repayments.
A general economic slowdown could have a material effect on our business. |
Periods of economic slowdown or recession may be accompanied by declines in real estate values. Delinquencies, foreclosures and losses generally increase during economic slowdowns or recessions. Because a portion of the investments we make are subordinate to other creditors, the rate of delinquencies, foreclosures and losses on our mortgage loans could be higher than those generally experienced in the mortgage lending industry. If our loans go into and remain in default, we may have to foreclose and may incur substantial losses. Because real estate investments are relatively illiquid, our ability to promptly sell one or more investments or properties underlying foreclosed investments in our portfolio may be limited. In addition, any material decline in real estate values would increase the loan to value ratio of loans that we have previously extended, weaken our collateral coverage and increase the possibility of a loss in the event of a borrower default. Any sustained period of increased delinquencies, foreclosures or losses is likely to materially and adversely affect our ability to finance loans in the future. Furthermore, certain international events have caused significant uncertainty in the global financial markets. While the long term effects of these events and their potential consequences are uncertain, they could have a material adverse effect on general economic conditions, consumer confidence and market liquidity.
Liability relating to environmental matters may impact the value of the underlying properties. |
Under various federal, state and local laws, an owner or operator of real property may become liable for the costs of removal of certain hazardous substances released on its property. Such laws often impose liability without regard to whether the owner or operator knew of, or was responsible for, the release of such hazardous substances. The presence of hazardous substances may adversely affect an owners ability to sell real estate or borrow using real estate as collateral. To the extent that an owner of an underlying property becomes liable for removal costs, the ability of the owner to make debt payments may be reduced, which in turn may adversely affect the value of the relevant mortgage asset held by us.
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We are substantially controlled by Arbor Commercial Mortgage and its controlling equity owner, Mr. Kaufman. |
Mr. Ivan Kaufman is our chairman and chief executive officer and the president and chief executive officer of our manager. Further, Mr. Kaufman and the Kaufman entities together beneficially own approximately 88% of the outstanding membership interests of Arbor Commercial Mortgage. Arbor Commercial Mortgage owns approximately 3.1 million operating partnership units, representing a 28% limited partnership interest in our operating partnership. The operating partnership units are redeemable for approximately 3.1 million shares of our common stock. Each of the operating partnership units Arbor Commercial Mortgage owns is paired with one share of our special voting preferred stock, each of which entitle Arbor Commercial Mortgage to one vote on all matters submitted to a vote of our stockholders. Therefore, Arbor Commercial Mortgage is currently entitled to approximately 3.1 million votes, or 28% of the voting power of our outstanding stock. Because of his position with us and our manager and his ability to effectively vote a substantial minority of our outstanding voting stock, Mr. Kaufman has significant influence over our policies and strategy.
We may engage in hedging transactions that may limit our gains or result in losses. |
We may use derivatives to hedge our liabilities and this has certain risks, including:
| losses on a hedge position may reduce the cash available for distribution to stockholders and such losses may exceed the amount invested in such instruments; | |
| counterparties to a hedging arrangement could default on their obligations; and | |
| we may have to pay certain costs, such as transaction fees or brokerage costs. | |
Our board of directors has adopted a general policy with respect to our use of interest rate swaps, the purchase or sale of interest rate collars, caps or floors, options, mortgage derivatives and other hedging instruments in order to hedge as much of the interest rate risk as our manager determines is in the best interest of our stockholders, given the cost of such hedges and the need to maintain our status as a REIT. Our boards policy does not set forth specific policies and procedures for the use of these instruments. We may use these hedging instruments in our risk management strategy to limit the effects of changes in interest rates on our operations. A hedge may not be effective in eliminating all of the risks inherent in any particular position. Our profitability may be adversely affected during any period as a result of the use of derivatives.
Risks Related to Conflicts of Interest
We are dependent on our manager with whom we have conflicts of interest. |
We have only eleven employees, including Mr. Fred Weber, Mr. Daniel M. Palmier, Mr. John C. Kovarik and an eight-person asset management group, and are dependent upon our manager, Arbor Commercial Mortgage, to provide services to us that are vital to our operations. Our chairman, chief executive officer and president, Mr. Ivan Kaufman, is also the chief executive officer and president of our manager. Our chief financial officer, Mr. Frederick Herbst, is the chief financial officer of our manager and our secretary and general counsel, Mr. Walter Horn, is the general counsel of our manager. In addition, Mr. Kaufman and the Kaufman entities together beneficially own approximately 88% of the outstanding membership interests of Arbor Commercial Mortgage and Messrs. Herbst, Weber, Palmier, Martello and Horn, collectively hold a 5% ownership interest in Arbor Commercial Mortgage. Mr. Martello also serves as the trustee of one of the Kaufman entities that holds a majority of the outstanding membership interests in Arbor Commercial Mortgage and co-trustee of another Kaufman entity that owns an equity interest in our manager. Arbor Commercial Mortgage holds a 28% limited partnership interest in our operating partnership and 28% of the voting power of our outstanding stock (without giving effect to the exercise of warrants).
We may enter into transactions with Arbor Commercial Mortgage outside the terms of the management agreement with the approval of majority vote of the independent members of our board of directors. Transactions required to be approved by a majority of our independent directors include, but are not limited to,
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We have entered into a management agreement with our manager under which our manager provides us with all of the services vital to our operations other than asset management services. However, the management agreement was not negotiated at arms length and its terms, including fees payable, may not be as favorable to us as if it had been negotiated with an unaffiliated third party. Certain matters relating to our organization also were not approved at arms length and the terms of the contribution of assets to us may not be as favorable to us as if the contribution was with an unaffiliated third party.
The results of our operations is dependent upon the availability of, and our managers ability to identify and capitalize on, investment opportunities. Our managers officers and employees are also responsible for providing the same services for Arbor Commercial Mortgages portfolio of investments. As a result, they may not be able to devote sufficient time to the management of our business operations.
Conflicts of interest could arise in transactions where we lend to borrowers in which Arbor Commercial Mortgage holds an equity interest. |
Arbor Commercial Mortgage has contributed loans to us that are secured by properties in which Arbor Commercial Mortgage owns equity interests in the borrower. Every transaction that we enter into with an entity in which Arbor Commercial Mortgage holds equity interests raises a potential conflict of interest. Conflicts of interest with respect to these mortgage loans include, among others, decisions regarding (1) whether to waive defaults of such borrower, (2) whether to foreclose on a loan, and (3) whether to permit additional financing on the properties securing our investments other than financing provided by us.
Termination of our management agreement may be costly. |
Termination of the management agreement with our manager is difficult and costly. Our management agreement may be terminated by us (1) without cause, after the initial two year period, on six months prior written notice and (2) with cause in the event of our managers uncured breach of the management agreement, if approved by a majority of our independent directors. If we terminate the management agreement without cause or elect not to renew the management agreement in connection with the decision to manage our portfolio internally, we are required to pay our manager a termination fee equal to the base management fee and the incentive compensation earned during the twelve month period preceding the termination. If we terminate the management agreement without cause (except in a case where we become internally managed) or elect not to renew the management agreement for any other reason, including a change of control of us, we are required to pay our manager a termination fee equal to two times the base management fee and the incentive compensation earned during the twelve-month period preceding the termination. If we terminate without cause and become internally managed, we are required to pay our manager a termination fee equal to the base management fee and the incentive compensation earned during the 12-month period preceding the termination. These provisions may increase the effective cost to us of terminating the management agreement, thereby adversely affecting our ability to terminate our manager without cause.
If our manager terminates the management agreement, we may not be able to find an adequate replacement manager. |
At any time after the initial two-year term of the management agreement, our manager may terminate the management agreement without cause or elect not to renew the agreement, without penalty (except in certain cases of a change in control of the manager during the first three years of the management agreement), on six months prior written notice to us. In the event of our uncured breach of the management agreement,
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Our directors have approved very broad investment guidelines for our manager and do not approve each investment decision made by our manager. |
Our manager is authorized to follow very broad investment guidelines. Our directors will periodically review our investment guidelines and our investment portfolio. However, our board does not review each proposed investment. In addition, in conducting periodic reviews, the directors rely primarily on information provided to them by our manager. Furthermore, transactions entered into by our manager may be difficult or impossible to unwind by the time they are reviewed by the directors. Our manager has great latitude within the broad investment guidelines in determining the types of assets it may decide are proper investments for us.
Our manager has broad discretion to invest funds and may acquire structured finance assets where the investment returns are substantially below expectations or that result in net operating losses. |
Our manager has broad discretion, within the general investment criteria established by our board of directors, to allocate the proceeds of the original offering and to determine the timing of investment of such proceeds. Such discretion could result in allocation of proceeds to assets where the investment returns are substantially below expectations or that result in net operating losses, which would materially and adversely affect our business, operations and results.
The management compensation structure that we have agreed to with our manager may cause our manager to invest in high risk investments. Our manager is entitled to a base management fee, which is based on the equity of our operating partnership. The amount of the base management fee does not depend on the performance of the services provided by our manager or the types of assets it selects for our investment, but the value of our operating partnerships equity will be affected by the performance of these assets. Our manager is also entitled to receive incentive compensation based in part upon our achievement of targeted levels of funds from operations. In evaluating investments and other management strategies, the opportunity to earn incentive compensation based on funds from operations may lead our manager to place undue emphasis on the maximization of funds from operations at the expense of other criteria, such as preservation of capital, in order to achieve higher incentive compensation. Investments with higher yield potential are generally riskier or more speculative. This could result in increased risk to the value of our invested portfolio.
Risks Related to Our Status as a REIT
If we do not qualify as a REIT or fail to remain qualified as a REIT, we will be subject to tax as a regular corporation and could face substantial tax liability. |
We intend to operate so as to qualify as a REIT under the Internal Revenue Code. However, qualification as a REIT involves the application of highly technical and complex Internal Revenue Code provisions for which only limited judicial and administrative interpretations exist. Even a technical or inadvertent mistake could jeopardize our REIT status. Our continued qualification as a REIT will depend on our satisfaction of certain asset, income, organizational, distribution, stockholder ownership and other requirements on a continuing basis. In particular, our ability to qualify as a REIT depends in part on the relative values of our common and special voting preferred stock, which have not been determined by independent appraisal, are susceptible to fluctuation, and could, if successfully challenged by the IRS, cause us to fail to meet the ownership requirements. In addition, our ability to satisfy the requirements to qualify as a REIT depends in part on the actions of third parties over which we have no control or only limited influence, including in cases where we own a preferred equity interest in an entity that is classified as a partnership for U.S. federal income tax purposes.
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Furthermore, new tax legislation, administrative guidance or court decisions, in each instance potentially with retroactive effect, could make it more difficult or impossible for us to qualify as a REIT. If we fail to qualify as a REIT in any tax year, then:
| we would be taxed as a regular domestic corporation, which, among other things, means we would be unable to deduct distributions to stockholders in computing taxable income and would be subject to federal income tax on our taxable income at regular corporate rates; | |
| any resulting tax liability could be substantial and would reduce the amount of cash available for distribution to stockholders; and | |
| unless we were entitled to relief under applicable statutory provisions, we would be disqualified from treatment as a REIT for the subsequent four taxable years following the year during which we lost our qualification, and thus, our cash available for distribution to stockholders would be reduced for each of the years during which we did not qualify as a REIT. |
Even if we remain qualified as a REIT, we may face other tax liabilities that reduce our cash flow. |
Even if we remain qualified for taxation as a REIT, we may be subject to certain federal, state and local taxes on our income and assets. Any of these taxes would decrease cash available for distribution to our stockholders. In addition, in order to meet the REIT qualification requirements, or to avert the imposition of a 100% tax that applies to certain gains derived by a REIT from dealer property or inventory, we may hold some of our assets through taxable subsidiary corporations. See Federal Income Tax Considerations Taxation of Arbor Realty.
Complying with REIT requirements may cause us to forego otherwise attractive opportunities. |
To qualify as a REIT for federal income tax purposes we must continually satisfy tests concerning, among other things, the sources of our income, the nature and diversification of our assets, the amounts we distribute to our stockholders and the ownership of our stock. We may be required to make distributions to stockholders at disadvantageous times or when we do not have funds readily available for distribution. Thus, compliance with the REIT requirements may hinder our ability to operate solely on the basis of maximizing profits.
Complying with REIT requirements may force us to liquidate otherwise attractive investments. |
To qualify as a REIT we must ensure that at the end of each calendar quarter at least 75% of the value of our assets consists of cash, cash items, government securities and qualified REIT real estate assets. The remainder of our investment in securities (other than government securities and qualified real estate assets) generally cannot include more than 10% of the outstanding voting securities of any one issuer or more than 10% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5% of the value of our assets (other than government securities and qualified real estate assets) can consist of the securities of any one issuer, and no more than 20% of the value of our total securities can be represented by securities of one or more taxable REIT subsidiaries. If we fail to comply with these requirements at the end of any calendar quarter, we must correct such failure within 30 days after the end of the calendar quarter to avoid losing our REIT status and suffering adverse tax consequences. As a result, we may be required to liquidate otherwise attractive investments.
Liquidation of collateral may jeopardize our REIT status. |
To continue to qualify as a REIT, we must comply with requirements regarding our assets and our sources of income. If we are compelled to liquidate our mortgage and preferred equity investments to satisfy our obligations to our lenders, we may be unable to comply with these requirements, ultimately jeopardizing our status as a REIT.
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Complying with REIT requirements may force us to borrow to make distributions to stockholders. |
As a REIT, we must generally distribute at least 90% of our annual taxable income, subject to certain adjustments, to our stockholders. To the extent that we satisfy the distribution requirement, but distribute less than 100% of our taxable income, we will be subject to federal corporate income tax on our undistributed taxable income. In addition, we will be subject to a 4% nondeductible excise tax if the actual amount that we pay out to our stockholders in a calendar year is less than a minimum amount specified under federal tax laws.
From time to time, we may generate taxable income greater than our net income for financial reporting purposes due to, among other things, amortization of capitalized purchase premiums, or our taxable income may be greater than our cash flow available for distribution to stockholders (for example, where a borrower defers the payment of interest in cash pursuant to a contractual right or otherwise). If we do not have other funds available in these situations we could be required to borrow funds, sell investments at disadvantageous prices or find another alternative source of funds to make distributions sufficient to enable us to pay out enough of our taxable income to satisfy the REIT distribution requirement and to avoid corporate income tax and the 4% excise tax in a particular year. These alternatives could increase our costs or reduce our equity.
We may be subject to adverse legislative or regulatory tax changes that could reduce the market price of our common stock. |
At any time, the federal income tax laws governing REITs or the administrative interpretations of those laws may be amended. Any of those new laws or interpretations may take effect retroactively and could adversely affect us or you as a stockholder. On May 28, 2003, The Jobs and Growth Tax Relief Reconciliation Act of 2003 was enacted, which decreases the tax rate on most dividends paid by corporations to individual investors to a maximum of 15% from current rates, and such rates are retroactive to the beginning of January 2003. REIT dividends, with limited exceptions, will not benefit from the rate reduction, because a REITs income generally is not subject to corporate level tax. As such, this legislation could cause shares in non-REIT corporations to be a more attractive investment to individual investors than shares in REITs and could have an adverse effect on the value of our common stock.
Restrictions on share accumulation in REITs could discourage a change of control of us. |
In order for us to qualify as a REIT, not more than 50% of the number or value of our outstanding shares of capital stock may be owned, directly or indirectly, by five or fewer individuals during the last half of a taxable year.
In order to prevent five or fewer individuals from acquiring more than 50% of our outstanding shares and a resulting failure to qualify as a REIT, our charter provides that, subject to certain exceptions, no person may own, or be deemed to own by virtue of the attribution provisions of the Internal Revenue Code, more than 9.6% of the aggregate value or number (whichever is more restrictive) of shares of our outstanding common stock or 9.6% by value of our outstanding capital stock. For purposes of this calculation, warrants held by such person will be deemed to have been exercised. The shares most recently acquired by a person that are in excess of these limits will not have any voting rights exercisable by such person. Any attempt to own or transfer shares of our common or preferred stock in excess of the ownership limit without the consent of the board of directors will result in the shares being automatically transferred to a charitable trust (or otherwise be void) and be deemed to have been offered for sale to us for a period subsequent to the acquisition. Any person who acquires shares in excess of these limits is obliged to immediately give written notice to us and provide us with any information we may request in order to determine the effect of the acquisition on our status as a REIT.
While these restrictions are designed to prevent any five individuals from owning more than 50% of our shares, they could also discourage a change in control of our company. These restrictions may also deter tender offers that may be attractive to stockholders or limit the opportunity for stockholders to receive a premium for their shares if an investor makes purchases of shares to acquire a block of shares.
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Complying with REIT requirements may limit our ability to hedge effectively. |
The REIT provisions of the Internal Revenue Code may limit our ability to hedge our operations by requiring us to limit our income in each year from qualified hedges, together with any other income not generated from qualified real estate assets, to no more than 25% of our gross income. In addition, we must limit our aggregate income from nonqualified hedging transactions, from our provision of services and from other non-qualifying sources to no more than 5% of our annual gross income. As a result, we may have to limit our use of advantageous hedging techniques. This could result in greater risks associated with changes in interest rates than we would otherwise want to incur. If we were to violate the 25% or 5% limitations, we would possibly have to pay a penalty tax equal to the amount of income in excess of those limitations, multiplied by a fraction intended to reflect our profitability. If we fail to satisfy the REIT gross income tests, unless our failure was due to reasonable cause and not due to willful neglect, we could lose our REIT status for federal income tax purposes.
Risk Factors Related to the Offering
There is no public market for the offered securities, and there may be no market for the offered securities after the completion of this offering. |
There has been no public market for the offered securities. We have agreed to use our best efforts to list or include the offered securities on The Nasdaq Stock Market, including The Nasdaq SmallCap Market, or the New York Stock Exchange, in our discretion, as soon as practicable after we are able to satisfy the applicable listing requirements for the offered securities, which will not occur for an indefinite period of time, if at all, after the registration statement of which this prospectus is a part is declared effective. If and when we apply for listing of the offered securities under the applicable listing requirements, we cannot guarantee that we will have the minimum number of holders required in order to list or include the offered securities on either The Nasdaq Stock Market, including The Nasdaq SmallCap Market, or the New York Stock Exchange. Consequently, because the warrants underlying the units do not become exercisable, detachable and fully tradable until after the registration of the common stock underlying the units under the Securities Act and listing on a national securities exchange or The Nasdaq Stock Market, including The Nasdaq SmallCap Market, the shares of common stock and the warrants may not be separately tradable for an indefinite period of time.
In addition, quotation through The Nasdaq Stock Market, including The Nasdaq SmallCap Market, or the New York Stock Exchange does not ensure that an actual market will develop for the offered securities. Accordingly, no assurance can be given as to (i) the likelihood that an actual market for the offered securities will develop, (ii) the liquidity of any such market, (iii) the ability of any holder to sell the offered securities, or (iv) the prices that may be obtained for the offered securities.
Although JMP Securities has advised us that they intend to make a market in the units, they are only obligated to make a market in the units and use reasonable efforts to engage additional market makers in connection with our listing on The Nasdaq Stock Market, including The Nasdaq SmallCap Market, or the New York Stock Exchange, as provided in the registration rights agreement with JMP Securities. Except as provided in the registration rights agreement, JMP Securities may discontinue market making at any time without notice. Their market-making activity will be subject to the limitations imposed by the securities laws. We cannot guarantee that the market for the units will be maintained. The trading price of the units will likely decline if there ceases to be an active trading market for them.
Our charter generally does not permit ownership in excess of 9.6% of our common or capital stock, and attempts to acquire our capital stock in excess of these limits are ineffective without prior approval from our board of directors. |
For the purpose of preserving our REIT qualification, our charter generally prohibits direct or constructive ownership by any person of more than 9.6% (by value or by number of shares, whichever is more restrictive) of the outstanding shares of our common stock or 9.6% (by value) of our outstanding shares of capital stock. For purposes of this calculation, warrants held by such person will be deemed to have been
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Maryland takeover statutes may prevent a change of our control. This could depress our stock price. |
Under Maryland law, business combinations between a Maryland corporation and an interested stockholder or an affiliate of an interested stockholder are prohibited for five years after the most recent date on which the interested stockholder becomes an interested stockholder. These business combinations include a merger, consolidation, share exchange or, in circumstances specified in the statute, an asset transfer or issuance or reclassification of equity securities. The statute permits various exceptions, including business combinations that are exempted by the board of directors before the time that an interested stockholder becomes an interested stockholder. An interested stockholder is defined as:
| any person who beneficially owns 10% or more of the voting power of the corporations shares; or | |
| an affiliate or associate of the corporation who, at any time within the two year period prior to the date in question, was the beneficial owner of 10% or more of the voting power of the then outstanding voting stock of the corporation. |
A person is not an interested stockholder under the statute if the board of directors approved in advance the transaction by which he otherwise would have become an interested stockholder.
After the five year prohibition, any business combination between the Maryland corporation and an interested stockholder generally must be recommended by the board of directors of the corporation and approved by the affirmative vote of at least:
| 80% of the votes entitled to be cast by holders of outstanding shares of voting stock of the corporation; and | |
| two-thirds of the votes entitled to be cast by holders of voting stock of the corporation other than shares held by the interested stockholder with whom or with whose affiliate the business combination is to be effected or held by an affiliate or associate of the interested stockholder. |
The business combination statute may prevent or discourage others from trying to acquire control of us and increase the difficulty of consummating any offer, including potential acquisitions that might involve a premium price for our common stock or otherwise be in the best interest of our stockholders. See Important Provisions of Maryland Law and of Our Charter and Bylaws Business Combinations and Control Share Acquisitions.
Our staggered board and other provisions of our charter and bylaws may prevent a change in our control. |
Our board of directors is divided into three classes of directors. The current terms of the Class I, Class II and Class III directors will expire in 2004, 2005 and 2006, respectively. Directors of each class are chosen for three year terms upon the expiration of their current terms, and each year one class of directors is elected by the stockholders. The staggered terms of our directors may reduce the possibility of a tender offer or an attempt at a change in control, even though a tender offer or change in control might be in the best interest of our stockholders. In addition, our charter and bylaws also contain other provisions that may delay or prevent a transaction or a change in control that might involve a premium price for our common stock or otherwise be in the best interest of our stockholders. See Important Provisions of Maryland Law and of Our Charter and Bylaws.
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Future offerings of debt securities, which would be senior to our common stock upon liquidation, or equity securities, which would dilute the holdings of our existing stockholders and may be senior to our common stock for the purposes of dividend distributions or distributions upon liquidation, may adversely affect the market price of our common stock. |
In the future we may attempt to increase our capital resources by making additional offerings of debt or equity securities, including commercial paper, medium term notes, senior or subordinated notes and classes of preferred stock or common stock. Upon liquidation, holders of our debt securities and shares of preferred stock and lenders with respect to other borrowings will receive a distribution of our available assets prior to the holders of our common stock. Additional equity offerings may dilute the holdings of our existing stockholders or reduce the market price of our common stock, or both. If we decide to issue preferred stock in addition to our special voting preferred stock already issued, it could have a preference on liquidating distributions or a preference on dividend payments that could limit our ability to make a dividend distribution to the holders of our common stock. Because our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, our stockholders bear the risk of our future offerings reducing the market price of our common stock and diluting their stock holdings in us.
Securities eligible for future sale may have adverse effects on our share price. |
The effect of future sales of our common stock or the availability of our common stock for future sales may affect the market price of our common stock. As of the date of this prospectus, we have 9,809,567 shares of our common stock outstanding (or authorized for issuance upon exercise of the warrants underlying our units for shares of common stock) and 3,776,069 shares of our common stock authorized for issuance upon redemption of operating partnership units (including 629,345 operating partnership units issuable upon exercise of 629,345 warrants for additional operating partnership units). Of the shares of our common stock outstanding, 9,616,998 shares of common stock are being registered pursuant to the shelf registration statement of which this prospectus is a part. If Arbor Commercial Mortgage redeems its 3,776,069 operating partnership units (including 629,345 operating partnership units issuable upon exercise of 629,345 warrants for additional operating partnership units) and we elect to issue shares of our common stock upon such redemption, an additional 3,776,069 shares would be eligible for future sale. We have granted registration rights to Arbor Commercial Mortgage relating to the resale of shares of common stock that we may issue upon redemption of its operating partnership units. Furthermore, we satisfy our obligation to pay up to 25% of the incentive compensation payable to our manager under the management agreement with shares of our common stock. The issuance of common stock could cause dilution of our existing common stock and a decrease in the market price.
You should not rely on lock-up agreements in connection with the original offering to limit the number of units sold into the market. |
In connection with the original offering, we agreed with JMP Securities not to offer to sell, contract to sell, or otherwise dispose of, loan, pledge or grant any rights with respect to any shares of our common stock, any options or warrants to purchase any shares of our common stock or any securities convertible into or exercisable for any of our common stock, including our units, for a period of 180 days following the completion of the original offering, subject to certain exceptions. Arbor Commercial Mortgage and each of the persons serving as our directors and executive officers at the consummation of the original offering also entered into lock-up agreements with respect to their units, common stock, warrants and the shares of common stock issuable upon redemption of operating partnership units restricting the sale of such securities without the consent of JMP Securities until the earlier of 180 days after the date of effectiveness of the registration statement of which this prospectus is a part or two years from the consummation of original offering, subject to certain exceptions. JMP Securities may, at any time, release all or a portion of the securities subject to the foregoing lock-up provisions. If the restrictions under the lock-up agreements with members of our senior management and directors are waived or terminated, approximately 260,750 units, including 1,303,750 shares of common stock and 260,750 warrants comprising the units, will be available for sale into the market, subject
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An increase in market interest rates may have an adverse effect on the market price of our securities. |
One of the factors that investors may consider in deciding whether to buy or sell our securities is our dividend rate as a percentage of our share or unit price relative to market interest rates. If the market price of our securities is based primarily on the earnings and return that we derive from our investments and income with respect to our properties and our related distributions to stockholders, and not from the market value or underlying appraised value of the properties or investments themselves, then interest rate fluctuations and capital market conditions will likely affect the market price of our securities. For instance, if market rates rise without an increase in our dividend rate, the market price of our securities could decrease as potential investors may require a higher dividend yield on our common stock or seek other securities paying higher dividends or interest. In addition, rising interest rates would result in increased interest expense on our variable rate debt, thereby adversely affecting cash flow and our ability to service our indebtedness and pay dividends.
Broad market fluctuations could negatively impact the market price of our common stock. |
The stock market has experienced extreme price and volume fluctuations that have affected the market price of many companies in industries similar or related to ours and that have been unrelated to these companies operating performances. These broad market fluctuations could reduce the market price of our common stock. Furthermore, our operating results and prospects may be below the expectations of public market analysts and investors or may be lower than those of companies with comparable market capitalizations, which could lead to a material decline in the market price of our common stock.
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FORWARD LOOKING STATEMENTS
We make forward looking statements in this prospectus that are subject to risks and uncertainties. These forward looking statements include information about possible or assumed future results of our business and our financial condition, liquidity, results of operations, plans, and objectives. They also include, among other things, statements concerning anticipated revenues, income or loss, capital expenditures, dividends, capital structure, or other financial terms, as well as statements regarding the subjects that are forward looking by their nature, such as:
| our business strategy; | |
| completion of any pending transactions; | |
| our ability to obtain future financing arrangements; | |
| our understanding of our competition; | |
| our projected operating results; | |
| the operating results presented in the historical consolidated financial statements included in this prospectus; | |
| market trends; | |
| estimates relating to our future dividends; | |
| projected capital expenditures; and | |
| the impact of technology on our operations and business. |
The forward looking statements are based on our beliefs, assumptions, and expectations of our future performance, taking into account the information currently available to us. We do not intend to update our forward looking statements. These beliefs, assumptions, and expectations can change as a result of many possible events or factors, not all of which are known to us. If a change occurs, our business, financial condition, liquidity, and results of operations may vary materially from those expressed in our forward looking statements. You should carefully consider this risk when you make a decision concerning an investment in our securities.
When we use words such as will likely result, may, shall, will, believe, expect, anticipate, project, intend, estimate, goal, objective, or similar expressions, we intend to identify forward looking statements. You should not place undue reliance on these forward looking statements. We are not obligated to publicly update or revise any forward looking statements, whether as a result of new information, future events, or otherwise.
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USE OF PROCEEDS
The selling stockholders will receive all of the proceeds from the sale of the securities. We will not receive any proceeds from the sale of the securities.
DISTRIBUTION POLICY
We have made and intend to make, regular quarterly distributions to our stockholders. To qualify as a REIT we must distribute to our stockholders an amount at least equal to:
| 90% of our REIT taxable income, determined before the deduction for dividends paid and excluding any net capital gain (which does not necessarily equal net income as calculated in accordance with generally accepted accounting principals); plus | |
| 90% of the excess of our net income from foreclosure property (as defined in Section 856 of the Internal Revenue Code) over the tax imposed on such income by the Internal Revenue Code; less | |
| any excess non-cash income (as determined under the Internal Revenue Code). See Federal Income Tax Considerations. |
We are subject to income tax on income that is not distributed and to an excise tax to the extent that certain percentages of our income are not distributed by specified dates. See Federal Income Tax Considerations. Income as computed for purposes of the foregoing tax rules will not necessarily correspond to our income as determined for financial reporting purposes.
Distributions are authorized by our board of directors and declared by us based upon a number of factors, including:
| actual results of operations; | |
| restrictions under Maryland law; | |
| the timing of the investment of our equity capital; | |
| the amount of funds from operations; | |
| our financial condition; | |
| debt service requirements; | |
| capital expenditure requirements; | |
| our taxable income; | |
| the annual distribution requirements under the REIT provisions of the Internal Revenue Code; | |
| our operating expenses; and | |
| other factors our directors deem relevant. |
Our ability to make distributions to our stockholders depends upon our receipt of distributions from our operating partnership, Arbor Realty Limited Partnership, which may depend, in part, upon the performance of our investment portfolio, and, in turn, from Arbor Commercial Mortgages management of our business. Distributions are made in cash to the extent that cash is available for distribution. If cash available for distribution is insufficient, we may be required to borrow funds or sell assets in order to meet our REIT distribution requirements.
Distributions to stockholders are generally taxable to our stockholders as ordinary income, although a portion of these distributions may be designated by us as long term capital gain to the extent they are attributable to capital gain income recognized by us, or may constitute a return of capital to the extent they exceed our earnings and profits as determined for tax purposes. We will furnish annually to each of our stockholders a statement setting forth distributions paid during the preceding year and their federal income tax
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We may not be able to generate sufficient revenue from operations to pay distributions to our stockholders. In addition, our directors may change our distribution policy in the future. See Risk Factors.
Our charter allows us to issue preferred stock that could have a preference on distributions. We currently have no intention to issue any such preferred stock, but if we do, the dividend preference on the preferred stock could limit our ability to make a dividend distribution to the holders of our common stock. We have previously issued approximately 3.1 million shares of our special voting preferred stock to Arbor Commercial Mortgage which does not have any preferential dividend, except a $.01 per share liquidation preference upon a liquidation or redemption.
On November 5, 2003, we declared a dividend of $.25 per share of common stock, payable with respect to the quarter ending September 30, 2003, to stockholders of record at the close of business on November 5, 2003. We distributed this dividend on November 18, 2003. On December 19, 2003, our board of directors authorized a dividend of $.25 per share of common stock, payable with respect to the quarter ending December 31, 2003, to stockholders of record at the close of business on December 19, 2003. We plan to distribute this dividend on December 30, 2003.
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PRICE RANGE OF UNITS
There is no established market for the units, which are not listed on any securities exchange, and trading in the units has not been quoted on any interdealer or over-the-counter bulletin board since the original offering. The units are eligible for trading in the Private Offering, Resales and Trading through Automated Linkages Market of the National Association of Securities Dealers, Inc., the PORTAL Market. As of December 24, 2003, there were approximately 143 beneficial owners of our units. This figure does not reflect the beneficial ownership of shares held in nominee name.
The table below reflects the high and low prices of trades of our units known to us for each of the months indicated.
Month | High | Low | ||||||
July 2003
|
$ | 75.250 | $ | 69.750 | ||||
August 2003
|
| | ||||||
September 2003
|
| | ||||||
October 2003
|
$ | 75.250 | $ | 75.125 | ||||
November 2003
|
$ | 76.000 | $ | 76.000 |
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SELECTED UNAUDITED CONSOLIDATED FINANCIAL INFORMATION
The following tables present selected historical consolidated financial information for the three months ended September 30, 2003 and at September 30, 2003. The selected historical consolidated financial information presented below under the captions Consolidated Statement of Operations Data and Balance Sheet Data have been derived from our unaudited, interim consolidated financial statements and include all adjustments, consisting only of normal recurring accruals, which management considers necessary for a fair presentation of the historical consolidated financial statements for such period. The information presented under the caption Consolidated Statement of Operations Data for the three months ended September 30, 2003 is not necessarily indicative of any other interim period or of the year ended December 31, 2003. In addition, since the information presented below is only a summary and does not provide all of the information contained in our historical consolidated financial statements, including the related notes, you should read it in conjunction with Managements Discussion and Analysis of Financial Condition and Results of Operations of Arbor Realty Trust, Inc. and Subsidiaries and our historical consolidated financial statements, including the related notes, included elsewhere in this prospectus.
Three Months Ended | ||||
September 30, 2003 | ||||
(Unaudited) | ||||
Statement of Operations Data:
|
||||
Interest Income
|
$ | 4,669,990 | ||
Other income
|
500 | |||
Total revenue
|
4,670,490 | |||
Total expenses
|
3,183,411 | |||
Net income
|
1,074,587 | |||
Earnings per share, basic and
diluted(1)
|
.13 | |||
Dividends declared per common share(2)
|
.25 |
At September 30, | ||||
2003 | ||||
(Unaudited) | ||||
Balance Sheet Data:
|
||||
Loans and investments, net
|
$ | 214,237,458 | ||
Related party loans, net
|
26,000,000 | |||
Total assets
|
255,389,573 | |||
Notes payable and repurchase agreements
|
91,913,811 | |||
Total liabilities
|
97,831,411 | |||
Minority interest
|
44,309,289 | |||
Total stockholders equity
|
113,248,873 |
Three Months Ended | ||||
September 30, 2003 | ||||
(Unaudited) | ||||
Other Data:
|
||||
Total originations
|
$ | 39,014,922 |
(1) | The warrants underlying the units issued in the original offering at $75.00 per unit have an exercise price of $15.00 per share and expire on July 1, 2005. This exercise price is equal to the price per share of common stock in the original offering and approximates the market value of our common stock at September 30, 2003. Therefore, the assumed exercise of the warrants were not considered to be dilutive for purposes of calculating diluted earnings per share. |
(2) | On November 5, 2003, we declared a dividend of $.25 per share of common stock, payable with respect to the quarter ending September 30, 2003, to stockholders of record at the close of business on November 5, 2003. We distributed this dividend on November 18, 2003. |
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SELECTED CONSOLIDATED FINANCIAL INFORMATION OF THE STRUCTURED FINANCE
On July 1, 2003, Arbor Commercial Mortgage contributed a portfolio of structured finance investments and related liabilities to our operating partnership. In addition, certain employees of Arbor Commercial Mortgage became our employees. These assets, liabilities and employees represented a substantial portion of Arbor Commercial Mortgages structured finance business.
The tables on the following page present selected historical consolidated financial information of the structured finance business of Arbor Commercial Mortgage at the dates and for the periods indicated. The structured finance business did not operate as a separate legal entity or business division or segment of Arbor Commercial Mortgage but as an integrated part of Arbor Commercial Mortgages consolidated business. Accordingly, the statements of revenue and direct operating expenses do not include charges from Arbor Commercial Mortgage for corporate general and administrative expense because Arbor Commercial Mortgage considered such items to be corporate expenses and did not allocate them to individual business units. These expenses included costs for Arbor Commercial Mortgages executive management, corporate facilities and overhead costs, corporate accounting and treasury functions, corporate legal matters and other similar costs. The selected consolidated financial information presented under the caption Consolidated Statement of Revenue and Direct Operating Expenses Data for the years ended December 31, 2002, 2001 and 2000 and under the caption Consolidated Statement of Assets and Liabilities Data as of December 31, 2002 and 2001 have been derived from the audited consolidated financial statements of the structured finance business of Arbor Commercial Mortgage included elsewhere in this prospectus. The selected consolidated financial information presented under the caption Consolidated Statement of Revenue and Direct Operating Expenses Data for the years ended December 31, 1999 and 1998 and the caption Consolidated Statement of Assets and Liabilities Data as of December 31, 2000, 1999 and 1998 have been derived from the unaudited consolidated financial statements of the structured finance business of Arbor Commercial Mortgage.
The selected consolidated financial information presented under the caption Consolidated Statement of Revenue and Direct Operating Expenses Data for the six months ended June 30, 2003 and 2002 and the nine months ended September 30, 2002 and under the caption Consolidated Statement of Assets and Liabilities Data at June 30, 2003 have been derived from the unaudited interim consolidated financial statements of Arbor Commercial Mortgages structured finance business and include all adjustments, consisting only of normal recurring accruals, which management considers necessary for a fair presentation of the historical consolidated financial information for such periods. The selected historical consolidated financial information presented under the caption Consolidated Statement of Revenue and Direct Operating Expenses Data for the six month period ended June 30, 2003 is not necessarily indicative of the results of any other interim period or the year ended December 31, 2003. The selected historical consolidated financial information presented under the caption Consolidated Statement of Revenue and Direct Operating Expenses Data for the six month period ended June 30, 2002 and the nine month period ended September 30, 2002 are not necessarily indicative of the results of any other interim period or the year ended December 31, 2002.
The consolidated financial statements of Arbor Commercial Mortgages structured finance business included in this prospectus represent the consolidated financial position and results of operations of Arbor Commercial Mortgages structured finance business during certain periods and at certain dates when Arbor Commercial Mortgage previously held our initial assets, as well as several other structured finance investments that we did not acquire in connection with our formation transactions. See Arbor Realty Trust, Inc. Accordingly, the historical financial results of Arbor Commercial Mortgages structured finance business are not indicative of our future performance. In addition, since the information presented is only a summary and does not provide all of the information contained in the consolidated financial statements of Arbor Commercial Mortgages structured finance business, including related notes, you should read it in conjunction with Managements Discussion and Analysis of Financial Condition and Results of Operations of the Structured Finance Business of Arbor Commercial Mortgage, LLC and Subsidiaries and the consolidated financial statements of Arbor Commercial Mortgages structured finance business, including related notes, contained elsewhere in this prospectus.
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Consolidated Statement of Revenue and Direct Operating Expenses Data:
Nine Months | |||||||||||||||||||||||||||||||||
Six Months Ended | Ended | ||||||||||||||||||||||||||||||||
June 30, | September 30, | Year Ended December 31, | |||||||||||||||||||||||||||||||
2003 | 2002 | 2002 | 2002 | 2001(1) | 2000(1) | 1999(1) | 1998(1) | ||||||||||||||||||||||||||
(Unaudited) | (Unaudited) | ||||||||||||||||||||||||||||||||
Interest Income
|
$ | 7,688,465 | $ | 7,482,750 | $ | 10,798,414 | $ | 14,532,504 | $ | 14,667,916 | $ | 10,707,551 | $ | 6,964,873 | $ | 6,807,617 | |||||||||||||||||
Income from real estate held for sale, net of
operating expenses
|
| | | | | | 925,999 | 1,608,172 | |||||||||||||||||||||||||
Other income
|
1,552,414 | 553,625 | 572,161 | 1,090,106 | 1,668,215 | 652,970 | 2,838,639 | 7,064,294 | |||||||||||||||||||||||||
Total revenue
|
9,240,879 | 8,036,375 | 11,370,575 | 15,622,610 | 16,336,131 | 11,360,521 | 10,729,511 | 15,480,083 | |||||||||||||||||||||||||
Total direct operating expenses
|
5,737,688 | 8,344,302 | 10,775,555 | 13,639,755 | 10,997,800 | 9,227,274 | 7,145,469 | 6,589,274 | |||||||||||||||||||||||||
Revenue in excess of direct operating expenses
before gain on sale of loans and real estate and income from
equity affiliates
|
3,503,191 | (307,927 | ) | 595,020 | 1,982,855 | 5,338,331 | 2,133,247 | 3,584,042 | 8,890,809 | ||||||||||||||||||||||||
Gain on sale of loans and real estate
|
1,024,268 | 7,006,432 | 7,006,432 | 7,470,999 | 3,226,648 | 1,880,825 | 1,818,299 | 1,898,558 | |||||||||||||||||||||||||
Income from equity affiliates
|
| 601,100 | 632,350 | 632,350 | 1,403,014 | 5,028,835 | 3,592,398 | 567,006 | |||||||||||||||||||||||||
Revenue, gain on sale of loans and real estate
and income from equity affiliates in excess of direct operating
expenses
|
4,527,459 | 7,299,605 | 8,233,802 | 10,086,204 | 9,967,993 | 9,042,907 | 8,994,739 | 11,356,373 |
Consolidated Statement of Assets and Liabilities Data:
At December 31, | ||||||||||||||||||||||||
At June 30, | ||||||||||||||||||||||||
2003 | 2002 | 2001 | 2000 | 1999 | 1998 | |||||||||||||||||||
(Unaudited) | ||||||||||||||||||||||||
Loans and investments, net
|
$ | 204,561,578 | $ | 172,142,511 | $ | 160,183,066 | $ | 85,547,323 | $ | 50,156,022 | $ | 75,604,351 | ||||||||||||
Related party loans, net
|
23,277,041 | 15,952,078 | 15,880,207 | | | | ||||||||||||||||||
Investment in equity affiliates
|
3,654,573 | 2,586,026 | 2,957,072 | 20,506,417 | 23,459,586 | 20,092,793 | ||||||||||||||||||
Total assets
|
241,667,960 | 200,563,236 | 183,713,747 | 119,110,446 | 84,751,032 | 96,537,674 | ||||||||||||||||||
Notes payable and repurchase agreements
|
171,045,404 | 141,836,477 | 132,409,735 | 70,473,501 | 47,154,530 | 58,678,062 | ||||||||||||||||||
Total liabilities
|
172,686,366 | 144,280,806 | 134,086,301 | 72,266,700 | 48,025,934 | 59,193,306 | ||||||||||||||||||
Net assets
|
68,981,594 | 56,282,430 | 49,627,446 | 46,843,746 | 36,725,098 | 37,344,368 |
Other Data:
Six Months Ended | Nine Months | |||||||||||||||||||||||||||||||
June 30, | Ended | Year Ended December 31, | ||||||||||||||||||||||||||||||
September 30, | ||||||||||||||||||||||||||||||||
2003 | 2002 | 2002 | 2002 | 2001 | 2000 | 1999 | 1998 | |||||||||||||||||||||||||
Total originations
|
$ | 117,965,000 | $ | 30,660,000 | $ | 49,510,000 | $ | 130,043,000 | $ | 86,700,000 | $ | 108,378,000 | (2) | $ | 120,378,900 | (2) | $ | 230,718,353 | (2) |
(1) | In June 1998, Arbor Commercial Mortgage entered into a joint venture with SFG I, an affiliate of Nomura Asset Capital Corp., for the purpose of acquiring up to $250 million of structured finance investments. Arbor Commercial Mortgage and SFG I each made 50% of the capital contributions to the joint venture and shared profits equally. Nomura Asset Capital Corp. provided financing to the joint venture in the form of a repurchase agreement. On July 31, 2001, Arbor Commercial Mortgage purchased SFG Is interest in this venture. This buyout was accounted for by the purchase accounting method. Prior to the purchase, net income from this venture was recorded in income from equity affiliates. The activities of the former joint venture have been included in the statements of revenue and direct operating expenses from the date of acquisition, August 2001. See the consolidated financial statements of Arbor Commercial Mortgages structured finance business and the related notes to the consolidated financial statements included elsewhere in this prospectus for further information. |
(2) | Total originations for 1998, 1999 and 2000 include originations from Arbor Commercial Mortgages joint venture with SFG I discussed in footnote 1. |
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MANAGEMENTS DISCUSSION & ANALYSIS OF FINANCIAL CONDITION
You should read the following discussion in conjunction with the sections of this prospectus entitled Risk Factors, Forward-Looking Statements and Selected Consolidated Financial Information of Arbor Realty Trust, Inc. and Subsidiaries and our historical consolidated financial statements, including related notes, included elsewhere in this prospectus.
Overview
We are a Maryland corporation that was formed in June 2003 to invest in real estate related bridge and mezzanine loans, preferred equity and, in limited cases, discounted Mortgage notes and other real estate related assets. We conduct substantially all of our operations through our operating partnership.
On July 1, 2003, Arbor Commercial Mortgage contributed $213.1 million of structured finance assets and $169.2 million of borrowings supported by $43.9 million of equity in exchange for a commensurate equity ownership in our operating partnership. In addition, certain employees of Arbor Commercial Mortgage were transferred to our operating partnership. These assets, liabilities and employees represent a substantial portion of Arbor Commercial Mortgages structured finance business. We are externally managed and advised by Arbor Commercial Mortgage and pay Arbor Commercial Mortgage a management fee in accordance with a management agreement. Arbor Commercial Mortgage will also originate, underwrite and service all structured finance assets on behalf of our operating partnership.
Concurrently with Arbor Commercial Mortgages asset contribution, we consummated a private equity offering of units, each consisting of five shares of common stock and one warrant to purchase one share of common stock. Gross proceeds from the private financing totaled $120.2 million. From the $120.2 million of gross proceeds from the original offering, we repaid $105.6 million of borrowings under our warehouse credit facility and repurchase agreements, purchased two mezzanine loans and one preferred equity investment from Arbor Commercial Mortgage for $6.7 million, paid offering expenses of $7.6 million and funded $.3 million of operating capital. Gross proceeds from the private financing combined with the concurrent equity contribution by Arbor Commercial Mortgage totaled approximately $164.1 million in equity capital. Offering expenses paid or accrued totaled $9.6 million, resulting in stockholders equity and minority interest of $154.5 million at our inception.
Sources of Operating Revenues
We derive our operating revenues primarily through interest received from making real estate related bridge and mezzanine loans and preferred equity investments. For the three months ended September 30, 2003, interest represented approximately 100% of our total revenues. We provide bridge loans secured by first lien mortgages on the property to borrowers who are typically seeking short term capital to be used in an acquisition of property. The bridge loans we make typically range in size from $1 million to $25 million and have terms of up to seven years. We provide real property owners with mezzanine loans that are secured by pledges of ownership interests in entities that directly or indirectly control the real property or second mortgages. These loans typically range in size from $2 million to $15 million and have terms of up to seven years. We also make preferred equity investments in entities that directly or indirectly own real property.
We also derive operating revenues from other income that represents miscellaneous asset management fees associated with our loans and investments portfolio. For the three months ended September 30, 2003, revenue from other income was $500.
Gain on Sale of Loans and Real Estate and Income from Equity Affiliates
We may derive income from the gain on sale of loans and real estate. We may acquire (1) real estate for our own investment and, upon stabilization, disposition at an anticipated return and (2) real estate notes generally at a discount from lenders in situations where the borrower wishes to restructure and reposition its short term debt and the lender wishes to divest certain assets from its portfolio.
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We may also derive income from equity affiliates relating to joint ventures that were formed with equity partners to acquire, develop and/or sell real estate assets. Such investments are recorded under the equity method. We record our share of net income from the underlying properties in which we invest through these joint ventures.
Significant Accounting Estimates and Critical Accounting Policies
Set forth below is a summary of the accounting policies that management believes are critical to the preparation of the consolidated financial statements included in this prospectus. Certain of the accounting policies used in the preparation of these consolidated financial statements are particularly important for an understanding of the financial position and results of operations presented in the historical consolidated financial statements included in this prospectus and require the application of significant judgment by management and, as a result, are subject to a degree of uncertainty.
Loans and Investments |
Loans held for investment are intended to be held to maturity and, accordingly, are carried at cost, net of unamortized loan origination costs and fees, unless such loan or investment is deemed to be impaired. We invest in preferred equity interests that allow us to participate in a percentage of the underlying propertys cash flows from operations and proceeds from a sale or refinancing. At the inception of each such investment, management must determine whether such investment should be accounted for as a loan, joint venture or as real estate. To date, management has determined that all such investments are properly accounted for and reported as loans.
Specific valuation allowances are established for impaired loans based on the fair value of collateral on an individual loan basis. The fair value of the collateral is determined by an evaluation of operating cash flow from the property during the projected holding period, and estimated sales value computed by applying an expected capitalization rate to the stabilized net operating income of the specific property, less selling costs, discounted at market discount rates.
If upon completion of the valuation, the fair value of the underlying collateral securing the impaired loan is less than the net carrying value of the loan, an allowance is created with a corresponding charge to the provision for loan losses. The allowance for each loan is maintained at a level believed adequate by management to absorb probable losses.
Revenue Recognition |
Interest Income. Interest income is recognized on the accrual basis as it is earned. In most instances, the borrower pays an additional amount of interest at the time the loan is closed, an origination fee, and deferred interest upon maturity. This additional income, as well as any direct loan origination costs incurred, is deferred and recognized over the life of the related loan as a yield adjustment. Income recognition is suspended for loans when in the opinion of management a full recovery of income and principal becomes doubtful. Income recognition is resumed when the loan becomes contractually current and performance is demonstrated to be resumed. Several of the loans provide for accrual of interest at specified rates, which differ from current payment terms. Interest is recognized on such loans at the accrual rate subject to managements determination that accrued interest and outstanding principal are ultimately collectible, based on the underlying collateral and operations of the borrower. If management cannot make this determination regarding collectibility, interest income is recognized only upon actual receipt.
Recently Issued Accounting Pronouncements
In January 2003, the FASB issued FASB Interpretation No. 46, Consolidation of Variable Interest Entities (FIN 46). FIN 46 provides guidance on identifying entities for which control is achieved through means other than through voting rights (a variable interest entities or VIE), and how to determine when and which business enterprise should consolidate a VIE. In addition, FIN 46 requires that both the primary beneficiary and all other enterprises with a significant variable interest in VIE make additional disclosures.
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In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45), Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an interpretation of FASB Statement of Financial Accounting Standards No. 5 (SFAS No. 5), Accounting for Contingencies, Statement of Financial Accounting Standards No. 57, Related Party Disclosures, Statement of Financial Accounting Standards No. 107, Disclosures about Fair Value of Financial Instruments and rescinded FASB Interpretation No. 34, Disclosure of Indirect Guarantees of Indebtedness of Others, an Interpretation of SFAS No. 5. It requires that upon issuance of a guarantee, the guarantor must recognize a liability for the fair value of the obligation it assumes under that guarantee regardless of whether it receives separately identifiable consideration (i.e., a premium). The new disclosure requirements were effective December 31, 2002. The adoption of FIN 45 did not have a material impact on our consolidated financial statements, nor is it expected to have a material impact in the future.
Results of Operations
Three Months Ended September 30, 2003 |
The following table sets forth our results of operations for the three months ended September 30, 2003:
Three Months | ||||||
Ended | ||||||
September 30, 2003 | ||||||
(Unaudited) | ||||||
Revenue:
|
||||||
Interest income
|
$ | 4,669,990 | ||||
Other income
|
500 | |||||
Total revenue
|
$ | 4,670,490 | ||||
Expenses:
|
||||||
Interest expense
|
721,854 | |||||
Employee compensation and benefits
|
446,845 | |||||
Stock based compensation
|
1,587,674 | |||||
Selling and administrative
|
133,304 | |||||
Management fee
|
293,734 | |||||
Total expenses
|
3,183,411 | |||||
Income before minority interest
|
1,487,079 | |||||
Income allocated to minority interest
|
412,492 | |||||
Net income
|
$ | 1,074,587 | ||||
Revenues |
Interest income was $4.7 million. The average balance of the loan and investment portfolio was $243.8 million during the quarter. The average yield on these assets was 7.59%.
Other income was $500, which represents miscellaneous asset management fees associated with our loans and investments portfolio.
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Expenses |
Interest expense was $722,000. The average balance of debt financing was $81.0 million during the quarter. The average cost of these borrowings was 3.56%. Our average leverage for the quarter was 33%, resulting in our interest margin on a levered basis being 9.61%.
Employee compensation and benefits expense was $447,000, which represents salaries, benefits and incentive compensation for the ten employees employed by us during the quarter.
Stock-based compensation expense was $1.6 million. This expense represents the cost of restricted stock granted to certain of our employees, executive officers and directors and certain executive officers and employees of our manager. Of the total shares granted, two-thirds of the shares granted vested immediately and the remaining one-third will vest over three years. The amount of compensation expense recorded in the quarter represents the full expense of the vested shares and a ratable portion of the expense of the unvested shares.
Selling and administrative expense was $133,000. This amount is comprised primarily of professional fees, including legal and accounting services.
Management fees were $294,000. This amount represents the base management fee as provided for in the management agreement with our manager. The management agreement also provides for incentive compensation; however, the requirements for incentive compensation were not satisfied and no incentive compensation was recorded in the period.
Income Allocated to Minority Interest |
Income allocated to minority interest was $412,000. This amount represents the portion of our income allocated to our manager, which owns a 28% limited partnership interest in our operating partnership and is allocated 28% of our income.
Liquidity and Capital Resources
Sources of Liquidity |
Liquidity is a measurement of the ability to meet potential cash requirements, including ongoing commitments to repay borrowings, fund and maintain loans and investments and other general business needs. Our primary sources of funds for liquidity consist of funds raised from our private equity offering in July 2003, borrowings under credit agreements, net cash provided by operating activities, repayments of outstanding loans and investments and the issuance of common, convertible and/or preferred equity securities.
To maintain our status as a REIT under the Internal Revenue Code, we must distribute annually at least 90% of our taxable income. These distribution requirements limit our ability to retain earnings and thereby replenish or increase capital for operations. However, we believe that our significant capital resources and access to financing will provide us with financial flexibility and market responsiveness at levels sufficient to meet current and anticipated capital requirements, including expected new lending and investment opportunities.
Gross proceeds from the original offering on July 1, 2003 totaled $120.2 million, which combined with Arbor Commercial Mortgages equity contribution of $43.9 million, resulted in total contributed capital of $164.1 million. From the $120.2 million of gross proceeds from the original offering, we repaid $105.6 million of borrowings under our warehouse credit facility and repurchase agreements, purchased two mezzanine loans and one preferred equity investment from Arbor Commercial Mortgage for $6.7 million, paid offering expenses of $7.6 million and funded $.3 million of operating capital. We paid or accrued offering expenses of $9.6 million, resulting in stockholders equity and minority interest of $154.5 million at our inception.
We also maintain liquidity through one warehouse credit agreement and two master repurchase agreements with three different financial institutions. Prior to July 1, 2003, Arbor Commercial Mortgage had similar financing facilities with these financial institutions.
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We have a $250.0 million warehouse credit agreement with a financial institution, dated as of July 1, 2003, with a term of three years. In the event this facility is not renewed, we have nine months to repay all outstanding advances. In addition to LIBOR-based interest obligations, this warehouse credit facility includes a profit sharing agreement, whereby the institution shares in the net interest spread of the assets financed. The profit sharing component represents the percentage of the net profits earned over the life of a loan that are payable to the lender upon repayment of the underlying investment. Net profits are based on interest income, interest expense and deferred interest payable at repayment of an investment. On September 30, 2003, the outstanding balance under this facility was $28.4 million.
We have a $100.0 million master repurchase agreement with a second financial institution, dated as of November 18, 2002, with a one-year term, renewable annually. This repurchase agreement was assigned from Arbor Commercial Mortgage to us on July 1, 2003. In the event this facility is not renewed, we have twelve months to repay all outstanding advances. This agreement has been extended until December 31, 2003. We are currently negotiating with the financial institution to renew this facility. On September 30, 2003, the outstanding balance under this facility was $63.5 million.
We have a $50.0 million master repurchase agreement with a third financial institution, dated as of July 1, 2003 with a term of three years. This facility has not yet been utilized.
The warehouse credit agreement and the two master repurchase agreements require that we pay interest monthly, based on our pricing over LIBOR. The amount of our pricing over LIBOR varies depending upon the structure of the loan or investment financed pursuant to the warehouse credit agreement or the master repurchase agreement. Our pricing over LIBOR is summarized in the table on the following page.
The warehouse credit agreement and the two master repurchase agreements require that we pay down borrowings under these facilities pro-rata as principal payments on our loans and investments are received. In addition, if upon maturity of a loan or investment we decide to grant the borrower an extension option, the financial institutions have the option to extend the borrowings or request payment in full on the outstanding borrowings of the loan or investment extended. The financial institutions also have the right to request immediate payment of any outstanding borrowings on any loan or investment that is at least 60 days delinquent.
We believe our existing sources of funds will be adequate for purposes of meeting our short-term liquidity (within one year) and long-term liquidity needs. These liquidity needs, which are present in the short-term and long-term, include ongoing commitments to repay borrowings, fund future investments, fund operating costs and fund distributions. Our loans and investments, the majority of which have been contributed to us, are financed under existing credit facilities and their credit status is continuously monitored; therefore, these loans and investments are expected to generate a generally stable return. Our ability to meet our long-term liquidity and capital resource requirements is subject to obtaining additional debt and equity financing. If we are unable to renew our sources of financing on substantially similar terms or at all it would have an adverse effect on our business and results of operations. Any decision by our lenders and investors to enter into such transactions with us will depend upon a number of factors, such as our financial performance, compliance with the terms of our existing credit arrangements, industry or market trends, the general availability of and rates applicable to financing transactions, such lenders and investors resources and policies concerning the terms under which they make such capital commitments and the relative attractiveness of alternative investment or lending opportunities.
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The maximum borrowing capacities, advance rates and other principal terms of our credit facilities are listed below:
Warehouse | Repurchase | Repurchase | ||||||||||
Facility | Agreement | Agreement | ||||||||||
Total Facility Amount
|
$ | 250,000,000 | $ | 100,000,000 | $ | 50,000,000 | ||||||
Sublimits based on Investment Type
Bridge Loan Sublimit Amount |
$ | 125,000,000 | $ | 75,000,000 | $ | 50,000,000 | ||||||
Maximum Advance Rate(1)
|
85 | %(2) | 80 | % | 80 | % | ||||||
Pricing over LIBOR
|
2.00 | % | 2.00 | % | 1.25 | % | ||||||
Profit Share(3)
|
20.0 | % | ||||||||||
Mezzanine Loans/ Preferred Equity Sublimit Amount
|
$ | 175,000,000 | $ | 25,000,000 | $ | 50,000,000 | ||||||
Maximum Advance Rate(1)
|
80 | %(4) | 65 | % | 75 | % | ||||||
Pricing over LIBOR
|
2.75 | % | 2.75 | % | 2.50 | % | ||||||
Profit Share(3)
|
20.0 | % | ||||||||||
Note Acquisitions Sublimit Amount
|
$ | 125,000,000 | ||||||||||
Maximum Advance Rate(4)
|
80 | %(5) | ||||||||||
Pricing over LIBOR
|
2.50 | % | ||||||||||
Property Acquisitions Total Line
|
$ | 125,000,000 | ||||||||||
Maximum Advance Rate
|
80 | % | ||||||||||
Pricing over LIBOR
|
2.50 | % |
(1) | Advance rates for certain investments funded under the credit facilities are negotiated on an individual basis and may differ from the maximum advance rate listed. |
(2) | Maximum loan amount advanced per bridge loan equal to $20.0 million. |
(3) | Certain investments included in contribution of the initial assets are financed under prior profit sharing agreements between the financial institution and Arbor Commercial Mortgage with profit sharing percentages ranging from 20% to 45% of net interest income of the loans and investments financed. |
(4) | Maximum loan amount advanced per mezzanine loan equal to $20.0 million. |
(5) | Maximum loan amount advanced per acquisition equal to $20.0 million. |
In addition to these credit facilities, we have a participation agreement with a financial institution to finance a portion of a $16.4 million apartment bridge loan. The interest payable on the participation agreement is LIBOR plus 3.00% with a floor of 4.75% and the outstanding balance as of September 30, 2003 was approximately $12.9 million.
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Contractual Commitments |
Pursuant to our management agreement with Arbor Commercial Mortgage, we pay Arbor Commercial Mortgage an annual base management fee based on the equity of our operating partnership, as further discussed below. The amount of the base management fee does not depend on the performance of the services provided by our manager or the types of assets it selects for our investment, but the value of our operating partnerships equity will be affected by the performance of these assets. We also pay our manager incentive compensation each fiscal quarter. We have paid $492,729 in base management fees to Arbor Commercial Mortgage for management services rendered for the five months ended November 30, 2003. Our manager did not earn incentive compensation for the quarter ended September 30, 2003. The table below summarizes the calculation of the base management fee, incentive compensation and other fees and expenses payable to our manager pursuant to the management agreement.
Type | Description and Method of Computation | Payable | ||
Base management fee(1) | (1) 0.75% per annum of the first $400 million of our operating partnerships equity, plus | Monthly in arrears in cash | ||
(2) 0.625% per annum of our operating partnerships equity between $400 million, and $800 million and 0.50% per annum of the equity in excess of $800 million. | ||||
Incentive compensation(2) |
(1) 25% of the amount by which: (a) our operating partnerships funds from operations per operating partnership unit, adjusted for certain gains and losses, exceeds (b) the product of (x) 9.5% per annum or the 10-year Treasury Rate plus 3.5%, whichever is greater, and (y) the weighted average of the book value of the net assets contributed by Arbor Commercial Mortgage to our operating partnership per operating partnership unit, $15 (representing the offering price per share of our common stock in the original offering), the offering price per share of our common stock in any subsequent offerings and the issue price per operating partnership unit for subsequent contributions to our operating partnership, multiplied by |
Each fiscal quarter, with at least 25% paid in our common stock | ||
(2) the weighted average of our operating partnerships outstanding operating partnership units. | ||||
Overhead expenses | Compensation of our independent directors, legal, accounting, due diligence tasks and other services that outside professionals perform for us. | Each fiscal quarter in cash | ||
Origination fee income(3) |
An amount equal to 100% of the origination fees paid by the borrower to us with respect to each bridge loan and mezzanine loan we originate, up to 1% of the loans principal amount. | Upon closing of each loan | ||
Termination fee(4) | If we terminate or elect not to renew the management agreement in order to manage our portfolio internally, we are required to pay a termination fee equal to the base management fee and incentive compensation for the 12-month period preceding the termination. | Upon termination | ||
If, without cause, we terminate or elect not to renew the management agreement for any other reason, including a change of control of us, we are required to pay a termination fee equal to two times the base management fee and incentive compensation paid for the 12-month period preceding the termination. |
(1) | For purposes of calculating the base management fee, our operating partnerships equity equals the month-end value computed in accordance with generally accepted accounting principles of total partners equity in our operating partnership, plus or minus any unrealized gains, losses or other items that do not affect realized net income. |
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(2) | At least 25% of the incentive compensation paid to our manager will be in the form of shares of our common stock, subject to ownership limitations in our charter. Beginning on January 1, 2004, the incentive compensation will be measured over a full fiscal year, subject to recalculation and potential reconciliation at the end of each fiscal year. We intend to pay our manager each installment of the incentive compensation within sixty (60) days following the last day of the fiscal quarter with respect to which such incentive compensation payment is payable. |
(3) | 100% of the origination fees paid by the borrower in excess of 1% of the loans principal amount are retained by us. |
(4) | The management agreement has an initial term of two years and is renewable automatically for an additional one year period every year thereafter, unless terminated with six months prior written notice. |
Related Party Transactions
Related Party Loans |
Arbor Commercial Mortgage has a 50% non-controlling interest in a joint venture, which was formed to acquire, develop and/or sell real estate assets. At September 30, 2003, Arbor Commercial Mortgages investments in this joint venture were approximately $2.6 million. At September 30, 2003, we had a $16.0 million bridge loan outstanding to the joint venture, which is collateralized by a first lien position on a commercial real estate property. There is a limited guarantee on the loan of 50% by our chief executive officer and 50% by the key principal of the joint venture. The loan requires monthly interest payments based on LIBOR and matures in October 2004. We have agreed to provide the borrower with additional mezzanine financing in the amount of up to $8.0 million. The mezzanine financing requires interest payments based on LIBOR and matures in May 2006. The loan will be funded in two equal installments of $4.0 million. The funding will be drawn down as construction progresses. The interest on the first component, which was funded by Arbor Commercial Mortgage in June 2003 and purchased by us in July 2003, will be earned on the full $4.0 million, while the interest on the second component, which has yet to be funded by us, will be earned as the $4.0 million is drawn down. This additional financing is secured by a second mortgage lien on the property. Interest income recorded from these loans was approximately $240,000, for the period ended September 30, 2003.
Our $16.0 million bridge loan to the joint venture was contributed by Arbor Commercial Mortgage at book value, which approximates fair value. At the time of contribution, Arbor Commercial Mortgage also agreed to provide a limited guaranty of the loans principal amount based any profits realized on its retained 50% interest in the joint venture with the borrower and Arbor Commercial Mortgages participating interests in borrowers under three other contributed structured finance assets.
In June 2003, Arbor Commercial Mortgage invested approximately $818,000 in exchange for a 12.5% non-controlling interest in a joint venture, which was formed to acquire, develop and/or sell real estate assets. This investment was purchased by us from Arbor Commercial Mortgage in August 2003. In addition, as of September 30, 2003, we had two mezzanine loans, secured by a second lien position in the ownership interests of the borrower and the property, to this joint venture totaling $6.0 million outstanding. The loans require monthly interest payments based on LIBOR and mature in May 2006. Interest income recorded from these loans was approximately $97,000 for the period ended September 30, 2003.
At the time of Arbor Commercial Mortgages origination of three of the structured finance assets that it contributed to us on July 1, 2003 at book value, which approximates fair value, each of the property owners related to these contributed assets granted Arbor Commercial Mortgage participating interests that share in a percentage of the cash flows of the underlying properties. Upon contribution of the structured finance assets, Arbor Commercial Mortgage retained these participating interests and its 50% non-controlling interest in the joint venture to which it had made the $16.0 million bridge loan. Arbor Commercial Mortgage agreed that if any portion of the outstanding amount of any of these four contributed assets (which had an aggregate balance of $48.3 million as of September 30, 2003) is not paid at the its maturity or repurchase date, Arbor Commercial Mortgage will pay us, subject to the limitation described below, the portion of the unpaid amount of the contributed asset up to the total amount then received by Arbor Commercial Mortgage due to the realization of any profits on its retained interests associated with any other of the four contributed assets. However, Arbor Commercial Mortgage will no longer be obligated to make such payments to us when the
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Related Party Formation Transactions |
Arbor Commercial Mortgage contributed the majority of its structured finance portfolio to our operating partnership pursuant to a contribution agreement. The contribution agreement contains representations and warranties concerning the ownership and terms of the structured finance assets it contributed and other customary matters. Arbor Commercial Mortgage has agreed to indemnify us and our operating partnership against breaches of those representations and warranties. In connection with its asset contribution Arbor Commercial Mortgage has also agreed to guaranty a portion of the principal amount of four contributed assets in which Arbor Commercial Mortgage has retained a participating interest or a joint venture interest in the borrower.
In exchange for Arbor Commercial Mortgage asset contribution, we issued to Arbor Commercial Mortgage approximately 3.1 million operating partnership units, each of which Arbor Commercial Mortgage may redeem for one share of our common stock or an equivalent amount in cash, at our election, and approximately 629,000 warrants, each of which entitles Arbor Commercial Mortgage to purchase one additional operating partnership unit at an initial exercise price of $15. The operating partnership units and warrants for additional operating partnership units issued to Arbor Commercial Mortgage were valued at approximately $43.9 million at July 1, 2003, based on the price offered to investors in our units in the original offering, adjusted for the initial purchasers discount. We also granted Arbor Commercial Mortgage certain demand and other registration rights with respect to the shares of common stock issuable upon redemption of its operating partnership units.
Each of the approximately 3.1 million operating partnership units received by Arbor Commercial Mortgage is paired with one share of our special voting preferred stock that entitles the holder to one vote on all matters submitted to a vote of our stockholders. As operating partnership units are redeemed for shares of our common stock or cash an equivalent number of shares of special voting preferred stock will be redeemed and cancelled. As a result of Arbor Commercial Mortgage asset contribution and the related formation transactions, Arbor Commercial Mortgage owns approximately a 28% limited partnership interest in our operating partnership and the remaining 72% interest in our operating partnership is owned by us. In addition, Arbor Commercial Mortgage has approximately 28% of the voting power of our outstanding stock (without giving effect to the exercise of Arbor Commercial Mortgage warrants for additional operating partnership units).
We and our operating partnership have entered into a management agreement with Arbor Commercial Mortgage pursuant to which Arbor Commercial Mortgage has agreed to provide us with structured finance investment opportunities and loan servicing as well as other services necessary to operate our business. As discussed above in Contractual Commitments, we have agreed to pay our manager an annual base management fee and incentive compensation each fiscal quarter and share with Arbor Commercial Mortgage a portion of the origination fees that we receive on loans we originate with Arbor Commercial Mortgage pursuant to this agreement.
Under the terms of the management agreement, Arbor Commercial Mortgage is also required to provide us with a right of first refusal with respect to all structured finance identified by Arbor Commercial Mortgage or its affiliates. We have agreed not to pursue, and to allow Arbor Commercial Mortgage to pursue, any real estate opportunities other than structured finance transactions. In addition, Mr. Kaufman has entered into a non-competition agreement with us pursuant to which he has agreed not to pursue structured finance investment opportunities, except as approved by our board of directors.
We and our operating partnership have also entered into a services agreement with Arbor Commercial Mortgage pursuant to which our asset management group provides asset management services to Arbor Commercial Mortgage. In the event the services provided by our asset management group pursuant to the agreement exceed by more than 15% per quarter the level of activity anticipated by our board of directors, we will negotiate in good faith with our manager an adjustment to our managers base management fee under the
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Recent Developments
Since September 30, 2003, we have made ten new loans and investments totaling $99.3 million. These new investments include five bridge loans for $43.9 million, three mezzanine loans for $43.3 million and two preferred equity investments for $12.1 million.
In relation to a mezzanine loan originated in December 2003, we have entered into a temporary repurchase agreement arrangement with a financial institution that has advanced us 62.5% of this loan at an interest rate of LIBOR plus 2.50%. We are currently in negotiations with this financial institution to execute a $150 million repurchase agreement with a proposed three-year term with interest based on LIBOR.
Since September 30, 2003, the following six investments contributed to us by Arbor Commercial Mortgage, totaling $49.3 million, were repaid in full, including all current and deferred interest, prior to maturity: the Holiday Inn Convention Center bridge loan ($4.7 million), the Park Place Apartments preferred equity investment ($3.9 million), the Vermillion Apartments bridge loan ($18.8 million), Carlton Arms Apartments mezzanine loan ($4.0 million), the Devonshire Apartments preferred equity investment ($2.5 million) and the Emerald Bay bridge loan ($15.4 million). All the initial assets contributed by Arbor Commercial Mortgage and substantially all the assets currently in our portfolio do not include prepayment protection which may result in prepayments on these loans occurring prior to their scheduled maturity date. We intend to structure loans that we originate in the future to provide for prepayment protection. If successful, we will be able to retain assets in our portfolio on a longer term basis.
Quantitative and Qualitative Disclosures about Market Risk
Market risk is the exposure to loss resulting from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices and real estate values. The primary market risks that we are exposed to are real estate risk and interest rate risk.
Real Estate Risk |
Commercial mortgage assets may be viewed as exposing an investor to greater risk of loss that residential mortgage assets since such assets are typically secured by larger loans to fewer obligors than residential mortgage assets. Multi-family and commercial property values and net operating income derived from such properties are subject to volatility and may be affected adversely by a number of factors, including, but not limited to, national, regional and local economic conditions (which may be adversely affected by industry slowdowns and other factors), local real estate conditions (such as an oversupply of housing, retail, industrial, office or other commercial space); changes or continued weakness in specific industry segments; construction quality, age and design; demographic factors; retroactive changes to building or similar codes; and increases in operating expenses (such and energy costs). In the event net operating income decreases, a borrower may have difficulty repaying our loans, which could result in losses to us. In addition, decreases in property values reduce the value of the collateral and the potential proceeds available to a borrower to repay our loans, which could also cause us to suffer losses. Even when the net operating income is sufficient to cover the related propertys debt service, there can be no assurance that this will continue to be the case in the future.
Interest Rate Risk |
Interest rate risk is highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond our control.
Our operating results will depend in large part on differences between the income from our assets and our borrowing costs. Most of our assets and borrowings are variable-rate instruments, based on LIBOR. The objective of this strategy is to minimize the impact of interest rate changes on our net interest income. Many of our loans and borrowings are subject to various interest rate floors. As a result, the impact of a change in
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In the event of a significant rising interest rate environment and/or economic downturn, defaults could increase and result in credit losses to us, which could adversely affect our liquidity and operating results. Further, such delinquencies or defaults could have an adverse effect on the spreads between interest-earning assets and interest-bearing liabilities.
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MANAGEMENTS DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
You should read the following discussion in conjunction with the sections of this prospectus entitled Risk Factors, Forward-Looking Statements and Selected Consolidated Financial Information of the Structured Finance Business of Arbor Commercial Mortgage, LLC and Subsidiaries and the historical consolidated financial statements of the structured finance business of Arbor Commercial Mortgage, including related notes, included elsewhere in this prospectus.
Overview and Basis of Presentation
We are a Maryland corporation that was formed in June 2003 to invest in real estate related bridge and mezzanine loans, preferred equity and, in limited cases, discounted Mortgage notes and other real estate related assets. We conduct substantially all of our operations through our operating partnership, Arbor Realty Limited Partnership. We intend to elect to be treated as a REIT for federal income tax purposes.
On July 1, 2003 Arbor Commercial Mortgage contributed a portfolio of structured finance investments and related liabilities to our operating partnership. In addition, certain employees of Arbor Commercial Mortgage related to its structured finance business became our employees. These assets, liabilities and employees represented a substantial portion of Arbor Commercial Mortgages structured finance business, which historically invested in real estate related bridge and mezzanine loans, preferred equity and other real estate related assets.
The structured finance business of Arbor Commercial Mortgage is not a separate legal entity and the assets and liabilities associated with Arbor Commercial Mortgages structured finance business are components of a larger business. We obtained the information in the consolidated financial statements included elsewhere in this prospectus from Arbor Commercial Mortgages consolidated historical accounting records.
The structured finance business of Arbor Commercial Mortgage never operated as a separate business segment or division of Arbor Commercial Mortgage, but as an integrated part of Arbor Commercial Mortgages consolidated business. Accordingly, the statements of revenue and direct operating expenses do not include charges from Arbor Commercial Mortgage for corporate general and administrative expense because Arbor Commercial Mortgage considered such items to be corporate expenses and did not allocate them to individual business units. These expenses included costs for Arbor Commercial Mortgages executive management, corporate facilities and overhead costs, corporate accounting and treasury functions, corporate legal matters and other similar costs.
The information in the statements of revenue and direct operating expenses include the revenue and direct operating expenses that relate to the structured finance business. Direct operating expenses include interest expense applicable to the funding costs of the structured finance business loans and investments, salaries and related fringe benefit costs, provision for loan losses and other expenses directly associated with revenue-generating activities. Direct operating expenses also include allocations of certain expenses, such as telephone, office equipment rental and maintenance, office supplies and marketing, which were directly associated with the structured finance business and were allocated based on headcount of the structured finance business in relation to the total headcount of Arbor Commercial Mortgage. All of these allocations are based on assumptions that management believes are reasonable under the circumstances.
The consolidated financial statements in this prospectus do not include a statement of cash flows because the structured finance business did not maintain a separate cash balance. Other than the debt required to fund the loans and investments of the structured finance business, operating activities of the structured finance business were funded by Arbor Commercial Mortgage.
Since the structured finance business never operated as a separate business division or segment of Arbor Commercial Mortgage, the consolidated financial statements included in this prospectus are not intended to be a complete presentation of the historical financial position, results of operations and cash flows of the structured finance business. These consolidated financial statements were prepared for inclusion in the
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Sources of Operating Revenues
We derive our operating revenues primarily from interest received from making real estate related bridge and mezzanine loans and preferred equity investments. We provide bridge loans secured by first lien mortgages on the property to borrowers who are typically seeking short term capital to be used in an acquisition of property. The bridge loans we make typically range in size from $1 million to $25 million and have terms of up to seven years. We provide real property owners with mezzanine loans that are secured by pledges of ownership interests in entities that directly or indirectly control the real property or second mortgages. These loans typically range in size from $2 million to $15 million and have terms of up to seven years. We also make preferred equity investments in entities that directly or indirectly own real property. Interest represented 83%, 93% and 95% of total revenue for the six months ended June 30, 2003 and June 30, 2002 and for the nine months ended September 30, 2002, respectively. Interest represented 93%, 90% and 94% of total revenue for the years ended December 31, 2002, December 31, 2001 and December 31, 2000, respectively.
We also derive operating revenue from other income that includes several types of income that are recorded upon receipt. Certain of our loans and investments provide for additional payments based on the borrowers operating cash flow, appreciation of the underlying collateral, payments calculated based on timing of when the loan pays off and changes in interest rates. Such amounts are not readily determinable and are recorded as other income upon receipt. Other income represented 17%, 7% and 5% of total revenue for the six months ended June 30, 2003 and June 30, 2002 and for the nine months ended September 30, 2003, respectively. Other income represented 7%, 10% and 6% of total revenue for the years ended December 31, 2002, December 31, 2001 and December 31, 2000, respectively.
Gain on Sale of Loans and Real Estate and Income from Equity Affiliates
We also derive income from the gain on sale of loans and real estate. We acquire (1) real estate for our own investment and, upon stabilization, disposition at an anticipated return and (2) real estate notes generally at a discount from lenders in situations where the borrower wishes to restructure and reposition its short term debt and the lender wishes to divest certain assets from its portfolio.
In addition, we derive income from equity affiliates relating to joint ventures that Arbor Commercial Mortgages structured finance business formed with equity partners to lend to, acquire, develop and/or sell real estate assets. These investments are recorded under the equity method. We record our share of net income from the underlying properties invested in through these joint ventures.
Significant Accounting Estimates and Critical Accounting Policies
Set forth below is a summary of the accounting policies that management believes are critical to the preparation of the consolidated financial statements included in this prospectus. Certain of the accounting policies used in the preparation of these consolidated financial statements are particularly important for an understanding of the financial position and results of operations presented in the historical consolidated financial statements included in this prospectus and require the application of significant judgment by management and, as a result, are subject to a degree of uncertainty.
Real Estate Owned |
Real estate owned represents commercial real estate property that the structured finance business of Arbor Commercial Mortgage owns and operates. Such assets are not depreciated and are carried at the lower
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Loans and Investments |
Loans held for investment are intended to be held to maturity and, accordingly, are carried at cost, net of unamortized loan origination costs and fees, unless such loan or investment is deemed to be impaired.
Arbor Commercial Mortgages structured finance business historically invested in preferred equity interests that allowed Arbor Commercial Mortgage to participate in a percentage of the underlying propertys cash flows from operations and proceeds from a sale or refinancing. At the inception of each such investment, management must determine whether such investment should be accounted for as a loan, joint venture or as real estate. To date, management has determined that all such investments are properly accounted for and reported as loans.
Specific valuation allowances are established for impaired loans based on the fair value of collateral on an individual loan basis. The fair value of the collateral is determined by an evaluation of operating cash flow from the property during the projected holding period, and estimated sales value computed by applying an expected capitalization rate to the stabilized net operating income of the specific property, less selling costs, discounted at market discount rates. If upon completion of the valuation, the fair value of the underlying collateral securing the impaired loan is less than the net carrying value of the loan, an allowance is created with a corresponding charge to the provision for loan losses. The allowance for each loan is maintained at a level believed adequate by management to absorb probable losses.
Revenue Recognition
The revenue recognition policies for Arbor Commercial Mortgages structured finance business are as follows:
Interest Income. Interest income is recognized on the accrual basis as it is earned. In most instances, the borrower pays an additional amount of interest at the time the loan is closed, an origination fee, and deferred interest upon maturity of the loan. This additional income as well as any direct loan origination costs incurred, is deferred and recognized over the life of the related loan as a yield adjustment. Income recognition is suspended for loans when in the opinion of management a full recovery of income and principal becomes doubtful. Income recognition is resumed when the loan becomes contractually current and performance is demonstrated to be resumed Several of the loans provide for accrual of interest at specified rates, which differ from current payment terms. Interest is recognized on such loans at the accrual rate subject to managements determination that accrued interest and outstanding principal are ultimately collectible, based on the underlying collateral and operations of the borrower. If management cannot make this determination regarding collectibility, interest income is recognized only upon actual receipt.
Results of Operations
Six Months Ended June 30, 2003 and 2002
Revenue. The following table sets forth the components of revenue:
Six Months Ended | Increase/ | |||||||||||||||
June 30, | (Decrease) | |||||||||||||||
2003 | 2002 | Amount | Percent | |||||||||||||
Interest income
|
$ | 7,688,465 | $ | 7,482,750 | $ | 205,715 | 3 | % | ||||||||
Other income
|
1,552,414 | 553,625 | 998,789 | 180 | % | |||||||||||
Total Revenue
|
$ | 9,240,879 | $ | 8,036,375 | $ | 1,204,504 | 15 | % | ||||||||
Interest income increased $206,000, or 3%, to $7.7 million for the six months ended June 30, 2003 from $7.5 million for the six months ended June 30, 2002. This increase was primarily due to a 21% increase in the
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Other income increased $1.0 million, or 180%, to $1.6 million for the six months ended June 30, 2003 from $554,000 for the six months ended June 30, 2002. This increase was primarily attributable to (a) the partial satisfaction of an impaired loan for an amount $350,000 in excess of the loans carrying value resulting in the recognition of other income for this amount (b) increased funds received on paid off loans of $337,000 and (c) increased accelerated amortization of revenue of $390,000 on loans with early payoffs.
Expenses. The following table sets forth the components of direct operating expenses:
Six Months Ended | Increase/ | |||||||||||||||
June 30, | (Decrease) | |||||||||||||||
2003 | 2002 | Amount | Percent | |||||||||||||
Interest expense
|
$ | 3,468,275 | $ | 3,370,777 | $ | 97,498 | 3 | % | ||||||||
Employee compensation and benefits
|
1,751,147 | 1,410,272 | 340,875 | 24 | % | |||||||||||
Selling and administrative
|
458,266 | 368,253 | 90,013 | 24 | % | |||||||||||
Provision for loan losses
|
60,000 | 3,195,000 | (3,135,000 | ) | (98 | )% | ||||||||||
Total direct operating expenses
|
$ | 5,737,688 | $ | 8,344,302 | $ | (2,606,614 | ) | (31 | )% | |||||||
Interest expense increased $100,000, or 3%, to $3.5 million for the six months ended June 30, 2003 from $3.4 million for the six months ended June 30, 2002. This increase is primarily attributable to a 26% increase in the weighted average borrowings partially offset by a 19% decrease in the weighted average effective financing rate primarily due to a decline in market interest rates.
Employee compensation and benefits increased $341,000, or 24%, to $1.8 million for the six months ended June 30, 2003 from $1.4 million for the six months ended June 30, 2002. This increase reflects increased staffing levels associated with the increased loan and investments opportunities.
Selling and administrative expenses increased $90,000, or 24%, to $458,000 for the six months ended June 30, 2003 from $368,000 for the six months ended June 30, 2002. This increase was primarily attributable to operating expenses incurred in 2003 for a real estate owned asset, and increased marketing expenses associated with the growth of the lending and investment activities.
Provision for loan losses decreased $3.1 million, or 98%, to $60,000 for the six months ended June 30, 2003 from $3.2 million for the six months ended June 30, 2002. This decrease was directly attributable to a $3.1 million provision for loan losses recorded in 2002 prior to this loan being foreclosed and reclassified to real estate owned. This provision was recorded to reflect this asset at its estimated fair value.
Gain on sale of loans and real estate and income from equity affiliates. The following table sets forth our gain on sale of loans and real estate and income from equity affiliates:
Six Months Ended | Increase/ | |||||||||||||||
June 30, | (Decrease) | |||||||||||||||
2003 | 2002 | Amount | Percent | |||||||||||||
Gain on sale of loans and real estate
|
$ | 1,024,268 | $ | 7,006,432 | $ | (5,982,164 | ) | (85 | )% | |||||||
Income from equity affiliates
|
| $ | 601,100 | $ | (601,100 | ) | |
Gain on sale of loans and real estate decreased $6.0 million, or 85%, to $1.0 million for the six months ended June 30, 2003 from $7.0 million for the six months ended June 30, 2002. This decrease was primarily attributable to a $6.8 million gain on the sale of a joint venture interest in March 2002 partially offset by a $900,000 gain on the partial liquidation of a joint venture interest in 2003.
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Income from equity affiliates for the six months ended June 30, 2002 consist of net income from a joint venture interest recognized prior to the sale of that joint venture interest in March 2002.
Nine Months Ended September 30, 2002
Revenues. The following table sets forth the components of revenue:
Nine Months | ||||
Ended | ||||
September 30, | ||||
2002 | ||||
Interest income
|
$ | 10,798,414 | ||
Other income
|
572,161 | |||
Total Revenue
|
$ | 11,370,575 | ||
Interest income was $10.8 million. The average balance of the loan and investment portfolio was $174.7 million during the period. The average yield on these assets was 8.24%.
Other income was $572,000. This amount represents funds received on loans and investments which generate additional payments to us based on the borrowers operating cash flow.
Expenses. The following table sets forth the components of direct operating expenses:
Nine Months | ||||
Ended | ||||
September 30, | ||||
2002 | ||||
Interest expense
|
$ | 4,832,260 | ||
Employee compensation and benefits
|
2,105,445 | |||
Selling and administrative
|
582,850 | |||
Provision for loan losses
|
3,255,000 | |||
Total direct operating expenses
|
$ | 10,775,555 | ||
Interest expense was $4.8 million. The average balance of debt financing was $118.9 million during the quarter. The average cost of these borrowings was 5.42%.
Employee compensation and benefits expense was $2.1 million, which represents salaries, benefits and incentive compensation for all employees who work directly in Arbor Commercial Mortgages structured finance business.
Selling and administrative expense was $583,000. This amount is comprised primarily of professional fees directly associated with Arbor Commercial Mortgage structured finance business, operating expenses incurred for a real estate owned assets, and marketing expenses incurred directly for Arbor Commercial Mortgages structured finance business.
The provision for loan losses was $3.3 million. Of this amount $3.1 million was directly attributable to a specific loan at was being foreclosed upon and reclassified to real estate owned. This provision was recorded to reflect this asset at its estimated fair value. The remaining provision of $200,000 was established to properly reflect the book value of an impaired loan.
Gain on sale of loans and real estate and income from equity affiliates. The following table sets forth our gain on sale of loans and real estate and income from equity affiliates:
Nine Months | ||||
Ended | ||||
September 30, | ||||
2002 | ||||
Gain on sale of loans and real estate
|
$ | 7,006,432 | ||
Income from equity affiliates
|
$ | 632,350 |
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Gain on sale of loans and real estate was $7.0 million. This amount consists primarily of a $6.8 million gain on the sale of a joint venture interest in March 2002.
Income from equity affiliates was $632,000. This amount consists primarily of net income from a joint venture interest recognized prior to the sale of that joint venture interest in March 2002.
Years Ended December 31, 2002 and 2001
Revenue. The following table sets forth the components of revenue:
Year Ended | Increase/ | |||||||||||||||
December 31, | (Decrease) | |||||||||||||||
2002 | 2001 | Amount | Percent | |||||||||||||
Interest income
|
$ | 14,532,504 | $ | 14,667,916 | $ | (135,412 | ) | (1 | )% | |||||||
Other income
|
1,090,106 | 1,668,215 | (578,109 | ) | (35 | )% | ||||||||||
Total Revenue
|
$ | 15,622,610 | $ | 16,336,131 | $ | 713,521 | (4 | )% | ||||||||
Interest income decreased $135,000, or 1%, to $14.5 million for 2002 from $14.7 million for 2001. This decrease was primarily due to a 16% decrease in the weighted average effective interest rate of loans and investments primarily due to a decline in market interest rates partially offset by a 17% increase in the weighted average balance of loans and investment. Most of our loans and investments are variable rates instruments based on LIBOR. The negative impact to interest income as a result of the decrease in market interest rates was partially offset by interest rate floors that were in effect on many of our loans and investments.
Other income decreased $578,000, or 35%, to $1.1 million for 2002 from $1.7 million for 2001. This decrease was primarily attributable to decreased extension fees earned of $215,000 and decreased funds received on paid off loans of $361,000.
Expenses. The following table sets forth the components of direct operating expenses:
Year Ended | Increase/ | |||||||||||||||
December 31, | (Decrease) | |||||||||||||||
2002 | 2001 | Amount | Percent | |||||||||||||
Interest expense
|
$ | 6,586,640 | $ | 7,029,374 | $ | (442,734 | ) | (6 | )% | |||||||
Employee compensation and benefits
|
2,827,191 | 2,888,603 | (61,412 | ) | (2 | )% | ||||||||||
Selling and administrative
|
910,924 | 839,823 | 71,101 | 8 | % | |||||||||||
Provision for loan losses
|
3,315,000 | 240,000 | 3,075,000 | 1,281 | % | |||||||||||
Total direct operating expenses
|
$ | 13,639,755 | $ | 10,997,800 | $ | 2,641,955 | 24 | % | ||||||||
Interest expense decreased $443,000, or 6%, to $6.6 million for 2002 from $7.0 million for 2001. This decrease is primarily attributable to a 20% decrease in the weighted average effective financing rate due to a decline in market interest rates partially offset by a 17% increase in the weighted average borrowings.
Employee compensation and benefits remained relatively stable from 2001 to 2002.
Selling and administrative expenses increased $71,000, or 8%, to $911,000 for 2002 from $840,000 for 2001. This increase was primarily attributable to increased legal expenses associated with the asset management and restructuring of our loans and investments portfolio.
Provision for loan losses increased $3.1 million, or 1,281%, to $3.3 million for 2002 from $240,000 for 2001. This increase was directly attributable to a $3.1 million provision for possible loan losses recorded in 2002 prior to this loan being foreclosed on and reclassified as real estate owned. This provision was recorded to reflect this asset at its estimated fair value.
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Gain on sale of loans and real estate and income from equity affiliates. The following table sets forth our gain on sale of loans and real estate and income from equity affiliates:
Year Ended | Increase/ | |||||||||||||||
December 31, | (Decrease) | |||||||||||||||
2002 | 2001 | Amount | Percent | |||||||||||||
Gain on sale of loans and real estate
|
$ | 7,470,999 | $ | 3,226,648 | $ | 4,244,351 | 132 | % | ||||||||
Income from equity affiliates
|
$ | 632,350 | $ | 1,403,014 | $ | (770,664 | ) | (55 | )% |
Gain on sale of loans and real estate increased $4.2 million, or 132%, to $7.5 million for 2002 from $3.2 million for 2001. This increase was primarily attributable to a $6.8 million gain on the sale of a joint venture interest in March 2002 partially offset by a $2.2 million gain from the sale of property from a joint venture interest and a $276,000 decrease in income from the sale of foreclosed loans.
Income from equity affiliates decreased $770,000, or 55%, to $632,000 for 2002 from $1.4 million for 2001. This decrease was primarily attributable to a $868,000 decrease in net income from joint venture interests due to dissolutions of joint ventures in 2001 and 2002, partially offset by a $97,000 increase in net income from other joint venture interest.
Years Ended December 31, 2001 and 2000
Revenue. The following table sets forth the components of revenue:
Year Ended | Increase/ | |||||||||||||||
December 31, | (Decrease) | |||||||||||||||
2001 | 2000 | Amount | Percent | |||||||||||||
Interest income
|
$ | 14,667,916 | $ | 10,707,551 | $ | 3,960,365 | 37 | % | ||||||||
Other income
|
1,668,215 | 652,970 | 1,015,245 | 155 | % | |||||||||||
Total Revenue
|
$ | 16,336,131 | $ | 11,360,521 | $ | 4,975,610 | 44 | % | ||||||||
Interest income increased $4.0 million, or 37%, to $14.7 million for 2001 from $10.7 million for 2000. This increase was primarily due to a 81% increase in the weighted average balance of loans and investment partially offset by a 24% decrease in the weighted average effective interest rate of loans and investments primarily due to a decline in market interest rates.
Other income increased $1.0 million, or 155%, to $1.7 million for 2001 from $653,000 for 2000. This increase was primarily attributable to increased funds received on paid off loans of $900,000.
Expenses. The following table sets forth the components of direct operating expenses:
Year Ended | Increase/ | |||||||||||||||
December 31, | (Decrease) | |||||||||||||||
2001 | 2000 | Amount | Percent | |||||||||||||
Interest expense
|
$ | 7,029,374 | $ | 5,518,463 | $ | 1,510,911 | 27 | % | ||||||||
Employee compensation and benefits
|
2,888,603 | 3,026,324 | (137,721 | ) | (5 | )% | ||||||||||
Selling and administrative
|
839,823 | 442,487 | 397,336 | 90 | % | |||||||||||
Provision for loan losses
|
240,000 | 240,000 | | | % | |||||||||||
Total direct operating expenses
|
$ | 10,997,800 | $ | 9,227,274 | $ | 1,770,526 | 19 | % | ||||||||
Interest expense increased $1.5 million, or 27%, to $7.0 million for 2001 from $5.5 million for 2000. This increase was primarily attributable to a 73% increase in the weighted average borrowings partially offset by a 26% decrease in the weighted average effective financing rate primarily due to a decline in market interest rates.
Employee compensation and benefits decreased $138,000, or 5%, to $2.9 million for 2001 from $3.0 million for 2000. This decrease was primarily attributable to the streamlining of certain levels of management of Arbor Commercial Mortgages structured finance business.
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Selling and administrative expenses increased $397,000, or 90%, to $840,000 in 2001 from $442,000 for 2000. This increase was primarily attributable to increased legal expenses associated with the asset management and restructuring of our loans and investments portfolio.
Provision for loan losses was stable from 2000 to 2001.
Gain on sale of loans and real estate and income from equity affiliates. The following table sets forth our gain on sale of loans and real estate and income from equity affiliates:
Year Ended | Increase/ | |||||||||||||||
December 31, | (Decrease) | |||||||||||||||
2001 | 2000 | Amount | Percent | |||||||||||||
Gain on sale of loans and real estate
|
$ | 3,226,648 | $ | 1,880,825 | $ | 1,345,823 | 72 | % | ||||||||
Income from equity affiliates
|
$ | 1,403,014 | $ | 5,028,835 | $ | (3,625,821 | ) | (72 | )% |
Gain on sale of loans and real estate increased $1.3 million, or 72%, to $3.2 million for 2001 from $1.9 million for 2000. This increase was primarily attributable to a $2.2 million gain from the sale of property from a joint venture interest partially offset by reduced gains on sales of foreclosed loans of $800,000.
Income from equity affiliates decreased $3.6 million, or 72%, to $1.4 million for 2001 from $5.0 million for 2000. This decrease was due to (a) a $3.3 million decrease in net income from a joint venture interest due to the dissolution of the joint venture interest in 2001 and (b) a $353,000 decrease in net income from other joint venture interest.
Pro Forma Effect of Arbor Commercial Mortgages Asset Contribution on Results of Operations
We were formed in June 2003 to operate as a real estate investment trust and to expand the structured finance business of Arbor Commercial Mortgage. On July 1, 2003, we completed a private placement of our units, each consisting of five shares of our common stock and one warrant to purchase one share of our common stock. Gross proceeds from the private financing totaled $120.2 million. In exchange for a commensurate equity ownership in our operating subsidiary, Arbor Commercial Mortgage contributed $213.1 million of structured finance assets subject to $169.2 million of borrowings supported by $43.9 million of equity. These assets and liabilities were contributed at book value, which approximates fair value, and represent 88% of the assets and 98% of the liabilities of Arbor Commercial Mortgages structured finance business as of June 30, 2003. In addition, certain employees of Arbor Commercial Mortgage were transferred to us.
We are externally managed and advised by Arbor Commercial Mortgage and pay Arbor Commercial Mortgage a management fee in accordance with the terms of the management agreement. Arbor Commercial Mortgage also sources originations, provides underwriting services and services all structured finance assets on our behalf. As a result, the operating expenses as presented in the historical consolidated financial statements of Arbor Commercial Mortgages structured finance business would have been affected had we been formed at an earlier time. Employee compensation and benefits expense would have decreased by $895,811 and $1,518,890 for the six months ended June 30, 2003 and year ended December 31, 2002, respectively, because these costs would have been borne by Arbor Commercial Mortgage under terms of the management agreement. Similarly, selling and administrative expense would have decreased by $65,752 and $127,753 for the six months ended June 30, 2003 and year ended December 31, 2002, respectively.
In accordance with the management agreement, we will pay Arbor Commercial Mortgage a management fee, composed of a base management fee and incentive compensation. The base management fee is 0.75% per annum of the first $400 million of equity. The incentive compensation is equal to 25% of the amount that our funds from operations, adjusted for certain gains and losses, divided by contributed capital, exceeds 9.5% per annum or the 10-year Treasury Rate plus 3.5%, whichever is greater.
This pro forma information does not reflect the results of the private financing. However, gross proceeds from the private financing totaled $120.2 million, which combined with Arbor Commercial Mortgages equity contribution of $43.9 million, resulted in total contributed capital of $164.1 million. Offering expenses of
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The pro forma consolidated financial information is limited to adjustments that are directly attributable to the original offering, expected to have a continuing impact on us and are factually supportable. These adjustments are based on the assumption that certain compensation and benefits expenses and certain selling and administrative expenses incurred by the structured finance business of Arbor Commercial Mortgage would not have been incurred if we had been in operation during the periods presented. The pro forma financial results do not include what the impact would have been had the gross proceeds from the original offering been available to the structured finance business of Arbor Commercial Mortgage during the entire period. Had these proceeds been available to the structured finance business of Arbor Commercial Mortgage during the entire period, there would have been an impact on certain revenues and expenses, including the management fees payable pursuant to the management agreement. The management fees are calculated based on such factors as funds from operations and equity of our operating partnership, each as defined in the management agreement. Such amounts represent speculative and forward-looking information that is not factually supportable.
Liquidity and Capital Resources
Liquidity is a measurement of the ability to meet potential cash requirements, including ongoing commitments to repay borrowings, fund and maintain loans and investments and other general business needs. On July 1, 2003, Arbor Commercial Mortgage contributed a portfolio of structured finance investments and related liabilities to our operating partnership. In addition, certain employees of Arbor Commercial Mortgage became our employees. These assets, liabilities and employees represented a substantial portion of the structured finance business of Arbor Commercial Mortgage.
On July 1, 2003 we completed the original offering, resulting in gross proceeds of $120.2 million. Gross proceeds from the original offering combined with the concurrent equity contribution by Arbor Commercial Mortgage totaled approximately $164.1 in equity capital.
Subsequent to and as a result of the original offering, substantially all of the operations of the structured finance business of Arbor Commercial Mortgage have been conducted by us. Therefore, a description of the liquidity and capital resources of the structured finance business of Arbor Commercial Mortgage is not presented. A description of our liquidity and capital resources is presented in the section of this prospectus entitled Managements Discussion & Analysis of Financial Condition and Results of Operations of Arbor Realty Trust, Inc. and Subsidiaries Liquidity and Capital Resources.
Related Party Transactions
Related Party Loans |
Arbor Commercial Mortgage has a 50% non-controlling interest in a joint venture, which was formed to acquire, develop and/or sell real estate assets. At June 30, 2003, December 31, 2002 and 2001, Arbor Commercial Mortgages structured finance business investments in this joint venture were approximately $2.6 million, $2.3 million and $1.8 million, respectively. This investment is accounted for under the equity method. At June 30, 2003 and December 31, 2002, Arbor Commercial Mortgage had a $16.0 million bridge loan outstanding to the joint venture, which is collateralized by a first lien position on a commercial real estate property. There is a limited guarantee on the loan of 50% by the chief executive officer of Arbor Commercial Mortgage and 50% by the key principal of the joint venture. The loan requires monthly interest payments based on LIBOR and matures in October 2004. Arbor Commercial Mortgage agreed to provide the borrower with additional mezzanine financing in the amount of up to $8.0 million. The mezzanine financing requires interest payments based on LIBOR and matures in May 2006. The loan will be funded in two equal installments of $4.0 million. The funding will be drawn down as construction progresses. The interest on the first component, which was funded by Arbor Commercial Mortgage in June 2003, will be earned on the full $4.0 million, while the interest on the second component, which has yet to be funded, will be earned as the $4.0 million is drawn down. This additional financing is secured by a second mortgage lien on the property. In
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In June 2003, Arbor Commercial Mortgage invested approximately $818,000 in exchange for a 12.5% non-controlling interest in a joint venture, which was formed to acquire, develop and/or sell real estate assets. This investment is accounted for under the equity method. In June, 2003, Arbor Commercial Mortgage made two mezzanine loans secured by a second lien position in the ownership interests of the borrower and the property to this joint venture totaling $6.0 million outstanding. The loans require monthly interest payments based on LIBOR and mature in May 2006. Interest income recorded from these loans was approximately $8,000 for the period ended June 30, 2003.
Related Party Formation Transactions |
Arbor Commercial Mortgage contributed the majority of its structured finance portfolio to our operating partnership pursuant to a contribution agreement. The contribution agreement contains representations and warranties concerning the ownership and terms of the structured finance assets it contributed and other customary matters. Arbor Commercial Mortgage has agreed to indemnify us and our operating partnership against breaches of those representations and warranties.
In exchange for Arbor Commercial Mortgages asset contribution, we issued to Arbor Commercial Mortgage approximately 3.1 million operating partnership units, each of which Arbor Commercial Mortgage may redeem for one share of our common stock or an equivalent amount in cash, at our election, and approximately 629,000 warrants, each of which entitles Arbor Commercial Mortgage to purchase one additional operating partnership unit at an initial exercise price of $15. The operating partnership units and warrants for additional operating partnership units issued to Arbor Commercial Mortgage were valued at approximately $43.9 million at July 1, 2003, based on the price offered to investors in our units in the original offering, adjusted for the initial purchasers discount. We have also granted Arbor Commercial Mortgage certain demand and other registration rights with respect to the shares of common stock issuable upon redemption of its operating partnership units.
Each of the approximately 3.1 million operating partnership units received by Arbor Commercial Mortgage is paired with one share of our special voting preferred stock that entitles the holder to one vote on all matters submitted to a vote of our stockholders. As operating partnership units are redeemed for shares of our common stock or cash an equivalent number of shares of special voting preferred stock will be redeemed and cancelled. As a result of Arbor Commercial Mortgages asset contribution and the related formation transactions, Arbor Commercial Mortgage owns approximately a 28% limited partnership interest in our operating partnership and the remaining 72% interest in our operating partnership is owned by us. In addition, Arbor Commercial Mortgage has approximately 28% of the voting power of our outstanding stock (without giving effect to the exercise of Arbor Commercial Mortgages warrants for additional operating partnership units).
We and our operating partnership have entered into a management agreement with Arbor Commercial Mortgage pursuant to which Arbor Commercial Mortgage has agreed to provide us with structured finance investment opportunities and loan servicing as well as other services necessary to operate our business. Arbor Commercial Mortgage is also required to provide us with a right of first refusal with respect to all structured finance identified by Arbor Commercial Mortgage or its affiliates. We have agreed not to pursue, and to allow Arbor Commercial Mortgage to pursue, any real estate opportunities other than structured finance transactions. As discussed above in Managements Discussion & Analysis of Financial Condition and Results of Operations of Arbor Realty Trust, Inc. and Subsidiaries Liquidity and Capital Resources Contractual Commitments, we have agreed to pay our manager an annual base management fee and incentive compensation each fiscal quarter and share with Arbor Commercial Mortgage a portion of the origination fees that we receive on loans we originate with Arbor Commercial Mortgage pursuant to this agreement.
We and our operating partnership have also entered into a services agreement with Arbor Commercial Mortgage pursuant to which our asset management group provides asset management services to Arbor
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Quantitative and Qualitative Disclosures about Market Risk
Since the consummation of the original offering and the related formation transactions, substantially all of the operations of the structured finance business of Arbor Commercial Mortgage have been conducted by us. Therefore, quantitative and qualitative disclosures about market risk relating to the structured finance business of Arbor Commercial Mortgage is not presented. A description of market risks relating to our business is presented in the section of this prospectus entitled Managements Discussion & Analysis of Financial Condition and Results of Operations of Arbor Realty Trust, Inc. and Subsidiaries Quantitative and Qualitative Disclosures about Market Risk.
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ARBOR REALTY TRUST, INC.
We are a Maryland corporation that was formed in June 2003 to invest in real estate related bridge and mezzanine loans, preferred equity and, in limited cases, discounted mortgage notes and other real estate related assets. We conduct substantially all of our operations through our operating partnership. We will elect to be taxed as a REIT under the Internal Revenue Code and generally will not be subject to federal taxes on our income to the extent we distribute our income to our stockholders and maintain our qualification as a REIT.
On July 1, 2003, Arbor Commercial Mortgage contributed the majority of its structured finance portfolio to our operating partnership. These initial assets, consisting of 12 bridge loans, five mezzanine loans, five preferred equity investments and two other real estate related investments, were transferred at book value, which, at June 30, 2003, represented $213.1 million in assets financed by $169.2 million borrowed under Arbor Commercial Mortgages credit facilities, giving effect to notes payable equal to the financing amount available for each contributed investment under Arbor Commercial Mortgages credit facilities, and supported by $43.9 million in equity.
We are externally managed and advised by Arbor Commercial Mortgage. Our manager is a national commercial real estate finance company operating through 15 regional offices in the United States, specializing in debt and equity financing for multi-family and commercial real estate. We believe Arbor Commercial Mortgages experience and reputation positions it to originate attractive investment opportunities for us. Our management agreement with Arbor Commercial Mortgage was developed to capitalize on synergies with Arbor Commercial Mortgages origination infrastructure, existing business relationships and management expertise.
We believe the financing of multi-family and commercial real estate offers significant growth opportunities that demand customized financing solutions. Arbor Commercial Mortgage has granted us a right of first refusal to pursue all structured finance investment opportunities identified by Arbor Commercial Mortgage. Arbor Commercial Mortgage will continue to provide and service multi-family and commercial mortgage loans under Fannie Mae, Federal Housing Administration and conduit commercial lending programs, which we believe will offer customer relationship synergies to our business. Our portfolio currently contains loans and investments that we originated and loans and investments that we purchased from third parties or from affiliates.
We have a strong senior management team with significant industry experience. Mr. Ivan Kaufman, the chief executive officer of Arbor Commercial Mortgage, and Mr. Frederick Herbst, the chief financial officer of Arbor Commercial Mortgage, also serve as our chief executive officer and chief financial officer, respectively. Mr. Fred Weber, the head of the structured finance group at Arbor Commercial Mortgage since 1999, is our executive vice president of structured finance. Mr. Daniel M. Palmier, the head of Arbor Commercial Mortgages asset management group since 1997, is our executive vice president of asset management, and the eight additional employees who comprised the asset management group of Arbor Commercial Mortgage have also joined us. In October 2003, we hired Mr. John C. Kovarik as our chief credit officer. Messrs. Kaufman, Weber, Palmier and Kovarik serve as members of our credit committee, which has the authority to decide whether we will invest in an individual loan or security originated by Arbor Commercial Mortgage.
We believe the asset management groups involvement in our credit underwriting process helps to mitigate investment risk after the closing of a transaction. The asset management group is integrated into the underwriting and structuring process for all transactions in order to enhance the credit quality of our originations before a transaction closes. After the closing of structured finance transactions, the asset management groups experience in managing complex restructurings, refinancings and asset dispositions is used to improve the credit quality and yield on managed investments.
In connection with Arbor Commercial Mortgages contribution of the initial assets, Arbor Commercial Mortgage arranged for us to have substantially similar credit facilities as those used by Arbor Commercial Mortgage to finance these assets. In exchange for Arbor Commercial Mortgages asset contribution, we issued to Arbor Commercial Mortgage approximately 3.1 million operating partnership units, each of which Arbor
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Industry Overview
Multi-family and commercial real estate encompasses a wide spectrum of assets including multi-family, office, industrial, retail and hospitality properties. We believe there is strong growth potential in customized financing of multi-family and commercial real estate. Commercial mortgage banks have arranged a significant portion of the debt financing for commercial real estate. In the past decade, the commercial mortgage industry has experienced significant change, due in part to increasingly standardized underwriting requirements, more demanding borrowers and lenders and the growth of a market for securitized commercial real estate pools. We believe we have the necessary levels of capital and financial flexibility to compete effectively in todays rapidly changing market. Our borrowers, who in the past relied on banks and life insurance companies as their primary source for commercial real estate financing, have benefited from our flexible underwriting standards. This flexibility has created significant demand for bridge, mezzanine and other forms of innovative financing.
Our Business Strategy
We capitalize on this demand by investing in a diversified portfolio of structured finance assets in the multi-family and commercial real estate market. Our principal business objectives are to invest in bridge and mezzanine loans, preferred equity and other real estate related assets and actively manage this portfolio in order to generate cash available for distribution, facilitate capital appreciation and maximize total return to our stockholders. We believe we can achieve these objectives through the following business and growth strategies:
Provide Customized Financing. We provide financing customized to the needs of our borrowers. We target borrowers who have demonstrated a history of enhancing the value of the properties they operate, but whose options may be limited by conventional bank financing and who may benefit from the sophisticated structured finance products we offer. Historically, Arbor Commercial Mortgage has attempted to provide customized loan structures and other financing alternatives to fit the characteristics and purpose of each individual borrower and its financing requirements and we employ a similar strategy. | |
Use Arbor Commercial Mortgages Relationships with Existing Borrowers. We capitalize on Arbor Commercial Mortgages reputation in the commercial real estate finance industry. Arbor Commercial Mortgage has relationships with over 125 distinct borrowers nationwide. Since Arbor Commercial Mortgages originators offer Arbor Commercial Mortgages senior mortgage loans as well as our structured finance products, we are able to benefit from Arbor Commercial Mortgages existing customer base and use its senior lending business as a potential refinance vehicle for our structured finance assets. | |
Offer Broader Products and Expand Customer Base. We have the ability to offer a larger number of financing alternatives than Arbor Commercial Mortgage has been able to offer to its customers in the | |
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past. Our potential borrowers are able to choose from products offering longer maturities and larger principal amounts than Arbor Commercial Mortgage could previously offer. | |
Leverage Our Experience and the Experience of Arbor Commercial Mortgage. Our executive officers and employees, and those of Arbor Commercial Mortgage, have extensive experience originating and managing structured commercial real estate investments. Our senior management team has on average over 20 years experience in the financial services industry. Additionally, our executive officers have prior experience in managing and operating a public company, the predecessor company to Arbor Commercial Mortgage. | |
Manage and Maintain Credit Quality. A critical component of our success in the real estate finance sector is our ability to manage the real estate risk that is underwritten by our manager and us. We actively manage and maintain the credit quality of our portfolio by using the expertise of our asset management group, which has a proven track record of structuring and repositioning structured finance investments to improve the credit quality and yield on managed investments. | |
Focus on a Niche Market in Smaller Loan Balances. We focus on loans with principal amounts under $20 million, which many larger lending firms do not target. We can afford to invest the time and effort required to close loans with smaller principal amounts because of our relatively efficient cost structure. | |
Execute Transactions Rapidly. We act quickly and decisively on proposals, provide commitments and close transactions within a few weeks and sometimes days, if required. We believe that rapid execution attracts opportunities from both borrowers and other lenders that would not otherwise be available. We believe our ability to structure flexible terms and close loans in a timely manner gives us a competitive advantage over lending firms that also serve the market for loans with principal amounts under $20 million. |
Our Investment Guidelines
Our board of directors has adopted general guidelines for our investments and borrowings to the effect that:
| no investment will be made that would cause us to fail to qualify as a REIT; | |
| no investment will be made that would cause us to be regulated as an investment company under the Investment Company Act; | |
| no more than 25% of our equity, determined as of the date of such investment, will be invested in any single asset; | |
| our leverage will generally not exceed 80% of the value of our assets, in the aggregate; and | |
| we will not co-invest with our manager or any of its affiliates unless (i) our co-investment is otherwise in accordance with these guidelines and (ii) the terms of such co-investment are at least as favorable to us as to our manager or such affiliate (as applicable) making such co-investment. |
Our manager is required to seek the approval of a majority of the independent members of our board of directors before we engage in a material transaction with another entity managed by our manager. These investment guidelines may be changed by our board of directors without the approval of our stockholders.
Our Investment Strategy
We actively pursue lending and investment opportunities with property owners and developers who need interim financing until permanent financing can be obtained. We will initially target transactions under $20 million where we believe we have competitive advantages, particularly our lower cost structure and in house capabilities. Our structured finance investments generally have maturities of two to five years, depending on type, have extension options when appropriate, and generally require a balloon payment of principal at maturity. Borrowers in the market for these types of loans include, but are not limited to, owners
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We target borrowers with reputations for enhancing value, but whose options are limited by conventional bank financing and can benefit from the sophisticated financing products we offer. Loan structures vary as they are customized to fit the characteristics and purpose of the financing. Our structured finance assets are underwritten in accordance with guidelines designed to evaluate the borrower and its ability to satisfy the repayment conditions of the loan, including an analysis of the various repayment strategies available to the investment. In certain instances, especially in our mezzanine and preferred equity investments, we may underwrite investments based on a stabilized value of the underlying property.
Our investment program emphasizes the following general categories of real estate related activities:
Bridge Financing. We offer bridge financing products to borrowers who are typically seeking short term capital to be used in an acquisition of property. The borrower has usually identified an undervalued asset that has been under managed or is located in a recovering market. From the borrowers perspective, shorter term bridge financing is advantageous because it allows time to improve the property value through repositioning the property without encumbering it with restrictive long term debt. | |
The bridge loans we make typically range in size from $1 million to $25 million and are secured by first lien mortgages on the property. The term of the loan typically is up to five years. Historically, Arbor Commercial Mortgages spreads have ranged from 3.00% to 5.00% over 30-day LIBOR. Additional yield enhancements may include origination fees, deferred interest and participating interests, which are equity interests in the borrower that share in a percentage of the underlying cash flows of the property. Borrowers usually use the proceeds of a conventional mortgage to repay a bridge loan. | |
Mezzanine Financing. We offer mezzanine financing in the form of loans which are subordinate to a conventional first mortgage loan and senior to the borrowers equity in a transaction. Our mezzanine financing may take the form of pledges of ownership interests in entities that directly or indirectly control the real property or subordinated loans secured by second mortgages. We may also require additional collateral such as personal guarantees, letters of credit and/or additional collateral unrelated to the property. | |
Our mezzanine loans typically range in size from $2 million to $15 million and have terms of up to seven years. Historically, Arbor Commercial Mortgages spreads have ranged from 4.00% to 7.00% over 30-day LIBOR, occasionally with an interest rate floor. As in the case with our bridge loans, the yield on these investments may be enhanced by prepaid and deferred interest payments, yield look-backs and participating interests. | |
We intend to hold our mezzanine loans through our operating partnership or subsidiaries that are pass-through entities for tax purposes. However, we may hold some of our mezzanine loans in a taxable subsidiary corporation if necessary for REIT or other tax compliance. | |
Preferred Equity Investments. We provide financing by making preferred equity investments in entities that directly or indirectly own real property. In cases where the terms of a first Mortgage prohibit additional liens on the ownership entity, investments structured as preferred equity in the entity owning the property serve as viable financing substitutes. With preferred equity investments, we typically become a special limited partner or member in the ownership entity. | |
Real Property Acquisitions. We may purchase existing real estate for repositioning and/or renovation and then disposition at an anticipated significant return. From time to time, we may identify real estate investment opportunities. In these situations, we may act solely on our own behalf or in partnership with other investors. Typically, these transactions are analyzed with the expectation that we will have the ability to sell the property within a one to two year time period, achieving a significant return on invested capital. In connection with these transactions, speed of execution is often the most critical component to success. We may seek to finance a portion of the acquisition price through short term |
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financing. Repayment of the short term financing will either come from the sale of the property or conventional permanent debt. | |
Note Acquisitions. We may acquire real estate notes from lenders in situations where the borrower wishes to restructure and reposition its short term debt and the lender wishes, for a variety of reasons (such as risk mitigation, portfolio diversification or other strategic reasons), to divest certain assets from its portfolio. These notes will generally be acquired at a discount. In such cases, we intend to use our management resources to resolve any dispute concerning the note or the property securing it and to identify and resolve any existing operational or any other problems at the property. We will then either restructure the debt obligation for immediate resale or sale at a later date or reposition it for permanent financing. In some instances, we may take title to the property underlying the real estate note. | |
We borrow against or leverage our investments to the extent consistent with our investment guidelines in order to increase the size of our portfolio and potential returns to our stockholders. We have substantially similar credit facilities as used by Arbor Commercial Mortgage to finance the initial assets. We are currently in negotiations with the providers of the credit facilities to provide similar credit facilities and to increase the amounts available under these credit facilities, but there can be no assurance that we will be able to obtain additional financing. We may also sell participating interests in our investments. | |
In order to meet the REIT qualification requirements, or to avert the imposition of a 100% tax that applies to certain gains derived by a REIT from dealer property or inventory, we may hold some of our assets through taxable subsidiary corporations. See Federal Income Tax Considerations Taxation of Arbor Realty. |
Our Assets
We own a diversified portfolio of structured finance investments consisting principally of bridge and mezzanine loans as well as preferred equity investments. $167.6 million of $213.1 million of the loan or investment balance of the initial assets contributed by Arbor Commercial Mortgage are currently outstanding and constitute the majority of our existing portfolio. Since the commencement of our operations in July 2003, we have originated structured finance loans and investments and purchased additional loans and investments from Arbor Commercial Mortgage.
At September 30, we had 30 loans and investments in our portfolio, totaling $241 million. These loans and investments were for 23 multi-family properties, four hotels, two commercial properties and one co-op. There are no loans that are non-performing within the portfolio. We continue to actively manage every single loan in the portfolio and believe that our strict underwriting and active asset management enable us to maintain the credit quality of our portfolio.
The yield for our first quarter of operations ended September 30, 2003 was 7.65% on average assets of $244 million. Our average cost of funds for the quarter was 3.56% on average borrowings of $81 million. Our average equity (average assets less average borrowings) invested for the quarter was $163 million, resulting in average leverage for the quarter of 33%. The net interest income earned for the quarter yielded a 9.69% annualized return on the average equity invested during the quarter. As we add more loans and investments to our portfolio, we anticipate our leverage ratio, levered return and level of earnings will increase over time. Our business plan contemplates an increase of our leverage ratio to 65% to 70% over time. However, our leverage will not exceed 80% of the value of our assets in the aggregate unless approval to exceed the 80% limit is obtained from our board of directors.
The table on the following page lists the principal terms of each of our investments and the financing relating to each individual investment, each as of September 30, 2003.
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OUR ASSETS
Property Information | Investment Information | Funding Information | ||||||||||||||||||||||||||||||||||||
Origination | Maturity | Interest Pay | Interest | Interest | Interest | Profit | Advance | |||||||||||||||||||||||||||||||
Name | Type | Location | Balance | Date | Date | Rate Index | Rate(1) | Balance | Rate Index | Rate(2) | Share(2) | Rate | ||||||||||||||||||||||||||
Bridge Loans:
|
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130 West 30th
|
Multi-family | New York, NY | $ | 16,000,000 | 9/2001 | 5/2006 | Libor + 2.25% | 3.36% | $ | 15,000,000 | Libor + 1.50% | 2.62% | Yes | 93.75 | % | |||||||||||||||||||||||
1025 5th Avenue
|
Co-op | New York, NY | 1,100,000 | 10/2002 | 10/2003 | 18.00% | 18.00% | | | | No | | ||||||||||||||||||||||||||
Libor + 5.50% | ||||||||||||||||||||||||||||||||||||||
Concord and Henry
|
Multi- family/office |
Massachusetts | 5,000,000 | 4/2003 | 4/2004 |
Floor 7.00% Libor + 5.00% |
7.00% | 4,000,000 | Libor + 2.00% | 3.12% | No | 80.00 | % | |||||||||||||||||||||||||
Dylan Hotel
|
Hotel | New York, NY | 14,000,000 | 3/2003 | 3/2005 |
Floor 6.50% 50% of net spread less 0.50% asset |
6.50% | 9,800,000 | Libor + 2.00% | 3.12% | No | 70.00 | % | |||||||||||||||||||||||||
Less: Participation
|
(2,100,000 | ) | mgmt fee | (3.00 | )% | (1.56 | )% | |||||||||||||||||||||||||||||||
3.50% | 1.56% | |||||||||||||||||||||||||||||||||||||
Libor + 3.50% | Libor + 3.00% | |||||||||||||||||||||||||||||||||||||
Emerald Bay
|
Multi-family | Winter Park, FL | 15,400,000 | 5/2003 | 12/2004 | Floor 5.50% | 5.50% | 12,946,300 | Floor 4.25% | 4.25% | No | 84.07 | % | |||||||||||||||||||||||||
Libor + 3.00% | ||||||||||||||||||||||||||||||||||||||
Grand Plaza
|
Multi-family | Las Vegas, NV | 25,232,102 | 11/2002 | 12/2004 | Floor 5.25% | 5.25% | 18,723,511 | Libor + 2.00% | 3.12% | No | 74.21 | % | |||||||||||||||||||||||||
Libor + 6.65% | ||||||||||||||||||||||||||||||||||||||
Holiday Inn-Deland
|
Hotel | Deland, FL | 4,700,000 | 3/2000 | 4/2004 | Floor 12.50% | 12.50% | | Libor + 2.00% | | Yes | | ||||||||||||||||||||||||||
Indiana Portfolio
|
Multi-family | Indiana | 14,624,845 | 3/2003 | 3/2004 | Libor + 4.25% | 5.37% | 500,000 | Libor + 2.25% | 3.37% | No | 3.42 | % | |||||||||||||||||||||||||
Libor + 4.00% | ||||||||||||||||||||||||||||||||||||||
Palmetto Villas Apts
|
Multi-family | Ontario, CA | 9,130,000 | 5/2003 | 4/2005 | Floor 5.50% | 5.50% | 7,304,000 | Libor + 2.00% | 3.12% | No | 80.00 | % | |||||||||||||||||||||||||
Libor + 3.50% | ||||||||||||||||||||||||||||||||||||||
Partners Portfolio
|
Multi-family | Baltimore, MD | 14,200,000 | 4/2003 | 4/2006 | Floor 5.00% | 5.00% | | Libor + 2.00% | | Yes | | ||||||||||||||||||||||||||
Libor + 3.50% | ||||||||||||||||||||||||||||||||||||||
Tropical Gardens
|
Multi-family | Lauderdale Lakes, FL | 8,800,000 | 12/2002 | 12/2004 | Floor 5.50% | 5.50% | 7,040,000 | Libor + 2.00% | 3.12% | No | 80.00 | % | |||||||||||||||||||||||||
Libor + 3.00% | Libor + 2.00% | |||||||||||||||||||||||||||||||||||||
Vermillion Apts
|
Multi-family | Miami Lakes, FL | 18,850,000 | 9/2002 | 9/2004 |
Floor 5.00% Libor + 4.500% |
5.00% | | Libor Floor 2.50% | | No | | ||||||||||||||||||||||||||
Walbridge Terrace
|
Multi-family | San Francisco, CA | 6,200,000 | 7/2003 | 7/2004 | Floor 6.00% | 6.00% | | Libor + 2.00% | | No | | ||||||||||||||||||||||||||
Bridge Loans Total
|
$ | 151,136,947 | 5.38% | $ | 75,313,811 | 3.01% | ||||||||||||||||||||||||||||||||
(1) | Interest rate excludes deferred interest component. See asset descriptions for terms. |
(2) | Interest rate does not include deferred interest component due to profit sharing arrangements pursuant to our warehouse facility. See Managements Discussion & Analysis of Financial Condition and Results of Operations of Arbor Realty Trust, Inc. and Subsidiaries Liquidity and Capital Resources for a description of these profit sharing arrangements. |
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Property Information | Investment Information | Funding Information | ||||||||||||||||||||||||||||||||||||||||||||||
Origination | Maturity | Interest Pay | Interest | Interest | Interest | Profit | Advance | |||||||||||||||||||||||||||||||||||||||||
Name | Type | Location | Balance | Date | Date | Rate Index | Rate(1) | Balance | Rate Index | Rate(2) | Share(2) | Rate | ||||||||||||||||||||||||||||||||||||
Mezzanine Loans:
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Pay Libor + 3.50% | ||||||||||||||||||||||||||||||||||||||||||||||||
80 Evergreen Avenue
|
Commercial | Brooklyn, NY | $ | 2,500,000 | 6/2003 | 5/2006 | Floor Pay 5.00% Libor + 7.00% |
5.00 | % | | Libor + 2.25% |
| No | | ||||||||||||||||||||||||||||||||||
130 West 30th Street
|
Condo | New York, NY | 4,000,000 | 6/2003 | 5/2006 | Floor 10.00% Pay: Libor + 3.00% |
10.00 | % | | Floor 1.75% Libor + 4.00% |
| Yes | | |||||||||||||||||||||||||||||||||||
333 E. 34th Street
|
Multi-family | New York, NY | 10,000,000 | 1/2002 | 2/2004 | Floor Pay: 8.00% Pay Libor + 3.50% |
8.00 | % | | Libor Floor 2.00% | | Yes | | |||||||||||||||||||||||||||||||||||
930 Flushing Avenue
|
Commercial | Brooklyn, NY | 3,500,000 | 6/2003 | 5/2006 | Floor Pay 5.00% Libor + 6.75% |
5.00 | % | | | | No | | |||||||||||||||||||||||||||||||||||
Carltons Arms
|
Multi-family | Tampa, FL | 4,000,000 | 11/2001 | 12/2003 | Floor 12.00% Libor + 7.00% |
12.00 | % | | Libor + 2.25% Libor + 3.00% |
| Yes | | |||||||||||||||||||||||||||||||||||
The Crossings
|
Multi-family | Glassboro, NJ | 2,000,000 | 6/2003 | 6/2006 | Floor 10.00% Libor + 7.00% Floor 9.00% |
10.00 | % | | Floor 2.00% | | Yes | | |||||||||||||||||||||||||||||||||||
James Hotel
|
Hotel | Arizona | 2,220,491 | 8/2003 | 7/2006 | Cap 10.00% Libor + 4.50% (Year 1); Libor + 6.50% (Year 2); Libor + 7.50% (Year 3) |
9.00 | % | | | | No | | |||||||||||||||||||||||||||||||||||
Libor + 3.00% | ||||||||||||||||||||||||||||||||||||||||||||||||
Partners Portfolio
|
Multi-family | Baltimore, MD | 4,725,569 | 4/2003 | 5/2006 | Libor Floor 2.00% Libor + 5.25 |
6.50 | % | | Floor 2.00% Libor + 4.00% |
| Yes | | |||||||||||||||||||||||||||||||||||
Schron B
|
Multi-family | New Jersey | 3,000,000 | 5/2003 | 4/2005 | Floor 6.75% Libor + 5.50% (Year 1); Libor + 6.50% (Year 2); Libor + 7.50% (Year 3); |
6.75 | % | | Libor Floor 2.00% | | No | | |||||||||||||||||||||||||||||||||||
Libor + 2.25% | ||||||||||||||||||||||||||||||||||||||||||||||||
SMC Portfolio
|
Multi-family | Baltimore, MD | 11,520,000 | 9/2003 | 9/2005 | Libor Floor 2.00% | 7.50 | % | | Floor 1.75% | | Yes | | |||||||||||||||||||||||||||||||||||
Mezzanine Loans Total
|
$ | 47,466,060 | 7.91 | % | | | ||||||||||||||||||||||||||||||||||||||||||
(1) | Interest rate excludes deferred interest component. See asset descriptions for terms. |
(2) | Interest rate does not include deferred interest component due to profit sharing arrangements pursuant to our warehouse facility. See Managements Discussion & Analysis of Financial Condition and Results of Operations of Arbor Realty Trust, Inc. and Subsidiaries Liquidity and Capital Resources for a description of these profit sharing arrangements. |
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Property Information | Investment Information | Funding Information | |||||||||||||||||||||||||||||||||||||||||||
Origination | Maturity | Interest | Interest Rate | Interest | Profit | Advance | |||||||||||||||||||||||||||||||||||||||
Name | Type | Location | Balance | Date | Date | Interest Pay Rate Index | Rate(1) | Balance | Index | Rate(2) | Share(2) | Rate | |||||||||||||||||||||||||||||||||
Preferred Equity:
|
|||||||||||||||||||||||||||||||||||||||||||||
Libor + 4.50% | |||||||||||||||||||||||||||||||||||||||||||||
CDS Portfolio
|
Multi-family | Texas | $ | 4,991,001 | 12/1998 | 1/2004 |
Floor 9.56% Libor + 4.50% |
9.56% | $ | | Libor + 2.75% | | No | | |||||||||||||||||||||||||||||||
Devonshire Apts
|
Multi-family | Holyoke, MA | 2,500,000 | 1/2002 | 1/2005 |
Floor 10.00% Libor + 4.50% (Year 1); Libor + 6.50% (Year 2); Libor + 7.50% (Year 3) |
13.50% | | Libor + 2.25% | | Yes | | |||||||||||||||||||||||||||||||||
Libor + 3.00% | |||||||||||||||||||||||||||||||||||||||||||||
Dutch Village
|
Multi-family | Baltimore, MD | 7,074,431 | 6/2003 | 11/2006 | Libor Floor 2.00% | 6.50% | | Libor Floor 2.00% | | Yes | | |||||||||||||||||||||||||||||||||
Libor + 5.00% | |||||||||||||||||||||||||||||||||||||||||||||
Park Place
|
Multi-family | Santa Ana, CA | 3,860,000 | 1/2002 | 1/2005 |
Floor 12.00% Libor + 5.25% |
12.00% | | Libor + 2.25% | | Yes | | |||||||||||||||||||||||||||||||||
Schron A
|
Multi-family | New Jersey | 19,300,000 | 5/2003 | 4/2005 |
Floor 6.75% Libor + 6.00% |
6.75% | 16,600,000 | Libor + 2.75% | 3.87 | % | No | 86.01 | % | |||||||||||||||||||||||||||||||
Villages at Gateway
|
Multi-family | Denver, CO | 2,800,000 | 2/2002 | 3/2004 | Floor 10.00% | 10.00% | | Libor + 2.25% | | Yes | | |||||||||||||||||||||||||||||||||
Preferred Equity Total
|
$ | 40,525,432 | 8.19% | $ | 16,600,000 | 3.87 | |||||||||||||||||||||||||||||||||||||||
Other Investments
|
|||||||||||||||||||||||||||||||||||||||||||||
Albion
|
Hotel | Miami, FL | $ | 1,977,245 | 3/2001 | 8/2023 | 7.39% Fixed | 7.39% | | | | No | | ||||||||||||||||||||||||||||||||
Total Assets
|
$ | 241,105,684 | 6.34% | $ | 91,913,811 | 3.17 | % | ||||||||||||||||||||||||||||||||||||||
(1) | Interest rate excludes deferred interest component. See asset descriptions for terms. |
(2) | Interest rate does not include deferred interest component due to profit sharing arrangements pursuant to our warehouse facility. See Managements Discussion & Analysis of Financial Condition and Results of Operations of Arbor Realty Trust, Inc. and Subsidiaries Liquidity and Capital Resources for a description of these profit sharing arrangements. |
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A description of the terms and characteristics of each of the investments listed in the table above follows.
Bridge Loans
130 West 30th Street. Arbor Commercial Mortgage originated this $16.0 million bridge loan to 130 West 30th, LLC in September 2001 and contributed it to us upon the consummation of the original offering. The borrower used the proceeds to acquire an 18 story office building in New York, New York. It is currently undergoing construction to convert the building from office to residential condominiums using the Arbor Commercial Mortgage mezzanine loan proceeds purchased by us on July 1, 2003.
The loan bears interest at a variable rate of LIBOR plus 2.25%. In connection with Arbor Commercial Mortgage providing the borrower with additional mezzanine financing in June 2003, the maturity date of this bridge loan was extended to May 31, 2006. Interest payments are due monthly, and the principal balance is due in full upon maturity. The loan is secured by a first mortgage lien on the property. There is a limited guarantee on the loan of 50% by Mr. Ivan Kaufman and 50% by the key principal of the borrower.
The borrower has the option to extend the term of the loan for one 12 month period at no fee.
Arbor Commercial Mortgage holds a 50% membership interest in 130 West 30th, LLC which it did not contribute to us in connection with the asset contribution. This interest is used to partially fund a loan loss guarantee by Arbor Commercial Mortgage. See Participating Interests in Our Investments Retained by Arbor Commercial Mortgage below.
1025 5th Avenue. Arbor Commercial Mortgage originated this $1.1 million bridge loan in October 2002 and contributed it to us upon the consummation of the original offering. The borrowers used the loan proceeds to renovate an apartment in a cooperative building in New York, New York.
As of September 30, 2003, the loan bore interest at a fixed rate of 18.00% per annum and was scheduled to mature in October 2003. In October 2003, the maturity date of the loan was extended to October 2004 and the interest rate was reduced to 10.00%. Interest payments are due monthly and the principal balance is due in full upon maturity. The loan is secured by a pledge of 225 cooperative shares owned by the lessee of the apartment and the apartment lease.
Concord Street & Henry Terrace. Arbor Commercial Mortgage originated this $5.0 million bridge loan to Henry Terrace, LLC and 100 Concord St., LLC in April 2003 and contributed it to us upon the consummation of the original offering. The borrowers used the proceeds to refinance an existing loan on a 74 unit multi-family residential property in Worcester, Massachusetts and a commercial property in Framingham, Massachusetts.
The loan bears interest at a variable rate of LIBOR plus 5.50%, with a 7.00% floor, and matures in April 2004. Interest payments are due monthly, and the principal balance is due in full upon maturity. In addition, upon maturity or prepayment of the loan, the borrower must pay deferred interest equal to the greater of 2.00% on the original principal balance or the amount necessary to generate an aggregate annual internal rate of return of 14.00%. The loan is secured by a first mortgage lien on the properties.
The borrower has the option to extend the term of the loan for one 6 month period at no fee if the loan has an outstanding principal balance of not more than $1.5 million at the time the extension is requested.
Dylan Hotel. Arbor Commercial Mortgage refinanced a discounted loan between Debis Financial Services Inc. and Grand Palace Hotel at the Park LLC with a $14.0 million bridge loan to Grand Palace Hotel at the Park LLC in March 2003. Arbor Commercial Mortgage contributed this bridge loan to us upon the consummation of the original offering. The borrower is the owner of a 107 room hotel in New York, New York.
The loan bears interest at a variable rate of one month LIBOR plus 5.00% with a floor of 6.50%, and matures in March 2005. Interest payments are due monthly, and the principal balance is due in full upon maturity.
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In addition, upon maturity of the loan, the borrower must pay deferred interest of 1.00% on the principal repaid. The loan is secured by a first mortgage lien on the property.
The borrower has the option to extend the term of the loan for one 12 month period for additional interest of 1.00% on the outstanding principal balance upon such extension, but only if the borrower is in compliance with certain financial covenants.
Arbor Commercial Mortgage entered into a participation agreement with BD Hotels, LLC pursuant to which BD Hotels funded $2.1 million of the equity in the loan and is entitled to receive 50% of the net interest received by Arbor Commercial Mortgage, less a 0.50% management fee payable to Arbor Commercial Mortgage.
Emerald Bay Apartments. Arbor Commercial Mortgage originated this $16.4 million bridge loan to Empirian Bay LLC in May 2003 and contributed it to us upon the consummation of the original offering. The borrower used the loan proceeds to acquire and renovate a 432 unit multi family property in Winter Park, Florida. Of the total loan amount, $15.4 million has been disbursed and the remaining $1.0 million will be released as the renovations to the property are completed.
The loan bears interest on the outstanding balance at a variable rate of LIBOR plus 3.50%, with a floor of 5.50% and matures in December 2004. Interest payments are due monthly, and the borrower must make monthly principal payments of $21,000 until June 2004 and $30,000 from July 2004 through November 2004, with the balance due upon maturity. In addition, if the loan is repaid within the first 14 months after its origination, the borrower must pay deferred interest of .50%, and if the loan is repaid after this time, the borrower must pay deferred interest of 1.00%. The loan is secured by a first mortgage lien on the property and has been unconditionally guaranteed by certain affiliates of the borrower.
The borrower has an option to extend the term of the loan for one 6-month period for additional interest of 1.00% on the outstanding principal balance upon such extension and, if the first option is exercised, an option to extend for an additional 12-month period for additional interest of 1.00% on the outstanding principal balance upon such extension. If the initial term is extended, the borrower must pay interest monthly and make monthly principal payments of $30,000 from December 2004 to June 2005 and $75,000 from July 2005 through May 2006.
The loan is financed with a $16.2 million participation agreement with one of our lending partners pursuant to which we have a first loss position of $1.0 million. Of this participation amount, $12.9 million is currently outstanding. The participant is paid interest at a variable rate of LIBOR plus 3.00%, with a floor of 4.25%.
In December 2003, this bridge loan, together with all interest due, was repaid in full.
Grand Plaza. Arbor Commercial Mortgage originated a $25.5 million bridge loan to Grand Plaza Limited Partnership in November 2002 and contributed it to us upon the consummation of the original offering. The borrower used the loan proceeds to refinance outstanding debt on a 676 unit multifamily residential property located in Las Vegas, Nevada. The current outstanding balance on the loan is approximately $25.2 million.
The loan bears interest at a variable rate of LIBOR plus 3.00%, with a floor of 5.25%, and matures in December 2004. Interest and principal payments are due monthly. The loan is secured by a first mortgage lien on the property.
The borrower has the option to extend the term of the loan for one 12-month period at no fee.
Holiday Inn Convention Center. Arbor Commercial Mortgage originated this $5.7 million bridge loan to Hospitality Associates of DeLand Florida, Ltd. in March 2000 and contributed it to us upon the consummation of the original offering. The borrower used the loan proceeds to acquire and renovate the Holiday Inn Convention Center, a 148 room hotel in DeLand, Florida, as well as fund a $1.1 million capital improvements program. In connection with the extension of the maturity date, the borrower repaid $1.0 million of the outstanding principal balance, to $4.7 million.
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The loan bears interest at a variable rate of LIBOR plus 6.65% with a floor of 12.50%, and matures in April 2004. Interest payments are due monthly, and the principal balance is due in full upon maturity. In addition, upon maturity or prepayment of the loan, the borrower must pay deferred interest of 3.00% on the principal repaid. The loan is secured by a first mortgage lien on the property, a pledge of the partnership interests of the borrower and a pledge of the membership interests of certain of the borrowers affiliates.
Since the loan was not paid off by July 1, 2003, the borrower was required to pay additional interest of 0.50% on the outstanding principal balance. In October 2003, this bridge loan, together with all interest due, was repaid in full.
Indiana Portfolio. Arbor Commercial Mortgage originated a $13.75 million bridge loan to NSH Affordable Housing of Indiana, Inc. in March 2003 and contributed it to us upon the consummation of the original offering. The borrower used the loan proceeds to acquire four affordable housing multi family properties located in Evansville, Indianapolis and Marion, Indiana.
The loan bears interest at a variable rate of one month LIBOR plus 4.25% and matures in March 2004. Interest payments are due monthly, and the principal balance is due in full upon maturity. The loan is secured by a first mortgage lien on the properties.
Arbor Commercial Mortgage also originated a separate $1.2 million bridge loan to the same borrower to fund renovations on the four properties described above. This loan also bears interest at a variable rate of one month LIBOR plus 4.25% and matures in March 2004. Interest payments on amounts drawn on the loan are due monthly, and the principal balance is due in full upon maturity. As of September 30, 2003, the outstanding principal balance was approximately $875,000. This loan is also secured by a first mortgage lien on the properties.
Palmetto Villas Apartments. Arbor Commercial Mortgage originated this $9.1 million bridge loan to Palmetto Villas Investors, LLC in May 2003 and contributed it to us upon the consummation of the original offering. The borrower used the loan proceeds to acquire and renovate a 134 unit multi family residential property in Ontario, California.
The loan bears interest at a variable rate of one month LIBOR plus 4.00%, with a floor of 5.50%, and matures in April 2005. Interest payments are due monthly, and the principal balance is due in full upon maturity. In addition, upon maturity or prepayment of the loan, the borrower must pay deferred interest of 1.00% on the principal repaid. The loan is secured by a first mortgage lien on the property.
The borrower has the option to extend the term of the loan for two 6 month periods. If the loan is extended the interest rate will increase to one month LIBOR plus 4.50%, with a floor of 6.00%. Additionally, the borrower must pay additional interest of .50% on the outstanding principal balance upon each such extension.
Partners Portfolio Bridge Loan. Arbor Commercial Mortgage originated this $14.2 million bridge loan to SRH/ LA Chesapeake Apartments L.P., SRH/ LA Nottingham, LLC, SRH/ LA Hunter, LLC and SRH/ LA Melvin, LLC in April 2003. Arbor Commercial Mortgage contributed this bridge loan to us upon the consummation of the original offering. The borrowers used the loan proceeds to acquire this 391 unit multi family residential portfolio, consisting of three properties in Baltimore, Maryland and fund a $1.6 million capital improvement program.
The loan bears interest at a variable rate of LIBOR plus 3.50% with a floor of 5.00%, and matures in April 2006. Interest payments are due monthly, and the principal balance is due in full upon maturity. In addition, upon maturity or prepayment of the loan, the borrowers must pay deferred interest of 1.00% on the principal repaid. The loan is secured by a first mortgage lien on each of the properties and partnership interests in certain affiliates of the borrower and a pledge of the cash flow of certain other properties.
Tropical Gardens Apartments. Arbor Commercial Mortgage originated this $8.8 million bridge loan to NHP Tropical Gardens Limited Partnership in December 2002 and contributed it to us upon the consummation of the original offering. The borrower used the loan proceeds to acquire and renovate a 245 unit multi family residential property located in Lauderdale Lakes, Florida.
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The loan bears interest at a variable rate of LIBOR plus 3.50%, with a floor of 5.50%, and matures in December 2004. Interest payments are due monthly, and the principal balance is due in full upon maturity. In addition, upon maturity or prepayment of the loan, the borrower must pay deferred interest of 1.00% on the principal repaid. The loan is secured by a first mortgage lien on the property.
Vermillion Apartments. Arbor Commercial Mortgage originated this $18.9 million bridge loan to SRH Vermillion Limited Partnership in September 2002 and contributed it to us upon the consummation of the original offering. The borrower used the loan proceeds to acquire a 330 unit multi family residential property located in Miami Lakes, Florida and fund a $1.3 million capital improvement program.
The loan bears interest at a variable rate of LIBOR plus 3.00%, with a floor of 5.00%, and matures in September 2004. Interest payments are due monthly and the principal balance is due in full upon maturity. The borrower must pay 0.50% of additional interest in September 2003, and 1.00% of deferred interest upon the prepayment or maturity of the loan unless the loan is refinanced with permanent financing from Arbor Commercial Mortgage in which case, the deferred interest will be waived, and Arbor Commercial Mortgage will reduce the management fee payable by us to Arbor Commercial Mortgage by an amount equal to 50% of the deferred interest waived. The loan is secured by a first mortgage lien on the property. An affiliate of the borrower has also provided a $1.5 million guarantee contingent upon the financial performance of the property. In October 2003, this bridge loan, together with interest due, was repaid in full.
Walbridge Terrace. We originated this $6.2 million bridge loan to Silver Lake Apartments, LLC in July 2003. The borrower used the loan proceeds to repay the existing construction loan and complete construction of this 40-unit senior housing property with 6,500 square feet of ground floor retail space in San Francisco, California.
The loan bears a variable rate of interest of LIBOR plus 4.50%, with a 6.00% floor, and matures in July 2004. The borrower paid a 2.00% origination fee on the date the loan closed. In accordance with our management agreement with Arbor Commercial Mortgage, the first 1.00% was paid to Arbor Commercial Mortgage and we retained the remaining 1.00%. The borrower must pay 1.00% of deferred interest upon the prepayment or maturity of the loan unless the loan is refinanced with permanent financing from Arbor Commercial Mortgage in which case, the deferred interest will be waived, and Arbor Commercial Mortgage will reduce the management fee payable by us to Arbor Commercial Mortgage by an amount equal to 50% of the deferred interest waived. The loan is secured by a first mortgage lien on the property and has been unconditionally guaranteed by key principals of the borrower.
Mezzanine Loans
80 Evergreen. Arbor Commercial Mortgage originated this $2.5 million mezzanine loan in June 2003. We purchased this loan from Arbor Commercial Mortgage effective August 1, 2003. The borrower used the loan proceeds to acquire and make repairs to a 77,680 square foot warehouse/ industrial space located in Brooklyn, New York.
The loan bears a variable rate of interest of one-month LIBOR plus 8.00% with a floor of 9.50% and matures in May 2006. The borrower has the option to remit interest at a rate of LIBOR plus 3.50% with a 5.00% floor and to accrue the differential interest owed. Interest payments are due monthly, and the principal balance is due in full upon maturity. The loan is secured by a junior lien on the property. The loan is subordinate to a $1.6 million first mortgage lien held by a third party lender.
In connection with our refinancing of this mezzanine loan and the first mortgage lien in October 2003, this loan was repaid in full and replaced with a $4.8 million bridge loan made by us. The new bridge loan bears a variable rate of interest on one-month LIBOR plus 4.75% and will mature in May 2006.
The borrower has the option to extend the term of the loan for two 12-month periods at no fee.
130 West 30th Street. In connection with Arbor Commercial Mortgages refinancing of the $16.0 million bridge loan to 130 West 30th, LLC on June 19, 2003, Arbor Commercial Mortgage agreed to provide the borrower with additional mezzanine financing in the amount of up to $8.0 million. This mezzanine loan
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The additional financing will allow for the renovation/ conversion of the office building to residential condominiums. The estimated cost of the construction project is $14.0 million, and it is estimated that the project will be completed by the end of the first quarter of 2004. Additional funds to complete construction are anticipated to come from the sales of the condominium units, cash flow from the operations and partner equity contributions.
The mezzanine financing bears interest at a variable rate of one-month LIBOR plus 7.00%, with a floor of 10.00%, and will be funded in two equal installments of $4.0 million. The two key principals will each contribute $1.0 million before either component is funded. The funding will be drawn down as construction progresses. The interest on the first component, which has been funded, will be earned on the full $4.0 million, while the interest on the second component, which had not yet been funded as of September 30, 2003, will be earned as the $4.0 million is drawn down. Currently, $3.8 million of the second component has yet to be funded. The unfounded portion of the second component will remain unfunded unless a specified number of condominiums have been sold. The additional financing is secured by a second mortgage lien on the property.
333 East 34th Street. Arbor Commercial Mortgage originated this $10.0 million mezzanine loan to 333 East 34th, LLC in January 2002 and contributed it to us upon consummation of the original offering. The borrower used the loan proceeds to acquire and renovate a multi family residential building located in New York. The borrower is converting the New York rental property into condominiums.
The loan bears a variable rate of interest of one month LIBOR plus 5.00%, with a 12.50% floor, and matures in February 2004. The borrower has the option to remit interest at a rate of LIBOR plus 3.00% with an 8.00% floor and to accrue the differential interest owed, which compounds at an annual rate of 12.50%. Interest payments are due monthly, and the principal balance is due in full upon maturity. The loan is secured by a pledge of the membership interests in the borrower, and two affiliates of the borrower have personally guaranteed the loan for up to $1.0 million. The loan is subordinate to a $31.0 million first mortgage lien held by a third party lender.
The borrower has the option to extend the term of the loan for three, 12-month periods, the second of which requires a payment of additional interest of $300,000.
Arbor Commercial Mortgage holds a 15% interest in the property which it did not contribute to us in connection with the asset contribution. This interest is used to partially fund a loan loss guarantee by Arbor Commercial Mortgage. See Participating Interests in Our Investments Retained by Arbor Commercial Mortgage below.
930 Flushing Avenue. Arbor Commercial Mortgage originated this $3.5 million mezzanine loan in June 2003. We purchased this loan from Arbor Commercial Mortgage effective August 1, 2003. The borrower used the loan proceeds to acquire the 300,000 square foot warehouse/ industrial space located in Brooklyn, New York.
The loan bears a variable rate of interest of one-month LIBOR plus 8.00% with a floor of 9.50% and matures in May 2006. The borrower has the option to remit interest at a rate of LIBOR plus 3.50% with a 5.00% floor and to accrue the differential interest owed. Interest payments are due monthly, and the principal balance is due in full upon maturity. The loan is secured by a junior lien on the property. The loan is subordinate to a $7.7 million first mortgage lien held by a third party lender.
The borrower has the option to extend the term of the loan for two 12-month periods for additional interest of 3.00% of the outstanding principal balance upon exercise of each extension.
Carlton Arms Apartments. Arbor Commercial Mortgage originated this $4.0 million mezzanine loan to HRA Egypt Lake, Inc. and Carlton Arms, LLC in November 2001 and contributed it to us upon consummation of the original offering. The borrowers used the loan proceeds to refinance the existing debt on a 650 unit apartment complex located in Tampa, Florida.
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The loan bears interest at a variable rate of one month LIBOR plus 6.75%, with a floor of 12.00%, and matures in December 2003. Interest payments are due monthly and since January 2002, the borrower has made principal payments from excess cash flow, with the unpaid principal balance due in full upon maturity. In addition, upon maturity or prepayment of the loan, the borrowers must pay deferred interest of $840,000 on the principal repaid. This deferred interest has not been accrued. Upon the maturity of this loan, we will allocate a portion of the amount received to our manager pro-rata based on the time frame this loan was held by our manager prior to Arbor Commercial Mortgages asset contribution. The loan is secured by a pledge of the membership interests in the borrower. The loan is subordinate to an approximately $21.4 million first mortgage lien held by a third party lender. The borrowers have the option to extend the term of the loan for up to six months with no additional interest due.
In connection with our refinancing of this $4.0 million mezzanine loan and the first mortgage lien in October 2003, this loan was repaid in full, including all deferred interest due, a portion of which we allocated to Arbor Commercial Mortgage pro rata for the timeframe it held the loan. We replaced the loan with a $27 million bridge loan made by us, which has an initial term of 24 months with one 12-month extension. The borrower must pay additional interest of 1.00% on the outstanding principal balance upon such extension. The borrower paid a 1.50% origination fee on the date the loan closed. In accordance with our management agreement with Arbor Commercial Mortgage, the first 1.00% was paid to Arbor Commercial Mortgage and we retained the remaining 0.50%. In addition, upon maturity or prepayment of the loan, the borrower must pay deferred interest of 1.50% of the principal repaid.
The new bridge loan is bifurcated into two notes. Note A, for $21.5 million, bears a variable rate of interest of LIBOR plus 3.50% with a 5.00% floor. Note B, for $5.5 million, bears a variable rate of interest of LIBOR plus 6.50% with an 8.50% floor. Note A must be repaid before Note B may be repaid. Note B contains a first loss guaranty by the key principal for the $5.5 million loan amount.
The Crossings Apartments. Arbor Commercial Mortgage originated this $2.0 million mezzanine loan to Audubon-Glassboro, LLC in June 2003. We purchased this loan from Arbor Commercial Mortgage on July 1, 2003 with a portion of the net proceeds from the original offering. The borrowers used the loan proceeds to acquire and renovate a 328-unit multi-family apartment complex located in Glassboro, Gloucester County, New Jersey.
The loan bears interest at a variable rate of LIBOR plus 7.00%, with a 10.00% floor, and matures in June 2006. Interest payments are due monthly, and the unpaid principal balance is due in full upon maturity. In addition, upon maturity or prepayment of the loan, the borrower must pay deferred interest equal to the amount necessary to provide an aggregate annual internal rate of return of 13.00%. The loan is secured by a pledge of membership interest in the borrowing entity. The loan is subordinate to a $11.0 million first mortgage loan on the property held by a third party lender.
The borrower has the option to extend the term of the loan for two 12-month periods upon payment of additional interest of $30,000, for the first extension, and $50,000, for the second extension, if the borrower is in compliance with certain financial covenants.
James Hotel. We originated this $6.6 million mezzanine loan to James Hotel Scottsdale, LLC in August 2003. The borrower is currently using the loan proceeds to renovate this recently acquired 206-room independent hotel located in Scottsdale, Arizona.
The loan bears a variable rate of interest of LIBOR plus 7.00%, with a 9.00% floor and a 10.00% cap. The loan matures in July 2006. The borrower paid a 2.00% origination fee on the date the loan closed. In accordance with our management agreement with Arbor Commercial Mortgage, the first 1.00% was paid to Arbor Commercial Mortgage and we retained the remaining 1.00%. Interest payments are due monthly, and the principal balance is due in full upon maturity. In addition, upon maturity of the loan, the borrower must pay deferred interest in an amount necessary to generate an aggregate annual internal rate of return of 18.00%. The loan is secured by a pledge of the membership interests in the borrower. The loan is subordinate to a $5.0 million first mortgage lien and a $5.0 million second mortgage lien held by a third party lender.
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Of the $6.6 million loan, $2.2 million had been funded and we had retained the remaining $4.4 million in a renovation reserve account as of September 30, 2003. Currently, the $6.6 million loan has been fully funded. These funds will be disbursed as required for the renovation. For the first ninety days, interest will be earned on only the disbursed proceeds; thereafter, interest will be earned on $6.6 million.
The borrower has the option to extend the term of the loan for one additional 12-month period for additional interest payment of 1.00% on the outstanding principal balance upon such extension.
Partners Portfolio. Arbor Commercial Mortgage originated this $4.7 million mezzanine loan to SRH/LA Chesapeake Apartments L.P., SRH/LA Nottingham, LLC, SRH/LA Hunter, LLC and SRH/ LA Melvin, LLC in April 2003. Arbor Commercial Mortgage contributed this loan to us upon consummation of the original offering. The borrowers used the loan proceeds to acquire this 443 unit multi family residential portfolio consisting of two properties in Baltimore, Maryland.
The loan bears interest at a variable rate of (1) in the first year, LIBOR plus 4.50%, with a floor of 6.50% (2) in the second year, LIBOR plus 6.50%, with a floor of 8.50% and (3) in the third year, LIBOR plus 7.50%, with a floor of 9.50%. The loan matures in May 2006. Interest payments are due monthly, and the principal balance is due in full upon maturity. In addition, upon maturity or prepayment of the loan, the borrowers must pay deferred interest of 1.0% on the principal repaid. The loan is secured by a pledge of partnership interests of the above entities and a pledge of the cash flows of certain affiliates of the borrower.
Schron Portfolio B. Arbor Commercial Mortgage originated this $8.5 million mezzanine loan to Central Jersey Sub VII LLC in August 2000 and contributed it to us upon consummation of the original offering. The borrower used the loan proceeds to acquire and renovate two multi family properties in New Jersey. The loan has been modified twice, first in October 2002 in connection with the repayment of $5.5 million of outstanding principal, and in May 2003 to extend the term.
The loan bears interest at a variable rate of LIBOR plus 5.25%, with a floor of 6.75%, and matures in April 2005. Interest payments are due monthly, and the principal balance is due in full upon maturity. The loan is secured by the ownership interests of certain affiliates of the borrower. The loan is subordinate to a first mortgage lien with a current unpaid principal balance of approximately $14.0 million.
The borrower has the option to extend the term of the loan for three one-year periods at no fee.
Arbor Commercial Mortgage holds an 18% interest in the properties which it did not contribute to us in connection with the asset contribution. This interest is used to partially fund a loan loss guarantee by Arbor Commercial Mortgage. See Participating Interests in Our Investments Retained by Arbor Commercial Mortgage below.
SMC Portfolio. We originated this $11.5 million mezzanine loan to various entities owned by Sawyer Realty Holdings, LLC in September 2003. The borrowers used the loan proceeds to refinance the existing mezzanine debt and make certain renovations to this 1,951-unit multi-family residential portfolio consisting of five properties in Baltimore, Maryland.
The loan bears interest at a variable rate of (1) in the first year, LIBOR plus 5.50%, with a floor of 7.50% (2) in the second year, LIBOR plus 6.50%, with a floor of 8.50% and (3) in the third year, if it is extended, LIBOR plus 7.50%, with a floor of 9.50%. The loan matures in September 2005. Interest payments are due monthly, and the principal balance is due in full upon maturity. In addition, upon maturity or prepayment of the loan, the borrower must pay deferred interest of 1.0% on the principal repaid. The loan is secured by a pledge of the membership interests in the borrowers as well as cash flow from another eight properties with first mortgage financing through Arbor Commercial Mortgages Fannie Mae DUS lending program. The loan is subordinate to $59.2 million of first mortgage liens held by third party lenders.
The borrowers have the option to extend the term of the loan for three 12-month periods, the first of which requires a payment of additional interest of 1% of the outstanding principal balance upon such extension.
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Preferred Equity Investments
CDS Texas Portfolio. Arbor Commercial Mortgage made this preferred equity investment in December 1998 and contributed it to us upon consummation of the original offering. This investment facilitated the acquisition and renovation of a nine property portfolio (Sea Breeze, Autumn Manor, Malibu, Lake Crest, Santa Fe, La Mesa, Trevino, Apache Arms and Harvard) containing 1,347 units located in Austin and El Paso, Texas. The investment was originally funded in the amount of $11.3 million. Subsequently, the property owner refinanced Lake Crest, Trevino, and Apache Arms and sold Harvard to reduce the principal balance. As of September 30, 2003, the outstanding equity balance was $5.0 million. The current outstanding equity balance is $4.3 million. The properties are also security to debt amounting to $12.8 million held by third party lenders.
The investment bears a preferred return at a variable rate of six month LIBOR plus 4.50%, with a floor of 9.56%. The investment is required to be repurchased in January 2004 and upon such repurchase, the holder of the preferred interest is entitled to receive an additional preferred return of 2.00%.
Devonshire Apartments. Arbor Commercial Mortgage made this $2.5 million preferred equity investment in January 2002 in Merchant Devonshire Limited Partnership, the owner of a 180-unit multi family residential property in Holyoke, Massachusetts. Arbor Commercial Mortgage contributed this investment to us upon consummation of the original offering. The investment proceeds were used in connection with the acquisition of an office building in Hartford, Connecticut for approximately $23.3 million.
The investment bears a preferred return at a variable rate of LIBOR plus 7.50%, with a floor of 13.50%. The borrower has the option of remitting the preferred return at a pay rate of LIBOR plus 4.50% with a 10.00% floor and to accrue the differential owed. The preferred interest is required to be repurchased in January 2005, although such date may be extended for one, 12-month period without payment of a fee. The property secures a first mortgage lien with a current unpaid principal balance of approximately $5.4 million. In October 2003, this investment, together with all preferred return then due, was repaid in full.
Dutch Village Preferred Equity. Arbor Commercial Mortgage made this $7.1 million preferred equity investment in SRH/LA Chesapeake Apartments, L.P., and Partners of Dutch, Inc. We purchased this investment from Arbor Commercial Mortgage on July 1, 2003 with a portion of the net proceeds from the original offering.
The investment proceeds will be used to acquire a 544-unit multi-family apartment complex located in Baltimore, Maryland. The investment provides a variable rate return of (1) LIBOR plus 4.50%, with a floor of 6.50%, in the first year, (2) LIBOR plus 6.50%, with a floor of 8.50%, in the second year and (3) LIBOR plus 7.50%, with a floor of 9.50%, in the third year. Although the company in which we have made this investment is required to redeem the preferred equity investment in November 2006, this date may be extended by the company upon the exercise of three one-year extension periods. Upon the redemption, either on the redemption date or prior to such date, of the preferred equity investment, the company is required to pay an additional return of 1.00% on the original investment amount. The property is subject to a first mortgage lien with a current unpaid principal balance of $11.7 million held by a third party lender.
Park Place Apartments. Arbor Commercial Mortgage made this $3.9 million preferred equity investment in January 2002 in Santa Ana Park Place Associates LLC, the owner of a 196 unit multi family residential building in Santa Ana, California, that also contains 7 retail units. Arbor Commercial Mortgage contributed this investment to us upon consummation of the original offering.
The investment proceeds were used to acquire and renovate the property. The owner has completed its improvements and currently has the property on the market. The investment bears a preferred return at a fixed rate of 16.00%, compounded monthly, although the owner has the option of remitting the preferred return at a pay rate of LIBOR plus 5.00%, with a 12.00% per annum floor and to accrue the differential owed, which compounds at an aggregate annual rate of 16.00%. The owner is required to repurchase the preferred interest in January 2005, although such date may be extended for one, 12-month period for a fee of $50,000. The property is subject to a first mortgage lien with a current unpaid principal balance of $10.7 million. As security
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Schron Portfolio A. Arbor Commercial Mortgage made a $19.3 million preferred equity investment in Central Jersey Prime Holdings LLC in May 2003 and contributed it to us upon consummation of the original offering. Arbor Commercial Mortgage had originally invested in May 2000 and also had an investment with a related party which was combined with this investment in May 2003. The investment proceeds were originally used to acquire 13 multi-family properties located throughout the state of New Jersey.
The investment bears a preferred return at a variable rate of LIBOR plus 5.25%, with a floor of 6.75%. The investment must be repurchased in April 2005, although the owner has the option to extend this obligation for three one year periods with no additional return. The properties are subject to a first Mortgage lien with a current unpaid principal balance of approximately $189.3 million.
Arbor Commercial Mortgage holds an 18% interest in the properties which it did not transfer to us in connection with the asset contribution. This interest is used to partially fund a loan loss guarantee by Arbor Commercial Mortgage. See Participating Interests in Our Investments Retained by Arbor Commercial Mortgage below.
Villages at Gateway. Arbor Commercial Mortgage made this $4.3 million preferred equity investment in February 2002 in BP C04 Property Associates, LLC, the owner of a 764 unit multi family residential property in Denver, Colorado. Arbor Commercial Mortgage contributed this investment to us upon consummation of the original offering. The owner used the proceeds to acquire and renovate the property. The investment was originally made in two components of $1.5 million and $2.8 million, one of which was repurchased by the owner leaving $2.8 million outstanding.
The investment bears a preferred return at a variable rate of LIBOR plus 6.00%, with a floor of 10.00%. The equity interest must be repurchased by the owner in March 2004, although the owner has the option to extend the repurchase date for one 12-month period at no additional return, followed by two six-month extensions subject to an additional return of $126,000 for the first and $140,000 for the second extension. The property secures a first mortgage lien with a current unpaid principal balance of approximately $23.4 million.
Upon repurchase of the interests, the owner must make an additional distribution, depending upon the year of repurchase: $100,240 during the first year, $300,160 during the second year and $529,760 during the third year and beyond. This additional distribution has not been accrued. Upon receipt of this additional distribution, we will allocate a portion of the amount received to our manager pro rata based on the time frame this investment was held by our manager prior to Arbor Commercial Mortgages asset contribution.
Other Investments
Albion. Upon consummation of the original offering, Arbor Commercial Mortgage contributed to us the B note of a bifurcated bridge loan that it made to Albion Associates, LTD in August 1998. The borrower used the proceeds of the original loan to acquire and renovate a 96 room hotel in Miami Beach, Florida.
The B note, which currently has an unpaid balance of approximately $2.0 million, bears interest at a fixed rate of 7.39% is amortized over 30 years, and matures in September 2023. However, if the loan is not repaid by September 2008, the interest rate is increased by 5.00% and additional provisions regarding the allocations of the borrowers cash flow become effective. Pursuant to an agreement with the holder of the A note, a third party lender, the B note is subordinate to the A note with respect to the right to receive payments of interest and principal. In addition, following an event of default, the B note holder is subject to a standstill whereby the B note holder cannot exercise its remedies to realize upon the collateral until such time that all interest, principal, fees and costs are fully repaid to the A note holder.
Arbor Commercial Mortgages Retained Interests in Our Investments
At the time of Arbor Commercial Mortgages origination of three of the assets contributed to us upon consummation of the original offering, the 333 East 34th Street and Schron B mezzanine loans and the
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The principal amount for each contributed investment protected by this payment obligation is equal to the principal balance of the investment at the time of contribution, plus the investments interest expense paid by us in cash since contribution, less the investment income and deferred interest or preferred return received by us in cash since contribution.
Operations
Our Managers Investment Services |
Under the management agreement, Arbor Commercial Mortgage is responsible for sourcing originations, providing underwriting services and processing approvals for all loans and other investments in our portfolio. Arbor Commercial Mortgage also provides certain administrative loan servicing functions with respect to our loans and investments. We are able to capitalize on Arbor Commercial Mortgages well established operations and services in each of these areas as described below.
Origination |
Our manager will source the origination of most of our investments. Arbor Commercial Mortgage serves its markets directly through its network of 14 sales offices located in Atlanta, Georgia; Bethesda, Maryland; Bloomfield Hills, Michigan; Boca Raton, Florida; Boston, Massachusetts; Chicago, Illinois; Dallas, Texas; Denver, Colorado; Los Angeles, California; Rochester, New York; San Clement, California; New York, New York; San Francisco, California; and Uniondale, New York. These offices are staffed by approximately 20 loan originators, each of which are employed by our manager, who solicit property owners, developers and mortgage loan brokers. In some instances the originators accept loan applications meeting our underwriting criteria from a select group of mortgage loan brokers. While a large portion of Arbor Commercial Mortgages marketing effort occurs at the branch level, Arbor Commercial Mortgage also markets its products in industry publications and targeted direct mailings. Our manager markets structured finance products as our product offerings using the same methods.
Once potential borrowers have been identified, Arbor Commercial Mortgage determines which financing products best meet the borrowers needs. Loan originators in every branch office are able to offer borrowers the full array of Arbor Commercial Mortgages financing products and our structured finance products. After identifying a suitable product, Arbor Commercial Mortgage works with the borrower to prepare a loan application. Upon completion by the borrower, the application is forwarded to Arbor Commercial Mortgages underwriters for due diligence. See Underwriting.
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Underwriting |
Our managers loan originators work in conjunction with underwriters who are also employed by our manager. These underwriters have the responsibility to perform due diligence on all proposed transactions prior to loan approval and commitment. Upon receipt of each new loan application, the underwriter analyzes it in accordance with the guidelines set forth below in order to determine the loans conformance and suitability with respect to those guidelines. In general, Arbor Commercial Mortgages underwriting guidelines require it to evaluate the following:
| the historic and in place property revenues and expenses; | |
| the potential for near term revenue growth and opportunity for expense reduction and increased operating efficiencies; the propertys location, its attributes and competitive position within its market; | |
| the proposed ownership structure, financial strength and real estate experience of the borrower and property management; third party appraisal, environmental and engineering studies; | |
| market assessment, including property inspection, review of tenant lease files, surveys of property comparables and an analysis of area economic and demographic trends; review of an acceptable mortgagees title policy and an as built survey; | |
| construction quality of the property to determine future maintenance and capital expenditure requirements; and | |
| the requirements for any reserves, including those for immediate repairs or rehabilitation, replacement reserves, tenant improvement and leasing commission costs, real estate taxes and property casualty and liability insurance. |
Key factors considered in credit decisions include, but are not limited to, debt service coverage, loan to value ratios and property, financial and operating performance. Consideration is also given to other factors, such as additional forms of collateral and identifying likely strategies to effect repayment. Arbor Commercial Mortgage will refine its underwriting criteria based upon actual loan portfolio experience and as market conditions and investor requirements evolve.
Investment Approval Process |
Arbor Commercial Mortgage applies its established investment approval process to all loans and other investments proposed for our portfolio before submitting each proposal to us for final approval. A written report is generated for every loan or other investment that is submitted to Arbor Commercial Mortgages seven member credit committee for approval. The presentation includes a description of the prospective borrower and any guarantors, the collateral and the proposed use of investment proceeds, as well as borrower and property consolidated financial statements and analysis. In addition, the presentation summarizes an analysis of borrower liquidity, net worth, cash investment, income, credit history and operating experience. If the transaction is approved by a majority of Arbor Commercial Mortgages credit committee, it is presented for approval to our credit committee, which consists of our chief executive officer, our chief credit officer, our executive vice president of structured finance and our executive vice president of asset management. All transactions require the approval of a majority of the members of our credit committee, including the vote of our executive vice president of structured finance.
Following the approval of any such transaction, Arbor Commercial Mortgages underwriting and servicing departments, together with our asset management group, assure that all loan approval terms have been satisfied and that they conform with lending requirements established for that particular transaction. If our credit committee and independent directors reject the loan and the independent directors allow Arbor Commercial Mortgage or one of its affiliates to pursue it, Arbor Commercial Mortgage will have the opportunity to execute the transaction. See Our Manager and the Management Agreement Rights of First Refusal.
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Servicing |
Arbor Commercial Mortgage services our loans through its internal servicing operations. Our manager currently services an expanding portfolio, consisting of approximately 500 loans with outstanding balances of $2.7 billion through its loan administration department in Buffalo, New York. Arbor Commercial Mortgages loan servicing operations are designed to provide prompt customer service and accurate and timely information for account follow up, financial reporting and management review. Following the funding of an approved loan, all pertinent loan data is entered into Arbor Commercial Mortgages data processing system, which provides monthly billing statements, tracks payment performance and processes contractual interest rate adjustments on variable rate loans. Our manager utilizes the operations of its loan administration department to service our portfolio with the same efficiency, accuracy and promptness. Arbor Commercial Mortgage also works closely with our asset management group to ensure the appropriate level of customer service and monitoring of these loans.
Our Asset Management Operations
Our asset management group is comprised of nine employees that comprised the asset management group at Arbor Commercial Mortgage. The experience and depth of services of the asset management group enabled Arbor Commercial Mortgage to improve the credit quality and yield of its structured finance investments. The asset management group, while at Arbor Commercial Mortgage, was responsible for managing over $2.5 billion in assets consisting of more than 500 real estate related investments for Arbor Commercial Mortgage. The asset management group has successfully managed numerous transactions, including complex restructurings, refinancings and asset dispositions. Through active participation in the financing and structuring strategies of transactions, many of these transactions have directly created value by generating excess cash flow or by enhancing asset values. Other transactions have dramatically reduced Arbor Commercial Mortgages financial exposure.
The professionals that are part of this group are experienced in managing and servicing many types and classes of assets. Because each property and loan is unique, the asset management group, at the point of origination, customizes an asset management plan with the origination and underwriting teams to track the asset from origination through disposition. The asset management group is committed to effectively communicating to senior management the status of transactions against a pre-established plan, enhancing and preserving capital, as well as avoiding litigation and potential exposure. The asset management group also performs frequent site inspections, conducts meetings with borrowers and evaluates and participates in the budgeting process, financial review of operations and the assets renovation plans.
Effective asset and portfolio management is essential to maximizing the performance and value of a real estate/ mortgage investment. The asset management group monitors each investments operating history and assesses potential financial performance to accurately evaluate and ultimately improve operations and financial viability. As an asset and portfolio manager, the asset management group focuses on increasing the productivity of on site property managers and leasing brokers as well. The asset management group also monitors local economic trends, rental and occupancy rates and property competitiveness within its market.
Accurate identification of an investments current issues and each stockholders objectives is important in the loan workout and restructuring process. Since existing management may not have the requisite expertise to effectively implement and manage the workout process, the asset management group determines current operating and financial status of an asset or portfolio and performs liquidity analysis of properties and ownership entities and then identifies and evaluates alternatives in order to maximize the value of an investment.
Our asset management group continues to provide its services to Arbor Commercial Mortgage on a limited basis pursuant to an asset management services agreement between Arbor Commercial Mortgage and us. The asset management services agreement will be effective throughout the term of our management agreement and during the origination period described in the management agreement. In the event the services provided by our asset management group pursuant to this agreement exceed by more than 15% per quarter the level anticipated by our board of directors, we will negotiate in good faith with our manager an
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Operating Policies and Strategies
Capital and Leverage Policies. Currently, we are financing our acquisition of mortgage assets through the proceeds of the original offering and through borrowings under our credit facility. In the future, we will finance our acquisition of mortgage assets primarily by borrowing against or leveraging our existing portfolio and using the proceeds to acquire additional mortgage assets. We expect to incur debt such that we will maintain an equity to assets ratio of up to 20%, although the actual ratio may be lower from time to time depending on market conditions and other factors deemed relevant by our manager. Our charter and bylaws do not limit the amount of indebtedness we can incur, and the board of directors has discretion to deviate from or change our indebtedness policy at any time. However, we intend to maintain an adequate capital base to protect against various business environments in which our financing and hedging costs might exceed interest income (net of credit losses) from our investments. These conditions could occur, for example, due to credit losses or when, due to interest rate fluctuations, interest income on our investments lags behind interest rate increases in our borrowings, which are expected to be predominantly variable rate. See Risk Factors Risks Related to our Business.
Liabilities. Our investments are financed primarily at short term borrowing rates through warehouse lines of credit, repurchase agreements, loan agreements, commercial paper borrowings and other credit facilities with institutional lenders. Although we expect that commercial warehouse lines of credit and repurchase agreements will be the principal means of leveraging our investments, we may issue preferred stock or secured or unsecured notes of any maturity if it appears advantageous to do so. We have substantially similar credit facilities as those used by Arbor Commercial Mortgage to finance the initial assets. These credit facilities are further described under Liquidity and Capital Resources Sources of Liquidity.
Credit Risk Management. We are exposed to various levels of credit and special hazard risk depending on the nature of our underlying assets and the nature and level of credit enhancements supporting our assets. We originate or purchase mortgage loans that meet minimum debt service coverage standards established by us. Arbor Commercial Mortgage, as our manager, and our chief credit officer review and monitor credit risk and other risks of loss associated with each investment. In addition, Arbor Commercial Mortgage seeks to diversify our portfolio of assets to avoid undue geographic, issuer, industry and certain other types of concentrations. Our board of directors monitors the overall portfolio risk and reviews levels of provision for loss.
Asset/ Liability Management. To the extent consistent with our election to qualify as a REIT, we follow an interest rate risk management policy intended to mitigate the negative effects of major interest rate changes. We minimize our interest rate risk from borrowings by attempting to structure the key terms of our borrowings to generally correspond to the interest rate term of our assets.
Hedging Activities. Although Arbor Commercial Mortgage has not found it advantageous to enter into hedging transactions in the past, we may enter into such transactions in the future to protect our investment portfolio from interest rate fluctuations and other changes in market conditions. These transactions may include interest rate swaps, the purchase or sale of interest rate collars, caps or floors, options, mortgage derivatives and other hedging instruments. These instruments may be used to hedge as much of the interest rate risk as Arbor Commercial Mortgage determines is in the best interest of our stockholders, given the cost of such hedges and the need to maintain our status as a REIT. In general, income from hedging transactions does not constitute qualifying income under current law for purposes of the REIT gross income requirements. To the extent, however, that we enter into a hedging contract to reduce interest rate risk on indebtedness incurred to acquire or carry real estate assets, any income that we derive from the contract would be qualifying income for purposes of the REIT 95% gross income test, but not for the 75% gross income test. See Federal Income Tax Considerations Taxation of Arbor Realty Derivatives and Hedging Transactions. Arbor
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Disposition Policies. Although there are no current plans to dispose of properties or other assets within our portfolio, Arbor Commercial Mortgage evaluates our asset portfolio on a regular basis to determine if it continues to satisfy our investment criteria. Subject to certain restrictions applicable to REITs, Arbor Commercial Mortgage may cause us to sell our investments opportunistically and use the proceeds of any such sale for debt reduction, additional acquisitions or working capital purposes.
Equity Capital Policies. Subject to applicable law, our board of directors has the authority, without further stockholder approval, to issue additional authorized common stock and preferred stock or otherwise raise capital, including through the issuance of senior securities, in any manner and on the terms and for the consideration it deems appropriate, including in exchange for property. Our existing stockholders, including stockholders purchasing in this offering, will have no preemptive right to additional shares issued in any offering, and any offering might cause a dilution of investment. See Description of Stock. We may in the future issue common stock in connection with acquisitions. We also may issue units of partnership interest in our operating partnership in connection with acquisitions of property.
We may, under certain circumstances, repurchase our common stock in private transactions with our stockholders, if those purchases are approved by our board of directors. Our board of directors has no present intention of causing us to repurchase any shares, and any action would only be taken in conformity with applicable federal and state laws and the applicable requirements for qualifying as a REIT, for so long as the board of directors concludes that we should remain a REIT.
Conflicts of Interest Policies. We, our executive officers and Arbor Commercial Mortgage face conflicts of interests because of our relationships with each other. Mr. Ivan Kaufman is our chief executive officer and the chief executive officer of Arbor Commercial Mortgage and serves on our credit committee and Mr. Kaufman and the Kaufman entities own approximately 88% of the outstanding membership interests of Arbor Commercial Mortgage. Mr. Frederick C. Herbst is our chief financial officer and the chief financial officer of Arbor Commercial Mortgage. In addition, Mr. Herbst, two of our executive vice presidents, Mr. Fred Weber and Mr. Daniel M. Palmier, and two of our directors, Mr. Joseph Martello and Mr. Walter Horn, have minority ownership interests in Arbor Commercial Mortgage, and Mr. Martello serves as the trustee of a trust through which Mr. Kaufman owns the majority of his ownership interest in Arbor Commercial Mortgage and co-trustee of another Kaufman entity that owns an equity interest in Arbor Commercial Mortgage.
We have implemented several policies, through board action and through the terms of our constituent documents and of our agreements with Arbor Commercial Mortgage, to help address these conflicts of interest:
| Our charter requires that a majority of our board of directors be independent directors and that only our independent directors make any determinations on our behalf with respect to the relationships or transactions that present a conflict of interest for our directors or officers. | |
| Our board of directors has adopted a policy that decisions concerning our management agreement with Arbor Commercial Mortgage, including termination, renewal and enforcement thereof or our participation in any transactions with Arbor Commercial Mortgage or its affiliates outside of the management agreement, including our ability to purchase securities and mortgage or other assets from or to sell securities and assets to Arbor Commercial Mortgage, must be reviewed and approved by a majority of our independent directors. | |
| Our management agreement provides that our determinations to terminate the management agreement for cause or because the management fees are unfair to us or because of a change in control of our manager will be made by a majority vote of our independent directors. | |
| Our independent directors will periodically review the general investment standards established for Arbor Commercial Mortgage under the management agreement. | |
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| Our management agreement with Arbor Commercial Mortgage provides that Arbor Commercial Mortgage may not assign duties under the management agreement, except to certain affiliates of Arbor Commercial Mortgage, without the approval of a majority of our independent directors. | |
| Our management agreement provides that decisions to approve or reject investment opportunities rejected by our credit committee that Arbor Commercial Mortgage or Mr. Kaufman wish to pursue will be made by a majority of our independent directors. | |
Other Policies. We intend to operate in a manner that will not subject us to regulation under the Investment Company Act. We may invest in the securities of other issuers for the purpose of exercising control over such issuers and underwrite securities of other issuers, particularly in the course of disposing of their assets.
Future Revisions in Policies and Strategies. Our board of directors has approved the investment guidelines and the operating policies and the strategies set forth in this prospectus. The board of directors has the power to modify or waive these policies and strategies, or amend our agreements with Arbor Commercial Mortgage, without the consent of our stockholders to the extent that the board of directors (including a majority of our independent directors) determines that such modification or waiver is in our best interest or the best interest of our stockholders. Among other factors, developments in the market that either affect the policies and strategies mentioned herein or that change our assessment of the market may cause our board of directors to revise its policies and strategies. However, if such modification or waiver involves the relationship of, or any transaction between, us and our manager or any affiliate of our manager, the approval of a majority of our independent directors is also required. We may not, however, amend our charter to change the requirement that a majority of our board consist of independent directors or the requirement that our independent directors approve related party transactions without the approval of two thirds of the votes entitled to be cast by our stockholders.
Policies With Respect to Certain Other Activities
Reporting Policies. Generally speaking, we intend to make available to our stockholders certified annual consolidated financial statements and annual reports. After this offering, we will become subject to the information reporting requirements of the Securities Exchange Act of 1934, as amended, referred to as the Exchange Act. Pursuant to these requirements, we will file periodic reports, proxy statements and other information, including audited consolidated financial statements, with the Securities and Exchange Commission.
Our Operating Partnership
We have organized Arbor Realty Limited Partnership, our operating partnership, as a limited partnership under the Delaware Revised Uniform Limited Partnership Act. We serve as the sole general partner of our operating partnership, and own a 72% partnership interest in our operating partnership represented by operating partnership units that we obtained in exchange for our contribution of the net proceeds of the original offering to our operating partnership. The remaining 28% partnership interest in our operating partnership is owned by Arbor Commercial Mortgage. In exchange for the contribution of the initial assets to our partnership, Arbor Commercial Mortgage received approximately 3.1 million operating partnership units and 629,000 warrants, each of which entitles Arbor Commercial Mortgage to purchase one additional operating partnership unit for two years from the date of issue. Arbor Commercial Mortgages operating partnership units, including units issued upon exercise of the warrants, each is paired to one share of our special voting preferred stock and is redeemable, at the option of Arbor Commercial Mortgage, for cash, or at our election, our common stock, generally on a one for one basis, at any time after the earlier of (1) two years following the closing of the original offering and (2) six months (180 days) following the effectiveness of the registration statement of which this prospectus is a part. However, Arbor Commercial Mortgage is limited at any given time to redeeming (whether for cash or stock) a number of units such that, if we were to issue shares of our common stock to satisfy the redemption right, Arbor Commercial Mortgage would not exceed the REIT-related ownership limitations contained in our charter.
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Competition
Our net income depends, in large part, on our managers ability to originate structured finance investments with spreads over our borrowing costs. In originating these investments, our manager competes with other mortgage REITs, specialty finance companies, savings and loan associations, banks, mortgage bankers, insurance companies, mutual funds, institutional investors, investment banking firms, other lenders, governmental bodies and other entities, some of which may have greater financial resources and lower costs of capital available to them. In addition, there are numerous mortgage REITs with asset acquisition objectives similar to ours, and others may be organized in the future. The effect of the existence of additional REITs may be to increase competition for the available supply of structured finance assets suitable for purchase by us. Competitive variables include market presence and visibility, size of loans offered and underwriting standards. To the extent that a competitor is willing to risk larger amounts of capital in a particular transaction or to employ more liberal underwriting standards when evaluating potential loans, our origination volume and profit margins for our investment portfolio could be impacted. Our competitors may also be willing to accept lower returns on their investments and may succeed in buying the assets that we have targeted for acquisition. Although management believes that we are well positioned to continue to compete effectively in each facet of our business, there can be no assurance that we will do so or that we will not encounter further increased competition in the future that could limit its ability to compete effectively.
Employees
We currently have eleven employees, including Mr. Kovarik, our chief credit officer, Mr. Weber, our executive vice president of structured finance, Mr. Palmier, our executive vice president of asset management, and a eight person asset management group. Mr. Kaufman, who serves as our chief executive officer and Mr. Herbst, who serves as our chief financial officer, each of whom is a full time employee of our manager, perform the duties required pursuant to the management agreement with our manager and our bylaws.
Legal Proceedings
We are not involved in any litigation nor, to our knowledge, is any litigation threatened against us.
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OUR MANAGER AND THE MANAGEMENT AGREEMENT
Manager
We have chosen to be externally managed by Arbor Commercial Mortgage to take advantage of the existing business relationships, operational and risk management systems, expertise and economies of scale associated with Arbor Commercial Mortgages current business operations. Arbor Commercial Mortgage is a national commercial real estate finance company, which was founded in 1993 as a subsidiary of Arbor National Holdings, which was primarily an originator and servicer of single-family residential mortgage loans. Our chief executive officer, Mr. Ivan Kaufman, is also Arbor Commercial Mortgages chief executive officer and controlling equity owner, and was the co-founder, chairman and majority stockholder of Arbor National Holdings. Under Mr. Kaufmans direction, Arbor National Holdings grew to 25 branches in 11 states and funded more than $4 billion in loans in its last full year of operations. Arbor National Holdings became a public company in 1992 and was sold to BankAmerica in 1995. As chairman and chief executive officer of Arbor National Holdings, Mr. Kaufman developed significant experience operating and managing a publicly traded company.
In connection with the sale of Arbor National Holdings, Mr. Kaufman purchased its commercial mortgage lending operations and the rights to the Arbor Commercial Mortgage name and retained a significant portion of Arbor National Holdings senior management team. This senior management team has guided Arbor Commercial Mortgages growth from a company originally capitalized with approximately $8.0 million, to its equity value, including its partnership interest in Arbor Realty Limited Partnership, of approximately $69 million as of September 30, 2003. Arbor Commercial Mortgage is now a full service provider of financial services to owners and developers of commercial and multi-family real estate properties. Arbor Commercial Mortgage has derived revenue from the origination for sale and servicing of government-sponsored and conduit mortgage loans for commercial and multi-family real estate properties as well as from the origination of structured finance loans and investments. Our primary business will be investing in structured finance loans and investments. Arbor Commercial Mortgage, which has been profitable every year since 1995, originated over $600 million in new loans in 2002 and is currently servicing a portfolio with a principal balance of $2.9 billion, including loans serviced for Arbor Realty Limited Partnership.
Arbor Commercial Mortgages executive officers and employees have extensive experience in originating and managing structured commercial real estate investments. The senior management team has an average of over 20 years experience in the financial services industry. Arbor Commercial Mortgage currently has 130 employees spread among its corporate headquarters in Uniondale, New York and 15 offices located throughout the United States.
At September 30, 2003, Mr. Kaufman and the Kaufman together beneficially owned approximately 88% of the outstanding membership interests in Arbor Commercial Mortgage. Our chief financial officer, our executive vice presidents of structured finance and asset management and our secretary collectively own an approximately 3.5% membership interest in Arbor Commercial Mortgage. One of our directors, Mr. Martello, owns an approximately 1.5% membership interest in Arbor Commercial Mortgage and serves as the trustee of one of the Kaufman entities that owns a majority of the outstanding membership interests in Arbor Commercial Mortgage and co-trustee of another Kaufman entity that owns an equity interest in Arbor Commercial Mortgage. In exchange for Arbor Commercial Mortgages contribution of the initial assets and related liabilities to our operating partnership, our operating partnership issued to Arbor Commercial Mortgage approximately 3.1 million units of limited partnership interest and 629,000 warrants to purchase additional units of limited partnership interest at an initial exercise price of $15 each, each of which are redeemable, at our election, for cash or one share of our common stock. Each of the approximately 3.1 million operating partnership units received by Arbor Commercial Mortgage, is paired with one share of our special voting preferred stock that has one vote on all matters submitted to a vote of the stockholders.
We have granted our non-employee executive officers and other employees of our manager who provide services to us awards of 128,500 shares of restricted stock, representing 1.6% of the number of shares of common stock currently outstanding. Our manager and its employees have a total beneficial ownership in our
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The executive offices of our manager are located at 333 Earle Ovington Boulevard, Suite 900, Uniondale, New York 11553 and the telephone number of its executive offices is (516) 832-8002.
Officers of Our Manager
The following table sets forth certain information with respect to the executive officers of our manager.
Name | Age | Position with Our Manager | ||||
Ivan Kaufman
|
42 | Chief Executive Officer and President | ||||
Frederick C. Herbst
|
46 | Chief Financial Officer | ||||
Ronald D. Gaither
|
45 | Chief Operating Officer | ||||
Walter K. Horn
|
60 | General Counsel | ||||
John Caulfield
|
39 | Senior Vice President Capital Markets |
Ivan Kaufman. Mr. Kaufman has served as our chairman of the board, chief executive officer and president since June 2003. Mr. Kaufman has been chief executive officer and president of Arbor Commercial Mortgage since its inception. In 1983, he co-founded Arbor National Holdings and its residential lending subsidiary, Arbor National Mortgage Inc. Under Mr. Kaufmans direction, Arbor National Holdings grew to 25 branches in 11 states and funded more than $4 billion in loans in its last full year of operations. Arbor National Holdings became a public company in 1992 and was sold to BankAmerica in 1995. As chairman and chief executive officer of Arbor National Holdings, Mr. Kaufman developed significant experience operating and managing a publicly traded company. Mr. Kaufman was named regional Entrepreneur of the Year by Inc. Magazine for outstanding achievements in financial services in 1990. He was appointed to the National Advisory Board of Fannie Mae in 1994. Mr. Kaufman has also served on Fannie Maes regional advisory and technology boards, as well as the board of directors of the Empire State Mortgage Bankers Association.
Frederick C. Herbst. Mr. Herbst has served as our chief financial officer since June 2003. Mr. Herbst has been chief financial officer of Arbor Commercial Mortgage since joining the company in November 1999. He is a member of Arbor Commercial Mortgages executive committee and is responsible for all aspects of Arbor Commercial Mortgages financial operations, including financial reporting, tax planning, budgeting and the appropriate utilization of Arbor Commercial Mortgages capital. From October 1998 until he joined Arbor Commercial Mortgage in November 1999, Mr. Herbst was chief financial officer with The Hurst Companies, Inc., where he was responsible for all financial operations, including financial reporting, budgeting and banking relationships. Previously, Mr. Herbst was controller with The Long Island Savings Bank, FSB, vice president finance with Eastern States Bankcard Association and senior manager with Ernst & Young. Mr. Herbst became a certified public accountant in 1983.
Ronald D. Gaither. Mr. Gaither is a member of Arbor Commercial Mortgages executive committee and is the senior credit officer. Before joining Arbor Commercial Mortgage in March 1999, he was the chief credit officer for PNC Mortgage Corporation in Chicago. During his tenure, he served on the board of directors of PNC Mortgage Reinsurance Corporation. Mr. Gaither also served on the Affordable Housing Advisory Board with Freddie Mac. Mr. Gaither has held senior management positions with Amerin Guaranty, Prudential Home Mortgage and First Union National Bank.
Walter K. Horn. Mr. Horn has served as our secretary, general counsel and one of our directors since his appointment in November 2003. Mr. Horn is also a member of Arbor Commercial Mortgages executive committee and is responsible for providing all legal services for Arbor Commercial Mortgage. Previously,
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John Caulfield. Mr. Caulfield is a member of Arbor Commercial Mortgages executive committee and is responsible for all capital markets activities, including interest rate, risk management and secondary marketing activities for Arbor Commercial Mortgage. Mr. Caulfields responsibilities include the pricing arid selling of Fannie Mae MBS/ DUS and conduit loans and managing Arbor Commercial Mortgages pipeline to ensure timely underwriting and funding. Before joining Arbor Commercial Mortgage in 1995, Mr. Caulfield was vice president of secondary marketing with Arbor National Holdings.
The Management Agreement
We and our operating partnership entered into a management agreement with Arbor Commercial Mortgage, pursuant to which Arbor Commercial Mortgage has agreed to provide us with structured finance investment opportunities and loan servicing as well as other services necessary to operate our business. We employ only three executive officers and eight individuals who provide asset management services for our portfolio of investments. Our chief executive officer, chief financial officer and our secretary are not our employees. We rely to a significant extent on the facilities and resources of our manager to conduct our operations.
The management agreement requires our manager to manage our business affairs in conformity with the policies and the general investment guidelines that are approved and monitored by our board of directors. Our managers management is under the direction of our board of directors.
Our directors will periodically review the investment guidelines and our investment portfolio but do not review each proposed investment. In conducting their periodic reviews, the directors rely on information provided to them by our manager. Transactions entered into by our manager may be difficult or impossible to unwind by the time they are reviewed by the directors.
Mr. Kaufman, our chairman and chief executive officer and Mr. Herbst, our chief financial officer, also serve as chief executive officer and chief financial officer, respectively, of our manager, and we were formed by our manager. As a result, the management agreement was not negotiated at arms length and its terms, including fees payable, may not be as favorable to us as if the agreement had been negotiated with an unaffiliated third party. In addition, Walter Horn, who is the general counsel of our manager, became our secretary after the original offering.
Management Services
Pursuant to the terms of the management agreement, our manager is required to provide a dedicated management team, including a chief executive officer, chief financial officer and secretary, Messrs. Kaufman, Herbst and Horn, respectively, to provide the management services to us, the members of which team will devote such of their time to the management of us as our independent directors reasonably deem necessary and appropriate, commensurate with our level of activity from time to time.
Our manager is responsible for our day to day operations and performs (or causes to be performed) such services and activities relating to our assets and operations as may be appropriate, including, without limitation, the services described below.
Management Oversight
| Providing executive and administrative personnel, office space and office services required in rendering services to us; | |
| Administering our day to day operations and functions necessary to our management as may be agreed upon by our manager and the board of directors, including the collection of interest, fee and other income, the payment of our debts and obligations, the payment of dividends or distributions to our |
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stockholders and maintenance of appropriate back office infrastructure to perform such administrative functions; | ||
| Serving as our consultant with respect to the periodic review of the investment criteria and parameters for our investments, borrowings and operations for the approval of our board of directors; | |
| Counseling us in connection with policy decisions to be made by our board of directors; | |
| Using commercially reasonable efforts to cause expenses incurred by us or on our behalf to be reasonable and customary and within any budgeted parameters or expense guidelines set by our board of directors from time to time; | |
| Advising us as to our capital structure and capital raising; | |
| Coordinating and managing operations of any joint venture or co-investment interests held by us and conducting all matters with the joint venture or co investment partners; | |
| Communicating on our behalf with the holders of any of our equity or debt securities as required to satisfy the reporting and other requirements of any governmental bodies or agencies or trading markets and to maintain effective relations with such holders; | |
| Handling and resolving all claims, disputes or controversies (including all litigation, arbitration, settlement or other proceedings or negotiations) in which we may be involved or to which we may be subject arising out of our day to day operations, subject to such limitations or parameters as may be imposed from time to time by our board of directors; and | |
| Evaluating and recommending to our board of directors, and engaging in potential hedging activities on our behalf, consistent with our status as a REIT and with the investment guidelines. |
Origination and Investment Expertise
| Building borrower relationships, originating investment opportunities with those borrowers and analyzing and underwriting possible investment opportunities for eventual submission to our credit committee; | |
| Assisting us in developing criteria for investment commitments that are specifically tailored to our investment objectives and making available to us its knowledge and experience with respect to mortgage loans, real estate and other real estate related assets; and | |
| Investing or reinvesting any money of ours, including investing in short term investments pending investment in long term asset investments. |
Regulatory Compliance
| Assisting us in complying with all regulatory requirements applicable to us in respect of our business activities, including preparing or causing to be prepared all consolidated financial statements required under applicable regulations and contractual undertakings and all reports and documents, if any, required under the Securities Exchange Act; | |
| Taking all necessary actions to enable us to make required tax filings and reports, including soliciting stockholders for required information to the extent provided by the REIT provisions of the Code and the Treasury Regulations promulgated thereunder; | |
| Counseling us regarding the maintenance of our status as a REIT and monitoring compliance with the various REIT qualification tests and other rules set out in the Code and the Treasury Regulations promulgated thereunder; | |
| Causing us to retain qualified accountants and legal counsel, as applicable, to assist in developing appropriate accounting procedures, compliance procedures and testing systems with respect to financial |
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reporting obligations and compliance with the REIT provisions of the Code and the Treasury Regulations promulgated thereunder and to conduct quarterly compliance reviews with respect thereto; | ||
| Counseling us regarding the maintenance of our exemption from the Investment Company Act and monitoring compliance with the requirements for maintaining an exemption from that Act; | |
| Causing us to qualify to do business in all applicable jurisdictions and to obtain and maintain all appropriate licenses; and | |
| Using commercially reasonable efforts to cause us to comply with all other applicable laws. |
Pursuant to the management agreement, our manager does not assume any responsibility other than to render the services called for thereunder and is not responsible for any action of our board of directors in following or declining to follow our managers advice or recommendations. Our manager, its directors and its officers are not liable to us, any subsidiary of ours, our directors, our stockholders or any subsidiarys stockholders for acts performed in accordance with and pursuant to the management agreement, except by reason of acts constituting bad faith, willful misconduct, gross negligence, or breach of their duties under the management agreement and except for claims by managers employees relating to the terms and conditions of their employment. Pursuant to the management agreement, we agree to indemnify our manager, its directors and its officers with respect to all expenses, losses, damages, liabilities, demands, charges and claims arising from acts of our manager not constituting bad faith, willful misconduct, gross negligence, or breach of duties, performed in good faith in accordance with and pursuant to the management agreement but excluding claims by the managers employees relating to the terms and conditions of their employment. Our manager agrees to indemnify us, our directors and officers with respect to all expenses, losses, damages, liabilities, demands, charges and claims arising from acts of our manager constituting bad faith, willful misconduct, gross negligence or breach of its duties under the management agreement and any claims by the managers employees relating to the terms and conditions of their employment. Our manager also carries errors and omissions and other customary insurance.
Term. The management agreement has an initial term of two years and is renewable automatically for an additional one year period every year thereafter, unless terminated with six months prior written notice.
Our Termination Rights. After the initial two-year term, we will be able to terminate the management agreement without cause for any reason upon six months prior written notice to Arbor Commercial Mortgage. If we terminate the management agreement without cause, or we give Arbor Commercial Mortgage notice of non-renewal, in order to manage our operations internally, we will be required to pay our manager a termination fee equal to the base management fee and the incentive compensation earned during the 12-month period preceding the termination. If, without cause, we terminate the management agreement or elect not to renew it for any other reason, including a change of control of us but excluding a change in control of our manager, we will be required to pay a termination fee equal to two times the base management fee and the incentive compensation earned during the 12-month period preceding the termination.
Notwithstanding the paragraph above, if we provide our six month notice of termination without cause because our independent directors have determined that the management fees are unfair, then Arbor Commercial Mortgage may agree to perform its management services at the fees our independent directors determine to be fair and the management agreement will not terminate. If Arbor Commercial Mortgage does not agree to perform its management services for those fees, or if Arbor Commercial Mortgage so agrees but then gives us notice that it wishes to renegotiate the fees, then we and Arbor Commercial Mortgage must negotiate in good faith and if we cannot agree on a revised fee structure at the end of our six-month notice period, the agreement will terminate and we must pay the termination fees described above.
We also have the right to terminate the management agreement for cause upon prior written notice to Arbor Commercial Mortgage with the approval of our board of directors including the consenting vote of a majority of our independent directors. In such a case, we would not be required to pay a termination fee. Cause is defined as fraud, misappropriation of funds, willful violation of the management agreement, gross negligence, breach by our manager of a material term of the management agreement that is not timely cured,
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Arbor Commercial Mortgages Termination Rights. Arbor Commercial Mortgage has the right to terminate the management agreement (effective upon expiration of the cure period) upon a breach of a material term of the management agreement by us that is not timely cured. Arbor Commercial Mortgage also has the right to terminate the management agreement after the initial two-year term without cause on six months prior written notice to us. Except in connection with a change in control of Arbor Commercial Mortgage within the first three years as described below, Arbor Commercial Mortgage will not be obligated to pay us a termination fee if it terminates or elects not to renew the management agreement.
Change of Control of Arbor Commercial Mortgage
Within the initial two-year term and the first one-year renewal term of the management agreement, if:
| Arbor Commercial Mortgage or its successor elects not to renew or to terminate the management agreement within two years after a change in control of Arbor Commercial Mortgage or the execution of an agreement that will cause a change in control of Arbor Commercial Mortgage, or | |
| Arbor Commercial Mortgage gives us a notice of non-renewal or termination, then experiences a change of control or executes an agreement that will cause a change in control of Arbor Commercial Mortgage in one year, then Arbor Commercial Mortgage or its successor will have to pay us a fee in an amount equal to two times the base management fee and the incentive compensation earned during the 12-month period preceding the termination or non renewal notice. | |
We are able to terminate the management agreement upon 30 days prior written notice to Arbor Commercial Mortgage, without payment of a fee, if: |
| Mr. Kaufman is no longer chief executive officer of Arbor Commercial Mortgage, but not by reason of his death, disability or incapacity, or | |
| a change of control of Arbor Commercial Mortgage occurs. | |
As defined in the management agreement, change of control of Arbor Commercial Mortgage shall not include any public offering of the capital stock of Arbor Commercial Mortgage.
Assignment. Neither we nor Arbor Commercial Mortgage are able to assign its rights or obligations under the management agreement without the consent of the other party. However, Arbor Commercial Mortgage may, without our consent, assign the management agreement to an affiliate (meaning any entity controlling, controlled by or under common control with Arbor Commercial Mortgage, and control means the direct or indirect ownership of at least 51% of the beneficial equity interests and voting power of such entity) whose day to day business and operations are managed and supervised by Mr. Kaufman, provided that Arbor Commercial Mortgage shall be fully responsible to us for all errors or omissions of such assignee. Our manager is also be permitted to subcontract or assign certain of its duties under the management agreement to any affiliate of our manager that meets the foregoing qualification.
Management Fees and Incentive Compensation
Since we employ only three executive officers and eight other employees, we rely to a significant extent on the facilities and resources of our manager to conduct our operations. For performing services under the management agreement, Arbor Commercial Mortgage receives a base management fee and incentive compensation calculated as described below. Our manager uses the proceeds from its base management fee in part to pay compensation to its officers and employees who, notwithstanding that some of them are also our officers, receive no direct compensation from us, other than restricted stock that may be granted pursuant to our stock incentive plan.
Base Management Fee. Our manager receives an annual base management fee based on the equity of our operating partnership, as further discussed below. The amount of the base management fee does not
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Incentive Compensation. Our manager is entitled to receive incentive compensation in installments each fiscal quarter. In addition, our manager is entitled to receive incentive compensation each fiscal quarter in an annual amount equal to the product of:
(1) 25% of the dollar amount by which: |
| the sum of: (i) our operating partnerships Funds From Operations (before the incentive compensation) per operating partnership unit (based on the weighted average number of operating partnership units outstanding, including operating partnership units issued to us equal to the number of shares of our common stock issued by us) for such quarter and (ii) gains (or losses) from debt restructuring and sales of property per operating partnership unit (based on the weighted average number of units outstanding, including operating partnership units issued to us equal to the number of shares of our common stock issued by us) for such quarter; exceeds | |
| the product of (i) the weighted average (based on shares of our common stock and operating partnership units) of (a) the per operating partnership unit book value of the net assets to be contributed by Arbor Commercial Mortgage, (b) the $15 offering price per share of our common stock in the original offering, (c) the offering price per share of any subsequent offerings by us of our common stock and (d) the issue price per operating partnership unit for subsequent contributions to our operating partnership (including shares of common stock issued upon exercise of warrants or options and adjusted for any prior stock dividends or distributions), and (ii) the greater of (x) 9.50% per annum and (y) the ten year U.S. Treasury rate plus 3.50% per annum; multiplied by | |
(2) the weighted average number of operating partnership units outstanding, including operating partnership units issued to us equal to the number of shares of our common stock issued by us. |
The incentive compensation will be measured in fiscal quarters for the remainder of 2003. Our manager did not earn any incentive compensation for the quarter ended September 30, 2003. Beginning on January 1, 2004, the incentive management fee will be measured over a full fiscal year, subject to recalculation and potential reconciliation at the end of each fiscal year.
Funds From Operations as defined by National Association of Real Estate Investment Trusts means net income, computed in accordance with generally accepted accounting principals, excluding gains (or losses) from debt restructuring and sales of property, plus depreciation and amortization on real estate assets, and after adjustments for unconsolidated partnerships and joint ventures. Funds from operations does not represent cash generated from operating activities in accordance with GAAP and should not be considered as an alternative to net income as an indication of our performance or to cash flows as a measure of liquidity or ability to make distributions.
As used in calculating the managers incentive compensation, the term Ten Year U.S. Treasury Rate means the arithmetic average of the weekly average yield to maturity for actively traded current coupon U.S. Treasury fixed interest rate securities (adjusted to constant maturities of 10 years) published by the Federal Reserve Board during a quarter, or, if such rate is not published by the Federal Reserve Board, any Federal Reserve Bank or agency or department of the federal government selected by us. If we determine in good faith that the Ten Year U.S. Treasury Rate cannot be calculated as provided above, then the rate shall be
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The management agreement provides that at least 25% of our managers incentive compensation is to be paid in shares of our common stock (subject to the ownership limitations contained in our charter) and the balance in cash. However, our manager is able to elect to receive a greater percentage of its incentive compensation in the form of our common stock. We may provide for registration rights for shares of common stock used to pay our managers incentive compensation. Under our management agreement, Arbor Commercial Mortgage agrees that it may not elect to receive shares of our common stock as payment of its incentive compensation, except in accordance with all applicable securities exchange rules and securities laws (including prohibitions on insider trading). In addition, Arbor Commercial Mortgage is not able to receive our stock in payment of fees, whether automatically or by Arbor Commercial Mortgages election, if it would cause Arbor Commercial Mortgage or Mr. Kaufman to beneficially own an amount of our common stock in violation of the ownership limitations in our charter.
For purposes of determining the number of shares to be delivered in satisfaction of the incentive compensation to be paid with our common stock, we will value our shares at the average per share closing price based on the period of 20 days ending on and including the last day of the applicable fiscal quarter.
In evaluating investments and other management strategies, the opportunity to earn incentive return based on Funds From Operations may lead our manager to place undue emphasis on the maximization of Funds From Operations at the expense of other criteria, such as preservation of capital, in order to achieve a higher incentive return. Investments with higher yield potential are generally riskier or more speculative. This could result in increased risk to the value of our invested portfolio.
The following examples illustrate how we calculate our managers incentive compensation in accordance with the management agreement. These calculations are for illustrative purposes only and do not reflect our actual operating results.
Example 1:
Assumptions:
|
||||
Adjusted Annual FFO Per OP Unit(1)
|
$2.00 | |||
Hurdle Rate(2)
|
9.50 | % | ||
Weighted Average Book Value Per OP
Unit(3)
|
$14.70 | |||
Weighted Average OP Units
Outstanding(4)
|
11,196,724 |
Calculation of Incentive
compensation: |
= 25% × (Adjusted Annual FFO Per OP Unit - (Hurdle Rate × Weighted Average Book Value Per OP Unit)) × Weighted Average OP Units Outstanding | |
= 25% × ($2.00 - (9.50% × $14.70)) × 11,196,724 | ||
= 25% × ($2.00 - $1.3965) × 11,196,724 | ||
= 25% × $0.6035 × 11,196,724 | ||
= $1,689,306 |
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Example 2:
Assumptions:
|
||||
Adjusted Annual FFO Per OP Unit(1)
|
$1.00 | |||
Hurdle Rate(2)
|
9.50 | % | ||
Weighted Average Book Value Per OP
Unit(3)
|
$14.70 | |||
Weighted Average OP Units
Outstanding(4)
|
11,196,724 |
Calculation of Incentive
compensation: |
= 25% × (Adjusted Annual FFO Per OP Unit - (Hurdle Rate × Weighted Average Book Value Per OP Unit)) × Weighted Average OP Units Outstanding | |
= 25% × ($1.00 - (9.50% × $14.70)) × 11,196,724 | ||
= 25% × ($1.00 - $1.3965) × 11,196,724 | ||
= 25% × -$0.3965 × 11,196,724 | ||
= Negative calculation results in no incentive compensation |
(1) | Adjusted Annual FFO per OP Unit means our operating partnerships funds from operations per operating partnership unit, adjusted for certain gains and losses. |
(2) | Hurdle Rate means 9.5% per annum or the 10 year Treasury Rate plus 3.5%, whichever is greater. |
(3) | Weighted Average Book Value Per OP Unit means the weighted average of the book value of the net assets contributed by Arbor Commercial Mortgage to Arbor Realty Limited Partnership per operating partnership unit, the offering price per share of our common equity in the original offering and subsequent offerings and the issue price per operating partnership unit for subsequent contributions to Arbor Realty Limited Partnership. |
(4) | Weighted Average OP Units Outstanding means the weighted average of Arbor Realty Limited Partnerships outstanding operating partnership units. |
Reimbursement of Expenses |
Our manager is responsible for all costs incident to the performance of its duties under the management agreement, including compensation of our managers employees, rent for facilities and other overhead expenses.
The expenses required to be paid by us or for which we reimburse our manager include, but are not limited to:
| legal, accounting and auditing fees and expenses of third parties for services rendered for us that are paid by the manager; | |
| the compensation, benefits and expenses of our independent directors and employees; | |
| travel and other out of pocket expenses of our employees in connection with the purchase, financing or sale of our investments; | |
| the costs of printing and mailing proxies and reports to stockholders; | |
| costs to obtain liability insurance to indemnify our directors and officers, the manager and its employees and directors and the underwriters; | |
| key man life insurance costs for our chief executive officer; and | |
| the compensation and expenses of our custodian and transfer agent, if any. |
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We are also required to pay or reimburse our manager for all expenses incurred on behalf of us in connection with:
| raising of capital or the incurrence of debt, | |
| interest expenses, | |
| taxes and license fees, | |
| litigation and | |
| extraordinary or non recurring expenses. |
Expense reimbursements to our manager are be made quarterly.
Restricted Stock Awards. We have granted to certain executive officers and employees of our manager who provide services to us 127,500 shares of restricted stock pursuant to our stock incentive plan. We have also reserved up to 35,500 shares for future grants to directors, officers and certain of our employees and certain employees of our managers. Two-thirds of the shares granted vested immediately and the remaining one-third will vest ratably over three years at a rate of 33.33% on each of the subsequent three anniversary dates of the date of grant. These restricted shares provide a means of performance based compensation in order to provide an additional incentive for our managers employees to enhance the value of our common stock.
Origination Fees. With respect to each bridge loan and mezzanine loan originated during the term of the management agreement, we agreed with Arbor Commercial Mortgage that we will (1) pay Arbor Commercial Mortgage an amount equal to 100% of the origination fees paid by the borrower to us, up to 1% of the loans principal amount, and (2) retain 100% of the origination fees paid by the borrower in excess of 1% of the loans principal amount.
Additional Interest. Under the management agreement, we receive any additional interest and other payments due upon maturity of any loan and fees paid by borrowers under bridge and mezzanine loans originated during the term of the management agreement, except that origination fees are allocated according the agreement described in the paragraph above. We have agreed with Arbor Commercial Mortgage that we are entitled to deduct from the applicable monthly installment of the base management fee due to Arbor Commercial Mortgage an amount equal to 50% of any otherwise payable additional interest due upon maturity of any of our loans if such interest is waived in accordance with the provision of the applicable loan agreement because the borrower refinances one of our structured finance investments with a Fannie Mae, FHA or conduit commercial loan originated by Arbor Commercial Mortgage.
Rights of First Refusal
Arbor Commercial Mortgage and Mr. Kaufman, through his non-competition agreement with us, have granted us a right of first refusal to pursue all opportunities identified by them or their affiliates related to structured finance investments in or with respect to commercial or multi-family real estate properties that are consistent with our investment objectives and guidelines and would not adversely affect our status as a REIT. If such investment opportunities are identified, Arbor Commercial Mortgage or Mr. Kaufman, as the case may be, will give our credit committee written notice and description of the investment opportunity. Our credit committee, which will consist of Mr. Kaufman, our chief executive officer, Mr. Weber, our executive vice president of structured finance, Mr. Palmier, our executive vice president of asset management and our chief credit officer, may either accept or reject the investment opportunity by a majority vote. If the committee rejects the opportunity, then Arbor Commercial Mortgage or Mr. Kaufman, as the case may be, will be able to present the opportunity to our independent directors. If our independent directors, by majority vote, reject the opportunity and allow Arbor Commercial Mortgage or one of its affiliates to pursue it, then Arbor Commercial Mortgage or the affiliate, as the case may be, will be able to do so on the same terms offered to us. If the terms of the investment opportunity materially change so that the benefits thereof are materially beneficial to Arbor Commercial Mortgage than such terms to us would have been under the transaction described in the original offer, then Arbor Commercial Mortgage must offer the revised investment opportunity to our credit
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During the term of the management agreement, we have agreed not to pursue, and to allow Arbor Commercial Mortgage to pursue, among other transactions and investment opportunities, opportunities related to multi-family and commercial mortgage loans that meet the underwriting and approval guidelines of Fannie Mae, FHA and conduit commercial lending programs secured by first liens on real property.
Mr. Kaufmans Non-Competition Agreement
Pursuant to his non-competition agreement with us, Mr. Kaufman has also agreed that:
| as long as he is serving as our chief executive officer or, during the term of the management agreement and the origination period described below, an affiliate of Arbor Commercial Mortgage, he will not pursue structured finance lending opportunities (and will refer those opportunities to us), unless our independent board members affirmatively approve the pursuit by Arbor Commercial Mortgage or one of its affiliates of structured finance lending opportunities that they have rejected on our behalf, See Rights of First Refusal; | |
| if he is no longer an affiliate of Arbor Commercial Mortgage and, within the first five years of the term of the management agreement, he is no longer our chief executive officer other than by reason of (1) his termination of his position for good reason, (2) our termination of him without cause, or (3) a change of control of Arbor Commercial Mortgage (which shall not be deemed to include any public offering of stock by Arbor Commercial Mortgage), he will not engage in the structured finance lending business for a period of one year after the earlier of his departure from us or the regular expiration of the one year origination period described below; and | |
| if there is a change of control of Arbor Commercial Mortgage within the first three years of the term of the management agreement, and he is no longer an affiliate of Arbor Commercial Mortgage and leaves us without good reason in that three year period, he will not engage in the structured finance lending business for one year after the date of his departure from us. | |
Mr. Kaufmans non-competition agreement also prohibits Mr. Kaufman from soliciting our customers or employees during its term.
Origination Period
For a period of one year following the expiration or termination of the management agreement due to our notice of non-renewal or termination without cause or our managers termination for cause:
| our manager and Mr. Kaufman agree to originate structured finance transactions for us, and | |
| we have granted them the exclusive right to provide these origination services to us. |
If we terminate the management agreement for cause (including because of a change in control of the manager), or if the manager terminates or elects not to renew the management agreement without cause, we will be able to accept origination services from others during the origination period.
With respect to each bridge loan and mezzanine loan originated during the origination period, we have agreed with Arbor Commercial Mortgage that we will (1) pay Arbor Commercial Mortgage an amount equal to 100% of the origination fees paid by the borrower to us, up to 1% of the loans principal amount, and (2) retain 100% of the origination fees paid by the borrower in excess of 1% of the loans principal amount.
We, Arbor Commercial Mortgage and, through his non-competition agreement, Mr. Kaufman have also agreed that (1) our right of first refusal to pursue all structured finance investment opportunities regarding commercial or multi-family real estate properties that are identified by Arbor Commercial Mortgage, Mr. Kaufman (so long as he is an affiliate of Arbor Commercial Mortgage) or their affiliates and (2) Arbor
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If such structured finance investment opportunities are identified during the origination period, Arbor Commercial Mortgage and, so long as he is an affiliate of Arbor Commercial Mortgage, Mr. Kaufman will give our credit committee written notice and description of the investment opportunity. Our credit committee will be able to either accept or reject the investment opportunity. If the committee rejects the opportunity, then Arbor Commercial Mortgage or Mr. Kaufman, as the case may be, will be able to present the opportunity to our independent directors. If our independent directors, by majority vote, reject the opportunity on behalf of us and approve Arbor Commercial Mortgages pursuit of that opportunity, then Arbor Commercial Mortgage may pursue the opportunity on the same terms offered to us. If the terms of the investment opportunity materially change, then Arbor Commercial Mortgage will be able to offer the revised investment opportunity to our credit committee and, if rejected, to our independent directors, who will be able to again be able to accept or reject the opportunity on behalf of us. Arbor Commercial Mortgage will be able to pursue the opportunity on the terms offered to us, if our independent directors reject the revised opportunity and approve Arbor Commercial Mortgages pursuit of such opportunity.
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MANAGEMENT
Our Directors and Executive Officers
Our board of directors consists of seven directors, four of whom are independent directors. See Corporate Governance Board of Directors and Committees. Pursuant to our charter, the board of directors is divided into three classes of directors. The current terms of the Class I, Class II and Class III directors will expire in 2004, 2005 and 2006, respectively. Upon the expiration of their current terms, directors of each class will be elected to serve a term of three years and until their successors are elected and qualify each year and one class of directors will be elected by the stockholders. The following table sets forth certain information about our directors and executive officers.
Name | Age | Position with Us | Class | |||||
Ivan Kaufman
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42 | Chairman of the Board of Directors, Chief Executive Officer and President | Class II | |||||
Frederick C. Herbst
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46 | Chief Financial Officer and Treasurer | ||||||
John C. Kovarik
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44 | Chief Credit Officer | ||||||
Daniel M. Palmier
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42 | Executive Vice President Asset Management | ||||||
Fred Weber
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42 | Executive Vice President Structured Finance | ||||||
Jonathan A. Bernstein
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57 | Independent Director | Class I | |||||
William Helmreich
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58 | Independent Director | Class III | |||||
C. Michael Kojaian
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42 | Independent Director | Class II | |||||
Melvin F. Lazar
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64 | Independent Director | Class II | |||||
Walter K. Horn
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60 | General Counsel, Secretary and Director | Class III | |||||
Joseph Martello
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48 | Director | Class I |
Information for each of our executive officers and directors is set forth below. For information regarding Messrs. Kaufman, Herbst and Horn, see Our Manager and the Management Agreement Officers of Our Manager.
John C. Kovarik. Mr. Kovarik was hired to serve as our chief credit officer in October 2003. From 1997 until October 2003, Mr. Kovarik was Senior Vice President and Chief Credit Officer of RER Resources, a commercial real estate consulting, underwriting and asset management services provider based in Virginia, where he was responsible for underwriting income property secured loans and managing teams providing acquisition underwriting. Mr. Kovarik has over twenty years of experience in credit, financial analysis and commercial real estate underwriting for various types of commercial properties.
Daniel M. Palmier. Mr. Palmier has served as our executive vice president of asset management since June 2003. He also continues to provide services to Arbor Commercial Mortgage in his capacity as a continuing member of Arbor Commercial Mortgages executive committee. Since 1997, he has been a member of Arbor Commercial Mortgages executive committee. From 1997 until the consummation of the original offering, he directed Arbor Commercial Mortgages asset management group, where he was responsible for asset management and formulation of value enhancement and disposition strategies of Arbor Commercial Mortgages debt and equity positions, with particular concentration on structured finance assets. Before joining Arbor Commercial Mortgage in 1997, Mr. Palmier was a vice president with Lehman Brothers Holdings Inc., where he was involved with asset management, restructuring, refinancing, development, leasing and disposition of commercial, retail and residential properties and mortgages. Mr. Palmier, a certified public accountant, has more than 18 years experience in various aspects of real estate management and practice.
Fred Weber. Mr. Weber has served as our executive vice president of structured finance since June 2003. He also continues to provide services to Arbor Commercial Mortgage in his capacity as a continuing
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Jonathan A. Bernstein. Mr. Bernstein has served as one of our directors since June 2003. Mr. Bernstein is of counsel at Pryor, Cashman, Sherman & Flynn, where he is head of the real estate department, specializing in finance and focusing on real estate investment trusts and structured financing involving real estate. Mr. Bernstein joined Pryor Cashman in 1993. He serves as an advisor to REITs and investment banks in the real estate area. Mr. Bernstein is also the vice chairman of TractManager LLC, an internet based software company, with offices in Saddle Brook, New Jersey and Chattanooga, Tennessee, specializing in contract management in the health care area.
William Helmreich. Dr. Helmreich has served as one of our directors since June 2003. Dr. Helmreich is the founder, and since 1980, owner and president of Byron Research and Consulting, a market research firm specializing in financial research, political polling, legal consulting, and issues relating to food products and real estate. He is chairman for Academic Affairs for North Shore Hebrew Academy, a member of the Board of Transaction Inc., as well as other not for profit boards, and was, for many years, a senior vice president of Good Earth Teas.
C. Michael Kojaian. Mr. Kojaian has served as one of our directors since June 2003. Mr. Kojaian is the chief operating officer of the Kojaian group of companies, a national multi-faceted real estate development investment and asset management organization. Before joining Kojaian in 1998, Mr. Kojaian was chairman of the Board of Grubb & Ellis, a commercial real estate advisory firm. Prior to that, Mr. Kojaian was Chairman of Dott Industries, a specialized automotive manufacturer. Mr. Kojaian is a member if the board of directors of Flagstar Bank, Grubb & Ellis and the United States Presidents Export Council.
Melvin F. Lazar. Mr. Lazar has served as one of our directors since his appointment in November 2003. Mr. Lazar is the founder of Lazar Levine & Felix LLP, certified public accountants, was managing partner from 1969 until September 2002, and is still an employee of the firm. Mr. Lazar specializes in business valuations and merger and acquisition activities. Mr. Lazar serves on the Board of Directors of Enzo Biochem, Inc., a publicly-held biotechnology company, Active Media Services, Inc., a privately-held corporate barter company, and CECO Environmental Corp., a publicly-held provider of innovative solutions to industrial ventilation and air quality problems.
Joseph Martello. Mr. Martello has served as one of our directors since June 2003. Mr. Martello is currently chief operating officer of Arbor Commercial Mortgage Management, LLC, the managing member of Arbor Commercial Mortgage, where he is responsible for management of the investment portfolio and overseeing the day-to-day operations. From 1995 to 1999, Mr. Martello was chief financial officer of Arbor Commercial Mortgage. From 1990 to 1995, Mr. Martello was the chief financial officer of Arbor National Holdings, Inc. Prior to that, he was a senior manager with the international accounting and consulting firm of Ernst & Young for eleven years. Mr. Martello is a member of the American Institute of Certified Public Accountants and the New York State Society of Certified Public Accountants where he is a former executive member of the Board of Directors of the Suffolk County Chapter.
Corporate Governance Board of Directors and Committees
Our business is ultimately managed through the oversight and direction of our board of directors, which has established investment guidelines for Arbor Commercial Mortgage to follow in its day to day management
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Our board consists of seven directors, three of whom are affiliated with Arbor Commercial Mortgage, Messrs. Kaufman, Martello and Horn, and four of whom are independent directors, Messrs. Bernstein, Kojaian and Lazar and Dr. Helmreich. The directors keep informed about our business at meetings of the board and its committees and through supplemental reports and communications. Our independent directors expect to meet regularly in executive sessions without the presence of our corporate officers.
Our board has established four committees, the principal functions of which are briefly described below. Matters put to a vote at any one of our four committees must be approved by a majority of the directors on the committee who are present at a meeting at which there is a quorum or by unanimous written consent of the directors on that committee.
Audit Committee
Our board of directors has established an audit committee, which is composed of three of our independent directors, Messrs. Bernstein, Lazar and Dr. Helmreich. Mr. Lazar serves as chairman of the audit committee. The audit committee assists the board in overseeing (1) our accounting and financial reporting processes; (2) the integrity and audits of our consolidated financial statements; (3) our compliance with legal and regulatory requirements; (4) the qualifications and independence of our independent auditors; and (5) the performance of our internal and independent auditors.
Compensation Committee
Our board of directors has established a compensation committee, which is composed of Messrs. Bernstein and Lazar and Dr. Helmreich. Dr. Helmreich serves as chairman of the compensation committee. The principal functions of the compensation committee will be to (1) evaluate the performance of our officers, (2) review the compensation payable to our officers, (3) evaluate the performance of Arbor Commercial Mortgage, (4) review the compensation and fees payable to Arbor Commercial Mortgage under our management agreement and (5) administer the issuance of any stock issued to our employees or, the employees of Arbor Commercial Mortgage who provide services to us.
Nominating/Corporate Governance Committee
Our board of directors has established a nominating/ corporate governance committee, which is composed of Messrs. Bernstein and Lazar and Dr. Helmreich. Dr. Helmreich serves as chairman of the nominating/ corporate governance committee. The nominating/ corporate governance committee will be responsible for seeking, considering and recommending to the board qualified candidates for election as directors and recommending a slate of nominees for election as directors at the annual meeting. It will also periodically prepare and submit to the board for adoption the committees selection criteria for director nominees. It will review and make recommendations on matters involving general operation of the board and our corporate governance, and annually will recommend to the board nominees for each committee of the board. In addition, the committee annually facilitates the assessment of the board of directors performance as a whole and of the individual directors and reports thereon to the board.
Independent Director Committee
Our board of directors has established an independent director committee, which is composed of all of our independent directors, Messrs. Bernstein, Kojaian and Lazar and Dr. Helmreich. The independent director committee is responsible for considering and voting upon matters as to which the board of directors determines Arbor Commercial Mortgage or its affiliates (other than us or our subsidiaries) or any of our directors (other than an independent director) or officers has a conflict of interest, including the approval of transactions between us and Arbor Commercial Mortgage.
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Director Compensation
Each of our independent directors are paid a directors fee of $25,000 per year. Each director who serves as a committee chairman of the audit, compensation or nominating/corporate governance committee is paid an additional fee of $3,000. Each director is also paid a fee of $2,000 for each board or committee meeting that he or she attends. Each director is also paid a fee of $1,000 for each telephone board or committee meeting that he attends. In addition, we reimburse all directors for reasonable out of pocket expenses incurred in connection with their services on the board of directors.
Our stock incentive plan provides for grants of restricted stock and other equity based awards with respect to our common stock. On July 1, 2003, Messrs. Bernstein, Kojaian, Martello and Dr. Helmreich each received 1,000 shares of our restricted common stock. Upon their appointment to the board, Messrs. Horn and Lazar each received 1,000 shares of our restricted common stock. Two-thirds of the restricted stock granted to these directors vested immediately upon the date of grant and the remaining one-third will vest ratably over three years from the date of grant at a rate of 33.33% on each of the subsequent three anniversary dates of the date of grant.
Executive Compensation
Because our management agreement provides that our manager assumes principal responsibility for managing our affairs, certain of our executive officers, who are employees of our manager, do not receive compensation from us for serving as our executive officers. However, in their capacities as officers or employees of our manager, or its affiliates, they devote such portion of their time to our affairs as is required for the performance of the duties of our manager under the management agreement. Mr. Ivan Kaufman, our chairman of the board of directors, president and chief executive officer serves as the chairman and chief executive officer of Arbor Commercial Mortgage. Mr. Frederick C. Herbst, our chief financial officer, also serves as chief financial officer of our manager. Walter Horn, our secretary and general counsel also serves as secretary and general counsel of Arbor Commercial Mortgage. Each of Messrs. Kaufman, Herbst and Horn receive their compensation from our manager.
On July 1, 2003, we granted Mr. Kaufman and Mr. Herbst, 120,000 shares and 4,000 shares, respectively, of restricted stock pursuant to our stock incentive plan, two-thirds of which vested immediately and the remaining one-third of which will vest ratably over three years at a rate of 33.33% on each of the subsequent three anniversary dates of the date of grant. On November 5, 2003, we granted Mr. Horn 1,000 shares of restricted stock pursuant to our stock incentive plan with the same vesting schedule. Our manager has informed us that, because the services to be performed by its officers or employees in their capacities as such is not performed exclusively for us, it cannot segregate and identify that portion of the compensation awarded to, earned by or paid to our executive officers by the manager that relates solely to their services to us.
Three of our officers, Mr. Fred Weber, our executive vice president of structured finance, Mr. Daniel M. Palmier, our executive vice president of asset management and Mr. John C. Kovarik, our chief credit officer, are employed and paid directly by us. Each of Mr. Weber and Mr. Palmier receive annual compensation of $360,000, plus a bonus to be determined at the discretion of our board of directors, which will not exceed $140,000 per year. On July 1, 2003, we granted each of Messrs. Palmier and Weber 7,000 shares of restricted stock pursuant to our stock incentive plan, two-thirds of which vested immediately and the remaining one-third of which will vest ratably over three years at a rate of 33.33% on each of the subsequent three anniversary dates of the date of grant. Mr. Kovarik receives annual compensation of $150,000 plus a bonus to be determined at the discretion of our board of directors, which will not exceed $75,000 per year. We began compensating our employee executive officers at the annual rates set forth above upon the commencement of our operations on July 1, 2003.
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Mr. Kaufmans Non-Competition Agreement
Pursuant to his non-competition agreement with us, Mr. Kaufman has also agreed:
| not to pursue any structured finance investment opportunities, except if our independent board members affirmatively approve the pursuit by Arbor Commercial Mortgage or one of its affiliates of structured finance opportunities that they have rejected on our behalf; | |
| if he is no longer an affiliate of Arbor Commercial Mortgage and, within the first five years of the term of the management agreement, he is no longer our chief executive officer other than by certain reasons, he will not engage in the structured finance lending business for a period of one year after the earlier of his departure from us or the regular expiration of the one year origination period; and | |
| if there is a change of control of Arbor Commercial Mortgage within the first three years of the term of the management agreement, and he is no longer an affiliate of Arbor Commercial Mortgage and leaves us without good reason in that three year period, he will not engage in the structured finance lending business for one year after the date of his departure from us. | |
Mr. Kaufmans non-competition agreement also prohibits Mr. Kaufman from soliciting our customers or employees during its term. See Our Manager and the Management Agreement Mr. Kaufmans Non Competition Agreement.
Stock Incentive Plan
We have adopted the Arbor Realty Trust, Inc. 2003 Omnibus Stock Incentive Plan, referred to in this prospectus as the stock incentive plan, to provide incentives to attract and retain the highest qualified directors, officers, employees, advisors, consultants and other personnel, including our manager and employees of our manager. The stock incentive plan is administered by our full board of directors or a committee appointed by our board of directors.
The stock incentive plan permits the granting of restricted stock awards. Under the stock incentive plan, 185,000 shares of common stock are reserved for issuance pursuant to restricted stock awards, subject to adjustment upon certain corporate transactions, and 147,500 restricted shares were issued upon consummation of the original offering. The initial awards were made to each of our initial directors, our chief executive officer, our chief financial officer, certain of our employees and certain employees of our manager who provide services to us. The remaining shares were reserved for issuance of restricted stock awards in the future. In addition, 1,000 restricted shares were issued to each of Messrs. Horn and Lazar upon their appointment to the board of directors.
A restricted stock award is an award of shares of common stock that is subject to restrictions on transferability and such other restrictions, if any, as our board of directors or committee may impose at the date of grant. Of the shares subject to the initial awards, two-thirds vested immediately and one-third will vest ratably over three years at a rate of 33.33% on each of the subsequent three anniversary dates of the date of grant. Future grants of restricted stock will be subject to vesting schedules as determined by our board of directors or the committee. The restrictions may lapse separately or in combination at such times, under such circumstances, including, without limitation, a specified period of employment or the satisfaction of pre-established criteria, in such installments or otherwise, as our board of directors or a committee of our board of directors may determine. Except to the extent restricted under the award agreement relating to the restricted stock, a participant granted restricted stock has all of the rights of a stockholder, including, without limitation, the right to vote and the right to receive dividends on the restricted shares. Although dividends are paid on all restricted stock, whether or not vested, at the same rate and on the same date as on shares of our common stock, holders of restricted stock are prohibited from selling such shares until they vest.
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Our board of directors may amend, alter or discontinue the stock incentive plan, but cannot take any action that would impair the rights of a participant without such participants consent. To the extent necessary and desirable, the board of directors must obtain approval of the stockholders, for any amendment that would:
| other than through adjustment as provided in the stock incentive plan, increase the total number of shares of our common stock reserved for issuance under the stock incentive plan; or | |
| change the class of officers, directors, employees, consultants and advisors eligible to participate in the stock incentive plan. |
Our board of directors (or a committee appointed by our board of directors to act as administrator of the stock incentive plan) may amend the terms of any award granted under the stock incentive plan, prospectively or retroactively, but, generally may not impair the rights of any participant without his or her consent.
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REGISTRATION RIGHTS AND LOCK-UP AGREEMENTS
In accordance with a registration rights agreement that we entered into with JMP Securities in connection with the original offering, we have filed a shelf registration statement, of which this prospectus is a part, covering the resale from time to time of the offered securities by the selling stockholders. 1,602,833 units, 9,616,998 shares of common stock and 1,602,833 warrants are being registered pursuant to the shelf registration statement, of which this prospectus is a part. 23,750 of these units, including 118,750 underlying shares of common stock and 23,750 underlying warrants are subject to lock-up pursuant to lock up agreements described below. The registration rights agreement is described below. The summary of the registration rights agreement is not complete and is subject to and qualified in its entirety by reference to the registration rights agreement, a copy of which is filed as an exhibit to the registration statement of which this prospectus is a part.
Under our registration rights agreement with JMP Securities, we agreed to file with the SEC by December 31, 2003, the shelf registration statement, of which this prospectus forms a part, providing for resale of the offered securities pursuant to Rule 415 under the Securities Act from time to time by the holders of the Offered Securities. We must use our best efforts to cause the