Arbor Realty Trust - Q2 2024

Transcript

Operator (participant)

Good morning, ladies and gentlemen, and welcome to the second quarter 2024 Arbor Realty Trust earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during this period, you will need to press star one on your telephone. If you want to remove yourself from the queue, please press star two. Please be advised that today's conference is being recorded. If you should need operator assistance, please press star zero. I would now like to turn the call over to your speaker today, Paul Elenio, Chief Financial Officer. Please go ahead.

Paul Elenio (CFO)

Thank you, Angela. Good morning, everyone, and welcome to the quarterly earnings call for Arbor Realty Trust. This morning, we'll discuss the results for the quarter ended June 30th, 2024. With me on the call today is Ivan Kaufman, our President and Chief Executive Officer. Before we begin, I need to inform you that statements made in this earnings call may be deemed forward-looking statements that are subject to risk and uncertainties, including information about possible or assumed future results of our business, financial condition, liquidity, results of operations, plans, and objectives. These statements are based on our beliefs, assumptions, and expectations of our future performance, taking into account the information currently available to us. Factors that could cause actual results to differ materially from Arbor's expectations in these forward-looking statements are detailed in our SEC reports.

Listeners are cautioned not to place undue reliance on these forward-looking statements, which speak only as of today. Arbor entertains no obligation to publicly update or revise these forward-looking statements to reflect events or circumstances after today or the occurrences of unanticipated events. I'll now turn the call over to Arbor's President and CEO, Ivan Kaufman.

Ivan Kaufman (President and CEO)

Thank you, Paul, and thanks to everyone for joining us on today's call. As you can see from this morning's press release, we have another strong quarter as we continue to effectively navigate through this extremely challenging environment. As we discussed in the past, we started preparing for the cycle well over two years ago, and our plan to appropriately position the company to navigate through and succeed for our investors in this challenging market is being executed in line with our expectations. We have a diversified business model with many countercyclical income streams, are focused on the right asset class with the appropriate liability structures, and are well capitalized, which has allowed us to continue to outperform our peers in every major financial metric. Last quarter, we posted some compelling charts on our website demonstrating this outperformance.

We updated these slides again this quarter, and we encourage you to review them as they clearly demonstrate that our total shareholder return, dividend growth, and book value appreciation over the last five years are outperforming everyone else in our peer group. In fact, most of our peers have cut their dividends substantially, have experienced significant book value erosion, and have generated a negative total shareholder return over the last five years. Clearly, this is not the position we are in, and we have continued to demonstrate over a long period of time that we are a consistent outperformer and leader in the space.

As we have communicated, we expected the first two quarters of this year to be the most challenging part of the cycle, and we have also guided to this period of peak stress affecting the third and fourth quarters as well if rates remain higher for longer. Even in the most stressful part of the cycle, we continue to post very strong operating results, which we'll discuss more in detail on today's call. We are aware of certain erroneous information in the marketplace, which has been driven by short reports and is inaccurate. While our performance in this quarter speaks for itself, we would be remiss if we didn't point out certain factual inaccuracies as well as ill-informed and/or inaccurate statements that are causing the most concern. First, there has been a swath of misinformation regarding one transaction in particular called the Westchase portfolio.

For example, misinformation started that the transaction should have been reported in the first quarter when, in fact, the transaction closed in the second quarter and was appropriately and timely reflected in the company's financials. We believe that the merits of this deal were in the ultimate interest of the shareholders. Specifically, we had a $100 million bridge loan collateralized by a portfolio of properties in Houston, Texas, in which the borrower defaulted. We immediately exercised our right to foreclose on these assets as we believed that there was a value above the debt. We simultaneously sold it to a new entity, which was capitalized with $15 million of fresh equity and a $95 million bridge loan at SOFR plus 300 basis points that we provided.

Of the $15 million of capital that was invested in the transaction, $6.25 million, or 40%, was funded by the Austin Walker Fund, which is a private minority-owned real estate fund focusing on affordable housing that we have a 49% non-controlling limited partnership interest in. The rest of the capital came from two independent separate investors, one of which is a borrower that we have a long-standing relationship with, which has a tremendous amount of expertise in renovating these types of assets and maximizing their value. We believe the stabilized value of these assets to be around $128 million, which is well above the capital stack of this deal, and the deal has now been recapitalized with the appropriate reserves, giving us confidence that the new ownership group will be able to hit the targeted business plan over the next few years.

Westchase is an outstanding transaction that fits what we want, which is lending to affordable housing communities. We believe this transaction is a very effective workout with sound economics and consistent with our values, yet the short sellers have levied what we believe are baseless criticisms about this transaction. Again, we are extremely pleased with the results of this transaction and the benefit it presents for our stakeholders. We continue to do an effective job in managing through our loan book, and this transaction represents management's capabilities in taking back an asset and replacing it with new sponsorship and having it appropriately recapitalized. Second, certain misinformation has been spread about the redemption of one of our CLOs. We have been a top issuer of CLOs for over 20 years, never once losing a single dollar of principal for our investors, even through the historic financial crisis.

We are experts in managing these vehicles and have issued and repaid many vehicles, returning all invested capital to our bondholders. We called a CLO on June 17th in the ordinary course of business, and in doing so, returned the principal investments of each bondholder in full to have outsized returns on our capital and maximized returns to our shareholders. Additionally, the short reports have also stated that we did not give proper notice to our bondholders prior to the redemption, but timely filed the appropriate SEC forms for the redemption and that we committed securities fraud. The rules are very clear.

We are required to give notice to our bondholders 10 days prior to the redemption, which we did formally through the trustee on May 31st, and we are required to file an SEC form on the redemption 45 days after the quarter in which the redemption occurred, which is, in this case, not until August 14. We have collapsed and redeemed over a dozen CLOs in the past 10 years, and each time giving the proper amount of notice and filing all SEC-required documents in a timely manner. Third, we have been criticized for how we have been managing our loan book in this distressed environment when, in fact, the company has done a very effective job in maximizing returns to our shareholders, which, again, are evidenced in the numbers that we have reported.

This quarter, we successfully modified a net worth of $730 million of loans, with $23 million of fresh capital being injected into these deals from the sponsors. This includes cash to purchase new interest rate caps, fund interest and renovation reserves, bring past-due interest current, and pay down loan balances where appropriate. We also continue to make progress on approximately $1 billion of loans that are past due by either modifying these loans, foreclosing and taking them into REO, or bringing in new sponsorship either consensually or simultaneously with the foreclosure. In addition, we had an extremely successful quarter given the recent decline in interest rates by generating $630 million of payoffs, with $490 million of these loans being refinanced into fixed-rate agency deals.

As I have said in the past, if interest rates go below 4%, obviously, as they've done in the last week or so, we expect that this will become more meaningful to our business. Despite these facts, Arbor has been subject to repeated attacks in the reports generated by short sellers, and we expect these attacks will continue. The best response to these attacks, and which we believe are unfair and unjustified, are our financial results and our earnings call here today. It has also been widely reported that in the wake of these attacks, over an 18-month period, Arbor has received requests for information from government agencies, including the Department of Justice. Arbor consistently has cooperated and will continue to cooperate with any such requests. Likewise, it is our policy not to comment on any such inquiries.

That said, I would like to provide more detail about some additional results that have resulted from our execution of strategies to manage the business through an environment that poses market-wide challenges. One of the items I touched on earlier is how important having adequate liquidity and appropriate debt instruments are to your success in these types of markets. As a result, we have focused heavily on maintaining a strong liquidity position. Currently, we have approximately $700 million of liquidity between around $700 million in corporate cash and $200 million of cash in our CLOs that results in an additional cash equivalent of approximately $15 million.

Having this level of liquidity is crucial in this environment as it provides us the flexibility needed to manage through the rest of the downturn and to take advantage of opportunities that will exist in this market to generate superior returns on our capital. We also continue to do an excellent job in deleveraging our balance sheet and reducing our exposure to short-term bank debt. We are down to approximately $2.8 billion in outstandings with our commercial banks from a peak of approximately $4.2 billion, and we have 67% of our secured indebtedness in non-mark-to-market, non-recourse, low-cost CLO vehicles. Our CLO vehicles are a major part of our business strategy as they provide us with a tremendous strategic advantage in times of distress and dislocation due to the nature of their non-mark-to-market, non-recourse elements.

In addition, they contribute significantly to providing a low-cost alternative to warehousing banks, which in times like this have fluctuating pricing and leverage point parameters. In fact, one of the significant drivers of our income streams are our low-cost CLO vehicles, as well as the fixed-rate debt and equity instruments that make up a big part of our capital structure. We are very strategic in our approach to capitalizing our business with a substantial amount of low-cost, long-dated funding sources, which has allowed us to continue to generate outsized returns on our capital. Another major component of our unique business model is our significant agency platform, which offers a premium value as it requires limited capital and generates significant, long-dated, predictable income streams and produces considerable annual cash flow. In the second quarter, we had a strong origination of $1.1 billion despite elevated rates for most of the quarter.

The recent drop in the 10-year and the 5-year, combined with tighter spreads, has allowed us to continue to build a strong pipeline of future agency deals, giving us confidence in our ability to grow our agency volumes going forward. We have also done a great job in converting our balance sheet loans into agency products, which has always been one of our key strategic and a significant differentiator from our peers. It is also very important to emphasize that a significant portion of our business is in the workforce housing part of the marketplace. As we all know, Fannie and Freddie have a very specific mandate to address the workforce affordable housing needs, which is a major issue in the United States, making Arbor a great partner that continues to fulfill a very important mandate for the federal agencies as well as the social needs for society.

Our fee-based servicing portfolio, which grew another 3% this quarter and 12% year-over-year to $32.3 billion, generates approximately $124 million a year in recurring cash flow. We also generate significant earnings on our escrow and cash balances, which act as a natural hedge against interest rates. In fact, we are earning 5% on around $2.4 billion of balances, or roughly $120 million annually, which, combined with our service and income annuity, totals $245 million of annual gross cash earnings, or $1.20 a share. This is in addition to the strong gain on sale margins we generate from our origination platform. It is extremely important to emphasize that our agency business generates 45% of our net revenues, the vast majority of which occurs before we even open our doors each day. This is completely unique to our platform.

In our single-family rental business, we continue to be the leader of choice in the premier market we traffic in. We have another strong quarter with $185 million of fundings and another $280 million of combined signed-up commitments. We have a large pipeline and remain committed to this business, and it offers us returns on our capital through construction, bridge, and permanent lending opportunities, and generates strong leverage returns in the short term while providing significant long-term benefits by further diversifying our income streams. We're also seeing steady progress in our newly added construction lending business. This is a business we believe can produce very accretive returns on our capital by generating 10%-12% unleveraged returns initially and eventually mid to high-returns on our capital once we leverage this business.

We continue to see a nice increase in our portfolio of potential deals with roughly $250 million under application, another $250 million in LOIs outstanding, and $850 million of additional deals we are currently screening. We believe this product is very appropriate for our platform as it offers us returns on our capital through construction, bridge, and permanent agency lending opportunities. In summary, we had another very productive quarter and are working exceptionally hard to manage through the teeth of this dislocation. We feel we have done an excellent job in working through our loan book and in getting borrowers to recap their deals with fresh equity, as well as bringing in quality sponsors to manage underperforming assets and working through our non-performing loans. We understand very well the challenges that lie ahead and feel we are well positioned. We have a diversified business model.

We are invested in the right asset class with very stable liability structures. We're also well capitalized and have a best-in-class asset management function and seasoned executive team, giving us confidence in our ability to navigate through this distressed environment. Despite the misinformation circulated in the marketplace about our business strategies, we continue to reiterate that we stand by our financials and our disclosures, and we have always conducted our business operations and practices in the best interests of our shareholders. I will now turn the call over to Paul to take you through the financial results.

Paul Elenio (CFO)

Okay. Thank you, Ivan. We had another strong quarter producing distributable earnings of $91.6 million, or $0.45 per share, which translated into ROEs of approximately 14% for the second quarter. As Ivan mentioned, we successfully modified 28 loans in the second quarter, totaling $733 million.

On approximately $398 million of these loans, we required borrowers to invest additional capital to recap their deals with us providing some form of temporary rate relief through a pay-and-accrual feature. Pay rates were modified on average to approximately 7.18%, with 2.14% of the residual interest due being deferred until maturity. $155 million of these loans were delinquent last quarter and are now current in accordance with their modified terms. Our total delinquencies were $1.05 billion at June 30th compared to $954 million at March 31st. These delinquencies are made up of two buckets: loans that are greater than 60 days past due, and loans that are less than 60 days past due that we are not recording interest income on unless we believe the cash will be received.

The 60+ day delinquent loans, or non-performing loans, were approximately $667 million this quarter compared to $465 million last quarter, due to approximately $264 million of loans progressing from less than 60 days delinquent to greater than 60 days past due. A $9 million loan that went non-performing this quarter, which was partially offset by $62 million of loans being modified in the second quarter that are now performing. The second bucket, consisting of loans that are less than 60 days past due, came down to $368 million this quarter from $489 million last quarter, mostly due to $264 million of loans that progressed to non-performing and $138 million of loans being modified or that paid off during the quarter, which was partially offset by approximately $281 million of new loans this quarter that we did not accrue interest on.

While we expect to continue to make progress in resolving these delinquencies, at the same time, we do anticipate that there'll be some new delinquencies in this environment. We're currently working through a number of these loans that we expect to resolve by taking back the properties and then working to improve these REO assets to create more of a current income stream. This could take 60-120 days, which will likely result in a low water mark for net interest income over the next couple of quarters until we have worked through this portfolio. This is what we expected and is consistent with our previous guidance that this would be the period of peak stress and the bottom of the cycle.

We also continue to build our CECL reserves, given the difficult market backdrop, recording an additional $29 million on our balance sheet loan book in the second quarter. $7.5 million were specific reserves we took on assets this quarter, with a balance in additional general reserves. The increase in general reserves from previous quarters was mainly due to changes in the assumptions in our models on real estate values, given the challenging environment. We feel it is very important to emphasize that despite booking approximately $145 million in CECL reserves across our platform in the last 18 months, $117 million of which was in our balance sheet business, we still were able to maintain our book value. This performance is well above our peers, the vast majority of which have experienced significant book value erosion in this market.

Additionally, we're one of the only companies in our space that has seen significant book value appreciation over the last five years, with 30% growth during that time period versus our peers whose book values have declined an average of approximately 20% in that time frame. As Ivan discussed earlier, we're pleased with the success we are having in working through our balance sheet loan book and in resolving our delinquencies. As we've stated many times, we have several recourse provisions in our loan documents that lend value to the resolution process. Last quarter, we realized a $1.6 million loss on an $11.3 million loan that paid off at a discount. We immediately pursued one of our recourse provisions and are pleased to report that we received a $900,000 settlement payment in the second quarter related to this loan.

We also had a very successful resolution on a legacy REO office property that we foreclosed on back in the fourth quarter of 2021. Through a lengthy marketing process, we were able to sell this asset above our carrying value, resulting in a second quarter gain of $3.8 million. In our agency business, we had a strong second quarter with $1.1 billion originations and loan sales. The margins on our loan sales were flat at 1.54% for both the first and second quarters. We also recorded $14.5 million of mortgage servicing rights income related to $1.1 billion of committed loans in the second quarter, representing an average MSR rate of around 1.32%, which was also flat compared to last quarter.

Our fee-based servicing portfolio also grew to approximately $32.3 billion at June 30th, with a weighted average servicing fee of 38 basis points and an estimated remaining life of 7.5 years. This portfolio will continue to generate a predictable annuity of income going forward of around $124 million gross annually. This income stream, combined with our earnings on escrows and gain on sale margins, represented 45% of our net revenues for the quarter. In our balance sheet lending operation, our $11.9 billion investment portfolio had an all-in yield of 8.60% at June 30th compared to 8.81% at March 31st, due to a combination of an increase in non-performing loans and some new loans that did not make their full payment that we did not accrue interest on, which was partially offset by modifications in the second quarter on some of our previously delinquent loans.

The average balance in our core investments was $12.2 billion this quarter compared to $12.5 billion last quarter, due to runoff exceeding originations in the first and second quarter. The average yield on these assets decreased to 9% from 9.44% last quarter, due to substantially more modifications in the first quarter, resulting in the collection of a significant amount of back interest owed, combined with an increase in non-performing loans and some new non-accrual loans in the second quarter. Total debt on our core assets decreased to approximately $10.3 billion, June 30th from $11.1 billion at March 31st, mostly due to the unwind of CLO 15 and the paydown of other CLO debt with cash in those vehicles in the second quarter. The all-in cost of debt was up to approximately 7.53% at 6/30 versus 7.44% at 3/31.

The average balance on our debt facilities was approximately $10.8 billion for the first quarter compared to $11.4 billion last quarter. The average cost of funds on our debt facility was up slightly, 7.54% for the second quarter compared to 7.50% for the first quarter. Our overall net interest spreads on our core assets decreased to 1.46% this quarter compared to 1.94% last quarter, again from a significant amount of back interest collected in the first quarter from modifications. Our overall spot net interest spreads were down to 1.07% at June 30th to 1.37% at March 31st, mostly due to an increase in non-performing and non-accrued loans during the quarter. Lastly, as we continue to shrink our balance sheet loan book, we have delevered our business 25% over the last 18 months to a leverage ratio of 3 to 1 from a peak of around 4 to 1.

Equally as important, our leverage consists of around 67% non-recourse, non-mark-to-market CLO debt with pricing that is below the current market, providing strong levered returns on our capital. That completes our prepared remarks for this morning, and I'll now turn it back to the operator to take any questions you guys may have at this time. Angela?

Operator (participant)

Thank you. As a reminder, to ask a question, please press star one on your telephone. To withdraw your question, press star two. So others can hear your questions clearly, we ask that you pick up your handset for best sound quality. We'll take our first question from Steve DeLaney with Citizens JMP. Please go ahead.

Steve DeLaney (Managing Director and Senior Equity Analyst)

Thank you. Good morning, Ivan and Paul. Congratulations on a solid performance in this difficult market. One of the things we noticed, obviously, you're very active on modified loans, the 60-day or less bucket.

We did note that that number of loans and the dollar amount declined. You know the figures, but in Q2, fewer loans to modify than in Q1. Looking at the modifications, which I guess so far this year is 67 modifications, $2.5 billion of loans. Looking at taking that data and then looking at the NPLs, which increased slightly in the second quarter, the 24 loans and $676 million, the question is this in terms of your process. Once you classify a loan as an NPL, are you still actively working to could you modify that loan and get it back in a current state, or once they go to NPL, is there a much higher probability that it might end up in REO? Thanks.

Ivan Kaufman (President and CEO)

Thanks, Steve. Let me give you a little overall view of the process.

We're talking about an overall number of about $1 billion, give or take, give or take. We believe we're pretty much in the peak part of the cycle with the most stress. As you know, the $1 billion has a negative effect on our financial performance, which is factored in because we're not accounting for the income on that. It's really incumbent on us to give you a good view of how that $1 billion is going to flow through the system. I'm pretty involved in this stuff, so we look at it this way. Of the $1 billion, we estimate about 30% of it will go REO. That's the toughest part of it. Those are usual ones that are not consensual. They take a bit of time, and they're non-income producing for us for that period of time.

It could take anywhere from three months to a year, depending on the jurisdiction. And then us getting into those assets and bringing them up to speed and then getting them cash flow and selling them. So that's the stickiest part. There's about another 10% or 15% of that that we're working with the existing sponsors to bring in new sponsorship. And we believe that over a period of three to six months, that those assets will have new buyers in them. And we estimate that, just to be conservative, it'll throw off about a 6% return once that's done. In that $1 billion, we estimate there's going to be about 20% of payoffs just because the assets are being sold. It's just a normal process. And then the other 40% are in the process of being modded. Mods take time.

A big part of what we do is we proceed to foreclosure when a loan's not paying. That path to a foreclosure usually leads to a very effective process of getting modified. We would estimate that that's the part that gets moved through the system the quickest. Generally, the average time is probably 90 days. Then it returns to an interest-earning asset, and we use about a 7% rate on that. We're in the thick of it. It's about $1 billion. We expect to get it through the system. There'll be some new ones coming in, but that's what we're expecting. Clearly, this drop in interest rates is extremely favorable for the company and its business model as it'll stimulate more multifamily sales, and people will be able to buy these assets with more affordable financing.

Steve DeLaney (Managing Director and Senior Equity Analyst)

Got it. Well, what I heard you say there, Ivan, is that because something is currently classified as an NPL, there is still a possibility that those loans could be modified. Did I hear you correctly?

Ivan Kaufman (President and CEO)

Yeah. I'm thinking about 40% of them based on what I see in the portfolio. I'm pretty intimate with the asset management group and the progress they're making. It takes time for a lot of these borrowers to find the capital and get these things brought up to speed. So that would be the approximate number I would be using to get it modified.

Steve DeLaney (Managing Director and Senior Equity Analyst)

Great. And the 30% to REO. Paul, I looked on the balance sheet. Can you tell us what's in REO currently? And I assume you have that in other assets. We couldn't find it.

Paul Elenio (CFO)

We do, Steve. Thank you. We absolutely do. So it is in other assets.

REO is $78 million right now on our books. It's sitting in other assets. We did sell, as I said, a South Carolina office property that we had on our books for $10 million. So it was $88 million last quarter. It's $78 million this quarter. And of that $78 million, just to give you a little color, the two biggest ticket items are a $41 million New York City office property we took back in 4Q of 2023 that we disclosed. And that's a building that we brought in new sponsorship and are converting it to a condo, and that'll take some time. And then the other big piece is we have about a $30 million multifamily deal in Texas that we took back in the fourth quarter of 2022 that we're working through. And then there's some little odds and ends.

But it's a small number, but as Ivan said, we are expecting, as we work through this $1 billion, that a decent amount more could go REO, and that number will grow, right, Ivan? That's what we're talking about.

Ivan Kaufman (President and CEO)

Yeah. That's the guidance that gave you about 30%.

Paul Elenio (CFO)

Yeah.

Steve DeLaney (Managing Director and Senior Equity Analyst)

Thank you both for your comments.

Ivan Kaufman (President and CEO)

Thanks, Steve.

Operator (participant)

Our next question comes from Stephen Laws with Raymond James. Please go ahead.

Stephen Laws (Managing Director)

Hi, good morning. Just to follow up, a minor point on the REO, about how many assets is that? Is the average loan size consistent with kind of the $20 million for the portfolio, or how do you see that, I guess, $300 million of potential REOs from a property count standpoint?

Ivan Kaufman (President and CEO)

We'll take a look at the list. I would take a guess, but Paul could be more accurate. It's probably an average loan size of around $30 million.

Paul Elenio (CFO)

Yeah. We have some chunkier stuff we're looking at, Stephen, that is in the 50, maybe even 100, but that's not a lot of what we do. And then we have some 10 and 15s and 20s. So it's hard to really project where these are all going to end up, but I would say that we're thinking it's probably in the $30-$40 million average range.

Stephen Laws (Managing Director)

Great. And then, Ivan, I want to go back to something you commented on around interest rates. And you said we go below four, certainly beneficial. And I think since the last time we spoke, as long into the curve's down, almost 100 basis points are fairly close. Can you talk about maybe how, and I know the most recent move's only been a couple of weeks, but can you talk about how that maybe has changed behavior from sponsors? Do you think they're more likely to protect assets, cheaper to buy new caps? And then how do you think it impacts agency volumes as you move forward?

Ivan Kaufman (President and CEO)

Well, let me address the cap issue. The cap issue has been an extremely expensive proposition for a lot of these sponsors, assuming for the last two years they've had to pile in another 6-8 points of capital to buy caps. We believe the curve's going to change and the cost of caps is going to go down, which believes they're paying a little bit. That's on that side. But the real meaningful issue is the drop in the 5-year and the 10-year. I mean, you could effectively borrow close to 5% off the 5-year. Up till now, people were paying close to 6%-6.5%, but spreads have tightened, rates have come down.

So if you have a borrower currently paying on a floating-rate basis close to 9%, he can then go ahead and pay 5%. So that's a great option for that particular borrower, even if they have put a little more capital into it. And they can secure long-term financing and really put themselves from a negative cash position into a positive cash position, assuming you have an asset that's 6-6.5 cap rate. All of a sudden, you've created positive cash flow from negative cash flow. And that's becoming very meaningful. The real key for people is, are they managing their assets well? Are they stabilized? Because in order to get fixed-rate financing, you need 90+ occupancy somewhere in that range.

So to the extent people have their assets stabilized, then that becomes a great option for them and will relieve the pain of carrying those assets, which has been extremely painful. Make no mistake about it. When you go into borrow a loan and you're paying 4.5% or 5%, and the next thing you're paying 9%, and it's for a prolonged period of time, you have a lot of capital needs. So I think we're at a great inflection point right now for many of these borrowers, if their assets are stabilized, that they can look through the fixed-rate market and reposition their assets and not have negative train.

Stephen Laws (Managing Director)

Great. Appreciate those comments, Ivan. And one last one, if I may, on portfolio seasoning. Origination volume was very strong in 2021 and the first half of 2022, really lightened up a lot in the second half of 2022. If you think about the seasoning of those loans, is it fair to say that you've covered the $1 billion of NPLs, but should we continue to see kind of the new 60-day delinquencies start to decline? I know there'll be more and some will move, but are we past the peak of kind of identifying the problem loans as you think about your portfolio?

Ivan Kaufman (President and CEO)

Well, I think that we've given pretty good guidance that the first and second quarter would be peak stress and if rates remain higher for longer, we're looking to the third and fourth quarter. I believe that with this rate move down, I think you'll see the market change a little bit. So perhaps the third quarter may be a little bit tough, but we're seeing a little bit of easing.

And if rates remain in this level, I believe there'll be a lot of liquidity returned to the multifamily sector and a lot of trades being done. So I'm hopeful and optimistic that perhaps the second quarter was the peak, a little leakage into the third, but we're definitely seeing the light at the end of the tunnel.

Stephen Laws (Managing Director)

Well, that's great to hear. And nice job managing your assets in a difficult market and look forward to next quarter. Thank you.

Ivan Kaufman (President and CEO)

Thanks, Steve.

Operator (participant)

Our next question comes from Rick Shane with JPMorgan.

Rick Shane (Analyst)

Hey, guys. Thanks for taking my questions this morning. A couple of different things. Just from a bookkeeping perspective, cash balances within the structured business declined by about 50%. I assume some of the decline in the restricted cash is from calling the CLO, but can you just help us understand what's going on there?

Ivan Kaufman (President and CEO)

Yeah, sure. I mean, the reason we did call our CLO is because we were sitting on excess cash balances and it was inefficient. So that's expensive to be sitting on cash balances which are not being deployed. So on the normal course of business, when we have those excess cash balances and can't use them, that's why we call a vehicle. And the efficiency of these vehicles is to keep the cash balances as low as possible. So it achieves exactly what we wanted.

Paul Elenio (CFO)

Yeah. And to add to that, Rick, that is a big piece of it. The other piece of it is some of these vehicles, as you know, are out of replenishment period, so they're naturally delevering as loans are running off. So the restricted cash is paying down debt, and that's part of the component as well. And then the third component is that we did pay off $90 million of unsecured debt in April, as you were aware, with cash. So those are kind of the three big components that guide you to decrease in cash for the quarter.

Rick Shane (Analyst)

Okay. Thank you. Second topic, you talked about modifying $730 million of loans in the second quarter. We've gone through the disclosure in the last Q related to mods. And I'm going to be honest, I don't fully understand all of the implications. Can we just walk through clearly the implications of the mods in this quarter in terms of what it means for the difference in cash that you will receive and the difference in interest accrual? So if you didn't modify the loans, what would you have expected to receive? How much are you giving up in cash over the next year or two, and what is the difference in the accrual rate so we understand the implications from an income perspective?

Paul Elenio (CFO)

Okay. So let me try to attempt to answer that. It's a little more complicated than that. Our Q will be out early next week, we hope, so you'll get more details on that disclosure. But the way I think I look at it, and don't know if it'll completely answer your question, is we did mod $1.9 billion or $2 billion of loans last quarter. I think $1.1 billion had paying accrual features.

What we did was what management does is we look at every single loan we modify, and we go through it on a loan-by-loan basis to determine how strongly we feel the value and the mod has put us in a position we'll still be able to recover the accrued interest. If we don't feel we're in that position, we won't accrue the accrued interest. If we do, we accrue it. For the most part, we accrue it. There are exceptions. There are loans that we decide not to accrue the accrual rate after the mod if we think it's still a challenging asset. Having said that, in the first quarter, our mods generated about, have it right here. I'm trying to get it in front of me. Our mods generated about, call it, $3 million of accrued interest that hit our P&L that wasn't cash.

In the second quarter, those first quarter mods were now $6 million of accrued interest that didn't hit cash because it was for a full quarter. The second quarter mods were $2 million in the second quarter of accrued interest. So our PIK interest, as we'll call it, for one Q mods was about $3 million in the first quarter. In the second quarter, the one Q mods were $6 million, and the two Q mods were $2 million for a total of $8 million. So that number will obviously grow because the second quarter numbers, the mods will be fully affected in the third and fourth quarter. And then if we mod any new loans. I don't know if that's answering your question, but that's the numbers for the first and second quarter mods of how those accrual rates that we accrued affected interest income, but not cash.

Rick Shane (Analyst)

Paul, no, it's a very thoughtful question to respond to a question I wasn't sure objectively you would be able to answer. So I was a little bit circumspect about asking that, so thank you. It's very helpful. Last question. Implicitly, the mods, $23 million of additional capital on $730 million of mods, that's about a 315 basis point contribution of capital. Ivan, I'd love to understand that in the context of your comment, an answer or two ago about caps running 6%-8% for your borrowers. I'm just curious how we sort of square those two numbers.

Ivan Kaufman (President and CEO)

Okay. It's 6%-8% over a 2-3 year period. Each year, a cap cost can be anywhere between 1.5-3, depending on the loan. So in context, we're looking at more of an annual than a cumulative on that number. But Paul can give you a good number in terms of the mods and how they work for the second quarter.

Paul Elenio (CFO)

Sure, I can. So of the $733 million of loans we modded and $23 million of capital was committed to be injected, $6 million of that capital went to buy rate caps. And they're at all different strike prices. Rick, some are out-of-the-money strikes, some are way in the money strikes, and I think the average strike was about 3.7%. And then the rest, we had one loan that paid down the principal balance by $2 million. We had past due interest of about $2 million that was collected. And then the rest were to fund rental reserves, interest reserves, and OPEX reserves. So it was kind of how it breaks out, if that helps you.

Rick Shane (Analyst)

It does. Very thoughtful answers. I appreciate the time. I would throw in one last request. There are a lot of numbers that get thrown around on these calls. You guys are unique among the companies that we follow in not providing a slide deck on the calls. And I think given the complexity of what Paul, you've described, it would be really helpful if people could see the numbers and you could be walking through slides on the call. So I'm just going to throw that out there, but I appreciate the time, guys.

Paul Elenio (CFO)

Sure. Thanks. Thanks, Rick. We appreciate it. We always want to be more transparent and have the best disclosures. We try to be. When the Q gets filed, there'll be a lot of good information in there, and then we'll always take into consideration whether we think we can put it in a better form for readers. And thank you for that comment.

Rick Shane (Analyst)

Great. Thanks, guys.

Operator (participant)

The next question comes from Jade Rahmani with KBW.

Jade Rahmani (Managing Director of Commercial Real Estate Finance)

Thank you very much. Can you please give the second quarter or six-month year-to-date cash flow from operations number?

Ivan Kaufman (President and CEO)

Yeah, it's in the 10-Q. Well, if you don't have the 10-Q, obviously, it's not filed yet. So I'll give it to you. One second, Jade. So the cash flow from number is $335 million, but you got to back out the changes in the originations and sales of held-for-sale assets, which is a $220 million swing. And then you've got $90 million in changes in operating assets. So call it, yeah, call it $335 million is cash flow from operations for the six months. And then you have a $220 million positive swing on originations, less proceeds from sales, and a $100 million negative swing in the change in operating assets and liabilities.

Jade Rahmani (Managing Director of Commercial Real Estate Finance)

Okay. That's great. The NPLs of around $1 billion. Do you have any numbers in mind as to where that total balance peaked?

Ivan Kaufman (President and CEO)

I'd say we're within range of the peak right now. I mean, maybe it can go up a little bit more, but we're kind of in the peak period of time. We're pretty optimistic about the number I've given you on the mods because we're pretty close to a conclusion on those mods. So I think that's a good number to ballpark.

Paul Elenio (CFO)

Yeah. It's a tough one to predict, as you know. I mean, I think Ivan's right. It kind of has. It's gone up a little bit since the first quarter, not significantly, $954 million-$1.050 billion. We do expect a few more delinquencies. Hopefully, we're at the peak, but we do have our eyes on a bunch of loans that are delinquent that we're going to successfully mod.

So hopefully, that number will not peak higher. And then we're going to have some of those loans come out and be REO, right? They'll just be on a different line item, but they'll still be non-performing until we work through them. So it's a tough answer, but I think Ivan's right. I think we feel like it shouldn't be significantly difficult.

Ivan Kaufman (President and CEO)

Yeah. I mean, what I would do is the sticky part is the REO because it takes time to get your hands on the asset. And then once you get your hands on the asset, you got to stabilize that asset. That's the sticky part. The rest is somewhat transitional.

Jade Rahmani (Managing Director of Commercial Real Estate Finance)

And when you look at the NPL and learning what's been going on this cycle, do they have anything in common in terms of maybe one issue that's been driving it? Do you think the main issue is really the borrower's basis and having paid too much, too low a cap rate for the assets? Or do you think, on the other hand, perhaps it's sponsorship, maybe leverage ratio, or the third category is probably underperformance?

Ivan Kaufman (President and CEO)

It's a whole slew of activities. And clearly, when interest rates go up as dramatically as they did when everybody believes we've been in a low-interest rate market forever, that's probably the single biggest driver. I've said in many calls before, the impact of COVID had a very significant impact because people were not able to move out tenants for many, many years. We've had in some of these properties, 10%-15%, even 20% economic occupancy where tenants are living for 3-4 years without paying rent. That was a big factor. That's an unanticipated factor.

A third factor, which we spoke about as well, is the increase in insurance costs. I mean, they doubled, tripled, and quadrupled. They're coming down a little bit now. The insurance costs, the economic occupancy, you can't predict those. So that created a lot of headwind. I think when people go into a buying frenzy in the top market, they focus on buying and not on management. And that's something that we've certainly learned a lot from because there's one thing to be an effective capital raiser and buyer of an asset. There's another thing to be an effective manager. So management cures a lot of ills.

One of the things that's extremely important to us when we're modifying a loan is that if we don't think the asset's being managed appropriately, either we won't modify and we'll take it through REO, or we'll insist and make sure they bring in new management. Management is also a major part.

Jade Rahmani (Managing Director of Commercial Real Estate Finance)

That's excellent. Thank you. My last question would just be on the GSEs. We've seen a lot of stories around them being pretty cautious right now. Not just the Meridian issue, which started back in maybe the third quarter of last year, but there have been others, appraisers, local small regional title companies. What exactly do you think is going on with the GSEs? Are they cracking down? Are they tightening their underwriting standards? Or are those just sort of a select few cases?

Ivan Kaufman (President and CEO)

I think in every cycle, you always have certain things that happen. In this cycle with all the volume, there are certain things that occur. Clearly, the agencies have changed their attitude towards brokers. Meridian is just a broker, but brokers have played a major role and were very dominant in garnering a lot of volume. In garnering a volume, obviously, they control a lot of the source documents. The industry has changed. Andy and Freddie have learned that if there are brokers in between that are not direct with them, they can't control the source documents. So they've changed the guidelines. I think that was a long time coming. You have to understand that since 2010, basically, we've been on a tremendous run. A lot of deals have been hidden. This is the first time there's a prolonged downturn.

And now you can see some of the things that were done in the industry that finally caught up. So I think that's going to be a healthy change that the lenders have to deal directly with the borrowers. And that's a very healthy change. Appraisals have always been a sore point within this industry, right? We rely so much on appraisals. I believe that a big part of AI and a big part of technology will have a significant impact on improving the valuation process. And appraisals are sometimes aligned, sometimes not aligned. It's like any other process that's human. Within the human process, there are always errors or corruption. And I think it happened to them. Not abnormal. It's part of life. Every part of life is corruption. So they got hit with a little bit, but not a lot, very small, relative to the overall thing.

I think when they find a bad actor, it's brought to light. They eliminate the bad actor. But I think the whole appraisal process, which everybody's relied on valuations extensively, I think with technology, that's going to be a much better process going forward.

Jade Rahmani (Managing Director of Commercial Real Estate Finance)

Thank you very much.

Operator (participant)

The next question comes from Jay McCanless with Wedbush.

Jay McCanless (Equity Research Analyst)

Hey, good morning. Thanks for taking my question. Congrats again on EAB covering the dividend, but that spread continues to narrow. Could you maybe talk to us about how comfortable you are with the current dividend level and especially if economic conditions worsen from here?

Paul Elenio (CFO)

Sure. Hey, Jay, it's Paul. Thank you for the question. I think it was clear in my prepared remarks that our spreads have come in given the fact that we've got $1 billion of loans not paying.

I think one of the things we really need to stress is that because our business model is so diversified and because we have so many different income streams, the agency business being one specific one, our SFR business being another that we continue to ramp up and get a 15% yield on our money, we have the ability to do things others don't, right? We're not afraid to take back an asset, right, Ivan, and not afraid to work it through, even if it means it's going to be non-interest earning for a little bit. So I've guided you guys to a little bit of a low watermark in the third and fourth quarter. So it's possible our numbers in the third and fourth quarter could approach that number or be slightly below it.

It'll depend on how successful we are in getting back interest and getting those loans back online. But what also will affect it is the drop in the 10-year, right? If the drop in the 10-year continues and our agency business starts to explode, that'll obviously offset any negative drag we have on non-performing loans. So it's a tough one. I'd say it's getting tighter. It will continue to get tighter. It may even dip around there or below for a quarter or two, but we're not concerned because we know that we're going to take this $1 billion of assets, and some good portion of it's going to turn into interest earning at some point. And on top of that, our agency business is going to continue to generate sizable returns.

As Ivan said, we are working on a bunch of assets now that we think are going to pay off. And we're going to take that capital on loans that were earning zero, and we're going to deploy it back into our system, even at 10%, 12%, 13%, whatever it is we come up with on an unlevered basis, which will be accretive. So it'll be a little bit of a timing issue in that the third and fourth quarter may get tight, and we've talked about that, but long term, we're very, very comfortable with the protection.

Jay McCanless (Equity Research Analyst)

Okay. Great. Thanks for taking my question.

Operator (participant)

The next question comes from Crispin Love from Piper Sandler.

Crispin Love (Senior Research Analyst)

Thanks, [Zach]. Good morning. Appreciate you taking my question. Just asking the GSE question from earlier just a little bit differently. Can you discuss recent activity with Freddie and Fannie? Because we did see Fannie originations come down meaningfully in the first quarter, but they bounced back nicely in the second. So curious if there were any changes there on tightening standards in the first versus the second quarter, and then just what you expect going forward from the agencies.

Ivan Kaufman (President and CEO)

I think it kind of mirrors a lot of the conversation we've had, and it's very much tied to interest rates. I think that the agency's volumes are going to increase considerably as rates drop. There are a lot of people who've been sitting on the sidelines waiting to refinance their loans when they got to a certain rate range. We're in prime-time rate range today with today's drop, the rates that have dropped, and I think the agency's volumes are going to really, really increase considerably.

You have to also keep in mind that there hasn't been that much in multifamily sales activity. Very, very low. I think that'll pick up, and that'll feed the agencies as well. So I think I'm very optimistic that the agency's volumes will really benefit off of this and will increase and will grow. And then we'll go back to the same old problem of, "Oh, the agencies are backed up," and they're taking longer. We're not that far away from that. We've experienced that. So I think that the agencies are going to have a very, very, very strong period of time relative to the last couple of quarters.

Paul Elenio (CFO)

Yeah. And I did say I had some call with that, Crispin. When we did $360 million of volume in our agency business in July, so that number was actually just around the target we did for the second quarter. But we think, and as Ivan said, we think given the recent move in rates, some people are going to move off the dime here. And I think we're going to see an increase to that volume in August and September. That's our view.

Crispin Love (Senior Research Analyst)

Great. Thank you. I appreciate the July number there as well. And then just one more for me. Can you just talk a little bit how you expect the first couple of rate cuts at the end of the, assuming they do happen at the end of the year and into 2025, could impact you? And could it be a net negative to your net interest income over the near term in a structured business, but of course, benefit originations and agency, as you mentioned? Just curious on how you think about the impact there, especially in NII. I'm doing lower yields, lower cost of funds, but unsure how much it would improve the borrower profile just with a couple of rate cuts. Thanks.

Ivan Kaufman (President and CEO)

I think we have to look at the rate cuts also in conjunction with what we've been talking about with the 5 and 10-year coming down. I think if there are rate cuts, two things will happen. It'll put the book in a better position because people can buy rate caps cheaper. I also think there'll be more transaction activity, and people will go into floating rate loans on some of these underperforming assets. So I think our book of floating rate loans will increase as well. So I think there'll be more volume on that side. I think offset of some revenue drop, I think you'll see the agency business pick up considerably.

I also think it'll stimulate some of the modifications and bring some of those modifications more online and create a lot of income-producing opportunities on that side to offset some declines in revenue. I think net-net, the rate drops are beneficial for the company. That's the way I would look at it from my chair.

Paul Elenio (CFO)

Yeah. And I would say, Crispin, I agree with Ivan. The timing may be something that's hard to predict. You're right. If rates drop, your net interest income squeezes, but you've got $1 billion of loans not paying, obviously, the health of the portfolio will increase with a rate drop, and then your agency business will pick up. But it's just a matter of the timing. And that's the stuff that's hard to tell. You may have a little bit of a dip in net interest income right away, and then it builds back up with your agencies. But long term, and as Ivan said, globally, that's a positive for us.

Ivan Kaufman (President and CEO)

Yeah. And I want to also point out what we've talked about for a long time on the calls is that we put a big investment through our single-family SFR business, a construction lending business. That's a business that funds up over time. We have these commitments, and those commitments and the equity deployed will go up, and that should be a mid to high-teens return. So that will offset some of the runoff in the portfolio, and that was clearly by design on our part.

Crispin Love (Senior Research Analyst)

Great. Thank you. Appreciate you taking my questions.

Ivan Kaufman (President and CEO)

Thanks, Crispin.

Operator (participant)

The next question comes from Lee Cooperman with Omega Family Office.

Lee Cooperman (President and CEO)

Finally. So let me.

Ivan Kaufman (President and CEO)

Hey, Lee.

Lee Cooperman (President and CEO)

How you doing?

Ivan Kaufman (President and CEO)

Good. Good.

Lee Cooperman (President and CEO)

Let me first. I'm not a pimp for you guys, but I just want to say I congratulate you on your performance. A year and a half ago, you told me how negative you were about the environment, and you couldn't have been more right. I detect a real frustration on your part in the beginning part of this call and dealing with the shorts. These are unmerciful and, in this case, uninformed people, basically. And I just will tell you, he lasts, lasts, lasts best. And so you're performing. They don't understand the uniqueness of the company and how you position the company. And let me tell you, you've been very right, and I congratulate you, and I thank you, as a large shareholder. Let me ask you a question since you've been more right than me about the environment.

Do you think we're heading into a recession? Number one. Number two, in terms of the book value, I'm out on vacation, so I'm dialing in on a cell phone. What is our book value at the end of the quarter? And are you a buyer of your stock in the low, in the $10, $11, $12 area? Right down there?

Ivan Kaufman (President and CEO)

Yeah. So you and I have had a lot of conversations over the last year or two, and I have told you my view on unemployment and the economy. And obviously, I've been more right than wrong. And my view towards interest rates. And we're exactly where I said we'd be, and we're exactly where I said we'd be almost to the exact timing. And what I've said on the calls repeatedly, the first and second quarter being the most difficult.

I get a good barometer for really the unemployment more on the workforce type of people, and I get a good read, and I do a lot of intel. So I think that the economy is off. And I also get a good idea from building costs and trades. And there's like a 20% differential in the period of post-COVID. People were paying 10%-20% premiums to build their projects. Now they're getting a 10% discount. So you almost have a 20%-30% differential from the peak in construction costs. People are hiring crews more easily and readily. Subcontractors are out there bidding and wanting jobs. So I think you've seen a tremendous change. So I think we are in a bit of a recession, and I think that you have another big factor here.

You have the shadow of unemployment being impacted by the 10+ million immigrants who have been letting into this country, and they're going to be starting to work. They're only letting about 10-20 thousand of them a month working. So that's a big impact on our unemployment. So I do think that we're in a period of time where we'll be a little bit recessionary, and I think rates will remain in this range, or short-term rates should come down, which is all good for our business.

Paul Elenio (CFO)

And as far as, Lee, as Paul, our book value is $12.46 at the end of 6/30. To your question about buybacks, we certainly have around $140 million of capacity left in our buyback plan. Ivan and I will always assess where we think it's appropriate based on our capital. And clearly, at levels that you talked about, we'd like to be active because it'd be very accretive to our book value and also to our earnings, right, Ivan?

Ivan Kaufman (President and CEO)

Yes.

Lee Cooperman (President and CEO)

I know it's been very frustrating to you. The short guys are unmerciful. They come out with inaccurate accusations on a Friday afternoon when you're in your quiet period and you can't respond. And it's just terrible with the damage you're doing to the public shareholders. But we're all lucky to have you guys in our corner because you've done a terrific job, and I appreciate it. Thank you.

Ivan Kaufman (President and CEO)

Thank you, Lee. And as you know, we're in a heavily regulated environment. They're unregulated. And we do get frustrated, black-out periods. And then we prepare very heavily for these earnings calls where it's out there in court.

As I said on my call, the numbers speak for themselves and the company's performance. Even in these very stressful times, we are performing extraordinarily well. When you compare us to our peers, it's not even the same group. We've posted those charts to do a comparison. We'll continue to work hard, be thorough, navigate these times, and appreciate you as a shareholder and all our shareholders who have had a lot of confidence in us. Thanks to you and Mark. It's very meaningful to us and to our management staff. We've been working extraordinarily hard just to get back to break even as an entrepreneur. I've always worked to grow companies, and it's not the most rewarding thing in the world to work to get back to break even, but life is life, and that's part of our job.

And we're working hard, and we've done a good job, and I think the quarter speaks for itself. And thank you again, Lee, for your comments.

Lee Cooperman (President and CEO)

It's my pleasure. They're well-deserved. Congratulations.

Ivan Kaufman (President and CEO)

Thanks. Thanks, Lee.

Operator (participant)

This does conclude today's question and answer period. I will now turn the program back over to our presenters for any additional or closing remarks.

Ivan Kaufman (President and CEO)

All right. Thank you, everybody, for listening today and for the long call and for your patience. And thank you for your participation in the call. Everybody have a great weekend and enjoy the rest of the summer.

Operator (participant)

This does conclude today's program. Thank you for your participation. You may disconnect at any time.