Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion in conjunction with the sections of this report entitled “Forward-Looking Statements,” “Risk Factors” and “Selected Financial Data,” along with the historical consolidated financial statements including related notes, included in this report.
Overview
Through our Structured Business, we invest in a diversified portfolio of structured finance assets in the multifamily, single-family rental and commercial real estate markets, primarily consisting of bridge and mezzanine loans, including junior participating interests in first mortgages and preferred and direct equity. We also invest in real estate-related joint ventures and may directly acquire real property and invest in real estate-related notes and certain mortgage-related securities.
Through our Agency Business, we originate, sell and service a range of multifamily finance products through Fannie Mae and Freddie Mac, Ginnie Mae, FHA and HUD. We retain the servicing rights and asset management responsibilities on substantially all loans we originate and sell under the GSE and HUD programs. We are an approved Fannie Mae DUS lender nationally, a Freddie Mac Multifamily Conventional Loan lender, seller/servicer, in New York, New Jersey and Connecticut, a Freddie Mac affordable, manufactured housing, senior housing and SBL lender, seller/servicer, nationally and a HUD MAP and LEAN senior housing/healthcare lender nationally. We also originate and service permanent financing loans underwritten using the guidelines of our existing agency loans sold to the GSEs, which we refer to as "Private Label" loans and originate and sell finance products through conduit/commercial mortgage-backed securities ("CMBS") programs. We pool and securitize the Private Label loans and sell certificates in the securitizations to third-party investors, while retaining the servicing rights and APL certificates of the securitization.
We conduct our operations to qualify as a REIT. A REIT is generally not subject to federal income tax on its REIT-taxable income that is distributed to its stockholders, provided that at least 90% of its REIT-taxable income is distributed and provided that certain other requirements are met.
Our operating performance is primarily driven by the following factors:
Net interest income earned on our investments. Net interest income represents the amount by which the interest income earned on our assets exceeds the interest expense incurred on our borrowings. If the yield on our assets increases or the cost or borrowings decreases, this will have a positive impact on earnings. However, if the yield earned on our assets decreases or the cost of borrowings increases, this will have a negative impact on earnings. Net interest income is also directly impacted by the size and performance of our asset portfolio. We recognize the bulk of our net interest income from our Structured Business. Additionally, we recognize net interest income from loans originated through our Agency Business, which are generally sold within 60 days of origination.
Fees and other revenues recognized from originating, selling and servicing mortgage loans through the GSE and HUD programs. Revenue recognized from the origination and sale of mortgage loans consists of gains on sale of loans (net of any direct loan origination costs incurred), commitment fees, broker fees, loan assumption fees and loan origination fees. These gains and fees are collectively referred to as gain on sales, including fee-based services, net. We record income from MSRs at the time of commitment to the borrower, which represents the fair value of the expected net future cash flows associated with the rights to service mortgage loans that we originate, with the recognition of a corresponding asset upon sale. We also record servicing revenue which consists of fees received for servicing mortgage loans, net of amortization on the MSR assets recorded. Although we have long-established relationships with the GSE and HUD agencies, our operating performance would be negatively impacted if our business relationships with these agencies deteriorate. Additionally, we also recognize revenue from originating, selling and servicing our Private Label loans.
Income earned from our structured transactions. Our structured transactions are primarily comprised of investments in equity affiliates, which represent unconsolidated joint venture investments formed to acquire, develop and/or sell real estate-related assets. Operating results from these investments can be difficult to predict and can vary significantly period-to-period. If interest rates were to rise, it is likely that income from these investments would be significantly and negatively impacted, particularly from our investment in a residential mortgage banking business, since rising interest rates generally decrease the demand for residential-real estate loans
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and the number of loan originations. In addition, we periodically receive distributions from our equity investments. It is difficult to forecast the timing of such payments, which can be substantial in any given quarter. We account for structured transactions within our Structured Business.
Credit quality of our loans and investments, including our servicing portfolio. Effective portfolio management is essential to maximize the performance and value of our loan and investment and servicing portfolios. Maintaining the credit quality of the loans in our portfolios is of critical importance. Loans that do not perform in accordance with their terms may have a negative impact on earnings and liquidity.
COVID-19 Impact. The global outbreak of COVID-19 that began in early 2020 has forced many countries, including the U.S., to declare national emergencies, to institute "stay-at-home" orders, to close financial markets and to restrict operations of non-essential businesses. Such actions are creating significant disruptions in global supply chains, and adversely impacting many industries. COVID-19 could have a continued and prolonged adverse impact on economic and market conditions and could trigger a period of global economic slowdown. The impact of COVID-19 on companies is evolving rapidly, and the extent and duration of the economic fallout from this pandemic, both globally and to our business, remain unclear and present risk with respect to our financial condition, results of operations, liquidity, and ability to pay distributions. We expect the effects of the COVID-19 pandemic to continue to negatively impact our financial performance and operating results during 2021.
Significant Developments During 2020
Capital Markets Activity.
● We raised $524.7 million of capital through issuances of senior unsecured debt and common stock issuances through a public offering and an “At-The-Market” equity offering sales agreement with JMP Securities LLC (“JMP”). We used a significant portion of the net proceeds to redeem secured indebtedness and make investments and also used $37.7 million to purchase OP Units and common shares; and
● We filed a shelf registration statement as a "well-known seasoned issuer," which registered an unlimited and indeterminate amount of debt or equity securities for future issuance and sale. The shelf registration statement was declared effective upon filing.
Financing Activity.
● We closed our thirteenth collateralized securitization vehicle (CLO XIII) totaling $800.0 million of real estate related assets and cash, of which $668.0 million of investment grade notes were issued to third party investors and $70.0 million of below investment-grade notes and a $62.0 million equity interest in the portfolio were retained by us;
● We closed our first Private Label multifamily mortgage loan securitization totaling $727.2 million and retained the APL certificates totaling $63.6 million;
● We completed the unwind of CLO VIII, redeeming $282.9 million of outstanding notes which were repaid primarily from refinancing the remaining assets within our existing financing facilities (including CLO XIII), as well as with cash held by CLO VIII;
● We completed the unwind of our $70.0 million Luxembourg commercial real estate debt fund (“Debt Fund”) and redeemed all the outstanding notes with a portion of the proceeds from our senior unsecured notes issued in March 2020; and
● We increased the capacity of our credit facilities and repurchase agreements by approximately $420.0 million primarily by increasing the capacity of existing facilities.
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Adoption of Current Expected Credit Losses (“CECL”). The new CECL guidance, which we adopted on January 1, 2020, requires companies to estimate the expected lifetime credit loss of an asset over its contractual term with quarterly updates. During 2020, we recorded a $74.6 million net credit loss provision under CECL. See Note 2 for details.
Agency Business Activity.
● Loan originations and sales totaled $6.71 billion and $6.59 billion, respectively, and our fee-based servicing portfolio grew 23% to $24.63 billion from $20.06 billion at December 31, 2019. Our loan sales and servicing portfolio totals include the Private Label loans sold and securitized in May 2020; and
● We recorded losses on derivative instruments totaling $58.3 million, primarily related to our over-the-counter interest rate swap futures (“Swap Futures”) held to hedge interest rate exposure on our Private Label loans until they are securitized.
Structured Business Activity.
● Our Structured loan and investment portfolio grew 28% to $5.48 billion on loan originations totaling $2.43 billion, partially offset by loan runoff totaling $1.21 billion; and
● We recorded income of $75.7 million and received $43.2 million of cash distributions from our residential mortgage business joint venture.
Dividend. We raised our quarterly common dividend for the past three consecutive quarters to $0.33 per share, a 10% increase over the dividend declared in the fourth quarter of 2019 of $0.30 per share.
Current Market Conditions, Risks and Recent Trends
As discussed throughout this report, the COVID-19 pandemic has impacted the global economy in an unprecedented way, swiftly halting activity across many industries, and causing significant disruption and liquidity constraints in many market segments, including the financial services, real estate and credit markets. The impact of COVID-19 on companies continues to evolve, and the extent and duration of the economic fallout from this pandemic remains unclear. COVID-19 could have a continued and prolonged adverse impact on economic and market conditions and could trigger a period of global economic slowdown. Adverse economic conditions have and may continue to result in declining real estate values, increased payment delinquencies and defaults and increased loan modifications and foreclosures, all of which could significantly impact our results of operations, financial condition, business prospects and our ability to make distributions to our stockholders.
The pandemic has caused a dislocation in the capital markets resulting in a reduction of available liquidity. Many commercial mortgage REITs are suffering from the reduced available liquidity as access to capital is critical to grow their business. Despite this reduction in liquidity, subsequent to the first quarter of 2020 we raised $233.6 million through two private placement debt offerings and common stock issuances through a public offering and our “At-The-Market” equity offering sales agreements.
Our Agency Business requires limited capital to grow, as originations are financed through warehouse facilities for generally up to 60 days before the loans are sold, therefore, this lack of liquidity has not and should not, impact our ability to grow this business. However, our Structured Business is more reliant on the capital markets to grow, and therefore, a lack of liquidity could limit our ability to grow this business. In our Structured Business, 81% of our portfolio is in multifamily assets with most of these loans containing interest reserves and/or replenishment obligations by our borrowers.
The federal government, Fannie Mae and Freddie Mac have made certain forbearance and non-eviction programs available to borrowers and tenants should they need to counteract any short-term pressure on their properties from COVID-19 and its impact on the economy. For borrowers, in order to qualify for a forbearance, they need to demonstrate they have been adversely affected by the pandemic and their ability to make their loan payments has been impacted. All loan and rent payments that are suspended remain the obligations of the borrowers and tenants.
As of December 31, 2020, our Agency Business had approved forbearances related to approximately 0.5% of our $18.27 billion Fannie Mae DUS portfolio and approximately 5.2% of our $4.88 billion Freddie Mac portfolio. We are closely monitoring and managing the requests for forbearances and there could potentially be additional economic stress during 2021.
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Interest rates have trended downward during 2020 and remain at historically low levels. While lower interest rates generally have a positive impact on origination volume as borrowers look to refinance loans to take advantage of lower rates, our net interest income may be negatively impacted as higher yielding loans are paid off and replaced with lower yielding loans. However, we are somewhat insulated from decreasing interest rates, since a large portion of our structured loan portfolio has LIBOR floors, which could increase our net interest income in the future if rates remain at these historically low levels. Conversely, if interest rates were to rise, it could negatively impact our net interest income. An increase in rates would cause an increase in interest expense as most of our debt is variable. However, since a large portion of our structured loan portfolio has LIBOR floors that are in the money, any increase in interest income due to rising interest rates is not likely to be as substantial as the corresponding increase in interest expense.
We are a national originator with Fannie Mae and Freddie Mac, and the GSEs remain the most significant providers of capital to the multifamily market. In November 2020, the FHFA released the 2020 Scorecard which established Fannie Mae’s and Freddie Mac’s loan origination caps at $70 billion each, for a combined total opportunity of $140 billion, and will run for a four-quarter period through the end of 2021. The new caps apply to all multifamily business, have no exclusions and mandate that 50% be directed towards mission driven business or affordable housing. Our originations with the GSEs are highly profitable executions as they provide significant gains from the sale of our loans, non-cash gains related to MSRs and servicing revenues. Therefore, a decline in our GSE originations could negatively impact our financial results. We are unsure whether the FHFA will impose stricter limitations on GSE multifamily production volume in the future.
Changes in Financial Condition
Assets – Comparison of balances at December 31, 2020 to December 31, 2019:
Our Structured loan and investment portfolio balance was $5.48 billion and $4.28 billion at December 31, 2020 and 2019, respectively. This increase was primarily due to loan originations exceeding loan payoffs and paydowns by $1.23 billion. See below for details.
Our portfolio had a weighted average current interest pay rate of 5.23% and 5.98% at December 31, 2020 and 2019, respectively. Including certain fees earned and costs associated with the structured portfolio, the weighted average current interest rate was 5.80% and 6.68% at December 31, 2020 and 2019, respectively. Advances on our financing facilities totaled $4.92 billion and $3.93 billion at December 31, 2020 and 2019, respectively, with a weighted average funding cost of 2.64% and 3.82%, respectively, which excludes financing costs. Including financing costs, the weighted average funding rate was 3.03% and 4.35% at December 31, 2020 and 2019, respectively.
Activity from our Structured Business portfolio is comprised of the following ($ in thousands):
Year Ended December 31,
2020
2019
Loans originated (1)
$
2,433,679
$
2,803,251
Number of loans
137
173
Weighted average interest rate
5.67
%
6.50
%
(1) We committed to fund six SFR build-to-rent bridge loans totaling $197.8 million in the third and fourth quarters of 2020.
Loans paid-off / paid-down
$
1,208,071
$
1,748,387
Number of loans
85
137
Weighted average interest rate
6.56
%
7.36
%
Loans extended
$
748,640
$
808,140
Number of loans
43
45
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Loans held-for-sale from the Agency Business increased $125.6 million, primarily related to loan originations exceeding sales by $124.2 million as noted in the following table (in thousands). Loan sales includes $727.2 million of Private Label loans which were sold in connection with our first Private Label multifamily mortgage loan securitization in the second quarter of 2020.
Loan
Originations
Loan Sales
Fannie Mae
$
5,041,925
$
4,771,113
Freddie Mac
960,508
816,802
Private Label
382,191
727,154
FHA
327,345
272,659
Total
$
6,711,969
$
6,587,728
Capitalized mortgage servicing rights increased $93.6 million, primarily due to MSRs recorded on new loan originations, partially offset by amortization and write-offs. Our capitalized mortgage servicing rights represent the estimated value of our rights to service mortgage loans for others. At December 31, 2020, the weighted average estimated life remaining of our MSRs was 8.6 years.
Investments in equity affiliates increased $32.5 million, due to income from our investment in a residential mortgage banking business of $75.7 million, partially offset by $43.2 million in cash distributions received from the same investment.
Real estate owned decreased $11.7 million, primarily due to the sale of our hotel property.
Other assets increased $56.3 million, primarily due to an increase in our operating lease right-of-use assets as a result of office lease extensions and the reclassification of our SFR bond from securities held-to-maturity.
Liabilities – Comparison of balances at December 31, 2020 to December 31, 2019:
Credit facilities and repurchase agreements increased $556.6 million, primarily due to funding of new structured loan activity and loan originations exceeding sales by $124.2 million in our Agency Business as described above, partially offset by a paydown in our securities repurchase facilities that contained margin call provisions.
Collateralized loan obligations increased $387.2 million, primarily due to the issuance of a new CLO, where we issued $668.0 million of notes to third party investors, partially offset by the unwind of a CLO totaling $282.9 million.
We completed the unwind of our $70.0 million Debt Fund.
Senior unsecured notes increased $343.0 million, primarily due to our issuances of $275.0 million of 4.50% notes and $70.8 million of 8.00% notes.
Convertible senior unsecured notes decreased $16.2 million, primarily due to partial redemption of our 5.25% convertible notes.
Allowance for loss-sharing obligations increased $29.7 million, primarily due to the adoption of CECL in the first quarter of 2020. See Note 2 for details.
Other liabilities increased $63.3 million, primarily due to an increase in our operating lease liabilities as a result of office lease extensions and an increase in accrued compensation.
Equity
During 2020, we sold 14,790,121 shares of our common stock through a public offering and our “At-The-Market” agreement and issued 368,498 shares of common stock in connection with settlements of our convertible notes. We also repurchased 4,184,394 shares of our common stock and OP Units from ACM and certain of its members and repurchased 993,106 shares of our common stock under our share repurchase program.
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Distributions
The following table presents dividends declared (on a per share basis) for 2020:
Common Stock
Preferred Stock
Dividend (1)
Declaration Date
Dividend
Declaration Date
Series A
Series B
Series C
February 13, 2020
$
0.30
January 31, 2020
$
0.515625
$
0.484375
$
0.53125
May 6, 2020
$
0.30
May 1, 2020
$
0.515625
$
0.484375
$
0.53125
July 29, 2020
$
0.31
July 29, 2020
$
0.515625
$
0.484375
$
0.53125
October 28,2020
$
0.32
October 28,2020
$
0.515625
$
0.484375
$
0.53125
(1) The dividend declared on January 31, 2020 was for December 1, 2019 through February 29, 2020. The dividend declared on May 1, 2020 was for March 1, 2020 through May 31, 2020. The dividend declared on July 29, 2020 was for June 1, 2020 through August 31, 2020. The dividend declared on October 28, 2020 was for September 1, 2020 through November 30, 2020.
Common Stock – On February 17, 2021, the Board of Directors declared a cash dividend of $0.33 per share of common stock. The dividend is payable on March 19, 2021 to common stockholders of record as of the close of business on March 3, 2021.
Preferred Stock – On February 1, 2021, the Board of Directors declared a cash dividend of $0.515625 per share of 8.25% Series A preferred stock; a cash dividend of $0.484375 per share of 7.75% Series B preferred stock; and a cash dividend of $0.53125 per share of 8.50% Series C preferred stock. These amounts reflect dividends from December 1, 2020 through February 28, 2021 and are payable on March 1, 2021 to preferred stockholders of record on February 15, 2021.
Deferred Compensation
During 2020, we issued 360,885 shares of restricted stock to our employees (including our chief executive officer) and 52,735 shares to the independent members of the Board of Directors. Our chief executive officer was also granted 275,569 shares of performance-based restricted stock units and 313,152 shares of performance-based restricted stock as a result of achieving goals related to the integration of our 2016 acquisition of ACM's agency platform (the “Acquisition”).
Our chief executive officer net settled 421,348 shares of fully vested performance-based restricted stock units for 215,014 common shares and 357,569 shares of fully vested performance-based restricted stock for 182,467 common shares. We also withheld 158,722 shares of restricted common stock from our employees (including our chief executive officer) to net settle and pay their respective withholding taxes in connection with awards that vested. See Note 17 for details of our deferred compensation transactions.
Agency Servicing Portfolio
The following table sets forth the characteristics of our loan servicing portfolio collateralizing our mortgage servicing rights and servicing revenue ($ in thousands):
December 31, 2020
Wtd. Avg.
Wtd. Avg.
Annualized
Servicing
Age of
Portfolio
Prepayments
Delinquencies
Portfolio
Loan
Portfolio
Maturity
Interest Rate Type
Wtd. Avg.
as a Percentage
as a Percentage
Product
UPB
Count
(in years)
(in years)
Fixed
Adjustable
Note Rate
of Portfolio (1)
of Portfolio (2)
Fannie Mae
$
18,268,268
2,712
2.8
9.0
97
%
3
%
4.12
%
6.40
%
0.33
%
Freddie Mac
4,881,080
1,413
2.6
11.7
88
%
12
%
3.99
%
11.47
%
0.65
%
FHA
752,116
89
3.0
32.9
100
%
—
%
3.39
%
33.60
%
—
%
Private Label
726,992
40
1.0
9.1
100
%
—
%
3.81
%
—
%
—
%
Total
$
24,628,456
4,254
2.7
10.3
95
%
5
%
4.06
%
8.05
%
0.37
%
December 31, 2019
Fannie Mae
$
14,832,844
2,349
3.0
8.6
95
%
5
%
4.52
%
11.37
%
0.23
%
Freddie Mac
4,534,714
1,475
2.2
12.6
96
%
4
%
4.23
%
11.37
%
0.57
%
FHA
691,519
92
3.6
32.1
100
%
—
%
3.71
%
3.98
%
0.00
%
Total
$
20,059,077
3,916
2.9
10.3
95
%
5
%
4.43
%
11.12
%
0.30
%
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(1) Prepayments reflect loans repaid prior to six months from the loan’s maturity. The majority of our loan servicing portfolio has a prepayment protection term and therefore, we may collect a prepayment fee which is included as a component of servicing revenue, net.
(2) Delinquent loans reflect loans that are contractually 60 days or more past due. As of December 31, 2020 and 2019, delinquent loans totaled $91.3 million and $59.2 million, respectively, of which $19.6 million and $33.5 million, respectively, were in the foreclosure process. In addition, as of December 31, 2019, loans collateralizing our servicing portfolio totaling $3.2 million were in bankruptcy.
Our servicing portfolio represents commercial real estate loans originated in our Agency Business, which are generally transferred or sold within 60 days from the date the loan is funded. Primarily all of the loans in our servicing portfolio are collateralized by multifamily properties. In addition, we are generally required to share in the risk of any losses associated with loans sold under the Fannie Mae DUS program, see Note 12.
Comparison of Results of Operations for Years Ended 2020 and 2019
The following table provides our consolidated operating results ($ in thousands):
Year Ended December 31,
Increase / (Decrease)
2020
2019
Amount
Percent
Interest income
$
339,465
$
315,940
$
23,525
7
%
Interest expense
169,216
186,399
(17,183)
(9)
%
Net interest income
170,249
129,541
40,708
31
%
Other revenue:
Gain on sales, including fee-based services, net
94,607
65,652
28,955
44
%
Mortgage servicing rights
165,517
90,761
74,756
82
%
Servicing revenue, net
54,385
54,542
(157)
—
%
Property operating income
3,976
9,674
(5,698)
(59)
%
Loss on derivative instruments, net
(58,335)
(1,962)
(56,373)
nm
Other income, net
4,109
1,178
2,931
nm
Total other revenue
264,259
219,845
44,414
20
%
Other expenses:
Employee compensation and benefits
144,380
122,102
22,278
18
%
Selling and administrative
37,348
40,329
(2,981)
(7)
%
Property operating expenses
4,898
10,220
(5,322)
(52)
%
Depreciation and amortization
7,640
7,510
130
2
%
Impairment loss on real estate owned
—
1,000
(1,000)
nm
Provision for loss sharing (net of recoveries)
14,822
1,147
13,675
nm
Provision for credit losses (net of recoveries)
61,110
—
61,110
nm
Total other expenses
270,198
182,308
87,890
48
%
Income before extinguishment of debt, sale of real estate, income from equity affiliates and income taxes
164,310
167,078
(2,768)
(2)
%
Loss on extinguishment of debt
(3,546)
(7,439)
3,893
(52)
%
Loss on sale of real estate
(375)
—
(375)
nm
Income from equity affiliates
76,161
10,635
65,526
nm
Provision for income taxes
(40,393)
(15,036)
(25,357)
169
%
Net income
196,157
155,238
40,919
26
%
Preferred stock dividends
7,554
7,554
—
—
Net income attributable to noncontrolling interest
25,208
26,610
(1,402)
(5)
%
Net income attributable to common stockholders
$
163,395
$
121,074
$
42,321
35
%
nm – not meaningful
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The following table presents the average balance of our Structured Business interest-earning assets and interest-bearing liabilities, associated interest income (expense) and the corresponding weighted average yields ($ in thousands):
Year Ended December 31,
2020
2019
Average
Interest
W/A Yield /
Average
Interest
W/A Yield /
Carrying
Income /
Financing
Carrying
Income /
Financing
Value (1)
Expense
Cost (2)
Value (1)
Expense
Cost (2)
Structured Business interest-earning assets:
Bridge loans
$
4,402,763
$
259,845
5.90
%
$
3,331,336
$
239,955
7.20
%
Preferred equity investments
207,736
22,701
10.93
%
180,336
20,679
11.47
%
Mezzanine / junior participation loans
174,622
15,421
8.83
%
183,324
22,529
12.29
%
Other
82,604
4,968
6.01
%
36,796
1,130
3.07
%
Core interest-earning assets
4,867,725
302,935
6.22
%
3,731,792
284,293
7.62
%
Cash equivalents
382,303
2,958
0.77
%
382,492
5,548
1.45
%
Total interest-earning assets
$
5,250,028
$
305,893
5.83
%
$
4,114,284
$
289,841
7.04
%
Structured Business interest-bearing liabilities:
CLO
$
2,462,799
$
56,800
2.31
%
$
1,816,217
$
80,094
4.41
%
Warehouse lines
985,693
34,444
3.49
%
871,407
43,018
4.94
%
Unsecured debt
877,420
52,378
5.97
%
488,865
32,930
6.74
%
Trust preferred
154,336
5,911
3.83
%
154,336
8,314
5.39
%
Debt fund
22,378
1,431
6.38
%
70,000
5,446
7.78
%
Total interest-bearing liabilities
$
4,502,626
150,964
3.35
%
$
3,400,825
169,802
4.99
%
Net interest income
$
154,929
$
120,039
(1) Based on UPB for loans, amortized cost for securities and principal amount for debt.
(2) Weighted average yield calculated based on annualized interest income or expense divided by average carrying value.
Net Interest Income
The increase in interest income was due to increases of $16.1 million, or 6%, from our Structured Business and $7.5 million, or 29%, from our Agency Business. The increase from our Structured Business was primarily due to a 30% increase in our average core interest-earning assets, as a result of loan originations exceeding loan runoff, partially offset by an 18% decrease in the average yield on core interest-earning assets, largely due to lower rates on originations as compared to loan runoff, a decrease in the average LIBOR rate and default interest and fees on a loan that paid off during 2019. The increase from our Agency Business was primarily due to an increase in the average loans held-for-sale as a result of higher originations, which includes Private Label loan originations prior to securitization in May 2020, partially offset by a decrease in the 10-year treasury note rate in 2020.
The decrease in interest expense was due to a decrease of $18.8 million, or 11%, from our Structured Business, partially offset by an increase of $1.7 million, or 10%, from our Agency Business. The decrease in our Structured Business was the result of a 33% decrease in the average cost of our interest-bearing liabilities, mainly from decreases in LIBOR and lower rates on recently issued debt, partially offset by a 32% increase in the average balance of our interest-bearing liabilities, due to growth in our loan portfolio and the recent issuance of additional unsecured debt. The increase from our Agency Business was primarily due to an increase in the average debt balance used to finance the increase in the average loans held-for-sale balance, partially offset by a decrease in the average LIBOR rate.
Agency Business Revenue
The increase in gain on sales, including fee-based services, net was primarily due to a 50% increase ($2.19 billion) in loan sales volume.
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The increase in income from MSRs was primarily due to a 41% increase in loan commitment volume, along with a 29% increase in the MSR rate (income from MSRs as a percentage of loan commitment volume) from 1.88% to 2.43%, mainly due to an increase in the average servicing fee on loan commitments.
Other Revenue
Property operating income and expenses both decreased in 2020 as a result of lower occupancy and closure of the hotel property for most of the second quarter as a result of the COVID-19 pandemic, as well as from the sale of the hotel in September 2020. See Note 9.
The increase in loss on derivative instruments was primarily due to losses recognized in our Agency Business on Swap Futures held in connection with our Private Label loans. See Note 13 for details.
Other Expenses
The increase in employee compensation and benefits expense was primarily due to an increase in commissions in our Agency Business in connection with higher loan sales volume, as well as increased headcount in both businesses associated with each business’s portfolio growth, including the full period impact in 2020 of new hires in 2019.
The decrease in selling and administrative expenses was primarily due to a $2.4 million decline in the Structured Business. Legal and consulting costs were lower as transactions and projects that were terminated or completed in 2019 did not recur in 2020. Administrative expenses were also lower in 2020 as a result of the COVID-19 pandemic due to travel restrictions and fewer events. These decreases were partially offset by a $2.5 million litigation settlement we recorded related to the hotel property that we sold in the third quarter of 2020.
The increases in provision for loss sharing and provision for credit losses were primarily due to CECL reserves recorded in connection with the adoption of Accounting Standard Update (“ASU”) 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”) in 2020. See Note 2 for details.
Loss on Extinguishment of Debt
The loss on extinguishment of debt in 2020 was primarily due to losses recognized in connection with the unwind of both CLO VIII and the Debt Fund. The loss on extinguishment of debt in 2019 was primarily due to the exchange transactions of our convertible notes. See Note 11 for details.
Income from Equity Affiliates
Income from equity affiliates in 2020 and 2019 primarily reflects income from our investment in a residential mortgage banking business of $75.7 million and $7.2 million, respectively, and distributions from an equity investment totaling $1.1 million and $3.5 million, respectively.
Provision for Income Taxes
In 2020, we recorded a tax provision of $40.4 million, which consisted of a current tax provision of $35.7 million and a deferred tax provision of $4.7 million. In 2019, we recorded a tax provision of $15.0 million, which consisted of a current tax provision of $14.9 million and a deferred tax provision of $0.2 million. The tax provision increase is primarily due to an increase in income generated from our residential mortgage banking business joint venture and growth in our Agency Business.
Net Income Attributable to Noncontrolling Interest
The noncontrolling interest relates to the outstanding OP Units issued as part of the Acquisition. There were 17,560,633 OP Units and 20,484,094 OP Units outstanding as of December 31, 2020 and 2019, respectively, which represented 12.5% and 15.7% of our outstanding stock at December 31, 2020 and 2019, respectively.
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Comparison of Results of Operations for Years Ended 2019 and 2018
For a discussion of our results of operations for the year ended 2019 compared to 2018, please refer to Item 7 of Part II, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2019, which was filed with the SEC on February 14, 2020, and is available on the SEC’s website at www.sec.gov and the “Investor Relations” section of our website at www.arbor.com.
Liquidity and Capital Resources
Sources of Liquidity. Liquidity is a measure of our ability to meet our potential cash requirements, including ongoing commitments to repay borrowings, satisfaction of collateral requirements under the Fannie Mae DUS risk-sharing agreement and, as an approved designated seller/servicer of Freddie Mac’s SBL program, operational liquidity requirements of the GSE agencies, fund new loans and investments, fund operating costs and distributions to our stockholders, as well as other general business needs. Our primary sources of funds for liquidity consist of proceeds from equity and debt offerings, proceeds from CLOs and securitizations, debt facilities and cash flows from operations. We closely monitor our liquidity position and believe our existing sources of funds and access to additional liquidity will be adequate to meet our liquidity needs.
We are monitoring the COVID-19 pandemic and its impact on our financing sources, borrowers and their tenants, and the economy as a whole. The magnitude and duration of the pandemic, and its impact on our operations and liquidity, are uncertain and continue to evolve. To the extent that our financing sources, borrowers and their tenants continue to be impacted by the pandemic, or by the other risks disclosed in our filings with the SEC, it would have a material adverse effect on our liquidity and capital resources.
We had approximately $4.92 billion in total structured debt outstanding at December 31, 2020. Of this total, approximately $3.64 billion, or 74%, does not contain mark-to-market provisions and is comprised of non-recourse CLO vehicles, senior unsecured debt and junior subordinated notes, the majority of which have maturity dates in 2022, or later. The remaining $1.28 billion of debt is in warehouse and repurchase facilities with several different banks that we have long-standing relationships with. While we expect to extend or renew all of our facilities as they mature, given the current market environment, we believe that the extension terms may be less favorable than the terms of our current facilities.
In addition to our ability to extend our warehouse and repurchase facilities, we have approximately $400 million in cash and available liquidity as well as other liquidity sources, including our $24.63 billion agency servicing portfolio, which is mostly prepayment protected and generates approximately $112.0 million a year in recurring cash flow.
At December 31, 2020, we had $86.5 million of securities financed with $38.5 million of debt that was subject to margin calls related to changes in interest spreads. During 2020, we significantly reduced the UPB of this debt by $178.6 million to $38.5 million through a debt restructuring and the use of proceeds from our senior notes issued in the second quarter of 2020.
To maintain our status as a REIT under the Internal Revenue Code, we must distribute annually at least 90% of our REIT-taxable income. These distribution requirements limit our ability to retain earnings and thereby replenish or increase capital for operations. However, we believe that our capital resources and access to financing will provide us with financial flexibility and market responsiveness at levels sufficient to meet current and anticipated capital and liquidity requirements.
Cash Flows. Cash flows provided by operating activities totaled $55.2 million during the year ended December 31, 2020 and consisted primarily of net income of $196.2 million, partially offset by net cash outflows of $121.6 million as a result of loan originations exceeding loan sales in our Agency Business.
Cash flows used in investing activities totaled $1.16 billion during the year ended December 31, 2020. Loan and investment activity (originations and payoffs/paydowns) comprise the bulk of our investing activities. Loan originations from our Structured Business totaling $2.38 billion, net of payoffs and paydowns of $1.24 billion, resulted in net cash outflows of $1.13 billion. Cash outflows also included $37.9 million to purchase APL certificates in connection with our Private Label securitization in the second quarter of 2020.
Cash flows provided by financing activities totaled $1.13 billion during the year ended December 31, 2020 and consisted primarily of net cash inflows of $557.6 million from debt facility activities (financed loan originations were greater than facility paydowns), net proceeds of $384.9 million from CLO activity, $345.8 million received from the issuances of senior unsecured notes
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and $183.6 million received from common stock issuances, partially offset by, $173.1 million of distributions to our stockholders and OP Unit holders, $70.0 million for the unwind of the Debt Fund and $32.2 million for the redemption of OP units.
Agency Business Requirements. The Agency Business is subject to supervision by certain regulatory agencies. Among other things, these agencies require us to meet certain minimum net worth, operational liquidity and restricted liquidity collateral requirements, purchase and loss obligations and compliance with reporting requirements. Our adjusted net worth and operational liquidity exceeded the agencies’ requirements as of December 31, 2020. Our restricted liquidity and purchase and loss obligations were satisfied with letters of credit totaling $50.0 million and $9.2 million of cash collateral. See Note 15 for details about our performance regarding these requirements.
We also enter into contractual commitments with borrowers providing rate lock commitments while simultaneously entering into forward sale commitments with investors. These commitments are outstanding for short periods of time (generally less than 60 days) and are described in Note 13.
Debt Facilities. We maintain various forms of short-term and long-term financing arrangements. Borrowings underlying these arrangements are primarily secured by a significant amount of our loans and investments and substantially all of our loans held-for-sale. The following is a summary of our debt facilities (in thousands):
December 31, 2020
Maturity
Debt Instruments
Commitment (1)
UPB (2)
Available
Dates (3)
Structured Business
Credit facilities and repurchase agreements
$
1,943,726
$
1,286,100
$
657,626
2021 - 2022
Collateralized loan obligations (4)
2,532,343
2,532,343
—
2021 - 2025
Senior unsecured notes
670,750
670,750
—
2023 - 2027
Convertible senior unsecured notes
278,300
278,300
—
2021 - 2022
Junior subordinated notes
154,336
154,336
—
2034 - 2037
Structured Business total
5,579,455
4,921,829
657,626
Agency Business
Credit facilities (5)
2,275,000
952,622
1,322,378
2021
Consolidated total
$
7,854,455
$
5,874,451
$
1,980,004
(1) Includes temporary increases to committed amounts which have not expired as of December 31, 2020.
(2) Excludes the impact of deferred financing costs.
(3) See Note 15 for a breakdown of debt maturities by year.
(4) Maturity dates represent the weighted average remaining maturity based on the underlying collateral as of December 31, 2020.
(5) The Multifamily As Soon as Pooled ® Plus (“ASAP”) agreement we have with Fannie Mae has no expiration date.
These debt facilities, including their restrictive covenants, are described in Note 11.
Off-Balance-Sheet Arrangements. At December 31, 2020, we had no off-balance-sheet arrangements.
Inflation. Changes in the general level of interest rates prevailing in the economy in response to changes in the rate of inflation generally would not have a significant effect on our income because the majority of our interest-earning assets and interest-bearing liabilities have floating rates of interest. See “Quantitative and Qualitative Disclosures about Market Risk” below.
Derivative Financial Instruments
We enter into derivative financial instruments in the normal course of business to manage the potential loss exposure caused by fluctuations of interest rates. See Note 13 for details.
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Significant Accounting Estimates
Management’s discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with the FASB Accounting Standards Codification™, the authoritative reference for accounting principles generally accepted in the U.S. (“GAAP”). The preparation of financial statements in conformity with GAAP requires the use of estimates and assumptions that could affect the reported amounts in our consolidated financial statements. Actual results could differ from these estimates.
A summary of our significant accounting policies is presented in Note 2. Many of these accounting policies require judgment and the use of estimates and assumptions when applying these policies in the preparation of our consolidated financial statements. Each quarter, we assess these estimates and assumptions based on several factors, including historical experience, which we believe to be reasonable under the circumstances. These estimates are subject to change in the future if any of the underlying assumptions or factors change.
Non-GAAP Financial Measures
Distributable Earnings. Beginning in the fourth quarter of 2020, we changed the name of our non-GAAP financial measure from core earnings to distributable earnings. Although calculated the same way as core earnings, we believe the name change to distributable earnings better reflects what this non-GAAP financial measure presents.
We are presenting distributable earnings because we believe it is an important supplemental measure of our operating performance and is useful to investors, analysts and other parties in the evaluation of REITs and their ability to provide dividends to stockholders. Dividends are one of the principal reasons investors invest in REITs. To maintain REIT status, REITs are required to distribute at least 90% of their REIT-taxable income. We consider distributable earnings in determining our quarterly dividend and believe that, over time, distributable earnings is a useful indicator of our dividends per share.
We define distributable earnings as net income (loss) attributable to common stockholders computed in accordance with GAAP, adjusted for accounting items such as depreciation and amortization (adjusted for unconsolidated joint ventures), non-cash stock-based compensation expense, income from MSRs, amortization and write-offs of MSRs, gains/losses on derivative instruments primarily associated with Private Label loans not yet sold and securitized, the tax impact on cumulative gains/losses on derivative instruments associated with Private Label loans sold during the periods presented, changes in fair value of GSE-related derivatives that temporarily flow through earnings, deferred tax (benefit) provision, CECL provisions for credit losses (adjusted for realized losses as described below) and amortization of the convertible senior notes conversion option. We also add back one-time charges such as acquisition costs and one-time gains/losses on the early extinguishment of debt.
We reduce distributable earnings for realized losses in the period we determine that a loan is deemed nonrecoverable in whole or in part. Loans are deemed nonrecoverable upon the earlier of: (i) when the loan receivable is settled (i.e. when the loan is repaid, or in the case of foreclosure, when the underlying asset is sold); or (ii) when we determine that it is nearly certain that all amounts due will not be collected. The realized loss amount is equal to the difference between the cash received, or expected to be received, and the book value of the asset.
Distributable earnings is not intended to be an indication of our cash flows from operating activities (determined in accordance with GAAP) or a measure of our liquidity, nor is it entirely indicative of funding our cash needs, including our ability to make cash distributions. Our calculation of distributable earnings may be different from the calculations used by other companies and, therefore, comparability may be limited.
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Distributable earnings is as follows ($ in thousands, except share and per share data):
Year Ended December 31,
2020
2019
2018
Net income attributable to common stockholders
$
163,395
$
121,074
$
108,312
Adjustments:
Net income attributable to noncontrolling interest
25,208
26,610
32,185
Income from mortgage servicing rights
(165,517)
(90,761)
(98,839)
Deferred tax provision (benefit)
4,726
150
(12,033)
Amortization and write-offs of MSRs
65,979
71,105
73,182
Depreciation and amortization
11,486
11,194
10,825
Loss on extinguishment of debt
3,546
7,439
5,041
Provision for credit losses, net
73,402
1,193
6,785
Loss (gain) on derivative instruments, net
43,596
1,687
(6,672)
Stock-based compensation
9,046
9,515
6,095
Distributable Earnings (1)
$
234,867
$
159,206
$
124,881
Diluted distributable earnings per share (1)
$
1.75
$
1.37
$
1.33
Diluted weighted average shares outstanding (1)
133,969,296
116,192,951
93,642,168
(1) Amounts are attributable to common stockholders and OP Units holders. The OP Units are redeemable for cash, or at our option for shares of our common stock on a one-for-one basis.
As noted above, we changed the name of our non-GAAP financial measure from core earnings to distributable earnings in the fourth quarter of 2020. Core earnings was introduced as our non-GAAP performance measure in the first quarter of 2020 as a replacement of adjusted funds from operations (“AFFO”). Core earnings was comparable to the previous AFFO metric, revised to exclude provisions for credit losses (including CECL) related to our structured loan portfolio, securities held-to maturity and loss-sharing obligations related to the Fannie Mae program. Prior period amounts presented in the table above have been conformed to reflect these changes.