Arbor Realty Trust Inc: Form 10-Q for the period ended Jun 30, 2018

You should read the following discussion in conjunction with the unaudited consolidated interim financial statements, and related notes and the section entitled “Forward-Looking Statements” included herein.

Overview

Through our Structured Business, we invest in a diversified portfolio of structured finance assets in the multifamily and commercial real estate markets, primarily consisting of bridge and mezzanine loans, including junior participating interests in first mortgages, preferred and direct equity. We may also 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 GSE, HUD and CMBS programs. We retain the servicing rights and asset management responsibilities on substantially all loans we originate and sell under the GSE and HUD programs.

Through May 2017, we were externally managed and advised by ACM. Effective May 31, 2017, we terminated the existing management agreement with ACM and fully internalized our management team.

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 and earnings on escrows, net of amortization on the MSR assets recorded. These originations, selling and servicing fees and other revenues are included in our Agency Business results. 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.

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 our unconsolidated equity investments can be difficult to predict and can vary significantly period-to-period. 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, 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.

Significant Developments During the Second Quarter of 2018

Capital Markets Activity.

• In May 2018, we completed a public offering and sold 5,500,000 shares of our common stock for $8.72 per share, receiving net proceeds of $47.8 million; and
• In May 2018, we issued an additional $25.0 million of our 5.625% Notes and received net proceeds of $24.4 million.

Financing Activity.

• In June 2018, we closed our tenth collateralized securitization vehicle (CLO X) totaling $560.0 million of real estate related assets and cash, of which $441.0 million of investment grade notes were issued to third party investors and $53.2 million of below investment-grade notes and a $65.8 million equity interest in the portfolio were retained by us; and
• In June 2018, we completed the unwind of CLO V, redeeming $267.8 million of outstanding notes which were repaid primarily from refinancing the remaining assets within our existing financing facilities (including CLO X), as well as with cash held by CLO V, and expensed $1.3 million of deferred financing fees into interest expense.

Agency Business Activity.

• Loan originations and sales totaled $1.04 billion and $1.02 billion, respectively; and
• Our fee-based servicing portfolio grew 3% to $17.11 billion from $16.69 billion at March 31, 2018.

Structured Business Activity.

• Our Structured loan and investment portfolio grew 13% this quarter to $3.13 billion on loan originations totaling $606.9 million, partially offset by loan runoff totaling $238.0 million; and
• We recorded an impairment loss of $2.0 million on an office building we own (see Note 9 — Real Estate Owned for details) and recorded a net loan loss recovery of $2.1 million, primarily related to the settlement of a non-performing preferred equity investment (see Note 3 — Loans and Investments for details).

Subsequent Events.

• In July 2018, we completed the issuance and sale of $245.0 million of our 5.25% Convertible Notes through two private placements. We received proceeds totaling $237.2 million, net of the underwriter’s discount and fees from these offerings. We used the net proceeds to exchange $99.8 million of our 6.50% Convertible Notes and $127.6 million of our 5.375% Convertible Notes for a combination of $219.8 million in cash (which includes accrued interest) and 6.8 million shares of our common stock to settle such exchanges (see Note 10 — Debt Obligations for details); and
• In July 2018, we received approximately $11 million from the settlement of a litigation related to a prior investment, which will be reflected in our consolidated financial statements in the third quarter of 2018.

Current Market Conditions, Risks and Recent Trends

Our ability to execute our business strategy, particularly the growth of our Structured Business portfolio of loans and investments, is dependent on many factors, including our ability to access capital and financing on favorable terms. The past economic downturn had a significant negative impact on both us and our borrowers and limited our ability for growth. If similar economic conditions recur in the future, it may limit our options for raising capital and obtaining financing on favorable terms and may also adversely impact the creditworthiness of our borrowers which could result in their inability to repay their loans.

We rely on the capital markets to generate capital for financing the growth of our business. While we have been successful in generating capital through the debt and equity markets over the past several quarters, there can be no assurance that we will continue to have access to such markets. If we were to experience a prolonged downturn in the stock or credit markets, it could cause us to seek alternative sources of potentially less attractive financing, and may require us to adjust our business plan accordingly.

The Federal Reserve increased its targeted Federal Rate 75 basis points during 2017 and by another 50 basis points during the first six months of 2018. To date, we have not been significantly impacted by these increases and do not anticipate a significant decline in origination volume or profitability as interest rates remain at historically low levels. However, we cannot be certain that such a trend will continue as the number, timing, and magnitude of additional increases by the Federal Reserve, combined with other macroeconomic factors, may have a different effect on the commercial real estate market.

The Trump administration continues to focus on several issues that could impact interest rates and the U.S. economy, including the recently enacted Tax Reform. As a result of the Tax Reform, we expect to realize a benefit from the reduction of the corporate federal income tax rate from 35% to 21%, as our Agency Business operates in a TRS. While there is uncertainty regarding the specifics and timing of any future policy changes, any such actions could impact our business.

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. The Federal Housing Finance Agency (“FHFA”) released the GSE 2018 Scorecard (“2018 Scorecard,”) which established Fannie Mae’s and Freddie Mac’s loan origination caps at $35.00 billion (“2018 Caps”) each for the multifamily finance market, a $1.50 billion decrease from the 2017 loan origination caps. Affordable housing loans, loans to small multifamily properties, and manufactured housing rental community loans continue to be excluded from the 2018 Caps. In addition, the definition of the affordable loan exclusions has added an extremely-high cost market category, continues to encompass affordable housing in high- and very-high cost markets and allows for an exclusion from the 2018 Caps for the pro-rata portion of any loan on a multifamily property that includes affordable units. The 2018 Scorecard continues to provide FHFA the flexibility to review the estimated size of the multifamily loan origination market quarterly and proactively adjust the 2018 Caps accordingly. The 2018 Scorecard also continues to provide exclusions for loans to properties in underserved markets and for loans to finance certain energy or water efficiency improvements, however, to qualify for this exclusion, the projected annual energy or water savings must be at least 25%. 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 would negatively impact our financial results. We are unsure whether the FHFA will impose stricter limitations on GSE multifamily production volume in the future.

The commercial real estate markets continue to improve, but uncertainty remains as a result of global market instability, the current political climate and other matters and their potential impact on the U.S. economy and commercial real estate markets. In addition, the growth in multifamily rental rates seen over the past few years are showing signs of stabilizing. If real estate values decline and/or rent growth subsides, it may limit our new mortgage loan originations since borrowers often use increases in the value of, and revenues produced from, their existing properties to support the purchase or investment in additional properties. Declining real estate values may also significantly increase the likelihood that we will incur losses on our loans in the event of default because the value of our collateral may be insufficient to cover our cost on the loan. Any sustained period of increased payment delinquencies, foreclosures or losses could adversely affect both our net interest income from loans as well as our ability to originate, sell and securitize loans, which would significantly impact our results of operations, financial condition, business prospects and our ability to make distributions to our stockholders.

The economic environment over the past few years has seen continued improvement in commercial real estate values, which has generally increased payoffs and reduced the credit exposure in our loan and investment portfolio. We have made, and continue to make, modifications and extensions to loans when it is economically feasible to do so. In some cases, a modification is a more viable alternative to foreclosure proceedings when a borrower cannot comply with loan terms. In doing so, lower borrower interest rates, combined with non-performing loans, would lower our net interest margins when comparing interest income to our costs of financing. However, since 2013, the levels of modifications and delinquencies have generally declined as property values have increased and borrowers’ access to financing has improved. If the markets were to deteriorate and the U.S. experienced a prolonged economic downturn, we believe there could be additional loan modifications and delinquencies, which may result in reduced net interest margins and additional losses throughout our sector.

Changes in Financial Condition

Assets — Comparison of balances at June 30, 2018 to December 31, 2017:

Our Structured loan and investment portfolio balance was $3.13 billion and $2.65 billion at June 30, 2018 and December 31, 2017, respectively. This increase was primarily due to loan originations exceeding payoffs and other reductions by $492.4 million. See below for details.

Our portfolio had a weighted average current interest pay rate of 6.76% and 6.28% at June 30, 2018 and December 31, 2017, respectively. Including certain fees earned and costs associated with the structured portfolio, the weighted average current interest rate was 7.40% and 6.99% at June 30, 2018 and December 31, 2017, respectively. Advances on our financing facilities totaled $2.81 billion and $2.24 billion at June 30, 2018 and December 31, 2017, respectively, with a weighted average funding cost of 4.34% and 4.12%, respectively, which excludes financing costs. Including financing costs, the weighted average funding rate was 4.93% and 4.83% at June 30, 2018 and December 31, 2017, respectively.

Activity from our Structured Business portfolio was comprised of the following ($ in thousands):

Loans held-for-sale from the Agency Business increased $14.0 million, primarily related to loan originations exceeding loan sales during the six months ended June 30, 2018 as noted in the following table (in thousands). These loans are generally sold within 60 days from the loan origination date.

Securities held-to-maturity increased $22.5 million as a result of two additional purchases of B Piece bonds from Freddie Mac SBL program securitizations. See Note 7—Securities Held-to-Maturity for details.

Due from related party increased $9.5 million, primarily due to payoffs to be remitted by our affiliated servicing operations related to real estate transactions.

Other assets increased $9.8 million, primarily due to an increase in interest and other receivables from new loan originations, as well as an increase in deferred tax assets.

Liabilities — Comparison of balances at June 30, 2018 to December 31, 2017:

Credit facilities and repurchase agreements increased $381.9 million, primarily due to funding of new structured loan activity.

Collateralized loan obligations increased $172.2 million primarily, due to the issuance of a new CLO, where we issued $441.0 million of notes to third party investors, partially offset by the unwind of a CLO totaling $267.8 million.

Senior unsecured notes increased $27.1 million, due to the issuance of $125.0 million aggregate principal amount of our 5.625% Notes, partially offset by the full redemption of our 7.375% Notes totaling $97.9 million.

In January 2018, we paid $50.0 million in full satisfaction of the related party financing entered into with ACM to finance a portion of the aggregate purchase price of the Acquisition.

Due to borrowers decreased $21.7 million, primarily due to a decrease in funds held on loan originations.

Other liabilities decreased $16.0 million, primarily due to the payment of incentive compensation during the first quarter of 2018, related to 2017 performance, and a decrease in current and deferred tax liabilities.

Equity

Distributions — Dividends declared (on a per share basis) for the six months ended June 30, 2018 were as follows:

(1) The dividend declared on May 2, 2018 was for March 1, 2018 through May 31, 2018 and the dividend declared on February 2, 2018 was for December 1, 2017 through February 28, 2018.

Common Stock — On August 1, 2018, the Board of Directors declared a cash dividend of $0.25 per share of common stock. The dividend is payable on August 31, 2018 to common stockholders of record as of the close of business on August 15, 2018.

Preferred Stock — On August 1, 2018, 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 June 1, 2018 through August 31, 2018 and are payable on August 31, 2018 to preferred stockholders of record on August 15, 2018.

Deferred Compensation

We issued 329,028 shares of restricted stock to employees of ours, including our chief executive officer, 58,620 shares to the independent members of the Board of Directors and up to 381,503 performance-based restricted common stock units to our chief executive officer in the first quarter of 2018. See Note 16 — Equity for details.

Comparison of Results of Operations for the Three Months Ended June 30, 2018 and 2017

The following table provides our consolidated operating results ($ in thousands):

nm — not meaningful

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):

(1) Based on UPB for loans, amortized cost for securities and principal amount of 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 is primarily due to an increase of $24.3 million, or 81%, from our Structured Business, which was primarily the result of a 62% increase in our average core interest-earning assets, due to loan originations exceeding loan runoff, and a 12% increase in the average yield on core interest-earning assets, largely due to increases in the average LIBOR rate.

The increase in interest expense is primarily due to an increase of $17.9 million, or 107%, from our Structured Business, partially offset by a decrease of $1.0 million from the pay off in January 2018 of the seller financing entered into in connection with the Acquisition. The increase from our Structured Business was primarily due to a 74% increase in the average balance of our interest-bearing liabilities and a 19% increase in the average cost of our interest-bearing liabilities. The increase in the average debt balance was due to growth in our loan portfolio and the issuance of additional unsecured debt. The increase in the average cost of our interest-bearing liabilities was primarily due to $2.9 million of accelerated deferred financing costs recorded in the second quarter of 2018 related to the unwind of a CLO in June and the redemption of unsecured debt, along with an increase in the average LIBOR rate.

Agency Business Revenue

The decrease in gain on sales, including fee-based services, net was primarily due to a $186.1 million decrease in loan sales. Sales margin (gain on sales, including fee-based services, net as a percentage of loan sales volume) was flat at 1.53% this quarter compared to 1.56% in the second quarter of 2017.

The increase in servicing revenue, net was primarily due to an increase in our servicing portfolio and an increase in earnings on escrows. Our servicing portfolio increased 14% from $15.02 billion at June 30, 2017 to $17.11 billion at June 30, 2018. Our servicing revenue, net in the second quarter of 2018 and 2017 included $11.9 million and $11.8 million, respectively, of amortization expense.

Other Expenses

The increase in employee compensation and benefits expense is comprised of $2.7 million from our Structured Business and $2.3 million from our Agency Business. The increase in both businesses is primarily due to compensation expense recorded directly by each business associated with the employees that transferred to us as a result of the internalization of our management team in 2017. Such costs were previously charged through the management fee prior to the termination of our management agreement with ACM in May 2017. In addition, increases in headcount associated with each business’s portfolio growth also contributed to the increase.

The increase in selling and administrative expenses is comprised of $0.6 million from our Structured Business and $0.4 million from our Agency Business. The increase from our Structured Business was primarily due to an increase in professional fees. The increase in our Agency Business was primarily due to increases in professional fees and rent expense.

Impairment losses on real estate owned were $2.0 million and $1.5 million for the three months ended June 30, 2018 and 2017, respectively. During these periods, we received market analysis which resulted in impairment losses on our real estate properties owned. See Note 9 — Real Estate Owned for details.

The recovery for loan losses in the second quarter of 2018 was due to a $31.6 million settlement of a preferred equity investment with a carrying value of $29.1 million resulting in a $2.5 million recovery and a $0.9 million payment received on a written-off junior participation interest in an office building. These recoveries were partially offset by a $1.3 million provision recorded on a bridge loan. The recovery of loan losses for the three months ended June 30, 2017 was the result of a $1.8 million pay-off of a fully reserved mezzanine loan.

The decrease in management fee — related party was due to the internalization of our management team and termination of the existing management agreement with ACM effective May 31, 2017.

Income (Loss) from Equity Investments

The increase in income (loss) from equity affiliates was primarily due to an increase in income from our investment in a residential mortgage banking business. In the three months ended June 30, 2018 we recorded income of $0.7 million from this investment, compared to a $0.7 million loss in the 2017 comparable period.

Provision for Income Taxes

In the three months ended June 30, 2018 and 2017, we recorded a tax provision of $4.5 million and $3.4 million, respectively. The provision for income taxes in the three months ended June 30, 2018 consisted of a current tax provision of $4.3 million and a deferred tax provision of $0.2 million and the provision for income taxes in the three months ended June 30, 2017 consisted of a current tax provision of $4.3 million and a deferred tax benefit of $0.9 million, respectively.

Net Income Attributable to Noncontrolling Interest

The noncontrolling interest relates to the 21,230,769 OP Units issued as part of the Acquisition, which represented 23.6% and 25.7% of our outstanding stock at June 30, 2018 and 2017, respectively.

Comparison of Results of Operations for the Six Months Ended June 30, 2018 and 2017

The following table provides our consolidated operating results ($ in thousands):

nm — not meaningful

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):

(1) Based on UPB for loans, amortized cost for securities and principal amount of 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 is primarily due to an increase of $43.0 million, or 74%, from our Structured Business, which was primarily the result of a 55% increase in our average core interest-earning assets, due to loan originations exceeding loan runoff, and a 12% increase in the average yield on core interest-earning assets, largely due to increases in the average LIBOR rate.

The increase in interest expense is primarily due to an increase of $32.9 million, or 103%, from our Structured Business, partially offset by a decrease of $1.6 million from the pay off in January 2018 of the seller financing entered into in connection with the Acquisition. The increase from our Structured Business was primarily due to a 71% increase in the average balance of our interest-bearing liabilities and an 18% increase in the average cost of our interest-bearing liabilities. The increase in the average debt balance was due to growth in our loan portfolio and the issuance of additional CLOs, unsecured debt and the Debt Fund. The increase in the average cost of our interest-bearing liabilities was primarily due to $5.3 million of accelerated deferred financing costs recorded in 2018 related to the redemption of unsecured debt and the unwind of a CLO, along with an increase in the average LIBOR rate.

Agency Business Revenue

The decrease in gain on sales, including fee-based services, net was primarily due to a $488.5 million decrease in loan sales, partially offset by a 15 basis point increase in the sales margin from 1.48% to 1.63% in 2018. The increase in the sales margin was primarily due to an increase in Fannie Mae margins.

The increase in servicing revenue, net was primarily due to an increase in our servicing portfolio and an increase in earnings on escrows due to increases in the average LIBOR rate. Our servicing portfolio increased 14% from $15.02 billion at June 30, 2017 to $17.11 billion at June 30, 2018. Our servicing revenue, net in the six months ended June 30, 2018 and 2017 included $23.8 million and $23.7 million, respectively, of amortization expense.

Other Income, Net

The increase in other income, net was comprised primarily of a $4.6 million increase from our Agency Business, which was due to changes in the fair value of our rate lock commitments. See Note 13 — Fair Value for details.

Other Expenses

The increase in employee compensation and benefits expense is comprised of $8.2 million from our Agency Business and $6.4 million from our Structured Business. The increase in both businesses is primarily due to compensation expense recorded directly by each business associated with the employees that transferred to us as a result of the internalization of our management team in 2017. Such costs were previously charged through the management fee prior to the termination of our management agreement with ACM in May 2017. In addition, increases in headcount associated with each business’s portfolio growth also contributed to the increase.

The increase in selling and administrative expenses is comprised of $1.2 million from our Agency Business and $1.1 million from our Structured Business. The increase in our Agency Business was primarily due to increases in professional fees and rent expense. The increase from our Structured Business was primarily due to an increase in professional fees, partially offset by a decrease in stock-based compensation expense.

Impairment losses on real estate owned were $2.0 million and $2.7 million for the six months ended June 30, 2018 and 2017, respectively. During these periods, we received market analysis which resulted in impairment losses on our real estate properties owned. See Note 9 — Real Estate Owned for details.

The decrease in our provision for loss sharing was primarily related to runoff and higher Fannie Mae loan sales in the six months ended June 30, 2017.

The recovery for loan losses for the six months ended June 30, 2018 was due to a $31.6 million settlement of a preferred equity investment with a carrying value of $29.1 million resulting in a $2.5 million recovery and a $0.9 million payment received on a written-off junior participation interest in an office building. These recoveries were partially offset by a $1.7 million provision recorded on a bridge loan. The recovery of loan losses of $2.5 million for the six months ended June 30, 2017 was primarily due to the pay-off of a fully reserved mezzanine loan with a UPB of $1.8 million.

The decrease in management fee — related party was due to the internalization of our management team and termination of the existing management agreement with ACM effective May 31, 2017.

Gain on Extinguishment of Debt

During the six months ended June 30, 2017, we purchased, at a discount, $20.9 million of our junior subordinated notes with a carrying value of $19.8 million and recorded a gain on extinguishment of debt of $7.1 million.

Income from Equity Investments

The increase in income from equity affiliates was primarily due to an increase in income from our investment in a residential mortgage banking business. In the six months ended June 30, 2018 we recorded income of $0.8 million from this investment, compared to a $0.6 million loss in the 2017 comparable period.

Benefit from (Provision for) Income Taxes

In the six months ended June 30, 2018 and 2017, we recorded a tax benefit of $4.3 million and a tax provision of $9.5 million, respectively. The benefit from income taxes in the six months ended June 30, 2018 consisted of a current tax provision of $8.8 million and a deferred tax benefit of $13.1 million, and the provision for income taxes in the six months ended June 30, 2017 consisted of a current tax provision of $8.6 million and a deferred tax provision of $0.9 million, respectively. The deferred tax benefit recorded in the six months ended June 30, 2018 was due primarily to our payoff in January 2018 of the $50.0 million preferred equity interest entered into with ACM to finance a portion of the Acquisition purchase price.

The provision for income taxes in the six months ended June 30, 2018 includes the effect of the newly enacted corporate federal income tax rate of 21% on our Agency Business as a result of the Tax Reform. The provision for income taxes primarily represents federal and state taxes related to the Agency Business, which was acquired by the TRS Consolidated Group in July 2016.

Net Income Attributable to Noncontrolling Interest

The noncontrolling interest relates to the 21,230,769 OP Units issued as part of the Acquisition, which represented 23.6% and 25.7% of our outstanding stock at June 30, 2018 and 2017, respectively.

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, debt facilities and cash flows from our 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.

While we have been successful in obtaining proceeds from debt and equity offerings, CLOs and certain financing facilities, current conditions in the capital and credit markets have and may continue to make certain forms of financing less attractive and, in certain cases, less available. Therefore we will continue to rely, in part, on cash flows provided by operating and investing activities for working capital.

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 requirements.

Cash Flows. Cash flows provided by operating activities totaled $18.6 million during the six months ended June 30, 2018 and consisted primarily of net income, adjusted for noncash items, of $62.7 million, partially offset by net cash outflows of $15.9 million as a result of loan originations exceeding loan sales in our Agency Business and a period-over-period increases in other assets of $9.8 million and due from related party of $9.5 million. We had net cash outflows from loans-held-for-sale during the six months ended June 30, 2018 due to the timing of agency loan sales, as agency loans are generally sold within 60 days of origination.

Cash flows used in investing activities totaled $518.1 million during the six months ended June 30, 2018. Loan and investment activity (originations and payoffs/paydowns) comprise the bulk of our investing activities. Loan originations from our Structured Business totaling $875.2 million, net of payoffs and paydowns of $429.1 million, resulted in net cash outflows of $446.1 million. Cash used in investing activities also includes $58.6 million of cash used to fund holdbacks and reserves on our loans and investments and $21.6 million in cash payments to purchase B Piece bonds from SBL Program securitizations.

Cash flows provided by financing activities totaled $536.3 million during the six months ended June 30, 2018, and consisted primarily of $566.0 million of net proceeds from the issuances of a CLO and additional unsecured notes, net cash inflows of $382.8 million from debt facility activities (funded loan originations were greater than facility paydowns) and $55.9 million of net proceeds from a public offering of our common stock. These cash inflows were partially offset by outflows of $267.8 million for the redemption of CLO V, $97.9 million for the redemption of our 6.50% Convertible Notes, $50.0 million for full satisfaction of the seller financing related to the Acquisition of the Agency Business and $42.3 million distributed to our stockholders and OP Unit holders.

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 June 30, 2018. Our restricted liquidity and purchase and loss obligations were satisfied with letters of credit totaling $47.0 million and $0.7 million of cash collateral. See Note 14 — Commitments and Contingencies 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 12 — Derivative Financial Instruments and Note 13 — Fair Value.

Debt Instruments. 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):

(1) Excludes the impact of deferred financing costs.

(2) Maturity dates represent the weighted average remaining maturity based on the underlying collateral as of June 30, 2018.

(3) The ASAP agreement we have with Fannie Mae has no expiration date.

The debt facilities, including their restrictive covenants, are described in Note 10 — Debt Obligations.

Contractual Obligations. During the six months ended June 30, 2018, the following significant changes were made to our contractual obligations disclosed in our 2017 Annual Report:

• Closed CLO X issuing $441.0 million of investment grade notes to third party investors;
• Unwound CLO V redeeming $267.8 million of outstanding notes;
• Subsequently issued $245.0 million of 5.25% Convertible Notes (which were used to repurchase substantially all of our 6.50% Convertible Notes and 5.375% Convertible Notes totaling $227.4 million);
• Issued $125.0 million of our 5.625% Notes (which were substantially used to redeem all of our 7.375% Notes totaling $97.9 million);
• Repaid the $50.0 million related party financing; and
• Closed new and modified existing credit facilities.

See Note 10 — Debt Obligations for details and refer to Note 14 — Commitments and Contingencies for a description of our debt maturities by year and unfunded commitments as of June 30, 2018.

Off-Balance Sheet Arrangements. At June 30, 2018, we had no off-balance sheet arrangements.

Derivative Financial Instruments

We enter into derivative financial instruments in the normal course of business through the origination and sale of mortgage loans and the management of potential loss exposure caused by fluctuations of interest rates. See Note 12— Derivative Financial Instruments for details about our derivative financial instruments.

Critical Accounting Policies

Please refer to Note 2 — Basis of Presentation and Significant Accounting Policies of the Notes to Consolidated Financial Statements in our 2017 Annual Report for a discussion of our critical accounting policies. During the six months ended June 30, 2018, there were no material changes to these policies.

Non-GAAP Financial Measures

Funds from Operations and Adjusted Funds from Operations. We present funds from operations (“FFO”) and adjusted funds from operations (“AFFO”) because we believe they are important supplemental measures of our operating performance in that they are frequently used by analysts, investors and other parties in the evaluation of REITs. The National Association of Real Estate Investment Trusts, or NAREIT, defines FFO as net income (loss) attributable to common stockholders (computed in accordance with GAAP), excluding gains (losses) from sales of depreciated real properties, plus impairments of depreciated real properties and real estate related depreciation and amortization, and after adjustments for unconsolidated ventures.

We define AFFO as funds from operations adjusted for accounting items such as non-cash stock-based compensation expense, income from MSRs, changes in fair value of certain derivatives that temporarily flow through earnings, amortization and write-offs of MSRs, deferred tax benefit and amortization of convertible senior notes conversion options. We also add back one-time charges such as acquisition costs and impairment losses on real estate and gains on sales of real estate. We are generally not in the business of operating real estate property and had obtained real estate by foreclosure or through partial or full settlement of mortgage debt related to our loans to maximize the value of the collateral and minimize our exposure. Therefore, we deem such impairment and gains on real estate as an extension of the asset management of our loans, thus a recovery of principal or additional loss on our initial investment.

FFO and AFFO are not intended to be an indication of our cash flow 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 FFO and AFFO may be different from the calculations used by other companies and, therefore, comparability may be limited.

FFO and AFFO are as follows ($ in thousands, except share and per share data):

(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.

We disclosed a quantitative and qualitative analysis regarding market risk in the Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our 2017 Annual Report. That information is supplemented by the information included above in Item 2 of this report. Other than the developments described thereunder, there have been no material changes in our quantitative and qualitative exposure to market risk since December 31, 2017.

The following table projects the potential impact on interest income and interest expense for a 12-month period, assuming an instantaneous increase or decrease of both 25 and 50 basis points in LIBOR (in thousands).

(1) Represents the UPB of our loan portfolio and the principal balance of our debt.

(2) The quoted one-month LIBOR rate was 2.09% as of June 30, 2018.

Our Agency Business originates, sells and services a range of multifamily finance products with Fannie Mae, Freddie Mac and HUD. Our loans held-for-sale to Fannie Mae, Freddie Mac and HUD are not currently exposed to interest rate risk during the loan commitment, closing and delivery process. The sale or placement of each loan to an investor is negotiated prior to closing on the loan with the borrower, and the sale or placement is generally effectuated within 60 days of closing. The coupon rate for the loan is set after we established the interest rate with the investor.

In addition, the fair value of our MSRs is subject to market risk since a significant driver of the fair value of these assets is the discount rates. A 100 basis point increase in the weighted average discount rate would decrease the fair value of our MSRs by approximately $9.7 million as of June 30, 2018, while a 100 basis point decrease would increase the fair value by approximately $10.3 million.

Management, with the participation of our chief executive officer and chief financial officer, has evaluated the effectiveness of our disclosure controls and procedures at June 30, 2018. Based on this evaluation, our chief executive officer and chief financial officer have concluded that our disclosure controls and procedures were effective as of June 30, 2018.

There were no changes in our internal control over financial reporting during the quarter ended June 30, 2018 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.