This share hurts too short. The bears are masochists.

Thirty-six percent (36%!) of the outstanding shares are sold short. This dividend is just Wait be squeezed higher.

Meanwhile, the bears are paying the stock’s 12.8% dividend out of their own pocket. That’s how short selling works – you have to borrow shares to place your bearish bet, making you responsible for the dividend.

Would not be My Bet. I am of course talking about our controversial favorite Arbor Realty Trust (ABR). ABR is a Mortgage Real Estate Investment Trust (mREIT) – a subset of REITs that typically does not trade in physical real estate, but rather owns properties on “paper.” Mortgages, to be exact.

Arbor founder Ivan Kaufman started ABR as a single-family mortgage lender, and even initially sent each new homeowner a tree at closing. But Ivan isn’t one to sit still. He’s turned the company around and added (or dropped) various business lines throughout Arbor’s history.

One of these expansions – multifamily lending – is now Arbor’s most important asset:

As you can see, Ivan Arbor has cleverly diversified away from commercial real estate. But when it comes to equity investor coverage, Arbor is often lumped in with commercial lenders and landlords.

This is unfair, as these loans range from 1% to none of the portfolio. But this misclassification is our contrary advantage. We know that:

• Arbor has increased its book value at a time when other mREITs have shrunk.
• The company pays a high dividend, which even grown lately.
• ABR is a heavily shorted stock, which creates potential price gains.

This last point has been attracting increasing interest for almost two years now, with skeptics initially few and far between but then increasingly gaining ground, eventually making ABR one of the most shorted stocks on the market.

We discussed ABR’s struggle with the shorts in December 2023 and again a few months ago. So far the shorts take it in the shorts. ABR has delivered a total return of over 20% since the beginning of 2023 despite a continued increase in short selling.

The short sellers were betting on something that even Arbor admitted. As long as the Fed kept interest rates high, ABR would feel the pressure:

“We are in a period of extreme stress and expect the next two quarters to be challenging, if not more challenging than the fourth quarter,” Kaufman said during the fourth-quarter 2023 conference call in February. “As a result of this environment, we are seeing increased delinquencies.”

The Fed has not budged so far in 2024, and that was reflected in Arbor’s latest earnings report. But the Fed is damned close to cuts, and in the meantime we see signs that Kaufman & Co. are navigating the difficult conditions.

Second-quarter distributable earnings per share of 45 cents per share beat estimates by 3 cents per share and were a few cents above the dividend of 43 cents. Book value declined, but only 1%, to $12.47 per share, also beating expectations of $12.42 per share.

Agency loans fell short of forecasts at $1.15 billion, but still represented a 35% increase from the previous quarter.

In fact, total delinquencies increased from $954 million in the first quarter to $1.04 billion in the second quarter:

• The number of non-performing loans (NPLs) increased from USD 465 million to USD 676 million, mainly because USD 264 million was in arrears from less than 60 days to over 60 days.
• The number of loans delinquent by less than 60 days decreased to $368 million from $489 million. This is partly due to the transition to delinquency of more than 60 days. In addition, $138 million of loans were either modified or repaid. (This item was also affected by $281 million of new loans that did not accrue interest.)

Importantly, however, Arbor is aggressively modifying loans to force repayment of delinquent loans. ABR modified over $730 million worth of loans in the second quarter. Kaufman says, “$23 million of fresh capital was put into these deals by the sponsors.” In the meantime, they are working on addressing the $1 billion in delinquent loans, through modification, REO (Real Estate Owned; basically foreclosure) or by bringing in new sponsors.

Arbor has also increased its expected credit loss (CECL) provision by approximately $29 million to further strengthen its defenses, bringing the total to $239 million. Importantly, however, the company has done so without taking a huge book value hit like some of its peers.

And what’s the biggest reason for optimism? According to Kaufman, Arbor was able to achieve $630 million in payouts, $490 million of which was refinanced into fixed-rate agency deals – a feat he attributed to recent declines in interest rates.

Arbor has been beating the same drum for several quarters: The company wants to convert its multifamily bridge loans into agency products. It can do so at high interest rates, but a drop in the 10-year Treasury yield to 4% would be a significant development, and Kaufman adds that any quarter-percentage point drop from that level should really speed things up.

Sustained weakness in the 10-year Treasury bond would be a boon for ABR stock and could in turn force some bears to give up – thus triggering the virtuous cycle of a short squeeze.

Further pressure on the bears comes from Arbor’s massive 13% dividend, which has grown over the past decade strong in contrast to the mREIT sector.

Brett Owens is Chief Investment Strategist for Contrary outlook. For more great income ideas, check out his latest special report: Your early retirement portfolio: Huge dividends – every month – forever.

Disclosure: none