FBI Probes ABR, and HESM is Too Good!

ABR: Selling All Shares (1.43%)

Short Version:

According to a Bloomberg report released on Friday July 12th, the FBI is currently “probing” Arbor Realty Trust (ABR), specifically its “lending practices, and its claims about the performance of its loan book”. 

I intend to close my ABR position when the market opens on Monday because the potential downside of this news exceeds the upside of ignoring it.

Long Version:

I’ve held ABR since early 2023, and ignored the “Sell” recommendations of the 2 short sellers that released reports on ABR, as explained in this video from March 17, 2023, and this video from November 19, 2023. 

In short, I found the Ninji and the Viceroy short seller reports to be unprofessional, lacking cohesion, and clearly motivated by the financial rewards they gained from timing the release of those reports, to coincide with shorting the stock.

I did my own independent research and concluded that 1/ It’s extremely difficult to review the complex financial statements and loan book of a mortgage REIT (that’s not ABR’s fault), and 2/ The multi-family lending sector is facing some significant short term challenges, as explained in this video from November 2023.

As a result of the challenges facing the sector, (not the short seller reports) I decided to sell ABR, with the intention of purchasing it again after a few quarters when the lending environment was more favorable.

In June of 2024, I began gradually re-establishing an ABR position, as explained in this video (at the 08:13 mark). The plan was to keep an eye on earnings reports and, barring any major issues, continue to add to the position over time.

That brings us to the July 12, 2024 report from Bloomberg, citing an FBI probe. I consider an FBI probe to be an entirely different risk than the short reports, or the challenges of the multi-family lending space. The FBI doesn’t probe a publicly traded company just because a short report is issued (especially if the short report is as unprofessional as those released by Ninji and Viceroy). In other words, I’m assuming that the FBI probe was prompted by information that warrants the use of their resources.

Given the limited information available (ie almost no information), my thought process is as follows:

My #1 priority is to maintain consistent income without losing my principal. I’m not looking to trade this news, or profit from price action.

At this point it’s impossible to verify if the FBI probe is real, and if it is real, what the outcome of the probe will be.

Case for Holding/Increasing Position:

If you believe that Bloomberg is wrong, and the FBI probe doesn’t exist, or that the FBI probe will be dropped, and won’t lead to a formal investigation, then the upside is that the stock recovers its 17% price drop from July 12th, and the distributions will continue unaffected.

Case for Selling:

The ABR price is unlikely to fully recover the 17% drop that occurred on July 12th unless the FBI probe is dropped, and does not lead to a formal investigation. If the FBI probe leads to a formal investigation, then the price is likely to fall further. If a formal investigation uncovers improper conduct from management, or worse…then the price is likely to fall further, and the distributions are potentially at risk.

I diversify to avoid being reliant upon, or affected by, any 1 investment. The price and performance of ABR is likely to be influenced by the outcome of the FBI probe (good or bad). That’s a roller coaster ride I can skip, at little to no cost.

ABR is just under 1.5% of my portfolio, and after the 17% drop, I’m sitting on a 4.65% loss, before dividends for the stock. After dividends, it’s a small net profit.

I hope ABR has done nothing wrong, is being unfairly treated, that the FBI probe goes nowhere, and that the stock recovers. If that happens, I’ll probably buy ABR again and enjoy the 10-12% yield.

HESM: Reduced from 5.18% to 2.64%

This midstream partnership is supposed to be a boring cash flow machine because it stores, processes, and transports oil and gas. A potential Chevron takeover, and stellar performance, have driven up the total return 24.8% year to date…that’s a better total return than the tech heavy S&P 500!

This is a “good problem”. The sky rockering price has pushed the yield down to 6.84% and expanded its weighting in the portfolio to north of 5%....too much. I’m selling half because 1/ The yield is now substantially lower than when I bought it, and 2/ It’s an individual stock which means it's subject to concentration risk. Where possible, I try to weight funds over individual stocks to reduce concentration risk.

I didn’t sell the entire position because it's still a great stock (as explained in this video). Even though it yields less than 8%, HESM has a history of growing its yield consistently, which means the yield on cost should eventually exceed 8%.

FSCO: Increased from 2.29% to 4.27%

Continuing the theme from last week, this Fixed Income Closed End Fund is focused on senior secured loans and corporate bonds. FSCO is currently trading at a 8.64% discount to Net Asset Value (NAV), but that discount is shrinking.

WDI: Increased from 2.44% to 4.36%

Similar reasoning to FSCO above. WDI is a Fixed Income Closed End Fund and its price discount to NAV (currently 4.55%) is rapidly shrinking. The portfolio is weighted towards sub-investment grade corporate bonds.