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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good day, and welcome to the Starwood Property Trust First Quarter and 2018 Earnings Call. Today’s conference is being recorded.
At this time,, I would like to turn the conference over to Zach Tanenbaum, Director of Investor Relations. Please go ahead, sir.
Thank you, operator. Good morning and welcome to Starwood Property Trust’s earnings call. This morning, the company released its financial results for the quarter ended March 31, 2018 filed its 10-Q with the Securities and Exchange Commission and posted its earnings supplement to its website. These documents are available on the Investor Relations section of the company’s website at www.starwoodpropertytrust.com.
Before the call begins, I would like to remind everyone that certain statements made in the course of this call are not based on historical information and may constitute forward-looking statements. These statements are based on management’s current expectations and beliefs and are subject to a number of trends and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. I refer you to the company’s filings made with the SEC for a more detailed discussion of the risks and factors that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today. The company undertakes no duty to update any forward-looking statements that maybe made during the course of this call.
Additionally, certain non-GAAP financial measures will be discussed on this conference call. Our presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. Reconciliations of these non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP can be accessed through our filings with the SEC at www.sec.gov.
Joining me on the call today are Barry Sternlicht, the company’s Chairman and Chief Executive Officer; Rina Paniry, the company’s Chief Financial Officer; Jeff DiModica, the company’s President; Andrew Sossen, the company’s Chief Operating Officer; and Adam Behlman, the President of our Real Estate Investing and Servicing segment.
With that, I will now turn the call over to Rina.
Thank you, Zach, and good morning, everyone. Our core earnings this quarter totaled $156 million, or $0.58 per share. This includes a positive impact of $0.04 from the payoff of our March 2018 converts, which I will discuss shortly.
I will begin this morning with the results of our largest business, the Lending segment. During the quarter, this segment contributed core earnings of $113 million, or $0.42 per share. On the commercial lending side, we originated or acquired $1.2 billion of floating rate loans in 12 separate transactions. The loans carried a blended LTV of 63% consistent with our overall portfolio LTV of 62%.
We funded $912 million, of which $743 million related to new loans and $169 million related to preexisting loan commitments. Consistent with our projection, we had gross repayments this quarter of $1.5 billion. As we have said in the past, the timing of repayments in any given quarter can be bumpy, but they tend to normalized over the full-year period. Over the past two years, we have averaged $3 billion of gross loan repayments per year and expect a similar level this year.
Our commercial loan book continues to be positively correlated to rising interest rates, with 93% being floating rate. On the residential lending side, we acquired $92 million of non-agency loans and received repayment of $30 million, bringing the total portfolio to $663 million and our net equity to $218 million. The current portfolio has an average 63% LTV and 723 FICO.
I will now turn to our Property segment, which contributed core earnings of $27 million, or $0.10 per share to the quarter. We previously announced the phased acquisition of a 27-property affordable housing portfolio in Florida, which we referred to as Woodstar II.
We closed on eight of these properties in late December and an additional 18 properties in Q1. The purchases in the first quarter totaled $405 million, including $27 million of contingent consideration, which is payable upon the achievement of certain real estate tax abatement. We levered this portfolio with fixed rate debt containing an 11-year average term.
On a weighted average basis, our cumulative purchases contributed 46 days of earnings to the quarter. As we mentioned last quarter, we utilized the down rate structure for the first time in executing this transaction. In connection with the closings this quarter, we issued 7 million OP units with an obligation to issue an additional 1.3 million units upon resolution of the contingency.
To date, we have issued 9.8 million OP units in connection with the acquisition of this portfolio. These units represent equity and a subsidiary, which are exchangeable into STWD common stock at the option of the holder. As we discussed with you last quarter, we treat these units similar to an equity issuance for core purposes, while GAAP treats them as non-controlling interest.
With regards to share count, these units were determined to be anti-dilutive under GAAP, so they were excluded from our GAAP share count. However, they are included in our share count for core EPS purposes. In Q1, we added back 5.1 million shares to arrive at our core diluted weighted average share count of $268 million.
With regards to income, the units are entitled to distribution, which are indexed to the dividend paid on our common stock. During the quarter, we paid $2.5 million in distributions on the outstanding units. These amounts are included in non-controlling interest expense in our GAAP P&L and then added back to arrive at core earnings.
The remainder of wholly owned assets in this segment continued to perform well, generating consistent returns with a blended aggregate cash-on-cash yields for the trailing 12-month period of 10.9% and a weighted average occupancy of 98%. We expect this cash-on-cash bill to increase in the near-term as we realize the impact of a significant lease-up in our Dublin portfolio that we mentioned last quarter. This quarter, we also sold two retail assets from our master lease portfolio. The asset had a cost basis of $33 million and generated a core gain of $4 million.
I will now turn to our Investing and Servicing segment, which contributed core earnings of $57 million, or $0.21 per share to the quarter. Our CMBS portfolio continues to perform well. Core yields on our 2.0 book, which now represents 86% of our overall CMBS portfolio continue to be in the mid-teens. We also recognized the positive mark-to-market adjustment of $14 million in our GAAP P&L related to tightening spreads on our 2.0 bonds.
On the servicing front, revenues increased to $33 million, up from our third and fourth quarter run rate of $23 million. These were driven by better than expected outcomes on $1 billion of resolutions that occurred during the quarter. We expect to return to our prior quarter run rate in Q2.
We also continued adding to our named portfolio, obtaining three new servicing assignments on deals totaling $2 billion of collateral. At the end of the quarter, our named servicer portfolio totaled 160 trusts with a balance of $73 billion, and our actively serviced portfolios stood at $9.2 billion.
Moving to our conduit, we securitized $257 million of loans this quarter in one transaction. And finally, on the segment’s property portfolio, we continue to harvest gains as these assets reach stabilization. During the quarter, we sold assets with a cost basis of $19 million for a core gain of $3 million. We also acquired $28 million of properties, bringing the undepreciated balance of this portfolio to $354 million across 24 investment.
While we’re on the topic of properties, I wanted to make a comment about our overall property portfolio and its impact to our book value metrics. Collectively, the properties in our REITs and Property segments totaled $3.5 billion on an undepreciated basis, representing 27% of our total undepreciated assets of $13.2 billion. These assets carry $205 million, or $0.78 per share of accumulated depreciation.
As we continue to realize gains in excess of our purchase price for these assets, we believe that GAAP book value is becoming an increasingly less relevant metric for us. At a minimum, adding back $205 million to our GAAP book value would arrive at purchase price. Any gains on this asset would suggest an add-back in excess of $205 million.
I will conclude with a few comments about our capitalization and dividend. This quarter, we were able to replace our convertible notes with more cost-effective senior unsecured debt. In January, we issued $500 million of high-yield debt at at a fixed coupon of 3.625%, which we swapped to floating.
We utilized those funds in part to repay the $370 million of our March 2018 convert, which carried a 4.55% fixed coupon and an all-in cost to funds of 5.7%. The equity component of our converts, which had been accreted through interest expense over their term expires worthless. This resulted in a gain of $10 million, or $0.04 per share that we recognized in core earnings.
We ended the quarter with $4.2 billion of undrawn debt capacity, a weighted average debt term of 58 months, and a modest net debt to undepreciated equity ratio of 1.5 times. If we were to include off-balance-sheet leverage in the form of A notes sold, this ratio would be two times. The decline of 0.1 times from last quarter’s ratio is due to a $143 million increase in non-controlling interest associated with Woodstar II, which resides within GAAP equity.
For the second quarter, we have declared a $0.48 dividend, which will be paid on July 13th to shareholders of record on June 29. This represents a 9.2% annualized dividend yield on yesterday’s closing share price of $20.96.
With that, I’ll turn the call over to Jeff for this comments.
Thanks, Rina On our last earnings call, we articulated our strategy to diversify and lower our borrowing cost to allow us to continue to grow our loan portfolio notwithstanding the tighter spread environment we see today. We issued $500 million of unsecured notes in Q1 with a 3.625% coupon swapped to LIBOR plus 128, the tightest spread for a high-yield bond issuance since the financial crisis and more in line with where investment-grade name trade.
Our diversified model has created a funding advantage that enabled to us to once again more than offset loan spread tightening and still achieve an optimal 12.3% IRR and $1.2 billion in loan originations on 12 assets this quarter. In the aggregate, we deployed $2 billion this quarter across our multi-cylinder platform despite having one $375 million loan we expected to close in Q1 slipped into very early Q2.
We expect a higher origination volume in Q2, with the majority coming from our loan portfolio. Our average loan size was just over $100 million in Q1 and we conservatively locked in financing on each asset at origination as we always do. We have not taken market risk on financings to improve our IRRs or originated extremely large loans that ultimately could create significantly – significant cash drag at maturity. We continue to think construction lending to great sponsors with conservative business plans attractive. But I will note that construction loans are less than 15% of the assets in our Lending segment today.
As Rina mentioned, we had large repayments in our loan book in Q1 with $967 million of equity returned more than any prior quarter and approximately the same as what we expect in the next three quarters combined. We expected that amount. We have been patient with the deployment of this excess cash on our balance sheet, leaving us ample liquidity to execute our business plan in the coming quarters.
Surprisingly, at this point in the cycle, our loan portfolio is rolling off at lower yield than we are replacing it with. Despite tighter loan spreads and without increasing leverage, we’re expanding our credit criteria, our optimal origination IRR this quarter with 12.3% consistent with our historical averages and 90 basis point above the optimal IRR on the loans that repaid in the quarter.
In addition to tighter lending spreads, this increase has been partially driven by higher LIBOR. Additionally, tighter lending spreads have the benefit of increasing the duration of our loans by providing borrowers with lower coupons that are less likely to refinance.
In Q1, our Lending segment created an additional $300 million in unencumbered assets, which will help us continue on the path of issuing unsecured debt and unencumbering our balance sheet at the best rate in our peer group. We have $3.6 billion of unencumbered assets in our book today with $2.3 billion of unsecured debt, a ratio of 1.6 times, leaving us ample room to issue more unsecure debt as we continue to grow our core lending book.
Unsecured issuance decreased as a cost of our liabilities, allowing us to grow our loan book without straying from our low-leverage strategy and credit-first culture and ultimately, should improve our credit rating, which will drive our borrowing spreads even lower. The credit of our portfolio continues its strong performance since inception almost nine years ago, and we expect our 100% performing 62% LTV portfolio to perform very well.
Our high FICO, low LTV residential loan portfolio continues to produce a very attractive levered IRR, and we expect to turn out a large portion of the existing financing for this portfolio in our first securitization, which we anticipate closing later this quarter, achieving a rate of return at least as great as our loan book.
Financed conservatively with long-term fixed rate debt, our diversified Property segment provides us with double-digit cash return. We retain the potential equity upside, extend our duration, and benefit from the depreciation shield, which lowers our required payout ratios. This portfolio continues to perform extremely well.
As we have previously mentioned, we believe that in the aggregate, our investment portfolio has over $1 per share in unrealized gains that are available for us to harvest in the future, but we view the bulk of this book as long-term core hold that we will continue to add earning for years to come.
With the bulk of the Woodstar II multifamily assets now closed, we are buoyed by continued strong performance in this 99%-plus leased portfolio. The portfolio was all based in strong markets in Florida with growth in medium – the growth in median income levels that will allow us to increase rents faster than we originally modeled. Our Dublin office portfolio is virtually 100% leased, and our medical office portfolio is 93% leased and both are performing very well.
Rina mentioned, we sold three small equity assets out of our REIT segment this quarter and two of our Bass Pro net lease assets from our Property segment. We plan to sell approximately one-third of our total Bass Pro investment in the coming months at tighter cap rates than are purchased, proving the mispriced credit and our wholesale to retail thesis we mentioned at acquisition, creating gains, lowering our basis and significantly improving the cash return of our remaining portfolio by several 100 basis points to over 13%.
In our Real Estate Investing and Servicing segment, special servicing fees were up this quarter. Our CMBS portfolio grew slightly. We added three new special servicing assignments and our best-in-class conduit origination business continues to be a steady contributor to our earning.
I’ll note that in Morgan Stanley’s year-end conduit scorecard, Starwood Mortgage Capital has the lowest percentage of loans in special servicing, only three out of 675 loans or 0.25% of loans originated. By far the best of the top 25 CMBS 2.0 lenders. This exemplary credit performance along with our funding advantage, relationship with borrowers and banks are positioned as a top special servicer, and our balance sheet ensures Starwood Mortgage Capital will continue to be a winner in the post-risk retention CMBS conduit origination business.
We are extremely happy to report that in Q2, through purchases, partnerships and assignments, we expect to add nine special servicing assignments or over $9 billion in notional value to our special servicing book, the most we have added in any one quarter since our acquisition of LNR in 2013.
Our reputation, scale and ability to underwrite every loan and every securitization allowed us to acquire servicing on those nine trusts, while investing just $30 million to $45 million of our own capital, giving us significant leverage per dollar we invest and significantly more future servicing revenue for our company.
Finally, as we’ve done opportunistically in the past, we bought back $12 million of stock in the quarter when our shares dipped in February and have $250 million left in our Board approved buyback. This is our ninth year in our Board and management team are top 10 shareholders and we will continue to act like your partners and purchase stock when appropriate.
With that, I’ll turn the call to Barry.
Thanks, Jeff. Thanks, Rina, and team. Good morning, everyone. There’s – whenever I do these calls, I think about what I’m going to say and how optimistic I’m going to be. And as you know, those of you listening to me on my last quarter call, I was pretty optimistic and I think our quarter proves that despite having some loans move to the second quarter in the origination side. The business is working well, and I’m fairly confident that we will meet or exceed our projections and your estimates for the year.
We have a pretty good view of what’s going on and we really like our positioning. The ability to drive our cost of financing down to better cost than anyone can in our sector is a permanent or sustainable competitive advantage. So our goal is to grow, and I’m hoping that we can continue to grow. And if we can do that, we can increase our dividend. But it’s been a tumultuous time as credit spreads have come in and lenders have gotten more aggressive. You can see the velocity of the repayments of our loan book was the highest in history, but completely anticipated. And as Rina said, the next three quarters will be about what we had in the first quarter.
So we actually...
In total.
…in total and we knew about it and we’re prepared for it. So, we talk about every, I should say, it all the time and it’s true, conservative. We’re on a conservative book. We can increase our earnings by levering up our book. We choose not to. We want to be stable and consistent, and I think, see we are pretty stable and fairly consistent.
We’re building businesses now that will replace lost earnings from the special servicer. I don’t think Rina mentioned it, but the current value of the servicer is $50 million, which is less than half the value of – like, on taking gains in our equity book. So it’s –you have a negative $50 is a free option for the shareholders. And I would like to also mention, again, this comment that Rina made about undepreciated book value. It’s been bothering me a bunch that I see our GAAP book, I guess, it is declining slightly. And you may say, oh, we’re eating into our business. We’re not.
I mean, we’re just – if you go to the undepreciated book value, you will see that that is the multiple that the analysts should use to determine the multiple of the book, because if you use the other one, we look, like we’re trading premiums into some of our peers, which in my view, we’re really not at the moment, because you’re using the wrong metric. And a lot of investors look at multiple book, but they’re looking at the wrong book because of our equity book.
And as Rina pointed out, if you actually had the fair value of those assets and I will tell you, I think, they’re considerably marked. Then you’re even more understating our multiple of book. And it is, while we did do our first ever issuance of stock to buy the Woodstart portfolio in a down REIT structure and would love to do more of that, we don’t really love selling stock where our stock is. And especially if you take my view of what the book value is of our stock, our multiple, our earnings, the safety of our business and, of course, the dividend yield.
So it was a good solid transaction. Our stock is incredibly attractive to people. We pay a very steady dividend that you can’t find anywhere in the world with a 62% LTV. But I’m always optimistic that these other businesses will be able to replace, which I think has been somewhat of a cloud over the company’s performance. As people thinking that the special servicing cycle is over and maybe we won’t have engine, and I think the team is pivoting and focused on that and you’ve seen us get into a few other businesses.
One of the comment about recurring gains and non-recurring gains. We were kind of like a trading out. And if you look at a company like Ladder, which I’ll mention also, they buy securities, they sell securities. We buy little properties and sell little properties and we’re probably always going to do that. And so our non-recurring earnings gains are actually recurring, non-recurring earnings gains.
So these are all the time and they have been the last several years, they’ll be going forward. And I just was – somebody sent me an article congratulation on selling a retail center. I didn’t even know we owned. It’s a small center, I think, we bought it for $5 million and sold it for $13 million or something like that, it was a 50 IRR. And we can do that, because the information in our book and the data we have and not to do so would be foolish and not enhancement of the shareholder value.
So we’ll continue to do that, continue to look for opportunities on our book and elsewhere, use our data and knowledge and our scale across the globe to find opportunities to push shareholder capital attractive rates of return. I think, I was going to say one more thing, because it wasn’t announced and it’s not in the paper that you may recall long ago. We made a construction loan on 701 7th Avenue and the results were brought in EB-5 financing, paid this down. We only had our ticker left in the transaction.
So the IRR on this deal is going to be in a 20, as I presume. But that that you’ll see something we were hoping would happen and did happen subsequent to quarter-end and we even talked about. You can see an estimate of the fair value that gain in a supplement of your financials, I believe, oh it’s not there, going to see it. You just be surprised.
So anyway, I was looking at a page at one of our Board book. So I’m pretty pleased about things. I think, we’re cooking with gas. The origination team is good. We’re adding businesses and volume and people. Some of our competitors are actually exiting the business, which is good. It is fiercely competitive out there. Don’t get me wrong, these are hard loans to win, our scale and we can write a big check, we’re happy and we’re happy to do it and also our ability to underwrite these markets globally.
I’d like to see us build a bigger book in Europe again, which we’re trying to do. And their spreads are even tighter, but mezzanine loans can be written at attractive enough price point that we – and again, the strategy of selling off a senior’s is open to us. We charged our team and some of our team to sort of get going and build that book.
We do expect, if I gave the wrong impression, that the servicer will remain profitable and we would actually expect it to reaccelerate its growth going forward. So pretty excited about. Things are good at the moment although believe me, it’s because we have a great team that we are able to execute in this marketplace, because it is – it’s tough out there. But what business isn’t tough, unless you don’t make electric cars.
All right. Thanks, everyone.
I’m going to add one point of clarity to what Barry said when he talked about the servicer at $50 million, he said it’s less than 50% of the gains in our equity book. I know, he meant the equity book that’s within our servicer, not our overall property portfolio, as he was thinking about that that larger number.
Yes. Thank you for the clarification. We’ll take questions.
[Operator Instructions] And we’ll take our first question from Doug Harter with Credit Suisse.
Hi, guys, this is actually Josh on for Doug. First, Jeff, you talked about the drivers behind higher optimal asset yield on the lending book. Is that sustainable on go-forward basis?
Well, listen, LIBOR is up. We all have disclosures, it’s pretty easy to figure out that that we’re going to do better on a LIBOR basis. If we average three turns of leverage and probably our competitors are closer to four turns of leverage, we do run less debt-to-equity ratios. So we’ll have less leverage in the improved financing.
But for every basis point of loan tightening, if we get a third of a basis point of financing tightening, we will ultimately make more money at the same LTV and with the same thickness of tranche. There are ways to make it appear like you have a higher IRR in our tranches different credits, we don’t do that, higher leverage, we don’t do that. We continue to run extremely conservatively there.
But we’re all being helped out a little bit by higher LIBOR. Our business isn’t set up to be quite as much growth in our earnings based on LIBOR as some of our competitors who don’t have the ancillary businesses and are only in the lending business. So I would say that our outperformance on the loan book is really actual outperformance of loans versus there where we’re funding them more so than our competitors who probably have more of benefits from LIBOR.
Great, makes sense. And then second in terms of competition, we’ve heard recently the bank bid for loans hasn’t been a strong and that non-banks have gained market share. I’m curious, if you guys have seen a similar dynamic? And if so, any thoughts on the drivers behind that shift? Thanks.
I’ll start and I’m sure Barry will have some comments. But at the end of the day, banks are financing out significantly better than they ever have. We are now able to compete with banks on the more transitional cash flow and properties that historically were properties that that they might have competed on. But we’re financing so much better there are people doing CLOs, we haven’t chosen that path. We’re borrowing unsecured debt extremely cheap.
Our warehouse lines continue to come in, and we can compete with the banks on transitional assets. They still will – they will still dominate on the LIBOR plus low 200s or in assets that are high cash flow and great sponsor assets. So we’re not going to compete there, it’s not part of our business plan.
Ever have.
Yes, it’s construction. It’s something that we continue to have an opportunity and although, this quarter we did less than 25% of our book. And as I said before, our book is only 15% or less than 15% construction.
[Multiple Speakers] just 15% of our book being construction is probably something like 7% of our overall asset base.
Yes.
So it’s not like – it’s just a nice place. It’s a cash management tool for us, And, of course, because we’re equity players from the start, not lenders, we clearly get this beautiful property at $0.60 – $0.50 to the $1, we’d be delighted. So they fail, we win. They pay us back, we also win. So it’s okay, I mean, at this point of the cycle, we’re very picky about what we do and where we do it. And sometimes, we pass, we think we’ve seen some crazy deals by the way.
I would say, there are pockets of stupidity emerging in the real estate lending market, again. And just they’re coming from nontraditional players often hedge funds wondering into the space looking for stable yield in the world where they don’t have much and the returns have been suboptimal.
So as a class, I do think that those are fewer and far between you are seeing continued construction that shouldn’t be built using actually the EB-5 financing program, which should be terminated. There’s absolutely no reason for the EB-5 financing to be in the marketplace today. All it does is induce supply that doesn’t stand on its own merit and we’re not trying to bring in green card or increase employment presumably at 3.9% unemployment rate. So I exactly does this program exist. I have no idea, but what a waste of money.
Great. Thanks for the comments, guys.
We’ll take our next question from Jade Rahmani with KBW
Thank you. In terms of the plethora of debt funds, are you seeing a bifurcation between firms such as Starwood Property Trust with multiple means of access financing and smaller debt funds that need to sell A notes, and so don’t have a competitive cost of capital. So are you seeing sort of a carved out area of deals in which you guys have a competitive advantage and competition is not as great as in other sectors of the market?
Yes. Thanks, Jade. I would say that where I think smaller debt funds who don’t have our cost of capital, what they’re doing to compete is, they’re simply taking more leverage. They’re doing things four or five times levered to achieve the same IRRs. And if you don’t have the cost of capital advantage, you’re ultimately going to run up leverage – and leverage if the market turns it ultimately what might bite you. I think we and Blackstone share best-in-class financing with the banks we have multi…
…there are on higher LTVs than we do, routinely borrowing 80% against their positions and we don’t typically. So, I think, let us talk about that for a second, because it’s really important. If you borrow 80%, probably you did 25% you want to have significant portion or equity right, I think all of us.
All of us.
5% drop would be 25%. So if you borrow 60% or 70% or something like that, you’re obviously not going to see the diminishing the equity book. Like all things there is no reward without commensurate risk. And they look the same, but they’re not the same and yet we trade at higher dividend yield. So co-figure it’s completely math backward.
But the market will eventually figured it out, plus our equity book it is rock solid and we own some salivating properties, our medical office and our multis there, long-term housing. Rina mentioned it, I think the first deal we did in the multi space at a 17-year fixed debt in place this one has 11 years fixed debt. We could float it increase our earning, stupid move, obviously as you expect rates just higher.
So we’ve taken the long-term approach consistent with stable and consisting growing revenue stream and we have kind of windfalls in the multi space, Jeff mentioned this but we’re under like 2% growth in rents because that’s what we figured inflation cost of living would be and let’s say in the Orlando sub market and they just increased rents 4%, plus everything in the town up 4%, so which is better than the actual market and apartment closed at the moment. And we remain totally full. And there’s no issue of affordability since were affordable.
So we’re really excited about and we bought those assets, as Jeff mentioned, the Board and management on the fortune of charity we bought them thinking we’d like to own them ourselves for ever and we could sell them, but what we do with and why? They are going to a short duration loan and it doesn’t seem like the smart move for shareholders. So we’re frustrated by that, we don’t want to increase the equity book of the company beyond maybe 30% of our asset base that’s kind of a guideline we’ve given ourselves. We could take it up a little higher, but and we really don’t on an equity basis feel like we should do that much beyond that.
And Jade I’ll add that, smaller funds can’t do the larger loans and really the larger more complex loans are where we differentiate ourselves. And we add value and we’re able to earn a more accretive IRR for ourselves. And the other thing that I think smaller funds are doing you’re seeing a lot more of it happen like there are referring to the CLO market and today CMBS spreads are tight and CLO spreads are tight and you can get AAAs off pretty good and you can fool yourself into thinking that you can get a LIBOR plus 150, LIBOR plus 160 base rate on your overall financing with seniors inside of LIBOR plus 100.
The problem in, we underwrite floating rate transitional asset. We don’t know exactly the day where we’re getting it back. But more importantly over a year if you build up a book of three-year assets that may pay you back in two. You can very quickly by the time you securitize be getting some loans that repay you and when they repay you the sequential nature of pay down hits the AAA first and that financing spread you fool yourself into thinking you’re borrowing at one 160, all of them borrowing at LIBOR plus 220 in a year.
And in the IRR that you thought you were running a 12 is a 7 or an 8. So in addition to having to show the world the assets, the loans that we have when we do a CLO, you giving the world a list, you’re giving them basically the phone numbers of the borrowers and who to call to refinance you out of your loans, we don’t think that’s really smart. And we don’t think that they will ultimately achieve the financing levels that they will achieve. So we’ll see over time how it works out, but we have term financing that where we’re pretty happy with.
No, I think unsecured debt issuance strategy has been very smart on your part. Can you give any color on the large loan that slipped in the quarter $375 million. And then also the power deal you did which sounded pretty interesting to me and something I haven’t seen you do before?
Yes. Sure I’ll start. The first was a $375 million across the large portfolio that just took – we probably have that in-house for nine months so it’s a great portfolio, we’re very happy with it, but ultimately we thought it would close before the end of March and it slipped to the first week in April, that happened, we’re not – we’re giving you a number that we’re very conservative we know we can make this quarter and…
You gave him the number, did you?
No, we just said it will be last quarter which is less.
And what kind of loan was that? What kind of portfolio was that?
It was crossed hotel portfolio.
Okay. And the power deal?
So power deal is interesting story, because the power deal like just like Cabela’s which I think I was asked about at a conference, Cabela’s may seem like a retailer to you, but to me it seem like a bank since 80% of their earnings came from a bank. And we’ve got these 25 year leases and we thought we were running a credit to Y.
So Jeff and the team suggested to me they go out and flip a couple of the building to prove to the market that we bought this really well. And that’s exactly what they’ve executed and you’ll see strategy continue to execute in the second quarter probably I don’t think we’re going to the third, is it second to second?
Second and third.
Second and third. So and we’re just increasing our ROE on that book and very happy with it. And if people don’t – this is a merger of Cabela’s and Bass Pro Shop. And they modeled like $300 million in EBITDA and savings, merging the two business together. We don’t actually care and had business actually takes place in our stores. We just need Cabela’s and Bass Pro Shop to stay alive.
And so as they shift to online which they’re dominant and they’re the player in the country. I don’t think it can happen by the way I believe physical retail will be fine. Considering they sell things like or they did sell things like on things like they don’t travel well across straight lines and don’t work on online. But anyway I think ago we thought that was a great credit.
So to answer your question on a power similar story misprice credit. There was a – it was actually originated by our energy team that was looking to buy these power plants. And the financing that they told me they were getting was so stupid, I’m involved in that. And there was a take contract, a power contract in place for the life of the loan. They gave us from a credit that’s buying all the power from the plant, so it’s a fully amortizing loan I believe.
Both fully amortizing over seven years, there’s five different triple BBB rated credits who are guarantee – who are on the hook to make the payment. So it’s a BBB credit loan seeing in a couple digit.
…double-digit return, it was a – so we’ll do a lot more like that and I think we always are looking for other business lines to lend against as long as REIT qualified other assets in the power sector.
But if we didn’t have an energy group it’s not something we would have seen or been able to underwrite.
Right.
Okay thanks very much.
Yes.
We’ll take our next question from Stephen Laws with Raymond James.
Hi, good morning. To follow-up a little bit on the competition side. Can you talk about what you’re seeing with regards to competition on senior loans, which more public players, more public competitors there versus the mezzanine opportunities as well as. Is there a point I think you guys have a lower cost of capital than most. But is there some point where spread compression stops, because people just aren’t able to reach or kind of their targeted required return on capital. And how close are we to that point?
I think we feel, couple things there that are interesting about the market. One, it’s kind of interesting and we’re the large owner of apartments in United States. I can tell you that the entire movement in short LIBOR which is significant off the floor has not been reflected in cap rates at the moment, it’s shocking.
And the same is probably true if you’ve been following the property merge in the United States volume is down, people aren’t selling. And so there’s fewer transactions and people like dogs in heat trying to find properties to buy so cap rates are very sticky at the moment, probably in all the asset classes with the weakest obviously being retail and hotel.
Hotel have had a kind of anemic performance here which is kind of interesting, I’m not sure having had spent my youth in the hotel business, I’m not sure exactly what it’s telling you about the U.S. economy. But I would say that we are a whole loan lender so we will write a whole loan and then we will sell off the A note or put it on one of our – or chop it up and stick the senior on one our lines.
And I think you’ve seen about half of the increase in LIBOR absorbed by spread compression. We think it’s kind of over, it looks like most lenders were targeting nominal rates they want to earn a four they want to earn 4.5. So as a base rates went up, as LIBOR went up spreads came down, because they were all happy at the 4, 4.5 number whatever they needed at 5.
So we think I mean the markets have been rallying, it’s been amazing and credit spreads and like CMBS are still way wide of where they were in 2006, 2007, and 2008 and the AAA as you’re talking four times. So, maybe real-estate credits continue to come in, I don’t know, but it’s all good for us and we’ll benefit from that as – because we are I mean among many of the banks whether, either the first or second largest borrower in real-estate, don’t forget we have the $60 billion asset base borrowing from these people.
So we’re not concerned about – it’s actually we didn’t have the unsecured waiver and we didn’t have the scale of the company. I would be more worried, but the access to capital that we have, both secured and unsecured makes us credibly competitive in the market place and we keep asking ourselves whether we should – we could get more aggressive and get more yield, which will be widening your LTVs and this is the same LTV that we had nine years ago, we are not in the same point in the cycle if anyone didn’t notice.
In the 12 optimized return at this point of the cycle it just seems outrageous. We could lower that, we could go to a 10, alright, or 9.5 and what we will be doing is we are writing a less transitional loan at a lower spread, but we would be hard-pressed to sustain the dividend at this level, we did that. And it wouldn’t turnover you wouldn’t see a $1.6 billion of debt repaid, because they are not transitional assets. We have to probably lever the book more, significantly more to achieve decent yields, but it is the strategy easier by the way than what we do, which really is as Jeff keeps saying credit service, I mean we underwrite these assets. And but right now we are content because it’s working.
I guess I’d add to that, I think there is significant room for our warehouse lines to come in. If I look at where we cap out and where banks come in, in the low 200s is where the banks will write a whole loan on their own and that historically hasn’t fit us so well. I would compare that at 65 LTV where banks might write that loan versus lending to us at 50% LTV, at LIBOR plus 175 which is above the average of our warehouse lines today.
The ROE for the bank, after regulatory capital charges is significantly better lending to us on a crossed portfolio with recourse bank to us at LIBOR plus 175 then it is making a whole loan at 65% LTV at 2.25. So I think there is room for the bank to move not only from LIBOR plus 175 to LIBOR plus 150, but I think LIBOR plus 100. I look at that asset 50 LTV with recourse to us which make it feel like 40 LTV on a crossed portfolio the assets that they have their choice and can – it is a credit event, it can make a credit call on the warehouse borrower, this is a quadruple A asset and I would compare it bank balance sheets to credit cards, auto, student loans things that trade LIBOR plus 10 to 50 and the fact they were still playing LIBOR plus 160, 170 is too high in my mind. So I think there is significant room for the bank to lower the cost of their warehouse lines to us and that will allow us to absorb spread tightening in a pretty significant way.
Great, and to touch base on the international bit for a second, it looks like sequentially the loan portfolio international moved from 12% to 9%, I think originations for the quarter were 5, we’ve seen a couple of competitors actually increase their activity mainly in Europe. Is there something specific that has caused you guys to pullback there or is it just a coincidental function of what came through and what prepaid here lately your – or maybe any comments on what you’re seeing in Europe?
Yes, our couple big long we paid, Center Point Shopping Center I guess in Portugal. Portugal, so there you don’t worry about any more, I think the question is about our retail exposure. If we paid and I think they pulled money out of the deal. The markets, again most of those are European asset and that in places like Germany it’s free, you can write 20 year paper at 80% LTV is a 2.5%. So there is no opportunity for us really in Germany maybe on a construction deal, we obviously haven’t looked at.
And the same way I would say is the Nordics, so you try to just find your spots like we do here. We have a team of people, I think we have eight or nine people in London looking for opportunities and they say they have – they went over a big book, it just hasn’t solidified into –
We have one in the pipeline for the coming quarter and we think probably one in the following quarter, decent sized loans and we’ll continue to [Multiple Speakers].
– go ahead and we want to grow per share and they know that, so.
Okay so it’s just a pipeline versus repayment situation, there is nothing specific to call or wither pull back over there.
Yes, yes.
Great, okay, thanks a lot of taking my question.
We’ll take our next question from Ken Bruce with Bank of America Merrill Lynch.
Thanks and good morning. Not sure where do I want to go. The frustration you have with the valuation of your stock is quite palpable. And interested in your thoughts as to what the market needs to see in order to rerate this stock high, I don’t if you pay attention to any of the transcripts from other call, I have been asking everybody this just try to get a sense as to what the operators think needs to occur in the markets for the stocks to be looked at more either on an intrinsic value basis or maybe even relative, in your case you’ve got a pretty significant discount to what we think it’s worth and I’m interested in, Barry, your thoughts in particular just because you’ve been operating in these markets in various forms for a long time.
I’m almost speechless, this is never the case. Just to get, I really don’t, I never would have thought at this point where the scale of company the biggest in the sector, the diversity, safety, the 62% LTVs, that we wouldn’t trade at 6, so they are not a 9. We all know many measures funded with a 2 and 20 structure that would be delighted to have earned over the last five years. And I don’t – we’ve talked about things like spinning off the equity book for example and the result in – if you think almost you probably know the equity REIT dividend yield today are probably 4.5 maybe 4.75.
So take that dividend yield on this asset base and one thing we get from that is you wouldn’t look at book anymore. I think one of the problems of mortgage REIT space is, and that you are looking and saying multiple book. Because it is true, it’s going to have portion of our business, you know we never make another loan that’s the number, that plus the underappreciated put the fair market value of our equity asset will be the liquidation value of the company.
But there aren’t growing concerns and I think if we can drop the collar of being a 1.2 times book whatever we trade at. And that comes from building a machine, building our company that’s diversified that you give us $1 and we turn it to $1.20 repeatedly in every market and that’s what we are trying to do, that’s why we are not trying to build just the mortgage book, we are trying to build the company in different verticals and different – and we talk about different cylinders actually if we can build any of these businesses to the scale of our loan book we’d be happy as long as the smart deployment of shareholder capital and we can tolerate the risk.
We look at lot of the different things, we just – it’s hard because you take for example the resi space the and only spacing some of the companies in that space and we’ve been taking on massive leverage on to our balance sheet and we would freak everyone out. We got a call the other day, we had a shareholder meeting and one of the people got all confused about our DIEs. I mean, that’s where the, that where the basically the service of the tuck and we consolidate their debt, and we freak people out. And to the average person, it’s not that sophisticated I mean we really need to get 30%, 40%, 50% of our stock held by retail account.
Morgan Stanley, is being or Smith Barney, we’ve got to move it out of institutions and people have to just use it, I don’t know, I told you that there’ll be no change in our stock price after they took the tax rate of our dividend from 37 whatever it is, 37, 38 to 29, 20, 25 I mean that’s unbelievable, but obviously most people don’t seem to care, but I’m actually questioned my mother yesterday, she was like, do I qualify for the leverage act? I think yes mom, she was all good. So I wish there were more moms, alright.
They, I don’t understand it, we did – our yields just went up 30% for an investor or our after tax yields and we got $0.30 in our stock, and nobody could have known it, because none of us knew it, none of you knew it, we didn’t know that was going to happen to employ the dividends.
And so it’s a – we’re patient, we’re not going anywhere so we’re okay I mean I’m just ashamed that we can’t issue equity to grow our company at the pace I think we’d improve our business, I think we’d be a better company if we were $20 billion company equity based on a $5.5 billion equity base, we’d just be better. We are more competitive, we’d be investment grade, we’d have a real machine, but this dividend is a bit of a – what’s definitely a problem under our neck, you know it’s like issuing equity to pay nine is not very exciting. So…
So we can always yield money.
Because I think of a while all of these stocks had the problem that we were just issuing equity to grow and billing off just wait for the next equity offering. We haven’t issued in a long time other than this down REIT deal we just did. And we’d like to have a reason to borrow, but we have to make sure to agree to the enterprise and to borrower like grow to issue equity, but you know it’s not, and we can create liquidity so we give you our cash reserves kind of meaningless to maybe, because we could sell three loans and create equity, everything in our company is based on the liquid, including out equity assets, we could flip our apartments in about three seconds in this climate.
So, we just got to keep moving around, our ROE is pretty good better than the most banks and with much less leverage, but they don’t have to payout a 9, so it’s interesting take someone like Ice Star, Ice Star pays no dividend at all and trades in a little discount right now of the book, but it’s interesting I mean we just – the sector hasn’t really found the proper reading probably, the larger companies in the sector I would say, but maybe that’ll happen I think grow our hair first.
Okay, well, we have been waiting for a long time, so I’m not sure [Multiple Speakers] –
That other way to go, that’s a long time.
You and I both, but we won’t get into that conversation. The – I guess the, you are talking about the dividend and obviously it’s a high on an absolute basis. There was a comment made and I just maybe you can just kind of help me think through this in terms of shielding more of the tax learnings in order to be able to in a sense reduce the dividend. I’m not sure if there is an active thought process around literally taking the dividend yield down via a smaller payout or if you’re just talking about retaining more capital as you grow earnings over time by being able to shield that. Could you just help us think through that?
Yes, I mean that is a precautionary move on our part, right, because these companies get into trouble when they have no shelter at all, they’ve got every dollar and they need the money for in a downturn, right so this allows us to another way we’re protecting ourselves in a downturn. So if we had to we could hold some cash right, if we had to in a down market. And let’s talk about what we might do, because it happened in another company in the cycle, last cycle. You might pay that less cash and buyback your bond which are probably trading poorly.
So it’s all about you know it doesn’t matter on the surface, not effecting us at all, we are not having touched our dividends, but it is a way of thinking about, okay there is a recession should it pertain, nobody can expect it. We go to war somewhere, and we need to be able to have access cash with probably some great opportunities, we can’t do it if I were to pay out every dollar or every cent, I think we have. So it’s really for the rainy day and it’s not raining right now in your business that’s the way I look at it.
Okay, I understand last question for me is the – there has been a significant amount of activity across the mortgage REIT universe in terms of consolidation, I don’t know if you all are in a position to talk about how you can review the overall landscape if there is options or opportunities that you might think are interesting to take advantage of in a sense some of the even more cheaply valued stocks that are the in and around the sector to beef up your own capabilities, whether it be on residential or otherwise?
So of course we look at everything and of course we looked at some of these companies had gone private and one of them went private 105% of book which is crazy. We mentioned already that they have significant leverage which is going to confuse everybody. Typically they have this, they may have a mismatch book barring short lending and longer durations which is something I hate. It’s – we’ve even used – thought about we have looked hard and since these things un – un – before they get involved in a deal they are trading at $0.80 to $1, we worry that it would hurt us, I believe pay – they are not going to sell us the company at $0.90 and a $1 we already tried that, they wouldn’t do it, they’d just liquid themselves. So, if we bought them at par and then we reverted back to where they were trading before it would pull our sack [ph] down, now we issued 9% stock to get there.
So we like – we think it’s interesting, it’s another business obviously it’s wholly related to us, but we haven’t yet figured a way to do it in that space. On the commercial side, we’d love to put our brother in law out of business, anybody wants to merger those just give one the banks on the phone a call and we’ll talk to them. That’s a smart move, consolidating the other commercial mortgage REITs, but for the most part you’ve seen a couple be born, not go away, relatively small entities. And the other thing I’d say I would say, we do our lending here and we don’t have certain other buckets to sell. So this is where we are focused and I hope we can grow the book and grow the company.
When you think about the agency model and I agree with Barry’s comments so hardly. The only reason, the biggest reason why we thought that that could be interesting was one if you could do a capital raise below book and it subsequently market showing that you can’t, but more importantly is the cash management strategy. We run this large real-estate and mortgage finance company and you would think that interest rates and credit would keep us up at night.
What we – interest rates were mostly floating and on the credit side we do enough work on the front end and 62% LTV, but it doesn’t really keep us awake and what keeps me awake at night and most of the management team is, when we get cash back and how quickly can we redeploy it? Are we making sure that we’re not having any negative drag on the company and that’s difficult and it’s one of the reasons we avoid these super large loans that some of peers will do.
One of the way to offset that would be to have a small bucket of something like agency mortgage securities which would allow you to have a very liquid asset that when you get a dollar in you can put out in the most liquid market in the world, the agent – $6 trillion agency mortgage market and when you need a $1 you can sell a $1 work of asset in a $6 trillion very liquid market so as the cash management strategy is cute it’s probably not a business that we would scale as Barry said for multiple reasons including leverage and making a yield curve that I don’t think is what our shareholders are wanting to do.
[Operator Instructions] We’ll now take our next question from Tim Hayes with B. Riley FBR.
Hey everyone, thanks for taking my question. Can you just give us a sense of the timing of when repayments were collected in the quarter and if that had a material impact on earnings in the quarter?
Hey Tim, the repayments were actually back ended in the quarter, so if you looked at the interest income was sort of flat to last quarter despite the $577 million decline in the balance. The repayment came in in the last 30 days of the quarter.
Yes, you might be surprised with this and we talked about it with the Board a great length, we spent a full day every quarter going over our entire book because we have our own internal asset management, not something we sub out like some people do and one of the big focuses that we have when we do that is to make sure that we are – that the most senior executives of the firm are looking at every loan and deciding when do we think as a – if we were an owner which we in many cases, when would we refinance this? What’s the market for refinancing this and try to get in front of when we think refinancings will happen.
In addition to being in constant contact with the borrowers, having repeat borrowers, we actually have a very good handle on and historically we’ve been almost spot-on every quarter what we’re going to get back. We don’t tend to get surprised very often and that’s an extensive part of what we do both in time and bodies, but it’s important part of what we do.
So Tim I guess just one other data point, if you look at the weighted average balance of the loan book even though the balance sheet showed a [$577 million] decline on a weighted average basis it was [falling by] $140 million, if that helps.
And we’ll take our next question from Ben Zucker with BTIG.
Good morning and thanks for squeezing me in here at the end. Building with the question on consolidation and the space, I had a little bit more specific of a focus, having touched about the GSE origination in the servicing business, just because when I think about your platform it really seems like the only hole right now and I don’t need to tell you how hot that market has been lately, so is there a specific reason you guys maybe haven’t stepped in there or something you don’t like or is it just hard to find someone?
You are on a really soar topic. We –
Can I start and then you can fill up?
Yes.
It does feel a little bit late cycle, you have this $45 billion agency cash that may or may not go up, but I would bet that they don’t and you have some risk around that and the cost of getting the brokers who get other relationships to bring these deals in, it’s really expensive you have to sign fairly long contracts with guys and lock yourself into a very high cost business model that you hope the government doesn’t change their mind and turn things around.
You are also heading into a slightly high interest rate environment, so volumes will be a little bit lower, purchase volumes are probably going to out a bit, but it’s got very expensive, the brokers in this business make more money than almost anything else that we see in real-estate finance and that can’t continue forever, it doesn’t tent to continue forever in buying a whole bunch of them late cycle doesn’t seem to me to be as smart as they would be. It would be great business to be in if you could do it in the right way, but jumping a late cycle might be difficult.
We have been dead wrong, we though, we are worried that the agencies are restructured and instead they’ve been giving more, more capacity. So obviously there are companies that were $14 a share that are $40 or $50 right now. The issue is again they are not cheap now and there is and each one is talking about restructuring with GSEs and they keep talking about it, so you are taking along, and that could be sort of a fatal flaw stupid deal, that the scale that some of these companies are repaid too much under the business and bought.
We are working on – we are looking at the sector, but we haven’t executed there, I’ll give us a D on that, because A, a lot of things and not having working on that. We probably overly thought it was too risky and it turned out to be not and there was a moment in time we could have entered that business in the hindsight. Again you have to look forward now and you tell, I mean in the predictable safe and conservative that would – that’s a – those are big bets right now if you bought a big buyer in the space. It just makes me nervous, like our business right now.
Any more questions operator?
There are no further questions at this time and that concludes today’s question-and-answer session. Mr. Sternlicht, at this time I will turn the conference back to you for any additional or closing remarks.
Thank you to everyone, have a warm spring and we’ll speak to you in the hot summer, thank you.
That concludes today’s presentation, thank you for your participation, you may now disconnect.