Business context and reporting period
Starwood Property Trust, Inc. (NYSE: STWD) filed this unaudited Form 10-Q for the quarter ended June 30, 2019. The externally managed REIT originates, acquires, finances and manages real estate and infrastructure debt, property investments, and real estate servicing and investment businesses. Its four reportable segments are commercial and residential lending, infrastructure lending, property, and investing and servicing.
The infrastructure lending business, acquired in September 2018, contributes to 2019 results but has no comparable 2018 segment results. Consolidated GAAP statements include large securitization VIE balances; those VIE assets are restricted to meeting the related VIE obligations and generally have no recourse to the Company.
Financial performance and position
Amounts below are in U.S. dollars; financial statement amounts are in millions unless otherwise noted.
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Total revenue | $311.2 | $269.6 | $621.7 | $530.1 |
| Net income attributable to STWD | $127.0 | $109.2 | $197.4 | $209.2 |
| Diluted EPS | $0.45 | $0.40 | $0.70 | $0.77 |
| Core Earnings per diluted share, non-GAAP | $0.52 | $0.54 | $0.81 | $1.12 |
- Q2 revenue increased 15.4% year over year and net income attributable to STWD increased 16.3%; diluted EPS rose from $0.40 to $0.45. Six-month revenue rose 17.3%, while attributable net income declined 5.6% and diluted EPS declined from $0.77 to $0.70.
- Core Earnings are a company-defined non-GAAP measure and exclude, among other items, certain noncash and unrealized gains and losses. The Company cautions that Core Earnings are not cash flow, liquidity, or funds available for distributions.
- Q2 commercial and residential lending segment net interest income was $128.9 million, up from $122.4 million. Its overall weighted-average unlevered yield declined to 7.4% from 7.6%; weighted-average secured borrowing cost was 4.5% versus 4.4%.
- At June 30, total assets were $72.95 billion, including $57.67 billion of VIE assets; total liabilities were $68.04 billion, including $56.45 billion of VIE liabilities. Total equity was $4.90 billion.
- Cash and cash equivalents were $334.3 million and restricted cash was $181.9 million. Net loans were $10.35 billion, including $8.76 billion held for investment and $1.59 billion held for sale. The loan-loss allowance was $33.3 million.
- Secured financing agreements, net, were $9.28 billion and unsecured senior notes, net, were $1.92 billion. The remaining $78.0 million principal of 2019 convertible notes was settled during the first half through 3.6 million shares and $12.0 million cash.
- For the six months, net cash used in operating activities was $482.9 million; investing activities provided $200.8 million and financing activities provided $311.0 million. Cash, cash equivalents and restricted cash increased $28.9 million to $516.2 million. Operating cash use reflected, among other items, net originations and purchases of loans held for sale.
Material changes versus comparable periods
- Q2 revenue growth was driven chiefly by higher loan and investment-securities interest income, reflecting increased average balances and LIBOR; spread compression partly offset the benefit. Interest expense also rose substantially.
- Q2 loan-loss provision fell to $2.5 million from $25.3 million in 2018, when impairment charges on commercial loans were higher.
- Six-month results included the newly acquired infrastructure lending segment, with $54.7 million of revenue and $5.8 million of Core Earnings.
- Property-segment six-month results were pressured by a $45.2 million fair-value decline in the Retail Fund investment, derivative movements, and the absence of prior-year property-sale gains. The investing and servicing segment also had lower servicing fees.
- Four properties were obtained through foreclosure during the first half, including two grocery distribution facilities. At June 30, certain department-store, residential and infrastructure loans were 90 days or more past due and on non-accrual status.
Outlook, risks and unusual items
- Management stated it believed current liquidity and access to additional liquidity were sufficient to meet financial obligations for at least the next 12 months. The filing provides no earnings or revenue guidance.
- The Board declared a third-quarter dividend of $0.48 per share, payable October 15, 2019. The filing notes dividends remain subject to operating and debt-service needs and Board authorization.
- At June 30, commercial lending had $2.2 billion of future loan-funding commitments, of which management expected to fund $2.0 billion. Infrastructure lending commitments totaled $267.5 million. Funding is subject to contractual conditions.
- Management identified risks including borrower defaults, collateral impairment, interest-rate and credit-spread changes, financing maturities and asset-liability timing mismatches, liquidity and funding costs, and integration of the acquired infrastructure business. Most loans held for investment were variable rate: approximately 94.8% carried LIBOR plus a weighted-average spread of 4.2%.
- Four CDO structures in the investing and servicing segment were in default or imminent default; none was consolidated. The filing says maximum loss exposure for unconsolidated securitization VIEs was $44.7 million at fair value and that the Company had not provided financial support to securitization VIEs.
- The Company reported compliance with secured-financing covenants, effective disclosure controls, and no material change in internal control. It reported no material pending legal proceedings and no material changes to previously disclosed risk factors.
- Subsequent events included July credit and repurchase facilities, a July securitization of residential loans with $546.0 million principal, and the August 7 declaration of the $0.48 third-quarter dividend.
Important facts for investors to verify
- Review the drivers and sustainability of GAAP and Core Earnings, particularly noncash fair-value movements and the Retail Fund exposure.
- Assess credit quality, non-accrual and impaired loans, foreclosure outcomes, and the adequacy of the $33.3 million loan-loss allowance; the filing says adoption of the expected-credit-loss standard was expected to increase allowances, but the amount was still under assessment.
- Verify liquidity against debt maturities, collateral-related repayment requirements, the near-term funding commitments, and the Company’s reliance on secured financing.
- Examine the VIE presentation and nonrecourse restrictions when interpreting reported assets, liabilities, revenue, and cash flows.
- Evaluate the dividend against taxable income, cash generation, leverage and funding needs; Core Earnings should not be treated as cash available for dividends.