Starwood Property Trust, Inc. — Q2 2012 Form 10-Q
Reporting period: Three and six months ended June 30, 2012. The company is an externally managed REIT focused on commercial real estate debt and related investments, with additional investments in CMBS, RMBS and residential real estate-owned properties. Financial figures below are in U.S. dollars; amounts are rounded to millions unless otherwise stated.
Financial performance and position
| Metric | Q2 2012 / June 30, 2012 | Comparable period / prior year-end |
|---|---|---|
| Net interest margin | $58.4 million for Q2; $124.3 million for the first half | $41.1 million and $73.3 million, respectively, in 2011 |
| Net income attributable to Starwood Property Trust | $44.5 million for Q2; $94.6 million for the first half | $32.4 million and $63.9 million, respectively, in 2011 |
| Diluted EPS | $0.40 for Q2; $0.92 for the first half | $0.39 and $0.82, respectively, in 2011 |
| Core Earnings, non-GAAP | $50.0 million, or $0.45 per diluted share, for Q2; $105.0 million, or $1.02 per diluted share, for the first half | $36.1 million, or $0.43 per diluted share, and $67.5 million, or $0.86 per diluted share, in 2011 |
| Cash and cash equivalents | $192.8 million | $114.0 million at December 31, 2011 |
| Total assets / total equity | $3,461.5 million / $2,249.1 million | $2,997.4 million / $1,765.1 million at December 31, 2011 |
| Secured financing agreements | $1,065.4 million; weighted-average cost 3.6%, including interest-rate hedges | $1,103.5 million at December 31, 2011 |
| Common dividend declared | $0.44 per share for Q2; $0.88 per share for the first half | $0.44 and $0.86, respectively, in 2011 |
The filing does not present a conventional revenue subtotal; interest income from loans and mortgage-backed securities was $68.9 million in Q2 and $146.6 million in the first half of 2012. Interest expense was $10.5 million and $22.3 million, respectively. Total expenses were $16.8 million for Q2 and $35.9 million for the first half.
For the six months ended June 30, 2012, operating activities provided $190.7 million, investing activities used $443.8 million, and financing activities provided $331.9 million. Cash increased by $78.8 million. The company reported $607.3 million of aggregate undrawn capacity under its financing facilities, including $212.1 million approved but undrawn. Management stated it believed available liquidity and access to additional liquidity were sufficient for obligations over at least the next 12 months.
Loans held for investment were $2,170.5 million, while CMBS and RMBS at fair value were $675.0 million and $233.5 million, respectively. The company reported no allowance for loan losses at June 30, 2012. Total contractual obligations disclosed were $1,300.8 million, including $116.1 million of future loan funding commitments.
Material changes versus the prior comparable period
- Q2 net income attributable to the company increased to $44.5 million from $32.4 million; first-half income rose to $94.6 million from $63.9 million. Net interest margin increased by $17.3 million for Q2 and $51.0 million for the first half.
- Management attributed higher interest income primarily to increased investment activity and deployment of capital. The first-half comparison also benefited from a prepayment of a GBP-denominated loan that generated approximately $13.1 million of accelerated discount accretion, described as non-recurring.
- Interest expense rose by $3.4 million for Q2 and $7.9 million for the first half, partly reflecting financing facilities entered into since June 2011. First-half expenses also increased, including management fees, incentive fees and investment-pursuit costs.
- Available-for-sale MBS grew to $908.5 million from $341.7 million at year-end 2011, driven by purchases and a conversion of a hotel-related loan position into securities. Investments in loans declined from $2,268.6 million to $2,170.5 million.
- The company issued 23.0 million common shares in April 2012, raising approximately $456.7 million net. The June 2012 ATM agreement permits up to $250 million of common stock sales; no shares had been sold under it through August 6, 2012.
- Q2 diluted EPS was $0.40, unchanged from Q2 2011, while the declared quarterly dividend was $0.44 per share. Management’s non-GAAP Core Earnings were $0.45 per diluted share in Q2; Core Earnings is not GAAP cash flow or a measure of liquidity.
Outlook, risks and unusual items
- No specific earnings or investment guidance was provided. Management described its objective as generating long-term risk-adjusted returns, primarily through dividends, and said it intended to continue regular quarterly distributions, subject to board authorization, cash availability and debt service.
- The board declared a $0.44-per-share dividend for Q3 2012, payable October 15, 2012. The filing notes that REIT qualification generally requires distribution of at least 90% of taxable income; cash distributions may require asset sales or borrowing if available cash is insufficient.
- Portfolio concentration is material: hospitality collateral represented approximately 48.2% of the investment portfolio at June 30, up from 39.9% at year-end 2011. A $578.5 million unrated senior hotel-sector security position represented 16.7% of total assets; management estimated its collateral loan-to-value ratio at 39%–44%. RMBS included substantial lower-rated exposure, with 54.3% rated CCC and 5.7% rated D.
- The company recorded RMBS other-than-temporary impairment charges of $1.4 million in Q2 and $2.1 million in the first half. Management emphasized that projected cash flows and impairment conclusions involve significant judgment. Despite this, it reported no loan-loss allowance and no individually risk-rated “5” loans at June 30.
- Key risks include borrower defaults and collateral-value declines; interest-rate, spread, prepayment and extension risks; foreign-exchange movements; and refinancing, liquidity and margin-call risk under secured financing arrangements. Derivative agreements include default provisions and a possible trigger if debt-to-assets exceeds 75%. Net derivative liabilities were $12.5 million; $6.9 million of collateral had been received.
- Financing maturities and collateral requirements warrant attention. The secured-financing repayment schedule included $490.8 million in 2013, assuming no defaults or extensions. Repurchase counterparties may determine collateral values and require margin payments. A new $250 million revolving facility entered into after quarter-end is full recourse and requires additional unencumbered collateral.
- Other notable items: the company acquired 252 residential REO properties for about $27.4 million, most vacant at acquisition; disclosed related-party hotel investments and an externally managed structure; and reported $116.1 million of future funding commitments on 14 loans. No material legal proceedings or defaults were reported, and management reported no material change in risk factors from its prior quarterly filing.
Important facts for investors to verify
- How much of reported earnings and Core Earnings reflects recurring interest income versus the $13.1 million accelerated discount accretion and other realized, unrealized or hedge-related items.
- The credit quality, valuation assumptions and concentration risk of the large hotel-related security position and the predominantly lower-rated RMBS portfolio.
- The terms, maturity profile, collateral requirements, margin-call exposure and available borrowing capacity of secured facilities, including the post-quarter $250 million revolving facility.
- The sustainability of the $0.44 quarterly dividend relative to taxable income, GAAP earnings, Core Earnings, cash generation and funding obligations.
- Related-party transactions, manager fees and incentive-fee calculations, including the company’s revised non-GAAP Core Earnings adjustments.
- Execution and funding of the $116.1 million loan commitments and the operating or sale outcomes for recently acquired, mostly vacant residential REO properties.