Starwood Property Trust, Inc. — Q2 2015 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2015. Financial amounts below are in U.S. dollars; “million” and “billion” are abbreviated as m and bn.
Business context
Starwood Property Trust is an externally managed REIT focused on commercial real estate lending, investing and servicing, and property ownership in the U.S. and Europe. In Q2, it established a Property Segment after acquiring the Ireland Portfolio. Its consolidated statements include large securitization VIE balances; those VIE assets are restricted to settling the VIEs’ obligations, which are nonrecourse to the Company. VIE consolidation can materially affect reported revenue and other income.
Key financial metrics
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Total revenue | $178.7m | $170.8m | $357.5m | $342.7m |
| Income from continuing operations | $117.6m | $120.4m | $238.4m | $242.8m |
| Net income attributable to Starwood Property Trust | $117.1m | $117.9m | $237.5m | $238.5m |
| Diluted EPS | $0.49 | $0.52 | $1.02 | $1.11 |
| Dividends declared per common share | $0.48 | $0.48 | $0.96 | $0.96 |
- For the six months, operating cash flow was $295.0m, investing cash outflow was $119.5m, and financing cash inflow was $18.3m. Cash and cash equivalents rose $193.8m to $446.5m; restricted cash was a further $26.8m.
- At June 30, total assets were $101.6bn and total liabilities $97.4bn, including $92.7bn of VIE assets and $92.0bn of VIE liabilities. Total equity was $4.2bn.
- Loans held-for-investment, net, were $5.9bn; loans held-for-sale were $367.4m. Net loans across the reported loan categories totaled $6.4bn. Investment securities were $877.2m after VIE eliminations; properties, net, were $397.0m.
- Secured financing agreements, net, were $3.58bn; convertible senior notes, net, were $1.32bn. Secured financing increased from $3.14bn at year-end 2014, while convertible notes declined from $1.42bn, partly due to repurchases.
- For Q2, Lending Segment net interest income was $110.8m, up from $102.5m. Its weighted-average unlevered yield was 7.9%, versus 8.3% a year earlier; weighted-average secured borrowing cost was 3.1%, versus 3.6%.
- Management’s non-GAAP Core Earnings were $0.53 per diluted share in Q2, versus $0.52 a year earlier, and $1.08 for the first half, versus $1.13. Core Earnings are management-defined and are not GAAP net income or a measure of cash available for distributions.
Material changes versus prior periods
- Q2 revenue increased 4.6% year over year, but income attributable to the Company declined slightly and diluted EPS fell from $0.52 to $0.49. Higher loan interest income was partly offset by increased interest expense and other costs.
- For the first half, revenue increased $14.8m, while income attributable to the Company declined $1.0m and diluted EPS decreased from $1.11 to $1.02. Interest expense rose to $100.3m from $75.5m.
- The Lending Segment’s loan investments grew approximately $1.1bn year over year. Management cited increased lender competition and tighter credit spreads as factors in the lower unlevered yield.
- The Ireland Portfolio acquisition added 12 fully occupied Dublin properties, approximately 520,000 square feet, for an aggregate cash purchase price of $106.7m. The portfolio was financed with a five-year euro mortgage facility; €220.5m had been drawn by June 30. The Company recorded $3.5m of acquisition-period revenue and a $2.7m net loss, including approximately $3.2m of acquisition-related costs.
- The Company issued 13.8m common shares for gross proceeds of $326.1m. It also repurchased $118.6m principal amount of 2019 convertible notes for $136.3m during the first half, recognizing a $5.9m extinguishment loss, and repurchased 400,000 common shares for $8.8m in Q2.
Outlook, risks, contingencies and unusual items
- The filing provides no quantitative full-year earnings or revenue guidance. Management said it believed available liquidity and access to additional liquidity were sufficient for at least the next 12 months.
- The board declared a Q3 2015 dividend of $0.48 per share, payable October 15, 2015. Management cautioned that dividends depend on operating and debt-service needs and board authorization; insufficient distributable cash could require asset sales, borrowing, or other distribution forms.
- Management identified borrower defaults, collateral-value impairment, availability of investment opportunities, interest-rate and credit-spread movements, funding costs and liquidity, and mismatches between asset repayments and financing maturities as key risks. The filing warns that forward-looking statements are uncertain and undertakes no general obligation to update them.
- At June 30, the Company had $2.0bn of future loan funding commitments on 57 loans and expected to fund $1.7bn, primarily for construction, capital improvements and leasing costs. Certain commitments are conditional. It also had $34.0m of future lease commitments.
- A $58.9m mezzanine loan on a New York luxury condominium project included $18.6m that was 90–120 days past due. The Investing and Servicing Segment also held $2.2m of loans more than 90 days past due. Management reported no individual held-for-investment loan impairment charge, but the allowance for loan losses rose to $9.0m from $6.0m at year-end.
- One CDO structure was in default and was not consolidated. The Company reported maximum risk of loss of $214.2m for VIEs in which it was not the primary beneficiary; it stated it had not provided financial support to securitization VIEs.
- Secured financing agreements contain covenants that could restrict future dividends if breached; the Company reported compliance at June 30. Several facilities had near-term maturities, and management said it was in discussions with lenders about extensions or amendments. Subsequent to quarter-end, it exercised or obtained several extensions and facility amendments, including an increase in Borrowing Base capacity from $250m to $450m.
- Interest-rate sensitivity analysis estimated that a 1 percentage-point increase in rates would raise annual net investment income by approximately $19.5m, or $0.08 per diluted share; a 1-point decrease would reduce it by approximately $2.2m, or $0.01 per share. The decrease scenario assumes LIBOR does not fall below zero.
- The Ireland acquisition and its lease-intangible valuations rely on provisional purchase accounting and estimates. The Company also disclosed substantial Level III fair-value measurements, which depend on unobservable assumptions.
- No material legal proceedings or material changes to previously disclosed risk factors were reported. Disclosure controls were concluded effective, with no material quarter-over-quarter change in internal control over financial reporting.
Important facts for investors to verify
- Reconcile reported GAAP results with Core Earnings and understand the effects of VIE consolidation, fair-value changes, derivatives and currency movements.
- Review credit performance, including the past-due condominium mezzanine loan, risk-rating migration, allowance adequacy and unfunded loan commitments.
- Assess liquidity and refinancing exposure against financing maturities, extension conditions, collateral requirements and the Company’s ability to maintain its dividend.
- Examine the Ireland Portfolio’s financing, operating contribution, purchase-accounting assumptions and subsequent property acquisition.
- Consider dilution and capital allocation from the common-stock offering, convertible-note repurchases, remaining repurchase authorization and the stated cash-settlement intent for note principal.