Starwood Property Trust, Inc. — Q2 2013 Form 10-Q
Business context and period. The filing covers the quarter and six months ended June 30, 2013. Starwood invests in commercial real estate loans and securities and residential real estate and non-performing loans. On April 19, it acquired selected LNR Property LLC businesses, expanding into special servicing, commercial mortgage origination and additional real estate finance activities. Results include LNR only from the acquisition date.
Financial performance and position
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Total revenue | $137.0 million | $68.9 million | $222.2 million | $146.8 million |
| Net income attributable to Starwood | $62.3 million | $44.5 million | $124.5 million | $94.6 million |
| Diluted GAAP EPS | $0.38 | $0.40 | $0.83 | $0.92 |
| Core Earnings, non-GAAP | $69.0 million; $0.42/share | $50.0 million; $0.45/share | $127.1 million; $0.85/share | $105.0 million; $1.02/share |
| Distributions declared per common share | $0.46 | $0.44 | $0.90 | $0.88 |
Revenue growth primarily reflects the LNR acquisition and higher loan interest income; Q2 servicing fees contributed $39.1 million. Higher expenses included $45.3 million of general and administrative costs, $13.0 million of Q2 acquisition costs, and $23.9 million of interest expense. Diluted EPS declined despite higher net income, alongside a substantially larger weighted-average share count following equity issuance. Core Earnings is a company-defined non-GAAP measure and is not cash flow or a substitute for GAAP results.
- Cash flow, six months: Operating activities provided $18.3 million, versus $190.7 million in 2012; investing activities used $1.205 billion; financing activities provided $1.376 billion. Cash and cash equivalents ended at $366.8 million, excluding $69.6 million of restricted cash.
- Balance sheet, June 30: Total assets were $103.2 billion and total liabilities $99.6 billion. This includes $97.3 billion of consolidated VIE assets and $96.9 billion of related VIE liabilities; the filing says these securitization obligations are nonrecourse to the Company and their assets are restricted. These grossed-up balances should not be read as ordinary corporate assets and debt.
- Borrowings and equity: Secured financing agreements were $1.707 billion; convertible notes, net, were $562.2 million; loan-transfer secured borrowings were $87.2 million; and a loan participation liability was $95.0 million. The Company issued $600 million of 4.55% convertible notes due 2018 in February and raised $822.4 million gross from a common-stock offering in April. Stockholders’ equity was $3.55 billion.
- Portfolio and credit: Net loans were $3.61 billion. Approximately 62% of loans were floating rate. The loan-loss allowance was $2.8 million; one $11.5 million loan was in default, with no individual impairment recorded. Future funding commitments on 27 loans totaled $546.2 million.
Material changes versus prior periods
- The LNR acquisition added servicing, conduit origination and finance operations and changed reporting to three segments: real estate investment lending, single-family residential and LNR. LNR reported $68.9 million of revenue and $34.6 million of net earnings during its post-acquisition period, before consolidation adjustments.
- GAAP total assets rose from $4.32 billion at December 31, 2012 to $103.19 billion at June 30, 2013, principally because of VIE consolidation, not a comparable increase in unencumbered corporate assets. The LNR acquisition also added $100.9 million of preliminary goodwill.
- Six-month GAAP net income rose to $124.5 million from $94.6 million, while diluted EPS fell to $0.83 from $0.92. Core Earnings increased to $127.1 million from $105.0 million, but Core Earnings per share declined to $0.85 from $1.02.
- Operating cash flow was materially lower year over year; investing outflows included the LNR purchase, loan originations and residential property investment. Financing inflows included debt and equity issuance.
Outlook, risks and unusual items
- No quantified company-wide earnings or revenue guidance is provided. Management said the single-family residential segment had operated at a loss since inception and expected losses to continue until the portfolio stabilizes and rental income covers operating and growth costs, excluding anticipated liquidation gains.
- LNR-related unusual costs included $17.6 million of acquisition costs for the first half and $8.5 million of change-in-control plan expense in the post-acquisition period. Management expected approximately $14.6 million of additional such expense through January 19, 2014, but excluded these costs from Core Earnings because the purchase price was reduced to account for the obligations. LNR also recorded $6.7 million of severance costs after a restructuring that eliminated 47 employees.
- Liquidity and refinancing merit attention: secured facilities had $843.7 million of scheduled principal repayments for the remainder of 2013 under stated assumptions. After quarter-end, the Company exercised a one-year extension on its Second Wells repurchase agreement and said it expected to extend Conduit I; extensions are subject to conditions. The filing also reported a $450 million issuance of 4.0% convertible notes due 2019 that closed July 3.
- Key risks include borrower defaults and collateral impairment, interest-rate and foreign-exchange movements, funding availability and cost, refinancing or timing mismatches, commercial real estate conditions, and integration of LNR. Two CDO structures were in default but were not consolidated; the Company reported no obligation to support its securitization SPEs.
- Fair-value estimates rely in part on significant unobservable inputs. Management noted a July 2013 FASB exposure draft on consolidated collateralized financing entities that could be difficult for the Company to apply if enacted as written. The filing reports no material change to previously disclosed risk factors, no pending or threatened legal proceedings known to management, and effective disclosure controls.
- The board declared a third-quarter dividend of $0.46 per share, payable October 15, 2013. The Company stated its intention to continue regular quarterly distributions, subject to operating requirements, debt service and board authorization.
Important facts for investors to verify
- How much of reported revenue and earnings growth is recurring and attributable to LNR, versus acquisition-related, fair-value, derivative and realized-gain effects.
- The effect of VIE consolidation on comparability: review segment results before consolidation alongside GAAP statements, and distinguish restricted, nonrecourse VIE balances from Company-level liquidity and obligations.
- Facility extension and refinancing outcomes, including the remaining 2013 maturities, borrowing-base availability and collateral requirements.
- Performance, funding needs and eventual stabilization of the residential portfolio; monitor the $546.2 million of loan commitments and the defaulted loan.
- Realization of servicing-right and other Level III fair values, integration costs and the remaining change-in-control expense; assess Core Earnings reconciliations against GAAP net income and cash flows.
- Dividend coverage and capital needs, including dilution from equity and convertible-note issuance and the terms of the post-quarter 2019 convertible notes.