Starwood Property Trust, Inc. — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014. Starwood Property Trust originates, acquires, finances and manages commercial real estate loans and related investments in the U.S. and Europe. Its two reportable segments are real estate investment lending and LNR. Results include substantial gross-up of securitization variable-interest entities (VIEs); VIE assets and liabilities are generally restricted and nonrecourse to the Company.
Financial performance and position
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Total revenue | $181.4 million | $150.4 million | $524.1 million | $368.8 million |
| Net income attributable to Starwood | $165.0 million | $87.4 million | $403.5 million | $210.1 million |
| Diluted EPS | $0.73 | $0.51 | $1.87 | $1.33 |
| Dividends declared per common share | $0.48 | $0.46 | $1.44 | $1.36 |
- Q3 revenue grew 20.6% year over year; attributable net income rose 88.9%. Q3 results included $87.8 million of net income from consolidated VIEs, a $29.3 million gain on derivatives, and a $21.5 million foreign-currency loss. Fair-value changes and VIE accounting affect comparability.
- Nine-month GAAP revenue increased 42.1% and attributable net income increased 92.1%. The period included a $1.6 million loss from discontinued operations versus $12.0 million in the prior-year period.
- Non-GAAP Core Earnings were $124.8 million, or $0.55 per diluted share, in Q3 2014, versus $104.4 million, or $0.61 per share, in Q3 2013. Nine-month Core Earnings were $361.6 million, or $1.67 per share, versus $231.4 million, or $1.47. Core Earnings excludes specified items and is not GAAP net income or cash flow.
- At September 30, cash and cash equivalents were $327.3 million; restricted cash was $45.7 million. Total assets were $116.9 billion and total equity was $3.9 billion, with the balance sheet heavily grossed up by VIE assets of $109.5 billion and VIE liabilities of $108.9 billion.
- Secured financing agreements were $2.71 billion, convertible notes net carrying value was $1.01 billion, and secured borrowings on transferred loans were $142.6 million. Secured financing agreements rose from $2.26 billion at December 31, 2013. The $1.06 billion principal balance of convertible notes is unsecured.
- For the first nine months, operating cash flow was $236.5 million, investing cash outflow was $915.2 million, and financing cash inflow was $691.5 million. Cash increased by $12.8 million to $327.3 million. Investing included $2.12 billion of loan originations and purchases; financing included $581.5 million of net common-stock proceeds and $293.6 million of dividends paid.
- Net loans were $5.59 billion, up from $4.75 billion at year-end. About 74.5% of loans were floating-rate, with a weighted-average spread of 6.18% over LIBOR. The loan-loss allowance was $5.9 million; management reported no individual held-for-investment loan impairment charges. About 0.8% of rated loans were risk-rated 5, and approximately $4.1 million of held-for-investment loans were in default.
Material changes and notable activity
- The Company completed the spin-off of its single-family residential segment, Starwood Waypoint Residential Trust (SWAY), on January 31, 2014. The spin-off distributed approximately $1.12 billion of equity and removed the residential assets from continuing operations.
- In April, Starwood issued 25.3 million common shares, including the underwriters’ exercised option, for approximately $564.7 million of gross proceeds. It also established a $500 million at-the-market program and issued 759,000 shares for $18.3 million gross proceeds during the nine-month period.
- In September, the board authorized a one-year share repurchase program of up to $250 million; 587,900 shares were repurchased for $13.0 million during the quarter.
- The lending portfolio expanded through commercial loan originations and acquisitions. Q3 activity included a $480 million San Francisco construction financing, a $264.3 million California land-improvement loan, and a $150 million Maui resort redevelopment loan. Some originated loans were subsequently sold or syndicated.
- In October, the Company issued $431.3 million principal of 3.75% convertible notes due 2017, generating approximately $420.8 million net proceeds. It also committed $150 million for a 33% interest in a retail fund; $132 million was funded in October.
Outlook, risks and contingencies
- No specific earnings or revenue guidance was provided. Management said it believed current liquidity and access to additional liquidity were sufficient to meet obligations for at least the next 12 months. It intended to continue regular quarterly dividends, subject to operating and debt-service needs and board authorization.
- Management identified risks including borrower defaults and collateral impairment; availability of suitable lending opportunities; interest-rate and foreign-exchange movements; refinancing and asset/financing maturity mismatches; competition; and availability and cost of liquidity. Mortgage servicing is subject to evolving regulation, including Dodd-Frank-related rules.
- There were $2.23 billion of future loan-funding commitments on 51 loans, generally conditional on specified draw requirements. Contractual obligations totaled $6.18 billion, including $2.71 billion of secured financings and $1.06 billion of convertible-note principal. Management reported compliance with financing covenants at September 30.
- The Company reported maximum exposure of $185.0 million to VIEs it did not consolidate and stated it had neither an obligation to provide nor provided financial support to securitization SPEs. One CDO structure was in default and was not consolidated. No material legal proceedings were reported.
- Significant non-GAAP and valuation considerations include fair-value estimates based on unobservable inputs, servicing-rights valuation, and management’s cash-flow assumptions for loans and securities. Domestic servicing rights declined $18.7 million in fair value during the first nine months.
Investor verification priorities
- Review the drivers and repeatability of GAAP earnings, especially VIE income, fair-value gains, derivative results and currency effects; compare them with Core Earnings and cash generation.
- Assess loan credit quality, risk-rating migration, the $5.9 million allowance, defaults, collateral values and the $2.23 billion of conditional funding commitments.
- Check refinancing and liquidity capacity against secured-debt maturities, facility extension conditions, collateral requirements and the $1.11 billion of commitments due within one year.
- Evaluate dilution and capital allocation following the 2014 share issuance, convertible-note issuance, stock repurchases and quarterly dividends.
- Examine related-party arrangements, including external management fees and the October retail-fund investment managed by Manager affiliates.