Starwood Property Trust, Inc. — Q1 2011 Form 10-Q
Reporting period: Three months ended March 31, 2011. The company is an externally managed REIT focused primarily on commercial real estate loans and related debt investments, CMBS and RMBS. Amounts below are in U.S. dollars; financial statement amounts are converted from thousands to millions unless stated otherwise.
Financial and operating highlights
- Portfolio: Investments totaled approximately $2.14 billion at quarter-end, versus $2.10 billion in total assets. The portfolio included $1.78 billion of loans and $335.6 million of available-for-sale mortgage-backed securities. The company originated or acquired $457.1 million of investments during the quarter.
- Income: Net interest margin was $31.4 million, up from $12.4 million in Q1 2010. Net income attributable to Starwood Property Trust was $31.4 million, or $0.44 per basic share and $0.43 diluted, compared with $5.9 million and $0.12 per share. Non-GAAP Core Earnings were $31.4 million, or $0.43 per diluted share, versus $7.5 million, or $0.15, a year earlier.
- Other income and unusual items: Net income included $8.1 million of realized investment gains, $3.2 million of unrealized gains on loans held for sale, and a $4.0 million foreign-currency remeasurement gain. It also included $3.9 million of unrealized currency-hedge losses, a $0.4 million other-than-temporary impairment on one RMBS, and other hedge-related gains and losses. These items make reported earnings sensitive to investment sales and fair-value movements.
- Expenses and margins: Total expenses were $11.5 million, versus $6.7 million. Management fees were $9.3 million and included $3.8 million of non-cash stock compensation. The filing does not provide a clear operating-margin or net-profit-margin measure.
- Cash flow: Operating cash flow was negative $46.2 million, investing cash flow negative $252.7 million, and financing cash flow positive $194.8 million. Cash and cash equivalents fell $104.2 million to $122.7 million. Operating cash use included loan originations for sale; investing cash use largely reflected loan and securities investment activity.
- Debt and liquidity: Secured financing agreements were $804.6 million, up from $579.7 million at year-end; the securitization trust liability was a further $53.9 million. Management said it believed liquidity and access to liquidity were sufficient for obligations over at least the next 12 months. Contractual obligations totaled $974.5 million, including $510.7 million due in less than one year; this included deferred underwriting fees and loan-funding commitments, not solely debt.
- Equity and distributions: Total equity was $1.34 billion. The company declared a $0.42-per-share Q1 dividend, paid April 15, 2011. Subsequent to quarter-end, the board declared a $0.44-per-share dividend for Q2, payable July 15, 2011.
Material changes versus the prior comparable period
- Net interest margin increased by about $19.0 million year over year, primarily because of greater investment activity; interest income rose $25.5 million and interest expense rose $6.5 million.
- Net income rose substantially from Q1 2010. The comparison reflects portfolio growth as well as Q1 2011 realized gains and unrealized valuation and foreign-currency items.
- Non-investment expenses increased by approximately $4.7 million. Management cited higher base management fees following the December 2010 equity raise, increased stock compensation, an accrued incentive fee, and higher professional costs.
- Loans held for investment increased to $1.52 billion from $1.23 billion at December 31, 2010. Secured financings increased by approximately $224.9 million over that period.
- Available-for-sale MBS declined to $335.6 million from $397.7 million. The company sold CMBS and RMBS during the quarter, generating $6.2 million in gains, and recorded a $0.4 million impairment on one security.
Outlook, risks and contingencies
- The filing gives no earnings or investment-volume guidance. Management described its objective as generating long-term risk-adjusted returns, primarily through dividends and secondarily through capital appreciation. It reported a belief that liquidity would cover obligations for at least 12 months.
- Management identified borrower defaults, collateral-value deterioration, availability of acceptable investments, economic and commercial-property conditions, competition, interest-rate changes, and liquidity costs as risks. Rising rates may pressure funding costs and asset values; prepayment, extension, and index-mismatch risks may also affect returns.
- The company used interest-rate swaps and foreign-exchange forwards to manage exposures. Derivative agreements had a net liability fair value of $13.7 million; $2.5 million of collateral was posted. Certain default or leverage-trigger provisions could require settlement, and the filing estimates a $12.5 million termination liability if those provisions had been breached at quarter-end.
- Secured financings had $349.7 million of scheduled principal repayments in 2011, assuming no defaults or extensions. Repurchase counterparties may determine collateral values and require margin payments. The company’s current repurchase and bank facilities generally limit specified leverage to 75%, subject to stated exclusions and adjustments.
- The company expected to pay $27.2 million in Q2 2011 under contingent IPO underwriting-fee arrangements after exceeding the specified Core Earnings threshold. It also had a $44.7 million unfunded obligation for its share of a hotel renovation loan, expected to be funded over the next three months, and $2.4 million of other unfunded investment commitments.
- No loan-loss allowance was considered necessary at March 31, 2011; no loans were in risk-rating category 5, while approximately $94.0 million were in category 4. The company reported no pending, threatened, or contemplated legal proceedings and no material changes to previously disclosed risk factors.
Important facts for investors to verify
- How much of Q1 earnings and Core Earnings is repeatable interest income versus realized gains, fair-value changes, and currency remeasurement.
- The cash-flow effects and timing of the $27.2 million contingent underwriting-fee payment and the $44.7 million hotel-loan funding commitment.
- Near-term refinancing, collateral-margin, and liquidity needs, especially the scheduled 2011 financing repayments and reliance on repurchase facilities.
- Credit quality and collateral performance of the loan portfolio, including the category 4 exposures, and the basis for the conclusion that no loan-loss allowance was required.
- The sensitivity of earnings, asset values, and distributions to interest rates, foreign exchange, prepayments, and derivative-counterparty requirements.