Starwood Property Trust, Inc. — 2011 Form 10-K
Reporting period: Fiscal year ended December 31, 2011; filed February 29, 2012. The filing also reports fourth-quarter results. Amounts below are in U.S. dollars.
Business context
Starwood Property Trust is an externally managed REIT focused on originating and investing in commercial real estate debt, including first mortgages, subordinated loans and mezzanine loans. It also invests in CMBS and RMBS. Its stated objective is long-term risk-adjusted returns, primarily through dividends and secondarily through capital appreciation.
Financial performance and position
| Metric | 2011 | 2010 |
|---|---|---|
| Interest income | $205.0 million | $93.5 million |
| Interest expense | $28.8 million | $15.8 million |
| Net interest margin | $176.2 million | $77.7 million |
| Net income attributable to Starwood Property Trust | $119.4 million | $57.0 million |
| Diluted earnings per share | $1.38 | $1.14 |
| Core Earnings, non-GAAP | $146.6 million; $1.70 per diluted share | $67.2 million; $1.34 per diluted share |
- Fourth-quarter 2011 net interest margin was $52.1 million, net income was $41.1 million, and diluted EPS was $0.44. Third-quarter net income was $14.5 million, or $0.15 per diluted share; the quarter included an approximately $19 million decrease in the value of derivative instruments and held-for-sale loans.
- Reported net interest margin increased $98.5 million year over year, primarily from expanded investment activity. Operating expenses rose $20.9 million to $50.9 million, mainly reflecting higher management fees, stock compensation, investment pursuit costs and general and administrative expenses.
- At year-end, total assets were $2.997 billion, total liabilities $1.232 billion, and total equity $1.765 billion. Cash and cash equivalents were $114.0 million.
- Investment carrying values included $2.448 billion of loans, $341.7 million of MBS and $44.4 million of other investments. Total portfolio carrying value shown in the portfolio summary was $2.834 billion, up from $1.837 billion at year-end 2010.
- Secured financing agreements totaled $1.104 billion; the securitization-trust debt obligation was $53.2 million. Debt was 41.5% of loans and MBS investments, against a 75% maximum leverage limit under current financing arrangements. Management reported a 12.1% weighted-average levered portfolio return and a 3.6% average secured financing cost, including hedges.
- Operating cash flow was $79.4 million; investing activities used $1.002 billion; financing activities provided $809.8 million. Cash declined $112.8 million during the year.
- The company declared $1.74 per common share in dividends for 2011. The board declared a further $0.44 per share for first-quarter 2012.
Material changes versus 2010
- Loan investment carrying value rose by approximately $1.0 billion; the company originated or acquired approximately $1.8 billion of loans during 2011.
- The portfolio shifted toward floating-rate assets: 52.4% of investments were variable-rate at year-end 2011, versus 25.4% a year earlier. Fixed-rate investments declined to 46.1% from 73.8%.
- MBS carrying value fell to $341.7 million from $397.7 million. RMBS holdings increased, while CMBS were reduced through sales and maturities; a $176.6 million loan was converted to CMBS, generating a $7.9 million unrealized gain on reclassification.
- Net losses on interest-rate hedges were $27.1 million in 2011, compared with $0.1 million in 2010. The company attributed losses associated with its conduit loans and derivatives to severe CMBS-market disruption beginning in late June 2011 and suspended the conduit platform. Six held-for-sale conduit loans remained at year-end, with an aggregate unrealized gain of $5.8 million.
- The company raised $476.7 million gross in a May 2011 common-stock offering. It repurchased 625,850 shares for approximately $10.6 million during 2011.
- RMBS other-than-temporary impairment charges were $6.0 million. The filing reported that all loans were performing as expected and no loan-loss allowance was required; however, $100.8 million of loans were assigned internal risk rating 4.
Outlook, risks and unusual items
- Management described commercial real estate capital markets as recovering gradually, with more conservative lending and improving conditions in some sectors and locations. The strategy was evolving from distressed-asset acquisitions toward direct origination across the capital structure, with continued acquisitions, recapitalizations, new-project financing, and use of syndication and securitization. The filing provides no numerical earnings or return guidance.
- Management stated that available liquidity, including access to liquidity, was sufficient for at least the next 12 months. Financing availability remains dependent on lenders, collateral valuations and market conditions. Although aggregate facility capacity was reported at $427.8 million, approved but undrawn capacity was only $37,000; additional borrowing depended on lender approval and collateral.
- Near-term financing maturities are significant: scheduled secured-financing principal repayments were $398.9 million in 2012 and $491.1 million in 2013. Contractual obligations totalled $1.292 billion, including $476.6 million due in less than one year and $79.7 million of loan funding commitments.
- Key risks include borrower defaults and declining collateral values; illiquid investments; interest-rate, spread, prepayment, extension and foreign-currency exposure; margin calls and refinancing risk; and dependence on repurchase facilities. A 100-basis-point LIBOR increase was estimated to increase annual net investment income on variable-rate instruments by $5.0 million, while reducing the fair value of fixed-rate investments by $42.6 million.
- Governance and related-party risks include external management by an affiliate of Starwood Capital Group, management fees based partly on equity and incentive fees tied to non-GAAP Core Earnings, and potential conflicts in investment allocation. The base management fee was 1.5% of defined stockholders’ equity per year; termination without cause after the initial term could require a fee equal to three times specified average fees.
- The company continues to depend on REIT qualification and an exemption from the Investment Company Act. Failure to maintain either status could materially affect taxes, operations, leverage or distributions. The company also cautioned that Core Earnings is non-GAAP and is not a measure of operating cash flow or funds available for dividends.
- Subsequent to year-end, the company bought $206.4 million of floating-rate CMBS, financed in part with a $155.4 million repurchase facility. It also originated a $40 million mezzanine loan and acquired $95.3 million of UK resort B-notes.
- No legal proceedings were reported as pending, threatened or contemplated. The independent auditor gave an unqualified opinion on the financial statements and internal controls; management also concluded internal controls were effective.
Important facts for investors to verify
- Repayment and refinancing plans for 2012–2013 financing maturities, and the conditions, collateral requirements and lender approvals governing reported undrawn capacity.
- Whether loan growth, portfolio returns and dividend levels can be sustained as competition increases and management shifts toward direct origination.
- Credit quality and valuation assumptions for the MBS portfolio: at year-end, 52.4% was unrated and 29.1% was rated CCC; management’s CMBS loan-to-value estimate of 39%–44% was based on limited fair-value information.
- Performance of the $100.8 million internal risk-rating-4 loan exposure, the $79.7 million of future loan-funding commitments, and the portfolio’s concentrated hospitality, retail and office exposures.
- Effects of hedge losses, market disruption, affiliate management fees and Core Earnings adjustments on GAAP earnings, cash generation and dividend coverage.
- Progress on the post-year-end CMBS purchase and related financing, and any material changes in market conditions or liquidity after the filing date.