STARWOOD PROPERTY TRUST, INC. quarterly report, Q3 FY2018

Starwood Property Trust, Inc. — Q3 2018 Form 10-Q

Reporting period: Three and nine months ended September 30, 2018. Starwood Property Trust is an externally managed REIT focused on real estate lending, property ownership, investing and servicing, and—following a September acquisition—infrastructure lending.

Financial performance and position

Metric	Q3 2018	Q3 2017	Nine months 2018	Nine months 2017
Revenue	$285.7 million	$226.8 million	$815.9 million	$637.1 million
Net income	$89.4 million	$92.8 million	$311.3 million	$318.9 million
Net income attributable to STWD	$84.5 million	$88.4 million	$293.7 million	$308.2 million
Diluted EPS	$0.31	$0.33	$1.09	$1.17
Dividends declared per common share	$0.48	$0.48	$1.44	$1.44

Q3 revenue rose approximately 26%, led by higher loan interest income, rental income from recently acquired property portfolios, and servicing fees. Attributable net income declined approximately 4%, while diluted EPS fell from $0.33 to $0.31.
For the first nine months, revenue increased approximately 28%, but attributable net income declined approximately 5%. Loan interest income grew, offset in part by higher financing costs, loan-loss provisions, and lower gains and earnings from certain investments.
Q3 Commercial and Residential Lending net interest income was $114.2 million, down $3.5 million year over year. Its weighted-average unlevered yield was 7.3% versus 7.4%; its weighted-average secured borrowing rate was 4.4% versus 3.9%. For the nine-month period, those rates were 7.6% versus 7.4% and 4.3% versus 3.8%, respectively.
GAAP operating cash flow was $174.6 million for the nine months, compared with cash used of $222.4 million in the prior-year period. Investing activities used $2.41 billion and financing activities provided $2.21 billion. Cash, cash equivalents and restricted cash totaled $390.0 million at period-end, including $265.8 million of unrestricted cash and cash equivalents.
At September 30, total assets were $62.92 billion and total equity was $4.88 billion. These totals include securitization VIE assets of $48.03 billion and VIE liabilities of $46.95 billion; the filing says those obligations are nonrecourse to the Company.
Secured financing agreements, net, were $8.59 billion; unsecured senior notes, net, were $2.02 billion; and secured borrowings on transferred loans, net, were $74.1 million. Secured financing rose from $5.77 billion at year-end 2017. The Company reported compliance with its financing covenants.
Net loans were $9.90 billion, up from $7.38 billion at year-end 2017. The loan-loss allowance increased to $32.1 million from $4.3 million, following $29.9 million of impaired-loan charges during the first nine months.

Material changes and notable items

On September 19, STWD acquired GE Capital’s project finance origination, underwriting and capital markets business for approximately $2.0 billion. The acquired portfolio included $1.9 billion of funded senior secured loans and securities and $466.3 million of unfunded commitments; $1.5 billion of new financing funded the acquisition. The portfolio was 97% floating rate and concentrated in power-related assets.
The infrastructure segment contributed only 12 days of results in Q3: $3.2 million of revenue and a $5.5 million net loss, including acquisition-related costs. The company recorded $116.0 million of goodwill. In October, it paid down $62.5 million on the facility and acquired an additional $147.1 million of project finance loans.
Property-segment revenue increased with the inclusion of the Master Lease and Woodstar II portfolios. The Investing and Servicing segment’s Core Earnings declined, principally reflecting the absence of substantial nonrecurring earnings from an unconsolidated investment recorded in 2017.
STWD settled $235.5 million of 2019 convertible-note redemptions during Q3 using 11.2 million shares and $20.8 million cash, recording a $1.8 million GAAP debt-extinguishment loss. An additional $27.9 million was settled after quarter-end using 1.2 million shares and $4.7 million cash.
Common shares outstanding were 274.1 million at September 30, compared with 261.4 million at year-end 2017. The filing attributes the increase in part to convertible-note settlements and Woodstar II-related equity interests.

Outlook, risks and contingencies

Management said it believed available liquidity and access to additional liquidity were sufficient for obligations over at least the next 12 months. The filing provides no earnings or revenue guidance.
The board declared a fourth-quarter dividend of $0.48 per share, payable January 15, 2019. Management noted that dividends remain subject to operating and debt-service requirements and board authorization.
Commitments included $1.58 billion of commercial loan funding commitments, of which management expected to fund $1.6 billion as described in the filing; $454.4 million of infrastructure commitments; and $25.0 million of residential loan purchase commitments. Funding obligations may require asset sales or additional borrowing if operating cash is insufficient.
Key risks include borrower defaults and collateral-value declines; interest-rate, credit-spread and foreign-exchange movements; refinancing and asset/financing maturity mismatches; and access to liquidity and capital markets. The acquisition adds integration, retention, covenant, tax and project-finance risks. Project finance exposure is concentrated in power, including thermal power, and repayment depends substantially on project cash flows and operations.
Two CDO structures were in default or imminent default but were not consolidated. The Company reported no material pending or threatened legal proceedings known to management.
After adoption of the expected-credit-loss standard, management expected higher loan-loss allowances; the size of any increase was not yet determined.

Investor facts to verify

How the infrastructure business performs after a full quarter, including acquisition integration, funding costs, credit quality and returns against its largely floating-rate portfolio.
Whether loan-loss reserves adequately reflect impaired exposures, including the New York residential conversion project and department-store loans, and how delinquent loans resolve.
Liquidity and refinancing capacity given increased secured borrowings, near-term facility maturities, and sizable commercial and infrastructure funding commitments.
The sustainability of the $0.48 quarterly dividend relative to taxable income, cash available for distribution, debt service and any required asset sales or borrowing.
How much reported earnings depend on fair-value movements, derivatives, property sales and other nonrecurring items; Core Earnings is a company-defined non-GAAP measure and is not operating cash flow or a liquidity measure.