Starwood Property Trust, Inc. — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016; filed November 2, 2016. Starwood Property Trust is an externally managed REIT investing in commercial real estate debt, securities, servicing businesses and properties. Reporting segments are Lending, Investing and Servicing, and Property.
Financial performance and position
Amounts below are in millions of dollars except per-share data.
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $204.7 | $192.1 | $600.2 | $549.7 |
| Net income attributable to Starwood Property Trust | $105.8 | $116.7 | $243.9 | $354.2 |
| Basic / diluted EPS | $0.44 / $0.44 | $0.49 / $0.49 | $1.02 / $1.00 | $1.51 / $1.51 |
| Dividends declared per common share | $0.48 | $0.48 | $1.44 | $1.44 |
- Q3 revenue increased about 6.5% year over year, while attributable net income fell about 9.4%. For the nine-month period, revenue rose about 9.2% but attributable net income declined about 31.2%.
- Core Earnings, a company-defined non-GAAP measure, were $0.59 per diluted share in Q3 versus $0.56 a year earlier, and $1.59 for nine months versus $1.64. The company cautions Core Earnings are not GAAP net income or cash flow and may not be comparable with peers.
- Lending Segment net interest income was $105.1 in Q3 versus $114.0, and $314.9 for nine months versus $339.1. Q3 average unlevered and levered yields were 7.4% and 10.1%, respectively; average secured borrowing cost was 3.4% including hedging costs and deferred financing amortization.
- Cash and cash equivalents were $501.6 at quarter-end, with restricted cash of $51.7. Nine-month operating cash flow was $201.2, compared with $259.7 in 2015. GAAP investing cash flow was $449.6 and financing cash flow was negative $517.1; consolidations of securitization VIEs affect the presentation of these flows.
- Total assets were $82.9 billion and equity was $4.1 billion. Loans held-for-investment, net, were $5.2 billion; properties, net, were $1.2 billion.
- Carrying amounts included $4.12 billion of secured financing agreements, $102.4 million of secured borrowings on transferred loans and $1.34 billion of convertible notes. These figures exclude $72.9 billion of VIE liabilities, which the filing says are limited to the related securitization structures and have no recourse to the company’s general credit. Secured financing maturities and projected repayments include $710.8 million due in the remainder of 2016 and $623.2 million in 2017.
Material changes versus comparable periods
- Higher rental income from the expanded property portfolio lifted reported revenue: Q3 Property Segment revenue was $29.2 million versus $7.3 million, primarily following acquisitions of the Woodstar and Ireland portfolios. For the nine months, Property Segment revenue was $85.1 million versus $10.8 million.
- Reported earnings were affected by non-cash fair-value items. Nine-month results included a $70.1 million fair-value gain on mortgage loans held-for-sale, a $33.2 million decline in servicing-rights fair value, $20.6 million of foreign-currency losses and $6.8 million of net derivative losses. The prior-year period included a $17.1 million property-sale gain and a $5.9 million loss on extinguishment of debt.
- The loan-loss allowance rose to $9.4 million from $6.0 million at year-end 2015; the company recorded $3.4 million of provision for the first nine months. It reported no individual held-for-investment loan impairment charges and no loans 90 days or more past due at September 30.
- Adoption of a consolidation accounting update led to consolidation of 14 CMBS trusts, adding approximately $15.1 billion of VIE assets and liabilities at March 31, 2016. The company reported no cumulative equity adjustment on adoption; these gross balances do not represent equivalent recourse obligations of the parent.
Outlook, risks and other notable items
- No specific earnings guidance was provided. Management said it believed existing liquidity and access to additional liquidity were sufficient for obligations for at least the next 12 months. It also said it was in discussions with lenders regarding facilities with near-term expirations.
- The company had $1.6 billion of future funding commitments on 48 loans and expected to fund $1.3 billion. Funding is generally conditional on borrower and project requirements.
- In September, the company agreed to acquire a 38-building medical office portfolio for approximately $837.9 million; closing was expected in December 2016, subject to customary conditions. A $40 million deposit was funded in October.
- Key stated risks include borrower defaults and collateral-value declines, availability of suitable investments, interest-rate and foreign-exchange movements, financing and liquidity costs, and mismatches between asset repayments and financing maturities. The company reported compliance with secured-financing covenants at quarter-end; covenant breaches could restrict dividends.
- About 89.4% of held-for-investment loans were variable-rate, principally at LIBOR plus a weighted-average spread of 5.8%. Internal ratings placed 78.7% of rated loans in category 3, 7.5% in category 4 and 1.1% in category 5.
- Subsequent events included an October 31 agreement to contribute the European real estate loan servicing and advisory subsidiary to a Situs affiliate for a minority interest in the combined entity, and a November 2 declaration of a fourth-quarter dividend of $0.48 per share.
- The company is externally managed by an affiliate controlled by its CEO. Q3 incentive fees were $6.3 million; the filing also reports management equity awards and other related-party arrangements.
Important facts for investors to verify
- Reconcile GAAP earnings with Core Earnings and identify how much reported income depends on fair-value changes, loan-sale activity and other non-recurring or non-cash items.
- Review the composition, performance and credit migration of the loan portfolio, including category 4 and 5 exposures, the increased loan-loss allowance and the large expected funding commitments.
- Assess liquidity and refinancing risk using facility-level maturities, extension conditions, lender capacity and the timing of expected asset repayments; distinguish parent debt from non-recourse VIE liabilities.
- Confirm the medical office acquisition’s closing, funding and financing terms, and assess the performance and leverage of the Woodstar, Ireland and other property portfolios.
- Evaluate dividend sustainability against taxable income, cash available for distribution, debt-service requirements and the gap between declared dividends and GAAP EPS.
- Examine valuation sensitivity and governance considerations for Level III assets, VIE accounting, external management fees and related-party transactions.