Starwood Property Trust, Inc. — Q2 2018 Form 10-Q
Business context and period. The company is an externally managed REIT investing in commercial real estate debt, properties, and real estate servicing/investments. This unaudited report covers the quarter and six months ended June 30, 2018; comparisons are with the corresponding 2017 periods unless otherwise noted.
Key financial results
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Total revenue | $269.6 million | $211.6 million | $530.1 million | $410.3 million |
| Net income attributable to STWD | $109.2 million | $117.4 million | $209.2 million | $219.7 million |
| Diluted EPS | $0.40 | $0.44 | $0.77 | $0.83 |
| Dividends declared per common share | $0.48 | $0.48 | $0.96 | $0.96 |
- Revenue and earnings: Q2 revenue increased about 27%, led by higher loan interest income and rental income from property acquisitions. Net income attributable to STWD declined about 7%, reflecting higher costs, loan-loss provisions, and changes in other income. Six-month net income also decreased.
- Core Earnings (non-GAAP): $148.4 million, or $0.54 per diluted share, versus $136.8 million, or $0.52, in Q2 2017. For the six months, Core Earnings were $304.3 million, or $1.12 per diluted share, versus $268.6 million, or $1.03. The company cautions that Core Earnings are not GAAP net income, operating cash flow, or a liquidity measure.
- Interest and credit: Lending Segment net interest income rose to $122.4 million from $104.1 million in Q2. Its average unlevered yield was 7.6% versus 7.0%; average secured borrowing rate, including hedging costs and financing-fee amortization, was 4.4% versus 3.9%. Q2 loan-loss allowance expense was $25.3 million, compared with a $2.7 million reversal in Q2 2017. The allowance was $31.1 million at June 30, up from $4.3 million at year-end.
- Assets and liquidity: Total assets were $60.6 billion and total equity $4.7 billion at June 30. Cash and cash equivalents were $235.4 million; restricted cash was $89.8 million. Cash, cash equivalents, and restricted cash totaled $325.2 million. Management said current liquidity and access to additional liquidity were sufficient for financial obligations for at least 12 months.
- Debt: Secured financing agreements were $6.22 billion and unsecured senior notes were $2.26 billion, net, at June 30; secured borrowings on transferred loans were $74.1 million. Separately, consolidated securitization VIE liabilities were $47.0 billion; the filing says these obligations have no recourse to the company’s general credit. Secured-financing covenants were met at quarter-end.
- Cash flow: For the six months, GAAP operating cash flow was negative $147.7 million, investing cash flow was positive $7.6 million, and financing cash flow was positive $47.6 million. Cash, cash equivalents, and restricted cash decreased $92.5 million. Cash dividends paid were $251.7 million.
Material changes and operating developments
- Lending Segment revenue increased as loan balances, LIBOR, and prepayment-related income rose; management also cited credit-spread compression. Its loan portfolio grew, with about 94.6% of held-for-investment loans variable rate, principally LIBOR plus a weighted-average spread of 4.8%.
- Property Segment revenue benefited from the Master Lease and Woodstar II portfolios acquired after Q2 2017. The company acquired 18 Woodstar II affordable-housing communities in Q1 2018 for $404.7 million, including contingent consideration; 6,109 units across the portfolio were reported as 99% occupied.
- Investing and Servicing Segment Core Earnings declined to $56.1 million from $70.9 million in Q2, mainly on lower servicing fees and CMBS interest income. The comparable 2017 period included $25.7 million of non-recurring income from an unconsolidated investment.
- Q2 commercial loan originations/acquisitions were $2.0 billion. The company also originated or acquired $440.0 million of conduit loans and received $215.1 million from conduit-loan sales. It reported 13 new special-servicing assignments covering $9.2 billion of unpaid principal balance.
- Debt financing activity included issuance of $500 million of 3.625% senior notes due 2021 and amendments/extensions to several secured facilities. The company repaid its 2018 convertible notes at maturity in March. It no longer asserted an intent to settle convertible-note principal fully in cash, changing diluted EPS treatment.
Outlook, risks, contingencies, and unusual items
- Subsequent acquisition: On August 7, 2018, STWD agreed to acquire GE Capital’s energy project finance origination business for approximately $2.2 billion. The business includes a $2.5 billion senior-secured loan portfolio and approximately $400 million of unfunded commitments; closing is subject to customary conditions. Financing commitments include up to $2.1 billion of senior-secured facilities, with an initial advance of $1.7 billion, and a bridge facility of up to $600 million.
- Convertible-note redemptions: After quarter-end, holders submitted redemptions of $258.8 million par amount of 2019 notes. The company reported $104.0 million settled in July through 4.7 million shares and expected to settle the remaining value with shares and cash.
- Funding commitments: The company had $2.0 billion of future funding commitments on 56 loans, of which it expected to fund $1.8 billion. It also had $65 million of outstanding residential-loan purchase commitments under an agreement to purchase up to $600 million over 12 months.
- Credit and market risks: Impairments included $21.6 million on a New York residential-conversion project and $8.3 million on two subordinated loans secured by department stores whose sole tenant entered bankruptcy and liquidation. The filing cites borrower defaults, collateral-value deterioration, interest-rate and foreign-exchange movements, financing maturities, liquidity access, and real estate conditions as risks. Two CDO structures were in default or imminent default; neither was consolidated.
- Dividend and guidance: The quarterly dividend remained $0.48 per share; a Q3 2018 dividend of $0.48 was declared after quarter-end. The filing provides no earnings guidance. The company intends to continue regular quarterly distributions, subject to board authorization and operating and debt-service requirements.
- Management expects the forthcoming expected-credit-loss accounting standard to result in higher loan-loss allowances, but had not quantified the impact. No material changes to previously disclosed risk factors were reported; no material legal proceedings were pending or known to be threatened.
Important facts for investors to verify
- Whether the $2.2 billion energy project finance acquisition closes on the stated terms, and the resulting leverage, funding needs, and portfolio credit exposure.
- Performance and resolution prospects for impaired loans, especially the New York conversion project and department-store collateral; also track allowance growth and migration in loan risk ratings.
- Near-term secured-financing maturities, extension conditions, collateral requirements, and liquidity under stress; management’s 12-month liquidity statement is an estimate.
- Sustainability of the $0.48 quarterly dividend relative to cash generation, funding commitments, debt service, and REIT distribution requirements.
- Effects of the 2019 convertible-note redemptions and share settlement on dilution, cash needs, and per-share results.
- Reliance on fair-value estimates: substantial consolidated VIE assets and several other financial instruments use Level III inputs and unobservable assumptions.