Starwood Property Trust, Inc. — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017. Amounts below are U.S. dollars; financial statement amounts are in millions unless otherwise noted.
Business context
Starwood Property Trust is an externally managed REIT focused on commercial real estate lending, property investment, and real estate investing and servicing in the U.S. and Europe. Its three reportable segments are Lending, Property, and Investing and Servicing. Consolidated securitization VIEs are presented gross on the balance sheet, although their assets are restricted and their liabilities generally have no recourse to the Company.
Financial performance and position
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Total revenue | $226.8 | $204.7 | $637.1 | $600.2 |
| Net income attributable to Starwood Property Trust | $88.4 | $105.8 | $308.2 | $243.9 |
| Diluted EPS | $0.33 | $0.44 | $1.17 | $1.00 |
| Dividends declared per common share | $0.48 | $0.48 | $1.44 | $1.44 |
- Q3 Lending Segment net interest income was $117.8 million, up from $105.1 million. Its weighted-average unlevered yield was 7.4%, unchanged year over year for the quarter; average secured borrowing rates rose to 3.9% from 3.4%.
- For the nine-month period, Lending Segment net interest income increased to $323.7 million from $314.9 million, while its weighted-average unlevered yield declined to 7.4% from 7.9%.
- At September 30, 2017, total assets were $62.7 billion and total equity was $4.54 billion. Cash and cash equivalents were $413.8 million, with restricted cash of $54.6 million.
- Reported debt included $5.51 billion of secured financing agreements, $2.04 billion of unsecured senior notes, and $74.2 million of secured borrowings on transferred loans. Separately, consolidated VIE liabilities were $50.15 billion; the filing says these obligations generally are nonrecourse to the Company.
- Loans held for investment were $6.38 billion net; loans held for sale were $608.6 million. About 92.6% of loans held for investment were variable rate. The loan-loss allowance was $6.6 million, down from $9.8 million at year-end; management reported no impaired loans and none 90 or more days past due.
- Operating cash flow was negative $222.4 million and investing cash flow negative $909.0 million for the nine months; financing cash flow was positive $947.4 million. Cash, cash equivalents and restricted cash decreased by $184.0 million to $468.4 million.
- Management’s non-GAAP Core Earnings were $0.65 per diluted share for Q3 versus $0.59, and $1.68 for the nine months versus $1.59. The company cautions that Core Earnings are not GAAP net income, cash flow, or a measure of liquidity, and may not be comparable across REITs.
Material changes versus comparable periods
- Q3 revenue rose 10.8%, while net income attributable to the Company fell to $88.4 million from $105.8 million. The decline occurred despite higher Lending and Property revenues; results included a $24.2 million net derivative loss, versus a $2.3 million loss a year earlier, and a $33.7 million decrease in the Retail Fund investment’s value.
- Nine-month attributable net income increased to $308.2 million from $243.9 million. Results included higher gains related to consolidated VIEs, a $53.9 million gain recognized from an unconsolidated investor entity’s sale of most of its interest in an online real estate company, and gains on property sales. These items make period comparisons less indicative of recurring performance.
- Property revenue increased, principally reflecting the full-period contribution of the Medical Office and Woodstar portfolios. The $553.3 million Master Lease Portfolio acquisition closed September 25; 20 retail and three industrial properties were leased back to the seller under corporate-guaranteed net leases with initial 24.6-year terms.
- Loans held for investment increased from $5.85 billion at year-end 2016, and properties, net, increased from $1.94 billion to $2.52 billion. Secured financing agreements increased from $4.15 billion to $5.51 billion.
- The Company issued $250 million of 4.375% convertible notes due 2023 and repurchased $230 million principal amount of 2018 convertible notes for $250.7 million, recognizing a $5.9 million debt-extinguishment loss. The 2017 notes were repaid at maturity in October 2017.
Outlook, risks and unusual items
- Management stated that current liquidity and access to additional liquidity were sufficient to meet obligations for at least the next 12 months. It provided no numerical earnings or revenue guidance. The board declared a fourth-quarter dividend of $0.48 per share, payable January 15, 2018.
- Future funding commitments covered 51 loans and totaled $1.5 billion; management expected to fund $1.3 billion. The contractual-obligations table included $1.28 billion of commitments, net of $238.3 million management projected would not be funded. Funding is generally conditional on specified requirements.
- Near-term financing maturities and repayment timing are important: projected investment principal inflows and financing outflows were nearly matched for the fourth quarter of 2017, while the filing shows a net outflow for the first quarter of 2018. The Company said it was discussing extensions or amendments with lenders for facilities nearing maturity; extensions are subject to conditions.
- Key risks identified include borrower defaults, declines in collateral values, financing availability and cost, asset/financing maturity mismatches, changing interest rates, and liquidity access. The Company reported compliance with secured-financing covenants at quarter-end.
- The Company disclosed two CDO structures in default; one entered default during the period and was deconsolidated. The carrying value of its investment was zero. The filing also describes significant Level III fair-value measurements, including VIE assets and liabilities, for which valuation depends on assumptions and may be difficult to verify independently.
- A new financing-related risk concerns the Company’s captive insurance subsidiary’s FHLB of Chicago membership. Its $250 million borrowing capacity may be available only through February 2021; replacement financing on comparable terms is not assured.
- The filing reports no material pending or threatened legal proceedings and no material change to previously disclosed risk factors apart from the FHLB membership risk.
Important facts for investors to verify
- How much of reported earnings and Core Earnings came from realized or unrealized gains, VIE fair-value changes, property sales, and the online real estate investment transaction, versus recurring lending and rental operations.
- The timing, conditions, and availability of the $1.3 billion of expected loan funding, and the Company’s ability to refinance or extend upcoming secured financing maturities.
- Liquidity available to the parent company versus restricted cash and cash held in subsidiaries or VIEs, and the Company’s capacity to sustain the $0.48 quarterly dividend after debt service and commitments.
- Credit quality and collateral performance across the loan portfolio, including the rated-risk distribution, and the assumptions supporting the small reported allowance for loan losses.
- Exposure to interest-rate and foreign-currency movements, derivative valuation changes, and the expected effect of the FHLB membership ending in February 2021.
- Related-party transactions and the external manager’s fees, including the incentive-fee calculation and the basis for reported non-GAAP Core Earnings.