STARWOOD PROPERTY TRUST, INC. quarterly report, Q2 FY2017

Full document

Starwood Property Trust, Inc. — Q2 2017 Form 10-Q

Business context and reporting period

For the quarter and six months ended June 30, 2017. Starwood Property Trust is an externally managed REIT investing in commercial real estate loans and securities, servicing and conduit lending, and commercial properties in the U.S. and Europe. Its reportable segments are Lending, Investing and Servicing, and Property.

Financial results and position

  • Q2 revenue: $211.6 million, up 5.8% from $200.0 million. Net income attributable to Starwood: $117.4 million, up from $111.5 million; diluted EPS was $0.44 versus $0.47.
  • First-half revenue: $410.3 million versus $395.5 million. Net income attributable to Starwood: $219.7 million versus $138.1 million; diluted EPS was $0.83 versus $0.58.
  • Core Earnings, a non-GAAP measure: $0.52 per diluted share in Q2 versus $0.50; $1.03 for the first half versus $1.00. Management cautions that Core Earnings is not GAAP cash flow or a liquidity measure.
  • Interest economics: Lending Segment net interest income was $104.1 million in Q2, down from $107.8 million. Its average unlevered yield was 7.0% versus 7.2%; average secured borrowing cost was 3.9% versus 3.4%, including hedging costs and deferred financing amortization.
  • Cash flows, first half: GAAP operating cash flow was negative $345.0 million, investing cash flow negative $253.3 million, and financing cash flow positive $251.7 million. Financing included net borrowings after repayments of about $543.8 million and dividend payments of $249.9 million. Cash, cash equivalents and restricted cash ended at $305.2 million, including $261.9 million of unrestricted cash and cash equivalents.
  • Assets and debt at June 30: Total assets were $64.5 billion and total liabilities $60.0 billion; equity was $4.6 billion. Secured financing was $4.75 billion and unsecured senior notes were $2.04 billion. Separately presented VIE liabilities were $52.86 billion; the filing says these obligations have no recourse to the Company’s general credit.
  • Portfolio and credit: Net loans were $6.82 billion, including $6.21 billion held for investment and $610.1 million held for sale. About 92.2% of held-for-investment loans were variable-rate, principally LIBOR plus a weighted-average spread of 5.4%. The loan-loss allowance was $6.8 million; management reported no impaired loans and none 90 days or more past due.
  • Dividends: $0.48 per common share was declared for each of Q1 and Q2. A further $0.48 Q3 dividend was declared after quarter-end.

Material changes versus comparable periods

  • Q2 and first-half revenue rose, with higher rental income from the expanded property portfolio, including the Medical Office Portfolio acquired in December 2016. Property Segment revenue increased $16.9 million in Q2 and $35.6 million in the first half year over year.
  • Reported earnings benefited from $25.7 million of income recognized on an investment in an entity holding equity in an online real estate company. The income was described as unusual and infrequent and generated a $9.9 million deferred tax provision.
  • First-half earnings also reflected higher gains in the change in net assets of consolidated VIEs. These fair-value-driven amounts and related eliminations vary with VIE consolidation and are not, management says, a meaningful standalone indicator of segment performance.
  • Interest expense increased to $71.3 million in Q2 from $57.6 million, while Q2 derivative results swung to a $37.6 million loss from a $20.3 million gain. First-half derivative loss was $41.9 million versus $4.5 million. Foreign currency movements partly offset hedge effects.
  • Total assets declined from $77.3 billion at year-end 2016, largely reflecting VIE deconsolidations; this balance-sheet movement should not be read as a comparable reduction in the Company’s underlying investment portfolio.
  • In March, 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, recording a $5.9 million extinguishment loss. The 2017 notes, with $411.9 million carrying value, mature in October 2017; $781.9 million of unsecured senior-note principal was scheduled within one year.

Outlook, risks and unusual items

  • No numerical earnings or revenue guidance is provided. Management stated it believed liquidity and access to additional liquidity were sufficient for obligations for at least the next 12 months; its liquidity strategy was unchanged.
  • Management intends to continue regular quarterly dividends, subject to board authorization and operating and debt-service requirements. The filing notes that asset sales, borrowing, or non-cash distributions could be required if available cash is insufficient to meet distributions.
  • Key disclosed risks include borrower defaults and collateral impairment; availability and cost of financing and liquidity; interest-rate and credit-spread changes; mismatches between asset repayments and financing maturities; property-market conditions; and foreign-exchange exposure. The Company noted that it discusses extensions or amendments with lenders for facilities nearing maturity.
  • Future funding commitments covered 55 loans and totaled $1.6 billion, of which management expected to fund $1.4 billion. Secured financing principal repayments were projected at $910.6 million for the remainder of 2017, subject to the filing’s assumptions and extension options.
  • Two CDO structures were in default and unconsolidated at quarter-end; one entered default during Q2. The reported maximum loss exposure for unconsolidated securitization VIEs was $13.8 million. A separate unconsolidated VIE exposure included $137.0 million invested and $15.5 million of unfunded commitments.
  • After quarter-end, the Company acquired a captive insurance entity providing membership in the Federal Home Loan Bank of Chicago, which management said provides additional financing capacity on qualifying collateral. No material legal proceedings or material changes to previously disclosed risk factors were reported. Management concluded disclosure controls were effective.

Important facts for investors to verify

  • How much of GAAP and Core Earnings depends on fair-value movements, VIE accounting, property sales, and the $25.7 million online real estate investment gain, and how repeatable those items are.
  • Cash available after funding loan commitments, paying dividends, and meeting near-term debt maturities; confirm lender extensions, refinancing plans, and access to the newly available FHLB capacity.
  • Credit performance of the loan portfolio, including risk-rating migration, collateral values, and the adequacy of the $6.8 million allowance despite management’s no-impairment conclusion.
  • Sensitivity of earnings and liquidity to LIBOR, borrowing costs, derivative marks, foreign-exchange movements, and possible collateral or margin requirements.
  • Related-party governance and transactions, including the external management fees and the loans acquired from third parties whose borrowers were affiliates of the Manager.