Starwood Property Trust, Inc. — Q3 2012 Form 10-Q
Business context and period. The company is a REIT focused primarily on commercial real estate debt, including mortgage loans and commercial mortgage-backed securities (CMBS); it also invests in residential mortgage-backed securities (RMBS) and residential real estate-owned properties. This unaudited report covers the quarter and nine months ended September 30, 2012, compared with the same periods in 2011.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net interest margin | $60.8 million | $50.8 million | $185.1 million | $124.1 million |
| Expenses | $18.4 million | $13.4 million | $54.2 million | $37.9 million |
| Net income attributable to Starwood | $50.2 million | $14.5 million | $144.9 million | $78.3 million |
| Diluted earnings per share | $0.43 | $0.15 | $1.34 | $0.94 |
| Distributions declared per common share | $0.44 | $0.44 | $1.32 | $1.30 |
Q3 interest income from loans was $56.3 million and from MBS was $16.6 million; interest expense was $12.0 million. For the nine months, the respective amounts were $179.1 million, $40.4 million and $34.3 million. The filing does not present a conventional operating margin measure.
Reported earnings included material valuation and hedging effects. Q3 included $9.0 million of gains on investment sales, a $7.5 million loss on currency derivatives, and a $7.1 million unrealized foreign-currency remeasurement gain. Nine-month earnings included $19.1 million of investment-sale gains, a $10.4 million currency-derivative loss, and a $2.7 million OTTI charge. Q3 comprehensive income was $100.2 million, substantially reflecting unrealized gains on available-for-sale securities.
Management’s non-GAAP Core Earnings were $58.8 million, or $0.50 per diluted share, for Q3, and $163.8 million, or $1.52 per diluted share, for the nine months. Core Earnings excludes specified noncash and other items, is used in calculating the manager’s incentive fee, and is not a substitute for GAAP income or cash flow.
Financial position, cash flow and portfolio
- At September 30, total assets were $3.805 billion, total liabilities $1.504 billion, and total equity $2.301 billion. Cash and cash equivalents were $144.2 million.
- Loans held for investment were $2.581 billion; available-for-sale MBS were $866.9 million; other investments were $75.8 million. Secured financing agreements, net, totaled $1.309 billion, with an additional $88.3 million of loan-transfer secured borrowings.
- For the nine months, the cash flow statement reports $231.5 million provided by operating activities, $755.0 million used in investing activities, and $553.7 million provided by financing activities, increasing cash by $30.2 million.
- Loan carrying value grew from $2.269 billion at December 31, 2011 to $2.581 billion at September 30, 2012. MBS fair value rose from $341.7 million to $866.9 million. About 56.7% of loans were variable rate.
- Hospitality collateral represented 49.3% of the investment portfolio, up from 39.9% at year-end 2011. A $425.2 million senior hotel-operator securities position was about 11.2% of total assets; management estimated its collateral loan-to-value ratio at 39%–44%. RMBS fair value was $337.9 million, and 52.9% of that portfolio was rated CCC.
- No loan-loss allowance was recorded. At quarter-end, $134.4 million of loans were risk-rated 4 and none were rated 5; the filing describes rating 4 as having adverse indicators, including lagging property performance or possible maturity-refinancing challenges.
Changes, outlook and risks
- Compared with Q3 2011, net interest margin increased $10.1 million, primarily from a larger investment portfolio. Nine-month margin increased $61.0 million, also reflecting portfolio growth and $13.1 million of accelerated discount accretion following early repayment of a GBP-denominated loan.
- Expenses increased year over year, including higher management fees and stock compensation. The manager’s base fee is tied to defined stockholders’ equity, and incentive compensation is based on Core Earnings. Nine-month management fees were $42.7 million versus $29.0 million in 2011.
- The company raised approximately $457.3 million gross through an April 2012 common-stock offering. Subsequent to quarter-end, it completed another offering of 18.4 million shares at $22.74, for approximately $418.4 million gross proceeds, and granted the manager 875,000 restricted stock units.
- Management stated that it believed available liquidity and access to additional liquidity were sufficient for financial obligations for at least the next 12 months. There is no specific earnings or investment guidance in the supplied filing text. The board declared a fourth-quarter dividend of $0.44 per share after quarter-end.
- Financing maturities and collateral terms remain important: scheduled secured-financing principal repayments were $749.3 million in 2013. Management expected to extend or refinance certain facilities maturing in March and August 2013, subject to conditions. Repurchase lenders may require margin payments if collateral values fall; several facilities include company guarantees.
- Future loan funding commitments totaled $128.2 million, primarily for development, leasing commissions and tenant improvements; another $1.7 million commitment related to an investment. Derivatives had a $22.3 million net liability position and $3.6 million of collateral was posted. Certain derivative agreements permit a default if the debt-to-assets ratio exceeds 75%.
- Key risks include borrower defaults and collateral-value declines, refinancing and asset-liability maturity mismatches, interest-rate and index-basis exposure, prepayment or extension risk, foreign-currency volatility, availability and cost of liquidity, and valuation uncertainty. Management reported no material change to previously disclosed risk factors and no material pending legal proceedings.
Important facts for investors to verify
- Reconcile the MD&A cash-flow discussion with the financial statements: the cash-flow statement reports $231.5 million of operating cash flow and $755.0 million of investing outflow, while the MD&A text gives different figures.
- Assess earnings quality and sustainability, particularly discount accretion, the prior GBP-loan prepayment benefit, investment-sale gains, unrealized currency and derivative movements, and the non-GAAP Core Earnings adjustments.
- Review concentration and credit exposure, including hospitality collateral, the large hotel-operator securities position, and the significant CCC-rated portion of RMBS; also monitor the absence of a loan-loss allowance against portfolio performance.
- Check refinancing capacity, extension conditions, margin-call exposure and guarantees against the 2013 financing maturity schedule and future funding commitments.
- Evaluate the impact of the October equity issuance and manager equity award on share count, per-share results, fees and future distributions; verify the declared $0.44 fourth-quarter dividend and its payment terms.