Starwood Property Trust, Inc. — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016; comparisons are with the corresponding 2015 periods unless otherwise noted. Amounts below are in U.S. dollars.
Business context
Starwood Property Trust is an externally managed REIT focused on commercial real estate lending, investing and servicing, and property ownership. Its three reporting segments are Lending, Investing and Servicing, and Property. The company added affordable housing and other real estate through acquisitions, including the Woodstar Portfolio.
Financial performance and position
| Metric | Q2 2016 | Six months 2016 |
|---|---|---|
| Total revenue | $200.0 million, up 11.9% | $395.5 million, up 10.6% |
| Net income attributable to Starwood Property Trust | $111.5 million, down 4.8% | $138.1 million, down 41.8% |
| Diluted EPS | $0.47, versus $0.49 | $0.58, versus $1.02 |
| Core Earnings per diluted share (non-GAAP) | $0.50, versus $0.53 | $1.00, versus $1.08 |
| Operating cash flow | Not separately provided for the quarter | $148.6 million, versus $295.0 million |
Q2 revenue growth primarily reflected higher rental income from the expanded property portfolio. For the six-month period, lower earnings reflected reduced investment and servicing results, including lower VIE-related gains and servicing fees, as well as the absence of a prior-year property sale gain. Core Earnings is a company-defined non-GAAP measure and is not a measure of cash available for dividends.
At June 30, cash and cash equivalents were $404.8 million and restricted cash was $41.1 million. Total assets were $89.4 billion and total equity was $4.1 billion. The balance sheet includes $80.1 billion of VIE assets and $79.1 billion of corresponding VIE liabilities; these securitization obligations are generally nonrecourse to the company and the assets are restricted to settling VIE obligations.
Secured financing agreements were $4.48 billion, convertible senior notes were $1.33 billion, and secured borrowings on transferred loans were $94.7 million. The company reported $1.37 billion principal amount of convertible notes, including $431.3 million due 2017 and $600.0 million due 2018. Secured debt increased from $3.98 billion at year-end 2015. Management said it believed available liquidity and access to additional liquidity were sufficient for obligations over at least the next 12 months.
Net loans held for investment were $5.69 billion; about 89.1% were variable-rate, principally LIBOR plus a weighted-average spread of 5.9%. No loans were 90 days or more past due, and management reported no individual held-for-investment loan impairment. Risk-rated loans in categories 4 and 5 represented 5.6% of the rated portfolio. The allowance for loan losses was $7.3 million.
For the six months, investing cash outflow was $89.0 million and financing cash outflow was $22.5 million on a GAAP basis. Cash increased by $37.0 million. The company paid $229.2 million in dividends and repurchased $19.7 million of stock during the period. Quarterly dividends were $0.48 per share; a further $0.48 dividend for Q3 was declared after quarter-end.
Material changes and notable activity
- Revenue increased year over year, supported by property rental income; Q2 net income and Core Earnings per share nevertheless declined.
- The Property portfolio expanded: Woodstar comprised 32 affordable housing communities and 8,948 units when complete, and Ireland holdings included 13 properties. Properties, net, rose to $1.23 billion from $919.2 million at year-end.
- The company recognized an $8.4 million bargain-purchase gain on the final two Woodstar properties acquired in Q2.
- Adoption of a consolidation accounting standard led to consolidation of additional CMBS trusts. The company said this presentation change had no economic effect; it increased reported VIE assets and liabilities and affects period-to-period comparisons.
- Loan originations and acquisitions continued, while the company also received substantial principal repayments and loan-sale proceeds. Q2 activity included $1.0 billion of loan maturities, sales and principal repayments.
Outlook, risks and contingencies
No earnings or revenue guidance was provided. Management stated its intention to continue regular quarterly dividends, subject to board authorization, cash availability, operating needs and debt-service requirements. The board declared a $0.48-per-share Q3 dividend.
Key disclosed risks include borrower defaults and collateral-value declines; interest-rate, credit-spread, foreign-exchange and liquidity risks; and mismatches between asset repayments and financing maturities. The company noted ongoing discussions with lenders about facilities with near-term expirations, and warned that covenant breaches could restrict dividends; it reported compliance with covenants at June 30. Secured financing principal repayments include $180.9 million for the remainder of 2016 and $858.0 million in 2017, subject to assumptions and extensions.
Brexit was identified as a new risk that could adversely affect European markets, property and investment values, and currency exposure. The company also disclosed $1.7 billion of future funding commitments on 54 loans, of which it expected to fund $1.4 billion, generally subject to conditions. It reported no known guarantee circumstances requiring payment and no material pending or threatened legal proceedings.
Important facts for investors to verify
- How much of reported earnings and quarter-to-quarter performance reflects fair-value changes, foreign-exchange movements, and VIE consolidation rather than recurring operations.
- Loan portfolio credit quality, including migration in risk ratings, collateral performance, and the adequacy of the $7.3 million loan-loss allowance.
- Liquidity and refinancing needs, including near-term secured-facility maturities, extension conditions, and the expected timing of $1.4 billion in loan funding commitments.
- Dividend sustainability: Q2 diluted GAAP EPS was $0.47 against a $0.48 dividend, while non-GAAP Core Earnings per share was $0.50.
- Exposure to European assets and currencies following Brexit, and compliance with affordable-housing program requirements for Woodstar properties.