Release Date: May 08, 2024
For the complete transcript of the earnings call, please refer to the full earnings call transcript.
Positive Points
- Starwood Property Trust Inc reported strong quarterly distributable earnings of $191.6 million, or $0.59 per share.
- The company successfully sold its master lease portfolio for $387 million, resulting in net proceeds of $188 million and a net distributable earnings gain of $37 million.
- Starwood Property Trust Inc maintains a robust liquidity position with $9.7 billion of availability under existing financing lines and $1.5 billion in current liquidity.
- The company's commercial and residential lending segments contributed significantly to earnings, with commercial lending alone contributing $205 million.
- Starwood Property Trust Inc accessed the debt capital markets, issuing $600 million of senior unsecured sustainability notes, enhancing financial flexibility.
Negative Points
- The company experienced underperformance in its CMBS portfolio, with a $17 million distributable earnings impairment due to lower-than-anticipated NOI and appraisals.
- Increased general CECL reserve by $35 million due to a pessimistic economic outlook, particularly affecting office loans.
- The infrastructure lending segment saw a decrease in portfolio balance to $2.5 billion due to high repayments totaling $210 million.
- Challenges in the macro environment, including higher interest rates impacting commercial real estate and leading to cap rate increases.
- Potential risks in the office loan portfolio, with a significant portion being in the asset class most disrupted since COVID-19.
Q & A Highlights
Q: This quarter has been a tale of two cities. While there's been ongoing credit migration, we've seen some positive surprises from the banks in terms of there being no big shoes to drop. At the same time, with the commercial mortgage REITs, there has been pronounced deterioration and broad recognition of losses. Starwood clearly is performing much better than peers. So I'm curious what you think explains the discrepancy if it's the nature of the transitional assets or more so, as you alluded to in your comments, the liabilities. And if it's the liabilities, that should open up opportunities for Starwood to be a net acquirer of weaker players that have very constrained capital structures.
A: (Jeffrey F. DiModica - President & MD) We did foreclose on some things early. We've been advantaged by having a portfolio that's set up to perform better in this market. With 11% U.S. office and the lowest leverage at 2.3 turns, plus tremendous liquidity, you would expect better outcomes. The difficult thing for this market, I think, and it goes for the banks and the nonbanks and all of us is looking at forward SOFR. If you go back to May of last year, forward SOFR in 2025 was going to be 2.6%. If you went back to October of last year, it was 4.6%. If you went to January of this year, it was back into 3.5% area. Well, Today, SOFR is expected in the middle of '25 a year from now to be 4.40% and a year later to be 4%. So we don't go below 4% for 2 years. We thought we were doing that a year from now by over 100 basis points. So I would say these reserve builds with SOFR having made a move significantly higher with the Fed being priced out and the spread versus the 10-year note, the 10-year note was 70 basis points above going back to the beginning of the year where forward SOFR was supposed to be in '25. Now it's below where forward SOFR is supposed to be.
Q: Can you talk a little bit about the outlook of migration of office loans from 3 to 4 rated. Last quarter, there was a pretty big increase. You've got a few this quarter. Are we just looking at a handful of loans each quarter? Are we getting closer to the end? And what's driving those movements this quarter?
A: (Jeffrey F. DiModica - President & MD) Clearly, this (inaudible) SOFR move that I talked about is putting stress on people. And I think the ability and desire to continue to put in capital in my prepared remarks, I said we had borrowers put in $1.3 billion last year and almost $0.5 billion already this year. If the forward SOFR curve continues to go higher, people are going to be less aggressive in doing that. And as they are less aggressive in doing that, and we have to have discussions about potentially carrying the loans or helping carrying the loans or potentially cutting rate by a little bit or anything that requires us to really be involved in the loan is potentially going to go noncurrent. We want to be in front of that and move it from May 3, which signifies something that is fully current and being supported to a date.
Q: Hoping you could talk a little bit more about the refinance on the medical office building looks like your debt against the property came down a little over $100 million, thoughts on that? And does that imply anything about the value of the properties?
A: (Barry Stuart Sternlicht - CEO & Non-Independent Executive Chairman of the Board) Less about the value and more -- service coverage -- but go ahead. Go ahead, Jeff. (Jeffrey F. DiModica - President & MD) Yes, Barry. I think you know that the properties continue to perform, but they're performing against the higher cap rate today, so the valuation is lower. It's not an income problem. It is a higher cap rate problem and the agencies are going to allow you to take a little bit less debt. Now the good news against that is against that, we tightened 25 basis points. The market felt really good about this. The agencies gave us good enhancement levels. We don't need -- like we're sort of happy to underlever this asset. So yes, we did put $100 million of equity in but it's a decent return for us of cash, and we're sitting on a lot of cash. And so we got a really good rate at $2.52 over on what we did take, which in this market feels pretty good, given high yield. We just issued that also for equivalent of $3.12 over.
Q: Just one thing. I'm curious behaviorally with really a significant change in sentiment in terms of rate outlook starting in January, higher for longer, if either within your portfolio or within the special servicing portfolio, you saw some sort of behavioral capitulation borrowers who thought they were going to get relief have an opportunity to buy caps cheaper, refinance in more attractive markets start to throw in the towel even more aggressively than we've seen.
A: (Jeffrey F. DiModica - President & MD) Yes. Listen, it's a really good question. It's only been a couple of months since we've seen this move. Volatility is not up. So the cap expense is still not quite as bad as it was when volatility was a little bit higher, but caps are expensive. You will find borrowers who may decide not to support, as I said earlier, on our multi -- this is really the multifamily side, where somebody is going to make a decision based on their need to buy a cap, and they're going to make a decision based on their view of cap rates, which are going to follow interest rates.
Q: I appreciate the commentary so far, Jeff, you talked a little bit about upcoming original maturity dates or cap expirations, maybe providing some opportunity. Looking at the other way on rates, what would increase transactions? Is there a clearing level on rates? If it goes back to 4.25 or 4, are there people that maybe were hoping for 3.5 early this year that all of a sudden move quickly because it gets back to 4, they missed their window. How do you think about a clearing level for rates of what creates more transaction opportunities?
A: (Jeffrey F. DiModica - President & MD) It's interesting. I think it's going to be cap rate dependent as well, right? You're seeing some multifamily trade in the low 5s. We've just seen some recently. You're seeing some office trade at cap rates that are better than you think they are sort of one-off. I believe if you
For the complete transcript of the earnings call, please refer to the full earnings call transcript.
