Starwood Property Trust Inc.

officer. With that, I am now going to turn the call over to Rena.

Thank you, Zach, and good morning, everyone. This quarter once again demonstrated the strength of our diversified platform with distributable earnings, or DE, of $153 million, or 51 cents per share. We were active on both the left and right-hand sides of our balance sheet, deploying $3.1 billion of capital and completing securitizations within our commercial, residential, and infrastructure lending businesses. I will start this morning with commercial and residential lending, which contributed DE of $127 million to the quarter. In commercial lending, we originated $1.7 billion across 12 loans, $1.4 billion of which was funded. We also funded $149 million of pre-existing loan commitments. Repayments were $1.1 billion, with A-Note and Mezloan sales totaling $231 million. This brought our commercial lending portfolio to a record $11.5 billion at quarter end. Despite $3.6 billion of loan repayments and sales post-COVID, our portfolio has grown nearly 25% over the past year. Also in the quarter, we completed our second CRE CLO, which totaled $1.3 billion. The CLO is actively managed with a weighted average coupon of LIBOR plus 150 and an advance rate of 85%. allowing us to move a significant amount of our existing repo financing to a term-matched, non-recourse, non-mark-to-market structure. We continue to see strong credit performance in our loan portfolio, with a weighted average LTV of 61%. Over 80% of the repayments this quarter were in office and hotel, and our retail exposure remains low at 3%, with nearly all of this exposure in a single loan, which has a significant entertainment component. We continue to have 100% interest collections and less than 2% of our loans on non-accrual. On the CECL front, our general reserve declined by $12 million in the quarter to $48 million due to improved macroeconomic forecasts. To conclude my comments on commercial lending, we have discussed with you previously certain loans related to a residential project in New York City. The foreclosure of the condo units representing our collateral in those loans was formally completed this quarter. You will now find the entirety of the project reflected as property on our balance sheet. In connection with the foreclosure, we incurred transfer taxes, which reduced distributable EPS in the quarter by two cents. Our residential lending business was also active. In our loan portfolio, acquisitions totaled $663 million, and we completed our 11th and 12th securitizations, totaling $564 million. Of the loans we acquired this quarter, 172 million resulted from unwinding one of our 2019 securitizations. This will allow us to significantly reduce the financing cost of these loans upon resecuritization. Our loan portfolio ended the quarter with a balance of 637 million, a weighted average coupon of 5.2%, average LTV of 68%, and average FICO of 739. Our retained RMBS portfolio ended the quarter at $232 million after retaining bonds in our Q2 securitization, selling previously retained bonds, and accounting for the impact of elevated prepayments. Next, I will discuss our property segment, which contributed $20 million of distributable earnings to the quarter. The credit performance of this portfolio remains very strong, with rent collections at 98 percent weighted average occupancy steady at 97%, and blended cash-on-cash yields increasing to 18.5% this quarter. Next, I'll turn to investing and servicing, which reported DE of $48 million. Our conduit was very active with 542 million of loans securitized or priced in three transactions, two of which settled subsequent to quarter end. Consistent with past practice, the two transactions which priced in June but settled in July are treated as realized for DE purposes. Our next securitization is not expected to price until September, so we expect a lower contribution from this business in Q3. In special servicing, fees increased by 31% this quarter to $16 million, due primarily to COVID-related modification and liquidation fees. While the timing of such fees cannot be predicted with certainty, we expect to see at least some portion of COVID-related fees in earnings going forward. We also continue to focus on obtaining new servicing assignments. Subsequent to quarter end, we were named special servicer on 12 CMBS trusts with a balance of $12.2 billion, bringing our pro forma named servicing portfolio to $91.3 billion and our pro forma active servicing portfolio to $8.7 billion. And finally, on this segment's property portfolio. During the quarter, we sold an asset with a cost basis of $25 million for $30 million, resulting in a net DE gain of $5 million and a gap gain of $10 million. At quarter end, the undepreciated balance of this portfolio was $250 million across 14 investments. Concluding my business segment discussion today is infrastructure lending, which contributed DE of $8 million to the quarter. We acquired $168 million of new loans and funded $23 million under pre-existing loan commitments. Repayments were $85 million, which increased the portfolio to $1.8 billion. On the right-hand side of the balance sheet, we completed our inaugural $500 million infrastructure CLO, which provides a significant expansion of our credit capacity, along with a term-matched, non-recourse, non-mark-to-market structure. The CLO is actively managed with a weighted average coupon of LIBOR plus 181 basis points and an 82% advance rate. I will conclude this morning with a few comments about our liquidity and capitalization. In addition to the securitizations we completed in Q2, subsequent to quarter end, we securitized a $230 million extended stay hotel loan in our commercial lending portfolio at a 91% advance rate. This allowed us to generate excess liquidity while lowering our exposure to recourse debt. Also subsequent to quarter end, we issued a $400 million unsecured sustainability bond with a five-year term and a fixed coupon of three and five-eighths. The proceeds will be used to retire a portion of our December $700 million 5% unsecured notes when they open for prepayment at PAR in September. In addition to financing capacity available to us via the securitization market, we continue to have ample credit capacity across our businesses, ending the quarter with $8.3 billion of availability under our existing financing lines, unencumbered assets of $2.8 billion, and an adjusted debt to undepreciated equity ratio of 2.2 times. This credit capacity, in addition to our current liquidity of $1.3 billion, provides us with ample dry powder to repay our December unsecured note maturity and execute on our pipeline. With that, I'll turn the call over to Jeff for his comments.

Thanks, Rena. My comments this quarter will be relatively brief, highlighting another strong quarter of activity on both sides of our balance sheet. I'll start by discussing our capital markets activity during the quarter. As Rena said, we issued $400 million of unsecured sustainability bonds at a three and five-eighths coupon in July. which was the tightest priced five-year unsecured bond offering on record for a mortgage REIT. Our offering was over four times oversubscribed with $2.2 billion in orders. Today, our outstanding unsecured bonds trade in a secondary market that yields between 2.75% and 3.25%, which gives us the option to issue very accretive capital to grow the business or pay off the remainder of our 5% coupon bonds that mature in Q4. For the first time, we chose to engage Fitch to rate this transaction and received a BBB Plus corporate and bond rating from them. In rating us BBB Plus, Fitch cited the diversity of Starwood's business model, strong asset quality, consistent operating performance, relatively low leverage, appropriate interest coverage, a diverse and well-laddered funding profile, and solid liquidity. Given where our bonds trade, we believe the bond market concurs with this view. During the quarter, we also closed on our second CRE CLO, a $1.3 billion transaction, and our $500 million inaugural energy infrastructure CLO, and subsequent to quarter end, completed a $230 million SASB securitization on a well-performing limited service hotel portfolio in our CRE loan book. Along with selling ANOTE senior mortgages, these securitizations importantly reduce our percentage of secured debt subject to credit marks and recourse, which has continued to be well below 50% of our CRE financing and contributed significantly to our best-in-class liquidity in the depths of COVID. These transactions also significantly increase our returns on the equity in these transactions. Our CRE lending business continues to take advantage of the momentum we built over the last 17 months, investing in every segment in every quarter since COVID began. Rena mentioned we originated $1.7 billion of CRE loans in our commercial lending segments in Q2, and we are on pace to have a record origination year in 2021 and expect to do so by the fall. Commercial and residential real estate fundamentals continue to improve, asset prices continue to increase, and we believe our credit-first culture has led to credit outperformance in excess of the market's rebound. As we said on our Q1 earnings call, Our base case modeling today suggests we will have little to no losses on our loan book as a result of COVID, a statement none of our peers have made to date. We used our best-in-class financing to more than double our multifamily loan exposure over the past year. In that time, our office loan exposure as a percentage of our loan book is down 24%, our hotel exposure is down 11%, and our exposure to construction loans is down 61%. As our book has become less transitional, we've also cut our future funding exposure in half over the last 18 months. We've used the scale and footprint of Starwood Capital to consciously increase our international exposure by 42% since the start of COVID, and that book is now a record 27% of our lending portfolio. We expect to continue to increase our exposure to highly accretive international loan opportunities in the coming year. We are finding higher returns internationally versus the US where lending markets rebounded more quickly after COVID and where we often see more competition on loans. Our own property portfolio has benefited from lower cap rates and the significant liquidity in the real estate capital markets today. The unrealized gain on our property portfolio rose again this quarter to over $1.3 billion or approximately $4.50 per share. Florida multifamily has been one of the biggest beneficiaries of our country's southern migration, lower taxes, and growth. As a result of another cash-out refinancing we will execute imminently, we will have a negative basis in our Florida multifamily portfolio, which is conservatively worth well in excess of $2 billion today and accounts for over 80% of our property segment gains. I will remind you that rents cannot go down in this 99% leased portfolio and will continue to rise with median income in their specific MSAs, which are centered around Orlando and Tampa, two of the fastest growing MSAs in the country. These gains put us in the enviable position of being able to choose whether to harvest them to reinvest and grow earnings or retain them at a very accretive yield and ensure our unparalleled dividend coverage. I will finish by saying management and our board are proud of the way we set up our company to outperform in volatile markets. And we will use our credit first lens to continue to work diligently to find opportunities to continue to diversify our business. We have been in business for over 12 years and invested over $70 billion with only one basis point of realized CRE loan losses to date, which has helped lead to an industry best 13 plus percent annual return to shareholders since inception. With that, I'll turn the call to Barry.

Good morning, everyone. This is Barry Sterling. It's fun to follow Jeff and Rena when the firm's nearly 350 professionals are all rolling in the same direction. And that's in addition to a team more than twice that size at the parent Starwood Capital. The overall real estate markets remain extremely healthy. Abundant liquidity is powering the values in everything, stocks, bonds, VC, private and public debt. Real estate is, after all, a proxy for yield, and people worldwide are in search of yield. Rates are cooperating and spreads have continued to come in. Real estate, AAAs still remain at spreads wide of corporate AAAs and capital is flowing to arbitrage these returns away. Capital is also flowing to the best and most safe asset classes like multifamily and industrials, causing pricing to become extremely stretched. Pricing remains not so attractive for hotels because the markets are assuming they will recover to full 2019 levels. While that may be true in some cities and some assets and other assets that could exceed 2019 levels, it's certainly not true overall for some period of time. The market seems to be a little ahead of itself in the hotel space. And then there's the office markets where vacancy rates in cities like New York and San Francisco are approaching 20%, including pressure on costs, including real estate taxes, and it's very hard to underwrite these cities at the time. I'm pleased to say we have very little, almost no exposure to either city. And that has made us smile through the pandemic. It is tricky to underwrite real estate right now with cap rates moving down so fast in some of these asset classes. But we remain happy 12 years into our creation that our loan to value in our portfolio is still 60%. The rental markets in single family and apartments are the best they've been in years. People are seriously wealthy. Look at retail spending, leisure travel, home prices. And everywhere you see, people are spending money on most everything. And now you have Washington putting kerosene on open fire, pending two large spending-free bills that will continue to power this economy forward, but in a very unbalanced and, in my opinion, unhealthy way. There are 9.5 million job openings in the United States, and the government really should figure out how to help people get these jobs and take these jobs rather than paying them to sit on the sidelines. by video games, iPhones, Netflix subscriptions, and all their goods that are made in China. Turning to us, we've worked hard for many years on something people give us little credit for. One of the key issues with mortgage rates historically has been mismatched term. That is loans that may refinance or be paid after or before the underlying debt that finances those securities. Our moves to CLO and the securitization financing have changed this and built a fortress balance sheet for Star Property Trust. We've always done this in our condo, but it's now part of our regular business in our large loan book, in our resident lending book, and for the first time ever in our infrastructure lending business, which was critical for our willingness to grow that book. Another item you may have noticed in our financials is that almost 30% of our book is now international, and we're leaning hard at our star capitals operations internationally. We have more than 60 people in London. We recently hired a new head of lending in Australia. And we continue to focus on these opportunities because they are, frankly, better spread, less competition, more relationship-based. And we are one of the few doing this in the mortgage business in the United States. So it is another major differentiator of our firm. And together with our European group, we're looking at some very large opportunities that really only come to us because of our scale. And any one of them would accelerate our growth and continue to increase our balance sheet. We are quite excited about those opportunities that are unique to us because of our scale. One other item, sometimes issues become opportunities. As many of you will recall, we were the first mortgage lender alongside some of the nation's largest money center banks in the American Dream Mall. It is dominated by entertainment and amusement rides, and the mall itself has now reached 82% occupancy. And I'm certain that our investment is sound as it represents roughly one-third of the construction costs. Make no mistake, the competition today is fierce. We are grateful that our company's scale, our funding costs, and our global reach continue to provide great opportunities for our company. We are on the offense in every market, and our last board meeting we considered more than a dozen additional verticals we could add to our platform. We'll be working to size and focus on these opportunities and see if we can accelerate our growth, improve our ROE, and continue to deliver on our goal at our IPO just 12 years ago, which is to provide safe, consistent, reliable dividends with best-in-class transparency so our shareholders can see what we own and how it is performing and ask us any questions they may have. Thank you today for your time and to our team, which is world-class.

Thanks, Barry. And with that, we'll open it up to questions.

Thank you. If you'd like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question comes from the line of Rick Shane with JPMorgan. Please proceed with your question.

Hey, guys. Thanks for taking my questions this morning. Just a quick question. When I look at slide 27, which shows your financial capacity, it's a very helpful walk. The big change quarter over quarter is an almost $600 million increase in approved and undrawn credit capacity. I just would like to understand what drives that change. Was there something contractual or does that have to do with repayments that have not been drawn again?

So Rick, it's Rena. I'll take that. A big driver of that increase is going to be the $400 million unsecured sustainability bond. So when we get cash in like that, we'll take that cash and pay down our lines, which drives up approved but undrawn capacity. So you're paying down repo with unsecured until you get to September when we'll pay down our December maturity early or a portion of our December maturity early, and then you'll have to draw back up your repo lines for that number will come down. So it's a timing issue caused by the unsecured issuance.

And Rick, I'll put a final point on it to help you sort of understand the value and power of the ability to accordion those lines. We have repo lines that are anywhere from LIBOR plus 125 on the bulk of our newer assets in our multifamilies lately, all the way out to maybe LIBOR plus 275, even 300 on some older, more transitional loans. So When we get a dollar of cash in, the first dollar pays down a LIBOR plus 300 loan and the next dollar might pay down a LIBOR plus 275 and then maybe even a LIBOR plus 250. So on our cash, we earn mid to high 2% on cash and most corporates don't have the ability to do that. It's pretty good in a world where we're raising debt at LIBOR plus 250 to 270 in the bond market. to know that we could raise debt and sit on it and really not have any negative drag because we get such a high return on our cash by what's effectively you see as increasing our improvement on drawing.

Got it. Okay. Very helpful, guys. Thank you very much.

Thank you. Our next question comes from the line of Tim Hayes with BTIG. Please proceed with your question.

Hey, good morning, guys. Thanks for taking my questions. And just, I guess, sticking on the theme of kind of liquidity here, I mean, you have a very strong liquidity position despite the very strong growth you've had over the past year. And I'm just curious, you know, as you look back to kind of pre-pandemic levels, how does your liquidity compare today? Do you find that there's a bit of a drag on earnings from having such an outsized liquidity position? And I'm just curious also, it's kind of like part B to that is, you know, what portfolio size can your current capital base support?

Yeah, that's a great question. You know, there's a few pieces to that. I would say that we have a December maturity coming up. We raised $400 million of that $700 million. We probably thought that we would pay off the remaining $300 with cash on our balance sheet. We've had a decent amount of repayments coming back as the market has come back. Performing assets have certainly paid off a little more quickly in 2021, which is created cash. So, I think we're sitting marginally higher in cash than where we would be optimally. Last year, we probably sat on an average of $400 million plus minus of cash more than normal, worried about a second dip in the market. We've probably cut that in half, but I think we're still being conservative. COVID's not over. We want to make sure we have access to tremendous liquidity, which we do. We have $2.8 billion of unencumbered assets. As I said before, we can raise capital in the high yield market very well. And the equity market is certainly cooperating. And we have a $3 billion property book that obviously we've talked a lot about. So we have a lot of ways to still raise cash, but we still think it's prudent to hold a little bit higher cash balances in this uncertain recovery than we did pre-pandemic. So We're getting a little bit of drag. You know, maybe it's two cents or so, but it's not the four or five cents that it was a year ago.

No, that's helpful, Jeff. And just part B of that was just kind of the, you know, obviously I'm sure your liquidity position can support some nice growth here, but what portfolio size can your current capital base support?

You know, it depends on leverage, right? If we wanted to run our business as highly levered as some of our peers, we could have a much bigger portfolio. We've never chosen that path to date. Obviously with the equity market where it is, we can grow the equity base and grow a bigger portfolio as well. You know, the wonderful thing for us is having seven investment cylinders and looking at a number more. We have the ability to really continue to grow I guess infinitely. I would say if we were a one-trick pony and all we did was wake up every day and make loans, and it's the only thing that we could do, I'd start to be uncomfortable if that loan book got over $20 billion or so, because these loans average two and a half years. And at $20 billion, you would need to write $8 billion a year just to stay invested. And coming out of the GFC, we went from $500 billion of loans a year before the GFC to 75 billion, then 100 billion, then 150 billion. In 2020, we were well below that 500 billion. And if you need to write 8 billion of transitional loans, Just to stay invested is the only thing that you do. And you have another year like 2020, it's going to be difficult to put that money out unless you're willing to be a higher percentage of the market's loans. And that means, by definition, that you're reaching for credit that you wouldn't have done in a more normal market. So I think the size of a CRE lending business alone is $20 to $25 billion is the most that I would think you would want to be. But again, we have the ability across. And it's one of the reasons why our cylinders, we've continued to add and we continue to look. We have the ability to be a lot bigger than that.

The only thing I can say is that we'd like to be bigger. At some point, we'd be healthy to raise capital, but we don't need it anytime soon, sadly. We'd like to have an opportunity to do something, whether it's an acquisition or one of these new businesses I talked about. But some of them are actually more focused on generating ROE. and won't deploy tons of capital, but work off our knowledge base and information that is proprietary to the firm. So we have some things we've been working on, and we'll see if we can execute them. And the goal is to balance those high ROE businesses against the lower ROE businesses of our large loan lending book and even our infrastructure lending. So it's interesting how the whole business sort of hedges itself. We've benefited. rates rise differently when rates fall. So it's been a pre-balanced growth story for us, at least earnings story, I'd say.

No, absolutely. And that's good to know. I mean, on the capital side, I'm just going to shift gears, I guess, Jeff, because you mentioned and highlighted all the gains, again, in the property book and how that could be a source of liquidity for you and and act as a mini capital raise as you harvest gains there. But it's been a goal of yours for quite a while to harvest those gains, and you continue to see those assets depreciate, but still nothing to write home about there in terms of crystallizing those gains. So just curious if you feel you're getting closer to coming to terms with some kind of agreement there and then selling a stake in any of these portfolios or just anything to report along that initiative.

Yeah, so I think it's a lot more powerful than a mini capital raise. A mini capital raise comes with the cost of the equity dividend. In this case, we're just freeing up cash that we could reinvest. So it's much more powerful and accretive to earnings, any dollars that we take out of gains and property because they're just sitting as a gain and there's no direct cost to us as there is on the equity side. So it is more powerful. We've been working for for a good chunk of this year to get the right timing, and timing means a lot. There were some tax changes that were happening in Florida. We wanted to let them settle in, and they came out favorably for us. And now with those having come in, I think that that's something we'll continue to work on, as much to sort of prove to the market that our gains are what we say they are, as it is to get that excess capital that, as you've mentioned previously, we don't really need today, but we think we have plenty of places to be able to deploy it credibly. We'll continue to work through the year on it. These things take a little time and we really slowed down a bit just to make sure that we waited out the tax changes that happened in Florida over the last month.

Gotcha. Okay. Got it. Well, thanks for the color this morning. I appreciate it.

Thank you.

Thank you. Our next question comes from the line of Don Fendetti with Wells Fargo. Please proceed with your question.

I was curious in your hotel portfolio, what you're hearing from owners in terms of the Delta variant, any travel behavior changes, bookings, cancellations, just checking in on that.

I'll let Barry start there. Nobody's closer to this than Barry. Barry, you want to start, and then I'll give some numbers?

Yeah, I don't think our hotel portfolio at the moment represents any exposure to the company. Jeff will tell you that we haven't had any losses in our hotel book. Um, you know, the market valuation of these assets has been astonishing. I mentioned in my comments that, you know, you're seeing hotels traded four caps and five caps. And I just don't think the big urban boxes are going to get back to 2019 levels for quite some time. And at the same time, while your revenues are not there, your, your property taxes are rising. Your costs are going up, labor costs are going up if you can find labor. So, um, We're being very cautious on how we underwrite the sector right now. And more importantly, what's the valuation? Because people are paying big, big prices for hotels and I don't think we can lend against some of these prices people are paying. So we have to be super careful. I just think there's so much capital, inflating values everywhere. At least in the multi-industrial, you have rising rents, which are real, and actually rising at an ever faster pace. And of course, rents are much more determinant in value and more important than small moves in interest rates. So the explosion of rents in single-family and in multis and in industrial, you can't really see that in hotels, although this isn't really a rate issue today. It's really an issue of occupancy and staff. Even if you have demand, you can't run some of your hotels full because you can't get people to work in the hotel. And that's across the whole country. I've talked to every CEO in the hotel industry, and we're seeing it ourselves in our thousand or so hotels we own in the equity side. So it's quite an interesting situation. But I don't think the firm, and Jeff will give you the numbers, but I don't think Property Trust has really any material exposure that I'm aware of really in the hotel sector right now.

Jeff? Yeah, Barry, I'll throw some numbers at it. We've talked a lot about, and you mentioned we haven't had any losses. Our extended stay portfolio is about a quarter of the 8% of assets that are in hotel. 8% of our company's assets are in loans on hotels. About a quarter of that is an extended stay, which has performed tremendously well from the get-go, right out of the gates in COVID. That stayed highly occupied, and ADR has never moved down very much. Limited service has come back very strong. That's another quarter or so. Destination is about a quarter. Our three largest loans in the hotel business are destination, and that's what we're seeing come back the fastest post-COVID in trading very well. And as Barry said, the urban sort of travel boxes is something that we've historically avoided. We have one loan in all of Manhattan, and it's a senior mortgage where we moved out of the MES last year. So we're very comfortable with that. We're also very comfortable that of the $800 million that our world-class sponsors have committed to their projects, since the beginning of COVID, $620 million of that is on the hotel side. So when we lend in hotels, we tend to lend to very well-capitalized sponsors. It's a central tenant for us, and it's something that Barry insists on. And we've seen them prove their liquidity and their desire to hold onto these assets with that massive equity injection. So I can't, as I look down our list of hotels, there's nothing in our hotel list that I'm worried about from a payoff perspective with what we know today. So we're super comfortable with it, but as Barry said, we're being cautious going forward.

Yeah, I mean, certainly, you know, you guys are in great shape. I was just more curious if you're sort of hearing any changes in trends at the property level and maybe some destination areas, if there's any impact on the ground from an occupancy standpoint.

You mean from the COVID variants emergence?

Yeah, exactly.

I would say no, not really, not yet. I'm really talking about our equity book here. I don't have the daily financials of the hotels we lend to, but we have a pretty good template. New York, Brooklyn, it's actually shocking how good the occupancies are. Brooklyn's running 85%, New York 580. West Hollywood, L.A. These numbers have been picking up. They're not going the other direction. So you'd expect some – actually, in Europe, you're seeing the opposite. You're seeing hotels cancellations. People are worried about the variant. And it's interesting because Europe has now more vaccines than it did. I think they got the wrong vaccine. I think some of the AstraZeneca may not have an effect on the Pfizer vaccine. So they are definitely – are not as busy in August as they were in July.

Got it. And then I guess I know in the past, on the call, it sounds like valuations are very high because of liquidity. So I wonder if some newer areas like mortgage origination that I think you've talked about in the past even become more interesting, particularly given where valuations have gone in that business. Are you still looking at those types of acquisitions? or are they going to maybe not be available?

By mortgage originations, I guess we do that in all of our businesses. Can you be more specific? Are you talking about agency mortgage lending? Sure.

Yeah, exactly, Jeff. Residential mortgage origination. I know in the past you've expressed some interest in that business, just given the returns are pretty high.

Yeah, listen, we do originate mortgage loans on the residential side already, mostly in the non-QM space. When you talk about agency, I think you might be talking about agency multifamily, which is a business that a number of our peers are in. That's something that we still would love to be in. We think it's an area of expertise for our firm. There's only low 20s licenses from Fannie and from Freddie. They're mostly very well used and we'll continue to look at opportunities to get involved in that space. I think if we had one thing and we could pull a magic lever and create a license for ourselves, we would love to be involved in that business and I think it's a great hedge and a great offset for other things in our portfolio and the servicing is is obviously going to be worth a decent amount of rates ever back up. So, yeah, that's a business we continue to look at. We just have to find the right way at the right cost to our shareholders to be involved in it.

Thank you. Our next question comes from the line of Stephen Laws with Raymond James. Please proceed with your question.

Hi, good morning. Jeff, you mentioned the seven cylinders a few minutes ago, and I realize you mentioned there's maybe a cap on how big you'd be want the loan portfolio to get. But, you know, when you think about the next dollar out the door, which of those cylinders is currently providing the best returns? And, you know, maybe as we look out 12 or 18 months, which of those cylinders do you see growing the most as a mix of the business?

Barry, do you want to start or do you want me to? Why don't I give it a start?

Go ahead. I'll follow up.

Yeah, I would say last year, I think on multiple calls, Barry and I both said that the residential business were buying loans at discounts and ultimately securitizing them to a very strong securitization bid, looked super attractive. The energy infrastructure business where we've done our first CLO now, and that's a key component for us to continue to grow that business. levered yields there are mid-teens to us. And we think that's a super attractive business. There aren't a lot of people writing loans at slightly higher spreads than the banks and below the private equity guys who don't have our ability to finance the same way. So we think we have a sweet spot there. I will tell you that in the last couple of quarters, there's been nothing better than our commercial lending business. Internationally, we're seeing tremendous opportunities. I mentioned on the call, we'll have a record year by the fall on the loan origination side, transitionally. So I think that's been a great business. The conduit business, obviously with spreads grinding tighter, we tend to make more money. And we are the number one non-bank originator of CMBS now. We've been that since COVID started as we stayed in that business where other people pulled away. We'd love to do more there, but our business model isn't really set up to grow dramatically beyond a couple of billion dollars a year. We tend to do smaller loans, high touch, that we can be a little bit more nimble and profitable on and leave the bigger loans for market share reasons to the banks who want to have that market share. I think those are businesses that we would lean in on, but today it feels to me like the CRE lending business, our core business, is a fantastic opportunity to keep putting money out. We still like Rezzy. We would love to do more. On the energy side, there's obviously been less deals, as you've seen coming out of the capacity auctions and other. There's less need, and we'll probably see some decommissioning there. But we think there's some great opportunities in midstream. In general, I would call the CRE lending business the best opportunity over the last six months and probably the next three. Barry?

The only thing I'd add, obviously, our servicers are the highest ROE there is. And, you know, looking at ways to make more money and fees in what we do, is an interesting thing for us to be focused on because that is unique to us in the whole competitive set. And there are other asset classes that have to be re-compliant. We still have, as the largest mortgage rate, we have a large bad bucket, but we still get taxed in that bucket. So the hurdles have to be higher in order to use the bucket for non-readable lending. But there is stuff we're looking at, so stay tuned. We're uncovering a lot of rock. We've completed a three-year plan, and now we're going to polish it up and then hopefully execute it.

Great. And one follow-up on the Europe opportunities have been mentioned, Barry and Jeff, both kind of throughout the call. Can you talk about what type, where in the capital stack, and maybe what property type and regions you expect to And has the COVID or Delta variant or have any restrictions in Europe made certain countries less attractive than maybe would have been attractive before COVID?

I'll take it, Jeff, and then you can have it if you want. I mean, most of our lending business has been in Ireland and the UK and some of the stuff in Spain, occasionally in Portugal. you know banks are pretty aggressive very low loan to value so there's always an interesting position for us if somebody wants to take more debt we'll look at any asset class and we've done on the equity side so we've invested in the equity side of data center in london so we we love the data center business as a lender life sciences all of the you know that you've heard from other companies what people are lending on i just think we have to be we have to watch out for supply because um you know it isn't really The good news about the cycle for real estate and for real estate lenders is construction costs are galloping forward across the globe. And so our loan to value, I bet if we actually looked at replacement costs, it's probably dropped 5%, 10% because you can't replace these buildings anymore for what these people bought them for or what our loan exposure is. As you know, rents have to rise theoretically to justify construction unless people are willing to accept 3% yields on costs for construction deals. So far, the market hasn't gotten that bad, but it's dangerous when rents are rising. What developers do is they trend the rents, and they basically say, well, I'll get that rent up to 8% for three years. When I complete my project, the rents will be 24% higher. and 50 other developers, it's the same thing. And then, of course, it doesn't happen because everybody has the same model, and then you wind up with a three-year ongoing cost. So, you know, the good news is rates continue to stay low and look like they'll stay low for reasons that I think, for those of us who went to economics class, you know, it's really the sheer weight of $12, $13, $16 trillion of money just sitting on rates globally looking for yield. And it's just there's so much money out there and everyone's You're looking for anything that has a yield in it. And it's obviously an interesting market. You have to be careful. But I like where we're pushing, certainly relative to other asset classes, even the BDCs. They're lending against companies and multiples that are historically quite high. So we'll see how this all plays out. But we'll continue what we're doing.

Yeah, I don't have a lot to add to that, Barry. You know the spots. I would say multi-office, industrial, starting to look at data centers in Europe, certainly less competition there. You don't have debt funds that can write loans with two guys in a Bloomberg and a broker relationship voyeuring into the European market. So certainly having less competition there and larger deals by nature is helpful for us as well.

Thank you. Our next question comes from the line of Jade Romani with KBW. Please proceed with your question.

Good morning. This is Ryan Tomasello on for Jade. Thanks for taking the questions. On the M&A front, I was wondering if you believe there are any acquisition opportunities that you potentially explore that could be beneficial to the company's cost of capital and goal of reaching an investment grade rating at some point.

Yeah, Barry, you want me to start? Go ahead, Barry.

I'll start, then you can pick up. You know, my feeling is that, you know, we love to get investment grade. You know, I think our primary goal there would be to be bigger. And so I think the rating agencies look at us and say, you know, what is our coverage for our debt? How diversified is our cash flow stream? How insulated is it from economic cycles? And I think just your scale helps you there. And, you know, we're growing our balance sheet, which is great. And we have almost $3 billion of unencumbered assets, which is great. I think we may have lost Barry a bit.

Why don't I take up for a second as he was starting to talk about rating agencies. I would say that we built a purposefully unique company. Unfortunately, the company doesn't fit into a box. It's much easier when the company fits into a box and you're going into a rating agency's model. As I look at the rating agency models, one of them doesn't add back depreciation on our portfolio. So as we fully depreciated, it would assume that the property is worth zero. They do the exact opposite on property REITs. They do add it back. And for some reason, even though we're a hybrid between a property REIT and a mortgage REIT, they don't add it back for us. In some calculations, that's $420 million of equity that is lost on our balance sheet. It makes us look more levered than we actually are and than any property would be. On the CMBS side, they don't count below investment grade CMBS in our equity calculation. Again, making us look significantly more levered. I argued on 10-year newly originated, newly appraised fixed rate loans with three times debt service coverage, you're effectively telling me I'm not going to get the August payment of interest by giving me no credit. You could give us zero credit at the end if you assume every CMBS loan is going to be bad in 10 years. But by that point, I've recaptured my full investment, which is a discount investment. And so to give us zero credit on our equity makes no sense. We have billions of dollars today in CLO liabilities. And despite them being non-recourse with no margin calls, they're treated the same way as repo in the rating agency model. We have a lot of work to do to get to investment grade. We have a lot of explaining to do with the rating agencies, why they need to look at us outside of a box and take metrics that come from a bunch of places. We're happy-ish with Fitch coming in at BB+. The bond market certainly trades us as a closer to investment grade company than others who are rated similarly to us, but We think when the rating agencies come around to sort of understanding our business better, that we have a much better shot at getting really close to investment grade, which would be wonderful for our financing costs and would, as Barry said, allow us to really help growing the business. You would also ask about cylinders, and I believe about M&A stuff, and Barry took on a lot of that, but I would say coming out of our three-year plan, we probably have eight or ten related businesses to what we do, I could go through some of them, but sort of add-ons to our existing businesses and then a few potentially slightly new businesses. But our task from our board over the next 12 to 18 months is to show some progress on those. So hopefully we'll be able to show you all some progress on those as well. There are reasons that we don't do. We look at every business. We put a list together, and I think we've looked at 30 or 40 different companies and looked at them multiple times. There are reasons that some of them won't sell, and there are reasons that we're not going to put our shareholders in them because we don't like some characteristics of the business. So it depends on how the markets sort of open up to us and at what price and at what premium we're willing to pay to get into some of these newer businesses. But I can assure you that we have a whole team of people looking at them all. Anything that we could add that would be accretive and smart and a good credit play every day.

Great. Thanks for that. And I appreciate your comments. around the CMBS business with the expected pricing of your next deal likely slated for September. But can you talk more broadly about your outlook for the back half of the year in terms of conduit volumes? You know, I guess you expect volumes to be consistent or grow in the back half versus the first half of the year.

You know, markets are cyclical. People see other people making money and they all jump in and they all jump in at the same time. And people like us who stayed in every quarter and wrote loans and became the largest non-bank originator, you know, other people will draft off that success and we'll have more competition going forward. This year for the first time, you know, the SASB market will be significantly bigger than the CMBS conduit market, which is really interesting. We don't tend to play much on the SASB side, although we just did a SASB securitization of some select service hotels in our portfolio that was priced a month or so ago and came off very well. But SASB is actually the biggest. CLOs are significantly bigger today, I think, than the conduit market as well. So if we want to do more CLOs, there's sort of two ways to do it, right? We can continue to do what we've always done, which is write loans for our balance sheet that fit our cost of capital with our available sources of financing. A-notes are a perfect match, more expensive but more safe, no margin calls, no recourse, no credit marks, and no cross on the assets. We'll continue to sell A-notes. We've sold more A-notes than all of our peers combined. We'll continue to use the repo market, which is the bank warehouse financing market, which is grinding in dramatically and giving us the reason. One of the reasons I like this part of our business probably better than others is the banks are all flush with cash, as everybody is now trying to do CLOs. The banks have less assets on their warehouse line businesses, and they want to grow them, so they're giving us better costs of funds and better advance rates there. So we'll continue to use those, and we'll write loans hoping that ultimately we can look at our portfolio and do another CLO, but we won't do what so many people in our space do, which is write loans to a CLO exit. The CLO exit is a higher advance rate and a lower cost of funds, but the CLO market goes away for six months out of every 18 months. It hasn't gone away in the last little bit, so now everybody's writing loans to their If you get hung with those loans and you don't get the CLO exit, your expected 12 IRR might be an eight or a nine and you're exposing yourself to credit marks and recourse and things like that that you don't really want to do. So I think of the 21 new businesses that we showed to our board, one got an X through it and that was let's originate loans to a CLO exit. It's just too risky. It's not a smart business plan, it's a trade. And if we've proven anything over 12 years, We're in this for the long run and not for a trade. So we'll do a CLO when it makes sense with things on our balance sheet and we can finance them better. And unless we have those assets, we're never going to write loans to a CLO exit assuming that the capital markets will be there. That's just a trade.

Thanks for taking the questions.

Thank you. Ladies and gentlemen, as a reminder, if you'd like to join the question queue, please press star 1 on your telephone keypad. Our next question comes from the line of Doug Harder with Credit Suisse. Please proceed with your question.

On the one hand, you said there's a lot of capital chasing real estate and just to kind of some of what lending is kind of the most attractive opportunity. I think you could kind of square those two comments.

So, Doug, you were cutting out, you might not be aware, and maybe it was just for me, I don't know if he was cutting out for others, but what I think I heard in a couple of pieces of it were that there's a lot of capital chasing CRE, the capital markets are very liquid, and that we are also saying that the CRE lending is super attractive and that maybe you're making the supposition that maybe those don't go together. Is that fair?

I'm sorry, Mr. Harder has disconnected. There are no other questions at this time. I'll turn the floor back to management for any final comments.

Well, terrific. Thank you, everybody, for your time. We're looking forward to talking to you again in three months, and that's it. Thank you very much.

Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.