Starwood Property Trust Inc.

Greetings and welcome to the Starwood Property Trust's third quarter 2022 earnings call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Zach Tannenbaum, Head of Investor Relations. Please go ahead.

Thank you, Operator. Good morning and welcome to Starwood Property Trust's earnings call. This morning, the company released its financial results for the quarter ended September 30th, 2022, filed its Form 10-Q with the Securities and Exchange Commission, and posted its earnings supplement to its website. These documents are available in the investor relations section of the company's website at www.starwoodpropertytrust.com. Before the call begins, I would like to remind everyone that certain statements made in the course of this call are not based on historical information, and may constitute forward-looking statements. These statements are based on management's current expectations and beliefs and are subject to a number of trends and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. I refer you to the company's filings made with the SEC for more detailed discussion of the risks and factors that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today. The company undertakes no duty to update any forward-looking statements that may be major in the course of this call. Additionally, certain non-GAAP financial measures will be discussed in this conference call. Our presentation of this information is not intended to be considered an isolation or as a substitute for financial information presented in accordance with GAAP. Reconciliations of these non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP can be accessed through our filings with the SEC at www.sec.gov. Joining me on the call today are Barry Sternlich, the company's chairman and chief executive officer, Jeff DiMatteca, the company's president, Rina Paneri, the company's chief financial officer, and Andrew Sossin, the company's chief operating officer. With that, I am now going to turn the call over to Rina.

Thank you, Zach, and good morning, everyone. Our business continues to produce strong earnings and a stable dividend while maintaining ample liquidity. This quarter, we reported Distributable Earnings, or DE, of $163 million or 51 cents per share. GAAP net income was $195 million or 61 cents per share. And our GAAP book value grew by 14 cents in the quarter to $20.82 with undepreciated book value increasing 18 cents to $21.69 from prior quarter. Beginning my segment discussion this morning is commercial and residential lending. which contributed DE of $153 million to the quarter, or 48 cents per share. In commercial lending, we originated $936 million across 10 senior secured first mortgage loans, all of which were floating rate and 76% of which were multifamily and industrial. We funded $657 million of these loans, as well as $211 million of pre-existing loan commitments. We also had $588 million of repayments during the quarter, resulting in a consistent portfolio size of $16.4 billion, up 36% year over year. Of this amount, 92% represents senior secured first mortgage loans, and 99% is floating rates. Our earnings continue to be positively correlated to rising interest rates. This is the first quarter where base interest rates have surpassed 100% of our floors, leading to a $14 million increase in net interest income from higher base rates, which was offset by the benefit from our floors last quarter and higher interest expense from the timing of debt draws this quarter. Company-wide, inclusive of floating rate assets and liabilities in all of our business lines, a 100 basis point increase in base rates would increase annual earnings by $42 million or 13 cents per share. Since quarter end, one month SOFR has already increased 76 basis points. International loans represented 26% of our loan portfolio at quarter end. Despite significant weakening in GBP, Euro, and AUD against the dollar, our book value actually increased 7 cents this quarter due to our currency hedges. As a reminder, we hedge 100% of our expected foreign currency cash flow exposure on non-USD loans, including both projected principal and interest. The credit performance of our portfolio continues to be strong, with a third quarter origination LTV of 60%, a weighted average risk rating of 2.6, and 100% of loans current as of quarter end, excluding loans on non-accrual. On the CECL front, our general reserve increased by $8 million from last quarter to a balance of $67 million as we applied a more negative macroeconomic scenario to the office property category, which represents 23% of our CRE portfolio. We had no new specific reserves in the quarter, no downgrades to a four or five risk rating, and no new non-accrual loans. With respect to our three existing non-accrual loans, We continue to utilize the breadth and experience of the Starwood platform to actively work towards a path of full repayment of the $465 million we currently have outstanding. We are confident in the underlying real estate and ultimately believe these loans are fully recoverable. The $348 million of equity that we have invested in these loans would significantly contribute to our earnings power once we are able to resolve them and reinvest the funds. Next, I will walk through our residential lending business. Our $2.2 billion loan portfolio, which was flat to last quarter, has a 4.7% weighted average coupon, 68% LTV, and 745 FICO, and includes $365 million of agency loans. Given continued rising rates and credit spread widening, we recorded a $92 million unrealized negative mark-to-market adjustment on this portfolio for gap purposes. We also recorded a $56 million unrealized negative mark-to-market adjustment on our commitment to purchase $713 million of agency loans, a transaction that closed after quarter end. Because we hedged interest rates in this book, the unrealized marks were offset by an $86 million unrealized positive mark-to-market on the related derivatives. Because these assets are held in a taxable REIT subsidiary, We also recorded a net tax benefit of $49 million, principally related to the net unrealized losses in this portfolio. We continue to believe in the credit quality of these loans and, as a result, have not recognized any DE losses for the loans on balance sheet. We likewise did not recognize a DE gain for the tax benefit. Also offsetting the overall negative mark was a $16 million positive mark to market on our retained RMBS portfolio, which ended the quarter at $418 million. This increase in fair value was driven primarily by lower projected prepayment speeds, which resulted in both extended and higher projected cash flows. And finally, during the quarter, we recognized $5 million of losses for both GAAP and DE, related to our investment in a residential mortgage originator, which we originally invested in during 2017. We expect to incur minor additional costs in the fourth quarter as we restructure this investment. Next, I will discuss our property segment, which contributed $21 million of DE, or seven cents per share, to the quarter. Our Florida affordable housing portfolio continues to perform exceedingly well. For GAAP purposes, we recorded an unrealized fair value increase in the Woodstar Fund of $103 million or $82 million net of non-controlling interest. This was driven by an increase in the fair value of property of $69 million resulting from the continued rollout of the HUD rents that we mentioned last quarter. The remainder of the increase relates to the debt and related interest rate cap on the portfolio. for which we recorded a $34 million favorable change due to market interest rates exceeding the 4.3% blended fixed and floating rate debt we have in place. Before leaving this segment, I wanted to mention the rents on our master lease portfolio, which contain contractual rent bumps every five years. On October 1st, a 10.6% rent increase took effect, which will increase quarterly rent by $700,000 beginning in Q4. Next, I will discuss our investing and servicing segment, which contributed DE of $33 million, or 10 cents per share, to the quarter. In our conduit, Starwood Mortgage Capital, we priced a securitization totaling $71 million at profits consistent with historic levels, despite significant widening in the credit market. As of quarter end, all securitizable loans have been priced into a pending securitization, leaving no mark-to-market exposure on the balance sheet. And in our special servicer, we obtained eight new servicing assignments totaling $6 billion, bringing our named servicing portfolio to $107 billion and allowing L&R to reclaim its top spot in conduit special servicing market share in the country. And on this segment's property portfolio, We sold an asset for $20 million, resulting in a net GAAP gain of $14 million and a net DE gain of $12 million. Concluding my business segment discussion is our infrastructure lending segment, which contributed DE of $20 million, or 6 cents per share, to the quarter. Fundings on new loan commitments of $223 million outpaced repayments of $99 million. increasing the portfolio to $2.5 billion from $2.4 billion last quarter. Because this portfolio is positively correlated to rising rates, the increase in base rates resulted in an additional $5 million of net interest income in the quarter. I will conclude this morning with a few comments about our liquidity and capitalization. As a reminder, 89% of our outstanding on and off balance sheet debt is non-mark-to-market. Structurally, 59% of this debt has no capital markets margin call provisions at all, and just 30% can only be margin called for credit issues. We continue to have ample credit capacity across our business lines, ending the quarter with $8.5 billion of availability under our existing financing lines, unencumbered assets of $3.9 billion, and an adjusted debt to undepreciated equity ratio of 2.35 times. As of Friday, we had $1.3 billion of liquidity, which includes $254 million of cash, $451 million of approved undrawn debt capacity, and the expected net proceeds from a $600 million sustainability term loan B issuance, which is scheduled to settle next week. With that, I'll turn the call over to Jeff.