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spk07: Greetings. Welcome to Starwood Property Trust's fourth quarter and full year 2023 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. Please note this conference is being recorded. At this time, I'll hand the conference over to Zach Tannenbaum, Head of Investor Relations. Zach, you may now begin.
spk03: Thank you, operator. Good morning and welcome to Starwood Property Trust earnings call. This morning, the company released its financial results for the quarter and year ended December 31st, 2023, filed its form 10K 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 a 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 made during the course of this call. Additionally, certain non-GAAP financial measures will be discussed on this conference call. A presentation of this information is not intended to be considered in isolation or as a substitute for the 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 DeModica, the company's president, and Rena Paneri, the company's chief financial officer. With that, I'm now going to turn the call over to Rena.
spk06: Thank you, Zach, and good morning, everyone. Starting with our results. We reported distributable earnings, or DE, of $189 million, or 58 cents per share for the quarter, and $663 million, or $2.05 for the year. The strong quarter was highlighted by contributions across our businesses, although it likely does not constitute a run rate. We had outsized performance from our conduit this quarter after a slow start to the year, and also had $0.04 of earnings related to commercial lending repayments including prepaid penalties and foreign currency hedge unwinds. GAAP net income was $71 million, or $0.22 per share for the quarter, and $339 million, or $1.07 per share for the year. GAAP book value per share ended the year at $19.95, with underappreciated book value at $20.93. These metrics were impacted by an increase in our commercial lending reserves, including increases in our general CECL reserve, charge-offs, and impairments related to REO properties, totaling $129 million and $351 million for the quarter and year. I will begin my segment discussion with commercial and residential lending, which contributed DE of $205 million to the quarter, or 63 cents per share. In commercial lending, we originated $707 million of loans, which brings our full-year originations to $1.1 billion. repayments of $815 million in the quarter and $2.9 billion in a year, outpaced fundings of $664 million and $1.7 billion. Our portfolio of predominantly senior secured first mortgage loans ended the year at $15.9 billion with a weighted average risk rating of 2.9. This is consistent with last quarter, despite downgrades of four loans totaling $502 million to a four risk rating, of which $450 million were U.S. office. Offsetting this were upgrades from a four to a three risk rating, totaling $197 million, including a $159 million formerly vacant office loan in Brooklyn that was converted to multifamily and brought current by the sponsor. In the quarter, we had one new foreclosure on a $61 million multifamily loan and one new non-accrual related to a $124 million office loan. Both loans were five-rated and will be covered in Jeff's remark. Last quarter, I mentioned that our CECL balance doesn't tell the whole story of our asset reserves because some of our loans have been moved to REO and some loans that are still on our balance sheet have reported charge-offs. Although these have already been taken out of GAAP book value, neither of these appear in our CECL reserve. However, they are really no different than a specific reserve, just on another financial statement line. In the quarter, our general CECL reserve increased by $28 million to a balance of $307 million, of which 74% relates to U.S. office, while REO impairments increased by $101 million to a balance of $172 million. Together, these reserves represent 3% of our lending portfolio. To clarify the REO component of this, I want to briefly discuss the GAAP accounting model. Once an asset is transferred into REO, it follows property accounting. This means it is held at amortized cost unless events or changes in circumstances indicate that its carrying amount may not be recoverable. We encountered these indicators on two previously foreclosed assets, which were either under written agreement or active discussion to be sold at our basis to unrelated third parties. Both transactions failed to materialize. The first asset is our vacant building in downtown LA that has a DE basis of $245 million. Because our current quarter negotiations to sell this asset were ultimately unsuccessful, we commissioned an updated appraisal which resulted in an incremental $71 million gap impairment. The second asset is our office building in Houston that has a DE basis of $126 million. After an LOI at our basis was terminated last quarter, we engaged an updated appraisal. Shortly thereafter, we entered into an LOI with another unrelated third party to sell the property at a price lower than our basis. That transaction was also unsuccessful. Although the appraisal indicated full recovery of our basis, we conservatively utilized the value implied by the most recent LOI to determine our gap impairment of $30 million. You will find these impairments presented in the other loss comma net line in our gap P&L and reflected as a reduction of the properties comma net line in our balance sheet. Next, I will discuss our residential lending business. Our on balance sheet loan portfolio ended the year at 2.6 billion, including 916 million of agency loans. The loans in this portfolio continue to repay at par with 60 million of repayments during the quarter and $239 million year-to-date. Given tighter spreads and a decline in longer rates, the mark-to-market on our portfolio improved by $152 million this quarter, partially offset by a negative hedge mark of $99 million. And our $450 million retained RMBF portfolio, lower prepay speeds continued to benefit this book, with tighter spreads contributing to a positive $6 million mark-to-market. Next, I will discuss our property segment, which contributed 22 million of DE, or seven cents per share, to the quarter. Of this amount, 13 million came from a Florida affordable housing fund. For GAAP purposes, we recorded an unrealized fair value increase related to this portfolio of 18 million in the quarter, net of non-controlling interest. The value was determined by an independent appraisal, which we are required to obtain annually. Turning to investing and servicing, This segment contributed DE of $33 million or 10 cents per share to the quarter. Our conduit, Starwood Mortgage Capital, helped drive our outperformance in the quarter, completing five securitizations totaling $467 million, which represented 61% of their securitization volume for the year. We expect to continue seeing higher volumes from this business in 2024 as loan maturities and originations pick up. The year is off to a good start with two securitizations totaling $118 million of loans completed in January. In our special servicer, fees increased to $14 million in the quarter due to $500 million of loan resolutions. These resolutions were offset by $1 billion of new transfers into active servicing, nearly two-thirds of which were office or contained an office component. Our named servicing portfolio ended the year at $98.7 billion, driven by $1.8 billion of new servicing assignments in the quarter and $6.7 billion during the year. And on this segment's property portfolio, we sold one asset in the quarter for $32 million. Since inception of this portfolio, we have sold 30 assets totaling $412 million for DE gains of $144 million. demonstrating our ability to successfully acquire and reposition transitional real estate. Concluding my business segment discussion is our infrastructure lending segment, which contributed DE of $23 million or seven cents per share to the quarter. We continue to see strong investing this quarter with $425 million of new loan commitments, bringing our total for the year to 1.1 billion, its highest level since we acquired this business in 2018. Repayments totaled $182 million for the quarter and $905 million for the year, with the portfolio ending the year at a balance of $2.6 billion. And finally this morning, I will address our liquidity and capitalization. Our leverage continues to remain low, with an adjusted debt to undepreciated equity ratio of just 2.47 times. This reflects the fourth quarter repayment of our $300 million unsecured notes which leaves us with no corporate debt maturities until December 31st, 2024, when our 400 million unsecured notes mature. In addition to low leverage, our liquidity position remains strong today at $1.2 billion. This does not include liquidity that could be generated through sales of assets in our property segment or debt capacity that we have via the unsecured and term loan B market. With that, I'll turn the call over to Jeff.
spk13: Thanks, Rena. Our industry originated more loans from late 2020 through early 2022 than any other period in our history, thus creating a significant amount of initial maturities in late 2024 and early 2025. Fortunately, the 10-year Treasury yield fell 100 basis points in the fourth quarter, and forward SOFR made a similar move and is now pricing at a 175 basis point reduction to 3.6% in 2025. While this more optimistic interest rate environment has reduced tail risk for the 90% of our assets that are not loans on U.S. office, the rate move to date has not been large enough to materially change U.S. office market outcomes, as office pricing also has to deal with lower net effective rent, the persistence of work from home, and a lack of liquidity in the office lending markets. Being managed by one of the largest real estate private equity firms in the world, asset management has always been a hallmark of our company's outperformance, and our entire team is focused on asset management today. We have had net realized gains on REO to date, but with lenders continuing to move away from the office sector, we have had multiple asset sales fall out of contract at our basis in recent months, and we are evaluating alternate disposition plans. Rather than wait for a better option that may not come, we have uniquely moved over $600 million of loans into REO to date. These assets are now the focus of our asset management team, and our goal is to maximize shareholder value. We will continue to evaluate options, including adding capital and repositioning assets, rather than quickly selling into a distressed market with seller financing that could put a longer-term drag on earnings. Rena mentioned we placed a $124 million five-rated office loan in Arlington, Virginia on non-accrual in the quarter. As you likely know, greater DC has been the hardest hit by work from home, with the majority of government employees still at home four years after COVID, making this long-term, stable, and consistent office market one of the most difficult to underwrite today. This loan went into payment default in the quarter, and we are evaluating foreclosing in the coming quarters to either reposition or sell the asset. The property is operationally cash flow positive and has 4.5 years of remaining vault. We will continue to look for accretive leasing while we decide on the right time to potentially sell the asset, assuming we take title. Rena also mentioned we foreclosed on our first multifamily loan in the quarter, a $61 million loan on a recently built multi in the Pacific Northwest that has been slow to reach stabilized occupancy. Should we choose to sell this asset, we expect to see a return of our basis in 2024. This asset is systemic of what we expect to see as the cycle moves to its next phase. Undercapitalized borrowers who lack the staying power to protect assets until stabilization will be replaced by large balance sheets with staying power like ours, or we will move the assets to the substantial pools of third-party capital that have been raised to recapitalize them. The majority of our industry's multifamily loans have stabilized debt yields above 6%, and assuming today's forward curve is correct, we expect most of these will be able to refinance at our loan proceeds or have sponsors who will see value in paying down their debt, buying interest rate caps, and replenishing reserves to qualify for extensions. Most of these borrowers bought new interest rate caps in 2022 or 2023 that were more expensive than they are today, so we expect them to do the same to qualify for extensions in 2024. Should they choose not to protect what is essentially a six-plus cap multifamily asset, and should we choose to foreclose, we expect to recover our basis or more if interest rates and cap rates continue to normalize going forward. As I just mentioned, we have profitably bridged assets to stabilization in the past. We will be patient where we see long-term investment opportunities and believe there is significant liquidity at or near our basis on lease-up multifamily assets where we don't choose to stay in them longer term. Looking at our broader CRE lending portfolio, we proactively cut our office exposure in half since 2019, while also reducing our construction and future funding exposure by half. Proforma for a data center loan that paid off in full last week, our future funding obligations sell to $800 million net of senior financing, a fraction of our company's typical and historic level. Less future funding obligations will allow us to maintain our significant liquidity as we look to pay off corporate debt maturities in December 2024 and March 2025. While we expect to refinance these in the capital markets, should we choose not to, we have ample liquidity to repay them with cash while maintaining a significant liquidity cushion. As Rena said, we received $4.8 billion of repayments in 2023, and we funded $3.6 billion of loans. Our projected excess liquidity will allow us to continue to invest accretively in 2024, albeit still at a measured pace. We created this diversified company and have maintained low leverage over the years to the benefit of both our equity and debt investors. You've heard us say we would like to be investment-grade in the future, and to do that, we need to maintain our lower leverage and increase the amount of unsecured debt on our balance sheet as a percentage of total debt. The high yield index hit 600 basis points over treasuries in the fall of 2022 and is at 355 basis points today. Our borrowing spreads have followed that trend. As we continued to lend in every quarter since COVID, we made many loans at higher asset spreads and financed them with nearly $2 billion of higher cost bank lines while still creating accretive shareholder returns. Should unsecured borrowing spreads continue to fall, we will be in position to replace these expensive, really prepayable bank lines in the unsecured debt markets at little to no cost to us for the first time in our history. Proforma for that debt replacement strategy, we would be in position to argue for a potential ratings upgrade as our unsecured debt percentage would increase substantially. I will note that our BB and BB Plus corporate ratings were affirmed by all three rating agencies in the higher rate environment we faced in 2023. As I just mentioned, the vast majority of our borrowings today are non-corporate debt. Our focus has always been on maintaining significant covenant ratio cushion in those facilities. We have a fixed charge covenant ratio defined as EBITDA over cash interest expense of 1.4 times on our non-corporate debt, as do most of our peers. Our lower leverage model creates lower interest expense, which in turn gives us significant flexibility under this and our other debt covenants. Our FCCR today sits at 1.8 times, giving us billions of dollars of additional debt capacity should we choose to use it, and over $100 million of EBITDA cushion, leaving us with tremendous flexibility on how to grow or further optimize the right side of our balance sheet going forward. We are addressing two opportunities created by the noticeable pullback of regional banks in middle market CRE lending. Our Starwood Solutions business is now up and running, and we believe a significant portion of the demand for valuation and workout services will come from the regional banking system. We also hired a seasoned CRE professional to create a middle market lending vertical at STWD for the first time to focus on the $15 to $50 million loan size that regional banks historically dominated and we have historically not participated in. This smaller balance loan segment offers premium unlevered yields, and we believe this increased ROE will be very accretive to shareholders in the coming years, albeit on less equity than in our large loan business. Moving to our energy infrastructure lending business, 2023 marks our highest origination volume year since we purchased the business from General Electric in 2018. We wrote $1.1 billion in loans in 2023, which is the same amount as we wrote in our core business, CRE Lending. We continue to like the attractive risk reward of power and midstream assets, and with funding costs remaining steady, we were again able to earn above historic levered returns in this segment in 2023, and we expect to continue to grow this segment in 2024. Finally, our low leverage and uniquely diversified business model that was built to outperform in volatile markets has allowed STWD to earn the only positive total return in our sector since the beginning of COVID. With that, I will turn the call to Barry.
spk12: Thanks, Jeff. Thanks, Reena. Thanks, Zach. Good morning, everyone. I wrote a colorful quote in our press release, but I do think it's worth noting that the real estate industry just has a balance sheet crisis. It's affected nearly every asset class. Every asset class may be safe data centers, but even there, yields on costs have to rise to reflect increased cost of capital. And the real estate industry didn't cause this economic situation. We were just an unintended consequence. But a material consequence for cities and municipalities as values drop and real estate taxes based on values will come down and cities and municipalities won't be able to fund their police, firemen, waste management and schools. So the Fed has three victims of their current policy and we're headed towards 300 basis point real rates unless they relent. The first is the government themselves paying 5.3% on $33 trillion, a third of which rolls over this year. The second are the regional banks, which cannot stay solvent with these current interest rates with $1.9 trillion of real estate exposure, not to mention the mark-to-market or not required mark-to-market on the securities book. And the third would be probably the entire real estate industry and the complex. People talk to me about the level of rates, and the four point three percent ten years not an issue we all could adjust to it adjusted to it before simply the pace of the increase the rapid increase and of course the statements that we were going to stay lower longer in December of twenty one and then actually easing into May of twenty two and the fact that the Fed relied on stale data or very delayed data for a third of its CPI so when rents were flying they showed no inflation and now that rents are falling they're still showing significant increase in rents in the apartment and residential sector so it's not clear why we use data for residential that's not current when we use current data for energy and for food it would take a minute for the Fed to call Fannie and Freddie and find out what's really happening in the apartment market and the residential markets they have more data than anyone on earth and they would see that they're running the economy and the global markets and causing recession both in Japan and now in parts of Europe based on the other governments' needs to increase rates to defend their currencies because of the Fed's actions. And when people outlawed the current Feds for their policies, they don't pay attention to the fact that $6 trillion of stimulus hit the shelves or hit pocketbooks as the things on the shelves disappeared. And so, inflation was simply too much money chasing too few goods. And that it was going to correct on its own, which it has, the supply chains have already fixed, and consumers are now running out of the $6 trillion. And the economy continues to be healthy, healthier than I think most anyone thought because of fiscal spending. And they cannot impact the economy with, or the job market, with interest rates anymore. When the half-year labor forces in healthcare in education and local governments. As you saw last month, 107,000 healthcare jobs were created. They're going to continue to be created despite anything the government does, other than crushing what's left of the economy, which would probably be the retail sector or the services sector. And that would include layoffs of stores and hotels, airlines, Goldman Sachs, all the investment banks, all the banks. That can only do with a real recession. We're going to have to be careful to land this plane softly. And the government spending continues apace, and we're not getting construction job losses that we expected. Now, all the asset classes in real estate have been impacted differently. You're going to see, and we continue to see, a wave of multifamily assets complete. And the total number of units being completed is not out of line between single family and apartments, but it's shifted from 40-60 apartments, single family, to 60-40 apartments, single family. And that The good news is the markets are absorbing this, but it's causing market rents or existing rents to weaken, which is why we've been so confident inflation will come down and will show up eventually in the CPI numbers. It is a third of CPI. That wave of new supply, fortunately, will die at the end of the middle of 2025. Almost all those units will be complete, and we'd expect to see rent growth accelerate again in the apartment markets. I think for that reason, with 40% of our lending book in the apartment space, we would like to get these assets back. We will make more money if we actually, if our borrowers give us these assets back. Our loans are 65% typically of cost. We're buying it. Our basis would be super attractive. And the best we can do when we lend is get our capital back and our coupons. We have infinite opportunity with well-positioned assets to make more money, frankly. If they were to fall into our into our lap, we've only had one default and as mentioned in the call We would expect to sell it at the at the basis of the loan very shortly but While there's light at the end of the tunnel because all of us believe I believe I think all of us believe most all of us believe That the Fed is done hiking other when they lower rates is going to be very interesting and And I'm pretty sure they're aware of the consequences and the teetering side of regional banks, the losses that you cannot exactly track, both in office, res and even in the industrial markets, which were being acquired at yields that are no longer market passing yields. So there is strain in the real estate markets. We are in the ship. We are in the boat. We are navigating these waters. We're going to take some losses. We're going to be okay. we have set the company up with a massive amount of liquidity. The decline in future funding that Jeff mentioned, $800 million in net funding, future funding calls on us, is really 60% construction, all of which is fine. And 40%, it's called good news, it's you committed to do a tenant improvement or lease a building. And those will happen if they happen. The borrower may not actually even call the capital because he's worried that the money that goes in for TI, the building may not be worth that if he goes and puts these tenants in these buildings. So I think we're certainly got a very diversified business model. We're delighted that we can invest in incremental capital in the energy space right now, which is providing very attractive double-digit yields. We continue to build that book. It's actually the biggest it's ever been, I think, since we started and bought that business from GE years ago. It is notable about the light at the end of the tunnel. The conduit markets are strong. We've had a good launch this quarter. The credit spreads are coming in. The market's anticipating rates coming down. And AAAs have come in probably 60, 70 basis points across the board just in the last three months. That's the first sign. that the markets are healing. And the CMBS markets are pretty wide open to act as a new exit strategy for borrowers who are trying to repay loans. Here before it was really just the existing lender. But now if the asset's stable and secure and it's in probably one of the favorite asset groups, but even office is finding its way into conduits and securitizations and now like 16, 20% of the securitization might have office in its portfolio. So you really are playing hand-to-hand combat, and in our case, partnering with our borrowers and figuring out workable solutions and using our entire organization, both here and in Europe, to get through what is a challenging period. But I think we feel pretty comfortable that our dividend will be secure, very comfortable our dividend will be secure for the foreseeable future. And we just had a really significant payoff of a loan a very large loan in the book. And there's some other things that are mentioned in Jeff's and Rena's comments that will provide additional liquidity to us. And we're very cognizant of getting through all of this. Sometimes you don't really know. We'll be taking, I visited recently an asset we took back in Washington, D.C., 1200 K Street, it's a beautiful building. It's an unimaginable amount of equity our borrowers have lost, unfortunately. But in that case, we will reposition that office building as an apartment building. It's actually quite beautiful. And we'll just take a little bit of capital, but it will come out of our book. And I want to look at the company. We have almost a billion dollars of assets that aren't earning much, if anything. So that's additional earnings power as we rationalize and redeploy the capital into things that could earn a substantial return on investment. This is actually as good a time to be a lender Maybe it was 2009 when we started the company. But we have to be very careful how much offense we go on. We are still investing. Unlike many of our peers, we are actually still finding opportunities and playing here and there, taking through the opportunities that the team sees. And that is good news for us. And we have an office loan in Europe that was 100% leased. It's going to repay. We know what we pay, and so our office exposure will continue to drop. Your biggest office loan. Our biggest office loan in Europe. So the complexion of the portfolio is solid. We have a $15 billion loan book against a $25 billion, $27 billion, $26 billion asset base. So we are not just a commercial mortgage lender today. We have other businesses. There are higher ROE businesses that are continuing to accelerate, like the special servicer. You just wonder how many of these office buildings are going to wind up in Eleanor's laps. I would say a lot of them. And you will see a lot of people still have caps on their loans, and they can cover debt service, but they cannot refinance. And if anybody thinks that the real estate markets have repaired themselves, that wouldn't be the case just yet. Although we do believe that, of course, if the Fed lowers rates, we expect 150 basis points real rates instead of 350. basis points of real rates, this will get much better faster in many asset classes that we're exposed to. The office markets in the US are unique. They're not like the European office markets. I recently returned from Germany, where rents were up 5% to 15% last year, and pretty much everything we've done in the construction has leased or pre-leased. Same is true in the Middle East and Asia. So this is a U.S. phenomenon really only, and there in the U.S. you have a bifurcation between the really good buildings, which actually remain full and are holding your tenants, and the B and C. So I think U.S. office is going to look a lot like the mall market. The best malls are full, tenants scramble to get in them, they have pricing power, and the B and C malls are going the way of the dodo bird. And many of these generic buildings will probably have to find alternative use, which might include tearing them down. So the team has dug in. Everyone's in their seats. The board is supportive and creative. We started Starwood Solutions, and I hope it becomes a meaningful contributor to our rings growth going forward. And we thank you for your support. That will take any questions, I guess.
spk07: Thank you. We will now be conducting a question and answer session. If you would 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 would 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. First question comes from Sarah Barkholm with BTIG. Please go ahead.
spk00: Hey, good morning, everyone. Thanks for taking the question. I'm hoping you can talk more about your new focus. middle market lending strategy. What's driving the decision to enter that market? Is it mostly a function of regional banks backing away or maybe reduce takeout liquidity on the large balance side? And would you consider looking at an existing middle market loan portfolio or primarily focus on new originations? Thank you.
spk12: We definitely look at existing books if they work. I mean, they have to be performing. We're not really an NPL business here. It's just That's really hard to run in a public company because you don't have any earnings until you can restructure the loan, and there may not be much return on capital. As far as middle market, if you look at the pyramid of opportunities in the world, it's a pyramid. The biggest deal is over a billion-dollar deals, which we've written loans as large as, I think, $800 million. There are not that many of those. And today, you know, there are not many large transactions being done. And most of our opportunities are refis, $160 million multi-loan. Those are the kinds of things you see at the moment. There are not any really giant transactions being financed. And most of those will probably get done in the CMBS markets right now. So, in terms of opportunity, there are the best opportunities in the middle markets and the smaller loans, which have been cleared out. by the regional banks, which are not lending. So recently, in two different situations, we went out on assets we own, not in the REIT, but in the Starwood Opportunity Funds. And one was an office building fully leased in Tennessee. The other one was a hotel in the Midwestern state. And you send out 128 books, and you get four letters of intent, and they're all from debt funds at 500 over. So we want to play in those markets. And the gentleman we hired to do that is actually sitting to my left.
spk04: Say hi.
spk13: Hi, guys. That's Pavan Melgari. Pavan joined us from Stellar. He was at Citi and Wells, the banker before that. And after Wharton, he spent nine years, I guess, at Stellar running their investments on both the debt and equity side. And we're super happy to have him joining us this week. So this will be a work in progress.
spk12: It's just another cylinder. It's obviously in the same sector, but it's a totally different scale asset and If we can build a giant book that's a couple of billion dollars of mid-market loans, we'd be very happy.
spk13: Barry gave you the reasons why we're unlikely to buy a portfolio of loans. We like current loans. We don't want to bring in fours and fives. And we like current income. So as we've looked at that, we've also talked to probably three or four different middle market lenders about us buying a team, partnering with a team. We looked at a lot of different ways to do this. And ultimately, we decided with the data we have, with the infrastructure we have, that it made more sense to build this internally. And we realized that these are going to be smaller loans. We're not going to have 75-page investment committee decks on smaller loans. So we're working on ways to scale this business using India resources and other that will allow us to scrape data and potentially asset manage and underwrite. But they'll still go through our credit process as our property trust. The hardest thing for us over the years on this is been deciding how can we put the same amount of credit attention. We have a chief credit officer. Many of our peers don't. We have a separate underwriting function, 18 people that do nothing but underwrite loans and bring them through investment committee for us. Our originators don't do that. At most other shops, that's what an originator does. They take it through fruition. Our credit process is very bank-like. Barry set it up that way in 2009. We've never changed from that. We don't intend to change from that. And We needed to find a way to be able to do this at the right cost, but we think it's a very large market, and we think it prices better than the large loan business, so we will earn a higher return on less dollars and hope that we can build it. So send us brokers, anybody, borrowers, please give us a call.
spk02: Okay, get an advertisement. This is a marketing call. It's a marketing call. Thank you.
spk07: Next question, Steven with Raymond James. Please go ahead.
spk11: Hi, good morning. Two questions this morning. First, regarding Woodstar, you know, Rena, I think in your prepared remarks, you mentioned it was a third party appraisal that drove the valuation increase. But can you talk about the cap rate where that asset is today? What gives you comfort in that and any color on rent bumps that we expect to see in the second quarter?
spk13: Yeah, Stephen, thanks a lot. Reena did mention that we're required to get an appraisal in the funds that that is in. And so we got our required appraisal that came in a couple of months ago. I think you asked about cap rate. It's basically a four and a half in place asset level cap rate. We expect that forward income as we look to May when rent get given to us by the state of Florida again, we expect them to be higher. They're based on, formulaically, on median income and CPI. Both were higher this year. We expect them to be not insignificantly higher. If you remember last year, we had a 3.8% holdback on our rents that we were allowed to put through. It's the first time the state of Florida did that. They wanted to make sure that we weren't increasing rents at a pace that tenants couldn't keep up with. We're okay with that. We know we're going to get the money down the line So we expect to be able to add three point eight percent incremental onto the median income and CPI. So this year will probably be another year that will be a fairly high number. And because of that we will probably get capped again.
spk12: And we'll just to clear that up. You know they they allowed I think an eight percent increase by formula is like eleven three and the three point eight or whatever they did that rolls over to the next year. So we would think the rent pretty certain the rent growth was between 5 and 10 percent. And again, if it's above 10, they're not going to let you take it. So it'll roll into 25. So that's an unusual asset class. Hold on a second. This is a very unusual asset class. You're 100 percent fault. You're effectively fault. The only vacancy you have is the turning of units because your rents are 30, 40 percent below market rents. So you're on 97 percent. Actually, we have one issue with squatters in one city in Florida. But other than that, you're fault. And rents can't go down. So it's a totally different animal than market rate apartments, which are obviously softening in many markets. In some cases, rents are negative. New leases in some markets, given the supply, are going negative. So you can go read Rick Campo's comments at Camden's Property Trust or comments at EQR, and you get a very good sense of what's going on. Maybe the Fed should read these reports and adjust their numbers later. Maybe they should fire 400 PhDs and get two people with a computer making full rents from rent.com and have a million data points.
spk13: Yeah, Stephen, it's interesting. We are more, our rents, even though our rents have gone up significantly and that's driven the value increase that you've seen on our financials, our rents are more below market today than they were when we bought the portfolio. So market rents have gone up by more. And to Barry's point to being 99% lease, that sort of almost ensures it. So as we look to April, May, when we'll get more information on the forward rents, you know, as I look at that in-place cap rate, asset level cap rate that I quoted before, you can almost think of that as a mid to high fours cap rate against where they see forward income coming with the increases that we have coming.
spk12: But again, this sector of multis isn't impacted by new supply. Sadly, all the 80-20 LIHTC deals, I mean, there's no affordable housing, not enough being built. So you have no issues with supply and affordable. And that's one of the reasons for the differentiation of the cap rate between what I'd say a market clearing price today would be for a market multi and affordable housing project.
spk02: You had a second question, Steve?
spk11: Yeah, as a follow-up, I wanted to touch on, I heard recently you bought an $80 million loan out of a CLO. Can you maybe talk about that, how you think about managing collateral in your CLOs, and kind of what drove that decision?
spk13: You're good. That just came out deep into the reports in the last week or two, but I appreciate the call. You know, CLOs for us have always been an opportunistic financing. A-notes are our favorite financing. They have no recourse. They're term. They have no credit marks, and they have no cross. CLO is our second favorite form of financing. We get rid of the ability to credit mark, and we get rid of the recourse. And we've issued three CLOs to date, $3.375 billion in total of CLOs. And they've come in general, it spreads slightly inside, even with our issuing costs, slightly inside where our bank repo financing costs were, and at slightly higher advance rates. That makes them very accretive to returns. And And one of the things that makes them continually accretive for a longer period of time is as loans pay off that you reinvest in those CLOs. We've done that, I think, a billion one of reinvestments on 53 or 56 different loans over the life of these three CLOs that we have, which has been very good for us. But, you know, we think of the CLO as a partnership with our bondholders. We intend to issue again when it's accretive, but again, it will be opportunistic. We've said before that having a CLO finance only public company is more of a trade and not a business. The CLO market does go away at times. We've seen it go away in the last year from being accretive to repo. And when it is accretive again, we will be back in the market. As part of being a partnership with our bondholders, and they allow us to reinvest, and that allows us to keep a lower cost of funds because we're not paying down the bonds sequentially starting with AAA, which would increase our cost of funds. So reinvestment is good for us. What's good for them is being partnered with a partner like us who is willing and able to buy loans out when there is a default. We don't want to have defaulted loans in there and have to work them out within. And we've said for a long time that everyone has the desire to buy loans out. We'll see in difficult times who has the ability to buy loans out. So, yes, we did buy a $81 million loan out of the CLO. That CLO is out of reinvestment. So that is costing us a higher cost of funds by virtue of that $81 million will pay off senior bonds. But we want this to be a partnership with our bondholders. We want them to see that we're willing to step up. And when we come back to the market, we expect better pricing than the market because we've continued to do that. I think we bought $260 million of loans out of CLOs. I'm getting away from the reinvestments now. But we bought $260 million of loans out of these CLOs, which I think is very good for our platform.
spk08: Thank you. Next question comes from Rick Shane with JP Morgan.
spk05: Please go ahead. Hey, Jeff, just one quick clarification. The $260 million, that was in the fourth quarter, or that was for 23?
spk13: No, that's life to date in the quarter. If you go into TRAP, you can see that we bought an $81 million senior office loan out.
spk05: Got it. Okay. Thanks for the clarification. Look, I'd like to talk a little bit about two aspects of... Well, first, REO. You guys have basically indicated that you are positioned to be long-term holders of REO and think that you're good operators and that this mitigates, to some extent, the charge-off risk associated with it. As we think about distributable earnings, is there enough cash flow available off of those assets to come close to replacing what you were generating as lenders?
spk13: Yeah, you know, it's a really interesting question. So a lot of the things that you're seeing go into our higher risk rated buckets, even the office, generally have four to six debt yields. They just don't have the seven or eight debt yield you might need to escape. So a four to six debt yield means that there is cash after operating the office building. There is cash to distribute. It's just not quite enough to distribute to cover a new interest, full interest loan. So there is cash flow coming out. So the drag is less because of that, Rick. So we will take that into account. We certainly, we've talked about a few assets that we would like to move on from because they don't pay current. We do care a lot about current income. So if an asset is, It's sort of too big of a drag, and it's more of an opportunity fund play where it's not going to pay something for an awful long time that will be difficult on DE in the shorter run. I think you would only see us doing that if we feel really comfortable with our ability to cover our dividend away from that. If we started to feel like we were uncomfortable being able to cover it, we would probably move on those assets more quickly, and we wouldn't have the room. But, you know, fortunately, we've had some cushioned in earnings, and we expect to have some cushion now, so we'll be able to be flexible and choose what we want to keep longer and what we want. I think we've seen some numbers this week on percentages of assets in non-accrual, and you just asked about REO. Between non-accrual and REO, it's only 3.4% of our assets. Not a terrible burden yet. If you think as long as you cover the dividend by 1.034 times and if they don't even kick off any cash flow, you're going to be able to cover the dividend. I just made a scenario where they do kick off some cash flow and we cover the dividend historically by more than 3.4%. So we don't see it as a major drag to distributed earnings, but it could become one if the cycle continues. It could become one if rates don't follow the forward curve and And, you know, we are aware and at our battle stations that this could get more difficult. But today, we feel okay about it.
spk12: Just to quickly sum up, I mean, they're all different. Some of these assets, if we get a multi back, it's probably yielding six or seven, six and a half percent. So that's kind of where we would expect to get assets back. And the cap rates for multis are not six and a half percent today. So Having said that, if it's a single asset partnership that borrowed against us, they may not have access to money. They may just don't have the capital or the investors don't want to put the money up. But again, that we would love to get those back. The challenging assets would be the office buildings like 1200 K Street, which I think we have the capability and it's now unlevered on our books. We can borrow the money to renovate and turn into an apartment. That'll just take a couple of years to go through the development process. Or we bring in a partner. He either buys it for us, we JV it with him. He puts up the money to renovate it and we just establish it basically. property value and we go 50 50 or something like that. So we have a lot of flexibility. I mean one of our our our loans that we know is we I believe is money good is the American Dream Mall which has had quite a long history. But I think we're probably 25 or 30 cents of construction costs on that asset and it is ramping. It's burning through its free rent. The theme park is doing really well. I think it's making like 90 million dollars. So we just got paid. 90% of our original underwriting. Right. And we just got paid $50 million of the principal that got paid down because we have cross-collateralization with another asset he has, another major mall, which did a CNBS transaction and funded $50 million to us. So our base, we're carrying like 69 cents on the dollar or something like that. So, and I actually think we have a chance of getting a lot of money back. So. There's upsides, too, to our marks, and it's going to be all over the place. It's a little hard to figure out. In one situation, one of our borrowers had $400 million against a $400 million loan for half of their costs, and we do think that we are expecting them to walk. That's a pretty household name borrower, so that's a fairly significant hit to them. We don't want the building back. It's an office building, but if we get it back... We'll be creative. The good news is we'll take the basis down appropriately, and it'll be reflected in our book guide.
spk07: Next question, Don Sandetti with Wells Fargo. Please go ahead.
spk09: Jeff, you know, the conduit volume was up this quarter. Can you talk a little bit about gain-on-sale margins on that production relative to normalized and Is this like a one to two quarter type opportunistic or could we see elevated levels for more of a mini secular type trend?
spk13: Yeah, Don, thanks. I have Adam Bellman in the room who runs L&R and runs the condo business for us, so I'll turn it over to him. I would say that we are looking at this year as a comeback year. I think 2024 will feel a lot better. We had a great fourth quarter with the first quarter starting off really well. I'll let Adam talk about it. But we've been profitable in this business because Adam probably won't go here pretty much every quarter since we took the business over in or since we took over L&R, excuse me. And that's for a bunch of reasons. One of the one pennies. There's a lot of reasons for that. We don't tend to do the bigger investment grade tighter loans. We tend to do smaller size loans where you have a little bit more cushion. And we hedge interest rates. And we hedge 40% or so of the credit exposure in the loans. And that's a very expensive thing to do, but it creates consistency. So we've been really excited about having a consistent book that we think has some upside this year as we're seeing some green shoots in CMBS. But I'll turn it to Adam to discuss.
spk10: Yeah, I mean, I think you can say, look, it's going to be a volume game. I think our, you know, P&L will be consistent with what we've been doing over time throughout our business with an S&C. I think, you know, the big problem that you saw in total, you know, we did $760 million of origination and You know, we're aiming to beat that, you know, much earlier this year than I think it would have. It's, you know, tighter spreads on CMBS deals. You know, there's less opportunity for other lenders out there. the NBA conference and we were the CMBS Lenders of the Bell of the Ball, I think. The only guy who's left standing.
spk00: Yeah, exactly.
spk10: So there really isn't, there's a lot of people who realize- Not that many people at the ball. Right, so it was good to see that, and we're seeing it, we're getting our head of credit is bombarded, he hasn't gone home. very early these days, and neither have I. So it's, I think we're seeing a rebound. We used to do 1.2 to 1.5 billion. Yeah, I think it's, you know, I'm hopeful that we're certainly not going to see what we did last year.
spk13: Thank you. So we don't really quote gain on sale, but I would say it's consistent with historic levels. And one other thing in the CMBS market that I find interesting, We've pivoted to having a decent-sized five-year CMBS market, and that's a newish phenomenon. We needed to get BP buyers comfortable because they don't have as long of a period of time to accrete from a lower dollar price in a BP on a five-year, so they have to buy a higher dollar price BP. So that was a little bit difficult to digest at first, but I think people are realizing there's a lot of value there. We look all the time at CMBS versus Dennis and Mark's book of transitional floating rate lending. And today, I think the CMBS market, we're quoting something like 275 over five-year swaps on a fixed rate basis for sort of multis, industrials, et cetera, maybe 350 over for hotels. And those numbers have really consisted with where we're quoting transitional floating rate, which are three-year loans floating with two one-year extensions. So the pricing-wise, if you can get the certainty of not having to deal with that role and you have cash flow that has debt service coverage that can get you into the CMBS market, the CMBS market is very interesting for that market. for that transitional borrower who has a decent amount of cash flow to go into in five years, where historically they probably would have all gone into the transitional floating market because they didn't want to take 10-year debt. So that will help volumes. They're not quite as profitable because it's a five-year deal instead of a 10-year deal, but it'll help volumes, and we think we can
spk10: grow there. We are part of every securitization that takes place in the non-banking five- and ten-year world. And I'll tell you, Jeff's right, it's almost 70% of the new deals out there are really five-year origination, which is taking the place and why we're below the ball, because we're kind of taking where the floating rate market was. But market, again, the floating rate side here is open, too, on the mid-market side. So hopefully that's going to allow us to really capture a lot of that business
spk13: It's good for borrowers to have choices, and we think they have more choices now.
spk02: It's good for everybody. Thank you for the question, Don.
spk08: Next question, Jade Ramani with KBW. Please go ahead.
spk04: Thank you very much. Are you seeing any projects eligible for conversion to data centers as an alternative use? This quarter we saw HomeBuilder agree to sell a vacant piece of land carried at $5 million. for a whopping 180 million. So I just thought I'd ask if you're seeing any alternative use cases there.
spk13: Wow. We have one asset I'll speak to where this sort of made some sense. It's in L.A., And I'm going to quote the megawatts wrong because I'm out of my area of expertise. But I think we thought that the size of the building, it would be accretive if we could get something like 90 megawatts, then we could only get 30. And the problem is there. In a downtown environment, you can't create power. You can't put a power center next to it. Barry knows this better than anybody, and it's why you're seeing a lot of data centers in places like Virginia where they can create more power. So we could only take the power that was available on the grid to us, and there wasn't enough power available on the grid to accretively turn this into a data center, which we had hoped to do. So in areas that are infill, I think it will be more difficult in power-oriented, and in areas where there's more land, you can create that if you create a large enough data center, but Barry's an expert.
spk12: You've got to have the substations. It's underutilized. So to the extent that there are, yes, it's possible. And we're the fourth largest owner of data centers now in the world, privately held. And it's quite a little business. We probably have to do a $3 billion capital raise in STWG. These things require a lot of money. They are gigantic commitments of capital. Yeah, if we got lucky, if I was visiting a building that actually we did take back, but not the REIT, actually, our opportunity fund, and there is a substation right next to it, and the fiber's right there, so we could get lucky. Not in the building. The building will stay a building, but we actually own the land next to the substation that's empty. It's going to be a multifamily site, and maybe it will be a data center someday. So, yes, I mean, it requires the power. The land isn't worth anything other than its original use unless the power's there. and the power has to be available. So these are negotiations, utility by utility, and there's a long queue. And to some extent, the tenants can help break the queue or move around the order of the queue. But some states have made data centers a big business, like Virginia, and others are catching up, like Texas. And California has no excess power, so California won't have any data centers for a while. But that's to the benefit of the places that do have the power. Yeah, it'd be great. I'd love to have it. Better be lucky than good. But I don't see in any of our current assets that I've visited. I actually haven't looked if there's an extra power station next to the American Dream Mall, which you can look. But in Washington, the office building is on K Street. No, I don't think it's a day. The our station there. Plus it would be the nicest looking data center in the history of mankind. Most of these are ugly, built up concrete. Most cities won't want them inside. You just have to bury them inside an existing shell. The LA property would have worked if we could get the big box, big load-bearing floors, which you need for the equipment.
spk13: And have the high-level internet.
spk12: We may not get the original basis, but the asset we talked about, we had a $250 down to 150, I think. Yeah, that puts a floor under the value, because 30 million, 30 megawatts, if somebody bought it for a data center, it doesn't have to be an office building. And I'm still working on a resin conversion there. So I actually think it's a beautiful building, an office in downtown LA. This is close to the worst market in the United States right now. It's a race to the bottom, but they'd certainly be in contention with San Francisco and Austin.
spk02: Those are two really tough markets right now. Thank you, Jade. Operator, any other questions?
spk07: Yes, our last question comes from Doug Harder with UBS. Please go ahead.
spk01: Thanks. Hoping you could give us an update on your casino loan in Australia, just given that there has been some news about that recently.
spk12: You mean the news about Taylor Swift's day in the casino, that one?
spk13: She was there last night. It's in the papers today. So we're expecting a big income pop.
spk12: Yeah, the earnings per one quarter will be great. We actually, we obviously don't own the casinos. They're held by a named firm, and we're less than half of the capital stack at our basis. They actually own the other half of the mortgage that we own on those assets. So they're sort of 75% of the cap stack, if you will. We're 51, they're 49 in the debt, and they're the equity. And they're continuing to support the property with a recent half a billion dollar infusion of the cap stack. It's a fairly significant investment of the firms. So we're comfortable that they have the expertise and they'll straighten it out. They're using some of this money to renovate the properties, which they intended to renovate them. So they never finish that, but they're major Domo assets in these markets. And we're comfortable right now that this credit is fine. So we'll see if things change. But as you know, they're coming out of some licensing issues the prior owner had. That has not been resolved as quickly as they hoped. But they are very, very supportive of the credit.
spk02: So we'll see. They do want half the paper as well as all the equity. Great. Thank you. Thank you, Doug.
spk07: Thank you. I would like to turn the call over to Barry for closing remarks.
spk12: Thank you, everyone, for joining us. I hope we have continued reasonably good news, and I look forward for this company to go back on offense. We're all chomping at the bit. More offense, not more. Not that we're not in the markets, but we are cherry-picking. And sitting on $1.2 billion of liquidity and then having these non-accrual assets is not the greatest position, but to be able to easily cover DE or dividend is certainly a very comfortable position. You are aware we mentioned some of the things we're selling in the first quarter, which will close in a minute or so. You know, we are in the recent repayment of more than half a billion dollars of a senior loan. That's the equity in the loan, which is in really good shape to combat this next eight months of relenting pressure from the Fed on the complex. So thank you, and we're excited about the future of the company.
spk07: This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.
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