Starwood Property Trust Inc

NYSE:STWD

Earnings Call Transcript 2017-Q4

[Operator]

Good day and welcome to the Starwood Property Trust Fourth Quarter and Full Year 2017 Earnings Conference Call. Today’s conference is being recorded. And now at this time, I will turn the call over to Mr. Zach Tanenbaum, Director of Investor Relations. Please go ahead, sir.

[Zach Tanenbaum, Director, Investor Relations]

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 December 31, 2017 filed its Form 10-K with the Securities and Exchange Commission and posted its earnings supplement to its website. These documents are available on 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 maybe made during the course of this call.

Additionally, certain non-GAAP financial measures will be discussed on this conference call. Our 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 Sternlicht, the company’s Chief Executive Officer; Rina Paniry, the company’s Chief Financial Officer; Jeff DiModica, the company’s President; Andrew Sossen, the company’s Chief Operating Officer; and Adam Behlman, the President of our Real Estate Investing and Servicing segment.

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

[Rina Paniry, Chief Financial Officer]

Thank you, Zach and good morning everyone. Jeff will covering our annual results in his remarks, so I will focus my discussion on the quarter. Our core earnings this quarter totaled $145 million or $0.55 per share. This includes a negative impact of $0.04 from federal tax reforms and a positive impact of $0.06 from the payoff of our October 2017 converts. I will discuss each of these shortly.

I will begin this morning with the results of our largest business, the Lending segment. During the quarter, this segment contributed core earnings of $110 million or $0.42 per share. On the commercial lending side, we originated or acquired $1.4 billion of floating rate loans with an average originated loan size of $166 million and an LTV of 61%. We have funded $1.1 billion, of which $947 million related to new loans and $137 million related to preexisting loan commitment. These funding slightly outpaced repayments of $914 million. Our commercial lending book ended the quarter at $7 billion and continues to be positively correlated to rising interest rates, with 93% of the portfolio being floating rates.

The credit quality of our book remains strong, with LTV improving to 52% this quarter. We also saw improvement in some of our poor-rated loans with the loan loss reserve declining from $6.6 million to $4.3 million. This was mostly due to upgrades of two loans, both of which are expected to payoff in the near-term. On the residential lending side, we acquired $220 million of non-agency loans this quarter bringing our total portfolio to $613 million and our net equity to $169 million. The current portfolio has an average 63% LTV, an average FICO of 723 and an optimal annual cash yield in the mid-teens.

I will now turn to our property segment. We are excited about our newest addition to this segment, a 27 property affordable housing portfolio in Florida, which we agreed to acquire for $595 million. This acquisition consists of 6,109 units that are 99% leased and concentrated primarily in Orlando. 3 days before year end, we closed on 8 of these properties for $156 million. Subsequent to quarter end, an additional 12 properties closed for a purchase price of $293 million. The remaining properties are expected to close next month. Combined with our existing portfolio known as Woodstar, we will now have 59 affordable housing communities totaling over 15,000 units. The properties will be financed with a combination of sub 4% fixed rate agency debt as well as the assumption of preexisting government-sponsored financing. The debt has a weighted average term of just over 11 years. The portfolio is being acquired at a high 5 cap rate with targeted cash-on-cash yields in the low double-digits. The investment is being made via downgrade structure, whereby the properties are contributed into a newly formed subsidiary in exchange for equity units in that subsidiary. These units are redeemable into our common stock at the option of the holder and prior to redemption the units – excuse me that are entitled to dividends which are index to our common stock.

In our GAAP balance sheet the subsidiary equity is reflected as non-controlling interest and in or GAAP P&L any accrued dividends are reflected as non-controlling interest expense. For core purposes, we are treating this similar to an equity issuance. And the non-controlling interest deducted from the P&L will be added back and the redeemable units will be included in our equity and share count. There was a little impact of this transaction during the quarter, because the first day is closed just three days prior year end. The remainder of our wholly owned assets in the Property segment continued to perform well. Weighted average occupancy increased this quarter to 98%, up from last quarter’s 94% due to a newly executed 55,000 square foot lease in Dublin. The lease carried a 20-year term and was signed in December that we expect to realize the full P&L impact next quarter. As our property portfolio continues to become a larger part of our book, so does depreciation. As of December 31, we had $174 million or $0.67 per share of accumulated depreciation. The economic reality is that these assets are appreciating in value, not depreciating. As a result, GAAP book value is becoming an increasingly less relevant metric for us.

I will now turn to our Investing and Servicing segment, which contributed core earnings of $42 million or $0.16 per share for the quarter. As I mentioned earlier, this segment was impacted by the effects of U.S. tax reform, principally because – excuse me it houses our acute primary taxable REIT subsidiary, our conduit and our servicer. While the decrease in our blended effective tax rate from 39% to 25% should benefit these entities going forward, it had a negative impact on our deferred tax assets during the quarter. Our DTAs resulted from temporary differences in certain of our intangible assets, mainly the servicing intangible and goodwill. Remeasurement of the DTAs at the lower effective tax rate resulted in a one-time write-off of $10.4 million or $0.04 per share during the quarter.

Our CMBS portfolio continues to perform well, generating mid-teens core yields in the quarter. On the servicing front revenues remained relatively flat to last quarter as expected with resolutions also flat. However, we did see a higher pace of transfers into servicing primarily for our 1.0 deal. Fourth quarter transfers outpaced third quarter by 2x, increasing our actively service portfolio from $9.6 billion to $9.9 billion. This quarter we obtained eight new servicing assignments on deals totaling $5.9 billion of collateral, bringing our main servicer portfolio to 160 trusts with the balance of $73 billion.

In 2018 where we expect the net contributions from our servicer to decline, we expect a compensating increase in the net contribution from the properties we acquire from CMBS Trust. In 2017 we have recognized approximately $16 million of core gains from the sale of five assets in this portfolio. As the remaining 25 assets reached stabilization, we expect to see significantly higher gains going forward. And before leaving this segment, I will say a few words about our conduit. This quarter we securitized $578 million of loans in three securitization transactions and ended the year with total securitization volume of $1.5 billion in eight deals.

Now shifting from the left side of our balance sheet to the right, in the past three months we completed two high-yield debt issuances totaling $1 billion. In December we issued $500 million of 7.25 year notes at LIBOR plus 253 and in January we issued another $500 million this time with a 3-year term at L+128. We also repaid our October 2017 converts, but are paramount to $412 million. The equity component of these notes which have been accretive through interest expense over their terms expired worthless. This resulted in a gain of $15.2 million or $0.06 per share that we recognized for core earnings purposes in the quarter. We ended the year with $3.9 billion of un-drawn debt capacity, a weighted average debt term of 53 months and a modest net debt to undepreciated equity ratio of 1.6x. If we were to include off balance sheet leverage in the form of A notes sold, this ratio would be 2.1x.

I will conclude my comments today with our outlook on 2018 and our dividends. Similar to what we told you last year, we expect to earn and continue to pay our $0.48 quarterly dividends this year. To that end for the first quarter of 2018, we have declared a $0.48 dividend, which will be paid on April 13 to shareholders of record on March 30. This represents a 9.6% annualized dividend yield on yesterday’s closing share price of $19.99. One item worth noting about this dividend yield is that under the new tax law, individual shareholders now receive a 20% deduction on REIT dividends. For those shareholders in the highest tax bracket, this adds another 110 basis points to their pre-tax yields making REIT investments such as ours even more attractive.

With that, I will turn the call over to Jeff for his comments.

[Jeff DiModica, President]

Thanks, Rina. We had an extremely successful fourth quarter deploying over $2.3 billion across all of our investment cylinders and expect to beat that amount with a record Q1 investment pipeline of approximately $2.5 billion.

In our Lending segment, we have always focused on the quality of the loans we put into our loan book and not the quantity. Facing large expected payoff in our loan book in 2017 and early 2018, we doubled the size of our originations team in the last 2 years leading to increased loan volume, while maintaining loan quality and expected IRR. In the last three quarters plus the current quarter, we will have realized over $4.2 billion in loan repayments versus just $1.4 billion in the next four quarters ending in Q1 2019. Fortunately, our large loan origination business is hitting on all cylinders and we expect it to continue to be the dominant user of our capital for the foreseeable future. In Q4, we originated $1.4 billion in large loans with an expected IRR of 13% and weighted average loan-to-value of 61%. Our volume and IRR were both the highest in the years and our loan book today is the largest it had been in our history. Our large loan originations were over $4.2 billion in 2017, up approximately 30% versus 2016 and we have seen the retail exposure in our loan book fall to below 5% by the end of this quarter.

The first quarter of 2018 is shaping up to be our largest lending quarter on record with over $1.75 billion of loans in various stages of closing. We expect to originate over $5 billion in floating rate balance sheet loans in 2018, while maintaining our credit first culture, the lowest leverage in our peer group and IRR commensurate with or above previous quarters as we continue to optimize the right side of our balance sheet to achieve the lowest possible cost of funds for our company. Over the last 4 years, we have purposefully built a diversified book of unencumbered assets that allow us to do what others in our space cannot to issue unsecured bond as spreads commensurate with investment grade issuers.

Since speaking with you in November, we have issued $1 billion of 7-year and 3-year unsecured bonds to go along with the $700 million of 5-year bonds we issued in December of 2016. We have built the business model that the bond markets think very highly of. At treasury plus 143, the 3-year we issued last month was 2 basis points outside the median spread of the BBB bond index and the tighter spread for Ba3 BB- rated or lower senior unsecured note since 1998 and the second tighter spread of any high-yield issuance since the financial crisis.

We believe that borrowing spread is inside where any of our peers would issue unsecured bonds if they have the unencumbered collateral to do so. As a mature company, we have moved away from convertible notes and replace them with longer duration, lower coupon unsecured bonds with no equity conversion risk. At our issuing costs, unsecured bonds are cheaper, more flexible and more efficient than CLOs for large floating rate loans today. Approximately, 30% of our debt is now unsecured decreasing our dependence on the secured debt market.

Also, our property book is over 25% of our assets putting us in position for a ratings upgrade as we continue to execute on our business plan to have the lowest cost of funds in our peer set. At 1.6x debt to equity, we continue to choose to run our business at significantly lower leverage than our peers. The credit of our loan book continues to perform exceptionally well. And as Rina mentioned our LTV fell again to 62%. Unlike others in our space, we have chosen to report or move to reporting only origination LTVs, our large internal asset management department updates our LTVs quarterly and management spend significant time reviewing that work. We believe origination LTVs are significantly less useful in dynamic market and think our shareholders deserve the transparency, which we will continue to provide.

Importantly, we continue to have only one loan above 80% LTV and have seen significant progress achieving the business plan as we have that asset in expectable repayments. Our other businesses are also performing very well. As we have talked about on prior calls, our property book has significant embedded capital gains, which are not valued in our book value. Our residential whole loan business has best-in-class warehouse financing and we expect to issue our first securitization in the coming months that will benefit from securitization spreads that continue to improve producing a low to mid-teens return on equity.

Additionally, this quarter we made a small investment in a mortgage origination platform giving us control over a growing portion of our deal flow. We also expect our CMBS conduit business, Starwood Mortgage Capital, to again be a steady contributor for earnings in 2018 and our platform has proven to be one of the few non-bank winners post risk reduction. We expect our servicing business to continue to be profitable on its own in the coming years, while also continuing to support our preeminent CMBS and REO purchase investment cylinders. We could not confidently make the high yielding CMBS investments that we have since inception without the breadth of the 300 plus people in our REIT segment. We have recently closed our second Freddie Mac small balance servicing assignment and hope to increase our agency servicing business in 2018 and beyond. We have begun to use resources in our REIT segment to build-out a middle-market balance sheet lending presence to add incremental and accretive loan to our book. Finally, our REO purchase cylinder has $350 million of assets with significant embedded gains that we will continue to harvest as recurring non-recurring gains in our book over the coming 3 to 4 years. In aggregate, these business volumes continued to contribute significant revenue in ROE offsetting the expected dip in the servicing revenue until 2.0 maturities lead to increasing servicing revenue once again.

In closing, we feel very good about the prospects for our company on both the left and right side of our balance sheet and have ample cash from this period of outsized loan maturities to continue to execute on our strategy. We have been in blackout during much of the recent dip in our stock price and view our common equity at 9.6% dividend yield as another attractive investment. We have historically bought back shares when we feel they are particularly undervalued and I will remind listeners that we have $267 million of equity and debt buyback capacity remaining on our $450 million Board approved buyback.

With that, I will turn it to Barry.

[Barry Sternlicht, Chief Executive Officer]

Thanks, Rina, thanks, Jeff and good morning everyone. Not sure where to start, I mean I guess I should start as a frustrated CEO of the large enterprise, because our stock obviously hasn’t responded well. And I want to talk about three markets that are interacting here and what’s going on, the real estate market, the fundamentals of the real estate in the United States which is primarily our focus there is really excellent and probably among the most balanced real estate markets I have ever seen in almost 30 years of doing this, whether in the multi-sector, we continue to see our rental growth to office sector which is having rental growth, industrial sector which is having rental growth, the medical office building sector which is having rental growth, you are hard pressed to really find tremendous leasing. There obviously is some uncertainty around retail, but as Jeff pointed out and we have very little exposure to the asset class and where we do. I mean, you can argue it’s not retail in one case, which we will talk about.

So, the fundamentals of property class are good and as you think as well as I do that the economy is going to accelerate with [indiscernible] tax cut and $300 billion spending bill, it’s just going to be good. And with that means commodity prices probably rise replacement cost goes up and our LTVs fall as values rice in properties. You could probably even see our book fall into the 50s a year from now, high 50s if in fact that we see what I expect to see, which is inflation in rising rates. So, against that, money is pouring out of the REIT sector and the flow of funds against our company and all real estate REITs is tough and it’s hard it’s like City Hall, on the other hand, people aren’t paying attention as they often do when you trade around ETFs to the individual names and how they react differently to different interest rate climates.

So recently earlier this week as early as last week, one of the banks, I will point out, because it’s totally responsible JPMorgan put a report out basically had to sell, because we are exposed to rising interest rates, which is actually completely untrue. In fact, it’s inaccurate, the analysts have never actually been on the call with us of understand our book, 92% of our loan book is floating. We benefit from rising interest rates. So, maybe they are thinking about the property sector, maybe they think our assets will go down in value with rising interest rates. I will point on how we financed our property sector, because we are long-term holders, we are not actually going to sell any of our assets anytime soon, except maybe some of our assets in Dublin which has soared in value. But looking at our apartments for example which are about 25% of our equity, both the deals we have closed and the deal that was pending. One of these deals is financed with 17-year paper at 3.38% fixed. The other deal was 10-year paper which is the one we are closing right now at 3.8% fixed. Our medical office building is financed with 6-year paper at 4.06% fixed. Our only floating exposure is the Dublin portfolio because we never intended to hold that portfolio forever. And so the market our Cabela’s investment is 10-year fixed rates for CMBS around 4.3. All of these investments in the aggregate including a zero accretion on the small $100 million rough investment which is less than 2% of our equity base in retail. So accruing the retail at zero is 10.5% on the cash and cash return out of the box rising as the economy rises and stable as it can be.

So when we started our business, we said we are going to be transparent, we are going to be consistent, we are going to be safe. And I think we built a book that’s transparent, consistent and safe. And we are really nervous about complexity. I can see conglomerate discounts across the real estate space and that we might be overly complex with people that analyze. When you look at the way we are balancing our return on equity and having a quarter like this, with some of the highest ROEs we have ever produced on the loan book and accelerating as Jeff mentioned the incredible first quarter we expect to have. I mean you told me 9 years into the cycle, we can originate loans with 61% LTV and a 13 ROE on capital. I would have said you would not. And if you told me our stock was going to trade at – and dividend yield of 61% credit, LTVs I would have thought would be 6 not 10 or 9.6. So I would tell, we are safe and we should be brought down because we are a mutual fund of real estate exposure. So we are actually a whole bunch of AAA paper.

And the shocking thing is the debt markets understand it as we have gone to issue unsecured debt, we look like an investment grade company in the debt market, looks like a jump credit in the equity markets. And the diversity of our book makes me as a major shareholder let me sleep at night and yet the shareholder base seems to be lost and confused and caught up ETFs and trading as many other mortgage REITs have done. Over time they have exploded, with a 61% LTV, I don’t think you are going to see us exploded you think – where do you think we have probably guys in the full 40% the next year. So by the way, we are happy these days to climb up in LTVs. We just have it like we will do loan to own. But the opportunities have been [Technical Difficulty] people aren’t borrowing like that today.

What is interesting again is the hold in the capital market, the ability of the team – our team which has grown and to the grade in origination business to really drive fine great flow. We still got all the calls. We are back into Europe on making loans in Europe again which is exciting. And we are not having to sacrifice returns even though it is a competitive market, what you have seen in the credit markets obviously is spread tightening, dramatic spread tightening. So the overall cost of borrowing for equity investors is not probably gone up less than half of the rising rate because credit spreads have come in as people search for yields and they are looking at nominal yields. So I do believe in one of the things we all talk about is that our book value is dropping, another place where sweeping computer programs generated looking at our company would misunderstand what’s happening. What’s happening is we are actually lowering our fixed – our payout ratio. We are increasing our property book, it throws depreciation on to our balance sheet. The strategy to be able to conserve cash if we ever needed to, because we won’t have to pay it out, we won’t when we started out being 100% interest income, 95% of all taxable income have to be distributed.

But now that we have this property book, we have the depreciation shield. But the negative impact is it’s driving our book value down, which is different than our peers. But it’s actually an asset because the assets are appreciating, not depreciating. But that takes more on a computer screen to figure out. And so you have to dive down into the company and as you know our team isn’t able and willing to talk to you about anything we do not just completely proprietary, but I am really proud of the team and the business strategy that we have executed. And having said that I am not going to bend my head against the wall and over periods of time we are going to have to look at whether we are too complex and whether it seems we can do to enhance shareholder value, because paying out the dividend yield we will have. The good news is you are getting capital or external capital. The bad news is, we want to go and it’s hard to grow issuing stock at this kind of dividend yield. So we have a competitive advantage, we have run this business with lower leverage also which we will get no credit for than almost any of any of our peers maybe any of our peers. And we can continually go, we have gone for safety, not, no, we haven’t looked like the high yield book, we haven’t levered ourselves 80% or 90%. So, the margin thickness of our slice is as we said the thickness of our B notes around mezzanine paper has always been our goal is to put as much money as we could in these very high rates of returns, not to get a 14 on $5 million, they get 11 on 30 and that’s how we continue to run the company. So, not sure I understand the disconnect in the equity markets other than the basic outflow of capital from all things real estate at the moment. And again if you take the sum of our part and you look at multiples on apartments, you look at multiples on office, on medical office, on Dublin office and then you add back to our peers multiple on the mortgage book. You get a number much higher than we trade today. And as you know, we have harvested and we will continue to harvest as Jeff said the embedded gains in our book over time and we continue to create them. We continue to buy assets out of our book and we continue to find attractive ways to deploy capital.

On the equity side, our equity book was meant to extend duration Jeff mentioned $40 billion something of repayments. That’s capital we have to put out again at the same rates of return or we are going to have a decreasing earnings stream, we haven’t suffered from that, but it’s scary. You may have to do that every quarter you have to get your team. So, we went into equity, long-duration great safe assets that are producing double-digit cash flow and very high ROEs we can take the leverage up if we wanted to. But the strategy at the moment obviously I feel good about the enterprise and so did the credit markets, but the equity markets are a little less excited at the moment and we are not sure we understand why. It has been a very good business and the team at SCG, Starwood Capital Group and the team at the REIT has really never worked more closely together to generate value for shareholders. We see a lot of deals, one of our big apartment deals came from one of our lending guys and vice-versa, so our deal that we just did in Europe came from one of the equity guys. So, we are continuing to source as we can all over the world. We continue to find attractive ways to deploy capital at rates commensurate with our historical returns.

And at this point of the cycle, I would have thought that would have been hard, you have asked me 9 years ago given you know what the world is like today, if I am not surprised, but Jeff mentioned a $1.75 billion book in the first quarter. And I think last time I looked at this and I went to do it right before the call, but I forgot. I think when the top 20, maybe 20 lenders, real estate lenders in the United States at that size. And so this is a broadly diversified company. We built it that way. We won’t be able to deploy capital and to not force into any sleeve and yet we are obviously dominated by our lending book, which is our basic backbone. So, we are really happy with our move in the residential markets. That’s turned out to be a very good business with very, very attractive ROEs and we will continue to grow that, but it will never be a dominant piece, it will just be another place we can deploy capital with one commercial real estate somehow. As a blip, we will be very capable on another sector. So with that, I think I will stop and thank my team for a great year, incredible year and thank our board for their support in executing our strategy and hopefully we will be talking to you about $30 stock price someday.

[Jeff DiModica, President]

I will add to Barry’s comment on Dublin, which was floating rate when we put it on that we are now 3 years in. We are a quarter away from being able to refinance it, which we could do it in either a tighter spread floating rate or a 2.1% fixed rate today as the quote we are getting to, very easy for us to lock in a very low attractive fixed rate there.

[Barry Sternlicht, Chief Executive Officer]

And let me go back on the equity markets, I think just comment on the apartments we own, if you can look at apartment multiples, they are probably 5 caps today, 540 and there is 6 that’s 20 times FFO, medical office 20 times FFO, Dublin is a foreign 4.5 cap market and we would sell those assets at 22 to 23 4 times EBITDA. We haven’t told you what we have done with Cabela’s, but we believe there is arbitrage between what we pay for those assets and what they are available to be sold for and I can talk about Cabela’s credit if you would like. At some point, I think that was quintessential of Starwood having conviction in the credit and what our thoughts are, I would be happy to talk about in Q&A. So, these asset classes trade at much higher multiples than our mortgage book and should drag us north and frankly to a multiple book that is well beyond any of our peers, which are simply collections of paper and yet that hasn’t succeeded yet. And I sound frustrated, I m probably frustrated, but I am comfortable. And as you know I have never sold a share of stock. Thank you.

[Zach Tanenbaum, Director, Investor Relations]

Operator, we will take questions now.

[Operator]

Thank you. [Operator Instructions] You will hear first from Douglas Harter with Credit Suisse.

[Douglas Harter, Credit Suisse]

Thanks. Can you talk about the – your available liquidity and the ability to balance the strong pipeline you referenced and the opportunity to repurchase shares?

[Barry Sternlicht, Chief Executive Officer]

I am sorry there was noise in hallway, can you get them to stop talking out there. You asked about it, great. We have like a $1 dollars of capacity including 260 of approved repurchase capability. Rina you might know the cash drag we experienced for the quarter. We have raised our debt when we could and the thing we payoff our credit facilities with the proceeds, but it does create an under-levered balance sheet that is not insignificant. We know our pipeline, so we can see what we are holding cash for. But used in a lot of cash and Rina do you have an estimate of what that might have cost us this quarter?

[Rina Paniry, Chief Financial Officer]

Probably about $0.02 to $0.03 for the quarter, so we had cash going around the path that converts that we need to – that are maturing tomorrow, that was $370 million that we got on. I will say that $0.02 to $0.03 a drag that we got, yes.

[Barry Sternlicht, Chief Executive Officer]

Good bye, converts. I hope you enjoyed owning it.

[Andrew Sossen, Chief Operating Officer]

But Doug, it’s Andrew. I mean just in terms of capacity to your question, I mean where we sit today, we have plenty of capacity to execute on business plan and to the extent we wanted to be out in the market repurchasing stock and not have to access the incremental new capital.

[Barry Sternlicht, Chief Executive Officer]

But both are capable, not only cash but also un-drawn – committed to un-drawn capacity which is probably well over $1 billion.

[Douglas Harter, Credit Suisse]

So I guess just to Rina’s point that there might have been $0.03 drag from cash and I guess since that converts payoff tomorrow, I guess should the first quarter see a similar drag and when might that drag be reduced?

[Barry Sternlicht, Chief Executive Officer]

We put into those somewhere in the area of $150 million a month of equity. And if you use that number, that value is at around $1 billion and you are five months or six months probably away from being to a more normal. And if you increase the pipeline a bit which we are hoping to do…

[Jeff DiModica, President]

Is your number net, like your $150 million is that net?

[Barry Sternlicht, Chief Executive Officer]

It’s net of repayment.

[Rina Paniry, Chief Financial Officer]

No, that number is equity out. I have heard Jeff’s comment. I think you are going to see that drag for the next six months.

[Barry Sternlicht, Chief Executive Officer]

Reducing each month for the next six months.

[Rina Paniry, Chief Financial Officer]

That’s right.

[Douglas Harter, Credit Suisse]

Alright. Thank you.

[Operator]

[Operator Instructions] Now we will hear from Jade Rahmani with KBW.

[Jade Rahmani, KBW]

Thanks very much. I appreciate the frustration on the stock price, dividend yield and personally think management has been doing the prudent thing in terms of pivoting towards unsecured debt issuance as well as continuing to incubate new business lines, just wanted to ask about unsecured debt, is the motivation about having more flexibility in terms of the types of deals that you are able to pursue because warehouse financing can be somewhat constraining or is it a risk management tool in terms of diversification of the liability structure?

[Barry Sternlicht, Chief Executive Officer]

How about all the above and in deep in the back of my mind, god forbid the world ever ended. You can buyback unsecured notes in the open market at discount to par. It’s very hard to do at the bank. So it is – that is a proven methodology in terrible cycles to keep these companies informed. And I am not anticipating that happening of course, but it is an asset. But I will say that’s cheap. It’s very important for rating agencies, that we issue unsecured debt and unencumbered assets. And it gives us maximum flexibility. So what we do as you probably know is we attribute that in our minds to different assets that are un-levered. And we look at like our leverage strategy and see if we are under-levered or over-levered. And that might change in our view. It’s management’s view. So we attribute even though it’s unsecured in our mind we are tacking it to a deal and saying we are levering it with unsecured debt.

[Jeff DiModica, President]

Yes. I mean Jade at LIBOR plus 160 area for our recent financing, you guys have seen everyone, a lot of CLOs get down the market. The CLOs have flashy headline numbers of what the financing is today. These are floating rate assets that can prepay tomorrow and as they do prepay which they do you pay off the sequentially your AAAs and your cost of funds goes up. We think that the CLOs that are getting done are well north of LIBOR plus 200 after all of that is factored in. And in addition you have to show the world your hand. You have to give the documents on every loan that you have. Those are assets that we are going to go out and make the phone calls on already have every time we see somebody, CLO out there. So we think it’s significantly better than you saw in the flexibility that Barry talked about. From a flexibility perspective, we could assign unsecured to a single loan, but we could also say well the warehouse lines or A notes are willing to lend us 70% of our loan balance at X and 60% at Y and Y is cheaper. But we could do at 60% at Y and top it off with that 10% of our corporate debt and everyone of our loans get the new price offer cheaper liability structure and every 10 basis points is 30 basis points in yield. And we think will save 20 basis points, 30 basis points, 40 basis points of financing by optimizing the strategy that others don’t have. But we think it’s not a big win and it takes a lot of work in creating unencumbered assets and having diligence to do that and it’s something we started to do for 4 years to be able to reap the benefits today.

[Jade Rahmani, KBW]

In terms of the 1Q investment activity of $2.5 billion, can you give some color how that splits by segment as well as the types of deals on the lending side that you are looking at?

[Barry Sternlicht, Chief Executive Officer]

It’s all over the place. And that would be another – I should have made that comment. As you told me we have a book that looks like we do. It’s not dominated by hotels. I would have been really surprised. I think if you ask me by segment, it’s pretty diversified, I haven’t seen the stat, but I have seen approved sequentially the deals. Do you have that Rina?

[Rina Paniry, Chief Financial Officer]

Yes. I do it’s 1.9 in our lending segment and then 450 in our property segment for the rest of the down REIT portfolio and then the rest is sort of split across.

[Jade Rahmani, KBW]

In terms of the $1.9 billion in lending, just good level of transition, the types of deals you are doing, are these construction loans, how much is whole loans versus mezzanine and what’s the level of credit risk do you think?

[Barry Sternlicht, Chief Executive Officer]

Are you still [ph] in our first quarter earnings call right now…?

[Jade Rahmani, KBW]

Well, I think you are talking about stock price evaluation and there is a perception that you guys have more credit risk than say BXMT?

[Barry Sternlicht, Chief Executive Officer]

Yes. Our construction book continues to fall Jade. I think it stayed at a relatively low level as a percentage of assets over the last year were significantly lower as a percentage of our lending book than we were a year ago in our lending book. So despite this opportunity in construction lending, we have not jumped in with both feet and moved the books entirely in that direction. The first quarter pipeline is a mix of construction and non-construction much as it looks a lot like the existing book today. But I would say it’s important to note that our construction book has not grown.

[Jeff DiModica, President]

I understand the recent development. And I am the first one who had said they are building – if you are building a high quality sponsoring you are lending in money at 50%, 60% of what it costs him to build the project. I go to bed every night hoping it will fall and we can buy that asset at 60% of the cost of construction. I know exactly what it’s costing, right. So this isn’t a guess on buying something and it’s [Technical Difficulty]. I know exactly that the cost of construction and getting a brand new asset. And we are smart enough having now a $60 billion booking incredible data to know where this asset and what it’s worth and word and when we will rent that and what the expenses are and what they trade for. So this is – we are an equity book team looking at debt deal and nearly every time we look at a deal in investment committee, what are the guys going to buy assets in that sector in the firm think of it. At this moment, there is an interesting deal right now on the hotel space and it’s a deal where we are not – anyway we look at the these things very closely. And I would put our LTV up against any company in the business and argue with it. Frankly, I’d say its paper, we have been taken out of positions we worried about by other public REITs and we are delighted to get out of those deals. So, I would say LTVs are sometimes in the judgment of management, I would say are conservative.

[Barry Sternlicht, Chief Executive Officer]

And Jade, our book sets up very well as we have spoken about before for construction loans, the large diversified nature of it and the amount of repayments that we have coming in from various places ensure that we always have cash coming in for those future fundings, also the fact that we have unsecured debt, which has ultimately significantly more flexibility is makes it a lot easier for us to be competitive in construction, where there are less competitors. So, we can be competitive, because we can use….

[Jeff DiModica, President]

Not a material portion of that.

[Jade Rahmani, KBW]

In terms of the uptick in special servicing balance this quarter, is that sort of a one-time thing and you expect further runoff this year or is there any inflection in the trends?

[Barry Sternlicht, Chief Executive Officer]

Rina?

[Jeff DiModica, President]

I can answer that. We actually took in a transfer from another transaction that brought in the significant amount of new loan in the special servicing from that. So, I think the trend is stabilization of that number over time, I don’t know, but we will seek increases like that, but there have been a couple of more transfers.

[Barry Sternlicht, Chief Executive Officer]

It’s obviously a little subtle, but we would point out that if rates were to spike, our servicer would probably have to be busier, our special servicer. So, we have always had that little guy and that little guy is only worth $60 million and $59 million right now on our balance sheet. So, it’s like the services carried is virtually nothing, almost 1% of our assets. And that it’s a nice little option to have on the rest of the businesses of the REITs are operating great. That one is operating great too. It’s just the planned decrease in its book over time, right, and then there are other businesses have to make up for it, we know what’s coming.

[Jade Rahmani, KBW]

The Freddie Mac agency servicing you cited how big in the opportunity is that?

[Barry Sternlicht, Chief Executive Officer]

We are doing the small balance deals as a starter. Hopefully, we get involved in the larger case series soon and prove ourselves there. So, I think with our ultimate plan, it’s the decent sized opportunity, but we are taking the baby steps we have to take to get involved in the program and we are going to do a good job in the small balance and then see if we can get into the larger balance.

[Jade Rahmani, KBW]

And lastly, since you guys are pretty bullish on multifamily, what’s your interest level in the GSE multifamily lending business. As I am sure you know, the FHFA slightly reduced their lending caps, but volumes are expected to remain pretty resilient and that business line would seem somewhat complementary to your existing businesses as well as expressed the positive view of multifamily that you have?

[Barry Sternlicht, Chief Executive Officer]

Yes, something we look at. We leave it at that.

[Jade Rahmani, KBW]

Thanks very much.

[Barry Sternlicht, Chief Executive Officer]

Thanks, Jade.

[Operator]

And we have time for one more question and that will come from Fred Small with Compass Point. Go ahead, please.

[Fred Small, Compass Point]

Hey, good morning. Thanks for taking my questions. Just leaving aside the depreciation shield and the potential ratings agency impacts, what’s your level of frustration with the implied valuation for something like multifamily property assets inside of Starwood compared with the public market valuations and assuming this persists what’s the probability that you will take some action these are separate – these assets are monetized for valuation discrepancy over the next 12 to 24 months?

[Barry Sternlicht, Chief Executive Officer]

I’d call it increasing frustration. I would not say, it’s a panic that we are here for the long run. And as the property book has grown, it’s a more relevant discussion to have and it’s something we have to look at, I mean, but is it in the long-term interest of the firm to spin out of property book. Again, it served the purpose of extending durations and giving us unlike a loan hopefully increasing cash flows. We expect – there are fixed bumps in our medical office building portfolio in the rent. So, their cash flows are going up and the same thing I think would be two of our multifamily assets over time. So, I think we like them. I personally like – I own a lot of stock, we can look it up. I mean, I like them in the book. I am happy that was our strategy, buy assets we want to own for a long time and that’s how we chose the assets. And but, I mean, if we can’t be competitive with a dividend yield like this, when we have to issue stock, because I don’t want to issue stock at this kind of dividend yield. So, it’s too expensive to us and we should be buying it in and that is obviously a very good place to deploy capital. So, we are – obviously our stock is a little higher than it was at the height of the panic recently. And our thought was – my thought was that we are getting in the way of a freight train and nothing to do with us. And we would have had to had we rushed into market to issue stock, to buyback stock, we would have had to accelerate our earnings release for you and it would have looked really silly. We decided in the day, nobody knew how long the balance was going to last and how much stock we are going to buy. But it is something, I mean, you can clearly see that we have done it before and we will do it again we will buy our stock back. So, it’s hard to argue the best credit is in the 96th dividend yield of our firm. And we are partners with our shareholders. We don’t want to see the stock at these levels.

The ETF flows will settle down. I mean, their withdrawal of funds from the REIT, they will find a level and then I guess we’ll backfill, people will come through debris that they created by selling all of the REITs and they will find the companies that are going to perform better in higher rates environment like us and we will see it in our earnings of it will be going down. Look at the resi REITs right now, they are having a bitch of a time, right, but they have mismatched books. We have perfectly matched books pretty much and we never create an FNL crisis here. We never floated. We never redeem capital. We never floated short and we had long assets. We didn’t borrow in REPO paper. So, our floating-to-floating, fixed to fixed and pretty much matchbook. And so we don’t have that kind of exposure know, people have longer memories I guess and same people take crazy risks, we haven’t. And again, that’s why there are some companies in our sector that have gotten a lot of trouble being conglomerates and diversified. I think you make up for that with full disclosure. We tell you what we are doing. And you can model, I have trouble modeling from these companies, but I won’t mention them, but I am lost, I can’t figure out what’s going on and we don’t provide enough information for me to figure it out. We will give you all information you need as long as my proprietary to figure us out and you take your own view of the risk we are taking in our enterprise. So, we want you to partner in our success and benefit all the shareholders. So, we are transparent. We have won the award 4 years in a row from NAREIT for the most transparent gold book, what do we call gold key or…

[Jeff DiModica, President]

Yes, gold medal.

[Barry Sternlicht, Chief Executive Officer]

And we are going to do more, exact sitting here and you will say whatever you want to know, but other than borrowers necessarily in the date of the maturity of loans, so we don’t wind up having four of the guys called the borrower. So, we are – I am really pleased with our – you should be very pleased with our loan origination volumes. I mean at this point given what you know the world is like, I mean, they are not the stressed bank of the world, but even increased their rallying. So, I think we compete head-to-head in the marketplace everyday, it’s competitive, where we have a very good cost of funds which Jeff and the team have built and we continue to see banks on our credit facilities and the spreads on those facilities and we are not being impacted, because it’s not like we lend at 375 or 295 over, over for everyone, we are not at a disadvantage with rates rising. They have to borrow from somewhere. So, we have to have the most competitive spreads, cheapest borrowing costs and produce the highest ROE and then this is a virtuous cycle. And that’s what we are trying to achieve. So, I think the market is freaked out, but things like our JPMorgan report and there was is a whole list of 50 stocks you should sell on a rising rate environment and I wrote to Morgan, I said, the analyst take their head out of their butt, because that was really an awful, I think, stupid report. He should have looked at our company before they did a computer screen and look and see their own debt and that’s all we did. So, it was irresponsible, but I will look through that before in my career, not a big problem.

[Fred Small, Compass Point]

Just stupid.

[Barry Sternlicht, Chief Executive Officer]

I think what they called fake news. That was fake news. That was actually a fact. I think that’s it right. One more? Okay.

[Operator]

And now we will take a follow-up from Jade Rahmani with KBW.

[Jade Rahmani, KBW]

Thanks. Do you have the amount of prepayment income in the quarter?

[Rina Paniry, Chief Financial Officer]

Yes. We have got prepayment penalties at an accelerated accretion of $11 million in the quarter which it flat to last quarter.

[Barry Sternlicht, Chief Executive Officer]

We want to run that more or less every quarter. We are always going to get those, Jade, right. I mean, I don’t think as JPMorgan about prepayments penalties in the earnings and we are not JPMorgan, but it’s kind of like we are in the business that we have let a $12 million book. I mean, we are telling to get some especially as spreads came in, Jade, right it’s spreads from people are refinancing at lower spreads and trying to extend their maturities. So, we are always going to have.

[Jade Rahmani, KBW]

So, we try to calculate what your underlying yields are excluding those to see these spread trends?

[Barry Sternlicht, Chief Executive Officer]

Yes. Well, the originations numbers we quote you to the expected maturity. And I still say the IRR is actually lot went up higher off in times, because you get the fee in and sometimes the fee out as the paper shortens, because lot of these assets are that it’s empty 10. They get a 10. They go refinance it. It seems they do and so your IRRs go up, not down, but it’s sort of – the good news is you are getting a higher ROE on your paper, the bad news is it’s paid out for them period of time to redeploy it. So, it’s a good question and it’s a fascinating situation.

[Barry Sternlicht, Chief Executive Officer]

Alright. Thank you everyone. I hope I am less frustrated next quarter.

[Operator]

With that, ladies and gentlemen this will conclude your conference for today. We do thank you for your participation. You may now disconnect.