Starwood Property Trust Inc

NYSE:STWD

Earnings Call Transcript 2019-Q4

[Operator]

Greetings. Welcome to Starwood Property Trust fourth quarter 2019 earnings call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]. Please note, this conference is being recorded.

I will now turn the conference over to your host, Zach Tanenbaum, Head of Investor Relations. Please go ahead.

[Zach Tanenbaum, Head of Investor Relations]

Thank you operator. Good morning and welcome to Starwood Property Trust earnings call. This morning, the company released its financial results for the quarter ended December 31, 2019, filed its Form 10-K with the Securities and Exchange Commission and posted its earnings supplement to its website. These documents are available on 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. 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, Jeff DiModica, the company's President, Rina Paniry, the company's Chief Financial Officer and Andrew Sossen, the company's Chief Operating Officer.

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

[Rina Paniry, Chief Financial Officer]

Thank you Zack and good morning everyone. The fourth quarter capped off another strong year for us. Core earnings in Q4 totaled $139 million or $0.47 per share. After adjusting for certain items impacting our property segment, core was $0.53 per share this quarter and $2.10 for the full year. I will discuss each of these items in detail a little later.

Our performance this quarter was led by our largest segment, commercial and residential lending, which contributed core earnings of $109 million to the quarter. On the commercial lending side, we originated 16 loans totaling a record $2.2 billion, bringing our 2019 volume to $5.5 billion with an average loan size of $147 million. In the quarter, we funded $1.4 billion on new loans and $536 million on pre-existing loan commitments. These fundings were offset by $551 million in loan repayments, bringing our commercial lending portfolio to a record $9.1 billion at a weighted average LTV of 64%.

As a reminder, we update the LTVs on our loan book at least once a year or more frequently if circumstances warrant. The values are typically based on internal based underwriting, which tends to be more conservative than the third party valuations we receive. With our implementation of the new Current Expected Credit Loss or CECL accounting standard, we will be revising our policy to utilize third-party instead of internal valuation. With this change, we expect our weighted average LTV to drop below 60%.

On the residential lending side, we continued our expansion of this business by purchasing $521 million of non-QM loans and completing our fifth securitization totaling $370 million. This brought our residential loan portfolio to $1.3 billion and our retained RMBS portfolio to $147 million at year-end. The loans carried an average LTV of 69% and an average FICO of 732 with $672 million of these loans classified as held for investment. Our retained RMBS portfolio produces a double digit yield and unlike our securitization gains, is not taxable.

I will now turn to our infrastructure lending segment which contributed core earnings of $7 million to the quarter. We acquired a record $640 million of loans of which $424 million was funded. The fundings were back-ended with 85% occurring in the second half of the quarter. This brings our post-acquisition portfolio representing the non-GE loans to $843 million at year-end. As for the loans we acquired from GE, these lower margin loans continue to roll-off with $336 million of repayments in the quarter. Between sales and repayments, this portfolio has decreased by 63% since acquisition, bringing the balance to $751 million at year-end and bringing the total infrastructure loan book to $1.6 billion. As we work to deploy capital into this segment, we continue to increase our borrowing capacity. In October, we closed a $500 million five-year financing facility at our lowest spread to-date, about 175. This bring our total financing capacity in this segment to $2.3 billion, of which $1.2 billion was drawn.

Next, I will turn to our investing and servicing segment which contributed core earnings of $63 million to the quarter. As we have said in the past, the various cylinders of this segment work together to produce a consistent and strong return. Our CMBS portfolio continues to perform very well. In late December, we entered into our eight and largest strategic CMBS BP joint venture. In doing so, we sold CMBS totaling $333 million to the JV with a third-party obtaining a 49% interest for cash consideration of $163 million.

For GAAP purposes, we consolidate the JV which is why our financial statements do not reflect the sale. Instead, the 49% third-party interest is reflected within the non-controlling interest line on our balance sheet. In our conduit, we securitized $794 million of loans in four transactions this quarter, bringing our total securitization volume for the year to $1.8 billion and 11 transactions. And finally, on the segment's property portfolio. We continue to harvest gains as these assets reach stabilization. At year-end, we had 17 assets remaining with an undepreciated balance of $278 million.

And finally, I will discuss our property segment where several significant items affected core earnings. First, we completed the sale of our Dublin portfolio on December 23, which generated a core gain of $60 million or $0.20 per share and net cash proceeds of $214 million. The transaction was structured in a way where we did not directly pay tax in Ireland. Instead, there was a tax withholding adjustment which was treated as a reduction of the gain. Without this tax adjustment, our gain on the transaction was $83 million.

The second item impacting the property segment's core earnings this quarter was a $72 million for $0.24 impairment relating to our interest in a regional mall portfolio. During the quarter, we commissioned independent appraisals for each of the assets within this portfolio, which resulted in a reduction of our investment to zero.

The last item I wanted to mention was the refinancings of two of our property portfolios this quarter, which enabled us to take out $190 million in debt proceeds and increase our cash-on-cash yield. In our medical office portfolio, we refinanced $495 million of debt with $600 million of five-year financing. This took our cash yield from 10% to just under 13%. We also entered into an $85 million six-year supplemental financing for first multifamily portfolio, which took our cash yield from 16% to just over 19%.

In connection with these refinancings, we recognized a $5 million or $0.02 per share loss on extinguishment of debt. Following these events, we expect the blended cash yield related to the assets in this segment to be 15%, with weighted average occupancy remaining steady at 97%. These assets are financed with debt containing an average remaining duration of seven years at a weighted average fixed rate of 3.7%.

As of quarter end, these properties along with those in our investing and servicing segment carried a cumulative depreciation of $311 million or $1.10 per share. As we have said in the past, we believe these assets have appreciated meaningfully since we have acquired them and the appreciation is not reflected in our GAAP book value. At a minimum, adding back $311 million for GAAP book value would arrive at a purchase price for these assets. The gains that we believe exist in this portfolio would be an incremental increase to undepreciated book value.

And now turning to our capitalization and dividend. We continue to have ample credit capacity across our business lines. During the quarter, we entered into new or expanded facilities totaling $1.8 billion bringing our undrawn debt capacity to $9 billion. We ended the year with an adjusted debt to undepreciated equity ratio of 1.9 times.

As for our dividend, for the first quarter of 2020, we have declared a $0.48 per share dividend which will be paid on April 15 to shareholders of record on March 31. This represents a 7.5% annualized dividend yield on yesterday's closing share price of $25.60.

Before I conclude, I wanted to say a few words about the CECL which took effect on January 1 and will be more fully disclosed in our first quarter 10-Q. Because we have no history of realized loan losses, we have subscribed to third-party database services to provide us with industry losses for both CRE and infrastructure loans. Using the losses as a benchmark for our loans, we estimate that the total change to our allowance from the implementation of CECL will be between $30 million and $40 million.

Approximately half of this change relates to infrastructure which currently has no reserve and the other half relates to our theory book, which currently has a $3.6 million general reserve along with specific reserve for certain loans. This adjustment will go against equity at the date of implementation. Afterwards, any changes to the reserve will flow through GAAP earnings. Consistent with our current policy, core earnings will not include the allowance.

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

[Jeff DiModica, President, Managing Director]

Thanks Rina. A strong fourth quarter capped off a banner year for shareholders of Starwood Property Trust. Our stock price was up 26% for a 37% total return with dividend, the highest return in our 11 years since inception. Our dividend yield today is over 5.5 times the yield of the 10-year U.S. Treasury and we believe the proven consistent performance of our multi-cylinder business, our best-in-class leverage, the low loan to value ratios of our loans which are going lower, our diversified liability structure and embedded gains of over $800 million or over $202.83 per share justifies continued outperformance both versus rate and versus our peers in the years to come.

Before commenting on our segment highlights, I would like to discuss our work on ESG initiative in 2019. We are proud to report that MSCI this quarter upgraded our ESG rating to BBB making us the leader in our peer group. I will address shareholders to the corporate responsibility tab in our website where we talk about our positive social and environmental impact and quickly highlight our large affordable housing portfolio actions we have taken in our own portfolio to reduce environmental impact, our very strong diversity hiring statistics and our community involvement initiatives.

As Rina said, we originated 16 CRE loans in our property segment for a record $2.2 billion in the quarter. The expected IRRs in these originations were in line with the first three quarters of 2019 and at similar leverage levels. 60% of our Q4 loans closed in the final two weeks of the quarter thus had a small investment on Q4 performance but will have a greater impact on 2020 and beyond. After starting 2019 cautiously following the credit widening in December 2018, we are happy to report that our CRE loan book is at a record size of $9.1 billion today and over $12 billion if we included senior financing sold as part of our originations. Q1 is off to a strong start as well and we expect the first seven months of the year to be busy as we head into the summer holidays and then the elections in November.

We care about volume originations but care more about credit quality and the quality and pricing of our liability. Our debt-to-equity ratios, both on and off-balance sheet, of 1.9 times and 2.9 times are significantly below our peer group. Only 40% of our $9.1 billion loan book is financed using bank warehouse lines today which is also significantly below our peer group and keeps us in better position should credit markets deteriorate in the future. With $9 billion of warehouse line capacity available today and $3.2 billion of unencumbered assets on balance sheet, we have tremendous secured and unsecured debt capacity. Add the accretive A Note sales, the CLO and term loan restructuring we executed in 2019 to the mix and the diversity of the right side of our balance sheet allows us to borrow extremely efficiently and therefore invest in higher quality assets at the lowest possible leverage to achieve our return threshold.

As a final point on credit, our CRE lending book loan-to-value fell to 64.1% in the quarter. And as Rina said, we expect it to fall below 60%, the lowest in our history with the implementation of CECL in Q1. 2019 was the first year in our 11 years as a company where our LIBOR fell bringing into focus the value of the LIBOR floors we negotiate for in our loan book. We have LIBOR floors on all our domestic loans. 32% of our floors are in-the-money today and our 2019 origination had a weighted average floor of 190 basis points putting them $17 million in-the-money to our expected maturity today. Due to these floors, our LIBOR sensitivity shows our floating rate loan book counterintuitively performs even better when LIBOR falls than when it rises and our worst-case scenario is our underwritten case, static LIBOR.

Our non-U.S. loan book was just 11% of our CRE loan portfolio at the beginning of 2019 and its 19% today and we expect going higher. We have hired talents to our loan originations team based in London and expect to continue to grow our international exposure as we take advantage of larger net interest margins and a positive basis swap when hedging expected cash flows back to dollars. Finally, only 3% of our lending portfolio is in retail today, half of that is in the American Dream Mall, which we have spoken a lot recently and its opening in full soon.

In property, as Rina mentioned, we opportunistically sold our Dublin office portfolio in the quarter at a significant gain, as our internal models expect moderating rent growth in that market going forward. Our property portfolio gives us significant asset duration and once again performed very well in 2019 with income up, cap rates tightening and our cash yields improving due to the accretive refinancing we executed in the quarter.

We refinanced our MOB portfolio and our first Florida multifamily portfolio, bringing the cash yield of our property portfolio up to 15%, not inclusive of the over $700 million in gains in our property book alone which come predominantly from our Florida multifamily portfolio, where rents can go up based on median MSA income growth but rents can not go down.

In REITs, as Rina said, we formed a $333 million CMBS joint venture in the quarter, of which we hold a 51% majority. STWD receives asset management fees and a promote on the JV which will increase the return on our retained investment while allowing us to keep the vast majority of the future servicing revenue. In the last nine quarters, we have increased our named special servicing by 34% to $93 billion across 185 trusts, while simultaneously taking advantage of tighter spreads and lower interest rates to tactically reduce our own CMBS book by 26% from its high to just 4.4% of our assets versus 10.4% of our assets five years ago.

Being named special servicer on more loans while decreasing our own book will ensure this book outperforms should an unexpected downturn hit the property or credit markets. Our equity investment in REITs continue to perform very well. As Rina mentioned, we harvested some gains in the quarter and expect to continue to harvest significant gains for the next two years, until the time when our special servicing revenue is expected to pick back up.

Rina also mention the performance of our conduit originations business, Starwood Mortgage Capital, which securitized $1.8 billion of loans in 11 transactions in 2019. We continue to be among the largest best-performing non-bank loan originators with the lowest historic delinquency rate of the top non-bank originators producing very consistent earnings at a very high ROE which expands our multiple to book value and creates long term shareholder value.

Turning to our non-QM book. As we underwrote, the credit performance of this sector has been stellar and we continued to add acquisition channels in 2019, allowing us to acquire over $2 billion of high quality loans. We expect to continue to grow this book in 2020 and beyond. Subsequent to quarter-end, we priced our sixth securitization and our deals continue to price at the tightest liability spreads in the market, a testament to the quality of the platform we have built. There is tremendous capacity of warehouse lines for this product and we expect to add significantly more warehouse capacity in 2020 as we are get closer to the February 2021 maturity of our FHLB line.

Finally, in infrastructure we are pleased to report that our energy infrastructure business is now running at full capacity with three financing facilities in place for $1.5 billion and two more in process. We took advantage of wider lending spreads to put out $640 million in the quarter, which is well above our underwritten annual run rate at spreads above our original underwriting. We still own some lower yielding assets from our acquisition portfolio but are happy to report that the $1 billion in loan volume in 2019 had an optimal IRR well in excess of 13% and we believe the outlook for 2020 is good and hope to execute our first CLO in this sector to further diversify our financing options for this business.

Before turning it to Barry, I would like to add something on the dividend. On an adjusted earnings basis, we again covered our dividend handily in 2019. We are confident in our ability to continue to earn our dividend in the coming years and are in the unique position of having over $800 million in unrealized gains to harvest if we choose, leaving us in the enviable position to never have to take outsized risks in our core businesses. We begin this new decade with the same investment philosophy in which we began the last, slow, steady and thoughtful.

With that, I will turn the call to Barry.

[Barry Sternlicht, Chairman, Chief Executive Officer]

Thank you Rina and thank you Jeff. Good morning everyone. Thank you Zach. I wonder what I can talk about today. These comments were fairly extensive. Let's start with the world because it's a fascinating world today. I think one thing is, the stocks fell off a little bit on the contagion from Coronavirus. We have no impact from Coronavirus. I mean that is not a risk for our firm in any way, shape or form. So it's just market sentiment that it fell off.

And one thing that's fascinating though is what the bond market is telling you. The bond market is telling you the economy is, well, the global economy is slowing. It clearly will slow from Coronavirus. Again, I actually think it makes property more valuable and I expect cap rates to drift down. Cap rates and property probably haven't adjusted to 1.38 treasury and not only are the base rates coming down, LIBOR will now fall this year which will make Jeff's LIBOR floors even more valuable. But my guess is that, spreads will come in as lenders are searching the world for yield.

So our enterprise and the mark-to-market of our loan book is becoming more and more valuable sort of every day and that we had a 3.25 10-year and the stock was $24 or whatever and now we have a 1.38 10-year. The stock is totally misvalued. The market is getting the quarter all wrong. You should have known that the Taubman transaction was in trouble. We told you that and we offset that with a gain from Dublin to prove to you the gains we talked about, the $800 million, was real.

We debated whether we should sell it or not. Ultimately we decided that we thought the rent profile in Dublin and new construction was going to slow the rate of growth and we totally offset the loss from the Taubman write-off with the gain from Dublin and we thought you might like that. It wasn't imperative that we do that but it was an $84 million gain and $70 million write-off. It looks funny in your GAAP accounting. So you can't find it correctly because there is all kinds of issues with taxes and hedges, but it was an $84 million total gain on Dublin which made it a terrific investment for us and the only asset that we own that we actually thought we might want to sell.

Everything else, I want to own for 150 years. Although at some point, we probably will harvest some of those gains. As Jeff mentioned and as Rina mentioned, when your property is earning 15% annually cash-on-cash on invested capital and it's growing every year, oh my God, it's as good as you can get. And that was the purpose of buying those assets was to create duration in our book. There is no issue of repayment. We control the sale and it's almost a third of our assets. So that was really exciting for us.

I think actually the company is in a better position probably than it's ever been overall. We had a transitional year in the energy business. We started out very slow selling assets and we did not have match duration financing for the loans we were originating. So rather than put on five-year paper with two-year debt, we just didn't do it. We waited until we got the facilities in place to have duration. You don't see that in our earnings, but it speaks to how we run the company which is, as Jeff said, safe and predictable and transparent, which as you know we won every award you can win up from NAREIT on disclosure and we want you to understand everything we are doing because all our business lines are performing well and getting better. So at the end of 2020, we actually are more bullish than we have ever been, I suppose.

One thing I think you will see us do is do more loans in Europe. There are better spreads in Europe right now. The banks are sitting back. I think we have seen some of our peers increase their exposure to Europe. We hope that will come to fruition. Those markets are very sound actually despite the slowing economies. The markets like places like the German property are just seeing substantial rent increases in the office markets as well as places like Spain and even the London market has really recovered in both residential and in office.

Another thing that's kind of fascinating, this will be our lowest LTV ever when the CECL numbers come in. And below 60% LTV on a book earning, what are we earning? Like 11.4 or something like that on the asset level, it's just ridiculous frankly. When Rina told me, we would have to revalue the assets to go with outside appraisals which is a requirement of CECL, I kind of gripped the table and was fearful that she is going to tell me we are at 70% LTV and actually shows you the conservative nature of our marks. We were 64%. We are dropping below 60%. Most of our peers are already using that methodology. So we haven't really been apples-to-apples to our comp set in our LTV marks.

One thing also that maybe not that obvious is, we are growing our resi book on held for sale. One reason we do that, which we have kind of never talked about, is that the GAAP accounting for the resi book is substantially lower than what we actually think we are going to earn on those assets. When you buy these or originate these loans, you basically can't assume for GAAP the refinancing of the remaining trust. And in reality, you will do that. You will pop a gain. You will take the IRRs that have in our financials higher. So also they are not taxable when we put them in the REIT then hold them to maturity. So you will see us continue to deploy capital behind that business not taking any excess credit risk. But that is a relatively new thing that the Board has approved and we really like because it's double digit yield on capital and it's been a very good business for us. And we will continue to do that as well as continue to securitize some of the loans that we acquire.

So the couple of other things. The book at $9 billion is as high as it's ever been in our loan book and that's good. We continue to look at yield versus duration and we still have a significant number of what we call transitional loans, large loans and we would like to originate slightly lower yields and keep these assets around longer. Something we keep talking about. Some of our peers are probably doing a little bit more of that than we are. And it's something we can do and expand our loan book going forward.

Lastly, I think on the CMBS, we didn't have to execute this trade that we did and lower our CMBS exposure. But there has been some volatility in the CMBS markets historically. Right now, it's really good time to have them. And we will continue to grow that base, restocking the pool, if you will, with new credits, which have less risk in them. Obviously, retail is all over the CMBS books of different lenders and retail will reset. It will have a value even if it's an alternative value and we have a chance to do that in a new deal which you didn't have in an old deal. So one of the reasons we have lightened up a little bit on our CMBS book in a JV with a partner which will, as Jeff said, earn a promote to the firm. It partly will go to some of the employees as a retention vehicle.

So overall, I am very confident in our business in 2020, probably entering next year, this year in as good a position as we ever have a year and the team is focused and we have a diverse business, all of which cylinders are doing just fine and we are excited.

So with that, I am going to stop and we are going to take questions. I will say one more thing, operator, before you go. The WeWork headquarter and the Lord and Taylor deal, some of you are aware, we have a piece of the first mortgage and a senior mezz in that transaction. You may also know that there are rumors that Amazon is going to take the building down. It's been published. And we have call protection in that loan. Obviously, if they want to stay, it will be really good loan. If they want to keep us in the tag, we will be really happy. But I think you are going to see a good outcome there and it's not an exposure for the firm at all.

As is the American Dream Mall loan. You shouldn't even think of that as a retail loan. When we underwrote that, as never opening a retail store and we underwrote it as, it's a theme park which it has indoor skis and whatever, Ferris wheels. And we also have the Mall of America's collateral. So there is no chance that we will ever see a problem in that loan. So just it was an unbelievable arbitrage of a moment in time when people needed assets like less than 50% LTV, if I recall. So, well less, especially if you take the additional collateral the company gave us. So those are not issues.

And with that, I will take questions or we will take questions. Thank you.

[Operator]

[Operator Instructions]. Our first question is from Doug Harter with Credit Suisse. Please go ahead.

[Doug Harter, Credit Suisse]

Thanks. Can you talk about the environment as we look into 2020 for the return environment for commercial mortgage loans and what your expectation is for net growth for the year?

[Jeff DiModica, President, Managing Director]

Yes. Thanks. I would say that we are earning very similar to what we have historically earned. We are will probably 50 basis points lower on levered IRR today than we were a year-and-a-half ago or something like that. But it stayed fairly consistent through 2019. We are borrowing better. We continue to borrow better. As I think I told you a year ago when we did our best warehouse facilities for LIBOR plus 150, I said for cash flow we are going to be seeing facilities at LIBOR plus 125 on our bank warehouses. That's come to fruition.

So as you are seeing spreads tighten, you have to also measure the fact that liability spreads are tightening. We did our CLO this year at a mid-130, I think, but at tremendously tight financing spread. Other people are doing the same across all parts of our financing capital structure. If we go into the high-yield market, we can finance ourselves better today. The Term Loan B market which we used this year is very efficient in the low LIBOR plus 200 and we can do whatever we want to there.

So we are borrowing better. We are lending at tighter spreads. Lending at tighter spread does give you more duration. People are less motivated to prepay those loans. We like duration to get those off the treadmill. I would expect that last year after $5.5 billion when you remember very well, Doug, that in the first quarter, we got together and we told you we were being extremely conservative and doing some stress testing coming out of the December widening.

So we started the year slow. If we hadn't, we would be right around the same $6 billion as we were last year. And we expect this year, we will do another $6 billion, somewhere right around these returns. So we are seeing a tremendous amount I think with our $109 billion of loans last year that we looked at versus maybe $104 billion the year before. So we are looking at more loans. We have a larger team to do that. And I am optimistic that 2020 will look very similar to 2019 in the lending book with a little bit more of a bent towards Europe where we are seeing some incremental return opportunities.

[Doug Harter, Credit Suisse]

And just a comment on kind of added duration. Is that any different loan products you are offering to get that duration? Or it's just that the loans wind up staying outstanding longer because --?

[Jeff DiModica, President, Managing Director]

Yes. The lower spreads, you would have left rationale for refinancing it. You will still sell it at the same time, arguably and potentially with the debt but you would have less rationale for refinancing at lower coupon than you do for refinancing a higher coupon. So they tend to say on our books a little bit longer. I would guess closer to three years on the lower coupon stuff as opposed to 28 to 30 months on the stuff where you get a higher coupon is more transitional and people are more motivated.

[Doug Harter, Credit Suisse]

Great. And Rina, it looked like there was a GAAP provision against the infrastructure. Just I guess what was that for?

[Rina Paniry, Chief Financial Officer]

So that was a loan that we had acquired from GE. We had marked it below par at the time we acquired in purchase accounting, we had marked that to $0.80 on the dollar. The project that was underlying that loan went into bankruptcy in 2019. It emerged from bankruptcy in November. So that was the price evaluation coming out of bankruptcy related to that loan. We hold a 10% participating interest. So it's a much larger loan overall.

[Jeff DiModica, President, Managing Director]

With our total.

[Rina Paniry, Chief Financial Officer]

So our total basis is now about $25 million after the $3 million write-down.

[Jeff DiModica, President, Managing Director]

It's kind of irrelevant, just pointing that out.

[Doug Harter, Credit Suisse]

But I guess how does that $3 million compare to where you had it more? Is that below kind of the 80% when you marked it?

[Jeff DiModica, President, Managing Director]

No. It was never marked.

[Doug Harter, Credit Suisse]

Okay. Got it.

[Rina Paniry, Chief Financial Officer]

So we took the $0.80 on the dollar and marked to $0.69.

[Doug Harter, Credit Suisse]

Got it. Okay. Thank you.

[Operator]

Next question comes from Steven DeLaney with JMP Securities. Please go ahead.

[Steven DeLaney, JMP Securities]

Thanks and good morning everyone. Your total investment portfolio is $17 billion and Barry highlighted the $9 billion loan book. When you look at those numbers macro, do you see yourself as roughly fully invested at December 31? And if not, how much growth do you think you could have in your investment portfolio with the existing capital base? Thanks.

[Barry Sternlicht, Chairman, Chief Executive Officer]

We will never fully invest it.

[Steven DeLaney, JMP Securities]

Yes. That would seem so.

[Jeff DiModica, President, Managing Director]

We have probably $3 billion or $4 billion. I would throw out, away from just the capacity which you can see in the supplemental in the $300 million to $400 million of cash that we normally sit on. We have tremendous amount of unencumbered assets. We could go out and raise more debt on if we wanted to. We are under levered versus our peers. We could take more asset level debt. Every one of those could add $4 worth of assets for every dollar we brought in if we were putting them out and levering them.

So there is clearly the potential to bring that $17 billion up to $20 billion-plus if we wanted to run the business hotter. But we have decided to run a more low leverage conservative business here, Steve. And we like having cash on the balance sheet. It does create a little bit of a drag but it leaves us opportunities, money for opportunities when they come in. If we were trying to be more perfect, we would run our cash balances a little tighter and reduce drag in the business. The conservatism that comes with holding cash is good for us and it gives us opportunities when things widen.

[Steven DeLaney, JMP Securities]

Great. And I had a second part to that question, but you have kind of already answered it. But I will go ahead and throw it out there. You guys have been very respectful of your shareholders over the years. Stock is up 30% since the end of 2018 and the dividend yield down to 7.5%. So the question would be, if the right opportunity presented itself and you needed more than $3 billion, at what point and what would the return profile have to look like for you guys to consider issuing common equity because you certainly I think would have earned the right to do that if you saw the opportunity?

[Barry Sternlicht, Chairman, Chief Executive Officer]

We are always in the market looking at ways to grow the enterprise. It would have to be accretive earning returns at least as consistent with what we earn on our book, strategic fits our overall plan and when you are stewarding capital like this, it is about reward versus the risk. And again, if you take the long term view and this is our 11th year or something as an enterprise, you never want to put the enterprise at risk, right. So we can produce higher returns but I was planning on sticking around and not having used to getting bombs in the mail.

So we are going to be careful on how we deploy capital and what we do with it. And this is really as supposed to be an incredible risk/reward with a 7.5% dividend yield in a world with 1.38 treasury. So that's the play. We are always in the play. You have seen, we have not entered the equity market every time the stock moves up. We have been very disciplined on issuing equity. Obviously, we like to grow the enterprise but not for the reason you might think. It's not about management thesis or anything like that. I think bigger is better is this space. It will drive our cost of funds down. It will help us achieve investment grade. And some of the assets that we are buying like our resi is higher leverage business.

So as we enter the businesses, our leverage levels as a firm are creeping up. The risk isn't changing, in my view, because the resi book is so diversified and such good credit, no one house is going to hurt us, not even penthouses and the securitizations. So it doesn't matter and we are optimizing our ROE for the asset classes. And it gets blended, sadly, by the street into, even though our overall debt remains below our peers, even bringing back the off-balance sheet leverage, we don't trade at the best-in-class.

And we used to think it was the servicer, maybe that was the issue. Well, the servicer is not making much money anymore. It's just an option on the future. So it's not the servicer. Maybe it's the resi book, maybe just too complicated. But you should us want to be complicated because we won't force feed the commercial lending book if we don't have to and we can grow the resi book, we can grow the conduit business has been a steady performer now for as long as we have owned LNR. And we had one quarter where we didn't make money.

We have never lost money in the conduit business. With 11 securitizations, we are a housing company. We just manufacture paper and sell it. And not only that, the big banks want our paper including the top rated conduit provider in the country. So all these businesses sort of sit nicely with each other. They are related to each other. The one, I have to say, we are disappointed with its early performance was the energy infrastructure business. But we slowed it down. We didn't want to take that mismatch in maturities.

You would never know until those are a problem. But we don't run the company that way. So we like the A Note because it is match funded. We did our CLOs, because they are match funded. And you can't see that from our quarterly earnings, but it's the way we are running the company. Jeff highlights the fact that the company has the best, it's the right or left side, I can't really remember.

[Jeff DiModica, President, Managing Director]

Right. Both sides, both sides.

[Barry Sternlicht, Chairman, Chief Executive Officer]

Left brain or right brain, I don't know. So I think it looks, it's just a solid company with $17 billion. Well, how many loans have we done? I think it's $60 billion? Almost $60 billion.

[Jeff DiModica, President, Managing Director]

Total investments.

[Barry Sternlicht, Chairman, Chief Executive Officer]

Total investments, $60 billion. It puts us in the top 10 as a bank in the United States by the way.

[Jeff DiModica, President, Managing Director]

Steve, you are one of the analysts who does a great job and we appreciate the flattering version of the question. It does a great job of pointing out our adjusted book value but looking today and these numbers are a couple days old, we are 1.54 times book. That doesn't include depreciation and taking out our fair market value gains that we have told you about. If you do that, we are around 1.2 times and our peer average is above that. And our largest peer is well above that. We feel like we have created a low leverage diverse amazing business. As Barry said, with a great right side of the balance sheet that can compete with any of them and we are really low on a price to book value, not high on a price to book value basis when you consider taking out depreciation.

That is a gate on us issuing equity, right, because we look at our fair value of our company as opposed to the book value of our company. And we own 15,000 affordable housing units, running like 97% occupancy with upwards only rent adjustments in two of the fastest-growing income towns in the United States. This is the gift that keeps on giving. Frankly, we blew it. I mean these assets would be among the greatest equity assets we have ever seen. So they are fantastic. They are in the REIT. They determined that would provide earnings literally forever for the company.

So we talked about realizing those gains and we have to figure out how we deploy all that excess cash. And we will do it at the point we are confident we can put out all that capital. So there is only one way apartment our cap rates are going. It's not up.

[Operator]

Thank you. Our next question comes from Don Fandetti with Wells Fargo. Please go ahead.

[Don Fandetti, Wells Fargo]

Yes. My first question is for Barry. Barry, I tend to agree with you that low rates and lower cap rates are probably going to continue to be good for company such as yourself. One thing that does cross my mind in this environment with Coronavirus, as you know, could you have some type of capital markets event and wanted to see if you can talk about how your positioned and what your playbook would be if you did get into some type of situation where securitization markets got wobbly, if you can address that?

[Jeff DiModica, President, Managing Director]

Hi Don. It's Jeff. I will start and then let Barry cleanup. As you know, we do a lot of things every day to prepare ourselves for what happens if a capital markets event happens. We have taken our CMBS book down from 10.5% to 4.5%. That's the one place where when the credit markets have wobbled, where people have said, while they own a lot of CMBS, so we should sell STWD. That book has performed tremendously well with a high teens return over the 11 year life. And we expect it to have a similar high teens return over the next 11 years. But if you head into a credit downturn, that certainly helps. Having a CMBS special servicer will help us significantly outperform our peers. We will make more money in credit distress.

On the CRE lending book side, we would make more money if we financed everything we do on a warehouse line. Many of our competitors lean towards doing almost that. 40% of our book is on warehouse lines. We can borrow at L125 on warehouse lines on cash flowing assets today. We can make tremendously higher returns if we leaned in there. We have 40% of our book there today. It's not the best earning place to be but it's the safest place to be having diversity on the right side of our balance sheet which includes our Term Loan, it includes our high-yield assets, it includes the CLO that we have done and then importantly it includes all the A Note sales that we have a separate group of professionals who help us sell A Notes and do CLO securitization.

So we are extremely cautious when it comes to managing the right side of the balance sheet and the left side of the balance sheet for a potential credit event, if we were to get one. So we think we will outperform in that environment. We get frustrated and you probably heard me talking about being below the peer average on a price to book which makes no sense to me. But we always say that we will outperform, if and when the credit markets do deteriorate. So we have tried to set the company up to be ready for that.

Barry, I don't know if you have other thoughts?

[Barry Sternlicht, Chairman, Chief Executive Officer]

I don't see that as a big issue for the company, really. I mean if I look at it as a double-edged sword. I love our loans this year because we have the match financing. So it's like, yes, people get nervous they may not refinance. And I don't see, I don't know, I mean it's hard to figure out what you might do if the credit markets just froze the bank markets. I think this cycle again, you have to remember where we are.

Property is not a problem for any bank in the United States. These banks have been very, very, very disciplined shockingly. The excesses in the market don't come from the banks. They come from our peers, shadow banks. And the one thing that's creeped into the market and it is happening now is you see these sort of outlier bids. And I remind our guys as we go through our loan review when we are looking at investment committee for these loans.

Just because somebody pays, it doesn't mean it's worth that. And when you get times like this where somebody is saying I own enough of the treasury, so I am going to buy a building at two cap. It doesn't mean it's worth a two cap. And so, in the equity book, we are selling assets all the time and you might see one guy 20% higher than the pack who is right on the LTV. And I think this is where our experience doing this for 30 years is super helpful.

I mean I see all kinds of things and we have been to these moves through multiple crisis. So as the stewards of capital, at least we have experience. We are not going to get -- there is a bunch of stuff out there that is really that we just debate and have arguments, there's three loans on the table that are probably $1 billion. And I am looking at Jeff, he is shaking his head, because we are just --

[Jeff DiModica, President, Managing Director]

The argument are, Barry, can we please do this loan? He says, no.

[Barry Sternlicht, Chairman, Chief Executive Officer]

Well, I mean, there's always going to be another loan. And there's issues like unions and all kinds of stuff. The one thing I should say is construction costs are rising. As people think inflation is 1%, they are certainly not in the real estate market. We are seeing almost double digit cost inflation on the West Coast. Labor is just scarce. It is one benefit of a 3.5% unemployment rate. So the contractors are telling you what you are building is going to cost and then they just say well, we can't do that for you.

So we are building a hotel on the West Coast in the Bay Area and through 80% drawn, the quote was $170 million and when we went to complete, the budget is $250 million. Like how is that even possible. But it's sort of, what do you do? You don't build. And that's good for existing loans. And property prices are increasing even because construction costs are rising. There are markets and cities where you shouldn't invest. We have an interesting portfolio because we don't have a lot of exposure other WeWork in New York City, for example. And we are not particularly bullish on the New York City office market.

We think expenses might rise faster than the rents and you need to be super careful there. Cap rates are obviously low, but they may change if people get the view that net rents are going to fall. And what's driving all these major markets is the same thing that's driving the stock market, five companies. They are expanding into Berlin, into New York, into Toronto and even Nashville. Amazon or what they call you the fangs and you can add three or four other names, Salesforce, these are driving these commercial property markets.

And if they get in trouble in the stock market, they will get in trouble in the real estate market. The markets have never been more intertwined. And it's a very -- you don't care about banks expanding anymore. In your cities, you have banks. It's not about banks anymore, it's TMC. And same thing in London, like all the incremental space is being driven by what Google wants, what Amazon wants, what Facebook wants. What Netflix wants or Twitter wants and then a dozen other unicorns. So for them, the cost of space is minuscule on their P&L military and they don't really care what they are paying, kind of like the hedge fund has evolved.

And we would just be careful about the exposure of those markets because actually, the thing that will stop these companies is regulation. It's the hardest thing to underwrite, right. If somebody that Amazon is destroying the world and we know it and Congress decides to change things, they will change things. So it's an interesting world. But there are asset classes, I mean the office markets in United States are fairly sound across the board, other than San Francisco or New York. I can't really think of something that I think is in Chicago, there are always more funds. But it's fine, it's stable. But other markets, rents are rising smartly ahead of expenses.

And Don, back to your original supposition, if credit markets widen, we have the most cash. We have the most availability on our facilities. We have the most unencumbered assets and we have the most, the only equity assets that we can sell. We were in a tremendous better position than others. So I hope you are going to ask the question about if credit markets deteriorate to others who report in the cycle, because I think we have set ourselves up for 10 years to outperform in exactly that scenario.

[Operator]

Our next question from Steven Laws with Raymond James. Please limit yourself to one question. Thank you.

[Steven Laws, Raymond James]

Okay. Good morning. I guess to follow-up then on the regulatory comment, switching gears. Maybe thoughts on how QM patch expiration plays out additionally GSE reform that might open back up FHLB? I think Barry, you mentioned in your prepared remarks that your facility there expires, I think, 2021. But those two issues and I will leave it at that. Thanks.

[Jeff DiModica, President, Managing Director]

Yes. Listen, it's only upside on the QM patch. We have no idea how it's going to play out. There is $180 billion that get done at the agencies of non-QM to the extent that the QM patch goes away. That's $180 billion that floods a $50 billion market and we are part of that $50 billion market and it gets a lot bigger and our footprint can get bigger, assuming that we can finance ourselves as well as we do today that would be wonderful. My best guess is that along the way, some portion of the patch comes off, but $180 billion of non-QM doesn't leave the agencies to flood the non-agency. I don't think the market equipped for it and I don't think that's what the government really wants. So there is upside to it. There is no real downside, if they don't. We are back to where we are today. So we are excited about that.

And as far as GSE reform, there will be a lot written. And the most important thing we can do is get ourselves set up as well as we can that if February 21 comes and we don't Home Loan bank, then we have tremendous amount of capacity elsewhere. We have an RFP out for quotes on warehouse lines. I think we had 11 or 12 different banks who want to provide us warehouse lines in that space. And I think they will trip over each other to finance them at the cheapest levels that they can find. And ultimately, we will end up in a very similar place on a level return.

[Barry Sternlicht, Chairman, Chief Executive Officer]

Because you think your business is tough to a bank today. I mean, they are chasing ever wider spreads and benefiting us too. So you know, again, I wouldn't have thought when we started that this market will evolve this way. But it's produced the same internal equity today that we did in 2008 and 2009 or 2010. I guess we launched in 2009. It is kind of remarkable, but it is because the banks have lowered their spreads to us and we have been able to lower our spreads to borrowers. And it's been a nice synchronized evolution of cheaper and more available financing. And we use our underwriting skills to pick our spots.

In a way, I feel bad for our -- I actually do feel bad for our origination team because it's been a bull market in real estate. And we probably killed $3 billion or $4 billion of loans that worked out just fine and somehow they don't complain all the time to me. They probably complain to Jeff. But that's the way it's going to go, right. I mean we are not going to approve loan that comes in a bull market. In a rising tide, all boats rise, but we try and keep afloat when the tide goes out. And there are crazy people in the world doing crazy things. And are they crazy?

I mean property, we are seeing yields in Europe and building a 2.5%. And that sounds insane, right. But every treasury, every duration treasury in Germany is negative. So you are picking up 250 basis points. So take that to the United States, 138 plus 250, it's like close to floor on our apartment, right. That's the same arbitrage, if you will. So you have to add in the borrowing spreads, but still people are issuing 25-year paper in Germany at like 1%, it's bananas. But that's, there is an opportunity there for us, 1.5%. Rina is looking at me like this is not right, it's impossible, it's true. The guy issued, I was talking about, 100-year bond in Austria at 1.8% on an office building.

So there is an opportunity to make real money today. It's a little uncomfortable, frankly, for guys who are used to 6% and 7% and 8%. But I don't think we are going back there. I don't see any pressure, upward pressure on rates in Europe. And you will have marvel, I went to HBS, which is my school in Boston. I mean I never learned that you could run $1 trillion plus deficit on its way to $2 trillion deficit with 3.5% unemployment rate, economy growing at 2% negative real rates and the 10-years at the lowest point in U.S. history. This is not a class I attended.

So every economist got it wrong in 2019. My big worry is they are all getting it wrong this year. They are all expecting rates will be low forever. That worries me. Because the entire consensus, 100 our of 100 economists, were wrong on 12/31/18 about where rates will wind up at the end of 31/18 and now we are at the end of 2019. Yes, 2019, that's right, that was last year. So here we are all talking about some money management, we are talking about 6% 10-years. Do you remember Jeffrey Gundlach and even Stanley Druckenmiller, not exactly dumb people and rates went the other way.

So conventional economist would have said and it's really, I think at the end of the day, the slowdown that came from the trade and uncertainties was one of the key reasons that global rates fell, particularly in Europe. And they pulled U.S. rates down with it. So I don't see it changing anytime soon because there's too much money that's been printed searching for yield. 28 banks using at the same time or something. I mean it's like you are at the fuel pumps and everyone thinks there is no piper to pay. So far, they have been right. Somehow, it doesn't feel it will be right long term.

[Operator]

Our next question comes from Jade Rahmani with KBW. Please go ahead.

[Jade Rahmani, KBW]

Thanks very much. As you look at the portfolio, the loan book is asked about 19% hospitality. How do you feel about the hotel loans and any potential impact from Coronavirus?

[Barry Sternlicht, Chairman, Chief Executive Officer]

Good question. I think everything we have is U.S. We don't have any hotels in offshore, right?

[Jeff DiModica, President, Managing Director]

We have one other construction in Spain. But no, nothing else.

[Barry Sternlicht, Chairman, Chief Executive Officer]

So far, obviously, the U.S. has been spared Coronavirus. I would have to get back to you because I would have to look at the individual loan exposures and I am not familiar with it. Dennis, are you on the phone?

[Dennis Schuh, Chief Originations Officer]

I am there.

[Barry Sternlicht, Chairman, Chief Executive Officer]

Do we have much exposure to Coronavirus anywhere? I don't think so.

[Jeff DiModica, President, Managing Director]

In New York City hotel, I will push in, Dennis, which is very helpful. Obviously, you would have a lot more there. Our portfolio is much more national, not really in much for tourist cities, not in Miami, not in New York. I doubt that it's going to have as big of an impact on us.

But go ahead, Dennis.

[Dennis Schuh, Chief Originations Officer]

Yes. I think, Jade, we should probably follow-up with you and get granular asset-by-asset. But none of the markets that have had a ton of exposure to Coronavirus, we don't have any exposure there. But obviously, it's an evolving issue.

[Barry Sternlicht, Chairman, Chief Executive Officer]

Currently, there are no markets in the U.S. that have had exposure to Coronavirus that I aware of, other than something in California, right. A couple of things. We will come back to you on that.

[Jade Rahmani, KBW]

Thank you.

[Operator]

Next question comes from Rich Shane with JPMorgan. Please go ahead.

[Rich Shane, JPMorgan]

Hi guys. Thanks for taking my questions this morning. Jeff and Barry, you both mentioned the conduit business. I am just curious, how much capital you allocate to that? How much you think you can allocate, realizing that it's a capital light business? And what types of returns sort of an annual basis because I realize there is going to be some volatility there?

[Jeff DiModica, President, Managing Director]

On the conduit business, it's difficult to grow using more capital. It's a relationship business. We could write larger loans. We could write tighter spread loans that have a little bit less P&L and that creates a little bit of volatility for us and takes more balance sheet but our balance sheet light strategy here is going to continue. It's $100 million-plus of balance sheet and it's across three or four different warehouse lines and we write $8 million to $12 million loans, occasionally a $20 million.

We don't try to take on really big investment grade positions. We are good at what we are good that and we sort of stay in our sandbox. We push the team to a little bit more. We are up a little bit. We did $1.6 billion. We are up to $1.8 billion. That's good. The larger the loans get, the lower the profitability it gets. And we picked a sweet spot for us in our relationships. And I think it works well. So I don't foresee us going and putting more balance sheet behind that business, not that we wouldn't but just because we are going to stick to what we are good at.

[Rich Shane, JPMorgan]

Got it. And the second part of the question was, what is your return target there over time?

[Jeff DiModica, President, Managing Director]

Yes. It's not really a returns business. It's a gain on sale business. So even though the ROE is tremendously high and very accretive to our price to book ratios and other, I don't really think about it that way. We try to write smart loans that we are confident will get into securitization. Some of those securitizations we will end up owning the BPs on, maybe a quarter of them or so. So we have secure on awful lot of the credit on those. We care about the credit of what we write, because ultimately we will be more successful in that space. We will get better enhancement levels when our loans perform better. And I think I just looked at something, we have 1.1% lifetime delinquencies when I looked at some Morgan Stanley end of year data and that was the best of the non-banks.

And it's not that far from the very best of the banks and it's better than a lot of the banks and they are writing large investment-grade loans. So our credit performance has been stellar. You know you don't see that on our balance sheet or on our performance, but it's important that that business writes really good loans because that's going to allow them to get into more deals at better enhancement levels. So we are proud of what those guys have achieved in what's been a volatile market. The consistency been amazing. And as Barry said, that was the one quarter we made a lot of money.

[Barry Sternlicht, Chairman, Chief Executive Officer]

And we didn't lose money, we just didn't make any. I think that's the end.

[Operator]

Thank you. Our final question comes from Tim Hayes with B Riley. Please go ahead.

[Tim Hayes, B Riley]

Hi. Good morning guys. Thanks for taking my question. Just a quick one for me. On the JV write-down, I am just wondering if there's a path to partial recovery there? And if there are any actions being taken by you or the other sponsors to improve those assets?

[Barry Sternlicht, Chairman, Chief Executive Officer]

Well, our basis is now approximately zero, I mean, our held, so yes. We are not giving up. We are going to look at restructuring the deal with the servicers. The first step was the appraisal because it marks where it is now in servicing, special servicing. And now you should look at it as a pure option. If we can create value, great. And if we can't, we won't.

And I will just talk about retail in general today. The retail assets need capital to be fixed. There is no way to transition like the bankruptcies of Forever 21 and the dozens of other retailers that have gone bankrupt without replacing it with other tenants. We had a record leasing year in our retail assets, but rents are lower, tenants have all the leverage. And I would say, the tenants themselves are an incredibly shitty job running their stores.

If you walk into some stores, even brand new stores here in Miami, on Lincoln Road, a brand new Nike store, you walk in and want a medium short, they are out. How could they be out of shorts? And so they are sending you to online. And why? Because the Wall Street want to hear about their online sales. So it's kind of a big mess. It will stabilize. The really good malls are still busy but the tenants, there are fewer tenants out there.

Interestingly, I wonder how this is going to translate into logistics, which is an incredibly hot industry in the United States and something we don't have much exposure to or actually almost nothing in the REITs that I can think of, because if the credits go bankrupt in the mall, they go bankrupt in the distribution centers. And so I mean you haven't seen that happen, but oh my God, it has to happen, unless every single decision center is occupied by Amazon, which I highly doubt.

So it's an interesting business today and there is just fewer tenants and the malls have to be smaller. They were built too big for the environment there is today. But everyone of those properties has an alternative use. Everyone, you can chop down. I am looking at property that someone was showing that they were dealing with in northeastern city and they are taking down three-quarters of mall and building apartments on it. It's well located. It's obviously got great access. It's got great parking. There is a value for these properties.

Somebody bold, not us, we are not in that business here, is going to make a lot of money buying distress retail. It's certainly the place with the most distressing in United States toady. And it is hard to figure out where the bottom might be. I mean JCPenney stock, I think, is $0.70. I think the bond yields 40% yield to maturity. So I thin the most junior bonds. So it's not over yet. And so we have to be super cautious that we don't deploy any capital in that business in any respect.

[Operator]

Thank you. I would now turn the call over to Mr. Sternlicht for closing comments. Please go ahead.

[Barry Sternlicht, Chairman, Chief Executive Officer]

I just say that we had a really interesting and a good year, solid year, but we really feel better about next year, this year 2020 than we did about 2019. We just had our three-year business planning meetings and we all looked at each other and said this looks pretty good. So we are happy with where we are. The teams never been more cohesive. The board is supportive and adds tremendous value to our enterprise and we want to thank you because it's the first quarter call and for all your support over the years and we look forward to continuing what we are doing and doing it even better going forward. Thank you very much.

[Operator]

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