Q3 2022 Starwood Property Trust Inc Earnings Call

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Greetings and welcome to the Starwood property Trust's third quarter 2022 earnings call. At this time all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference. Please press star zero on your.

A telephone keypad as a reminder, this conference is being recorded it is now my pleasure to introduce your host Zach Tanenbaum head of Investor Relations. Please go ahead.

Thank you operator, good morning, and welcome to Starwood property Trust's earnings call.

This morning, the company released its financial results for the quarter ended September 32022 filed its Form 10-Q 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 Dot Starwood property Trust's dotcom.

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.

It may constitute forward looking statements.

These statements are based on management's current expectations and beliefs and are subject to a number of trends and uncertainties that could cause actual results to differ materially from those described in the forward looking statements.

I refer you to the company's filings made with the SEC for more detailed discussion of the risks and factors that could cause actual results to differ materially from those expressed or implied in any forward looking statements made today.

<unk> 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 in this conference call. Our presentation of this information is not intended to be considered in isolation or as a substitute for financial information presented in accordance with GAAP.

Reconciliations of these non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP can be accessed through our filings with the SEC at Www Dot S. Dot com joining me on the call today are Barry Stern like the company's chairman and Chief Executive Officer, Jeff Demotic are the company's president.

An area of the company's Chief Financial Officer, and Andrew sauce, and the company's Chief operating officer with that I'm now going to turn the call over to arena.

Thank you Zach and good morning, everyone.

Our business continues to produce strong earnings and a stable dividend, while maintaining ample liquidity. This quarter, we reported distributable earnings our D E F $163 million or 51 five per share.

GAAP net income was 195 million or 61 per share and our GAAP book value grew by 14 cents in the quarter to $20.82 with unappreciated book value, increasing 18, fad at $21 and 69% from prior quarter.

Beginning my segment discussion this morning, if commercial and residential lending, which contributed D. E F 153 million for the quarter of 48 per share.

In commercial lending, we originated $936 million that cross 10, senior secured first mortgage bonds, all of which were floating rate and 76% of which were multifamily and industrial waste.

We funded $657 million of these loans as well as 211 million of preexisting loan commitments.

We also had $588 million of repayments during the quarter, resulting in a consistent portfolio of $16 4 billion up 36% year over year.

Of this amount, 92% representing senior secured first mortgage loans and 99% is floating rate.

Our earnings continue to be positively correlated to rising interest rates. This is the first quarter with base interest rates have surpassed 100% of our fourth leading to a $14 million increase in net interest income from higher base rates, which was offset by the benefit from our fourth quarter and higher interest expense from the time.

If that draws this quarter.

Companywide inclusive of floating rate assets and liabilities in all of our business line, a 100 basis point increase in base rates would increase annual earnings by $42 million or 13 cents per share.

Since quarter end, one month, so far has already increased 76 basis points.

International loans represented 26% of our loan portfolio at quarter end.

Despite significant weakening in D V P.

ROE and a U D against the dollar our book value actually increased seven cents a quarter due to our currency hedges as a reminder, we had 100% of our expected foreign currency cash flow exposure on non USD loans, including both projected principal and interest.

The credit performance of our portfolio continues to be strong with a third quarter origination LTV of 60% a weighted average risk rating of 2.6, and 100% of long parent as of quarter end, excluding loans on non accrual.

On the Cecil Fry, our general reserve increased by $8 million from last quarter to a balance of $67 million as we applied a more negative macroeconomic scenario to the office property category, which represents 23% of our CRE portfolio.

We have no new specific reserves in the quarter no downgrades to a four or five risk rating and no new non accrual loan.

With respect to our three existing non accrual loans, we continue to utilize the breadth and experience of the Starwood platform to actively work towards the path of full repayment of the $465 million. We currently have outstanding.

We are confident in the underlying real estate and ultimately believe these loans are fully recoverable.

The $348 million of equity that we have invested in these loans would significantly contribute to our earnings power. Once we are able to resolve them and reinvest the fun.

Next I will walk through our residential lending business are $2.2 billion loan portfolio, which was flat to last quarter has a 4.7% weighted average coupon, 68% LTV and 745, FICO and includes $365 million of agency alone.

Given continued rising rates and credit spread widening we recorded a $92 million unrealized negative mark to market adjustment on this portfolio for GAAP purposes. We also recorded a $56 million unrealized negative mark to market adjustment on our commitment to purchase $713 million of agency.

Without a transaction that closed after quarter end.

Because we hedge interest rates and that book the unrealized marks were offset by an $86 million unrealized positive mark to market on the related derivative.

Because these assets are held in our taxable REIT subsidiary. We also recorded a net tax benefit of $49 million principally related to the net unrealized losses in this portfolio.

We continue to believe in the credit quality of these loans and as a result have not recognized any D E losses for the loans on balance sheet.

We likewise did not recognize a D E gain for the tax benefit.

Also offsetting the overall negative mark was a $16 million positive mark to market on our retained our MBS portfolio, which ended the quarter at $418 million. This increase in fair value was driven primarily by lower projected prepayment speeds, which resulted in both extended and higher projected cash.

Clothes.

And finally during the quarter, we recognized $5 million of losses for both GAAP and D E related to our investment in a residential mortgage originator, which we originally invested in during 2017.

We expect to incur minor additional costs in the fourth quarter as we restructure this investment.

Next I will discuss our property segment, which contributed $21 million of D. E. R. Seven cents per share to the quarter.

Our Florida Affordable housing portfolio continues to perform exceedingly well for GAAP purposes, we recorded an unrealized fair value increase in the Woods Star fund of $103 million or $82 million net of Noncontrolling interests. This was driven by an increase in the fair value of prop.

Pretty $69 million, resulting from the continued rollout of the HUD rent that we mentioned last quarter.

The remainder of the increase relates to the debt and related interest rate cap on their portfolio for which we recorded a $34 million favorable change due to market interest rates exceeding the 4.3% blended fixed and floating rate debt we have in place.

Before leaving this segment I wanted to mention the rents on our master lease portfolio, which contain contractual rent bumps every five years.

On October 1st a 10.6% rent increase took effect, which will increase quarterly rent by $700000 beginning in Q4.

Next I will discuss our investing and servicing segment, which contributed <unk> of $33 million or 10 cents per share to the quarter.

In our conduit Starwood mortgage capital, we priced a securitization totaling $71 million at profits consistent with historic level, despite significant widening in the credit market.

As of quarter end, all securitize, the loans have been priced into our pending securitization, leaving no mark to market exposure on the balance sheet.

And then our special servicer, we obtained eight new servicing assignments totaling $6 billion, bringing our named servicing portfolio to 107 billion and allowing LNR to reclaim its top spot and conduit special servicing market share in the country.

And on this segment's property portfolio, we sold an asset for $20 million, resulting in a net GAAP gain of $14 million and a net D E gain of $12 million.

Concluding my business segment discussion is our infrastructure lending segment, which contributed D E F $20 million or six cents per share to the quarter.

Fundings on new loan commitments of 223 million outpaced repayments of 99 million, increasing the portfolio to 2.5 billion from $2 4 billion last quarter.

Because this portfolio is positively correlated to rising rates the increase in base rates resulted in an additional $5 million of net interest income in the quarter.

I will conclude this morning with a few comments about our liquidity and capitalization as.

As a reminder, 89% of our outstanding on and off balance sheet debt is non mark to market.

Structurally 59% of this debt has no capital markets margin call provisions at all and just 30% can only be margin calls for credit issues.

We continue to have ample credit capacity across our business line ending the quarter with $8 $5 billion of availability under our existing financing lines unencumbered assets of $3 9 billion and an adjusted debt to underappreciated equity ratio of 2.35 times.

As of Friday, we had $1.3 billion of liquidity, which includes $254 million of cash $451 million of approved undrawn debt capacity and the expected net proceeds from our $600 million sustainability term loan b issuance, which are scheduled to settle next week with.

That I will turn the call over to Jeff.

Thanks, Rina during the quarter, we invested $1 $3 billion across our seven cylinders and underwritten returns well in excess of historical levels.

To create capital for the outsized opportunities we are seeing continuing in front of US last week management and our board made the decision to access the term loan market and we price the $600 million five year sustainability term loan at Super plus 325 basis points.

We were able to tightened pricing upsize the deal by 50% and generate nearly $1 billion of demand in the order book notwithstanding a sell off in equities and an increase in base rates during our marketing period.

If we invest just 20% of this capital raise and pay down our financing lines with the remainder this capital rate is earnings neutral while at the same time, creating significant liquidity to both enhance our fortress balance sheet and invest accretively.

Needless to say investing more than 20% of this capital is accretive to the.

In summary, our differentiated asset and liability structure continues to provide us with the most diverse sources of capital in our peer group.

So we deployed $1 $3 billion in the quarter and $9 $5 billion year to date, we've recently been more selective.

That said, we are seeing great investment opportunity today, not just in CRE lending, where we are seeing mid teens returns on equity the highest in my term as president, but also in energy infrastructure, where ltvs are down Unlevered coupons are up and financing is abundant and stable.

This new capital gives us the most liquidity, we've ever reported $1.3 billion of dry powder.

Fortunately by issuing a term loan which is not supported by our $3 9 billion unencumbered asset base, we retained our unique ability to create significant liquidity from our unencumbered assets or from adding leverage to or reducing the size of our owned real estate portfolio.

We've always been laser focused on our corporate leverage level and feel our investors should be also.

Our debt to equity is just 2.4 times after the $600 million term loan, which has a benefit in volatile markets.

We have discussed in the past our goal of receiving an investment grade rating and maintaining a best in class leverage profile has always been a hallmark of our business and will be an important driver in improving our corporate rating and therefore, our borrowing costs.

Rina mentioned interest rate sensitivities and I would add that our new CRE loans have floors that at todays gopher levels, which will have a big benefits so for decline in the future faster than the forward curve.

34% of our CRE loan portfolio is on multifamily assets among the highest in our peer group and our office exposure is down from 38% of our portfolio pre COVID-19 to just 23% today among the lowest of our peer group.

The credit quality of our portfolio remains strong at a 2.6 rating on a five scale and as Rina said, we had no new downgrades into the four and five category in the quarter.

Our loan portfolio has no exposure in San Francisco at only one 8% of our CRE loan portfolio was on loans in Manhattan, the lowest in our history and likely the lowest in our peer group.

The bulk of our Manhattan exposure is secured by for sale condominiums with World class sponsors, a 40% loan to value and a blended maturity date over four years from now so we have a lot of runway in a very comfortable position.

The larger of these two condo loans, the mixed use property with $910 million of debt and equity capital subordinate to us that closed within the last year.

We have only two office buildings in Manhattan, totaling just $36 million and those loans have an in place 10% debt yield.

Looking forward only 15% of the office loans in our global portfolio of mature in 2020, three giving us runway to what we hope will be a better refinancing market.

Finally, 96% of the loan portfolio has rate caps or other structural enhancement guarantees or reserves to protect their ability to pay us in a rising rate environment.

Performance of this portfolio remains strong and we can again report, 100% interest collections today, despite rates increasing by 300 basis points. This year.

We have a credit first business model, depending on high quality real estate to well capitalized sponsors who we expect will be able to support their investment and be able to refinance in this higher rate environment.

Over 13 years. This business model has produced not only zero credit losses on our lending book, but we have made net gains on the loans, we have taken back to date.

Although CRE transaction volume is expected to slow in the short run lending competition is thinner and less well capitalized that fun single asset single borrower see MBS market and many banks around the sidelines.

We expect to receive better structure and pricing on our investments in this environment than at almost any time in our history.

Eight of the 10 loans, we originated in the quarter were on multifamily properties with Ltvs in the mid Sixty's and the other two where a limited service hotel portfolio with tremendous cash flow at 55% LTV and a well located last mile industrial property.

These loans were underwritten to returned nearly 15% to the forward curve today and we believe we can continue to grow our portfolio with similar collateral and returns.

The $3 billion worth of series C. L. OS we issued in prior years at very low borrowing rates are actively managed giving us the ability to replace maturing loans with other loans that would otherwise be financed at today's higher threat.

In the next year, we expect to be able to lever $1 billion worth of higher coupon new origination and our CLO.

Reinvesting in our CLO allows us to finance, new higher coupon loans at lower historical financing spread which are over 150 basis points below where they would otherwise be financed today producing returns of approximately 5% greater than if they were financed outside our C. L O today.

In our residential lending business non agency credit spreads have widened since the fed stopped buying mortgage backed securities in February .

As a pullback in buyers non agency senior bonds is kept spreads wider than expected.

As Rina said, we hedge interest rate risk in our residential loan portfolio, but the spread widening has made financing our loan portfolio more expensive.

We significantly slowed our loan purchases this year and have the ability to be patient while current market values recover as.

As we believe in the credit of the underlying loans given their low origination ltvs in the mid sixties, the very high FICO scores of the underlying borrowers and in most markets. The home price depreciation we have experienced the last few years.

We have enough term on our facilities to be patient and when it makes sense to securitize or reduce our position we will.

In our property segment Rina mentioned the income driven increase in book value that this segment helped produced in the quarter are 3 billion dollar owned property portfolio continues to be our best performing investment we increased the fair value on our Florida multifamily solely based on rent growth and below market debt and we expect rents to continue to rise in the coming years.

Our net lease and medical office assets also continued to perform exceptionally well, earning 12% cash returns in addition to having over $140 million in available distributable earnings gains.

At our current marks we have over $5 per share of gains in our owned property portfolio that can be harvested reinvested distributed or we can continue to create long term shareholder value by holding them.

Our below market rate debt on our owned property assets as an asset itself and has significant remaining term we.

We don't need to refinance any debt until November 'twenty 'twenty four for our medical office portfolio.

August 2026 for our Wood Star portfolio and October 2027 for our net lease portfolio.

Our energy infrastructure lending business has continued to perform well, we invested $223 million in the quarter at higher than historical returns. This $2 5 billion of our portfolio is now almost three quarters, new originations with much higher return than the portfolio, we acquired from GE in 2018.

Ltvs are fallen below 60% this year as energy infrastructure utilization rates continue to rise.

Significantly less competition lending in the space, but we continue to be able to finance this business well and we will look to issue our third CLO in the coming months should bread stabilize we like the credits and returns here and expect to continue to add in this sector in the coming quarters will.

We uniquely have seven cylinder, allowing us to pivot to the best investments available at any given time in our REIT segment, we own a special servicer LNR that makes more money in times of distress.

For the bond Geeks like me, it's a positive carry credit hedge.

With the addition of Morningstar this quarter, our special Servicer now carries the highest rating among all special servicers across all three rating agencies.

Quality matters, and we have significantly grown our special servicing book since Covid led by third parties choosing to assign their special servicing to us.

We are now named special on over $100 billion worth of E. M B a.

Again, the largest C M B S conduit special servicer in the world, which will produce incremental revenue should spreads and rates remain elevated in.

In summary, our diversified balance sheet has done what we hoped performing well during times of market volatility, giving us access to significant liquidity and the most options where two invested accretively.

With that I will turn the call to Barry.

Thanks, Jeff Rina, Zack and good morning, everyone, what fascinating times that we're living in.

There's something of a financial her.

Oh, yes.

Many of you might have.

It's really negative.

It's doing.

You really can't cure this inflation that isn't driven by mostly Texas stim.

Stimulus and then lack of goods on the shelves.

With interest rates and as long as you have 10 million then open jobs.

Youre not going to see massive decreases unemployment without eliminating many of those open jobs, and then causing massive layoffs and the derivative effects of that would.

Would be catastrophic on the country.

You're seeing all these companies is missing earnings and I wish Paul that was long the S&P.

Actually I've, obviously after they Miss earnings they have layoffs like this morning, Facebooks 13000 people 11000.

Yeah.

And the tech companies will really powering growth in many cities.

And now they'll be pulling back it is.

Obvious to me that the economy was slowing even before the fed started raising interest rates and inflation was more transient.

And of course, they got it wrong in the beginning and they're getting it wrong now with in determining the outcome. So I would say that the most important thing I would tell you about US is were on defense, we're not really on offense.

We have the record liquidity of 1 billion three we raised 600 million dollar debt deal last week earlier. This week I guess it was last week.

What was it this week and we're gonna be very careful where we deploy the capital. It is the market opportunity for US is as good as it's been since we IPO of the company in 2009, not only their banks pulling back on credit given the craziness of the fed nobody knows what to do so the banks are not only not lending but.

Sure.

They're reluctant to do anything frankly that creates unbelievable opportunities for companies like us on the other hand, we have a large lending book and we have to watch our each loan individually, but we're very encouraged we start with a portfolio that was only 60% L. T. D. So we have significant room for.

For valuation adjustments and then our multifamily book, which we told you was 34% of our $18 billion odd a mortgage book stabilized debt yields for us around 7.6% to our.

Loans, it's pretty much feels very comfortable that the multifamily book at seven six stabilized loans is solid and the office portfolio the stabilized debt yields to our exposures around 8828, and a half something in that range. It really depends on the quality of the building where it is but we're feeling pretty good about that are hot.

Tells a more like 11% greater than 11, 2% exposure and it's something like 18% of the book.

That includes things like the montage in Los Angeles, Beverly Hills, which is owned by one of the richest men in the world and inconceivable that we will ever see an issue with that asset and probably would get repaid fairly shortly.

So I think also we've talked for 10 years about a diversified business model and it really helps us at times like this having the equity book continues to be rock solid the real real assets that we own affordable housing, which cannot have downward moves in rates is a nice thing to have we have no debt equity invested and we have over one.

The games that get harvest should we need to although we look at each other every day and say should we do that.

But we like having the duration the stability of those cash flows and we can tell you for the next two years given inflation and median income growth in the markets. We're in with brands will continue to rise fairly significantly actually over the next two years and with at book value.

The other hidden gem, which we which has really been an amazing business for.

Cycle in cycle out is our services business, which is going to have a real good time. If in fact, there are distress in the market with $100 billion of named servicing being the largest in the country and in fact the world.

It has enormous earnings potential for us.

Which could drive profits and it also obviously provides an unusual look into what's going on across the country and in each asset class.

So I think were situated as well as we possibly we could be in and arguably better shaped than almost any of our peers. You would you would think we rina mentioned a significant amount of equity that's on nonaccrual and our job. This year is to resolve them the hits are ready in our.

In our in our evaluations and take that capital and reinvested at the spreads that are available today.

There are only three or four assets that we're focused on there.

And they're in various states of restructuring or or lender borrower.

I guess you'd call them distress, so where we're optimistic that these these those situations get resolved, but it is the best.

Investing market.

That we've seen since 2009 with the banks on the sideline and many of our public mortgage REIT friends.

Recently, taking write offs and in taking write downs.

There isn't much liquidity in the alternative lenders the only real capital at the moment is in the debt funds that are private.

And we will lose deals to them given they don't really have our underwriting expertise and real estate expertise globally, but we will win more than I'm sure. It would be very careful of how we put out capital and of course, our energy book.

The other day I was shown a deal of that 24, IRR and I said to Jeff We would do it if we could sell some other thing and pay for it just we'll just because theyre going to hoard liquidity right now and what's really interesting about the firm is that if we don't make any more investments next year. We just hold the book we have in it.

It should produce earnings that will cover our dividend. So we don't have to invest at all which is the luxury of the of the structure that we have and a huge benefit of course that there is a benefit to rising rates that will help us.

In the book in General also one other comment that 97% of the book has caps in place that means the borrowers have caps in place or are there structural reserves in the loans to help them meet the interest payments over the coming Oh that gets to the lifetime of the loans. So.

While we are not sure everybody will be able to refinance us on time and much like a home mortgage or if you have a loan at a.

3% youre not going to refinance it seven and that's really the issue is that the credit quality is money. Good. It's just that people might want to hold onto our loans for longer and so how does this look and go back to the real estate asset classes today, which is fundamentally what's going to drive the performance of our of our loan book and everyone else's and fundamentals in the real estate conflicts.

They are pretty good.

<unk> family continues to be strong even if rents are beginning to slow in some cases rolling down slightly.

You got to believe that with nobody's ability to buy a home the rental complex whether its S. F. Our multis will hold its own industrial continues to power ahead, you can't keep going up at 20% rents nobody needs that but its fairly solid in the leased vacancies here and there and Amazon will pull out of it of a deal but in general.

The industrial complex as pretty strong its not a huge component of our lending book. The office markets are not what people think it's really city by city and quality of asset if it's a nice asset at leases, there's actually leases at higher rents if it's a big old commodity box mid block with no views, it's very hard to lease and so the markets even in places like.

San Francisco, we have to we're actually renew our own office lease if we want to move to a nice building the rents are astonishing Lehigh and I keep saying how could this be in the market with 30% vacancy, but they're high because of good buildings are still in demand same thing in Manhattan, almost all of the net leasing in the United States is in buildings built since 2015 and everything else is losing occupancy.

The hotel market, obviously hotels that had a field day and we can't expect in my view that these.

Revpar is will hold I'm on the other hand, holding and they continue to go up and I look at our over 1000 hotels on the equity side that we own in various.

All the way from budget hotels, or five star hotels on.

The numbers are consistently good and you have places like New York, where there are no foreign tourists or they're down about 80% from prior levels.

And that bodes well for cities like New York overtime out you, obviously expect office to gain more occupancy to over time. So some of the urban markets that have suffered probably will do better and I got to believe this earnings crash in the Tech World, which has been the home or work from home I think these guys are getting back to you.

Or they'll find themselves getting those pink slips from Mark Zuckerberg, They will be the first to be let go of the ones that the management team forgot who they are where they are and they certainly won't get promoted and the kids are going to figure that out right. Now it was a labor market where people thought they could get a job anywhere. They can remember this move to quit your job and it won't be the case in a recession that's coming.

And so the rest of the fundamentals of real estate are good at which is really the most important thing when we look at our our or anyone's mortgage book the issue for all of US in the question Mark is what is your forecast for the future and I think base case, and that's probably the 70 <unk> percentile is that rates will come down and that's what the forward curves.

Jos and it's not just rates, it's spreads I think the gap out in spreads as a function of the pace and uncertainty of what the fed has been doing the chaos in the market and the fact that people AAA has went from 80 over to 225 over a deal just got priced at 300 over in AR.

Hotel deal that a large competitor of ours led.

That's why I E that that's crazy and cause 300 over the curve right now is like 7% Triple A's.

That should change there's still too much liquidity, we still printed so much money and it will come back into the market at some point when the coast is clear they won't ring, a bell, but you'll get a sense as the economy begins to scribble, which it will and inflation will come down as we see housing markets broiler.

Right now as the most of the affordable housing market on my lifetime, It's gonna be interesting and again I think the fed is making a really bad mistake on the other hand, it has its positives, which the crash will be very quick and very evident.

To them over the next six months and they will lower rates faster than they probably thought it would because we'll have an election year and they don't want to they don't raise in so late that they get swept out Congress I think.

It's a fast and anytime the company is in really good shape. The team is focused and dedicated we're running.

All kinds of scenarios and plans as he sees these knees, but we'd like to get back to investing as soon as we can and we have the ample liquidity to do it so including also moving out assets that are not hitting Roe targets.

That capital anything we get on those five bad assets, we will quickly deploy into new new new opportunities that are abundant in front of us. So the distress in the market should be good for us we have the liquidity to take advantage of it we have the earnings power to get through the dividends till we see the end of world or.

And jobs as cycle the tightening cycle.

Consumers are really literally broke colony has to slow down dollars, obviously not competitive exports will suffer but it takes time the fed doesn't seem to understand that I don't fire people when they they raise rates 75 basis points every month, but it's not like I turned around and fire two people sitting next to me because he raised rates.

Businesses don't work like that I don't know what on Earth, you would expect to see in three months raising interest rates 75 basis points at a time.

And the data they're using on rental complex is absolutely absurd with six month lags and they don't actually know what's going on who could run the country. Like this anyway, we are optimistic about the firm and excited about our future. We have a great team a great board and we thank you for your support.

Okay.

Question.

Thanks Wes.

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Your first question comes from Doug Harter with Credit Suisse. Please go ahead.

Thanks can you just talk about how you're thinking about balancing you know kind of holding extra liquidity versus deploying some of that liquidity into the opportunities that you're seeing and you know kind of what youre looking for to maybe be a little bit more aggressive in taking advantage of the opportunities.

I mean, we haven't liquidity right now that we would probably do some investing.

Brain dead is great.

With huge margins of safety. So I wouldn't say, we're close now with the completion of the of the 600 million of our term loan I think we've given ourselves ample liquidity, but it is gonna be spot buy spot, where we're really going to see as loans repay will probably redeploy that capital at this point, so we have like $100 million longer paying.

In December .

Where my team says or <unk> 98 per cent sure. It will repay when it repays, we'll redeploy the hundred million dollars. So it's really that's probably gross loan Oh, that's the equity. So we will we will redeploy that so it will be back in business and we will be writing loans at higher a higher Roe.

Then to the loans that are leaving the book So our earnings should drag north as this transition takes place, but again I don't want you to think we're going to deploy a $1 billion of the 1 billion. Three we're not we're going to we're going to sit on it by the way we earn decent returns were paying off repo lines that are marginally tighter.

But obviously I'm you know tighter, meaning they were like 300 over but were borrowed at three in a quarter.

So we'll pay off those lines create capacity Mr Bank will never call as hopefully and they'll be focused on some of our peers that probably don't have the cushion of the balance sheet that we do so it's just we're gonna be defensive until we get a better read on whats happening I mean, there's a 20% shot instead completely screw this up.

The nation goes into a tailspin and and we have to be concerned about that I mean, they the government people, who talk about Paul Volcker's.

Aggressive moves forget the United States is 32 trillion dollars of debt and the 32 Julian is growing by a trillion or two trillion a year now but may even go to two and a half trillion given the receipts are going to drop because nobody has any capital gains to harvest anymore. So I think the I think but I think he has lost his mind Powell.

And I don't understand what they're doing the government's gonna be the biggest taking the biggest hit from rising interest rates or interest rate Bill will go north of a trillion up from 400 billion last year.

It's again, it's it could be really bad and as Paul singers note recently pointed out I don't believe that's a base case, but it can't be completely excluded from your from your calculations and we're gonna be where for mortgage REIT. We have a servicer that will have a field day, if things go bad that's not what we want to see happen.

You can see the country prosper and the and that night, the 75% odd that rates come down the <unk>.

Country.

It's doing well incomes continue to rise.

As they should by the way and again I don't know why anyone said, 2% is an inflation target why not three why not for as long as its wage driven we should applaud that so and I think youre going to see sales like you've never seen before at Christmas or right. After Christmas.

I think you'll see them going into Christmas inventories are sky high.

Consumers are not going to be buying you saw Amazon had a sort of a failed prime day in July and I don't know what they're looking at but that every CEO I talked to and it's not just consumer its tech software Danny our sales force.

And the crypto world they've lost two and a half trillion dollars of market cap Theres. Just this money isn't available to be spent anymore. So the economy was gonna do slow down on its own just give it a little time fed just wait and otherwise you know they could cause really undue harm we're not going to put the enterprise at risk and get very aggressive right now.

Thanks, and then just you know I guess, how are you thinking about the relative attractiveness of your move to kind of be on having unsecured funding versus you know being a pure secure lender in an environment like this.

Okay.

Obviously, the more unsecured we have that that helps our ratios with the rating agencies. They want us to see our leverage low and they'd like to see us have more unsecured if we were to get to investment grade. Obviously, that's very important to us in this case, we didn't issue unsecured we issued a term loan which is off of a different color.

Admiral base, we saved the unencumbered assets that support the unsecured debt because we think thats. The most liquid if we were ever to need capital quickly in the future. We can either encumbered the specific assets or we could do with honey.

Unsecured bond deal.

So we definitely look at that mix very closely we would love to have more unsecured over time.

We misread it we think we should trade at much tighter spreads than we do today and when we do trade to a much tighter spread I think you should look for us to issue significantly more unsecured take asset leverage down and.

And make it very difficult for the rating agencies not to look at the company the way that we look at the company.

Thank you next question comes from Stephen Laws with Raymond James. Please go ahead hi.

Good morning.

Appreciate the color around office Barry wanted to follow up there you know it looks like you've got more CBD exposure internationally has been really in the U S. At least from a percentage basis from the disclosures on 13.

Can you talk a little bit about the differences you see overseas versus your in CBD office.

Yeah.

Yeah.

I'm not aware of any issues that are international office book at the moment I actually asked a question about our.

Chief Credit officer, right before the call.

As for some of this is net leased office and it's like give me a second Jeff is pulling the ball. So I can actually work with them, but we don't have that much why don't I come I'll interrupt the future.

Question is we pulled this information for you.

The other one was just an update on AR I believe Houston office asset were close to me.

[laughter], Yeah, you want to talk about it Jeff.

Yeah listen we've.

We've gone down a few strategies we could.

I'll give you a little background here of one of the smartest investors in the World a hedge fund based in Boston Hum.

Household name in real estate, I think putting $100 million and we had like a 120 or $30 million alone.

So we never really expected until.

It was like 100, and something dollars, a foot, which I I laugh with our team because I think if we took the steel down and sold that we'd probably get $80 a foot back from them from them just scrap metal costs.

Hmm.

We had a we had an opportunity to lease the building them to a significant extent not not but it would have at least the top of the building and left us to lease the bottom.

And if we do a lease as an office structure, we have to put up a mountain of Ti for the tenant today and I opted not to do that and we have an opportunity hopefully to convert it's a rosy.

Sell it to somebody who's going to do that and we'll see whether or not it takes place, but it's not material in our book value and hopefully we'll work it out.

And I would say going back to the last piece, we're not looking at the CBD versus the.

<unk> CBD and our international then they book our largest loan in office in Europe as in the U K. It's in London, It's a 46 L. T b very well sponsored getting good leasing our second best is our second largest in Berlin, Barry I know you have a strong opinion on Berlin.

It's the best office market in the World probably.

Anywhere between two and 4% vacancy rate today and then the only other loan over $100 million is also downtown in London, a 48% LTV as of our as our origination about nine months ago, So still really expensive.

Let me give you the maturity dates of their three loans 12 24. The biggest one the next one is $12 28.

And the third one is 12 to 25.

So we don't have any near term exposure at all in these in these buildings in Europe and they are very good lenders borrowers sorry household names so.

Actually that we don't see any credit issues in our European portfolio.

Entirety at the moment and Steven you mentioned from that that 70% is DVD and 30% is non CBD, but I'll note that that 30% is only $200 million on an $18 billion loan book. So these are relatively small sample sizes for office in Europe .

Next question comes from Rick Shane with J P. Morgan. Please go ahead.

Oh, Hey, guys. Thanks for taking my question.

Look the the question was asked when in terms of.

Starting to reenter the market and obviously a lot of uncertainty there.

I think the other part of that question is how when you do reenter the market what that will look like.

Jeff you talked about opportunities on.

The equity side as opposed to necessarily on the lending side.

Curious if you think that that will be where you first reenter the market and see a portfolio, that's got a little bit less leverage and a little bit more focused on owning properties yet.

Yeah. Thanks, Rick.

Let me start by saying, we put up $1 $3 billion. This quarter I don't think anybody put out close to and I think if you added up all of our competitors. They might have just got there. So we were still putting out money, where it's smart to put out money, where we're not completely although to be fair. It was front end of the quarter.

It was worth it.

And then.

As far as sort of reentering the market I don't think you'll see it Rick I hope that I didn't say something that alluded to equity as in real estate equity.

When we accumulated our portfolio in 2015 in the first quarter of 2016, we were getting cash returns of close to 10% on core real estate properties, we had cap rate.

What were very attractive we thought it was a better time to be a borrower than a lender and we pivoted from having our biggest year ever in 2014, as a lender to being a bigger borrowers and amassing a portfolio. That's created $1.6 billion of gains. So we will time those things when it makes sense I don't think that as I look at the equity opportunities today.

Where cap rates are and where borrowing rates are for us. If we were to be a buyer that we could get cash returns anywhere near 10% on any core asset. The reality is in a lot of cases.

Negative leverage and buying new core real estate is going to have very low cash yields today, we could always obviously play for rent increases or other ways that we're gonna have income that will offset that for an IRR, but where a mortgage REIT and we pay our income out every every quarter and we do not like to drink our own blood.

Paying out something that we didn't earn so it's unlikely in my mind that without a lot of core property portfolio.

I'll give you an example, what's going on in the market. Two examples because as you know we have a $125 billion book of real estate around the world. So.

So domestically we went this historic cowboy Google on the equity side went out to get alone a construction loan on the life Science project.

And we had just built and sold the building next door close this summer.

And chiefs.

North of 50, IRR and three times return on our capital in the building leased and we sold it.

18 to 24 months start to finish so that's being equity guys. We bought the land next door, which we quickly assembled.

And I went to market to build a new building had multiple inquiries into leasing it and we went out to get alone. We got I think one lender and insurance company normally we'd have 20 people bidding on this.

The loan is S. 459% first mortgage it's 65% of cost on a brand new building.

Fully guaranteed by a $10 billion fund for completion and Ti.

And with the points upfront and other costs, it's north of a nine and a half cost of funds.

And the equity funds first so if you close this thing youre going to get to all of our money quickly. It is ridiculous environment right now that is ridiculous and I asked and if I can put my kids trusting that long and that's the way I feel about lending today and the opportunities we have those kinds of opportunities.

And in Europe .

We took to market a property in London.

And we.

We didn't like the bids the.

The bids were lets say 350, and we thought we could get 375 400.

Theres alone around $220 million in place, we we we actually the loan was maturing. This December because we assumed we were selling the asset. So we asked our canvas the market to refinance the loan and got no bids or the existing lender said they'd extend for one year and the cost of funds is north of nine cap rates for these.

Assets in London's of fours and fives, even today so.

Is a really good time to be a lender and less of a time to be a borrower and at times like this I listen to Sam Zell on CNBC, the other day and I want to disagree with him on this.

Don't think in times of distress like this that the mark to market is the right thing to do for equity real estate really the only people who would sell stuff today are people who are in distress and they can't find any data or they don't have any money to bridge from here to there and hope that rates come down so where our values. I mean, if you are it's hard to tell.

Well I believe we are in the equity side have sold multis from two 8% to four four cap rates and you can say well maybe they should be five nobody who has an assay to a multi today would sell at a five unless they add too.

Especially if you think the multi complex will benefit over time, both from capital flowing into its asset class as opposed to office and retail and hotels potentially because it's viewed as more stable.

The retail complex should be buoyed by capital flows and having just returned from the middle East I will say that as an asset class. We're looking very closely at and there's not been a big participant in the past industrial has had an enormous bids from Asia.

Gigantic giant bids and even there there are bonds with negative convexity. So you have to be careful whether you have rent rolls today and can capture the.

The the where you are I mean do you have a 10 year deal in your 30% below market that's interesting but.

You know that that's a bond that has upside potential in 10 years, even their cap rates are or are being supported a lot of people are buying real estate as an alternative to cash so youre seeing unlevered buyers come out and take things down eight five is fine like that office building is leased for 12 years to a credit tenant all bye.

It's seven or six instead of buying a corporate bond or instead of buying because they feel like they've got a good yield some day it will be able to lever it and in the meantime, they get inflation protection ultimately on costs, because the thing may drop to 30% of replacement cost of inflation keeps up so the market is complicated it's not a it's not an obvious market and in sometimes is where cell.

Assets ourselves, we kind of say well why are they buying this I saw a big hotel is trading at a five five cap rate on 2022 numbers.

That's negative leverage you your hotel loans today.

If it's got a double digit debt yield at Navy. So for 400, that's 8% on a.

I don't know 10 or 11% debt yield if.

If it's five it's L 600, it's a 10% long and a deal in New York, just close with F 600 dead on it at 60% of the purchase price. So that's important for us.

So you know big players are going to use this opportunity to lay down bets and footprints.

But it is it really quirky weird time and you know the question really is is it.

Placing heaters day.

I there was amazing and the administration, you know congratulate themselves or the biggest increase in social security payments in history, which is basically tied to inflation and actually reinforces inflation. The thing they're trying to kill so and eight 7% increase in social security payments. Congratulations you've just driven inflation higher somebody might speak to this.

Bad because you just did that so it's.

You Gotta be you just gotta what'll right now you've got to be careful and pick your shots and pick your spots.

Next question Jade Rahmani with K B W. Please go ahead.

Thank you very much.

Commercial mortgage REIT mortgage REIT sector have always had issues with the liability side of the balance sheet.

The term loan pricing it looks like a strong move but would you look at some alternatives such as buying a bank would that make sense at some point for the company.

And I loved the biobank [laughter], there's a lot of things we'd like to do.

Yeah, No I don't.

I'm not an expert on bank regulations, we have invested.

Time to time as a minority shareholder in the banks coming out of this the TFC I think we had Pacific Premier Bank, we owned 25% of our equity funds.

I don't know how that would work for us more interesting is sort of the insurance wrapper insurance company, probably but.

We can produce a lot of product for the liability management or an insurance company when people have come to us to manage separate accounts for them in this space, it's something that we probably should should look at <unk>.

To leverage our skill set.

But.

I'm pretty excited we're also working [laughter] I hate to use the word but.

We have some activities in the blockchain, we've invested exactly zero dollars, so don't get nervous but.

It's funny that technology is real the tokens or who knows but the technology. The blockchain technology is fabulous and it will revolutionize finance, who wins is a coin and the exchanges I don't know, but there will be somebody who will do well here and it does have.

Interesting applications to the real estate world and we're watching it.

And Jade I think the other discussion that's happening you know we are hopeful that the federal home loan bank reopens the discussion on insurance captives as you'll remember four years ago or so we were we did have the captive insurance and we're able to use the federal home loan bank window in.

It's been some discussion about whether that gets renewed in the future and opens up to a two well capitalized companies like ours in the mortgage REIT side of it.

I think that's the more likely of the better financing tools away from term loans and high yield and everything else that we do.

Thank you very much a follow up on just the commercial mortgage REIT space. Many of the companies taking very large write downs on office exposure and some of the stocks trading at a very almost distressed price to book value multiples.

That would be a attractive areas to deploy capital or acquiring a company or a portfolio at a discount to par or.

It's all about them and I'll say problems, it's obviously all about their boards.

They can't raise capital both debt and equity so theres sort of zombie little companies right now, but nobody's wanted to give up ship and and if they can ride it out they tend to want to ride it out we've tried by the way.

[laughter] multiple times [laughter].

But we also sometimes in our in our due diligence have disagreements on book value and.

You know maybe we think they are optimistic in some cases on some of the larger troubled loans.

And.

So they have a stated book maybe even if the board thinks the book is soft there, they're not willing to sell the company at levels. We think it's warranted if it ever was going to happen. It would happen now because of the crisis, we're in and the pressure, they're under and and the funding lack of equity.

Do you view some of these guys trying to issue equity I mean, I assume the market will have a heart attack by the way we would we as you know, we we don't like to issue equity and.

And we would at some point, but we also have always been a steward of our book value.

We continue to be a stupid okay.

So and you know we think it's a fascinating thing I mean, you can see in our numbers. We took we took a big hit temporarily not credit but to market on a recipe book and that has not worked that has been a problem and having said that because of the machine that we have we were able to get.

Through that and again, we're going to get our money back we just will have.

We have to wait for the securitization markets to reopen so we can move that capital into higher productive spots, but.

It's been a it's been a it hasnt worked out the way we anticipated that's for sure.

It's a good business and then when rates go up 400 basis points in six months it doesn't turn out to be.

To the securitization market shut down completely.

You know its like you need you need you need spreads to come in which again once theories out of the markets spreads will come down even over a high base rates of people either forget it's like the base rates are one thing the fed should should notice in the credit markets. It's not dead funds, it's the spread on top of the fed funds that are so wide.

Historical norms, which make financing really bad and create all this massive illiquidity in the market. So you know spreads have to come in and you should not get 300 over in a triple a security that's like historically obscene I'm not sure if you've ever seen it. So you know that's that's a function of a buyers' strike.

Saying that I don't know if I should put our capital at 300 over maybe tomorrow will be three in a quarter when the world looks like its changing when the fed changes there their tune that.

That will be the first sign that maybe it's time to rush in and grab these bargain deals in the credit space and then of course the equity complex will be supported after that looking at cross all ratings Jade.

Looking at it the spread chart from the year to date minimum to where we are today, and we're basically <unk> or higher spreads.

From where we were at one point this year. So obviously at some point where people think.

Things are going to start turning the other way with tremendous yield it needs as Barry said I'll go back to the comment on M&A on CRE.

<unk> and other reads and the hard thing is today of with a lot of them trading at 50 or 60% of book value.

It got there.

It's significantly less than book value because they believe in it I actually think the M&A opportunities tend to be when you are in the 75% to 85% of book value.

Going to get somewhere closer to book value and a deal can get done. So I would note that these significantly depressed levels, where some of them are you seeing anything happen in M&A.

Last question comes from Don <unk> with Wells Fargo. Please go ahead.

Hi.

Certainly good to see you're playing defense and hoarding cash or I guess my question would be if we did have a hard landing how would you expect infrastructure.

Perform on a chronic perspective versus your commercial real estate loan portfolio.

Sean Murdock, who can answer this question.

Sure I think in this regard.

<unk>, who runs that infrastructure.

Yeah.

I think we're in this environment positives with respect to.

Energy infrastructure trends in the narrative the world has seen.

The cost of lacking energy infrastructure in places like California, and Europe and so.

Theres a strong narrative behind this space right now that I think sort of overcomes cycles and crashes around the economy clearly.

Lose access to the debt markets in terms of refinancing in all the discussions we've had around spread.

This morning, but.

In terms of asset performance and cash flows where we're optimistic about how energy infrastructure does.

Declining economy.

Would you or do you think it will perform better than commercial real estate or just trying to think how you sort of.

Sensitize that.

But as John's biased, but I can tell you we're looking at deals every day and.

Across all of them and right now what we're seeing in the energy infrastructure World is the highest yields that we shouldn't probably generate anywhere else with a combination of ltvs as low or lower than we're seeing anywhere else.

I would say that today, if I had an incremental dollar to put out I think it's the most interesting given that the highest returns for sure and especially you can hedge out all the commodity risk of the of the loan would you in some cases you can do.

So it's there is it's not it's not power and its something else you know the power stuff you can't really you could actually cause that not in there.

Production costs.

Because I guess my question is is it more defensive than commercial real estate lending or is it sort of on par.

South Korea, I think it's I wouldn't say, it's more defensive I think the commodity complex will have a beta tied to the economy.

So I think.

Look I don't expect one of the other things when I talk about inflation, there's no chance energy prices can stay high in the United States. We have it we have the ability to pump a lot of oil and gas and don't have to worry about we can you can consume everything on the margin gas and oil price on the margin extra million barrels of oil or gas or Bcf produced will hit.

The lower prices dramatically in the U S and there's nothing to do with Russia that has to do with global prices and which do have something to do with Russia, but but but it really is the U S. Can can knock energy prices down at any time and I don't think people understand maybe this how energy affects all the other.

Components.

Of CPI for example, food food actually has to be harvested with or without a tractor or something that uses oil than interested shipped to the processing plant and a car or truck that uses oil then they turn the turbines on in process the stop using gas probably of electricity and then it's.

Chip back out to the market in a truck or a car or a train that uses electricity gas or oil and all of those components are part of food inflation and it's not food, it's actually the transportation component of the food cost. So everything is tied to these crazy runaway energy prices, which are now subsides against that seems to be beyond the pale or it's fed to understand.

Yes.

And I would say half or more of our book is on power plants and the spark spreads which is a difference between where we.

Acquire the commodity power and where we sell the power.

Sean from mid single digits to higher single digits, and our Ltvs have actually gone down here, whereas on the commercial real estate side I think most people would say a lot of commercial real estate assets are worth less today than they were yesterday. So your ltvs have modestly gone up the problem. In this business is obviously you need to take out and the.

Capital markets need to be there and the banks and others have pulled back for ESG reasons et cetera, and so you have to be very convinced that you have.

They take out to in the capital markets and that's the risk on the other side, but I think the ltvs have performed extremely well and we.

We certainly believe that these irr's are achievable low LTV.

And I think that probably if thats. The end of your questions on where were I think thats, the and we don't have anything else in the queue.

Thank you I will now turn the call over to Mr. Stern Lynch for closing remarks.

Thank you for your time today and wish you luck and happy holidays with you your families and only positive returns in the equity markets from here on so thanks again, we are optimistic.

About R R.

Our position, but we certainly like the country there.

To continue to prosper. Thank you so much have a great day.

This concludes today's teleconference. You may disconnect your lines at this time and thank you for your participation.

Mhm.

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