Starwood Property Trust Inc. Q1 2023 Earnings Call
Greetings and welcome to the Starwood property Trust first quarter 2023 earnings call. At this time, all participants are in a listen only mode.
A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference. Please press star zero on your telephone keypad.
A reminder, this conference is being recorded it is now.
My pleasure to introduce your host Zach Tanenbaum director of Investor Relations. Thank you Jack.
Yeah.
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 March 31st 2023.
Filed its Form 10-Q, with the Securities and Exchange Commission and posted its earnings supplement to its website.
The documents are available on the Investor Relations section of the company's website at Www Dot Starwood property Trust's Dot 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 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.
The 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 Dot FCC desktop.
Joining me on the call today are Barry started like the company's chairman and Chief Executive Officer.
Jeff the moniker of the company's President and Rina <unk>, the company's Chief Financial Officer.
With that I'm now going to turn the call over to arena.
Thank you Zach and good morning, everyone. This quarter, we reported distributable earnings our D E F $157 million or 49 cents per share.
GAAP net income was 52 million or 16 cents per share one.
One of the primary differences between GAAP and D. E is a $43 million increase in our seasonal reserve, which I will discuss later.
GAAP book value per share ended the quarter at $20.44 with underappreciated book value at $21.37.
Book value metrics include in accumulated seafood reserve balance of $153 million or 49 cents.
Beginning my segment discussion. This morning is commercial and residential lending, which contributed D E F $192 million for the quarter or 60 cents per share.
In commercial lending, we funded $260 million, including 222 million of preexisting loan commitments and a new $59 million loan of which 38 million was funded.
These were offset by $257 million of repayments during the quarter more than half of which were office loans.
Our portfolio ended the quarter at $16 9 billion with a weighted average risk rating of 2.8 of which 93% representing senior secured first mortgage loans and 99% of which is floating rate.
On the Cecil front, we increased our general reserves by $31 million in the quarter due to worsening macroeconomic conditions in our model, particularly in the U S office sector, bringing our general diesel reserve for commercial lending to $125 million as a reminder.
It requires you to estimate life of loan loss with the forecasted macroeconomic environment being a critical component of the resulting reserve estimate it is not a current market conditions only number like it used to be under the pre sea salt incurred loss methodology, when we reserved a certain percentage of our four.
Five risk rated loans.
We use a third party software to model these losses, which in turn utilize as macroeconomic advisers for purposes of determining the economic outlook. If we have specific information related to a particular alone which would suggest a law. We would've moved alone out of the model General reserve category and into.
And asset specific reserve. We currently have no specific reserves other than one legacy 5 million dollar reserve on the entire balance of a retail asset in Chicago.
Regarding our risk ratings, we downgraded five loans this quarter into the four and five category of which three were U S office and upgraded one previously for RAIT as long, Jeff will speak more about these loans shortly.
We also placed two of our five rate as loans on non accrual status, a 121 million senior secured loan on an office complex in Washington, D C and a $42 million senior secured loan on a two storey retail in downtown Chicago, both of which we expect to foreclose upon in the near term.
We continue to actively work towards the path of full repayment of our nonaccrual loans and Oreo once we are able to resolve them and reinvest the funds the related equity would significantly contribute to our earnings power.
Next I will discuss our residential lending business our on balance sheet loan portfolio ended the quarter at $2 7 billion, including $1 7 billion of non QM and $994 million of agency loans.
We fully hedge the fixed rate interest rate exposure in this portfolio with our hedge is having a positive mark of 107 million at quarter end after $15 million of cash receipts in the quarter.
Because of our hedge strategy the spread mark to market from our lenders during the quarter actually resulted in an $18 million net cash inflow.
Lower projected prepayment speeds benefited our retained our MBS portfolio, which increased in fair value by $15 million ending the quarter at $428 million.
Next I will discuss our property segment, which contributed $21 million of D E or six cents per share to the quarter.
This amount $11 million came from our Florida Affordable housing fund with 5 million from each of our master lease and medical office portfolios.
For the White Star Fund, our GAAP valuations were relatively consistent with last quarter, we are still awaiting HUD, which governs the Max rents for the over 15000 units in this portfolio you released the rent increases for 2023 we expect their announcement later this month with the increased rents taking effect in July.
Turning to investing and servicing this segment contributed D E F 13 million or four cents per share to the quarter in.
In our conduit Starwood mortgage capital, we originated $74 million alone for securitization next quarter we.
We typically see lower securitization volume in Q1, and expect to see volumes increase over the remainder of the year.
And our special Servicer, we obtained two new servicing assignments totaling 1.5 billion with our named servicing portfolio ending the quarter at 107 billion amongst the highest level, we have seen since 2016.
Concluding my business segment discussion is our infrastructure lending segment, which contributed D E of $20 million or six cents per share to the quarter.
We funded 160 million of new loan commitments, and 15 million of preexisting ones, which was offset by repayments totaling $204 million.
The balance of the portfolio remained consistent with last quarter at $2 4 billion, which was 100% floating rate.
During the quarter, we increased our seasonal reserve by $12 million principally for two small legacy investments from our G acquisition in 2018.
Their combined the E basis was 29 million and both assets were placed on nonaccrual.
I will conclude this morning with a few comments about our liquidity and capitalization.
As a reminder, 87% of our total outstanding on and off balance sheet debt is non mark to market as is 92% of our commercial lending debt with the majority having no capital markets margin call provisions at all.
After repaying our April $250 million convertible notes and our first quarter dividend in cash we had $620 million of liquidity as of last week.
This includes $449 million of approved Undrawn borrowing under our repo facilities, all of which are with global banks represent immediately available funds and are not subject to further credit approval with the lender.
In addition to 1.5 billion of Harvestable D E gains in our property portfolio, we have $4.2 billion of unencumbered assets that together with our term loan b capacity can be fully levered to generate additional liquidity.
Our leverage remains low with an adjusted debt to underappreciated equity ratio of just 2.5 times consistent with last quarter.
With that I'll turn the call over to Jeff.
Thanks, Rina, we added a new slide to our supplemental on page nine where you can now clearly see our differentiated total asset base.
We'll see only 13% of our assets are invested in office bonds globally, with just 10% in U S offer including life Sciences.
This compares very favorably to our peers and it's part of why you see our accumulative CRE seasonal reserves of $130 million against our 28.5 billion diversified balance sheet and $7 billion of equity are lower than our peers per dollar of equity we.
We built as TWD to perform well in normal markets and outperform in volatile ones. So we are pleased that our stock has outperformed since the fed's aggressive rate hikes and the unprecedented spread volatility we have seen in the last year.
In addition to our smaller exposure to domestic offers one we have thematically increased their exposure away from high tax negative migration areas lower tax positive migration areas following.
Following the lead of our manager Sabra capital over 60% of our $5 7 billion dollar multifamily exposure is in the southeast and southwest and today, we have no loan exposure in any asset class in San Francisco and only 1% of our loan book is in Manhattan, two of the weakest office markets in the country.
We have always run our company to a significantly lower leverage than our peer group, who also write predominantly first mortgage loans.
2.5 times debt to equity we in fact manage our business over a full turn of leverage lower than our largest peers. Despite having 25% of our equity in businesses like residential and infrastructure lending that have run into significantly higher leverage by others in the public markets investing in those disciplines.
Running our business with significantly less leverage and financing it with more.
L B yellows and corporate debt also narrowed the range on possible liquidity needs should markets deteriorate.
Our loans up over 30% sponsor equity sitting behind us in the capital stack at loan origination.
We are uniquely positioned to absorb volatility in underlying asset valuations should that sponsor equity become impaired as our diversified low leverage business model also benefits from almost $5 per share and unrealized gains in our owned property segment.
To date in our 13 year history, our organization of over 300 real estate professionals, along with the support of another 350 professionals at our manager Starwood capital group have generated significant gains on Oreo when we have taken loans back onto our balance sheet.
We have tremendous internal asset management expertise across sectors and markets. We are in the process of closing our second conversion of office to residential and should borrowers stumble we have a proven track record of creating value on assets we take over.
In sum our low origination ltvs are low leverage and are almost one $5 billion in durable property gains give us enviable cushion to run our business and volatile market, we have by far the most unencumbered assets of our peer group, which we believe can be quickly leveraged to create liquidity if needed without creating incremental drag on our balance sheet.
They are not.
Despite all this on article Friday discussed the increase in short interest in S. T. W. D and other CRE Sox as a short on office fundamentals.
It is my view that in times like this funds indiscriminately short of sector and disproportionately the largest most liquid and lowest dividend yielding stock like S. TWD.
We believe in our differentiated diverse low leverage model and think Theres significant short covering upside when people who understand the resilience of our business model realize that our unique company, which has historically traded at 122% of book value in our 13 year history is mispriced at today's level.
I said earlier that U S office and life science loans make up only 10% of our diversified asset base today.
Holding the rest of our $28 5 billion dollar balance sheet constant versus just one times book value. The market is effectively pricing and 50% losses on our $2 7 billion dollar U S office portfolio and that is after 30 plus percent sponsor equity is depleted.
Versus our 13 year average price to book of one point to two times our price today implies we will lose 96% of our investment after borrower equity on our office loan.
To state the obvious our low leverage diversified company with large property gains themes mispriced rates are down significantly since we last spoke I'm sure Barry will touch on rate, but lower rates are generally positive for CRE valuation.
In our CRE lending segment, we only wrote one small loan in the quarter and as you can imagine our team remains focused on asset management and continuing the progress we talked about last quarter. Our non office loans are generally performing very well and in line with our original underwriting assumptions.
83% of our loans have interest rate caps in place or are fixed rate loans and an additional 11% of our book is interest reserves are guarantees so 94% of our loans have interest rate protection in place today offsetting a significant amount of interest rate stress for our borrowers.
Finally, 82% of our office exposure globally is on class a properties.
Our European office portfolio is performing very well as is our entire European loan portfolio.
We have a significant competitive advantage due to our scale and decades of history of investing in and lending in these less competitive markets, we know very well.
Rina mentioned, we downgraded three loans from a four to five risk rating in the quarter.
We downgraded a $197 million of office loan in Irvine, California, with $160 million of sponsor equity behind us due to a near term maturity.
As I mentioned last quarter, the asset is being marketed for sale and the sponsors we see bids above and near our debt basis.
Did the loan not repay we're considering several options, including an extension.
The second downgrade is on a $156 million alone on a property in Brooklyn that we classify as office, but it's more likely to be converted accretively at our basis into mixed use multifamily <unk> self storage.
Last quarter I mentioned that this asset benefits from cross collateralization against the Newbuild multifamily portfolio, which are the only other assets in this sponsors $500 million fun.
The fund has no one called capital to support debt service shortfalls and Capex needs. Thus, we have cautiously downgraded it.
Given the excess collateral we continue to feel secure in our very low resulting basis on this property that we believe is fully recoverable.
The final downgrade to five is on a $120 million office asset in downtown D. C that we have not foreclosed on yet but are working on a consensual transfer.
Yes, it is 100% vacant since the departure of a GSA tenant which was a known event at the time of underwriting.
The original business plan with this top five global sponsor, who invested almost $70 million of equity in the asset was to completely renovate and add additional square footage to the top of this building, which they are no longer pursuing in this environment.
Having the building empty is actually a benefit to us given no deep tenant and costs and minimal operating expenses as we consider alternative uses for the property.
Assuming we take title we are already under LOI with a new sponsor the purchased the asset at our loan basis and convert it to multifamily.
Most office asset don't convert easily to residential because of location workplace windows or elevator configuration, but we see this as it is it relatively easy conversion like the ask that we just completed the sale on in Honolulu in the quarter.
The two loans, we downgraded from three to four in the quarter a relatively small loans.
The first is a $65 million exposure to a mixed use asset in Phoenix that we downgraded since the sponsor declared they will no longer put money into it.
Sponsor his build components of the Asa to date with $49 million and we expect this loan to pay down significantly with the borrowers component sales in the coming months and we expect full repayment on alone at the completion of this process.
The other is our only multifamily loan in our fours and fives, a $60 million loan we made on an asset in the Pacific Northwest, which were downgrading due to slow lease up and cash flow shortfalls with rates higher.
The sponsor is expected to sign a mezzanine loan term sheet, imminently, which would pay down our loan and likely result in a near term risk rating upgrade.
We have a final maturities in 2020 three on 16 loans, representing less than 10% of our loan book and only half of that is office.
Two of those off as long as our risk rated four or five the DC conversion I just spoke about and a 50% L. T. C loan we made on an office building in Houston that we extended six months, while the sponsor explores a sale or recapitalization.
Rina mentioned, our liquidity and I will note that we expect the largest equity return in our 2023 final maturities $125 million of equity to pay off on Friday, which will add $125 million to the liquidity numbers Rina mentioned tomorrow.
Finally, I will touch briefly on our three Oreo assets.
On a mixed use asset in Los Angeles, we continue to work on non office conversion strategies, but at the same time, our receiving bids, which we expect will be at or near our basis.
On our former office asset in Houston, we are under a signed PSA at our basis for a residential conversion and on the condos on the upper West side, we began selling renovated units this quarter and are under contract on three of our remaining units for just over $10 million in residential lending we continue to work to lower our financing cost is more.
Banks aggressively pushed into residential financing.
Loan prices have increased as rates have moderated and as Rina said, Unlike a lot of the banks you have recently read about we fully interest rate hedge this book and it received $107 million in games on that rate hedged to date. Our property segment continues to perform very well and Rina mentioned, we are waiting for HUD to provide us with allowable rent increases for 2023 of this month, which.
We pass through mid year.
These increases are CPI and median income base and I would expect them to be in excess of 6%, which will increase income and at the same cap rate book value in the coming quarters.
Our energy infrastructure business continues to provide very attractive return we.
We invested $160 million in the quarter at high teens Levered returns and we believe we can continue to grow this book Accretively in the coming years.
Finally in Reece, we continue to make money in a choppy sea MBS market with $13 million of earnings in the quarter.
As Rina said LNR was named special Servicer on 107 billion of loans and we expect to earn higher fees. If this high rate credit cycle continues beyond what the forward curve is telling us.
Also this quarter LNR again received the highest servicer rating by Fitch of C. S. S. One.
We are the only special servicer with this highest rating and are proud of the hard work it recognizes.
With that I will turn the call to Barry.
Thanks, Jack Rina and Jeff Good morning, everyone, well, we joined the day after the fed did their 10th increase in a row.
I think I've been pretty clear on what I think of this it is bordering on idiotic.
Biggest victims of this or the regional banks.
Every quarter point as a $50 billion loss in there.
And their books last we checked.
<unk> 200 billion and Theyre going to have two choices. They can take 100 banks back in.
And have to sell their loans as they are doing in assets as they are doing.
Signature and Silicon Valley Bank and it doesn't look like they did because they supported the federal first Republic acquisition.
And you'll have Archie too.
Clearly the government will have to step in and save all these banks, who really are a victim of the fed zone stupidity frankly.
You had a situation where the government said the rules. They said you buy treasuries with all these deposits that are floating.
Flooding your banks because of the stimulus we've put in by treasuries have advantaged tax <unk>.
Capital regulations.
And you don't have to market to market and it's kind of like if you had a hurricane or told everyone you'd never experienced a hurricane.
So why would you buy hurricane insurance now I think with the managements misses the pace at which those deposits could disappear.
Obviously helped by social media today.
But realistically you have a purely new Orleans solved and regional banking system based on the rules that were set up by a government that has 30000 people to monitor the banks that's between the FDIC the OCC and the federal reserve itself, but we are filled with phds running models that make no sense.
There's no question that credit will decline.
The decline that's already the tightest credit history, and you see the markets vote on this with the steepest yield driven version in the history of this country.
So despite the fact that some people call for credibility besides.
The regional banks, and obviously real assets.
The victim as the federal government itself, the only benefit to them is they're going to have to spend more on interest expense and.
And their deficit will grow because the value of assets dropped capital gains or income and other receipts drop so the deficit widened I continue to worry that he hits the point of no return where people realize that a three Chilean interest expense is significantly higher than the 480 billion that ran in 'twenty, one which is 5% on three.
32 trillion dollars only headed in one direction.
I'm done with my speech about that because I really.
<unk>.
Understand that our view is we need to navigate between now and then then is when the yield curve says at the end of this year, the 80 basis points lighter on LIBOR, but let's forget about that let's say a year from now or even a year and a half from now and clearly the economy should slow.
Given what's going on in the with interest rates declining manufacturing <unk>.
This sector remains strong there's no doubt the travel remains strong.
And we'll see how long this can continue but it does defy most logic and obviously employment is solid and that is what's keeping the economy alive with the fed seemingly adding them to increase unemployment and so you see this inverted yield curve.
But more or less suggesting that we're going to go into not a shallow recession as Paolo said yesterday, but something more severe let's talk about the real estate markets. Because again, we were not the reason.
For this recession or this crisis. This was all the government too much money too few goods than a lot of good and now dwindling money prices went up.
They're now coming down oil $68, a barrel the only person who seem to not know inflation is going down as chairman Powell and as Mary abandon fed governors.
So in the real estate markets, you have three or four superb segments that are really behaving quite well anything in single family and multifamily is doing fine industrial remains fine hotels are at record high Occupancies and rates you saw Marriott's earnings. This week Hilton reported earlier in the week business travel remains good.
Travel remains good.
Only real data centers are good life Sciences are good the only issue is office offices story. It's a very it is a tale of countries anywhere, but the United States Office. This fall we have a large exposure to Germany in the office market not only are our buildings remaining pool, but rents are actually rising.
Across Germany, 5% to 7% in places like Berlin, Hamburg Munich.
In the U S. You have a tail of city by city you have the Bluest states the Chicago to the West Coast New York.
Really experiencing maybe two days a week in some cases I was recently with one of the state pension plans in California. There are two days a week they own they own the building there in sort of a shame.
But that is what's happened you have sort of unique to the U S. And then in the office market you have a bifurcation that the good buildings are full or holding their rents and it's actually hard to get into we recently, even tried to renegotiate a lease in San Francisco or our own Starwood capital group lease landlord insisted on a 10 year deal we wanted a five year.
Deal you saw about a seven year deal my team wanted to be in that building I want them to be in a big building that they'd be happy and so you can see that it is a city by city market by market underwriting exercise and you are throwing our the markets. That's rolling in the federal government is throwing the baby out with the bathwater the federal government make no mistake is leaning in.
Ross all the banks big and small and saying reduce your exposure to the office segment I don't know what they think is going to happen two or three trillion dollar asset class. It will take down the banks. When you look at the regional banks were marking their securities to market and seeing that they are virtually insolvent those are their treasuries, which are money. Good we haven't really even touched the CRE books.
And obviously there are four times is dependent on CRE lending as are the major banks are 28% of their assets into trillion nine of loans. So it is a serious situation that I hope will improve as the fed realizes what it's doing.
Our friends in the industry talk to the fed but they are seeking credibility. So I guess theyre, taking credibility is destroying the U S economy.
Anyway in this morass, you want to lend to get good assets that have bad balance sheets, and they werent bad per se when we started but they become stretched when interest rates go from zero to 5% and so those are the assets that actually as an equity player starwood as an equity player if a $120 billion of it.
Assets, we don't want to take them back, but we have made money taking back assets every time, we have done it in a 12 year history and as an equity player whether it's the conversion of our museum building in Los Angeles for the New building, we got from a major sponsor in Washington, DC I'm confident we'll recover if not every dollar than most every dollar across the board.
If we had more money, we might actually take on the development yourself, we actually those of you who have been with us for a long time.
We started starwood financial that's today called ice Star financial any survived their 2007 2008 crisis took back tons of assets and started to build.
Real value for their shareholders, we will make more money as an equity REIT and we will answer that right now we don't expect to be there, but we would be delighted to take our multifamily book, which is 33% of our loan book not including the $2 billion of multifamily own on balance sheet, which are affordable housing that remains solid and I would expect the rent increase to be.
Above eight 9% that was received this month from the federal government for those assets in the asset class, but going back to that multifamily book the debt yield stabilized on that book as a seven one I would be delighted if we would take every single asset back I don't think that will happen.
But that would make it the cheapest REIT in the United States.
Including all of the fallen Angels at that cap rate. So we would be very happy to see.
On our balance sheet, we don't think we'll see or maybe one.
Asset in that portfolio and in the city that was hit by the Georgia Floyd.
Fallout crisis.
It's not coming to us yet, it's just leasing slower than we anticipated. So we do think the economy is going to slow and our job is really to manage through the cycle keep our liquidity high obviously, our stock has an intoxicating value at these levels, but caution is the right word for us since we play defense and decided when again it will go on offense.
Yes.
We are again somewhat excited by this you should see that note then we our loan to values worst 60% to 65%. So again, when we get assets back we're getting them back at a attractive basis that allows us to do things. The prior borrower couldn't perfect example, as Jeff mentioned was that building in D C, which works as a residential conversion because we fund.
60 of the cost it wouldn't work as an office conversion. So it's under LOI will see if we can get rid of it and you should know also that we believe we can make our earnings with no new investments that is a benefit of having floating rate debt, having said that between non accrual and Oreo assets. If we can put that capital to work, which we intend to.
Do over the coming months.
Let's say six months, we could earn an incremental 30 to 40 cents a share that's between the earning of 12, which would be easy today on the new capital and also.
Not having to spend the money, we do carrying those assets until we can put them back or sell them and put them back in the market. So you know I also want to highlight what Jeff said that our lending book really did mirror the strategy of our equity book, which is we have very little or no exposure to San Francisco.
And de Minimis exposure to Manhattan.
Which are two very difficult markets right now with these states are running massive budget deficits.
And the only way they can cover them missed and continued increase taxes, which of course trade. This negative cycle for both cities, where they can't support the social infrastructure.
So in summary, I think we feel confident we will navigate through the cycle. It is choppy and the headlines are bad.
We do expect there will be losses here and there, but we also expect there will be gains offset them over time, we do have this unique business model and in our I'm sitting in LNR has offices in Miami today, we have 300 people that are foaming at the mouth ready for the what the market assumes will be a massive onslaught of defaults and restructurings.
And the commercial real estate industry. So they act as an enormous hedge for us and it's different makes us different and then the other business in the sector. We have the the owned real estate assets, which are material. The lending business is only 60% of our earnings today. So we have many other cylinders that will hopefully function even better.
And offsetting the softness in the lending portfolio that we are well positioned for what we think we're going to see over the next 12 months.
So with that I want to thank our team, which remains dedicated and focused on navigating through this crisis. This isn't.
Fed induced strides since the beginning of the governments at all or is the government did all the stimulus package. The government created the inflation by throwing money at everyone.
Some of it went offshore apparently and then the government decided that inflation turned out not to be transient.
And then increase interest rates at the fastest pace in history and it isn't the level of rates at the pace at which we got there and then he said a set of rules for the banks that are made in hindsight very little sense and HTM would be a lovely thing for us to have we don't have it really and as you see because we are not.
Our bank, we hedged our MBS exposure, we are interest expense, our hedges covered 100% of our losses.
In that book and we have no real exposure rates. So we behaved there's probably in the regional bank should have behaved, but we're told by the government. They didn't have to do you can blame management or you can blame the fed but I only hold the management responsible for not understanding how fast the partnership could leave but $42 billion in a single.
Day that also was a world record that wasn't Swan and now of course from Etfs. The regional banks are facing serious issues with the government's gonna have to cover.
Not every bank has the franchise of first Republic and many of these banks won't have residual value and it is a criminal to put all these people out of business. These people that work at these banks.
It is not right and it should all beyond the fed it's.
Their fault. So they did this and they don't need to be as less for killing inflation at what cost you can't manage the employment rate in nine states with CT point interest rating. Please.
So with that which is kind of our aggressive my apart.
How I feel inches inflation will fall as soon as the rent index there until late.
Rent index.
Included in the CPI, we should be in the twos by the fourth quarter.
I think it's.
It's a shame if theres no point to doing what they're doing and I don't know who they're trying to get credibility with but it's a it's just not the right thing to do for this country. At this time so with that in my diatribe is over we're going to take questions. Thank you all.
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Okay.
Yeah.
Thank you. Our first question is from Stephen laws with Raymond James. Please proceed with your question.
Hi, good morning, Mike.
Congrats on a solid quarter and I appreciate the new page nine so that is helpful to look at the company that way.
Rina I'd like to start with special servicing and maybe leverage off Barry's comments.
We've got all of this debt maturity coming you know.
Whatever amount trillium something over the next two to three years.
Look at your special servicing book I think it's only got about 5 billion inactive right now yeah, how should we think about that number or what the range of.
Of that active servicing book could be over the next 12 or 24 months and then kind of what would the resulting revenue be at those ranges as you think about that working through the system. This transaction volumes increase.
Thanks, Stephen good to hear from me it's Jeff.
The way I think about this the MBS book is sort of a simple you went through a period from 2008 to 2011, where there was really no see MBS you add a little bit in 2012 in 2013 was the first year above a $100 billion again, we maintained above that and grew it through 2019 and beyond.
You are now starting to see those 2013 originations come on a 10 year a lot of them were Io. They don't tend to they have to add significant cash flow with two to four times debt service coverage at origination so they make it to the 10th year and at the 10th year. We may see some fall in so we're just at the beginning.
What will it be a bigger wave of.
Maturities has been a lot written about those maturity, but the MBS market is just starting in the maturity cycle. So when something does mature and it gets put to our special and we're a little over $5 billion. As you said today, we'll start earning ticking fees for the next year year and a half as we may maybe reposition or work to sell the asset.
Then we get the largest fee at the end so even on the 2000 thirteen's, It's really 24 revenue it could be 25 revenue.
And as we look at the credit cycle that we're in today, if it's met with the rate environment that we're at today versus what was underwritten we're going to have a bevy. So when you're modeling. It you can take 107 billion you pick the percentage of losses that you want on that and that's what's going to add onto the $5 billion and first sort of simple math, we tendered multiply that.
One in a quarter to one 5% of that will become revenue at some point in the future a year to two years. Later, so we're really excited about 'twenty 'twenty. Four later part of 'twenty, four and heading into 'twenty five.
And there is a lag and a delay there. So just wanted to make sure everybody understood that.
That's helpful. I mean from a run rate standpoint.
$709 million a quarter I mean, I'm looking at my model from <unk> 13 to 15, I mean, you're running 50 or $60 million of revenue to that segment. I mean are those levels that are attainable or so.
And how the how it works a little differently.
Given what given what changed.
Yes.
Thank you.
I mean, there are a lot of these losses will have to slice and dice will all be restructured recipe a note b note and you get paid not at the end you get paid when you restructure it so.
Just heard from Jeff I mean, we might do to exit it might be the restructuring and then the final deal. So there'll be two two opportunities for us and I think that's probably the only way the office market J&J restructured youre going to have to set a new level with an a note and then there'll be.
New capital come in with a breath and then there'll be a wholesale for the back end.
That is I would guarantee you that's probably 80% of the restructurings in the office market Nobody wants the assets back right.
No borrower is really keen on putting capital in.
This environment when when the government is telling banks don't make office phone. So the banks do real lender for office as the existing lender.
And there is no other lender. So we're happy because I mean, we will get the coupons that are put in place in those buildings and some as I mentioned are full and most of our book is a class a office building so those tend to be full.
But there will be capital cost and I think for the first time in 35 years everyone's focused on these capital above that.
What is the cap rate that nears for building value.
It makes the investment of the Ti worthwhile for the for the for the borrower is interested interesting that in prior soft cycles borrowers and strange credit conditions said, we won't put the Ti and <unk>.
You put the Ti and we will give you a break on the rent and you might actually see that come to fruition, because I think that's going to be an easier way to solve some of these issues. The tenants have the money theoretically a facebook.
Or Google or Apple or any of the they have the money. They can put the tio. There's just the convention has been to the landlords do an allowance and then the tenants invest over that but typically lets take a building in new York the allowance might be $100, a foot tenants, putting $300 a foot into the space and all he put 300 that are 200.
They want the space not a big deal it will just be restructured and the office asset classes not going away. It is not going to be every building is going to be empty frankly, we all know Amazon goes to work in order to five days, the night, and we'll see which tech companies followed but I.
I will say I, just and I think many of you would agree and we are so much more productive in the office and they are at home and some industry is probably little work from home, particularly the tech industries, but that's not the majority of the country.
We will see Tesla is telling everybody to stay in the office of you're fired so theres quite a quite a.
Variety of approaches I was talking to one of the banks yesterday.
Major top four bank and they said well they noticed that a significant number of their people, 2030% werent coming in the minimum days required and the executive said those are the first people, we will fire and none of them will get raises so you know it was a blanket statement, but I think that's how management's feel and as you probably know so.
Hence you to want to come back to the offices inverted with each.
One there are people in and the kids one have dialed in from Montauk injection Hall.
So that is not going to be acceptable in a recession in my view. So I think you will see the office environment, where people can walk by an office and say hey, what about that and it is not a scheduled zoom calls for 30 minutes, leaving 22 minutes empty and you have now figuring out how to manage your time better.
Simply a better model and I think I think we'll see that but it's going to take some time in the U S. It is just wild. If this is just a U S phenomenon not in Asia, not in the Middle East Europe , London, and Berlin, Paris, Milan, I mean, the Europeans there other ones that are supposed to work from home.
They are working they are in the office. So they are traditionally a little less productive than we are but we have adopted this new model of new economy, where people labor. So far has been able to dictate how theyre going to work.
It is so fascinating we built a new headquarters in Miami and the readers in this building the accounting team was going to work from home and the old building, which is kind of in Gn dark we built a nice building everyone shows up at work and we didn't ask anyone to come and they all came in themselves so and they like to be here in beautiful offices.
What youre going to need to compete in a world today, you cannot have cubes and dark hole nobody warrants that environment period, so improve your space and you'll have a full office and they're happy for them.
Thank you. Our next question is from Jade Rahmani with BW. Please proceed with your question.
Thank you very much I'm trying to square two things.
When I look at the seasonal reserve.
Amongst the lowest I know, it's an accounting treatment.
But it is amongst the lowest of the commercial mortgage REIT.
Below that of the banks I understand it's a different methodology. The loans are shorter in duration floating rate there's capital that's come in so theres reasons for that.
And then I look at the disclosure around.
Properties held in the lending segment that have gone through foreclosure as well as the non accrual non performing loans and I appreciate.
The disclosure you've provided it is amongst the higher end of the range, it's not as high as some of your peers, but it's higher than.
And then a few.
And then from Jeff's comments loan by loan it seems like there is a plan.
Many if not most of these assets to recover value close to steroids basis.
So just I think one of the reasons. The stock is down today is nervousness about whats coming on credit and if the seasonal reserve has to move.
Fully higher to accommodate that can you can you address that please.
Yes, listen Jade when something we've taken two into Oreo and I. Appreciate that you heard my comments, but do you see new euroskeptical on and so we're more than happy to go over the five assets that I said, we expect full repayment on so therefore, there's no reason to take a seasonal reserve. We also used the most.
<unk> version of the model because we know were lower than our peers were significantly lower than our peers by the way we have 10% U S office, our peers are in the 30.
Or above 30%.
Reason why were a lot lower than our peers. We just spent 25 minutes of prepared comments, hoping people would understand why we set up this business is so dramatically different than our peers with massively lower leverage than our peers. Those are the reasons, we have significantly lower seasonal reserves management may or may not be right in our assumption.
On all of those loans that were going to get repaid fully but we believe it today and this is a public earnings call and that is that is our best guess of where things go but we feel very good we're willing to take things into Oreo. We've done it we've made money off of it and we're using the most draconian model that we can possibly use to bring our reserves up because we know people are going to be <unk>.
The global skeptical of our reserves. So we pushed the model as hard as we could to increase it but this is just the reality of what we see and it is the reality of the business that we built which is the underlying piece to compare us to anyone else well I'll tell you what take out a turn of leverage to us a turn and a half versus our biggest peer of leverage to us we would have more.
Reserves add 25% more office, we would have more seasonal reserves.
It's not how we built this business so it's sort of frustrating when the people who know us the best don't do that but we're happy to spend more time on any one of those assets and repeat what we said that'll deeper I'm going to add another point like we have.
Mark our nonaccrual loans is like 80 cents on the dollar so.
Obviously, we expect.
One of the lowest 76, so we've already taken those into D. So.
We think they are marked appropriately and that's one of the reasons again.
It's a puzzle right and the seasonal reserve UC is it's formulaic.
Math model that we don't control, but if an asset is already.
Mark.
No.
To start the Mark and and based on is we have we can see what we think the values are so we've tried to be conservative.
Don't get US wrong, you could see a drop of $1 you can see some book value deterioration, but the earnings power of the company is tremendous and I think I think we will come out of this stronger.
And when we can go back into the aggressive lending. This is the best lending environment. Since 2009. It is it is amazing.
Amazing thing there.
And we will if we have to take the gains in our book to offset the losses, we can sell down or our fee income book, which no one else has to actually.
Actually preserve and actually with obviously the delta between our book value and our fair value. So.
It's our gains are 10 times, our seasonal reserves. So we and we're confident that this is affordable housing.
This isn't an injured ASIC class, where rents are being adjusted by inflation and by and by wage growth. I mean, two really good things that are driving the rents are much higher than we ever thought it would be so you have you have a very flexible balance sheet.
And we've got we've got our CLO as we've got our corporate debt.
There was some extraordinary opportunities David.
As an example, the lending environment.
A site in Midtown Manhattan. This is in our equity book This isn't part of this company and.
It's a it's a spectacular building that's to be constructed on the upper East side of New York City. The single best well, we could get for construction loan was 50% of that's 500 that is guaranteed by a massive fund.
It will be completed.
Because there is a $10 billion fund behind it as 500 today is 10% on a first mortgage with light leverage your I don't know what you are 13, 14 and 15.
And that attachment point on that project would be half less than half of what properties are selling for a per square foot in Manhattan today.
Backup the truck MTR Kids' trust funds and invest in credit today.
This is crazy and the fact that there is this sort of prices with the fed created creates enormous opportunity on the investing side today and our sector. If you know what youre doing is be careful not everything is relevant today.
But in this in the asset classes that are fundamentally performing well you have a really good opportunity in the housing complex will sadly the fed's actions will do the opposite of what he wants long term you will increase supply of everything everything and so rents will rise again more smartly than they would've had he not.
Crushed starts and that's all coming to a movie theater near you you don't get to see it yet because everybody is completing everything they started because everyone has completion guarantees to us and to every other lender in the country. So as soon as our projects are finished we will be laying off the construction workers and though the government has a trillion dollar infrastructure built they're not going to be able to get there.
Act together fast enough to actually employ people to spend the money given that your federal government is so screwed up so let's go do an investigation of a meaningless.
<unk> of our prior president.
It's really important that that's really helpful to growing the U S economy.
Yes.
Just one other thing to what I said earlier lending as Barry said is 60% of our balance sheet is not 100% of our balance sheet.
Thank you.
In the interest of time, we ask the participants limit themselves to one question.
Our next question is from Rick Shane with J P. Morgan. Please proceed with your question.
Thanks, guys for taking my question and I may try to squeeze two in here, but when.
Jeff laid out the disconnect between the implied losses and your expectations.
As you think about capital allocation, how aggressively should you be allocating some of that additional capital, particularly.
Particularly given the low leverage to your buyback.
I would still like to build our reserves up slightly.
If we achieve north of one.
1 billion of liquidity, we would aggressively go back in the market.
So in.
And that would be attainable with some of the Oreo sales and loan sales that we could achieve them. So.
I think that's kind of where we'd like to be.
And.
We have a few things cooking debt.
The repayment of a large loan that will happen this week.
And that would include repurchase.
The stock, it's not just making new loans that our stock is now are better.
Probably a better investment than most new loans, we may.
I mean, the issue is construction loans as we don't get to put the money out of that coupon upfront, they're drawn over time, whereas we're saving the dividend yield on our stock on day one.
So that would that would as we have in the past every time the stock has gotten down we've repurchased debt. So we.
We would do the same this time as soon as we clear what I think is.
Look you know that your credit is constrained today so.
We have to be careful but you know for the for the multis. The agencies are wide open that's a third of our lending book Alright, So thats not an issue.
We expect that spread but first thing that will happen in the credit markets and <unk>.
Once this banking crisis sort of clears.
They take back a 100 banks if the pay at the rate they're going on maybe more.
Spreads will come in some of the spreads and the security markets, including the RBS and CBS markets or our wide because the regional banks for dumping their secure.
No.
And people are fearful to try it on the water you cannot have a functioning market with AAA that 222 40, they were coming in but Silicon Valley Bank and everything else. That's transpired post that sort of shook the Cannes again, and then it's like what do they call it a snow globe.
Just as in the air it will settle and spreads will come in there is as you can see theres. So much money out there and it's looking for homes and frankly, a 335 10 years a lot different than a four and a quarter 10 years, so to get duration today youre going to want to buy securities with higher yields and the short end is lovely, but it's only three to six.
Month can you and 5% so.
The shape of the curve is going to help forest capital into longer term assets, which will look really good as the yield curve inevitably flattens. So I think.
I think this is a great opportunity for people and for us, but we do.
First and foremost we are always been predictable.
And safe and we want to project, if we can at all costs our dividend so.
We're not going to be Cowboys, but it is accretive to buying the stock obviously at these levels to our dividend.
I would add that.
I would add to that that Bina mentioned that $612 million of cash we have a loan closing tomorrow, that's coming back to us that would be 750 of cash. The reality is we have $4 $2 billion of unencumbered assets. We can go borrow against those unencumbered assets tomorrow at today's sofa and.
Paying out taking a loan and taking that 300 or 325 over which is where the market has moved to we're going to pay eight 5% to create more liquidity. So we have more liquidity available to us, but the cost of that is eight 5%. So it's very difficult to convince yourself against the cost of liquidity of eight 5%.
Sort of lever up the balance sheet or try to create a lot more of that you end up ultimately sitting on.
In doing this borrowing also would increase our leverage and we are very cognizant of our credit rating and at two five turns of leverage and we believe we're going to have a great opportunity to issue unsecured later in the year against this higher cost financing we've taken when we do that we will have increased the amount of unsecured debt secured debt that we have on our company.
And we believe that along with holding the line on low leverage is tremendous the important because it will lead to a ratings upgrade for our debt, we will borrow cheaper than we win so being cognizant of the cost of that excess borrowing today to create a tremendous amount of liquidity that we could flash deal. You guys did you would be billions of dollars as well would be paying eight and a half.
Or is that for and others are effectively too.
So we're choosing to run our leverage our liquidity, where we are and as Barry said, if we come up with excess liquidity that sort of doesn't cost eight 5% I think we would love buying back our software rather.
Thank you. Our next question is from Don Vendetti with Wells Fargo. Please proceed with your question.
Barry if the fed did come in and cut rates.
Futures market is projecting do you think that would change.
The cytology and CRE property markets and kind of put a floor on values you talked about a lot of money on the sidelines.
Again, I think it spreads come in first and then rates go down those are that's a double whammy spreads are twice as wide as it used to be because of the fear in the market.
I think look I think the office asset classes can evolve like the mall the.
The mall market, we all thought and we read and everyone was completely panic that there'll never be another physical store, we thought the world was ending and retail like dawn and yet look at filings results yesterday I mean, the good malls are full.
Aventura <unk> added several hundred thousand foot expansion and it's completely full.
The office markets will behave exactly like the retail markets. They will be good buildings and dead zombies, all around and you'll have a great opportunity to lend against the good buildings, and Thats, where <unk> get paid to do be smart investors and take the right risks I think.
Not really about the asset single family say I look at the look at even the prices of homes, they've held up really well or better than most people thought.
And you see multifamily rents have re accelerated.
There was a weird thing that happen the end of last year were tours for Reynolds dropped, but they then have gone bananas in the first quarter of the year.
We don't want and don't expect to see 20% increase in single and multifamily rents that is that some weird condition. That's never happened before we saw it in 'twenty one everyone saw it in real estate, except the fed which waited six months to realize that inflation number was going to go way up and that's one of the reasons. They were so late.
Now they are doing the exact opposite they still have it rising every month is the biggest component of CPI and it's falling dramatically from 'twenty before that's national rental growth.
Our multifamily rental growth.
Yes, I think I think it will take a little time to people. This regional banking crisis, you cannot have these banks haven't value everyday youre, well, it's a little tornadoes and hurricanes blowing over the system.
There'll be real estate people will still want to live somewhere.
Some place where just canceled just balance sheet.
To this end.
We were formed at the RTC I started this firm 1991 buying assets from the RTC, we made a lot of money and we made a lot of good returns.
This trip will be more like seven or eight or the government participated in the sale of the assets and they financed the purchasers I mean, the difference the big difference here is <unk>, they lowered rates to zero when the economy blew up and so banks were fine because all they have to do is keep their doors open and the <unk>.
We rebuilt our capital basis, and they didn't have to mark anything to market. They are doing the opposite.
They are increasing interest rates into a falling asset class on the economy and so the banks I look at our I looked at a bank we have a small it's not the REIT, but we haven't invested in a personal investment in and they have billions of deposits earnings zero.
Billions of deposits that are uninsured above the bounce mean data and those needs with 10 to one leverage banks cant makeup. They can't liquefy that fast is no way so they wind up being custodians of the state.
And whether they let J P. Morgan by every bank or wells, if they don't do anything I mean.
The government is completely screwed up completely screwed up and.
I don't know how to handicap that because the.
I don't know what theyre looking at but they arent looking at what everyone in the real estate industry is telling them to look at an office asset classes three trillion dollars.
Three trillion.
I mean, that's noticeable.
And the losses will go somewhere it will go on to see MBS securities and to regional banks and major banks and bonds and Fortunately LNR will have a good time, but.
Again, it's not going to be uniform, it's going to be like retail the really good retail looking at having to stretch their fall.
And the tenants are doing well separate bed bath and beyond but most of the tenants are doing well.
So new uses we get padel sports and old anchor space.
People are repurposing stuff and they do make.
Good housing sites, so theres value there is value here and smart investors are going to make a lot of money in the cycle again, but right now we.
To deal with the conditions as they are and we will and we have the balance sheet and liquidity to do it so.
Thank you. Our next question is from Doug Harter with Credit Suisse. Please proceed with your question.
Yes.
Thanks.
You know as you look forward.
Any need or desire to kind of reallocate any of your capital.
Coming year or so towards.
Lending opportunity that you say is building.
In the next year will we look at lending opportunities towards what I'm, So sorry, sorry.
Sorry.
Commercial real estate space as Youre talking about that.
As potentially being a good lending opportunities for opportunity to reallocate capital away from the residential portfolio or the property portfolio.
To be able to take advantage of the lending opportunity kind of on the other side of it.
The.
Downturn.
Yeah listen the easy one to say is we're not adding property today sort of today's financing costs. Our cash on cash returns are nowhere near our dividend. So that's not getting bigger could it get smaller obviously as you look across the other ones I think we really like our energy infrastructure segment right now we earned almost almost 20% if we ultimately.
The earn what we believe will learn on the investments we made in the last quarter.
Been as big of an investment cylinder for US recently as CRE lending, we think CRE lending fantastic today. There. We think there are opportunities to get really good spread obviously you're financing it at an expensive rate. The more we can do there as I mentioned before the more repo, we can take or.
Or if we if we don't choose the CLO financing, which is unlikely today or in a note financing which is more difficult today. If you use repo when you take more expensive repo. It is a great opportunity later to pay that off with unsecured as I talked about that ability to potentially get a ratings upgrade on our debt. So we would love to do more we think it's a great environment to do more but our cost.
That is really expensive the MBS originations are really interesting heading into the back half of this year. Our team has done an amazing job over the last couple of years of making money every quarter. When every bank lost money and most of those quarters, though we hedge the credit risk there we hedge the interest rate risk there and we think that there will be a significant pick up later this year.
So where we have a great team on the field that we're excited to run into the second half of this year and start picking up picking up there. So there's a lot of things to choose from properties. The one place we won't be investing <unk>, probably unlikely today, but our book is sort of moving in our favor a bit but the other ones.
We have a great business model, we get to wake up every day and choose where to invest Doug. It's awesome I would hate being at a job where I had to make a commercial real estate loans everyday I woke up regardless of whether I wanted to make a commercial real estate loan and going back to credit I think we made a lot of great credit decision by not investing in loans at times.
When others did and so to the question on diesel reserves. There's 50 reasons why I think our it should be better.
But one of them is we're not forced to make a loan on a date, we don't make alone there were a lot of loans that probably looking back to people in 2016, or so that probably don't look as good but lending lending markets were really quite well guess, what we bought a massive equity portfolio in 2016 and were up $1 billion on it. So we're going to make decisions everyday into what's the best investment to make other people.
Can only make a loan today, let's make another loan and youre going to ultimately get into more trouble. When you can only make alone today. So the diversification. We think it's a great. It's a great upside for us and we like just about everything that we're looking at today in terms of opportunity.
Thank you. Our next question is from Sarah powerful with BTG. Please proceed with your question.
Hi, everyone. Thanks for taking the question. So in the prepared remarks, you mentioned the high concentration to the southeast and southwest within the multifamily bucket.
Specifically curious about the deals that were underwritten in the back half of 2021 and front half of 2022, when we saw rapid rent growth and higher LTV lending and while we're still seeing high rent growth in those markets or are you starting to see any signs of NOI at the property level coming in below <unk>.
Expectations on deals that were penciled with negative leverage back then when rates were near zero and.
Are you seeing any risk in the sponsor's ability to service their debt in those situations are you seeing any issues on the ground year pop.
Pop up yet.
So I'm sorry, I thought there was going to take it I guess I'll start.
A rent perspective, you've obviously seen rent push round late 'twenty one.
Today. So income is up expenses are up a little bit income is up a lot more so even the loans that we wrote I think youre, implying that we all as an industry wrote loans again lower cap rate than today.
We've gone over this in our portfolio in total as a sort of $6 two in place debt yield go into seven one is very clear that feel pretty cheap to us I would say the stuff. We did at the very bottom there may be some high fives debt yields are the things that we did in late 'twenty, one, but again you've had any.
Excuse me <unk> had rent push and we expect to continue to push but at a more moderated pace today and as long as the opaque.
<unk> growth I think.
Honestly, we get these assets back where we've learnt a fraction of their construction costs. The happier our careers, we'll just add them to our Oreo book and Malone.
Leverage them when spreads come down with Fannie and Freddie in alone and the brand new assets and they're good assets in good markets. So.
That would be a really positive outcome for us. We are happy we are the only mortgage REIT that had always had fee assets. We always went into the fee ownership business. We just couldnt get yields on cost we got for the initial portfolio, but even there we never anticipated that rent growth we saw.
On the affordable housing portfolio.
Alright, I think that deal was like 100 IRR.
We can refinance our equity out of the deal and so $11 billion of gains.
Some of which we obviously took with the sale of a.
The minority interest so.
We have we have issues that are different issues like these gains are taxable. So we have to be we have to be very careful how to how to harvest them.
And.
And so we want to we want to.
Make sure that we paid.
He is little taxes as we can.
On the on the gains.
And our portfolio.
Distributable.
That's all right.
Right.
Distributable that's excellent.
That doesn't help us that much on liquidity, that's what we're saying.
Thank you any other questions other questions.
There are no further questions at this time I would like to turn the floor back over to Barry Stern look for any closing comments.
Thank you all I mean these are trying times that we're available to talk to you as.
As long as you want.
Currency is not a hallmark I think our new disclosure pages very helpful to argue or you look at our company different from others in the sector, we don't wish anyone ill.
But we are slightly different company than most and we built this business model on purpose and as Jeff said, having the ability to do nothing or investing in all these other alternative businesses isn't asset benefit to the firm so with our 300 plus people that are dedicated activities here.
Hope you navigate these waters as well and we look forward to talking to you next quarter.
Thank you.
This concludes today's conference you may disconnect your lines at this time. Thank you for your participation.