STARWOOD PROPERTY TRUST, INC. Q3 FY2024 earnings call

• Financial results: Distributable earnings $159 million, $0.48 per share; GAAP net income $76 million, $0.23 per share. • Investments: Committed $2.1 billion to new investments, 60% in non-commercial lending. • Commercial lending: Originated $848 million loans, funded $635 million, repayments $1.1 billion; loan book at $14.6 billion with risk rating 3.0. • CECL: Reserve increased by $65 million to $445 million, 71% related to office. • Residential lending: On-balance sheet loan portfolio $2.5 billion, prepayment speeds down, spreads tightening. • Property segment: Florida Affordable Multifamily Portfolio drove DE; sold one asset for $18 million. • Investing and servicing: $398 million securitizations, $122 million CMBS purchases, etc. • Infrastructure lending: $527 million new loans committed, portfolio at $2.5 billion; fourth infrastructure CLO completed. • Liquidity: Enhanced liquidity with $392 million common stock issuance and $400 million senior notes, liquidity at $1.8 billion.

Commercial and residential lending contributed distributable earnings (DE) of $190 million, or $0.57 per share. In commercial lending, $848 million of loans were originated, $635 million funded, and $134 million on pre-existing loan commitments. Repayments totaled $1.1 billion. The loan book ended at $14.6 billion with a weighted average risk rating of 3.0. Residential lending's on-balance sheet loan portfolio was $2.5 billion, with prepayment speeds slightly down and spreads tightening. Property segment recognized $14 million of DE, driven by Florida Affordable Multifamily Portfolio. Investing and servicing segment contributed $38 million of DE, with $398 million securitizations, $122 million CMBS purchases, etc. Infrastructure lending contributed $23 million of DE, with $527 million new loans committed, $440 million funded, and portfolio at $2.5 billion.

• Expect to continue increasing investing pace as working down nonaccrual and REO assets. • Aim to significantly increase investing pace and work towards ratings upgrade. • CRE lending pipeline strong with transaction volume returning; expect CRE lending to be a significant portion of business. • Continue to opportunistically access capital markets and grow balance sheets.

• Market risks including impact of election uncertainty, fiscal spending, and interest rate policies. • Interest rate risks affecting refis and cap rates. • CRE credit cycle risks with office loans taking longer to optimize exit. • Risks related to non-accrual and REO assets if not managed properly.

Q: Congrats on a solid quarter and nice to see the acceleration and origination activity. Jeff kind of along those lines you know high liquidity, low leverage, accelerating originations. You know I know you do watch leverage because you're pursuing an investment grade rating. But can you talk about the investment capacity as you deploy that and kind of what kind of incremental earnings you know do you think that can generate as you shift more to office?

A: Yes. Thank you, Stephen. Excuse me, I may cough a little bit. So in terms of investment capacity and the ability to sort of grow earnings here. It depends on a few things. Obviously our ability to move assets out of non-approval or REO would create earnings capacity in the easiest form in the form of growing through equity and debt in some combination and you've seen us this year issue equity once and debt twice. If we did continue to issue equity and debt to grow, I sort of think of it as at a 2.1 in terms of leverage it's for every dollar of equity that you that you issued you could issue 2.1 dollars of debt. Your debt costs you somewhere around 6%. We issued a 6% sixth year, six to five and a half year note in September and your equity costs you in the nines or somewhere around that. So you end up with a blended with 2.1 versus one somewhere around a 7% cost of new capital. Our historic ROE has been 12% to 13% and if we could put that 7% money back out at 12% you make 500 basis points. So for every billion dollars that you're able to do in a combination of equity and debt if that's how you choose to grow and maintain that leverage at 2.1, you would add $50 million to distributable earnings on a zero loss basis if you earned a 12 and paid an effective cost of 7. So if you did 2 billion you'd earn $100 million. We've told you that we have a little over a billion dollars on non-accrual today, so our goal is to earn $100 million incremental to offset that or start bringing down these non-accruals and REOs. We're working hard to do that but hopefully that gives you some scale of what we think the power of growing the businesses. We are full steam ahead on trying to grow. We have the most significant pipeline that we've had since I think the fourth quarter of '21 or maybe in the first quarter of '22 as I look at our actionable pipeline list. There is less competition from banks. There is more competition from debt funds. It feels like we have a pretty good runway right now in energy infrastructure to continue to grow. We really like that sector as well and we'll continue to look in a lot of different places. We did our first Freddie B piece this quarter so we're looking there. We're looking at CMBS B pieces but our goal is to grow and growing our way out of the drag of the non-accrual et cetera to make sure that we can continue to earn our core $0.48 is the main goal of the of the management team today.

Q: Seems like a positive story is building around the commercial real estate recovery prospects. The one damper on that is the treasury market and I know you all have been sensitive in your comments around long-term treasuries and how that creates risk for refis. What are your views on how that might change the positive trajectory we're currently seeing?

A: Yes, Jade. It's a great question. Barry would certainly take this one normally. The 10-year is obviously up today. The curve is normalizing and steepening. The thought that there'll be more government expenditures and potentially creating inflation and growth is not great for the 10-year and that will have an impact on cap rates. I will say that it's not all negative. If I look over a longer period of time over the last two years, I've been really focused on where's SOFR in 2026. SOFR in 2026 is somewhere in the 375 area today after this big move. It was 350 just a couple of days ago. That is in the middle of the range of where we've been for the last couple of years. On this call last year, at Halloween of last year, SOFR in 26 was 460. So it's significantly better than where we were, but it's not as good as the 285 or so that we were at five or six months ago where we expected the Fed to be more aggressively cutting. I would say that our portfolio from a credit perspective, we certainly want lower SOFR. That will benefit us more than lower cap rates driven by the 10-year. So this move and this steepening of the curve doesn't hurt our portfolio as much. But should we normalize somewhere around here? I think you will see cap rates potentially be slightly higher, obviously, with what's happened in the 10-year. And you will see our ability to look at our entirety of our multi-books, et cetera, that might have a five and a half or six debt yield that we thought a week ago were easy to refine, might be a little bit more difficult to refine. But we think there's enough capital out there and we're certainly seeing liquidity. We talked about the two assets that we sold at our basis this quarter. That was in a similar rate environment to where we are now. And I think that the impact at this move will be fairly small. Should this move turn into something another 50 or 100 basis points higher, then we'll reevaluate. But it's certainly important to talk about. But I want to talk about the other side of it, because it's really important. If rates do continue to go higher, it's going to be because people have optimism about the economy. With that optimism, we're going to expect to see more leasing on the office side. That's what the commercial real estate markets are really hoping for. With that optimism and job growth and the things that will create inflation, we're also going to see higher rents on the multi-side. We'll see higher rents at hotels, higher ADRs at hotels. So you would assume that higher rates are going to come with a stronger economy. A stronger economy certainly offsets a tremendous amount of the difficulties that I talked about in the beginning of this that are rate imposed only. And in the meantime, we'll continue to monitor our hedges across our book. We told you that, I told you in my prepared remarks that we extended our hedges on our entire resi book, and that saved us $10 million or $12 million. That's before this move over the last 24 hours, probably up more than that by extending our hedges. We're going to stay fully hedged in books like that and try to not have a treasury rate bet on in any way. We don't do that. We don't bet on FX. We don't bet on direction of treasuries. We try to match our fixed inflating assets and liabilities. We'll continue to. And hopefully a stronger economy is part of this higher rate environment that we're headed into. And hopefully rates kind of stay here because we like lower volatility and we like seeing the activity that's back in the real estate markets, and we don't want to slow that down.