Starwood Property Trust, Inc. Q1 FY2020 Earnings Call

Greetings. Welcome to Starwood Property Trust First Quarter 2020 Earnings Call. At this time, all participants are in listen-only mode. A brief question-and-answer session will follow the formal presentation. Operator provided instructions. Please note this conference is being recorded. At this time, I'll turn the conference over to Zach Tanenbaum, Director of Investor Relations. You may begin.

Thank you, operator. Good morning, and welcome to Starwood Property Trust earnings call. This morning, the Company released its financial results for the quarter ended March 31, 2020, filed its Form 10-Q with the Securities and Exchange Commission and posted its earnings supplement to its website. These documents are available in the Investor Relations section of the Company's website at www.starwoodpropertytrust.com. Before the call begins, I would like to remind everyone that certain statements made in the course of this call are not based on historical information and may constitute forward-looking statements. These statements are based on management's current expectations and beliefs and are subject to a number of trends and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. I refer you to the Company's filings made with the SEC for a more detailed discussion of the risks and factors that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today. The Company undertakes no duty to update any forward-looking statements that may be made during the course of this call. Additionally, certain non-GAAP financial measures will be discussed in this conference call. A presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. Reconciliations of these non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP can be accessed through our filings with the SEC at www.sec.gov. Joining me on the call today are Barry Sternlicht, the Company's Chief Executive Officer; Jeff DiModica, the Company's President; Rina Paniry, the Company's Chief Financial Officer; and Andrew Sossen, the Company's Chief Operating Officer. With that, I am now going to turn the call over to Rina.

Thank you, Zach, and good morning, everyone. Despite a clearly volatile market backdrop resulting from the impacts of COVID-19, our liquidity, core earnings and portfolio performance were strong this quarter, once again demonstrating the benefits of our diverse platform with multiple business lines. Core earnings for the quarter was $162 million or $0.55 per share. However, as I will discuss later, our GAAP results were impacted by the current economic environment and our implementation of the new credit loss accounting standard known as CECL. We do not believe the GAAP charges we took against our assets this quarter are reflective of the credit characteristics of these assets. I will divide my comments this morning into three main parts. First, I will discuss our quarterly results across each segment. I will then highlight several items that impacted our GAAP results, including CECL and mark-to-market, and finally, I will conclude with comments on our capitalization, financing facilities and liquidity. Our performance this quarter was led by our largest segment Commercial and Residential Lending, which contributed core earnings of $148 million to the quarter. On the commercial lending side, despite the increase in our loan loss allowance resulting from the implementation of CECL, we experienced no losses or impairments and the credit quality of our portfolio remains strong with a weighted-average LTV of 61%. In fact, one of the loans we risk rated a five last quarter, which carried a $3 million loan loss allowance, paid off this quarter at par. During the quarter, we originated seven loans totaling $853 million with an average loan size of $120 million. We funded $1.1 billion of loans in the quarter, including $350 million under preexisting loan commitments. We also received $703 million in loan repayments, bringing our commercial lending portfolio to a record $9.5 billion. Also this quarter, over 90% of our domestic floating rate loans had LIBOR floors. For the month of April, we received over 99% of total interest due on our loans with all but one borrower making the required payments. On the residential lending side, we continued our expansion of this business by purchasing $386 million of non-QM loans and completing our sixth securitization totaling $381 million. Our residential loan portfolio ended the quarter with a balance of $1.2 billion, an average LTV of 69%, and an average FICO of 730. Our retained RMBS portfolio grew to $150 million this quarter, consisting entirely of retained securities on our sixth securitization. Next, I will discuss our Property segment, which contributed $23 million of core earnings for the quarter. The assets in this segment continue to perform very well with blended cash-on-cash yield of 14.6% and weighted-average occupancy of 97%. For the month of April, 95% of the total rent due from the tenants in this portfolio was received. The performance of our Florida affordable housing portfolio continues to vastly exceed our expectations. Area median income levels, which govern rents for the over 15,000 units in this portfolio, were recently released. Higher median income for Northern and Central Florida, where this portfolio was concentrated, resulted in a blended rent increase of just under 5%. These rents create a new floor, which cannot decrease going forward. While the increases were released on April 1, we will likely defer them until the impacts of COVID-19 to our tenants can be assessed. As of quarter-end, the properties we owned carried accumulated depreciation of $334 million or $1.18 per share. As we have said in the past, we continue to believe that these assets have appreciated meaningfully since we acquired them and the appreciation is not reflected in our GAAP book value. At a minimum, adding back $334 million or $1.18 per share to our GAAP book value would arrive at a purchase price for these assets. The gains that we believe exist in this portfolio would be an incremental increase to undepreciated book value. Next is our Investing and Servicing segment, which contributed core earnings of $35 million to the quarter. In our CMBS portfolio, we continue to opportunistically sell assets. During the quarter, we sold $21 million of securities for a net GAAP gain of $9 million and a net core gain of $11 million. In our conduit, we securitized $336 million of loans in two transactions this quarter at profitability levels consistent with our historical performance. And in our special servicing business, we obtained five new special servicing assignments with a total unpaid principal balance of $4.2 billion bringing our named servicing portfolio to $94.7 billion. Our fees this quarter do not reflect any impacts from COVID-related modifications, but we have seen a meaningful increase in activity after quarter end, which Jeff will discuss. Concluding my segment discussion is our Infrastructure Lending segment, which contributed core earnings of $6 million to the quarter. We acquired loans of $50 million and funded $48 million under preexisting loan commitments. We also received $78 million from sales and repayments. Our total portfolio stands at $1.6 billion at the end of the quarter, with the loans we acquired from GE representing $687 million of this amount; these loans have decreased 64% since acquisition. We also increased our borrowing capacity by up-sizing one of our financing facilities from $500 million to $750 million, bringing our total financing capacity in this segment to $2.5 billion of which $1.2 billion was drawn. For the month of April, we collected all interest due on the loans in this segment. Next, I would like to walk you through two of the larger items that impacted our GAAP results this quarter. CECL and mark-to-market adjustments, both of which are non-cash and unrealized, combined these resulted in a $0.70 decrease to our GAAP earnings, $0.17 for CECL and $0.53 for mark-to-market and an $0.87 increase to book value per share, $0.29 per CECL and $0.58 for mark-to-market. As we discussed last quarter, we were required to adopt a new CECL accounting standard on January 1 for assets within our commercial real estate and infrastructure portfolios that are recorded at amortized cost. Because CECL requires you to estimate a life-of-loan loss, the forecasted macroeconomic environment is a critical component of the resulting reserve estimate. The environment which existed when we adopted CECL on January 1 was very different than the one which existed at March 31, and that change drove an increase to the reserve. Our adoption on January 1 resulted in a general CECL reserve of $36 million. The net impact of this new reserve and reversal of our prior year general reserve of $4 million was recorded directly against equity. On March 31 while the credit characteristics of our assets had not changed, the macroeconomic environment had changed drastically. That change resulted in an increase to the reserve by $49 million of which $40 million related to commercial lending. Unlike the establishment of the reserves at January 1, these changes went through our GAAP P&L. Next on the topic of mark-to-market, our CMBS and Residential Lending businesses were most impacted by the significant spread widening that occurred at the end of the quarter. There are a few important items to consider when looking at the mark-to-market effect on these assets. As we have said before, ours is not a short-term business model. To the contrary, we intend to hold the vast majority of these investments long-term and unrealized spread marks are not an indicator of value recovery over time. Second, we were not forced sellers of any of these instruments during the quarter and did not realize any losses from the spread widening, which occurred in March. Consistent with past practice, due to the non-cash and unrealized nature of both the CECL and mark-to-market charges we took this quarter, they were not included in core earnings. I will conclude this morning with a few comments about our liquidity, financing facilities and capitalization. We continue to have ample credit capacity across our business lines. We ended the quarter with undrawn debt capacity of $8.6 billion and an adjusted debt to undepreciated equity ratio of 2.1x. As of Friday, we had $870 million of cash and approved undrawn debt capacity. This amount is after payment of our first quarter dividend and after $253 million of deleveraging across our facilities. The deleveraging includes voluntary paydowns on our warehouse facilities, which contain hotel collateral, where we have secured modifications with 94% of these warehouse lenders. The modifications cover $1.4 billion of the total $1.5 billion in hotel assets that we have financed on warehouse lines and relate to $1 billion of warehouse debt on our balance sheet. In exchange for these voluntary paydowns, we have been provided with a margin call moratorium for a minimum of six months after any hotel loan modification. In addition, we have been afforded a suite of pre-approved modifications that we can make to the underlying hotel loans without going back to our warehouse lender for approval. This provides us with maximum flexibility to enter into constructive discussions with our borrowers going forward. And finally, I wanted to comment about the alignment and commitment of our manager to our shareholders. During the quarter, our Board approved a $400 million repurchase program. Pursuant to this program, in March, we purchased 1.9 million shares of common stock with a weighted-average repurchase price of $14.95 per share for a total cost of approximately $29 million. Also with regards to our first quarter base management fee, which totaled $19 million, our manager has agreed to take this amount in stock. With that, I'll turn the call over to Jeff for his comments.

Thanks, Rina, and good morning, everyone. It feels like much more than 10 weeks ago that we last spoke and we hope you and your families are healthy and safe. We closed our offices on March 15, and since then, I've been working alongside other Starwood executives out of Barry's house in Miami. Despite the circumstances, the senior management team has never been more connected, and I am proud of the hours and work the entire organization has put in to optimize our liquidity position, protect our balance sheet, and, importantly, ensure we come out of this period in a position of strength. We are confident enough in our excess liquidity position that we have in fact recently gone on the offensive and begun investing capital selectively at extremely attractive levels. We moved our earnings call up three days this week to provide more information to the market earlier and heard that people think we did so to allow us to come to market quickly to raise capital. That is not our plan. We have no need or plans given our excess liquidity to raise debt or equity capital in the near future, absent an unforeseen opportunity. We have been saying for over seven years that our diversified investment strategy was built to perform well in normal markets and outperform in periods of distress. Q1 gave us both. The strength and quality of our multi-cylinder portfolio has never been more apparent. We have $3.3 billion of unencumbered assets on our balance sheet, which include unlevered loans and securities, and various other sources of liquidity. As Rina said, after paying down our financing lines by over $250 million since COVID-19 and paying our dividends, we have $870 million of cash and undrawn capacity. We are in the unique position of having substantial unlevered assets, equity and property assets and other levers we can pull to create well over $1 billion plus of potential liquidity if needed, adding strength to our already strong balance sheet. Our unlevered loans and property assets can be borrowed again, sold or pledged to delever our warehouse line. Pledging assets would lower our bank lender's LTVs and return cash we have previously paid down lines with. Simply put, while every sub-sector of mortgage REIT faced a liquidity crisis and many of our peers were hours or days away from defaulting on bank lines or selling any assets that they could, there was never a point where our solvency was in question. Although our stock went down with our sector, we believe there are very few of our peers who can say that. Regardless of the pace of credit market improvements, we are prepared to be in position to go on offense. We did not make any distress sales during this crisis and we did not take any losses, which will leave us in position to recover more quickly. Given our liquidity, we have begun to go on offense to invest in loans that are mispriced due to the liquidity crisis in the capital markets. With credit spreads wider and capital more expensive, we do expect loan repayments to slow perhaps significantly. Fortunately, our balance sheet is not solely reliant on loan repayments to create liquidity. In our stress testing, we conservatively moved $2 billion of repayment out of our 2020 forecast, leaving only $718 million or $130 million of net equity being returned to us from our lending portfolio over the next three quarters, which is less than 10% of the $1.5 billion of net equity returned to us in the last three quarters. Even with these conservative assumptions, we are comfortable looking for opportunities to deploy a portion of this excess cash today. We are pleased that the third-party appraisal methodology we adopted with CECL confirmed the credit of our 61% LTV lending book. At 61% LTV and after recent paydowns, our bank lenders' attachment points are significantly below 50% LTV today, lessening the likelihood of margin calls. Pro forma for Q2, construction loans are less than 15% of our Lending segment assets, the lowest they have been in our book in over six years. Since quarter end, we executed on $640 million of off-balance sheet senior mortgage A Note sales, helping reduce our future funding needs by almost 40% from their third quarter 2019 peak. We've talked over recent quarters about how we reduce our warehouse line exposure through A Note sales and our CLO. Less than half of our CRE loans are financed on warehouse lines leaving us less exposed to credit mark. Hotel loans are only 12% of our total assets today and retail is less than 2%. Given our strong cash position, we proactively addressed the uncertainty around our hotel loan exposure by being the first to proactively pay down our warehouse lines in exchange for six to nine month moratoriums on incremental paydowns, allowing us to work with select borrowers on forbearance plans, while giving us confidence in our future liquidity needs. To date, we have reached agreement with 94% of our lenders, and of those agreements, 93% of the voluntary paydowns have already been made. We have some good news to share with you. If you will recall about 18 months ago, we took back two loans secured by industrial properties located in Montgomery, Alabama and Orlando, Florida after Winn-Dixie rejected their leases coming out of bankruptcy. At the time, we told you we were confident that despite taking an impairment that we would ultimately breakeven or make money on those assets. We are happy to report that a high quality tenant signed a long-term lease and moved into the Montgomery facility and we have executed a long-term lease on 100% of the Orlando facility to another very high quality tenant. We will decide soon whether to sell or hold those properties and are in very high cash yields, but expect approximately $80 million, $40 million of which would be a gain on those properties if we choose to sell them. We believe this example highlights the value of the alignment with our manager, Starwood Capital Group, one of the largest real estate managers in the country working together with our large special servicer, who together made this outcome possible. We have approximately $90 million in gains in the LIBOR floors embedded in our loans today, and as the U.S. dollar has appreciated, we have over $50 million of gains on our foreign exchange hedges on our international loan book. We could take those gains to increase liquidity today, but with no liquidity needs, we have not sold our floors or realized foreign exchange gains. Selling would be a call on the future direction of rates or currencies, which is not what we do. Taking those gains today for liquidity would likely lower future returns on those assets by more than the cash they would raise and create more uncertainty around future earnings. We spoke on our November earnings call about the cash management strategy some players in our sector employed to buy Senior CLO or CMBS assets with massive amounts of leverage to earn higher yields on their cash. We said we would not do that, that the assets were near the lowest historic spreads over treasury bonds and that bid-offer spreads can widen significantly as liquidity dries up. In our February earnings call, we talked about being prepared for a capital markets event, significantly reducing our CMBS books and significantly reducing the warehouse line exposure in our CRE loan book. We said that we manage the left and right sides of the balance sheet for a potential credit event if we were to get one. We finished by saying we set the company up to outperform if and when the credit markets deteriorate. They clearly have and we believe we have. On to our property book. Our property book continues to perform well with fair market value gains of over $700 million in mid-teens and increasing cash returns on our invested capital. We are in the process of refinancing our first Florida multifamily portfolio, which will raise $85 million of additional liquidity while lowering our loan rates by 100 basis points today. In REIT, we told you last quarter that we have sold retail-heavy CMBS securities to reduce our non-investment grade CMBS portfolio from 10.5% of our assets to under 5% of our assets, while increasing our named special servicing mandates. Our special servicer has not been busier in the seven plus years we have owned LNR. We have onboarded over 500 loans since COVID-19 representing over $14 billion in assets. Having doubled the amount of assets we are working on, we have repurposed multiple professionals to help the servicer work through this backlog and expect revenue to increase in the coming years. In our Residential Lending business, we completed our sixth securitization in Q1 and expect to execute multiple securitizations in Q2 with expected returns similar to pre-COVID returns. Looking back to the great financial crisis of 2008, loans similar to the 730 FICO, 66% LTV portfolio we have created had losses of less than 1%. Originated residential REITs and banks aggressively sold whole loans in March and April, creating a potential market opportunity for us to add loans with term financing and exceptionally attractive returns. Finally, I want to talk about our Energy Infrastructure Lending segment given the drop in commodity prices. The bulk of our loan book is on power plants that have contracted cash flows that contribute to the repayments of our debt and the plants' profitability is based on the difference between where they can buy gas and sell electricity, commonly referred to as the spark spread. With natural gas prices lower, spark spreads remained significantly above our debt breakeven. All of our loans benefit from strong structural protection and/or financial maintenance covenants to ensure our debt is being serviced adequately. We do not have market price-based margin calls on these loans. Margin calls would require a specific credit event at the project level, typically leading to an acceleration of the loan. We have four financing facilities with roughly $2.5 billion of capacity and $1.2 billion of current utilization. Only $162 million of our facilities are subject to ratings-based margin calls, requiring a two notch downgrade in the credit rating or a commensurate non-market driven deterioration in price of our loan investment. To date, we have not had any of those; none have even experienced a one notch downgrade. The rest of the loans require an event of default or payment forgiveness that is unanimously agreed to by the lender group or a debt service coverage ratio breach. We feel very good about the quality of our book, the return profile of the loans we have originated since acquisition and the stability of our financing. With that, I will turn the call to Barry.

Thanks, Jeff. Thanks, Rina. Thanks, Zach, and thank you all for dialing in this morning. This is a strange process and I know you're all experiencing a strange time. It is odd to be doing an earnings call from your home and with your colleagues at their own locations. I'd like to start my comments. First of all, I know you just heard somewhat exhaustive detail about the plumbing of the company. From the start, we said we'd be transparent. We try to be consistent, predictable, and we built the company to do that. We built the company with multiple business lines with different credit characteristics that would react differently to different times. And it was really when the tide goes out that you see the strength of the platform. And there you can simply look at the cash on the balance sheet, the property book and some of the other incredibly valuable assets this company owns. I wanted to back up and compare this time because I saw what you all saw, which was the comparison of the 2007, 2008 crisis to today, and the fact that commercial mortgage REITs, most of them, blew up in 2007, 2008. One of them, which I actually started Starwood Financial that became iStar, actually survived, but many of them disappeared. If you go back to that time period, for those of you who weren't analysts or even alive, there was negative leverage, people who were lending at 6%, 7% property yields to 3%, 4% and 5%. You also had an undisciplined lending market. You had typically loans 95%, 80%, 85%, 100%, 105% of LTV. It was a totally different time period and the mortgage REIT was constructed totally differently. I want to make sure that we separate the commercial mortgage REITs, which were primarily a commercial mortgage REITs from the residential mortgage REITs today because they have totally different balance sheets, they look totally different, they have totally different risk profiles. Sadly, they're both included in the same ETFs. And so when money swings in and out of the ETFs and mortgage REITs, all the stocks go up and down. To some extent, I'm beginning to feel like the Rodney Dangerfield of commercial mortgage REITs — we get no respect. Going back to what the world was like before. Today, you should start with our LTV. Our LTV actually fell when the CECL rankings came in. It was the first time you had a third-party appraiser come in and look at our loans. If you go back to our third quarter of last year, it was like 64%, and CECL marked them around 59% and this month they went back to 61%. They're still as low as they've ever been since the company was started in the last 10 years of the company, and that was a third-party mark, and what happened there was the shift, as Rina said, to a recession scenario and that created these paper losses in the books, similar to what you saw the commercial banks take. In general though, our marks – I think best-in-class in the industry that's attributed to the quality of the book we have. So what we did, and I should say one more thing. The banks which lend us money against the 61% marks, well their averages maybe 70%, 75% in average, they are less than 50% exposure, something like 48%, 45% exposure LTV. So the banks are super safe. So there's no particular need for them to breakdown their loans or call us on any facilities that they could and they really haven't. We've worked with them proactively to restructure our hotel loans, which we’re, obviously going to have interrupted cash flow, and it's been a very good conversation. The banks have been super supportive. We really appreciate their partnership. And they know we're not their problem. So the company remains strong, and one of our quandaries is showing the strength of this company might actually entice the banks to ask for some of our liquidity, which we are not interested in sharing with them and don't need to. So the first thing you do in a situation like this, which is obviously unprecedented, as you run multiple scenarios on what the future of the company might look like, we pushed back all of our repayments. There were a lot of management had estimated early repayment on so many loans, and now we have almost nothing maturing this year in our forecast and we end the year extremely strong. We halted all of our investments per se, although obviously we had to fund some of our future commitments. Our underlying lending partners funded theirs. And after paying down $250 million of debt facilities, mostly on our securities, we still have over $800 million of liquidity in the company. That's not necessarily good news. Cash does not earn anything in this environment, but that is what we're facing. The tug of war between investing capital and making sure we have liquidity on hand should something else happen, we have to be mindful of. It's also extremely exciting to see all the loans performing and the underlying conditions in the property market in most sectors are okay. The multifamily market, particularly the exposure this company has to the affordable housing sector is fantastic. Everybody paid, and where you see the unpaid is actually the medical office portfolio, where doctors simply went out of business temporarily, but we think there will be no impairment to the future of those cash flow streams going forward. So you batten down the hatches, we test everything you can today. You run all these scenarios and you look then what you're going to earn — sitting with nearly $1 billion in cash is not in the model we had, and I've never run this company this way. So that creates earning scenarios that we have to be careful about. It's not just creating liquidity. We can do that easily with $3 billion of unencumbered assets. The issue is, what are we giving up in the future of the company? And we're here for the long haul. We're not built for a quarter to impress you. We're here to produce earnings that are consistent and an excellent risk reward for our shareholders going forward. I want to stress our business lines are incredibly solid. As Jeff said, the infrastructure business had a great quarter. It has almost no credit markdowns, no rating decreases in the portfolio. Our property portfolio, led by our multifamily, is exemplary. It's been the Rock of Gibraltar, earning a mid-teens return and they cannot go down; the rents cannot go down in the multifamily market. Though, we're going to suspend the rent increases that we're entitled to as we work through the COVID situation with our tenants. Our conduit business is a solid business, but it's no big deal to the company, it securitizes 11x a year. We have always run around $150 million, $200 million of loan balances. We got a bunch done. We have some of these loans on our books. They're small loans. The CMBS business has been shrunk and it provides us extraordinary insight into the capital markets. We've always been in the business. It comes with the servicer. The servicer business is a reverse hedge. We always mentioned this would be a hedge against the downturn, while we have the downturn. And interestingly enough, as Jeff pointed out and Rina, we shifted a bunch of assets over to that side because the servicers now are overwhelmed with requests for forbearance, particularly in the hotel space. The Residential Lending business is a very solid business. We've held one securitization. We hope to get it done later in the year. But holding both the conduit loans and the securitization, the resi loans is actually earnings accretive. We have in place facilities. We can hold these loans. We don't have to rush to market. We don't need the liquidity that we would like to complete these securitizations. And then the large loan lending book speaks for itself. That's a business that is the core of the company, and it has performed exceedingly well, surprisingly well. So I think now you see a situation with our industry, it’s been split between the haves and the wish-they-haves. The people who can go on offense and those that are trying to protect the limited liquidity they have or, in fact, have to reach out to do dilutive deals. We put up our book value every quarter, including our fair value of our assets because we want you to know we've always been dedicated to not issuing equity below book value, and we're not going to do that unless we have an extraordinary opportunity to deploy the capital immediately to something that's massively accretive for the company. So our job right now is to figure out what is in fact excess capital and figure out how much of that we want to invest. As Jeff mentioned, we are looking at an opportunity or several opportunities to have an investment committee call following this afternoon's situation. The opportunity is to put capital out — spreads are wider than we have historically seen and that's obvious right now. There aren't that many transactions, so there's not a flooded situation, but there are several — because we're in multiple businesses, many of these business lines are finding compelling opportunities to put out capital. So we've turned our conduit back on, for example. Now we've given them some capital to go ahead and make additional loans, which will enhance yields or improve the portfolio and the eventual securitization of those assets. We're also looking at a few whole loans in our lending book. And we're also quite excited about the residential opportunities given our expertise in the general distress in the area despite, obviously, the situation on forbearance of mortgage payments that is rolling through the country. So I think we're feeling the book is very safe. And I should talk for a second about the dividends. Our dividend policy will follow the philosophy of safety for the company. Can we earn our dividend? Yes. Should we pay it out? We're going to decide as the future unfolds. So we will wait till June to see how the year looks. What's happened to the return of the economy? How our borrowers are faring? It's going to be a little bit — we don't know, I mean, nobody can really know. Signs are good, and we sent all this cash. So we're going to do the prudent thing, and make sure that obviously as a major shareholder, myself, I would like us to pay the maximum dividend we can, but we are here for the long run and that will be a Board decision. So I want to thank all the people of the company, who are working credibly hard. I mean, you have to batten down the hatches and look through every loan in every corner of the company. Doing this remotely has been a fascinating challenge — even producing your financials for every company in the country remotely has been fascinating. And I want to also thank our Board because the Board has worked really hard with weekly calls as we gave them updates of the situation, and gave us advice on how to navigate this. It's been exceptional. So with that, I think I'm going to stop. It was a good quarter. I think you will see less earnings from us near term, but obviously we can produce earnings anytime we want. We harvest the gains in our books and we've always done that. I was really pleased with the news that a major tenant and tech tenant signed the lease on one of the warehouses. Again that goes to the strength of the platform because we can also play in the equity side. This was a loan we didn't want to take back on two distribution centers, and one was just signed this week with one of the largest companies in the United States, in the world. It should produce approximately a $48 million gain, reversing an $8 million reserve we took against the assets. So $50 million swing plus the basis and the asset, you're talking $75 million, $80 million in cash and an asset that really doesn't have anything to do with our core business, but it's now at least to the long-term at very attractive rates. We think it's exciting for us. We'd love to get back on offense, put everyone back to work, finding great investment opportunities. It's kind of tricky when your stock trades like Rodney Dangerfield, but we're excited and we hope you'll see the power of the platform as we go forward. We'll take questions, operator.

Thank you. Operator provided instructions. And our first question is from the line of Doug Harter with Credit Suisse. Please proceed with your questions.

Thanks. Can you talk about how you're viewing buyback in the context of those opportunities that you mentioned over and above what you did in March?

Obviously, in the world as it was falling apart early mid-March, we suspended the buyback. And again, it all fits together. It's a puzzle. We're keeping liquidity of $800 million. It seems like not the smartest thing to buy back stock and to hopefully wait for the stock to recover on its own. We can't fight these ETFs, and it’s simply just a waste of energy and capital. I think we may be the only commercial mortgage REIT that's bought back stock; I'm not sure of any others that have done so. That's because we come from protecting the book value of the company, and I think we're going to sit for now on that. We're not going to repurchase stock right now, somewhat enticing, but there's — we also have some bonds outstanding that are trading cheap. And so we'd rather, if we could do so, repurchase the debt of the company, which was close to investment grade and now doesn't trade like it. So that's probably something that we focus on first.

Great. And then, I guess the opportunities that you talked about. I guess on the loan side, would that solely be kind of newly originated loans or are there kind of loans in the secondary market that you’d be looking at kind of given dislocations, just kind of the thoughts around that?

Securities, one of the things we're looking at is buying some whole loans, but there are pre-securitization opportunities, and we are looking at some. There will be some people that need to refinance stated maturities, and they'll probably take fairly significant spread widening if you will. I mean the markets are better, but they're not great. And we have urged Congress to do what they did in 2007, 2008 by supporting the investment grade classes of CMBS. So far, they've put in high-yield debt for some reason, but they did not put in investment grade non-government CMBS. They've put the AAAs. As you know, I don't believe that repurchase facilities are even actually activated yet. But I think it would help the property markets if they did include those classes, which they did in 2007, 2008. I think you would see a lot more stability. And the problem in the market as you saw in March was the repo banks and the repo facilities are quite different than the guys who are individually approving loans that go on their credit lines. They're more mechanical in what they do. And we were looking at situations. I mentioned one of them where — our security was 50% of what one of the largest PE firms in the United States paid for the assets not six months ago. And when they told us what they were marking the bonds at, I said, we'll then deliver us all the bonds at that price; we would love to buy them all. And of course, you can't find $5 million worth. They're just artificial marks, and they were driven out of some computer. And any property person in the nation would love to buy the assets at that price, including us. And so it's a tricky time and as you know, as we said, we have less than like — just over a $100 million of debt on almost $400 million of position left in the security suite and we don't believe we have any real issues that are going forward. So we believe that these are good paper. If we have the financial strength, which is weighted out. We had the same situation a couple of years ago where the CMBS book was marked down and it recovered fully and actually went to a gain again. So look, this is going to be different. This is going to be slower. So we do think that the country will open and cash flow will be restored to quality assets in good locations. In the hotel space, the resorts will do better than the big urban boxes and the big convention hotels of either Atlanta or New Orleans or Vegas and Manhattan. So I think our exposure is very little to Manhattan frankly in the aggregate, very little.

And Doug, it's Jeff. I would say that Barry and the Board certainly helped guide us towards what our future will look like and it will look a little bit different. We'll avoid spread mark repo to the extent that we can. There are opportunities in securities on leverage. CMBS BBB for example probably traded at 11%. And as you know, with 300 people at LNR, we can underwrite every loan and every deal, and we've been very successful in doing that. So there are opportunities in securities without taking leverage, but we as an industry will take less spread mark leverage than we have in the past. As Barry said, we have very little left against a decent size book there, so not a place where we're particularly worried. I think when we look to get aggressive on the CRE lending side, you will see us selling more A Notes and using less warehouse as an industry. Our last two earnings calls, we've told you that our company has already done that and we had brought our warehouse exposure down significantly below 50% of our book. I think before others did and I think you'll see others join that where we all try to sell more A Notes and have less potential credit marks in an unknown world. So our playbook will change a little bit, but we have the resources to do it and these are things that we've been doing for a long time.

Thank you. Our next question is from the line of Rick Shane with JPMorgan. Please proceed with your question.

Hi guys. Thanks for taking my questions this morning. I think we’re right now in a situation where you've got long-lived assets that are facing somewhere between three and six to nine months of revenue compression. I'm curious given your multi-pronged approach, does it make sense in that environment to move more towards ownership as opposed to being a lender? And will there be opportunities there for you?

Thanks for the question. You started within the REIT owns about, I think, 15,000 or so apartment units and overall 80,000 apartments. So our collections have been — I think 97% in our portfolio. So I'm going to first object to the tenure that our revenues are compressed because in what we own in the geographies we own. We don't own anything in New York City. We don't own anything in the West Coast of California, where compliance and the politics are different. And in our portfolio — and the REIT is in Florida, almost exclusively, in Northern and Central Florida. On the office side, I think 94% or 95% of our tenants have paid. The real weakness in the office side is from some shared office operators as you would think. In our experience, one of the large operators paid in every location but one and we're negotiating that one. So office has held up pretty well. Again, it obviously depends who your tenants are. We don't have any of the airlines as tenants. And in our portfolio, we're not seeing any major issues, and Rina mentioned that. And again, when you're 60% LTV, borrowers are going to try to pay you if they can. And if they don't, we probably would like to take the property back. But that's not our core business. I don't think given the uncertainty in the markets, hotels are zero cash flow right now, and they are all largely shut. Actually it's not quite true. The very low end of the market is actually doing fine. We have a chain of hotels that is running 80% occupancy. It's at the low end of the market, called InTown Suites. That's quasi apartments. That's why it kind of trades like that. But for the most part, hotels that are closed, our portfolio, I think, most of the hotels are closed. That ramp will be interesting. All the borrowers are working collaboratively with us and the underlying lenders are working with us because it's nobody's fault. We would like to own these hotels if they were economically attractive and it made sense for our strategy. If they give us the keys, I suppose it'd be okay taking them. But that's not really what we're trying to do. We're not trying to be vultures to our own borrowers. Industrial — we don't have much exposure to it. It will be an interesting asset class. It will be a bit of a minefield. I think it's always had a strong run, but companies like Crew or J.C. Penney filed — you can imagine their distribution centers might be stressed. If nothing else, we're going to negotiate the rents down just like they will in the mall or High Street retail. So I think industrial, with the explosion of e-commerce, will remain attractive. The residential markets, I think, we're pretty careful about where we're buying or where we're taking on loans and obviously trying to avoid the very low end of the market. Right now, the average non-QM loan size tends to be larger than conforming loans. So I think the long way of answering, I did it because I thought I should give our perspective on the market. We're really focused on the equity side when we buy assets on replacement cost and making sure it's our relevant replacement cost. The asset has real value and we can buy it really cheaply. We've been through, I've been through, sadly I'm older and I've been through four cycles. I started in the RTC days, and we had the best returns ever back then. We made a fortune coming out of the 2007, 2008 cycle. I was running Starwood Hotels through the dot-com bust and then 9/11. So I've been to this movie before. There's no question the U.S. will recover. It's just a question of when and how fast? And it's a linear line between now and the vaccine. I'm optimistic. I think as you've seen — I said World War III for 90 days on CNBC in mid-March and we're about halfway. It's really ugly, but when it's really ugly, it's a good time to invest. They don't ring a bell, and we're going to — we've got Board approval to make investments. So we will put money to work and I say the returns on the deals are probably significantly higher than we would have seen historically. So be very choosy on what you invest in. Make sure there's no downside. The money you put out is the only money you could put out. You won't have a capital fall of any nature ever. And you're in a very attractive rate of return on your equity investment. So we're not in the business of doing equity deals in the REIT aggressively right now. The transaction market is frozen. Buyers are not selling assets at prices you and I would want to buy them. So not yet. That's why some of these markdowns or these pricing in some of these securities are, frankly, out of line. If a bank would let you cover, even in retail, even in the most distressed markets like malls, most of these assets can cover debt service. They just can't mature. Nobody will lend you the proceeds that the original loan was at. But you can produce 2% all-in costs and 2.5%. You can cover a lot of sins, and that's what happened in 2007, 2008. The blend and extend became the mantra of that time. You might not see the kinds of fire sales that you saw in prior crashes. Right now you can have the same outcome and we can cover debt service or borrowers can get forever. But we would like to redeploy capital into new opportunities to better spread. So we think it's an interesting time where we actually have to be selective. We are one of the 'haves.' We're not one of the 'wish we hads.' We're not restructuring the company. We don't need outside capital. We even heard a rumor we accelerated earnings because we were going to go raise money; that is not true. We accelerated our earnings release because we wanted to tell you how well we were positioned. That was the entire reason we did it. We've never done it before and we just wanted to share the good news.

And Rick, I would say specifically about properties: with low to mid-teens available yields at 70 LTV lending and very little transparency on cap rates in high-quality assets that we would buy, plus the fact that cap rates are relatively low still and our financing costs would go up on those, I just don't think you can return double-digit yields today versus where our dividend yields are. The property segment probably is a hard place for us to add in the near future.

Thank you. The next question comes from the line of Don Fandetti with Wells Fargo.

Hi, good morning. It's definitely good to see you guys having made the right moves to get to the other side. Wanted to see, Jeff, if you could talk a little bit about the hotel loan portfolio. Are the majority of the owners just prepared to sort of dig into their pockets for a few months? Is it kind of playing out like you thought? And can you give us a sense on how many of the loans have been modified? Obviously that's proprietary to some degree, but can you just give us a sense of that?

Great. I think I have Mark Cagley on the line, who is our Chief Credit Officer. One of the main things that we look at is the sponsor capability and their financial condition when we go into a loan and we have some very well-heeled sponsors on the hotel side and on other sides of our business. We expect them to pay at a much higher rate and to avoid special servicing and avoid forbearance and other things. And then you have some properties where you certainly need to work with people. And we've been fairly open about that. We were very quick to call our repo lenders and cut deals where we got ourselves six to nine months to be able to allow borrowers who needed the help into forbearance, come up with a plan together as their partner and try to figure out a way that we could all come out on the other side. We did that. We paid a decent amount to do that, but it gave us the ability to sleep very well at night by the fact that we have nine months to work this out. And it gave our borrowers opportunity to get into loans the way that they wanted to. You look to our downgrades this quarter and it sort of speaks to what happened in hotel. We had a fairly significant number of loans downgraded. We moved $940 million worth of loans…

Yes, before Mark does it, you can't say a hotel loan got better, right. So I couldn't say they had improved. We moved them for internal risk management. It doesn't mean we think they're permanently worse; it's just for our own management and reserves.

I apologize Barry. On our one through five rating scale, where we start a loan at a three and they generally tend to stay there, we have very little in the four to five buckets. We moved some loans out there and we moved them because we have a very quantitative way of thinking about it between sponsor capability and loan structure, that's about 40% of the risk rating we internally give ourselves. But the other two pieces — loan collateral performance relative to underwriting and the quality and stability of project cash flows — those are about 60% and clearly on hotels, those two pieces of the ratings had to change because of what's going on with COVID and the fact that they just don't have revenue because they're not open. So we used it as an opportunity to move a few ratings worse. We think these are ratings that we will move back the other way when these hotels open up again or be consistent with the guidelines that we've set up for ourselves. We wanted to make sure that we did that and that's the vast majority of what we moved was on the hotel side.

This is Mark Cagley. In our hotel loan portfolio, about half of the loan portfolio in terms of number of borrowers have asked for some sort of payment relief — speaking glass half full, that means that half of them have not asked for that and are planning to and continue to make full interest payments on the loan. We have no borrowers whatsoever that we plan to completely waive all interest payments on. So we're working our plans with those borrowers to make partial payments and potentially defer partial payments, but then there will be a cash flow sweep until it's repaid as things rebound into the market. Our borrowers have been universally committed to support their properties and to put equity in and to use resources and use PPP funds to support the assets as we've tried to figure out what's going to happen for the next three to six months with these assets.

I'll note that all but one of our roughly 120 loans in the CRE lending book paid their debt service payments in April.

Okay. Thank you.

Our next question is from the line of Jade Rahmani with KBW. Please proceed with your question.

Thanks very much. Good to hear from all of you and I hope you're all doing well. I've gotten a lot of questions about the company's liquidity position over the last month, as you can imagine, and just going through details for example, the unencumbered assets. I was wondering if you could provide color on the billion of additional liquidity that you cited. What does that consist of? And on the unencumbered assets, how does that break out between senior unlevered positions and subordinate positions? How much of the unencumbered assets can actually be tapped if necessary?

Thank you, Jade. We used the number a little bit over $1 billion because we felt like we have a decent amount and more than that. Our property portfolio alone at our current mark, if we were to liquidate or monetize parts of our property portfolio, could create over $1 billion on its own. In addition, we mentioned the ability to monetize LIBOR floors and unwind FX hedges. Those could create well north of $100 million. We have other unencumbered assets that could create over another $100 million. We have assets we could sell — we talked about the two industrial properties and another industrial property that we could sell. All in, you get to over $1 billion with just the property portfolio and everything else is above that, over and above the $870 million of cash and approved, but undrawn capacity that's still on the balance sheet today. So we felt really comfortable that if we had to, we could make the moves. Those are not moves that we’re jumping into making. We certainly have looked at levering some unencumbered assets over the course of the last month and a half. And we've done that in a few instances, but we haven't made any panic moves, and as Rina said, we haven't sold any assets at distressed prices to create liquidity in an emergency because we haven't felt like we're there.

Okay. And then secondly, can you touch on, just your broader expectations in terms of commercial real estate prices, maybe specific to the hotel space. Do you have a view on how much values have declined or would you say it's too early to tell?

It's way too early to tell, Jade. It depends on the asset and the market. For example, the casino hotels in Las Vegas will be among the slowest to recover. A resort hotel may come back more quickly, particularly if it's smaller and higher end. If you ran the math broadly, you might estimate values are down 10% to 15% in many markets. One of the dynamics as a property investor is that rates are going to be lower for longer than pre-COVID, which supports property values because the income yield is scarce in this world. The key underwriting concern is direction and timing of rent and cash flows. If the country doesn't open, these assets will struggle. Real estate taxes and insurance costs haven't dropped even if values have. Municipalities are not giving broad waivers on taxes. Workers and operating costs remain. I think unions and operators will need to adapt to help hotels operate at lower occupancy levels. In many non-union markets, operators will find ways to lower breakevens. Full service hotels will have declines in some revenue streams like banquets until events return, but room revenue can be optimized. Overall, it's a mixed picture and highly dependent on local demand, union structure and the speed of economic reopening.

And I would add that hotel borrowers that had CARES Act support and interest reserves have had more tools to weather the storm. There are opportunities and complexities, but the financing structures often provide paths to manage these temporary cash flow issues.

The next question is from the line of Stephen Laws with Raymond James. Please proceed with your question.

Hi, good morning. The dislocation that's out there and everything that we're all seeing, can you talk about any opportunities that may present to, in the past, you've obviously acquired LNR. You've moved into single-family rental, non-QM resi, a number of things you've tried to acquire CreXus. Is there anything out there that either due to the higher relative stock multiple or just simply attractive business lines you think fit that you're revisiting now that maybe more attractive given what's going on and cheaper to add that to the Starwood platform?

Sure. We're looking all the time. We have to do a relative value trade. We're trading at roughly 0.7x book — we can't issue stock meaningfully below book unless the opportunity generates very high returns to offset dilution. There are companies and product lines we'd like to look at, but we must be prudent. Transaction volumes are down significantly and many sellers are not yet willing to transact at prices we'd accept. There are opportunities, but we have to preserve liquidity and not overcommit. If something attractive appears that fits our return thresholds and preserves downside protection, we would consider it. But for now, the market is a bit frozen and we remain selective.

Yes. And then as a quick follow-up, I think in the prepared remarks, you guys mentioned in the discussions on the hotel financing you had gotten a list of some pre-approved modifications that they're okay with. Can you give some examples of what those modifications are that you're able to offer that have really already been addressed by your counterparties and just kind of any examples of those?

Sure. Mark, do you want to go through the types of modifications you've been dealing with on the hotels?

High level, Steve, the forbearance or payment modification framework has been central. We're discussing use of FF&E reserves in certain cases where the brand allows deferment of required FF&E contributions; if a property is newly renovated or doesn't need those reserves in the near term, we have approval to use some of those reserves to fund operations. We're not eliminating any LIBOR floors and we're not forgiving interest. So it's generally approval to close hotels temporarily, use of FF&E reserves, deferral or partial accruals of payments with cash flow sweeps when operations recover, and modifications to certain loan covenants or extension tests to give borrowers room to ride out the near-term. We're trying to keep these modifications shorter-term — 90 to 120 days — so we can reassess as the operating environment evolves.

And I'd add that we are not giving full accruals broadly. We're looking for borrowers with equity and capability to support assets. We're making deals that preserve long-term value and protect our balance sheet.

The next question is coming from the line of Steve Delaney with JMP Securities. Please proceed with your question.

Good morning, and congrats on a strong report given this environment. A bit surprised by your remarks about the opportunity in residential. The Fed has not put AAA RMBS in facility programs yet, and we've seen a lot of problems in warehouse financing. So I'm just curious, Jeff, if you could comment on what's working for you and do you think that you can see a securitization getting done in the next three to four months? Thank you.

Thanks Steve. Yes, I do. You're going to have a CMBS deal later this week. You'll probably have a couple more in a week or so. So we think that capital markets are starting to come back. Talking to our bankers and bond buyers, we think there's a very good chance we could get a non-QM securitization done in the next month or so. We don't need to. We have terrific financing lines that we actually earn as much or more leaving them on. Our goal has always been to reduce those and we think we're a month away from being in the market in a pretty accretive way. The playbook will be more plain vanilla: avoid mark-to-market leverage, do fewer warehouse financings and more A Notes or term financing. If we can get term financing, non-recourse, without mark-to-market until securitization, that's very interesting. So I think you'll see opportunities and we could execute non-QM securitizations in the near term if market technicals cooperate.

The next question comes from the line of Tim Hayes with B. Riley FBR. Please proceed with your questions.

Hey. Good morning, guys. Thanks for taking my question. Just a quick follow-up on Steve's question there. I know that you were under contract to acquire an originator. Can you just remind us where you're at in the process there and what type of capital outlay that could entail and is that still on track to close?

Sure. From a capital perspective, it's not going to change anything materially. It's a relatively small transaction. We've been working with the seller for some time and we'll continue to work through it this quarter. There's no great rush to get over the finish line. We have some things to work through. When we do close, it will not be a major capital difference for us. We're taking our time given the market conditions.

Okay. Got it. That's helpful. And then just one quick, one more for me. You noted Jeff just added resources at LNR given how busy that platform is right now. Should we expect to see the increased staffing there weigh on earnings near-term, and what level of delinquencies would really need to see for those fees to meaningfully increase?

I would say the increased staffing may slightly weigh on near-term earnings, but we expect increased earnings over the next few years as our special servicing activity generates fees. We mentioned onboarding over 500 loans representing over $14 billion in assets. Those fee opportunities ramp over time, not in a single quarter. Having a large team allows us to repurpose professionals across the organization to support servicing. The revenue upside will be multi-quarter and multi-year as the servicer works through these assets. Also, to be clear, special servicers in CMBS are not typically on the hook for servicing advances in the same way mortgage lenders are, so there's no direct liquidity risk tied to special servicing activities for us.

One thing I'd add: servicers get paid more when there's work to do on defaulted loans and when loans are resolved or assets sold. Approving forbearance itself is not a massive fee event; the larger fees come with resolution, workouts and eventual disposition. So it's early in the lifecycle and not a massive windfall yet, but an important and growing stream.

Thank you. Our final question is from the line of George Bahamondes with Deutsche Bank. Please proceed with your question.

Hi. Good morning. I just had a follow-up for Mark or anyone on the team. Are you guys able to disclose the number of borrowers in the portfolio who have asked for interest deferral, forbearance or other loan modifications?

We typically don't disclose borrower-by-borrower details, but Mark can give some high-level percentages across the portfolio.

Yes. In the hotel book specifically, roughly half of the borrowers have asked for some sort of payment relief. Broadly across the total loan book, round numbers: approximately 25% of the total loan portfolio have asked for some sort of modification; of those, about half have asked for some deferral or accrual of interest. So in total, roughly 12% to 14% of the total loan portfolio may have some form of temporary payment deferral or accrual. We are not giving full accruals broadly and we expect borrowers with material equity to support their properties. These are round numbers and we'll continue to monitor and update as things evolve.

Great. Thanks for the color there Mark.

Thank you. At this time, I'll turn the floor back to Mr. Sternlicht for closing remarks.

Well, thank you everyone. I'm glad you could join us today. I hope we provided some clarity to you and we appreciate your support and interest in the company. Again, I want to thank all the people at Starwood Property Trust. We've done virtual gatherings, and in a strange way, we're better together. We're getting through this, and I look forward to a $25 stock price. Again, thank you very much for being with us.

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