Starwood Property Trust, Inc. Q4 FY2020 Earnings Call

Greetings. Welcome to the Starwood Property Trust Fourth Quarter and Full Year 2020 Earnings Call. At this time, all participants are in a listen-only mode. Please note this conference is being recorded. I will now turn the call over to your host, Zach Tanenbaum, Head of Investor Relations. You may begin.

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 December 31, 2020, filed its Form 10-K 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.

Thank you, Zach, and good morning, everyone. Before I walk through our financial results, I wanted to briefly comment on our non-GAAP earnings measure. What we used to call core earnings is now called Distributable Earnings or DE in order to more accurately describe what this metric represents. While the term has changed, the calculation has remained the same. You will find additional disclosures about this non-GAAP measure in our 10-K. Despite the volatile market backdrop caused by COVID, the fourth quarter capped off another successful year for us with DE of $0.50 per share for the quarter and $1.98 for the year. Throughout 2020, our liquidity and capital deployment were strong, which would not have been possible without the strength of our balance sheet and our diverse platform with multiple business lines. Even after $4.6 billion of capital deployment, $3 billion of which occurred during COVID, and after early retiring $500 million of unsecured debt, we maintained an average cash position of over $700 million post-COVID.

Thanks, Rina. I want to start today with a couple of non-market related topics. Transparency and investor reporting are at the core of every decision we make. We are proud to have been recognized by NAREIT as the recipient of their Gold Star Award for Excellence in those areas in each of the last seven years. In March, we will release to our website a virtual Investor Day webinar that Zach and the entire management team put together that we hope will explain exactly what we do as investors across seven businesses in more detail than we’ve ever gone through in the past. We look forward to sharing that with you, and we’ll send a press release when it is uploaded to our website. Also, on our website is a discussion of our corporate ESG initiatives. I want to highlight a few things you will find there that we are very proud of. 43% of Starwood Property Trust employees identify as female, and 49% of employees identify as racially diverse. Each year we strive to increase our diverse talent pool, and for 2020, we continued that trend with 52% of hires identifying as either female or minority. We are a top 10 owner of affordable housing in the United States with over 35,000 residents in our Florida multifamily portfolios. In our non-QM residential lending business, with over $5 billion of capital deployed since 2016, we are a leading provider of mortgages to high-quality borrowers who otherwise struggled to secure access to housing credit. Our energy infrastructure lending business has financed over $800 million of renewable energy assets since our purchase in 2018, generating 7,900 gigawatt hours of energy and avoiding 7.4 million tons of CO2 emissions. Finally, we are also proud to have issued our inaugural $300 million sustainability bond in Q4 backed by eligible green and/or social projects.

Thanks, Jeff. Thanks, Rina, Zach, and good morning, everyone. I don’t know how to actually handle this call. I’m so excited about the year we had and even more excited about the future of the firm. When we created this company 11 years ago, we were a $900 million pile of cash. Now, we’re an $18 billion balance sheet with 300 extremely talented people and a best-in-class Board of Directors. Our business model and diversified finance strategy showed strength as we continued to do what we do. It was a remarkable year for us. When the pandemic hit, every person here manned their station and as the smoke cleared, we decided to go back on the offense. Our balance sheet allowed us to capture extraordinary opportunities. One trade we made in our residential business yielded us nearly $50 million pretax with no capital deployment needed. We completed the second-most probable securitization in the company’s history in the fourth quarter, followed by a significant securitization earlier this quarter. We made the decision to maintain our dividend while ensuring our company’s financial health. Our loan-to-book value remains strong at 60% and our dividend yield remains attractive. Overall, we’re positive about the company’s future and our ability to navigate challenges in the market.

Thank you. Our first question comes from Steven Laws with Raymond James. Please go ahead.

Hi, good morning. Jeff, I wanted to start off really with your comment in your prepared remarks about the earnings growth that can be generated organically. Can you talk about that building off another roughly $2 per share of distributable earnings this past year? What’s the capacity to deploy capital and the return suite we should think about on that deployment as you think about where you’re putting money to work today?

Yes. Thanks, Steven. Great question. I think from an earnings growth perspective, there are a few ways you can do that. One would certainly be unlocking gains in our property portfolio and redeploying those gains. That’s something we’ve been working on. Another way to grow earnings is to deploy more capital. We’ve been very defensive, but we're moving to our front foot now. For every $100 million of capital we deploy at a 12% return instead of paying off a bank line at a 3% return, we can add $9 million a year to earnings, which translates to $0.03 per share. So certainly, bringing our cash balance down is a goal during this year as we gain confidence coming out of COVID.

Great. And as a follow-up, I wanted to hit on the energy infrastructure. Congratulations on getting the first CLO done. When you look at the origination pipeline and returns on new investments, how does that change the ROE equation and the amount of capital you’re looking to allocate to that business?

Yes, it’s massive. If you remember, we bought a lot of lower coupon loans and they were financed on warehouse lines at decent rates, but overall ROE was low. Post-CLO, we think there’s an opportunity to earn mid-teens in returns on our best CLO executions and we plan to open up the gates for more capital going into that business.

The stabilized returns on our residential business and the energy business are higher than in the large loan real estate business. The CLO has made our returns even higher. We have some complexities in our real estate loans that we’re underwriting and we believe that our total IRRs are significantly higher than what we’re currently able to report. There is great potential for us to grow those businesses.

Our next question comes from Charlie Arestia with JPMorgan. Please go ahead.

Hey, good morning guys. Thanks for taking the questions today. You’ve laid out the platforms that have grown and diversified, which obviously paid off this year. Looking ahead to 2021 and beyond, do you see Starwood being active in M&A or any other channels to further diversify that platform?

Yes, we are currently working on a few things in the M&A world. There is at least one business line that we're working to enter that we've pursued unsuccessfully for about four years. We’ll continue to explore opportunities that could further diversify our business and align with our strategic goals.

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

Hi, good morning. A couple of things; one, it’s good to see the stock almost back to pre-COVID levels. I guess two questions; one, around hotels and macro, Barry, do you see a big pent-up demand snapback for travel in the U.S.? And are you guys interested in expanding in residential mortgage origination?

I think there is pent-up demand for leisure travel. Our hotels in high-demand markets are proving to be profitable. Urban markets, however, are more difficult due to reliance on business travel. Regarding M&A in residential mortgage origination, we do have an originator on contract and its approval has taken longer than expected.

To clarify, we made a preferred equity investment in a mortgage originator about two years ago. We're awaiting regulatory approval for that investment to convert into common ownership. This process has been lengthy, but we’re optimistic about its completion.

We do aim to grow our residential business and we'll work hard on this front, whether through loans, securities, or origination capabilities. If we maintain current returns, we believe we can achieve good results from our efforts.

The quality of our equity book is robust, and we're exploring various ways to redeploy capital effectively. We want to ensure our decisions enhance shareholder value and the company's long-term success.

Hey, good morning guys. Congrats on a really strong quarter. Can you provide an update on monetizing parts of the real estate portfolio and any timing for that?

Sure. We have several assets in our portfolio that we’re evaluating for monetization, including some substantial properties. We will look to execute on these opportunities while ensuring they are beneficial for our shareholders. We believe that our multifamily low-income housing tax credit portfolio could be particularly valuable and worth exploring for interest.

Ultimately, we want to manage shareholder capital wisely. If it economically makes sense to sell a minority interest in our portfolio to unlock equity for reinvestment, we’ll aim to do that. Our assets have significant hidden value that we can leverage for future growth.

I’m curious about the outlook for commercial real estate credit. Do you believe the worst is past, or should we expect more challenges?

In general, I think real estate credit has stabilized. However, I do anticipate distressed assets towards the end of this cycle. Markets in urban centers are facing significant challenges, and we must be cautious with our underwriting in those areas while pursuing opportunities elsewhere. Thanks, everyone for giving us your time today and again, thanks for the incredible efforts of the Starwood Property Trust team in making this a great year. I am optimistic about what we can achieve in the upcoming year, so stay tuned.

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