Starwood Property Trust, Inc. Q4 FY2022 Earnings Call

Greetings and welcome to the Starwood Property Trust Fourth Quarter and Full Year 2022 Earnings Call. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Zach Tanenbaum, Head of Investor Relations for Starwood Property Trust. Thank you. 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, 2022; filed its Form 10-K with the Securities and Exchange Commission; and posted its earnings supplement to its website. These documents are available on the Investor Relations section of the company’s website at www.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 on this conference call. Our 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 Chairman and 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. Our unique multi-cylinder platform once again demonstrated consistent performance with distributable earnings or DE of $161 million or $0.50 per share for the quarter and $726 million or $2.28 for the year. Undepreciated book value ended the year at $21.70, up 26% from two years ago and up 5% over last year driven by NOI growth in our 15,000 plus unit Florida affordable housing portfolio, which I will touch on later. In 2022, we completed $10.7 billion of new investments across businesses with initial fundings of $9.3 billion and follow-on fundings of $1.1 billion. Against that, we had repayments and sales of $3.7 billion, including $1.9 billion from commercial lending, securitization proceeds of $3 billion and newly issued corporate debt of $1.1 billion. We continue to have significant liquidity with $1.1 billion of cash today, $250 million of which we will use to repay our convertible notes maturing on April 1. We also benefit from excess unencumbered assets and gains within our property portfolio, both of which can be utilized to create additional liquidity. I will start my segment discussion this morning with Commercial and Residential Lending, which contributed DE of $172 million for the quarter. In commercial lending, we originated $266 million of loans, including a $112 million loan on an industrial build-to-suit that is pre-leased to an investment-grade tenant. This brings our full year originations to $5.3 billion, of which 56% was multifamily and industrial. At quarter-end, our aggregate multifamily and industrial exposure is 39%, which is nearly 3 times the pre-COVID level. Our predominantly Class A office exposure continues to be just 23% of our commercial loan book, which is down from 29% a year ago and 38% pre-COVID. In 2022, we received $362 million of office repayments. And subsequent to quarter-end, a $92 million office loan in Canary Wharf, London, repaid early, further reducing our office exposure today. During the quarter, we funded $84 million of new loans and $395 million of pre-existing loan commitments, which were partially offset by $301 million of loan repayments. This brought our loan portfolio to a record $16.8 billion, up 18% year-over-year, with 99% positively correlated to rising interest rates. Company-wide, inclusive of floating-rate assets and liabilities in all of our business lines, a further 50 basis point increase in base rates would increase annual earnings by $19 million or $0.06 per share. On the CECL front, we increased our general reserve by $27 million in the quarter to a balance of $94 million or just over 0.5% of our commercial lending portfolio. In looking at credit performance and the adequacy of our CECL reserve, one of the key indicators of future loss is historical experience. Unlike our peers, our model focuses more on this actual historical loss experience as well as property type and LTV, while placing no emphasis on the more subjective internal risk ratings. To that end, we had no new specific reserves in the quarter. However, we downgraded 4 office loans totaling $724 million from a 3 to a 4 in the quarter, which Jeff will discuss and one $42 million retail loan from a 4 to 5 million, bringing our total 4-rated loans to $872 million and 5-rated loans to $287 million. We are confident in the underlying real estate and ultimately believe these assets are fully recoverable. During the quarter, we foreclosed on a 5-rated $245 million first mortgage loan related to an office building in L.A., which Jeff will discuss in more detail. The property was recognized at the carryover basis of our loans and we have in-place financing on the asset totaling $117 million. In our Residential business, we acquired $745 million of loans, including $713 million of agency investor loans that we discussed last quarter, bringing our on-balance sheet portfolio to $2.8 billion. As prepayments have slowed, we recognized a $17 million GAAP mark-to-market increase in our retained RMBS portfolio this quarter, bringing the balance to $423 million. We have previously discussed our equity interest in a residential mortgage originator. During the quarter, we exited this investment, resulting in an $11 million GAAP and DE loss. Next, I will discuss our Property segment, which contributed $17 million of DE to the quarter. Of this amount, $9 million came from our Florida affordable housing portfolio. For GAAP purposes, we recorded an unrealized fair value increase related to this portfolio of $68 million in the quarter or $555 million for the year, net of non-controlling interest. The value was determined by an independent appraisal which we are required to obtain annually. The implied cap rate is consistent with our prior valuation. In our Master Lease portfolio, we recognized a 10.6% increase in rents effective October 1 as part of the 5-year contractual rent bumps in this portfolio. This will result in $2.8 million of higher rental income annually. Next, I will discuss our Investing and Servicing segment, which contributed DE of $31 million to the quarter. Our conduit Starwood Mortgage Capital completed 1 securitization totaling $93 million in the quarter, bringing our total volume for the year to $1.2 billion across 9 securitizations. In our special servicer, we obtained 4 new special servicing assignments totaling $4 billion during the quarter and 27 assignments totaling $24 billion during the year bringing our named servicing portfolio to $109 billion, the highest level since 2017. Our active servicing portfolio declined slightly to $5.4 billion as $700 million of resolutions were offset by transfers into servicing of $300 million. And on the segment’s property portfolio, this quarter, we sold 1 asset for proceeds of $37 million, resulting in a net GAAP gain of $25 million and a net DE gain of $23 million, once again demonstrating the embedded value of this portfolio, which has been a source of consistent and recurring gains across cycles. Concluding my business segment discussion is our Infrastructure Lending segment, which contributed DE of $18 million to the quarter. We acquired $76 million of loans in the quarter, bringing our total volume for the year to $726 million. Funding totaled $68 million with repayments and sales totaling $75 million, keeping the balance of the portfolio consistent with last quarter at $2.4 billion, which was 97% floating rate. I will conclude this morning with a few comments about our capital markets activity and capitalization. We continue to focus on non-recourse and non-mark-to-market financing, with 88% of our outstanding financings not containing spread marks, which are solely based on market events. During the quarter, we issued a 5-year $600 million sustainability Term Loan B at SOFR plus 325. This is in addition to our ATM capital raises early in the quarter where we issued 750,000 shares of common stock for gross proceeds of $16 million at an average share price of $21.17, bringing our full year ATM issuance to 2.2 million shares or $49 million at an average share price of $22.72. We continue to have ample credit capacity across our businesses ending the year with $8 billion of availability under our existing financing lines, unencumbered assets of $3.9 billion and an adjusted debt to undepreciated equity ratio of 2.5x. With that, I will turn the call over to Jeff.

Thanks, Rina. We strategically built our business over the last 14 years to perform well in normal markets and outperform in volatile ones. Higher leverage would have created higher earnings in normal markets, but our focus has always been on tail risk and dividend sustainability. We have held the line on very low leverage, diversified both sides of our balance sheet and added a special servicer that makes more money in times of distress. This model has proven itself through cycles with $1.5 billion or $5 per share in harvestable gains in our owned property portfolio; we have significantly grown book value, yet our stock has lagged with our sector. On average, our stock has traded at 123% of book value since inception, and today, we trade below 90% of book value. Given the significant rise in base rates this year, the market’s focus is clearly on credit and specifically on office credit. As Rina said, we have reduced our exposure to office loans from 38% to 23% of our CRE lending portfolio since COVID, but since we have other investment cylinders on our balance sheet, Lending segment loans on office make up only 13.6% of our assets, which is by far the smallest percentage of our peers and a fraction of most of them. One would expect lower office exposure to require lower reserves in the current environment, and that is the case again this quarter. Other than our previously disclosed $4.9 million reserve on the entire balance of a retail loan in Chicago, we have no asset-specific CECL reserves today. With $1.5 billion in harvestable property gain over 15 times our cumulative model-driven CECL reserve, we are the only mortgage REIT with multiples of cushion to cover potential losses should CRE markets weaken from here. We have re-underwritten our portfolio multiple times in the past few months to ensure we maintain significant liquidity to both run our business and to be able to go on offense as markets stabilize. We aren’t dependent on raising incremental capital in the next year even after the cash repayment of a maturing $250 million convertible bond in April and a maturing $300 million unsecured bond in November. Our ability to earn our dividend also doesn’t depend on raising incremental capital. As spreads and rates normalize, we will continue to monitor the capital markets for capital raising opportunities to execute on the very accretive investment opportunities we see today, and we will continue to optimize our existing investments by rotating credit and sectors as we always have. In the fourth quarter, we invested $1.2 billion, which is a fraction of our multiyear run rate, and we expect to maintain this defensive posture in the coming months. Credit spreads have begun to stabilize since peaking in early Q4. And once longer-term credit spreads stabilize, we expect to resume our run rate investment base. We have produced significant gains on assets we have taken into REO since inception, proof that scale and experience matter in volatile markets. We will again use the experience of our manager, Starwood Capital Group, and our 350-person dedicated team to execute on our liquidity enhancement strategies this year. Resolving our REO and non-accrual loans and reinvesting that equity into new current-pay assets is management’s greatest focus and doing so successfully as we have in the past will increase earnings by over $0.20 per share annually. Without the benefit of any reduction in drag or realizing any recurring nonrecurring gain, we project we will continue to earn our dividend each quarter this year in our core businesses alone. I want to spend a minute on our REO and newly downgraded position. As Rina said, we added an REO asset in the quarter, having taken title to a vacant office building in downtown Los Angeles during the quarter. We are working through several non-office redevelopment scenarios and are in discussion with a number of interested parties to redevelop with us or sell the property to. We talked previously about an office asset we foreclosed on in the Galleria section of Houston, an area we believe is better suited for residential use than office use. Since we last spoke to you, we have executed a purchase and sale agreement at our loan basis with a third party for a residential conversion, and we will keep you updated on progress in future quarters. Finally, in the quarter, we began selling the 21 units we own in our Upper West Side condo conversion called the Chatsworth, which shows tremendously. We have put 2 units under contract since quarter-end at pricing in line with our expectations, and we expect that exposure to shrink this year. Risk ratings can be very subjective, and we cautiously downgraded 4 office loans to a 4 rating this quarter due to pending maturities but did not take any asset-specific reserves as we believe them to be fully collectible. The assets are in Brooklyn; Washington, D.C.; Orange County, and Houston. All of these borrowers are large institutional real estate investors, and we are working with them to find the best solution on each. In all 4 cases, their sponsor fund-related reasons they may be unwilling to support the assets if they can’t stabilize them this year. Against that, we feel secure at our basis in Brooklyn due to having significant excess loan collateral. D.C. is a great candidate for resi conversion, and we are already in discussions with third parties at our loan basis should we get control of the asset. And in Orange County and Houston, the assets are being marketed, and the sponsor has received or we expect them to receive bids at or above our basis. In residential lending, we have stopped buying loans. We exited our small preferred equity investment in a mortgage originator, and we saw securitization spreads begin to normalize in January. Banks have become very competitive funding unsecuritized residential loans, and we expect to close on new financing facilities at materially better financing terms in the coming months. As Rina said, our securities book has performed well as prepayment speeds have slowed helping to offset below-target returns on our unsecuritized loan portfolio. We continue to add to our energy infrastructure lending portfolio in Q4 and Q1 at above-trend risk-adjusted returns. When we go back on offense, I would expect we will invest more heavily in this attractive lending segment. Finally, we have talked about the earnings power of our special servicer in times of distress. As Rina said, today, we named special servicer on $109 billion worth of CMBS, up from $68 billion just 4 years ago. Maturities will start picking up this year and going forward, as we are now past the 10-year anniversary of CMBS 2.0 or post-GFC loans. And if markets continue to be volatile, this could produce significant earnings for our company in 2024 and beyond. With that, I will turn the call to Barry.

Thank you, Zach. Thank you, Rina and thank you, Jeff and good morning, everyone. Welcome to our earnings call. Thanks for being with us. I usually start with the economy, and those of you who have seen me on TV, I’ve been fairly aggressively trying to get the Fed to stop raising rates and let the impact of what they have done, the largest increase in rates, the fastest increase in rates in the history of the country, coupled with the balance sheet reduction, coupled with the OCC telling most of the banks to cut back lending and shrink their balance sheets, has created incredibly tight conditions. And I saw a report this morning that construction in the U.S. has dropped 27%. That’s commercial construction. Obviously, single-family homes have fallen off a cliff. And when we complete this wave of construction, I would expect many projects to get tabled. When we look back at the great financial crisis and where job losses were, they were really in two categories: manufacturing and construction. And if you look at manufacturing, which is about to go negative, you will get some of the job losses in manufacturing. Construction will be a tug of war between commercial projects ending for private developers and whatever it is the government gets their act together to spend their $1 billion infrastructure budget. So that can be a little harder, which is one of the reasons I wonder where the Fed is going to be effective, knocking jobs off without actually destroying real wages and real jobs across the service economy. During ‘07, ‘08, ‘09, actually education and healthcare went up. So you can’t change that with interest rates. So the only place that really hurt the economies in the service sector, which would be retail, travel, airlines, and things of that sort. Business services already let go 400,000 people, but you see the first and the largest dichotomy between unemployment claims and job layoffs. And it’s never happened before, but this has been a white-collar recession. All these people are getting unemployment benefits, and you’ll see these numbers show up when the unemployment benefits, which could last as long as 6 months from tech companies, actually come off. I think the economy, you’re seeing the numbers from Target and growth from retailers, and yet you see these retail prints. I think that was clearing of inventories in January because, obviously, everybody wants to restock for the summer. People forget that because of inflation when you’re getting a retail number up 3%, it’s actually down 2% because prices are up 6%. So you’re getting a nominal growth, but you’re not getting unit volume. Eventually, the unit volume will fall further than the price increases, and you’ll see those let up. The other thing I think about inflation, which will definitely head south, as I said, and we’re just waiting for these rent data to fall into the CPI. And that’s the single reason the government was so late raising rents, when rents were up 13% to 20% in the United States. It wasn’t in the Fed CPI numbers because of the delay in their reporting. And now that rents are falling, they are still having them rising. It’s black and white. It’s not – it’s a fact. I don’t know why they choose to do that for one category with such a lag. But eventually, we expect – I’ve said inflation could actually go negative – it will depend on other categories right now, I think, given the world complex. The reopening of China is great. I don’t expect it to be super inflationary. Basically, it will help the supply chain and finish when you’re building a building, and you can’t get the dishwasher you need, all the components of the building there. If 80% of the supply chain is fixed, you need 100% of the supply chain to be fixed to actually get things done on time and on budget. So I wouldn’t call that in and of itself necessarily inflationary, but actually, you could argue it’s deflationary. If demand comes down, the supply increases, prices will fall. And that really goes to the structure in the company, and that’s why I set it up that way. Let’s talk about the real estate landscape for a second. It is a bit of a minefield. You can’t really tell looking at companies in private or public today what’s going on exactly in these companies because many of us have floating rate debt, which is fantastic. Our earnings are going up with floating rate debt. Our borrowers, most of whom have caps in place and can pay us until the loan maturity. And also, you’ll see the key is the asset class they have, of course, and what’s happened to rents and the time we made those loans, or we, as an industry, made loans and the banks, I’ll include the banks and the insurance companies in this. And then, of course, what they can refinance that, and where the spreads are, and where rates are. So in general, this probably is as good an opportunity to put capital out as it was in 2009 when we started Starwood Property Trust in a way, I wish we had a $900 million blind pool that we had in 2009. We’ve never seen spreads like this. Construction loans, I was in Washington the other day, and I was driving near a site and driver told me that they made a loan on a hotel at SOFR plus 950, a new construction loan at 60% of cost. It’s 14% for new loans. I mean I’d love to own the hotel at $0.60 of construction costs. I back up the truck, end up empty the kids’ trust and make that loan today. Many of the companies were not – are not in a position to do that right now. We’re mostly paying defense and picking and choosing where to deploy the capital. But we can’t wait to go back on offense. And we will as soon as we see the landscape clear and the Fed basically says they are done. And what we expect to be a recession comes into place, forcing the Fed to probably lower rates. I saw a report yesterday that once they are done, as rates fall 200 basis points, it’s probably been pushed off a quarter or two because there are some remnants of rolling strength in the economy, but I still expect it to happen in the fourth quarter. So let’s talk about the asset classes for a second. A multifamily, which has become a bigger and bigger focus of our firm and our lending book, is going to go through a little – multifamily will be halted until not only your cap rates up because of financing is way up, the ability to get financing construction loans has gone. You already have a 1.7 million housing shortage. So short and long-term, you’re going to see rents – they are actually – headline rents are going down, but in-place rents are going up because it’s the gap in these buildings in our portfolio alone on the loan book, Jeff tells me our rents have increased more than 20% since we started making those loans. So they will hit their stabilized yields, we think, fairly quickly. I would be delighted and sad, but delighted if we take the multis back because the long game for multi is excellent. There is no ChatGPT issue going to attack the residential sector. And because housing single-family home supply is going down, single-family construction costs are going up, interest rates and the cost of owning a home are going up, it makes rental homes that much more attractive. Long-term, the asset class is solid as a rock. And the values will be supported by over $250 billion of capital at single-digit rates to buy multis. So the issues in other asset classes are going to help the multifamily asset class. People will run to it as a safe haven and away from things they can’t really understand or underwrite or they can’t get loans for. The multifamily sector, of course, is supported by Fannie and Freddie, where spreads today are available like 200 over. Fixed-rate debt is pretty cheap, 130 to 150 over, and that actually total cost of funds or fixed-rate debt is lower than floating costs at today. So, if you want to park some money away, if you’re a high net worth or in a family, it’s an interesting place to invest even into the softness of the market at the moment. We make no doubt about the Wall Street Journal, of course, writing 6 months after we talked about it, the supply has been evident. It’s coming through. It’s class A stuff. They are charging a fortune or trying to get the fortune in the B class assets will have a longer runway than the A class, which we will fight against each other and compete and probably – but will ease up because of the shortage of supply. Industrial has been a great market, going to a good market. The market is bifurcated again. The markets remain occupancies across the country; remain solid big boxes are bonds. So if you have an Amazon 15-year lease, you don’t have steps; your bond has negative convexity, and the debt on industrial is not supported by a government agency. So it’s under more pressure from a cap rate perspective, but having the most solid and the strongest income growth of any asset class at the moment. You do wonder how that – if that slows down, which inevitably should, and pricing has been under some strain. The office markets, you have a tale of two worlds, which is everything but the United States and the United States. Everywhere but the United States offices are leasing. I just – we have some investments in Europe, particularly in Germany. The vacancy rate in Berlin is 4%; in Munich, it’s less than that. Rents are up; in Munich, by 12%. If you look at Asia, the Middle East, Korea, Japan, Australia, people have gone back to the office. It is a U.S. phenomenon probably led by the tech sector, which has created this unusual situation in U.S. office. And in the U.S., you have a tale of two cities. You have newer buildings and class A buildings leasing and everything else emptying. It’s almost a one-for-one switch. So if you are in the A sector, you’re doing okay. You probably were just renewing a lease in probably the worst office market in the United States is to start with Capital Group lease. We have 10 buildings to choose from, A quality in San Francisco, and they are not lowering their rents. I was incredulous. I mean I can’t believe it. It’s like a 40% vacant market, and we have to pay more – much more than we’re paying today to be in the best buildings; there is very good demand for high-quality assets. And there is no demand at all for other assets. Over time, these buildings will be converted to other uses. They’ll become green silos in cities, or waste lands, indoor parks. I don’t know what will happen to them, but they will be removed from the stock unless people really go back to the office in a big way. I personally like being in the office. I don’t like working from home, but most of the younger generation actually likes working from Jackson Hole and Montauk. So I think that’s going to change in a recession. It has been easier for people to fire people that are not in their offices. You obviously don’t see them; you’re not attached to them, and they aren’t exactly raising the banner for the company and making it a great place to work. So I do think that will change. Having said that, the office markets are the toughest; it’s only 13% of our overall asset book, a little over 13%, as Jeff mentioned, which I think might be the lowest of any commercial mortgage REIT out there today. And we made that switch long ago, and as you know, we have almost no exposure to New York or for San Francisco to speak of in that portfolio, which has been two of the toughest markets. Interestingly, the red states – the Austins, the Nashvilles; that’s not a state; the Texas; Tennessee and Florida research triable – a part those markets have performed pretty well and continue to not only hold their occupancies better; there is fewer subletting. They continue to attract space, and there is some net positive absorption in these cities. So, you’re going city by city as you’d expect, and there is still a migration of people out of the blue states to the red states where there are no trade unions; it’s the right to work; obviously, there is no income taxes, and that will continue for the office markets. Hotels have been incredibly strong. One of the things you all know how much you’re paying for your hotel rooms, but you don’t pay attention to is the hotel industry is missing almost 25% of its workers that it used to have in 2019; the rates are higher, but the workers aren’t there, so the margins are really good. Your service is probably not as good as it was. You should bring your own sheets to a hotel today because we’re not going to change them for you. That may change in January; half of the jobs added were in the hospitality industry. There are 250,000 jobs in the hospitality industry that went away – a long way back to hiring the people that they couldn’t hire. But the debt markets are a mess; nobody wants to lend against hotels, which we would be delighted to step into that vacuum. It’s an asset class we obviously know very well. I’m not sure anyone has made more loans or bought more hotels than Starwood Capital Group in the last 30 years. And those are really the major groups. Data centers continue to be strong. We have credit issues you have to watch. The key is that this is probably the best lending environment we’ve seen since 2009. Lease has increased 3 or 4 times during the last 12 years of our existence. If we’re 13 yet or still – 13.5. We’ve moaned and groaned about too much competition; this is not an issue today because the lenders, the banks are on the sidelines; insurance companies are actually filling the void, but playing at low leverage. Given our background and credit, our knowledge of the markets, our real-time data from a $120 billion asset base, we feel we could deploy capital extremely well and incredible spread in this market. But we’ve always not issued equity below book value. If we were above book value, we love, we think we can make extraordinary loans today with a credible risk-reward characteristic. But at the moment, we’re going to play defense and make sure we have the liquidity to handle anything that comes our way as we navigate through this unusual situation that the world finds itself in. What we’re doing here is really running multiple scenarios, which is we do nothing. Virtually nothing; we can earn our dividend earnings doing almost nothing, which is phenomenal and probably shocking; we have surprising to me at least. But it’s primarily because the floating-rate book is carrying the firm and the loans. We always got repaid, and not getting repaid is actually a good thing because we don’t have the downtime; the money doesn’t go into cash; we’re earning the coupon, and they get paid currently. The other thing we’re doing is how do we get focus on turning the asset base over faster to look at things that are not earning their keep, and we’re earning, I would say, a 7 on the situation can be deployed at 14; maybe we sell the 7 take whatever small loss or might be to redeploy that capital in 14. The last thing, of course, is to get the unproductive assets from our book out, whether it’s the buildings in Houston or the Tower in Los Angeles or the Chatsworth apartment; they are not contributing anything. They tie up capital in them; they are a source of equity for us. We could sell additional liquid – we can create additional liquidity by selling additional interest in the Woodstar portfolio, our multifamily assets, if we wanted to. We have not really wanted to do that. We have lots of ways to create liquidity for the firm on top of the $1.1 billion of liquidity we sit on today. So I think we’re excited about the opportunities. We’re cautious about the environment. It’s nice to have a special servicer; they are the largest in the country; they will continue to perform and is a hell of a hedge against everything else going on in the world. They have unparalleled knowledge both in the CMBS markets and of the loan book. We employ something inside the firm, something like 16 people in IT who run the databases that power the LNR service business. We have information that is mind-boggling, and it’s been accumulated over 30 years. Actually, the head of servicing has been here 30 years and he’s one of the original employees of our company. They do an amazing job. I think it will be an amazing opportunity for him to grow and add additional earnings to the company in the foreseeable future. The worse it gets, the better their life will be and the more they’ll learn. Today, we are roughly, I think, a third of what we earned in the peak in ‘07, ‘08, something like that. So there is good upside, hopefully, for that business, which is not – is a pure ROE business. It doesn’t deploy any capital, raises the ROE of the firm, and hopefully, we will see positive things. So we don’t want to get too good because obviously it’s probably bad for the loan book if it’s too good. I think we’re positioned to take advantage, and what we’re looking for is to signal from the Fed that they are done. I think the first thing that happens is spreads come in. AAA is the 200-plus over is an anomaly. It should not be that way. That fear in the market; there are tons of capital out there; it runs the equity market. I do think the equity markets are a bit ahead of themselves. You can see the speculation creep back in with AMC and Bed Bath & Beyond and all these companies they get rated by the guys I thought were dead. Immune stocks show up again; that is not healthy. We want these markets to settle down and be driven on fundamentals on a growth potential; really, a fundamental analysis of the future and the cost of capital of equity and debt normalizing. I do think we can get back to 3% inflation. I’m not sure we can get to 2%. I don’t know how he could actually try to hold the number like that, you’re really going to just crush the economy, and then try to balance to the 2% inflation; that would be the visitor, couldn’t do that. I am not even sure the lords themselves could actually make that happen. We have a great balance sheet today, a great fortress balance sheet. We’ve worked hard over the past decade to expand our CLOs and our balance sheet debt, not repo debt. We’ve done pretty much what we could do to sit in a really excellent position to prosper into the future. We’re all hands on deck. Everyone’s committed. We’ve got a great team, a great Board, and a great shareholder base, and thank you. We will take questions.

Thank you. Our first question comes from Doug Harter with Credit Suisse. Please go ahead with your question.

Thanks. I’m hoping you could touch on – you talked about not being interested in selling down Woodstar. But I guess just curious, given your comments that this is a sort of a lending opportunity, what’s your appetite or willingness to sell down Woodstar to raise additional funds for lending opportunities?

Yes. We could do it. I mean, actually, you were talking about it yesterday in a different situation. One of our clients has come to us for a separate account to buy affordable housing. Of course, we want to go to the two institutions that took the interest first. It hasn’t been – we don’t need a ton of excess liquidity, but we’d love to have it to deploy. I think my number one source would be taking the condos and Chatsworth forgetting about the book value. We probably are right around realizing prices consistent with where our marks are. There are other assets that we’d like to move on and just redeploy the capital first. Woodstar is like selling gold. Don’t forget in affordable housing, rents can’t go down. So – and all this building, none of it’s affordable. So there is no risk of not being 100% full or virtually full. The only question is what rents are going to be, and they can’t go down. We have attractive debt in place. It’s always something you can sell. When we bought those, I took the – I literally said this is what I want to own in my kids’ trust accounts. As you know, I’ve never sold a share of stock in 13 years of Starwood Property Trust. I would love to own that stuff. Should we sell another 20% and raise a couple of hundred million bucks? Yes, maybe we will do that. I mean we will look at other things. We can move some of our residential assets that aren’t yielding that double-digit return of everything else. We are hedged on interest rates, but the market has gotten a little better in the non-QM book. It’s too big at the moment, and we know it’s too big. That would be a place that has less – it may be a shame. The markets will rally when the world gets better, but if you can earn 14% and you are selling 7%, and you get a couple of years, you can quickly make up for any deterioration in the book with great earnings power. It would be nice to – now don’t forget, some of the stuff, if you go to a 14% or 13%, as soon as the rule gets better going to try to refinance you. So, that’s also kind of a trick. We have to be careful. Because we will get the book back more 14 per year, and then everything will be liquid against, which is not great. It’s a balance, and the good news is we have so many ways we can deploy capital. I didn’t say it, but the energy infrastructure, energy lending has been extraordinary. It’s probably the highest returns on equity we can get today. I keep killing deals, transactions, and investments just because I want to maintain our liquidity right now. But it’s probably – maybe it’s an overabundance of caution, but I am very worried about that and them doing the exact reverse of what they did during the pandemic, which is keeping fiscal policy too stimulative or their policy too stimulative over and now they will do the opposite: they will tighten too long, and when it’s evident it will be too late; they won’t be able to correct it. They will cause real pain. I go back to wage growth; it’s good inflation; we should applaud wage growth and be patient. Everything else is bad inflation. So, we want wage growth. It isn’t about killing wage growth; it is about killing commodity price inflation, which really came from dislocations in the supply chain and throwing trillions of dollars to consumers that went out and spent because they had nothing else to do. They sat home, bought everything they could buy. We all know it; we all try to buy a couch, we tried to buy a chair; we tried to buy a desk. You want to buy a golf cart, a golf bag, you couldn’t get anything. Watches, used cars, everything went in sync, and now they have reversed. I just think we have to be careful. We have chosen really to our dividend. I get letters from shareholders complementing us on our dividend. They count on us in their retirement accounts, and Woodstar provides a great amount of safety, and a very consistent and growing cash flow stream to help us support the dividend. It doesn’t come without a cost because we marked up the book with the sale. It actually went up. The third-party appraisal took it up based on NOI increases, which were substantial. We could sell it and probably have a little gain; I would think I realized the gain again. It’s all gain. We will look at it. We are turning over; nothing is not available to be sold.

Great. Thanks.

Thank you. Our next question comes from the line of Stephen Laws with Raymond James. Please proceed with your question.

Hi. Good morning. Kind of a follow-up on the Woodstar, and Rina, you touched on this a little bit, but can you talk about – I think you mentioned the rent increases. I’m not sure if that was trailing or as we look forward. But when you think about AMI and CPI, when do those numbers come out? I believe it might have been last year in May that drives the forward increases that roll through. And how should we think about that given we continue to see strength in Florida, as you guys mentioned about the red states in your prepared remarks?

Yes. Hey Stephen. Thanks for the question. They will come out again in April. As usual, they will have a 3-year look on CPI and maybe the income. We know those inputs for the next couple of years look really good. So, for the next few years, we feel really comfortable that we are going to continue to see rent increases, but the new data will come actually in April.

We actually expect that number to be north of 10%, if the government changed their calculations on this. They would notice the number can exceed 10%, which is unbelievable. So, that will be the strongest sector in multifamily, and affordable housing will be driven.

I think it could be higher depending on the portion that’s coming from the local income growth. So, like I said, it keeps on giving.

So, it’s a strong market there. One quick follow-up, Jeff, could you talk a little bit about the Washington, D.C. office asset? It looks like the maturity in early Q4. I know you guys, I think have 4-rated, but correct me if I am wrong there. But can you give us a little more detail and update on those conversations and how you expect the resolution or payoff together?

Yes. So, there was one that I spoke about earlier, which is not the other asset that we touched there. So, there is one that you see in our deck that’s a 2023 maturity. We are working with the sponsor right now to potentially extend that asset into late ‘23, early ‘24 and get a pay-down. There is another asset that I spoke about today that is a 4-rated loan, if that was your question. And that’s a downtown asset. It’s 370,000 square feet office asset with a GSA tenant; the good news is it’s completely vacant with that GSA tenant leaving, and we think it’s a really good candidate for residential conversion. We haven’t taken the asset back yet. The sponsor is still touring some potential GSA tenants. But if they strike out and we take it back, we think there will be a lot of interest to convert this asset to residential, and we are in significant discussions already at our basis to do exactly that. One of the difficult things sometimes is emptying these buildings out for residential; you obviously have to have the right floor plan; you have to have the right center – core; you have to have the right size, floor plate; you have to be in an area that’s desirable for residential; that this one sort of checks all of those boxes. Along with our Houston asset that we are working on a residential conversion, we think these are two really prime examples of what can happen in the office space when the office market pulls back, and residential is a better play. So, we are optimistic that there is a better play on that one to move forward if they don’t clip a GSA tenant before the maturity this year.

Great. Appreciate the color there, Jeff. Thank you.

Thank you. Our next question comes from the line of Jade Rahmani with KBW. Please proceed with your question.

Thank you very much. Just in terms of the outlook on commercial real estate credit overall, trying to understand how nervous or worried you are about the environment, and also about the Starwood portfolio, and hoping you can comment on each separately?

I mean the fundamentals of real estate, as you can see from all the equity REITs are okay. It’s the issue of spreads rising and rates rising and what the impact is on cap rates. Different asset classes, cap rates are expanding at different levels, different amounts. A lot of – as you may know, there is a lot of stuff that isn’t being sold because people expect if they don’t have to sell, they won’t sell. It’s a little like even though it’s not the GFC, it mirrors that in the sense that there is a big bid-ask spread between buyers and sellers. Everybody doesn’t want to have to sell today isn’t going to sell. If there is a sale, it’s pretty much a distressed sale. A loan is coming due. You’re going to give the building back to the lender, which in this case is to us. To see an institution, a household name institution hand us back a building in D.C. that had a third of it was equity is kind of shocking actually. But I think in the office sector, it is really tricky. Loans are almost 10% today, probably SOFR plus 400 to 500, 600. It depends on what the building is. If you have a cash-flowing hotel, you can get a loan; maybe it’s 400 over, which is 8.5%, close to 9%. But if you don’t have a cash-flowing hotel, you are going to see – but you think you can turnaround, it’s going to be significantly wider than that. Lending – lenders are scarce. They are not looking to put out capital. Now that makes the environment tricky. I mean bigger quality borrowers are able to borrow. Many banks are shutting down credit to smaller players. The Fed has no idea, it seems, what’s going on in the commercial real estate markets. It’s not – it’s tricky; there is no doubt, and we are all doing the best we can. Long-term, we are going to make more money in this environment; that’s the funniest thing. We are going to make more money because our new loans will be better. If we get these buildings – any of these buildings back, getting back that building in Washington, two-thirds of the – we land like 60%, like 62% of cost. Our basis is fantastic, right? So, we are the Saudis in that market. We should be able to convert that building to a residential in an attractive basis. But we will pick and choose how we deploy capital, and ultimately, I think we will make more money on these investments we have for the last 13 years. As Jeff is proud of saying all the time, all of our foreclosed real estate, we have sold in the aggregate of profit, significant profit to the value of the loans that we put in place because we are an equity shop too, and we are used to taking assets back, fixing them up and selling them. The REIT has done an amazing job with that. Even buying assets from the trust and from the loan book, it’s been an incredible source of earnings for us for 13 years. I expect that would continue, and you get it significantly cheaper than the last guy who was a smart person who bought that building or built it expecting a sort of a different outcome, of course, we will see how it plays out.

Hey Jade, I want to jump back to Stephen’s question for a second because now I am realizing what you guys are seeing on Page 13 that’s up, but on Page 13, the first asset, the largest asset in our office exposure, which is what I think you were talking about. That’s a tremendously well-leased, 93% leased 10-year weighted average life of lease term, excuse me, $313 million loan, and that will pay off in October of this year. That is a very strong asset, I think probably risk-rated too for us. The ones I spoke about were the North Carolina and Virginia, where we think that there will be a material pay-down or potentially a short extension. Again, I talked about the 4-rated loan when I was talking about the conversion to resi. But I don’t want anyone to think that the largest loan in that bucket is in anything but really good shape.

Okay. Thanks for taking that clarification. It’s good to know that, because I did get some questions on it. On the LNR side, I wanted to ask about if there is an opportunity to broaden the scope of business to do special servicing loan workouts, portfolio consultations to others away from the CMBS market because the fixed-rate nature of that business means you probably won’t see an uptick in special servicing fees until probably 2024 and beyond. So, in the meantime, there is all these capabilities; why not put them to work?

I mean, the fundamentals of real estate, as you can see from all the equity REITs are okay. It’s the issue of spreads rising and rates rising and what the impact is on cap rates. Different asset classes, cap rates are expanding at different levels, different amounts. A lot of – as you may know, there is a lot of stuff isn’t being sold because people expect if they don’t have to sell, they won’t sell. It’s a little like even though it’s not the GFC, it mirrors that in the sense that there is a big bid-ask spread between buyers and sellers. And everybody doesn’t want to have to sell today isn’t going to sell. And if there is a sale, it’s pretty much a distressed sale. A loan is coming due. You are going to give the building back to the lender, which in this case is to us. To see an institution, a household name institution hand us back a building in D.C. that had a third of it was equity is kind of shocking actually. But I think in the office sector, it is really tricky. Loans are almost 10% today, probably SOFR plus 400 to 500, 600. It depends on what the building is. If you have a cash-flowing hotel, you can get a loan; maybe it’s 400 over, which is 8.5%, close to 9%. But if you don’t have a cash-flowing hotel, you are going to see – but you think can turnaround, it’s going to be significantly wider than that. Lending – lenders are scarce. They are not looking to put out capital. Now that makes the environment tricky. I mean bigger quality borrowers are able to borrow. Many banks are shutting down credit to smaller players. The Fed has no idea, it seems that what’s going on in the commercial real estate markets. It’s not – it’s a tricky environment, there is no doubt, and we are all doing the best we can. Long-term, we are going to make more money in this environment. That’s the funniest thing. And we are going to make more money because our new loans will be better. But if we get these buildings – any of these buildings back, getting back that building in Washington, a two-thirds of the – we land like 60%, like 62% of cost. Our basis is fantastic, right? So, we are the Saudis in that market. We should be able to convert that building to a resi in an attractive basis, but we will pick and choose how we deploy capital. Ultimately, I think we will make more money on these investments we have for the last 13 years. As Jeff is proud of saying all the time, all of our foreclosed real estate, we have sold in the aggregate of profit, significant profit to the value of the loans that we put in place because we are an equity shop too and we are used to taking assets back, fixing them up and selling them. The REIT has done an amazing job with that. Buying assets from the trust and from the loan book, it’s been an incredible source of earnings for us for 13 years. I expect that would continue, and you get it significantly cheaper than the last guy who was a smart person who bought that building or built it expecting a sort of a different outcome, of course. We will see how it plays out.

It’s something Barry has been pushing us on for a significant amount of time. We actually have an active search out there for the right person to lead that. We have a deck all put together on all the different services that we can do out of LNR. As you said, we have tremendous capabilities from valuation on down. We will be out with a business plan on that, and there will be an employee of ours knocking on doors that insurance companies and banks and others to create fee-based revenue from our capabilities in LNR in the next six months; I promise you.

I am smiling. We have been talking about this for 3 years, so maybe longer. But there is no reason we can’t be a fighters in the service to people. I am not sure anyone being the largest in the nation. I don’t know if anyone has the credit that we do in the space. We are the highest-rated servicer by multiple agencies. If you are picking the best and an experienced group, and we only do it for ourselves, which seems like a mistake. We will hopefully have an opportunity to make some serious money. It goes to our book value. We are not unlike everyone else in the industry. We are not just a collection of loans. We have a team of 300 people that run six different cylinders for us. We are really a company in the form of a REIT. We are a lender; we could be a bank. It’s really an interesting thing. We are different than everyone else in the sector on the purpose, and we can deploy capital to any one of these leads, as you know. The idea was not to have to force one, and if there was nothing to do. It is interesting in overriding that we will earn the dividend; we think. We are confident we can probably earn the dividend and make no new – virtually no new investments, which is something that I find is surprising and good news. We have to work the balance sheet. We get paid to do that. We are going to do that. That’s really the right side of the balance sheet; the side where the assets are liabilities, which is we decide where the assets are. I wasn’t it very good at accounting, but I can’t add.

Thank you. Our next question comes from the line of Don Fandetti with Wells Fargo. Please proceed with your question.

Hi. Can you talk a little bit about how you are balancing a willingness to work with a borrower as their rate cap expires or whatever the other event is versus just kind of playing hardball and saying, you know what, we wouldn’t mind owning this asset because we think this is temporary, the Fed will cut outside of office? Like how are you thinking about that sort of those two scenarios?

I will turn it to Barry, but it depends a lot on how we have it financed and how our senior partner, whether it’s a bank or a CLO, what they want us to do or require us to do, whether they are forcing us to have a new rate cap bought in, what strike that new rate capacity brought in, they are very expensive as you know, or whether they will allow us to take interest reserves or other guarantees towards that. With our premier borrowers, we are certainly open to talking about the different potential solutions in a very difficult rate cap environment. But a lot of times it’s set by where our senior lender requires us to do, and we will hold the line to what the senior lenders do. Our senior lenders are tremendously important to the success of the business. Barry, anything to add to that?

Not really.

Yes. And I guess my follow-up is on the infrastructure portfolio. Are the caps – the interest rate cap similar where almost all the loans have them, and they are protected? Can you talk a little bit about that relative to CRE loans?

Yes. These are probably syndicated loans that some – that do and don’t. But for the most part, they do have very similar – I will get you the exact numbers on after this on exactly what percentage do have them. Broadly speaking, it is more protected than not, but I will come back with the exact numbers on rate caps there.

Okay. Thanks.

Our next question comes from Rick Shane with JPMorgan. Please go ahead with your question.

Hey. This is A.J. on for Rick Shane. First, just on the loans that were downgraded, I know there are no specific reserves on those assets today. But if any of those loans don’t work out, would we see additional reserve build, or is that already included in your December 31st reserves, and we would just see kind of a shift from general to specifics?

So, they are part, A.J., of the general reserve currently. So, it would probably be two-fold. If there was further deterioration in the asset, you would have a transfer from a general reserve to a specific reserve, and it would be increased at that point.

Okay, great. That’s helpful. Thank you. And then you said there were sponsor fund-related reasons for the office downgrades. I mean is there anything you can share with us that what are the reasons sponsors going to want to support the assets?

It’s a fully invested fund in a few cases. And in a case, there is a large fund that is leaving commercial real estate and they are not putting more money in. It’s different in each one. I think you are seeing a similar trend where a lot of people either don’t have the cash available today or are unwilling to. These are more scenarios where they don’t have the cash available in the specific funds that the assets are owned in to be able to continue to support the project. These are opportunities where if we do step in, they tend to be more accretive to us where we do have the capital to be able to continue.

Great. Thank you.

Thank you. Ladies and gentlemen, this concludes our question-and-answer session. Mr. Sternlicht, I will turn the floor back to you for any final comments.

Thank you, operator. Thank you everyone. Thanks for your questions, and we obviously are here to be transparent and welcome your questions, and the team is available. So, thank you and have a great first quarter. Stay warm. Bye.

Thank you. This concludes today’s conference. You may disconnect your lines at this time. Thank you for your participation.