Starwood Property Trust, Inc. (STWD) Q4 2012 Earnings Report, Transcript and Summary

Good day, everyone, and welcome to today's Starwood Property Trust Fourth Quarter and Year End 2012 Earnings Conference Call. [Operator Instructions] As a reminder, today's conference is being recorded. At this time, I'd like to turn the call over to Mr. Andrew Sossen, Chief Operating Officer and General Counsel. Please go ahead, sir.

Thank you, Melody. Good morning, everyone, and welcome to Starwood Property Trust's earnings call. Earlier this morning, we released our financial results for the quarter and year end December 31, 2012, and filed our Form 10-K with the Securities and Exchange Commission. These documents as well as our quarterly supplement 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 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 Chief Executive Officer; Stew Ward, the company's Chief Financial Officer; Boyd Fellows, the company's President; and Mike Berry, the company's Chief Accounting Officer. With that, I'm now going to turn the call over to Stew.

Thank you, Andrew, and good morning. This is Stew Ward, the Chief Financial Officer of Starwood Property Trust. This morning, I'll be reviewing Starwood Property Trust's fourth quarter and annual financial results for 2012, and we'll highlight several noteworthy items pertinent to the fourth quarter of 2012, the first quarter of 2013 and our overall business. Following my comments, Barry will discuss current market conditions, the state of our business, our impending acquisition of LNR and the opportunities we see as we look forward. For the fourth quarter of 2012, we recorded -- we reported $64.5 million of core earnings, 10% above core earnings of $58.8 million recorded the prior quarter. On a per-share basis, we earned $0.48 per diluted share. Core Earnings for the year totaled $228.3 million or $1.99 per diluted share, an increase of more than 50% on a dollar basis and a 17% increase on a per diluted share basis over the 2011 levels of $146.6 million and a $1.70 per share respectively. GAAP net income for the fourth quarter was $56.3 million, a 12% increase over the prior quarter's level of $50.2 million. This represents 42% -- $0.42 per diluted share, roughly in line with the $0.43 per share of GAAP net income reported for the prior quarter. As of December 31, 2012, the fair value of our net assets was $20.57 per diluted share. As of the same date, GAAP book value per diluted share was $19.90. Both of these figures are above the September 30 levels of $20.13 and $19.56, respectively, and represent the highest quarter end values for both measures since the inception of the REIT. These increases are primarily the result of the increase in asset values associated with the continued tightening of credit spreads that began in earnest more than a year ago and the accretive impact of our October 2012 equity rate, which was completed at pricing well in excess of both booked and fair value per diluted share. Now let me outline some other significant details for the fourth quarter and 2013 to date. The fourth quarter 2012 was an incredibly busy period for us from an investment perspective, with new investments totaling an excess of $1 billion. The highlight for the quarter was the October core origination of a $475 million first mortgage and mezzanine loan secured by a redevelopment project in Times Square. We discussed this transaction at length on last quarter's call. By quarter's end, we had also originated or acquired an additional 12 commercial real estate loan assets totaling an additional $493 million in funding commitment, bringing the company's commercial loan new business totals for the quarter to $760 million, by far our biggest quarter ever. During the quarter, we also made significant additions to our portfolio of single-family home and nonperforming residential loan assets, bringing our total investment in the sector to $170.3 million, representing over 1,300 housing units. With the addition of these commercial and residential investments, our total investment portfolio stood at $4.1 billion on December 31, $1.3 billion larger than at the same time a year earlier. We expect this portfolio of commercial real estate debt assets to earn an annualized leverage return between 11.7% and 12.2%, and think our single-family residential strategy will generate similar returns when mature. As we've said in the past, but continued to be worthy of mention, we think this represents compelling risk adjusted return for investors in light of the portfolio of average last dollar loan-to-value ratio of approximately 63%, absence of material credit issues and the low single-digit investment yields available from other comparable fixed-income investments. Since the beginning of the new year, we've closed or acquired $113 million in new investments, including an $86 million construction financing for the development of 30 residential condominium units and ground floor retail on the upper east side of Manhattan with what we think is a very attractive last dollar exposure of $860 per square foot. More importantly, excluding our anticipated acquisition of LNR, we now have a pipeline of new loans and investments in various stages of due diligence under term sheets with initial fundings of approximately $650 million and a total capital commitment of $1.3 billion over the next 48 months. While we're likely to experience some attrition in this pipeline, we're confident that the pace of new investments in the coming months will be substantial, and we're extremely pleased with what we anticipate will represent new deployments to capital to both meet our asset quality and return targets, but also help further diversify the loan book, as well as maintain its overall attractive risk profile. The last items from the fourth quarter of 2012 and first quarter of 2013 I'll mention involve important events on the financing front. As we've discussed on previous calls, one of our significant advantages in the lending marketplace is our ability to act as a one-stop shop solution for borrowers, particularly on large complex lending transactions where the competition has a complicated combination of a multibank syndicate for the senior component of the loan, and a mezzanine lender or lenders for the junior components of the debt stack. What allows us to act as a one-stop shop lending solution is the combination of our extensive array of financing facilities, coupled with our dedicated, experienced team of loan syndication professionals that give us the market knowledge, presence and confidence to originate a whole loan with a strategy to subsequently sell our senior A-note component in a timely and efficient manner. To that end, we were extremely active in the syndication markets during the fourth quarter, closing 4 A-note sales and 1 period of participation totaling $315 million. These sales allowed us to manufacture $104.7 million in match-funded subordinate debt investments with an average first dollar LTV of 48.3%, averaged last dollar exposure of 66.8%, LTV and average expected annualized investment yield of 11%. Next, earlier this month, we issued $600 million in 4.55% coupon, 5-year convertible senior notes due in 2018. We were very pleased with the overall execution of the transaction, which adds $600 million of unsecured debt to our capital structure with an accretive cost to fund well below our current dividend yield. Now let me bring up to date on our current investment capacity. As of February 22, we had $175 million of available cash, $578 million of financing capacity approved, but undrawn, and $163 million of net equity invested in liquid residential mortgage-backed security. With this, we have the capacity to acquire an additional $750 million to $1.5 billion in new investments. As announced in our press release, our board has declared a $0.44 dividend for the first quarter of 2013, which will be paid on April 15, 2013 to shareholders of record on March 29, 2013. This equals the standard quarterly dividend paid for the last 7 consecutive quarters, and including the $0.10 special annual distribution we made this past January represents a 7.05% annualized dividend yield on yesterday's closing share price of $26.37. Before I turn the call over to Barry, I want to briefly bring our attention to a couple of new items in our 10-K that was filed this morning. In the expense section of the income statement, you'll see that for the first time, we've established the loan loss allowance of approximately $2 million in the fourth quarter of 2012. This loan loss allowance was not the result of any specific credit issues on our portfolio and we still do not expect the loss on any individual loan investment. In fact, we would be required to establish a loan, a specific loss allowance if we did expect the loss on any individual loan. Our portfolio has grown into a sufficient size and age that we feel it's prudent to establish a loan loss allowance for certain categories of loans that have more risk of loss than others. Detail behind the methodology employed for determining the composition of the allowance can be found in Note 4 to the financial statements. Lastly, I'd like to bring your attention to new disclosure we've added, which provides detail on both our growing single-family home business as well as the impending acquisition of LNR. The single-family home disclosure can be found in Note 5 to the financial statements and a description of the LNR acquisition can be found in the discussions of our investment strategy, the discussion of business objectives and outlook and in a number of new risk factors. With that, I'd like to turn the call over to Barry for his comments.

Thank you, Stew. Thank you, Andrew, and good morning, everyone. I think we've completed an extraordinary year in 2013. And I want to thank -- 2012, I want to thank our shareholders for supporting us and also all the employees that made the performance of the company possible. It was an extraordinary quarter for us as we count January in the LNR transaction, a transformative one. Originating and purchasing over $1 billion of debt in a quarter is exciting and even more exciting as it continues into the first quarter of this year. I think you'll see a similar volume, it was mentioned in the financial press release this quarter, and we'll talk a little bit more about the market in a second. We also did a raise and one of our keys in creating earnings for our company is how we raise money and when we raise money. And I'd say we're in this sort of funny transition period right now when we won't be back in the capital market until we close the LNR transaction and provide further information on the pro forma earnings and pro forma balance sheet of the combined entities. And so, recently, we raised the $600 million in the convert, which was upsized from $450 million and met with demand more than 2x the offering, 3x on the original balance of the offering. And we voted to increase the raise, probably taking more money than we needed, because between now and closing of the LNR transaction, we cannot easily access the capital markets again. And will depend on -- the use of our capacity will depend on ultimately the closing of our pipeline. And then we'll see what additional capacity we might need to close LNR. The October -- or equity raise we did actually knocked a couple of pennies off of the quarter earnings. We wound up having unused capacity on average of almost $380 million for the quarter, invested in any coupon you want, and you can see that we left some money on this table, but this is a long game. And as you know from the start, which was not that long ago, we talked about being predictable and safe and best-in-class transparency. And I think with the additional disclosures schedules and what we provided you in the earnings release, I think we've got a long way to doing that. We're very excited about the progress in the company. I also want to mention how the relationship with SCG, the REIT's adviser is so powerful and was particularly powerful on a quarter when we originated this $475 million loan for 701 Times Square, subsequently splitting that loan only the third investment that was split between the REITs and our private equity funds, and also selling down 25% of that investment to Vornado. Those will recap the origination fee on a transaction. And the reason the loan is split is because we expect the IRR in that investment to be in excess of 14%, which is our guideline for splitting investments between the funds and the REIT. The fund took 25%. I can mention it's the first time that we've actually received an equity kicker in the transaction, the REIT and the fund and Vornado will split at 20%, equity kicker in that transaction. It's ground zero real estate and probably one of the most exciting retail locations in the United States, if not in the globe. And we've already been offered a significant premium price for that equity kicker. It's obvious it's not in our fair market value number. It's not anywhere in our numbers. And given the developments at the site, which I won't talk about until they're announced. We're pretty excited about that transaction and what it represents for our shareholders, and also reflects the ability of the manager to do real estate-related investments that still meet the criteria of the REIT going forward. I mean, it's a pretty interesting balance as you look to that quarter going forward. It's almost the 50-50 origination sourcing between the executives at SCG, as well as the dedicated originators at the REIT. And it's a very compelling and powerful combination of balance, the REIT being experts in structuring, deal sourcing, selling off A-notes, and the equity guys here are being pretty good at seeing lots of transaction up and down the capital stack. I think that really has differentiated us from our peers, and we'll serve us very well going forward. I think the quality of the pipeline, both what we closed and what we see in the future is very strong. It's sort of tilting towards Manhattan, which is unusual, but high-quality, and I think a good thing to do. It is a very competitive market today. I probably, if you don't know that, you haven't been following the debt market. The CMBS market is rapidly improving, and one might say almost exploding. I expect CMBS volume to be $55 billion to $60 billion this year, and it could go even higher as the world searches for yield. That is a little dangerous in the sense that I think the market's losing discipline a little bit again. Having said that, what you're seeing is compression of spreads more than you're seeing a gigantic increase in LTVs. The market's remaining more disciplined on LTV, but taking spreads in because real estate continues to trade at very wide spread relative to similar credits in the other -- in the structuring credit market. So we were once in the conduit business. As you may recall, those of you who have been with us a while, and turned out to be an incredibly profitable business of the past 12 months as the credit curve crashed, as people felt comfortable that the economy wasn't rolling over. It is a business we know, Boyd, the team were gigantic conduit lenders. But with LNR, we will be back in that business, and it's a successful business. It's a little different the business they do than what we did in the sense that their investments are on average $20 million, $30 million or small loans, and they turn their inventory 3 or 4x a year, which is very good from a perspective of hedging out risk, credit risk and duration risk. I did think you have to look at the market today and the developments going forward. And there's one thing that we are watching quite carefully and cheerleading along, which is the concept that a bank or anyone has to retain 5% of the loan for 5 years. That is the current proposal in Washington, and it's still not finalized, but we think that is a huge competitive advantage for us. I think it's absolutely critical on this market that we originate the loan, and then we chop it off and slice and sell if off, whether it's going to be in the future, the CDO or CLO. Whatever we choose to do or simply selling at the A-notes, which we've done historically. And I think the banks, I don't know the number, but we've probably partnered with a dozen banks selling off C -- in life companies selling off the A-notes and sizing them to their needs and also to keep our piece as wide as the capital stack as possible. Stew mentioned the $100 million of debt created from 48% to 66% of the capital stack. That's not B-Piece. The B-Piece is the 68% to 70%. So it may have the same yield, but it does not represent the same risk in the capital stack. Having said that, we do think the B-Pieces's business is attractive. It is a core business that LNR has been in for its entire life. It has both the systems, the information and the people to process B-Pieces's loans and it's something that we here before has not had in our arsenal. We just didn't have the people to do the work on 700 loans in the portfolio, but they do. So you will see us continue to grow in that market going forward. And I do think that should bring us over to LNR for a second. I think our core historical competitive advantage, and clearly the pace for the quarter and the quarter going forward, is that we have gravitated to exactly what we hope to become, which is a go-to shop for large complex loans that have to be done quickly. We need flexibility, where the borrower wants to know who he's borrowing from. And in some cases, they want to come back to us to restructure the loan. So we have the knowledge and the real estate knowledge, and I think a prime example of that is 701 Seventh Avenue in New York City, where I think we closed it in 3 weeks. And Eddy LaBar [ph] who is talking to us about upsizing the facility, to do some additional development there, that would be very accretive to us. He couldn't do that with a bank lender. It would be very expensive and very difficult, and we'll continue to work on opportunities like that. So let's talk about LNR and in that context, let me take a brief digression and talk about Europe. We closed the loan in Europe in the quarter on the 3 hotels, the Connaught, the Berkeley and what's the third one? It was [indiscernible] -- it wasn't the Savoy it was x the Savoy portfolio. We split that loan with Blackstone. We do think there'll be tremendous opportunities going forward in Europe for us, and they are big. It is a big market. There's a lot of opportunity, and we're gearing up to do so. One of the pieces of LNR that we're excited to be purchasing is a business called Hatfield Philips, which is the largest special servicer in Europe and has something like a better than 75% market share in countries like Germany. I think they will provide us a unique opportunity to see this stress debt and to offer bars, unique solutions to -- to recapitalize their investments. And so we hopefully would see an increase and there was a much bigger increase in our book over time now in Europe going forward. LNR also, I think, provides additional sustainable competitive advantage for us because it does have this $100-plus billion seat at the table where they see and oversee over $100 billion of loans for which they are named special servicer. And then about $20 billion split $6 billion roughly in REO and $14 billion in loans that is in their portfolio, which they are actually actively special servicing. But that actually is less than half of value of LNR. It's a portion that the REIT is buying. There's a significant CMBS book in the company with the rally in the CMBS markets. Hopefully that will be quite valuable to us. It also is an interesting hedge against the servicing business because as the world improves, likely the value of CMBS book will go up. And if the world improves, it's possible that loans we expect to fall into special servicing would not. So there's a natural hedge in the portfolio which were kind of unusual and interesting, and it buys value, that CMBS books on the way we value the company is worth as much and slightly more than the special service or the way we underwrote it. Also, as we mentioned is a very effective conduit business archetype, and their team has done a superb job in that market. They're one of the largest top-5, I think, or so, lenders in the marketplace. And they've been doing it a long time and they're terrific. And the last investment, which we consider kind of interesting and fascinating, is our interest and the REIT's interest in Auction.com, which is the largest online real estate residential broker, as well as commercial broker that exists. And that company is wildly profitable, and it's growing quite rapidly, with EBITDA as an excess of $100 million. And we think it's a fascinating seat at the table, and we believe it will provide interesting lending opportunities to the REIT going forward as well. So they will see whether what kind of capital market transaction they may do in the future, but we're really excited to have that opportunity to be and have a seat at the table for the REIT. That investment will go and it's the first time we'll be really activating the CRS, the taxable real estate subsidiary of the REIT because obviously, that income does not tax -- is not good income for the REIT. But with the scale, the company, as you know, we can put almost 20% of income of the company into those taxable sub, and then with some totally legitimate structuring, hopefully, reduce the leakage to taxes in the CRS going forward. So with that, I think -- we expect, let me mention one more thing, we expect the LNR transaction. I think we've said it will close sometime in April. That is our goal. We're, again, working hard on getting the consents necessary to close that transaction. We're pretty -- I say we're thrilled with that opportunity for us. We're thrilled with the management team, the depth and breadth and the people that are there. I think that was an asset, which you don't pay for it necessarily, but it's probably one of the most valuable assets of LNR. Additionally, the data they have is extraordinary. And right now, we're working on systems integration between the REIT and the LNR whose technology is actually superior to the technology we've been using and their systems are pretty damn good. So we're pretty excited about -- we're very excited about the opportunity to work with the team. And I think we'll take questions.

[Operator Instructions] And we'll go to Ken Bruce with Bank of America Merrill Lynch.

It's interesting looking back prior to the IPO. I remember talking about what your 5-year plan was and looking at the last -- kind of looking back at that point, I think you've achieved most of those goals in about half the time. So I'm wondering, as you look forward, what do you see as maybe the next 5 years. How do you see this playing out?

So the business plan is to build a multi-cylinder company. You have 12 cylinders. 6 of them are going to be firing at any one time and 6 might be dormant. Turn them on and off. One example of that would be the conduit business, which we got into, we got out off. But the time we did it, Stew and the team created these very powerful hedges, but it actually went awry on us because there really wasn't depth in the market, there wasn't liquidity, there wasn't a provider that really the market's kind of went off track. And it didn't quite -- we wound up losing nothing on overall. But for a moment in time there, it got a little nerve-racking. But that's a business that I -- we never, I never did thought we'd exit permanently. I think it keeps our team busy, and I think it's good to be a full stop, a one-stop shop that can do everything across the whole spectrum. But it's better for our people because they can earn a living, they can use conduit loans. So while they make them work, our balance sheet loans that we're going to retain. So I think with LNR, we've added 4 or 5 new cylinders to our engine. And I think you'll see us when we talk about the triple-net lease business over and over again, we saw one of our competitors recently buy a mobile home or manufactured home business. We've looked at a lot of these transactions and we trip over the fact that we, when we read this philosophy of Kit, keep it simple, stupid. And the reason is that we can produce earnings in a triple net lease business. It's quite accretive. But for the most part, every time we get involved with these companies, they have debt in place that's fully amortizing and matching the duration of the leases. So we have GAAP income, but we do not have a heavy amortization of the debt, provides no cash flow with which to pay a dividend. So we're basically borrowing from future to pay the dividend. And so that's kept us from doing what I thought was a pretty interesting business for us, which is the triple-net lease business because it provided this depreciation shield for us, which would allow us to drive down the payout ratio of the REIT. Right now, as you saw, we earned about $1.99 what we call Core Earnings, we paid out $1.86. So we're inside of what we're earning, which was also our goal. You're not going to drink your blood. If in fact we mentioned, and I should have mentioned in my comments, that the LNR transaction looks to be accretive and maybe materially accretive in -- even after the transaction costs, which are substantial in year 1. We think we'll have to be examining our dividend policy going forward, but we don't really want to get ahead of that. And that's why we declared the same dividend in the first quarter as we did in the last quarter, in this quarter than we did in the last quarter. So I think you'll see us continue to look at service providers and businesses that are relevant and related to what we do. We think that the single-family home business, which is now less than 5% of our assets or roughly $200 million of dollars of investment. It's been interesting. We've been sort of dabbling in it. We've been doing it slightly different than other players if you look at our disclosure. We think it's actually cost us a penny or 2 in earnings probably, but that's good the book is unlevered at the moment. We've mentioned in our earnings letter that we're going to lever the portfolio, reduce the equity investment in it. So that's a business we're watching. We obviously, we're aware of what other people are doing in the business including Two Harbors and Silver Bay. But I think it's interesting. It's a different business. It has an interesting inflation. It has characteristics to it. And I think, again, when we started out, we made a mistake. I mean, we -- I made a mistake. I thought rates would rise faster than they did. I didn't expect QE17 [ph] and print money forever. So I thought the curve would rise. We kept our durations shorter probably than they could have been because we thought we could reinvest the money at higher levels going forward. I would say, now, I think we still have that philosophy that the government is subsidizing interest rate curves. And eventually, QE3 will raise -- will expire, might even expire at the end of this year. I think you'd see a significant shock to the interest rate curve and maybe, 50 to 75 basis points, we're aware of that. And so we originate with that in mind. And we're doing a lot of floating deals, which will floating-to-floating, which will not have any -- there'll be no issue if rates rise. And we actually stress our loans to make sure that if rates rise, we still have sufficient coverage and LTV to get through it all. So we are very -- I'm very -- I love floating rate debt right now. I prefer it to fixed than -- and I don't think the rising rates is tomorrow, but it could be just around tomorrow or tomorrow plus 1. I just don't know when tomorrow is. So over under, I would suggest that rates will rise and that's not going to be bad for us overall. So it actually will help the special service or maybe some guys who were paying LIBOR plus nothing will default, and we'll have an opportunity to restructure the loans. So overall, I think you'll see us continue to broaden our product lines. And so we can play in many markets, and Boyd and his team have looked at other businesses that are relevant to us, that where there is capital gaps, they don't fit as -- they never fit in the conduit business. And I should have said, and I think it's really important, and again, I regret that I left it for the Q&A, that if we had a choice between extra yield or safety, we're going to be safety. We're going to give up at aggressive '12 for a safe '10. And in this world, we cannot compete, make no mistake about the giant financing markets with trillions of dollars in them. But when the Street originates a loan, we're not going to compete against the hedge fund buying a mezzanine bond at 7%. And they are doing that today. So we must originate and in order to originate, we must be big. So we are fairly big, although we're tiny. I mean, we're a pimple in the Capital Markets. We're relatively big in the -- our sector of the REIT universe, but we can be bigger with no problem. And actually, as you see, we kind of injure ourselves by raising more money than we need because now we're going to be shut out of the markets for a while. And for Boyd and his team, he's always saying, "Well, what do I tell my guys? Do we have the money to close the deal?" And I said, "Don't worry, we'll get the money." But the truth is we actually can't enter the market until at this point until we close the LNR transaction. So --

That's very helpful and I guess, you managed to touch on every single follow-up question that I have, but I do want to see these few things out. I guess if we look back to part of the triple net lease strategy really was related to the ability to shield earnings, as you point out. And I assume that the exercising the TRS effectively is going to be a similar strategy that's going to allow you to grow your book value, create a better optimal financial strategy over time, is that a right interpretation?

Yes. I think that's right. I think we have to be careful with obviously the tariffs are taxable. So we've enjoyed this tax-free nature of the REIT. So but there are businesses that can't go in the REIT. So they are service providers to the REIT, and we're going to continue to look at what exactly fits where if we get to the closing of the one R because it's not -- there are many, there's lots of -- it's not obvious always how things, how this all should be played out.

Okay. And Europe has been an interesting market to watch, and maybe things are beginning to happen there. But it's always seemingly longer and drawn out, and more drawn out than anticipated. So maybe you can just give us a sense as to how you think that the timing of that opportunity will evolve?

Yes, Europe's funny. We -- the Capital Group's announced the closing of a hotel transaction today in Europe. And you can borrow for -- within a country, you can borrow in the country from the banks in the country. And as it's fully percent LTV kind of like the states, the banks are lending. And it's not so bad, probably 100 basis points wider to similar credit in the United States. Where the opportunity is, is in the mezzanine. And then right now, there are not that many transactions taking place. And the nature of some of them taking place, the borrowers are -- with the buyers are -- the transaction going down to a sovereign wealth fund right now. And we quoted this opportunity fund buyer at 12% mezzanine. That was over $200 million, but they lost to the sovereign wealth fund who's going to leverage like 30% and doesn't want to borrow at 12%. So it's really is a nature of whose buying what. A lot of these loan pools that are being done are small. They have a fast paid debt, the debt that's available maybe 600-over, but you can pay it off immediately. And that makes it unattractive for us to be that player because we will be paid down so fast. It's no point making a loan. It's too much work. We don't make any money. So we'll wait to see as pools of capital circle, and there's a lot of people looking at providing, filling the great banking system hole in Europe, but you still haven't seen the level of the volume of transaction as anywhere approaching 2010, '11 in United States, and we're still in 2009 in Europe where banks just sticky. They don't want to realize the losses. And they still, the pace of transaction it's, still quite low across the continent and including U.K. And that might also be a reflection of the fact that they think things will get better, the banks, and they'd rather hold the assets for a while and that the buyers are nervous about the macro of Europe even though I think most people feel like the currency is going to stay together. The economies are sort of floundering, and maybe they believe they won't get a reasonable price their portfolios. So unless the institution's been nationalized and NAMA [ph] selling assets in Ireland, maybe in the U.K. for example. You're not seeing the kind of flow of investment volume that you would have predicted at this point in the cycle. But it's coming, so we're there with we have about, we've tripled the overhead in Europe in the last year and hired the head of UBS's debt business, and he's on SCG's books, but -- and he's been sourcing transactions. And then again, picking up Hatfield Philips, which I think has like a couple of hundred or 200 people -- 150 people, which is the special servicer based in London and has a big presence in Germany. While I can imagine it can't hurt us, it must create great opportunities and great insights into distressed situations, which we hope to take advantage of.

[Operator Instructions] We'll go to Stephen Laws with Deutsche Bank.

I think you're hitting a lot of questions regarding Europe with your last comment. Could you maybe take a second and talk about the financing line you're currently negotiating on a single-family opportunity, maybe what you see a rough range of where expenses to that may be? And what type of leverage do you think you can get on that portfolio of asset?

Yes. I mean, listen, we don't want to -- Stephen, it's Andrew. I mean, we obviously don't want to go into great detail on that because we're talking to a couple of different financing sources. They don't want to show our hand too early, but these affiliates are getting somewhere between, let's call it, mid-60s leverage, L plus 300 or so is the terms they're getting, their facilities are getting done. That's the ballpark of where we're talking about. There's obviously different types of facilities. There's the talk of a securitization market coming back for long-term financing that market, but it's a little early to know whether that's actually going to play out or not.

And what's the long-term focus with this? Is it something you see as a core business line for the company? Is it something like maybe some other similar entities you see it as eventually being its own independent company that you guys may or may not manage. How do you guys see kind of the longer-term opportunity in this fair amount of this business?

Well, we're sort of an R&D shop. We're -- we -- it could stay inside. We could bulk sell the portfolio. We could spin it out and trade a new company around it. We're considering all options. The pace of our investing has increased. I won't really talk about what we're doing exactly because the world is competitive. But I would suggest that we didn't do this in the opportunity funds by the way. The opportunity funds are not -- we're not sharing these investments with the opportunity funds. This is just being done in the REIT. And the reason is I felt that the market would get so competitive on the acquisition side that the yield would be brought -- would be driven down. And as you know, this is a new business. And I would suggest that there isn't anybody on the planet earth that really understands the capital costs and maybe it'll create earnings, but the capital cost of the turnover of the house, we're spending $11,000, $12,000 a house to fix them up. But it's the turnover. It's when the tenant leaves that sort of the unknown, the business on scale doesn't really exist. You've heard the pitches I'm sure the companies that are in the states, so that I think 2 or them are public now or 1.5. And we'll see if this does become this new asset class akin to the multi-family business. But I think that a lot of the purchases -- well, beauty's in the eye of the underwriter. If you're not getting enough current yields, your IRR is going to be driven by the appreciation. At the moment, I suggest that appreciation is being driven more by investors, clamoring to buy inventory than by underlying fundamentals of some of these markets. So we are doing this micro-ly [ph] carefully and with an emphasis on the age of what we're buying, as well as the geographic locations of what we're buying. and I kind of look at it as fishing with a net as they are -- you're out in the ocean. You're trolling for your tuna and you put the net -- you stick that net out there and you catch a lot of fish, and you keep the tuna and throw everything back in the ocean, and -- of which you have to do here. You buy portfolios and you cherry pick the ones you want to keep and rent or resell. And I think we sold like $38 million at home or something like that. So far as we just toss the stuff back we don't want -- so it's an interesting little business. We'll see if it becomes a big business for us. We are curious to that. It certainly is -- it has a lot of interesting characteristics and we all know how difficult this business is to manage.

And then, Stephen, I wanted to point out making in our release, we talked about the unlevered return from the portfolio being kind of between 6.5% to 7.5%. That's actually a yield and not an IRR number. Right.. So as Barry talked about people banking on HPA or home price appreciation to hit their return. Our number that we quoted is true. It's a true weighted average, kind of net yield off the portfolio.

And that's net yield, not a gross yield. You're hearing people saying they're getting 11s and 12s. No way, that is not accurate. [indiscernible] 12%.

I appreciate the color there. Maybe switching to the servicing in TRS. I mean, you guys chewed on a couple of it. But any guidance you can give us on expected pace of UPB paydown? At what point that may kind of plateau and even grow at some point in the future? And then maybe kind of extending on that is any kind of margin rate a target as far as pushing expenses into the TRS to minimize the income level exposed to taxes?

Well, why don't we wait on that for the next quarter and give you more guidance as we finish our structuring? I think I can tell you that LNR is having -- the company's run for our benefit. It's a close book for the moment. And so that we won't close, we will -- we are in taking in their earnings. No, there's no money leaving the company at the moment. So -- and they're having a good quarter so far. So ahead of their plans and I would suggest ahead of our underwriting at the moment. So it's a little bit of a -- it's a very difficult company to look at from that perspective because there's sometimes on the servicing side they're getting a payment that's a timing variation. You have to be careful about, they renegotiate something this quarter. They expect you to renegotiate next quarter and then they get paid for it. But for the most part, actually from what I can tell, they're simply just ahead of our underwriting at the moment. And some of their businesses like the conduit business is better than we thought. And they participated its public information in the securitization that just took place with Goldman Sachs and it was a very successful securitization. They did quite well. So we're so far pleased as can be.

Great. And then one final question, as far as the income there and I think you hit on it earlier with Ken's questions, but it looks like you primarily will look to repaying those earnings for the TRS to grow book. But can you maybe talk about any, I believe the convert that was just done has an adjustment policy for any dividends paid in excess of the $0.44 quarterly level. Can you talk about how that may sway you, one way or the other, on distributions versus retaining cash that you can? Or is that something you're not going to really look that closely as far as your distribution policy?

I think we should wait on that. And we -- to get the $455 million coupon, we provided that dividend protection to the convert. We could have done that transaction tighter and buy -- if we stayed to the original size, it was going to be done below $450 million. We gave up 10 basis points or so by increasing the size of the offering from $450 million to $600 million. And as you could tell, the stock was sort of screwed around with on the last hour of trading, but that's not either here nor there. I think we're going to do the right thing, that we're all big shareholders here. And we'll do the right thing by the dividend, by the company going forward. We obviously were aware of the fact we would like to increase the dividend over time. Offsetting that is the fact that the market's pretty damn competitive out there and we're trying to maintain our double-digit mezzanine yields in a world where that's not easy. And getting increasingly difficult. So we'd be delighted if base rates rose. But I think, as I mentioned, we are going to go for safety rather than 13 mezzanine layers for crap. Stew mentioned the loan loss reserves we set up, and we have to with the fact we don't have any losses in the portfolio. We'd like to keep it that way for the foreseeable future. So, so far, so good.

We'll hear next from Gabe Poggi with FBR and company. Gabriel J. Poggi - FBR Capital Markets & Co., Research Division: You've answered the majority of my questions. I just want to ask a quick question about Europe. Can you just talk about if there are any conflicts with what SCG is doing in their kind of European finance business? It's just a question I get often and want you guys to clarify that.

Gabe, so we did raise the small $350 million to all our -- GBP 200 million something debt fund in Europe and it is sharing those deals with the REIT. I think it was 60/40 to the REIT on the mezzanine we did in Europe recently.

Well, yes, Gabe, just to add a little bit color to what Barry said. So as we disclosed I think in note 9 or 10 of the 10-K, STWD made an investment in that fund, a small investment in that fund, and in exchange for making that investment is going to effectively get, as Barry said, depending on the kind of lever on the return of the underlying asset. We'll get anywhere between call it 50% to 60% of the investment. So we see it as obviously, as a bigger opportunity. Our -- we've been very selective in Europe, doing less than half a dozen in transactions. And the fact that we're able to raise dedicated money in Europe as a firm allowed us to grow the bodies we have on the ground in Europe and build up a bigger infrastructure which should only help STWD going forward.

And the European vehicle will do seniors. It's a blend of mezzanines and seniors, and that's not what we do. I mean, their seniors are seniors. There is like a 4% paper that doesn't fit for us. And we'll see how we -- what it looks like going forward. It's competitive. There's another reason to do a European vehicle in pounds and denominated in pounds, which is a hedging cost or nearly 100 basis points off the coupons and sort of be competitive. If their local guys are offering a 7, then we have to finance it at 8 and swap it back to make a 7. We actually don't win. So we needed a vehicle that doesn't -- and the U.S. vehicle here we hedge the currency risk, both coupons. In fact, you can see the fluctuations in our income statements on changes in the currency. So it creates a wobbly earnings year even though they're sort of fictitious, but -- and it would drive you and me a little nuts with wild currency swings in our earnings in the United States, which are obviously, just mark-to-markets on the hedges, and have no -- ultimately the loan pays off, the whole thing collapses and you haven't realized any loss or gain for that matter. So having the local currency vehicle is helpful that this remain competitive in situations. And I think we're in a [indiscernible], see if we kind of get it, I don't want to say cherry pick but it's a cherry pick, and what we want to do in the vehicle.

We'll go next to Joel Houck with Wells Fargo.

Just a question, if you look at the growth in 2012, over 40% in the investment portfolio, the mezz portion grew even faster closer to 70%. And I guess that makes sense given just based on your disclosure at the highest levered return, yet the attachment point of 65% in any LTV isn't really all that much higher than first mortgages. So that's, I guess, that's good asset allocation. What's your outlook kind of going forward in terms of mix in mezz kind of give you. It sounds like you're a little more cautious that it's becoming more difficult to get those types of returns. But if we were to look out over the course of 2013 and you guys have already made some comments about robust origination in Q1, what are your thoughts on mix?

You should expect the LTV's decline, close to the 70%, I would expect, and I think that the lenders are at 75%. There are certain asset categories we just can't touch. With our Star Capital just closed yesterday alone on Maltese, it's 79.5% at $277 million. I mean, where are we going to play in that stack, right? But if we provide anything on top of that, it will be at 90% LTV. And frankly, the asset can't even support our mezzanine. So there are certain asset class. Asset is one very encouraging thing as we're doing more office deals. And the portfolio is moving less in the hotel space. And if you look at our hotel concentration, there's really one big investment there that is AAA paper. It's really not even a hotel. That's the senior in a very public buyout of a very large hotel company. So it's distorted. Our actual exposure to the hotel market is not, I would not say, as high as it might look at when you look at the pie charts in our disclosure statements. So Boyd, you want to add anything on that?

When you talk about the mix -- Stew, I think, elaborated on it really well. Our big advantage right now is this being a one-stop shop, where we do the whole loans and then sell off the A-notes. I think that more than likely will represent the majority of what we do. So we'll -- how you describe that, they are big structure deals. And when we take down the whole stack, simplify it for the borrower, but then once we sell it all off, we wind up with mezz. So it's really -- you do a whole loan, and then you wind up with mezz eventually.

And it's really no different than when we -- the risk position is very similar. If we use unbalanced sheet leverage, as well, right. We, for a variety of risk reasons, it makes the most sense to sell A-Notes or do securitizations or something because they really represent match term nonrecourse financing. So we have warehouse facilities and manufacturer effectively the same position. One shows up as a whole loan, one shows up as a mezzanine loan or a sub-debt, but they're for all intents and purposes the same thing.

The numbers may be a little bit misleading to you. I mean, if we choose to do unbalanced sheet leverage, then it looks like we don't own mezz, but we really functionally do.

We'll go next to Jade Rahmani with KBW. Jade J. Rahmani - Keefe, Bruyette, & Woods, Inc., Research Division: A quick one on the loan-loss provision. Is this the recurring expense you expect to run through in earnings? And is there a target reserve ratio or some way that you're thinking about it?

Sure. Jade, it's Stew. The loan loss or the loan allowance methodology that we have historically done, because we have very good clarity into our assets, we have a total number of assets in the a little over 100. We're able to surveil on a very detailed basis on an ongoing basis, every asset and so the allowance methodology we use is not a pooled concept, it's a loan-specific concept. And at this point in time, as I mentioned in my part today, we still have no expectations of any losses associated with any of the individual loan investments that we have. That said, we have now gotten large enough that it's prudent for us to take, to recognize that there are certain categories of assets that would have a higher likelihood of loss than others. We've included in the, as outlined in the K's and Qs, has been since I think the inception of the REIT, we have a loan-scoring system, in which we, across a variety of measures, we score loans from 1 to 5, 1 being the best and 5 to be the worst. What we decided to do, and it's outlined in Note 4 in this month, the methodology, is to take -- create a loan loss allowance equal to 1.5% of all the loans that we independently deemed to be rated for. And the greater 5% or any expected value deficiency on loan on 5. We don't have any loans that are value-deficient at this point in time. We have 1 loan that for $11 million, that we have as a Category 5 because it has a reserve-deficiency issue, that's in the process of being resolved. But it's a formulaic methodology. It will be applied every quarter to the expense of which loans migrate out of the 4 category and up to a 3, the loan loss provision will be reduced and it will show up as income. To the extent of which new loans go in as 4s or 5s, it'll add -- it'll be a charge-off or an expense for that period, and that's a way to work, unless we decide to change the way that it works in the future. Jade J. Rahmani - Keefe, Bruyette, & Woods, Inc., Research Division: Okay, that's -- that color's very helpful. Regarding the LNR transaction, I wanted to see if you'd be willing to comment on whether you anticipate acquiring additional special servicing assets, perhaps, from banks or other players put onto the LNR platform. As we've seen a lot of consolidation in the residential distress servicing space because I wondered if you could anticipate a similar trend emerging in the commercial market?

Let's just not comment. I mean, obviously, there's scale advantages in servicing businesses.

And ladies and gentlemen, that does conclude today's question-and-answer session. We'll turn the call back over to Mr. Sternlicht for any additional or closing remarks.

It is year end and I just want to thank the shareholders for supporting us all year long and sticking with us. Many of our shareholders have been with us since the IPO. And I also have to thank the team of professionals that make this all happen, and I get to coach. So it's really been a great joint venture between dedicated professionals led by Boyd, Stew, Warren De Haan and Chris Tokarski at their REIT, and then the guys at Starwood Capital Group who have worked really hard. And both on the LNR transaction, which was really run at a Greenwich-Starwood Capital, and then all these loans which are really I think are great. So thank you all and have a great day.

Ladies and gentlemen, that does conclude today's conference. Thank you all for joining.