Starwood Property Trust, Inc. (STWD) Q2 2013 Earnings Report, Transcript and Summary

Good day, and welcome to the Starwood Property Trust's Second Quarter 2013 Earnings Conference Call. [Operator Instructions] As a reminder, today's conference is being recorded. At this time, I'd like to turn the conference over to Mr. Andrew Sossen, Chief Operating Officer and General Counsel. Please go ahead, sir.

Good morning, everyone. I'd like to welcome you to our second quarter earnings call. With me this morning are Barry Sternlicht, the company's Chairman and Chief Executive Officer; Boyd Fellows, the company's President; Stew Ward, the company's Chief Financial Officer; Cory Olson, the President of LNR; and Mike Berry, the company's Chief Accounting Officer. This morning, the company released its financial results for the quarter ended June 30, 2013, and filed its Form 10-Q with the Securities and Exchange Commission. In addition, the company has once again posted supplemental financial information to its website. These documents are available in the Investor Relations section of the company's website at www.starwoodpropertytrust.com. Before the call begins, I'd 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 in the course of this call. Additionally, certain non-GAAP financial measures will be discussed on this conference call. The company's 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 the company's filings with the SEC at www.sec.gov. With this behind us, 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 will be reviewing Starwood Property Trust's results for the second quarter of 2013 and third quarter to date. I'll also highlight a variety of new and expanded items contained in the financial statements we filed this morning that now incorporate the operations of LNR and provide new segment level breakouts for our traditional lending business, for LNR and for single-family residential property business. Following my comments, Barry will discuss current market conditions, the state of our business and the opportunities we see looking forward for our newly expanded platform. Let me begin by pointing out that LNR's results and contribution are not for the full quarter, since the acquisition closed 3 weeks into the quarter on April 19. For the second quarter of 2013, we reported core earnings of $86.1 million before the transaction and restructuring expenses associated with our acquisition of LNR or $0.52 per fully diluted share. Net of these transactions and restructuring expenses, which were comprised of professional, due diligence and severance costs totaling $17.1 million, core earnings stood at $69 million or $0.42 per fully diluted share. GAAP net income for the same period, inclusive of these transaction expenses, totaled $62.3 million or $0.38 per fully diluted share. A component of the $0.04-per-share difference between GAAP and core net income is an $8.5 million expense associated with an accounting anomaly regarding change in control payments to LNR executives per their old contracts, which are deemed to be expenses of Starwood Property Trust under GAAP, but which, in fact, were always contemplated as a liability of the sellers and were fully funded by the sellers at close. As of June 30, 2013, GAAP book value per diluted share was $21.21, an increase of $1.12 over the level of $20.08 we reported as of March 31. Fair value per share stood at $21.77, also well in excess of the $20.48 per diluted share reported at the end of the first quarter. Both increases are reflective of the $822 million capital raise we completed in mid-April. Our acquisition of LNR closed in mid-April for a final purchase price of $730 million plus assumed liabilities, and therefore for the first time, we'll be presenting results for the combined entities. In the Form 10-Q we filed this morning, we also provided details of many important changes that have occurred in our overall financial statements as a result of the acquisition. Before I review the financial result of the LNR business for the quarter, I want to bring your attention to 3 issues you'll need to comprehend in order to properly understand our financial statements going forward. First, one of LNR's primary revenue sources results from their role as a special servicer for commercial mortgage-backed securitization transactions. Of a critical importance to that business are the investments in CMBS made by the company that allow LNR to name itself special servicer for the CMBS trust. Under GAAP, the combination of special servicing and capital at risk in the same CMBS trust requires us to consolidate, onto our balance sheet, the full assets and liabilities of the majority of the CMBS trust LNR special services. As a result, you'll now see an inflated overall GAAP balance sheet for the company presented at over $103 billion, $97 billion of which are assets and offsetting liabilities that, from an economic perspective, we fundamentally do not have an interest in. These are assets we don't actually own and liabilities we don't actually owe. To provide a clearer picture of our true economic exposure, we provide an alternative presentation in the Form 10-Q of the income statement, balance sheet and the consolidated statement of cash flows, as well as a reconciliation of GAAP and core earnings on a de-consolidated basis, which is how we as management review our financial performance and should facilitate your review of the same. Second, it's important to highlight that as anticipated and modeled, we now hold 100% of LNR's servicing activity and conduit operations in a taxable REIT subsidiary to ensure our qualification as a REIT. Accordingly, our Form 10-Q disclosure has been significantly expanded to describe the taxable nature of these operations. Third, given the nature of LNR's operations and the unintended consequences of CMBS trust consolidation, the majority of revenue-generating assets we acquired from -- in the LNR transaction will be accounted for on a fair value or mark-to-market basis for the purposes of determining GAAP net income. The result is if we may have more volatility in GAAP net income going forward than we've had in the past, and in some instances, the results may not reflect our expected long-term financial performance of these assets. As a consequence, we've developed methods for the computation of core earnings for each of these fair value asset classes that we believe are consistent with the message we utilize to compute core earnings for our traditional hold-to-maturity assets and are aimed at providing an alternative measure of the stabilized long-term earnings power of each of these asset classes. Now let me outline the second quarter results for our 3 major business segments. Since the beginning of the second quarter, the commercial real estate lending division has been very active, closing 16 transactions with total lending commitments of $1.46 billion. 11 of these transactions totaling $831 million were closed in the second quarter, with an additional 5 transactions totaling $626 million closing in the first 30 days of the third quarter. Importantly, we continue to be extremely pleased with the risk and return profiles of these new transactions, with the bulk of these transactions located in the best markets in the country, involving high-quality experienced sponsors with great real estate. These transactions have an average loan-to-value of 64%, which is consistent with our overall portfolio metrics and an expected leverage return of approximately 10%. With the addition of these commercial loan investments, our total traditional commercial real estate loan and security portfolios stands today at about $4.2 billion, with an average expected annualized return of approximately 12% and an average loan-to-value ratio of 64%. The first 18 days of April, prior to the close of the LNR acquisition on April 19, was an extremely strong period for LNR, with profits on a GAAP basis of $39 million for these 18 days alone. As a consequence of the structure of our purchase agreement, all of these profits, as well as $118 million in profits earned between October 1, 2012 and March 31, 2013, accrued to the benefit of Starwood Property Trust as a reduction in the goodwill component of purchase price. For the second period -- for the period following the acquisition close through the end of the quarter on June 30, LNR as a business segment earned after-tax profits on a GAAP basis of $34.6 million and had core earnings of $35.6 million, both inclusive of allocated shared cost of $4.2 million. Measured on a stand-alone basis, the LNR business segment would've earned core earnings for the quarter of over $1 per allocated share. We continue to be pleased with the performance and risk profile of LNR's conduit operation, as well as the integration of our legacy Starwood Property operations with their current counterparts at LNR. Also during the quarter, Fitch and Standard & Poor's affirmed the company's range for the domestic servicer at CSS1- and strong, respectively. And Fitch also upgraded the ratings for LNR's European special servicer to CSS2 from CSS2-. It's also worth mentioning that special servicing revenues, CMBS income and projected cost savings associated with the planned and executed rightsizing of the business are either ahead or consistent with our pre-acquisition underwriting. Beginning this quarter, we have expanded substantially the segment reporting for our single-family home business. Since the beginning of the second quarter, the number of properties owned has grown from 1,678 units to 3,150 units, and our single-family nonperforming portfolio has increased from 1,318 loans to 1,559 loans. Our total portfolio of property and loans now comprises over 4,700 units with an aggregate investment basis of $590 million. We continue to be actively -- to actively be buying properties in our target markets. This segment of our business is still in ramp-up, and we opted to acquire NPLs to lower our entry basis and convert loans to REO rental. As a result, the single-family business has operated in the red since inception. However, we fully expect the portfolio, when stabilized, to earn leverage cash yields of 10-plus percent and a total return factoring in long-term price appreciation in the low to mid-teens. One last comment about our single-family residential business before I move on. As I've mentioned in the past and as worth repeating now, one of the primary motivations behind the LNR acquisition was the benefit it would provide by substantially expanding and diversifying our lines of business and greatly expanding our lending, processing and analytical infrastructure. As a market-leading, full-service real estate finance platform, we feel we have grown to the size and scale to start and incubate new lines of business like the single-family residential business without major disruption to our operations nor unacceptable impacts on our near-term earnings. With the recent concerns in the market over the prospects for higher interest rates, we've gotten a lot of questions regarding our exposure to interest rates. The answer to the question is complex when you consider the potential relationships between interest rates, property cap rates, bond credit spreads, et cetera. However, from a core earnings perspective, assuming a reasonably stable environment for real estate credit, we feel we are well positioned against rising short-term rates. First of all, the vast majority of our new -- of the new assets we originate for our conventional loan book are floating rate, indexed to short-term LIBOR. Over 90% of the current pipeline is floating rate indexed to LIBOR. Additionally, an announce [ph] of our current portfolio, including the financial assets acquired with LNR, suggests we're well positioned there as well. The equity deployed in earning assets of our most recent balance sheet can essentially be split into 3 categories. 50% supports floating-rate assets, nearly all of which are indexed to short-term LIBOR. With these assets, our returns increase when short-term rates increase. 35% supports high-yield fixed-rate assets: assets which yield generally between 10- and 15-plus percent. We feel these asset yields are sufficiently high to mitigate concerns over rising rates. The final 15% represents equity supporting other fixed-rate assets, the bulk of which are single-family properties and NPLs. We feel the interest rate exposure embedded in this final asset group, as well as that of our overall fixed-rate book, in general, is substantially mitigated by the more than $1 billion in 5-year term convertible debt we issued earlier this year at very advantageous sub-5% coupon levels. Let me finish my remarks with a discussion of our current investment capacity, our second quarter dividend and provide an update to our 2013 earnings guidance. As of August 1, we had $354 million of available cash, $127.4 million of financing capacity approved but undrawn and $177.9 million of net equity investment in liquid residential mortgage-backed securities. With this, we have the capacity to acquire an additional $500 million to $700 million in new investments. Our board has declared a $0.46 dividend for the third quarter of 2013, which will be paid on October 15, 2013, to shareholders of record on September 28, 2013. This is equal to the dividend paid for the second quarter and represents a 7.15% annualized yield -- dividend yield on yesterday's closing share price of $25.72. At this time, we are revising upward our core earnings guidance for the full year 2013 to a range of $1.90 to $2.10 per diluted share. Excluding the LNR acquisition on restructuring costs discussed earlier, it translates a comparable range of $2.04 to $2.24 per diluted share. With that, I'd like to turn the call over to Barry for his comments.

Thank you, Stew. Now we got a little more complicated. Good morning, everyone. I've got to use this opportunity to talk about where we've been and where we are and what we see in the market today. We are approximately 5 days short of our 4-year anniversary of the birth of the company. I'm really proud of what we've done and the accomplishments of our team, and use this opportunity to thank the team that's made this company as one of the biggest and most successful in this year in the public markets. So far, in 4 years from a standing start, we've invested more than $9 billion of capital. And we've done so, it's interesting to note, even though credit spreads have come in and the world has gotten more competitive and lenders have entered the market, the leverage yield on our core business is about what it was when we started. And as we told you during multiple conference calls over the last 4 years, as our credit facility spreads narrowed, we were able to keep our net yields on our mezzanine positions or I call them the [indiscernible] relatively consistent despite the volatility in the market. We have now built up the largest commercial real estate platform in the United States and with a total enterprise value well in excess of $7 billion. I am really proud to say that I recently saw some data that said we are the best performing, not only are we big, but we are the best-performing commercial or residential mortgage REIT over this time period in United States. We also secured something like $2.4 billion of credit facilities, and when we started, we couldn't get any credit facilities, from 7 district [ph] institutions, and we've completed 2 very shareholder-friendly converts that Stew mentioned with coupons less than 5% to continue to raise our ROE and provide long-term stable financing for the company to execute our business plan. We've also grown our dividend from 0 to $1.84, and obviously, with the horizon, our core earnings and also our earnings clean of the one-time LNR transaction, we'll have to be evaluating a dividend as we go forward. I also think we've delivered on our promise of a best-in-class transparency. You can tell we've overdone it for the quarter. We've been predictable and we focus from the start on safety, and by safety, we said we would diversify our book and we've done so not only by product type, but by geography and also internationally, as we've grown our European lending operations. We've manufactured an ROE that has been consistent even as the debt markets tightened. And I think we've also penalized ourselves by entering the single-family business, which we think, obviously as major shareholders ourselves, is a really good move for our shareholders long term, and I'll talk about that in a second. I also think we've been doing this long enough to have been through -- I think this might be our fourth cycle, or mini-crisis in the credit cycle when rates rose or the markets froze. And -- but it's pretty interesting that we ebb and flow our lending activities. We always have a conversation for being with boys in the team, are we being competitive, are we remaining best in class. And I will say that we feel like at our scale, we could win every loan we compete on but we choose not to. We are very concerned about credit quality, the quality of the assets, our debt yields. And I would say that I'm equally pleased, maybe most pleased about the great synergy that's developed between the equity shop and the nearly 300 people that work at Starwood Capital Group and the team that's dedicated their activities to the REIT both in their San Francisco main offices, as well as the LNR team. And I think the best is ahead of us with LNR. We've been spending our time, as Stew mentioned, we did a reduction in force that we contemplated to rightsize their servicing operations for their activity before going forward. That was completed smoothly by their CFO and COO and President, Cory Olson. And that integration has gone well, but it's really about what's going to happen going forward that we're most excited about. I also see today, which I've mentioned, acceleration of lending opportunities in Europe. There, that business is led entirely by SCG's team over there. There are no REIT personnel in Europe at the moment, and so the REIT gets the benefit of the activities and the overhead of Starwood Capital Group as it should. SCG's also led the acquisition of the 701 investment in New York. In fact, the deal had a total of high-yielding above a 14% return on equity that was split, per the documents and the agreements we have with the board, between 75% to the REIT and 25% to our opportunity fund. And also SCG led the acquisition, incredibly complex acquisition, of LNR from start to finish. It was an interesting quarter and it's not obvious how wild a quarter it was. First, at the macro level, interest rates did rise nearly 100 basis points. That was an interesting thing because a lot of the conduits stepped out of the market, and with the street not willing to hold any inventory, they held -- they've gotten pretty tighten on spreads. Some of them found themselves having to securitize paper with no spread at all. That was really good for us and it remains good for us. And in a rising interest rate environment, conduit lending, fixed-rate lending is hard to do. It's very hard to hedge these positions today, and they're reluctant to lay themselves out and expose themselves to a rising interest rate environment. So this period is actually kind of fun for us. The conduits, in fact, as many of them have shut down waiting for a more stable interest rate environment, as they've watched the machinations of the Fed. It's really kind of, as I've said, very good for us, and the universe was what -- the odd thing was what's happened to our stock. The stock was probably swept up in selling of ETFs or the mortgage REITs, hence, the residential mortgage REITs have probably swept up in taken significant hits to their book value. I think we couldn't be much more different from a lending perspective than the resi REITs, which might be viewed as our cousins. And we have, as Stew has pointed out and I'll repeat and we mentioned on the convert call, a very little exposure to rising interest rates both, as Stew mentioned, because of the nature of what we've done with double-digit returns in our fixed income book and also the duration of our book. Our book tends to be shorter. We actually anticipated from the very start of the company a rising interest rate environment with an average life of something like 4 years, you're not going to have a kind of volatility in your paper that you have in 30-year paper. We also are modestly levered. We don't have 5:1 or 7:1 leverage and we're not mismatched on term. Many of the residential mortgage REITs finance short and invest long. We don't do anything like that. So we're kind of fixed across the board. We saw a very little impact to volatility in rates. And actually, because of the floating rate nature of not only our core book but also our pipeline, we actually do better in a rising interest rate environment so long as we've been able to keep our LTV so low. And LTVs have stayed around 65% to last 4 years and I find that quite shocking, but it's a wonderful thing and shows you that we've been very disciplined since we've started. It hasn't been just about being big. It's about being big when it benefits the shareholders and the strategy that we're trying to deploy. 60%, almost 2/3 of our book is floating and what's fixed is match-funded. So we have a wide margin of safety on the paper we carry on our books. I think we've distinguished ourselves over the 4 years as the go-to guys. We're seeing most of the large loans that fit our criteria, we have a chance to look at. Unlike many of our -- some of our peers, it's pretty clear exactly what goes where in our firm. An NPL loan, we don't do NPLs in the REIT. We've never done them in the REIT. That's on the commercial side. And loans that are at ROEs over 14% are split between a REIT and the opportunity fund. So we don't have any other vehicles to place paper in and everything towards to the benefit of the shareholders. We are, as I said, very capable of lending everything we bid on but we've been choosy. And we're choosing also the price of our capital at a fairly dear price. Our pipeline loans are better than 600 basis points over LIBOR spread, and we choose to use our capabilities and underwriting real estate, in being flexible, in working with borrowers, using our relationships, our ability to close things quickly to get excess pricing that works for our borrowers and many of them come back to us and look at us for refinancing or doing additional transactions with them. And as big as we are, we are a tiny player in the market, so our growth opportunities are relatively unlimited. And it is the truth that the bigger loans that we're capable of doing and we'd like to be able to do even more, and now we're working on increasing our credit facility as well as tightening the spreads on our credit facilities. The big loans are typically better credits in bigger cities with better sponsors, and they build a better, higher-quality firm. So being big really helps. Looking out in the future, we'll continue to look at adding cylinders to our company or I call them having 12 cylinders, and any one of them may not be firing at a time, but the other 11 will be working. So we'll continue to work on expanding our capabilities, and that was kind of the core -- one of the core reasons to do LNR. LNR may be regarded as a special servicer, but it's less than 1/3 of the value of the company when you look at the way we've allocated the purchase price. There is a conduit lender that's very successful. There's the CMBS book that's kind of unique to the scale of what LNR was that we continue to monitor. We have deployed capital in the quarter behind the LNR platform, and they continue going forward to look at the synergies and unique proprietary opportunities we [ph] might have to lend behind their special servicing book. But in general, the servicer is not the core -- it's not even the majority of the purchase price of the LNR transaction. We've also talked last quarter and I'll talk again about the spinning off our residential portfolio. We continue to look at that obviously, this -- we've been investing this much capital in this business. You can see from the financial, has been dilutive to the parent company. But I believe it's a legitimate business that we can talk about, maybe in the Q&A if you want to. I think you will achieve leverage double-digit yields, but I think it is an equity play. And as such, I personally don't really believe it belongs in the company long-term. And as I mentioned, it is hurting our EPS both for the year and the quarter and it's incorporating our guidance. But I will also distinguish what we've done against some of the other players that have gone public or tried to go public. We have split our purchases between NPLs, nonperforming loans, that was typically bought from financial institutions, as well as acquiring single-family homes in the open market and target markets. And we've done so with about an 80% broker opinion of value acquisition price. So if you take the $580 million and you were willing to say with [ph] their worth value, then you have nearly $100 million gain in the book value of those houses. That's $0.20 on roughly $580 million. I think that's close to $100 million. That is not only a tiny fraction of that, a small markup of a couple of pennies. It's included in our fair market value number that we gave you of $21.77, the book value per share at fair market value. So we haven't embedded gain in that. We've chosen to be very picky how we buy houses, and we could have been 5x the size and maybe we should've been, but we chose to, as we always do, try to find value in our acquisitions. And on our NPLs, our average purchase price was $0.64 of broker opinion of value. We've also not bought certain markets and focus in others and that's been included in our disclosures. So you can see the portfolio and where it is and we'll talk later about why we did what we did and where we did it. So I think also going forward, I want to specifically mention that upgrading the consistent ratings on the servicer in the upgrading of Hatfield Philips. Hatfield Philips is the largest servicer in the U.K. and Germany in Europe, and we will look forward to taking advantage of their scale and their positions in Europe as we identify paper. And that is a very unique business that we acquired in LNR, that is somewhat the sleeping beauty. Hopefully, we will be able to extract value off that platform going forward. And I think as we spin out the residential book, we will continue to boost the ROE of the firm. And I think uniquely, you've known that we've been probably most proud that we've been a good partner to our shareholders, that we've not issued dilutive off secondary offerings and we've done now $2 billion of paper converts that are exceedingly attractive for our shareholder basis. We seek to become a major player in the financial markets and the commercial real estate finance industry. So with that, again, I want to thank all the guys, Andrew, Boyd, to Cory and the team at LNR for all their hard work. It's a lot of work. I look forward to reporting clean quarters going forward. They won't have all this noise of unusual GAAP expenses and severance payments to the LNR team and the earnouts on their contracts. But so hopefully, that will all be behind us and we'll be able to report clean earnings. I will mention one other thing about the quarter is it's actually unusual for us not to have any securities gains in the quarter. So usually, we have a prepayment or somebody pays us back on something and we didn't have that happen this quarter, which is somewhat unusual. Maybe in the first that I can recall that it's ever happened to us. They're hard to predict, but they usually are recurring, nonrecurring events. So hopefully, as you know, we still have significant paper that discounts the book, and some of it, will probably pay off and create additional earnings for the company going forward. So with that, we'll take any questions.

[Operator Instructions] And we'll take our first question from Joel Houck with Wells Fargo.

I guess the first question is maybe obviously, the origination pace in Q2 and post-Q2 is very robust, and maybe that's a result of some spread widening we've seen. Maybe if you could comment and provide a little more color in terms of where you see value in kind of what I'll call the traditional Starwood business and what the pipeline looks like going forward.

This is Boyd. The pipeline today is as robust as ever. It's -- I guess, it's a combination of a whole host of things coming together. It's very common that before, we've become sort of a go-to player for big transitional transactions. Right now, the pipeline itself is very diverse, both by a property type as well as geographically, domestically. And then there's several solid deals in the U.K. that feel imminent [ph] . It is the competitive environment, but in the end, there's a very short list of players that we compete with on these large transactions. Retrospectively, if you go -- our average transaction was roughly $65 million to date, but if you look at our current portfolio, our average -- the average transaction in the current pipeline is more than double that right now. So we really are focusing on a lot of large transactions, that our scale enables us to, as Barry said, feel like we can win them when we want. One other thing I would just point out is that one of the things that I love about this business especially when LIBOR is at 25 basis points is that virtually all the transactions we do we're lending to a borrower who's got a transitional underlying transaction, and so by definition, they need prepayment flexibility, and by definition accordingly, they expect the loan to float. So we're really building an enormous portfolio of loans that float over LIBOR. And when LIBOR's at 25 basis points, that feels pretty good to me. The overall pipeline, I'd say is, what is it, $3 billion? It's right now, pretty big. I didn't even want to use -- I didn't want to -- it's solid, and we're calling through it and picking our -- we call it cherry picking, picking up deals we really like the most.

Well, and I'll point out that it is difficult as it's always been and that's been consistent quarter-to-quarter on the timing of the closings. We don't get to choose when the borrower closes. And we like it when the asset close because then we know we have to close. But when they're just doing refinancing and the work in Europe particularly, guys are usually buying back their loans, term loans from a bank or -- and then they keep negotiating and it's sort of hard to predict. And the good news is we have many pieces of paper today. We're not -- we don't have 7 loans, we have over hundreds of loans, over 100 direct loans and obviously LNR of $17 billion of special servicing assets. So the pipeline is -- as I said, ebbs and flows, right now, it's flowing. It's not the ebbing part. It's flowing.

As Barry said earlier, the spike in rates helped cause the back up in the CMBS world, which pushes people back into our hands. So that really helped, and we're still feeling that.

And one other nuance with the market, as you probably know, the wise [ph] companies tend to be more aggressive in the first half of the year than the second half of the year as they put out their allocation. So that's good for us, and we'll see how that works going forward.

Okay. I guess more of a numbers question. The income tax provision for LNR, it looks like about 25%. Is that indicative of what we should model going forward, that rate?

Can you repeat that?

It looks like the income tax rate with respect to LNR, the TRS is around 25%. Is that a good estimate going forward?

This is Stew. I'd say that's on the -- I would say that would be the high side. Their earnings for the quarter were very -- were lumpy and very strong. We had a few sort of extraordinary, as it occurs in that business, recoveries of -- ease in recoveries and some other things that pushed income up for the quarter. In general, we do expect the quarter to be in sort of a more normalized run rate. We'll probably have a little lower tax rate.

They're at $40 million in 18 days that weren't included in the quarter, so they nearly doubled their earnings in 18 days. They just -- all that money just went against the goodwill provision for the company and bizarre accounting. So we effectively reduced the purchase price by $100-something million. They earned while they were kind of being held at for our benefit, and we got the approval to close the company. It's -- I'll say this about the LNR transaction. So far, the pace of the diminishing of the special servicing book is ahead of our forecast. It's not going down as fast as we thought and modeled. And Cory and his team have done a pretty good job of rightsizing our G&A ahead of our estimates. So yes, we're -- and we're deploying capital, which we didn't really model the B-pieces, which is a new line of business for us. It's hard to predict, but they are uniquely qualified to be fueling special servicing in B-piece buying because I know many of the loans, and they can underwrite them in a way we never could because the loans are different, small and just too many of them. So all of that stuff is we hope very accretive to the company long term. And I think we're one of the top 5 B-Piece buyers. But even there, we choose not to bid on certain paper, and they're pretty picky.

And Joel, this is Andrew. One other point to make is that, as Stew mentioned in his remarks, when we've modeled this transaction, as we restructured it today, all of the special servicing income sits within the taxable REIT subsidiary. We have been looking at ways and have been in dialogue with the IRS as to different structures to use to potentially move some of the special servicing income out of the TRS, which, depending on what tax rate you want to use, could provide some incremental...

Don't model that. If we can get it done, that will be great. We'll let you know.

And we'll go next to Ken Bruce with Bank of America Merrill Lynch.

My question really kind of starts with where Barry was ending his comments in terms of the size of Starwood Property Trust. It's obviously grown quite significantly here in the last few [ph] years. And I'm wondering, is there any natural place that you think this business should be in terms of its ability to turn over capital and essentially support the lending function? How should we be thinking about the longer-term growth potential for the company because you're kind of in the situation where, as you pointed out, the market opportunities are quite attractive, there's been the ability to raise capital in an accretive manner. Where do you think this business naturally should get to?

Well, it's unclear. I don't know the answer to the question. As long as the market appreciates what we're doing and we're delivering, I'd say terrific dividends at a very attractive risk profile, I think they'll continue to be open and support the growth of our company. And if we can do that, keep the stock of [ph] book value or even higher than book value, like that may be spread further away from books. It can be a better machine the bigger it gets. And I kind of look at it a little like Wells Fargo Bank, and I'm giving them a compliment here. They survived maybe better than some of the other real estate-laden banking institutions by keeping their LTVs quite low. And the real estate -- they're the largest lending bank in the country, and they should by all rights have seen that disaster when the world ended in '07 and '08 given their book. But because their LTVs are low, they also had lower funding costs than many major other institutions, and they weathered the storm pretty well. And I think for us, we're trying to follow the same kind of philosophy, better loans, bigger assets to allow us to borrow on our credit facilities or secure fixed-rate or floating-rate seniors on our paper at tighter spread, yielding higher ROEs. And then we have to have other cylinders that thinks [ph] business lines that we can execute on when there's nothing to do or less attractive things to do in our other -- in our core business. So we continue to explore other areas that we might want to be in lending, without getting too exotic. I don't think we should have to explain in gross details and you not capable of modeling things we're doing. We're not going to go into Angola and make loans on gold mines with [ph] kickers. Not that there's anything wrong with that. It's not our business plan. So we're going to keep this as core and understandable as we can. And we think, long term, the shareholders will reward us for that.

Right. And just in the context of the market opportunities you -- that you're -- we're viewing today, is there evidence of any diminishing returns? Have you -- we've been very encouraged by the ability of Starwood to produce very consistent returns over what has been, looking back, a very unstable market backdrop by many respects. So are you just able to essentially pivot towards different parts of the market that give you this return bogey that call it the 12%, the 13%, 14% range? And do you see a kind of a collection of opportunities that are out there? Or are we seeing any evidence of diminishing return, that it's just been interrupted by, in a sense, the back-up in rates in May and June?

I'd say that the market's gotten tighter. I'd say that, overall, it's tighter. Maybe at the moment, it's better for us. European yields are a little better than domestic yields on the retained piece. But I would say that, like-for-like, you're probably a couple hundred basis points inside of where you started in '09, like [ph] just scrubbed it directly. I mean, I had credit facilities that were wider by probably 100 basis points from where they are today in '09. So that absorbed some of the decrease in pricing that you had to chase to stay competitive. But I would say 10% to 11%, we have seen guys in 8s and 7s. And again, if you're buying off the Street, you see mezzanines at 7%. We don't play there, and we have to be the manufacturer, not the buyer off the Street. We will not be competitive. You see still many money market funds, hedge funds, big money managers buying paper at -- fixed paper at 7%. And again, for those of you who are new to our business and we are writing very wide mezzanines or B notes. So we make a loan, with the average loan-to-value is 65%, the A note might be 45%, 50%, the B note would be 15 points in the LTV stack. In the old days, that B note would have the same yield, but B is 72% to 73%. It might have 12% yields but of a totally different risk profile because it was 1 LTV basis point or 100 basis points wide. So there's more safety in it. And as you look at that sheet that we give you in the disclosure statement, it shows you that almost -- if you took out the 50% -- the 0 to 50% portion of our book, our permanent book, which would be AAA, that would trade today at 105 [ph] over the curve. So the -- like in this curve, if the average duration of paper's less than 5 years, the curve's about 30. That would be 230 [ph] paper, something like that. And we're paying out 7. So it's kind of a so far, so good. But I will say that we will have to follow the market. If peers are price leaders and start winning every deal because all they want to do is be big, we're going to have an issue. So we're trying to keep our ROE up and -- but it's good that the market has sort of sorted itself out. We don't have in a public market that many guys who can do the scale of what we can do. So...

Okay. I was going to add, you were asking about diminishing returns. I think that our scale and the rate at which we've grown, has been a huge advantage and allowed us to avoid having to go down to the lower -- those yields that people -- when people are buying things at 7% or 8%, those are typically very small shops that are -- that don't have the scale and the enormous number of [indiscernible] .

And they can't warehouse the deals, so we'll talk about for one, as the example, is the loan we made on Hudson Yards. There, we haven't sold them, we are funding the construction ourselves. Though [ph] spread was wide enough and a structured transaction that it's -- I think I won't tell you what it is, but it's pretty damn good. And later down the road, we're going to lever that position. We're not going to lever it today. We're going to wait until we get a really good price on the A-note when we sell it, and that'll boost the yield on the paper substantially higher, probably 400 to 500 basis points higher than it is today. And that's a big loan. But we can do that. We have a balance sheet to do a very large transaction as we did in 701 Seventh Avenue. So I think those are really poster child deals that are kind of things we want to focus on. And the best case for us is a 40% leased office building in San Francisco or where the debt yield's low, the lenders don't want to do it, and we step up and make the loan because we feel very comfortable on our basis [ph] on the loan and -- so then we get paid for that.

Sounds good. Well, you've had some amazing -- your pricing discipline or just stayed out of the price-sensitive parts of the market, so congratulations for that.

And we'll take our next question from Jade Rahmani with KBW. Jade J. Rahmani - Keefe, Bruyette, & Woods, Inc., Research Division: I wanted to ask what kind of runoff rate you think is reasonable to expect on both the special servicing portfolio and the legacy CMBS portfolio? You mentioned the runoff was coming in better than you expected. What do you expect in modeling in your guidance? And also if you could comment on 2014.

We don't do want to do that yet. And like I said, it's kind of a -- obviously the company has its view, and we don't want to give you that view yet. I mean, we'll probably update our guidance at the end of the third quarter for 2014. I can't say it's directionally up, not down, but we don't know. It's a funny business because it's not that easy to model parts of it. And I don't think -- what Stew mentioned, the fair market value marks on the CMBS book, I don't know if that's going to be a big deal if rates kind of just sort of stay here. Our view, by the way, relevant to our businesses is that rates probably won't move materially over the next 24 months or 48 months. Maybe you'll see it 2.75%, 2.85% to 3% or maybe even go to 3%. We're fine with that. That's actually good for us. And it is, as Stew said, you have this -- I mean, Boyd said, you have the big call on LIBOR. If they ever increase LIBOR for us, we're going to earn better numbers. So embedded in this is, is a free call on interest rates, which is kind of interesting. And we would clearly increase our ROE dramatically if short rates went up. Well, somebody mentioned short rates. It really isn't short rate. They're our friend that's -- the long rate is -- being volatile is good for us because it keeps the conduits kind of sidelined. Jade J. Rahmani - Keefe, Bruyette, & Woods, Inc., Research Division: With the -- do you view the rate volatility as potentially slowing the runoff rate on LNR? Is that what the driver is or...

That's an interesting question. I mean, higher rates are good for LNR obviously. There's more defaults, more things will fall into special. I think their named servicer at 100 -- it's $110 billion [ph] or something.

131.

Is that Cory or...?

Yes. 131 deals.

Thank you for that. And, Cory, do you want to answer that -- any of these questions? You want to give him a little color, so they can...

Yes, I think clearly, to the extent that we have a rising interest rate environment that, generally speaking, is going to drive more defaults and more assets into the SS [ph] book, I don't think, per Barry's comment, we want to target a specific number of runoff for you for the SS [ph] portfolio. I will tell you we monitor it on a monthly basis. And as was mentioned, I think, in the opening remarks, our fee income, our special servicing fees are coming in significantly higher than expectations. And the portfolio is tracking right about on plan, so both good factors for us, higher fee income and the stability as it relates to our underwriting for the runoff in the portfolio.

When he says plan, he's actually not talking about Starwood's underwriting, they had [ph] a plan that was more aggressive than our underwriting for the acquisition. So they're doing just fine. I will mention that the CMBS book that we have is fairly short duration. And you can see by the financials, by the disclosure, that we've marked it at a fraction of its face, right? I mean, it's like, what, $0.20?

Yes.

$0.20, so that's -- we have this natural hedge, which is kind of fascinating. And they're unique among the special services in the scale of their CMBS books. There are other -- there's 2 other major players, they don't really look like this. So you have -- if the rates get -- go down as CMBS is worth more, and if rates go -- and the special services are worth less, maybe because you can refinance and the opposite holds true, if rates go up, the servicer gets more stuff, and the CMBS might be worth less. But we're pretty -- there's a lot of -- some of what we own are fairly liquid positions and as Stew said, we mark [indiscernible] checkmark so we're hopefully bordering on being conservative. And I think I can tell you for a fact, we're pretty conservative. On a number of things that we have trouble marking, we just don't mark them or we keep them at 0. So they wind up being positive surprises. Jade J. Rahmani - Keefe, Bruyette, & Woods, Inc., Research Division: I have 2 other quick questions, one, on Auction.com, whether your earnings for the quarter included any of those -- the 50% share of those equity earnings? And then just on the single-family if you, in addition to concerning a spinoff, would consider combining that with another existing entity's portfolio.

So, Cory, we only take earnings from Auction when we get distributions out of Auction. I don't believe we got any. Cory, is that correct?

There was a small distribution, less than $1 million. Jade J. Rahmani - Keefe, Bruyette, & Woods, Inc., Research Division: So you're seeing nothing for that?

Don't forget we own 7.5% of that -- of the company. Is that 100% or is that -- because of the warrant, how many additional fees was...

We're only half the 7.5%.

Right. That's right. We're only 3.75% as of right -- that we own of them right now. It's kind of tiny. And there's a warrant for additional equity in their company, depending on what we contribute to their platform for sale. For the moment, it's at 0, it's an asset that has no income coming out of it for us. What was the second question on that, was it about combining them? Jade J. Rahmani - Keefe, Bruyette, & Woods, Inc., Research Division: Yes. On the single-family residential portfolio, you've put together -- I mean, there's several existing public entities that are trying to get scale. Would you consider combining your portfolio with another company in order to accelerate the size and scale of the operation?

Possibly. I mean, you could also see us be a consolidator, we'd do the opposite. While we might not be the largest, we're the second largest, potentially, of the public companies that filed, was it [ph] Silver Bay and RCAP, I think that's what it's called, as being smaller, and we're twice the size of those guys. We're un-levered at the moment also, so that not only is no earnings but there's no leverage against it. And the -- I think you're going to like we're going to do there, so hang on to your chairs.

We will go next to Stephen Laws with Deutsche Bank.

To kind of follow up on the single-family residential strategy, can you maybe talk about the timeline to expected cash flows with regards to the homes that you've purchased versus those acquired through the NPL strategy. Looks like, from the supplemental deck, that, that business had about a $0.03-per-share drag on core earnings. So can you talk about kind of the outlook of when we should see that move to breakeven and then a contributor to core earnings?

Yes, NPLs, obviously, are nonperforming loans, so they don't have much in the way a coupons associated with them there. The loans there in Florida, we had a pretty interesting development in Florida, which is they shortened the foreclosure process and that -- so that -- those loans, they'll be there -- today, if you bought NPLs in Florida, they will be trading tighter than what we bought, just the process is kind of cut in half of the eviction [ph] . What you see in the loan book, by the way, is you're going -- we're going to -- some of those assets, we'll just sell. And we have sold houses that we've gotten back that don't fit our geographic footprint or core portfolio. Others, we'll remodel in terms of rental pool or -- and others, we'll continue to work through the inventory. Our largest concentration, as you can see from the deck -- the closure deck, is in Florida with nearly 2,000 houses in loans. So that's not an accident. We wanted to be in that market. And I think all these companies here have different footprints. And just like the Avalon Bay and the associated estates, eventually, the markets will separate between the footprints of the companies and decide that my coastal strategy, it might have been a higher -- the Avalons, and we're worth more and traded better than associated states because they're in the middle of the country without any kind of growth. You might ask why we did this in the REIT to begin with. You haven't ask, but I'll tell you. So the reason was that we expected that as home price appreciation accelerated, more of the total return would come from appreciation and less from current yields. And in fact, the inverse would happen. As soon as the markets took off, and they took off faster than we thought in some markets like Phoenix, we had almost no exposure because homes rose 24% in value. That's not reproducible. You can't have 24%, 24%, 24%, 24%, 24% and 24%. So what happened there is they bid down current yields to the point where they weren't interesting to us. And we did want to keep our current yields somewhere between 6% and 7% on an un-levered basis. So double-digit on a current basis levered, and then IRRs, and then hopefully, higher -- with home price appreciation in the mid-teens. So we actually think we have a book that looks like that and will perform like that. And I guess I've been reading all the paparazzi reports about the industry or the nascent industry, it doesn't really exist as a business today. And we have our thoughts, and we'll share them later on that. But we actually -- it was an experiment we wanted to play, and we've done better on the current yields than we would've thought -- or the expected current yields on the portfolio as we lease it up. And we'll see. I actually think it is -- I think there will be -- and you probably would agree, out of the 5, 4 national or large players in the space in the public markets, and they'll take their place alongside the multi-REITs, and I think they'll be competitive from a dividend strategy and a growth perspective, and I think they will be competitive, although there may be periods of time when they're just earning the dividend and they're not appreciating, which isn't any different than commercial real estate. There are times when there's no rental growth. In fact, some markets have seen negative rental growth, real effective rents, and cap rates will pop around. So I think it can be an interesting business.

Great. I appreciate the color on that. I guess one more -- just kind of a more specific question to guide us. When we think about the new range, x LNR transaction-related expenses of about $2.04 to $2.24, is that comparable number for the first half there, the $0.98, basically, the $0.52 in Q2 and the $0.46, which will be core, x related expenses in Q1?

I don't really follow -- I'm not following your question.

Okay. I'll ask you guys -- I'll follow up with you guys after the call to try and...

Yes, sorry, but it's a clean year last year. What do we do in 2012 for the year.

Without LNR? We did 1 -- what do we do last year, we did $1.97 last year or some, right?

I was looking at the first half this year. I think you reported second quarter core, x the $0.10 in LNR, it will be $0.52.

That's correct.

And Q1, I think, was $0.46. Is that accurate? Were there about $4.5 million of expenses in Q1?

Right.

Okay. So those are the 2 numbers that would compare to the core guidance of $2.04 to $2.14 for this year?

That should work. Sure.

$2.04 to $2.24. Great. Just wanted to make sure I was getting the right numbers.

That's correct. Yes.

[Operator Instructions] And we'll take our final question from Dan Altscher with FBR. Daniel K. Altscher - FBR Capital Markets & Co., Research Division: Yes, just thinking about the taxable earnings that's now going to be coming out of LNR, how do you think about that in terms of dividend policy? Is there now a targeted payout ratio on, I guess, gap for core earnings that you can think of that incorporates the taxable earnings that are coming out of LNR?

Obviously, REIT regs still apply and we still have to pay 95% of our taxable income. I don't want to really comment on our dividend policy ahead of the board because it is -- we like dividends to go one way. I guess, it was a year -- 2 years ago, we did a special onetime last year, and we decided we didn't get any benefit from the shareholders for that, so we did raise the dividend instead. And of course, given -- if you look at the guidance, and you can take estimate of what we might do. But we'll also be looking at the 2014, obviously, and the pace of what we're doing and where the stock is. And then one of the things that we do -- I mean, we've done $9 billion of transactions and -- while market cap is x, less than that, we are recycling capital aggressively. There are loans being repaid [ph] seeing the [ph] CMBS being paid off or NPLs being sold. So we are redeploying. And our pipeline of the loans, if we close it, it might not be that we have to go out and raise new capital. It might be capital that we -- we look at our maturity schedules. And when we're open to repayment, and we try to -- we kind of like some of the -- the difference between the commitment, I think, in the quarter were like $850 million, and we funded $550 million, something like that. So we kind of like that because we know that we can match that with repayments on our loans coming in. So we look at the whole book that way and say, "okay, we got these loans coming in, they are paying off, and we have the -- we know where the proceeds are going, they're going on this loan, on Hudson Yards, for example. So that's actually -- we're trying to manage our ROE that way. What we don't want is cash. We don't want cash. It's a very derivative thought [ph] . Actually, it's the moment we don't want cash or houses. We didn't realize -- I'll explain. I would tell you, we didn't realize just how much we'd hurt ourselves, from an earnings perspective, not from a value perspective, going into the -- that business. Daniel K. Altscher - FBR Capital Markets & Co., Research Division: Yes, no, I mean, I guess it's kind of part of the market's phenomenon, too. Right? And then just last couple of months haven't been good for [indiscernible] rental space. Barry, just one last question. When you think about the recent securitization that you, I think, just completed or maybe in the market as selling, how can we think about the returns on your share of the subordinate pieces that you are going to be retaining?

Well, I mean, I think the right way to describe there are -- I mean, there are a couple securitizations that were -- have been in the marketplace recently, so I'm not quite sure which ones you're discussing. There are some we may -- the Eleanor conduit unit contributes loans on a very, very systematic basis. They have one of the quickest turnover rates in the industry, so they're contributing to 5 or 6 securitizations a year, and they haven't had recent sales. We also have a securitization in the market involving one of -- a large loan that we -- that effectively, the commercial real estate division originated, and that securitization is really akin to an A-note sale for us. It's a securitized sort of sale of the senior component of a loan, very, very much akin to the sale of an A-note. So if -- were you referring to the... Daniel K. Altscher - FBR Capital Markets & Co., Research Division: Yes, I was referring to that latter transaction.

Yes. The right way to look at that, is that's a substitute for either A note sale yields or warehouse borrowings, that you can assume that if we undertake one of those transactions, that, that's a transaction that is accretive to one of the lot to stay, a warehouse line for the same asset. In this particular instance, it reduced our borrowing cost by 25 to 30 basis points. But it importantly improves the -- it creates a perfectly matched funded, non-recourse, non-cross-collateralized financing source. But all -- for all intents and purposes, it's leveraged to produce that -- the B-Piece that we retain.

And it opens up lines and stake for the line, so it creates additional capacity for us.

And we've talked about a lot in the past. If you look -- we relentlessly utilize the sales of the A-note markets, whether they're through securitization or direct sales. As substitutes for line draws [ph] , it gives us current market, again, at market pricing, and it has all those positive risk-related attributes, whereas, in fact, if you look at the aggregate amount of -- I mean, "financing activity" we've done since the beginning of the year, my bet is A-note sales dominate new draws [ph] online [ph] by 8:1.

It's 8:1. And what the lines wind up functioning as is a warehouse for us to let the asset sit on the lines, while we run an auction and eventually sell the A-notes. In some cases, it could be 100 basis points tighter than what we were paying to have them on the line. They're a great vehicle for us. The lines to the A-note sale is interesting. In the CMBS business, people put long-time, short-term warehouse lines and sell the deals and the securitizations. In our case, we're essentially putting the loans on matched-term long-term lines, and then ultimately sell A-notes.

We are -- as I mentioned in my comments, we are working with our lenders to lower our spreads on our credit facilities to keep our -- us competitive. I'd say the bad news is we are in business for so long before this time period is that we have heritage spreads which are wider than market today. So the team assures me that's going to change. So we're going to -- a lot of effort is going into [indiscernible] extend and restructure in ways that facilitate using -- we got to be competitive on both sides of our balance sheet. Daniel K. Altscher - FBR Capital Markets & Co., Research Division: Right. And I guess the other synergy that comes along with that, that I think LNR was also named the special servicer on that transaction to you, right?

Oh, absolutely. We'll use those...

We hope that, that deal never goes [indiscernible]

[indiscernible] is if they don't make any money.

[indiscernible] Not make any money on that.

Let's assume that's of no value.

And that concludes our question-and-answer session. I'd like to turn the conference back over to Barry Sternlicht for any closing remarks.

Well, I do think it was a transitional quarter but an excellent quarter for us. It was a lot of tough work by a lot of people in both Florida, the Miami headquarters at LNR, and the team in San Francisco, as well as some of the people that will clear out the grass at [ph] the headquarters. So I want to thank them for -- in behalf of the shareholders and the board, for doing a great job. And I think it will [ph] be easier now. I mean, this was a complicated quarter for us. Closing the books this quarter was a Herculean task. And LNR has 1,000 little pieces, and we've gone and still going on -- going forward, we're actually collapsing the accounting system and other software and programs onto their system, so that is ongoing and moving ahead nicely. So again, thank you all, and we look forward to our next quarter with you.

Thanks, everyone. That does conclude today's conference. We thank you for your participation.