Starwood Property Trust, Inc. (STWD) Q4 2018 Earnings Report, Transcript and Summary

Greetings and welcome to Starwood Property Trust Fourth Quarter 2018 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to our host Zach Tanenbaum, Director of Investor Relations. Please go ahead.

Thank you, operator. Good morning and welcome to Starwood Property Trust Earnings Call. This morning the company released its financial results for the quarter ended December 31, 2018, filed its Form 10-K with the Securities and Exchange Commission, and posted its earnings supplement to its website. These documents are available in the Investor Relations section of the company's website at www.starwoodpropertytrust.com. 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 that are not -- and are subject to a number of trends and uncertainties that 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 thorough discussion of risks and the factors that could cause actual results to differ materially from those expressed or implied any forward-looking statements made today. The company undertakes no duty to update any forward-looking statements made during the course of this call. Additionally, certain non-GAAP financial measures will be discussed on this conference call. A presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. Reconciliations of these non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP can be accessed through our filings with the SEC at www.sec.gov. Joining me on the call today are Barry Sternlicht, the company's Chief Executive Officer; Jeff DiModica, the company's President; and Andrew Sossen, the company's Chief Operating Officer. Unfortunately Rina Paniry, our Chief Financial Officer, is out with bronchitis and will not be on the call today. Andrew Sossen will be presenting her section. With that, I'm now going to turn the call over to Andrew.

Thank you, Zach, and good morning, everyone. As Zach mentioned, Rina will not be joining us this morning and I will therefore be providing an update our financial results for the quarter. Feel better Rina. The fourth quarter kept off another great year for Starwood Property Trust, one, which, demonstrated the strength of our diverse multi-cylinder platform. Our core earnings for the fourth quarter totaled $155 million or $0.54 per share, bringing total earnings per share for the year to $2.19. Collectively, our investment cylinders delivered an ROE of just over 12% in 2018, despite having higher cash balances at times during the year. I will begin this morning with our largest business, the Commercial and Residential Lending segment. During the quarter, this segment contributed core earnings of $108 million or $0.37 per share. On the commercial lending side, we had originated $1.6 billion of loans across 13 investments. We funded $1.1 billion during the quarter, of which $1 billion related to new loans and $145 million of which, related to pre-existing loan commitments. We received $806 million from repayments, bringing the size of our sizable commercial loan portfolio at year-end to a record $7.8 billion. Also on this segment is our non-qualified mortgage or non-QM residential lending business. As a reminder, these are loans with high FICO scores and low LTVs that do not qualify for agency financing. As of quarter end, the loans in our non-QM portfolio had a weighted average coupon of 6.3% and average LTV of 66% at an average FICO of 724. When securitized, these loans have a double-digit leverage yield. During the quarter, we completed our second non-QM securitization. So $280 million of loans and retaining $45 million of subordinate securities. While the transaction qualified as a sale for GAAP purposes, we consolidated the related trust on our balance sheet under the VIE rules, after the sale and new purchases during the quarter of $319 million. At year-end, we held $624 million of loans and $88 million of securities with net equity outstanding for this business totaling $268 million at year-end. I will now turn to our newest segment, Infrastructure Lending, which contributed core earnings of $4 million or $0.01 per share for its first full quarter results. Although, the majority of this acquisition was completed in September, there was a delayed closing on two loans which we ultimately purchased from GE in October for $146 million. During the quarter, we received repayments of $160 million and acquired three loans with gross commitments of $96 million, bringing the total portfolio to $2 billion at year-end, 97% of these assets are floating rates. I will now turn to our Property Segment, which contributed core earnings of $33 million or $0.12 per share. During the quarter, we sold four properties within our master lease Cabelas portfolio for a core gain net of tax of $11 million bringing our year-to-date sales in this portfolio to $209 million. We have now completed the sales plan that management established for the assets in this portfolio. In doing so, we have decreased our net equity exposure by 50%, while increasing underwritten current cash yield for the remaining portfolio by 200 basis points to over 12%. The wholly-owned assets in this segment continued to perform very well with a blended cash on cash yield of 11.4% and weighted average occupancy of 98%. Collectively, these assets are financed with debt containing an average remaining duration of nine years and weighted average fixed rate of 3.8%. I will now turn to our Investing and Servicing Segment, which contributed core earnings of $62 million or $0.22 per share to the quarter. In our CMBS book, as we do almost every quarter, we opportunistically sold $76 million of bonds for core gains of $30 million. We also purchased $70 million of CMBS, leaving our portfolio relatively flat to last quarter at $1 billion. On the servicing, front we recognized fees of $12 million this quarter. This amount does not include a $2 million fee that was expected in Q4, but slipped into the first quarter. In our conduit, we securitized $692 million of loans and three transactions, bringing our total securitization volume for the year to $1.5 billion in seven transactions. As we mentioned last quarter, we had eight $224 million securitization flip from the third quarter into the fourth quarter, which drove the higher quarter-over-quarter volume. In the REIT property portfolio, as we do almost every quarter, we sold assets with a cost basis of $25 million for net core gains of $2 million bringing an undepreciated balance of this portfolio to $342 million across 22 investments. Together with the properties in our Property Segment these asset carry $291 million or $1.06 per share of accumulated depreciation. Before I conclude, I wanted to walk you through a $7 million increase for our loan loss reserve which is recorded during the quarter. We had an impairment charge during the quarter related to a $21 million first mortgage loan on a grocery distribution facility located in Montgomery Alabama that is leased to a single tenant. This loan was risk-weighted five last quarter. The tenant filed for bankruptcy earlier in the year, but the bankruptcy court subsequently rejecting the lease. This loan had an appraised value below our loan balance, which resulted in an increase to our allowance for loan losses by $7 million, representing the difference between the loan's previous general reserve, which were reversed, and a specific impairment reserve which we established this quarter. In addition, we also had a $14 million first mortgage loan on a grocery distribution facility in Orlando Florida that is leased to the same tenant. This lease was similarly rejected by the bankruptcy court. This loan was risk-weighted four last quarter. No loan losses required on this loan, since the appraised value of the assets exceeded our loan balance. The excess value was driven by our unamortized purchase discount on the loan and certain lease termination payments that we received in 2019. Both of these loans were originally purchased as part of a pool in 2009. I will conclude by remarks with a few comments about our capitalization and dividend. We ended the year with over $13 billion of credit facilities from 27 different credit providers and $2 billion of corporate debt. As of December 31, we had $3.9 billion of undrawn debt capacity and a net debt to undepreciated equity ratio of two times. As we discussed with you last quarter, we began settling our 2019 convertible notes when they entered their open redemption period. During the fourth quarter, we settle $28 million principal amount of notes with $5 million in cash and $1.2 million newly issued common shares. Subsequent to year-end, we settled the remaining $78 million principal amount of notes with $12 million in cash and $3.6 million newly issued common shares. During the quarter we also issued $1.7 million of the $1.9 million contingent OP units related to our second affordable housing portfolio. These units were issuable upon realization of certain property tax abatements, which decreased our ongoing property expenses. The majority of tax abatements have not been realized. Finally, I will turn to our dividend for the first quarter of 2019. We declared a $0.48 per share dividend which will be paid on April 15 to shareholders of record on March 29. This represents an 8.7% annualized dividend yield on yesterday's closing share price of $22.05. With that, I'll turn the call over to Jeff for his comments.

Thanks, Andrew. 2018 was another tremendous year for our company with a $16 billion balance sheet we continue to diversify our business model, our opportunities set and our financing sources, while deploying a record $11.6 billion of capital in 2018 alone. More than half of our 2018 volume came from our core business, large loan lending which originated $6 billion of loans up 43% versus 2017 and at similar risk and return metrics to what we've achieved since inception. Our capital markets team was again able to actively manage our borrowing costs lower through a combination of high-yield unsecured where we issued bonds at LIBOR plus 128 in January and were put on upgrade watch in Q3 by Moody's through the runoff of what turned out to be more expensive convertible debt, bank warehouse lines where were lowered spread and increased capacity single borrower securitizations to optimize deal-level financing and first mortgage sales. We were able to continue to lower our borrowing costs to produce consistent returns on our large loan lending business. Additionally, it's worth noting that in the last year we have consistently sold off a large junior mezzanine first loss position on our largest and most complex originations. And we've used our financing advantage and global reach to earn junior mezzanine or equity-like returns on what's ultimately senior risk in the capital deck. Going forward, we expect another strong loan originations quarter in Q1 with approximately $1 billion close to date in our core large loan lending basis alone. But like many of our peers we pulled back on investing during the market turbulence of late 2018 as transaction volumes simultaneously fell. At times of market stress, we've always raised the bar on new investments and therefore focus on only the highest value-add investments, through runoff asset sales and A Note sales, we've been able to build a cash cushion for opportunities across businesses in the coming months and quarters without raising new debt or equity capital. On December 14, we welcomed approximately 200 investors and analysts to our second Investor Day in New York City. The slides and audio of which are available on our website. Management spent over five hours going through each of our investment cylinders in detail and we're excited to have the opportunity to explain our newest cylinders non-QM residential lending and energy infrastructure lending in detail. We completed our second non-QM residential lending securitization in the quarter. And in our infrastructure lending business, we have closed over $250 million in new loans since acquisition and have a significantly larger pipeline today. We expect these purchases will achieve yields which are very accretive to our current portfolio. We have begun the process of selling down the lowest returning assets from our energy infrastructure portfolio of acquisition and expect that through maturities and sales that that portfolio we purchased in September will be cut in half within a year and replaced with new assets that we expect to contribute significantly to core earnings versus the existing portfolio. At our Investor Day, we also went through a detailed analysis of net operating income and cap rate expectations across our approximately $3.5 billion owned real estate portfolios, that add up to well over $500 million in gains or nearly $2 per share of potential upside. These gains give us significant dividend cushion and a potential source of capital that can create incremental earnings as we ultimately reinvest those gains over time. Andrew mentioned, the Bass Pro and Cabela sale which we made to date which have returned approximately half of our equity and left us with a core portfolio of 16 assets with long term fixed rate financing that now return a 13.5% cash return, inclusive of contractual rents step ups, on a company that's performing beyond our expectations since their acquisition, as evidenced by their term loan, which trades at approximately par today versus 90 when we acquired the portfolio. We also talked about our low income housing tax credit multifamily portfolio in Florida, which has seen rent increases far in excess of our underwriting, tax abatements that have added significant equity value and have additional upside in units rolled to market rental rates in future years. These apartment investments are extremely consistent and durable and make up nearly half of the overall gains in our Property Segment. Our REIT segment obtained 11 new servicing assignments in the quarter and 34 in fiscal year 2018, which totaled $21 billion in unpaid balance and brought our name servicer portfolio up to 176 trusts with an unpaid balance of $84 billion. When we purchased LNR in 2013, we were named service -- special servicer on $127 billion of trusts which fell to below $69 billion in Q3 of 2017. Through partnerships and third-party assignments we managed to significantly increase our named portfolio, despite the planned runoff of our 1.0 book, which will produce incremental revenue for our servicer well into the future and provide a hedge against credit deterioration in the broader market. Our mortgage capital continue to grow market share among non-bank lenders in the quarter and for the first time in our history grow over 20% of all non-bank CMBS loans in the second half of 2018, benefiting from tremendous historical collateral performance, long-term relationships and their standing within the Starwood brand. We've seen a dramatic flattening of the yield curve in the last year; with a 10-year treasury rate down 21 basis points from 290 to 269 while one-month LIBOR increased by over 80 basis points from 166 to 249. As interesting as that, 100-plus basis point flattening of the curve is, is that forward LIBOR is now below spot LIBOR for the first time in 10 years. You will see in our supplemental that we released this morning that we disclosed, for the first time, our estimation of the impact to earnings of LIBOR following the forward curve lower. Due to our diversified business model and the after money LIBOR floors we typically put in all of our CRE loans, our earnings are only forecast to fall by $0.01 per share for 200 basis point drop in LIBOR from today's levels, which we believe is exemplary versus both our peers and versus the $0.15 in gains we will have per share if LIBOR rises by the same amount. I will also note that we expect our property portfolio to perform better in a lower rate environment as well. With that, I will turn the call to Barry.

Thanks, Jeff. Thanks, Andrew. Thanks, Zach. Good morning everyone. Thank you for listening in. I'm going to keep my comments pretty short this morning. Well, I'll just -- and it's the beginning of the year, so I'll talk about our view for the year and even next year. I think we're operating under the common assumption or the gross assumption that the economy was slow in 2020, probably for two reasons. One is the expiration of stimulus package of $300 billion. And the second will be the CEOs and other business leaders years in headlines as we're seeing between left and right and the political battle next year. And with uncertainty comes delays in capital spending and it'll probably break the economy. I think you'll see that manifest itself in the fourth quarter of this year people anticipate the election cycle and also you're not lapping against this stimulus package, it will be zero spend in 2020 at the moment. That informs the view of interest rates. And right now, we may or may not see a June increase. Given this morning GDP forecast and revisions maybe 50-50. Don't think you'll see the December increase and don't think they'll do anything in the election cycle. Most likely you could even see a decrease in LIBOR, which is one of the reasons Jeff highlighted the impact of a drop in rates which is shocking for me to say that because I never thought we'd see the 10-year 265, frankly. So whatever these comments are worth it, I'm shocked. You have virtually negative real rates again in the United States and across the world and the weight of all the quantitative easing around the world has kept rates lower everywhere, which has created some interesting opportunities for us. And one of those which is not obvious to you probably is that our pace of investment offshore has picked up. So we had a book of roughly $500 million -- actually, even less $326 million in Europe in 2017, those were the loans originated in our book. In 2018, it was almost $900 million of investments offshore, almost all in Europe and what we call the wine growing countries.

Beer drinking.

Beer drinking countries, sorry. Yes, it's not Southern Europe. And this year, 2019, we've already closed or committed to around $450 million in just February. So you're going to see us diversify and achieve our LTVs now through our infrastructure investments. We have 55 people in London and a dedicated debt team. So I'd expect you might see us continue to increase our lending internationally which is exciting and that's what our job is, to be a steward of capital and earn the highest risk-adjusted returns on the capital, which goes to our thoughts on the complexity of the business we built, which were in my comments and in the press release. And we're -- I think you all know we probably have the higher direct ownership with any mortgage trust -- or, what we call, finance company in the business today, which positions well over a $100 million owned by senior management. So we treat our investors capital just as we do with our own, because it is substantially our own. So my theory is and that we should have multiple business lines and we should never have to force capital down the sleeve where the risks exceed the rewards. And so, we've built multiple product lines and excited to see what we've accomplished in the nearly 10 years since we started, with the near non-QM business and now the energy lending business. The energy lending business, I'd say, we lagged into. We paid a price that probably was slightly higher than we would have liked at the end of the day. But I'm really encouraged by the pipeline and the new commitments we have, both what we've weed close and what we expect to close, which will probably exceed the return on our real estate book, which was the whole point of getting the business anyway. So you'll see us in a year of semi transition as we have the maturities and sales of lower yielding notes and then the ROE and the business will increase and basically contribute, we hope, meaningfully to our earnings next year. But it's a really exciting vertical and so far we're doing better than we under wrote on new originations and we're pretty happy about that. And I'm excited that is not correlated to our real estate book. Although, I understand the complexity we've now thrown on the analyst community, because those of you who follow property don't know much about energy. But bear with us, because it was a 10% of equity. It wasn't a giant trade, it will be even less. We'll probably keep it around that $500 million of equity deployed in the 5 base or something like that. I also think that again you have to look at where we are in the cycle. The slowing economy is good for us. We like rates low. Slow growth is nirvana for the property cycle. It doesn't induce tons of new supply, people are kind of reticent to begin construction. You've already seen those factors in the multifamily start numbers you saw I guess this week. And one of the reasons driving the drop in construction is the extreme rise in construction prices. The cost of construction is up probably 10% in some markets year-over-year, driven at least half by labor, which is really scarce and also by materials, particularly steel prices in high rises. So existing property and all of our roughly $8 billion of loan book is worth more, because it's harder to replace and rents have to rise and to justify new construction. Slower economy, rather than a galloping economy, keeps the real estate community, development community, keeps their capital in their pocket as they contemplate whether they should start consumption now or not. And the banks, God bless them, have been incredibly disciplined in the cycle and remain disciplined. We don't see -- the excesses we see in the lending market come from the non-bank lenders not from the banks and that can include offshore money particularly in the mezzanine market that searching the goal for yields and sometimes I think doesn't really understand the returns that their -- or the -- where pricing might be if there we were not. So we've taken advantage of that and we've actually layered in recently in DOE with a scene of -- we took the junior -- the senior mezzanine and not the junior mezzanine and pushed ourselves way down in the stack. So to achieve our returns there with safety, which has been our model from the start and we could run this company at higher ROEs but levering it up further and more like our peers. And we've decided not to do that and we're trying to deploy capital consistent returns and be safe and disciplined and predictable. And the diversification, which some of you don't really like gives us -- allows us to sleep at night. There's no one thing happening anywhere that's going to injure the model. The other thing I -- two things I talked about Andrew mentioned it briefly on this. These two loan losses or one loan loss will have -- we brought that portfolio in 2009, nine years ago. So that was a different team actually it wasn't even this team. And this was...

Two teams ago.

Two teams ago. So...

None of both impairments were taken.

Yeah, so we've never taken the impairments anyway. So those are -- in a book of large actually I think we've originated over $24 billion of loans in the 10 years I'll take that ratio. Pretty impressive actually I'd say nine years later, so we've got a lot of earnings out of that thing for a long time and then belly flop by the borrower. The other thing is -- it is really something when you see the servicing book turnaround and the name servicer go from 64 to 84 or something billion dollars. I mean that's super exciting. You're getting a free option on the collapse of something down the road. And you're not paying for it. There's not a lot of earnings coming from bit but we're excited to see LNR continue its growth and the teams are doing a great job. And the other thing we mentioned, we talked -- we're always going to have gains most likely. I mean, we have these gains in our book. We told you about them repeatedly including at our Investor Day, which Jeff mentioned then. They're recurring/non-recurring. We understand that that they're not easy to underwrite but if you look at companies like Ladder, which I'll mention by name, which I don't often do, I mean they're doing this for a business. That's what their businesses. They make investments, they trade a pretty good number right now relative to us and that is a business recurring/nonrecurring gains, they invest, they lever, they take harvest they take gains and that's sort of a portion, a small portion of what we do all the time. Because for us with the database we have it will be foolish to not take advantage of that. We always have information on this trust, we buy and sell securities all the time and hopefully their guys are doing a job and we're making money. Interestingly if you look at our portfolio split. Things like our conduit slow down this year. It was down year-over-year, but it's a good business and we -- and it's a high ROE business. And so we are able to observe that with other business units that we have. And I think -- I'm really pleased with the team development, but we've never been had a bigger footprint in the market. Jeff mentioned our conduit market share of nonbank originations of ROE and then our lending team led by Dennis and his group have done a great job. And we probably see every -- most obviously 90% of every large loan and maybe 90% -- yes probably 90%. And we balance, you can see us we're doing very diversified book. I mean we're both by product type, by geography, within the United States, and then outside the United States and this is a diversified company and what we're trying to do is convince the market that they should divorce us from book value. This company can continue to produce high ROEs on the dollar. You give us $1 we'll give you $1.12 back a $1.14 back all the time from our various lenders. Someday we might exceed that in the market. We still have a dividend yield, which is widely too far away from the risk that investors are assuming. That is -- you ask me about 10 years, the one thing that surprises me is the shared fixed dividend yield. Given the quality of the world and verification and the multiple business lines. We look more like a bank than we do like a mortgage trust. And that's what we intended to do and we'll hopefully we'll find other lines of business that will meet or exceed our ROE targets. So with that, I think I'm going to stop. I want to thank our -- it's annual time I think our board has been very involved and disciplined and supportive of our strategy execution of the team, which is 300-plus people I'm speaking here from Miami where the real estate service is based and the LNR team as well our teams all over the world that help originate bonds and contributes hopefully a virtual cycle for the company. So with that, I think I'm going to stop and take -- we'll take questions and thank you for listening.

Thank you. At this time, we'll be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Doug Harter with Credit Suisse. Please proceed with your question.

Thanks. Can you talk about your outlook for asset yields in the commercial lending segment, given the flattening of the LIBOR curve you talked about, and expectations around competition on loan spreads?

Spreads gap out in the fourth quarter. Well, there weren't a lot of trades both you can't finance assets that are on trading so -- and one of the reasons was the financing markets kind of gapped out a little bit AAA backed out and they've now rallied. And again as the market settle in and obviously Dow, S&P is up. I don't see any material pressure on spreads right now looking at Jeff and saying I think they're of consistent with what we've done before?

That's right. And if rates rise there is certainly some upside to spreads widening back out here.

We love to mold some molds are good for spreads. So we don't mind a more choppy market. But we do need transaction volumes in order to finance anything. And I don't see much pressure at the moment. It's more asset selectivity what do you want to lend against, where do you think your catchment points are? And we've been super cautious on high-end residential in New York City. So things like that. We're not just in the market to finance condo construction in New York. And that's proven - we've been saying that for three years probably anticipating what becomes a pretty tough market on the high end. So -- and we have other markets like that that will be -- will wary of. And it isn't really the spread it's really Doug it's our LTV kind of wind up. We think its 63 against 83 because the asset that is going to decline. We also stress test our book and looked at what happens for a 10% or 20% decline in property value. And Jeff you want to mention that? Because I think it's kind of interesting.

Sure. We did stress test over New Year's, which the team wasn't that happy about doing but coming off December 14th to December 24th contagion. That seem like it could continue for a while. We thought it was important. So for Barry we did a Draconian scenario where we said 20% decline in real estate values and a 250 basis points widening in all of our securities. And we looked at the cash that we have on hand that we routinely hold. And we do routinely hold a tremendous amount of cash as a conservative way of being ready for opportunities and obviously being ready for spread marks or anything else that could happen in our portfolio. And we realized that we have more cash on hand at that time than we -- than in that Draconian scenario of 20% down trade in real estate prices and a 250 basis points widening in securities. That's all interesting that it all happening in one day.

We can observe that all in one day.

Never, never happened. And the company would be fine. So there's no -- we stress test that against all of our bank lines, credit facilities, repos, the whole enchilada to make sure that we can withstand that. But Jamie Diamond said sort of maybe that systemic event. And that was something the board is supposed to do in risk assessment and so we did it ourselves.

And I'll just note it's something that we've done historically for the rating agencies as well. So from a risk perspective for the company we do at least annually.

Yes, Barry I'd add that there's still tremendous amount of powder on the sidelines. I think we expect to see transaction volumes to be fairly significant again this year and that will have a tremendous not of loan volume to choose from if rates do follow the forward curve lower that could mean wider spreads, but in general, we've seen slightly--

Actually that's a good point. What we saw is spread rates rose those spreads came in because lenders were pegging a nominal total return. It was 4% or 4.5%. That is most likely to happen if rates drop, spreads will widen. So, they wind up with the same kind of nominal rates of return. That's kind of sort of a boycott of buyers -- that so as the rates fall. So, it is fascinating also the data that Jeff gave you on 200 basis point drop in LIBOR. So, the Fed economies weakening, they lowered the short end again just like they did last time which of course is what they are setting themselves up they have the ability to do. And we lose a $0.01. I mean that's -- from a floating rate book, that's kind of shocking. So, that's good news for us and good news for the company and our shareholders.

And then you guys mentioned that the biomass at this time was a purchase loan from prior origination team and I believe the other ones have been as well. Can you just update us on the size of that remaining portfolio? How much of the portfolio is kind of originated by the current team versus prior teams?

Interesting questions. I'm not sure we have the answer at hand.

100% I'd say, I have a graph, but I think I can answer the question perfectly.

Okay. While he's looking for the answer we'll take another question. We'll come back and answer that one. Rina is not here. Rina was out. But she's like horizontal most likely [indiscernible]. Hold on we have the answer. Almost nothing. Well, these are -- that looks like nothing. Like four or five loans from 2009. There's none left from 2010, none from 2008, none from 2011. And maybe it looks like one or two from -- and I can't tell because this is just little dots, it's a bubble chart of size.

We'll come back and give you the exact -- by year.

Looking at this it's probably 3% of our loans something like that. It looks to me -- I think that's all of it. Yes, they're -- there are four Winn-Dixie loans right from 2009 of which two are the ones that are impaired.

One.

One -- sorry one is impaired.

And the other one we do not expect impaired. I don't expect an impairment.

That will fall from rebound. So, anyway that's the answer, almost nothing.

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

Thanks very much. I was looking at the 10-K, noticed two interesting trends on credit in the quarter. Number one, the percentage of loans in the risk-rate two category increased quite notably. So, that's a strong credit improvement to about 36% from 31% last quarter. So, wanted to see if you can give color on that? And then secondly, the LTV on new originations was 69.5%. Nothing alarming there, but a tick-up, I don't know if that reflects may be a move to later transition or anything else. So, could give any comment on both of those facts?

Sure. Sure thanks Jade. I appreciate it. And I appreciate you digging out that specific. I think on the first one the percentage moving to two. We do have a -- we've in this business longer for the same reason we just talked about how a little of our portfolio goes back to 2011. We do have a lot of loans from 2013, 2014, 2015, and for the most part, those loans have performed very well. And as those loans -- legacy loans performed well and the benefit of the length that we've been in this business and the percentage of moving to 2, it makes sense to me going from 31% to 36%. As for this quarter, there was one relatively larger loan. It's fully guaranteed by an investment-grade counter-party with a construction loan that allowed us to go up a little bit in LTC. So, we're just about 80% on that particular loan to S&P 50 Company with a lease that they cannot get out of. So, we feel very comfortable going a little bit higher in LTC than we normally would. We also had some preferred equity investments in multifamily that we expect to perform really well that are a slightly higher LTV. The biggest move in the quarter that drove it in terms of the overall LTV of the book is that the roll-off of the existing book was a significantly lower LTV book. We had a 20-something LTV loan in Hawaii. We had a couple of 40 LTV loans, one in Hawaii, one in London. So, the book that rolled-off was very low LTV. At the same time, within a quarter for obvious reasons, we have originated a couple of loans that we thought were great relative value on really safe assets at slightly higher LTVs. So, the net rate is a one quarter phenomenon.

Just as a reminder, we're the third largest owner of multies in the nation. So, in that scenario we have data and can try really well. So, -- and my favorite thing we probably bought globally and our $60 billion of assets are the affordable housing assets with 17,000 units in the REIT which are like you would love -- I've said when we -- these are the things that went on forever and they are occupied 100% 100% of the time. And the rent increase vastly exceeded our underwriting. So, -- and as Jeff mentioned, some of these units actually come off the restrictions in a couple of years. So, it's -- there's nothing but goodness coming from that portfolio. And what we effectively did with stretch duration of our book. And that was the goal in achieving double-digit cash and cash yields with fixed debt. The debt is locked. And there was a comment about nine-plus years. The average loan on our equity book this is almost 25%, 30% of our assets is astonishingly good for the shareholder base. And obviously I don't know if we were an equity REIT, we wouldn't shed you with an any dividend yield so.

In terms of the investment pipeline, can you give any color on the size of it? And maybe how it's split across the businesses?

Sure. We have $1 billion closed quarter-to-date in the large loan lending business. My guess is you do another 50% on top of that, so we end up in the mid $1 billion in the first quarter. The second quarter, I think, like our peers, we'll be slower because we did pull back in December. We did get a little bit cautious. There was a little bit less transaction volume. Across the other segments, I think, we have a business plan for the year that we feel we can hit fairly consistently in that sort in mid-$1 billion origination in the residential business, in the infrastructure finance business, and our CMBS book will probably stay about flat over the course of the year. So, the runoff in sales we met with some new purchases.

I just want to say we're agnostic, right? I mean if we get a great real estate loan, the capital goes through real estate loan. If we get a great energy infrastructure loan, we'll deliver capital as it becomes available for that business. So, we get really an exciting opportunity in the resi business, which is much more granular, we would deploy capital. I'm not saying that's what we're trying to do and we continue to reassess our cost -- our return on equity in each of these businesses. And actually -- I mean they all -- like the two big ones, the resi and the energy book, are ramping. I mean they're both businesses that we did our first securitization last year in the resi business. It was a little bit of a learning curve for us. We absorbed more cost than we should have, it will be amortized over future securitization. So, we -- I'm happy and we're into something -- into 2019 or whatever it was. While fixing or driving the ship through this little storm and we had a great year. And it's better than we budgeted. And I think we're setting ourselves up really well for 2019 and hopefully 2020. We don't care where the returns come from. I've never cared. You bet the jockey not the horse. We're going to have to deploy capital in these multiple business lines and remain opportunistic through all of them and not force-feed anything. And as you know we -- this is our sole business in this space. We don't have 43 other things we do in debt space. So, this is what we do and we'll continue to do it.

And Jade, to your LTV question earlier, one other thing that I would note is we use LTC on our construction loans. So, that doesn't give any credit for permitting or tenanting or things that have been done. It's purely based on cost. We think the LTVs on these construction loans will tend to be lower, but we are using loan-to-cost which is going to make the number look a little higher on the ones that we haven't told you about the -- two of them are multifamily, one in the Great Boston market, another one in the Philadelphia market, and two are in London, and one in Dublin that we're very confident in. So, I think this split is a little bit interesting. And on the construction side, we didn't do any construction in the third quarter. We did a little bit more in the fourth quarter and that's going to be part of the month -- or the quarter-over-quarter blip higher in LTV.

Our next question comes from the line of Steve Delaney with JMP Securities. Please proceed with your question.

Hey good morning everyone and thanks for taking my question. On Page 16 of the deck, you show a new $175 million preferred equity investment. Just wondering if you could give us a little bit of color around that? I'm curious if it represents pretty much just a coupon or if there's some embedded equity option in that structure as well? Thank you.

Yes. Sure, thank you. It is coupon-only. It's multifamily. It's very low leverage. It's full recourse. It's in primary NFAs. It's a fixed-rate investment and something that again as Barry said, an area that we're extremely comfortable in the multifamily side.

Got it. Okay, thanks Jeff. And then in terms of new lending activity in the first quarter I noticed the two -- that's laid out on page 15, I noticed there were two of the loans were national hotel portfolios and just wondered if you could give us a little insight into whether the property type, where this limited service, full-service kind of what was -- what type of property were you really lending on there?

Right it's a combination. One of the portfolio is a little more fold but it's bit more of a -- more of a limited service portfolio, smaller dollar-priced assets but that add up across a very large portfolio to something a little bit bigger. So it is...

Same borrower Jeff, or two different borrowers?

No, two different borrowers. But both national portfolios and both very well-known they are both very well-known borrowers among the largest in the world.

Okay. Thanks for the comments.

Thank you.

Our next question comes from the line of Ben Zucker with BTIG. Please proceed with your question.

Good morning and thanks for taking questions and congrats on the nice uptick in your names, service and portfolio. I just wanted to touch on the NonQM program real quickly. Your purchase volumes were growing really nicely at the year-end. And I think we know that this business doesn't eat a ton of capital, but you've also spoken about better returns here than the large one segment. And it sounds like that's still might be the case. So I'd love to get your outlook for this business in 2019, but also maybe your thoughts around where you could take this business over the next couple of years looking a little beyond 2019?

We put it like -- some guardrails around on deployment of capital on the company that remake them up, right? Their management guide increase, we wouldn't promote 1/3 of the book in equity assets. We keep our CMBS book around $1 billion around 20% of our -- 18%, 20% of our assets. And I think in NonQM, it is a business like the conduit business where we originate package and sell. And it's -- we're actually working on improving our origination cost there as well to raise ROEs to other businesses. I think we previously returned slightly below our real estate book last year. And actually we think they stabilized at 100, 200 basis points above our real estate book. And so far this business is doing really well. As you said, I don't think -- it'll look a lot like the conduit business our mortgage. I think we'll get 500, 700 and they will securitize it also dropped down to a couple -- they want to keep going. We will do that as often as we can. We've turned the conduit book as many as seven, I guess 11 times a year and last year seven times. So I think business is there the team is doing a really nice job. And if it -- our issue is it might require -- it can get bigger. It could get really bigger. And if it gets really bigger we're going to have to do something with it like spin it out. And that is something we'll look at. We have another child actually went to the Invitation Home's board meeting yesterday and as usual held that stock is doing pretty well. That was spun-off from us as you recall and then merged with Invitation Homes. And you could see future spin-off of businesses that might get too big for our current capital base or my trade at a much lower dividend yield they are outside of our penalized beast. So I it's -- it will all be optionality and the upside for our shareholders. I mean like I said, I mean I'm a shareholder we're going to do what we think increases the value of the company overall and that might include a spin or two...

With a very similar franchise obviously helping increasing...

Yes, Jeff pointed something out. There's a business for sale right now. In this business very similar and they're getting a huge price for this business. So that's the reason, I mentioned the spin-off. So it's -- I've been corrected on something. When we had a smaller asset base the CMBS was 20%. Now it's 8% of our $16 billion in assets, the $1 billion on $16 billion. I was looking in -- and 12% of our equity. So it's not 20%, it's 12%, take that back. Thanks Jeff for the correction. Mid-course correction I love it.

And just as a follow-up, I just kind of would like to hear what you view as the Starwood playbook? In your prepared remarks you spoke about may be seeing more market uncertainty coming towards the end of this year. And kind of what does that make you think as you look over your property portfolio with some nice gains as cushions now with your expectation for more uncertainties? Does that make you kind of a better hold and wait? Are you more motivated to sell? Or is it kind of just very opportunistic path both?

Well I mean Jeff and I debate with the board taking some of these gains in real estate book. As Jeff says the gain is not earning anything, right? So we have $600 million of gains and you put it out 12% this is hitting earnings value for us. My issue is duration. I love the duration of these assets and the cash flows are growing and we don't -- I mean we're looking at them. You -- we will probably harvest some of the gains and just approve to the street that they exist okay since they don't seem to always believe us. And there's for example -- well, I'm not going to give you an example. My outlook I think if rates fall the property book is worth more. And I think our -- I mean you have heard the impact on the loan book. I don't -- it'll be interesting to see if transaction volumes drop because -- and that's not great for the originators forget about us the whole industry. Then the other businesses will do better and maybe they'll absorb more capital. But that probably is the biggest -- but again real estate is a yield play. And lower rates will make property probably more valuable, not less valuable as it's leased and fully occupied. And I think what we're doing -- I mean, we're avoiding certain asset categories. Like hotels for example are the most susceptible that will slow down. And so we need to be super careful in the hotel space. And that's always we've usually been in a downturn. Like asset category that trips up the insurance companies and the banks. There's always -- by the way the best macro demand of all the asset classes in real estate. Like traveler is going one way north. But supply and volatility of the economy which is demand that's tied to GDP growth, an important growth, I mean, it's more volatile. So you may not lose money, yes, but it's one of the asset classes that we really scrub. And we did do a hotel on the last quarter so -- or this quarter. I think it's in this quarter. But it's again it's a super -- it's a senior division and massive amount of equity behind us and other paper so. And we look at -- I think the good news about what we do today is we look at these and we don't want to own the assets, but we're like, forget it, we're really happy. We just loaned the property book at a better price strike price so. It's one of the funny things about construction lending. When you're doing $0.65 on the dollar partial recourse usually or something like that you say like, defaults, I mean I can't wait to get the assets for $0.65 replacement cost. Sadly or for the better we haven't had that happened to us yet, but we don't mind it. We've now gone into the property sector, it's not our goal or trying to just be a lender. But moment to own is something we're fine with and we've best heritage of Starwood. That's where we started the company. So that's not what we're trying to do by the way, but if it happens we do okay.

Yes Barry as you always say, it's hard to replace the cash return on these property assets. We originated stuff at cap rates that -- bought from a cap rates that are similar to today, when rates were significantly lower and we've locked in long term rates. So we have extremely high cash return that is going to look like a significant premium bond. So you're either getting it through the premium bond or you could get it through reinvesting the assets cash and taking the gains that we struggle with.

I want -- I mean I'm going to choose the team form. I mean we did a very conscious investment in this Cabela's portfolio. And we -- I think at the peak it was probably $400 million $500 million of equity. The same size of our energy deal actually. And our business and now it sounds like $200 million or something. And it's earning pretty solid return north of 13.5%. And I mean that's just -- that was just -- and you realize, yes, I mean, it's retail, we probably hate retail in general it's really hard today. But it was 25-year leases there's a bank behind this company, the bonds are trading at par. And so you buy the bonds and get whatever like I don't know 3%. And you can buy or buy our stock and 13.5% in the same credit. So it was like that's really smart investing and we look for poles like that. That's what we're supposed to do with our capital.

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

Hi. Good morning. Can you talk a little bit about the energy infrastructure lending business? How the volatility is in December and then some stabilization that has impacted the returns you're seeing to deploy capital? May be a little bit of color there since that's a new business line for the company?

Yes, sure. So, in December and January, we certainly saw some spread widen out on deals that had to come. Unfortunately there weren't that many deals that have to come. We were able to capitalize on a couple. I would say and Denise is on the line with us if you wanted to go deeper into it. But I would say, in general, spreads are flat to slightly wider versus where they were in November, where they've probably got 50 to 75 basis points wider. We've been able to get higher returns on this book, as we're putting in term financing lines. We've been able to get higher returns then I think what we underwrote. And so we're extremely excited about the potential to do that to the extent that we are able to get high returns. We'll probably do what we've always done in our book, and that's take less leverage and earn a little bit less, and try to run overall at a slightly lower leverage point. But I think the opportunity that is a little bit better today than we thought it was when we bought the company and probably not quite as good as it was at the wides in late December early January. But a tremendous amount of volume in that business and a lot of really smart trades for us to do. I am not sure, Barry, if you have anything to add?

I'd say the originations are couple of hundred basis points wide than we modeled.

Levered yield.

Levered yield. And that's -- talking north of 13, which is obviously better than our real estate book. And I think you may or may not know we hired a fellow named, Armin Rothauser, who ran a $50 [billion] book for Deutsche Bank in the secured lending space. And he's going to wind up being helping us in that space and basically help Jeff run the team and manage the existing book and its runoff. So he was a MD at Goldman Sachs for three years. And he was obviously an MD at Deutsche Bank and you may or may not know but there's a change in the rules in Basel IV, which will make lending by foreign banks in particular much less competitive in the space. So, we invest in a key athlete that we think will be tremendously additive to our team and help us in a business that he was in at Deutsche Bank. So, we're pretty excited about that.

Great. And one my follow-up on the loan portfolio. Can you touch on the maturity schedule, your expected repayments through the year? And how you think about any type of concentration and the maturities with extension risk later this year if we do start to see the economy weaken? Thank you for taking my questions.

So, repayments are expected to come down a little bit this year for us overall. A part of that is we have less originations in 2015 and early 2016. That was a slow period for us. If you remember that's when we started to pivot into the property segment and we put a lot more money into property. We were investing in CMBS at that time. So, we were doing other things and our loan origination volume in 2015 and 2016 were significantly lower. I think we went from $2.5 billion to $3.3 billion to $4.2 billion to $6 billion this year. So, the loan maturities are going to likewise be slower they were late in 2018. They were elevated in early 2018, but they were -- through late 2018 all through 2019, we expect them to run at a slightly lower pace. And given where rates are today and tightness in spreads, we feel that it's fairly likely that we're able to achieve the amount of runoff that we expect. There's no blitz on the credit side. There's no real blitz on the refinance ability side. So, I would think that our guesstimates are pretty close and they're down I would say 30% or so versus last year in terms of run offs.

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

Hey, good afternoon everyone and thank you for taking my questions. You contributed nearly $700 million of loans to conduit this quarter. And it sounded like most of that was scheduled for 3Q, might have slipped into early 4Q missing some of the more severe volatility. But just wondering how gain on sale compared to historical levels and what it looks like so far in 1Q 2019. And then just how you would describe your appetite to execute on conduit deal this year relative to last year?

Yes, we've always had a higher gain on sale than what the average gain on sale I think is when you look at banks and others who are doing larger investment-grade loans. The part of the market that we play in tends to give us a little bit more room. December, we obviously saw a widening in spreads. Adam, do you want to talk a little bit about what that widening caused in terms of the conduit book?

Yes I mean see we dropped them. We had deals that were scheduled to go. So they did. We saw an average probably 3/4 of the point to point reduction in overall P&L due to just spread widening across the deals. The first quarter things have tightened back up again. And I would expect a continuation of where we work from there, we're not -- seeing on the market itself is delayed a bit for first quarter because of just typical January lightness on origination overall. But we should see a pickup toward the end of the quarter into the next.

But we hope to price our first deal of the quarter on Friday. And I would expect again sale to be sort of a -- in the same vein as what we've historically seen. And when you do get these splits wider, if you're able to walk up some loans in that chaos, you can certainly make a little bit of excess spread as well by taking that risk when markets are a little bit weaker. So we're somewhat excited about that. As Adam said, CMBS spreads have come back and they come back voraciously and we're back in one AAA to where we were few quarters ago.

Got it. Appreciate the comments there. And on the resi securitization, what type of gain on sale do you recognize there? And how does that compare to maybe your first deal. And it seems like you've accumulated enough assets to complete another securitization and just reflecting current market conditions, when do you expect to be out with number three?

That's a great question. So we had a small gain I think $4 million on the first securitization of smallest loss, I think $2 million in the second securitization. You're right the third securitization is something we've been talking a lot about and spending time on. We will continue to take advantage of the markets, while they're open. The gain or loss on securitization isn't something that we think about, like we think about in the conduit business. And the conduit business it is our lifeblood, it is how we pay our people it's the profitability of that business. Ultimately our RMBS investment will be determined over the life of these investment. It will be the cash flow that happened over and expected six or seven-year average life, but really over 30 years. And obviously you have IOS in there and longer securities that will have a bigger impact and we believe that our securitization IRR are very much the same across those two even though one had a small gain and one had a small loss on securitization. Ultimately, we retained securities and we expect the cash flows from those over much longer time.

One thing we're going to change probably strategically is we're going to sell some of the most senior bonds that we held onto. We will increase the ROE. And we talked about doing that BB for example and...

BBBs.

And the BBBs. So we kind of artificially depressed our ROEs by keeping those notes and we just met the other -- recently as a team and size we should just [chuck] them out into the market and increase the ROEs of the business. So we're going to do that.

Ladies and gentlemen we have reached the end of the question-and-answer session and I would like to turn the call back to Barry Sternlicht for closing remarks.

Thank you everyone. Again I want to thank the team. I don't even know how many people it is 400, 500 people have worked with us. Enterprise is a big company and we're excited about the future. Thanks for listening today and obviously the team is available to answer all your questions. Thank you.

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