Greetings and welcome to Starwood Property Trust Second Quarter 2020 Earnings Call. At this time, all participants are in listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I’d now like to turn the conference over to your host, Mr. Zach Tanenbaum, Director of Investor Relations for Starwood Property Trust. Thank you. You may begin.

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 June 30, 2020, filed Form 10-Q 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 and are subject to a number of trends and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. I refer you to the company’s filings made with the SEC for a more detailed discussion of the risks and factors that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today. The company undertakes no duty to update any forward-looking statements that may be made during the course of this call. Additionally, certain non-GAAP financial measures will be discussed in 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 Chairman and Chief Executive Officer; Jeff DiModica, the company’s President; Rina Paniry, the company’s Chief Financial Officer; and Andrew Sossen, the company’s Chief Operating Officer. With that, I am now going to turn the call over to Rina.

Thank you, Zach and good morning, everyone. For the second quarter, we reported core earnings of $126 million or $0.43 per share. As we proactively manage the initial market impacts from COVID-19. We quickly moved our balance sheet into a more defensive position. When we last spoke in early May, we had already de-levered our balance sheet and increased our cash position significantly. Although prudent in the face of unprecedented market volatility, this strategy created over $1 billion of balance sheet inefficiency, which came at a cost earnings in the quarter and continues to have an impact today. GAAP earnings for the quarter was $140 million or $0.49 per share. This led to a $0.03 increase in our GAAP book value per to $15.79 and a $0.09 increase in underappreciated book value per share to $17.03. Our book value per share includes year-to-date decline of $0.32 related to CECL and $0.38 related to mark-to-market adjustments on our assets. These amounts do not reflect a fair value of the assets and our property portfolio, which we continue to believe have appreciated meaningfully since we acquired them. This is demonstrated by our continued refinancings of these assets, which I will touch on later. Despite the macroeconomic headwinds, we faced this quarter, the power of our diverse platform with evidence with each of our business lines contributing to earnings and liquidity. I will begin with our largest segment, Commercial and Residential Lending, which contributed core earnings of $112 million to the quarter. On the commercial lending side, we selectively originated $198 million of loans with a weighted average LTV, a 44%, $156 million of which was funded. We also funded $220 million under preexisting loan commitment. These cash outflows of $376 million were more than offset by $566 million of cash inflows resulting…

Thanks, Rina and good morning, everyone. I’d like to start by congratulating Rina, Zach and the rest of our team for being awarded the NAREIT Investor Care Award for the seventh straight year. The award is given to only one company in our space each year for excellence in reporting and shareholder communications. And we are proud to have been voted it by our shareholders and analysts for seven straight years. Although some of our company has been working remotely, I’ve been back in the office, along with the senior management team since our last call, and I have to say, it’s been nice to have some part of life feel normal again. Since COVID began, we’ve worked hard to strengthen our balance sheet by both deleveraging our business and significantly reducing our future obligations. Inclusive of our deleveraging, we have been sitting on over $700 million of cash on most days since COVID began, and over $800 million today, as Rina said. This liquidity has given us the ability to go cautiously on offense purchasing or agreeing to purchase approximately $700 million worth of low loan-to-value residential mortgage loans made the high-quality borrowers at a large discount to par near the bottom of the COVID pricing dip. We can securitize those loans today well above par reducing the net permanent required equity on these purchases to less than $50 million. We have also selectively written CRE loans and have an actionable pipeline of accretive large loans we plan to execute on in the second half of 2020. We are investing today, but we’ll maintain a balance of caution and maintain ample liquidity to weather any future tremors if its recovery stalls. With both $500 million of senior secured notes maturing and our federal home loan bank membership set to…

Thank you, Jeff. Thank you, Rina. Thank you, Andrew and thanks everyone for dialing in this morning. It’s hard to add a lot to what Rina and Jeff said. I think my quote in the earnings release reflects my view that we’re kind of at the Indianapolis Speedway and the pit car, I guess they call it is out and we’re lapping around the track and all of the mortgage rates, all of the lenders are sort of on the tracking, two of them had to pull into the pits and having the tires changed and getting new bodies, because they had a crash in this crisis and we’ve never experienced that. As you remember, you’ve seen we have significant cash recourses on this filing, never having any kind of issues with a recap necessary for the company. And as I look out for the years ahead, the really interesting company, which as Jeff said, we have all the gains in the investments we’ve made. And you’ll soon learn about another gain that will look to be opportunistic in a whole lot in the middle of the crisis, within new usual structure. Jeff referenced that securitization will take place this quarter. So, we have a funny company, which is resilient. But the diversification of the business lines is proven to be a significant advantage and I think also that some of our business lines are still not performing at the appropriate stabilized earnings power, specifically our energy infrastructure business, which has kept a significant overhead, what we pulled back from investing and that continues to decrease its contribution to earnings given the scale that we hope to be out at this time, but obviously, pauses the energy markets went into a free fall. But as I mentioned and Jeff mentioned,…

Thank you. [Operator Instructions] Our first question comes from the line of Steven Laws with Raymond James. please proceed with your question.

Hi, good morning. I guess first, it looks like you’ve made some new investments, obviously, CRE as well as the purchase of the non-agency loans that you covered that hasn’t closed. Curious on the Energy Infrastructure Lending, how do you feel about that portfolio and segment? I think a few weeks ago, you saw Hancock Whitney sell some energy loans. Was that something you guys looked at? Was there read-through on that sale that makes you more positive or less – or more negative on that asset class? Maybe talk about the outlook for the energy portfolio and any growth there.

Hey, Steven. Great question. Thank you for recognizing new investments. And on the energy side. We were quiet this quarter. Spreads have certainly widened out. The banks have pulled back a bit. We think we can generate levered yields that are in excess of what we were generating before COVID. We actually approved the deal just a couple of weeks ago that we didn’t end up buying. We thought we could potentially buy a little bit cheaper secondary, and that didn’t quite work out. I have Sean Murdoch and Denise Tate on the line with me. And regarding your question on the portfolio and what they’re seeing specifically there, why don’t I turn it to Sean and Denise to quickly give you an update.

Sure. I think we’re seeing the markets in energy stabilize it sort of finds it putting after COVID and our portfolio of the tenant investment opportunities are growing. And as Jeff said, they’re attractive returns versus the returns we were generating pre-COVID. I’d add that Jeff mentioned, we’re working hard on doing a CLO, which we think sort of prunes out the business model in terms of generating term nonrecourse financing for our loan activities.

Sorry, it’s Denise. Just to add on the Hancock deal, [indiscernible] those were all oil gas drilling deals and service deals. So we’re not investing in close to the wellhead, which is what those deals are. So they have a lot of commodity risk associated with those deals. So not really a good comp for our book.

Okay, that’s helpful. And Steven, finally, we probably need 15 or so new investments to complete portfolio for the CLO that Sean and I have now both talked about. So, our goal over the next six to nine months will be to get to the point where we can accretively come with a CLO to move this debt off balance sheet.

Great. And then Barry, a question on the election, if the date holds, your next conference call will take place the morning after the presidential election. And I guess depending on mail and votes in different states, we may or may not have an answer of who the next president is. Can you talk a little bit about – I know you got the new investments you’re doing. You’ve got a very strong balance sheet. You mentioned maybe raising some debt maturities later this year. Let’s go in November election as well. The risk, if Biden’s selected regarding the real estate taxes he’s proposed eliminating like kind exchange, how does that – the different things, I’m sure you’re aware of, how does that impact how you think about Starwood, the mortgage REIT? And then bigger just how you think about real estate investing in general, if that were to come to fruition?

I think we look at is rates,, and there’s no yield in the world. And underpinning real estate, there’s tremendous – rates are too wide. I think I was reading something where we mentioned Amazon lease credit will trade at a five cap rate and their bonds traded like 30 basis points or something like that. There’s a huge premium on real estate yields because people perceive I think weakness in the income streams, which is not only – you can’t really invest macro. You have to invest micro and you have to go block by block, and you look at the credit quality of the cash flow stream. So, I think – if you think that Biden’s election will decelerate the economy, whatever that means given, we have a minus 32% on GDP. I think there’ll be no issue. Rates will stay low. And I don’t think, like, for example, like-kind exchange is relevant to the kinds of assets we finance. I think it’s mostly used by individuals buying strip centers and franchise net lease assets. And again, because there’s no alternative, will they sell at seven caps instead of six caps because their tax the like-kind exchange I think should go away. It isn’t required. It isn’t helpful and it’s unique to real estate. So I – that’s an easy loophole for them to fill. I’ve never used it in my life, by the way. So I have never been affected. But I think other situations, other issues like municipalities, taxing, real estate, is a double-edged sword, reducing the volume or the value of buildings and cities, because they’re doubling property taxes means that capital won’t flow into those. It’s either buy – build a new building or to buy a building, if you think values are going…

Thank you. Our next question comes from the line of Rick Shane with JPMorgan. Please proceed with your question.

Hey, guys. Thanks for taking my questions this morning. Jeff, you had spoken about the purchase of the low loan-to-value resi portfolio and the possibility of securitizing that above par. How should we think of that from an economic contribution? And if you do the securitization, is that a gain that you recognize? Or would that discount continue to be accreted into income going forward?

Yes. Thanks, Rick, good questions. These purchases, we were fortunate during COVID to be able to buy them. At a discount, as you just said, the securitizations today are above par. I think single Bs are trading in a yield that are about equivalent to the growth WACC, the coupon of the underlying pools. So, these are obviously very accretive when we can sell AAAs at 120 over or whatever that is. So the financing markets have come roaring back. And I think one of the reasons is there’s going to be a lot less supply in the coming months. The non-QM originators will be doing less volume. People have cleaned out most of the loans that they have. So, given there are a lot of bond buyers, who really like this sector and they like it because of the strong credit characteristics that we like it for. The reality is that securitization pricing should continue to be pretty strong going forward, and we’ll increase the whole loan bids to significantly above where we purchased them. As far as the gain goes, these gains are taxable. So we will have some tax issues. They are also – there are hedges in these. And given what rates have done, there’ll probably be some small hedge losses. But net of all of that, there should be very large gains that we will likely take along with the – at the time of the securitization. So, as we head into the next couple of securitizations, I think you’ll likely see some fairly large gains along with that, as opposed to just running it all through coupon. Rina, do you have anything different you would say there?

No. I would just say that it’s consistent with how we’ve treated the past securitizations in this business as well as our conduit Star mortgage capital. So we recognized the gain at securitization.

Great, perfect. Thanks, guys.

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

Hey, good morning, guys. Hope you’re all doing well. My first question, just on the CRE pipeline. Can you maybe size that for us today? And just give us a little bit more color on the characteristics? It seems like you’re migrating towards higher quality, more stabilized assets. So are you seeing yields come in a bit there or spreads come in a bit there and LTVs move up? Or just curious, maybe, you can talk about the assets also that or asset types you’re focusing on?

Yes. Sure, it’s Jeff. I’ll start, and I’m sure Barry might jump in and Dennis Schuh, our Head of Originations, is on the line. I would say, immediately post-COVID, the handful of opportunities that we saw were significantly wider. You’ve seen some spread tightening here as people are coming back into the market. There – a lot of our competitors are not looking to invest today. So, there is a little bit better opportunity set for us to get into some things that we couldn’t necessarily get to our rates of return on pre-COVID. I think we’re seeing a decent amount of multifamily that we really like. We’re seeing industrial that we really like. We’re seeing sectors that we want to be in with the ability to potentially sell A-notes or use them as CLO collateral as opposed to continuing to add to warehouse lines, which, as you know, are less than half of our financing of our [indiscernible] book and the lowest, I think, among our peers. So we will continue to sort of look to keep less – to bring on assets with less future fundings. I think given the uncertainty around repayments, we’ve pushed out – cautiously, we pushed out repayment significantly into the future. Right now, we would like to have less future funding and more future funding obligations until we have a little bit more clarity about how we get repaid. So I think you’ll see us stick to our meeting with some fairly conservative product types and probably not doing much, if anything, in retail, which we haven’t done in the last few years or other sectors that could be considered a little bit more volatile. Barry, do you have any thoughts or Dennis, that are different?

Well, the only thing I’ll say is our loans are chunky, right? I mean, we want to do – we’re doing bigger loans, obviously, than maybe some of our smaller peers. And there’s patients in the deck. We invest $200 million in the back half of the year, it’s like $0.04 to $0.05 in earnings. It’s not going to make or break our year. So we – or we – if we can get a 15 on capital is to put out a third less to get to [indiscernible] we’re running our model on even though loans are doing better than that. And the energy book is well north of the returns we can get in real estate right now. So the one problem that I see for lenders is the volume of deals. Until sort of the dam breaks here where people really run out of the extensions and collaboration that banks are doing, they don’t really have to sell, and they don’t want to sell. Nobody wants to sell premium of COVID. So transaction volumes globally are down. I mean financing opportunities are down. And yet, I think people perceive that there will be light at the end of the tunnel. So as Jeff mentioned, the spreads have come in. There have been a few, I call them, [indiscernible] financing for a few of our peers. And even though their spreads have come in, they’re being bid heavily dramatically. It’s interesting because, obviously, we did one of them. And there’s [indiscernible] now. If you see where the pricing is – you’re seeing a lot of hedge fund or just if [indiscernible] market. They’re – I would call it [indiscernible] and a little less and so done this for so long, but sometimes we’ve seen these assets trade three…

I personally would [indiscernible] a lot of Barry of Barry subscriptions to all the new services that show them every deal that gets done because we do get a question on all of them. To finish that up, I would say, our pipeline today is about two pages long, almost two full pages, which is almost similar to where we were pre-COVID. It started to be very small. We have eight loans or so in the red zone that would use a decent chunk of our budget at returns that are above what we’ve seen. And I would say also, when the Street originates a loan and they try to sell the mezzanine, something that we do very little of. We’ve seen two deals that we actually liked the credit on, but they thought they could sell them mezzanine 300 basis points or so inside of where we would bid, which is why we like to create our own cooking and underwrite – originate our own loans and then sell off our seniors ourselves. The bid from hedge funds and others who don’t have the origination capability is back and it’s voracious, and it’s causing those mezzanines that are originated by the Street to trade multiple hundreds of basis points inside of where we would begin to care. Sorry, for the long answer.

Jeff.

I’d say generically returns are up about 200 basis points versus pre-COVID levels. And I’d say generically leverage on the asset classes that we want to be lending them are probably down about five points on average, that’s just generic. But as Barry said, it’s deal by deal, asset by asset, street by street.

Yes. I mean, I appreciate the detailed response there. That was a lot of good information. So, I appreciate that. And then just on the margin call holidays, you haven’t placed on the hotel loan portfolio. Can you just remind me when those were put in place in the duration of those agreements? And just curious, if you – if it’s too early to begin having conversations about extending those and what it would take, whether it’s just additional de-leveraging or other kinds of give ups that would be needed to if you want it to extend those agreements?

Yes. Thanks for the question. I would say in general, they expire around year-end this year. We’re certainly hoping that hotels start to see a little bit better performance come year-end. In general, the de-leveraging was somewhere in the 10% area. My guess is if year-end comes and things are still not great that you potentially have another small de-leveraging, but a fraction of the 10% that we paid down previously, which was only a $100 million in total across those. So, not a huge liquidity scare for us, but, sort of hoping that the hotel numbers come back a little bit into Q4 and that we’re able to hold the line. The bank lines generically, if we’re writing a 65 LTV loan or something like that, the banks are lending to us at 45 LTV on these assets. So, if we’ve already paid them down by 10%, at some point it becomes a sort of ridiculously low leverage level from the seniors. So the next round will be very small is my hope.

Got it. Okay. And then just my last one here, circling back on the dividend, I know it sounds like investment activity should pick up a little bit on your guys end in the second half in a year. A lot of good opportunities for capital work, but also sounds like you’re elevating cash levels aren’t going anywhere. So, just wanted to circle back and see how, I know it’s a board decision, but how you’re thinking about continuing to under earn the dividend for the foreseeable future, just knowing that you could earn it if you wanted, but that might not be in a near term pipeline?

Can we say no comment. The – again, it’s – I’m a big shareholder myself. I’d love to maintain the dividend. And the market doesn’t think we’re going to maintain the dividends. I think the Street has us paying $1.60, I’m told. So – and the stock trades at a ridiculous yield. So given what’s going on in the discount to our peers. So it’s really – and there’s plenty of competitors that actually aren’t paying any dividend and their stocks are holding up. So we don’t – we’re going to just look at it month by month. And at the moment, we’ve obviously held a dividend. And – but I think my comments would intrigue you as we can’t cover the dividend. We just want the world to be normal and we [indiscernible] it can get to normal some time soon. So, I think we’ll leave it at that.

Thank you. Our next question comes from line of George Bahamondes with Deutsche Bank. Please proceed with your question.

Hi, good morning. You cited roughly a 11 loans modified during the quarter. Imagine that the majority of the loans were hotel or retail. When I wanted to confirm if that was accurate and secondly, if maybe there were some other ones that were not hotel retail, I’m just kind of giving some more context around the mix there.

Yes. The vast majority was hotel as you suppose that that’s absolutely correct. The others are some very small – some very small, mostly technical modifications that have been done to date, but the majority of the mods have been on hotel book.

Great. And my second question this detail you’ve talked about good news money for unfunded commitments. Can you just revisit those comments on how much of the $2 billion is callable? Or maybe it’s going to be dependent on some sort of performance milestone?

How much of the $2 billion is callable? I’m not sure I understand exactly if you can…

Even like good news. Right. So it’s going to be dependent on some sort of lease-up back to the basin, right? Or just kind of any sort of performance milestone, just wondering, how much of the $2 billion is maybe tied to that?

Yes, I said in my comments, I believe about a third of it typically is good news money. And about two thirds is future draws on construction. So, and the $2 billion is gross. I would assume that none of our banks fund alongside of us, and we always assume that our banks will fund alongside of us and leaves us less than a $1 billion of net future fundings from us. So using that same math, $333 million [ph], if it were exactly a $1 billion of good news money and in $666 million [ph] or so of construction drawers coming out over the next three and a half years, extremely manageable numbers given the size of our book and in the amount that we expect to come back into the book on repayments.

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

Yes, Barry, there’s some bearish views on New York office. You had commented a little bit about the tech CEO that you spoke to, maybe implying it was somewhat overdone. Can you provide your thoughts on New York office and kind of where you [Technical Difficulty].

Yes. I do think the big blue cities are facing some troubles and the pressures on real estate taxes on office properties will be tremendous because they’re big, you can still tax them. You can’t tax street-level retail and hotels are closed. So it’s going to – I think it’s not even so much of rent fall so much as expenses going up. Rent have to go up to meet the increase in expenses for a while, as you know, the way leases are structured, the tenants will pay those increases. But when the lease rolls, it will be – and sometimes, the lease is written so that the landlord has to increase the [indiscernible] taxes. I think you’re seeing interesting issues emerge in some office markets, mainly San Francisco and New York. San Francisco, nearly 10% of the space in Downtown is now up for sub led. So I think you’re going to see a significant decrease in the rents in San Francisco. At – being the heart of tech land and the fact that the downtown San Francisco is less clean and a bit – has issues right now, I think people are thinking they can go somewhere else and work in the suburbs. And so the CBD has some issues. I think in New York City – it’s funny. I think I got a lot of criticism for saying values would be down New York, the values will be down in New York. They’re already down in New York. And – but I do think people want to work from their offices. And what I was really referring to wasn’t actually COVID or even protests, some of which turned into riots. I think there’s a general perception that the cities aren’t safe. And nothing will clean out…

And Don, I will say and Barry has pushed us this way for a long time, but less than 3% of our loan portfolio is Manhattan office. That’s three loans. Two of them are small and we expect to be in one is on a diversified portfolio, including a large investment grade tenant taking the bulk of it. We feel really good about those three loans, but again, very small percentage of our portfolio in Manhattan office.

Thank you. Ladies and gentlemen our last question for today will come from the line of Jade Rahmani with KBW. Please proceed with your question.

Thank you very much. I get a lot of questions on Starwood, New York city exposure. And I was wondering if you could quantify that and also provide some commentary as to the few specific loans that are in the New York market and how they might be positioned in terms of future credit performance?

Great, Jade, thanks for the question. In total, including all New York City area our exposure is about 14% of the loan book today. About 37% of that is office. There are condos in there and these condos have significantly low basis. You and I have talked about a few of them in the past, and we feel that we feel very good about the condos. I would, as I look at across our portfolio, we do have the one condo that we have spoken about before that we have taken a reserve on so away from that, the rest of it, that condo book feels pretty good. We still have a recourse guarantee on that. And it is still in the process of selling units that we believe will be done in the next 12 months to 15 months with that loan, again, with full recourse.

And I’m just interrupting you, can you reconcile the 3%? You said it was in New York and your first comment, last question, the 14% you said it was in New York on [indiscernible] in you answer to Jade’s question.

Absolutely. So we’re about 5% of our book in total, is office 60% or 3% of that, or so is in Manhattan. And the rest is in as I look here at Brooklyn and Long Island. So about 5% of our portfolio is office out of, and then 14% of our portfolio includes all New York City office condo hotel and multifamily, Barry. Our one hotel loan is only $36 million…

In the north of $17 billion and our loan book is $9.4. You said you got in mind too.

Great. Thanks for taking the questions. And then just in terms of the overall loan portfolio given the recent A-note sales, what percentage of the loan portfolio is being out at this point?

I don’t have that exact number. I want to make sure we can give you an exact number. I think we’re about 45% today on bank lines. And we obviously have the large CLO and the rest would effectively B-notes noticed, but I don’t have it on the tip of my tongue Rina, unless you have a Jade, we can come back to you with the exact number for percentage B-note.

I do not. I will come back to you.

I just point out again that you have a warehouse line on this FHLB line, but we have different set of lines on the energy books, not just talking about real estate anymore or real estate.

Jade it’s Andrew, out of the around $9.4 billion in a commercial lending book. There’s about $600 million and about, you know, $150 million, $160 million preferred equity. So call around $750 million out of $9.4 billion. And that’s carrying value of the assets.

Andrew, I think he’s also considering things where we sold A note. So I think we should get back to him with the exact number includes that.

Thank you very much. I’ll follow up on that later.

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

Thank you, operator, and thanks for your questions and for joining us today. The one thing I’d say is, I’m very proud of the fact that we’ve won this award for seven years in a row. And [indiscernible] And so we’re available to answer your questions without and always to going to do so. So without things consider proprietary, we want you to understand, what we’re doing list in the book and we appreciate you spending the time with us and supporting us. Thanks. Have a great holiday. Take care.

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