Starwood Property Trust Inc (STWD) 2012 Q4 法說會逐字稿

Good day, everyone and welcome to today's Starwood Property Trust's fourth-quarter and year-end 2012 earnings conference call. All participants are now in a listen-only mode. After the speakers' remarks will be a question-and-answer session.

(Operator Instructions)

As a reminder, today's conference is being recorded. At this time I'd like to turn the call over to Mr. Andrew Sossen, Chief Operating Officer and General Counsel.

Thank you, Melody. Good morning everyone and welcome to Starwood Property Trust's earnings call. Earlier this morning we released our financial results for the quarter and year ended December 31, 2012, and filed our form 10K with the Securities and Exchange Commission. These documents, as well as our quarterly supplement, are available in the Investor Relations section of the Company's website at www.StarwoodPropertyTrust.com.

Before the call begins, I would like to remind everyone that certain statements made in the course of this call are not based on historical information and may constitute forward-looking statements. These statements are based on management's current expectations and beliefs, and are subject to a number of trends and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. I refer you to the Company's filings made with the SEC for a more detailed discussion of the risks and factors that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today. The Company undertakes no duty to update any forward-looking statements that may be made during the course of this call.

Additionally, certain non-GAAP financial measures will be discussed on this conference call. Our presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. Reconciliations of these non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP, can be accessed through our filings with the SEC at www.sec.gov.

Joining me on the call today are Barry Sternlicht the Company's Chief Executive Officer; Stew Ward the Company's Chief Financial Officer; Boyd Fellows, the Company's President; and Mike Berry the Company's Chief Accounting Officer. With that I'm now going to turn the call over to Stew.

Thank you, Andrew, and good morning. This is Stew Ward the Chief Financial Officer of Starwood Property Trust. This morning I'll be reviewing Starwood Property Trust's fourth-quarter and annual financial results for 2012 and will highlight several noteworthy items pertinent to the fourth quarter of 2012, the first quarter of 2013, and our overall business. Following my comments, Barry will discuss current market conditions, the state of our business, our impending acquisition of LNR and the opportunities we see as we look forward.

For the fourth quarter 2012 we reported $64.5 million of core earnings, 10% above quarter earnings of $58.8 million recorded the prior quarter. On a per-share basis we earned $0.48 per diluted share. Core earnings for the year totaled $228.3 million or $1.99 per diluted share, an increase of more than 50% on a dollar-basis and a 17% increase on per-diluted-share basis over the 2011 levels of $146.6 million and the $1.70 per share, respectively. GAAP net income for the fourth quarter was $56.3 million, a 12% increase over the prior quarter's level of $50.2 million. This represents $0.42 per diluted share, roughly in line with the $0.43 per share of GAAP net income reported for the prior quarter.

As of December 31, 2012, the fair value of our net assets was $20.57 per diluted share. As of the same date, GAAP book value per diluted share was $19.90. Both of these figures are above the September 30 levels of $20.13 and $19.56, respectively, and represent the highest quarter-end values for both measures since the inception of the REIT. These increases are primarily the result of the increase in after-values associated with the continued tightening of credit spreads that began in earnest more than a year ago, and the accretive impact of our October, 2012 equity rates, which was completed at pricing well in excess of both book and fair value per diluted share.

Now, let me outline some other significant details for the fourth quarter and 2013 to date. The fourth quarter 2012 was an incredibly busy period for us from an investment perspective, with new investments totaling in excess of $1 billion. The highlight for the quarter was the October core origination of a $475 million first mortgage and mezzanine loan secured by our redevelopment project in Times Square. We discussed this transaction at length on last quarter's call. By quarter's end, we had also originated or acquired an additional 12 commercial real estate loan assets, totaling an additional $493 million in funding commitments, bringing the Company's commercial loan new business totals for the quarter to $760 million, by far our biggest quarter ever.

During the quarter we also made significant additions to our portfolio of single-family homes and non-performing residential loan assets, bringing our total investment in the sector to $170.3 million, representing over 1,300 housing units. With the addition of these commercial and residential investments, our total investment portfolio stood at $4.1 billion on December 31, $1.3 billion larger than at the same time a year earlier. We expect this portfolio of commercial real estate debt assets to earn an annualized leverage return between 11.7% and 12.2%, and think our single-family residential strategy will generate similar returns when mature.

As we've said in the past, but continues to be worthy of mention, we think this represents compelling risk-adjusted return for investors, in light of the portfolio's average last dollar loan-to-value ratio of approximately 63%, absence of material credit issues, and the low single-digit investment yields available from other comparable fixed-income investments. Since the beginning of the new year, we've closed or acquired $113 million in new investments, including an $86 million construction financing for the development of 30 residential condominium units and ground-floor retail on the Upper East Side of Manhattan, with what we think is a very attractive last dollar exposure of $860 per square foot.

More importantly, excluding our anticipated acquisition of LNR, we now have a pipeline of new loans and investments in various stages of due diligence under term sheets, with initial fundings of approximately $650 million and a total capital commitment of $1.3 billion over the next 48 months. While we're likely to experience some attrition in this pipeline, we are confident that the pace of new investments in the coming months will be substantial, and we're extremely pleased at we anticipate will represent new deployments of capital, that both meet our asset quality and return targets, but also help further diversify the loan book, as well as maintain its overall attractive risk profile.

The last items from the fourth quarter 2012 and first-quarter 2013 I'll mention, involve important events on the financing front. As we've discussed on previous calls, one of our significant advantages in the lending marketplace is our ability to act as a one-stop shop solution for borrowers, particularly on large complex lending transactions where the competition has a complicated combination of a multi-bank syndicate for the senior component of the loan, and a mezzanine lender or lenders for the junior components of the debt stack. What allows us to act as a one-stop shop lending solution is the combination of our extensive array of financing facilities, coupled with our dedicated experienced team of loan syndication professionals, to give us the market knowledge, presence and confidence to originate a whole loan with a strategy to subsequently sell a senior A note component in a timely and efficient manner.

To that end, we were extremely active in the syndication markets during the fourth quarter closing four A note sales in one period per two participation totaling $315 million. These sales allowed us to manufacture $104.7 million in match-funded subordinate debt investments, with an average first dollar LTV of 48.3%, average last dollar exposure of 66.8% LTV, and average expected annualized investment yield of 11%.

Next, earlier this month we issued $600 million in 4.55% coupon five-year convertible senior notes, due in 2018. We were very pleased with the overall execution of the transaction, which adds $600 million of unsecured debt to our capital structure, with an accretive cost of funds well below our current dividend yield.

Now let me bring you up to date on our current investment capacity. As of February 22, we had $175 million of available cash, $578 million of financing capacity approved but undrawn, and $163 million of net equity invested in liquid residential mortgage-backed security. With this, we have the capacity to acquire additional $750 million to $1.5 billion (sic - see press release) in new investments. As announced in our press release, our Board has declared a $0.44 dividend for the first quarter of 2013, which will be paid on April 15, 2013 to shareholders of record on March 29, 2013. This equals the standard quarterly dividend paid for the last seven consecutive quarters, and including the $0.10 special annual distribution we made this past January, represents a 7.05% annualized dividend yield on yesterday's closing share price of $26.37.

Before I turn the call over to Barry, I want to briefly bring your attention to a couple of new items in our 10-K that was filed this morning. In the expense section of the income statement, you'll see that for the first time we've established a loan-loss allowance of approximately $2 million in the fourth quarter of 2012. This loan-loss allowance was not the result of any specific credit issues in our portfolio, and we still do not expect a loss on any individual loan investment. In fact, we would be required to establish a loan-specific loss allowance if we did expect a loss on any individual loan. But our portfolio has grown to a sufficient size and age that we feel it prudent to establish a loan-loss allowance for certain categories alone that have more risk of loss than others. The detail behind the methodology we employed for determining the composition of the allowance can be found in Note 4 to the financial statements.

Lastly, I like to bring your attention to new disclosure we've added which provides detail on both our growing single-family home business, as well as the intended acquisition of LNR. The single family home disclosure can be found in Note 5 to the financial statements. And a description of the LNR acquisition can be found in the discussions of our investment strategy, the discussion of business objectives and outlook, and in a number of new risk factors. With that, I'd like to turn the call over to Barry for his comments.

Thank you, Stew. Thank you, Andrew. And good morning, everyone. I think we've completed an extraordinary year in 2012. I want to thank our shareholders for supporting us and also all the employees that made the performance of the Company possible. It was an extraordinary quarter for us, if you count January and the LNR transaction, a transformative one. Originating and purchasing over $1 billion of debt in a quarter is exciting, and even more exciting as it continues into the first quarter of this year. I think you'll see a similar volume, as mentioned in the financial press release this quarter. We'll talk a little bit more about the market in a second.

We also did a raise, and one our keys in creating earnings for our Company is how we raise money and when we raise money. And I'd say we're in this sort of funny transition period right now, when we won't be back in the capital markets until we close the LNR transaction and provide further information on the pro forma earnings and pro forma balance sheet of the combined entities. And so, recently we raised it the $600 million in the convert, which was upsized from $450 million in net with demand more than two times the offering. Three times on the original balance of the offering. And we voted to increase the raise, probably taking more money than we needed, because between now and closing of the LNR transaction we cannot easily access the capital markets again. The use of our capacity will depend on ultimately the closing of our pipeline, and then we'll see what additional capacity we might need to close LNR.

The October equity raise we did actually knocked a couple pennies off of the quarter's earnings. We wound up having unused capacity on average of almost $380 million for the quarter. Invest it any coupon you want and you can see that we left some money on the table, but this is a long game and, as you know from the start, which was not that long ago, we talked about being predictable and safe and best-in-class transparency, and I think with the additional disclosure schedules and what we provided during earnings release I think we've gone a long way to doing that. We're very excited about the progress in the Company.

I also want to mention how the relationship with SCG, the REIT's advisor is so powerful and was particularly powerful in the quarter, when we originated this $475 million loan for 701 Times Square. Subsequently splitting that loan, only the third investment that was split between the REIT and our private equity Funds. And also selling down 25% of that investment to Vornado, though the REIT kept the origination fee on the transaction. The reason the loan is split is because we expect the IRR on that investment to be in excess of 14%, which is our guideline for splitting investments between the Fund and the REIT, the Fund took 25%.

I can mention it's the first time that we've actually received an equity kicker in a transaction. The REIT and the Fund and Vornado will split a 20% equity kicker in that transaction. It's Ground Zero real estate and probably one of the most exciting retail locations in the United States, if not in the globe. And we've already been offered significant premium price for that equity kicker. It's obviously not in our fair market value numbers, it's not anywhere in our numbers. Given the developments at the site, which I won't talk about until they're announced, we're pretty excited about that transaction and what it represents for shareholders. And also it looks like the ability of the manager to do real estate-related investments that still meet the criteria of the REIT going forward.

It's pretty interesting balance. As you look at the quarter going forward, it's almost a 50/50 origination sourcing between the executives at SCG, as well as the dedicated originators at the REIT. It's a very compelling and powerful combination of talents, the REIT being experts in structuring, deal sourcing, and selling off A notes; and the equity guys here being pretty good seeing lots of transactions up and down the capital stack. I think that really has differentiated as from our peers and will serve us very well going forward.

I think quality of the pipeline, both what we've closed and what we see in the future, is very strong. It sort of tilting towards Manhattan, which is unusual but high-quality, and I think a good thing to do. It is a very competitive market today. I probably, if you don't know that, you haven't been following the debt markets. The CMBS market is rapidly improving, one might say almost exploding. I expect soon the volume to be $55 billion to $60 billion this year, and could go even higher as the world searches for yield. That is a little dangerous, in the sense that I think the market's losing discipline a little bit again. Having said that, what you're seeing is compression of spreads more than you're are seeing a gigantic increase in LTVs. The market's remaining more disciplined on LTV, but taking spreads in because real estate continues to trade at very wide spreads their offers of similar credits in the structured credit market.

So we were once the conduit business as you may recall, those of you who've been with us a while. It turned out to be an incredibly profitable business over the past 12 months, as the credit curve crashed, as people felt comfortable that the economy wasn't rolling over. It is a business we know, avoid the team word gigantic conduit lenders, but with the LNR, we will be back in that business and it's a successful business. It's a little different, the business they do than what we did, in a sense that their investments are, on average $20 million, $30 million. They're small loans, and they turn inventory three or four times a year, which is very good from the perspective of hedging out risk, credit risk and duration risk.

I do think you have to look at the market today and the developments going forward. There's one thing that we are watching quite carefully, and cheer-leading along, which is the concept that a bank, or anyone, has to retain 5% of the loan for five years. That is the current proposal in Washington and it's still not finalized, but we think that is a huge competitive advantage for us. I think it's absolutely critical in this market that we originate the loan and then we chop it up and slice it and sell it off, whether it's going to be the future in a CBO or CLO, whatever we choose to do. Or simply selling the A notes, which we've done historically. And I think the banks, I don't know the number, but we've probably partnered with a dozen banks, selling off the C, unwise companies, selling off the A notes and sizing them to their needs, and also to keep our piece as wide as the capital stack as possible.

Stew mentioned the $100 million of debt created from 48% to 66% in the capital stack, that's not a B piece. A B piece is 68% to 70%, so it may have the same yield, but it does not represent the same risk in the capital stack. Having said that, we do think the B piece businesses attractive. It is a core business that LNR has been in for its entire life. It has built the systems, the information, and the people to process B piece loans and it's something the we heretofore have not had in our arsenal. We just didn't have the people to do the work on 700 loans in a portfolio, but they do. So you will see us continue to grow in that market going forward, and I do think that should bring us over to LNR for a second.

I think our core historical competitive advantage, and clearly the case for the quarter, and the quarter going forward, is that we have gravitated to exactly what we hope to become, which is a go-to shop for large complex loans that have to be done quickly, where you need flexibility, where the borrower wants to know who he's borrowing from, and in some cases may want to come back to us to restructure the loan. So we have the knowledge and the real estate knowledge, and I think a prime example of that is 701 7th Avenue in New York City, where I think we closed it in three weeks. And already the borrower is talking to us about up-sizing the facility to do some additional development there. That would be very accretive to us. He couldn't do that with a bank lender. It would be very expensive and very difficult and we'll continue to work on opportunities like that.

So let's talk about LNR and in the context, let me take a brief digression, talk about Europe. We closed the loan in Europe in the quarter on the three hotels. The Connaught, the Berkeley, and what is the third one? It wasn't Savoy, it's the ex-Savoy portfolio. We split that loan with Blackstone. We do think there'll be tremendous opportunities going forward in Europe for us, and they are big. It is a big market. There's a lot of opportunity and we're gearing up to do so. One of the pieces of LNR that we are excited to be purchasing is, a business called Hatfield Philips, which is the largest special servicer in Europe, and has something like better than 75% market share in countries like Germany. I think they will provide us a unique opportunity to see distressed debt and to offer borrowers unique solutions to re-capitalize their investments. And so we hope we would see an increase, a much bigger increase, in our book over time now, in Europe going forward.

LNR also, I think, provides additional sustainable competitive advantage for us because it does have this $100 billion-plus seat at the table where they see and oversee over $100 billion of loans for which they're named special servicer, and then about $20 billion, split $6 billion, roughly, in REO, and $14 billion in loans, that has been in their portfolio, in which they are actually actively special servicing. But that actually is less than half the value of LNR, of the portion that the REIT is behind. There is a significant CMBS book in the Company. With the rally in the CMBS market, hopefully that will be quite valuable to us. It also is an interesting hedge against the servicing business because, as the world improves, likely the CMBS book will go up, and if the world improves, it's possible that loans you would expect to fall into special servicing, would not. So there's a natural hedge in the portfolio, which is kind of unusual and interesting, and by value that CMBS book, on way we value the Company, is worth as much and slightly more than, the special servicer the way we underwrote it. Also as we mentioned, is the very effective conduit business archetype and their team has done a superb job in that market. They're one of the largest, top five, I think, or so, lenders in the marketplace and they been doing it a long time and they're terrific.

And the last investment, which we consider kind of interesting and fascinating is our interest in, or the REIT's interest in auction.com, which is the largest online real estate residential broker, as well as commercial broker that exists. That company is wildly profitable. It's growing quite rapidly with EBITDAs in excess of $100 million. And we think it's a fascinating seat at the table, and we believe it will provide interesting lending opportunities to the REIT going forward as well. We will see what kind of capital markets transaction they may do in the future, but we're really excited to have that opportunity to be there, have a seat at the table for the REIT. That investment will be go and this is the first time we'll be really activating the TRS, the taxable real estate subsidiary of the REIT, because obviously that income is not good income for the REIT. But with the scale of the Company, as you know REIT regs, we can put almost 20% of the income of the Company into the taxable sub, and then with totally legitimate structuring, hopefully reduce the leakage to taxes in the TRS going forward.

So with that, I think we expect -- let me mention one more thing. We expect the LNR transaction, I think we said it will close sometime in April. That is our goal. We're, again, working hard on getting the consents necessary to close that transaction. We are pretty, I would say we're thrilled, with that opportunity for us. We're thrilled with the management team, the depth and breadth, and the people that are there. I think that was an asset which you don't pay for necessarily, but it's probably one of the most valuable assets of LNR. Additionally, the data they have is extraordinary, and right now we're working on systems integration between the REIT and LNR. The technology is actually superior to the technology we've been using, and their systems are pretty damn good. So we're pretty excited about, we're very excited about, the opportunity to work with the team. I think we'll take questions.

(Operator Instructions)

Ken Bruce, Bank of America Merrill Lynch.

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

The business plan is to build a multi-cylinder company. If you have 12 cylinders, 6 of them are going to be firing at any one time and 6 might be dormant. You'll turn them on and off. One example would be the conduit business, which we got into, we got out of. At the time we did it, the team created these very powerful hedges that actually went awry on us, because there really wasn't depth in the market. There wasn't liquidity, there wasn't a provider. But really, the markets went off track, and it didn't quite, as you know, we wound up losing nothing overall. But for a moment in time it got a little nerve-wracking.

But that's a business that I never thought we'd exit permanently. I think it keeps our team busy and I think it's good to be a full stop, a one-stop shop, that can do everything across the whole spectrum. It's better for our people, because they can earn a living making these conduit loans, while they make them work as balance sheet loans we're going to retain. So I think with LNR, we've added four or five new cylinders to our engine. And I think you'll see us, we've talked about the triple net lease business over and over again.

We saw one of our competitors recently buy a mobile home -- manufactured home business. We've looked at a lot of these transactions and we trip over the fact that we have this philosophy of keep it simple, stupid. The reason is that we can produce earnings in the triple net lease business, that is quite accretive. But for the most, part every time we get involved with these companies, they have debt in place that's fully amortizing and matching the duration of the leases.

So we have GAAP income, but we do not have -- the heavy amortization of the debt provides no cash flow with which to pay a dividend. So we're basically borrowing from future to pay the dividend. And so that kept us from doing what I thought was a pretty interesting business for us, which is the triple net lease business, because it provided this depreciation shield for us, which would allow us to drive down the payout ratio of the REIT.

Right now, as you saw, we aren't about $1.99, what we call core earnings, we paid out $1.86, so we're inside what we're earning which is also our goal. You're not going to drink your blood. If, in fact we mentioned, I should have mentioned in my comments, that the LNR transaction looks to be accretive and may be materially accretive, even after the transaction costs, which are substantial, in year one.

We think we will have to be examining our dividend policy going forward, but we don't really want to get ahead of that and that's why we declared the same dividend in the first quarter as we did in the last quarter and this quarter we did in last quarter.

So I think you'll see us continue to look at service providers and businesses that are relevant and related to what we do. We think that the single-family home business which is now less than 5% of our outfit, is roughly $200 million of investment. It's been interesting. We've been dabbling in it. We've been doing it slightly different than other players, if you look at our disclosure.

We think it's actually cost us a penny or two in earnings probably, but that's good the book is un-levered at the moment. We mentioned in our earnings letter that we're going to lever the portfolio, reduce the equity investment in it. So that's a business we are watching. We are obviously aware of what other people are doing in the business including Two Harbors and Silver Bay.

We think it's interesting. It's a different business. It has some interesting inflation hedge characteristics to it. And I think, again, when we started out we made a mistake. I made a mistake. I thought rates would rise faster than they did. I didn't expect to QE 17 and print money forever. So I thought the curve would rise. We kept our duration shorter, probably, than they could have been because we thought we could reinvest the money at higher levels going forward.

I would say now I think we still have that philosophy that the government is subsidizing it. It's a straight curve and eventually QE 3 will expire. It might even expire at the end of this year. I think you'd see a significant shock to the interest rate curve, maybe 50 to 75 basis points. We are aware of that. And so we originate with that in mind and we are doing a lot of floating deals. Floating to floating, which there will be no issue, if rates rise.

And we actually stress our loans to make sure that if rates rise we still have sufficient coverage in LTV to get through it all. So we are very -- I love the floating rate debt right now. I prefer it to fixed. I don't think the rise in rates is tomorrow, but it could be just around tomorrow. Tomorrow plus one. I just don't know when tomorrow is. So over/under, I would suggest that rates will rise and that's not going to be bad for us overall. It actually will help the special servicer, maybe some guys who are paying LIBOR plus nothing will default, and we'll have an opportunity to restructure their loans.

Overall, I think you'll see us continue to broaden our product lines, so we can play in many markets. Boyd and his team have looked at other businesses that are relevant to us, where there is capital gaps that don't fit, that never fit in the conduit business. And I should have said, and I think it's really important, and again I regret that I left it to the Q&A, that if we had a choice between extra yield or safety, we're going to be safety. We're going to give up an aggressive 12 for a safe 10.

And in this world, we cannot compete, make no mistake about it, giant financing markets with trillions of dollars in them. But when the Street originates a loan, we are not going to compete against a hedge fund buying a mezzanine bond at 7%. And they are doing that today. So we must originate and in order to originate we must be big.

So we are fairly big, although we're tiny. We're a pimple in the capital markets. We're relatively big in our sector of the REIT universe. But we can be bigger with no problem. And actually, as you see, we injure ourselves by raising more money than we need, because now we're going to be shut out of the markets for a while. And for Boyd and his team, he's always saying, what do I tell my guys? Do we have the money to close the deal? And I said, don't worry, we'll get the money. But the truth is, we actually can't enter the market at this point, until we close the LNR transaction.

That's very helpful. You managed to touch on every single follow-up question that I have (laughter) but I do want to smooth things out.

I anticipate your questions.

Yes you do. If we look back to part of the triple net lease strategy, really, was related to the ability to shield earnings, as you pointed out, and I assume that exercising the TRS effectively is going to be a similar strategy that's going to allow you to grow your book value, create a better optimal financial strategy over time. Is that a right interpretation?

Yes. I think that's right. I think you have to be careful, because obviously the TRS is taxable. We've enjoyed this tax-free nature of the REIT. But there are businesses that can't go in a REIT, so they are service providers to the REIT. We're going to continue to look at what exactly fits where, as we get to the closing of LNR. It's not obvious always how this all should be played out.

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

Yes. Europe is funny. Capital Groups announced the closing of a hotel transaction today in Europe. Within a country, you can borrow in the country, from the banks in the country, and if it's 40% LTV, like the States, the banks are lending. And it's not too bad. Probably 100 basis points wide of the similar credit in the States. Where the opportunity is in the mezzanine. And then, right now there are not that many transactions taking place. And the nature of some of them taking place, the borrowers are -- the buyers are -- there's a transaction going down to a sovereign wealth fund right now.

We quoted the opportunity fund buyer at 12% mezzanine, and that was over $200 million, but they lost to the sovereign wealth fund, who's going to lever it 30%, and doesn't want to borrow at 12% percent. So it really is the nature of who's buying what. A lot of these loan pools that are being done are small. They have fast-pay debt, the debt that's available maybe 600 over but you have to pay it off immediately. And that makes it unattractive for us to be that player, because we will be paid down so fast it's no point in making the loan, it's too much work. We don't make any money.

So we'll wait to see as pools of capital circle. There's a lot of people looking at filling this great banking system hole in Europe, but you still haven't seen the level of volume of transactions anywhere approaching 2010, 2011 in the United States. And we're still in 2009 in Europe where banks are sticky, they don't want to realize the losses. The pace of transactions still is quite low across the continent and including the UK.

That might also be a reflection of the fact that they think things will get better, the banks. And they'd rather hold the assets for a while. And that the buyers are nervous about the macro of Europe, even though I think most people feel like the currency is going to stay together. The economies are floundering and maybe they believe they won't get a reasonable price for their portfolios.

So unless the institution has been nationalized, and Nama is selling assets in Ireland, there may be in the UK for example. You are not seeing the kind of flow of investment volume that you would have predicted at this point in the cycle. But it's coming, so we're there. We have tripled our overhead in Europe in the last year, and hired head of UBS's debt business, and he's on SCG's books. And he's been sourcing transactions and then again picking up Hatfield Philips, which I think has like a couple hundred or 200 people.

150.

150 people, which is a special servicer based in London and has a big presence in Germany. I can't imagine it could hurt us. It must create great opportunities and great insight into distressed situations, which we hope to take advantage of.

Great. Well, thank you for your comments. Good quarter, good year and look forward to 2013.

(Operator Instructions)

Stephen Laws, Deutsche Bank.

Congratulations on a nice year and looking forward to more details on the acquisition. I think you hit on a lot of questions regarding Europe with your last comment. Could you take a second to talk about the financing line your currently negotiating on the single-family opportunity? What you see as a rough range of where expenses of that may be and what type of leverage you think you can get on that portfolio of assets?

We obviously don't want to go into great detail on that because were talking to a couple of different financing sources. We don't want to show our hand too early. But those facilities are getting somewhere between, call it mid-60s leverage L plus 300 or so, is the term they are getting, that the facilities are getting done. So that's the ballpark of where we are talking to folks. There's obviously different types of facilities. There's the talk of the securitization market coming back for long-term financing for that market, but it's a little early to know whether that is going to play out or not.

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

Well, we are sort of an R&D shop. It could stay inside. We could bulk-sale the portfolio. We could spin it out and create a new company around it. We're considering all options. The pace of our investing has increased. I won't really talk about what we're doing exactly because the world is too competitive.

We didn't do this in the Opportunity Fund, by the way. The Opportunity Funds are not, we're not sharing these investments with the Opportunity Funds, it's adjusting done in the REIT. The reason is, I felt that market would get so competitive on the acquisition side that the yield would be driven down. And as you know, this is a new business and I would suggest there isn't anybody on the Planet Earth that really understands the capital costs. Maybe it will create earnings, but the capital cost of the turnover of the house, we're spending $11,000, $12,000 a house to fix them up. But it's the turnover. It's when the tenant leaves that's the unknown. The business, on scale, doesn't really exist.

You've heard the pitches from, I'm sure, the companies that are in the space, I think two of them that are public now or 1.5. We'll see if this does become this new asset class akin to the multi-family business. A lot of the purchases, well beauty is in the eye of the underwriters. If you're not getting enough current yield, your IRR is going to be driven by the appreciation. At the moment, I'd suggest that appreciation is being driven more by investors clamoring to buy inventory than by the underlying fundamentals of some of these markets. We are doing this micro-ly, carefully and with an emphasis on the age of what we're buying, as well as the geographic locations of what we're buying.

I look at it as fishing with a net. You're out the ocean, you're trolling for your tuna and you put this big net out there and you catch a lot of fish, and you keep the tuna and throw everything back in the ocean. That's what you have to do here. You by portfolios and you cherry pick the ones you want to keep and rent or lease everything out and I think we've sold like $38 million of homes or something like that.

So far, we just toss the stuff back we don't want. So it's interesting little business. We'll see if it becomes a big business for us. We are curious about it. It certainly has a lot of interesting characteristics and we all know how difficult this business is to manage.

And, Stephen, the one other point I would make, in our release we talked about the un-levered return from the portfolio being between 6.5% and 7.5%. That's actually a yield and not an IRR number. So as Barry talked about people banking on HPA or home price appreciation to hit their return, our number that we quoted is a true weighted average, net yield off the portfolio

And that's a net yield, not a gross yield. You're hearing people saying they're getting 11%s and 12%s, no way. That is not happening. That'll be the day they can get 11% or 12%.

I appreciate the color there. Maybe switching to the servicing and TRS. I know you hit on a couple of it, but any guidance you can give us on expected pace that you UPB pay-down? At what point that may plateau and even grow at some point in the future? And that maybe expanding on that, any margin rate target as far as pushing expenses into the TRS to minimize the income level exposed to taxes?

Why don't we wait on that for the next quarter and give you more guidance as we finish our structuring. LNR's company is being run for our benefit. It's a closed book at the moment. So we won't close, we are in taking in their earnings. There is no money leaving the company at the moment. And they're having a good quarter so far. So ahead of their plans, and I would suggest ahead of our underwriting, at the moment.

It's very difficult company to look at from that perspective, because there's sometimes on the servicing side, they're getting a payment that it's a timing variation. You have to be careful about they renegotiate something this quarter, they expect to renegotiate next quarter and they get paid for it. But for the most part, actually, from what I can tell, they're simply just ahead of our underwriting at the moment.

And some of their businesses, like the conduit business, did better than we thought, and they participate as public information in the securitization that just took place with Goldman Sachs and it was a very successful securitization. It did quite well. We're so far pleased as can be.

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

I think we should wait on that. To get the $455 million coupon, we provided that dividend protection to the convert. We could've done that transaction tighter, if we stated the original size. It was going to be down below $450 million. We gave up 10 basis points or so, by increasing the size of the offering from $450 million to $600 million. As you could tell, the stock was screwed around with on the last hour of trading but that's neither here nor there. I think we're going to do the right thing. We're all big shareholders here and we'll do the right thing by the dividend by the Company going forward.

Obviously we're aware of the fact we would like to increase the dividend over time. Offsetting that is the fact that the market is pretty darn competitive out there, and we're trying to maintain our double-digit mezzanine yields in a world where that's not easy, and getting increasingly difficult. We'd be delighted if base rates rose. But I think we are going to go for safety rather than 13 mezzanine [yields] for crap. Stew mentioned the low loss reserve we set up and we have to with the fact we don't have any losses in the portfolio. We'd like to keep it that way for the foreseeable future. So far so good.

Okay thanks again for taking my questions and you guys have a good afternoon. Appreciate it.

Gabe Poggi, FBR and Company.

I just wanted to ask a quick question about Europe. Can you just talk about if there are any conflicts with what SCG is doing in their European finance business? This is a question I get often and wanted you guys to clarify that. Thanks so much.

We did raise a small $350 million, GBP200 million-something, debt fund in Europe. And it is sharing those deals with the REIT. I think it was 60/40 to the REIT on the mezzanine we did in Europe recently.

Yes, Gabe, just to add a little bit of color to what Barry said, as we disclosed, I think in Note 9 or 10 of the 10-K, STWD made an investment in that fund, a small investment in that fund, and in exchange for making that investment, is going to effectively get, depending on the return of the underlying assets, we will get anywhere between, call it 50% to 60% of the investment. So we see it obviously as a bigger opportunity.

We've been very selective in Europe, doing less than a half-dozen transactions. And the fact that we were able to raise dedicated money in Europe as a firm, has allowed us to grow the bodies we have on the ground in Europe, and build up a bigger infrastructure, which should only help STWD going forward.

And the European vehicle will do seniors. It's a blended mezzanines and seniors. And that's not what we do. Their seniors are seniors. There's like 4% paper, and it doesn't fit for us. We'll see what it looks like going forward. It is competitive. There's another reason to do a European vehicle denominated in pounds, which is a hedging cost, or nearly 100 basis points off the coupons. To be competitive, if their local guy's offering seven and we have to finance it at eight and swap it back to make a seven, we actually don't win. We needed a vehicle that doesn't -- and the US vehicle here, we hedged the currency risk post-coupon.

In fact, you can see fluctuations in our income statement on changes in the currency. It creates a wobbly earnings year, even though their fictitious. It would drive you and me a little nuts with wild currency swings in earnings in the United States, which are obviously just mark-to-markets on the hedges, and have no -- ultimately if the one pays off the whole thing collapses, and you haven't realized any loss or gain, for that matter. So having the local currency vehicle is helpful to remain competitive in situations and we're in the cap route, so we get to, I won't say, cherry pick but sort of cherry pick, what we want to do in the vehicle.

Think that's very helpful. I didn't see the note in the 10-K. Nice job again, guys.

Joel Houck, Wells Fargo.

Thanks and congratulations on an outstanding year. If you look at the growth in 2012, over 40% in the investment portfolio, the mezz portion grew even faster, closer to 70%. That makes sense given, this based on your disclosure, the highest-levered return, yet the attachment point is 65% and the LTV isn't really all that much higher than first mortgages, so that's good asset allocation.

What's your outlook going forward, in terms of mix and mezz? It sounds like you're a little more cautious that it's just becoming more difficult to get those types of returns. But if we were to look out over the course of 2013, and you guys already made some comments about robust origination Q1, what are your thoughts on mix?

You should expect LTVs to climb. Closer to 70%, I would expect. I think lenders are at 75%. There are certain asset categories we just can't touch. Star Capital just closed yesterday a loan on multis it's 79.5%, it's $2.77? Where are we going to play in that stack? If we provided anything on top of that, we'll be at 90% LTV, and frankly the asset can't even support our mezzanine. So there's certain asset classes.

Actually there is one very encouraging thing, is we're doing that more [office] yield. And the portfolio is moving less in the hotel space, and if you look at our hotel concentration, there's really one big investment there, that is AAA paper. It's really not even hotels. It's the senior in a very public buy-out of a very large hotel company. So it's distorted. Our actual exposure in the hotel market is not, I would say, as high as it might look, when you look at the pie charts in our disclosure statements. Boyd, you want to add anything on that?

When you talk about the mix, Stew elaborated on it really well. Our big advantage right now is this being a one-stop shop where we do the whole loans and then sell off the A notes. I think that more than likely will represent the majority of what we do. So how you describe that --

-- structured deals.

Where we take down the whole stack, simplify it for the borrower, but then once we sell it all off we wind up with mezz. So it's really, you do a whole loan and then you wind up with mezz, eventually.

And it's really no different than when we -- the risk position is very similar if we use on-balance sheet leverage as well. For a variety of risk reasons, it makes the most sense to sell A notes or use securitizations or something, because they represent matched term non-recourse financing. But we have warehouse facilities that manufacture effectively the same positions. One shows up with a whole loan, one shows up as the mezzanine loan, or sub-debt, but they're for all intents and purposes the same things

The numbers may be a little bit misleading to you. If we choose to do on-balance sheet leverage, then it looks like we don't own mezz, but we really functionally do.

No, that's an excellent point. Thanks for clarifying.

Jade Rahmani, KBW.

A quick one on the loan-loss provision. Is this the recurring expense you expect to run through earnings? And is there target reserve ratio, or some way that you're thinking about it?

The loan-loss or the loan allowance methodology that we have historically done, because we have very good clarity into our assets, we have a total number of assets a little over $100 million, we are able to surveil on a very detailed basis, on an ongoing basis, every asset, and so the allowance methodology we use is not a pooled concept. It's a the loan-specific concept. And at this point in time, as I mentioned in my part today, we still have no expectations of any losses associated with any of the individual loan investments that we have.

That said, we've now gotten large enough that it's prudent for us to recognize that there are certain categories of assets that would have a higher likelihood of loss than others. We've included, as outlined in the Ks and Qs, has been since the inception of the REIT, we have a loan scoring system. In which we, across a variety of measures, we score loans from one to five, one being the best and five to be the worst.

What we decided to do, and it's outlined in Note 4 in the methodology, is to create a loan-loss allowance equal to 1.5% of all the loans that we independently deemed to be rated four. And the greater of 5% or any expected value deficiency on fives. We don't have any loans that are value-deficient at this point in time. We have one loan for $11 million, that we have as a category five, because it has a reserve deficiency issue. That's in the process of being resolved.

But is a formulaic methodology. It will be applied every quarter to the extent to which loans migrate out of the four category and up to a three, the loan-loss provision will be reduced and it will show up as income. To the extent that which new loans go in as fours or fives, it will be a charge up or an expense for that period. And that's the way it will work. Unless we decide to change the way that it works in the future.

Okay, that color is very helpful. Regarding the LNR transaction, I wanted to see if you'd be willing to comment on whether you anticipate acquiring additional special servicing assets, perhaps from banks or other players to put onto the LNR platform. As we've seen a lot of consolidation in the residential distress servicing space, I wondered if you could anticipate a similar trend emerging in the commercial market.

Let's just not comment. (Laughter). Obviously there's scale advantages and servicing businesses.

Ladies and gentlemen, that does conclude today's question-and-answer session. I'm going to turn the call back over to Mr. Sternlicht for any additional closing remarks.

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

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