Starwood Property Trust Inc (STWD) 2013 Q2 法說會逐字稿

Good day,and welcome to the Starwood Property Trust second quarter 2013 earnings conference call. (Operator Instructions).

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

Good morning, everyone. I would like to welcome you to our second quarter earnings call. With me this morning are Barry Sternlicht, the Company's Chairman and Chief Executive Officer, Boyd Fellows, the Company's President, Stu Ward the Company's Chief Financial Officer, Cory Olson, the President of LNR, and Mike Berry, the Company's Chief Accounting Officer.

This morning, the Company released its financial results for the quarter ended June 30, 2013 and filed the Form 10-Q with the Securities and Exchange Commission. In addition, the Company has once again posted supplemental financial information to its website. These documents are available in the Investor Relations section of the Company's website at www.starwoodpropertytrust.com.

Before the call begins, I would like to remind everyone that certain statements made in the course of this call are not based on historical information and may constitute forward-looking statements. These statements are based on Management's current expectations and beliefs, and are subject to a number of trends and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements.

I refer you to the Company's filings made with the SEC for more a detailed discussion of the risks and factors that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today. The Company undertakes no duty to update any forward-looking statements that may be made in the course of this call.

Additionally, certain non-GAAP financial measures will be discussed on this conference call. The Company's presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. Reconciliations of these non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP can be accessed through the Company's filings with the sec at www.sec.gov. With this behind us, I am now going to turn the call over to Stu.

Thank you, Andrew, and good morning. This is Stu Ward, the Chief Financial Officer of Starwood Property Trust.

This morning, I will be reviewing Starwood Property Trust results for the second quarter of 2013 and third quarter to date. I will also highlight a variety of new and expanded items contained in the financial statements we filed this morning that now incorporate the operations of LNR and provide new segment-level break outs for our traditional lending business, for LNR, and for our single-family residential property business.

Following my comments, Barry will discuss current market conditions, the state of our business and the opportunities we see looking forward for our newly expanded platform. Let me begin by pointing out that LNR's results and contribution are not for the full quarter since the acquisition closed three weeks into the quarter on April 19th.

For the second quarter 2013, we reported core earnings of $86.1 million before the transaction and restructuring expenses with our acquisition of LNR or $0.52 per fully diluted share. Net of these transaction and restructuring expenses, which were comprised of professional, due diligence and severance costs totaling $17.1 million.

Quarter earnings stood at $69 million or $.042 cents per fully diluted share. GAAP net income for the same period inclusive of these transaction expenses totaled $62.3 million or $0.38 cents per fully diluted share. A component of the $0.04difference between GAAP and core net income is an $8.5 million expense associated with an accounting anomaly regarding change and control payments to LNR executives per their old contracts, which are deemed to be expenses of Starwood Property Trust under GAAP, but which, in fact, were always contemplated as a liability of the sellers and were fully funded by the sellers at close.

As of June 30, 2013 GAAP book value per diluted share was $21.21,an increase of $1.12 over the level of $20.08 reported as of March 1st. Fair value per share stood at $21.77, also well in access of the $20.48 per diluted share reported at the end of the first quarter.

Both increases are reflective of the $822 million capital raise we completed in mid-April. Our acquisition of LNR closed in mid-April for a final purchase price of $730 million plus assumed liabilities, and therefore, for the first time, we will be presenting results for the combined entities.

In the form 10-Q we filed this morning, we also provide details of many important changes that have occurred in our overall financial statements as a result the of the acquisition. Before I review the financial results of the LNR business for the quarter, I want to bring your attention to three issues you will need to comprehend in order to properly understand our financial statements going forward.

First, one of LNR's primary revenue sources results from their role as a special servicer for commercial mortgage-backed securitization transactions. Of critical importance to that business are the investments in [CNBS] made by the Company that allow LNR to name itself special servicer for the CNBS Trust.

Under GAAP, the combination of special servicing and capital at-risk in the same CNBS trust requires us to consolidate on to our balance sheet the full assets and liabilities of the majority of the CNBS trust, LNR special services. As a result, you will now see an inflated overall GAAP balance sheet for the Company presented at over $103 billion, $97 billion of which are assets and offsetting liabilities that from an economic perspective we fundamentally do not have an interest in.

These are assets we don't actually own and liabilities we don't actually owe. To provide a clearer picture of our true economic exposure, we provide an alternative presentation in the form 10-Q of the income statement balance sheet and the consolidated statement of cash flows as well as a reconciliation of GAAP and core earnings on a deconsolidated basis, which is how we as Management review our financial performance and should facilitate your review of the same. Second, it is important to highlight that as anticipated and modeled, we now hold 100% of LNR's servicing activities and conduit operations in a taxable resubsidiary to ensure our qualification as a [REAP].

Accordingly, our form 10-Q disclosure has been significantly expanded to describe the taxable nature of these operations. Third, given the nature of LNR's operations and the unintended consequences of CNBS trust consolidation, the majority of revenue generating assets we acquired in the LNR transaction will be accounted for on a fair value or mark-to-market basis for the purpose of determining GAAP net income.

The result is that we may have more volatility and GAAP net income going forward than we have had in the past. And in some instances, the results may not reflect our expected long-term financial performance of these assets.

As a consequence, we have developed methods for the computation of core earnings for each of these fair value asset classes that we believe are consistent with the message we utilize to compute core earnings for our traditional holds and maturity assets and are aimed at providing an alternative measure of the stabilized long-term earning power of each of these asset classes.

Now let me outline the second quarter results for our three major business segments. Since the beginning of the second quarter, the commercial real estate lending division has been very active closing sixteen transactions with total lending commitment of $1.46 billion.

Eleven of these transactions, totaling $831 million, were closed in the second quarter, with an additional five transactions totaling $626 million, closing in the first 30 days of the third quarter. Importantly, we continue to be extremely pleased with the risk and return profiles of these new transactions, with the bulk of these transactions located in the best markets in the country involving high-quality experience sponsors with great real estate.

These transactions have an average loan to value of 64%, which is consistent with our overall portfolio metric, and an expected leverage return of approximately 10%. With the addition of these commercial loan investments, our total traditional real estate loan and security portfolio stands today at $4.2 billion. With an average expected annualized return of approximately 12% and average loan to value ratio of 64%.

The first 18 days of April, prior to the close of the LNR acquisition on April 19, was an extremely strong period for LNR, with profits on a GAAP basis of $39 million for these 18 days alone. As a consequence of the structure of our purchase agreement, all of these profits, as well as $118 million in profits earned between October 1 2012 and March 31 2013, accrued to the benefit of Starwood Property Trust as a reduction in the goodwill component of the purchase price.

For the second period -- for the period following the acquisition's close through the end of the quarter on June 30, LNR as a business segment earned after tax profits on a GAAP basis of $34.6 million and had core earnings of $35.6 million, both inclusive of allocated shared cost of $4.2 million.

Measured on a stand-alone basis, the LNR business segment would have earned core earnings of over $1.00 per allocated share. We continue to be pleased with the performance and risk profile of LNR's conduit operations as well as the integration of our Legacy Starwood Property operations with their counterparts at LNR.

Also, during the quarter, Fitch and Standard and Poor's affirmed the Company's ratings for the domestic servicer as css1 minus and strong respectively and fish -- and Fitch also upgraded the ratings for LNR's European special servicer to css2 from css2 minus. It is also worth mentioning that special servicing revenues, dnbs income and projected cost-savings associated with a planned and executed right sizing of the business are either ahead or consistent with our pre-acquisition on array.

Beginning this quarter we have expanded substantially the segment reporting for our single-family home business. Since the beginning of the second quarter, the number of properties owned has grown from 1,678 units to 3,150 units, and our single family non-performing portfolio increased from 1,318 loans to 1,559 loans.

Our total portfolio property on loans now comprises over 4,700 units with an aggregate investment basis of $590 million. We continue to actively be buying properties in or target markets.

We continue to actively be buying properties in our target markets. This segment of our business is still in ramp-up and we opted to acquire MPL's to our entry basis and convert loans to REO rental. As a result, the single-family business has operated in the red since inception. However, we fully expect the portfolio, when stabilized, to earn leverage cash yields of 10% plus and a total return factoring in the long-term price appreciation in the low to mid 13%'s.

One last comment about our single-family residential business before I move on. As I have mentioned in the past, and is worth repeating now, one of the primary motivations behind the LNR acquisition was the benefits it would provide by substantially expanding and diversifying our lines of business and greatly expanding our lending, practicing and analytical infrastructure.

As a market leading full PHS is real estate platform we feel we have grown to the size and scale to start and incubate new lines of business like the single-family residential business without major disruptions to our operations nor unacceptable impacts on our near term earnings. With the recent concerns in the market over the prospects for higher interest rates, we have received a lot of questions regarding our exposure to interest rates.

The answer to the question is complex when you consider the potential relationships between interest rates, property cap rates bond credit spreads, et cetera. However, from a core earnings perspective, assuming a reasonably stable environment for real estate credit, we feel we are well-positioned against rising short-term rates.

First of all, the vast majority of the new assets we originate for our conventional loan book are flowing rate, index to short-term [libor]. Over 90% of the current pipeline is floating rate, index to libor.

Additionally, an announcement of our portfolio, including the assets required with LNR, suggest we are well positioned there as well. The equity deployed in earning assets of our recent balance sheet can eventually be split into three categories.

50% supports floating rate assets, nearly all of which are indexed to short-term libor. With these assets, our returns increase when short-term rates increase. 35% supports high-yield fixed rate assets, assets with yields generally 10% and 15% plus. We feel these asset yields are sufficiently high to mitigate concerns over rising rates.

The final 15% percent represents equities supporting other fixed rate assets, the bulk of which are single family properties and NPL's. We feel the interest rate exposure embedded in this final asset group, as well as that of our overall fixed rate book, in general is substantially mitigated by the more than $1 billion in five-year convertible debt we issued earlier this year at very advantageous sub- 5% coupon levels.

Let me finish my remarks with a discussion or our current investment capacity, our second quarter dividend and provide an update to our 2013 earnings guidance. As of August 1st, we had $354 million of available cash and $127.4 million of financing capacity approved but undrawn, and $177.9 million of net equity invested in liquid residential mortgage-backed security.

With this, we have the capacity to acquire an additional $500 million to $700 million in new investments. Our Board has declared a $0.46 dividend for the third quarter of 2013, which will be paid on October 15th, 2013 to shareholders of record on September 28th, 2013. This is equal to the dividend paid for the second quarter and represents a 7.15% annualised dividend yield on yesterday's closing share price of $25.73.

At this time, we are revising upward our core earnings guidance for the full year 2013 to a range of $1.90 to $2.10 per diluted share. Excluding the LNR acquisition and restructuring costs discussed earlier translates to a comparable range of $2.04 to $2.24 per diluted share. With that, I would like to turn the call over to Barry for his comments.

Thank you, Stu. We have become little more complicated. Good morning, everyone.

I thought I would use this opportunity to talk about where we have been and where we are and what we have seen in the market today. We are approximately five days short of our four-year anniversary of the birth of the Company.

I am really proud of what we have done and the accomplishments of our team and use this opportunity to thank the team that has made this company one of the biggest and most successful this year in the public markets. So far, in four years from a standing start, we have invested more than $9 billion of capital.

We have done so -- it is interesting to note, even though credit spreads have come in and the world has become more competitive, and lenders have entered the market, the leverage yield on our core business is about what it was when we started. As we told you during multiple conference calls over the last four years, as our credit facility spreads narrowed we were able to keep our net yields on our mezzanine positions or, as I call them, the ATunas,

relatively consistent despite the volatility in the market. We have now built out the largest commercial real estate platform in the United States, and with a total enterprise value well in excess of $7 billion. I am really proud to say that I recently saw some data that we are the best performing, not only are we big, but the best performing commercial or residential mortgages over this time period in the United States. We also have secured something like $2.4

billion of credit facilities, and when we started we couldn't get any credit facilities from seven different institutions and we have completed two very shareholder friendly-converts, as Stu mentioned, with coupons less than 5%. We continue to raise our ROE and provide long-term stable financing for the Company to execute our business plan.

We have also grown our dividend from 0 to $1.84, and obviously, with the Verizon, our core earnings and our earnings clean of the one-time LNR transaction we will have to evaluate our dividend going forward. I also think we have delivered on our promise of best of class transparency.

You can tell we have overdone it for the quarter. We have been predictable. And focused from the start of safety.

And by safety, we have said we would diversify our book and we have done so not only by product type, but by geography and internationally as we have grown our European lending operations. We have manufactured an ROE that has been consistent even as the debt markets tightened. I think we have penalized ourself by entering the single-family business which, we think, is a really good move for our shareholders long-term, and I will talk about that in a second.

I also think we have been doing this long enough for our fourth cycle. Our mini-crisis in the credit cycle when rates rose orthe markets froze, and it is pretty interesting. We have been slow, our lending activities.

We always have a conversation for being with Boyd and the team, are we being competitive, and are we remaining best in class? And I will say that we feel like at our scale, we can win every loan we compete on, but we choose not to.

We are very concerned about credit quality. The quality of the assets, our debt yields and, I would, say I am equally, maybe most pleased about the great synergy that has developed between the equity shop and the nearly 300 people that work at Star and Capital Group. And the team that has dedicated activities to the read, both in our San Francisco main offices as well as the LNR team.

I think the best is ahead of us with LNR. We have been spending our time in a reduction of force that we contemplated. To right-size their servicing operations going -- operations going forward. That was completed smoothly by their CFO and COO and President Cory Olson.

That integration has gone well, but it is really about what will happen going forward that we are most excited about. I also see today, we should mention, acceleration of lending opportunities in Europe. There, that business is lead entirely of SCG's team over there.

There are no lead personnel in Europe at the moment. The lead gets the benefit of the activities and the overhead of Starwood Capital Group, as it should. SCG has also lead the acquisition of the 701 investment in New York.

In fact, a deal is high yielding above a 14% return on equity that was split per the documents and the agreements we have with the Board. Between 75% to the read and 25% to opportunity fund. Also SCG lead the acquisition an incredibly complex acquisition of LNR from start to finish.

It was an interesting quarter, and it is not obvious how wild a quarter it was. First, at the macro level, interest rates rose nearly 100 basis points. That was an interesting thing because a lot of the conduits stepped out of the market, and with the street not ready to hold any inventory they held -- they had become pretty tight on spreads. Some of them found themselves having securitiezed paper with no spread at all.

That was really good for us, and remains good for us. And a rising interest rate environment, conduit lending fixed rate lending, is hard to do. It is very hard to hedge these positions today, and and they are reluctant to lay themselves out and expose themselves to a rising interest rate environment. This period is actually kind of fun for us.

The conduits, in fact, many of them have shut down waiting for a more stable interest rate in the environment as they watch the machinations of the Fed. It is really very good for us, as I said, in the universe. The odd thing was what happened to our stock.

The stock was probably swept up in the selling of ETF or the mortgage reads as the residential mortgage reads have taken significant hits to their book value. I think we couldn't be much more different from a lending perspective than the residue reads that might be reviewed as our cousins.

What we have, as Stu pointed out, and I'll repeatingly mention on the convert call, is very little exposure to rising interest rates, both as Stu mentioned, because of the nature of what we have done with double-digit returns in our fixed income books, and also the duration of our book. Our book tends to be shorter. We anticipated from the very start of the Company a rising interest rate environment, so the average life of something like four years you won't have the volatility in your paper that you would have in a 30-year paper.

We also are modestly levered. We don't have a 5 to 1 or a 7 to 1 leverage. And we are not mismatched on term. Many of the mortgage residential reads say finance short and invest long. We don't do anything like that.

We are fixed across the board. We have very little impact to volatility in rates. And actually, because of the floating rate nature of not only our core book, but also our pipeline, we actually do better in a rising interest rate environment so long as we have been able to keep our LTV's so low.

LTV's have stayed around 65% for the last four years. I find that quite shocking. It is a wonderful thing, and it shows you that we have been very disciplined since we started.

It hasn't been just about being big. It is about being big when it benefits the shareholders and the strategy we are trying to deploy. 60%, almost two-thirds of our book is floating, and what is fixed is match-funded. We have a wide range of safety on the paper that we carry on our books.

I think we have distinguished ourselves over the four years as the go-to guys. We are seeing most of the large loans that fit our criteria we have a chance to look at.

Unlike many or some of our peers, it is clear exactly what goes where in our firm. Mpl loan, we don't do mpl's in the read. We have never done them in the read. That's on the commercial side.

And loans that are ROE's over 14% are split between the read and the opportunity funds. We don't have any other vehicles to place paper in and everything innures to the benefit of the shareholders. We are as, as I said, very capable of winning everything we bid on but we have been choosy. We have chosen to price our capital at a fairly dear price.

Our pipeline loans are better than a 600 basis point over libor spread. We choose to use our capabilities and underwriting real estate in being flexible and working with borrowers and using our relationships, and our ability to close things quickly to get excess pricing that works for our borrowers. Many of them come back to us and look at us refinancing or doing additional transactions with them. And as big as we, are we are a tiny player in the market. Our growth opportunities are relatively unlimited.

It is the truth that the bigger loans that we are capable of doing, and we would like to be able to do even more, now we are working on increasing our credit facility as well as tightening the spreads on our credit facilities. The big loans are typically better credits, in bigger cities with better sponsors, and they build a better, higher quality firm.

Being big really helps. Looking out in the future, we will continue to look at adding cylinders to our Company, or I call them having 12 cylinders and any one may not be firing at a time, but the other 11 will be working. We will continue to work on expanding our capabilities, and that was the -- one of the core reasons to do LNR.

LNR may be regarded as a special servicer, but it is less than a third of the value of the Company when you look at the way we have allocated the purchase price. There is a conduit lender that is very successful. There is a CNBS book that is kind of unique to the scale of what LNR was that we continue to monitor.

We have deployed capital in the quarter behind the LNR platform, and they continue, going forward, to look at the synergies and the unique proprietary opportunities we might have to lend behind their special servicing book. In general, the servicer is not the core. It is not even the majority of the purchase price of the LNR transaction. We also have talked last quarter, and I will talk again, of the spinning off our residential portfolio. We continue to look at that.

Obviously, investing this much capital in this business, you can see from the financials, has been diluted to the parent company. But I believe it is a legitimate business that we can talk about in the Q&A and if you want to. I think you will achieve leverage double-digit yields,but I think it is an equity play. As such, I personally don't really believe it belongs in the Company long-term.

And, as I mentioned, it is hurting our EPS, both for the year and the quarter. And it is incorporated in our Guidance. I also will distinguish what we have done against some of the other players that have gone public or have tried to go public. We have split our purchases between NPL's nonperforming loans that was typically bought from financial institutions, as well as acquiring single-family homes in the open market, the target market.

We have done so with about an 80% broker opinion of value acquisition price. So if you take the $580 million and you were willing to say they are worth value, then you have nearly $100 million gain in the book value of those houses. That's $0.20 cents on roughly $580 million. That's close to $100 million.

That is not only a tiny fraction of that, a small markup of a couple pennies is included in our fair market value number that we gave you of $21.77 (inaudible) per share at fair market value. We have an embedded gain in that. We have chosen to be very picky in how we buy houses, and we could have been five times the size, and maybe we should have been, but we chose to, as we always do, try to find value in our acquisitions.

On our NPL's, our average purchase price was $0.64 broker opinion to value. We have also not bought certain markets and focused on others and that is included in our disclosures. You can see the portfolio and where it is and we will talk later about why we did what we did and where we did it.

Going forward, I want to specifically mention the upgrading of the consistent ratings on the servicer and the upgrading of Hatfield Philips. Hatfield Philips is the largest servicer in the UK in Germany and Europe, and we look forward to taking advantage of their scale and their positions in Europe as we identify paper. That is a very unique business that we acquired in LNRthat is somewhat of a sleeping beauty.

Hopefully, we will be able to extract off that platform going forward. I think as we spin out the AAA residential book, we will boost the ROE of the firm. And I think uniquely we have known we have been a -- I'm probably most proud that we have been a good partner to our shareholders.

We have not issued dilutive off secondary offerings, and we have done now $2 billion of paper converts that are exceedingly attractive for our shareholder basis. We seek to become a major player in the financial markets and the commercial real estate finance industry. With that, again, I want to thank all of the guys Andrew, Cory, Stu, and the team at LNR for all of their hard work. It

It is a lot of work. I look forward to reporting clean quarters going forward. They won't have all of this noise of unusual GAAP expenses and severance payments to the LNR team and the earnouts on their contracts.

Hopefully, that will all be behind us, and we will be able to report clean earnings. I will mention other thing about the quarter, is it is unusual for us not to have any securities gains in the quarter. Usually, we have a prepayment, or somebody pays us back on something and we didn't have that happen this quarter, which is somewhat unusual.

Maybe the first that I can recall it has ever happened to us. They are hard to predict, but they are usually recurring and nonrecurring events.

Hopefully, as you know, we still have significant papers and discounts to book. Some of the -- some of it will probably pay off and create additional earnings for the Company going forward. So with that, we will take any questions.

Thank you. (Operator Instructions). We will pause for just a moment. We will take our first question from Joel Houck with Wells Fargo.

Good morning. And again, thanks for the incremental disclosure. It is very helpful. The first question is, maybe obviously the origination pace in Q2 and post-Q2 is very robust. Maybe that is a result of some spread widening we have seen. Maybe you can comment and provide a little more color in terms of where you see value in what I will call the traditional Starwood business and what the pipeline looks like going forward.

This is Boyd. The pipeline today is as robust as ever. I guess it is a combination of a whole host of things coming together. It is very common that before we have become a go-to player for big transitional transactions. Right now, the pipeline itself is very diverse, both by property type, as well as geographically, domestically. And then there are several solid deals in the U.K. that feel eminent. It is a competitive environment, but in the end, there is a very short list of players we compete with on these large transactions.

Retrospectively, our average transaction was roughly $65 million to date, but if you look at our current portfolio, the average transaction in the current pipeline is more than double that right now. So we really are focusing on a lot of large transactions as that our scale enables to, as Barry said, feel like we can win them when we want.

One other thing I would just point out is, one of the things I love about this business, especially when LIBOR is at 25 basis points, is that virtually all of the transactions we do we are lending to a barrower who has got a transitional underlying transaction. By definition they need prepayment flexibility, and by definition, accordingly, they expect the loan to float.

So we are really building an enormous portfolio of loans that float over LIBOR. And when LIBOR is at 25 basis points that feels pretty good to me.

Overall pipeline I would say is -- what is it, $3 billion?

It is right now --

pretty big.

I didn't want to -- we are culling through it, and we call it cherry picking, picking the deals we like the most.

And I will point out that it is difficult as it as always been and that has been consistent quarter to quarter, and with timing of the closing. We don't get to choose when the bar closes. We like it when they have to close, because then we know we have to close. When they are doing refinancing, and they're working in Europe, particularly, guys are usually buying back their loans from a bank, and then they keep negotiating and it is hard to predict. The good news is that we have many pieces of paper today. We own seven loans. We have over a hundred direct loans and, obviously, LNR has $17 billion of special servicing assets. The pipeline ebbs and flows and right now it is flowing. It is not the ebbing part, it is flowing.

As Barry said earlier, the spike in rates helped cause the backup in the CNBS world, which pushes people back into our hands. That really helps and we are still feeling that.

One other nuance of the market, as you probably know, the live companies tend to be more aggressive in the first half of the year than the second half of the year as they put out their allocations. That is good for us, and we will see how that works going forward.

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

Can you repeat that?

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

This is stu. I would say that would be the high side. Earnings for the quarter were very -- I mean we are lumpy and very strong. We had a few extraordinary, as occurs in that business, recoveries of other things that push income up for the quarter. In general we would expect the quarter to be -- it is a more normalized run rate and we will have a little lower tax rate.

And they earned $40 million in 18 days, which weren't included in the quarter. They nearly doubled their earnings in 18 days. All of that money went against the goodwill provision for the Company and bizarre accountingg. We effectively reduced the purchase price by the $100 million something dollars they earned while they were being held for our benefit, and we got the approval to close the Company.

I will say this about the LNR transaction so far. The pace of the diminishing of the special servicing book is ahead of our forecast. It is not going down as fast as we thought and modeled. Cory and the team have done a pretty good job of right-sizing our gna ahead of our estimates. And we are deploying capital, which we didn't really model. The [BP's], which is a new line of business for us. It's hard to predict.

But they are uniquely qualified to be doing special servicing in the BP's buying, because they know many of the loans and they can underwrite them in a way we never could, because the loans are different. Smaller, and there are too many of them. All of that stuff is, we hope, very accretive to the Company long-term, and I think we are one of the top five BP spires but even there we choose not to bid on certain paper and the -- and they are pretty picky.

Joel, it's Andrew. One other point to make, as Stu mentioned in his remarks, and we have modeled this transaction as we have structured it today, all of the special servicing income sits within the taxable re-subsidiary. We have been looking at ways, and we have been in dialogue with the IRS as to different structures to use to potentially move some of the special servicing income out of the TRS. Which, depending on what tax rate you want to use, could provide some incremental --

we will model that if we can get it done. We'll let you know.

Thanks, guys.

We will go next to Ken Bruce with Bank of America Merrill Lynch.

Thank you. Good morning. Also thanks for the disclosure. My question really kind of starts where Barry was ending his comments in terms of the size of Starwood Property Trust. It has obviously grown quite significantly in the last few years. I'm wondering, is there a natural place that you think this business should be, in terms of its ability to turn over capital and essentially support the lending function? How should we be thinking about the longer-term growth potential for the Company, because you are going to have a situation where, as you pointed out, the market opportunities are quite attractive. There is the ability to raise capital in an accretive manner. Where do you think this business naturally should get to?

It is unclear. I don't know the answer to the question. As long as the market appreciates what we are doing, and we are delivering I would say, terrific dividends at a very attractive risk profile. I think we will continue to be open in the supportive growth of our Company. If we can do that and keep the stock above book value, or even higher than book value, you can spread further away from books. It can be a better machine the bigger it gets. And I kind of look at it a little like Wells Fargo Bank, and I am giving them a compliment here. They survived maybe better than some of the other real estate-laden bank institutions by keeping their LTV's quite low. They are the largest lending bank in the country, and they should by all rights, after seeing the disaster when the world ended in 2007 and 2008 given their books.

But because their ltv's were low, they also had lower funding costs than many major other institutions. And they weathered the storm pretty well. And, I think, for us, we are trying to follow the same kind of philosophy, better loans and bigger assets to allow us to barrow on our facilities or fixed rate or floating rate seniors on paper at tighter spreads, yielding higher ROE's. And then, we have to have other cylinders, business lines, that we can execute on when there is nothing to do or less attractive things to do in our core business. We continue to explore other areas that we might want to be in lending.

Without getting too exotic, I don't think we should have to explain in gross detail, and do not capable of modeling things we are doing. We are not going to go into an Angola and make loans on gold mines with kickers. Not that there is anything wrong with that, but that is not or business plan. We will keep this as core and understandable as we can, and we think long-term the shareholders will reward for us for.

In the context of the market opportunities that you are reviewing today, is there evidence of any diminishing returns? We have been very encouraged by the ability of Starwood to produce very consistent returns over what has been, looking back, a very unstable market backdrop by many respects. Are you able to pivot toward different parts of the market that give you this return Bogey that called the 12%, 13%, 14% range, and do you see a collection of opportunities that are out there? Or are we seeing any evidence of diminishing returns, that it has just been interrupted by the backup in rates in May and June?

I would say the market has gotten tighter. I would say overall it is tighter. Maybe at the moment it is better for us. European yields are a little better than domestic yields on their [retained P's]. I would say that, like for like, you are probably 200 basis points inside of where you started in 2009. I just scrubbed it directly. You had credit facilities that were wider by probably a hundred basis points from where they were today in 2009. That absorbs some of the decrease in pricing that you had to take to stay competitive.

I would say in 2010 to 2011 we have seen guys in [8's and 7's] and if you are buying off the street you are seeing Mezzanines at [7]. We don't play there. We have to be the manufacturer, not the buyer off the street. We will not be competitive. You see so many market funds, hedge funds, big money managers buying fixed paper at [7]. For those of you, if you are new to our busines,s and we are riding very wide mezzanines or B-notes.

We make a loan, an average loan to value, at 65 %. The A-note might be 45%, 50%. And the B-note would be 15 points in the LTE stack. In the old days, that B-note would have the same yield, but 72% to 73%. They might have 12% yields, but it was a totally different risk profile because it was one LTV basis point (inaudible) basis points wide. There is more safety in it, and as you look at that sheet we give you in the disclosure statement, it shows you that if you took out the 50% -- the 0% to 50% portion of our permanent book, that would be treppe AAA, that would trade at [105%] over the curve. The curve is the average duration of papers less than five years.

The curve is $1.30? That would be $2.30 a paper, or something like that, and we are paying out $7.00It is a so far, so good, but I will say we have to follow the market. If peers are price leaders and start winning every deal because all they want to do is be big, we are going to have an issue. We are trying to keep our ROE up. It is good that the market has sorted itself out. We don't have, in the public markets, that many guys who can do the scale of what we can do.

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

and they they can't warehouse the deal. Take -- One example is the loan we made on Hudson Yards. There we haven't sold any note. We are funding the construction ourselves. The spread was wide enough and structured transaction that -- I won't tell you what it is, but it is pretty damn good.

And later, down the road, we will lever that position. We won't lever today, but we will wait until we get a good price on the A-note when we sell it, and that will boost the yield on the paper substantially higher, probably 400 to 500 basis points, than it is today. And that is a big loan. But we can do that. We have the balance sheet to do a very large transaction, as we did in 701 7th Avenue. I think those are poster child yields of the kind of things we want to focus on.

The best case for us is a 40% leased office building in San Francisco where the debt yield is low and the lenders don't want to do it, and we step up and make the loan because we feel very comfortable at our basis on the loan and those -- and we get paid for that. So that's good.

Well, you have had some amazing pricing discipline or just stayed out of the price-sensitive parts of the market. Congratulations on that. Thank you for the additional disclosure, and I look forward to those clean quarters. Thanks.

Me too. Who needs a valium?

I have one going on anyway.

Looks like "50 shades of gray here."

I think That's good.

Take that off the transcript.

We will take that next questio from Jade Rahmani with KBW.

Thanks for taking the question. I wanted to ask what kind of runoff rate you think is reasonable to expect on both these special servicing portfolio and the Legacy CNBS portfolio. You mentioned the runoff was coming in better than you expected. What are you expecting or modelling in your Guidance, and also, if you could comment on 2014.

We don't want to do that yet. Like I said, it is kind of -- obviously the Company has its view, and we don't want to give you that view yet. We will probably update our guidance at the end of the third quarter for 2014. I can say it is directionally up, not down. But we don't -- we don't know -- it is a funny business. Because it is not that easy to model parts of it. I don't think what Stu mentioned, the fair market value, marks on the TMBS book. And I don't think that is going to be a big deal if rates stay here. Our view, by the way, relevant to our business, is that rates probably won't move materially over the next 24 months, 48 months. Maybe you will see a 2.75%, 2.85%, or maybe it will go to 3%. We are fine with that. That is actually good for us. It is astucity of this -- As Boyd said, we have a big call on LIBOR. If they ever increase LIBOR for us, we are going to earn better numbers.

So embedded in this is a free call on interest rates, which is kind of interesting. And we would clearly increase our ROE dramatically if short rates went up. Somebody mentioned short rates. It really isn't short rates. They are our friend. The long rate being volatile is good for us, because it keeps the conduits sidelined.

With the -- do you view the rate volatility as potentially slowing the runoff rate on LNR?Is that what the driver is?

That's an interesting question. Higher rates are good for LNR, obviously. There is more default. More things will fall into special. I think they are named servicer and it is $110 billion.

$131 billion.

Is that Cory?

Yes, $131 billion deals.

Thank you for that. Cory, do you want to answer any of these questions? Do you want to give them a little color?

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

When he says planned he is not talking about Starwood's underwriting. They had a plan that was more aggressive than our underwriting for the acquisition. So they are doing just fine. I will mention that the CNBS book we have is fairly short-duration and you can see by the financial -- by the disclosure that we marked it at a fraction of its -- a fraction of its face, right? What is it, $0.20?We have this natural hedge which is kind of fascinating. They are unique among the special servicers in the scale of their CNBS book. There are two other major players, and they don't look really like this. If the rates go down, the CNBS is worth more, and if the rates go -- and the special services worth less, maybe, because people can refinance.

And the opposite holds true. If rates go up, the servicer gets more stuff and the (inaudible) might be worth less. But we are pretty -- there is a lot of of -- some of what we own are fairly liquid positions. And while Stu said we mark their auditors, we have to check our mark. We are hopefully bordering on being conservative, and I can tell you for a fact that we are being conservative on a number of things we have trouble marking. We mark them and keep them at 0 so they wind up being positive surprises.

Have I two other quick questions. One on auction.com Whether your earnings for the quarter included any of those, the 50% share of those equity earnings? And then on the single-family, if you, in addition to considering a spinoff, would consider combining that with another existing entity 's portfolio?

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

There was a small distribution, less than $1 million.

You are seeing nothing for that. Don't forget we own 7.5% of that, of the Company. Is that 100% or is that -- there is a warrant on the additional piece. Right, that's what I thought. We are only 3.75% as of right -- that we own of them right now. It is tiny. There is a warrant for additional equity in their Company, depending on what we contribute to their platform for sale. At the moment, it is an asset that has no income coming out of it for us. What was the second question on that? Combining?

On the single-family residential portfolio you put together -- I mean there are several existing public entities that are trying to get to scale. Would you consider combining your portfolio with another company in order to accelerate the size and scale of the operation?

Possibly. You can also see us being a consolidator, and we can do the opposite. While we might not be the largest, we are the second largest, potentially, of the public companies that have filed with Silver Bay and Arcap, I think it is called, being smaller and we are twice the size of those guys. We are unleverered at the moment. Not only are there no earings, but there are no earnings against it. I think you are going to like what we are going to do there. Hang on to your chairs.

We will go next to Stephen Laws with Deutsche Bank.

Good morning. To fall on the single-family residential strategy, let me talk about the time line of respected cash flow with respect to the home fee purchased and the NPL strategy. Looks like from the supplemental deck that that business is a $0.03 cent per drag on core earnings. Can you talk about the outlook of when we should see that move to break even and then a contributor to core earnings?

NPL's, obviously, are non-performing loans, so they don't have much in the way of coupons associated with them. The loans that are in Florida -- We had a pretty interesting development in Florida. They shortened the foreclosure process and so those loans, they will be -- today, if you bought NPL's in Florida they would be trading tighter than what we bought. The process got cut in half of eviction. What you see in the loan book, by the way, is you are going to -- some of those assets will just sell. We have sold houses that we have gotten back that don't fit our geographic footprint or core portfolio. Others we'll remodel and [towards] the rental pool. And others will continue to work through the inventory.

But our largest concentration, as you can see from the deck of the disclosure, deck is in Florida you with nearly 2,000 homes and loans. That is not an accident. We wanted to be in that market. I think all of these companies will have different footprints. Just like the Avalon Bays and the Associated Estates, eventually the markets will separate between the footprints of the companies and decide that the bi-coastal strategy may have been higher and the Avalons were worth more and traded better than the Associated Estates because they were in the middle of the country without the growth. You might ask why we did this in the REIT to begin with. You haven't asked, but I will tell you. The reason was that we expected that as home price appreciation accelerated, more of the total return would come from appreciation and less from current yield.

And in fact, the inverse would happen. As soon as the markets took off, and they took off faster than we thought, in some markets like Phoenix we have, almost no exposure. Because homes have rose 24% in value. That is not reproduceable. You can't have 24%, 24%, 24%, 24%, 24% and 24%. What happened there was that they bid down current yields to the point they weren't interesting to us. We did want to keep our current yields somewhere between 6% and 7% on an unleverred basis. So double-digit on the current basis levered, and then IRR's, hopefully, with the home price appreciations in the [midteens]. We actually think we have a book that looks like that, and will perform like that. And I guess I have been reading all the paparazzi reports about the industry or the nation's industry. It does doesn't exist as a business today.

And we have our thoughts, but we will share them later on that. It was an experiment. We wanted to play. We have done better on the current yields than we would have thought, or the expected current yields on the portfolio as we lease it up. And we'll see. I actually think -- I think there will be, and you probably would agree, five, four national or large players in the face of the public markets, and they will take their place along the multi-REITs. And I think they will be competitive from a dividend strategy and a growth perspective.

I think they will be competitive. Although there may be periods of time when you are just earning a dividend they're not appreciating, which is not any different than commercial real estate. There are times when there is no rental growth. In fact, ome markets have seen negative rental growth. Real effective rents. Cap rates will plop around. I think it will be an interesting business.

Great. I appreciate the color on that. One more specific question to guidance. When we think about the new range, XLNR transaction-related expenses 204 to 224, is the comparable number for the first half there $0.98, basically? The $0.52 in Q2 and the $0.46, which would be core is expenses in Q1?

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

I will ask -- I will follow-up with you after the call to try to --

yes.

What did we do in 2012 for the year ?

Without lnr? What did we do last year? We did 197 last year or something.

I was looking at the first half of this year. I think you reported second quarter core x to $0.10 cents of LNR would be $0.52 cents.

That's correct.

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

Right.

So those are the two numbers that would compare to the core guidance of 204 to 214 of this year?

That should work, right. 204 to 224.

Just wanted to make sure I was getting the right numbers. Thank you.

That's correct.

And once again, (Operator Instructions). We will take our final question from Dan Altscher with FBR.

Thanks, good morning, everyone. Glad we are not talking about valium and whatever shades of gray. Reservations there.

Sorry.

If you think about the taxable earnings that are coming out of LNR, how do you think about that in terms of dividend policy? Is there now a targeted payout ratio on GAAP per core earnings that we can think of that incorporates the taxable earnings out of LNR?

Obviously the REIT rates still apply. We still have to pay out 95% of our taxable income. I don't really want to comment on our dividend policy ahead of the Board. We like dividends to go one way. I guess it was two years ago we did a special one-time -- last year. And we decided we didn't get any benefit from the shareholders for that. We did raise the dividend instead. And you can look at the guidance and you can take an estimate of what we might do. We will also be looking at 2014, obviously. In the pace of what we are doing, and where the stock, is and we have done $9 billion of transactions and our market cap is ex, it is less than that. We are recycling capital aggressively. There are loans being replayed, CMBs being paid off, and NPL's being sold.

So we are redeploying. And our pipeline, the loans we close, it might not be we have to go out and raise new capital. We look at our maturity schedule and what we are open to repayment. We kind of like some of -- the difference between the commitments in the quarter were like 850 and we funded like 550. We like that because we know we can match that with repayments on our loans coming in. We look at the whole book that way and say, we have these loans coming in. And they are paying off. And we know where the proceeds are going to go. On this loan on Hudson Yards, for example. That's actually -- we are trying to manage our ROE that way. What we don't want is cash.

Actually at the moment we don't want cash or houses. We didn't realize -- honestly, I telling you the truth. We didn't realize how much we would hurt ourselves from an earnings perspective, and not from a value perspective going into that business.

I know, I guess that is on par for the market phenomenon too. The last couple of months haven't been good for the single-family rental space. One last question, when we think about the recent securitization that you just completed or are maybe in the market of selling, how can you think of the returns on your share of the subordinated pieces you will be repaining? retaining?

Well, I think the right way to describe, there are a couple of securitizations that we have been in the marketplace recently. I am not quite sure which ones you are discussing. There were some we made -- the LNR conduit unit contributes loans on a very, very systematic basis. They have one of the quickest turnover rates in the industry. They are contributing to five or six securitizations a year, and they have had recent sales. We also have a securitization in the market involving a large loan that, affectively, the commercial real estate division originated, and securitization is really akin to an A-note sale for us. It's a securitized sale of the senior component of a loan very much akin to the sale of an A-note. Were you referring to the --

Yes, I was referring to that latter transaction.

Right way to look at that is after substitute for A-note sale yields or warehouse borrowings, you can assume that if we undertake one of those transactions, that that is a transaction that is accretive to one of the -- to say a warehouse line draw from the same asset. In this particular instance, it reduced our borrowing costs by 25 to 30 basis points, and, importantly, creates aperfectly match-funded and non-recourse and noncross collaterallized financing source. But for all intents and purposes, its leverage to produce the B piece that we retain.

And opened up lineup space on the line. So it creates additional capacity for us.

I think we have talked about it a lot in the past. If you look, and we relentlessly utilize the sale [Enil] the markets, whether they're through securitization or direct sales, as substitutes for line drives it gives this current market at market pricing, and it has all of those positive risk-related attributes.

In fact, if you look at the aggregate amount in quotes financing activity we have done since the beginning of the year, my bet is that A-note sales dominate new draws on lines by 8 to 1.

It is 8 to 1. And what the lines wind up functioning as is a warehouse for us to let the assets sit on the lines while we run an auction and eventually sell the A-notes.

And in some cases, it could be 100 points tighter than what we were paying to have them on the line. They are a great vehicle for us. The lines to the A-note sale, and it is interesting. And the CNBS business people put loans on short-term warehouse lines and sell the deals into securitizations. In our case, we are essentially putting the loans on matched term long-term lines, and then ultimately selling A-Notes.

We are as I mentioned in my comments we are working with our lenders to lower our spreads on our credit facility to keep us competitive. I would say the bad news is we were in business for so long before this time period that we have heritage spreads which are wider than market today. So the team ensures me that is going to change. So we are going to --

a lot of effort is going into restructuring.

Expand and restructure in ways that facilitate using them.

We have to be competitive on both sides of our balance sheet.

Exactly.

The other synergy that comes along with that I think LNR was named the special servicer on that transaction too, right?

Absolutely. We will use those --

we hope that deal never goes --

They are not making money on that.

Lets 's assume that is no value.

Great, thanks.

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

I do think it was a transitional quarter, but an excellent quarter for us. It was a lot of tough work by a lot of people in both Florida and the Miami headquarters of LNR and the team in San Francisco, as well as some of the people that work here out of the Greenwich headquarters. I want to thank them for [Cheryl] and the boys are doing a great job. I think it will be easier now.

This was a complicated quarter for us. Closing the books this quarter was a Herculean task and LNR is a thousand little pieces. We are done, and so, going forward, we actually are collapsing accounting systems and other software and programs on to their system so that is ongoing and moving ahead nicely. So, again, thank you all, and we look forward to our next quarter with you.

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