Starwood Property Trust Inc (STWD) 2014 Q1 法說會逐字稿

Good day and welcome to the Starwood Property Trust first quarter 2014 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.

Thank you and good morning, everybody. Welcome to Starwood Property Trust earnings call. This morning, the Company released its financial results for the quarter ended March 31, 2014, filed its Form 10-Q with the Securities and Exchange Commission, and posted its earnings supplement to its website. These documents are available in the Investor Relations section of the Company's website at www.starwoodpropertytrust.com.

Before the call begins, I would like to remind everyone that certain statements made in the course of the 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 a forward-looking statement. 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 CEO, Stew Ward, the Company's current CFO, Boyd Fellows, the Company's President, Rina Paniry, the Company's new CFO, Corey Olsen, the President of LNR, and Zack Tanenbaum, our recently named Director of Investor Relations. With that, I'll turn the call over to Stew.

Thank you, Andrew and good morning. This is Stew Ward, Chief Financial Officer of Starwood Property Trust. This morning, I'll be reviewing Starwood Property Trust results for the first quarter 2014. I'll also provide details of the performance of our investment lending business, LNR, and briefly comment on the impact the single family residential property business had on the quarter prior to the January 31 spin-off. Following my comments, Barry will discuss current market conditions, the state of our business, and the opportunities we see looking forward.

For the first quarter, we reported core earnings of $121.5 million, or $0.60 per fully diluted share which is more than double the $58.1 million of core earnings we recorded in the first quarter of last year. The primary drivers behind our earnings rose were obviously the acquisition of LNR which accounted for 78% of the growth as well as the deployment of $4.7 billion in new loan and securities investments during the past 12 months, which accounted for the remaining 22%.

GAAP net income for the first quarter of 2014 totaled $120.6 million or $0.60 per fully diluted share. Which compares to GAAP net income of $95 million or $0.48 per diluted share in the fourth quarter of 2013. And $62.2 million or $0.46 per diluted share in the first quarter of 2013.

As of March 31, 2014, GAAP book value per diluted share was $15.85, a decrease over the pro forma level of $16.42 we reported at year end after adjusting for the spinoff of SWAY. The decline was primarily driven by the dilutive impact of an incremental 6 million shares included in our share count at quarter end. Of this amount, 3.2 million shares related to the in-the-money conversion value of our convertible debt instruments and the remainder relates to the issuance of stock compensation awards in the first quarter.

Also contributing to the decline was a greater than expected asset distribution to SWAY due to the pace of our asset acquisitions in the segment during the first month of the year. There were no credit losses or impairments during the quarter. After adjusting for our accretive share issuance in April of 2014, our pro forma book value per share was $16.57 and pro forma fair value per share stood at $17.05.

Now, let me outline the first quarter results for our major business segments. During the quarter, the lending segment closed ten transactions with total commitments of $1.7 billion of which $700 million was funded at closing. 98% of these new investments are LIBOR based floating rate loans, as is approximately 94% of the lending segments pipeline.

These transactions included a good mix of property types, primary market locations, and first rate institutional sponsors. The last dollar loan-to-value exposure for these transactions ranged from 55% to 80% and as a group we expect to earn an average leveraged return of 11.3%. Included in this transaction set are several large construction loans we've been working on for the better part of the past six months. In aggregate, we now have eight construction loans with an aggregate funded balance of $500 million and future funding commitments of $1.1 billion in our target portfolio.

I want to make a couple of important points about our construction exposure. Commercial construction activity fell dramatically during the recession and the traditional lending sources for large commercial construction projects have been largely absent as the commercial real estate market rebounded to the point that significant new construction is warranted. During the past year, we've been able to step into this financing void and originate what we think are some of the most attractive loan investments we've ever done. We expect these loans to yield risk adjusted returns in excess of 11% on a stabilized LTV below 60%, and an average loan-to-cost of approximately 72%. Over 95% of these loans are in New York City with well capitalized world-class sponsorship and the property types that compromise the portfolio are well diversified with the majority representing mixed use developments.

Additionally, we've been extremely thoughtful in analyzing the impact that future funding commitments associated with these transactions have on our future liquidity picture, and at this point feel these commitments fit in extremely well with anticipated repayments and asset sales in our existing portfolio. LNR continues to be accretive to STWD and has delivered another strong quarter of operating results.

In the first quarter, the LNR segment contributed GAAP and core earnings of $62.8 million and $49.3 million respectively, inclusive of allocated shared cost. When compared to the fourth quarter of 2013, GAAP and core earnings of this segment increased by $27.1 million and $4.3 million or 76% and 10% respectively.

This strong performance is principally due to the rally in the CMBS markets during the quarter. LNR was able to harvest realized gains from its investment securities portfolio of $17.3 million, resulting from the sale of approximately $64 million in CMBS. Also related to this portfolio were $19.7 million of unrealized gains, and $23 million of interest income.

As we discussed last quarter, the servicing intangible is an economically deteriorating asset which continues to amortize. During the quarter, the intangible associated with this asset declined by $12.2 million which was in line with our expectations. The remaining fair valuable of the intangible at March 31 was approximately $222 million.

Despite its continuing amortization, the servicing asset continues to perform well ahead of our underwriting expectations, and the current contract base is expected to continue to generate positive returns on our invested capital as these legacy CMBS transactions run their course. We continue to be a preeminent player in the CMBS special servicing business, investing substantial capital in a new subordinate CMBS, and acting as a special servicer for the CMBS trust involved with these new investments. As I've said in the past, the LNR platform provides us with absolute best-in-class talent and systems infrastructure to optimally exploit high-yield opportunities in the CMBS business. The performance of which is naturally hedged by the earnings potential of our role as a special servicer in the same transactions.

As of March 31, LNR was named special servicer on $15.7 billion of loans and real estate owned, which continues to exceed our underwriting expectations at the time of acquisition. On the financing and capital fronts, we've had a very busy last four months. In January, we upsized our largest and most active financing facility from $550 million to $1 billion, extended the maturity of this facility to a new five-year term, revised the pricing and sizing of new assets to significantly more competitive levels, and negotiated a new term-out option for assets remaining at the facility's maturity to mitigate overhang risk.

Additionally, in early April, we sold 25.3 million shares of common stock for gross proceeds of $564.7 million for the purposes of funding a pipeline of identified transactions. As I'm sure you're aware, we completed a successful spin-off of our single family residential segment on January 31st, which now trades on the New York Stock Exchange under the ticker SWAY.

On the spin-off date, the asset base totaled approximately $1.1 billion, including approximately $100 million in cash. For the month prior to the spin date, this business segment contributed modest GAAP and core earnings losses of $3.4 million and $1.9 million respectively, primarily reflective of allocated management fees and overhead charges. In accordance with GAAP, the single family residential segment has been presented as a discontinued operation.

Let me turn the discussion to our current investment capacity, second quarter dividend, and 2014 earnings guidance. As of Friday, May 2, we had $277 million of available cash, $123 million of net equity invested in liquid residential mortgage backed securities, and $225 million of financing capacity approved but undrawn. Accordingly, we have the capacity to originate or acquire an additional $450 million to $725 million in new investments. This investment capacity is anticipated to be further expanded by several significant A note and loan participation sales we expect to close in the coming months.

This week, our board has declared a $0.48 dividend for the second quarter of 2014 consistent with the prior quarter, reflecting the Company's continued strong earnings. The dividend will be paid on July 15, 2014 to shareholders of record on June 30, 2014. This represents a 7.9% annualized dividend yield on yesterday's closing share price of $24.18. In addition, at this time, we're reaffirming our 2014 core earnings per share guidance range of $2 to $2.20.

On a final note, this will -- as Andrew mentioned, this will be my last earnings call as the CFO of Starwood Property Trust. When we initially evaluated the possibility of acquiring LNR in late 2012, one of the many synergies we identified was the potential to consolidate all accounting, treasury and asset management functions with LNR in Miami to take advantage of the substantial infrastructure in those areas they had developed over the years. To that end, we've spent the past year orchestrating that transition which is now complete. As such, Rena Paniry, who has served as the Chief Financial Officer of LNR will be assuming that responsibility for the overall Company. She is a stupendously smart and capable person.

I don't use the term "stupendous" lightly. You'll find her a delight to deal with as well. I couldn't have had a better partner over the past year. In her, the firm's in excellent hands. With that, I would like to turn the call over to Barry.

Thank you, Stew. I think I should start my comments by thanking you for your amazing work the past years and for putting yourself out of a job by transitioning all your reports to Miami when you're based in San Francisco, as I think our shareholder base knows. You've been a pleasure to deal with and the whole team, and the shareholder base, and the Board of Directors thank you for all of your efforts these past years. As I told you privately, and I'll say publicly, you should go into a business that we could possibly fund. We'd be delighted to be your partner going forward.

So I think we had a pretty good quarter this year. This past quarter. I want to start by talking about the economy a little bit because I think, as you know, from the start, we have an overall macro view which informs the investments we make and where we deploy shareholder capital. Our feeling is the economy is what you see it to be. It is not that strong and even though the weather impacted the quarter, for sure, I don't expect GDP growth to accelerate dramatically in the US primarily because the rest of the world is not pulling its weight any longer. Rapid growth.

I see the number between 1% and 2% GDP growth in the United States. Lower than that in Europe and nobody believes the numbers coming out of China. And obviously South America, led by Brazil, is functioning at a dysfunctional rate of growth, not really absorbing the cost increases inherent in their labor structure. I think we're going to see lower, longer globally, and I think most of you and I, and most every economist has been surprised at the ten years below 260 at the moment. That has to be good news for the REIT and good news for our shareholders as our dividend yields globally becomes super valuable and super attractive. High yield continues to trade around 5%.

I would argue that our dividend of 7.9% with secured mortgages, whether they're first or we call A2 notes because they're first sliced in half, match funded, or just far superior risk-adjusted returns for shareholders than you could find in high yields and certainly in corporate. I do think what this means though, with a flood of liquidity the world, especially attracting to real estate, we see a lot of crossover capital coming out of corporate bonds into real estate, mortgage bonds again, and that's propelling the rise in growth in the CMBS market once again. That spread will continue to come and which will absorb some increase in rates going forward, if it in fact it happens.

But, I think you'll see short rates go up. We, please, God, they go up. Good for us because we have LIBOR-based loans. I don't think the curve is going to steepen or it's going to flatten. I think the -- without growth, I don't see the ten-year racing away from there even if it goes to three, if the shorting goes to two, you're going to see a huge compression in rates or a flattening of the curve. Good for banks. Good for LIBOR-based lenders.

Keep that in mind as we continue to generate LIBOR-based loans and focus only on LIBOR-based loans going forward. I really like our book. I think it is amazing as we've said. If you've been with us, some (inaudible) since the IPO, we said we would build a diverse book, which we have, by asset class and geography, which we have. We said we would focus on safety, which we have.

It is pretty interesting to see the LTV of our book hovering around [66%] percent. Pretty consistent quarter-to-quarter. We've moved into Europe, as you know, and done some amazing deals. The cover of the annual report, if you haven't seen it, is Heron Tower, which is one of the finest buildings in London. We featured it on the cover of the annual report for that reason.

We have a great book. It is quite valuable. I think if we sold it in bulk, a [life] company would take it down at a very attractive price compared to where we're marketing it at book or fair market value. We have, as you know, also focused on the major assets -- the major markets and the major assets. New York City is well represented in our portfolio. And that's because it is by far, the best market in the U.S. with deep investor interest. We see that from our equity positions.

Our client base which includes almost ten of the world's sovereign wealth funds are very focused on that city and will keep values high for a very long time. We're also watching, as it relates to loan to value, first [year] reforms that are making their way through Congress and the biggest beneficiary of [first year] reform would clearly be New York City. All of the property markets in the United States are pretty stable. They are slowly improving, even the once-dead suburban office markets are getting better. Certain markets are actually doing quite well in suburbia. Just to pick your spots. (inaudible) Minneapolis after the quarter end which is a pretty good suburban market.

Even multis which we feared were going to be over-built are seeing rents rise. I think there is a great debate about the housing market. I actually think the housing market is fine. I think the issue is more of the subs. There aren't trained subs, then there isn�t demand. That doesn't mean in certain markets, housing prices didn't run further than they should have, based on galloping investor interest, which propelled these markets like Vegas and Phoenix far beyond where they should have been pushed. So they're correcting.

But, for the balance of the Company -- for the country, as you saw this morning with TRI Point's earnings, the housing market is quite good, particularly in southern California though they are limited to their ability to add product. Nobody is going to allow spec housing there because of subs. Which means that you might see some tick up in inflation in the construction trades, and maybe some of those people will re-enter the workforce and that's good because that will propel the GDP growth higher. The lending markets, on the other hand, are super competitive.

We continue to rely on our speed, our knowledge, our relationships, the 46 acquisition guys we have in Starwood Capital Groups to [Amanda Eng] that works with Boyd, and Warren de Haan, that's dedicated to the REIT as well as the 74 asset management people in the various functions of the firm who also can look for opportunities for us. I would have liked to have seen more loans from Europe in the quarter. We continue to press our European team there, too. Spreads have come in dramatically over the last 12 months. Even on the equity side, we were able to refinance loans at a LIBOR plus 450 and LIBOR plus 275. Those spreads will continue to come in as Europe recovers.

Probably the most important statistic I look at when I look at what's happening in the world and how sanguine investors are becoming is the ten-year in Spain and Italy which has hovered for years above 4%, high as 5%, and 6% and 7%, and then crashed this year. Falling from 4% to like 3.18% and actually getting very close to US ten-year treasury rates which is quite something given the moribund economies of both countries, so they're both mending. So we are looking at other geographies today and other product lines to add to our business lines. We have many business lines. We don't have the one. The special services, interesting, at $222 million, that's less than 5%, 4% of our book. A very small part of our overall business.

In fact, our small and conduit business, the CMBS investment and trading business, the [BPs] business, the service or Hatfield Philips which is a servicing business owned by the REIT in Europe. All of those are contributing meaningfully to our growth and take us away from being a book value company and toward a global finance company which is what my goal is for our firm. We also made a key to run Hatfield Philips in Blair Lewis, and he joins us in January, and we're really excited about the future growth and potential of that business.

Also I'll point out in the quarter or prior -- early in the quarter it was announced that Google took an interest for $50 million investment into auction.com at $1.2 billion strike price. I'll point out in our book, in our earnings that is Euro value. It clearly has value. Google wouldn't invest in Google capital in something they thought couldn't be a leader in its field. That's a free option for shareholders, and something that could have significant value down the road.

Also I'll point out that assets like 701 7th Avenue in New York City which was a retail base deal where we financed the project for (inaudible) Steve Witkoff in partnership with Vornado, who we sold a piece to to secure our -- to make sure our position was safe. Then signed a deal to put a Marriott on top of the box. Marriott provided a put on the hotel which gave us the ability to significantly increase the construction loan, and then we split it in half and sold it to another investor so we wouldn't have too much exposure to that. But we do have our 10% equity kicker in the transaction which we believe is worth tens of millions of dollars. And the (inaudible) in the book and also we did not accept an offer to sell it.

And I'll also point out that we believe our CMBS book is quite valuable and though its market share value, we would suggest it might be worth more than that. The sales that we made in the quarter, you should expect us to continue to look at individual securities, some of which they recently bought. [It was] trading around very high IRRs. But we think that's an interesting business. We have an un-level playing field, but we have very good information on all the CMBS legacy securities, and will continue to mine those opportunities going forward and every day I seem to get a wire transfer of $22 million, or $5 million, or $8 million as they buy and sell these positions. We sold the ones we sold because the yields to maturity fell below 5% and there are others that when we see stuff like that, we must take advantage of the marketplace and sell these positions. So we'll continue to do that.

It should be viewed as a recurring non-recurring because they will recur overall going forward. I also will reiterate how Stew's comments about the accomplishments of Rina, and Stew, and Cory, and the teams in integrating the Starwood systems in with the LNR platform. We had I don't know how many people we had in accounting before. Half a dozen? Now we have 60. We had an IT platform of, I don't know.

None.

None. And now we have like 40 people doing IT One of the other projects we have here is working on our database and making it a usable across the Company and across all of our ITs so we have unbelievable information on loans, and on assets, and on our performance, which will help us underwrite. And Stew raised that in year end discussion with me that we're not taking full advantage of the extraordinary skill of our enterprise which, today, is I think a $38 billion asset manager.

So I think we'll keep working on the market opportunities that are afforded to us. We want to drive the earnings growth to create a full-fledged finance company and that will create continued growth in our dividends. The key for me has always been the diversity of our book and the ability to not face rollover risks. The construction loans we made will fully -- pretty much fully match the expected maturities pre-payments and repayments of our loan book in the near couple of years which means the cash we get back that we couldn't deploy -- don't forget it is earning close to between 7% and 11%, then goes to ten basis points. That's a problem for us.

If we can fund these construction loans, they will absorb those repayments. And because of the nature of the borrowers and the quality of the projects, we're very comfortable that these are really good assets. And for example, we have a construction loan in an apartment building on the upper east side where our basis is (inaudible) $850 a foot. If you know anything about Manhattan real estate, that's about a third of what it is probably selling for. In fact, I think that project is sold out or close to being sold out.

90%.

90% sold out.

At more than two times.

At more than two times our [footed] construction exposure, but it is not really a construction exposure. Included in that book is also Hudson Yard which (inaudible) making a construction loan as good as this. It's above an eight [coupons] the first mortgage and as the project completed we will lever it. I think our basis is something like $500 a foot which no office building is traded at $500 a foot.

I think it is like 70% leased now. Very exciting stuff. You saw Tishman Speyer paid $438 million for a piece of dirt next door. Our construction loan is -- I forgot how big, but it's about that big.

With total it's $475 million.

$475 million for a first mortgage. A million square foot office tower. It is super safe in producing a great yield for you and better when we lever it. It's still unlevered. One of the other things that Stew mentioned briefly was that we have decided from some of our clients to lay off some of the construction exposure.

We have a deal cooking to sell down $150 million positions in one of our New York City loans, one of the newer ones, which we will do. It is in process, we believe. We will earn a profit on that sell-down and then recycle the cash which is a significant trade for us, a $150 million layoff to a foreign insurance company. We would like to do more of that.

The only issue is that capital is typically much slower than we are which gives us the opportunity to make the loans in the first place. We'll have to warehouse them and then sell them down. And we have a significant interest from clients looking to participate. Then we're really going to be a bank (inaudible) our loans. So in summary, our outlook in the pipeline is quite strong for the Company. I expect we will tighten our spreads to lend against ever better real estate but I also think our new credit facilities, which Stew and Carrie Carpenter helped negotiate, are going to allow us to lever them a bit more and still achieve a reasonably good, and better than good yield, LIBOR-based again going forward.

We think this is better than stretching too far with worth collateral. But I would like to take advantage of our 90-odd, hundred people at SEG to do more loans that have kickers in them, and participate in the recovery of the real estate market. So hopefully you'll see it climb a little bit in LTV and take some of the kickers that may be available in the marketplace today. Not everybody wants to borrow 80% and give you 20% of the project but some people might, especially if they believe we're going to add expertise to their capital stack.

Also a consensus, these kickers will give us for the upside and hopefully we won't have any incremental downside if we get our real estate calls right. We can only achieve -- do this strategy because of the breadth of the total organization and we're very excited about the future of the Company. We welcome Rina Paniry as our new CFO, and I want to thank all the people in the Company for a really broad-based, giant effort. This is a big company. Today we produce over $120 million of profit in the quarter, so almost $500 million a year in profits if we annualize that. This is a big company. It is one of the largest banks, except it is not a bank in the United States.

But doing almost $5 billion of new lending in a year makes us, I would think, in the top ten financial institutions in the country. My guess is. So with that, I think we'll take questions.

(Operator Instructions). We'll go first to Jade Rahmani with KBW.

Hi, thanks for taking the question. I wanted to ask about the real estate lending portfolio and what you think an appropriate leverage target would be. If you assume 50% to 60% of your lending portfolio is mezzanine or subordinate mortgage debt, how much on balance sheet leverage do you view as what you're comfortable running with?

Well, we're running lower than our -- I guess our major competitor would be Blackstone at the moment. We're not running as lever to book. We look a little differently. Partly because of the nature of our -- we are doing first mortgage loans which is more cash. They are high enough coupons that they're slightly dilutive to the enterprise while they're unlevered and then wildly accretive when we lever them down the road.

We could lever some of them today but we might as well wait until we can get sizable first. It is very attractive in the spread rate. So I would guess, what do you think? Three? Two and a half?

Well, we've talked about it, Jade, I think in the past a number of times. We have three ways to finance ourselves. We use, historically, prior to February of 2013 when we did our first convert, we really only had ac -- we financed ourselves either with secured warehouse lines, on balance sheet warehouse lines, or we manufactured the same kind of leverage with A note sales, so it would be an off-balance sheet equivalent. With 2013 we matured to this spot as a company that we issued over $1 billion in convertible debt at really attractive pricing and we also now have a rated term loan of almost $700 million.

We now have a fairly substantial access to corporate style debt. We have $3.3 billion in on balance sheet, secured warehouse capacity. And then we have a very -- as Barry mentioned earlier, I think we have one of the premiere syndications in A notes [health desk] on the Street let alone for a company that looks like us. So to some extent � and we talked about it, again, I know I've covered this concept on these types of calls in the past.

Our business M.O. is to make safe, call it, 70% first mortgages. And retain the 45%, 50% to 70% slice of those mortgages. And we manufacture that retention with both -- in those methods I just talked about. Either with on balance sheet leverage or off balance sheet leverage.

To some extent in all -- historically we've been running at about one-to-one in leverage. It's an absolute artifact of just the optimization of what's the right financing source. If the A note market -- if as Barry mentioned, if we start doing -- if in the next six months to 12 months, we do a wide -- a large -- if we originate a lot of high-quality, very attractive bank-like loans, we'll probably sell the bulk of those in A note form.

If we do a securitization, a CDO market, is returning in a fairly substantial way. That's a market that we watch constantly. That will represent in most structures, that would be an off-balance sheet style transaction. We have, like I said, we have access to corporate debt to the extent to which we utilize that. That will represent on balance sheet.

So to some extent, the business M.O. will at least -- unless we decide to change it won't change but the actual on balance sheet leverage will be a function of the rela -- the combination of on balance sheet alternatives and off-balance sheet alternatives that we utilize. We don't have a firm target. That said, I would be surprised if we ever got above -- really much above one-to-one.

Great. I think that's very helpful. In the past, I think you've mentioned further diversifying the business. I want to ask if at this juncture, you're comfortable discussing, as you survey the real estate spectrum, what other markets could be of interest. One example that comes to mind is, lending to small to middle markets, single family rental operators which some have started conduit operations for with plans to securitize. Is that market attractive or are there any other ancillary markets you're considering?

Why don't we tell you after we do it? We have been looking at a number of businesses. It is one of our key objectives in the next 12 months is to start three or four new lines of business. Hopefully we'll get them done and we think there's opportunities to not only lines of business but also in geography, different geographies or capitals. Capital like ours. So we've just built the organization to do so. Find the right people.

Great. Thanks for taking the questions.

We'll go next to Joel Houck with Wells Fargo.

Thanks. If you look at LNR, the conduit business gain on sale was over 5%. The UPB base is increasing. Is this -- the platform more stable than you previously anticipated and how -- relative to your initial expectations going in when you first closed the deal, can you give us a sense for how much more accretive it is turning out to be? Is it 10%, 20%, or if you could put a range on it, that would be helpful.

Yes. So yes. Both the fees and the liquidation of the book is slower than we thought. Part of this you manage yourself. As you work with borrowers and work the books. Some of it, you're a victim of the markets taking longer.

Don't forget, I mean the key years -- there were two key years for us. By the way, LNR is now the largest servicer again in the United States. There are -- the 2016 and 2017 years will represent the ten-year maturity of the 2006 and 2007 legacy CMBS. Those are really critically interesting years for us. We kind of expected almost a two-hump camel, great earnings short term, a slowdown, and then good earnings in 2016 and 2017. I think across the board, these businesses are performing better than we underwrote. Some of it, you just can't easily underwrite.

And I think you're wrong about the CMBS trading operations. Don't forget we have a TRS and -- where a lot of the trading is housed. That's taxed. So we do pay taxes. And we should mention, I don't think we did mention that the unrealized gains in the book is not part of core earnings. It is really important -- I should have said that multiple times. That's just in GAAP but not in core.

And you could expect that as we harvest those gains, then they will fall into core. But I would say that some of our securities, honest to God, are not -- there is some judgment in marking them and we're hopefully on the conservative side so we don't have any issues going forward. It is performing far better than we thought. I would say in its entirety, that would be true. Every part of the business actually. Cory, you want to add anything? You're the expert.

I think that's a fair statement. (inaudible - multiple speakers) We've got more, as we call it, cars on the lot, the amount of loans in REO that are sitting in special servicing is higher than we anticipated it would be at this point in time, just under $16 billion. The conduit, the smaller balance loan origination platform is doing extremely well in a very competitive market. We did three deals and in Q1, we think we'll do another nine in the balance of the year. All of the cylinders that LNR are performing are at or above expectations at this time.

Okay.

We're thinking that the only business we're going to call special service -- LNR is the special service center and the rest of the businesses, our conduit business carries mortgage capital. We're going to hopefully over time, this won't be its own -- it will be integrated into the whole company which it is. We can continue to do a better job of that. Having Rina there will help to carry the Starwood interest (inaudible). So I think, Cory, if I would guess, we might have underwritten the book to be 12 now as opposed to just under 16. Is that about right?

That's about right. I think we're almost 20% higher at this point than we anticipated we would be as part of the underwriting.

That's very helpful. And just to clarify in your reconciliation, net income to core, your core EPS is $0.60. That does back out $22.5 million of securities gains for the quarter, does it not?

Right.

It backs out -- the unrealized gains are in GAAP but they're not in core. (multiple speakers)

Okay. Thank you very much. Congratulations on a great quarter.

(Operator Instructions).

All right. Well thanks everyone for being with us today. As usual -- whoa, whoa, whoa, there�s one more question. I'm being pointed to.

We'll take our final question from Arren Cyganovich with Evercore.

Thanks. Sorry. I snuck one in there. I had a question, the liquidity position relative to your unfunded commitments. You talked about it a little bit, I guess, with the maturities expected. How easily are those matched relative to the unfunded commitments and what other areas can you use to help fund those unfunded as they come due over the next couple of years?

So the construction jobs are fairly predictable from our clients at this point. We know what they look like. We have the stated maturities. Those are very predictable. Then we have prepayments which would mean we get -- if they're faster, we get more capital earlier than we modeled. But we've modeled what we think will be -- when loans are open to prepayments. They're very well matched right now.

That's one of the reasons we've put brakes on some of our construction opportunities. Even though they're really interesting opportunities, we just don't want to do the entire book that way. So we're going to balance this business, part of our overall business but if we needed to, we have an RMBS book we can flip, we have a CMBS book we can sell. We have undrawn credit facilities we could call on. We could sell individual loans that we own. So we don't really worry about our liquidity although we watch it obviously as anyone would. And it is one of our key things that we look at.

I think it is also interesting that we had no impairments in the quarter and the book is pretty damn good. It is producing an 8%, 7.9% yield on $24. Which (inaudible) that this morning. It is pretty impressive. I think it's really impressive. Given where the world is today.

And that's really a combination of lots of things. But we -- we see -- we don't see a lot of issues at the moment. Other than, it is competitive out there. Don't kid yourself. US lending market, you've got to have people wanting to do business with you today because there's -- they like our -- the best thing that happens to us are references from borrowers. When people say your team was fantastic. And I do hear that a lot.

So that means that they come back to do additional deals with us. Working on a deal, big deal right now on the West Coast with a repeat borrower. He's going to probably give us a deal because we did a really good deal on the last deal we did with him. That means you get a last look and you decide if you want to take the exposure or not. That's happening a lot, actually, for us. We'll say "You know what? We're going to pass." Occasionally, we see guys now wandering from offshore making hedge funds that are making construction loans, believe it or not.

We also see life companies coming into the business which is relatively new. Because the banks really can't do these big construction loans when Basel III kicks in. The capital regs for them are brutal. So you're going to see a complete makeover of construction lending in the United States. And given the nature of the capital that might make them whether it is life or us, some portion of them, I expect the markets will be much more -- what's the word -- balanced and less prone to get overbuilt because I think we approach it with a much more skeptical eye. We have one more question, and we'll take that.

Thanks, that's helpful. Just as a follow-up, Stew made some comments about the potential A loans and securitization. What form would the securitization likely come in? And do you have any idea of what exactly you would be looking to put into that specific property type geography or capital stack, I guess, probably senior loans I'm assuming?

Yes. If you look at -- if you look at the recent CMBS activity, CMBS, CLO-type CDO activity, there have been a number of whole loan, flowing rate securitizations of small loan count, large average balance, floating rate loans that look similar to the types of loans that we make. And for a variety of reasons, I mean we -- I think we're -- it is fair to say we are absolute experts on this space. For the most part, the economics of those transactions hasn't competed well with our alternative financing sources, with our direct sales of senior components and loans to other senior lenders or the credit facilities that we have and the corporate debt alternatives that we have.

Of late, there have been continued rallies in the CMBS markets and some structural nuances that are now becoming more prevalent in the marketplace, a whole loan style small securitization of, call it, a dozen to two dozen loans now have economics that look like they're -- likely could compete reasonably well with some of our other alternatives. So I think the type of thing that we would look to do would be to take 10 or 20 loans, let's say, they would -- unlikely to have like construction exposures. Unlikely to have large, unfunded balances. They would be funded loans, transitional in nature, transitional and stabilized in nature. Very much like the rest of the book that we do.

We would -- if you think about that comment I made earlier where our goal is to hold a very wide slice of a safe lending transaction, let's call it a 70 LTV overall mortgage whole loan where our goal is to retain 45%, 50% to 70% slice, if we pooled 20 of those loans together, let's say we put $500 million of those loans in a pool, we could sell $300 million to $350 million of investment grade debt at expense -- at an all-in cost including issuance expenses and things, probably compete pretty well with our warehouse lines and where we're selling A notes and it might be the type of transaction that we'd do. It would be another substitute. It would be similar in every respect from our perspective to the other financing alternatives that we do.

As a layman in that space, I've always challenged the team to look at that, whether we should just do our own securitizations of our A notes if you will. I'm always astonished at the coupons that our guys -- when you look at the duration and the fees and the costs, not the coupons, the cost of the rating agency process and the underwriting, the whole thing, the fees are much higher than the coupon so the all-in cost to the firm has been not attractive. As the CMBS market continues to tighten, and let's assume we can't tighten our lines, credit lines which we have been able to do, lower the spreads on the credit facilities, then it is a more attractive execution, we will do it. We might -- while (inaudible) construction loan we certainly do the loan when the building is open and utilized. So we'll have to -- when we're earning an [eight] on a first mortgage, we might wait.

Having the Hudson Yards project in a securitization would be a great anchor to our own deal. We'll have to wait and see and see where the world winds up. It is interesting, the markets are bouncing around a little bit lately. If you've been following the CMBS market, it is widening, it's tightening, it is widening, it's tightening. It is a weird market. Although the payoffs that people are seeing in these AJs and AMs are really often far greater than people thought they would be today with the property values soaring. So you're seeing some windfalls in some of these securities from the astonishing prices people are paying for some real estate across the US.

That's very helpful. Thank you.

Now, the final question will come from Dan Altscher with FBR.

Thanks, good morning. Appreciate you taking my call. Barry, is was great seeing you at that event a couple of weeks ago at Georgetown. Hope you're feeling better. I was wondering if you can give us a sense for some of the legacy portfolio loans that have now paid down. Maybe what those overall yields were, whether it is ROA or unlevered or levered. And maybe how that's -- or what that's being replaced with.

I don't know the answer to that. I've never really looked at that. I think it is interesting. We looked at -- 75% -- 98% of our pipeline, what we've done this quarter was -- 96% or whatever it was, was LIBOR-based. 98% of the pipeline was LIBOR-based. 75% of the existing working books is LIBOR-based. That's relatively new because we did --

Then of the 25% that's not LIBOR-based, about two-thirds is mezz and -- yeah two-thirds is mezz and one-third is first mortgages. And the first mortgage coupons are close to 7%. That are fixed. The mezzes are close to 10%. So we don't think there's any real risk in that book from a rise in rates because obviously the LTDs might be improving not from where we originated them given the rise in property values. They probably are gains in the whole book across the board.

So I think that you have this call on rates in the book which is a free option for us if we do get rates in October to rise, we're going to have a big party. Short rates, that is. And I think that's probably the biggest difference in the book. The LTVs have been fairly constant for our entire life as a public company, I think. The mix of properties, pretty much the same, I think. We did a Walgreens loan in the beginning.

(inaudible -- multiple speakers) early on and now that's dissipated, it is really much more balanced.

Yes. It is interesting to me that the book is not hotels. We've -- by the way, if we want to do construction loans on hotels, we can put out $25 billion in the quarter. You won't see us do that. But there's -- it's interesting. I don't know. We would have to go look. My guess is we're down 100, 150 basis points on stuff that's maturing.

If you look at the migration in the release, we always provide that table, the leverage returns. If you think back -- (multiple speakers) you think back, we're at 11.5%. And I think the biggest number was probably 12.6%, 12.7% or something like that, a couple of years ago.

That was like in 2009 when we had (inaudible -- multiple speakers) was our only position.

It is worth pointing out that the unlevered IRRs on almost all of the construction loans are north of 9% unlevered and their levered IRRs are well north of 11%. So that migration from the old really high yielding paper into easily leveraged construction loans to surpass those rates is a big reason why we put them on.

The reason it is 11% is they actually are 9% and then they're 9% for a year or two and then they're 14%. That gets you at 11%. Because they got levered, obviously their credit is in place. It is an office building or whatever is a multifamily rental property. We have lost two large deals to hedge funds in the lending space. One of them is an overseas hedge fund. So we see all kinds of players in the market today. Not necessarily the traditional guys you would have expected but -- and I think the banks like us. They like seeing us on top of them although sometimes they like to take the whole loan themselves. But we're easier to deal with than most of the banks.

Thanks for that. Maybe just a follow-up also. I think generally you've been fairly agnostic in terms of property types, it's generally all been finding the best risk adjusted returns. Is there anything you see coming up these days that you continually are passing on? Whether it is property types, or geographies because you think the risk adjusted returns are just so poor?

Interesting. We've built a retail platform at Starwood so we have 180 people in Chicago in Star Retail Properties. We're finding retail tough to do at the level people are willing to do it. So enormous expertise. In fact, I was with the team yesterday, the retail team, and they were telling me about a deal that they work with the team in San Francisco and killed. Because they knew everything about the center. So Boyd whispered retail. And I think that's true.

You're not seeing us make a lot of retail. It's only 8% of our book by net. Whereas office is 29%, multis is 29%. Hospitality is 29%. Mixed use is 10%. Multis is 7%. It�s surprising to see that. But I think really good retail is probably in core and they're borrowing 45% against it and that's it.

We're not playing there. It is both when we see it, it is probably screwed up. We don't think it is a value-add return situation, we're just going to pass. It's interesting. I think the other thing we're seeing is we still see deals -- We have one deal in shop where the borrower has more than $200 million invested in a hotel property and they're looking for $80 million first but the asset only makes $3 million to $4 million (inaudible) yield. It actually covers debt service on an $80 million mortgage but I'm not sure why when we lend against it, it is going to perform better tomorrow than it did yesterday.

It's the same management company, same owners. The asset's in great shape, there's nothing you can do to it. Tough deals. It is interesting. Equity value, appraisal there, I think, is $120 odd million. But the appraisal is forecasting a turnaround. I don't think that market is going to perform much better than it is right now. There�s a lot of supply coming in that town. So there's lots of things out there. We just cherry pick them.

Thanks for that.

Thank you. Thanks, everyone. Have a great day and we appreciate you being on the call with us. And Stew, and Rena, Boyd, Andrew, Zach, everyone is here to answer your questions today or tomorrow or come visit us both here and in San Francisco and happy to spend time. Thank you very much.

Go visit them in Miami, too. You'll be impressed. Bye-bye. Thanks, Cory, remotely. Have a good day.

See ya.

This concludes today's conference. We thank you for your participation.