Starwood Property Trust Inc (STWD) 2014 Q2 法說會逐字稿

Good day and welcome to the Starwood Property Trust second-quarter 2014 earnings conference call. Today's conference is being recorded. At this time, I'd like to turn the call over to Mr. Zachary Tanenbaum, Director of Investor Relations. Please go ahead.

Thank you, operator. Good morning and welcome to Starwood Property Trust earnings call.

This morning, the Company released our financial results for the quarter ended June 30, 2014, filed its Form 10-Q with the Securities and Exchange Commission, and posted its earnings supplement to its website. The documents are available in the Investor Relations section of the Company's website at ww.starwoodpropertytrust.com. Before the call begins, I would like to remind everyone that certain statements made in the course of this call are not based on historical information and may constitute forward-looking statements.

These statements are based on management's current expectations and beliefs and are subject to a number of trends and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. I refer you to the Company's filings made with the SEC for a more detailed discussion of the risks and factors that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today. The Company undertakes no duty to update any forward-looking statements that may be made during the course of this call.

Additionally, certain non-GAAP financial measures will be discussed on this conference call. Our presentation of this information is not intended to be considered in isolation or as an substitute for the financial information presented in accordance with GAAP. Reconciliation 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, Rina Paniry, this Company's CFO, Boyd Fellows, the Company's President, Andrew Sossen, the Company's COO, and Cory Olson, the President of LNR.

With that I am now going to turn the call over to Rina.

Thank you, Zack, and good morning.

I will begin this morning by reviewing the Company's second quarter results, both on a consolidated basis and for each of our two business segment. Following my comments I will turn the call over to Barry, who will discuss current market conditions, the state of our Business and the opportunities we see looking forward.

Starwood Property Trust continued to deliver strong results for its shareholders this quarter. During the second quarter, we reported core earnings of $115.2 million or $0.51 per diluted share, which is up 67% and 21% from the $69 million of core earnings and $0.42 per diluted share that we reported in the same period last year. When we normalized last year's quarterly results for the $13 million in costs associated with the LNR acquisition, core earnings year-over-year grew by 40%.

The primary drivers behind our earnings growth were of continued expansion of our loan book, which is $1.6 billion larger than it was last year, as well as a continued rally in the CMBS markets, which increased the fair value of our securities portfolio this quarter. The CMBS portfolio has more than doubled sine the LNR acquisition in April of last year, growing to $638 million at the end of the quarter from just $314 million at the time of the acquisition. During the quarter, we were able to harvest gains of approximately $15 million in both our RMBS and CMBS books, selling securities which no longer met our return requirements.

In addition to these factors, we have LNR contributing a full quarter of earnings, compared to only 73 days in the prior year period. As of June 30, book value per diluted share was $16.59, a $0.74 or 5% increase over our book value per share at the end of last quarter.

Fair value per share, which we compute as the fair value of our assets [and under] the par value of our debt stood at $17.20 at the end of the quarter, an increase of $0.81 or 5% over the level we reported at the end of last quarter. These increases are principally the result of continued strong earnings from both our business segments, as well as our April equity offering, where we issued just over 25 million shares of stocks and raised approximately $565 million.

Though out equity offering was immediately accretive to our shareholders, we encountered some unexpected delays in deploying the incremental capital we raised during the quarter. These delays impacted our core EPS, principally in our lending segment, which takes me to the next topic of discussion, the second quarter results for each of our two business segments.

I'll start with the lending segment. During the quarter, this segment contributed GAAP and core earnings of $65.4 million and $76.2 million, which were nearly twice the levels we reported last year. As I mentioned earlier, these increases are attributed to growth in the loan book, as well as the one time charges incurred last year as a result of the LNR acquisition.

The lending segment closed approximately $600 million of new investments during the quarter, which was lower than our first quarter run rate. This brings us back to the discussion of the April equity raise. As we have mentioned in the past, excess capital is very dilutive to earnings and we therefore always look to raise capital when we have an identified pipe line transactions that we expect to close over a 60-day to 90-day period.

However, the timing of loan closings cannot always be predicted with precision, and certain loans may be delayed, while others simply do not close at all. In looking at our pipeline at the time of the equity raise in April, $212 million of that pipeline did not close. About $327 million closed late by an average of 33 days. And another $30 million are still in closing today. As a result, our cash balance at the end of the quarter stood at just over $500 million.

That said, shortly after the end of the quarter, we deployed just over $1 billion, $1.1 billion to be exact, in additional new loan commitments. Most of these were loans that we expected to close during the second quarter. These new loan commitments include a variety of property types and primary market locations, all with first rate institutional sponsors.

Nearly 100% of this $1.7 billion in new loan commitments are LIBOR-based floating rate loans, as is 88% of the lending segment pipeline. The fixed rate exposure in our pipeline is attributable to a single large loan. We agreed to a fixed rate on this loan because the loan provides two key features, the first of which is 10-year call protection and the second of which is a level of return in the low double-digits.

Looking forward, we have a strong pipeline of high quality transactions that continue to meet our risk adjusted return criteria. Given the high volume of our loan book that is floating rate, we should benefit from a rising rate environment. We continue to finance our floating rate investments with floating rate debt and our fixed rate investments with either fixed rate debt or floating rate debt hedged by interest rate swaps.

We estimate that 100 basis point increase in LIBOR would result in an increase to income of $14 million. In addition, the credit quality of our portfolio continues to be our utmost priority with an average loan to value of 65%.

Moving to the LNR segment, this business has delivered another strong quarter of operating results, contributing GAAP and core earnings a $52.5 million and $39 million during the quarter, an increase of 60% and 9% over the same period last year. Driving the current quarter growth are two main factors. First, we benefited from having LNR for a full quarter versus just a sub period after the April 19, 2013 acquisition last year.

The second main driver was the continued rally in the CMBS markets, which led to higher unrealized gains on a GAAP basis, higher realized gains from sold bonds on a core basis and higher interest income overall. These increases were offset by a slight decrease in the normalized operating results of the servicer. As we're mentioned in the past, the services revenues are expected to trend downward until 2016 and 2017, when10-year CMBS maturities will more than do to the peak issuance from the 2006 and 2007 vintages.

Included in LNRs results for the quarter is a reduction to the domestic servicing intangible of $12.8 million, which is consistent with the reduction we reported last quarter. This leaves the intangible with a remaining book and fair value of approximately $206 million at the end of the quarter.

Despite its continuing expected amortization, the servicing asset continues to perform well ahead of our underwriting expectations, and we expect that it will continue to generate positive returns on our invested capital. As we stated in the past, the LNR platform allows us to exploit high yield opportunities in the CMBS space across various market provisions.

The performance of these securities is naturally hedged by the earnings potential of our role as special servicer in the same transaction. To that end, we continue to be a preeminent player in the CMBS [BP] space, investing substantial capital in new subordinate CMBS and acting as special servicer for the related CMBS trust. For the first half of the year, LNR ranked first in new issued special servicing assignments and continues to be a leader in this space with over one-third overall market share.

As of June 30, 2014, LNR was actively servicing $15.6 billion of loans and real estate owned, for 152 trusts with a collateral balance in excess of $135 billion. This balance is fairly consistent with where we were at the end of last quarter. Our conduit business continues to be a key contributor to the LNR segments operating results. For the quarter, our conduit originated over 300 million of loans and completed three securitizations.

Now turning to capital markets. As I mentioned earlier, in addition to the April equity raise, during the quarter, we reestablished our ATM stock offering program, which provides us with a flexible mechanism to issue up to $500 million of common stock in the future. In the quarter, we issued 759,000 shares under this ATM program. I would also like to mention that during the quarter, we announced the introduction of a dividend reinvestment and direct stock purchase plan.

The dividend reinvestment component provides our shareholders with the opportunity to reinvest all or part of their dividends in additional Starwood Property Trust shares. While the direct stock purchase component allows our shareholders to purchase shares directly from the Company. More information on these programs can be found in our SEC filings.

On the financing front, during the quarter, we upsized one of our debt facilities by $43 million and reduced pricing on this facility. After the quarter we increased our borrowing capacity on another facility by $100 million and entered into a new three year, $250 million warehouse line to finance our more transitional assets. This brings our total borrowing capacity to approximately $4.8 billion.

We continue to take a very conservative approach to our overall leverage, inclusive of corporate level debt, such as our convertible notes and our term loans. Even with these facilities, our debt to equity ratio was just 0.9 times at the end of the quarter. We are currently in the process of up sizing or renewing certain of our facilities and negotiating additional new facilities, which should provide incremental capacity of approximately $400 million.

As we look ahead, I'd like to turn to a discussion of our current investment capacity, the third quarter dividend and our 2014 earnings guidance. As of Friday, August 1, 2014 we had $251 million of available cash, $89 million of net equity invested in liquid RMBS, $18 million of approved, but undrawn, financing capacity and $474 million of unallocated warehouse capacity. In addition to this, we expect to receive approximately $545 million during the third quarter in loan maturities, prepayments, sales and participation.

With these various funding sources, we have the capacity to originate or acquire up to $1.2 billion in additional new investments. Our growing level of capital deployment and ability to generate consistent returns has allowed us to sustain our existing dividend to our shareholders. To that end and consistent with prior quarters, our Board has declared a $0.48 dividend for the third quarter.

A dividend will be paid on October 15, 2014 to shareholders of record on September 30. The $0.48 dividend represents an 8% annualized dividend yield on yesterday's closing share price of $23.57. We believe that this reflects an out size return on a high quality portfolio, comprised of 65% LTV loans with modest debt to ratio of less than one time. As we look to the remainder of the year, we continue to be pleased with our financial results and are reaffirming our core EPS guidance in the range of $2 to $2.20.

With that, I'd now like to turn the call over to Barry for his comments.

Thanks, Rina. That was pretty comprehensive. I have nothing left to say. If anybody knows me from these calls, that's not possible.

But I want to thank the team, again, for a really good quarter. I think what you don't see is the tremendous efforts and work of Rina and Cory and the team at LNR on the consolidation of the accounts of both companies: the Heritage Star Property Trust integrating into LNR and its accounting systems and all of the technology that's behind the Company, which is certainly best in class.

So I'll say it was a solid quarter. I'll talk about the quarter first and then about the market, a little inverse of what I usually do. But I think it was a solid quarter. We slightly screwed up the closings, but we did close $1.1 billion after the quarter end. I think that's common on the market, which I'll come back to in a second.

I think also you see and my quote in the earnings release talks about the deployment of capital at LNR. One of the key reasons we bought LNR was to continue to be able to deploy capital at high rates of return for the shareholders in new business lines. All of our segments performed fairly well. The large loan business, especially if you include the $1.1 billion of originations post quarter end, $1.7 billion is a good number.

The LTV in the Company is quite remarkable that it hasn't really dribbled up over the last four years we've been doing this. It still remains around 65%. Actually it was higher earlier. It's actually come down. The servicer continues to do well, well outperforming our expectations of $135 billion of main securitizations. I will point out, for those of you who don't know, that there's only $44 billion of CMBS maturity this year. 2016 and 2017 was nearly $120 billion each year. Those are 10-year maturity, the 2006 and 2007 of series CMBS, legacy CMBS securities.

We consider those optionality for the Company if interest rates are high, they'll be very distressed and fees will likely be larger. If the interest rates are low, that stuff will get refinanced and it's pretty much what we probably modeled. So it's an interesting embedded optionality that investors are getting for free in the Company, which is really unique.

It's nice to see the servicer maintain its position or reassert its position as the largest in the country. And that's really because of the B piece investments they've made and the growth in the CMBS book. It was really a surprise to me and is really great and the team at LNR has done a really nice job. You actually won't hear us talk about LNR as LNR much longer because the only thing left in LNR that we'll call out is the servicer. So we'll call it Starwood Securities Trading or something like that.

And Hatfield Philips, which you haven't head about, which is our servicer in Europe, has had a reasonably good quarter too. And continues to perform vastly ahead of our underwriting. That is the number one servicer in England and the UK. It has about 120 people based in Frankfurt and in London. It's doing a nice job.

So we're also continuing to look at entering new business lines. And recently we've met with the management team and all of the reports and talked about things that we can use the talent pool that we have and places we should deploy capital which can meet or exceed our target rates of return. So we also are working to increase the ROI of the Company. So you see -- you saw some CMBS sales where the yields to maturities were sub 8% on the notes and value spiked and we quickly mined the book and found some securities.

And there are more like that. If I look at our -- I was asking Andrew as we were talking this morning whether or not our kickers and our equity -- of the equity kickers that we have are in our fair market value for the stock, and they're not. I can tell you there were some things that we were offered recently by one of the borrowers to buy back.

So our fair market value is higher, and I would almost guarantee you that there's more value in the CMBS book than we're marketing it to. So our actual fair market value book, I would say is, probably $1, maybe $2 higher than it looks like on -- than all we gave you in the earnings release.

So the market overall is really quite competitive. There are 38 conduits operating today. I think we have one of the best in class. Certainly we produce good margins. We have a great team. Very dedicated to what they do. They don't bite off more than they can chew.

Our job is to pick the spots in the market where we think we can get these excess returns and we continue to do so. We go where the banks can't easily go or the finance companies have left the table. And we do leverage significantly off the Starwood Capital Group Equity team which is big and broad.

And I'll point out that one of the loans we made in the quarter was sales of equity purchase. We were bidding on a property on the West Coast. We lost. And we turned around and made the loan on it. And that's perfect synergy, because we know the asset. We knew what we were willing to pay to it. We certainly leant to it -- I think we leant it was 50% of what we did.

So we were delighted when that happens, and we want to do more of that. We actually have to take advantage of the relationships that the equity side of the house has more and finance people you can partner with on the equity side. So it was great to see a very large, very lucrative loan that we came off of the equity desk essentially.

We're also looking at other geographies where debt may not be prevalent and where we think we can get excess returns. And we're organizing ourselves to perhaps put a foot in the water in some of these other countries. Our business in Europe, Europe has also tightened dramatically. But there are countries in Europe that is less prevalent. So we're seeing good activity in Europe. But clearly the credit markets have come down, the spread has come in very dramatically in Europe.

And that leads me to one last comment about the market, which is the Fed noticed. The Fed had put out a warning to banks that don't lose your stuff here. And don't let your credit quality of your loans drift too low. I think that's very good. The Fed is paying attention, a little bit. Better than they did in 2006 and 2007.

But clearly the world is scraping for yield, and we just have to be really careful. I think having an equity background is a key component of treading the water through what I think is getting increasingly competitive environment. I'll say again, it is remarkable that the LTV as a Company as stayed low as it is. It's also remarkable the width of the mezzanines we're writing or that we're creating. These are not 72% to 73% earning 12%. These are 50% to 65% or 50 to 70% slices of capital stack earning 10%.

That is clearly the best risk adjusted return available in any fixed investment anywhere in the globe today, that I can think of. It's almost two times what you're getting in high yield. On the personnel front, we continue to look at our own talent. But we're also willing to bring in new talent that helps the firm grow. And to match what we think will be our future opportunities.

So we recently hired Jeff DiModica who was a managing director at Bank of Scotland, RBS. And he was the former -- he ran sales and strategy for them and co-ran the mortgage group. He had 38 reports and a group of 182 people that reported to him. He's come joined us.

We've already deployed him quite actively and looking at and exploring new business lines and helping us in the security operations of the firm, value deploying capital. We're really excited to have Jeff here. He's actually sitting here in Connecticut with me. And we welcome him to the firm. Look forward to his contributions.

I think I'm going to stop. I don't -- I don't really think that there's -- it's business as usual. I mean, we're in good shape. We have plenty of capacity and plenty of capital. We will be funding -- we have pretty much match funded repayments, expect repayment with draws.

We're pretty comfortable. What we argue about internally is how low do we go in spreads. And where do you -- we'd rather do better asset tighter spreads than go higher in the curve for lesser quality assets at higher returns. And hopefully ultimately the market will recognize that.

Spreads will clearly be in pressure over the next year or two unless the market backs up. And you don't think it's going to back up, it's going to be a one way road and then it backed up two weeks ago when the junk fund market collapsed. So we like that.

I think we've been through this three or four times already. Since 2009 when we IPO'd, the markets have gapped out and in and out and in and we just stay the course. And I think borrowers understand that we'll do that. And I'll say that these are highly negotiated deals. Some of the transactions we've done recently, we've gone back and forth, even to my desk, asking to borrow for recourse or other changes of provisions. Make sure the borrower has net worth covenance.

These are very highly negotiated large loan transactions, and I think we'll continue to find them, though, as in any of our businesses, you never know where your next investment is coming from. With that, I'll stop.

Any questions?

Thank you.

(Operator Instructions)

We'll take our first question from Jade Rahmani with KBW.

Good morning. Thanks for taking the question. I wanted to ask if you've seen any spread widening over the last couple of quarters and if you view that as a positive opportunity in the last couple of weeks?

Yes. It's too early to tell you that. Too early to tell you. We'll see. As you know, the CMBS markets backed out a little bit. The new issue markets here today felt a little choppy there at the end of the quarter.

But it's too early to tell what this all means. The volatility in the market is, what, 11 now. It's 17 or so, last I looked. I mean the market is definitely saying that we're in for a little unusual period. But the 10-year has rallied. I think rates, my general view is short end is going to go up over the next 12 months.

And even though the economy is not creating great jobs, a lot of these jobs are part-time jobs, which are called full-time jobs in the unemployment consensus numbers. They still put up a headline number that's showing reasonably good progress on unemployment. So, I think that the Fed knows that they're not high quality jobs. The Fed is worried, though, about what's happening. These are jobs, by the way, they're 29.75 hours. They're jobs that you don't have to -- you don't have to give your employee healthcare.

That's the new US -- United States, that's the negative consequence of ObamaCare. And it's impacting everything. Including the income growth of Americans, which is affecting spending and the desire to buy houses and everything else. So, given that, I think short rates go up. But I don't think the long end as much. I think the curve flattens. So, the Fed will have to raise rates. I think it's actually really good for us. Really good for real estate as an asset class. And I think that actually is pretty good.

And I don't really see a lot of inflation because I don't see the labor pressures or commodity complex. Without the Chinese buying everything in sight like they used to. They used to buy all of the copper in the world. I don't think you're going to see -- I mean, we have excess production of oil and gas. I can't see it in the near future. So, I think we're fine.

Regarding the competitive environment, which you referred to, can you talk to where the pressure is greatest? Whether it -- is it on yield or are there other things, like deal structure fees, you've given concessions on prepayment penalties or origination fees?

I said this four years ago that the credit crisis was caused -- was really -- there was a referee to the credit crisis. And they were never -- the guys driving the bus are still driving the bus. Those are the rating agencies.

They facilitate the credit ratings that allow securitizations to take place, perhaps on paper that shouldn't be securitized because they don't really understand the real estate. I think the toughest place in the credit complex is the conduit market. I think the conduits are very aggressive and very undisciplined, some of the conduits. We have yet to have a loan rejected out of the securitization. Probably done five or six billion, you've done in the last five years, four years. More than that.

I've done about three billion. We'll do 1.6 billion projected this year up from 1.5 billion last year.

But they're really picky. We've done deals where we've written a little larger loan and then we, the Property Trust, took the mezzanine and then we sold them each separately. We partnered with the conduit to stretch proceeds. And then we said get rid of the mezzanine, which they did. So the conduit market is super competitive, and I would say that spreads are coming and LTVs are climbing. No doubt.

The -- on the whole loan side, on the major assets, there aren't that many guys. And, to some extent, we're partnering rather than competing with them. We just split a loan three ways that we sourced with two other public companies actually. So, that seemed to be the right thing to do. The other thing we're doing, which I should have mentioned, in terms of increasing our return on equity or ROI, returning it to capital, we are selling down some positions. We're selling a position to an Asian life company in one of our loans. It's almost like an IPO, right, because we're going to raise, in this case $150 million and redeploy into other assets.

So, we continue to look to diversify our book. And if it's accretive to us, it's accretive to shareholders, because we don't have to actually go out and raise any money. And we can deploy it into a new asset at a higher return. So, that transaction we'll talk about the next quarter. It's just supposed to close in the next two weeks. But all -- we're just getting better at what we do, probably. A little more sophisticated and smarter. And we recognize the disruption that the equity offerings create in the marketplace.

And we -- if we're growing, great. If we can redeploy our capital, in higher rates of return, we find new business opportunities, which we're actively looking for. With coming back to the market for something like that, an acquisition of scale, we'd be willing to do it if it's accretive to the shareholders.

Great.

Maybe a quick one for Rina. Do you have an assessment of what the impact of the delayed loan closings was? Maybe on a per share basis? What the impact to core EPS was?

On the high side, we came to $0.05 or $0.06. It's probably lower than that when you consider the fact that we took that capital; we deployed it elsewhere. We've paid down debt. So, you kind of have to look at the net.

The net.

And that's where we struggled to kind of come up with the net. But, on the high side, it was $0.05, $0.06.

Thanks very much.

A lot -- (laughter) Thanks a lot.

And we'll go next to Charles Nabhan with Wells Fargo.

Hi. Good morning. I know you touched on some avenues for capital deployment, but could you elaborate on, specifically, if you're looking to grow organically or if you're looking at acquisitions in certain areas? I know you've talked about bolting on to the Hatfield -- the servicer in Europe. But if you could elaborate on potential avenues for capital deployment.

Yes. Sure. All of the above. Organic growth. Every business line. Through acquisitions or obviously organic growth. And we talked over time about triple net real estate. There's a reason we didn't do cap lease, which we looked at in some of the companies we've acquired.

And the reason has always been the term debt and those goes to our risk aversion. Which is if these companies had debt that were coterminous with their leases. And you'd wind up happening, you're [hyper-ammoring] the debt down, so that when the lease terminated, in cap leases case, the asset was unleveraged.

But what that created for the shareholders was income without cash to pay the dividend. So you have equity in the asset. And I didn't want to do that. I don't like drinking my own blood. So I wanted to, basically, make sure that we cover the dividend earnings and cash flow. And we've actually used that philosophy since the day we started the firm. Our dividend is going to match our -- we're not going to pay off future earnings and get into trouble. We're going to pay out what we earn. And whatever we need to meet regulations. But when you're hyper-ammoring debt like that, you obviously have income, taxable income must be distributed. And we didn't have the cash because all your cash was paying off the debt. So that means you're using cash from somewhere else. And you can't refinance the debt. You can't relever it because they're first mortgages and they do not let you do that.

We've passed on many a transaction that have that debt feature. We have looked at other companies where the debt could be done corporately, which was IO. And that would be far more attractive to us. We continue to look in those spaces. We still think that's semi-interesting. Some potentially very interesting. And there are other public companies we are talking to that over time-- that maybe one day we'll actually agree on price. And find something to do. (laughter) In the meantime, we're -- we'd like to grow faster. I'm the last person to think big is better. I think this economy is scale. Having said that, in a finance company, I do believe big is better. It drives our cost of capital down.

And we still have an eye on investment grade. If we can make investment grade, our whole business is better. So we can finance cheaper. We can lend at lower spreads because we can borrow at lower spreads. And we're the virtual cycle and it's all good. We actually -- our Company is running, for example, at a lot less leverage than Blackstone, our biggest competitor at the moment, the XMT. And we've chosen and talked about whether we should raise our debt.

And we're going to continue to look at that. It represents ammunition, if you will. We've raised ROE, if we raised our debt levels. Obviously, we can convert very, very cheap. I think we're 0.9 versus maybe 3, as I think Blackstone talked about in the last earnings release last week. That's a very different risk profile and our dividend is obviously higher than theirs at the moment. So less than half the debt, dividend is higher. Lots of lines of business, hopefully bigger balance sheet.

More diversification. Arguably a better mouse trap at the moment. But, time will tell. We'll have to work hard to keep up our results.

Okay. And as a follow-up, could you give us a sense for how large you see the construction portfolio growing? And if you could give us a sense of the economics of some of the recent transactions in terms of return expectations and duration of the portfolio?

Yes. Big debate internally actually and with the Board on the scale of what we want to do in that space. We've been very picky. We've leant in, basically, Manhattan and San Francisco. But we've kind of put a halt to it for a while.

The returns are fairly compelling. If you've lending $0.50 or $0.60 on the construction $1, you're obviously investing 50% or 60% of replacement costs. And we've diversified our transactions by property type, so we have a loan on Hudson Yards, which is one million square foot tower. I consider that one to be one of the best loans in the whole book.

And a classic example of where we can compete very well. I won't give you the coupon, but it's a lot. It's not prepayable. It's backed by credit tenants. And if you and I would empty our trust accounts to buy the building at our loan balance. So, it's a very safe loan at a very good coupon. Structurally, it was really hard for the banks to figure out how to handle the Coach lease. Coach is buying their space in the building and they were funding [para plus two] was related enough and it's really a screwy security.

The banks got all tickled up in their underwear and there were four or five banks doing the loan and then the ladies called us and said -- she called me and said, can you help us? And we said absolutely. We can definitely help you. So we did the loan. And they're happy and we're happy.

And the way we structured it, even though they're paying us more coupon than they were paying the banks, their ROE is actually higher because we funded closer. And down the road we intend to lever that investment, which is currently unlevered. So we have that. That's an office tower. Then we have the Charles condominium, which is now completely sold out, just about, on the Upper East Side.

I think we're in $850 a foot. Can you find anything in Manhattan for $850 a foot? And that -- we don't think that's a construction loan, but it's not really a traditional loan anymore. The building is being built and completed. The [C of Os] going out and the units will close and we will be paid off.

So another deal, though, is just starting that West 57th Street transaction, which we're funding now. It took awhile for them to get their permits. That's an example of a deal that took a long time to close. It was probably was in our books for nine months with One Worldwide. We've been really picky on borrowers. Really picky on the assets. But we really don't want to overload our balance sheet with too many of these investments. They are the obvious place the banks are not competing as heavily because of the regulation that the capital requirements for construction loans.

But it does change, at least on the face, people would quickly look at our construction and say, oh, my God, they're doing a construction loan. Having bought Corus, which was 101 construction loans and now work that portfolio out and it's completely liquidated now. I think we have 2% of the assets left. We've seen the dark side of construction. But I think you'll -- I think it's around what it's going to be. We've recycled capital into that as well as the non-construction balance sheet. But we like what we've done. And we're very comfortable with it and we review it all of the time.

Actually, we should mention that -- I think our credit score of the portfolio is as good as they've ever been, I think? Right? I think that's true, right? In terms of --

Yes, yes.

So, our book is performing really well across the board.

Okay. Great. Thank you for taking my question.

(Operator Instructions)

We'll go next to Eric Beardsley with Goldman Sachs.

Hi. Thank you. Just with your expected maturities this year and the yields that you're putting on new loans, where would you expect your I guess target portfolio, total yield, to go on a leverage basis?

We're 10 to 12 now.

Yes. 10.2 to 10.8.

Yes. I think it's drifting down. It's drifting down. Again, this is the risk about leverage.

Do we put more leverage on, then we can take it up again? Do we go up in LTV? We haven't yet. The book stayed the same. We will. I mean, it depends on the asset.

We're doing a multi-family, we go to 75%. But we don't see a lot of multi-family that we can't get our spreads in that. So I think our supplement talks about 10.2, and we'll go to 10.8 when we lever, fully lever the seniors. One of the things that's pulling that down, actually, are the construction loans. Because, they go out as first mortgages and they're not leant -- there's no leverage on them at all. So let's say we're making a loan at L plus 7 and points, L plus 6 or L plus 8, as the deal may be done. We're going to lever it later. We're going to lever it when it gets closer to completion and there's a more sizable senior in place. And we're looking at that.

But that is one of the reasons, the key reasons why that is actually drifted a little bit down because we have, for example, Hudson Yards is an unleveraged first mortgage construction loan. And when it got to, let's say, $400 million, we could borrow $200 million and sell a senior. But we do that L+ 2.25. Imagine what the coupon is on the debt at that time. We've actually looked at the coming spread, if you will, that's coming off.

We are seeing a few more prepayments than we would have seen last year. Kind of expected that. And I think that is -- so that's why we're aggressively looking at new businesses too.

So, in terms of the 11.5%, I think you were the end of the first-quarter versus the 10.8% at the end of the second-quarter. I mean, is that a similar trajectory we would expect to see, or was there something larger that happened in the second-quarter to bring it down?

We changed our methodology in computing the optimal leverage return. We can take you through that offline. But if you go through the supplement deck, we've shown you an as restated version that conforms. So, you have comparable metrics for March 31, 2014 and December 31, 2013. So the 10.8 as of June is actually comparable to a 10.9 as of March.

And 11.2 is the end of last year. So, again, I think it's the nature of the mix, the construction loan, the first mortgages. And I think as they are -- remain in the portfolio until these prepaid or repaid on schedule, I think we've gotten repaid $4 billion or $5 billion of loans since we started.

So, it's normal course. It's not like we've never been repaid before. We actually look carefully at those repayments and make sure we know what's coming in and we can redeploy the cash quickly. As Rina said, we just pay off a line. The lines today are tight. They're not 4% anymore.

So they're LIBOR plus 2 something. So you're not gaining that much by paying off the debt. But it's not 100% loss, if you will. It's not going to go as a cash earning 10 basis points. It goes to something. But we have been relatively unlevered at periods. And that's -- it's nice and safe, but it's not good for earnings. (laughter)

Got it. And then just on the risk factor that you added in the 10-Q related to LNR. I guess is there anything behind that other than just the new stories that we had just a couple months ago?

Yes. Hey, it's Andrew. I think we just felt from a legal perspective that it made sense to be protective and put a risk factor in there. But obviously those stories came out a month or so ago, and then there was a quick retraction by the New York State Department of Financial Services.

We'll see where, if anywhere, this story goes. But we've received nothing from them, either formally or informally to have any discussion around the LNR business.

Okay. Great. Then just lastly, I guess, what contributed to the delays in terms of getting loans closed? Was there anything that was market specific, or was it just individual deals being slightly pushed back?

It was really borrowers. Like the West 57th Street deal that took forever. They had to get some city approvals. That took a long time. I mean, it's hard. It's hard to predict sometimes. And usually we're better than this. This was a bad quarter. Usually, I don't remember it impacting us this much.

And we were debating. We had such a big book at this time. We didn't know how to size the equity offering. And the shoes get done automatically. That was dilutive. We obviously haven't been back to the market with an equity offering [to basal].

It did not -- we try to do better than that. It was not a good execution on our part. It's hard. I mean, the borrower-- you've got to have the money when the borrower wants to close. And then he doesn't close and you're like, what. We've several transactions in the hopper that have been on the book for six months. We think we're doing the deal, but the guy, for one reason or another, hasn't closed. So we don't get to determine when they close. I hate that part. (laughter) And we don't want to pull our commitments either, because they're good.

All right. Great. Thank you.

And we'll go next to Ken Bruce with Bank of America.

Thanks. Good morning. How's everybody doing? Quick question for you.

Just as you are thinking about leverage or maybe willing to take leverage up a little bit, how should we be really thinking about that? I mean, leverage has to be looked at carefully. You've kind of identified one of your competitor/peers. They've got a higher ratio, just the assets that you're focused on are slightly different.

How should we really be thinking about what the upward bound might look like? How you would think about just increasing that leverage? And I realize it's kind of a moving target, but if you could just give us some help, that would be useful.

On the equity side of our business, we lever to the cash flow stream, the security of the cash flow stream. And I wouldn't think we'd approach the debt side much differently.

We'd look at one of the earliest deals we did I think 25 Walgreen leases which were AAA and 25 years long in duration. I think we levered that deal 90%. I think it's a weight opted curve in our -- and the only one, at that point, I think it's still in our book. So, we don't really have a fixed rule. And I wouldn't give you on this call what the Board would determine is the optimal leverage for the Company. But we are looking at it.

And I think as you pointed out, we do some slightly different things. Obviously, we do compete with that company and several others in originating loans. And a first mortgage, if you write a first mortgage, would you take the debt, let's see, we wrote 75% first. Would you take 50% senior? Absolutely.

Would you take 60% senior? I suppose so. I mean, depends on what the security -- what kind of asset it was. If it's a hotel, maybe not. If it was an office building, maybe. Especially, it was a long-leased office building. So, you're right, you can't go perfectly apples-to-apples. It isn't are you buying or originating a mezzanine and so you're buying mezzanine. We bid on some notes yesterday. I don't know what happened to them. But they're all mezzanines. So what we do is we look at each of our assets and we take our convert debt and our term debt and we allocate it to these paper. As if it was direct debt on those instruments. And we see if we're, what we call levered or overlevered. Right now, we're about where we want to be.

But, as these loans fund, the construction loans fund, we're going to be underlevered. And so there we have something to do. And we know what we have something to do, so we'll go do it, I hope. But I think it changes as the complexion of the portfolio changes. And no hard and fast rule.

Okay. On a related note and one that's sensitive for investors. There was some discussion about what level you would need to be at in terms of having enough turnover within the portfolio that you would be able to essentially self-fund your origination pipeline as you go forward. Obviously, you're having a pretty significant pipeline as it is. And the sense is that --

We're getting awfully close, right. I mean, we have $1.2 billion of capital deployed and $500 something million coming from repayments. We're getting pretty close. It really depends on -- we're -- we haven't changed our thoughts. If we can deploy capital accretively and if we need more capital, we'll get it.

Because, again, I think it drives -- it makes the rating agencies happier the more equity we have and the closer we'll get to investment grade and we can finance at the entity level at very cheap spreads. That is nirvana as a finance company. But right now, we're busy deploying the money that's coming back. So -- we -- I don't think it's going to change for a while. I think we'll be out of the equity markets for a while. But then if we buy General Motors-- that's a joke.

I have --. (laugher) Yes. We'll look for that print to come across the ticker here shortly. I guess you know where I'm focused on.

Plants and equipment. Don't worry about it. Not the whole thing.

Okay. I think investors are clearly have been comfortable with the growth that Starwood's been able to achieve. And I think that there's a view that,to the degree, that there's maybe a little less dilution over a period of time, then that would be even -- that would be nirvana from an investor's perspective. But, obviously, you've got to balance the growth and the opportunities that you see.

You have two kinds of businesses here. You have the lower ROE businesses is a the large loan leverage business and then you have the higher ROEs of the LNR activities. The conduit is an ROE that is fantastic. And they turn our capital 11 times.

11 times.

11 times. So --

Triple digit leverage.

We give them a little balance sheet and they have a really good team that does a really nice job.

Yes. That's a turnover business. And actually that brings up a point. What was the gains on sale margins in the quarter? I haven't had a chance to look at it that detailed. But was there a significant move quarter-over-quarter or how are they holding up?

It was roughly $10 million gain for the conduit it this quarter.

It went to like three points. We've been kind of high threes.

So still well above the twos that's quote unquote, normal.

Yes. They got a big team. And they do a good job.

Okay. Well, thank you for your comments. Thanks for your comments. Try not to beat yourself too much up on the late closings. I think we all know how lumpy the business can be.

And we'll go next to Arren Cyganovich with Evercore.

Thanks. Just a follow-up on the earlier questions about credit spreads gapping out. I know it's too early to tell how it's impacting the market today. But, in general, if this were to sustain for a while, how do you view that affecting your business?

I would think it would be generally a good thing to have a little bit more fear in the market, help your spreads maybe slow down originations a little bit. But what are your thoughts historically on how this impacts your business?

Are you talking about the tightening of credit spreads, how it affects our business?

No. Recently, you know how credit spreads have been widening out over the past few weeks. If that were to sustain.

We like it. I mean, it would be fantastic. We love [the spread because we're going to be there and we're not] a bank and the bank tends to over react, both directions, right. They get too tight, they buy at the lows and sell at the highs. And I think the same thing's true in lending. When the market is [burr] they freeze and they don't want to have market-to-market losses. It is interesting how the market's evolving. It's sort of just-in-time lending. They want to lend, usually, unless it's -- well, pretty much to the next securitization where they can get rid of the loan.

They want the loan to close day two and securitization to take place three day. They don't want to warehouse this stuff. They don't want any movement on their balance sheets or credit spread erosion. I think -- I think we like this better than the other direction. I'll tell you that. This is really good. Also, we use this competitively with people. We say -- we say that, we're your guy, right. When the (expletive) hits the fan, or you need to -- you have a tenant blow out and you need a TI loan or you need to put a new roof on suddenly, come to us, we're the guy.

We'll stretch our junior notes. So, we're flexible. That is a big selling point for us as opposed to the securitization of the -- big securitizations where they're dealing with inflexible situation. So that's probably the single most important thing we can do is be an understanding lender and be flexible. We've had that happen many times, where a guy needs a little more money for something and we look at it and we say, okay, you can have it. And then there's a tight spread, so we're good with that. But I think that's a good thing. It's one of our most important differentiating features and how we continue to compete in the market.

I have -- we just made a loan and the guy's coming here to talk, we got the loan because of another loan we made to the guy. And it was not only a first look, but last look. And he wants to come here and thank us and talk about other things we can do together. They just like our flexibility and they complement our team. And the team's done a nice job. They're tough, but they deliver what they say. And that's what our calling card in the market.

That's really important in lending markets. Some people don't care. They scrape the bottom basis point. These are trillion dollar markets. We're not going to get every deal. Not with a $500 billion equity base. We seem to find enough stuff to keep us busy.

Thanks. And moving on to the servicing book, you have I guess around $136 billion of UPB. Do you have any idea of or could you provide the potential amounts that are going to be maturing in 2016 and 2017 when we get to that kind of steeper wall there?

Our main servicer on something like $35 billion each year of the -- I think it's $117 billion, $119 billion of maturity in two years, 2016 and 2017. We have roughly a third of the market where we're named servicer. Again, we don't know what that means. (laughter) We know it's good. I'll give you the exact numbers. It's -- we're named on $27 billion of $118 billion in and 2016 and $41 billion of $117 billion in 2017. By the way, in 2015, next year, this year we're named on $15.8 billion of $44 billion and next year, 2015, we're $30 billion of $80 billion. So, that's quite a bit. Now, don't forget, those loans can get extended. Refinanced. There's no guarantees on anything.

But it's not a bad thing. And our guys fight every day to maintain those drifts and we own, some of our senior debt securities go to those control features that allow us to eat those fees. But you'll look in our and Rina mentioned in her comments. The book value of our servicer now is roughly $200 odd million, which is what, like, 4% of our assets or something.

So it's a nice fee stream. But there are other parts of LNR that are doing really well. And we just had a Town Hall meeting down there with Cory and the team and we're working on lots of new ways to deploy capital. We've given them I think four new business lines or something like that at the last Board meeting, which we won't tell you what they are. (laughter) But they've got four new things to do. We've broadened their scope. There is a lot of people down there. These are businesses that you can put $250 million out per business a year. Billion dollars of capital. All good. And it diversifies us again. And there will be a time when we can't do something. And we have to have other businesses take the slack.

The other thing I would say is we've done --

That's Cory, by the way, speaking.

Yes. This is Cory Olson. We've done 10 deals this year are we've been named SS. We've done that by buying the B pieces.

That's a special service. Not secret service. (laughter)

And we've accomplished that mostly through partnering. I think every single deal we've had a partner. So we've deployed less than 50% of the BPs purchase price on our balance sheet but picked up another 20% in UPBs of the portfolio.

So when you think of 2016, 2017, we're constantly extending out that window into the future. So we're refreezing some ice, if you will, onto the ice cubes. So lots of activity on that front.

Great. Thanks, that's helpful. And then just, lastly, with doing less construction loans, I would assume that you're funding more of the loans? So the roughly $600 million that you did this quarter, most of that funded in out of the $1.1 billion that are kind of scheduled for the third-quarter, how much would you expect to fund out of those as well?

Well, of the $600 million that we closed in Q2, we funded approximately $500 million of that. Of the $1.1 billion that we've closed subsequent to quarter-end, I'll have to look and see how much that actually went out at closing. I don't know if-- Rina, do you know?

I don't know it off the top of my head.

Yes. We can look and get back to you.

I think -- I think our funding -- the fundings under the construction loans, I think, are around $300 million a quarter, something like that. Roughly over the near quarters.

Yes. A little less. More like $150 million. They're heavy in the third-quarter; $250 million. But you heard about the repayments of $500 million. So you can see where half of the money is going. And then that $150 million, $170 million quarter.

I will -- I don't know who votes on these things, but when we went public in 2009, we said we had the best transparency and the best reporting, and we just won some gold award. I have a little trophy somewhere from [Navy] for the best disclosure in our sector.

It's nice to see that somebody noticed. And we think that's just good for you and we can make smarter decisions. So we are clearly very transparent. Leading the industry in transparency. A little too transparent, frankly. (laughter). I don't know -- there's some of this, that I can't figure out in our own disclosure. But anyway. There you have it.

That makes two of us. (laughter) All right. Thank you very much.

And our last question comes from Gabe Poggi with EJF Capital.

Thanks for taking the question. We are almost up to the one-year anniversary of the last generation of the risk retention rules, as proposed by Dodd Frank as it pertains to CMBS.

I just want to get an update on your guys' thoughts as to when maybe we would get, I know you guys are talking to a lot of people in the market on a daily basis, when you might get that next update of a rule? And then really, what that would mean for you guys? Obviously with LNR --

I have the answer.

Potentially, as written could be very positive. But just curious as to your thoughts. Thanks.

Yes.

We just had a correspondence recently providing some information to the Treasury. At this point, still no commitment as it relates to timeline. When we'll see anything. And then as you know, there's a period of time, up to two years, to implement whatever comes out.

I have to tell you, it's unbelievable. I was down at the Treasury, I think 2 1/2 years ago now, and, wow, just -- I don't know -- I was going to say. I was joking, I said when Obama shows leadership is when they'll -- never.

So, it's okay. Anyway, the -- I do want to end on one note. Boyd has an issue with a family member, so he's not here in Connecticut with us. I just want to wish him well.

Thanks, Barry. I am on now. I came in.

I know you're on. (laughter)

I'm not physically there. Thank you very much, Barry.

You're welcome. So, I know the whole Company wishes you well with your situation. It's not Boyd, by the way. It's a family member. So with that, thanks, everyone, for listening in. And we're always here to answer your calls. We really also want to thank Zack for joining us. He's done a great job in IR and -- a really great job. So you have a point person also to talk to. So, thank you. Have a great day.

Thank you. This concludes today's conference. We appreciate your participation.