Starwood Property Trust Inc (STWD) 2015 Q2 法說會逐字稿

Good day, and welcome to the Starwood Property Trust Second Quarter 2015 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Zach Tanenbaum, Director of Investor Relations. Please go ahead.

Thank you, Operator. Good morning and welcome to Starwood Property Trust's earnings call.

This morning the Company released its financial results for the quarter ended June 30, 2015. It filed its 10-Q with the Securities and Exchange Commission and posted its earning supplement to its website. These documents are available on the Investor Relations section of the Company's website at www.starwoodpropertytrust.com.

Before the call begins, I would like to remind everyone that certain statements made in the course of this call are not based on historical information, may constitute forward-looking statements. These statements are based on management's current expectations and beliefs and are subject to a number of trends and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. I refer you to the Company's filings made with the SEC for a more detailed discussion of the risks and factors that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today.

The Company undertakes no duty to update any forward-looking statements that may be made during the course of this call. Additionally, certain non-GAAP financial measures will be discussed on this conference call. Our presentation of this information is not intended to be considered in isolation or as a substitute for 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, www.sec.gov.

Joining me on the call today are Barry Sternlicht, the Company's CEO; Rina Paniry, the Company's CFO; Jeff DiModica, the Company's President; and Andrew Sossen, the Company's COO. With that I am now going to turn the call over to Rina.

Thank you, Zach, and good morning, everyone. This quarter once again demonstrated the strength of our multi-cylinder platform with all components of our business contributing to core earnings of $125.9 million, or $0.53 per diluted share. Excluding certain one-time costs related to the acquisition and pursuit of property-related investments, which I will touch on shortly, the quarter was $130.8 million, or $0.55 per share.

During the quarter we deployed $1.9 billion of capital across a variety of asset classes including $810 million in our lending segments, $552 million in our investing and servicing segment, and $503 million in our new property segment. I will discuss each of these segments individually, but I will start with our newest segment, the property segment.

We established this segment to house our stabilized operating properties, assets which carry high occupancy levels and stabilize cash on cash yields, such as the Dublin portfolio we spoke about in our last call.

During the quarter, we closed 12 of the assets in this portfolio for a gross purchase price of $383 million. We closed the final asset in the portfolio on July 24th for $122 million. Also included in this segment is our 33% equity investment in the mall portfolio we acquired in the fourth quarter of last year. We have reclassified our prior period segment financials to reflect this investment in the property segment.

Excluding the impact of one-time acquisition in pursuit class primarily relating to the Dublin portfolio, the property segment contributed core earnings of $4.6 million in the quarter. Keep in mind that most of the Dublin assets were acquired mid-quarter and therefore did not have a full quarter of contribution or results.

We have a robust pipeline of over $1 billion in assets for this segment, all consisting of stabilized assets across a variety of property types. We hope to tell you more about these assets during our next call.

Now turning to the results of our lending segment. During the quarter this segment contributed core earnings of $108.1 million, or $0.46 per diluted share, a slight increase over last quarter's core earnings of $107.3 million. We originated or acquired $810 million of new investments of which we funded $560 million. We also funded $132 million under preexisting loan commitments for total fundings of $692 million.

These new assets were funded almost exclusively with recycled cash from the lending segment's target portfolio, which, in line with our expectations received $928 million during the quarter from repayments, partial paydowns, refinancings, and sales. The new investments made by this segment during the quarter were accretive to the loans that were repaid.

Credit quality continues to be a priority for us with the average LTV on our loan book declining to 61.3% and our track record of zero credit losses continuing across over $15 billion of historical loan originations and acquisitions.

The returns on our lending segment's target investment portfolio remained strong at nearly 8% on an unlevered basis with optimal asset level returns increasing to 11% this quarter due primarily to new investments being made at higher returns than those that repaid.

Keep in mind that these returns do not include the impact of corporate-level debt such as our term loan and convertible notes. If we were to allocate this debt to the asset level, we estimate that our optimal return would be over 14%.

Our loan book continues to remain positively correlated to a rising rate environment with 82% of the portfolio consisting of floating rate loans. We estimate that 100 basis-point increase in LIBOR would result in an increase to annual income of $19.5 million, or $0.08 per fully diluted share. This does not include any benefits that our Special Servicer would realize in a rising-rate environment.

To give you a bit of color on this particular point, for the loans that are scheduled to mature in 2015 to 2017 in CMBS Trust where we are currently named Special Servicer. There are approximately $60 billion of performing loans in those trusts. In a rising rate environment, higher rates would make it more difficult for these loans to refinance resulting in more loans entering special servicing and more fee income to the bottom line. This puts us at a very unique advantage to other REITs generally and specifically to other mortgage REITs.

Speaking of special servicing, I will now turn to our investing and servicing segment, which returned another strong quarter of results reporting core earnings of $61.1 million, or $0.25 per diluted share, a slight increase over last quarter's core earnings of $60.9 million and an increase of more than 28% over the earnings we reported in the same quarter last year.

All cylinders of this segment contributed to the improved performance. Our conduit operation, Starwood Mortgage Capital, participated in a record five securitizations this quarter selling $533 million of loans for net securitization profit of $17.3 million on a core basis. The remarkably high turnover rate for this book helps to limit our exposure to some of the market volatility we have seen recently.

Our servicer continues to maintain its dominant position in the market, again ranking first in name, special service, or market share. As of June 30, we were named Special Servicer on 153 trusts with a collateral balance of approximately $125 billion, and we were actively servicing $12.6 billion of loans and real estate owned.

Our CMBS portfolio remained relatively flat this quarter increasing to $830 million from $807 million last quarter. While CMBS spreads widened this quarter, it is important to recognize that our CMBS do not trade in the same way as other CMBS bonds unless our marks are less vulnerable to spread movement.

First, the majority of our bond portfolio is marked to a loss-adjusted yield, which means we assess the credit quality of every loan in each CMBS deal we invest in and mark down the bonds when we believe credit deterioration has occurred. Although our pricing yield is impacted by market spread movements, those spreads are often muted by treasuries, whose yields typically move in the opposite direction. The other factor to keep in mind is that we plan to hold much of our CMBS to maturity.

Our CMBS pipeline looks strong with three B-Pieces and the related servicing already secured thus far in the third quarter. Once the Dodd-Frank risk retention rules are implemented in 2016, we expect the playing field to shrink considerably, which will uniquely position us to benefit from increased opportunity in this space.

Turning briefly to our corporate segment, unallocated corporate overhead on a core basis totaled $43.6 million, or $0.18 per diluted share, a decline of 8% from the $47.2 million we reported last quarter. The decline resulted from fewer convertible note repurchases this quarter.

Moving to a discussion about our capitalization, early in the quarter we issued 13.8 million shares of common stock primarily to help fund our acquisition of the Dublin portfolio. On June 22, our Board authorized a $200 million increase to our repurchase program. We repurchased 400,000 shares pursuant to this program during the last week of the quarter before we entered the blackout period. Our total borrowing capacity, excluding capacity, which we could create from selling senior interest in our loan portfolio stood at $6 billion at the end of the quarter and has increased to $6.5 billion subsequent to quarter-end.

We continue to stay within our historical leverage levels with our debt-to-equity ratio falling to 1.2 times at the end of the quarter, a level, which we believe is extremely conservative compared to our peers.

And, finally, I'll add just a few brief comments about our current investment capacity, our 2015 earnings guidance update, and the third quarter dividend.

As of July 30th, we have the capacity to originate or acquire up to an additional $1.5 billion of new investments driven by available cash, capacity under our financing facilities, and expected cash returning from our loan book. This number does not assume any incremental leverage that we could obtain on new investments.

As we look to the remainder of the year, our business continues to perform in line with our expectations, and we therefore reaffirm our 2015 core EPS guidance in the range of $2.05 to $2.25. Consistent with that, we have declared a $0.48 dividend for the third quarter. The dividends will be paid on October 15th to shareholders of record on September 30th and represents an 8.8% annualized dividend yield on yesterday's closing share price of $21.78.

With that, I'll turn the call over to Jeff for his comments.

Thanks, Rina. We've run a complex that are complementary businesses here. We believe that complexity is also a competitive advantage giving us the ability to see the entire playing field from many angles, lever our expertise and scale across the real estate capital markets and invest across many platforms in the highest risk-adjusted returns available.

We believe the more engines we have the more opportunities we will find, and that we will never be in a position to need to reach in a specific vector to invest capital. Our multiple platforms give us the ability to be flexible and very selective in the assets we acquire.

We continue to venture to overcome the complexities by telling our story to investors and value that opportunity, and we'll host meetings in Chicago, San Francisco, and the mid-Atlantic in the coming months. We allocated nearly half our over-subscribed equity offering in April to retail investors, and we continue to think there is upside in our equity story with retail investors who historically owned less of our stock than our peers. At an 8.8% dividend yield, we feel the better they understand our story, the more our stock price will benefit. We continue to think book value is not the appropriate valuation method for large parts of our operating platform.

We are finally at the beginning of the 30-month wall of CMBS maturities we've been waiting for and getting closer to the December 2016 implementation of Dodd-Frank (background noise) for us as investors in CMBS B-Pieces.

We worked very hard on some large portfolios this quarter -- some that may work for us and a few that did not. We utilized the scale of nearly 500 people at Starwood Property Trust and another 1,000 across our managers who underwrite large portfolios of assets that we simply could not underwrite in sufficient detail without our scale.

We underwrite in asset manager entire book ourselves, staying close to every detail of the credit quality of our assets. As Rina just mentioned, our LTVs sell again, and we continue to have zero dollars in realized loan losses.

Importantly, in our mature low LTV book, our internal asset management process and interactive borrower feedback helps us hone in on the timing of our expected maturities. Managing our liquidity is among our most important jobs, and we had over $900 million in loan payoffs, refinancings, and maturities this quarter, but none of them were a surprise for us, and we have been able to or will reinvest that money in a timely fashion.

We have many places to use cash. We deployed nearly $2 billion during the second quarter across the many investment engines available to us, and the third quarter is starting off strong across all our investment platforms.

We added seven new borrower partners this quarter and have lent to over 100 distinct borrowers over the last six years. We constantly mine our portfolio for refinancing and repeat borrower opportunities and did so effectively this quarter as well. It will be very difficult to stay invested without repeat borrowers in a relationship of a 1,500-person organization.

I always talk about our credit first philosophy and our goals of lending great properties in great locations globally with great sponsors. This quarter we made eight loans for $810 million at a 12.9% levered IRR in our lending book, which is well above the yield of our legacy portfolio. That credit first philosophy now is spent into our equity purchases. As Rina mentioned, highlights this quarter includes the Dublin portfolio purchase and the turnover and volume of our conduit operation, which was the large contributor to five distinct DMBS conduit deals -- quite a feat.

Our borrowing rates continue to fall this quarter, and we added a tremendous amount of new capacity. We closed, modified, or amended a handful of lines this quarter and are working on eight new lines of modifications. In addition to the 23 loans totaling over $1.5 billion we've put on warehouse lines this quarter, we also sold our syndicated 17 loans for almost $1.2 billion and believe that mix is both prudent for the long line growth of our business and allows us to optimize multiple sources of available financing. I would consider our dedicated sales and syndications expertise another engine in our diversified platform.

As a side note, we announced the new Chief Credit Officer this quarter, Mark Cagley, who we hired after 30 years at Bank of America and Wachovia, and we also announced Co-Presidents of the REIT segments, Adam Behlman and Isaac Pesin, and look forward to introducing them to you all in the future.

I'll now turn it over to Barry.

Thank you, Jeff. Thanks, Rina. Good morning, everyone. An interesting quarter, I mean, the world was volatile, and we were not. We talk about being stable, transparent, predictable, and I think we delivered all three as we have from the start of the firm to our shareholders.

The market was a little volatile. Every time interest rates look like they're ticking up, our stock ticks down. I'll point out that the eight/tenths from the increase in LIBOR; 1% is nearly twice our second-largest competitor's being in the increase in earnings per share will be only twice what they achieved in this in fact. Rates do bop up.

I would also point out that it was a sloppy quarter, and we actually beat the Street estimates because we didn't realize that we'd be taking up on hits from the equity yields we did in our earnings. So we did $0.55, your estimate was $0.53, but it was a really sloppy quarter. While Jeff said, we anticipated $900 million of cash coming back, we sat around with a lot of cash during the quarter and, hopefully, we'll be able to put that out quickly in the third quarter, and we anticipate being -- I can't remember the last time we ended a quarter with $1.5 billion of capacity.

So we're not operating on all cylinders. The good news, we've got a lot of dry powder, and the really good news is we're finding opportunities to deploy it, which even surprises me. And the two highlights of that, which I'll say again will be duplicates I have with Rina and Jeff's comments are the LTV dropping, which is shocking at this point in the cycle.

And also the yield on our target assets that's going up not down. We actually told you this. We told you that we'd be able to finance cheaper as these credit lines came in in cost, and we could lower our cost to borrowers but, at the same time, our cost of financing would drop, and we expect to continue to see that happen.

The other thing, you're looking at very different strategies in the space. You're looking at companies that is 1.2 times levered. It is really not very leveraged, and we highlighted for you that if you attribute our on-balance you leverage across the Company, we're earning a 14% of return on capital, which is best-in-class. And we expect that will get better not worse as we continue to deploy capital and grow the enterprise.

Really excited about the pipeline both on the team on the origination side. We are not looking for mass, we're looking for quality, and we find we're very picky. I'm really excited. I want to say a side note as Mark Cagley. We'll really excited to have him onboard as the Chief Credit Officer of the REIT. He's done a really nice job integrating the team really well. And the coordination between Greenwich, our regional offices, our European offices, and the team in Miami, which is 350 people strong, has never been better, as well as Rina's efforts to consolidate and drive the quality of our earnings information and our back offices. I think you'll continue to see those get scale synergies as we continue to grow and get better coordination, an increase in coordination between the parts of the firm.

We also bought a little stock in, and we've been involved in some transactions, and when we're involved in large transactions, we actually can't buy our stock, and so we will be -- after repurchases, the Board approved the repurchase program, and we recognize where our dividend is on the stock right now.

And I think, overall, we're pretty happy. I'm pretty happy with the quarter given how much cash -- we wound up with an average balance, which was excessive and unusual for us. We had some timing delays, as you always, always talked about when a loan is invested or to be closed. The Dublin deal had a split closing. We had to close one piece and the second piece, and we have some really interesting deals under contract, which we're not going to talk about. Our strategy, as you know, on the equity side is the stretch duration -- invest in very safe deals with very high cash-on-cash returns so we can pay the dividend right off the bat, sustain our dividend or grow it, over time, if it's possible.

And when we don't do that, we'll let you know when we change strategies. But right now the strategy is available to us, and we're executing it literally on a global basis.

And monitoring our cash position and also our stock price to know that we have to be careful about raising additional capital at these levels.

So, with that, I want to thank the whole team -- Zach and Andrew and Jeff and Rina and Adam and everyone for all their effort. The continued hard work at the company, and we're pretty excited about our market-leading position in the space, but we do think we have to continue to introduce the Company to different audiences. Jeff mentioned retail probably in Asia, something we should go do. A yield like this with 61% LTV remains a bit of a joke. I wish -- I own a lot of stock, so it's hard for me to even buy more, but I guess I could.

Thank you very much. Now we'll take questions.

Thank you. (Operator Instructions) Doug Harter, Credit Suisse.

Thanks. Can you talk about, sort of, as the portfolio is seasoning, and as you get more, sort of, repayments on a quarterly basis, how you plan to manage those cash balances down to kind of a more normalized level?

One of the things that we have, which we're benefiting from, is a very good construction book, and it has draws, like Hudson Yards is in the power going up. It has draws, so we actually know cash is going out and cash is coming back and is going out -- you know, we actually projected out only two years. So net cash that we have -- expect to have for new investments is not nearly -- we're counting on these repayments, and we know they're going to be repaid.

Things like Hudson Yards -- I can guarantee the day that that loan, an 8% first mortgage on a trophy office building in New York, that will go away, and be replaced with far lower cost of the same thing. So we know it's going -- coming back, and we can anticipate that coming back.

We have about $1.5 billion that's left to go out on those -- to some of those existing high-quality loans, which are very low LTVs. They're actually helping our LTV calculation. I should have mentioned -- I didn't mention, Jeff mentioned briefly, and I'll do it in your question not in my comments. But the changes that are going on with the banking system with Dodd-Frank and BASEL III really should be a very good thing for us. And across our platform, we can take advantage of that every part of our business, whether it's by BP as originating paper, for Larry's conduit business in Starwood Mortgage Capital, part of large loan business for construction lending -- that could be just the greatest thing that's happened to us since 2009.

So we just have to make sure, and we will look, and we did. We have worked on some larger things that we didn't win but yields to assets, too. That's another low-yielding asset, which is a fairly clean quarter with not a lot in the way of asset sales, almost nothing. But we have, in the past, looked to taking advantage of the markets and sold stuff. And that's another source of capital.

We have a very liquid balance sheet. I'm not sure people -- we can sell pretty much anything on the book, and then we have stuff on the book, like auction.com, which actually is doing pretty well -- the kickers and some of our deals that we don't value at all, so they're not in the -- virtually not in the book. So the Company is unusual. It's built differently. It's a pretty interesting Ferrari. Maybe we're just -- we weren't quite a Ferrari this quarter, we were kind of like a Lexus, an off-scale Lexus, but we're going to be a Ferrari. We're going to continue to better what we do, and I think we have a great opportunity in this space.

(Operator Instructions) Charles Nabin, Wells Fargo.

One of the themes you've touched on in this, the opportunity in the B-note space. So I was hoping you could comment on the incremental returns you've seen over the past couple of months with the recent spread widening. And also if you've seen any change in competitor behavior?

Do you want to take that, Jeff? I mean, the B-Piece market is inactive, as you know. There were eight buyers last quarter, I think. Different buyers, more than we've seen before. We like our position. The spreads bop in and out. When they bop in, we walk away, and when they bop out, we step up. We've been very tough in our B-Piece buying. We've been kicking deals out of securitization, and that doesn't always make us the guy of choice, but for one reason or another, it's actually working okay for us. It's not like we feel like we're not.

Don't forget, we also, as a Servicer, we get a high ROE when we buy out B-Piece and many people then hire a Servicer, so we can bid a penny more, and we get a higher return. Maybe we get bid a penny less. So that's a competitive image of the integrated platform. Do you want to add anything to that?

No.

I think the BP CO has backed out into the, sort of, high 14% or thereabouts, probably 100 basis points wider than where they were not that long ago, but it's really a combination (inaudible) of what we're able to kick out, how we're able to shape the pool and the yield. A wide yield alone won't get us in. We need to shape the pool to something that makes sense for us. There was only one of those last quarter. We have three already this quarter.

And, again, we like this environment, we like volatility in the credit market in the sense that -- I mean, it hurts us maybe in one securitization out of 11 or so we'll probably do this year. But it also widens spreads and makes all those conduit lenders get more nervous, and they don't keep tightening, tightening that things always go in one direction. So the backing up of AAAs is good for us. We really like that, frankly. We want more of that. Give us more volatility.

The traditional lenders walk away. They freeze, and we wander in and use our real estate underwriting to say that this is final. Take us down. We're a holder, anyway. So vol is good for us. Higher interest rates are good for us. I keep mentioning that every time rates go up we get sold. We're the ones with the largest and most liquid of five-something billion dollar equity market cap. We're the fun guy to sell with ETFs. They buy us and sell us, and we go down every time there's liquidation yielding ETFs, and they assume the REIT's going to go down, they sell us. They sell to the resi REIT.

Shareholders have to look through that noise, and the long-term value and the franchise and enterprise and use those opportunities to buy the stock because these ETFs are really, as Larry pointed out, I always pointed out to Larry I think (inaudible).

ETFs are creating interesting opportunities for smart investors. They have to take advantage of that because they're just pushing buttons to sell the stock. And, for us, we just have to dance around that situation.

Okay, just a quick follow-up to that. You had disclosed $33.4 million in properties acquired through the trust in the investing and servicing segment. I was wondering -- are those -- is the intention to hold those properties for investment or to sell those properties?

Both -- mostly to holds, remodeling five-year holds. But those are off the LNR book (multiple speakers) LNR book. That's what those are.

(Operator Instructions) Jade Rahmani, KBW.

At this point, the number-one question I get asked by investors about Starwood Property Trust concerns, the external manager. Can you comment on whether the Board has discussed a potential internalization transaction? A couple of your peers are internally managed, and one has merged with its private equity parent as you've previously noted. How realistic do you think a potential transaction might be?

Where in the structure we are, we have well north of $100 million plus overhead at LTG, the parent company that's deployed in the house with a REIT. So all the equity deals we're doing are done by the manager, and they are growing in number, and they will grow in number in the Company.

So I don't think at the moment -- I think we're steering the Company, which is (inaudible) calling these internalizations was a company with a different potential future. It was a very different-looking book. It was already an equity book. It was more of a diversified, almost an opportunity for us -- strategy as opposed to the BXMT, which is obviously externally advised. I didn't expect to see them internalize anytime in my lifetime.

So -- this is a debt book, a high-yielding book, and it's managed like a fund, and I think that's the strategy we're going to keep in place for the time being.

Okay, just turning to the lending business, can you discuss what drove the increase in optimal levered returns? Was that mainly due to leverage on the first mortgage position or something else?

Better origination. It's interesting, we had a -- obviously, we changed our origination team for those of you who have been following our firm over the years, and we haven't made a construction loan in, like, a year or maybe more, and we were getting full up. We like the opportunity, and it's something that we're blacklining -- or redlining, it's something we're going to do, and we liked it. But we (background noise) looking at the enterprise risk to the Company decided we could pull back. And we did, and what's interesting is without -- even those are juicy deals. But without having to do those, I think just better originations and better credit review and just better deals got us better yield.

So a combination of the fact that our spreads are a little tighter on our line, which we continue to work to drive down, and it's not really because of more leverage because the firm's overall leverage helped quarter-to-quarter. So kind of shockingly interesting. I actually am scratching myself. I pointed out to the Board at our recent Board meeting that the quality of our book -- now, we're not doing probably -- we're not doing $2 billion of loan origination a quarter. And then we've always done, we've always focused on the capital of putting out over the equity retention piece or the A-Note that I call the A-2 Note because the first mortgages that we'd buy off seniors to match funds that -- the risk.

That's something else that I think is lost sometimes on some of the analysts -- the match funded nature of the book. It's really important because you can repo this stuff, and we could drive earnings if we feel like it, if we chose to just do an overnight financing, and you wouldn't see the risk until we had our own little S&O crisis when we couldn't roll the repos. But very effect way to finance yourself. It's just not effective when the [world dries up].

There's no credit anywhere that show our -- not basically, as you know, one of the reasons the resi REITs trade the way they do is they worry about their impact. They're both a declining book when rates go up, the value of their book. And the fact, as repo rates, you know, they're short-term, and there are longer-term investments against it. So they have the S&L risk in them, which we don't. But, again, you wouldn't know it from the stock prices, not exactly where we want it to be.

Can you also touch on what drove the loan loss provision in the quarter?

Well, we added one loan, I think. One of our worst loans was just taken out, so it was the worst loan I was worried about because I love being able -- do we have another loss in six years or five years, whatever it is. But they repaid us, and it was sold and we're done. So we added something else to the watch list.

So that one was left out until the third quarter, so it actually just a couple of loans that added to it this quarter. And, again, it's not that we don't expect to be fully repaid on those loans, we just have what we call impairment indicators the way they took the debt. We also we think ultimately we'll be overcome.

The auditors would like us to keep our reserves, but we've instituted one because of the size of the book. But the actual, I was just reminded of what loan that is. There's no chance that's going to be an issue. I hate to say things like that, but the man has a zillion dollars. It's in California, invaluable real estate. He has a ton of money in the deal, so they lost a tenant, so we moved our new CCO, Mark Cagley, who is running that risk retention. He said, "Okay, let's put it in the bucket," so we did. And then we automatically increased the reserve when that happened. No big deal.

And then just finally on the servicing intangible. In the 2016 through 2018 time period, if there are additional servicing transfers that increase the amount of special servicing, would the intangible on the balance sheet increase?

Yes, it would. It would. And as we get closer in time because we discount those cash flows at 15% as we get closer in time, it will increase as well because of that.

Yes, that's an interesting point. We've talked about that also in our meeting with (audio break). We've been discounting those streams at very high discount rates. Probably inappropriate, and the book value of the servicer would go up as we got more visibility on the stock. They've done some pretty good analysis now of what's coming down the pike, and we really would like the Fed to raise the rates (laughs). We're big fans of high interest rates, at least higher interest rates, because they will trust every one of those loans that they [restamp].

Just for those loan people, I don't even remember that period, but those loans were written at 90% plus LTVs of very high [Z]. Most of them were written, like, 30, 40 basis points over LIBOR. So they have absolutely no risk of defaulting until maturity, and no borrower would refinance that. Why bother?

So when they go to refinance it, some subset of those should be opportunities that will fall into special and we will earn good (inaudible) working them out. So we would really like rates to be up by -- I think maybe 16 would certainly -- I do think we'll see rate increases here, maybe at 25 -- they have 50 BPS on LIBOR, but I think it will be -- we'll look forward to it. My stock will probably fall, but we'll make more money until people realize that.

And just finally, if I could -- in terms of capital, I think at the Investor Day, you commented on potential plans for a CLO. Is that still something you anticipate doing this year?

Yes, I would say it is something that we will more likely than not do by the end of this year. It's lined up against everything else that we have. The reality is our borrowing lines continue to get cheaper, and it's a function of where it lays, vis-a-vis our borrowing lines and where the capital markets execution is on any given day. With more volatility in the market, it's a little harder to get a deal done, and as this market gets less volatile and CLO spreads tighten in to make it more competitive then we are ready to pull the trigger on it.

Some people buy the coupon. It's the total cost of the financing, that as I always say to these guys, why are we doing these? And they always push back that we already paid for our credit facilities, they're fairly -- that accordion features of their (inaudible) based on credit quality on the spreads and the overall cost -- and the duration the way a sequential pay -- how it pays off, especially reduces that value of some of the leverage to the firm.

So I've been honest but convinced that it's something. Now, we've looked at it in terms of some of the deals we've been doing or looking at doing, whether we would take some of the assets that we buy and pulling it together and doing a CLO. And there, of course, it's not incremental to anything. We don't actually have the capacity in some of these to put it on our line. So that might work.

But we'd love to be there. We also know we didn't bring it up, and we should bring it up that we have some marching orders on investment grade, and it's something that we'd like to do, although it may take longer, of course, than we'd like. But we know where we have to go across the different parts of the firm, and you will see us do move -- that will move us in that direction. And so we are -- Andrew and Rina and the team have done a really nice job of laying out a roadmap, working with the rating agencies. What we need to do in order to achieve what we talked would be just -- maybe we could get investment grade, and the bank can't make loans anymore in real estate, that would be a good thing. So we'll see.

There are some other interesting things we'll talk to you about in the quarter that's coming up that we're working on, but we'll just tease you right now. It's like a feature film -- Jaws 4 (laughs).

Dan Altscher, FBR.

Actually, I wanted to talk a little bit about the buyback. You know, (background noise) prepared remarks get a little bit towards the end of the quarter. Just curious, why up the buyback authorization if it seems like there were still some adequate capacity in going into that -- into late June. Is that maybe in preparation of some increased activity, going forward, given where the stock is?

Upton reissued the buyback authorization, but as I mentioned in my comments, every time we're involved in something at scale, we're not allowed to buy back stock. We're obviously insiders. And then we have a natural time for the earnings we're not allowed to buy back, too.

So you saw us, I would say, wander in and buy some stock but, again, if we have something large that we're looking at, which we were and do and are, then we'll stop because we think we can deploy -- we can use the cash for something else.

But, yes, like I said, from a balance sheet perspective, it actually may have been one of the sloppiest quarters we've ever had with a lot of cash splashing around. It wasn't actually splashing around, it was paydown credit facility, so we were unleveraged for a portion of the quarter, moreso than I think we typically would be. Do you agree, Andrew?

Yes, and, Dan, if you -- sorry, I have a little cold -- but if you look at our share price over the course of the quarter, I mean, as of June 11 or 12, we were still north of $23 a share. So we started stepping into the market kind of subsequent to that, and as Barry mentioned, you know, as you hit June 30 you go into your blackout window from a buyback perspective. So we were forced legally to have to step out of the market.

And remember that our share -- our buyback authorization also covers our convert. I think we've disclosed we bought some converts back to the quarter and bought a greater quantum back last quarter. So although we had capacity, it's covering a wider spectrum of securities today than it has historically.

Yes, no, I definitely saw the converts also. I mean, I guess that does kind of lead to my next question, and in some ways you're answering already is, how do you think about the mix versus convert versus common? I mean, just, the simple math kind of suggests $22 is a price where you start to like the common as well. So how do we weigh that against what, you know, both of those options versus the big things that sound like they're maybe in process and it kind of feels like the buyback there -- is there a supplement, but it's not maybe going to be used in a super big way at the end of the day.

The converts are obviously attractive financing for us, but when we have an opportunity and when we've had an opportunity to buy them back at a discount to parity, which is a function of both the convert price and the equity price, then we've stepped in and done that. I think that's the strategy we will continue to do. Today the converts have traded better, vis-a-vis the equity, and they're not at the discount to parity that they were when we were repurchasing them. We think it makes economic sense to do so. When they get down there, they're not there today, so we've pulled back on purchasing the convert.

We all love them (laughs). I don't think you're going to see us do a lot of that because of the ball they trade. The facility use the cash, it's like the price of funds goes up and we have to buy them in. So it's -- they're fine, but we'd rather find other ways to grow, probably, at this point.

One of the unusual things that all those converts with is spin. The shareholders that are here, newer, we did spin out our wave point, which is roughly $5 a share, so where stock is really good at 5-point split, it's 26-something company. It's probably paid out, I don't know, $13 of dividends to start. But it was a $40 stock, if you will, since we started.

So I think they're making us best-in-class, which I actually know we are. So we've got to look at everything and find the vol that that convert creates in our earnings is kind of upsetting, and it's not exactly like what we pay us to do, it's manage that side of our balance sheet -- it's a headache.

And then, you know, Barry, I just want to follow up on a point or question -- or a comment, excuse me, that you made earlier in the prepared remarks, and I think it was that you recognized where the dividend is. Maybe -- what do you mean by that -- recognizing that it's obviously very generous at the current rate or that there is potential or hopes to step it up, over time, like you have in the past? Or that, you know, we're just really comfortable with where it is. What did you mean by that, exactly?

I think it's too high (laughs). The stock has stock that on the dividend rate is too high, and I look at my peers' dividends, you know, and I'm -- it's too high, given what we have and they have on a relative basis, that I started to pay a dividend. It pays their 1.3 times book. So there's an example.

Or, you know, I think our PLO, the second-largest tier at the moment is more lever than we are to 3:1. By region, they have a lower dividend yield, and I think -- what obviously is the case, and what Jeff and Andrew, Rina, and the team have been working on is that is educating people on the Servicer, because the only possible explanation I can have for where our dividend is that people don't understand, the recurring nature of the servicing income in the Company and the business that was a substantial portion of the profits of the Company coming even from the conduit business, which has nothing to do and, hopefully, it will be here forever and remain best-in-class as it's been for a long time.

And the CMBS book throws off a very predictable value for us, and that's the bulk of the -- the Servicer is only valued at $175 million or something like that -- $165 million at the end of the quarter, so what is that, like, 2% of assets? And, yes, it throws off some good income, and there's opportunities there, but we hope, as you know, as their deployment in the equity space is kind of, in part, to cushion what we'd expect might be a reduction of income for that area in 2018, 2019, and 2020. We can't do it in 2020, we've got to do it now.

So we know what -- just like we know the repayments, we know what we're looking at, and I think -- I just don't understand the yield on their stock, and I do blame it on the ETS, I blame it on the fact that the ETS -- there have been accounts that -- that's like I highlighted quality of the book we're originating today because you might say the credit cycle is getting long in the tooth, and I myself say it's [realized]. It's not like it's easy to find good loans that we can make that spreads the work for us, but there are opportunities and some of it's with just repeat borrowers -- guys coming back and -- in one of our deals, we're refinancing the fourth time -- or our fourth refinance.

So we're easy to deal with, and -- but we're -- you know, we're -- and we're flexible. That's what we've told everybody. We're staffed, flexible, we know real estate, we'll hold the loan, they want to upsize it, they want to expand their asset. We're a great lender for that. If it's [not as good as Manhattan] leverage 35%, we're not worthy of a phone call. Don't waste your time, we won't be competitive.

But our mature loan book, two of the loans this quarter were refinancing as Barry just mentioned, and they were at attractive yields to us. We control those. We're the only persons who can rewrite those loans. They have prepayment penalties. That borrower can't go out to another person in the market without significant penalties, and while we control it, we look for opportunities to extend it and refinance and -- with a six-year-old mature book, that is enough to me that we'll continue to take advantage of.

Eric Beardsley, Goldman Sachs.

Just on the dividend, I guess, how should we think about the potential for dividend growth from here? Is it going to be a function of more leverage, over time, growth in the fee income or just better reinvestment yields?

I think, look, I think all the above. I think as the book grows the constant finance book will continue to drop, and then with the obvious goals making investment grade and then the ROE of the business goes up, and you can pay a bigger dividend.

It's the [yield star] of the world, it would be less yield star if the rates go up, but -- so -- I think there's pressure on you. I mean, you're in the yield star world, we look at a lot of equity deals to try to find deals that are cash pay rate, and we can do equity deals all day long that pay 6% current, but that's not going to work in our model. So we're looking for the kind of equities that look like us -- stable, long term, really no risk, we believe, to the corpus of our capital, and things we would like to own forever. So the deals you'll see us announce are kind of like one of them that's very long financing in place -- fixed financing forever.

So -- hopefully, you'll see the kinds of stuff, and we think of it as, like, if we want to drive it first and then we want it own it for 20 years, and I feel comfortable with it. That's how we screen this stuff, and then we say, okay, can we get cash and cash yields (inaudible) to the 10%, which we've achieved on the first two investments we've made, and we expect we can achieve on further ones.

But that is a subset, a small subset of what you can actually buy. You're not going to see us buy, likely. I mean, we'll tell you if we're going to do it, but our $2 billion office building in New York is a 2-Cap. I mean, that would interrupt our dividend, so -- and that would be a change in strategy, which we have not yet decided to do. So -- or found a need to do.

Got it. And on the equity investments, are you primarily targeting fixed rate funding to keep that asset sensitivity?

It depends what it is, but I think that's what we've done [in the end]. But it depends on what it is. We've also done -- in a private book, we've done deals with floating with caps and -- but it depends on what it is. We don't -- things are not trading 30. I'm not thinking we're going to be buying this up and selling it.

So having said that, you know, we've invested in a mall portfolio, which could go public at some point, and our form of ownership would change with the stock, I guess. We also -- if we look, and we'll give it to you next earning call, give you the IRR on these deals. One interesting thing about these loans repaying the way they are is the IRRs are through the moon. I bet we're achieving 16, 17, 28 IRRs on invested capital because the prepayment penalties or other stuff, but the duration is shorter so the fee up front is more important than it was when we underwrote the deal. So we're telling you what we think about IRRs, but then when these things pay off early, Center Parks, we had a big investment. That loan, for example, we marked that deal, I think, at, like, I don't remember, probably 65% LTV with a company sold. That loan was a 40% LTV loan.

So our marks, you might think that 61% is that you guys are crazy. I will tell you they're conservative because it's probably lower. They're probably 50%. I don't know what our (inaudible) will trade for, but it will trade for -- that loan is probably, I don't know, 35% of what that thing will sell for? So it's not marked that way, because we marked it as a percent of cost not a percent of -- at least (inaudible).

So you can earn 8.8 at a credit book like this? That is ridiculous, but it is what it is. Our job is to convince people it's worth a lot more. And we have to get retail. I mean, we don't have retail.

Ken Bruce, Bank of America.

I've been following this stock since the IPO and, Barry, you've been talking about this as being a stable, transparent and predictable business, really, from the outset. You've delivered on that. You know, everything that you're talking about in terms of the quarter reflects the positive fundamentals and the things that you can do to enhance the returns in the portfolio.

But you point out that your stock is more or less being treated more like an asset class versus a standalone stock with a very good investment thesis behind it. And I wonder, as you kind of look back or as you think forward, excuse me, and try to, I guess, kind of deal with the conundrum of stock that seems to be perpetually undervalued, what you're willing to do strategically that might, if you will, create shareholder value over a period of time?

You say you're teasing us a little bit in terms of what you may do from an operating perspective, but I guess thinking about it more strategically over a longer window, if you can't get the market to rationally price your stock, what might you be willing to do?

Probably we should [somewhere find] a REIT conference because -- we don't because we're a mortgage REIT, and people don't understand that. But as you think about-- I was looking through the multiples of the REIT, the equity REITs the other day -- cross factors. And then I was looking at their dividend yields, which are kind of like, depending on what they are, as low as 3 and 4.5. We're paying an 8.8 right? So there's a lot of stuff that could go wrong, you know, before. And we're going to revert to cash at some point.

So -- I don't -- you can get a lot of return from owning us, and I think your principal (inaudible) that's a risk at a higher rate, right? I think -- our earnings go up with higher rates, most REITs will go down with higher rates, and their stocks will fall at higher rates. What you're seeing every time there's a tickle up in the tenure, equity REITs fall. And those multiples are stretched. They've corrected, but they're still high. I mean, you've got plenty of company with 25 -- 20, 25 EBITDA multiples. They're up almost, which are levered yields at 20 times. I mean, so as a value play in the REIT space, playing real estate and now we're cherry-picking equity deals with great cash-on-cash returns. I mean, you total IRRs today with equity investors are lower than our dividend -- total IRRs. People are aiming for 6 and 7 and 8 IRRs on their target investments. We're paying a current.

So unless you think you're principal is at risk, it's an insanely stupid thing to do, frankly. And we're now stretching duration with our equity book, so we think, in the universe of investment alternatives, go margin our stock and earn yourself 13. If you do that, if you're a hedge fund, you're the best-performing hedge fund in the United States this year. Very few guys are earning that kind of return in this market with the Dow up 1.6% and the S&P is lateral, whatever it is.

So, I mean, we are a nice core holding and now the stock is where it is it shouldn't be here. I don't know why we're here, but you're right, I mean, we'll have to work on ways to get the stock up, and I have some ideas, but we won't tell you because we have a lot of imitators. So we'll just do them and then you can applaud, I hope.

Well, you know, I guess, you know, there's the unfortunate reality that we may have to wait for rates to move to actually have the asset sensitivity work its way through the P&L and ultimately, you know, I think the market will kind of get it when it sees it's not one that wants to give a lot of credit for theoretical asset sensitivity.

[Because the team] is in the aggregate well over $100 million of stock. We are very interested in supporting the stock. I am very patient. It's a long story, it's not one inning. And if we want to pump near-term earnings, we can do that. I'm not sure that's going to help the stock. I think we've just got to keep telling the story it's different, in ever-wider circles of investors, to bring this thing into the position where it needs to go. The team has spent a lot of time doing it in the quarter, and they can do more to different audiences and did our first trip to Europe. You know, I think, frankly, you've just go to be -- it also helps to be bigger. You get more attention and people seem to get in and out of the stock more easily. Those are also big factors for us.

Say we go the other way. In most sectors, the bigger you are, the lower your dividend yields. In our case, we're not there. So the yield is what's surprising to me. It's not given the credit volumes, the recurring nature of the cash flow stream, what are we doing here?

But, anyway --

Well, I guess for my own vantage point, you know, the investment returns that you are able to deliver are very attractive. They are compelling. We'd like to see you get bigger not smaller. I know that buyback always seems like -- you know, it's a good way to support the stock, but I don't prefer that you get smaller. I'd like you to get bigger.

You're right. I mean, that's just -- you go to debt (inaudible) levering enterprise by that stock or capacity.

Thanks, everyone. We hope if you have any questions, you'll call all of our people and we welcome any and all of your questions. Thanks a lot, have a great day.

This concludes today's conference call. Thank you for your participation. You may now disconnect.