Starwood Property Trust Inc (STWD) 2015 Q4 法說會逐字稿

Good day, and welcome to the Starwood Property Trust Fourth Quarter and Full-Year 2015 earnings conference call. Today's conference is being recorded. At this time, I would like to turn the call over to Mr. Zach 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 its financial results for the quarter ended December 31, 2015, filed its 10-K with the Securities and Exchange Commission, and posted its earnings 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, 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 statement 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 in this conference call. Our presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. 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, the Company's CFO, Jeff DiModica, the Company's President, and Andrew Sossen, the Company's COO. With that, I'm now going to turn the call over to Rina.

Thank you Zach, and good morning everyone. I will start by walking you through our overall 2015 performance, then move to our fourth quarter results and conclude with our outlook for 2016. 2015 proved to be a great year for us, again demonstrating the strength of our multi-cylinder platform. We saw continued strong performance from the various components of our business and we lengthened the duration of our book by adding $842 million of stabilized real estate assets, 43% of which were multi-family.

Core earnings came in at the high-end of our previously announced range at $2.19 per share for the year and $0.55 for the quarter. We believe that our diversified model is one of our greatest strengths, especially in a period of market turbulence. The effectiveness of that model can be seen in our annualized return on equity, which stood at 12.8% this quarter. We were able to maintain this ROE even after considering our conservative approach to leverage. Our debt to equity ratio was just 1.3 times at December 31. If we were to include off-balance sheet leverage in the form of A note sold, our debt-to-equity ratio would be only 2.4 times. Excluding cash, these ratios would be 1.2 times and 2.3 times. We believe these levels are extremely conservative when compared to others in our sector and when compared to the LTV of our loan portfolio. They are even more conservative than the numbers alone would suggest when you consider the non-recourse nature of our structural off-balance sheet leverage.

As of December 31, book value per share stood at $17.29. This amount reflects depreciation and amortization associated with our new property segments. As a result, we introduced a new metric this quarter for undepreciated book value per share, which was $17.37. The majority of the $0.09 decline and undepreciated book value per share from last quarter is mainly due to unrealized non-credit related marks on our securities portfolio, which I will discuss later. I will begin the discussion of our fourth quarter results with our lending segment.

During the quarter, the segment contributed core earnings of $103.9 million or $0.43 per share. We originated or acquired investments of $678 million, of which we funded $569 million. We also funded an additional $147 million under pre-existing loan commitments. These amounts were funded with recycled cash from the lending segment's investment portfolio, which returned $643 million of capital during the quarter. The portfolio continues to be diversified by both geography and product types. Over time, we have reduced our hotel exposure to its current 25% from a peak of 45%.

Our average LTV remains modest at just under 63%. I will now turn to our Investing and Servicing segment, which reported core earnings of $62.3 million or $0.26 per share during the quarter. Beginning with our conduit, Starwood Mortgage Capital continued its remarkably high turnover rate with a record six conduit securitizations completed in the quarter, for net core securitization profit of $12.3 million. For the full year, we completed a record 18 securitizations, hoping to limit our exposure to some of the market volatility we have seen in this space. Our focus on credit quality has also allowed us to avoid the level of kick out that our peers have been experiencing, as BP fires kick out nearly a quarter of conduit loans.

Our loan inventory at December 31 has already been securitized except for $116 million loan, which is designated to enable securitization. While our conduit is not immune to current market volatility, our frequent turnover and high credit quality have limited the pressure we have seen on securitization process.

Moving on to our servicer, our dominant position in this market continues. As of December 31, we remained special servicer on 159 trusts with a collateral balance of approximately $112 billion and they were actively servicing $10.8 billion of loans and REO. We expect this balance to decline in the early part of 2016, as assets were liquidated and then increase later in the year when we expect to see the majority of maturity defaults from the 2006 vintage and to our special servicing.

While our legacy pre-2008 portfolio begins to roll off in the coming years, we are gaining new assignments and new issued deals that should position us well for the future. During the fourth quarter, we gained four servicing assignments with a total of 12 assignments secured in 2015.

On the CMBS' front, we acquired $116 million of BP's investments this quarter. Because we left the fair value auction under GAAP for our CMBS portfolio, our GAAP results reflect an unrealized negative spread mark of $13 million in the quarter. This mark is unrelated to credit. Our BP portfolios are no credit deterioration during the quarter and our intent continues to be to hold these investments to maturity. You also notice that we've recognized a tax benefit in this segment this quarter. The benefit resulted from us finalizing calculations associated with certain agreements entered into by our TRS earlier this year. Our role as special servicer and as controlling class representative in certain of our CMBS investments have allowed us to add another cylinder to the segment, which we are referring to as the REO portfolio. These represent real estate assets that we acquired directly from CMBS trusts.

During the quarter we acquired $78 million of these assets, with $144 million acquired during the year. Now, I'll turn to our property segment, which contributed quarterly core earnings of $9.3 million or $0.04 per share. We closed on 18 of our previously announced multi-family affordable housing communities this quarter and have re-branded them under the name Woodstar. During the quarter, we deployed $93 million of equity towards these purchases and expect to deploy another $94 million of equity for the remaining 14 assets in the first quarter. These assets are expected to return levered cash yields in the low double digits.

Moving to a discussion about our capitalization. We spoke last quarter about our membership into the Federal Home Loan Bank. Due to restrictions imposed on REIT members last month, we no longer expect to utilize this facility. Our outstanding balance at the end of the year was only $9.3 million and we've had no subsequent borrowing on this line.

We continue to have ample access to capital for a variety of financing facility and we will continue to use them prudently in this period of market volatility. During the quarter we obtained a new $1 billion repurchase facility that carries an initial three-year term at an interest rate of LIBOR plus 2.5%, bringing our total capacity to $8.3 billion. And finally, I'll add just a few brief comments about our 2016 outlook. Given our current investment capacity and our expected loan repayments in 2016, it is unlikely that we will need to raise equity this year to execute on our core business strategy. We will remain patient in our capital deployment and as we search for only the safest and most opportunistic risk adjusted return.

Looking to 2016 earnings, there are a few things to keep in mind. First, we do not expect to see the increase in our servicing book until later this year, when the initial wave from the wall of maturities is expected to enter special servicing. Second, we expect a slightly lower contribution from our conduit early in the year until loan spreads catch up to CMBS spreads, which we expect will happen in the second quarter. And third, as we take a very careful approach to investing during this period of market volatility, our visibility into the timing of capital deployment in 2016 is somewhat limited.

Inclusive of these factors, we expect to earn and continue to pay $0.48 quarterly dividend. To that end, we have declared $0.48 dividend for the first quarter of 2016, which will be paid on April 15 to shareholders of record on March 31. This represents a 10.8% annualized dividend yield on yesterday's closing share price of $17.75. With that, I'll turn the call over to Jeff for his comments.

Thanks Rina. Rina spoke about liquidity and I would add that we are purposely holding more cash today than we have it any time since our IPO. We also expect considerable repayment that will add to our available capital this year and we're excited about the opportunity to reinvest in the current environment, though we've been patient in deploying capital over the last three months and we will continue to be. As a borrower, lender, and active participant in financing and capital markets, (inaudible) from which the sea storm (inaudible). We pulled back last summer as volatility increased and as we watch the growing distrust in the commodity, credit and capital markets in the fall, we made the decision would have better opportunities to deploy capital and they're starting to see them now.

We've seen them in loans, in equity, and in securities, but we will remain patient as global financial correlations and volatility remain elevated. CMBS issuance will likely fall again this year. 2015 saw $92 billion in CMBS originations versus an expectation of $110 billion inflated in the third quarter, and this year's similar expectations have already been lowered by 30%, its spreads have widened, which will likely create more investment opportunities and eventually scarcities should be good for spreads.

In the short-run, our conduit originations business would be less profitable, but we expect to recover as markets stabilize, which we are now seeing signs of and making even more spreads (inaudible) lower again. Today, CMBS is nothing like what was issued prior to crisis, and we expect going forward to get more yield for a less risky bigger slice of the capital structure. We are (inaudible) from new risk retention rule of kicking in and believe we are very well situated to take advantage of them and expect higher risk adjusted returns for our capital going forward.

With our 63% LTV loan book in very good shape in the wall of CMBS maturities directly in front of us any further distress in the financing markets will be both an opportunity for us to invest and will drive more loans into our special servicing book into the [fall] creating significant feed for us. We're named special service around $112 billion of CMBS and are nearly one-third of the 2006-2007 worst in class vintages that we'll need to refinance in the coming two years.

On the financing side, borrowing rates are just beginning to creep higher and we are more than able to pass that through to our borrowers that don't expect unlevered IRRs to be adversely impacted. The credit quality of our book is the best it's been since I've been here and our loan book today can withstand a significant credit deterioration. We have a high degree of confidence in the loan maturities, we expect to be coming this year, many IRR assets that are performed above plan and have the opportunity to refinance into lower yield and distress in the markets will give us the opportunity to reinvest that capital accretively.

Finally, (inaudible) gave us another interesting opportunity this month and we were able to hire Dennis Schuh from JPMorgan to run originations. Dennis spent 19 years at JP, nine of them running originations and we're excited to have him on Board and look forward to growing the size and quality of the loan book even more.

We also hired Michael Cowen to run our San Francisco originations effort and we'll continue to add to our originations that globally to be ready to invest into what looks to be a great environment for us. As the largest commercial mortgage REIT, our assets will continue to roll over, giving us ample firepower to invest into markets that will continue to provide opportunities to business built on scale and relationships like ours. With that I will turn it over to Barry.

Good morning, everyone. I'm actually remote, I am not in the same location as Jeff and Rina, and Andrews. So when we get questions, I'm going to pass them to those guys. Rina and Jeff's comments are pretty thorough, but I think I will take a step up backwards and tell you about the environment and how we've been thinking about things. The first thing you do in an environment like this when credit spreads start to back up probably late early fall is make sure your house in order. So, we sat together as a group, went through every loan in our $6.3 billion or $6.4 billion loan book and as Jeff said it, it's actually rock solid. We are virtually, I think, the credit quality has been the lowest loans in our highest category that we've ever had and as Rina mentioned, our exposure to more vulnerable sectors of the economy outside hotels has never been really lower than this, slightly lower, but it is 25%, which is we think terrific. And obviously there is a massive hedge in our company, which is a further deterioration if things do go awry or get worse from here. We never thought we'd be able to say this, but our servicer should have a field day with its $112 billion name servicing, of which 10 and some changes is in-servicing already. So, I actually love this environment, fantastic for the largest player in this space, which is us, the two times the size of anyone else. We've looked at our loan repayments, because mortgage REIT gets it sometimes in trouble and loans do not get repaid.

And to give you one example, we have a loan on the tower in London. I think our loan is like 400 over something like that. First mortgage, and that's been refinanced by European bank at 1.25 over as we speak. The mortgages are deep and they're liquid and banks were looking for solid loans to make. So, it continues to astonish me that a portfolio of loans with a 63% LTV, which is really probably 50% to 55% would be investment grade, trades at 10.5% dividend yield. So, I think obviously we've been whipsawed by ETFs and inclusion with the Resi REITs and their issues, but we don't look like that. We've reviewed all of our maturities, making sure we had no mismatches, we've gone through all of our CMBS holdings, I've got them updated and the board's men update on everything we own. And we feel really good about what we own going into what it should be, a really fun time for us and this is the fifth time in the 5 years we've been operating that the markets have backed up, this time feels worse, feels worse probably because of long-term changes to the credit markets, coming from changes in risk retention rules and other capital rates that are being forced on things. That actually all is good for us. All that stuff creates better opportunities for us to deploy capital at higher spreads and we think there'll be more competitions in the long run as the storm passes through the capital markets for the investment grade securities as much as you saw in Europe earlier in the cycle or in the last cycle. But the non-rated stock, where you need equity of expertise in order to take those risks, exactly the kind of stuff we were built to take advantage of. So, we think it's a really interesting time for us and we hope 43 conduits go out of business and there's only one left. Larry runs a great business and then we've had a rough first quarter which is obvious. We are not going to try to double it up and make it back, we're going to be measured and steady, we're about consistency I hope and stability of our earnings stream. So, we're pretty excited about the opportunities, the disruptions that create for a company that's going to have more than a couple of billion dollars to invest over the next 18 months from existing facilities and repayments of loans that we are expecting, things like our first mortgage on South Tower of Hudson Yards, which we know will be repaid one second after it becomes pre-payable in mid-summer, and that's a large (inaudible) cash for us. So the bad news is we have to deploy that cash and the hard news is or the difficult thing is, how fast do you deploy that cash, because you think there will be better opportunities tomorrow than there are today. As people come to realize that the old financing market may be not back for a short period of time. I don't expect actually that -- it looks to us like investors are asking for 3% or 4% yields, so when base rates went down, spreads widened to give the buyer the same yield that he wanted.

So, we don't know when the AAA has now gone from 87 to 165, or 180 in some cases. When does it go back to 85, you remember it was 27 basis points before the financial crisis. And real estate is in much better shape than the other asset classes. And we do believe that what's happened in the CMBS complex is more of a result and what's happened in other areas of the financing roles, like high yield where spreads have got gapped out, investors are asking for more yield, so it's kind of pull the whole CMBS complex along with it. Though there hasn't been to date any deterioration in the fundamentals of real estate assets, you may have some cap rate changes although they will be minor. You haven't seen the fundamentals of the real estate asset classes, whether it's office, apartments, even retail hotels. As you know, we own 85,000 apartments. We owned more than 1,000 hotels, 30 malls, maybe pretty good view what's going on in the world and while slowing, certainly not going negative.

And so, we're very comfortable that these will hold up barring complete collapse of the financial system in which case, don't worry about us. Anyway, I want to thank our team for navigating this really choppy waters, and we're always looking to improve our team. I'm really excited about the team we have today, built to take advantage of the opportunities we have in front of us. I think the world of changing (inaudible) for banks is good for us. We're very focused on and given our scale, what we can do, which might be a catalyst for our stock, obviously we are depressed, where our stock is trading, like every good CEO, I have to be depressed.

But I'm really excited about our scale, the quality of our book and our LTVs being so modest and they've anything crabbed up and I was questioning them and I looked at them, and they're actually what they are. And we continue to look for interesting things to do unlocking the value of the enterprise, and take advantage of the marketplace today because I think it is actually a lot more fun for us to invest in these kinds of markets than it was probably in the market of the summer. So with that, I'll stop and take comments, questions, and I'll direct traffic apparently.

(Operator instructions). Dan Altscher, FBR.

I don't want to put words in anyone's mouth, but I think the tone has been maybe what we're seeing out there in CMBS, certainly driven by some regulatory items for broader commercial real estate. I mean there seems to be more of a stay on pricing exercise than really a greater fundamental exercise. I mean, I think you probably would agree with that, right?

Yes. I totally agree with that. I think there's plenty of liquidity. I think it's Jamie Dimon recently at a conference (inaudible) today and if the banks have about $7.5 trillion of deposits prior to the crisis they had, I'm sorry of loans, and they had about $7 trillion of loans in the peak of the financial crisis and then they had deposited $7 trillion, today they have deposits of $10 trillion. So, there's tons of capacities to lend between regulatory changes and restrictions and scaredy tactics I mean, things that they have to do, and there is everyone you deal, whether it's an insurance company or sovereign wealth fund, I mean people are desperate for yield, people right now are like they don't really know what's going on, so let me take a step back. And that's creating -- and the markets were liquid(inaudible) because the banks are making markets and securities where they used to experience this kind of funny environment and nobody likes losing money, margins are always been thin, the conduits which you are saying -- okay I've made a loan at 375 over, it's now 475 over. And we saw that starting to happen probably six months ago, I mean, in parts of the market, spreads started to widen because of the widening in the credit compass, which actually didn't start in the real estate space. It really started in the high yield and as the energy complex began to implode and money just left the stack, I think, to go to higher yielding opportunities in other places where they look like there might be distress. So, I think it's a pause, I think you are in a little bit of a passing storm and I think on the other side, as I said four months ago at our Equity Conference, when the rates are lower longer, I mean, there is a global slowdown and it's really good for property. People don't understand it, it doesn't induce new supply and rates staying low, it's really good, because real estate is the source of yield. I mean, we just want to be careful. We are not cowboys. Things we don't do, we don't buy insecurities and lever them nine to one, right. We looked at it. We can get 14% to 18% yields in (inaudible) but the wall will be nightmares and we just don't do that, I mean other companies have done that. We are trying to stretch our durations, which is our move into the equity space. I mentioned or Rina mentioned the multifamily deal we did, the Wilson Portfolio, double-digit out of the box cash yield, stable, very affordable housing, great stuff in terms of quality; we really wanted that deal because it gives us a double-digit growing yield we think for the foreseeable future like, I think (inaudible) 18 years Rina, like 17 years or 18 years. Are you there Rina? It's down on the Wilson Portfolio, actually know it was 18 years. How long?

18 years.

So, we have debt in place for 18 years [on multi -- ex] portfolio. So we're hopefully built withstand and weather the cycles and having a ton of cash available to you is a good thing in times like this and unfortunately [cash hasn't earned much].

So with that in mind, I think I want to understand the reason to be cautious and may be conservative on the capital plan, but what needs to maybe change to reverse that course of it -- further pricing exercise, is that actually seeing better quality loans, actually seeing better quality sponsors, better LTVs, better terms. What gets you kind of out of that (multiple speakers) and be proactive to do that?

We're open for business right now. We've just committed to more loans. We're not making loans, we're just being pickier and we are adding spread. We are adjusting our loan pricing to the reality of the marketplace whether it's an A note buyer or credit facilities, we're going to -- even though our credit facilities don't move in terms of their spreads. We have -- even us, even though the biggest in terms of capacity, we don't have infinite capacity. So, we want to make sure that we're earning high spreads on what we do and that we really like what we're doing, but we are continuing to trend towards safety. I mean we're trying to find things that we look at and we feel really good about the real estate that's fundamentally good real estate in our attachment points, we will be delighted to own the property.

Now, we've got the equity, we kind of joke in-house that the [walls] will get the asset back at a great price, which is something never happened to us in $20 billion of loans, but you know we do look fundamentally at the real estate. These are the credit committee of the REIT, includes a lot of guys from a certain capital group and we are one of the largest most active players in the space. So, we are very, very cautious and there's things we're avoiding junior notes in hotels tax, you can get them at 900 over today, 1,000 over, we are going to stay away, especially -- and other people take them and I work out, but it may not and we're just going to try to be very cautious about the risk we are taking in this environment. I do think being that way and given the scale, given the other lenders backing out of the market that we're going to have great opportunities both on [Larry's] side, where 100% confident is team's ability to re-price and still get their volumes up and hit their numbers. That isn't the issue. This is a better environment for us today because even our BPs, the whole market for -- no it's totally restructured with people I guess being able to basically private label the BPs picking and choosing collateral that we like based on all the data we have in the LNR book, which is hundreds of thousands of loans probably over history.

We can create tailor-made BPs at yields we haven't seen -- 700 basis points wide of where they were 6 months ago. So, we have to modulate our capital into the various channels to maximize overall return to the shareholders and minimize risk and there are no free lunches. So, it's easy to lever up, we could go four to one, other people have done that, we haven't done that. You heard from Rina and our leveraged staff in the early part of our earnings call -- 1.3 times, and look through to do something, Q3, Q4; Q3 I think was without cash, I mean that's materially lower than our largest competitor. So, we are running a conservative book and we're trying to at least and doing the best we can to maintain and support and grow the company.

Steven DeLaney, JMP Securities.

Good morning everyone and thank you for taking the question. Barry you just commented on the BPs blowing out 700 basis points wider. When we looked at your release, maybe the most impressive number to me was the fact that your book value held up so well, just the GAAP bigger than $0.14 or less than 1%. I think frankly the street is looking at everybody that has CMBS, whether it's senior stuff that you have in your core portfolio or the subordinate bonds in the Investing and Servicing segment. I just was wondering -- Rina, this is for you or Barry, could talk a little bit about, I'm looking at page 10 of your slide deck and your carry value on your CMBS in the Investing and Servicing portfolio is right at $1 billion and it represents about 22% in the face.

How do we think about that and your methodology because you are using a fair value option. Just talk to us a little bit about exactly how you're applying fair value and whether it's actually, mark-to-market or mark-to-model just so we can kind of understand why -- I guess the question is why did this hold up so well for you relative to the third quarter when we've seen what's going on in the market. Sorry for the long question.

Rina, do you want to answer that.

Yes. We've hired fair value options (inaudible) entire portfolio that includes our 1.0 stand or 2.0, the BBs that we have are more susceptible, the spread marks that you're seeing are really on our BB book. The other bonds that we have are -- they're mark to model. So, in all cases we look at expected cash flows, but our discount rate is more sensitive to spread marks on the BB.

This is Jeff. I would add that I don't think anything that's happened in spreads in the last couple of months. And I do believe it's mostly technical. I don't believe any of it has anything to do with the likelihood of loan made in 2014 or 2015, paying off in 2024 or 2025. From a credit perspective, we feel the same about those loans as we did and we're not going to move around the pricing on those dramatically, although we will be cognizant of the market being weaker.

That's very helpful, Jeff, and obviously you even have these things on the VIEs, you have some of them consolidated. So in effect, you've got the loans on your balance sheet, you've got the debt on your balance sheet. And at the end of the day, it really is the performance of the loans that drives you return on your net equity. So that's very helpful to know that your book values are going to be more stable relative to support in investments in that you are going to look at fundamentals and mark to model, and not just have to [slap off] a lousy price, because that's where the market says last printed a deal at the end of a quarter. So, thank you all of you for the comments. That's very helpful.

Yes. I have one thing, it's interesting because we have such enormous data on certainly the legacy CMBS securities that, it is a -- you scratch your head about the amount of capital you want to deploy, when you understand and know so much about the stock, you might even own a tranche of bonds in the stock today. Some of these -- if you like -- really interesting opportunities. So, we are nibbling here and there on buying stuff. When we know it's money-good and is trading, it's stupid -- it's kind of like as you know and as you've seen, I mean, the percentage of loans going to default in commercial real estate, I think is at historical lows. I mean, I think (inaudible) practically.

Right, 2%.

Yes. I think it's really an odd thing and we are so bullish on anything for rent in the residential space, whether it's houses, single family of residential platform, has 30,000 houses or apartments, we're now the fourth largest owner or fifth largest in the country. And we see -- and then we've been a homebuilder and we're involved with such as board meeting in that right now. So, it's a good opportunity. Even the retail, which is probably the most controversial, almost media-hyped, this actually you're seeing pretty record occupancies in malls. So, I mean you don't need if you're a lender for cash flows to go up 4%, 5% a year, you just need stability and ability to repay, right, so anyway.

Doug Harter, Credit Suisse.

Can you talk about the relative attractiveness you're seeing today across the different investment opportunities, whether its property loans, BPs?

Everything is good. Our core business is lending. And we had a choice between earning a 15 and/or 16 in BPs or 16 in loan. We'll probably do the loan to 13 versus the 15 BPs. Even though the BPs is wider than it was, and even though you were able to select you collateral, we'll do them, in fact, we just talked about doing one. But we're going to balance that and probably it's three to one in terms of ratio of how I like to see capital deployed. But we want to be quintessentially opportunistic and we see great opportunities, we're going to go after them. So, they may not even be in what we're exactly doing today. So, we've looked at a new program that we're working on. I won't tell you about, but it's a new business that looks super exciting in the joint venture. And we think we can produce, we actually can produce what we think we can produce, then we'll pour our money on that, you'll find it very interesting. So, but we've got to keep our eyes open in this kind of landscape and make sure that we're comfortable with what we are doing, we have a very good collegial group of executives that I think are more than ever before are passing information amongst them and sharing knowledge and data to actually make better investment decisions. I personally have spent a lot of time in LNR offices in Miami in the last two months and nice type of weather to do that, but it's been interesting to see the cross-pollination between the lending side and the heritage, LNR side and Larry Brown's really significant mortgage company. And that the feedback we get from our banking syndicate such as that with heads of one of the lending groups this week had dinner with them. So, we are keeping our eyes open and again, it's not easy by the way, I mean it's not like people are throwing 11, 12 yields at you in a world where the tenure is 175 so, but we think we can find attractive things to do.

And then can you talk about the balance of the spread widening versus lower kind of absolute yields on how that might impact kind of especially servicing refinances that need to happen in the next two years.

Yes, we still expect a vast majority of legacy CMBS to refi. The (inaudible) that were being quoted by life companies even have gapped out probably 100 basis points, but there is still way inside what we create when we make a whole lot of them, so often a note. So, likely maybe 11, 11.4, there may be 8, instead of 7 or 8.5 instead of 7.5, so the same has been true for the last several years that we originated and we're going to get a lot juicier piece of paper than we buy it off the street or we buy a mezzanine from a Bank -- that's trying to (inaudible) classes of securitization they got stuck with.

So, Jeff, you want to talk about the other question about spread widening versus base rate. Rina, has anyone in (inaudible) have a point to add to that.

Well, I will add on a macro level first, we are seeing loans come out of banks, the SASB market -- single-asset single-borrower market has certainly widened with CMBS, in a lot of banks who had loans on that expected to bring them out in large floating rate or fixed rate securitization that are now potentially selling those, and we are seeing discounted loans come out of there as another opportunity for investment.

On the lending side, we're also seeing borrowers willing to pay for certainty and certainly a lot of deals in the market in the last couple of weeks as people would like to get something done. And, it feels like there are less lenders to compete with them. So on that side, I think we feel good. Could you sort of restate, we all looked at each other here, none of us were exactly sure on the spread question when you asked, could you restate exactly what you meant by that question.

You guys have talked about, the inputs -- if rates rise, that could impact the amount of people, the amount of loans that ultimately could be refinanced of the coming maturities out of CMBS and just wondering sort of the give and take between spread widening and lower base rates.

Got it -- he best example I can give you here is we are placed out in AAA CMBS and I'll get your answer. You've seen AAA CMBS spreads go from $85 last year to $120 at the beginning of this year to $165 or something today, maybe $160 today is more likely the right number, for 40 years still wider, but at the same time you've seen 10 years swap rate go from $220 on January 1 probably $160 today, so rates have rallied by 60 basis points, spreads have widened by 40 basis points. The net of it is (inaudible) CMBS AAA rate, it's actually 20 basis points lower, even though it had its blowouts, everyone talks about it and has spread widening the reality of yields are actually lower, you've yield buyers in the CMBS market who are willing to take those security for 20 basis points less, when I think about the rate impact on the focus, we talked it will be before we have an $0.08 question for 100 basis point increase in LIBOR, i.e., we make $0.08 more. So, what's going to drive more loans in the special servicing is higher rates and it is wider spread, because refinancing will be harder. On a higher rate side, I think it's fairly clear we were able to lay out exactly what that is. The harder part is what the spread widening will do. Certainly with the amount of high yield loans and others coming up from the 2006, 2007 vintages, these wider spreads that we are seeing in CMBS loan spreads, which are 100 basis points or so wider from three or four months ago is going to push more loans in special servicing.

We don't really advertise any number, we sort of look at debt yields and try to figure out what we think the percentage of loans of the 30% of 2006 or 2007 that are rolling off that we are special service run. We try to think on a loan-by-loan debt yield basis, what's going to happen, but certainly spread widening will push more in, higher rate will push more in, we're not counting on higher rates, but the spread widening side is going to help us there and again, that's one of the hedges to a spread widening in our book overall.

I'll just add one quick comment to that. You know what Jeff (inaudible) swap rates in the treasuries, it gets worse as you get further out on the LTV right, as you get the junior classes and there I think you're seeing overall -- the yields gone up. But there's an interesting market because there isn't a level of leverage today in real estate that there was back in 2007 or 2008. Nobody really borrowed 85% of anything or 90% of anything. The nature of most buyers today is actually to push the leverage down, so that's not totally true in the conduit market, but it's certainly true of the big assets. So, real estate is not the problem child of the economy here. In fact, we probably the rock solid best place to put capital for stability in the world right now, because there's not a lot of new supply anywhere and values in real estate look solid given where the alternatives are and where treasuries are and where the spreads to the cost of debt between unmet yields and cost of capital. So, it looks like a very comfortable place to be and we trade it (inaudible) with the yield. So, I can't' find -- I find a hedge (inaudible) 10.5, I'd go over and hug the guy, our whole company is earning 10.5, so there is no 80/20 split here. So not like that. Anyway zero, that's my comment, I'm going to stop talking.

Jade Rahmani, KBW.

Thank you. What drove the higher incentive fee in the quarter? At this earnings level, is that a run rate or did something unusual happen, because it was placed what we modeled despite earnings being close to what we projected?

Jade, that has to do with the adjustment that we made in the fourth quarter of last year, if you recall. We adjusted the calculation of the incentive fee, so account for the place went off. And because that calculation runs off of the rolling fourth quarter, the large payment that we made in the fourth quarter of last year rolled off in fourth quarter of this year. So, we will continue to have this issue for the fourth quarter and that being a catch-up, because you're dropping off a quarter that has a high payment in it.

Okay. I will ask the follow-up with you afterwards to really understand that. On credit, can you comment on the overall credit quality in the portfolio and if there is any deterioration you've seen over the last quarter or then year-to-date and any loans that you moving into a watch list, or increasing your risk ratings on?

We actually didn't increase risk ratings on any loans this quarter. We spent nine hours of full day with our entire management team at about 30 people on the run going over every asset, we did that about 2.5 weeks ago. And we did not increase risk rating on any assets and we had a few decreases and don't really see anything that I think somebody on the, I'd say, looking in what thing was troubling at all. I don't know Barry if you have different comments, you certainly (inaudible) as well.

Yes. But no, as I said in my comments, we went through everything we have (inaudible) all the hatches were battened into the storm and we went through the loan book. And we have a loan on an apartment building, a construction loan on an apartment building in New York (inaudible) $1,000 a foot. So there is an example of something, maybe it's $1,100 a foot. They are trying to sell the units for probably, I don't know $2300, $2400, $2500 a foot, $1,100 a foot, I don't know if I'm happy or sad if I get the building back. So, we're fine, we actually talked about selling all of them, I only said why, I will just keep it. But it's actually, it's not even the loans in balance, not like out of balance, (inaudible) selling a little bit slowly get its permits and get his building built. But our construction exposure is dropping rapidly. And things like Hudson Yards where I think we're in it $400, $500 a foot or something on a first mortgage and building (inaudible) $1,200, $1,300 $1,400, and $1,500 a foot, 30% LTV, (inaudible) construction loan (inaudible) I don't know what it is, but it's not really a construction loan. So, we haven't really made any construction loans in year and a half.

And I guess the other thing to point out, say one of the loans actually that we had rated 4 at the end of the year paid off in fall, just a week or two ago.

Okay. That's good to hear. Regarding the cash flows coming in, can you just address the timing of anticipated 2016 repayments, the magnitude and timing? And also the unfunded commitments are significant, so over what time period do you expect to make those? And finally, how are you actually thinking at this stage about the 2017 converts?

Yes. I'll start on the payoffs. I think we expect over $2 billion in loans to repay this year, that's our conservative estimate, because (inaudible) percentage chance on each loan and then kind of come up with some of profit across the curve and we think it will be north of $2 billion, which will return a little north of $1 billion equity this year. And as Barry said, most of those are ones where we have great insight into, it's (inaudible) question whether they'll pay off at or around the open date when they can pay off without these -- as for the converts, Barry would you like to (inaudible).

Well, I mean, they are due next fall, I guess year-over-year-and-a-half away. And is that right, Rina?

Yes. October 2017.

I'm just double checking on the other side here. We were aware of that, we are looking at other ideas now that could extend and potentially extend and replace them or will just save cash to redeem, I guess, we can redeem them in stock if we wanted to. So, it is a year and a half away, but we're paying attention. I think we are working on something right now that might allow us to get rid of them.

We've bought back $110 million or so to date, and when the opportunity is there and that looks like the cheapest investment for us effectively, we could spend cash there.

That's a good point by the way. We did buy $110 million in the back, again which caused stock repurchase.

Charles Nabin, Wells Fargo.

When we think about the gap in capital that needs to be filled as a result of Dodd-Frank risk retention. It's obviously an opportunity that Starwood is well positioned to capitalize on, but we're also hearing about capital pursuing that capital forming to pursue that opportunity, there's a possibility of banks holding on to that bottom piece as well. So, I was wondering if you could comment on your expectations or I guess the filling of that gap and how you see that competitive dynamic playing out over next couple of years?

I'll start, if you want. We have our entire LNR team in our senior management from LNR up in New York this week seeing banks and we talked about nothing, but that topic, I do think there is a chance that the banks could be involved when we sit and talk to them, none of them are telling us firsthand their intention. You see a number of third parties who are out talking about solutions where they will effectively take the loans under the book and securitized off their own shelves. We think that may be difficult, and people may have a hard time with the fact that a loan that was on (inaudible) book yesterday, we're putting it on your book just so you can securitize. We don't know if that model works, but we are out talking to the banks, we think we have a structure or two that works better and will lessen the blow to the overall CMBS market.

We have the advantage of being a sponsor in transaction by virtue of what Larry Brown does at Mortgage Capital and by being a sponsor, the potential that we can go beyond that -- I won't get into great detail, but become a retaining sponsor and be somebody who is working with the bank to bring the deals and will effectively lower the cost of capital and allow us to bring in third-party partner money alongside of us which is similar to what we've done in our BPs program over the last 3 years. We brought in partners and but if the minority of the capital to get a majority or 100% of the servicing fees, we'll look to do something similar to that and we're out talking to people, and we expect that with our brand and our expertise and long history in effect through that if anyone is going to be successful there, it should be up, so we're spending a lot of time on it and certainly know it advantages us.

I would just say, we are 300 people, so we're well positioned and we're aware of what should be an interesting opportunity for us and we're excited about it. I mean, it's like wow, and then there's transformation depending on how banks react to this and there are other areas that are completely going to be fascinating. It's really good for real estate by the way. It's really hard to get a construction loan going forward in some capacity. Because the regular parameters are so difficult for banks and if that is the banks and the banks aren't even going crazy, they are really not, maybe the conduits got a little sloppy in here, some of them, not all of them. And the market is differentiating frankly between the papers, the different conduit sponsors. So, it's just, in a way it's a better market, it's a little more disciplined than it was. But I think we really think the net of this is got to be a positive for us. All of this, the only thing I know is direction is good. And it's good for guys like us, unregulated lenders that can fill holes in the capital stacks.

Barry, Adam is actually also remote. Adam Behlman who's in New York, live from New York on this tour that I just talked about, Adam do you have anything to add?

Adam, tell them what you do.

So, I'm the President of the Real Estate Investing and Servicing segment, which effectively is the old LNR. So Jeff was right, we're up here in New York talking to all the banks that work with Larry on the [SFC] side, which is six of them which is why he gets to do 18 yields a year. And Jeff, first to your point about the bank retaining a portion of it, that may be true and some banks may try to go down that road. But even if that's the case, they still wouldn't be retaining most definitely not the horizontal or the old BPs on the bottom. So that market wouldn't go away from any of those kind of moves. In addition, just right we've been talking to everybody so far, and we have been putting to them kind of our ideas on, an alternative structure that could be used and it gets receiving very positive feedback and is kind of definitely I think change a bit of the discourse going forward here that there may be other opportunities or options that they can use some more liberal, some more conservative, but certainly different than I think they had in their minds beforehand.

And we'll come back to you over the next couple of quarters, when we are able to be a little bit more open about where we are. But we're certainly working hard on that.

Eric Beardsley, Goldman Sachs.

Just want to clarify spreads have widened out, you feel good about the environment, why now lend into this, why wait for the storm to clear when margins will be lower?

No, we are lending into this. We're just being careful on the quality is what we're looking and I think borrowers are moving -- they're behind the markets, right. So your loan you thought it was 350, it's one in a quarter and goes somewhere else, right. So, and then he finds out there is no 350 bit. So, we are lending and we were actively lending. We would like to -- we are happy to put out all of our [attempts]. But we want to be careful because we are -- this is a balance sheet lender, we're going to not -- we're being judicious because certainly we are not that big a player in the capital markets. We're the biggest in our space, but we're not that big. We want to make sure that we're investing our money wisely in a world that looks a little soft. I mean, it looks like -- it's a little like quicksand right now (inaudible). We don't know -- partly because nobody knows what's going on in China. There isn't anyone. I think it's through the Chinese (inaudible) you understand what's happening to their economy. Nobody can tell up to 5% growth, or 5.5% or it's really all fiction. I mean, I think that kind of uncertainty and then you have the political uncertainty of our election. It's quite something out there and it just feels like trying to be prudent. So we're wide open for business. We're not -- we shouldn't have given you the idea that, but we're asking a lot for our paper. For our loans we're going to keep our spreads a little wider.

And I think the proof is that we just hired Dennis Schuh, a 19-year veteran of significant -- $15 billion book over at JPMorgan Bank. So, we wouldn't hire Dennis if we weren't going to put the pedal to the medal and grow our originations capability and continue to -- and we just hired another athlete out in San Francisco. So, we will use this opportunity to sweep up some really good originators and we don't head into the capital. So, we have to be careful.

Got it. So, relative to funding costs, where do you, I guess, where have the loan yields gone that they've fully kept up?

I think we reported basically flat at 11.

11.2, I think optimal yield, we're actually up slightly from last quarter, and it's driven mainly by increases in LIBOR (multiple speakers).

Okay. I guess, on the warehouse, where you guys have more fixed pricing if I were to look at someone who is relying on market funding?

Yes. I would say that, we are starting to see a little bit of pressure on the A note side, I mentioned that in my call, but we are certainly getting more than that on the whole loan side who are borrowers. I think we have a good window here, where we borrow hasn't really repriced or it's barely moving and where we're able to lend it is moving fairly significantly both into less competition and a more volatile universe where they just want certainty, they want to do a loan with somebody they know will get to table and closed and has the ability to underwrite a complex transaction. So, we think this will be a good period for us.

Got it. And then just really quickly, what percentage of the CMBS book is mark-to-model versus market prices?

I would say that that will be the probably two-thirds of the portfolio.

It's mark-to-market or wonder mark to model, we can get back to more exacting answer to this.

No. Actually Rina, it's two-thirds, it's (inaudible) 1.0 positions.

I don't think -- I didn't understand you.

I'm sorry, we were at 1.0 and 2.0 positions. So, of the 2.0, the BBs are I think it's about $250 million.

1.0 for those who don't know it's the legacy CMBS pre-financial crisis, 2.0 is post (inaudible).

Okay and 1.0 is mark-to-model, sorry just want to clarify that.

Yes, 1.0 is the mark to model, and unfortunately 2.0 is (inaudible).

Okay perfect, thank you.

Thanks guys. Thank you for being with us today. Good luck (inaudible).

That does conclude today's conference. Thank you for your participation.