Starwood Property Trust Inc (STWD) 2017 Q3 法說會逐字稿

Good day, everyone, and welcome to the Starwood Property Trust Third Quarter 2017 Earnings Call. Today's conference is being recorded.

For opening remarks, I will now turn the conference over to Zach Tanenbaum, Director of Investor Relations. Zach, 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 September 30, 2017, filed its Form 10-Q 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 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 statements made today.

The company undertakes no duty to update any forward-looking statements that may be made during the course of this call. Additionally, certain non-GAAP financial measures will be discussed on this conference call. Our presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. Reconciliations of these non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP can be accessed through our filings with the SEC at www.sec.gov.

Joining me on the call today are Barry Sternlicht, the company's Chief Executive Officer; Rina Paniry, the company's Chief Financial Officer; Jeff DiModica, the company's President; Andrew Sossen, the company's Chief Operating Officer; and Adam Behlman, the President of our Real Estate Investing and Servicing Segment

With that, I'm now going to turn the call over to Rina.

Thank you, Zach, and good morning, everyone. This quarter, we reported core earnings of $171 million or $0.65 per share. This amount includes $35 million or $0.13 per share from the previously announced sale of a portion of our Ten-X investment, which I will discuss shortly. We delivered these results despite a slight drag on earnings from excess cash that we held to repay our October 2017 converts. We estimate that the impact was just over $0.02 in the quarter.

I will begin my discussion this morning with the results of our Lending Segment. During this quarter, this segment contributed core earnings of $112 million or $0.43 per share. On the commercial lending side of this segment, we originated $937 million of loans, with an 11.3% optimal IRR to spot LIBOR and a 65% LTV. We funded $1 billion, of which $787 million related to new loans and $187 million related to preexisting loan commitments.

Our commercial lending book ended the quarter at $6.8 billion, with an LTV of less than 63%. Repayments totaled $951 million for the quarter, in line with our expectations.

On the residential side of this segment, we acquired $128 million of non-agency loans this quarter, bringing our total portfolio to $419 million and our net equity to $169 million. The current portfolio has an average 62% LTV and unlevered yield of 5.9%.

Our loan book continues to be positively correlated to rising interest rates, with 93% of our commercial portfolio being floating rate. We estimate that a 100 basis point increase in LIBOR would add $0.08 of core earnings annually.

Next, I will discuss our Property Segment. On September 25, we added a new portfolio to this segment, bringing its total assets to $2.6 billion. The acquisition was part of a sale leaseback transaction, where we acquired $425 million of retail assets and $128 million of distribution centers from the recently merged Bass Pro-Cabela's entity. The properties were concurrently leased back to Bass Pro and Cabela's tenants under triple net master leases that carry 25-year terms and built-in rent escalations. The assets were levered with 10-year debt at a blended fixed rate of 4.37%.

Because the acquisition closed 5 days before quarter end, it had little impact on core earnings. Jeff and Barry will discuss this portfolio in more detail during their remarks.

Overall, the Property Segment contributed core earnings of $16 million or $0.06 per share. This is down $0.01 from last quarter, principally as a result of our 33% interest in a regional mall portfolio, for which we did not recognize core earnings in the quarter.

In our GAAP results, we recorded a $34 million unrealized loss related to this investment. This relates to a reduction in fair value recorded by the fund vehicle that holds the underlying property. Because the fund is an investment company under GAAP, the asset it holds must follow a mark-to-market accounting model versus the more traditional historical cost model that you typically see when accounting for properties held by REITs and other noninvestment companies.

As a result, market movements are reflected in the fund's P&L, and our GAAP earnings reflect our 33% share of that P&L. The markdown recorded by the fund was based on lender appraisals that assumed an as-is liquidation of the property. As with our other unrealized mark-to-market adjustment, the markdown was added back to core earnings.

Despite the markdown, these properties continue to generate positive NOI, are 91% occupied and have sales per square foot of $558. However, the free cash flow is expected to be utilized for CapEx and for principal amortization on their newly extended debt. We will not be recognizing core earnings related to this investment until operating distributions to the LCs are resumed.

Our GAAP investment, inclusive of the unrealized loss and $16 million of funded capital commitments this quarter, is now $110 million, which represents 1% of our total assets and 2% of our equity. The remainder of the assets in this segment, including our Dublin, Woodstar and medical office portfolios continue to perform very well, generating consistent returns with a blended aggregate cash-on-cash yield of 10.5% and a weighted average occupancy of 94%.

I will now turn to our Investing and Servicing Segment, which contributed core earnings of $94 million or $0.36 per share. The $0.09 increase from last quarter is primarily due to the sale of 88% of our investment in Ten-X. As you may recall, last quarter, we recorded a $26 million GAAP gain related to the warrants we hold in Ten-X. This quarter, we recorded a $28 million GAAP gain for the common stock portion of our investment. For core purposes, the entirety of the realized gain, which excludes a 12% equity interest that we retained in the acquiring entity, is reflected in the current quarter. The core gain totals $52 million and was offset by income taxes of $18 million.

We also capitalized on opportunities to harvest gains in our CMBS portfolio and in the properties that we acquire from CMBS Trust. During the quarter, we recognized net core gains of $8 million related to these assets. We also recognized a $14 million positive mark-to-market adjustment in our GAAP P&L related to our CMBS, principally as a result of tightening spreads on our BBs.

On the servicing front, we saw lower transfers in the servicing than we saw in each of the last 2 quarters. We also saw fewer resolution, which drove this quarter's decline in servicing fees. During the quarter, we obtained 2 new servicing assignments on deals totaling $2.1 billion of collateral, bringing our named servicer portfolio to 153 trusts with a balance of $69 billion.

And before leaving this segment, I will say a few words about our conduit, which continues to perform well. This quarter, we securitized $498 million of loans in 2 securitization transactions. We expect to see similar volumes in the fourth quarter.

I will conclude with a few brief comments about our recapitalization and fourth quarter dividend. We ended the quarter with $3.8 billion of undrawn debt capacity, a weighted average debt term of 54 months and a modest debt to undepreciated equity ratio of 1.6x. If we were to include off balance sheet leverage in the form of A-Notes sold, our debt to undepreciated equity ratio would be 2.2x or 2.1x, excluding cash.

As our property portfolio continues to become a larger part of our book, we believe that metrics based on undepreciated equity are more meaningful than depreciated GAAP equity, and will therefore present them to you on this basis going forward. Our historical debt-to-equity metric would not have changed using this new approach.

For the fourth quarter, we have declared a $0.48 dividend, which will be paid on January 15 to shareholders of record on December 29. This represents an 8.9% annualized dividend yield on yesterday's closing share price of $21.46.

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

Thanks, Rina. We've always ran this company with as much focus on the right side of our balance sheet as the left, and the capital markets continue to treat us well. We've increased our borrowing capacity significantly in 2017 and at lower rates. We have been able to offset loan spread tightening with cheaper secured and unsecured debt while maintaining on and off balance sheet leverage ratios significantly below our peer group.

The 5-year unsecured bonds we issued last December trade at 365 today at 3.65%, in line with where many investment-grade companies trade. Being able to issue unsecured debt inside where others in our space issued convertible bonds is a great advantage, and we will continue that rotation of our capital structure towards unsecured debt.

As Rina said, we recently paid off our October 2017 convertible bonds with cash. We expect to continue to term out our liabilities by issuing unsecured fixed-rate debt, which is very powerful and would allow us to both unencumber our higher-cost assets accretively and bid more competitively on a variety of new debt and equity investments.

Our Lending Segment had another strong quarter, and our lending book today at $6.8 billion is the largest it has been in our history, up 32% or $1.7 billion since the first quarter 2014. Rina mentioned we had significant loan payments in this quarter. 2014 was our highest volume originations year, and as those loans pay off, we expect elevated repayments to continue through the first quarter of 2018, giving us ample near-term dry powder to invest.

We are confident in our ability to recycle these assets accretively and expect to continue to do so at equal or higher return. We will continue to add origination staff to increase lending volumes and take advantage of the opportunity to recycle that capital fully and accretively as we did this quarter.

Q4 is shaping up to be our largest loan origination quarter in my 3-plus years here, with $700 million closed to date and an optimal IRR above 12%. While base lending spreads have undoubtedly tightened, we have maintained discipline in our lending book. Our loan book today is 82% first mortgages and 42% office, which is up 36% versus 12 months ago.

No MSA in our lending book is over 15%, and less than 1% of our loan book is over 80% LTV, which we believe is more important than the 62.8% LTV of our portfolio overall.

Construction lending continues to offer an outsized opportunity for our expertise, our scale and our capital. We made one construction loan in the quarter for $72 million. We are extremely discriminating in every loan we make, writing less than 5% of the loans we look at and more so in construction loans. So despite the opportunity created by HVCRE and the pull back of the traditional lenders, our funded balance of construction loans today as a percentage of our entire loan portfolio is the lowest it's been since we started the strategy 4 years ago. This provides us ample room to grow that book as opportunities present themselves in the coming months and quarters.

Switching gears to our residential lending platform. We expect our balance in non-agency loans to be over $500 million by year-end. We plan to securitize the majority of these loans in Q1 of 2018. Fortunately, non-agency securitization spreads continue to tighten across the debt stack. Based on the strong credit performance of our loans and where deals are getting done today, we expect to earn higher full-term IRRs on these than our pro forma underwritings.

We have talked before about our preference for experiential retail. As Rina said, commensurate with Bass Pro's acquisition of Cabela's in September, we acquired 3 industrial and 20 retail locations that will be triple net master leased for 25 years with inflation-protected rent escalations and a corporate guarantee from Bass Pro. The combined companies produce a stable cash flow through cycle and is now more diversified across segments, with Bass Pro being bigger in boating and fishing and Cabela's in hunting and shooting. Cabela's also has an exceptionally durable credit card program that accounted for 73% of its operating income in 2016, and will continue to help drive performance of the combined company.

We believe the merger makes great strategic sense and expect there to be substantial synergies realized in the combined company. We were able to purchase these properties at a price we believe is materially lower than where the properties would sell on a one-off basis, and we expect to earn an accretive cash-on-cash return from day 1 of this investment that will increase over time.

We financed our investment with 10-year CMBS debt at 48% of cost and expect to earn an accretive cash-on-cash return of over 11% during that 10-year period. Some of you have never entered a Bass Pro or Cabela's and would be surprised to learn that the average customer spends almost 3 hours in the store from the time they enter. This is the definition of experiential retail, complete with active exhibits, restaurants and an extremely loyal patronage that puts great value on the credit card loyalty program.

With this purchase, our own real estate across our property and REIT segment is now over $3 billion. Additionally, we are in process of closing an accretive multifamily portfolio that will further increase our Property Segment in the coming months.

Rina just described the Q3 write-downs to our retail JV, an investment that I would note accounts for less than 1% of our assets. The rest of our property portfolio, which is much more significant in size and contribution, has performed extraordinarily well, with a cash-on-cash return of over 10.5% and significant unrealized upside across each property type. If we mark those to market today, we conservatively believe that our Dublin office portfolio, Woodstar multifamily portfolio, medical office portfolio and REIT property portfolio each have gains similar to or greater than the appraisal-driven GAAP write-down we are taking this quarter.

En masse, the Property Segment has done exactly what we hoped when we began our diversification process, providing current income duration, depreciation and significant portfolio level appreciation. In addition to the Ten-X gain we took this quarter, we also have 2 significant equity kickers on our loan book that are carried at 0 basis on our financial statement.

I would be remiss not to mention Starwood Mortgage Capital, our CMBS conduit origination business, that continue to perform well in an increasingly competitive lending environment. Many of you have noted the significant CMBS spread tightening we've witnessed in the past few weeks and months. The world is starved for yields, and CMBS and corporate credit continue to perform very well. We think we have a pretty good yield story, too.

Barry mentioned on this call years ago that the Holy Grail for us was to someday become investment-grade. We set a long-term goal to run a diversified real estate finance business of complementary businesses that outperform through cycles and seek value across a spectrum of possible investments. We believe by continuing to add stable equity investments, increasing our unsecured versus secured debt, keeping our leverage significantly lower than our peers and maintaining laser focus on our liabilities and the credit of our portfolio that we will continue to lower our borrowing costs, which, over time, will grow our earnings and our company. We believe we are well on our way.

With that, I'll turn it over to Barry.

Thank you, Zach. Thank you, Rina. Thank you, Jeff. I think we had a really solid quarter. And obviously, I was fairly bullish last quarter. So you can see the results, and you can see Jeff's optimism, the team's optimism on the pipeline going forward.

I was struck as we reviewed the company's evolution by 2 really fascinating facts on the loan book, which reached its highest size in the history of the firm this quarter. The LTV of the portfolio has actually fallen over the last 3 years. In 2013, it was 65%, 65.5%. And today it's 62.8%. And it's kind of remarkable because the dividend yield obviously doesn't reflect the credit of the portfolio. That's the loan book. And then you add in the equity book, and if we were an equity REIT, obviously our dividend would be probably on those assets in the 5s maybe, maybe in sub-5, 4.5.

So the stock continues to hold extraordinary value, and I think we've successfully diversified into these new business lines to fill the gaps that will evolve over time as the servicing book declines. Especially, kudos again to Larry Brown's team in the conduit business. We had an exceptional quarter. It continues to -- it's a manufacturing business. They turn their book 11x a year. So we have never had experienced a loss in that business in now going on 9 years.

And our resi business has outperformed even our expectations, and it's growing nicely, very nicely. And we said we'll need to exceed our return expectations, those are also double-digit on equity. So we expect to grow that business and continue to grow our equity book. And all that rate is kind the of similar to the rates we were doing 3, 4, 5 years ago.

We told everybody that as spreads tighten, our cost of funds borrowings would tighten, and we would be able to preserve our yield. And it's nice to do exactly that 11.4 target yield on the portfolio originated last quarter, and then 60 on an LTV basis. It's just spectacular investing.

Just to go over how we select assets, you may not know but we are the, I think, the largest or second-largest market rate apartment owner in the United States. And we look in the REIT for stable assets with double-digit cash-on-cash yields, and there are very few real estate assets that can perform like that.

Multifamily is the ones we bought the affordable housing portfolio, we call the Wilson Portfolio. We didn't expect rapid growth because it's affordable housing but we felt incredibly stable. And if you recall, we financed it with, I think at that time, 17-year debt, fixed debt. So the partners here say, will we like to own this forever? And we say, yes, and so we put it in the REIT. And we expect, since we own it for a long time, that the IRR will be low double digits and attractive for our core investing and our goal of having consistent dividend yields.

I'll also say that our move into Cabela's into this credit was controversial, but it's actually, when you think -- I didn't think of it as a retail deal. I thought of it as a credit deal and it disrupts credit side, because the market has so kicked retail in the face that this investment actually looks totally compelling. And I don't really care about the stores or where they're located because we have the full credit support of the parent. Bass Pro, as you know, is private. Cabela's was public. And as Jeff mentioned, it's credit card receivable.

Actually they had a bank. And the bank is -- was 3/4 of their income. And so we lent against the bank. The bank is now owned basically by Capital One, but they pay hundreds and hundreds and hundreds of millions of dollars to this combined entity in the form of EBITDA receipts, which actually is a bigger portion of their EBITDA than they make in their stores. So we lent against the bank, not against the retailer in my view. And there'll be hundreds of millions of dollars of synergy. I won't even tell you what the company thought.

But the Bass Pro shops, which was a successful private enterprise, bet the ranch on doing this investment. And so our LTC of 40-something percent, we were super happy with their credit guarantee. That bank, by the way, or that -- it relies well -- it is a private-labeled credit card that Cabela's issues, only 5% of transactions on that card actually take place in the Cabela's store. And the company has already successfully migrated online. So if all their stores were to go dark, God forbid, we still have their corporate guarantee and the credit card business as long as they have an online business would stay intact. So we actually think now that they can redeem those points at Bass that that business will grow in scale, and so does the company.

So we thought it was a mispriced credit, and we reached up and took advantage of it and are really excited about that investment opportunity for our -- it was long, live deal. It was kicking around for a long time, and we're not -- we don't really care what happens to same-store sales, I might add again, especially if it's migrating online for them, because that's higher-margin business than even in the stores.

One other thing about hunting is you can't sell rifles online. So that part -- portion of their business and everything to do with hunting most likely stays in a physical retail store for a long time. As Jeff mentioned these are 3-hour visits. So we're pretty excited about that.

And we're also excited about our -- all of our new businesses, and we're looking at several others in this portfolio that Jeff mentioned, another multifamily portfolio that you'll see announced in the coming weeks. They are -- and then the multifamily portfolio, they're all in Florida and concentrated in Orlando, a market we know really, really well. And we'll finance it with our long-term debt, and we'll have a double-digit cash-on-cash yield out of the box. So there'll be no need to pro forma a double-digit yield as we'll provide that right out of the box with fixed-rate debt.

So the other thing is, as Rina mentioned at the top of her comments, is that we didn't run a very efficient book, and we haven't really for most of the year. We've been sitting on a lot of cash and took advantage of the credit markets and did a big loan refinancing early in the year. We sat on a ton of cash to pay off the convert in October. And we hope to run a more optimal book going forward. And to continue to look to delever our assets, our unencumbered assets and issue unsecured debt, which will keep us marching towards an investment-grade credit.

What's fascinating about it is the debt markets think we're a [stud], and the equity markets treat us like we're a junk bond. So it's a fascinating situation because our debt has traded great and continues to tighten and tighten. And our stock continues to sort of be a plus. So trading is almost a 9% dividend yield. So we think it's a ridiculously compelling investment. If it was -- I've never understood why the stock has been trading at 6 dividend yield given diversity and where rates are and the amount of money in the market and the lack of yield.

And we're seeing mezzanines now at 7%, 6.5%, 6%, just pointing down. The yields are going down. So we have a 62% LTV book, and we traded at 9. Figure that out. The mezzanines have been trading for, what -- they go from 60% to 70%, 75% LTV, and there's 7. We have a diversified book with amount of equity investments in the company, and we traded at 9 is sort of preposterous. But anyway, it's -- and then we have the embedded gains in the book, which are substantial. And we think our management would estimate over $1 share of gains net of the small unrealized loss we took this quarter in the [indiscernible] portfolio.

So we're pretty excited about coming months. The team's jazzed up. We're cooking on cylinders, and we continue to be a major force in the market being 2x the size of our nearest competitor. And we're ramping up, looking aggressively at loans in Europe, much we're really trying to build that book up. It basically doesn't exist today, and we're looking at some investments across that sector. It's probably what, 5% of our assets?

Yes, I think it's 7%.

7%. So (inaudible) think it's 7%. So 7%. But we'd like to get that back up to like 20%. And what we'd like to see is that loan book, which is 6, 9 or so grow to $10 billion, right? And that's -- that we can find investments, we just got to keep adding people and continue to gain market share and work with the banks, which are our friends and partners and competitors, in a very competitive market. It's not exactly a lap out there.

So the only other thing I -- because we don't always say it, the equity book stretches the duration of our investments. And you can see, with $900 million in payoff, it's awfully nice to have a 30-year book not rolling over and earning double-digit yields and has great stability, lower debt and strong income stream.

So super happy, and with that, we'll take any questions.

(Operator Instructions) We'll take our first question from Jade Rahmani with KBW.

In terms of risks on the horizon, I wanted to find out if you could share your thoughts on things you worry about and how you expect commercial real estate performance to perform in 2018.

Yes. So I think I worry about what everybody worries about that the unwind of the stimulus gets a little out of hand when the government start selling bonds, they will raise rates in December. I just worry the economy getting too hot and the rates move too fast. It's actually good for us, but I just -- it's not good for general economic activity. So that'll be good for our earnings. It will be hard to refinance our debt. So we'll have less payoff, which is great. But I think since we're floating rate, I mean, most of our book, people can -- if spreads come in because dollars are going up because inflation's returned and replacement cost arising. On the margin, I guess we'd like to see economic activity, and we're seeing in the country. But -- so risks on disciplined lending, this foreign capital that showed up that is powering most of these mezzanine players to buy debt. They're typically East Asian sources of capital. The Chinese are probably backing off a little bit, certainly from the equity markets, they're backing off completely. But from the debt markets, if they're already committed to a fund, they're in the fund and the sovereigns haven't shut down their investing. You saw recently, I think it was CIC, said they're going to put $5 billion into property in the U.S. So -- but all of the life companies, and they've probably closed for business in the states for a while. So maybe you're seeing the tail end of some of that wave of money that blew into the country and started to buy these mezzanines at spreads we haven't seen before. So it's lack of discipline. Right now, you're seeing the market remain fairly disciplined. The government -- the federal government continues to look at the banks and look at their books and look at their real estate loans outstanding and those held. We have seen a few investment banks do equity deals again on the balance sheet, and that was a horrible thing last cycle. Morgan Stanley, I'll name, bought a casino. A federally chartered bank shouldn't be buying a casino. They bought a development piece of land, they outbid us for a land -- piece of land in Jersey City. Since that CEO is no longer there, I can say that. In Atlantic City, sorry. And that to lose to an investment bank and doing on their balance sheet and borrowing money from the government at 0, it's pathetic. And we've recently seen a few other investment banks get back into the equity business just because federally chartered banks and they're looking for spread. Don't want to see that. Don't want to see anything like that. And that's a winning bid. We can't compete with that, right? They borrow at the window at nothing, and we can't. So we'd like to see the banks stay banks and not put big real estate deals on their balance sheet to get the earnings and yields because their trading operations aren't doing so well. So I would say that's a warning. That's a warning sign. It hasn't been a flood. It's been more of a trickle, something north of a trickle and less than a flood. And I think that's -- we're watching the retail complex. We -- sales you've seen recently -- yesterday there was a rumor that General Growth is going to be bought by Brookfield. There are -- the retail complex is kind of like a bid-ask place today, right? I mean, the people feel the assets -- the owner of the assets really feel their stable. There's turnover in tenants, but the patina of the sector is tough. And we're grateful that our investment represents 1% of our assets, and we're not accruing any income from the investment right now and won't for the foreseeable future as we continue to invest in those properties. But -- so it's not an earnings estimate, it's not an issue, but will we like it to perform better? Absolutely. Did we bat at 1,000%? No. Do we net gains in the equity book overall? For sure. So I think the retail space, I mean, nobody knows where equilibrium is, but there is -- I think it was one of the companies. I think it was -- I think it might have been GGP. So they signed more leases last year than they've ever signed last 12 months. So there's tenants. It's just they're different tenants, and you've got the wrong tenant in the mall. It's not the tenants millennials want. And so when you put Warby Parker and Bonobos and [Box] and these other guys in your mall and the kids go. And you put -- unfortunately, for them, you put Gap and The Limited, Express, and those are yesterday's brands. It's kind of like post cereal. Nobody's buying Special K. The same thing is happening in the mall. Our job again is the mall as an experience and drive traffic. In the old days, the mall owner did nothing. He just made it clean. He turned the lights on, the AC. Now you got to program the mall like you would a concert hall. You've got to bring in events and really pull people off of their couches for the experience. And all the tenants are doing it together. I'd say that the industries understand the pressure it's under. And so we're cognizant of -- we're wondering if it's a great opportunity for lending, right? We're not sure in all cases. So we're getting super picky and find where we think the right risk-reward place is. We made a management change at our own management company, and brought in Michael Glimcher to run our retail assets. And he's managing those assets, and he's fairly optimistic. But everyone's under pressure in that space. So there's the department stores -- the good news at many of our malls, we want the department stores to go out. They pay us nothing. Sometimes we don't even own the store. And when we do own the store, they probably pay us $2 or $3. So essentially, the land value would be higher as apartments or a hotel or an office building, and we're looking at all those JVs for all of our retail assets.

On the retail JV, is there any conservative -- conservatism baked into the write-down you took? And what would be the time frame for the JV to start providing -- generating operating earnings again?

If you asked me -- first of all, conservatism, we're taking no income. So that's conservative. And the appraisal is the appraisal, and I think it's fine. I know it's done for the recent re-extension of the debt, which I believe is a 2-year extension. Honestly, if we lost a lot of those investments, it would be a disaster for the [eagle eyes] but nothing for the company. So is that going to happen? You tell me. I mean, I think these are great assets in great markets. I happen to think the mall is like a patient that's at the doctor getting resuscitated, that needs a new -- it needs a few new organs. And -- but it's a healthy body, and it will recover. So very well located. They've got great parking. Everybody knows where they are. They've got great access. They're just going to have to evolve, and it's a cliché, into more of an entertainment environment to bring people there. But as the whole sector, will Amazon be the only retail left in the United States? I have a feeling that municipalities will be very bum when their main streets are completely empty, and they don't know what to do with all the retail stores on Madison Avenue and Soho and Michigan Avenue. So if you think people got upset about the bookstore closing, and then did movies about that, wait till take down every single company in America, and (expletive) the malls, don't worry about them. Think about main streets all across the United States. And people say it's Walmart, it's not Walmart. It's different. This is predatory pricing. Their ability to use prime, the prime card and deliver basically below cost wouldn't be legal in other industries. So in the old days, if you price aluminum below cost, you got the federal government at your front door. So this company trades at 100x EBITDA. I mean, it's game over, right? There's -- nobody trades 100x EBITDA. So their profits in their AUS business, their cloud business kind of support an aggressive move against everybody. I mean, CVS, delivered subscriptions to your house. You tell me where that ends. I'm not smart enough, but I have a feeling somebody's getting annoyed here at some point. It has nothing to do with us. I'm way off topic but you asked. So I answered.

On the special servicing side, can you touch on the outlook for 2018 for special servicing? And also, the surveillance and CMBS 2.0 side, given the retail lows, are there any uptick in CMBS 2.0 delinquencies that could potentially provide somewhat of an offset to the special servicing run off?

I did want to answer -- say one thing I forgot in my comments. We kind of made a decision to keep our CMBS book at roughly $1 billion or 10% of our overall assets for the last 4 or 5 years, probably. And so we haven't been -- we've been cherry-picking [BP steals]. But I was surprised when I look at our book today, and I think it's almost like 85% of our book of that is 2.0 today, and it's not 1.0. So we're no longer -- that business is kind of already done potentially and coming off. And those were good high-income paper. We've navigated that transition beautifully. I would say that our -- as we look at our budgets for '18 at this moment in time, we're in better shape than we were going into '17. So we budget what we can, and with -- and so we're feeling pretty good about '18, and we're not -- we're managing the decline in the revenues of the special servicing book. It's not -- we know what we're going to see pretty much. There's a lot less fall in the numbers. And so we have to manage the decline of that business, and we're 100% aware of it and replace it with other things, which is why we started our resi business and we're doing some other stuff. So...

And the 2.0 delinquency is still very, very small, Jade. That's not going to be a big revenue driver yet on 2.0s. We'll get those in the next few years, we hope. But I think it's too early to be counting on a lot from 2.0.

And then on the non-agency residential mortgage originations, was this quarter sort of a run rate pace so you expect that to meaningfully ramp? And did you say that you're going to do a CLO in the first quarter of those deals or CMBS?

No. What I was mentioning in terms of securitization was the residential business, where we've built the portfolio of a little over $500 million. So we'll do a non-agency residential securitization in the first quarter to term that out, take it off of warehouse lines. In terms of the CLO market, which you asked about on the CRE side, you've seen a lot of deals get done. For people that don't have our cost of capital, the CLO market is absolutely a place to look today. We financed inside of our competitors. On a spot basis, our high yield trades in the low LIBOR 200, and we can't compete with that on -- in a CLO that's significantly better than where a lot of our peers are able to borrow in the secured and unsecured markets. So I think you'll see our peers continue to go there. We have been pushing towards doing some more smaller balance loans, and ultimately, that may be a good exit for that. So you could see is in the CLO market later in '18 or early '19 at some point. But that's not something that we need to lean on because of our cost of capital, both unsecured and secured. So I'll think you'll see us stay the course in unencumbered assets.

(Operator Instructions) We'll go next to Doug Harter with Crédit Suisse.

Can you talk about with where your debt is trading where it is? What else you can do to the capital structure, what we should -- what that capital structure might look like a year from now?

Yes, listen, our warehouse lines, in general, are LIBOR 1.75 to 2.25, let's just say, and there's a few assets...

There's not a lot at 1.75. What would you say the blended spread is on our warehouse lines, on draw on capital?

Yes, about 2.10, 2.5, 2.10, somewhere around there.

So given that on the warehouse lines side, one of the phenomenons we've seen is warehouse lines have come in a lot. Obviously, the banks, from a regulatory capital perspective, like this business. They get cross lines of multiple assets, and they get a guarantee of some portion of that back from the parent, and these are good lines for the banks. And from a regulatory capital perspective, they are a strong ROE. So they push the warehouse line business pretty hard, and we're getting better levels today than we've got historically. That said, I think that's still a great business for the banks, and that we expect them to continue to bring those levels down. I look at it versus other floating-rate assets like cards and auto, even on the AA side, and it's still significantly wide at over 200 basis points for cross with recourse. I think about it versus where I can finance BB CMBS at LIBOR plus 1 60 for the 60 to 63 size of the capital structure. These borrowings at LIBOR plus 2.05 or so are significantly better investments for the bank. So I think the banks will continue to move those spreads lower, but A-Notes haven't really followed. So our ability to sell A-Notes and get them off balance sheet, it's still there and we're still doing it on some portion of our portfolio, but not the majority of our portfolio, which is how we started this business. And that is because the banks are really pushing on the warehouse side as opposed to the A-Notes side. So I don't know that we will replace the entirety of our warehouse lines of unsecured debt, but I think ultimately, as opposed to going to the A-Note market, you'd more likely see us use unsecured. For the higher price lines that we have on warehouse, you'll likely see us rotate from warehouse into unsecured. I think there's the ability to put $1 billion-plus, taking them off and accretively or flat, move them from secured to unsecured borrowing. And the rating agencies will like that. I think you guys should like that as investors, and that's something that we'll endeavor to do in the short period from now, given how well our bonds are trading.

(Operator Instructions) We'll go next to Jessica Levi-Ribner with B. Riley FBR.

Could you talk maybe a little bit about, I know you've touched on the non-agency resi that you're doing, but what kind of competition you're seeing there? And maybe if you have market share targets, what you're thinking for that business in the long term?

It's really good right now for us, and it's an area that we're kind of -- we've got experienced team, but for me, it's a bit of a learning curve, I have to say, so we towed in. And the net equity after the securitization will only be like $150 million probably or even less. It's coming on the leverage we want to deploy. We're going to like we have done in our loan book, real estate loan book. We're going to make -- we could borrow probably $0.87 on the dollar on those loans, but we're not going to do that. And that would be like a 17 that you'd go -- would look like some of our peers in leverage if we did that. We're probably thinking it's going to be 70% or something like that to create a lower but a very attractive low teens double-digit yield. So I think we could get to $1 billion of equity in the business. That would be a target maybe, 10% of our assets. And hopefully, our assets will be 15 and then it would float up from there. One of the things that we decided recently as we take our CMBS book up a little from here because of the -- we've grown and our asset base is bigger, and the $1 billion was at 10% of assets. And we will be okay at something a little north of that. So we'll take that business up a little bit, be a little more aggressive in the BP's market. We think actually that BP's being originated today are pretty high quality. And to [Jade Rahmani's] point earlier in the call, I mean, a lot of retail is going to kicked out of these the securitizations. And whether they're right or wrong, nobody wants to take the risk. So you're seeing low LTVs but very aggressive pricing and very bespoke pool of paper being originated. So we'll go back in that business, and I think there was a lot of dancing in Miami when we said we're going to increase our investment in the space. But overall, on the resi side, we don't have a market share target, frankly. It's more of the sizing in our own book and not 7.24 on the -- 7.42 or 7.24, I'm dyslexic.

Yes, it's 7.24 FICO Scores.

FICO Scores. These are good loans, and we're feeling our way. We're going to do something. We're going to buy an entity into the REITs, and we're going to grow these -- our origination business ourselves. So that's yield under contract. And we're going to -- so we're going to take that engine and put it in the REIT. And we're going to take advantage of the opportunities as long as it meets our ROE targets. And we don't think we're taking too much or even any real credit spread risk.

And we think we finance ourselves better than anybody in that market, and financing obviously matters. And so it's an advantage to us. And ultimately, the securitizations business coming back helps a lot. There's a handful of private equity competitors in that space. It's not a massive market today. We think a couple hundred million dollars a month would be an optimistic goal in today's market, absent owning your own originator, but it's a business we look to grow profitably.

Okay. And then just piggybacking off your comments in terms of BP's buying, what kind of yields are you seeing today? And Barry, you said you would be wanting to take it up. Do you have a percentage of equity like 15%, something like that?

Something between 10% and 15%. I will let Adam talk about the targets.

Yes, spreads, as they are in the top of the stack, are tightening. So we're seeing 15-ish yields on the unencumbered, 13s on the verticals and probably the 17, 16, high 16s, low 17s on the bottom of all securities. So they're in probably about 50 to 100 basis points, depending upon which of the originators are having a collateral on the deal.

One thing is the risk retention rules haven't been one of the things that Trump has deregulated, and there's no sign of him doing that right now. And it has changed the market a lot. They're -- the smaller conduits are having trouble competing, and the banks are tough. So it's a challenging environment today more so than it's been. But because of the way our business has been structured, the conduit business, they've been able to dance around the changes in the market very adeptly. So I wouldn't expect that would change going forward. So they're working with these banks, and we can participate in the vertical or we can do our own horizontal. So mostly those markets move to vertical deals.

Jess, I would also say that deals today have a much lower LTV than certainly precrisis or than 2.0. And as LTVs have come down into the high-50s and low-60s, you've seen a much better collateral, which leads to, as Adam gave you numbers, of 15. The spread between a pre-loss and post-loss expectation in yield is tighter today than it's ever been historically. You have more investment-grade loans. So as you expect to lose, we're also going to kick 25%-plus out of these deals still, shaping the pool in the way that we want to. Our post-loss yield is not far from what it's always been, even though pre-loss sales have tightened in because we moved to the higher investment-grade collateral with a significantly lower LTV. And the CMBS markets, that market is responding to it. AAAs aren't trading mid-70s for no reason. They see that as better collateral, and it's a bank-dominated collateral, investment-grade-dominated collateral, and it's trading very well and bond buyers see that as well.

Okay, great. That's really helpful color. One last question for me would be just, I know that there's -- you've had kind of a long-standing frustration with how the stock trades on a dividend yield basis. What are you seeing kind of the equity markets don't get that the debt markets do? Do you think maybe the property portfolio is lost in translation? Is it the conduit? How do you guys think about that?

I'm sorry. Can you say that again? What was the question?

The dichotomy between the debt markets and the equity markets? What are the equity markets missing?

So we're an ETF. And as the most liquid name in our sector, we kind of -- in our mortgage or yield ETFs, we're one of the largest players now. We're #3. So we get whipsawed lot with people's expectation where rates are going and when the resi REITs, which don't have positive convexity, arising interest rates get crushed. We get sold off with them, and it's a blind trade. It's just programmatic. It has nothing to do with our underlying assets. It was amusing as [indiscernible] rates were going up, sort of amusing. But we were going down with the residential REITs and us. And most of our peers' earnings go up, not down, with rising rates. The ETFs don't care. They just -- we're all on the same bucket, and they just sell us based on our market caps. That's one issue. I'd say the second issue is people worried about the servicer that must be in our yield. That is a declining asset base, and we're well aware of it. It's not a secret that the ROE from that business will go away over time and be slightly reduced. But -- and maybe that explains it, but you can't account for the differential between us and our nearest competitor. Even if the servicer had 0, I guess, when we adjusted our dividends, it's not -- to that level, we trade where our peer trade. So they trade it like 7.9 or something like that. We trade at 8.9. So take out the earnings, and you get the same dividend yield as they do. Assuming we have -- but we have all the equity assets, and we have a totally in book. I mean, we have appreciating equity assets. We don't have loans paying off at par. We have equity assets that are rising in value on the whole fairly significantly, producing double-digit cash yields every day. I mean, we were talking about the other day there are things we can do with our equity just as we spun out our single-family rate point. I mean, there are ways to recognize value if we have to down the road if we -- what we're doing is because we want to stretch the ratio to the books. So the debt markets really value the diversity of our income streams, and they value the quality of -- they're looking at the LTVs. They're looking at the scale of the enterprise, the size of the company. And our ability is sort of to produce earnings from multiple cylinders. We never said that every cylinder was going to be operating and firing at the same time. That's why you have 12 different businesses, right? You may recall we were out of the conduit business almost shut in the first quarter of this year, I think it was, and we did nothing. And then the team said to me, if you want us to make it up the rest of the year the earnings that we had in our budgets. I said, you just do it with the right pace. Do with whatever pace you're comfortable with, but don't press it. Don't force it. So we know that these businesses all won't work perfectly every moment, but the credit markets love that. Somehow that hasn't translated into a 6 dividend yield for the stock when -- and it's kind of odd. I mean, you don't really see this very often in the capital markets. You see the opposite. The debt markets are freaking out. The equity markets think there's nothing going on. They're just fine. So you see the opposite here. You see that the credit market is loving the story, loving the diversity of the asset base, enjoying the equities, the ability of multis and fully-leased office buildings. And the equity markets don't seem to care. So I don't know. Maybe Zach needs to get better at what he does. He's sitting in front of me. So I'm smiling as I say that. I don't know. The asset is 9 years, and the company's bigger, better more diversified, and we continue to try. It has to be the income from the servicer. There's no -- I almost want it to go away, and sell it, and just move on and stabilize the company. We've even considered that, but we love the business. It gives us optionality. It gives us deal flow. And we thought rates would rise rapidly. We'd have more bad loans to service. So it hasn't quite. That didn't happen, we're fine. So the Ten-X investment turned out to be something nobody obviously valued, and we made, I think, close to $100 million in proceeds, $60 million, $70 million in proceeds in cash for the company. So we -- it's a long road. We're okay.

Ladies and gentlemen, that will conclude our question-and-answer session. I'll turn the call back to Barry Sternlicht for closing remarks.

Well, everyone, thank you for dialing in and listening to our story, and the team's around to answer any questions. And as you know, our transparency and our desire to partner with you is -- has been the way we've started this company from the beginning. No surprises. And we're delighted with the team's performance and look forward to another great quarter. Thank you very much.

Ladies and gentlemen, thank you for your participation. This concludes today's conference. You may now disconnect.