Starwood Property Trust Inc (STWD) 2018 Q2 法說會逐字稿

Greetings, and welcome to Starwood Property Trust Second Quarter 2018 Earnings Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Zach Tanenbaum, director Investor Relations.

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 June 30, 2018, filed its 10-Q with the Securities and Exchange Commission and posted its earnings supplement to its website. These documents are available in the Investor Relations section of the website at www.starwoodpropertytrust.com. In addition, we also posted a slide presentation relating to the company's acquisition of GE's project finance debt business at the Investor Relations section of the website.

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 more detailed discussion of the risk 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 in this conference call. The presentation of 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 call today are Barry Sternlicht, the company's Chief Executive Officer; Rina Paniry, the company's Chief Financial Officer; Jeffrey DiModica, the company's President; and Andrew Sossen, the company's Chief Operating Officer.

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

Thanks, Zach, good morning, everyone. As you saw in the press release and the investor presentation released earlier this morning, we are very excited to announce that we have entered into a definitive agreement to acquire GE Capital's Energy Project Finance debt business. The acquisition is comprised of both the full-service Energy Project Finance platform and a $2.6 billion loan portfolio, including $400 million of unfunded future commitments. The platform is vertically integrated with a seasoned leadership team that averages over 21 years of industry experience and has 21 full-time employees across loan origination, underwriting, capital markets and asset management.

The platform has successfully originated in excess of $24 billion of loan since 2004 and has experienced less than 10 basis points of charge-offs per year over the last 10 years.

The $2.6 billion portfolio consists of 51 senior secured loans that are collateralized by energy infrastructure real assets. These assets have an attractive risk-adjusted returns with a strong credit profile and are largely backed by long term purchase contracts with investment-grade counter-parties.

Importantly, this acquisition leverages existing expertise at Starwood Energy Group, which specializes in energy infrastructure equity investments. Starwood Energy, led by Himanshu Saxena, who's on the call with us today, has a history of over $7 billion of capital deployments since its inception in 2005 and the platform has 17 investment professionals with an average of 15 years of relevant industry experience. We plan to finance $1.7 billion of the $2.2 billion purchase price with a committed secured term loan facility from MUFG. The term loan also provides additional committed capacity for the $400 million of future funding associated with the portfolio we are acquiring from GE.

We have ample available liquidity on our balance sheet to close the transaction in addition to a $600 million committed acquisition financing facility. Closing of the transaction is expected by the end of Q3 2018.

This transaction benefits us in several key areas, all of which are outlined of Page 3 of the supplement posted to our website this morning.

Importantly, the 97% floating rate portfolio is positively correlated to rising interest rates and has an initial portfolio duration of over 4 years. This, coupled with the duration on new loan origination being excess of 5 years extends the overall duration of our portfolio and adds to assets with a low correlation to the commercial real estate sector, improving our overall portfolio diversification.

Similar to our other investment cylinders, we think that Energy Project Finance is a highly scalable business. The Energy Project Finance market is in excess of $200 billion per year and provides for significant additional capital deployment opportunities and exceptional credit at attractive rates of return for our shareholders. This purchase brings us one step closer to realizing our goal of becoming a leading global diversified finance company and we look forward to answering any questions you might have relating to this transaction. Just to reiterate, we do not need to raise capital to close this transaction.

With that, I will now turn the call over to Rina to discuss our Q2 results

Thanks, Andrew, and good morning, everyone. Our core earnings this quarter totaled $148 million or $0.54 per share. This now includes a $0.01 of severance expense associated with a reduction in source that we completed in April.

I will begin this morning with the results of our Lending Segment. During the quarter, this segment contributed core earnings of $114 million or $0.42 per share. On the commercial lending side, we originated $2 billion of loans with an average loan size of $113 million, all of which were first mortgages.

Our funded commitment of $1.5 billion outpaced repayments by nearly 2x, increasing our target portfolio to $7 billion at the end of the quarter.

More than 90% of this balance represents first mortgages and 95% is floating rate.

On the residential lending side, we acquired $193 million of nonagency loans and received repayment of $64 million, bringing the total portfolio to $793 million and our net equity to $295 million. The current portfolio has an average 63% LTV and 724 FICO.

I will now turn to our Property Segment, which contributed core earnings of $30 million or $0.11 per share. The wholly-owned assets in this segment have an undepreciated carrying value of $3 billion and continue to generate consistent return. The blended aggregate cash on cash for the trailing 12-month period was approximately 11% and weighted average occupancy stood at 98%.

We also sold one retail asset from our master lease portfolio this quarter, bringing the cost basis of our year-to-date sales in this portfolio to $48 million with core gains of $7 million.

I will now turn to our Investing and Servicing Segment, which contributed core earnings of $56 million or $0.20 per share.

On the servicing front, we recognize fees of $25 million this quarter. As anticipated, these fees have declined, but it is important to keep in mind that the amortization of our servicing intangible has likewise declined.

As a reminder, when we acquired LNR in 2013, we allocated $244 million of our purchase price to the intangible. Since then, we have reduced core earnings by almost $200 million as a result of the amortization of this asset. If we just look at servicing fees, net of this amortization, the contribution to core earnings for the first 6 months of this year is actually $5 million higher than the same period last year.

On the conduit side. We securitized $208 million of loans in one transaction. We had second securitization that straddled the quarter with $188 million of loans that priced in June but settled in July. Consistent with past practice, both of these transactions are treated as realized for core earnings purposes.

And finally, on the segments Property portfolio. We continue to harvest gains as these assets reach stabilization. During the quarter, we sold assets with a cost basis of $15 million for net core gains of $6 million. We also acquired $25 million of new assets, bringing the undepreciated balance of this portfolio to $373 million across 24 investments.

Together with the properties in our Property Segment, these assets carry $237 million or $0.91 per share of accumulated depreciation.

Before I conclude, I wanted to walk you through a few unusual items for the quarter. The first of which impacted both GAAP and core and the other two of which impacted only our GAAP financials.

In our Lending Segment, we monetized a portion of our equity participation in 701 7th Avenue, receiving $12.3 million in proceeds. This amount is reflected with an interest income in our P&L and was offset somewhat by the lower prepayment fees and accelerated accretion we experienced this quarter a result of lower repayments.

Also in our Lending Segment, we increased our allowance for loan losses by $25 million, representing the difference between the loans previous general reserve, which we reversed, and their specific impairment reserve, which we established this quarter.

$22 million of this reserve relates to a residential project in New York City for which the underlying first mortgage and mezzanine loans totaled $173 million. The loans mature this month and we expect that they will not pay off due to unit sales being slower than anticipated.

As a reminder, in formulating the specific reserve under GAAP, we discount expected cash flows at the rate implicit in the loan. Of the $22 million reserve related to this project, $15 million relates to the effect of discounting.

The remaining reserve of $8 million relates to 2 smaller loans, for which the sole tenant of the underlying properties went into liquidation during the quarter.

Consistent with our treatment of general reserve, these announced are excluded from core earnings because they are unrealized. All of these loans were purchased in 2014 by our prior origination scheme.

And finally, this quarter, we changed the methodology we use to compute our GAAP diluted share count for the principal portion of our outstanding convertible notes.

In the past, we only applied the U.S. converted method to the conversion spread when calculating our diluted GAAP shares, given our intent to settle the principle portion in cash. As we approach the end of the quarter in the open redemption period for 2019 convertible notes, which began on July 15, this intent changed.

Given our robust pipeline, we determined that our available liquidity would be better suited for these investment opportunities rather than the early settlement of our converts.

The impact of this change to GAAP EPS was $0.01 per share. The effect is excluded for core EPS purposes.

Subsequent to quarter end, we received early redemptions representing a par amount of $259 million.

Assuming yesterday's closing share price, this represents $300 million of value inclusive of the related conversion spread of which we expect to settle $272 million in shares by the end of Q3.

I will conclude my remarks with a few comments about our capitalization and dividend. We ended the quarter with ample liquidity, including $4 billion of undrawn debt capacity. This amount does not include the new facilities associated with the GE transaction that Andrew mentioned earlier.

Our net debt to undepreciated equity ratio increased slightly this quarter to 1.7x. If we were to include off-balance sheet leverage in the form of A Note sold, this ratio would be 1.9x. For the third quarter, we have declared a $0.48 dividend, which will be paid on October 15 to shareholders of record on September 28. This represents an 8.6% annualized dividend yield on yesterday's closing share price of $22.45.

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

Thanks, Rina, and good morning, everyone. With the acquisition of GE Capital Energy Project Finance portfolio, our balance sheet will now have over $15 billion in assets. We expect to continue benefiting from our scale, both in opportunities and the diversified best-in-class financing of our business. We deployed $2.8 billion this quarter with over $2 billion of that coming from our primary business of large loan lending. This record origination this quarter encompassed [15] new loans, 100% of which were first mortgages with an optimal IRR in excess of 12% and in line with previous quarters. I will note that our $7 billion, 62.4% LTV loan book is over 90% first mortgages today, the highest since our inception.

Our energy finance acquisition adds another [stone] at a time when our loan book is producing record volumes at accretive yields. This is the third straight quarter that we've written more loans than any quarter since 2014 and our pipeline for Q3 is also strong. The staff increases we made last year paid tremendous dividends along with our best-in-class partnerships with all the leading banks in the nation from which we benefit. We, again, significantly lowered the cost of our asset specific financing this quarter, allowing us to continue to be able to achieve great risk-adjusted returns at lower spreads that will benefit our book for years to come.

We deployed $4.7 billion of capital across cylinders in the first half of 2018, up 63% versus 2017 with significant contributions from all of our investment cylinders.

In our Property Segment, our Dublin office portfolio and our 2 Florida multifamily portfolios continue to benefit from very strong market fundamentals. We spoke in depth about our view on the Florida markets where these assets are located when we purchased them. We have seen cash flow increase much more quickly than we underwrote and cap rates have continued to compress in this sector. Operating income is up and similar quality portfolios are trading at 5% cap rates today versus a blended purchase cap rate of almost 6%.

Regarding the Cabela's Bass Pro investment, we are buoyed by strong operations at the store level, a terrific credit card business and merger synergies that are well exceeding our underwritten estimates. The bond market recognizes the post-merger performance and their term loan has rallied from $92.50 when we did the deal in September 24 to par and 7/8 today.

Finally, I will remind you that we have previously stated we have estimated unrealized gains exceeding $1 per share in our own property portfolio.

As for the right side of our balance sheet, I mentioned earlier that our secured warehouse borrowing rates have continued to come down. We have talked previously about our ability to borrow in the unsecured market significantly inside our peers as bond market investors put tremendous value on the diversified nature of our company. We continue to add unencumbered assets to our balance sheet, allowing us to continue to tap the debt capital markets very efficiently.

We added $270 million in unencumbered assets this quarter and have over $3.9 billion worth as of June 30, which would support over $950 million of incremental unsecured borrowings if we chose to come to market. As Rina mentioned, subsequent to quarter-end, our January 2019 convertible bonds entered their open conversion period and to-date, we've had $259 million out of $341 million outstanding [senior] notes to settle. We chose that, for the first time, to settle the majority of these converts in shares, which will provide us significant additional liquidity between now and January 2019.

Our on-balance sheet debt-to-equity ratio is a very low 1.7x as of June 30 and importantly, just 1.9x when including off balance sheet financing. These numbers have converged as we have taken advantage of significantly better on-balance sheet financing rates in the last year.

Both leverage ratios are, again, significantly below our peer group as we have, and we'll continue to hold the line on leverage on our 90% first mortgage loan book.

In our residential Non-QM book, we expect to price our first Non-QM securitization today and expect to be a frequent issuer in this space. We have built a cherry picked portfolio of over $1 billion in Non-QM residential loans to date with a FICO of over 720 and LTVs in the low 60s. In this quarter, we formalized an agreement which allows us to purchase up to $600 million of loans over the next 12 months.

While our energy finance acquisition and $2 billion of loan production will dominate the headlines from today's call, I'm extremely proud of the terrific quarter posted in the REIT segment.

Our team added 13 new special servicing assignments this quarter, representing over $9 billion of name servicing, which is by far the most in any quarter since our 2013 acquisition of LNR. You won't see this in this quarter's numbers, but it's the type of accomplishment that will build our revenue stream for years to come. We achieved this by leveraging our best-in-class servicer and significant coinvestment relationships that allowed us to only invest 20% of the dollars required to buy these pieces, effectively giving us 5 serving -- excuse me, effectively giving us 5 servicing assignments for every 1 we buy. Every incremental assignment has the potential to add significant revenues over time and we will continue to be focused on building a sustainable business for the long term. We believe as shareholders, we will all be rewarded by these investments and partnerships for years in the future.

With that, I will turn the call to Barry

Thanks, Jeff. Thanks, Rina. Thanks, Andrew. Thanks, Zach, and good morning, everyone. I think I go back to the IPO of our company back in 2009 and I was asked a question by some shareholder -- perspective shareholder at the time, that kind of said, "Well -- why would I buy a mortgage REIT? They always blow up." And I said, "We don't have to invest capital." And we're not going to go overstay our welcome in the business and we promised to do that and since the start of the firm back in 2009, we've looked at probably -- seriously chased a dozen and maybe more than 15 different acquisitions, including the GE health care business, which I'll point out we lost to Bank One in a neck and neck race, which was bigger than this energy business. We're willing to lend capital in any business that meets our risk profile and return objectives, and when this business came up for sale, Himanshu, who is on the call, led our Energy Group for the past 10 years, he brought it to our attention and, when we looked at the nature of this business, it looked an awful lot like what we do with our property loans, there are assets, whether there are turbines and wind farms or plants behind these loans, their creditworthiness -- 80% of the contracts are credit-worthy energy behind them. And the yields -- the returns we thought were even better than in the property sector, and we had our first exposure when we participated in the loan some while -- a while back. And obviously, having picked one -- I think Himanshu is leading our third fund, which just closed at 1.2 billion of commitments, I think they've done more than $7 billion of transactions. We obviously know where things trade and how we finance our own projects. So I think Himanshu and his team, plus the GE team, have incredible depth and knowledge of the space and frankly, the GE unit was a little bit hamstrung as GE Capital pulled in their lending aspirations and really financed mostly their own projects so people buying their equipment. You'll be -- you'll find it amusing that Starwood Capital has bought $1 billion of turbines from GE for our various projects over the years.

So when this came up for sale, the fact that it was floating rate paper, solid as a rock, we can underwrite every credit, there was no actuarial analysis involved, we were pretty excited and we thought it would be a great move to diversify the company. It is actually not a comment at all about the real estate cycle. I mean, we are not saying that the cycle is over and there's nothing to do and in fact, as Jeff pointed out, we had the best originations quarter in the history of our firm and the momentum continues into this quarter. And when I do go back to the last call, I said, "Were cooking on all cylinders." And I think the results show that we were cooking on all cylinders, but we played a long ball here. I don't as a management team in our business, I can say this factually, that has as much might invested in their company as we do. So the entire team, including most of the Starwood Capital executive's, all the Starwood Property Trust executives own stock. We own more stock cumulatively than I believe any other sponsor does in their vehicles in this space.

So we're playing this like it's our own money and what will we do with your capital and our capital to ensure that we can continue to grow and prosper long into the future. We think this business can grow rapidly. In fact, far more rapidly than we underwrote. I look at every deal we underwrite whether the equity or debt side and say, "What are the odds of losing capital and the odds of doing better?" In this case, I'm pretty convinced we can do better than we underwrote, which is a good thing and what we underwrote was an accretive deal. The deal is accretive out of the box and to pull our entire enterprise, which has grown in scale to make an accretive deal, it has to be truly accretive on a stand-alone basis and then when you blend it into the enterprise, it's still accretive from day one. And that means it's hitting the double-digit cash on cash yield that we want to achieve with our equity deployment.

I'd also say that it's one thing that we've talked about before, but I have to reiterate is the bond markets love us and the equity markets don't. If we are in the hunt to become investment-grade traders and, if we do that, our enterprise will be transformed. Both the move into the property sector, which is applauded tremendously by the rating agencies and this move into a diversified business should help drive our motions towards investment-grade. Our bonds trade close to investment-grade without having investment-grade ratings. What that means for our company is the ability to issue debt at the corporate level at spreads nobody else can and then we can cherry pick what loans we want to make because we'll be able to finance them better than anybody else. So given our scale and we actually just completed strategic planning cycle, we would expect that this business will grow, other businesses will grow. I'll point out another business that has grown and has become a significant generator of earnings to us and will into the future is our residential lending company which is pretty exciting because as you know, we'll complete our securitization hopefully this week, and you'll see how bonds trades and the nature of our first deal, you'll see the returns on equity. You can drive -- which we think are compelling in building a diversified commercial lending operation. What -- if you ask why, we could go the other way. We could become incredibly simple and drop all these businesses and maybe at some point, we spin everything out. We'll spin our resi business, we'll spin our lending -- our energy business, we'll spin our Property Segment. But together, it forms -- it gives you that opportunity to basically get to investment-grade and not have to force capital into any one vertical when the returns don't meet the risks that you're taking. So this was not in any way saying the cycle is over in real estate and this one loan impairment -- now you may recall those if you have been shareholders with us. We had a $50 million hit, I think in the CMBS book, 3 years ago or 4 years ago, I don't remember. We took the same mark-to-market hit, and it has come back and actually been an incredibly profitable business. We're really taking being conservative as we've always been and taking this GAAP write-off, on particularly this one loan, which we don't expect to lose money on and we expect to recover all the capital. We're going to restructure the loan. It's well underway, and again, if you listen to Rina's comments, she mentioned that $15 million of the $22 million was simply the discount rate associated with -- when we get the money back, but we expect to get our capital back. And frankly, we would take the property tomorrow, but there are transfer taxes in New York City and it's sort of a waste of time. So we will restructure this and then hopefully, get all our money back and we'll report it to you later. This is the prudent way to handle that.

And one other thing that Jeff mentioned I wanted to touch on. Everything we do is around price credit or taking on where we see opportunities on holding the capital markets and we started this way in 2009 and we continue this way to what we do today -- every day.

The Cabela's deal was an interesting case study of that where, as Jeff mentioned, the term loans traded up from 92 to 101 roughly, given the hundreds of millions of dollars of synergies that the company said they can achieve that we did not expect them to achieve. Just to remind you, Cabela's has merged with Bass Pro shops, and basically Bass Pro, which is private, bet the ranch that this would build a [BNF] in the space and actually we'll report later on in the quarter, but we are -- have sold down -- or later in the year, have sold down a few assets to lower our basis and to show the spread between the yield that we underwrote the deal at and what the markets will take the stores at, even in today's -- what you might call rough retail climate.

So I also want to reiterate that we don't need to raise capital again, that we have plenty of committed capital lines to acquire the business. And as a shareholder -- a co-shareholder, we're aware of our cost of equity. So we don't mind, given our leverage ratio, which I think are a full turn below our next lowest -- our biggest competitor. So I think they're closer to 3:1 and we're fully levered like 1.9:1. We can run the enterprise more levered and increase ROE. We've chosen not to do that because I'll say it until I'm blue, we've chosen to build a company that was conservative, transparent, predictable and safe, hoping that our 8.5 dividend yield should be more like 5.5. Given we are 9 years into the cycle, we still maintain the largest loan book we've ever had with 62% or 63% LTV and all -- almost all floating rate and almost all now first mortgages.

So it is an anomaly that the company trades where it does. And one last thing. When we ask ourselves, "Why do we trade here?" I think we're glued to book value and I keep saying to people who ask, "You need to [undepreciated] the book and then you need to mark-to-market some of the positions." And Jeff mentioned over $1 share of equity gains, which we think is conservative in our multifamily portfolio, in our Dublin office portfolios, in some of our other assets, in our bond book and also in our fair value purchase book. The other thing that we've been doing and the other reason perhaps we trade -- by the way, if we continue to diversify into other product lines, maybe we'll leave the world of book value and you'll believe that you give us $1 and we'll return $1.12 sequentially over the years all the time and we're a good place to deploy capital to generate tremendous risk-adjusted returns on invested capital.

The next question would be, "Well, what about the special servicer?" I think Rina touched on this. The special servicer is really nearing the end of its life. It will probably last a couple of more years. The part of it that relates to CMBS 1.0, the original CMBS tranche is, but that business carries like a [$15 million] amortization, what's it called, Rina?

It's intangible. something intangible...

It's intangible and more than half of that now relates to 2.0, not 1.0. So that number may start going up, not down and we've written off, as Rina points out, $250 million of that intangible for the past years. I mean, it hasn't all been gravy, we've been writing down the intangible as we booked earnings and lowering the net effective earnings for the company.

So that business is no longer that material to us, and that's planned. We knew it was going to go away, and all these moves into the resi business, into the energy business, and to the other -- the Property Segment were meant to offset a featuring from 1.0 that we were going to lose and now 2.0 as Jeff mentioned, the best quarter in our history, getting new servicing contracts, 13 of them just in the quarter alone to build servicing business up for inevitably the next cycle.

So I'm really proud of the company. We really are a team. I'm so proud of the energy -- the cooperation between our energy team, our -- sorry, Capital Group executives, head of the due diligence on the energy deal and our property trust executives working together in the way it's actually supposed to work. It was a tremendous achievement of the team and I want to thank everyone and we think it's a tremendous deal for us and we're super excited about the team and growing the company within our company.

So with that, I think, we'll take any questions.

(Operator Instructions) Our first question is from Doug Harter with Crédit Suisse.

I was hoping just to get a little more color on that New York City residential loan. Just when you expect it might be modified? When we would expect -- when you would expect to get repaid on it?

Sure. We've been working for the modification over the last few weeks. We would expect it sort of imminently and we think there's another year of extension at the most with significant pay downs along the way. So a few months out, the balance will be significantly smaller than it is today.

Got it. And just to be clear to what Rina said, so of the reserve or impairment against that, $15 million is -- would be related to sort of time value discount and $8 million would be what you've baked in now as potential less proceeds that you would receive?

Yes. The time value is the big story because you have to use the mezzanine rate, which is a very high rate when you're discounting and Rina went through the that, but that is the $15 million of the -- all in because this project will end up selling out at prices that aren't far from where we originally underwrote them. It's just taken longer and we're very comfortable that the sales process will happen over the next 12 months and then we will be able to stick with those.

I think it's fair to say the borrower thinks he has X proceeds well in excess of our loan, by the way. He's already taken a small recourse facility from us to finish the project, which he drew only 1/3 of, it was a small loan. It was like under $20 million. But he thinks he can make money. We're just lenders. We don't get paid to take equity risk in loans.

So if that were the case, then you would get repaid in full? Obviously, it was in the contract.

That would be correct, that would be correct.

Our next question is from Jade Rahmani with KBW.

Just talking about the GE acquisition. Can you give some color on the collateral? The competitive landscape as well, who this business competes with directly? And I think you mentioned double-digit cash on cash target returns, but what are historical leverage ratios in these projects? And I guess, that's a start.

Why don't we let Himanshu answer that?

Yes, on collateral fees, these loans are generally secured with first liens on ...

Himanshu, you have to get closer to the phone.

Is this better? So let's start with the collateral. From a collateral standpoint, these loans would have generally first lien on the underlying project assets. So whether you have a wind farm or a gas-powered power plant, the loans would be secured by the entirety of the hard assets and any contracts that the projects have. Many of these agreements are with credit-worthy customers who would have 10-, 15-, 20-year contracts with high credit counter parties who are responsible for making payments that ultimately go to service the loans. So the loans are backed by investment-grade counter parties with long term contracts. So the cash flows are very stable and the loans are generally -- if you look at the default rates on these loans over the years, their -- it's very small and highly uncorrelated with the CMBS loans. So it's a very good and safe play from a cash flow standpoint. From a competitor standpoint, there are banks that would invest in this business. These banks are generally lending at the highest and safest spot in the credit spectrum. So very, very safe deals. The other competitors include other finance organizations. They could be names like Apollo and others who are also in this business, lending to similar kinds of projects. And then there is a big market on the [trombone] B side, which is comprised of a lot of other financial institutions. So generally it plays where investors are spending -- investing money in different credit ranges here and the competitors change, depending on which part of the credit spectrum you want to play.

And in terms of the leverage underlying the projects, how much equity is typically behind the first lien?

So yes, the deal assets are not overly levered. In general you have something in the 50% to 60% loan-to-value. So there's substantial amounts of equity underneath these loans in the underlying project levels.

And is LTV the right way to look at leverage?

It is. It loan-to-value, loan-to-cost and debt-to-recover ratio are the 3 metrics we use for credit analysis. And the [DSTR], which is a reflection of how much excess cash you have to service the debt for these deals tend to be -- close to 2 in many of these deals. So these are, again, very, very safe loans. A lot of these loans at the underlying level are rated and they are rated generally high investment-grade, high non-investment-grade, low investment-grade. So about B+, -BBB minus, BBB kind of loans.

And in addition, what's the amortization on the loans look like?

So yes, so there are 2 kinds of amortization profiles. One that fully amortizes over the life of the underlying customer contract. If you have a 15-year contract with a utility, these loans would be fully paid up over the 15-year period. The other structure is you get paid a mandatory amortization and a cash flow sweep, depending on the cash flow generation, but really, the loans are paid off in its entirety over a 5- to 10-year period. Most of these loans would mature in about 5 years.

And just, can you give any color on the non-U. S. exposure in the portfolio you're acquiring?

Yes, it's very little non-U. S. this quarter. 90% plus of the exposure is in the U.S.. There is some exposure in Mexico, but the Mexico exposure is with CFE, which is a very high credit counter party and the CFE contracts are all U.S. dollar-denominated. If you could look at the currency exposure, it's predominantly the U.S. dollar-denominated with investment-grade counter party even if it's outside the U.S.

Great. I just wanted to ask Barry, what do you think construction costs rising -- how do you think that will impact the CRE market? Do you expect it to limit the amount of new supply and to cause an inflow in additional value-add and transitional assets?

You are -- good question. I mean, our construction costs are rising very quickly, across the board, both labor and material costs and steel cost. I know somebody had dinner with Trump on Tuesday night and said they were going to talk to him about steel prices, which are up, I think -- I don't know, steel prices but he meant -- I don't -- the rough numbers are $700 to like $1,100 a metric ton or something like that. So yes, the deals won't cancel. The disciplined people will pull their projects and stop building. And I think -- it's good across all sectors of real estate. The only thing you'd like to go away now is EB-5 financing because that money is not tied to the economics of the project. It's used to supplement the capital stack where a normal capital stack, the project won't work. So at the moment, EB-5 financing has slowed down, certainly from China, and maybe it'll go away. But that would also help the markets in the major cities if that financing disappeared, which is clearly not needed in cities like New York. You don't need to create jobs with a 3.9% unemployment rate. So I think the answer is you have to be super careful because prices aren't rising as fast as construction costs. So as you make these loans, I'm really focused here on the U.S. One should be aware that of the -- frankly, what happened in the Upper East -- West side of New York with us, the borrower held out for very high prices. He could have cleared these units lower, at lower prices, he chose not to, and as a lender, you kind of just accrete at your coupons while you're waiting for them to sell the unit and the longer he sells, the more he wants to raise the prices in a market that is probably not as bullish a markets, the high-end residential market in New York. So you're going to see all kinds of issues across the New York high end residential market. We're already seeing it on the Spire deal, I guess, it's on West 57th Street, where the mezz foreclosed on the asset and the senior and kind of a mess and I don't know what's going to happen there. But you're going to see this in a bunch of projects. Fortunately we don't have that exposure. And like we mentioned on the call, this was a 2012 loan that was acquired in a pool by the team we had running the origination group. And that is not, obviously, the best underwriting in the history of mankind, although we still think we'll recover a par on the loan at some point. But that's -- those are the dangers of being a lender, especially in a resi project, where a borrower decides -- prices have gone up for my steel so I got to raise the price on my unit and you can't. And they see this equity disappear and it's like, I'll just play lotto. So I think New York City is a particularly weak high-end market. These units are not stupid high-end. They're not 3-plus thousand a foot. So as you climb the pyramid-type pricing, you get fewer buyers. But the economy is generally okay, and pretty good. Just had labor shortages here and there. It would be good for all real estate if it becomes harder to justify new construction and buy existing product and reskinning and renovating, it's clearly going to get a better return on equity than new builds in most cases at this point in the country.

And at this point in this cycle, do you think lenders are being disciplined or are you starting to see notable underwriting standard slippage?

I mean, with Tesla announcing they're going to private with no free cash flow for $80 billion, I don't know the answer to that. I would say in the real estate world, the lenders are still disciplined. For the most part, we're not seeing craziness. We see some guys going a little higher. I'd say -- what do you call us, they used to call it shadow banking, but we had a -- I was laughing at somebody's words for us, specialized lenders. Some of the newbies, what I think without the 30 years of real estate equity underwriting experience, we see them doing odd -- stretching a little bit on LTVs and they're going to ease.

With a record quarter for us, I would say that -- I don't know, the 36 quarters that we've been public. Sometimes in the prior 9 years, I kind of gulped when I saw some of the deals and pricing. I don't actually feel that way right now. I don't think what we're seeing and what we're doing doesn't make my head spin or not -- it's pretty much I'll say that we're happy with our risk profile and I think where people get -- sometimes lenders lend just off metrics without understanding the actual real estate. And so what looks good on paper is not great because these projects never work or you have bad assets. And I'd say in some of the hotel deals that have been done lately, the single asset large hotel deals, some of these loans are bananas. But that's not a space we've been in. So I should say that -- like for example, we have a loan -- I think it's like -- the first mortgage of $1 billion, and Jeff, correct me if I'm wrong, on Xanadu or what will be the future new project adjacent to the Meadowlands and we fully expect to get repaid. We had a mixed price security and it's going to -- the mall's opening and the leasing has gone pretty well. So we'll be repaid within months, if not weeks of the project's completion in construction. Jeff, is that, right?

Yes. We're a couple hundred million dollars off just over a billion dollar first mortgage senior that we think is sub-40%, probably 35% of cost loans that will likely pay off in the spring when it opens.

On the residential mortgage business, how big a cylinder do you think that could be? And are you looking to expand the joint venture with Impac?

It could be material, and I'm hoping it's material. I kind of think it can make as much money as a servicer mix. So we're pretty pleased with what we're doing there, and I hope -- again, we're growing these lines to whatever size their natural size is. I think Rina mentioned, there were some repayments actually in the resi book. So we're not -- I can't tell you we're going to have a $5 billion book or to peak out -- at roughly $1 billion. At the moment, I expect it to grow into a more material portion of our earnings and kind of fully supplement the income we got from 1.0 special servicer at some point in the future.

When we first mentioned that [donor], there was something we said we didn't think in the near future it would be 10% of our equity. It will take some work to get to 10% of our equity over the coming 12 to 18 months, but...

Yes, I should point out that the energy business is 10% of our equity roughly, more like 8%, but something like that.

Our next question is from Tim Hayes with B. Riley FBR.

Sorry about that, I was on mute. On the GE acquisition, you noted it's accretive and I know you don't provide forward guidance. But can you just help us frame how accretive this transaction could be to earnings and what that could mean for the dividend? Do you suspect that incremental earnings power might influence you to raise the dividend? Or do you think that taxable income might actually be increasing enough that you might need to raise the dividend?

I'll take a crack at this. I'm remote from the team right now. Had some slight trouble this morning. I would say that we're scratching our heads about how we trade, right? I mean, raising our dividend, is that going to matter? Is our stock going to go up? If goes up $0.25, does it matter? We need a re-rating of our company. We need to figure out how to get the share price up $3, not $0.25 and I don't expect that us raising our dividend is going to do that. We already trade stupidly. And we trade beyond our peers and we have the best business, we're the biggest and our bonds trade the cheapest and we have the best borrowing rates. We're the #1 borrower of any name playing actively in the United States. I mean, we trade completely bizarrely in the equity markets. And I don't think a dividend increase is going to solve that problem. Having said that, I would expect that this business will grow as they expand wha)t they can do and financing not only GE projects for example. Actually Himanshu and his team are in the market on Friday. It's for a large $700 million loan on a project they're doing. And we're giggling like -- because we see the spread, we know -- that deal would fit perfectly in the things we would do. And some of our peers have made a big business of financing their own deals. We haven't -- we've done that once and it's long been repaid twice, I think, once or twice, yes. We did an (inaudible) and I forgot what else we did if we did anything else. We did one other one, so two. But there, we wind up taking minority positions and if the loan ever gets in default, we are not the guy negotiating with the shareholders. We let the other person, the majority interest in the paper negotiate and we dropout or use our voting rights. So that's how we protect you from being on both sides of the trades. So anyway, the -- I'd expect this business to be bigger than we underwrote and will be more accretive than we underwrote, particularly at the spreads they are going to underwrite. So I do think that we were conservative on both on what they have originated in the past and I mentioned the GE health care business. We lost that deal, it was super tight and that business has done much better than we underwrote under the leadership of Bank One. So we were not -- we were looking at our history and saying we're probably being too conservative on the volume and spread these guys can do in the space going forward.

Tim, it's Andrew. Just one thing to point out. As you know and as a REIT, we're required to have a minimum 75% of our assets in income be in real estate qualifying assets in order to maintain REIT status. Just based on the size of our entry, we have sufficient cushion to acquire this portfolio outside of a taxable REIT subsidiary. So there won't be any tax impact on the cash flows coming from this portfolio. And also note that a portion of the underlying collateral is a good REIT qualifying asset. So obviously, that helps drive kind of where the portfolio can sit in our capital structure, but as you're thinking about this going forward, again, you should kind of model this as sitting outside of a taxable REIT subsidiary. So not being a taxable business for us [TWD].

Okay. I appreciate all those comments. And would you be able to just touch on, maybe the expected G&A and comp expense -- or increase in expense there, just based off of the acquisition? And maybe any cost synergies you expect to recognize?

Yes, I mean, we did a full bottoms up obviously, analysis of the platform and there are several millions of dollars of synergies between the 2 platforms. We're modeling, I'll call it, a mid-teens kind of $1 million G&A number going forward. And as I think we mentioned in our comments, we believe that the business is entirely scalable. So this platform can support significantly more originations than it's currently doing today. So I think you'll see kind of returns elevate through here without having to increase the G&A.

Okay, got it. And then switching gears a little bit. Very encouraging to see the strong CRE lending activity this quarter. Can you just touch on how the yield on new originations compare to the existing portfolio? And if you experienced any spread -- observed any spread compression this quarter?

I'll do it, and I'm sure Jeff can -- yes, if you have a 12% optimized yield, it's better than 24 years ago. So we're in the 11%, low 11%, I think -- so the 12%, how do you get to 12%? Our credit lines are tighter. The spreads are tighter across the whole real estate sector. We can make tighter loans and finance them more cheaply and maintain our return on equity. And after -- and that's in part because of our scale because we are actually lending -- warehouse lenders and also our corporate debt, which is pretty cheap. So in fact the banks are willing -- because the LTV is so tight, they are willing to lower the spreads on warehouse lines to keep us from doing A Note sales frankly, they'd rather just give us warehouse facilities. We'd rather do A Notes so it's a little bit of a trick. But in the public market, given the difference (inaudible) different vehicles, nobody seems to care. So you can't say that one guy does A Notes, one guy does credit facilities and there's a material difference. In fact, the ones doing credit facilities are trading better activity and getting larger

than we are. So I would say that we're able to manage and that is a good -- really good thing for not an obvious reason. If we can make loans "more markets" let's say, 300 over 275 and still produce 12 optimized yield in the market we retain, there is less likelihood that the guys can refinance this one property and stabilize it. So the tighter the loan, the longer the duration because you can stay in the deal. So it's got a hidden benefit to actually be able to lower unleveraged yields but maintain our equity spreads our debts -- our yields on those pieces.

Our next question is from Ben Zucker with BTIG.

Well, congrats on the GE acquisition. I understand that this makes sense with the broader platforms experience and the duration that the assets provide. When I look at Slide 10 of the acquisition deck, it sounds like most of the loans are backed by fully contracted or partially contracted deals. Is it your expectation that you will focus less on the merchant category? Or is that kind of like mezzanine lending and maybe a little bit riskier, but an ability to get paid more for risk there?

Yes, it's Himanshu again. It's super safety in our sector that our completely contracted are generally trading in the big 100 spreads on LIBOR, maybe even high 100. I think what we said we are going to focus on is something that is a combination of contracted cash flows and some contracted cash flows to serve the debt, and then those deals, what we look for, it's really more loan-to-value, loan-to-cost and those provisions for measuring the safety of these loans and those deals are only priced in our sector at about mid-300, low-300, high-300 ranges and this is spread over LIBOR. And I think the plan here is to really focus on these deals which are still safe from a loan collateral and value standpoint, but excluding the churns, that are more commensurate with a REIT needs, which is in, at least, the low- to mid-300 ranges.

I got you. That make sense. One small thing while we're talking about the portfolio. I think I saw that the GE loans are indexed at 3-month LIBOR. First of all, is that correct? And second of all, would you expect to finance this with 3-month LIBOR index that maintains your interest rate alignment?

Yes, it's Andrew. The answer to both of those questions is yes.

Great. And then in your prepared remarks, your referenced the profit participation you received in the quarter. Could you remind us if there any other significant participation still kind of buried across your loan portfolio? Or was that the last major one worth keeping track of?

There are others and that was a portion of that profit participation, 701 Seventh Ave, we expect at least one, probably 2 more payments in the coming quarters on that and we do have others in the book.

Great, Jeff. And then real quickly, if I may. Can you guys just provide an update on that JV regional mall portfolio?

Yes, I can take that. As you know, it's like 1% of our asset mix. We're not accreting any earnings or any dividends from the -- above the investment because all the money is going back into we re-tenanting the malls. And I would say that the mall space is certainly challenged. I recently toured those -- 3 of the 4 malls and they have to be repositioned in what's happening in the retail space, you couldn't really guess, and if you go file bankruptcy when your tenancy is actually solvent and has a good health ratio in your mall and even in other malls, before the company decides, for whatever reason to -- I'll take a Teavana bankruptcy, which is a subsidiary of Starbucks, for example, and the anchors are all moving around. What stops you moving about the anchors, of course, is that they probably have alternative uses, these boxes, either Dave and Busters or (inaudible) a restaurant or even a shared office facility. You saw recently that New York has made a deal with Lord and Taylor's in one year, so suburban Lord and Taylor's, they make perfect co-working things. The problem is the anchors in malls aren't driving traffic anymore. They were put there to drive traffic. So almost anything will drive more traffic than a Bon-Ton store or Carson Pirie at this point. Those 2 tenants -- actually we have one of them. We have a Carson. I think they're up in 1 of the 4 malls in that collateral. So we're talking to another department store though about -- it's very anxious to get into the center because the mall that they're in, one they do $35 million is closing. So this whole sector is tumultuous, and we think these are good assets, but of course, it's kind of hard to peg where the cap rates are because nobody really wants to sell until the dust clears. There was, obviously, an incredibly large trade done by Brookfield on general growth. It was recently the forward city trade with a mall portfolio that is under contract and I can't say anything more about it with an Australian firm. Those are very big cap rates, the acquisition cap rates. I mean, some of the mall analysts thought the GDB was wise. So that's a big price today than in this space that is going through so much change and re-tenanting and taking out your power and putting in your team. The good malls are certainly going to survive and some of them are actually thriving, if you look at the numbers at Taubman, they were good this quarter with their larger assets, even since their sales were okay. But these -- partly, these malls are being driven now with their Apple stores and their Tesla dealerships. So sales per square foot which is a green shoot metric is kind of an odd thing. You have 2 stores doing huge numbers and that doesn't necessarily bode -- talk about the health of the mall. So I think we have 4 Apple stores in each of these -- one in each of the 4 malls. They are the anchors now of these malls. They are driving traffic and their product cycle affects your sales in the overall mall.

Ladies and gentlemen, we have reached the end of the question-and-answer session. I'd like to turn the call back over to Mr. Sternlicht for closing remarks.

Thank you, everyone. Thanks for your generous time. We're all available, as always, to answer your questions and Himanshu can help as needed to answer any questions about Energy transaction. Thanks, again, and have a nice August. Bye.

Thank you. This concludes today's conference. You may disconnect your lines at this time and thank you for your participation.