Greetings, and welcome to the Starwood Property Trust First Quarter 2023 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Zach Tanenbaum, Director of Investor Relations. Thank you, Zach. You may begin.

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 March 31, 2023, 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’s website at www.starwoodpropertytrust.com. Before the call begins, I would like to remind everyone that certain statements made in the course of this call are not based on historical information and may constitute forward-looking statements. These statements are based on management’s current expectations and beliefs and are subject to a number of trends and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. I refer you to the company’s filings made with the SEC for a more detailed discussion of the risks and factors that could cause actual results to differ materially from those expressed or implied in any forward-looking 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. A 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 Chairman and Chief Executive Officer; Jeff DiModica, the company’s President; and Rina Paniry, the company’s Chief Financial Officer. With that, I’m now going to turn the call over to Rina.

Thank you, Zach, and good morning, everyone. This quarter, we reported distributable earnings or DE of $157 million or $0.49 per share. GAAP net income was $52 million or $0.16 per share. One of the primary differences between GAAP and DE is a $43 million increase in our CECL reserve, which I will discuss later. GAAP book value per share ended the quarter at $20.44 with undepreciated book value at $21.37. These book value metrics including accumulated CECL reserve balance of $153 million or $0.49. Beginning my segment discussion this morning is Commercial and Residential Lending, which contributed DE of $192 million to the quarter or $0.60 per share. In Commercial Lending, we funded $260 million, including $222 million of pre-existing loan commitments and a new $59 million loan, of which $38 million was funded. These were offset by $257 million of repayments during the quarter, more than half of which were office loans. Our portfolio ended the quarter at $16.9 billion with a weighted average risk rating of 2.8, of which 93% represents senior secured first mortgage loans and 99% of which is floating rates. On the CECL front, we increased our general reserve by $31 million in the quarter due to worsening macroeconomic conditions in our model, particularly in the U.S. office sector, bringing our general CECL reserve for Commercial Lending to $125 million. As a reminder, CECL requires you to estimate a life of loan loss with the forecasted macroeconomic environment being a critical component of the resulting reserve estimate. It is not a current market conditions only number like it used to be under the pre-CECL incurred loss methodology when we reserved a certain percentage of our 4 and 5 risk-rated loans. We use third-party software to model these losses, which, in turn, utilizes macroeconomic advisers…

Thanks, Rina. We added a new slide to our supplemental on Page 9, where you can now clearly see our differentiated total asset base. You will see only 13% of our assets are invested in office loans globally with just 10% in the U.S. office, including life sciences. This compares very favorably to our peers, and it’s part of why you see our cumulative CRE CECL reserves of $130 million against our $28.5 billion diversified balance sheet and $7 billion of equity are lower than our peers per dollar of equity. We built STWD to perform well in normal markets and outperform in volatile ones. So we are pleased that our stock has outperformed since the Fed’s aggressive rate hikes and the unprecedented spread volatility we have seen in the last year. In addition to our smaller exposure to domestic office loans, we have thematically increased our exposure away from high tax negative migration areas to lower tax positive migration areas. Following the lead of our manager, Starwood Capital, over 60% of our $5.7 billion multifamily exposure is in the Southeast and Southwest. And today, we have no loan exposure in any asset class in San Francisco and only 1% of our loan book is in Manhattan, two of the weakest office markets in the country. We have always run our company to a significantly lower leverage than our peer group who also write predominantly first mortgage loans. At 2.5x debt to equity, we, in fact, manage our business over a full turn of leverage lower than our largest peers despite having 25% of our equity in businesses like Residential and Infrastructure Lending that are run to significantly higher leverage by others in the public markets investing in those disciplines. Running our business with significantly less leverage and financing it…

Thanks, Zach, Rina and Jeff. Good morning everyone. While we joined the day after the Fed did their 10th increase in a row. I think I’ve been pretty clear what I think of this. It is bordering on idiotic. The biggest victims of this are the regional banks, which every quarter point is a $50 billion loss in their books. Last we checked, a point is $200 billion, and they’re going to have two choices. They’re going to take 100 banks back and have to sell their loans as they’re doing in assets, as they’re doing in Signature and Silicon Valley Bank, and it doesn’t look like they did because they supported the First Republic acquisition. And you’ll have RTC2. Clearly, the government will have to step in and save all these banks who really are a victim of the Fed zone stupidity, frankly. I mean you had a situation where the government set the rules. They said, you buy treasuries with all these deposits that are floating – flooding your banks because of the stimulus we’ve put in, buy treasuries have advantaged tax capital regulations and you don’t have the market to market. And it’s kind of like if you had a hurricane or told everyone, you’d never experienced a hurricane. So why would you buy a hurricane insurance? Now I think what the management’s missed is the pace at which the deposits could disappear obviously helped by social media today. But realistically, you have a really nearly insolvent regional banking system based on the rules that were set up by a government that has 30,000 people to monitor the banks. That’s between the FDIC, the OCC and the Federal Reserve itself, but we are filled with PhDs running models that make no sense. There’s no question that credit…

Thank you. [Operator Instructions] Our first question is from Stephen Laws with Raymond James. Please proceed with your question.

Hi. Good morning. Congrats on a solid quarter, and I appreciate the new Page 9. That’s helpful to look at the company that way. Rina, I’d like to start with special servicing and maybe leverage off Barry’s comments. If we’ve got all of this debt maturity coming, whatever amount $1 trillion something over the next 2 to 3 years. When you look at your special servicing book, I think it’s only got about $5 billion in active right now, how should we think about that number or what the range of that active servicing book could be over the next 12 or 24 months? And then kind of what would the resulting revenue be at those ranges as you think about that working through the system as transaction volumes increase?

Thanks, Stephen. Good to hear from you. It’s Jeff. The way I think about the CMBS book is sort of simple. You went through a period from 2008 to 2011, where there was really no CMBS. You had a little bit in 2012, and 2013 was the first year above $100 billion again. We maintained above that and grew it through 2019 and beyond. And you’re now starting to see those 2013 originations come on a 10-year. A lot of them were IO. They don’t tend to add significant cash flow with 2x to 4x debt service coverage at origination. So they make it to the 10th year. And at the 10th year, we may see some fall in. So we’re just at the beginning of what will be a bigger wave of maturities. There is been a lot written about those maturities but the CMBS market is just starting in the maturity cycle. So when something does mature and it gets put to our special and we’re a little over $5 billion, as you said today, we will start earning ticking fees for the next year, 1.5 years as we maybe reposition more work to sell the asset and then we get the largest fee at the end. So even on the 2013, it’s really ‘24 revenue. It could be ‘25 revenue. And as we look at the credit cycle that we’re in today, if it’s met with the rate environment that we’re at today versus what was underwritten, we’re going to have a bevi. So when you’re modeling it, you can take $107 billion. You pick the percentage of losses that you want on that, and that’s what’s going to add on to the $5 billion. And for sort of simple math, we tend to multiply that by 1.25% to 1.5% of that will become revenue at some point in the future, a year to 2 years later. So we’re really excited about 2024, later part of ‘24 and heading into ‘25 and there is a lag and a delay there. So just wanted to make sure everybody understood that.

That’s helpful. I mean from a run rate standpoint, $7 million, $8 million, $9 million a quarter, I mean, I’m looking at my model from 2Q ‘13 into ‘15. I mean, you’re running $50 million or $60 million of revenue to that segment. I mean are those levels sort of attainable? Or is it pricing and how it works a little different on...

Given what we’re seeing today, that could be a [indiscernible]. I mean a lot of these losses will have to be slides and [indiscernible] be restructured, right? There’ll be A note – to B noted and you get paid, not at the end, you get paid when you restructure it. So that’s this differ from Jeff. I mean, we might do two exits. It might be the restructuring and then the final deal then. So there’ll be two opportunities for us. And I think that’s probably the only way the office markets are going to get restructured. You’re going to have to set a new level with an A note and then there’ll be a new capital coming with the press, and then there’ll be a – note for the back. And that is – I would guarantee you that’s probably 80% of the restructurings in the office market. Nobody wants the assets back, right? But no borrower is really keen on putting capital in, in this environment when the government telling banks don’t make office loans. So the bank – the real lender for office is the existing lender and there is no other lender. So we’re happy because – I mean, we will get the coupons. There are tenants in place in most buildings and some, as I mentioned, are full. And most of our book is A class office building, so they’ll tend to be full, but there will be capital cost. And I think for the first time in 35 years, everyone is focused on these capital costs now. And what is the cap rate that clears the building value and makes the investment of the TI worthwhile for the borrower? It’s interesting that in prior soft cycles, borrowers in strained credit conditions that we won’t…

Thank you. Our next question is from Jade Rahmani with KBW. Pleas proceed with your question.

Thank you very much. I’m trying to square two things. When I look at the CECL reserve, it’s amongst the lowest. I know it’s an accounting treatment, but it is amongst the lowest of the commercial mortgage REITs and much below that of the banks. I understand it’s a different methodology. The loans are shorter in duration, floating rate. There is capital that’s come in. So there is reasons for that. And then I look at disclosure around properties held in the lending segment that have gone through foreclosure as well as the non-accrual non-performing loans. And I appreciate the disclosure you’ve provided. It is amongst the higher end of the range. It’s not as high as some of your peers, but it’s higher than a few. And then from Jeff’s comments loan by loan, it seems like there is a plan on many, if not most of these assets to recover value close to Starwood’s basis. So just – I think one of the reasons the stock is down today is nervousness about what’s coming on credit and if the CECL reserve has to move meaningfully higher to accommodate that. Can you address that, please?

Yes. Listen, Jade, when something – we’ve taken two into REO, and I appreciate that you heard my comments, but you seem to be very skeptical on them. So we’re more than happy to go over the five assets that I said we expect full repayment on. So therefore, there is no reason to take a CECL reserve. We also use the most draconian version of the model because we know we’re lower than our peers. We’re significantly lower than our peers. By the way, we have 10% U.S. office. Our peers are in the 30% or above 30%, like there is a reason why we’re a lot lower than our peers. We just spent 25 minutes in prepared comments hoping people would understand why we set up this business so dramatically different than our peers with massively lower leverage than our peers. Those are the reasons we have significantly lower CECL reserves. Management may or may not be right in our assumption on all of those loans that we’re going to get repaid fully, but we believe it today, and this is a public earnings call, and that is our best guess of where things go, but we feel very good. We are willing to take things into REO. We’ve done it. We’ve made money off of it. And we are using the most draconian model that we can possibly use to bring our reserves up because we know people are going to be skeptical of our reserves. So we pushed the model as hard as we could to increase it. But this is just the reality of what we see. And it’s the reality of the business that we built, which is the underlying piece to compare us to anyone else. Well, I will tell you what, take – add a turn of leverage to us, 1.5 turns versus our biggest peer of leverage to us, we would have more CECL reserves. Add 25% more office we would have more CECL reserves. That’s not how we built this business. So, it’s sort of frustrating when the people who know us the best, don’t see that, but we are happy to spend more time on any one of those assets and repeat what we said or go deeper.

I am going to add another point, like we have marked our non-accrual loans is like $0.80 on the dollar. So – but obviously, we expect – one is as low as $0.76. We have already taken those into these. So, we think they have marked appropriately, and that’s one of the reasons. Again, it’s a puzzle, right. And then the CECL reserve you see is formulaic. It is a math model that we don’t control, but an asset is already which doesn’t get more done. And so, it’s just hard to mark. And based on bids we have, we can see where we think the values are. So, we have tried to be conservative. I don’t – don’t get us wrong. You could see a drop of the dollars. You could see some book value deterioration, but the earnings power of the company is tremendous. And I think we will come out of this stronger. And when we can go back into the aggressive lending, this is the best lending environment since 2009. It is an amazing thing there. And we will, if we have to take the gains in our book to offset the losses, we can sell down our fee income book, which no one else has to actually preserve and actually – obviously, there is a delta between our book value and our fair value. So, it’s – our gains are 10x our CECL reserves. So, we – and we are confident and this is affordable housing. This is an insured asset class where rents are being adjusted by inflation and by wage growth. I mean two really good things that are driving the rents much higher than we ever thought they would be. So, you have a very flexible balance sheet. And we have got…

And just one other thing to what I said earlier, lending, as Barry said, is 60% of our balance sheet. It’s not 100% of our balance sheet. So, unless you are going to assume losses on property and some of our other areas, we should also come in lower on the CECL side. Thank you.

[Operator Instructions] Our next question is from Rick Shane with JPMorgan. Please proceed with your question.

Thanks guys for taking my question. And I may try to squeeze two in here. But when – Barry, you talked about the opportunity related to capital freed up from the REO and the non-accruals. You talked about an intoxicating stock price and Jeff, laid out the disconnect between the implied losses and your expectations. As you think about capital allocation, how aggressively should you be allocating some of that additional capital, particularly given the low leverage to your buyback?

I would still like to build our reserves up slightly. I think if we achieved north of $1 billion of liquidity, we would aggressively go back in the market. So – and that would be attainable with some of the REO sales and loan sales that we could achieve them. So, I think that’s kind of where we would like to be. And we have a few things cooking that – including the repayment of a large loan that will happen as a week, we think. And that would include repurchase of the stock. It’s not just making new loans. Our stock is now a better – probably a better investment than most new homes we would make. I mean the issue with construction loans is we don’t get to put money out of that coupon upfront. They are drawn over time, whereas we are saving the dividend yield on our stock on day one. So, that would – as we have in the past, every time the stock has gotten down, we have repurchased it. So, we would do the same this time as soon as we clear what I think is – look, you know that your credit is constrained today, so we have to be careful. But you know for the multis, the agencies are wide open. That’s a third of our lending book, right. So, that’s not an issue. We expect that spread – the first thing that will happen in the credit markets, and we will see if – once this banking crisis sort of clears and they take back 100 banks at the rate they are going or might be more, spreads will come in. Some of the spreads in the security markets, including RMBS and CMBS markets are wide because the regional banks…

And I would add that – I would add to that, that Rina mentioned the $620 million of cash. We have a loan closing tomorrow that’s coming back to us. There will be $750 million of cash. The reality is we have $4.2 billion of unencumbered assets. We can go borrow against those unencumbered assets tomorrow. At today’s SOFR and paying up – taking a loan and taking debt at 300 or 325 over, which is where the market has moved to, we are going to pay 8.5% to create more liquidity. So, we have more liquidity available to us, but the cost of that is 8.5%. So, it’s very difficult to convince yourself against cost of liquidity of 8.5% to sort of lever up the balance sheet or try to create a lot more that you end up ultimately sitting on and doing this borrowing also would increase our leverage. And we are very cognizant of our credit rating. And at 2.5 turns of leverage, and we believe we are going to have a great opportunity to issue unsecured later in the year against this higher cost financing we have taken. When we do that, we will have increased the amount of unsecured debt to secured debt that we have on our company. And we believe that along with holding the line on low leverage is tremendously important, because it will lead to a ratings upgrade for our debt. We will borrow cheaper than we win. So, being cognizant of the cost of that excess borrowing today to create a tremendous amount of liquidity that we could flash to you guys and you would see billions of dollars, well, we would be paying 8.5% for it and others are effectively too. So, we are choosing to run our liquidity where we are. And as Barry said, if we come up with excess liquidity that sort of doesn’t cost 8.5%, I think we would love buying back our stock rather.

Thank you. And our next question is from Don Fandetti with Wells Fargo. Please proceed with your question.

Barry, if the Fed did come in and cut rates like the futures market is projecting, do you think that would change sort of the psychology and the CRE property markets and kind of put a floor on values you talked about a lot of money on the sidelines?

Again, I think if spreads come in first and then rates go down. Those are – that’s a double whammy. Spreads are twice as wide as it used to be because there as fear in the markets. I think – look, I think the office asset class is going to evolve a little like the malls, right. The mall market, we all thought and we read and everyone was completely panicked that there will never be another physical store. We thought the world was ending in retail like done, and yet look at Simon’s results yesterday. I mean the good malls are full, right. We are near Aventura. They just added like a several hundred thousand foot expansion and it’s completely full. So, the office markets will behave exactly like the retail markets. They will be good buildings and dead zombies all around. And you will have a great opportunity to lend against the good buildings. And that’s what we get paid to do, be smart investors and take the right risks. I think – but right now, it’s fun to hear every day. And Charlie Munger say, the real estate asset class is getting pummeled. It’s not really about the asset – single family say, look at even the prices of homes, they have held up really well, far better than most people thought. And you see multifamily rents have reaccelerated. They were – there was a weird thing that happened at the end of last year where tourists for rentals dropped, but they then have gone bananas in the first quarter of the year. We don’t want and don’t expect to see 20% increase in multifamily rents. That is – that’s some weird condition that’s never happened before. We saw it in ‘21. Everyone saw it in real…

Thank you. Our next question is from Doug Harter with Credit Suisse. Please proceed with your question.

Thanks. As you look forward, is there any need or desire to kind of reallocate any of your capital in the coming year, so towards this lending opportunity that you said is building?

Okay. In the next year, will we look at lending opportunities towards what? I am so sorry.

Alright, sorry. But in the commercial real estate space, as you are talking about this potentially being a good lending opportunity, is there opportunity to reallocate capital away from say the residential portfolio or the property portfolio to be able to take advantage of the lending opportunity kind of on the other side of this downturn?

Yes. Listen, the easy one to say is we are not adding property today at sort of today’s financing costs, our cash-on-cash returns were nowhere near our dividend. So, that’s not getting bigger. Could it get smaller, obviously. As you look across the other ones, I think we really like our Energy Infrastructure segment. Right now, we earned almost 20%. If we ultimately earn what we believe we will earn on the investments we made in the last quarter, that’s been as big of an investment cylinder for us recently as CRE lending. We think CRE lending is fantastic today. We think there are opportunities to get really good spread. Obviously, you are financing it at an expensive rate. The more we can do there, as I mentioned before, the more repo we can take or if we don’t choose the CLO financing, which is unlikely today or an A note financing, which is more difficult today. If you use repo and you take more expensive repo, it’s a great opportunity later to pay that off with unsecured, as I talked about that, that ability to potentially get a ratings upgrade on our debt. So, we would love to do more. We think it’s a great environment to do more. But our cost of debt is really expensive. CMBS originations are really interesting heading into the back half of this year. Our team has done an amazing job over the last couple of years of making money every quarter when every bank lost money in most of those quarters. So, we hedge the credit risk there. We hedge the interest rate risk there. And we think that there will be a significant pickup later this year. So, we are – we have a great team on the field that we…

Thank you. Our next question is from Sarah Barcomb with BTIG. Please proceed with your question.

Hi everyone. Thanks for taking the question. So, in the prepared remarks, you mentioned the high concentration to the Southeast and Southwest within the multifamily bucket, and I am specifically curious about the deals that were underwritten in the back half of 2021 and front half of 2022, when we saw rapid rent growth and higher LTV lending. And while we are still seeing high rent growth in those markets, are you starting to see any signs of NOI at the property level coming in below expectations on deals that were penciled with negative leverage back then when rates were near zero? And are you seeing any risk in the sponsor’s ability to service their debt in those situations? Are you seeing any issues on the ground here pop up yet?

So, I am sorry, I thought Barry was going to take it. I guess I will start. From a rents perspective, you have obviously seen rent push from late ‘21 into today, so income is up. Expenses are up a little, but income is up a lot more. So, even the loans that we wrote, I think you are implying that we all, as an industry, wrote loans on lower cap rate than today. We have gone over this, and our portfolio in total is sort of 6.2% in-place debt yield going to 7.1%. As Barry said, that feels pretty cheap to us. I would say the stuff we did at the very bottom, they are – there may be some high-5 debt yields of the things that we did in late ‘21. But again, you have had rents pushed, and we expect rents to continue to push, but at a more moderated pace today. And as long as they outpace expense growth, I think there is a lot of [ph] in those loans.

Honestly, if we get these assets back where we win a fraction of their construction costs, we would be happy to say our careers. We will just add them to our REO book alone. I mean we will leverage them when the spreads come down with Fannie and Freddie and we will loan. And they bring new assets, and we – they are good assets in good markets. So, that would be a really positive outcome for us. We are happy. We are the only mortgage REIT that had always had fee assets. We always went into the fee ownership business. We just couldn’t get the yields on cost we got for the initial portfolio. But even there, we never anticipated the rent growth we saw in the affordable housing portfolio. That’s frankly I think the deal is like 100 IRR. I mean we have refinanced our equity of the deal and still have $1.5 billion of gains, some of which we obviously took with the sale of the minority interest. So, we have issues that are different issues like these gains are taxable. So, we have to be very careful how to harvest them. And so we want to make sure that we pay as little taxes as we can on the gains in our portfolio.

They are distributable not necessarily taxable...

It is distributable not taxable.

And we have to…

That doesn’t help us that much on liquidity. That’s what we are saying. Yes.

Thank you. There are no further questions at this time. I would like to turn the floor back over to Barry Sternlicht for any closing comments.

Thank you all. I mean these are trying times so we are available to talk to you as long as you want and transparency has been our hallmark. I think our new disclosure page is very helpful to all of you, whether you look at our company different from others in the sector, we don’t wish anyone ill. But we are a slightly different company than most. And we built this business on a purpose. And as Jeff said, having the ability to do nothing or investing in all these other alternative businesses is an asset and benefit to the firm. So, with our 300-plus people that are dedicated to activities here, hope you navigate these waters well, and we look forward to talking to you next quarter. Thank you.

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