Ladies and gentlemen, good morning and welcome to the Starwood Property Trust Second Quarter 2023 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Zach Tanenbaum, Head of Investor Relations. Please go ahead.

Thank you, operator. Good morning and welcome to Starwood Property Trust earnings call. This morning, the company released its financial results for the quarter ended June 30, 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. 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 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 $158 million or $0.49 per share. GAAP net income was $169 million or $0.54 per share. GAAP book value per share increased $0.07 to $20.51 with undepreciated book value increasing $0.09 to $21.46. These book value metrics include an accumulated CECL reserve balance of $260 million or $0.83 per share. Since our last earnings call, we significantly enhanced our liquidity position with the July issuance of $381 million in convertible notes and commercial and infrastructure loan repayments of $1.3 billion during the quarter and $472 million subsequent to quarter end. Net of $787 million in fundings across businesses, our current liquidity increased to $1.2 billion. Beginning my segment discussion this morning is Commercial and Residential Lending which contributed DE of $182 million to the quarter or $0.56 per share. In commercial lending, our pace of repayments picked up with $1 billion during the quarter and another $386 million in July alone, well in excess of last quarter's $257 million. More than half of these repayments were on mixed-use and hotel loans. These were offset by fundings of $272 million on a refinanced loan and another $235 million of pre-existing loan commitments. Our portfolio, 93% of which represents senior secured first mortgage loans ended the quarter at $16.4 billion with a weighted average risk rating of 2.9. On the CECL front, we increased our general reserve by $104 million due to our third-party model indicating a worsened macroeconomic outlook. We also applied more negative macroeconomic assumptions to our office loans in addition to loans with 4 or 5 risk rating. This brought our general CECL reserve to $228 million. Of this amount, $136 million or 60% relates to office. As a reminder, CECL reduces our…

Thanks, Rina. We have run our business conservatively since inception 14 years ago. We've uniquely diversified into multiple cylinders, including commercial and residential lending, energy infrastructure lending, CMBS loan origination and investing and our $102 billion named special servicer that produces countercyclical income in times of credit distress. We've also built a large owned property portfolio that accounts for a record 29% of our company's undepreciated book value, predominantly in the highly resilient low-income housing multifamily sector. This segment has produced high cash returns and additionally, over $1.5 billion of harvestable gains contributing to the liquidity Rina just mentioned. Starwood Property Trust is the diversified low leverage hybrid we set out to build with no true direct peers. As a result of this diversification, we have managed our exposure to U.S. office assets down from a peak of 26% to just 10% of our assets today. In that time, we significantly increased our allocation to more defensive multifamily and industrial loans and to the owned low-income multifamily investments I just mentioned; all of which sit at all-time highs as a percentage of our balance sheet and continue to perform exceptionally well today. Our company's leverage improved again in the quarter to 2.4 turns which is about a full turn of leverage lower than our peer group average. If our asset mix looked more like our lending peers or if we increase leverage by over 1 full turn to look more like them, our company would significantly outearn its dividend in this higher rate environment. But that is not how we chose to run the company at this time. We built a diversified company with a conservative balance sheet that would best enable it to pay a stable and perhaps at times a growing dividend. We have not and will not…

Thanks, Jeff and good morning, everyone. Thanks for joining us. We started this business now almost 13 years ago, we talked about being transparent and predictable [ph] running a conservative business. So we could depend on our dividend I think we proved our transparency in this earnings call. That's a lot of detail. I'm going to go all the way to the top and talk about what I think is going on and how we're going to address it. As you know, many of you know, I've been critical of the Fed. I wasn't really critical of the need to raise interest rates. So obviously, they should have been raised as well before the Fed raised them. It was more the pacing of the increases and how quickly they did it, sort of a U-turn, it was more to me than a u-turn even and straight up and then we have the highest interest rates we've seen in 22 years. When you do something like this, my other overarching theme was that the economy was going to slow anyway. You can see that savings were dissipating that consumer spending was slowing, confidence was falling. And as inflation too cold, people were using less of their wallets. What I didn't really anticipate and what you're seeing now is the scale of the government programs under the Vynamic [ph] legislation, both the Infrastructure Bill, the inflation reduction actually which is really a stimulus package centered around climate, the CHIPS Act, all that spending is creating a lot of public spending that is offsetting the slowdown in private construction and private setting. And of course, private construction slows only as property is complete. You don't stop a project in the middle of construction when the Fed is raising interest rates. So you sort…

Thank you. Ladies and gentlemen, we will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Stephen Laws with Raymond James.

Another nice quarter and congratulations on that. I guess for my question, I'd really like to hit on Woodstar. Can you talk about the strength there, pretty material fair value increase? It looks like rental income was relatively flat versus Q1. So can you talk about the rent rolls that hit in Q2, when we should see those come through? And what assumptions went into the fair value mark for June 30?

Rina, do you want to start?

Yes, I'll start. So Stephen, the fair value increase that you saw is the result of the 7.5% HUD maximum rent increase. Those increases are going to start taking effect. We roll them out beginning July 1. So you're not seeing them in our second quarter earnings number. That's why earnings is flat quarter-over-quarter but we know that those rents are in place. And so the valuation was based on in-place rents at the end of the month, even though you're not seeing them in earnings, if that makes sense. So it's just the 7.5% rent growth that we factored into the valuation and that's how we got the incremental $209 million.

Let me add one thing that the actual increase was 10% -- 11%, 11% [ph] and HUD restricted it to 7.5% [ph]. And we can take that left over increase in applied to next year's increase. So we didn't lose it, we just deferred it. And they'll also be whatever the increases next year. And the rent for the affordable portfolio is determined by 2 factors, inflation and also media income. So media income growth will probably remain positive, significantly positive and so you'd expect the total growth next year. It's also a rolling 3-year thing. It's not 1 last 12 months. So you should have good momentum into further rent growth in the portfolio next year as well. One thing about affordable housing, just as it's obvious but I should say maybe it's not that obvious to everyone. It stays full, always full because it's 30% to 40% less than prevailing market rents. So the question is rents and what they're set up by the government. So it was -- I think it might have been unprecedented for the government to step in and not give you the full amount of their calculation, you know how it's a very transparent calculation. So they just decided, I think politically, it wasn't possible to increase affordable rents at that pace in those markets. It was not applied across the country. It was just certain markets we happen to be in those markets.

And Stephen, you know we have pretty low fixed rate debt that doesn't start rolling until '26 and then there's a series of roles after that. So we have plenty of room on our debt to continue to get similar cash returns and not have to worry about refinancing that portfolio.

We take our next question from the line of Doug Harter with Credit Suisse.

Can you talk about the potential size of the new lending opportunity and whether you would kind of look to accelerate some of that, the disposition of some of the nonperforming assets to be able to deploy into that? Or would you continue to be patient on that -- on those assets?

Well, I think you know about one of our biggest non-accruing assets is as we're part pursuing the first mortgage of a giant property over in New Jersey here. And our basis will be down soon to $0.70 or so, a little below -- a little below. And so that's the first mortgage, by the way. There's cross collateralization and all kinds of good on top of that which is a fairly gigantic property. So I think we challenge ourselves every day to say, even though the property's performance is getting better and better and better. So what's the right time to sell it. But it is -- and we can sell it for $0.70 and on take a loss, I'm pretty sure we can sell it for that. And then we can deploy a couple $25 million [ph] into stuff. So we're probably getting close. Again, you know that if short rates are lower in -- as soon as it breaks, as soon as the Fed says they're done, or it's more obvious, I think spreads come in. for new buyers. And then I think people's expectations and I think whether they price that mortgage, do they price it to 10 to 11 to 9 [ph]. That all depends on what they think the future of interest rates will look like. It's -- if you think rates are going up, you're going to be $0.68. And if you think rates are going down, you're going to $0.75. So -- because it is the first mortgage. So yes, I mean, we are very much paying attention to that. I'll just point out with all of these nonincome-producing assets, we're still learning our dividend, right? So is actually shocking. I think I said this like 3 quarters ago, we didn't have…

To put it into scale, we did $15 billion in loans in 2021, a little over $10 million in our transitional floating book. We have repo capacity. If we were to do that same volume over the next year, we have retail capacity. Most of our peers, I don't think do. We have the equity if we want to create it to do that. And I think the market is turning to where we could probably do 75% of that given what we think the landscape will be over the coming months. It will really come down to how certain we are about what money is coming in and continuing to see loans repay and our desire to further leverage the company to take out, create more equity to do it. But we have the capacity in repo. We've been here before and I think that we're probably going to run at 60% to 75% pace in terms of opportunities where we've been and we'll probably pick up our pace where we've stopped -- we slowed down to about $1.5 billion a year. I think you'll see us starting to trend back up.

What's the amount of the unused repo?

Three point something of unused loans [indiscernible] feel comfortable. We can look out in the landscape and we really go along by loan and like who do we think can take us out, where they're likely to take us out. It is an interesting situation because you've seen it in the media from Starwood. I mean there are some office buildings that you are just walking away from. Why are you walking away from the building? Many of them are fairly lease but the loan, what's the cap rate on an office building today? Odyssey will tell you, it's a 4.4. I will tell you, it's double that because if you want to get financing to buy an office building today, is in 7%, 8%, 9%, 10%. So nobody is going to buy an office building at a 4.4. Nobody is a big word, very few people. Maybe there's a sovereign well somewhere that decides they want a trophy in some city for their brochure and we'll take a 20 years or but we're not able to do that. So when you have a building, even if it's 70% leased and you have to get it 90% leased, you have to put in more capital for the tenant improvements and between the paydown and the debt that's required by the bank and the capital improvements that you have to put in to stabilize the asset. And in the cycle so far, the bank doesn't want to give you a 5-year extension for the world to reset itself. You just can't do it. As a fiduciary, that's not a great move. So you've seen, frankly, Blackstone, Brookfield Starwood all walk away from properties on occasion in markets that we thought were injured. I do think the office markets are better than…

Our next question comes from the line of Rick Shane with JPMorgan.

I'd like to talk a little bit about the special servicing at LNR. It looks like the active special servicing went up about 10% quarter-over-quarter but the name special servicing declined about 5% I'd just like to talk about sort of the movements there and also how we should expect that to play through the P&L over the next 6 to 12 months?

Thanks, Rick. Yes, you're right. The active will move around as you start to see roll off. So one gets to the other. So you had about $5 billion or so of maturities and we'll start to see maturity take up. So our named special servicing absent us continuing to buy new deals and we have recently been investing in newbie pieces. So we will add to that at the same time it gets subtracted. But for a long time, deals weren't maturing, so our balance only went up of named special servicing. Now you're getting into those the end of the 2013 maturities. So you're seeing maturities that we had about $4.5 billion or so roll off and mature. I think we'll have another $3.5 billion or so for the rest of this year. Some percentage of that $4.5 billion rolls in, right? And if 10% of that rolled in, then that's the $500 million increase in active; so one creates the other. And I think that this cycle will continue now for the next few years as you had more originations in 2014 and into 2015. You'll start to see the runoff pick up a little bit and you should see the active pick up a little bit. And obviously, we get paid on the active. So we've been saying for the last few quarters that we expect the revenues to really be a 2025 phenomenon as the 2013 and 2014 is mature and run through the special. So we're expecting the increase on the revenue side to sort of be later next year. So we always say it's sort of 18 to 24 months of lag. So, more of a 2025 revenue thing but it's playing out just as we expected it. The percentage of that runoff that rolls into active is what will be interesting. The more office we see, the more you'll probably see roll in and that was a bulk of what we did see come in this period but we will pay attention to those maturities. And most of our company is hoping that you don't have a lot of distress. This is the one part where we're hoping that there is distress and we will make money off of that distress which makes this great carry hedge for us. So we're staying fully staffed, getting ready for the opportunity but it will really pick up over the next 12 to 18 months.

Our next question comes from the line of Don Fandetti with Wells Fargo.

Can you talk a little bit about multifamily in terms of the outlook at your largest exposure in CRE lending? I know there's a couple of factors like higher cap rates and also just hire debt service burdens given Fed rate hikes. How do you feel about that, especially if the 10-year were to go higher?

Started the basics. I mean the Fed's actions in a strange way will hurt inflation longer term because they're creating a bigger dearth of housing stock and the lack of single family -- existing single-family home sales have created a really odd outcome with the new construction being not only robust but at good prices. And I think everyone's been surprised at the strength of the new home building. When -- I'm not sure in history, you've ever seen a situation like this where rates go up and existing -- new home sales go up not higher than they were but the backlogs are growing. People are still moving. They want to buy a new house and nobody is selling their old house. So they have to buy a new house. And that's relevant to multis. Multis -- we stress this book, I personally sat down with the team. I think we're selling today multis, there's no attractive debt in the 4.75% range. Because it's really good long-term juicy debt, you can get low force. And why are people buying it, they do think you're going to see rents accelerate again. They are slowing down. Nationally, rents are almost flat. And that came from Fannie Mae which obviously has loans on pretty much every asset in the country. And they vary from down in California up in Florida, it's up in New York, up in Boston, you saw that recent report, I think, came out last week on the housing market. They are softening but they're still, as I mentioned, positive and we have 120,000 apartments, some of which is significant chunk of it is affordable but our market rate stuff. We're around 4, 4.5. And some markets are accelerating and some markets are decelerating. The cap rate where we…

I'll throw on looking at our portfolio, right? The area we probably built up the portfolio was 2021 and that was the lowest cap rate. So you were taking 4 cap assets that we thought had 5%, 9% [ph] or 6% exit debt yields. You pushed rents in '21 and early '22 by 10% or so. In the last 12 months, our portfolio has seen 7.8% rent growth. So by pushing those rents, your exit cap rates have now gone into the mid- or mid- to high 6s. So for a moment in time, on a roll on that loan in 2024 or 2025, if the silver curve [ph] stays right here, for a moment in time, you'd be negative carry for a couple of months but if the forward curve is at all right, you will be positive carry. And over the life of it, it'll be significant positive curve. So we have great escape velocity at today's forward curve, even against those sort of 4 cap assets that were at the highs because we pushed rents and expenses haven't gone up nearly as much. So exit debt yields are higher. And we think right now, we have plenty of escape velocity to get out all those loans as they start rolling in '24 and '25.

Our next question comes from the line of Jade Rahmani with KBW.

You look back to early March and the Siri, the storm was really taking hold, then we had the bank distress. Fast forward to today and we've gone through second quarter results and it seems no huge shoes to drop a couple of big credit losses in the mortgage REIT space. You all took up the CECL reserve on macro nothing really new, that large on specific loans. So my main question would be, given the category 5 hurricane as you put it, are you surprised that there have not been huge new shoes to drop of late? And do you think it's just a timing issue? Or do you think this represents kind of a green shoot in your view?

Sorry, it's a timing issue. Again, if you have caps, your loan is not maturing, it's not blowing up until it matures but it could be offset by what I'd expect to see a lowering of short rates maybe early next year. But I don't -- I know you on going to see a month [ph]. If we have a complete crack every time that's happened, the Fed has gone to 0 on short rates. That would be good news and bad news. That would be the opposite of collateral damage. That's the windfall for the property sector. It is what -- if he is measuring his success by rising unemployment, I just think that is really hard. That is a very -- I guess, the additive is a blood tool. It's more like a sledgehammer because the -- you can only get the unemployment in certain industries, the service industries, manufacturing industry. it's not going to come from government spending; government being 3 and 7 [ph]. You imagine Apple was spending a $1.7 trillion. I mean, $1.7 billion is a lot spending. That's just the fiscal budget before you get to the stimulus programs that are still coursing through the economy. So I think it's -- like I said, I think it's a mine field. And that's one of the reasons, we're not deploying all this $1 billion today because we have to be careful of every single loan and every single borrower each borrower was in a different position when I was saying about Starwood Blackstone and Brookfield, I think big borrowers and small borrowers are being judicious as fiduciaries for their capital in this climate. And it's not like we've seen a deal like the deal in D.C. that we took back the -- it was a…

We take the last question from the line of Sarah Barcomb of BTIG.

So the single-family resi market has held up pretty well. Could you speak a little more to how that resi credit book is performing and how you view the optionality to move that book. Maybe you could touch on that in the context of the SFR portfolio sale at SREIT, are you seeing any newly emerging bad debt issues that are concerning and is there any way for Starwood to recycle that into new commercial real estate opportunities? And if so, what sectors or geographies do you find most compelling right now?

I'll do my part and then Jeff to his part. We're not -- the REIT is not in the single-family rental lending business. That's not one of our verticals. We have non-QM loans and we have agency assets but we don't have loans against SFR. The SREIT sale to invitation homes was not something we really wanted to do. We love the asset class. We love the prospects for the asset class but we had redemptions to make and that book was the lowest-yielding thing in our portfolio. So it makes sense to sell the thing that's at least contributing to the dividend of the company. And it was a sub-5% cap rate on our numbers. And I'm fairly sure invitation can do better given their scale. And so they're probably looking at a better number than that. But given the debt markets and where that was and how it was financed, it was something -- I think it was a a win-win. Unfortunately, we did book a small loss on selling it but that had nothing to do with our views actually at SFR. One of the markets that Starwood getting out of SFR, not at all. We own 16,000 homes away from that in our equity funds or something like that. And we really like our position. We like, again, the scarcity of new product is exacerbating the deficit of housing and housing is probably the least impacted by anything going on in the world. People have to live somewhere. They cannot live in their computer. The AI, maybe you'll find your home differently. You'll still have a home. I don't think you can live in the metaverse, even though some people seem to -- so until we look and live on Mars, in the moon, we're probably okay in the housing market given the U.S. alone among most of the Western nations is actually growing, although it's going. And the other thing that's happening is demographically, the -- I don't know what's the generation of millennials, they've moved into the house buying market age. So the demographics have changed and that's a very big positive for SFR because they're moving -- instead of buying a house now if they can't afford it, they'll move into a house and rent it. So we're bullish on the business. We could get into the business here. It is a business of a couple of other firms and they've done quite well. And it didn't focus on small owners. This is such a granular lending business. It's not something we built but it is something we could do. The returns are pretty good.

So regarding our books, Sarah and thanks for the question. We're going to be patient on selling down that book, as Rina talked about, it's about $2 billion of non-QM loans, about $1 billion of agency eligible loans. We took a large GAAP write-down about a year ago, over $200 million, I believe, as spreads widened. We don't tend to hedge. There's no easy way to hedge spread there. In our CMBS book, we hedge about 35% or 40% of our spreads because we have a CMBX market to do so post GFC, there's no way to hedge spreads in residential lending. So we do hedge rates. The early move in that book was a massive amount of spread widening. So we -- that is why the GAAP write-down came. But fortunately, we moved our hedges up and up and up. But I think Rina and I mentioned that we have about $170 million of hedge gains. So over the last year, our hedges have outperformed collateral, even though collateral hasn't tightened significantly. You are seeing some green shoots with new securitizations coming tighter. We do believe after the last Fed move that those will continue to tighten. We continue to finance that book on repo and our repo balances -- or excuse me, our repo loans are coming in at a tighter and tighter spread. We've opened a couple of new facilities this quarter and expect to open another new one. Next quarter, we'll be about 25 to 30 basis points lower overall in our cost of funds on that book. So even though they are relatively lower coupons than they are negative carried today against the forward curve and looking at the hedge gains that we have and effectively taking that $170 million, you can go pay down…

Thank you. Ladies and gentlemen, we have reached the end of the question-and-answer session. I would now hand the conference over to Mr. Barry Sternlicht, Chairman and Chief Executive Officer, for closing comments.

Thanks for being with us today. And as always, we're here to answer any questions and thank our Board of Directors and our great team at the start of property cash put us in this position that we are and have a great August, everyone. And we'll have the whole political year ahead of us to be entertained.

Thank you. The conference of Starwood Property Trust has now concluded. Thank you for your participation. You may now disconnect your lines.