Greetings. Welcome to Starwood Property Trust's First Quarter 2024 Earnings Call. [Operator Instructions] Please note, this conference is being recorded. At this time, I'll hand the conference over to Zach Tanenbaum, Head of Investor Relations. Zach, you may now 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, 2024, filed its Form 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 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. We reported a strong quarter with distributable earnings or DE of $191.6 million or $0.59 per share. Our results were highlighted by contributions across all of our businesses with outsized performance in property from the sale of our master lease portfolio and in commercial lending from prepayment fees which was partially offset by underperformance in our CMBS book. In all, DE includes an $0.08 net gain from these items. They also contributed to higher GAAP net income, which was $154 million or $0.48 per share. Undepreciated book value ended the quarter at $20.69 with GAAP book value at $19.85. Beginning my segment discussion this morning is Commercial and Residential Lending, which contributed DE of $205 million to the quarter or $0.63 per share. In commercial lending, repayments of $909 million outpaced fundings of $128 million on pre-existing loan commitments. Our portfolio of predominantly senior secured first mortgage loans ended the quarter with a funded balance of $15.1 billion and a weighted average risk rating of 2.9. Jeff will cover our risk rating changes in greater detail. Turning to CECL, we had no new specific reserves in the quarter and no new loan or REO impairments. Our general CECL reserve increased by $35 million to a balance of $342 million, of which 70% relates to office. This increase was driven by our selecting the most pessimistic economic outlook of seven scenarios available to us in our third-party model for our office loans. Together with our previously taken REO impairments of $172 million, these reserves represent 3.4% of our lending and REO portfolio and translate to $1.64 per share of book value. Next, I will discuss our residential lending business. Our on-balance sheet loan portfolio ended the quarter at $2.5 billion, including $880 million of…

Thanks, Rina, good morning, everyone. We accessed the debt capital markets in the quarter, issuing $600 million of senior unsecured sustainability notes, leaving us with record liquidity today. This issuance was the first in our industry in over 2 years and was 7x oversubscribed with orders from 156 institutional investors, both records for our company. Record demand allowed us to tighten pricing by 75 basis points. And after swapping this fixed rate issuance to floating, we borrowed at a repo equivalent of SOFR plus 312 basis points, in line with pricing we achieved throughout our history despite today's high rate and spread environment. After paying down bank warehouse lines, this issuance was leverage neutral, allowing us to maintain just 2.3 turns of leverage, a 2-year low for our company and it will not affect our dividend paying ability. Creating excess liquidity in a leverage-neutral fashion will allow us to, again, ramp up our investment pace at the appropriate time. Market transaction volumes are picking up and our pipeline of actionable deals is as strong today as it has been in over 2 years. As for the macro environment, commercial real estate continues to face headwinds created by higher interest rates that have driven cap rates higher, thus causing the reserve increases you are seeing in our sector for the last year. Partially offsetting that, 3/4 of our CRE loans have interest rate caps in place and 85% of our portfolio has embedded interest rate protection. Rates rose in the quarter since we last spoke and have now begun falling again after last week's weaker-than-expected employment number and the Fed's decision to slow the pace of quantitative tapering from $60 billion per month to $25 billion per month, which in turn will reduce treasury bond issuance by $420 billion per year.…

Thanks, Jeff. I want to thank Rina and Zach, and good morning, everyone. I'm on the West Coast. So dialing in remotely and to the team's call. I'm not at the Milken complex. I would say that the question on everyone's mind is where are we in the cycle? Are we bottoming, we think it's going to get better, when will they get better? And I think it's pretty clear that most every property type, things are okay at the property level. And so it's really a question of how do you finance yourself? This is a balance sheet crisis in the United States, not a property level crisis. Most of the asset classes where there are some decelerating rent in multifamily. Most everyone is sophisticated in real estate knows that the supply of new apartments is going to fall precipitously as soon as this wave completes more or less middle of 25%. And then rents should reaccelerate. So you are seeing buyers come out of the woods, particularly since the credit markets, the CMBS markets are wide open. Even diversified portfolios are getting done in the CBS market spreads are in. So the markets are repairing themselves. And even the tone of the banks at least the large banks is getting slightly better as they grasp but they get their arms around what they happen, who's going to do what with what? It is remarkable how many sponsors are coming in and working to fix their capital stacks, buying caps, trying to push their loans into coverage ratios. And I think there's a lot of dry powder on the sidelines, and you've recently seen Blackstone's large take private of a multifamily, two of them. It's like one in Canada, one in the U.S. There are transactions taking place in…

[Operator Instructions] First question comes from Jade Rahmani with KBW.

This quarter has been a tale of 2 cities. While there's been ongoing credit migration, we've seen some positive surprises from the banks in terms of there being no big shoes to drop. At the same time, with the commercial mortgage REITs, there has been pronounced deterioration and broad recognition of losses. Starwood clearly is performing much better than peers. So I'm curious what you think explains the discrepancy if it's the nature of the transitional assets or more so, as you alluded to in your comments, the liabilities. And if it's the liabilities, that should open up opportunities for Starwood to be a net acquirer of weaker players that have very constrained capital structures.

Barry, you want me to start? I will start. Jade, we did foreclose on some things early. We've been advantaged by having a portfolio that's set up to perform better in this market. I hate to keep repeating it, but it's hard to hide from the fact that with 11% U.S. office and the lowest leverage at 2.3 turns, you would -- plus tremendous liquidity, you would expect better outcomes there. The difficult thing for this market, I think, and it goes for the banks and the nonbanks and all of us is looking at forward SOFR. If you go back to May of last year, forward SOFR in 2025 was going to be 2.6%. If you went back to October of last year, it was 4.6%. If you went to January of this year, it was back into 3.5% area. Well, Today, SOFR is expected in the middle of '25 a year from now to be 4.40% and a year later to be 4%. So we don't go below 4% for 2 years. We thought we were doing that a year from now by over 100 basis points. So I would say these reserve builds with SOFR having made a move significantly higher with the Fed being priced out and the spread versus the 10-year note, the 10-year note was 70 basis points above going back to the beginning of the year where forward SOFR was supposed to be in '25. Now it's below where forward SOFR is supposed to be. So the Fed being priced out is very difficult for transitional floating rate loans. And to the extent the Fed continues to get priced out of the market, I think you'll continue to see reserves build. And to the extent that we flatten here and take some advantage…

I'll be a little more optimistic about that. it's not fun. And when you have nothing to do, you can't issue stock, you're getting repo calls. But it's not a question if they want to volunteer it will be more because they have to and merge with a stronger balance sheet. It is one thing that's interesting about the market is, yes, you've seen these, I call fairly sophisticated borrowing or managers of books take hits in their book whether it's REO or just write-downs, almost everyone in the sector, I think, has experienced some form of one or the other. If you think of the regional banks that have $1 trillion of loans and maybe levered 8:1, you wonder what's going on, like how could they not be experiencing larger losses certainly in their office portfolios. And it wouldn't take much to wipe out an 8:1 levered book and the equity of that book. So they typically have went on smaller properties and tertiary markets, which don't have the liquidity of the option of being placed in the CMBS execution. So there is -- you continue to scratch your head. I do think it's an incredible opportunity for us. And will we be fortunate enough to go out and raise additional capital in this market we could deploy it at extraordinary returns. And we continue to stay active in these markets with our private credit vehicles because we want to keep our people busy, but we're following at the mouth to get back in the game but have to be prudent about it. So we have paid down repos. We have the liquidity to do that where banks have been wobbly, and there's been significant and still we remain with $1.5 billion of liquidity. So I'm not of the…

Next question, Don Fandetti with Wells Fargo.

Yes. Can you talk a little bit about the outlook of migration of office loans from 3 to 4 rated. Last quarter, there was a pretty big increase. You've got a few this quarter. Are we just looking at a handful of loans each quarter? Are we getting closer to the end? And what's driving those movements this quarter?

Yes. Clearly, this [indiscernible] SOFR move that I talked about is putting stress on people. And I think the ability and desire to continue to put in capital in my prepared remarks, I said we had borrowers put in $1.3 billion last year and almost $0.5 billion already this year. If the forward SOFR curve continues to go higher, people are going to be less aggressive in doing that. And as they are less aggressive in doing that, and we have to have discussions about potentially carrying the loans or helping carrying the loans or potentially cutting rate by a little bit or anything that requires us to really be involved in the loan is potentially going to go noncurrent. We want to be in front of that and move it from May 3, which signifies something that is fully current and being supported to a date. We're not making any concessions to a for where we feel if this economic environment stays and SOFR stays higher, we could end up having to commit more capital to help support an asset. And so you saw 2 assets in the office space go from 3 to 4 this quarter, neither one was here or just spoke about both earlier, the other one was an apartment. But Donald, I think if the forward curve goes is much higher in the next quarter as it did this quarter versus where it's been, I think that's type of migration that shouldn't be unexpected in a $20-odd billion balance sheet, it's not huge. It's sort of normal course, but SOFR certainly is going the wrong way in the quarter and we're being conservative given we may have to put capital in to help support assets. So I think this credit migration. It will follow SOFR and hopefully, it slows down in the coming quarters as we turn it around.

Got it. And Jeff, what's your appetite for residential mortgage credit portfolio, it's sort of flattish. If you think about non-QM, I mean credit is still pretty good. Are you seeing opportunities or just not a ton of deals out there?

On resi mortgage credit, was out the question? I apologize, I was just looking at some notes on something else. And would we go back into the investment side? Is that your question?

Yes. Just kind of how are you thinking about the asset growth there. Credit has been pretty good. I mean are you seeing opportunities? Or are you going to sort of keep the portfolio flat until you get more on offense?

It's interesting. We talked a lot about credit tightening across markets. Credit has really tightened on the resi side as well. There is certainly a bit. It's driven by insurance companies 4 bonds that are highly rated. We're seeing 2 AAA securitizations this week, Verus and, one other that are in the 130, 135 area for AAAs. What's more interesting to me is that BBB is on those deals are 200 over. I don't remember a 70 basis point spread between BBBs and AAAs anytime recently, and that is really tight. So the credit curve is collapsing, where the insurance bid and others for the much smaller classes of BBBs, we've tightened those in significantly. So with an active securitization market there, it is pretty interesting. You look at a lot of the non-QM type of assets, the type of things that we have on our books. There are 8 plus coupons, gross WAC coupons being produced today. And if you can securitize at those type of spreads in the 130 over for seniors, you can make a tremendous return on an 8% gross WAC resi mortgage but you are very levered to prepayment speeds. And so the discussion we've had internally about whether to add or not has really been around what do we think happens to speed, Barry's baseline and our baseline is that rates do go lower? And I think a lot of people who take out an 8% to 8.5% gross WAC coupon residential loan, if rates go 100 basis points lower and they just got their financials ready for the last one, they're going to be very quick to repay. I think you could see historically quick repayments on those. So you're going to have something that's high 20s IRR that could turn into a…

Next question, Rick Shane with JPMorgan.

Just one thing. I'm curious behaviorally with really a significant change in sentiment in terms of rate outlook starting in January, higher for longer, if either within your portfolio or within the special servicing portfolio, you saw some sort of behavioral capitulation borrowers who thought they were going to get relief have an opportunity to buy caps cheaper, refinance in more attractive markets start to throw in the towel even more aggressively than we've seen.

Yes. Listen, it's a really good question. It's only been a couple of months since we've seen this move. Volatility is not up. So the cap expense is still not quite as bad as it was when volatility was a little bit higher, but caps are expensive. You will find borrowers who may decide not to support, as I said earlier, on our multi -- this is really the multifamily side, where somebody is going to make a decision based on their need to buy a cap, and they're going to make a decision based on their view of cap rates, which are going to follow interest rates. So this is really a multifamily borrower. I think I said earlier, 60 of our 72 borrowers have committed more capital out of pocket. The other 12, we are not worried about those loans. So we've continued to have people commit capital out of pocket to support their loans. The 4 loans, I think the multifamily that we have rated 4 or 5 are probably not going to continue to support them, and they're coming up against that decision. So that decision that you're that you're talking about is the decision to continue to support today. And a lot of that's going to depend on the type of equity that you have. If you are a syndicator and unfortunately, there were a lot of syndicators in 2018, '19, '20, 21, and even early '22. And you have to pick up a phone and call 100 different wealthy guys to have them put in $5000 a piece to be able to make a pay down on a loan you're probably not going to call all 100 guys and you're going to not have the capital to continue to support your loan, and that's the most likely person to stop paying. We -- Barry said in the past, we're looking at that as an opportunity. These are -- the debt yield of our multifamily book is over 6%. We would expect that if we own those at effectively a 6 cap going forward and we hit the rate cycle that we think will hit over the next 3 or 4 years, that we'll have an opportunity to make money on that and get our capital back, first of all, for shareholders, which is our job and potentially have these as good investments. I think the larger, well-capitalized people are going to be much more likely and have been more likely to continue to put money in on a over 6 debt yield because it's effectively selling a 6 cap. And if you have some money to hang in, you will probably hang in. So I think that capitulation trade will be the syndicators and we've seen that and the rest of the real money we'll hold on, and we're happy to step in for the syndicators and be the real money and wait for a better cycle. Barry, anything to add to that?

No, I just caution anyone to think the forward curve is right. It changes with the breathe. I really think people were a little surprised to that last jobs report at 175 and the downgrades to the prior reports. Again, hoping the jobs report 100,000 jobs in health care. I mean, again, it's the power of this economy, the service economy and the interest rates are not changing that. So I do think if the cracks open and you can start seeing them, obviously, he will be worried about breaking the economy is not really a sign of it today. I mean it's small cracks. But -- and so I don't -- I think a lot of people -- and I think a lot of high net worth, I'm out of confidence with a lot of capital out in the West Coast. You're seeing a lot of interest in property sector from regions of the world that we probably are not overweighted. And they're even interested in the unlevered yield that they know that probably treasuries of 4.5 may go lower. But even if there's 5 having an asset at a 6, 7, 8, 9 on leverage, isn't unattractive if you have a lot of capital. They don't need 22 IRRs. They're happy to get 10. And as you know, every endowment in the world tries to get a need. So if you can get even an office building that's well leased with WALT and your purchase price is significantly below replacement cost, you protect you on the way out. You probably will see some major trades as you've seen in the hotel industry and the apartment sector, people are sort of taking advantage of this opportunity when there are fewer shoppers and taking a long-term position that they're positioning…

Next question is Stephen Laws with Raymond James.

I appreciate the commentary so far, Jeff, you talked a little bit about upcoming original maturity dates or cap expirations, maybe providing some opportunity. Looking at the other way on rates, what would increase transactions? Is there a clearing level on rates? If it goes back to 4.25 or 4, are there people that maybe were hoping for 3.5 early this year that all of a sudden move quickly because it gets back to 4, they missed their window. How do you think about a clearing level for rates of what creates more transaction opportunities?

It's interesting. I think it's going to be cap rate dependent as well, right? You're seeing some multifamily trade in the low 5s. We've just seen some recently. You're seeing some office trade at cap rates that are better than you think they are sort of one-off. I believe if you get to the point where people can get some equity out where they weren't sure yesterday if they could get equity out that everybody gets deal fatigue and people want to move on from things. And if they can start repatriating some equity and turning to do something else. I think that that's where a deal flow really starts to pick up, which you're not far from today, but you probably need -- every 50 to 100 today means more than it's ever meant as I look at it. As I look at it, we all started by lending at 70% LTV. And with cap rate expansion that we've seen to date, that cushion has been eaten into. So as that cushion gets eaten into every basis point where we end up and Barry is 100% correct. The forward curve has not been right for 30 years. So let's just assume that we don't know where it's going to go. But given some of our attending cushion has been eaten up by cap rate expansion, every basis point actually matters more than it has historically because lenders in that are closer to the equity than they were when they made the loan. So I would say 50 to 100 basis points forward curve or 50 to 100 basis points in the 10-year, I think transaction volume starts to pick up very significantly. I don't think you need a large move, but you need to sustain it. We were there…

Next question, Doug Harter with UBS.

Hoping you could talk a little bit more about the refinance on the medical office building looks like your debt against the property came down a little over $100 million, thoughts on that? And does that imply anything about the value of the properties?

Less about the value and more -- service coverage -- but go ahead. Go ahead, Jeff.

Yes, Barry. I think you know that the properties continue to perform, but they're performing against the higher cap rate today, so the valuation is lower. It's not an income problem. It is a higher cap rate problem and the agencies are going to allow you to take a little bit less debt. Now the good news against that is against that, we tightened 25 basis points. The market felt really good about this. The agencies gave us good enhancement levels. We don't need -- like we're sort of happy to underlever this asset. So yes, we did put $100 million of equity in but it's a decent return for us of cash, and we're sitting on a lot of cash. And so we got a really good rate at $2.52 over on what we did take, which in this market feels pretty good, given high yield. We just issued that also for equivalent of $3.12 over.

No, I was just going to say that we could have taken more leverage, but the junior classes are dilutive to the dividend. So with -- not the spread, it's just where base rates are. So it wasn't so much the cap rate. It's really a debt service coverage to get debt that's attractive enough to take it. The $250 million over was pretty decent debt. And if we increase the leverage levels higher, which we could have it was silly money and we want to buy it, not borrow it. So we just cut the proceeds to a level that we thought was attractive and accretive to the company, and that's it.

I would like to turn the floor over to Barry Sternlicht for closing remarks.

Well, thank you, everyone. We appreciate you listening in, and good luck to you, and we hope your loans pay off. Take care. Thanks, team.

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