Starwood Property Trust's CEO Discusses Q4 2013 Results - Earnings Call Transcript

| About: Starwood Property (STWD)

Starwood Property Trust, Inc. (NYSE:STWD)

Q4 2013 Earnings Conference Call

February 26, 2014 11:00 AM ET

Executives

Andrew J. Sossen – Chief Operating Officer and General Counsel

Barry S. Sternlicht – Chairman and Chief Executive Officer

Boyd W. Fellows – President

Stew Ward – Chief Financial Officer and Managing Director

Cory Olson – the President-LNR

Analysts

Daniel K. Altscher – FBR Capital Markets & Co.

Kenneth M. Bruce – Bank of America Merrill Lynch

Joel J. Houck – Wells Fargo Securities LLC

Jade J. Rahmani – Keefe, Bruyette & Woods, Inc.

Donald Fandetti – Citigroup Global Markets Inc.

Operator

Good day, and welcome to the Starwood Property Trust's Fourth Quarter 2013 Earnings Conference Call. All lines are now in a listen-only mode. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions) As a reminder, today's conference is being recorded.

At this time, I’d like to turn the conference over to Mr. Andrew Sossen, Chief Operating Officer and General Counsel. Please go ahead, sir.

Andrew J. Sossen

Thank you, operator and good morning, and welcome everyone to Starwood Property Trust's earnings call. This morning, the company released its financial results for the quarter and year ended December 31, 2013, filed its Form 10-K with the Securities and Exchange Commission, and posted its earnings supplement to its website. These documents are all 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 Chief Executive Officer; Stew Ward, the company’s Chief Financial Officer; Boyd Fellows, the company’s President; Cory Olson, the President of LNR and Rina Paniry, the CFO of LNR.

With that, now I’m going to turn the call over to Stew.

Stew Ward

Thank you, Andrew, and good morning. This is Stew Ward, the Chief Financial Officer of Starwood Property Trust. This morning, I’ll be reviewing Starwood Property Trust's results for 2013 fourth quarter and full year and our initial guidance for 2014. I will also discuss the performance of each of our three business segments, our traditional lending business, LNR and a Single-Family Residential business. Following my comments, Barry will discuss market conditions, the state of our business and the opportunities we would be looking forward.

For the fourth quarter, we reported core earnings of $121.2 million or $0.62 per fully diluted share, an increase of 29% when compared to core earnings of $64.5 million or $0.48 per diluted share in the fourth quarter of 2012. For 2013 core earnings per diluted share increased 12.6%, $2.24 before LNR acquisition cost of $0.13 per diluted share. The primary drivers behind this earnings growth by the acquisition of LNR and a deployment of $3.8 billion in new investments during the year. These figures were also reflected of operating losses for the quarter and full-year of $0.01 and $0.08 respectively per diluted share in our single-family residential business.

GAAP net income for the fourth quarter of 2013 totaled $95 million or $0.48 per fully diluted share, which compares to GAAP net income of $56.3 million or $0.42 per diluted share in the fourth quarter of 2012.

In addition to our improved operating performance, we also committed over $2 billion in new investments in the fourth quarter. In the last two months, we have also upsized re-priced and extended both of our primary secured financing facility, adding an aggregate $550 million an additional capacity at best in market terms.

Another item I wanted to point out with that, in Q4, we completed the successful integration of the legacy STWD and LNR platform. We have leveraged LNR significant investments and technology and finance infrastructure, which has enabled us to centralize the IT, accounting, planning, tax and treasury functions. We have also reallocated resources in loan servicing to enable the primary and special servicing functions to be combined.

As of yearend GAAP book value per diluted share was $21.83, a slight increase over the level of $21.78 we reported as of September 30. Fair value per share stood at $22.17 also above the level of $22.09 per diluted share reported at the end of the third quarter.

Pro forma for the spin-off of our single-family residential business, which we completed on January 31, 2014, book value and fair value per share as of December 31, 2013 would have decreased by approximately 25%, this $16.42 and $16.76 per diluted share respectively.

Now let me outline the fourth quarter results for each of our three major business segment. Following on the heels of an extremely active third quarter, where the lending segment closed 12 transactions with total commitments of $1.1 billion. This segment closed an additional 12 transactions with total commitments of $1.7 billion in the fourth quarter.

When combined with new originations to date of $1.2 billion in the first quarter of 2014, new loan originations totaled $2.9 billion during the past 150 days. This represents the significant increase in phase over past quarters.

Included in this quarter's lending activity were the $246 million originations of preferred equity interest in a commercial asset REIT and a £288 million or on a equivalent basis of $448 million loan collateralized by the Iconic Heron Tower in the city of London.

Over 80% of our new originations in the quarter were floating rate, as are nearly all of our hold and maturity pipeline loans. Some of the impressive year-over-year increase in lending activity is reflective of continued improvements in the commercial real estate market. But as I have said in the past, to a greater degree its clear testimony to the brand and presence we have built in the real-estate debt capital markets both domestically and in Europe.

Now let’s turn our attention to LNR, which we acquired in April. LNR has been accretive to STWD’s since acquisition and continue to strong results during the fourth quarter. The LNR segment contributed GAAP and core earnings of $35.7 million and $45 million respectively inclusive of allocated shared costs. LNR's total revenues increased $12.3 million or 15% in the fourth quarter compared to the third quarter, reflecting higher levels of both servicing fees and interest income on CMBS. However, GAAP and core earnings of this segment decreased $6.4 million and $1.2 million, respectively, mainly due to the decrease in fair value of LNR’s domestic servicing intangible. During the fourth quarter, the decrease in the fair value of the intangible was $18 million on a GAAP basis and $15.8 million on a core basis.

The net decline is attributable to the expected amortization of this declining asset, net of increase is in fair value due to the impairment of new servicing contracts because the intangible represents the net present value of future fees on existing servicing contracts, the asset burns off as those fees are earned.

As a result, the remaining fair value of the domestic servicing intangible, which totaled $230.7 million as of December 31, is expected to substantially decrease over the next five years as we recognize the revenues from our existing servicer contracts. The bulk of which are associated with CMBS transaction consummated between the years 2000 and 2007.

However, the servicing asset continues to perform well ahead of our underwriting expectation, and the current contract base is expected to continue to generate positive returns on our invested capital as these legacy CMBS transactions run their course.

Additionally, our intent at this point is to remain a preeminent player in the CMBS special servicer business. Investing substantial capital in new subordinate CMBS and acting as special servicer for the CMBS trusts involved in these new investments.

As we’ve said in the past, the LNR platform provides us with absolute best-in-class talent and systems infrastructure to optimally exploit high yield opportunities in the CMBS business, but performance of which are naturally hedged by the earnings potential of our role as a special servicer in the same transaction.

Interestingly, the CMBS special servicing business is the only credit that I know that is inherently – that is an inherently profitable transaction in its own right. As of year-end, LNR was named special servicer around $16.2 billion in loans in real-estate owned, well ahead of our underwriting expectations at the time of acquisition.

As I mentioned earlier, we completed the spin-off of our single-family residential segment on January 31. Barry will be discussing the spin-off in greater detail in his remarks later in today’s call. I would like to provide some financial details on this segment for the quarter. During the fourth quarter, the number of properties in NPLs grew from 5,800 to 7,200 units. As of year-end, the net assets of this segment totaled approximately $1 billion, comprising 13% of our net assets.

On the spin-off date, the asset base totaled approximately $1.1 billion, including $100 million in cash. While this business segment continued to operate below breakeven on a GAAP basis throughout 2013, we’ve made material progress in leasing homes that are ready to rent. We also anticipate the financial performance for this segment following the spin-off will improve, as portfolio occupancy continued to increase and gains are realized on the sale of non-target assets. In accordance with GAAP, beginning in the first quarter of 2014, we will retrospectively reclassify the Single-Family Residential segment as a discontinued operation.

Now looking forward to 2014, let me turn our discussion to our current investment capacity, our first quarter dividend and our 2014 earnings guidance. As of Friday, February 21, we had $293 million of available cash, $104 million of net equity invested in liquid residential mortgage-backed securities and $68 million of financing capacity approved, but undrawn. With this, we have capacity to acquire an additional $300 million to $525 million in new investments.

In addition with the strong rally in credit spreads seen in the CMBS markets in the recent months, we are reviewing LNR’s book of CMBS holding, which now totals in excess of $550 million, looking to identify for potential sale turns security with no longer meet our return.

This week, our Board declared $0.48 dividend for the past quarter for the first quarter of 2014, which is an increase of $0.02 from the prior quarter, reflecting the company’s continued strong earnings. The dividend will be paid on April 15, 2014, to shareholders of record on March 31, 2014. This represents an 8.03% annualized dividend on yesterday’s closing price of $23.89.

I’d like to finish my remarks with the discussion of our 2014 core of earnings guidance, which we are providing during this call for the first time. Our initial guidance for 2014 is core earnings of $2 to $2.20 per fully diluted share. There were variety of factors, impacting the formulation of its guidance, and I want to take some time to watch it through them.

It’s important to look at each of the primary asset category and business lines independently, because each of them impacts our P&L and the core earnings differently. When we build projection for our held-to-maturity lending business, we think about it in the context of the runoff of our current portfolio, our existing pipeline and prospects for future origination. And importantly, all of it is within the investment than we’ve articulated since day one, which is to hold us wider portion of the capital stack as possible, in a state lending transaction, while achieving our target equity returns of 9.5% to 12%.

Historically and still true today, this is generally represented the portion of the debts back between approximately 45% loan-to-value and 65% loan-to-value. For the better part over the last 18 months, the majority of new lending transactions have involved our origination of the entire debt back as the one stop shop financing solution for the borrower, and the subsequent manufacturer of the subsequent 45% to 65% portion of debt back targeted for long-term retention.

Utilizing either off-balance sheet financing in the form of email [ph] sales and securitization or on-balance sheet financing provided through one of our many secured financing facilities or through attribution of the portion of a more than $1 billion in convertible debt, we’ve issued since February 2013.

Now with respect to LNR, our projection is primarily focused on six key items. First, we utilize extremely sophisticated software and expertise to project future special servicing fees and expenses, for both the loans currently in special servicing, as well as potential new additions to the special servicing last year.

Special servicing revenues are composed of a variety of details with the majority of revenues coming from inventory to you, resolutions to you and default interest, inventory fees and resolution fees are a bit more predictable, and is there a function of the volume and duration of loans that goes through special servicing over time. Default interest is more difficult to predict and as such, we generally take a more conservative approach to projecting future collections.

Secondly, and of equal importance are the estimates of our likelihood to retain these existing servicing contracts and gain new contracts. All of these factors contribute to both our estimates of future special servicing revenues and expenses, as well as the speed and timing of the decline in the value of the servicing intangible.

The third important item in our forecast will be expected performance of LNR’s $550 million plus portfolio of high yield CMBS and our expectations concerning future investment and sales activity as well as market yield levels for the asset class.

In the current environment, we expect loss adjusted yield to maturity on new issued CMBS investment in the 13% to 15% range. The fourth major element of the LNR business involves projecting origination volume and net profits from our small loan balance conduit operation.

As we have discussed in the past, the last 12 plus months have been an extremely strong period for the conduit business. Competition has increased in that business and we would expect profit margins to revert over time to their historical average of 2% to 3%. The fifth key element to the LNR forecast involves projecting the taxation level of the various taxable REIT subsidiaries we utilized to operate the special servicing and conduit operations. While we seek to operate this business in the most efficient manner possible, based on the current tax rules, these subsidiaries are expected to pay federal state and foreign tax.

In 2013 which was a partial year for LNR these entities incurred tax expense of $25.5 million. Lastly, we obviously spent a good deal of time estimating the future path for cost and expenses across all the elements of our platform. As we have talked about earlier, LNR’s operations have now been integrated with those of the legacy Starwood operation, which will allow the combined entity to realize sufficient use across the business line.

It’s important to point out that nearly 75% of LNR’s cost structure is variable, which affords us enormous flexibility to respond to market conditions and changes to the business model overall.

With that, I would like to now turn the call over to Barry for his comments.

Barry S. Sternlicht

Thanks Stew. As you just said to the comments for the long and details, we hope to answer lot of questions that you might have about the company today. I think I’ll start off by saying that it’s a very good year and it’s a really transformative year. We did over $4 billion – $4.7 million of loan origination reported through transaction averaging over a $100 million of loan.

There is no question the company has become behind a very dedicated team, a well-known player in the commercial real estate finance market in the United States and more recently in Europe. It also I think obviously was a transformative year because this is a year we converted from just being a mortgage book or a pool of mortgages to really being more of a finance company. And that was led of course with the acquisition and the integration of LNR into STWD.

I want to take a moment to thank all the people that work together globally collaboratively with maximum productivity, utilizing all of our global banking relationships, sourcing underwriting and effectively cost innovative ideas taken to task every investment we made both in the LNR platform and in Starwood book because I think it’s really the cross-pollination and best practices with all these people that have led the company to be a market leader and actually position it to sell in the future.

I think we have a lot of experienced people here looking in sliding up and down, the depth fact looking at the proper pricing, debating, sizing, choosing between different borrowers, and you will see that in the coupon, but when you’re lending to people like Mike Milk in high networks family, firms like Blackstone or Colony or any of the many people we lend money to related.

We can’t really see it in an IRR with an earnings numbers, but you have really credit worthy people, assuming the equity that we think will pay us back and under their obligations and we utilized also the 65 banking relationships. We have over 102 lenders to serve the capital group. But we have 65 existing lenders today. We are in constant dialog with, and I think the greater platform, which is very powerful and I think we can use it better in the coming years. So, I’ll talk about that in a second.

So, I think we’ve closed the more key transactions during the year; 701 Seventh Avenue is an investment source here in the Renaissance headquarter office, but the trophy office building will be converted to retail building. In addition, hotel, we have a great position including a 20% equity kicker, which we don’t really value. But I’m sure we’ll be with a lot of money someday, I must guarantee that.

and then we closed an investment at Hudson Yards, it was related in a very creative structure that work for both of us and we are proud to be part of that, shareholders should be proud that the building what will be their anchor to – what will be the new Rockefeller Center of Manhattan.

And then as Stew mentioned, Heron Tower, another market, maybe, the best new office building in the city of London that we closed with some friends on the other side were refinancing loan that was in trouble from a European Bank. These are all highly negotiated very relationship based and really were the best of our platform, working with speed, execution, getting around some of the banking rags that bother banks that they couldn’t figure out structure, that’s where we can really have sustainable competitive advantage in the marketplace.

What the shareholders got from us than we are great real-estate investments and a big fat wide piece of paper producing a double-digit rate of returns. So, I think given the 2.74 10-year and the one point something 5-year, if you look at, we are earning 700, 800, 900 basis points wide of that and I think some really compelling real-estate bulk of our assets today and our loans. I think it’s a great risk adjusted return. I notice we’re treading at 8 dividend yield, which remained a lot higher than the five-year and certainly higher than one year paper.

But probably, the most important transaction was the acquisition of LNR during the year. And I think with LNR, we’ve only bought a great group of people and maybe, we spend a minute on that. And we have 50 people, who do accounting now and 41 people in IT. and our job, my job, or his job is to take advantage of that extremely knowledgeable basis, excellent asset to grow our businesses behind and that’s where perhaps we pick many new lines of business and you’ve heard about the condo operations, which were quite profitable last year, remain profitable this year.

You heard about the CMBS book. I felt we specifically gave you a number of how much LNR invested during the nine month we own them, but Cory over $200 million, is that right?

Cory Olson

That’s correct. That’s correct.

Barry S. Sternlicht

And behind the platform, buying additional servicing strip, buying the pieces, investing in one of the piece of the paper was their insight knowledge of the markets and their activities. We continue to work with them on finding new ways to deploy capital and very advantageous ways.

Ways Starwood Capital can ever do, for example we don’t have the trading desk here to trade CMBS. We don’t even know what they look like and we don’t [indiscernible]. Stew also mentioned but the integration of LNR, which was led by a teams from both companies from STWD and SCG help and then Cory and his teams helped seamlessly. and today, I think we’ve got a streamlined asset management function accounting, reporting and that’s going to make my life, Boyd’s life, Stew’s life and Rina’s life much easier, maybe even Andrew’s life too.

And then in the transformative way, I think we have like six new businesses. We want to add more businesses, but one business we did separate was our residential business and we completed that spinoff as mentioned at January 31st. It was an excellent transaction for the STWD shareholders where they choose to stay in this way stock we sell it, move on. I believe we have created a state-of-the-art company and went hopefully when the company does proper road show in the future going to raise capital, more shareholders will see the technology backbone that is unique to Starwood way point, the 550 and growing dedicated assets they have to that business. and the opportunity I think which is long-term that create real value for shareholders both in the fee business owning, buying houses, renovating them and renting them and in the NTL business, which is a big portion of what they do also buying loans, adjust loans and converting those to fee and in some cases keeping them and renting them and adding them to the core base of the company.

So, it was interesting transaction from my perspective, but I wasn’t sure what the reception would be to the stock given that we had investors, our shareholders and yield vehicle and that company never have not paid a dividend to-date, but it was a right thing to get it out of here with totally different business with different risk profile and it too will hopefully pay a dividend in the near future and grow its business from there.

We have fell off on leverage and it had credit facilities of $500 million from which you could buy probably over a billion of houses or loans before coming back to extend the separate line for NPL, but it can more than double in size just about before it have access to every markets again and that’s why $2 billion of phones will know ever doing great we think they are or we will be able to asses on your own.

So, I’m going back to the future for a second, what’s ahead for the company. I think we continue to build lines of business to find ways to deploy capital and advance its way. I will be disappointed if we didn’t pickup on two or three new business lines type of financing that we should be doing whether we believe they are hold in the capital market. I also look to grow our book in Europe and take full advantage of Hatfield Philips. Hatfield Philips is our special servicing subsidiary based in London and Frankfurt, which has something like 90 odd people in London and about 30 I think it is in Frankfurt.

And more actively and much more proactively use that platform to source and drive growth in our European loan book, where there is a need for lenders like us, who understand property, help to refinance becoming tidal wave of loans being sold by the bank, which are going to have some mark their assets to market we have been waiting as long as we have arrived four years [indiscernible].

So even if we capture small share, not alarming share for the company, we are pretty excited about that. I think it’s a real imperative that we do that going forward. I also think we need to take better advantage of somebody assets that we don’t mention that are part of a company like auction.com.

Auction is a dominant player in the auctioning sale of both small commercial assets from us in fact and people like TW Capital. We have auto filling and we get it back to our [indiscernible] dollars put in the platform that they should ask as well as single family homes it’s auction of on the behalf of the wide array of things and federal government agencies.

But it is very exciting our auction there, again announced an important deal, which I won’t mention or let them do that and hopefully we will be able to help them grow their business and that will become an important asset for the REIT in the future and important advantage way for us to deploy capital helping them grow in the future.

So, pretty excited about that and also further our investment behind LNR’s in the business that we have talked about, whether it’s CMBS, repositioning OREO and selling them or buying acquiring additional control shares and existing CMBS structure.

We have to remember that special servicing business, which you all think that LNR is a special service, but Stew mentioned that the baseline value of the service today is $235 million. So it’s not – what is that, less than 5% of our asset base. So I think if you look, just talk more what Stew said, we thought the book would deteriorate or decline faster than it did and what we thought was $17 billion would be like much lower at the end of the year and it turned out to be $16 billion or so. So we are guessing at the pace that we’ve got and to some extent you control it, but you have to remember that CMBS [indiscernible] the restructuring of these, there was a five-year and a 10-year shift.

The five year matured. They originated in 2006, in 2007. The real estate market matured in 2012 and 2013 with expansion. Those are sort of behind us and there is another huge way of coming which is those 10-year maturities of those CMBS strips and frankly we’re all sort of guessing, because you have interest rate and valleys for real estate. We have a base case. We know what we’re going to do, but interest rates are 10%. There’s going to be massive instruction in those bonds and there will be a field day for a special service or just in fact interest rates are zero, but you’ll look at it and file because people will be able to refinance those loans.

But there will be – this is, we say, declining it or this is a high variability deviation on what those fees could be in 2016 and 2017 and to some extent, as Stew mentioned, the CMBS book is the perfect hedge to that because if in fact rates go to zero the CMBS will obviously appreciate and things we are taking today or we think are nothing could be worth a lot of money. So it’s a nice position where we’re at with less to be in it and we think our teams were executing so well during the year.

So finally, as I mentioned some trends in the business, I think what you see is that we have some sustainable competitors, advantages our scale, never been more important. We actually need to bigger. We need to write whole loans in Europe and we’re probably not going to be able to compete unless we can do that and that’s going to get us from the shareholders the highest ROE. So scale is really important. Also I think we’ve chosen not to take up our leverage in our sales. We could drive a higher ROE and there are people in our business who are doing so, keeping a much smaller piece of the loan they originated if you will. We both make a loan at 65%, 70%. They take leverage up to 80% to 10% swag of the holding piece, the mezzanine 10% wide, 50 to 60 or 55 to 65 or 45 to 65, I mean the market is going to have to figure out over time about the leverage we deploy and the risks we are taking in our ROE. But different terms are taking different approaches to this and neither is right or wrong. It will depend I guess some day down the road. Obviously leverage is the double edge sword and we’ve chosen the revenue paper to be lighter on our same pieces and maybe some of our peers doing.

Interesting, we’re looking at it. We can do it. We haven’t chosen to do it. I do think as Stew has talked a lot down the cap stack I would expect and you actually said you might start seeing more transactions like 701 where we took 20% of the equity. I don’t know for sure. We get nervous a lot. We start climbing the LTV, but obviously stand and looking at that advantage where obviously during the quarter we can move fast. And we understand this kind of word I think maybe better than a lot of [indiscernible] naming the assets we see, we might have seen in my 20 years career just five times.

And having all the expert vendors in a situation where whether it’s a hotel and team at STWD since Cisco is calling our hotel guys here to ask their opinion or they call Chris Graham, our head of acquisitions in Washington to ask him about a building that’s being told. And most of the time we can provide a lot of healthy guidance and then the expertise of the STWD teams, the new team as I voiced Chris Tokarski and Warren a sourcing pricing and structuring those investments is really a tremendous competitive advantage long-term.

So, I think that’s it. I think that’s all. I’ll leave that, cut it off there. I think I’ve covered everything I want to say. And we’ll take questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And we’ll take our first question from Dan Altscher with FBR.

Daniel K. Altscher – FBR Capital Markets & Co.

Hey, thanks good morning everyone. And it looks like a very, very strong quarter. I was wondering if you could help maybe bridge the gap here on leverage. I think the philosophy is really then not to be a over leveraged vehicle, equity like returns with equity like financing in some cases or sales [indiscernible]. The same time it looks like you’ve taken up some leverage on the term-loan and some other repurchased facilities. Could you maybe just help us get sense there, is there a change in philosophy or is a kind of just the functional where the business is going.

Unidentified Company Representative

I think we just leveraged out. I think we increased the line capacity.

Daniel K. Altscher – FBR Capital Markets & Co.

All right.

Unidentified Company Representative

If you think about, as I mentioned in my script and Barry mentioned as well, our basic, in the lending segment our basic business plan is to hold a wide spot of the capital structure in a first mortgage transaction. The first mortgage, the leverage can be either on balance sheet or off balance sheet. A-note sales would constitute off balance sheet leverage, they wouldn’t show up on our balance sheet where as if we replicated the exact same risk position and utilize the same leverage but with one of our warehouse facility on balance sheet leverage, so leverage that, it appeared in the financial statements would go up. We optimize the use of on and off balance sheet leverage, but within the context for that same basic message.

Now, historically we’ve been reasonably stable but nonetheless for example in 2013 we took advantage of access to the convert market at very attractive pricing to create a leverage bucket, a $1 billion worth of what is on balance sheet leverage if we conceptually attribute to other loans. We in a lot of cases, we could have laid, we could have manufactured comparable leverage with A-note sales, but the execution and the converts were so strong, it gives us an on balance version of the exact same thing. But it is all within the theme of that business, our basic business plan which is to originally call in a first mortgage [indiscernible] and the layoff is 0% to 45% either with directly on balance sheet with a financing facility were with term debt or through the asset sale, an A-note sale.

Daniel K. Altscher – FBR Capital Markets & Co.

Okay, thanks for that. And Stew, in your guidance range, can you maybe just help us all out a little bit. What type of capital needs are being considered there if any, and then also is there any impacts on the converts now I guess being in the money?

Barry S. Sternlicht

Capital need, I’m not sure…

Daniel K. Altscher – FBR Capital Markets & Co.

I guess what I mean if there a assumption for more permanent capital that’s baked within the guidance i.e. I know there are convert for instance or common equity or the like…

Barry S. Sternlicht

That’s going to rebalance that enough for you we are going to balance between equity issuance convert sale of paper. Me mentioned talk to the CMBS you will see itself the CMBS going forward some of these CMBS are yielding now yielding 13 within 6. So, I will sell that rather than come back to the equity market for that. We try to balance all that. I think it’s the long game and as you know we aligned with everybody. We have a big shareholding ourselves in the company here.

So, we have recognized that and we offset that against building our equity base, which allows us to do these things and talked about in Europe, which we need to do and the bigger we are they are more likely the company can get better and better credit facilities. To convert obviously they are in the money, I think they are all in the money.

So, some half chosen to do so, but not material announced yet, but perhaps they will and the dividend goes up and made decisive pay the dividend from the common and then convert. But usually that’s been involved in some arbitrage trade by some people. I don’t understand what they do. So, I can’t speak to that. I don’t know. But you do have as lovely to convert money I’m happy that we are definitely placed great source of capital for us not to lose the shareholder [indiscernible] at the time cheap financing.

Daniel K. Altscher – FBR Capital Markets & Co.

Convert there in the money all right good problem to have per se. And then just one final one also. You have seen some other players maybe on the special servicing side and maybe the distressed assets like CW do large auctions of assets. Do you get the sense of maybe they or others are trying to pull back maybe a little bit in the market there and maybe there is opportunity to pick up share for you guys or there is a kind of quarterly rotation in terms of like market share that’s going on.

Barry S. Sternlicht

I think that different firms – there are three firms that basically dominate the space. I think there are using different strategies and why they are chose to do both sale, we can speculate. They might have been losing control of those stress and decided to do it all at once. So I do think that we are running of well we are hopeful it will be a long-term business and I think some of the guys maybe do some trade and it’s been very special trade there. That’s why we are investing more capital in that business lines today than they are and really referring this to TW.

Andrew J. Sossen

Right and Dan I think LNR is the only major special service actively participating in the new issue BP’s market so to Barry’s point and Stew’s points in the script we are playing for the cycle if you will.

Daniel K. Altscher – FBR Capital Markets & Co.

Got it. Thanks for the answers everyone.

Operator

And we will now go to Kenneth Bruce with Bank of America Merrill Lynch.

Kenneth M. Bruce – Bank of America Merrill Lynch

Thanks. Good morning. Quick question for you. Just a follow-up on Dan’s maybe just ask the question slightly differently. Does your guidance include the converts being converted or does it not include those?

Barry S. Sternlicht

No.

Kenneth M. Bruce – Bank of America Merrill Lynch

Okay. Barry, you mentioned in your prepared remarks, essentially the dividend yield being around 8%, and that’s on a relative basis is very high. What do you think is required to get the market to rerate Starwood Property Trust? Do you think it’s something that first of all that you all can do? You’ve been around the markets a lot Barry, in particular. what do you think is necessary to get the stock rerated at this point?

Barry S. Sternlicht

A couple of things and we’re going to build up our IR – I can say IR effort, which probably haven’t done as much, we’ve been so busy, we’re hiring dedicated athletes to do that and talk. We need more retail participation in the stock. I think surprisingly, we’re still pretty institutionally held stock.

I thought over time that would risk retail, mostly because when we have done secondary to our add-on offering, they’ve gone institution, we’re stepped up above in the scale, so that the banks are not pushing down the retail channel and to understand they’ve done well, surprises the academy. More as you look at HPT for example, has held almost small retail, and it’s not very main institutions in the trade, only well inside of our dividend and the average REIT is what 3% dividend yield. So, it’s funny when you get – we look at this all the time if you’re obviously, buying equities and their institutions are looking for eight IRRs owning assets with more current or something like that, we’re all going through better than that, not the equity risk right there at 65%.

Why we’re interested? Why the debt? But it’s a funny thing, because if you have view of inflation saying low, it’s probably it’s the case at the moment, then the debt book is really compelling and frankly, real estate correlations inflation is probably overexaggerated, certainly asset class will be okay, but others won’t.

I don’t know the answer to that, floating rate base we kind of like interest rate to go up. But mostly on that any time it’s being looked like. I think and Ladder went public during the quarter. We look a lot like Ladder through assets like, we just look like Ladder. The trading has a pretty good number, pretty good multiple of the business. You can share – you share we’re going to keep looking at ways and enhance shareholder value.

Kenneth M. Bruce – Bank of America Merrill Lynch

Yes, I mean you’ve done a good job of creating shareholder value. You can look at the stock where it’s trading today and it’s almost trading essentially at the fair market value for the – for your portfolio based on kind of yields and where other things at similar risk or higher risk of trading in the market. So the LNR business seems to be almost coming along for free, because do you think it’s just a matter of being able to demonstrate over time, the performance of the different LNR businesses and partially grow them you talked about that without much detail, but I mean it’s just a matter of showing some persistency in the market?

Barry S. Sternlicht

Yes, that’s correct. I think the more like any company – like any major company, if you can have fortune to position well contributing earnings, then we’ll be not that significant during periods of time. but in other sense, there will be the drivers of values. So, that’s I think for us, we have to continue to reassess risk and reward it. We got to find new ways to deploy capital, which reflects that access to. So I mean the burdens on us to continue to show that we can build the diversified income stream there, every time when we mentioned that there is default interest. We don’t model default interest but we get it, it’s sort of a recurring, non-recurring thing and it comes off the strips to the CMBS to target figure out, but that's great earnings but we want to find ways to use this, the 350 [Indiscernible] of LNR to create sustainable credit advantage for the company and the market. I think we are doing great. It's based on your roles, you got to be going.

Kenneth M. Bruce – Bank of America Merrill Lynch

All right. Okay and just lastly. There has been a lot of debate in the market as to how competitive the commercial lending markets are becoming and whether they being gateway or non-gateway cities. Is there anything from your advantage point that suggest that things are grinding meaningfully tighter, I mean you can see that there is opportunities in Europe and you have begun to explore those more aggressively, you’ve kind of gotten into transactions that others cannot, I mean it’s just a matter of finding these pockets of value where others are chasing down yield or any color on that side would be helpful.

Barry S. Sternlicht

Okay. The current markets are wide open, they are there in the city. I mean there is lot of competition for credit today and there is –we can count on any kind of lenders there are a lot of them. You went into the market share of trillions of dollars and you won’t win every deal. And we actually talk about it as Boyd said we got 25 basis points to get this deal, let's pass on this when we got this other one. We are large but we are not that large and then things were nothing.

So we pick and choose, what we choose to chase and sometimes we’ll partner with other people that were bidding the same loan when you do that and the deal is closed, now that we hope to get closed, one of our, you call him a competitor. But I think, it’s always been the case since we started that as we told you four years ago that we can’t win a 50% LTV loan that a wise company bids through today’s deal, but this is probably our third or fourth ebb and flow of the capital market since the IPOs, that those markets got really tied and they gaped out and they got tied.

At one point, if you remember the conduit operation that was over a year and a half ago, the credit markets blew up. Right now you're in a pretty aggressive period. I am worried about underwriting standards that is for sure we see it in our equity deals. We see the closer we get and we see the spreads were offered. And you just worry of [indiscernible], so its just part of my DNA.

But I do think capitals come back to Europe at a ferocious pace. And like the U.S., capital that came back is the first capital to come back is the senior, a very tight senior, which the British banking is nationalized how to put money out. That spread is coming 200 basis points in 12 months. And that’s actually good, because now I can layer on that from 50 to 70 or 75 on the collateral and the overall cost of borrowing again is acceptable so far. So good thing is the markets are rapidly changing. There is a ton of capital with a ton of yield, you see is obviously the equity markets overall. We are doing okay, I mean the pace of our origination is a record high and we’ve never put out more capital I think. We don’t know anything.

You made a comment, worth pointing out to your shareholders is that under one year the conduit business is got over 30 players and those are guys being repo, by pushing leverage and also offering borrowers what I will call loosely structured loan. That kind of competition isn’t really happening in our market at all. The balance sheet lenders like ourselves that are doing large or midsize transitional loans have not positioned up on the structure.

On the elements of the loans that we closed if we put in place to protect ourselves in a downsize scenario, we are feeling very little or no real pressure on that side of the equivalent. The credit underwriting part in our space balance sheet transitional stuff is stable and not getting over heated.

Kenneth M. Bruce – Bank of America Merrill Lynch

Thanks.

Barry S. Sternlicht

I think funny thing you have people like Wells they compete head-to-head with us and finance us and Blackstone probably Colony. So, it’s kind of a funny thing. When we win a deal against the Wells because we are sooner and better looking and we will take whatever and do whatever it take legally. They call us in the finance. They already underwrote the notes and that happens all the time.

So, it’s a funny situation actually. We won’t bid a deal, we know that Wells is going to win it, they have want to buy it. They are going to be really tight. We don't bother quoting it. So, it’s kind of fascinating.

Kenneth M. Bruce – Bank of America Merrill Lynch

Well, you have had for your history your picking your spots very well. So, congratulations on the good quarter. Thank you for all your comments.

Operator

And we will now go to Joel Houck with Wells Fargo.

Joel J. Houck – Wells Fargo Securities LLC

Thanks. Just wanted to echo my congratulations on a really good year, obviously it was a tough year for mortgage REIT, but you guys really stood out. I guess first the question is, if you look back in 2013 you see kind of a full-year at least in your disclosures on page 21, it looks like the real estate investment lending was about two-thirds of net income and LNR is about a third.

In the guidance of 200 to 220, can you give us a sense for what you guys are thinking in terms of the relative contribution of the lending segment versus LNR because I think obviously we still I think we have more certainty and more confidence forecast in lending segment in LNR is a little trickier forecast?

Barry S. Sternlicht

Our forecast is pretty consistent. I would expect maybe slightly more lending side really depends on the page origination in the back half of the year, it is hard to tell, but it’s not easy to know.

The loans that we are making today some of them large, really large and that number could to be 80/20. We don’t really know. Especially if we talk doing like selling the CMBS position and redeploying the capital and other businesses we did a lot of I don’t know Cory how many you passed on, how many bid, how many did you win on the three pieces?

Cory Olson

We bid something like 25 transactions last year, which would be underwriting several thousand loans and we participated in eight deals in one fashion either is the sole [indiscernible] or partnering with someone else.

Barry S. Sternlicht

How many you have been choosing partners showing up there?

Cory Olson

It would probably another 15 or 20 that we didn’t even bid on.

Barry S. Sternlicht

For various collateral concern reason. So again we are picking shoes and we are not actually in charge of the pace of those deals. That’s where the credit market. So, it’s a best guess.

Joel J. Houck – Wells Fargo Securities LLC

Okay, but certainly the fulcrum of leverage would seem to be on the real estate lending side based on market conditions and how aggressive or lack of aggressive you are going to see I guess is that fair way to look at it or think about it.

Stew Ward

Kind of safety.

Barry S. Sternlicht

We’ll tell you, we don't at the moment, expect 15 from LNR, that’s much different than 2014.

Joel J. Houck – Wells Fargo Securities LLC

Okay. That’s helpful.

Barry S. Sternlicht

And we will tell you this 2014, we are projecting down 2013, but you only saw 2013 for about nine months.

Joel J. Houck – Wells Fargo Securities LLC

Yes.

Barry S. Sternlicht

So now, we could be wrong, it could be up. We beat our budgets fairly handily last year with LNR. so we don’t really know, but so far positive surprises are good.

Joel J. Houck – Wells Fargo Securities LLC

In fact I’d have another one. Do you disclose or talk about gain on sales margins you saw it’s in the kind of lending business and what maybe – what’s reasonable run rate going forward?

Barry S. Sternlicht

He said 2% to 3% is more reasonable as a run rate.

Joel J. Houck – Wells Fargo Securities LLC

Okay, all right. And then, okay – could you maybe just…

Barry S. Sternlicht

What’s been amending on that. Cory, how many securitizations did our team participate in, how many, where they do 10 deals?

Cory Olson

We’ve got 10 done last year and should do a dozen this year.

Barry S. Sternlicht

So, we’re not going on wild by the way, I mean we are at a level we’re comfortable at, more accurately the guy running this group which is Cory and me is comfortable doing. We said hey, this is a problem, we do more. I think like no, can’t do more, got to do this in style. So, you can add a little bit of scale, but he is not doubling and tripling his size, probably going to go up 30% or so. Because margins go down and we’re probably – well, we expect churn there I guess.

Joel J. Houck – Wells Fargo Securities LLC

Okay, all right. Thank you very much guys.

Operator

And we will now go to Jade Rahmani with KBW.

Jade J. Rahmani – Keefe, Bruyette & Woods, Inc.

Great, thank you for taking the question. On the [indiscernible] lending segment, both of the growth in the core portfolio was in the first mortgage segment. With that quarter end, I think was one times leverage. Is that a function of the whole loan originations on development deals are doing? And also can you talk to whether this category, if you expect to retain all of it or there’s potential for the sale of A notes within that category and also the first mortgage category includes B notes?

Barry S. Sternlicht

Yes, yes and yes. So yes, when we’re originating a loan and it let’s say our senior loans, we anticipate as we fund and we would like our coupon on our first mortgage. There is no leverage against it, as it’s funded, we will go out and selling A note down the road dramatically enhance the yield on the first, dramatically. So that is the strategy behind many of those loans and it may possible through these of leverage, maybe it’s corporate leverage and also, because the way we structured the deals, I know we’re able to get three live coupons on the first that’s been a pretty good in of it themselves. And that’s why you see that leverage of one to one, supposed to two to one or…

Stew Ward

Absolutely been there.

Barry S. Sternlicht

The business mix, and it’s a little tricky again, because we do think about attributing converts as we leverage against certain investment that we have in the balance sheet. We’re going to have to rethink that.

Jade J. Rahmani – Keefe, Bruyette & Woods, Inc.

That’s the first mortgage category…

Barry S. Sternlicht

First.

Jade J. Rahmani – Keefe, Bruyette & Woods, Inc.

Sorry that’s the first mortgage category includes B notes or those in subordinate mortgages?

Stew Ward

Those are in subordinate mortgage?

Jade J. Rahmani – Keefe, Bruyette & Woods, Inc.

Okay. The press release noted your thoughts on further diversifying the business, and I want to see, if you can provide any additional color on that, I mean you have mentioned triple net lease in the past, which you’ve looked and I wonder what you’re thinking on that side?

Barry S. Sternlicht

We won’t see balance on that. I mean tripling, it was a business we looked at and I’ll reiterate the reason we haven't done it is that our conservative nature. So, triple net lease is a bond, if we do think interest rates are going up, we are going to be in trouble. If you – most of those, I’ll say the 10-year lease, you may have a 10-year loan again, that’s fully amortizing. So even though you have a decent cash and cash yields on the equity, you have no cash, because all of your cash is going to pay down the senior, the building will be empty in 10 years, right.

And so we have no cash to pay the divined. We’ll be borrowing into the theoretical residual to pay you a dividend. That’s what – and for us about the single-family triple net lease business. Isn’t that you could have a corporate facility IO, no problem, but most of these portfolios like the LSG, which we look I know you talk about cap lease, great credits off, but the outstanding debt, I just don't want to do that, I don’t want to pay a dividend out of – because all the cash is going to pay off to pay down the senior to amortize the debt, which usually matches lease term. So we’ve not done it and we’ve looked and we know we presented with a zillion of different deals, some of which have gone public on their own, but we’ve chosen to be conservative on that matter at least.

Jade J. Rahmani – Keefe, Bruyette & Woods, Inc.

Any other businesses sort of business types that you’d look at, I mean I assume your properties.

Barry S. Sternlicht

There are types of financing that we’d like to be involved with. But Board and the team, we have to figure out that’s how we're going to execute in these lines of businesses, but we don’t want to talk about it.

Jade J. Rahmani – Keefe, Bruyette & Woods, Inc.

Okay. And lastly, the comment in the press release that leveraging LNR’s infrastructure to run Starwood’s day-to-day operations that that was interesting. I mean that is periodically asked me about whether you might think about potential internalization of management, and I’m curious if you could offer any comments on that?

Barry S. Sternlicht

Something that we’re thinking about at the moment, I think what you’re seeing is, you do as more back of the house than front of the house, obviously. And we have a team, 40 people by triple lower head in Europe and there is no single employee of REIT Europe at the moment other than there are other [indiscernible] people.

So, other stuff we are originating Europe is done to our management essentially over head, we hired the head of that from BNP Paribas, I think it is, Peter Denton who is just depending on the [indiscernible] or hirers when they can do that group in Europe.

So we are expanding the overhead certain places like Europe. We are focused by the way is mostly England UK. You can see us broaden that out and probably there are some countries and the continent we won’t lend in. So we are not much friendly to lenders. So we won’t do that. You won’t see us there. But it has a Prime Minister has [indiscernible] country that is, just like I have recently that. This is what happens when the call goes over a lot of time.

Jade J. Rahmani – Keefe, Bruyette & Woods, Inc.

Actually I have two quick just technical ones. One is on the 701 Seventh Avenue, you said 20% of the equity, is that relative to the refi recap you did or the original size of the loan or the parameters that could provide?

Barry S. Sternlicht

Taking place, so it was part of the original loan most refi is taking place. And the deal – the reason the deal was refi-ed was built the additional hotels, which they Marian provided; I don’t know what he said about that. But that – there is a guaranty in place that facilitates that construction of that hotel and it really interesting case in point; I built the W across the street. I know exactly even today I know what it makes. and so I know what I mean when we built it and I know exactly what the totals make. More or less, I’m borrowing a worldwide something that’s happening. But I know what it cost to build, I know it’s literally not a 1000 piece from here. And frankly, this is going to be a damn good hotel point of view [ph]. But it’s really going to be much better [indiscernible] any common area, kind of common area.

If you look at the building today, the top of the building will be the lobby of addition hotel, which will rise from the existing building, something like 40 floors or something. It’s going to be fantastic and that is the best hotel submarket in the past. Times Square because full on weekend you get the foreign travelers and everybody wants to stay in Times Square.

Jade J. Rahmani – Keefe, Bruyette & Woods, Inc.

Great. I appreciate the color. Thank you very much.

Barry S. Sternlicht

Yes.

Operator

And we’ll take our last question from Don Fandetti with Citi.

Donald Fandetti – Citigroup Global Markets Inc.

Just curious this pause, if you look at the special servicing business, would you ever make another acquisition there. It’s kind of a scale business are we seeing kind of what you need in that business. And then secondarily if you could just talk a little bit more about the competitive landscape in your lending business?

Andrew J. Sossen

In the lending business?

Donald Fandetti – Citigroup Global Markets Inc.

Yes, just with spread lending business, so two separate question.

Barry S. Sternlicht

I’ll take the first one. I mean obviously everybody looks at everybody in our business, taxable business and our servicing business is taxable to everyone, we own them. LNR it is funny mentioned the $250 million or $230 million something is the value with the service there.

As I mentioned it’s hard to value. So, I’m not sure everybody agrees on the valuations of these thing. As far as the competitive landscape, just name anyone and they probably are competing against the, anyone we can think whether it’s the money center bank, the big bank, so Deutsche Bank, or your bank or Wells, who is on the call or if you view a balance sheet of Goldman Sachs, what it is, it is get a re-partner and we compete, and all the above. And then you have the public companies.

We don’t see much of too smaller guys in the lending business in case. The case where we see Colony, don’t really see much of Apollo. I shouldn’t say that they are quite active in Europe, but through their insurance company. I think it is…

Donald Fandetti – Citigroup Global Markets Inc.

And then as you look at guidance into 2014 on the lending business, do you assume any spread compression and if you do, do you just sort of offset that with lower financing cost and more leverage to where sort of the levered returns or ROEs are pretty static today into 2014.

Barry S. Sternlicht

Pretty comfortable or…

Cory Olson

Yes. The levels where we’re doing, what we think we can do.

Barry S. Sternlicht

We can’t quote the number, because we’ve wobble based on the quality of what we’re doing, right. I mean we’re not cow boys we’re not doing 92% of LTVs and but the guys take out take out. I’m not doing dividend recap and the guys take out 100 million upfront, but it will change. I mean in the office building, Manhattan towards the office building, can it get a different quote from us and that office building in Bismarck, North Dakota, which quite booming in this month.

Cory Olson

And to that point in my remarks, I think I gave you a range. I said that given that with our basic again that kind of that business model of 45% to 65% retention, we’re sort of targeting the various points wide range, but in the low 9% to 12% after manufacturing and leverage and all of that other stuff on what we target as the retention as the portion that we’re using the equity capital, your shareholders’ money to invest in and it’s absolutely a functional of the attributes of the transaction; the market sponsors all I can.

Unidentified Company Representative

I’d like to mention that LIBOR plus – it’s still LIBOR-based 9 to 12 with the floating rate.

Stew Ward

That’s the reason that.

Barry S. Sternlicht

Very dependent.

Donald Fandetti – Citigroup Global Markets Inc.

Excellent, okay, thank you.

Barry S. Sternlicht

That’s why we want to keep it.

[Multiple Speakers]

Stew Ward

I don’t think you did the jobs where you will follow, be it MTA and then you’ve seen the book five in a quarter, 475 LIBOR or 50, you can see the same kind of like more competitive with those guys they’re compared with us. And they were all and sometimes we choose like something about the deal they may like it and vice versa.

Barry S. Sternlicht

All right. Thank you very much for being here today and we [indiscernible] call. Thank you for being with us today.

Operator

Ladies and gentlemen, this concludes today’s conference. we thank you for your participation.

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