Starwood Property Trust's (STWD) CEO Barry Sternlicht on Q1 2017 Results - Earnings Call Transcript

| About: Starwood Property (STWD)

Starwood Property Trust, Inc. (NYSE:STWD)

Q1 2017 Earnings Conference Call

May 9, 2017 10:00 ET

Executives

Zach Tanenbaum - Director, Investor Relations

Barry Sternlicht - Chief Executive Officer

Rina Paniry - Chief Financial Officer

Jeff DiModica - President

Andrew Sossen - Chief Operating Officer

Adam Behlman - President, Real Estate Investing and Servicing

Analysts

Ben Zucker - JMP Securities

Jade Rahmani - KBW

Jessica Levi-Ribner - FBR Investment Bank

Charles Nabhan - Wells Fargo

Douglas Harter - Credit Suisse

Operator

Good day and welcome to the Starwood Properties Trust First Quarter 2017 Earnings Conference Call. As a reminder, today’s conference is being recorded. At this time, I would like to turn the conference over to Mr. Zach Tanenbaum, Director of Investor Relations. Please go ahead, sir.

Zach Tanenbaum

Thank you, operator. Good morning and welcome to Starwood Property Trust’s earnings call. This morning, the company released its financial results for the quarter ended March 31, 2017 filed its 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 maybe made during the course of this call. Additionally, certain non-GAAP financial measures will be discussed on this conference call. The 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 CEO; Rina Paniry, the company’s CFO; Jeff DiModica, the company’s President; Andrew Sossen, the company’s COO; and Adam Behlman, the President of our Real Estate Investing and Servicing segment.

With that, I am going to now turn the call over to Rina.

Rina Paniry

Thank you, Zach and good morning everyone. This quarter, we reported core earnings $132 million or $0.51 per share, up from the $0.50 we reported last quarter. We delivered these results with slight drag on earnings resulting from our capital raises in December. We estimate that this excess capital cost of $0.02 per share of earnings in the quarter. As you may recall, we earmarked a portion of this excess capital to repay the balance of our 2017 converts that mature in October.

I will begin the discussion of our results with our lending segment. During the quarter, this segment contributed core earnings of $98 million or $0.38 per share. We have always told you that our book was positively correlated to rising rates. This quarter, the increase in LIBOR resulted in approximately $3 million of additional interest income. We estimate that a 100 basis point increase in LIBOR would add another $0.11 of core earnings annually, not including the incremental benefit that could be realized by our servicer in a higher rate environment. This quarter, our target loan book grew by $326 million. We originated or acquired $934 million of loans, which averaged a 12.5% optimal IRR, a 62% LTV and an average loan size of $127 million. We funded $489 million of these new loans as well as $142 million under preexisting loan commitments. These fundings were offset by sales and repayments of $338 million.

Next, I will discuss our investing and servicing segment, which as a reminder, held as our conduit, CMBS book, servicing platform and asset purchased from CMBS trust. This segment contributed core earnings of $65 million or $0.25 per share. Starting with our CMBS book, similar to last quarter, we took advantage of market conditions and sold certain of our securities for core gains of $14 million. We also invested in one new issued BPs for a purchase price of $57 million marking the industry’s first horizontal risk retention structure. Jeff will walk you through some of the details of this trade. On the servicing front, we obtained two new servicing assignments on deals totaling $1.7 billion of collateral, including the horizontal deal I just mentioned. As of March 31, we were named special servicer on 154 trusts, with a collateral balance of approximately $80 billion and we were actively servicing $10.5 billion of loans and OREO. The balance and servicing is down from last quarter principally due to five large loans totaling over $700 million that resolved during the quarter. As we have mentioned in the past, the specific loans that ultimately fall into servicing and their timing of resolution can be difficult to predict. And finally, on our conduit, this quarter, we securitized the $169 million of loans in one securitization transaction. As expected, volume was lower this quarter as the market gains comfort in the viability of risk retention structures. We expect volume to pick up next quarter.

I will now turn to our property segment, which benefited from a full quarter of results coming from the medical office portfolio that we have purchased in late December. This segment contributed core earnings of $19 million or $0.07 per share, up from $0.05 last quarter. The wholly owned assets in this segment continue to generate consistent returns with aggregate cash-on-cash yields of 11.2% and occupancy ranging between 95% and 100%. I will conclude with a few brief comments about our capitalization and second quarter dividend.

During the quarter, we extended the maturity of a portion of our 2018 convert by repurchasing $230 million of these notes and issuing $250 million of 2023 notes. The repurchase resulted in a GAAP P&L loss of $6 million. However, because this transaction was effectively an exchange, the loss was deferred for core earnings purposes and will be amortized over the term of new debt. We ended the quarter with $10.4 billion of debt capacity and a debt to equity ratio of 1.4x. If we were to include off balance sheet leverage in the form of A-Notes sold, our debt-to-equity ratio would be 2.2x or 2.1x, excluding cash. For the second quarter, we have declared a $0.48 dividend, which will be paid on July 14 to shareholders of record on June 30. This represents an 8.7% annualized dividend yield on yesterday’s closing share price of $22.07.

With that, I will turn the call over to Jeff for his comments.

Jeff DiModica

Thanks, Rina and good morning everyone. As long time shareholders know, we have always been focused on optimizing the liability side of our balance sheet as the assets side. Our leverage profile remains conservative and best-in-class with 1.4x on balance sheet and just 2.2x, including off balance sheet financing. We have built a multi-cylinder investment company with the belief that if we ran a consistent, transparent low leverage vehicle that the credit markets and our lenders would ultimately allow us to borrow at the best rates in our industry. Our bank partners continue to offer us larger warehouse lines at tighter spreads and our dedicated capital market have sold A-Notes to finance approximately half of the loans that required third-party leverage since inception.

Last quarter, we discussed the $700 million 5% 5-year debut unsecured debt offering that we completed in December. We are very pleased that those bonds have traded above par everyday since issuance and now trade above 104 or at a 3.9% yield today. The 5-year treasury yield has unchanged over that period. So, the outperformance in our bonds has been driven by our credit spread tightening and we now have the ability to issue debt at much lower rates going forward. We put great value in the diversity of our best-in-class funding model and the credit markets have validated our strategy as we look forward to finding ways to take advantage of our ability to borrow both secured and unsecured at the most attractive level since our inception in 2009.

As the debt market becomes more competitive, we believe we can and will outperform given our cost of capital advantage, the scale of our global originations team and our proven credit first philosophy to investing. We have recently won NAREIT’s Investor Care award for the fourth year in a row as judged by the analyst portfolio managers and academics that study our industry. The award honors members for their transparency and providing the most comprehensive clearly articulated and useful information and in the most efficient manner. We greatly value our relationship with our shareholders and we will continue to strive to provide best-in-class transparency to help you understand our business as well as we do.

As Rina said, we deployed $1.4 billion of capital this quarter. We continue to add to our loan origination staff in this quarter hired a new Head of West Coast originations, in addition to adding more support to our teams in New York and in Greenwich. We continue to focus our efforts on the sub-segments of the lending market where increased competition is not as apparent and where our deep credit expertise, global footprint, scale and borrowing advantage can differentiate us. Brokered $50 million to $100 million cash flowing loans have very well did today. As banks creep higher in LTV on cash flowing transactions that do not require excess regulatory capital in smaller players without our relationship or global scale often show up. We have seen this movie before and fortunately those loans have never been our focus.

We will continue to focus on larger, more complex transactions that our 2,200 person global organization has the expertise to underwrite and regulations have forced the bank to be less competitive in. As a side note, post-Brexit, we are also seeing more interesting opportunities in the UK we hope to convert on in the coming quarters. We have held on to significant undrawn capacity today to allow us to invest in attractive opportunities and payoff our October 2017 convertible bond maturity. Although the equity and credit markets are wide open to us today, we have always run our business in a conservative manner that we will not be forced to raise capital at an inopportune time to manage our debt repayment. Accordingly, excess cash has created some drag in our portfolio in a short run as Rina said. But we expect to be back in line with our historical cash averages in the coming months.

This quarter, we paid a small premium to buyback $230 million of the $600 million of convertible notes just to mature in March of ‘18 and issued $250 million of new convertible notes that won’t mature until ‘23. These new notes have a conversion premium that is 15% higher or 25% – excuse me, 15% higher than the stock price at the time or $25.91 on our share price, which is 23% higher than the conversion price of the 2018 convertible notes we repurchased, which were in the money and therefore, dilutive to earnings, with a convergent price of $21.04. In our REIT segment, we are proud to restructure the purchase of the first post risk retention horizontal BP deal. We were able to purchase this transaction only as a result of Starwood Mortgage Capital being the retaining sponsor on the securitization. This symbiotic relationship between the sponsor and BP, but it allows us to deploy capital in areas where many of our competitors cannot invest.

Finally, in the property segment, we remain encouraged by the performance of our entire portfolio. We have talked about the significant improvement in the Dublin market in the past. And since Rina mentioned the MOB portfolio, I will add that we were very happy to see a large trade of similar assets and scale in April, at a significantly tighter cap rates than where we closed our transaction.

I would like to now turn it over to Barry.

Barry Sternlicht

Thanks Jeff. Thanks Rina. Thanks Zach. And thanks everyone for dialing in today. Just some overall comments on the environment that we are in. There was a fascinating quarter for real estate in general. Transaction volumes dropped dramatically across the United States and particularly in Europe almost by I think of 35%, 40% drop in transactions volume. In Europe, you know that was in front of the French election and the potential for the explosion or implosion of the Europe. And also the ongoing uncertainty around negotiations for the Brexit and what that would mean for a different asset classes in different countries. Domestically, we were quite active on the equity side. Transaction volume kind of slowed also fairly dramatically, because of the delta adherence between buyers and sellers. I think stemming from the different views of the pace and the rate have increased in interest rates and obviously, rates shocked almost everybody. I think probably 100 out of 100 economists were wrong and rates went down instead of up. And it remained lower than anyone would have thought.

And I think most people including ourselves still have the baseline, prediction or forecast that rates will rise and Trump will get at least one, if not 3 of his 5 simulative programs, so those being deregulation or increased less regulation on the financial sector as well as the general economy, corporate or private or both tax cuts, something will get done. Infrastructure spending which will be longer lived, but simulative to the economy and repatriation of foreign capital, which also probably will fund the infrastructure spending going forward. I think what we wanted to see happen actually happened, which was fiscal conservative stood up and said you can’t do all of this on a 4.5% to 4.4% on employment base will blow ourselves just another reins will be such rapid inflation where interest rates will skyrocket and will cause a recession. And whether people didn’t know how to price real estate and cap rates and yields, it was quite a tug-of-war between who people want to deploy capital and people fear that they might actually get the entry point wrong.

So transactions loan volume was down. If transaction volume is down loan origination volume is down. And still I think we had a superb quarter in that light. And more importantly, the pipeline continues to be quite robust. I am not exactly sure what’s going on, also the conduit market kind of paying to a screeching halt, because of the uncertainty around vertical – I mean horizontal and what would happen in this Trump’s environment to the banks regarding risk retention is still unclear. So in that vein, having the quarter we had with the three big drags, I would say, one the cash drag which is anywhere from $0.02 to $0.06, it depends how you count, because we raised the capital opportunistically, we financed unsecured at 3.93%, something like that. As obviously, our costs were higher, but the bonds were relative that we were first time issuer in that space and that’s a very gratifying long-term for the company.

And then you saw the conduit business, which has been a pretty good solid business for us. It has been a reliable player to kind of get one deal done. So we didn’t have the drivers and that actually continues to be tested only to our earnings model, which is diversified cylinders that if one is not available others do better. The core strategy continues to be to build the loan book and play opportunistically in the CMBS, conduit, the BPs markets as well as other businesses and also we would like to see our book in Europe grow significantly. It used to be I think 15% of our book and now it’s virtually zero, sub-5%. So with the restructuring and the uncertainty in Europe, we do expect as Jeff mentioned that those opportunities will open up for us.

There are other businesses that we are entering right now and we will talk about them if any become material to us. And we only look at that businesses that we can deploy capital repeatedly over longer periods of time and in a meaningful way to a company of our scale and then meet our ROI targets as well as the complexity, because I think one of the things we most value here is what Jeff mentioned, the transparency, the consistency of our earnings to you and gratefully NAREITs have recognized that. So some of our businesses might be really great, but dissecting them for you would be really hard for you to understand. And some of the things we have considered would really skew our leverage ratios even though we have no issue with the leverage, whether it’s unsecured or non-recourse or not cross or whatever it might be but it will follow-up our financials. So we have avoided to-date doing anything like that.

The banks are still fighting pretty aggressively for very low LTV loans and we continue to execute on those strategies, we use the warehouse lines. The business has evolved I would say almost to a mature business now that the banks are very comfortable with us. With our underwriting skills and continue to extend and increase and lower the cost of funds of our credit facilities is going down. As much as we told you that it would, even when rates went up 3 years ago, kind of what exactly we thought would happen happened. The markets again have been fluctuating, so I think these transactions now that you have the French elections behind you, I am pretty sure Merkel will get or somebody like Merkel will get reelected in Germany, you got wide open markets. I think you will see transaction volumes pick up. And I would be happy to deploy a lot of cash in accretive deals. 12.5% return on the debt to capital was absurd in the 2.28, around 2.32 10-year market and 62%, 63% LTV, which is where we have been from virtually the start of the firm is astonishing 9 years in into a cycle.

And what’s more astonishing is our stock continues to pay an 8.5% of dividend yield, which I find inexplicable. But it is what it is, especially since we have no need to reenter the capital markets anytime soon. We are flushed with capital and obviously, we have new – the only REIT that I know that has done in our space that has done unsecured credit deal, so that’s a unique funding source for us. I think overall, we are pretty pleased with our property portfolio, 11.5%. Cash-on-cash returns are really good. Obviously, the earnings numbers look funny, because the depreciation and that gets involved and the EPS that you got, it’s been now – now we have to look through that to the core FFO of the company. They are not over-levered either. These portfolios were modestly levered. So this is an 11.5% cash yield which we expect to grow. It strengthens – lengthens the duration of our entire book. If you look at the pool of assets that is why we entered into that and we told you when we choose assets and transactions, they were pretty steady, cash flowing deals that we continue to pay our dividends, so we would always have the cash to pay our dividends and hopefully grow it over time.

And we have set our own goals of how much money we will be deploying to that sector, but it’s just – call lining the standards more like a scribble in a puddle. If we see something fantastic, we might do it. It’s pretty hard to generate 11.5% cash-on-cash returns with modest leverage in the equity markets today. But occasionally, we run into these transactions and we are also – and have done so and we have etched to do them when we could like our medical office building portfolio and nearly doing our deals. So in that trade later in the quarter we looked at hard, you can talk about buying, but the pricing was just too rich for us and didn’t meet our return objectives.

So with that, I thank our team across the board, I mean, there is a lot of people working on behalf of the REIT, including the whole team in Miami and Belmont in the room of the team. So I think that’s what I am going to say today. And now we will take any questions. Thanks.

Question-and-Answer Session

Operator

Yes, thank you. [Operator Instructions] And will go first to Ben Zucker with JMP Securities.

Ben Zucker

Good morning everyone and thanks for taking my questions. First is more of a high level question. I wanted to ask about the pipeline. The press release described it as robust across all segments. And I heard you touch on the international opportunity opening up which I think relates more to the principal lending. So, I was hoping you could take a minute to talk about what’s interesting as it relates to the recent property segments and if there is anything in the pipeline that would be related to M&A activity or if this is organic focused?

Barry Sternlicht

We always looked it – we got 25 deals in the public sector since we have been public. I can’t roll it out though I say it’s unlikely that it’s a major acquisition or something like that at this point. As far as the property segment, we are just quintessentially opportunistic. We deployed probably $2 billion or something like that, $1 billion to $2 billion equity, which is what $6 billion to $8 billion of transactions a year and if one comes in that looks like a steady earnings lower, that’s below where we think will be 15 or 16 IRR kind of thing, then we will probably try to do it here. We just recently killed a deal in Europe on the equity side. We really liked it, but it was in the retail class, which you guys don’t really love these days. This was in – I know I was going to say that, I was trying to figure out what to say. I know it very well. And I just think if it puts any kind of dent in [indiscernible] of the stock it’s really not worth doing, even if we love the asset. So it’s just not worth it, because you don’t – I mean, having run like 6 public companies, it’s very hard for investors to know IRRs, which you can see from us is cash flow. And so in this REIT, we are focused on paying a dividend and hopefully someday growing it again. Although, what I rather see is the stock traded at 6 dividend yield not how soft to continue to grow the dividend. So, I would say at the moment, I mean, we bought a portfolio of apartments, really great stuff and we – our approach to this is that we want to own this stuff for 20 years. Right, this stuff we want to own and do we think like we will have a major capital call and down the road that would screw us up. And so, our apartment portfolio I think is running in the high 90s occupancy and its affordable housing, but it’s really well built and it’s in great shape and it’s well maintained. The medical office buildings have built in rent growth into the REIT leases, I think, 2.5%. And we like that asset class. We like the locations of these buildings. They are near hospitals and schools. So, they are dominating 60% of them or something like that as the only campus of a hospital. So, we feel really comfortable with that stuff. As you know, we own four good malls. We actually took the cash flows down, because we are putting a movie theater into Wellington Green and here in Wellington, Florida and we took out a fully producing furniture store and put in a brand new movie theater, because I think [indiscernible], but it’s got the new seating and everything and that creates more traffic and then we have to retain it some of the space, but these malls have been doing okay. And I would say one comment at the mall sector. Our sales are kind of flat. What’s happening in the malls is more the churn of the tenants which you are reading about, but in no cases – and we own 24 malls that are 4 in the REITs. Has any of our anchors left? And we have Macy stores doing $50 million and Sears even doing $30 million. I kind of hope Sears goes bankrupt everyday, because we love to repurpose that wing over the mall. I don’t think we have much exposure really to tenants. What we are saying is the small guys like you saw Bebe stores and stuff go out. We got to replace them. We got to do TI. So, fortunately there are tenants. And if you look at Taubman, first time, you look at the occupancies of these malls are actually near record highs, but pertain on Amazon, clobbering the mall. The mall will probably survive much more easily frankly than the strip center, because you have parking, you got visibility, you got access. Everybody knows where it is and it’s going to repurpose itself and you are seeing a lot of restaurants and deals with more entertainment. We say it, but it happens to be true is what – we have a deal it’s not in here – it’s not in our portfolio, but in Texas, we are putting an Equinox, [indiscernible] kids club, a new movie theater, etcetera, 8 new restaurants and we chew up the GLA and we improve and make it a must-see destination for the local community. And it’s just raised the game for retailers. It just can’t be a passive owner anymore. And that’s our approach to the malls we own and we take the long-term view. So, we don’t think the mall is dying and we just think it’s under CNBC assault. So, it’s got a lot of – it’s fun to talk about everybody shops somewhere, so we talk about – if you [indiscernible] stores that went bankrupt preexistence of the internet before it ever existed, it’s as long as the hairs I have lost on my head. So, a lot. So, the Caldor’s, the Bradley’s and my neck of the woods, where I grew up in New England they all went bust. Alexanders, everybody went bust. So, it is just a constant churn business. It’s the way it is.

And what’s interesting about the mall – the only interesting that’s happening about the mall, I just say about the last comment about value is going to be defensive. But we signed I think 10 deals with H&M in our portfolio and I think 7 or 6 with ZARA. So you are taking little guys out and you are putting big guys in and the credit quality of the big guys is better than the little guys and so the mall is actually changing and becoming, I think in many cases a better credit portfolio than it was in the old days and it’s just interesting, because it’s subtle. I mean, you have these other retailers and they have struggled but if I think the retailers were also – I would call it as retail or resize – you will lose in Dallas – North Dallas, Plano, you can’t get a better market 2 of the 6 malls will closed. The other four will get stronger. So, it’s probably the evolution of retail and over retail we have too many square feet.

Ben Zucker

I appreciate the commentary there. And if I could ask one more since you kind of teed it up for me. In your loan portfolio the retail exposure is only 7%, I think. So, it’s clearly not an asset class you guys have targeted per se. But I was just wondering if maybe the widespread fear around everything retail has the potential to open up maybe some more lending opportunities for you guys?

Barry Sternlicht

That’s for sure. That’s for sure. And it really is about the credit there, right, if you have 60% of your stuff is really good credit stuff, you would make that loan. And you are absolutely right, because where the fear is we will get the best returns. And on the other hand, we are – perception can be reality, so we have to be careful, but clearly that is an area where the markets are little skittish, but it hasn’t been an asset class. We could never get the returns we need, lending to that sector. And we are looking by the way I should say, in our portfolio, we are looking at, I would say, disguised credit deals. So you will probably see us do something in the near future that looks retailers, but it’s not retail in my view and it is more of a credit play of mis-priced corporate bond. So, we think there is interesting plays there, where you dig a level deeper and if we complete this transaction, we will talk about it probably next quarter.

Ben Zucker

Well, that’s great. Thanks, again for the comments and thanks for taking my question guys.

Operator

[Operator Instructions] We will go next to Jade Rahmani with KBW.

Jade Rahmani

Thank you. What you make of the current competitive environment? On the one hand, there seems to be a continued proliferation of debt funds and other vehicles. Additionally, the GSEs are quite aggressive and life insurance companies are also active. But lastly, the Federal Reserve senior loan officer survey in April did show a tightening in lending standards and some consternation from banks on Seary exposure. So just want to get your sense of the competitive environment?

Barry Sternlicht

Well, I will let Jeff go first and then I will see if I need to fill anything.

Jeff DiModica

Yes, thanks, Jade and good morning. I would say that we are seeing more people show up on the cash flowing deals, deals with high cash flow that are easy to underwrite, generally that are brokered and I made that statement in my remarks. There are more debt funds now. We show up for those everyday. I think if you can’t differentiate yourself with a large global platform, with repeat borrower relationships and create opportunities out of your own portfolio that aren’t brokered, it’s a more difficult sled. And so I think you are seeing people complain about the difficulty in the market for those. I also think that once you get above $100 million and certainly above $200 million that there is only a few players who can really differentiate themselves in that space. Also the more complexity you will get, there is only a few players who can really understand the complexity and underwrite a business plan on a very complex asset. I think I mean those are the things where we would differentiate ourselves. So we will continue to look for the larger, more complex deals that get away from the $50 million cash flowing deals that are brokered. We do a small percentage, as does our biggest competitor, a smaller percentage of broker deals than a lot of the debt funds who are out there and rely on the brokerage community. We are not as reliant on them. And I think it speaks to the quality. And ultimately I think it speaks to the performance and why we have been able to have a significantly better book. You get into these brokerage deals with 20 debt funds and you will see 20 term sheets on some deals. You are unlikely to come out with a loan that you really excited about having, you are going to have something where you got the worst in class execution and credit…

Barry Sternlicht

I just interrupt and that’s been the case since we started. Like if the street originated a deal and they call 25 debt funds. We were really never often going to be there and be competitive. And that hasn’t been what 8 years – 8.5 years. I mean that - it adds in flows, right. The street gets excited because the conduit markets open up again and they start to originate loans again. They try to sell the junior classes and even whole owns. This has been the way this business has evolved for 8 years, so seven cycles in 8 years. The market – the conduit deal blows up or spreads widen, people get caught with the wrong price book and they stop originating again. So our business has been a different kind of business. Our business has been 11 terms a year of our book. We don’t hold it. We don’t aggregate it too much. So we sell it down very quickly on the conduit side. And on the loans, we try to originate the whole loan and then we sell the A note or we use our sub-lines. So we don’t – the manufactured somewhere else business is brutally difficult for us to be competitive at the rates of return we are looking for. And our peers – some of the guys who were teed up to go public, they play a lot more in that space than we do. It lower even then I assume they think they are going to have a lower dividend yield. I don’t know. I know what the market thinks. But I think – I will say the market, I don’t totally agree with Jeff in the one sense that I think the big guys are getting better looks at bigger deals. I mean we are big and we can do a $500 million deal. We can do a $700 million deal. And there is not a lot of guys that can do that and we are those. But I think our equity base is the largest by a factor of 2, against our nearest competitors. So we have the most and I always look at our book is treatable, like we can just sell our CMBS if we want [indiscernible] raise another $1 billion, so there was some unbelievable thing that we wanted to do. We don’t have to go to the equity markets to do it. We can just [indiscernible] our book and some off those. We can sell our loans to other guys in our space. So we look at that as we want to raise our ROE. We look at peeling off, lower yielding stuff. And I would say the one thing that is obviously, I didn’t talk about is construction markets. It has been very hard to get construction loans. That is really gotten, really hard, they are high [indiscernible], HVCRE, high volatility commercial real estate.

Jade Rahmani

I can never remember that.

Barry Sternlicht

They are ugly loans to banks. And the banks don’t really want to make…

Jeff DiModica

50% more regulatory capital.

Barry Sternlicht

Right. So that market and we are, you saw some of our peers go into that business having not in that business, because it is a vast void. And there are really materially good projects getting build by definition, you are lower than replacement cost, because you are going to be at $0.60 on the dollar or even less. So but we can’t do too much of that in our portfolio. And again, we play as a real estate guy and now that we have an equity book and if the guy defaults, I was going to use the slang word or a bad word, but I am not going to use it. We get the building at $0.60 on a dollar and we know these property markets. We are the largest owner of our apartments in the United States today, started capital groups, so we have hundred thousand plus units. And we have malls and I don’t even know how many million square feet of office. We can underwrite pretty well and brand new building at $0.60 like you would not like it because we would have a default and I would love it, it will make a lot of money in someday when these markets rebound. And that’s the way we are going to run this company. It’s the way to make money for our shareholders we hope for long periods of time. So the construction book we do it in moderation, because the future funding needs have to balanced against repayments and [indiscernible] we have seen that movie before. So right now I think our – if you have to guess I would say rates continue to rise slowly from here and as you see two quarters or three quarters tenure at the end of the year. But this is all of that on what this tax reform bill looks like. And I am assuming, we are not going to run $1.5 million deficit in next year, which would happen if everything took place before what we have discussed with corporate costs. So I don’t know. We will see what happens. But we are watching that. And – again rising rates is good for us, but for every reason, frankly. We will make earn more money, there will be more defaults in our servicing books just still $80 billion, $10 billion of it we actually are actively managing today. So we love a little – I was kind of looking forward just 3% in 10 years, what happened. So have you lower leverage rate for property, but it was sort of an odd thing. And I do worry that the economy is you saw crazy bad first quarter number. But you can see a crazy good second quarter GDP number. Balance together you are going to have the 2% growth we have had, it’s like 3.5% and above 0.7%, 0.8%, you have like 2, 2 growth and that seems odd to 10 years lower than it was before Trump ever said he was going to run for office January1, 2016 the 10 year was higher than it is today. And Trump’s has been elected. And I would say one thing that Trump’s good for business. And people, the CEOs I talk to, I happen to be one of them are fairly bullish on their prospects going forward. So business is not being vilified anymore. And consumer confidence and business confidence is up. So can’t be that this the economies stay this week. I think I do think if trade stuff is the equivalent of Dodd-Frank for banks. And corporations are not exactly sure where to invest capital, so competing capital investments by businesses which is a material portion of GDP growth. And until he clears that up, I think people are confused. And if you see companies buying back stock, even M&A is down, so [indiscernible] what the rules are. So they have got to clear this up, so we can move forward. And when they do I think economy will pick up.

Jade Rahmani

Just on the retail exposure, I wanted to ask about the retail joint venture if you could give any color on occupancy, leasing spreads, same-store NOI and just also the types of projects in the lending segment?

Barry Sternlicht

Okay, hold please.

Jeff DiModica

Same-store sales have been relatively flat year-over-year. We will get the exact number. But last quarter we were up just over 1%, I believe. But it was basically flat and the sale per square foot are still very similar, mid-500.

Rina Paniry

I think we were like at 540 square foot Jade, which is flat to last year and I think on the occupancy, we were around 95%?

Barry Sternlicht

94.8% and lease rate is 96.2%.

Rina Paniry

Which is flat to last year?

Barry Sternlicht

And I think I mentioned it was a – that’s as of year end 12.31, so I don’t know...

Rina Paniry

They haven’t.

Barry Sternlicht

So we have what we have.

Rina Paniry

Sorry, Jade your other questions was…?

Jade Rahmani

Yes. Just in the lending book, the retail exposure on the lending book, can you give any color on the types of projects?

Barry Sternlicht

And are supplemented 7%, I think when we breakout out mix use, it includes our mixed use space it raises to as much as 9%. If we take the retail component of our mixed use and put it back into retail, it would bring us up to 9%, it’s still very small.

Rina Paniry

And the third of that...

Jade Rahmani

Are those urban retail projects?

Rina Paniry

And most of it is actually is the deal we did in Portugal last year.

Barry Sternlicht

It’s a really good deal.

Rina Paniry

Of the exposure that we have $200 million relates to the Portugal property.

Barry Sternlicht

I see the largest unpaid principal balance is 108.

Rina Paniry

It will be 108.

Barry Sternlicht

Are the same lines [indiscernible].

Rina Paniry

Yes.

Barry Sternlicht

Then we have Portugal $200 million, $180 million. LTV is 51% and 64% and I don’t have any more information on it. Those are good lines.

Jade Rahmani

Okay. And then just lastly can you comment on the outlook for these CMBS special servicing portfolio seems like it’s been lumpy. There has been an uptick in legacy delinquencies, but your portfolio of activity service is declining. So what do you expect for that?

Jeff DiModica

Yes, look it’s still a guessing game at this point. We are into the heavy edge of what’s going to happen with the maturities. Second and third quarters were really the major origination times in 2007. As always, there is no timing or direct knowledge of when a loan is going to be finished through its special servicing business. So it’s difficult to say. I don’t think we are expecting significant upticks or significant downticks, is kind of where it is, is kind of where we are right now. This past quarter was as Rina mentioned earlier, was heavily based on some large incoming loans and also some very large outgoing loans, which led to the slight decline.

Rina Paniry

Yes. I mean, Jade it’s an unusual day to have a loan for call it a $150 million come in or out and we have 5 of them go out. So, that’s what caused the decline and again, you just don’t know when those particular loans are going to come in or lease.

Jade Rahmani

Okay, well. Thanks very much.

Operator

And we will go now to Jessica Levi-Ribner with FBR Investment Bank.

Jessica Levi-Ribner

Hi, how are you? Just one on the conduit, what you are seeing in the market now? I think, Barry you mentioned that transaction volume had come to kind of a screeching halt. Is it picking up now that the First Horizontal deal is done and how do we think about that maybe even through the year?

Barry Sternlicht

Yes, I was talking about equity transaction volumes. We have got borrowers having to finance an acquisition. And at the same time, the CMBS market, the conduit market slowed, the CMBS market – the sale of new origination CMBS, I think just a couple of deals done in the quarter. I think at the end of the day.

Jeff DiModica

There is a handful of transactions like the market really went through a major change in the first quarter. It was the first quarter, where all the risk retention rules went into play. So, I think everybody had ideas of how much they wanted to get out. They were making sure they had partners to deal with their deals. We were seeing deals being shown to beat these buyers significantly earlier, because they were worried that they weren’t going to be enough parties around. We are now into the second quarter. You are seeing that, I think a lot of the fears that they weren’t going to be BP's buyers or that we are switching to rules. We are going to stop the origination process of have somewhat been alleviated, so that you will see pickup as time goes on and it’s just been the new-new as to how the market will react to these new changes and keep moving accordingly.

Barry Sternlicht

And Jeff, if you remember in December before the regulations went into effect, there was a significant amount of issuance. So, everybody basically cleared the deck. So we expected a very slow first quarter and so part of it is the digestion of the new regs and part of it is just that the deck had been cleared. I would say that BPs has consistently whether it’s vertical or horizontal have traded tighter as the quarter has gone on. That is good news for the future of the CMBS market. That is good news for volumes as you head into the second half of the year. The fact that BP pieces has continued to trade better in the senior bonds and the senior bonds continue to trade very well. So, I would expect to see a pretty good rebound after the books were depleted going into the beginning of the year.

Jessica Levi-Ribner

Okay, great. Thanks. And then just going back to your comments on construction lending, I know that you want to keep it kind of a smaller part of your portfolio, but are you seeing a lot of opportunities, especially it sounds like lot of the debt funds certainly not the insurance companies are competing for those loans. Are you seeing more opportunities?

Barry Sternlicht

Well, yes, I mean, we are seeing a lot – yes, you got to be big to make your construction loan. I mean, you are not going – I don’t think you are going to syndicate this to – there is one large hedge fund out of Europe that has made some massive construction loans in New York City, like billion dollar loans. But for the most part, you don’t see it’s on the players and there is a bunch of us in the space. The banks just are doing construction loans. They are just – they are often recourse. They are modest LTVs. We find that IRRs and these loans higher than the coupon, because they are never often fully drawn. And you get your fees than on a lesser balance or drawn capital than you actually ever deployed. So, it depends on what it is, whether it’s a condo loan or an office building, for example, but I mean, it’s really about balancing ins and outs for our portfolio of cash and repayments that we expect that we can count on. Yes, I think the good thing as you saw repayments in the quarter were modest compared to prior quarters. And I think they look like we are going forward for the year they are not bad, but we had much higher repayments in prior years than we have had this year. So that’s good for us. I mean if we can net originate – net capital well above our deployed capital we have all this cash to get rid of in a creative and constructive way, but it is unusual for us to be running the company with as much cash as we have at the moment. And it’s a little over the top. We are reserving several $100 million just for rainy days as we get run our company with that baseline. Even that is deployable if we had to, but we don’t generally run it that way. There are some restrictions on running a negative cash balance company, but we would never do that. So I think, we are not going to tell you what our targets are. It’s not really relevant, because you can’t see everything we can see about repayments and everything. But the other thing about construction is also like our other book it’s diversified by product type and by location. We are not going to be lending just in Manhattan condos. That’s not what we are going to do. Even if they are good deals we won’t do it. Because we are not going to have that concentration risk just in case [indiscernible] bomb goes off or something. There are things you can’t even, despite the [indiscernible] being 962, the world is a volatile place and we are going to run diversified book. And we have and I think that’s one reason our bonds trade where they trade. And when you look at I would say the credit guys are smarter than the equity guys. If you look at our credit guys they really like our story.

Jeff DiModica

And without giving away any percentages that were part of what Barry talked about was the repayments was a lot of the construction loans that we did from 2012 to early 2014 paid off in the last year and we stopped doing construction for a reasonable amount of time. We have a significantly smaller construction book today as a percentage than we have had in the past. So there is room as we see that as an opportunity.

Barry Sternlicht

Yes. I would say that New York City got to be too big concentration risk for us. They all paid off everything worked out fine. But frankly, we didn’t want to have 20%, 30% of the book in New York City in the construction loan. I mean, it’s not prudent from my work out, but it’s not the way we run the company. So, it’s like sometimes the real details behind the number, right, not how you got the number, but it’s how you got the number not the number.

Jeff DiModica

To be technically correct. We have one more construction loan that will pay off this year in New York City. It’s significantly.

Barry Sternlicht

They said we are all paid off, some paid off, like Hudson Yards, for example. I don’t think everything paid off. We have construction loan on the part building. We got all the stuff. Right?

Jessica Levi-Ribner

Okay, thank you.

Operator

And we will go next to Charles Nabhan with Wells Fargo.

Charles Nabhan

Hi, good morning guys and thanks for taking my question. I know you touched on the decline in the special servicing UPB. I was hoping to get some color around the decline in servicing fee revenue during the quarter. I know you had mentioned that there was some large loans that were resolved and that typically results in higher fees on the back end. So, I wanted to get a sense for the drivers behind the decline and if there weren’t any offsets to what I would expect to be large resolution fees from those loans?

Rina Paniry

Sure. So part of the decline you are seeing quarter-over-quarter actually relates to Europe. So you need to back out $2 million of the servicing fees in Q4 related to Europe. But we didn’t sell in Europe until of end of October. So, the one month of servicing fees were $2 million. You have to back that out. The other thing is on the resolutions I mentioned on the $700 million. We actually did not earn a liquidation fee on all of those loans. Some of them were modified and returned to performing. So, the fee will come at some point in the future. It will not come today. So two of those loans were modified, were not actually liquidated. So they were resolved. And they were treated as resolved, so they come out of the balance, but they weren’t liquidated. So, you don’t earn your point liquidation fee. The other thing, the other nuance is negotiated fees. We had higher negotiated fees in Q4 than we had in Q1 as being principally default interest. And when it comes to default interest it vary loan by loan specific. And it’s one of those things that you can have a large default interest down from a loan that pays and you never get your full amount. You rarely get your full amount, but it’s just a negotiated item, so negotiated with fees were down $4 million a quarter.

Charles Nabhan

Got it. And as a follow-up, you mentioned a transaction that priced in April that was tighter than one of your deals and that you view it as a comp and I was hoping to get some color around that to the extent that you can comment on where price specifically relative to where your deal was and kind of how you view the market conditions in that property segment?

Barry Sternlicht

You are talking about the equity deal…?

Charles Nabhan

Yes.

Barry Sternlicht

It traded probably 50 basis points inside the deal we did. 40 points to 50 points and that’s a lot when you are talking around 6, 5.5 or 5.8 or 5.7 so 5.3. And those are big numbers. Again, I think the world loves yields right now. And that’s the comments about proliferation of private debt funds and that is the world is looking for anything above the 2.28. And so this asset class is pretty secure. And view it as a core portfolio and so levered up, even 20%, 30% when the spreads in the A notes trading. I think, what’s AAA trading out, 78%.

Jeff DiModica

Yes.

Barry Sternlicht

Like that in the high 70s, 80s. I mean you can lever these things pretty well and get pretty nice cash yield. So I feel fairly secure plus you have the inflation hedge in the equity book which you don’t have in the debt book. So you have it because your LTVs will drop, but not in the same way you do it upside in rents would follow inflation. So these are the markets good stuff that’s trading tight in the apartments. We were selling apartments only that we bought sub-5. And you can pay, levered up and pay 5s and 6s, you are making money. And on a one-off deal there is great demand for most asset classes. But markets overall are very balanced. There are problems. There are problems in New York City rentals and there are problems in Miami hotels. But there are problems. There is just – there is a lot of good stuff going on. The overall markets they are pretty balanced across the United States in almost every asset class you have vacancy rates in industrial sub like 2% in Los Angeles. So these markets are pretty decent. And you just got to be careful. So one interesting thing about the market it is interesting in our portfolio. When we started out we thought we have all hotel loans, because we figured banks don’t like hotels and neither do insurance companies, but it’s not turn out to be okay. And somebody has to comment about the GSD. The GSD is really competing a multi space. And it’s very hard for us to find multi-deals. You can’t get them. You can’t get the returns what we want. You can get them. But we can’t produce 12.5% returns on equity which are booked $1 billion of capital deployed will do in the quarter. That’s just not going to happen. Unless we have levered it 90%, which you don’t want us to do and we don’t want to do. So we can’t compete against the GSDs.

Jeff DiModica

You have a lot of multi-constructions that we do very limited amounts of it, but we see almost nothing cash flowing.

Charles Nabhan

Got it, okay. Thanks guys.

Operator

And we will now take our last question from Douglas Harter with Credit Suisse.

Douglas Harter

Thanks. Can you just talk a little bit about the new originations and kind of the characteristics that we are able to get such a higher return on those versus the portfolio, how you view the risk on those versus the portfolio?

Barry Sternlicht

I want to correct something I just said. I think that portfolio traded 75 basis points inside of ours, the medical office building, but I just got [indiscernible] recorded something like 5.5%. So it was the Duke Medical office building portfolio, if you are counting. So that’s quite a spread. Turn that into multiples and you will see the impact of that a book leverage. So I am sorry, can you repeat your question. We were talking about something.

Douglas Harter

Yes. So the new investments you had 12.5% return on that versus the portfolio of products 11%, can you just talk about kind of the characteristic that allowed you to get higher return there, whether there is sort of theoretically higher risk on that or again, what kind of led you to be able to get that higher return on those new investments?

Barry Sternlicht

Well, I think it’s a blend. I mean the first large deal, the new quarter is that number, so maybe higher. It’s really – it’s just a blend of loans we originated were 8 months or 9 months in the quarter.

Rina Paniry

And I guess it was similar to what we originated last quarter, which had a blend of 12.6%, so we were sort of flat.

Barry Sternlicht

Construction loans in there, that boost the returns a little bit. I mean you can’t obviously, we look at our competitors and assume the public ones who recorded we look at their books and their spreads and their cost of funds. We were quite similar to some of them, not all of them. We pay more attention to some than others. But I would personally be – I look forward, to the other company just to see the benchmark our team and see how we are doing. And we are doing fine. We have split loans before some of our peers, by the way one on a large construction loan in San Francisco, we wind up just splitting it. It was being enormous. And that loan is probably 1 year old now, 1.5 year.

Jeff DiModica

1.5 year, it should pay off by the end of this year.

Barry Sternlicht

Yes, big loan.

Jeff DiModica

Probably next year.

Barry Sternlicht

It’s on – we can tell what it is. It’s the loan on...

Jeff DiModica

181 Fremont.

Barry Sternlicht

181 Fremont, the giant project down at the Transbay that’s what they call it.

Jeff DiModica

Making sales of more than 2x our basis today in the conduit.

Douglas Harter

So you just mentioned that the first one you closed this quarter was a comparable yield, I mean is that – do you view that as sustainable and then you can kind of drive the portfolio yield higher over time or is this kind of a nice pocket of opportunity?

Barry Sternlicht

So I think what we would try to do with those secure one, that’s in 11 maybe even at 10 and then we do a more exotic one and that might be a 14% blend into 12%. So we are not seeing every loan at 12.5%. I mean we just see them all over the place. And we are doing right now because we now have corporate debt of unsecured. We are also thinking of – in our mind we ascribe value from our funding facilities to these loans, because we all talk about our stabilized yields from our portfolio and optimum leverage you have seen us all talk about that. So that’s how we kind of behave to. We can lever it standalone. We can sell an A note. And buy our warehouse lenders to leverage standalone [indiscernible] or we can just assign corporate debt in our minds and we kind of levered them correctly and you have heard and wanted to repeat that all of our credit staff for the company which are better than our peers, I think so overall.

Jeff DiModica

And we did talk about the larger loans being a fee deposit, two of the loans make up about half of what we did and they were the highest yielding loans. So in some quarters the large loans will have high yields, in some quarters that won’t be the case. But I think that ultimately as we push the number to be a little higher this quarter.

Barry Sternlicht

Another thing that goes the same since we are chatting almost past an hour now, duration matters to us. So we can earn $0.14 in 5 minutes and you earn $0.33 and I can’t pay our dividend. So we do need to try to keep the money outstanding. It’s a payment that you have to make it six months loan. And so we balance everything that way.

Douglas Harter

Great. Thank you.

Operator

And that does conclude our question-and-answer session. I will now turn the call back to Mr. Sternlicht for any additional or closing remarks.

Barry Sternlicht

Thanks everyone. Thanks for your support and we hope we take as always we are available to answer your questions after the call and Rina, Andrew, Adam, Jeff, Zach and all the team. So thank you very much. Thank you, that’s a new English way. And we will see you next quarter.

Operator

That concludes your conference for today. Thank you for your participation.

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