Starwood Property Trust, Inc. (NYSE:STWD) Q2 2018 Results Earnings Conference Call August 8, 2018 10:00 AM ET
Zach Tanenbaum - Director of Investor Relations
Barry Sternlicht - Chief Executive Officer
Rina Paniry - Chief Financial Officer
Jeff DiModica - President
Andrew Sossen - Chief Operating Officer
Himanshu Saxena - CEO, Starwood Energy
Doug Harter - Credit Suisse
Jade Rahmani - KBW
Tim Hayes - B. Riley FBR
Ben Zucker - BTIG
Greetings and welcome to the Starwood Property Trust Second Quarter 2018 Earnings Call. At this time all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder this conference is being recorded.
I would now like to turn the conference over to your host Zach Tanenbaum, Director of Investor Relations.
Thank you, Operator. Good morning and welcome to Starwood Property Trust earnings call. This morning the company released its financial results for the quarter ended June 30, 2018 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 website at www.starwoodpropertytrust.com. In addition we’ve also posted a slide presentation relating to the company’s acquisition of GE’s project finance debt business in the Investor Relations section of the website.
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; Rina Paniry, the company’s Chief Financial Officer; Jeff DiModica, the company’s President; and Andrew Sossen, the company’s Chief Operating Officer.
With that, I'm now going to turn the call over to Andrew.
Thanks, Zach, and good morning, everyone. As you saw in the press release in our investor presentation released earlier this morning. We are very excited to announce that we've entered into a definitive agreement to acquire GE Capital's energy project finance asset. The acquisition is comprised of both the full service energy project finance platform and a $2.6 billion loan portfolio, including $400 million of unfunded future commitment. The platform is vertically integrated with a seasoned leadership team that averages over 21 years of industry experience and has 21 full-time employees across loan origination, underwriting, Capital Markets and asset management. The platform had successfully originated in excess of $24 billion of loan in 2004 has experienced less than 10 basis points of charge-offs per year over the last 10 years.
The $2.6 billion portfolio consists of 51 senior secured loans that are collateralized by energy infrastructure real asset. These assets have an attractive risk-adjusted return with a strong credit profile and are largely backed by long-term purchase contracts with investment grade counterpart. Importantly this acquisition leverages existing expertise at Starwood Energy Group which specializes in energy infrastructure equity investment. Starwood Energy led by Himanshu Saxena was on the call with us today, has a history of over 7 billion of capital deployment since its inception in 2005 and the platform has 17 investment professionals with an average of 15 years of relevant industry experience.
We plan to finance $1.7 billion of $2.2 billion purchase price with a committed secured term loan facility from MUFG, the term loan also provides additional committed capacity for the 400 million in the future funding associated with the portfolio we are acquiring from GE. We have ample available liquidity on our balance sheet to close the transaction in addition to a $600 million committed acquisition financing facility.
Closing of the transaction is expected by the end of Q3 2018, this transaction benefits us in several key areas all of which are outlined on page 3 of the supplement posted to our website this morning. Importantly the 97% floating rate portfolio is positively correlated to rising interest rate and has an portfolio duration of over four years this coupled with the duration on new loan originations being excess of five years, extend the overall duration of our portfolio and add assets with a low correlation to the commercial real estate sector, improving our overall portfolio diversification.
Similar to other investment cylinders we think that energy project finance is highly scalable energy project finance market is an excess of $200 billion per year and provide for significant additional capital deployment opportunities on exceptional credit at attractive rates of return for our shareholders. This purchase brings us one step closer to realizing our goal of becoming a leading global diversified finance company and look forward to answering any questions you might have related to the transaction. Just to reiterate we do not need to raise capital to close this transaction. With that I will now turn the call over to Rina to discuss our Q2 results.
Thanks Andrew and good morning everyone. Our core earnings this quarter totaled $148 million or $0.54 per share; this amount includes a $0.01 of severance expense associated with a reduction in force that we completed in April; I will begin this morning with the results of our lending segment. During the quarter this segment contributed core earnings of $114 million or $0.42 per share; on the commercial lending side we originated $2 billion of loans with an average loan size of $113 million all of which were first mortgage loans; our funded commitments of 1.5 billion outpaced prepayments by nearly two times increasing our target portfolio to $7 billion at the end of the quarter. More than 90% of this balance represents first mortgages and 95% is floating rate. On the residential lending side we acquired $193 million of non-agency loans and received prepayments of $64 million bringing the total portfolio to $793 million and our net equity to 295 million; the current portfolio has an average 63% LTV and 724 FICO.
I will now turn to our property segment which contributed core earnings of $30 million or $0.11 per share; the wholly owned assets in this segment has an underappreciated carrying value of $3 billion and continue to generate consistent returns. The blended aggregate cash-on-cash yield for the trailing 12 months period was approximately 11% and weighted average occupancy stood at 98%. We also sold one retail asset from our master lease portfolio this quarter bringing the cost basis of our year-to-date sales in this portfolio to $48 million with core gains of 7 million.
I will now turn to our investing and servicing segment which contributed core earnings of $56 million or $0.20 per share; on the servicing front we recognized fees of $25 million this quarter; as anticipated these fees have declined but it is important to keep in mind that the amortization of our servicing intangibles have likewise declined. As a reminder when we acquired LNR in 2013 we allocated $244 million of our purchase price to the intangibles; since then we have reduced core earnings by almost $200 million as a result of the amortization of this asset. If we just look at servicing fees net of this amortization the contribution to core earnings for the first six months of this year is actually $5 million higher than the same period last year.
On the conduit side we securitized 208 million of loans in one transaction. We had a second securitization at the start of the quarter with 188 million of loans that priced in June that settled in July; consistent with past practice both of these transactions are treated as realized for core earnings purposes. And finally on the segment property portfolio, we continue to harvest gains as these assets reach stabilization, during the quarter we sold assets for the cost basis of 15 million for net core gains of $6 million. We also acquired $25 million of new assets bringing the underappreciated balance of this portfolio to $373 million across 24 investments. Together with the properties in our property segment these assets carry 237 million or $0.91 per share of accumulated depreciation.
Before I conclude I wanted to walk you through a few unusual items for the quarter; the first of which impacted both GAAP and core and the other two of which impacted only our GAAP financials. In our lending segment we monetized the portion of our equity participation in 701 7th Avenue, receiving 12.3 million in proceeds. This amount is reflected with an interesting comp in our P&L and was offset somewhat by the lower prepayment fees and accelerated accretion we experienced this quarter as a result of lower repayments. Also in our lending segment we increased our allowance for loan losses by $25 million representing the difference between the loans previous general reserve which we reversed and their specific impairment reserve which we established this quarter. $22 million of this reserve relates to a residential project in New York City to which the underlying first mortgage and mezzanine loans total $173 million. The loans mature this month and we expect that they will not payoff due to unit sales being slower being anticipated. As a reminder in formulating the specific reserve under GAAP we discount expected cash flow at the rate interest in the loan.
Of the $22 million reserve related to this project, $15 million relates to the effect of discounting. The remaining reserve of $8 million relates to two smaller loans for which the small payment of the underlying properties went into liquidation during the quarter. Consistent with our treatment of general reserve these amounts are excluded from core earnings because they are unrealized. All of these loans were purchased in 2014 by our prior originations team. And finally this quarter we changed the methodology we used to compute our GAAP diluted share count for the principal portion of our outstanding convertible note.
In the past we only applied converted method to the conversion spread when calculating our diluted GAAP shares, given our intent to settle the principal portion in cash. As we approach the end of the quarter and the open redemption period for our 2019 convertible notes which began on July 15, this intent changed, given our robust pipeline we determined that our available liquidity would be better suited for these investment opportunities rather than the early settlement of our convert. The impact of this change to GAAP EPS was $0.01 per share. The effect is excluded for core EPS purposes. Subsequent to quarter end we received early redemptions representing a par amount of $259 million. Assuming yesterday closing share price this represents $300 million of value inclusive of the related conversion spread of which we expect to settle 272 million in shares by the end of Q3.
I will conclude my remarks with the few comment about our capitalization and dividend. We ended the quarter with ample liquidity including $4 billion of undrawn debt capacity. This amount does not include the new facilities associated with the GE transaction that Andrew mentioned earlier. Our net debt to underappreciated equity ratio increased slightly this quarter to 1.7 times. If were to include off balance sheet leverage in the form of A notes sold this ratio would be 1.9 times. For the third quarter we have declared a $0.48 dividend which will be paid on October 15 to shareholders of record on September 28. This represents an 8.6% annualized dividend yield on yesterday’s closing share price of $22.45. With that I will turn the call over to Jeff for his comments.
Thanks Rina and good morning everyone. Qith the acquisition of GE Capital's energy project finance portfolio our balance sheet will now have over $15 billion in asset. We expect to continue to benefiting from our scale both in opportunities and the diversified best in class financing of our business. We deployed $2.8 billion this quarter with over 2 billion of that coming from our primary business of large loan lending. This record origination this quarter encompassed 15 new loans, 100% of which were first mortgages with a optimal IRRs in excess of 12% in line with previous quarter.
I will note that our $7 billion, 62.4% LTV loan book is over 90% first mortgages today, the highest since our inception. Our Energy Finance acquisition adds another stone right at the time when our loan book is producing record volumes at accretive yields. This is the third straight quarter that we’ve written more loans than any quarter since 2014 and our pipeline for Q3 is also strong. DAF increases we made last year paid tremendous dividend along with our best in class partnership with all lien banks in the nation from which we benefit. We again significantly lowered the costs of our asset specific financing this quarter allowing us to continue to be able to achieve great risk-adjusted return at lower spreads that will benefit our book for years to come. We deployed $4.7 billion of capital across cylinders in the first half of 2018 up 63% versus 2017, with significant contributions from all of our investment cylinders.
In our property segment our Dublin office portfolio and our two-Florida multifamily portfolios continue to benefit from very strong market fundamentals. We spoke in depth about our view on the Florida markets where these assets are located when we purchased them. We’ve seen cash flow increase much more quickly than we underwrote and cap rate have continue to compress in this sector. Operating income is up and similar quality portfolios are trading at 5% cap rates today versus the blended purchase cap rate of almost 6%. Regarding the Cabela's Bass Pro investment we are buoyed by strong operations at the store level, a terrific credit card business and merger synergies that are well exceeding our underwritten estimates. The bond markets recognize the post merger performance and their term loan has rallied from 90 to 50 when we did the deal in September to par and 78 today.
Finally, I will remind you that we’ve previously stated we have estimated unrealized gains exceeding a $1 per share in our owned property portfolio. As for the right side of our balance sheet I mentioned earlier that our secured warehouse borrowing rates have continued to come down. We’ve talked previously about our ability to borrow in the unsecured market significantly inside our peers as bond market investors put tremendous value on the diversified nature of our company. We continue to add unencumbered assets to our balance sheet allowing us to continue to tap the debt capital market very efficiently. We added $270 million in unencumbered assets this quarter and have over $3.9 billion worth as of June 30th, which would support over $950 million of incremental unsecured borrowings if we chose to come to market. As Rina mentioned, subsequent to quarter end our January 2019 convertible bonds entered their open conversion period. And to-date we’ve had 259 million out of 341 million outstanding than those to settle. We chose that for the first time to sell the majority of these converts in shares, which will provide us significant additional liquidity between now and January 2019.
Our on balance sheet debt to equity ratio is very low 1.7 times as of June 30th. And importantly, just 1.9 times when including off-balance sheet financing. These numbers have converged as we’ve taken advantage of significantly better on balance sheet financing rates in the last year. Both leverage ratios are again significantly below our peer group, as we have and will continue to hold the line on leverage on our 90% first mortgage loan book. In our residential non-QM loan book we expect to price our first non-QM securitization today and expect to be a frequent issuer in this space. We’ve built the cherry pick portfolio of over $1 billion in non-QM residential loans today with a FICO of over 720 and LTV in the low 60. In this quarter we formalized an agreement which allows us to purchase up to $600 million of loans over the next 12 months. While our Energy Finance acquisition and $2 billion of loan production will dominate the headlines from today's call. I'm extremely proud of the terrific quarter posted in the REIT segment.
Our team added 13 new special servicing assignments this quarter, representing over $9 billion of name servicing, which is by far the most in any quarter since our 2013 acquisition of LNR. You won't see that in this quarter's numbers but it is the type of accomplishments that will build our revenue team for years to come. We achieved this by leveraging our best in class service area and significant co investment relationship that allowed us to only invest 20% of the dollars required to by these pieces effectively giving us five servicing assignments for every one we buy.
Every incremental assignment has the potential to add significant revenues over time and we will continue to focus on building a sustainable business for the long-term. We believe as shareholders we will be rewarded by this investments and partnerships for years in the future.
With that I will turn the call to Barry.
Thanks Jeff. Thanks Rina, thanks Andrew, thanks Zach and good morning everyone. I think I go back to the IPO of our company back in 2009 and I was asked the question by some shareholder prospective shareholder at the time that kind of said, why would I buy a mortgage REIT sale this below and I would say well we don't have to invest capital and we're not going to overstay our welcome in the business and we promise to do that and since the start of the firm back in 2009, we looked at probably seriously chase the dozen and maybe more than 15 different acquisition, including the GE healthcare business, which I'll point out we lost to Bank One in a neck and neck raise which was bigger than this energy business, we're willing to lend capital in any business that meets our risk profile and return objective.
And when this business came up for sale Himanshu who is on the call who's led our Energy Group for the past ten years, he brought to our attention and when we looked at the nature of this business it looked awful lot like what we do, with our proxy loans, there are assets whether they're turbines or wind farms or plants behind these loans their credit worthiness 80% of the contracts, credit worthy entities behind that and yield both the return we thoughts were even better than in the property sector and we had our first exposure when we participated in a loan some while back and obviously, I think Himanshu's leading our third fund which just closed at 1.2 billion of commitment I think they done more than $7 billion of transactions, we obviously know we can trade and how we finance our own projects. So I think Himanshu and his team plus the GE team have incredible depth and knowledge of the space and frankly the GE unit was a little bit hamstrung as GE Capital pulled in their lending aspiration and really financed mostly only their own project they're people buying their equipment. You'll find it amusing that Starwood Capital has bought a billion dollar turbines from GE for various projects over the years.
So when this came up for sale expected over floating rate paper solid as a rock, we can underwrite every credit there was actually no analysis involved. We’re pretty excited and we thought it would be a great move to diversify the company. It is actually not a comment at all about the real estate cycles. I mean we’re not saying that the cycle is over and there's nothing to do and in fact as Jeff pointed out we have the best originations quarter in the history of our firm and momentum continues into this quarter and when I do go back to the last slide, that we’re cooking on all cylinders and I think the results show that we were cooking on all cylinders.
But we played a long ball here, I don’t think there’s a management team in our business I can say that’s actually that has a much money invested in their company as we do; so the entire team including most of the Starwood Capital executives all the Star Property Trust executives own stock -- we own more stock cumulatively then I believe any other sponsor does in their vehicles in their space. So we're playing this like it’s our own money and what will we do with this capital and our capital to ensure that we can continue to grow and prosper long into the future. We think this business can grow rapidly in fact far more rapidly than we underwrote, I look at every deal we underwrite whether it’s equity or debt side, and say what are the odds of losing capital and the odds are do better.
In this case, I am pretty convinced we can do better than we underwrote which is a good thing. What we underwrote was an accretive deal. The deal is accretive out of the box and to pull our entire enterprise that’s been growing at scale to make an accretive deal it has to be materially accretive on a standalone basis then we blended in to this enterprise, it’s still accretive from day one; and then it’s hitting the double digit cash on cash yield, we want to achieve with our equity deployment. I’d also say that it’s one thing that we’ve talked about before but I have to reiterate it's the bond markets love us and the equity market don't. We are in the hunt to become an investment grade credit and if we do that our enterprise will be transformed both in move into the property sector which was applauded tremendously by the rating agencies and this move into a diversified business should help drive our motion towards investments our bonds stay close to investment grade without having investment grade rating.
What that means for our company is the ability to issue debt on the corporate level, at spreads nobody else can then we can cherry pick what loans we want to make because we will be able to finance them better than anybody else. So given our scale and we actually just completed strategic planning cycle. We would expect that this business will grow other business will grow; I’d point out another business that has grown and become a significant generator of earnings to us and well into the future is our residential lending company which is pretty exciting because there as you know we’ll complete our securitization hopefully this week and you’ll see how bonds trade and the nature of our first deal, but you’ll see the returns on equity we can drive which we think are compelling building a diversified commercial lending operation.
If you ask why? I mean we could go the other way, we could become incredibly simple and drop all these businesses and maybe at some point we spin everything out, we spin our resi business, we’ll spin our lending or energy business we’ll spin out our property segment but together it gives you that opportunity to basically get to investment grade and not have to force capital if any one vertical ones return don’t meet the risk that you are taking. So this was not in any way I think the cycle's over in real estate and there’s one loan impairment that you may recall those of you have been shareholders with us, we had a $15 million hit I think in the CMBS book, three years ago or four years and I don't remember, we took the same mark-to-market hit and come back and actually been incredibly profitable business and we’re really taking being conservative as we’ve always been and taking this gap right off on particularly this one loan which we don’t expect to lose money on and we expect to recover all the capital we’re going to restructure the loan, it’s well underway.
And again if you listen to Rina’s comments she mentioned that 15 million of the 22 million was simply the discount rate of those related with the -- when we get the money back, but we expect to get our capital back and, frankly, we will take the property tomorrow, but their transfer taxes in New York city and it's sort of a waste of time. So we will restructure this and hopefully get all our money back and reporting to you later this was a prudent way to handle that. And one other thing that Jeff mentioned I wanted to touch on, everything we do is on this price credit or taking on where we see opportunity of hold in the capital market when we started deploying in 2009, we continue to wait. What we do every day.
The Cabela's deal was an interesting case study of that where Jeff mentioned the term loan traded up from 92 to 101 roughly given the hundreds of millions of dollars of synergies that the company said they can achieve that we did not expect them to achieve remind Cabela's merged with Bass Pro shop and basically, Bass Pro, which is private that's a ranch that this would be rather be that in the space and actually we will report later on in the quarter but we are have sold down later on in the year have sold down a few assets to lower our basis and to show the spread between the yield that we underwrote the deal at and while some market will take the stores at, even in today's what you might call roughly till climate.
So I also want to reiterate that we don't need to raise capital again that we have plenty of committed capital lines to acquire the business as a shareholder, co shareholder, we are aware of the cost of equity. So we don’t mind given our leverage ratio, which I think are full turn below our next lowest or biggest competitor so I think they're close to the 3 to 1 and we’re fully leverage like 1.9 to 1. We can run the enterprise more leveraged and increase ROE, we've chosen not to do that because I'll state it until I'm blue, we've chosen to build a company that is conservative, transparent, predictable and safe, hoping that our dividend yield should be more like 5.5 given we're nine years into the cycle we still maintain the largest loan book we've ever had with a 62% or 63% LTV and almost all floating rate and almost all now first mortgages.
So is an anomaly that the company trades where it does and one last thing we ask ourselves why do we trade here, I think that we’re glued to book value and I keep saying to people who ask, you need to under appreciate the book and then you need to mark the market some of the position and as Jeff mentioned over dollars share of equity gain, which we think is conservative in our multifamily portfolios in our double office portfolio and some of our other assets in our bond book and also in our fair value purchase book. The other thing that we been doing and the other reason perhaps we trade and if by the way we continue diversifying to other product line may be we will leave the world of book value and you believe that you give us a dollar and return $1.12 sequentially over the years all the time and we’re at good place to deploy capital to generate tremendous risk-adjusted returns on invested capital.
The next question would be what about the special services. I think Rina touched on this a special servicer is really nearing the end of its life it'll probably last couple more years. The part of it that relates to CMBS 1.0 the original CMBS tranches, but that business carries like a $15 million amortization, what’s it called Rina?
It’s intangible, something intangible…
It’s intangible. And more than half of that now relates to 2.0 not 1.0 so it’s fair -- that number may start going up not down, and we’ve written off as Rina pointed out $250 million of that intangible over the past year, so it hasn't all been gravy, we’ve been writing down the intangible as we booked earnings and lowering the net effective earnings for the company; so that business is no longer that material to us and that’s planned; we knew it’s going to go away and all this moves into the resi business into the energy business into the other -- the property segment were meant to offset what is a sea change from 1.0 that we’re going to lose and now 2.0 as Jeff mentioned the best quarter in our history getting new servicing contracts 13 of them just in the quarter alone to build the servicing business up for inevitably the next cycle.
So I am really proud as a company we really are a team I am so proud of the cooperation between our energy team, our Star Capital Group executives that -- we’re ahead of the due diligence on the energy deal and then Star Property Trust executives working together in a way actually supposed to work, that was a tremendous achievement of the team and I want to thank everyone. And we think it is a tremendous deal for us and we’re super excited about the team and in building the company within our company, so with that I think we’ll take any questions.
Thank you. At this time we’ll be conducting a question-and-answer session. [Operator Instructions] Our first question is from Doug Harter with Credit Suisse.
[Indiscernible] when we would expect -- when you would expect to get repaid on it?
Sure we’ve been working for the modification over the last few weeks; we would expect it sort of imminently and we think there’s another year of extension at the most with significant paydowns along the way. So a few months out there’s the balance that will be significantly smaller than it is today.
And just to be clear to what Rina said so of the reserve for impairment against that 15 million is -- would be related to sort of time value discount and the 1 million would be what you baked in now is potential less proceeds that you would receive?
Yes, the time value is the big story because you’ve to use the mezzanine rate which is very high rate when you’re discounting and Rina went through that but that's added the $50 million of it -- all in this project will end up selling out at prices that aren’t far from where we originally underwrote them, it’s just taken longer and we’re very comfortable that these sales process will happen over the next 12 months and then we can just stick with those.
I think it’s fair to say the borrowers think it has willingness to support loan by the way, so, he’s already taken a small recourse facility from us to finish the project which he's drew only a third of there’s a small loan that is like under 20 million but he thinks it’s going to make money; we’re just lenders we don’t get paid to take equity risk in loans.
So if that were the case, then you would get repaid in full.
That will be correct.
Our next question is from Jade Rahmani with KBW. Please proceed.
Just talking about the GE acquisition. Can you give some color on the collateral, the competitive landscape as well who this business competes with directly? And I think you mentioned double-digit cash on cash target returns. But what historical leverage ratios in these projects and I guess that’s the start.
Why don’t we let Himanshu answer that?
On the collateral piece, it's the one generally secured bit…
Himanshu you have to get closer to the phone.
Better. So let’s start with the collateral, from a collateral standpoint these loans would have generally first lien on the underlying project asset, so whether you have a wind farm or a gas powered power plant the loans would be secured by the entirety of the hard assets and any contracts that the project have, many of these agreements are with trade worth customers you would have 10,15, 20 of contracts with high credit counter parties, who are responsible for making payments that ultimately goes to service the loans, so the loans are backed by investment grade counterparties with long-term contracts but the cash flow are very stable and loans are generally if you look at the default rate on these loans over the years, they have very small and highly uncorrelated with the CMBS loans, so it’s a very good and safe play from a cash flow standpoint. From a competitors standpoint there are banks that would invest in this business these banks are generally lending at the highest and safest product in the credit spectrum, so very safe deal. The other competitors include other finance organizations they could be names like Apollo and others who are also in this business lending to similar types of project and then there is a big market on the term loan B side which is comprised of a lot of other financial institutions so generally a play where investors are spending investing money in different credit ranges here competitors change depending on which part of the credit spectrum you want to play.
And in terms of the leverage underlying the projects how much equity is typically behind the first lien.
These efforts are not overly levered in general, you would have something in the 50% to 60% loan to value, so there is substantial amount of equity underneath these loan and the underlying project level.
And is LTV the right way to look at leverage?
It is, it's loan to value, loan to cost and that's how the coverage ratio is of the three metrics we use for credit analysis and the DSTR which is the reflection of how much excess cash you have over the debt for these deals tend in be close to 2 in many of these deals but these are again very, safe loans. A lot of these loans at the underlying level are rated and they are rated generally high investment grade, high non investment grade, low investment grade but several B plus, BBB-, BBB kinds of loans.
And in addition what’s the amortization on the loans look like?
So there are two kinds of amortization profile one that fully amortizes over the life of the underlying customers contract that if we have 15 year contract with a utility, these loans would be fully paid up over the 15 year period. The other structure is where you get paid a mandatory amortization in the cash flow sweep depending on the cash flow generation but really the loans are paid off in its entirety over a five to ten year period. Most of these loans would mature in about five years.
And just can you give any color on the non-U.S. exposure in the portfolio you’re acquiring?
Yes it’s very little non-U.S. exposure, 90% plus of exposure is in the U.S. there is some exposure in Mexico, but the Mexico exposure is with CFE which is a very high credit counterparty and the CFE contracts are all U.S. dollar denominated; if you look at the current exposure predominantly U.S. dollar denominated with investment grade counterparties even if its outside the U.S.
Great, thanks for that. I just wanted to ask Barry what do you think construction costs rising, how do you think that will impact the CRE market, do you expect to limit the amount of new supply and cause an inflow in additional value add and transitional assets?
You’re -- good question I mean, our construction costs are rising, very quickly, across the board, both labor and material costs, and steel costs I know somebody had dinner with Trump on Tuesday night and he said he was going to talk about steel prices; which are up I think I don’t know steel prices but he meant and don’t -- the rough numbers are 700 to 1,100 a metric ton or something like that, so yes the deals won’t cancel, the disciplined people will pull their projects and stop building; and I think it’s good across all sectors of real estate the only thing you'd like to go away now is EB-5 financing because that money is not tied to the economics of the project, it’s used to supplement the capital back where normal capital stack over the project won’t work. So, at the moment EB-5 financing has slowed down, generally from China and maybe it'll go away. But that would also help the markets in the major cities as that net financing disappeared which is clearly not needed in cities like New York, to create jobs at a 3.9% unemployment rate.
So, I think the answer is you got to be super careful because prices aren’t rising as fast as construction costs. But as you make these loans and I'm really focused here on the U.S. One should be aware that of the -- if anything would happen in the upper east-west side of New York with us the borrower held out for very high prices we could have cleared these units lower -- lower prices chose not to. And as a lender you kind of just accrete at your coupons while you're waiting for them to sell the units, the longer he sells the more he wants to raise the prices in the market that is probably not a voice of market time, residential market in New York.
So you are going to see all kinds of issues across the New York high-end residential market, you’ve already seen it on the buyer deal and I guess on West 57th Street where the manage we're pulling some asset and the senior and kind of the mess and I don’t know if that’s even happen there, but you're going to see this in a bunch of projects, fortunately we don’t have that exposure. And like we mentioned in the call this was a 2012 loan that was acquired in the pool by the team we had running origination group and that does not obviously the best underwriting in the history of mankind. Although we still think we will recover par on the loan at some point but that’s the dangers of being a lender, specially in a resi project where borrower decides, oil prices have gone up from right field, so I got to raise the price on my [indiscernible] and he can’t and they see this equity disappear and well just play lotto.
I think New York City is a particularly weak high-end market and these units were not stupid high end they are not 3000 plus a foot. As you climb the pyramid by pricing you get fewer buyers. But on and the economy is generally okay, and pretty good just has labor shortages here and there. And I will be good for all real estate if it become harder just to find new construction and finding existing product in reskinning renovating and its clearly going to be better return on equity than new built in most cases at this point in the country.
And at this point in the cycle do you think lenders are being disciplined or you starting to see notable underwriting standards slippage.
[indiscernible] with no free cash flow for $80 billion. You know I don’t know the answer to that, I would say in the real estate world the lenders are still disciplined. For the most part we’re not seen crazy, we see some guys going little higher, I would say what you call it hate to call it shadow banking, but we had a -- I was laughing at somebody's words for us, specialized lenders. Some of new bids without the 30 years of real estate equity underwriting experience we see them doing stretching little bit on LTV here and there going to 80s. It was a record quarter for us I would say that for I don’t know whether it's 36 quarters that we been public. I sometimes in the prior nine years I kind go when I thought some of the deals in the pricing I don’t actually feel that way right now. I don’t think what we’re seeing and what we’re doing doesn’t make my head spin or not it’s pretty much I'll say that we’re happy with our risk profile and I think where people get, that sometimes lenders lend just off metrics without understanding the actual real estate.
And so what looks good on paper is not very good if projects never work or we got asset. And I say in some of the hotel deals that have discussed lately the single asset large hotel deals some of these loans are bananas. But that’s not the space we've been in. So I should say that like for example we have a loan and I think it's like and it’s first mortgage of a billion and just correct me if I'm wrong on Xanadu or what will be the future new project adjacent to the Meadowlands and we fully expect to get repaid, we have a mid price security and malls opening and leasing gone pretty well. So we will be repaid within months if not weeks of the project's completion of construction. Jeff is that right?
We’re couple of $100 million up a just over billion dollar first mortgage senior that we think is up 40% probably 35% of cost loan that will like to be pay off in the spring when it opens.
On the residential mortgage business how big cylinder do you think that could be and are you looking to expand the joint venture with impact.
It could be material and I’m hoping its material. I think it’s a make as much money as servicing that. So we pretty pleased with what we’re doing there and I hope again we're growing these lines to whatever size their natural size is. And I think Rina mentioned there was some repayment actually in the resi book. So we’re not -- I can’t tell you we’re going to have a $5 billion book we've to eke out roughly $1 billion, at the moment I expect it to grow into a more material portion of our earnings and finally fully supplement the income we got from the 1.0 special services at some point in the future.
We first mentioned that donor, there was something we said we didn’t think in the near future it would be 10% of our equity it’ll take some work to get the 10% of our equity over the coming 12 to 18 months.
I should point out that the energy business is 10% of our equity roughly, more like the 8% but something like that.
Our next question is from Tim Hayes with B. Riley FBR. Please proceed.
On the GE acquisition, you note it's accretive and I know you don't provide forward guidance. But can you just help us frame how accretive this transaction could be to earnings and what that could mean for the dividend? Do you suspect that incremental earnings power might influence you to raise the dividend? Or do you think that taxable income might actually be increasing enough that you might need to raise the dividend?
I’ll take a crack at this. I am remote from the team right now. Had some slight trouble this morning. I would say that we’re tracking ahead about how we trade, I mean raising our dividend is that going to matter is our stock going to go up and because of the quarter does it matter. We need to be raising out our company we need to figure out how to get the share price up $3 not a quarter and I don’t expect that us raising our dividend is going to do that, we already trade stupidly; so and we trade beyond our peers and we have the best business, we’re the biggest and our bonds trade the cheapest and we have the best borrowing rates, we’re the number one borrowing trading in United States I mean we trade completely bizarrely in the equity market and I don’t think the dividend increase is going to solve that problem; having said that I would expect that this business will grow as we expand what they can do and financing not only GE projects for example, and actually Himanshu and his team are in the market on Friday for a large $700 million loan of target issuing; and we’re giggling like we could we see the spread we know that deal would fit perfectly in the things we would do.
And some of our peers have made a big business of financing their own deals, we haven’t -- we have done that once, and long been repaid, twice I think, once or twice yes. I forgot what I was really thinking of. Well we did one other one so two, but there we wind up taking minority positions in if the loan ever gets in default we’re not the guys negotiating with the shareholders and we let the other person who has majority interest in the paper negotiate we drop out with either holding rate. So that’s how we protect you from being on both sides of the trade. But anyway I do expect this business to be bigger than we underwrote and we’ll be more accretive then we underwrote, particularly at the spreads they’re going to be underwrote. So I do think we were conservative on both on what they’ve originated in the past and I mentioned the GE Healthcare business, we’ve lost that deal was super tight and that business has done much better than we underwrote under the leadership of Bank One.
So, we were not -- we were looking at our history and saying we were probably being too conservative on those volume and spread these guys can do in this space going forward.
Just one thing to point out, I mean as you know as a REIT we require to have a minimum 75% of our assets in income, be in the real estate qualifying asset in order to maintain REIT status, just based on the size of our entities we have sufficient cushion to acquire this portfolio outside of the a taxable re-subsidiary so if there won't be any tax impact on cash flows coming from this portfolio and also note that a portion of underlying collateral is a qualifying assets that help drive kind of where the portfolio can fit in our capital structure. But as you think about it going forward again you should kind model this as sitting outside of a taxable re-subsidiary. So not being a taxable business for us.
Okay I appreciate all those comments and would you be able to just touch on the expected G&A and comp expense are increasing expense there just based off of the acquisition and maybe any cost synergies you expect to recognize.
We did a full kind of bottoms up obviously analysis of the platform and there are several million dollars of synergies between the two platform and we're modeling out call it a mid teen, and million dollar G&A number going forward and as I think we mentioned in our comments and we believe this business is highly scalable, so this platform can report significantly more originations then it's currently doing today, so I think you will see kind of the term having G&A.
Okay got it and switching gears a little bit very encouraging to see the strong cherry lending
activity this quarter can you just touch on how the yields on new originations compared to the existing portfolio. And if you experienced any -- observed any spread compression this quarter.
I will go and then I’m sure Jeff, we have 12% optimized yield that's better than 24 years ago, we’re in the 11s low 11s but I think so the 12, so how do you get the 12, our credit line are tighter. The spreads across are tighter across the whole real estate section. We can make tighter loan and finance then more cheaply and maintain our return on equity. And that’s being part because of our scale because we have sort of lending sense with your warehouse lenders and also our corporate debt which is pretty cheap. So in fact the banks are willing to do LTV just little tight, they are willing to lower the spreads on warehouse doing to keep us from doing a note sales frankly, they rather just give us warehouse facility, we rather do a note, so little bit of a trick but in the public market give the different synergy strategies, different vehicles nobody seems to care.
So you can't say that one guy does A notes, one guy does credit facility and there's a material there is some tax, one that is incredible facilities trading dollars activity in your life and we’re so. I would say that we’re able to manage and that is a really good thing for not an obvious reason. If we can make loans 'one market' I'd say it’s $300 over $275 and still produce 12 the optimized yield in the mezz that we retain there is much likelihood that the guy is going refinance this one loan property stabilize it so the tighter the loan the longer the duration because we can spend it beyond and so it's got a hidden benefit to actually be able to lower or unlever deal and maintain our equity spreads, our yields on those pieces.
Our next question is from Ben Zucker with BTIG. Please proceed.
Well, congrats on the GE acquisition. I understand that this makes sense with the broader platforms experience and the duration that the assets provide. When I look at slide 10 of the acquisition deck, it sounds like most of the loans are backed by fully contracted or partially contracted deals. Is it your expectation that you will focus less on the merchant category? Or is that kind of like mezzanine lending and maybe a little bit riskier, but an ability to get paid more for risk there?
It’s super safe deal in our sector that are completely contracted, generally trading in the mid 100 rates on LIBOR maybe high 100, maybe what these guys going to focus on is something that is combination of contracted cash flows and some contracted cash flows to serve the debt. And then those deals where you look for is really more loan to value, loan to cost and that coverage ratio is for measuring the safety of the loans and those deals are generally priced in our sector at about mid 300, low 300, high 300 ranges that is a spread over LIBOR and I think the plan here is to really focus on those deals which are still super safe from the loan collateral value standpoint but excluding returns that are more commensurate with what a REIT needs which is in the at least lower to mid 300 range.
I got you, that makes sense. One small thing while we're talking about the portfolio. I think I saw that the GE loans are indexed to three-month LIBOR. First of all, is that correct? And second of all, would you expect to finance this with three-month LIBOR index that maintains your interest rate alignment?
The answer to both of those questions is yes.
Great, and then in your prepared remarks you referenced the profit participation you received in the quarter can you remind us if there’re any other significant participations still kind of buried across your loan portfolio or was that the last major one worth keeping track of?
There’re others and that was a portion of that participation, 701 Seventh Ave, we expect at least one probably two more payments in the coming quarters on that and we do have others in the book.
And then real quickly, if I may. Can you guys just provide an update on that JV regional mall portfolio?
I can take that, as you know it’s like 1% of our assets today, we’re not accreting any earnings or any dividends from the portfolio investments because all the money is going back and so the re tenency in the mall and I would say that the mall space is certainly challenged, I recently toured those three of the four malls and they’ve to be repositioned, with what’s happening in the retail space, you couldn’t really guess and if you go file bankruptcy when your tenancy is actually solvent and has a good health ratio in your mall and other malls that the company decided for whatever reasons are I'll take it through bond of bankruptcy by which is subsidiary of Starbucks, for example, and the anchors are all moving around what’s fascinating about the anchors of course, is that they probably have alternative uses, these boxes, either Dave and Busters or Resno or even a shared office facility.
You saw recently that New York has made a deal with Lord and Taylor's in one year, so suburban Lord and Taylor's, they make perfect co-working things. The problem is the anchors involved aren’t driving traffic anymore, they were put there to drive traffic. So almost anything will drive more traffic than a Bon-Ton store or Carson Pirie at this point both two tenants actually one of them we have a Carson in one of the four malls in that collateral. So we’re talking to another s department store though about who is very anxious get in this the center because while that they're in when they do $35 million they're closing. So this whole sector is tumultuous.
And we think these are good assets, but of course its kind hard to peg where the cap rates because there's nobody that wants to sell and so that's clear there was obviously an incredibly large trade done by Brookfield on general growth. There was recently the for city trade with a mall portfolio that is under contract and I can’t say anything more about it with a Australian firm. They got very good cap rate, the acquisition cap rate and in some of them mall I always thought the GDP growth is live, that’s the big price today in the space that is going to so much change and re tenanting and taking out your paddle and putting in your team.
A good mall is certainly going to survive, and some of those are actually thriving if you look at the numbers at Taubman, they were big this quarter with their larger assets, even things are itself are okay. But these probably these malls are being driven now with their Apple stores and Tesla dealerships. So sales per square foot which is a green shoot it kind of odd things, there are two stores in huge numbers and that doesn’t necessarily talk about the health of the mall. I think we have four Apple store one in each of the four malls. So they are the anchors now at these malls. They are driving traffic and their product cycle affects your sales in the overall mall.
Ladies and gentleman we’ve reached the end of the question and answer session. I would like to turn the call back over to Mr. Sternlicht, for closing remarks.
Thank you to everyone, thanks for your generous time. We’re all available to always answer your question and Himanshu can help need to answer any question about energy transaction. Thank you again and have a nice August. Bye.
Thank you. That concludes today’s conference. You may disconnect your lines at this time. and thank you for your participation.